Revolve Group, Inc.

Good afternoon. My name is Chris, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Revolt's third quarter 2020 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you'd like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you'd like to withdraw your question, press the pound key. Thank you. At this time, I would like to turn the conference over to Eric Randerson, Vice President of Investor Relations at Revolve. Thank you. You may begin.

Good afternoon, everyone, and thanks for joining us to discuss Revolve's third quarter 2020 results. Before we begin, I'd like to mention that we have posted a presentation containing Q3 2020 financial highlights to our Investor Relations website located at investors.revolve.com. I'd also like to remind you that this conference call will include forward-looking statements. These statements include our current expectations regarding the continued impact of the COVID-19 pandemic on our business, operations, and financial results, and our outlook for net sales, product mix, gross margin, operating expenses, and capital expenditures for the fourth quarter. These statements are subject to various risks, uncertainties, and assumptions that could cause our actual results to differ materially from these statements, including the risks mentioned in this afternoon's press release, as well as other risks and uncertainties disclosed under the caption risk factors and elsewhere in our filing for the Securities and Exchange Commission, including without limitation our annual report on Form 10-K for the year ended December 31, 2019, and subsequent quarterly reports on Form 10-Q, all of which can be found on our website at investors.revolve.com. We undertake no obligation to revise or update any forward-looking statements or information except as required by law. During our call today, we will also reference certain non-GAAP financial information, including adjusted EBITDA and free cash flow. We use non-GAAP measures in some of our financial discussions as we believe they more closely represent the true operational performance and underlying results of our business. The presentation of this non-GAAP financial information is not intended to be considered an isolation or a substitute for or superior to the financial information prepared and presented in accordance with GAAP, and our non-GAAP measures may be different from non-GAAP measures used by other companies. Reconciliations of GAAP to non-GAAP measures, as well as the description, limitations, and rationale for using each measure, can be found in this afternoon's press release and in our SEC filings. Joining me on the call today are our co-founders and co-CEOs, Mike Karanikoulis and Michael Mente, as well as Jesse Timmermans, our CFO. Following our prepared remarks, we'll open the call for your questions. With that, I'll turn the call over to Mike.

