The Lovesac Company (NASDAQ:LOVE) Q2 2024 Earnings Call Transcript

The Lovesac Company (NASDAQ:LOVE) Q2 2024 Earnings Call Transcript November 3, 2023

Operator: Ladies and gentlemen, good morning, and welcome to the Lovesac’s Second Quarter Fiscal 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host Ms. Rachel Schacter of ICR. Please go ahead.

Rachel Schacter: Thank you. Good morning, everyone. With me on the call is Shawn Nelson, Chief Executive Officer; Mary Fox, President and Chief Operating Officer; and Keith Siegner, 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 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.

Shawn Nelson: Thank you, Rachel. Good morning, everyone, and thank you for joining us today. I will start this call off by reviewing the highlights of our second quarter fiscal 2024, briefly providing an update on our operational accomplishments and finishing up with our outlook. Then Mary Fox, our President and COO, will update you on the progress we made against our strategic initiatives. And finally, Keith Siegner, our new CFO will review our financial results and a few other items related to our outlook in more detail. Before diving in, I want to thank everybody for their patience as we work through our financial restatement. We hold ourselves to very high standards of integrity, accuracy and reliability of our financial statements is paramount.

As of today, all amended filings are complete. Additionally, we’re enhancing teams and implementing procedures and disciplines as we work to build a world-class organization able to support growth for years to come. Moving on to our results. We’re pleased with our second quarter performance with top and bottom line exceeding our initial outlook provided in June. The economic environment remained challenging as macro pressures drove a more cautious consumer in turn, keeping pressure on the home category. While we also felt pressure, Lovesac operated from a position of strength, leveraging our 25th anniversary campaign and omnichannel expansion to continue our track record of outperforming the category and achieving positive net sales growth.

Not to be overlooked, we delivered growth despite a difficult comparison lapping top line growth of 45% in the second quarter of fiscal 2023. Specifically, total net sales were $154.5 million, up 4% versus the prior year period, supported by total comparable sales growth of 7.2% for the quarter. On a two-year basis, net sales grew an impressive 51%. Adjusted EBITDA was $5.3 million as compared to $12.3 million in the prior year period. As expected, gross margin expansion was more than offset by important investments in growth. Deleverage in marketing and advertising resulted from our 25th anniversary celebrity campaign and the launch and support of our Angled Side innovation, both of which will benefit us in the coming quarters. We also continue to make necessary and disciplined infrastructure investments to ensure we have the foundations for category beating profitable growth for the long-term.

The pressure from the investments will abate later this year as we’ll talk more about that in a few minutes. Operationally, we made good progress on our initiatives to strengthen our Infinity flywheel that supports our differentiated business model. Mary will discuss in detail the progress on specific growth strategies but let me provide a brief update. On the product innovation front, as previously discussed, we formally launched Angled Side in the quarter. Angled Side offers benefits to augment both aesthetics and comfort, importantly, addressing the number one style gap we identified in our research. By opening the aperture of potential customers we’re reaching, more new and existing customers and seeing meaningful contribution every week since the launch of the Angled Side.

We continue to wisely expand our physical footprint supporting awareness and benefiting our e-commerce sales, altogether, delivering a seamless omni-channel experience to our customer. We’re driving marketing efficiency with new tactics, including hyperlocal marketing to drive traffic. Lastly, we are still carefully investing in technology and R&D to fuel continued innovation to further elevate the entire customer experience and to ensure that we have a strong foundation to support the long runway of growth ahead. Looking to the second half of the year, we expect the macro environment to remain challenging, continuing to pressure the home category. We are not planning for any meaningful recovery in category growth this fiscal year. In terms of the promotional environment, we expect it will be more competitive as we head into holiday season and anticipate more frequency and depth of discounting across the industry.

We’ve adapted our own plans accordingly, and we’ll remain very agile through the holiday season. Even taking this into account, which doesn’t change our confidence that Lovesac will continue to outperform the category and yes, generate stronger growth in the second half than the first half. This is clear in our guidance where we estimate third quarter revenues of approximate $154 million and are tightening the range of our fiscal 2024 net sales guidance to $710 million to $730 million nationally. Given the macro back drop we are highly caused operationally we are focused on efficiency and will control expenses very tightly. This will become more clear, as we lap necessary foundational investments that began in the second half of fiscal 2023, and which put peak pressure on bottom line growth in second and third quarters this year.

