10-Q 1 q32020form10-q.htm FORM 10-Q Document
e.l.f. Beauty, Inc.
10-Q on 02/06/2020   Download
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SEC Filing



 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549 
_______________________________________________________________   
FORM 10-Q
_______________________________________________________________   
x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the Quarterly Period Ended December 31, 2019

¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 001-37873
_______________________________________________________________ 
e.l.f. Beauty, Inc.
(Exact name of registrant as specified in its charter)
_______________________________________________________________
Delaware
 
46-4464131
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
570 10th Street
Oakland, CA 94607
 (Address of principal executive offices, including zip code)
_______________________________________________________________ 
(510) 778-7787
(Registrant’s telephone number, including area code)
_______________________________________________________________ 
Securities registered pursuant to Section 12(b) of the Securities Exchange Act of 1934:
 
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, par value $0.01 per share
ELF
New York Stock Exchange
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    x  Yes    ¨  No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    x  Yes    o  No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
¨
Accelerated filer
x
 
 
 
 
Non- accelerated filer
¨  
Smaller reporting company
¨
 
 
 
 
Emerging growth company
x
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  x
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    o  Yes   x  No
The number of shares of the registrant’s common stock, par value $0.01 per share, outstanding as of January 31, 2020 was 49,958,125 shares.





e.l.f. Beauty, Inc.
Table of Contents
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2




PART I. FINANCIAL INFORMATION
Item 1. Financial statements (unaudited)

e.l.f. Beauty, Inc. and subsidiaries
Condensed consolidated balance sheets
(unaudited)
(in thousands, except share and per share data)
 
December 31, 2019
 
March 31, 2019
 
December 31, 2018
Assets
 
 
 
 
 
Current assets:
 
 
 
 
 
Cash and cash equivalents
$
74,740

 
$
53,874

 
$
51,205

Accounts receivable, net
35,082

 
32,275

 
36,724

Inventory, net
48,382

 
43,779

 
46,341

Prepaid expenses and other current assets
8,054

 
7,340

 
7,473

Total current assets
166,258

 
137,268

 
141,743

Property and equipment, net
16,487

 
16,006

 
21,804

Intangible assets, net
91,893

 
97,053

 
98,773

Goodwill
157,264

 
157,264

 
157,264

Investments
2,875

 
2,875

 
2,875

Other assets
21,474

 
21,222

 
13,397

Total assets
$
456,251

 
$
431,688

 
$
435,856

 
 
 
 
 
 
Liabilities and stockholders' equity
 

 
 

 
 
Current liabilities:
 

 
 

 
 
Current portion of long-term debt and finance lease obligations
$
11,939

 
$
10,259

 
$
9,861

Accounts payable
19,589

 
16,280

 
20,483

Accrued expenses and other current liabilities
29,767

 
18,590

 
12,671

Total current liabilities
61,295

 
45,129

 
43,015

Long-term debt and finance lease obligations
129,236

 
138,025

 
140,523

Deferred tax liabilities
17,633

 
16,753

 
20,217

Long-term operating lease obligations
5,084

 
15,898

 

Other long-term liabilities
556

 
668

 
2,770

Total liabilities
213,804

 
216,473

 
206,525

 
 
 
 
 
 
Commitments and contingencies (Note 7)


 


 


 
 
 
 
 
 
Stockholders' equity:
 

 
 

 
 
  Common stock, par value of $0.01 per share; 250,000,000 shares authorized as of December 31, 2019, March 31, 2019 and December 31, 2018; 49,914,987, 49,645,450 and 48,715,276 shares issued and outstanding as of December 31, 2019, March 31, 2019 and December 31, 2018, respectively
486

 
483

 
478

Additional paid-in capital
753,151

 
744,147

 
740,354

Accumulated deficit
(511,190
)
 
(529,415
)
 
(511,501
)
Total stockholders' equity
242,447

 
215,215

 
229,331

Total liabilities and stockholders' equity
$
456,251

 
$
431,688

 
$
435,856

The accompanying notes are an integral part of these condensed consolidated financial statements.

3


e.l.f. Beauty, Inc. and subsidiaries
Condensed consolidated statements of operations and comprehensive income
(unaudited)
(in thousands, except share and per share data)
 
Three months ended December 31,
 
Nine months ended December 31,
 
2019
 
2018
 
2019
 
2018
Net sales
$
80,760

 
$
78,571

 
$
208,139

 
$
201,515

Cost of sales
28,240

 
31,652

 
75,080

 
78,982

Gross profit
52,520

 
46,919

 
133,059

 
122,533

Selling, general and administrative expenses
39,632

 
33,898

 
110,131

 
100,345

Restructuring expense (income)
8

 

 
(5,982
)
 

Operating income
12,880

 
13,021

 
28,910

 
22,188

Other (expense) income, net
(335
)
 
(371
)
 
602

 
498

Interest expense, net
(1,560
)
 
(1,963
)
 
(4,920
)
 
(5,853
)
Income before provision for income taxes
10,985

 
10,687

 
24,592

 
16,833

Income tax provision
(2,983
)
 
(1,015
)
 
(6,367
)
 
(1,998
)
Net income
$
8,002

 
$
9,672

 
$
18,225

 
$
14,835

Comprehensive income
$
8,002

 
$
9,672

 
$
18,225

 
$
14,835

Net income per share:
 
 
 
 
 
 
 
Basic
$
0.16

 
$
0.20

 
$
0.38

 
$
0.32

Diluted
$
0.16

 
$
0.20

 
$
0.36

 
$
0.30

Weighted average shares outstanding:
 
 
 
 
 
 
 
Basic
48,525,904

 
47,477,597

 
48,430,871

 
46,957,494

Diluted
50,966,550

 
49,211,311

 
50,741,492

 
49,254,848

The accompanying notes are an integral part of these condensed consolidated financial statements.

4


e.l.f. Beauty, Inc. and subsidiaries
Condensed consolidated statements of stockholders’ equity
(unaudited)
(in thousands, except share data)
 
 
 
Common stock
 
Additional
paid-in
capital
 
Accumulated deficit
 
Total
stockholders'
equity
 
 
Shares
 
Amount
 
 
 
Balance as of March 31, 2019
 
48,288,720

 
$
483

 
$
744,147

 
$
(529,415
)
 
$
215,215

Net income
 

 

 

 
3,706

 
3,706

Stock-based compensation
 

 

 
3,926

 

 
3,926

Exercise of stock options, net
 
179,225

 
2

 
238

 

 
240

Repurchase of common stock
 
(89,610
)
 
(1
)
 
(1,078
)
 

 
(1,079
)
Balance as of June 30, 2019
 
48,378,335

 
$
484

 
$
747,233

 
$
(525,709
)
 
$
222,008

Net income
 

 

 

 
6,517

 
6,517

Stock-based compensation
 

 

 
4,004

 

 
4,004

Exercise of stock options, net
 
236,803

 
2

 
624

 

 
626

Repurchase of common stock
 
(89,026
)
 
(1
)
 
(1,466
)
 

 
(1,467
)
Balance as of September 30, 2019
 
48,526,112

 
$
485

 
$
750,395

 
$
(519,192
)
 
$
231,688

Net income
 

 

 

 
8,002

 
8,002

Stock-based compensation
 

 

 
3,352

 

 
3,352

Exercise of stock options, net
 
93,182

 
2

 
406

 

 
408

Repurchase of common stock
 
(60,127
)
 
(1
)
 
(1,002
)
 

 
(1,003
)
Balance as of December 31, 2019
 
48,559,167

 
$
486


$
753,151


$
(511,190
)

$
242,447









5


 
 
Common stock
 
Additional
paid-in
capital
 
Accumulated deficit
 
Total
stockholders'
equity
 
 
Shares
 
Amount
 
 
 
Balance as of March 31, 2018
 
46,539,619

 
$
465

 
$
724,221

 
$
(526,336
)
 
$
198,350

Net income
 

 

 

 
1,248

 
1,248

Stock-based compensation
 

 

 
4,631

 

 
4,631

Exercise of stock options, net
 
156,543

 
2

 
283

 

 
285

Balance as of June 30, 2018
 
46,696,162

 
$
467

 
$
729,135

 
$
(525,088
)
 
$
204,514

Net income
 

 

 

 
3,915

 
3,915

Stock-based compensation
 

 

 
4,193

 

 
4,193

Exercise of stock options, net
 
412,899

 
4

 
995

 

 
999

Balance as of September 30, 2018
 
47,109,061

 
$
471


$
734,323


$
(521,173
)

$
213,621

Net income
 

 

 

 
9,672

 
9,672

Stock-based compensation
 

 

 
4,357

 

 
4,357

Exercise of stock options, net
 
720,695

 
7

 
1,674

 
 
 
1,681

Balance as of December 31, 2018
 
47,829,756

 
$
478

 
$
740,354

 
$
(511,501
)
 
$
229,331

The accompanying notes are an integral part of these condensed consolidated financial statements.



6


e.l.f. Beauty, Inc. and subsidiaries
Condensed consolidated statements of cash flows
(unaudited)
(in thousands)
 
Nine months ended December 31,
 
2019
 
2018
Cash flows from operating activities:
 
 
 
Net income
$
18,225

 
$
14,835

Adjustments to reconcile net income to net cash provided by
   operating activities:
 
 
 

Depreciation and amortization
16,863

 
13,573

Restructuring income
(5,982
)
 

Stock-based compensation expense
11,282

 
13,181

Amortization of debt issuance costs and discount on debt
565

 
593

Deferred income taxes
880

 
(1,674
)
Other, net
410

 
334

Changes in operating assets and liabilities:
 

 
 

Accounts receivable
(3,027
)
 
(5,122
)
Inventories
(4,603
)
 
15,387

Prepaid expenses and other assets
(3,260
)
 
(6,986
)
Accounts payable and accrued expenses
17,628

 
6,640

Other liabilities
(11,181
)
 
(209
)
Net cash provided by operating activities
37,800

 
50,552

 
 
 
 
Cash flows from investing activities:
 

 
 

Purchase of property and equipment
(7,073
)
 
(6,205
)
Net cash used in investing activities
(7,073
)
 
(6,205
)
 
 
 
 
Cash flows from financing activities:
 

 
 

Repayment of long-term debt
(7,013
)
 
(6,187
)
Repurchase of common stock
(3,546
)
 

Cash received from issuance of common stock
1,272

 
2,965

Other, net
(574
)
 
(394
)
Net cash used in financing activities
(9,861
)
 
(3,616
)
 
 
 
 
Net increase in cash and cash equivalents
20,866

 
40,731

Cash and cash equivalents - beginning of period
53,874

 
10,474

Cash and cash equivalents - end of period
$
74,740

 
$
51,205

The accompanying notes are an integral part of these condensed consolidated financial statements.

7

e.l.f. Beauty, Inc. and subsidiaries
Notes to condensed consolidated financial statements (unaudited)


Note 1—Nature of operations
e.l.f. Beauty, Inc. (“e.l.f. Beauty” and together with its subsidiaries, the “Company,” or “we”) was formed as a Delaware corporation on December 20, 2013 under the name J.A. Cosmetics Holdings, Inc. and changed its name to e.l.f. Beauty, Inc. in April 2016. e.l.f. Beauty is organized as a holding company and operates through its subsidiary, e.l.f. Cosmetics, Inc., which conducts business under the name “e.l.f. Cosmetics” or “e.l.f.” The Company makes the best of beauty accessible to every eye, lip and face by offering high-quality products at an extraordinary value, all formulated 100% vegan and cruelty-free.
Note 2—Summary of significant accounting policies
Basis of presentation
The Company changed its fiscal year end from December 31st to March 31st effective on December 7, 2018. This document reflects the Company's third quarter of the fiscal year ending March 31, 2020, covering the period from October 1, 2019 to December 31, 2019.
The accompanying unaudited condensed consolidated financial statements and related notes have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). In the opinion of the Company, these interim financial statements contain all adjustments, consisting of only normal recurring adjustments, necessary for a fair statement of its financial position as of December 31, 2019, March 31, 2019 and December 31, 2018, its results of operations and stockholders' equity for the three and nine months ended December 31, 2019 and 2018, and its cash flows for the nine months ended December 31, 2019 and 2018. The condensed consolidated balance sheet as of March 31, 2019 is unaudited and does not contain all footnote disclosures from the Company's annual financial statements. All intercompany balances and transactions have been eliminated in consolidation.
These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018, as amended (the “Annual Report”), and the Company's Transition Report on Form 10-QT for the three months ended March 31, 2019, as amended. Operating results for the interim periods are not necessarily indicative of the results that may be expected for the full year.
Use of estimates
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.
Segment reporting
Operating segments are components of an enterprise for which separate financial information is available that is evaluated by the Company's chief operating decision maker in deciding how to allocate resources and in assessing performance. Utilizing these criteria, the Company manages its business on the basis of one operating segment and one reportable segment.
Significant accounting policies
Effective January 1, 2019, the Company adopted the requirements of Accounting Standards Update (“ASU”) No. 2016-02, Leases (Accounting Standards Codification (“ASC”) Topic 842) (“ASC 842”) using the modified retrospective approach and elected the transition relief option to make the date of initial adoption concurrent with the effective date. Accordingly, comparative periods remain presented under ASC Topic 840, Leases ("ASC 840"). The Company also elected the following practical expedients:
The package of practical expedients, which permitted the carryforward of historical conclusions around lease identification, classification and initial direct costs; and
Non-separation of lease and non-lease components for commercial property leases.

