Good afternoon, and welcome to Lulu's third quarter 2023 earnings conference call. Today's call is being recorded, and we have allocated one hour for prepared remarks and Q&A. At this time, I'd like to turn the conference over to Lulu's General Counsel and Corporate Secretary, Naomi Beckman-Straus. Thank you. You may begin.

Good afternoon, everyone, and thank you for joining us to discuss Lulu's third 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 fact 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, consumer demand and return rates on our business, our future expectations regarding financial results, references to the year ending December 31, 2023, including our financial outlook for full-year 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 in 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 cash 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 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; and our President and CIO, Mark Vos. 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. We appreciate you joining us today. Before we delve into our results, I'd like to thank our team for their steadfast commitment and nurturing our brands and delivering an exceptional experience to Lulu's fans. I'll begin with a recap of our third quarter results, followed by highlights of important growth and efficiency initiatives that we believe will strengthen the company's long-term financial success and brand expansion. Setting macro headwinds aside for a moment, as we reflect on our performance in the third quarter, there are things we did well and things we needed to adjust to position us for sustained long-term success. Let's jump into the things that we did well in the quarter. Our new product introductions continue to resonate with our customer during the quarter. With single to double-digit positive net revenue comps across many product classes, including wedding-related apparel, most dress classes, as well as a few other smaller, but growing product classes resulting in our total new product net revenue for the quarter comping up high-single-digits compared to Q3 last year, giving us further confidence in our future reorder funnel. Of the previously mentioned growth product classes, we're most proud of reaccelerating growth metrics across wedding, special occasion, and event apparel with new products, net revenue growth of high double-digits over Q3 last year. New technologies and investments in site experience across the website, mobile app, and mobile web resulted in increased engagement metrics across all device platforms. We successfully reduced our revolving line of credit by $4 million as intended and decreased our net debt by approximately $10.9 million, ending the quarter in a net cash positive position. Our business continues to generate liquidity, and our balance sheet remains strong, enabling us to maintain our investments in strategic…

Thank you, Crystal. First, I'd like to start by providing an update on our customer and how she interacted with us during the quarter. New and repeat customer counts were down Q3 year over year with new customers coming in lighter than repeat customers during the quarter. Units per transaction on the other hand, was up sequentially from Q2 2023, and decreased only marginally compared to Q3 of last year. This was primarily the result of the shift from performance marketing spend towards markdowns and promotional pricing in response to the customer's bias towards promotional pricing during the quarter. Despite increased promotions and markdowns, we saw slightly improved average unit retail at slightly lower units per transaction compared to Q3 2022, resulting in a near identical $133 average order value compared to Q3 2022. Although the active customer count declined year over year, the decline was less than our net revenue, meaning that at a comparable Q3 $133 average order value year-over-year, we were able to retain customers but with a slightly lower purchase frequency driven by, we believe, primarily discretionary income pressure experienced by our customers leading to more discerning purchase decision making. In reviewing the various customer household income segments purchasing behavior across the various price tiers, we did not see clear trading up or down. From a marketing perspective, we redirected a part of our performance marketing dollars towards markdowns and discounts to drive better conversion and inventory sell-throughs in various product classes and to manage the seasonal shifts. Our primary focus remains on expanding brand awareness markets to keep overall marketing, efficacy, and spend as a percent of revenue within our targeted ranges to remain first order contribution margin profitable. This strategy allows us to introduce Lulu's to more consumers and improve the overall efficiency of…

