Brilliant Earth Group, Inc. Q3 FY2021 Earnings Call

Ladies and gentlemen, thank you for standing by. And welcome to Brilliant Earth Third Quarter Fiscal 2021 Earnings Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to Allison Malkin of ICR. Thank you. Please, go ahead.

Thank you. Good morning, everyone. Thank you for joining us for our third quarter fiscal year 2021 conference call. Joining me today are Beth Gerstein, our Chief Executive Officer, and Jeff Kuo, our Chief Financial Officer. For this morning's call, Beth will begin with an overview of the company, our differentiation and mission, highlights of our third quarter financial and operational performance and the drivers of our future growth. Jeff will follow with more details on our third quarter financial results and introduce our guidance. Following this, the operator will begin the Q&A session with our presenters Beth and Jeff available to answer the questions you have for us today. Before we start, I would like to remind you that management will make certain remarks today that are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to our SEC filings for a description of the risks that could cause our actual performance and results to differ materially from those expressed or implied in these forward-looking statements. These forward-looking statements reflect our opinions only as of the date of this call, and we undertake no obligation to revise for publicly released results of any revision to these forward-looking statements, in light of new information or future events. Also, during this call, we will discuss both GAAP and non-GAAP financial measures. You will find additional information regarding these non-GAAP financial measures and a reconciliation of these non-GAAP to GAAP measures in today's earnings release, which is available at the investor relations section of our website at investors.brilliantearth.com. A live broadcast of this call is also available at the investor relations section of our website. With that, I'll turn the call over to Beth.