8




The Company made no other material changes in the application of its significant accounting policies that were disclosed in Note 2, “Summary of significant accounting policies,” to the audited consolidated financial statements as of and for the fiscal year ended December 31, 2018 included in the Annual Report.
Revenue recognition
The Company distributes product both through national and international retailers, as well as direct-to-consumers through its e-commerce channel and historically (prior to February 2019) through its e.l.f. retail stores. The marketing and consumer engagement benefits that the direct-to-consumer channel provides is integral to the Company’s brand and product development strategy and drives sales across channels. As such, the Company views its two primary distribution channels as components of one integrated business, as opposed to discrete revenue streams.
The Company sells a variety of beauty products but does not consider them to be meaningfully different revenue streams given similarities in the nature of the products, the target consumer, and the innovation and distribution processes.
The following table provides disaggregated revenue from contracts with customers by geographical market, as the nature, amount, timing and uncertainty of revenue and cash flows can differ between domestic and international customers (in thousands).
 
Three months ended December 31,
 
Nine months ended December 31,
Net sales by geographic region:
2019
 
2018
 
2019
 
2018
United States
$
74,282

 
$
68,801

 
$
187,793

 
$
179,052

International
6,478

 
9,770

 
20,346

 
22,463

Total net sales
$
80,760

 
$
78,571

 
$
208,139

 
$
201,515

As of December 31, 2019, other than accounts receivable, the Company had no material contract assets, contract liabilities or deferred contract costs recorded on its condensed consolidated balance sheet.

 

9




Recent accounting pronouncements
The following table provides a brief description of recent accounting pronouncements that could have a material effect on the Company’s financial statements:
Standard
Description
Date of expected adoption/adoption
Effect on the financial statements or other significant matters
Recently adopted accounting standards
ASU 2016-02, Leases (Topic 842)
 
 
The standard requires lessees to recognize a right-of-use asset and a lease liability for virtually all of their leases (other than leases that meet the definition of a short-term lease). The liability is equal to the present value of lease payments. The asset is based on the liability, subject to adjustment, such as for initial direct costs. Lessor accounting is similar to the current model, but updated to align with certain changes to the lessee model (e.g., certain definitions, such as initial direct costs, have been updated) and the new revenue recognition standard. It requires a modified retrospective approach for all leases existing at, or entered into after, the date of initial application.
January 1, 2019
The Company adopted ASC 842 on a modified retrospective basis. The results for periods beginning after January 1, 2019 are presented under ASC 842, while comparative information has not been restated and continues to be reported under the accounting standards in effect for those periods. The adoption of the new standard resulted in the recognition of the right of use (“ROU”) assets and lease liabilities for operating leases of approximately $21.2 million and $23.5 million, respectively, as of January 1, 2019, with corresponding adjustments to prepaid and deferred rent. As discussed in Note 9, “Restructuring and other related costs,” these assets and liabilities were subsequently adjusted as a result of the closure of all 22 e.l.f. retail stores in February 2019. The adoption of the standard did not impact the Company's beginning retained earnings, its consolidated statements of operations or cash flows.
Standards that are not yet adopted
ASU 2018-15, Intangibles-Goodwill and Other- Internal-Use Software (Subtopic 350-40)
The standard will require customers in a cloud computing arrangement that is a service contract to follow the internal-use software guidance in ASC 350-40 to determine which implementation costs to capitalize as assets or expense as incurred. Certain implementation costs incurred during the application development stage would be deferred and capitalized (e.g., costs of integration with on-premises software, coding, configuration, customization). Other costs incurred during the preliminary project and post-implementation stages would be expensed (e.g., planning the project, training, maintenance after implementation, data conversion). The amendments in the ASU can be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption.
April 1, 2020
The Company intends to adopt ASU 2018-15 prospectively, and the adoption is not expected to have a material impact on its consolidated financial statements.


10




Note 3—Investment in equity securities
On April 14, 2017, the Company invested $2.9 million in a social media analytics company, which is included in investments on its condensed consolidated balance sheets. The Company has elected the measurement alternative for equity investments that do not have readily determinable fair values. The Company did not record an impairment charge on its investment during the three and nine months ended December 31, 2019 or 2018, as there were no significant identified events or changes in circumstances that would be considered an indicator for impairment. Further, there were no observable price changes in orderly transactions for the identical or a similar investment of the same issuer during the three and nine months ended December 31, 2019.
Note 4—Goodwill and intangible assets
Information regarding the Company’s goodwill and intangible assets as of December 31, 2019 is as follows (in thousands):
 
Estimated useful life
 
Gross carrying amount
 
Accumulated amortization
 
Net carrying amount
Customer relationships – retailers
10 years
 
$
68,800

 
$
(40,707
)
 
$
28,093

Customer relationships – e-commerce
3 years
 
3,900

 
(3,900
)
 

Total finite-lived intangibles
 
 
72,700

 
(44,607
)
 
28,093

Trademarks
Indefinite
 
63,800

 

 
63,800

Goodwill
 
 
157,264

 

 
157,264

Total goodwill and other intangibles
 
 
$
293,764

 
$
(44,607
)
 
$
249,157

Information regarding the Company’s goodwill and intangible assets as of March 31, 2019 is as follows (in thousands):
 
Estimated useful life
 
Gross carrying amount
 
Accumulated amortization
 
Net carrying amount
Customer relationships – retailers
10 years
 
$
68,800

 
$
(35,547
)
 
$
33,253

Customer relationships – e-commerce
3 years
 
3,900

 
(3,900
)
 

Total finite-lived intangibles
 
 
72,700

 
(39,447
)
 
33,253

Trademarks
Indefinite
 
63,800

 

 
63,800

Goodwill
 
 
157,264

 

 
157,264

Total goodwill and other intangibles
 
 
$
293,764

 
$
(39,447
)
 
$
254,317

Information regarding the Company’s goodwill and intangible assets as of December 31, 2018 is as follows (in thousands):
 
Estimated useful life
 
Gross carrying amount
 
Accumulated amortization
 
Net carrying amount
Customer relationships – retailers
10 years
 
$
68,800

 
$
(33,827
)
 
$
34,973

Customer relationships – e-commerce
3 years
 
3,900

 
(3,900
)
 

Total finite-lived intangibles
 
 
72,700

 
(37,727
)
 
34,973

Trademarks
Indefinite
 
63,800

 

 
63,800

Goodwill
 
 
157,264

 

 
157,264

Total goodwill and other intangibles
 
 
$
293,764

 
$
(37,727
)
 
$
256,037

Amortization expense on finite-lived intangible assets was $1.7 million and $5.2 million in the three and nine months ended December 31, 2019, respectively, and $1.8 million and $5.4 million in the three and nine months ended December 31, 2018, respectively. Trademark assets have been classified as indefinite-lived intangible assets and accordingly, are not subject to amortization. There were no impairments of goodwill or intangible assets recorded in the three and nine months ended December 31, 2019 and 2018.

11




The estimated future amortization expense related to finite-lived intangible assets, assuming no impairment as of December 31, 2019 is as follows (in thousands):
Remainder of 2020
$
1,720

2021
6,880

2022
6,880

2023
6,880

2024
5,733

Thereafter

Total
$
28,093

Note 5—Accrued expenses and other current liabilities
Accrued expenses and other current liabilities as of December 31, 2019, March 31, 2019 and December 31, 2018 consisted of the following (in thousands):
 
December 31, 2019
 
March 31, 2019
 
December 31, 2018
Accrued expenses
$
15,489

 
$
9,594

 
$
8,783

Current portion of operating lease liabilities
2,916

 
4,172

 

Accrued compensation
7,134

 
3,200

 
1,983

Income taxes payable
2,366

 
123

 
71

Other current liabilities
1,862

 
1,501

 
1,834

Accrued expenses and other current liabilities
$
29,767

 
$
18,590

 
$
12,671

Note 6—Debt
The Company’s outstanding debt as of December 31, 2019, March 31, 2019 and December 31, 2018 consisted of the following (in thousands):
 
December 31, 2019
 
March 31, 2019
 
December 31, 2018
Term loan(1)
$
138,199

 
$
144,810

 
$
146,737

Finance lease obligations
3,209

 
3,783

 
3,982

Total debt(2)
141,408

 
148,593

 
150,719

Less: debt issuance costs
(233
)
 
(309
)
 
(335
)
Total debt, net of issuance costs
141,175

 
148,284

 
150,384

Less: current portion
(11,939
)
 
(10,259
)
 
(9,861
)
Long-term portion of debt
$
129,236

 
$
138,025

 
$
140,523

(1) See Note 8, “Debt,” to the consolidated financial statements included in the Annual Report for details regarding the Senior Secured Credit Agreement (as defined below under the heading “Description of indebtedness”). As of December 31, 2019, the Company was in compliance with all applicable financial covenants.
(2) The gross carrying amounts of the Company’s long-term debt, before reduction of the debt issuance costs, and finance lease obligations approximate their fair values, based on Level 2 inputs (quoted prices for similar assets and liabilities in active markets or inputs that are observable), as the stated rates approximate market rates for loans with similar terms. The Company did not transfer any liabilities measured at fair value on a recurring basis to or from Level 2 for any of the periods presented.

12




Note 7—Contingencies
Legal contingencies
From time to time, the Company may become involved in legal proceedings, claims and litigation arising in the ordinary course of business. The Company is not currently a party to any matters that management expects will have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows.
Note 8—Stock-based compensation
Service-based vesting stock options
The following table summarizes the activity for options that vest solely based upon the satisfaction of a service condition for the nine months ended December 31, 2019:
 
Options
outstanding
 
Weighted-average exercise price
 
Weighted-average remaining
contractual life
(in years)
 
Aggregate intrinsic
values
(in thousands)
Balance as of March 31, 2019
2,575,579

 
$
12.24

 
 
 
 

Granted
143,760

 
13.56

 
 
 
 

Exercised
(249,192
)
 
4.85

 
 
 
 

Canceled or forfeited
(375,315
)
 
14.72

 
 
 
 

Balance as of December 31, 2019
2,094,832

 
$
12.77

 
6.6
 
$
9,363

 
 
 
 
 
 
 
 
Exercisable, December 31, 2019
1,295,459

 
$
11.21

 
5.7
 
$
7,519

The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the Company's closing stock price of $16.13, as reported on the New York Stock Exchange on December 31, 2019.
The Company recognized stock-based compensation cost related to service-based vesting options of $0.5 million and $1.7 million in the three and nine months ended December 31, 2019, respectively, and $0.8 million and $2.5 million in the three and nine months ended December 31, 2018, respectively. As of December 31, 2019, there was $3.5 million of total unrecognized stock-based compensation cost related to unvested service-based stock options, which is expected to be recognized over the remaining weighted-average period of 2.2 years. All stock-based compensation cost is recorded in selling, general and administrative expenses.
Performance-based and market-based vesting stock options
The following table summarizes the activity for stock options that vest based upon the satisfaction of performance or market conditions for the nine months ended December 31, 2019:
 
Options
outstanding
 
Weighted-average exercise price
 
Weighted-average remaining
contractual life
(in years)
 
Aggregate intrinsic
values
(in thousands)
Balance as of March 31, 2019
1,323,432

 
$
7.96

 
 
 
 
Exercised
(18,600
)
 
3.45

 
 
 
 
Canceled or forfeited
(17,400
)
 
26.84

 
 
 
 
Balance as of December 31, 2019
1,287,432

 
$
7.77

 
5.2
 
$
13,974

 
 
 
 
 
 
 
 
Exercisable, December 31, 2019
987,432

 
$
1.98

 
4.6
 
$
13,974

The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the Company's closing stock price of $16.13, as reported on the New York Stock Exchange on December 31, 2019.

13




The Company recognized stock-based compensation cost related to performance-based and market-based vesting options of $0.2 million and $0.8 million in the three and nine months ended December 31, 2018, respectively. As of December 31, 2019, there was no unrecognized compensation cost related to performance-based and market-based vesting stock options.

Restricted stock
The following table summarizes the activities for restricted stock awards (“RSAs”) and restricted stock units (“RSUs”) for the nine months ended December 31, 2019:
 
Shares of restricted stock outstanding
 
Weighted-average grant date fair value
Balance as of March 31, 2019
2,786,398

 
$
13.26

Granted
439,957

 
13.53

Vested
(241,418
)
 
17.62

Canceled or forfeited
(347,039
)
 
12.66

Balance as of December 31, 2019
2,637,898

 
$
13.07

As of December 31, 2019, there were 1,355,820 unvested shares subject to RSAs outstanding.
The Company recognized stock-based compensation cost related to RSAs and RSUs of $2.8 million and $9.6 million in the three and nine months ended December 31, 2019, respectively, and $3.4 million and $9.9 million in the three and nine months ended December 31, 2018, respectively. As of December 31, 2019, there was $25.5 million of total unrecognized stock-based compensation cost related to unvested RSAs and RSUs, which is expected to be recognized over a weighted-average period of 2.5 years.
Note 9—Restructuring and other related costs
In February 2019, the Company closed all 22 e.l.f. retail stores and implemented a workforce reduction of employees that operated and managed the e.l.f. retail stores (the “Restructuring Plan”). The Restructuring Plan resulted in the termination of the employment of 170 retail store employees and 5 corporate employees who managed and operated the e.l.f. retail stores. The purpose of the Restructuring Plan was to enable a reallocation of investment against the e.l.f. brand and prioritization of the Company's national retailer and digital channels.
The following table presents the restructuring (income) expenses incurred in the three and nine months ended December 31, 2019 with respect to the Restructuring Plan (in thousands):
 
Three months ended
December 31, 2019
 
Nine months ended
December 31, 2019
Gain from extinguishment of lease liabilities
$

 
$
(7,733
)
Other costs, including other asset write-offs
8

 
1,751

Total
$
8

 
$
(5,982
)
The gain from extinguishment of lease liabilities represents the difference between the aggregate operating lease liability and the aggregate cash payment incurred to extinguish such liability. The majority of the other costs incurred during the nine months ended December 31, 2019 are legal fees related to these extinguishments. As of December 31, 2019, the Company has settled all outstanding lease liabilities related to its e.l.f. retail store closures and does not expect to incur additional material costs associated with the Restructuring Plan.

