Lovesac Co files 10-Q

Lovesac Co revealed 10-Q form on September 13, 2019.

Immediately prior to the follow-on offerings in October 2018 and May 2019, Mistral and its affiliates owned approximately 56% and 41% of our common stock, respectively. Immediately after the completion of the follow-on offerings, such entities owned approximately 41% and 28.8% of our common stock, respectively. As a result, we are no longer a ‘controlled company’ within the meaning of the corporate governance standards of Nasdaq and we will, subject to certain transition periods permitted by Nasdaq rules, no longer rely on exemptions from corporate governance requirements that are available to controlled companies.

The Company had a line of credit with Siena Lending Group, LLC to borrow up to $7.0 million, which matured on May 14, 2018. Borrowings were limited to the lesser of 75% of inventory or 85% of the net orderly liquidation value of inventory and may be reduced by certain liabilities of the Company. All amounts outstanding bore interest at the base rate, defined as the greatest of (i) Prime Rate published by The Wall Street Journal, (ii) Federal Funds Rate plus 0.5% or (iii) 3.25%, plus 3% (7.00% at February 4, 2018). The line was subject to a monthly unused line fee of 0.75%. The agreement was secured by the first lien on substantially all assets of the Company. In February 2018, the Company paid the outstanding loan balance of $405, an early termination fee of $70,000 and fully amortized the remaining deferred financing fees of $48,149 on its line of credit with Siena Lending Group, LLC.

On February 6, 2018, the Company established a line of credit with Wells Fargo Bank, National Association (‘Wells’). The line of credit with Wells allows the Company to borrow up to $25.0 million and will mature in February 2023. Borrowings are limited to 90% of eligible credit card receivables plus 85% of eligible wholesale receivables plus 85% of the net recovery percentage for the eligible inventory multiplied by the value of such eligible inventory of the Company for the period from December 16 of each year until October 14 of the immediately following year, with a seasonal increase to 90% of the net recovery percentage for the period from October 15 of each year until December 15 of such year, seasonal advance rate, minus applicable reserves established by Wells. As of August 4, 2019, and August 5, 2018, the Company’s borrowing availability under the line of credit with Wells Fargo was $15.8 million and $10.5 million, respectively. As of August 4, 2019, there were no borrowings outstanding on this line of credit.

Under the line of credit with Wells, the Company may elect that revolving loans bear interest at a rate per annum equal to the base rate plus the applicable margin or the LIBOR rate plus the applicable margin. The applicable margin is based on tier’s relating to the quarterly average excess availability. The tiers range from 2.00% to 2.25%. The loan agreement calls for certain covenants including a timing of the financial statement’s threshold and a minimum excess availability threshold. On May 3, 2018, the Company elected a one-month revolving loan with a maturity date of June 4, 2018, that bears interest at the LIBOR rate plus the applicable margin for an all-in-rate of 3.1875%. The one-month revolving loan matured and was paid in full on June 4, 2018.

In March 2019, the Company granted 8,780 Restricted Stock Units to certain non-executive employees of the Company with a fair value of $264,015. The unit vesting is based on both time and performance. The time and performance vesting units will vest fifteen percent on July 1, 2020, 25% on both July 1, 2021 and July 1, 2022 and 35% on July 1, 2023. The performance vesting units will only vest upon the achievement of certain benchmarks. As of August 4, 2019, there were 6,620 unvested units outstanding related to this grant. There were 2,160 units forfeited from this grant and no units cancelled or expired during the thirteen and twenty-six weeks ended August 4, 2019.

In June 2019, the Company granted 38,318 Restricted Stock Units to certain officers of the Company with a fair value of $1,420,448. The unit vesting is based on both time and performance. The time and performance vesting units will vest 33.33% percent on June 5, 2020, June 5, 2021 and June 5, 2022. The performance vesting units will only vest upon the achievement of certain benchmarks. As of August 4, 2019, there were 38,318 unvested units outstanding related to this grant. There were no units forfeited, cancelled or expired during the thirteen and twenty-six weeks ended August 4, 2019.

In July 2019, the Company granted 100 Restricted Stock Units to a certain non-executive employee of the Company with a fair value of $3,131. The unit vesting is based on both time and performance. The time and performance vesting units will vest fifteen percent on July 1, 2020, 25% on both July 1, 2021 and July 1, 2022 and 35% on July 1, 2023. The performance vesting units will only vest upon the achievement of certain benchmarks. As of August 4, 2019, there were 100 unvested units outstanding related to this grant. There were no units forfeited, cancelled or expired from this grant during the thirteen and twenty-six weeks ended August 4, 2019.

