Rent the Runway, Inc. (NASDAQ:RENT) Q3 2022 Earnings Call Transcript

Rent the Runway, Inc. (NASDAQ:RENT) Q3 2022 Earnings Call Transcript December 7, 2022

Rent the Runway, Inc. reports earnings inline with expectations. Reported EPS is $-0.56 EPS, expectations were $-0.56.

Operator: Welcome to Rent the Runway’s Third Quarter 2022 Earnings Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. I would now like to turn the call over to Rent the Runway’s, CEO and Co-Founder, Jennifer Hyman.

Jennifer Hyman: I wanted to take a moment before we begin today’s earnings call to introduce our new Head of Investor Relations, Jackie Blatt. Jackie has been a Rent the Runway for over seven years, first within our Finance Department and for the last four years as my Chief of Staff. As a result, she knows an enormous amount about Rent the Runway and I am personally very excited for her to build strong relationship with all of our current and future investors. Here’s Jackie.

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Jackie Blatt: Thanks, Jen. Good afternoon, everyone. And thanks for joining us to discuss Rent the Runway’s third quarter 2022 results. Joining me today to discuss our results for the quarter ended October 31, 2022, our CEO and Co-Founder, Jennifer Hyman; and Chief Financial Officer, Scarlett O’Sullivan. 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 this afternoon’s press release, as well as our filings with the SEC, including our Form 10-Q that will be filed in the next few days.

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. Reconciliations of 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 will turn it back to Jennifer Hyman, Co-Founder and CEO of Rent the Runway.

Jennifer Hyman: Thanks, Jackie, and thank you everyone for joining our earnings call today. We are very proud of our strong financial performance in the third quarter of 2022, as we beat both top and bottomlines of our guidance. We posted record quarterly revenue of $77.4 million, demonstrating strong 31% year-over-year revenue growth. We have seen an improving trend in subscriber acquisition, pause and retention rates since the end of Q2, as our Q3 ending active subscriber count grew 8% quarter-over-quarter. Despite the uncertain consumer environment, this tells us that our offering is still resonating with our target consumer. This quarter we delivered a gross margin above 40% for the second quarter in a row. We also posted a very strong adjusted EBITDA margin of 8.5%, our second consecutive quarter of positive adjusted EBITDA, beating our Q3 guidance and demonstrating adjusted EBITDA profitability significantly ahead of the timeline we shared at IPO.

In the third quarter of 2022, we largely completed our restructuring plan to reduce costs, streamline our organizational structure and drive operational efficiency, which was previously announced in September. As a reminder, the restructuring had three main objectives. First, to transform the cash flow profile of our business, at approximately $400 million in revenue we expect to be able to reduce annual cash burn before interest expense to approximately $30 million. Second, to accelerate our path to breakeven on adjusted EBITDA after taking into account product depreciation, which we continue to expect to achieve in the near-term. Finally, and perhaps, most importantly, to allow us to reinvest into delivering value to our customers. The brands we offer are unmatched by other fashion rental companies and our cost actions allow us to deliver even more Rent the Runway to customers.

Posting growth in our active subscriber count this quarter in a tough macro environment is a step in the right direction, but we are not satisfied. We are encouraged by recent performance trends as this Cyber Monday marked our second-highest subscriber acquisition day in company history. As I will outline, we intend to further accelerate growth. Our plans for 2023 are bold and focus on providing our customer with even more reasons to love their Rent the Runway subscription. I am confident we will look back on 2023 as a year where we gave our customers more value, more choice and a better experience overall. Before I discuss where we are going in more detail, I want to take a step back and acknowledge how far we have come. I founded Rent the Runway over 13 years ago, and in this time, we created the market for fashion rental, where there was none before and have driven broad acceptance of secondhand apparel.