14


Liabilities related to the Restructuring Plan are reported within accrued expenses and other current liabilities in the accompanying condensed consolidated balance sheets. The following table presents a roll-forward of the Company's restructuring liability for the three and nine months ended December 31, 2019 (in thousands):
 
 
Employee severance and related expenses
 
Other costs
 
Total
September 30, 2019
 
$

 
$
837

 
$
837

    Costs incurred
 

 
8

 
8

    Cash disbursements
 

 
(6
)
 
(6
)
    Other adjustments
 

 
(2
)
 
(2
)
December 31, 2019
 
$

 
$
837

 
$
837

 
 
Employee severance and related expenses
 
Other costs
 
Total
March 31, 2019
 
$
96

 
$
675

 
$
771

    Costs incurred
 
(22
)
 
1,773

 
1,751

    Cash disbursements
 
(74
)
 
(1,472
)
 
(1,546
)
    Other adjustments
 

 
(139
)
 
(139
)
December 31, 2019
 
$

 
$
837

 
$
837

Outstanding lease liabilities are not included in the table above, as those liabilities were established upon adoption of ASC 842, not in connection with the Restructuring Plan.
The Company expects to make all cash disbursements in connection with the Restructuring Plan by the end of the fiscal year ending March 31, 2020.

15




Note 10—Repurchase of common stock
On May 8, 2019, the Company's board of directors authorized a share repurchase program to acquire up to $25.0 million of the Company’s common stock (the “Share Repurchase Program”). Purchases under the Share Repurchase Program may be made from time to time through a variety of methods, which may include open market purchases, privately negotiated transactions, block trades, accelerated share repurchase transactions, or by any combination of such methods. The timing and amount of any repurchases pursuant to the Share Repurchase Program will be determined based on market conditions, share price and other factors. The Share Repurchase Program does not require the Company to repurchase any specific number of shares of its common stock, and may be modified, suspended or terminated at any time without notice. There is no guarantee that any shares will be purchased under the Share Repurchase Program and such shares are intended to be retired after purchase.
During the three months ended December 31, 2019, the Company repurchased a total of 60,127 shares for $1.0 million at an average price of $16.65. During the nine months ended December 31, 2019, the Company repurchased a total of 238,763 shares for $3.6 million at an average price of $14.87 under the Share Repurchase Program. A total of $21.4 million remains available for purchase under the Share Repurchase Program.
Note 11—Net income per share
The Company computes basic net income per share using the weighted average number of common shares outstanding. Diluted net income per share amounts are calculated using the treasury stock method for equity-based compensation awards. The following is a reconciliation of the numerator and denominator in the basic and diluted net income per common share computations (in thousands, except share and per share data):
 
Three months ended December 31,
 
Nine months ended December 31,
 
2019
 
2018
 
2019
 
2018
Numerator:
 

 
 

 
 

 
 

Net income
$
8,002

 
$
9,672

 
$
18,225

 
$
14,835

 
 
 
 
 
 
 
 
Denominator:
 

 
 

 
 

 
 

Weighted average common shares outstanding - basic
48,525,904

 
47,477,597

 
48,430,871

 
46,957,494

Dilutive common equivalent shares from equity awards
2,440,646

 
1,733,714

 
2,310,621

 
2,297,354

Weighted average common shares outstanding - diluted
50,966,550

 
49,211,311

 
50,741,492

 
49,254,848

 
 
 
 
 
 
 
 
Net income per share:
 

 
 

 
 

 
 

Basic
$
0.16

 
$
0.20

 
$
0.38

 
$
0.32

Diluted
$
0.16

 
$
0.20

 
$
0.36

 
$
0.30

 
 
 
 
 
 
 
 
Weighted average anti-dilutive shares from outstanding equity awards excluded from diluted earnings per share
1,861,620

 
4,143,027

 
2,232,528

 
3,638,002

Note 12—Leases
The Company leases warehouses, distribution centers, office space, and equipment. Prior to the Restructuring Plan, the Company also leased retail store locations. The majority of the Company's leases include one or more options to renew, with renewal terms that can extend the lease term for up to five years. The exercise of lease renewal options is at the Company's sole discretion and such renewal options are included in the lease term if they are reasonably certain to be exercised. Certain leases also include options to purchase the leased asset. The Company's lease agreements do not contain any material residual value guarantees or material restrictive covenants. Most of the Company's equipment leases are finance leases of assets used to operate its distribution centers in Ontario, California and Columbus, Ohio.

16


Significant judgment is required to determine whether commercial contracts contain a lease for purposes of ASC 842. The discount rate used in measuring lease liabilities is generally based on the interest rate on the Company’s revolving line of credit, assuming sufficient unused capacity exists at the time the lease liability is measured.
A reconciliation of the balance sheet line items that were impacted or created as a result of the Company’s adoption of ASC 842 is as follows (in thousands):
 
 
Classification
 
December 31, 2019
Assets
 
 
 
 
Operating lease assets (a)
 
Other assets
 
$
7,395

Finance lease assets (b)
 
Other assets
 
2,342

Total leased assets
 
 
 
$
9,737

Liabilities
 
 
 
 
Current
 
 
 
 
Operating (a)
 
Accrued expenses and other current liabilities
 
$
2,916

Finance
 
Current portion of long-term debt and finance lease obligations
 
802

Noncurrent
 
 
 
 
Operating (a)
 
Long-term operating lease obligations
 
5,084

Finance
 
Long-term debt and finance lease obligations
 
2,407

Total lease liabilities
 
 
 
$
11,209

___________________
(a) In accordance with ASC 842, $15.7 million of ROU assets related to operating leases were derecognized in the three months ended March 31, 2019 in connection with the Restructuring Plan. Pursuant to ASC 842, each related lease liability is derecognized only after the Company is released from that liability. See Note 9, “Restructuring and other related costs” for further details on the Restructuring Plan and the gain recorded on lease liabilities derecognized in the nine months ended December 31, 2019.
(b) Finance leases are recorded net of accumulated amortization of $2.7 million as of December 31, 2019.

The components of operating and finance lease costs were as follows (in thousands):

 
 
Classification
 
Three months ended
December 31, 2019
 
Nine months ended
December 31, 2019
Operating lease cost
 
Selling, general and administrative (“SG&A”) expenses
 
$
778

 
$
2,161

Gain from extinguishment of lease liabilities
 
Restructuring expense (income)
 

 
(7,733
)
Finance lease cost
 
 
 
 
 
 
Amortization of leased assets
 
SG&A expenses
 
248

 
747

Interest on lease liabilities
 
Interest expense, net
 
44

 
138

Total lease cost (gain)
 
 
 
$
1,070

 
$
(4,687
)

17


As of December 31, 2019, the aggregate future minimum lease payments under non-cancellable leases presented in accordance with ASC 842 are as follows (in thousands):
 
 
Operating
leases
 
Finance
leases
 
Total
Remainder of 2020
 
$
756

 
$
238

 
$
994

2021
 
3,170

 
950

 
4,120

2022
 
1,583

 
908

 
2,491

2023
 
1,179

 
1,208

 
2,387

2024
 
1,198

 
234

 
1,432

Thereafter
 
764

 

 
764

Total lease payments
 
8,650

 
3,538

 
$
12,188

Less: Interest
 
650

 
329

 


Present value of lease liabilities
 
$
8,000

 
$
3,209

 


For leases commencing prior to January 1, 2019, minimum lease payments exclude payments to landlords for real estate taxes and common area maintenance. These payments can be either fixed or variable, depending on the lease.
As of December 31, 2018, the aggregate future minimum lease payments under non-cancellable leases presented in accordance with ASC 840 were as follows (in thousands):
Year ending December 31,
 
 

2019
 
$
5,375

2020
 
5,210

2021
 
3,876

2022
 
2,832

2023
 
2,858

Thereafter
 
7,167

Total
 
$
27,318

The weighted average remaining lease term (in years) and discount rate were as follows:
 
 
December 31, 2019
Weighted-average remaining lease term
 
 
Operating leases
 
3.5 years

Finance leases
 
3.5 years

Weighted-average discount rate
 
 
Operating leases
 
4.6
%
Finance leases
 
5.2
%
Operating cash outflows from operating leases for the nine months ended December 31, 2019 were $9.7 million.


18




Item 2. Management’s discussion and analysis of financial condition and results of operations
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 December 31, 2018, as amended (the “Annual Report”), and the Company's Transition Report on Form 10-QT for the three months ended March 31, 2019, as amended, and the unaudited condensed consolidated financial statements and accompanying notes included in Part I, Item 1 of this Quarterly Report on Form 10-Q (the “Quarterly Report”), which include additional information about our accounting policies, practices and the transactions underlying our financial results.
Cautionary note regarding forward-looking statements
The MD&A and other parts of this Quarterly Report contains forward-looking statements within the meaning of the federal securities laws concerning our business, operations and financial performance and condition, as well as our plans, objectives and expectations for our business operations and financial performance and condition. Any statements contained herein that are not statements of historical facts may be deemed to be forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as “aim,” “anticipate,” “assume,” ”believe,” “contemplate,” “continue,” "could,” “due,” “estimate,” “expect,” “goal,” “intend,” “may,” “objective,” “plan,” “predict,” “potential,” “positioned,” “seek,” “should,” “target,” “will,” “would” and other similar expressions that are predictions of or indicate future events and future trends, or the negative of these terms or other comparable terminology. These forward-looking statements are based on management's current expectations, estimates, forecasts and projections about our business and the industry in which we operate and management’s beliefs and assumptions and are not guarantees of future performance or development and involve known and unknown risks, uncertainties, and other factors that are in some cases beyond our control. Although we believe that the expectations reflected in the forward-looking statements contained herein are reasonable, our actual results and the timing of selected events may differ materially. Factors that may cause actual results to differ materially from current expectations include, among other things, those listed under “Risk Factors” in Part II, Item 1A and elsewhere in this Quarterly Report. Potential investors are urged to consider these factors carefully in evaluating the forward-looking statements. These forward-looking statements speak only as of the date of this Quarterly Report. Except as required by law, we assume no obligation to update or revise these forward-looking statements for any reason, even if new information becomes available in the future.

19




Overview
e.l.f. Beauty, Inc. (“e.l.f. Beauty” and together with its subsidiaries, the “Company,” or “we”) is organized as a holding company and operates through its subsidiary, e.l.f. Cosmetics, Inc., which conducts business under the name "e.l.f. Cosmetics" or "e.l.f." We make the best of beauty accessible to every eye, lip and face by offering high-quality products at an extraordinary value, all formulated 100% vegan and cruelty-free. As one of the first online beauty brands, we have a passionate social following, national distribution at leading retailers such as Target, Walmart and Ulta Beauty, and a growing international presence.
National retailers.    We sell our products in the United States in the mass, drug store, food and specialty retail channels.
e-commerce.   Our e-commerce platform is 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, where we sell our full product offering.
International.    e.l.f. products are sold in a number of international markets, including the United Kingdom, Canada, Mexico and Germany.
We believe our ability to combine cost, quality and speed makes us unique in the first-to-mass beauty market. Additionally, we have a strong pipeline of innovation and continue to expand into 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 on elfcosmetics.com and through social media. In concert with our digital efforts, we have strong relationships with our retail partners that have allowed 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 from China and despite the signing of a Phase One trade agreement between the United States and China, 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 in July 2019. We have also implemented or are currently evaluating various other tariff mitigation initiatives including, but not limited to, negotiating lower prices with our suppliers in China and exploring potential new suppliers outside of China. In addition, favorable movements in foreign exchange rates and shifting product mix toward margin accretive innovation may also reduce the impact of the tariffs. We cannot provide any assurances that these mitigation initiatives will be successful.
e.l.f store closing
In February 2019, we exited our stand-alone e.l.f. retail stores business (the “Restructuring Plan”). As part of the Restructuring Plan, we closed all 22 e.l.f. retail stores and implemented a workforce reduction of employees that managed and operated the e.l.f. retail stores. Refer to Note 9 to our condensed consolidated financial statements in Item 1 of this Quarterly Report under the heading “Restructuring and other related costs” for further discussion of the Restructuring Plan.
Net sales associated with e.l.f. retail stores were $3.7 million and $10.1 million in the three and nine months ended December 31, 2018, respectively.
Seasonality
Our results of operations are subject to seasonal fluctuations, with net sales in the second and third fiscal quarters (i.e., the third and fourth calendar quarters) typically being higher than in the fourth and first fiscal quarters (i.e., the first and second calendar quarters). The higher net sales in our second and third fiscal quarters are largely attributable to the increased levels of purchasing by retailers for the holiday season, and lower holiday purchases in the second or third fiscal quarter could have a disproportionate effect on our results of operations for the entire fiscal year. To support anticipated higher sales during the second and third fiscal quarters, we make investments in working capital during the first and second fiscal quarters. 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 reduce our liquidity.

