Lovesac Co - Quarter Report: 2021 August (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended August 1, 2021

or

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                to         

Registrant’s telephone number, including area code: (888) 636-1223

Not applicable

(Former name, former address and former fiscal year, if changed since last report)

Securities registered pursuant to Section 12(b) of the Act:

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ☒ Yes ☐ No

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files) ☒ Yes ☐ No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act ☐

Indicate by check mark whether the Registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

As of September 7, 2021, there were 15,118,514 shares of common stock, $0.00001 par value per share, outstanding.

THE LOVESAC COMPANY

FORM 10-Q

INDEX TO QUARTERLY REPORT ON FORM 10-Q

AUGUST 1, 2021

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other legal authority, which statements may involve substantial risk and uncertainties. Forward-looking statements generally relate to future events or our future financial or operating performance. In some cases, you can identify forward-looking statements because they contain words such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “could,” “intends,” “target,” “projects,” “contemplates,” “believes,” “estimates,” “predicts,” “potential,” or “continue” or the negative of these words or other similar terms or expressions that concern our expectations, strategy, plans, or intentions.

You should not place undue reliance on forward looking statements. We cannot assure you that the events and circumstances reflected in the forward-looking statements will be achieved or occur at all or on a specified timeframe. The cautionary statements set forth in this Quarterly Report on Form 10-Q, including in Part I – Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations, and elsewhere, identify important factors which you should consider in evaluating our forward-looking statements. These factors include, among other things:

We caution you that the foregoing list may not contain all the forward-looking statements made in this Quarterly Report on Form 10-Q.

You should not rely upon forward-looking statements as predictions of future events. We have based the forward-looking statements contained in this Quarterly Report on Form 10-Q primarily on our current expectations and projections about future events and trends that we believe may affect our business, financial condition, results of operations, and prospects. The outcome of the events described in these forward-looking statements is subject to risks, uncertainties, and other factors described in the sections entitled “Risk Factors” and in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our most recent Annual Report on Form 10-K filed with the Securities and Exchange Commission and in this Quarterly Report on Form 10-Q. Moreover, we operate in a very competitive and rapidly changing environment. New risks and uncertainties emerge from time to time, and it is not possible for us to predict all risks and uncertainties that could have an impact on the forward-looking statements contained in this Quarterly Report on Form 10-Q. We cannot assure you that the results, events, and circumstances reflected in the forward-looking statements will be achieved or occur at all or on a specified timeline, and actual results, events, or circumstances could differ materially from those described in the forward-looking statements.

The forward-looking statements made in this Quarterly Report on Form 10-Q relate only to events as of the date on which the statements are made. We undertake no obligation to update any forward-looking statements made in this Quarterly Report on Form 10-Q to reflect events or circumstances after the date of this Quarterly Report on Form 10-Q or to reflect new information or the occurrence of unanticipated events, except as required by law. We may not actually achieve the plans, intentions, or expectations disclosed in our forward-looking statements, and you should not place undue reliance on our forward-looking statements. Our forward-looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, joint ventures, or investments we may make.

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

THE LOVESAC COMPANY

CONDENSED CONSOLIDATED BALANCE SHEETS

The accompanying notes are an integral part of these condensed consolidated financial statements.

THE LOVESAC COMPANY

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements.

THE LOVESAC COMPANY

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY 

FOR THE THIRTEEN AND TWENTY-SIX WEEKS ENDED AUGUST 1, 2021 AND AUGUST 2, 2020

(unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements.

THE LOVESAC COMPANY

CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS

(unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements.

THE LOVESAC COMPANY

CONDENSED CONSOLIDATED NOTES TO FINANCIAL STATEMENTS

FOR THE THIRTEEN AND TWENTY-SIX WEEKS ENDED AUGUST 1, 2021 AND AUGUST 2, 2020

NOTE 1 - BASIS OF PRESENTATION, OPERATIONS AND LIQUIDITY

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.

NOTE 2 – 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.   

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.

NOTE 3 – INTANGIBLE ASSETS, NET

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:

NOTE 4 – INCOME TAXES

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.

NOTE 5 – BASIC AND DILUTED NET INCOME (LOSS) PER COMMON SHARE

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.

NOTE 6 – COMMITMENTS, CONTINGENCY AND RELATED PARTIES

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.  

