Beauty market

ELF BEAUTY, INC. Management report and analysis of the financial situation and operating results. (Form 10-Q)

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 March 31, 2021 (the "Annual
Report"), and the unaudited condensed consolidated financial statements and
accompanying notes included in Part I, Item 1 of this Quarterly Report on Form
10-Q (this "Quarterly Report"), which include additional information about our
accounting policies, practices and the transactions underlying our financial
results.
Overview and Business Trends

We are a multi-brand beauty company that offers inclusive, accessible,
cruelty-free cosmetics and skincare products. Our mission is to make the best of
beauty accessible to every eye, lip and face.
We believe our ability to deliver 100% cruelty-free, premium-quality products at
accessible prices with broad appeal differentiates us in the beauty industry. We
believe the combination of our fundamental value equation, digitally-led
strategy, as well as our world-class team's ability to execute with speed, has
positioned us well to navigate a rapidly changing landscape in beauty.
Our family of brands includes e.l.f. Cosmetics, e.l.f. Skin, Well People and
Keys Soulcare. Our brands are available online and across leading beauty,
mass-market, and clean-beauty specialty retailers. 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 domestically and
internationally.
Global Supply Chain Disruptions

We have experienced an increase in freight and shipping costs due to the shortage of shipping containers. A continued shortage of ships and containers globally would further delay future inventory receipts and in turn delay deliveries to our retailers and product availability in our direct-to-consumer e-commerce channel and increase our costs. shipping. Such shipment delays and disruptions could adversely affect our results of operations due to increased inventory costs, reduced sales and increased transportation costs.

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
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.
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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 

December

                                                                 31,                      Nine months ended December 31,
(in thousands)                                          2021              2020               2021                2020
Net sales                                           $  98,118          $ 88,562          $  287,020          $ 225,439
Cost of sales                                          33,777            31,443             102,788             77,841
Gross profit                                           64,341            57,119             184,232            147,598
Selling, general and administrative expenses           55,384            50,828             156,580            136,330
Restructuring (income) expense                            (14)                -                  68                  -
Operating income                                        8,971             6,291              27,584             11,268
Other expense, net                                       (146)             (677)               (954)            (1,566)
Interest expense, net                                    (570)             (855)             (1,912)            (3,228)
Loss on extinguishment of debt                              -                 -                (460)                 -
Income before provision for income taxes                8,255             4,759              24,258              6,474
Income tax provision                                   (2,041)             (462)             (4,044)              (218)
Net income                                          $   6,214          $  4,297          $   20,214          $   6,256
Comprehensive income                                $   6,214          $  4,297          $   20,214          $   6,256



                                                       Three months ended December 31,             Nine months ended December 31,
(percentage of net sales)                                 2021                  2020                  2021                  2020
Net sales                                                     100  %               100  %                 100  %               100  %
Cost of sales                                                  34  %                36  %                  36  %                35  %
Gross margin                                                   66  %                64  %                  64  %                65  %
Selling, general and administrative expenses                   56  %                57  %                  55  %                60  %
Restructuring (income) expense                                  -  %                 -  %                   -  %                 -  %
Operating income                                                9  %                 7  %                  10  %                 5  %
Other expense, net                                              -  %                (1) %                   -  %                (1) %
Interest expense, net                                          (1) %                (1) %                  (1) %                (1) %
Loss on extinguishment of debt                                  -  %                 -  %                   -  %                 -  %
Income before provision for income taxes                        8  %                 5  %                   8  %                 3  %
Income tax provision                                           (2) %                (1) %                  (1) %                 -  %
Net income                                                      6  %                 5  %                   7  %                 3  %
Comprehensive income                                            6  %                 5  %                   7  %                 3  %



Comparison of the three months ended December 31, 2021 to the three months ended
December 31, 2020
Net sales
Net sales increased 11%, or $9.6 million, to $98.1 million for the three months
ended December 31, 2021, from $88.6 million for the three months ended December
31, 2020. The increase was driven by strength in our national and international
retailers. Net sales increased $8.1 million, or 10% in our retailer channels and
increased $1.5 million, or 16% in our e-commerce channels.
Gross profit
Gross profit increased $7.2 million, or 13%, to $64.3 million for the three
months ended December 31, 2021, compared to $57.1 million for the three months
ended December 31, 2020. Gross margin increased to 66% from 64%, when compared
to the three months ended December 31, 2020. Increased volume accounted for
approximately $6.2 million of the increase in gross profit, with the remaining
$1.0 million driven by an increase in gross margin rate. The increase in gross
margin rate was
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primarily driven by product mix, price increases and cost savings, partially
offset by unfavorable foreign exchange rates and increased transportation costs
in the three months ended December 31, 2021.