20




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)
2019
 
2018
 
2019
 
2018
 
Net sales
$
80,760

 
$
78,571

 
$
208,139

 
$
201,515

 
Cost of sales
28,240

 
31,652

 
75,080

 
78,982

 
Gross profit
52,520

 
46,919

 
133,059

 
122,533

 
Selling, general and administrative expenses
39,632

 
33,898

 
110,131

 
100,345

 
Restructuring expense (income)
8

 

 
(5,982
)
 

 
Operating income
12,880

 
13,021

 
28,910

 
22,188

 
Other (expense) income, net
(335
)
 
(371
)
 
602

 
498

 
Interest expense, net
(1,560
)
 
(1,963
)
 
(4,920
)
 
(5,853
)
 
Income before provision for income taxes
10,985

 
10,687

 
24,592

 
16,833

 
Income tax provision
(2,983
)
 
(1,015
)
 
(6,367
)
 
(1,998
)
 
Net income
$
8,002

 
$
9,672

 
$
18,225

 
$
14,835

 
Comprehensive income
$
8,002

 
$
9,672

 
$
18,225

 
$
14,835

 
 
Three months ended December 31,
 
Nine months ended December 31,
 
(percentage of net sales)
2019
 
2018
 
2019
 
2018
 
Net sales
100
 %
 
100
 %
 
100
 %
 
100
 %
 
Cost of sales
35
 %
 
40
 %
 
36
 %
 
39
 %
 
Gross margin
65
 %
 
60
 %
 
64
 %
 
61
 %
 
Selling, general and administrative expenses
49
 %
 
43
 %
 
53
 %
 
50
 %
 
Restructuring expense (income)
 %
 
 %
 
(3
)%
 
 %
 
Operating income
16
 %
 
17
 %
 
14
 %
 
11
 %
 
Other (expense) income, net
 %
 
 %
 
 %
 
 %
 
Interest expense, net
(2
)%
 
(2
)%
 
(2
)%
 
(3
)%
 
Income before provision for income taxes
14
 %
 
14
 %

12
 %
 
8
 %
 
Income tax provision
(4
)%
 
(1
)%
 
(3
)%
 
(1
)%
 
Net income
10
 %
 
12
 %
 
9
 %
 
7
 %
 
Comprehensive income
10
 %
 
12
 %
 
9
 %
 
7
 %
 

Comparison of the three months ended December 31, 2019 to the three months ended December 31, 2018
Net sales
Net sales increased 3%, or $2.2 million, to $80.8 million for the three months ended December 31, 2019, from $78.6 million for the three months ended December 31, 2018. The increase was primarily driven by increased productivity across channels and timing of product shipments. This was partially offset by the closing of all 22 e.l.f. retail stores in February 2019.
Gross profit
Gross profit increased $5.6 million, or 12%, to $52.5 million for the three months ended December 31, 2019, compared to $46.9 million for the three months ended December 31, 2018. Gross margin increased to 65% from 60% compared to the three months ended December 31, 2018, with benefits from price increases, margin accretive innovation, cost savings, favorable movements in foreign exchange rates, and a lower inventory reserve, partially offset by tariffs on goods imported from China.

21




Selling, general and administrative expenses
Selling, general and administrative (“SG&A”) expenses were $39.6 million for the three months ended December 31, 2019, an increase of $5.7 million, or 17%, from $33.9 million for the three months ended December 31, 2018. SG&A expenses as a percentage of net sales increased to 49% for the three months ended December 31, 2019 from 43% for the three months ended December 31, 2018. The $5.7 million increase was primarily due to investments in marketing and digital expenses and bonus accrual, partially offset by the closure of e.l.f retail stores.
Restructuring expense (income)
Activities related to the Restructuring Plan incurred were minimal for the three months ended December 31, 2019. As of December 31, 2019, 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 $0.1 million to $0.3 million for the three months ended December 31, 2019, as compared to $0.4 million for the three months ended December 31, 2018. This change was primarily due to foreign exchange rate movements.
Interest expense, net
Interest expense, net decreased $0.4 million, or 21%, to $1.6 million for the three months ended December 31, 2019, as compared to $2.0 million for the three months ended December 31, 2018. This change was primarily due to a reduction in our long-term debt, in addition to an increase in interest income generated on our cash and cash equivalents.
Income tax provision
The provision for income taxes was $3.0 million, or an effective rate of 27.1%, for the three months ended December 31, 2019, as compared to $1.0 million, or an effective rate of 9.5%, for the three months ended December 31, 2018. The change was driven by lower discrete tax benefits of $2.4 million, primarily related to share-based compensation in 2018.
Comparison of the nine months ended December 31, 2019 to the nine months ended December 31, 2018
Net sales
Net sales increased 3%, or $6.6 million, to $208.1 million for the nine months ended December 31, 2019, from $201.5 million for the nine months ended December 31, 2018. The increase was primarily driven by increased productivity across channels, partially offset by the closing of all 22 e.l.f. retail stores in February 2019.
Gross profit
Gross profit increased $10.5 million, or 9%, to $133.1 million for the nine months ended December 31, 2019, compared to $122.5 million for the nine months ended December 31, 2018. Gross margin increased to 64% from 61%, when compared to the nine months ended December 31, 2018, with benefits primarily from margin accretive innovation, cost savings, favorable movements in foreign exchange rates and price increases, partially offset by higher sales adjustments and the impact of tariffs on goods imported from China.
Selling, general and administrative expenses
SG&A expenses were $110.1 million for the nine months ended December 31, 2019, an increase of $9.8 million, or 10%, from $100.3 million for the nine months ended December 31, 2018. SG&A expenses as a percentage of net sales increased to 53% for the nine months ended December 31, 2019 from 50% for the nine months ended December 31, 2018. The $9.8 million increase was primarily due to investments in marketing and digital expenses, bonus accrual, and increased depreciation expenses driven by customer fixture programs. These increases were partially offset by the closure of e.l.f retail stores.

22




Restructuring income
Activities related to the Restructuring Plan generated income of $6.0 million for the nine months ended December 31, 2019 and included a $7.7 million gain related to operating lease liabilities that were extinguished. The remainder of restructuring expense consisted of $1.8 million in other costs, which were primarily legal fees related to these extinguishments. As of December 31, 2019, 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 income (expense), net
Other income (expense), net increased by $0.1 million to $0.6 million for the nine months ended December 31, 2019, as compared to $0.5 million for the nine months ended December 31, 2018 primarily due to foreign exchange rate movements.
Interest expense, net
Interest expense, net decreased $0.9 million, or 16%, to $4.9 million for the nine months ended December 31, 2019, as compared to $5.9 million for the nine months ended December 31, 2018. This change was primarily due to an increase in interest income generated on our cash and cash equivalents, in addition to a reduction in our long-term debt.
Income tax provision
The provision for income taxes was $6.4 million, or an effective rate of 25.9%, for the nine months ended December 31, 2019, as compared to $2.0 million, or an effective rate of 11.9%, for the nine months ended December 31, 2018. The change was primarily driven by an increase in income before taxes of $7.8 million and a decrease in discrete tax benefit of $2.8 million, primarily related to share-based compensation in 2018.
Financial condition, liquidity and capital resources
Overview
As of December 31, 2019, we held $74.7 million of cash and cash equivalents which consisted of cash and money market funds. In addition, as of December 31, 2019, we had borrowing capacity of $49.8 million under our Revolving Credit Facility (as defined below under "Description of indebtedness").
Our primary cash needs are for capital expenditures, retail product displays and working capital, as well as any share repurchase activity we choose to effect pursuant to the Share Repurchase Program (as defined in “Risk Factors” in Part II, Item 1A). Capital expenditures typically vary depending on strategic imperatives selected for the fiscal year, including investments in infrastructure, digital capabilities and expansion into additional national 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 of December 31, 2019, we had working capital, excluding cash, of $30.2 million, compared to $38.3 million as of March 31, 2019. Working capital, excluding cash and debt, was $42.2 million and $48.5 million as of December 31, 2019 and March 31, 2019, 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 12 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. 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 listed under “Risk Factors” in Part II, Item 1A. and elsewhere in this Quarterly Report. 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.

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Cash flows
 
Nine months ended December 31,
(in thousands)
2019
 
2018
Net cash provided by (used in):
 
 
 
Operating activities
$
37,800

 
$
50,552

Investing activities
(7,073
)
 
(6,205
)
Financing activities
(9,861
)
 
(3,616
)
Net increase in cash:
$
20,866

 
$
40,731

Cash provided by operating activities
For the nine months ended December 31, 2019, net cash provided by operating activities was $37.8 million. This included net income before adding depreciation, amortization and other non-cash items of $42.2 million and an increase in net working capital of $4.4 million. The increase in net working capital was driven by an $11.2 million decrease in other liabilities primarily related to termination payments on store leases, partially offset by the timing of cash payments related to accounts payable and accrued expenses.
Cash used in investing activities
For the nine months ended December 31, 2019, net cash used in investing activities was $7.1 million, compared to $6.2 million for the nine months ended December 31, 2018. The increase was primarily driven by new customer fixture programs in the nine months ended December 31, 2019.
Cash used in financing activities
For the nine months ended December 31, 2019, net cash used in financing activities was $9.9 million and was primarily related to mandatory principal payments under our Term Loan Facility (as defined below under " Description of indebtedness"), as well as share repurchases made pursuant to the Share Repurchase Program.
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 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.
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 December 31, 2019 was $49.8 million.
The Term Loan Facility maturity date is also August 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) $2,475,000 for fiscal quarters ending September 30, 2019 through June 30, 2020, (ii) $3,093,750 for fiscal quarters ending September 30, 2020 through June 30, 2021 and (iii) $4,125,000 for fiscal quarters ending September 30, 2021 through June 30, 2022. The remaining Term Loan Facility balance is due upon the maturity date on August 25, 2022. 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 12 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 for U.S. dollar deposits for the applicable interest period

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(subject to a minimum floor of 0%) plus an applicable margin ranging from 1.50% to 2.75% (amended from 2.00% to 3.50% as previously set forth in the Credit Agreement) based on our consolidated total net leverage ratio or (ii) a floating base rate plus an applicable margin ranging from 0.50% to 1.75% (amended from 1.00% to 2.50% as previously set forth in the Credit Agreement) based on our consolidated total net leverage ratio. The interest rate as of December 31, 2019 for the Term Loan Facility was approximately 3.9%.
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 of December 31, 2019, we were in compliance with all applicable 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 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, 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 of December 31, 2019, 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 of December 31, 2019, 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 in SEC rules and forms and that such information is accumulated and 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 in our internal control over financial reporting during the period covered by this Quarterly Report that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
PART II. OTHER INFORMATION

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Item 1. Legal proceedings
We are involved from time to time in various legal proceedings arising in the ordinary course of business. Although the outcome of any pending matters, and the amount, if any, of our ultimate liability and any other forms of remedies with respect to these matters, cannot be determined or predicted with certainty, we do not believe that the ultimate outcome of these matters will have a material adverse effect on our business, results of operations or financial condition.
Item 1A. Risk factors
Certain risks may have a material adverse effect on our business, financial condition and results of operations. These risks include those described below and may include additional risks and uncertainties not presently known to us or that we currently deem immaterial. These risks should be read in conjunction with the other information in this Quarterly Report, including our condensed consolidated financial statements and related notes thereto and “Management’s discussion and analysis of financial condition and results of operations” in Part I, Item 2 of this Quarterly Report.
We have marked with an asterisk (*) those risks described below that reflect changes from, or additions to, the risks described in our Annual Report.
The beauty industry is highly competitive, and if we are unable to compete effectively our results will suffer.
We face vigorous competition from companies throughout the world, including large multinational consumer products companies that have many beauty brands under ownership and standalone beauty brands, including those that may target the latest trends or specific distribution channels. Competition in the beauty industry is based on the introduction of new products, pricing of products, quality of products and packaging, brand awareness, perceived value and quality, innovation, in-store presence and visibility, promotional activities, advertising, editorials, e-commerce and mobile-commerce initiatives and other activities. We must compete with a high volume of new product introductions and existing products by diverse companies across several different distribution channels.
Many multinational consumer companies have greater financial, technical or marketing resources, longer operating histories, greater brand recognition or larger customer bases than we do and may be able to respond more effectively to changing business and economic conditions than we can. Many of these competitors’ products are sold in a wider selection or greater number of retail stores and possess a larger presence in these stores, typically having significantly more inline shelf space than we do. Given the finite space allocated to beauty products by retail stores, our ability to grow the number of retail stores in which our products are sold and expand our space allocation once in these retail stores may require the removal or reduction of the shelf space of these competitors. We may be unsuccessful in our growth strategy in the event retailers do not reallocate shelf space from our competitors to us. Increasing shelf space allocated to our products may be especially challenging in instances when a retailer has their own brand. In addition, our competitors may attempt to gain market share by offering products at prices at or below the prices at which our products are typically offered, including through the use of large percentage discounts and “buy one and get one free” offers. Competitive pricing may require us to reduce our prices, which would decrease our profitability or result in lost sales. Our competitors, many of whom have greater resources than we do, may be better able to withstand these price reductions and lost sales.
It is difficult for us to predict the timing and scale of our competitors’ activities in these areas or whether new competitors will emerge in the beauty industry. In recent years, numerous online, “indie” and influencer-backed beauty companies have emerged and garnered significant followings. In addition, further technological breakthroughs, including new and enhanced technologies which increase competition in the online retail market, new product offerings by competitors and the strength and success of our competitors’ marketing programs may impede our growth and the implementation of our business strategy.
Our ability to compete also depends on the continued strength of our brand and products, the success of our marketing, innovation and execution strategies, the continued diversity of our product offerings, the successful management of new product introductions and innovations, strong operational execution, including in order fulfillment, and our success in entering new markets and expanding our business in existing geographies. If we are unable to continue to compete effectively, it could have a material adverse effect on our business, results of operations and financial condition.

