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spk06: Greetings and welcome to the Lovesac third quarter fiscal 2022 earnings call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Ms. Rachel Schachter of ICR. Thank you. You may begin.
spk03: Thank you. Good morning, everyone. With me on the call is Shawn Nelson, Chief Executive Officer, Jack Krause, Chief Strategy Officer, Mary Fox, President and Chief Operating Officer, and Donna Delamo, 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 discussion of these risks and uncertainties, you should review the company's filings with the SEC, which includes today's press release. You should not rely on our forward-looking statements as predictions of future events. All forward-looking statements that we make on this call are based on assumptions and beliefs as of today, and we undertake no obligation to update them except as required by applicable law. Our discussion today will include non-GAAP financial measures, including EBITDA and adjusted EBITDA. These non-GAAP measures should be considered in addition to and not as a substitute for or in isolation from our GAAP results. A reconciliation of the most directly comparable GAAP financial measure to such non-GAAP financial measure has been provided a supplemental financial information in our press release. Now, I'd like to turn the call over to Sean Nelson, Chief Executive Officer of the Lovesac Company.
spk00: Thank you, Rachel. Good morning, everyone, and thank you for joining us today. I will begin by reviewing the highlights of our third quarter financial and operational performance before Jack outlines our third quarter progress on our key growth initiatives. Donna will wrap up our prepared remarks with a review of our financial results and a few other items related to our outlook. Also joining us on the call today is Mary Fox, who, as you know, was appointed president and chief operating officer at Lovesac on November 15th, assuming the same role that Jack filled before. As you are aware, Mary had been serving on our board of directors since February 2020. She brings a strong digital and brand building background to Lovesac that spans a 25-year career in the consumer goods sector. significant experience in scaling businesses, and extensive supply chain and operational expertise as well. Along with her keen and prescient adoption of ESG principles, she has an expansive knowledge of Lovesac's unique business model. And all of these attributes make Mary a particularly great fit, especially given Lovesac's growth trajectory. We're thrilled to have her as part of the leadership team and equally excited that Jack will be serving in the newly created role of chief strategy officer, as well as having recently been appointed to join the board of directors. We are very pleased with our third quarter results, delivering growth of 56.1%, while improving net income by 11% for the quarter, even in the context of making significant investments in our infrastructure. This sales growth is on top of last year's 43.5% growth, so our continued and widening growth this year is a testament to the strong demand for our product, growth in brand awareness and conversion, even as we are actively managing the tight supply chain environment. We experienced growth across all sales channels, including, most notably, an increase in showroom sales of nearly 70% and a nearly 40% increase for internet sales. This marks 14 consecutive quarters of greater than 25% growth with continued improvement overall in our ability to generate cash and profits. One of our major competitive advantages is that we are generally totally in stock and expect to be in stock delivering nearly all orders direct to consumer in just days amidst a challenging supply chain backdrop. Customers are continuing to recognize the strength as reflected in our Q3 results. and consistently strong customer satisfaction scores throughout this tumultuous time. This has always been something that distinguishes Lovesac, and in this environment, where industry lead times can stretch into months, it is particularly advantageous. Our ability to maintain stock levels is rooted in our product design and business model. Factionals drive more than 80% of our sales, but more than half of those dollars are supported by just two SKUs, seats and sides. What's more, We manufacture those two SKUs redundantly with no variation in quality across diversified manufacturers in three different countries, allowing us to better manage unplanned events like disruptions from COVID flare-ups, et cetera. This inventory is not seasonal and does not go bad or become irrelevant with time. So investment in this type of inventory is lower risk than most. Our core products are packed and shipped in very unique ways that allow for extreme efficiency inside of ocean containers and via FedEx direct to the consumer's home. While we are not immune to the currently elevated container and inbound freight costs, our packaging and shipping solution helps to partially offset these costs and risks. Our growth and in stock position is also a testament to the incredible job our teams are doing across the organization. Adjusted EBITDA of 5.8 million exceeded our outlook of a loss of negative 3 to negative 4 million as we beat our sales goals and absorbed expected freight headwinds, while simultaneously making important people and infrastructure investments in support of our growth. While we expect some gross margins headwinds to persist in the near term, which Jack and Donna will expand on, in the long term, We remain committed to a mid-50s gross margin rate as the environment normalizes, and we continue to scale the business. We have raised prices at MSRP some already, and we are discounting less to counteract gross margin headwinds. We will continue to move the business in this direction and believe we can continue to generate very strong gross margins relative to this category, even in this challenging environment. Operationally, a key highlight of the quarter was the much-anticipated launch of the Saxional Stealth Tech Sound Plus Charge product. This is the first of its kind innovation, which leverages new Lovesac patents to deliver an immersive surround sound system developed in partnership with Harman Kardon and convenient wireless charging, all seamlessly embedded and hidden inside the endlessly adaptable Saxional's platform. It is the only home theater system that is hidden in plain sight. From the business perspective, this launch accomplishes many goals. Not only does it increase our relevancy with our existing consumers and with