Item 7. Management’s Discussion and Analysis
of Financial Condition and Results of Operations.
The following discussion and analysis of our
financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes
appearing elsewhere in this Annual Report on Form 10-K. As discussed in the section titled “Forward-Looking Statements,” the
following discussion and analysis contains forward-looking statements that involve risks and uncertainties, as well as assumptions that,
if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking
statements. Factors that could cause or contribute to these differences include, but are not limited to, those identified below and
those discussed in the section titled “Risk Factors” under Part I, Item 1A in this Annual Report on Form 10-K.
We operate on a 52- or 53-week fiscal year
that ends on the Sunday closest to February 1. Each fiscal year generally is comprised of four 13-week fiscal quarters, although in the
years with 53 weeks, the fourth quarter represents a 14-week period.
Overview
We are a technology driven company that designs,
manufactures and sells unique, high quality furniture derived through our proprietary Designed for Life philosophy which results in products
that are built to last a lifetime and designed to evolve as our customers’ lives do. Our current product offering is comprised of
modular couches called Sactionals, premium foam beanbag chairs called Sacs, and their associated home decor accessories. Innovation is
at the center of our design philosophy with all of our core products protected by a robust portfolio of utility patents. We market and
sell our products primarily online 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 pop-up-shops with third party retailers. We believe that our ecommerce centric
approach, coupled with our ability to deliver our large upholstered products through express couriers, is unique to the furniture industry.
Our Operations
See “Item 1. Business” for information
on our products, customers, business model, channels, growth strategies, seasonality and other factors describing our business.
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Factors Affecting Our Operating Results
While our growth strategy has contributed to our
improving operating results, it also presents significant risks and challenges. The timing and magnitude of new showroom openings, existing
showroom renovations, and marketing activities may affect our results of operations in future periods. These strategic initiatives will
require substantial expenditures.
Other factors that could affect our results of
operations in future periods include:
Impact of COVID-19
As a result of certain government actions in response
to the COVID-19 pandemic, on March 18, 2020, we closed all showroom locations following the guidance of local, state and federal governments,
as well as health organizations. We also implemented a reduction in workforce of approximately 445 part time associates (representing
57% of our total headcount) as well as a temporary reduction in executive cash compensation. Cash compensation was reduced by 20% for
Shawn Nelson, Chief Executive Officer, Jack Krause, President and Chief Operating Officer, and Donna Dellomo, Executive Vice President,
Chief Financial Officer, Treasurer and Secretary. The base salaries of all other senior management and full-time headquarter associates
were temporarily reduced by graduated amounts. Our Board of Directors agreed to a temporary reduction of its retainer and monitoring fees
and an extension of the associated payment timeline. As of October 1, 2020, we restored cash compensation for all headquarter associates
other than senior management. As of December 1, 2020, we restored compensation levels for all senior management to include Mr. Nelson,
Mr. Krause and Ms. Dellomo, and as of December 17, 2020 we restored compensation levels for our Board of Directors. We also proactively
reduced our promotional discounts which drove higher gross profit, deferred infrastructure investments and delayed hiring as part of our
financial resilience measures. Additionally, we believe that the pandemic has contributed to an acceleration in the shift of commerce
to online sales which resulted in an increase in sales on our ecommerce platform and a slight decline in showroom sales. However, it is
possible that this increased ecommerce demand may not continue in future periods. We continue to monitor the situation closely and it
is possible that we will implement further measures.
Overall Economic Trends
The industry in which we operate is cyclical.
In addition, our revenues are affected by general economic conditions. Purchases of our products are sensitive to a number of factors
that influence the levels of consumer spending, including economic conditions, consumer disposable income, housing market conditions,
consumer debt, interest rates and consumer confidence.
Seasonality
Our business is seasonal. As a result, our revenues
fluctuate from quarter to quarter, which often affects the comparability of our results between periods. Net sales are historically higher
in the fourth fiscal quarter due primarily to the impact of the holiday selling season.
Competition
The retail industry is highly competitive and
retailers compete based on a variety of factors, including design, quality, price and customer service. Levels of competition and the
ability of our competitors to attract customers through competitive pricing or other factors may impact our results of operations.
How We Assess the Performance of Our Business
We consider a variety of financial and
operating measures, including the following, to evaluate our business, measure our performance, identify trends affecting our
business, formulate business plans, and make strategic decisions.
Net Sales
Net sales reflect our sale of merchandise plus
shipping and handling revenue less returns and discounts. Sales made at Company operated showrooms, including shop-in-shops and pop-up-shops,
and via the web are recognized in accordance with the guidance set forth in ASC 606, which is typically at the point of transference of
title when the goods are shipped.
