Lulu's Fashion Lounge Holdings, Inc. (LVLU) Earnings Call Transcript & Summary

Good afternoon, and welcome to this next session of the Global Retailing Conference at Goldman Sachs. My name is Brooke Roach, and I cover the apparel and brand sector here at Goldman Research, and I'm very pleased to introduce this next session with Lulu's Fashion Lounge. Here with me today are Tiffany Smith, CFO; and Mark Vos, President and CIO. Welcome, Tiffany. Welcome, Mark.

Thank you.

Thank you, Brooke.

Perhaps we can kick it off with an update on Lulu's competitive positioning and the core value proposition that you offer to the consumer. How has that changed over the last 12 months? And what are you doing to pivot the business against the current macro backdrop?

Yes. So as it relates to our competitive positioning, we feel that Lulu's stands apart from other brands and retailers in 3 ways or the combination of 3 things. First is, we are not a fast fashion company. We're actually focused more on the core of our customers' closet and really work towards delivering products that happen enduring quality and enduring style that last for multiple seasons and even multiple years. And so in that perspective -- from that perspective, we are somewhat insulated from all the fashion trends that are constantly coming in and out. And what it also does is that it allows us to focus really on a broader set of age range of customers as well as household incomes. The product and the quality that I mentioned is really about the -- essentially the fabrics and the construction from more luxury garments, but offering that at prices that are attainable for more. So our addressable market is high. Then combine that with our data test learn and reorder model, there's not a single product that we introduced, and we introduced about 200 to 250 new products every week, that is -- and they're all being tested. So small quantities to see what our customer is interested in, what is it that you would like to buy. And that is really driving our assortment from that point on. And because of our products having a longer life, we also collect a lot more data on our products that really helps us to essentially reduce fashion risk by better being able to understand the demand, when we need it, how much we need it, but also to use our products essentially as data to understand the attributes and the setup and combinations of attributes to really recommend also from there on new product development. So that is the second part. So really, the reduction in fashion risk. And then the third component is that Lulu's is increasingly becoming a lifestyle brand. And so we're adding the brand magic to that. And we're really leaning in and focusing on building that out. We are not a department store, for example, that offers a multitude of brands. We're not a portfolio of brands. We wake up every day and we go to bed every with only one brand on our mind, and that is Lulu's. So that's our positioning. And we believe that, that is the right model even with -- in the current economic environment where often the demand side, the consumer or portions of the consumer base are pressured. We still believe that, that is the right way to move forward.

And the competitive positioning and the competitive market, have you seen any increased pressures from your competitors being either more promotional or gaining more market share? And what is Lulu's doing to make sure that you're maintaining and growing market share?

Yes. So what we have seen already for the last year or so is that in the industry at large, there's certainly, I would say, over inventory, and that is actually one of the areas where Lulu's also stands out is that because of our data-driven buying that we do, if you look at our inventory turns, for example, then we are so much faster than our peers in the industry. And -- so last year, it was actually a little bit too fast. We were turning about 9 to 10 times a year, so imagine every 5 to 6 weeks, we sold through our entire inventory, which was not the best customer experience at all times. So we purposefully reduced those turns, but we're still very fast from that perspective. But because not everybody is in that position, that obviously puts pressure from a promotional perspective to work through that inventory. And there's times that we participate in that, certainly in the tentpole moments that everybody's got to participate in. But for the medium- and the longer-term health of the brand, we certainly have pulled back from that and we can afford to do so due to our excellent position and to maintain our brand strengthen and health.

Let's talk a moment for -- let's talk a moment about advertising and marketing. What is your strategy for connecting with the consumer today? What are you observing across all of your various metrics look at on loyalty, whether that's customer acquisition cost, loyalty program, engagement or otherwise?

Yes. So obviously, we look at all the metrics. They're all important. But we have been working. So if you take Lulu's a couple of years back, we were very much grounded in wonderful word-of-mouth advertising essentially, where family and friends recommendations is the #1 customer acquisition source, survey has demonstrated that. What we also did along the way is really build up our performance marketing, our direct response marketing capability sets, and in that way, supplanted -- not supplanted, supported the word of mouth with that from a marketing perspective. What we do believe is that in the longer run, we need to focus more on building that brand awareness. And for -- to that extent, we don't want to increase our spend, so we have decided to work our way out of -- not out of, but reduce our performance marketing spend and invested more on the awareness side because we believe that in the longer run, that will give us the biggest bang for our buck, not just because of potentially attracting more customers, but also that it will make our performance marketing spend also more efficient over. So that's what we have been focusing on. We did see the last couple of quarters as a result of leaning into the brand awareness, obviously, some increases, which was expected in our customer acquisition. But we operate, and that is also an aspect of Lulu's business model is the first order contribution margin, profitable marketing approach.

