Greetings. Welcome to The Lovesac Second Quarter Fiscal 2022 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] Please note that this conference is being recorded. At this time, I will turn the conference over to Rachel Schacter, ICR. Rachel, you may now 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, our 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 second quarter financial and operational performance before Jack outlines our second 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. We are very pleased with our second quarter results as the momentum from Q1 continued into Q2 and we achieved our highest quarterly growth rate ever reported as a public company. This was on top of the 28.7% sales increase, we reported in Q2 last year. Our 65% quarterly growth rate in Q2 is even more noteworthy when taking into account that it builds upon three years of a sustained 44% CAGR with only a slight attenuation in our growth rate last year during the pandemic even with limited showroom operation to that time. Even on a two-year basis, we are achieving very strong results. Bottom-line, we believe our continued success stems from the huge gains we are making as a brand in terms of awareness and conversion while actively managing the tight supply chain environment. We remained almost always in stock, delivering nearly all orders direct to the consumer in just days. Throughout the active pandemic and amidst a turbulent supply chain backdrop. Customers are recognizing the competitive strength of our unique product and are notable in-stock positions, which is evident in our Q2 results and our continued market share gains. The strength on strength in demand, we continue to experience now gives us confidence to test into new pricing and promotional scenarios to drive margins over the long-term. Now let me review the highlights of our second quarter performance. Total sales were 102.4 million up…

Thank you, Shawn, and good morning everyone. We're very pleased with our second quarter results and the strides we've made against our growth strategies, which I will now review. Starting with one efficient marketing and merchandising strategies. Despite increased cost per click our established digital marketing strategies and tactics coupled with newer initiatives, like SMS marketing, hyperlocal advertising and consideration advertising are driving higher than expected marketing ROIs based on what we see as a very strong leading indicators of brand strength. One, overall media ROI continues to perform above our benchmarks brand health has seen tremendous growth since pre-pandemic, particularly within awareness and perceptions on quality, value, and style within target audience. Source of awareness for purchasers, themes driven by TV and word of mouth with word of mouth growing the fastest overall, and overall digital seems to be filling the top of the funnel more frequently than last year. Social CPM continues to increase on core channels but this has been offset by higher conversion rates. We expect overall media to continue to see cost pressures but anticipate offsetting a higher conversion. We have scheduled refresh of TV and social creative during the second half of the year. We also have testing plan on new social channels including TikTok, Snapchat and Reddit. These tactics combined with a strengthening of the brand proposition and advantaged inventory position have enabled us to shorten as well as reduce promotional campaigns and discounting by approximately 900 basis points year-over-year in the second quarter, which is a key driver in helping us mitigate the supply chain headwind impacts. Our merchandising strategies are also driving continued mixed benefits as customers are increasingly gravitating to the premium priced and higher margin Love soft covers. On the omnichannel front, we have added additional automated touch points…

Thank you, Jack. Good morning, everyone. I will begin my remarks with a review of our second 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 40.5 million or 65.4% to 102.4 million in the second quarter of fiscal 2022 as compared to 61.9 million in the prior year period. This net sales increase was driven by both our showroom and other channels. The increase in these channels was partially offset by a decrease in our internet channel net sales against a period of elevated digital sales last year given the pandemic related showroom closures and shift to online purchasing. Showroom net sales increased 49.7 million or 387.1% to 62.6 million in the second quarter of fiscal 2022 as compared to 12.9 million in the prior year period. This increase was due primarily to a $40.3 million increase in comparable showroom point of sales transactions to 54.1 million in the second quarter of fiscal 2022 as compared to 13.8 million in the prior year periods due to limited showroom operations in the prior year as a result of COVID-19 as well as the sale shifted back into in-person shopping. As a reminder, point of sales transactions represent orders placed through our showrooms, which does not always reflect the point at which control transfers to the customer and when net sales are recorded. In addition, we opened 26 additional showrooms since the second quarter of last year, which was a meaningful driver of the non-com showroom sales increase. Other net sales, which includes pop-up shop and shop-in-shop net sales increased 7.4 million, or 243.4% to $10.4 million in the second quarter of fiscal 2022 as compared to $3…

Thank you. We'll now be conducting the question-and-answer session. [Operator Instructions] Thank you. Our first question is coming from the line of Tom Forte with D.A. Davidson. Please proceed with your questions.