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Our new product introductions may not be as successful as we anticipate.
The beauty industry is driven in part by fashion and beauty trends, which may shift quickly. Our continued success depends on our ability to anticipate, gauge and react in a timely and cost-effective manner to changes in consumer preferences for beauty products, consumer attitudes toward our industry and brand and where and how consumers shop for those products. We must continually work to develop, produce and market new products, maintain and enhance the recognition of our brand, maintain a favorable mix of products and develop our approach as to how and where we market and sell our products.
We have an established process for the development, evaluation and validation of our new product concepts. Nonetheless, each new product launch involves risks, as well as the possibility of unexpected consequences. For example, the acceptance of new product launches and sales to our retail customers may not be as high as we anticipate, due to lack of acceptance of the products themselves or their price, or limited effectiveness of our marketing strategies. In addition, our ability to launch new products may be limited by delays or difficulties affecting the ability of our suppliers or manufacturers to timely manufacture, distribute and ship new products or displays for new products. Sales of new products may be affected by inventory management by our retail customers, and we may experience product shortages or limitations in retail display space by our retail customers. We may also experience a decrease in sales of certain existing products as a result of newly-launched products, the impact of which could be exacerbated by shelf space limitations or any shelf space loss. Any of these occurrences could delay or impede our ability to achieve our sales objectives, which could have a material adverse effect on our business, financial condition and results of operations.
As part of our ongoing business strategy, we expect we will need to continue to introduce new products in the eyes, lips, face, kits, tools and skin care categories, while also expanding our product launches into adjacent categories in which we may have little to no operating experience. The success of product launches in adjacent product categories could be hampered by our relative inexperience operating in such categories, the strength of our competitors or any of the other risks referred to above. Furthermore, any expansion into new product categories may prove to be an operational and financial constraint which inhibits our ability to successfully accomplish such expansion. Our inability to introduce successful products in our traditional categories or in adjacent categories could limit our future growth and have a material adverse effect on our business, financial condition and results of operations.
We depend on a limited number of retailers for a large portion of our net sales, and the loss of one or more of these retailers, or business challenges at one or more of these retailers, could adversely affect our results of operations.
A limited number of our retail customers account for a large percentage of our net sales. Walmart and Target accounted for 30% and 21%, respectively, of our net sales in calendar year 2018. We expect a small number of retailers will, in the aggregate, continue to account for the majority of our net sales for foreseeable future periods. Any changes in the policies or our ability to meet the demands of our retail customers relating to service levels, inventory de-stocking, pricing and promotional strategies or limitations on access to display space could have a material adverse effect on our business, financial condition and results of operations.
As is typical in our industry, our business with retailers is based primarily upon discrete sales orders, and we do not have contracts requiring retailers to make firm purchases from us. Accordingly, retailers could reduce their purchasing levels or cease buying products from us at any time and for any reason. If we lose a significant retail customer or if sales of our products to a significant retailer materially decrease, it could have a material adverse effect on our business, financial condition and results of operations.
Because a high percentage of our sales are made through our retail customers, our results are subject to risks relating to the general business performance of our key retail customers. Factors that adversely affect our retail customers’ businesses may also have a material adverse effect on our business, financial condition and results of operations. These factors may include:
any reduction in consumer traffic and demand at our retail customers as a result of economic downturns, changes in consumer preferences or reputational damage as a result of, among other developments, data privacy breaches, regulatory investigations or employee misconduct;
any credit risks associated with the financial condition of our retail customers;
the effect of consolidation or weakness in the retail industry or at certain retail customers, including store closures and the resulting uncertainty; and
inventory reduction initiatives and other factors affecting retail customer buying patterns, including any reduction in retail space committed to beauty products and retailer practices used to control inventory shrinkage.

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Our success depends, in part, on the quality, performance and safety of our products.
Any loss of confidence on the part of consumers in the ingredients used in our products, whether related to product contamination or product safety or quality failures, actual or perceived, or inclusion of prohibited ingredients, could tarnish the image of our brand and could cause consumers to choose other products. Allegations of contamination or other adverse effects on product safety or suitability for use by a particular consumer, even if untrue, may require us to expend significant time and resources responding to such allegations and could, from time to time, result in a recall of a product from any or all of the markets in which the affected product was distributed. Any such issues or recalls could negatively affect our profitability and brand image.
If our products are found to be, or perceived to be, defective or unsafe, or if they otherwise fail to meet our consumers’ expectations, our relationships with consumers could suffer, the appeal of our brand could be diminished, we may need to recall some of our products and/or become subject to regulatory action, and we could lose sales or market share or become subject to boycotts or liability claims. In addition, safety or other defects in our competitors’ products could reduce consumer demand for our own products if consumers view them to be similar. Any of these outcomes could result in a material adverse effect on our business, financial condition and results of operations.
We may not be able to successfully implement our growth strategy.*
Our future growth, profitability and cash flows depend upon our ability to successfully implement our business strategy, which, in turn, is dependent upon a number of key initiatives, including our ability to:
drive demand in the brand;
invest in digital capabilities;
improve productivity in our national retailers;
focus on first-to-mass by providing prestige quality products at an extraordinary value; and
implement the necessary cost savings to help fund our marketing and digital investments.
There can be no assurance that we can successfully achieve any or all of the above initiatives in the manner or time period that we expect. Further, achieving these objectives will require investments which may result in short-term cost increases with net sales materializing on a longer term horizon and therefore may be dilutive to our earnings. We cannot provide any assurance that we will realize, in full or in part, the anticipated benefits we expect our strategy will achieve. The failure to realize those benefits could have a material adverse effect on our business, financial condition and results of operations.
Our growth and profitability are dependent on a number of factors, and our historical growth may not be indicative of our future growth.
Our historical growth should not be considered as indicative of our future performance. We may not be successful in executing our growth strategy, and even if we achieve our strategic plan, we may not be able to sustain profitability. In future periods, our revenue could decline or grow more slowly than we expect. We also may incur significant losses in the future for a number of reasons, including the following risks and the other risks described in this Quarterly Report, and we may encounter unforeseen expenses, difficulties, complications, delays and other unknown factors:
we may lose one or more significant retail customers, or sales of our products through these retail customers may decrease;
the ability of our third-party suppliers and manufacturers to produce our products and of our distributors to distribute our products could be disrupted;
because substantially all of our products are sourced and manufactured in China, our operations are susceptible to risks inherent in doing business there;
our products may be the subject of regulatory actions, including but not limited to actions by the Food and Drug Administration (the “FDA”), the Federal Trade Commission (the “FTC”) and the Consumer Product Safety Commission (the “CPSC”) in the United States;
we may be unable to introduce new products that appeal to consumers or otherwise successfully compete with our competitors in the beauty industry;

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we may be unsuccessful in enhancing the recognition and reputation of our brand, and our brand may be damaged as a result of, among other reasons, our failure, or alleged failure, to comply with applicable ethical, social, product, labor or environmental standards;
we may experience service interruptions, data corruption, cyber-based attacks or network security breaches which result in the disruption of our operating systems or the loss of confidential information of our consumers;
we may be unable to retain key members of our senior management team or attract and retain other qualified personnel; and
we may be affected by any adverse economic conditions in the United States or internationally.
We may be unable to grow our business effectively or efficiently, which would harm our business, financial condition and results of operations.
Growing our business will place a strain on our management team, financial and information systems, supply chain and distribution capacity and other resources. To manage growth effectively, we must continue to enhance our operational, financial and management systems, including our warehouse management and inventory control; maintain and improve our internal controls and disclosure controls and procedures; maintain and improve our information technology systems and procedures; and expand, train and manage our employee base.
We may not be able to effectively manage this expansion in any one or more of these areas, and any failure to do so could significantly harm our business, financial condition and results of operations. Growing our business may make it difficult for us to adequately predict the expenditures we will need to make in the future. If we do not make the necessary overhead expenditures to accommodate our future growth, we may not be successful in executing our growth strategy, and our results of operations would suffer.
Any damage to our reputation or brand may materially and adversely affect our business, financial condition and results of operations.
We believe that developing and maintaining our brand is critical and that our financial success is directly dependent on consumer perception of our brand. Furthermore, the importance of our brand recognition may become even greater as competitors offer more products similar to ours.
We have relatively low brand awareness among consumers when compared to other beauty brands and maintaining and enhancing the recognition and reputation of our brand is critical to our business and future growth. Many factors, some of which are beyond our control, are important to maintaining our reputation and brand. These factors include our ability to comply with ethical, social, product, labor and environmental standards. Any actual or perceived failure in compliance with such standards could damage our reputation and brand.
The growth of our brand depends largely on our ability to provide a high-quality consumer experience, which in turn depends on our ability to bring innovative products to the market at competitive prices that respond to consumer demands and preferences. Additional factors affecting our consumer experience include our ability to provide appealing store sets in retail stores, the maintenance and stocking of those sets by our retail customers, the overall shopping experience provided by our retail customers, a reliable and user-friendly website interface and mobile applications for our consumers to browse and purchase products on our e-commerce websites. If we are unable to preserve our reputation, enhance our brand recognition or increase positive awareness of our products and in-store and Internet platforms, it may be difficult for us to maintain and grow our consumer base, and our business, financial condition and results of operations may be materially and adversely affected.
The success of our brand may also suffer if our marketing plans or product initiatives do not have the desired impact on our brand’s image or its ability to attract consumers. Further, our brand value could diminish significantly due to a number of factors, including consumer perception that we have acted in an irresponsible manner, adverse publicity about our products, our failure to maintain the quality of our products, product contamination, the failure of our products to deliver consistently positive consumer experiences, or the products becoming unavailable to consumers.

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A disruption in our operations could materially and adversely affect our business.
As a company engaged in distribution on a global scale, our operations, including those of our third-party manufacturers, suppliers, brokers and delivery service providers, are subject to the risks inherent in such activities, including industrial accidents, environmental events, strikes and other labor disputes, disruptions in information systems, product quality control, safety, licensing requirements and other regulatory issues, as well as natural disasters, pandemics (such as the coronavirus), border disputes, acts of terrorism and other external factors over which we and our third-party manufacturers, suppliers, brokers and delivery service providers have no control. The loss of, or damage to, the manufacturing facilities or distribution centers of our third-party manufacturers, suppliers, brokers and delivery service providers could materially and adversely affect our business, financial condition and results of operations.
We depend heavily on ocean container delivery to receive shipments of our products from our third-party manufacturers located in China and contracted third-party delivery service providers to deliver our products to our distribution facilities and logistics providers, and from there to our retail customers. Further, we rely on postal and parcel carriers for the delivery of products sold directly to consumers through our e-commerce websites. Interruptions to or failures in these delivery services could prevent the timely or successful delivery of our products. These interruptions or failures may be due to unforeseen events that are beyond our control or the control of our third-party delivery service providers, such as inclement weather, natural disasters or labor unrest. If our products are not delivered on time or are delivered in a damaged state, retail customers and consumers may refuse to accept our products and have less confidence in our services. Furthermore, the delivery personnel of contracted third-party delivery service providers act on our behalf and interact with our consumers personally. Any failure to provide high-quality delivery services to our consumers may negatively affect the shopping experience of our consumers, damage our reputation and cause us to lose consumers.
Our ability to meet the needs of our consumers and retail customers depends on the proper operation of our distribution facilities, where most of our inventory that is not in transit is housed. Although we currently insure our inventory, our insurance coverage may not be sufficient to cover the full extent of any loss or damage to our inventory or distribution facilities, and any loss, damage or disruption of the facilities, or loss or damage of the inventory stored there, could materially and adversely affect our business, financial condition and results of operations.
The recent coronavirus outbreak in China could materially and adversely affect our business*
In December 2019, a novel strain of coronavirus was reported to have surfaced in Wuhan, China. We currently source and manufacture substantially all of our products from third-party suppliers and manufacturers in China, and have employees in Shanghai, China to manage our supply chain. The outbreak of the coronavirus and other adverse public health developments could materially and adversely affect our business, financial condition and results of operations. These could include disruptions from the temporary closure of third-party supplier and manufacturer facilities and/or our China office, restrictions on the export or shipment of our products, significant cutback of ocean container delivery from China and restrictions on our employees' and other service providers' ability to travel. For example, on January 27, 2020, the Shanghai city government issued a notice that most employers, including our offices, may not reopen until February 10, 2020, extending the spring festival holiday. The extent to which the coronavirus impacts our results will depend on future developments, which are highly uncertain and cannot be predicted, including new information which may emerge concerning the severity of the coronavirus and the actions to contain the coronavirus or treat its impact, among others.
We rely on third-party suppliers, manufacturers, distributors and other vendors, and they may not continue to produce products or provide services that are consistent with our standards or applicable regulatory requirements, which could harm our brand, cause consumer dissatisfaction, and require us to find alternative suppliers of our products or services.
We use multiple third-party suppliers and manufacturers based in China and the United States to source and manufacture substantially all of our products. We engage our third-party suppliers and manufacturers on a purchase order basis and are not party to long-term contracts with any of them. The ability of these third parties to supply and manufacture our products may be affected by competing orders placed by other persons and the demands of those persons. If we experience significant increases in demand or need to replace a significant number of existing suppliers or manufacturers, there can be no assurance that additional supply and manufacturing capacity will be available when required on terms that are acceptable to us, or at all, or that any supplier or manufacturer will allocate sufficient capacity to us in order to meet our requirements.
In addition, quality control problems, such as the use of ingredients and delivery of products that do not meet our quality control standards and specifications or comply with applicable laws or regulations, could harm our business. These quality control problems could result in regulatory action, such as restrictions on importation, products of inferior quality or product stock outages or shortages, harming our sales and creating inventory write-downs for unusable products.

