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Brilliant Earth Group, Inc. (NASDAQ:BRLT)
Q3 2021 Earnings Call
Nov 12, 2021, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

Ladies and gentlemen, thank you for standing by, and welcome to Brilliant Earth's third quarter fiscal 2021 earnings call. [Operator instructions] After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to Allison Malkin of ICR.

Thank you. Please go ahead.

Allison Malkin -- Investor Relations

Thank you. Good morning, everyone. Thank you for joining us for our third quarter fiscal year 2021 conference call. Joining me today are Beth Gerstein, our chief executive officer; and Jeff Kuo, our chief financial officer.

For this morning's call, Beth will begin with an overview of the company, our differentiation and mission, highlights of our third quarter financial and operational performance, and the drivers of our future growth. Jeff will follow with more details on our third quarter financial results and introduce our guidance. Following this, the operator will begin the Q&A session, with our presenters, Beth and Jeff, available to answer the questions you have for us today. Before we start, I would like to remind you that management will make certain remarks today that are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to our SEC filings for a description of the risks that could cause our actual performance and results to differ materially from those expressed or implied in these forward-looking statements. These forward-looking statements reflect our opinions only as of the date of this call, and we undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements in light of new information or future events. Also, during this call, we will discuss both GAAP and non-GAAP financial measures.

You will find additional information regarding these non-GAAP financial measures and a reconciliation of these non-GAAP to GAAP measures in today's earnings release, which is available at the investor relations section of our website at investors.brilliantearth.com. A live broadcast of this call is also available at the investor relations section of our website. With that, I'll turn the call over to Beth.

Beth Gerstein -- Chief Executive Officer

Thank you, Allison. Good morning, everyone, and thank you for joining us this morning. I am delighted to speak with you today and share our record third quarter performance, highlighted by strength across our financial metrics and continued progress on our long-term growth initiatives. The quarter also marked an exciting milestone in our history as we completed our IPO.

I want to thank our team for their hard work and dedication. I am proud of all that we have accomplished together, and I am excited about the many opportunities that lie ahead of us in the near and long term. Before I discuss our results, for those new to Brilliant Earth, let me first share our vision and approach to modernizing and transforming the jewelry industry. Brilliant Earth is a next-generation fine jeweler for millennial and Gen Z consumers.

We offer a personalized, joyful, omnichannel shopping experience, with a leading e-commerce platform and 14 showrooms across the United States. And always underlying this are the mission-driven values we were founded on. Our commitment to sustainability; transparency; giving back; and diversity, equity, and inclusion. We are transforming the industry with our approach and are proud to have become a global leader in ethically sourced fine jewelry.

Our unique business is highly profitable and well-positioned to deliver sustained growth over the long term. Let me share why Brilliant Earth is both compelling and incredibly hard to replicate. First, the Brilliant Earth brand. We have spent over a decade building a globally recognized premium jewelry brand, with an authentic ESG focus and mission-driven values.

We're proud that these are the principles that we founded the company on 16 years ago. We're always reminding ourselves that this is a journey that we need to continually work toward and that our values are and always will be our north star. Technology. We are a digital-first innovator, with a strong mindset for data analysis and technology.

From the beginning, we have used data to inform our decisions, from product design and merchandising to real estate strategy, to our pricing engine that enables us to maintain and grow margins. As a digital-first leader for over 16 years, we've been testing, iterating, and customizing a true omnichannel customer experience, from our e-commerce platform and digital channels to our showrooms. This experience is well aligned with how today's younger consumer prefers to shop. Our high Net Promoter Scores show that our customers love their Brilliant Earth experience, and we're continually striving to make it even better.

Omnichannel. Our innovative appointment-driven model allows us to curate and personalize our customer's experience in a way that truly modernizes jewelry shopping. Our showrooms have also driven transformative customer acquisition economics in the metros where we have opened them, resulting in an average 50% improvement in conversion across the entire metropolitan area within the first year after opening, increasing to an average 90% conversion uplift by Year 3. Design.

In jewelry, product design is incredibly important. Ninety-nine percent of our customers tell us that design is a top priority for them. We are leaders here, with new proprietary products being constantly and rapidly introduced by our award-winning design teams, informed by deep data-driven insights about our consumers and their purchasing preferences. Supply chain.

We've developed a network of strategic long-term relationships and proprietary APIs to deliver on-demand, carefully sourced, and highly customized products. Navigating the incredibly complex and opaque global jewelry industry is very challenging. It has taken us many years of investing in people, technology, processes, and relationships to be able to deliver trusted, ethically sourced products at our quality standards and in our time frames. Our business model.

Our business is asset-light and capital efficient. Our customers can choose from over 150,000 natural and lab diamonds on our website and can personalize their jewelry using our Create Your Own digital tools. And in contrast to traditional jewelers, we do not need to carry most of these products on our balance sheet, allowing us to remain capital efficient. And finally, we are disruptors in a large and growing industry.

The jewelry industry is $300 billion globally, with more than $60 billion in the U.S., and growing at 7% per year. The industry is highly fragmented, with 65% of it made up of independents that lack the technology and resources to compete at our level and mall operators that are faced with antiquated, inventory-heavy store formats in outdated malls with declining foot traffic. We believe that all of these competitive advantages will allow us to continue delivering strong revenue growth, with robust profit margins, while furthering our mission. Now, turning to third quarter results.

