The Lovesac Company (LOVE) Q3 2019 Earnings Report, Transcript and Summary

Greetings, and welcome to The Lovesac Third Quarter Fiscal 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ms. Rachel Schacter of ICR. Thank you. You may begin.

Thank you. Good morning, everyone. With me on the call is Shawn Nelson, Chief Executive Officer; Jack Krause, President and Chief Operating Officer; and Donna Dellomo, Chief Financial Officer. Before we get started, I would like to remind you that some of the information discussed will include forward-looking statements regarding future events and our future financial performance. These include statements about our future expectations, financial projections, and our plans and prospects. Actual results may differ materially from those set forth in such statements. For a discussion of these risks and uncertainties, you should review the company's filings with the SEC, which includes today's press release. You should not rely on our forward-looking statements as predictions of future events. All forward-looking statements that we make on this call are based on assumptions and beliefs as of today, and we undertake no obligations to update them, except as required by applicable law. Our discussion today will include non-GAAP financial measures, including EBITDA and adjusted EBITDA. These non-GAAP measures should be considered in addition to and not as a substitute for or in isolation from our GAAP results. A reconciliation of the most directly comparable GAAP financial measure to such non-GAAP financial measure has been provided as supplemental financial information in our press release. Now, I'd like to turn the call over to Shawn Nelson, Chief Executive Officer of The Lovesac Company.