new consumers, it also expands our competitive differentiation by creating an even deeper moat, given there is no one else that offers this unique product. Initial customer response has been extremely positive so far. And with the base price of the Stealth Tech portion of the system at about $3,000, that has the potential to nearly double the average order value of transactions it is included in on top of the typical sectional AOV of $3,400. Like sectional sofas, the TAM or total addressable market for home audio equipment is very large in terms of categories to compete in within the home segment. But as home audio is a completely different category to upholstered furniture, Stealth Tech's introduction presents little to no threat of cannibalization to our current business. Furthermore, a stealth tech ad on TV or digital is the same ad as that for Saxional. They are rolled into one and therefore essentially cost no more than we were paying before to advertise Saxional. As surprising as it may sound, Lovesac intend to compete in home audio and win. Our system is unlike any other. And in many ways, we believe it is the best one available in the market today. Turning to our ESG efforts, we are on track to publish our inaugural ESG report later this month. This fiscal year 2021 inaugural report that aligns with the Sustainability Accounting Standard Board's SASB, Building Products and Furnishings Sector Standard, sets the benchmark for Lovesac's ESG journey, supporting our commitment to achieving a 100% circular and sustainable business model, reaching targets of zero waste and zero emissions by 2040. In the coming years, we plan to focus on measuring emissions across our value chain. Future reporting will align with the Greenhouse Gas Protocol corporate accounting and reporting standard, which provides requirements and guidance for companies. And Jack will discuss in detail our progress on other growth strategies, including our marketing and merchandising strategies, showroom operations, expanding other channel presence, and making disciplined investments. As we look to the final quarter of the year, we are well positioned for the upcoming holiday season. We expect the operating and supply chain environment to remain dynamic, but as described above, we believe Lovesac is better suited than most in our categories to remain in stock and successful throughout. The fourth quarter is always a heavily weighted time period for us. We operate more than 120 high traffic showrooms located mostly in the highest traffic malls across the United States. We believe that Saks and now Stealth Tech products represent one of the coolest holiday gifts any family could hope for. And post-holiday is a strong month for all of home decor naturally. And because our fiscal year cutoff is at the end of January, this adds to our fourth quarter waiting. Now on the other side of Black Friday and Cyber Monday, as a brand that garners 100% of its sales by direct consumer and digital means and has immediate access to all sales and customer data, we can confidently say that we can expect continued strong growth for the quarter, and we look forward to driving more market share gains. Looking ahead, we intend to just keep doing what we've done for almost four years straight now, generate high sales growth while increasing EBITDA margins on an annual basis. Were it not for the huge leap we made at the EBITDA line last year in the context of significantly holding back on spending during the early parts of the COVID pandemic, we would be increasing EBITDA and EBITDA margins this year. But looking at fiscal year 22 this year, on a two-year basis, we expect a trajectory of increasing profitability. We also expect to continue to manage this business in a way that will allow us to stay on the course to lift annual EBITDA margins through next year, despite pressures at the gross margin line in the near term due to macro forces. We believe this will allow us to emerge someday as a dominant player in our categories and become the most beloved brand in the home category, which is our stated mission, and maximize value to our shareholders over the long run. With that, I will hand it over to Jack to cover our strategic priorities and progress. Jack?
spk12: Thank you, Sean, and good morning, everyone. As we look to the next chapter of growth and the many opportunities that lie ahead, Lovesac will need talent, systems, and infrastructure to scale in a manner that drives value for all of our stakeholders, and I'm very excited to take on the new role of Chief Strategy Officer and Board Member in pursuit of this goal. I've had the benefit of getting to know Mary well since she joined our board and have witnessed firsthand her valuable contributions. I'm delighted to partner with her in her position as President and COO. Now, turning to our third quarter performance. We are very pleased with our third quarter results and the strides that we've made against our growth strategies, which I will now review. Starting with one, product innovation, of which the key highlight was our Stealth Tech launch on October 18th. It is in its early days, but the customer reception to this new product launch has been strong, and we are seeing associated increases in factional transaction AOVs that bode well for customer engagement, loyalty, and repeat purchases. Two, efficient, and marketing merchandising strategies. We continue to generate attractive marketing ROIs, and our marketing efforts continue to help raise overall awareness and deliver the 58% revenue growth year-to-date that we have experienced. Some Stealth Tech highlights. In the third quarter, with the launch of Stealth Tech, at the end of the quarter, we had introduced new and social assets with early indications looking very promising, including a 13% year-over-year increase in web sessions driven mainly by paid search. Broadcast syndication has been rolled out for holiday after successful local testing during Memorial Day and Labor Day and resulted in an increase in overall TV reach by 25%. Additionally, as part of the Stealth Tech product launch, Lovesac has partnered with Amazon Video's newest series, Wheel of Time, which launched in the third quarter and had great success. In terms of social and digital marketing, social CPM continues to increase on core channels but this is largely offset by higher conversion rate. Despite continued increases in CPM across our digital media channels, our established digital strategies and newer initiatives like SMS marketing, hyperlocal advertising, and consideration advertising are driving strong