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.

Thanks, Mike, and hello, everyone. The strength of our business, the power of our brand, and most importantly, the incredible execution of our team enables us to deliver our most profitable quarter ever. even surpassing our record profitability from last quarter. I'm truly proud of how much our team has accomplished during this extremely challenging period. This phenomenal execution has further strengthened our financial profile and positions us well to capitalize on the long-term opportunity ahead. To expand on Mike's opening remarks, we are focused on building the fashion destination for the next generation consumer. Our customer comes to us for discovery and looks to us for inspiration. Even during this unique and challenging time, these shopping behaviors remain. We continue to provide a broad yet curated assortment of the most on-trend merchandise that provides her with the ability to discover products that suit her lifestyle, whether it's travel and social occasions, most recently a more stay-at-home and active lifestyle. To complement our merchandise offering, we provide her with content inspiration through authentic and aspirational lifestyle content. Important to this authenticity is providing content that connects with their own platforms she's engaging with and speaks to what's happening in her life. The team has done a great job of expanding into emerging social platforms and providing content centered around her current lifestyle. I'm excited about the progress we continue to make on the merchandising and marketing front and believe that despite the challenges of the last couple quarters, we will emerge much stronger and even better positioned for the long term. Starting with our merchandise, the ongoing reality of a more stay-at-home lifestyle has allowed us to further deepen the relationship with our customer by highlighting our offering of incredible fashion and design in areas that were not top of mind until very recently. Our emerging categories such as beauty, intimate, and loungewear are all strongly resonating. Additionally, more than ever, our customer is demonstrating a healthy and active lifestyle, leading to a greater opportunity in activewear and swimwear. Our results for the past two quarters demonstrate our ability to serve a customer in new ways and broaden how customers perceive Evolve's product selection. In the third quarter, sales in the at-home and active categories of beauty, accessories, intimates, sweaters, knits, and swimwear increased approximately 50% year-over-year on a combined basis. By further enhancing our merchandising strategy, we believe we can expand our share of our wallet over the long term. It's incredibly important to us that whatever our customer needs, she can always come to Revolve as a trusted source of style. An exciting example of one of the more prominent shifts in our mix is the beauty category, with net sales increasing more than 100% year-over-year for the second straight quarter as COVID-19 has been a catalyst for shifting beauty sales online. Beauty is a category where the majority of customers in our demographic look to influencers for beauty product inspiration, a great fit with our global network of influencers. In fact, this month we are launching a beauty gift box with mega influencer actress and model Shay Mitchell, who has nearly 30 million Instagram followers. An important component within our long-term merchandising strategy is the expansion of our own brands. As we discussed on previous calls, we temporarily pulled back our own brand offering as a response to the uncertainty and demand pressures introduced by COVID-19. The result was a chaff in the number of new styles delivered in the quarter. We already started making the investments necessary to increase our style production and assortment with a target 50% increase in the number of own brand styles delivered as we exit the year as compared to the third quarter. Additionally, we had discussed making investments into the own brand division to increase the diversity and quality of our product offering. I'm pleased to report that the early results are extremely encouraging with a significant improvement in productivity per style as compared to the same period last year. While we are optimistic on the trajectory of our own brands, bear in mind that despite the increase in new styles delivered in the coming months due to inventory dynamics, we still expect a sequential decline of our own brand penetration in the fourth quarter of 2020, before beginning to increase sometime in mid-2021. Shifting to a discussion of our brand marketing strategy, we continued with a successful digital playbook in the third quarter, hosting several well-attended virtual events. Similar to the shift in merchandising focus in this COVID period, we have also broadened our marketing message to address more aspects of our life. This was the concept behind Revolve U, an event we had been developing even before COVID. Posted in late September, Revolve U was a week-long virtual activation that included seven keynote speakers and over 300 influencers. This unique event increased our reach and followers across multiple social channels and featured content focused on topics such as the business of social media, building a brand, career journeys, mental and physical health, and entrepreneurship. While we continue to expand and invest in new digital platforms such as IGTV, Instagram Reels, YouTube, and TikTok, we're also excited to share that we have recently hosted a series of successful in-person events called Camp Revolve that included adherence to comprehensive safety precautions. Dipping our tool back into in-person events is important to build the brand and differentiate ourselves. Furthermore, our in-person events have to capture more eyeballs, garner more press, and generate more customer interactions, all of which are important drivers of traffic and new customers. We are excited about a future that will include hosting regular in-person events with the added element of our new digital playbook, which we believe will be a very powerful combination. We are executing well while continuing to invest in our key growth initiatives during this challenging period. At Revolved, we are always focused on the long term, and I'm confident we are well positioned to capture further market share in the years ahead, particularly with what we believe is an accelerating and permanent shift to digital commerce. With that, Jesse will close out with some additional detail on the financial results and trends.

