Business Context and Reporting Period
Lulu’s Fashion Lounge Holdings, Inc. is a digitally native online retailer of women’s clothing, shoes and accessories serving primarily Millennial and Gen Z customers. This unaudited Form 10-Q covers the quarter and six months ended July 3, 2022, compared with July 4, 2021. The company operates on a 52–53-week fiscal year ending on the Sunday closest to December 31.
Key Financial Metrics
| Metric | Three Months Ended July 3, 2022 | Year-over-Year Change | Six Months Ended July 3, 2022 | Year-over-Year Change |
|---|---|---|---|---|
| Net revenue | $131.5 million | +27% | $243.4 million | +41% |
| Gross profit | $60.2 million | +17% | $113.1 million | +37% |
| Gross margin | 45.8% | Down from 49.6% | 46.5% | Down from 47.8% |
| Income from operations | $10.9 million | Down from $15.2 million | $14.2 million | Down from $17.8 million |
| Net income | $6.0 million | Down from $8.3 million | $8.0 million | Up from $7.0 million |
| Adjusted EBITDA | $14.8 million | Down from $17.8 million | $24.7 million | Up from $23.2 million |
| Adjusted EBITDA margin | 11.2% | Down from 17.2% | 10.1% | Down from 13.4% |
Quarterly revenue growth reflected a 29% increase in total orders and a 13% increase in average order value to $137. For the six-month period, total orders increased 38% and average order value increased 16% to $135. Active customers increased to approximately 3.25 million from 2.13 million for the comparable trailing twelve-month periods.
Selling and marketing expense increased 72% in the quarter and 68% year to date, primarily due to higher online marketing spending. Advertising expense was $20.2 million in the quarter and $37.2 million year to date. General and administrative expense increased 11% in the quarter and 41% year to date, including higher equity-based compensation, labor, insurance and professional services costs.
Cash Flow, Liquidity and Capital Structure
- Six-month operating cash flow was $10.6 million, down from $29.8 million in the prior-year period.
- Investing cash flow was negative $2.7 million, including $1.2 million of capitalized software costs and $1.4 million of property and equipment purchases.
- Financing cash flow was negative $10.9 million, principally reflecting $20.0 million of revolver repayments, partly offset by $10.0 million of borrowings.
- Cash, cash equivalents and restricted cash declined to $8.8 million at July 3, 2022, from $11.9 million at January 2, 2022. Cash and cash equivalents were $8.3 million, compared with $11.4 million at year-end.
- Inventory increased to $48.6 million from $22.2 million, primarily to support higher sales volume. The increase materially absorbed operating cash flow.
- The company had $15.0 million outstanding under its $50.0 million revolving facility, with $34.8 million available for borrowing and approximately $7.25 million available for letters of credit. The facility matures November 15, 2024, and the company was in compliance with its financial covenants.
- Reported net debt, defined as revolver borrowings less cash and cash equivalents, was $6.7 million, compared with $13.6 million at January 2, 2022.
- Adoption of ASC 842 added $31.8 million of lease right-of-use assets and $32.5 million of lease liabilities to the balance sheet. Total future undiscounted operating and finance lease payments were $41.1 million.
Management stated that cash and cash equivalents, operating cash flow and available revolver capacity are expected to be sufficient for capital expenditures, working capital and debt repayments for at least the next 12 months. Management also cautioned that future cash generation and borrowing availability are not assured.
Material Changes Versus the Prior Comparable Period
- Revenue growth remained strong, but quarterly profitability weakened as gross margin fell 380 basis points and marketing expense grew substantially faster than revenue.
- Higher returns, fuel surcharges and other outbound shipping costs pressured cost of revenue and gross margin.
- Interest expense declined 96% in the quarter and 95% year to date because the company repaid its former $105.8 million term loan and $1.4 million of accrued interest using IPO proceeds and revolver borrowings in November 2021.
- Operating cash flow declined by $19.2 million year to date, primarily because inventory increased significantly and working-capital movements were less favorable.
- The company adopted ASC 842 on January 3, 2022, resulting in recognition of operating lease assets and liabilities.
- Equity-based compensation expense increased to $8.6 million year to date from $3.6 million, contributing to higher general and administrative expense. The company also granted approximately 2.16 million restricted stock units during the first six months.
- In May 2022, Google search algorithm changes temporarily reduced organic search rankings, which management believes negatively affected traffic and sales.
Outlook, Commentary and Risks
The filing does not provide specific revenue, earnings or margin guidance. Management expects continued revenue growth but notes that growth rates may slow. The business is typically strongest in the second and third fiscal quarters because of demand for special-event dresses and spring and summer fashion.
Management is responding to inflation, supply-chain pressure, shipping costs and COVID-19-related uncertainty by ordering earlier, using a “test, learn and reorder” inventory strategy, and diversifying suppliers. Key risks include discretionary consumer spending, fashion and inventory execution, customer acquisition costs, returns, competitive retail conditions, supply-chain and transportation disruptions, reliance on third-party platforms and service providers, cybersecurity and technology risks, and potential effects of COVID-19 variants.
The company reported no material pending legal proceedings or material changes to previously disclosed risk factors. Disclosure controls and procedures were deemed effective as of July 3, 2022.
New employment agreements with the co-president and chief financial officer and the co-president and chief information officer provide for annual base salaries of $470,000 each, target annual bonuses equal to 60% of base salary, and specified severance and equity-vesting benefits.
Important Facts for Investors to Verify
- Whether revenue growth can continue as macroeconomic pressure, reduced organic search traffic and consumer discretionary risks persist.
- Whether gross margin can recover from the 45.8% quarterly level amid returns, shipping inflation and inventory-related costs.
- Inventory levels, sell-through, markdowns and return rates, given the increase to $48.6 million and the associated cash absorption.
- Marketing efficiency and customer acquisition returns as selling and marketing expense grew 72% in the quarter.
- Cash runway, operating cash generation and revolver availability, including compliance with the maximum leverage covenant.
- The impact of ASC 842 lease obligations and total contractual lease payments of $41.1 million.
- The effect of substantial equity-based compensation and outstanding unrecognized compensation costs on future expenses and dilution.
- Whether the company’s stated expectation of sufficient liquidity for at least the next 12 months remains valid under weaker sales or margin scenarios.