Good morning. This is Clark Wright from D.A. Davidson talking on behalf of Tom Forte. Thanks for taking my questions. My first one is just for you guys would be from your vantage point, do you think consumers have scaled back their purchases in the home category? From our vantage point, it seems clear to us that they're spending more money on travel as reflected in the TSA throughput data?

Hey, Clark, this is Jack, I'll start that and Shawn or Donna, please add on to it. Well, I think what we're seeing due to the disruption we're making in the industry that we're not seeing any dynamics industry-wide in terms of changes in buying behaviors that relates to our brand. As we discussed earlier, we're seeing conversion rates that are higher than they've ever been, which I really think is we're winning in the awareness to decision making part of the funnel which is farther down than obviously consideration. So while there are things happening, I think in the macro market, which have been headwinds or tailwinds for some of our competitors that are in more of a static growth rate, we are seeing continued strength based on all of the measures we do for brand health. So I can't really comment on those sector changes because we just can't see those within our brand data right now.

Thank you. And then just my second question would be even with the challenging supply chain, you're able to get consumer couches faster within the competition. Do you think this is a greater -- an even greater competitive advantage today?

Yes, absolutely, we know it is. I think part of, obviously part of the purchase product process is to get the product and enjoy it and use it. And we are continuing to have industry leading service levels, which we're very proud of driven by not only a product that's evergreen in nature, but a series of decisions the teams have made to really put us in a great stock position. So it is clearly in this environment giving us a competitive advantage that we really want to take advantage of because we continue to -- while there's a pandemic going on, our objective is just to disrupt the category and continue to gain share which we are doing.

Thank you. Great color.

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

Thank you. Great quarter. Congratulations on the results in a very tough environment. I first wanted to ask Donna, if you could just unpack the components of the Q3 gross margin expectation, the decline on 530 basis points just -- if you could just articulate the puts and takes around that? And also if you could quantify what the infrastructure expense that was pushed out from Q2 into the second half how much that was? And then I have a follow up?

Yes. Good morning. So yes, the puts and take on the gross margin are essentially net-net. The negative impact is 100% related to inbound freight. We're no different than other importers. We're currently seeing an 85% increase on our container costs coming in from overseas. And then there's a slight piece of that too that relates to our diversified supply chain, which gives us an advantage as well. So where we see container congestion may be coming out of Vietnam, we're able to shift inventory purchases over to our vendors in China. And we know that the inventory that comes in from China is impacted by tariffs, but it allows us to stay in stock on our inventory, which is super important to us as it is to our customers. We have and we continue to reduce promotional discounting, which is helping us mitigate those. And I think on an overall, given the 85% container increase, the impact, and the way that we've been able to mitigate in the first half of the year, seeing these costs come down the line to only have we're seeing 150 basis points impact on our gross margin year-over-year has been very strategic for us. That does -- does that answer that piece, the gross margin question? And then on the -- does that, Camilo?

Yes. So just to clarify, you're talking about Q3 total gross margins have been down 530 basis points, given all the puts and takes that you just articulated?

Correct. Yes.

Okay. Okay, perfect. And then just the infrastructure spend and how much of that has been pushed out of what you thought was going to happen in Q2 that now looks to be more back half realized?

Yes. It's probably, I don't have the exact number. I would probably say it's probably close to $1.5 million knowing what I know and being so close to the financial statements. But the other piece of that is not only infrastructure investment, but the timing on HQ and showroom hires, which has been -- that was not strategic to push out those hires. We're just making sure that when we bring our players on the team, they're the A players. And our onboarding and our interview process is very extensive. And we were probably a little too aggressive in thinking that we can onboard as many people as we thought we were going to do at the beginning of the year. So that's probably on an SG&A and that's not necessarily a shift, that's we'll call it a save. That was not strategic, that was just timing, but the infrastructure investments themselves, I would probably say they're probably close to $1.5 million that were shifted out to the second half of the year.

That's great. Thank you. And then Jack, you gave some great detail on your marketing ROIs. I'm wondering if you could just isolate how you're toggling back and forth between increased media, maybe not media, but more online marketing spend in the face of rising CACs to continue to generate traffic to the top end of the funnel?

