You are correct. They were actually piling up word blocks reading LOVE. I'm not sure if each layer was one long word LOVE, or if they were 4 individual blocks.
And although there were hippie Muppets present, the "lead" singer was a "normal" anything-Muppet -- sort of like Farley. He did the "It's so fine, it's sunshine" part solo.
This is the second-rarest of the Beatles covers they did in the earliest years. What's the first-rarest? Their version of "Help!" where, after a boy Muppet is apparently ditched by a girlfriend on the phone (where upon he starts singing Help), a monster chases him around the room to the rest of the song. The other two Beatles covers, "Yellow Submarine" and "Octopus's Garden" have surfaced (pardon the pun) on YouTube after not seeing the light of day for decades; the former may not have been in English, tho, but I'd found the audio elsewhere.
[In a very rare skit, Ernie and Cookie Monster (or Beautiful Day M) had among other things "A phonograph record of the Beatles" (I thought it was an educational platter about coleoptera.) The monster ate said items, including the record, by proclaiming the item before devouring it, as usual. However, with the record, for some reason he saved the label for last. He then called out "Bee-tles", and if the report is correct, his usual consumption sounds took on a "yeah-yeah-yeah" tone.]
For a laugh: I must have been four years old when I first watched this sketch, and I wasn't so sure I wanted to go back to being three again, as in "Say the word, and you'll be three"