In June 2019, the Company granted 495,366 Non statutory Stock options to certain officers of the Company with an option price of $38.10 per share. 100% of the stock options are subject to vesting on the first trading day after the date on which the closing price of the Company’s stock price has been at least $75 for 60 consecutive trading days so long as this goal has been attained by June 5, 2022 or the options will terminate. These options were valued using a Monte Carlo simulation model to account for the path dependent market conditions that stipulate when and whether or not the options shall vest.

In February 2017, the Company established The Lovesac Company 401(k) Plan (the ‘401(k) Plan’) with Elective Deferrals beginning May 1, 2017. The Plan calls for Elective Deferral Contributions, Safe Harbor Matching Contributions and Profit-Sharing Contributions. All employees of The Lovesac Company (except for union employees and nonresident aliens) will be eligible to participate in the 401(k) Plan as of the day of the month which is coincident with or next follows the date on which they attain age 21 and complete one month of service. Participants will be able to contribute up to 100% of their eligible compensation to the 401(k) Plan subject to limitations with the IRS. The employer contributions to the 401(k) Plan were $116,880 and $88,995 for the thirteen weeks ended August 4, 2019 and August 5, 2018 and $191,112 and $150,224 for the twenty-six weeks ended August 4, 2019 and August 5, 2018, respectively.

We have determined that we operate within a single reporting segment. The chief operating decision maker of the Company is the Chief Executive Officer and President. The Company’s operating segments are aggregated for financial reporting purposes because they are similar in each of the following areas including economic characteristics, class of consumer, nature of products and distribution method and products are a singular group of products which make up over 95% of net sales.

Our Sactionals product line currently represents a majority of our sales. Sactionals are a couch system that consists of two components, seats and sides, which can be arranged, rearranged and expanded into thousands of configurations easily and without tools. Our Sactional products include a number of patented features relating to their geometry and modularity, coupling mechanisms and other features. We believe that these high quality premium priced products enhance our brand image and customer loyalty and expect them to continue to garner a significant share of our sales. Our Sactionals represented 79.6% and 79.9% of our sales for the thirteen and twenty-six weeks ended August 4, 2019, respectively or $38.3 million and $71.2 million as compared to 76.1% and 72.0% of sales for the thirteen and twenty-six weeks ended August 5, 2018 or $25.3 million and $43.2 million, respectively. We are currently reviewing our allocation methodology of the application of product discounts to each product segment of our business which we believe will provide a more comparative view of product category growth on a go forward basis.

We believe that our products complement one another and have generated a loyal customer base, evidenced by our recent estimate that 38% of our transactions in fiscal 2019 were from repeat customers. We believe the strength of our brand is reflected in the number of customers who routinely share their purchases of Lovesac products with their friends through social media, often displaying our logos or company name in their posts. Our customers include celebrities and other influencers who support our brand through postings made on an uncompensated and unsolicited basis. As of August 4, 2019, we had approximately 811,000 followers on Facebook and 379,000 followers on Instagram.

As part of our direct to consumer sales approach, we also sell our products through our ecommerce platform. We believe our products are uniquely suited to this channel. Our foam-based Sacs can be reduced to one-eighth of their normal size and each of our Sactionals components weighs less than 50 pounds upon shipping. With furniture especially suited to ecommerce applications, our sales completed through this channel accounted for 19.6% and 20.1% of our total sales for the thirteen and twenty-six weeks ended August 4, 2019 and August 5, 2018, respectively, up from 16.6% and 16.8% for the thirteen and twenty-six weeks ended August 4, 2019 and August 5, 2018, respectively. Our showrooms and other direct advertising and marketing efforts work in concert to drive customer conversion in ecommerce.

We have also enhanced our sales through the use of pop up shops and shop in shops. The pop up shop showrooms display select Sacs and Sactionals and are staffed with associates trained to demonstrate and sell our products. Unlike the pop up shops which are 10-day shows, and pop up locations, shop in shops will be designed to be in permanent locations carrying the same digital technology of our showrooms and will be staffed with associates trained to demonstrate and sell our products. We have an ongoing working relationship with Costco to operate pop up shop showrooms that typically average ten days at a time. The pop up shop showrooms display select Sacs and Sactionals and are staffed with associates trained to demonstrate and sell our products. Due to the success of our roadshows, we worked with Costco to bring an eighteen-day Internet roadshow to Costco.com, in which our products were offered for purchase through the Costco.com website. The Costco.com Internet roadshow generated nearly $750,000 in the eighteen days and due to the success, we have scheduled an additional two Internet roadshows that will occur before the end of fiscal 2020. In the thirteen and twenty-six weeks ended August 4, 2019, we hosted over 209 and 368 pop up shop showrooms at Costco locations respectively; up from 137 and 257 Costco ship-in-shops hosted in the thirteen and twenty-six weeks ended August 5, 2018, respectively. We continue to explore other shop in shop and pop up shop partnerships and opportunities to promote our products and facilitate customers interacting with our products in the real world. Other sales which includes pop up shop sales accounted for 15.4% and 14.6% of our total sales for the thirteen and twenty-six weeks ended August 4, 2019 and August 5, 2018, respectively, up from 14.2% and 13.9% for the thirteen and twenty-six weeks ended August 4, 2019 and August 5, 2018, respectively.