After adding in some discrete expenses, primarily professional fees related to the restatement of approximately $4 million, we now anticipate fiscal 2024 net income in the range of $20 million to $29 million. In summary, we have an unwavering commitment to the customer, delivering our unique design for life platforms through circular operations and an omni-channel experience. We’re pleased with our performance thus far in fiscal 2024. Growing net sales and comping positively in a declining category, while funding essential investments in long-term growth and maintaining a very healthy balance sheet. We’re committed to operating the business with great discipline as we navigate the current environment and build on our track record of market share gains, which will become more evident in the coming quarters.

We’re confident in the future. And we believe that we are well-positioned to deliver on our outlook for the remainder of this fiscal year and capitalize on any opportunities the macro backdrop offers. I want to extend my gratitude and appreciation to our Lovesac team. It is their execution that enables our best-in-category financial and operational performance and drives my confidence and excitement in our future. With that, I’ll hand it over to Mary to cover our strategic priorities and progress in more detail. Mary?

Mary Fox: Thank you, Shawn, and good morning, everyone. We’re pleased to have extended our track record of industry leading growth for quarter two and also quarter three, as you can see from our preliminary results. Our second quarter net sales growth of 4% continues to be significantly ahead of the category, and more importantly, is up 221% on a four-year basis to give a comparison to pre-pandemic levels. And even with the planned SG&A deleverage that Shawn mentioned, adjusted EBITDA margin has increased over 1,000 basis points over the same four-year time period. It is our unique and compelling design for life platform and the virtually unparalleled value proposition it offers that enables us to continue to profitably take share even with current market dynamics.

With a clear strategy for growth and crisp execution by a team that is coalesced around the priorities that support our growth strategy, we continue to drive operational excellence across the business and make progress as illustrated by the highlights I will now share with you. Firstly, starting with product innovation. As previously announced, our highly anticipated new product introduction, the Angled Side first launched in May in conjunction with our 25th anniversary brand campaign. Our customers have been very receptive. As we have discussed before, Star was the number 1 reason, customers left our purchase funnel and the Angled Side addressed our biggest opportunity around disparity to purchase. But the benefit is not only aesthetic, we also received strong feedback on enhance, comfort from existing and new customers.

During third quarter, we expanded distribution and the Angled Side has now been available across our showroom base as well as our e-com platform since the end of July. A full media campaign launched during the summer is support and helped drive Angled Side as a percentage of total size sold to over 40% in recent periods. We believe we will continue to gain market share through this new product introduction as awareness and appreciation continues to grow. Secondly, our omnichannel experience. We continue to execute as a true omnichannel retailer through a combination of our physical touch points and digital platform. During second quarter, we opened 18 showrooms and three Best Buy shop-in shops. Our success in driving strong efficiencies in the time from construction to opening enabled us to pull-forward some openings with 15 of the 18 showrooms opening ahead of our original schedule.

With regards to our Costco partnership, sales were up 15% in Q2, driven by increased pop-up shop presence versus last year. Our e-commerce channel performance continued to impress, up 12.8% for last year including costco.com and bestbuy.com and contributing meaningfully to our category outperformance. Underlying all channels and proof that our plan is working, our customer satisfaction scores continue to improve and increase sequentially, driven by surgical initiatives in enhancing the digital experience and customer service improvements with technology investments in our customer loved teams. Thirdly, our brand ecosystem. Our efficient marketing, including our strong customer lifetime value to customer acquisition cost ratio lies at the center of our ecosystem and serves as an effective driver of fans awareness and customer acquisition.

The back end, we are being very selective about marketing where the traffic is and where the eye bills are, as we continue to widen our customer aperture with both product innovation and marketing strategy and tactics. We continue to deploy new marketing tactics, including continuing to invest in high ROI performing programs and growing hyper local marketing to drive relevant traffic to our touch points. We remain focused on customer acquisition and have been utilizing vehicles such as direct mail campaigns that deliver strong ROIs for us. As previously mentioned, we’ve also begun leveraging prime and linear TV buys to continue to drive reach and strengthen our brand love. The objective of our launch of Angled Side was to broaden our aesthetic appeal to address the segment of the market that we were missing with our current assortment.

So we partnered with Architectural Digest, a leader in style to launch the product. The launch partnership included content and advertisement on architecturaldigest.com and their partners as well as the launch event in New York City with designers and influencers, which generated additional content driving awareness of the launch. To-date, we are over 750 million impressions from this launch partnership and really pleased with not only the reach, but also the quality of the coverage. Regarding our circular operations initiative, we have made good progress on our open-box inventory as we focus on improving the executional effectiveness and brand experience. And we are seeing over 20% improvement in returns back to start versus last year as one key measure for this initiative.

