The first quarter of Bed Bath & Beyond's (NASDAQ:BBBY) 2020 fiscal year ran from March 1 to May 30. That period roughly corresponded to the peak of the COVID-19 pandemic. As a result, the struggling retailer had to keep most of its stores closed for most of the quarter.

Bed Bath & Beyond was able to drive strong growth in digital sales last quarter, but it wasn't nearly enough to offset the sharp plunge in brick-and-mortar revenue. Furthermore, digital sales are less profitable than in-store sales, mainly due to the cost of shipping. Thus, Bed Bath & Beyond reported dreadful results for the first quarter. While the rest of the year isn't likely to be quite as bad, management will face formidable challenges in trying to return the company to sustainable profitability.

Sales and profitability plummet

Bed Bath & Beyond's digital sales more than doubled in April and May and grew 82% year over year for the first quarter as a whole. However, the company has historically had fairly low e-commerce penetration, and the pandemic caused in-store sales to drop by 77%. Even high-double-digit e-commerce growth couldn't come close to offsetting this decline in brick-and-mortar sales. Total revenue fell 49% to $1.31 billion, missing the average analyst estimate of $1.39 billion.

Meanwhile, gross margin plunged by 7.8 percentage points (from 34.5% to 26.7%), reflecting a huge jump in shipping costs, as well as a shift toward lower-margin items and greater promotional activity.

Two people's hands holding a Bed Bath & Beyond gift card

Image source: Bed Bath & Beyond.

The home furnishings retailer did manage to reduce its first-quarter operating expenses (excluding one-time items) by about 15%. Nevertheless, Bed Bath & Beyond reported a massive first-quarter adjusted loss of $243 million, or $1.96 per share. For comparison, it earned a modest adjusted profit of $0.12 per share a year earlier.

Burning through cash -- and book value

In a press release last month, Bed Bath & Beyond said that it ended the first quarter with about $1.2 billion of cash and investments on its balance sheet. Based on the company's previously announced financing activity, this implied that it burned through at least $400 million last quarter.

Sure enough, the earnings report revealed that Bed Bath & Beyond used $395 million of cash in its operations and spent another $42 million on capex. That put its Q1 cash burn at $437 million.

Bed Bath & Beyond's losses are also rapidly burning through its book value. Shareholders' equity fell from $2.56 billion at the beginning of fiscal 2019 to $1.76 billion by the end of the fiscal year. Shareholders' equity fell again last quarter, this time to $1.46 billion. While book value is still positive -- and slightly higher than Bed Bath & Beyond's market cap of roughly $1.3 billion -- it provides no meaningful downside protection for shareholders.

A tough road ahead

The first quarter was particularly bad for Bed Bath & Beyond because so many of the company's stores were closed for most of the period. Management has been pleasantly surprised by sales trends in stores as they have reopened, and online demand remains strong, with digital sales up more than 80% year over year in June. That said, rising COVID-19 case numbers in many parts of the U.S. could spoil Bed Bath & Beyond's brick-and-mortar momentum.

Moreover, Bed Bath & Beyond's profit margin has been in free fall for more than five years. As sales shift toward digital channels (especially ship-to-home), Bed Bath & Beyond will face continuing margin pressure. A slower pace of sales declines won't be enough to bring it back to profitability.

Management is addressing these margin woes from two angles. First, CEO Mark Tritton and his team plan to improve the company's product assortment and pricing to reconnect with customers. Second, Bed Bath & Beyond aims to reduce annual costs by $250 million to $350 million, including by closing about 200 of its 1,478 stores (mainly from its flagship banner) over the next two years.

These actions may be a case of too little, too late. Bed Bath & Beyond faces structural headwinds to its store traffic, particularly compared to rivals like Target. Cost cuts and product improvements may only partially offset the margin headwinds from persistently weak store traffic. As a result, Bed Bath & Beyond may struggle to return to profitability.