E.L.F. Beauty, Inc. — FY 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016. Although the request metadata refers to 2016 Q4, this filing is an annual report; fourth-quarter figures are included where relevant. Unless otherwise noted, financial amounts below are in millions of dollars.
Business context
e.l.f. sells affordable cosmetics through national and international retailers, e-commerce and its own stores. The majority of products retail for $6 or less. National and international retailers generated 88% of FY 2016 sales; direct-to-consumer channels generated 12%. The U.S. accounted for 92% of sales. Walmart and Target represented 30% and 28% of sales, respectively. The company sources and manufactures all products through third parties in China and operates as one reportable segment.
Key financial metrics
| Metric | FY 2016 | FY 2015 |
|---|---|---|
| Net sales | $229.6 | $191.4 |
| Gross profit / gross margin | $132.2 / 58% | $100.3 / 52% |
| SG&A | $109.2 | $74.8 |
| Operating income / margin | $23.1 / 10% | $25.6 / 13% |
| Net income | $5.3 | $4.4 |
| Net cash from operating activities | $2.1 | $24.5 |
| Capital expenditures | $9.2 | $10.2 |
Sales increased 20% year over year, driven mainly by increased shelf space and productivity at leading retailers. Gross margin rose six percentage points, primarily from margin-accretive innovation. SG&A grew 46%, faster than sales, reflecting IPO-triggered stock compensation, distribution-center relocation and startup costs, growth investments, and higher IT costs. Operating income consequently declined about 10% despite sales and gross-profit growth.
Operating cash flow fell sharply from $24.5 million to $2.1 million. Management attributed the 2016 cash use in working capital mainly to a $38.0 million inventory increase and $15.4 million increase in receivables, partly offset by a $43.1 million increase in payables and accrued expenses.
At year-end, cash was $15.3 million; reported working capital excluding cash was $29.3 million. Total debt and capital lease obligations were $165.4 million, including $162.6 million under the term loan and $2.8 million in capital leases. The company had $34.5 million available under its revolving facility. The new five-year, $200 million secured facility carries variable rates; the term loan rate was 4.5% at year-end. The company reported compliance with financial covenants.
Fourth quarter: Sales were $76.4 million versus $65.4 million in Q4 2015; gross profit was $45.3 million versus $35.0 million; and net income was $6.6 million versus $2.4 million.
EPS comparability: The filing reports FY 2016 net income of $5.3 million but a net loss attributable to common stockholders of $497.5 million and basic and diluted loss per share of $39.47. These common-stock figures reflect substantial preferred-stock accretion and dividend-related allocations during the IPO year; they should not be read as the company’s reported net income or as directly comparable operating performance.
Material changes and unusual items
- Gross margin improved from 52% to 58%, while operating margin decreased from 13% to 10% as SG&A growth outpaced sales.
- In June 2016, the company borrowed an additional $64 million and declared a $72 million special dividend, or $1.79 per share. The cash outflow was $68 million after amounts applied to employee notes.
- The September IPO generated $54.9 million in net proceeds to the company; $40.4 million was used to repay debt and a prepayment penalty, with the remainder for working capital and general corporate purposes. Preferred stock converted into common shares.
- In December, the company refinanced its debt with a new secured credit facility. FY 2016 interest expense rose to $16.3 million from $12.7 million, including debt-extinguishment costs and refinancing-related charges.
- Other income was $3.0 million versus expense of $4.2 million in 2015, primarily reflecting favorable currency movements and maturity of legacy forward contracts. No forward contracts remained at year-end, and the company had no active hedging program.
- The company recorded $7.1 million of stock-based compensation expense in 2016, including costs associated with IPO-triggered vesting and awards.
Outlook, risks and contingencies
No quantified forward guidance is provided. Management expects near-term SG&A to increase as it invests in the brand, infrastructure, stores and international expansion, as well as public-company compliance. It expects to leverage prior investments over time and states that operating cash flow and cash on hand should cover operating, investing and financing needs for the next 12 months, with revolver availability as a potential additional source.
Principal risks include dependence on Walmart and Target and other retailers without firm purchase commitments; demand and seasonal order variability; product-launch execution; inventory and working-capital requirements; reliance on Chinese suppliers, manufacturing and shipping; variable-rate debt; foreign-exchange exposure; regulatory and product-safety requirements; cybersecurity and privacy; and execution of growth and store expansion. A hypothetical 1% rate increase would add about $1.7 million to annual interest expense. Management estimates a hypothetical 10% adverse RMB movement could adversely affect cost of sales and net income by about $10.1 million, before any offsetting historical hedging effects.
The company said it was not aware of pending litigation expected to have a material adverse effect. Disclosure controls were assessed as effective at the reasonable-assurance level. The report did not include management’s annual assessment of internal control over financial reporting under the transition provisions for newly public companies. The independent auditor issued an unqualified opinion on the financial statements but did not opine on internal-control effectiveness.
Most important facts for investors to verify
- Whether retailer concentration and shelf-space gains remain sustainable, particularly given Walmart and Target’s combined 58% share of sales.
- Whether inventory growth, receivables and operating cash flow improve after the 2016 working-capital build.
- Whether gross-margin gains can be sustained while SG&A investments and public-company costs rise.
- Debt amortization, variable-rate exposure, covenant headroom and the company’s ability to fund seasonal working capital needs.
- The drivers and accounting treatment of the large preferred-stock accretion and dividend allocations underlying the reported common-stock loss per share.
- Progress on internal-control reporting, supply-chain resilience in China, and compliance with evolving product and data-privacy rules.