Greetings and welcome to The Lovesac Q1 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] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Rachel Schacter of ICR. Please go ahead.

Thank you. Good afternoon, 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 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 joining us today. I will begin today’s call by discussing the financial highlights of our first quarter results, after which I'll briefly review the long-term opportunity we see for our brand with the focus on our point of view regarding the new shop-in-shop opportunities on the horizon, and the tariffs that we face at this time. Then, Jack Krause, our President and COO, will outline the progress we are making on our key growth initiatives with more metrics and details on these aspects of our business. Finally, Donna Dellomo, our CFO will review our financial results and a few items related to our outlook in more detail. We had a strong start to the year and are very pleased with our first quarter financial results. Net sales increased by 53% to $41 million. Total comparable sales, which includes same showroom and internet sales, increased 43.5% driven by a strong showroom comp increase of 31.7% and significant growth in our internet business of 85.3%. Once again in Q1, we 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 effectively draw new customers to the brand, while also driving repeat purchase behavior. Adjusted EBITDA came out ahead of expectation at a loss of $4.7 million for the first quarter, versus a loss of $4.2 million in the prior year period. From an operational standpoint, we made good progress against all of our strategic initiatives, which are centered around traditional, digital, and social marketing; investing in our infrastructure; growing and improving our showroom footprint; and expanding our shop-in-shop presence. From a performance standpoint, we are very encouraged by the efficiency of our marketing efforts in Q1. We drove over 53%…

All right. Thanks Shawn and good morning everyone. As Shawn said, we're very pleased with our first quarter results and continued momentum of our business to start the year. We just spoke to you a few weeks ago on our year-end call. So, my comments today will be brief as that we are on track with the execution against our strategic priorities and plans for the remainder of the year. Starting with expanding our marketing efforts to increase brand awareness and drive sales. Our first quarter top-line results are testament to the effectiveness of our marketing strategies, including comparable sales growth of 85.2% for e-com business, and 31.7% for showrooms. While we're not providing quarterly updates to our customer lifetime value, CLV to customer acquisition cost, CAC, we expect the continuation of CLV exceeding CAC as we lean into marketing and acquire new customers this year. As a reminder, we finished the end of fiscal 2019 with the CLV to CAC ratio of 5x. In Q1, we are encouraged by the 59% increase in new Sactional customers and 38.9% of transactions driven by repeat customers, both of which measure marketing effectiveness and health of the business. We again saw strong returns on our marketing efforts in Q1. We ran national advertising leading into Presidents Day from January 31st through February 19th and pre-Memorial Day starting on 4/15. [Ph] This national advertising campaign was supplemented with digital advertising, which included increased search, social and remarketing spend to capture those searching, after seeing our TV advertising. Remarketing spend is utilized to capture the increased volume and lead conversion either online or in showrooms. As we look to increase our marketing efficiency, we've increased 15-second spots as a core part of our overall TV mix and continue to benefit from our transition to…

Thank you, Jack. Good afternoon, everyone. I will begin my remarks with the review of our first quarter results and then provide some commentary around our thoughts for fiscal 2020. Net sales increased 53% to $41 million from $26.8 million in the prior year quarter. This sales growth was driven by strong showroom, internet and shop-in-shop performance with an increase in new customers as well as an increase in the total number of units sold, reflecting a higher average order volume per customer. Our advertising and marketing investments which drive brand awareness and an increase in the number of showrooms also helped fuel our Q1 sales performance. Comparable sales, which includes showroom and internet sales, increased 43.5%. Comparable showroom sales increased 31.7% and represents our tenth consecutive quarter of positive comp showroom sales increases. Internet sales increased 85.3% versus an increase of 49.6% in the prior year period. We opened five new showrooms, remodeled three legacy stores into our new showroom format and closed two showrooms during the first quarter. We ended the quarter with 78 showrooms. Looking at our results by channel. Showroom sales increased 45.2% to $26.9 million; internet sales increased to 85.3% to $8.5 million; and our other channel, which includes our shop-in-shops and Costco locations, increased 52.5% to $5.6 million. By product category, our Sactional sales increased 65.4%; our Sacs sales increased 10.1%; and our other category, which includes decorative pillows, blankets and other accessories, increased 42.8% in the first quarter as compared to the prior year quarter. Gross profit dollars increased 43.3% to $21 million in the first quarter. As expected, gross margin percentage decreased by 340 basis points to 51.3% from 54.7% reported in the same period last year. This year-over-year decline was primarily driven by the 10% tariffs, partially offset by reduced cost…

Thank you. At this time, we’ll be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of David King with Roth Capital. Please proceed with your question.

