Greetings and welcome to The Lovesac Q1 Fiscal 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. 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 filing 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 measures 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.

Thank you, Rachel. Good morning, everyone, and thank you for being with us today. I will start today’s call by highlighting our financial performance for the first quarter, after which I'll touch on the long-term opportunities we see for our brand, including shop-in-shop possibilities and the tariffs currently affecting us. Following that, Jack Krause, our President and COO, will discuss our key growth initiatives with more specific metrics and details about these areas of our business. Finally, Donna Dellomo, our CFO, will go through our financial results and our outlook in more detail. We had a strong start to the year and are pleased with our financial results for the first quarter. Net sales rose by 53% to $41 million. Total comparable sales, which includes same showroom and internet sales, increased by 43.5%, driven by a 31.7% showroom comp increase and significant internet business growth of 85.3%. In Q1, our comp growth was driven by both more transactions and higher ticket amounts as our digital marketing strategies and multi-channel approach successfully attracted new customers while encouraging repeat purchases. Adjusted EBITDA exceeded expectations with a loss of $4.7 million for the first quarter compared to a loss of $4.2 million in the same period last year. Operationally, we made good progress on our strategic initiatives focused on traditional, digital, and social marketing; investing in our infrastructure; expanding our showroom presence; and increasing our shop-in-shop footprint. We are encouraged by the effectiveness of our marketing efforts in Q1, achieving over 53% total sales growth while marketing spend rose only 22% from last year. We anticipate making our largest marketing investments in Q4, given the proven efficiency during that quarter and our expectation that the advertising and conversion tests we are currently running can be scaled up by then. While we wish for consistent sales trends throughout the year, Lovesac traditionally sees its strongest growth and profitability in the fourth quarter, and we expect this pattern to continue. This seasonal trend can be attributed to four unique characteristics of our business and category. First, we operate over 80 Lovesac showrooms mostly located in high-traffic shopping malls across the U.S. As foot traffic peaks in late November, so do visits from new customers and overall sales. Second, Sacs are popular gifts during the holidays, whether parents are purchasing for their children or families looking for a large gift for their entertainment spaces, leading to significant holiday sales for us. Third, January is a well-known month for home decorating, and with our fiscal year ending in January, Sactional sales peak during this time. Finally, we've learned from testing our TV and digital advertising during two holiday seasons in selected markets that our ad spend efficiency is higher in the fourth quarter. Given this context, we are very pleased with our Q1 performance and feel confident about our annual guidance of 40% to 45% revenue growth, which we are reaffirming today. Regarding adjusted EBITDA, we are actively working to address the impact of the 25% tariffs on our business. We are confident in our ability to achieve high sales growth this fiscal year while maintaining a positive adjusted EBITDA. Although we expect some temporary impact on gross margins due to tariffs, we remain committed to achieving a positive adjusted EBITDA and will be strategic and innovative in managing our operations during this growth phase. We are improving product costs and margins and continuously seeking ways to refine our merchandising, pricing, and operational efficiencies. Once tariffs are lifted, we believe Lovesac will be an even more robust and efficient business. I want to take a moment to outline the steps we are taking to manage the challenges posed by tariffs in the short term, as well as our longer-term vision for efficiency, reliability, and sustainability in our manufacturing and logistics. We are completely focused on the long-term potential for Lovesac, which we believe is much greater than many may realize, and we make our decisions with that long-term perspective. Simply put, the tariffs on Chinese goods represent a short-term obstacle for us. We are on course to exit China as a manufacturing option nearly entirely within the next 18 months, or until tariffs are rescinded. We would prefer to have the tariffs suspended to maintain the efficiency of our Chinese supply chain, which supports our growth. Our phased exit from China is prioritized, with the remaining parts of our supply chain transitioning to Vietnam expected to conclude by the next fiscal year, assuming tariffs are lifted by that time. Sactionals covers account for about 40% of our total sales. We plan to source half of Sactionals from Vietnam by the end of this year, and we are close to achieving that goal. Currently, we work with three manufacturers for Sactionals: two in China and one in Vietnam. The Vietnam facility has greater capacity than the two in China, with no quality difference. Additionally, Sactionals manufactured in Vietnam are slightly less expensive and not subject to the tariffs. Our two Chinese Sactionals partners are actively seeking to establish facilities outside China, with one expected to be operational by late spring 2020. We are confident in our ability to circumvent the Chinese tariffs, even if they persist. It’s also important to highlight that we have sufficient cash reserves to weather any challenges. The remaining 40% of our Chinese manufacturing primarily involves cut-and-sew operations for Sacs, Sactionals covers, and a few wooden accessories. We are already in discussions with cut-and-sew and wood accessory manufacturers outside China to create products of similar quality. Our largest Chinese supplier, who produces both Sactionals and cut-and-sew items for us, is the one opening the Vietnamese facility for us next year, which will produce