Greetings, and welcome to the Lovesac First Quarter Qiscal 2021 Earnings 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. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Ms. Rachel Schacter with ICR. Thank you. You may begin.
Thank you. Good morning, everyone. With me on the call is Shawn Nelson, Chief Executive Officer, Jack Krause, 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 filing with the SEC, which includes today's press release. You should not rely on our forward-looking statements as prediction of future events. All forward-looking statements that we make on this call are based on assumptions and beliefs as of today, and we undertake no obligation to update them except as required by applicable law.
Our discussion today will include non-GAAP financial measures, including EBITDA and Adjusted EBITDA. These non-GAAP measures should be considered in addition to, and not as a substitute for, or in isolation from, our GAAP results. A reconciliation of the most directly comparable GAAP financial measure to such non-GAAP financial measure has been provided as supplemental financial information in our press release. Now I'd like to turn the call over to Shawn Nelson, Chief Executive Officer of The Lovesac Company.
Thanks, Rachel. Good morning, everybody, and thanks for joining us today. I will begin my remarks by providing an overview of the company's continued response to COVID-19, followed by a summary of our performance for the first quarter. Jack Krause, our President and COO, will discuss the operational highlights of our fiscal 2021 first quarter performance and progress being made on our key initiatives against the current backdrop. Donna Dellomo, our CFO, will then review our financial results and a few other items related to our outlook. I wanna offer some quick thoughts on the ongoing tumultuous events in our country. Of course, we have previously addressed the COVID-19 pandemic on both a human level and in terms of the impact on our business. We are so grateful for the first responders, healthcare workers, and essential workers who are on the front lines of this battle.
We love and appreciate you and are committed to doing all we can to continue to lend our support. Secondly, but no less importantly, the health and safety of our associates and customers continues to be our number one priority. To that end, all of our showrooms remain closed for approximately half of the quarter, beginning March seventeenth through the end of the first quarter. As customers spend more time at home, we responded with a rapid and successful pivot to a web-only model, resulting in very strong e-commerce performance in the face of showroom closures. More recently, of course, the nationwide civil unrest in the wake of the appalling Minneapolis event that tragically is not an isolated incident has caused further dislocation. Let me just say this.
From the boardroom to the break room, we are heartbroken that the country continues to endure the painful legacy of racism, and we are eager for action to solve it. As for the tangible impact on our business, firstly, we are grateful for our team members who are safe. We have not sustained store damage, but the unrest has somewhat complicated our store reopening planning, though it has not changed our fundamental approach, namely, as the economy begins to reopen and the unrest dissipates, we are going to approach our own reopenings in a measured manner, adhering to local regulations and strict health and safety standards. This means not being a leader when it comes to the pace of reopenings and instead deploying a phased reopening plan, which Jack will discuss in more detail in just a moment.
Not only is this the right thing to do for our associates and customers, but we are fortunate that the continued strength of our e-commerce performance affords us the opportunity to be far more deliberate in our approach to reopening, taking into account myriad factors. Turning to our Q1 results, we reported Q4 results a little over six weeks ago, and at that time provided detail on our Q1 quarter to date results through April twelfth. We are very pleased that the aggregate 400% e-commerce POS transaction dollar increase we saw post-showroom closure through that date, as we referenced on our last call, was more than just a trend. It reflects a fundamental business advantage of a company with multi-channel selling discipline and logistical expertise in its DNA. Through the end of Q1, we saw total company sales growth of 33% versus last year.
This post-showroom closure performance, particularly in the month of April, illustrates the strong customer appeal of our changeable, flexible, sustainable, upgradable, and shippable design for life Seats and Sides that are driving market share gains, with Sac sales also showing strong growth of 63% and Sactionals of 33%. It also reflects the agility and execution of the entire Lovesac team, who adapted swiftly to the rapidly changing operating conditions. I want to extend my deepest appreciation to every one of our team members for their effort. We are, of course, cognizant of the need to complement this top-line growth with the kind of operational excellence that yields sustained profitability and bottom-line improvement.
Our headwinds in this respect include, most notably, the impact of tariffs, which was the primary contributor to a 110 basis point decline in gross margin versus last year before the tariffs were elevated to the current levels. I do want to reiterate that we have taken and will continue to take aggressive steps to mitigate the tariff impact. We are currently manufacturing the vast majority of our Sactional inserts in Vietnam and Malaysia, regions that are outside the purview of the special tariffs. We are still manufacturing the majority of our sewn goods, Sac inserts to be imported and filled in Texas, along with Sac and Sactional covers in China. We are actively milling fabric for some of these items in Indonesia now, and we'll be doing some selling of these goods in Vietnam by the end of Q2 and receiving goods in Q3.
