The Lovesac Company (LOVE) Q3 2022 Earnings Call Transcript

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The Lovesac Company ( LOVE 20.76% )
Q3 2022 Earnings Call
Dec 08, 2021, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Greetings, and welcome to the Lovesac third quarter fiscal 2022 earnings call. [Operator instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Ms. Rachel Schacter of ICR.

Thank you. You may begin.

Rachel SchacterInvestor Relations

Thank you. Good morning, everyone. With me on the call is Shawn Nelson, chief executive officer; Jack Krause, chief strategy officer; Mary Fox, president and chief operating officer; and Donna 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 measure 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 begin by reviewing the highlights of our third quarter financial and operational performance, before Jack outlines our third quarter progress on our key growth initiatives. Donna will wrap up our prepared remarks with a review of our financial results and a few other items related to our outlook.

Also joining us on the call today is Mary Fox, who, as you know, was appointed president and chief operating officer at Lovesac on November 15, assuming the same role that Jack filled before. As you are aware, Mary had been serving on our board of directors since February 2020. She brings a strong digital and brand-building background to Lovesac that spans a 25-year career in the consumer goods sector, significant experience in scaling businesses and extensive supply chain and operational expertise as well. Along with her keen impression adoption of ESG principles, she has an expansive knowledge of Lovesac’s unique business model.

And all these attributes make Mary a particularly great fit, especially given Lovesac’s growth trajectory. We’re thrilled to have her as part of the leadership team and equally excited that Jack will be serving in the newly created role of chief strategy officer, as well as having recently been appointed to join the board of directors. We are very pleased with our third quarter results, delivering growth of 56.1%, while improving net income by 11% for the quarter, even in the context of making significant investments in our infrastructure. This sales growth is on top of last year’s 43.5% growth.

So our continued and widening growth this year is a testament to the strong demand for our product, growth in brand awareness and conversion even as we are actively managing the tight supply chain environment. We experienced growth across all sales channels, including most notably, an increase in showroom sales of nearly 70% and a nearly 40% increase for Internet sales. This marks 14 consecutive quarters of greater than 25% growth with continued improvement overall in our ability to generate cash and profits. One of our major competitive advantages is that we are generally totally in stock and expect to be in stock, delivering nearly all orders direct to consumer in just days amid the challenging supply chain backdrop.

Customers are continuing to recognize the strength as reflected in our Q3 results and consistently strong customer satisfaction scores throughout this tumultuous time. This has always been something that distinguishes Lovesac. And in this environment, where industry lead times can stretch into months, it is particularly advantageous. Our ability to maintain stock levels is rooted in our product design and business model.

Sactionals drive more than 80% of our sales, but more than half of those dollars were supported by just two SKUs, seats and sides. What’s more, we manufacture those two SKUs redundantly with no variation in quality across diversified manufacturers in three different countries, allowing us to better manage unplanned events like disruptions from COVID flareups, etc. This inventory is not seasonal and does not go bad or become irrelevant with time. So investments in this type of inventory is lower risk than most.

Our core products are packed and shipped in very unique ways that allow for extreme efficiency inside of our ocean containers and via FedEx direct to the consumer’s home. While we are not immune to the currently elevated container and inbound freight costs, our packaging and shipping solution helps to partially offset these costs and risks. Our growth and in-stock position is also a testament to the incredible job our teams are doing across the organization. Adjusted EBITDA of $5.8 million exceeded our outlook of a loss of negative $3 million to negative $4 million as we beat our sales goals and absorbed expected freight headwinds, while simultaneously making important people and infrastructure investments in support of our growth.

While we expect some gross margin headwinds to persist in the near term, which Jack and Donna will expand on, in the long term, we remain committed to a mid-50s gross margin rate as the environment normalizes, and we continue to scale the business. We have raised prices at MSRP some already, and we are discounting less to counteract gross margin headwinds. We will continue to move the business in this direction and believe we can continue to generate very strong gross margins relative to this category even in this challenging environment. Operationally, a key highlight of the quarter was the much anticipated launch of the Sactional Stealthtech Sound Plus Charge product.

This is the first of its kind innovation, which leverages new Lovesac patents to deliver an immersive surround sound system developed in partnership with Harman Kardon and convenient wireless charging, all seamlessly embedded and hidden inside the endlessly adaptable Sactionals platform. It is the only home theater system that is hidden in plain sight. From a business perspective, this launch accomplishes many goals. Not only does it increase our relevancy with our existing consumers and with new consumers, it also expands our competitive differentiation by creating an even deeper moat given there is no one else that offers this unique product.

Initial customer response has been extremely positive so far. And with the base price of the Stealthtech portion of the system at about $3,000, that has the potential to nearly double the average order value of transactions it is included in on top of the typical Sactionals’ AOV of $3,400. Like sectional sofas, the TAM, or total addressable market, for home audio equipment is very large in terms of categories to compete in within the home segment. But as home audio is a completely different category to upholstered furniture, Stealthtech’s introduction presents a little to no threat of cannibalization to our current business.

Furthermore, a Stealthtech ad on TV or digital is the same ad as that for Sactional. They are rolled into one, and therefore, essentially cost no more than we were paying before to advertise Sactionals. As surprising as it may sound, Lovesac intend to compete in home audio and win. Our system is unlike any other.