Thanks, Mark, and good afternoon, everyone. We consider the current macroeconomic pressures as temporary headwinds and acknowledge the impact of shifting consumer spending and purchase behavior on our third quarter results. Our net revenue of $83.1 million was down 21% year-over-year, falling short of our expectations for the quarter. The decline was primarily driven by a decrease in total orders of 19% compared to the prior year, as well as mark downs in return rates that were higher in the quarter. Our overall return rate in the third quarter was 50 basis points higher than the prior year, primarily due to product mix shifts and final sale ratios; it was 50 basis points lower on a sequential basis. Gross margins for the third quarter declined by about 180 basis points from the same period last year to 40.3%. Elevated markdown rates during the quarter drove the margin decline compared to prior year as our customers sought value and we leveraged more markdowns to move through spring and summer inventory that was heavier coming into the third quarter due to the late start to spring. We were more aggressive with markdowns on these products, resulting in a cleaner transition out of the third quarter from a spring and summer inventory perspective, which was approximately 40% lower compared to the prior year. Moving down the P&L to give some insights into expense line items. Q3 2023, selling and marketing expenses were $16.8 million, down about $2.5 million from Q3 2022, due to lower performance marketing spend and favorability in merchant processing fees, partially offset by higher brand awareness investments. As already noted, we invested more heavily in markdowns and discounts, which was offset with lower performance marketing spend. General and administrative expenses decreased by about $2.8 million to $21.6 million, a 12%…

Thank you, Tiffany. On a final note, I'd like to reaffirm our confidence in our long-term growth as we strengthen our business model amidst these near-term headwinds. For the past two decades, we prioritize timeless quality versus being excessively trend-driven, and we believe our ability to test, learn, and optimize positions us well for enduring growth. This wouldn't be possible without the incredible work of our LuCrew, our brand fans and our stakeholders who support us in our mission to deliver attainable luxury to our customers and be the online destination for all of life's fashionable moment. With that, I'll turn it over to questions now.

We will now be conducting a question-and-answer session. [Operator Instructions]. And the first question comes from the line of Brooke Roach with Goldman Sachs. Please proceed with your question.

Good afternoon and thank you for taking our question. Crystal, I was hoping you could discuss what you're seeing in the competitive environment more broadly and how that has impacted your view of sales trends in the quarter versus your expectations, relative to other exogenous factors that we saw in the quarter, like a weather transition or macro headwinds on the consumer? Further, can you elaborate on what actions you plan to take to differentiate your brand and product from some of these fast growing online, fast fashion retailers? Thank you.

Hey Brooke, thanks for the question. So I think I'd like to just address this in a very, very direct way, where we don't believe that Shian or Timo or any of the other fast fashion giants that are out there caused our negative comp in the quarter. They probably nibbled on the edges of our customer base, but it's not what drove the negative comp for us in the quarter. And outside of obvious macro headwinds, being underinvested in newness and overreliance on our older reorder products that have been driving so much of our business for us over the last two years is really the biggest driver of our negative comps. And in our opinion, that's really easy to fix. It just might take a couple of quarters to fix it. We do, however, recognize the shift in the competitive environment as aggressive fast fashion retailers are gaining more traction with U.S. consumers, especially over the last few years as well as more dynamic shifts in general within our customer base and for spending. In Q3 compared to Q2 for example, our customers shifted to a larger percent of spend from full-price products towards promotionally priced products. That's probably more macro within our customer set. And while we possess the agility to adapt to consumer demand changes, we're not looking to compete in the faster disposable fashion race at all. We believe in the resilience of our business model and we're dedicated to upholding the quality and integrity that we've built over the last two decades. Our strategy has been and continues to be very focused on customers who are seeking quality over quantity and enduring sales that last beyond the moment in time. Our existing customers recognize the value not only in our quality product offering, but also in our brand and in our community. So we see this as a competitive advantage over fast-fashion retailers who are less loyalty driven and have more of a transactional relationship with their customers. To that end, we're focused on continuing to cost effectively build awareness for our attainable luxury product offering and further set ourselves apart from excessively trend chasing brands. Given the increased demand for our new and now fresh styles, we're leaning into those designs in a very measured and thoughtful way, and we believe that's going to continue to be a differentiator for us.

