# Lovesac Co (LOVE) FY 2025 MD&A Verbatim Item 7 Management's Discussion and Analysis from Lovesac Co's 10-K for fiscal year 2025. SEC filing source: https://www.sec.gov/Archives/edgar/data/1701758/000162828025017241/love-20250202.htm Accession: 0001628280-25-017241 Filing date: 2025-04-10 Report date: 2025-02-02 Extracted from Item 7 to the first post-MD&A boundary after HTML sanitization. Confidence: high Company profile: /company/LOVE/ All MD&A years: /company/LOVE/mda/ Previous year: /company/LOVE/mda/fy2024/ (FY 2024) Next year: /company/LOVE/mda/fy2026/ (FY 2026) Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our financial statements and related notes appearing elsewhere in this Annual Report on Form 10-K. As discussed in the section titled “Forward-Looking Statements,” the following discussion and analysis contains forward-looking statements that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. Factors that could cause or contribute to these differences include, but are not limited to, those identified below and those discussed in the section titled “Risk Factors” under Part I, Item 1A in this Annual Report on Form 10-K. We operate on a 52- or 53-week fiscal year that ends on the Sunday closest to February 1. Each fiscal year generally is comprised of four 13-week fiscal quarters, although in the years with 53 weeks, the fourth quarter represents a 14-week period. The fiscal year ended February 2, 2025 consisted of 52 weeks. Fiscal years 2024 and 2023 consisted of 53 weeks and 52 weeks, respectively. 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, the immersive surround sound home theater system called StealthTech, and the 35 Table of Contents most recently launched PillowSacTM Accent Chair and Sactionals Reclining Seat. 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 points in the form of our own showrooms, which include our mobile concierge and kiosks, and online directly at 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. Our Operations See Item 1. Business for information on our products, customers, business model, channels, growth strategies, seasonality and other factors describing our business. Factors Affecting Our Operating Results While our growth strategy has contributed to our improving operating results, it also presents significant risks and challenges. The timing and magnitude of new showroom openings, existing showroom renovations, and marketing activities may affect our results of operations in future periods. These strategic initiatives will require substantial expenditures. Other factors that could affect our results of operations in future periods include: Macroeconomic Factors There are a number of macroeconomic factors and uncertainties affecting the overall business environment and our business, including increased inflation, elevated interest rates, housing market conditions, consumer debt and available credit, increased tariffs and trade restrictions, global conflicts 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, 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 in future periods. Seasonality in Quarterly Results Our business is seasonal. As a result, our revenues fluctuate from quarter to quarter, which often affects the comparability of our results between periods. Working capital requirements are typically higher in the third fiscal quarter due to inventory built-up in advance of the holiday selling season. Net sales are historically higher in the fourth fiscal quarter due primarily to the impact of the holiday selling season. As such, results of a period shorter than a full year may not be indicative of results expected for the entire year. Competition The retail industry is highly competitive and retailers compete based on a variety of factors, including design, quality, price and customer service. Levels of competition and the ability of our competitors to attract customers through competitive pricing or other factors may impact our results of operations. How We Assess the Performance of Our Business We consider a variety of financial and operating measures, including the following, to evaluate our business, measure our performance, identify trends affecting our business, formulate business plans, and make strategic decisions. Net Sales Net sales reflect our sale of merchandise plus shipping and handling revenue less returns and discounts. 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 36 Table of Contents 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 U.S. GAAP. 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. Repeat customers accounted for approximately 46.8% of all transactions in fiscal 2025 compared to 43.6% in fiscal 2024. We expect a healthy mix between new and repeat customers in our transaction mix as we spend on acquiring new customers. Cost of Merchandise Sold Cost of merchandise sold includes the direct cost of sold merchandise; inventory shrinkage; inventory adjustments due to obsolescence, including excess and slow-moving inventory and lower of cost or net realizable value reserves; inbound freight; freight costs to ship merchandise to our showrooms, and warehousing and all logistics costs associated with shipping product to our customers. Certain competitors and other retailers may report gross profit differently than we do, by excluding from gross profit some or all of the costs related to their distribution network and instead including them in selling, general and administrative expenses. As a result, the reporting of our gross profit and profit margin may not be comparable to other