Good afternoon, and welcome to Lulu's First Quarter 2023 Earnings Conference Call. Today's call is being recorded, and we have allocated 1 hour from the prepared remarks and Q&A. At this time, I would like to turn the conference over to Naomi Beckman-Straus, General Counsel and Corporate Secretary at Lulu's. Thank you. You may begin.

Good afternoon, everyone, and thank you for joining us to discuss Lulu's first quarter 2023 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 that do not relate to matters of historical facts should be considered forward-looking statements including, but not limited to, statements regarding management's expectations, plans, strategies, goals and objectives and their implementation, our expectations around the continued impact of the macroeconomic environment on our business, our future expectations regarding financial results, references to the year ending 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, net debt and free cash flow. 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. Reconciliation 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 our CEO, Crystal Landsem; our CFO, Tiffany Smith, our President and CIO, Mark Vos; and David McCreight, our Executive Chairman. Following our prepared remarks, we'll open the call for your questions. With that, I'll turn the call over to Crystal.

Thank you, Naomi, and good afternoon, everyone. Thank you for joining us today. Before I discuss the quarter, I'd like to express my gratitude to our team and their relentless dedication to building our brand and continuing to create value for our brand fans and our stakeholders. We continue to make great progress on several key initiatives that we believe will benefit our brand long term. And despite the current macro challenges, we are able to do so given our healthy balance sheet and capital efficient cash flow positive business model. Like many companies, we are managing a diverse range of challenges from external factors. However, we view these challenges as temporary and continue to be laser-focused on our long-term growth initiatives while managing expenses judiciously. Jumping into the highlights from Q1. Revenues amounted to $91 million, representing a 19% decline compared to Q1 2022 and a 32% increase compared to Q1 2021 and in line with our expectations heading into the quarter. Recall, we faced tough revenue comparisons as we were up against the 62% gain in Q1 last year due to pent-up demand as our customer refreshed for wardrobe and returned to her social calendar as COVID-related restrictions eased, including an anomalous spike in weddings and wedding-related events. Our adjusted EBITDA was a breakeven versus $9.9 million last year. Like others, we were impacted by the continuation of a challenging macro environment, which required us to be more promotional year-over-year. But I would highlight that promotions were down sequentially. Similar to prior quarters, we chose to reallocate marketing spend into promotions as this was a more efficient use of capital. For historical comparisons, markdowns and discounts represented 13.4% of sales compared to Q1 2019 at 15.6% of sales. This underscores the value of our fresh fashion assortment and…

Thank you, Crystal. Our customers in Q1 2023 showed similar patterns to Q4 2022 as it relates to year-over-year new customer acquisition being strongest in the lower household income brackets. A broad customer segment where Lulus' affordable luxury positioning resonates well with her particularly. Order frequencies trended as expected quarter-over-quarter and our repeat customers marginally increased units per transactions compared to Q1 2022. At the end of Q1 2023, we had 3.2 million active customers compared to 3.0 million active customers at the end of Q1 2022, a 6% increase year-over-year. We are encouraged by our ability to retain customers in a more difficult macroeconomic environment, which confirms the strength of Lulu's brand, the affordable quality of our products and the effectiveness of the Lulu's brand hub. From a marketing perspective, we continue to work our strategy to shift more of our marketing spend from direct response performance marketing to brand awareness marketing, while keeping overall marketing efficacy and spend as a percent of revenue within our targeted ranges to remain first order contribution margin profitable. This strategy leads to higher aided and unaided brand awareness, resulting in improved ability to introduce Lulu's to more consumers and to improve the efficiency of our marketing investments overall. We have continued to expand investments and improve efficiency of our influencer and ambassador generated brand reach, impressions and earned media value to support Lulu's word-of-mouth marketing. Based on our social media data, we have seen meaningful gains in the Lulu's share of voice across multiple channels, which provide us with the confidence that we are on the right growth path, which should benefit Lulu's in the future. Kudos to our creative content, brand and marketing teams for delivering in unison this forward brand momentum. We see much growth potential ahead of us, and…

