Lovesac Co Q1 FY2023 Earnings Call

Greetings. Welcome to Lovesac First Quarter Fiscal 2023 Earnings Conference Call. Please note, this conference is being recorded. I will now turn the conference over to Rachel Schacter of ICR. Thank you. You may begin.

Thank you. Good morning, everyone. With me on the call is Shawn Nelson, Chief Executive Officer; Mary Fox, President and Chief Operating Officer; and Donna Dellomo, Chief Financial Officer. Before we get started, I would like to remind you that some of the information discussed will include forward-looking statements regarding future events and our future financial performance. These include statements about our future expectations, financial projections and our plans and prospects. Actual results may differ materially from those set forth in such statements. For a discussion of these risks and uncertainties, you should review the company's filings with the SEC, which includes today's press release. You should not rely on our forward-looking statements as predictions of future events. All forward-looking statements that we make on this call are based on assumptions and beliefs as of today, and we undertake no obligation to update them, except as required by applicable law. Our discussion today will include non-GAAP financial measures, including EBITDA and adjusted EBITDA. These non-GAAP measures should be considered in addition to and not as a substitute for or in isolation from our GAAP results. A reconciliation of the most directly comparable GAAP financial measures to such non-GAAP financial measures 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 joining us today. Today, we will start by reviewing the highlights of our first quarter fiscal 2023 performance and then discuss Lovesac's strong positioning within the industry. Then Mary Fox, our President and COO, will update you on the progress we made against our strategic initiatives this quarter. And finally, Donna Dellomo, our CFO, will review our financial results and a few other items related to our outlook in more detail. Jack Krause, Chief Strategy Officer, is also in the room to participate in the Q&A session. Let me now review some key highlights of our first quarter financial performance. We are very pleased with our first quarter results with top and bottom line performance that exceeded expectations despite a dynamic macro backdrop. Total sales were $129.4 million, up 56% versus the prior year period. We delivered total comparable sales growth of 42.2% and continue to be very encouraged by the broad-based strength from both new and existing customers. We again saw strong growth across our showroom, internet and other channels. Notably, we grew adjusted EBITDA to $6.4 million from $5.3 million in the prior year period despite gross margin pressure of 450 basis points, driven by supply chain headwinds, which Mary and Donna will share more details around. I want to take a moment to share why we believe we have and will continue to deliver higher growth at a more consistent rate than much of our category. Lovesac is not a furniture retailer. Lovesac is not just a direct-to-consumer marketing engine selling clever seating solutions in a sea of comparable furniture. At our core, Lovesac is a branded consumer products company. We sell proprietary home furnishing inventions that are more useful, longer-lasting and more sustainable than all comparable products. We sell only direct to the consumer through our website and physical touchpoints, including shop-in-shop partnerships that we directly operate. This means the way we approach doing business from the standpoint of product, pricing, go-to-market strategy, insights and even talent, is different than all others within the home furnishings category. We aim to build lasting and meaningful relationships with each customer. And because of this direct-only model, we have a powerful set of data and insights for each one of our customers. We are focused on building a brand that is based on product platforms, not a brand built around a broad merchandising assortment that includes thousands of products or that competes mostly on aesthetic, like most of our competitors. This approach leads to fundamentally different outcomes for our business compared to the category. As a result, Lovesac's business performance and customer experience was not subject to some of the ups and downs that some of our peers were subject to throughout the different stages of Covid. I'd like to focus on three main differences that drive our reliable performance, making the point that these strengths will continue to benefit us through other macro headwinds and distortions to come. First, our approach allows us to continuously strengthen our product platforms by relentlessly investing in research to understand our customers. We invent new concepts and platform additions that no competitors have ever thought of. We test them and we develop them to succeed from launch, instead of endlessly chasing new seasonal styles and collections based on the desires to win or a merchandiser's point of view. We are totally focused on making a product that meets our customers' current and future needs by evolving the platform with them. We will apply this approach to other product categories in the home, most recently, home audio. Our research shows us that Lovesac's brand perception among our target audience is "a good value for my money," is advantaged versus our core competitive set and that these perceptions increased year-on-year in Q1 FY '23. We are driving increasing value perception at a higher rate than our price increases. Secondly, because we are selling a branded product platform, not just commodity furniture versus light commodities, every Sactional we sell is a legitimate opportunity for those customers to share our brand with friends and family, and they do. Our products are truly unique, and the most unique aspects of them are truly novel and readily demonstrable right in our customers' living room. They know how to operate and manipulate their Sactionals because they did not just have them delivered and set in place. They had to configure, cover and