The Lovesac Company (NASDAQ:LOVE) Q2 2023 Results Earnings Conference Call September 8, 2022 8:30 AM ET
Company Participants
Rachel Schacter – Investor Relations, ICR Inc.
Shawn Nelson – Chief Executive Officer
Mary Fox – President and Chief Operating Officer
Donna Dellomo – Executive Vice President and Chief Financial Officer, Treasurer and Secretary
Jack Krause – Chief Strategy Officer
Conference Call Participants
Thomas Forte – D.A. Davidson
Brian Nagel – Oppenheimer & Co.
Alex Fuhrman – Craig-Hallum Capital Group
Matt Koranda – ROTH Capital
Maria Ripps – Canaccord Genuity
Operator
Greetings. And welcome to the Lovesac Second Quarter Fiscal 2023 Earnings Call. At this time, all participants are in a listen-only mode. [Operator Instructions]. As a reminder, this conference is being recorded.
I would now like to turn the conference over to your host, Rachel Schacter with ICR. Thank you. You may begin.
Rachel Schacter
Thank you. Good morning, everyone. With me on the call is Shawn Nelson, Chief Executive Officer; Mary Fox, President and Chief Operating Officer; and Donna Dellomo, Chief Financial Officer.
Before we get started, I would like to remind you that some of the information discussed will include forward-looking statements regarding future events and our future financial performance. These include statements about our future expectations, financial projections and our plans and prospects. Actual results may differ materially from those set forth in such statements.
For a discussion of these risks and uncertainties, you should review the company’s filings with the SEC, which includes today’s press release. You should not rely on our forward-looking statements as predictions of future events. All forward-looking statements that we make on this call are based on assumptions and beliefs as of today, and we undertake no obligation to update them, except as required by applicable law.
Our discussion today will include non-GAAP financial measures, including EBITDA and adjusted EBITDA. These non-GAAP measures should be considered in addition to, and not as a substitute for, or in isolation from, our GAAP results. A reconciliation of the most directly comparable GAAP financial measures to such non-GAAP financial measure has been provided as supplemental financial information in our press release.
Now I’d like to turn the call over to Shawn Nelson, Chief Executive Officer of The Lovesac Company.
Shawn Nelson
Thank you, Rachel. Good morning, everyone. And thank you for joining us today. Today, we will start by reviewing the highlights of our second quarter fiscal 2023 performance and then discuss Lovesac’s strong positioning within the industry. Then Mary Fox, our President and COO, will update you on the progress we made against strategic initiatives this quarter. And finally, Donna Dellomo, our CFO, will review our financial results and a few other items related to our outlook in more detail. Jack Krause, Chief Strategy Officer, is also in the room to participate in the Q&A session.
We are pleased with our second quarter results and with top and bottom line performance that exceeded expectations against a still dynamic macro backdrop. After recognizing some pullback in consumer spending at the outset of the quarter, as we said on our last call, the pursuant attenuation was less dramatic than anticipated. This was up against last year’s very strong Q2 when we achieved our highest quarterly growth rate ever as a public company.
I’ll also remind you that our results are perhaps one of the most recent and real time results in the home category because we typically ship out and deliver goods just days after order and do not carry much of a backlog ever.
Now, let me review the highlights of our second quarter performance. Total sales were $148.5 million, up 45% versus the prior-year period. We delivered total comparable sales growth of 31% with broad-based strength from both new and existing customers.
Adjusted EBITDA grew to $14.1 million from $12.4 million in the prior-year period despite expected supply chain driven gross margin pressure as we manage our expense structure with discipline. We continue to invest in high ROI marketing and advertising, which is a key contributor of the brand awareness gains and resulting sales success that we’re seeing.
Importantly, we deliver these results against an industry backdrop that proved challenging for many, illustrating our market share gains off a very small base in a large and fragmented total addressable couch plus home audio market of $46.2 billion. The home category is down year-on-year into the double digits.
Our very high growth rate quarter after quarter, and four-and-a-half years now, should speak for itself. This growth is fueled primarily by the compelling value proposition of our design for live product platforms, which are reaching brand awareness and customer adoption rates that are currently at important inflection points, building strength on strength.
So why has Lovesac proved to be so resilient throughout the past number of tumultuous years, and even the most recent quarters? Sustainability, in-stock position, best-in-class showroom economics, rapid product adoption, and growth with profitability are all a direct result of our designed for life business model in action.
We believe this will continue to be made apparent as we continue to grow. We do not merchandise a broad assortment like most of our peers. We do not operate on seasonal cycles like most of our peers. We don’t create all of the operational and executional inefficiencies that come along with that model for the business or for the consumer. We invent and patent new solutions in categories with big ticket items and high margins to be had.
We will continue to expand on this with superior products, paired with deft marketing, comes superior market share, and we are well on our way to achieving that with a long way to grow still. We believe we can ultimately take an outsized portion of market share with superior solutions like these.
Sactional, with their myriad advantages, are currently the best example of the scale that is possible for a Designed for Life product. Having only achieved between 1% and 2% market share so far in a highly fragmented couch category, we believe we are finally through that early adopter phase and on to the early majority phase of that classic product adoption curve. For this reason, we believe the best is yet to come.