Selling, general and administrative expenses
Selling, general and administrative expenses ("SG&A") were $55.4 million for the
three months ended December 31, 2021, an increase of $4.6 million, or 9%, from
$50.8 million for the three months ended December 31, 2020. SG&A expenses as a
percentage of net sales decreased to 56% for the three months ended December 31,
2021 from 57% for the three months ended December 31, 2020. The $4.6 million
increase was primarily related to an increase in marketing and digital spend of
$2.0 million, increased software subscription costs of $0.9 million, increased
professional fees of $1.1 million, and increased amortization and depreciation
costs of $0.5 million.

Restructuring expense
Restructuring income was $14 thousand in the three months ended December 31,
2021, and relates to the closure of our manufacturing facility in California.
See Note 9 Restructuring and other related costs to our condensed consolidated
financial statements for further details.
Other expense, net
Other expense totaled $0.1 million for the three months ended December 31, 2021,
as compared to other expense of $0.7 million for the three months ended December
31, 2020. The year-over-year variance was primarily related to foreign exchange
rate movements.
Interest expense, net
Interest expense, net decreased $0.3 million, or 33%, to $0.6 million for the
three months ended December 31, 2021, as compared to $0.9 million for the three
months ended December 31, 2020. This decrease was due to a reduction in our
long-term debt as well as a decline in interest rates.
Income tax provision
The provision for income taxes was $2.0 million, or an effective rate of 24.7%,
for the three months ended December 31, 2021, as compared to a provision of $0.5
million, or an effective rate of 9.7%, for the three months ended December 31,
2020. The change was primarily driven by an increase in income before taxes of
$3.5 million and a decrease in discrete tax benefit of $0.9 million, primarily
related to stock-based compensation.
Comparison of the nine months ended December 31, 2021 to the nine months ended
December 31, 2020
Net sales
Net sales increased $61.6 million, or 27%, to $287.0 million for the nine months
ended December 31, 2021, from $225.4 million for the nine months ended December
31, 2020. The increase was driven primarily by strength in our national and
international retailers. Net sales increased $61.3 million, or 31% in our
retailer channels and increased $0.3 million, or 1% in our e-commerce channels.
Gross profit
Gross profit increased $36.6 million, or 25%, to $184.2 million for the nine
months ended December 31, 2021, compared to $147.6 million for the nine months
ended December 31, 2020. Gross margin decreased to 64% from 65%, when compared
to the nine months ended December 31, 2020. Increased volume accounted for
approximately $40.3 million of the increase in gross profit with offset of the
remaining $3.7 million driven by a decrease in gross margin rate. The decrease
in gross margin rate was primarily driven by unfavorable foreign exchange rates
and elevated transportation costs in the nine months ended December 31, 2021.
These increases were partially offset by price increases, cost savings and
product mix.

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Selling, general and administrative expenses
SG&A expenses were $156.6 million for the nine months ended December 31, 2021,
an increase of $20.2 million, or 15%, from $136.3 million for the nine months
ended December 31, 2020. SG&A expenses as a percentage of net sales decreased to
55% for the nine months ended December 31, 2021 from 60% for the nine months
ended December 31, 2020. The $20.2 million increase was primarily related to an
increase in marketing and digital spend of $14.3 million. Additionally, we
experienced increased software subscription costs of $3.2 million, increased
operational costs (including outbound freight and shipping costs) of $2.8
million, increased fixturing costs of $1.1 million and increased amortization
and depreciation cost of $0.9 million. These increases were partially offset by
a decrease in professional fees, including $1.6 million related to proxy contest
costs in the prior year.
Restructuring expense
Restructuring expense was $0.1 million in the nine months ended December 31,
2021, and relates to the closure of our manufacturing facility in California.
See Note 9 Restructuring and other related costs to our condensed consolidated
financial statements for further details.
Other expense, net
Other expense totaled $1.0 million for the nine months ended December 31, 2021,
as compared to other expense of $1.6 million for the nine months ended December
31, 2020. The year-over-year variance was primarily related to foreign exchange
rate movements.
Interest expense, net
Interest expense, net decreased $1.3 million, or 41%, to $1.9 million for the
nine months ended December 31, 2021, as compared to $3.2 million for the nine
months ended December 31, 2020. This decrease was due to reduction in our
long-term debt as well as a decline in interest rates.
Loss on extinguishment of debt
Loss on extinguishment of debt was $0.5 million for the nine months ended
December 31, 2021. See Note 6, Debt to our condensed consolidated financial
statements for further details.
Income tax provision
The provision for income taxes was $4.0 million, or an effective rate of 16.7%
for the nine months ended December 31, 2021, as compared to a provision of $0.2
million, or an effective rate of 3.4% for the nine months ended December 31,
2020. The change was primarily driven by an increase in income before taxes of
$17.8 million, partially offset by an increase in discrete tax benefit of
$0.6 million, primarily related to stock-based compensation.
Financial condition, liquidity and capital resources
Overview
As of December 31, 2021, we had $32.9 million of cash and cash equivalents. In
addition, as of December 31, 2021, we had borrowing capacity of $100.0 million
under our Amended Revolving Credit Facility.
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 and cash equivalents, cash generated from operations and, if
necessary, draws on our Amended 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 of
December 31, 2021, we had working capital, excluding cash, of $89.7 million,
compared to $39.0 million as of March 31, 2021. Working capital, excluding cash
and debt, was $95.5 million and $55.3 million as of December 31, 2021 and
March 31, 2021, respectively.
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We believe that our operating cash flow, existing cash and cash equivalents and
available financing under the Amended Revolving Credit Facility will be adequate
to meet our planned operating, investing and financing needs for the next twelve
months. If necessary, we can borrow funds under the Amended 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. 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 based on our ability to
provide innovative products to our customers, manage production and our supply
chain.
Cash flows
                                         Nine months ended December 31,
(in thousands)                                 2021                    2020
Net cash provided by (used in):
Operating activities              $          7,826                  $   1,950
Investing activities                        (4,596)                    (3,958)
Financing activities                       (28,109)                    (8,720)
Net decrease in cash:             $        (24,879)                 $ (10,728)


