Lovesac Co (LOVE) 2019 Q1 法說會逐字稿

Greetings and welcome to the Lovesac Q1 Fiscal 2020 Earnings Conference Call.

(Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Rachel Schacter of ICR.

Please go ahead.

Thank you.

Good afternoon, everyone.

With me on the call is Shawn Nelson, Chief Executive Officer; Jack Krause, President and Chief Operating Officer; and Donna Dellomo, Chief Financial Officer.

Before we get started, I would like to remind you that some of the information discussed will include forward-looking statements regarding future events and our future financial performance.

These include statements about our future expectations, financial projections and our plans and prospects.

Actual results may differ materially from those set forth in such statements.

For a discussion of these risks and uncertainties, you should review the company's 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'd like to turn the call over to Shawn Nelson, Chief Executive Officer of the Lovesac Company.

Thanks, Rachel.

Good afternoon, everybody, and thanks for joining us today.

I will begin today's call by discussing the financial highlights of our first quarter results after which I'll briefly review the long-term opportunity we see for our brand with a focus on our point of view regarding the new shop-in-shop opportunities on the horizon and the tariffs that we face at this time.

Then Jack Krause, our President and COO will outline the progress we are making on our key growth initiatives with more metrics and details on these aspects of our business.

Finally, Donna Dellomo, our CFO, will review our financial results and a few items related to our outlook in more detail.

We had a strong start to the year and are very pleased with our first quarter financial results.

Net sales increased by 53% to $41 million.

Total comparable sales, which includes same showroom and Internet sales, increased 43.5% driven by a strong showroom comp increase of 31.7% and significant growth in our Internet business of 85.3%.

Once again, in Q1, we saw our comp growth driven by both transactions as well as ticket growth as our digital marketing strategies and multichannel model allow us to effectively draw new customers to the brand while also driving repeat purchase behavior.

Adjusted EBITDA came out ahead of expectation at a loss of $4.7 million for the first quarter versus a loss of $4.2 million in the prior year period.

From an operational standpoint, we made good progress against all of our strategic initiatives which are centered around traditional, digital and social marketing, investing in our infrastructure, growing and improving our showroom footprint and expanding our shop-in-shop presence.

From a performance standpoint, we're very encouraged by the efficiency of our marketing efforts in Q1.

We drove over 53% in total sales growth with spends that were only up 22% versus last year.

We expect to deploy our biggest marketing spends in the fourth quarter due to the proven efficiency of marketing in that quarter, and our expectation that the advertising and conversion tasks we are actively executing on right now can be rolled out on a larger scale by fourth quarter of this year.

As much as we would all like to see smooth sales trends across the whole year, Lovesac has always seen its strongest growth and profitability in the fourth quarter, and this will likely continue for the foreseeable future.

This fourth quarter waiting is a result of 4 unique aspects of our business and category.

One, we operate more than 80 Lovesac branded showrooms that are primarily located in the most trafficked shopping malls across the United States.

As traffic in these centers spike in late November, so do our new customer visits and our sales in general.

Two, Sacs make a great gift during the holiday season whether it's parents buying them for the kids or great big family gift to the movie room, Lovesac enjoys huge holiday sales for this reason.

Sacs are a very high margin product for us, and this is unique in the otherwise sleepy furniture category during that time of the year.

Three, January is long established as a big month for home decorating and home decor.

And because our fiscal year ends at the end of January, Sactional sales spike at that time for us.

And lastly, we know now -- we now know it, having tested our TV and digital advertising across two holiday seasons, at least in select markets, that efficiencies evidenced by our reported returns on ad spend are simply greater during the fourth quarter.

In this context, we are very pleased with our top line results of Q1 this year and feel great about our annual guidance of 40% to 45% annual revenue growth, which we are reiterating today.

As it relates to adjusted EBITDA, we are working hard to mitigate the impact of the 25% tariffs on our business.

What we are confident of is generating sales at the projected high grade -- high rate of growth this fiscal year 2020 even while producing still a positive adjusted EBITDA.

While we see some temporary degradation of our gross margins due to tariffs, we are committed to preserving a positive adjusted EBITDA and will be careful to -- and will be careful and creative in the managing of our business even through this high-growth time of our brand development.

We are actually driving improved costing and margins at the product level and are always finding ways -- and are also finding ways to tweak our merchandising, our pricing and our operations to drive efficiencies across the business.

When tariffs someday go away, Lovesac will be an even healthier and more efficient business than before.

I will spend a few minutes now listening -- listing some of the ways that we are achieving these efficiencies in pursuit of being able to mitigate the impact that tariffs will have on our business in the near term as well as our ambitious vision for efficiency, reliability and sustainability in manufacturing and logistics over the long term.

We're totally focused on the long-term opportunity for Lovesac as we believe it is much bigger than many realize and make decisions with that long-term view in mind.

Put bluntly, the tariffs on China-made goods is only a short-term issue for us, a speed bump as it were.

We are on a straight path to exit China as a manufacturing source almost completely over the next 18 months or the tariffs will fall off.

We would prefer to see the tariffs be suspended and to keep the most efficient parts of our China supply chain intact to support our growth.

Our exit from China is, therefore, prioritized with the last portions appropriate for resourcing to places like Vietnam, slated to happen later in the next fiscal year in hopes that tariffs will go away between now and then.

Sactionals, sans covers, make up approximately 40% of our sales overall.

We expect to have 1.5 of Sactionals coming out of Vietnam before the end of this year and we are almost there now.

We currently work with 3 Sactionals manufacturers, 2 in China and 1 in Vietnam.

The facility in Vietnam is now running at greater capacity than either of the 2 in China with no quality difference at all.

Sactionals made in Vietnam are actually slightly cheaper than those made in China and are completely outside of the special tariffs.

Both of our existing Chinese Sactionals partners are actively exploring opening facilities on our behalf outside of China in that general region, and one is slated to be operational by late spring of 2020.

We feel confident in our own ability to escape the Chinese tariffs even if they were to persist.