companies. The primary drivers of our cost of merchandise sold are raw materials costs, labor costs in the countries where we source our merchandise, and logistics costs. We expect gross profit to increase to the extent that we successfully grow our net sales and continue to realize scale economics with our manufacturing partners. We review our inventory levels on an ongoing basis in order to identify slow-moving merchandise and use product markdowns to efficiently sell these products. The timing and level of markdowns are driven primarily by customer acceptance of our merchandise. Gross Profit Gross profit is equal to our net sales less cost of merchandise sold. Gross profit as a percentage of our net sales is referred to as gross margin. Selling, General and Administrative Expenses Selling, general and administrative expenses include all operating costs, other than advertising and marketing expense and depreciation and amortization, 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; customer financing fees; 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. Historically, our 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 to increase as we grow our business. We expect to leverage total selling, general and administrative expenses as a percentage of net sales as net sales volumes continue to grow. We expect to continue to invest in infrastructure to support the Company’s growth. Our continued infrastructure investments include research and development costs on our existing and future products and foundational technology investments to support our continued 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 greatest leverage occurring within the fourth quarter. Advertising and Marketing Expense Advertising and marketing expense include digital, social, and traditional advertising and marketing initiatives, that cover all of our business channels. Advertising and marketing expenses are projected to rise as the Company drives net sales growth, supported by ongoing investments in these areas and careful monitoring to ensure efficient resource allocation.. 37 Table of Contents Basis of Presentation and Results of Operations The following discussion provides an analysis of the Company’s financial condition and results of operations from management's perspective and should be read in conjunction with the financial statements and related notes included in this report. The discussion in this Form 10-K generally focuses on fiscal 2025 compared to fiscal 2024. Our fiscal 2024 results contain an additional, non-comparable 53rd week when compared to fiscal 2025. A discussion of our results of operations and changes in financial condition for fiscal 2024 compared to fiscal 2023 has been excluded from this report, but can be found in Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations in our fiscal 2024 Annual Report on Form 10-K. Results of Operations The following table summarizes key components of our results of operations for fiscal 2025, 2024, and 2023: [[GREPCENT_TABLE]] [["","","2025","","2024","","2023","","2025","","2024","","2023"],["","","(In thousands)","","(Percentage of net sales)"],["Net sales"],["Showrooms","","$","425,863","","","$","437,394","","","$","398,184","","","62.6","%","","62.5","%","","61.2","%"],["Internet","","196,313","","","199,778","","","176,519","","","28.8","%","","28.5","%","","27.1","%"],["Other","","58,452","","","63,093","","","76,476","","","8.6","%","","9.0","%","","11.7","%"],["Total net sales","","680,628","","","700,265","","","651,179","","","100.0","%","","100.0","%","","100.0","%"],["Cost of merchandise sold","","282,793","","","299,222","","","307,528","","","41.5","%","","42.7","%","","47.2","%"],["Gross profit","","397,835","","","401,043","","","343,651","","","58.5","%","","57.3","%","","52.8","%"],["Operating expenses:"],["Selling, general and administrative expenses","","281,450","","","264,314","","","215,979","","","41.4","%","","37.7","%","","33.2","%"],["Advertising and marketing","","88,027","","","94,050","","","79,864","","","12.9","%","","13.4","%","","12.3","%"],["Depreciation and amortization","","14,710","","","12,603","","","10,842","","","2.2","%","","1.8","%","","1.7","%"],["Total operating expenses","","384,187","","","370,967","","","306,685","","","56.5","%","","52.9","%","","47.2","%"],["Operating income","","13,648","","","30,076","","","36,966","","","2.0","%","","4.4","%","","5.6","%"],["Interest and other income (expense), net","","2,801","","","1,747","","","(117)","","","0.4","%","","0.2","%","","\u2014","%"],["Net income before taxes","","16,449","","","31,823","","","36,849","","","2.4","%","","4.6","%","","5.6","%"],["Income tax expense","","4,893","","","7,962","","","10,361","","","0.7","%","","1.1","%","","1.6","%"],["Net income","","$","11,556","","","$","23,861","","","$","26,488","","","1.7","%","","3.5","%","","4.0","%"]] [[/GREPCENT_TABLE]] Other Operational Data Our recent showroom growth is summarized in the following table: [[GREPCENT_TABLE]] [["Showroom Count:","","February 2, 2025","","February 4, 2024"],["Showrooms open at beginning of period","","230","","195"],["Showrooms opened","","39","","46"],["Showrooms closed","","(12)","","(11)"],["Showrooms open at end of period(1)","","257","","230"],["Showroom remodels","","\u2014","","","\u2014"]] [[/GREPCENT_TABLE]] (1) Showrooms open at the end of the period include 1 kiosk and 2 mobile concierges as of fiscal 2025, and 6 kiosks and 2 mobile concierges as of fiscal 2024. 