Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion and analysis of our financial condition and results of operations together with our consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements based upon current plans, expectations and beliefs involving risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth in Part I, “Item 1A. Risk Factors” and other factors set forth in other parts of this Annual Report on Form 10-K. Discussion of the year-to-year comparisons between 2021 and 2020 can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of the Company’s Annual Report on Form 10-K for the fiscal year ended January 2, 2022.
Overview
Lulus is a customer-driven, digitally-native fashion brand primarily serving a large, diverse community of Millennial and Gen Z women, who typically meet us in their 20s and stay with us through their 30s and beyond. We focus relentlessly on giving our customers what they want. We do this by using data coupled with human insight to deliver a curated and continuously evolving broad assortment of on-trend, affordable luxury fashion for many of life’s moments. Our customer obsession sets the tone for everything we do, from our personalized online shopping experience to our exceptional customer service.
Initial Public Offering
On November 10, 2021, our registration statement on Form S-1 relating to its IPO was declared effective by the SEC and the shares of its common stock began trading on the Nasdaq Global Market on November 11, 2021. The IPO closed on November 15, 2021, pursuant to which we issued and sold 5,750,000 shares of our common stock at a public offering price of $16.00 per share. On November 15, 2021, we received net proceeds of approximately $82.0 million from the IPO, after deducting underwriting discounts and commissions of approximately $6.1 million and other issuance costs of approximately $3.9 million. Immediately prior to the completion of the IPO, we filed an amended and restated certificate of incorporation, which authorized a total of 250,000,000 shares of common stock at $0.001 par value per share, and 10,000,000 shares of preferred stock, $0.001 par value per share. Immediately prior to the completion of the IPO, all shares of the Series A Preferred Stock then outstanding were converted into 15,000,000 shares of common stock. Additionally, 215,702 shares of common stock were issued to the LP immediately prior to the completion of the IPO. All shares of the Series B Preferred Stock and the Series B-1 Preferred Stock were redeemed and extinguished for a total payment of approximately $17.9 million on November 15, 2021.
Impact of the COVID-19 Pandemic
While there continues to be uncertainty related to the COVID-19 pandemic, we believe the significant impact of the pandemic on the demand for our product related to social distancing mandates, lockdowns, cancelled social events and travel has largely subsided. However, we are still susceptible to broader COVID-19 risks globally, especially in relation to our supply chain. We continue to take actions to anticipate changes in the business environment and supply chain pressures, including placing orders earlier than pre-pandemic times, leveraging our “test, learn and reorder” approach to test small order quantities and then graduate successful styles to our re-order algorithms and diversifying our supply chain network to mitigate rising costs and service delays. We have modified our business practices in response to the COVID-19 pandemic and plan to continue to take proactive measures.
We expect ongoing volatility in these trends as the continued impact from COVID-19 remains uncertain. We may take further actions that impact our business operations as may be required by federal, state, or local authorities or that we determine to be in the best interests of our employees and our customers. For additional discussion of risks related to the COVID-19 pandemic and the impact of the COVID-19 pandemic on our Company, see “Risk Factors—Risks Related to our Business—The COVID-19 pandemic has had and may in the future have an adverse effect on our labor workforce availability, supply chain, business, financial condition, cash flows, and results of operations in ways that remain unpredictable.”
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Impact of Macroeconomic Trends on Business
Changing macroeconomic factors, including inflation, interest rates, fuel prices, and overall consumer confidence with respect to current and future economic conditions have directly impacted our sales in fiscal 2022 as discretionary consumer spending levels and shopping behavior fluctuate with these factors. During fiscal 2022, we have responded to these factors by taking appropriate pricing, promotional and other actions to stimulate customer demand. These factors are expected to continue to have an impact on our business, results of operations, our growth and financial condition.
Historically, our business model has resulted in strong growth. Between fiscal years 2016 and 2019, we grew our net revenue by 179% to $370 million, or an annual compounded growth rate of 41%. In fiscal year 2020, our net revenue declined by 33% to $249 million as a result of the COVID-19 pandemic. In fiscal year 2021, our business rebounded from the initial impact of the pandemic on consumer behavior, and we grew our net revenue by 51% compared to 2020. Our sales growth slowed in fiscal year 2022 due to heightened macro-economic pressures, resulting in a 17% growth in net revenue compared to 2021.
Key Operating and Financial Metrics
We collect and analyze operating and financial data to assess the performance of our business and optimize resource allocation. The following table sets forth our key performance indicators for the periods presented (in thousands, except for percentages and Average Order Value).
Adjusted EBITDA Margin (1) 6.6 % 11.0 % 7.6 %
Active Customers
We define Active Customers as the number of customers who have made at least one purchase across our platform in the prior 12-month period. We consider the number of Active Customers to be a key performance metric on the basis that it is directly related to consumer awareness of our brand, our ability to attract visitors to our digital platform, and our ability to convert visitors to paying customers. Active Customers counts are based on de-duplication logic using customer account and guest checkout name, address, and email information.
Average Order Value
We define Average Order Value (“AOV”) as the sum of the total gross sales before returns across our platform in a given period, plus shipping revenue, less discounts and markdowns, divided by the Total Orders Placed in that period. AOV reflects average basket size of our customers. AOV may fluctuate as we continue investing in the development and introduction of new Lulus merchandise and as a result of our promotional discount activity.
Total Orders Placed
We define Total Orders Placed as the number of customer orders placed across our platform during a particular period. An order is counted on the day the customer places the order. We do not adjust the number of Total Orders Placed for any cancellation or return that may have occurred subsequent to a customer placing an order. We consider Total Orders Placed as a key performance metric on the
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basis that it is directly related to our ability to attract and retain customers as well as drive purchase frequency. Total Orders Placed, together with Average Order Value, is an indicator of the net revenue we expect to generate in a particular period.
Gross Margin
We define Gross Margin as gross profit as a percentage of our net revenue. Gross profit is equal to our net revenue less cost of revenue. Certain of our competitors and other retailers report cost of revenue differently than we do. As a result, the reporting of our gross profit and Gross Margin may not be comparable to other companies.
Non-GAAP Financial Measures
We report our financial results in accordance with accounting principles generally accepted in the United States of America (“GAAP”). However, management believes that certain non-GAAP financial measures provide investors of our financial information with additional useful information in evaluating our performance and that excluding certain items that may vary substantially in frequency and magnitude period-to-period from net income (loss) provides useful supplemental measures that assist in evaluating our ability to generate earnings and to more readily compare these metrics between past and future periods. These non-GAAP financial measures may be different than similarly titled measures used by other companies.
To supplement our audited consolidated financial statements which are prepared in accordance with GAAP, we use “Adjusted EBITDA”, “Adjusted EBITDA Margin” and “Net Debt” which are non-GAAP financial measures (collectively referred to as “Adjusted EBITDA”). Our non-GAAP financial measures should not be considered in isolation from, or as substitutes for, financial information prepared in accordance with GAAP. There are several limitations related to the use of our non-GAAP financial measures as compared to the closest comparable GAAP measures. Some of these limitations include:
Due to these limitations, Adjusted EBITDA, Adjusted EBITDA margin, and Net Debt should not be considered as measures of discretionary cash available to us to invest in the growth of our business. We compensate for these limitations by relying primarily on our GAAP results and using these non-GAAP measures only supplementally. As noted in the table below, Adjusted EBITDA includes adjustments to exclude the impact of depreciation and amortization, interest expense, income taxes, management fees, transaction fees, which represent the write-off of offering costs deferred during 2019 upon abandonment of a prior offering in 2020, and equity-based compensation. It is reasonable to expect that some of these items will occur in future periods. However, we believe these adjustments are appropriate because the amounts recognized can vary significantly from period to period, do not directly relate to the ongoing operations of our business and may complicate comparisons of our internal results of operations and results of operations of other companies over time. In addition, Adjusted EBITDA includes adjustments for other items that we do not expect to regularly record. Each of the normal recurring adjustments and other adjustments described in this paragraph and in the following reconciliation table
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help management with a measure of our core operating performance over time by removing items that are not related to day-to-day operations. Adjusted EBITDA Margin is a non-GAAP financial measure that we calculate as Adjusted EBITDA (as defined above) as a percentage of our net revenue.
The following table provides a reconciliation for Adjusted EBITDA and Adjusted EBITDA margin:
(in thousands)
Loss on extinguishment of debt — 1,392 —
Income tax provision (benefit) 4,047 6,212 (1,271)
Management fees (1) — 534 626
Transaction fees (3) — 476 —
Adjusted EBITDA Margin 6.6 % 11.0 % 7.6 %
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Net Debt
We define Net Debt as total debt, which includes short-term borrowings and long-term obligations, less cash and cash equivalents. We consider net debt to be an important supplemental measure of our financial position, which allows us to analyze our leverage.
