Lovesac Co: Form 10-Q for the period ended Oct 29, 2023

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited condensed financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q and Amendment No. 2 to our Annual Report on Form 10-K/A for the fiscal year ended January 29, 2023 ("Form 10-K/A"). 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/A 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. The fiscal year ended February 4, 2024 will consist of 53 weeks.

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 through an omni-channel platform that includes direct-to-consumer touch-feel points in the form of our own showrooms, which include our newly created mobile concierge and kiosks, and online directly at www.lovesac.com (http://www.lovesac.com). 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.

Macroeconomic Factors

There are a number of macroeconomic factors and uncertainties affecting the overall business environment and our business, including increased inflation, rising interest rates, housing market conditions, consumer debt, the recent failures of several financial institutions, conflicts around the globe and uncertainties in the global financial markets. These factors may have a negative impact on markets in which we operate, including the potential for an economic recession, a continued downturn in the housing market, disruption in the U.S. banking system, and a reduction in consumer discretionary spending. We believe that these macroeconomic factors have contributed to the slowdown in demand that we have experienced in our business which may continue.

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.

• Sactionals. Our Sactional product line currently represents a majority of our net sales. We believe our Sactionals platform is unlike competing products in its adaptability yet is comparable aesthetically to similarly priced premium couches and sectionals. Our Sactional products include a number of patented features relating to their geometry and modularity, coupling mechanisms and other features. Utilizing only two, standardized pieces, “seats” and “sides,” and approximately 200 high quality, tight-fitting covers that are removable, washable, and changeable, customers can create numerous permutations of a sectional couch with minimal effort. Customization is further enhanced with our specialty-shaped modular offerings, such as our wedge seat and roll arm side. Our custom features and accessories can be added easily and quickly to a Sactional to meet endless design, style, storage and utility preferences, reflecting our Designed for Life philosophy. Sactionals are built to meet the highest durability and structural standards applicable to fixed couches. Sactionals are comprised of standardized units and we guarantee their compatibility over time, which we believe is a major pillar of their value proposition to the consumer. Our Sactionals represented 91.1% and 88.6% of our net sales for the thirteen weeks ended October 29, 2023 and October 30, 2022, respectively, and 90.9% and 89.9% of our net sales for the thirty-nine weeks ended October 29, 2023 and October 30, 2022, respectively.

In October 2021, we introduced the new Sactionals StealthTech Sound + Charge product line. This unique innovation features immersive surround sound by Harman Kardon and convenient wireless charging, all seamlessly embedded and hidden inside the adaptable Sactionals platform. The System includes two Sound + Charge Sides each with embedded front- and rear-firing Harman Kardon speakers, a Subwoofer that easily integrates into a Sactionals Seat Frame and a Center Channel, all working in unison to deliver captivating surround sound that is completely hidden from view.

• Sacs. We believe that our Sacs product line is a category leader in oversized beanbags. The Sac product line offers 6 different sizes ranging from 22 pounds to 95 pounds with capacity to seat 3+ people on the larger model Sacs. Filled with Durafoam, a blend of shredded foam, Sacs provide serene comfort and guaranteed durability. Their removable covers are machine washable and may be easily replaced with a wide selection of cover offerings. Our Sacs represented 7.3% and 9.3% of our net sales for the thirteen weeks ended October 29, 2023 and October 30, 2022, respectively, and 7.5% and 8.3% of our net sales for the thirty-nine weeks ended October 29, 2023 and October 30, 2022, respectively.
• Other. Our Other product line complements our Sacs and Sactionals by increasing their adaptability to meet evolving consumer demands and preferences. Our current product line offers Sactional-specific drink holders, Footsac blankets, decorative pillows, fitted seat tables and ottomans in varying styles and finishes and our unique Sactionals Power Hub, providing our customers with the flexibility to customize their furnishings with decorative and practical add-ons to meet evolving style preferences.

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.