perhaps even connect StealthTech with their own two hands. This is powerful and disruptive since our competitors sell numerous unbranded lines of couches, each with limited appeal or comparable benefits. This is why we are seeing nearly one-third of our customers in the purchase phase, tell us that they learned about Lovesac from a friend or family member. Every time we sell a product, it becomes a marketing asset, unique to us as our broadly appealing product is being showcased and demonstrated by our own customers in their own homes. Lastly, from an operations perspective, this focus is a critical advantage versus the category. We do not have to worry about obsolete inventory. The benefits of scale are leveraged against these few core products, not many, and our people truly become experts in the products we make. We see these benefits of scale manifest in the resiliency of our supply chain, the efficiency of our inventory carry and marketing spend, just to name a few. This approach is what gives us confidence of continued success in the categories we compete in, and we will apply it in the new categories that we decide to enter thereafter. We have proven we can innovate successfully into new home categories, having chosen one of the most technologically complex ones to go after first, following Sactionals, that is home audio. Based on the performance of StealthTech to date, we are confident that over time, we will gain significant market share even as we are working on the next platform to launch. We have great confidence in our ability to generate high growth and continually improving profitability on an annual basis as the business leverages rapidly with size and scale, even in the face of macro headwinds or disruptions that affect all players in our category. And we believe that the attributes of our unique model can provide some insulation from these potential disruptions as they have over the past few years. We are committed to delivering results to that end as proof. Now let me provide an overview of our positioning within the current environment. Macro headwinds appear to have intensified in the last few months. We have observed some moderation in demand only within the last few weeks. We continue to operate from a position of strength as our 56% top line growth in the first quarter reflects, which is a testament to our robust business model and momentum-driven brand appeal. We believe that we are still in the early majority phase of the product's adoption curve for both Sacs and Sactionals, as evidenced by their growing strength from word-of-mouth. Our recent StealthTech introduction is just entering the early-adopter phase of that same curve and has a long way to go. We continue to be in stock, delivering nearly all orders direct to the consumer in just days, whereas industry lead times from others selling soft seating can be several weeks or even months of late. In-stock positions and lead times continue to be a competitive advantage for us, driving up Lovesac's brand affinity and customer satisfaction at a time when many other brands are driving some discord and disappointment. Our trajectory of consistent strength and performance has extended pre, during and post pandemic, and we have seen meaningful gains and awareness. In short, the business is firing on all cylinders. Since our IPO four years ago, trailing 12-month sales have quintupled. We've driven trailing 12-month EBITDA from being negative into the double digits. And even with this monstrous increase in top line sales and commensurate marketing spends, our CLV to CAC ratio has grown from about 4x to 5.3x. I could not be prouder of the execution of the entire Lovesac team. Given the backdrop I know many people believe there is the prospect of a recession, and how consumer-facing companies might fare during one is top of mind. While Lovesac was a far smaller business back in 2008, here are the reasons I'm optimistic about our ability to outperform the competition should we enter into a recessionary environment. One, our product platform is built for life and utilitarian in nature. It is an investment and more of a need than a want, driven by aesthetic only. Two, the fact that we are so early in our adoption curve, we are driving our growth with market disruptions and share gains, so short-run market contractions may impact us to a lesser degree than more mature brands. Three, we sell to a younger upper middle income customer demographic who takes pride in what we stand for in terms of our commitment to sustainability. These are high earners and more resistant to inflation than those buying at the lower end of the market without as heavy an impact from the wealth effect that participants at the highest end of the market may experience in a volatile market. Four, we have a rock-solid balance sheet. And five, we were much smaller during previous market pullbacks and receptions, but even then, the sheer momentum of our extremely high growth rate, while even higher in times of abundance, allowed us to grow straight through those pullbacks and even take advantage of other opportunities to further disrupt the category that come at times like these. Looking to the remainder of the year, while we are very pleased with our Q1 performance, given the recent uncertain macro backdrop and the fact we are only one quarter into the year, we are not changing our full year outlook at this time. We remain very confident in the future of the Lovesac brand and its proliferation. We are a nimble and capable team that has built this business up organically through lean times in the past and through every kind of headwind. I believe we can continue to navigate well in whatever operating environment we are faced with. It was a great first quarter. We made significant operational progress on our growth initiatives that continue to drive Lovesac's financial outperformance. I would like to thank the entire Lovesac team for their constant hard work and dedication to our brand and customers. Without them, our strong performance would not be possible. And with that, I'll hand it over to Mary to cover our strategic priorities and progress. Mary?