Word of mouth is now driving nearly a third of Sactional’s purchases because of their unique and highly competitive qualities. This bolsters our marketing ROIs ongoing versus other competitors who essentially sell well designed, but generic solution. We have demonstrated the more we sell, the more we will sell. And with our customer satisfaction scores improving even as we scale due to our continued investments in process, system, services and infrastructure, we believe Lovesac is a brand that can continue to gain further strength in the mind of the consumer. This is in part why our growth has been so resilient.
Our growth was very high before COVID, during COVID, after COVID. And now even in this challenging macro environment continues to be extremely strong versus the broader home furnishings category, which is down overall this year, even as we are way up.
Finally, we have built our brand with the right consumer in mind, the young parent want-it-all, we are targeting with our pricing, marketing and advertising are a resilient group during times like these. These are high earners at the peak of their household establishment and furniture investment years, typically 35 to 45 years old. Our narrow focus on the couch as a subcategory of the broader furniture category is no accident. There are many objects within the home that are truly discretionary spends. But as we know through our considerable investments in research, when household need to replace worn-out sofas, relocate or remodel, the couch is on the top of the list in furniture priorities. And our marketing is there to highlight the unique attributes of our platform and win their business.
Our marketing spend in absolute dollars growing nearly as fast as our top line sales have. This further strengthens our moat, the bigger we get. Our now 174 Lovesac touchpoints, 158 showrooms, 14 kiosks and 2 mobile concierge Lovesac trucks and seamless omnichannel execution drives conversion.
Those three drivers – replacement, relocation and remodeling – are the top three drivers of sales for Sactional, only lastly followed by new home purchases. That dynamic is unique to Lovesac versus the broader category. Which is why, even in times like these, we believe we can continue to thrive.
Our growth strategies are designed to fortify our position and build on our market share gains, and I am proud of the progress we continue to make against each initiative.
From the more recent strong reception of our key innovation, StealthTech, to the effectiveness of our marketing and brand awareness investments, to the expanding productivity of showrooms and healthy digital channel growth. We’re thrilled to see the impact of the work we’re doing across all these areas continue to drive our top line performance and fuel our market share gains.
The runway we have with our growth initiatives, combined with our focus on disciplined execution, gives me confidence in our ability to continue our share gains in any type of macroenvironment.
Even as we navigate the supply chain challenges the industry is facing, our teams have demonstrated strong expense discipline and prioritized high ROI marketing spending as well as investments in key systems, talent and infrastructure in order to solidify our foundation to support the long runway of growth that lies ahead. It is the supply chain and technology investments we have made and continue to make that have enabled our industry-leading in-stock position and improving customer satisfaction scores.
So, in support of our actual and planned market share gains, we’re accelerating growth investments in these areas, as Mary and Donna will discuss momentarily. While we could easily deliver adjusted EBITDA margin expansion this year, redeploying approximately 100 basis points of EBITDA margin toward these important technology and supply chain areas is the right decision for the operational efficiency of our business, and in turn customer satisfaction, which will set us up to win ongoing.
Finally, our commitment to sustainability is foundational to how we operate and continues to lead us to unique and competitive outcome that resonate with consumers in these changing times. Sustainability at Lovesac means not only sustained highsainable [ph] products, things that actually sustain, but a sustained highsainable [ph] business model that you are seeing the fruits of every time we report. We will marry our long-term Designed for Life products with long-term focused services, programs, and policies according to our circle to consumer philosophy, ultimately resulting in long-term relationships with customers who love our brand for myriad reasons.
Even in high growth mode, we have always and will always operate this business with great discipline, managing our expenses and investments and balancing our growth goals with a focus on profitability and returns. Our stated mission includes the mandate to build the world’s most beloved home brand, while achieving targets of zero waste and zero emission by 2040. We’re rapidly on our way.
Lastly, I want to thank the entire Lovesac team for their commitment and execution that have enabled our financial and operational performance. We call them the #LovesacFamily. We are able to deliver what we deliver because you do what you do.
With that, I’ll hand it over to Mary to cover our strategic priorities and progress. Mary?
Mary Fox
Thank you, Sean. And good morning, everyone. Our quarter two results mark the record second quarter for our company. As Sean shared, it was an outstanding performance. And given these results, we have now achieved 17 consecutive quarters of greater than 25% growth. This represents a CAGR of 45.4% in the past four years, demonstrating significant market share gains over this course of time.
Using fiscal 2020 as our baseline, our three-year comp growth stack is 215%, with a strong focus on profitability and an adjusted EBITDA margin dollar growth of over 500% in the same time period.
We are also encouraged by the continued demand strength we are seeing this year, which is again in sharp contrast to what the category is experiencing, as Shawn shared. In quarter two, our estimates show that we continue to win with our customers, gaining significant market share as the strongest performing competitive brand in the seating category.
The large and highly fragmented markets in which we operate presents significant share opportunity, even if macro conditions were to turn less favorable for our core demographic. This is due to the unique values that are built-to-last products offers, the strong word of mouth and relevancy, and the disciplined execution of our key strategic priorities, which I will provide a few updates on now.