38 Table of Contents Fiscal 2025 Compared to Fiscal 2024 Net sales Net sales decreased $19.7 million, or 2.8%, in fiscal 2025 compared to fiscal 2024 driven by a decrease of 9.3% in omni-channel comparable net sales, partially offset by new showroom openings. New customers increased by 1.4% in fiscal 2025 as compared to 13.3% in fiscal 2024. Showroom net sales decreased $11.5 million, or 2.6% in fiscal 2025 compared to fiscal 2024. Internet sales (sales made directly to customers through our ecommerce channel) decreased $3.5 million, or 1.7%, in fiscal 2025 compared to fiscal 2024. Other sales, which include pop-up-shop sales, shop-in-shop sales and barter inventory transactions, decreased $4.6 million, or 7.4% in fiscal 2025 compared to fiscal 2024. The decrease was primarily driven by a reduction in barter transactions coupled with lower productivity of our temporary online pop-up-shops on Costco.com, partially offset by an increase in Best Buy shop-in-shop sales. We opened 5 additional Best Buy shop-in-shop locations compared to the prior year. Gross profit Gross profit decreased $3.2 million, or 0.8%, in fiscal 2025 compared to fiscal 2024. Gross margin increased 120 basis points to 58.5% of net sales in fiscal 2025 from 57.3% of net sales in fiscal 2024. The increase was primarily driven by a decrease of 240 basis points in inbound transportation costs, partially offset by a decrease of 80 basis points in product margin driven by higher promotional discounting and an increase of 40 basis points in outbound transportation and warehousing costs. Selling, general and administrative expenses SG&A expenses increased $17.2 million, or 6.5%, in fiscal 2025 compared to fiscal 2024. The increase was primarily related to increases of $15.8 million in payroll, $3.7 million in equity-based compensation, $1.7 million in rent, $1.5 million related to a settlement with the SEC, and $1.1 million in professional fees, partially offset by decreases of $5.0 million in credit card fees and $1.6 million in other overhead costs. As a percentage of net sales, SG&A was 41.4% in fiscal 2025, compared to 37.7% in fiscal 2024. Advertising and marketing expenses Advertising and marketing expenses decreased $6.1 million, or 6.4%, in fiscal 2025 compared to fiscal 2024. Advertising and marketing expenses were 12.9% and 13.4% of net sales in fiscal 2025 and 2024, respectively. Depreciation and amortization expenses Depreciation and amortization expenses increased $2.1 million, or 16.7%, in fiscal 2025 compared to fiscal 2024, primarily driven by assets being placed into service related to leasehold improvements for new showrooms. Interest and other income, net Interest and other income, net was $2.8 million in fiscal 2025 compared to $1.7 million in fiscal 2024. The increase in interest income was primarily the result of higher cash deposits in the Company's interest-bearing bank accounts combined with higher interest rates. Income tax expense Income tax expense was $4.9 million in fiscal 2025 compared to $8.0 million in fiscal 2024. The decrease is primarily driven by lower net income before taxes, partially offset by an increase in the effective tax rate. 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. At February 2, 2025, we had $83.7 million in cash and cash 39 Table of Contents equivalents. Our primary cash needs are for marketing and advertising, inventory, payroll, showroom rent, capital expenditures associated with opening new showrooms and updating existing showrooms, as well as infrastructure and information technology. We periodically use cash to repurchase shares of our common stock under our share repurchase program. The most significant components of our working capital are cash and cash equivalents, merchandise inventory, prepaid expenses, accounts payable, accrued expenses, customer deposits, and other current liabilities. 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. Capital Expenditures Historically, we have invested significant capital expenditures in opening new showrooms and updating existing showrooms. These capital expenditures have increased in the past and may continue to increase in future periods as we open additional showrooms. Capital expenditures are anticipated to support our showroom growth, including capital outlays for leasehold improvements, fixtures and equipment, and the construction of new showrooms. Cash paid for capital expenditures was $21.5 million in fiscal 2025. Capital expenditures are projected to be in the range of $22.0 million to $28.0 million for fiscal 2026. Leases The majority of our operating leases relate to company showrooms. We also lease our corporate facilities. At February 2, 2025, we had aggregate lease obligations of $222.9 million, with $32.0 million payable within 12 months. See Note 6, “Leases” of the Notes to Financial Statements for further discussion of our operating leases. Cash Flow Analysis The following table summarizes operating, investing, and financing activities for fiscal 2025, 2024, and 2023: [[GREPCENT_TABLE]] [["in thousands","","2025","","2024","","2023"],["Net cash provided by (used in) operating activities","","$","38,977","","","$","76,441","","","$","(21,375)"],["Net cash used in investing activities","","(21,517)","","","(29,211)","","","(25,549)"],["Net cash used in financing activities","","(20,762)","","","(3,727)","","","(1,935)"],["Net change in cash and cash equivalents","","(3,302)","","","43,503","","","(48,859)"],["Cash and cash equivalents at end of period","","$","83,734","","","$","87,036","","","$","43,533"]] [[/GREPCENT_TABLE]] Net cash provided by (used in) operating activities Net cash provided by (used