LoveSac

Q2 22’ SUMMARY

LoveSac continued to take market share in the massive and highly fragmented U.S. home furniture industry. The company is a leading player in the modular furniture space, which is experiencing a boom in popularity. LoveSac has significant competitive advantages stemming from being the first mover in the category, which has positioned the business to benefit from the rapid shift up the adoption curve in the last couple of years.

While the U.S. furniture industry is experiencing moderation from the massive growth in 21’, LoveSac continued to demonstrate that the business is on a fundamentally different trajectory. LoveSac is far from maturity as the business has many years of high growth ahead from taking share away from traditional players.

LoveSac’s outperformance is also being driven by the business’ focus on the higher income consumer, which is a group that has been largely insulated from elevated prices. LoveSac’s target customer is between 35-45 with high household income. The business’ focus on couches means that they offer non-discretionary furniture which is more resistant to macro headwinds than other types of furniture. Additionally, LoveSac’s purchase occasions are relocations, remodels, and replacements rather than home purchases. This means that the business’ demand conditions are much more stable than the housing market volatility implies.

Key Takeaways from Q2 22’

Key Takeaway 1- growth was balanced across channels

• Showrooms continued to be a source of growth driven by same store sales momentum as well as new store contributions.

• Partnership with Best Buy contributed meaningful incremental revenues as the shop-in-shop concept proves to be a powerful customer acquisition strategy.

• LoveSac’s online store continued to re-build from the pullback experienced in 21’ driven by consumers returning to brick and mortar shopping.

Key Takeaway 2- sactional momentum remains strong

• Sactionals continued to drive the business’ growth, especially with the addition of StealthTech as this new product is driving meaningful sales lift for the business.

• Sales of Sacs were a headwind for the business in Q2 22’ as the marketing strategy was redirected towards Sactionals as these are much more valuable to the business from an average selling price perspective.

Key Takeaway 3- furniture spending in the u.s. maintained stability

• Spend was stable in Q2 22’ relative to Q1 22’ even with the industry coming off of a high growth period.

• Market research firms forecast sustained momentum through 22’ and the next several years.

GROWTH TRENDS

growth Factor 1- Showrooms

LoveSac’s showroom channel is the main driver of growth for the company. While the business has an omni-channel strategy, the physical showrooms represent the largest share of revenues for LoveSac. The showrooms are more “manifestation of a concept” than simply a brick and mortar store front as they are highly immersive and experiential. This is central to LoveSac’s business model which is designed to cut out the middleman by bringing innovative products directly to the consumer. LoveSac is able to control the brand as well as the experience by building out a fleet of showrooms to stage the furniture. This approach is critical for a challenger brand that is seeking to disrupt the status quo of a mature industry.

LoveSac deployed hyper-localized advertising in Q2 22’ to drive traffic into showrooms. The brand is still relatively unknown which means that advertising activities are highly impactful as the advertising is highly likely to be viewed by consumers who do not know the brand. This strategy was a driver of the 37% same store sales growth in the quarter.

The same store sales growth is the result of LoveSac’s business model which is designed to land and expand by investing advertising dollars behind the launch of new locations. Importantly, the business’ footprint is nowhere near fully developed, which means LoveSac has plenty of room to expand. This will position the company to reach more consumers who have demonstrated a desire to engage with the business via the showroom locations.

growth Factor 2- sactionals

Although LoveSac got its start from the business’ Sacs product type, Sactionals has quickly become the core product of the business at the current stage of scale. The product type is only increasing in importance now that modular furniture is gaining in popularity, which drives greater commercial interest in the entire category. The Sactional product growth was partially driven by LoveSac deciding to pull ad spend away from Sacs to more heavily promote the Sactional product as these products have much higher customer value levels. The higher valuation is apparent at the outset with higher transaction values. It is also observable over time as customers expand the size of their previously purchased Sactional.

Sactionals are central to LoveSac’s business model as they are designed to be highly efficient products based on the limited number of SKU’s, high ticket price, and lack of seasonality. This means that the products are evergreen and management does not need to be worried about inventory risk from styles that do not resonate with customers. In Q2 22’, demand signals remained strong not just from a revenue perspective but also from a realized price perspective on a unit level. In the quarter, product margins actually increased which indicates that the business did not have to lower prices to move inventory. This performance is driven by a highly valuable customer that is attracted to the unique value that LoveSac’s Sactionals offer.