A reconciliation of non-GAAP Net Debt as of January 1, 2023 and January 2, 2022 is as follows:
As of
(in thousands)
Revolving line of credit, long term $ (25,000) $ (25,000)
Factors Affecting Our Performance
Our financial condition and results of operations have been, and will continue to be, affected by a number of factors that present significant opportunities for us but also pose risks and challenges, including what is discussed below. See “Risk Factors.”
Customer Acquisition
Our business performance depends in part on our continued ability to cost-effectively acquire new customers. We define customer acquisition cost (“CAC”) as our brand and performance marketing expenses attributable to acquiring new customers, including, but not limited to, agency costs and marketing team costs but excluding any applicable equity-based compensation, divided by the number of customers who placed their first order with us in a given period. As a digital brand, our marketing strategy is primarily focused on brand awareness marketing and digital advertising in channels like search, social, and programmatic – platforms that enable us to engage our customer where she spends her time, and in many cases also quickly track the success of our marketing, which allows us to adjust and optimize our marketing spend.
Customer Retention
Our continued success depends in part on our ability to retain and drive repeat purchases from our existing customers. We monitor retention across our entire customer base. Our goal is to attract and convert visitors into active customers and foster relationships that drive repeat purchases. During the trailing twelve months ended January 1, 2023, we served 3.2 million Active Customers compared to 2.8 million for the trailing 12 months ended January 2, 2022.
Inventory Management
We utilize a data-driven strategy that leverages our proprietary reorder algorithm to manage inventory as efficiently as possible. Our “test, learn, and reorder” approach consists of limited inventory purchases followed by the analysis of proprietary data including real-time transaction data and customer feedback, which then informs our selection and customization of popular merchandise prior to reordering in larger quantities. While our initial orders are limited in size and financial risk and our supplier partners are highly responsive, we nonetheless purchase inventory in anticipation of future demand and therefore are exposed to potential shifts in customer preferences and price sensitivity over time. As we continue to grow, we will adjust our inventory purchases to align with the current needs of the business.
Investment in Our Operations and Infrastructure
We will continue to invest in our operations and infrastructure to facilitate further growth of our business. While we expect our expenses to increase accordingly, we will harness the strength of our existing platform and our on-trend fashion expertise to make informed investment decisions. We intend to invest in headcount, inventory, fulfillment, logistics, and our software and data capabilities in order to improve our platform, expand into international markets, and drive operational efficiencies. We cannot guarantee that increased spending on these investments will be cost effective or result in future growth in our customer base. However, we set a high
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bar for approval of any capital spending initiative. We believe that our disciplined approach to capital spending will enable us to generate positive returns on our investments over the long term.
Components of Our Results of Operations
Net Revenue
Net revenue consists primarily of gross sales, net of merchandise returns and promotional discounts and markdowns, generated from the sale of apparel, footwear, and accessories. Net revenue excludes sales taxes assessed by governmental authorities. We recognize net revenue at the point in time when control of the ordered product is transferred to the customer, which we determine to have occurred upon shipment.
Net revenue is impacted by our number of customers and their spending habits, AOV, product assortment and availability, and marketing and promotional activities. During any given period, we may seek to increase sales by increasing promotional discounts, and in other periods we may instead seek to increase sales by increasing our selling and marketing expenses. We consider both actions together, so increased promotional discounts in a period, which would reduce net revenue accordingly in such period, might also result in lower selling and marketing expenses in such period. Similarly, if we increase selling and marketing expenses in a given period, promotional discounts may be correspondingly reduced, thereby improving net revenue.
Cost of Revenue and Gross Margin
Cost of revenue consists of the product costs of merchandise sold to customers; shipping and handling costs, including all inbound, outbound, and return shipping expenses; rent, insurance, business property tax, utilities, depreciation and amortization, and repairs and maintenance related to our distribution facilities; and charges related to inventory shrinkage, damages, and our allowance for excess or obsolete inventory. Cost of revenue is primarily driven by growth in orders placed by customers, the mix of the product available for sale on our site, and transportation costs related to inventory receipts from our suppliers. We expect our cost of revenue to fluctuate as a percentage of net revenue primarily due to how we manage our inventory and merchandise mix.
Gross profit is equal to our net revenue less cost of revenue. We calculate Gross Margin as gross profit as a percentage of our net revenue. Our Gross Margin varies across Lulus, exclusive to Lulus, and third-party branded products. Exclusive to Lulus consists of products that we develop with design partners and have exclusive rights to sell across our platform, but that do not bear the Lulus brand. Gross Margin on sales of Lulus and exclusive to Lulus merchandise is generally higher than Gross Margin on sales of third-party branded products, which we offer for customers to “round out” the shopping basket. As we continue to optimize our distribution capabilities and gain more negotiation leverage with suppliers as we scale, our Gross Margin may fluctuate from period to period depending on the interplay of these factors.
Selling and Marketing Expenses
Our selling and marketing expenses consist primarily of payment processing fees, advertising, targeted online performance marketing and customer order courtesy adjustments. Selling and marketing expenses also include our spend on brand marketing channels, including compensation and free clothing to social media influencers, events, and other forms of online and offline marketing related to growing and retaining the customer base. As discussed in “Net Revenue” above, in any given period, the amount of our selling and marketing expense can be affected by the use of promotional discounts in such period.
General and Administrative Expenses
General and administrative expenses consist primarily of payroll and benefits costs, including equity-based compensation for our employees involved in general corporate functions including finance, merchandising, marketing, and technology, as well as costs associated with the use by these functions of facilities and equipment, including depreciation, rent, and other occupancy expenses. General and administrative expenses are primarily driven by increases in headcount required to support business growth and meeting our obligations as a public company.
Since our IPO, we have incurred significant legal, accounting, and other expenses that we did not incur as a private company. We expect that compliance with the Sarbanes-Oxley Act and the Dodd-Frank Wall Street Reform and Consumer Protection Act, as well as
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rules and regulations subsequently implemented by the SEC, will increase our legal and financial compliance costs and will make some activities more time consuming and costly.
Other Income (Expense), Net
Other income (expense), net consists primarily of interest expense and other miscellaneous income.
(Provision) Benefit for Income Taxes
The (provision) benefit for income taxes represents federal, state, and local income taxes. The effective rate differs from the statutory rate primarily due to non-deductible equity-based compensation expenses and state taxes. Our effective tax rate will change from quarter to quarter based on recurring and nonrecurring factors including, but not limited to, the geographical mix of earnings, enacted tax legislation, state and local income taxes, the impact of permanent tax adjustments, and the interaction of various tax strategies.
Our Results of Operations
The following tables set forth our consolidated results of operations for the years presented and as a percentage of net revenue:
Percentage Change
(in thousands)
Other income (expense), net:
Loss on extinguishment of debt — (1,392) (100) —
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Cost of revenue 56 53 56
Gross profit 44 47 44
Selling and marketing expenses 19 18 19
General and administrative expenses 23 23 27
Income (loss) from operations 2 6 (2)
Other income (expense), net:
Interest expense — (3) (6)
Loss on extinguishment of debt — — —
Other income, net — — —
Total other expense, net — (3) (6)
Income (loss) before income taxes 2 3 (8)
Income tax (provision) benefit (1) (2) —
Net income (loss) 1 % 1 % (8) %
Comparisons for the Fiscal Years Ended January 1, 2023 and January 2, 2022
Net Revenue
Net revenue increased in 2022 by $64.0 million, or 17%, compared to 2021. The increase in revenue was primarily due to 17% increase in Active Customers, 16% increase in Total Orders Placed and 9% increase in Average Order Value. The higher revenue was partially offset by higher sales returns, markdowns and promotional discounts compared to 2021.
Cost of Revenue
Cost of revenue increased in 2022 by $49.3 million, or 25%, compared to 2021, primarily due to the increase in our net revenue. Additionally, there were sales mix shifts into higher product cost categories, higher outbound and returned product shipping costs, as well as the impact of higher depreciation and allocated facility costs related to our Southern California distribution facility that was not in place until late 2021.
Selling and Marketing Expenses
Selling and marketing expenses increased in 2022 by $16.9 million, or 25% compared to 2021. There was a $14.2 million increase in online marketing expenses to acquire new customers and retain existing customers compared to 2021. In addition, merchant processing fees increased by $2.7 million in 2022 compared to the same period of the prior year largely due to the increase in net revenue coupled with higher merchant fee rates.