Thanks, Michael. As our results attest, we have continued to execute well in a very difficult environment. For the second straight quarter, we achieved record net income and record adjusted EBITDA. We generated strong free cash flow that strengthened our balance sheet, and we drove our highest inventory turns in several years. Now, starting with the third quarter results, net sales decreased 2% year over year. As Mike mentioned, we began the third quarter with low single-digit growth in July and August that was offset by a larger single-digit decline in September. Occasional air product categories faced the most significant headwinds since many special occasions remain on pause due to social distancing concerns, and as we worked through our markdown inventory in those categories in the second quarter. To provide some context regarding the impact of reduced markdown inventory on net sales in the third quarter, our largest category, dresses, is a good example. If year-over-year growth in markdown sales of dresses alone had remained consistent between the second quarter of 2020 and the third quarter of this year, our total net sales would have actually increased year-over-year in the third quarter. drilling further into the top line for the third quarter by segment revolve segment net sales decreased four percent and forward segment net sales increased nine percent year-over-year active customers were 1.5 million an increase of five percent year-over-year the trend is consistent with our commentary last quarter that we expected growth and active customers to further decelerate as the trailing 12-month metric captured a larger number of quarterly periods impacted by covid as compared to the high customer growth quarters of last year. With the continued pressures on traffic and demand, we expect further deceleration in this metric until we start to cycle out of the suppressed COVID period. Orders placed were 1.1 million, a decrease of 4% year-over-year. Average order value was $232, an increase of $204 in the second quarter of 2020, but remained 16% lower compared to Q3 of 2019. The year-over-year decline in AOV was primarily driven by a shift in net sales mix to at-home product categories, such as beauty and loungewear, with lower average price points, and a decline in net sales of dresses, which carry higher average order values. These AOV headwinds were partially offset by a higher mix of full price sales, our highest full price sales for a third quarter in over 10 years, as well as a greater sales mix attributable to our higher price point luxury segment forward. Partially offsetting the lower number of orders and the lower average order value was a decrease in merchandise returns year over year. we attribute the lower return rate year over year to a combination of more deliberate purchasing behavior by consumers during the COVID-19 pandemic, as well as a COVID-19 driven shift in mix to product categories with lower price points and lower return rates, such as beauty, and away from occasion wear, such as dresses, a category with a higher than average return rate. That said, we did experience a sequential increase in the return rate from the second quarter, but it remains well below the prior year periods. International net sales increased 18% year-over-year, outperforming the 6% decline in net sales in the U.S. As Mike mentioned, we experienced strength in western regions and emerging markets, partially offset by weakness in Asia. Moving to gross profit, consolidated gross margin was 55.3%, the highest ever reported for a third quarter and an increase of approximately 160 basis points over the prior year. This performance was much better than we anticipated and reflects healthy increases in margin across both segments. Within the revolved segment, we delivered growth margin of 57.2%, up approximately 180 basis points year-over-year. The revolved segment margin benefited from meaningfully improved inventory dynamics exiting the second quarter of 2020 that contributed to a healthy inventory balance, leading to a year-over-year increase in the percentage of revolved segment net sales at full price and a decrease in the depth of markdowns. These positive contributors to gross margin were partially offset by a year-over-year decrease in the mix of owned brands as a percentage of revolved segment net sales, consistent with the outlook we shared on recent investor conference calls. Within the forward segment, we delivered gross margin of 42.9%, an increase of approximately 190 basis points year-over-year. The increase reflects a healthy inventory balance, shallower markdowns, and a favorable mix of merchandise sold. We were encouraged to see an easing of promotional activity across the luxury space in Q3. And now, moving to the cost structure, where we delivered highly efficient results. For the second straight quarter, we achieved leverage on every major expense line item in the P&L. Starting with fulfillment, the final cost was 2.8% of net sales, an improvement of about 60 basis points year on year. The team did an outstanding job driving efficiencies while maintaining our top priority of protecting the health and safety of our employees and delivering a best-in-class experience for our customers. The automation launched last year was further expanded during the second quarter and is delivering a compelling return. We also continue to benefit from cost efficiencies resulting from a lower return rate year over year. Selling and distribution costs were 13.8% in net sales, an improvement of approximately 80 basis points year over year. Once again, we benefited from reduced shipping costs due to lower returns and, to a lesser extent, efficiencies in payment processing and customer service costs. Marketing costs were 12.5% of net sales, a decrease of approximately 250 basis points year-over-year. Marketing efficiency primarily reflects reduced brand marketing investments since hosting in-person Revolve events remained on pause. Our investment in brand marketing decreased by $3.2 million year-over-year, and performance marketing investments decreased by the remaining $1.1 million in Q3. It is important to note that our brand-building investments will remain a key component in our long-term growth algorithm, so we do not expect the total marketing expense as a percentage of net sales to remain at the reduced levels we have reported for the past two quarters. General and administrative costs were 11.7% of net sales in the third quarter, an