Greetings and welcome to The Lovesac Third Quarter Fiscal 2022 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I’d now like to turn the conference over to your host, Ms. Rachel Schacter of ICR. Thank you. You may now begin.

Thank you. Good morning, everyone. With me on the call is Shawn Nelson, Chief Executive Officer; Jack Krause, Chief Strategy Officer; Mary Fox, 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 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 measure to such non-GAAP financial measure has been provided as supplemental financial information in our press release. Now, I would like to turn the call over to Shawn Nelson, Chief Executive Officer of The Lovesac Company.

Thank you, Rachel. Good morning, everyone and thank you for joining us today. I will begin by reviewing the highlights of our third quarter financial and operational performance, before Jack outlines our third quarter progress on our key growth initiatives. Donna will wrap up our prepared remarks with a review of our financial results, and a few other items related to our outlook. Also joining us on the call today is Mary Fox, who, as you know was appointed President and Chief Operating Officer at Lovesac on November 15, assuming the same role that Jack filled before. As you are aware, Mary had been serving on our Board of Directors since February 2020. She brings a strong, digital, and brand building background to Lovesac that spans a 25-year career in the consumer goods sector, significant experience in scaling businesses and extensive supply chain and operational expertise as well. Along with her keen and prescient adoption of ESG principles, she has an expansive knowledge of Lovesac’s unique business model. And all these attributes make Mary a particularly great fit, especially given Lovesac’s growth trajectory. We're thrilled to have her as part of the leadership team, and equally excited that Jack will be serving in a newly created role of Chief Strategy Officer as well as having recently been appointed to join the Board of Directors. We are very pleased with our third quarter results delivering growth of 56.1%, while improving net income by 11% for the quarter, even in the context of making significant investments in our infrastructure. This sales growth is on top of last year's 43.5% growth. So, our continued and widening growth this year is a testament to the strong demand for our product, growth in brand awareness and conversion, even as we are actively managing the tight…

Thank you, Shawn, and good morning, everyone. As we look to the next chapter of growth and the many opportunities that lie ahead, Lovesac will need talent, systems and infrastructure to scale in a manner that drives value for all of our stakeholders. And I'm very excited to take on the new role of Chief Strategy Officer and board member in pursuit of this goal. I've had the benefit of getting to know Mary well since she joined our board, and have witnessed firsthand for valuable contributions. I'm delighted to partner with her in her position as President and COO. Now turning to our third quarter performance, we're very pleased with the third quarter results and the strides we've made against our growth strategies, which I will now review. Starting with, one, product innovation, of which the key highlight was our Stealthtech launch on October 18. It is in its early days, but the customer reception to this new product launch has been strong, and we are seeing associated increases in Sactional transaction AOVs that bode well for customer engagement, loyalty, and repeat purchases. Two, efficient and marketing merchandising strategies. We continue to generate attractive marketing ROI and our marketing efforts continue to help raise overall awareness and deliver the 58% revenue growth year-to-date that we have experienced. Some Stealthtech highlights, in the third quarter with the launch of Stealthtech at the end of the quarter we'd introduced new and social assets with early indications looking very promising, including a 13% year-over-year increase in web sessions, driven mainly by paid search. Broadcast syndication has been rolled out for holiday after successful local testing during Memorial Day and Labor Day, and resulted in an increase in overall TV reach by 25%. Additionally, as part of the Stealthtech product launch, Lovesac has…

Thank you, Jack. I'm delighted to be part of The Lovesac leadership Team with Shawn, Jack and Donna. And as you can all imagine, it's been a busy and productive months since I joined on November the 15th, both getting to know the business even further in addition to meeting all of the team. From my time on the board throughout my career, and as a Lovesac customer for the past 11-years, I have gained great respect and admiration for Lovesac’s differentiated direct to consumer business model, unique product, loyal customer base and deep commitment to sustainability, including its circle to consumer philosophy. I'm very honored to take on this new role and will leverage my extensive experience working with consumer goods companies throughout my career, to help execute the company's growth strategy and drive long-term value. With that, I will hand the call over to Donna, to review our third quarter financial results. Donna?

