Greetings. Welcome to Lovesac Second Quarter Fiscal 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note, this conference is being recorded. I will now turn the conference over to 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 filing 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 obligation 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 measures to such non-GAAP financial measures 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 joining us today. I will begin today’s call by discussing the financial and operational highlights of our second quarter results, after which I’ll briefly review our high level thoughts around our outlook and provide an update on our tariff mitigation efforts. Then, Jack Krause, our President and COO, will outline the progress we are making on our key growth initiatives, including details on an exciting new shop in shop program that is launching in Q3. Finally, Donna Dellomo, our CFO, will review our financial results and a few items related to our outlook in more detail. We feel great about our second quarter financial results. Net sales increased by almost 45% to $48.1 million. Total comparable sales, which include same showroom and internet sales, increased 40.7%, driven by strong showroom comp increase of 31.8% and significant growth in our internet business of 71.5%. In Q2, we again saw our comp growth driven by both transactions as well as ticket growth as our digital marketing strategies and multi-channel model allow us to draw new customers to the brands, while also driving repeat purchase behavior. Adjusted EBITDA was a loss of $3.3 million for the second quarter. Operationally, we made good progress against our strategic priorities in the second quarter. A few highlights are: One, we continue to lean into marketing, including a successful Memorial Day campaign to increase brand awareness and drive sales, which is reflected in our almost 45% topline growth for the quarter; two, we made strategic investments in our infrastructure to improve the overall customer shopping experience and position us for continued success as we scale the business including expanded capacity and increased accuracy of customer delivery; three, we opened two new and remodeled three showrooms during the quarter as…

Thank you, Shawn, and good morning, everyone. As Shawn said, we’re pleased with our second quarter results. We delivered strong financial performance and continued to execute against our key growth initiatives. I’ll now review some of the operational highlights and discuss our plans for the remainder of the year. Starting with expanding our marketing efforts to increase brand awareness and drive sales. Our second quarter top line results are a testament to the continued effectiveness of our marketing strategies. For the quarter, we achieved overall comparable sales growth of 40.7%, driven by web comps of 71.5% and showrooms at 31.8%. Overall, Memorial Day marketing ROI finished very strong, as indicated by our sales performance. The Memorial Day pre-tentpole TV campaign test market saw a strong lift in weekly sales averages versus their pre-twelve-week sales average, increasing both sales and program ROIs. Given these encouraging results, we scaled the test to 11 markets for Labor Day, and subject to continued positive results, we will look to scale this nationally in the fourth quarter of this year. In terms of digital media advertising, the six-week Pinterest test Campaign during Memorial Day proved to be an efficient driver of brand awareness and site traffic with over 360,000 clicks to the site at a very favorable CPC or cost per click. We also saw great engagement within the platform with almost 30-time increase in monthly viewers and an over 30x increase in monthly engagers. Overall, we’ll continue to test increased digital marketing in the second half, as we continue to see increased ROIs as a result of the synergy with TV advertising. We will look at new efficient marketing strategies to drive the business as we look towards the fourth quarter. Importantly, many of the in marketing initiatives we have successfully tested so far…

Thank you, Jack. Good morning, everyone. I will begin my remarks with the review of our second quarter results and then provide some commentary around our thoughts for fiscal 2020. Total net sales increased 44.8% to $48.1 million from $33.2 million in the prior year quarter. This sales growth was driven by strong showroom, internet and pop up shop performance with both transaction as well as ticket growth resulting from successful advertising and marketing strategies, which drew new customers to the brand while also driving repeat purchase behavior. An increase in the number of showrooms also helped fuel our Q2 sales performance. Comparable sales, which include showroom and internet sales, increased 40.7%. Comparable showroom sales increased 31.8% and represent our 11th consecutive quarter of positive comp showroom sales increases. We opened two new showrooms and ended the quarter with 80 showrooms. Looking at our results by channel for the second quarter. Showroom sales increased 35.8% to $31.3 million, internet sales increased 71.5% to $9.5 million, and our other channel, which includes our pop up shops in Costco locations, increased 57.7% to $7.4 million. By product category, our Sactionals sales increased 51.5%, our Sac sales increased 35%, and our other category sales, which include decorative pillows, blankets and other accessories, decreased to $200,000 from $800,000 in the second quarter as compared to the prior year quarter. Gross profit dollars increased 36.1% to $24.3 million in the second quarter. As expected, gross margin percentage decreased by 320 basis points to 50.4% from 53.6% reported in the same period last year. This year-over-year decline was primarily driven by the 10% tariff impact, partially offset by reduced costs of our Sactionals and Sac products, primarily related to cost savings from a change in the sourcing of our Lovesoft and down blend fills and an…

Thank you. [Operator Instructions] Our first question is from Dave King with ROTH Capital Partners. Please proceed.