And in many ways, we believe it is the best one available in the market today. Turning to our ESG efforts. We are on track to publish our inaugural ESG report later this month. This fiscal year 2021 inaugural report that aligns with the Sustainability Accounting Standard Board, SASB, building products and furnishing sector standard, sets the benchmark for Lovesac’s ESG journey, supporting our commitment to achieving a 100% circular and sustainable business model, reaching targets of zero waste and zero emissions by 2040.

In the coming years, we plan to focus on measuring emissions across our value chain. Future reporting will align with the greenhouse gas protocol, corporate accounting and reporting standard, which provides requirements and guidance for companies. And Jack will discuss in detail our progress on other growth strategies, including our marketing and merchandising strategies, showroom operations, expanding other channel presence and making disciplined investments. As we look to the final quarter of the year, we are well-positioned for the upcoming holiday season.

We expect the operating and supply chain environment to remain dynamic. But as described above, we believe Lovesac is better suited than most in our categories to remain in stock and successful throughout. The fourth quarter is always a heavily weighted time period for us. We operate more than 120 high-traffic showrooms located mostly in the highest traffic malls across the United States.

We believe that Sacs and now Stealthtech products represent one of the coolest holiday gifts any family could hope for, and post holiday it’s a strong month for all of home decor naturally. And because our fiscal year cutoff is at the end of January, this adds to our fourth quarter weighting. Now on the other side of Black Friday and Cyber Monday, as a brand that garners 100% of its sales by direct-to-consumer and digital means and has immediate access to all sales and customer data, we can confidently say that we can expect continued strong growth for the quarter and we look forward to driving more market share gains. Looking ahead, we intend to just keep doing what we’ve done for almost four years straight now, generate high sales growth, while increasing EBITDA margins on an annual basis.

Were it not for the huge leap we made at the EBITDA line last year in the context of significantly holding back on spending during the early parts of the COVID pandemic, we would be increasing EBITDA and EBITDA margins this year. But looking at fiscal year ’22 this year, on a two-year basis, we expect a trajectory of increasing profitability. We also expect to continue to manage this business in a way that will allow us to stay on the course to lift annual EBITDA margin through next year despite pressures at the gross margin line in the near term due to macro forces. We believe this will allow us to emerge someday as a dominant player in our categories, and become the most beloved brand in the home category, which is our stated mission and maximize value to our shareholders over the long run.

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

Jack KrauseChief Strategy Officer

Thank you, Shawn, and good morning, everyone. As we look to the next chapter of growth and the many opportunities that lie ahead, Lovesac will need talent, systems and infrastructure to scale in a manner that drives value for all of our stakeholders, and I’m very excited to take on the new role of chief strategy officer and board member in pursuit of this goal. I’ve had the benefit of getting to know Mary well since she joined our board and have witnessed firsthand for valuable contributions. I’m delighted to partner with her in her position as president and COO.

Now turning to our third quarter performance. We are very pleased with our third quarter results and the strides that we’ve made against our growth strategies, which I will now review. Starting with one, product innovation, of which the key highlight was our Stealthtech launch on October 18. It is in its early days, but the customer reception to this new product launch has been strong, and we are seeing associated increases in Sactional transaction AOVs that bode well for customer engagement, loyalty and repeat purchases.

Two, efficient and marketing merchandising strategies. We continue to generate attractive marketing ROIs and our marketing efforts continue to help raise overall awareness and deliver the 58% revenue growth year to date that we have experienced. Some Stealthtech highlights. In the third quarter, with the launch of Stealthtech, at the end of the quarter, we had introduced new and social assets with early indications looking very promising, including a 13% year-over-year increase in web sessions, driven mainly by paid search.

Broadcast syndication has been rolled out for holiday after successful local testing during Memorial Day and Labor Day, and resulted in an increase in overall TV reach by 25%. Additionally as part of the Stealthtech product launch, Lovesac is partnering with Amazon Video’s newest series, Wheel of Time, which launched in the third quarter and had great success. In terms of social and digital marketing. Social CPM continues to increase on core channels, but this is largely offset by higher conversion rate.

Despite continued increases in CPM across our digital media channels, our established digital strategies and new initiatives like SMS marketing, hyper local advertising and consideration advertising are driving strong engagement, conversion and revenue performance. Overall media ROI continues to perform above our benchmarks. And while we expect overall media to continue to see cost pressures, especially in the fourth quarter due to holiday retail pushes, we anticipate offsetting this by higher conversion. Three, touch point operations.

We are continuing to see synergies across our various touch points where customers can experience the product, feel how good it is and make their final decisions. Our showrooms continue to be an important part of our omnichannel touch point strategy and continue to deliver strong results as reflected in our Q3 showroom comps of plus-53% or 79% two-year comps. We opened nine new showrooms in Q3 and remain on track to open 28 for this fiscal year. With added capabilities like the on-the-spot scheduling specialists, we continue to enhance the showrooms’ shopping experience.

Throughout the third quarter, the post-purchase specialist team continued to expand their reach across both physical touch points and e-commerce. In Q3, post-purchase specialists communicated with over 92% of Lovesac customers whose purchases met the predetermined dollar threshold for their service. We are continuing to see a lift in post-purchase CSAT scores for customers who engage with a post-purchase specialist versus those who did not. We continue to roll out our sales and service strategy throughout Q3 and will be present in all touch points in Q4.

