Q2 2020 Earnings Call
Fiscal 2020 earnings conference call at this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance. During the conference. Please press star zero on your telephone keypad. Please note. This conference is being recorded I will now turn the conference over to Rachel Schacter.
I see thank you you may begin.
Thank you good morning, everyone with me on the call is Sean Nelson, Chief Executive Officer, John Krafcik, President and Chief operating Officer and on a dollar <unk> 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 filing with the FCC, 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 you and not as a substitute for or in isolation from our GAAP results.
Reconciliation of the most directly comparable GAAP financial measures to such non-GAAP financial measure has been provided a supplemental financial information in our press release.
Now I'd like to turn the call over to Sean Nelson Chief Executive Officer of the lots that company.
Thanks, Rachel good morning, everybody and thanks for joining us today.
I will begin today's call by discussing the financial and operational highlights of our second quarter results.
After which I'll briefly review our high level thoughts around our outlook and provide an update on our tariff mitigation efforts then Jack Crowley, our president and COO will outline the progress we are making on our key growth initiatives, including details on an exciting new shop in shop program that is launching in Q3.
Finally, Donna Delano, our CFO , who will review our financial results in a few items related to our outlook in more detail.
We feel great about our second quarter financial results.
Net sales increased by almost 45% to 48.1 million.
Total comparable sales, which includes same showroom and internet sales increased 40.7%.
Driven by strong showroom comp increase.
31.8% and significant growth in our internet business of 71.5%.
In Q2, we again saw our comp growth driven by both transactions as well as ticket growth as our digital marketing strategies and multi channel model allow us to draw new customers to the brand while also driving repeat purchase behavior.
Adjusted EBITDA was a loss of 3.3 million for the second quarter.
Operationally, we made good progress against our strategic priorities in the second quarter.
A few highlights our one we continue to lean into marketing, including a successful Memorial day campaign to increase brand awareness and drive sales, which is reflected in our almost 45% topline growth for the quarter. Two we made strategic investments in our infrastructure to improve the overall customer shopping experience and position us for continued success as we scale the business, including expanded capacity and increased accuracy of customer delivery.
Three we opened two new and remodeled three showrooms during the quarter as we continue to increase our showroom presence.
Four we enjoyed strong results from our pop up shop business with Cosco and given our continued success.
During the quarter, we were given the opportunity to run an 18 day event on Costco Dot com.
Which every lakes the in store pop up shop partnership online.
We had very encouraging results from this initial online events and have plans for another two online road shows with Costco for later this year.
In addition to our pop up shop business with Cosco, we continue to foster new relationships with other retailers and we're very excited to announce today, our new partnership with Macy's to pilot for permanent shop in shop locations.
Not only will that increase our brand awareness and drive customer acquisition, but it's also a testament to the existing strengths and appeal of our small but rapidly growing brand and innovative product line.
Jack will discuss our second quarter operational progress and expand on the details of this exciting new partnership in just a moment.
As it relates to our outlook given our strong Q2 financial performance, our marketing and other plans for the remainder of the year. We are reiterating today, our fiscal 2020 annual revenue guidance of 40% to 45% sales growth.
We are also reiterating our expectations for positive adjusted EBITDA for fiscal 2020.
We are very pleased to be in a position to reiterate our full year adjusted EBITDA outlook. Despite increased tariffs, which is a testament to the tremendous progress we have made with tariff mitigation actions, which I will now discuss.
To start I could not be more proud of our teams for their efforts and dedication to mitigating the impact of these special tariffs and optimizing our supply chain.
Our focus on optimizing our supply chain is threefold number one.
Swiftly relocating manufacturing out of China to negotiating aggressive vendor discounts three assortment promotional shifts and surgical price adjustments that have shown zero negative impact on sales to date.
First in terms of relocating manufacturing outside of China. We have already successfully moved the majority of our socks, those manufacturing to Vietnam and also Malaysia for redundancy.
The actions without covers currently represents approximately 57% of our overall sales based on costs.
The remaining portion of our sectional production will have moved entirely out of China by the end of Q2 next year.
A long term Chinese manufacturing partner of ours is currently in construction on a new purpose built highly automated sectionals factory located in Vietnam to support our continued rapid growth along with co located cut and sew facilities for both stock and Sectionals covers.
Based on our success. Thus far we are confident that we will make progress this year toward resourcing the balance of our Soc and Sox. Most covers at a similarly rapid pace and expect to have only a small percentage of our covers manufacturing in China by the end of Q2 next year.