And then lastly, disciplined infrastructure investments and efficiency. For fiscal 2024, we are investing in the areas of technology and research and development to best fuel our Infinity Flywheel. We are focused on continuing to enhance customer satisfaction through continued delivery of orders in just days. In addition, we believe our recent investments in supply chain will help drive inventory product improvements of 20%. We’re pleased with the team’s progress so far and are on track to deliver this by year-end. As we’ve said before, we expect these initiatives will drive a significant improvement in efficiency of working capital as well as associated cost reductions across inbound freight and warehousing, which we started realizing in quarter three and will continue to realize in quarter four.

Our AI pilots that we mentioned last quarter provides generative AI-guided experiences to our customer-facing service associates to improve customer service and we’re pleased with initial results. So it is still very early. We continue to believe this has the potential to enhance the overall customer shopping experience and we are already seeing the benefits in the specific customer service satisfaction for improvement. As part of our people infrastructure investments, we recently appointed Carly Kawaja as our new Chief People Officer, as we continue to build our capabilities and evolve the organization strategically so that we can effectively scale the business. Through leveraging our extensive human resources experience we will be very strategic, building our organization through an optimal balance of human resources and impactful and efficient technology capabilities.

Make no mistake, we are laser focused on operational excellence as we manage our cost structure and capital allocation. As Shawn mentioned, this will become more evident in coming quarters as deleverage abate. In summary, we’re pleased with our year-to-date performance and are ready to deliver the all-important fourth quarter. We’re very proud of our team and their continued execution against our strategic initiatives, which in turn further strengthens our competitive positioning and powers our Infinity flywheel. I will now pass the call over to Keith to review our quarter two results and our outlook for quarter three and the balance of the year. Keith?

Keith Siegner: Thank you, Mary. Before I get started, I want to express how excited I am to be here today as part of this amazing team that this remarkable brand, this truly differentiated business model. After having spent 16 years covering consumer companies on Wall Street, then being part of the leadership and a large-cap consumer company and the start-up, I can say the outlook for profitable growth at Lovesac is truly special. Between continued growth and market share gains for Sactionals and Saks, introduction of new products and categories and eventual geographic expansion, the opportunity is immense. All right. On to a quick review of second quarter, followed by our outlook for the rest of fiscal 2024. Net sales increased $6 million or 4% and to $154.5 million in the second quarter of fiscal 2024, with the year-over-year increase driven by web and showrooms.

This was in line with what we projected for the quarter driven by our July 4th promotional campaign and 25th anniversary celebration. Showroom net sales increased $5.8 million or 6.3% to $98.2 million in the second quarter of fiscal 2024 as compared to $92.4 million in the prior year period. The increase in Showroom sales was driven by an increase of 2.7% in comparable Showroom sales related to higher point-of-sale transactions with lower promotional discounting than the prior year, and the net addition of 49 net new showrooms compared to the prior year period. As a reminder, point-of-sale transactions that we reflect in our comparable sales metrics, represent orders placed through our showrooms, which does not always reflect the point at which control transfers to the customer and when net sales are recorded.

Internet net sales increased $5.9 million or 16.6% to $41.4 million in the second quarter of fiscal 2024 as compared to $35.5 million in the prior year period. Other net sales, which include pop-up shop, shop-in-shop and open-box inventory transactions decreased $5.7 million or 27.7% to $14.9 million in the second quarter of fiscal 2024. The decrease was principally due to a lower open-box inventory transactions, only $2.8 million compared to $9.5 million in the second quarter fiscal 2023. As a reminder, our open-box inventory transactions with ICON are a part of our circular operations, design for life and ESG initiatives. We’re making great progress in reviewing all options for this returned product to align with our sustainability goals, and which should retain more profits for Lovesac at the same time.

We expect some of these initiatives to ramp in Q4. In the meantime, we may engage in limited open-box inventory transactions with ICON to ensure our warehouses are operating as efficiently as possible. In fact, in the third quarter, we will have an incremental $2.5 million in open box sales, which are included in our outlook. By product category, in the second quarter, our Sactional net sales increased 3%. SaaS net sales increased 18% and our other net sales, which includes decorative pillows, blankets and accessories increased 12% over the prior year. Gross margin increased 650 basis points to 59.8% of net sales in the second quarter versus 53.3% in the prior year quarter, primarily driven by a decrease of 720 basis points in total distribution and related tariff expenses.

