Hour Loop (NASDAQ: HOUR)
Hour Loop (NASDAQ: HOUR) operates as a third-party seller on Amazon. Per the “Business” section of its 10-K, “Our primary strategy is to bring most of our vendors product selections to the customers. We have advanced software that assists us in identifying product gaps so we can keep such products in stock year-round including the entirety of the last quarter (holiday season) of the calendar year (“Q4”). In upcoming years, we plan to expand our business rapidly by increasing the number of business managers, vendors and SKUs.” In 2021, the business generated $62.8 million in revenue and $7.7 million in listed free cash flow. Hour Loop is headquartered in the mean streets of Redmond, Washington.
History
Per the 10-K, Hour Loop was founded in 2013 by Sam Lai and Maggie Yu. Hour Loop originally sold products through its own website, but has since pivoted to selling them through Wal-Mart and Amazon’s online sales platform. Since 2020, the business has generated all its sales through Amazon. That was all that I could find about its history. There is not a History section on its website nor is there a Wikipedia page and I was unable to find any kind of social media presence, podcasts or interviews. Hour Loop went public in January of this year.
CEO
In addition to cofounding the business, Mr. Lai serves as the CEO and Chairman of the Board while Ms. Yu serves as the Senior Vice President. It is also worth noting that Mr. Lai and Ms. Yu are married. Mr. Lai had a distinguished career before cofounding the business. Per the 10-K, “He is a seasoned software engineer who has designed and built software and code from the ground up at Hour Loop, Inc., Amazon.com, Inc., UnifiedEdge, Inc., Kits, and Applied Research Labs for the past 18 years. From December 2009 through June 2017, Mr. Lai served as a Software Development Engineer for Amazon.com, Inc. From March 2009 through December 2009, he served as a Senior Java Developer at UnifiedEdge, Inc. From February 2007 through March 2009, Mr. Lai served as a Senior Java Developer at Kits. From September 2005 through February 2007, he served as a Software Development Engineer for Amazon.com, Inc. From March 2003 through January 2004, Mr. Lai served as a Research Engineer Scientist Assistant at Applied Research Labs. Mr. Lai graduated with a Bachelor Degree in Computer Science from University of Texas at Austin in 2003 and a Masters Degree in Computer Science from University of California, San Diego in 2004. Mr. Lai does not hold, and has not previously held, any directorships in any reporting companies.” Ms. Yu did not have any professional experience before cofounding the business. Per the 10-K, “Since graduating from University of California, San Diego until June 2013, Ms. Yu has no employment history. Ms. Yu graduated with a Bachelor Degree in Computer Science from University of California, San Diego in 2004. Ms. Yu does not hold, and has not previously held, any directorships in any reporting companies.”
I came across two members of the Board of Directors who deserve to be mentioned. The first member who stood out was Michael Lenner. Per p. 49 of the 10-K, “Mr. Lenner has been an independent member of our Board of Directors since June 1, 2021. Since May 2018, Mr. Lenner has served as Vice President, Software Engineering, Disney Streaming Services at The Walt Disney Company. From August 2017 through May 2018, he served as Vice President, Software Engineering at BAMTECH Media. From July 2014 through August 2017, Mr. Lenner served as Vice President, Software Engineering and Senior Director, Software Engineering at Major League Baseball Advanced Media. From February 2011 through June 2014, he served as the Vice President, Engineering at H. Bloom. Mr. Lenner graduated with a Bachelor of Arts Degree in Physics from Binghamton University and a Masters of Science Degree in Computer Science from Columbia University.” The other member of the Board who stood out was Minghui (Alan) Gao. Per p. 49 of the 10-K again, “Mr. Gao has been an independent member of our Board of Directors since October 6, 2021. Since October 2021, Mr. Gao has served as the Chief Technology Officer of Cue Health, Inc. From January 2018 to October 2021, he served as the Chief Technology Officer of PillPack (which was acquired by Amazon Pharmacy). From October 2016 to January 2018, Mr. Gao served as the Director of Prime Video at Amazon.com. From September 2013 to October 2016, he served as Engineering Director of Seller Services at Amazon.com. From September 2011 to September 2013, Mr. Gao served as the Chief Technology Officer and Senior Vice President of Product and Engineering at Xiu.com, an e-commerce company in China. From November 2008 through June 2011, he served as Engineering Director at Amazon.cn in China. From October 2007 to November 2008, Mr. Gao served as Senior Manager, Software Development at Amazon.com. From November 2006 to October 2007, he served as a Software Development Manager at Amazon.com. From April 2001 to November 2006, Mr. Gao served as Software Design Engineer and Development Lead. Mr. Gao graduated with a Masters Degree in Computer Science from Baylor University in 1999.” Both members stood out because of how small the business is and how well qualified they are. I cannot recall members of a Board of Directors at a business this small with such impressive resumes.