These expeditious production moves will eliminate our exposure to special tariffs and also result in lower first costs for these goods even versus their pre tariff levels, which you will see starting to flow through our piano with a turnover of the associated inventory throughout next year.
Second regarding vendor discounts the minority piece of our stock sells manufacturing there remains in China today has been discounted by our manufacturer to a cost that offsets most of the effect of the recently announced tariffs increase from 25% to 30%.
Our cotton sewn covers for Sox, and Sectionals and various accessories like throw pillows and blankets.
Still manufactured in China are all subject to list one through four tariffs and we have recently achieved aggressive vendor discounts on all of these items as well to carry us through the near term as we transition nearly everything out of China.
We are particularly grateful to our vendors for their support in this area. They have been collaborative partners and most of them are moving their operations with us out of China to various other countries in the region to retain our business same on costs and diversify our overall supply chain risk.
As a result of this work we're pleased to share that as of this month only 44% of our total good are now manufactured in China down from approximately 75% at the end of last year.
And we expect this number to continue to fall by year end by a few more points heading towards zero before the end of next fiscal year. If tariffs are not listed.
It is because of all the swift execution in sourcing coupled with surgical assortment and pricing adjustments and disciplined expense management that we expect to deliver positive adjusted EBITDA.
Even with all of the recent tariff elevations and additions and our growth.
Essentially by the second half of next year, we projected the majority of our products will be coming in at lower cost than they were a year ago and our supply chain will be far more robust and diverse.
This year, we expect gross margins to decline temporarily by 320 to 350 basis points for the full year versus last year, but with our newly well diversified supply chain and the lower corresponding ongoing product cost we expect to return our run rate gross margins percents to the mid 50% range by the second half of next year.
Because of our exhibited pricing power strong value proposition collaborative manufacturing partners and relentless innovation machine. We are confident that we can maintain these best in class gross margins over the long term.
Finally speaking of innovation, we are excited by the launch of the news actual power hub this month.
It is our first foray into electronics and it opens the door into numerous new technology innovation opportunities ahead for this brand.
The concept is patented and we believe it will not only drive repeat business increase basket size and our average order value, but more importantly, because its reverse compatible with all the structural pieces, we've ever sold it reinforces our unique commitment to our design for life east dose in the eyes of our loyal customers.
The actuals or a platform that is designed to grow and evolve and allow customers to add to it or upgrade it through out their own lifetime.
Even in ways, they could not have imagined when they originally bought the product.
Every sexual space that we have ever sold over these many years already has the receiver a whole already embedded in it just waiting for this power hub and maybe other inventions as well yet to come.
We believe that over the long term. This will result in customer satisfaction and brandloyalty level that will be unprecedented in the competitive landscape not to mention the platform's unique implications in terms of sustainability and reduced waste in landfills.
So in summary, I'm very pleased with our financial and operational progress throughout the quarter as we look to the second half of this year, we will continue to focus on executing against our strategic initiatives and leveraging our distinct competitive advantages to realize the significant growth potential that exists for luxoft.
Before I turn the call over to Joc I want to again, thank all of our team members for the great job that they do day in and day out.
Their hard work in driving a rapid growth and we look forward to building on this performance as we move into the second half of the year.
From our standpoint, it's simple.
As I hope we've demonstrated across the four quarters, we reported since becoming a public company.
We're going to keep delivering high sales growth, while maintaining positive adjusted EBITDA on an annual basis external challenges notwithstanding.
We are very confident in our ability to deliver on our near and long term goals and look forward to updating you on our progress.
I will now turn the call over to Joc, our president and COO to go over our key priorities for the remainder of this year.
Thank you John and good morning, everyone. As Sean said, we are pleased with our second quarter results. We delivered strong financial performance and continue to execute against our key growth initiatives I will now review some of the operational highlights and discuss our plans for the remainder of the year.
Starting with expanding our marketing efforts to increase brand awareness and drive sales our second quarter Top line results are a testament to the continued effectiveness of our marketing strategies for the quarter. We achieved overall comparable sales growth of 40.7% driven by web comps of 71.5% and showrooms at 31.8% overall Memorial day marketing ROI finished very strong as indicated by our sales performance. The memorial day pre tent pole TV campaign test markets saw strong lifts and weekly sales averages versus their pre 12 week sales average increasing both sales and program our allies. Given these encouraging results we scaled the pass through 11 markets for Labor day and subject to continued positive results. We will look to scale. This nationally in the fourth quarter of this year.
In terms of digital media advertising the six week Petrus Test campaign during memorial day proved to be an efficient driver of brand awareness and Todd site traffic with over 360000 clicks to decide at a very favorable CPC or cost per click.