In fact, our unaided awareness as the clothing rental service is 21%. In other words, 21% of women in our target demographics when asked to name a clothing rental service, say, Rent the Runway. I am really proud of that. I have never felt more confident in our opportunity to thrive and deliver tangible value to our customers, both because of what we have accomplished over the past few years and because of the plans we have for 2023 and beyond. Rent the Runway is not only already a larger business in 2022 than we were in 2019, but we are also fundamentally a stronger business in three key ways; first, we have built a more powerful revenue platform; second, we have transformed the cash needs of the business by innovating the way we acquire the fashion we rent; and third, we have dramatically improved our underlying cost structure.

Now I will discuss how each of these levers makes us stronger today than three years ago. First, we have strategically built a more powerful revenue platform with multiple engines of growth, subscription, a-la-carte rental and resale that help us to capture the opportunity ahead of us and a large TAM customers who come to us for diverse reasons in different life stages. We are the only platform to offer all three of these revenue engines in one place. In 2019, resale was only available to our subscribers and now anyone can buy the fashion we have on our site. In addition, we have doubled the penetration of high margin add-on revenues since 2019 amongst our subscribers, by giving them the ability to personalize their programs. In the first nine months of fiscal 2022, nearly 30% of our subscribers have paid for at least one add-on slot.

Our customer base is more diverse than ever before. Since 2019, we have seen a 14-point increase in the geographic diversification of our subscriber base away from our top five MSAs. And they use Rent the Runway across more use cases, broadening our utility in their lives. In 2019, customers used their subscription for work in special occasions, 55% of the time. Today, they use us for casual everyday life, 55% of the time. This means she’s renting items like denims, sweaters, winter coats and handbags from us. Things that keep subscribers sticky in this program even when they don’t have special events. That said, we are thrilled by the success of special occasion wear and workwear on our platform this year. We have seen and are continuing to see near record highs in terms of special occasion utilization, as well as nearly double the workwear demand in 2022 compared to last year and we still believe there is opportunity here.

Second, it’s hard to overstate how much we have transformed how we acquire the fashion our customers love and how this has changed the cash needs of our business. In fiscal 2022, Share by RTR and Exclusive Designs are expected to together comprise around 60% of our product acquisition versus 26% in 2019. In 2019, we spent $118 million on upfront purposes of rental products, compared to our estimate of approximately $60 million this year, despite being a larger business. Further, we bear considerably less risk, as 30% of our inventory is procured on consignment. Finally, we have made significant advances in using our customer data and brand relationships to manufacture another 30% of inventory at significantly lower than wholesale costs via our Exclusive Designs.

These designs are desired by our customers, and as Scarlett will discuss later on the call, show early signs of being sought after by other retailers. Over these three years, we believe we have also become an even more important partner to our brands, who value us for customer acquisition and data insights. In short, we believe our inventory leads the market in terms of quality and provides us with an enduring cost advantage. The third key transformation to our business since 2019 is our vastly improved cost structure and margin profile. The changes we made to our subscription program since 2020 have resulted in a 16-point reduction in fulfillment as a percent of revenue, which has decreased from 46% in 2019 to 30% in Q3 2022. As a result, we doubled our gross margins since 2019 to 41% in Q3 2022.

Moreover, we restructured our fixed cost base allowing us to significantly improve the overall profitability of the business. In summary, these major changes to our business model over the past three years have a quantifiable and meaningful impact. The fact that our customers are more diverse and are using us for a wider variety of use cases means they have higher retention and stick with us longer, resulting in a long tail of loyal long-term customers. Our improvements to fulfillment and product acquisition costs mean we have gross margins after fulfillment costs that are better than many traditional retailers and online peers. All in as previously shared, at around $400 million in revenue, we expect to reduce annual cash burn before interest expense to approximately $30 million in the near-term.

Shifting to this year, we are proud to have laid three primary foundations in 2022 that we believe will set us up for an exciting path forward in the next year. The first is our customer experience foundation. Our conversion and loyalty and thus our growth, our reliance on women’s seamlessly browsing, finding and receiving inventory they love. Over the last 13 years, we believe we have collected more unique product metadata than many other retailers. Data on everything from fit to quality, customer feedback and reviews, attribute, garment longevity, style, sizing, occasions and the list goes on. Despite amassing this incredibly rich inventory database as one of our biggest competitive advantages, our technology is just now beginning to connect our data mode into the customer experience.