Thank you, Shawn, and good morning, everyone. Our first quarter results marked a record first quarter for our company. As Shawn said, it was an outstanding first quarter. And given these results, we have now achieved 16 consecutive quarters of greater than 25% growth and a CAGR of 48.7% in the past four years, gaining significant market share every quarter. In the last two years alone, our comparative sales have doubled and almost tripled on a three-year stack basis. This growth has all been achieved with a strong focus on profitability, with our adjusted EBITDA margin increasing by 440% in the past four years. As our home category has seen many ebbs and flows over the past three years with brick-and-mortar heavy brands suffering significantly during the early stages of COVID as consumers shifted to e-commerce, and recently our e-commerce heavy competitors suffering from channel shift back to brick-and-mortar, our consistent overperformance in the past four years is the scorecard we look to as we gain market share every quarter and deliver our financial commitments. This is the result of Lovesac's strong word-of-mouth and relevancy, our best-in-class omnichannel go-to-market level and our first-to-market innovation. And we believe these market share gains and brand awareness will continue. As we consider our unique omnichannel go-to-market strategy, I'm very excited to share an update today on our strategic retailer partnerships with Costco and Best Buy. Our advantaged product and selling space productivity allows us to develop partnerships with other best-in-class retailers to further grow our distribution in smart ways to meet and expand our consumer base in the places where they frequently shop for other larger ticket purchases but do not conventionally expect to find furniture. We are very pleased with the strength of our Costco business, hosting roadshows directly on costco.com for the last 24 months. We're also pleased to share that we'll be restarting the physical roadshows in the second quarter throughout the rest of the year, which represents significant opportunity to drive sales and, more importantly, demonstrates our physical platform to our target customers as they continue to transition back to more physical shopping. We know how successful these roadshows were pre-COVID and are excited to be restarting them. At Best Buy, we've seen our business increase at a strong rate, which we attribute to improvements in the customer experience on bestbuy.com and strong StealthTech performance, particularly in our shop-in-shops. We continue to be excited about our partnership with Best Buy and are planning a continued expansion and growth of our footprint within Best Buy. This will include further strengthening the experience of StealthTech as it aligns so well with what the Best Buy shopper is looking for. Now turning to our first quarter performance. As Shawn mentioned, we are very pleased with these record results and the strides we have made against our key strategic growth initiatives, which I'll now review, starting with number one, product innovations, of which the key highlight continues to be our StealthTech launch in mid-October '21. We're very pleased with the continued strong performance of StealthTech. As the first of its kind innovation, we believe adoption will continue to grow on a sequential basis. As we grow our footprint also within Best Buy, we are excited about the potential to strengthen the experience of StealthTech, which is materially advantaged with Best Buy locations, meeting the home audio buyer where they go to shop and also to develop more significant co-programming to drive awareness of our partnership with Best Buy. Also as a part of our road map with StealthTech trying to coincide with National Streaming Day, we partnered with Disney + to elevate the at-home viewing experience, featuring the most anticipated movies and series launching on the streaming platform. Customers can visit Lovesac showrooms to select Best Buy to see how Disney paired with the innovative StealthTech sound and charge home audio systems can create the ultimate family movie night. Number two, efficient marketing and merchandising strategies. Based on KPIs we track, we continue to see distinguishing attributes of our brand strengths and with our core target customer. These include key metrics of brand awareness and quality, integrating home electronics being a sustainability-focused company, providing the most comfortable seating and reflecting customer personal style among other key metrics. Additionally, our in-market media performance is trending as expected, and our media costs as a whole are beginning to stabilize with some exceptions such as search and remarketing. This has allowed us to return to more testing and expansion into additional innovative programs, including cookie-less solutions. Lastly, we are experiencing a continued tailwind with customer referrals. During our last quarter, we believe word-of-mouth was the largest driver of awareness for the customers that made it to the purchase phase. This not only benefits our business, but it's also a strong endorsement of our brand from our customers. Three, our mid-channel operations, which are going to include touchpoints and e-commerce together. Like many other businesses, more customers return to in-person shopping during quarter one, and we began to see a channel shift back to physical touchpoints from e-commerce. As omnichannel was a focal point for us pre-COVID, we have set ourselves up to efficiently react to these shifts without disruption. By creating a frictionless business model where sales associates are compensated to sales they influence from any online or physical channel, we have demonstrated that we are agnostic to where our sale is generated. Touchpoints and e-commerce are interdependent, and most of our shoppers utilized both during their buying journey. I'll now discuss a few ways that we continue to evolve this business strategy. First is digital marketing. In quarter one FY '23, we leaned more heavily into driving traffic into touchpoints as we know that customers who receive a demo in a showroom convert at a higher rate. Specifically in Q1, we launched Google Local that uses Google Beacon traffic, tracking to get customers to the closest store, which represented 60% of our search impressions. Over 70% of our social media spend was aimed at trade area marketing, which encourages shoppers in a trade area to go to their local showroom for a demo or those outside of a trade area to shop online. Also new in quarter one, we utilized specific digital advertising to drive customers for StealthTech education and conversion. As StealthTech is primarily purchased in touchpoints, these served to drive customers to touchpoints to experience an audio experience demo. Lastly, we added a team of post-purchase specialists specifically designed for customers who purchased via lovesac.com. With the addition of this team, we introduced the personalized touch for our digital customers, and these specialists connected with 98% of lovesac.com customers and also more than 90% of our omnichannel customers in quarter one. As we look to our touchpoints, our showrooms continue to play an important role in our omnichannel strategy, driving strong results as reflected in our quarter one comp of 53.2% and our two-year comp of 235.9%. These touchpoints provide our customers with the ability to see, feel and now hear our unique product offering. Our Q1 traffic rose 70% year-over-year and up 33% from last year in comp locations, significantly outpacing the U.S. trends as reported by ShopperTrak, our national reporting system. Even more impressive is our industry-leading sales per square foot productivity, with only Apple and Tiffany ahead of us as we look at the most recent data. In Q1, we opened 17 new touchpoints and continue to be on pace to achieve our FY '23 target. We opened 11 new showrooms, one new Best Buy shop-in-shop and five new kiosks. We continue to see strong performance in lifestyle at the off-mall locations and plan to actively pursue similar opportunities as part of our evolving real estate strategy. Of the 11 showrooms opened in quarter one, 82% of those are in off-mall locations, primarily made up of lifestyle centers or street locations. Combined, our new touchpoints are performing above expectations, and we feel confident in the real estate pipeline we have generated as part of our strategy. Understanding that touchpoints can also play an important role in our customer shopping journey, we have remained focused on investing in our teams through staffing and compensation. In quarter one, we onboarded a team specifically focused on recruiting top talent to the field organization. We are also strategically investing in compensation, taking a conservative approach on base pay while focusing our efforts on growing variable pay for performance, allowing flexibility to optimize payroll and drive service levels. We are confident in our ability to staff and support our continued growth, and we saw a 10-point reduction in open field positions in Q1, coupled with industry-leading retention performance. All of this being balanced to demand with 80% of the field positions being part-time. For e-commerce, our sales and traffic grew year-over-year even with outsized results last year as the pandemic continued. We continue to lead in our ongoing improvements and test-and-learn strategy to optimize the customer journey on our website. We're excited to be exploring technology updates that we believe will enhance the customer experience even further this year, and we'll keep you updated as we have more to share. And finally, making disciplined infrastructure investments. We were excited on April 15 to announce Todd Duran as our new Chief Information Officer, and we plan to continue to build out his IT team. Todd and his group will play a critical role in delivering a customer experience that drives elevated satisfaction, and I'm thrilled to see him hitting the ground running. Then regarding supply chain update. In Q1, we continued to benefit from our diversified supply chain and inventory strategies, which enabled us to not only over deliver net sales in quarter one but also exit the quarter in a strong planned inventory position with quarter-ending in-stocks in the high 90s and expected strong position heading into quarter two with our evergreen inventory. Our delivery times for customers continue to be best-in-class in our category, and we remain committed to this performance. As we look to quarter two, we expect continued operational progress despite ongoing headwinds in the global supply chain. Our active strategy to manage inventory and our diversified sourcing has enabled stronger and consistent supply performance thus far, and we will continue to manage through the current environment while delivering our expected margins. We're also happy about the progress we are making as we continue to mitigate some of the tariffs in China and ramp up North American production, both of which will create and strengthen redundancy to ensure our industry-leading in-stock position. So in summary, we're pleased with our financial and operational performance during quarter one, and I continue to be very excited about the opportunities this year as we further implement our strategic growth initiatives. Our strong results reflect exceptional execution by the entire Lovesac team and we are so appreciative of the passion and commitment they demonstrate day-in and day-out. The results also reflect the strength of our brand as we continue to navigate a dynamic operating environment. We feel confident about the underlying trajectory of the business and are reiterating our outlook for the year. We're very well positioned to continue to gain market share and benefit from the broader trend of consumers who value purpose-driven brands founded on sustainability. I will now pass the call over to Donna to review our quarter one results and a few details relating to our fiscal 2023 outlook.

