Rent the Runway, Inc. (NASDAQ:RENT) Q2 2023 Earnings Call Transcript

Rent the Runway, Inc. (NASDAQ:RENT) Q2 2023 Earnings Call Transcript September 8, 2023

Rent the Runway, Inc. misses on earnings expectations. Reported EPS is $0.4 EPS, expectations were $0.43.

Operator: Hello, and welcome to Rent the Runway’s Second Quarter 2023 Earnings Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I’ll now turn the call over to Rent the Runway General Counsel, Cara Schembri. Cara, please go ahead.

Cara Schembri: Good morning, everyone, and thanks for joining us to discuss Rent the Runway’s second quarter 2023 results. Joining me today to discuss our results for the quarter ended July 31, 2023, our CEO and Co-Founder, Jennifer Hyman, and CFO, Sid Thacker. During this call, we will make references to our Q2 ’23 earnings presentation which can be found in the Events and Presentations section of our Investor Relations website. Before we begin, we would like to remind you that this call will include forward-looking statements. These statements include our future expectations regarding financial results, guidance and targets, market opportunities and our growth. These statements are subject to various risks, uncertainties and assumptions that could cause our actual results to differ materially.

These risks, uncertainties and assumptions are detailed in today’s press release as well as our filings with the SEC, including our Form 10-Q that will be filed later today. We undertake no obligation to revise or update any forward-looking statements or information, except as required by law. During this call, we will also reference certain non-GAAP financial information. The presentation of this non-GAAP financial information is not intended to be considered in isolation or as a substitute for financial information presented in accordance with GAAP. Reconciliation of the GAAP to non-GAAP measures can be found in our press release slide presentation posted on our investor website and in our SEC filings. And with that, I’ll turn it over to Jen.

Jennifer Hyman: Thanks, Cara, and thank you, everyone, for joining. I want to start by talking about our progress in Q2, starting with our strong bottom line performance and momentum towards profitability. We’re pleased that we exceeded our Q2 profitability guidance by remaining disciplined, adjusted EBITDA margins had a historic high at 10.2% in Q2 driven by fulfillment efficiencies, strong gross margins and fixed cost control. And notably, today, we announced that we have accelerated our plan to be free cash flow breakeven before cash interest expense to full year ’24. For some time now, we’ve been focused on taking decisive actions that the goal to bring Rent the Runway to profitability. And we believe now is the right time to accelerate our efforts.

Our growth and improvement story starts with our cash, where we’ve made immense progress. We’ve transformed a business that consumed almost $100 million in cash in full year ’22, to a business that will consume around $50 million in cash in full year ’23 and will break even next year less cash interest expense. We believe that a key part of getting to profitability is also making decisive choices that are prioritizing the medium and long-term health of the business over short-term revenue gains and lower margin customers. Next, Q2 was the fifth consecutive quarter of positive adjusted EBITDA. We’ve made significant improvements over the past several years, reducing both our fixed and variable cost structure and growing our margins. Cost discipline continues to be firmly embedded in to Rent the Runway’s culture.

Our ’22 restructuring was clearly an important step, and we have continued to make progress on optimizing costs during the first half of full year ’23. Our teams are continuing to examine our cost structure to assess additional steps we can take to remain agile, flexible and able to achieve our profitability goals in a range of revenue scenarios. Going up to gross margins. We’ve continued to improve performance in our fulfillment operations and in how we acquire inventory. Even as we changed our subscription programs to offer customers 25% more value in every shipment in Q1. Our fulfillment costs have improved primarily by focusing on labor productivity and transportation efficiencies. The strength of our inventory expense is a reflection of the continued impact of product acquisition mix changes towards more efficient channels.

Lastly, I want to acknowledge our Q2 miss on revenue. We had a slight revenue miss due to lower-than-expected active subscriber count primarily driven by lower early term subscriber retention, which we believe to be attributed to inventory debt levels that were too low. Reserve, our onetime event rental business also declined year-over-year which we believe was the result of greater focus on subscription in our marketing efforts and on our site as we discussed last quarter as well. Our goal is driving this business to free cash flow profitability less cash interest expense next year. To do so, we are making deliberate choices that we anticipate will negatively impact short-term revenue and subscriber count. We’re planning to be less promotional and focus more on rebuilding our high-margin reserve business.