Thanks Rachel. Good morning everybody and thanks for hanging out with us today. I will begin today’s call by covering the many highlights of our third quarter results followed by further explanation of Lovesac’s highly differentiated business model and our long-term outlook. Then Jack Krause, our President and COO will outline the progress we are making on our current key growth initiatives before Donna Dellomo, our CFO reviews our financial results and a few items related to our outlook in more detail. We had an exceptional third quarter and we’re thrilled with our financial results. Net sales increased by 70.9% to $41.7 million. Total comparable sales, which includes same showroom and Internet sales, increased 51%, driven by a strong showroom comp increase of 40.5% and significant growth in our Internet business of 93.9%. These third quarter fiscal 2019 comparable sales were again driven by both transaction and ticket growth as we continue to attract both new and existing customers alike through our digital marketing strategies, growing e-commerce platform, and expanding showroom presence. Adjusted EBITDA was almost breakeven for the third quarter and a loss of $400,000, an improvement over the loss of $800,000 in the prior year period. This improvement is despite significant increase in marketing spend of $2.4 million year over year in Q3 and an increase of approximately $200,000 in other non-recurring financing expenses over the prior-year quarter. Donna will review our financials in more detail, but due to its importance at this moment, I want to make one comment regarding tariffs upfront. The now enforced 10% tariffs on goods produced in China is a widely discussed challenge that we are facing along with others, but as stated before, we expect little to no impact from tariffs on this year's results, due to the timing of inventory sell-through. We feel confident in our ability to mitigate costs of the effects of these potential tariffs ongoing from a gross profit dollar perspective and in-part due to the fact that we began resourcing much of our overseas production to Vietnam more than a year ago, and third-party manufacturing operations for us in Vietnam are actively shipping goods now. I will allow Jack and Donna to further expand on the specifics of this, and our many other tariff mitigating initiatives later on during this call. Given our newness to national advertising and our tiny market share, this brand is in many ways just in its infancy as we compete in a large attractive and highly fragmented segment of the overall furniture category. This segment of couches, chairs, and seating represents a total addressable market of nearly $31 billion with our patented highly differentiated products and disruptive direct consumer business model, our growth opportunity is significant. We are primarily focused on capturing market share for now by leveraging our very effective traditional and digital marketing strategies that we’ve been leaning further into quarter-by-quarter as we focus on new customer acquisition. Due to the nature of our product platform, which is meant to be added to and upgraded over time, we are also naturally driving significant repeat business from our existing base of loyal Lovesac customers, but I’ll let Jack expand on the specifics regarding these results, as I would like to take a few minutes to further explain just why it is we are so confident in our business and brand. Our products are very unique. Our premium Sacs and modular Sactionals enjoy many patent-protected attributes. They are high-quality, customizable, and shippable within days direct to our consumers’ homes free of charge. Even with very limited brand awareness today, we are proving that this uniqueness in the marketplace commands high margins for us relative to the category. We’ve introduced new add-on products such as fitted tables, drink holders, and a convenient device charging embedded accessory called the Power Hub to the existing Sactionals platform, just to name a few. We also have a robust pipeline of new products that we are continuously investing, patenting, and testing for introduction over the near and long-term, which we are excited about. We believe due to the results of actual prelaunch consumer testing that our existing customers will love these new introductions yet to come, and some have tested to be impactful enough to raise the overall appeal of the Sactionals platform by at least 20% to new customers in the consideration funnel. Our introductions are proving equally delightful to existing customers, due to their intentional reverse compatibility, which drives excitement amongst our ever-expanding customer base. Our near-term focus is on getting as many households as possible on to our Sactionals platform, confident that over time they will discover the breadth of utility and the real lifetime value of this platform, allowing us to re-market to them with little friction. We plan to launch significant additions to the Sactionals platform each year ongoing. We have years of useful and innovative product launches yet to come on the Sactionals platform alone. Not to mention further out, Sactionals as solutions to other categories outside of seating in our long-range pipeline. Our products are environmentally conscious with all the upholstery fabric of our standard Sactionals couches now made from thread that is spun from 100% recycled plastic water bottles having made no concessions on durability, hand feel aesthetic, or product margin to effectuate this transition over the past year. We understand by information from our leading recycled, reprieved, branded textile supplier Unifi, that we are already the most prolific user of recycled fiber for sale to consumer home textiles in the United States. We estimate that we have repurposed more than 12.5 million plastic water bottles from the waste stream into our upholstery fabric this year alone so far. We are committed to a higher standard of sustainability as we actively promote and live up to our designed for life philosophy, which is how we conceive of and design new additions to our existing product platforms and new product categories alike. This design for life approach is totally unique to Lovesac. It is an actual eight-point design framework, which I spent years developing that we attempt to live up to religiously. We even open sourced the framework on my blog hoping others might emulate it in other categories for the good of the world. Put simply, this design philosophy demands that core products are built to last a lifetime and designed to evolve that they might adapt to the ongoing and changing needs of the user only with characteristics