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.…

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…

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…

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.