Thanks, Mark, and good afternoon, everyone. As we previously shared, we faced difficult comparisons to last year where net revenue in Q1 '22 increased 62% as our customer refreshed her wardrobe and fully returned to her social calendar. In addition to the tough comps, Q1 23 softened further in mid- to late March, which we attribute to macroeconomic pressures. 5 weeks into Q2 '23, we've observed improving demand trends with sequentially improving weekly year-over-year gross revenue comparisons. During Q1 '23, we noted a better-than-normal selling season for fall and winter-related products well through March, coupled with a slower-than-normal start to our spring and summer related product sales that typically begin to build during Q1. As a result of these factors, we decided to shift spending into promotions and discounts from marketing during Q1. The combination of these factors impacted both our top line and margin results for Q1, yet the strength of our cash flow generative business enabled us to continue paying down our revolver and generate net cash provided by operating activities of $3.7 million and free cash flow of $2.6 million for the quarter. With respect to the first quarter results, our net revenue of $91 million was down 19% year-over-year, in line with our expectations of year-over-year comparisons in the negative mid- to high teens. Compared to the first quarter of 2021, net revenue grew by approximately 32%. Compared to the prior year period, total orders decreased by 14% and average order value decreased 3% to $129. Gross margin for the first quarter declined by about 560 basis points from Q1 '22 to 41.7%, but improved sequentially by 440 basis points. Compared to Q1 '22, gross margin declined primarily as a result of several factors: higher markdowns and discounts, product costs as well as continued higher shipping…

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

We will now begin the question-and-answer session. [Operator Instructions] And the first question will be from Ed Yruma from Piper Sandler.

I guess, first, on the improvement in the trend quarter to date. It seems like a fairly sharp view. I'm trying to understand, as you look at, obviously, the macro pressures were all documented in March, but kind of what's maybe changed? Have you seen a difference in kind of what the consumer is buying? And then I guess as you kind of think about the back half of the year, do you assume when you talked about kind of some of the compressor expecting, do you assume that macro improves from here? Or kind of what assumptions are embedded in that guide?

This is Tiffany. I'll take your question. So the -- I would just maybe caveat that what we've seen so far trend-wise in Q2 is not necessarily a sharp improvement, more of a soft upward turn of the curve, I would say, but it has been noticeable week-over-week improvements in demand. And I think we've chopped up some of the things that we saw in Q1 to a slower turn on of our spring and summer merchandise sales and really a longer, more pronounced selling period for our fall/winter product. And so we're not meteorologists or anything of that nature. So not pointing the finger to weather, but just it was a more pronounced fall winter selling season that went longer through Q1 than what we've ever seen. And so that definitely picked up as we moved into the second quarter. So that's been an encouraging sign that we've seen continue to improve our normal peak season, as you know, is this time of year. And so we're sort of riding this wave here through the second quarter. We have not seen worsening trends. In fact, they're improving week over week. The other part of that, that I'll say aside from demand, we've actually seen -- we were able to scale back the level of promotions in the second quarter compared to where we were pacing towards a lot of Q1 and much of March, we were highly promotional. So we pulled back and that hasn't had a negative detriment on demand. And in fact, it's had a positive outcome on margins. So far, we're pleased with what we've seen, but it's not -- maybe not a dramatic upturn, but it's certainly noticeable for us. And then I think -- was there one more question there? In terms of guidance, we still view this as a very choppy macroeconomic environment. Our guidance contemplates that. We don't view what we're going through right now in terms of some improvement in trend is necessarily the macro effect is done and not affecting us for the rest of the year. We're expecting there could still be ups and downs throughout the year. Our guidance contemplates that for the full year, and that's -- we're still very much viewing it as a choppy environment. And then the comps also -- just one more point as we've talked about before, the comps do ease up for us as we move through the back half of May and towards the end of Q2 and into the rest of the year.

And the next question will be from Brooke Roach from Goldman Sachs.

I was wondering if you could provide some additional context on the -- and quantification of the increase in customer acquisition costs that you saw in the quarter and your outlook for that for the rest of the year? And then perhaps secondly, can you help us understand the confidence and conviction you have in the sequential margin improvement that's embedded in the full year outlook? And help us understand what's getting better, what's getting worse? And how does this look relative to last quarter when you spoke to it last?

Brooke, this is Mark. I'll talk about the customer acquisition cost. We have not given specific numbers recently, but I have always spoken about how are these costs trending. And basically in Q1 of this year because we were essentially focusing more on that and have the ability as well to invest more on the brand awareness side, top of the funnel marketing. Then, of course, by nature of that type of investment, the cost of customer acquisition will also go up. But at the same time, that because what we've seen in the market in general and how things are trending and how Lulu's is positioned there, specifically from a share of voice and how we see our engagement metrics as well. That gives us also the belief that the path that we are on is solid and that we are continuing that shift that's what I've spoken about in the past, right, that we want to move more dollars from the performance marketing spend into that brand awareness for the longer-term play, the longer-term increase of Lulus' brand awareness and growing the amount of costs that the Lulu's products are present in. And so from that perspective, we are happy, but I did want to call out that, that cost obviously went up in comparison to last Q1 2022.

