The Lovesac Company (LOVE) Earnings Call Transcript & Summary

Thank you. Good morning, everyone; joining me today are Shawn Nelson, our Chief Executive Officer, Jack Krause, Chief Strategy Officer, Mary Fox, President and Chief Operating Officer, and Donna Dellomo, Chief Financial Officer. Before we begin, I want to remind everyone that certain information we'll discuss will contain forward-looking statements about upcoming events and how our finances will perform going forward. That covers statements regarding our expectations for the future, financial projections, plus our plans and prospects. Results in reality could vary materially from what those statements describe. To understand these risks and uncertainties, please look at the Company's filings with the SEC, which include today's press release. You shouldn't treat our forward-looking statements as forecasts of what will happen down the road. Every forward-looking statement we make during this call rests on assumptions and beliefs held as of today, and we assume no duty to revise them unless applicable law requires it. Today's discussion will also feature non-GAAP financial measures, among them EBITDA and Adjusted EBITDA; these non-GAAP measures ought to be viewed alongside our GAAP results, not as a replacement for them or on a standalone basis. A reconciliation showing the most directly comparable GAAP financial measure against that non-GAAP financial measure appears as supplemental financial information in our press release; at this point I'd like to hand the call over to Shawn Nelson, Chief Executive Officer of The Lovesac Company.