We delivered an outstanding third quarter, highlighted by significant growth across our key financial metrics. Net sales increased 33% above last year's third quarter, driven by our showrooms and website and across our products, including Create Your Own diamond rings; wedding, gemstone, and anniversary rings; and fine jewelry. Our strong performance highlights Brilliant Earth's brand resonance with millennial and Gen Z consumers as we continue to gain share in the jewelry industry. Our margins were up significantly versus last year's third quarter.

Gross margin increased to 50.4%, from 43.2%; and our adjusted EBITDA margins continue to be strong, growing year over year to 14.2%. Jeff, our CFO, will talk more about the drivers of this strong margin performance in a few minutes. In addition to strong top and bottom-line results, we made great progress in the quarter on many of our long-term growth initiatives. We continued our omnichannel leadership, opening our new San Francisco flagship and four new showroom locations in Portland, Austin, Dallas, and Manhattan.

Our openings include innovative new store formats such as ground-floor retail locations in top-tier shopping districts with other like-minded premium brands that attract a similar audience. These new store formats offer expanded browsing and retail area for walk-in while continuing to serve our successful appointment-driven model and deliver highly attractive economics. The early data from these new showrooms is compelling, with a rapid acceleration in customer appointments and traffic, demonstrating strong latent demand in these markets. For our 2021 new showrooms, we've seen an average year-over-year metro bookings growth of over 100% in the first month post-opening.

This is better than the historical 80% first gear uplift that we have previously seen with new showroom openings. In addition, the conversion uplift for digital traffic across this entire metro areas is similar or better than our strong historically demonstrated results. This consistent, powerful synergy between our stores and e-commerce reinforces our conviction in our omnichannel strategy. We also expanded our product offerings.

We introduced a record number of collections in Create Your Own diamond rings, fine jewelry, and other products. As just a few examples, our ensemble design collection reimagines classic bridal trends for engagement rings. Our fashion rings collection builds on our strong foundation in ring design. And our fine jewelry collections highlight key trends like yellow golden pearls and include new products that can be personalized like our Zodiac pendants, engravables, and Create Your Own birthstone jewelry.

We're so excited about all of these beautiful collections. You can see a few of them highlighted in the presentation materials for today's call. Consumers are increasingly turning to Brilliant Earth for design-driven, premium fine jewelry with meaning. And in Q3, our fine jewelry products continue to experience rapid growth.

While still a relatively small part of our business today, we see long-term opportunities to significantly grow our fine jewelry business, which we expect will increase repeat purchase frequency and drive higher customer lifetime value. Data-driven, agile product development is a core strength for us. And we believe this strength in developing, merchandising, and selling compelling new design collections, as well as our strong customer relationships and brand affinity, will drive our continued success in the fine jewelry space. We are supporting the launch of these new products with enhanced digital experiences to make shopping with us even more seamless, engaging, and personalized.

In time for the holidays, we have launched a new digital gifting experience, featuring new ways to shop our assortment of fine jewelry. We also launched our ring stacking visualization tool, which allows customers to mix and match styles and products in myriad different ways and to see how those styles look together. Our customers love it. And we continually invest in improving what we believe are already best-in-class digital capabilities and a truly seamless omnichannel customer experience.

For example, we recently launched a new virtual showroom, which allows consumers to see the same curated selection of products online that they saw in their visit to our showroom, along with personalized recommendations based on their specific preferences and shopping history. It's an incredible example of how our omnichannel model really does deliver an elevated customized shopping experience for our customers wherever and however they prefer to shop. Continued ESG leadership. ESG has been at our core before the acronym ESG went mainstream, and we strive for continuous improvement in this area.

In the third quarter, we achieved several milestones that demonstrate our continued commitment to ESG leadership. We created and funded the Brilliant Earth Foundation with $1 million to provide long-term support for nonprofit organizations aligned with social and environmental causes that we champion. One organization we have been proud to support is Pure Earth, which provides artisanal gold miners with training in mercury-free mining methods. We also introduced our new Fairmined jewelry collection as part of our mission to support development efforts in artisanal gold mining cooperatives.

We have significantly expanded the number of blockchain-enabled diamonds on our site to more than 10,000. We continued to be a leading retailer of blockchain-enabled diamonds at scale, offering consumers a high level of transparency into the journey of their diamonds. Finally, we recently completed an audit of the recycled gold and silver content in our jewelry, which confirmed that over 90% of the metal content in our gold and silver jewelry is recycled. We're proud of this industry-leading accomplishment.

On the corporate side, we successfully completed our IPO in September, which will be instrumental in providing future access to capital, attracting and retaining talent, and elevating the company's visibility and brand awareness. Overall, I am extremely proud of our passionate and dedicated team. We accomplished and exceeded many of our ambitious goals for the third quarter, and we are well-positioned to drive many more successes in the fourth quarter and beyond. And now, I would like to turn the call over to Jeff to review our financials in more detail and introduce our outlook for 2021.

Jeff Kuo -- Chief Financial Officer

Thanks, Beth, and good morning, everyone. I'm also pleased to speak with you on our first earnings call as a public company. I'll begin my discussion with an overview of our business and proceed with a review of our third quarter results. Following this, I'll share our outlook for fiscal year 2021.

