Good afternoon, and welcome to Lulu's Fourth Quarter and Fiscal Year 2022 Earnings Conference Call. Today's call is being recorded, and we have allocated 1 hour for prepared remarks and Q&A. At this time, I'd like to turn the conference over to Naomi Beckman-Straus, General Counsel at Lulu's. Thank you. You may begin.

Good afternoon, everyone, and thank you for joining us to discuss Lulu's fourth quarter and fiscal year 2022 results. Before we begin, we would like to remind you that this conference call will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All statements made on this call do not relate to matters of historical fact should be considered forward-looking statements, including, but not limited to, statements regarding leadership transition, management's expectations, plans, strategies, goals and objectives and their implementation, our future expectations regarding financial results, references to the year ended December 31, 2023, market opportunities, product launches and other initiatives and our growth. These statements, which are subject to various risks uncertainties, assumptions and other important factors could cause our actual results, performance or achievements to differ materially from results, performance or achievements expressed or implied by these statements. These risks, uncertainties and assumptions are detailed in this afternoon's press release as well as our filings with the SEC, including our annual report on Form 10-K for the fiscal year ended January 1, 2023 filed with the SEC on March 14, 2023, all of which can be found on our website at investors.lulus.com. Any such forward-looking statements represent management's estimates as of the date of this call. While we may elect to update such forward-looking statements at some point in the future, we undertake no obligation to revise or update any forward-looking statements or information, except as required by law. During our call today, we will also reference certain non-GAAP financial information, including adjusted EBITDA, adjusted EBITDA margin and net debt. We use non-GAAP measures in some of our financial discussions as we believe they more accurately represent the true operational performance and underlying results of our business. The presentation of this non-GAAP financial information is not intended to be considered in isolation or as a substitute for or superior to the financial information prepared and presented in accordance with GAAP. Our non-GAAP measures may be different from non-GAAP measures used by other companies. Reconciliations of GAAP to non-GAAP measures as well as the description, limitations and rationale for using each measure can be found in this afternoon's press release and in our SEC filings. Joining me on the call today are Executive Chairman of the Board, David McCreight; our CEO, Crystal Landsem, President and CIO, Mark Vos; and our CFO, Tiffany Smith. Following our prepared remarks, we'll open the call for your questions. With that, I'll turn the call over to David.

Thank you, Naomi, and good afternoon, everyone. I want to begin by thanking the Lulu's crew, who continue to do a tremendous job executing on our strategy and pleasing our millions of brand fans. I am delighted to pass the baton to Crystal Landsem, who officially assumed the role of CEO on March 6, 2023. Crystal has been a wonderful partner who has a deep understanding of our business and customer embodies our core values and has consistently demonstrated her leadership as we've scaled and grown the company these last few years together. As we've communicated in November, I've transitioned to the Executive Chairman role after rewarding few years as Lulu's CEO. This transition has been part of a long-term plan since I joined the company, and I am thrilled to leave the business in the capable hands of this excellent management team. Their commitment to the brand and the Lulu's customer is inspiring. Over the next few seasons, I'm confident Crystal and team will continue to make great strides in building on Lulu's strong brand equity and evolving our go-to-market strategy for the future. I can't wait to see what Lulu's does next. I'll turn it over to Crystal so you can now hear directly from her as CEO. Crystal?

Thank you, David, and good afternoon, everyone. I'm honored and thrilled to have assumed the role as CEO. It's been an incredible 7 years so far at Lulu's, and I'm very much looking forward to leading this exceptional and dedicated team as we continue to execute our long-term growth plans. I'd like to start with some full year highlights following our first full year as a public company, followed by our key priorities for 2023. 2022 net revenue of $440 million was up $64 million or 17% year-over-year from $376 million in 2021. Adjusted EBITDA of $29.1 million, an 11.4% 3-year CAGR despite no incurring public company expenses and developing infrastructure to position Lulu's for long-term growth. Active customers grew 17% over last year with an all-time record of repeat customers engaging with our brand. We implemented automation and robotics in our distribution center network, driving operational efficiencies, cost savings and increased employee morale by vastly reducing travel distances to pick, pack and ship orders, also resulting in an improved customer experience by reducing the time between order and shipment. Roughly 83% of our units sold without markdown pricing, right in line with pre-pandemic years. And those units sold on markdown, sold on average at a higher, more profitable net merchandise margin than pre-pandemic periods. We completed the move of our creative studio to a location adjacent to our Southern California buying office. And already, we're seeing the benefits of that move through strong new product conversion, which we expect to continue in the future. We continue testing and expanding more into brand awareness marketing while maintaining first order contribution margin profitability and year-over-year active customer growth. Our marketing initiatives remain efficient and impactful. At its core, Lulu's continues to be a profitable, data-driven growth concept with a customer-led assortment,…