Thanks, Rachel. Morning, everyone — appreciate you being with us today. I'll start by going over the highlights from our third quarter in both financial and operational terms, and after that Jack will walk through how we progressed on our key growth initiatives during Q3. Donna will then close out the prepared portion with a look at our financial results plus a handful of other items tied to our outlook. On the call with us as well is Mary Fox, who, as you're all aware, took on the President and Chief Operating Officer position at Lovesac on November 15, stepping into the very role Jack held previously. You'll recall that Mary had been a member of our board of directors from February 2020 onward. Her background is strong in digital and brand building, and she brings that to Lovesac along with a 25-year career spent in the consumer goods sector, meaningful experience scaling businesses, and deep supply chain and operational know-how too. Add to that her sharp, prescient embrace of ESG principles, and she also carries a broad understanding of Lovesac's distinctive business model. Taken together, those qualities make Mary an especially strong fit, particularly when you consider Lovesac's growth trajectory. We're delighted she's on the leadership team, and just as excited that Jack will take on the newly created Chief Strategy Officer position, in addition to his recent appointment to the board of directors. Our third quarter results make us very happy: we delivered 56.1% growth while net income improved by 11% for the quarter, and that's even as we made substantial investments in our infrastructure. This sales growth comes on top of the 43.5% growth from last year, so the continued and widening growth we've seen this year speaks to strong demand for our product, gains in brand awareness and conversion, all while we're actively navigating the tight supply chain environment. Growth showed up across every sales channel, including, most notably, a rise of nearly 70% in showroom sales and an increase of nearly 40% for internet sales; that makes 14 consecutive quarters of greater than 25% growth, with overall continued improvement in our capacity to generate cash and profits. A major competitive advantage of ours is that we're generally completely in stock and expect to stay that way, getting nearly all orders delivered direct to consumer within just days despite the challenging supply chain backdrop. Customers keep recognizing this strength, which our Q3 results reflect, along with consistently strong customer satisfaction scores through this tumultuous time; this has always set Lovesac apart, and in an environment where industry lead times can stretch into months, it's especially advantageous. Underpinning our ability to hold stock levels are our product design and our business model. Sactionals account for more than 80% of our sales, yet over half of those dollars come from just two SKUs: seats and sides. Additionally, we produce those 2 SKUs with redundancy, maintaining consistent quality across multiple manufacturers located in 3 separate nations, which lets us handle unexpected situations such as COVID-19 outbreak interruptions, and so on, more effectively. This stock isn't tied to seasons, nor does it spoil or lose relevance over time, making investment in this kind of inventory less risky than most. Our primary offerings get packaged and dispatched in highly distinctive manners that enable tremendous efficiency within ocean containers and through FedEx straight to the customer's residence. Although we aren't fully shielded from today's heightened container and inbound freight expenses, our packaging and shipping approach assists in partially counterbalancing those costs and risks. Our expansion and available stock situation likewise demonstrates the outstanding work our teams are performing throughout the company. Adjusted EBITDA reached $5.8 million, surpassing our guidance of a loss between -$3 million and -$4 million, as we exceeded our sales targets and took on anticipated freight challenges while at the same time investing significantly in personnel and infrastructure to fuel our growth. Though we anticipate certain gross margin pressures will continue short term, which Jack and Donna will elaborate on, over the long run we stay dedicated to achieving a mid-50s% gross margin rate once conditions stabilize and we keep expanding the business. We've already increased prices at MSRP in some cases, and we're offering fewer discounts to counter gross margin pressures. We'll keep steering the business this way and think we can still produce remarkably robust gross margins for this category, even amid these difficult circumstances. On the operational side, a major quarter highlight was the highly awaited debut of the Sactionals StealthTech Sound plus Charge product; this marks a first-of-its-kind breakthrough, utilizing fresh Lovesac patents to provide an immersive surround sound system created alongside Harman Kardon plus handy wireless charging, all smoothly integrated and concealed within the infinitely configurable Sactionals platform; it stands as the sole home theater system hidden right out in the open. From a commercial standpoint, this introduction achieves numerous objectives. It not only boosts our relevance among current customers and prospective ones, but it also widens our competitive edge by building an even stronger moat, since nobody else provides this distinctive offering. Early customer feedback has been overwhelmingly favorable thus far, and with the StealthTech component's base price around $3,000, it could almost double the average order value for transactions where it's added, on top of the usual Sactionals AOV of $3,400. Similar to Sactionals sofas, the TAM, or Total Addressable Market, for home audio equipment is quite substantial when it comes to categories available to compete in within the home segment. Since home audio represents an entirely separate category from upholstered furniture, bringing in StealthTech poses minimal to no cannibalization risk to our existing business. Also, whether a StealthTech commercial airs on television or online, it's identical to the one for Sactionals. Since they're combined into a single campaign, the expense is basically no greater than what we previously spent promoting Sactionals. Strange though it might seem, Lovesac aims to be a contender in home audio — and to come out on top. No other system resembles ours, and by many measures, we think it's the finest option you can buy right now. Moving on to our ESG initiatives, we remain on schedule to release our first ESG report before this month ends. For this fiscal year, that 2021 inaugural report, consistent with the Sustainability Accounting Standards Board's, SASB, Building Products and Furnishings Sector Standard, establishes the reference point for Lovesac's ESG path, backing our pledge to reach a 100% circular and sustainable business model, hitting goals of zero waste and zero emissions by 2040; over the next several years, our attention will be on tracking emissions throughout our value chain. Reporting down the road will follow the Greenhouse Gas Protocol Corporate Accounting and Reporting Standard, which lays out what companies must do and how. Jack will go into depth about how we're advancing on additional growth strategies, among them our marketing and merchandising approaches, showroom operations, growing our presence in other channels, and making prudent investments. With an eye toward the year's final quarter, we're in a strong position for the holiday season ahead.