We also saw great engagement with a new platform with almost 30 time increase in monthly viewers and an over 30 X increase in monthly Engagers. Overall, we will continue to test increased digital marketing in the second half as we continue to see increased ROI as a result of the synergy with TV advertising.
We will look at new efficient marketing strategies to drive the business as we look towards the fourth quarter importantly, many of the in marketing initiatives. We have successfully tested so far this year.
To drive sales will be leveraged the most heavily in the fourth quarter.
Next expanding and improving our showroom presence, we opened two new showrooms and remodeled three in the quarter ending the quarter with a total of 80 showrooms and approximately 70 of our locations having been remodeled to the current rebranded showroom design.
We remain on track to open 17, new showrooms in fiscal 2020, including showrooms and 12, new markets and improving our penetration in five markets.
Turning to our pop up shops in the second quarter fiscal 2020, we operated 209 pop up shops with Cosco up from 137 in the second quarter last year, which drove a 40.9% increase and our other channel sale to $7.4 million pop up productivity increased 5.1% in the quarter.
As discussed on previous calls pop up shops have been a contributor to our growth over the past 24 months last year. Our 10 day road shows with Cosco delivered a dollar per square foot productivity multiples higher than even our own showrooms driving over 19 million in net sales, which was over 300% year over year growth.
In addition, we believe these pop up shops drive additional revenue on our website, both during and post show.
We continue to believe that the pop up shop format allows us to capitalize on customer acquisition opportunities in high traffic locations by showcasing a limited offering of our products in areas, where we don't necessarily have a showroom presence introducing our brand and unique product attributes to a wider market.
Due to the success of our road shows we worked with Cosco to bring an 18 day event to Cosco Dot com, providing love stack with nationwide coverage. This event ran in July and the results were very encouraging the dot com event generated nearly $750000 in sales in 18 days and do the success. We've scheduled an additional two events for the balance of the year.
We've also been exploring more permanent shop in shop opportunities to deploy a similar concept with other retailers and are very pleased to announce that we have officially entered into a partnership with Macy's to pilot a test of shop in shops and for highly attractive Macy's locations in Q3 of this year. The locations include their Herald square flagship store in New York City, as well as Carl placed furniture Gallery in long Island.
The Lama fashion center in La County, and Lenox square in the Buckhead District of Atlanta, Macy's is a logical choice for us they have demonstrated the ability to be a leader in bringing innovation to the retail furniture space. We have had tremendous success with pop up shops outside of our own channels and look forward to establishing additional reach for the love SEC brand with Macy's as we expand the love stack shop in shop presence in an agile and efficient manner.
Unlike the Costco Road shows, which are 10 day shows and pop up locations that make these tests will be launching permanent asset light shop in shops in key Macy's locations. We know that experiencing this action will demo is extremely important to many customers shopping journeys and through this partnership will be able to deliver more demos to a broader audience and accelerate adoption of the sectionals platform.
We believe the Macy's brand and customer profile is a great fit with the love that brand and look forward to kicking that pilot off in Q3 with a majority of the sales impact expected in Q4.
These shop in shops will be designed to be permanent locations carrying the same digital technology of our showrooms and will be staffed by less stack employed under the direct supervision of our sales operation team. Because these will be run like around showrooms, we expect margin rates and contribution to be similar to our freestanding showrooms, but with significantly less capex investment.
Less than a third of our current capex per share. The current plan is to test. These four initial locations for at least the full year prior to expansion.
And we will continue to update you on test details performance and potential expansion plan at that information becomes available.
Finally, as part of our continued investment in our team in support of our substantial future growth. We're very excited to announce the appointment of calmly as our chief supply chain officer effective September nine comments, a season supply chain and merchandising executive and most recently served as SVP chief supply chain officer, Spartannash and prior to that he spent years at Wal Mart and office depot in both senior supply chain and Merchandizing roles.
We are very excited to have him on board and look forward to benefiting from his expertise as we continue to develop a world class supply chain that delivers an unparalleled customer experience.
This important addition positions the business well for continued success.
So in summary, we are pleased with our second quarter results and the operational progress made on our strategic priorities, including all of the tariff Mitigations work, that's Sean whatever.
As we look to the remainder of the year, we will continue to focus on growing the business and strategically investing in our infrastructure and technology to position that business for long term growth.
Don I will discuss our guidance in further detail, but as we look ahead, we continue to be confident and the drivers of our business.
Of which we will see the greatest impact in Q4, including the new business opportunities I, just discussed with Cosco and maybe the marketing plans with the proven highest effectiveness and year over year spend increases in Q4 as well as increased showroom opening along with.
