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 2, 2020

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)

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 8, 2020, there were 14,533,963 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 2, 2020

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which statements 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. Forward-looking statements contained in this Quarterly Report on Form 10-Q include, but are not limited to, statements about:

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 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our most recent Annual Report on Form 10-K, Quarterly Report on Form 10-Q for the quarterly period ended May 3, 2020, and elsewhere 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, 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 2, 2020 AND AUGUST 4, 2019 (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 2, 2020 AND AUGUST 4, 2019

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 February 2, 2020. 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” herein and 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 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.

The name “Lovesac” was derived from our original innovative product, a premium foam beanbag chair, the Sac. The Sac was developed in 1995 and provided the foundation for the Company. We believe that the large size, comfortable foam filling and irreverent branding of our Sacs products have been instrumental in growing a loyal customer base and our positive, fun image. Sales of this product were $7.9 million and $17.5 million in the thirteen and twenty-six weeks ended August 2, 2020, as compared to $9.6 million and $15.5 million for the thirteen and twenty-six weeks ended August 4, 2019.

Our Sactionals product line represents a majority of our sales. Sactionals are a couch system that consists of two components, seats and sides, which can be arranged, rearranged and expanded into thousands of configurations easily and without tools. Our Sactional products include a number of patented features relating to their geometry and modularity, coupling mechanisms and other features. We believe that these high quality, premium priced products enhance our brand image and customer loyalty and expect them to continue to garner a significant share of our sales. Our Sactionals represented 86.4% and 83.7% of our sales for the thirteen and twenty-six weeks ended August 2, 2020, respectively or $53.5 million and $97.4 million as compared to 79.6% and 79.9% of sales for the thirteen and twenty-six weeks ended August 4, 2019 or $38.3 million and $71.2 million, respectively.

Sacs and Sactionals come in a wide variety of colors and fabrics that allow consumers to customize their purchases in numerous configurations and styles. We provide lifetime warranties on our Sactional frames and the foam used in both product lines, and 3-year warranties on our covers. Our Designed for Life trademark reflects our dynamic product line that is built to last and evolve throughout a customer’s life. Customers can continually update their Sacs and Sactionals with new covers, additions, and configurations to accommodate changes in their family and housing situations.

We believe that our products complement one another and have generated a loyal customer base, evidenced by our recent estimate of 35% of our transactions in fiscal 2020 from repeat customers. We believe the strength of our brand is reflected in the number of customers who routinely share their purchases of Lovesac products with their friends through social media, often displaying our logos or company name in their posts. Our customers include celebrities and other influencers who support our brand through postings made on an uncompensated and unsolicited basis.

We market and sell our products through 97 showrooms at top tier malls, lifestyle centers and street locations in 35 states in the U.S. Our modern, efficient showrooms are designed to appeal to millennials and other purchasers looking for comfortable, enduring, premium furniture. They showcase the different sizes of our Sacs, the myriad forms into which our Sactionals can be configured, and the large variety of fabrics that can be used to cover our products. Our retail showrooms are technology driven and focus on educating prospective customers about the many benefits of our unique products, enabling us to require just 498 to 1,794 square feet for each showroom. All of our showroom locations closed in March 2020 as a result of COVID-19, as further discussed below. All of our showrooms have since reopened in some format, many still virtual or by appointment only. We have followed and will continue to follow the guidance of federal, state, and local governments as well as local health organizations, to determine the operating status of our showrooms.

Through our direct-to-consumer sales approach, we also generate significant interest and demand and sell our products through our ecommerce platform. We believe our products are uniquely suited to this channel. Each of our Sactionals components weighs less than 50 pounds upon shipping and our foam-based Sacs can be reduced to one-eighth of their normal size. With furniture especially suited to ecommerce applications, our sales completed through this channel accounted for 74% and 66% of total sales for the thirteen and twenty-six weeks ended August 2, 2020; up from 19.6% and 20.1% for the thirteen and twenty-six weeks ended August 4, 2019. Our showrooms and other direct advertising and marketing efforts work in concert to drive customer conversion in ecommerce. As a result of COVID-19, we had shifted the focus of our salesforce to our ecommerce platform when our showrooms were closed and experienced accelerated sales growth through this channel. We have adapted our systems, technology and logistics capabilities to manage the increase in online demand. We plan to continue to develop our digital capabilities and invest in our technological infrastructure.