Of the production that still remains in China now, all first costs have been discounted significantly to mitigate much of the impact of tariffs. We continue to see gradual recovery at the gross margin line, even as we face some expected elevated costs in our distribution network, namely FedEx rate hikes and near-term deleveraging as we expand to multiple warehouses. Last quarter, we stated that we expect gross margin recovery from tariff pressure to take about eight quarters. We still expected gross margin recovery, but given the unforeseen disruptions, like the inability to travel abroad right now, which has slowed our resourcing efforts a bit in the nearest term, as well as some movements in timeline for our warehouse initiatives caused by the pandemic disruption, the recovery may take slightly longer than we originally anticipated.
From a profitability perspective, our Adjusted EBITDA loss of $5.7 million was only $1 million below Q1 last year, despite having our entire showroom fleet closed for half the quarter. This reflects our proactive and purposeful steps in the wake of the pandemic to reduce our cost structure, preserve liquidity, and run as lean as possible without compromising operational excellence. Importantly, our liquidity remains strong as we previewed on our call in April. As of the end of Q1, we had $45.5 million in cash, no debt, and $11.4 million in availability under the line of credit. During the quarter, we focused on reducing expenses, working capital, and capital expenditures, as Donna will discuss. We continue to prioritize cash preservation, which, combined with our strong liquidity, provides us with the financial flexibility to continue to successfully weather this period.
Thus far in fiscal Q2, we have reopened 89 of 91 showrooms as of today. In some format, many still virtual or appointment only. We are in continued conversations with landlords where showrooms are still closed, and our conversations have been productive. In terms of shop-in-shops and pop-up shops with Costco, Best Buy, and Macy's, none are open within markets where these retail partners have reopened their stores. However, regardless of the pace at which showroom and shop-in-shops reopen, we continue to believe that we are very well-positioned within the current environment and beyond, given the unique attributes of our company and business model, including, number one, our strong balance sheet and financial position. Number two, our evergreen shippable product offering that resonates during this time and lends itself particularly well to a DTC-only environment.
Number three, a very flexible marketing budget with no long-term advertising contracts in place that is enabling whatever pivots may be necessary as the environment changes. Number four, an agile and lean operating model. Number five, a diversified sales channel that allows us multiple high-return options to expand our brand reach. These attributes continue to serve us well, and so far in Q2, we are seeing an acceleration in the April business trends I discussed, driven in large part by the success of our Heroes campaign as well as overall demand. However, it is impossible to predict how long this demand surge may last. As I said earlier, we are focused on executing against our key strategic priorities and positioning Lovesac for continued market share gains, irrespective of the macro backdrop.
Before turning the call over to Jack, I want to again thank all of our employees for their hard work, seamless execution, and continued commitment to serving our customers in a challenging and evolving environment. We are grateful for all of their efforts that have contributed to our financial and operational performance during these unprecedented times. With that, I will turn the call over to Jack to discuss our plans to navigate the current environment and the recovery plan for FY 2021.
Thank you, Sean, and good morning, everybody. I'll begin my remarks by elaborating on our continued approach to managing the COVID-19 pandemic, and then I'll briefly discuss our plans for fiscal 2021. As Sean said, the strength of our multi-channel model was illustrated in the 255% e-commerce increase in Q1 that enabled us to preserve more than all of our prior period sales in a post-COVID closed showroom environment. We are pleased to have seen continued strength in our e-commerce channel performance so far in fiscal Q2, and with approximately 89 of our 91 showrooms open as of today, June 9, we're also very encouraged by the initial performance of showrooms in these early days of reopening. Our very effective Heroes campaign that kicked off in late March and ended a few days ago was a significant contributor in these strong results.
Moving to our response to COVID-19. Our efforts have remained centered around the three pillars that I outlined last quarter and executed by cross-functional teams across the organization, which allowed us to develop plans on a parallel path, ensuring an effective and rapid response. These pillars are, one, team health and safety. Two, business strength. And third, financial resilience. The health and safety of our associates and customers remain our number one priority. Our headquarters staff continues to work from home, and we are currently in the process of opening showrooms at a very measured pace and adhering to local and government regulation. We are implementing a three-phased approach to showroom openings. Phase one will be opening in a virtual environment in which associates operate from showrooms without customer traffic.
In this phase, they respond to phone calls, chat online, and fulfill swatch requests, as well as provide virtual demos to our customers. Phase two begins after two weeks of phase one, and if conditions permit in phase two, the showrooms will operate on an appointment basis, only allowing one customer at a time into the showroom. In phase three, we will open showrooms to foot traffic while abiding by all locally mandated social distancing and protection standards. These phases will be based upon city recommendations and local laws, and therefore we may have showrooms revert back a stage if local conditions require increased restriction. On the business strength front, we continue to leverage our DTC model and adapt to the current environment.
Full-time associates of closed showrooms continue to be active, with customers using digital platforms such as Podium to help guide customers through the buying process from remote locations at home, serving as remote-based customer service agents for their trade areas. These associates have been incredibly nimble and have continued to generate more than enough revenue to cover their payroll during this period. Going forward, we fully expect to leverage our associates utilizing a far more trade area approach to serving customers across all channels as we navigate a return to a new normal. Over the last nine weeks, the showroom teams have conducted more than 80 Facebook Live sessions with 278 peak viewers on average. These sessions, combined with post-engagement, is the equivalent of performing 1.2 million product demos.
