LoveSac

Q3 22’ SUMMARY

LoveSac continued to drive growth in Q3 despite significant headwinds in the furniture industry. The business demonstrated that its high income target market continues to demand the unique modular furniture that LoveSac offers. The business continued to scale from showroom expansions as well as partnerships with Best Buy and Costco. LoveSac’s growth moderated; however, the business continued to gain significant share as LoveSac’s modular furniture represents meaningful innovation in the mature furniture industry. While spending in the industry likely contracted in Q3, it is very difficult to ascertain if the decline was due to volume and price reductions or if it was only driven by price reductions.

In Q3, LoveSac’s growth was driven by sactional sales at the business’ showrooms. Sales of sacs and sales through the internet channel continued to underperform. The business continued to see material sales lift from the new StealthTech product, which appeals to both new customers as well as existing customers. LoveSac’s profitability reduced materially in the period due to one-time step-ups in expenses that will support the next stage of growth. Overall, the business remains in a strong position to drive growth from share gains in the massive furniture market. LoveSac is a true disruptor in the mature furniture industry, which is why the business continues to grow regardless of market conditions.

Key Takeaways from Q3 22’

Key Takeaway 1- growth was mixed across channels

• Showroom sales continued to drive growth from new showroom launches and traffic increases at existing locations.

• Trends at Best Buy shop-in-shop continued to outperform company average as LoveSac captures traffic at Best Buy locations given the large customer overlap.

• Momentum in the LoveSac website continued to decelerate as consumers increasingly opted to shop at the showroom, which management attributes to a superior shopping experience in the showroom as opposed to the website.

Key Takeaway 2- sactional momentum remains strong

• Sactional demand continued to demonstrate strength, especially when combined with StealthTech purchases.

• Sac demand continued to demonstrate weakness as consumers focus on Sactionals over Sacs, especially given management’s decision to allocate more promotional attention to Sactionals rather than splitting between the two products.

• Repeat purchases represented a material portion of sales in Q3 as LoveSac’s products are designed for easy expansion over time.

Key Takeaway 3- near term furniture spending headwinds

• Spend trends started weakening in Q3 22’ followed by a meaningful pullback in November; however, there is no indication that overall demand has weakened as prices have fallen meaningfully compared to last year.

• Market research firms continue to forecast material compounded growth over the next several years.

GROWTH TRENDS

growth Factor 1- Showrooms

LoveSac’s showroom channel continued to drive the business’ growth in Q3 as consumers demonstrated preference of physical shopping over digital. While the overall e-commerce category has experienced weaker performance than physical shopping in 22’, LoveSac’s products can be experienced much better in the showroom opposed to the website. The showrooms are professionally designed to showcase the look and feel of the products within the context of a large space. Given that modular furniture is designed to have relatively homogenous features, LoveSac is able to secure smaller store sizes with a primary function of showcasing several furniture configurations.

LoveSac’s data indicates that physical touchpoints are important purchase consideration drivers. This is especially true in LoveSac’s case as the furniture is more unique and expensive than the typical furniture player. As a result, prospective customers benefit from experiencing the product in the appropriate context. Additionally, informed sales associates can educate prospective customers as the products are novel. Given that new customers represent over 55% of sales, there is likely a high degree of educating involved in the purchasing process.

LoveSac’s existing showroom fleet performed stronger than new showrooms, which led to a combined result that far exceeded the internet channel. This has helped the showroom channel regain some of the lost significance experienced during the pandemic years as many consumers decided to shop online rather than in stores. In Q3, LoveSac experienced a 30% increase in store traffic, which led to sales growth from higher transactions. Additionally, the company had over 40% more showrooms operating in Q3 22’ than it did in Q3 21’. While this footprint expansion benefited the business in Q3, the existing showroom fleet drove the vast majority of sales growth in the showroom channel. The new stores need more time to mature, which is not a cause for concern given the short payback period (<2yrs) and normal sales ramp period. Overall, the showroom performance demonstrated that consumer spending at physical stores is not dead, which many were prognosticating during the pandemic. This means that LoveSac’s store expansion strategy remains a viable path to scale. Going forward, the business has plenty of incremental revenues likely to come in 23’ as new stores from 22’ scale to material levels of productivity.

growth Factor 2- strong sactional demand

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 Q3 22’, LoveSac generated virtually all of revenue growth from Sactional sales as demand remained strong for the company’s core product. While the furniture industry is facing significant pressure, LoveSac’s affluent customer base continued to demonstrate their strong spending power. Management did offer more promotional events than Q3 21’; however, this activity was still well below pre-pandemic levels.

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 Q2 22’ levels, which was even higher than Q1 22’. 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 continued to struggle in Q3 22’, which is now becoming a trend. It appears that the redirection of advertising spend continued to push Sactionals over Sacs. Additionally, management decided to offer more promotional events for Sactionals rather than both products. It appears that the product mix is optimizing to levels that are more appropriate as LoveSac continues to scale. This means that Sacs simply will not support meaningful growth for LoveSac given the massive price difference between Sacs and Sactionals. Additionally, the addition of StealthTech creates an additional tailwind for Sactional demand. Even with these headwinds, Sac sales contribute to the business’ revenues and profitability through resource sharing. LoveSac’s growing customer base should keep this product line relevant over the next few years.

