Luvu Brands, Inc. 10-K

ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. This discussion summarizes the significant factors affecting the results of operations and financial condition of the Company during the fiscal years ended June 30, 2025, and 2024 and should be read in conjunction with our financial statements and accompanying notes thereto included elsewhere herein. Certain information contained in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” is “forward-looking statements.” Statements that are not historical and which may be identified by the use of words like “expects,” “assumes,” “projects,” “anticipates,” “estimates,” “we believe,” “could be” and other words of similar meaning, are forward-looking statements. These statements are based on management’s expectations and assumptions and are subject to risks and uncertainties that may cause actual results to differ materially from those expressed. Our actual results may differ materially from the results discussed in this section because of various factors, including those set forth elsewhere herein. See “Forward-Looking Statements” included in this report. Results of Operations Overview The following table sets forth, for the periods indicated, information derived from our Consolidated Financial Statements, expressed as a percentage of net sales. The discussion that follows the table should be read in conjunction with our Consolidated Financial Statements. Year Ended June 30, 2025 2024 Net sales 100 % 100 % Cost of goods sold 74 % 73 % Gross profit 26 % 27 % Operating Expenses 26 % 26 % Income from operations 0 % 1 % Fiscal Year ended June 30, 2025 Compared to the Fiscal Year Ended June 30, 2024 Net Sales. Net sales remained nearly flat in fiscal 2025 compared to fiscal 2024. Our Direct to Consumer segment rose by $1.1 million, or 16%, compared to FY2024, while our Wholesale segment declined by $1 million. The direct sales channel includes consumer sales via our three websites. The growth in this segment was driven by new marketing efforts on social media and influencer promotions on Liberator.com, along with higher sales through Jaxxbeanbags.com. The decrease in wholesale sales was due to weaker demand from our brick-and-mortar customers and aggressive, low-price products from Chinese manufacturers sold via Amazon. Gross profit. Gross profit, derived from net sales less than product sales, includes the cost of materials, direct labor, manufacturing overhead, and depreciation. Total gross profit as a percentage of sales for the year ended June 30, 2025, decreased to 26% from 27% in the prior year. Gross profit dollars decreased to $6,469,682 from $6,526,367 in the prior year, representing a 1% decrease. The Company increased the Inventory Reserve by $18,056 to $232,278 which impacted the Gross Profit for the year. The Company also continued to implement cost reduction strategies such as sourcing more raw materials from China and India, reducing warehouse and production headcounts, and system improvements to better forecast inventory requirements. The impact of import tariffs on raw materials may offset some of the savings from lower cost manufacturers and may impact our gross margin in the future. Operating expenses. Excluding depreciation expense, total operating expenses for the year ended June 30, 2025, were 25% of net sales, or $6,114,497, compared to 24% of net sales, or $5,940,238, for the year ended June 30, 2024. The 3% increase in operating expenses from the prior year was primarily due to higher non-capitalizable facilities and equipment repairs, as well as personnel-related costs. Other income (expense). Other expense decreased to ($378,696) from expense of ($411,165) in the prior fiscal year. 10 Table of Contents Income tax expense. Income tax expenses were $0 compared to an expense of ($162,000) in the prior fiscal year. Net Income/ (Loss). We had a net loss from operations of $448,659 or $(0.01) per diluted share, for the year ended June 30, 2025 compared with net loss from operations of $398,602 or $(0.01) per diluted share, for the year ended June 30, 2024 due to decrease in net sales and increase in operating expenses related to facilities and equipment repairs, as well as administrative headcount related costs. Financial Information about Our Business Segmentation We conduct our business through two segments: Direct (consisting of our Internet websites) and Wholesale (consisting of our stocking resellers, drop-ship accounts, contract manufacturing, and distributor accounts). During the last two years, substantially all of our revenue has been generated within North America, and all of our long-lived assets are located in the United States. The following is a summary of our business segments: Twelve Months Ended Twelve Months Ended June 30, 2025 June 30, 2024 (in thousands) Direct to Consumer Wholesale Total Direct to Consumer Wholesale Total Revenues $ 8,155 $ 16,535 $ 24,691 $ 7,016 $ 17,558 $ 24,574 Cost of Goods Sold 5,723 12,431 18,154 5,020 13,028 18,048 Other direct operating expenses (a) 859 1,598 2,457 768 1,795 2,563 Overhead expenses(b) 4,083 3,789 Operating (loss) income 1,574 2,506 (3 ) 1,229 2,734 174 Interest income (5 ) (6 ) Interest expense 377 417 Other expense, net 7 0 Loss from operations before income taxes (382 ) (237 ) Reconciliation of operating (loss) income to adjusted operating income: Operating (loss) income 1,574 2,506 (3 ) 1,229 2,734 174 Adjustments: Share-based compensation expense 37 19 Depreciation and amortization 428 412 Adjusted operating income $ 1,574 $ 2,506 $ 462 $ 1,229 $ 2,734 $ 605 (a) Other direct operating expenses are directly attributable to the business segment, such as marketing, salaries, customer relationship expenses, and travel and entertainment expenses. (b) Overhead expenses are all non-direct expenses related to the operation of the business segment. It includes G&A, unallocated marketing expenses, facilities, product development, and depreciation. 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 due to changes in sales levels to consumers and wholesalers, competition, seasonality costs associated with new product introductions, and increases in raw material costs due to changing import tariffs. In addition, future operating results may fluctuate due to factors beyond our control, such as increases in raw material costs, labor cost increases, foreign exchange fluctuations, changes in government regulations, and economic changes in the region where we operate and sell. A portion of our operating expenses are relatively fixed and the timing of expense level increases is largely based on future sales forecasts. Therefore, if net sales are below expectations in any given period, the adverse impact on the results of operations may be magnified by our inability to adjust spending in certain areas meaningfully 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 adversely affect the financial condition and results of operations. 