This rollout leverages talent across trade areas to support customers in the shopping journey, both pre and post purchase with a goal of enhancing the customer experience and further increasing customer satisfaction. We are continuing to expand our real estate strategy with the launch of two mobile concierge vehicles in Q3. These vehicles serve as additional asset-light touch points in key markets. Preliminary results are exceeding conversion and AOV expectations, and we are evaluating the launch of additional vehicles next year.

In addition, we opened one kiosk in Q3 and are on track to open up to eight branded kiosks by the end of Q4 and markets with and without a showroom presence. Stealthtech has been incorporated into the showroom, kiosk and mobile concierge experience and would be rolling out to the balance of our Best Buy shop-in shops in Q4. While we have returned to normal operating procedures, we continue to monitor the pandemic situation carefully following local and state guidelines and prioritizing the health and safety of both our customers and team members. And number four, expanding our other channel presence.

We are very pleased with the strength of the Costco business, which we’re hosting our online roadshows directly with costco.com. And we have seen productivity increases year over year, driven by an expanding premium cover and Lovesac offering. We continue to be excited about the partnership with Best Buy as we have seen our bestbuy.com business increased at a strong rate this year, which we attribute to performance to our customer experience on bestbuy.com, as well as some marketing tests that we’ve run. In addition, we opened one Best Buy shop-in-shop in the third quarter.

We will continue to pursue opportunities with other partners as our other channel presence continues to be an effective way of expanding our brand awareness and reach. Five, making disciplined infrastructure investments. Starting with e-commerce. We continue to make key investments to enhance our e-commerce replatform during the quarter.

Conversion rate continued to be a highlight for us in Q3, with an improvement of 58% versus LY, driven by 74% increase in mobile conversions. Integrating Stealthtech into e-commerce shopping experience was a major accomplishment during the quarter. We have made Stealthtech selection process during online shopping experience customized and easy for new and existing customers based on Sactional size and configuration. We’ve also upgraded the latest version of Magento 2 platform, which includes significant security updates heading into this holiday season.

In September, we successfully launched a new customer data platform, or CDP. This platform unifies and enhances our customer and shopper data, giving us the ability to expand our usage of first-party data for digital marketing and provide the intelligence needed to personalize the omnichannel customer experience even further. Regarding supply chain updates. Our strategic investments in forward inventory placement, product flow optimization and supply chain redundancy allowed us to maintain a differentiated position in in-stock and order fulfillment, which helped drive our Q3 results.

For the all-important holiday season, our inventory is well-positioned heading into our busiest time of the year. As we look ahead, we expect the same supply chain headwinds to persist throughout fiscal 2023. Over the near term, we continue to mitigate through several tactics and are responding over the longer term with key initiatives to reinforce our sourcing base, supply chain channels and end-to-end investments. So in summary, we are pleased with our third quarter financial performance and the progress made against our strategic growth initiatives.

Our strong Q3 results reflect the exceptional execution by the entire Lovesac team as we continue to navigate a dynamic operating environment. We feel good about the underlying momentum and trajectory of the business for the holiday season and look forward to closing out the year strong. Before Donna reviews our Q3 results, I wanted to turn the call over to Mary, president and chief operating officer, for a few brief introductory remarks. Mary?

Mary FoxPresident and Chief Operating Officer

Thank you, Jack. I’m delighted to be part of the Lovesac leadership team with Shawn, Jack and Donna. And as you can all imagine, it’s been a busy and productive month since I joined on November 15, both getting to know the business even further, in addition to meeting all of the team. From my time on the board throughout my career and as a Lovesac customer for the past 11 years, I have gained great respect and admiration for Lovesac’s differentiated direct-to-consumer business model, unique product, loyal customer base and deep commitment to sustainability, including its circle to consumer philosophy.

I’m very honored to take on this new role and will leverage my extensive experience working with consumer goods companies throughout my career to help execute the company’s growth strategy and drive long-term value. With that, I will hand the call over to Donna to review our third quarter financial results. Donna?

Donna DellomoChief Financial Officer

Thank you, Mary. Good morning, everyone. I will begin my remarks with a review of our third quarter results and then provide an update on the framework I shared with you last quarter as it relates to how we are approaching the remainder of fiscal 2022. Net sales increased $42 million or 56.1% to $116.7 million in the third quarter of fiscal 2022 as compared to $74.7 million in the prior-year period.

The year-over-year net sales increase was driven by growth across all channels, with overall comparable sales increasing 47.1% due to the success of our Labor Day campaign, 28 year-on-year increase in ending showroom count and higher productivity of our temporary online pop-up shops on costco.com. Showroom net sales increased $28.2 million or 67.8% to $69.7 million in the third quarter of fiscal 2022 as compared to $41.5 million in the prior-year period. This increase was due primarily to a $19.5 million increase in comparable showroom point of sales transactions to $56.1 million in the third quarter of fiscal 2022 as compared to $36.6 million in the prior-year period. As a reminder, point-of-sales transactions represent orders placed through our showrooms, which does not always reflect the point at which control transfers to the customer and when net sales are recorded.

