The Lovesac Company — Q3 FY2019 Form 10-Q
Business context and period. The filing covers the 13 and 39 weeks ended November 4, 2018; prior-year comparisons are to October 29, 2017. Lovesac designs and sells modular Sactionals, foam-filled Sacs and accessories through showrooms, ecommerce and wholesale/shop-in-shop channels. It operated 77 leased U.S. showrooms. Management notes that sales are seasonal, with most activity in the second half of the fiscal year.
Financial performance
| Metric | 13 weeks ended Nov. 4, 2018 | 13 weeks ended Oct. 29, 2017 | 39 weeks ended Nov. 4, 2018 | 39 weeks ended Oct. 29, 2017 |
|---|---|---|---|---|
| Net sales | $41.7m | $24.4m | $101.7m | $62.8m |
| Gross profit / margin | $22.9m / 54.9% | $13.7m / 56.0% | $55.4m / 54.4% | $34.3m / 54.6% |
| Operating loss | $(2.7)m | $(2.1)m | $(15.3)m | $(7.6)m |
| Net loss | $(2.5)m | $(2.2)m | $(15.1)m | $(7.9)m |
| Basic and diluted loss per share | $(0.22) | $(0.43) | $(4.51) | $(1.43) |
- Growth and channels: Quarterly sales rose 70.9%; 39-week sales rose 62.0%. For the 39 weeks, showroom revenue was $69.6m, internet revenue $17.8m and other revenue, including shop-in-shops, $14.3m. Sactionals generated $77.3m and Sacs $21.7m.
- Margins and expenses: Quarterly gross margin declined 1.1 percentage points, mainly from product/channel mix and freight, partly offset by sourcing cost savings. Quarterly SG&A rose to $19.3m but fell as a share of sales to 46.4% from 49.6%. Marketing increased to $5.2m, or 12.4% of sales. For the 39 weeks, marketing was $13.2m, or 12.9% of sales.
- Cash flow: In the 39 weeks, operating activities used $14.2m and investing activities used $8.9m, while financing provided $58.6m. The operating cash outflow reflected the net loss and a $13.0m inventory increase, partly offset by higher payables and customer deposits.
- Liquidity and debt: At November 4, cash was $44.7m, working capital $53.4m, current assets $78.5m and current liabilities $25.1m. No Wells Fargo revolver borrowings were outstanding; reported borrowing availability was $11.3m under a facility with a $25m maximum, subject to borrowing-base limits. The filing reports no material debt balance.
Material changes and unusual items
- The June 2018 IPO generated approximately $59.2m in net proceeds. A secondary offering of 2.3m shares by existing holders in October generated no proceeds for the Company. IPO financing helped lift cash from $9.2m at February 4 to $44.7m at November 4.
- Preferred stock converted to common stock upon the IPO. The 39-week loss attributable to common shareholders included $27.8m of preferred and deemed dividends, including a $22.6m deemed dividend related to conversion; this materially affected the reported $4.51 loss per share. Quarterly per-share comparisons also reflect a larger weighted-average share count after the IPO.
- Equity-based compensation was $2.85m for the 39 weeks, compared with $0.02m a year earlier. Management also identifies IPO, financing, public-company, recruitment and secondary-offering costs among expense increases. Adjusted EBITDA remained negative: $(0.4)m for the quarter and $(6.3)m for the 39 weeks; these are non-GAAP measures.
- Lease commitments totaled $62.8m, including $9.5m due in less than one year. The Company states it has no material off-balance-sheet arrangements other than ordinary-course operating leases and employment agreements.
Outlook, commentary and risks
- Management expects continued healthy sales growth and internet sales to rise as a share of total sales. It expects annual marketing investment at 10%–12% of sales and anticipates positive Adjusted EBITDA on an annual basis, with improvement in fiscal 2019 and thereafter.
- Management expects FY2019 gross margin to be slightly, but not materially, below FY2018. It expects FY2020 margin to be lower than FY2019, citing product/channel mix, tariffs and investment in warehousing and distribution. Management says tariffs should have little or no FY2019 gross-margin effect; a 10% tariff is expected to affect margin percentage in FY2020 despite mitigation in total dollars.
- The Company expects infrastructure investment over the next 18 months, which may temper SG&A leverage during that period. It states that cash, operating cash flows and the credit facility should cover working capital and anticipated capital spending for at least 12 months from issuance, while acknowledging ongoing operating losses and uncertainty in achieving projected sales.
- Risks include execution of showroom expansion and ecommerce growth, competition, brand and intellectual-property protection, cost and margin pressure, and the ability to manage growth. The filing reports no material changes to previously disclosed risk factors. Ordinary-course legal matters are not expected by management to have a material adverse effect, though outcomes are uncertain.
Investor verification points
- Assess whether sales growth and new-customer momentum can persist, including the contribution and margins of shop-in-shop and ecommerce channels.
- Track inventory growth, operating cash use, seasonal working-capital needs and actual revolver availability under borrowing-base restrictions.
- Reconcile GAAP losses and loss per share to preferred-stock conversion dividends, equity compensation and non-GAAP Adjusted EBITDA adjustments.
- Monitor gross-margin trends, tariff exposure and planned distribution/infrastructure spending against management’s FY2019–FY2020 commentary.
- Review lease commitments, related-party service arrangements and potential dilution from outstanding warrants and restricted stock units.