Yes, in the top of the funnel, I think a couple of things, one is, we are continuing to get more targeting through use of media like OTT, which has a higher CPM, but it's very effective. In addition, I think overall TV costs have gone up, but we're just seeing brand stickiness as I mentioned it. We're seeing ROIs despite increasing CPMs across the board go up because of, we really believe is the brand stickiness, and I think that indicator is the word of mouth coming out of nowhere to become the leading change and awareness year-over-year, which is pretty amazing. And that provides tailwinds to your efficiency at the media at the top of the funnel. Obviously, the brand equity points that I made earlier also create efficiencies in the middle and the bottom of the funnel in terms of conversion. So we're getting a lot of tailwinds right now that are really generated by the brand just getting stronger. Obviously, I can't predict how long that's going to happen, but we've certainly seen efficiencies continue to bear out positive for us despite a environment this year so far, where marketing costs are increasing.

Is that giving you insights into perhaps dialing back the quantity of spend and still receiving those same level of traffic inbounds from the word of mouth component? And are you seeing that actually in your post purchase surveys?

Well, we certainly started to look at -- we've continued to, I think and is a percentage of the business we've continued to look at more digital and digital becomes significantly more important as we get to hyper-local marketing, for sure. That helps answer a little bit of your question.

Great. And that's all for me, but great job and continued success into the holiday.

Thanks, Camilo.

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

Great. Congrats on very strong results and thanks for taking my questions. So just on Q2 revenue, can you maybe talk about what drove this very healthy outperformance versus your expectations? And so you mentioned strong performance during key events, but is there anything else that was maybe different from what you expected? And then I have a quick follow-up.

I think the biggest and Donna and Shawn, Donna will probably have much better color on the details. But overall look, we had overperformance in both showrooms, while showrooms had obviously very strong comp growth, both to LY and LLY, and they definitely exceeded our expectations. The web is welded because it's LLY, numbers were outstanding as well at 351. So what I would say is our organic business beat our expectations, as well as that business -- sorry, our business development segment, which is the Costco and Best Buy also. So really, we're seeing strength across all segments. We do see dramatic increases in strength during promotional periods. And I think that's because of the growing brand strength and benign promotional environment causing people to really engage with us during those periods. And that's a real opportunity for us as we go forward as we strengthen our pricing proposition, as well as look to manage margins in the fourth quarter.

Got it. Thank you, Jack. And sort of, it seems like you widened your customer base pretty significantly over the past several quarters. Can you maybe just refresh us on who your core target customer is today and how that may have changed sort of now coming out of the pandemic?

Well, I don't think really our core customer has changed dramatically. We're attracting a lot of new customers across the board, but that core, young parent, want-it- all is critical to our business, and our engagement with them are really the real indicators of future growth as well. So we're doing very well with that group. Our awareness is growing dramatically. And the young parent want-it-alls are the older millennials that are engaging in either looking to buy a home or expanding their family and they're right in our sweet spot. And what I can tell you is among them, not only awareness has gone up, but engagement and awareness of the brand values and alignment with Lovesac brand is a brand that represents their values. So we're very pleased with that and that continues to be our sweet spot.

Great. Thanks so much for the color.

Our next question comes from the line of Matt Koranda with ROTH. Please proceed with your questions.

Hi guys, thanks. Wondered if you could maybe just talk about quarter-to-date trends in the context of the 50% growth guidance for the quarter that you provided? How was Labor Day just maybe qualitatively at least that'd be helpful?

Donna, do you want to hit that or?

I was on mute. Sure, okay, I could start with that. Labor Day was very good. I mean, from what I can share, we had a very strong Labor Day weekend, actually stronger than what we had projected internally to happen. We had a strong promotion that we ran, I think for four days over Labor Day weekend and it was very well received, and that could be because we've pulled back on discounting over the last handful of months. So, yes, people embraced our Labor Day and weekend promotion, so very strong. The year-over-year growth of 50%, just to remind everybody, any of the guidance or we'll say framework that we have provided in the past did not account for any of our new initiatives, because we were early on in the year, so we just needed to make sure some of these new initiatives we could trigger them when we had plans. So that being kiosks, that being concierges and our new product launch, which is super exciting. So any of the guidance or framework that we're providing to you, the updates are -- and the opening of additional showrooms, right. So originally, we were planning to open 25 and now we're at 28. So the additional or I will say the updates that we're providing to you in order to update your modeling now include all of the initiatives because we are pretty certain at this point in time that they will all be able to happen when we have in our plans.

Right.

Okay, that's helpful. And then --

The only I'll add -- I'll add to that is we certainly saw in the last couple of weeks continued support for the fact that we're not seeing a lot of demand elasticity to decrease promotions. So I think we have a very strong lever we'll continue to look at as we look to manage margins in the third quarter and on into next year.