In addition, we opened 28 additional Lovesac showrooms, including two mobile concierges and one kiosk since the third quarter of last year, which was a meaningful driver of noncomp showroom sales increase. Internet net sales, sales made directly to customers through our e-commerce channel, increased $9.8 million or 38.2% to $35.5 million in the third quarter of fiscal 2022 as compared to $25.7 million in the prior-year period, principally driven by the performance of our Labor Day campaign this fiscal year. Other net sales, which principally includes pop-up shop and shop-in shop net sales increased $3.9 million or 52.7% to $11.9 million in the third quarter of fiscal 2022 as compared to $7.5 million in the prior-year period, with the increase primarily related to higher productivity of our temporary online pop-up shops on costco.com. By product category, our Sactional net sales increased 58.6%, stock net sales increased 39.2% and our other category net sales, which includes decorative pillows, blankets and other accessories, increased 69.8% over the prior year quarter.

The decrease in gross margin percentage of 510 basis points over the prior-year period was primarily driven by an increase of approximately 748 basis points in total distribution and related tariff expenses partially offset by an improvement of 238 basis points in product margin. The increase in total distribution and related tariff expenses over prior year was principally related to the negative impact of 953-basis-point increase in inbound transportation cost and increased tariff related to higher product sourcing from China, partially offset by 205-basis-point improvement due to higher leveraging of warehousing and outbound freight costs. The product margin rate improvement was due to lower promotional discounting and continuing vendor negotiations to assist with the mitigation of tariffs. We exceeded the third quarter net sales guidance we shared with you on our last call, primarily driven by the success of our Labor Day campaign and higher shipment volume due to higher warehouse throughput.

Our gross margin percent in the third quarter of fiscal 2022 was in line with our guidance, which contemplated continued supply chain headwinds that are driving higher inbound transportation costs. We were able to partially mitigate these higher costs through continued reductions in promotional discounting, selective price increases and better leveraging of our warehousing and distribution costs. The 46.8% year-over-year increase in SG&A was driven largely by higher employment costs due to an increase in new hires and variable compensation. We also had higher rent expense from the additional 28 showrooms and higher percentage rent from the increase in net sales.

Overhead expenses increased due to infrastructure investments, travel expenses and equity-based compensation. Selling-related expenses also increased, primarily due to credit card fees related to the increase in net sales. SG&A expense as a percent of net sales decreased by 207 basis points due to higher leverage within infrastructure investments, equity-based compensation, insurance, rent and selling-related expenses partially offset by a deleverage in employment costs and travel. The deleverage in certain expenses was related to the investments we are making into the business that were put on hold in the prior year related to COVID-19 financial resilience measures.

SG&A expense was lower than our expectations in the third quarter, principally related to lower employment costs due to delays in hiring, planned in-person company meeting shifting to virtual events, and a shift in some of our infrastructure investments into the fourth quarter of the fiscal year. This favorability versus our expectations was partially offset by higher rent expense and higher credit card fees due to the increased net sales. Advertising and marketing expenses increased $4.8 million or 44.3% to $15.8 million in the third quarter of fiscal 2022 as compared to $11 million in the prior-year period, resulting from continued investments in marketing spends to support our sales growth. Advertising and marketing expenses were 13.6% of net sales in the third quarter of fiscal 2022 as compared to 14.7% of net sales in the prior-year period.

The 111-basis-point decrease was due to improved performance in media activities, driving higher sales volume at lower promotional discounting. Depreciation and amortization expense decreased approximately $200,000 from the prior-year period to $1.7 million, primarily due to the accelerated depreciation expense in the prior-year period, partially offset by current year capital investments for new and remodeled showrooms. In the third quarter of fiscal 2022, operating income was $3 million as compared to an operating income of $2.5 million in the third quarter of last year, driven by the factors just discussed. Net interest expense for the third quarter was approximately $45,000, principally relating to unused line fees on our revolving line of credit.

Tax expense in the third quarter of fiscal 2022 was $174,000 as compared to $11,000 in the prior-year period with the increase related to minimum state income tax liabilities. Before we turn our attention to net income, net income per diluted share and adjusted EBITDA, please refer to the terminology and reconciliation between each of our adjusted metrics and their most directly comparable GAAP measurements in our earnings release issued earlier today. Net income was $2.8 million or $0.17 per diluted share in the third quarter of fiscal 2022, compared to net income of $2.5 million or $0.16 per diluted share in the prior-year period. We generated adjusted EBITDA of $5.8 million in the third quarter of fiscal 2022 as compared to adjusted EBITDA of $6 million in the prior-year period.

Turning to our balance sheet. Our liquidity continues to remain strong as we ended the third quarter with $47.9 million in cash and cash equivalents and $22.5 million in availability on our revolving line of credit. Please refer to our earnings press release for other details on our third quarter fiscal 2022 financial performance. Turning to our outlook.

We expect to close out another year of strong sales growth with 28 new Lovesac showrooms, the opening of eight kiosks and the introduction of two mobile concierges. We’ve been restoring expenses that were pulled back in fiscal 2021 due to the pandemic and strategically making infrastructure investments to support the substantial multiyear growth opportunity that lies ahead. For our fourth quarter, we expect sales growth of approximately 35%, with adjusted EBITDA dollars in the $12 million to $13 million range, compared to positive adjusted EBITDA of $25.9 million in the same quarter last year. Adjusted EBITDA is being impacted by expected lower gross margins of approximately 1,000 basis points year over year due to significant supply chain headwinds, most notably current inbound freight rate inflation versus the prior year.