in) operating activities consists primarily of net income adjusted for certain non-cash items, including depreciation and amortization, equity based compensation, non-cash lease expense, and deferred income taxes, and the effect of changes in working capital and other activities. Net cash provided by operating activities was $39.0 million in fiscal 2025, a decrease from $76.4 million in the prior year period, primarily driven by lower net income and changes in working capital related to inventory management actions and income taxes paid. The decrease was partially offset by cash inflows resulting from the timing of payments to vendors. Net cash used in investing activities Investing activities consist primarily of investments related to capital expenditures for new showroom openings and the acquisition of intangible assets. Net cash used in investing activities was $21.5 million in fiscal 2025, a decrease from $29.2 million in the prior year period, primarily attributable to a reduction in capital expenditures, driven by a year-over-year decrease in the number of new showroom openings. Net cash used in financing activities Financing activities consist primarily of repurchases of our common stock, taxes paid for the net settlement of equity awards and payment of deferred financing costs. 40 Table of Contents Net cash used in financing activities was $20.8 million in fiscal 2025, an increase from $3.7 million in the prior year period, primarily resulting from repurchases of our common stock beginning in fiscal 2025. Revolving Line of Credit On March 25, 2022, we amended our existing credit agreement providing for an asset-based revolving credit facility with the lenders party thereto, and Wells Fargo Bank, National Association ("Wells Fargo Bank"), 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. 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. On March 24, 2023, the Company amended the credit agreement to extend the maturity date to September 30, 2024. On July 29, 2024, we amended the credit agreement to add an uncommitted accordion feature that allows the Company, subject to certain customary conditions, to increase the size of the revolving credit facility by $10 million and, among other things, extend the maturity date of the loans made under the Amendment from September 30, 2024 to July 29, 2029. For additional information regarding our line of credit with Wells Fargo Bank, see Note 8. Financing Arrangements in the Notes to the Financial Statements included in Part IV of this report. As of February 2, 2025 and February 4, 2024, the Company’s borrowing availability under the line of credit was $32.6 million and $36.0 million, respectively, and there were no outstanding borrowings under our credit facility. Share Repurchase On June 11, 2024, our board of directors authorized a share repurchase program for up to $40.0 million of shares of our common stock. Under the share repurchase program, we may repurchase shares from time to time in the open market, privately negotiated transactions and accelerated share repurchase. The timing, volume and nature of share repurchases, if any, will be at our sole discretion and will be dependent on market conditions, liquidity, applicable securities laws, and other factors. We may suspend or discontinue the share repurchase program at any time. We plan on funding any repurchases in the future with our current cash and cash equivalents and future cash flows. As of February 2, 2025, we had $20.1 million available to repurchase shares pursuant to the share repurchase program. For additional information, see Note 9. Stockholders' Equity in the Notes to the Financial Statements included in Part IV of this report. Critical Accounting Policies and Estimates The management's discussion and analysis of financial condition and results of operations is based upon our financial statements, which have been prepared in conformity with U.S. GAAP. Certain accounting policies and estimates are particularly important to the understanding of our financial position and results of operations and requires us to make significant estimates and assumptions. Because of the uncertainty inherent in these matters, actual results may differ from these estimates and could differ based upon other assumptions and conditions. 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, and other various other assumptions that we believe to be reasonable under the circumstances. We evaluate our estimates and assumptions on an ongoing basis. We continue to monitor the effects of global macroeconomic and geopolitical uncertainty,general market, political and economic conditions. 41 Table of Contents All of our significant accounting policies are outlined in Note 1. Basis of Presentation, and Summary of Significant Accounting Policies in the Notes to the Financial Statements included in Part IV of this report. There have been no material changes to the significant accounting policies during fiscal 2025. Barter Arrangements The Company has a bartering arrangement with a third-party vendor, whereby the Company will provide inventory in exchange for media credits. Barter sales transaction with commercial substance are recorded at a transaction price based on the estimated fair value of the non-cash consideration of the media credits to be received and the revenue is recognized when control of inventory is transferred, which is when the inventory is picked up in our warehouse. Fair value is estimated using various considerations, including the cost of similar media advertising if transacted directly, the