CEO Compensation
I will discuss both Mr. Lai and Ms. Yu’s compensation in this section. I usually don’t do this, but decided to make an exception in this case because they cofounded the business and make a similar amount of money. They also collectively own a majority of the stock which I will discuss later in this section. Both of their compensation is made up of a base salary and a cash bonus. Stock awards and stock options are other forms of compensation permitted by the business, but neither Mr. Lai nor Ms. Yu has received either kind of award in the past. Hour Loop also has a section in its 10-K devoted to its equity incentive plan, but I do not feel like it’s worth mentioning at this time as the business currently does not issue forms of equity as compensation. Mr. Lai’s employment agreement is as follows and is taken from pp. 54-55 of the 10-K, “Mr. Lai’s agreement provides for an annual base salary of $500,000... Each of the base salaries may be subject to annual adjustments as determined in the discretion of the Board. Pursuant to their agreements, on December 31, 2021, each of Mr. Lai and Ms. Yu are also entitled to receive a guaranteed bonus of $50,000, subject to the applicable agreement being in effect at that time. Additionally, pursuant to their agreements, Mr. Lai and Ms. Yu are entitled to each receive a guaranteed bonus of $100,000 on December 31, 2022, subject to the applicable agreement being in effect at that time. Mr. Lai’s agreement provides that, for the Company’s 2021 fiscal year, (1) if the net profits of the Company for the 2021 fiscal year equals at least 175% of the net profits of the Company for the 2020 fiscal year, excluding any costs of the Company related to the IPO, in each case as determined by the Board, Mr. Lai is entitled to receive a bonus of 50% of the base salary as in effect as of the last business day of the 2021 fiscal year; and (2) if the net profits of the Company for the 2021 fiscal year equals at least 200% of the net profits of the Company for the 2020 fiscal year, excluding any costs of the Company related to the IPO, in each case as determined by the Board, Mr. Lai is entitled to receive an additional bonus of 50% of the Base Salary as in effect as of the last business day of the 2021 fiscal year. On January 20, 2022, the Company entered into Addendum No. 1 to Mr. Lai’s agreement, pursuant to which Mr. Lai’s 2022 bonus targets and payments were set as follows:
· If the Company grows its net profits (excluding taxes) to at least $7,000,000 during the 2022 fiscal year, Mr. Lai will receive a bonus equal to 50% of base salary.
· If the Company grows its net profits (excluding taxes) to at least $8,500,000 during the 2022 fiscal year, Mr. Lai will receive a bonus equal to 100% of base salary.
The satisfaction of the above conditions will be determined following the end of the 2022 fiscal year. For the avoidance of doubt, only one of the above bonus amounts, if at all, will be payable.”
Ms. Yu’s compensation arrangement is as follows and is taken from pp. 54-55 of the 10-K, “Ms. Yu’s agreement provides for an annual base salary of $450,000… Ms. Yu’s agreement provides that, for the Company’s 2021 fiscal year, (1) if Ms. Yu successfully launches the Company’s Vendor Acquisition Team, as determined by the Board, Ms. Yu will be entitled to receive a bonus of 50% of the base salary as in effect as of the last business day of the 2021 fiscal year; and (2) if Ms. Yu acquires 50 or more new vendors for the Company, as determined by the Board, Ms. Yu will be entitled to receive a bonus of 50% of the base salary as in effect as of the last business day of the 2021 fiscal year. On January 20, 2022, the Company entered into Addendum No. 1 to Ms. Yu’s agreement, pursuant to which Ms. Yu’s 2022 bonus targets and payments were set as follows:
· If the Company acquires at least 75 but fewer than 100 new vendors during the 2022 fiscal year, Ms. Yu will receive a bonus equal to 50% of base salary.