Thanks, Eric. Good afternoon, everyone, and thanks for joining us today. Before we get into the details of the quarter, I'll provide some higher-level thoughts on our longer-term vision. We founded Revolve 17 years ago with the goal of becoming the fashion destination for the next generation consumer. From the beginning, our focus was on the customer experience, the utilization of data to drive decisions, and the creation of an authentic connection with our customer through our merchandise offering and marketing message. These areas of focus are still at the core of what we do today and what differentiates us and what we believe will continue to drive growth into the future. As a brand known for the discovery of on-trend merchandise centered around aspirational experiences and lifestyle content, including social gatherings, travel, and special occasions, the current environment impacted by COVID has resulted in revenue pressure in what we believe is a temporary deviation from our historical growth pattern. Despite these pressures, we have been able to leverage the investments in our platform over time to produce notable increases in margin and profitability that we are excited to share with you today. We believe the revenue pressures are temporary as people will eventually socialize in person again and travel will return. Until then, we'll continue to invest in our brand and platform to set ourselves up to take advantage of what we believe post-COVID will be a strong rebound as a result of prolonged pent-up demand. With that longer-term framework as a backdrop, there are three key financial highlights of our third quarter that I want to call out. First, we delivered record EPS of $0.27 per share, record net income of $19 million, and record adjusted EBITDA of $24 million. Adjusted EBITDA grew 66% year-over-year, and EPS grew at an even faster rate. Second, we achieved our highest ever gross margin in the third quarter of 55.3%, a nearly five-point increase from the second quarter and up almost two points year-over-year, the higher gross margin year over year was a key driver of our significant growth and profitability and reflects a high percentage of net sales at full price in the third quarter and improved inventory dynamics third we generated 14 million of operating cash flow and 14 million in free cash flow which was up 86 percent year over year on the heels of generating 54 million in operating cash flow in the second quarter we now have 159 million in cash on the balance sheet Our strong balance sheet not only provides us with the capital necessary to navigate through this uncertain time, but more importantly, allows us to reinvest in the business to drive long-term growth. I'm extremely thankful for all of our dedicated employees who have shown impressive collaboration and agility day in and day out. Even with most of our teams continuing to work from home, the organization has remained laser-focused on ensuring the safety of our employees and maintaining exceptional service levels for our customers while continuing to drive efficiencies throughout the business. Now, getting into the specifics of our third quarter results. Recall that on our second quarter investor call in August, we talked about the strong pace of recovery for much of the second quarter before net sales leveled off in mid to late June. As previously shared, our net sales in July and early August remained very slightly positive, increasing year over year in the low single digits. The modest growth trend in net sales remained consistent through the end of August. The trend changed in September, with the modest growth in July and August turning to a year-over-year decline in net sales in September, the first year-over-year decline since May of this year. For the third quarter as a whole, net sales declined 2% year-over-year, which is a 10-point improvement on a sequential basis compared to the 12-point decline in net sales reported for the second quarter. While we are pleased with the 10-point sequential improvement for the quarter as a whole, we would have liked to see a stronger close to the quarter. As we look at the recent trends, there are a few things that we believe are contributing to the top-line deceleration. First, the impact of COVID-19, and more specifically, social distancing, continues to have a significant impact on our business. Our inability to host large-scale in-person events has a lagging and growing negative impact the longer we are in a COVID-19 sheltered state. While the brand marketing team has done an incredible job pivoting into live streaming content and other avenues of engagement, it's very difficult to make up for the millions of engagement points and billions of impressions that come with our in-person events. We are excited to reverse both of these trends in what we believe will be a strong and healthy post-COVID world. Second, competition for keywords and other forms of digital advertising increased in the third quarter, particularly on a sequential basis compared to the second quarter when online advertising rates were still recovering from the March lows. We attribute the significant increase in online advertising investment in our product categories industry-wide to traditional brick-and-mortar retailers shifting their focus online given the unprecedented increase in e-commerce penetration driven by COVID-19. Third, in looking at the net sales trends from the second quarter to the third quarter, it's important to note that net sales contributions from markdowns were very strong in the second quarter, helping the top line comp. While we were able to successfully work through our markdown inventory and rebalance our overall inventory levels, the significant reduction in markdown inventory entering the third quarter led to incremental top line pressure. At the same time, a lower mix of markdown sales and shallower markdowns helped drive the very strong margins and profitability in the quarter. Aside from the strong Q3 financial results, I am encouraged by the positive impacts from continued operational enhancements on our platform and the customer experience initiatives that we continue to roll out in our international markets. Our operations team delivered phenomenal results as we saw the impact of lower return rates as well as efficiency gains from automation and other investments we've made over the last 18 months continue to provide benefits. Consider that fulfillment costs per order decreased 15% year-over-year, all the while maintaining best-in-class service levels with a record 99% of customer orders received by noon Pacific time shipping out the very same day. We believe this level of performance benchmarks very favorably compared to most other e-commerce companies. Shifting to a discussion of our international business. We had a strong third quarter in our international markets, financially and operationally. Australia, Canada, and Western Europe each delivered strong double-digit growth in net sales year over year, partially offset by a decline in Asia. One of the most important strategies we can employ in international markets is to localize the country to provide the same great experience offered in the U.S. We recently announced that, for the first time, Revolve customers in Canada, one of our top five international markets, have access to hassle-free returns at no cost, including refunds of all applicable duties and taxes. Our launch of all-inclusive pricing for Canadian customers is very important because by including duties within the price of the product upfront, we eliminate the sticker shock at checkout and significantly streamline the process for merchandise returns. Now, shifting to the more recent trends in the fourth quarter to date. The softer year-over-year net sales trends in September carried through to October with a high single-digit decline in net sales on a year-over-year basis. Similar to what we experienced in September, we continue to experience strength in the at-home categories that is more than offset by the ongoing pressure in occasion-driven categories. By geography, in October, international net sales continue to remain stronger than net sales in the U.S. However, we are very cautious due to the resurgence of COVID-19 cases and the corresponding social distancing restrictions in some of our largest international regions, including the U.K. and Western Europe. Before I turn it over to Michael, I want to reiterate how pleased I am with our ability to navigate through these challenging times. So again, thanks to all of our team members for your hard work and resilience, for staying nimble, and for your dedication to exceeding our customers' expectations.