• Showrooms. We market and sell our products through 230 showroom locations at top tier malls, lifestyle centers, mobile concierge, kiosk, and street locations in 41 states in the U.S. We carefully select the best small-footprint showroom locations in high-end malls and lifestyle centers for our showrooms. Compared to traditional retailers, our showrooms require significantly less square footage because of our need to have only a few in-store sample configurations for display and our ability to stack our inventory for immediate sale. The architecture and layout of these showrooms is designed to communicate our brand personality and key product features. Our goal is to educate first-time customers, creating an environment where people can touch, feel, read, and understand the technology behind our products. Our new showroom concept utilizes technology in more experiential ways to increase traffic and net sales. Net sales generated by this channel accounted for 64.0% and 62.3% of total net sales for the thirteen and thirty-nine weeks ended October 29, 2023, respectively, up from 61.5% and 62.2% of total net sales for the thirteen and thirty-nine weeks ended October 30, 2022.
• Ecommerce. Through our ecommerce channel, we believe we are able to significantly enhance the consumer shopping experience for home furnishings, driving deeper brand engagement and loyalty, while also realizing more favorable margins than our showroom locations. We believe our robust technological capabilities position us well to benefit from the growing consumer preference to transact at home and via mobile devices. With furniture especially suited to ecommerce applications, our net sales generated by this channel accounted for 26.0% and 27.1% of total net sales for the thirteen and thirty-nine weeks ended October 29, 2023, respectively, up from 24.7% and 24.3% of total net sales for the thirteen and thirty-nine weeks ended October 30, 2022, respectively.
• Other touchpoints. We augment our showrooms with other touchpoint strategies including online, pop-up-shops, shop-in-shops, and barter inventory transactions. Our barter inventory transactions with a third party vendor are part of our Circle to Customer ("CTC"), Designed for Life and Environmental, Social and Governance ("ESG") initiatives. CTC is our operational philosophy in which business processes, including the design of our products, are optimized for looped (circle) and/or local operations. We repurpose returned open-box inventory in exchange for media credits, which are being used to support our advertising initiatives to create brand awareness and drive net sales growth. We utilize in store pop-up-shops to increase the number of locations where customers can experience and purchase our products, a low cost alternative to drive brand awareness, in store net sales, and ecommerce net sales. These in store pop-up-shops are staffed similarly to our showrooms with associates trained to demonstrate and sell our products and promote our brand. Unlike the in store pop-up-shops which are typically 10-day shows, and pop-up locations, shop-in-shops are designed to be in permanent locations carrying the same digital technology of our showrooms and are also staffed with associates trained to demonstrate and sell our products. Shop-in-shops require less capital expenditure to open a productive space to drive brand awareness and touchpoint opportunities for demonstrating and selling our products. We operated 2 and 7 online pop-up-shops on Costco.com for the thirteen and thirty-nine weeks ended October 29, 2023, and 3 and 8 for the thirteen and thirty-nine weeks ended October 30, 2022. We operated 41 Best Buy shop-in-shops for the thirteen and thirty-nine weeks ended October 29, 2023, up from 22 for the thirteen and thirty-nine weeks ended October 30, 2022. Other net sales which includes pop-up-shop sales, shop-in-shop sales, and barter inventory transactions accounted for 10.0% and 10.6% of our total net sales for the thirteen and thirty-nine weeks ended October 29, 2023, down from 13.7% and 13.6% of our total net sales for the thirteen and thirty-nine weeks ended October 30, 2022.

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. Net sales made at Company operated showrooms, including shop-in-shops and pop-up-shops, and via the web are recognized, typically at the point of transference of title when the goods are shipped.

Omni-channel Comparable Net Sales

Omni-channel comparable net sales is a measure that highlights the performance of our existing locations and websites by measuring the change in net sales for a period over the comparable prior-period of equivalent length. Comparable net sales includes sales at all retail locations and online, open greater than 12 months (including remodels and relocations) and excludes closed stores. Comparable net sales is intended only as supplemental information and is not a substitute for net sales presented in accordance with GAAP. We have updated how we calculate comparable sales to better reflect our business, store growth and omni-channel sales approach.