that satisfy this very high bar for design. Can a product offer the kind of value that Sactionals represent versus any other sactional or couch in the marketplace? Not to mention the natural sustainability aspects that emerge almost as a side effect of this design approach. These are products that can sustain. Even well-built or highly durable competitive products are easily cast aside, worn-out, stained or simply rendered out of style in a short time by the user if they are not designed to evolve and adapt in the way that Sactionals and this business model that supports it allow for. This model is the antithesis to planned obsolescence. From the promise of ongoing availability to buy compatible add-on pieces to new kinds of pieces with different functionality like the wedge or the roll-arm to myriad reverse compatibility accessories, the drink holder, the Sactionals table, the power hub to an ever-evolving assortment of cover options where core fabrics are maintained for years via a custom order, even if dropped from our stock line. We believe it is not just a product, but the entire ecosystem of the Sactionals business that makes it so appealing to consumers. This is also one aspect of the moat we have dug around this business that makes it far more difficult for new entrants to compete with us head-to-head in the value equation. This is also why with less than 2% unaided brand awareness at our last measure, we are so focused on simply getting the word out to marketing and advertising. And likely, we will be largely focused on marketing this Sactionals platform for the foreseeable future. By operating a business model like ours it is patently different as it does not subscribe to the throwaway model, but instead is committed to a design for life approach we have departed from the seasonal merchandising model that is more typical for the rest of the industry. Our patented adaptable, changeable, and rearrangeable platform is not only great at meeting our customers’ needs, but is also the environmentally friendly option, something we take very seriously and something that our millennial customers also care deeply about. Yes. This built to last attribute of our platform inherently means far longer product lifespans and therefore likely fewer coach is sold industrywide at some point in the future even as we gain market share. We observe that our concept has a meaningful built-in buyers toward repeat purchasing and upgrading over time as our platform expanding innovation efforts continue. The Sactionals platform is the best embodiment of our philosophy in action so far, and proves that this approach works as evident in the continued growth of our revenue from Sactionals, which increased 65.2% in the year-to-date period and the fact that nearly 40% of our transactions are repeat transactions. Our differentiation, uniqueness and competitive mode, as well as our culture of innovation are embodied in the strength of our existing and growing intellectual property position. As of today, we have a total of 36 U.S. and foreign issued patents, up from 30 patents at the end of 2017. Looking ahead, we are extremely excited about the future of this business and see significant growth opportunities over the long-term. We’re focused on rapid growth at the topline to gain market share, balanced by tracking and implementing programs to enhance consumer satisfaction to ensure the company's long-term health. We make all investment decisions through this lens with the caveat of meeting the annual earnings expectations we have committed to deliver for our investors. Given the extremely attractive marketing ROIs we continue to experience, we have increased our marketing investment and that has helped to raise overall awareness and delivered the 62% revenue growth year-to-date you have witnessed, even while being accretive to overall adjusted EBITDA margins. We have also invested in our infrastructure and capabilities, particularly in technology within our showrooms and back of the house operations to support our future growth. We feel confident that our existing core ERP software, our supply chain, sales operations, and our overall approach to management is scalabile now, but as a relatively small company, we are continually investing in infrastructure processes and system to enhance operational efficiency across many areas within the organization. There are many expense items in our P&L that are already beginning to leverage on annual basis and this is why we do expect to deliver continual annualized adjusted EBITDA expansion, even as we are growing top line sales aggressively. Donna will expand on these topics, and Jack will dive further into key opportunities to further improve operations that are intended to enhance the customer experience. As we look to the fourth quarter and EBITDA into next year, fiscal 2020, we are planning to continue to lean into marketing, testing and learning and investing, and the strategies that are driving the desired outcomes. This ramp in our marketing investment to drive brand awareness comes on the heels of the strong success these investments have delivered to date. We are running this business for the long-term and the pace of our investments will often result in quarterly fluctuations due to timing, particularly on the EBITDA line, which is why we don’t believe prescriptive near-term guidance is appropriate. That said, we fully expect to deliver adjusted EBITDA expansion for the year as promised over the $1.3 million in adjusted EBITDA we generated in fiscal 2018. It should go without saying that the infrastructure and strategic investments we are making the business and expect to continue to make throughout next year will continue to affect near-term profitability, but they position us well to drive meaningful top and bottom-line growth for years to come. Long-term, we believe our business will generate very healthy adjusted EBITDA margins relative to our category. Based on our demonstrable pricing power, our high gross margins, and our intent to leverage the investments on infrastructure that we're making currently on our rapid journey toward meaningful market share. Before I turn the call over to Jack, I want to thank our very passionate teams spread across the nation for a productive and successful third quarter. This #LovesacFamily, as we call it, now includes the public investor, and we'd love that. We hope to always live-up to our very appropriate ticker symbol. We feel great about the business and our unique positioning and cannot be more excited about our long-term potential. I will now turn the call over to Jack, our President and COO to go over key priorities in further detail.

