The Lovesac Company — Q3 FY2020 Form 10-Q
Reporting period: Thirteen and thirty-nine weeks ended November 3, 2019; comparisons are to the periods ended November 4, 2018. Lovesac sells modular furniture and accessories through showrooms, online sales, and pop-up/shop-in-shop channels. It operated 84 U.S. showrooms at period-end. Results are seasonal, with the majority of activity typically in the fiscal fourth quarter.
Financial performance
| Metric | 13 weeks ended Nov. 3, 2019 | 13 weeks ended Nov. 4, 2018 | 39 weeks ended Nov. 3, 2019 | 39 weeks ended Nov. 4, 2018 |
|---|---|---|---|---|
| Net sales | $52.1 million | $41.7 million | $141.2 million | $101.7 million |
| Gross profit | $26.3 million | $22.9 million | $71.5 million | $55.4 million |
| Gross margin | 50.4% | 54.9% | 50.7% | 54.4% |
| Operating loss | $(6.9) million | $(2.7) million | $(21.1) million | $(15.3) million |
| Net loss | $(6.7) million | $(2.5) million | $(20.6) million | $(15.1) million |
| Basic and diluted loss per share | $(0.46) | $(0.22) | $(1.45) | $(4.51) |
| Adjusted EBITDA, non-GAAP | $(3.7) million | $(0.4) million | $(11.7) million | $(6.3) million |
Growth and mix: Quarterly sales increased 25.0%; year-to-date sales increased 38.8%. Internet sales grew 47.7% in the quarter and 64.7% year to date. Sactionals remained the largest product category, generating $43.1 million in quarterly sales and $114.3 million year to date. The company attributed growth to unit volume and average order size, customer response to Sactionals, showroom expansion, and marketing.
Costs and margins: Gross margin contracted 4.5 percentage points in the quarter and 3.8 points year to date, primarily due to 25% China tariffs; sourcing changes and a shift of manufacturing to Vietnam partly offset the pressure. Quarterly SG&A rose 26.7% to $24.5 million, while advertising and marketing rose 40.5% to $7.3 million. Year-to-date SG&A increased 27.9% to $70.3 million and marketing rose 42.2% to $18.7 million.
Cash, liquidity, and obligations
- Cash and cash equivalents were $27.9 million at November 3, 2019, down from $49.1 million at February 3, 2019. Current assets were $95.4 million and current liabilities were $31.8 million; inventory was $50.2 million.
- For the 39 weeks, operating cash flow was $(36.4) million, investing cash flow $(7.0) million, and financing cash flow $22.2 million. Operating cash use included a $24.1 million inventory increase.
- No borrowings were outstanding under the Wells Fargo revolving facility; reported borrowing availability was $13.5 million. The facility permits up to $25 million, subject to borrowing-base limits.
- Operating lease commitments totaled $65.7 million, including $2.7 million due for the remainder of FY2020. The company also disclosed $3.7 million in employment-agreement obligations.
- The company received approximately $25.6 million net proceeds from its May 2019 primary offering. Management said cash, expected operating cash flows, offering proceeds, and the credit facility were expected to cover working capital and anticipated capital spending for at least 12 months.
Outlook, risks, and notable items
- Management forecast FY2020 sales growth of 40%–42% over FY2019 and said it expected positive Adjusted EBITDA for FY2020. It expected FY2020 gross margin to be below FY2019, citing product mix, tariffs, and investment in warehousing and distribution.
- Management expected annual advertising and marketing investment of 10%–12% of sales and continued infrastructure investment over the next 18 months; it anticipated greater SG&A leverage after that investment period.
- Accelerated vesting of certain senior executives’ restricted stock units resulted in $2.9 million of equity-based compensation. The company reported $4.0 million total equity-based compensation for the 39-week period.
- The company received a favorable IRS ruling on approximately $10.8 million of NOLs previously treated as an uncertain tax position; the resolution had no financial-statement impact because of a full valuation allowance.
- Management said ordinary-course legal matters were not expected to have a material adverse effect and reported no material changes to previously disclosed risk factors. It identified a significant balance-sheet impact from adoption of the new lease standard, planned for FY2021.
- Subsequent to quarter-end, an exchange involving SAC Acquisition LLC options resulted in 175,390 company shares being transferred for issuance to participating former option holders; 73,507 shares were withheld for payroll taxes and treated as treasury stock.
Most important facts for investors to verify
- Whether management’s 40%–42% FY2020 sales-growth and positive Adjusted EBITDA expectations were achieved, given year-to-date losses and cash use.
- How tariffs, product mix, and sourcing changes affect gross margin, and whether the margin decline moderates as management anticipated.
- Whether inventory growth and seasonal working-capital needs continue to pressure cash, and how much revolving-credit availability remains usable.
- Whether showroom, marketing, and infrastructure investment translates into sustainable sales growth and operating leverage.
- The eventual balance-sheet effect of lease accounting adoption and the company’s capacity to meet its substantial lease commitments.