In addition, our showroom teams have averaged 195+ unique web chats a day since installing the Podium widget on the website and averaged $1.1 million in sales per week from web chat alone. On the marketing front, we continue to increase our communication focus on the Lovesac value-added services, including free shipping, returns, risk-free trial periods, and increased availability of swatches. In recognition of the incredible contribution of our essential workers, we launched our Heroes campaign in the first quarter, which started on 4/3/2020 and ended on 5/31/2020, with the redemption period still continuing through middle of this June. This campaign has offered 40% off to all frontline workers and has seen very strong traction.
In terms of marketing mix, we continue to be pleased with increased efficiency of Lovesac on Pinterest, Instagram, and our search campaigns, as well as a jump in conversion rates associated with our email and digital marketing programs. Additionally, as we continue to see significant increases in traffic to our website, we are pleased that website conversion has also increased, leading us to believe that we are attracting a much more targeted and engaged visitor. Donna will discuss the financial resilience in a moment, but to reiterate Shawn's comments, the quarter's been off to a very strong start. We remain very comfortable with the liquidity position, with our debt-free balance sheet, and over $45 million in cash. This is a testament to the core appeal of our platform as consumers focus more on their homes, as well as the flexibility, adaptability, and the dedication of the entire Lovesac organization.
As we look ahead, the current environment continues to evolve on a daily basis, and it's hard to determine the duration of the strength and demand that we have seen, but we are staying flexible. We're also not losing sight of our strategic priorities. While the timeline for each may be altered as circumstances dictate, we remain focused on key priorities, which are, one, product innovation. We are excited about the new product launches in the pipeline that will be additive to the Sactionals platform. We're continuing to evaluate the appropriate launch timing, which had originally been slated for this fall, but will likely be pushed into the early calendar of 2021 given the macroeconomic environment. Two, utilizing effective and efficient marketing strategies. As we have discussed, our ability to rapidly pivot to a DTC-only model during this crisis has been very effective.
We remain both agile and disciplined with our marketing efforts and are focused on maximizing ROI, which we are pleased we are able to achieve across channels. In addition to our successful Heroes campaign, we saw strong results from paid search, social media, digital remarketing, and our affiliate program. Many of you have likely seen our TV ads, and I'm pleased to share that our TV ROIs since starting the ads in early May have been very strong. This improved performance has been driven by rates which have been lower than expected, as well as strong and engaged web traffic. Third, door openings and new showroom plans. I already discussed our approach to showroom reopenings. The range of potential new showrooms this year is likely to be between 15 and 18, as we have been working with landlords to adjust and continue to expand our footprint.
Four. Operating Costco pop-up shop locations and test shop-in-shops with Macy's and Best Buy. While we have little in the way of updates due to the COVID-19 pandemic, we remain optimistic about our prospects with all these important channel partners, while continuing to explore the shop-in-shop format with other retailers, given the positive results we have seen thus far. Lastly, we continue to make disciplined investments in our infrastructure, including technology and supply chain. On the supply chain side, we opened our third-party managed California warehouse in February and are continuing to ramp up operations and expect to be operating 150,000 sq ft of space by August. This, combined with the planned opening of our East Coast warehouse late this fiscal year or early next fiscal year, is expected to help drive reductions in freight costs as we head into fiscal 2022.
In addition, we are engaged in a multi-phase project to launch a supply chain management system, which will drive efficiencies in planning, production management and order fulfillment functions. This will begin in the second quarter and will be completed by the first half of fiscal 2022. We expect to see benefits in phase one, including visibility of tracking, demand planning and forecasting, which will positively impact our ability to execute with excellence in the fourth quarter of this fiscal year. We're very pleased with how the business has performed as we continue to adapt to the challenges of the current environment. Importantly, we could not be more proud of the entire Lovesac team and how they have continued to demonstrate great resilience throughout this period.
As encouraged as we are by the strong e-commerce trends we have seen in this environment, we do expect a moderation given that our Heroes campaign I discussed earlier has ended and as our showrooms continue to reopen. While there is some uncertainty on how sales will trend as states reopen and consumers adjust to the evolving economic realities, we are confident that the unique advantages of our business model will continue to serve us well, and in combination with the disciplined execution of our strategic priorities, position us well to build on our market share gains. With that, I'll turn the call over to Donna to review our Q1 financials and provide a quick summary of the financial resilience teamwork. Donna.
Thank you, Jack. Good morning, everyone. I will begin my remarks with a review of our first quarter results and then provide a framework for how we're approaching the remainder of fiscal 2021. The 32.8% increase in net sales to $54.4 million was driven by triple digit growth in our internet channel, along with an 11% increase in our other channel related to our shop in shop locations. This was partially offset by showroom revenue decrease due entirely to COVID-19 related temporary showroom closures. Please refer to our press release for details on our comparable sales performance. Looking at our results by channel for the first quarter, showroom sales decreased 32.7% to $18.1 million due to COVID-19 related temporary showroom closures.
