LOVE 10-Q Quarter ended Aug. 1, 2021

The condensed consolidated balance sheet of The Lovesac Company (the “Company”, “we”, “us” or “our”) as of January 31, 2021, which has been derived from our audited financial statements as of and for the 52-week year ended January 31, 2021, and the accompanying interim unaudited condensed consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (the “SEC”) for interim financial reporting. Certain information and note disclosures normally included in annual financial statements, prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”), have been condensed or omitted pursuant to those rules and regulations. The financial information presented herein, which is not necessarily indicative of results to be expected for the full current fiscal year, reflects all adjustments which, in the opinion of management, are necessary for a fair presentation of the interim unaudited condensed consolidated financial statements. Such adjustments are of a normal, recurring nature. These condensed consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements filed in its Annual Report on Form 10-K for the fiscal year ended January 31, 2021.

Due to the seasonality of the Company’s business, with the majority of our activity occurring in the fourth quarter of each fiscal year, the results of operations for the thirteen and twenty-six weeks ended August 1, 2021 and August 2, 2020 are not necessarily indicative of results to be expected for the full fiscal year.

Nature of Operations

The Company is a technology driven company that designs, manufactures and sells unique, high quality furniture derived through its proprietary “Designed for Life” approach which results in products that are built to last a lifetime and designed to evolve as our customers’ lives do. The Company markets and sells its products through modern and efficient showrooms and, increasingly, through online sales directly at www.lovesac.com, supported by direct-to-consumer touch-feel points in the form of our own showrooms as well as through shop-in-shops and online pop-up-shops with third party retailers. The Company was formed as a Delaware corporation on January 3, 2017, in connection with a corporate reorganization with SAC Acquisition LLC, a Delaware limited liability company (“SAC LLC”), the predecessor entity to the Company.

COVID-19

In March 2020, the World Health Organization declared the outbreak of COVID-19 as a global pandemic and, in the following weeks, the U.S. federal, state and local governments issued lockdown orders and related safety measures impacting the operations of our showrooms and consumer demand. Although there has been a general improvement in conditions, there continues to be significant uncertainties around the scope and severity of the pandemic, its impact on the global economy, including supply chains, and other business disruptions that may impact our operating results and financial condition. We continue to follow the guidance issued by federal, state and local governments and health organizations and have taken measures to protect the safety of our associates and customers.

Operations and Liquidity

The Company had incurred significant operating losses and used cash in its operating activities since inception through fiscal 2020. Operating losses resulted from inadequate sales levels for the cost structure and expenses as a result of impact of tariffs on inventory, expanding into new markets, opening new showrooms, and investments into advertising, marketing and infrastructure to support increases in revenues. The Company plans to continue to open new retail showrooms in larger markets and increase its shop-in-shop relationships to increase sales levels invest in advertising and marketing initiatives to increase brand awareness and invest in infrastructure to support growth of the Company. There can be no assurance that anticipated sales levels will be achieved. The Company believes that based on its current sales and expense levels, projections for the next twelve months, current cash on hand and the credit facility with Wells Fargo Bank, National Association, see Note 7, the Company will have sufficient working capital to cover operating cash needs through the twelve-month period from the financial statement issuance date.

Except as described below, the Company has considered all other recently issued accounting pronouncements and does not believe the adoption of such pronouncements will have a material impact on its financial statements. The Company, as an emerging growth company, has elected to use the extended transition period for complying with new or revised financial accounting standards.

The following new accounting pronouncements were adopted in fiscal 2022:

In February 2016, FASB issued ASU No. 2016-02, Leases (Topic 842) amending lease guidance to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. ASU No. 2020-05 extended the effective date to fiscal years beginning after December 15, 2021, and interim periods within fiscal years beginning after December 15, 2021, with early adoption permitted. The Company adopted the guidance in fiscal 2022 and there was not a material effect on the Company’s consolidated results of operations.

Adoption of this standard resulted in the recognition of operating lease right-to-use (“ROU”) assets and corresponding lease liabilities of approximately $ 90 million and $ 97 million, respectively, and reclassification of deferred rent of $ 6.7 million as a reduction of the right-of-use assets on the consolidated balance sheet as of February 1, 2021. The new standard also provides practical expedients for an entity’s ongoing accounting. We elected the short-term lease recognition exemption for all leases that qualify. This means, for those leases that qualify, we will not recognize ROU assets or lease liabilities, and this includes not recognizing ROU assets or lease liabilities for existing short-term leases of those assets in transition. We also elected the practical expedient to not separate lease and non-lease components for all of our leases.