Thank you, Shawn, and good morning everyone. As Shawn said, it was a great Q3 with strong financial performance, as well as good operational progress made against our key priorities. Let me give you a quick update. Expanding our digital TV and direct mail and increased brand awareness is our number one priority. We believe the disruptive nature of our products and go to market strategy lends itself very well to advertising and that the effectiveness of our marketing strategy is reflective in our very attractive ratio of customer acquisition cost or CAC, the customer lifetime value or CLV of 4.4x. In fiscal 2018, the customer lifetime value of nearly 1,236 far exceeded the customer acquisition cost of approximately $283, and year-to-date we continue to see strong ROI in our marketing efforts that we should continue to lean in the marketing as we drive the brand. In the third quarter, we ran our first ever national TV campaign for Labor Day and the results were very encouraging. ROIs were attractive across the board, including markets without a showroom, which we are particularly excited about. This means that we have an effective direct-to-consumer model with advertising and e-commerce that can build awareness and sales in new markets before we invest and CapEx for showrooms. This strong marketing effort drove the accelerating comparable sales numbers that we saw in the third quarter, which were plus 94% for e-com and plus 41% for showroom. And markets with a showroom as you’d expect retail marketing efficiency significantly above the levels of the direct-to-consumer markets, supporting our plans to continue open showrooms in higher density areas. We also continue to see ROI response curves grow in markets where we have previously run advertising indicating that we have plenty of room to grow the market share with the current advertising and creative executions. Additionally, after the campaign aired this summer, we saw significant e-commerce growth, which we believe further validates the marketing investments as we thoughtfully test additional channels, especially digital, which we believe has ample room to scale as we build brand awareness. For holiday, we’ve already launched our national advertising campaign followed by strong digital marketing, our national media flights ran from November 12 through December 2 and will be supported by digital and social media efforts for the balance of the year. In January, we’ll also be testing a Sacs media campaign for evaluation as the calendar 2019 holiday program. Investing in infrastructure and capabilities, particularly in technology is a key area of focus for us as we continue to elevate our customer experience and support the substantial growth that lies ahead. In the third quarter, we made enhancements to our technology infrastructure to prove the overall omni channel customer experience. Within our showrooms, we completed an infrastructure refresh across the fleet, including the addition of point-of-sale iPads in all locations upgraded Internet and Wi-Fi network technology to improve speed and stability of our systems and we rolled out chip card payment devices to all locations. On the back end, we completed the first phase of our data warehouse implementation, which allows new real-time online sales reporting for all channels among other features and we also completed the deployment of a showroom communication portal to enable unified communication among showrooms, management, and headquarters. We will continue to invest in our technology and infrastructure across the business as a result of brand, expand our capabilities and further elevate our customer experience. Just last week, we launched the Lovesac app for iOS, Android, and web browsers that we are particularly excited about. This new mobile app allow customers design their own Sactionals, while providing in-room sizing and 360° visualization. Turning to another key element of our growth strategy, increasing and improving our showroom presence. Showrooms are an integral part component of our disruptive omni-channel model. They complement and amplify the effectiveness of our marketing campaign and help drive brand awareness. With 76 showrooms today across top tier malls, lifestyle centers, and street locations in 30 states in the U.S., we still have significant showroom growth potential. During the quarter, we opened five locations and are on track to open 13 new locations in fiscal 2019 to end the year with 77 locations. Two less than initially expected for the year as one showroom opening has been moved to Q1 and the other was not executed due to terms that were not meeting our hurdle rates. Due to the strong run rates of our showrooms, we did not expect this change to have a material effect on our overall volume this year. Two years ago, we embarked upon tech-enabled experiential showroom strategy and began updating our locations to this new format. We continue to be very pleased with the strong economics and performance of our updated showrooms that create an even more compelling very visual experience that better enables our customers to see and appreciate the uniqueness, incredible flexibility of our products. And now for an update on our shop-in-shops. As we discussed last quarter, shop-in-shops are unique opportunity for us to showcase a limited offering of our products as we focus on customer acquisition, particularly in areas that we don't have a showroom presence. Our other channel sales, which includes our pop-up shops in Costco locations more than tripled to 5.9 million. In the third quarter of fiscal 2019, we operated in 155 shop-in-shops with Costco. We believe this increase in volumes driven by both [store count at plus 92] and per showroom productivity at plus 10%. This supports I believe – this is also an awareness building program is the fact that 2% of our showroom purchasers reported that they actually became aware of Lovesac by visiting a Costco Lovesac roadshow, and 8% of our purchasers attended a Costco Lovesac shop-in-shops. Finally, we continue to draw higher levels of social media engagement, but are very active and engage social media followers across platforms, including Facebook and Instagram. Our customers are extremely passionate about the brand and love to follow and share their experiences with our social media enthusiast through pictures and posts. As our social media following grows, our brand awareness will continue to grow. In the third quarter, we accelerated our social media marketing through organic social media and paid social media, including targeted Facebook advertisement. As an example of our ongoing social media efforts is our [indiscernible] partnership in September where we collaborate with [indiscernible] Lovesac meeting at our exclusive [indiscernible] in New York City. An entire room was filled with [indiscernible] offering Lovesac branding a comfortable place to sit for Ariana and her VIP fans. This program alone garnered 137 million views. For the quarter, social awareness spend increased by 280%, while clicks from social paid increased by 395%. Now, before turning over the call to Donna, I do want to touch on the topic of Chinese tariffs from a business execution perspective. Approximately 75% of our purchases or 50 million are currently sourced from China. As Shawn mentioned briefly, we are now already actively manufacturing in Vietnam and are rapidly moving towards the majority of our overseas production, will occur there outside of the purview of China tariffs. Our many efforts to mitigate the effects of tariff on our business are well underway, including aggressive current vendor negotiations components to listen, merchandising's, logistics, and selective pricing actions. From a negotiation perspective, the strength of the U.S. dollar has worked in our favor and our strong topline growth makes us and ever more valuable partner to our suppliers, which also aids in our negotiations. We have been and will be taking selective promotional changes and we will be testing into selective price increases on certain items as an additional litigations step. Given all these efforts, we continue to expect there to be very minimal, if any financial impact on these issues fiscal year results. And these swift moves put us into a strong position to face the challenges of next year as they relate to tariff headwinds. The goal of our tariff work is to mitigate the dollar impact of the tariffs, but there will be mathematically some gross margin rate pressure next year related to tariffs, as well as our continued channel of products mix shifts that are driven by the success of our marketing efforts around driving Sactionals and the shop-in-shops business. We will continue to keep you updated on the progress of our efforts and give you more detailed guidance on fiscal 2020 on our Q4 call. So, in summary, we’re very pleased with our third quarter results and progress made on our strategic priorities, our brand is in its infancy and the growth runway ahead is substantial, our focus is on disciplined execution as we capitalize on this opportunity and realize the full potential of the business. And with that, for a more detailed review of our third quarter results, as well as a few items related to our outlook, I will now turn the call over to Donna Dellomo, our Chief Financial Officer.