We anticipate that the operational and supply chain landscape will stay fluid, yet as outlined earlier, we think Lovesac is positioned better than most companies in our sectors to keep items available and thrive throughout. For us, the fourth quarter is consistently a period with outsized importance. We run over 120 showrooms with heavy foot traffic, situated primarily in the busiest malls throughout the United States. In our view, Sacs along with the newer StealthTech offerings make up one of the most exciting holiday presents a family could wish for. The month following the holidays is a robust one for the entire home decor sector, of course. Since our fiscal year ends at the close of January, that further boosts how weighted our fourth quarter is. Now, having passed Black Friday and Cyber Monday, as a brand that gets 100% of its sales through direct-to-consumer and digital channels and has instant access to all sales and customer data, we can state with confidence that we anticipate ongoing robust expansion for the quarter, and we are eager to capture additional market share gains. Going forward, we plan to simply continue what we have been doing for nearly four years without interruption, producing strong sales growth while raising EBITDA margins year over year. Had it not been for the massive jump we achieved at the EBITDA line in the prior year amid substantially restraining our spending during the initial stages of the COVID pandemic, we would be boosting EBITDA and EBITDA margins in the current year. Turning to fiscal year 2022, this year, viewed over a two-year span, we foresee a path of rising profitability. We also anticipate continuing to run this business in a manner that keeps us on track to raise annual EBITDA margin through the next year, even with near-term gross margin pressures stemming from macro factors. We think this will let us eventually rise as a leading force in our categories and turn into the most cherished brand in the home space, which is the mission we have stated, and optimize shareholder value over the long term; with that, I will pass it to Jack to discuss our strategic priorities and progress. Jack.