Internet sales increased 255.4% to $30.1 million as a result of the successful pivot we made to focus on our e-commerce channel in a closed showroom environment. Our other channel, which includes our pop-up shops and Costco locations and shop-in-shops in four Macy's and three Best Buy locations, increased 11% to $6.2 million. This YoY increase was driven by Macy's and Best Buy shop-in-shops, partially offset by a slight decrease in our Costco business as a result of the COVID-19 driven temporary halt to pop-up shop activities at Costco.
By product category, our Sactionals sales increased 33.4%, our Sacs sales increased 63.3%, and our other category sales, which includes decorative pillows, blankets and other accessories, decreased 58.7% due to a decrease in sales related to certain Sactionals accessories and new platform product introductions like the Power Hub are now being captured in their respective Sactionals and Sacs platform net sales figures. The 110 basis point decrease in our gross margin was principally driven by the impact of tariffs, an increase in promotional activity specifically related to our Heroes campaign, and an increase in freight costs, which were partially offset by reduced product costs resulting from tariff mitigation related vendor negotiations, as well as a continued shift in product sourcing out of China to Vietnam and Malaysia.
As a reminder, the timing of our tariff mitigation efforts and increased shipping costs are driving this temporary gross margin pressure. As Sean said, we expect gross margin recovery over time. The 8.3% increase in SG&A dollars, excluding one-time items, was driven largely by increases in infrastructure improvements relating to our e-commerce platform and an increase in selling-related expenses related to the increase in net sales. These increases were partially offset by a decrease in equity compensation expense. SG&A, as a percentage of net sales, leveraged 1,075 basis points as a result of the cost reduction measures previously mentioned by Jack, as well as the decrease in equity-based compensation expense. The SG&A financial resilience measures we have taken so far had a slight impact on the first quarter. The full impact of those measures will begin in Q2.
Our investments in advertising and marketing, which benefit extended periods, increased $2.8 million or approximately 190 basis points to 15.1% of sales. The increase was driven by our focus on communicating important Lovesac value-added services, such as free shipping, returns, and risk-free trial periods, as well as marketing investments for content production, product innovation, and research spend in fiscal 2020, which was expensed in the first quarter of fiscal 2021. These first quarter 2021 expenses for production, innovation, and research costs of approximately $750,000 were included in prepaid assets and other current assets on our balance sheet as of February 2, 2020. Depreciation and amortization increased $570,000 from the prior year period to $1.6 million, principally related to capital investments for new and remodeled showrooms and infrastructure investments.
In the first quarter of fiscal 2021, operating loss was $8.4 million, as compared to an operating loss of $9.3 million in the first quarter of last year, driven by the sales increase and SG&A leverage I just discussed. Our net interest income for the first quarter was $56,000. Tax expense in the first quarter of fiscal 2021 and 2020 was not material, and it was related to minimum state income tax liability. Before we turn our attention to net income, net income per share and EBITDA, please refer to the terminology and reconciliation between each of our adjusted metrics and their most directly comparable GAAP measurements in our earnings release issued earlier today.
Net loss was $8.3 million, or a loss of $0.58 per share in the first quarter of fiscal 2021, compared to a net loss of $9.1 million, or a loss of $0.67 per share in the first quarter of fiscal 2020. Adjusted EBITDA was -$5.7 million, as compared to -$4.7 million in the first quarter of last year. The reason for the YoY decrease in Adjusted EBITDA as compared to the YoY decrease in operating loss is related to the net reduction in Adjusted EBITDA add backs, principally equity compensation.
Turning to our balance sheet, our liquidity remains strong as we ended the first quarter with $45.5 million in cash and cash equivalents and $11.4 million in availability under our revolving line of credit, with no outstanding debt on the revolver. This is better than expected by about $10 million, as POS transactions exceeded our projections for Q1. Ending inventory increased 8.1% YoY, driven by higher sales and an increase in capitalized freight and warehousing costs related to tariffs and increased inventory levels. Free cash flow, defined as cash from operations less CapEx, was a use of approximately $2.7 million in the thirteen weeks ended May 3, 2020, as compared to a use of approximately $10.1 million in the prior year quarter.
The YoY improvement was driven principally by an improvement in cash from working capital. In terms of outlook, given the continued uncertainty around COVID-19 related disruption, we are not providing an outlook for fiscal 2021. As Jack and Shawn mentioned, we are pleased with the continued strong e-commerce performance we've seen to date, as well as the performance of our showrooms in the initial days of reopening. However, we know that our Heroes campaign have redemption codes valid through June fourteenth, has been a big driver of the strength and performance, and it is hard to determine the duration of tailwinds like increased customer interest in home-related categories like ours. We will continue to stay flexible and tightly manage our expense structure to revenue trends as we navigate the uncertainties of the current environment.
