The Lovesac Company (LOVE) Q4 2022 Earnings Call Transcript

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The Lovesac Company ( LOVE 5.18% )
Q4 2022 Earnings Call
Mar 29, 2022, 8:30 a.m. ET


  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Greetings, and welcome to The Lovesac fourth quarter fiscal year 2022 earnings conference call. [Operator instructions] As a reminder, this conference is being recorded. It is now my pleasure to turn — it is now my pleasure to introduce your host, Rachel Schacter of ICR. Thank you, Rachel.

You may begin.

Rachel SchacterInvestor Relations

Thank you. Good morning, everyone. With me on the call is Shawn Nelson, chief executive officer; Mary Fox, president and chief operating officer; and Donna Dellomo, chief financial officer. Before we get started, I would like to remind you that some of the information discussed will include forward-looking statements regarding future events and our future financial performance.

These include statements about our future expectations, financial projections, and our plans and prospects. Actual results may differ materially from those set forth in such statements. For a discussion of these risks and uncertainties, you should review the company’s filings with the SEC, which includes today’s press release. You should not rely on our forward-looking statements as predictions of future events.

All forward-looking statements that we make on this call are based on assumptions and beliefs as of today, and we undertake no obligation to update them, except as required by applicable law. Our discussion today will include non-GAAP financial measures, including EBITDA and adjusted EBITDA. These non-GAAP measures should be considered in addition to and not as a substitute for or in isolation from our GAAP results. A reconciliation of the most directly comparable GAAP financial measures to such non-GAAP financial 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 NelsonChief Executive Officer

Thank you, Rachel. Good morning, everyone, and thank you for joining us today. I will start by reviewing the highlights of our fourth quarter and fiscal 2022 financial and operational performance. Then Mary Fox, our president and COO, will outline our key growth initiatives for 2023.

And finally, Donna Dellomo, our CFO, will review our financial results and a few other items related to our outlook in more detail. Before turning to our results, let me first say that our heart goes out to all those affected by the war in Ukraine. Our ultimate guiding principle at Lovesac is, of course, love, and it breaks our hearts to see the human tragedy. While we have no business operations in the Ukraine region, we know our servicemen and women are certainly on alert, and our thoughts are with them and their families.

As for our fiscal 2022 performance. Fiscal 2022 was another record year for Lovesac with business continuing to perform extremely well despite the challenging and volatile backdrop. Our strong financial and operational results for the year are reflective of our unique competitive advantages across our people, brand, business model, and operating platform. For the year, we delivered a total annual net sales increase of 55.3%, total comp sales growth of 46.9%, and adjusted EBITDA of $55-point million, a 96.1% increase.

This incredible growth is stacked on a four-year CAGR of 48.7% growth and comps versus prior year comps of 53%. So this is not just a prior year COVID down-period easy beat. We achieved many operational accomplishments in fiscal ’22. Key among these were: we opened 28 Lovesac branded showrooms, two mobile concierge trucks, and eight kiosks; 18 new Best Buy shop-in-shops, which we operate directly for a total of 21.

We now operate a total of 167 physical touchpoints that help our customers on their digital journey. We believe we best represent what a successful digital model should look like. We launched the much-anticipated Sactionals StealthTech Sound + Charge product in partnership with Harman Kardon, which is a first-of-its-kind innovation, leveraging new Lovesac technology patents to deliver an immersive surround sound system and convenient wireless charging completely out of sight in the living room. We maintained in-stock levels throughout the year, shipping the vast majority of orders to customers in just days despite the challenging supply chain environment.

This is enabled by our unique product design and business model, including redundant manufacturing of key Sactional SKUs in four different countries, allowing us to better manage unplanned supply chain challenges. We continue to grow our customer file and drive loyalty with existing customers, showing new customer growth of 14.3%. We saw a lift in our CSAT scores, that’s customer satisfaction, as customers are appreciating more than ever our best-in-class service levels and in-stock positioning, while others in the industry are reporting long delays given supply chain challenges. We made critical investments in people and infrastructure in support of our growth, including our e-commerce platform that will allow us to continue to scale rapidly without sacrificing the customer experience.

We remain focused on our ESG efforts with the publication of our inaugural ESG report in December that sets the benchmark for Lovesac’s ongoing ESG journey, supporting our commitment to achieving a 100% circular and sustainable business model, reaching targets of zero waste and zero emissions by 2040. Last year, we diverted more than 15 million plastic bottles from the waste stream, up-cycling them into home decor fabric, more than any other firm were aware of. Since we transitioned to manufacturing, all of our gray upholstery fabric for Sactionals to 100% recycled plastic bottles, we estimate to have diverted well over 100 million bottles from the waste stream overall and counting. Now let me discuss the key highlights of our fourth quarter performance.

We are very pleased with our fourth quarter performance that well exceeded expectations with broad-based strength across channels as we continue to drive market share gains. For the quarter, we delivered top-line results of 51.3% to $196.2 million, on top of last year’s 40.7% growth, with total comparable sales growth of 50% and Internet growth of 22.8%. This marks 15 consecutive quarters of greater-than-25% growth. Net income increased by 50.4% to $32.6 million, and we reported an increase in adjusted EBITDA of 23.6% to $32 million for the quarter.

As we’ve said before, excluding shorter-term supply chain disruptions, gross margins and adjusted EBITDA for the company would be tracking at historical highs. We remain confident in our ability to deliver gross margins in the mid-50s range once some of these disruptions abate. In the meantime, we have taken price increases on our core seats and sides and could also look at price increases on a lot of our cover business as well. But we want to be really careful because in this environment, we believe Lovesac is gaining significant market share, while surprising and delighting customers with our speed to delivery and stock levels throughout these uncertain times.

Importantly, we are seeing no resistance. So in the short run, we are being very strategic. In regards to managing margin beyond price increases, we have multiple levers still available to us. We will continue to adjust promotion, mix, and merchandising, both online and in showrooms, which the team has done really well, as evidenced by our beats to expectations in this realm.

Now turning to our outlook for fiscal ’23. Demand is strong, and we feel confident ab
out our momentum in the coming year. We do expect and have planned for supply chain headwinds to persist through FY ’23. To that end, we will leverage our tremendous growth as we work with our manufacturing partners to mostly stem inflation at the raw goods and labor input levels, and we will use our pricing power judiciously.