improvement of approximately 60 basis points year-over-year. The reduced G&A costs reflects lower headcount and our COVID-19 cost containment efforts that were in place for a portion of the third quarter. In addition, as part of the Own Brands Reset that was accelerated due to COVID, we reduced costs in this area. As we start to rebuild and design into new product categories and get ahead of an anticipated return of demand, we will reinvest in this area over the coming quarters. For the third quarter of 2020, we achieved record net income of $19 million, or 27 cents per diluted share, more than doubling the 13 cents in diluted EPS in the prior year. In addition to our strong operating results, our EPS comparison benefited from a lower tax rate in 2020. primarily due to excess tax benefits realized as a result of stock option exercises. Even when excluding these discrete tax benefits, our net income and deleted EPS would have each increased more than 65% year-over-year. We also reported record adjusted EBITDA of $24 million, an increase of 66% year-over-year for a margin of 15.9%. Moving to the cash flow statement, we had another outstanding quarter for cash flow generation. Free cash flow was $14 million, a year-over-year increase of 86%. For the nine months ended September 30, 2020, free cash flow was $74 million, more than doubling our free cash flow reported for all of 2019. The strong cash flow generation significantly strengthened our balance sheet and liquidity. Cash and cash equivalents as of September 30, 2020, were $159 million, an increase of $8 million during the third quarter, despite the repayment of $9 million on a revolving line of credit. As we look ahead and think about capital allocation and the use of cash, our number one priority is fortifying our balance sheet to position us to invest in growth as we exit the COVID era. followed by strategic organic investments to drive long-term growth. Given our capital efficiency, we also have the opportunity to explore other investments, including opportunistic and disciplined M&A. We are pleased with our inventory levels and the healthy inventory dynamics in the quarter. We ended Q3 with $74 million in inventory, a year-over-year decrease of 29%, but up $9 million from the second quarter as we started to reinvest to build a sufficient inventory level and appropriate inventory mix to support demand. By comparison, our net sales decreased year-over-year by only 2%, which illustrates our significant improvement in inventory returns. Now, let me talk about the business trend since the third quarter ended on September 30th. Given the fluid and uncertain environment that we continue to operate in, we'll again skip any traditional guidance. Instead, we will share some recent trends and assumptions to help in your modeling of the fourth quarter. Starting from the top, as Mike mentioned, net sales in October were down by a high single-digit percentage year-over-year. In terms of product categories, we continue to see strength in new at-home categories that has been offset by continuing headwinds in occasion-wearing categories such as dresses and skirts. From a macro perspective, we see a great deal of uncertainty affecting our customer demographic. COVID-19 cases around the world are reaccelerating, leading to increased restrictions on social outings that have been a key driver for our brand. When combined with the high unemployment rates and lack of new U.S. stimulus measures, we see continuing challenges in the current environment. Shifting to growth margin. The Q3 gross margin performance was well ahead of our initial expectations, benefiting from a higher mix of full-price sales and shallower markdowns. Moving to Q4, we expect gross margin to come in more in line with the prior year fourth quarter gross margin of 53%, as a result of a lower mix of own-down sales year-over-year, as well as what we expect to be a prolonged holiday promotional cadence. For our selling and distribution and fulfillment cost line items, We expect the combination of selling and distribution and fulfillment expenses to be flat to slightly higher than the percentage of met sales in the fourth quarter when compared to Q4 of 2019. There are a couple of factors contributing to this assumption. First, as you've all heard, the major shippers are imposing surcharges on packages during the fourth quarter that are likely to drive higher shipping costs in Q4. Second, fulfillment and selling and distribution have each realized efficiencies from the lower return rate year over year. In fulfillment, we incur lower labor costs due to less time spent handling the returned units that come into the warehouse. And in selling and distribution, where the majority of the costs are shipping related, fewer returns means reduced shipping, packaging, and payment processor costs. Since bottoming out in the second quarter of 2020, our return rate has been increasing with each passing month. So we are planning for a sequential increase in costs as a result. We do, however, expect our return rate in the fourth quarter of 2020 to remain lower on a year-over-year basis. These cost pressures will be partially offset by continued efficiencies realized as a result of the automation and process improvements discussed earlier. Marketing. We are planning for marketing as a percentage of net sales in the fourth quarter to remain approximately flat year-over-year. After two straight quarters of significantly reduced marketing spend and with our strong balance sheet, we believe it's time to start pushing our marketing investment again to continue to build the brand, drive traffic, and increase customer activity. General and administrative. On a year-over-year basis, we are planning for GMA expense to be lower in the fourth quarter as compared to the prior year. Compared to the third quarter of 2020, we expect the GMA expense to increase in Q4 since the temporarily reduced salaries and wages have been fully restored to their pre-COVID levels for our active employees. To recap, we believe we have executed well during what is a very challenging environment with a focus on safety for our employees, efficiency in our operations, and building a strong balance sheet. With a healthy base of inventory and our cash balance, we are shifting back into investment mode. with an increase in our marketing investments, an increase in our inventory levels and assortment, and investments into our own brand capabilities. Now, we'll open it up for your questions.