Thank you, Mary, and good morning, everyone. I will begin my remarks with a review of our first quarter results and then provide a framework for how we are approaching the remainder of fiscal 2023. Net sales increased $46.5 million or 56% to $129.4 million in the first quarter of fiscal 2023. The year-over-year net sales increase was driven by growth across all channels. Overall, comparable sales increased 42.2% due to the success of our Easter holiday campaign for both showrooms and the Internet and the year-over-year increase in our touchpoints to include 31 showrooms, 13 kiosks, two mobile concierges and 18 Best Buy shop-in-shops. Additionally, we had higher productivity in our online pop-up shops on costco.com, which included one additional event over the prior year. Showroom net sales increased $32.3 million or 65.9% to $81.3 million in the first quarter of fiscal 2023. This increase was due primarily to a $22 million increase in comparable showroom point-of-sales transactions to $63.3 million in the first quarter of fiscal 2023 as compared to $41.3 million in the prior year period, principally driven by a very strong Easter campaign. As a reminder, point-of-sale transactions represent orders placed through our showrooms, which do not always reflect the point at which control transfers to the customer and when net sales are recorded. Internet net sales, which are sales made directly to customers through our e-commerce channel increased $6.1 million or 24.1% to $31.3 million in the first quarter of fiscal 2023 as compared to $25.2 million in the prior year period, principally driven by the performance of our Easter campaign. Other net sales, which principally include pop-up shop and shop-in shop net sales, increased $8.1 million or 92.7% to $16.9 million in the first quarter of fiscal 2023 as compared to $8.8 million in the prior year period, principally driven by higher productivity of our temporary online pop-up shops, one additional Costco.com pop-up shop and the additional Best Buy shop-in-shops over the prior year period. By product category, our Sactional net sales increased 55.4%, Sac net sales increased 67%, and our other category net sales, which includes decorative pillows, blankets and other accessories, increased 39.1% over the prior year period. The decrease in gross margin percentage of 450 basis points over the prior year period was primarily driven by an increase of approximately 640 basis points in total freight costs, which includes inbound and outbound freight, tariff expenses and warehousing costs. These costs were partially offset by an improvement of 190 basis points in product margin principally driven by lower promotional discounting and continuing vendor negotiations to assist with the mitigation of tariffs. We exceeded our first quarter net sales guidance we shared with you on our last call, primarily driven by the success of our Easter campaign and higher than projected shipment volume. Our gross margin percent in the first quarter of fiscal 2023 exceeded our guidance, principally driven by lower inbound freight costs than we had projected. While the rate component was in line with expectations, there were some delays with the timing of container arrivals due to supply chain headwinds and port shutdowns in Q1 that caused the delay in cost realization. Importantly, we expect those deliveries to arrive in Q2, and the good news is that the redundancies in our system ensured no degradation in CSAT scores or customer delivery times. The freight rate favorability is partially offset by a slightly higher discount, primarily driven by the tremendous success of our Easter campaign. The 46.2% year-over-year increase in SG&A was largely driven by an increase in employment costs due to the new hires and variable compensation, an increase in rent expense related to the addition of 46 touchpoints, and higher rent related to the sales increase. Overhead expenses also incurred due to infrastructure investments and selling-related expenses increased principally due to credit card fees related to the sales increase. The SG&A expense as a percent of net sales decreased by 230 basis points due to higher leverage within infrastructure investments, rent, equity-based compensation, selling-related expenses, and insurance, partially offset by deleverage in employment costs and travel. The deleveraged certain expenses related to the continuous investments we are making into the business to support our ongoing growth. Advertising and marketing expenses increased $5.2 million or 48.9% to $15.9 million in the first quarter of fiscal 2023 as compared to $10.7 million in the prior year period, resulting from continued investments in marketing spend and awareness campaigns to support our sales growth. Advertising and marketing expenses were 12.3% of net sales in the first quarter of fiscal 2023 as compared to 12.9% of net sales in the prior year period. The slight decrease in basis points is due to improved performance in our media activities. Depreciation and amortization increased $200,000 from the prior year period to $2.7 million, principally related to current year capital investments for new showrooms and kiosks. Operating income was $2.6 million compared to $2.3 million in the first quarter of last year, driven by the factors just discussed. Net interest expense of $35,000 for the first quarter was in line with the prior year's first quarter expense. Interest expense principally relates to unused line fees on our revolving line of credit. Before we turn our attention to net income, net income per diluted share and adjusted EBITDA, please refer to the terminology and reconciliation between each of our adjusted metrics and their most directly comparable GAAP measurements in our earnings release issued earlier today. Net income was $1.9 million or $0.12 per diluted share in the first quarter of fiscal 2023 compared to net income of $2.1 million or $0.13 per diluted share in the prior year period. During the first quarter of fiscal 2023, the company recorded $700,000 in provisional income taxes as compared to $200,000 in the prior year period. There was a utilization of deferred tax assets of $500,000 during the first quarter of fiscal 2023 based on the expected generation of taxable income for the fiscal year 2023. We generated adjusted EBITDA of $6.4 million in the first quarter of fiscal 2023 as compared to $5.3 million in the prior year period. Now turning to our balance sheet. Our evergreen in-stock inventory is an advantage that is not comprised of seasonal merchandise. Therefore, we do not run the risk of being overstocked or having to be promotional to reduce inventory levels. Our inventory levels are in line with our projections and our goal to support our growth and maintain industry-leading in-stock positions, with nearly half of the increase in the year-over-year ending balance sheet inventory related to freight costs on our inventory build. The increase in inbound freight costs reflects the impact of the continued global supply chain situation. We are projecting that the rate of the year-over-year increase in our total inventory balance to moderate by year-end. Our liquidity continues to remain strong as we ended the first quarter with $64.4 million in cash and cash equivalents and $31.2 million in availability on a revolving line of credit. Our liquidity continues to remain strong as we ended the first quarter with $64.4 million of cash and cash equivalents and $31.2 million in availability on a revolving line of credit with no borrowings. Please refer to our earnings press release for other details on our first quarter fiscal 2023 financial performance. Now regarding our outlook. We are still operating in a dynamic environment with a wider range of potential outcomes as it relates to fiscal '23. Given this, we are not providing a formal outlook for the year, but are reiterating our previously provided framework for fiscal 2023 that we shared with you on our fourth quarter earnings call, which was more than 25 showroom openings and continued infrastructure investments to support the substantial multi-year growth opportunity that lies ahead. In a scenario where net sales growth is in the low 30% range, we continue to expect gross margin rate to only be approximately 300 basis points below fiscal 2022, and adjusted EBITDA margin rate in this scenario will be slightly above fiscal 2022 levels despite lower margin rates and infrastructure investments. We expect to leverage certain operating expenses with a net sales increase in the low 30% range. We are still expecting to generate cash from working capital in fiscal 2023, with CapEx spend to be in the $20 million to $22 million range. For our fiscal second quarter 2023, we expect net sales growth to be between 25% to 30%. While we do not guide to comp, I will make some qualitative comments on what we have seen quarter to date. We continue to see strength across our products that over-index to the higher-end consumer demographics with StealthTech being a prime example. We have seen some moderation at the other end with our more entry-level product. So comps have moderated from the very strong Q1 levels, but they continue to be up in the healthy double-digit range, which gives us confidence to reiterate our full-year outlook. From a profitability perspective, for the second quarter of fiscal 2023, we expect a decrease in adjusted EBITDA margin of approximately 355 basis points as compared to the prior year period. Adjusted EBITDA margin is primarily being impacted by higher SG&A leverage, which is expected to be more than offset by lower gross margins of approximately 710 basis points year-over-year related to higher inbound ocean freight rates and higher outbound transportation costs resulting from higher fuel surcharges. So in conclusion, we are very pleased with our first quarter fiscal 2023 results that exceeded our expectations on both the top and bottom line. Our results continue to reflect the consistent contributions of the entire Lovesac team and we are grateful for their hard work. We look forward to building on our success in fiscal 2023 and beyond. With that, we would now like to turn the call back to the operator who can open it up for questions.