We expect to be able to largely mitigate these pressures in the short term while we strengthen our core for the long term, including sourcing, supply chain, and our digital capabilities. Pursuant to our goals of zero waste and zero emissions by 2040, designed for life is how we innovate at Lovesac, making things that are built to last a lifetime and designs to evolve for true sustainability, circle to consumers how we operate, pairing our long-life products with long-term policies and programs that breed lasting and long-term relationships with consumers. We believe Lovesac can become authentically synonymous with sustainability over time. Over the long term, we intend to just keep doing what we’ve been doing for more than four years straight now: generate continued high net sales growth while increasing adjusted EBITDA margins on an annual basis by driving margin leverage at various points in the P&L structure, where we see increasing efficiencies even with our growth.

As long as we can do that, we are less concerned about quarterly movements at the gross margin line or other temporary shifts within the P&L. So in summary, our confidence continues to grow by the resiliency of our performance throughout such a tumultuous macro backdrop. Our team is strong. Our strategy is sound.

The best way to understand why Lovesac can continue to perform at high levels and remain somewhat insulated from industry swings is to understand how our Designed for Life philosophy delivers true innovation. Our primary product, Sactionals, looks like other sectional furniture, but adds many advantages to the consumer, like modularity, decoupling of the fashion elements from the core elements, compressed packaging for shipping, etc. These provide major advantages to our supply chain and business operating model in general. Even more importantly, we are not a retailer.

We are also not just a direct-to-consumer business model. Our actual products are proprietary, protected by many patents, and deliver heightened utility, durability, and sustainability versus the competition. As these products are adopted now more broadly, word-of-mouth increases, which drives great efficiency in our marketing spend and creates a virtuous cycle of growth. The more product we sell, the more we will sell more efficiently, combined this fact, which we have demonstrated for many quarters now, with our ongoing innovation pipeline and continued growth is possible.

Sactionals are now a few years into this product adoption curve, otherwise known as the diffusion of innovation curve. Perhaps, we’re moving past those early adopters who took the risk on our heretofore obscure brand and unique offering and into that early majority of consumers where the real volumes lie. We are not concerned about saturation or diminishing returns yet because our share of the now $40-plus billion highly fragmented couch category, it’s still only about 1%. Meanwhile, StealthTech another fantastic and proprietary innovation from Lovesac has only just begun its journey toward acceptance beyond the early adopters on this curve.

It may be years before our brand Lovesac has gained the credibility in the consumer electronics space to reach into a meaningful number of consumer homes with the word of mouth as the driver, like Sactionals have started to do, enjoying the growth that comes at the steeper portion of that curve. We look forward to that. Finally, we will remain differentiated as we continue to innovate into new categories, as we’ve proven we can do, and take advantage of this product adoption curve as a core driver for our business into the future. We are inventors, coupled with a totally direct-to-consumer omnichannel business model not interrupted by wholesale resellers, where we capture all the data and focus on building long-term relationships with each of our customers in order to remarket to them our future inventions.

This model is gaining in strength, and we believe we can continue to disrupt. Before I turn the call over to Mary, I want to thank the entire Lovesac team for all they accomplished in fiscal 2022 while navigating an uncertain environment. We are so thankful for their dedication and relentless efforts, and we are looking forward to building on our successes in fiscal 2023. With that, I will hand it over to Mary to cover our strategic priorities and progress.


Mary FoxPresident and Chief Operating Officer

Thank you, Shawn, and good morning, everyone. Our strong fourth quarter and record full year performance are a testament to the strengths of our business model and the agility of our teams. As Shawn shared with you, our highly differentiated business is benefiting from a growing product reduction curve as a result of strong relevancy and innovation. In the four months since I joined Lovesac as president and COO, I have really appreciated spending time in our showrooms as well as getting to know all of our associates in all functions and the strategic priorities they are all driving.

What stands out to me the most is the passion and commitment of everyone at Lovesac and the consistency of the performance they drive, with 15 consecutive quarters of greater-than-25% growth and a CAGR of 48.7% in the past four years. In the last two years alone, our comparative sales have doubled and almost tripled on a three-year stacked basis. We are very pleased with these record results and the strides we have made against our five strategic growth initiatives, which I will now review. Starting with one product innovation, of which the key highlight was our StealthTech launch in the middle of October in ’21.

We continue to be very pleased with the launch of StealthTech, and it is meeting our internal expectations. The only element that has been different to our plan is the customer demand on satellite side per transaction is higher than we had anticipated, and we are actively getting back in stock on this item. The launch generated activity of over 1 billion impressions and was a great jump start to the product launch. Since launch, StealthTech has demonstrated the ability to accelerate Sactionals AOV by over 700 basis points as well as overall brand preference even for those who are not buying StealthTech.

Our priority in fiscal ’23 will be continuing to drive awareness through media and PR while leveraging experiential marketing and our touchpoints to drive demo and conversion. We expect performance to build sequentially as this year progresses, and we will continue to drive awareness of this strong innovation. Two, efficient marketing and merchandising strategies. In fiscal ’22, our customer lifetime value was $2,840, and our customer acquisition cost was $548.74, delivering a ratio of 5.17, which was our highest level yet and up 10% year over year.

This ratio improved despite significant media cost headwinds versus last year as our innovation and assortment mix drove margin performance that provided an offset to these headwinds. Broadcast indication was rolled out for the holidays after successful local testing during Memorial Day and Labor Day, which resulted in a 25% increase in overall TV reach. In addition, we have expanded into TikTok and Snapchat, which has resulted in more efficient CPMs that we continue to expect through fiscal ’23. Lastly, we ran a premium placement for the first time.

This placement was around the NFC and ASC Championship games, and we saw significant performance that drove over 30 million impressions that translated into traffic to the Lovesac website. Year to date, overall media ROI continues to perform above our benchmarks. And while we expect overall media in fiscal ’23 to continue to see cost pressure
s, we anticipate offsetting this by higher conversion, increased AOV and margin improvements, and expanding segmentation capabilities, utilizing our customer data platform. We will also continue to invest in fiscal ’23, focused on driving spend to high ROI performing programs such as search and continuing to grow these programs with hyper-local marketing and geolocation to drive relevant traffic into our touchpoints.