A summary of intangible assets follows:

Amortization expense associated with intangible assets subject to amortization is included in depreciation and amortization expense on the accompanying condensed consolidated statements of operations. Amortization expense on other intangible assets was $ 79,751 and $ 86,179 and $ 543,072 and $ 164,550 for the thirteen and twenty-six weeks ended August 1, 2021 and August 2, 2020, respectively.

As of August 1, 2021, estimated future amortization expense associated with intangible assets subject to amortization is as follows:

The Company continues to provide a full valuation allowance against its net deferred tax assets due to the uncertainty as to when business conditions will improve sufficiently to enable it to utilize its deferred tax assets. As a result, the Company did not record a federal or state tax benefit on its operating losses for the thirteen and twenty-six weeks ended August 1, 2021 and August 2, 2020.

The Company does not anticipate any material adjustments relating to unrecognized tax benefits within the next twelve months; however, the ultimate outcome of tax matters is uncertain and unforeseen results can occur. We had no material interest or penalties during the thirteen and twenty-six weeks ended August 1, 2021 and August 2, 2020, respectively, and we do not anticipate any such items during the next twelve months. Our policy is to record interest and penalties directly related to uncertain tax positions as income tax expense in the condensed consolidated statements of operations.

Basic net income (loss) per common share is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per common share is computed by dividing net income (loss) by the weighted average number of common shares outstanding and common stock equivalents outstanding during the period. Diluted net income (loss) per common share includes, in periods in which they are dilutive, the effect of those potentially dilutive securities where the average market price of the common stock exceeds the exercise prices for the respective periods.

For the thirteen and twenty-six weeks ended August 1, 2021, the effects of 558,021 shares of common stock related to restricted stock units, 495,366 shares of common stock underlying stock options and warrants to purchase 281,750 shares of common stock were included in the diluted share calculation.

As of August 2, 2020, there were 2,241,802 potentially dilutive shares which may be issued in the future, including 707,316 shares of common stock related to restricted stock units, 495,366 shares of common stock underlying stock options and warrants to purchase 1,039,120 shares of common stock. These were excluded from the diluted loss per share calculation in the thirteen and twenty-six weeks ended August 2, 2020, because the effect of including these potentially dilutive shares was antidilutive.

Leases

The Company leases its office, warehouse facilities and retail showrooms under operating lease agreements which expire at various dates through June 2031. The Company determines if a contract contains a lease at inception based on our right to control the use of an identified asset and our right to obtain substantially all of the economic benefits from the use of that identified asset. Certain operating leases have renewal options and rent escalation clauses. We assess these options to determine if we are reasonably certain of exercising these options based on all relevant economic and financial factors. Any options that meet these criteria are included in the lease term at lease commencement.

Lease right-of-use assets represent the right to use an underlying asset pursuant to the lease for the lease term, and lease liabilities represent the obligation to make lease payments arising from the lease. Lease right-of-use assets and lease liabilities are recognized at the commencement of an arrangement where it is determined at inception that a lease exists. These assets and liabilities are initially recognized based on the present value of lease payments over the lease term calculated using our incremental borrowing rate generally applicable to the location of the lease right-of-use asset, unless an implicit rate is readily determinable. We combine lease and certain non-lease components for our showroom real estate leases in determining the lease payments subject to the initial present value calculation. Lease right-of-use assets include upfront lease payments and exclude lease incentives, where applicable. Lease terms include options to extend or terminate the lease when it is reasonably certain that those options will be exercised.

Lease expense for operating leases consists of both fixed and variable components. Expense related to fixed lease payments are recognized on a straight-line basis over the lease term. Variable lease payments are generally expensed as incurred, where applicable, and include certain index-based changes in rent, certain non-lease components, such as maintenance and other services provided by the lessor, and other charges included in the lease. Leases with an initial term of twelve months or less are not recorded on the balance sheet. In addition, certain of our equipment lease agreements include variable lease payments, which are based on the usage of the underlying asset. The variable portion of payments are not included in the initial measurement of the asset or lease liability due to uncertainty of the payment amount and are recorded as lease expense in the period incurred.