Thank you, Crystal. In Q4, we continued to invest in our operations to expand the foundations for growth and drive further operational efficiencies. We have finished testing and setting up our fulfillment and returns processing capacity in our Southern California facility, so we can go live as soon as this incremental capacity is needed. We are also on track with the introduction of robotics into our Northern California fulfillment center in the first half of this year. After the successful implementation of robotics in our Eastern Pennsylvania facility, we have seen a variable fulfillment labor productivity gain of over 20% in that facility, and we aim to accomplish similar results in the Northern California fulfillment center. Now some color around our customers. We are proud of our large and diverse community of loyal customers that are passionate about the Lulu's brand. At the end of Q4, we had 3.2 million active customers, compared to 2.76 million active customers. At the end of Q4 in 2021, a 17% increase year-over-year, reflecting double-digit gains among new and repeat customers. In Q4 2022 compared to Q4 2021, we saw flat to positive year-over-year customer count growth in most of the middle to lower household income segments, who are drawn to our accessible luxury positioning. Customers in our loyalty program maintained higher AOV and higher order frequency, and we continue to focus on expanding the number of customers joining and staying in the program by adding loyalty benefits over time. As a reminder, the loyalty program is focused on customer engagement, not discounting. We also see continued growth in our mobile app revenue, primarily driven by continued increases in downloads and usage, combined with a higher conversion rate than mobile app. In 2023, we will continue to invest in our mobile app with features…

Thanks, Mark, and good afternoon, everyone. Let me start out by saying how excited I am to be taking on the CFO role. I look forward to engaging with you and working closely with Crystal, Mark and David to continue to execute our long-term growth strategies. Moving on to the fourth quarter. While we were not immune to the [indiscernible]. On the IPO. For the quarter, we reported a loss per share of $0.14, which is an improvement of $4.55 compared to a loss per share of $4.69 in the fourth quarter of 2021. And finally, adjusted EBITDA for the fourth quarter was a loss of $972,000 compared to positive adjusted EBITDA of $6.4 million in the same period in 2021. Our Q4 adjusted EBITDA margin was negative 1.1% compared to a positive 6.6% in the same period in 2021. Moving on to the balance sheet and cash flow statement. We believe our balance sheet remains strong and positions us well to execute our long-term growth plans and manage through near-term macro uncertainty. Similar to the past several quarters, 1 key change compared to last year worth noting is we adopted the accounting lease standards under ASC 842 at the beginning of fiscal 2022, resulting in offsetting assets and liabilities reflected on the balance sheet this year that were not reported on the 2021 balance sheet. We ended the quarter with cash of $10.2 million and a balance of $25 million drawn on our revolver, resulting in net debt of roughly $14.8 million. In light of recent disruptions in the banking industry, it is important to highlight that we maintain our corporate banking relationship with Bank of America. Our inventory balance at quarter end was $43 million, up $21 million from the same period last year. The majority of this…

Thank you, Tiffany. We'd like to take a moment to thank each of you, to Lulu's crew, our brand fans, shareholders and Board for their continued support as we continue to work towards executing on our strategy and delighting our customers. With that, we'll turn it over to questions now.

[Operator Instructions]. Our first question comes from the line of Brooke Roach with Goldman Sachs.