We also plan to pull back on marketing spend to prioritize inventory in-stock rate. Above all, we’re empowering our leaders to make the right choices to drive profitability. We do not waver from our long-term belief in the enormous market opportunity for rental. As a result, we are focused on creating a sustainable business so that we can control our own destiny and capture as much of the large and growing market as possible over the upcoming years. Before I discuss the positive improvements we’ve made to the customer experience in the first half, I want to discuss what we believe are the two biggest challenges we had, lower inventory depth than needed and a softer reserve business. We learned a lot in Q2 about the criticality of inventory depth to the customer experience.

We started Q2 with a record number of subscribers and on the heels of our extra item plans launched in April. While we had enough inventory overall to serve our customer base during the quarter, we did not have enough depth in new styles and as a result, our in-season in-stock rates were down 17% versus Q2 last year. We have data that indicates that an inventory depth issue was the primary driver of lower early term subscriber retention and therefore, lower active sub count. To take a step back, we fully transitioned from our unlimited swap program to fix swap plans in 2021 and 2022 was our first year of operating these programs in a more normalized environment where customers were going to offices and out to events again. In 2022, we revamped success metrics for inventory in fixed swap programs, shifted our go-forward strategy away from a breadth strategy to focus on a depth strategy and established inventory availability as one of our key strategic pillars for 2023.

The most important component of this strategy is greater investment in depth of styles and brands, We Know She Wants. So we are in stock more of the time. Given the nature of a six-month fashion buying cycle, we were able to implement our learnings from 2022 and impact our Q3 and Q4 2023 buys with higher depth, which is now coming to life in our fall 2023 assortment. As we shared previously, we expected that the customer impact would begin to be felt on this time line, which was key in informing our original back half-weighted growth expectations for full year ’23. However, we believe that the lag between the time of the buy and live to site impacted the customer experience more than we expected in Q2, particularly for new customers, given the high growth we experienced in Q1.

In a fashion rental business, availability changes moment to moment, and we have observed that new customers are more likely to be disappointed by lower in-stock rates because they expect to see the items they got excited about while browsing as a prospect. Retention of tenured customers continue to be strong because they understand that when they don’t see something they’ve parted one day, they’re confident they’ll be able to rent soon. We believe that this issue is temporary in nature. Depths of our 2H 2023 buy are expected to be approximately 1.7x the depth of our 1H ’23 buy, which would increase our in-stock rate by 700 basis points to 1,000 basis points. We have acquired even higher depth in our most popular brands and in key items, we have confidence our customers will want this fall and winter.

Functionally, we expect this will be felt by customers throughout the second half of Q3 as they’re refreshing their fall wardrobe and through to Q4. We anticipate that this will result in a meaningfully better customer experience and improve retention in the near to midterm. While 2H depth will be a huge improvement over 1H, customer behavior in Q2 illuminated that we should go even further on our depth strategy. To that end, we have further expanded our depth plans for ’24. We expect that we will see continued improvement on in-stock in the first half of 2024 as a result of this. The nature of our business model dictates that any significant transition in inventory strategy must be done in multiple phases, given that we monetize inventory over multiple years, and it stays in our rental ecosystem for multiple seasons.

To be clear, while we have made significant improvements already, we expect the lion’s share of the positive impact of our debt strategy and therefore, the positive impact to revenue and subscriber growth to be in 2024, one significantly more of our inventory tranches have appropriate depth. Our data thus far indicates that we should see loyalty gains from all customers with the greatest gains coming from early term customers. For reserve, we believe we have great opportunity here. Our onetime rental business is what we launched this business with 15 years ago. It’s the easiest value proposition for customers to understand as every woman finds herself having to buy outfits every year for event she really wears to get. We’ve made three exciting changes to our reserve business over the past quarter.