Thank you, Mary. Good morning, everyone. I will begin my remarks with a review of our third quarter results, and then provide an update on the framework I shared with you last quarter as it relates to how we are approaching the remainder of fiscal 2022. Net sales increased $42 million or 56.1% to $116.7 million in the third quarter of fiscal 2022, as compared to $74.7 million in the prior year period. The year-over-year net sales increase was driven by growth across all channels with overall comparable sales increasing 47.1%, due to the success of our Labor Day campaign, 28th year-on-year increase in ending showroom count, and higher productivity of our temporary online pop up shops on costco.com. Showroom net sales increased $28.2 million or 67.8% to $69.7 million in the third quarter of fiscal 2022, as compared to $41.5 million in the prior year period. This increase was due primarily to a $19.5 million increase in comparable showroom point of sales transactions to $56.1 million in the third quarter of fiscal 2022, as compared to $36.6 million in the prior year period. As a reminder, point of sales transactions represent orders placed through our showrooms, which does not always reflect the point of which control transfers to the customer, and when that sales are recorded. In addition, we opened 28 additional Lovesac showrooms, including two mobile concierge and one kiosk since the third quarter of last year, which was a meaningful driver of non-comp showroom sales increase. Internet net sales, sales made directly to customers through our e-commerce channel increased $9.8 million or 38.2% to $35.5 million in the third quarter of fiscal 2022, as compared to $25.7 million in the prior year period, principally driven by the performance of our Labor Day campaign this fiscal year. Other…

Thank you. At this time, we'll be conducting a question-and-answer session. [Operator Instructions] Thank you. Our first question comes from line of Brian Nagel with Oppenheimer and Company. Please proceed with your question.

Hi, good morning. Nice quarter. Mary and Jack, congratulations on your new appointments. The first question I have, with regard to the outlook and specifically gross margins. So, you telegraphed for Q4, 1,000 basis point reduction in gross margin. So, you just talked a lot about the fact that you’re going to continue with that would represent, I guess it would be suggestive of more headwinds than we saw in the third quarter. So the question I had there is, can you kind of articulate what that is? And where we are right now in the quarter? We're past, we're into the holiday season. Is that 1,000 basis point degradation what you're seeing at this moment?

Hey, Brian, it's Donna. Good morning. Yeah, so that 1,000 basis points, if you remember, we take pretty heavy stock inventory positions, as Shawn had mentioned earlier on the call, right. Our inventory is evergreen. So, it's just the timing of the cycling through the inventory that has the higher freight rates on it. What's coming through in the fourth quarter of this year is fully burdened by those higher freight rates. So, I think I had mentioned on the second quarter earnings call, our inbound container costs were this time last year 5,000. We're paying upwards to $26,000 a container at this point in time. So, what we see coming through or coming through the financials in the fourth quarter is fully burdened by those costs. But the point of that is, when we gave the not formal guidance for fiscal 2023, we’re conservatively estimating that we will be impacted by those higher freight rates all throughout next year, which, if they do turn around at any point in the year, that will be beneficial to us. So, again, fourth quarter we feel is fully burdened, and then going into fiscal 2023 again, very conservative approach that we're taking that we don't see any positive impact, but we're hoping it happens going into next year. So hopefully, that helps.

No, that's very helpful. And a follow up just on the supply chain, so we understand the dynamics. So, should we think about the supply chain disruptions? I know that you and a lot of other companies are discussing it, and then the Lovesac P&L. Is the impact isolated to cost of sales? You're not seeing any type of impact on sales?

Yeah, I'll start that, and then Shawn, you can add up. At this point, we are in an excellent because of the redundancy that Shawn mentioned upfront across the same product, really our Sactionals platform, we are in a fantastic place in terms of inventory to carry out our sales projections for the rest of this year as well as the view we have into next year, and we feel very good about that. It certainly hasn't been without a lot of actions by the team. But I think, our belief is this is during this type of period of time where there's so many questionable dynamics that this is truly a strength of the business we're going to lean into as we continue to disrupt the market and gain share.

Well, I'll turn the call over to somebody else. Thank you very much. Appreciate it.

Thank you. Our next question comes from the line of Victoria James with D.A. Davidson. Please proceed with your question.

Good morning. Thank you for taking my call. So, my question is, we've noticed your TV ads promoting your Sactionals with immersive sound. Can you talk to us a little bit about your near-term marketing spending plans, including TV to promote your new effort? And then sort of in addition to that, how your ads for your new immersive sound product also positively impacted your Sactional sales for consumers buying them without that immersive sound?

Yeah. Thank you. At this point, if you look at our overall spend, I'll say on an annual basis, it's between 13% and 14% of net sales. So that's where we'll head. I think in terms of Stealthtech, what it really has done for us, it provides another really unique selling proposition for the whole line. So we're seeing the ads be effective as not only lifting up the Stealthtech sales, which we're seeing a very nice attachment rate, but we're also seeing very high ROIs and continued excellent run rates in terms of the core business as well. So, we're continuing to evaluate it. As you probably know, we always do. We're constantly doing tests and learning and so more to come as we get more experience about the dynamic between the Stealthtech, advertising, included in the brand advertising. But right now, they're really synergistic, and they're lifting the overall business quite well.