Thank you, Allison. Good morning, everyone. And thank you for joining us this morning. I am delighted to speak with you today and share our record third quarter performance highlighted by strength across our financial metrics and continued progress on our long-term growth initiatives. The quarter also marked an exciting milestone in our history, as we completed our IPO. I want to thank our team for their hard work and dedication. I am proud of all that we have accomplished together and I'm excited about the many opportunities that lie ahead of us in the near and long term. Before I discuss our results, for those new to Brilliant Earth, let me first share our vision and approach to modernizing and transforming the jewelry industry. Brilliant Earth is a next-generation fine jeweler for millennial and Gen Z consumers. We offer a personalized, joyful omnichannel shopping experience, with a leading e-commerce platform and 14 showrooms across the United States. And always underlying this are the mission-driven values we were founded on; our commitment to sustainability, transparency, giving back, and diversity, equity, and inclusion. We are transforming the industry with our approach and are proud to have become a global leader in ethically sourced fine jewelry. Our unique business is highly profitable and well-positioned to deliver sustained growth over the long term. Let me share why Brilliant Earth is both compelling and incredibly hard to replicate. First, the Brilliant Earth brand. We've spent over a decade building a globally recognized premium jewelry brand with an authentic ESG focus and mission-driven values. We're proud that these are the principles that we've founded the company on 16 years ago. We're always reminding ourselves that this is a journey that we need to continually work towards, and that our values are and always will be our Northstar. Technology. We are a digital-first innovator with a strong mindset for data analysis and technology. From the beginning, we've used data to inform our decisions from product design and merchandising to real estate strategy to a pricing engine that enables us to maintain and grow margins. As a digital-first leader for over 16 years, we've been testing, iterating, and customizing a true omnichannel customer experience from our e-commerce platform and digital channels to our showrooms. This experience is well-aligned with how today's younger consumer prefers to shop. Our high net promoter scores show that our customers love their Brilliant Earth experience and we're continually striving to make it even better. In jewelry, product design is incredibly important. 99% of our customers tell us that design is a top priority for them. We are leaders here with new proprietary products being constantly and rapidly introduced by our award-winning design teams, informed by deep data-driven insights about our consumers and their purchasing preferences. We've developed a network of strategic long-term relationships and proprietary APIs to deliver on-demand, carefully sourced and highly customized products. Navigating the incredibly complex and opaque global jewelry industry is very challenging. It has taken us many years of investing in people, technology, processes and relationships to be able to deliver trusted, ethically sourced products at our quality standards and in our timeframes. Our business model is asset-light and capital efficient. Our customers can choose from over 150,000 natural and lab diamonds on our website and can personalize their jewelry using our create your own digital tools. And in contrast for traditional jewelers, we do not need to carry most of these products on our balance sheet, allowing us to remain capital efficient. Finally, we are disruptors in a large and growing industry. The jewelry industry is $300 billion globally, with more than $60 billion in the US and growing at 7% per year. The industry is highly fragmented, with 65% of it made up of independents that lack the technology and resources to compete at our level, and mall operators that are faced with antiquated inventory-heavy store formats in outdated malls with declining foot traffic. We believe that all of these competitive advantages will allow us to continue delivering strong revenue growth with robust profit margins, while furthering our mission. Now turning to third-quarter results. We delivered an outstanding third quarter highlighted by significant growth across our key financial metrics. Net sales increased 33% above last year's third quarter, driven by our showrooms and website and across our products, including create your own diamond rings, wedding gemstone and anniversary rings, and fine jewelry. Our strong performance highlights Brilliant Earth’s brand resonance with millennial and Gen Z consumers, as we continue to gain share in the jewelry industry. Our margins were up significantly versus last year's third quarter. Gross margin increased to 50.4% from 43.2%. Our adjusted EBITDA margins continue to be strong, growing year-over-year to 14.2%. Jeff, our CFO, will talk more about the drivers of this strong margin performance in a few minutes. In addition to strong top and bottom-line results, we made great progress in the quarter on many of our long-term growth initiatives. We continued our omnichannel leadership, opening our new San Francisco flagship and four new showroom locations in Portland, Austin, Dallas, and