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Comparable Showroom Sales
Comparable showroom sales are calculated based
on point of sale transactions from showrooms that were open at least fifty-two weeks as of the end of the reporting period. These sales
will differ from sales on our income statement which are reported when goods are shipped and title has transferred to the customer. A
showroom is not considered a part of the comparable showroom sales base if the square footage of the showroom changed or if the showroom
was relocated. If a showroom was closed for any period of time during the measurement period, that showroom is excluded from comparable
showroom sales. The Company made an exception to this calculation in fiscal 2021 when all of our showrooms were temporarily closed due
to government regulations in response to the COVID-19 pandemic. For fiscal years 2021 and 2020, 19 and 14 showrooms, respectively were
excluded from comparable showroom sales. Comparable showroom sales allow us to evaluate how our showroom base is performing by measuring
the change in period-over-period net sales in showrooms that have been open for twelve months or more. While we review comparable showroom
sales as one measure of our performance, this measure is less relevant to us than it may be to other retailers due to our fully integrated,
omni-channel, go-to-market strategy. As a result, measures that analyze a single channel are less indicative of the performance of our
business than they might be for other companies that operate their distribution channels as separate businesses. Further, certain of our
competitors and other retailers calculate comparable showroom sales (or similar measures) differently than we do. As a result, the reporting
of our comparable showroom sales may not be comparable to sales data made available by other companies.
Customer Lifetime Value and Customer Acquisition
Cost
We calculate CAC on an annual basis by dividing
our expenses associated with acquiring new customers for a fiscal year by the number of new customers we acquire in that fiscal year.
We include premium rent for locations above commercial rates, media costs to new customers, and a portion of showroom merchandising costs
in our marketing expenses associated with acquiring new customers when calculating our CAC. We believe that fiscal 2018 is the first fiscal
year that our CAC fully reflects the implementation of changes to our marketing. In fiscal 2018 we significantly increased our spending
on marketing expenses and media costs. Our marketing expenses for fiscal 2021 was equal to 13.1% of revenue as compared to fiscal 2020
at 12.5% of revenue and 11.1% of revenue for fiscal 2019. For fiscal 2021, our CAC was $434.61 per customer compared to a CAC of $391.71
for fiscal 2020. This increase was a result of our increased marketing spend that targeted Sactional customers. We expect our CAC to continue
to increase over the next few years as a result of our continued focus on increasing marketing efforts. We expect this increase in CAC
to correspond with a continued increase in CLV.
We monitor repeat customer transactions in aggregate
through our point of sale platform and in groups based upon the year in which customers first made a purchase from us, which we refer
to as cohorts, as a way to measure our customer’s engagement with our products over their lifetime. Our fiscal 2021 cohorts CLV
is $2,044. In addition, our fiscal 2015 cohort has increased its CLV from $1,071 in fiscal 2015 to $1,346 in fiscal 2021, a 25.6% increase
in customer value since the fiscal 2015 cohorts’ first purchases with Lovesac.
Retail Sales Per Selling Square Foot
Retail sales per selling square foot is calculated
by dividing the total point of sales transactions for all comparable showrooms, by the average selling square footage for the period.
Selling square footage is retail space at our showrooms used to sell our products. Selling square footage excludes backrooms at showrooms
used for storage, office space or similar matters.
Cost of Merchandise Sold
Cost of merchandise sold includes the direct cost
of sold merchandise; inventory shrinkage; inventory adjustments due to obsolescence, including excess and slow-moving inventory and lower
of cost or net realizable value reserves; inbound freight; all freight costs to ship merchandise to our showrooms; design, buying and
allocation costs, warehousing and all logistics costs associated with shipping product to our customers. Certain of our competitors and
other retailers may report gross profit differently than we do, by excluding from gross profit some or all of the costs related to their
distribution network and instead including them in selling, general and administrative expenses. As a result, the reporting of our gross
profit and profit margin may not be comparable to other companies.
The primary drivers of our cost of merchandise
sold are raw materials costs, labor costs in the countries where we source our merchandise, and logistics costs. We expect gross profit
to increase to the extent that we successfully grow our net sales and continue to realize scale economics with our manufacturing partners.
We review our inventory levels on an ongoing basis in order to identify slow-moving merchandise and use product markdowns to efficiently
sell these products. The timing and level of markdowns are driven primarily by customer acceptance of our merchandise.
Gross Profit
Gross profit is equal to our net sales less cost
of merchandise sold. Gross profit as a percentage of our net sales is referred to as gross margin. In September 2018, the Office
of the U.S. Trade Representative began imposing a 10 percent ad valorem duty on a subset of products imported from China, inclusive of
various furniture product categories. In September 2019, the Office of U.S. Trade Representative imposed an additional 15 percent ad valorem
duty on products imported from China.