This was offset partially by 70 basis points of pressure from higher promotional discounting. The decrease in total distribution and related tariff expenses over the prior year is principally related to the positive impact of 880 basis points decrease in inbound transportation costs, partially offset by 160 basis points in higher outbound, transportation and warehousing costs. As a reminder, the benefits of the decrease in inbound freight rates will continue in the third quarter albeit at a slightly lower level. SG&A expense as a percent of net sales increased by 840 basis points, primarily due to deleverage within employment costs, selling-related expenses tied to the Lovesac credit card and continued investments to support current and future growth as well as professional fees.

In dollars, employment costs increased by $5.7 million, primarily driven by an increase in new hires in fiscal 2023. Overhead expenses increased $6.2 million, consisting mainly of increases of $3 million in professional fees and $3.2 million in infrastructure investments in other miscellaneous items. Rent increased by $0.9 million related to $1.9 million rent expense from our net addition of 49 showrooms, partially offset by $1 million reduction in percentage rent. We estimate non-recurring incremental fees associated with the restatement of prior period financials was approximately $1.7 million in the second quarter. Advertising and marketing expenses increased $7.4 million or 39% to $26.5 million for the second quarter of fiscal 2024 compared to $19.1 million in the prior year period.

Advertising and marketing expenses were 17.2% of net sales in the second quarter as compared to 12.9% of net sales in the prior year period. The primary contributor to the increased percentage was the launch of the 25th anniversary campaign. This will serve as the foundation for many of our marketing messages through the remainder of the fiscal year. Operating loss for the quarter was $1 million compared to operating income of $8.1 million in the second quarter of last year, driven by the factors we just discussed. Before we turn our attention to net loss, net loss 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 this morning.

Net loss for the quarter was $0.6 million or negative $0.04 per diluted share compared to net income of $5.8 million or $0.37 per diluted share in the prior year period. During the second quarter of fiscal 2024, we recorded an income tax benefit of $7,000 as compared to a $2.3 million tax provision for the second quarter of fiscal 2023. The change in provision is primarily driven by the net loss for the quarter. Adjusted EBITDA for the quarter was an income of $5.3 million as compared to adjusted EBITDA of $12.3 million in the prior year period. Adjusted EBITDA for the second quarter was ahead of our expectations, principally driven by the upside to gross margin. Turning to our balance sheet. Our total merchandise inventory levels are in line with our projections, and have leveled out, as we discussed on our prior call.

This is despite the addition of Angled Side SKUs, and we believe this is a clear highlight of the uniqueness of our business model. We feel exceptionally good about both the quality and quantity of our inventory and our ability to maintain industry-leading in-stock positions and delivery times. We ended the second quarter with a very healthy balance sheet, inclusive of $54.7 million in cash and cash equivalents as well as $36 million in availability on our revolving line of credit with no borrowings. Please refer to our earnings press release for other details on our second quarter financial performance. So now our outlook, and let’s start with the fiscal third quarter. We estimate net sales of $154 million. This includes approximately $2.5 million of open-box inventory sales compared to $4.2 million in the third quarter of fiscal 2023.

We expect adjusted EBITDA between positive $0.5 million and negative $1.5 million. This includes gross margins between 56% and 57%. Merchandising and advertising slightly above 14 as a percent of net sales and SG&A slightly above 44% as a percent of net sales. We estimate net loss to be $3.2 million to $5.2 million. This includes approximately $1 million of non-recurring incremental expenses associated with our restatement of prior period financial statements. We estimate diluted loss per common share is expected to be $0.20 to $0.33 with 15.5 million weighted average shares outstanding. Now, for the full year fiscal 2024. We are tightening the range of our full year outlook for net sales to $710 million to $730 million. We expect adjusted EBITDA between $51 million and $63 million.

This includes gross margins of $57 million to $57.5 million merchandising and advertising of slightly above 13% as a percent of net sales and SG&A between 37% and 38% as a percentage of net sales. We estimate net income to be between $20 million and $29 million. These fiscal 2024 estimates include approximately $4 million of non-recurring incremental expenses associated with our restatement of prior period financial statements. We estimate diluted income per common share in the range of $1.21 to $1.75, and approximately 16.5 million estimated diluted weighted average shares outstanding. As a reminder, the 53rd week in the fourth quarter is expected to contribute approximately $6 million in net sales. Quickly on our cash balance outlook. Given the timing of new touch point openings and our planned flow of inbound inventory ahead of the seasonally strong fourth quarter, the third quarter tends to be our lowest quarter ending cash balance of the year.