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

LoveSac’s internet channel slowed in Q3 22’ as traffic shifted to showrooms at the expense of the internet channel. While the internet business supported meaningful growth during the pandemic, customers are clearly voting in favor of showrooms. This is the primary reason the business is expanding the store footprint to address this customer demand for physical shopping. Even with the pullback, the internet channel still represents much more significance than it did pre-pandemic. LoveSac is a scaling multi-channel, multi-product business which means that the balances are likely to shift as the business develops.

• Trends are strong in Q4 with management sharing that Cyber Monday sales were “really strong”, which is very likely a gauge for the internet channel rather than the showroom channel.

• Website was relaunched after a reconfiguration consisting of augmented reality tech that improves UI and overall experience.

• Attachment and conversions experienced a 6% lift after website was revamped.

LoveSac delivered strong growth from sales at Best Buy and Costco. The business continued to expand relationships with both retailers, which is a powerful strategy given the customer overlap. Additionally, these relationships serve a marketing purpose given that they raise awareness for LoveSac as both retailers have massive brand recognition. Partnering with these household names positions LoveSac to benefit from the massive traffic that LoveSac does not have to pay directly in the form of marketing expense. In the period, LoveSac hosted ~60 roadshows at Costco stores as well as several events on Costco’s websites. These channels are still nascent for LoveSac, which represents a material incremental revenue opportunity.

OPERATIONAL EFFICIENCIES

LoveSac continued to face material expense headwinds in Q3 22’, albeit to a lesser degree than the Pragmatic forecast due to gross margins holding stronger than expected. Expenses in the period were primarily driven by higher freight costs, expenses related to a new distribution center in Dallas, higher occupancy costs associated with new stores, and higher salary expense related to IT headcount expansion. These expenses represent investments in the next stage of LoveSac’s journey to secure even greater share of the massive furniture market. While LoveSac could have delayed these expenses to mitigate the headwinds from revenue headwinds, management decided to charge ahead on the business’ strategic initiatives. Importantly, these expenses are not permanent changes to LoveSac’s cost structure as the percentage of revenues they represent will not repeat in 23’. This is due to the fact that these expenses will not increase at the same rate as revenues next year.

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.

In Q3 22’, data from the BEA showed that home furniture sales increased at a similar rate as Q2 22’; however, growth in September turned negative. This growth was flat in October before decreasing -3% in November, which is material for an entire industry to contract at that level. Interestingly, there was considerable deflation in the goods sector in November as many retailers lowered prices to compete better and pass on reduction in input costs. This likely drove a material portion of the decline in November.

In 22’, market research firm Euromonitor continues to expect spend on living room furniture to decrease -2% followed by a flat CAGR through 26’. The firm continues to expect 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 still expected to remain stable, at least, which is very positive given the boom in the last two years.

FORECAST AND VALUATION

LoveSac is positioned to deliver continued revenue growth in Q4, albeit at a more moderate level than previously forecasted. This reduced forecast is driven by headwinds in the industry that has resulted in less spending, which translates to less demand available to capture in Q4. Even still, this moderated growth is far greater than the home furniture market is experiencing, which means that LoveSac is positioned to continue taking share while others are materially lowering prices to drive volume (and still lose share). This means that the average player in the industry is in such a vulnerable position that they must lower prices just to minimize market share losses as share gains are really out of the question for the average player.

LoveSac’s revenue growth in Q4 will likely be driven by new locations, best Buy store-in-stores, and Costco pop-up shops that were not present in Q4 21’. Trends are already supportive of a constructive outlook for Q4 as Black Friday and Cyber Monday sales trends were “really strong”, according to management. Additionally, management shares that trends post-Cyber Monday have continued to be “really strong”. Based on these cross currents, the business is likely to generate -$33mm less revenue than previously expected, which represents growth of 19% compared to the previous Pragmatic forecast of 35% growth. Importantly, the reduced revenue forecast is not a function of weakening growth potential as LoveSac’s products are still highly differentiated and the business model is still superior to the average player in the industry.

While the business delivered earnings that outperformed Pragmatic forecast for Q3, LoveSac is likely to deliver weaker than expected earnings growth in Q4 driven by lower than expected revenues and lower than expected operating leverage. This pressure is likely to drive EBITDA and EPS growth to outpace revenue growth by a lower rate than previously expected. Specifically, COGS and OpEx expenses are expected to grow less than revenues driving EBITDA growth of 46% and EPS growth of 22%. Importantly, LoveSac is well positioned in the furniture market to continue growing in 23’ at a rate much faster than the industry. All of this leads to continued confidence in LoveSac’s stock price performance over the next year. This is supported by a strong growth outlook, operating leverage, and a deeply discounted stock.