And it goes without saying that we have plenty of cash on our balance sheet to withstand any storm.

The remaining 40% of our Chinese manufacturing is mostly cut-and-sew business supporting covers for Sacs and Sactionals, along with a few other mostly wood accessories.

We are already sampling with cut-and-sew manufacturers and wood accessory suppliers outside of China to make the same goods at the same quality.

Our largest single Chinese supplier who makes both Sactionals and cut-and-sew goods for us is the one opening the facility in Vietnam for us next year.

That facility will manufacture both Sactionals and cut-and-sew covers at Vietnam costing.

We are absolutely confident in our ability to mitigate any long-term effects of these Chinese tariffs.

For the immediate future, there are other direct moves we are making to preserve our positive adjusted EBITDA on an annual basis even as we grow rapidly and face these tariff headwinds.

We have pushed our existing vendors in China for further discounts and rebates to offset the impact of tariffs at the gross margin line, and we have made some meaningful headway already to that end.

Needless to say, these China-based vendors all wish to retain our business in the long term, and so they are willing to share some of the pain, but that is still not enough to shield our gross margin entirely from the impact.

Besides our work in Asia over the next 18 months, we are making numerous small changes in our operations to mitigate the impact these tariffs will have at our bottom line.

Jack will spend more time expanding on the specifics.

But in a nutshell, we're able to make price adjustments on certain types of covers and accessories in ways that the customer will be mostly unaware of.

As we test these adjustments, we're pleased to see no meaningful impact on sales due to these efforts.

This is a unique aspect of our business where we're able to leave the pricing of our core product in place and take careful price adjustments on covers and ancillary products in ways that are not as obvious or impactful to the consumer.

We're also able to drive sales of more margin-rich products by how we merchandise them in the showroom.

We're changing the ways we package some items for shipping, which will have positive results on freight costs as well as customer satisfaction, and we are tightening our belt on numerous aspects of our HQ headcount and spending plan even while growing and building infrastructure to support ongoing high growth.

We are committed to operating a fiscally responsible business, and delivering on our most important annual KPIs even with the headwinds we are facing.

Sacs are made in America and continue to be a growing part of our business.

As discussed in our previous call, we have plans to open and operate a light manufacturing facility in Utah by the end of this year in pursuit of redundancy and efficiency for the manufacturing of this long-term namesake product of ours.

Those plans are in motion and we're on schedule and within budget on that project at this time.

All custom order covers for Sacs and Sactionals, approximately 10% of our cover demand, are made at a third-party facility in Los Angeles.

There is no change to that business and it remains mostly unaffected by the tariffs.

Over the very long term, we see a future supply chain for Lovesac that is actually very unique and much advantaged versus the current state of the globalized supply chain pattern utilized by almost every product company at scale.

This is important for any long-term minded investor to grasp.

We know we operate in a huge category that is also a very important one to every household in America and throughout the world.

The couch is the new kitchen table.

Upholstered seating is a greater than $30 billion per year category, and we humbly think that we make the best one.

A washable changeable, durable, built to last a lifetime and designed to evolve couch, sofa, loveseat, armchair, sectional pit or ottoman, all supported by essentially 2 SKUs, seats and sides.

We believe this Sactionals product even in its current form should find its way into most households in America, as it can be as opulent or expensive as one likes, depending on their cover choice or chosen upgrades or it can be purchased piece by piece and eventually financed over time by even the humblest of households that choose to recognize the value of this adaptable, guaranteed-for-life platform.

When we have successfully garnered any meaningful market share of this huge category of which we have less than 1% right now.

We will have put in motion a massive machine meant to drive repeat purchase and brand loyalty.

We already see that 38% of our transactions today are from repeat customers, mostly buying more Sactional pieces or new cover sets and Sactionals upgrades and accessories.

With all of the new Sactionals platform innovations that we will put out every few months, we know that the platform will continue to become even more desirable to new customers and delightful to existing customers who already own the product and are pleased when they see they can upgrade and add to it in ways that they couldn't have even imagined even when they chose to buy it in the first place.

As we are a truly direct-to-consumer business, we already know them.

They already love us for our ethos and commitment to customer satisfaction and sustainability, and we have their data and the ability to remarket to them over time.

The implications are this, we may be manufacturing and selling these same 2 SKUs in roughly their current form for decades to come along with other things as well.

But at least for the seats and sides that make up the core of Sactionals volume, and will hopefully become the default furniture solution for U.S. households, we should be able to conceive of and develop the most efficient manufacturing and supply chain ever going forward.

The product is simple and uniform and exact and that is what makes it so unique in a landscape.

The available efficiencies should come not only from a materials and assembly standpoint but also from a geography and shipping standpoint as well, all contingent upon mass reach, mass acceptance and mass scale.

Without going into the details of our vision, which are already -- which we are all very long into research phases on by the way, that is the logic that underpins our plans to essentially infiltrate every U.S. household -- every household on the planet someday, hopefully, with this uniformly beautiful and useful world's most adaptable couch.

And then work backwards to create a supply chain befitting of a product with that much ongoing demand and that much uniformity.

The end result will not only be for us to achieve maximum efficiency from a business standpoint, but we can also achieve maximum sustainability even while delivering maximum utility, satisfaction and even speed of delivery to the customer.

We have great ambitions at Lovesac.

We're not just here to compete and sell more couches.

We very much intend to disrupt this sleepy category doing business differently, and taking market share, not just with our growing brand power, but with the outside utility and value we can uniquely deliver to the consumer, and it will only improve as we become more mature, achieve greater brand awareness through marketing and through broad acceptance.

Whereas now we have almost no brand awareness and at our small market share, we believe we are still only being adopted by those elusive early adopters willing to try out new brands.

We have a long way to go.

But to sum it up, not only are these Chinese tariffs just a temporary annoyance to us but doing business in this inefficient, bad for the environment, globalized way is hopefully a short-lived reality for us as well.

The power of our platform approach to product development is what will lead us to a place where we can hopefully demonstrate a much more efficient, sustainable and profitable way of doing business in the future.