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Selling, General and Administrative Expenses
Selling, general and administrative expenses include
all operating costs, other than advertising and marketing expense, not included in cost of merchandise sold. These expenses include all
payroll and payroll-related expenses; showroom expenses, including occupancy costs related to showroom operations, such as rent and common
area maintenance; occupancy and expenses related to many of our operations at our headquarters, including utilities, equity based compensation,
financing related expenses and public company expenses. Selling, general and administrative expenses as a percentage of net sales is usually
higher in lower volume quarters and lower in higher volume quarters because a significant portion of the costs are relatively fixed.
Our recent revenue growth has been accompanied
by increased selling, general and administrative expenses. The most significant components of these increases are payroll and rent costs.
We expect these expenses, as well as rent expense associated with the opening of new showrooms, to increase as we grow our business.
We expect to leverage total selling, general and administrative expenses as a percentage of sales as sales volumes continue to grow.
We expect to continue to invest in infrastructure to support the Company’s growth. These investments will lessen the impact of
expense leveraging during the period of investment with the greater impact of expense leveraging happening after the period of investment.
However, total selling, general and administrative expenses generally will leverage during the periods of investments with the most deleverage
occurring in the first three quarters of the fiscal year, and the greatest leverage occurring in the fourth quarter.
Advertising and Marketing Expense
Advertising and marketing expense include digital,
social, and traditional advertising and marketing initiatives, that cover all of our business channels. Advertising and marketing expense
is expected to increase as a percentage to sales as we continue to invest in advertising and marketing which has accelerated sales growth.
Basis of Presentation and Results of Operations
The following discussion contains references to
fiscal years 2021 and 2020 which represent our fiscal years ended January 31, 2021 and February 2, 2020, respectively. Our fiscal year
ends on the Sunday closest to February 1. Both fiscal 2021 and 2020 were 52-week periods.
The following table sets forth, for the periods
for fiscal 2021 and 2020, our consolidated statement of operations as a percentage of total revenues:
For the Fiscal Year Ended
Statement of Operations Data:
Cost of merchandise sold 46 % 50 %
Gross profit 54 % 50 %
Selling, general and administrative expenses 35 % 42 %
Advertising and marketing 13 % 13 %
Depreciation and amortization 2 % 2 %
Operating income (loss) 4 % -7 %
Interest income 0 % 0 %
Income (loss) before taxes 4 % -7 %
Provision for income taxes 0 % 0 %
Net income (loss) 4 % -7 %
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Fiscal 2021 Compared to Fiscal 2020
Net sales
Net sales increased $87.4 million, or 37.4%, to
$320.7 million in fiscal 2021 compared to $233.4 million in fiscal 2020. The increase in net sales is primarily due to an increase in
new customers, which grew by 32.9% in fiscal 2021 as compared to 22.5% in fiscal 2020 and was partially offset by a decrease in the total
number of units sold by 18.4% over prior year. The fiscal 2021 average net sales based on point of transactions per showroom is $1.5 million
compared to $1.8 million in fiscal 2020, which reflects the temporary closure of our showrooms related to COVID-19. We had 108 and 91
showrooms open as of January 31, 2021 and February 2, 2020, respectively. We opened 19 additional showrooms and closed 2 showrooms in
fiscal 2021. Showroom net sales decreased $1.9 million, or 1.3%, to $146.2 million in fiscal 2021 compared to $148.0 million in fiscal
2020 primarily due to the decrease in our non-comparable showrooms point of sales transactions related to COVID-19 temporary closures.
Our comparable showroom point of sales transaction increased by $0.1 million or 0.1%, to $124.5 million in fiscal 2021 compared to $124.3
million in fiscal 2020. Point of sales transactions represent orders places through our showrooms which does not always reflect the point
at which when control transfers to the customer, which occurs upon shipment being confirmed and the sale is recorded. See Note 1 to the
consolidated financial statements. Retail sales per selling square foot based on point of transactions decreased $406, or 19.5%, to $1,676
in fiscal 2021 compared to $2,083 in fiscal 2020 due to temporary closures of our showrooms. Internet sales (sales made directly to customers
through our ecommerce channel) increased $95.3 million, or 170.8%, to $151.1 million in fiscal 2021 compared to $55.8 million in fiscal
2020. We believe that the increase in Internet sales was due primarily to the shift in our customers’ shopping preferences during
the pandemic, our increased marketing initiatives, and the temporary closures of our showroom locations. Other sales, which include pop-up-shop
sales and shop-in-shop sales decreased $6.1 million, or (20.5%), to $23.5 million in fiscal 2021 compared to $29.6 million in fiscal 2020.
This decrease was due to decrease in in store pop-up-shops as a result of temporary closures and ongoing vendor negotiations partially
offset by an increase in temporary online pop-ups on Costco.com and Best Buy shop-in-shops.