Thanks, Shawn, and hello everybody on this call. When we think about what comes next for growth and all the possibilities in front of us, Lovesac is going to require people, technology platforms, and operational foundations so we can expand in a way that creates value for every one of our stakeholders — and I couldn't be more thrilled to step into the fresh position of Chief Strategy Officer as well as serve on the board as we chase that objective. Since Mary came onto our board, I've been fortunate enough to get to know her, and I've seen with my own eyes the important things she brings to the table. It's a pleasure to work alongside her as she serves as President and COO. So, let's shift to how we did in Q3. Our results for the third quarter make us quite happy, along with the progress we've achieved on the growth plans I'm about to walk through. First up: product innovation — the standout here was the debut of StealthTech on October 18th. It's still very early, yet customers have responded strongly to this new offering, and we're noticing corresponding lifts in sectional transaction AOVs, which is a good sign for engagement, loyalty, and repeat buying. Number two: smart approaches to marketing and merchandising. Our marketing returns remain appealing, and these efforts keep helping us build general awareness and produce the 58% revenue growth year-to-date that we've delivered. A few StealthTech notes. During Q3, since the launch came at the very end of the quarter, we rolled out fresh ad and social creative, and the first signals look quite encouraging — among them a 13% year-over-year gain in web sessions, mostly fueled by paid search. After solid local trials around Memorial Day and Labor Day, broadcast syndication was extended for the holiday period, lifting total TV reach by 25%. On top of that, as part of bringing StealthTech to market, Lovesac teamed up with Amazon Prime Video's newest series, The Wheel of Time, which premiered in the third quarter and performed really well. On the social and digital side, social CPM keeps climbing on our core channels, though a better conversion rate mostly cancels that out. Even as CPM rises across our digital media channels, our proven digital playbook plus newer efforts such as SMS marketing, hyperlocal advertising, and consideration advertising are producing solid engagement, conversion, and revenue results. Media ROI overall remains ahead of our benchmarks. We do expect media costs to keep facing pressure, particularly in Q4 given holiday retail pushes, but we believe higher conversion will make up for it. Number three: touchpoint operations. We keep finding synergies among our different touchpoints, where customers can try the product, feel just how great it is, and then finalize their choices. Showrooms remain a key piece of our omni-channel touchpoint approach and keep producing strong numbers, as our Q3 showroom comps of +53%, or 79% on a two-year basis, show. During Q3, we launched 9 new showrooms, and we're still on pace to debut 28 across this fiscal year. By adding things such as on-the-spot scheduling specialists, we keep improving what shoppers experience in those showrooms. All through the third quarter, our post-purchase specialist team kept widening its coverage across in-person locations as well as e-commerce. In Q3, post-purchase specialists reached out to more than 92% of Lovesac customers whose orders crossed the set dollar threshold for that service. We keep observing higher post-purchase CSAT scores among customers who worked with a post-purchase specialist compared with those who didn't. Our sales and service strategy kept rolling out during Q3, and by Q4 it will be live at every touchpoint. That rollout draws on talent across trade areas to help customers along their shopping journey, before and after purchase, aiming to improve the customer experience and push customer satisfaction even higher. Our real estate strategy keeps growing too, with 2 mobile concierge vehicles launched in Q3. Those vehicles act as extra asset-light touchpoints in key markets. Early results are beating conversion and AOV expectations, and we're assessing whether to launch more vehicles next year. Beyond that, we opened 1 kiosk in Q3 and expect to open as many as 8 branded kiosks before Q4 ends, in markets that have a showroom presence and those that don't. StealthTech now sits inside the showroom kiosk and mobile concierge experience, and during Q4 it will extend to the rest of our Best Buy shop in shops. Even though we're back to normal operating procedures, we keep watching the pandemic situation closely, abiding by local and state guidelines and putting the health and safety of our customers and team members first. Number four, growing our other channel presence. We're quite happy with how strong the Costco business is — we host our online road shows directly with costco.com — and productivity has risen year-over-year, fueled by a growing premium cover and Lovesoft offering. We stay enthusiastic about the Best Buy partnership, since our bestbuy.com business has grown at a strong rate this year, which we credit to how our customer experience performs on bestbuy.com plus some marketing tests we run. Also, we opened 1 Best Buy shop in shop during the third quarter. We'll keep chasing opportunities with other partners, because our other channel presence remains an effective way to grow brand awareness and reach. Five, making disciplined infrastructure investments. Beginning with e-commerce, we kept making key investments during the quarter to improve our e-commerce replatform. Conversion rate remained a highlight for us in Q3, improving 58% versus LY, powered by a 74% jump in mobile conversions. Bringing StealthTech into the e-commerce shopping experience was a major accomplishment during the quarter. During the online shopping journey, we've tailored the StealthTech selection process to be simple and personalized for both new and returning customers, depending on their sectional's dimensions and setup. We've also rolled out the newest release of the Magento 2 platform, bringing major security enhancements as we head into this holiday period. In September, we successfully introduced a new customer data platform, or CDP. That platform brings together and improves our customer and shopper data, enabling us to broaden our use of first-party data for digital marketing and deliver the intelligence required to personalize the omni-channel customer experience even more. On the supply chain front, our strategic investments in forward inventory placement, product flow optimization, and supply chain redundancy let us hold a differentiated position in in-stock and order fulfillment, which contributed to our Q3 results; for the crucial holiday season, our inventory is in a strong position as we enter our busiest time of the year. Looking forward, we anticipate the same supply chain headwinds will continue through fiscal 2023. In the near term, we keep mitigating them through several tactics and are addressing them over the longer term with key initiatives to strengthen our sourcing base, supply chain channels, and end-to-end investments. To sum up, we're happy with our third quarter financial performance and the progress achieved on our strategic growth initiatives. Our robust Q3 results demonstrate the outstanding execution by the whole Lovesac team as we keep steering through a dynamic operating environment. We're optimistic about the underlying momentum and trajectory of the business for the holiday season and look forward to finishing the year strong. Before Donna reviews our Q3 results, I wanted to hand the call to Mary, President and Chief Operating Officer, for a few brief opening remarks. Mary.

Thanks, Jack. It's a real pleasure to be here as a member of the Lovesac leadership group alongside Shawn, Jack, and Donna. As everyone can picture, the month since I came aboard on November 15 has been full and productive — I've been learning even more about how the business runs while also getting to meet the entire team. Between my board service over the course of my career and being a Lovesac shopper for 11 years now, I've developed tremendous respect and admiration for the company's distinctive direct-to-consumer model, its one-of-a-kind product, its devoted customer base, and its strong dedication to sustainability, which includes the circle to consumer philosophy. It's a true honor to step into this new position, and I'll draw on my broad experience working with consumer goods companies over my career to help carry out the growth strategy and create long-term value; with that, I'll turn things over to Donna for a look at our third quarter financial results. Donna.