both types of products at competitive costs. We are fully confident in our ability to mitigate any long-term effects of these tariffs. In the interim, we are making strategic moves to maintain our positive adjusted EBITDA as we grow rapidly while facing these tariff challenges. We have negotiated further discounts and rebates from our existing vendors in China to counteract the impact of the tariffs on our gross margins, and we have made substantial progress in this area. Needless to say, these vendors are eager to retain our business long-term and are willing to share some of the burden. However, this alone is not enough to completely shield our gross margin from the impact. Aside from our efforts in Asia over the next 18 months, we are also implementing several operational changes to minimize the tariffs' effects on our bottom line. Jack will elaborate on these specifics, but in simple terms, we can adjust pricing on certain types of covers and accessories in ways that customers are largely unaware of. So far, our trials of these adjustments have shown no significant impact on sales. This aspect of our business allows us to maintain the core product pricing while carefully adjusting pricing on covers and ancillary items with minimal consumer impact. We are also increasing sales of higher-margin products through strategic merchandising in our showrooms, changing packaging for shipping to reduce freight costs and improve customer satisfaction, and tightening our budgets on various HQ staffing and spending, all while expanding our infrastructure to support ongoing growth. We are committed to running a financially responsible operation and fulfilling our key annual objectives despite the headwinds we are encountering. Sacs are manufactured in America and are becoming an increasingly important part of our business. As mentioned in the previous call, we plan to open a light manufacturing facility in Utah by year-end to enhance redundancy and efficiency for our flagship product. These plans are on track and within budget. All custom covers for Sacs and Sactionals, which make up about 10% of our cover demand, are produced at a third-party site in Los Angeles. This aspect of the business remains largely unaffected by tariffs. Looking forward, we envision a unique long-term supply chain for Lovesac that differentiates us from the typical globalized supply chain model used by most large product companies. This perspective is essential for long-term investors to understand. We are aware that we operate in a massive and crucial sector, with upholstered seating representing over $30 billion annually. We believe we produce the best options in this category—a washable, adaptable, durable product designed to last, consisting of just two components: seats and sides. We envision that Sactionals, in its current state, should become a staple in American households, as it can cater to any budget depending on the cover or upgrades chosen, and can be acquired piece-by-piece, allowing even modest households to appreciate its value. As we capture a meaningful market share in this vast category, in which we currently hold less than 1%, we aim to create a significant machine to drive repeat purchases and brand loyalty. Currently, 38% of our transactions come from repeat customers, largely from subsequent sectional piece purchases or new cover sets and Sactionals upgrades. With the ongoing innovations in the Sactionals platform, we believe it will become even more appealing to new customers and delightful for existing ones, who appreciate new upgrade options they might not have envisioned when first purchasing the product. As a direct-to-consumer brand, we maintain strong relationships with our customers, who appreciate our dedication to their satisfaction and sustainability. We also possess their data, allowing us to effectively market to them over time. The implication is this: we may produce and sell these two SKUs in their current forms for many years, alongside additional products, but for the core components of Sactionals that make up the bulk of our sales, we are determined to establish the most efficient manufacturing and supply chain possible going forward. The simplicity and uniformity of the product provides a significant competitive edge. Efficiency will be derived not only from materials and assembly but also from geography and logistics, provided we reach a mass audience and scale. Without delving into the details of our vision—of which we are already deep into research—that is the rationale behind our plans to ideally penetrate every household in the U.S. and eventually worldwide with this versatile, beautiful couch, and afterward establish a supply chain capable of supporting such ongoing demand and uniformity. The outcome will not only maximize our business efficiency but also enhance sustainability while ensuring maximum customer satisfaction and prompt delivery. We have ambitious goals at Lovesac; we're not just here to sell more couches, but we also aim to redefine this stagnant category by doing business differently and capturing market share through our growing brand strength, exceptional utility, and unique value proposition for consumers. We believe our brand awareness will improve as we mature and expand through marketing efforts and gaining broader acceptance, which is currently limited as we only have minimal brand recognition. We recognize that we have a journey ahead. In summary, not only are these Chinese tariffs a temporary inconvenience for us, but I also hope that the ineffective globalized business model is a short-term reality we can move beyond. Our platform-based approach to product development is what will propel us toward a more efficient, sustainable, and profitable business model in the future, which we are confident consumers will appreciate. Before I hand over the call to Jack, I want to express my gratitude to all of our team members at HQ and in our showrooms for their hard work and commitment every day. Our extended Lovesac Family plays a crucial role in fostering customer loyalty and satisfaction, contributing to our impressive Q1 results. I will now turn the call over to Jack, President and COO, to discuss our key priorities for the remainder of this year.