NOTE 7 – FINANCING ARRANGEMENTS

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.

NOTE 8 – STOCKHOLDERS’ EQUITY

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.

NOTE 9 – EMPLOYEE BENEFIT PLAN

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.

NOTE 10 – SEGMENT INFORMATION

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. 

NOTE 11 – BARTER ARRANGEMENTS

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.

NOTE 12 – REVENUE RECOGNITION 

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 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 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:

The Company has no foreign operations and its sales to foreign countries was less than .01% of total net sales in both fiscal 2022 and 2021.

The Company had no customers in fiscal 2022 or 2021 that comprise more than 10% of total net sales.

See Note 10 for sales disaggregated by product.

Item 2. 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 unaudited condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K for the fiscal year ended January 31, 2021. 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 in the Forward-Looking Statements section herein and set forth below and those discussed in the sections titled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our most recent report on Form 10-K filed with the Securities and Exchange Commission.

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” approach 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 online 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.

Impact of 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.

While the COVID-19 pandemic led to shifts in the way in which we operated in fiscal 2021, we continued to serve our customers through our online channels as our products can be easily configured, shopped online and delivered quickly in a touchless way, coupled with consumers’ demand for home related products and solutions. In fiscal 2022, our showroom sales have increased, including sales from shop-in-shop and pop-up-shops, and our internet sales have decreased demonstrating a customer shift back to in-store purchases. As our showrooms are now fully reopened, we continue to experience growth as our net sales increased $69.0 million, or 59.4%, to $185.4 million for the twenty-six weeks ended August 1, 2021, compared to $116.3 million for the twenty-six weeks ended August 2, 2020. Retail sales drove an increase of $80.6 million, or 260.3%, to $111.6 million for the twenty-six weeks ended August 1, 2021 compared to $31.0 million for the twenty-six weeks ended August 2, 2020. The increase in retail sales over the prior year period was mainly due to the limited showroom operations related to COVID-19 in the prior year period, which more than offset the decrease in our internet sales (sales made directly to customers through our ecommerce channel) of $21.5 million, or 28.2% in the twenty-six weeks ended August 1, 2021. New customers increased by 9.6% for the twenty-six weeks ended August 1, 2021 as compared to 52.5% for the twenty-six weeks ended August 2, 2020 due to large number of new internet customers acquired related to the Heroes campaign and the temporary closures of some showroom locations.

Product Overview

Our products serve as a set of building blocks that can be rearranged, restyled and re-upholstered with any new setting, mitigating constant changes in fashion and style. They are built to last and evolve throughout a customer’s life.

Sales Channels

We offer our products through an omni-channel platform that provides a seamless and meaningful experience to our customers online and in-store. Our distribution strategy allows us to reach customers through four distinct, brand-enhancing channels.

SELECTED CONDENSED CONSOLIDATED FINANCIAL INFORMATION

The following tables present our summary condensed consolidated financial and other data as of and for the periods indicated. The condensed consolidated statement of operations data and the condensed consolidated statement of cash flow data for the thirteen and twenty-six weeks ended August 1, 2021 and August 2, 2020 and the summary condensed consolidated balance sheet data as of August 1, 2021, are derived from our unaudited condensed consolidated financial statements included elsewhere in this Quarterly Report filed on Form 10-Q and have been prepared on the same basis as the audited condensed consolidated financial statements.

The summarized financial information presented below is derived from and should be read in conjunction with our audited condensed consolidated financial statements including the notes to those financial statements and our unaudited condensed consolidated financial statements including the notes to those financial statements both of which are included elsewhere in this Quarterly Report filed on Form 10-Q along with the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Our historical results are not necessarily indicative of our future results.

These Non-GAAP Measures should not be considered as alternatives to net income (loss) or net income (loss) per share as a measure of financial performance, cash flows from operating activities as a measure of liquidity, or any other performance measure derived in accordance with GAAP. They should not be construed as an inference that our future results will be unaffected by unusual or non-recurring items. Additionally, our Non-GAAP Measures are not intended to be measures of free cash flow for management’s discretionary use, as they do not consider certain cash requirements such as tax payments and debt service requirements and certain other cash costs that recur in the future. Our Non-GAAP Measures contain certain other limitations, including the failure to reflect our cash expenditures, cash requirements for working capital needs and cash costs to replace assets being depreciated and amortized. In addition, our Non-GAAP Measures exclude certain non-recurring and other charges.