New Customer

We define a customer as new when the customer has completed a transaction at Lovesac either at a showroom or internet channel only for the first time. We have updated how we calculate new and repeat customers to better reflect business across all of our channels as well as the purchase cycle of the categories we compete.

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.

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; public company expenses; and credit card transaction fees. 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. While we expect to leverage total selling, general and administrative expenses as a percentage of net sales as net sales volumes continue to grow, the impact will be lessened by our continued investments to support our continued growth. These investments include research and development costs on our existing and future products and foundational technology investments..

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 of net sales as we continue to invest in advertising and marketing which has accelerated net sales growth.

Basis of Presentation and Results of Operations

(amounts in thousands)

17

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

18

Thirteen weeks ended October 29, 2023 compared to the thirteen weeks ended October 30, 2022

Net sales

Net sales increased $19.2 million, or 14.3%, to $154.0 million in the thirteen weeks ended October 29, 2023 as compared to $134.8 million in the thirteen weeks ended October 30, 2022. The increase in net sales was driven by new showroom openings, and an increase of 2.0% in omni-channel comparable net sales. New customers increased by 15.9% in the thirteen weeks ended October 29, 2023 as compared to a decrease of 0.4% in the thirteen weeks ended October 30, 2022.

We had 230 and 189 total showrooms as of October 29, 2023 and October 30, 2022, respectively. The Company opened 48 new showrooms, closed 7 kiosks, and opened 19 additional Best Buy shop-in-shop locations in the twelve months preceding October 30, 2023.

During the thirteen weeks ended October 29, 2023, we opened 10 additional showrooms and closed 1 showroom and 2 kiosks. We did not remodel any showrooms in the thirteen weeks ended October 29, 2023. In comparison, we opened 16 showrooms, closed 1, and remodeled 3 showrooms in the thirteen weeks ended October 30, 2022.

Showroom net sales increased $15.7 million, or 18.9%, to $98.7 million in the thirteen weeks ended October 29, 2023 as compared to $83.0 million in the thirteen weeks ended October 30, 2022.

Internet net sales (sales made directly to customers through our ecommerce channel) increased $6.7 million, or 20.1%, to $40.0 million in the thirteen weeks ended October 29, 2023 as compared to $33.3 million in the thirteen weeks ended October 30, 2022 driven by strong promotional campaigns.

Other net sales, which include pop-up-shop sales, shop-in-shop sales, and barter inventory transactions decreased $3.1 million, or 17.1%, to $15.4 million in the thirteen weeks ended October 29, 2023 as compared to $18.5 million in the thirteen weeks ended October 30, 2022. This decrease was principally due to timing of inventory barter transactions coupled with lower productivity of our temporary online pop-up-shops on Costco.com partially offset by 87 Costco in store pop-up-shops that we did not have last year. We also opened 19 additional Best Buy shop-in-shop location compared to the prior year period.

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 2 to the condensed 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 decreased $79, or 14.5%, to $464 in the thirteen weeks ended October 29, 2023 as compared to $543 in the thirteen weeks ended October 30, 2022. Total number of units sold at point of transaction also decreased by approximately 5.8% driven by lower productivity related to inflationary concerns.

Gross profit

Gross profit increased $23.5 million, or 36.3%, to $88.4 million in the thirteen weeks ended October 29, 2023 from $64.9 million in the thirteen weeks ended October 30, 2022. Gross margin increased to 57.4% of net sales in the thirteen weeks ended October 29, 2023 from 48.2% of net sales in the thirteen weeks ended October 30, 2022. The increase in gross margin percentage of 920 basis points was primarily driven by a decrease of approximately 1,070 basis points in total distribution and related tariff expenses, partially offset by a decrease of 150 basis points in product margin driven by higher promotional discounting. The decrease in total distribution and related tariff expenses over prior year is principally related to the positive impact of 1,160 basis points decrease in inbound transportation costs partially offset by 90 basis points in higher outbound transportation and warehousing costs.