Thanks, Crystal. And secondly, for Tiffany, there's a lot of discussion about the engagement that customers have with promotions recently. And indeed you leaned into markdowns as a driver this quarter. Can you talk about your expectations for promotions and investing in markdown dollars for the next couple of quarters as you look to reposition some of the merchandising assortment in the next year? Thank you.

Thanks for the question, Brooke. So as we oftentimes say, we do look at markdowns and discounts as one of our levers alongside of performance marketing spend where we're able to shift back and forth as needed based on what the customer is telling us. So for the third quarter, as you all heard, that was an important moment for our customer to be seeking out value. We also leverage the opportunity to take what was a heavier spring summer inventory coming into Q3 and move through that, so that we ended the season with cleaner 40% less, in fact, spring-summer balance compared to the prior year. So as always, I think we don't want to give out specifics on markdown rates going forward or performance marketing spend anticipation going forward. We'll continue to leverage sort of our internal models to ensure that we're working through all of those avenues and those levers and the most on contribution margin positive way. I think historically, if you look back on prior years, you'll see Q4 is typically a time, particularly in December, where we'll pull back on performance marketing relative to competitors, just given we aren't a gifting destination in Q4, we may follow suit with that this year. But again, I'm not going to give any real specifics around that because I think we are going to continue to follow where the customer is leading us in terms of promotion, markdowns, and how we want to leverage those.

And the next question comes from the line of Mark Altschwager with Baird. Please proceed with your question.

Hi, this is Amy on for Mark. Thank you for taking our question. To start, can you please speak a bit more to the month-to-month top-line cadence for the quarter and give us any color on differences in shopping behavior by income group?

Sure. Hi, Amy. This is Tiffany. I'll start with just the quarterly cadence that we typically provide. The quarter itself ended on a stronger note from a year-over-year comp basis. We were weakest in the early part of the core -- early to mid-part of the quarter end started to see improving comps towards through September. Also, I can just give a little highlight on sort of our view of the first five weeks into Q4. We've continued to see some gradual continued improvement in our overall transacted comps year-over-year starting to improve there on that on a pre-return basis, just because we haven't fully rolled up all of our return estimates yet through the first five weeks, but we have continued to see some good top-line growth year-over-year improvement on the comp. And I'll hand it to Mark to talk a little about the household income in cohort question.

Yes. When reviewing the various customer household income segments and their purchasing behavior across multiple price tiers in our assortment, we actually did not see clear trading up or down between the segments. And the revenue contributions in each price tier across those household incomes remained stable compared to Q3 of 2022. So from that perspective, there were no specific shifts there. As I mentioned, our new customer acquisition compared to existing customers there, what we saw is that the new customers as a percent of our total active customers was slightly lower compared to Q3 2022. But over time, that is obviously expected when you see when we are successful in retaining customers. But from an absolute perspective, we did see that new customers compared to Q3 2022, were lagging compared to our existing customers. And shifting a portion of our performance marketing expense into markdowns and discounts has certainly played a role into that. I hope that answers your question.

Yes, thank you for the detail. I'll pass it on.

[Operator Instructions]. The next question comes from the line of Janine Stichter with BTIG. Please proceed with your question.

Hey, Janine.

Hey, you got Ethan Saghi on for Jeanine. Thanks for taking our questions. First off, just on increasing newness and novelty to pre-pandemic levels, just curious how quickly we should expect that to take?

I would expect it to evolve over the next several quarters, but we want to remain true to our test, learn and react model and we don't want to overseeing in any direction. So I would say that could take a couple of quarters, if not two to three.

Got it. Okay. And then next question -- just going back to returns. I know you guys talked about the new return policies in place. Sounds like it's good to hear the sequential improvement. I'm just curious how your customers are responding to those, if you could give any color there. Thanks.