In the future, we may incur expenses that are the same as or similar to some of the adjustments in our Non-GAAP Measures. Our presentation of our Non-GAAP Measures should not be construed to imply that our future results will be unaffected by any such adjustments. Management compensates for these limitations by relying primarily on our GAAP results and by using our Non-GAAP Measures as supplemental information. Our Non-GAAP Measures are not necessarily comparable to other similarly titled captions of other companies due to different methods of calculation.

Reconciliation of Non-GAAP Financial Measures

The following provides a reconciliation of Net income (loss) to EBITDA and Adjusted EBITDA for the periods presented:

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.

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.

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 expense 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 continue 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 table sets forth, for the periods presented, our condensed consolidated statement of operations data as a percentage of total revenues:

Thirteen weeks ended August 1, 2021 Compared to the Thirteen weeks ended August 2, 2020

Net sales

Net sales increased $40.5 million, or 65.4%, to $102.4 million in the thirteen weeks ended August 1, 2021 as compared to $61.9 million in the thirteen weeks ended August 2, 2020. The increase in overall net sales was driven by our Showroom and Other channel sales, partially offset by the decrease in Internet sales. New customers increased by 16.5% in the thirteen weeks ended August 1, 2021 as compared to 47.8% in the thirteen weeks ended August 2, 2020 driven by the successful Heroes’ campaign. We had 123 and 97 showrooms as of August 1, 2021 and August 2, 2020, respectively. We opened 7 additional showrooms, and we did not close or remodel any showrooms in the thirteen weeks ended August 1, 2021, as compared to opening 8 additional showrooms, closing 2 showrooms and remodeling 1 showroom in the thirteen weeks ended August 2, 2020. Showroom sales increased $49.7 million, or 387.1%, to $62.6 million in the thirteen weeks ended August 1, 2021 as compared to $12.9 million in the thirteen weeks ended August 2, 2020. This increase was due in large part to comparable sales increase of $40.3 million, or 290.9%, to $54.1 million in the thirteen weeks ended August 1, 2021, compared to $13.8 million in the thirteen weeks ended August 2, 2020, related to higher point of sales transactions with lower promotional discounting. Point of sales transactions represent orders placed through our showrooms which does not always reflect the point at which control transfers to the customer, which occurs upon shipment being confirmed. See Note 12 to the condensed consolidated financial statements. We believe point of sales transactions is a more accurate way to measure showroom performance and how our showroom associates are incentivized. Retail sales per selling square foot increased $418, or 215.6%, to $611 in the thirteen weeks ended August 1, 2021 as compared to $194 in the thirteen weeks ended August 2, 2020. Total number of units sold at point of transaction increased by approximately 222.6% driven by higher comparable sales. The increase in comparable sales, retail sales per selling square foot and total number of units sold over prior years is the result of limited showroom operations due to COVID-19 in the prior year period. Internet sales (sales made directly to customers through our ecommerce channel) decreased $16.6 million, or 36.0%, to $29.5 million in the thirteen weeks ended August 1, 2021 as compared to $46.1 million in the thirteen weeks ended August 2, 2020. The decrease in Internet sales was due primarily to the shift of sales into the internet channel in prior year as a result of the limited showroom operations due to COVID-19. Other sales, which include pop-up-shop sales and shop-in-shop sales increased $7.4 million, or 243.4%, to $10.4 million in the thirteen weeks ended August 1, 2021 as compared to $3.0 million in the thirteen weeks ended August 2, 2020. This increase was due to hosting 1 additional temporary online pop-up-shop on Costco.com compared to the prior year period and sales increase from shop-in-shop locations that were closed in the prior year period due to COVID-19.