engagement, conversion, and revenue performance. Overall media ROI continues to perform above our benchmarks, and while we expect overall media to continue to see cost pressures, especially in the fourth quarter, due to holiday retail pushes, we anticipate offsetting this by higher conversions. Three, touchpoint operations. We are continuing to see synergies across our various touchpoints where customers can experience the product, feel how good it is, and make their final decisions. Our showrooms continue to be an important part of our omni-channel touchpoint strategy and continue to deliver strong results, as reflected in our Q3 showroom comps of plus 53%, or 79% two-year comps. We opened nine new showrooms in Q3 and remain on track to open 28 for this fiscal year. With added capabilities like the on-the-spot scheduling specialists, we continue to enhance the showrooms shopping experience. Throughout the third quarter, the post-purchase specialist team continued to expand their reach across both physical, touchpoints, and e-commerce. In Q3, post-purchase specialists communicated with over 92% of Lufstack customers whose purchases and and that's the predetermined dollar threshold for their service. We are continuing to see a lift in post-purchase CSAT scores for customers who engage with a post-purchase specialist versus those who did not. We continue to roll out our sales and service strategy throughout Q3 and will be present in all touch points in Q4. This rollout leverages talent across trade areas to support customers in their shopping journey, both pre- and post-purchase, with the goal of enhancing the customer experience and further increasing customer satisfaction. We are continuing to expand our real estate strategy with the launch of two mobile concierge vehicles in Q3. These vehicles serve as additional asset-like touchpoints in key markets. Preliminary results are exceeding conversion and AOV expectations, and we are evaluating the launch of additional vehicles next year. In addition, we opened one kiosk in Q3, and are on track to open up to eight branded kiosks by the end of Q4 in markets with and without a showroom presence. Delftec has been incorporated into the showroom, kiosk, and mobile concierge experience and would be rolling out to the balance of our Best Buy shopping shops in Q4. While we have returned to normal operating procedures, we continue to monitor the pandemic situation carefully, following local and state guidelines and prioritizing the health and safety of of both our customers and team members. And number four, expanding our other channel presence. We're very pleased with the strength of the Costco business, which we're hosting our online roadshows directly with Costco.com, and we have seen productivity increases year over year, driven by an expanding premium cover and LoveSoft offering. We continue to be excited about the partnership with Best Buy, as we have seen our BestBuy.com business increase at a strong rate this year, which we attribute to performance to our customer experience on BestBuy.com, as well as some marketing tests that we run. In addition, we opened one Best Buy shop-and-shop in the third quarter. We will continue to pursue opportunities with other partners as our other channel presence continues to be an effective way of expanding our brand awareness and reach. Five, making disciplined infrastructure investments. Starting with e-commerce, we continue to make key investments to enhance our e-commerce re-platform during the quarter. Conversion rate continued to be a highlight for us in Q3, with an improvement of 58% versus OY, driven by a 74% increase in mobile conversions. Integrating stealth tech into e-commerce shopping experience was a major accomplishment during the quarter. We have made stealth tech selection process during online shopping experience customized and easy for new and existing customers based on transactional size and configuration. We've also upgraded the latest version of Magento to platform, which includes significant security updates heading into this holiday season. In September, we successfully launched a new customer data platform, or CDP. This platform unifies and enhances our customer and shopper data giving us the ability to expand our usage of first-party data for digital marketing and provide the intelligence needed to personalize the omni-channel customer experience even further. Regarding supply chain updates, our strategic investments in forward inventory placement, product flow optimization, and supply chain redundancy allowed us to maintain a differentiated position in in-stock and order fulfillment, which helped drive our Q3 results. For the all-important holiday season, our inventory is well-positioned heading into our busiest time of the year. As we look ahead, we expect the same supply chain headwinds to persist throughout fiscal 2023. Over the near term, we continue to mitigate through several tactics and are responding over the longer term with key initiatives to reinforce our sourcing-based supply chain channels and end-to-end investments. So, in summary, We are pleased with their third quarter financial performance and the progress made against our strategic growth initiatives. Our strong Q3 results reflect the exceptional execution by the entire Lovesac team as we continue to navigate a dynamic operating environment. We feel good about the underlying momentum and trajectory of the business for the holiday season and look forward to closing out the year strong. Before Donna reviews our Q3 results, I wanted to turn the call over to Mary, President and Chief Operating Officer, for a few brief introductory remarks. Mary?
spk09: Thank you, Jack. I'm delighted to be part of the Lovesac leadership team with Sean, Jack, and Donna. And as you can all imagine, it's been a busy and productive month since I joined on November the 15th, both getting to know the business even further in addition to meeting all of the teams. From my time on the board throughout my career and as a Lovesac customer for the past 11 years, I have gained great respect and admiration for Lovesac's differentiated direct-to-consumer business model, unique product, loyal customer base, and deep commitment to sustainability, including its circle-to-consumer philosophy. I'm very honored to take on this new role and will leverage my expansive experience working with consumer goods companies throughout my career to help execute the company's growth strategy and drive long-term value. With that, I will hand the call over to Donna to review our third quarter financial results. Donna?