Selling, general and administrative expenses

Selling, general and administrative expenses increased $14.1 million, or 26.4%, to $67.6 million in the thirteen weeks ended October 29, 2023 as compared to $53.5 million in the thirteen weeks ended October 30, 2022. The increase in selling, general and administrative expenses was primarily related to an increase in overhead expenses, employment costs, and selling related expenses. Overhead expenses increased $10.0 million consisting mainly of increases of $6.3 million in professional fees, $3.7 million in other investments in the business to support current and future growth, and $0.4 million in equity-based compensation, partially offset by a decrease of $0.4 million in insurance expense. Employment costs increased by $2.9 million driven by an increase in new hires. Selling related expenses increased $1.5 million principally due to credit card fees related to the increase in net sales and an increase in credit card rates. Selling, general and administrative expenses were 43.9% of net sales in the thirteen weeks ended October 29, 2023, an increase of 420 basis points as compared to 39.7% of net sales in the thirteen weeks ended October 30, 2022.

Advertising and Marketing

Advertising and marketing expenses increased $2.0 million, or 10.8%, to $21.1 million for the thirteen weeks ended October 29, 2023 as compared to $19.1 million in the thirteen weeks ended October 30, 2022. The majority of the increase in advertising and marketing dollars relates to the ongoing investments in marketing spends to support our net sales growth. The investment by quarter may vary greatly. Advertising and marketing expenses were 13.7% of net sales in the thirteen weeks ended October 29, 2023 as compared to 14.1% of net sales in the thirteen weeks ended October 30, 2022.

Depreciation and amortization expenses

Depreciation and amortization expenses increased $0.8 million, or 34.6%, to $3.3 million in the thirteen weeks ended October 29, 2023 as compared to $2.5 million in the thirteen weeks ended October 30, 2022. The increase in depreciation and amortization expense principally relates to capital investments for new and remodeled showrooms.

Interest income (expense), net

For the thirteen weeks ended October 29, 2023, interest income was $0.3 million, compared to interest expense of less than $0.1 million for the thirteen weeks ended October 30, 2022. Interest income earned on the Company’s cash and cash equivalents balances was favorable from higher interest rates compared to the prior year period.

Benefit from income taxes

Income tax benefit was $1.0 million for the thirteen weeks ended October 29, 2023, compared to $2.8 million for the thirteen weeks ended October 30, 2022. The change in benefit is primarily driven by the Company generating net loss before taxes of $3.3 million and $10.2 million for the thirteen weeks ended October 29, 2023 and October 30, 2022, respectively.

Thirty-nine weeks ended October 29, 2023 compared to the thirty-nine weeks ended October 30, 2022

Net sales

Net sales increased $37.1 million, or 9.0%, to $449.8 million in the thirty-nine weeks ended October 29, 2023 as compared to $412.7 million in the thirty-nine weeks ended October 30, 2022. The increase in net sales was driven by new showroom openings, partially offset by a decrease of 3.6% in omni-channel comparable net sales. New customers increased by 18.5% in the thirty-nine weeks ended October 29, 2023 as compared to 2.4% in the thirty-nine weeks ended October 30, 2022.

We had 230 and 189 total showrooms as of October 29, 2023 and October 30, 2022, respectively. The Company opened 48 new showrooms, closed 7 kiosks, and opened 19 additional Best Buy shop-in-shop locations in the twelve months preceding October 29, 2023.

In the thirty-nine weeks ended October 29, 2023, we opened 44 additional showrooms, closed 4 showrooms and 5 kiosks, and did not remodel any showrooms. In comparison, we opened 38 showrooms, 6 kiosks, remodeled 3 showrooms, and closed 1 showroom in the thirty-nine weeks ended October 30, 2022.

Showroom net sales increased $23.9 million, or 9.3%, to $280.5 million in the thirty-nine weeks ended October 29, 2023 as compared to $256.6 million in the thirty-nine weeks ended October 30, 2022.

Internet net sales (sales made directly to customers through our ecommerce channel) increased $21.6 million, or 21.5%, to $121.7 million in the thirty-nine weeks ended October 29, 2023 as compared to $100.1 million in the thirty-nine weeks ended October 30, 2022 driven by a strong promotional campaigns.