Gross profit

Gross profit increased $28.0 million, or 90.1%, to $59.0 million in the thirteen weeks ended August 1, 2021 from $31.1 million in the thirteen weeks ended August 2, 2020. Gross margin increased to 57.6% of net sales in the thirteen weeks ended August 1, 2021 from 50.1% of net sales in the thirteen weeks ended August 2, 2020. The increase in gross margin percentage of 749 basis points was primarily driven by an increase of approximately 506 basis points due to lower promotional discounting, continuing vendor negotiations to assist with the mitigation of tariffs and continued shift of products from China to Vietnam, Malaysia, and Indonesia. Distribution expenses improved by 243 basis points over the prior year due to higher leverage of 793 basis points in warehousing and distribution costs, partially offset by the increase in inbound freight of 550 basis points due to escalating inbound container costs as well as some shift of inventory purchases back to China, which are impacted by the 25% tariff rate to help alleviate container congestion coming from our other overseas vendors.

Selling, general and administrative expenses

Selling, general and administrative expenses increased $12.0 million, or 51.3%, to $35.4 million in the thirteen weeks ended August 1, 2021 as compared to $23.4 million in the prior year period. The increase in selling, general and administrative expenses was primarily related to an increase in employment costs, overhead expenses, rent, and selling related expenses. Employment costs increased by $6.9 million driven by an increase in new hires and variable compensation. Rent increased by $2.4 million related to our net addition of 26 showrooms. Selling related expenses increased $1.7 million due to an increase of $1.9 million in credit card fees related to the increase in sales, partially offset by a decrease of $0.2 million due to a lower fee structure relating to online pop-up shops at Costco.com. Overhead expenses increased $1.0 million consisting of an increase of $0.6 million in equity-based compensation related to an option trigger event that caused an acceleration of the recognition of stock option equity compensation expense, an increase of $0.4 million in infrastructure investments, and an increase of $0.1 million in travel expenses, partially offset by a decrease of $0.1 million in insurance expenses.

Selling, general and administrative expenses were 34.5% of net sales in the thirteen weeks ended August 1, 2021 as compared to 37.7% of net sales in the thirteen weeks ended August 2, 2020. The decrease in selling, general and administrative expenses of 3.2% of net sales was primarily due to higher leverage within infrastructure investments, rent, insurance and selling related expenses, partially offset by deleverage in employment costs, equity-based compensation, and travel. The deleverage in certain expenses relate to the investments we are making into the business that were put on hold in the prior year relating to COVID-19 financial resilience measures and the acceleration of stock compensation expense related to stock options vesting as a required market condition was achieved in the thirteen weeks ended August 1, 2021.

Advertising and Marketing

Advertising and marketing expenses increased $5.9 million, or 81.9%, to $13.0 million for the thirteen weeks ended August 1, 2021 as compared to $7.2 million in the thirteen weeks ended August 2, 2020. The majority of the increase in advertising and marketing dollars relates to the reinstatement of marketing spends as showroom locations are fully open in the current period versus the limited showroom operations due to COVID-19 in the prior year period. The investment by quarter may vary greatly. Advertising and marketing expenses were 12.7% of net sales in the thirteen weeks ended August 1, 2021 as compared to 11.6% of net sales in the thirteen weeks ended August 2, 2020. The majority of the increase in advertising and marketing as a percent of net sales is related to increased media activities and higher media costs compared to the COVID-19 related marketing environment in the prior year period.

Depreciation and amortization expenses

Depreciation and amortization expenses increased $0.1 million, or 3.8%, to $1.6 million in the thirteen weeks ended August 1, 2021 as compared to $1.5 million in the thirteen weeks ended August 2, 2020. The increase in depreciation and amortization expense principally relates to capital investments for new and remodeled showrooms.

Interest (expense) income, net

 Interest expense, net which is less than $0.1 million principally relates to the interest expense related to unused line fees and amortization of deferred financing fees on the asset-based loan with a slight offset of interest earned on the Company’s cash and cash equivalents balances for the thirteen weeks ended August 1, 2021. The increase in net interest expense from prior year was the result of a decrease in interest rates being earned on the Company’s cash and cash equivalents during the thirteen weeks ended August 1, 2021 as compared to the same period in the prior year.

Provision for income taxes

Income tax provision was less than 0.60% and 0.06% of sales for the thirteen weeks ended August 1, 2021 and August 2, 2020, respectively.