We also utilize other sales channels, such as pop-up shops and shop-in-shops, and will continue to explore other partnerships and opportunities to promote our products and to facilitate customers interacting with our products. The pop-up shop showrooms display select Sacs and Sactionals and are staffed with associates trained to demonstrate and sell our products. Unlike the 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. We have an ongoing working relationship with Costco to operate pop-up shop showrooms, as well as Internet pop-up shop on Costco.com. In the thirteen and twenty-six weeks ended August 2, 2020, we hosted 19 and 154 pop up shop showrooms at Costco locations respectively, down from 209 and 368 Costco shop-in-shops hosted in the thirteen and twenty-six weeks ended August 4, 2019, respectively. Due to the impacts of COVID-19, we do not currently expect any contribution from Costco for the balance of the fiscal year. We also have an ongoing working relationship with Macy’s to operate shop-in-shop showrooms. Other sales which includes pop-up shop sales and shop-in-shop sales accounted for 4.9% and 7.9% of our total sales for the thirteen and twenty-six weeks ended August 2, 2020, respectively, down from 15.4% and 14.6% for the thirteen and twenty-six weeks ended August 4, 2019, respectively.

Despite the increase in sales, net losses were $1.1 million and $9.5 million for the thirteen and twenty-six weeks ended August 2, 2020, respectively, and $4.8 million and $13.9 million for the thirteen and twenty-six weeks ended August 4, 2019, respectively. SG&A as a percent to net sales for the thirteen weeks ended August 2, 2020 decreased 7.9% primarily due to leveraging of employment costs, rent, and selling related expenses such as credit card fees and pop-up shop fees, partially offset by increases in insurance costs, equity compensation and computer expense related to infrastructure investments. SG&A as a percent to net sales for the twenty-six weeks ended August 2, 2020 decreased 9.1% primarily due to leveraging employment costs, rent, selling related expenses such as credit card fees and pop-up shop fees, and equity based compensation, partially offset by increases in insurance and computer expense related to infrastructure investments.

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, many U.S. states and localities issued lockdown orders impacting the operations of our stores and consumer demand. Since then, the COVID-19 situation within the U.S. has rapidly escalated. On March 18, 2020, we closed all of our showroom locations. All showrooms have since reopened in some format, many still virtual or by appointment only. We have followed and will continue to follow the guidance of federal, state, and local governments, as well as health organizations, to determine the operating status of our showrooms. Additionally, we implemented a reduction in workforce of approximately 447 part time employees (representing 57% of our total headcount) as well as a temporary reduction in executive cash compensation. Cash compensation was reduced by 20% for Shawn Nelson, Chief Executive Officer, Jack Krause, President and Chief Operating Officer, and Donna Dellomo, Executive Vice President and Chief Financial Officer. The base salaries of all other senior management and full-time headquarter team members has been temporarily reduced by graduated amounts. Our Board of Directors has also agreed to a temporary reduction of its retainer and monitoring fees and an extension of the associated payment timeline. As of August 2, 2020, we had hired 137 part time showroom associates to assist with showroom sales. We continue to monitor the situation closely and it is possible that we will implement further measures.