Other net sales, which include pop-up-shop sales, shop-in-shop sales, and barter inventory transactions decreased $8.4 million, or 14.9%, to $47.6 million in the thirty-nine weeks ended October 29, 2023 as compared to $56.0 million in the thirty-nine weeks ended October 30, 2022. This decrease was principally due to timing of inventory barter transactions coupled with lower productivity of our temporary online pop-up-shops on Costco.com partially offset by 274 Costco in store pop-up-shops that we did not have last year. We also opened 19 additional Best Buy shop-in-shop location compared to the prior year period.

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 2 to the condensed 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 decreased $387, or 21.0%, to $1,452 in the thirty-nine weeks ended October 29, 2023 as compared to $1,839 in the thirty-nine weeks ended October 30, 2022. Total number of units sold at point of transaction also decreased by approximately 12.6% driven by lower productivity related to inflationary concerns.

Gross profit

Gross profit increased $41.4 million, or 19.7%, to $251.4 million in the thirty-nine weeks ended October 29, 2023 from $210.0 million in the thirty-nine weeks ended October 30, 2022. Gross margin increased to 55.9% of net sales in the thirty-nine weeks ended October 29, 2023 from 50.9% of net sales in the thirty-nine weeks ended October 30, 2022. The increase in gross margin percentage of 500 basis points was primarily driven by a decrease of approximately 610 basis points in total distribution and related tariff expenses, partially offset by a decrease of 110 basis points in product margin driven by higher promotional discounting. The decrease in total distribution and related tariff expenses over prior year is principally related to the positive impact of 750 basis points decrease in inbound transportation costs partially offset by 140 basis points in higher outbound transportation and warehousing costs.

Selling, general and administrative expenses

Selling, general and administrative expenses increased $40.7 million, or 27.7%, to $188.0 million in the thirty-nine weeks ended October 29, 2023 as compared to $147.3 million in the thirty-nine weeks ended October 30, 2022. The increase in selling, general and administrative expenses was primarily related to an increase in overhead expenses, employment costs, selling related expenses, and rent. Overhead expenses increased $18.5 million mainly consisting of an increase of $9.2 million in professional fees and $8.7 million in other investments in the business to support current and future growth. Employment costs increased by $14.5 million driven by an increase in new hires. Selling related expenses increased $5.5 million principally due to credit card fees related to the increase in net sales and an increase in credit card rates. Rent increased by $2.1 million related to a $4.5 million increase in rent expense from our net addition of 41 showrooms partially offset by a $2.4 million reduction in percentage rent. Selling, general and administrative expenses were 41.8% of net sales in the thirty-nine weeks ended October 29, 2023, an increase of 610 basis points as compared to 35.7% of net sales in the thirty-nine weeks ended October 30, 2022.

Advertising and Marketing

Advertising and marketing expenses increased $10.6 million, or 19.5%, to $64.6 million for the thirty-nine weeks ended October 29, 2023 as compared to $54.0 million in the thirty-nine weeks ended October 30, 2022. The majority of the increase in advertising and marketing dollars relates to the ongoing investments in marketing spends to support our net sales growth. The investment by quarter may vary greatly. Advertising and marketing expenses were 14.4% of net sales in the thirty-nine weeks ended October 29, 2023 as compared to 13.1% of net sales in the thirty-nine weeks ended October 30, 2022.

Depreciation and amortization expenses

Depreciation and amortization expenses increased $0.9 million, or 11.6%, to $9.1 million in the thirty-nine weeks ended October 29, 2023 as compared to $8.2 million in the thirty-nine weeks ended October 30, 2022. The increase in depreciation and amortization expense principally relates to capital investments for new and remodeled showrooms.

Interest income (expense), net

For the thirty-nine weeks ended October 29, 2023, interest income was $1.0 million compared to interest expense of $0.1 million for the thirty-nine weeks ended October 30, 2022. Interest income earned on the Company’s cash and cash equivalents balances was favorable from higher interest rates compared to the prior year period.