At this time, I would like to remind everyone, in order to ask a question, press star and then the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Our first question is from Edward Irma with KeyBank Capital Markets. Your line is open.

Hey, good afternoon, guys. A couple quick ones for me. I guess first, as you think about inventory, you know, you talk about mobility hopefully improving at some point in the short to medium term. You know, when you start rebuilding inventory in anticipation of improved sales trends, and then I guess second as a follow-up on the marketing, which I think you guys indicated you're leaning into, you know, are there particular categories you're going to lean into? Is this kind of to hopefully keep top of mind as we head into a stronger sales period? Kind of what's the direction you hope to take that into? Thank you.

Hey, Jeffrey. Mike here. So with regards to inventory, we've already begun building up our inventory position, certainly from the lows, and we think that'll have beneficial impacts on the sales trends. Of course, at the same time, it's a very uncertain environment, we think, until we get to more of a post-COVID world. And it's not just about the overall inventory levels, right? It's about those categories. So we're placing calculated bets at the appropriate level so that we can balance our revenue goals and our profitability goals. And I think he won't really see us put our foot on the accelerator until the timing is a bit more clear in terms of when the post-COVID world hits. But there's definitely going to be some level of calculated risk-taking in advance of that window to make sure that we're poised to take advantage of that world, which we think is going to be a fantastic world for us. There's going to have been a year or more of pent-up demand from consumers who haven't been able to do the things that they love, these special social occasions that we're known for. And so we want to make sure we're ready and positioned with our inventory and marketing to take advantage of that situation as soon as it comes.