Thanks. Good morning, everyone. I guess, maybe first off, what's driving the confidence in the Q4 growth versus the Q3 guidance you laid out? It sounds like some of that's Macy's, but what are you anticipating from a two-year comp perspective versus what you had in Q2 and what you’re expecting for Q3, and what's driving that?

Yes. Consistently -- hey, Dave, it’s Jack. We believe, roughly speaking, the two-year comps will maintain pretty consistent throughout the year. Obviously, we're going against tougher and tougher comparables. And the reason we feel confident in that is it's harder to see in terms of total marketing spend on a quarter-to-quarter basis. But, the working market -- the effect of our working marketing, which starts in Q3 and goes into Q4 will be by far the greatest impact in Q4 with roughly year-over-year working media spends plus -- over plus 60%, whereas if you look at the effect of the Q3 media, it was roughly flat to a year ago, so that'll give us a dramatic increase in comparable sales acceleration.

Okay. That helps.

And to give just a background on that, the reason that we're doing that delay is, as we’ve talked about earlier, we've had several tests going on. And as we do our analysis, the opportunities to implement have come really in Q4 versus Q3.

Okay. And so, I know it's a little bit early on that front, but can you talk about the initial performance of the expanded regional media runs you had prior to Labor Day? Are the ROIs increasing, any early learnings so far?

Yes. The pretty pre-tentpole events, so the expansion of the events is showing increases in ROI and run rate. So, at this point, we believe it will be part of the Q4 program. What I'll do -- I'll need to do is, we still haven't done sort of the final analysis of our Labor Day media. So, we'll be finalizing that in the next couple of weeks and then putting it into Q4 finalized program.

Our next question is from Brian Nagel with Oppenheimer and Company. Please proceed.

Nice quarter. The first question I want to ask, and I apologize, Donna, when you were laying out the guidance for sales, Q3 and Q4, I maybe just missed it. Could you remind or reiterate what the sales guidance for the third and fourth quarter is and the components of that?

Yes. What we're saying is that year-over-year total sales will -- we're expecting to increase about 30% with a significant increase in fourth quarter. So, we're still lining into the annual guidance of 40% to 45%. So, we didn't give guidance for Q4. But, it will be significantly higher than the high range of the 40% to 45% annual guidance that we've provided.

Got it. We can back into that just given basically a missing piece. And the primary reason for that -- and again, I'm sorry, because I know, I think, you have reiterated. I just want to make sure I get this right. The primary reason for that, so to say, choppiness is one, more difficult comparison; and then, two, just the cadence of the marketing investment?

Yes. There are two things. So, you're right. So, I'll confirm that comment. And it's really broken into two things. So, you have on a comp basis, I just explained that that we’re dramatically increasing our marketing, relatively speaking our working marketing in the fourth quarter relative to the third, and we believe we'll get significantly higher lift. The other component of that is just initiatives. So, for example, in fourth quarter, we’ll have a dramatic increase in new showroom openings versus the third. The third quarter was really our lowest rate of new showroom openings we had in the last several quarters. And in the fourth quarter, we’ll also get the results of the Macy's shop in shop rollout as well as the two additional Costco shows we mentioned. So, those will have an incremental effect. So, we have some comp effects as well as just new business initiatives kicking in, in the fourth quarter.

Got it. Then, the other question I had, just with regard to gross margins. Now, clearly, you've been – as you articulated in the press release and in your prepared comments, there’ve been a lot of efforts done to deal with so to say, the tariffs, so congrats on that. As we look at the gross margin degradation here in the second quarter, is there a way to parse that out of how much of that -- we're down 330 basis points year-on-year, how much of that is investment or one time in nature, as you deal with these tariffs versus a newer run rate type number?

Yes. The guidance that we had given, and it's still pretty consistent, that about 75% of that decrease in margin year-over-year is related to the tariff pressure. The other 25% relates to initiatives we have with opening up multiple warehouses, investing into some infrastructure, some cost increases on FedEx, some cost increases relative to the increase in inventory levels. But, the majority -- or at a minimum of 75% relates to the impact to tariffs.

And then, my final question, with regard to Macy's, recognizing it's very, very early, how should we think about -- it sounds to me like the Macy's initiative will be closer to or more analogous, so to say, to one of your own showrooms. How should we think about the economics of a Macy's location in a showroom? And then, the second question on that is -- now this is, so Costco, Macy's, are you in discussions whether should we expect other type of retail partnerships in the not too distant future?