Gross profit
Gross profit increased $58.1million, or 49.8%,
to $174.8 million in fiscal 2021 compared to $116.7 million in fiscal 2020. Gross margin increased to 54.5% of net sales in fiscal 2021
from 50.0% of net sales in fiscal 2020. The 450 basis points increase in gross margin versus the prior year period reflects 400 basis
points improvement in gross profit as a result of a reduction in promotional discounts, higher Sactional product mix impact related to
premium covers, reduced inventory reserve levels, and lower product costs related to vendor negotiated tariff mitigation initiatives due
to higher volume. Distribution expenses including warehousing, freight and tariff related expenses also improved by 50 basis points due
to higher leverage on warehousing and tariff expenses, partially offset by deleverage in freight expense.
Selling, general and administrative expenses
Selling, general and administrative expenses increased
13.5%, or $13.3 million, to $111.4 million for the fiscal year ended January 31, 2021 compared to $98.1 million for the fiscal year ended
February 2, 2020. The increase in selling, general and administrative expenses was primarily related to an increase in employment costs
of $7.3 million primarily driven by an increase in variable compensation and new hires in our headquarters, $1.7 million of increased
rent associated with our net addition of 17 showrooms, partially offset by a decrease of $1.2 million in selling related expenses due
to a decrease of $4.6 million of in store pop-up-shop fees, partially offset by the increase of $3.1 million of credit card fees and $0.3
million of web related selling expenses. Overhead expenses increased $5.5 million consisting of an increase of $6.4 million in infrastructure
investments and an increase in insurance expense of $1.0 million related to the growth of the Company, partially offset by a decrease
of $1.3 million in travel expenses related to COVID-19 restrictions and a decrease of $0.6 million in equity-based compensation.
Selling, general and administrative expenses were
34.7% of net sales for fiscal year ended January 31, 2021 compared to 42.1% of net sales for fiscal year ended February 2, 2020. SG&A
expense as a percent of net sales decreased 740 basis points due to a decrease of 240 basis points in selling related expenses related
to a reduction in in store pop-up-shop fees partially offset by temporary online pop-up fees and the ability of the Company to leverage
expenses during COVID-19 of 500 basis points such as rent expense, employment costs, equity-based compensation, travel expenses, infrastructure
investments, and credit card fees.
Advertising and marketing expenses
Advertising and marketing
expenses increased $12.7 million, or 43.6%, to $41.9 million for the fiscal year ended January 31, 2021 compared to $29.2 million for
the fiscal year ended February 2, 2020. The increase in advertising and marketing costs relates to increased media and direct to consumer
programs which are expected to drive revenue beyond the period of the expense. The increase in advertising and marketing as a percent
of net sales is due to increased rates in media coupled with increased media spending during key minor market share events. We expect
to continue to maintain our advertising and marketing investments at 12% to 14% of net sales on an annual basis. The investment by quarter
may vary.
Advertising and marketing expenses were 13.1%
of net sales in fiscal year 2021 compared to 12.5% of net sales in fiscal 2020. The increase in advertising and marketing expenses of
approximately 60 basis points was driven largely by an increase in national media with a focus on holiday media, increase in direct to
consumer programming and the introduction of 15 second spot into our television advertising mix.
Depreciation and amortization expenses
Depreciation and amortization expenses increased
28.2%, or $1.5 million to $6.6 million in fiscal 2021 compared to $5.1 million in fiscal 2020 to. The increase in depreciation and amortization
expense is principally related to capital investments for new and remodeled showrooms.
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Interest (expense) income
Interest expense, net in fiscal 2021 was $0.1
million which reflects $0.1 million of interest income on cash and cash equivalents, offset by $0.2 million of interest expense related
to unused line fees, interest on borrowings and amortization of deferred financing fees on the asset-based loan for the fiscal year ended
January 31, 2021. Interest income, net in fiscal 2020 was $0.6 million which reflects earnings related to the net proceeds from the IPO
and primary share offerings of $0.8 million net of interest expense of $0.2 million relating to unused line fees, interest on borrowings
and amortization of deferred financing fees on the asset based loan for the fiscal year ended February 2, 2020.
Provision for income taxes
Income tax expense was less than 0.03% of sales
for both fiscal 2021 and fiscal 2020.
Repeat customers
Repeat customers accounted for approximately
37.5% of all transactions in fiscal 2021 compared to 35.6% in fiscal 2020. We expect new transactions to continue to become a larger
portion of our transaction mix as we spend on acquisition.
Quarterly Results
Our business is seasonal and we have historically
realized a higher portion of our net sales and net income in the fourth fiscal quarter due primarily to the holiday selling season. Working
capital requirements are typically higher in the third fiscal quarter due to inventory built-up in advance of the holiday selling season.