Thank you. Our first question is from Tom Forte with D.A. Davidson. Please proceed.

Thank you, Shawn, Mary, and Donna for a fantastic quarter. I have a question and a follow-up. Shawn, you mentioned this in your opening remarks, and I don't want to imply that a recession is inevitable for anyone. However, it seems that you could really benefit from a recession in several ways: with reduced container costs, lower freight expenses, and cheaper component prices, which could provide an opportunity to acquire prime real estate at favorable rates, as well as lower advertising costs. Am I understanding this correctly, and is there anything I'm overlooking?

Yes. Thanks, Tom. There are many ways that Lovesac has resiliency through pullbacks. And we've lived through these in our past. Let's begin by just the sheer momentum of our growth rate can carry a company like this through various kinds of pullbacks in headwinds because a headwind versus momentum that's strong, while it may moderate, certainly won't stop growth, and that's heartening to us. And then all the things that you mentioned from back in 2008 when Lovesac only had a few dozen locations, we were able to scoop up locations with much more favorable lease rates, our negotiating power with vendors, across supply, of course, increased because with so many companies flattening out, growth becomes dear to both suppliers whom made you into the shipping companies eventually. Hopefully, companies like ours will reap the rewards that come from having the momentum going in and also having so much headroom in our category even as we become, in a lot of ways, the apex predator of couches as we view it, the disruptor with the best product in the category. So yes, all the things that you mentioned are accurate, and we look forward to being able to take advantage of those things if there were to be some major market pullback. In the meantime, out of an abundance of caution, we've reiterated guidance as opposed to, say, taking it up because it is a crazy world out there, and we just want to be super conservative and careful with what the expectations are, but we continue to grow and grow at a rapid pace and do it profitably, and we're really happy with that.

Excellent. So for my follow-up, I want to congratulate Jack on a great quarter as well. I haven't asked this in a while, but what is your M&A strategy? I imagine there are many opportunities right now to acquire assets at lower valuations. How do you feel about pursuing a multi-branded strategy, either through M&A or by launching a second brand?

Yes, I'll share a few thoughts and then Jack can add his perspective. To build on what's been discussed, during uncertain times, assets tend to become more affordable. Our approach to mergers and acquisitions isn’t a central part of our strategy. As you know, we've been focusing on organic growth for quite some time and remain optimistic about our potential for significant ongoing expansion. However, we recognize that there are other direct-to-consumer brands that lack our strength, profitability, and reliable business model, which presents opportunities that we are considering. More importantly, we are ambitious about our manufacturing capabilities, particularly in reducing costs. We’ve developed a product that maximizes cost savings, featuring a consistent and straightforward product line with a low SKU count. Our manufacturing capabilities also present numerous opportunities, which could make M&A a possibility for us to enhance operations. Still, we are trying to maintain focus given our strong growth trajectory. We remain open to opportunities and will proceed carefully. We have a considerable cash reserve relative to our size and see many possibilities within the home segment. We define our market as everything from your mailbox to your property line, and we aim to innovate within that scope. Naturally, we'll prioritize substantial, high-value items using a designed-for-life approach. There could be potential spin-offs or product categories that are large enough to establish their own brand, which is something we think about. However, we don't see the need to fracture our brand to target lower or higher-end demographics. Sactionals is universally appealing, reflecting the beauty of our demand-driven products. Customers can buy it without covers and gradually add pieces, or opt for fully outfitted versions that come at a higher price. Although we cater to the higher end, we believe we can attract a broad range of customers. We haven't even scratched the surface yet, as our core demographic is extensive. The potential is vast, and despite achieving about $0.5 billion in sales last year, we have captured only a small share of the market. Therefore, we remain focused on one product category. Jack, do you have anything to add?

Thanks. And I did get off mute. Thank you. I guess two, Shawn, you're summarizing it in two ways. First, I think, for the next three to five years, we clearly have plenty of runway organically with Lovesac, and we know that based on our consumer insights, our research and new product pipeline. The way we look at my position in the short run is working with Mary and the team on how we strengthen our process, structures, and governance to get the most out of the ideas that are going through the pipeline. Then I think the second phase has been beyond three to five years is what opportunities DFL creates for us and the affinities with future customers. We have a great deal of opportunities we're looking at because of how strong DFL rings true with our core customers. As time goes on, we'll be able to talk more about the filters we're looking at. But great question.

Our next question is from Maria Ripps with Canaccord. Please proceed.

Good morning, and thanks so much for taking my questions. And congrats on very strong results here. So you mentioned several factors that have contributed to the strength in Q1, including your Easter campaign. I guess, is there anything else you'd highlight here again from maybe competitive positioning or consumer behavior that may have added to revenue or performance in the quarter? And then my second question is, as it relates to your outlook. So you mentioned some sort of moderation in demand in the last few weeks. Any way maybe you'd be able to quantify that relative to sort of the 56% growth rate in Q1?

Yes. Good morning, Maria, I will take that question. Thank you. In terms of the first quarter, we were very pleased with the performance, especially due to the success of our Easter campaign, which built on the word-of-mouth strength that Shawn mentioned earlier and the ongoing brand loyalty we are seeing. One of the highlights I pointed out was the launch of Google Local in the first quarter, particularly related to the Easter campaign. We observed a significant increase in showroom visits and online conversions, which helped keep us top of mind for customers considering purchases. This momentum has continued. We have also seen strong growth for StealthTech, generating great excitement. Looking at the results from other channels in the first quarter, which showed a 92% growth, we can see continued demand. Regarding your question about the second quarter, it’s important to consider that we are comparing against our toughest comps over the last two years, and this is our biggest quarter of the year. As we move into the second half, we expect some softer comparisons, but the focus on these higher numbers will be significant. Much of the moderation we see can largely be attributed to these comparables. However, we still observe strong demand as we began the second quarter. We are being careful with our guidance to ensure we deliver and maintain the high standards we've set over the past four years. Donna, do you want to add anything on Q2?