Starting with, one, product innovation. We continue to be pleased with the progress of StealthTech, which was a game changer for us and the category from an innovation standpoint. Here are some key highlights. We saw attachment rates increased significantly versus quarter one fiscal 2023 as adoption continues to grow on a sequential basis. This is meaningful as Sactionals that were sold with StealthTech had an AOV nearly three times that of those that did not. The initial success of the launch and the sequential progress we are seeing in what is a multi-year commitment provides us reassurance that the launch support and product continue to build relevance and appeal.
Number two, efficient marketing and merchandising strategies. In quarter two, we continue to be pleased with our ability to maintain product margin in light of the inflationary environment. Additionally, based on KPIs we track, we continue to see strengthening of our brand health metrics versus the category trends. This bodes well for our goals of driving the higher share of our category as we continue to expand awareness through our media mix, relationships with Costco and Best Buy and leveraging our very strong word of mouth referral from customers, which is again our number one driver of awareness for customers who made it to the purchase base.
Further, the lower part of the purchase funnel is strengthening, driven by both brand health and a focus on consideration to conversion targeted media. We continue to see our end market media performance trending in line with projections and our media costs as a whole have stabilized which allows us to lean into testing, including new programs such as spending on TikTok and additional local and hyper targeted media.
Which brings me then to number three, omnichannel operations including touchpoints and e-commerce. We continue to see strong ecommerce sales versus last year, up 20.5% which is also bucking the trend in the category. We attribute these results to the strength of our brands adding new digital programs into our mix, as well as the expansion of full funnel advertising throughout search and social media marketing. For ecommerce, optimization of the customer journey remains a main focal point for the balance of the year, heading into the holiday season.
For digital marketing in quarter two, we continue to expand and lean into advertising that drives the shopper into their closest touchpoints. We are expanding into new local based programs like YouTube Locals and the amplification of geomarketing and social media advertising.
And in quarter three, we’re launching Gladly, a new omnichannel customer service platform, allowing us to better service our customers across all of our customer journey touchpoints and increasing customer satisfaction and loyalty.
As we look to our touchpoints, our showrooms continue to play a critical role in our omnichannel strategy, driving these strong results delivered in quarter two. The strengthening of the lower portion of our purchase funnel is supported by expansion of the number of highly productive touchpoints and location-based digital marketing targeted at driving traffic into these locations.
In quarter two, we opened 11 new showroom touchpoints and one kiosk. We continue to see strong performance in lifestyle and off-mall locations and plan to actively pursue those opportunities as part of our evolving real estate strategy.
Of the 11 showrooms opened quarter two, eight are off-mall, primarily made up of lifestyle center locations. We are very happy with the performance of these new touchpoints which are performing above expectations and delivering higher sales per square foot than our targeted performance.
As we continue to focus on delivering a best-in-class omnichannel experience, in quarter two, we accelerated our investment in the new omnichannel cloud-based POS platform and launched a strategic relationship with PredictSpring.
This POS vendor is a world class global POS provider and aligns closely with our technology focus. This investment lays the groundwork for 15 location pilots in quarter four, paving the way for the balance of the chain rollout in fiscal 2024. This new POS aims to increase transaction efficiencies and sets the showroom operating model up for greater productivity, especially through peak times.
And then, four, making disciplined infrastructure investments. As you continue to see, we’re growing our customer base, selling more and we’re doing it while creating happier customers. We continue to invest in our infrastructure and capabilities to drive and fuel our growth.
Building a frictionless and inspiring customer experience from research to living with our product has been a priority for us for years. And we have seen our customer satisfaction score significantly increase year-over-year. This performance has been led in particular by improvements in fulfillment and our digital experience, which has been a key focus for us this year.
The fulfillment customer satisfaction increase in quarter two of over 500 basis points versus last year was achieved as our inventory levels returned to the weeks of stock that we have been targeting. We’ve been delivering orders to our customers better than ever. And as you are aware, our business model is advantaged versus our competitors, with evergreen inventory and only 1% of our inventory that is aging, which is world class.
The increase of customer satisfaction and fulfillment improvement was also driven by our commitment to making disciplined investments in infrastructure. Our investments in supply chain around diversifying and creating redundancy have allowed us to remain in a strong, yet appropriate inventory position. This sets us up well to deliver a very strong back half of the year while continuing to reduce the impact that tariffs on goods from China have had on our business and maintaining a best-in-class delivery time.
We’re pleased to see a return to pre pandemic lead time for manufacturing and ocean transportation despite some US port delays and inbound trucking volatility. As we all see, container pricing is coming down from the historic levels, although not yet for 2019 rates. And we will see the associated benefits in fiscal 2024.
As Shawn said, to achieve the strong growth into and beyond fiscal 2024, we are accelerating growth investments this year in three key areas. The first is increasing our distribution capacity by adding one DC to our four DC network to support our future growth. This facility is expected to be operational at the end of quarter four. And our team has already started to work on this and will begin to realize the associated expenses in quarter three. This DC will increase our distribution capacity by approximately 15% and enable us to improve lead times and customer satisfaction.
The second is accelerating supply chain technology investments, including a transportation management and order management system, to ensure that we continue to drive customer satisfaction and manage the growing scale of our business.