· If the Company acquires 100 or more new vendors during the 2022 fiscal year, Ms. Yu will receive a bonus equal to 100% of base salary.
The satisfaction of the above conditions will be determined following the end of the 2022 fiscal year. For the avoidance of doubt, only one of the above bonus amounts, if at all, will be payable.”
Overall, I’d say that the incentive structure at Hour Loop is good, but not great. Tying bonuses to pre-tax income for Mr. Lai and growth in the number of vendors for Ms. Yu isn’t the worst thing in the world. Ideally, I’d like to see bonuses tied to high returns on invested capital or growth in free cash flow, but what can I do?
I found something of note in Executive Compensation section under the Bonuses subsection on p. 59 of the 10-K where it states, “The bonuses for 2021 and 2020 were determined based on peer comparable compensation paid in the Seattle, Washington area reported by www.PerSalary.com (https://www.salary.com/tools/salary-calculator/ceo/seattle-wa?view=table). According to www.PerSalary.com, the CEO salary range in Seattle was $453,109 to $1,318,542 for 2020. The $650,000 and $815,467 compensation (base salary and bonus) paid to Mr. Lai for 2021 and 2020, respectively, fell in such range and we believed to be reasonable due to the significant growth in the company in 2021 and 2020, respectively, due in large part to Mr. Lai’s leadership. According to www.PerSalary.com, the head of operations salary range in Seattle was $285,369 and $776,354 for 2020. The $818,461 and $746,237 compensation (base salary and bonus) paid to Ms. Yu for 2021 and 2020, respectively, fell slightly above such range and we believed to be reasonable due to Ms. Yu being instrumental in delivering high growth along with profitability to the company in 2021 and 2020, respectively.” I am not sure if Mr. Lai and Ms. Yu’s salaries are still based on peer salaries in Seattle. My hope is that their compensation is now benchmarked to a peer group of publicly traded businesses. This is one of the many questions that I have for the business which I describe in further detail in the Risks section of this writeup.
Before showing the Summary Compensation Table, there is one thing I like in particular about Mr. Lai and Ms. Yu and that is they put their money where their mouths are. They collectively own ~95% of the outstanding stock which means that Hour Loop is a controlled company. The Summary Compensation table is shown below and is taken from p. 54 of the 10-K.
What Does Hour Loop Do?
Since its inception, Hour Loop has operated as a third-party online retailer meaning that it buys product wholesale from its brand partners and resells them to consumers. As stated above, Hour Loop has sold all its products through Amazon since 2020. Per the 10-K, Hour Loop claims to be a top 100 seller on Amazon. A feather in its cap is that it has a 4.9/5 seller rating. Per p. 37 of the 10-K, “We manage more than 100,000 stock-keeping units (“SKUs”). Product categories include home/garden décor, toys, kitchenware, apparels, and electronics. Our primary strategy is to bring most of our vendors product selections to the customers.” Links to its Amazon storefronts can be found here, here and here. That’s really all the business does. It’s as simple as that.