Good morning everyone. We are very pleased with our first-quarter results and the ongoing momentum of our business at the start of the year. Since we spoke just a few weeks ago during our year-end call, I will keep my comments brief. We are on track with executing our strategic priorities and plans for the rest of the year, starting with expanding our marketing efforts to increase brand awareness and drive sales. The top-line results from the first quarter demonstrate the effectiveness of our marketing strategies, which include a comparable sales growth of 85.2% for our e-commerce business and 31.7% for showrooms. Although we aren’t providing quarterly updates on our customer lifetime value to customer acquisition cost ratio, we anticipate that customer lifetime value will continue to exceed customer acquisition cost as we intensify our marketing efforts and attract new customers this year. In fiscal 2019, we ended with a customer lifetime value to customer acquisition cost ratio of 5x. In Q1, we saw a 59% increase in new Sactional customers and 38.9% of transactions were from repeat customers, both indicators of our marketing's effectiveness and the business's health. We achieved strong returns on our marketing initiatives in Q1, including a national advertising campaign leading up to Presidents Day and pre-Memorial Day campaigns. This effort was complemented by digital advertising that increased our search, social, and remarketing spends to capture interest from consumers who saw our TV ads. We revised our advertising strategy to include more 15-second spots in our TV campaigns and are seeing benefits from our national TV transition that began during Labor Day of 2018. In Q1, we expanded our TV presence by adding additional weeks before the Memorial Day campaign in four DMAs, and due to the positive response, we plan to extend our media presence in 10 to 12 markets before Labor Day, while also testing marketing flights before the July 4th holiday. We see further growth opportunities within social marketing, aiming to enhance our Lovesac community and maintain relevance with our customers. Our initiatives in social media include expanding our presence on Pinterest and targeting niche markets such as eco-friendly pet owners and parents, all while optimizing our marketing strategies to leverage increased advertising exposure. Overall, we're encouraged by the efficiency of our marketing in Q1, achieving over 53% total sales growth with a marketing spend that only increased by 22% year-over-year. We plan to ramp up our marketing efforts in the second half of the year, especially in the fourth quarter, where we expect the successful tests we're currently executing to be applied on a broader scale in Q3 and Q4. Next, we continue to invest in our infrastructure and capabilities, particularly in technology and supply chain enhancements. Our technology and infrastructure improvements in showrooms made last year are yielding positive results, and the first phase of our data warehouse implementation is effective, aiding in our trade area model. The Lovesac app for both iOS and Android is also proving beneficial for customers during the purchasing process, with features that allow for custom Sactional designs and detailed visualization of products in a room. We're pleased that the app continues to generate sales and noted high engagement rates, with an email open rate of 71% and an average order value of $7,800. We plan to enhance the mobile app and launch the upgraded version in Q2. As part of our technology, supply chain, and customer service investments, we have begun reconceptualizing our showrooms with new technologies, including a podium SMS platform which allows associates to request Google Reviews, thereby enhancing our search ranking and communication with showroom customers. Over the past year, we have also re-evaluated our logistics capabilities and are pleased to report significant improvements. Year-to-date, we have increased our in-stock rate of quick ship items from 86% to 97%, enhancing product availability for quick delivery. We've also improved shipment accuracy from 99.5% to 99.8%. This is particularly important for Sactional orders that often have many components. Furthermore, our distribution capacity has expanded by 400% over the last year, supporting our growth by adding warehouses and processing labor. Supplier reliability has increased as well, from 69% to 97% in on-time order fulfillment over the past three quarters. Another key aspect of our strategy is expanding and enhancing our showroom presence. As we open new showrooms, our physical footprint supports increased brand awareness, addressing current low levels of visibility. In the first quarter, we opened five new showrooms, bringing our total to 78 across 30 states in high-traffic areas. We are on track to open between 17 and 20 new showrooms in fiscal 2020, which reflects our operational excellence and improved brand presence with landlords. We updated three showrooms in Q1 to a new experiential design, meaning 84% of our total showrooms have been updated. We will continue to invest in our showrooms to enhance the shopping experience and to implement tools for gathering customer feedback. Recently, we launched a pilot for an omni-channel trade area approach, engaging customers through a channel-agnostic manner. This strategy rewards associates based on transactions within their trade area, independent of where customers finalize their purchases, which is crucial for delivering a top-tier customer experience despite the challenges associated with brand expansion. The product teams are enthusiastic about this new approach, and we plan to roll it out to all showrooms in the latter half of the year. In Q1 of fiscal 2020, we operated 159 shop-in-shops with Costco, an increase from 120 in the same quarter last year, contributing to a 52.5% rise in our other channel sales, reaching $5.6 million. Additionally, productivity in shop-in-shops improved by 17% this quarter in terms of sales per shop period. We believe that the shop-in-shop format effectively enhances customer acquisition in high-traffic locales, allowing us to showcase a limited selection of our products where we lack physical showrooms. We remain committed to expanding our shop-in-shop presence throughout fiscal 2020. To summarize, we are very satisfied with our first-quarter results and the operational advancements made on our strategic initiatives. Looking ahead, we will continue to focus on business growth and strategic investments in our technology and infrastructure to set the stage for long-term success. Finally, regarding the recent tariff increase, we are ramping up our mitigation efforts, but at this time, we do not have an updated view on the gross margin impact of tariffs for the year. Nonetheless, we remain confident in delivering 40% to 45% sales growth and achieving a positive adjusted EBITDA.