Not to mention, we believe the consumer will love us for it.

Before I turn the call over to Jack, I want to thank all of our team members here at HQ and across all showrooms for their hard work and dedication every single day.

Our extended #LovesacFamily is a primary reason that our customers love our products and reward us with their loyalty, and the reason we get to report such favorable Q1 results.

I will now turn the call over to Jack, the President and COO, to go over our key priorities for the remainder of this year.

All right.

Thanks, John and good afternoon, everyone.

As Shawn said, we're very pleased with our first quarter results to continue the momentum of our business in the start of the year.

We just spoke to you a few weeks ago on our year-end call, so my comments today will be as brief, as we are on track with the execution against our strategic priorities and plans for the remainder of the year.

Starting with expanding our marketing efforts to increase brand awareness and drive sales.

Our first quarter top line results are testament to the effectiveness of our marketing strategies, including comparable sales growth of 85.2% (sic) [85.3%] for our e-com business and 31.7% for showrooms.

While we're not providing quarterly updates to our customer lifetime value, CLV, to customer acquisition cost, CAC, we expect the continuation of CLV exceeding CAC as we lean into marketing and acquire new customers this year.

As a reminder, we finished the end of fiscal 2019 with the CLV to CAC ratio of 5x.

In Q1, we are encouraged by the 59% increase in new Sactional customers and 38.9% of transactions driven by repeat customers, both of which measure marketing effectiveness and health of the business.

We again saw strong returns on our marketing efforts in Q1.

We ran national advertising leading into Presidents' Day from January 31 through February '19 and pre-Memorial Day starting on 4/15.

This national advertising campaign was supplemented with digital advertising, which included increased search, social, and remarketing spends to capture those searching after seeing our TV advertisements.

Remarketing spend is utilized to capture the increased volume and lead conversion either online or in showrooms.

As we look to increase our marketing efficiency, we've increased 15 seconds spots as a core part of our overall TV mix, and continue to benefit from our transition to buying TV nationally, which we first did during Labor Day of 2018.

During the first quarter, we tested the viability of expanding our TV footprint by adding 3 weeks leading into our core Memorial Day campaign and 4 DMAs.

Given the positive response, I'm happy to say we're extending media runs in 10 to 12 media markets prior to Labor Day in addition to our continued testing of extended marketing flights prior to the July 4 holiday.

In terms of social marketing, we see continued opportunity to grow our Lovesac family, as we optimize and lean into marketing to drive our brand awareness this year, and stay relevant with our customers.

Initiatives within social marketing that we're working on are expanded paid social presence on Pinterest, which has been a new channel for us as we begin an initial test in the interest of niche target market audiences including eco-friendly pet owners/parents for the Lovesac brand by targeting and engaging them in social media and have implemented new search tactics to capitalize on our increased advertising exposure.

Overall, we're very encouraged by the efficiency of our marketing efforts in Q1.

We drove over 53% percent in total sales growth with spends that were only up 22% year-over-year.

We expect that we will deploy our biggest marketing efforts in the second half of the year due to the importance of the fourth quarter, the responsiveness we've seen through our advertising in Q4, and our expectation that the tests we're executing now will be rolled out on a larger scale as well in both Q3 and Q4.

Next, in terms of investing in infrastructure and capabilities particularly, technology and supply chain.

We continue to gain traction from the technology and infrastructure improvements in our showrooms deployed last year, and the first phase of our data warehouse implementation is proving effective and are helping us to execute the trade area model, I'll discuss a little bit later.

The Lovesac app for iOS and Android has been very helpful to customers during the purchasing process given its unique features including the ability to design their own Sactional while providing in-room sizing and 360-degree visualization.

We are pleased that our sales generated from the app continue to grow, and engagement stats from the app e-mail in Q1 remained high with an open rate of 71% and an AOV of 7,800.

We are currently -- $7,800.

We're currently adding enhancements to the mobile app, and will launch this enhanced version in the second quarter.

As part of our strategic investments in technology, supply chain and customer service this year, we have begun to roll out the reconcepting of our showrooms.

This includes additional technologies including our already rolled out podium SMS platform that enables our associates to request Google reviews from new customers, which naturally improves -- which improves our national search ranking and additionally it's helped improve the communication experience between our showroom customers and sales teams.

In addition, about a year ago we began to review and reimagine our logistics capabilities, and I'm happy to report that we've made some great progress.

So far this year, we improved our stock rate, in stock rate of quick ship items from 86% to 97%, allowing our product to be more available to our customers to take quick delivery.

We've improved the accuracy of our shipments to customers in the last 3 months from 99.5% to 99.8% based on units in air over units shipped.

This is meaningful when you consider that many Sactional orders have 30 to 40 pieces in an order between the seat size covers and accessories.

In addition, we've increased our distribution capacity by 400% over the last 12 months in support of our significant growth by securing multiple warehouses and additional processing labor.

And lastly, we've improved the reliability of our suppliers from 69% to 97% measured in terms of orders received on time and as planned in the last 3 quarters.

The next key component of our multipronged approach to grow the business is expanding and improving our showroom presence.

As we continue to open more showrooms, our brick-and-mortar footprint drives increased brand awareness given the current levels that are very low.

In the first quarter, we opened 5 new showrooms to end the quarter with 78 showrooms in 30 states in the U.S. with locations in top-tier malls, lifestyle centers and high visibility street locations.

I'm also now pleased to say that we are on track to open between 17 and 20 new showrooms in the fiscal year of 2020 from a range of 15 to 20 that I had earlier mentioned on previous calls, as we capitalize on our improved brand presence with landlords, and our operational excellence in the showroom opening process.

In terms of opening -- updating our remaining legacy store models experiential showrooms, we updated 3 showrooms in the first quarter and we now have 84% of our fleet updated to the new showroom format.

Given the strength of the new prototype and supporting our pivot showroom design and approach, we'll continue to invest in our showrooms to improve the overall shopping experience, including tools to collect customer feedback and enhancing our technology.