Manhattan. Our openings include innovative new store formats, such as ground floor retail locations in top-tier shopping districts, with other like-minded premium brands that attract a similar audience. These new store formats offer expanded browsing and retail area for walking, while continuing to serve our successful appointment-driven model, and deliver highly attractive economics. The early data from these new showrooms is compelling, with a rapid acceleration in customer appointments and traffic, demonstrating strong latent demand in these markets. For our 2021 new showroom, we've seen an average year-over-year metro bookings growth of over 100% in the first month post-opening, which is better than the historical 80% first year uplift that we've previously seen with new showroom openings. In addition, the conversion uplift for digital traffic across these entire metro areas is similar to or better than our strong historically demonstrated results. This consistent powerful synergy between our stores and e-commerce reinforces our conviction in our omnichannel strategy. We also expanded our product offerings, introducing a record number of collections in create your own diamond rings, fine jewelry, and other products. As just a few examples, our ensemble design collection reimagines classic bridal trends for engagement rings. The fashion rings collection is built on our strong foundation in ring design. And our fine jewelry collections highlight key trends like yellow gold and pearls and include new products that can be personalized like our zodiac pendants, engravables, and create your own birthstone jewelry. We're so excited about all of these beautiful collections. You can see a few of them highlighted in the presentation materials for today's call. Consumers are increasingly turning to Brilliant Earth for design driven premium fine jewelry with meaning. In Q3, our Fine Jewelry products continue to experience rapid growth. While still a relatively small part of our business today, we see long-term opportunities to significantly grow our Fine Jewelry business, which we expect will increase repeat purchase frequency and drive higher customer lifetime value. Data-driven agile product development is a core strength for us. We believe this strength in developing, merchandising, and selling compelling new design collections, as well as our strong customer relationships and brand affinity will drive our continued success in the Fine Jewelry space. We are supporting the launch of these new products with enhanced digital experiences to make shopping with us even more seamless, engaging, and personalized. In time for the holidays, we have launched a new digital gifting experience featuring new ways to shop our assortment of fine jewelry. We also launched our ring stacking visualization tool, which allows customers to mix and match styles and products in myriad different ways and see how those styles look together. Our customers love it. We continually invest in improving what we believe are already best-in-class digital capabilities, and a truly seamless omnichannel customer experience. For example, we recently launched a new virtual showroom, which allows consumers to see the same curated selection of products online that they saw in their visit to our showroom, along with personalized recommendations based on their specific preferences and shopping history. It's an incredible example of how our omnichannel model really does deliver an elevated, customized shopping experience for our customers, wherever and however they prefer to shop. Continued ESG leadership, ESG has been at our core before the acronym ESG went mainstream, and we strive for continuous improvement in this area. In the third quarter, we achieved several milestones that demonstrate our continued commitment to ESG leadership. We created and funded the Brilliant Earth Foundation with $1 million to provide long-term support for non-profit organizations allied with social and environmental causes that we champion. One organization we've been proud to support is Pure Earth, which provides artisanal gold miners with training in mercury-free mining methods. We also introduced our new Fairmined Jewelry collection as part of our mission to support development efforts in artisanal gold mining cooperatives. We have significantly expanded the number of blockchain-enabled diamonds on our site to more than 10,000, and we continue to be a leading retailer of blockchain-enabled diamonds at scale, offering consumers a high level of transparency into the journey of their diamonds. Finally, we recently completed an audit of the recycled gold and silver content in our jewelry, which confirmed that over 90% of the metal content in our gold and silver jewelry is recycled. We're proud of this industry-leading accomplishment. On the corporate side, we successfully completed our IPO in September, which will be instrumental in providing future access to capital, attracting and retaining talent, and elevating the company's visibility and brand awareness. Overall, I am extremely proud of our passionate and dedicated team. We accomplished and exceeded many of our ambitious goals for the third quarter, and we are well positioned to drive many more successes in the fourth quarter and beyond. Now, I would like to turn the call over to Jeff to review our financials in more detail and introduce our outlook for 2021.