How can a third-party seller on Amazon be a unique business? Well, part of my answer is that I find it interesting that the business manages to survive by doing just that. Hour Loop has figured something out and thrived over the last couple of years. The business started from zero less than ten years ago and now does almost $70 million a year in sales all while being profitable. Its financial results over the same period have been intriguing too and I will discuss them later in the Valuation section of this writeup. Knowing what I know about Amazon, it seems like it does everything it can to drive down prices and compete with the brands and resellers that operate on its platform. This tells me that Hour Loop has managed to work around Amazon’s policies and other competitors. Part of its success is stated in the Competitive Advantages section on p. 5 of the 10-K where it states, “Among 9.7 million sellers on Amazon, we believe we have two main competitive advantages. First, we have strong operations and sales teams experienced in listing, shipment, advertising, reconciliation and sales. By delivering high quality results and enhancing procedures through the process, our teams are competitive. Second, we believe our proprietary software system gives us an advantage over our competition. The system is highly customized to our business model; it collects and processes large amounts of data every day to optimize our operation and sales. Through advanced software, we can identify product gaps and keep them in stock all year round. With respect to our advertising strategy, we advertise those products that we estimate will have greater demand based on our experience. This lets us allocate our advertising budget in a fashion that delivers positive value. We advertise our products on Amazon. We allocate our advertising dollars prudently. This is accomplished by advertising items that deliver the most return for our advertising spending. We monitor the items being advertised by our competitors. On the operations side, we constantly refine our processes based on learnings from historical data. The combination of managing the business operations effectively along with allocating our advertising budget to high value items allows us to grow profitably. In cases, where the advertising is fierce, we allocate the spending appropriately. Our strategy for competing with larger competitors is to monitor their pricing and not compete with them when their pricing is low or at a loss. Competitors sell at low prices or at a loss due to a variety of reasons, including, but not limited to, their desire to liquidate inventory or achieve short term increase in revenue. During these times, we avoid matching their prices. This strategy allows us to stay profitable.” Hour Loop’s pricing strategy is discussed further on p. 6 of the 10-K where it states, “In an ideal world, we would like to price our products at key stone pricing or double wholesale cost. However, we operate in a hyper competitive environment and we must stay competitive. Therefore, we must draw a good balance between gross margin and revenue. Our main objectives focus on increasing volume and maximizing profits, which is achieved with a customized auto pricing system we developed internally, in combination with well trained business managers’ judgment on pricing skills as well as constant monitoring. One principal feature of the pricing system is that it automatically syncs public data of competing offers from Amazon regularly, so business managers can make price settings and adjustments based on accurate data, and thus be able to set optimal selling prices for products. In addition, the system is constantly improved with new features and optimizations.” The use of software to identify product gaps and not competing on price, especially as an online retailer, were interesting takeaways. I haven’t seen other retailers mention either of these strategies before.
Two other advantages for Hour Loop are cost advantages. The first is its access to low-cost products. Per p. 9 of the 10-K, “We lower our product average costs by direct import items that have high volume, purchasing in bulk with better prices, and negotiating discounts or rebates over increased purchase volume every year. Our strong growth of purchase every year allows us to negotiate better discounts than the rivals. Therefore, we have the cost advantages to compete at low prices.” The other cost advantage is through low-cost distribution and logistics. Per p. 10 of the 10-K, “We saved the cost of managing the warehouse, shipping, and product distribution as we are enrolled in Amazon’s FBA program. The program allows us to reduce fixed costs of the physical assets and quickly scale up the business without thinking much about infrastructure complexity. Apart from using the FBA program, we also use FedEx, Amazon partnered carrier, Amazon Freight, and Amazon Global Logistics to reduce expense. The competitive shipping rates we secured provide us a cost-efficient way to deliver shipments from overseas and domestic to Amazon warehouse.” From what I gathered, Hour Loop outsources almost all its distribution and logistics through the Fulfilled By Amazon (FBA) program. For those of you who are unfamiliar with this program, a link to its website is here. Per the website, Amazon describes FBA as “… a service that allows businesses to outsource order fulfillment to Amazon. Businesses send products to Amazon fulfillment centers and when a customer makes a purchase, we pick, pack, and ship the order. We can also provide customer service and process returns for those orders.”
The final advantage I will discuss is its product selection. Hopefully you’ve clicked on the links to its Amazon storefronts and have gone through at least some of Hour Loop’s catalog. What I noticed is that the storefronts have a quirky selection available for sale. Hour Loop sells all kinds of home décor and gardening items along with one manga series and pool floats. Hopefully you understand what I’m trying to get at here. I was confused by the selection when I first went through it, but after thinking about it I realized that it had to be intentional. Those items wouldn’t be for sale if Hour Loop couldn’t make money from them. This must be what the data is telling the business to sell.
Valuation
Hour Loop’s revenues have accelerated rapidly over the last few years from $25.6 million in 2019 to $62.8 million in 2021 which is a CAGR of 33.21%. That is the kind of growth I want to see as a potential investor in the business. Now on to free cash flow.