Our next question is from Ross Sandler with Barclays. Your line is open.

Hey, guys, just a question about active customer count. So that actually declined quarter on quarter for the first time. I know that's a TTM number, but can you just walk us through how much of that is from just the overall environment and things like stimulus checks that are out of your control versus the reduction in marketing or maybe tougher time retaining customers? And it sounds like I'm glad to hear that you guys are going to lean back in starting now. But how are you thinking about balancing these record high EBITDA margins with just growing the top of the funnel and getting back out there with more customer acquisition? that's the first question and then just any learnings from the live streaming efforts thus far how's that uh in terms of adding to your uh ability to kind of grow the funnel and attract new customers yeah hey ross um this is jesse sorry i'll start start out with a couple of the just quick details and then turn it over to mike to talk a little bit more about the acquisition and the lean in um yeah you know you're right we did see active customers decline sequentially

And, you know, that's largely an impact of the COVID world. We do think there was a benefit from the stimulus check and the extra unemployment that was happening, you know, through July, you know, that started to hit us. And also the second wave of COVID cases and everything else that you hear out there. So there definitely is an impact there. And we anticipated that active customer number to come down sequentially from the plus 12-ish we were at at the end of last quarter to plus five now. And, you know, it's a combination of both the new and the repeat. And that's what, you know, tells us it's largely a COVID impact. You know, 45% of that active customer base is a repeat or an existing customer, but they contribute a much larger share of the revenue. So important that we lean on that existing customer.

In looking at the broader picture, Ross, we're in a world today, we were in a world in the second quarter and then the third quarter as well, that doesn't play to our strengths as a brand. And as a retailer, you know, be known for social occasions and live in your best life. And we're talking a period where those things were all true. So, you know, it's due to the environment we're facing. And then certainly with the quarter-to-quarter dynamics, you know, you have a 12-month number, as well as some of the pressures that we acknowledged in the third quarter where we saw, you know, for example, The digital advertising markets get much more competitive in the third quarter, not just on a sequential basis, but also on a year-over-year basis, where there were a lot of players stepping in in a big way that they hadn't historically. And from a year-over-year comp perspective, that has an impact, but we feel great about the trajectory there. And, you know, as we discussed, we're going to start meeting on the marketing as well as the inventory position as we get closer to, you know, a post-COVID world, which it looks like based off the best information available should be sometime Q2 or Q3. And we want to be first there so that we can, you know, leverage our brand that's really going to work in that world.

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

Hi, thank you. The September information is very helpful. On the down high single digit, what were some of the levers underneath that with average order value and transaction count? And what are some of the optimistic cases for how that could improve going forward? We would also just love your take on your commentary on brands. It's such a dynamic environment currently, but what are you seeing that really helps inform the innovation that you have planned there and the impact that it will have later to your prepared remark on own brands? Thank you.

Yeah, hello. This is Jesse. I'll take the first one and then kick it over to Michael. You know, as we said in our prepared remarks, we did see September come down in that high single-digit range, and that continued through October. The drivers there are really, you know, consistent with the remarks we made on both September and October. And, you know, lower average order value continues, driven by those same factors of a shift in mix, you know, offset by continued strength in full price. That was really strong in the quarter, which drove that margin. better margins on the markdown merchandise, you know, all centered around that improved inventory health. So, you know, it's a lot of the same as the commentary we made earlier and, you know, just the overall macro pressure. And I guess, Whitney, one more comment. I missed that last part of your question on kind of you know, the back half of Q4. You know, we're not commenting on that. We're just commenting, you know, what happened through October. You know, and November to date is really volatile with elections and, you know, just such a short period of time. So, you know, kind of staying away from comments there and also, you know, kind of prepared for the prolonged promotional cadence in this holiday period. And back to the comments on margin we made for the quarter.