Thanks, Beth, and good morning, everyone. I'm also pleased to speak with you on our first earnings call as a public company. I'll begin my discussion with an overview of our business and proceed with a review of our third quarter results. Following this, I'll share our outlook for fiscal year 2021. Our digitally native, technology-driven business model has allowed us to grow rapidly, profitably, and in a capital-efficient manner. I'd like to highlight some of the key distinguishing characteristics of our business. First, consistent robust top-line growth. Our revenue has grown at a CAGR of more than 30% since 2016. Strong gross margins and adjusted EBITDA. Our business has had strong, consistent, and increasing gross margins. We generate positive net income, adjusted EBITDA, and operating cash flow, in contrast to many other rapidly growing direct-to-consumer companies. An inventory-light negative working capital model. We run our business in a capital-efficient manner. We are paid in full in advance of product fulfillment and typically before we pay our vendors. This combined with our inventory returns of more than 10 times allows us to operate with negative working capital and generate strong operating cash flow conversion. Compelling showroom economics. Our showrooms also drive transformative customer acquisition economics in the metros where we open them, as Beth mentioned. This strong top-line uplift is coupled with a very CapEx and OpEx efficient model to drive robust showroom economics. We believe our omnichannel model gives us the ability to achieve broad coverage of the US market with a footprint of fewer than 100 showrooms. Now turning to our results. We're pleased to report strong third quarter performance highlighted by significant growth in sales, gross profit margin, and adjusted EBITDA compared to the third quarter of fiscal 2020. I'll focus on adjusted non-GAAP measures of profitability and EPS in my remarks. For these adjusted measures that I referenced, you can find reconciliation tables to the most comparable GAAP figures in our earnings release. This can be found at the investor relations portion of our website @investors.brilliantearth.com. Our net sales for the third quarter increased 33% to $95.2 million from $71.4 million in the third quarter of 2020. We saw growth in both orders and AOB across our product categories, with an overall 30% increase in total orders compared to the third quarter of fiscal 2020. We also saw a 3% increase in average order value to $3,301 from $3,210 in the third quarter of 2020. Our differentiated premium brand continues to resonate with millennial and Gen Z shoppers, and our strategic investments in marketing have amplified our brand awareness and consumer demand during the quarter. Our omnichannel strategy is working. Our website and showrooms contributed to our strong third quarter sales growth. We saw outstanding growth across our products and our Fine Jewelry products, which are an emerging opportunity for us, grew over 100% year-over-year for the third quarter in a row. We expect these products will continue to contribute to top-line growth, repeat purchases, and gross margin accretion for the company in the future. Fine Jewelry, in addition to contributing to top-line growth, brings new customers to Brilliant Earth while also providing exciting new repeat shopping occasions for our existing customers. We have historically seen a high increase in repeat purchase behavior for customers that have either come into a showroom or purchased fine jewelry. As we continue to open new showrooms and grow Fine Jewelry, we expect that they will lead to additional increases in overall repeat purchases. We have seen a double-digit percentage increase in repeat purchase behavior at the 12-month mark for our most recent customer cohort compared to recent cohorts. This shows us the growing affinity of our customers to the Brilliant Earth brand. Moving on to gross margin. Gross margin expanded by more than 700 basis points to 50.4% compared to 43.2% in Q3, 2020. That expansion was across our products and was driven by our strong brand affinity and continuous optimization of our pricing engine. Our past customer affinity and our differentiated product design enable us to continue to improve our margins and command premium prices. Our pricing engine incorporates proprietary technology-enabled algorithms that allowed our team to continually test and refine pricing to optimize our revenue and gross margins. In the third quarter, we were able to drive better-than-expected gross margin expansion through these efforts. Additionally, as we scale, we expect to continue to drive procurement efficiencies across our supply chain, including ongoing optimization of our vendor mix. Our gross margin was not negatively impacted on a year-over-year basis by increased shipping costs in the third quarter, given that we use air freight for inventory shipping. All said, we drove better-than-expected gross margin in Q3 as everything came together incredibly well. While we expect gross margin to continue to expand in the future, we believe it is prudent not to plan for the same level of gross margin outperformance in Q4 that we saw in the third quarter, given the competitive sales environment that is typical during the holiday season. Now moving on to SG&A. SG&A increased to 40.1% of sales in Q3, 2021 compared to 30.1% in Q3, 2020; approximately 360 basis points of this increase was made up of add-backs to adjusted EBITDA from increased other G&A and employment expenses. These included new showroom pre-opening expenses, donations to fund the Brilliant Earth Foundation, equity-based compensation expenses, and costs in preparation for operations as a public company, all of which are added back in our presentation of adjusted EBITDA. The remainder of the increase in SG&A was principally driven by expenses to support the growth of our business. First, increased investments in marketing for brand awareness and to support strategic growth initiatives such as our expansion into Fine Jewelry. Our marketing remains efficient and we continually refine our marketing spend across diversified channels. We've also developed sophisticated analytics based on our consumer behavior to optimize our campaign. We had higher employment costs to support our operations as a public company. Showroom related employment costs also increased due to employment costs for new showrooms, which are still in the earlier stages of their ramp-up. It's worth noting that employment costs were unusually low in the third quarter of 2020 due to temporary COVID-related staffing changes. We saw increased other G&A costs to support our ongoing operations as a public company. Our adjusted EBITDA for the third quarter was $13.6 million, up 42% from an adjusted EBITDA of $9.5 million in Q3, 2020, an increase of $4 million. Our adjusted EBITDA margin was 14.2% in this quarter, improving from last year's adjusted EBITDA margin of 13.3%, driven by strong sales and gross margin expansion, which were partially offset by increases in SG&A, as I described earlier. Our adjusted net income was $8.5 million, representing an adjusted diluted EPS of $0.09 per diluted share, on $96.6 million diluted weighted average shares of common stock outstanding. Turning to the balance sheet, as of September 30, 2021, we had cash and cash equivalents of $161.1 million, which included proceeds from our IPO, compared to $66.3 million at the end of 2020. Our operating cash flow for the nine months ended September 30, 2021, was $33.8 million, compared to $15.2 million in the nine months ended September 30, 2020. Now moving on to our outlook. For fiscal year 2021, we expect net sales in the range of $366 million to $369 million, driven by growth across our products and the continued strength of our brand and omnichannel model. This represents an increase of over 45% compared to fiscal year 2020 revenue and an increase of more than 80% compared to fiscal year 2019 revenue. While we recognize the majority of the quarter remains ahead of us, we feel that we are strongly positioned for the holiday season. Our adjusted EBITDA for the year is expected in the range of $40.5 million to $42 million, which represents an adjusted EBITDA margin of approximately 11%. This reflects a full quarter run rate of public company operating costs that are part of our ongoing expense structure and therefore are not added back in adjusted EBITDA. We also plan to continue to invest in marketing to support the growth of our strategic initiatives. In summary, we're very pleased with our third quarter results and expect the ongoing execution of our strategy to enable us to continue our strong momentum in the final quarter of the year and into the future. Thanks. And I'll now turn the call back over to Beth.