Crystal, I was wondering if you can talk to your confidence in driving the reacceleration of revenue growth in second half following what appears to be a tough 1H, what assumptions are contemplated in that improved outlook? And then for Tiffany, can you talk a little bit more about the puts and takes within your margin outlook for the year? What assumptions do you have for promotionality and shipping expense among others?

Brooke, thanks for the question. For us and the way that our business runs, we're typically -- as we talked about, not so large in Q4, also not so large in Q1, but we've continued to get momentum going into Q2, 3 and 4. And we think that this year is going to be very similar to that. Our guidance is contemplating the macro level, not really getting any better, but more a normalization of markdowns and discounts and a more normalized promotional cadence for us. I think it was outsized last year in the second half. So from our perspective, it's more of business as usual with the normalization back to what we expect to be business as usual for us in the second half.

Sure. And Brooke, just a follow on to your second point of the question. This is Tiffany. Nice to meet you. Basically, in terms of puts and takes anticipated this year in terms of margin. Overall, we're anticipating gross margins to be relatively flat for the year with, I would say, our merch margin, probably under the most pressure in the first half of the year, given we're going up against a fairly non-promotional period in half 1 of last year with some improvement on that in the second half in terms of merch margins. As that flows through to gross margin, shipping costs is a key lever there with where we have experienced cost pressures. We're working very actively. Our teams are in terms of managing the shipping costs this year, making modifications and tweaks where we can with regard to carrier diversification to help us to mitigate sort of those cost increases and pressures that we felt last year. And should those continue into this year, we feel like we've got good plans in place to mitigate those.

Could I just ask 1 more? I think a couple of times in the script, you mentioned plans for physical channels, and perhaps wholesale. Can you talk a little bit more about that pivot into physical channels that you're planning for the year?

I wouldn't necessarily call it a pivot, Brooke. What I would say is it's more of investing in what we had spoken about 1 year, 1.5 years ago when we originally went public. Is that we're going to be wherever our customer is and where she wants to engage with us. And we've got continued feedback from her that she prefers or would also like to engage with us in an in-person experience. And -- while we're not ready to talk about the details of that, we will be over the next couple of quarters, providing updates around our investments and how strategically we'll be doing so. But I guess the direct answer is we will be investing in more in-person experiences and the way that manifests will be talk for our next quarterly call.

Our next comes from the line of Janine Stitcher with BTIG.

Hoping you can elaborate a little bit more on what you're seeing in Q1 to date in terms of the sales trends, how much is being driven by active customer growth in orders versus what you're seeing on AOVs. And then within that, I would like to hear more about the promotionality that you're seeing in the environment? What does it look like as the quarter progressed in Q4 and then what you're seeing within the broader environment in Q1 to date.

Yes. Thank you for the question. So as noted during my prepared remarks, we are comping against very high 62% comp in Q1 of last year, which is really setting up for a challenging quarter. We anticipated this in our guidance in the 9 to 10 weeks in so far, I had cited the 15%, roughly mid-teens negative comp is in line with what we expected. So that's more or less contemplated in, I would say, as far as what's driving the negative comp overall, it's macro -- it's continued macroeconomic pressures that have not yet wholly subsided. With that said, we are very confident in terms of our overall strategies to move forward. We have an extremely nimble cost structure that allows us to pull back a lot of variable cost structure where we can really pull back and make adjustments as needed.

Great. And then just on the broad promotional environment and what you're seeing quarter-to-date?

I can speak to the promotional environment. We basically see a continuation of Q4. And in that sense, it's not getting less, so to say, and that is also -- we play -- or need to play a role in that. Everybody is loud and doing all kinds of offers. And we also need to make sure that we are heard every now and then. We do that in various ways. It's not just 1 single type of promo. We have a diverse set of promos that we execute against. They have different goals, different outcomes, whether that is engagement or reengagement of certain customer groups, whether that is focused on increasing sell-through in particular categories or whether that is simply rewarding customers or driving downloads on our app, right? So there's a wide variety of that. And so we use that as surgically as possible across -- not always, I would say, but specifically now to make sure that we're hitting all the things that we have set out to do. Janine, welcome to the coverage. Look forward to working with you.

Our next question comes from the line from Mark Altschwager with Baird.

I guess just first, I was hoping to clarify on some of the adjusted EBITDA commentary. I think you said you expect the year to follow typical seasonality, which would be lower profitability maybe in Q4. But just given the more intense sales and gross margin pressure you're pointing to in Q1, is that still the case or maybe just any more granularity on how we should be thinking about that adjusted EBITDA margin for the first quarter?

Yes. Thanks, Mark, for the question. So I think that's a good call out and worthy of highlighting for the group because we do typically highlight our lowest profitability and lowest sales quarter of the year is in a normal year Q4. I would say Q1 is giving Q4 a little run for their money this year just in terms of the promotional environment that we're in and the negative sales comps that we're having a comp against the 62% comp from Q1 of last year and 27% in Q2. That's up Q1, I would say, this year to be a little more challenged. And so we may see that distinction between Q4 being our lowest profit, lowest sales month. But sort of moderated a little bit with Q1, and you may look at those to be a little bit more similar this year than what they've been in prior years. We still expect to see Q2 being our peak season in Q3 still maintain that as far as what you've seen historically there.

Mark, that's not dissimilar than what we have always had for Q1 was just ahead of Q4. So it's not as dramatic a shift as it may seem and that the big shoulders of the business flow through are Q2 and Q3.

Okay. And then I wanted to follow up on AOV. I was hoping you could give a bit more color on the trend you're seeing there. It's 1 of the bigger quarter-over-quarter changes that we've seen. I'm just curious how we should think about that for 2023. Is this - dish level a good way to be thinking about the trend as consumer behavior address?

Yes. Good question. AOV is just generally speaking, year-over-year context, I would say think of Q1 being relatively flat with some single-digit year-over-year growth in the sequential quarters. Figure gains coming really in the back half as we start to comp the impacts of higher markdowns and discounts.

Our next question comes from the line of Jonna Kim with Cowen.

Just curious about your non strategy this year as you're locking strong demand from addressed last year. And then as we think about return rates what are some key puts and takes that we should consider in our model as you're all having a lot of demand for dresses from last year, that would be helpful.

Yes. So we have seen great progress across a lot of our event and our non-event apparel. And what's most interesting for us right now is our new customer conversions have been increasing over pre-pandemic years in our non-dress categories. So while we're still doing a really great job with our events and our dress business in general, just the performance of our other categories and product classes specific to non-event apparel is reiterating our thesis that we can take more share for wallet barring the macro environment, we still believe that we have confidence that going forward, we're making the right investments in the right area. I think the great thing about our buying model is our customer is driving the assortment. So we're able to flex and pivot wherever she's wanting to drive us. And right now, we're seeing success in many of our, I should say, non-bridal or non-wedding event-related product classes, specifically in dresses, rompers and jumpsuits, but also in our other nonevent classes.

And I'll jump in on the return rate question. And so I just want to point out, return rates are driven not only by product classes, but also the impact of promotions and markdowns can have meaningful impact on our return rates. And so we've modeled a modest decrease in return rates for the year, which is really driven by, I'd say, the first half of the year, year-over-year, lower -- slightly lower return rates just due to increased expectations that we are being more promotional in half 1 relative to last year. I also want to just point out, very high level, we're making some policy changes to be rolled out in the coming weeks. With regard to return rates, really aimed at preserving our customer-centric, free pending return period, which is really important to us because we want her to maintain her ability to have product coming into her at-home dressing room and be able to try out different sizes and styles but we do want to roll out some changes to help kind of curb the excessive return behavior. We haven't explicitly modeled in decreases in return rates as a result of those policy changes. But just trying to keep things conservative. We are expecting a slight decrease in our rates for the year..

Our next question comes from the line of Noah Zatzkin with KeyBanc Capital Markets.

Just a couple. I was hoping you could speak to your test and reorder model and kind of the benefits of that model as you navigate an uncertain macro. And then second, just hoping you could provide some color on inventory composition, your level of comfortability there and just your approach to bringing that in line by Q2.

I'll take the first part with regard to the benefits of our test-and-learn approach. It's particularly impactful in an environment that we're in right now. So in a difficult environment like this, we lean heavily into our ability to flex up and flex down. We've proven this over the years. We've had to do it in terms of COVID -- the COVID year, and then the year ending after COVID when demand return, we're able to really lean into our nimble approach. But the other thing that I think is really critical is with regard to the -- our reorder pipeline in terms of how we build that out. It really gives us a low-risk way to move into new products that she is voting for by buying those and we introduce those new styles. We're able to use our data-driven approach to essentially decide on what we want to enter into the reorder funnel. So we think that, that -- having that ability to do that and the fact that our whole merchandise model is based on this, really sets us up nicely to have lower risk all around our inventory and then lower gross margin risk in the future just because we don't expect to see the same levels of markdowns as inventory becomes obsolete that you may see with other retail models.

As it relates to our inventory positioning, I say we're pleased with how we ended the year. And as we signaled on previous calls, we have been trying to strategically slow our inventory turns to better meet customer demand, have better size and stock ratios and generally just navigate the challenges in China and the supply chain risk that we feel we're maybe disproportionately exposed to. And candidly, we're not that concerned about it. We don't lose a lot of sleep at night over our inventory. Most of it was strategic. We are heavy in some areas, but those areas are reorder products that are tested and tried and true. So in that sense, we feel pretty good about our inventory levels. Candidly, we might be 1 or 2 weeks of supply heavier than we would normally be in what we feel is an optimized environment, but that's not something that really concerns us in terms of obsolescence or markdown risk just based on the inventory model that just reviewed.

Our next question comes from the line of Randy Konik with Jefferies.

Yes, maybe with all the different pieces this year in 2023 as it relates to impacting your margin structure. Maybe just give us a reminder on how you think about what sustainable long-term kind of normalized gross margin and EBITDA margins would look like. That would be super helpful in this time of just some volatility here with the margin structure. So if you could do that, would be great.

Yes, I think as for the question, Randy. So we haven't actually invested in 1 of -- a lot of our cost of goods and management over pricing, where we've not pushed our vendors to optimize our own margin flow-through, which has been such a dynamic environment over these last 3 years. So what we can say is we started hiring internally for teams to do just that. So longer term, we feel there's a meaningful benefit to our margin profile as we start to invest in taking more control over our supply chain. So we're looking forward to updating you all over the next few quarters as that progresses.

And is there any kind of levels you want to point out to that you think that the gross margin should kind of be normalizing that or the EBITDA margins?

I would say we should be able to perform better than our pre-COVID levels and continue to grow based on that as a baseline. I think Tiffany have spoke about our markdowns being at historical lows for the first half of last year, and I think there's a lot of noise between 2020 through 2022. So I would look at improvements for pre-pandemic years, yes.

Got you. May last question...

Randy. It is a model that we still believe is going to scale, and there's things that we've built into the structure that will help the flow-through as we continue to scale, top line and grow our customers and stay close to this approach. So we go to market.

Yes. Mark, I just want to ask you about marketing. You gave some perspective on the call. We all know about different changes that have gone on from the Apple privacy standpoint and so on and so forth. When you think about the next few years of allocating marketing dollars, maybe give us some perspective on how you think about -- how you go about changing the allocation of those marketing dollars in the next 3 years or so versus how you deployed them in the last 3 years. How do you kind of think about that in doing the same or different things to kind of get that cost of acquisition to be moving lower going forward?

Great question. Yes. So we have taken the position you're right. If you look at the past 3 years and certainly historically, from a marketing perspective, we have leaned heavily let's say, from a direct response performance marketing perspective, and we've done really well with that and still do, obviously. Not so much because of privacy or other technology reasons, but more from the perspective that we feel that for the long run, the longer term, switching dollars from that performance marketing towards brand awareness will help us grow faster as well as have benefits as it relates to the efficiency also of the performance marketing. And so what -- the path that we have put ourselves on is to in a very measured, controlled way to start switching away dollars from the performance marketing side into the brand awareness side. And we have seen thus far that we have been able to do so that without raising our overall marketing expense, if you will, to make those shifts deeper into the awareness side. So we feel that we're on a good trajectory, and that is what also the trajectory that we would like to continue to pursue to achieve that 1 of the key growth levers that we feel in our business that our business has, and that is increasing our brand awareness because that is relatively low, and it presents us with a huge growth opportunity in the future.