Thank you.

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

Thank you. Good morning, everyone. I want to get back to the gross margin discussion, if we could. It seems that in the third quarter, you experienced incremental margin pressure, some more goods coming from China. Is this a result -- and the resulting tariffs that are still in place -- is that a result of supply disruptions from Vietnam? And if so, when do you expect a rebound in production such that tariff pressures from China will lessen as you shift some of that production out of Mainland?

Sorry about that. Camilo, to some degree that is true, we've shifted production around to our various manufacturers that manufacture Sactionals Malaysia, China, Vietnam based on COVID flare up, based on container availability, all these sorts of things. And next year, without a doubt, there will be fewer goods, fewer Sactionals manufactured in China than in the year that we are currently consuming them. And so, tariff pressure is one of those puts and takes that will change the dynamic of gross margins for us throughout the course of next year. And it is part of the reason that while we're experiencing, as Donna put it fully burdened gross margin pressure in Q4, there are a number of things moving within the business on the front-end in terms of discounts, pricing, all sorts of things that affect our gross margins. And on the back-end, like what you mentioned, that gives us optimism in terms of what we can expect for gross margins overall next year. And so, I think Q4 is unique in that way.

Got it. So it seems like Q4 margins really should be kind of the mid-year through next year really, and it starts to rebound, especially or particularly in the back-half if there is any sort of relief on container shortages and overall freight costs. Is that a fair way to think about that, even though it doesn't look like you're guiding to that?

Yeah, we won't commit quarter-to-quarter helping to move yet. It's obviously early looking forward toward next year without being through Q4 yet. But from a logical standpoint, that's correct. And we believe that there are a number of things that we can do in the business to mitigate some of this gross margin pressure as next year evolves throughout the year.

Sorry, go ahead, Jack.

Yeah, just to add to that, really, as you see the fully burdened fourth quarter, we knowingly made decisions to that, as a brand that's disrupting and everybody knows our expectations in the long-term to grow. That being in stock is critical over anything else, as long as we can continue to maintain margins, that are strong as they have been on an annual basis over 50%, because of its attracting customers, we're gaining CSAT dramatically, our service levels are better than competition. So this is really a fertile environment. While the headwinds are there on freight costs, we are not burdened by the supply chain issues that many others are having. And we're really leveraging that and will continue over the next year, because we do believe obviously, after the year or so we will start to see a normalization, and we'll be in an excellent position with dramatically greater shares. But that's the way we're looking at this.

That's great. And then just my follow up on pricing, you mentioned that you've already taken selected price increases. Can you state what those have been? Does selected become broad based price increases next year? And if so, what are you seeing from a consumer response, if any, to those price increases?

If we really -- okay, so we've taken price increases on our core Seats and Sides. And we have an opportunity to also look at price increases on a lot of our cover business. But we want to be really careful. I think the way we're looking at it, there are obviously costs that are going to be long-term and there are some long-term inflationary costs. But there are also a lot of transient costs. And what we don't want to do is manage our MSRP around what we think are the more volatile factors. So we did take the one MSRP change, I think the other aspect, we have a lot of opportunities to continue managing margins through promotion and mix management, which the team has done an amazing job on. And I would tell you that I think we have a lot of levers to continue to pull as we get through the year. What we don't want to do is be sort of too opportunistic in a very soft market in terms of supply, in terms of MSRP, because we don't want to be moving our MSRP around. So we're really looking to manage the next year through more tactical changes, as we evaluate the price proposition. And look the long-term price will be based on where we think adds the most value to the brand and the most stickiness. So we're managing from both ends, it’s a very strategic point of view as well as tactical. I think you'll see more changes in the next six months in terms of ways of looking at promotions et cetera, because what we are getting are tremendous levels of ROIs out of our advertising, out of the awareness, out of the word of mouth. So, the good news is I think we have some tailwinds that can help us manage some of these in terms of the brand stickiness that we're experiencing.

Fantastic. All the best for the balance of the year, guys.

Thank you.

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

Great. Thanks for taking my questions, and congrats on continued strength in the business. I just wanted to follow-up on the Stealthtech launch, sort of recognizing that it's still pretty early, can you maybe talk about how customers are engaging with the product? To what extent it is attracting new buyers versus sort of reengaging existing buyers? And is there anything you can share about sort of the portion of product that is purchased by your existing customers at this point? And then I have a quick follow-up.