While the COVID-19 pandemic led to shifts in the way in which we operate, 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, we experienced increased growth during this period. Our net sales increased $13.8 million, or 28.7%, to $61.9 million in the thirteen weeks ended August 2, 2020 compared to $48.1 million in the thirteen weeks ended August 4, 2019 driven by our Internet sales. Internet sales (sales made directly to customers through our ecommerce channel) increased $36.6 million, or 387.2%, to $46.1 million in the thirteen weeks ended August 2, 2020 compared to $9.5 million for the thirteen weeks ended August 4, 2019.  The increase in Internet sales was driven in part by a very strong “Heroes” campaign, which honored first responders and frontline workers, that attracted new customers to our brand while driving over half of our sales during the period in which it ran from April 3, 2020 to May 31, 2020 with redemption lingering into early June 2020.  New customers increased by 47.8% in the thirteen weeks ended August 2, 2020 as compared to 15.9% in the thirteen weeks ended August 4, 2019.  We redeployed 179 full-time field associates, leveraging numerous forms of one-on-one virtual customer interactions such as Facebook live events, Facetime, text messaging and Podium chat systems. We believe that these tactics, which bolster our ongoing direct-to-consumer core competencies, allow us to capitalize on the accelerated growth and demand. Due to the significant growth of our ecommerce platform, we have adapted our systems, technology and supply chain and logistics capabilities to manage the increase in online demand. We plan to continue to develop our digital capabilities and invest in our technological infrastructure.

In an effort to appropriately manage the business in this uncertain environment, we tightly managed our cash outlay. In addition to temporary reduction in compensation of employees and Board of Directors, we also tightly managed inventory purchases, marketing and promotion spend, working capital and capital expenditure. As a result, we had a cash position of $54.8 million as of August 2, 2020.

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 2, 2020 and the summary condensed consolidated balance sheet data as of August 2, 2020, 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 included in our Annual Report on Form 10-K for the most recent fiscal year and our unaudited condensed consolidated financial statements including the notes to those financial statements included elsewhere in this Quarterly Report 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 loss to EBITDA and Adjusted EBITDA for the periods presented:

How We Assess the Performance of Our Business

In assessing the performance of our business, we consider a variety of financial and operating measures, including the following:

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

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 2, 2020 Compared to the Thirteen weeks ended August 4, 2019

Net sales

Net sales increased $13.8 million, or 28.7%, to $61.9 million in the thirteen weeks ended August 2, 2020 compared to $48.1 million in the thirteen weeks ended August 4, 2019. The increase in overall net sales was driven by our Internet sales. New customers increased by 47.8% in the thirteen weeks ended August 2, 2020 as compared to 15.9% in the thirteen weeks ended August 4, 2019. We had 97 and 80 showrooms as of August 2, 2020 and August 4, 2019, respectively. We opened 8 additional showrooms, closed 2 showrooms and remodeled 1 showroom in the thirteen weeks ended August 2, 2020. Showrooms sales decreased $18.4 million, or 58.9%, to $12.9 million in the thirteen weeks ended August 2, 2020 as compared to $31.3 million in the thirteen weeks ended August 4, 2019. This decrease was due in large part to our comparable showroom point of sales transaction decrease of $11.5 million, or 45.3%, to $13.8 million in the thirteen weeks ended August 2, 2020 as a result of showroom closures due to COVID-19, compared to $25.3 million in thirteen weeks ended August 4, 2019. 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 decreased $250, or 56.3%, to $194 in the thirteen weeks ended August 2, 2020 as a result of showroom closures due to COVID-19, compared to $444 in the thirteen weeks ended August 4, 2019. Total number of units sold at point of transaction decreased by approximately 56.5% driven by COVID-19 showroom closures. Internet sales (sales made directly to customers through our ecommerce channel) increased $36.6 million, or 387.2%, to $46.1 million in the thirteen weeks ended August 2, 2020 compared to $9.5 million for the thirteen weeks ended August 4, 2019. We believe that the increase in Internet sales was due primarily to our showroom closures related to the impact of COVID-19 and our increased advertising and marketing initiatives. Other sales, which include pop-up shop sales and shop-in-shop sales, decreased $4.4 million, or 59.3%, to $3.0 million in the thirteen weeks ended August 2, 2020 as compared to $7.4 million in the thirteen weeks ended August 4, 2019. This decrease was due to pop-up shops and shop-in-shops closures as a result of COVID-19, partially offset by the addition of Internet pop-up shops.