And thirdly, we will be investing in IT capabilities including talent, external expertise and technology, including the new POS system I mentioned earlier. These investments are critical for us to continue our overall growth trajectory with the operational efficiencies required to deliver this.
So, in summary, we’re very pleased with our financial and operational performance during quarter two. We will continue to invest in high ROI marketing and advertising which has been a key contributor to our brand awareness growth and overall results.
We will continue to build out our operational capabilities to drive our future growth and ensure that we can continue to scale with excellence. We are proud of our results and the outperformance to the category which is being driven by a compelling value proposition that our Designed for Life business model offers.
As we look to the back half of the year, we will continue to drive the exceptional execution of the entire Lovesac team as we navigate the dynamic operating environment. And we remain committed to our growth initiatives, financial controls and operational excellence to drive market share gains and stronger financial return.
I will now pass the call over to Donna to review our quarter two results and a few details related to our fiscal 2023 outlook. Donna?
Donna Dellomo
Thank you, Mary. And good morning, everyone. I will begin my remarks with a review of our second quarter results and then provide a framework for how we’re approaching the remainder of fiscal 2023.
Net sales increased $46.1 million or 45% to $148.5 million in the second quarter of fiscal 2023. The year-over-year net sales increase was driven by growth across all channels. Showroom net sales increased $29.8 million or 47.7% and $92.4 million in the second quarter of fiscal 2023. This increase was due in large part to a comparable sales increase of $19.9 million or 36.8% to $74 million in the second quarter of fiscal 2023, which is compared to $54.1 million in the prior-year period. This increase is principally related to higher point of sales transactions and slightly higher promotional discounting, strong promotional campaigns and the addition of 35 new showrooms, 14 kiosks and 2 mobile concierge as compared to the prior-year period.
As a reminder, point of sale transactions represent orders placed through our showrooms, which does not always reflect the point at which control transfers to the customer and when that sales are recorded.
Internet net sales, sales made directly to customers through our ecommerce channel, increased $6.1 million or 20.5% to $35.5 million in the second quarter of fiscal 2023 as compared to $29.5 million in the prior-year period, with the increase principally driven by the strong performance of our promotional campaigns.
Other net sales, which principally includes pop-up shop, shop-in-shop and barter inventory transactions, increased $10.2 million or 98.3% to $20.6 million in the second quarter of fiscal 2023 as compared to $10.4 million in the prior-year period. The increase is primarily driven by a pull forward of planned openbox returned inventory transactions with Icon, our inventory barter partner.
As a reminder, our inventory transactions with Icon are part of our CTC, DFL and ESG initiatives, where we repurpose returned openbox inventory in exchange for media credits, which are being used to support our advertising initiatives to create brand awareness and drive net sales growth.
Additionally, we extended our Best Buy shop-in-shops by 18 locations, bringing the total count to 22 locations. These increases were partially offset by a shift in programming coupled with lower productivity of our temporary online pop-up shops on costco.com compared to the prior-year period.
By product category, our Sactional net sales increased 53.1%. Our other category net sales, which includes decorative pillows, blankets and other accessories, increased 35.6% over the prior-year period. Due to the shifts in our sac promotional activity, sac net sales decreased 15.4% in the second quarter, but has increased 15.8% over the prior year six month period.
We exceeded the second quarter net sales guidance we shared with you on our last call, primarily driven by the success of our Father’s Day and July 4 promotional campaigns in addition to increased warehouse throughput even with increased demand.
We also accelerated the majority of our full-year projected return box inventory transactions to provide us additional space for a normal growth in inventory levels prior to the holiday season.
The decrease in gross margin rate of 310 basis points over the prior-year period was driven primarily by an increase of approximately 440 basis points in total freight costs, which includes inbound and outbound freight, tariff expenses and warehousing costs. These costs were partially offset by an improvement of 130 basis points in product margin, principally driven by a one-time vendor rebate related to currency impacts, lower promotional discounting and vendor negotiations to assist with the mitigation of tariffs.
Our gross margin percent exceeded our guidance, driven primarily by lower inbound freight costs than we had projected as a result of less than projected volume of inbound containers received during the second quarter, which is shifting these costs to the third quarter, and a slight benefit to the inbound freight rates we have projected.
We do anticipate freight rates to continue to decrease over the remainder of fiscal 2023, but because of the amount of inventory we maintain on hand to support customer satisfaction of the brand, we will not see the full benefit of the drop in these rates as compared to the prior year until the associate inventory is sold beginning late Q4 through the first half of fiscal 2024.
The 38.1% year-over-year increase in SG&A was largely driven by an increase in employment costs due to new hires and variable compensation, overhead expenses and an increase in rent expense related to the addition of 51 touchpoints and higher percentage rent related to the touchpoint net sales increase.
Overhead expenses increased due to infrastructure investments and selling related expenses, principally due to the credit card fees related to the net sales increase.
SG&A expense as a percent of net sales decreased by 160 basis points due to higher leverage within rent, infrastructure investments, equity-based compensation, insurance and selling-related expenses, partially offset by travel and employment costs. The deleverage in certain expenses relate to the continuous investments we are making into the business to support ongoing growth.