As we look to fiscal 2023, we remain confident in the trajectory of the business. While we are not providing formal guidance for fiscal 2023 at this time, at a high level, we expect healthy net sales growth in the high 20% range and adjusted EBITDA growth to exceed net sales growth. This is despite an expectation that supply chain headwinds persist throughout fiscal 2023. As a result of our continued supply chain headwind mitigation efforts, full year gross margins are expected to be around 50%.

In terms of capex spend, we continue to expect to end fiscal 2022 in a healthy cash and cash equivalent position and now expect capex to be in the $16 million to $17 million range versus the prior $17 million to $18 million range shared. This includes capex spends for our new showrooms, kiosks and mobile concierge openings that we shared earlier. So in conclusion, we are pleased with our Q3 results that exceeded our expectations from a net sales and profitability perspective. We are so proud of the excellent execution by the entire Lovesac team who remain agile and nimble amid a dynamic backdrop.

We are confident in our positioning for the fourth quarter and look forward to building on our success to date as we finish the year. With that, we would now like to turn the call back to the operator who can open it up for questions. Operator?

Questions & Answers:

Operator

Thank you. [Operator instructions] Our first question comes from the line of Brian Nagel with Oppenheimer & Co. Please proceed with your question.

Brian NagelOppenheimer and Company — Analyst

Hi, good morning. Nice quarter. Mary and Jack, congratulations on your new appointments.

Jack KrauseChief Strategy Officer

Thank you, Brian.

Brian NagelOppenheimer and Company — Analyst

The first question I have is with regard to the outlook and specifically gross margins. So you telegraphed for Q4 a 1,000-basis-point reduction in gross margin. So that’s — and you talked a lot about the factors you’ve been continuing with — that would represent, I guess, it would be suggestive of more headwinds than we saw in the third quarter. So the question I have there is, can you kind of articulate what that is? And where we are right now in the quarter? We’re past — we’re into the holiday season.

Is that 1,000-basis-point degradation what you’re seeing at this moment? 

Donna DellomoChief Financial Officer

Hey, Brian, it’s Donna. Yeah, so that 1,000 basis points, if you remember, we take pretty heavy stock inventory positions. As Shawn had mentioned earlier on the call, right, our inventory is evergreen. So it’s just the timing of the cycling through the inventory that has the higher freight rates on it.

What’s coming through in the fourth quarter of this year is fully burdened by those higher freight rates. So I think, I’d mentioned on the second quarter earnings call, our inbound container costs were, this time last year, 5,000. We’re paying outwards to $26,000 a container at this point in time. And so, what we see coming through or coming through the financials in the fourth quarter is fully burdened by those costs.

But the point of that is when we gave the formal guidance for fiscal 2023, we are conservatively estimating that we will be impacted by those higher freight rates all throughout next year, which, if they do turn around at any point in the year, that will be beneficial to us. So again, fourth quarter, we feel is fully burdened. And then, going into fiscal 2023, again, very conservative approach that we’re taking that. We don’t see any positive impact, but we’re hoping it happens going into next year.

So hopefully, that helps. 

Brian NagelOppenheimer and Company — Analyst

No, that’s very helpful. And then, if I follow up, just on the supply chain, so we understand the dynamics. So as we think about the supply chain disruptions, I know that you and a lot of other companies are discussing and then the Lovesac P&L. Is the impact isolated to cost of sales? You’re not seeing any type of impact on sales?

Jack KrauseChief Strategy Officer

Yeah. I’ll start that and then, Shawn, you can add up. At this point, we are in an excellent — because of the redundancy that Shawn mentioned upfront across the same product, really our Sactionals platform, we are in a fantastic place in terms of inventory to carry out our sales projections for the rest of this year, as well as the view we have into next year, and we feel very good about that. It certainly hasn’t been without a lot of actions by the team.

But I think, our belief is this is during this type of period of time where there’s so many questionable dynamics that this is truly a strength of the business we’re going to lean into as we continue to disrupt the market and gain share.

Brian NagelOppenheimer and Company — Analyst

Well, I’ll turn the call over somebody else. Thank you very much. Appreciate it.

Operator

Thank you. Our next question comes from the line of Victoria James with D.A. Davidson. Please proceed with your question.

Victoria JamesD.A. Davidson — Analyst

Good morning. Thank you for taking my call. So my question then is, we’ve noticed your TV ads promoting your Sactionals with immersive sound. Can you talk to us a little bit about your near-term market spending plans, including TV to promote your new efforts? And then, sort of in addition to that, how are your ads for your new immersive sound product also positively impacted your Sactional sales for consumers buying them without that immersive sound?

Jack KrauseChief Strategy Officer

Yeah, thank you. At this point, if you look at our overall spend, I’ll say, on an annual basis, it’s between 13% and 14% of net sales. So that’s where we’ll head. I think, in terms of Stealthtech, what it really has done for us, it provides another really unique selling proposition for the whole line.

So we’re seeing the ads be effective of not only lifting up the Stealthtech sales, which we are seeing a very nice attachment rate, but we’re also seeing very high ROIs and continued excellent run rates in terms of the core business as well. So we’re continuing to evaluate it. As you probably know, we always do, we’re constantly doing tests and learning. And so, more to come as we get more experience about the dynamic between the Stealthtech advertising included in the brand advertising.

But right now, they’re really synergistic and they’re lifting the overall business quite well. 

Victoria JamesD.A. Davidson — Analyst

Thank you.