The launch of the power hub that Sean discussed and with that for a more detailed review of our second quarter results as well as a few items related to our outlook I will now turn the call over to Donna del Amo, Our Chief Financial Officer.
Thank you Jack Good morning, everyone. I will begin my remarks with a review of our second quarter results and then provide some commentary around thoughts for fiscal 2020.
Total net sales increased 44.8% to 48.1 million from $33.2 million in the prior year quarter. This sales growth was driven by strong showroom Internet and pop up shop performance with both transaction as well as ticket growth, resulting from successful advertising and marketing strategies, which drew new customers to the brand while also driving repeat purchase behavior.
An increase in the number showrooms also helped fuel our Q2 sales performance.
Comparable sales, which includes showroom and internet sales increased 40.7%.
Comparable showroom sales increased 31.8% and represents our 11th consecutive quarter of positive comps showroom sales increases.
We opened two new showrooms and ended the quarter with 80 showrooms.
Looking at our results by channel for the second quarter Sjogren sales increased 35.8% to 31.3 million Internet sales increased 71.5% to $9.5 million and our other channel, which includes our pop up shops in cosco locations increased 57.7% to 7.4 million.
By product category, our sectional sales increased 51.5%, our sac sales increased 35% and our other category sales, which includes decorative pillows blankets and other accessories decreased to $200000 from 800000 in the second quarter as compared to the prior year quarter.
Gross profit dollars increased 36.1% to $24.3 million in the second quarter as expected gross margin percentage decreased by 320 basis points to 54.4% from 53.6% reported in the same period last year.
This year over year decline was primarily driven by the 10% Paris impact, partially offset by reduced cost of our sectional and Soc products, primarily related to cost savings from a change in the sourcing of our luxoft and down blend Phil and an ongoing shift of our manufacturing to Vietnam and other countries outside of China.
For the second quarter total SDMA, excluding advertising and marketing expense increased 7.3% to $22 million from $28.5 million in the second quarter of last year. Excluding approximately 300000 other nonrecurring expenses total SGN a increased to 21.7 million. The increase in SDMA was driven largely by variable expenses related to the increase in sales as well as higher employment costs and rent, which were partially offset by a decrease in overhead expenses and equity compensation.
As detailed in our press release.
As a percentage of sales total SGN a expense decreased by 15.9% driven largely by decreases in stock compensation and IPO related expenses.
As described above.
Our investments in advertising and marketing, which benefit extended period increased $2.5 million or 68.8% over Q2 prior year.
As a percentage of sales advertising and marketing expenses increased to 180 basis points to 12.6% this quarter largely due to an increase in advertising related to memorial day.
Which had a very positive ROI.
Depreciation and amortization increased 447000 from the prior year period to 1.2 million principally related to capital investments for new and remodeled showrooms.
In the second quarter of fiscal 2020 operating loss was 4.9 million compared to an operating loss of 7 million in the second quarter of last year.
In the second quarter of fiscal 2020, adjusted operating loss was 4.6 million, excluding approximately $300000 of non recurring expenses.
In the second quarter of fiscal 2019, adjusted operating loss was 5.7 million, excluding approximately 1.3 million of non recurring expenses.
Net interest income was 169000, which relates to the impact of our IPO and other primary share financing.
Tax expense in the second quarter of fiscal 2020, and 2019 was less than $10000 and is related to minimum state income tax liability.
Before we turn our attention to net income net income per share and EBITDA I would like to point out that my discussion of these metrics will focus on net income and net income per share adjusted for the IPO and other financing costs as well as adjusted EBITDA. Please refer to the terminology and reconciliation between each of our adjusted metrics and their most directly comparable GAAP measurement in our earnings release issued earlier today.
Adjusted net loss was $4.5 million in the second quarter fiscal 2020 compared to an adjusted net loss of $5.7 million in the second quarter fiscal 2019.
Net loss per share adjusted for the IPO and financing costs was 31 cents in the second quarter fiscal 2020.
And.
63 cents in the second quarter of fiscal 2018.
Adjusted EBITDA was a loss of 3.3 million as compared to a loss of $2 million in the second quarter of last year.
Turning to our balance sheet, we ended the quarter with 44.2 million in cash and cash equivalents.
Ending inventory increased 101% year over year, driven by higher sales as well as an increased investment in the weeks of supply of inventory on hand to support sales growth across all channels to be agile enough to support the success of our advertising and marketing investments.
And includes an increase in capitalize freight and warehousing costs relative to the build of inventory and Paris charges.