That's a lot. So I would say the first thing I'll say is I'll have a lot more information for you, or we will as a team have a lot more information for you at the fourth quarter call, because really just to put it into perspective, we launched Stealthtech at the end of the third quarter. We had demand in the third quarter, but we really haven't had actual net sales until the fourth quarter. But with that said, we are seeing some tremendous things. I can tell you this qualitatively from the field, Stealthtech introduction has raised the level of engagement between the associate and the customers to amazing levels. And that's where I think as I mentioned earlier, the Stealthtech advertising is sort of a microcosm of what's happening in the field, it's lifting the interest in the brand, it's adding another very unique selling proposition to a brand that already has many, and causing a lot of engagement in the showrooms. And I think that's why we're able to not only lift the sales of product without Stealthtech, but Stealthtech has a pretty high attachment rate. We've seen the attachment rate as high as 15%. We've seen it from both new and repeat customers. A lot of dynamics happening right now, so what I would say is, and we've done modeling as well, it's going to attract new customers, we know that based on that total market that's addressable, that's the audio market. We also are seeing a lot of attraction by current customers and interesting current customers and adding it to their current setup. And that's really enhancing the DFL philosophy and the support, which we know our most loyal customers are really triggered into that idea of flexibility. So, a lot more to come, and I think I'll be able to give you a more fulsome outlook after the quarter. But we are seeing initially also AOVs that are pretty high related to the Stealthtech purchases. So we're seeing about a $200 increase in AOV on Sactionals when Stealthtech is involved, and that's completely incremental. So we certainly are seeing some incrementality at the outset. And we look forward to sharing even more with you in the next quarter.

Thank you, Jack, that's helpful. And just going back to your preliminary outlook for next year, so you're guiding to EBITDA margin expansion, despite sort of continued gross margin compression. Can you maybe just talk about where you see operating leverage coming from? I guess what should drive that?

Good morning, Maria. Yeah, so there's a couple of things, normal SG&A, we're going to see some leverage in maybe not around payroll, as we continue to build out the teams needed to support the healthy growth. But in normal consulting, insurance, professional fees, we're projecting leverage in those areas, and also some slight leverage in marketing as the ROIs on marketing continued to increase. So yeah, that's where coming through.

Got it. Thanks so much.

Yeah, things like rent, some other items and SG&A categories.

Got it. Thank you.

Thank you. Our next question comes from the line of Matt Koranda with Roth Capital Partners. Please proceed with your question.

Excuse me. Hey, guys, thank you for taking the questions. Just spinning back to the gross margin topic, just wanted to see if you could clarify it for us. How much of the inventory currently that you have on hand was brought in sort of during the peak of the inbound freight crunches? So if you look at inbound freight, probably at least ocean shipping kind of peaked in that July to August timeframe. So I would assume most of your inventory this time is sort of fully laden with those costs. But maybe you could speak to sort of how much inventory that has been brought in since that time.

Yeah, Matt, you're right. It's probably close to 100% of the inventory that we're bringing in from overseas has those higher freight rates on it. That's why we're saying that the inventory that we're selling through in the fourth quarter, and then going into at least the beginning of next year, we'll have those higher freight rates related to that inventory as it passes through the P&L.

And then mitigation action on it, I mean you mentioned a number of levers that you have at hand. But obviously, there's also promotional environment to contend with kind of in holiday and early next year. Just wondering if you could speak to sort of some of the more specific levers that you have to counteract some of the inbound freight pressure in the next quarter or two?

Yeah, I mean, clearly, we didn't want to put a number around it. But the first thing is certainly promotional levers not being theme right now. While we're in this environment, where there is in general some delays in terms of supply in the marketplace, that gives us a real opportunity, since we are in stock to sell at a higher level or higher value of selling with less discounts. And we do see opportunities continuing through next year to make adjustments. And not only in better -- and just to be clear adjustments, in terms of decreasing the frequency and the level of discounts. And on top of that, the team has really done an excellent job in managing mix, that as we manage or mix through our more premium covers, or more premium inserts, we get higher margins as well. So there's a number of places we're really attacking it from a selling perspective. And then obviously, as Donna mentioned, we're being conservative, while we expect the heaviest costs to be the ones we're bearing right now.

Okay. Makes sense. And if I can just clarify, if we think about sort of how quickly you can sell through inventory that was sort of at that peak portion of the inbound freight pressure. Just wondering if you could kind of speak to inventory terms, expectations heading into next year, in terms of kind of turning that P cost inventory versus where when we start laughing that and coming down the back-end of the sort of lower freight costs sequentially that we've seen into the end of the year here?