We are also very encouraged that word of mouth is now the No. 1 driver of our brand awareness and share gains. We expect this to continue to be a tailwind for our growth as we continue to drive brand awareness and perception. Our customers and prospects are proving to be very effective brand ambassadors with nearly one in four customers who purchased Lovesac having experienced our products at a family or friend’s house.

Overall, our brands and business experienced significant strengthening year over year in fiscal ’22 with our customer count up 14.3%, and overall customer satisfaction scores were up 250 basis points versus fiscal ’21. Our brand perception and positioning in the market has significantly improved year over year, and this strength has allowed us to drive down discounting across all channels while taking limited price increases to offset increased costs and improve our margins. Number three, touchpoints operation. We are continuing to see synergies across our various touchpoints.

Customers can now experience Sacs and Sactionals with the addition of StealthTech in all of our locations, enabling them to now see and hear the product offerings before making their final decision. Our showrooms continue to be an important part of our omnichannel touch-point strategy and continued to deliver strong results as reflected in our Quarter 4 showroom comp of plus 72.6% or plus 95.1% on a two-year comp basis. With the launch of four new showrooms in Quarter 4, we met our target to open 28 new showrooms this fiscal year. In addition, in Quarter 4, we opened seven kiosks as well as 16 Best Buy shop-in-shops in market with and without a showroom presence.

Appointments continue to play an important role in our touchpoint shopping experience. And during Quarter 4, we conducted more than 3,200 appointments, which was a 25% increase over Quarter 3. These appointments represent nearly 8% of total touch-point business, and Quarter 4 was our highest converting quarter at a 50% conversion rate. Throughout the fourth quarter, the post-purchase specialist team continued to expand their reach across both physical touchpoints at e-comm.

In Quarter 4, our post-purchase specialist communicated with more than 89% of Lovesac customers, whose purchases met the predetermined dollar threshold for their service. Post-purchase CSAT for customers that engage with a post-purchase specialist was 3.4 points higher than those that did not. As planned, we expanded our sales and service strategy to all touchpoints throughout Quarter 4. This rollout leverages talent across trade areas to support customers in their shopping journey, both pre- and post-purchase with a goal of enhancing the customer experience and further increasing customer satisfaction.

As we look forward to the year ahead, we continue to leverage our strong traffic-driving ability to expand our real estates in off-mall locations, with 75% of our currently planned touchpoint growth being focused on off-mall locations and therefore, driving our four-wall contribution up. We have been investing in additional recruiting resources focused specifically on the rapid expansion of our field organization. This investment allows us to continue to scale talent with our growth plans. Four, expanding other channel presence.

We’re very pleased with the strength of the Costco business, where we’re hosting our online roadshows directly on We have seen productivity increases year over year driven by an expanding premium cover and Lovesac offering that have also significantly expanded product margin year over year. We continue to be excited about the partnership with Best Buy, and we opened 16 additional shop-in-shops in Quarter 4. We have also seen our business increased at a strong rate this year, which we attribute to the improvement to our customer experience on, the launch of StealthTech as well as the marketing tests in support of StealthTech, and the holiday sales period.

We look forward to continued expansion of this partnership. In fiscal ’23, we will also 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. And then five, making disciplined infrastructure investments. Starting with e-commerce, we continue to see strong year-over-year results throughout the holiday season as we made key investments to enhance our e-commerce platform throughout the quarter.

With the launch of our new customer data platform in September, in Quarter 4, we began to utilize our first-party data to heighten targeting and segmentation in all of our marketing efforts. We are excited to harness the power of this tool this year as we continue to enhance and improve our omnichannel customer journeys, and it positions us strongly for a COVID-less world that is approaching. As we look to this year, we are obsessed about improving the customer experience on with research projects underway to understand improvements needed in our customer journey. We’ll also be investing in a new omnichannel customer service platform, providing customers with the right support for both reactive and proactive needs.

This solution will enhance our already connected omnichannel experience by providing valuable business intelligence and positively impacting customer satisfaction and employee engagement. And then finally, regarding supply chain update. In Quarter 4, we continued to benefit from our supply chain and inventory strategies, which enabled us to not only over-deliver sales in Quarter 4, but also close the year in a great position with year ending in stocks in the high 90s and substantial inventory quantities on the water ahead of the Chinese New Year shutdown. Our delivery time to customers continues to be best-in-class in our category, and we remain committed to this performance.

As we look forward, we took bold action back in Quarter 3 to address the anticipated roughly start from Chinese New Year and the ongoing pressures on cost and inventory flow over at least the first half of fiscal ’23, executing plans to ensure product flow from which we’re now benefiting. Our diversified sourcing base on key categories has helped us to support our strong and consistent supply performance. But we do expect some logistic cost pressure in the form of fuel surcharges that Donna will cover further. Into fiscal ’23, we will continue to focus on the customer experience from order to delivery, increasing our efficiencies, reducing costs, and mitigating risks in our supply chain.

We will continue to drive our supply chain capabilities and disciplined systems and people investments to improve the performance of our inventory, our largest assets. So in summary, we are very pleased with our financial and operational performance in fiscal ’22 and continue to be very excited about the opportunities this year as we drive our strategic growth initiatives. We are very proud that our overall customer satisfaction scores ended the year significantly higher than when we started fiscal ’22. As we have seen, our customers can really drive awareness and perception of our brands, and we want to make sure that we’re servicing them better and building closer longer-lasting relationships with them.

Our commitment to circle to consumer will help us to continue to drive our CSAT and impact the future growth of our business. Our strong results reflect 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 as w
e start fiscal ’23. And we really appreciate all of the team’s commitment and passion to driving our business.

We are very well-positioned to continue to gain market share and benefit from the broader trend of consumers who value purpose-driven brands founded on sustainability. I will now pass the call over to Donna to review our Quarter 4 results, full year financials, and a few details relating to our fiscal ’23 outlook. Donna?