ASC 842 requires companies to use the rate implicit in the lease whenever that rate is readily determinable and if the interest rate is not readily determinable, then a lessee may use its incremental borrowing rate. Most of our leases do not have an interest rate implicit in the lease. As a result, for purposes of measuring our ROU asset and lease liability, we determined our incremental borrowing rate by computing the rate of interest that we would have to pay to (i) borrow on a collateralized basis (ii) over a similar term (iii) at an amount equal to the total lease payments and (iv) in a similar economic environment. We used the incremental borrowing rates we determined as of February 1, 2021 for operating leases that commenced prior to that date. In the case an interest rate is implicit in a lease we will use that rate as the discount rate for that lease. The lease term for all of our lease arrangements include the noncancelable period of the lease plus, if applicable, any additional periods covered by an option to extend the lease that is reasonably certain to be exercised by the Company. Our leases generally do not include termination options for either party to the lease or restrictive financial or other covenants. Some of our leases contain variable lease payments based on a Consumer Price Index or percentage of sales, which are excluded from the measurement of the lease liability.

The Company’s lease terms and rates are as follows:

During the thirteen and twenty-six weeks ended August 1, 2021, we recognized operating lease expense of $ 4.6 million and $ 9.1 million, respectively. In addition, during the thirteen and twenty-six weeks ended August 1, 2021, we recognized $ 3.0 million and $ 4.3 million, respectively, for index-based changes in rent, maintenance, real estate taxes, insurance and other charges included in the lease as well as rental expenses related to short term leases.

During the thirteen and twenty-six weeks ended August 1, 2021, we recognized impairment charges totaling $ 0.6 million associated with showroom-level ROU assets that are included as part of selling, general and administrative expenses. We did not recognize any impairment charges associated with showroom-level ROU assets during fiscal year 2021 as we did not adopt the guidance in ASU No. 2016-02, Leases (Topic 842) until fiscal 2022.

The following table discloses the location and amount of our operating lease costs within our condensed consolidated balance sheets:

The table below reconciles the undiscounted future minimum lease payments (displayed by year and in the aggregate) under noncancelable leases with terms of more than one year to the total lease liabilities recognized on the condensed consolidated balance sheet as of August 1, 2021:

Supplemental Cash Flow information and non-cash activity related to our operating leases is as follows (in thousands):

Severance Contingency

The Company has various employment agreements with its senior level executives. A number of these agreements have severance provisions, ranging from 12 to 18 months of salary, in the event those employees are terminated without cause. The total amount of exposure to the Company under these agreements was $4.7 million at August 1, 2021 if all executives with employment agreements were terminated without cause and the full amount of severance was payable.

Legal Contingency

The Company is involved in various legal proceedings in the ordinary course of business. Management cannot presently predict the outcome of these matters, although management believes, based in part on the advice of counsel, that the ultimate resolution of these matters will not have a materially adverse effect on the Company’s condensed consolidated financial position, results of operations or cash flows.

Related Parties

Our equity sponsor Mistral Capital Management, LLC (“Mistral”) performed management services for the Company under a contractual agreement that ended on January 31, 2021. Certain of our directors are members and principals of Mistral. Management fees totaled approximately $ 100,000 and $ 200,000 for the thirteen and twenty-six weeks ended August 2, 2020, respectively, and are included in selling, general and administrative expenses. There were no amounts payable to Mistral as of August 1, 2021. Amounts payable to Mistral as of January 31, 2021 were $ 15,213 related to reimbursable fees and were included in accrued liabilities in the accompanying condensed consolidated balance sheets.

Our equity sponsor Satori Capital, LLC (“Satori”) performed management services for the Company under a contractual agreement that ended on January 31, 2021. One of our directors is a partner at Satori. Management fees totaled approximately $ 25,000 and $ 50,000 for the thirteen and twenty-six weeks ended August 2, 2020, respectively, and are included in selling, general and administrative expenses. There were no amounts payable to Satori as of August 2, 2021. Amounts payable to Satori as of January 31, 2021 were $ 8,333 consisting of management fees which were included in accounts payable and accrued liabilities in the accompanying condensed consolidated balance sheets. In addition, the Company reimbursed Satori for expenses incurred in the amount of $ 0 and $ 36,401 for out-of-pocket expenses for the twenty-six weeks ended August 1, 2021 and August 2, 2020, respectively. There were no such reimbursements during the thirteen weeks ended August 1, 2021 and August 2, 2020, respectively.

The Company engaged Blueport Commerce (“Blueport”), a company owned in part by investment vehicles affiliated with Mistral, as an ecommerce platform in February 2018. One of our directors was also a director of Blueport. The Company terminated the Blueport contract in fiscal 2021 in order to launch a new enhanced ecommerce platform. There were $ 1,218,278 and $ 1,701,126 of fees incurred with Blueport sales transacted through the Blueport platform during the thirteen and twenty-six weeks ended August 2, 2020, respectively. There were no amounts payable to Blueport as of August 1, 2021 and January 31, 2021, respectively.