General and Administrative Expenses
General and administrative expenses increased by $11.4 million in 2022, or 13%, compared to 2021. The increase was primarily due to a $3.3 million increase in variable labor costs, which increased by 15% from 2021 to 2022 and was in line with our increase in net revenue. Additionally, fixed labor costs increased by $2.0 million primarily due to higher base wages and health insurance which were partially offset by lower bonus expenses. There was higher equity-based compensation expense of $0.9 million related to equity-based awards during 2022 due to an increase of $2.9 million in equity-based compensation expense and an additional $0.5 million of expense related to Executive Chairman liability-classified awards, offset by a decrease of $1.5 million in equity-based compensation expense related to redeemable preferred stock issuance and a decrease of $1.0 million in CEO special compensation awards expense. In
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addition, there was a $4.5 million increase in insurance costs and professional services, which was primarily driven by a $3.2 million increase in director and officer insurance costs associated with being a public company. There was also an increase of $1.1 million in hardware, software and supplies. These increases were partially offset by a $0.4 million reduction in other expenses, primarily comprised of management fees that were eliminated at the time of our IPO in November 2021.
Interest Expense
Interest expense decreased significantly in 2022 by $11.7 million, or 91%, compared to 2021. The decrease is attributable to the repayment of our Term Loan with the proceeds from our IPO in November 2021, which was partially offset by interest expense and unused fees related to the New Revolving Facility, under which $25.0 million of borrowings remained outstanding as of January 1, 2023.
Income Tax Provision
Our income tax provision in 2022 decreased by $2.2 million, or 35%, to $4.0 million, from $6.2 million in 2021. The decrease in the income tax provision was primarily due to an increase in non-deductible equity-based compensation expenses and non-deductible officer compensation.
Quarterly Trends andSeasonality
We experience moderate seasonal fluctuations in aggregate sales volume during the year. Seasonality in our business does not follow that of traditional retailers, such as a typical concentration of revenue in the holiday quarter. Our quarterly net revenue in 2021 was most highly concentrated outside of the fourth fiscal quarter. In 2021, we saw our highest net revenue in the second and third fiscal quarters compared to the rest of the year as customers purchased dresses and event wear for special occasions that had been postponed during the height of the COVID-19 pandemic. Our quarterly net revenue in 2022 reflected the highest concentrations in the first and second fiscal quarters compared to the rest of the year, as customer demand remained strong for dresses and event wear, carrying forward the trend seen in 2021 with the resurgence of events and special occasions. The third and fourth fiscal quarters of 2022 were impacted by a worse macroeconomic environment where consumers generally lowered their spending levels and sought higher levels of promotions and discounts.
Our quarterly gross profit fluctuates primarily based on how we manage our inventory and merchandise mix and has typically been in line with fluctuations in net revenue. When quarterly gross profit fluctuations have been unfavorable relative to the fluctuations in sales, these situations have been driven by non-recurring, external factors, such as the COVID-19 pandemic and the ensuing macroeconomic slowdown that began in mid-2022. We saw strong demand and favorable gross profits, with very limited promotions and discounts, during 2021 and the first half of 2022, largely due to the increase in demand for event and occasion wear. During the second half of 2022, we successfully utilized increased promotional discounts and markdowns to optimize our inventory mix and quantities and stimulate customer demand, which was negatively impacted by macroeconomic conditions, such as inflation and higher fuel prices.
Selling and marketing expenses generally fluctuate with net revenue. Further, in any given period, the amount of our selling and marketing expense can be affected by the use of promotional discounts in such period. In addition, we may increase or decrease marketing spend to assist with optimizing inventory mix and quantities.
General and administrative expenses consist primarily of payroll and benefit costs and vary quarter to quarter due to changes in the number of seasonal workers to meet demand based on our seasonality.
Liquidity and Capital Resources
Our primary sources of liquidity and capital resources are cash generated from operating activities and borrowings under our New Revolving Facility. Our primary requirements for liquidity and capital are inventory purchases, payroll and general operating expenses, capital expenditures associated with distribution, network expansion and capitalized software and debt service requirements. Our corporate banking relationship is with Bank of America.
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Credit Facilities
During November 2021, we entered into a Credit Agreement with Bank of America to provide a revolving facility that provides for borrowings up to $50.0 million. During the term of the Credit Agreement, we may increase the aggregate amount of the New Revolving Facility up to an additional $25.0 million (for maximum aggregate lender commitments of up to $75.0 million), subject to the satisfaction of certain conditions under the Credit Agreement, including obtaining the consent of the administrative agent and an increased commitment from existing or new lenders. In addition, the Credit Agreement may be used to issue letters of credit up to $7.5 million (the “Letter of Credit”). During 2022, we borrowed $30.0 million under the New Revolving Facility and repaid $30.0 million of the outstanding balance. As of January 1, 2023, we had $25.0 million outstanding under the New Revolving Facility and had utilized $0.3 million under the Letter of Credit. As of January 1, 2023, we had $24.7 million available for borrowing under the New Revolving Facility and $7.2 million available to issue letters of credit.
The New Revolving Facility matures three years after November 15, 2021, and borrowings thereunder will accrue interest at a rate equal to, at our option, either (x) the term SOFR rate, plus the applicable SOFR adjustment plus a margin of 1.75% per annum or (y) the base rate plus a margin of 0.75% (with the base rate being the highest of the federal funds rate plus 0.50%, the prime rate and term SOFR for a period of one month plus 1.00%). The New Revolving Facility contains a financial maintenance covenant requiring a maximum total leverage ratio of no more than 2.50:1.00, stepping down to 2.00:1.00 after 18 months. A commitment fee of 37.5 basis points will be assessed on unused commitments under the New Revolving Facility.
Availability and Use of Cash
As of January 1, 2023, we had cash and cash equivalents of $10.2 million and no restricted cash. We believe that our cash and cash equivalents, cash flows from operating activities and the available borrowings under our New Revolving Facility, will be sufficient to meet our capital expenditures, working capital needs and debt repayments for at least the next 12 months from the date of this Annual Report on Form 10-K. However, we cannot ensure that our business will generate sufficient cash flow from operating activities or that future borrowings will be available under our borrowing agreements in amounts sufficient to pay indebtedness or fund other working capital needs. Actual results of operations will depend on numerous factors, many of which are beyond our control as further discussed in Part I, “Item 1A. Risk Factors” included elsewhere in this Annual Report on Form 10-K.
Cash Flow Analysis
The following table summarizes our cash flows for the periods indicated:
(in thousands)
Net cash provided by (used in):
Operating Activities
During 2022, net cash provided by operating activities was $6.2 million after net income of $3.7 million was adjusted for certain non-cash items, including depreciation and amortization, non-cash lease expense, amortization of debt discount and debt issuance costs, equity-based compensation, deferred taxes and the effect of changes in working capital and other activities.
In 2022, net cash provided by operating activities decreased $20.7 million from $26.9 million in 2021 to $6.2 million in 2022. The changes in cash provided was primarily driven by an increase of $1.7 million due to an increase in net income from $2.0 million in 2021 to net income of $3.7 million in 2022, a decrease of $29.5 million related to changes in our operating assets and liabilities and an increase of $7.1 million of non-cash items. The decrease of $29.5 million was due to changes in our operating assets and liabilities from a net increase of $6.6 million in 2021 to net decrease of $22.9 million in 2022. This was primarily driven by a $19.6 million decrease in accrued expenses and other current liabilities, $15.7 million increase in inventory balances, $6.5 million increase in income tax receivable and a $2.6 million decrease in operating lease liabilities; these were partially offset by $4.0 million increase in accounts
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payable, $3.4 million increase in prepaid and other current assets, $3.5 million decrease in accounts receivable, $2.6 million decrease in assets for recovery, and a $1.4 million decrease in other non-current liabilities. In addition, the increase of $7.1 million of non-cash items was from a net increase of $18.3 million in 2021 to a net increase of $25.4 million in 2022. This was primarily driven by $3.8 million less payments in interest capitalized to principal of long term debt and revolving line of credit, $3.4 million increase in deferred income taxes, $3.3 million increase in non-cash lease expense as a result of the adoption of Financial Accounting Standards Board Accounting Standards Codification 842, Leases (“ASC 842”) in 2022, $1.3 million increase in depreciation and amortization and an increase of $0.9 million in non-cash equity-based compensation expenses due to increase in non-cash equity-based compensation expense including employee and Executive Chairman equity-based compensation grants, which were partially offset by reductions in equity-based compensation expense related to CEO special compensation awards and redeemable preferred stock issuance. These increases in non-cash expenses were offset by reductions associated with the payoff of our long-term debt in 2021, including decreases of $2.1 million of amortization of debt discount and debt issuance costs, $2.1 million of interest capitalized to principal of long-term debt and revolving line of credit, and $1.4 million of loss on debt extinguishment.