Our digitally native, technology-driven business model has allowed us to grow rapidly, profitably, and in a capital-efficient manner. I'd like to highlight some of the key distinguishing characteristics of our business. First, consistent, robust top-line growth. Our revenue has grown at a CAGR of more than 30% since 2016.

Strong gross margins and adjusted EBITDA. Our business has had strong, consistent, and increasing gross margins. We generate positive net income, adjusted EBITDA, and operating cash flow in contrast to many other rapidly growing direct-to-consumer companies. An inventory-light, negative working capital model.

We've run our business in a capital-efficient manner. We are paid in full in advance of product fulfillment and typically before we pay our vendors. This, combined with our inventory turns of more than 10 times, allows us to operate with negative working capital and generate strong operating cash flow conversion. Compelling showroom economics.

Our showrooms also drive transformative customer acquisition economics in the metros where we open them, as Beth mentioned. This strong top-line uplift is coupled with a very capex and opex efficient model that drives robust showroom economics. We believe our omnichannel model gives us the ability to achieve broad coverage of the U.S. market, with a footprint of fewer than 100 showrooms.

Now, turning to our results. We're pleased to report strong third quarter performance, highlighted by significant growth in sales, gross profit margin, and adjusted EBITDA compared to the third quarter of fiscal 2020. I'll focus on adjusted non-GAAP measures of profitability and EPS in my remarks. For these adjusted measures that I referenced, you can find reconciliation tables to the most comparable GAAP figures in our earnings release.

This can be found at the investor relations portion of our website at investors.brilliantearth.com. Our net sales for the third quarter increased 33% to 95.2 million, from 71.4 million in the third quarter of 2020. We saw growth in both orders and AOV across our product categories, with an overall 30% increase in total orders compared to the third quarter of fiscal 2020. We also saw a 3% increase in average order value to $3,301, from $3,210 in the third quarter of 2020.

Our differentiated premium brand continues to resonate with millennial and Gen Z shoppers, and our strategic investments in marketing have amplified our brand awareness and consumer demand during the quarter. Our omnichannel strategy is working. Our website and showrooms contribute to our strong third quarter sales growth. We saw outstanding growth across our products.

And our fine jewelry products, which are an emerging opportunity for us, grew over 100% year over year for the third quarter in a row. We expect these products will continue to contribute to top-line growth, repeat purchases, and gross margin accretion for the company in the future. Fine jewelry, in addition to contributing to top-line growth, brings new customers to Brilliant Earth while also providing exciting new repeat shopping occasions for our existing customers. We have historically seen a high increase in repeat purchase behavior for customers that have either come into a showroom or purchased fine jewelry.

As we continue to open new showrooms and grow fine jewelry, we expect that they will lead to additional increases in overall repeat purchases. And we have seen a double-digit percentage increase in repeat purchase behavior at the 12-month mark for our most recent customer cohort compared to recent cohorts. This shows us the growing affinity of our customers to the Brilliant Earth brand. Moving on to gross margin.

Gross margin expanded by more than 700 basis points to 50.4%, compared to 43.2% in Q3 2020. That expansion was across our products and was driven by our strong brand affinity and continuous optimization of our pricing engine. Our powerful customer affinity and our differentiated product design enable us to continue to improve our margins and command premium prices. Our pricing engine incorporates proprietary technology-enabled algorithms that allow our team to continually test and refine pricing to optimize our revenue and gross margins in a very granular fashion.

In the third quarter, we were able to drive better than expected gross margin expansion through these efforts. Additionally, as we scale, we expect to continue to drive procurement efficiencies across our supply chain, including ongoing optimization of our vendor mix. And of note, our gross margin was not negatively impacted on a year-over-year basis by increased shipping costs in the third quarter given that we use airfreight for inventory shipping. All said, we drove better than expected gross margin in Q3 as everything came together incredibly well.

While we expect gross margins to continue to expand in the future, we believe it is prudent not to plan for the same level of gross margin outperformance in Q4 that we saw in the third quarter given the competitive sales environment that is typical during the holiday season. Now, moving on to SG&A. SG&A increased to 40.1% of sales in Q3 2021, compared to 30.1% in Q3 2020. Approximately 360 basis points of this increase was made up of add backs to adjusted EBITDA from increased other G&A and employment expenses.

These included new showroom preopening expenses, donation to fund the Brilliant Earth Foundation, equity-based compensation expenses, and costs in preparation for our operations as a public company. All of which are added back in our presentation of adjusted EBITDA. The remainder of the increase in SG&A was principally driven by expenses to support the growth of our business. First, increased investments in marketing for brand awareness and to support strategic growth initiatives such as our expansion in the fine jewelry.

Our marketing remains efficient, and we continually refine our marketing spend across diversified channels. We have also developed sophisticated analytics based on our consumer behavior to optimize our campaigns. We had higher employment costs to support our operations as a public company. Showroom-related employment costs also increased due to employment costs for new showrooms, which are still in the earlier stages of their ramp-up.

It's worth noting that employment costs were unusually low in the third quarter of 2020 due to temporary COVID-related staffing changes. And finally, we saw increased other G&A costs to support our ongoing operations as a public company. Our adjusted EBITDA for the third quarter was 13.6 million, up 42% from an adjusted EBITDA of 9.5 million in Q3 2020, an increase of $4 million. Our adjusted EBITDA margin was 14.2% in this quarter, improving from last year's adjusted EBITDA margin of 13.3%, driven by strong sales and gross margin expansion, which were partially offset by increases in SG&A as I described earlier.