As we look ahead, we are so excited about our business and expect our positive momentum to continue in the near and long-term. The holidays are an exciting and important time for us, and our team has done an incredible job preparing for the upcoming holiday surge. We have a robust supply chain with significant redundancy. We also have minimal exposure to geographies that are experiencing major supply chain disruptions. And with our new product assortment, gifting and omnichannel experiences, we believe that we are well poised to succeed and thrive during the holiday quarter. We are very happy with our financial and operational performance in the third quarter. We believe we can continue to build on our positive momentum in the fourth quarter and beyond. And now, I would like to turn the call over to the operator to begin the Q&A portion of the call.

Thank you. Our first question comes from Michael Binetti with Credit Suisse. Your line is open.

Hey guys, congrats on a great quarter. And very nice to have you on a public call here; look forward to the story as we go here. I think the first thing that jumps out is a bit of a model question for Jeff. Jeff, the 700 basis points of gross margin, if we look at that, as we learned about the company through the IPO process, we didn't hear about gross margin with a five handle on it in over the planning horizon, maybe longer term. But I know you said look, let's not get over our skis and we expect some promotions in the fourth quarter, but is the 50 plus gross margin in the third quarter something that you feel like we build on going forward into 2022 after we get past that holiday quarter that you gave, and I know you said, I'm sure you're rank ordering some of the inputs there, but I think when we talked, you thought over the next few years there's about 100 basis points of opportunity on the gross margin from the pricing optimization, it seems like you got more than that already here. So maybe just a little bit more thinking on what drove the 700 and what you think you might get back, or what’s a single point in time? And then aside from the gross margins maybe for Beth, I'm just curious on the Fine Jewelry, I know you're very excited about the category, I know it's a big opportunity for brands like yours; it's great to see that up over 100%. Maybe a little bit more what's working there, it sounds like the marketing is working well, but how much of it was from new SKUs versus SKUs that you already had in place, are they just getting better lift for marketing or anything like that? We’d love to hear a little bit more as it seems like a good opportunity for you guys?

Sure. Thanks, Michael. So I’ll take each of your questions. So in terms of what drove the gross margin, strongest gross margin performance in Q3, we described it as our one, the very strong customer affinity that we have that allows us to command premium prices. And then as you discuss the pricing engine that we have that incorporates proprietary technology-enabled algorithms, and is very dynamic and lets our team continually test and refine pricing to optimize both revenue and gross margin. I would describe Q3 as an outperformance, even against our expectations in terms of how well everything worked together on those levers. We do continue to see long-term upside in gross margin; we’d say that in the going forward period, not to expect necessarily the same high level of gross margin outperformance as we saw in Q3, as we don't want to assume the same, kind of, almost perfect set of circumstances that we saw in the quarter. But we do expect to continue delivering strong gross margins and do see long-term upside there. We, in terms of specifically on 2022, we're not yet providing guidance on 2022; we do expect to provide an outlook as part of our annual earnings call. But we do continue to see long-term upside potential in gross margin, but Q3 was a really perfect convergence of everything and outperformance in some way for us.

Thanks Jeff.

Hi, Michael. I just wanted to address your question on Fine Jewelry and thanks for the question. We were really excited to see the growth in the Fine Jewelry category and the continued growth of the category, as Jeff mentioned, it's been growing for many quarters now. In terms of what's working, I think there are several factors. One, I think the fact that we have such strong customer connections, and that loyalty to the brand, I think is really important here. We've mentioned in the past that the brand really resonates with the giver, the receiver, with all genders involved. Both of those genders are actually involved in the bridal purchase. I think that really, we see that she is really excited to receive a Brilliant Earth's product. And that helps to drive repeat overall. So we do see a lift in repeat. We also see new customers coming to us for that experience. I think that customer connection is just so important. The showrooms also help to drive that. We see increased repeat if you come into the showroom. As we build out our showrooms, that is going to be a bigger contributor. The second thing I would say is the product assortment, I think is really working across all levels, both new SKUs and existing SKUs. I think some of the new SKUs are pretty early in terms of the release. So, we're really excited to see how they perform over holiday, but I do think that the assortment is key. The data-driven design and our excellence in that area really position us very well. The third thing I think that's really important is the marketing and that the marketing efforts that we have are showing early promise in driving new customers as well as that repeat. I think we're seeing strength in all areas. The fact that we have that digital experience that we're improving over time and that new gifting experience is really positioning us well for the holiday. So, I know that there's a lot of factors there, but I think it's really essential that we're checking on all sides.

All right, we hear it. Thanks a lot.

Thank you. Our next question comes from Matthew Ross with JPMorgan. Your line is open.

Great. Thanks, and congrats on a really nice quarter.

Yes.

So, Beth, on your 35% revenue growth CAGR this quarter, and I think more than 30% implied guidance for the fourth quarter; how much would you attribute recent performance to an expanding industry TAM, given the accelerated penetration of digital and the Fine Jewelry market, as opposed to company-specific execution and market share gains? And what I know you've pointed out as a fragmented industry backdrop?