Thank you, Mary. Good morning, everyone. I'll start by walking you through our third quarter results, and after that I'll give you an update on the framework I discussed with you last quarter regarding how we're thinking about the rest of fiscal 2022. In the third quarter of fiscal 2022, net sales rose $42 million, or 56.1%, reaching $116.7 million, compared with $74.7 million during the same period a year earlier. Growth across every channel drove that year-over-year net sales gain, with overall comparable sales up 47.1% thanks to a successful Labor Day campaign, a 28 year on year increase in ending showroom count, and stronger productivity from our temporary online pop-up shops on costco.com. Showroom net sales climbed $28.2 million, or 67.8%, to $69.7 million in the third quarter of fiscal 2022, versus $41.5 million in the prior year period. That gain stemmed mainly from a $19.5 million rise in comparable showroom point of sales transactions, which reached $56.1 million in the third quarter of fiscal 2022, compared with $36.6 million in the prior year period. As a reminder, point of sales transactions represent orders placed through our showrooms, which does not always reflect the point at which control transfers to the customer and when net sales are recorded. Beyond that, since the third quarter of last year we opened 28 additional Lovesac showrooms, including two mobile concierges and one kiosk, which contributed meaningfully to the non-comp showroom sales increase. Internet net sales made directly to customers through our e-commerce channel grew $9.8 million, or 38.2%, to $35.5 million in the third quarter of fiscal 2022, compared with $25.7 million in the prior year period, driven principally by how our Labor Day campaign performed this fiscal year. Other net sales, which principally includes pop-up shop and shop net sales, rose $3.9 million, or 52.7%, to $11.9 million in the third quarter of fiscal 2022, compared with $7.5 million in the prior year period, with that increase primarily tied to higher productivity of our temporary online pop-up shops on costco.com. Turning to product category, our Sactionals net sales rose 58.6%, Sacs net sales rose 39.2%, and our other category net sales, which includes decorative pillows, blankets, and other accessories, rose 69.8% over the prior year quarter. Gross margin percentage fell 510 basis points over the prior year period, driven primarily by an increase of approximately 748 basis points in total distribution and related tariff expenses, partially offset by an improvement of 238 basis points in product margin. The rise in total distribution and related tariff expenses over prior year was principally related to the negative impact of a 953 basis points increase in inbound transportation costs and increased tariff related to higher product sourcing from China, partially offset by 205 basis points improvement due to higher leveraging of warehousing and outbound freight costs. Better product margins came from cutting back on promotional discounts and from ongoing talks with vendors to help offset tariffs. We beat the third quarter net sales outlook we gave you during the previous call, mainly because our Labor Day campaign performed well and shipment volume rose thanks to greater warehouse throughput. Gross margin percent for the third quarter of fiscal 2022 matched what we had guided, and that guidance assumed ongoing supply chain pressures pushing inbound transportation costs up; we managed to offset part of those added costs by continuing to trim promotional discounting, raising prices selectively, and getting better leverage on our warehousing and distribution costs. SG&A climbing 46.8% versus a year earlier largely reflected greater employment costs stemming from more new hires and variable compensation. Rent expense was also higher because of the 28 additional showrooms, along with greater percentage rent tied to the net sales increase. Overhead costs rose because of infrastructure investments, travel expenses, and equity-based compensation. Selling-related costs also went up, mostly from credit card fees linked to the net sales increase. SG&A expense measured as a percent of net sales fell 207 basis points, helped by greater leverage within infrastructure investments, equity-based compensation, insurance, rent, and selling-related expenses, partly offset by deleverage in employment costs and travel. That deleverage in certain expenses stemmed from the investments we are making into the business that had been paused the prior year because of COVID-19 financial resilience measures. SG&A expense came in below our expectations for the third quarter, chiefly because of lower employment costs from hiring delays, planned in-person company meetings moving to virtual events, and some infrastructure investments shifting into the fourth quarter of the fiscal year. That favorability relative to our expectations was partly offset by higher rent expense and higher credit card fees from the increased net sales. Advertising and marketing expenses rose $4.8 million, or 44.3%, to $15.8 million in the third quarter of fiscal 2022, compared to $11 million in the same period a year earlier, reflecting continued investment in marketing spend to support our sales growth. Advertising and marketing expenses represented 13.6% of net sales in the third quarter of fiscal 2022, versus 14.7% of net sales in the prior period. That 111 basis point decrease came from better performance in media activities, generating higher sales volume with less promotional discounting. Depreciation and amortization expense declined roughly $200,000 from the prior year period to $1.7 million, mainly because of accelerated depreciation expense in the prior year period, partly offset by current year capital investments for new and remodeled showrooms; in the third quarter of fiscal 2022, operating income was $3 million, compared to operating income of $2.5 million in the third quarter of last year, driven by the factors just discussed. For the third quarter, net interest expense came to around $45,000, mostly tied to fees on unused portions of our revolving line of credit. Our tax expense for the third quarter of fiscal 2022 reached $174,000, versus $11,000 during the same period a year earlier, and that rise stems from minimum state income tax liabilities. Before we move on to net income, net income per diluted share, and Adjusted EBITDA, we ask that you consult the terminology and the reconciliation between each adjusted metric and its most directly comparable GAAP measurement included in the earnings release we put out earlier today. In the third quarter of fiscal 2022, net income stood at $2.8 million, or $0.17 per diluted share, which compares with net income of $2.5 million, or $0.16 per diluted share, in the prior year period. Adjusted EBITDA we generated during the third quarter of fiscal 2022 totaled $5.8 million, against Adjusted EBITDA of $6 million in the prior year period. Now, on our balance sheet, liquidity is still in a strong position, since we closed the third quarter holding $47.9 million in cash and cash equivalents along with $22.5 million of availability on our revolving line of credit. For additional details regarding our third quarter fiscal 2022 financial performance, please see our earnings press release. Now let's discuss our outlook.

