Lovesac Co

NASDAQ:LOVE

Earnings Call Transcript 2024-Q1

[Operator]

Greetings and welcome to the Lovesac's First 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 Rachel Schacter of ICR. Thank you. Please go ahead.

[Rachel Schacter, Investor Relations, ICR]

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, our 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, Chief Executive Officer]

Thank you, Rachel. Good morning, everyone, and thank you for joining us today. Today, I will start by reviewing the highlights of our first quarter fiscal 2024 performance and then briefly provide an update on our operational accomplishments and outlook.

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.

We are pleased with our first quarter results that beat expectations even amidst a challenging macro backdrop and against our toughest comparison of the year in the first quarter. Elevated inflation and higher interest rates continued to drive a more cautious consumer pressuring the home category overall.

We are not immune from these headwinds, but as evidenced by our consistent and reliable results, we have significant advantages versus the broader category, which I will expound upon in a moment.

We are confident that our unique business model and product designs allow us to continue to outperform the category, which was down 20% in the first quarter, as reported by our data sources in contrast to our sales growth and positive comps.

Now, let me review the highlights of our first quarter performance. Total sales were 141.2 million, up 9.1% versus the prior year period. We delivered total comparable sales of 15.1%, which was better than expected, driven by the timing of our marketing campaigns, even as we lapped a very strong Q1 comp last year of 42%. Given the plan for gross margin pressure this quarter and some SG&A deleverage as we've continued to prudently invest in the business to support long-term prospects.

Adjusted EBITDA was a loss of 2.4 million for the quarter, which Mary and Donna will discuss along with our financial performance in more detail. We made good progress on our operational initiatives this quarter, meant to strengthen our Infinity Flywheel. The uniqueness of our top quality products and overall concept continues to drive strong word of mouth benefits with customers becoming our most fervent advocates continually propelling this flywheel.

This is especially beneficial in a macro environment such as this one. Mary will discuss in detail the progress on specific growth strategies. But by far the key Q1 accomplishment was the in showroom launch of our new Angled Side roughly two months ahead of our internal schedule. This is the new product launch that we teased last quarter.

The Angled Side for sactionals seems innocuous enough, but our concerted research efforts show us that this particular addition to the Sactionals family can drive significant upside for sactionals amongst new and existing customers.

We believe based on the numbers, Sactionals is already the number one best-selling couch design in America right now. But new introductions like this one layered onto our proprietary platform only widen our moat. And there are many more to come. Style is obviously a critical component when it comes to winning in home decor. Sactionals are far and away the most functional design in the marketplace as we continue to innovate on more functional add-ons to come.

There are aesthetic ways for the platform to evolve as well, like this one, they can offer customers in the consideration phase greater choice and control. Initial sales rates confirmed this hypothesis and we look forward to seeing the entire Sactionals platform of products continue to take market share and grow, even as business in the overall macro category is shrinking at the moment.

We expect to see continued growth in what is a gigantic $41 billion upholstery category, of which even with our market share gains, we still have only captured very low single-digit penetration. As with all Designed For Life product platform expansions, the Angled Side can be added to any Sactionals collection ever sold and is available from the outset with StealthTech sound plus charge as an option.

Our Designed For Life way of managing product platforms is revolutionary in product design and branding. The result is not only true sustainability products that can actually sustain, but a satisfying brand experience. This builds extreme levels of trust between our brand and our customers, and that is the point.

We are building a brand that people love. This is the unlock for sustained future value to our shareholders. We will continue to invent and innovate in this unique way forever, both on existing Sacs, Sactionals and StealthTech platforms and in other categories yet to be announced where home meets tech.

Looking at the remainder of the year, we expect the macro environment to remain challenging, pressuring the home category. We also expect our trajectory of relative outperformance versus the category to continue. Given this backdrop, we remain highly cautious operationally as we continue to control expenses very tightly, making investments very prudently.

Our strong debt rebalance sheet continues to position us well to navigate in this environment. While we are pleased with our Q1 outperformance, we are reiterating our full year outlook at this time with some sharpening for Q2, which Donna will discuss.

The Memorial Day timeframe was strong for us beating last year. Remember, our net sales figures align closely with real time sales demand. We have virtually no realized revenue from backlog as we typically ship directly to the customer just days from when their order is placed.

We remain in stock of all key items because of the advantages of our platform based approach and the skew efficiencies afforded us by our evergreen inventory. We continue to put up the strongest demand numbers in the category that we are aware of.

The competitive landscape is highly promotional at the moment, but we have been holding the line on promotions in general. While higher than the abnormally low levels exhibited last year, we are still not back to pre-pandemic promotional levels and our ability to continue these share gains with promotional intensity that is well below the competition speaks to the real demand for our products.

We are not just selling generic furniture to people when they're looking for furniture in the marketplace. On that note, it is important for investors to understand one key reason why Lovesac demand remains so strong versus the competition and why management remains confident, at least cautiously optimistic in this environment.

We sell value products. This is widely misinterpreted because of our products, high sticker price. Our Sacs, which look like giant bean bags, sell for more than $1,000 on average. Sactionals, which are the majority of our sales, are priced at the high end for upholstery to be sure.

The typical first sactionals purchase averages around $5,000, and it is not at all uncommon to see transactions in the $10, 000, $15,000 and even $20,000 range on a daily basis, especially since the introduction of StealthTech. But this customer is a value customer. They are choosing to spend quite a bit of money with us because of all the value we design into the product and platform.

These are adaptable, upgradable, changeable and washable products. They are uniquely durable, built to last a lifetime, and designed to evolve with our customers throughout their life. Our fundamental quality and commensurate lifetime guarantee cannot be beat by any competitor. Furthermore, we are a couch specialist and the strongest one in the marketplace at that.