Thanks for the question. So what I would say is that really, I think there are a few different factors. You mentioned that e-commerce is experiencing fast growth; I think that really plays to our strengths as a digital-first company here. The fact that branded remains a really big opportunity; it’s the fastest-growing segment within Fine Jewelry and the jewelry industry, is important for us. We represent a strong premium brand that resonates with the younger consumer, which is instrumental to the growth, and has been in the past as well. The fact that we are small relative to that $300 billion market is really important. We're disruptors here and continue to gain share within this market, given that differentiated business model we talked about. Jewelry is also expanding; weddings are expected to have the highest levels that they've had in decades; I think that also has contributed to growth.

Great answer. Jeff, maybe as a follow-up. On your long-term EBITDA margin target of 15% to 20% plus; I guess two questions. Help us to think about linearity, multi-year beyond this year, on that margin target? And then how high is the plus on that 15% to 20% plus, in your view?

Thanks. And could I confirm on the first part of your question, were you asking about the linearity on the EBITDA target or another compound?

Yes. EBITDA target, just how best to think about it multi-year in terms of it being linear from the exit point of this year to the 15% to 20%, and then the 15% to 20% plus, what, how do you view the potential of the plus?

Yes, in terms of linearity, you know, it may be hard to project necessarily on a year-over-year basis. What I can say is that we do expect because there's upside potential, both in terms of growing gross margin with some of the factors that we've described, such as our premium brand positioning, the pricing engine, and other procurement efficiencies, as well as with SG&A leverage as we grow, which we expect to be able to drive leverage in the longer-term model in marketing as well as employee costs and other G&A. So I would say that while I can't necessarily speculate very precisely on the exact linearity, there is upside potential in the different layers, the different layers of our cost structure. And we're pleased with our strong performance and continue to see upside in the different areas of our costs. Could you repeat the second part of your question one more time?

So your long-term EBITDA margin target is 15% to 20% plus, how high could the plus be?

Yes, I would say that there is some meaningful upside to that; I can't necessarily point to a specific number, but I would say that our approach to modeling has been to be prudent in terms of how we think about our targets. We believe that the engines of margin growth we have all have delivered historically, and we think that there's potential as we grow all of our strategic initiatives to exceed that, but I can't point to a specific number.

That's great color. Best of luck.

Thank you. Our next question comes from Randy Konik with Jeffries. Your line is open.

Good morning, and thank you for the opportunity to ask my question. I would like to hear more about the pricing optimization engine. Specifically, can you explain how granular and dynamic this engine is? How does your team make use of it, and how frequently does it lead to changes? Additionally, do you expect that the insights gained from this engine will lead to more sustainable improvements in merchandise margins over time? Thank you.

Sure. Yes. So this includes price optimization engine. I can provide maybe just a bit of color. So this is something that we've developed in-house over many years; it's proprietary to us. It's very data-driven, relies on that continual input of data that we see in terms of product sales and consumer behavior, and it does cover many different products. To how dynamic and granular it is, it can get quite granular down to the product level, in terms of the level of precision that allows our teams to be making decisions. It's dynamic in terms of it's something that the team can look at on a daily basis to see different trends in products and how we should be adapting accordingly. It's a very powerful tool for us and a differentiator. We believe that it has led to structural improvements in our gross margin structure and we’ll continue to be able to drive long-term accretion to gross margin.

Super helpful. Thanks.

What I would add to that is one of the learnings that we have is because we have unique offerings. So you know, we've mentioned in the past that two-thirds of our products are proprietary to us in terms of that design. You think about offerings, like blockchain, for example, these are unique offerings to us, and I think that because of that, we're able to command that higher prices. That's something that we've learned over time, and that we've been able to adjust in a dynamic fashion.

Super helpful. And now I want to kind of go after it. So we think about the quarter. You know, a lot of it seems like the gross margin expansion is driven by this price optimization, and you didn't get a lot of benefit from fine jewelry. Next going up we're still in the early stage. So maybe give us some perspective on where is fine jewelry penetration right now? Where was it last year? And where do you think it sits in the next five years from now? Where can that penetration go? And then finally, just remind us the gross margin differential between fine and engagement tool. Thanks, guys.

We're not providing that particular metric, but what I can say is that it still remains relatively small, though we think that it's going to increase, certainly as we continue to improve our offering, and I think we're in the journey in that respect. Jeff, do you want to comment on the second part?