Hour Loop’s free cash flow, what I call real free cash flow, is shown below. Please note that I am using the results from the last two years because those are the only ones shown in full in the 10-K. One thing to be aware of is that its cash from operations has more than doubled since 2020 and this is due almost entirely to an increase in accounts payable due to the holiday season as that is when the business orders the most product from its vendors. One thing I really like is that the business does not have any stock-based compensation. Hour Loop’s market capitalization is ~$100 million as of the publishing of this writeup meaning that it trades at ~13x real free cash flow. Finding a profitable, growing and cash flow generative business over the last several years for under 15-20x FCF has been tough, so this is certainly an interesting valuation multiple. Let’s move on to returns on invested capital.
So, what have its returns on invested capital (ROIC) been? The results are shown in the screencap below.
ROIC has been exceptional over the last two years. I know it’s only been two years, but these returns are another indication that Hour Loop has been doing something right. An added bonus is that the business has been able to do all of this without long-term debt or goodwill. Please note there is an important caveat to my ROIC calculations. Mr. Lai and Ms. Yu provided a $4+ million loan to the business in 2021 out of retained earnings which was not included as debt for some reason. If it was considered debt and subsequently as a type of invested capital, then Hour Loop’s ROIC in 2021 would’ve been around 40% instead of 61%. I discuss this further in Question 8 in the Risks section of this writeup. Let’s move on to returns on incremental invested capital (ROIIC).
Unfortunately, Hour Loop hasn’t compounded the value of its business as well as I’d like over the last two years. Its returns on incremental invested capital are very good, but the reinvestment rate needs to be higher in my opinion. I’ve stated multiple times that Hour Loop has figured something out with their business model, but for whatever reason management has not been investing a ton back into the business. My hope is that they come through on their promise to “… expand our business rapidly by increasing the number of business managers, vendors and SKUs” as described in the introductory paragraph. This is something I’ll have to be on the lookout for as it continues its journey as a publicly traded business.
One final thing to be aware of in relation to Hour Loop’s finances and valuation is that the business owes ~$693,000 in backed taxes. Per its Q1 2022 10-Q on p. 25, “We estimate that as of March 31, 2022, we owed $693,531 in sales taxes, along with penalties and interest. However, we are currently engaged in the process of negotiating and remediating the amount of sales tax with the states in which we owe sales tax and anticipate becoming compliant in tax payments in such states by December 31, 2022.”
Risks
The biggest risk that I came across while researching Hour Loop is Amazon. In addition to being the platform that Hour Loop sells on, Amazon also competes with it. Per p. 10 of the 10-K, “Our key competitor is Amazon Retail. Amazon Retail frequently buys from the same brands we sell and sells them at a loss. Amazon Retail offers can be identified by the “Sold by Amazon” tag on Amazon’s site, and they are formed by the two components: (i) Amazon Vendor Central, and (ii) Sold by Amazon program. We do not consider other third-party sellers as key competitors, because none of them represent enough market share to influence sales outcome.” Amazon’s Vendor Central program is discussed next in the 10-K where it states, “Amazon Vendor Central allows manufacturers and brand owners to sell directly to Amazon as a first-party seller. This is one of the key competitive factors as Amazon usually buys bulk from the brands and sells at a very low price, which leads to hyper-competitive pricing. On pricing control, Amazon does not always follow the Minimum Advertised Pricing guidelines from manufacturers, which also puts us at a disadvantage when selling the same products.” The Sold by Amazon Program is also discussed on p. 10 of the 10-K where it states, “With the rise of e-commerce platforms, Amazon is looking for opportunities to attract customers away from its retail store rivals. In 2019, Amazon rolled out a new program entitled Sold by Amazon (“SBA”) to help sellers grow their business. This program gives brand owners the control of inventory management and listings with Amazon having the authority to constantly monitor and change the price to make sure customers are getting the best deals. Once the products are enrolled in the SBA program, Amazon will set the Minimum Gross Proceeds (“MGP”) to pay sellers the lowest possible amount on each unit sold. This new program is another threat to our company as Amazon is the one taking control of pricing, and they set the price very low in order to compete with competitors’ low price strategy.” These two programs seem incredibly powerful for Amazon and pose major challenges for Hour Loop going forward.