I’m pleased to share that we ended fiscal third quarter with approximately $37 million in cash, which is up substantially from $3.8 million at the end of third quarter fiscal 2023. As we monetize inventory through the busy season, we continue to estimate we will end fiscal 2024 with a higher net cash balance than we ended fiscal 2023. So in conclusion, we are pleased with our second quarter results. Market share gains, strengthening foundations, exciting new growth drivers and a healthy balance sheet, put Lovesac in an enviable position. I’m new here, but I’m already very proud of the team’s execution and what continues to be a challenging macro backdrop as well as their exuberance for optimizing the opportunity ahead of us. With a strong focus on growth, underpinned by an ROI-based approach to measured reinvestment I’m confident in the outlook.

I’ll now turn the call back to the operator to start our Q&A session.

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Q&A Session

Operator: Thank you. Ladies and gentlemen, we will now be conducting a question-and-answer session. [Operator Instructions] Our first question is from Thomas Forte with D.A. Davidson. Please go ahead.

Thomas Forte: Great. So congrats on the performance and welcome, Keith. I have one high-level question. I wanted to give you an opportunity to address the question, I guess, from investors a lot. You have a great business with a high gross margin, yet historically you have not generated a lot of free cash flow. What have been the limiting factors in the past for this? How might this change in the future? And when you get to a point where you’re generating significant free cash flow, how do you intend to use it including reinvesting in the business, buybacks and strategic M&A? Thanks.

Shawn Nelson: Yeah. Thanks for the question, Tom. I appreciate where it’s coming from. This is Shawn. Lovesac has been on a rapid growth curve for about a decade now. I think when we look at our CAGR going back many, many years, it’s extremely high. Leading into the pandemic — heading into the pandemic brought an unprecedented growth and we’ve just been focused on chasing that, chasing market share and building the business in the most profitable way that we know how. Now that we’ve achieved the scale that we’re at today, I believe that even in real time, the evidence of free cash flow growing and producing the kind of results that you’re — I think investors would hope for and expect out of a business that’s the cheapest kind of scale will be evident, and we’re really excited about that.

Obviously, here, we’re reporting on Q2, which is a strong path, because of the restatement process. But we’ve given a flash on Q3. And while we haven’t spoken specifically about cash, we feel really encouraged about those results and believe that the evidence of this business’ ability to generate free cash flow will be obvious. And so looking forward to sharing more on that, I’ll kick it to Keith who can probably give a little more insight.

Keith Siegner: Thanks, Shawn. So this is a topic that’s near and dear to my heart. And I think listening to each of the three of us, both Shawn, Mary and myself, I think you would have heard a very clear commitment to a disciplined approach to reinvestment both in the organization and in future growth drivers. But just to put a couple of numbers around this in terms of proof in the pudding, you could say, look, SG&A deleverage, as an example, was a little over 840 basis points in the second quarter. When you build into your model, the G&A ranges that I gave you for the third quarter for the full year. What you’ll see is that deleverage in SG&A in Q3, let’s call it approximately half of what we had in 2Q and then when you see what falls out for fourth quarter, it’s a substantial reduction even from there. So this isn’t a fiscal 2025 only commitment. You’re going to start to see this flow through in the next couple of quarters.

Thomas Forte: Thank you.

Operator: Thank you. Our next question is from the line of Maria Ripps with Cannacord Genuity. Please go ahead.

Maria Ripps : Great. Good morning and thanks for taking my questions. First, I just wanted to ask about your outlook for Q4, which implies a pretty wide range for revenue growth for your biggest quarter. Can you maybe just talk about what’s implied in your assumptions, both at the lower and the upper end of your guidance? And then I have a quick follow-up.

Keith Siegner: Sure, thing. So I’ll start with a couple of numbers around this, and then if Shawn or Mary want to add in some high level. It’s basically a $20 million range on a big quarter given the macro backdrop that remains a little uncertain as you’re hearing from pretty much everybody in the consumer category, particularly in our — including in our close-in categories. The way we’re thinking about approaching that range is to plan prudently and allocate expenses prudently. We have a really unique business model that lets us react to upside surprises and demand much more quickly than others given that we’re not merchandising led and can fulfill orders in retail inventory really quickly. So we think it’s a better approach.