E.L.F. BEAUTY, INC. Management's discussion and analysis of financial condition and results of
operations ("MD&A") should be read together with the MD&A presented in the
Annual Report on Form 10-K for the year ended
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Overview
e.l.f. Beauty, Inc. is organized as a holding company and operates through its principal subsidiaries,e.l.f. Cosmetics, Inc. , which conducts business under the name "e.l.f. Cosmetics" or "e.l.f.", andW3LL People, Inc. , which conducts business under the name "W3LL PEOPLE".e.l.f. Cosmetics makes the best of beauty accessible to every eye, lip and face by offering high-quality cosmetics and skin care products at an extraordinary value, all formulated 100% vegan and cruelty-free. W3LL PEOPLE is a pioneer in clean beauty that offers accessible clean beauty products that work. • National retailers. We sell our products inthe United States in the mass, drug store, food and specialty retail channels. • e-commerce. Our e-commerce platforms are an important component of our engagement and innovation model. We have nurtured a loyal, highly active online community for over a decade. Our roots as an e-commerce company and our digital engagement model drive conversion on elfcosmetics.com and w3IIpeople.com, where we sell our full product offerings. • International. Our products are also sold in a number of international markets, including theUnited Kingdom ,Canada ,Mexico ,China ,Germany ,Australia andCanada . We believe our unique ability to combine cost, quality and speed differentiates us in the beauty industry. This combination, along with our innovation capabilities, enables us to deliver prestige quality products at extraordinary prices across color cosmetics and adjacent categories like skin care. In response to a rapidly changing landscape in beauty, we are investing in our digital engagement model to reach consumers through multiple channels, including elfcosmetics.com, our national retail partners online sites and social media. In concert with our digital efforts, we have strong relationships with our retail partners such as Walmart, Target, Ulta Beauty and other leading retailers that have enabled us to expand distribution both within existing retailers and with new retailers, domestically and internationally. Business trends Tariffs Tariffs have impacted the majority of products that we import fromChina . Despite the signing of a Phase One trade agreement betweenthe United States andChina , the majority of our products remain impacted by increased tariffs. To mitigate the financial impact of these tariffs on our results of operations, we selectively increased prices on certain of our products inJuly 2019 . We also implemented various other tariff mitigation initiatives including, but not limited to, negotiating lower prices with our suppliers inChina and exploring potential new suppliers outside ofChina . In addition, favorable movements in foreign exchange rates and shifting product mix toward margin accretive innovation has also partially offset the impact of tariffs on our gross margin. We cannot provide any assurances that these mitigation initiatives will continue to be successful. COVID-19 We have seen volatility in our sales performance due to the COVID-19 outbreak. We anticipate our sales results will continue to be impacted until consumers return to normal shopping patterns. We continue to focus on the following areas to address the impact of the COVID-19 pandemic on the business: 1) supporting the health and safety of our employees and community; 2) minimizing disruption to the supply chain; and 3) keeping adequate levels of liquidity and flexibility within the our credit agreement.
Seasonality
Our results of operations are subject to seasonal fluctuations, with net sales in the third and fourth fiscal quarters typically being higher than in the first and second fiscal quarters. The higher net sales in our third and fourth fiscal quarters are largely attributable to the increased levels of purchasing by retailers for the holiday season, and customer shelf reset activities, respectively. Lower holiday purchases or shifts in customer shelf reset activity could have a disproportionate effect on our results of operations for the entire fiscal year. To support anticipated higher sales during the third and fourth fiscal quarters, we make investments in working capital to ensure inventory levels can support demand. Fluctuations throughout the year are also driven by the timing of product restocking or rearrangement by our major retail customers as well as expansion into new retail customers. Because a limited number of our retail customers account for a large percentage of our net sales, a change in
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the order pattern of one or more of our large retail customers could cause a significant fluctuation of our quarterly results or impact our liquidity. Results of operations The following table sets forth our consolidated statements of operations data in dollars and as a percentage of net sales for the periods presented:
Three months ended June 30,
(in thousands) 2020 2019
Net sales $ 64,527 $ 59,764
Cost of sales 21,186 22,573
Gross profit 43,341 37,191
Selling, general and administrative expenses 40,332 32,055
Restructuring income - (1,792 )
Operating income 3,009 6,928
Other (expense) income, net (30 ) 351
Interest expense, net (1,468 ) (1,717 )
Income before provision for income taxes 1,511 5,562
Income tax (provision) benefit 1 (1,856 )
Net income $ 1,512 $ 3,706
Comprehensive income $ 1,512 $ 3,706
Three months ended June 30,
(percentage of net sales) 2020 2019
Net sales 100 % 100 %
Cost of sales 33 % 38 %
Gross margin 67 % 62 %
Selling, general and administrative expenses 63 % 54 %
Restructuring income - % (3 )%
Operating income 5 % 11 %
Other (expense) income, net - % 1 %
Interest expense, net (2 )% (3 )%
Income before provision for income taxes 2 % 9 %
Income tax (provision) benefit - % (3 )%
Net income 2 % 6 %
Comprehensive income 2 % 6 %
Comparison of the three months ended June 30, 2020 to the three months ended
June 30, 2019
Net sales
Net sales increased 8%, or $4.8 million , to $64.5 million for the three months
ended June 30, 2020 , from $59.8 million for the three months ended June 30,
2019 . The increase was primarily driven by strength in digital, partially offset
by certain retailer store closures in the U.S. and internationally due to
COVID-19.
