Good afternoon, and welcome to Lulu's Fourth Quarter and Fiscal Year 2022 Earnings Conference Call. Today's call is being recorded, and we have allocated 1 hour for prepared remarks and Q&A. At this time, I'd like to turn the conference over to Naomi Beckman-Straus, General Counsel at Lulu's. Thank you. You may begin..

Good afternoon, everyone, and thank you for joining us to discuss Lulu's fourth quarter and fiscal year 2022 results. Before we begin, we would like to remind you that this conference call will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

All statements made on this call do not relate to matters of historical fact should be considered forward-looking statements, including, but not limited to, statements regarding leadership transition, management's expectations, plans, strategies, goals and objectives and their implementation, our future expectations regarding financial results, references to the year ended December 31, 2023, market opportunities, product launches and other initiatives and our growth.

These statements, which are subject to various risks uncertainties, assumptions and other important factors could cause our actual results, performance or achievements to differ materially from results, performance or achievements expressed or implied by these statements.

These risks, uncertainties and assumptions are detailed in this afternoon's press release as well as our filings with the SEC, including our annual report on Form 10-K for the fiscal year ended January 1, 2023 filed with the SEC on March 14, 2023, all of which can be found on our website at investors.lulus.com.

Any such forward-looking statements represent management's estimates as of the date of this call. While we may elect to update such forward-looking statements at some point in the future, we undertake no obligation to revise or update any forward-looking statements or information, except as required by law.

During our call today, we will also reference certain non-GAAP financial information, including adjusted EBITDA, adjusted EBITDA margin and net debt. We use non-GAAP measures in some of our financial discussions as we believe they more accurately represent the true operational performance and underlying results of our business.

The presentation of this non-GAAP financial information is not intended to be considered in isolation or as a substitute for or superior to the financial information prepared and presented in accordance with GAAP. Our non-GAAP measures may be different from non-GAAP measures used by other companies.

Reconciliations of GAAP to non-GAAP measures as well as the description, limitations and rationale for using each measure can be found in this afternoon's press release and in our SEC filings.

Joining me on the call today are Executive Chairman of the Board, David McCreight; our CEO, Crystal Landsem, President and CIO, Mark Vos; and our CFO, Tiffany Smith. Following our prepared remarks, we'll open the call for your questions. With that, I'll turn the call over to David..

Thank you, Naomi, and good afternoon, everyone. I want to begin by thanking the Lulu's crew, who continue to do a tremendous job executing on our strategy and pleasing our millions of brand fans. I am delighted to pass the baton to Crystal Landsem, who officially assumed the role of CEO on March 6, 2023.

Crystal has been a wonderful partner who has a deep understanding of our business and customer embodies our core values and has consistently demonstrated her leadership as we've scaled and grown the company these last few years together.

As we've communicated in November, I've transitioned to the Executive Chairman role after rewarding few years as Lulu's CEO. This transition has been part of a long-term plan since I joined the company, and I am thrilled to leave the business in the capable hands of this excellent management team.

Their commitment to the brand and the Lulu's customer is inspiring. Over the next few seasons, I'm confident Crystal and team will continue to make great strides in building on Lulu's strong brand equity and evolving our go-to-market strategy for the future. I can't wait to see what Lulu's does next.

I'll turn it over to Crystal so you can now hear directly from her as CEO.

Crystal?.

Thank you, David, and good afternoon, everyone. I'm honored and thrilled to have assumed the role as CEO. It's been an incredible 7 years so far at Lulu's, and I'm very much looking forward to leading this exceptional and dedicated team as we continue to execute our long-term growth plans.

I'd like to start with some full year highlights following our first full year as a public company, followed by our key priorities for 2023. 2022 net revenue of $440 million was up $64 million or 17% year-over-year from $376 million in 2021.

Adjusted EBITDA of $29.1 million, an 11.4% 3-year CAGR despite no incurring public company expenses and developing infrastructure to position Lulu's for long-term growth. Active customers grew 17% over last year with an all-time record of repeat customers engaging with our brand.

We implemented automation and robotics in our distribution center network, driving operational efficiencies, cost savings and increased employee morale by vastly reducing travel distances to pick, pack and ship orders, also resulting in an improved customer experience by reducing the time between order and shipment.

Roughly 83% of our units sold without markdown pricing, right in line with pre-pandemic years. And those units sold on markdown, sold on average at a higher, more profitable net merchandise margin than pre-pandemic periods. We completed the move of our creative studio to a location adjacent to our Southern California buying office.