Now I would like to discuss a few items as it relates to our fiscal 2020 outlook.
From a showroom perspective for the full fiscal year 2020, we are on track to open 17, those showrooms for this year with 11 Shoreham openings in the second half of fiscal 2020 and continue to expect for remodel eight.
We are now referring to our Cosco road shows has pop up shops, and our Macy's pilot as shop in shops, given the nature of the shop set up.
As mentioned for fiscal 2020, we will operate three Costco online road shows in addition to our in store pop up shops with Cosco as well as for pilot shop in shop locations with Macy's.
We continue to expect to deliver a strong levels of sales growth between 40% to 45% and full fiscal 2020.
However, we do expect Q3 revenue to be below the low end of our annual growth target with growth of approximately 30%.
While Q4 is expected to be significantly above the high end of this annual range.
This expected cadence is due to the following items.
We expect to see a deceleration in total comp sales in Q3 with Q3 comps expected to be slightly ahead of Q3 total sales growth with a significant increase in total comp sales in Q4.
However, important to point out that Q3 total comps on a two year basis are projected to be in line with Q2 of fiscal 2020.
Normal seasonality of the business.
With Q4, being our largest volume quarter.
The cadence of planned investments in marketing and advertising with investments in working media strategically being made late in Q3, which have greater ROI is in greater impact on Q4 sales growth.
In addition, total showroom revenue will be impacted by the timing and the number of new showroom openings during Q3 and Q4.
Which this fiscal is we'd have more heavily in Q4 than Q3.
The number of Costco pop up shops continue to increase over prior year with the most significant increase in the number of pop up shops happening in the first half of fiscal 2020 as compared to prior year.
Second half 2020, Cosco pop up shops are projected to be as revenue productive as those in the first half of fiscal 2020.
The new initiatives that Jack mentioned to include Costco Dot Com Road shows and the Ford New Macy's pilot shop in shops will have the greatest amount of fiscal 2020 impact on Q4 revenue.
Consistent with the just discussed expected sales growth cadence, we expect the larger Q3 adjusted EBITDA loss than we reported in Q2, followed by a substantial improvement in Q4.
Given the significant tariffs mitigation process, we've made as Sean discussed we continue to expect to generate positive adjusted EBITDA for fiscal 2020.
We expect full year gross margins for fiscal 2020 to be approximately 320 to 350 basis points lower than fiscal 2019, principally related to the bottom line.
Expected tire pressure, which is being offset by mitigation actions and SGN a initiatives.
Investments into our distribution infrastructure to support future growth.
A slight headwind due to the continued shift in product mix towards Sectionals.
As well as a slight impact from higher pop up shop channel mix Sal.
These decreases are partially offset by product margin gains relating to changes in discounting and promotional strategies reduced product costs related to vendor sourcing strategy and vendor rebates as well as accelerated shift of sourcing outside China.
In terms of SGN day, excluding advertising and marketing expense as previously mentioned, we expect the most significant SGN a leverage to be generated in Q4, given the seasonality of our business.
As a reminder, embedded in our SGN eight outlook is all of the investments we are making in the business across people process and infrastructure and our Q4 net sales volumes enable us to produce the greatest amount of leverage on these investments over the prior year.
So in summary, while we continue to expect quarterly fluctuations due to the timing of our tariffs mitigation efforts, our advertising and marketing investments and investments across all areas of the business to support the significant growth opportunity. We have we anticipate that we will again deliver a high sales growth rate and will generate a positive adjusted EBITDA in fiscal 2020.
Finally, as it relates to capital expenditures, we now expect to incur approximately $11.5 million of Capex in fiscal 2020 versus our prior guidance of approximately $13 million due to a timing shift of investments of the sock manufacturing capex to fiscal 2021.
The vast majority of our Capex will be spent on the opening of 17 showrooms. The remodel of approximately eight legacy stores. The opening of four Macy's shop in shop pilot locations and approximately $1.3 million being invested into the sock manufacturing facility this difficult.
The remaining spend is being allocated to technology in our showrooms inventory management and logistics systems E Commerce platform enhancements and for headquarters data and support system.
For all other details related to our results. Please refer to our earnings press release with that we would like to turn the call back to the operator, who can open it up for questions operator.
Thank you.
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Our first question is from Dave King with Roth Capital Partners. Please proceed.
Thanks, Good morning, everyone.
Hi, good morning.
Let me first off what what's driving the confidence in the in the Q4 growth.
Versus the Q3 guidance you laid out it sounds like some of that's Macy's or whatever what are you getting from a two year comp perspective.
Versus what you had in Q2, and we are expecting for Q3 and what's driving that.