We recently launched an omnichannel trade area pilot, allowing us to engage with customers in a channel-agnostic way.

This approach incentivizes associates beyond their individual showroom targets and rewards them for transactions occurring within their trade area regardless of the channel, the final purchases made.

This shift plays an important role in delivering a best-in-class customer experience without the pain points often caused by brand expansion.

These pilot teams have been very excited by this approach, and we expect to roll this out to all showrooms in the second half of the year.

Turning to shop-in-shops.

In the first quarter of fiscal 2020, we operated 159 shop-in-shops with Costco, up from 120 in the first quarter of last year, which drove a 52.5% increase in our other channel sales to $5.6 million.

At the same time, shop-in-shop productivity increased by 17% in the quarter in terms of measuring sales per show -- per 10-day show period.

We continue to believe that the shop-in-shop format allows us to capitalize on customer acquisition opportunities in high-traffic areas, showcasing a limited offering of our products in areas where customers or potential customers don't necessarily see us without a showroom presence.

We remain on track to expand our shop-in-shop presence for fiscal 2020.

And as discussed on previous calls, shop-in-shops have been a major contributor to our growth in the past 24 months.

This has enabled us to capitalize on the customer acquisition in areas where we don't have a showroom presence.

And as previously mentioned, we continue to explore similar opportunities to deploy this concept with other retailers, and we will keep you updated on our progress.

So in summary, we're very pleased with our first quarter results and the operational progress we've made on our strategic initiatives.

As we look to the remainder of the year, we'll continue to focus on growing the business and strategically investing our infrastructure technology to position the business for long-term growth.

Finally, given the recent tariff increase, as Shawn said, we are continuing to ramp-up our mitigation efforts.

Given our ongoing discussions with vendors and resourcing efforts, we're not in a position today to provide an updated view on the gross margin headwind from tariffs for the year, but we feel comfortable that we will deliver 40% to 45% sales growth and a positive adjusted EBITDA.

And with that, for more detailed review of the first quarter results as well as a few items related to our outlook, I'll turn the call over to Donna Dellomo, our Chief Financial Officer.

Thank you, Jack.

Good afternoon, everyone.

I will begin my remarks with a review of our first quarter results and then provide some commentary around our thoughts for fiscal 2020.

Net sales increased 53% to $41 million from $26.8 million in the prior year quarter.

This sales growth was driven by strong showroom, Internet and shop-in-shop performance with an increase in new customers as well as an increase in the total number of units sold, reflecting a higher average order volume per customer.

Our advertising and marketing investments, which drive brand awareness and an increase in the number of showrooms also helped fuel our Q1 sales performance.

Comparable sales, which include showroom and Internet sales, increased 43.5%.

Comparable showroom sales increased 31.7% and represents our tenth consecutive quarter of positive comp showroom sales increases.

Internet sales increased 85.3% versus an increase of 49.6% in the prior year period.

We opened 5 new showrooms, remodeled 3 legacy stores into our new showroom format, and closed 2 showrooms during the first quarter.

We ended the quarter with 78 showrooms.

Looking at our results by channel, showroom sales increased to 45.2% to $26.9 million.

Internet sales increased 85.3% to $8.5 million.

And our other channel, which includes our shop-in-shops in Costco locations, increased 52.5% to $5.6 million.

By product category, our Sactional sales increased 65.4%, our Sacs sales increased 10.1%.

And our other category, which includes decorative pillows, blankets and other accessories, increased 42.8% in the first quarter as compared to the prior year quarter.

Gross profit dollars increased 43.3% to $21 million in the first quarter.

As expected, gross margin percentage decreased by 340 basis points to 51.3% or 54.7% reported in the same period last year.

This year-over-year decline was primarily driven by the 10% tariffs, partially offset by reduced cost of our Sactional and Sacs products, primarily related to cost savings from a change in the sourcing of our Lovesoft and down blend fills.

For the first quarter, total SG&A, excluding advertising and marketing expense, increased 57% to $23.9 million from [$152 million] (sic) [$15.2 million] in the first quarter of last year.

Excluding $150,000 of other nonrelated expenses relating to board and executive recruitment fees, total SG&A increased to $23.7 million, increased.

The increase in SG&A was driven largely by an increase in employment costs of $2.1 million, $500,000 of increased rent associated with our net addition of 5 showrooms, reached actually net of 5 -- 3. $2 million of expenses related to the increase in sales such as $200,000 of credit card fees, $1.1 million of showroom and web-related selling expenses, $200,000 of web-affiliate program and web platform hosting commissions, and $500,000 of shop-in-shops sales agencies.

Also to note, overhead expenses increased $1.2 million to support company initiatives related to infrastructure and public company expenses, and stock-based compensation increased $2.9 million in the first quarter, related to accelerated investing.

As a percent of sales, total SG&A expense deleveraged by 150 basis points driven largely by an increase in infrastructure investments, stock compensation and public company costs.

Our investments in advertising and marketing, which benefit extended periods, increased $1 million or 22.3% over the first quarter of prior year.

We leveraged advertising and marketing expenses by 330 basis points this quarter, largely due to a shift in the timing of media investments to later periods in this fiscal year, buying media nationally as well as introducing 15-second spots into our TV mix, and we plan to reinvest these savings into marketing efforts in the second half of the year.

As we've discussed before, advertising and marketing investments are a key priority for us given our low brand awareness and very attractive financial returns on this spend.

As evidenced in the CLV-to-CAC cost economics we previously discussed.

We will continue to lean into advertising and marketing with a projected annual spend of 10% to 12% of net sales.

The year-over-year increases in our advertising and marketing investments that you see in any given quarter can and will vary often substantially as we maintain flexibility when investing against this very compelling customer acquisition opportunity.

Depreciation and amortization increased $400,000 from the prior year to $1.1 million, principally related to capital investments for new and remodeled showrooms.

Our operating loss was $9.3 million compared to an operating loss of $5.6 million in the first quarter of last year.