Yes, in regards to the gross margin potential. It's not something that I plan to break out in terms of product-level gross margins. We can say that this group product is definitely one that's accretive to our gross margins and higher than those for the business as a whole. Players in the space that are much more weighted towards fine jewelry have a lot of gross margin accretion potential as fine jewelry becomes a larger part of our business.

The other thing I would mention is we were really excited to see gross margin improvement across the categories, including fine jewelry, so it will be increases, gross margin increases. I think all of that is trending upward.

Thanks, guys.

Thank you.

Our next question comes from Oliver Chen with Cowen. Your line is open.

Hi, thank you. Beth, one of the distinguishing factors is ESG, obviously, as you think about the consumer and the younger as well as your broader consumer, which factors of sustainability and other efforts that you're making are really in demand from the customer and which ones that they appreciate most? And then Jeff and Beth, best on the lab-grown opportunity, do you have any thoughts around how that may impact AOB and/or margins over time and some key things we should monitor as it seems like also a big opportunity where Brilliant Earth is well-positioned? Thank you.

In terms of ESG, it's integral to our company; we're really founded based on these values, and that's the DNA of the company. In terms of which factors, I think that it's the holistic offering. The fact that our customers understand the importance to us and how integral it is to our company, to our offerings. The fact that we're continually messaging on it, whether it's the recycled content of our metals, or that new fairmine collection; it’s really top of mind for us. I think that comes across in a really authentic way, and our customers just know that we're doing work on their behalf and that we're a trusted ESG retailer for them. Sustainability is very important, but you need to have a complete offering. The fact that we have that design, that overall experience, both digital and in-showroom that's really joyful, all of those I believe work together in a seamless way. And I think all of that is important to the brand for the customer and that's really where we are. In terms of your second question on Lab, we don't disclose or talk about that specific metric and break down subcategories in that way, but what I can say is that overall we've seen expanding AOBs within engagement rings and that's really how we think about it as customers come to us for the engagement ring.

Okay. And then your free cash flow conversion rate is really outstanding as well. As you're extending to find and maximize LTV as well as think more holistically about your offering. What do you think about the inventory management on that side of the business and how you'll pursue it? And any things we should think about on a longer-term basis with working capital? Thank you.

Yes. So I can talk to that thing. Our free cash flow conversion in our negative silicon capital model are definitely differentiators for us as a business. We combine a few different factors, such as getting paid in full from our customers before we fulfill, keeping a light inventory, and typically getting paid before we pay our vendors. So it's definitely a powerful tool for us. We believe we will continue to operate in a very working capital-efficient manner. We continue to introduce new products; we’re able to do this in a very data-driven way. We don't need to bring on a lot of inventory to stock, hundreds of thousands of stores; we're able to test and iterate very efficiently. Our relationships with our suppliers and our differentiated ability to produce in a quick-turnaround fashion allow us to develop and produce in an agile and inventory-light manner. We continue to expect to operate in a very working capital-efficient model.

Thank you. Best regards.

Thanks.

Our next question comes from Ed Yruma with KeyBanc. Your line is open.

Hey, good morning, guys, and congrats on the IPO. First, a quick question around inflation. I know you guys don't carry the same balance sheet risks that a traditional jeweler might have, but talk about if gold prices start to move, and we noted that raw diamond prices started to move inside of the first quarter, what's the implications for margins? Did you benefit from that in the quarter and how do you think about that if we do see this inflationary pressures longer term? And then as a follow-up on the fashion jewelry side, any insight into how the marketplace is doing, specifically to Corey? Thank you.

Great. I can take that. And maybe I'll start with the second one. So, in terms of our to Corey partnership, we're really pleased with the performance there. It shows that we’re a destination for the younger consumer. Having a curated offering where we collaborate with other brands, and we’re selected; we think the fact that we had that IPO really increases our visibility. We're going to have increased opportunities there, but that collection has been performing well. We're excited about future opportunities there, both with to Corey and other partners. In terms of the first part, I think that as it relates to gold pricing and diamonds, the real beauty is just the fact that we're able to adjust dynamically our prices. As we see the gold pricing, increasing and decreasing, and keep in mind, we also offer platinum. There are a lot of dynamics in play there. We are able to adjust, and that pricing engine is really powerful. In the past, we've maintained our margins, even in the face of increasing costs, and our margins continued to expand even as gold prices increased.

Great. Thanks so much.

Thank you. Our next question comes from Erinn Murphy with Piper Sandler. Your line is open.