And already, we're seeing the benefits of that move through strong new product conversion, which we expect to continue in the future. We continue testing and expanding more into brand awareness marketing while maintaining first order contribution margin profitability and year-over-year active customer growth.

Our marketing initiatives remain efficient and impactful. At its core, Lulu's continues to be a profitable, data-driven growth concept with a customer-led assortment, and we believe the runway is long. We believe we have significant opportunity to grow our brand fan community and occupy more space in her closet.

Our consumer insights and customer feedback tells us she is seeking opportunities to experience our brand beyond our digital platform, and we believe there is consumer demand outside the U.S.

In addition to capturing more wallet share in the digital space, we see an opportunity to broaden our distribution channels across both digital and physical platforms increase our international penetration and pursue incremental wholesale opportunities.

Consistent with everything we do at Lulu's, we will follow a data-driven, test-and-learn, capital-light strategy when pursuing these opportunities, which is further supported by our strong balance sheet.

We have benefited from robotics and automation investments and see opportunity to further increase operational efficiencies through continued investments across our distribution facilities. Above all, we believe our business model is resilient and adaptable.

Let me remind you of the unique characteristics, which enable us to execute through these uncertain times for the consumer and achieve our goals for long-term profitable growth. First and foremost, we are not a fast fashion retailer.

We are a lifestyle brand whose loyal customers appreciate the durability, uniqueness and quality of our assortment relative to the price. As a reminder, over 90% of the items we sell are Lulu's branded. Further, and unlike many in the apparel industry, shifting demand does not necessarily mean obsolete inventory and excessive markdowns.

Roughly half of our inventory can be carried from 1 season to the next and much of the remaining half is often brought back as a reorder product the following year.

Also, our data-driven product development reduces fashion risk so we're able to respond appropriately from an inventory perspective when preferences do change; second, we have a nimble and largely variable cost structure and the largest components of our operating expenses, specifically in marketing, staffing and product costs for the future.

So we're in a position to adjust a large part of our cost structure on an as-needed basis in order to preserve profitability; third, we believe we have 1 of the fastest inventory turns in the industry. Our data-driven merchandising process allows for optimization of inventory turns.

So even in the most challenging macroeconomic environments, we're able to stay nimble and take a brand-friendly surgical approach to our inventory management; fourth, we have a capital-light model, which typically generates positive cash flow from operations.

Thanks to our bespoke internal technology platforms and our highly skilled operations teams, we're able to react to demand patterns quickly, enabling us to expand or contract our distribution networks just in time with minimal impact to the business or the balance sheet versus needing to invest in large-scale operations ahead of unknown growth trajectories.

And finally, we have a solid balance sheet without any term loan debt, bolstered by strategic investments, resulting in further operational efficiencies as well as an agile business model with a nimble cost structure.

With significant liquidity available, we believe we are well positioned to navigate the evolving business conditions and continue to invest in future growth and capitalize on our brand potential. Moving on to the fourth quarter. We generated revenues of $91 million and produced a modest adjusted EBITDA deficit of about $1 million.

I'm proud of our team's ability to manage through such a dynamic and evolving environment. As a reminder, unlike many consumer brands, Q4 is our smallest quarter from a revenue perspective, while fixed expense levels remain fairly consistent throughout the year.

Our LTM active customer count continues to grow, increasing 17% from last year to $3.2 million. Average order value declined modestly by 2% in the fourth quarter. That being said, like others in the industry, we witnessed inconsistent consumer behavior during the quarter, characterized by volatile traffic trends and conversion.

We attribute this to macro pressures leading our customer to be more discerning with her spending. Similar to our peers, we responded to this by shifting marketing spend to product discounts. Our assortment resonated with our customer during Q4, and she thought items that could be worn for many occasions.

We are particularly pleased with the gains we experienced in some of our non-dress categories. These gains reinforce our conviction in the opportunity to occupy more space in her closet beyond the core occasion wear categories.

For 2023, based on the uncertain macro consumer environment, combined with the return to pre-pandemic wedding event cycles, we are targeting revenues of $410 million to $430 million.

Driven by the combination of maintaining flexibility on product pricing to meet customer demand in the near term that is likely to temporarily soften merchandise margins, as well as maintaining investments in order to catalyze future growth and expansion of our brand across both digital and physical distribution channels, we estimate our adjusted EBITDA will be between $23.1 million and $25.6 million.