Advertising and marketing expenses increased $6.1 million or 46.4% to $19.1 million in the second quarter of fiscal 2023 as compared to $13 million in the prior-year period as a result of continued investments in marketing spend and awareness campaigns to support our sales growth. Advertising and marketing expenses were 12.9% of net sales in the second quarter of fiscal 2023 as compared to 12.7% of net sales in the prior-year period. This slight increase in basis points is due to an increase in media spends to support our net sales growth.
Depreciation and amortization expense increased $1.5 million from the prior-year period to $3.1 million, principally related to the current year capital investments for new and remodeled showrooms.
Operating income was $9.9 million compared to $9 million in the second quarter of last year, driven by the factors just discussed.
Net interest income of $3,000 for the second quarter was a both prior-year second quarter expense of $46,000.
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 the most directly comparable GAAP measurements in our earnings release issued early today.
Net income was $7.1 million or $0.45 per diluted share in the second quarter of fiscal 2023 compared to net income of $8.4 million or $0.52 per diluted share in the prior-year period.
During the second quarter of fiscal 2023, the company recorded $2.8 million for provision of income taxes as compared to $500,000 for the second quarter of fiscal 2022. The increase in income taxes is primarily driven by the increase in the effective tax rate to 28% in the second quarter of fiscal 2023 from 5.8% in the second quarter of fiscal 2022. This is due to fiscal 2022 having the benefit of the release of the valuation allowances on the company’s net deferred assets. The valuation allowance was fully released as of the end of fiscal year 2022.
We generated adjusted EBITDA of $14.1 million in the second quarter of fiscal 2023 as compared to $12.4 million in the prior-year period. Adjusted EBITDA rate exceeded expectations, driven by the higher gross margin percent, partially offset by an increase in SG&A related to the increase in net sales, as well as a conscious decision to reprioritize spend from the second half of the fiscal year, which is advertising and marketing, and increase investments surrounding supply chain technology, including a new POS system, and resources to support the continued growth of the business.
Turning to our balance sheet. Inventory increased 95% year-over-year and we feel very good about both the quality and the quantity of our inventory. Our evergreen in-stock inventory is a competitive advantage and is not comprised of seasonal merchandise. Therefore, we do not run the risk of being overstocked or having to be promotional to reduce inventory levels.
Our inventory levels are in line with our annual projections and our goal to support our growth and maintain industry-leading in-stock positions, with nearly half of the increase in year-over-year ending balance sheet inventory cost related to increased freight.
The increase in inbound freight costs reflect the impact of the continued global supply chain situation. We expect that the rate of the year-over-year increase in our total inventory balance will moderate by year-end.
We ended the second quarter with $17.7 million of cash and cash equivalents and $36 million in availability on a revolving line of credit with no borrowings. Please refer to our earnings press release for other details on our second quarter fiscal 2023 financial performance.
Regarding our outlook, we continue to operate in a dynamic environment with a wider range of potential outcomes as it relates to fiscal 2023. Given this, we are not providing formal guidance, but we’ll provide you a framework for how we are approaching fiscal 2023.
For fiscal 2023, we reiterate what we shared with you on our first quarter earnings call, which was more than 25 planned showroom openings and continued infrastructure investments to support the substantial multi-year growth opportunity that lies ahead.
Even with all of the headwinds the furniture category is experiencing, our competitive product advantage and in-stock inventory position provides us the confidence to reiterate the net sales and gross margin framework for the year that we shared on our first quarter earnings call.
In a scenario where net sales growth for the fiscal year is in the previously discussed low 30% range, third quarter and fourth quarter net sales growth would be approximately 15% and 23%, respectively. The expected moderation in sales growth rate in Q3 from the levels we just reported is principally related to increased throughput and acceleration of returned open box inventory transactions in Q2 representing approximately $9.5 million in net sales, as discussed earlier.
While we continue to expect gross margin rate to be approximately 300 basis points below fiscal 2022. The decline is expected to be approximately 574 basis points in Q3 and 40 basis points in Q4 over the prior-year quarters.
In Q3, we are estimating an increase in total freight costs over the prior year of approximately 400 basis points, primarily related to higher outbound last mile fuel surcharges and higher inbound freight costs incurred in the first half of fiscal 2023 as compared to the prior year.
As a reminder, inbound freight costs are capitalized in inventory and amortized to the P&L based on projected weeks of supply of inventory. This aligns the cost of the inbound freight to when the inventory is sold.
Product margin is also estimated to decline by approximately 174 basis points related to higher promotional discounts than prior-year period.
As John and Mary mentioned, we have reprioritized and accelerated certain infrastructure spend around supply chain, technology and resources to support our strategic growth roadmap. As a result of this reprioritization, while adjusted EBITDA for fiscal 2023 is projected to grow in dollars over the prior year, we expect adjusted EBITDA margin rate to decrease slightly by approximately 100 basis points for fiscal 2023.
Q3 is projected to decrease approximately 1,210 basis points and Q4 is projected to increase approximately 735 basis points over the prior-year quarters. The Q3 decrease is related to the gross margin and incremental infrastructure investments discussed, which principally impact third quarter adjusted EBITDA margin rate. The increase in Q4 over prior year is due to expected leverage of operating expenses with the seasonally higher sales volumes and higher sales growth rate.
