The Lovesac Company — Q2 FY2023 Form 10-Q
Reporting period: The 13 and 26 weeks ended July 31, 2022, compared with the periods ended August 1, 2021. Amounts below are in millions unless noted. Lovesac designs and sells modular Sactionals, Sacs and related products through showrooms, ecommerce and retail partnerships. Its business is seasonal, with sales typically highest in the fiscal fourth quarter.
Financial performance
| Metric | 13 weeks ended Jul. 31, 2022 | 13 weeks ended Aug. 1, 2021 | 26 weeks ended Jul. 31, 2022 | 26 weeks ended Aug. 1, 2021 |
|---|---|---|---|---|
| Net sales | $148.5 | $102.4 | $277.9 | $185.4 |
| Gross profit / margin | $80.9 / 54.5% | $59.0 / 57.6% | $147.0 / 52.9% | $105.1 / 56.7% |
| Operating income / margin | $9.9 / 6.7% | $9.0 / 8.8% | $12.5 / 4.5% | $11.3 / 6.1% |
| Net income | $7.1 | $8.4 | $9.0 | $10.5 |
| Diluted EPS | $0.45 | $0.52 | $0.56 | $0.66 |
| Adjusted EBITDA | $14.1 | $12.4 | $20.5 | $17.7 |
- Quarterly sales rose 45.0%; first-half sales rose 49.9%. Growth came from all channels. First-half showroom sales were $173.7 million, internet sales $66.8 million and other-channel sales $37.4 million.
- Despite higher gross profit dollars, gross margin fell 3.1 percentage points in the quarter and 3.8 points for the first half. Management attributed the decline mainly to higher distribution and tariff costs, especially inbound freight, partly offset by product-margin improvement.
- First-half operating cash flow was negative $59.4 million, versus positive $0.8 million a year earlier. Cash used in operations reflected inventory growth of $38.1 million, higher prepaid assets of $17.9 million, lower accounts payable and accrued expenses of $16.0 million, lower customer deposits of $6.8 million and lease-liability payments.
- Investing cash outflow was $13.7 million, primarily for showroom investments and patents and trademarks. Financing cash outflow was $1.7 million. Cash declined $74.7 million to $17.7 million.
- At July 31, current assets were $209.3 million and current liabilities $98.1 million; reported working capital was $111.2 million. There were no borrowings under the revolving credit facility and $36.0 million of borrowing availability under the $40.0 million asset-based facility, which matures in March 2024. Total lease liabilities were $128.4 million.
Changes, outlook and risks
- Sales expansion included 22 showroom openings and six kiosk openings in the first half; Lovesac reported 174 showrooms, kiosks and mobile-concierge locations. Other-channel growth also reflected 22 Best Buy shop-in-shops and increased barter activity.
- Operating expenses grew with hiring, variable compensation, rent, selling costs, infrastructure and marketing. Management said it expects continued investment in growth, including showrooms and infrastructure, and ongoing marketing spending. The filing provides no specific earnings or sales guidance.
- Income tax expense rose to $2.8 million for the quarter and $3.5 million for the first half; the effective tax rate was approximately 28%, compared with unusually low prior-year rates reflecting release of a deferred-tax valuation allowance.
- Management cited exposure to inflation, freight and supply-chain disruption, tariffs, consumer spending and confidence, interest rates, competition, and COVID-19-related uncertainty. The company said it believes cash, operating cash generation and credit availability will meet working-capital needs and anticipated capital expenditures for at least 12 months.
- Unusual items and contingencies: Barter transactions contributed $6.5 million to quarterly gross profit and $8.2 million for the first half; unused media credits were $14.1 million at July 31. The filing reports a $5.6 million potential severance exposure if covered executives were terminated without cause. Management said ordinary-course legal matters are not expected to have a material adverse effect.
- Controls: Management concluded disclosure controls were not effective at July 31 because of a previously identified material weakness in IT general controls over user access and segregation of duties. A remediation plan was implemented during the first half, but the filing does not state that the weakness was fully remediated.
Important facts for investors to verify
- Reconcile the filing’s conflicting comparative balance-sheet data: the condensed balance sheet reports January 30, 2022 cash of $92.4 million and total assets of $371.6 million, while the selected financial information reports cash of $65.7 million and total assets of $264.6 million. Confirm the correct comparative figures.
- Assess whether sales growth can offset persistent freight, tariff and other cost pressure and restore gross margins.
- Review the cash conversion and seasonal inventory build, including the extent to which working-capital outflows reverse in the second half.
- Evaluate the quality and repeatability of barter-related gross profit and the usability of the associated media credits.
- Monitor remediation and subsequent auditor or management assessments of the material weakness in financial reporting controls.
- Consider lease commitments and borrowing-base restrictions when assessing liquidity; the $36.0 million availability is subject to facility terms and eligible collateral.