Excluding $150,000 of nonrecurring expenses related to Board and executive recruitment fees in the first quarter of fiscal 2020 and $216,000 of nonrecurring expenses related to financing initiatives in the first quarter of fiscal 2019, the operating loss was $9.1 million for the first quarter of fiscal 2019, that's actually '18.

And $5.4 million for the first quarter of 2019.

Net interest income was $235,000.

This reflects $243,000 of earnings related to net proceeds from the initial public offering, partially offset by an immaterial amount of interest expense related to unused line fees on the company's line of credit for the 13 weeks ended May 5, 2020.

Tax expense in the first quarters of fiscal 2020 and 2019 was less than $20,000 and it relates to minimum state income tax liabilities.

Before we turn our attention to net income -- net income loss per share and EBITDA, I would like to point out that my discussion of these metrics will focus on net loss and net loss per share adjusted for the IPO and other financing costs as well as adjusted EBITDA.

Please refer to the terminology and reconciliation between each of our adjusted metrics in their most directly comparable GAAP measurements in our earnings release issued earlier today.

Net loss adjusted for nonrecurring type expenses was $9.1 million in the first quarter of fiscal 2020 compared to $5.5 million for the first quarter of 2019.

Net loss per share adjusted to the IPO and financing costs was $0.67 in the first quarter of fiscal 2020 and $0.41 in the first quarter of 2019.

Adjusted EBITDA was a loss of $4.7 million for Q1 fiscal 2020 as compared to a loss of $4.2 million in the first quarter of last year with the first quarter of fiscal 2020 being impacted by expenses related to being a public company, and infrastructure investments not present in the first quarter of fiscal 2019.

Turning our -- turning to our balance sheet, we ended the quarter with $35.7 million in cash and cash equivalents.

Ending inventory increased 123% year-over-year, driven by an increased investment in the weeks of supply of inventory on hand to support sales growth across all channels to be agile enough to support the success of our advertising and marketing investments and an increase in capitalized freight and warehousing costs relative to the build in inventory and tariff charges.

Now while we're not providing formal guidance, I would like to discuss a few items as it relates to fiscal 2020.

From a showroom perspective, for the full fiscal year 2020, we are on track to open 17 to 20 new showrooms this year and remodel 8. In terms of shop-in-shops, we continue to plan to operate approximately 690 pop-up shop-in-shops this year versus 553 pop-up shop-in-shops in last year with more than 75% of the shop-in-shops occurring in the first 3 quarters of fiscal 2020.

We continue to expect to deliver strong levels of sales growth, although a moderation from 2019 levels, and we continue to expect to drive sales growth for the full fiscal year between 40% to 45%.

We're still evaluating the impact on our financials of the tariff increasing to 25% and will be in a better position to update you on our next call.

But based on what we know today, we feel confident that we will be able to generate positive adjusted EBITDA dollars this fiscal year.

We continue to expect gross margins for fiscal 2020 to be lower than fiscal 2019, principally related to the following: the expected 10% tariff pressure, which is being offset by margin and SG&A initiatives; the increased tariff pressure as a result of the recently announced increase in tariffs to 25%; investments into our distribution infrastructure to support future growth; a slight headwind due to the continued shift in product mix towards Sactionals as well as slight impacts from higher shop-in-shops channel mix sales.

These decreases are partially being offset by product margin gains relating to changes in discounting and promotional strategies, and reduced product costs related to vendor sourcing strategy.

For fiscal -- for the second quarter of fiscal 2020, we expect gross margin declines of approximately 320 to 340 basis points from the prior year quarter, driven by all of these same factors with the exception of the step-up to the 25% tariff, as this is not expected to impact our gross margin until late Q3 fiscal 2020.

In terms of SG&A excluding advertising and marketing expense, as previously mentioned, we expect the most significant SG&A leverage to be generated in Q4 given the seasonality of our business.

As a reminder, embedded in our SG&A outlook is all of the investments we're making in the business across people, process, and infrastructure, and our Q4 net sales volumes enables us to leverage these investments over prior year.

Regarding advertising and marketing investments, we will continue to invest strategically in fiscal 2020 given the attractive returns on this investment with an annual investment of 10% to 12% of net sales.

So in summary, while we continue to expect quarterly fluctuations due to the timing of our tariff mitigation efforts, our advertising and marketing investments, and investments across all areas of the business to support the significant growth opportunities we have, we anticipate that we will again deliver a high sales growth rate and will generate a positive adjusted EBITDA in fiscal 2020.

Finally, as it relates to capital expenditures, we continue to expect to incur approximately $13 million of CapEx in fiscal 2020 with the vast majority of this spent on the opening of 17 to 20 showrooms, the remodel of approximately 8 legacy stores, and approximately $2.8 million being invested into a company operated Sac manufacturing factory.

The remaining spend is being allocated to technology in our showrooms, inventory management and logistic systems, e-commerce platform enhancements, and for headquarters data and support systems.

For all other details relating to our results, please refer to our earnings press release.

With that, we'd like now to turn the call back to the operator who can open it up for questions.

Operator?

(Operator Instructions) Our first question comes from the line of David King with Roth Capital.

I guess first off on the pre-Memorial Day ad spend that you ran, how did the ROIs compare there to what you were getting previously?

And then how should we think about the impact moving forward, particularly as you get into the second half when you'll be anniversarying the start of national TV?

Yes.

I think it's a good question, Dave, but one I can't answer in detail because Memorial Day is it runs through Q2.

So I don't think we're seeing any surprises versus what we expected.

But the Memorial Day run, we're still analyzing as we still get a tail in terms of return.

So it's -- the run hasn't completed in terms of our analysis.

But what I can tell you again -- what's that?

I said fair enough.

Go ahead.

Go ahead.

Yes, but what I can tell you is some of the things that we're excited about are those tests I mentioned.

So we've had a couple of market tests where we've extended our advertising for 3 weeks at a fairly robust increase in GRPs and we are see -- we were seeing increasing lifts, and we're continuing to expand to the 12 markets prior to Labor Day.