Yeah, I consistently hey, Dave it's Jack.
We believe roughly speaking that two year comps will maintain pretty consistent throughout the year, obviously, we're going against tougher and tougher comparables and the reason we feel confident in that is it's harder to see in terms of total marketing spend on a quarter to quarter basis, but the working marketing the effect of our work in marketing, which starts in Q3 and goes into Q4 will be by far the greatest.
Impacting Q4 was roughly year over year, working media spend plus over plus 60%, whereas if you look at the effect of the Q3 media. It was roughly flat to a year ago. So that that will give us a dramatic increase in comparable sales acceleration.
Okay, Okay that helps and the background on that the reason that we're doing that delay is as we talked about earlier, we've had several tests going on and.
As we do our analysis.
The opportunities to implement have come really in the Q4 versus Q3.
Okay, and so I know I know, it's a little bit early on on that front, but can you talk about the initial performance of the expanded regional media runs you had prior to labor day, the ROI as increasing any early learnings so far.
Yes that the pre tent pole events. So the expansion of the event is showing increases in ROI and run rate. So.
At this point, we believe they will be part of the Q4 program what I'll do I'll need to do is we still haven't done sort of be the final analysis of our labor day media. So.
We'll be finalizing that in the next couple of weeks and then putting it into a Q4 finalized programming.
Okay. That's good color thanks for taking the question.
Our next question is from Brian Nagel with Oppenheimer and company. Please proceed.
Nice quarter.
Thanks, Brian .
The first question I want to ask I apologize.
Got it when we were laying out the the guidance for.
Sales Q3, Q4, I, maybe just missed it could you could you remind me or reiterate what with.
With the sales guidance for the third and fourth quarters of the components of that.
Yeah, what we what we're saying is that year over year total sales will we're expecting to increase about 30%.
With a significant increase in fourth quarter. So we are still lining in to the annual guidance of 40% to 45%.
So we didnt give guidance for Q4.
But it will be significantly higher than the high range of the 40% to 45%.
Annual guidance that we provided.
Got it we can back into that just given that it's basically a missing piece, but and then in the primary reason for that.
Hi, good I'm, sorry, yes, I know I think you're right. It does make sure I get this raise the primary reason for that sort of say Choppiness is one more difficult comparison to then to just the cadence of the in the marketing investment.
Yes, there are two things to say you're right so that.
From that comment and it's really broken into two things. So you have on a comp basis I just explained that that were dramatically increasing our marketing relatively speaking are working marketing in the fourth quarter relative to the third.
And we believe we'll get significantly higher lift the other component of that is just initiatives. So for example in the fourth quarter will have a dramatic increase a new show room openings versus the third the third quarter was really our lowest rate of new show room openings. We've had in the last several quarters and in the fourth quarter also get the results of the the Macy's shop in shop.
Rollout as well as the two additional Cosco shows we mentioned so those will have we will have an incremental effect. So we have some comp effects as well as just new business initiatives kicking in in the fourth quarter.
Got it then just a question I had just with regard to gross margins clearly you've been you articulated in the press release and your prepared comments have been a lot of averaged onto.
Deal with so to say the tariffs so congrats on that as we look at the gross margin degradation here in the second quarter.
Is there a way to parse that out or how much of that is were down.
330 basis points year on year, how much of that is.
Investment or onetime in nature as you deal with these tariffs versus a newer run rate type number.
Yes.
On the guidance that we have given and it's still pretty consistent at about 75% of that decrease in margin year over year is related to the tire pressure.
The other 25% relates to.
The initiatives, we have with opening up multiple warehouses investing into some infrastructure some cost increases on Fedex some cost increases relative to the increase in inventory levels, but the majority or at a minimum of 75% relates to be.
Impact its parents.
Okay got it and then my final question with regard to Macy's and the amazing recognizing it's very very early.
How should we think about.
So it sounds to me like the Macy's initiative will be closer to.
More now I guess, so to say to one of your own showrooms, how should we think about the economics of.
Macy's location in a show room and then the second question on that is so now this so costco macys are you.
And discussion is worth or should we expect other type of retail partnerships in the not too distant future.
Yes. Good question. So I think you're right I think Macy's is more analogous to our own showrooms.
Really with that being a a an asset light execution. So we expect the capex spend that on the Macy's to be less than a third of a normal showroom and we expect.
Those two obviously.
It's pretty easy to assume our hurdle rate would be the same types of returns we want to get as we wouldn't show room. So if you look at the Capex that way.
You could easily say that roughly between.
30% to 50%.