Thank you, Jack. Good afternoon, everyone. I will start with a review of our first quarter results and share our thoughts for fiscal 2020. Net sales grew 53% to $41 million from $26.8 million in the previous year’s quarter. This growth came from strong performance in showrooms, online sales, and shop-in-shop formats, along with an increase in new customers and the total number of units sold, indicating a higher average order volume per customer. Our investments in advertising and marketing, which enhance brand awareness and the number of showrooms, also contributed to our Q1 sales success. Comparable sales, which include showroom and online sales, rose 43.5%. Comparable showroom sales increased 31.7%, marking our tenth consecutive quarter of positive showroom sales growth. Internet sales surged 85.3%, compared to 49.6% growth in the same period last year. During the first quarter, we opened five new showrooms, remodeled three existing locations into our new showroom format, and closed two showrooms, ending the quarter with a total of 78 showrooms. In terms of sales by channel, showroom sales increased 45.2% to $26.9 million, internet sales rose 85.3% to $8.5 million, and our other channel, which includes shop-in-shops and Costco locations, grew 52.5% to $5.6 million. By product category, sales of Sactionals increased 65.4%, Sacs sales grew by 10.1%, and our other category, which includes decorative pillows, blankets, and other accessories, rose 42.8% compared to the prior year quarter. Gross profit dollars grew 43.3% to $21 million in the first quarter. As anticipated, gross margin percentage fell by 340 basis points to 51.3% from 54.7% in the same period last year, mainly due to 10% tariffs, although this was partly offset by reduced costs for our Sactionals and Sacs, mainly from sourcing changes for our Lovesoft and down blend fills. For the first quarter, total SG&A, excluding advertising and marketing expenses, increased by 57% to $23.9 million from $15.2 million in the same quarter last year. After excluding $150,000 in non-recurring expenses related to Board and Executive recruitment, total SG&A stood at $23.7 million, reflecting a significant rise. The increase was primarily due to a $2.1 million rise in employment costs, $500,000 additional rent from opening five new showrooms, and $2 million from increased sales expenses, including $200,000 in credit card fees, $1.1 million for showroom and web-related selling expenses, $200,000 for web affiliate program and hosting commissions, and $500,000 for shop-in-shop sales agent fees. Additionally, overhead expenditures rose by $1.2 million to support initiatives related to infrastructure and public company costs. Stock-based compensation also increased by $2.9 million in the first quarter due to accelerated vesting. As a percentage of sales, total SG&A expense rose by 150 basis points, primarily from increased infrastructure investments, stock compensation, and public company expenses. Our advertising and marketing investments, which have long-term benefits, increased by $1 million, or 22.3% over the previous year's first quarter. We leveraged advertising and marketing expenses by 330 basis points this quarter due to a shift in the timing of media investments to later periods this fiscal year, national media buys, and the introduction of 15-second spots in our TV advertising. We plan to reinvest these savings into marketing in the second half of the year. As mentioned before, advertising and marketing investments are a key focus for us, given our low brand awareness and the attractive financial returns from this expenditure, as illustrated by the customer lifetime value to customer acquisition cost metrics we discussed earlier. We will maintain a focus on advertising and marketing with an expected annual spend of 10% to 12% of net sales. Year-over-year fluctuations in our advertising and marketing spending can be substantial as we adapt to the compelling opportunities for customer acquisition. Depreciation and amortization rose by $400,000 from the prior year to $1.1 million, mainly due to capital investments in new and remodeled showrooms. Our operating loss was $9.3 million, compared to a loss of $5.6 million in the first quarter of last year. Excluding $150,000 in non-recurring board recruitment expenses for fiscal 2020 and $216,000 in financing-related non-recurring expenses from fiscal 2019, the operating loss was $9.1 million for the first quarter of fiscal 2020, compared to $5.4 million in the prior year quarter. Net interest income was $235,000, reflecting $243,000 from net proceeds of our initial public offering, partially offset