Our quarterly operational cash burn for Q2 and Q3 of this fiscal year is expected to be lower than the corresponding prior year periods, and we expect to end our fiscal year with a healthy cash balance and no borrowings under our line of credit. We still expect to generate cash from working capital this year through accounts receivable, inventory reductions relative to sales volume, and vendor-approved extended payment terms. Our expectations reflect that CapEx will be in the $12 million-$14 million range with 15-18 planned new showroom openings for the year. With the business trends we are seeing, our continued cost and cash management discipline, our debt-free balance sheet and strong liquidity position, we feel confident in our financial strength, our ability to successfully navigate the current environment and position Lovesac for a continued market share gain.
With that, we would now like to turn the call back to the operator who can open it up for questions. Operator?
Thank you. At this time, we'll be conducting a question-and-answer session. If you'd like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key. Our first question comes from the line of Thomas Forte with D.A. Davidson. Please proceed with your question.
Great. Thanks for taking my question. Two questions, then I'll get back in the queue.
The first one is I wanted to know if you can give some additional thoughts on the new tools in your tool shed you've learned during the pandemic, such as essentially your telesales effort, and how you may employ them in the future, when your showrooms are fully reopened.
Hey, Tom, thanks for the question. I'll take that. This is Jack. I think it's definitely changed our perspective on the way we look at our showrooms. In fact, the nomenclature really inside of the company is in terms of moving from showroom employees to trade area employees. I think it has a dramatic impact on the way we think about a lot of things. I think it has an incredible ability to make us more efficient as a company as we think about utilizing our largest pool of employees to flex up and down between service and sales and other activities. It's really been an eye-opener for us. The other thing I think that's been really an eye-opener for us is how quickly we can transform from a sort of a traffic-dependent company to a destination company.
When you do that opens all kinds of opportunities. A lot of things we're analyzing. Obviously, there's so many dynamics changing, but we see a lot of opportunities to pursue in terms of changing the way we market and really leveraging our associates.
Great. That's wonderful news. My second question, then I'll get back in line, is can you talk about the financial state of your core consumer, given we have 13.3% unemployment and your bad debt expense in particular or bad debt exposure in particular?
Yeah, I think we don't have a lot of insights right now. Things have been changing so much. We obviously feel that within the context of our business, we know we have an affluent customer who does not appear to be in the immediate danger of being impacted by what's happened in the last couple of months. However, it's very unpredictable in the long run. We feel we have the right target customer. We're a premium brand, and so as much as that can help to insulate us, I think we feel good. There are so many unknowns out there in terms of what's gonna happen in the next six months.
Good. I have some more, but I'll get back in the line.
Donna.
Sorry, Donna.
Yeah, Tom. As far as bad debt, we have minimal, if any, exposure. The majority of our sales are done through credit cards, even our Synchrony Financial credit card, which is about 40% of our volume. The financial burden is on Synchrony. We do not bear that burden. Our wholesale receivables are principally Costco, so we don't feel that there's any risk there at all either.
Great.
Thank you. Our next question comes from the line of Brian Nagel with Oppenheimer. Please proceed with your question.
Hi, good morning. Very nice quarter.
Good morning.
Congratulations on managing a tough environment really well. The first question I wanna ask is, if we look at this continued surge in online sales, and I know it's hard to break it out. You mentioned in the prepared comments the positive impact of the Heroes campaign. Maybe you could. One question would be to size that, if you can, better. But also, as we look at, is there any way to know how the portion of customers that are coming new to the Lovesac brand?
As you think about that, is that more the split between just kind of the overall shifting dynamic within retail that more people are spending time at home versus some of the changes you've made to your own marketing going more digital?
Yeah, I think there's a lot of. I'll try to answer that question, and Shawn and Donna, you guys can chime in perhaps here. I think there's a lot of. Number one, our new customer count was pretty dramatic in the first quarter. We saw the highest level of a new customer in terms of increase QoQ that we've seen since we've been recording it. We saw a 60% increase in new customers. Clearly, I think that indicates that during the disruption of the brick-and-mortar environment, we became a real go-to. I think obviously that disruption will be reduced in the next couple of months, but I think there are some lasting effects that will stay on us forever. That happened now.
We really have two groups of customers we're talking about. We're talking about new customers coming into us through disruption, and then we have groups of customers that we know put off purchases due to showrooms being closed. As they open, we're seeing those trade areas open as well. I think what this tells us is the way we're thinking about this is that showrooms are always going to be important. Well, let me put it this way. Touch-feel points will be important for people who buy $4,000-$6,000 products. Knowing now that we can drive our business as a destination business redefines what a touch-feel point is, whether it's a shop in shop, whether it's a strip location, whether it's even a person who does a demo at somebody's house.