Sure, thanks for the question, Ethan. Yes, the returns continues to be a key area of focus for us. And frankly, it's an area that we have accepted as a very integral part of the business model in e-com. Without physical stores, it's really important to give our customer, the customer, the confidence that she needs to bring her purchases home to her at home fitting rooms. So we want to continue to maintain flexibility and all of our -- subtle, I would say, return policy changes that we've made this year have maintained a free 10-day return period that our customer does leverage certainly. We've continued to improve some of the back of the house metrics or data insights around returns, adding some technology enablement as well for us to be able to learn more about our customers' return behavior, also tackle some of the issues with customers who have a more excessive return rate, try to work with them to improve their shopping behavior and return behavior. Overall, the policy changes that we've read, there's actually been quite a few where we see customers who are citing how they love our flexible policy that we maintain, room for them to be able to initiate a free return where a lot of other companies are starting to take those things away. So I think that's an important element of the policy that we've maintained. We haven't experienced a significant amount of friction or complaints on the customer's part with regards to some of the changes that we've made around changes to the shipping return, shipping cost fee structure either.

And the next question comes from the line of Dana Telsey with Telsey Advisory Group. Please proceed with your question.

Hi. Good afternoon, everyone. As you're thinking about the metrics, whether it's active customers' orders, AOV, and the AOV increased that a tiny bit compared to last year. How are you seeing the promotional environment and how you planning going forward? And then, when you look at category performance, any updates on categories as compared to last quarter what you're seeing from the consumer? Thank you.

Sure. Dana, this is Tiffany. As it relates to AOV, you're correct, there was a slight uptick actually in our AOV year-over-year, which Mark broke down pretty well, I think, in his section during the call where we did see a bit of an increase in AUR offset a bit by UPTs to hold pretty steady or increase year-over-year. I think one thing to note is the AOV does move for us in somewhat of a seasonal fashion. So when certain product classes are more predominant that carry higher AURs, then we may see that impact on AOV as well as during promotional timeframes. But we typically see in Q4, we would typically see AOVs come down. So I'm not going to give any real specifics around that, but that's a fairly seasonal metric for us, and we continue to plan for it to react accordingly to what we've seen AOV movements look like in the past.

Got it. And on the category side, anything to mention?

In terms of category specifics, I would say we're very happy with the momentum that we're seeing building again across our wedding and wedding-related event categories. And specifically across all of our dress categories, that's been very encouraging to see some normalization there versus what we experienced from the previous quarter. And generally speaking, the newness and novelty that we've been introducing has been checking really well across the majority of our product classes.

Got it. An initial framework as you think about the upcoming year, any pushes and pulls on margins that we should be thinking about, as you're thinking about qualitatively, 2024?

So we haven't shared any expectation yet around 2024. In fact, we're pretty heavily focused on internally building out our plans and framing the plans for next year. So we haven't changed anything. I think what stays true for us next year is we're continuing to lay the groundwork, make the necessary investments and adjustments that we've already started on this year to position us well going into next year. We've spoken about some investments that we've made with our product costing team, getting those folks hired in this year that we've spoken to in the past as being an opportunity for us to improve upon our product costing. But that's going to be a multi-quarter, potentially multi-year effort for us. I don't know if Mark, you have anything to elaborate there. But I think that's an important lever that I think could have some effect for next year.

Yes. So we were able to hire the team and we're very excited with the talent that we have. We're right now focused on -- let's call it, a low hanging fruit. And at the same time, we started working on some medium-term improvements that are going to layer on top of that. And obviously, we need to balance our needs of our buying model with the possibility of reducing those costs. I would say, from an effect that we'll have we've already seen some positive impacts there. So we're encouraged by that. And we'll see how that's -- based upon what the extra margin potential that there is, what we -- how we apply that. In some cases, we will apply that to be more price competitive, for example. So that would not immediately leads to a higher margin per se, but more margin dollars and in other cases, globally apply to expense the margin will make those decisions and trade-offs based upon what Lulu's brand needs at that moment in time.

At this time, there are no further questions, and that concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.