Net sales reflect our sale of merchandise plus shipping and handling revenue collected from our customers, less returns and discounts. Sales made at Company operated showrooms, including pop up shops, are recognized at the point of sale when payment is tendered, and ownership is transferred to the customer, which may occur after the sale. Sales of merchandise via the Internet are recognized upon receipt and verification of payment and shipment of the merchandise to the customer. We expect to continue to experience growth in net sales and Internet sales to increase as a percentage to total sales, with fiscal 2020 growth to be between 40% and 45% over fiscal 2019.

Gross profit is equal to our net sales less cost of merchandise sold. Gross profit as a percentage of our net sales is referred to as gross margin. We expect fiscal 2020 gross profit margin to be lower than fiscal 2019 gross profit margin relating to the continued impact of product and margin shift, tariffs and investment into warehousing and distribution infrastructure to support growth. The 10% tariff is being mitigated in total dollars but will have impact on margin percent. We are still evaluating the impact on our financials of the tariff increasing to 25%. If the increase in tariffs to 25% remains in effect for this fiscal year, we do not anticipate any impact of the 15% increase impacting our gross margin until the end of third quarter this fiscal year.

Advertising and marketing expense include digital, social, and traditional advertising and marketing initiatives that cover all of our business channels. Advertising and marketing expense will continue to increase as a percentage to sales as we continue to invest in advertising and marketing which has accelerated sales growth. We expect to continue to maintain our advertising and marketing investments at 10%-12% on an annual basis. The investment by quarter may vary greatly.

Net sales increased $14.9 million, or 44.8%, to $48.1 million in the thirteen weeks ended August 4, 2019 compared to $33.2 million in the thirteen weeks ended August 5, 2018. The increase in net sales is primarily due to an increase in the total number of units sold by approximately 57,618, which reflects a higher average order volume per customer and was accompanied by an increase in new customers, which grew by 15.9% in the thirteen weeks ended August 4, 2019 as compared to 37.1% in the thirteen weeks ended August 5, 2018. We had 80 and 72 showrooms open as of August 4, 2019 and August 5, 2018, respectively. We opened two additional showrooms and closed zero showrooms in the thirteen weeks ended August 4, 2019. Showrooms sales increased $8.2 million, or 35.8%, to $31.3 million in the thirteen weeks ended August 4, 2019 as compared to $23.0 million in thirteen weeks ended August 5, 2018. This increase was due in large part to our comparable showroom sales increase of $6.1 million, or 31.8%, to $25.3 million in the thirteen weeks ended August 4, 2019 compared to $19.2 million in thirteen weeks ended August 5, 2018. Retail sales per selling square foot increased $58, or 15.0%, to $444 in the thirteen weeks ended August 4, 2019 compared to $386 in the thirteen weeks ended August 5, 2018. Internet sales (sales made directly to customers through our ecommerce channel) increased $3.9 million, or 71.5%, to $9.5 million in the thirteen weeks ended August 4, 2019 compared to $5.5 million for the thirteen weeks ended August 5, 2018. We believe that the increase in both showroom and Internet sales was due primarily to our customers’ favorable reaction to our Sactionals products, the opening of additional showrooms, the redesign of our showrooms and our increased advertising and marketing initiatives. Other sales, which include pop up shop sales, increased $2.7 million, or 57.7%, to $7.4 million in the thirteen weeks ended August 4, 2019 as compared to $4.7 million in the thirteen weeks ended August 5, 2018. This increase was due in large part to our increase in the use of pop up shops. We expect to continue to experience healthy growth in net sales and Internet sales to increase as a percentage of total sales.