We have significant scale now. We estimate that our Sactionals business alone to be larger than many of our furniture generalist competitors, entire upholstery businesses across all of their disparate upholstery SKUs. Unlike furniture generalists, however, the couch category operates on slightly different dynamics than the home decor market broadly.

The number one driver of couch replacement behavior is old or worn out couches, not new home sales, relocation or even remodels. Even in a recession, couches wear out. This doesn't make us recession-proof, but it is still a much better dynamic than being in the furniture business as a generalist at times like these.

Not to mention the inventory implications alone. These advantage Lovesac. On top of that, we maintain constant contact with our customer base because every single Lovesac customer made their purchase directly with us, never through a distributor.

Our platform based approach to innovation allows us to introduce new add-ons with regularity from StealthTech to the brand new Angled Side to changeable covers and smaller accessories that we introduce regularly. This Designed For Life platform approach and outreach programs drive our repeat business to constitute roughly 40% of our transactions ongoing.

We have chosen to blaze a trail in this category, utilizing this differentiated value proposition from all of our competitors paired with a proven, effective and efficient go-to market strategy, as evidenced by our many, many years of unrelenting growth and profitability. As we look to the long-term, we remain very confident in the future of the Lovesac brand for all of these reasons.

We believe we have significant growth runway still ahead of us with a very robust pipeline of new products that we are designing to dominate the myriad home plus tech categories that we have yet to enter, but that we perceive as ripe for disruption.

Before turning the call over to Mary, I'd like to thank the entire Lovesac team for their relentless efforts and execution of our strategies. This year is Lovesac's 25th anniversary. We will find ways to celebrate this milestone throughout the year to drive exposure and credibility. It is a significant milestone for us, not just because we've made it for this long, but because it really underscores our ability to stand behind our enduring products.

It is reflective of the sustained-ability of our Designed for Life product platform. And it's not just about our long-term products. We are building a sustained-a [indiscernible] organization quarter by quarter, year by profitable year. A business that can actually sustain. We have done so now for a very long time with a near spotless track record as a listed company.

Even as we've generated very high growth on an annual basis for many years now, stacked with profitability regardless of the landscape its ever evolving management team maintains the highest ambitions.

Our ultimate goals are lofty. We are totally committed to our decade long vision and we are focused on making sharp decisions to continue to deliver sustained results, sustainable products, and a truly sustainable brand.

It should be obvious, based on our track record, we intend to make it continue that way. To that end, I'd like to take a moment to address today's announcement of Donna's retirement and the appointment of our new CFO, Keith Siegner.

I am thrilled to welcome Keith as our new CFO. With his proven track record in financial leadership, I look forward to the impact he will have in guiding our finance functions as we continue to scale the Lovesac business and brand. I also want to express how very grateful we are for Donna's contributions during her six years at Lovesac. She has been an amazing business partner throughout some of our most formative years.

We have greatly benefited from her work ethic and professionalism in leading our finance organization. I particularly want to highlight her invaluable contributions in helping us navigate the recent pandemic years, as well as her leadership leading up to the 2018 IPO and subsequent transition to being a public company. We wish her all the best in her retirement.

While this change is effective, on June 30th, Donna will be around for one year as a Senior Strategic Advisor to ensure a smooth transition. In addition, I would like to extend my sincere thank you to Jack for his seven years of service with the company, which includes his roles of President and Chief Operating Officer and more recently, Chief Strategy Officer.

He has really been my business partner since joining Lovesac back in 2015. Jack has played an instrumental role in transforming the company into a true omnichannel retailer by helping expand our physical touchpoints and digital platform as we continue to disrupt the industry.

We wish him nothing but the best in his retirement and look forward to his continuing his service on the board. Gratefully, Mary has already proven to be an invaluable partner to me for this new chapter at Lovesac. She is awesome. Mary and I are both grateful to continue to have Jack's wisdom and judgment available to us through his continued role on the board.

With that, I will now hand it over to Mary to cover our strategic priorities and progress. Mary?

[Mary Fox, President and Chief Operating Officer]

Thank you, Shawn, and good morning, everyone. We are pleased with our first quarter results that beat expectations with industry leading growth against the difficult macro backdrop.

As Shawn said, while the industry is seeing pressure, we continue to outperform as we execute against our strategic initiatives driven by our customer and product centric focus, differentiated omnichannel business model and unique Infinity Flywheel.

Our net sales growth rate of 9.1% continues to be ahead of the category on a one year basis and is up 244.4% on a four year basis to give you a comparison to pre-pandemic levels, with an adjusted EBITDA margin increase of 980 basis points over the same four year time period.

While we observed that customers are being more cautious with discretionary purchases and impacted by tightening credits in the first quarter, we continue to be encouraged by the strength of our brand metrics and market share gains fueled by our strong operational execution as evidenced in the KPIs we track closely.

We also continue to see best-in-class paybacks across our touchpoints and relatively consistent performance across our geographical markets. We are uniquely positioned to continue to profitably take share even through the current market dynamics by continuing to make progress on our growth strategies and delivering great value through our Designed For Life platform at a time when this value matters to our customers more than ever.

A few highlights on our go-forward plans for each of our strategic initiatives all centered on Infinity Flywheel. Firstly, starting with product innovation, where we had very notable progress in quarter one as Shawn discussed, our highly anticipated new product introduction, the Angled Side soft launched in May in conjunction with our 25th anniversary brand campaign.

The Angled Side addresses our biggest opportunity around barriers to purchase for our consumer as style is the number one reason they leave our purchase funnel and Angled Side was the top scoring silhouette. This new introduction will enable us to continue to gain market share in this fragmented category. This product is currently only available in our showrooms, and we anticipate it will be available on our e-comm platform by the end of July with a full media campaign starting in August.

Innovation is an inherent part of our DNA at Lovesac. So we are excited for this launch and many more launches to come over the coming years. After the first few weeks of launching our Angled Side in showrooms, we are seeing immediate traction in KPIs, including quotes and conversion as well as very positive feedback from customers on the design and how comfortable it is.