One of the questions that I get from investors pretty consistently is what competitive threat is posed to Lulu's Fashion Lounge from some of these fast rising e-commerce players? I'm sure you can fill in the names of each of them. But what are you doing to protect your business against some of that growth? Do you see that as a threat today? And do you see more opportunity to lean into those areas now versus 12 months ago?

So the race to the bottom as we view it, right, the price fighting in order to get the sales or to have a very cheap disposable fashion. That is not the business where we are in. That is not the products that we construct. That's not the prices at which we sell. And so from our perspective, it is -- yes, there is -- and over the last 5 years, there have been even more -- now there's more competition and the barriers to entry have become low. I mean you can -- everybody can open Shopify website, so to say. But it's no different than it used to be before. There has always been price fighters and there will always be price fighters. So in that sense, it is, in a way, business as usual. Now in the current economic environment where customers or more customers are making choices are more discerning or need -- have less discretionary income to spend, then in those times, those price fighters certainly can benefit from that. But for the long run, we believe we're in the right place.

You've grown up as an e-commerce-only company, but you recently announced that you're going to be opening your first store in L.A. What are you most excited about here? And what metrics are you looking at to judge the success of this and potential future stores?

Yes. So we're very excited about opening a store on Melrose in Los Angeles. It's going to be a multipurpose store. There's obviously a retail, but it's also to engage with influencers and even which we can also talk about is some of our wholesale activities. So it's really about having a place to connect directly with our customers. Our customers are telling us in various ways through various means that they are interested in seeing Lulu's in stores and actually seeing and engaging with us through products in a physical way. And so in that sense, we're super excited. We've done pop-ups in the past, which have been majorly successful. And so this is a -- it's not a pop up, it's a short-term lease, where we really are going to try to figure out how can we have that connection with our customers and build that out on a more deeper level. And then from -- obviously, there's the metrics around the store, the sales per square foot. But most importantly, this is to support our direct-to-consumer business. So we're really looking at do we see that brand awareness increase in the region as well as do we see the overall LTV and repeat rates of customers in the region where a store like that is operating, do we see that in.

You also just announced a new wholesale B2B partnership. And I imagine we'll get more details on that as you continue to roll out that platform. But can you talk a little bit more about the decision and the reasoning behind expanding into that model? What's the opportunity for this wholesale partnership? And then maybe for Tiffany, what's the impact on the financials?

Yes. So for us, like I said, our customers are asking for -- where can I see the products. I would like to touch them and feel them. And we have great products, and it's actually the ability to have that in physical stores in that sense is a major opportunity, not just from a brand awareness perspective but also for customer acquisition. And we have worked with a wholesale partner, and we have seen those outcomes. And so by expanding that across the country, we believe that we can have -- again, doing a better job for our current customers than deepening that relationship.

On the financial point, I think it's worth mentioning, both for the retail store in L.A., as well as these wholesale partnership expansions. We view this largely as profitable brand awareness spend. So really being able to get our product out there, as Mark said, in the physical domain where people can touch it and feel it and see the quality. That's one of the key financial benefits from this is really improving on our brand awareness, which we know we already have wholesale partnerships with Nordstrom as it stands today. And we hear through surveys when customers tell us, "Hey, I didn't know who you were, but I found you in a Nordstrom store and I came online and started shopping." So we know that this is a good avenue for us to really grow that brand awareness overall. And I also think, generally speaking on the wholesale front, this is a longer-term initiative we've spoken to, which will help kind of boost margins in terms of wholesale in the future is really starting -- we're starting to invest internally in building out a product costing team. So as our brand grew up over the years, we didn't necessarily have the in-house expertise nor did we want to really disrupt our base of vendors that we work with in terms of merchandise. And we largely source our product through vendors that are based in the L.A. market. And so what we're starting to delve into now, and this is not contemplated in guidance this year or anything that we expect to take off until further down the road, is that ability to seek out opportunities to reduce costs, whether it's going direct. We don't currently manufacture our own product directly and different opportunities there, which will then, over time, as we grow wholesale opportunities, we would expect to even bigger benefits on the margin front.

One of the other costing opportunities that you have this year, that's been a little bit of a headwind has been return rates. And you've been making some adjustments to your business and the customer experience to try and optimize return rates, while also maintaining that customer connection. Can you speak to those actions in a little bit more detail as well as any other initiatives that you have in place to drive those return rates down?