Last month, we debuted a distinct product experience for reserve, which separates the reserve funnel from the subscription funnel. This is intended to make it easier for customers to understand the reserve value proposition of locking in a look in advance and getting the second size for free. It also clarifies how the pricing compares to subscription. Second, we started acquiring distinct inventory for the reserve business, mostly on consignment, focused on premier designers that elevate our reserve assortment. Finally, we’ve shifted our org design to add new leadership focus on reserve, intended to ensure we can grow both this business and subscription side by side. We believe that the appetite for rental at large is big enough that both of these offerings can grow, and we expect this change to the funnel to benefit both reserve and subscription from a conversion standpoint over time.

Beyond our inventory depth strategies and focus on improving reserves, the teams have continued their work across our other strategic pillars, the efficient and easy-to-use experience and best-in-class product discovery and have been successful in the first half of 2023 at markedly improving our overall customer experience. We believe we’ll see more of the full retentive impact of these changes to customer experience and discovery when the in-stock rates are higher. Let me share a fewer — those initiatives here. Related to our pillar on efficient and easy-to-use experience, we’ve seen early success with our SMS-based concierge program that is leading to improvements in loyalty amongst those who sign up. Concierge has already accelerated our learnings from early term customers and priority areas to improve their experience.

Given its success, we plan to continue to invest in concierge in full year ’23 through expanding this program to more customers across more terms. Yesterday, we launched a new subscriber onboarding experience based on our learnings from concierge to help lead them to inventory they love quickly and pick their first shipment. This also includes the creation of an interactive customer filing profile and encourage sign-up into our concierge program to aid with live one-on-one assistance. Finally, we continue to drive major improvements in site performance and reliability. Improving Lighthouse scores of key acquisition pages by 50% year-over-year. a Lighthouse score is the rating Google gives to websites based on a combination of criteria, including performance, accessibility, SEO and other best practices.

Related to best-in-class product discovery, we introduced multiple improvements during the quarter, which have driven reductions in time to select shipments for our customers. We achieved this by one, launching a fully redesigned app product detail page experience that features more detailed larger product images, clearly displayed Fitted Vice and makes the availability of that item more obvious to the customer. Two, we’re elevating the look and feel of our brand in sight across all touch points from photography to design and creative, which is intended to ensure that our premium positioning is clear to our customers and brand partners. Three, we created more visibility for editorial durations throughout our site and accelerated our schedules for refreshing them.

We’ve seen high engagement with our editorial suggestions. Four, we improved filters, making it easier for customers to search with specificity. And finally, we rolled out our AI search beta to 20% of our customer base. We are using this data to get user feedback and iterate on the best and quickest way to search our catalog. I firmly believe that we are making the right decisions for customers and that our customers will reward our product improvements, additional items and improved experience with inventory. I’m excited about our plans for the remainder of full year ’23 and into full year ’24. Most importantly, we are excited to drive this business to free cash flow profitability, excluding cash interest. With that, I’ll hand it over to Sid.

Sid Thacker: Thanks, Jen, and thanks again, everyone, for joining us. Prior to reviewing second quarter results, I would like to provide some perspectives on the significant acceleration in our time lines of free cash flow breakeven before cash interest expense. While the inventory debt issue that Jen just described, is expected to affect revenue growth negatively this year, we continue on our steady path to providing more value and a better experience for our customers. We’re confident that with a favorable market backdrop, these improvements will translate to stronger revenue growth. Importantly, slower revenue growth will not mean slower progress on profitability for Rent the Runway. In fact, as Jen outlined earlier, one reason for our reduction in revenue guidance for fiscal ’23 is our decision to prioritize more rapid progress on profitability by reducing promotions and therefore, subscriber acquisition.

Over the past few quarters, we have made significant changes to our fixed cost structure, improved our variable cost structure by finding efficiencies across fulfillment and product costs and fundamentally changed how we approach promotions and customer acquisitions. On account of these changes, we now expect to be free cash flow breakeven before cash interest expense for fiscal year 2024. This relies on only modest levels of subscriber growth in fiscal ’24. We plan to provide more details later this fiscal year, but we expect these results at subscriber levels that are much lower than our previously communicated level of 185,000 subscribers. Free cash flow breakeven before cash interest expense is an important milestone for Rent the Runway and one that we think will demonstrate the attractive underlying economics of the business our focus on profitability and the progress our teams have made on improving efficiency throughout our business.