by immaterial interest expenses related to unused line fees on our company line of credit for the 13 weeks ending on May 5, 2020. Tax expense in both the first quarters of fiscal 2020 and 2019 was less than $20,000, related to minimum state income tax liabilities. Before discussing net income, loss per share, and EBITDA, I want to note that my comments will focus on net loss and net loss per share adjusted for IPO and other financing costs, as well as adjusted EBITDA. Please see our earnings release issued earlier for terminology and reconciliations between our adjusted metrics and their closest GAAP counterparts. The adjusted net loss for the first quarter of fiscal 2020 was $9.1 million, up from $5.5 million in the first quarter of 2019. The adjusted net loss per share, accounting for IPO and financing costs, was $0.67 for the first quarter of fiscal 2020, compared to $0.41 in the same quarter of 2019. Adjusted EBITDA was a loss of $4.7 million for Q1 fiscal 2020, compared to a loss of $4.2 million in the first quarter of last year, with the fiscal 2020 first quarter affected by expenses related to being a public company and infrastructure investments not present in the previous year's first quarter. Turning to our balance sheet, we ended the quarter with $35.7 million in cash and cash equivalents. Ending inventory grew 123% year-over-year, driven by increased investment in inventory to support sales across all channels and to enhance the success of our advertising and marketing efforts, as well as higher capitalized freight and warehousing costs due to increased inventory and tariff expenses. While we are not providing formal guidance, I want to share a few insights for fiscal 2020. In terms of showrooms, we plan to open 17 to 20 new locations and remodel eight this fiscal year. Regarding shop-in-shops, we intend to operate approximately 690 pop-up locations this year, up from 553 last year, with over 75% of these occurring in the first three quarters of fiscal 2020. We expect strong sales growth levels, although with a moderation compared to 2019, projecting sales growth between 40% to 45% for the full fiscal year. We are still assessing the financial impact of the tariff increase to 25%, and will provide updates in our next call, but we are confident in our ability to generate positive adjusted EBITDA this fiscal year. We anticipate lower gross margin for fiscal 2020 compared to fiscal 2019, primarily due to the anticipated 10% tariff pressure, which is being countered by margin and SG&A initiatives; the increased tariff pressures from the recent additional 25% tariffs; and investments in our distribution infrastructure to support future growth; a slight headwind from ongoing shifts in our product mix toward Sactionals; and minor impacts from a greater proportion of shop-in-shop channel sales. These declines are partially offset by product margin improvements related to changes in discounting and promotional strategies, as well as reduced product costs from vendor sourcing changes. For Q2 fiscal 2020, we expect gross margin declines of around 320 to 340 basis points from the same quarter last year, driven by similar factors, except for the impact of the 25% tariff, which is expected to influence our gross margin later in Q3 fiscal 2020. For SG&A excluding advertising and marketing expenses, we anticipate the most substantial leverage in Q4, given the seasonality of our business. Our SG&A outlook embodies all investments in areas such as personnel, processes, and infrastructure, with Q4 sales volumes allowing us to leverage these investments from the prior year. We will continue to strategically invest in advertising and marketing in fiscal 2020, anticipating a spend of 10% to 12% of net sales, due to the attractive returns on these investments. In conclusion, while we expect quarterly variances due to the timing of our tariff mitigation strategies, our advertising and marketing investments, and overall business investments to harness substantial growth opportunities, we project high sales growth and aim for a positive adjusted EBITDA in fiscal 2020. Lastly, regarding capital expenditures, we expect to spend about $13 million in fiscal 2020, primarily on the opening of 17 to 20 showrooms, remodeling around eight legacy stores, and approximately $2.8 million for a company-operated Sacs manufacturing facility. Additional expenditures will focus on technology for showrooms, inventory management, enhanced logistics systems, improvements to our e-commerce platform, and upgrading headquarters data and support systems. For more details on our results, please refer to our earnings press release.