Donna DellomoChief Financial Officer

Thank you, Mary. Good morning, everyone. I will begin my remarks with a review of our fourth quarter results and then provide a framework for how we’re approaching fiscal 2023. Net sales increased $66.5 million or 51.3% to $196.2 million in the fourth quarter of fiscal 2022.

The year-over-year net sales increase was driven by growth across all channels with an overall comparable sales increase of 50%, which was due to the success of our holiday campaigns; ending showroom count increase of 28% year on year; the introduction of eight kiosks and two mobile concierge touchpoints; higher productivity of our online pop-up shops on, with one additional event over the prior year; and an additional 18 Best Buy shop-in-shop locations as compared to the prior year. Showroom net sales increased $44.1 million or 59.8% to $117.7 million for the fourth quarter of fiscal 2022. This increase was due primarily to a $43.1 million increase in comparable showroom point-of-sales transactions to $102.6 million in the fourth quarter of fiscal 2022, as compared to $59.4 million in prior-year period. As a reminder, point-of-sale 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 Q4, while comps or orders increased 50%, at fiscal year-end 2022, approximately $13 million of this increase is waiting to be shipped to our customers principally related to the timing of customers’ orders. We also opened additional Lovesac showrooms, kiosks, and mobile concierge since the fourth quarter of last year, as I just mentioned, which was a meaningful driver of the non-comp showroom sales increase. Internet net sales, which are sales made directly to customers through our e-commerce channel, increased $11.2 million or 22.8% to $60.4 million in the fourth quarter of fiscal 2022, as compared to $49.2 million in the prior-year period, principally driven by the performance of our fiscal 2022 holiday campaigns. Other net sales, which principally include pop-up shop and shop-in-shop net sales, increased $11.2 million or 164.9% to $18 million in the fourth quarter of fiscal 2022, as compared to $6.8 million in the prior-year period given the higher productivity of our pop-ups in addition to the one additional pop-up shop during the fourth quarter of fiscal 2022 and the increase in Best Buy shop-in shops just discussed.

By product category, our Sactionals net sales increased 56.8%; Sacs net sales increased 12.6%; and our other category net sales, which includes decorative pillows, blankets, and other accessories, increased 81.5% over the prior-year period. The decrease in gross margin percentage of 200 basis points over the prior-year period was primarily driven by an increase of approximately 480 basis points in total freight costs, which includes inbound and outbound freight tariff expenses and warehousing costs. These costs were partially offset by an improvement of 280 basis points in product margin, principally driven by lower promotional discounting and continuing vendor negotiations to assist with the mitigation of tariffs. The increase in total freight costs over prior year was principally related to the negative impact of 590 basis points increase in inbound container freight costs and increased tariffs related to higher product sourcing from China, partially offset by 110 basis point improvement due to higher leverage of warehousing and outbound freight costs on higher net sales.

We exceeded the fourth quarter net sales guidance we shared with you on our last call, primarily driven by the success of our holiday campaigns. Our gross margin percentage in the fourth quarter of fiscal 2022 exceeded our guidance of approximately 760 basis points, driven primarily by lower inbound freight costs than we had projected. These freight costs are a function of freight rate as well as volume and the expected arrival of those containers. While the rate component was in line with expectations, there were some delays with timing on containers’ arrivals due to the broadly reported supply chain headwinds and port congestion in Q4 that caused the delta.

Importantly, we expect these deliveries to arrive in Q1. And the good news is that with the redundancies in our supply chain and distribution network, we had no degradation in CSAT scores or customer delivery times. In addition, we saw higher product margin as a result of less promotions, better leveraging of our warehousing, and outbound freight costs than projected. The 59.6 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 eight kiosks, plus higher percentage rent from the increase in net sales. Overhead expenses increased due to infrastructure investments, equity-based compensation, travel expense, and insurance. Selling-related expenses also increased, primarily due to credit card fees related to the increase in net sales and a onetime settlement fee to terminate an existing agreement with a vendor partner. SG&A expense as a percentage of net sales increased by 154 basis points due to deleverage within selling-related expenses from sales agent fees, employment costs, travel, rent, infrastructure investments, and insurance, which were partially offset by leverage on credit card fees and equity-based compensation.

The increase in sales agent fees is related to a onetime settlement payment I just discussed. The deleverage in other expenses relates to the investments we are making in the business that were put on hold in the prior-year period due to COVID-19 financial resilience measures. Advertising and marketing expenses increased $9.9 million or 63.8% to $25.5 million in the fourth quarter of fiscal 2022, as compared to $15.6 million in the prior-year period, resulting from continued investments in marketing spend and awareness campaigns to support our sales growth. Advertising and marketing expenses were 13% of net sales in the fourth quarter of fiscal 2022, as compared to 12% of net sales in the prior-year period.

The 99 basis point increase was due to media activities, which are expected to drive revenues into future periods. Depreciation and amortization increased approximately $500,000 from the prior-year period to $2.1 million, principally related to current year capital investments to the new and remodeled showrooms. Operating income was $24.2 million, compared to operating income of $21.8 million in the fourth quarter of last year, driven by the factors just discussed. Net interest expense of $44,000 for the fourth quarter was in line with the prior year’s fourth quarter expense.

Interest expense principally relates to unused line fees on our revolving line of credit. In the fourth quarter of fiscal 2022, we reversed the full valuation allowance we had against our deferred tax assets, resulting in a net tax benefit of $8.5 million, as compared to tax expense of $16,000 relating to minimum state income tax liabilities in the prior-year period. Before we turn our attention to net income, net income per diluted share and adjusted EBITDA, please refer to the terminology and reconciliation between each of our adjusted metrics and their most directly comparable GAAP measurements in our earnings release issued earlier today. Net income was $32.6 million or $2.03 per diluted share in the fourth quarter of fiscal 2022, compared to net income of $21.7 million or
$1.37 per diluted share in the prior-year period.

The increase in net income per diluted share in the fourth quarter of fiscal 2022 was significantly impacted by the onetime tax benefit of $8.5 million, which equates to $0.53 per share, as I just discussed. We generated adjusted EBITDA of $32 million in the fourth quarter of fiscal 2022, as compared to adjusted EBITDA of $25.9 million in the prior-year period. Turning to our balance sheet. Our liquidity continues to remain strong as we ended the fourth quarter with $92.4 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 fourth quarter and fiscal year 2022 financial performance. Regarding our outlook. We are still operating in a dynamic environment with wider range of potential outcomes as it relates to fiscal ’23. Given this, we are not providing formal outlook for the full year, but we’ll share a framework that will be helpful as you are updating your models.