Benefit from (provision for) income taxes

Income tax benefit was $2.3 million for the thirty-nine weeks ended October 29, 2023, compared to income tax expense of $0.1 million for the thirty-nine weeks ended October 30, 2022. The change in provision is primarily driven by the Company generating net loss before taxes of $9.3 million and net income before taxes of $0.4 million for the thirty-nine weeks ended October 29, 2023 and October 30, 2022, respectively.

Reconciliation of Non-GAAP Financial Measures

To supplement our condensed financial statements, which are prepared and presented in accordance with GAAP , we use the following non-GAAP financial measures: EBITDA and Adjusted EBITDA. EBITDA and Adjusted EBITDA are “Non-GAAP Measures” that are supplemental measures of financial performance that are not required by, or presented in accordance with, GAAP. We believe that EBITDA and Adjusted EBITDA are useful measures of operating performance, as they eliminate expenses that are not reflective of the underlying business performance, facilitate a comparison of our operating performance on a consistent basis from period-to-period and provide for a more complete understanding of factors and trends affecting our business. Additionally, EBITDA is frequently used by analysts, investors and other interested parties to evaluate companies in our industry. We use EBITDA and Adjusted EBITDA, alongside GAAP measures such as gross profit, operating income (loss) and net income (loss), to measure and evaluate our operating performance and we believe these measures are useful to investors in evaluating our operating performance.

We define “EBITDA” as earnings before interest, taxes, depreciation and amortization. We define “Adjusted EBITDA” as EBITDA adjusted for the impact of certain non-cash and other items that we do not consider in our evaluation of ongoing operating performance. These items include equity-based compensation expense and certain other charges and gains that we do not believe reflect our underlying business performance.

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.

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

(amounts in thousands)

(a) Represents expenses, such as compensation expense and employer taxes related to RSU equity vesting and exercises associated with stock options and restricted stock units granted to our associates and board of directors. Employer taxes are included as part of selling, general and administrative expenses on the Statements of Operations.

(b) Represents loss on disposal of property and equipment.

(c) Other non-recurring expenses in the thirteen and thirty-nine weeks ended October 29, 2023 represents professional fees related to the restatement of previously issued financial statements. Other non-recurring benefit in the thirty-nine weeks ended October 29, 2023 also includes business loss proceeds received from an insurance settlement. Other non-recurring benefit in the thirty-nine weeks ended October 30, 2022 represents a legal settlement. There were no other non-recurring expenses in the thirteen weeks ended October 30, 2022.

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 investments in our future and information technology. The most significant components of our working capital are cash and cash equivalents, merchandise inventory, prepaid expenses, accounts payable, accrued expenses, and customer deposits. Borrowings generally increase in our third fiscal quarter as we prepare to build our inventory levels in preparation for the fourth quarter holiday selling season. 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:

(amounts in thousands)

Net cash provided by (used in) operating activities

Cash from operating activities consists primarily of net income adjusted for certain non-cash items, including depreciation and amortization, equity-based compensation, non-cash operating lease cost, and deferred income taxes and the effect of changes in working capital and other activities.

In the thirty-nine weeks ended October 29, 2023, net cash provided by operating activities was $20.1 million and consisted of net loss of $7.1 million, adjustments to reconcile net loss to cash provided by operating activities of $26.8 million, and changes in operating assets and liabilities of $0.4 million. Net cash provided by working capital and other activities consisted primarily of a decrease in merchandise inventories of $3.0 million, and increases in accounts payable and accrued expenses of $15.1 million and customer deposits of $2.9 million, partially offset by increases in trade accounts receivable of $3.9 million, other assets of $4.6 million, and prepaid expenses and other current assets of $1.6 million, and a decrease in operating lease liabilities of $10.5 million.

In the thirty-nine weeks ended October 30, 2022, net cash used in operating activities was $68.4 million and consisted of changes in operating assets and liabilities of $93.6 million, net income of $0.3 million, and adjustments to reconcile net income to cash used in operating activities of $24.9 million. Net cash used in working capital and other activities consisted primarily of increases in merchandise inventories of $46.0 million, trade accounts receivable of $6.8 million, and prepaid expenses and other current assets of $17.7 million, along with decreases in operating lease liabilities of $16.8 million and customer deposits of $7.5 million, partially offset by an increase in accounts payable and accrued expenses of $1.2 million.