Our adjusted net income was $8.5 million, representing an adjusted diluted EPS of $0.09 per diluted share on 96.6 million diluted weighted average shares of common stock outstanding. Turning to the balance sheet. As of September 30, 2021, we had cash and cash equivalents of $161.1 million, which included proceeds from our IPO, as compared to $66.3 million at the end of 2020. Our operating cash flow for the nine months ended September 30, 2021, was $33.8 million, compared to $15.2 million in the nine months ended September 30, 2020.

Now, moving on to our outlook. For fiscal year 2021, we expect net sales in the range of $366 million to $369 million, driven by growth across our products and the continued strength of our brand and omnichannel model. This represents an increase of over 45% compared to fiscal year 2020 revenue and an increase of more than 80% compared to fiscal year 2019 revenue. While we recognize the majority of the quarter remains ahead of us, we feel that we are strongly positioned for the holiday season.

Our adjusted EBITDA for the year is expected in the range of $40.5 million to $42 million, which represents an adjusted EBITDA margin of approximately 11%. This reflects a full quarter run rate of public company operating costs that are part of our ongoing expense structure, and therefore, are not added back in adjusted EBITDA. We also plan to continue to invest in marketing to support the growth of our strategic initiatives. In summary, we're very pleased with our third quarter results and expect the ongoing execution of our strategy to enable us to continue our strong momentum in the final quarter of the year and into the future.

Thank you. And I'll now turn the call back over to Beth.

Beth Gerstein -- Chief Executive Officer

As we look ahead, we are so excited about our business and expect our positive momentum to continue in the near and long term. The holidays are an exciting and important time for us, and our team has done an incredible job preparing for the upcoming holiday surge. We have a robust supply chain with significant redundancy. We also have minimal exposure to geographies that are experiencing major supply chain disruptions.

And with our new product assortment, gifting, and omnichannel experiences, we believe that we are well poised to succeed and thrive during the holiday quarter. We are very happy with our financial and operational performance in the third quarter, and we believe we can continue to build on our positive momentum in the fourth quarter and beyond. And now, I would like to turn the call over to the operator to begin the Q&A portion of the call.

Questions & Answers:


Operator

Thank you. [Operator instructions] Our first question comes from Michael Binetti with Credit Suisse. Your line is open.

Michael Binetti -- Credit Suisse -- Analyst

Hey, guys. Congrats on a great quarter and very nice to have you on a public call here. Look forward to the story as we go here. I think the first thing that jumps out is a bit of a model question for Jeff.

But, Jeff, the 700 basis points of gross margin. You know, as we look at that, as we learned about the company through the IPO process, you know, we didn't hear about a gross margin with a five handle on it in -- over the planning horizon. You know, maybe longer term. But I know you said, look, let's not get over our skis, and we expect some promotions in the fourth quarter.

But is the 50-plus gross margin in third quarter something that you feel like we build on, you know, going forward into 2022 after you get past that holiday quarter that you gave? And I know you said -- I'm sure you're rank-ordering some of the inputs there. But I think when we talked, you thought, you know, over the next few years, there's about 100 basis points of opportunity on the gross margin from the pricing optimization. It seems like you got more than that already here. So, maybe just a little bit more thinking on what drove the 700 and what you think you might give back or was -- you know, a single point in time.

And then aside from the gross margins, maybe for Beth, I'm just curious on the fine jewelry. I know you're very excited about the category. I know it's a big opportunity for a brand like yours, and it's great to see that up over 100%. Maybe a little bit more on what's working there.

Sounds like the marketing is working well. But how much of it was from new SKUs versus, you know, SKUs you already had in place that are just getting better lift from marketing or anything like that? We'd love to hear a little bit more as it seems like a good opportunity for you, guys.

Jeff Kuo -- Chief Financial Officer

Sure. Thanks, Michael. So, to take each of your questions. So, in terms of what drove the gross margin -- strong gross margin performance in Q3, I think, you know, describe it as our, one, the very strong customer affinity that we have that allows us to command premium prices.

And then as you've discussed, you know, the pricing engine that we have that incorporates proprietary technology-enabled algorithms and is very dynamic and lets our team continually test and refine pricing to optimize both revenue and gross margin. And we'd say that, in Q3, everything really came together ideally. And, you know, we -- I would describe it as an outperformance even against our expectations in terms of how well everything worked together, you know, on those levers. We do continue to see long-term upside in gross margin.

We'd say that, you know, in the going forward period, you know, kind of the near term, not to expect necessarily the same high level of gross margin outperformance as we saw in Q3 as we don't want to assume the same kind of almost perfect set of circumstances that we saw in the quarter. But we do expect to continue delivering strong gross margin and do see long-term upside there. We -- you know, in terms of specifically on 2022, not yet providing guidance on 2022, we do expect to, you know, providing outlook as part of our annual earnings call. But, you know, we do continue to see long-term upside potential in gross margin.

But Q3 was kind of a really perfect convergence of everything and an outperformance in some ways for us.

Michael Binetti -- Credit Suisse -- Analyst

Thanks, Jeff.

Jeff Kuo -- Chief Financial Officer

Sure.