So, in conclusion, we are pleased with our second quarter fiscal 2023 results that exceeded our expectations from a net sales and operating profit perspective. Despite the challenging macroenvironment, our team continued to execute against our growth strategies and operate the business with discipline.
We are confident in our positioning for the second half of the year, and we will continue to capitalize on the attractive opportunities we see for growth and market share gains.
With that, we would now like to turn the call back to the operator who can open it up for questions. Operator?
Question-and-Answer Session
Operator
[Operator Instructions]. Our first question comes from the line of Thomas Forte with D.A. Davidson.
Thomas Forte
First off, Sean, Mary, Donna, Jack, congrats on an amazing quarter once again. So my first question is, you mentioned a few times in your prepared remarks, Shawn, what does Designed for Life mean at Lovesac and why is it such a competitive differentiator?
Shawn Nelson
Designed for Life is our design strategy. It’s how we conceive of products and circle to consumer in a nutshell is how we conceive of services married to those products. And our focus is to develop long-term products, long-term services, programs, policies to develop long-term relationships with customers.
So it has become our entire business strategy, to put it bluntly, and we see it as totally unique in the marketplace because so much of consumerism in any category is driven by temporized products meant to disintegrate and compel us to buy new ones. And so, while we do believe we have some razor/razorblade aspects of this business that we’re very excited to exploit that drives repeat business, that drives loyalty, and you’re seeing that unfold with Sactional, Sactional cover, Sactionals accessories, accoutrements, et cetera, et cetera, we will also utilize these philosophies to achieve the same kind of results in other adjacent categories throughout the home.
We don’t just throw ourselves into new categories rapidly because we try to do them – design them to this level. And that takes time. But the results are the kind of results that you’ve seen us now put up for years and years when you have dominant solutions. And so, to us, it really is everything. And we’re proud of the results and we’re proud to represent that ethos, which, of course, and the outcome, as we see it, is true sustainability.
Thomas Forte
For my follow-up, while it seems hard to believe you sell a product, it’s even better than your Sactional, in my opinion, at least, the StealthTech sound system, how much revenue could you generate from that product at maturity? And how does its gross margin compare against Sactionals [indiscernible]?
Shawn Nelson
I think the easiest way to characterize that because we have not broken out sales at StealthTech as its own product line is to say broadly, look, in just the next few years, we will do hundreds of millions of sales in StealthTech. Right? This is not just some little accessory, little add-on to make Sactionals cute. StealthTech, from our point of view, is the best home theater system in the marketplace today. And I’m very proud of it. I live with it myself. And I am blown away nightly by the experience I get to have on a StealthTech embedded Sactionals, which by the way are my 15-year-old Sactional pieces that I’ve added StealthTech to which is emblematic of our Designed for Life philosophy in action. Right? We aren’t just make a new thing and then tell you should have waited and bought the newest thing. Right? It’s so unique the way that we put things forward. And so, StealthTech is our most recent invention, the most recent embodiment of a Designed for Life product and it is so much fun. If you’re following Lovesac and haven’t experienced it, it’s critical that you experience it. And that’s why we have showrooms, by the way. It really pays off our whole business model. This is a product that cannot be understood, certainly not on this call, certainly not even from the website on its face. You really have to experience in person. So, grateful to see it off and running, grateful that we’ve had little to no warranty issues of any meaningful kind and we feel very proud of the launch and expecting things from it.
Operator
Our next question comes from line of Brian Nagel with Oppenheimer & Company.
Brian Nagel
Actually want to add my congrats for a nice quarter. I’ve got a couple of questions. And I apologize, I think they’re going to both be a little shorter term in nature. But first off, Shawn, in your opening comments, you mentioned, I guess, the commentary you made last quarter about maybe some softness at the low end and that abating here a bit. So I was wondering if you can just add a little more color on there, so we can understand better that piece of your business and the trajectory of the business.
Then my second question, Donna, with regard to the different the framework you outlined for the balance of the year, especially with the Q3 piece, is what you – the framework you outlined for Q3, is that consistent with what you’re seeing now that we’re, I guess, almost halfway through the quarter?
Shawn Nelson
Often a quarter may begin – the timing of a quarter may begin with some kind of moments. Like, for instance, Q3 begins with Labor Day and we get a quick read on Labor Day, and that’s all we have necessarily to shape the outlook for a quarter. Q2, similarly, just from a few weeks in, our read was soft, we were transparent about that. And then as you can see from results, it wasn’t as soft as maybe we had feared it may become.
I think, Mary, you may have – or Jack, you may have any other specific observations from the shape of the quarter, different promos within, but that’s essentially what happened.
Mary Fox
Just to add to Shawn’s point, we had a really successful Father’s Day through to July 4. So that’s obviously what you see in the results, and obviously gave us continued confidence in how much the brand is resonating and the success that we see going forward. So, I think there’s always the danger of kind of giving too much detail within a quarter and a week and a month because there’s just always so much that we’re moving around in programming and being very agile. But we were obviously very pleased with quarter two, and feel very confident going into quarter three. Donna can share a bit about some of the shifts that actually came into quarter two, which means that quarter three, obviously, we’ve given you that framework, but we feel very good about the balance of the year and actually feel great strength, particularly around StealthTech anniversarying and all the excitement that Shawn talked about. Hopefully, it’s the gift of the season and so forth. So we’re in great inventory position, great position with the field, hiring et cetera. We are set to go and feel good for the rest of the year.
Donna, I don’t know if there’s anything you want to add on quarter three for Brian.
Donna Dellomo
I think to what both Shawn and Mary had said, we have a very good line of sight, we believe, into how Q3 is going to shape up. And although it may look on the lower end at the guidance that I provided for Q3 at a 15% rate, I think it’s important to note – Mary had just said too – we had a couple of things that we were able to pull forward, consciously pull forward into Q2. And if you take some of that into consideration, that $9.5 million between increased throughput and accelerating our open boxed transactions with Icon, you’d see that Q3 would be in line with what we’re projecting for Q4 as well, closer to a 23% rate.
But as you know, we try to bake in as much conservatism on the other side as well because you just never know, but right now we believe we have a pretty good line of sight into our Q3 performance.
Operator
Our next question comes from line of Alex Fuhrman with Craig-Hallum Capital Group.
Alex Fuhrman
Congratulations on another really strong quarter. I wanted to ask about the additional investments that you’re making. And it sounds like that’s the primary reason for EBITDA margin outlook being a little bit lower for this year. Can you talk a little bit about how much these projects are going to cost and what the timeframe is for them? I would imagine putting together a new distribution center is something that would likely go into next year, if not mostly next year. And I know it’s obviously – you seem to be talking about numbers for next year, but just in terms of the impact that these investments are going to have on next year, should we continue to expect investment of some of your EBITDA margin in the first half of next year into these initiatives and just wondering kind of what the what the timing of some of these investments will be?
Mary Fox
We’re always focused, obviously, in two horizons, the year and then kind of our forward view in our strategic plan. And during the summer, as we were reviewing with all of our leaders, it became very clear to us that, based on our continued growth rate that we needed to accelerate the investments, obviously, that I had laid out. As you rightly said, for example, the additional DC, but also in terms of our talents and capabilities in critical infrastructure that really will help us to be able to drive the growth through FY 2024 and beyond. So, for us, making bold moves that we believe sets us up for that continued growth is something that we’re aligned upon.
As you said, obviously, some of the costs really bear in this year when it’s around the DC, and frankly, also the heavy lift as you work to build, putting in systems in places, the processes that have to be done, there is more of a heavy lift there.
When we kind of come to thinking through on the FY 2024 framework, obviously, we’ll factor that in, but for us it is more of a heavier lift of the investment this year in order for us to be set up. So, we’ll share more at the end of the year. But for us, we feel good based on taking that move now, and the teams are excited because we really do need to give them that infrastructural support.
Alex Fuhrman
Just a follow-up on the new distribution center. Obviously, you’re taking your inventory up here and the business is growing very fast at the same time. Can you give us a sense of kind of what your peak ability to handle inventory is now, prior to this new distribution center? Is it something that you think you’re going to be needing very quickly?
Mary Fox
We have the ability still to deliver [indiscernible] this year. Part of bringing in the new DC is actually to be able to serve customers in the south at a faster speed. And as I shared with you before, we’re so happy to see the fulfillment, customer satisfaction really jumped up this year. So it’s as much around geographic proximity to customers, as well as the capacity that obviously I laid out before. So, we don’t see any constraints for this year. But we certainly see that it’s needed as we go into next year, and now is the time for us to start to build in that capacity. And frankly, DCs don’t always come up so easily. So it was also important, it was perfect for us. Great for the model. So, it was also about being able to lock that in. So bit of both from that side, Alex.
Operator
Our next question comes from the line of Matt Koranda with ROTH Capital.
Matt Koranda
Just wanted to clarify the quarter-to-date trend that you guys had discussed earlier in the Q&A. Just wanted to put a finer point on it. Are we tracking quarter-to-date up 15% in line with the Q3 guidance. I’m just curious if you could maybe comment on how the consumer responded to the Labor Day sale and how you’re factoring in the broader promotional environment in the industry into the Q3 and Q4 outlook.
Mary Fox
Quarter-to-date, including Labor Day, we feel really good about the framework Donna shared and feel strong around our performance. We continue to grow and are well ahead of the category, taking market share. So as we saw through the quarter two, there’s always ebbs and flows throughout, but we feel really good as to where we stand right now. And as Donna said, we always also manage our frameworks with conservatism baked in because, whilst we’re full throttle on driving growth, there is obviously the macro dynamics that we all read and see all the time. And whilst we continue to grow, we have the best performance in the category. And actually, we’re seeing a widening gap in our performance to the category that’s just strengthening more and more. So we feel good. And even if you think of just quarter two, the three year geometric stack up, 215%, this just is continuing to build from that side. So, nothing other than confidence through quarter three and into quarter four and the rest of the year.
Matt Koranda
Just on StealthTech, wanted to see if we could get a little bit more detail on product adoption there. Any more quantifiable metrics you can share around attach rates to Sactionals. And I’m curious, maybe on Shawn’s front, how is this helping with marketing efficiency because some of our checks seem to indicate word of mouth on Sactional is a pretty big driver of store traffic. And just wanted to see how that threads into sort of the marketing efficiency that you’re seeing?