I don’t know, you want to handle that?

I'm sorry, what was that Matt?

Yeah, I wanted to get a sense for just how we should think about inventory terms, I guess, embedded in that first question I was trying to figure out, just sort of, when we think about sort of peaking gross margin pressure, does a peak in the fourth quarter, just based on sort of, I guess, the rough math you could do here, we could assume that most of the inventory you're going to turn through sort of was fully burdened with that peak, inbound ocean freight costs back in kind of July, August. So wondering if you could speak to sort of inventory terms and how quickly you can sell through that higher cost inventory that you have on hand.

Yeah, so we probably, I mean, we sell through our inventory -- we turn our inventory probably four times a year on a safe side, right. So we don't look to drive inventory turns. That's not what we think to do with the business. We bring the inventory in to make sure that we can remain in stock. So some quarters, maybe a little longer than that time period, some might be a little shorter, right. I think that thing to just focus on or one of the things to focus on is when we gave a piece of outlook for next year, we were pretty conservative in saying that, if next year is fully burdened by these freight headwinds, which we're all hoping that they eventually go away and that they're not here through the whole year, that we still will be able to drive margins of 60% at least 50%, with all the other mitigation efforts that we're taking. So, very conservative approach we're looking at. Our goal here is to make sure that we maintain our inventory positions, we're in stock. We can fulfill our customer's orders. And we'll mitigate and if throughout the P&L, so we'll leverage where we can in SG&A, so that's why you see that the adjusted EBITDA margin is growing at a greater rate of sales. So I think all really positive things, given the headwinds that we're all facing related to inbound container costs.

Got it. Very helpful. Thank you, guys.

Thank you. Our next question comes from the line of Alex Fuhrman with Craig-Hallum Capital Group. Please proceed with your question.

Great. Thanks very much for taking my question, and congratulations on another really strong quarter. I wanted to ask about what you've been doing with ticket pricing. And obviously, we've seen just from your promotions around key holidays like Labor Day and Thanksgiving, you've been discounting a lot less than you have in prior years. Where if anywhere, have you started to see any resistance to these higher prices? Are there any particular product categories or times of year or channels where you're seeing any resistance? And on the flip side, are there any categories where maybe you think prices remain too low and there's an opportunity to continue to be a little bit more aggressive there?

Yeah, that's a great question, Alex. And that really goes back to sort of this idea of where we are in terms of inventory relative to the rest of the world, and then how we think about what's going to happen in the next year. So our assumption is, in the next year, a lot of the marketplace will probably be in a better position of inventory. And while our internal data and certainly our CSAT and our evaluation by our customers of our value have remained very strong, if not at the strongest levels ever, we want to be very careful to separate that value based on the one company that's available to ship in two to three weeks versus everybody else. As that goes away, we want to make sure in a competitive environment, we still have a very good value to the customer that's based on thinking that they can understand. So I think in the short run what does that mean, less frequent, less deeper types of flash sales. We still like the idea of having the events because they rally us around, obviously, our advertising as well as it really is something that customers in the industry understand. But in terms of frequency and depth of discounts, they will continue to probably go down in the near future, I would expect. And we're really seeing no resistance in the short run, of course, in sales to the price increases. But we've got to be really, really careful, I think strategically, because the game for us is the five year game.

Great. That's really helpful. Thanks, Jack.

Thank you. Ladies and gentlemen, our final question today comes from the line of Lamont Williams with Stifel. Please proceed with your question.

Hi, thank you. Thanks for taking my question. Just you're opening up 20 showrooms this year, do you have a range we can think about for next year, as well as a kiosk and the mobile concierge?

Yeah, look, the touchpoints as we've continued to discuss are incredibly important to us. And we will continue to expand our touchpoints overall at a rate consistent with what you've seen. In terms of the mix between showrooms and concierge and shop-in-shops, we're still developing, we're still analyzing the business. And I think we'll have a more clearer view of next year, but I would certainly expect the touchpoint growth and total touchpoints to be approximately the same as it was this year, and we will give you more detail at the fourth quarter discussion.

Okay, great. Thank you.

Thank you. Ladies and gentlemen, this concludes our question-and-answer session. I'll turn the floor back to Mr. Nelson, for any final comments.

Yes, I just want to say thank you to our associates who have made these results happen. Very proud of our team, really proud of the business and the results that we've been able to generate. Thanks. Thank you to our investors who continue to stand with us and help us grow this company. We look forward to a fantastic Q4, and an even brighter next year. Thank you.

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