Operator

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

Camilo LyonBTIG — Analyst

Thank you. Good morning, everyone. I want to get back to the gross margin discussion, if we could. It seems that in the third quarter, you experienced incremental margin pressure.

Some more goods coming from China. Is this a result in the resulting tariffs that are still in place? Is that a result of supply disruptions from Vietnam? And if so, when do you expect a rebound in production such that tariff pressures from China will lessen as you shift some of that production out of Mainland?

Shawn NelsonChief Executive Officer

Sorry about that. Camilo, to some degree, that is true. We shifted production around to our various manufacturers — the manufacture Sactionals of Malaysia, China, Vietnam based on COVID flare-ups, based on container availability, all these sorts of things. And next year, without a doubt, there will be fewer goods, fewer Sactionals manufactured in China than in the year that we are currently consuming them.

And so, tariff pressures is one of those puts and takes that will change the dynamic of gross margins for us throughout the course of next year. And it’s part of the reason that while we are experiencing, as Donna put it, fully burdened gross margin pressure in Q4, there are a number of things moving within the business on the front end in terms of discounts, pricing all sorts of things that affect our gross margins. And on the back end, like what you mentioned, that give us optimism in terms of what we can expect for gross margins overall next year. And so, I think, Q4 is unique in that way. 

Camilo LyonBTIG — Analyst

Got it. So it seems like Q4 margins really should be kind of the need year for over the next — through next year, really. And it starts to rebound, especially — particularly in the back half if there is any sort of relief on container shortages and overall freight costs. Is that a fair way to think about that even though it doesn’t look like you’re guiding to that?

Shawn NelsonChief Executive Officer

Yeah, we won’t commit quarter to quarter how things will move yet. It’s, obviously, early looking forward toward next year without Q4 — without being through Q4 yet. But from a logical standpoint, that’s correct. And we believe that there are a number of things that we can do in the business to mitigate some of this gross margin pressure as next year evolves throughout the year. 

Camilo LyonBTIG — Analyst

And — sorry, go ahead, Jack.

Jack KrauseChief Strategy Officer

Yeah. Just to add to that, really, as you see the fully burdened fourth quarter, we knowingly made decisions to that, as a brand that’s disrupting and everybody knows our expectations in the long term to grow, that being in stock is critical over anything else as long as we can continue to maintain margins that are as strong as they have been on an annual basis, over 50% because of its attracting customers. We’re gaining CSAT dramatically. Our service levels are better than competition.

So this is really a fertile environment, while the headwinds are there on freight costs. We are not burdened by the supply chain issues that many others are having, and we’re really leveraging that and will continue over the next year because we do believe, obviously, after the year so we will start to see a normalization and we’ll be in an excellent position with dramatically greater shares. So that’s the way we’re looking at this. 

Camilo LyonBTIG — Analyst

That’s great. And then, just my follow-up on pricing. You mentioned that you’re taking — you’ve already taken selective price increases. Can you state what those have been? Does selective become broad-based price increases next year? And if so, what are you seeing from a consumer response, if any, to those price increases? 

Jack KrauseChief Strategy Officer

If we really — OK. So we’ve taken price increases on our core seats and sides and we have an opportunity to also look at price increases on a lot of our cover business. But we wanna be really careful. I think, the way we’re looking at it, there are, obviously, costs that are gonna be long term, and there are some long-term inflationary costs, but there are also a lot of transient costs.

And what we don’t want to do is manage our MSRP around what we think are the more volatile factors. So we did take the one MSRP change. I think, the other aspect we have are a lot of opportunities to continue managing margin through promotion and mix management, which the team has done an amazing job on. And I would tell you that I think we have a lot of levers to continue to pull as we get through the year.

What we don’t want to do is be sort of too opportunistic in a very soft market in terms of supply, in terms of MSRP because we don’t wanna be moving our MSRP around. So we are really looking to manage the next year through more tactical changes as we evaluate the price proposition. And look, the long-term price will be based on where we think it adds the most value to the brand and the most stickiness. So we’re managing from both ends a very strategic point of view, as well as tactical.

I think, you’ll see more changes in the next six months in terms of ways of looking ad promotions, etc., because what we are getting are tremendous levels of ROIs out of our advertising, out of the awareness, out of the word of mouth. So the good news is I think we have some tailwinds that can help us manage some of these in terms of the brand stickiness that we’re experiencing. 

Camilo LyonBTIG — Analyst

Fantastic. All the best for the balance of the year, guys.

Jack KrauseChief Strategy Officer

Thank you.

Operator

Thank you. Our next question comes from the line of Maria Ripps with Canaccord Genuity. Please proceed with your question.

Maria RippsCanaccord Genuity — Analyst

Great. Thanks for taking my questions, and congrats on continued strength in the business. I just wanted to follow up on the Stealthtech launch. Sort of recognizing that it’s still pretty early.

Can you maybe talk about how customers are engaging with the product? To what extent it is attracting new buyers versus sort of reengaging existing buyers? And is there anything you can share about sort of the portion of product that is purchased by your existing customers at this point? And then, I have a quick follow-up. 

Jack KrauseChief Strategy Officer

That’s a lot. So I would say, the first thing I’ll say is I’ll have a lot more information for you or we will, as a team, have a lot more information for you at the fourth quarter call because really, just to provide a perspective, we launched Stealthtech at the end of the third quarter. We had demand in the third quarter, but we really haven’t had actual net sales until the fourth quarter. But with that said, we are seeing some tremendous things.