Shawn Nelson
We have not broken out StealthTech and talked about attachment rates. Broadly, I’ll just say that they’re on target. They’re moving according to plan. Given that it’s been in market for less than a year and it’s a huge leap from being seen – not anymore just being that company and not even as a couch company, but as a home electronics company, home electronics brand, with our brand on the side of these home electronics products, that’s a huge brand lead for us. It’s going to take years to come to maturity.
The good news is it’s off and running and making a meaningful impact on the performance of our marketing. I think the clearest example is any TV commercial, which is a massive portion of our advertising spend, shows StealthTech with Sactional. So, I think we’ve spent over $40 million already to date, roughly, on StealthTech-related commercials. This is something we are materially behind, and think we’re seeing material success with it.
In terms of word of mouth, no doubt about it. This is a product that is quite remarkable. And I think that’s probably the most misunderstood and underappreciated aspect of Lovesac. Why are we winning? Why is word of mouth so strong for us? Why are our marketing ROIs so high quarter after quarter for years now? Because the product is remarkable. In a landscape where most products – there are good brands out there. There are beautiful designs, but they’re not remarkable. They don’t cause people to talk about it, to remark. And that’s what’s beautiful about StealthTech. And so, it absolutely is buoying up and improving our marketing ROIs, our word of mouth at a time when, of course, Sactionals were just coming into their own and finally becoming part of the mainstream, we hope, and being adopted at a broad rate.
StealthTech has a long, long runway to come to maturity. We believe it is a big business line for us. We think of home audio as a category we’re competing in. This is, again, not just icing on the cake for Sactionals. And by the way, we will leverage the StealthTech sub brand in other categories as we eventually expand the brand that way. So, sorry, not give more color, but given that it’s a new category and we step into the granularization of our public data very carefully and thoughtfully, that is our approach thus far.
Jack Krause
One thing to add to that, John, is I think with our – it’s amazing to get that kind of word of mouth. And if you think about the funnel, a lot of that driving the top of the funnel and also making the middle and bottom of the funnel easier to convert. And I think as you see what Mary discussed and the marketing team is doing, there’s a lot of hyperlocal targeting. That’s the power of word of mouth and our advertising helping the top of funnel, enabling us to get really closer in and creating higher conversion rates, which is what we’re seeing.
The thing we’re also seeing is our own ability to drive our own traffic outside of what we would call these classic holidays. So we’re seeing the signs, we’re more of a word of mouth driven destination brand, and we have a lot of control over our future. And we feel great about it.
Operator
Our next question comes from the line of Maria Ripps with Canaccord Genuity.
Maria Ripps
Just following up on the last question and sort of strong referrals driving incremental demand for you, can you just maybe talk about how you’re thinking sort of about balancing that with marketing investments in the environment of broadly softening consumer demand versus the backdrop of you gaining share?
Mary Fox
Obviously, our great success, as you talk about with strong referrals, word of mouth, and so forth, is just back to what Shawn’s been talking around, just people love our products. Every one we talk about, it’s not just that they like it, it’s functional, they really love our products. So, I think as we look at everything we’re doing around marketing, whether it be investing in TV or, as Jack said, much more kind of local, hyper targeted programs, all of it is really just continue to strengthen the funnel from the top to the bottom. As we look at the latest brand health update, we’re just seeing conversions higher than ever, especially from consideration through to purchase and those ROIs are strong and it’s all just a key rank for us around the brand stickiness. And it’s just more and more people know us and as we put a showroom in their local area as well, you get that kind of double down in terms of just people starting to talk about us coming in and trying it.
And frankly, StealthTech has created an amazing dynamic in the showrooms that really brings it beyond just thinking about coming in for furniture. It creates a whole family moment and a lot of excitement. So, we will continue to be very agile, adjusting. I think I talked a bit about test and learning in marketing around social media and so forth.
The team do a great job. They’re always adjusting real time in terms of where they’re seeing the ROIs. And we have a very disciplined approach to every dollar we spend. So more to continue to build on as that brand stickiness continues to increase.
Maria Ripps
secondly, on StealthTech, can you maybe talk about if you’re seeing more traction and conversion with StealthTech in your Best Buy shop-in-shop locations or other customer touchpoints?
Mary Fox
I think part of, obviously, our excitement for our Best Buy partnership is the strength of StealthTech. And we’re seeing double the rate of attachments in Best Buy shop-in-shop and that continues to build and accelerate. So for us, that’s a lot of where consumers go into, look for home audio. So we are there front and center. And as I shared with you in the last quarter, for next year and beyond, we will continue to expand our partnership with Best Buy and play a very strong role in the home audio market, with what we see as the number one product for every family in America to be able to have access to.
Operator
Thank you. Ladies and gentlemen, that concludes our time allowed for questions. I’ll turn the floor back to Mr. Nelson for any final comments.
Shawn Nelson
Thank you to all of the Lovesac family and all of our associates, partners and investors who continue to support the company, and we appreciate it. Look forward to speaking with you next time.
Operator
Thank you. This concludes today’s conference. You may disconnect your lines at this time. Thank you for your participation.
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