And based on -- if those results continue to look good, we will see a pretty major expansion in the level of GRPs at a national level.

So we're very happy about those test results.

Okay.

And is that the advertising and conversion test that you had alluded to?

Or is that something else?

That was the test where we're literally, right now, we run 3 to 4 weeks prior to what we call our major tentpole events.

So the Memorial Day, Labor Day, holiday, et cetera.

We took 3 markets and extended it from 3 to 4 weeks to 6 to 7 weeks, and we did see an increase in ROI in those markets.

However, consistent with where we've been in the past, we're not going national, we're going to 12 markets prior to Labor Day, which are some of our stronger markets, balanced out with a mix of some of our sort of average markets.

And based on what we see there, we will either extend nationally or extend to those 12 markets again during the fourth quarter.

Okay.

And then maybe trying the first part of the question again in a different way.

It sounds like several retailers and brands for that matter, have talked about a tough May with weak mall traffic.

Have you guys seen any of that through early June, even if on just the showroom side?

I think in the past, you've probably demonstrated your ability to, whatever the word is, do much better than your peers?

Just curious if that's -- continue to be the case.

I would say that we did not experience challenges in traffic relative to our expectations in the first quarter.

And since we're in the beginning of the second quarter, we don't want to share it.

Okay.

Then maybe high level, taking a step back, Shawn, how are you thinking about the competition these days?

I saw Nectar or Bundle rolled out a couch and beanbags, and then there's Burrow.

Just what are you thinking about what's out there from others at this point and your ability to continue to take share?

Do you worry about them at all?

Just some thoughts would be great.

Yes.

I think that we continue to see new entrants in both the couch and Sacs categories, albeit, relatively slow compared to other categories in the direct-to-consumer markets that we've witnessed, whether it be fashion, whether it be mattresses.

We are very focused on just sort of doing our thing.

We're very confident in not just our intellectual property, which we continue to get more of.

We continue to actually lay out new patent claims that get there -- that get issued.

But we also have some long-established patents that we continue to defend.

And we'll continue to defend against the likes of those that infringe upon them and -- but more importantly, I think we're confident in our business model.

It's one thing to make something and put in the box.

It's another thing to build a platform like we have around Sactionals that drives true repeat customer value as well as have the path to kind of ongoing and expansive growth as a platform.

And so I think that the way that we do business is radically different than anyone else so far.

And while we should fully expect given our success to see new entrants come into the market.

I think that the IP moat we have around Sactionals are solid.

I think our pace rate of growth and customer affinity is solid, and we're just focused on doing business our own way.

I think one of the things we'll watch is incumbents.

We still have yet to see any incumbent furniture companies really go down the path of direct-to-consumer couch in a box, all these kind of things.

It will be interesting to see if that happens.

But as of yet, we continue to be confident in what we're doing.

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

Shawn, thanks for the detail on your tariff mitigation plans.

You mentioned that you are starting to see some cost differentials and cost improvements on product that's being produced in Vietnam.

Can you help us understand how to think about that cost improvement and how that improvement increases as your scale with those manufacturing partners increases?

Yes.

So we haven't put out specific guidance on the types of savings that we're experiencing in Vietnam.

But suffice it to say, apples-for-apples product cost less there than it does in China.

It's not dramatic or crazy gap in margin, but it certainly is positive to the business.

It took us a little while to get that fully in gear, as the sampling process and the product development process around Sactionals is tough.

It's a very technical product in its category.

It's very exacting.

And we have to really go through number of -- a number of cycles with any new vendor to vet the vendor and also to then -- get to manufacturing at -- en masse.

And so we're there now with at least the one Sactional supplier, and we feel very good about that.

In terms of the long-term implications, look, we'll be buying stuff, we believe, less expensively.

In as much as Vietnam will experience inflation, China always experience -- look, we've been doing business in Asia for -- I've been doing business in Asia with Lovesac for almost 20 years now.

We got started very early there partially because I speak Mandarin Chinese and lived over there for 1/10 of my life.

And so very familiar with the region, very comfortable operating in that region.

I think it's one of the reasons that we feel confident in our ability to navigate these sort of crazy waters that the tariffs have kind of thrown us into over there is we've been sourcing and resourcing in Asia, in general, for a very long time.

And so will it -- I'm sure that Vietnam will experience some kind of inflation as a lot of manufacturing move there.

At the same time, Vietnam is undergoing economies of scale as the infrastructure there improves.

So the one offsets the other and we hope that we can continue to maintain high gross margins at the product -- high gross margins.

And that's something that we intend to do.

We feel confident that we can do that.

And Vietnam won't be the end of how we do that.

And I kind of spoke at length to that during my remarks but did it a little abstractly on purpose, but we have very long-term views to the supply chain and to our ability to maintaining high gross margins in this business.

So assuming that the tariffs at 25% do not get lifted by next year.

I think you said that by the end of next year, you will be fully out of China if need be.

So is that to say that when we roll over to fiscal '22 that, that should be over?

From an all else equal perspective, that should be a year where you'll have that margin recovery because you won't have that pressure from tariffs to deal with or contend with anymore?

Yes.

That's exactly right.

I mean minus any inflation across the whole system or the world or Vietnam in particular.

But even there we hope that as we explore Chinese alternatives, it may not all be in Vietnam either.

So we have our hands in a number of different baskets right now.

And again, our hope is that tariffs do fall away because China is a very strong infrastructure that can support our scaling.

But we are totally mentally flexible on the subject, and we feel like we're -- we wish we were further ahead of the eight ball here.

But we're at least halfway ahead of the eight ball, and it won't impact our business in the long term.

And just to add to that, and we're also at the same time -- so if you think of in a 24-month period, we'll have a supply chain that's delivering where we need -- need it to deliver in terms of tariffs.

We're continually looking at merchandising approaches, tier pricing changes in terms of promotions to increase our margins at the side.

And then I think after the next 24 months, as we -- we'll start to see some dramatic increases in efficiency of supply chain, which will also give us some real positives in terms of costs and efficiency in the long run.

Great.