Gross profit
Gross profit increased $6.2 million , or 17%, to $43.3 million for the three
months ended June 30, 2020 , compared to $37.2 million for the three months ended
June 30, 2019 . Gross margin increased to 67% from 62%, when compared to the
three months ended June 30, 2019 . The improvement was primarily driven by the
shift in our sales mix to elfcosmetics.com, price increases implemented last
summer, margin accretive innovation, cost savings, and favorable movements in
foreign exchange rates, partially offset by the impact of tariffs on goods
imported from China .
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Selling, general and administrative expenses SG&A expenses were$40.3 million for the three months endedJune 30, 2020 , an increase of$8.3 million , or 26%, from$32.1 million for the three months endedJune 30, 2019 . SG&A expenses as a percentage of net sales increased to 63% for the three months endedJune 30, 2020 from 54% for the three months endedJune 30, 2019 . The$8.3 million increase was primarily due to increased employee compensation costs related to annualizing headcount from building out our marketing, digital and innovation capabilities, proxy contest costs, operations costs driven by the increase in eCommerce sales, and investments in marketing and digital. Restructuring income We incurred no expenses related to the Restructuring Plan for the three months endedJune 30, 2020 . We recognized restructuring income of$1.8 million for the three months endedJune 30, 2019 , which included a$2.6 million gain related to operating lease liabilities that were extinguished during the period. We have settled all outstanding lease liabilities related to our e.l.f. retail store closures and we do not expect to incur additional material costs associated with the Restructuring Plan. Other (expense) income, net Other (expense) income, net decreased by$0.4 million to$30 thousand for the three months endedJune 30, 2020 , as compared to$0.4 million for the three months endedJune 30, 2019 primarily related to foreign exchange rate movements. Interest expense, net Interest expense, net decreased$0.2 million , or 15%, to$1.5 million for the three months endedJune 30, 2020 , as compared to$1.7 million for the three months endedJune 30, 2019 . This change was primarily due to the balance outstanding on our Term Loan Facility as well as a decline in interest rates. Income tax provision The benefit for income taxes was$1 thousand , or an effective rate of 0%, for the three months endedJune 30, 2020 , as compared to a provision of$1.9 million , or an effective rate of 33.4%, for the three months endedJune 30, 2019 . The change was primarily driven by a decrease in income before taxes of$4.1 million and an increase in discrete tax benefit of$0.7 million , primarily related to share-based compensation. Financial condition, liquidity and capital resources Overview As ofJune 30, 2020 , we held$54.2 million of cash and cash equivalents. In addition, as ofJune 30, 2020 , we had borrowing capacity of$49.8 million under our Revolving Credit Facility. InApril 2020 , we borrowed$20.0 million against the available capacity under our Revolving Credit Facility (as defined below under "Description of indebtedness") in order to increase our cash position given the volatility driven by the COVID-19 pandemic, which was subsequently repaid during the quarter. Our primary cash needs are for capital expenditures, retail product displays and working capital. Capital expenditures typically vary depending on strategic initiatives selected for the fiscal year, including investments in infrastructure, digital capabilities, and expansion within or to additional retailer store locations. We expect to fund ongoing capital expenditures from existing cash on hand, cash generated from operations and, if necessary, draws on our Revolving Credit Facility. Our primary working capital requirements are for product and product-related costs, payroll, rent, distribution costs and advertising and marketing. Fluctuations in working capital are primarily driven by the timing of when a retailer rearranges or restocks its products, expansion of space within our existing retailer base and the general seasonality of our business. As ofJune 30, 2020 , we had working capital, excluding cash, of$34.1 million , compared to$35.1 million as ofMarch 31, 2020 . Working capital, excluding cash and