The Company has a line of credit with Wells Fargo Bank, National Association (“Wells”). The line of credit with Wells allows the Company to borrow up to $ 25.0 million and will mature in February 2023 . Borrowings are limited to 90 % of eligible credit card receivables plus 85 % of eligible wholesale receivables plus 85 % of the net recovery percentage for the eligible inventory multiplied by the value of such eligible inventory of the Company for the period from December 16 of each year until October 14 of the immediately following year, with a seasonal increase to 90 % of the net recovery percentage for the period from October 15 of each year until December 15 of such year, seasonal advance rate, minus applicable reserves established by Wells. As of August 1, 2021 and January 31, 2021, the Company’s borrowing availability under the line of credit with Wells was $ 22.5 million and $ 15.9 million, respectively. As of August 1 2021, we had borrowings of $ 115 relating to fees associated with the line of credit. As of January 31, 2021, there were no borrowings outstanding on this line of credit.

Under the line of credit with Wells, the Company may elect that revolving loans bear interest at a rate per annum equal to the base rate plus the applicable margin or the LIBOR rate plus the applicable margin. The applicable margin is based on tier’s relating to the quarterly average excess availability. The tiers range from 2.00 % to 2.25 %. The loan agreement calls for certain covenants including a timing of the financial statement’s threshold and a minimum excess availability threshold.

Common Stock Warrants

The following represents warrant activity during the twenty-six weeks ended August 1, 2021 and August 2, 2020:

In the twenty-six weeks ended August 1, 2021, a total of 5,625 warrants were exercised on a cashless basis, whereby the holders received fewer shares of common stock in lieu of a cash payment to the Company. Warrants exercised in the twenty-six weeks ended August 1, 2021 resulted in the issuance of 10,956 common shares. There were 98 warrants that expired in the twenty-six weeks ended August 1, 2021.

Equity Incentive Plan

The Company adopted the 2017 Equity Incentive Plan (the “2017 Equity Plan”) which provides for awards in the form of stock options, stock appreciation rights, restricted stock awards, restricted stock units, performance shares, performance units, cash-based awards and other stock-based Awards. All awards shall be granted within 10 years from the effective date of the 2017 Equity Plan. The number of shares of common stock reserved for issuance under the 2017 Equity Plan was 2,104,889 at August 1, 2021.

Stock Options

In June 2019, the Company granted 495,366 non-statutory stock options to certain officers of the Company with an option price of $ 38.10 per share. 100 % of the stock options are subject to vesting on the third anniversary of the date of grant if the officers is still employed by the Company and the average closing price of the Company’s common stock for the prior 40 consecutive trading days has been at least $ 75 by the third anniversary of the grant. Both the employment and the market condition must be satisfied no later than June 5, 2024 or the options will terminate. These options were valued using a Monte Carlo simulation model to account for the path dependent market conditions that stipulate when and whether or not the options shall vest. The 495,366 stock options were modified in fiscal 2021 to extend the term of the options through June 5, 2024. This resulted in additional compensation of approximately $ 874,000 , of which, $ 315,000 was recorded upon modification and the remaining expense to be recognized over the remaining expected term. The market condition was met on June 5, 2021, which was the date on which the average closing price of the Company’s common stock had been at least $ 75 for 40 consecutive trading days. The options will vest and become exercisable on June 5, 2022 as long as the officers are still employed on that date. As a result of the market condition being met, the Company accelerated the amortization and recognized additional stock-based compensation expense during the thirteen weeks ended August 1, 2021 of approximately $ 0.2 million.

A summary of the status of our stock options as of August 1, 2021 and August 2, 2020, and the changes during the twenty-six weeks ended August 1, 2021 and August 2, 2020 is presented below:

Restricted Stock Units

A summary of the status of our unvested restricted stock units as of August 1, 2021 and August 2, 2020, and changes during the twenty-six weeks then ended, is presented below:

Equity based compensation expense was approximately $ 1.1 million and $ 1.8 million for the thirteen and twenty-six weeks ended August 1, 2021 and $ 0.7 million and $ 1.6 million and for the thirteen and twenty-six weeks ended August 2, 2020, respectively.

The total unrecognized equity-based compensation cost related to unvested restricted stock awards was approximately $ 6.1 million as of August 1, 2021 and will be recognized in operations over a weighted average period of 1.89 years.