Let me now provide commentary on second quarter results and guidance for 2023. We ended Q2 with 137,566 ending active subscribers, up 10.8% year-over-year. Average active subscribers during the quarter were 141,393 versus 129,565 subscribers in the prior year, an increase of 9.1%. The ending active subscribers declined from 145,220 subscribers at the end of Q1 2023, which we believe is primarily due to inventory depth. Active subscriber levels were also affected by promotional experiments during the quarter. Total revenue for the quarter was $75.7 million, down 1% year-over-year. The shortfall versus guidance was primarily driven by lower-than-expected subscriber growth. Subscription and reserve rental revenue was $68 million versus $70 million last year, a decrease of 2.9%.

The Subscription and reserve rental revenue was negatively impacted by a decline in our reserve business versus last year. Revenue per average subscriber for the quarter was negatively impacted by lower add-on rates, changes in subscriber program mix and promotional testing. During the quarter, we tested the effects of both increasing and reducing promotions. Our learnings from these tests have informed our go-forward promotional strategy and revenue guidance for the remainder of the year. Other revenue was $7.7 million, an increase of 18.5% versus $6.5 million last year. Other revenue represented 10.2% of revenue during the quarter versus 8.5% of revenue last year. Fulfillment costs were $22.5 million in Q2 ’23 versus $23.4 million in Q2 ’22.

Fulfillment costs as a percentage of revenue improved to 29.7% of revenue in Q2 ’23 from 30.6% of revenue in Q2 ’22. Fulfillment costs as a percentage of sales benefited from continued processing and transportation cost efficiencies. In August, we entered into a new transportation agreement with UPS to lock in competitive rates and consolidate the vast majority of our shipping needs while continuing to serve our customers with premium delivery and return service. Gross margins were 43.9% in Q2 ’23 versus 42.4% in Q2 ’22. Q2 ’23 gross margins reflect both the aforementioned fulfillment cost improvements as well as lower rental product depreciation due to our ongoing progress in procuring more consignments and exclusive design inventory. As expected, gross margin improved sequentially due to seasonally lower product acquisition costs compared to Q1 ’23.

Operating expenses were about 12% lower year-over-year, primarily due to the favorable impact of our 2022 restructuring plan. Total operating expenses, including technology, marketing, G&A and stock-based compensation were about 62% of revenue versus approximately 70% of revenue last year. Adjusted EBITDA for the quarter was $7.7 million or 10.2% of revenue versus $1.8 million and 2.4% of revenue in the prior year. Adjusted EBITDA margins reflect improved operating and fixed cost efficiencies along with lower promotions. Free cash flow for the six months ended July 31, 2023, was negative $30 million versus negative $54 million for the same period in fiscal ’22. Let me now turn to Q3 and 2023 guidance. We are reducing revenue guidance for 2023 and now expect that 2023 revenue will be at least $296.4 million for our fiscal 2022 revenue.

We expect Q3 revenue to be between $72 million and $74 million. We are not providing specific active subscriber guidance for Q3 or fiscal year ’23 as our general expectations are reflected within our revenue guidance. We no longer expect ending active subscriber growth of more than 25% for fiscal ’23. Let me outline the rationale and underlying assumptions behind our lower fiscal ’23 revenue guidance. First, after our experimentation with promotions in Q2, we expect to be significantly less promotional for the remainder of the year. While we believe a lower level of promotions will improve customer experience, retention, profitability over time, we expect lower subscriber acquisitions in the near term. Second, revenue guidance reflects the timing of inventory in-stock improvements that we believe will impact customer experience towards the end of Q3 and into fiscal ’24.