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We have also outsourced significant portions of our distribution process, as well as certain technology-related functions, to third-party service providers. Specifically, we rely on third-party distributors to sell our products in a number of foreign countries, our warehouses and distribution facilities are managed and staffed by third-party service providers, we are dependent on a single third-party vendor for credit card processing and we utilize a third-party hosting and networking provider to host our e-commerce websites. The failure of one or more of these entities to provide the expected services on a timely basis, or at all, or at the prices we expect, or the costs and disruption incurred in changing these outsourced functions to being performed under our management and direct control or that of a third-party, may have a material adverse effect on our business, financial condition and results of operations. We are not party to long-term contracts with some of our distributors, and upon expiration of these existing agreements, we may not be able to renegotiate the terms on a commercially reasonable basis, or at all.
Further, our third-party manufacturers, suppliers and distributors may:
have economic or business interests or goals that are inconsistent with ours;
take actions contrary to our instructions, requests, policies or objectives;
be unable or unwilling to fulfill their obligations under relevant purchase orders, including obligations to meet our production deadlines, quality standards, pricing guidelines and product specifications, or to comply with applicable regulations, including those regarding the safety and quality of products and ingredients and good manufacturing practices;
have financial difficulties;
encounter raw material or labor shortages;
encounter increases in raw material or labor costs which may affect our procurement costs;
disclose our confidential information or intellectual property to competitors or third parties;
engage in activities or employ practices that may harm our reputation; and
work with, be acquired by, or come under control of, our competitors.
The occurrence of any of these events, alone or together, could have a material adverse effect on our business, financial condition and results of operations. In addition, such problems may require us to find new third-party suppliers, manufacturers or distributors, and there can be no assurance that we would be successful in finding third-party suppliers, manufacturers or distributors meeting our standards of innovation and quality.
The management and oversight of the engagement and activities of our third-party suppliers, manufacturers and distributors requires substantial time, effort and expense of our employees, and we may be unable to successfully manage and oversee the activities of our third-party manufacturers, suppliers and distributors. If we experience any supply chain disruptions caused by our manufacturing process or by our inability to locate suitable third-party manufacturers or suppliers, or if our manufacturers or raw material suppliers experience problems with product quality or disruptions or delays in the manufacturing process or delivery of the finished products or the raw materials or components used to make such products, our business, financial condition and results of operations could be materially and adversely affected.
If we fail to manage our inventory effectively, our results of operations, financial condition and liquidity may be materially and adversely affected.
Our business requires us to manage a large volume of inventory effectively. We depend on our forecasts of demand for, and popularity of, various products to make purchase decisions and to manage our inventory of stock-keeping units. Demand for products, however, can change significantly between the time inventory or components are ordered and the date of sale. Demand may be affected by seasonality, new product launches, rapid changes in product cycles and pricing, product defects, promotions, changes in consumer spending patterns, changes in consumer tastes with respect to our products and other factors, and our consumers may not purchase products in the quantities that we expect. It may be difficult to accurately forecast demand and determine appropriate levels of product or componentry. We generally do not have the right to return unsold products to our suppliers. If we fail to manage our inventory effectively or negotiate favorable credit terms with third-party suppliers, we may be subject to a heightened risk of inventory obsolescence, a decline in inventory values, and significant inventory write-downs or write-offs. In addition, if we are required to lower sale prices in order to reduce inventory level or to pay higher prices to our suppliers, our profit margins might be negatively affected. Any of the above may materially and adversely affect our business, financial condition and results of operations. See also “—Our quarterly results of operations

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fluctuate due to seasonality, order patterns from key retail customers and other factors, and we may not have sufficient liquidity to meet our seasonal working capital requirements.”
Our substantial indebtedness may have a material adverse effect on our business, financial condition and results of operations.*
As of December 31, 2019, we had a total of $141.4 million of indebtedness, consisting of amounts outstanding under our credit facilities and capital lease obligations, and a total availability of $49.8 million under our Revolving Credit Facility. Our indebtedness could have significant consequences, including:
requiring a substantial portion of our cash flows to be dedicated to debt service payments instead of funding growth, working capital, capital expenditures, investments or other cash requirements;
reducing our flexibility to adjust to changing business conditions or obtain additional financing;
exposing us to the risk of increased interest rates as our borrowings are at variable rates;
making it more difficult for us to make payments on our indebtedness;
subjecting us to restrictive covenants that may limit our flexibility in operating our business, including our ability to take certain actions with respect to indebtedness, liens, sales of assets, consolidations and mergers, affiliate transactions, dividends and other distributions and changes of control;
subjecting us to maintenance covenants which require us to maintain specific financial ratios; and
limiting our ability to obtain additional financing for working capital, capital expenditures, debt service requirements and general corporate or other purposes.
Our quarterly results of operations fluctuate due to seasonality, order patterns from key retail customers and other factors, and we may not have sufficient liquidity to meet our seasonal working capital requirements.*
We generate a significant portion of our net sales in the second and third quarters of our fiscal year as a result of higher sales during the holiday season, and adverse events that occur during the second or third fiscal quarter could have a disproportionate effect on our results of operations for the entire fiscal year. As a result of higher sales during the second and third fiscal quarters, we are required to make investments in working capital during the first and second quarters of the fiscal year. In addition to holiday seasonality, we may experience variability in net sales and net income throughout the fiscal year as a result of the size and timing of orders from our 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 reduce our liquidity.
Furthermore, product orders from our large retail customers may vary over time due to changes in their inventory or out-of-stock policies. If we were to experience a significant shortfall in sales or profitability or internally generated funds, we may not have sufficient liquidity to fund our business. As a result of quarterly fluctuations caused by these and other factors, comparisons of our operating results across different fiscal quarters may not be accurate indicators of our future performance. Any quarterly fluctuations that we report in the future may differ from the expectations of market analysts and investors, which could cause the price of our common stock to fluctuate significantly.
We are increasingly dependent on information technology, and if we are unable to protect against service interruptions, data corruption, cyber-based attacks or network security breaches, our operations could be disrupted.*
We rely on information technology networks and systems to market and sell our products, to process electronic and financial information, to manage a variety of business processes and activities and to comply with regulatory, legal and tax requirements. We are increasingly dependent on a variety of information systems to effectively process retail customer orders, and fulfill consumer orders from our e-commerce business. We depend on our information technology infrastructure for digital marketing activities and for electronic communications among our personnel, retail customers, consumers, manufacturers and suppliers around the world. These information technology systems, some of which are managed by third parties, may be susceptible to damage, disruptions or shutdowns due to failures during the process of upgrading or replacing software, databases or components, power outages, hardware failures, computer viruses, attacks by computer hackers, telecommunication failures, user errors or catastrophic events. Any material disruption of our systems, or the systems of our third-party service providers, could disrupt our ability to track, record and analyze the products that we sell and could negatively impact our operations, shipment of goods, ability to process financial information and transactions, and our ability to receive and process retail customer and e-commerce orders or engage in normal business activities. If our information technology systems suffer damage, disruption or shutdown, we may incur substantial cost in repairing or replacing these

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systems, and if we do not effectively resolve the issues in a timely manner, our business, financial condition and results of operations may be materially and adversely affected, and we could experience delays in reporting our financial results.
Our e-commerce operations are important to our business. Our e-commerce websites serve as an effective extension of our marketing strategies by introducing potential new consumers to our brand, product offerings and enhanced content. Due to the importance of our e-commerce operations, we are vulnerable to website downtime and other technical failures. Our failure to successfully respond to these risks in a timely manner could reduce e-commerce sales and damage our brand’s reputation.
We must successfully maintain and upgrade our information technology systems, and our failure to do so could have a material adverse effect on our business, financial condition and results of operations.
We have identified the need to significantly expand and improve our information technology systems and personnel to support recent and expected future growth. As such, we are in process of implementing, and will continue to invest in and implement, significant modifications and upgrades to our information technology systems and procedures, including replacing legacy systems with successor systems, making changes to legacy systems or acquiring new systems with new functionality, hiring employees with information technology expertise and building new policies, procedures, training programs and monitoring tools. These types of activities subject us to inherent costs and risks associated with replacing and changing these systems, including impairment of our ability to leverage our e-commerce channels, fulfill customer orders, potential disruption of our internal control structure, substantial capital expenditures, additional administration and operating expenses, acquisition and retention of sufficiently skilled personnel to implement and operate the new systems, demands on management time and other risks and costs of delays or difficulties in transitioning to or integrating new systems into our current systems. These implementations, modifications and upgrades may not result in productivity improvements at a level that outweighs the costs of implementation, or at all. In addition, difficulties with implementing new technology systems, delays in our timeline for planned improvements, significant system failures, or our inability to successfully modify our information systems to respond to changes in our business needs may cause disruptions in our business operations and have a material adverse effect on our business, financial condition and results of operations.
If we fail to adopt new technologies or adapt our e-commerce websites and systems to changing consumer requirements or emerging industry standards, our business may be materially and adversely affected.*
To remain competitive, we must continue to enhance and improve the responsiveness, functionality and features of our information technology, including our e-commerce websites and mobile applications (if we develop any). Our competitors are continually developing innovations and introducing new products to increase their consumer base and enhance user experience. As a result, in order to attract and retain consumers and compete against our competitors, we must continue to invest resources to enhance our information technology and improve our existing products and services for our consumers. The Internet and the online retail industry are characterized by rapid technological evolution, changes in consumer requirements and preferences, frequent introductions of new products and services embodying new technologies and the emergence of new industry standards and practices, any of which could render our existing technologies and systems obsolete. Our success will depend, in part, on our ability to identify, develop, acquire or license leading technologies useful in our business, and respond to technological advances and emerging industry standards and practices in a cost-effective and timely way. The development of our e-commerce websites and other proprietary technology entails significant technical and business risks. There can be no assurance that we will be able to properly implement or use new technologies effectively or adapt our e-commerce websites and systems to meet consumer requirements or emerging industry standards. If we are unable to adapt in a cost-effective and timely manner in response to changing market conditions or consumer requirements, whether for technical, legal, financial or other reasons, our business, financial condition and results of operations may be materially and adversely affected.
Failure to protect sensitive information of our consumers and information technology systems against security breaches could damage our reputation and brand and substantially harm our business, financial condition and results of operations.*
We collect, maintain, transmit and store data about our consumers, suppliers and others, including personally identifiable information and financial information, as well as other confidential and proprietary information important to our business. We also employ third-party service providers that collect, store, process and transmit proprietary, personal and confidential information, including consumer payment information, on our behalf.
Advances in technology, the expertise of criminals, new discoveries in the field of cryptography, acts or omissions by our employees, contractors or service providers or other events or developments could result in a compromise or breach in the security of confidential or sensitive information. We and our service providers may not be able to prevent third parties, including criminals, competitors or others, from breaking into or altering our systems, disrupting business operations or

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communications infrastructure through denial-of-service attacks, attempting to gain access to our systems, information or monetary funds through phishing or social engineering campaigns, installing viruses or malicious software on our e-commerce websites or devices used by our employees or contractors, or carrying out other activity intended to disrupt our systems or gain access to confidential or sensitive information in our or our service providers’ systems. We are not aware of any breach or compromise of the personal data of our customers, but we have been subject to attacks (e.g. phishing, denial of service, etc.) and cannot guarantee that our security measures will be sufficient to prevent a material breach or compromise in the future.
Furthermore, such third parties may engage in various other illegal activities using such information, including credit card fraud or identity theft, which may cause additional harm to us, our consumers and our brand. We also may be vulnerable to error or malfeasance by our own employees or other insiders. Third parties may attempt to fraudulently induce our or our service providers’ employees to misdirect funds or to disclose information in order to gain access to personal data we maintain about our consumers or website users. In addition, we have limited control or influence over the security policies or measures adopted by third-party providers of online payment services through which some of our consumers may elect to make payment for purchases at our e-commerce websites. Contracted third-party delivery service providers may also violate their confidentiality or data processing obligations and disclose or use information about our consumers inadvertently or illegally.
If any breach of information security were to occur, our reputation and brand could be damaged, our business may suffer, we could be required to expend significant capital and other resources to alleviate problems caused by such breaches, and we could be exposed to a risk of loss, litigation or regulatory action and possible liability. Actual or anticipated attacks may cause us to incur increasing costs, including costs to deploy additional personnel and protection technologies, train employees and engage third-party experts and consultants. In addition, any party who is able to illicitly obtain a subscriber’s password could access the subscriber’s financial, transaction or personal information. Any compromise or breach of our security measures, or those of our third-party service providers, may violate applicable privacy, data security and other laws, and cause significant legal and financial exposure, adverse publicity, and a loss of confidence in our security measures, all of which could have a material adverse effect on our business, financial condition and results of operations. We may be subject to post-breach review of the adequacy of our privacy and security controls by regulators and other third parties, which could result in post-breach regulatory and consumer litigation and regulatory oversight, at significant expense and risking reputational harm. We are subject to diverse laws and regulations in the United States and abroad requiring notification to affected individuals in the event of a breach involving personal information. Failure to comply with these regulations could subject us to regulatory scrutiny and additional liability. Although we maintain privacy, data breach and network security liability insurance, we cannot be certain that our coverage will be adequate for liabilities actually incurred or that insurance will continue to be available to us on economically reasonable terms, or at all. We may need to devote significant resources to protect against security breaches or to address problems caused by breaches, diverting resources from the growth and expansion of our business.
Payment methods used on our e-commerce websites subject us to third-party payment processing-related risks.*
We accept payments from our consumers using a variety of methods, including online payments with credit cards and debit cards issued by major banks in the United States and the United Kingdom, payments made with gift cards processed by third-party providers and payment through third-party online payment platforms such as PayPal, Afterpay, and Apple Pay. We also rely on third parties to provide payment processing services. For certain payment methods, including credit and debit cards, we pay interchange and other fees, which may increase over time and raise our operating costs and lower our profit margins. We may also be subject to fraud and other illegal activities in connection with the various payment methods we offer, including online payment options and gift cards. Transactions on our e-commerce websites are card-not-present transactions, so they present a greater risk of fraud. Criminals are using increasingly sophisticated methods to engage in illegal activities such as unauthorized use of credit or debit cards and bank account information. Requirements relating to consumer authentication and fraud detection with respect to online sales are complex. We may ultimately be held liable for the unauthorized use of a cardholder’s card number in an illegal activity and be required by card issuers to pay charge-back fees. Charge-backs result not only in our loss of fees earned with respect to the payment, but also leave us liable for the underlying money transfer amount. If our charge-back rate becomes excessive, card associations also may require us to pay fines or refuse to process our transactions. In addition, we may be subject to additional fraud risk if third-party service providers or our employees fraudulently use consumer information for their own gain or facilitate the fraudulent use of such information. Overall, we may have little recourse if we process a criminally fraudulent transaction.
We are subject to payment card association operating rules, certification requirements and various rules, regulations and requirements governing electronic funds transfers, which could change or be reinterpreted to make it difficult or impossible for us to comply. As our business changes we may also be subject to different rules under existing standards, which may require new assessments that involve costs above what we currently pay for compliance. If we fail to comply with the rules or requirements of any provider of a payment method we accept, or if the volume of fraud in our transactions limits or