That sounds like the long-run margin structure should remain in that mid-50s range.

Perfect.

If we could just switch topics quickly to the advertising, and more as it relates to the back half, given that you began a national campaign last year on Labor Day, you separate results.

How do you answer the question?

And it's one that we get often that how you struggle through those difficult comparisons.

What is the plan to anniversary that really first successful launch?

And what confidence do you have in the ability to maintain this continued level of growth?

That's a good question.

There's a couple of factors.

One is just the size of the fleet of showrooms, right, and the touch points.

And as we discussed earlier, I think I've mentioned that an area with a showroom is 600% more efficient than an area without a showroom.

So as we continue to grow our showrooms, we'll have a natural increase in efficiency in markets where we haven't been before.

In addition, we continue to learn from our testing.

We've consistently discussed what we're testing each quarter.

Last quarter, we discussed 15-second commercials, and they've become 30% of our -- basically 30% of our mix.

And those savings get applied to other areas and reinvestments.

So we take that efficiency and we don't increase -- decrease our spending, we actually increase it.

And at the same time, I think as we discussed just earlier today, we are seeing very positive results in extending our media runs in the major markets.

So I would expect those savings that we're getting with 15 seconds are going to be redeployed into higher levels of GRPs in the fourth quarter.

So I think right now, I think what we've got is a learning agenda and efficiency from showrooms that we believe will match the increasing comparables as we go forward.

And then if you could just remind me, Jack.

I think you had -- you've tested some of this before in the San Francisco market, if I'm not mistaken, where you had multiple years of very consistently high levels of growth.

Could you just remind me of that?

Yes.

We have -- and this all -- we've got new cohorts in here.

But what we've basically seen in San Francisco, we've seen over the past, San Francisco marketing started 18 months before many of the other markets, and we continue to see very strong levels of growth in San Francisco.

And that's really due to the fact that even at the -- basically year-over-year growth of 3 digits, we haven't seen significant increases in awareness.

So there's a long runway to go for us.

Basically, in San Francisco, I think we have less than 3% awareness.

So we still see huge opportunities for the brand.

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

I had one on marketing spending velocity and then one on urban showrooms.

So first on marketing spending velocity, I think you indicated that the lifetime value of a customer versus the customer acquisition cost ratio is like 5x.

How do you think about spending marketing dollars and potentially ramping your marketing spend, even if it means lowering that ratio as a way to acquire customers.

And then after that, I'll ask about the urban showrooms.

Okay.

Yes, we will continue to -- I think what we're really pleased with, and we mentioned earlier, is some of the improvements in supply chain are making us feel more confident and the operational excellence of the business in terms of supply chain as well as the efficiency of opening showrooms.

So I think we are going to continue to look for ways to lean forward in marketing and increase our revenue growth.

So I obviously don't want to give you any guidance here.

But as discussed earlier in answering some of the other questions, when we see opportunities, based on testing to lean more into marketing, we will do so.

We don't -- we're not saying that we're going to lead the 10% to 12% of sales in terms of marketing rate right now, but we will continue to look for ways to increase our efficiency, increase our commitment.

And yes, you're absolutely right.

In terms of -- we're not going to become literally prisoners of a pure ROI because there are many cases where certain ROI approaches -- or certain -- I'm sorry, certain media approaches may have a lower ROI but a higher scalability, netting out rate of revenue growth.

And we're certainly aware of that.

And we're not afraid to change the mix up in order to get greater overall revenue as long as the system that we're putting together can support it in a way that our customers still love us.

Great.

And then the second question on urban showrooms.

You talked a little about the halo effect in showrooms in general.

But I was wondering specifically you now have 3 urban locations, you recently added one in Philly.

Are the urban showrooms materially different than your suburban locations?

And are you seeing a different or perhaps bigger halo effect for sales in urban markets when you open one?

Yes.

We are.

So generally speaking, what we see is the higher the population density, really what we're seeing and unlike sort of a specialty retail model where the more stores the better.

And it's based on convenience.

It's really based -- what we've seen is the trading areas are really based on the time it takes to get to a showroom.

And our trading areas are typically a radius of 30 to 40 minutes.

So you can imagine in New York City you basically have a trading area that one showroom practically covers the whole trading area or maybe 2 or 3 in terms of if you go up, and up north in Manhattan.

So basically, the bottom line is you'll see, for example, in New York City, 30% to 40% of the sales -- if you have a showroom that based on measuring the way we measure showroom sales right now is an index of 1, we'll get e-commerce share of sales driving 30% to 40% of that.

And as you look in less populated areas, you'll see a 15% to 20% ratio.

So those high-urban areas have a tremendously higher return in terms of the total mix, the DTC mix combined showroom and e-com.

Our next question comes from the line of Alex Fuhrman with Craig-Hallum Capital Group.

Congratulations on another quarter of very strong growth.

I wanted to ask about the -- some of your supply chain plans and curious if the tariff situation persisted, you end up going down the road where you completely move your production outside of China in the next 18 months.

How much capital investment would that entail on your part?

It sounds like there's an appetite on behalf of some of your vendors to make investments to be able to handle your business.

Just curious what we should expect in terms of your own spending to be able to complete that transformation.

Yes.

This is Shawn, I'll comment and then Donna can follow up if there's something to add.

In terms of our core manufacturing as it's been described, almost nothing.

We intend -- we have a third-party manufacturer bias, all things being equal.

We've done very well with our outside partners.

We hold them very close, and we feel like we've got a good control over our supply chain with pretty robust ability to scale at almost any pace.

And so while we will be expanding that network and taking on some new suppliers as we've done already, we feel confident in that cadence and our ability to manage that and in our ability to get that investment out of our third-party partners.

What happens with us because of this -- of the nature of what Sactionals are, again, highly uniform, highly exacting, difficult product development process.

However, once you're in motion, it's -- we become the favorite of any of our suppliers and usually the biggest of any of our suppliers -- client, that is because all they do is make the same thing over and over and over forever.

And that's the nature of the business we're building.