Twenty-six weeks ended August 1, 2021 Compared to the Twenty-six weeks ended August 2, 2020

Net sales

Net sales increased $69.0 million, or 59.4%, to $185.4 million in the twenty-six weeks ended August 1, 2021 as compared to $116.3 million in the twenty-six weeks ended August 2, 2020. The increase in overall net sales was driven by our Showroom sales, Other sales and partially offset by a decrease in our Internet Sales. New customers increased by 9.6% in the twenty-six weeks ended August 1, 2021 as compared to 52.5% in the twenty-six weeks ended August 2, 2020 driven by the successful Heroes’ campaign in the second quarter. We had 123 and 97 showrooms as of August 1, 2021 and August 2, 2020, respectively. We opened 15 additional showrooms and did not permanently close or remodel any showrooms in the twenty-six weeks ended August 1, 2021. Showroom sales increased $80.6 million, or 260.3%, to $111.6 million in the twenty-six weeks ended August 1, 2021 as compared to $31.0 million in the twenty-six weeks ended August 2, 2020, related to higher point of sales transactions with lower promotional discounting. This increase was due in large part to our comparable showroom point of sales transaction increase of $67.0 million, or 235.3%, to $95.4 million in the twenty-six weeks ended August 1, 2021 as compared to $28.5 million in the twenty-six weeks ended August 2, 2020. Point of sales transactions represent orders placed through our showrooms which does not always reflect the point at which control transfers to the customer, which occurs upon shipment being confirmed. See Note 12 to the condensed consolidated financial statements. We believe point of sales transactions is a more accurate way to measure showroom performance and how our showroom associates are incentivized. Retail sales per selling square foot increased $768, or 178.5%, to $1,198 in the twenty-six weeks ended August 1, 2021 as compared to $430 in the twenty-six weeks ended August 2, 2020. Total number of units sold at point of transaction increased by approximately 179.5%. The increase in comparable point of sales transactions, retail sales per selling square foot and number of units sold for the twenty-six week ended was principally driven by the limited showroom operations due to COVID-19 in the prior year period. Internet sales (sales made directly to customers through our ecommerce channel) decreased $21.5 million, or 28.2%, to $54.7 million in the twenty-six weeks ended August 1, 2021 as compared to $76.1 million in the twenty-six weeks ended August 2, 2020. The decrease in Internet sales was due primarily to the shift of sales into the internet channel in prior year as a result of the limited showroom operations due to COVID-19. Other sales, which include pop-up-shop sales and shop-in-shop sales, increased $9.9 million, or 107.7%, to $19.1 million in the twenty-six weeks ended August 1, 2021 as compared to $9.2 million in the twenty-six weeks ended August 2, 2020. This increase was due to hosting 2 additional temporary online pop-up-shops on Costco.com compared to the prior year period and sales increase from shop-in-shop locations that were closed in the prior year period due to COVID-19.

Gross profit

Gross profit increased $46.8 million, or 80.2%, to $105.1 million in the twenty-six weeks ended August 1, 2021 from $58.3 million in the twenty-six weeks ended August 2, 2020. Gross margin increased to 56.7% of net sales in the twenty-six weeks ended August 1, 2021 from 50.2% of net sales in the twenty-six weeks ended August 2, 2020. The increase in gross margin percentage of 655 basis points was primarily driven by an increase of approximately 457 basis points due to lower promotional discount, continuing vendor negotiations to assist with the mitigation of tariffs and continued shift of products from China to Vietnam, Malaysia, and Indonesia. Distribution expenses improved by 198 basis points over the prior year due to higher leverage of 945 basis points in warehousing and distribution costs, partially offset by the increase in inbound freight of 747 basis points due to escalating inbound container costs as well as some shift of inventory purchases back to China, which are impacted by the 25% tariff rate to help alleviate container congestion coming from our other overseas vendors. 

Selling, general and administrative expenses

Selling, general and administrative expenses increased $16.9 million, or 34.3%, to $66.1 million in the twenty-six weeks ended August 1, 2021 as compared to $49.2 million in twenty-six weeks ended August 2, 2020. The increase in selling, general and administrative expenses was primarily related to an increase in employment costs, rent, overhead expenses, and selling related expenses. Employment costs increased by $9.9 million driven by an increase in new hires and variable compensation. Rent increased by $3.9 million related to our net addition of 26 showrooms. Overhead expenses increased $1.7 million consisting of an increase of $1.4 million in infrastructure investments and an increase of $0.3 million in equity-based compensation. Selling related expenses increased $1.4 million due to an increase of $2.8 million in credit card fees, partially offset by a decrease of $1.4 million in due to a lower fee structure in for online pop-up-shop sales at Costco.com.