Yes. Good question. So, I think, you're right. I think, Macy's is more analogous to our own showrooms, really with it being an asset light execution. So, we expect the CapEx spend on the Macy’s to be less than a third of a normal showroom. And we expect those to -- obviously, it's pretty easy to assume our hurdle rate would be the same types of returns we want to get as we would in showrooms. So, if you look at the CapEx that way, you could easily say that roughly between a 30% to 50% of -- the run rate of a Macy’s shop in shop will be roughly 30% to 50% of a normal showroom. Obviously, there are huge exceptions. For example, Herald Square is a substantial opportunity. So, that we'd look at that separately. But, it's very early. So obviously -- I think, the best way to look at it is look at the math and the CapEx investment and the way we're running them and model and what you think makes sense, because that's going to be as close as it is right now, because what we're really doing is testing it out.

Thank you.

Our next question is from Thomas Forte with D.A. Davidson. Please proceed.

Great. Thanks for taking my question. I had a couple follow-ups on Macy's. So, the first question I had is, and I know Jack touched on this a little. But, why Macy's? Do you feel like they have a similar core customer base, just in general? And then, how should we think about the economics of the Macy's versus Costco? And then, refining that last question. So, if this pilot results in more shop in shops in Macy's, would you then limit adjacent showroom locations near those shop in shops?

Good questions. So, one is, why Macy's? I think, we're really looking at it -- I think, the one thing to do is think of this as a collaboration with Macy's and their top stores. So, if you look at the top 100 Macy's to the top 50 Macy's, we see a lot of shared attributes with our customers. Macy's is also a significant retailer in the furniture segment with hundreds of millions of dollars sold there. So, we think it’s a huge opportunity for furniture shoppers with like characteristics to be able to experience our product. And especially in those top Macy's, they're really doing a lot of interesting things. And I think that -- I think it will be a great partnership. In terms of the way it works is they are working much more like a showroom in terms of the way we will staff them with our own employees, we manage them through our own system. And we are essentially paying a rent rate to be inside of them that we expect the contribution of these to be significantly higher than what we’ve seen in the Costco pop up shops because of the way those are run.

And then, adjacencies for other showrooms, would you not fill the showrooms within a close proximity to Macy’s shop in shop?

Yes, a little bit of insight into that. So, the way we're running the Macy's test, the reason we ran those four is for some interesting test parameters. So, for example, Herald Square is very close to our Flatiron District showroom. So, we'll look at what happens between showrooms that are left with a mile apart. We'll also have a test which has a showroom in the same mall as the Macy's, and we'll have that opportunity to see what happens. And then, we have a showroom in the Carle Place, Macy's, as this is one of their furniture locations. And we'll see what happens there. So, really at this point that -- the primary purpose of this test is to understand the dynamics and then to start laying out a plan in terms of how we maximize our penetration at the most efficient way and also do it in a win-win way with our Macy's partners.

Our next question is from Alex Fuhrman with Craig-Hallum. Please proceed.

Great. Thanks very much for taking my question, and congratulations on another very strong quarter. A couple of things that I wanted to touch on here. One is, it certainly sounds like you guys have made a lot of progress in moving your production out of China and have a good line of sight to being completely out of there. It sounds like you're -- relative to the prior conference call, it sounds like that that has moved a lot faster and better than expected. Can you give us a sense of what's driving that? I mean, it sounds like your vendors have been incredibly supportive. Has there just been more buy in and capital commitment on the part of your vendors than you expected? Just kind of curious why you've been able to accelerate that so nicely.

Yes, great question. We have been moving very rapidly and we intend to continue moving rapidly. I don't believe that we ever intended to go slow. I just don't think we gave specific guidance on how fast we thought we could do it. I think, everything's moving according to our plan and it's exactly that. Our current suppliers have been very supportive, and in most cases, as I described are investing themselves in other countries outside of China, Malaysia, Vietnam, and even some others that are coming up. And meanwhile, for the goods that are left behind still, they're offering us heavy discounts in order to keep that business and kind of get through the tunnel, as it were with their lights on, so that they can support us on the other side, outside of China. And so, I think, it's just a confluence of things going well, things going according to plan, and our ability to execute, which obviously in the public markets, we're only a year out. And I think, it's a matter of those watching Lovesac, getting familiar with how we operate.

And then, a couple of questions just on the Macy's partnership. Obviously, this sounds like a huge opportunity, big difference relative to Costco. I imagine, is that -- Macy's is a large furniture retailer on their own, and I'm curious, if you have a sense of or if it's been a big part of your negotiations with Macy's, where in the stores your shop in shops are going to be located? Are they going to be in the furniture sections or are you maybe going to do some that are near other furniture brands and some that aren't? Just curious how we should think about the placement of those shop in shops? And then, if it's going to be your own employees, is it fair to assume that you will be able to capture all of the customer data and own that customer relationship?