I can tell you this qualitatively from the field, Stealthtech introduction has raised the level of engagement between the associate and the customers to amazing levels. And that’s where, I think, as I mentioned earlier, the Stealthtech advertising is sort of well — is a microcosm of what’s happening in the field. It’s lifting the interest in the brand. It’s adding another very unique selling proposition to a brand that already has many and causing a lot of engagement in the showrooms.

And I think, that’s why we’re able to not only lift the sales of product without Stealthtech, but Stealthtech has a pretty high attachment rate. We’ve seen the attachment rate as high as 15%. We’ve seen it from both new and repeat customers. A lot of dynamics happening right now.

So what I would say is — and we’ve done modeling as well. It’s going to attract new customers. We know that based on that total market that’s addressable. That’s the audio market.

We also are seeing a lot of attraction by current customers and interest in current customers and adding it to the current setup, and that’s really enhancing the DFL philosophy and the support, which we know our most loyal customers are really triggering to that idea of flexibility. So a lot more to come, and I think I’ll be able to give you a more fulsome outlook after the quarter, but we are seeing initially also AOVs that are pretty high related to the Stealthtech purchases. So we’re seeing about a $200 increase in AOV on Sactionals when Stealthtech is involved, and that’s completely incremental. So we certainly are seeing some incrementality at the outset, and we look forward to sharing even more with you in the next quarter. 

Maria RippsCanaccord Genuity — Analyst

Thank you, Jack, that’s helpful. And just going back to your preliminary outlook for next year. So you’re guiding to EBITDA margin expansion despite sort of continued gross margin compression. Can you maybe just talk about where you see operating leverage coming from? I guess, what should drive that?

Donna DellomoChief Financial Officer

Good morning, Maria. Yeah, so there’s a couple of things. Normal SG&A, we’re going to see some leverage and maybe not around payroll as we continue to build out the teams needed to support the healthy growth. But in normal consulting, insurance, professional fees, we are projecting leverage in those areas and also some slight leverage in marketing as the ROIs on marketing continued to increase.

So yes, that’s where it’s coming through.

Maria RippsCanaccord Genuity — Analyst

Got it. Thanks so much.

Donna DellomoChief Financial Officer

Yeah, things like rents, some other items in the SG&A categories.

Maria RippsCanaccord Genuity — Analyst

Got it. Thank you.

Operator

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

Matt KorandaROTH Capital Partners — Analyst

Excuse me. Hey, guys, thank you for taking the questions. Just spinning back to the gross margin topic. Just wanted to see if you could clarify for us how much of the inventory currently that you have on hand was brought in sort of during the peak of the inbound freight crunches.

So if you look at inbound freight, probably, at least ocean shipping kind of peaked in that July to August time frame. So I would assume most of your inventory this time is sort of fully laden with those costs? Or maybe you could speak to sort of how much inventory has been brought in since that time?

Donna DellomoChief Financial Officer

Yeah, Matt, you’re right. It’s probably close to 100% of the inventory that we’re bringing in from overseas has those higher freight rates on it. That’s why we’re saying that the inventory that we’re selling through in the fourth quarter and then going into at least the beginning of next year, we’ll have those higher freight rates related to that inventory as it passes through the P&L. 

Matt KorandaROTH Capital Partners — Analyst

And then, mitigation action on it. I mean, you mentioned a number of levers that you have at hand. But obviously, there’s also a promotional environment to contend with kind of in holiday in the early next year. I just wondered if you could speak to sort of some of the more specific levers that you have to counteract some of the inbound pressure in the next quarter or two?

Jack KrauseChief Strategy Officer

Yeah, I mean, clearly, we didn’t want to put a number around it, but the first thing is certainly promotional levers not being seen right now is while we’re in this environment where there is, in general, some malaise in terms of supply in the marketplace that gives us a real opportunity since we are in stock to sell at a higher level, a higher value of selling with less discounts and we do see opportunities continuing through next year to make adjustments. And not only in better — and just to be clear, adjustments, in terms of decreasing the frequency and the level of discounts. And on top of that, the team has really done an excellent job in managing mix. And as we manage our mix to our more premium covers, a more premium inserts, we get higher margins as well.

So there’s a number of places we are really attacking it from a selling perspective. And then, obviously, as Donna mentioned, we’re being conservative while we expect the heaviest cost to be the ones we’re bearing right now. 

Matt KorandaROTH Capital Partners — Analyst

OK, makes sense. And if I can just clarify, if we think about sort of how quickly you can sell through inventory that was sort of at that peak portion of the inbound freight pressure. But I’m just wondering if you could kind of speak to inventory turns, expectations heading into next year in terms of kind of turning that peak cost inventory versus sort of when we start lapping that and then coming down the back end of the sort of the lower freight cost sequentially that we’ve seen into the end of the year here?

Jack KrauseChief Strategy Officer

Donna, you want to handle that?

Donna DellomoChief Financial Officer

I’m sorry, what was that, Matt? 