As we announced last week, Tiffany Smith, our former VP of Finance, assumed the role of CFO on March 6, 2023, and she will provide more details about Q4 and 2023 guidance.

I am thrilled to have Tiffany take over this role given her intimate knowledge of Lulu's financials, her holistic and strategic approach to financial decision-making and her genuine love for our customer.

As expected, the leadership transition has been seamless given that Tiffany, Mark and I have all collaborated in developing the long-term strategy building for Lulu's.

We expect to maintain the same focus and vision for the company that we've previously communicated, including growing brand awareness and attracting new customers, retaining, enhancing and broadening our existing customer relationships through physical and digital channels, pursuing further product category expansion and developing international markets.

Before I turn it over to Mark to provide an update on operational and marketing efforts, I'd like to express my gratitude to our team and their relentless dedication to building our brands and creating value for our shareholders in this very dynamic ever-changing environment.

And now I'd like to turn the call over to Mark Vos, our President and Chief Information Officer.

Mark?.

Thank you, Crystal. In Q4, we continued to invest in our operations to expand the foundations for growth and drive further operational efficiencies. We have finished testing and setting up our fulfillment and returns processing capacity in our Southern California facility, so we can go live as soon as this incremental capacity is needed.

We are also on track with the introduction of robotics into our Northern California fulfillment center in the first half of this year.

After the successful implementation of robotics in our Eastern Pennsylvania facility, we have seen a variable fulfillment labor productivity gain of over 20% in that facility, and we aim to accomplish similar results in the Northern California fulfillment center. Now some color around our customers.

We are proud of our large and diverse community of loyal customers that are passionate about the Lulu's brand. At the end of Q4, we had 3.2 million active customers, compared to 2.76 million active customers. At the end of Q4 in 2021, a 17% increase year-over-year, reflecting double-digit gains among new and repeat customers.

In Q4 2022 compared to Q4 2021, we saw flat to positive year-over-year customer count growth in most of the middle to lower household income segments, who are drawn to our accessible luxury positioning.

Customers in our loyalty program maintained higher AOV and higher order frequency, and we continue to focus on expanding the number of customers joining and staying in the program by adding loyalty benefits over time. As a reminder, the loyalty program is focused on customer engagement, not discounting.

We also see continued growth in our mobile app revenue, primarily driven by continued increases in downloads and usage, combined with a higher conversion rate than mobile app. In 2023, we will continue to invest in our mobile app with features our customers are requesting and to further support our marketing efforts.

In previous calls, we have mentioned that just like other retailers and brands have seen return rates remain elevated compared to pre-pandemic years.

Some adjustments to our return policy will be made for heavy and excessive returners, and we remain committed to our customers by providing a safe, frictionless conversion path with our existing 10-day free return period. Switching gears to marketing.

Our cost of customer acquisition in Q4 2022 was slightly higher than Q3 2022 but comparable with previous quarters and years, and we also maintained first quarter contribution margin profitability. Q4, in general, is a very competitive and expensive quarter for marketing, and we remain focused on contribution margin positive marketing investments.

We were pleased to see meaningful improvements in impressions, earned media value generation, traffic and conversions in the affiliate, social and influencer marketing channels, which were also great supporting drivers of our national cadence.

I am proud of the marketing, logistics, customer service and the technology teams who in this dynamic environment continue to deliver first order contribution margin profitable marketing results, authentic customer experiences with Lulu's brand hog and expanded the foundations of our continued growth.

With that, I will hand the call over to Tiffany Smith, our Chief Financial Officer to discuss the quarter in more financial detail..

Thanks, Mark, and good afternoon, everyone. Let me start out by saying how excited I am to be taking on the CFO role. I look forward to engaging with you and working closely with Crystal, Mark and David to continue to execute our long-term growth strategies. Moving on to the fourth quarter. While we were not immune to the [indiscernible]. On the IPO.

For the quarter, we reported a loss per share of $0.14, which is an improvement of $4.55 compared to a loss per share of $4.69 in the fourth quarter of 2021. And finally, adjusted EBITDA for the fourth quarter was a loss of $972,000 compared to positive adjusted EBITDA of $6.4 million in the same period in 2021.

Our Q4 adjusted EBITDA margin was negative 1.1% compared to a positive 6.6% in the same period in 2021. Moving on to the balance sheet and cash flow statement. We believe our balance sheet remains strong and positions us well to execute our long-term growth plans and manage through near-term macro uncertainty.