During these peak periods we have historically increased our borrowings under our line of credit. As such, results of a period shorter
than a full year may not be indicative of results expected for the entire year, and the seasonal nature of our business may affect comparisons
between periods.
Liquidity and Capital Resources
General
Our business relies on cash flows from operations,
our revolving line of credit (see “Revolving Line of Credit” below) and securities issuances as our primary sources of liquidity.
Our primary cash needs are for marketing and advertising, inventory, payroll, showroom rent, capital expenditures associated with opening
new showrooms and updating existing showrooms, as well as infrastructure and information technology. The most significant components of
our working capital are cash and cash equivalents, inventory, accounts receivable, accounts payable and other current liabilities and
customer deposits. Borrowings generally increase in our third fiscal quarter as we prepare for the holiday selling season, which is in
our fourth fiscal quarter. We believe that cash expected to be generated from operations, the availability under our revolving line of
credit and our existing cash balances are sufficient to meet working capital requirements and anticipated capital expenditures for at
least the next 12 months.
Cash Flow Analysis
A summary of operating, investing, and financing
activities during the periods indicated are shown in the following table:
in thousands Fiscal Year Ended
Provided by (used in) operating activities $ 40,521 $ (11,194 )
Used in investing activities (9,052 ) (10,650 )
(Used in) provided by financing activities (1,667 ) 21,312
Increase (decrease) in cash and cash equivalents 29,802 (532 )
Cash and cash equivalents at end of period 78,341 48,539
Net Cash Provided by (Used in) Operating
Activities
Cash from operating activities consists primarily
of net income (loss) adjusted for certain non-cash items, including depreciation, amortization, loss (gain) on disposal of property and
equipment, impairment of property and equipment, equity based compensation, deferred rent, and non-cash interest expense and the effect
of changes in working capital and other activities.
In fiscal 2021, net cash provided by operating
activities was $40.5 million and consisted of changes in operating assets and liabilities of $10.5 million, a net income of $14.7 million,
and non-cash items of $15.3 million. Working capital and other activities consisted primarily of increases in inventory of $14.0 million
and prepaid expenses and other current assets of $2.1 million, partially offset by a decrease in accounts receivable of $2.7 million and
increases in accrued liabilities and accounts payable of $19.6 million, and customer deposits of $4.3 million.
In fiscal 2020, net cash used in operating activities
was $11.2 million and consisted of changes in operating assets and liabilities of $7.8 million, a net loss of $15.2 million, and non-cash
items of $11.8 million. Working capital and other activities consisted primarily of increases in inventory of $10.2 million, accounts
receivable of $3.2 million, and prepaid expenses of $2.2 million, partially offset by increases in accrued liabilities and accounts payable
of $7.2 million, and other current liabilities of $0.6 million.
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Net Cash Used In Investing Activities
Investing activities consist primarily of investment
in supply chain and systems infrastructure and capital expenditures related to new showroom openings and the remodeling of existing showrooms.
For fiscal 2021, capital expenditures were $9.1
million as a result of investments in new and remodeled showrooms and intangibles.
For fiscal 2020, capital expenditures were $10.7
million as a result of investments in new and remodeled showrooms and intangibles which included $0.3 million in proceeds from the disposal
of property and equipment.
Net Cash (Used in) Provided By Financing
Activities
Financing activities consist primarily of the
proceeds from stock offerings and taxes paid for the net settlement of equity awards.
For fiscal 2021, net cash used in financing activities
was $1.7 million primarily due to $0.1 million of net proceeds from the issuance of warrants net of $1.7 million of taxes paid for net
share settlement of equity awards.
For fiscal 2020, net cash provided by financing
activities was $21.3 million, primarily due to $25.6 million of net proceeds from a primary share offering net of $4.3 million of taxes
paid for net share settlement of equity awards.
Revolving Line of Credit
On February 6, 2018, we entered a four-year,
secured revolving credit facility with Wells Fargo Bank, National Association (“Wells”). The credit facility permits borrowings of up to $25.0 million, subject to borrowing
base and availability restrictions. For additional information regarding our line of credit with Wells, see Note 9 to our
consolidated financial statements. As of January 31, 2021, the Company’s borrowing availability under the line of credit with
Wells was $15.9 million. As of January 31, 2021, there were no borrowings outstanding on this line of credit.
Contractual Obligations
We generally enter into long-term contractual
obligations and commitments in the normal course of business, primarily debt obligations and non-cancelable operating leases. As of January
31, 2021, our contractual cash obligations over the next several periods were as follows:
Payments due by period
Total Less than 1 year 1 - 3 years 3 - 5 Years More than 5 years
Off Balance Sheet Arrangements
We have no material off balance sheet arrangements
as of January 31, 2021, except for operating leases and employment agreements entered into in the ordinary course of business.