Net cash used in investing activities

Investing activities consist primarily of investments related to capital expenditures for new showroom openings, the remodeling of existing showrooms, and the acquisition of intangible assets.

For the thirty-nine weeks ended October 29, 2023 and October 30, 2022, capital expenditures were $22.2 million and $18.3 million, respectively, mainly as a result of investments in new showrooms.

Net cash used in financing activities

Financing activities consist primarily of taxes paid for the net settlement of equity awards and payment of deferred financing costs.

For the thirty-nine weeks ended October 29, 2023 and October 30, 2022, net cash used in financing activities was $3.7 million and $1.9 million, respectively, mostly due to taxes paid for the net share settlement of equity awards.

Revolving Line of Credit

On March 25, 2022, the Company amended our existing credit agreement providing for an asset-based revolving credit facility with the lenders party thereto, and Wells Fargo Bank, National Association, as administrative agent. The maturity date of our credit agreement was extended to March 25, 2024 and, among other things, the maximum revolver commitment was increased from $25.0 million to $40.0 million, subject to borrowing base and availability restrictions. Our credit agreement includes a $1,000,000 sublimit for the issuance of letters of credit and a $4,000,000 sublimit for swing line loans. On March 24, 2023, the Company amended the credit agreement to extend the maturity date to September 30, 2024. All other terms of the credit agreement remain unchanged. As of October 29, 2023, the Company’s borrowing availability under the line of credit was $35.7 million. As of October 29, 2023, there were no borrowings outstanding on this line of credit.

We are required to pay a commitment fee of 0.30% based on the daily unused portion of the credit facility. Amounts outstanding under the credit facility, at our option, bear interest at either a base rate or a term secured overnight term rate ("SOFR") based rate, plus, in either case, a margin determined by reference to our quarterly average excess availability under the credit facility and ranging from 0.50% to 0.75% for borrowings accruing interest at base rate and from 1.625% to 1.850% for borrowings accruing interest at term SOFR. Swing line loans will at all times accrue interest at a base rate plus the applicable margin. The lower margins described above will apply initially and will adjust thereafter from time to time based on the quarterly average excess availability under the credit facility. For additional information regarding our line of credit with Wells Fargo, see Note 7. Financing Arrangements.

Off Balance Sheet Arrangements

We have no material off balance sheet arrangements as of October 29, 2023, 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 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 financial statements included in the Amendment No. 2 on Form 10-K/A for the fiscal year ended January 29, 2023 for a complete description of our significant accounting policies. There have been no material changes to the significant accounting policies during the thirty-nine weeks ended October 29, 2023.

Recent Accounting Pronouncements

Refer to Note 1. Basis of Presentation and Summary of Significant Accounting Policies, contained in the Condensed 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.

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

Cash and cash equivalents and short-term investments were held primarily in cash deposits, certificates of deposit, money market funds and investment grade corporate debt. The fair value of our cash, cash equivalents and short-term investments will fluctuate with movements of interest rates, increasing in periods of declining rates of interest and declining in periods of increasing rates of interest.

Interest on the revolving line of credit incurred pursuant to the credit agreements described herein would accrue at a floating rate based on a formula tied to certain market rates at the time of occurrence; however, we do not expect that any changes in prevailing interest rates will have a material impact on our results of operations.

Inflation

In fiscal year 2023, we saw inflationary pressures across various parts of our business and operations, including, but not limited to, wholesale cost inflation and rising costs across our supply chain. We continue to monitor the impact of inflation in order to minimize its effects through pricing strategies, productivity improvements and cost reductions. If our costs were to be subject to more significant inflationary pressures, we may not be able to fully offset such higher costs through price increases or other cost efficiency measures. Our inability or failure to do so could harm our business, financial condition and results of operations.