Okay, and with that, we'll talk about own brands. Thank you.

Hey, Oliver. Yeah, with regards to own brands, I'm sure you all can recall that pre-COVID period, we were pulling back own brand and kind of resetting and regrouping there, continue to invest. And then with COVID, we really accelerated that because of the dollar commitment per style with the own brand division compared to third party, where we have a lot more flexibility. As of now, we're beginning to ramp up quite aggressively. We know I think Q3 will probably be our trough in terms of styles delivered and call it a ballpark, you know, lose the 50% increase into Q4 and similar growth rates into Q1 and Q2 of next year. So we'll be, you know, that march in that reinvestment period has already begun. On top of that, I'm very excited because it's not just getting those numbers up, but also the diversity and the quality of the product is going to be, you know, much, much different and very, very exciting for us. You know, largely in times past, we were loosely, you know, we're very, very successful with China-based wovens and dresses and tops and such. And that's been, you know, where the own brand divisions really thrive. They would continue to make investments in other aspects of the supply chain. Again, COVID really accelerated this, and now the sweaters and knits business first is extremely important. Our own brand division is doing very, very well with sweaters and knits and continued investment in other categories. In 21, we'll be seeing continued investment in denim, continued investment in activewear, actually, and also sustainable product as well. So we'll be ramping up aggressively in the product that we have coming in. We're very, very excited. I think it's going to be better than ever.

Thank you very much. Final question. So your call out on large-scale in-person events, has that been different from how you previously observed the impact there? And also, how do you plan on this dynamic environment to be ready, and what are different risk factors? Are there uncontrollable and controllable factors around the environment that we're seeing? Thanks.

Yeah. In times past, large-scale in-person events were also synonymous with deploying large amounts of marketing capital in very, very effective ways. And I think that's been a playbook that we continue to expand and continue to expand. We started with smaller events and were able to scale them, get more impact and more efficiency. And that's something that for sure we missed. We have things that have been starting to ramp up. Right now, we're Camp Revolve, which we had to do, instead of doing a large CL event, we did four separate groups instead of having all groups together at once. But we're starting to ramp up in-person events. We have a number of options on the menu for Q1 and Q2. We'll have to be a little patient in terms of committing to anything just to see how the world plays out. We're very optimistic, as I'm sure the rest of the world is, about the vaccine. And depending on how the environment is, the events will just get larger and larger in scale as we progress. And ultimately, when we feel like we're in the safe world where we can all get together again and give each other hugs, you'll probably see the largest scale event and the best party in the world coming from us very, very soon. It will evolve around the world in the roaring 2020s with a lot of people really just excited to wear their favorite clothes and hang out with their friends, and that's a time that we're all looking forward to, and I'm sure our shareholders are really looking forward to that as well.

Our next question is from Mark Altschweger with Baird. Your line is open.

Good afternoon. Thanks for taking my question. First, more of a short-term question, but given the plan to lean back into marketing, is it your expectation that you can drive some re-acceleration from the down high single digits over the remainder of the quarter? Is there any other leverage you're pulling from an assortment perspective or otherwise that would give you some more optimism for the holiday season? And then just longer term, looking into 2021 and the spring and festival season, obviously, very important period for you. And where we sit today, it seems like we can't really plan on events being back to normal by then, though I sure hope I'm wrong. So maybe just give us some insight on how you're positioning yourself for the spring season. How much more aggressively do you want to lean into some of these stay-at-home categories? How responsive can you be? Should consumers shift back into the traditional fashion categories more roughly than expected? And I'm seeing the insight there would be great. Thanks.