We are targeting another year of strong net sales growth, which will include more than 25 showroom openings. We are also continuing to make infrastructure investments to support the substantial multiyear growth opportunity that lies ahead. In a scenario where net sales growth is in the low 30% range, we expect gross margin rate to be approximately 300 basis points below fiscal 2022 levels driven by the continuation of higher inbound and outbound freight costs. Adjusted EBITDA margin rate in this scenario is projected to be slightly above fiscal 2022 levels despite increased freight costs and infrastructure investments as we expect to leverage operating expenses with a net sales increase in the low 30% range.

For our fiscal first quarter of 2023, we expect net sales growth of approximately 39% and breakeven adjusted EBITDA, compared to positive adjusted EBITDA of $5.3 million in the same quarter last year. Adjusted EBITDA is primarily being impacted by expected loss gross margin of approximately 700 basis points year over year related to higher inbound ocean freight rates and higher outbound transportation costs resulting from higher fuel surcharges. We expect to generate cash from working capital in fiscal 2023, and we expect capex to be in the $20 million to $22 million range. Before I wrap it up, I want to mention that in the upcoming fiscal 2022 Form 10-K, you will see mention of a material weakness in internal control related to certain technology controls in the areas of user access rights and the monitoring of such rights for systems that support our financial reporting processes.

Remediation efforts are in process, and we fully expect that the remediation of this material weakness will be completed prior to the end of fiscal 2023. Most important, this has no impact on our cybersecurity controls, financial statements or the timing of our 10-K filing as a large accelerated filer. So in conclusion, we are pleased to close out fiscal 2022 with strong fourth quarter results that exceeded our expectations on both the top and bottom line. Our performance continues to serve as a testament to the caliber of the entire Lovesac team, and we are grateful for their contributions.

We look forward to building on this performance in fiscal 2023 and beyond. With that, we would now like to turn the call back to the operator who can open it up for questions. Operator?

Questions & Answers:


Thank you. [Operator instructions] Our first question comes from Thomas Forte with D.A. Davidson. Please proceed with your question

Thomas ForteD.A. Davidson — Analyst

Great. Thank you. So first off, Shawn, Mary, and Donna, bravo. Excellent year.

I look forward to this year. So you sort of touched on this in your prepared remarks, but I want to talk about unaided awareness. So you had a television ad during the NFC title game. It sounds like you also had one during the AFC title game.

And then last night, I saw a product reference for your original Lovesac product in the Renee Zellweger TV show. So, Shawn, I’m curious on your thoughts on how increasing unaided awareness can drive sales for Lovesac even as we’re seeing signs that the home category overall is slowing.

Shawn NelsonChief Executive Officer

Yeah. As I mentioned, I think that we are — thankfully, a big portion of our continued success has to do with timing, not to say that the team hasn’t done a fantastic job, that’s exactly what they’ve done. But Lovesac just happens to be at this moment of inflection where we are still small and we have tons of headroom as a brand, as a product adoption, as a moment in that curve where Sactionals have penetrated enough and word of mouth has really kicked in and driving unaided awareness for us, but we’re still small. And so for us, at this moment, where the world is in great tumult, where the home category has gone through an obvious cycle that was unpredictable, driven probably by COVID and people remaining at home and all of these factors, we emerge from that in a better place than we went into it.

And by the way, we did pretty well through that cycle. And so for us, it’s just a confluence of great timing, great execution, and great marketing decisions. We are being very judicious in our marketing spend while taking risks and balancing those factors. And with that, our unaided awareness is growing, but the category has grown just as much.

And so we continue to have the headroom that we have. And I’m sure that Jack, who by the way, is also available on this Q&A, might have some comments on this.

Jack KrauseChief Strategy Officer

Absolutely. Thanks. Hey, Tom. I’m still here at least for a couple of quarters, right? Anyway, I think the key is unaided awareness is absolutely critical because we win at conversion.

So if you start to get people into the funnel and they funnel down, we know we’d crush it in the conversion funnel. So it is absolutely important, unaided awareness because it allows us to be a comparable to the other critical products. And when our products are compared, we win every time. So it’s critical, and that’s why we’re disrupting.

We’re not only fighting for overall awareness, but we’re disrupting at the point of consideration. And that what causes the brand to have a trajectory that’s well above any of the category trends.

Thomas ForteD.A. Davidson — Analyst

Great. Thank you, Shawn. Thank you, Jack.


Thank you. Our next question comes from Maria Ripps with Canaccord. Please proceed with your question.

Maria RippsCanaccord Genuity — Analyst

Good morning. Congrats on very strong results here. First, you mentioned the success of your holiday campaign, but sort of in addition to that, how much of the top line outperformance would you attribute to having inventory in stock and being able to get it to consumer quickly versus sort of all the new touch points added in the past year between showrooms, kiosks, and mobile concierge, etc.?

Shawn NelsonChief Executive Officer

Yeah. Sorry, just deciding who would jump in. There are so many factors to separate out with — in the business over the last — obviously, over the last couple of years. It’s very difficult for us to strip out what growth is coming because of what factor.

We — and the main reason for that is the sheer volume of growth. Obviously, it’s massive for us. And so any kind of industry movement, any kind of, let’s call it, a tailwind from some of the factors you mentioned, whether it’s just as simple as being in stock, is extremely hard for us to separate out when the growth is greater than 50%, especially. But we’ll take it.

We think that, for instance, the element of being in stock over the past — well, over the past many, m
any years, but over the past year, in particular, has been a huge advantage for us. And it’s evidenced not just of like we bought plenty of inventory and we prepared well and the management team is sharp or whatever, which I hope is all true, but it really is rooted in the fundamentals of our product and our business. And we’ve been pounding the table on that for a long time. And frankly, the tumultuous environment that we’ve been operating in has been proven ground for the things that we’ve been saying for years.