This year we completed key foundational work to connect our proprietary inventory data system into our on-site search and discovery experiences. As a result of this, we expect that we will be able to significantly expand the way our customers are able to browse our site next year. In Q3, we also launched ElasticSearch, a third-party industry leader in enterprise search technology, which coupled with our enhanced product catalog is expected to provide a much richer search experience to our customers. Second is our technology foundation. We made improvements across our tech stock in 2022 in order to enable greater scale, enhanced resiliency and faster site speed. This year we completed our migration to the cloud, an important milestone, which we think will be key to unlocking even better resiliency, performance and reliability, increased developer velocity, as well as the ability to scale more efficiently to subscriber growth.

Next year we plan to build upon this work to improve our site speed even more, which we believe will help us improve conversion. Lastly, in 2022, we solidified our fashion foundation by expanding our Exclusive Design capabilities and launching our first celebrity collection. Throughout 2022, we co-created Exclusive Design with a total of 18 brand partners, half of which were new to the program. We have increased the number of factories we work with, which has enabled us to manufacture more categories of clothing. For example, as a result of this diversification in our production capabilities, for the first time, our Exclusive Design channel is set up to manufacture black tie and evening wear, two of the most expensive categories we procure, where the relative cost savings versus wholesale are significant.

This is an important lever as we continue to reduce our upfront cost per unit. Most recently this November, we launched our first celebrity collection with Ashley Park, the Co-Star of Netflix’s Emily in Paris. Celebrity collections enable us to develop fashion that our customers love, while simultaneously providing built in marketing as a result of the brand heat and cultural relevance of the personality. Ashley Park has a social following over — of over 2.4 million across her platform and has been actively engaged in organically promoting the collection and Rent the Runway. To-date, around the launch of our capital selection with Ashley, we have been able to leverage her media bug for over 1 billion earned media impressions and counting. Last call we spoke about how even just small improvements in conversion and retention like the ones I just discussed, can have a substantial impact on growth and are within our control.

We think that providing more value and a better user experience to our customers are key drivers of influencing these metrics. The purpose of our key 2022 investments is to deliver more to the customer in 2023 and to iterate quickly to accelerate growth. We will share more detailed plans on our Q4 call, but we believe 2023 will be a transformative year for Rent the Runway. Our plans are informed by a deep analysis of customer data, as well as by constant experimentation and testing. Our customers can expect to see significant improvements in plan design, site experience and in the clothing they love. In a tough macro environment, with inflation and price consciousness top of mind for many consumers, Rent the Runway plans to lead by offering more value and more fashion to our customers, as our customers benefit, so too should our brand partners.

We expect these changes to provide lasting benefits for growth well past 2023. With that, I will turn it over to Scarlett.

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Scarlett O’Sullivan: Thanks, Jen, and thanks, again, everyone, for joining us. I will provide an overview of our third quarter results for fiscal 2022 and we will end with guidance for the fourth quarter and full year. In Q3 we generated record revenue of $77.4 million, up 31% year-over-year. Ending active subscribers increased 15% year-over-year to $134,000, up 8% quarter-over-quarter. Total subscribers increased 17% year-over-year to 176,000 subs and up 2% quarter-over-quarter. As we pointed out last quarter, the macroeconomic environment remains tough and has had an impact on our business. Our active subscriber growth this quarter versus Q2 reflects 2 key factors; first, our acquisitions improved in Q3 versus a seasonally weaker Q2; second and with the benefit of more data from Q3, we believe that the reaction by customers for our April price increase was a significant contributor to our elevated levels of churn and post activity in Q2.

As customers have adjusted, we have seen reduced rates of churn and pause in Q3. We also believe that this affected our Q2 acquisitions to some extent. In Q3, we have also seen a slightly higher proportion of new subscribers going into our lower price program, which we factored into our expectations for Q4. As Jen mentioned, we have plans for next year that are designed to accelerate subscriber growth. Rent the Runway has solid site traffic that we believe we could do more to monetize and that’s why we are focused on strategies that drive conversion and loyalty. Our strong revenue beat versus our guidance was primarily due to strength in ARPU, driven by add-on spots and solid other revenue performance. 28% of active subs paid for one or more add-ons in the quarter.