Critical Accounting Policies and Estimates
The discussion and analysis of financial condition
and results of operations is based upon our consolidated financial statements, which have been prepared in conformity with GAAP. Certain
accounting policies and estimates are particularly important to the understanding of our financial position and results of operations
and require the application of significant judgment by our management or can be materially affected by changes from period to period in
economic factors or conditions that are outside of our control. As a result, they are subject to an inherent degree of uncertainty. In
applying these policies, management uses their judgment to determine the appropriate assumptions to be used in the determination of certain
estimates. Those estimates are based on our historical operations, our future business plans and projected financial results, the terms
of existing contracts, observance of trends in the industry, information provided by our customers and information available from other
outside sources, as appropriate. Please see Note 1 to our audited consolidated financial statements included in this Annual Report on
Form 10-K for a complete description of our significant accounting policies. There have been no material changes to the significant accounting
policies during fiscal 2021.
Revenue Recognition
Our revenue consists substantially of product
sales. We report product sales net of discounts and recognize 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. We record estimated refunds for net sales
returns on a monthly basis as a reduction of net sales and cost of sales on the statement of operations and an increase in inventory and
customers returns liability on the balance sheet.
In some cases, deposits are received before the
Company transfers control, resulting in contract liabilities. These contract’s liabilities are reported as deposits on the Company’s
balance sheet.
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Upon adoption of ASC 606, we have elected the
following accounting policies and practical expedients:
We recognize shipping and handling
expense as fulfillment 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.
We exclude from the measurement of
the transaction price all taxes imposed on and concurrent with a specific revenue- producing transaction and collected by the entity from
a customer, including sales, use, excise, value-added, and franchise taxes (collectively referred to as sales taxes).
The Company does not adjust revenue
for the effects of any financing components if the contract has a duration of one year or less, as the Company receives payment from the
customer within one year from when it transferred control of the related goods.
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 pop-up-shops that typically average ten days at a time and are staffed
with associates trained to demonstrate and sell our product.
Impairment of Long-Lived Assets
The Company’s long-lived assets consist
of property and equipment, which includes leasehold improvements. Long-lived assets are reviewed for potential impairment at such time
that events or changes in circumstances indicate that the carrying amount of an asset might not be recovered. The Company evaluates long-lived
assets for impairment at the individual showroom level, which is the lowest level at which individual cash flows can be identified. When
evaluating long-lived assets for potential impairment, the Company will first compare the carrying amount of the assets to the individual
showroom’s estimated future undiscounted cash flows. If the estimated future cash flows are less than the carrying amounts of the
assets, an impairment loss calculation is prepared. An impairment loss is measured based upon the excess of the carrying value of the
asset over its estimated fair value which is generally based on an estimated future discounted cash flow. If required, an impairment loss
is recorded for that portion of the asset’s carrying value in excess of fair value.
During the year ended January 31, 2021, the Company
recorded impairment charges of $0.2 million, associated with the assets of an underperforming retail location. The impairment charge was
calculated using a discounted cash flow model and was recorded in selling, general, and administrative in the Company’s consolidated
statement of operations and comprehensive income. During Fiscal Year 2020, the Company did not record any impairment charges associated
with property and equipment.
Advertising and Catalog Costs
The Company capitalizes direct-response advertising
costs, which consist primarily of television advertising, postcards, catalogues and their mailing costs, and recognizes expense over the
related revenue stream if the following conditions are met (1) the primary purpose of the advertising is to elicit sales to customers
who could be shown to have responded specifically to the advertising, and (2) the direct-response advertising results in probable and
estimable future benefits.
For the years ended January 31, 2021 and February
2, 2020 the Company did not capitalize any deferred direct-response television, postcard and catalogue costs.
Direct-response advertising costs, which are included
in prepaid expenses and other current assets, are amortized commencing the date the catalogs and post cards are mailed and the television
commercial airs through the estimated period of time for the Company has determined the related advertising impacts sales. There was no
balance as of January 31, 2021 or February 2, 2020.
Advertising and marketing costs not associated
with direct-response advertising are expensed as incurred. Advertising and marketing expenses (including amortization of direct-response
advertising) were $41,924,487 in fiscal 2021 and $29,194,289 in fiscal 2020.
Merchandise Inventories
Merchandise inventories are comprised of finished
goods which are carried at the lower of cost or net realizable value and capitalized freight and warehousing costs. Cost is determined
on a weighted-average method basis. Merchandise inventories consist primarily of foam filled furniture, sectional couches, and related
accessories. The Company adjusts its inventory for obsolescence based on historical trends, aging reports, specific identification and
its estimates of future retail sales prices. In addition, the Company includes capitalized freight and warehousing costs in inventory
related to the finished goods in inventory.