Investing Activities
Our primary investing activities have consisted of purchases of equipment to support our overall business growth and internally developed software for the continued development of our proprietary technology infrastructure. Purchases of property and equipment may vary from period-to-period due to timing of the expansion of our operations. We have no material commitments for capital expenditures.
In 2022, net cash used in investing activities was $5.1 million, which was a $1.7 million increase from $3.4 million in 2021. This was attributable to capital expenditures related to the opening of our new distribution facility in Ontario, California, the relocation and opening of our new studio facility in Los Angeles, California, as well as equipment for our general operations, software and hardware purchases, and internally developed software.
Financing Activities
Financing activities consist primarily of borrowings and repayments related to our New Revolving Facility and Credit Facility, and issuance of common and preferred stock.
In 2022, net cash used in financing activities was $2.8 million, which was a decrease of $24.9 million from $27.7 million of net cash used in financing activities in 2021. This decrease was attributable primarily to a reduction of $110.1 million in repayments of long-term debt and debt issuance cost and a reduction of $16.5 million related to the net of redemption and issuance of redeemable preferred stock. This was offset by a reduction of $83.4 million of net proceeds from the IPO in 2021 and related offering costs, a $16.5 million decreases in proceeds (net of repayments) from our revolving line of credit facilities, $1.1 million of withholding tax payments related to vesting of RSUs, and a $0.8 million increase of finance lease payments primarily attributed to the robotics system at the Pennsylvania distribution center.
Contractual Obligations and Other Commitments
Our most significant contractual obligations relate to our New Revolving Facility and operating lease obligations on our distribution facilities and corporate offices. For information on our New Revolving Facility, see Note 5, Debt, and for information on our contractual obligations for operating leases, see Note 6, Leases, of the accompanying notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
Critical Accounting Policies and Estimates
Our consolidated financial statements and the related notes thereto included elsewhere in this Annual Report on Form 10-K are prepared in accordance with GAAP. The preparation of consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ significantly from our estimates. To the extent that there are differences between our estimates and actual results, our future financial statement presentation, financial condition, results of operations and cash flows will be affected.
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We believe that the assumptions and estimates associated with revenue recognition, equity-based compensation, and income taxes have the greatest potential impact on our consolidated financial statements. Therefore, we consider these to be our critical accounting policies and estimates. For further information on all of our significant accounting policies, please see Note 2, Significant Accounting Policies, of the accompanying notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
Revenue Recognition
While our revenue recognition does not involve significant judgment, it represents an important accounting policy. We generate revenue from the sale of merchandise products sold directly to end customers. We recognize revenue when the product is transferred to the customer, which is generally upon shipment. We estimate a reserve of future returns based on historical return rates. There is judgment in utilizing historical trends for estimating future returns. Our refund liability for sales returns is included in returns reserve on the consolidated balance sheets and represents the expected value of the refund that will be due to our customers.
Leases
On January 3, 2022, we adopted ASC 842. We elected the practical expedient package, which among other practical expedients, includes the option to retain the historical classification of leases entered into prior to January 3, 2022, and allows entities to recognize lease payments on a straight-line basis over the lease term for leases with a term of 12 months or less. We also elected the practical expedient to combine lease and non-lease components. We determine if an arrangement contains a lease at inception based on whether the Company has the right to control the asset during the contract period and other facts and circumstances.
We are the lessee in a lease contract when we obtain the right to control the asset. Operating leases are included in lease right-of-use ("ROU") assets, lease liabilities, current and lease liabilities, noncurrent in our consolidated balance sheets. ROU assets represent our right to use an underlying asset for the lease term, and lease liabilities represent our obligation to make lease payments arising from the lease. Lease liabilities are recognized based on the present value of the future minimum lease payments over the lease term at lease inception or modification, with ROU assets recorded based on the corresponding lease liability at lease inception or modification adjusted for payments made to the lessor at or before the lease commencement date, initial direct costs incurred and any tenant incentives allowed for under the lease. We determine the lease term by assuming the exercise of renewal options that are reasonably certain. As most of our leases do not provide an implicit interest rate, we use our incremental borrowing rate (“IBR”) to determine the present value of lease payments. The determination of the IBR requires judgment and is primarily based on publicly-available information for companies within similar industries and with similar credit profiles. We adjust the rate for the impact of collateralization, the lease term and other specific terms included in each lease arrangement. The IBR is determined at the lease commencement and is subsequently reassessed upon a modification to the lease arrangement. Refer to Note 6, Leases, of the accompanying notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
Equity-Based Compensation
Equity-based compensation is measured at the grant date or modification date (“measurement date”) for all equity-based awards made to employees and nonemployees based on the estimated fair value of the awards. Equity-based compensation expense is recognized on a straight-line basis over the period the employee or non-employee is required to provide service in exchange for the award, which is generally the vesting period. We recognize forfeitures as they occur.
Under an employment agreement entered into with Mr. McCreight in 2021 and subject to ongoing employment, and in light of the closing of the IPO, Mr. McCreight will receive two bonuses to settled in fully-vested shares of our common stock equal to $3.0 million each ($6.0 million in aggregate) on March 31, 2022 and March 31, 2023. We initially concluded that the two bonuses were liability-classified upon issuance. Upon the completion of the IPO, the two bonuses became equity-classified as they no longer met the criteria for liability classification and $2.9 million was reclassified from accrued expenses and other current liabilities and other noncurrent liabilities to additional paid-in capital in 2021. Under a new employment agreement with Mr. McCreight signed in November 2022, reflecting his new role as Executive Chairman, which became effective on the Effective Date, Mr. McCreight will receive two bonuses equal to $2.0 million and $1.0 million in March 2023 and March 2024, respectively, which will be settled in RSUs that vest in 4 and 2 quarterly installments from March 2023 and March 2024, respectively, through December 2023 and June 2024, respectively. We concluded that the two bonuses were liability-classified upon issuance in November 2022.
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The fair value of grants of restricted stock or restricted stock units is based on the fair value of our common stock underlying the award on the measurement date. For stock option awards, we apply the Black-Scholes option pricing model to determine the fair value. The model utilizes the estimated per share fair value of our underlying common stock at the measurement date, the expected or contractual term of the option, the expected stock price volatility, risk-free interest rates, and the expected dividend yield of the common stock.
We base estimates of expected volatility on the historical volatility of comparable companies from a representative peer group selected based on industry, financial, and market capitalization data.
Determining the grant date fair value of options using the Black-Scholes option pricing model requires us to make assumptions and judgments. These estimates involve inherent uncertainties and, if different assumptions had been used, stock-based compensation expense could have been materially different from the amounts recorded.
Income Taxes
We compute our provision for income taxes using the asset and liability method, under which deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities and for operating losses and tax credit carryforwards. Deferred tax assets and liabilities are measured using the currently enacted tax rates that apply to taxable income in effect for the years in which they are expected to be realized or settled.
Deferred tax assets are evaluated for future realization and reduced by a valuation allowance to the amount that is more likely than not to be realized. We consider many factors when assessing the likelihood of future realization, including our recent cumulative loss, earnings expectations in earlier future years, and other relevant factors. We believe that it is more likely than not that forecasted income, together with future reversals of existing taxable temporary differences and results of recent operations, will be sufficient to fully recover the deferred tax assets. In the event that the Company determines all or part of the net deferred tax assets are not realizable in the future, the Company would record a valuation allowance.
Recent Accounting Pronouncements
See Note 2, Significant Accounting Policies—Recently Issued Accounting Pronouncements, of the accompanying notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for more information about recent accounting pronouncements, the timing of their adoption, and our assessment, to the extent we have made one, of their potential impact on our financial position and our results of operations.
JOBS Act Accounting Election
We are an “emerging growth company,” as defined in the JOBS Act. Under the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards until such time as those standards apply to private companies. We have elected to use this extended transition period until we are no longer an emerging growth company or until we affirmatively and irrevocably opt out of the extended transition period. Accordingly, our consolidated financial statements and our unaudited interim consolidated financial statements may not be comparable to companies that comply with new or revised accounting pronouncements as of public company effective dates.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Our operations are solely based within the United States and the majority of our sales are within the United States. We are exposed to market risks in the ordinary course of our business, including the effects of foreign currency fluctuations, interest rate changes and inflation. Information relating to quantitative and qualitative disclosures about these market risks is set forth below.