spk04: Thank you, Mary. Good morning, everyone. I will begin my remarks with a review of our third quarter results and then provide an update on the framework I shared with you last quarter as it relates to how we are approaching the remainder of fiscal 2022. Net sales increased $42M or 56.1% to $116.7M in the third quarter of fiscal 2022 as compared to $74.7M in the prior year period. The year-over-year net sales increase was driven by growth across all channels, with overall comparable sales increasing 47.1% due to the success of our Labor Day campaign, 28 year-on-year increase in ending showroom count, and higher productivity of our temporary online pop-up shops on Costco.com. Showroom net sales increased 28.2 million or 67.8% to $69.7 million in the third quarter of fiscal 2022 as compared to $41.5 million in the prior year period. This increase was due primarily to a $19.5 million increase in comparable showroom point of sales transactions to 56.1 million in the third quarter of fiscal 2022 as compared to $36.6 million in the prior year period. As a reminder, point-of-sales transactions 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. In addition, we opened 28 additional Love Sock showrooms, including two mobile concierge and one kiosk, since the third quarter of last year, which was a meaningful driver of non-comp showrooms sales increase. Internet net sales, sales made directly to customers through our e-commerce channel, increased $9.8 million, or 38.2%, to $35.5 million in the third quarter of fiscal 2022, as compared to $25.7 million in the prior year period, principally driven by the performance of our Labor Day campaign this fiscal year. Other net sales, which principally includes pop-up shop and shop-in-shop net sales, increased $3.9 million, or 52.7%, to $11.9 million in the third quarter of fiscal 2022, as compared to $7.5 million in the prior year period, with the increase primarily related to higher productivity of our temporary online pop-up shops on Costco.com. By product category, Our sectional net sales increased 58.6%, SAC net sales increased 39.2%, and our other category net sales, which includes decorative pillows, blankets, and other accessories, increased 69.8% over the prior year quarter. The decrease in gross margin percentage of 510 basis points over the prior year period was primarily driven by an increase of approximately 748 basis points in total distribution and related tariff expenses, partially offset by an improvement of 238 basis points in product margin. The increase in total distribution and related tariff expenses over prior year was principally related to the negative impact of 953 basis points increase in inbound transportation costs and increased tariff related to higher product sourcing from China, partially offset by 205 basis points improvement due to higher leveraging of warehousing and outbound freight costs. The product margin rate improvement was due to lower promotional discounting and continuing vendor negotiations to assist with the mitigation of tariffs. We exceeded the third quarter net sales guidance we shared with you on the last call. primarily driven by the success of our Labor Day campaign and higher shipment volume due to higher warehouse throughput. Our gross margin percent in the third quarter of fiscal 2022 was in line with our guidance, which contemplated continued supply chain headwinds that are driving higher inbound transportation costs. We were able to partially mitigate these higher costs through continued reductions in promotional discounting, selective price increases, and better leveraging of our warehousing and distribution costs. The 46.8% year-over-year increase in SG&A was driven largely by higher employment costs due to an increase in new hires and variable compensation. We also had higher rent expense from the additional 28 showrooms and higher percentage rent from the increase in net sales. Overhead expenses increased due to infrastructure investments, travel expenses, and equity-based compensation. Selling-related expenses also increased primarily due to credit card fees related to the increase in net sales. SG&A expense as a percent of net sales decreased by 207 basis points due to higher leverage within infrastructure investments, equity-based compensation, insurance, rent, and selling-related expenses. partially offset by a deleverage in employment costs and travel. The deleverage in certain expenses was related to the investments we were making into the business that were put on hold in the prior year related to COVID-19 financial resilience measures. SG&A expense was lower than our expectations in the third quarter, principally related to lower employment costs due to delays in hiring, planned in-person company meetings shifting to virtual events, and a shift in some of our infrastructure investments into the fourth quarter of the fiscal year. This favorability versus our expectations was partially offset by higher rent expense and higher credit card fees due to the increased net sales. Advertising and marketing expenses increased $4.8 million or 44.3% to $15.8 million in the third quarter of fiscal 2022 as compared to $11 million in the prior year period. resulting from continued investments in marketing expense to support our sales growth. Advertising and marketing expenses were 13.6% of net sales in the third quarter of fiscal 2022, as compared to 14.7% of net sales in the prior year period. The 111 basis points decrease was due to improved performance in media activities, driving higher sales volume at lower promotional discounting. Depreciation and amortization expense decreased approximately $200,000 from the prior year period to $1.7 million, primarily due to the accelerated depreciation expense in the prior year period, partially offset by current year capital investments for new and remodeled showrooms. In the third quarter of fiscal 2022, operating income was $3 million as compared to an operating income of $2.5 million in the third quarter of last year, driven by the factors just discussed. Net interest expense for the third quarter was approximately $45,000, principally relating to unused line fees on a revolving line of credit. Tax expense in the third quarter of fiscal 2022 was $174,000 as compared to $11,000 in the prior year period with the increase related to minimum state income tax liabilities. 