Beth Gerstein -- Chief Executive Officer

Hi, Michael. I just wanted to address your question on fine jewelry, and thanks for the question. We were really excited to see the growth in the fine jewelry category, and really, the continued growth of the category. As Jeff mentioned, it's been growing for many quarters now.

In terms of what's working, I think there's several factors [Audio gap] You know, one I think the fact that we have such strong customer connections, and that loyalty to the brand, I think, is really important here. We've mentioned in the past that the brand really resonates with the giver, the receiver, with all genders involved, and both of those genders are actually involved in the bridal purchase, and I think that, really, we see that she is really excited to receive a Brilliant Earth product, and that helps to drive repeat overall. So, we do see a lift in repeat. We also see new customers coming to us for that experience.

And I think that that customer connection is just so important. The showrooms also helped to drive that. We see increased repeat if you come into the showroom. And I think that as we build out our showrooms, that is going to be a bigger contributor.

So, the second thing I would say is the product assortment, I think, is really working across all levels, both new SKUs and existing SKUs. I think some of the new SKUs are pretty early in terms of the release, so we're really excited to see how they perform over holiday. But I do think that that assortment is key. And the fact that we have a data-driven design and that we really excel here, I think really positions us very well.

And then the third thing I think that's really important is that marketing. And the marketing efforts that we have are showing early promise as it relates to driving new customers, as well as that repeat. So, I think we're seeing strength in all areas. And the fact that we have that digital experience that we're really improving over time.

And that new gifting experience, I think, has also positioned us really well for holiday. So, I know there's a lot of factors there, but I think it's really important that we're really checking on all sides.

Michael Binetti -- Credit Suisse -- Analyst

All right. We heard. Thanks a lot, Beth.

Operator

Thank you. Our next question comes from Matthew Boss with J.P. Morgan. Your line is open.

Matt Boss -- J.P. Morgan -- Analyst

Great. Thanks, and congrats on a really nice quarter. So, Beth, on your 35% revenue growth CAGR this quarter, and I think more than 30% implied guidance for the fourth quarter, how much would you attribute recent performance to an expanding industry TAM given the accelerated penetration of digital and the fine jewelry market as opposed to company-specific execution and market share gains in what I know you've pointed out as a fragmented industry backdrop?

Beth Gerstein -- Chief Executive Officer

I think -- thanks for the question. It's nice to talk to you, Matt. So, what I would say is that, really, I think there's a few different factors. You know, you mentioned the fact that e-commerce is experiencing fast growth.

I think that really plays to our strength and as a digital-first company here. The fact that branded remains a really big opportunity. It's the fastest-growing segment within fine jewelry, and the jewelry industry, I think, is really important for us. And the fact that we represent a really strong brand, a premium brand that really resonates with that younger consumer, I think is really going to be instrumental to the growth and has been in the past as well.

And then I think the fact that we are really small relative to that $300 billion market is really important. We're really disruptors here. We continued to gain share within this market given that differentiated business model that we talked about. So, really, I think it's actually all the factors.

You know, I think jewelry is also expanding. You know, weddings are expected to have the highest levels that they've had in decades. And I think that also has contributed to the growth.

Matt Boss -- J.P. Morgan -- Analyst

Great answer. Jeff, maybe as a follow-up, on your long-term EBITDA margin target, the 15% to 20%-plus, I guess two questions. How best to think about linearity multiyear beyond this year on that margin target? And then how high is the plus on that 15 to 20-plus in your view?

Jeff Kuo -- Chief Financial Officer

Thanks, Matt. And can I confirm, on the first part of your question, were you asking about the linearity on the EBITDA target?

Matt Boss -- J.P. Morgan -- Analyst

Yeah.

Jeff Kuo -- Chief Financial Officer

Or another --

Matt Boss -- J.P. Morgan -- Analyst

The EBITDA target, just how best to think about it multiyear in terms of it being linear from the exiting -- exit point of this year to the 15 to 20, and then the 15 to 20-plus. You know, what -- well, how do you view the potential of the plot?

Jeff Kuo -- Chief Financial Officer

Yes. So, in terms of linearity, you know, we -- may be hard to project, you know, necessarily on a year-over-year basis. You know, what I can say is that we do expect that there's upside -- you know, upside potential both in terms of growing gross margin with some of the factors that we've described such as our premium brand positioning, the pricing engine, and other procurement efficiencies, as well as with SG&A leverage as we grow, which we expect to be able to drive leverage in the longer-term model in marketing, as well as employee cost and other G&A. So, I would say that, you know, while I can't necessarily speculate it, you know, very precisely on the exact linearity, that there is upside potential in the different layers of our cost structure.

And we're pleased with our strong performance and continuing to see upside in the different areas of our cost. And then could you -- I'm sorry, can you repeat the second part of your question one more time?

Matt Boss -- J.P. Morgan -- Analyst

So, your long-term EBITDA margin target is 15% to 20%-plus, how high could the plus be?

Jeff Kuo -- Chief Financial Officer

Yeah, I would say that there is some meaningful upside, you know, to there. You know, can't necessarily point to a specific number, but I would say that, you know, our strong approach to modeling has been to be prudent in terms of how we think about our targets, and we think that the engines of margin growth, if you will, that we have all have long-term legs, all have delivered historically. And we think that there is, you know, there is potential as we grow all of our strategic initiatives to exceed that. But I can't point to a specific number.

Matt Boss -- J.P. Morgan -- Analyst

That's great color. Best of luck.

Jeff Kuo -- Chief Financial Officer

Thank you.

Beth Gerstein -- Chief Executive Officer

Thank you.

Operator

Our next question comes from Randy Konik with Jefferies. Your line is open.

Randy Konik -- Jefferies -- Analyst

Yeah. Great. Good morning. Thanks a lot.

I really appreciate your allowing me to ask my questions. So, a couple of things. One, I guess, first, Jeff, what would be really instructive is if you give us some perspective on this pricing optimization engine. You talked about granularity.

You talked about the dynamic -- how dynamic it is. Can you give us a little bit more detail on how granular this -- the engine gets? You know, how dynamic does the engine get in terms of giving us perspective on how your team utilizes this engine? Obviously, we know about it, but what I want to understand, you know, how often things are changing? Yeah -- and then if you -- the learnings from this engine, can you see more improved permanence in merchandise margin improvement over time because of the early learnings or the productivity of the engine getting better and better? Thanks.

Jeff Kuo -- Chief Financial Officer

Sure. Yeah. So, in terms of price optimization engine side, maybe just a bit of color. So, this is -- it's something that we've developed in-house, you know, over many years.

And it's -- so it's proprietary to us. It's very data-driven, you know, and relies on kind of continual input of data that we see in terms of product sales, consumer behavior. And it does, you know, cover many of our different products. In terms of how dynamic and granular it is, it can get quite granular down to the product level in terms of the level of precision that allows our teams to be making decisions.

And it's dynamic in terms of it's something that the team can look at, you know, on a daily basis to see different trends in products and how we should be adapting accordingly to be thinking about both our top line and our gross margin. So, it's something that is proprietary, very data-driven, continually used by our team. And it's also, of course, not a static tool. It's something that as we look at performance, we're kind of continuing to refine the inputs and the operations of that engine.

So, it's a very powerful tool for us and really a differentiator for us. And we do believe that it has led to structural improvements in our gross margin structure and, you know, will continue to be able to drive long-term accretion to gross margin.

Randy Konik -- Jefferies -- Analyst

Super helpful.

Beth Gerstein -- Chief Executive Officer

And one thing that -- what I would add to that is one of the learnings that we have is because we have unique offerings. So, you know, we've mentioned in the past that how two-thirds of our products are proprietary to us in terms of that design. And, you know, you think about offerings like blockchain for example. These are unique offerings to us.

I think that because of that, we're able to command that higher prices. And that's something that we've learned over time and that we've been able to adjust in a dynamic fashion.

Randy Konik -- Jefferies -- Analyst

Super helpful. And now, I want to kind of go after -- so we think about the quarter. You know, a lot of it seems like the gross margin expansion was driven by this price optimization, and you didn't get a lot of benefit from fine jewelry mix going up, which we know is still early stage. So, maybe give us some perspective on, you know, where is fine jewelry penetration right now, where was it last year, and where do you think it sits in the next, we'll say, five years from now, where can that penetration go? And then finally, just remind us, the gross margin differential between fine and engagement jewelry.

Thanks, guys.

Beth Gerstein -- Chief Executive Officer

So, maybe I can start that. We're not providing that particular metric, but what I can say is that, you know, it still remains relatively small though we think that it's going to increase, you know, certainly as we continue to improve our offering. And I think we're into the journey in that respect. Jeff, do you want to comment on the second part?

Jeff Kuo -- Chief Financial Officer

Yeah. In regards to the gross margin potential, so it's -- it is not something that I'll plan to break out in terms of like product level gross margins. We can't say that it is -- you know, this group products is definitely one that's accretive to our gross margins and higher than those for the business as a whole. And if you look at players in the space that are much more weighted toward fine jewelry, you know, that there's a lot of gross margin accretion potential as fine jewelry becomes a larger part of our business.

Beth Gerstein -- Chief Executive Officer

The other thing I would mention is we were really excited to see gross margin improvement across the categories, including fine jewelry. So, it will be increases -- gross margin increases, I think all of that is trending upward.

Randy Konik -- Jefferies -- Analyst

Thanks, guys.

Jeff Kuo -- Chief Financial Officer

Thank you.

Operator

Our next question comes from Oliver Chen with Cowen. Your line is open.

Oliver Chen -- Cowen and Company -- Analyst

Hi. Thank you. Beth, one of the distinguishing factors is ESG of Brilliant Earth. As you think about the consumer and the younger, as well as your broader consumer, which factors of sustainability and other efforts that you're making are really in demand from the customer, and which ones do they appreciate most? And then, Jeff and Beth, on the lab-grown opportunity, do have any thoughts around how that may impact the AOV and/or margins over time and some key things we should monitor as this seems like also a big opportunity where Brilliant Earth is well-positioned? Thank you.

Beth Gerstein -- Chief Executive Officer

Thanks, Oliver. So, in terms of ESG, you know, obviously, it's an integral part of our company. We're really founded based on these values, and, you know, it's the DNA of the company. In terms of which factors, I really think that it's the holistic offering.

I think the fact that our customers understand the importance to us and how integral it is to our company, to our offerings. The fact that we're continually messaging on it, whether it's the recycled content of our metals, that new Fairmined collection. It's really top of mind for us. And I think it just comes across in a really authentic way, and our customers just know that we're doing work on their behalf and that we're a trusted ESG retailer for them.

So, I think that that is really important. But I also think that, you know, sustainability right now is table stakes. I think that, really, you need to have a complete offering. So, sustainability is very important, but I think you need to complement it, and the fact that we have that design, that overall experience, both digital and in showroom, that's really joyful.

All of those, I think, work together in a really seamless way, and I think all of that is important as the, really, the brand to the customer, and that's really what we are. And in terms of your second question on lab, you know, we don't disclose -- talk about that specific metric and break down subcategories in that way. But what I can say is that, you know, overall, we've seen expanding AOVs within engagement rings, and that's really how we think about it. As customers come to us for the engagement ring, they, you know, will start with the design.

They will balance all of the different characteristics, whether it's lab and natural, you know, the 4Cs. And frankly, it's a very complex process. And we're -- we want to guide them into what they're looking for. We're agnostic in terms of which they decide.

But we have seen that AOV has increased over time as we're seen as this premium brand.

Oliver Chen -- Cowen and Company -- Analyst

OK. And then you're free cash flow conversion rate is really outstanding as well. As you expand and define and maximize LTV, as well as think more holistically about your offering, what do you think about the inventory management on that side of the business and how you pursue it, and anything we should think about on a longer-term basis with working capital? Thank you. 

Beth Gerstein -- Chief Executive Officer

Jeff, do you want to take that one?

Jeff Kuo -- Chief Financial Officer

Yes. So, I can talk to that. You know, I think our free cash flow conversion and our negative working capital model are definitely differentiators for us as a business. You know, it combines a few different factors such as our getting paid in full from our customers before we're fulfilling, you know, keeping a light inventory, typically getting paid before we pay our vendors.

So, it is definitely a powerful tool for us. And we believe that we'll continue to operate in a very working capital-efficient manner I would say. Some things that I'd point to is like as we continue to introduce new products, we're able to do this in a very data-driven way. You know, we don't need to bring on a lot of inventory to stock.

You know, hundreds or thousands of stores, we were able to test and iterate very efficiently. We have a very strong online business. And then our relationships with our suppliers and our differentiated ability to produce in a quick turnaround fashion, that's a capability that we've developed over many years, involves a lot of technological integrations with our supply chain, and allows us to really develop and produce in a very agile and inventory-light fashion. So, I think that going forward, we continue to expect to operate in a very working capital-efficient model as this has been, and we think will be -- continue to be a differentiator for us. 

Oliver Chen -- Cowen and Company -- Analyst

Thank you. Best regards.

Jeff Kuo -- Chief Financial Officer

Thanks, Oliver.

Operator

Our next question comes from Ed Yruma with KeyBanc. Your line is open.

Ed Yruma -- KeyBanc Capital Markets -- Analyst

Hey, good morning, guys, and congrats on the IPO. First, a quick question around inflation. I know you guys don't carry the same balance sheet risks that a traditional jeweler might have given just in time X factoring. But how could we think about if gold prices start to move and we noted that raw diamond prices started to move inside of the third quarter, what's the implications for margins? Did you benefit from that in the quarter? And how should we think about that if we do see these inflationary pressures longer term? And then as a follow-up, on the fashion jewelry side, any insight into how the marketplace is doing, specifically Tacori? Thank you.

Beth Gerstein -- Chief Executive Officer

Great. I can take that. And maybe I'll start with the second one. So, in terms of our Tacori partnership, you know, we're really pleased with the performance there.

I think that it shows that, you know, we really are a destination for the younger consumer. And I think having a curated offering where we collaborate with other brands and we're selective there. I think the fact that we had that IPO really increases our visibility, and so we're going to have increased opportunity there. But that collection has been performing well, and we think that there's future opportunity there, both with Tacori, as well as other partners.

In terms of the first part, I think that as it relates to gold pricing and diamonds, the real beauty I think of the model is just the fact that we're able to adjust dynamically our prices. So, as we see gold pricing increasing and decreasing, and keep in mind, we also offer platinum. And so, there's a lot of dynamics in play there. We are able to adjust dynamically.

That pricing engine is really powerful. And so, in the past, we have been able to maintain our margins even in the face of increasing costs, and I think 2020 was a great example of this. Our margins continued to expand even as gold prices increased. So, you know, really, I think we're very well positioned, regardless of what happens in terms of the input prices.

Ed Yruma -- KeyBanc Capital Markets -- Analyst

Great. Thanks so much.

Operator

Thank you. Our next question comes from Erinn Murphy with Piper Sandler. Your line is open.

Erinn Murphy -- Piper Sandler -- Analyst

Great. Thank you. Good morning. Beth, my question is for you around the iOS privacy changes.

A lot of DTC brands have seen challenges over the last six months. Can you just drill down on that topic? How are you navigating this for Brilliant Earth? And then have you seen any erosion in advertising metrics thus far as a result?

Beth Gerstein -- Chief Executive Officer

Great. So, marketing -- the marketing increase that we had was intentional. It was part of our overall strategy. And our digital marketing efforts continue to remain efficient.

And I think there's a few points that are worth mentioning. First, organic referrals and word of mouth for us are strong contributors to driving new customers. Two-thirds of our customers are influenced by word of mouth, so I think that is an important factor. Second, the approach we have to digital advertising is diversified.

It's multichannel. And it's not overly concentrated in any specific channel such as Facebook. And I think that has served us well in the face of some of the changes that have happened. Third, you know, we do have a very data-driven thematic approach, and we're continually refining and optimizing across our digital channels.

Because jewelry is a very considered purchase, many years ago, we've developed capabilities to be able to optimize across multiple actions along the customer journey. I think this approach has really been robust against the changes in the digital landscape, including some of the recent privacy changes that you mentioned with Apple. And then, you know, finally, the way we think about it is we really have a strong opportunity to strategically invest in marketing to be able to build brand awareness to support the brand momentum that we've seen, as well as support future growth initiatives, including fine jewelry. So, the bottom line is I think that we have a really robust offering in the face of some of the changes that we've seen.

Erinn Murphy -- Piper Sandler -- Analyst

Great. That's super helpful. Thank you. And then maybe just a different take on the gross margin, Jeff, for you.

I guess, historically, if we look back at the model, Q4 has been a higher gross margin quarter on a linear basis versus Q3. Is there anything different about this fourth quarter that would prevent that from being the case? Thank you.

Jeff Kuo -- Chief Financial Officer

Yeah, I would say that with respect to Q4, I mean, I think that is a time that, you know, there are competitive holiday dynamics in play. You know, I'd probably think about it that we did have a very strong -- we did have that very strong outperformance in Q3 with the convergence of a lot of factors coming together in an ideal fashion. You know, I think going to the Q4, we may not have that same convergence of perfect factors. You know, we do -- then there are competitive holiday dynamics.

We do expect to have a strong gross margin performance in Q4. And I think our dynamic engine will allow us to continue to adapt to that environment that we see in the holiday. And so, we expect to maintain our premium pricing, but there's, you know, less potential for margin expansion in the holiday season.

Erinn Murphy -- Piper Sandler -- Analyst

OK. So, still looking for expansion year on year but potentially not to the level that would get it toward that 50%-plus. Is that -- am I interpreting your kind of thought process correctly?

Jeff Kuo -- Chief Financial Officer

Yeah, I think that, you know, we would expect to deliver a similar better gross margin than we have historically in the fourth quarter. But like I said, not necessarily the same level of outperformance as we saw in Q3.

Erinn Murphy -- Piper Sandler -- Analyst

OK. Thank you.

Operator

Thank you. Our last question comes from Telsey with Telsey Advisory Group. Your line is open.

Dana Telsey -- Telsey Advisory Group -- Analyst

Good morning, everyone, and congratulations on the nice results. As you think about some of the partnerships that you've engaged with recently like Tacori, how is that performing? Should we see more partnerships like that as you move forward? And then on the new showrooms that have been opening, any difference in the results that you've seen from prior showrooms? And given availability of real estate, does anything change in terms of the number of new showrooms expected to open? Thank you.

Beth Gerstein -- Chief Executive Officer

Great. Well, I'll start with the first part of the question. In terms of the partnerships with Tacori, you know, as I mentioned, I think that it has performed really well. I think it's proven itself that it's a nice aspect to our model, and we do think that there is room to add additional partnerships, as well as to expand that Tacori partnership.

So, look for more in the future there. In terms of the showrooms, you know, as we mentioned on the call, we continue to have strong conviction in our omnichannel model. We are really encouraged by the recent performance with our newest launches and certainly excited to have those new team members in those locations as well. Jeff has mentioned in his remarks that we expect to reach under 100 showrooms that provides really nice U.S.

coverage, and we do expect to reset over the next several years. So, nothing has really changed there. In the near term, we really feel confident about the robust pipeline that we've developed across many different metro markets. And I think the strength of the brand, the increased brand visibility that we've had has really been beneficial in influencing some of the compelling real estate opportunities that we're seeing that's increasingly available to us, that we really have an attractive demographic for some of these centers.

And as we continue to look at a variety of different retail formats, I think that also helps to complement the offering. So, really, I think feeling very positive about that omnichannel strategy, and we'll continue to add and complement the digital experience. And I think the omnichannel experience that we're developing is really going to be key in this category, and I think that's what we're building toward, and we're definitely on the path.

Dana Telsey -- Telsey Advisory Group -- Analyst

Thank you.

Operator

Thank you. And I'm currently showing no questions at this time. I would like to turn the call back over to Beth Gerstein for closing remarks.

Beth Gerstein -- Chief Executive Officer

Great. So, thank you, everyone, for taking the time to speak with us. We are very excited to have completed such a successful quarter, our first as a newly public company. And we're excited about the elevated platform we have now to continue modernizing and transforming the jewelry industry, pursuing our mission, and to being the fine jeweler of choice for millennial and Gen Z jewelry consumers.

I wish each of you a happy holiday and New Year and look forward to speaking with many of you at upcoming investor meetings, including the JPM conference on November 15.

Operator

[Operator signoff]

Duration: 63 minutes

Call participants:

Allison Malkin -- Investor Relations

Beth Gerstein -- Chief Executive Officer

Jeff Kuo -- Chief Financial Officer

Michael Binetti -- Credit Suisse -- Analyst

Matt Boss -- J.P. Morgan -- Analyst

Randy Konik -- Jefferies -- Analyst

Oliver Chen -- Cowen and Company -- Analyst

Ed Yruma -- KeyBanc Capital Markets -- Analyst

Erinn Murphy -- Piper Sandler -- Analyst

Dana Telsey -- Telsey Advisory Group -- Analyst

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