Interest Rate Sensitivity
Cash and cash equivalents are held primarily in money market funds and cash deposits. The fair value of our cash and cash equivalents would not be significantly affected by either an increase or decrease in interest rates due mainly to the short-term nature of these instruments. Interest on any borrowings incurred pursuant to our New Revolving Facility accrue at a floating rate based on a
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formula tied to certain market rates at the time of incurrence; however, we do not expect that any change in prevailing interest rates will have a material impact on our results of operations.
Foreign Currency Risk
All of our sales and operating expenses are denominated in U.S. dollars, and therefore, our net revenue is not currently subject to foreign currency risk.
Inflation
We have experienced inflationary pressures in our supply chain and in our operating costs, as well as impacts related to our customers’ spending levels, which fluctuate with inflation. We continue to monitor the impact of inflation in order to minimize its effects through pricing strategies, productivity improvements and cost reductions. If our costs were to become subject to significant inflationary pressures, we may not be able to fully offset such higher costs through price increases. Our inability or failure to do so could harm our business, financial condition and results of operations.
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Item 8. Financial Statements and Supplementary Data.
LULU’S FASHION LOUNGE HOLDINGS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Report of Independent Registered Public Accounting Firm (PCAOB ID No. 34) 70
Financial Statements:
Consolidated Balance Sheets as of January 1, 2023 and January 2, 2022 71
Notes to Consolidated Financial Statements 76
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the stockholders and the Board of Directors of Lulu’s Fashion Lounge Holdings, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Lulu’s Fashion Lounge Holdings, Inc. and subsidiaries (the "Company") as of January 1, 2023 and January 2, 2022, the related consolidated statements of operations and comprehensive income (loss), redeemable preferred stock, convertible preferred stock and stockholders’ equity (deficit), and cash flows, for each of the three years in the period ended January 1, 2023, and the related notes (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of January 1, 2023 and January 2, 2022, and the results of its operations and its cash flows for each of the three years in the period ended January 1, 2023, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ Deloitte & Touche LLP
San Francisco, California
March 14, 2023
We have served as the Company's auditor since 2017.
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LULU’S FASHION LOUNGE HOLDINGS, INC.
Consolidated Balance Sheets
(in thousands, except share and per share amounts)
January 1, January 2,
Assets
Current assets:
Income tax refund receivable 4,078 748
Prepaids and other current assets 3,738 5,364
Restricted cash — 506
Property and equipment, net 4,391 3,231
Lease right-of-use assets 32,514 —
Liabilities and Stockholders' Equity
Current liabilities:
Accrued expenses and other current liabilities 17,976 21,948
Lease liabilities, current 4,456 —
Lease liabilities, noncurrent 29,042 —
Other noncurrent liabilities 623 1,108
Commitments and Contingencies (Note 7)
Stockholders' equity:
Total liabilities and stockholders' equity $ 167,204 $ 113,776
The accompanying notes are an integral part of the consolidated financial statements.
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LULU’S FASHION LOUNGE HOLDINGS, INC.
Consolidated Statements of Operations and Comprehensive Income (Loss)
(in thousands, except share and per share amounts)
Fiscal Years Ended
January 1, January 2, January 3,
(52 weeks) (52 weeks) (53 weeks)
Other income (expense), net:
Loss on extinguishment of debt — (1,392) —
Income tax (provision) benefit (4,047) (6,212) 1,271
Net income (loss) and comprehensive income (loss) 3,725 2,045 (19,304)
Deemed dividend to preferred stockholders — (122,962) (504)
Stock dividend issued to LP — (3,451) —
The accompanying notes are an integral part of the consolidated financial statements.
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LULU’S FASHION LOUNGE HOLDINGS, INC.
Consolidated Statements of Redeemable Preferred Stock, Convertible Preferred Stock and Stockholders’
Equity (Deficit)
(in thousands, except share amounts)
Additional Total
Shares Amount Shares Amount Shares Amount Capital Deficit Equity (Deficit)
The accompanying notes are an integral part of the consolidated financial statements.
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LULU’S FASHION LOUNGE HOLDINGS, INC.
Consolidated Statements of Cash Flows
(in thousands)
Fiscal Years Ended
January 1, January 2, January 3,
(52 weeks) (52 weeks) (53 weeks)
Cash Flows from Operating Activities
Noncash lease expense 3,257 — —
Loss on debt extinguishment — 1,392 —
Amortization of debt discount and debt issuance costs 157 2,283 2,485
Write-off of deferred offering costs — — 1,950
Loss (gain) on disposal of property and equipment 18 9 (25)
Changes in operating assets and liabilities:
Income taxes (receivable) payable (4,364) 2,094 (302)
Prepaid and other current assets 694 (2,721) 339
Accrued expenses and other current liabilities 1,691 21,263 (9,346)
Operating lease liabilities (2,608) — —
Other noncurrent liabilities 8 (1,390) (1,357)
Net cash provided by operating activities 6,199 26,896 4,856
Cash Flows from Investing Activities
Capitalized software development costs (2,500) (1,522) (1,273)
Purchases of property and equipment (2,511) (1,447) (700)
Net cash used in investing activities (5,123) (3,394) (1,913)
Cash Flows from Financing Activities
Proceeds from borrowings on revolving line of credit 30,000 25,000 5,300
Repayments on revolving line of credit (30,000) (8,580) (800)
Repayment of long-term debt — (109,608) (2,531)
Payment of debt issuance costs — (514) (437)
Redemption of redeemable preferred stock — (17,900) —
Principal payments on finance lease obligations (786) — —
Payment of offering costs related to the IPO (832) — —
Advance from LP — — 37
Repayment of advance from LP — — (2,040)
Withholding tax payments related to vesting of RSUs (1,115) — —
Reconciliation of cash, cash equivalents and restricted cash
Restricted cash — 506 505
(Continued)
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LULU’S FASHION LOUNGE HOLDINGS, INC.
Consolidated Statements of Cash Flows
(in thousands)
Fiscal Years Ended
January 1, January 2, January 3,
(52 weeks) (52 weeks) (53 weeks)
Supplemental Disclosure
Cash paid for income taxes, net $ 6,436 $ 6,112 $ 171
Assets acquired under finance lease obligations $ 4,750 $ — $ —
Prepaid rent reclassified to lease right-of-use assets $ 381 $ — $ —
Debt issuance costs included in accrued expenses $ — $ — $ 917
Deemed dividend to preferred stockholders $ — $ (122,962) $ 504
Offering costs included in accrued expenses $ — $ 542 $ —
(Concluded)
The accompanying notes are an integral part of the consolidated financial statements.
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LULU’S FASHION LOUNGE HOLDINGS, INC.
Notes to Consolidated Financial Statements
1.Description of Business, Organization and Liquidity
Organization and Business
Pursuant to a reorganization, Lulu’s Fashion Lounge Holdings, Inc., a Delaware Corporation (“Lulus”, “we”, “our”, or the “Company”), was formed on August 25, 2017 as a holding company and its primary asset is an indirect membership interest in Lulu’s Fashion Lounge, LLC (“Lulus LLC”). Prior to the Company’s initial public offering, the Company was majority-owned by Lulu’s Holdings, L.P. (the “LP”). In connection with the Company’s initial public offering, the LP was liquidated.
Lulus LLC was founded in 1996, starting as a vintage boutique in Chico, CA that began selling online in 2005 and transitioned to a purely online business in 2008. The LP was formed in 2014 as a holding company and purchased 100% of Lulus LLC’s outstanding common stock in 2014. The Company, through Lulus LLC, is an online retailer of women’s clothing, shoes and accessories based in Chico, CA.
Initial Public Offering
On November 10, 2021, the Company’s registration statement on Form S-1 relating to its initial public offering (“IPO”) was declared effective by the Securities and Exchange Commission (“SEC”) and the shares of its common stock began trading on the Nasdaq Global Market on November 11, 2021. The IPO closed on November 15, 2021, pursuant to which the Company issued and sold 5,750,000 shares of its common stock at a public offering price of $16.00 per share. On November 15, 2021, the Company received net proceeds of approximately $82.0 million from the IPO, after deducting underwriting discounts and commissions of approximately $6.1 million and other issuance costs of approximately $3.9 million. Immediately prior to the completion of the IPO, the Company filed an amended and restated certificate of incorporation, which authorized a total of 250,000,000 shares of common stock at $0.001 par value per share, and 10,000,000 shares of preferred stock, $0.001 par value per share. Immediately prior to the completion of the IPO, all shares of the Series A Preferred Stock then outstanding were converted into 15,000,000 shares of common stock. Additionally, 215,702 shares of common stock were issued to the LP immediately prior to the completion of the IPO. All shares of the Series B Preferred Stock and the Series B-1 Preferred Stock were redeemed and extinguished for a total payment of approximately $17.9 million on November 15, 2021.