We anticipate wrapping up yet another year marked by robust revenue expansion, featuring 28 additional Lovesac showrooms, 8 kiosk launches, and the debut of two mobile concierges. We have been reinstating costs that had been reduced during fiscal 2021 because of the pandemic, while also making deliberate infrastructure outlays to underpin the considerable multi-year growth prospect that awaits us. Turning to our fourth quarter, we anticipate revenue growth of roughly 35%, with Adjusted EBITDA dollars ranging between $12 million and $13 million, in contrast to positive Adjusted EBITDA of $25.9 million dollars during the equivalent quarter a year ago. Adjusted EBITDA is under pressure from anticipated gross margins that are about 1,000 basis points lower year-over-year, driven by major supply chain challenges, chiefly the present inbound freight rate inflation relative to the previous year. Looking ahead to fiscal 2023, our confidence in the business's trajectory remains intact. Although we are not offering formal guidance for fiscal 2023 right now, broadly speaking, we anticipate solid net sales growth in the high 20% range, along with Adjusted EBITDA growth that surpasses net sales growth. This holds true even with an expectation that supply chain challenges will continue through fiscal 2023. Thanks to our ongoing efforts to mitigate supply chain challenges, gross margins for the full year are projected to be approximately 50%. Regarding CapEx spending, we still anticipate finishing fiscal 2022 with a robust cash and cash equivalent position, and we now project CapEx between $16 million and $17 million, compared to the earlier range of $17 million to $18 million that was shared. This encompasses CapEx outlays for our new showrooms, kiosks, and mobile concierge openings that we mentioned before. To sum up, we are happy with our Q3 results, which beat our expectations on both net sales and profitability fronts. We take great pride in the outstanding execution by the whole Lovesac team, who stay agile and nimble in a dynamic environment. We feel confident about our positioning for the fourth quarter and are eager to build on our achievements so far as we conclude the year. With that, we would now like to hand the call back to the operator, who can open it up for questions. Operator?