LoveSac is driving momentum in the Sactionals product segment through the introduction of StealthTech, which represents substantial innovation from the business. StealthTech has been well received by new and existing customers, which has resulted in attachment rates increasing from Q1 22’ levels. This product line is driving substantial incremental revenues as the average order value is 3x greater with a StealthTech attachment than orders without StealthTech.

• The product is so successful because it materially enhances the value of the Sactionals given that it is primarily used in conjunction with media consumption.

• LoveSac’s business model based on products that have lifetime value led to products with backward mobility, which means that new products such as StealthTech are compatible with all Sactionals.

• This has given LoveSac a massive existing customer base to sell into. The strong reception combined with the market size of home audio systems is giving management confidence that the product can add hundreds of millions of dollars of revenues in the medium term.

The Sacs product line struggled to generate growth in Q2 22’ as management redirection marketing spend away from Sacs to Sactional. While this was a great decision on a company-wide level, it did cause demand for Sacs to fall rather materially in Q2 22’. Management did not offer much additional commentary about the Sacs business, which could be a signal of a fundamental shift in strategy going forward. While Sacs was the foundational product, the long-term trajectory appears must more modest than that of Sactionals, especially given the introduction of StealthTech. This will be monitored over time to get a better handle on the situation.

growth Factor 3- Internet and store-in-store channels

LoveSac’s strength in Q2 22’ was driven by strength across channels, which include internet and other (shop-in-shop and pop-up shops) channels. These represent ways for the business to acquire customers outside of showroom reach. The internet business has materially increased as a percentage of revenues compared to pre-pandemic periods. Sales thru this channel pulled back in 21’ compared to the elevated pandemic levels driven by COVID lockdowns driving business to the internet channel. The reopening of brick and mortar stores caused consumers to resume visits to the showrooms; however, sales through the internet channel remain above pre-pandemic levels. This indicates that the internet channel has permanently gained more traffic due to the pandemic and LoveSac’s advertising activities.

The company is generating strong demand from the shop-in-shop partnership with Best Buy, which is a positive development after the business ended its former relationship with Costco. While the company has resumed the relationship with Costco, it is much smaller in nature than it used to be. This is proving to be a great move as the StealthTech products have a 2x higher attachment rate than LoveSac’s own showrooms. The stronger adoption in Best Buy is a positive sign given that many consumers visit Best Buy for home audio products. Importantly, LoveSac is expanding the relationship in 23’, which positions the company for even more growth from the partnership.

OPERATIONAL EFFICIENCIES

LoveSac continued to manage through elevated prices while investing for the next stage of business. While margins compressed in Q2 22’, they are well above pre-pandemic levels. This is strong evidence that the cost structure of the business has reached a level in which material profits are generated from incremental increases in revenues. The business is positioned to return to material operating leverage in Q4 22’ followed by a year of operating leverage in 23’. Importantly, margins were suppressed by elevated logistics and long-term infrastructure investments rather than product margin compression.

INDUSTRY TRENDS

LoveSac’s business model of offering high-end modular furniture to high income consumers positions the business to continue taking share despite growth fatigue in the furniture industry. The company is well positioned in a high growth area of the industry, which offers even greater insulation.

Importantly, spend on furniture remained stable in Q2 22’ based on data from the government. According to the BEA, spend on furniture increased about 2% in Q2 22’, which is on par with the spend growth in Q1 22’.

In 22’, market research firm Euromonitor expects spend on living room furniture to decrease -2% followed by a flat CAGR through 26’. The firm expects spend on “other sofa” such as modular furniture to increase 4% in 22’ followed by a CAGR of 4% through 26’. Overall, the industry spend is expected to remain stable, at least, which is great given the boom in the last two years.

FORECAST AND VALUATION

LoveSac is well positioned to continue taking share in the furniture industry by continuing to execute on the effective business model. The focus on high-end modular furniture targeting high income young families uniquely positions LoveSac for abnormal growth. These consumers are open to innovation; however, they lack options given that they are above the low income segment but below the high net worth segment. LoveSac is poised to continue gaining share from expanding the footprint to reach more of the market in 2H 22’ and beyond. Importantly, the business is positioned to return to strong operating leverage as the elevated logistic expenses subside.

LoveSac’s stock is deeply discounted based on the business’ earnings growth trajectory, especially given that the business is now profitable yet the multiple is a fraction of historical levels. Similar to other stocks, LoveSac’s stock has been caught up in the market volatility, which has ensnared high growth companies much more than low growth companies. The stock is highly likely to materially increase as the negativity breaks. This is the likely catalyst that will cause investors to demand LoveSac’s stock given the business’ profitability and growth trajectory.