Third, we are not reflecting all potential improvements from our strategic pillar initiative to improve customer experience or from an increased focus new leadership and more optimal inventory for our reserve business. As we saw in Q2, inventory in-stock rates have to improve before we see the positive impact from these initiatives. Finally, we ended Q2 with lower-than-expected active subscribers. We believe our second half plan, despite the expected negative impact on short-term subscriber growth are a key pillar to our path to positive free cash flow and strengthen the health of the business. Our guidance also provides business leaders with the flexibility needed to make the right decisions for the long-term health of our business. Despite lower revenue, we expect to maintain our adjusted EBITDA margin guidance of between 7% to 8% of revenue for fiscal 2023.

The Note that due to significantly higher seasonal inventory acquisition cost in Q3, we expect higher adjusted EBITDA margins in Q4 versus Q3. We expect Q3 adjusted EBITDA margins to be between 3% and 4%, and primarily as a result of approximately 300 basis points of sales in higher revenue share payments in Q3 versus Q4. We expect continued operational and fixed cost efficiencies along with lower promotions in the back half of 2023. Note that our expectations for adjusted EBITDA margins reflect lower gross margins in the second half of 2023 compared to fiscal 2022 on account of higher rental product depreciation and revenue share costs as a percentage of sales. We now expect fiscal year ’23 rental product purchases to be between $74 million and $77 million as we expect to shift dollars between marketing and rental product acquisition to further improve in-stock levels.

As a result, we expect cash consumption for the year to be approximately $2 million to $3 million higher in the range of $50 million to $53 million. While Q2 was challenging, we have transformed — we are confident, we continue to make the right decisions for our customers. Financially, we have transformed a business that consumes almost $100 million in cash in fiscal ’22 to a business that we expect will be free cash flow breakeven before cash interest expense in fiscal year ’24. We will now take your questions.

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Q&A Session

Operator: [Operator Instructions] Our first question today is coming from Rick Patel from Raymond James. Your line is now live.

Rick Patel: Thank you. Good morning, everyone. Can you talk about the assumptions underpinning the third quarter revenue guidance as you reduce promotions and marketing, what’s the right way to think about the driver count in the quarter? I know you’re planning for it to be lower, but just any guardrails there as we think about modeling? And if you can – rate trends, that would be great.

SidThacker: Sure. So if you look at our subscriber – if you look at our revenue guidance, we’re obviously not providing subscriber guidance for Q3 specifically. But if you look at our $72 million to $74 million revenue guidance, that is obviously down from Q2 level and that would – you can run your math, but that will imply a subscriber count that you can determine. Now what I want to do is try and give you a sense of the changes we’re making and why we’re issuing the guidance that we are. So we’re making a lot of changes to promotions for the year. And just to give you a sense of the magnitude of what we have decided to do. Historically, our promotions have been two months long, the current level of promotions that we’re running essentially only one month.

So we have made very significant changes in promotions. And importantly, these promotional changes form a very key part of our progress to profitability in fiscal ’24. We’re changing a significant amount as it has to do with the reserve funnel and so our guidance encompasses a whole range of scenarios. And we want to be prudent and not really factor in all of the benefits of improved in-stock, the reserve funnel. And so that’s the underlying premise behind the guidance, which is we want to be prudent. We want to make sure that we factor in all possible scenarios. And we also want to be mindful that it’s going to take a little while for in-stock levels to improve and to be felt by our customers. And some of the initiatives that we have may not be quite felt until in-stock improves.

So – it’s just a matter of encompassing all possible scenarios and being prudent.

Rick Patel: Can you also touch on marketing. I believe you talked about pulling back a little bit on the near term, but then you also talked about shifting some of that focus to reserve revenue. Just some additional color there would be great.

Jennifer Hyman: Yes. We really learned in Q2 just this criticality of inventory depth to the customer experience, especially amongst early term customers. So because we learned that while depth is up in second half, 1.7x, what the depth was in first half, we should have gone even further than 1.7x. So we thought that it was a smart decision to take some dollars away from marketing, put it towards reorders in the back half of this year that could further accelerate in-stock rate. Another way to think about this is we don’t want to market or promotionalize into an experience with inappropriate levels of in-stock rates, because early term subscribers are the ones who are affected the most by not seeing the inventory that they wanted when they were a prospect. So this is really in favor of the top priority, which is getting the in-stock rates higher, which we know really positively affect retention of early terms up.