In February 2017, the Company established the TLC 401(k) Plan (the “401(k) Plan”) with Elective Deferrals beginning May 1, 2017. The 401(k) Plan calls for Elective Deferral Contributions, Safe Harbor Matching Contributions and Profit-Sharing Contributions. All associates of the Company will be eligible to participate in the 401(k) Plan as of the day of the month which is coincident with or next follows the date on which they attain age 21 and complete one month of service. Participants will be able to contribute up to 100 % of their eligible compensation to the 401(k) Plan subject to limitations with the IRS. The employer contributions to the 401(k) Plan were $ 242,801 and $ 398,483 for the thirteen weeks and the twenty-six weeks ended August 1, 2021 and $ 117,190 and $ 234,470 for the thirteen and twenty-six weeks ended August 2, 2020, respectively.

The Company has determined that the Company operates within a single reporting segment. The chief operating decision makers of the Company are the Chief Executive Officer and President. The Company’s operating segments are aggregated for financial reporting purposes because they are similar in each of the following areas including economic characteristics, class of consumer, nature of products and distribution method and products are a singular group of products which make up over 95% of net sales.

The Company has a bartering arrangement with Icon International, Inc. (“Icon”), a vendor, whereby the Company will provide inventory in exchange for media credits. During fiscal 2021, the Company exchanged $ 3,169,825 of inventory plus the cost of freight for certain media credits. To account for the exchange, the Company recorded the transfer of the inventory asset as a reduction of inventory and an increase to a prepaid media asset account of $ 2,937,035 which is included in “Prepaid and other current assets” on the accompanying condensed consolidated balance sheet. During the first half of fiscal 2022, the Company used $ 1,084,292 in media credits. There were no additional barter arrangements entered into during the thirteen weeks and twenty-six weeks ended August 1, 2021. The Company had $ 1,436,979 and $ 2,521,271 of unused media credits remaining as of August 1, 2021 and January 31, 2021, respectively.

The Company accounts for barter transactions under ASC Topic No. 845 “Nonmonetary Transactions.” Barter transactions with commercial substance are recorded at the estimated fair value of the products exchanged, unless the products received have a more readily determinable estimated fair value. Revenue associated with barter transactions is recorded at the time of the exchange of the related assets.

The Company’s revenue consists substantially of product sales. The Company reports product sales net of discounts and recognizes them at the point in time when control transfers to the customer, which occurs when shipment is confirmed.

Estimated refunds for returns and allowances are recorded using our historical return patterns, adjusting for any changes in returns policies. The Company records estimated refunds for net sales returns on a monthly basis as a reduction of net sales and cost of sales on the condensed consolidated statement of operations and an increase in inventory and customers returns liability on the condensed consolidated balance sheet. As of August 1, 2021 and January 31, 2021, there was a returns allowance recorded on the condensed consolidated balance sheet in the amount of $ 1,534,078 and $ 2,226,723 , respectively, which was included in accrued expenses and $ 319,361 and $ 334,896 , respectively, associated with sales returns included in merchandise inventories.

In some cases, deposits are received before the Company transfers control, resulting in contract liabilities. These contract liabilities are reported as deposits on the Company’s condensed consolidated balance sheet. As of August 1, 2021 and January 31, 2021, the Company recorded under customer deposit liabilities the amount of $ 13,365,940 and $ 5,992,633 , respectively. During the twenty-six weeks ended August 1, 2021 and August 2, 2020, the Company recognized approximately $ 5,992,633 and $ 1,653,597 , respectively, related to our customer deposits.

Upon adoption of ASC 606, we have elected the following accounting policies and practical expedients:

The Company recognizes shipping and handling expense as fulfilment activities (rather than as a promised good or service) when the activities are performed even if those activities are performed after the control of the good has been transferred. Accordingly, we record the expenses for shipping and handling activities at the same time we recognize revenue.

The Company excludes from the measurement of the transaction price all taxes imposed on and concurrent with a specific revenue-producing transaction and collected by the Company from a customer, including sales, use, excise, value-added, and franchise taxes (collectively referred to as sales taxes).

The Company offers its products through an inventory lean omni-channel platform that provides a seamless and meaningful experience to its customers in showrooms and through the internet. The Other channel predominantly represents sales through the use of online pop-up-shops and shop-in-shops that are staffed with associates trained to demonstrate and sell our product. The following represents sales disaggregated by channel:

See Note 10 for sales disaggregated by product .