11 Table of Contents Liquidity and Capital Resources Year ended The following table summarizes our cash flows: June 30, 2025 2024 (in thousands) Cash flow data from continuing operations: Cash provided/(used) by operating activities $ (410 ) $ 475 Cash used in investing activities $ (41 ) $ (71 ) Cash provided/(used) in financing activities $ 158 $ (417 ) As of June 30, 2025, our cash and cash equivalents totaled $734,911 compared to $1,028,448 in cash and cash equivalents as of June 30, 2024. Operating Activities Net cash used by operating activities primarily consists of the purchase of inventories and the effect of changes in operating assets and liabilities. Net cash used by operating activities decreased from the prior year due to the increase in accounts receivable. Investing Activities Cash used in investing activities in the year ended June 30, 2025, was primarily for a replacement database server purchased in the period. In the year ended June 30, 2024, cash used from investing activities was related to the purchase of a forklift and commercial printer. Financing Activities Cash provided by financing activities in the year ended June 30, 2025, was due to the addition of two unsecured notes payable totaling $500,000, offset partially by the repayment of unsecured notes payable and equipment loans. Cash used by financing activities in the year ended June 30, 2024, was from the repayment of equipment notes payable and the unsecured line of credit. Capital Resources We expect total capital expenditures for fiscal 2026 to be less than $100,000, funded primarily by equipment loans and, to a lesser extent, anticipated operating cash flows and borrowings under the line of credit with Advance Financial Corporation. This includes capital expenditures supporting our usual operations. If our business plans and cost estimates are inaccurate, or if our operations require additional cash, or if we deviate from our current plans, we might need to seek additional debt financing for specific projects or ongoing operational needs. Such debt could harm our business if we cannot secure further financing on acceptable terms. Additionally, any debt we take on in the future could come with restrictive covenants that limit our flexibility in planning for or responding to changes in our business. If we fail to comply with these covenants, our lenders could accelerate the repayment of our debt or restrict our access to more borrowings, which could limit our operational flexibility and threaten our ability to continue operations. 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 June 30, 2025, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K. We have entered into operating leases primarily for certain equipment and our facilities in the normal course of business. These arrangements are often referred to as a form of off-balance-sheet financing. Future minimum lease payments under our operating leases as of June 30, 2025, are detailed in the section entitled “Commitments and Contingencies” in the Notes to the Consolidated Financial Statements. 12 Table of Contents Effect of Recently Issued Accounting Standards and Estimates We do not believe that any recently issued, but not yet effective, accounting standards, if currently adopted, will have a material effect on our consolidated financial position, results of operations, or cash flows. Application of Critical Accounting Policies and Estimates Our consolidated financial statements included under Item 8 in this report have been prepared in accordance with GAAP. Our significant accounting policies are described in the notes to our consolidated financial statements. Preparing financial statements in accordance with GAAP requires that we make estimates and assumptions that affect the amounts reported in our financial statements and their accompanying notes. We have identified certain policies that we believe are important to the portrayal of our financial condition and results of operations. These policies require the application of significant judgment by our management. We base our estimates on our historical experience, industry standards, and various other assumptions that we believe are reasonable under the circumstances. Actual results could differ from these estimates under different assumptions or conditions. An adverse effect on our financial condition, changes in financial condition, and results of operations could occur if circumstances change that alter the various assumptions or conditions used in such estimates or assumptions. Our critical accounting policies include those listed below. Revenue Recognition We record revenue based on the five-step model which includes: (1) identifying the contract with the customer; (2) identifying the performance obligations in the contract; (3) determining the transaction price; (4) allocating the transaction price to the performance obligations; and (5) recognizing revenue when the performance obligations are satisfied. Substantially all of our revenue is generated by fulfilling orders for the purchase of manufactured products and product purchased for resale to retailers, wholesalers, or direct to consumers via online channels, with each order considered to be a distinct performance obligation. These orders may be formal purchase orders, verbal phone orders, e-mail orders or orders received online. Shipping and handling activities for which we are responsible under the terms and conditions of the order are not accounted for as performance obligations but as fulfillment costs. These activities are required to fulfill our promise to transfer the goods and are expensed when revenue is recognized. The impact of this policy election is insignificant as it aligns with our current practice. Revenue is measured as the net amount of consideration expected to be received to fulfill a performance obligation. We have elected to exclude sales, use and similar taxes from the measurement of the transaction price. The impact of this policy election is insignificant, as it aligns with our current practice. The amount of consideration expected to be received and revenue recognized includes variable consideration estimates, including costs for trade promotion programs, coupons, returns, and early