Sure. Yes. I think just as a philosophy, we view returns as an integral part of our business. We want to encourage the customer to feel confident with her purchases from Lulu's to be able to bring in whatever she wants to her home fitting room, given that we don't have a broad base of retail stores, we're soon to be one store, but not enough stores to allow them to come in and try it on in person. So having the customer feel comfortable with her purchase decisions, and having -- up until now, we continue to preserve a free return option for folks who return within 10 days. We wanted to preserve that, and we have tinkered around a bit with the policy this year and rolled out some changes earlier, largely directed at getting the customer to sort of help subsidize the cost of the returns. So there's a restocking fee that we've implemented on a per unit basis of return 12 items, they'll be paying a restocking fee on all 12 of those items. It's fairly nominal in terms of $1.49 per item, but that's only after that 10-day free return period. So they still could return it within 10 days and get free returns. So we're trying to be very customer conscious. We are aware and we hear from our customers how much they love our policy. So we don't want to make changes to that -- to the detriment of the customer. But we are also -- and we have rolled out some policy changes around those customers that are -- have a history of returning what we'll call excessively over a certain return percentage threshold and a certain dollar value of returns over a period of time. We've specifically rolled out some policy provisions for them to further subsidize their own shopping behaviors by paying for returns, having returns only back to store credit, for example. So just putting a little more friction in place for certain shoppers. But again, we've done that in a very data-driven way where we're utilizing our data and reporting to sort of identify those customers really then supplemented by sort of human level review by our team, just so we're not punishing people who maybe have valid reasons for maybe they had a struggle and had been in contact with our customer service team. We're trying not to push it too hard where we're creating a negative experience for them. So those are a number of things we've changed policy-wise. And like I said, I think there is a byproduct that could result in a return rate reduction. As a result of all these, I don't think it's necessarily materialized to a large enough extent that we've noted anything noteworthy there. But it's largely around reducing or helping to get some supplemental cost from the customer to help essentially cover the cost around returns.

Part of the return rate dynamic is also because event wear has a higher return rate proportion than casual wear. And we've had a lot of different trends in event wear in the last couple of years from no event wear when we were in the peak of the pandemic to the summer of the wedding last year. How do you think about the normalized growth rate of this event wear driven category for you? And what's the path to return back to that normalized level from where we're at today?

So the -- I was actually listening to the previous speakers as well. So when it comes to events, there's different types of events, right? You have, obviously, the wedding and wedding-related events but there's also all the other events from date-night to going out or prom and homecoming, graduation and so on. So there's quite a diversification, obviously, if there's a pandemic that is a little bit different. But in general, we see that and have seen over the years that those will certainly continue to play out. And we knew coming in this year that from a wedding perspective, it would be softer than the last year and the last 2 years actually due to all the pent-up demand. But comparatively speaking, we see in our own assortment that non-wedding-related event or occasion where it's still strong, and we expect that to continue. And it's -- overall, we operate in a very large market, very fragmented as well. And so there's always the opportunity to take share and that is that's what we set out to do.

One of the questions that we're asking all companies at our conference that are presenting today is how they view the consumer backdrop and the consumer health into next year. Do you think that the consumer is going to face more headwinds or less headwinds next year in comparison to 2023? And how are you thinking about the potential impact from trade up or trade down for your business in 2024, including any color by income cohort?

So it has been choppy, and we continue to think that it's going to stay choppy and certainly towards -- that's certainly contemplated in our guidance for the rest of this year. As it relates to how that's going to further evolve, the major drivers for that choppiness, we don't think are going to necessarily go away anytime soon. If you think about -- things are moderating inflation is moderating, but there's -- in determined there's students alone, repayments coming back, our customer group is largely well educated, so it can be affected by that. And so it's going to be a mixed -- I think it's still going to be a mixed bag throughout next year from that perspective. And as it relates to -- sorry, what was the second part of your question there?

Trade up, trade down.

Trade up, trade down. Yes. So what we have seen thus far is that because we offer appeal such a broad range of income -- household income categories, we are certainly for those income brackets that are affected and are -- and have made some changes, obviously, we see that in our data. And so therefore, we are, to that extent, affected by that as well. And so yes, trading down at this moment, we do not see clear signals, so that is happening just yet, but that could be -- but that would start happening next year.

One other question that we're asking all companies at our conference is that of share of wallet, and there's been a lot of shift between the consumer spending on experiences versus things. As you look into next year, what do you think is the one most important factor to drive higher spending in your core category?