Of the run rate of a Macy's shop in shop will be roughly 30% to 50% of the normal showroom. Obviously, they're huge exceptions. For example Herald square is is a substantial opportunity so that we'd look at that separately.
But it's very early so obviously.
I think the best way to look at it is look at the math on the Capex investment and the way, we're running them and.
You get a model and what what.
What do you think makes sense, because thats going to be as close it is right now because what we're really doing is testing it out.
Got it.
Thank you.
Our next question is from Thomas Forte with D.A. Davidson. Please proceed.
Great. Thanks for taking my questions I had a couple follow ups on Macy's. So the first question I had is and I know Jack touched on this a little but why Macy's and feel like they have a similar core customer base.
Just in general and then how should we think about the economics of the macys versus Cosco and then.
Refining that last question. So if this pilot results in more shop in shops in Macy's.
Would you then limit adjacent showroom locations near the shop in shop.
Good question. So one is why Macy's I think.
We're really looking at it I think the one thing to do is think of that is.
A collaboration with Macy's in their top top stores. So if you look at the top 100 macys to the top 50, macys, we see a lot of.
A shared attributes with our customers Macy's is also a significant retailer in the furniture segment with hundreds of millions of dollars sold there. So we think it's a huge opportunity for furniture shoppers with a like characteristics to be able to experience our product.
And especially in those top Macy's, they're really doing a lot of.
Interesting things and I think that I think it will be a great partnership.
In terms of the way. It works is they are working much more like a show room in terms of the way, we we will staff them with our own employees, we manage them through our own system and we are essentially paying a.
Rent rate to be inside of them that we expect the contribution of these to be significantly higher than what we've seen in the Costco pop up shops because of the way those arrive.
And then adjacent fees for other showrooms.
Do not build a showroom.
Within.
Close proximity to.
Maintenance shop in shop, Yeah, a little bit of insight into that so the way we're running the Macy's test. The reason we ran those four as for.
Some interesting test parameters. So for example.
Harold Square is very close to our flat our district showroom. So we'll look at what happens between showrooms that are less than a mile apart.
We will also have a test which has a showroom and the same mall as the Macy's and we will have that opportunity to see what happens and then we have a show room and the.
In the car O place Macy's is as one of their furniture locations and we'll see what happens there. So really at this point that is the primary purpose of this test to understand the dynamics and then to start laying out a plan in terms of how we maximize our penetration at the most efficient way and also do it in a when went way with our Macy's partners.
Great sounds very thoughtful Jack thank you very much.
Thank you Tom.
Our next question is from Alex Fuhrman with Craig Hallum. Please proceed.
Great. Thanks, very much for taking my question and congratulations on another very strong quarter couple of things that I wanted to touch on here. One is is it certainly sounds like you guys have made a lot of progress in moving your production out of China and have a good line of sight to being completely out of there.
Yes, it sounds like your relative to the prior conference call. It sounds like that that has moved a lot faster and better than than expected.
I think it can you give us a sense of what's driving that I mean, it sounds like your vendors have been incredibly supportive have this has been more more buy in and capital commitment on the part of your vendors than than you expected is it just kind of curious why you've been able to accelerate that so nicely.
Yes, great question.
We have been moving very rapidly and we intend to continue moving rapidly.
I don't believe that we ever intended to go slow I, just don't think we give specific.
Guidance on how fast we thought we could do it.
I think everything is moving according to our plan and it's exactly that are our current suppliers has been.
Very supportive and in most cases as I described are investing in cells and other countries outside of China, Malaysia, Vietnam, and even some others.
That are coming up and.
Meanwhile.
For the goods that are.
Left behind still they're offering us heavy discounts in order to keep that business and kind of get through the tunnel as it were with their lights on so that they can support us on the other side outside of China. So I think it's just a confluence of things going well things going according to plan.
And our ability to execute which obviously in the public markets. We're only a year out and I think it's it's a matter of.
Those watching less out getting familiar with how we operate.
Great Thats really helpful. Thanks, Sean and then a couple of questions just on the Macy's partnership obviously this this sounds like a huge opportunity.
Big difference relative to Cosco I imagine is that is that Macy's is a is a large furniture retailer on their own and I'm curious if you have a sense.
Or if it's been a big part of of your negotiations with Macy's where in the stores Youre shop in shops are going to be located are they going to be in the furniture sections are you maybe going to do some that are near other furniture brands and some that aren't.
Just curious you know how we should think about the placement of those shop in shops, and then if its its going to be your own employees is it fair to assume that you will be able to capture all of the the customer data and own that customer relationship.