debt, was$47.2 million and$47.6 million as ofJune 30, 2020 andMarch 31, 2020 , respectively. We believe that our operating cash flow, cash on hand and available financing under our Revolving Credit Facility will be adequate to meet our operating, investing and financing needs for the next twelve months. If necessary, we can borrow funds under our Revolving Credit Facility to finance our liquidity requirements, subject to customary borrowing conditions. To the extent additional funds are necessary to meet our long-term liquidity needs as we continue to execute our business strategy, we anticipate that they will be obtained through the incurrence of additional indebtedness, additional equity financings or a combination of these potential sources of funds; however, such financing may not be available on favorable terms, or at all. 23
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Our ability to meet our operating, investing and financing needs depends to a significant extent on our future financial performance, which will be subject in part to general economic, competitive, financial, regulatory and other factors that are beyond our control, including those described elsewhere in Part II, Item 1A "Risk Factors". In addition to these general economic and industry factors, the principal factors in determining whether our cash flows will be sufficient to meet our liquidity requirements will be our ability to provide innovative products to our customers and manage production and our supply chain. Cash flows
Three months ended June 30,
(in thousands) 2020 2019
Net cash provided by (used in):
Operating activities $ 11,823 $ 12,865
Investing activities (1,155 ) (2,904 )
Financing activities (2,611 ) (3,089 )
Net increase in cash: $ 8,057 $ 6,872
Cash provided by operating activities
For the three months ended June 30, 2020 , net cash provided by operating
activities was $11.8 million . This included net income before adding
depreciation, amortization and other non-cash items of $12.4 million and an
increase in net working capital of $0.6 million . The slight increase in net
working capital was driven by an $6.5 million increase in inventory, partially
offset by the timing of cash payments related to accounts payable and accrued
expenses.
Cash used in investing activities
For the three months ended June 30, 2020 , net cash used in investing activities
was $1.2 million , compared to $2.9 million for the three months ended June 30,
2019 . The decrease was primarily driven by an investment in new customer fixture
programs in the three months ended June 30, 2019 that did not occur in the three
months ended June 30, 2020 .
Cash used in financing activities
For the three months ended June 30, 2020 , net cash used in financing activities
was $2.6 million and was primarily related to mandatory principal payments under
our Term Loan Facility and a payment on debt issuance costs (as defined below
under "Description of indebtedness"), partially offset by cash received from
exercise of stock options.
Description of indebtedness
Senior secured credit agreement, as amended
On December 23, 2016 , we entered into a five-year, $200.0 million Senior Secured
Credit Agreement (as amended, the "Credit Agreement") with a syndicate
consisting of several large financial institutions. The Credit Agreement was
first amended on August 25, 2017 , increasing the aggregate commitments to $215.0
million . The Credit Agreement, as amended, consists of a $50.0 million revolving
line of credit (the "Revolving Credit Facility") and a $165.0 million term loan
(the "Term Loan Facility"). The Credit Agreement was amended again on December
7, 2018 to reflect the change in our fiscal year-end from December 31 to March
31 . The Credit Agreement was further amended on April 8, 2020 to (i) increase
the maximum permitted total net leverage ratio for the fiscal quarters ending
June 30, 2020 , September 30, 2020 , December 31, 2020 , March 31, 2021 and June
30, 2021 , (ii) reduce the minimum fixed charge coverage ratio for the fiscal
quarters ending December 31, 2020 and March 31, 2021 , (iii) add additional
interest rates to correspond to the increased maximum permitted total net
leverage ratios, (iv) increase the amount of cash netted in the calculation of
the consolidated total net leverage ratio, and (v) amend the language around the
level of add backs to the adjusted consolidated EBITDA definition.