Gross profit increased $6.4 million, or 36.1%, to $24.3 million in the thirteen weeks ended August 4, 2019 from $17.8 million in the thirteen weeks ended August 5, 2018. Gross margin decreased to 50.4% of net sales in the thirteen weeks ended August 4, 2019 from 53.7% of net sales in the thirteen weeks ended August 5, 2018. The decrease in gross margin percentage of 3.2% was driven primarily by the impact of the 10% China tariffs. The decrease in gross margin was partially offset by reduced costs of our Sactionals and Sacs products. The decrease in costs of our Sactionals and Sacs products was primarily related to cost savings from a change in the sourcing of our Lovesoft and down blend fills in addition to an ongoing shift of manufacturing to Vietnam.

We expect fiscal 2020 gross profit margin to be lower than fiscal 2019 gross profit margin relating to the continued impact of product and margin shift, tariffs and investment into warehousing and distribution infrastructure to support growth. In fiscal 2020, the effect of 10% tariffs are being mitigated in total dollars but will have impact on margin percent.

Selling, general and administrative expenses increased $1.5 million, or 7.3%, to $22.0 million in the thirteen weeks ended August 4, 2019 compared to $20.5 million in the thirteen weeks ended August 5, 2018. The increase in selling, general and administrative expenses was primarily related to an increase in employment costs of $1.4 million, $0.8 million of increased rent associated with our net addition of 2 showrooms, $3.6 million of expenses related to the increase in sales such as $0.5 million of credit card fees, $2.3 million of showroom and web related selling expenses, $0.2 million of web affiliate program and web platform hosting commissions and $0.6 million of pop up shop sales agent fees. Overhead expenses decreased $4.3 million consisting of a decrease in IPO related expenses of $1.3 million, management fees of $0.7 million, one-time professional fees of $0.3 million, net loss on the disposal of property and equipment of $0.1 million and equity-based compensation $1.9 million.

Selling, general and administrative expenses were 45.6% of net sales in the thirteen weeks ended August 4, 2019 compared to 61.5% of net sales in the thirteen weeks ended August 5, 2018. The decrease in selling, general and administrative expenses of 15.9% of net sales and was driven largely by decreases in equity-based compensation and IPO related expenses, partially offset by infrastructure investments such as increased headcount, supply chain optimization efforts and technology enhancements to support increased sales growth.

Advertising and marketing expenses increased $2.5 million, or 68.8%, to $6.1 million in the thirteen weeks ended August 4, 2019 compared to $3.6 million in the thirteen weeks ended August 5, 2018. The increase in advertising and marketing costs relates to increased media and direct to consumer programs which are expected to drive revenue beyond the period of the expense. We expect to continue to maintain our advertising and marketing investments at 10% to 12% on an annual basis. The investment by quarter may vary greatly. Advertising and marketing expenses were 12.6% of net sales in the thirteen weeks ended August 4, 2019 compared to 10.8% of net sales in the thirteen weeks ended August 5, 2018. The increase in media percentage is largely due to additional media tests and running both 15 and 30 second spots into our television – advertising mix.

Depreciation and amortization expenses increased $0.4 million or 58.9% in the thirteen weeks ended August 4, 2019 to $1.2 million compared to $0.8 million in the thirteen weeks ended August 5, 2018. The increase in depreciation and amortization expense principally relates to capital investments for new and remodeled showrooms.

Income tax provision was less than 0.04% of sales for the thirteen weeks ended August 4, 2019 and August 5, 2018, respectively.

Net sales increased $29.1 million, or 48.5%, to $89.1 million in the twenty-six ended August 4, 2019 compared to $60.0 million in the twenty-six weeks ended August 5, 2018. The increase in net sales is primarily due to an increase in the total number of units sold by approximately 126,485, which reflects a higher average order volume per customer and was accompanied by an increase in new customers, which grew by 17.8% in the twenty-six weeks ended August 4, 2019 as compared to 28.3% in the twenty six weeks ended August 5, 2018. We had 80 and 72 showrooms open as of August 4, 2019 and August 5, 2018, respectively. We opened seven additional showrooms and closed two showrooms in the twenty-six weeks ended August 4, 2019. Showrooms sales increased $16.6 million, or 40.0%, to $58.2 million in the twenty-six weeks ended August 4, 2019 as compared to $41.6 million in twenty-six weeks ended August 5, 2018. This increase was due in large part to our comparable showroom sales increase of $11.0 million, or 31.0%, to $46.7 million in the twenty-six weeks ended August 4, 2019 compared to $35.6 million in the twenty-six weeks ended August 5, 2018. Retail sales per selling square foot increased $164, or 23.9%, to $848 in the twenty-six weeks ended August 4, 2019 compared to $684 in the twenty-six weeks ended August 5, 2018. Internet sales (sales made directly to customers through our ecommerce channel) increased $7.8 million, or 77.7%, to $17.9 million in the twenty-six weeks ended August 4, 2019 compared to $10.1 million for the twenty-six weeks ended August 5, 2018. We believe that the increase in both showroom and Internet sales was due primarily to our customers’ favorable reaction to our Sactionals products, the opening of additional showrooms, the redesign of our showrooms and our increased advertising and marketing initiatives. Other sales, which include pop up shop sales, increased $4.6 million, or 55.4%, to $13.0 million in the twenty-six weeks ended August 4, 2019 as compared to $8.4 million in the twenty-six weeks ended August 5, 2018. This increase was due in large part to our increase in the use of pop up shops. We expect to continue to experience healthy growth in net sales and Internet sales to increase as a percentage of total sales.

Gross profit increased $12.8 million, or 39.4%, to $45.3 million in the twenty-six weeks ended August 4, 2019 from $32.5 million in the twenty-six weeks ended August 5, 2018. Gross margin decreased to 50.8% of net sales in the twenty-six weeks ended August 4, 2019 from 54.1% of net sales in the twenty-six weeks ended August 5, 2018. The decrease in gross margin percentage of 3.3% was driven primarily by the impact of 10% China tariffs. The decrease in gross margin was partially offset by reduced costs of our Sactionals and Sacs products. The decrease in costs of our Sactionals and Sacs products was primarily related to cost savings from a change in the sourcing of our Lovesoft and down blend fills in addition to an ongoing shift of manufacturing to Vietnam.

We expect fiscal 2020 gross profit margin to be lower than fiscal 2019 gross profit margin relating to the continued impact of product and margin shift, tariffs and investment into warehousing and distribution infrastructure to support growth. In fiscal 2020, the 10% tariff is being mitigated in total dollars but will have impact on margin percent. We are still evaluating the impact on our financial performance of the tariff increasing to 25%. If the increase in tariffs to 25% remains in effect for this fiscal year, we do not anticipate any impact of the 15% increase impacting our gross margin until end of third quarter this fiscal year.

Selling, general and administrative expenses increased $10.2 million, or 28.5%, to $45.8 million in the twenty-six weeks ended August 4, 2019 compared to $35.6 million in the twenty-six weeks ended August 5, 2018. The increase in selling, general and administrative expenses was primarily related to an increase in employment costs of $3.5 million, $1.3 million of rent associated with our net addition of 5 showrooms, equity based compensation of $1.1 million and $7.3 million of expenses related to the increase in sales such as $0.7 million of credit card fees, $5.1 million of showroom and web related selling expenses, $0.4 million of web affiliate program and web platform hosting commissions, $1.1 million of pop up shop sales agent fees. Overhead expenses decreased $3.0 million related to IPO fees related to the public offering of $1.5 million, reduction in one-time professional fees of $0.9 million and one time IPO bonuses of $0.6 million.

Selling, general and administrative expenses were 51.4% of net sales in the twenty-six weeks ended August 4, 2019 compared to 59.4% of net sales in the twenty-six weeks ended August 5, 2018. The decrease in selling, general and administrative expenses of 8.0% of net sales and was driven largely by decreases in equity based compensation and IPO related expenses, partially offset by infrastructure investments such as increased headcount, supply chain optimization efforts and technology enhancements to support increased sales growth.

Advertising and marketing expenses increased $3.5 million, or 43.2%, to $11.5 million in the twenty-six weeks ended August 4, 2019 compared to $8.0 million in the twenty-six weeks ended August 5, 2018. The increase in advertising and marketing costs relates to increased media and direct to consumer programs which are expected to drive revenue beyond the period of the expense. We expect to continue to maintain our advertising and marketing investments at 10% to 12% on an annual basis. The investment by quarter may vary greatly. Advertising and marketing expenses were 12.9% of net sales in the twenty-six weeks ended August 4, 2019 compared to 13.3% of net sales in the twenty-six weeks ended August 5, 2018. The reduction in media percentage is largely due to a shift to buying media nationally as well as introducing 15 second spots into our television – advertising mix.

Depreciation and amortization expenses increased $0.8 million or 59.0% in the twenty-six weeks ended August 4, 2019 to $2.3 million compared to $1.4 million in the twenty-six weeks ended August 5, 2018. The increase in depreciation and amortization expense principally relates to capital investments for new and remodeled showrooms.

Income tax provision was less than 0.04% of sales for the twenty-six weeks ended August 4, 2019 and August 5, 2018, respectively.

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