Gross profit

Gross profit increased $6.8 million, or 27.9%, to $31.1 million in the thirteen weeks ended August 2, 2020 from $24.3 million in the thirteen weeks ended August 4, 2019. Gross margin decreased to 50.1% of net sales in the thirteen weeks ended August 2, 2020 from 50.4% of net sales in the thirteen weeks ended August 4, 2019. The decrease in gross margin percentage of 31 basis points was driven by an increase of approximately 198 basis points in distribution and tariff related expenses, partially offset by improvements of approximately 167 basis points in reduction in product costs as a result of vendor negotiations to assist with the mitigation of tariffs and continued shift of products from China to Vietnam and Malaysia.

Selling, general and administrative expenses

Selling, general and administrative expenses increased $1.4 million, or 6.5%, to $23.4 million in thirteen weeks ended August 2, 2020 as compared to $22.0 million in the prior year period. The increase in selling, general and administrative expenses was primarily related to $0.6 million of increased rent associated with our 97 showrooms, partially offset by a decrease in employment costs of $0.5 million and decrease of expenses related to sales such as a reduction of $1.3 million of pop-up shop sales agent fees. Overhead expenses increased $2.6 million consisting of an increase of $2.0 million in infrastructure improvements, an increase of $0.4 million related to operating costs of the business such as insurance and an increase in equity-based compensation of $0.5 million, partially offset by a decrease of $0.3 million in travel and entertainment costs as a result travel restrictions from COVID-19.

Selling, general and administrative expenses were 37.7% of net sales in the thirteen weeks ended August 2, 2020 compared to 45.6% of net sales in the thirteen weeks ended August 4, 2019. The decrease in selling, general and administrative expenses of 7.9% of net sales was primarily due to leveraging employment costs, rent, and selling related expenses such as credit card fees and pop-up shop fees, partially offset by increases in insurance costs, equity compensation and computer expense related to infrastructure investments.

Advertising and Marketing

Advertising and marketing expenses increased $1.1 million, or 18.1%, to $7.2 million in the thirteen weeks ended August 2, 2020 compared to $6.1 million in the thirteen weeks ended August 4, 2019. The majority of the increase in advertising and marketing dollars relates to increased media and direct to consumer programs which are expected to drive revenue beyond the period of the expense. The investment by quarter may vary greatly. Advertising and marketing expenses were 11.6% of net sales in the thirteen weeks ended August 2, 2020 compared to 12.6% of net sales in the thirteen weeks ended August 4, 2019. The majority of the decrease in advertising and marketing as a percent of net sales is principally due to reduced rates in media which is not likely to repeat into next year.

Depreciation and amortization expenses

Depreciation and amortization expenses increased $0.3 million or 28.0% in the thirteen weeks ended August 2, 2020 to $1.5 million compared to $1.2 million in the thirteen weeks ended August 4, 2019. The increase in depreciation and amortization expense principally relates to capital investments for new and remodeled showrooms.

Interest (expense) income, net

Interest (expense) income, net reflects ($0.03 million) consisting of $0.01 million in earnings related to the net proceeds from the IPO and primary share offering, offset by $0.04 million of interest expense related to unused line fees on the Company’s line of credit for the thirteen weeks ended August 2, 2020. The decrease in interest income from prior year was the result of a decrease in interest rates during the thirteen weeks ended August 2, 2020.

Provision for income taxes

Income tax provision was less than 0.06% and 0.02% of sales for the thirteen weeks ended August 2, 2020 and August 4, 2019, respectively.