Thank you, Jack. Good morning, everyone. I will begin my remarks with a review of our fiscal 2019 third quarter results and then provide some commentary around our thoughts for the remainder of fiscal 2019. As Shawn said, we are extremely pleased with our Q3 results. Net sales increased 70.9% to $41.7 million from $24.4 million in the prior year quarter. Our robust sales growth was driven by strong showroom, Internet, and shop-in-shop performance with an increase of new customers, as well as an increase in the total number of units sold reflecting a higher average order volume per customer. Also, our marketing investments to drive brand awareness and an increase in the number of showrooms continue to fuel our Q3 sales performance. Comparable sales, which includes showroom and Internet sales increased 51%. Comparable showroom sales increased 40.5%, which represents our eighth consecutive quarter of positive comments showroom sales increases. Internet sales increased 93.9% versus an increase of 50% in the prior year period. We opened five new showrooms, remodeled three legacy stores into our showroom format and had no store closures during the third quarter. We ended the quarter with 77 showrooms. Looking at our results by channel, showroom sales increased 47.3% to $28 million. Internet sales increased 93.9% to $7.7 million and now our other channel, which includes our shop-in-shops and Costco locations more than tripled to $5.9 million. By product category, our Sacs increased 25.2%, our Sactionals increased 82.7%, and our other category, which includes decorative pillows, blankets, and other accessories increased 120.1% in the third quarter, as compared to the prior year quarter. Gross profit dollars increased 67.5% to $22.9 million in the third quarter this year. As expected, gross margin decreased by 110 basis points to 54.9% from 56% reported in the same period last year. The decrease in gross margin was primarily due to a channel mix shift toward our shop-in-shop locations and growth in Sactional products, which carry out slightly lower margin in Sacs. As a reminder, although shop-in-shops sales carry a lower gross margin, they have generated positive operating margins, which has an overall positive impact for the business and create an installed base of customers who based on historical purchasing behavior should engage in repeat purchase behavior. For the third quarter, total SG&A increased $7.2 million, inclusive of $400,000 of IPO and financing-related expenses to 19.3 million from 12.1 million in the third quarter of last year. The increase in SG&A was driven largely by a $5.2 million increase in sales-related expenses to support sales growth such as credit card fees, commissions, and showroom labor, in addition to $1.1 million increase in rent expense related to the increase in the number of showrooms a $500,000 increase in stock compensation-related to restricted stock awards and an increase of $239,000 in IPO and other financing-related costs. As a percent of sales, total SG&A expense leveraged by 320 basis points. This supports that both our variable and non-variable cost scale favorably as we continue to increase revenues. Our investment in marketing, which benefits extended periods, increased 2.4 million or 84.6% over third quarter prior year. Specifically, on marketing, we are significantly increasing our marketing investments both on an absolute dollar basis, as well as on a rate to sales basis given the very attractive financial returns on the spend as evidenced in the CLV and CAC cost economics that Shawn and Jack went over. The year-over-year increases in our marketing investments that you see in any given quarter can and will vary often substantially as we maintain flexibility when investing against this very compelling customer acquisition opportunity. Depreciation and amortization increased $248,000 in the prior year period to $1.1 million, due to capital investments for new and remodeled showrooms and other infrastructure investments. As a result of these factors, operating loss was $2.7 million, compared to an operating loss of $2.1 million in the third quarter of last year. Excluding $400,000 of non-recurring items related to the IPO and other financing initiatives in the third quarter of fiscal 2019, and $200,000 of non-recurring items related to financial initiatives in the third quarter of fiscal 2018, operating loss was $2.3 million and $1.9 million in the third quarters of fiscal 2019 and 2018, respectively. Net interest income was $200,000. This reflects approximately $225,000 of earnings related to the net proceeds from the initial public offering and interest expense of approximately $25,000 related to unused line fees on the asset-based loan in the 13 weeks ended November 4, 2018. We did not recognize any tax expense in the third quarters of fiscal 2019 or 2018. Before we turn our attention to net income, net income per share and EBITDA, I'd like to point out that my discussion of these metrics will focus on net income and net income per share adjusted for the IPO and other financing costs, as well as adjusted EBITDA. Please refer to the terminology and reconciliation between each of our adjusted metrics in their most directly comparable GAAP measurements in our earnings release issued earlier today. Net loss adjusted for IPO and financing costs was $2 million in both the third quarter of fiscal 2019, and the third quarter of fiscal 2018. Net loss per share adjusted for the IPO and financing costs was $0.15 in both the third quarter of fiscal 2019, and the third quarter of fiscal 2018. Adjusted EBITDA was a loss of $400,000 versus a loss of $800,000 in the third quarter of last year, with the year-over-year change more than entirely driven by the increase in revenue. Turning to our balance sheet. We ended the third quarter of fiscal 2019 with $44.7 million in cash and cash equivalents and no debt. Ending inventory increased 111% year-over-year, driven by an increased investment in the weeks of supply of inventory on-hand to support sales growth across all channels and to be agile enough to support the success of our marketing investments. Now, while we’re not providing formal guidance for fiscal 2019, I would like to remind you a few items as it does relate to fiscal 2019. From a showroom perspective for the full fiscal year 2019, we now plan to open 13 new showrooms this year versus 15 previously projected, and we'll remodel 14 showrooms versus 10 previously projected, to end the fiscal year with 77 showrooms, as compared to the 66 showrooms at the end of fiscal 2018. The change in the number of new showrooms being opened this fiscal year relates to the timing of lease negotiations on certain locations. We intend to operate 526 shop-in-shops this year, with more than 76% of the shop-in-shops having already happened in the first three quarters of this fiscal year. We expect gross margins for fiscal 2019 to be slightly, but not materially lower than fiscal 2018 related to the shift in channel and product mix. This implies Q4 gross margins down a little over 200 basis points, due to the adjustments in channel dynamic, as well as a revision to our annual vendor rebates, which the company recognizes in the fourth quarter. For the 39 weeks ended November 4, 2018, shop-in-shops net sales were 14.1% to total net sales as compared to 5.1% for the same period to prior year. As previously mentioned, shop-in-shops sales carry a lower gross margin. Sactional net sales were 76% of total net sales for the 39 weeks ended November 4, 2018, as compared to 74.5% for the prior year. As previously noted, Sactional sales carry a lower gross margin and continue to be the largest growing product category for Lovesac. Any impact of tariffs for the remainder of fiscal 2019 are expected to be mitigated and have little to no impact on gross margin. In terms of SG&A, excluding marketing expenses, I just discussed and as expected, the largest year-over-year increases in SG&A occurred in the first three quarters of the year and given the seasonality of our business, we continue to expect the most significant SG&A leverage to be generated in Q4. Regarding marketing investments, we will continue to ramp up this year given the attractive returns we have seen. So, in summary, we continue to expect to deliver an improvement in adjusted EBITDA for both Q4, as well as the full fiscal year. Finally, as it relates to capital expenditures, we now expect to incur approximately $12 million of capital expenditures in fiscal 2019 with the vast majority of the spend on the opening of 13 showrooms, and the remodeling of approximately 14 showrooms. The remaining spend is on technology in our showrooms, inventory management and logistic systems, e-commerce platform enhancements and for headquarters data and support systems. For all other details related to our results, please refer to our earnings press release. With that, we'd like now to turn the call back to the operator who can open it up for questions. Operator?