Impact of COVID-19
While there continues to be uncertainty related to the COVID-19 pandemic, we believe the significant impact of the pandemic on the demand for our product, related to social distancing mandates, lockdowns, cancelled social events and travel, has largely subsided. However, we are still susceptible to broader COVID-19 risks globally, especially in relation to our supply chain. We continue to take actions to anticipate changes in the business environment and supply chain pressures, including placing orders earlier than pre-pandemic times, leveraging our “test, learn and reorder” approach to test small order quantities and then graduate successful styles to our re-order algorithms and diversifying our supply chain network to mitigate rising costs and service delays. We have modified our business practices in response to the COVID-19 pandemic and plan to continue to take proactive measures.
Impact of Macroeconomic Trends on Business
Changing macroeconomic factors, including inflation, interest rates, fuel prices, and overall consumer confidence with respect to current and future economic conditions, have directly impacted our sales in 2022 as discretionary consumer spending levels and shopping behavior fluctuate with these factors. During 2022, we have responded to these factors by taking appropriate pricing, promotional and other actions to stimulate customer demand. These factors are expected to continue to have an impact on our business, results of operations, our growth and financial condition.
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LULU’S FASHION LOUNGE HOLDINGS, INC.
Notes to Consolidated Financial Statements
2.Significant Accounting Policies
Basis of Presentation and Fiscal Year
The Company’s fiscal year consists of a 52-week or 53-week period ending on the Sunday nearest December 31. The fiscal year ended January 1, 2023 (“2022”) consisted of 52 weeks, the fiscal year ended January 2, 2022 (“2021”) consisted of 52 weeks, and the fiscal year ended January 3, 2021 (“2020”) consisted of 53 weeks.
The consolidated financial statements and accompanying notes include the accounts of the Company and its wholly owned subsidiaries, after elimination of all intercompany balances and transactions. The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the Unites States of America (“GAAP”) and the requirements of the Securities and Exchange Commission.
Use of Estimates
The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. The significant estimates and assumptions made by management relate to sales return reserves and related assets for recovery, lease right-of-use assets and related lease liabilities, income tax valuation allowance and fair value of equity awards. Management evaluates its estimates and assumptions on an ongoing basis using historical experience and other factors, including the current economic environment, which management believes to be reasonable under the circumstances. The Company adjusts such estimates and assumptions when facts and circumstances dictate. Changes in those estimates resulting from continuing changes in the economic environment will be reflected in the consolidated financial statements in future periods. As future events and their effects cannot be determined with precision, actual results could materially differ from those estimates and assumptions.
Segment Reporting
The Company manages its business on the basis of one operating and reportable segment, retail. The Company’s chief operating decision maker is its chief executive officer (“CEO”). All long-lived assets are located in the United States and substantially all revenue is attributable to customers based in the United States. International sales are not significant.
Concentration of Credit Risks
Financial instruments that potentially subject the Company to concentrations of credit risk consist of cash, cash equivalents and restricted cash. Such amounts may exceed federally insured limits. The Company reduces credit risk by depositing its cash with major credit-worthy financial institutions within the United States. To date, the Company has not experienced any losses on its cash deposits. As of January 1, 2023, and January 2, 2022, a single wholesale customer represented 15% and 24% respectively, of the Company’s accounts receivable balance. No customer accounted for greater than 10% of the Company’s net revenue during 2022, 2021 and 2020.
Accounts Receivable
Accounts receivable consist primarily of receivables from credit card processing agencies and wholesale customers. Based on historical collections from these agencies and wholesale customers, no allowance for doubtful accounts was deemed necessary as of January 1, 2023 and January 2, 2022.
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LULU’S FASHION LOUNGE HOLDINGS, INC.
Notes to Consolidated Financial Statements
Inventory
Inventory consists of finished goods, which are recorded at the lower of cost or net realizable value, with cost determined using the first-in-first-out method. The cost of inventory consists of merchandise costs and inbound freight costs. Inventory levels are reviewed to identify slow-moving merchandise, and promotions and markdowns are used to clear merchandise. In the period in which the Company determines estimated selling price, less costs to sell, is below cost, or identifies excess, obsolete, or unsalable items, the Company writes its inventory down to its net realizable value.
Property and Equipment, net
Property and equipment are recorded at cost and depreciated on a straight-line basis over their estimated useful lives, which range from 3 to 9 years. Improvements that extend the life of a specific asset are capitalized, while normal maintenance and repairs are expensed as incurred. When assets are sold or otherwise retired, their cost and related accumulated depreciation are removed from the balance sheet with any resulting gain or loss reflected in general and administrative expenses in the consolidated statements of operations and comprehensive income (loss).
Goodwill and Tradename
Goodwill is stated at the excess of the acquisition price over the fair value of net assets acquired in a purchase acquisition and is not amortized. Goodwill arose from the LP’s purchase of 100% of the outstanding common stock of Lulus LLC on July 25, 2014 and the Company has one reporting unit. The Company’s tradename is an indefinite-lived intangible asset and is not amortized. The Company reviews its goodwill and tradename for impairment at least annually (on the first day of the fourth quarter) or more frequently whenever events or changes in circumstances indicate that the carrying amount may be impaired.
When testing goodwill for impairment, the Company first performs an assessment of qualitative factors (“Step 0 Test”). The qualitative assessment includes assessing the totality of relevant events and circumstances that affect the fair value or carrying value of the reporting unit. These events and circumstances include macroeconomic conditions, industry and competitive environment conditions, overall financial performance, reporting unit specific events and market considerations. The Company also considers recent valuations of the reporting unit, including the magnitude of the difference between the most recent fair value estimate and the carrying value, as well as both positive and adverse events and circumstances, and the extent to which each of the events and circumstances identified may affect the comparison of a reporting unit’s fair value with its carrying value. If the qualitative assessment results in a conclusion that it is more likely than not that the fair value of a reporting unit exceeds the carrying value, then no further testing is performed for that reporting unit. The Company performed the qualitative assessment of its goodwill and determined that it is more likely than not that the fair value of its reporting unit exceeds the carrying value of the reporting unit. As a result, there was no goodwill impairment during 2022, 2021 and 2020. There was no accumulated impairment of goodwill as of January 1, 2023, and January 2, 2022.
When testing the tradename for impairment, the Company first performs an assessment of qualitative factors. If qualitative factors indicate that it is more likely than not that the fair value of the tradename is less than its carrying amount, the Company tests the tradename for impairment at the asset level. The Company determines the fair value of the tradename and compares it to the carrying value. If the carrying value of the tradename exceeds the fair value, the Company recognizes an impairment loss in an amount equal to the excess. The Company performed the qualitative assessment of its tradename and determined that it is more likely than not that the fair value of the tradename exceeds the carrying value of the reporting unit. There were no additions to, disposals of, or impairments of the tradename during 2022, 2021 and 2020, There was no accumulated impairment of the tradename as of January 1, 2023, and January 2, 2022.
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LULU’S FASHION LOUNGE HOLDINGS, INC.
Notes to Consolidated Financial Statements
Intangible Assets, net
Intangible assets, net consists of capitalized internal-use software development, which is amortized over a 3-year period. The Company capitalizes certain costs in connection with obtaining or developing software for internal use. Additionally, the Company capitalizes qualifying costs incurred for upgrades and enhancements that result in additional functionality to existing software. Amortization of such costs begins when the project is substantially complete and ready for its intended use. Costs related to design or maintenance are expensed as incurred. Intangible asset amortization expense was $1.7 million, $1.6 million and $1.7 million during 2022, 2021 and 2020, respectively.
Intangible assets are amortized on a straight-line basis over the estimated useful life of the assets. The Company reviews intangible assets for impairment under the long-lived asset model described below. No impairment of intangible assets was recorded during the years presented.
Long-Lived Asset Impairment
The Company evaluates long-lived assets, including lease right-of-use assets, for impairment periodically whenever events or changes in circumstances indicate that their related carrying amounts may not be recoverable. In evaluating long-lived assets for recoverability, the Company uses its best estimate of future cash flows expected to result from the use of the asset and eventual disposition. To the extent that projected undiscounted future net cash flows attributable to the asset are less than the carrying amount, an impairment loss is recognized in an amount equal to the difference between the carrying value of such asset and its estimated fair value. There was no impairment recorded during the years presented.
Deferred Offering Costs
Deferred offering costs consist of expenses incurred in connection with an equity offering, including legal, accounting, printing, and other IPO-related costs. Deferred offering costs are written off to operating expenses in the consolidated statements of operations and comprehensive income (loss) upon the termination or significant delay of a planned equity offering. During 2020, approximately $2.0 million of deferred offering costs from an offering that was postponed were written off to general and administrative expenses in the Company’s consolidated statements of operations and comprehensive income (loss). There were no deferred offering costs related to the IPO capitalized in the consolidated balance sheets as of January 1, 2023, January 2, 2022 and January 3, 2021.