No. Mary, you did great.

Our next question is from Brian Nagel with Oppenheimer. Please proceed.

Good morning. I also want to congratulate you on a strong Q1. My first question is a follow-up regarding the commentary about the slowdown in Q2. You mentioned that it seems to be more concentrated at the lower end of the product range. Can you provide more insight into what you're observing? Specifically, when did it begin and to what extent has the slowdown occurred? Additionally, if this trend continues, are there any strategies you would implement within the Lovesac model to counteract it? I have a follow-up question after that.

I'll address that. Firstly, we had an exceptionally strong quarter one, particularly in April. Our results outshine the competition, and we're continuing to increase our market share. However, we should approach the notion of moderation cautiously, as it only applies to the start of this quarter. As mentioned earlier, we're facing our most challenging comparisons over the past two years. Therefore, the degree of moderation we’re experiencing is relative to these comparisons, in contrast to some trends others may be witnessing. We're optimistic about our persistent growth across all channels, with high customer engagement contributing to favorable growth rates. We understand the current dynamics and will adapt, which is why we're maintaining our guidance instead of raising it. Regarding your second question about the potential for this trend to continue, we've thoroughly analyzed various scenarios and feel confident about achieving our guidance, even accounting for any moderation at the lower end. It's essential to note that at the upper end, we're actually experiencing acceleration and sustained growth, including in our sales tax. We've carefully reviewed all aspects, and it's worth mentioning that our Q1 performance was reached without exploiting all our available strategies as we have in previous years; our discount rates were at a historic low. There are opportunities, such as purchasing marketing at more affordable rates, which we are beginning to see stabilize, along with other strategies to propel growth. Overall, as we progress through the year, our inventory levels are better than they were last year, our customer interactions are performing at a high level, and based on what we know now, we are confident about the remainder of the year.

Got it. Then maybe my follow-up, just on the gross margin side. So I know we talked a lot about gross margins for the last several quarters. You mentioned a lot in your prepared comments here. But as you see the, so to say, the supply chain dynamics continue to unfold, how should we, as we're looking at our models, how should we think about that path back to kind of historical levels for gross margins at Lovesac?

Yes. I think, look, first of all, to build on what Mary said, Lovesac will continue to do what it's been doing. High growth rate at the top line continues to pursue leverage at the bottom line. Our North Star is to grow EBITDA even as we are scaling rapidly. We're very confident in that outlook. If that continues, through the strengthening of the dollar versus foreign currency and back. You have a lot of companies with too much inventory and their inventory is not like ours. It's not evergreen. It's not the same as ours, right? Our inventory is highly concentrated on just a few key SKUs that will be relevant 15 years from now. So it creates no pressure on us to make radical moves and start discounting and dumping. You pair that with the basic economic outlook that's out there. You have a recipe where a lot of companies will be struggling to achieve the kind of reliable profitable growth that we believe we can achieve. As that happens, our strength with our suppliers and our sourcing perspective as well as our manufacturing efforts will drive this right back to where we want to be on a gross margin basis, which has always been, again, our North Star, the mid-50s range, outside of the turbulence that has been undeniably swirling for the last couple of years in the supply chain realm, whether it be the raw cost of goods, the times, or just the availability of containers and the cost of shipping containers. Our path back is continued growth, and that buys us the leverage versus all of these factors that are swirling. As other companies normalize their inventories and pull back on the inflow they had to deal with because there's so much pent-up demand that is already on its way, it's created dilemmas for customer relationships with those brands, and we'll continue to be steady. Our key is steadiness, and that will bring us back to the gross margins that we believe continue to be our guiding North Star, and we will be able to deliver against.

Got it. Thank you.

Our next question is from Camilo Lyon with BTIG. Please proceed.

Thanks, and good morning, everyone. Very nice job in Q1. Just going back to the commentary around the moderating trends you're seeing here in Q2. So you talked about softening from that lower income consumer. Can you just tell us how that actually manifests in the new business? Is it smaller couch Sactional purchases? Is it an increase in credit applications? Just curious how that's manifesting. Then the second component of that question is a higher-income consumer more than making up for that moderation by the low end? And then I have a follow-up.

Yes, good morning, Camilo. Thank you for the question. In the moderation, again, as I shared earlier, it's only a few weeks, and I think when we look at the two years back basis, we have to kind of be careful because some of the lower end actually, when we run the numbers, they were very strong a couple of years ago. But what we're seeing is just more of the standard fill, which is that opening price point is still growing and still good, but just slightly softening to where we were, obviously, of an incredibly successful quarter one. But what we do continue to see is that the other sales that we continue to have great growth and in some places actually accelerating, and we continue to see StealthTech building in its growth. So that continued drive in AOV and all that we can drive as we think about bringing traffic into the showrooms as we go to the year-end as well as into other channels and online. There's plenty of room for us to be able to drive that traffic and the acquisition of customers as we kind of see through. We are giving you full transparency as we see the early part, but I really do believe as we look at comparables, it's the toughest quarter on that two-year stack. It really starts to scale down in the second half. And that's why we still feel very confident as we look to our guidance for the year.