Thank you. [Operator Instructions] Our first question comes from the line of Dave King with ROTH Capital Partners. Please proceed with your question.

Thanks, good morning everyone. First half looks like the marketing spend was $5.2 million for the quarter, so call it 12% of sales. Given the success you've had on national TV, how should we think about that in terms of Q4, in the next year, and in longer-term? And then, Shawn, what do you think are the right EBITDA margins for the business longer term and then how do you envision the trajectory or slope of that improvement over time? Thanks.

Hi, Dave. This is Jack. I'll take that first part of the question before handing it over. So, I think, we would expect to see as we go forward, right now, roughly 10% to 12% of our sales to go into marketing, so that's on an annual basis, so we will see quarter-by-quarter changes based on the opportunities, certainly. We – as we mentioned before in our previous calls, that's given today's information. So, we will continue to test into new programs. For example, we're finding that there has been room for scaling of digital at greater rates than we had previously seen earlier in the year. So, we will do that and we'll continue to test and give you updates on what we're seeing in our changes. But I think that the general rule right now is 10% to 12% of sales is a good approach.

Yes. This is Shawn. In terms of longer range EBITDA outlook for this business, we are reticent yet to put out a specific target, but the way to think about it is pretty straightforward from our perspective, I mean, we start at a high gross margin place to begin with relative to our category, certainly at the moment, as a small company, we're building infrastructure, we're investing in all kinds of initiatives that bear fruit over time, and as the business matures and our SG&A sort of rationalize to our size, age, and stage, we believe that we end in a place, not end, but we operate in a place that is healthy relative to our category for sure, and we very much intend to maintain gross margins in the range that they're in now. As Donna mentioned, we know we will experience some slight compression as the business revenue channels shift, frankly due to our own success, right? But still in that range, even with all the various headwinds that many businesses like ours are facing right now, and we look forward to just growing into that EBITDA model. And as we move forward, SG&A overall is leveraging in real time even now, and we intend to continue to deliver net EBITDA margin expansion, as we go forward, as we described even in this high growth mode.

Fair enough. And then sort of a big picture question, Shawn. So, it seems like a few retailers here and there have pointed to some slower trends in November, December, maybe due to macro, what have you, with some of the weaker housing data, are you guys seeing any signs of slower consumer spending in all post quarter or is that not something that you...?

We are not. As evidenced by our growth in the third quarter, the business has great momentum. I will give the caveat that we've stated this on other calls and in other forums. This business is in high growth mode overall and quarter-by-quarter results will experience some fluctuation, but on an annualized basis, our growth rate is high and we're managing the business to achieve that. I think that's – can be expected. And that's what we expect the business to live up to for the foreseeable future. Again, focusing on top line growth without completely abandoning growth of the – at the EBITDA line without getting too much into the – too much into fourth quarter results because we're not giving guidance, as Donna mentioned. We feel good about what we're seeing overall, and I'll just make this comment having lived through various slowdowns long way, I remember Lovesac is not a two-year old startup. I've had the opportunity to witness our growth. In fact, we were born originally in 2001 at retail and lived through all of that and experienced everything in between. When we're achieving – when we're in these growth modes, particularly with the product has almost – well, I'll say, very, very little awareness, it can be counter cyclical a little bit at least compared to the industry because as much of the headwinds hit us all when people are discovering something that they've never heard of before, we can see – I've lived with growth rate through some of these various slowdowns even as more mature businesses that are essentially selling the same thing experienced headwinds without that kind of mitigation. So, without making any promises or forecast of the future, that's been my experience with this concept.

Okay.

Yes, just to build on that, if you look at quarter-over-quarter one thing – this is Jack, just to sort of summarize it in a different way. While we saw extraordinary results in the third quarter, I think we'll see some modulating of the comps in the fourth quarter, not because we're seeing any kind of slowdown, but because we are seeing a spend ratio difference between fourth quarter this year and last year. So, for example, in the third quarter, we spent about 300% more media in the year ago as we go into the fourth quarter because of this time last year we started the lean in the marketing. We'll see about a 50% increase in media spend. So, you will see some modulation of comp increases off of the third quarter, not because of any weakness that we're seeing from a consumer perspective, but just the way we're managing the business in spending. In terms of overall growth we had in the last quarter, 36% growth in new customers, which was higher than what we've seen year-to-date on average, and really important thing also as we saw a dramatic increase in our new repeat customers at 24 months and newer coming back for the second time. So, we're very, very pleased with some of the foundational aspects in terms of attracting new customers, getting repeat customers early on, and growing the business. So, we feel good about it from the macro perspective of how we're interacting with our customers, we're very strong.

Okay. Thanks for taking my questions and good luck. Nice quarter and good luck to the next of the year.

Thank you. Our next question comes from Alex Fuhrman, with Craig-Hallum. Please proceed with your question.

Great. Thanks very much for taking my question and congratulations on a really strong third quarter. Wanted to ask, just from a general perspective, I mean, it seems like you obviously have an incredible opportunity to keep spending on marketing, getting more people onto the Sactionals platform. Just from a big picture perspective, what are some of the things you are looking for in 2019 and 2020, as you kind of decide at what rate you want to balance growth versus profitability, as if you're continuing to see strong customer acquisition costs relative to the lifetime value. Is it fair to assume that you're going be prioritizing growth and just trying to get more people on the platform over the next couple of years, as you build for a really more substantial ramp and profitability in the future? Just trying to get a sense of kind of the sign post that you're looking for over the next couple of quarters and years as you balance those trade-offs?

Yes, it's a great question. I'd say, in broad terms, I'd say the next 18 months are still really focused on infrastructure and building support for our – really our customer interactions in the process. So, I think the way we look at it is, we have a very, I think a very strong handle on how to drive the business and how to attract customers. And what we need to do to catch up in terms of scale is really invested in infrastructure, so we can track orders, we can ship orders very quickly, we can surprise and delight customers from the first phone call, they make to the delivery and picking their own delivery, that's the kind of thing we want to get into in the future. So, the bottom line here is, we have 18 months of investing in warehousing, warehousing systems, back-end systems, as well as making sure we have the infrastructure that's allowing us to report and talk in an omnichannel way. So, I'd say 18 months is the investment period and then I see some significant leveraging happening after that.