And Brooke, I'll cover the margin question for you. We do have some confidence in the margin improvement through the rest of the year, really 3 main factors there. One is, as we've already seen heading into Q2, we've seen our customers be responsive to full price and being less promotional in general. So we're -- should that trend continue, that's going to certainly be a positive margin factor for us. There's also areas where we expect to proactively improve margin component. Product costing is one that we've talked about on prior calls. We started to make investments there in terms of staffing a team towards the end of Q1 and into Q2 to really support us there with taking sharper pencils to our product costing and working closely with our vendors to develop that. Now that's something that will likely not pan out until probably later in the year. So I wouldn't necessarily anticipate that to have immediate impact, but that's an area where we're investing and it's a big focus for us. And then lastly, we do include shipping costs in our gross margin. So shipping cost is one where there'll be a little bit of moderating year-over-year impact as we start to comp the escalated fuel surcharges that were implemented last year kind of following the Ukraine war and everything, the surcharges bumped up. So we'll start to comp the charges at the higher rate here pretty much in Q2. And then we're also taking proactive measures ourselves around carrier diversification. We spoke to that, that we started to move forward on some of that during the first quarter. We've already seen some benefits there. Additional actions there will continue to benefit our margins throughout the year.

And the next question is from Jungwon Kim from TD Cowen.

Just curious on the customer behavior across different income brackets. Are you seeing any more pullback or softness during the quarter from certain income group than others? And just if you can give any color on the new customers acquired during the quarter? Was it more through promotions or full price? And sort of how do you plan to retain those customers?

So as it relates to -- from an income bracket perspective, Lulu's, with our affordable luxury positioning offers and serves essentially a very broad group of income brackets. And from what we've seen in the first quarter was similar to last quarter, the Q4 of 2022 is where we were actually very delighted to see that the, let's say, the middle to lower income brackets were from a new customer acquisition perspective, doing comparatively speaking to the quarter year-over-year well. And so that really speaks for us as it relates to our affordable luxury concept and how that is resonating. And then as it relates to the new customers, we were -- we offered a variety of promotions in Q1. I would not want to characterize that. It was purely the promotions that were driving new customer acquisition. That is always a mix, so to say, so there's certainly those that were intrigued by Lulu's or to try this out for the first time as a result of a promotion. But I would also say that, in general, our collective brand marketing and also our performance marketing are driving that customer acquisition. And don't forget that word-of-mouth is one of the strongest advertisers for Lulu's, the family and friends is a critical component in that as well. And what we do -- what we see over -- and that hasn't changed is that oftentimes, new customers joined the Lulu's family with whether Lulu's for you [indiscernible] wear or dresses. And from there on, we build out that relationship with our customers, not just through our loyalty program, but also just by exposing and introducing the other categories that we offer and from that perspective, grow broader into her closet and also give them more opportunities and more opportunities to buy Gogo's products.

The next question is from Alice Xiao from Bank of America.

Following up on the gross margin details, can you give more quantifications of what you expect for each component just as we go through the year, whether it's markdown levels, lapping of higher freight surcharges and higher return rates offset by the carrier diversification efforts. What could be a tailwind? What might still be an incremental headwind? How big can each piece be? And any other components I may have missed.

Sure. Al. So I would say the shipping-related items, the fuel surcharges should start to ease up here soon in the second quarter. We should start to at least lap what we saw last year increase wise. I do think during my prepared remarks, I did comment on the carrier diversification actions as being in the 7-figure ballpark on an annualized basis. We did implement, I would say, a good portion of those towards the end of mid- to late Q1, so we didn't get a full benefit of that during the first quarter. And so that will be in place for the rest of the year. We also have some other diversification actions underway in the second quarter. So those are going to kind of stack and, I think, increase throughout the year as we go. But with most of the implementation done in the first half of the year benefiting us for the full second half, in terms of markdown rates and considering how that impacts margin. Generally speaking, I would say, normally for us, second, third quarter being our kind of peak season. We're typically leaning less heavily into discounting during that period. So I would expect those to Q2, Q3 to be lighter in terms of discounts in general, and then we pick it back up generally in Q4 just because marketing tends to be very -- marketing, performance marketing areas tend to be more expensive at the end of the year. So that's just sort of a little bit of how the markdown discounts will lay out. In terms of return rates, those are, again, somewhat follow a seasonal flow for us. And we've modeled those out fairly consistent with how they were in 2022. As we've talked about before, we had all-time low return rates during 2020 and '21, they ratcheted up during '22, and we're modeling them pretty consistent with '22. And those will also follow along with our level of promotional discounts because typically the more price-sensitive people are if they're paying full price, their tendency is to return. So we generally expect to have higher return rates in our Q2, Q3 period, and then lower return rates during the quarter 1 and quarter 4, where we'll be more promotional and there's a higher mix of final sale. So hopefully, that gives you some sense on timing.

Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to Crystal Landsem for any closing remarks.

Just wanted to thank everyone for your time today and your continued support, and we're looking forward to updating you on all of our progress on our next call. Have a great evening.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.