Similar to the past several quarters, 1 key change compared to last year worth noting is we adopted the accounting lease standards under ASC 842 at the beginning of fiscal 2022, resulting in offsetting assets and liabilities reflected on the balance sheet this year that were not reported on the 2021 balance sheet.

We ended the quarter with cash of $10.2 million and a balance of $25 million drawn on our revolver, resulting in net debt of roughly $14.8 million. In light of recent disruptions in the banking industry, it is important to highlight that we maintain our corporate banking relationship with Bank of America.

Our inventory balance at quarter end was $43 million, up $21 million from the same period last year. The majority of this growth was planned and intentional to better support our fast-turning model.

As a reminder, in Q4 2021, we were turning over 9x on an LTM basis and had indicated our need to chase into more inventory, not only to better serve our customers, but to also insulate us from supply chain risk, specifically from China.

Year-ending inventory levels were down $6.2 million or 13% from Q3 2022 levels as consistent with our seasonal fluctuations. We anticipate our year-over-year inventory growth comparisons will normalize and be more in line with revenue growth beginning in Q2 2023.

On an annual basis, we feel a year-ending inventory balance of $43 million in a year with $440 million in net revenue is a solid way to end the year and prepare for the upcoming busy season in late Q1 and Q2. We remain a very quick inventory turning brand with what we believe are industry-leading turns.

As always, we aim to be disciplined in our inventory management approach and we'll continue to relentlessly pursue further optimization of inventory levels that balances the customer experience and minimizes markdown risk. As a reminder, our data-driven buying model results in roughly 70% of our buyers being proven sellers with lower markdown risk.

New styles during the quarter resonated particularly well, which gives us conviction in the strength of our reorder pipeline. We are a fresh fashion concept, not fast fashion, which means our inventory mostly consists of products that are relevant across seasons and in many cases, for multiple years.

So we're less exposed to inventory obsolescence and the ensuing markdown risk. Nothing speaks to this more that our average number of units sold on markdown, which in a normal non-pandemic year, were consistently between 16.5% to 17%. 2022 was no exception to that, with roughly 16.6% of units sold with markdown pricing.

Said differently, approximately 83% of units were sold without markdown pricing. Also worth noting, our gross merchandise margin for products sold on markdown have increased over time, with 2022 being roughly 10 percentage points higher than pre-pandemic years.

We continue to operate a highly capital-efficient business that positions us to generate positive cash flow. Moving on to guidance. We are expecting 2023 full year net revenues between $410 million and $430 million.

As you think about modeling revenue for our business, in a normalized year, our net revenue is typically highest in our second and third fiscal quarters due to demand seasonality for event dressing with Q4 typically representing the lowest net revenue and profit quarter of our fiscal year.

We are not a gifting destination and typically do not participate proportionately in holiday peak season sales volume like other retailers in our space.

As it relates to 2023 half 1 comparisons, Q1 and Q2 last year reflected 62% and 27% year-over-year net revenue growth, respectively, as those quarters benefited from pent-up demand as our customer refreshed her wardrobe to return to her social calendar as COVID-related constraints ease, including wedding-related events which are expected to decline in 2023.

Recent revenue trends in the first 9 weeks of the quarter are pacing to negative mid- to high teens when compared to our 62% comps in Q1 '22, with the declines primarily attributed to the general macroeconomic environment as well as the previously cited decline in wedding-related events.

For modeling purposes, our guidance contemplates that we expect to turn to positive comps in the second half of 2023. Adjusted EBITDA is expected to be between $23.1 million and $25.6 million. This equates to an adjusted EBITDA margin of between 5.6% and 6%.

Our adjusted EBITDA guidance captures incremental investments in support of longer-term initiatives. Our guidance targets are for the full year 2023.

To set expectations for modeling purposes, our quarterly adjusted EBITDA margin rates have similar seasonality fluctuations as our net revenues and will likely fluctuate above or below our full year guidance rate depending on the quarter.

As a result of paying down our long-term debt following the IPO, we continue to expect modest levels of interest expense for 2023 at approximately $1.1 million, in line with 2022, driven by a lower outstanding balance on our revolving line of credit, offset by higher interest rates. We currently have $25 million drawn on our $50 million revolver.

Our guidance contemplates that we will begin paying down the revolver in Q1 2023 and to be net debt free by the end of 2023. Stock-based compensation expense for the quarter was down $5.8 million from Q4 2021, primarily due to IPO-related stock-based compensation expense accelerations in the prior year.