Cash provided by operating activities
For the nine months ended December 31, 2021, net cash provided by operating
activities was $7.8 million. This included net income before adding
depreciation, amortization and other non-cash items of $56.0 million and an
increase in net working capital of $48.2 million. The increase in net working
capital was driven by a $7.2 million increase in accounts receivable, a $28.4
million increase of inventory, a $8.6 million increase of prepaid expense and
other assets, a $0.7 million decrease of accounts payable and accrued expenses
and a $3.3 million decrease of other liabilities.
For the nine months ended December 31, 2020, net cash provided by operating
activities was $2.0 million. This included net income before adding
depreciation, amortization and other non-cash items of $35.1 million and an
increase in net working capital of $33.2 million.

Cash used in investing activities
For the nine months ended December 31, 2021, net cash used in investing
activities was $4.6 million. The increase was primarily driven by capital
expenditures related to customer fixture programs during the nine months ended
December 31, 2021.
For the nine months ended December 31, 2020, net cash used in investing
activities was $4.0 million.

Cash used in financing activities
For the nine months ended December 31, 2021, net cash used in financing
activities was $28.1 million and was primarily drivedn by repayment of the
revolving line of credit and the term loan facility, and cash received from the
exercise of stock options, net of proceeds from the amended revolving line of
credit and the Amended term loan facility.
For the nine months ended December 31, 2020, net cash used in financing
activities was $8.7 million and was primarily related to mandatory principal
payments under the Term Loan Facility (as defined below under "Description of
indebtedness") and a payment on debt issuance costs, partially offset by cash
received from exercise of stock options.
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Description of indebtedness
Amended credit agreement

At April 30, 2021we have amended and restated the Prior Credit Agreement (the “Amended Credit Agreement”), amended and restated the Prior Term Loan Facility and the Prior Revolving Credit Facility, and refinanced all loans under the previous credit agreement.

The Amended Credit Agreement has a five year term and consists of (i) a $100
million revolving credit facility (the "Amended Revolving Credit Facility") and
(ii) a $100 million term loan facility (the "Amended Term Loan Facility").

All amounts under the Amended Revolving Credit Facility are available for draw
until the maturity date on April 30, 2026. The Amended Revolving Credit Facility
is collateralized by substantially all of our assets and requires payment of an
unused fee ranging from 0.10% to 0.30% (based on our consolidated total net
leverage ratio (as defined in the Amended Credit Agreement)) times the average
daily amount of unutilized commitments under the Amended Revolving Credit
Facility. The Amended Revolving Credit Facility also provides for sub-facilities
in the form of a $7 million letter of credit and a $5 million swing line loan;
however, all amounts under the Amended Revolving Credit Facility cannot exceed
$100 million. The unused balance of the Amended Revolving Credit Facility as of
December 31, 2021 was $100.0 million.

Both the Amended Revolving Credit Facility and the Amended Term Loan Facility
bear interest, at borrowers' option, at either (i) a rate per annum equal to an
adjusted LIBOR rate determined by reference to the cost of funds for the U.S.
dollar deposits for the applicable interest period (subject to a minimum floor
of 0%) plus an applicable margin ranging from 1.25% to 2.125% based on our
consolidated total net leverage ratio or (ii) a floating base rate plus an
applicable margin ranging from 0.25% to 1.125% based on our consolidated total
net leverage ratio. The interest rate as of December 31, 2021 for the Amended
Term Loan Facility was approximately 1.6%.

The Amended 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 Amended 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 of December 31, 2021, we were in
compliance with all financial covenants under the Amended Credit Agreement.

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 with U.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.
Recent accounting pronouncements
Recent accounting pronouncements are disclosed in Note 2 to our 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.
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