Rick Patel: Thanks very much.

Operator: Thank you. Next question is coming from Ike Burochow from Wells Fargo. Your line is now live.

Ike Burochow: Hi. Good morning. So a couple of questions around the longer-term commentary you provided. So the free cash flow breakeven before interest expense in fiscal ’24, can you just give just a reminder, what is the expectation for cash interest expense? What is that going to be in fiscal ’24? And then is there any help you can give us around what is the revenue number that is associated with that assumption that you guys have next year? Thanks.

SidThacker: Sure. So let me – let me answer the first part of your question, which is about $12 million in – we expect about $12 million in cash interest expense in fiscal ’24. But the next part of your question, let me just address what gives us confidence that we’ll get the free cash flow breakeven in fiscal ’24, right? So there are a few key pillars here. The first is we – and let me just bridge effectively, where we will end up in fiscal ’23 to where we expect to end up in fiscal ’24. So the first thing we expect is – and we’ll provide a lot more detail later this year on all of this. But first, we expect to realize both in efficiencies versus fiscal ’23. Secondly, we expect lower fixed costs versus fiscal ’23 and fiscal ’24.

Third, and this is where the promotions and all of the customer acquisition work we’re doing plays in that we expect rental product spending in fiscal ’24 to benefit both from provisioning for much more modest levels of revenue growth as well as continued increases in mix towards more non-wholesale channel. So I think it’s important to realize that when we promote and we get customers, not only do we acquire a bunch of customers that stay with us for a shorter period of time because they’re less qualified, but we also go out and buy inventory and provision inventory for those customers. So in some ways, as we attract and really focus on higher qualified customers, we really do accelerate our progress towards free cash flow, and that’s going to be reflected in rental product spending in fiscal ’24 versus ’23.

Fourth, obviously, the promotional changes do result in improved profitability per subscriber. And then finally, we expect the modest subscriber and revenue growth we have in fiscal ’24 or we expect in fiscal ’24 to contribute to profitability and cash flow. I think the last thing I would point out is that a substantial portion of the improvement, so if you think about lower fixed cost, the fulfillment cost efficiencies, the plans we have on rental products, the promotional changes we’ve made, we’ve already made those decisions and those improvements, we have a lot of confidence in. And as the last part of it is that we’re relying only on relatively modest levels of growth in fiscal ’24. So we have high confidence that we can get to these numbers in fiscal ’24.

Ike Burochow: Great. Thanks a lot.

Operator: Thank you. The next question is coming from Andrew Boone from JMP Securities. Your line is now live.

Andrew Boone: Good morning. And thanks for taking my questions. Jen, you guys made a number of improvements to products. Can you just talk about getting customers past that 90-day threshold? Are you seeing any improvement there? How do we think about just new customers your ability to turn them into long-term customers?

Jennifer Hyman: Yes. So we saw in Q2 that fundamentally, the other improvements that we were making to the customer experience, we’re not going to be felt deeply until the in-stock rates were higher. So for early term subscribers, they come in, they expect to see the inventory that they signed up for. If they don’t see that inventory, they have a much higher probability of churn. And these were the lowest – you can ask, well, why didn’t we know this before? I think the confluence of the highest subscriber count we had ever had coming into Q1, I mean, coming at the end of Q1, coupled with the launch of our extra item plan and the fact that we already knew the depth would be a problem. We just didn’t realize how big of a problem it was.

We saw that in-stock rates were 17% lower year-over-year. And so while the retention of the longer-term customers continue to remain strong, they responded very well to the customer experience improvements we were making, we essentially saw like in stock has to go up and has to be at a better level before these improvements will start to impact those early term customers. So we still have a lot of confidence that we’re making the right changes for early term customers. As an example, we mentioned that amongst those people who sign up for our concierge program, they have higher loyalty rates than those that don’t sign up, and those are T-0 customers. But the in-stock rates now were really those improvements are in-flight. Depths are going to be up 1.7x in the second half where they were in the first half.