Stock-based compensation expense is expected to be approximately $16 million to $19 million in 2023, which captures $1.2 million in accelerated expenses in Q1 associated with David McCreight voluntarily forfeiting his unvested stock options and the conversion of certain potential performance-based bonuses from cash to equity base for 2023 tied to net revenue and adjusted EBITDA financial criteria.

For 2023, we expect a weighted average fully diluted share count of approximately 40.6 million shares. Moving on to capital expenditures. We expect to invest between $5 million and $6 million. We're focused on setting the stage for future growth opportunities, enhancing the customer experience and driving further operating efficiencies.

For 2023, we will continue to invest in distribution center automation and robotics capabilities, which are expected to drive further labor efficiencies. And with that, I'll pass it back to Crystal for closing remarks..

Thank you, Tiffany. We'd like to take a moment to thank each of you, to Lulu's crew, our brand fans, shareholders and Board for their continued support as we continue to work towards executing on our strategy and delighting our customers. With that, we'll turn it over to questions now..

[Operator Instructions]. Our first question comes from the line of Brooke Roach with Goldman Sachs..

Crystal, I was wondering if you can talk to your confidence in driving the reacceleration of revenue growth in second half following what appears to be a tough 1H, what assumptions are contemplated in that improved outlook? And then for Tiffany, can you talk a little bit more about the puts and takes within your margin outlook for the year? What assumptions do you have for promotionality and shipping expense among others?.

Brooke, thanks for the question. For us and the way that our business runs, we're typically -- as we talked about, not so large in Q4, also not so large in Q1, but we've continued to get momentum going into Q2, 3 and 4. And we think that this year is going to be very similar to that.

Our guidance is contemplating the macro level, not really getting any better, but more a normalization of markdowns and discounts and a more normalized promotional cadence for us. I think it was outsized last year in the second half.

So from our perspective, it's more of business as usual with the normalization back to what we expect to be business as usual for us in the second half..

Sure. And Brooke, just a follow on to your second point of the question. This is Tiffany. Nice to meet you. Basically, in terms of puts and takes anticipated this year in terms of margin.

Overall, we're anticipating gross margins to be relatively flat for the year with, I would say, our merch margin, probably under the most pressure in the first half of the year, given we're going up against a fairly non-promotional period in half 1 of last year with some improvement on that in the second half in terms of merch margins.

As that flows through to gross margin, shipping costs is a key lever there with where we have experienced cost pressures. We're working very actively.

Our teams are in terms of managing the shipping costs this year, making modifications and tweaks where we can with regard to carrier diversification to help us to mitigate sort of those cost increases and pressures that we felt last year. And should those continue into this year, we feel like we've got good plans in place to mitigate those..

Could I just ask 1 more? I think a couple of times in the script, you mentioned plans for physical channels, and perhaps wholesale.

Can you talk a little bit more about that pivot into physical channels that you're planning for the year?.

I wouldn't necessarily call it a pivot, Brooke. What I would say is it's more of investing in what we had spoken about 1 year, 1.5 years ago when we originally went public. Is that we're going to be wherever our customer is and where she wants to engage with us.

And we've got continued feedback from her that she prefers or would also like to engage with us in an in-person experience. And -- while we're not ready to talk about the details of that, we will be over the next couple of quarters, providing updates around our investments and how strategically we'll be doing so.

But I guess the direct answer is we will be investing in more in-person experiences and the way that manifests will be talk for our next quarterly call..

Our next comes from the line of Janine Stitcher with BTIG..

Hoping you can elaborate a little bit more on what you're seeing in Q1 to date in terms of the sales trends, how much is being driven by active customer growth in orders versus what you're seeing on AOVs.

And then within that, I would like to hear more about the promotionality that you're seeing in the environment? What does it look like as the quarter progressed in Q4 and then what you're seeing within the broader environment in Q1 to date..

Yes. Thank you for the question. So as noted during my prepared remarks, we are comping against very high 62% comp in Q1 of last year, which is really setting up for a challenging quarter. We anticipated this in our guidance in the 9 to 10 weeks in so far, I had cited the 15%, roughly mid-teens negative comp is in line with what we expected.

So that's more or less contemplated in, I would say, as far as what's driving the negative comp overall, it's macro -- it's continued macroeconomic pressures that have not yet wholly subsided. With that said, we are very confident in terms of our overall strategies to move forward.