Liquidity Risk

We are committed to maintaining a strong balance sheet and minimizing potential liquidity risk. We have taken numerous steps to ensure we partner with strong banking financial institutions to help reduce the risk of exposure to any failing institution while also allowing us to ensure the ability to access the credit markets through our existing credit agreement. In addition, as of October 29, 2023, we have not identified any major customer or supplier that had been materially impacted by the bank failures in 2023.

Evaluation of Disclosure Controls and Procedures

Our management, under the supervision and with the participation of our Chief Executive Officer (principal executive officer) and Chief Financial Officer (principal financial officer), evaluated the effectiveness of the design and operation 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 October 29, 2023.

Based on such evaluation, management identified certain material weaknesses in our internal control over financial reporting which was also disclosed in our Amendment No. 1 on Form 10-K/A filed on November 2, 2023 ("Amendment No. 1"). As a result of these material weaknesses, management concluded that our disclosure controls and procedures were not effective as of October 29, 2023.

Previously Reported Material Weaknesses in Internal Control over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). As reported in our Amendment No. 1, we did not maintain effective internal control over financial reporting as of January 29, 2023, as a result of material weaknesses in the control environment and control activities areas. A material weakness (as defined in Rule 12b-2 under the Exchange Act) is a deficiency, or combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. Refer to our Amendment No. 1 for a description of our material weaknesses.

Ongoing Remediation Efforts to Address Material Weaknesses

Our material weaknesses were not remediated as of October 29, 2023. Our Board of Directors and management are committed to the continued implementation of remediation efforts to address the material weaknesses. Management is devoting substantial resources to the ongoing implementation of remediation efforts to address the material weaknesses described herein. These remediation efforts, summarized below, which either have already been implemented or are continuing to be implemented, are intended to address both the identified material weaknesses and to enhance the Company’s overall internal control over financial reporting and disclosure controls and procedures.

Certain organizational enhancements and remedial actions have been completed, including:

(i) the appointment of a new Executive Vice President and Chief Financial Officer effective June 30, 2023, as part of our program to develop and implement effective internal controls over financial reporting, and enhance the accounting and financial reporting function; (ii) the replacement and hiring of additional accounting and finance resources with public company experience to expand the knowledge of GAAP and SEC accounting rules and regulations; and (iii) the engagement of third-party consultants to assist in enhancing processes and policies over the existing controls and implementing new controls.

The Company has further identified and begun to implement several additional remedial actions, as follows:

(i) the enhancement of the policy on manual journal entries, including clarification of review and approval of authorization matrices, and training of requisite personnel to provide for appropriate levels of oversight and monitoring; and (ii) the enhancement of the Company’s organizational structure over all finance functions and evaluating and realigning roles and responsibilities of management and personnel.

The Company also intends to enhance and implement effective control activities that contribute to the mitigation of risks and establish procedures that put policies into action. This will include: (i) enhancing, designing and implementing controls over the transportation accrual and estimation process; (ii) leveraging systems and workflows to enhance existing controls around financial reporting, and (iii) providing relevant training on internal controls over financial reporting to control owners and control preparers.

Management believes the foregoing efforts will effectively remediate the material weaknesses described above. As the Company continues to evaluate and improve its internal control over financial reporting and disclosure controls and procedures, management may determine to take additional measures to improve controls or determine to modify the remediation plan described above. The Company is working to remediate the material weaknesses as efficiently and effectively as possible with the goal of remediating each of the material weaknesses described above as soon as possible. Procedures to implement this remediation plan have to date required significant amounts of time, allocation of internal resources and external costs, and remaining remediation efforts will continue to place significant demands on financial and operational resources until this plan is completed.

Changes in Internal Control Over Financial Reporting

Other than as described above in connection with our material weaknesses, there were no changes in our internal control over financial reporting that occurred during the quarter ended October 29, 2023 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

There have been no material changes to the risk factors previously disclosed in the Company’s Amendment No. 2 to Annual Report on Form 10-K/A for the fiscal year ended January 29, 2023, filed with the SEC on November 30, 2023.