We're really opening our minds up in terms of what does it look like in terms of creating the touch-feel points that we need to have in an effective way and mix them with a marketing plan now that we know we can drive our business as a destination business. There's a lot up there, and there's a lot of tailwinds we've had too. Quite frankly, in the last couple of months, we've had lowered ad rates and increased interest, obviously, in nesting and increased returns on our e-com business. We don't know what's gonna happen in the next couple of months in terms of the short-term dynamics, but we do believe the trends we're seeing allow us to really be smarter as we go forward and think about our real estate strategy.
We will continue to have shop in shops and showrooms, but I think we'll be very aggressive in the way we think about negotiating in the future.
The follow-up question I had, Jack, or for anyone really, it's and again, I know it's early, but as you're starting to reopen your showrooms and considering some of the adjustments you have to make now for sort of, say, a post-COVID world, could there be any type of significant shift in the expense infrastructure of the showrooms?
I don't think there's anything that I could say at this point. I think the answer is no. I think what we'll do is, in the way we're thinking about our business and our service model and our showroom model, we will get an increased ability to leverage our expenses and to grow without raising the rates of labor as we go forward. I think we'll become more efficient as we grow, but other than that, nothing dramatic.
Got it. Appreciate all the color. Thank you.
Thank you.
Thank you. Our next question comes from the line of Maria Ripps with Canaccord Genuity. Please proceed with your question.
Great, thanks for taking my question. I just wanted to ask about your advertising and marketing spend. Can you just maybe update us on your thoughts around brand spending in general? Do you still see that as a big opportunity for the company? How should we think about the level and progression of ad spend as we move through the year? I have a follow-up.
Thanks. In general, a couple things, and I think Donna mentioned it in her script. There was a pretty big increase in spend over prior year in the first quarter, and a lot of that had to do with prepaids moving out of the last year into this year. As we're currently looking at spend, we're still looking at a normalization around marketing spends to be anywhere between 10%-13% of the total business. We're not seeing a need for a dramatic change. In fact, ROIs are actually going up right now, so we're in a real good place where we're able to manage our spends very efficiently and getting higher ROIs actually in the first quarter than we have seen to date.
I think that bodes well as we go forward and see our business accelerating, but not having to depend on outsized marketing growth.
Got it. Secondly, did you have any online Costco events in Q1, and are there any sort of expectations for the rest of the year?
I think we had one event. Donna. One event. We will have online events with Costco. We are working with Costco in terms of our roadshow. Obviously, with the pandemic, all kinds of organizations have changed their priorities, so Costco has changed some of their priorities, and obviously their mixes and merchandise mixes have changed. We've been put on hold with them. In terms of the performance prior to the pandemic and our expectation go forward is that we will likely be reengaging and getting that business going in the second half of the year. I can't give you any insights specifically.
Great. Thank you.
Thank you. Our next question comes from the line of Matthew Koranda with ROTH Capital Partners. Please proceed with your question.
Hey, guys. Good morning. Thanks for taking the question. Just wanted to see if I could follow up on some earlier questions. How important was the Heroes campaign in terms of sales mix-
Yeah.
to your Q1? As that rolls off, do we replace that campaign with something else heading into Q2? Would the benefit from an additional campaign sort of accrue to the showroom or online side of the business?
The Heroes campaign. The Heroes campaign was very important. As we look at May, it ramped up to becoming over 50% of sales for the high volume weeks prior to Memorial Day. We do expect, obviously, to lose a percentage of that momentum as we come out of Memorial Day. We've reflected that in our internal plans and our spending. We don't foresee ourselves needing to depend on events like the Heroes event throughout the year. It may be something we do based on market conditions. The one thing I would say is we don't see discounts increasing in the second half of the year at any rate that would be any different than what you've seen thus far.
Okay. On the showroom or online front, in terms of accrual to the benefit of which side of the business, you know, where did you see, I guess, the biggest benefit? Obviously, I guess it would've come from e-com this last quarter.
I think a couple things. I think, yeah, online is definitely where the impact came in, I think, because there was obviously marketing focused on those target groups, and the access online was dramatically higher than obviously showrooms. I think proportionate to everything that happened in the quarter, that was dramatically driven by online.
Got it. Then just on the showroom front, I know it's sort of a choppy environment, but any help in terms of trying to triangulate how to model, you know, Q2 on showroom? I mean, maybe you could help us understand, you know, traffic trends, conversion at the showrooms that have been opened. Are we comping up year on year for the showrooms that have been opened thus far? Any help on that front, that'd be helpful.
Yeah, super. This is like, I mean, this is.
We laugh internally, this is almost like business at the speed of gaming. You know, we had a week and a half ago, we had 40-something showrooms open and up to, you know, what we had in June 9, 89. Within those openings, there are a series of. Remember, they're all in three phases, so there's some that aren't even taking in traffic. We can't really measure traffic right now on half the showrooms. We can tell you this, the ones that are taking appointments, we are seeing some really interesting things going on along with our learning. The showrooms that have gone into appointments have jumped up to having positive comps immediately, and all showrooms that have opened have taken the trade area trends significantly up.
It certainly goes back to say, look, showrooms are really important. They drive the trade area, they drive interest in the brand, and we'll just have to see what happens in the next couple of months.