Selling, general and administrative expenses were 35.7% of net sales in the twenty-six weeks ended August 1, 2021 as compared to 42.3% of net sales in the twenty-six weeks ended August 2, 2020. The decrease in selling, general and administrative expenses of 6.6% of net sales was primarily due to higher leverage within infrastructure investments, selling related expenses, rent, insurance, equity-based compensation and travel.

Advertising and Marketing

Advertising and marketing expenses increased $8.4 million, or 54.4%, to $23.7 million in the twenty-six weeks ended August 1, 2021 as compared to $15.4 million in the twenty-six weeks ended August 2, 2020. The majority of the increase in advertising and marketing dollars relates to the reinstatement of marketing spends as showroom locations are fully open in the current period versus the limited showroom operations due to COVID-19 in the prior year period. The investment by quarter may vary greatly. Advertising and marketing expenses were 12.8% of net sales in the twenty-six weeks ended August 1, 2021 as compared to 13.2% of net sales in the twenty-six weeks ended August 2, 2020. The majority of the decrease in advertising and marketing as a percent of net sales is primarily due to improved performance in our media activities which has driven an increase in net sales, higher Sactional sales mix and higher average selling price.

Depreciation and amortization expenses

Depreciation and amortization expenses increased $0.8 million, or 26.5%, to $4 million in the twenty-six weeks ended August 1, 2021 as compared to $3.2 million in the twenty-six weeks ended August 2, 2020. The increase in depreciation and amortization expense principally relates to capital investments for new and remodeled showrooms.

Interest income (expense), net

Interest expense, net which is less than $0.1 million principally relates to the interest expense related to unused line fees and amortization of deferred financing fees on the asset-based loan with a slight offset of interest earned on the Company’s cash and cash equivalents balances for the twenty-six weeks ended August 1, 2021. The increase in net interest expense from prior year was the result of a decrease in interest rates being earned on the Company’s cash and cash equivalents during the twenty-six weeks ended August 1, 2021 as compared to the same period in the prior year.

Provision for income taxes

Income tax provision was less than 0.40% and 0.06% of sales for the twenty-six weeks ended August 1, 2021 and August 2, 2020, respectively.

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 advertising and marketing, 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:

Net Cash Provided By Operating Activities

Cash from operating activities consists primarily of net income(loss) adjusted for certain non-cash items, including depreciation and amortization, loss on disposal 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 the twenty-six weeks ended August 1, 2021, net cash provided by operating activities was $0.8 million and consisted of changes in operating assets and liabilities of ($25.1) million, net income of $10.5 million, and adjustments to reconcile net income to cash provided by operating activities of $15.4 million. Working capital and other activities consisted primarily of increases in inventory of $24.6 million, trade accounts receivable of $2.9 million, and customer deposits of $7.4 million, and accounts payable and accrued expenses of $2.8 million, partially offset by decreases in prepaid expenses and other current assets of $0.5 million and operating lease liabilities of $8.4 million.

In the twenty-six weeks ended August 2, 2020, net cash provided by operating activities was $12.1 million and consisted of changes in operating assets and liabilities of $14.4 million, a net loss of $9.5 million, and adjustments to reconcile net loss to cash used in operating activities of $7.2 million. Working capital and other activities consisted primarily of decreases in prepaid expenses of $2.4 million and accounts receivable of $1.0 million and increases in accounts payable and accrued expenses of $8.2 million and customer deposits of $7.4 million, partially offset by an increase in inventory of $4.6 million.

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 the twenty-six weeks ended August 1, 2021, capital expenditures were $7.4 million as a result of investments in new and remodeled showrooms and intangibles such as patents and trademarks.

For the twenty-six weeks ended August 2, 2020, capital expenditures were $5.3 million as a result of investments in new and remodeled showrooms and intangibles such as patents and trademarks offset by proceeds from disposal of property and equipment.

Net Cash Used In Financing Activities

Financing activities consist primarily of the proceeds from stock offerings and taxes paid for the net settlement of equity awards.