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terminates our rights to use payment methods we currently accept, or if a data breach occurs relating to our payment systems, among other things, we may be subject to fines and higher transaction fees and lose our ability to accept credit and debit card payments from our consumers, process electronic funds transfers or facilitate other types of online payments, and our reputation and our business, financial condition and results of operations could be materially and adversely affected.
We have significant operations in China, which exposes us to risks inherent in doing business in that country.*
We currently source and manufacture substantially all of our products from third-party suppliers and manufacturers in China. As of December 31, 2019, we had a team of 69 employees in China to manage our supply chain. With the rapid development of the Chinese economy, the cost of labor has increased and may continue to increase in the future. Our results of operations will be materially and adversely affected if our labor costs, or the labor costs of our suppliers and manufacturers, increase significantly. In addition, we and our manufacturers and suppliers may not be able to find a sufficient number of qualified workers due to the intensely competitive and fluid market for skilled labor in China. Furthermore, pursuant to Chinese labor laws, employers in China are subject to various requirements when signing labor contracts, paying remuneration, determining the term of employees’ probation and unilaterally terminating labor contracts. These labor laws and related regulations impose liabilities on employers and may significantly increase the costs of workforce reductions. If we decide to change or reduce our workforce, these labor laws could limit or restrict our ability to make such changes in a timely, favorable and effective manner. Any of these events may materially and adversely affect our business, financial condition and results of operations.
Operating in China exposes us to political, legal and economic risks. In particular, the political, legal and economic climate in China, both nationally and regionally, is fluid and unpredictable. Our ability to operate in China may be adversely affected by changes in U.S. and Chinese laws and regulations such as those related to, among other things, taxation, import and export tariffs, environmental regulations, land use rights, intellectual property, currency controls, network security, employee benefits, hygiene supervision and other matters. In addition, we may not obtain or retain the requisite legal permits to continue to operate in China, and costs or operational limitations may be imposed in connection with obtaining and complying with such permits. In addition, Chinese trade regulations are in a state of flux, and we may become subject to other forms of taxation, tariffs and duties in China. Furthermore, the third parties we rely on in China may disclose our confidential information or intellectual property to competitors or third parties, which could result in the illegal distribution and sale of counterfeit versions of our products. If any of these events occur, our business, financial condition and results of operations could be materially and adversely affected. See also “—Recent and potential additional tariffs imposed by the United States government or a global trade war could increase the cost of our products, which could materially and adversely affect our business, financial condition and results of operations.”
Recent and potential additional tariffs imposed by the United States government or a global trade war could increase the cost of our products, which could materially and adversely affect our business, financial condition and results of operations.*
The United States government has imposed increased tariffs on certain imports from China, some of which cover products that we import from that country. We currently source and manufacture substantially all of our products from third-party suppliers and manufacturers in China, and as such, current tariffs may increase our cost of goods, which may result in lower gross margin on certain of our products. Despite the signing of a Phase One trade agreement between the United States and China, the majority of our products remain impacted by increased tariffs. In July 2019, we selectively increased prices on certain of our products, which could reduce the competitiveness of those products and consumer purchases thereof, as well as reduce consumer purchases of other non-affected products as well. Furthermore, similar effects may occur if we raise prices on other products to account for any increase in costs of goods. In any case, increased tariffs on imports from China could materially and adversely affect our business, financial condition and results of operations. In retaliation for the current United States tariffs, China has implemented tariffs on a wide range of American products. There is also a concern that the imposition of additional tariffs by the United States could result in the adoption of tariffs by other countries as well, leading to a global trade war. Trade restrictions implemented by the United States or other countries in connection with a global trade war could materially and adversely affect our business, financial condition and results of operations.

Changes in tax law, in our tax rates, or in exposure to additional income tax liabilities or assessments could materially and adversely affect our business, financial condition and results of operations.*
Changes in law and policy relating to taxes could materially and adversely affect our business, financial condition and results of operations. For example, the Tax Cuts and Jobs Act ("2017 Tax Act") remains unclear in many respects and could be subject to potential amendments and technical corrections and will be subject to interpretation and implementing regulations by the Treasury and U.S. Internal Revenue Service, any of which could mitigate or increase certain adverse effects of the 2017 Tax Act. In addition, it is still unclear how these U.S. federal income tax changes will affect state and local taxation.

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We collect and remit sales tax in all states that currently impose a sales tax, regardless of whether we have a “nexus” in that particular state. However, as we continue to expand our business internationally, the application and implementation of existing, new or future international laws regarding indirect taxes (such as a Value Added Tax) could materially and adversely affect our business, financial condition and results of operations.
If our cash from operations is not sufficient to meet our current or future operating needs, expenditures and debt service obligations, our business, financial condition and results of operations may be materially and adversely affected.
We may require additional cash resources due to changed business conditions or other future developments, including any marketing initiatives, investments or acquisitions we may decide to pursue. To the extent we are unable to generate sufficient cash flow, we may be forced to cancel, reduce or delay these activities. Alternatively, if our sources of funding are insufficient to satisfy our cash requirements, we may seek to obtain an additional credit facility or sell equity or debt securities. The sale of equity securities would result in dilution of our existing stockholders. The incurrence of additional indebtedness would result in increased debt service obligations and operating and financing covenants that could restrict our operations.
Our ability to generate cash to meet our operating needs, expenditures and debt service obligations will depend on our future performance and financial condition, which will be affected by financial, business, economic, legislative, regulatory and other factors, including potential changes in costs, pricing, the success of product innovation and marketing, competitive pressure and consumer preferences. If our cash flows and capital resources are insufficient to fund our debt service obligations and other cash needs, we could face substantial liquidity problems and could be forced to reduce or delay investments and capital expenditures or to dispose of material assets or operations, seek additional debt or equity capital or restructure or refinance our indebtedness. Our credit facilities may restrict our ability to take these actions, and we may not be able to affect any such alternative measures on commercially reasonable terms, or at all. If we cannot make scheduled payments on our debt, the lenders under our Credit Agreement can terminate their commitments to loan money under our Revolving Credit Facility, and our lenders under our Credit Agreement can declare all outstanding principal and interest to be due and payable and foreclose against the assets securing their borrowings, and we could be forced into bankruptcy or liquidation.
Furthermore, it is uncertain whether financing will be available in amounts or on terms acceptable to us, if at all, which could materially and adversely affect our business, financial condition and results of operations.
Our success depends, in part, on our retention of key members of our senior management team and ability to attract and retain qualified personnel.
Our success depends, in part, on our ability to retain our key employees, including our executive officers, senior management team and development, operations, finance, sales and marketing personnel. We are a small company that relies on a few key employees, any one of whom would be difficult to replace, and because we are a small company, we believe that the loss of key employees may be more disruptive to us than it would be to a larger company. Our success also depends, in part, on our continuing ability to identify, hire, train and retain other highly qualified personnel. In addition, we may be unable to effectively plan for the succession of senior management, including our chief executive officer. The loss of key personnel or the failure to attract and retain qualified personnel may have a material adverse effect on our business, financial condition and results of operations.
Closing our e.l.f. retail stores may not result in improvements to our business, financial condition, or results of operations.*
In February 2019, we closed all 22 of our e.l.f. retail stores and implemented a workforce reduction of our employees that managed and operated the e.l.f. retail stores. The closing of our e.l.f. retail stores has caused us to expend significant capital and other resources, write-off assets, accelerate rent expenses. Our reputation and brand may be damaged in connection with the closing of our e.l.f. retail stores. Consumers that shopped in our e.l.f. retail stores may not continue to purchase the same number (or any) of our products from our e-commerce websites or our other retail customers. Any of these results could have a material and adverse effect on our business, financial condition, or results of operations.

The closing of our e.l.f. retail stores may not improve our business, financial condition, or results of operations. In addition, we may not be able to reallocate capital historically allocated to our e.l.f. retail stores efficiently or effectively to other strategic priorities.
Adverse economic conditions in the United States, Europe or China or any of the other countries in which we may conduct business could negatively affect our business, financial condition and results of operations.
Consumer spending on beauty products is influenced by general economic conditions and the availability of discretionary income. Adverse economic conditions in the United States, Europe, China or any of the other countries in which we do significant business, or periods of inflation or high energy prices may contribute to higher unemployment levels, decreased

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consumer spending, reduced credit availability and declining consumer confidence and demand, each of which poses a risk to our business. A decrease in consumer spending or in retailer and consumer confidence and demand for our products could have a significant negative impact on our net sales and profitability, including our operating margins and return on invested capital. These economic conditions could cause some of our retail customers or suppliers to experience cash flow or credit problems and impair their financial condition, which could disrupt our business and adversely affect product orders, payment patterns and default rates and increase our bad debt expense.
Legal, political, and economic uncertainty surrounding the planned exit of the United Kingdom from the European Union are a source of instability and uncertainty.*

In March 2017, the United Kingdom formally notified the European Council of its intention to withdraw from the European Union pursuant to Article 50 of the Lisbon Treaty. Regardless of the outcome of the negotiations of the United Kingdom's withdrawal, the process of the United Kingdom's withdrawal from the European Union has created significant uncertainty about the future relationship between the United Kingdom and the European Union, including with respect to the laws and regulations that will apply as the United Kingdom determines which European Union laws to replace or replicate. There is also considerable uncertainty about whether the United Kingdom will be able to participate in transitional arrangements that would grant the United Kingdom and United Kingdom-based businesses full access to the European Union Customs Union and the Single Market until for any period post-withdrawal; failure to agree to these transitional arrangements could result in increased costs or otherwise adversely impact our operations as we, through a third-party, utilize a warehouse in the United Kingdom to distribute our products to our European Union based retailers and distributors. The uncertainty around, and developments regarding, the United Kingdom's withdrawal from the European Union have had and may continue to have a material and adverse effect on global economic conditions and the stability of global financial markets and may significantly reduce global market liquidity and restrict the ability of key market participants to operate in certain financial markets. Any of these factors could depress economic activity and restrict our access to capital, which could materially and adversely affect our business, financial condition and results of operations.
We are subject to international business uncertainties.
We sell our products to customers located outside the United States. In addition, substantially all of our third-party suppliers and manufacturers are located in China. We intend to continue to sell to customers outside the United States and maintain our relationships in China. Further, we may establish additional relationships in other countries to grow our operations. The substantial up-front investment required, the lack of consumer awareness of our products in jurisdictions outside of the United States, differences in consumer preferences and trends between the United States and other jurisdictions, the risk of inadequate intellectual property protections and differences in packaging, labeling and related laws, rules and regulations are all substantial matters that need to be evaluated prior to doing business in new territories. We cannot be assured that our international efforts will be successful. International sales and increased international operations may be subject to risks such as:
difficulties in staffing and managing foreign operations;
burdens of complying with a wide variety of laws and regulations, including more stringent regulations relating to data privacy and security, particularly in the European Union;
adverse tax effects and foreign exchange controls making it difficult to repatriate earnings and cash;
political and economic instability;
terrorist activities and natural disasters;
trade restrictions;
differing employment practices and laws and labor disruptions;
the imposition of government controls;
an inability to use or to obtain adequate intellectual property protection for our key brands and products;
tariffs and customs duties and the classifications of our goods by applicable governmental bodies;
a legal system subject to undue influence or corruption;
a business culture in which illegal sales practices may be prevalent;
logistics and sourcing;

