The Lovesac Company — Q1 FY2020 Form 10-Q
Reporting period: Thirteen weeks ended May 5, 2019; comparisons are with the thirteen weeks ended May 6, 2018. Lovesac sells modular Sactionals, Sacs and accessories through showrooms, ecommerce and shop-in-shop arrangements. The company cautions that results are seasonal and this quarter is not necessarily indicative of the full fiscal year.
Financial and operating results
- Revenue: $41.0 million, up 53.0% year over year. Showroom sales were $26.9 million (+45.2%), internet sales $8.5 million (+85.3%) and other sales, including shop-in-shops, $5.6 million (+52.5%). Sactionals sales increased to $32.8 million from $16.7 million; Sacs sales declined to $5.9 million from $9.1 million.
- Profitability: Gross profit was $21.0 million, up 43.3%, but gross margin declined to 51.3% from 54.7%, primarily due to 10% tariffs. Operating loss widened to $9.3 million from $5.6 million; net loss widened to $9.1 million from $5.7 million. Net loss per share was $0.67 versus $1.25; the prior-period figure included $1.9 million of preferred and deemed dividends, and share counts also changed following the IPO.
- Expenses: SG&A increased 57.0% to $23.9 million, including higher employment, showroom and growth-related costs, public-company expenses, and stock-based compensation. Advertising and marketing rose 22.3% to $5.4 million. Depreciation and amortization increased to $1.1 million. Accelerated vesting of executive restricted stock units contributed $2.9 million of stock-based compensation.
- Cash flow: Operating cash use was $8.2 million, versus $5.6 million used in the prior-year quarter; inventory increased by $4.8 million. Investing cash use was $2.0 million, and financing cash use was $3.2 million, including $3.2 million of taxes paid for net share settlement of equity awards. Cash fell $13.4 million during the quarter to $35.7 million.
- Liquidity and debt: Working capital was $50.6 million. No borrowings were outstanding on the Wells Fargo revolving facility at May 5; borrowing availability was $13.4 million under the $25 million facility. Total liabilities were $29.0 million. The company reported $57.6 million of future minimum operating lease payments.
- Non-GAAP measure: Adjusted EBITDA was negative $4.7 million, compared with negative $4.2 million. The filing adds back items including equity compensation; this measure is not a substitute for GAAP results or operating cash flow.
Changes and developments
- Sales growth reflected higher customer and unit volumes, favorable Sactionals performance, additional showrooms, showroom redesign and increased marketing. Comparable showroom sales increased 31.7%; retail sales per selling square foot rose 31.4% to $401.
- Internet sales represented 20.7% of revenue, compared with 17.1% a year earlier. The company reported hosting more than 150 Costco shop-in-shops in the quarter, versus 120 in the prior-year period.
- Cash was substantially higher than the $1.9 million reported at May 6, 2018, but lower than the $49.1 million balance at the preceding fiscal year-end. The company had received IPO proceeds in 2018.
- After quarter-end, the company completed a May 21, 2019 offering that included 750,000 primary shares and received approximately $25.5 million net proceeds. Selling stockholders sold additional shares; the underwriters’ May 29 option exercise was for selling-stockholder shares, with no proceeds to the company.
- ASC 606 was adopted in the quarter; the company said adoption had no material financial impact, but expanded disclosures. Management anticipated that future lease-accounting adoption would materially affect the balance sheet.
Outlook, risks and unusual items
- Management expected positive Adjusted EBITDA dollars for FY2020, continued net-sales growth and internet sales to increase as a share of sales. No specific revenue or earnings target was provided.
- Management expected FY2020 gross margin to be below FY2019, citing product and channel mix, tariffs, and investment in warehousing and distribution. The company was evaluating the possible effect of tariffs increasing to 25%; it said any effect from the additional 15% would not be expected in gross margin until the end of the third quarter if the increase remained in effect.
- The company expected advertising and marketing investment of 10%–12% of annual sales and infrastructure investment over the next 18 months, which could delay expense leverage. Management said cash from operations and the IPO and May 2019 offering were expected to cover working capital and anticipated capital expenditures for at least 12 months.
- Key risks include sustaining growth, managing expansion and new showrooms, competition, brand and intellectual-property protection, and dependence on successful ecommerce and marketing. The company disclosed significant seasonal activity in the second half of its fiscal year and ongoing operating losses and operating cash use.
- Management reported no material change to previously disclosed risk factors and no legal proceeding expected to have a material adverse effect. Ordinary-course litigation remains possible. The filing also disclosed related-party management and platform-service fees.
Important facts for investors to verify
- Whether sales growth can continue while losses and operating cash use increase, and whether the stated Adjusted EBITDA outlook is achieved.
- How tariffs, product mix, sourcing savings and distribution investments affect gross margin, particularly if tariffs rise to 25%.
- The apparent showroom-count differences in the filing: the notes say 75 leased showrooms at May 5, while MD&A reports 79 open at that date. Confirm the correct count and basis.
- The sustainability of liquidity after the May offering, seasonal inventory needs, available borrowing capacity and the $57.6 million lease commitment.
- The effect of the accelerated stock-award vesting, future equity compensation and share issuance on expenses and dilution; also note that management was reviewing product discount allocation by category, which may affect comparisons of product-line growth.