That’s great. Thanks for that Jack and then, just if we could switch years briefly to the tariff situation going on overseas. Can you give us a sense of, as you look at your production capabilities in North America, and Vietnam, and China and it sounds like you're already starting to ship product from Vietnam, are you able to make the full product assortment outside of China? And can you give us a general sense of your cost that you're seeing in those different regions in North America, versus Vietnam, versus China if things were to escalate, do you feel that you would be able to shift production of a substantial amount of your product assortment to the other regions?

Take back again. We feel very confident in our ability to be relocating our China production outside of China. We began this effort, as I mentioned on the call, more than a year ago just of our own volition, seeking redundancy, seeking greater capability for the future, including just sheer volume and flow. Right now, about 75% or historically I should say, leading up to now about 75% of our overall production occurs in China and the shifting pretty rapidly with the goal of having most of our production outside of China by the end of next year. The balance – the other 25% mostly has occurred in North America. We manufacture our Sacs in Texas and our covers and Sactionals, so this Sactionals covers, Sac covers and the Sactionals themselves are what historically have been built in China for us. We are focusing on the biggest piece of the business first, in terms of resourcing, and that would be Sactionals themselves, the actual Sactionals pieces, which constituted the lion's share of our sales by volume, by dollar. And that is what's in production in Vietnam even now and ramping rapidly. And as your question, as you asked, will we be able to resource all of our assortment outside of China? We certainly will be able to do that, but again, we'll be working on the biggest pieces in that order because of the impact it will have on our P&L. In terms of what we experience cost in Vietnam is less expensive than in [technical difficulty] gross margin opportunity there, but – and I guess, is one other kind of comment in this vein, we have numerous product development, sourcing efforts focused on reducing costs, increasing quality and just making us more competitive, even as we – the new [indiscernible] Sactionals platform. So, innovating and [technical difficulty] goal. So, I think that net-net as we've discussed, we certainly do expect to feel the headwinds of the tariffs, if they continue, presuming they continue in the first half of next year. But as that ex-China production ramps, we’ll definitely feel some of those mitigation efforts. And, in fact, many of our efforts to mitigate the effect of tariffs on our net margin dollars, as we've discussed come from other aspects of the business as well from merchandising to the way that we – just the way we operate the business on the front end, I'll let Jack to speak to, if he'd like.

Thank you. Our next question comes from the line of Camilo Lyon with Canaccord Genuity. Please proceed with your question.

Thanks, good morning everyone and very nice job on the quarter. Shawn, you're cutting in and out there, when you just mentioned about the gross margin puts and takes on the tariffs. Could you just repeat that, just – that we set out and as to what you thought the net overall impact could be next year? And maybe, if you can just discuss some of the pricing options that you have to mitigate those headwinds, other companies have talked about concessions that they are receiving from Chinese manufacturers, price increases and obviously the shifting production outside of Mainland China. So, if you could just articulate that, that'd be great?

Yes. Sorry about that. I don't know what happened. Yes. So, we continue to – so we began, as we mentioned, working toward Vietnam quite some time ago, just of our volition to seek, balancing the supply chain, we're far along, we're manufacturing in Vietnam now, it is less expensive than our manufacturing in China. So, we're very excited about that. We do believe we'll be able to manufacture – mostly, almost all of our full range of product there, over time. There are a number of initiatives, a foot to reduce the cost of goods overall from product development design initiatives, long range vision is to what we can do with our very replicable and highly homogenous platform. And we look forward to just allowing those initiatives to play out over time, even as we do continue to ramp production in Vietnam. We would expect some headwinds from tariffs presuming they continue in the first half of next year, particularly as we're waiting, not waiting, but as we are experiencing the ramp of production in Vietnam and outside of China and leaning into that, and we expect for the bulk of our Sactionals ideally to be manufactured outside of China by the end of next year. And so, it's difficult obviously, impossible to predict what will happen with the tariff levels, including the threatened jump to 25%, but we have numerous tariff mitigation efforts even outside of our supply chain that I'll allow Jack to speak to in terms of how we intend to mitigate the net margin dollar impact on the business and deliver expanding EBITDA even as we continue to grow. Last thing, I'll mentioned in regards to our vendors, all of – everything from the strength of the dollar to just our overall increase in volume, which is pretty radical has given us a lot of leverage with our suppliers and the ability to negotiate in real-time as we operate even in China in the interim, as well as leaning into Vietnam. We know Lovesac becomes larger and larger and more significant in – and at the pace that we're growing that strength only helps us the further out we get.

Just to build on what Shawn has said from a non-supply chain point of view as well. Obviously, we're getting dramatic increases in volume driven by advertising and as we have additional tools, we also are evaluating how to use other tools perhaps less forcefully. So, as we go into the future, we'll look at discount rates as possible opportunities, we're looking at mix of opportunities. We have a wide range of margins within our mix of products that we can enable. We can encourage customers to pick higher margin offers through selective promotions, which are – have been shown already to give us increases in margins and there are some selective price increases. We can also make that don't appear across the board, because of the way you're really as a customer, you're building your own custom item with lots of choices, then we can change some of the pricing on some of those choices without making a feel or appear like a wholesale price change. So, we'll be testing into that as well. And then, I'm going to hand it over for Donna, just to summarize what she sees in the future on the EBITDA.