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 gap measurements in our earnings release issued earlier today. Net income was $2.8 million or 17 cents per diluted share in the third quarter of fiscal 2022 compared to net income of $2.5 million or 16 cents per diluted share in the prior year period. We generated adjusted EBITDA of $5.8 million in the third quarter of fiscal 2022 as compared to adjusted EBITDA of $6 million in the prior year period. Turning to our balance sheet, our liquidity continues to remain strong as we ended the third quarter with $47.9 million in cash and cash equivalents and $22.5 million in availability on our revolving line of credit. Please refer to our earnings press release for other details on our third quarter fiscal 2022 financial performance. Turning to our outlook, we expect to close out another year of strong sales growth with 28 new low shock showrooms, the opening of eight kiosks, and the introduction of two mobile concierge. We've been restoring expenses that will pull back in fiscal 2021 due to the pandemic and strategically making infrastructure investments to support the substantial multi-year growth opportunity that lies ahead. For our fourth quarter, we expect sales growth of approximately 35% with adjusted EBITDA dollars in the 12 to $13 million range compared to positive adjusted EBITDA of $25.9 million in the same quarter last year. Adjusted EBITDA is being impacted by expected lower gross margins of approximately 1,000 basis points year over year due to significant supply chain headwinds, most notably current inbound freight rate inflation versus the prior year. As we look to fiscal 2023, we remain confident in the trajectory of the business. While we are not providing formal guidance for fiscal 2023 at this time, at a high level, we expect healthy net sales growth in the high 20% range and adjusted EBITDA growth to exceed net sales growth. This is despite an expectation that supply chain headwinds persist throughout fiscal 2023. As a result of our continued supply chain headwind mitigation efforts, full-year gross margins are expected to be around 50%. In terms of CapEx spend, we continue to expect to end fiscal 2022 in a healthy cash and cash equivalent position and now expect CapEx to be in the $16 to $17 million range versus the prior $17 to $18 million range shared. This includes CapEx spends for our new showrooms, kiosks, and mobile concierge openings that we shared earlier. So, in conclusion, we are pleased with our Q3 results that exceeded our expectation from a net sales and profitability perspective. We are so proud of the excellent execution by the entire LOSAC team who remain agile and nimble amidst a dynamic backdrop. We are confident in our positioning for the fourth quarter and look forward to building on our success to date as we finish the year. With that, we would now like to turn the call back to the operator who can open it up for questions. Operator?
spk06: Thank you. At this time, I'll be conducting a question and answer session. If you'd like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. In the interest of time, we ask that you each keep to one question and one follow-up. Thank you. Our first question comes from the line of Brian Nagel with Oppenheimer and Company. Please proceed with your question.
spk08: Hi, good morning. Nice quarter. Mary and Jack, congratulations on your new appointments. Thank you, Brian. The first question I have, just with regard to the outlook and specifically gross margin. So you telegraphed for Q4 a 1,000 basis point reduction in gross margin. So that's – and you talked a lot about the factors you've been continuing with. That would represent – I guess it would be suggestive of more headwinds than we saw in the third quarter. So the question I have there is can you kind of articulate what that is? And where we are right now in the quarter, we're past, well, we're into the holiday season. Is that thousand basis point degradation what you're seeing at this moment?
spk14: Hey, Brian, it's Donna.
spk04: Good morning. Yeah, so that thousand basis points, if you remember, we take pretty heavy stock inventory positions, as Sean had mentioned earlier. um on the call right our inventory is evergreen um so it's just the timing of the cycling through the inventory um that has the hot the higher freight rates on it um what's coming through in the fourth quarter of this year is fully burdened by those higher freight rates so i think i mentioned on the the second quarter earnings call um you know our inbound container costs were This time last year, $5,000, we're paying over $26,000 a container at this point in time. So what we see coming through or coming through the financials in the fourth quarter is fully burdened by those costs. But the point of that is when we gave the not formal guidance for fiscal 2023, we're conservatively estimating that we will be impacted by those higher freight rates all throughout next year, which if they do turn around at any point in the year, that will be beneficial to us. So, again, fourth quarter we feel is fully burdened. And then going into fiscal 2023, again, very conservative approach that we're taking that we don't – We don't see any positive impact, but we're hoping it happens going into next year. So hopefully that helps.
spk08: No, that's very helpful. If a follow-up does on the supply chains, we understand the dynamics. So as we think about the supply chain disruptions, I know that you and a lot of other companies are discussing, and then the Lovesac P&L, is the impact isolated to cost of sales? You're not seeing any type of impact on sales?
spk14: Yeah, I'll start that and then Sean, you can add up.
spk12: At this point, we are in an excellent, because of the redundancy that Sean mentioned up front across the same product, really our sectionals platform, we are in a fantastic place in terms of inventory to carry out our sales projections for the rest of this year as well as the view we have into next year and we feel very good about that. It certainly hasn't been without a lot of actions by the team, but I think You know, our belief is this is during this type of period of time where there's so many questionable dynamics that this is truly a strength of the business we're going to lean into as we continue to disrupt the market and gain share.
spk14: Well, I'll turn the call over to someone else.
spk08: Thank you very much. I appreciate it.
spk06: Thank you. Our next question comes from the line of Victoria James with DA Davidson. Please proceed with your question.
spk02: Good morning. Thank you for taking my call. So my question then is, we've noticed your TV ads promoting your sectionals with Immersive Sound. Can you talk to us a little bit about your near-term market spending plans, including TV to promote your new effort? And then sort of in addition to that, how have your ads for your new Immersive Sound product also positively impacted your sectional sales for consumers buying them without that Immersive Sound?
spk12: Yeah, thank you. At this point, if you look at our overall spend, I'll say on an annual basis, you know, it's between 13% and 14% of net sales. So that's where we'll head. I think in terms of stealth tech, what it really has done for us, it provides another really unique selling proposition for the whole line. So we're seeing the ads be effective at not only lifting up The stealth tech sales, which we're seeing a very nice attachment rate, but we're also seeing very high ROIs and continued excellent run rates in terms of the core business as well. So we're continuing to evaluate it. As you probably know, we always do. We're constantly doing tests and learning. And so more to come as we get more experience about the dynamic between the stealth tech advertising included in the brand advertising, but right now they're really synergistic and they're lifting the overall business quite well.
spk14: Thank you. Thank you.
spk06: Our next question comes from Lyon of Camilla Lyon with BTIG. Please proceed with your question.
spk07: Thank you. Good morning, everyone. I want to get back to the gross margin discussion, if we could. It seems that In the third quarter, you experienced incremental margin pressure for more goods coming from China. Is this a result in the resulting tariffs that are still in place? Is that a result of supply disruptions from Vietnam? And if so, when do you expect a rebound in production such that tariff pressures from China will lessen as you shift some of that production out of the mainland?
spk14: Sorry about that.
spk00: Camila, to some degree that is true. We've shifted production around to our various manufacturers that manufacture satchels, Malaysia, China, Vietnam, based on COVID flare-ups, based on container availability, all these sorts of things. And next year, without a doubt, there will be fewer goods, fewer satchels manufactured in China than in the year that we are currently consuming them. And so... Tariff pressures is one of those puts and takes that will change the dynamic of gross margins for us throughout the course of next year. And it's part of the reason that while we're experiencing, as Donna put it, fully burdened gross margin pressure in Q4, there are a number of things moving within the business on the front end in terms of discounts, pricing, all sorts of things that affect our gross margins. And on the back end, like what you mentioned, that give us optimism in terms of what we can expect for gross margins overall next year. And so I think Q4 is unique in that way.
spk07: Got it. So it seems like Q4 margins really should be kind of the, the need year for over the next, you know, through next year, really. And it starts a, it starts to rebound, especially, or particularly in the back half, if there is any sort of relief on container shortages and overall freight costs. Is that a fair way to think about that, even though it doesn't look like you're guiding to that?
spk00: Yeah, we won't commit quarter to quarter how things will move yet. You know, it's obviously early looking forward toward next year without Q4 being, without being through Q4 yet. But from a logical standpoint, that's correct. And we believe that there are numbers, there are a number of things that we can do in the business to mitigate some of this gross margin pressure as next year evolves throughout the year. Great. And then I hope, sorry, go ahead, Jack.
spk12: Yeah. Just to add to that really is that you see the fully burdened fourth quarter. We knowingly made decisions to that, you know, as a brand that's disrupting and everybody knows, uh, our expectations in the longterm to grow. Um, That being in stock is critical over anything else as long as we can continue to maintain margins that are as strong as they have been on an annual basis, over 50%. Because of attracting customers, we're gaining CSAT dramatically. Our service levels are better than competition. So this is really a fertile environment while the headwinds are there on freight costs. We are not burdened by the supply chain issues that many others are having, and we're really leveraging that, and we'll continue over the next year because we do believe, obviously, after the year or so, we will start to see a normalization and we'll be in an excellent position for dramatically greater shares. That's the way we're looking at this.
spk07: That's great. And then just my follow-up on pricing. You mentioned that you've already taken selective price increases. Can you state what those have been? Does Selective become broad-based price increases next year? And if so, what are you seeing from a consumer response, if any, to those price increases?
spk12: Okay, so we've taken price increases on our core seats and sides, and we have an opportunity to also look at price increases on a lot of our cover business. But we want to be really careful. I think the way we're looking at it, there are obviously costs that are going to be long-term, and there are some long-term inflationary costs, but there are also a lot of transient costs. And what we don't want to do is manage our MSRP around what we think are the more volatile factors. So we did take the one MSRP change. I think the other aspect we have are a lot of opportunities to continue managing margin through promotion and mix management. which the team has done an amazing job on. And I would tell you that I think we have a lot of levers to continue to pull as we get through the year. What we don't want to do is be sort of too opportunistic in a very soft market in terms of supply, in terms of MSRP, because we don't want to be moving our MSRP around. So we're really looking to manage the next year through more tactical changes as we evaluate the price proposition. And look, the long-term price will be based on where we think adds the most value to the brand and the most stickiness. So we're managing from both ends, a very strategic point of view as well as tactical. I think you'll see more changes in the next six months in terms of ways of looking at promotions, et cetera, because what we are getting are tremendous levels of ROIs. out of our advertising, out of the awareness, out of the word of mouth. So the good news is I think we have some tailwinds that can help us manage some of these in terms of the brand stickiness that we're experiencing.
spk07: Fantastic. All the best through the balance of the year, guys. Thank you.
spk06: Thank you. Our next question comes from the line of Maria Rips with Canaccord De Nuit. Please proceed with your question.
spk05: Great. Thanks for taking my questions, and congrats on continued strength in the business. I just wanted to follow up on the Stealth Tech launch, sort of recognizing that it's still pretty early. Can you maybe talk about how customers are engaging with the product, to what extent it is attracting new buyers versus sort of reengaging existing buyers? And is there anything you can share about sort of the portion of product that is purchased by your existing customers at this point? And then I have a quick follow-up.
spk12: That's a lot. So I would say the first thing I'll say is I'll have a lot more information for you, or we will as a team have a lot more information for you at the fourth quarter call. Because really, just to put it in perspective, we launched Dell Tech at the end of the third quarter. We had demand in the third quarter, but we really haven't had actual net sales until the fourth quarter. But with that said, we are seeing some tremendous things. I can tell you this qualitatively from the field. Stealth Tech introduction has raised the level of engagement between the associate and the customers to amazing levels. And that's where I think, as I mentioned earlier, the Stealth Tech advertising is sort of a microcosm of what's happening in the field. It's lifting the interest in the brand. It's adding another very unique selling proposition to a brand that already has many and causing a lot of engagement in the showrooms. And I think that's why we're able to not only lift the sales of product without Stealth Tech, but Stealth Tech has a pretty high attachment rate. We've seen the attachment rate as high as 15%. We've seen it from both new and repeat customers. A lot of dynamics happening right now. So what I would say is, you know, and we've done modeling as well, it's going to attract new customers. We know that based on that total market that's addressable, that's the audio market. We also are seeing a lot of attraction by current customers and interest in current customers and adding it to their current setup. And that's really enhancing the DFL philosophy and the support, which we know our most loyal customers are really triggering to that idea of flexibility. So a lot more to come, and I think I'll be able to give you a more fulsome – outlook after the quarter, but we are seeing initially also AOVs that are pretty high related to the Stealth Tech purchases. So we're seeing about a $200 increase in AOV on sectionals when Stealth Tech is involved, and that's completely incremental. So we certainly are seeing some incrementality at the outset, and we look forward to sharing even more with you in the next quarter.
spk05: Thank you, Jack. That's helpful. And just going back to your preliminary outlook for next year, so you're guiding to EBITDA margin expansion despite sort of continued gross margin compression. Can you maybe just talk about where you see operating leverage coming from? I guess what should drive that?
spk04: Good morning, Maria. Yeah, so there's a couple of things. Normal SG&A, we're going to see some leverage in EBITDA. maybe not around payroll as we continue to build out the teams needed to support the healthy growth, but in normal consulting, insurance, professional fees, we're projecting leverage in those areas and also some slight leverage in marketing as the ROIs on marketing continue to increase. So, yeah, that's where it's coming through. Got it. Thanks so much. Yeah, things like rent, you know, some other items in the SG&A categories.
spk05: Got it. Thank you.
spk06: Thank you. Our next question comes from the line of Matt Caranda with Roth Capital Partners. Please proceed with your question.
spk11: Excuse me. Hey, guys. Thank you for taking the questions. Just spinning back to the gross margin topic. Just wanted to see if you could clarify for us how much of the inventory currently that you have on hand was brought in sort of during the peak of the inbound freight crunches. So if you look at inbound freight, probably at least ocean shipping kind of peaked in that July to August time frame. So I would assume most of your inventory at this time is sort of fully laden with those costs. But maybe you could speak to sort of how much inventory has been brought in since that time.
spk04: Yeah, Matt, you're right. It's probably close to 100% of the inventory that we're bringing in from overseas has those higher freight rates on it. That's why we're saying that the inventory that we're selling through in the fourth quarter and then going into at least the beginning of next year, we'll have those higher freight rates related to that inventory as it passes through the P&L.
spk11: And then mitigation action on it. I mean, you mentioned a number of levers that you have at hand, but obviously there's also a promotional environment to contend with kind of in holiday and early next year. I just wondered if you could speak to sort of some of the more specific levers that you have to counteract some of the amount of pressure in the next quarter or two.
spk12: Yeah, I mean, clearly we didn't want to put a number around it, but the first thing is certainly promotional levers not being seen right now is While we're in this environment where there is, in general, some malaise in terms of supply in the marketplace, that gives us a real opportunity, since we are in stock, to sell at a higher level, a higher value of selling with less discounts. And we do see opportunities continuing through next year to make adjustments.
spk14: And not only in... Thank you.
spk12: And just to be clear, adjustments in terms of decreasing the frequency and the level of discounts. And on top of that, the team has really done an excellent job in managing mix. And as we manage our mix to our more premium covers, our more premium inserts, we get higher margins as well. So there's a number of places we're really attacking it from a selling perspective. And then obviously, as Donna mentioned, we're being conservative while we expect the heaviest cost to be the ones we're bearing right now.
spk11: Okay, makes sense. And if I could just clarify, if we think about sort of how quickly you can sell through inventory that was sort of at that peak portion of the inbound freight pressure, just wondering if you could kind of speak to inventory turns, expectations heading into next year in terms of kind of turning that peak cost inventory versus sort of when we started lapping that and coming down the back end of the sort of the lower freight cost sequentially that we've seen into the end of the year here.
spk14: Anna, do you want to handle that one? I'm sorry, what was that, Matt?
spk11: Yeah, I wanted to get a sense for just how we should think about inventory turns, I guess. And better than that first question, I was trying to figure out just sort of, When we think about sort of peaking gross margin pressure, does it peak in the fourth quarter? Just based on sort of, I guess, the rough math that you could do here, we could assume that most of the inventory you're going to turn through sort of was fully burdened with that peak inbound ocean freight cost back in kind of July, August. So I wondered if you could speak to sort of inventory terms and how quickly you can sell through that higher cost inventory that you have on hand.
spk04: Yeah. So we probably, I mean, we sell through our inventory, turn our inventory probably four times a year on a safe side. Right. But we don't, we don't look to drive the inventory turns. That's not what we think to do with the business. We, we bring the inventory in to make sure that we can remain in stock. So some quarters, uh, maybe a little longer than that time period. Some might be a little shorter, right. I think the thing to just focus on or one of the things to focus on is when we gave a piece of outlook for next year, we were pretty conservative in saying that if next year is fully burdened by these freight headwinds, which we're all hoping that they eventually go away and that they're not here through the whole year, that we still will be able to drive margins of 50%, at least 50%. right, with all the other mitigation efforts that we're taking. So, you know, very conservative approach we're looking at. Our goal here is to make sure that we maintain our inventory positions, we're in stock, you know, we can fulfill our customers' orders, and we'll mitigate, and if throughout the P&L, so we'll leverage where we can in SG&A, So, that's why you see that the adjusted EBITDA margin is, you know, growing at a greater rate of sales. So, I think all really positive things given the headwinds that we're all facing related to inbound container costs.
spk14: Got it. Very helpful. I'll turn back to you. Thank you, guys.
spk06: Thank you. Our next question comes from the line of Alex Furman with Craig Hallam Capital Group. Please proceed with your question.
spk10: Great. Thanks very much for taking my question and congratulations on another really strong quarter. I wanted to ask about what you've been doing with ticket pricing. And obviously, we've seen just from your promotions around key holidays like Labor Day and Thanksgiving, you've been discounting a lot less than you have in prior years. Where, if anywhere, have you started to see any resistance to these higher prices? Are there any particular product categories or times of year or channels where you're seeing any resistance? And on the flip side, are there any categories where maybe you think prices remain too low and there's opportunity to continue to be a little bit more aggressive there?
spk12: yeah that's a great question alex and that really goes back to sort of this idea of where we are in terms of inventory relative to the rest of the world and then how we think about what's going to happen in the next year so our assumption is in the next year a lot of the marketplace will probably be in a better position of inventory and while our internal data and certainly our CSAT and our evaluation by our customers of our value have remained very strong, if not at the strongest levels ever. We want to be very careful to separate that value based on the one company that's available to ship in two to three weeks versus everybody else. As that goes away, we want to make sure in a competitive environment we still have a very good value to the customer that's based on thinking that they can understand. So I think in the short run, what does that mean? Less frequent, less deeper types of flash sales. We still like the idea of having the events because they rally us around obviously our advertising as well as it really is something that customers in the industry understand. But in terms of frequency and depth of discounts, they will continue to probably go down in the near future, I would expect. And we're really seeing no resistance in the short run, of course, to the sales, to the price increases. But we've got to be really, really careful, I think, strategically, because the game for us is the five-year game.
spk14: Great. That's really helpful. Thanks, Jack.
spk06: Thank you. Ladies and gentlemen, our final question today comes from the line of Lamont Williams with Stiefel. Please proceed with your questions.
spk01: Hi, thank you. Thanks for taking my question. You're opening up 20 showrooms this year. Do you have a range we can think about for next year, as well as a kiosk and the mobile concierge?
spk12: Yeah, look, the touch points, as we've continued to discuss, are incredibly important to us, and we will continue to expand our touch points overall at a rate consistent with what you've seen in terms of the mix between showrooms and concierge and shop and shops. We're still developing, you know, we're still analyzing the business and I think we'll have a more clear view of next year, but I would certainly expect the touchpoint growth and total touchpoints to be approximately the same as it was this year. And we'll give you more detail after the, at the fourth quarter discussion.
spk14: Okay, great. Thank you.
spk06: Thank you. Ladies and gentlemen, this concludes our question and answer session. I'll turn the floor back to Mr. Nelson for any final comments.
spk00: Yes. Thank you to our associates who have made these results happen. Very proud of our team. Really proud of the business and the results that we've been able to generate. Thank you to our investors who continue to stand with us and help us grow this company. We look forward to a fantastic Q4. and an even brighter next year. Thank you.
spk06: Thank you. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.
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