We are pleased that our subscribers are willing to spend more with us despite the inflationary environment. We are increasing our ARPU estimate for the year to be up approximately 7% for fiscal year 2022 versus last year. We also saw a healthy performance in our reserve business, which continues to be a strong funnel of new customer growth. Reserve orders from new customers in Q3 were up 27% year-over-year and 46% quarter-over-quarter, with the proportion of high formality rentals higher than last year and near record high in terms of utilization. We successfully increased assortment in Q3 real-time to address the increased need for special events preparing us for Q4 and fiscal 2023. Other revenue represented 11% of revenue in Q3 versus 8% in Q3 2021 and up 83% year-over-year.

We saw a 14% increase in average items bought by subscribers in the quarter versus Q2 2022 and a 53% increase versus Q3 2021, resulting in 84% of total revenue being generated by subscribers in Q3. Other revenue also included $1.6 million from a pilot-to-wholesale brand new Exclusive Designs to a third-party, showcasing demand for our products from other retailers and the consumer appeal of our design. We generate strong margins from Exclusive Design sales, given the low cost of these items. It’s too early to see how this pilot will evolve, but we believe it highlights the power of the Rent the Runway data and platform, and the monetization opportunities of our products. Our Q2 gross margin of 41% was 7 percentage points higher than prior year.

Fulfillment costs as a percentage of revenue came in at 30% versus 33% in Q3 2021, primarily due to higher revenue per order. We improved transportation cost per shipment versus Q2 2022 by negotiating lower carrier rates and optimizing carrier and ship method mix, including a higher penetration of at-home pickup. We expect higher fulfillment cost per shipment in Q4 as we typically would see seasonally and now expect fulfillment costs as a percentage of revenue for the full year 2022 to be approximately 32%. Total product costs came in at 29% versus 34% last year, with rental product depreciation at 18% of revenue versus 23% in Q3 2021 as it was absorbed over a higher revenue base. We now expect gross margin to be up approximately 400 basis points versus full year 2021.

Q3 adjusted EBITDA continued to be positive and came in significantly ahead of our guidance, at $6.6 million versus negative $5.6 million in Q3 last year, representing a positive 8.5% margin and an 18-point improvement versus negative 5.5% — negative 9.5% in Q3 last year. Our total operating expenses, marketing, technology and G&A represented 63% of revenue, compared with 101% in Q3 2021. Employee expenses in Q3 saw the partial positive impact of the restructuring. We largely expect the full impact in Q4 as we still carry approximately $2.4 million of employee expenses in Q3 that will go away by the end of Q4. As expected, when we provided guidance last quarter, we saw sales from a new liquidation partnership. Proceeds came in higher than anticipated this quarter, positively impacting the G&A line, where we usually recognize the net impact of liquidation sales by approximately $2.5 million this quarter.

We partnered with a new third-party retailer to broaden our liquidation network and drive additional monetization of our products, while giving our rental garments a second life. Overall, the Exclusive Designs pilot and new liquidation partnership together contributed approximately $4.6 million to adjusted EBITDA. Even without these deals, we have made significant progress driving adjusted EBITDA to be positive, especially for our third quarter, which historically sees lower profitability. Going forward, as you will hear when we discuss guidance, we expect to continue to generate a strong positive adjusted EBITDA margin, reflecting the increased profitability of the business and full benefit of the restructuring. We are choosing to be opportunistic and take advantage of the current retail slowdown to buy attractive inventory from our brand partners at discounted prices.