Great. Thank you. Good morning. Beth, my question is for you around the iOS privacy changes, a lot of DTC brands have seen challenges over the last six months. Can you just drill down on that topic? How are you navigating this for Brilliant Earth? And then have you seen any erosion in advertising metrics as far as a result?

Great. The marketing increase that we had was intentional; it was part of our overall strategy, and our digital marketing efforts continue to remain efficient. There are a few points that are worth mentioning. First, organic referrals and word of mouth for us are strong contributors to deriving new customers; two-thirds of our customers are influenced by word of mouth, which I think is an important factor. Second, the approach we have to digital advertising is diversified; it's multi-channel and not overly concentrated in any specific channels such as Facebook. That has served us well in the face of the changes that have happened. Third, we do have a very data-driven, fanatic approach and we're continually refining and optimizing across our digital channels, because jewelry is a very considered purchase. Many years ago, we've developed capabilities to be able to optimize across multiple actions along the customer journey. That approach has really been robust against the changes in the digital landscape, including some of the recent privacy changes that you mentioned with Apple. Finally, the way we think about it is really have a strong opportunity to strategically invest in marketing to build brand awareness and support the brand momentum we've seen, as well as future growth initiatives, including Fine Jewelry. So the bottom line is, I think that we have a really robust offering in light of those changes.

Great. That's super helpful. Thank you. And then maybe just a different take on gross margin, Jeff for you. I guess, historically, if we look back at the model, Q4 has been a higher gross margin quarter on a linear basis versus Q3. Is there anything different about this fourth quarter that would prevent that from being the case?

Yes. I would say that with respect to Q4, I think that there are competitive holiday dynamics in play. I would probably think about it that we did have a very strong outperformance in Q3, with the convergence of many factors coming together ideally. Going into Q4, we may not have that same convergence of perfect factors, and there are competitive holiday dynamics. We do expect to have strong gross margin performance in Q4, and our dynamic engine will allow us to continue to adapt to that environment that we see in the holiday. We expect to maintain our premium pricing, but there's less potential for margin expansion in the holiday season.

Okay. So still looking for expansion year-on-year, but potentially not to the level that would get it towards that 50% plus. Is that am I interpreting or kind of thought process correctly?

Yes. I think that we would expect to deliver kind of, similar better gross margin than we have historically in Q4, but unlike the not necessarily the same level of outperformance as we saw in Q3.

Thank you.

Thank you. Our last question comes from Telsey with Telsey Advisory Group. Your line is open.

Good morning, everyone, and congratulations on the nice results. As you think about some of the partnerships you've engaged with recently like Tacori, how is that performing? Should we see more partnerships like that as you move forward? And then on the new showrooms that have been opening. Any difference in the results that you've seen from prior showrooms? And given the availability of real estate, does anything change in terms of number of new showrooms expected to open? Thank you.

Great. I'll start with the first part of the question. In terms of the partnerships with Tacori, as I mentioned, I think that it performed really well. I think it's proven itself that it's a nice aspect to our model. We do believe that there is room to add additional partnerships, as well as to expand that Tacori partnership. So look for more in the future there. In terms of the showrooms, as you mentioned on the call, we continue to have strong conviction in our omnichannel model. We are really encouraged by the recent performance with our newest launches, and certainly excited to have those new team members in those locations as well. Jeff has mentioned in his remarks that we expect to reach under 100 showrooms that provides really nice U.S. coverage. We do expect to reach out over the next several years. Nothing has really changed there; in the near term, we feel confident about the robust pipeline that we've developed across many different Metro markets. The strength of the brand, the increased brand visibility we've had has really been beneficial in influencing some of the compelling real estate opportunities that we're seeing, which are increasingly available to us. We have an attractive demographic for some of these centers, and as we continue to look at various retail formats, I think that also helps to complement the offering.

Thank you.

Thank you. And I'm currently showing no questions at this time, I'd like to turn the call back over to Beth Gerstein for closing remarks.

Great. So thank you, everyone, for taking the time to speak with us. We are very excited; we have completed such a successful quarter. Our first as a newly public company, and we're excited about the elevated platform we have now to continue modernizing and transforming the Jewelry Industry, pursuing our mission and being the fine jeweler of choice for millennial and Gen Z Jewelry consumers. I wish each of you a happy holiday and New Year, and look forward to speaking with many of you at upcoming Investor Meetings, including the JPM Conference on November 15th.

This concludes today's conference call. Thank you for participating. You may now disconnect.