All right, thanks. I'll jump back in queue, guys.
Thank you. Our next question comes from the line of Camilo Lyon with BTIG. Please proceed with your question.
Thanks, everyone. Good morning. Sean, I wanted to go back to some of the gross margin comments that you laid out in your prepared remarks. I think you talked about, well, you talked about a lot of puts and takes to the gross margin component and, culminating in what looks to be a little bit of a delay in the resumption of mid-50s gross margin target by the end of next year. Could you just provide a little bit more detail around the influences to that and maybe where in this two-year process do you see that delay occurring? Is it in this year, the back half of the year? Is it into next year? I'm just trying to get a little bit more precision around the comments that were made.
Yeah, good question. We, like, as mentioned in the scripts, you know, I guess we aren't traveling abroad. That combined with other delays, you know, that were kind of obvious in terms of what's been going on in the world. As we were opening, for instance, our second warehouse on the distribution front domestically, we ran into the COVID-19 pullbacks and delays there. All of these things combined have just sort of kicked the can down the road a little bit for us.
Rather than commit to, especially right now while it continues to be so messy in general, rather than commit to a number of quarters in terms of what that recovery looks like, we've chosen to just, you know, put out there that we still expect the same kind of recovery. It'll just continue to be prolonged because of these sort of disruptions that are beyond our control and frankly, beyond our ability to predict totally what's around the next corner. Our freight costs continue to improve on a continued basis. You know, this is due to our sourcing efforts that haven't been thwarted, just sort of slowed down in certain aspects and in certain pockets.
As I mentioned, most of our Sactionals now, which represent most of our sales, are made outside of China. We continue to make moves on the sewn goods in real time. All these things are still happening. Certain pockets just continue to get pushed back. Sorry to be vague, but it's impossible for us to, at this point, with everything as disrupted as it has been and unpredictable, give much better guidance than we had put out there before.
If I could just ask a follow-up on that. Are you just saying that just the progression of sequential improvement is less than what you had anticipated before? Or that there will be some moments in, you know, the go-forward period where gross margins could actually kind of revert back and take some side steps before starting to get to that sequential improvement line?
Hi, Camilo. It's Donna. Yeah, just I'll take the part on, I guess if you wanna use the term step back a little bit on gross margin improvement. Relative to building inventory, the investments that we're making into additional space, I think Jack had mentioned by the time August rolls around, we'll have 150,000 sq ft of additional space we need to take. We will see that impact on gross margin in the second quarter. QoQ, we're projecting a decrease, maybe double what we saw or right around double what we saw in the first quarter. In contemplating and building and looking at your models, you probably wanna take that into consideration. On a step back, we'll call it out there.
We're in our internal models, again, we're not giving guidance, but second quarter will be the quarter where we see the biggest YoY decrease in gross margin impact.
That's perfect. Thank you for that, color. Just the follow-up I had, the second question I had was, you talked about your cadence of store-showroom openings of 15-18. Donna, is there anything you can provide from a cadence throughout the quarters as to how we should model the openings? And are you getting any rent concessions? It looks like you're having very good negotiations with those landlords on these new openings.
Yeah, I mean, obviously they didn't happen in the—they're not happening where we thought that they would originally happen in our model, that they would be happening, you know, first, second, third quarter. So they are later in the year as far as how we built our CapEx spend on that 15-18 showrooms. So taking that into consideration and looking at your models, you'd see the CapEx spend. Now it's spend, which happens after opening—well, it happens before, during, and after opening, right? So when building your models, but that was all contemplated in the limited information I provided on liquidity and our cash usage in Q2 and Q3 being slightly less than last year's cash usage from operations. Jack, do you wanna mention something about rent concessions?
Yeah. We've been fortunate. I think we decided to take a look. We believe in the value of our showrooms and the value of our relationships, obviously, with the landlord. We have basically, at this point, I would say, without getting into details, had concessions in about 60%-75% of our showrooms with landlords and locking 65%-70% of the fleet, and it's really worked out. In addition to that, in terms of new openings, yes, we have worked through concessions that help us open in a less predictable environment that are win-win.
They're different in different cases, so I just keep it a little bit general that we've been very aggressive and been proactive in keeping our relationship positive with these landlords, and I think that's what's helped us to still be able to say we'll be opening a fairly heavy amount of showrooms in the second half of the year.
Fantastic. Good luck, guys. Thank you very much.
Thank you. Our next question comes from the line of Alex Fuhrman with Craig-Hallum Capital Group. Please proceed with your question.
Hi, guys. Thanks for taking my question, and congratulations on such a strong quarter during these difficult times. You know, one thing I wanted to follow up on is, I think, Jack, you mentioned during the Q&A that your showrooms that have now reopened for appointments, and I know it's so early and it's only such a small number of showrooms, but considering, you know, showrooms were the majority of your revenues last year, I feel like it is, you know, important to kind of drill into whatever, you know, it is that you are seeing now.