Good morning, and congratulations on a strong quarter. Mary and Jack, I want to congratulate both of you on your new roles.

Thanks, Brian.

My first question concerns the guidance, particularly where gross margin is concerned. For Q4, you signaled a decline of 1,000 basis points in gross margin. That is. You discussed at length the elements you've kept dealing with. That would suggest, you know, I suppose it points to stronger headwinds than what we observed during the third quarter. What I'd like to ask there is, could you sort of explain what that consists of and where things stand for us at present in the quarter? You know, we've moved beyond, you know. Well, we're now within the holiday season. Is that 1,000 basis point deterioration what you're currently witnessing?

Hi, Brian Nagel, this is Donna Dellomo. Good morning. That 1,000 basis points, in case you recall, we hold fairly substantial stock inventory positions, as Shawn Nelson brought up earlier during the call, correct? Our inventory is evergreen. It's simply the timing of working through the inventory that carries the higher freight rates on it. What arrives in the fourth quarter of this year is completely burdened by those elevated freight rates. I believe I noted during the second quarter earnings call, you know, our inbound container costs at this same point last year were $5,000. We're paying as much as $26,000 per container right now. What we observe flowing through the financials in the fourth quarter is completely burdened by those costs. The reason for that is, when we provided the informal guidance for fiscal 2023, we're conservatively projecting that we will be affected by those elevated freight rates throughout all of next year, which should they reverse at any moment during the year, that would work in our favor. Once more, fourth quarter we believe is completely burdened. Then as we head into fiscal 2023, once more, a very conservative approach that we're adopting that we foresee no favorable effect, but we're hoping it occurs as we move into next year. Hopefully that helps.

No, that's really useful. If I could ask one more about the supply chain, just so we get how things are working. When we consider the supply chain problems, I'm aware you and plenty of other businesses are talking about them, but then looking at the Lovesac P&L. Is the effect confined to cost of sales? You aren't seeing any kind of effect on sales?

I'll take that first, then Shawn, you can jump in. Right now, thanks to the redundancy Shawn brought up at the start, within the same product, really our Sactionals platform, we're in a terrific spot when it comes to inventory to fulfill our sales projections for the remainder of this year and also the outlook we have into next year, and we feel really good about that. It definitely hasn't come without a great deal of effort from the team, but I think, you know, our view is that during this sort of stretch when there are so many uncertain dynamics, this is genuinely a strength of the business we're going to lean into as we keep disrupting the market and gaining share.

Alright, I'll hand things off to another person. Thanks so much. I'm grateful for that.

Morning. I appreciate you taking my question. What we've been seeing is your television commercials that feature Sactionals paired with immersive sound. Could you give us some detail on your short-term plans for market spending, TV included, to support this new initiative? And then, on top of that, in what ways have the advertisements for this new immersive sound offering also helped your Sactionals revenue when shoppers purchase them without that immersive sound?

Thanks. Right now, looking at what we spend in total, on a yearly basis, I'd put it at somewhere in the range of 13% to 14% of net sales. That's the direction we're moving. Regarding StealthTech, the real benefit it has brought is giving the entire line yet another truly distinctive selling proposition. The ads are proving effective — not just in raising StealthTech sales, where we're seeing a really strong attachment rate, but we're also seeing very high ROIs and continued excellent run rates on the core business side too; we keep assessing it. As you're likely aware, that's something we always do. We're always running tests and learning, so there's more to come as we gain additional experience regarding the interplay between StealthTech advertising and the brand advertising. At present, they're genuinely synergistic, and they're elevating the overall business quite nicely.

Thanks.