Twenty-six weeks ended August 2, 2020 Compared to the Twenty-six weeks ended August 4, 2019

Net sales

Net sales increased $27.2 million, or 30.5%, to $116.3 million in the twenty-six weeks ended August 2, 2020 compared to $89.1 million in the twenty-six weeks ended August 4, 2019. The increase in overall net sales was driven by an increase in our Internet sales. New customers increased by 52.5% in the twenty-six weeks ended August 2, 2020 as compared to 17.8% in the twenty-six weeks ended August 4, 2019. We had 97 and 80 showrooms as of August 2, 2020 and August 4, 2019, respectively. We opened 8 additional showrooms, permanently closed 1 showroom, and temporarily closed 91 showrooms in the twenty-six weeks ended August 2, 2020 related to COVID-19. Showrooms sales decreased $27.2 million, or 46.8%, to $31.0 million in the twenty-six weeks ended August 2, 2020 as compared to $58.2 million in twenty-six weeks ended August 4, 2019. This decrease was due in large part to our comparable showroom point of sales transaction decrease of $18.2 million, or 39.0%, to $28.5 million in the twenty-six weeks ended August 2, 2020 as a result of showroom closures due to COVID-19, compared to $46.7 million in twenty-six weeks ended August 4, 2019. 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 decreased $445, or 52.5%, to $403 in the twenty-six weeks ended August 2, 2020 as a result of showroom closures due to COVID-19, compared to $848 in the twenty-six weeks ended August 4, 2019. Total number of units sold at point of transaction decreased by approximately 52.6% driven by COVID-19 showroom closures. Internet sales (sales made directly to customers through our ecommerce channel) increased $58.2 million, or 325.0%, to $76.1 million in the twenty-six weeks ended August 2, 2020 compared to $17.9 million for the twenty-six weeks ended August 4, 2019. We believe that the increase in Internet sales was due primarily to our showroom closures related to the impact of COVID-19 and our increased advertising and marketing initiatives. Other sales, which include pop-up shop sales and shop-in-shop sales, decreased $3.8 million, or 29.2%, to $9.2 million in the twenty-six weeks ended August 2, 2020 as compared to $13.0 million in the twenty-six weeks ended August 4, 2019. This decrease was due in large part to pop-up shops and shop-in-shops which were closed temporarily as a result of COVID-19, partially offset by the addition of Internet pop-up shops.

Gross profit

Gross profit increased $13.1 million, or 28.9%, to $58.3 million in the twenty-six weeks ended August 2, 2020 from $45.3 million in the twenty-six weeks ended August 4, 2019. Gross margin decreased to 50.2% of net sales in the twenty-six weeks ended August 2, 2020 from 50.8% of net sales in the twenty-six weeks ended August 4, 2019. The decrease in gross margin percentage of 66 basis points was driven by an increase of approximately 247 basis points in distribution and tariff related expenses, partially offset by improvements of approximately 181 basis points in reduction in product costs as a result of vendor negotiations to assist with the mitigation of tariffs and continued shift of products from China to Vietnam and Malaysia.

Selling, general and administrative expenses

Selling, general and administrative expenses increased $3.4 million, or 7.4%, to $49.2 million in twenty-six weeks ended August 2, 2020 as compared to $45.8 million in the prior year period. The increase in selling, general and administrative expenses was primarily related to an increase in employment costs of $1.0 million, $0.7 million of increased rent associated with our 97 showrooms and a decrease of $0.7 million of expenses related to sales such as an increase of $0.7 million of credit card fees, offset by a reduction of $1.4 million of pop-up shop sales agent fees. Overhead expenses increased $2.4 million consisting of an increase of $4.2 million in infrastructure improvements and an increase of $0.6 million related to operating costs of the business such as insurance, partially offset by a decrease in equity-based compensation of $1.8 million and a decrease of $0.6 million in travel and entertainment costs as a result of travel restrictions from the impact of COVID-19 on our business.

Selling, general and administrative expenses were 42.3% of net sales in the twenty-six weeks ended August 2, 2020 compared to 51.4% of net sales in the twenty-six weeks ended August 4, 2019. The decrease in selling, general and administrative expenses of 9.1% of net sales was primarily due to leveraging employment costs, rent, selling related expenses such as credit card fees and pop-up shop fees, and equity based compensation, partially offset by increases in insurance and computer expense related to infrastructure investments.