Are you seeing that as your showrooms reopen, at least on an appointment basis, is the lift you're seeing, has it been pretty uniform across the country, or are there certain, you know, regions or certain impacts, you know, perhaps places that have been impacted more or less by the virus that have come back quicker? Just curious what you're seeing and what we could perhaps expect to see as more of your showrooms start to move through the three phases of reopening that you've laid out.
What I'll say, and it's sample sizes and the time frames are so strange and dynamic, you know, it's literally the amount of showrooms that were open to appointments doubled in three days. So we gotta be really careful about how we talk about it. But what we are seeing is the showrooms that have been open to appointments the longest and have started to engage are basically filling out their appointment books to the maximum level and are seeing conversion rates that are three-four times what we've seen in the past. Obviously, when you do appointments, that's what happens.
I think it's starting to enlighten us back to the idea of, the showroom is a place to engage and convert and feel the product, not necessarily a source of awareness in the future. I think what we are seeing and getting amazing feedback from our associates is the one-on-one engagement is creating possibly a better brand experience. There are a lot of silver linings we're trying to work out through this process. We don't know what the, you know, what the new normal will be with traffic relative to conversion, but our.
I think the high side of that is this: We don't believe the new normal, the way we operate, we will be disadvantaged at all because we do believe people will go to showrooms and continue to go to showrooms, but the showroom may be one out of three visits, and two out of three may be online, and that's just fine for us.
Great. That's really helpful. Just a, you know, quick follow-up if I could. I'm curious where all of the leads for these appointments have been coming from. Is it mostly people that have been interacting with your customer service online? I noticed that, you know, you're not exactly hanging big grand opening banners of, you know, "We're back open, come to the store," which certainly seems smart. Just curious, you know, where you've been getting this pipeline of appointments coming from and if you think that can last through the year.
Yeah. I think it's two areas. I think one is obviously there will be a boost in the short run of pent-up demand by people who had been engaged with the showroom employees and basically put off their decision. We know at some point, roughly six weeks ago, 30%-40% of our people who had been in showrooms were holding off a purchase because they wanted to come back. We know we're gonna get that lift. However, we are seeing significant increases in our ability to use, you know, the Podium and the digital chatting to talk to our customers. Literally what...
I think I described it last time, but literally it enables a customer or someone going online in their area to talk to the showroom leader, and that showroom leader can set up an appointment with them through a chat, and then basically start the relationship there and bring them into the showroom. So I think the power of the chat has really surprised us in the way it synergizes with e-commerce as well as just even making appointments has continued to please us. So, a lot of positives out of it, but we just don't know how it's gonna work as things start to settle down with the post-COVID-19, you know, economy.
Sure. That makes sense. Thank you very much.
Thank you. Our next question is a follow-up from the line of Thomas Forte with D.A. Davidson. Please proceed with your question.
Great. Two quick follow-up questions, and then everyone, please stay well. For my two follow-ups, I wanna know if your new product roadmap is still two big innovations a year, if that's the pace. Then second, on by-appointment retail, you already have a pretty light labor model, but will that change your labor model at your showrooms?
Yeah. On the innovation front, the cadence that we have been trying to you know set internally was a couple of small innovations per year, and hopefully a bigger innovation you know every year or so that will you know take us into either a new expand our total available market as we see it or expand into a demographic or customer base that's new to us. We are still working on how the balance of this year shakes out. You know, we have teased for a long time that we expected to launch what we think of as one of our more important innovations this year later this year.
For us, that's kinda still on the bubble based on what's happening in the world. You know, the good news is, as I said before, we're not too concerned about ultimately whether you know, the timing of that specifically because we had, in our own plans, no revenue associated with the new product launch for this year. It was more about being a soft launch and getting it out there and really becoming part of the sales mix for the balance of this year. I'll let Jack answer your second question.
Yeah. It's the labor model question is an interesting one. I can't give you a lot of detail other than to say, you know, with that change from a showroom perspective of an employee to a trade area, it makes us think a lot more, I think, creatively in terms of applying our associates and having full-time associates that can flex to do chats when traffic in showrooms is low or do other things to counterbalance what they've experienced within the foot traffic-driven environment allows us to think about things incredibly differently. We're still trying to understand how to maximize our employees as we go forward.
Great. Thank you.
Thank you. Ladies and gentlemen, that concludes our question and answer session. I'll turn the floor back to Mr. Nelson for any final comments.
Yes. Thank you to all of our shareholders, and especially to our incredibly capable and diverse Lovesac family of associates across the nation, who continue to show grit and passion every day as we navigate through this time period. This is the driving force that continues to enable our organization to thrive even in these turbulent times. At Lovesac, our essence of our five guiding principles is love matters. Love is in our name. It's painted over our doorways, and we wear it on our T-shirts. Love does not discriminate. We invite everyone to join our extended hashtag Lovesac family on social media and on our website. We thank you for your support and look forward to chatting with you next quarter.
Thank you. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.