Great. And then just following up from that line of questioning, does this moderation, even though it seems to be very more comp-driven, change your view on your promotional strategies? That's been a tailwind for you guys now for well over a year. I'm curious, does this alter how you're going to view your promotional cadence with respect to distributors that you have for units bought and what that triggers from a discount perspective?

Yes, you're right. Absolutely because in the last year and more, we've seen a very benign promotional environment, and our discount rates have continued to be lower. But like anything, we're a very agile business. We're always looking for where there might be opportunities. How do we think in with when our customers are thinking about buying with Lovesac and making sure that we really do consider the promotional level? It may not be for everything. It may be on certain product sites as we've been testing, and we've seen great success with that in the Easter campaign. So like everything, and we've always done, we'll continue to be agile and respond where it's needed. All of that is factored into our guidance, allowing for room if we need to drive higher traffic acquisition through promotions, and we'll continue to respond accordingly.

Yes. And I would just add, our point of view, our overall point of view on what this company can and will deliver even throughout these turbulent times is very high growth in a category that is a match right now in many respects. That high growth comes from organic word-of-mouth affinity for our totally proprietary products that continues. Even though there are headwinds against maybe the home category in general and consumer in general, those headwinds cannot mitigate the raw momentum that we've built into this brand. Our moderation statement in terms of just, let's say, reiterating our framework for the year is out of an abundance of caution. This is a very turbulent time with all kinds of macro craziness. We're just going to be very cautious, even as we still experience a probably leading growth in the category, coupled with a path to continued expansion of profitability. So quarter by quarter, maybe lumpy. There are some comp issues that we'll have to face in terms of just tough comps coming up and whatnot. The overall delivery of this business will continue to be what it's been, and we're very proud of that.

Prudent conservatism is definitely appreciated in this environment. Good luck, guys.

Our next question is from Matt Koranda with ROTH Capital. Please proceed.

Hi guys. It's been covered quite a bit, but I just wanted to see if you could put a finer point on your second quarter commentary. Could you just confirm that you've been tracking within the guidance range of 25% to 30% quarter-to-date? Or are you assuming things get worse incrementally for the rest of the quarter to get to that guide?

I think when we look at the entire quarter, we feel very positive about our progress, especially from Memorial Day through July 4. We are confident enough that we wouldn't be providing guidance for the quarter if we weren't completely assured. As Camilo mentioned, we've been cautious in light of all the commentary out there, but our outlook remains strong.

Okay, great. And then just on the inventory growth front, you guys called out that some of the growth was due to increases in inbound freight. But could you maybe speak to unit growth within your inventory on a year-over-year basis? And then also how much StealthTech just kind of directionally is embedded in that inventory growth as well to support the higher attach rates that you guys are seeing?

About half of the inventory increase is related to items that are not comparing to the previous year. For instance, StealthTech is a smaller part of this non-comparable segment, but there is significant self-inventory that we did not have last year because it was only launched at the end of the third quarter of fiscal 2022. Half of our inventory growth is in what we will call typical seat size stock covers, which we planned to support the increase in sales volume. The other half is attributed to the rise in freight-in costs. Importantly, this was all planned. The inventories I mentioned are not at risk; they are evergreen. We do not have seasonal inventory. In our planning at the beginning of the year, we thought it would be wise to maintain this inventory on hand to ensure we remain well-stocked. I hope that answers your question.

Yes, very helpful, Donna. Best of luck. See you guys, thanks.

Our next question is from Alex Fuhrman with Craig-Hallum Capital Group. Please proceed.

Hi guys, thanks for taking my question, and congratulations on the really strong quarter. I wanted to ask about the return to Costco. That used to be a really big part of your business. Now it looks like you're going to be going back to their stores for the first time in a couple of years. I think if I remember correctly in the past, that partnership was dilutive to your margin rate but it was great exposure, got the product in front of a lot of people at the time when your awareness was very, very low. Now that you're a much bigger company, can you talk about what that partnership is going to look like now that you're back in the stores and how the margin of that might compare to your Lovesac showrooms as well as the showrooms that you're starting to operate now within Best Buy?

Yes. Great. Thank you for the question, Alex. Yes, we're excited equally in terms of the return to the Costco physical roadshows, and obviously, we stopped those just as COVID hit. It's mentally great because it feels like we're all getting back to retail. Those will start, and we take the numbers into our framework for the rest of the year. One thing that's a real advantage this time is we're going to be staffing all of the roadshows with our own team, which is an elevation to the model before that we believe will drive stronger conversion. From that side, it's still very good. I think in terms of your question, we look at the full P&L; yes, the product margins are a little bit dilutive, but the EBITDA impact is positive. We really look across the P&L. We consider all of our decisions because clearly, we have very strong momentum across all of our channels. We see this as additive from the top line and then from even the EBITDA line. So we're very positive there.

We have reached the end of our question-and-answer session. I would like to turn the conference back over to Shawn for closing comments.

Yes. Thank you to all of our investors and supporters who continue to watch our company grow. We're especially grateful to our entire Lovesac family. The team that has built this company continues to put up amazing growth, even as we continue to disrupt the category that we operate in. Appreciate you being with us this morning.

Thank you. This does conclude today's conference. You may disconnect your lines at this time, and thank you for your participation.