Advertising and Marketing

Advertising and marketing expenses increased $3.9 million, or 34.1%, to $15.4 million in the twenty-six weeks ended August 2, 2020 compared to $11.5 million in the twenty-six weeks ended August 4, 2019. The majority of the increase in advertising and marketing dollars relates to increased media and direct to consumer programs which are expected to drive revenue beyond the period of the expense. The investment by quarter may vary greatly. Advertising and marketing expenses were 13.2% of net sales in the twenty-six weeks ended August 2, 2020 compared to 12.9% of net sales in the twenty-six weeks ended August 4, 2019. The majority of the increase in advertising and marketing as a percent of net sales is principally due to prior year investments in content production, product innovation and research. These investments were included in prepaid expenses and other current assets on the condensed consolidated balance sheet as of February 2, 2020 and were expensed in the twenty-six weeks ended August 2, 2020.

Depreciation and amortization expenses

Depreciation and amortization expenses increased $0.9 million or 40.0% in the twenty-six weeks ended August 2, 2020 to $3.2 million compared to $2.3 million in the twenty-six weeks ended August 4, 2019. The increase in depreciation and amortization expense principally relates to capital investments for new and remodeled showrooms.

Interest income (expense), net

Interest income (expense), net reflects $0.02 million consisting of $0.1 million in earnings related to the net proceeds from the IPO and primary share offering, partially offset by $0.08 million of interest expense related to unused line fees on the Company’s line of credit for the twenty-six weeks ended August 2, 2020. The decrease in interest income from prior year was the result of a decrease in interest rates during the twenty-six weeks ended August 2, 2020.

Provision for income taxes

Income tax provision was less than 0.06% and 0.01% of sales for the twenty-six weeks ended August 2, 2020 and August 4, 2019, 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 (Used In) Operating Activities

Cash from operating activities consists primarily of net 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 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.

In the twenty-six weeks ended August 4, 2019, net cash used by operating activities was $23.0 million and consisted of changes in operating assets and liabilities of $14.8 million, a net loss of $13.8 million, and adjustments to reconcile net loss to cash used in operating activities of $5.6 million. Working capital and other activities consisted primarily of increases in inventory of $14.5 million, prepaid expenses of $1.1 million and accounts receivable of $1.6 million, partially offset by increases in accounts payable and accrued expenses of $1.9 million, and customer deposits of $0.5 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 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.

For the twenty-six weeks ended August 4, 2019, capital expenditures were $4.1 million as a result of investments in new and remodeled showrooms and intangibles such as patents and trademarks.

Net Cash (Used In) Provided By Financing Activities

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

For 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.

For the twenty-six weeks ended August 4, 2019, net cash provided by financing activities was $22.2 million, primarily due to $25.6 million of net proceeds from a primary share offering in May 2019.

Revolving Line of Credit

On February 6, 2018, we entered a five-year, secured revolving credit facility with 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 2, 2020, the Company’s borrowing availability under the line of credit with Wells was $9.9 million. As of August 2, 2020, there were no borrowings outstanding on this line of credit.

Contractual Obligations

We generally enter into long term contractual obligations and commitments in the normal course of business, primarily debt obligations and non-cancelable operating leases. As of August 2, 2020, our contractual cash obligations over the next several periods were as follows:

Off Balance Sheet Arrangements

We have no material off balance sheet arrangements as of August 2, 2020, except for operating leases and 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 29, 2020 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 2, 2020.

Recent Accounting Pronouncements

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

In February 2016, FASB issued ASU No. 2016-02, Leases (Topic 842) amending lease guidance to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. ASU No. 2019-10 extended the effective date to fiscal years beginning after December 15, 2020, and interim periods within fiscal years beginning after December 15, 2021, with early adoption permitted. We will adopt this standard beginning in 2022. Management has evaluated the impact ASU No. 2016-02 will have on these condensed consolidated financial statements. Based on the initial evaluation, we have determined that adopting this standard will have a material impact on our condensed consolidated balance sheet as we have a significant number of operating leases.