You got to remember that while Sactionals look like sectional furniture, they pack very, very differently on container ships. They pack very, very differently for last-mile delivery. And through COVID, touchless delivery, no appointments possible in people’s homes for all of our competitors, that sort of thing, we rode through with all of these attributes and just continued to sell at a healthy clip because of these attributes. And so I wish that we had the data to strip that out.

We don’t. I think that as long as we’re operating in tumult, we will continue to be a winner. And I think when we operate in peace times, I think we can be a winner as well partly because of what I mentioned before, we are really growing into our a formidable size at the right time, still small enough to have plenty of headroom, but be enough to matter and become — get into the forefront of people of the consumer mindset. It will be no less volatile in the next few years based on the many insights that we’re obviously seeing.

So our supply chain will continue to add stability to this business. And you couple that, just as you mentioned, Maria, with the business model on the front end, a truly direct-to-consumer model that we are in control of. We’re not reliant on wholesale relationships. We’re not collecting receivables.

We’re not separated from our consumer by a middleman. We have all of the data to those consumers, and we’re able to market and remarket to them and build those relationships that we talk about through our CTC, our circle-to-consumer efforts that are, by the way, very fledgling and just beginning. But the bigger that our customer base grows, the more useful that will be to us, to mine and to leverage, and to cultivate. And so we’re very — listen, we feel very blessed to be in a situation where we can continue to win.

And I think based on all these attributes and others that we don’t even have time to get into, I think Lovesac can continue to win in these ways and demonstrate how these fundamentally different aspects of our product and business model deliver advantages.

Maria RippsCanaccord Genuity — Analyst

Got it. That’s very helpful, Shawn. And then secondly, I appreciate all the colors around StealthTech. But is there any way you could maybe describe the contribution from StealthTech to your Q4 results? And any update on the attached rate? I believe last quarter, you mentioned that it was around 15% or so.

And then can you share sort of any color on how this product compares to Sactionals from the gross margin standpoint?

Mary FoxPresident and Chief Operating Officer

Yes. Maria, it’s Mary. I’ll start, and then Donna may want to kick in, in terms of overall contribution. So obviously, in terms of StealthTech, as I shared, you’ve seen that we are very happy with the performance.

It’s in line with our expectations. And that looks at multiple data points that we are looking for us to achieve in our KPIs. And I think for us, it was what we planned for Quarter 4 as we have seen that initial launch at the middle of October through to Quarter 4. So we’re very happy with that.

I think also another point, Maria, is that we’re always trying to balance demand with having in-stocks. And you know with many competitors out there, they’re not able to deliver on in-stocks, and that’s a foundation of everything that Lovesac does and that we will never let go of. So managing that in-stock to service ratio with demand has always been key. I don’t know, Donna, anything else that you want to comment in terms of the overall contribution for Q4?

Donna DellomoChief Financial Officer

Not specifically for Q4, and I won’t give stats for the year. And I know, Maria, you like the numbers. But we were really pleased with the attachment rate as we ended fiscal 2022, and we expect it to be as strong going into fiscal 2023. So again, very pleased with [Inaudible] StealthTech overall.

Mary FoxPresident and Chief Operating Officer

Yes. And I think, Maria, you asked about margins as well. That’s in line with our overall margins. So that is continuing to perform.

So contribution rates, everything is strong. So yes, we’re very excited. But as Shawn said before, it’s in the early stage of adoption, and we will continue to put a lot of emphasis around driving awareness. But also, honestly, demos in the showrooms because what we’ve seen to be proven is that what consumers see and hear our product, they love it.

They think it’s remarkable. So we feel very good about the forward momentum.


Thank you. Our next question comes from Brian Nagel with Oppenheimer. Please proceed with your question.

Brian NagelOppenheimer and Company

Good morning. First off, I too would like to add my congratulations on another nice quarter. Congrats. So the question I have, my first question, just with regard to — I know you spent a time in the prepared comments talking about the supply chain and the issues you continue to deal with.

But I guess the question I have is we look at the gross margin performance in the fourth quarter, tracked significantly better than I think most estimates out there, significantly better than the guidance you provided, and really map that far off of kind of like what I would say, historical highs. And then the initial, I guess, not guide is necessarily framework for Q1 would suggest more pressures here going — in the current quarter. So the question is this — and maybe I’ll go back to kind of the puts and takes. And is there any reason why that from a gross margin sourcing perspective, shipping whatever, it should be more challenging here in Q1 than it was in Q4?

Donna DellomoChief Financial Officer

Brian, it’s Donna. So really, as I outlined in my script, the rates are where we thought they would come in. So they’re as high as where we thought they would come in. The thing is, it’s based on volume as well because as the freight comes in, it sits in our inventory and we amortize it out off the P&L.

But the other contributing factor going into Q1 is outbound freight, right? The outbound freight costs for us to last mile to the customer is seeing some significant impacts as well, more than what we thought last year, but what — 100% covered in all of our models. So not only are we seeing the inbound freight from overseas at accelerated costs, we’re starting to see the outbound freight build as well. But again, covered all of those increased rates are covered in all the models that I — all the — I’ll call guidance for Q1 and framework for the year. But that’s why you see, specifically for Q1, it’s the timing of the containers.

We’re getting a lot more containers coming into Q1, and then it’s the outbound freight.

Brian NagelOppenheimer and Company

OK. That’s helpful, Donna. Then my second question, I guess, a little bit bigger picture, but Shawn, you talked about the continued initial success here about — of StealthTech that product launch. On the heels of that, I know we’ve talked to discussed this in the past, but any update as to how we should be thinking about additional products, newer products in Lovesac, either timing or maybe even idea of what these could be?

Shawn NelsonChief Executive Officer

Yeah. As we’ve said, we’ll continue to put out new products at a trickle constantly. And what I mean by that is we’re a platform-based business. Sactionals is a very powerful platform, been driving most of our sales.

But the Sac platform continues to have opportunity to grow. We have a number of projects brewing in that realm. The Sactionals platform has all kinds of accessories and add-ons that will be meaningful, that will move the needle for us and continue to make that platform even more competitive than it has been. Heretofore, there are many people who have the style, the shape, whatever it is, doesn’t work for their — for them esthetically or even comfort-wise.