Thanks. Hi, everyone. I guess, first off on the pre-Memorial Day ad spend that you ran, how did the ROIs compare there to what you were getting previously? And then, how should we think about the impact moving forward, particularly as you get into the second half, anniversarying the start of national TV?

Yes. I think, it’s a good question, Dave, but one I can’t answer in detail because Memorial Day runs through Q2. So, I don’t think we’re seeing any surprises versus what we expected. But, the Memorial Day run we’re still analyzing as we still get a tail in terms of return. So, it’s -- the run hasn’t completed in terms of our analysis.

Okay, fair enough.

But what I can tell you -- what’s that?

I said fair enough. Go ahead.

Yes. What I can tell you is some of the things that we’re excited about are those tests I mentioned. So, we’ve had a couple of market tests where we’ve extended our advertising for three weeks at a fairly robust increase in GRPs and we were seeing increasing lift, and we’re continuing to expand to the 12 markets prior to Labor Day. And based on -- if those results continue to look good, we will see a pretty major expansion in the level of GRPs at a national level. So, we’re very happy about those test results.

Okay. And is that the advertising and conversion test that you had alluded to or is that something else?

That was the test where we literally right now where we run three to four weeks prior to what we call our major tent pole event, so the Memorial Day, Labor Day holiday et cetera. We took three markets and extended it from three to four weeks to six to seven weeks, and we did see an increase in ROI in those markets. However, consistent with where we’ve been in the past, we’re not going national, we’re going to 12 markets prior to Labor Day, which are some of our stronger markets, balanced out with the mix of some of our sort of average markets. And based on what we see there, we will either expand nationally or expand to those 12 markets again during the fourth quarter.

Okay. And then, maybe trying the first part of the question again in a different way. It sounds like several retailers and brands for that matter have talked about a tough May with weak mall traffic. Have you guys seen any of that through early June, even if on just showroom side? I think in the past, you’ve probably demonstrated your ability to, whatever the word is, do much better than your peers, just curious if that's continued to be the case?

I would say that we did not experience challenges in traffic relative to our expectations in the first quarter, and since we're in the beginning of the second quarter, we don't want to share it.

Okay. And then, maybe high level, taking a step back, Shawn, how are you thinking about the competition these days? I saw Nectar or Bundle rolled out a couch and beanbags and then there is Burrow, just what are you thinking about what's out there from others at this point, your ability to continue take share, do you worry about them at all? Just some thoughts will be great.

Yes. I think that we continue to see new entrants in both the couch and Sac categories, albeit relatively slow compared to other categories in a direct consumer market that we witness whether it be fashion, whether it be mattresses. We are very focused on just sort of doing our thing. We are very confident in not just our intellectual property, which we continue to get more of. We continue to actually lay out new patent claims that get issued. But, we also have some long-established patents that we continue to defend and we'll continue to defend against the life of those that infringe upon them. But more importantly, I think we're confident in our business model. It's one thing to make something and put it in a box; it's another thing to build a platform like we have our around Sactionals that drives true repeat, customer value as well as has a path to kind of ongoing and expansive growth as a platform. And so, I think that the way that we do business is radically different than anyone else so far. And while we should fully expect given our success to see new entrants come into the market, I think that the IP mode we have around Sactionals is solid. I think, our pace, rate of growth, and customer affinity is solid, and we're just focused on doing business our own way. I think, one of the things we'll watch is incumbents. We still have yet to see any incumbent furniture companies really go down the path of direct to consumer, couch in a box, all these kinds of things. And it will be interesting to see if that happens. But, as of yet, we continue to be confident what we're doing.

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

Hi. Thank you. Good afternoon, everyone. Shawn, thanks for the detail on your tariff mitigation plans. You mentioned that you are starting to see some cost differentials and cost improvements on product that's being produced in Vietnam. Can you help us understand how to think about that cost improvement and how that improvement increases as your scale with those manufacturing partners increases?