For the twenty-six weeks ended August 1, 2021, net cash used in financing activities was $3.3 million, due mostly to taxes paid for net share settlement of $3.4 million offset by proceeds from the exercise of warrants of $0.1 million. For the twenty-six weeks ended August 2, 2020, net cash used in financing activities was $0.5 million, due mostly to taxes paid for net share settlement of $0.5 million.

Revolving Line of Credit

On February 6, 2018, we entered into a five-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 7 to our condensed consolidated financial statements. As of August 1, 2021, the Company’s borrowing availability under the line of credit with Wells was $22.5 million. As of August 1, 2021, there were $115 borrowings outstanding on this line of credit related to line of credit fees.

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 associates 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.

Off Balance Sheet Arrangements

We have no material off balance sheet arrangements as of August 1, 2021, except for employment agreements entered 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 condensed 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 consolidated financial statements included in the Annual Report on Form 10-K filed on April 14, 2021 for a complete description of our significant accounting policies. There have been no material changes to the significant accounting policies during the twenty-six weeks ended August 1, 2021.

Recent Accounting Pronouncements

Refer to Note 2, Recent Accounting Pronouncements, contained in the Condensed Consolidated Notes to Financial Statements in Item 1 of Part 1 of this Quarterly Report on Form 10-Q for a full description of the recent accounting pronouncements and our expectation of their impact, if any, on our results of operations and financial condition.

Item 3. Quantitative and Qualitative Disclosures about Market Risk.

In the normal course of business, we are exposed to a variety of risks, including fluctuations in interest rates that could affect our financial position and results of operations.

Interest Rate Risk

Debt

Interest rate risk exists primarily through our borrowing activities. We use U.S. dollar denominated borrowings to fund our working capital and investment needs. It is anticipated that the fair market value of any future debt under the line of credit will continue to be immaterially affected by fluctuations in interest rates and we do not believe that the value of such debt would be significantly impacted by current market events. Under the line of credit, 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%. We currently do not engage in any interest rate hedging activity and we have no intention of doing so in the foreseeable future. A hypothetical 100 basis point change (up or down) in the one-month LIBOR rate would not have a material effect on our condensed consolidated results of operations.

LIBOR Transition

Borrowings under our revolving line of credit have an interest rate tied to LIBOR, which is the subject of recent national, international, and other regulatory guidance and proposals for reform. These reforms and other pressure may cause LIBOR to disappear entirely or to perform differently than in the past. It is expected that certain banks will stop reporting information used to set LIBOR at the end of 2021 when their reporting obligations cease. This will effectively end the usefulness of LIBOR and end its publication. If LIBOR is no longer available, or otherwise at our option, we will pursue alternative interest rate calculations in our Credit Agreement, including the use of the Secured Overnight Financing Rate (SOFR). A number of other alternatives to LIBOR have been proposed or are being developed, but it is not clear which, if any, will be adopted. Any of these alternative methods may result in interest payments that are higher than expected or that do not otherwise correlate over time with the payments that would have been made on such indebtedness for the interest periods if the applicable LIBOR rate was available in its current form.

Item 4. 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 (our 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 Securities Exchange Act of 1934, as amended (the “Exchange Act”)), as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting during the thirteen weeks ended August 1, 2021 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

From time to time we may become involved in legal proceedings or be subject to claims arising in the ordinary course of our business. We are not presently a party to any legal proceedings that, if determined adversely to us, would individually or taken together have a material adverse effect on our business, operating results, financial condition or cash flows. Regardless of the outcome, litigation can have an adverse impact on us because of defense and settlement costs, diversion of management resources and other factors.

Item 1A. Risk Factors

Other than as set forth below, there have been no material changes to the risk factors previously disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended January 31, 2021.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

In the thirteen weeks ended August 1, 2021, 4,500 warrants with an exercise price of $16 per share were exercised on a cashless basis, resulting in the issuance of 3,600 common shares, and 5,250 warrants with an exercise price of $16 per share were exercised upon cash payment of the exercise price to the Company. We received no proceeds from the cashless exercise of the warrants. In issuing these shares, we relied on an exemption from the registration requirements provided by Section 4(a)(2) of the Securities Act of 1933, as amended.

Item 3. Defaults upon Senior Securities.

Not applicable.

Item 4. Mine Safety Disclosures.

Not applicable.

Item 5. Other Information.

None.

Item 6. Exhibits

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

32