In June 2018, the FASB issued ASU 2018-07, Improvements to Nonemployee Share-Based Payment Accounting (Topic 718). ASU 2018-07 eliminates the separate accounting model for nonemployee share-based payment awards and generally requires companies to account for share-based payment transactions with nonemployees in the same way as share-based payment transactions with employees. The accounting remains different for attribution, which represents how the equity-based payment cost is recognized over the vesting period, and a contractual term election for valuing nonemployee equity share options. ASU 2018-07 is effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. Early adoption is permitted, but no earlier than an entity’s adoption of Topic 606. Management is currently evaluating the impact ASU 2018-07 will have on these condensed consolidated financial statements.

Item 3. Quantitative and Qualitative Disclosures about Market Risk.

Not Applicable.

Item 4. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our principal executive officer and 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 principal executive officer and principal 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 and twenty-six weeks ended August 2, 2020 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 February 2, 2020.

The COVID-19 pandemic may have a significant negative impact on our business, sales, results of operations and financial condition.

The global outbreak of COVID-19 has led to severe disruptions in general economic activities, particularly retail operations, as businesses and federal, state, and local governments take increasingly broad actions to mitigate this public health crisis. We have experienced significant disruption to our business, both in terms of disruption of our operations and the adverse effect on overall economic conditions. All of our showroom locations and shop-in-shops closed in March 2020 due to the regulations implemented by federal, state and local government in response to COVID-19. All of our showrooms have since reopened in some format, many still virtual or by appointment only. All of our shop-in-shops have also reopened pursuant to applicable guidelines. We have followed and will continue to follow the guidance of federal, state and local governments as well as local health organizations to determine the operating status of our showrooms, shop-in-shops and pop-up shops. Health concerns, social distancing measures or changes in consumer spending behaviors due to COVID-19 may continue to impact traffic in our showrooms as they resume operations. We may incur significant additional costs to ensure we meet the needs of our team members and customers, including additional cleanings of our showrooms and other facilities. In response to the showroom and shop-in-shop closures and to help mitigate the impact of the pandemic, we have increased marketing of our website and e-commerce platform.

Additionally, we implemented a reduction in workforce of approximately 447 part-time employees (representing 57% of our total headcount) as well as a temporary reduction in executive cash compensation. As of August 2, 2020, we had hired 137 part-time showroom associates to assist with showroom sales. Our business is also dependent on the continued health and productivity of our associates, including showroom, region and corporate management teams, throughout this crisis. Individually and collectively, the consequences of the COVID-19 outbreak could have a material adverse effect on our business, sales, results of operations and financial condition.

Additionally, our liquidity could be negatively impacted if these conditions continue for a significant period of time, and we may be required to pursue additional sources of financing to obtain working capital, maintain appropriate inventory levels, and meet our financial obligations. Currently capital and credit markets have been disrupted by the crisis and our ability to obtain any required financing is not guaranteed and largely dependent upon evolving market conditions and other factors. Depending on the continued impact of the crisis, further actions may be required.

The extent to which the COVID-19 outbreak and governmental responses thereto ultimately impacts our business, sales, results of operations and financial condition will depend on future developments, which are highly uncertain and cannot be predicted, including, but not limited to, the duration and spread of the outbreak, its severity, the actions to contain the virus or treat its impact, and how quickly and to what extent normal economic and operating conditions can resume. Even after the COVID-19 outbreak has subsided, we may continue to experience significant impacts to our business as a result of its global economic impact, including any economic downturn or recession that has occurred or may occur in the future. The potential effects of COVID-19 also could impact many of our risk factors included in our Form 10-K for the fiscal year ended February 2, 2020; however, the potential impact remains uncertain.

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

Not Applicable.

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.

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