Yes. So, we haven't put out specific guidance on the types of savings that we’re experiencing in Vietnam. But, suffice it to say, apples-for-apples product costs less there than it does in China. It's not dramatic or crazy gap in margin, but it certainly is positive to the business. It took us a little while to get that fully in gear as the sampling process and the product development process around Sactionals is tough. It's a very technical product in its category, it's a very exacting, and we have to really go through number of cycles with any new vendor to vet the vendor and also to then get to manufacturing in mass. And so, we're there now, which at least the one Sactional supplier and we feel very good about that. In terms of the long-term implications, like we’ll be buying stuff we believe less expensively in as much as Vietnam we’ll experience inflation. China always experienced -- we've been doing business in Asia for -- I've been doing business in Asia with Lovesac for almost 20 years now. We got started very early there, partially because I speak Mandarin, Chinese and lived over there for a 10th of my life. And so, very familiar with the region, very comfortable operating in that region. I think, it's one of the reasons that we feel confident in our ability to navigate these sort of crazy waters that the tariffs have kind of thrown us into over there is we've been sourcing and resourcing in Asia in general for very long time. And so, I'm sure that Vietnam will experience some kind of inflation as a lot of manufacturing moves there. At the same time, Vietnam is undergoing economies of scale as the infrastructure there improves. So, the one offsets the other. And we hope that we can continue to maintain high gross margins at the product -- high gross margins. And that's something that we intend to do, we feel confident that we can do that. And Vietnam won’t be the end of how we do that. And I kind of spoke at length to that during my remarks, but did it a little abstractly on purpose. But we have very long-term views to the supply chain and to our ability to maintaining high gross margins in this business.

So, assuming that the tariffs at 25% do not get listed by next year, I think you said that by the end of next year, you will be fully out of China if need be. So, is that to say that when we roll over to fiscal ‘22 that that should be -- from an all else equals perspective, that that should be a year where you'll have that margin recovery because you won’t have that pressure from tariffs to deal with and contend with anyone?

Yes. That's exactly right. I mean, minus any inflation across the whole system over the world or Vietnam in particular. But, we -- even there, we hope that as we explore Chinese alternatives, it may not all be Vietnam either. So, we have our hands in a number of different baskets right now. And again, our hope is that tariffs do fall away, because China is a very strong infrastructure that can support our scaling. But, we are totally mentally flexible on the subject. And we feel like we're -- wish we were further ahead of the eight ball here, but we're at least halfway ahead of the eight ball, and it won’t impact our business in the long term.

And just to add to that, and we're also at the same time -- so if you think of in a 24-month period, we’ll have a supply chain that's delivering where we need -- needed to deliver in terms of tariffs. We're continuing looking at merchandising approaches, tier pricing changes in terms of promotions to increase our margins at the side. And then, I think after the next 24 months, we will start to see some dramatic increases in efficiency of supply chain, which will also give us some real positives in terms of cost and efficiency in the long run.

Great. It sounds like the long run margin structures should remain in that mid 50s range. Perfect. If we could just switch topics quickly to the advertising and more as it relates the back half, given that you began a national campaign last year on Labor Day, you saw great results. How do you answer the question, and it's one that we get often about how you cycle through those difficult comparisons? What is the plan to anniversary that really first successful launch and what conference do you have in the ability to maintain this continued level of growth?

That's a good question. There's a couple of factors, one is just the size of the fleet of showrooms and the touch points. And as we discussed earlier, I think I've mentioned that an area with the showroom is 600% more efficient than an area without a showroom. So as we continue to grow our showrooms, we'll have a natural increase in efficiency in markets where we haven't been before. In addition, we continue to learn from our testing. We've consistently discussed what we're testing each quarter. Last quarter, we discussed 15-second commercials and they’ve become 30% of our -- basically 30% of our mix. And those savings get applied to other areas in reinvestment. So, we take that efficiency and we don't increase -- decrease our spending, we actually increase it. And at the same time, I think as we discussed this earlier today, we are seeing very positive results in extending our media runs in the major markets. So, I would expect those savings that we're getting with 15 seconds are going to be redeployed into higher levels of GRPs in the fourth quarter. So, I think right now, I think what we've got is a real learning agenda and efficiency from showrooms that we believe will match the increasing comparables as we go forward.

And then, if you could just remind me, Jack, I think you had -- you tested some of this before in the San Francisco market, if I'm not mistaken, where you had multiple years of very consistently high levels of growth. Could you just remind me of that?

Yes. We have -- and this all -- we've got new cohorts in here. But, what we've basically seen in San Francisco, we've seen over the past -- San Francisco market started 18 months before many of the other markets and we continue to see very strong levels of growth in San Francisco. And that's really due to the fact that even at the basically year-over-year growth of three digits, we haven't seen significant increases in awareness. So, there's a long runway to go forth. Basically in San Francisco, I think we have less than 3% awareness. So, we still see huge opportunities for the brand.

Great. Thanks a lot, guys, and good luck in the second quarter.

Thank you.

Our next question comes from the line of Thomas Forte with D.A. Davidson. Please proceed with your question.

Great, thanks for taking my questions. I had one on marketing spending philosophy and then one on urban showrooms. So, first on marketing spending philosophy. I think you indicated that the lifetime value of a customer versus the customer acquisition cost ratio is 5x. How do you think about spending marketing dollars and potentially ramping your marketing spend, even if it means lowering that ratio as a way to acquire customers? And then, after that, I’ll ask about the urban showrooms.