Leases
Prior to the adoption of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 842 on January 3, 2022
Leases were reviewed for classification as operating or capital leases. For operating leases, the Company recognized rent on a straight-line basis over the term of the lease. The Company recorded the difference between cash payments and rent expense recognized as a deferred rent liability included in accrued expenses and other current liabilities and other noncurrent liabilities on the condensed consolidated balance sheets. Incentives granted under the Company’s facility leases, including allowances to fund leasehold improvements, were deferred and are recognized as adjustments to rental expense on a straight-line basis over the term of the lease. The Company changed its method of accounting for leases as of January 3, 2022 due to the adoption of FASB ASC 842, Leases (“ASC 842”).
Subsequent to the adoption of ASC 842 on January 3, 2022
Contracts that have been determined to convey the right to use an identified asset are evaluated for classification as an operating or finance lease. For the Company’s operating and finance leases, the Company records a lease liability based
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LULU’S FASHION LOUNGE HOLDINGS, INC.
Notes to Consolidated Financial Statements
on the present value of the lease payments at lease inception. The present value of lease payments is determined by using the interest rate implicit in the lease, if that rate is readily determinable; otherwise, the Company uses its incremental borrowing rate (“IBR”). The determination of the IBR requires judgment and is primarily based on publicly-available information for companies within similar industries and with similar credit profiles. We adjust the rate for the impact of collateralization, the lease term and other specific terms included in each lease arrangement. The IBR is determined at the lease commencement and is subsequently reassessed upon a modification to the lease arrangement. The right-of-use asset is recorded based on the corresponding lease liability at lease inception, adjusted for payments made to the lessor at or before the commencement date, initial direct costs incurred and any tenant incentives allowed for under the lease. The Company does not include optional renewal terms or early termination provisions unless the Company is reasonably certain such options would be exercised at the inception of the lease. Lease right-of-use assets, current portion of lease liabilities, and lease liabilities, net of current portion are included on the condensed consolidated balance sheets.
Fixed lease expense for operating leases is recognized on a straight-line basis, unless the right-of-use assets have been impaired, over the reasonably assured lease term based on the total lease payments and is included in operating expenses in the condensed consolidated statements of operations and comprehensive income (loss). Fixed and variable lease expense on operating leases is recognized within operating expenses in the condensed consolidated statements of operations and comprehensive income (loss). Finance lease expenses are recognized on a straight-line basis. Fixed and variable expenses are captured within interest expense and depreciation expense, which has components within general and administrative expenses and cost of revenue. The Company’s non-lease components are primarily related to maintenance, insurance and taxes, which varies based on future outcomes and is thus recognized in lease expense when incurred.
Revenue Recognition
The Company generates revenue primarily from the sale of merchandise products directly to end customers. The sale of products is a distinct performance obligation, and revenue is recognized at a point in time when control of the promised product is transferred to customers, which the Company determined occurs upon shipment based on its evaluation of the related shipping terms. Revenue is recognized in an amount that reflects the transaction price consideration that the Company expects to receive in exchange for those products. The Company’s payment terms are typically at the time of order processing and shipment.
The Company elected to exclude from revenue taxes assessed by governmental authorities, including value-added and other sales-related taxes, that are imposed on and concurrent with revenue-producing activities. The Company has elected to apply the practical expedient, relative to e-commerce sales, which allows an entity to account for shipping and handling as fulfillment activities, and not a separate performance obligation. Accordingly, the Company recognizes revenue for only one performance obligation, the sale of the product, at shipping point (when the customer gains control). Shipping and handling costs associated with outbound freight are accounted for as fulfillment costs and are included in cost of goods sold. The Company has elected to apply the practical expedient to expense costs as incurred for incremental costs to obtain a contract when the amortization period would have been one year or less.
Revenue from merchandise product sales is reported net of sales returns, which includes an estimate of future returns based on historical return rates, with a corresponding reduction to cost of sales. There is judgment in utilizing historical trends for estimating future returns. The Company’s refund liability for sales returns is included in the returns reserve on its consolidated balance sheets and represents the expected value of the refund that will be due to the Company’s customers. The Company also has a corresponding asset for recovery that represents the expected net realizable value of the merchandise inventory to be returned.
The Company sells stored-value gift cards to customers and offers merchandise credit stored-value cards for certain returns. Such stored-value cards do not have an expiration date. The Company recognizes revenue from stored-value cards when the card is redeemed by the customer. The Company has determined that sufficient evidence exists to support an
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LULU’S FASHION LOUNGE HOLDINGS, INC.
Notes to Consolidated Financial Statements
estimate for stored-value card breakage. Subject to requirements to remit balances to governmental agencies, breakage is recognized as revenue in proportion to the pattern of rights exercised by the customer, which is substantially within thirty-six months from the date of issuance. The amount of breakage recognized in revenue during 2022, 2021 and 2020 was not material.
The Company has two types of contractual liabilities: (i) cash collections from its customers prior to delivery of products purchased (“deferred revenue”), which are initially recorded within accrued expenses and recognized as revenue when the products are shipped, (ii) unredeemed gift cards and online store credits, which are initially recorded as a stored-value card liability and are recognized as revenue in the period they are redeemed.
The following table summarizes the significant changes in the contract liabilities balances during 2022, 2021 and 2020 (in thousands):
Deferred Stored-Value
Revenue Cards
Cost of Revenue
Cost of revenue consists of the product costs of merchandise sold to customers; shipping and handling costs including all inbound, outbound, and return shipping expenses; rent, insurance, business property tax, utilities, depreciation and amortization, and repairs and maintenance related to the Company’s distribution facilities; and charges related to inventory shrinkage, damages and the allowance for excess or obsolete inventory.
General and Administrative Expenses
General and administrative expenses consist primarily of payroll and benefits costs, including equity-based compensation for the Company’s employees involved in general corporate functions including finance, merchandising, marketing, and technology, as well as costs associated with the use by these functions of facilities and equipment, including depreciation and amortization, rent and other occupancy expenses.
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Notes to Consolidated Financial Statements
Selling and Marketing Expenses
Selling and marketing expenses consist primarily of customer service, payment processing fees, advertising, targeted online performance marketing and search engine optimization costs. Selling and marketing expenses also include spend on brand marketing channels, including cash and free clothing compensation to influencers, events and other forms of online and offline marketing related to growing and retaining the customer base. Advertising costs included in selling and marketing expenses were $64.4 million, $53.6 million, and $38.1 million in 2022, 2021 and 2020, respectively.
Equity-Based Compensation
The Company grants stock-based awards to certain employees, officers, directors, and other nonemployee service providers. Equity-based compensation is measured at the grant date or modification date for all equity-based awards made to employees and nonemployees based on the estimated fair value of the awards. Equity-based compensation expense is recognized on a straight-line basis over the period the employee or non-employee is required to provide service in exchange for the award, which is generally the vesting period. The Company classifies equity-based compensation expense as general and administrative expense in the Company’s consolidated statements of operations and comprehensive income (loss).
The Company has elected to recognize forfeitures by reducing the equity-based compensation expense in the same period as the forfeitures occur.
The fair value of grants of restricted stock or restricted stock units (“RSUs”) is based on the fair value of the Company’s common stock underlying the award on the grant date or modification date. For stock option awards, the Company applies the Black-Scholes option pricing model to determine the fair value. The model utilizes the estimated per share fair value of the Company’s underlying common stock at the grant date, the expected or contractual term of the option, the expected stock price volatility, risk-free interest rates, and the expected dividend yield of the common stock.
The Company bases its estimate of expected volatility on the historical volatility of comparable companies from a representative peer group selected based on industry, financial, and market capitalization data. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury implied yield at the date of grant. The Company has elected to use the “simplified method” to determine the expected term which is the midpoint between the vesting date and the end of the contractual term because it has insufficient history upon which to base an assumption about the term; the Company believes the simplified method approximates a term if it were to be based on expected life. The expected dividend yield is 0.0% as the Company has not paid and does not anticipate paying dividends on its common stock.
Determining the grant date fair value of options using the Black-Scholes option pricing model requires management to make assumptions and judgments. These estimates involve inherent uncertainties and, if different assumptions had been used, stock-based compensation expense could have been materially different from the amounts recorded.
Certain prior year amounts have been reclassified for consistency with the current year presentation. The Company combined equity-based compensation expense and equity-based compensation expense related to CEO special compensation awards into one line item, equity-based compensation expense, in the consolidated statements of cash flows.