Equity-based Compensation
The Company accounts for equity-based compensation
for associates and directors by recognizing the fair value of equity-based compensation as an expense in the calculation of net income,
based on the grant-date fair value. The Company recognizes equity-based compensation expense in the periods in which the associate or director
is required to provide service, which is generally over the vesting period of the individual equity instruments. The fair value of
the equity-based awards is determined using the Black-Scholes option pricing model or the stock price on the date of grant.
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Recent Accounting Pronouncements
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.
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, 2022, with early adoption permitted. The Company will adopt this standard beginning in fiscal 2022. Management has evaluated the impact
ASU No. 2016-02 will have on these consolidated financial statements. Based on the initial evaluation, we have determined that adopting
this standard will have a material impact on our consolidated balance sheet as we have a significant number of operating leases.
While we continue to assess all of the effects
of adoption, we currently believe the most significant effects relate to the recognition of new Right of Use “ROU” assets
and lease liabilities on our balance sheet for our showroom and office real estate leases. We do not expect a significant change in our
leasing activities between now and adoption. The Company currently has deferred rent of $7 million in long-term liabilities. On adoption,
we currently expect to recognize additional liabilities of approximately $92 million, of which $14 million will be short-term and $78
million will be long-term with corresponding ROU assets of the same amount based on the present value of the remaining minimum rental
payments under current leasing standards for existing operating leases. The new standard also provides practical expedients for an entity’s
ongoing accounting. We currently expect to elect 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 currently expect to elect the practical expedient to
not separate lease and non-lease components for all of our leases.
In June 2018, the FASB issued ASU 2018-07, Improvements
to Nonemployee Share-Based Payment Accounting (Topic 718). ASU 2018-07 eliminates the separate accounting model for nonemployee share-based
payment awards and generally requires companies to account for share-based payment transactions with nonemployees in the same way as share-based
payment transactions with employees. The accounting remains different for attribution, which represents how the equity-based payment cost
is recognized over the vesting period, and a contractual term election for valuing nonemployee equity share options. ASU 2018-07 is effective
for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. Early adoption
is permitted, but no earlier than an entity’s adoption of Topic 606. Management does not expect there to be a material impact on
these consolidated financial statements.
Item 7A. Quantitative and Qualitative Disclosures
About Market Risk.
Not applicable.
Item 8. Financial Statements and Supplementary
Data.
The Company’s financial statements are
contained in the pages beginning on F-1, which appear at the end of this Annual Report on Form 10-K.
32
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure.
None.
Item 9A. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our
Chief Executive Officer (our principal executive officer) and Chief Financial Officer (principal financial officer), has evaluated the
effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the
end of the period covered by this Annual Report. Our Chief Executive Officer and Chief Financial Officer have concluded, based on their
evaluation, that our disclosure controls and procedures were effective as of January 31, 2021.
Management Report on Internal Control over
Financial Reporting
Our management is responsible for establishing
and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act.
The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting
principles in the United States of America. The Company’s internal control over financial reporting includes those policies and
procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions
and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted accounting principles in the United States of America, and
that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the
Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition
of the Company’s assets that could have a material effect on the financial statements.
Management assessed the effectiveness of the Company’s
internal control over financial reporting as of January 31, 2021. In making this assessment, management used the criteria set forth in
2013 by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in “Internal Control-Integrated Framework.”
Based on management’s assessment using the COSO criteria, management has concluded that the Company’s internal control over
financial reporting was effective as of January 31, 2021.
This Annual Report on Form 10-K does not include
an attestation report of the Company’s registered public accounting firm. Our independent registered public accounting firm will
not be required to formally attest to the effectiveness of our internal control over financial reporting as long as we are an “emerging
growth company” pursuant to the provisions of the JOBS Act.
Changes in our Internal Control over Financial
Reporting
There were no changes in our internal control
over financial reporting that occurred during the quarter ended January 31, 2021 that have materially affected, or are reasonably likely
to materially affect, our internal control over financial reporting.
Limitations on the Effectiveness of Controls
Our management, including our Chief Executive
Officer and Chief Financial Officer, does not expect that the Company’s disclosure controls and procedures or the Company’s
internal controls over financial reporting will prevent all errors and all fraud. A control system, no matter how well conceived and operated,
can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control
system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs.
Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control
issues and instances of fraud, if any, within the Company have been detected.
Item 9B. Other Information.
None.
33
PART III.
Item 10. Directors, Executive Officers and
Corporate Governance.