We have an extremely nimble cost structure that allows us to pull back a lot of variable cost structure where we can really pull back and make adjustments as needed..

Great.

And then just on the broad promotional environment and what you're seeing quarter-to-date?.

I can speak to the promotional environment. We basically see a continuation of Q4. And in that sense, it's not getting less, so to say, and that is also -- we play -- or need to play a role in that. Everybody is loud and doing all kinds of offers. And we also need to make sure that we are heard every now and then. We do that in various ways.

It's not just 1 single type of promo. We have a diverse set of promos that we execute against.

They have different goals, different outcomes, whether that is engagement or reengagement of certain customer groups, whether that is focused on increasing sell-through in particular categories or whether that is simply rewarding customers or driving downloads on our app, right? So there's a wide variety of that.

And so we use that as surgically as possible across -- not always, I would say, but specifically now to make sure that we're hitting all the things that we have set out to do. Janine, welcome to the coverage. Look forward to working with you..

Our next question comes from the line from Mark Altschwager with Baird..

I guess just first, I was hoping to clarify on some of the adjusted EBITDA commentary. I think you said you expect the year to follow typical seasonality, which would be lower profitability maybe in Q4.

But just given the more intense sales and gross margin pressure you're pointing to in Q1, is that still the case or maybe just any more granularity on how we should be thinking about that adjusted EBITDA margin for the first quarter?.

Yes. Thanks, Mark, for the question. So I think that's a good call out and worthy of highlighting for the group because we do typically highlight our lowest profitability and lowest sales quarter of the year is in a normal year Q4.

I would say Q1 is giving Q4 a little run for their money this year just in terms of the promotional environment that we're in and the negative sales comps that we're having a comp against the 62% comp from Q1 of last year and 27% in Q2. That's up Q1, I would say, this year to be a little more challenged.

And so we may see that distinction between Q4 being our lowest profit, lowest sales month. But sort of moderated a little bit with Q1, and you may look at those to be a little bit more similar this year than what they've been in prior years.

We still expect to see Q2 being our peak season in Q3 still maintain that as far as what you've seen historically there..

Mark, that's not dissimilar than what we have always had for Q1 was just ahead of Q4. So it's not as dramatic a shift as it may seem and that the big shoulders of the business flow through are Q2 and Q3..

Okay. And then I wanted to follow up on AOV. I was hoping you could give a bit more color on the trend you're seeing there. It's 1 of the bigger quarter-over-quarter changes that we've seen. I'm just curious how we should think about that for 2023.

Is this - dish level a good way to be thinking about the trend as consumer behavior address?.

Yes. Good question. AOV is just generally speaking, year-over-year context, I would say think of Q1 being relatively flat with some single-digit year-over-year growth in the sequential quarters. Figure gains coming really in the back half as we start to comp the impacts of higher markdowns and discounts..

Our next question comes from the line of Jonna Kim with Cowen..

Just curious about your non strategy this year as you're locking strong demand from addressed last year. And then as we think about return rates what are some key puts and takes that we should consider in our model as you're all having a lot of demand for dresses from last year, that would be helpful..

Yes. So we have seen great progress across a lot of our event and our non-event apparel. And what's most interesting for us right now is our new customer conversions have been increasing over pre-pandemic years in our non-dress categories.

So while we're still doing a really great job with our events and our dress business in general, just the performance of our other categories and product classes specific to non-event apparel is reiterating our thesis that we can take more share for wallet barring the macro environment, we still believe that we have confidence that going forward, we're making the right investments in the right area.

I think the great thing about our buying model is our customer is driving the assortment. So we're able to flex and pivot wherever she's wanting to drive us.

And right now, we're seeing success in many of our, I should say, non-bridal or non-wedding event-related product classes, specifically in dresses, rompers and jumpsuits, but also in our other nonevent classes..

And I'll jump in on the return rate question. And so I just want to point out, return rates are driven not only by product classes, but also the impact of promotions and markdowns can have meaningful impact on our return rates.

And so we've modeled a modest decrease in return rates for the year, which is really driven by, I'd say, the first half of the year, year-over-year, lower -- slightly lower return rates just due to increased expectations that we are being more promotional in half 1 relative to last year.

I also want to just point out, very high level, we're making some policy changes to be rolled out in the coming weeks.

With regard to return rates, really aimed at preserving our customer-centric, free pending return period, which is really important to us because we want her to maintain her ability to have product coming into her at-home dressing room and be able to try out different sizes and styles but we do want to roll out some changes to help kind of curb the excessive return behavior.