And that's the tariffs. So, our plan is to be able to mitigate and protects our dollar impact of tariffs. But the headwinds will impact our ability to protect the margin impact. But the important thing to know there is despite the tariffs and our investments into infrastructure next year, we are projecting healthy sales growth and a slight improvement in adjusted EBITDA dollars.

Perfect. Great. Thank you for that color. That’s very helpful. Just if we step back a bit and look at the success that you've been achieving this year, and certainly the initiatives that are gaining traction, it's excellent to see a business of your size invest against those growth initiatives and actually start to see return on those investments so soon. So that's wonderful that you're continuing to do so. I wonder if you could just give us a little bit of color as to maybe the demographic – the customer demographics, that you're seeing the most success with, as we – as we try to understand who you're reaching, what type of customer you're reaching, you're connecting with the strongest and how that may inform, how you then go and spend or reallocate or allocate your investment dollars around marketing?

Yes, the sweet spot of the business has been and I believe it will continue to be that older millennial, which sounds like an oxymoron. So, the more mature millennial, who is probably hitting more of a peak in their career and having children, certainly is our key target and obviously those are millennials that would be millennials who are making well above north of $100,000 a year. What we are also seeing with our advertising is an overall increase in interest and awareness, obviously from the brand, and we are getting some – we are seeing some increases in the age of the customers, as well as with the wealth of the customers. And I think that bringing that new customer group in, will entail, we'll continue to focus on communicating the product benefits and hoping or helping them to understand what a great product we have and what a great value we have. More to come on that, I would say as we get through the end of the year, we are looking at samples of our customers. But quarter-by-quarter that's a hard one to give you a really good sense of, it is changing with advertising, and I think as we get out of the – as we get into the annual year-end results, we'll talk more about the customer demographics and how we’re going after those.

Great. And then just finally for me, if you can think about the outline for next year and the investments that you've highlighted. Jack you talked about another 18 months of investments before you really start to see some inflection in your EBITDA dollar growth, could you just maybe highlight some of those key investments that you'll be making next year. I'm sure you're marketing as a key focus, but are there any other sort of investments either in infrastructure, I think you mentioned just broadly that any projects that we should be looking forward to next year that will ultimately help drive both the top and bottom line next in the future?

Yes. We have – I think the biggest area will be in logistics and supply chain. So, we are in the midst of negotiating and doing a study or what does the future growth in placement of our warehouses in our system, look like, that's number one. Then the implementation of ERP and WMS to support that will be obviously critical to the success of our business. Those are the biggest ones right now. We also have some – I would say, we're researching some additional ways to get manufacturing efficiencies in the long run that we'll share with you when it's appropriate. And the other area of course is people and resources. So, if you look at the next year, we have the departments with the most dramatic increase in resource needs, which will be consistent with what we've talked about are logistics, customer service, finance and IT.

Perfect. All the best to your guys. Thank you very much.

Thank you.

Thank you.

Thank you. Our next question comes from the line of Scott McConnell with DA Davidson. Please proceed with your question.

Great. Thanks for taking my questions. So, looking at your showroom locations, how many of them do you believe are in A, B, and C malls? And then as a second question, can you update us on what percentage of showrooms are upgrades to the new format and what your strategy is for getting the remaining locations updated?

Sure. So, I believe a majority – a vast majority are in A malls. I would say, we probably have a couple, I'd say, less than 10 B mall locations and all the rest are A locations. And just to put it in perspective, we will not have a showroom. That is not a positive contribution on a four-wall basis this year. So, we're very profitable, [no showrooms]. We've been very – because of the way we've developed, we're in a really nice position to just to leverage and grow based on the information we have, not necessarily being able – needing to adjust really our approach to our showrooms at this point.

And just to answer the last part of that, 77% of our showroom fleet is in the remodeled format.

Yes, we have roughly – over the next 18 months, it's roughly 20 more to do.

Okay, great. And if I can get one follow-up question. Can you provide your updated thoughts on future plans for international expansion?

Yes. I think the international expansion timing goes all along or consistent with the discussion in terms of our infrastructure investments. We really believe that in the next 12 to 18 months, as we get this model super-efficient in the United States, then we create the opportunity to start leveraging and replicating the model. I think we will first – we're highly interested in Canada, and we also obviously have some opportunities outside of North America, as well. What I will say is working on the model, step one, moving into Canada, step two, and we are protected in all of the major trading areas by our patents, which I think Shawn has discussed a lot in the past, we have a major patent protection and all of them, the trading markets in terms of Asia, the European Union, Australia, UK, as well, obviously is North America.

Very well. Thanks for your time and happy holidays.

Thank you.

Thank you.

Thank you. We have reached the end of our question-and-answer session. I would like to turn the call back over to Mr. Nelson, for any closing remarks.

Yes, thank you so much for joining us on this call. We appreciate all of your support. As I mentioned, the public investor is now part of our #LovesacFamily, and we intend to operate a good business on all of our behalf. Have a happy holiday, and looking forward to future conversations.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.