And we’re making all kinds of innovations in that realm that we’ll launch quarter on quarter over the next number of years. There’s probably a decade less still of Sactionals innovation. And then StealthTech is our first toe into a completely new category, home audio, right? You look around your home. What are the categories that we could innovate in? I don’t think people expected us to innovate into home audio.

But we’ve done it, and I think that StealthTech is absolutely a newborn. I can’t emphasize that enough. Like you will be asking it, and it’s fair, I’ll take the question any time and pontificate on all of our exciting new products to come, but recognize that like an invisible home theater system that’s shrouded underneath foam and upholstery and then a removable cover, but tuned to be music to your ears with no sound quality loss at all because of our patented technology. That is a far-fetched crazy idea coming to you from a beanbag company, not one of the big names in the home audio.

It’s going to take years before StealthTech has matured to a place where Sactionals have matured to, and even Sactionals are still a toddler. Sactionals are still a toddler in the category. And I say that with lots of love for our own products and for the team, but like I just — I don’t know how to communicate that enough. So look, it will be a couple of years before we make another major launch into a new category because we don’t spew out a merchant’s beautiful, esthetically pleasing idea on a commodity.

We invent things. We solve problems you didn’t know you had, like a home theater system that perhaps your partner didn’t even really care about because the last thing they wanted was speakers cut into their ceiling or wires strewn across the floor or whatever, right? That’s not a problem that a lot of people necessarily contemplated. But I think we solve that elegantly. We’ll continue to solve problems like that throughout the home elegantly.

Those things take time. They take a lot of invention, a lot of work to bring to market. And meanwhile, we’ll drive awareness of these remarkable products that we have launched to the point where they’re beyond newborns, the newborn stage beyond the toddler stage, and hopefully get into some more meaningful growth that comes with adolescents. So we’ll see.

But that really is our point of view, every couple of years on — every two or three years on a major product launch, and in between, we’ll grow the platform. And by the way, StealthTech’s another platform. We’ll continue to grow that platform. And so really excited about the future, but that will be my answer to that question for a long time to come.


Thank you. Our next question comes from Camilo Lyon with BTIG. Please proceed with your question.

Camilo LyonBTIG — Analyst

Thank you. Good morning, everyone and congrats also on a very strong close to the year. To that point, there’s a lot that’s changed from a macro perspective since the end of your fourth quarter. And I’m curious if you could give us some details on the health of the consumer.

You clearly alluded to a very strong continued momentum in this first quarter sales framework you provided. But I’m just trying to parse out the components of that as it relates to price increases, expectations on StealthTech adding to that. Is that the doubling of the average ticket that you usually enjoy? And really trying to parse out the health of the consumer in a world where inflationary pressures are mounting, rates are rising and Russian invasion is creating some consternation around sentiment.

Mary FoxPresident and Chief Operating Officer

Hi, Camilo. Great question. Thank you. So I think the first thing is, as we shared in our outlook, we feel very confident around demand and particularly also confident around our ability to supply to our customers in a matter of days.

So I think that will continue, and we feel very strongly about that. And I think also then as you talk around disruptions, we’re not yet seeing anything in terms of any dynamics that are really impacting demand or traffic into showrooms or on the web. We’re really continuing to see great strength from our consumers as they buy into whether it be Sactionals or, as you said, around adopting early on StealthTech. So from that side, as we look at whether it be AOVs, we look at basket spend, we really continue to see great strength.

So for that side, we feel with that disruptions that you mentioned, that we’re so small in the category, and with everybody else unable to deliver with so many delays and so many other things, that we truly are winning each and every day because of that formula of success. So obviously, we’ll always be very mindful, continue to watch, and adjust as we see anything. But today, we feel very good as we look forward into fiscal ’23.

Camilo LyonBTIG — Analyst

That’s great to hear. And on —

Jack KrauseChief Strategy Officer

Just to add to that.

Camilo LyonBTIG — Analyst

Oh, sure. Sorry.

Jack KrauseChief Strategy Officer

Oh, sorry. Camilo, how are you doing? A couple of things. One is our target customer is, we think, a little bit more protected from some of the dynamics in the short run than the total population. And on top of that, I think something really important to add to Mary’s points is that despite promoting significantly last, last year, despite taking price increases, we’ve seen the value of the brand as determined by our own customers go up.

And so they’re valuing our brand more and more as they get to know it, and the disruption, I think, getting back to the whole conversion. That’s why we’re seeing the significant conversion. And that conversion is really important to talk about because we’re disrupting by converting in the category while everybody else is trying to figure out how to play with the small hits or misses within the category growth, we’re just playing disrupting. And that conversion rate is what’s doing it for us.

Camilo LyonBTIG — Analyst

Got it. That’s excellent to hear. Thanks for that color, Jack. Donna, if I could ask you, when you think about the guidance, the margin guidance that you provided, the framework you provided, can you just tell us the expectations on freight costs? And if you’re embedding a relief in those pressures this year or if you expect those to persist throughout the year at the current rate?

Donna DellomoChief Financial Officer

Hi. Yeah. So consistent with what we said at the end of the third quarter when we had provided an outlook or a framework, we are still building the higher freight rates from a conservative standpoint as if they will persist throughout the remainder of this year. Also just remember, we maintain because of our strong inventory position in evergreen inventory, we maintain a healthy in-stock position.

So even if those were inbound or outbound freight costs started to drop, throughout the year, we would still have the inventory that would be impacted by the higher freight. So in any of the guidance or the outlook that
we provided, we’ve assumed higher freight rates throughout the full fiscal year.


Thank you. Our next question comes from Alex Fuhrman with Craig-Hallum Capital Group. Please proceed with your question.

Alex FuhrmanCraig-Hallum Capital Group — Analyst

Great. Thanks very much for taking my question. I wanted to ask about your inventory. It looks like you have a pretty huge war chest to begin this year with.

Can you tell us a little bit of what that consists of? Is it basically just your regular assortment, but just more of it? Curious just how you’re managing your big inventory in anticipation of not — knowing, I guess, what the supply chain could bring this year.

Mary FoxPresident and Chief Operating Officer

Yes. Hi, Alex. Thank you for the question. I think as we look, we — I think I mentioned it earlier.

In quarter 3, we made a big bet around continuing to build up our inventory levels, firstly, as we saw demand continue to be very strong, but secondly, also in the anticipation of the Chinese New Year impacts that obviously we’re starting to see also. That was really put into our top-selling SKUs and continuing to drive out just on our core business on seats and sides. So you’ll see, across the board, it’s just a continuation of us are always trying to deliver within days to our consumers. I touched on earlier also, the CSAT improvement.

That’s just really a reflection of how our customers are feeling. Every day is — Lovesac is able to deliver to them in such a short time when the rest of the industry is really struggling and continually delaying. So we feel really good. We were bullish because it’s certainly going to help us go through.

And the start of this year, we actually are at the best in-stock levels that we’ve ever been in. So congratulations to the team for anticipating that, and we will continue to always invest and manage forward so that we make sure that we always deliver to our customers.

Donna DellomoChief Financial Officer

I just want to add to that, too. There is a piece of that inventory, as I say, about the inbound freight that sits on the balance sheet. So there’s an increase year over year of about $20 million. So when you look at that, in prepaid freight, that sits on the balance sheet as well.

So it’s our tangible inventory plus the freight that follows the inventory sitting on our balance sheet, which is what I talked about, will go through the P&L as that inventory is sold. So I just want to make sure that you’re — you focus on there’s a tangible piece of that inventory growth and then there’s the freight associated with it.


Thank you. Our next question comes from Matt Koranda with ROTH Capital. Please proceed with your question.

Matt KorandaROTH Capital Partners — Analyst

Hey, guys. Thanks and congrats on a great quarter. Just wanted to attach the StealthTech question may be from a different angle here. Can you provide any commentary on sort of the lift to average order values, either in the fourth quarter or full year ’22, and how those benefited from StealthTech? And then just you mentioned in your commentary that customer demand on satellite sides was higher than expected.

Should we be interpreting that as sort of customers are choosing larger systems than the base suggested configuration that you guys have put out there? And what are the implications for AOVs?

Mary FoxPresident and Chief Operating Officer

Yeah. I’ll start, and then I think Jack can also add on. And nice to hear from you, Matt. Thank you for the question.

So obviously, from a StealthTech point of view, we’re seeing AOVs for just the StealthTech alone of just over $3,000. And it’s lifting our overall AOV by just over 700 basis points, so just over $207 per transaction. So we’ve been very pleased to see where that lift has come from. And to your points around the satellite side overselling to where we’d initially forecasted, which we feel great about, it is a little bit around the fact that we’re seeing the larger configuration being purchased.

So it’s not just — as you go through kind of the 6- through to the 8- to the 10-seat side, we’re actually seeing the larger configurations being bought into. So again, that gives us great confidence going forward that people really want to have a great experience with StealthTech. So from that side, we are in stock. We just want to build back the inventory on those satellite side so that we deliver every day.

And then, Jack, I don’t know if there’s anything else you want to add to that?

Jack KrauseChief Strategy Officer

You’ve covered it at all. Thanks.

Mary FoxPresident and Chief Operating Officer

All right. Thank you, Matt.


Thank you. Our next question comes from Lamont Williams with Stifel. Please proceed with your question.

Lamont WilliamsStifel Financial Corp. — Analyst

How are you doing, guys? Congrats. Just wanted to ask where you are in your hiring plans? And where you can expect investing in people for next year? And then secondly, on — just a quick follow-up on StealthTech. How is it the product working to bring in new customers? And are the initial sales going? So what’s the breakdown between new and existing Sactionals customers? Thanks.

Mary FoxPresident and Chief Operating Officer

Great. Thank you, Lamont, for the question. So I think the first one you talked in terms of on hiring. I think from the first point, we feel good about the progress of hiring as we’re entering into fiscal ’23.

We did make some adjustments in the field, whether it be around base pay, but we also rolled out our sales and service strategy, which includes a great incentive program. And I think coupled with the purpose-driven brand, we’re seeing great hiring and really filling in the roles as well as honestly building the expansion that we have in touchpoints that Donna shared for fiscal ’23. So feel good there. I think also in the head office, the hubs, we also see great abilities to hire talents, and we feel very good in terms of where that builds out.

So today, we feel, from a fiscal ’23, very strong there. I think then, in terms of your question around StealthTech, yes, we are seeing predominantly new consumers to Lovesac that are being attracted to us via StealthTech, which we’re very excited about. But we’re also seeing current consumers coming back and adding StealthTech to their Sactionals in their home. Because that’s a wonderful thing that there’s so much flexibility whether you bought a Sactional 12 years ago, you can add StealthTech.

And that strength of the new technology to your current product is phenomenal. The StealthTech index for return customers is higher than anything we’ve seen before. So again, it just bodes very well for us as we continue to raise awareness and drive the demos that we feel very confident around the StealthTech performance through the year. But as Shawn said, it’s at the early stage of adoption, and we will continue to really get people excited and get them to see, hear and feel it as they come to our showrooms or even just understanding about it on the web.


Thank you. There are no further questions at this time. I would like to turn the floor back over to Shawn Nelson for any closing comments.

Shawn NelsonChief Executive Officer

Yes. Thank you. Thank you to all the investors and supporters joining the call but continue to invest and support Lovesac. A huge thank you to our Lovesac team who are amazing and resilient, capable, and who drive our business forward with lots of love.

As we say at Lovesac, the
se results are their fault. Have a great day. Looking forward to another great year.


[Operator signoff]

Duration: 72 minutes

Call participants:

Rachel SchacterInvestor Relations

Shawn NelsonChief Executive Officer

Mary FoxPresident and Chief Operating Officer

Donna DellomoChief Financial Officer

Thomas ForteD.A. Davidson — Analyst

Jack KrauseChief Strategy Officer

Maria RippsCanaccord Genuity — Analyst

Brian NagelOppenheimer and Company

Camilo LyonBTIG — Analyst

Alex FuhrmanCraig-Hallum Capital Group — Analyst

Matt KorandaROTH Capital Partners — Analyst

Lamont WilliamsStifel Financial Corp. — Analyst

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