Luvu Brands, Inc. 10-Q

ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Results of Operations The following table sets forth, for the periods indicated, information derived from our Interim Unaudited Condensed Consolidated Financial Statements, expressed as a percentage of net sales. The discussion that follows the table should be read in conjunction with our Interim Unaudited Condensed Consolidated Financial Statements. Three Months Ended (unaudited) September 30, 2021 September 30, 2020 Net Sales 100.0 % 100.0 % Cost Of Goods Sold 75.9 % 72.3 % Gross Margin 24.1 % 27.7 % Total operating expenses 18.9 % 19.6 % Income from operations 5.2 % 8.1 % The following table represents the net sales and percentage of net sales by product type: Three Months Ended (unaudited) (Dollars in thousands) September 30, 2021 September 30, 2020 Net Sales: Liberator $ 2,741 44 % $ 2,013 38 % Jaxx 1,880 30 % 1,713 32 % Avana 744 12 % 960 18 % Products purchased for resale 428 7 % 337 6 % Other 431 7 % 344 6 % Total Net Sales $ 6,224 100 % $ 5,367 100 % Three Months Ended September 30, 2021 Compared to Three Months Ended September 30, 2020 Net sales . Sales for the three months ended September 30, 2021 were $6,224,000, a 16% increase from the comparable prior year period. The major components of net sales, by product, are as follows: · Liberator sales - Sales of Liberator branded products increased $728,000, or 36%, during the quarter from the comparable prior year period, due primarily to higher sales through the Company’s e-commerce site, Liberator.com and higher sales through Amazon and brick-and-mortar retail customers. · Jaxx sales – Jaxx product sales increased 10% from the prior year first quarter, primarily due to an expanded product offering and greater sales through e-merchants, including Amazon and Wayfair. · Avana sales – Net sales of Avana products decreased 23% during the quarter from the comparable prior year quarter to $744,000 and is due largely to increased competition of these products, including lower priced “copycat” products from China. · Intimacy products purchased for resale – This product category increased by $91,000, or 27%, from the prior year first quarter due to higher sales of certain products through our e-commerce website, Liberator.com. Gross margin . Gross profit, derived from net sales less the cost of goods sold, includes the cost of materials, direct labor, manufacturing overhead, freight costs, royalties and depreciation. As a result of raw material and labor cost increases on many products, the gross profit margin, as a percentage of sales, decreased to 24.1% from 27.7% in the prior year first quarter. Despite the increased net sales, gross profit remained essentially unchanged at $1,499,000, up slightly from $1,488,000 in the prior year first quarter. 25 Table of Contents Operating expenses . Total operating expenses for the three months ended September 30, 2021 were approximately 19% of net sales, or approximately $1,176,000, compared to 20% of net sales, or approximately $1,052,000, for the same period in the prior year. Other income (expense) . Interest expense decreased from approximately ($107,000) in the three months ended September 30, 2020 to approximately ($96,000) during the three months ended September 30, 2021. The decrease was primarily due to lower average borrowing balances and reduced interest expense on those lower balances. Variability of Results We have experienced significant quarterly fluctuations in operating results and anticipate that these fluctuations may continue in future periods. Operating results have fluctuated as a result of changes in sales levels to consumers and wholesalers, competition, seasonality costs associated with new product introductions, and increases in raw material costs. In addition, future operating results may fluctuate as a result of factors beyond our control such as foreign exchange fluctuation, changes in government regulations, and economic changes in the regions in which we operate and sell. A portion of our operating expenses are relatively fixed and the timing of increases in expense levels is based in large part on forecasts of future sales. Therefore, if net sales are below expectations in any given period, the adverse impact on results of operations may be magnified by our inability to meaningfully adjust spending in certain areas, or the inability to adjust spending quickly enough, as in personnel and administrative costs, to compensate for a sales shortfall. We may also choose to increase spending in response to market conditions, and these decisions may have a material adverse effect on financial condition and results of operations. Liquidity and Capital Resources The following table summarizes our cash flows: Three Months Ended September 30, (Dollars in thousands) 2021 2020 (Unaudited) Cash flow data: Cash provided by operating activities $ 169 $ 130 Cash used in investing activities $ (50 ) $ (27 ) Cash used in financing activities $ (135 ) $ (323 ) As of September 30, 2021, our cash and cash equivalents totaled $960,635, compared to $931,741 in cash and cash equivalents as of September 30, 2020. For purposes of reporting cash flows, the Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents. Our