Great questions, Yes, our team I can tell you it varies by.
The Macy's organization from a from the way they operate obviously because of the the stores are such big volume and they have independent store management. The negotiations are store by store, we literally have to do walk throughs with their teams in every store what I can tell you is that.
They really believe in terms of the Macy's I'd say the Macy's evolution. They believe this.
Type of relationship is critical and they're putting essence in key places and we walk the stores with them and are very happy with the locations and they are primarily.
Very strong locations not necessarily obviously next to furniture because in a lot of the locations we are testing.
They are not even in furniture sections. So that's part of our learning agenda is to figure out what we're exposed to and I would expect coming out of this.
Along with the answer some of Tom's questions would be some answers to your questions in terms of what adjacent fees are working most effectively what parts of the model are working are their attributes of a Macy's store over another store that allow us to accelerate the path is that's all that we're trying to do now so that.
Hopefully the next time, we talk about this we have some answers and we start laying out and execution plan. So good questions and we'll keep you posted on it.
Great. Thanks, very much for that and then and then lastly.
Your marketing is of course been been very successful over the last couple of years and TV seems to have played a nice role in that.
It looks like up until the last couple of months and it basically been different versions of the same TV commercial that you came out with a different creative a few months ago can you can you talk a little bit about it have you seen a lift from that new TV creative or or was there maybe something.
Kind of a magic formula in in the last commercial just just kind of curious now that you've got your second commercial out there in the market what type of response youve seen from that.
Yes. Good question I would say that we were very careful obviously, because we had such a successful creative execution as we started with this new execution.
We tested these quantitatively and the new and a quantitative research mode in terms of persuasion and brand attributes et cetera, the new commercial actually tested to equal to or better than the old one across the board. We also can tell you that.
Initial initial results on the new television are showing that its driving traffic at at levels that we expect it to drive to drive at historically now other than that I think you start to get into a whole media mix discussion, which I cant get into because we still don't have the total results for.
For the Labor day media run, which is still being analyzed and actually still the post labor day work still going on so we'll probably have a lot more information for you in the next quarter about that.
But we're feeling very good about the creative overall.
That's terrific well, thanks very much all of you.
Thank you. Thank you.
Next we have a follow up question from Thomas Forte with D.A. Davidson. Please proceed.
Great. Thanks, So an investor asked me to ask a follow on question. They are real impressed with your comments on your gross margin outlook for next year returning to the mid Fiftys can you. Once again discuss what are the inputs that will drive the strong gross margin performance next year.
Yeah, I mean, the pressure on the business has been largely terraces Donna has has.
Spoken to.
We have a few other outside pieces be at freights or pressures in the supply chain legit logistics et cetera.
That are small in Dominican can touch on that but the vast majority has been tariffs so as as we mitigate those terrorists primarily through exiting China.
Not only are we then.
Terrorists free as it were.
At least special tariff free, but we also as as I mentioned are getting lower first costs in these outside countries and so we were operating in the mid Fiftys range on gross margins and we expect to get right back to that.
As that as that as that that product flow through our supply chain. So it'll be the second half of next year before on a run rate basis.
We begin to see that.
Return return to those levels and and.
Because it's a run rate basis may take even longer to flow through the PML as it were but.
We feel very good about our ability to get back there in our ability to maintain that on the go forward.
And I don't know John if you have anything else to add no I mean, not really the major component is the tariff.
The some investments into infrastructure, which we will still continue to see through next year.
And then I think we'll start to see less of an impact on the shift to the pop up shops in socks, and obviously I think we're seeing the greatest amount of that shift happening now.
So in that all starts to level itself out as Sean as mentioned, we'll start to see.
On a run rate rates start to see those margins elevate.
We don't expect the full year to come in at that but we'll start to see the.
The quarters in the second half start to elevate to the higher mid 50 range.
Great. Thank you Sean Thank you Donna.
Yes, and just to add a note and beyond that I think it's important to state that we just hired Tom Lee.
As our chief supply chain officer, and I think in the next 18 to 24 months may really be working on combining that supply chain and logistics aspects into a value chain that allows us to start leveraging other areas.
So I think we've only just begun to really get efficient as a company and we'll be catching up with that growth in the next 18 to 24 months outside of the whole tariffs issue.
Great. Thank you Jay.
Thank you.
We have reached the end of our question and answer session I would like to turn the call back over to management for closing remarks.
Thank you very much for your support and investors and we appreciate it.
All the questions and King and encourage you to continue to.
Keep an eye on us as we grow.
Thank you. This concludes today's conference you may disconnect your lines at this time and thank you for your participation.