Our next question comes from the line of Edward Yruma with Piper Sandler.

I guess, first, what is the assumed growth or lack of of new customers in the '23 guide? And I know you indicated that you saw some extra growth in kind of the lower and middle-income cohort. I guess, do you believe that that's kind of pressuring results today? Are you seeing some of the same repeat behavior in some of your historical cohorts? And then as a follow-up, just so I'm clear, how much incentive comp build back is baked into the SG&A number for '23?

I'll take the first part. What we've seen play out over the last couple of quarters and have also projected that forward is that -- basically the slower order frequency or a reduction in order frequency with our customers. And it's more either discerning or wants to spend less frequently or is waiting for some deal because like I said, there's lots of promotions out there. So there's also other choices, of course, that can be made. Whatever the mixture there is, is certainly the fact what we see mostly impacting the order frequency. And then on the other hand, due to promotions. We've also then seen obviously the lower AOVs come out as a result of that. And so when you think about it -- so it's not necessarily a reduction in active customers, but it's more the frequency of purchases that we've seen primarily the impact.

It's more a signal of the macro environment versus anything else.

And then I'll jump in and on the -- you had a question about stock compensation, feel free to chime in if I misheard it, but just to give you some year-over-year perspective on that we're going from '22 into '23 -- at the low end, I would say, I provided a range of $16 million to $19 million in terms of stock comp expectations for '23. And I'm going with a range for this year. For probably, I would say, 1 main reason. One main reason is that we're -- we've put into place a lightly restructured performance bonus plan for our employees this year, that's shifting away from a cash-based bonus to a stock-based bonus. This is entirely for our executives tied to key metrics, revenue and adjusted EBITDA. And for other bonus eligible we'll have similar performance -- financial performance based [indiscernible]. So there's going to be some flex there in terms of how high we go in terms of that range. So that's why I provided you with a range there. But otherwise, in absence of that plan, I would say, our stock comp year-over-year would remain relatively flat from '22 to '23 with 1 exception that was highlighted around some acceleration related to Davis options that were forfeited, that's getting accelerated into Q1. However, most of that would have been normally recognized throughout the course of the year. That's sort of just being more front loaded into the year, I would say. Let me know if that answers your question.

Our next question comes from the line of Lorraine Hutchinson with Bank of America.

This is Alex [indiscernible] for Lorraine. And congrats, Tiffany. On the full year adjusted EBITDA guidance, can you just elaborate on which investments in key growth initiatives you're referring to there that will cause the pressure? And then do you have any flexibility on the expenses as you kind of observe how sales trends play out?

Thank you so much. It's a great question and happy to answer this. So just in terms of the -- I'll kind of start from your second question, Bruce. There is a lot of variability in terms of our cost structure, where we are able to make quick adjustments as needed as sales come in better or worse than what we've anticipated. We have levers there that we're able to pull. And in regards to the overall adjusted EBITDA and the investments that are resulting in some of the fixed cost deleveraging this year. I can't provide you a lot of specifics, but I would just say for us, as a company, it remains really critical to be committed to growing for the long term, which includes employee-related costs, payroll costs, things like that, where it's very important to continue to have our key strategic initiatives, the original ones that were laid out with our IPO moving forward. And so we're not making any sort of changes to our strategy. We're fully bought into who we are and where we're going. And so we're wanting to maintain those investments, keep initiatives moving forward so that we're not positioned in a spot where we come out of this downturn in the economy, and we're not poised for growth. So we're really committed to remaining poised for what's in the future and the ultimate turnaround in the economy.

And we have reached the end of the question-and-answer question. And I'll now turn the call back over to Crystal for closing remarks.

Thanks, everybody. We appreciate your time and continued support and looking forward to our next call. Have a great rest of your night.

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