This pull-forward some of next year’s buy into this year. Our anticipated cash usage now reflects incremental product spend this quarter. As a result, we currently expect our fiscal 2022 free cash flow margin to be slightly lower versus last year. A couple of housekeeping items I want to call out for the quarter. The restructuring-related severance charge came in at $2 million in Q3. In addition, we decided not to move forward with a long-term CapEx project in our warehouses as part of our restructuring work and we recognized a largely noncash loss of $3.8 million due to the asset impairment. Our Q3 results reflect our improved quarter-over-quarter subscriber trends and we believe showcases the strength of our offering and how it resonates with customers even with this macro backdrop.

So we are pleased to be raising guidance. We continue to be an uncertain macro environment, and as we have mentioned, we typically see a higher rate of churn and pause in January due to the seasonality of our business at that time of year. For Q4, we expect revenue of $72 million to $74 million. We expect a positive adjusted EBITDA margin of 4% to 5%. In terms of full year, we now expect revenue in the range of $293 million to $295 million, representing 45% growth at the midpoint of the range versus full year 2021. Our adjusted EBITDA margin guidance for full year is revised to positive 1%, reflecting our strong Q3 performance, our cost discipline throughout the year and the cost restructuring employee base by the end of Q4. We have made a few weeks of our full year expectations for a few other items, so please refer to the guidance page of our earnings deck on our website.

For fiscal 2023, we are not providing revenue guidance at this time, but I want to reinforce a few important points. First, as Jen mentioned, we are excited about our plans in fiscal 2023 and believe they will be impactful for growth. Second, we are reaffirming the estimated restructuring annual OpEx reduction of $25 million to $27 million for next year versus a Q2 2022 run rate, which is expected to boost adjusted EBITDA for next year. This means that we anticipate reducing annual cash burn substantially versus this year. This is expected to hold even if revenue growth is lower next year due to macro or other factors. We will provide additional details on our Q4 call. In the medium-term, we intend to maintain strict cost discipline and anticipate higher flow-through on incremental revenue, generating approximately 30% adjusted EBITDA margin.

That represents a 15% margin on adjusted EBITDA less product depreciation. At that level, we believe we would be free cash flow profitable, fully internally self-funding the business even at strong growth rates and we aim to get there with the cash we have on hand. We continue to be intensely focused on balancing robust growth with profitability and we will seek to strike the right balance to attain both objectives and maximize the long-term value of Rent the Runway. With that, we are happy to open it up for questions.

Q&A Session

Operator: Thank you. Our first question is from Edward Yruma with Piper Sandler. Please proceed.

Abbey Zvejnieks: Hi. This is Abbey Zvejnieks on for Ed. Thanks for taking our question. Just, first of all, in terms of the favorable terms on getting inventory in this excess inventory environment, can you talk a little bit about that and then the kind of flow-through impact on product depreciation going forward? And then on the brand seeking this data and this new marketing funnels in the current environment, can you talk about any potential to be more of a partner with these brands maybe from an advertising perspective on Rent the Runway? Thank you.

Jennifer Hyman: Yeah. So, first, I want to address what makes us different than most other retailers and why this environment where there’s kind of softness in overall retail is positive for Rent the Runway. Most of the retailers have to clear through 2022 inventory in 2022, because there won’t be any relevance of that inventory on a go-forward basis. We have proven over the past 13 years, that there is demand for and we monetize our inventory over multiple years. What the customer cares about is when she comes to Rent the Runway, she wants to wear something new every single time she comes. She doesn’t care if that new thing that she’s wearing is from last year or from a week ago or from a few years ago and we keep that inventory in high quality conditions for multiple years.

So we can be opportunistic right now in the market, whereas everyone else needs to be promotional. So what we are doing is we are going to our 800-plus brand partners, we are looking at what they have available and we are acquiring inventory at very healthy discounts pulling forward some of the inventory spend that we would have spent in 2023. Now the other thing that is great about the environment that we are in. It’s the very inventory that is available right now is inventory that is the highest performing inventory at Rent the Runway. So what we are seeing from our brand partners is the most fashionable inventory that isn’t selling in store. The most colorful inventory, the trendiest inventory and that is exactly what performs the best on Rent the Runway.