Income Taxes
The Company accounts for income taxes using the asset and liability method, under which deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax basis of assets and liabilities and for operating losses and tax credit carryforwards. Deferred tax assets and liabilities
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Notes to Consolidated Financial Statements
are measured using the currently enacted tax rates that apply to taxable income in effect for the years in which they are expected to be realized or settled.
The Company believes that it is more likely than not that forecasted income, together with future reversals of existing taxable temporary differences and results of recent operations, will be sufficient to fully recover the deferred tax assets. In the event that the Company determines all or part of the net deferred tax assets are not realizable in the future, the Company would record a valuation allowance.
The Company recognizes tax benefits from uncertain tax positions only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the consolidated financial statements from such positions are then measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. The Company recognizes interest and penalties related to unrecognized tax benefits, if any, as income tax expense.
Net Income (Loss) Per Share Attributable to Common Stockholders
The Company calculates basic and diluted net income (loss) per share attributable to common stockholders in conformity with the two-class method required for participating securities as the application of the if converted method is not more dilutive. The two-class method requires income (loss) available to common stockholders for the period to be allocated between common stock and participating securities based upon their respective rights to receive dividends as if all income for the period had been distributed.
The Company considers its redeemable preferred stock and convertible preferred stock to be participating securities. In accordance with the two-class method, net income (loss) is adjusted for earnings allocated to these participating securities and the related number of outstanding shares of the participating securities, which include contractual participation rights in undistributed earnings, have been excluded from the computation of basic and diluted net income (loss) per share attributable to common stockholders. The redeemable preferred stock and convertible preferred stock contractually entitle the holders of such shares to participate in dividends but do not contractually require the holders of such shares to participate in the Company’s losses. As such, where applicable, net losses were not allocated to these securities.
Basic net income (loss) per share attributable to common stockholders is computed using net income (loss) attributable to common stockholders divided by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share attributable to common stockholders represents net income (loss) attributable to common stockholders divided by the weighted average number of common shares outstanding during the period, including the effects of any dilutive securities outstanding.
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Notes to Consolidated Financial Statements
The following table presents the calculation of basic and diluted weighted average shares used to compute net income (loss) per share attributable to common stockholders:
Dilutive securities:
Unvested restricted stock 55,127 - -
Unvested RSUs 139,064 - -
Special compensation awards 67,547 - -
Employee Stock Purchase Plan 7,801 - -
The following securities were excluded from the computation of diluted net income (loss) per share attributable to common stockholders for the fiscal years presented because including them would have been anti-dilutive (on an as-converted basis):
Series A convertible preferred stock — — 3,129,634
Unvested RSUs 904,076 — —
CEO award share settlement — 417,828 —
Redeemable Preferred Stock
The Company has elected to record its redeemable preferred stock at the greater of its redemption value or the issuance date fair value, net of issuance costs, as it is probable of becoming redeemable due to the passage of time. Any change to the carrying value of redeemable preferred stock recognized in each period is recorded to additional paid-in capital, or in the absence of additional paid-in capital, recorded to accumulated deficit.
The issuance date fair value of the redeemable preferred stock shares purchased by entities related to current employees, board members, and service providers was higher than the consideration paid and such excess was recorded as equity-based compensation. The excess of the fair value over consideration paid for redeemable preferred stock shares purchased by an existing convertible preferred stockholder was accounted for as a deemed dividend and recorded in additional paid-in capital.
Comprehensive Income (Loss)
Comprehensive income (loss) is defined as a change in equity of a business enterprise during a period, resulting from transactions from non-owner sources. To date, the Company has not had any transactions that are required to be reported in comprehensive income (loss) other than the net income (loss) incurred from operations. Thus, comprehensive income (loss) is the same as net income (loss) for the periods presented.
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Notes to Consolidated Financial Statements
Recently Adopted Accounting Pronouncements
The Company is an emerging growth company, as defined in the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”). Under the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards issued subsequent to the enactment of the JOBS Act until such time as those standards apply to private companies. The Company has elected to use this extended transition period for complying with new or revised accounting standards that have different effective dates for public and private companies until the earlier of the date that it (i) is no longer an emerging growth company or (ii) affirmatively and irrevocably opts out of the extended transition period provided in the JOBS Act. As a result, these consolidated financial statements may not be comparable to companies that comply with the new or revised accounting pronouncements as of public company effective dates.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), as amended, which requires lessees to recognize a right-of-use asset and lease liability on their condensed consolidated balance sheets for all leases with a term longer than 12 months. Under the new lease standard, the Company determines if an arrangement is a lease at inception. Lease liabilities and their corresponding right-of-use assets are recorded based on the present value of lease payments over the expected lease term. In determining the present value of lease payments, the Company uses its incremental borrowing rate based on the information available at the lease commencement date if the rate implicit in the lease is not readily determinable. The new standard requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase by the lessee. This classification will determine whether lease expense is recognized based on an effective interest method or on a straight-line basis over the term of the lease. A lessee is also required to record right-of-use assets and lease liabilities for all leases with a term of greater than 12 months regardless of their classification. Leases with a term of 12 months or less may be accounted for similar to existing guidance for operating leases today and are not recorded on the Company’s balance sheet. The Company adopted the new standard as of January 3, 2022 on a modified retrospective basis under the alternative transition method. The Company elected to take the practical expedient to not separate lease and non-lease components as part of the adoption. Lease agreements entered into after the adoption of Topic 842 that include lease and non-lease components are accounted for as a single lease component. Beginning on January 3, 2022, the Company’s operating leases, excluding those with terms less than 12 months, were discounted and recorded as assets and liabilities on the Company’s balance sheet. As of the effective date of adoption, the Company recognized lease right-of-use assets of $28.0 million, which included $0.4 million previously recorded as prepaid rent net of $1.0 million previously recorded as deferred rent, $2.2 million of current lease liabilities and $26.4 million in lease liabilities, net of current portion, related to its operating leases.
In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes, which is intended to simplify various aspects related to accounting for income taxes. ASU 2019-12 removes certain exceptions to the general principles in Topic 740 and also clarifies and amends existing guidance to improve consistent application. This standard is effective for fiscal periods beginning after December 15, 2021, including interim periods within fiscal years beginning after December 15, 2022, with early adoption permitted. The Company adopted this guidance on January 3, 2022, and it did not have a material impact on its condensed consolidated financial statements.
Recently Issued Accounting Pronouncements
In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, as amended, which amends guidance on reporting credit losses for assets held at amortized cost basis and available-for-sale debt securities from an incurred loss methodology to an expected loss methodology. For assets held at amortized cost basis, the guidance eliminates the probable initial recognition threshold and instead requires an entity to reflect its current estimate of all expected credit losses. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the assets to present the net amount expected to be collected. For available-for-sale debt securities, credit losses are recorded through an allowance for credit losses, rather than a write-down, limited to the amount by which fair value is below amortized cost. Additional disclosures about
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Notes to Consolidated Financial Statements
significant estimates and credit quality are also required. The guidance is effective for the Company for fiscal years beginning after December 15, 2022. The Company will adopt this guidance on January 2, 2023, and does not expect such adoption to have a material impact on its consolidated financial statements or disclosure requirements.
3.Fair Value Measurements
The Company discloses and recognizes the fair value of its assets and liabilities using a hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date. The guidance establishes three levels of the fair value hierarchy as follows:
Level 1—Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date.
Level 2—Inputs are observable, unadjusted quoted prices in active markets for similar assets or liabilities, unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the related assets or liabilities.
Level 3—Unobservable inputs that are significant to the measurement of the fair value of the assets or liabilities that are supported by little or no market data.
The Company’s financial instruments consist of cash and cash equivalents, restricted cash, accounts payable, accrued expenses, revolving line of credit and long-term debt. As of January 1, 2023 and January 2, 2022, the carrying values of cash and cash equivalents, restricted cash, accounts payable and accrued expenses and other current liabilities approximate fair value due to their short-term maturities. The fair value of the Company’s new revolving facility that provides for borrowings up to $50.0 million (the “New Revolving Facility” — see Note 5, Debt) approximates its carrying value as the stated interest rates reset daily at the daily secured overnight financing rate (“SOFR”) plus an applicable margin and, as such, approximate market rates currently available to the Company. The Company does not have any financial instruments that were determined to be Level 3.
4.Balance Sheet Components
Property and Equipment, net
Property and equipment, net consisted of the following (in thousands) as of:
Estimated Useful Lives January 1, January 2,
Construction in progress 36 107
Total property and equipment 8,377 9,010
Less: accumulated depreciation and amortization (3,986) (5,779)
Property and equipment, net $ 4,391 $ 3,231