Thanks. Morning, everybody. Let's revisit the gross margin topic, if that works. In Q3, it appears you faced added margin strain because more products originated in China along with the tariffs that remain in effect. Does that stem from supply chain problems out of Vietnam? And if that's the case, when should we see production recover so that China tariff pressure eases as you move part of that output away from the mainland?

My apologies for that. Camilo, to an extent, that's accurate. We've moved output among our different makers of sectionals — Malaysia, China, Vietnam — depending on COVID outbreaks, depending on container availability, and everything along those lines. Without question, next year there will be fewer products, fewer sectionals made in China than during the year in which we're presently buying them. Tariff pressure is among those puts and takes that will shift how gross margins behave for us across next year. That's partly why, while we're dealing with, as Donna described it, fully burdened gross margin pressure in Q4, numerous items are in motion on the front end regarding discounts, pricing, and all sorts of things that influence our gross margins. On the back end, like what you referenced, that gives us optimism about what we can anticipate for gross margins generally next year. I believe Q4 is distinctive in that regard.

Understood. So it sounds as though Q4 margins truly ought to be roughly the lowest point of the year, and that holds across the coming year too. They begin to recover, especially in the latter half, should any easing arrive regarding container shortages and freight costs generally. Is that a reasonable way to view it, even if your guidance doesn't appear to point that way?

Right. We won't yet make quarter-by-quarter commitments about how things will trend. Obviously it's early as we look ahead to next year, since we haven't gotten through Q4 yet. Logically speaking, that is accurate. We think there are several actions available to us within the business that can help offset a portion of this gross margin strain as next year plays out over the course of the year.

Absolutely—here's a natural spoken-English version, lightly edited:

Great. Oops, sorry, go ahead, Jack.

Yeah, just to build on that—really, when you look at the fully burdened fourth quarter, we also deliberately made choices, you know, because as a brand that's disrupting and as everyone knows, our long-term expectations for growth mean that staying in stock matters more than anything else, provided we can keep maintaining margins, you know, that are as strong as they've been, on an annual basis, above 50%. Because if it's bringing customers in, we're improving CSAT dramatically, our service levels beat the competition; this is really a fertile environment while the headwinds are there on freight costs. We aren't weighed down by the supply chain problems that so many others are facing, and we're really taking advantage of that, and we'll keep doing so over the next year because we do believe, obviously, after about a year, we'll begin to see a normalization and we'll be in an excellent position with dramatically greater share. That's how we're looking at this.

Great. For my follow-up, I want to ask about pricing. You said you've already made some targeted price hikes. Could you tell us what those were? Will targeted moves turn into across-the-board increases in the coming year? And if that happens, what feedback, if any, are you hearing from consumers about those higher prices?

On our core seats and sides, we've raised prices. There's also a chance for us to consider raising prices across a large portion of our cover business. We want to proceed very cautiously. The way I see it, some costs are clearly here for the long haul, and certain inflationary costs will persist long term, yet many costs are temporary. What we want to avoid is running our MSRP based on what we believe are the more unstable factors. We did make that one MSRP adjustment. Another thing we have going for us, I think, is plenty of chances to keep steering margin via promotions and managing mix, and the team has performed brilliantly on that. I'd say there are many levers we can keep pulling as the year goes on. What we want to avoid is getting too opportunistic in a market where supply is very soft, when it comes to MSRP, since we don't want to be constantly shifting our MSRP. Our real aim is to steer the coming year through more tactical adjustments while we assess the value proposition. Ultimately, the long-term price will depend on where we believe the greatest value and the greatest stickiness for the brand lie. We're steering from both sides — a highly strategic lens and a tactical one. I believe you'll see additional shifts over the next 6 months in how we approach promotions and so on, because what we're getting are enormous ROI levels from our advertising, from awareness, from word of mouth. The bright side is, I think we have some tailwinds that can assist us in handling some of these, given the brand stickiness we're seeing.

Great. Wishing you the best for the rest of the year, everyone.

Thanks.