principal sources of liquidity are our cash flow that we generate from our operations, availability of borrowings under our line of credit and cash raised through equity and debt financings. Operating Activities Net cash provided by operating activities was $169,000 during the three months ended September 30, 2021 compared to $130,000 net cash provided by operating activities in the three months ended September 30, 2020. The primary components of the cash provided by operating activities in the current year is the net income of $227,000, an increase in accounts payable of $58,000 and a decrease in accounts receivable of $47,000, offset in part by an increase in inventory of $113,000 and an increase in accrued compensation of $105,000. Investing Activities Cash used in investing activities in the three months ended September 30, 2021 was $50,000 and related to the purchase and installation of certain production equipment and computer software during the quarter. 26 Table of Contents Financing Activities Cash used in financing activities during the three months ended September 30, 2021 of $135,000 was primarily attributable to the repayment of the secured and unsecured notes payable and payments made on equipment notes, offset in part by borrowings from the unsecured note payable. Inflation During fiscal 2020 and 2021, we experienced increases in various raw material costs and increases in labor and transportation costs. These cost pressures have not stabilized and we anticipate they will continue to increase throughout fiscal 2022. These inflationary cost increases will harm our profit margins and profitability if we are unable to increase prices or improve productivity enough to offset the effects of such increases in our cost base. Furthermore, if our customers reduce their levels of spending in response to increases in retail prices and/or we are unable to pass such cost increases to our customers, our revenues and our profit margins may decrease. Non-GAAP Financial Measures Reconciliation of net income to Adjusted EBITDA for the three months ended September 30, 2021 and 2020: (Dollars in thousands) Three months ended September 30, 2021 2020 Net income $ 227 $ 329 Plus interest expense, net 96 107 Plus depreciation and amortization expense 71 52 Plus stock-based compensation 4 6 Adjusted EBITDA $ 398 $ 494 As used herein, Adjusted EBITDA represents net income before interest income, interest expense, income taxes, depreciation, amortization, and stock-based compensation expense. We have excluded the non-cash expenses and stock-based compensation, as they do not reflect the cash-based operations of the Company. Adjusted EBITDA is a non-GAAP financial measure which is not required by or defined under GAAP. The presentation of this financial measure is not intended to be considered in isolation or as a substitute for the financial measures prepared and presented in accordance with GAAP, including the net income of the Company or net cash provided by operating activities. Management recognizes that non-GAAP financial measures have limitations in that they do not reflect all of the items associated with the Company’s net income or net loss as determined in accordance with GAAP, and are not a substitute for or a measure of the Company’s profitability or net earnings. Adjusted EBITDA is presented because we believe it is useful to investors as a measure of comparative operating performance and liquidity, and because it is less susceptible to variances in actual performance resulting from depreciation and non-cash charges for stock-based compensation expense. Off-Balance Sheet Arrangements We do not use off-balance sheet arrangements with unconsolidated entities or related parties, nor do we use other forms of off-balance sheet arrangements. Accordingly, our liquidity and capital resources are not subject to off-balance sheet risks from unconsolidated entities. As of September 30, 2021, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K. 27 Table of Contents Critical accounting policies The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amount of assets and liabilities, the disclosure of contingent assets and liabilities and the reported amounts of revenue and expenses during the reported periods. The more critical accounting estimates include estimates related to revenue recognition, accounts receivable allowances and impairment of long-lived assets. We also have other key accounting policies, which involve the use of estimates, judgments and assumptions that are significant to understanding our results, which are described in Note 2 to our unaudited condensed consolidated financial statements appearing in this report. Recent accounting pronouncements The Company does not believe that any recently issued effective pronouncements, or pronouncements issued but not yet effective, if adopted, would have a material effect on the unaudited condensed consolidated accompanying financial statements. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We do not enter into any transactions using derivative financial instruments or derivative commodity instruments and believe that our exposure to market risk associated with other financial instruments is not material.