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military conflicts; and
acts of terrorism.
The occurrence of any of these risks could negatively affect our international business and consequently our overall business, financial condition and results of operations.
New laws, regulations, enforcement trends or changes in existing regulations governing the introduction, marketing and sale of our products to consumers could harm our business.
There has been an increase in regulatory activity and activism in the United States and abroad, and the regulatory landscape is becoming more complex with increasingly strict requirements. If this trend continues, we may find it necessary to alter some of the ways we have traditionally manufactured and marketed our products in order to stay in compliance with a changing regulatory landscape, and this could add to the costs of our operations and have an adverse impact on our business. To the extent federal, state, local or foreign regulatory changes regarding consumer protection, or the ingredients, claims or safety of our products occur in the future, they could require us to reformulate or discontinue certain of our products, revise the product packaging or labeling, or adjust operations and systems, any of which could result in, among other things, increased costs, delays in product launches, product returns or recalls and lower net sales, and therefore could have a material adverse effect on our business, financial condition and results of operations. Noncompliance with applicable regulations could result in enforcement action by the FDA or other regulatory authorities within or outside the United States, including but not limited to product seizures, injunctions, product recalls, and criminal or civil monetary penalties, all of which could have a material adverse effect on our business, financial condition and results of operations.
In the United States, the FDA does not currently require pre-market approval for products intended to be sold as cosmetics. However, the FDA may in the future require pre-market approval, clearance or registration/notification of cosmetic products, establishments or manufacturing facilities. Moreover, such products could also be regulated as both drugs and cosmetics simultaneously, as the categories are not mutually exclusive. The statutory and regulatory requirements applicable to drugs are extensive and require significant resources and time to ensure compliance. For example, if any of our products intended to be sold as cosmetics were to be regulated as drugs, we might be required to conduct, among other things, clinical trials to demonstrate the safety and efficacy of these products. We may not have sufficient resources to conduct any required clinical trials or to ensure compliance with the manufacturing requirements applicable to drugs. If the FDA determines that any of our products intended to be sold as cosmetics should be classified and regulated as drug products and we are unable to comply with applicable drug requirements, we may be unable to continue to market those products. Any inquiry into the regulatory status of our cosmetics and any related interruption in the marketing and sale of these products could damage our reputation and image in the marketplace.
In recent years, the FDA has issued warning letters to several cosmetic companies alleging improper claims regarding their cosmetic products. If the FDA determines that we have disseminated inappropriate drug claims for our products intended to be sold as cosmetics, we could receive a warning or untitled letter, be required to modify our product claims or take other actions to satisfy the FDA. In addition, plaintiffs’ lawyers have filed class action lawsuits against cosmetic companies after receipt of these types of FDA warning letters. There can be no assurance that we will not be subject to state and federal government actions or class action lawsuits, which could harm our business, financial condition and results of operations.
Additional state and federal requirements may be imposed on consumer products as well as cosmetics, cosmetic ingredients, or the labeling and packaging of products intended for use as cosmetics. For example, several lawmakers are currently focused on giving the FDA additional authority to regulate cosmetics and their ingredients. This increased authority could require the FDA to impose increased testing and manufacturing requirements on cosmetic manufacturers or cosmetics or their ingredients before they may be marketed. We are unable to ascertain what, if any, impact any increased statutory or regulatory requirements may have on our business.
We sell a number of products as over-the-counter (“OTC”) drug products, which are subject to the FDA OTC drug regulatory requirements because they are intended to be used as sunscreen or to treat acne. The FDA regulates the formulation, manufacturing, packaging and labeling of OTC drug products. Our sunscreen and acne drug products are regulated pursuant to FDA OTC drug monographs that specify acceptable active drug ingredients and acceptable product claims that are generally recognized as safe and effective for particular uses. If any of these products that are marketed as OTC drugs are not in compliance with the applicable FDA monograph, we may be required to reformulate the product, stop making claims relating to such product or stop selling the product until we are able to obtain costly and time-consuming FDA approvals. We are also required to submit adverse event reports to the FDA for our OTC drug products, and failure to comply with this requirement may subject us to FDA regulatory action.

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We also sell a number of consumer products, which are subject to regulation by the CPSC in the United States under the provisions of the Consumer Product Safety Act, as amended by the Consumer Product Safety Improvement Act of 2008. These statutes and the related regulations ban from the market consumer products that fail to comply with applicable product safety laws, regulations, and standards. The CPSC has the authority to require the recall, repair, replacement or refund of any such banned products or products that otherwise create a substantial risk of injury and may seek penalties for regulatory noncompliance under certain circumstances. The CPSC also requires manufacturers of consumer products to report certain types of information to the CPSC regarding products that fail to comply with applicable regulations. Certain state laws also address the safety of consumer products, and mandate reporting requirements, and noncompliance may result in penalties or other regulatory action.
Our products are also subject to state laws and regulations, such as the California Safe Drinking Water and Toxic Enforcement Act, also known as “Prop 65,” and failure to comply with such laws may also result in lawsuits and regulatory enforcement that could have a material adverse effect on our business, financial condition and results of operations.
Our facilities and those of our third-party manufacturers are subject to regulation under the Federal Food, Drug and Cosmetic Act (the “FDCA”) and FDA implementing regulations.
Our facilities and those of our third-party manufacturers are subject to regulation under the FDCA and FDA implementing regulations. The FDA may inspect all of our facilities and those of our third-party manufacturers periodically to determine if we and our third-party manufacturers are complying with provisions of the FDCA and FDA regulations. In addition, third-party manufacturer’s facilities for manufacturing OTC drug products must comply with the FDA’s current drug good manufacturing practices (“GMP”) requirements that require us and our manufacturers to maintain, among other things, good manufacturing processes, including stringent vendor qualifications, ingredient identification, manufacturing controls and record keeping.
Our operations could be harmed if regulatory authorities make determinations that we, or our vendors, are not in compliance with these regulations. If the FDA finds a violation of GMPs, it may enjoin our manufacturer’s operations, seize product, restrict importation of goods, and impose administrative, civil or criminal penalties. If we or our third-party manufacturers fail to comply with applicable regulatory requirements, we could be required to take costly corrective actions, including suspending manufacturing operations, changing product formulations, suspending sales, or initiating product recalls. In addition, compliance with these regulations has increased and may further increase the cost of manufacturing certain of our products as we work with our vendors to assure they are qualified and in compliance. Any of these outcomes could have a material adverse effect on our business, financial condition and results of operations.
Government regulations and private party actions relating to the marketing and advertising of our products and services may restrict, inhibit or delay our ability to sell our products and harm our business, financial condition and results of operations.
Government authorities regulate advertising and product claims regarding the performance and benefits of our products. These regulatory authorities typically require a reasonable basis to support any marketing claims. What constitutes a reasonable basis for substantiation can vary widely from market to market, and there is no assurance that the efforts that we undertake to support our claims will be deemed adequate for any particular product or claim. A significant area of risk for such activities relates to improper or unsubstantiated claims about our products and their use or safety. If we are unable to show adequate substantiation for our product claims, or our promotional materials make claims that exceed the scope of allowed claims for the classification of the specific product, whether cosmetics, OTC drug products or other consumer products that we offer, the FDA, the FTC or other regulatory authorities could take enforcement action or impose penalties, such as monetary consumer redress, requiring us to revise our marketing materials, amend our claims or stop selling certain products, all of which could harm our business, financial condition and results of operations. Any regulatory action or penalty could lead to private party actions, or private parties could seek to challenge our claims even in the absence of formal regulatory actions which could harm our business, financial condition and results of operations.
Our business is subject to complex and evolving U.S. and foreign laws and regulations regarding privacy and data protection. Many of these laws and regulations are subject to change and uncertain interpretation, and could result in claims, changes to our business practices, monetary penalties, increased costs of operations or otherwise harm our business, financial condition and results of operations.*
We are subject to a variety of laws and regulations in the United States and abroad regarding privacy and data protection, some of which can be enforced by private parties or government entities and some of which provide for significant penalties for non-compliance. For example, the General Data Protection Regulation (“GDPR”) allows for a private right of action, and imposes stringent EU data protection requirements on companies established in the European Union or companies that offer goods or services to, or monitor the behavior of, individuals in the European Union. The GDPR establishes a robust framework

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of data subjects’ rights and imposes onerous accountability obligations on companies, with penalties for noncompliance of up to the greater of 20 million euros or four percent of annual global revenue. Furthermore, the California Consumer Privacy Act, which went into effect on January 1, 2020, requires new disclosures to California consumers, imposes new rules for collecting or using information about minors, affords California consumers new abilities to opt out of certain disclosures of personal information and also establishes significant penalties for noncompliance.
Data privacy continues to remain a matter of interest to lawmakers and regulators. A number of proposals are pending before federal, state and foreign legislative and regulatory bodies and additional laws and regulations have been passed but are not yet effective, all of which could significantly affect our business. For example, the European Union's institutions are debating the ePrivacy Regulation, which would repeal and replace the current ePrivacy Directive. The proposed ePrivacy Regulation would impose strict opt-in marketing rules, alter rules on cookies, web beacons and similar technology and significantly increase penalties for breach of the rules to the greater of 20 million euros or four percent of annual global revenue. Increased regulation of privacy and data protection may lead to broader restrictions on our activities, our ability to reach our consumers, and our ability to provide our consumers with personalized services and experiences.
Further, the United Kingdom’s withdrawal from the European Union has created uncertainty with regard to the status of the United Kingdom as an ‘adequate country’ for the purposes of data transfers outside the European Economic Area. In particular, it is unclear how data transfers to and from the United Kingdom will be regulated. These changes may require us to find alternative bases for the compliant transfer of personal data outside the United Kingdom and we are monitoring developments in this area. Invalidation of any mechanism on which we rely could require operational changes and increased costs and may lead to governmental enforcement actions, litigation, fines and penalties or adverse publicity that could have an adverse effect on our business.
Laws and regulations regarding privacy and data protection are also constantly evolving and can be subject to significant change. There is also no harmonized approach to privacy and data protection laws and regulations globally although several frameworks exist. The application, interpretation and enforcement of these laws and regulations may be uncertain, and may be interpreted and applied inconsistently from jurisdiction to jurisdiction and inconsistently with our current policies and practices. Changes in, or the interpretation of, a single law or regulation may affect how we comply with others. This has resulted in some uncertainty, and compliance obligations could cause us to incur costs or require us to change our business practices in a manner adverse to our business.
Compliance with existing, not yet effective, and proposed privacy and data protection laws and regulations can be costly and can delay or impede our ability to market and sell our products, impede our ability to conduct business through websites we and our partners may operate, change and limit the way we use consumer information in operating our business, cause us to have difficulty maintaining a single operating model, result in negative publicity, increase our operating costs, require significant management time and attention, or subject us to inquiries or investigations, claims or other remedies, including significant fines and penalties or demands that we modify or cease existing business practices. In addition, if our privacy or data security measures fail to comply with applicable current future laws and regulations, we may be subject to litigation, regulatory investigations, enforcement notices requiring us to change the way we use personal data or our marketing practices, fines or other liabilities, as well as negative publicity and a potential loss of business.
Failure to comply with the U.S. Foreign Corrupt Practices Act, other applicable anti-corruption and anti-bribery laws, and applicable trade control laws could subject us to penalties and other adverse consequences.
We currently source and manufacture substantially all of our products from third-party suppliers and manufacturers in China, and we have an office in China from which we manage our supply chain. We sell our products in several countries outside of the United States, primarily through distributors. Our operations are subject to the U.S. Foreign Corrupt Practices Act (the “FCPA”), as well as the anti-corruption and anti-bribery laws in the countries where we do business. The FCPA prohibits covered parties from offering, promising, authorizing or giving anything of value, directly or indirectly, to a “foreign government official” with the intent of improperly influencing the official’s act or decision, inducing the official to act or refrain from acting in violation of lawful duty, or obtaining or retaining an improper business advantage. The FCPA also requires publicly traded companies to maintain records that accurately and fairly represent their transactions, and to have an adequate system of internal accounting controls. In addition, other applicable anti-corruption laws prohibit bribery of domestic government officials, and some laws that may apply to our operations prohibit commercial bribery, including giving or receiving improper payments to or from non-government parties, as well as so-called “facilitation” payments. In addition, we are subject to U.S. and other applicable trade control regulations that restrict with whom we may transact business, including the trade sanctions enforced by the U.S. Treasury, Office of Foreign Assets Control (OFAC).
While we have implemented policies, internal controls and other measures reasonably designed to promote compliance with

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applicable anti-corruption and anti-bribery laws and regulations, and certain safeguards designed to ensure compliance with U.S. trade control laws, our employees or agents may engage in improper conduct for which we might be held responsible. Any violations of these anti-corruption or trade controls laws, or even allegations of such violations, can lead to an investigation and/or enforcement action, which could disrupt our operations, involve significant management distraction, and lead to significant costs and expenses, including legal fees. If we, or our employees or agents acting on our behalf, are found to have engaged in practices that violate these laws and regulations, we could suffer severe fines and penalties, profit disgorgement, injunctions on future conduct, securities litigation, bans on transacting government business, delisting from securities exchanges and other consequences that may have a material adverse effect on our business, financial condition and results of operations. In addition, our brand and reputation, our sales activities or our stock price could be adversely affected if we become the subject of any negative publicity related to actual or potential violations of anti-corruption, anti-bribery or trade control laws and regulations.
Government regulation of the Internet and e-commerce is evolving, and unfavorable changes or failure by us to comply with these regulations could substantially harm our business, financial condition and results of operations.
We are subject to general business regulations and laws as well as regulations and laws specifically governing the Internet and e-commerce. Existing and future regulations and laws could impede the growth of the Internet, e-commerce or mobile commerce. These regulations and laws may involve taxes, tariffs, privacy and data security, anti-spam, content protection, electronic contracts and communications, consumer protection, social media marketing, third-party cookies, web beacons and similar technology for online behavioral advertising and gift cards. It is not clear how existing laws governing issues such as property ownership, sales and other taxes and consumer privacy apply to the Internet as the vast majority of these laws were adopted prior to the advent of the Internet and do not contemplate or address the unique issues raised by the Internet or e-commerce. It is possible that general business regulations and laws, or those specifically governing the Internet or e-commerce, may be interpreted and applied in a manner that is inconsistent from one jurisdiction to another and may conflict with other rules or our practices. We cannot be sure that our practices have complied, comply or will comply fully with all such laws and regulations. Any failure, or perceived failure, by us to comply with any of these laws or regulations could result in damage to our reputation, a loss in business and proceedings or actions against us by governmental entities or others. Any such proceeding or action could hurt our reputation, force us to spend significant amounts in defense of these proceedings, distract our management, increase our costs of doing business and decrease the use of our sites by consumers and suppliers and may result in the imposition of monetary liability. We may also be contractually liable to indemnify and hold harmless third parties from the costs or consequences of non-compliance with any such laws or regulations. In addition, it is possible that governments of one or more countries may seek to censor content available on our sites or may even attempt to completely block access to our sites. Adverse legal or regulatory deve