expected sales price of product given up in exchange for the media credits, and the expected usage of media credits prior to expiration based on forecasted media spend subject to media credits under the barter arrangement. Projecting marketing spend requires estimating such factors as sales growth, inflation, overall economics of the retail industry, and changes in marketing trends, and are therefore subject to variability and difficult to predict, among other things. The Company recognizes an asset for media credits which is subsequently evaluated for impairment at each reporting period for any changes in circumstances. For fiscal 2025, 2024, and 2023, the Company recognized $9.0 million, $12.3 million, and $21.3 million, respectively, of barter sales in exchange for media credits. The Company had $36.7 million and $32.8 million of unused media credits as of February 2, 2025, and February 4, 2024, respectively, and did not recognize any impairment. Impairment of Long-Lived Assets Our long-lived assets consist of property and equipment and right-of-use assets from leases. Property and equipment includes leasehold improvements, and other tangible assets. Long-lived assets are reviewed for potential impairment at such time that events or changes in circumstances indicate that the carrying amount of an asset might not be recovered. We evaluate for impairment at the individual showroom level, which is the lowest level at which individual cash flows can be identified. When evaluating long-lived assets for potential impairment, we will first compare the carrying amount of the assets to the future undiscounted cash flows for the respective long-lived asset. If the estimated future cash flows are less than the carrying amounts of the assets, an impairment loss is measured as the excess of the carrying value over its fair value. We estimate fair value based on future discounted cash flow based on our historical operations of the showroom and estimates of future showroom profitability and economic conditions. These estimates include factors such as sales growth, gross margin, employment costs, lease escalation, and overall macroeconomic conditions, and are therefore subject to variability. Actual future results may differ from those estimates. If required, an impairment loss is recorded for that portion of the assets' carrying value in excess of fair value. In fiscal 2025, 2024, and 2023, we did not recognize any impairment charges for any long-lived assets. Merchandise Inventories Merchandise inventories are comprised of finished goods which are carried at the lower of cost or net realizable value, including warehousing and capitalized freight costs. Cost is determined on a weighted-average method basis. Merchandise inventories consist primarily of foam filled furniture, sectional couches, and related accessories. We adjust our inventory for obsolescence based on historical trends, aging reports, specific identification and its estimates of future retail sales prices. In addition, we include capitalized freight and warehousing costs in inventory related to the finished goods in inventory. Operating Leases The Company determines if a long-term contractual obligation is a lease at inception. The majority of our operating leases relate to company showrooms. We also lease our corporate facilities. These operating leases expire at various dates through fiscal 2035. Showroom leases may include options that allow us to extend the lease term beyond the initial base period, subject to terms agreed upon at lease inception. Some leases also include early termination options, which can be exercised under specific conditions. Our lease agreements do not contain any material residual value guarantees or material restrictive covenants. The Company records lease liabilities at the present value of the lease payments not yet paid, discounted at the rate of interest that the Company would have to pay to borrow on a collateralized basis over a similar term. As the Company's leases do not provide an implicit interest rate, the Company uses an incremental borrowing rate based on the information available at possession date in determining the present value of lease payments. 42 Table of Contents We recognize operating lease cost over the estimated term of the lease, which includes options to extend lease terms that are reasonably certain of being exercised, starting when possession of the property is taken from the landlord, which normally includes a construction period prior to the showroom opening. When a lease contains a predetermined fixed escalation of the fixed rent, we recognize the related operating lease cost on a straight-line basis over the lease term. In addition, certain of our lease agreements include variable lease payments, such as payments based on a percentage of sales that are in excess of a predetermined level and/or increases based on a change in the consumer price index or fair market value. These variable lease payments are excluded from minimum lease payments and are included in the determination of net lease cost when it is probable that the expense has been incurred and the amount can be reasonably estimated. If an operating lease asset is impaired, the remaining operating lease asset will be amortized on a straight-line basis over the remaining lease term. Recent Accounting Pronouncements See Note 1. Basis of Presentation, and Summary of Significant Accounting Policies in the Notes to the Financial Statements included in Part IV of this report for a discussion of recently issued and adopted accounting standards.