All amounts under the Revolving Credit Facility are available for draw until the
maturity date on August 25, 2022 . The Revolving Credit Facility is
collateralized by substantially all of our assets and requires payment of an
unused fee ranging from 0.35% to 0.25% (based on our consolidated total net
leverage ratio) times the average daily amount of unutilized commitments under
the Revolving Credit Facility. The Revolving Credit Facility also provides for
sub-facilities in the form of a $7.0 million letter of credit and a $5.0 million
swing line loan; however, all amounts under the Revolving Credit Facility cannot
exceed $50.0 million . The unused balance of the Revolving Credit Facility as of
June 30, 2020 was $49.8 million .
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The Term Loan Facility maturity date is alsoAugust 25, 2022 and is collateralized by substantially all of our assets. Amortization installment payments on the Term Loan Facility are required to be made in quarterly installments of (i)$2,062,500 for fiscal quarters endedSeptember 30, 2017 throughJune 30, 2019 , (ii)$2,475,000 for fiscal quarters endedSeptember 30, 2019 throughJune 30, 2020 , (iii)$3,093,750 for fiscal quarters endingSeptember 30, 2020 throughJune 30, 2021 and (iv)$4,125,000 for fiscal quarters endingSeptember 30, 2021 throughJune 30, 2022 . The remaining Term Loan Facility balance is due upon the maturity date. The Term Loan Facility can be prepaid at any time without penalty and is subject to mandatory prepayments when there is (i) excess cash flow, which is defined as EBITDA less certain customary deductions, (ii) non-ordinary course asset dispositions that result in net proceeds in excess of$2.5 million during a year, unless reinvested within twelve months or (iii) issuance of additional debt. Both the Revolving Credit Facility and the Term Loan Facility bear interest, at our option, at either a rate per annum equal to (i) an adjusted LIBOR rate determined by reference to the cost of funds forU.S. dollar deposits for the applicable interest period (subject to a minimum floor of 0%) plus an applicable margin ranging from 1.50% to 3.25% based on our consolidated total net leverage ratio or (ii) a floating base rate plus an applicable margin ranging from 0.50% to 2.25% based on our consolidated total net leverage ratio. The interest rate as ofJune 30, 2020 for the Term Loan was approximately 2.1%. The Credit Agreement contains a number of covenants that, among other things, restrict our ability to (subject to certain exceptions) pay dividends and distributions or repurchase our capital stock, incur additional indebtedness, create liens on assets, engage in mergers or consolidations and sell or otherwise dispose of assets. The Credit Agreement also includes reporting, financial and maintenance covenants that require us to, among other things, comply with certain consolidated total net leverage ratios and consolidated fixed charge coverage ratios. As ofJune 30, 2020 , we were in compliance with all financial covenants. Contractual obligations and commitments There have been no material changes to our contractual obligations and commitments as included in the Annual Report. Off-balance sheet arrangements We are not party to any off-balance sheet arrangements. Critical accounting policies and estimates The MD&A is based upon our condensed consolidated financial statements, which have been prepared in accordance withU.S. generally accepted accounting principles. The preparation of these condensed consolidated financial statements required the use of estimates and judgments that affect the reported amounts of our assets, liabilities, revenues and expenses. Management bases estimates on historical experience and other assumptions it believes to be reasonable under the circumstances and evaluates these estimates on an on-going basis. Actual results may differ from these estimates. There have been no significant changes to the critical accounting policies and estimates included in the Annual Report, except as noted below. Recent accounting pronouncements Recent accounting pronouncements are disclosed in Note 2 to the condensed consolidated financial statements. Item 3. Quantitative and qualitative disclosures about market risk There have been no material changes to our primary risk exposures or management of market risks from those disclosed in the Annual Report. Item 4. Controls and procedures Evaluation of disclosure controls and procedures over financial reporting As ofJune 30, 2020 , our management conducted an evaluation, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the "Exchange Act"). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as ofJune 30, 2020 , our disclosure controls and procedures were effective to provide reasonable assurance that the information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified inSEC rules and forms and that such information is accumulated and 25
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communicated to the officers who certify our financial reports and to the members of the Company's senior management and board of directors as appropriate to allow timely decisions regarding required disclosure.
Changes in internal control over financial reporting
There were no changes to our internal control over financial reporting that
occurred during the quarter ended
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