E.L.F. Beauty, Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018, compared with the same period in 2017. The company sells cosmetics and skin-care products through retailers, e-commerce and e.l.f. stores. Results are unaudited; the company reports one operating and reportable segment.
Key financial results
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Net sales | $65.9 million | $60.6 million | Up 9% |
| Gross profit / margin | $40.2 million / 61% | $38.2 million / 63% | Profit up 5%; margin down 2 percentage points |
| SG&A | $36.2 million | $33.0 million | Up 10% |
| Operating income / margin | $4.0 million / 6% | $5.2 million / 9% | Down $1.2 million |
| Net income / diluted EPS | $0.7 million / $0.01 | $2.2 million / $0.04 | Net income down 68% |
| Operating cash flow | $5.0 million | ($22.0) million | Improved $27.1 million |
Revenue growth was primarily driven by national retailers, reflecting shelf space gained in 2017 and additional retailer locations. Gross margin declined mainly due to foreign exchange, customer mix and freight costs; margin-accretive product innovation partly offset these effects. SG&A rose with increased sales and marketing investment, stock compensation, additional stores, and depreciation and amortization, partly offset by lower warehouse, distribution and administrative costs. Interest expense declined 9%, primarily following the August 2017 refinancing. The effective tax rate was 39%, versus 5% a year earlier, affected by discrete tax items; the lower U.S. federal statutory rate partly offset the increase.
Financial position and liquidity
- At March 31, 2018, cash was $10.5 million; total assets were $403.7 million and total liabilities were $205.3 million.
- Total debt and capital lease obligations were $154.8 million gross, including a $152.5 million term loan and $2.3 million of capital leases. The term-loan interest rate was approximately 4.0%.
- The $50 million revolving facility had $49.5 million of unused availability. The company reported compliance with applicable debt covenants.
- Cash increased $0.4 million during the quarter. Operating cash flow of $5.0 million was offset by $2.7 million of capital expenditures and $1.9 million of net financing cash outflow. Operating cash flow benefited from receivable collections, partly offset by payments of prior-year inventory-related payables and accrued expenses.
- Management stated cash, operating cash flow and available revolver capacity should meet operating, investing and financing needs for the next 12 months. It noted future financing may be needed for longer-term needs and may not be available on favorable terms, or at all.
Material changes and notable disclosures
- Net sales increased, but operating income and net income fell as costs and expenses grew faster than sales; gross margin also contracted.
- Inventory declined to $61.7 million from $76.9 million at March 31, 2017. Accounts receivable rose year over year to $31.8 million from $29.1 million; cash rose to $10.5 million from $5.4 million.
- Cash from operations improved substantially from the prior-year quarter, when working-capital outflows—especially accounts payable and accrued expenses—were significantly larger.
- Effective January 1, 2018, the company adopted ASC 606 using the modified retrospective method, reducing opening retained earnings by $0.1 million net of tax. Q1 2018 net sales and accounts receivable would each have been $0.6 million higher under the former standard; prior-year comparatives were not restated.
- Capital expenditures increased to $2.7 million from $0.7 million, primarily for a new e-commerce platform and stores opened in early 2018.
- The filing reports no material legal matters expected to adversely affect the company, no material changes in contractual obligations, and no off-balance-sheet arrangements.
Outlook, risks and contingencies
The filing provides no specific revenue, earnings or margin guidance. Management highlighted the company’s multi-channel model, product innovation and retailer growth strategy. Sales are typically higher in the third and fourth quarters due to holiday purchasing, while seasonal working-capital needs can rise in the second and third quarters. Retailer order timing can add volatility.
Key risks include dependence on a limited number of retail customers and shelf space; intense competition and uncertain acceptance of new products; reliance on third parties and China for substantially all sourcing and manufacturing; foreign-exchange, freight and supply-chain exposure; inventory forecasting; variable-rate debt and covenant restrictions; and execution risks from store expansion and technology investments. The filing also identifies product safety and regulatory, privacy and cybersecurity, and international trade and tax risks. Operating leases had $31.9 million of disclosed future minimum payments. The company reported no material litigation contingency, while noting ordinary-course proceedings may arise.
Important facts for investors to verify
- Whether retailer-driven sales growth and expanded shelf space persist, and how much revenue depends on a small number of retail customers.
- Whether gross-margin pressure from foreign exchange, customer mix and freight continues, and whether innovation offsets it.
- Whether higher sales and marketing, stock compensation and store costs produce sustainable growth and improved operating margins.
- Cash conversion and seasonal working-capital needs, including the timing of retailer collections and supplier payments.
- Debt repayment, interest-rate exposure, revolver availability and ongoing covenant compliance.
- The realized impact of ASC 606 on reported sales and receivables, and the execution and returns from e-commerce and store investments.