The following is a list of the names, ages and backgrounds of our current
executive officers:
Name Age Present Position Business Experience
We will file with the
SEC a definitive proxy statement (the “2021 Proxy Statement”) pursuant to Regulation 14A for our 2021 annual meeting of stockholders
within 120 days of the fiscal year ended January 31, 2021. The additional information required by this Item will appear in the 2021 Proxy
Statement and is incorporated by reference herein.
Our board of directors
has adopted a Code of Business Conduct and Ethics applicable to all officers, directors and associates, which is available on our website
(https://investor.lovesac.com) under "Governance." We intend to satisfy the disclosure requirement under Item 5.05 of Form 8-K regarding
amendment to, or waiver from, a provision of our Code of Conduct by posting such information on the website address and location specified
above.
34
Item 11. Executive Compensation.
The information required by this Item will appear
in the 2021 Proxy Statement and is incorporated by reference herein.
Item 12. Security Ownership of Certain Beneficial
Owners and Management and Related Stockholder Matters.
Securities
Authorized for Issuance under Equity Compensation Plans
The
following table provides information as of January 31, 2021, about the securities which are either already issued, or authorized for future
issuance, under our Amended and Restated 2017 Equity Incentive Plan (the “2017 Equity Plan”).
(a) (b) (c)
Equity compensation plans not approved by shareholders - - -
(2) Calculations based on 2017 Equity Plan.
The remaining information required by this Item
will appear in the 2021 Proxy Statement and is incorporated by reference herein.
Item 13. Certain Relationships and Related
Transactions, and Director Independence.
The information required by this Item will appear
in the 2021 Proxy Statement and is incorporated by reference herein.
Item 14. Principal Accounting Fees and Services.
The information required by this Item will appear
in the 2021 Proxy Statement and is incorporated by reference herein.
35
PART IV.
Item 15. Exhibits, Financial Statement Schedules.
(a) The following documents are filed as part of this report:
1. Financial
Statements (see Part II, Item 8 – Consolidated Financial Statements and Supplementary Data)
Report of Independent Registered Public Accounting Firm F-3
Consolidated Balance Sheets – As of January 31, 2021 and February 2, 2020 F-4
2. Financial
Statement Schedules
Schedules have been omitted
because they are not required or are not applicable or because the information required to be set forth therein either is not material
or is included in the financial statements or notes thereto.
3. Exhibits
See the Exhibit Index.
Item 16. Form 10-K Summary.
Optional disclosure not included in this Annual
Report on Form 10-K.
36
EXHIBIT INDEX
3.1 Amended and Restated Certificate of Incorporation S-1/A 3.3 6/25/2018
4.1 Form of Amended and Restated Series A Warrant Agreement S-1/A 4.2 5/23/2018
10.4 Amended and Restated Registration Rights Agreement S-1 10.5 4/20/2018
10.11+ Form of Stock Option Award Agreement Filed herewith.
21.1 List of Subsidiaries Filed herewith.
23.1 Consent of Marcum LLP Filed herewith.
101.INS XBRL Instance Document
101.SCH XBRL Taxonomy Extension Schema Document
101.CAL XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF XBRL Taxonomy Extension Definition Linkbase Document
101.LAB XBRL Taxonomy Extension Label Linkbase Document
101.PRE XBRL Taxonomy Extension Presentation Linkbase Document
± Indicates a management
contract or compensatory plan.
* This certification is deemed not filed
for purposes of section 18 of the Securities Exchange Act of 1934, as amended (Exchange Act), or otherwise subject to the liability of
that section, nor shall it be deemed incorporated by reference into any filing under the Securities Act of 1933, as amended or the Exchange
Act.
37
SIGNATURES
Pursuant to the requirements of the Securities
Exchange Act of 1934, as amended (the “Exchange Act”), the registrant has duly caused this Report to be signed on its behalf
by the undersigned, thereunto duly authorized on April 14, 2021.
THE LOVESAC COMPANY
By: /s/ Shawn Nelson
Shawn Nelson
Chief Executive Officer
(Principal Executive Officer)
38
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE
PRESENTS, that each person whose signature appears below constitutes and appoints Shawn Nelson and Donna Dellomo, and each of them, as
his or her true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him or her and in his
or her name, place and stead, in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K, and to file
the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting
unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite
and necessary to be done in connection therewith, as fully to all intents and purposes as he or she might or could do in person, hereby
ratifying and confirming that all said attorneys-in-fact and agents, or any of them or their or his or her substitute or substitutes,
may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Exchange Act,
this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
/s/ Shawn Nelson April 14, 2021
Shawn Nelson
Chief Executive Officer and Director
(Principal Executive Officer)
/s/ Donna Dellomo April 14, 2021
Donna Dellomo
Executive Vice President and Chief Financial Officer
(Principal Financial Officer and Principal Accounting Officer)
Jack Krause
President and Chief Operating Officer
/s/ Andrew Heyer April 14, 2021