Great questions. Yes, our team -- I can tell you, it varies by -- the Macy's organization from the way they operate, obviously, because of the -- the stores are such a big volume and they have independent store management, the negotiations are store by store. We literally have to do walk-throughs with their teams in every store. What I can tell you is that they really believe in terms of the Macy's -- I'd say that the Macy's evolution, they believe this type of relationship is critical, and they're putting us in key places. And we’ve walked the stores with them and are very happy with the locations. And they're primarily very strong locations. Not necessarily obviously next to furniture, because in a lot of the locations we're testing, they're not even in furniture section. So, that's part of our learning agenda as to figure out what works most. And I would expect coming out of this, along with the answer to some of Tom's questions, would be some answers to your questions, in terms of what adjacencies are working most effectively, what parts of the model are working, are there attributes of a Macy's store over another store that allow us to accelerate the fastest? That's all that we're trying to do now, so that hopefully the next time we talk about this, we have some answers and we start laying out an execution plan. So, good questions, and we'll keep you posted on it.

Great. Thanks very much for that. And then, lastly, your marketing has of course been very successful over the last couple of years and TV seems to have played a nice role in that. It looks like up until the last couple of months that it’s basically been different versions of the same TV commercial, and then you came out with a different creative, a few months ago. Can you talk a little bit about have you seen a lift from that new TV creative, or was there maybe something kind of a magic formula in the last commercial? Just kind of curious, now that you've got your second commercial out there in the market, what type of response you've seen from that?

Yes. Good question. I would say that we were very careful obviously because we had such a successful creative execution as we started with this new execution. We tested these quantitatively and the new and a quantitative research mode in terms of persuasion and brand, attributes, et cetera. The new commercial actually tested equal to or better than the old one across the board. We also can tell you that initial results on the new television are showing that it's driving traffic at levels that we expect it to drive at, historically. Now, other than that, I think, you start to get into a whole media mix discussion, which I can't get into because we still don't have the total results for the Labor Day media run, which is still being analyzed and actually still -- the post Labor Day work is still going on. So, we'll probably have a lot more information for you in the next quarter about that. But, we're feeling very good about the creative overall.

Next, we have a follow-up question from Thomas Forte with D.A. Davidson. Please proceed.

Great, thanks. So, an investor asked me to ask the following question. They are really impressed with your comments on your gross margin outlook for next year returning to the mid-50s. Can you once again discuss what are the inputs that will drive that strong gross margin performance next year?

Yes. I mean, the pressure on the business has been largely tariffs, as Donna has spoken to. We have a few other outside pieces, be it freights or pressures in the supply chain, logistics, et cetera, that are small, and Donna can touch on that. But, the vast majority has been tariffs. So, as we mitigate those tariffs, primarily through exiting China, not only are we then tariffs free as it were, at least special tariff free, but we also, as I mentioned, are getting lower first costs in these outside countries. And so, we were operating in the mid-50s range on gross margins and we expect to get right back to that as that product flows through our supply chain. So, it’ll be the second half of next year before on a run rate basis we begin to see that return to those levels. And because it's a run rate basis, it may take even longer to flow to the P&L as it were. But we feel very good about our ability to get back there and our ability to maintain that on the go forward. And I don't know, Donna, if you have anything else to add?

Yes. I mean, really, the major component is the tariff, some investments into infrastructure, which we will still continue to see through next year. And then, I think we'll start to see less of an impact on the shift to the pop up shops and Sactionals. I think, we're seeing the greatest amount of that shift happening now. So, when that all starts to level itself out, as Shawn has mentioned, we'll start to see on a run rate, right, start to see those margins elevate. We don't expect the full year to come in at that, but we'll start to see the quarters in the second half start to elevate to the higher mid-50% range.

Great. Thank you, Shawn. Thank you, Donna.

Yes. And just to add a note and beyond that, I think, it's important to state that, we've just hired Tom Lee as our Chief Supply Chain Officer. And I think, in the next 18 months to 24 months, we'll really be working on combining that supply chain and the logistics aspects into a value chain that allows us to start leveraging other areas. So, I think, we've only just begun to really get efficient as a company. And we'll be catching up with that growth in the next 18 to 24 months, outside of the whole tariffs issue.

We have reached the end of our question-and-answer session. I would like to turn the call back over to management for closing remarks.

Thanks very much for your support as investors. And we appreciate all the questions and encourage you to continue to keep an eye on us as we grow.

Thank you. This concludes today's conference. You may disconnect your lines at this time. And, thank you for your participation.