Hour Loop offers a counter to these risks in the “Weaknesses of Sold by Amazon” subsection on p. 11 of the 10-K where it states, “As Amazon focuses on sales more than relationships with vendors, they do not follow vendors’ Minimum Advertised Pricing (“MAP”) strictly. We believe this has led to the devaluation of brands and will have a negative impact on building a long-term relationship with the vendors. Once the vendor hands over their price control to Amazon, we believe it is unlikely for them to sell at their original target price further, and it influences their offline sales. And in fact, it makes a huge difference in profitability to both Amazon and the vendor when reacts to the competitive pricing changes. Apart from the weaknesses of business relationships, we believe Amazon also has disadvantages in the niche marketplaces, where product offerings are narrower and more personalized. As a third-party seller, we cooperate with vendors in developing custom projects that bring product differentiation and scarcity effect. However, we believe Amazon only concentrates on the masses, which gives them the deficiency of having products that are targeted in certain market segments.” Apologies for the sentence about Amazon and vendors reacting to price changes. I copy and pasted it directly from the 10-K and I’m not sure what word or words are supposed to be at the end of that sentence to make it coherent.
I also have a set of questions and concerns about the business. I reached out to Hour Loop’s Investor Relations department which it is outsourced to a company called Gateway. Given its small market cap, I figured I had a good chance of speaking to someone, so I called Gateway on 6/10/22. I spoke to a representative and was told that both points of contact that were listed on Hour Loop’s Investor Relations site were not available, so I left a voicemail. I decided to follow up one week later on 6/17/2022 as I had not heard back from them. The representative who answered the phone told me that both points of contact for Hour Loop were on calls and I was again sent to voicemail. I have not heard from them as of the posting of this write up. Provided below are the questions and concerns that I have for Gateway and/or Hour Loop’s management after finishing my research on the business. Section “a.” under select questions is additional, new information for you, the reader, because the topic has not been discussed in the writeup so far and I feel you should know more about it.
1. When did management realize that it was better for the business to sell on Amazon and not its own website? Is management trying to get Hour Loop off Amazon and back on to their own site at some point?
2. How are they dealing with increasing fees paid to Amazon? Ask them to discuss platform fees, take rates and any other fees associated with Amazon.
3. Does “Fulfilled By Amazon” (FBA) program allow the business to be asset free? Does Amazon handle all of your logistics? How does Hour Loop handle inventory and logistics if it isn’t 100% asset free?
a. The business claims to have a warehouse in Seattle, but there is no description as to what kinds of business activities go on there.
4. Amazon Retail is listed as the main competitor. Does Hour Loop really want to compete with Amazon over the long-term when it can sell a lot of the same items at a loss? I know the counter point is that Amazon is damaging their brand relationships by undercutting the Minimum Advertised Price, but is there anything that you or other brands can do about this in the short to medium term?
5. How is management dealing with the Sold by Amazon program where they seek to pay out as little as possible going forward on each unit sold through their Minimum Gross Proceeds initiative? As a follow up to Question 4, does Hour Loop have proof that Amazon is weakening their brand relationships by selling under the Minimum Advertised Price? Ask them to explain this in more depth.
a. Major red flag if I don’t get a good answer.
6. Can they explain what product gaps are and how their advanced software helps the business identify them?
7. Corporate headquarters are in Redmond, WA, but it’s a virtual office? Are the CEO’s in Redmond? If not, where are they?
a. Yes, you read that right. The headquarters is listed as a virtual office in the 10-K. I don’t know where the business conducts its day-to-day operations. This is a red flag if I cannot get a straight answer.
8. Why did the CEO and Senior Vice President lend the business $4+ million?
a. This is called the July 2021 Loan on p. 14 of the 10-K. A description of it is provided on the same page where it states, “On July 27, 2021, Sam Lai, our Chief Executive Officer, and Maggie Yu, our Senior Vice President, made a loan (“July 2021 Loan”) to us of the outstanding retained earnings of approximately $4,170,418 in a single payment ($2,085,209 attributable to each of Mr. Lai and Mrs. Yu). The loan is memorialized in a Loan Agreement dated October 15, 2021. Pursuant to the terms of the Loan Agreement, the loan bears interest of 2% per annum and the principal of the loan ($4,170,418) and accrued interest becomes due and payable on December 31, 2022. As of December 31, 2021, the outstanding principal balance was approximately $4,170,418 and accrued interest was $21,023 on the July 2021.” I did not include this as debt in my ROIC calculations because I want to know more about the terms of the loan and why it isn’t included as a form of debt on the balance sheet. I would like to repeat that if the loan was included as a type of debt and invested capital in the business, then ROIC would’ve been around 40% instead of 61%.