payment discounts. Such estimates are calculated using historical averages adjusted for any expected changes due to current business conditions and experience. We review and update these estimates at the end of each reporting period and the impact of any adjustments are recognized in the period the adjustments are identified. In assessing whether collection of consideration from a customer is probable, we consider the customer's ability and intent to pay that amount of consideration when it is due. Payment of invoices is due as specified in the underlying customer agreement, typically 30 days from the invoice date, which occurs on the date of transfer of control of the products to the customer. Revenue is recognized at the point in time that control of the ordered products is transferred to the customer. Generally, this occurs at the time of the shipment from our warehouse. or in some cases, picked up from one of our distribution centers by the customer. Allowance for Doubtful Accounts We maintain an allowance for doubtful accounts to reflect our estimate of current and past due receivable balances that may not be collected. The allowance for doubtful accounts is based upon our assessment of the collectability of specific customer accounts, the aging of accounts receivable and our history of bad debts. We believe that the allowance for doubtful accounts is adequate to cover anticipated losses in the receivable balance under current conditions. However, significant deterioration in the financial condition of our customers, resulting in an impairment of their ability to make payments, could materially change these expectations and an additional allowance may be required. 13 Table of Contents Inventories We value inventory at the lower of cost or net realizable value on an item-by-item basis and establish reserves equal to all or a portion of the related inventory to reflect situations in which the cost of the inventory is not expected to be recovered. This requires us to make estimates regarding the net realizable value of our inventory, including an assessment for excess and obsolete inventory. Once we establish an inventory reserve amount in a fiscal period, the reduced inventory value is maintained until the inventory is sold or otherwise disposed of. In evaluating whether inventory is stated at the lower of cost or net realizable value, management considers such factors as the amount of inventory on-hand, the estimated time required to sell such inventory, the foreseeable demand within a specified time horizon and current and expected market conditions. Based on this evaluation, we record adjustments to cost of goods sold to adjust inventory to its net realizable value. These adjustments are estimates, which could vary significantly, either favorably or unfavorably, from actual requirements if future economic conditions, customer demand or other factors differ from expectations. Finished goods and goods in process include a provision for manufacturing overhead, including depreciation. Accounting for Income Taxes We utilize the asset and liability method of accounting for income taxes. We recognize deferred tax liabilities or assets for the expected future tax consequences of temporary differences between the book and tax basis of assets and liabilities. We regularly assess the likelihood that our deferred tax assets will be recovered from future taxable income. We consider projected future taxable income and ongoing tax planning strategies in assessing the amount of the valuation allowance necessary to offset our deferred tax assets that will not be recoverable. We have recorded and continue to carry a full valuation allowance against our gross deferred tax assets that will not reverse against deferred tax liabilities within the scheduled reversal period. If we determine in the future that it is more likely than not that we will realize all or a portion of our deferred tax assets, we will adjust our valuation allowance in the period we make the determination. We expect to provide a full valuation allowance on our future tax benefits until we can sustain a level of profitability that demonstrates our ability to realize these assets. At June 30, 2025, we carried a valuation allowance of $1.5 million against our net deferred tax assets. Impairment of Long-Lived Assets We assess the impairment of long-lived assets whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. An asset or asset group is considered impaired if its carrying amount exceeds the undiscounted future net cash flows the asset or asset group is expected to generate. If an asset or asset group is considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds its fair value. If the estimated fair value is less than the book value, the asset is written down to the estimated fair value, and an impairment loss is recognized. In fiscal year 2025, we generated negative cash flow from operations, and in fiscal year 2024, we generated positive cash flow from operations. If our long-term future results do not yield positive cash flows in excess of the carrying amount of our long-lived assets, we would anticipate possible future impairments of those assets. Considerable management judgment is necessary in estimating future cash flows and other factors affecting the valuation of long-lived assets, including operating and macroeconomic factors that may affect them. We use historical financial information, internal plans and projections, and industry information to make such estimates. Non-GAAP Financial Measures Reconciliation of net loss to Adjusted EBITDA for the years ended June 30, 2025 and 2024: Twelve Months Ended June 30, 2025 2024 (in thousands) Net income (loss) $ (448 ) $ (399 ) Plus interest expense, financing costs and income tax 377 578 Plus depreciation and amortization expense 428 412 Plus stock-based compensation expense 36 19 Adjusted EBITDA $ 393 $ 610 As used herein, Adjusted EBITDA represents net income before interest income, interest expense and financing costs, depreciation, and stock-based compensation expense. We have excluded the non-cash expenses and stock-based compensation expenses as they do not reflect the cash-based operations of the Company. Adjusted EBITDA is a non-GAAP financial measure that 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 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 amortization and non-cash charges for stock-based compensation expense and loss on disposal of assets. ITEM 7A. Quantitative and Qualitative Disclosures about Market Risk. Not applicable for a smaller reporting company. 14 Table of Contents