So not only are we getting inventory at a discount, we are getting the best inventory from some of our best brand partners at that competitive pricing. Now. of course, this will help to further accelerate upfront cost per unit going down and that decreases the depreciation expense.

Scarlett O’Sullivan: Abbey, what I would say here is, this is part of the overall philosophy that every year we want to be showing improvement in our upfront cost per unit. The items that we are acquiring is a combination of our three different methods. So, obviously, the ones where we own will have a nice impact on product depreciation. Some of them could be with assignment deals, which is also great for us that we can do that even in this environment and that would show up in the revenue share line.

Jennifer Hyman: And one other point, the 800-plus brands that we work with are luxury or designer brands. So clearly, a highly promotional environment like the one that we are in right now is extremely brand dilutive to them. They have a choice. They could either mark their inventory down on sale or on clearance or they can work with Rent the Runway often through our consignment channel, which is brand accretive to them. We don’t mark down the inventory on our platform. We are displaying the original retail price and by nature of putting it up on Rent the Runway, they are getting access to new younger customers. So it’s really a win-win for the brands of being brand accretive and adding to customer acquisition in an environment where that matters more than ever.

Abbey Zvejnieks: Thanks. And then maybe just one more, can you just elaborate maybe a little bit on the wholesale partnership for liquidation and then will that continue in 4Q and how should we think about kind of the go-forward benefit to adjusted EBITDA from that? thanks.

Jennifer Hyman: Yeah. So this pilot is really exciting and it showcases the consumer appeal and demand for our Exclusive Design products from other retailers. So, as Scarlett mentioned, we already generate strong margins from

Scarlett O’Sullivan: Yeah.

Jennifer Hyman: that is design sales.

Scarlett O’Sullivan: Exclusive Design partnership, Abbey, I think, you are asking also about the liquidation part we will talk with about those.

Jennifer Hyman: We will talk about those. So we generate strong margins from Exclusive Designs, because of the lower cost of these items. And so for us, it’s too early to say how the pilot is going to evolve, but we really believe it highlights the power of the Rent the Runway data and our platform, and monetization opportunities of our products. Scarlett, do you want to talk to the partner — the liquidation partner?

Scarlett O’Sullivan: Yeah. So here we are always looking to expand our network of partners. It’s great for us to be able to have more partners that we are working with to be able to give our items a second life and to really create more opportunity for initiation. So we were really excited to see this partnership. It was a pretty significant one. Nothing — no plans on a go-forward basis just yet, but for both of these, I think, they really showcased the power of our data, the appeal of our design, as well as the appeal of our items that we believe are at the end of their rental line and yet still have another life somewhere else.

Abbey Zvejnieks: Okay. Thank you.

Operator: Our next question is from Michael Binetti with Credit Suisse. Please proceed.

Michael Binetti: Hey, guys. Thanks for taking my questions here. You mentioned the pricing a little bit of hindsight here, diagnostics on the price increase in April, causing a little bit of churn in the second quarter that you think improved in third quarter. I know a lot of the vendors you deal with are still seeing some inflation today. Do you anticipate needing to take price next year, and if so, maybe any learnings you can point to on, as you look back at April and help you navigate that if the consumers still in value seeking mode with share household budgets?

Jennifer Hyman: Yeah. So, first, on our Q2 call, we were going through some of the various reasons we thought why there might have been softness. And with the benefit of more data in Q3, we think that the reaction that our customers had to our April price increase was a significant contributor to the elevated levels of churn and pause activity that we saw in Q2. And the good news is as customers have adjusted, we have seen increased acquisition, reduced rates of churn and reduced rates of pause activity in this past quarter Q3 compared to Q2. So, the price increase we believe was the right thing to do at the time. We have been very focused on driving profitability as you know and there was a lot going on in the macro environment, our input costs were getting higher and we have seen a significant positive impact of that price increase in that revenue per order has gone up.

You have seen it reflected in our profitability and our gross margin. Having said that, we take our obligation to provide value to our customers very seriously and our focus next year is all about how do we deliver even more value to the customer. We are very excited about the plans that we have in place.