9. One of the Risk Factors stated on p. 20 of the 10-K is about receiving reimbursements from Amazon. Specifically, it states that, “Our profit is dependent on reimbursements from Amazon and any change in Amazon’s policy regarding reimbursement could adversely impact our ability to generate profits.” Can they explain these reimbursements in more depth and break down why they affect Hour Loop’s profitability?
10. Is executive compensation now tied to a publicly traded peer group?
11. What exactly does FlyWheel do and does it bring in a material amount of revenue in to the business?
a. FlyWheel Consulting Limited, also known as FlyWheel in this writeup, is a subsidiary of Hour Loop based in Taiwan. Per p. 79 of the 10-K, “In 2019, Hour Loop formed a wholly owned subsidiary, Flywheel E-commerce Co., Ltd. (“Flywheel”), to provide business operating consulting services, exclusively to Hour Loop.” That is the only description of the subsidiary and it seemed pretty vague in my opinion so I’d like some further insight if possible. This is another potential red flag.
12. Can anyone at Gateway or Hour Loop comment on the backed tax situation? Why did this happen and why did the amount increase from ~$620,000 in the 2021 10-K to ~$693,000 in the Q1 2022 10-Q?
13. Can you provide any more information as to why Mr. Ratan resigned less than a year after taking the CFO role? It says it was for “personal reasons”, but that’s kind of vague.
a. Per p. 49 of the 10-K, “Rahul Ratan served as our Chief Financial Officer from June 14, 2021 until March 29, 2022, when he resigned such position for personal reasons.” There is no description of what his qualifications were or further details as to why he resigned less than a year after taking the CFO role. This is also a red flag if I cannot get a well explained answer.
14. Does management have plans to focus on more niche products to fend off competition from Amazon? If so, can they provide an update on the types of products or brands they’re sourcing?
15. Does Mr. Lai feel like his and Mr. Gao’s previous work experience give the business an advantage in dealing with Amazon and other competitors? If so, why?
Tailwinds
There are four tailwinds for Hour Loop going forward. The first is the Amazon platform. In addition to being a risk, it is also an advantage because of its scale. I don’t think Hour Loop would be able to drive as much traffic to its own website as it can on Amazon’s. The second tailwind is the nearly endless product assortment that it can offer. I think the business is right to focus on niche products and my hope is that it will broaden its quirky offering in the future. The third tailwind comes from continued online shopping. I don’t envision a decline in the amount of money spent on online shopping any time soon. Based on these three tailwinds, there appears to be a long growth runway for the foreseeable future.
I know that I have a question about it, but my gut tells me that Mr. Lai and Mr. Gao’s previous employment at Amazon is a fourth tailwind. I think this because each of them worked for Amazon for several years. I’ve heard that it’s a badge of honor to last more than two years there so this makes me think that they’re highly driven and can deal with chaotic and demanding work environments. I also think that their previous work experience gives Hour Loop a leg up on their competitors because Mr. Lai and Mr. Gao know the ins and outs of Amazon’s behind the scenes operations better than most. Based on these two factors (their length of employment and insider knowledge), I also think that part of Amazon’s DNA has been transferred to Hour Loop. To be clear, I have no definitive way to prove this as I have not talked to anyone at the business, but it is something that stood out to me after researching it.
Conclusion
Is Hour Loop a compounder? I don’t think so at the current time. I certainly find that it interesting that the business survives by being a third-party seller on Amazon. I also like that the business has high returns on capital, but it has not been compounding its value at a suitable rate. Also, the incentive structure is good, but not great. The biggest detractor, in my opinion, is that I have too many questions and concerns about the risks that the business faces going forward. If I was able to talk to its Investor Relations department or management and have a discussion with them about my questions and concerns then I might be more comfortable with the business, but I don’t have that luxury as of now. Unfortunately, the negatives outweigh the positives in this case. I won’t totally write off Hour Loop though. I will continue to pay attention to its results as time goes on, but for now I’m going to pass on the business.
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Disclosure: I do not own stock in Hour Loop