Okay. Yes. We will continue to -- I think what we’re really pleased with and we mentioned earlier is some of the improvements in supply chain are making us feel more confident in the operational excellence of the business in terms of supply chain as well the efficiency of opening showrooms. So, I think we are going to continue to look for ways to lean forward in marketing and increase our revenue growth. So, I obviously don’t want to give you any guidance here. But as discussed earlier and answered some of the other questions, when we see opportunities based on testing to lean more into marketing, we will do so. We don’t -- we’re not saying that we’re going to leave the 10% to 12% of sales in terms of marketing rate right now but we will continue to look for ways to increase our efficiency, increase our commitment. And yes, you’re absolutely right, in terms of -- we’re not going to become literally prisoners of a pure ROI because there are many cases where certain ROI approaches -- or certain, I'm sorry, certain media approaches may have a lower our ROI but higher scalability, netting out greater revenue growth. And we’re certainly aware of that and we’re not afraid to change the mix up in order to get greater overall revenue as long as the system that we’re putting together can support it in a way that our customers still love us.

Great. And then the second question on urban showrooms, you talked a little about the halo effect in showrooms in general, but I was wondering specifically, you now have three urban locations, you recently added one in Philly. Are the urban showrooms materially different than your suburban showroom locations and are you seeing a difference or perhaps bigger halo effect for sales in other markets and opened ones?

Yes, we are. So, generally speaking, what we see is the higher the population density, really what we’re seeing and unlike sort of a specialty retail model where the more stores, the better and it’s based on convenience, it’s really based -- what we’ve seen is the trading areas are really based on the time it takes to get through a showroom. And our trading areas are typically a radius of 30 to 40 minutes. So, you can imagine. And New York City -- you basically have trading area that one showroom practically covers the whole trading area or maybe two or three in terms of -- if you go up and up north in Manhattan. So, basically, the bottom line is, you’ll see for example in New York City 30% to 40% of the sales -- if you have a showroom that based on measuring the way we measure showroom sales right now, it’s an index of one, will get e-commerce sales driving 30% to 40% of that. And as you look in less populated areas you’ll see a 15% to 20% ratio. So, those high urban areas have a tremendously higher return in terms of the total mix, the DTC mix combined showroom and e-com.

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 quarter of very strong growth. I wanted to ask about the -- some of your supply chain plans and curious if the tariff situation persists and you end up going down the road where you completely move your production outside of China in the next 18 months, how much capital investment would that entail on your part? It sounds like, there is an appetite on behalf some of your vendors to make investments to be able to handle your business. Just curious what we should expect in terms of your own spending to able to complete that transformation?

Yes. This is Shawn. I'll comment and then Donna can follow up if there is something to add. In terms of our core manufacturing as it's been described, almost nothing. We have a third-party manufacturer bias all things being equal. We've done very well with our outside partners. We hold them very close and we feel like we've got a good control over our supply chain with pretty robust ability to scale at almost any pace. And so, while we will be expanding that network and taking on some new suppliers as we’ve done already, we feel confident in that cadence and our ability to manage that and in our ability to get that investment out of our third-party partners. What happens with us because of the nature of what Sactionals are, again highly uniform, highly exacting, difficult product development process. However, once you are in motion, we become the favorite of any of our suppliers and usually the biggest of any our suppliers, client that is because all they do is make the thing over and over and over forever, and that's the nature of the business we're building. We're intentionally -- we are out against planned obsolescence and perceived obsolescence, and everything that drives the rest of merchandising model that we've escaped from. And so, everyone benefits, the consumer benefits, we benefit as evidenced by our success and our vendors benefit. And so, they're always willing to make those investments for us to what we've experienced so far. So, we don't expect huge capital outlays. We don't intend to pursue vertical manufacturing opportunities except as they present themselves as obviously advantageous as our little Sac operations that we’ve already been talking about.

That's terrific, Shawn. That's really helpful. And then, if I could just ask one more question about the marketing, the increase planned for the fourth quarter, is that -- just thinking about the comment about that being the largest quarter for marketing this year. Is that in absolute dollars in terms of the year-over-year increase, is that set to accelerate in the fourth quarter as well? And just kind of curious where some of those dollars are going to going, is that for TV commercials or better TV placement or channels outside of TV, just curious how that will manifest itself.

Yes. I would say a couple of things, as absolutely in terms of absolute it is the largest in terms of growth, but I will say is that -- we are redeploying the savings, marketing numbers that we underspent in the first quarter, we're obviously redeploying those in the third and fourth quarter, primarily in the fourth quarter. And it’d be primarily based on our knowledge, so far, based on what we're seeing it will primarily be extended runs in major markets where we're seeing the benefit of additional GRPs for an extended period driving up ROIs and efficiency.