We are intentionally -- we are out against planned obsolescence and perceived obsolescence and everything that drives the rest of the merchandising model that we've escaped from.

And so everyone benefits, the consumer benefits, we benefit as evidenced by our success and our vendors benefit.

And so they are always willing to make those investments for us is what we've experienced so far.

So we don't expect huge capital outlays.

We don't intend to pursue vertical manufacturing opportunities except as they present themselves as obviously advantageous as our little Sac operation has that we've already been talking about.

I don't know if that's helpful...

Yes, that's terrific, Shawn.

That's really helpful.

And then if I could just ask one more question about the marketing, the increase plan for the fourth quarter.

Is that -- just thinking about the comment about that being the largest quarter for marketing this year, is that in absolute dollars in terms of the year-over-year increase?

Is that set to accelerate in the fourth quarter as well?

And just kind of curious where some of those dollars are going to be going, is that more TV commercials or better TV placement or channels outside of TV?

Just curious what the -- how that will manifest itself?

Yes.

I would say -- well, a couple of things is obviously in terms of absolute, it is the largest.

In terms of growth, what I will say is that we are redeploying the savings that -- the marketing numbers that we underspent in the first quarter, we're obviously redeploying those in the third and fourth quarter, primarily in the fourth quarter.

And it'll be primarily based on our knowledge so far.

Based on what we're seeing, it will primarily be extended runs in major markets where we're seeing the benefit of additional GRPs for an extended period driving up ROIs and efficiency.

Our next question comes from the line of Brian Nagel with Oppenheimer & Co.

So maybe a bit longer term in nature.

But you talked quite a bit about the opening of the showrooms.

As you think longer term in connecting with customers, how do you balance -- how do you think about the opening and running of your showrooms versus the partnership you have with Costco.

How do those 2 channels sort of say, work together over time?

That's a good question.

I think that it really -- I think that in high-population areas -- areas with a high concentration of population -- excuse me, that's hard for me to say.

Showrooms will continue to be a very efficient way for us to roll out the business.

And I believe we'll -- a 200-showroom target for $1 billion business is probably a reasonable thing to say at this point, but that doesn't mean we'll continue.

We certainly see, for example, the Costco has been incredibly efficient because it's a low capital, really in that case very -- almost no capital way to create consumer touch points that create business really outside of Costco.

We generate a lot of online business as well as showroom sales in the weeks following our Costco roadshows.

So what we see in terms of that is a model to reach additional customers in a low-CapEx way.

And we are because of the value of the business and the quality of the Costco business, I think it tells us that there are a lot of potential partners out there that have a desirable customer base who want to partner with a desirable company that's growing as fast as we are.

So we see it as a big opportunity.

And I'd say this is the way we look at it is how do we enter a market and leverage the CLV over CAC to get the -- keep the multiple as high as possible.

And when you look at some of the shop-in-shop opportunities and partnerships, it can really help us become superefficient.

So we'll continue to look at that.

And we're continuing to learn a lot.

We're obviously growing very fast.

We went from 0 Costco shows 24 months ago to where we are today, and we've grown our showroom base tremendously.

So we're really starting just to get an understanding on how the shows and the showrooms and the e-commerce business work together.

So I think we'll be giving you more and more details in the long run on how they look.

But I think that we're going to continue to look at other opportunities for shop-in-shops.

Absolutely.

That's very helpful.

Then if I could follow up with one question on a separate topic.

We've talked a lot about tariffs here.

I think, Shawn, you were mentioning just some of the efforts to potentially move manufacturing capacity, the potential impact upon margins.

The simple question I have is, as you look at your product and that demand trends for the product, how much pricing power do you have to the extent that if -- we've seen some tariffs, if more tariffs come in, could you pass along some of these costs to consumers in the form of higher retail price points?

Yes.

I mean we feel like we could.

We know we can.

We are kind of walking this fine line as evidenced by one of the questions earlier between even more rapid growth -- between rapid growth and rapider rapid growth.

And so we feel good about the sort of price/value equation right now as it lies.

And the kind of growth that it drives for us with the marketing model as we know it.

And I guess what I'm really saying is we did on the call mention that we will be taking some price increases, albeit very surgically and mostly we like to think invisibly to the customer.

We're not raising prices on the core product.

To your point, we could do it.

We've chosen not to because we have the longer term in mind.

We like the simplicity of the model.

We like the way it's resonating.

We're on a good pace, and we just want to keep the good times going as it were.

And so we're willing to take the slight hit in gross margin in the near term, especially as we feel confident in our ability to project that positive EBITDA and yet achieve these high-growth rates to the top line, which is -- so it kind of falls in line with all of our objectives while keeping intact the model as we know it and as the consumers know it and as it's resonating today.

Yes.

Just to add to that, I think we're learning a lot about the quality of selling.

And as we invest more in marketing, I think we're getting smarter about the quality of selling in terms of the merchandising strategy and the discount strategies.

And I think one specific one, for example, which was a pretty big change but very subtle and we saw absolutely no resistance from customers is at the beginning of the year, we changed our "Stack More, Save More” promotion, which is our everyday promotion.

And the 20% requirement previously was 10 pieces.

We've moved it to 11 pieces.

And for the 25% discount, we moved it to 16 pieces.

We saw absolutely no impact on the business.

And there are other things we're looking at for example in terms of flash sales.

We're learning a lot about frequency and length of flash sales and how to get more return out of events and spending less money on discounts when we're starting to take not just at a promotional level but what customers are doing, what's happening with quotes and how do we leverage the marketing combined with strategic timing of flash sales to get greater lifts with lower discounts.

So a lot of opportunities there for us too as we get smarter about the business.

Ladies and gentlemen, we have reached the end of the question-and-answer session.

And I would like to turn the call back to management for closing remarks.

Thank you all for your support.

We appreciate your interest in our business, and we look forward to continuing to operate the business in the way that we only know -- that we know how.

So we will wrap up on that note.

This concludes today's conference.

You may disconnect your lines at this time.

Thank you for your participation.