Matt KorandaROTH Capital Partners — Analyst

Yeah, I wanted to get a sense for just how we should think about the inventory turns, I guess, embedded in that first question, I was trying to figure out — just sort of when we think about sort of peaking gross margin pressure, does it peak in the fourth quarter just based on sort of, I guess, the rough math that you could do here? We could assume that most of the inventory you’re going to turn through sort of was fully burdened with that peak inbound ocean freight cost back in kind of July, August. So I wondered if you could speak to sort of inventory terms and how quickly you can sell through that higher cost inventory that you have on hand? 

Donna DellomoChief Financial Officer

Yeah. So we probably, I mean, we sell through our inventory — we turn our inventory probably four times a year on a safe side, right? But we don’t look to drive inventory turns. That’s not what we think to do with the business. We bring the inventory in to make sure that we can remain in stock.

So some quarters may be a little longer than that time period, some might be a little shorter, right? I think, the thing to just focus on — or one of the things to focus on is when we gave a piece of outlook for next year. We were pretty conservative in saying that if next year is fully burdened by these freight headwinds, which we’re all hoping that they eventually go away and that they’re not here through the whole year. That we still will be able to drive margins of 50% — at least 50%, right, with all the other mitigation efforts that we’re taking. So a very conservative approach we are looking at.

Our goal here is to make sure that we maintain our inventory positions. We’re in stock. We can fulfill our customers’ orders and we’ll mitigate and if, throughout the P&L. So we’ll leverage where we can in SG&A.

So that’s why you see that the adjusted EBITDA margin is growing at a greater rate of sales. So I think, all really positive things, given the headwinds that we’re all facing related to inbound container costs.

Matt KorandaROTH Capital Partners — Analyst

Got it. Very helpful. Thank you, guys.

Operator

Thank you. Our next question comes from the line of 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, and congratulations on another really strong quarter. I wanted to ask about what you’ve been doing with ticket pricing? And obviously, we’ve seen just from your promotions around key holidays like Labor Day and Thanksgiving, you’ve been discounting a lot less than you have in prior years. Where, if anywhere, have you started to see any resistance to these higher prices? Are there any particular product categories, or times of year, or channels where you’re seeing any resistance? On the flip side, are there any categories where maybe you think prices remain too low and there’s opportunity to continue to be a little bit more aggressive there? 

Jack KrauseChief Strategy Officer

Yeah, that’s a great question, Alex, and that really goes back to sort of this idea of where we are in terms of inventory relative to the rest of the world and then how we think about what’s going to happen in the next year. So our assumption is, in the next year, a lot of the marketplace will probably be in a better position of inventory. And while our internal data and certainly our CSAT and our evaluation by our customers of our value have remained very strong, if not at the strongest levels ever, we wanna be very careful to separate that value based on the one company that’s available to ship in two to three weeks versus everybody else. As that goes away, we want to make sure in a competitive environment, we still have a very good value to the customer that’s based on thinking that they can understand.

So I think, in the short run, what does that mean? Less frequent, less deeper types of flash sales. We still like the idea of having the events because they rally us around, obviously, our advertising, as well as it really is something that customers in the industry understand. But in terms of frequency and depth of discounts, they will continue to probably go down in the near future, I would expect, and we’re really seeing no resistance in the short run, of course, in sales to the price increases, but we’ve got to be really, really careful, I think, strategically because the gain for us is the five-year gain. 

Alex FuhrmanCraig-Hallum Capital Group — Analyst

Great. That’s really helpful. Thanks, Jack.

Operator

Thank you. Ladies and gentlemen, our final question today comes from the line of Lamont Williams with Stifel. Please proceed with your question.

Lamont WilliamsStifel Financial Corp. — Analyst

Hi, thank you. Thanks for taking my question. Just you’re opening up 20 showrooms this year. Do you have a range we can think about for next year, as well as kiosks and the mobile concierge? 

Jack KrauseChief Strategy Officer

Yeah, look, the touch points as we’ve continued to discuss are incredibly important to us, and we will continue to expand our touch points overall at a rate consistent with what you’ve seen. In terms of the mix between showrooms and concierge and shop-in shops, we’re still developing — we’re still analyzing the business, and I think we’ll have a more clear view of next year. But I would certainly expect the touch point growth and total touch points to be approximately the same as it was this year. And we’ll give you more detail after the — at the fourth quarter discussion. 

Lamont WilliamsStifel Financial Corp. — Analyst

OK, great. Thank you.

Operator

Thank you. Ladies and gentlemen, this concludes our question-and-answer session. I’ll turn the floor back to Mr. Nelson for any final comments. 

Shawn NelsonChief Executive Officer

Yes. I just want to say thank you to our associates who have made these results happen. Very proud of our team. Really proud of the business and the results that we’ve been able to generate.

Thank you to our investors who continue to stand with us and help us grow this company. We look forward to a fantastic Q4 and an even brighter next year. Thank you.

Operator

[Operator signoff]

Duration: 62 minutes

Call participants:

Rachel SchacterInvestor Relations

Shawn NelsonChief Executive Officer

Jack KrauseChief Strategy Officer

Mary FoxPresident and Chief Operating Officer

Donna DellomoChief Financial Officer

Brian NagelOppenheimer and Company — Analyst

Victoria JamesD.A. Davidson — Analyst

Camilo LyonBTIG — Analyst

Maria RippsCanaccord Genuity — Analyst

Matt KorandaROTH Capital Partners — Analyst

Alex FuhrmanCraig-Hallum Capital Group — Analyst

Lamont WilliamsStifel Financial Corp. — Analyst

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