Our next question comes from line of Brian Nagel with Oppenheimer and Company. Please proceed with your question.

So, maybe a bit longer term in nature. But, you talked quite a bit about the openings of the showrooms. As you think longer term in connection with customers, how do you balance, how do you think about the opening and running of your showrooms versus the partnership you have with Costco? How do those two channels, so to say, work together, over time?

I think -- that's a good question. I think that it really -- I think that in high population -- areas with the high concentration of population -- excuse me, that's hard for me to say, showrooms will continue to be a very efficient way for us to roll out the business. And I believe will -- a 200 showroom target for a $1 billion business is probably a reasonable thing to say, at this point. But that doesn't mean, we'll continue. We certainly see, for example, the Costco has been incredibly efficient, because it's low capital, really, in that case, very -- almost no capital, way to create consumer touch points that create business really outside of Costco. We generate a lot of online business, as well as showroom sales in the weeks following our Costco road show. So, what we see in terms of that is a model to reach additional customers in a low CapEx way, and we are because of the value of the business and the quality of the Costco business. I think, it tells us that there are a lot of potential partners out there that have a desirable customer base, who want to partner with a desirable company that's growing as fast as we are. So, we see it as a big opportunity. And I'd say, this is -- the way we look at it is how do we enter a market and leverage the CLV over CAC to get -- keep the multiples as high as possible. And when you look at some of these shop-in-shop opportunities and partnerships, it can really help us become super efficient. So, we'll continue to look at that. And we're continuing to learn a lot. We're obviously growing very fast. We went from zero Costco shows 24 months ago to where we are today. And we've grown our showroom base tremendously. So, we're really starting just to get an understanding on how the shows and the showrooms and the e-commerce business work together. So, I think, we will be giving you more and more details in the long run on how they look. But I think that we're going to continue to look at other opportunities for shops-in-shops absolutely.

If I could follow-up with one question on a separate topic and we talk a lot about tariffs here? I think, Shawn, you were mentioning just some of the efforts to potentially move manufacturing capacity to potentially impact upon margins. The simple question I have is, as you look at your product and the demand trends for the products, how much pricing power do you have? To the extent that if -- we've seen some tariffs, if more tariffs come in, could you pass along some of these costs to consumers in the form of higher retail price points?

Yes. I mean, we feel like we could. We know we can. We are kind of walking the timeline as evidenced by one of those questions earlier between even more rapid growth -- between rapid growth and rapider rapid growth. And so, we feel good about the sort of price value equation right now as it lies and the kind of growth that it drives for us with the marketing model as we know it. And I guess, what I'm really saying is, we did on the call mention that we will be taking some price increases, albeit very surgically and mostly we'd like to think invisibly to the customer. We're not raising prices on the core product. To your point, we could do it. We’ve chosen not to, because we have a longer term in mind. We like the simplicity of the model. We like the way it's resonating. We're on a good pace, and we just want to keep the good times going as it were. And so, we're willing to take the slight hit in gross margin in the near-term, especially as we feel confident in our ability to project that positive EBITDA and yet achieve these high growth rates at the top line, which is -- it kind of like falls in line with all of our objectives while keeping intact the model, as we know and as the consumers know, and as it's resonating today.

Yes. Just to add to that we are, I think we're learning a lot about the quality of selling. And as we invest more in marketing, I think we're getting smarter about the quality of selling in terms of the merchandising strategy and the discount strategies. And I think one specific one, for example, which was a pretty big change, but very subtle, and we saw absolutely no resistance from customers at the beginning of the year, we changed our Stack More, Save More promotion, which is our everyday promotion. And the 20% requirement previously was 10 pieces. We moved it to 11 pieces; and for the 25% discount, we moved it to 16 pieces. We saw absolutely no impact on the business. And there are other things we're looking at, for example, in terms of flash sales. We're learning a lot about frequency and length of flash sales and how to get more return out of events and spending less money on discounts when we're starting to think not just at a promotional level, but what customers are doing, what's happening with quotes, and how do we leverage the marketing combined with strategic timing of flash sale to get greater list with lower discount. So, a lot of opportunities there for us too as we get smarter about the business.

Ladies and gentlemen, we have reached the end of the question-and-answer session. And I would like to turn the call back to management for closing remarks.

Thank you all for your support. We appreciate you interest in our business and we look forward to continuing to operate the business in the way that we only know -- that we know how. So, we will wrap up on that note.

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