We haven't explicitly modeled in decreases in return rates as a result of those policy changes. But just trying to keep things conservative. We are expecting a slight decrease in our rates for the year...

Our next question comes from the line of Noah Zatzkin with KeyBanc Capital Markets..

Just a couple. I was hoping you could speak to your test and reorder model and kind of the benefits of that model as you navigate an uncertain macro. And then second, just hoping you could provide some color on inventory composition, your level of comfortability there and just your approach to bringing that in line by Q2..

I'll take the first part with regard to the benefits of our test-and-learn approach. It's particularly impactful in an environment that we're in right now. So in a difficult environment like this, we lean heavily into our ability to flex up and flex down. We've proven this over the years.

We've had to do it in terms of COVID -- the COVID year, and then the year ending after COVID when demand return, we're able to really lean into our nimble approach. But the other thing that I think is really critical is with regard to the -- our reorder pipeline in terms of how we build that out.

It really gives us a low-risk way to move into new products that she is voting for by buying those and we introduce those new styles. We're able to use our data-driven approach to essentially decide on what we want to enter into the reorder funnel.

So we think that, that -- having that ability to do that and the fact that our whole merchandise model is based on this, really sets us up nicely to have lower risk all around our inventory and then lower gross margin risk in the future just because we don't expect to see the same levels of markdowns as inventory becomes obsolete that you may see with other retail models..

As it relates to our inventory positioning, I say we're pleased with how we ended the year.

And as we signaled on previous calls, we have been trying to strategically slow our inventory turns to better meet customer demand, have better size and stock ratios and generally just navigate the challenges in China and the supply chain risk that we feel we're maybe disproportionately exposed to. And candidly, we're not that concerned about it.

We don't lose a lot of sleep at night over our inventory. Most of it was strategic. We are heavy in some areas, but those areas are reorder products that are tested and tried and true. So in that sense, we feel pretty good about our inventory levels.

Candidly, we might be 1 or 2 weeks of supply heavier than we would normally be in what we feel is an optimized environment, but that's not something that really concerns us in terms of obsolescence or markdown risk just based on the inventory model that just reviewed..

Our next question comes from the line of Randy Konik with Jefferies..

Yes, maybe with all the different pieces this year in 2023 as it relates to impacting your margin structure. Maybe just give us a reminder on how you think about what sustainable long-term kind of normalized gross margin and EBITDA margins would look like. That would be super helpful in this time of just some volatility here with the margin structure.

So if you could do that, would be great..

Yes, I think as for the question, Randy. So we haven't actually invested in 1 of -- a lot of our cost of goods and management over pricing, where we've not pushed our vendors to optimize our own margin flow-through, which has been such a dynamic environment over these last 3 years.

So what we can say is we started hiring internally for teams to do just that. So longer term, we feel there's a meaningful benefit to our margin profile as we start to invest in taking more control over our supply chain. So we're looking forward to updating you all over the next few quarters as that progresses..

And is there any kind of levels you want to point out to that you think that the gross margin should kind of be normalizing that or the EBITDA margins?.

I would say we should be able to perform better than our pre-COVID levels and continue to grow based on that as a baseline. I think Tiffany have spoke about our markdowns being at historical lows for the first half of last year, and I think there's a lot of noise between 2020 through 2022. So I would look at improvements for pre-pandemic years, yes..

Got you. May last question....

Randy. It is a model that we still believe is going to scale, and there's things that we've built into the structure that will help the flow-through as we continue to scale, top line and grow our customers and stay close to this approach. So we go to market..

Yes. Mark, I just want to ask you about marketing. You gave some perspective on the call. We all know about different changes that have gone on from the Apple privacy standpoint and so on and so forth.

When you think about the next few years of allocating marketing dollars, maybe give us some perspective on how you think about -- how you go about changing the allocation of those marketing dollars in the next 3 years or so versus how you deployed them in the last 3 years.

How do you kind of think about that in doing the same or different things to kind of get that cost of acquisition to be moving lower going forward?.

Great question. Yes. So we have taken the position you're right. If you look at the past 3 years and certainly historically, from a marketing perspective, we have leaned heavily let's say, from a direct response performance marketing perspective, and we've done really well with that and still do, obviously.

Not so much because of privacy or other technology reasons, but more from the perspective that we feel that for the long run, the longer term, switching dollars from that performance marketing towards brand awareness will help us grow faster as well as have benefits as it relates to the efficiency also of the performance marketing.