Okay, that's helpful, guys. And then yes, I wanted to touch on gross margins maybe in a different way here. I guess, I was just surprised that the year-over-year headwind that you're citing, like more than 500 basis points in Q3, understandable on the inbound freight front, but it sounded like there were quite a few offsets and levers you have to pull on sort of lower promotional environments, your existing warehouse leverage that you're getting. Wanted to see maybe could you unpack that a little bit more in terms of the headwind that you're facing, specifically on inbound freight, if you could quantify that, that'd be helpful just so we know what you're offsetting it with?

I can start. So I don't have specific numbers I can share with you other than what I did share a few minutes ago, I guess, on a call with an 85% increase in container costs, right, who would have expected that, that certainly, we had built in our projection somewhere around 50% and maybe even a lower rate on increases, but we're currently at an 85% increase. So as we see those freight headwinds coming toward us, we're very flexible and nimble and agile enough to be able to plan for that in our promotional discounting, and the team has done a great job. As you can see, the gross margins that we came through in the second quarter were far ahead of where we had guided to or even had in our internal plans, right. So that shows you how quickly we can turn when additional information is being presented to us. So those headwinds are really specific to the increase in container costs, and then the shift of bringing some of our product in from China to make sure that we're most -- if not always in stock, right. And again, that goes back to the divert -- the strong diversification that we have in our supply chain. It may cost us a little bit more to bring the inventory in, but we have the inventory, which gives us a competitive advantage.

Yes, just that just really circles back around in my comment earlier, because we're in stock, we're seeing our price value equation, our value equation go up even in a year, we've dramatically decreased discounts, which I think just is a note to we have pricing power to continue to manage things.

Okay, makes sense. If I could sneak one more in just on the EBITDA guide, I guess, I have to step up OpEx quite a bit sequentially to kind of get to the in line with the EBITDA guidance you gave for 3Q and on order of more than $11 million, I believe sequentially in terms of raw dollars, but Donna, I think you cited only like about $1 million of delayed investments. Maybe could you guys just speak a little bit more to the split between maybe SG&A and marketing as you expect it to play out in 3Q and maybe even in the fourth quarter? And maybe just bonus accruals maybe accounts for some of that, but it'd be helpful to get a little bit more color on that one?

Well, so you're saying operating. So the biggest adjustment in that operating margin is the gross margin adjustment. We probably based on what I know that's out there for consensus, marketing spend may be a little higher. It's hard because I don't see a lot in the marketing spend what's out there broken up between marketing and SG&A, I see it more as a total number. Marketing spend, as we mentioned, will be a little higher as a percent to sales in Q3. Probably the biggest reason for that is all the marketing initiatives that we're putting up against our product, our new product launch, right. So as I remind you that the new product launch was not in -- the new product launch was not accounted for, even in our 2Q guidance that we provided or fiscal year framework on our first quarter earnings call. So that new product launch is coming in now full force in the numbers that we're providing to you. And it does involve heavy investments into marketing if that helps. So it's everything --

It makes sense. I'll take gross amount offline.

Yes, it's everything around all of these new initiatives that are coming through now on the top-line, they have support dollars needed to support which are coming through now in marketing and SG&A.

Got it. Makes sense. I'll take gross amount offline. Thanks, guys.

The next question comes from the line of Brian Nagel with Oppenheimer. Please proceed with your questions.

Hi, good morning, and thank you for taking my question. Very nice quarter. Congratulations. So my first question and that was a bit of a follow-up just on the supply chain. But I guess the way I want to frame the question is, you look at the results for the fiscal second quarter, you as a company managed extraordinarily well with a very, very difficult supply chain environment. Now the guidance in Q3 would suggest that maybe it -- maybe you're at least leaving room for not managing as well. So, of course, I mean, what's changing, what factors out there could be more difficult for Lovesac to manage in this coming quarter over the balance of the year that we're managing in the second quarter?

That were managed in the second quarter or we're not. I mean, again, the gross margin is just on the principally the container costs. And we do -- we have a, I won't say a competitive advantage, but we are able to mitigate because of our evergreen inventory, we are. It allows us to plan inventory purchases in the most cost efficient manner, but at the same time, we're not isolated from those increased container costs. So our evergreen inventory, like I said, allows us to plan appropriately. We're not bringing in seasonal merchandise that has to come in today. So we can manage weeks of supply of inventory. We can manage timing of inventory. We work with our overseas vendors to make sure that they're -- they can produce to our needs. So we definitely have an advantage on that part, which keeps us in stock. And, but again, we're not isolated from the increased container costs that everybody else is seeing as well.

Yes. And just to add to that, I think sometimes we get caught up into a sequential game, which causes us to perhaps think there's a big trend when there isn't. And what I mean by that is, look, we know this pandemic has had all kinds of fluctuations. We knew ahead of time, we would have headwinds in the third quarter, but we pulled the lever in the second quarter to give us extraordinary margin gains that for the year are going to get us exactly where we want to be. So I think we've got to be really careful overanalyzing the quarter-by-quarter stuff. We're going to land I believe, where we always thought we would, and as we start to look at next year, it's the same thing. We have pricing strength, yes, we have headwinds, we will strategically continue to be a leader in the industry, not only in growth, but I believe in gross margins.

Okay. And then actually the follow-up question I have just with regard to sales, again, extraordinarily strong sales quarter in Q2. So maybe just more from a nuance standpoint, the economy now is pulling away from the COVID crisis. There's been the concern out there that Lovesac among other companies potentially benefited through the crisis because consumers were more focused on this category. So, but your sales strength is holding up, if not strengthening further, as the crisis abating. Are you seeing that the composition of sales or the makeup of sales change in anyways we pulled away from the crisis?

No, it's continuing to be exactly where we want it to be on our core items, especially sectionals, where we're spending our investment and our money on getting the platform out there, because obviously, it'll support new initiatives in the next couple of years and build upon them. So I think we're seeing it flow pretty much in terms of the long-term plan and looking at to your trends, they're about right where we thought they would be.

Great. Okay, I'll leave it there. I appreciate it. Thank you.

The next question comes from the line of Alex Fuhrman with Craig-Hallum. Please proceed with your questions.

Great. Thanks very much for taking my question. Wanted to ask about how you're thinking about pricing and promotion. It seems like you kind of described being less promotional a little bit as a gross margin mitigation effort, given the rising supply chain costs and yet it doesn't seem like there was really any slowdown in demand at all. So how do you think about both the ticket prices of your products, as well as the promotions and discounts that you deploy over the next couple of years? Is it your intention to kind of get back to being a little bit more promotional as supply chain costs come down or do you think maybe you're kind of starting to discover that maybe the higher prices are just warranted given the improvements you've made to the platform over the years?

Right. That's a great question with a lot of nuances. What I would say is, we've continued to obviously through this year understand that we can use less promotions at today's MSRPs and continue to get demand that's outstanding. I think the promotional approach is really within the year tactic as we look at it and MSRP is obviously long-term strategic. I think as we're starting to get a longer track on the value, the price value relationship of the brand with the customer, we're going to get smarter about potentially looking at MSRP changes. But I believe in the long run, we will always have some sort of promotional cadence that's associated with the stack more, save more, because internally, we really believe that it helps expose the benefits of the product, the flexibility of the product, the design for life aspects. So what I would say is we're looking at both, one is a strategic platform and one is a, within the year tactical way to manage the dial of demand a little bit more finite. So you can expect adjustments on both areas as we go forward.

Okay, that's really helpful, Jack. Thank you.

Thank you. Our final question is coming from the line of Lamont Williams with Stifel. Please proceed with your questions.

Hi, everyone, thank you for taking my question. Now that we're further into the recovery, could you just talk a little bit about what you're seeing in traffic in the showrooms? I know you've opened some more showrooms off mall. Are you seeing any differences in the recovery in traffic there?

Yes, we are seeing. So we are seeing some differences and it's interesting. I think we're seeing much more robust returns in traffic in areas that are not as cosmopolitan. And we believe it's really associated with the work-from-home movement and some of the more concentrated areas. Now, with that said, we're seeing extremely strong growth across all segments of showrooms right now. And I think what we're seeing if you look at it versus on a two-year basis, we are seeing traffic slightly lower, but with a model that's generating conversion rates of 40%, which are almost unheard of. So it gets back to that touchpoint strategy. We'll continue to exist and evolve and we'll continue to look at the most efficient way to have showrooms, which probably leads us to continue to look at obviously the off malls, as well as some of the other concepts we've talked about.

Okay, all right, great, thank you.

Thank you. At this time, I'll turn the floor back to management for closing remarks.

Yes. So I want to just offer special thanks to our own team, everyone who has been a part of our #LovesacFamily that played a pivotal role in generating these outstanding results, leading up to and ever since going public, our momentum has never missed a beat. And thank you so much to our investors for supporting us as well. We won't let up. Have a great day.

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