For us, it's back to what I was saying is that the opportunity for us and especially by continuing to invest not just in our products, but also in our brand awareness is to really take share in a very large market. And so even if the share of wallet in our category, whether it grows or it doesn't grow, the opportunity obviously is still there. And that is what we're focused on. We are not pulling back. We're not pulling back on our investments. We're not in pulling back increasing our efficiencies. We're not pulling back on the marketing side and leaning in on the brand awareness side so that we are poised to take share and that we set ourselves on that path instead of sitting back and waiting until it gets better.

Tiffany, as we pull all together, there's brand-building initiatives, there's brand awareness initiatives and yet revenue has been under relative pressure this year. And your current outlook continues to embed double-digit declines in revenues at midpoint as we look into the second half. How are you thinking about the path to return to growth in the business? And what's the right timeline to thinking about reachieving that momentum?

So Mark alluded to, we -- given the setup of our strong balance sheet, our free cash flow generating business even through more challenging environments like we're in currently, that all sets us up and enables us to continue making these investments in the -- expanding on our distribution channels, being able to put those investments behind brand marketing, the retail store, all those different things that were part of kind of our longer-term growth strategy way back when we first develop that. Those are all still very much front and center in terms of our strategy, we're not changing those just due to the backdrop of the macro. And so I think we're positioned well, and we've been positioned well to continue making those investments so that once the macro clouds start to clear out of the way, we think we are in a spot to be able to start to work our way back to those plus 20% revenue growth long-term targets that we had put out there. So those are still very much on the horizon for us. Now I think the setback this year is really just kind of some of the macro factors being more -- a little more sustained than what we had expected at the beginning of the year plus the student loan staff plus some of those additional things that have made their way into sort of our back half guidance is just sort of the situation we're in this year. But we do still believe very strongly in the long-term premise around the revenue growth targets.

As you bridge the near term down double digits to the long term, very strong growth opportunity that you see on the horizon, is there any way to help us contextualize how much of that you think is in your control driving that improvement to what's the function of the macro?

I don't know that I've said anything or put any specific numbers out there around kind of the splits in terms of what we think is macro versus what we think is internal. And so I don't think there's anything specific I can share on that. But we certainly are taking control of what I would say, all the controllables, be it our product, our merchandising strategy, keeping good handle on our inventory levels. And again, just knowing that our buying model itself supports this very low-risk inventory business that we have. So I think all of those things that we're trying to control on top of investments in things that enhance our efficiency. So like the shipping cost investments that we've made diversify our shipping carrier network. That's a very controllable thing we invested in earlier in the year, and we've seen benefits to our gross margin as a result. We've also made the necessary investments around automation and robotics in our distribution centers, which has been driving efficiencies throughout our labor costs in the DC. So we're really trying to account for the things that we can control in-house and then further add in efficiencies on top of that, just, again, sets us up for, I think, a good -- being in a really good position once things start to clear out of the way that aren't within our control.

Can you round up the discussion that you're seeing on costs and efficiencies and talk to the rest of the puts and takes that you see in your adjusted EBITDA margin target into the -- or adjusted EBITDA margin guidance into the back half. What additional cost savings opportunities do you have? And how are you thinking about the puts and takes to protect earnings?

Yes. So the guidance does contemplate all of the initiatives we've spoken to in terms of the expanding our distribution channels in the retail store. And we do all of those things, I'll mention, we do those in a very capital-light way to ensure that we're not out ahead of our skis in terms of those investments and being very cautious about those particular expenditures. So those are all baked into the guidance for the balance of the year. And I just spoke to sort of the impacts and the benefits that we expect to continue to see on the shipping cost. We had implemented that earlier this year. So we're comping sort of the higher shipping costs in the back half of the year. So that's embedded in the guidance is some improvement there. We do expect overall gross margin rates for the back half of the year to be moderately better year-over-year than where they were at last year. And the labor cost, as I mentioned, is already baked in. What we're seeing now in terms of our fixed costs, things like public company costs and other investments that we've had to make since we went public with the sales decline that we've seen, there's just been a bit of deleverage happening there. So we're really confident that as soon as our sales start to tick back up, and we've seen this in the past that our fixed cost leverage very. And so that's another area where we expect once sales start to turn the corner, we're able to reclaim some of those EBITDA margin points pretty quickly.

And as you think about bridging that reclaiming of some of those easy wins on the EBITDA margin point to bridging to the 12% long-term target. Is 12% still achievable? And what are the biggest buckets of improvement that you see?