And so what -- the path that we have put ourselves on is to in a very measured, controlled way to start switching away dollars from the performance marketing side into the brand awareness side.

And we have seen thus far that we have been able to do so that without raising our overall marketing expense, if you will, to make those shifts deeper into the awareness side.

So we feel that we're on a good trajectory, and that is what also the trajectory that we would like to continue to pursue to achieve that 1 of the key growth levers that we feel in our business that our business has, and that is increasing our brand awareness because that is relatively low, and it presents us with a huge growth opportunity in the future..

Our next question comes from the line of Edward Yruma with Piper Sandler..

I guess, first, what is the assumed growth or lack of of new customers in the '23 guide? And I know you indicated that you saw some extra growth in kind of the lower and middle-income cohort.

I guess, do you believe that that's kind of pressuring results today? Are you seeing some of the same repeat behavior in some of your historical cohorts? And then as a follow-up, just so I'm clear, how much incentive comp build back is baked into the SG&A number for '23?.

I'll take the first part. What we've seen play out over the last couple of quarters and have also projected that forward is that -- basically the slower order frequency or a reduction in order frequency with our customers.

And it's more either discerning or wants to spend less frequently or is waiting for some deal because like I said, there's lots of promotions out there. So there's also other choices, of course, that can be made. Whatever the mixture there is, is certainly the fact what we see mostly impacting the order frequency.

And then on the other hand, due to promotions. We've also then seen obviously the lower AOVs come out as a result of that. And so when you think about it -- so it's not necessarily a reduction in active customers, but it's more the frequency of purchases that we've seen primarily the impact..

It's more a signal of the macro environment versus anything else..

And then I'll jump in and on the -- you had a question about stock compensation, feel free to chime in if I misheard it, but just to give you some year-over-year perspective on that we're going from '22 into '23 -- at the low end, I would say, I provided a range of $16 million to $19 million in terms of stock comp expectations for '23.

And I'm going with a range for this year. For probably, I would say, 1 main reason. One main reason is that we're -- we've put into place a lightly restructured performance bonus plan for our employees this year, that's shifting away from a cash-based bonus to a stock-based bonus.

This is entirely for our executives tied to key metrics, revenue and adjusted EBITDA. And for other bonus eligible we'll have similar performance -- financial performance based [indiscernible]. So there's going to be some flex there in terms of how high we go in terms of that range. So that's why I provided you with a range there.

But otherwise, in absence of that plan, I would say, our stock comp year-over-year would remain relatively flat from '22 to '23 with 1 exception that was highlighted around some acceleration related to Davis options that were forfeited, that's getting accelerated into Q1.

However, most of that would have been normally recognized throughout the course of the year. That's sort of just being more front loaded into the year, I would say. Let me know if that answers your question..

Our next question comes from the line of Lorraine Hutchinson with Bank of America..

This is Alex [indiscernible] for Lorraine. And congrats, Tiffany.

On the full year adjusted EBITDA guidance, can you just elaborate on which investments in key growth initiatives you're referring to there that will cause the pressure? And then do you have any flexibility on the expenses as you kind of observe how sales trends play out?.

Thank you so much. It's a great question and happy to answer this. So just in terms of the -- I'll kind of start from your second question, Bruce. There is a lot of variability in terms of our cost structure, where we are able to make quick adjustments as needed as sales come in better or worse than what we've anticipated.

We have levers there that we're able to pull. And in regards to the overall adjusted EBITDA and the investments that are resulting in some of the fixed cost deleveraging this year.

I can't provide you a lot of specifics, but I would just say for us, as a company, it remains really critical to be committed to growing for the long term, which includes employee-related costs, payroll costs, things like that, where it's very important to continue to have our key strategic initiatives, the original ones that were laid out with our IPO moving forward.

And so we're not making any sort of changes to our strategy. We're fully bought into who we are and where we're going. And so we're wanting to maintain those investments, keep initiatives moving forward so that we're not positioned in a spot where we come out of this downturn in the economy, and we're not poised for growth.

So we're really committed to remaining poised for what's in the future and the ultimate turnaround in the economy..

And we have reached the end of the question-and-answer question. And I'll now turn the call back over to Crystal for closing remarks..

Thanks, everybody. We appreciate your time and continued support and looking forward to our next call. Have a great rest of your night..

And this concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation..