The Lovesac Company Quarterly report pursuant to Section 13 or 15(d)

Quarterly report pursuant to Section 13 or 15(d)

Commitments and Contingencies

Commitments and Contingencies

9 Months Ended

Oct. 30, 2022

Commitments and Contingencies Disclosure [Abstract]

Leases

The Company leases its office, warehouse facilities and retail showrooms under operating lease agreements which expire at various dates through January 2033. The Company determines if a contract contains a lease at inception based on our right to control the use of an identified asset and our right to obtain substantially all of the economic benefits from the use of that identified asset. Certain operating leases have renewal options and rent escalation clauses. We assess these options to determine if we are reasonably certain of exercising these options based on all relevant economic and financial factors. Any options that meet these criteria are included in the lease term at lease commencement.

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

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

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

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


	October 30, 2022
Weighted average remaining lease term (in years)
Operating Leases	7.5

Weighted average discount rate
Operating Leases	4.07	%

During the thirteen and thirty-nine weeks ended October 30, 2022 and October 31, 2021, the Company recognized operating lease expense of $6.3 million and $4.9 million and $17.5 million and $13.9 million, respectively. In addition, during the thirteen and thirty-nine weeks ended October 30, 2022 and October 31, 2021, we recognized $4.3 million and $2.9 million and $10.9 million and $7.3 million, respectively, for index-based changes in rent, maintenance, real estate taxes, insurance and other charges included in the lease as well as rental expenses related to short term leases.

We did not recognize any impairment charges associated with showroom-level ROU assets during the thirteen and thirty-nine weeks ended October 30, 2022. During the thirteen and thirty-nine weeks ended October 31, 2021, we recognized impairment charges totaling $0.6 million associated with showroom-level ROU assets that are included as part of selling, general and administrative expenses.

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


(amounts in thousands)	Balance sheet location	October 30, 2022
Assets
Operating leases	Operating lease right-of-use assets (non-current)	$	133,075

Liabilities
Current:
Operating leases	Current operating lease liabilities	$	20,774

Noncurrent:
Operating leases	Operating lease liability, long term	130,229

Total lease liabilities		$	151,003

The table below reconciles the undiscounted future minimum lease payments (displayed by year and in the aggregate) under noncancelable leases with terms of more than one year to the total lease liabilities recognized on the condensed balance sheet as of October 30, 2022:


(amounts in thousands)
Remainder 2023	$	6,600
2024	26,537
2025	25,415
2026	23,204
2027	20,806
Thereafter	74,588
Total undiscounted future minimum lease payments	177,150
Less: imputed interest	(26,147)
Total present value of lease obligations	151,003
Less: current operating lease liability	(20,774)
Operating lease liability- long term	$	130,229

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


(amounts in thousands)	For the Thirty-nine weeks ended October 30, 2022		For the Thirty-nine weeks ended October 31, 2021
Operating cash flow information:
Amounts paid on operating lease liabilities	$	13,227	$	10,396
Non-cash activities
Right-of-use assets obtained in exchange for lease obligations	$	44,934	$	106,415

Severance Contingency

The Company has various employment agreements with its senior level executives. A number of these agreements have severance provisions, ranging from 12 to 18 months of salary, in the event those employees are terminated without cause. The total amount of exposure to the Company under these agreements was $4.9 million at October 30, 2022 if all executives with employment agreements were terminated without cause and the full amount of severance was payable.

Legal Contingency

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