At this time, we’ll be conducting a question-and-answer session. Our first question comes from the line of David King with Roth Capital. Please proceed with your question.

Thanks. Hi, everyone. 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, anniversarying the start of national TV?

Yes, that's a good question, but I can't provide detailed answers because Memorial Day occurs in Q2. I don't believe we are seeing any unexpected outcomes compared to our expectations. We are still analyzing the Memorial Day period as we continue to evaluate the returns. The analysis is not yet complete, but I can share some insights.

Okay, fair enough.

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 three weeks at a fairly robust increase in GRPs and we were seeing increasing lift, and we’re continuing to expand to the 12 markets prior to Labor Day. 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 literally right now where we run three to four weeks prior to what we call our major tent pole event, so the Memorial Day, Labor Day holiday et cetera. We took three markets and extended it from three to four weeks to six to seven 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 the mix of some of our sort of average markets. And based on what we see there, we will either expand nationally or expand to those 12 markets again during the fourth quarter.

Okay. And then, maybe trying to 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 continued 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 at the beginning of the second quarter, we don't want to share it.

Okay. And 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 is Burrow, just what are you thinking about what's out there from others at this point, your ability to continue take share, do you worry about them at all? Just some thoughts will be great.

Yes. I think that we continue to see new entrants in both the couch and Sac categories, albeit relatively slow compared to other categories in a direct consumer market that we witness whether it be fashion or mattresses. We are very focused on just sort of doing our thing. We are 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 issued. But we also have some long-established patents that we continue to defend and we'll continue to defend against the life of those that infringe upon them. But more importantly, I think we're confident in our business model. It's one thing to make something and put it in a box; it's another thing to build a platform like we have around Sactionals that drives true repeat customer value as well as has a path for 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 mode we have around Sactionals is 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 kinds of things. And 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. Please proceed with your question.

Hi. Thank you. Good afternoon, everyone. 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 products 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, we haven't provided specific guidance on the savings we are seeing in Vietnam. However, we can say that product costs are lower there compared to China. The margin difference is not huge, but it is beneficial for our business. It took some time to get everything in place because the sampling and product development process for Sactionals is complex and requires several rounds with new vendors to ensure they are vetted before moving to mass manufacturing. We are now in a good position with at least one supplier for Sactionals. Looking ahead, we expect to purchase items at lower costs in Vietnam, although we also anticipate inflation there. Having been involved in business in Asia for nearly 20 years, and with my experience living in the region and speaking Mandarin, I feel comfortable navigating the challenges posed by tariffs while sourcing in Asia. I do expect some inflation in Vietnam as more manufacturing relocates there, but the country's economies of scale are improving its infrastructure, balancing the situation. We aim to maintain high gross margins on our products, and we are confident in our ability to achieve this. Vietnam is just one part of our strategy to maintain these margins, and we have a long-term perspective on managing our supply chain to keep high gross margins in our business.

Assuming that the tariffs at 25% remain in place next year, you indicated that by the end of next year, you will completely exit China if necessary. Does this mean that as we transition into fiscal '22, it could be a year of margin recovery, since you won't face the tariff pressures anymore?

Yes, that's correct. I mean, aside from any inflation affecting the global market or specifically Vietnam. However, we are exploring options beyond just Vietnam as well. We are currently considering a variety of alternatives. We hope that tariffs will reduce, as China has a robust infrastructure that can help us scale. We're open-minded about this situation. While we wish we were further along, we feel we're making good progress, and we believe this will not negatively affect our business in the long term.

To add to that, over a 24-month period, we will have a supply chain that meets our delivery needs concerning tariffs. We are continuously exploring merchandising strategies and tier pricing changes in promotions to enhance our margins. After the next 24 months, we expect significant improvements in supply chain efficiency, which will provide us with notable benefits regarding cost and efficiency in the long run.

Great. It sounds like the long run margin structures 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 saw great results. How do you answer the question, and it's one that we get often about how you cycle 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 great question. There are several factors at play. One is the size of our showroom fleet and the number of touchpoints we have. I mentioned earlier that having a showroom makes an area 600% more efficient compared to one without. As we expand our showrooms, we naturally increase our efficiency in new markets. Moreover, we're continuously learning from our testing. We've talked about our tests each quarter, and last quarter we introduced 15-second commercials, which now account for about 30% of our advertising mix. The savings we gain from this approach are reinvested into other areas, allowing us to increase our spending rather than reduce it. Additionally, as we noted today, we're achieving very positive results by extending our media runs in major markets. I expect that the savings from the 15-second spots will be redirected into a larger number of gross rating points in the fourth quarter. Currently, we have a strong focus on learning and efficiency from our showrooms, which we believe will align with the increasing comparisons as we progress.

Could you remind me, Jack, about the testing you did in the San Francisco market, which showed multiple years of consistently high growth?

Yes. We have new cohorts in place. In San Francisco, we have experienced strong growth levels over the past 18 months, which started earlier than in many other markets. We continue to see significant growth in San Francisco. Despite year-over-year growth reaching three digits, awareness levels remain low, with less than 3% awareness. This indicates substantial opportunities for the brand moving forward.

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

Great, thanks for taking my questions. I had one on marketing spending philosophy and then one on urban showrooms. So, first on marketing spending philosophy. I think you indicated that the lifetime value of a customer versus the customer acquisition cost ratio is 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.

We are pleased with the improvements in our supply chain, which boost our confidence in our operational excellence regarding supply chain management and showroom openings. We will keep exploring ways to enhance our marketing efforts and drive revenue growth. While I’m not providing specific guidance, we are committed to investing in marketing based on our testing results. We are not rigid in adhering to the current marketing spend rate of 10% to 12% of sales; rather, we will strive to improve our efficiency and dedication. Additionally, we recognize that some media strategies may have a lower return on investment but offer better scalability, resulting in higher revenue growth. We are open to adjusting our approach to achieve overall revenue growth, provided that our system meets customer expectations.

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 three urban locations, you recently added one in Philly. Are the urban showrooms materially different than your suburban showroom locations and are you seeing a difference or perhaps a bigger halo effect for sales in other markets and opened ones?

Yes, we are. Generally, we find that higher population density impacts our trading areas differently than a typical specialty retail model. In our case, the effectiveness of the trading areas is determined by the time it takes to navigate through a showroom rather than the number of stores. Typically, our trading areas have a radius of 30 to 40 minutes. In places like New York City, one showroom can cover an entire trading area or two or three showrooms can serve northern Manhattan. Consequently, in New York City, we observe that 30% to 40% of sales from a showroom, based on our current measurement of showroom sales, comes from e-commerce. In less populated regions, this ratio drops to about 15% to 20%. Therefore, urban areas show a significantly higher return when combining direct-to-consumer sales along with showroom and e-commerce sales.

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

Thank you for taking my question, and congratulations on another quarter of impressive growth. I wanted to inquire about your supply chain plans. If the tariff situation continues and you decide to fully relocate your production outside of China in the next 18 months, what kind of capital investment would that require from you? It seems that some of your vendors are willing to invest to support your business. I'm interested in understanding what to expect regarding your own spending to achieve that transition.

Yes, this is Shawn. I'll make a comment, and then Donna can add if necessary. Regarding our core manufacturing, there is almost nothing to report. We work with a third-party manufacturer, and overall, we've had success with our external partners. We maintain close relationships with them and feel we have strong control over our supply chain, which allows us to scale at almost any pace. While we will be broadening that network and onboarding new suppliers as we have already started doing, we are confident in our ability to manage this growth and in securing investments from our third-party partners. Due to the nature of our Sactionals, which are uniform and have a precise, challenging development process, we typically become a preferred and significant client for our suppliers. This is because they produce our product continuously, which aligns with our business model. We are intentionally against planned and perceived obsolescence, avoiding typical merchandising practices. This creates benefits for everyone involved: consumers gain from our products, we benefit from our success, and our vendors also gain. Therefore, they are generally willing to invest in our needs based on our experiences to date. We do not anticipate large capital expenditures, and we don't plan to pursue vertical manufacturing unless it becomes clearly advantageous, like our current Sac operations we have been discussing.

That's great, Shawn. That's really helpful. I have one more question about the marketing. The planned increase for the fourth quarter, since it's expected to be the largest quarter for marketing this year, is that increase in absolute dollars compared to last year supposed to accelerate in the fourth quarter as well? I'm also curious about where some of that budget will be allocated. Will it be for TV commercials, improved TV placements, or channels outside of TV? I'm just interested in how that will take shape.

Yes. I would say a couple of things. In terms of growth, it is indeed the largest. We are redeploying the savings from the marketing budget that we underspent in the first quarter, primarily in the fourth quarter. Based on our current understanding, it will mainly focus on extended runs in major markets where we are seeing the benefits of additional GRPs for an extended period, which is driving up our ROIs and efficiency.

Our next question comes from line of Brian Nagel with Oppenheimer and Company. Please proceed with your question.

So, maybe a bit longer term in nature. But you talked quite a bit about the openings of the showrooms. As you think longer term in connection 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 two channels, so to say, work together, over time?

I think that's a good question. In high population areas with a dense concentration of people, showrooms will remain an efficient way for us to grow the business. A target of 200 showrooms for a billion-dollar business seems reasonable at this point, but that's not the only path forward. For example, we've seen that Costco has been incredibly effective due to its low capital requirements, enabling us to create consumer touchpoints that drive business beyond just Costco. We've noticed significant online sales and showroom transactions following our Costco events. This model allows us to reach more customers with minimal investment. Given the value and quality of our partnership with Costco, it suggests there are many potential partners with desirable customer bases looking to collaborate with a rapidly growing company like ours. We see this as a major opportunity. Our focus is on how to enter new markets and maximize customer lifetime value relative to customer acquisition costs to maintain high multiples. Exploring shop-in-shop opportunities and partnerships can enhance our efficiency. We'll keep pursuing this and learn as we go. Our growth has been impressive; we've transitioned from no Costco shows two years ago to our current status and expanded our showroom network significantly. We're beginning to understand how shows, showrooms, and e-commerce can work in tandem. We'll provide more insights in the future about how these elements are interconnected. We'll certainly continue to investigate additional shop-in-shop opportunities.

I have a follow-up question on a different topic regarding tariffs. Shawn, you mentioned efforts to possibly relocate manufacturing capacity that could affect margins. My question is about your product and the demand trends. How much pricing power do you possess? If more tariffs are imposed, would you be able to pass some of those costs onto consumers by raising retail prices?

We believe we can manage our pricing effectively. We are currently navigating our growth trajectory, balancing between different rates of growth. We're confident in our pricing strategy, which is linked to our marketing model. As mentioned earlier, we are planning to implement some price increases, but these will be very targeted and mostly not noticeable to customers. We're not increasing prices on our core product. While we have the ability to raise prices, we decided against it because we are focused on the long-term. We appreciate the simplicity of our model and the positive response from consumers. We're on track and want to maintain this momentum. Therefore, we're prepared to accept a small decrease in gross margins in the short term, as we are confident in our projected positive EBITDA and high growth rates at the top line, which aligns with our objectives while maintaining our established model that consumers are familiar with and that is currently resonating well.

Yes. Just to add to that we are, 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 at the beginning of the year, we changed our Stack More, Save More promotion, which is our everyday promotion. The 20% requirement previously was 10 pieces. We 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 spend less money on discounts while we're starting to think 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 lift with lower discount. 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 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.