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 this quarter, we opened 16 showrooms and one Best Buy shop-in-shops.

For the quarter, our e-commerce channel performance was very strong at 28.7% increase, well ahead of the category according to our estimates, by over 5,300 basis points and ahead of our expectations. This strong performance has been driven from the customer experience improvements we made last year, delivering an increase in conversion and AOV and then higher ROI from our digital programs versus last year.

In terms of our Costco partnership, demand was up 5.6%, driven by physical road show point-of-sale transactions versus quarter one last year. Also importantly, as a result of our unique omnichannel experience, our customer satisfaction scores continue to improve and sequentially increased in quarter one, especially for our digital experience and fulfillment stores.

Thirdly, our ecosystem. This is centered around our efficient marketing, including our strong customer lifetime value and customer acquisition cost ratio with payback after the first purchase and word-of-mouth, which continues to drive brand awareness and an effective customer acquisition funnel.

This year, we've begun deploying new marketing tactics that include continuing to invest in high ROI performing programs and growing hyper local marketing to drive relevant traffic to our touch points.

We continue to drive new customer acquisition using vehicles such as direct mail campaigns. We've also begun leveraging prime and linear TV buys to continue to drive reach and to strengthen our brand LOVE. And as Shawn mentioned, our 25th anniversary celebrity campaign is very successful, generating over 3 billion impressions to date, with coverage from Rolling Stone, Billboard, People, New York Times and many more.

We are also making good progress internally on our circle to consumer initiative on open-box inventory, which is focused on improving the executional effectiveness and the brand experience and we will be sharing more details later this year. And finally disciplined infrastructure investments.

Despite the uncertain environment, we operate our business with a strong focus on growth and an ROI-driven investment discipline, and we believe it is important to prudently invest in the business for the near and long-term.

This year, our investments for growth were both primarily in the areas of technology and research and development to continue fueling our flywheel. AI is an important area for our investment, and we have recently begun a pilot providing generative AI-guided experiences to our customer-facing service associates. So early in our results, we're seeing great promise in this initiative and the potential to enhance the overall customer experience.

As previously mentioned, we expect this year to reinforce our customer satisfaction by continuing to deliver orders in just days, while also delivering inventory productivity improvements of 20% enabled by our recent investments and the teams are making good progress on this initiative. We expect this will have significant effects on the efficiency of working capital as well as associated cost reductions across inbound freight and warehousing, which we will start to see in the second half of this year.

So in summary, we are pleased to have reported results ahead of expectations amidst a challenging environment. We are very proud of our team and their continued execution against our strategic initiatives, which enables the continued strengthening of our competitive positioning and powers our Infinity Flywheel.

I also wanted to really thank Jack and Donna for their incredible partnership and I am very happy that we will continue to work together in their new capacities. And I'm also really looking forward to work with Keith.

I will now pass the call over to Donna to review our quarter one results and our outlook for fiscal '24. Donna?

[Donna Dellomo]

Thank you, Mary, and good morning, everyone. I will begin my remarks with a review of our first quarter results and then discuss our outlook for fiscal 2024.

Net sales increased $11.8 million or 9.1% to $141.2 million in the first quarter of fiscal 2024, with the year-over-year increase driven by growth in all channels. This increase was stronger than what we had projected for the quarter, primarily driven by higher-than-planned Internet net sales due to strong promotional campaigns which pulled forward some internal projected demand from Q2 into Q1.

Showroom net sales increased $2.3 million or 2.9% to $83.6 million in the first quarter of fiscal 2024 as compared to $81.3 million in the prior year period. The increase in showroom net sales was driven by an increase of 8.4% in comparable showroom sales related to higher point-of-sale transactions with higher promotional discounting than the prior year and a net addition of 49 new showrooms compared to the prior year period.

As a reminder, point-of-sale transactions that we reflect in our comparable sales metric represents orders placed through our showrooms which does not always reflect the point at which controls, transfers to the customer and when the net sales are recorded. Internet net sales increased $8.9 million or 28.7% to $40.2 million in the first quarter of fiscal 2024 as compared to $31.3 million in the prior year period.

Other net sales, which include pop-up shop, shop-in shop and open-box inventory transactions increased $500,000 or 3.1% to $17.4 million in the first quarter of fiscal 2024 as compared to $16.9 million in the prior year period.

The increase was largely driven by 95 in-store Costco pop-up shops that generated $4 million of net sales that we did not have in Q1 last year as we only reintroduced in-store pop-up shops with Costco in the second quarter of fiscal 2023 as they had been put on hold due to COVID in March of 2020.

This increase was also a result of a planned increase of approximately $1.4 million of open-box inventory transactions to $4 million in the first quarter of fiscal 2024 from $2.6 million in the first quarter of fiscal 2023. These increases were partially offset by lower productivity of our temporary online pop-up shops on costco.com.

We opened one additional Best Buy shop-in-shop location compared to the prior year period. As a reminder, our open-box inventory transactions with ICON are part of our C2C DFL and ESG initiatives. We are making great progress in reviewing all options for this return product that align with our sustainability goals.

We expect some of these initiatives to go live beginning in Q2 and into the second half of the fiscal year. In the meantime, we may have some open-box inventory transactions with ICON to ensure our warehouses are operating as efficiently as possible and we'll disclose any net sales on future calls in the event that they occur.

By product category in the first quarter, our Sactionals net sales increased 11.2%. Sacs net sales decreased 10% and our other category net sales, which includes decorative pillows, blankets and other accessories, increased 4.2% over the prior year period.

Gross margin decreased 100 basis points to 50.1% of net sales in the first quarter of fiscal 2024 from 51.1% of net sales in the prior year quarter primarily driven by a decrease of 120 basis points in product margin, driven by planned higher promotional discounting than the prior year, partially offset by a decrease of approximately 20 basis points in total distribution and related tariff expenses.

The slight decrease in total distribution and related tariff expenses over the prior year is principally related to 170 basis points inbound transportation benefit from decreased container costs, partially offset by 150 basis points in higher outbound transportation and warehousing costs due to higher FedEx rate and the expansion of our warehouse network.

As shared with you on our fourth quarter earnings call, we expected to see modest benefits related to the decrease in inbound freight rates in Q1 and the benefits to be most impactful in Q2 and Q3 of fiscal 2024. The 26.6% year-over-year increase in SG&A was primarily related to an increase in employment costs, overhead expenses, sales related expenses and rent. Employment costs increased by $5.9 million driven by an increase in new hires in fiscal 2023.

Overhead expenses increased $2.9 million with the majority of this increase or $1.6 million related to computer expense investments in our new point-of-sale system to support current and future growth. Rent increased by $1.4 million, principally related to the rent for the additional 49 net showroom. SG&A expense as a percentage of net sales increased by 560 basis points primarily due to planned deleverage within employment costs, selling-related expenses, rent and continued investments to support current and future growth.

Advertising and marketing expenses increased $1 million or 6.4% to $16.9 million for the first quarter of fiscal 2024 as compared to $15.9 million in the prior year period. Advertising and marketing expenses were 12% of net sales in the first quarter of fiscal '24 as compared to 12.3% of net sales in the prior year period. As a reminder, advertising and marketing investments benefit multiple fiscal periods.

Depreciation and amortization increased $100,000 from the prior year to $2.8 million, principally related to capital investments for new and remodeled showrooms. Operating loss for the quarter was $5.9 million compared to operating income of $2.6 million in the first quarter of last year, driven by the factors just discussed.

Net interest income was $300,000 for the first quarter as compared to an interest expense of less than $50,000 for the prior year period. Interest income earned on our cash and cash equivalent balances was favorable from higher interest rates compared to the prior year period.

Before we turn our attention to net loss income, net loss 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 loss for the quarter was $4.2 million or $0.28 per diluted share, compared to net income of $1.9 million or $0.12 per diluted share in the prior year period. During the first quarter of fiscal 2024, we recorded an income tax benefit of $1.3 million as compared to a $700,000 tax provision for the first quarter of fiscal 2023. The change in the provision is primarily driven by the net loss for the quarter.

Adjusted EBITDA for the quarter was a loss of $2.4 million as compared to positive adjusted EBITDA of $6.4 million in the prior year period. Adjusted EBITDA for the first quarter was ahead of our expectations principally driven by higher net sales.

Turning to our balance sheet. Our total merchandise inventory levels are in line with our projections and have leveled out as we had discussed on our prior call. Inventory decreased 13% year-over-year and we feel exceptionally good about both the quality and the quantity of our inventory and our ability to maintain industry-leading in-stock positions and delivery time.

As we move through fiscal 2024, inventory levels will continue to moderate due to inbound freight relief and our technology investments, which enable us to allocate inventory more efficiently. We ended the first quarter with $45.1 million in cash and cash equivalents and $36 million of availability on our revolving line of credit with no borrowing. We are pleased with our strong balance sheet and our cash position at the end of the first quarter. Please refer to our earnings press release for other details on our first quarter financial performance.

Now moving to our outlook. As you saw in our press release, we are reiterating our full year outlook for net sales of $700 million to $740 million, approximately 30 net new showrooms, total comps in the high single-digit to low double-digit range, adjusted EBITDA margins in the 8% to 9% range and earnings per share in the $1.83 to $2.24 range with a share count of 16.4 million weighted average diluted shares.

Given our strong results in Q1, factoring in our expected Q2 performance, our second half touch point expansion, the launch of our new innovation of Angled Side along with the accompanying media support, our 25th anniversary brand campaign and the additional 53rd week, we remain confident in our full year outlook.

As a reminder, the 53rd week in the fourth quarter is expected to contribute approximately $6 million in net sales, $400,000 in adjusted EBITDA and $0.02 in EPS, which is reflected in our fiscal 2024 guidance.

For the second quarter, we expect net sales of $149 million to $151 million being driven by the planned opening of approximately seven showrooms and a total comparable sales increase in the 3% to 5% range. The second quarter decrease in comp sales from Q1 is a result of a shift in demand relating to promotional activity between Q1 and Q2, such that the first half total comps overall are within the range of expectations embedded in our full year outlook. As we have discussed before, we are up against the toughest comps in the first half of the year.

Our second quarter projections include open-box inventory transactions which will be significantly less than the $9.6 million from the second quarter of last year and not more than our Q1 fiscal '24 open-box inventory net sales. We expect adjusted EBITDA of $1 million to $1.5 million, driven by an expected gross margin increase of 200 basis points, which will be more than offset by planned deleverage in marketing and advertising related to investments in test-and-learn initiatives, future innovation and events surrounding Lovesac's 25th anniversary brand building. In addition, the planned deleverage in SG&A, primarily in payroll, rent and credit card fees.

Loss per share is expected to be $0.12 to $0.16 for the second quarter with 15.2 million weighted average shares outstanding. We are continuing to make important investments in the business to support current and future growth. These investments are critical to our ability to drive long-term growth and sustained market share gains.

As I mentioned last quarter, with the second half of our year, traditionally being the strongest in net sales, the timing of our new touch point openings, new product launches, and our planned flow of inbound inventory, we expect to use cash during the second and third quarters of the year before generating substantial free cash flow in the fourth quarter to end fiscal 2024 with a significantly higher year-over-year cash balance.

We are pleased with our first quarter results, which came in better than our expectations. We are proud of our team's execution in what continues to be a challenging macro backdrop. We will continue to operate our business with a strong focus on growth and ROI-driven investment discipline.

Finally, as you saw announced earlier today, I've made the decision to retire as EVP and CFO of Lovesac effective June 30th. It has been a privilege to be part of the Lovesac team for over the last 6.5 years and witnessed first-hand the brand's expansion, while working alongside our leadership team and the many talented individuals throughout the company.

With Lovesac well-positioned for success, I felt it was the right time to make this transition, and we view Keith as the ideal candidate for the role. I look forward to continuing to support Lovesac's success in my new role as Senior Strategic Adviser.

Now I'll turn the call over to Shawn for a quick wrap up. Shawn?

[Shawn Nelson, Chief Executive Officer]

Before Q&A, I just want to take a moment again to thank our dedicated #Lovesac family and team who have proven their ability to beat expectations with consistency. We are proud of these continued category-leading results, particularly in the current macro landscape.

These results along with what we've seen so far in Q2 give us the confidence to reiterate our full year guidance and continue to invest prudently in our initiatives to drive future growth even as we are surely taking significant market share in real-time based on these numbers.

Thanks again to Donna and to Jack, who have both been key to our ability to drive such consistency over many years now, they have each given a piece of their life to building what we all believe can be an influential, valuable and much loved brand with decades of growth yet to come.

We are grateful to them. They have given our newer members and leadership, a solid foundation to build on, and we are confident that we, once again, have a top-notch team in place to carry the momentum forward and take it even further.

With that, we'll turn the call back to the operator to manage Q&A.

[Operator]

Thank you. The floor is now open for questions. [Operator Instructions] Today's first question is coming from Brian Nagel of Oppenheimer. Please go ahead.

[Brian Nagel, Oppenheimer]

Good morning. First off, congratulations, Donna and Jack on your retirement. It's been a pleasure working with you.

[Donna Dellomo]

Thank you.

[Brian Nagel, Oppenheimer]

So my question -- my question, I guess, the first question, we talk about -- just the gross margins is you're maybe getting better line of sight now to some improving cost metrics. I mean, how should we think about the gross margins from here. There's been some stabilization, but you're still tracking meaningfully below what had been historic peaks.

[Donna Dellomo]

Brian, specifically around the gross margin, are you looking to say where do we see the benefits?

[Brian Nagel, Oppenheimer]

Yes. So just as we think about the trajectory from here, either through the balance of '23 to '24 and maybe kind of the puts and takes? Any update there?

[Donna Dellomo]

Yes. So, first of all, thank you for acknowledging me earlier today. Just on the puts and takes of the gross margin, really, what we're going to see is some substantial benefits, as we said, 200 basis points increase on gross margin, which is substantially related to the benefits that we're seeing coming in through the lower freight cost split, which we paid for last year. We're just getting the benefit of it coming through the P&L this year.

That benefit that we will see will fully come through in Q4 and we feel really confident in that. We have really good line of sight into that. Our container costs are actually still continuing to come down. But what we are still seeing there is some we'll call it, in land transportation costs that are related, what we call is demurrage, right, which is beyond our control. It's really getting the containers once they hit the ports here in the US to our facilities.

So where you do hear while container costs are coming down to $3,000, $4,000, there is still some additional costs there related to the inbound transportation of those containers, but significantly less than a year ago when we were saying it's $25,000, we're probably paying all in even with the demurrage probably closer to five.

So those costs will see the full benefit coming through of that on the fourth quarter. So barring anything else that comes our way with inbound container costs next year will be a clean year for us. But we do have some headwinds as those other companies on last mile, which is the FedExes of the world and the UPS, we predominantly use FedEx, but we are doing all that we can to mitigate that. Mary may share some additional initiatives that we're looking at with other carrier opportunities.

We actually start with a really -- at a really good spot with our negotiations and our rates with FedEx and then on warehousing, the same thing with higher labor costs, we are seeing a little headwind in there. But that all being said, that is all accounted for in any of the guidance that we've provided plus a little extra to make sure that we cover things that we may not see coming our way.

[Brian Nagel, Oppenheimer]

That's very helpful. I appreciate it. And then my follow-up question with regard to sales. So I think, Donna, you mentioned in your comments, a pull forward from, I guess, from Q2 into Q1. Maybe just help size that and what that relates to specifically. And then within sales, we talked about some of the promotional activity, Shawn, you talked about promotion still tracking up from last year, but still below where they've been historically. As you think about the business and this backdrop, would you consider being acting more promotional, stepping up promotions more to really help, I guess, on the continued market share front?

[Mary Fox, President and Chief Operating Officer]

Good morning, Brian. It's Mary here. So just your first question in terms of the shift that Donna referenced, I think one of the great things that we're learning is that we don't necessarily always have to have promotions at key tentpole moments. The quote pipeline fills up very fast and we actually tested doing an off-cycle promotion to basically just drive a bit more conversion.

So that was towards the end of April and our demand far exceeded our net sales for the quarter. So there was a little bit of a shift and some of that is obviously in reflection of what Donna guided to for Q2. And I think it again goes back to the strength of our brand and also the ability for us to game customers in advance of maybe sometimes when they were thinking of purchasing when others are on promotions. So we feel very good for quarter two.

As Shawn shared, we've got a great perspective, having cleared frankly, Memorial Day, which is our biggest tentpole in this quarter. And we feel good with a strong quote pipeline, good promotional cadence and good in the stocks and the teams are really set to keep continuing to outperform as we demonstrate every single quarter.

Shawn, I think, on promotions, and I'll touch on it and then I'll hand to you. I think the team continually demonstrate the ability to be agile and testing, as you can see by the results. We're very agile. We're actually getting better and better at being more programmatic in going directly to customers with quote versus site-wide flashes, but as Shawn shared, it's generally promotions have been holding the line since the second half of last year.

You can see from our results, we've far exceeded anyone else. We continue to gain share and that's all just reinforcing the strength of our flywheel and that we are a company-specific product cycle story, not a macro demand business. So we feel good with the plans, but the teams will continue to adjust accordingly.

[Shawn Nelson, Chief Executive Officer]

Yes, I agree. Nothing to add, other than we'll continue to be really diligent on this front. We are focused on building the brand in the most long-term focused way possible even through tighter times and that's definitely affecting our outlook on promotions, in general, we intend to be really disciplined.

[Brian Nagel, Oppenheimer]

I appreciate all the color. Thank you.

[Mary Fox, President and Chief Operating Officer]

Thank you, Brian

[Operator]

Thank you. The next question is coming from Mary Ripps of Canaccord Genuity. Please go ahead.

[Maria Ripps, Canaccord Genuity]

Good morning. Thanks for taking my questions and Donna and Jack, best of luck going forward. It was great working with you. First, is there any indication as to whether consumer trends and maybe discretionary spend is getting better or worse over the past couple of months? Obviously, you reiterated your full year outlook. And then any color maybe you can add in terms of higher-end consumer versus more price-sensitive buyers here?

[Mary Fox, President and Chief Operating Officer]

Yes. Good morning, Maria. It's great to hear from you. So I think we've obviously just the year-end update a couple of months ago. We're not seeing anything that's significant from that or any consistent trade down trends. I think, in fact, actually, what we're seeing is that they've tended to have a flat or slightly elevated mix of premium upgrades in their purchase.

We do see, as we shared before, the use of financing that continues to trend up versus last year, which we fully planned for. And as other brands have shared, we're actually seeing customers buying later at the end of a promotional event versus last year. And I think a lot of that, last year, they were buying because of concerns around availability, just in general in the market, and obviously, with that more secure for the category, people are holding back a bit.

But I think that's consistent to what everyone else has shared and it's more settling back to pre-pandemic buying patterns. But I think we also see and I think Shawn shared this before, 38% of our customers don't even cross shop us with anyone else. So, they come in, they want to buy, they use the credit where they want to on the financing, but just the brand strength just continues as you can see in the results.

[Maria Ripps, Canaccord Genuity]

Got it. That's very helpful. And then you talked about making some sort of infrastructure tech and R&D investments to support future growth. Could you maybe provide us with an update on how those initiatives are progressing? Maybe a little bit more color on what those investments are? And I guess which areas of the business they designed to impact the most?

[Mary Fox, President and Chief Operating Officer]

Yes. No, thank you for that question. So I think, firstly, on the tech investment, a key one. And I think as Donna shared, and I shared the ability for us to start to optimize on our inventory levels was some of the investments we started last year into this year, with order management systems and really the availability to be a lot more surgical around where we place inventory and how we replenish to orders.

So that was a big investment. We're seeing that benefit that will come through, obviously, in working capital and also the ability to have less weeks of sale, but yet still delivering the outstanding continued improvements in customer satisfaction.

The another example that we're investing in is around customer service. We shared with you before around some of the work there. And just obviously, more recently, we kicked off a pilot with an AI platform called Thankful, which is testing machine-generated responses for our frontline associates that are serving customers.

And we think this investment in AI is so critical for our customer experience and then supporting our teams in all of their crucial work every day. So those are just a couple of examples on the tech side and then the rest of the investments that we have always shared is around research and development, which is for our long-term growth, Maria.

[Maria Ripps, Canaccord Genuity]

That's very helpful. Thank you so much for the color, Mary.

[Mary Fox, President and Chief Operating Officer]

Thank you, Maria.

[Operator]

Thank you. The next question is coming from Thomas Forte of D.A. Davidson. Please go ahead.

[Thomas Forte, D.A. Davidson]

Great. So first off, congrats, Shawn, Mary and team, Jack, best of luck. It was a pleasure working with you. I look forward to your guidance on the Board. Donna, I'm going to miss you. It's a pleasure working with you and best of luck as well. All right. So for my first question, then I'll pause and then a follow-up. So Shawn, I think, you did a great job with data analysis. What does the data tell you regarding consumers who may appreciate the functionality of their product, but don't purchase it or maybe they purchase it, but they don't buy it for more rooms in their house because of the aesthetics. And then can you talk about the Angled Side versus the Roll Arm when you rolled out the Roll Arm and how that had a positive impact on your results?

[Shawn Nelson, Chief Executive Officer]

Yes. So thanks for the question. Great to hear from you. Sactionals is a very successful couch platform because of its flexibility. It has taken us years of being in the marketplace, paying for research to continue to refine the platform and tease out where the biggest opportunities lie.

And we continue to knock those out one after the other year after year as we continue to drive the Sactionals platform to become as we think of it, the Apex Predator in couches, right? We want it to be all things to all people as much as it can be. And so far, it's proving successful. And the results, of course, are in the -- the evidence is in the results.

That said, we know that there are two core things that drive this business. One is comfort and Two is style. In the case of the Angled Side, we have both being addressed, and it's been a really effective launch. We knew that it would be based on our research and I think that really speaks to the strength of how Lovesac operates.

We are a research-led organization. We blend this, call it, CPG approach to research, product development, customer development, customer research along with pure invention to generate platform that are uniquely competitive.

And so we know that style is always going to be an issue when you're dealing with a product that was intentionally created to be evergreen, to be the same for years and years. Theoretically forever, hopefully, by taking a very vanilla and simple approach in a way that would offend nobody and hopefully be addressable -- be relevant to everybody.

With that, there leaves tons of opportunity left on the table. So for instance, years ago, you mentioned we launched Roll Arm, as a way to address a more conservative traditional customer that is looking for that more traditional look in their home.

And it was wildly successful, and it's been part of our Lovesac Sactionals ecosystem for years now. You can think of Angled Side as a more modern version of that. But Angled Side goes further because not only does it address an aesthetic that we did not have, but it also, frankly, provides a different comfort level than we offered up until now.

Like when you get the chance to sit on an Angled Side because I understand the word side in our world is not just an arm, it's a back, it's interchangeable. So you can have all Angled Sides, all the way around and now your Sactionals will lean back a little further, the sitting space is a little larger. And it really sets the table for other innovations that will come as well that will further address comfort and aesthetics.

So Sactionals already, what we witness happening is if people buy Sactionals for whatever room they have in mind for it. Often, it will be a basement, a bonus room who knows what because you can make them so large. You can integrate StealthTech and have surround sound.

You can have these huge pit setups that kind of thing. And we'll take it. Those are huge purchases. But their experience is so good, of course, with Sactionals and that proves over time, right, as people spill, live their life, expand, make mistakes, animals, kids, dogs, pets, who knows what.

And then we end up in other rooms in their home or even in their second homes or who knows what, because their experience with the brand is so good. That's what we like to see and the further that we expand the Sactionals platform, the more of that we make possible because people could have one look here and another look there, and we addressed those aesthetic opportunities. And so we're really excited about it. But Roll Arm was more niche than Angled Side, and we believe that the opportunity for Angled Side is even larger.

[Thomas Forte, D.A. Davidson]

Excellent. Right. So then for my follow-up, I'll try to ask this one quicker. All right. So one of the big challenges for direct-to-consumer companies, and I consider you the best-in-class direct-to-consumer companies is driving brand awareness. So I wanted to know if you could talk about your unaided awareness and how that's changed over time? And if you could talk specifically about the social media engagement you had as it related to your 25th anniversary celebration, which was amazing.

[Shawn Nelson, Chief Executive Officer]

Yes. We have seen our unaided awareness continue to be quite low. And part of that is -- and I say that with a smile because it's just -- we have a huge opportunity to continue to reach people. While we have grown the business tremendously and we're proud of the growth, we have a long way to go on unaided awareness. And the way that we come at that are many -- through advertising, through promotion, through influencers, social media, et cetera. Our aided awareness has gone through the roof.

In the furniture category, we are now up there with the best of them as brands that come to mind when brands that can be recognized on a sheet of paper, let's say, when given the opportunity. So Lovesac. So clearly, our advertising has been working. Again, the evidence is in the results.

We recently celebrated our 25th anniversary with a huge media party kickoff in New York. We'll be celebrating it all year. So you'll get sick of hearing about it, but it really is super relevant to us for the reasons I talked about in my script. But we have estimated now more than 3 billion impressions from that event alone.

We have an attendance all kinds of social media influencers, A List celebrities. Of course, we had Travis Barker and Machine Gun Kelly, on stage, who are all fans of Lovesac. All these celebrities who appeared, who support us, who even played our event are fans of Lovesac for many, many years to come and many, many years have been fans of Lovesac have owned our product. It's in their homes right now. So it's truly authentic. And this is one thing that's underestimated about Lovesac.

We are resonating with teenagers and kids in ways that our competitors are not. And by the way, those kids are driving sales of sometimes $15,000, $20,000 StealthTech Sactionals setup in their parent's basement. I witness it every day personally. I meet people who have come to our brand through their children.

And so it's not that, that's our core marketing philosophy. But my point is that this brand resonates with customers like no other furniture brand does. And we're really proud of that. It's a super power of ours, we think, and we'll continue to lean into it.

[Thomas Forte, D.A. Davidson]

Great. Thank you for taking my questions.

[Operator]

Thank you. The next question is coming from Matt Koranda of ROTH. Please go ahead.

[Matthew Koranda, ROTH Capital Partners]

Hey, guys. Good morning and congrats to Donna and Jack on a great run. Just wanted to start out with -- quickly just clarifying the showroom comp is ahead of revenue growth in the channel and I know there's a demand comp dynamic. So I just wanted to make sure that we understand what the delta is there and what the spillover is that's incorporated in the second quarter revenue guide? And then just also on May sales and Memorial Day, I know you mentioned it was up year-over-year. Just what were the key drivers in terms of the improvement on a year-over-year basis, was it promos. It sounds like you're seeing consumers respond to those. Just wanted to get your take on that as well.

[Donna Dellomo]

Yes. Hi, Matt, it's Donna. Hopefully, I can provide some clarification. So our first, as I noted earlier that our first half comps are exactly in line where we thought they were going to be. There was a slight shift, which caused the overperformance in Q1, as we noted, where we had guided to $133 million to $136 million and came in at $141 million.

And that was due to planned promotional activity at the end of Q1, but that planned promotional activity, obviously, it pulled forward demand. So, again, we're really happy with where we're going to end for first half comps, but it did -- our promotional activity at the end of the quarter was so well-received, it did.

We're anticipating a pull forward in our guidance of demand. Does that help you on that piece? And that's -- one of the other things is where we talk about -- we also have orders on our balance sheet, we're sitting with about $13 million. I think it's about $13 million, $15 million worth of orders at the end of the quarter that we'll be shipping into Q2 and if you remember, our comps for showrooms are based on demand and not net sales.

So that's where you see that little bit of flex where we're reporting higher demand than we are net sales. We're going to see a part of that demand that's in the comp number shift into Q2 that become sales. And that's the timing like that's at the actual end of the quarter.

These are not orders that were -- that we took at the beginning of the quarter and they're still sitting there. It was just timing of promo and when we can ship. So essentially, our open orders turn into net sales within a week or so of the demand being created. But that timing of demand versus shipments is what you're also seeing flex in demand being higher than our net sales for the quarter for Q1.

[Mary Fox, President and Chief Operating Officer]

Yes. And then -- that on Memorial Day, Matt, to your question, obviously, we were thrilled with the performance, the promotion depth and frequency we've been holding in as a cadence in the second half of last year, so nothing new from that side. I think there was some excitement from the Angled Side soft launch, which is just obviously in showrooms at the moment.

And then I think back to the investment that Shawn talked about, about our 25th anniversary and just the level of media impressions that we get then you just -- you see a long-term benefit to that as well as obviously in the quarter. But we were very pleased, and we've seen that performance continue from Memorial Day.

[Matthew Koranda, ROTH Capital Partners]

Okay. Great. And then just for my follow-up, on the margin guide for the second quarter. It sounded like, I think, Donna, you said up maybe 200 basis points on gross margins. I want to make sure I heard that correctly. What does that assume in terms of promotional cost headwinds on a year-over-year basis? Just trying to triangulate sort of around what you're assuming there versus some of the freight benefit. And then on the -- how that flows down to the adjusted EBITDA guide, just curious, it sounds like you're going to be leaning into marketing in the second quarter. So I just wanted to understand a bit more about where you guys see opportunity to invest those dollars on the marketing side.

[Donna Dellomo]

Yes. So I'll start. Yes. So, Matt, that's correct. I did say a 200 basis point increase in gross margin, Q2 this year as compared to Q1 there the upside to gross margin from the benefits of the inbound freight is greater than the 200 basis points year-over-year increase. I don't have the specific numbers, but it's not only promotional activity.

And as Mary has said and I think Shawn has said, we are a little bit more promotional than we were this time last year, but we are nowhere close to as promotional as we were pre-pandemic levels. So there is a little bit there in product margin. But we also, as I had noted, we do have some deleverage, I would call it, in outbound freight just as a relationship to cost increasing for us and everybody else.

And a little bit of deleverage in our warehousing as we expand our warehouse network and costs there become a little bit more expensive just as relative to labor at the warehouses. Those are not our warehouses by the way, just to remind you, those are 3PLs.

So that net of 200 basis points is greater inbound freight, which is netting down to 200 basis points because of increased year-over-year and product discounting as well as outbound freight costs and warehousing. The adjusted, yes, so your question on marketing, we will see a, where we saw in Q1 a slight leverage of marketing, I think it was about 30 basis points. We are expected to see because of the investments around our 25th brand building event in addition to Angled Side. Big, big, big things for Lovesac.

We will see deleverage in marketing in Q2, specifically around those events. It all, put planned into guidance, planned into our annual guidance, it all accounted for in our quarter guidance. And SG&A, on a deleverage of SG&A, we are deleveraging approximately the same amount we did in Q1.

So they're all the planned costs, their planned investments. And we will start to see all of those costs leveraging into the second half of the year, predominantly the fourth quarter. And that will all impact the adjusted EBITDA. But we feel really comfortable, very, very confident and we've built in all the costs that we can see coming our way. And any upside to those numbers, the team will decide strategically how to and when to reinvest those dollars.

[Matthew Koranda, ROTH Capital Partners]

Okay. Super helpful guys. Congrats again, Donna and Jack, and I'll turn back in queue.

[Donna Dellomo]

Thank you.

[Operator]

Thank you. Our final question today is coming from Alex Fuhrman of Craig-Hallum. Please go ahead.

[Alex Fuhrman, Craig-Hallum]

Hey, guys. Thanks for taking my question. Congratulations on a strong quarter. And to Jack and Donna, it's been a pleasure getting to know you over the years. So congratulations to you both as well. Shawn, I wanted to ask about the -- just big picture here. You mentioned the average first-time transaction value for a Sactional purchase now is about $5,000. Is it feels like it was only maybe a couple of years ago that, that number was closer to $3,500. Can you kind of give us a sense of what are people buying today in terms of pieces and fabrics and things like that compared to what they were buying just a couple of years ago?

[Shawn Nelson, Chief Executive Officer]

Yes. Thanks for the question. Sactionals average order value has just continued to go through the roof year after year. It's been climbing steadily as you've witnessed. It's been a major part of our growth overall. And we're really proud of that. And that's driven by innovation. People are buying larger setup generally.

I just think the bigger our brand gets, the more that aided and unaided awareness expands and the more that our brand is accepted in the marketplace is something that's not so fringe, something is not such an unknown people just get more comfortable, I think, spending with us and really taking the risk on bigger setups. And so that's number one.

Number two, StealthTech, huge, huge driver of AOV for us. And we expect to see some of the same behavior around Angled Side. Remember, it also drives repeat business for us. But speaking specifically about that first purchase is what you asked, and that's what we're referencing, people that are buying Sactionals for the first time, that's where the largest dollar take is for us. We're totally focused on that. We've been focused on that for years.

We'll continue to be focused on it. As much as we feel really great about our growth and our success and how much just the sheer size of Lovesac compared to what it was two or three years ago even. The reality is we're still just a small fraction of this upholstery category, just a small fraction.

Because it's so splintered, it's so fragmented, and it's vast. Every home that you know of have a couch in it. We intend to be there. We think we make the best one, and we'll continue to make it better through innovations like the Angled Side.

And so that's -- all this innovation is what's driving that first purchase that have combined with our brand cloud. And that's where all of our investments are. All of our focus, social media, marketing, everything is all part of that effort.

[Alex Fuhrman, Craig-Hallum]

That's really helpful. Thank you, Shawn.

[Shawn Nelson, Chief Executive Officer]

Yes. Great to hear from you.

[Operator]

Thank you. At this time, I'd like to turn the floor back over to Mr. Nelson for closing comments.

[Shawn Nelson, Chief Executive Officer]

Yes. Thank you so much for joining today. We look forward to another year of growth as we build toward our longer-term ambitions. We appreciate the continued support of all of our investors and hope to create continued value for all stakeholders with our commitment to this Designed for Life way of doing business. Have a great day.

[Operator]

Ladies and gentlemen, thank you for your participation. This concludes today's event. You may disconnect your lines at this time or log off the webcast, and enjoy the rest of your day.