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) March 31, 2022 March 31, 2021 Net Sales 100.0 % 100.0 % Cost Of Goods Sold 73.4 % 71.8 % Gross Margin 26.6 % 28.2 % Operating Expenses 18.7 % 19.1 % Income from operations 7.9 % 9.1 % Nine Months Ended (unaudited) March 31, 2022 March 31, 2021 Net Sales 100.0 % 100.0 % Cost Of Goods Sold 75.9 % 72.2 % Gross Margin 24.1 % 27.8 % Operating Expenses 18.7 % 19.4 % Income from operations 5.5 % 8.4 % The following table represents the net sales and percentage of net sales by product type: Three Months Ended (unaudited) (Dollars in thousands) March 31, 2022 March 31, 2021 Net Sales: Liberator $ 3,257 48 % $ 2,830 46 % Jaxx 1,906 28 % 1,476 24 % Avana 735 11 % 1,010 16 % Products purchased for resale 431 7 % 532 9 % Other 424 6 % 333 5 % Total Net Sales $ 6,753 100 % $ 6,181 100 % Nine Months Ended (unaudited) (Dollars in thousands) March 31, 2022 March 31, 2021 Net Sales: Liberator $ 9,254 46 % $ 7,300 42 % Jaxx 6,132 30 % 4,903 29 % Avana 2,266 11 % 2,803 16 % Products purchased for resale 1,349 7 % 1,327 8 % Other 1,163 6 % 929 5 % Total Net Sales $ 20,164 100 % $ 17,262 100 % 25 Table of Contents Three Months Ended March 31, 2022 Compared to Three Months Ended March 31, 2021 Net sales . Sales for the three months ended March 31, 2022 were approximately $6,753,000, a 9% 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 $427,000, or 15%, 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, partially offset by lower sales through brick-and-mortar retail customers. · Jaxx sales – Jaxx product sales increased 29% from the prior year third quarter to $1,906,000, 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 27% during the quarter from the comparable prior year quarter to $735,000. Sales of this product line have been impacted by lower-priced competitive products in the marketplace, production constraints which resulted in longer delivery lead times which resulted in lower sales through drop ship channels including Amazon, Overstock and Wayfair. · Products purchased for resale – This product category decreased by 19%, or $101,000, from the prior year third quarter due to lower 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 ongoing labor and raw material cost increases, the gross profit margin, as a percentage of sales, decreased to 27% from 28% in the prior year third quarter. Despite the increased net sales, gross profit increased only slightly to $1,794,000 from $1,746,000 in the prior year third quarter. Operating expenses . Total operating expenses for the three months ended March 31, 2022 were approximately 19% of net sales, or approximately $1,261,000, compared to 19% of net sales, or approximately $1,183,000, for the same period in the prior year. Other income (expense) . Interest expense during the third quarter decreased slightly from approximately ($94,000) in fiscal 2021 to approximately ($81,000) during the third quarter of fiscal 2022. The decrease was primarily due to lower average borrowing balances and reduced interest expense on those lower balances. Nine Months Ended March 31, 2022 Compared to Nine Months Ended March 31, 2021 Net sales . Sales for the nine months ended March 31, 2022 were approximately $20,164,000, a 17% increase from the $17,262,000 recorded in the comparable prior year period. The major components of net sales, by product, are as follows: · Liberator sales - Sales of Liberator branded products increased $1,954,000, or 27%, during the nine months from the comparable prior year period, due primarily to greater sales through the company’s Liberator.com website and through Amazon.com. · Jaxx sales – Jaxx product sales increased $1,229,000 or 25%, from the prior year nine months, primarily due to an expanded product offering of outdoor and indoor products and greater sales through e-merchants, including Amazon and Wayfair. · Avana sales – Net sales of Avana products decreased $537,000, or (19%), to $2,266,000 during the nine months from the comparable prior year period. Sales of this product line have been impacted by lower-priced competitive products in the marketplace, production constraints which resulted in longer delivery lead times which resulted in lower sales through drop ship channels including Amazon, Overstock and Wayfair; and · Products purchased for resale – This product category increased by $22,000, or 2%, from the prior year first nine months due to greater 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 and depreciation. As a result of ongoing labor and raw material cost increases, the gross profit margin, as a percentage of sales, decreased to 24% from 28% in the prior year nine months. Despite the increased net sales, gross profit increased only 1% to $4,870,000 from $4,800,000 in the prior year nine months. The Company continues to raise product selling prices, but may not be able to raise prices quickly enough to offset ongoing raw material and labor cost increases. 26 Table of Contents Operating expenses . Total operating expenses for the nine months ended March 31, 2022 were 19% of net sales, or approximately $3,344,000, compared to 19% of net sales, or approximately $3,763,000, for the same period in the prior year. Of the $419,000 increase, approximately $260,000 was due to higher rent and building occupancy costs, $50,000 was due to higher advertising expense, $70,000 was due to higher depreciation expense. Other income (expense) . Interest expense during the nine months decreased from expense of approximately ($289,000) in fiscal 2021 to expense of approximately ($261,000) during the nine months of fiscal 2022. The decrease was primarily due to lower average borrowing balances and reduced interest expense on those higher balances. The PPP Note forgiveness by the U.S. Small Business Administration resulted in Other Income of approximately $1,096,000 during fiscal 2021. 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: Nine Months Ended March 31, (Dollars in thousands) 2022 2021 (Unaudited) Cash flow data: Cash provided by operating activities $ 263 $ 505 Cash used in investing activities $ (50 ) $ (164 ) Cash used in financing activities $ (255 ) $ (223 ) As of March 31, 2022, our cash and cash equivalents totaled $935,110, compared to $1,269,711 in cash and cash equivalents as of March 31, 2021. 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 $263,000 during the nine months ended March 31, 2022 compared to $505,000 net cash provided by operating activities in the nine months ended March 31, 2021. The primary components of the cash provided by operating activities in the current year is the net income of $846,000, offset in part by an increase in accounts receivable of $218,000, increase in inventory of $417,000, a decrease in accounts payable of $89,000 and an increase in accrued compensation of $90,000. Investing Activities Cash used in investing activities in the nine months ended March 31, 2022 was $50,000 and related to the purchase and installation of certain production equipment during the period. 27 Table of Contents Financing Activities Cash used by financing activities during the nine months ended March 31, 2022 of $255,000 was primarily attributable to the repayment of the secured and unsecured notes payable and payments made on equipment notes. Inflation Since fiscal 2020 we continue to experience 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 the remainder of 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 nine months ended March 31, 2022 and 2021: (Dollars in thousands) Nine months ended March 31, 2022 2021 Net income $ 846 $ 2,263 Plus interest expense, net 261 289 Plus depreciation and amortization expense 227 157 Plus stock-based compensation 14 12 Adjusted EBITDA $ 1,348 $ 2,721 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 March 31, 2022, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K. 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. 28 Table of Contents 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.