Yes. So we still stand behind those long-term targets, the 12% EBITDA -- adjusted EBITDA margin is still out there as far as our long-term goal. And I think it's definitely -- all of the things mentioned before that I won't mention again, are going to help to drive that. And then back to a point earlier in the conversation around product costing and being able to rationalize what's the biggest cost on our income statement essentially is going to be one of those items that does drive us towards that longer-term 12% EBITDA margin. And that's not baked into the back half of this year. We're just making those investments now and building out the team and the structure, and that is something we expect to be more multi-quarter, multiyear in nature.

One final question as it relates to margins is the promotional landscape. And last year, there was a little bit more promotions in Lulu's business in the back half relative to what you were running at before. Some of that is a function of just inventory turn normalization. But some of it was also a function of the industry backdrop. Inventories appear to be in a much better place for a lot of the industry. How are you thinking about the potential for promotions into the back half in holiday? And what opportunity is there specifically for promotion-driven margin expansion into the back half?

Yes. Sorry, I can start.

Go on.

We -- even last year, as you mentioned, we had much higher markdown promotion rates relative to -- particularly relative to what we saw in the first half of '22, where we had so much pent-up demand for event wear, we didn't really need to be promotional in the first half. Overall, though, even last year as a whole, our overall markdown in discount rate as a percentage of revenue was very much in line with where we were historically pandemic. So there was nothing, I would say, overly concerning about that. And then similarly, this year, we're not seeing or projecting anything in the back half that would suggest we're going to be increasing beyond our normal markdown discount rate. And I will say our markdown in discounts in combination or typically in the like low to mid-teens. That's significantly below where we see other retailers out there. That's a very low overall use of promos and markdowns for our business. And we expect it to remain similar as we wrap up the year. There are times, as Mark said, where it just doesn't market-wise, maybe marketing spend is too costly at certain times of the year, we may lean more into counting at that point, which is what we did last year. So it's really a balance of deploying our capital to the most profitable avenue that we can find the lowest cost option that's out there.

Let's speak for just a moment about some of those investments that you have that can drive long-term efficiencies for the business. Mark, you've been leading a lot of these investments, whether that's automation in distribution centers, whether that's AI and other types of investments. What are the most important investments that you've recently completed that you're starting to see efficiencies on? And as you look ahead, where are the most important investments focused?

You already pointed out the robotics and automation aspects in our DCs. We will continue on that trajectory. And I must say we do that in a capital-light way because what we also like is our ability to flex up and down with the demand. We've done that in the past, for example, during the pandemic. So we don't want to lose those capabilities and overinvest in fixed cost from an automation or robotics perspective, but there's still great opportunities there to continue to drive that cost per unit down. And so that will remain a focus because that is obviously one key cost component. The other cost component is really about the costing that we talked about. And so that is not just people and systems and software, but it's also the retooling some of the way how we do our business. And from that perspective -- and that's where AI then comes in as it relates to we've done already for many years, have been optimizing various aspects of our business, including our buying model to understand demand prediction, where is the demand so that we can put the products closest to our customers, inventory forecasting, returns forecasting, et cetera. And so continuing down that path remains a key from a profitability perspective to stay ahead, I would say. And then there is the science together with the art as it relates to our product assortment and where that -- what our customers are telling us, that remains a key focus because product is key.

One final question for you today. If the tough consumer backdrop -- macro backdrop is more persistent in nature. What changes would you contemplate in your strategy? And what changes would you consider on your capital allocation and your investments?

So our investment thesis is that this is a market -- this is an opportunity as well, right? So even though if the backdrop is challenging, we see several in our industry pull back and wait, and we have chosen to continue on the path on the growth -- and working on the growth levers that we have set out, whether around improving the relationship, existing with our -- relationship with our existing customers through wholesale and opening a store and maybe some more to focusing on expanding our product assortment into also the nonevent to become really successful there and change the dynamics, higher purchase frequency and increasing that -- the touch points with our customers. International is a part of this as well. We've been working on removing the barriers there to also improve the customer experience there for -- and that is, of course, a massive opportunity as well. And then there's brand awareness. And so we continue to do that. And we can scale, like i said, we have a lot of variable costs. So if the demand truly were to increase further, we can decrease along with that and still have room for -- to make those investments. At least that's what we're working to do it soon.

Excellent. Any closing comments or things that we haven't touched on that we should be touching on.

No, I think in summary, we have a good balance sheet. And so we're in a position to win. And so I think that is what the message is here and we'll focus on that.

Excellent. Well, with that we are out of time. So thank you, Tiffany. Thank you, Mark, and thank you for all of you in the audience who joined us today for this session.

Thank you.