Yeah, definitely. So we've begun increasing our marketing expenditures. At the same time, historically, the way we always play things is we go with the current. And so we're not going to fight a brick wall just to achieve a certain number and put dollars to work that we think are effective, but we rebound will occur, particularly on the brand marketing side, where a lot of the impact of brand marketing is longer term in terms of the messaging, in terms of seeding awareness. So that's really where we're going to lean in on starting to ramp up investments, as is practical given the environment, because there's still a lot of constraints within the environment as far as us making those investments, to make sure that we're well positioned as soon as the world turns. And then I think in terms of thinking through merchandise, mix and timing of, you know, pre-COVID, post-COVID, you know, kind of transitionary period. It's going to be balanced. We're willing to take some bets and be wrong there, just because we think it's such a huge opportunity to be there first with a great selection as soon as people are able to get out and do the things that they love. And it's just... perfectly aligned with what our brand is all about. So we're willing to take a little bit of risk there. But obviously, you know, I think if you look at our track record, you know, we don't take foolish risks, you know, they're calculated managed risks.

Our next question is from Michael Venetti with Credit Suisse. Your line is open.

Hey, guys.

Thanks for taking all our questions here. I wanted to ask you a couple things, I guess.

The sustainability of the margins that you saw in the third quarter, obviously you heard Jesse's commentary on some of the components for the fourth quarter. But maybe just some thoughts on when you think the mix of owned brands will be back higher year over year and when the inventory in total will be back in line with sales. And then I guess do you feel like when you look at the active customer trends, do you feel like you lost a customer that was coming to you for markdowns, discounted products only, or do you have data that that's a customer that mostly lapsed or was a temporary lapse and that they'll be back as the markdown levels normalize? And do you want them back if so? yeah hey michael um i'll take the first one and then uh kick it over to mike on the customer component um you know as we commented on you know we're starting to already invest in inventory inventories up nine million dollars sequentially um so we're starting to make that improvement um our investment in inventory is still down meaningfully year over year so we don't expect that line to cross until you know probably mid-year next year you have to of course consider the The significant cuts we made this year, so there's some calm dynamics, you know, as you look into 2021. But, you know, we're taking, as Mike mentioned on the previous question, some, you know, balanced risk as we look ahead into a post-COVID world. And then, you know, on gross margin and own brand, same thing. We've already started to make those investments. You know, those won't kick in really until mid-2021 before we see that line start to cross, just given the timing and inventory dynamics there.

On the customer front, I think there's a couple dynamics going on. Certainly, there's the decreased level of markdowns, which are really pretty much historical lows in the current quarter as far as if you look at how we normally perform in the third quarter. And so, you know, certainly there's some customers that aren't buying now but would buy if we have markdowns. And as great as the performance of the quarter was and as great as our momentum is and you know, in what we believe is our ability to manage inventory. We will have quarters in the future that have more markdowns, and so that customer will come back then. But I think more importantly, you know, we know that, you know, There's a huge portion of customers out there that know us, that love us, that haven't forgotten about us, that are dying to shop, but just don't have the right occasions to shop for in the ways that they normally shop. I actually got an email just this morning from a customer that was just talking about how much she loved Revolve and how much she was looking forward to shopping with us again as soon as COVID was over and her husband could run his business again. And I'm sure there's many more stories like that out there. I have another customer that last earnings call, she saw me on TV and reached out. And she talked about how she loves us. She shops us all the time. She can only shop us for activewear. She's pretty much only been shopping us for activewear in the current period. But she can't wait until things are back to normal and she can shop us for all the same things that she normally loves us for. So the customer is there. She loves us. We're really pleased with the results that we've had during this period, given how opposite it is of what our brand is all about. And we're going to make sure we make the investments into marketing, our inventory position, and just be operationally nimble so that when the post-COVID world hits and when that pent-up demand is unleashed and everyone goes back to doing the things they love, we're going to be there to take advantage of it.

Our next question is from Kimberly Greenberger with Morgan Stanley. Your line is open.

great thank you so much um i wanted to ask a question about q4 marketing this year it makes sense obviously to to start investing back into marketing um i'm wondering if you did that in the month of october and if so did you see any knock-on benefits to revenue in the month of october from that And then as we look out to next year, should we expect to see marketing normalized back at that kind of 15 percent level? Or are there any kind of savings that you think you'll flow to the bottom line on that marketing line? Thanks so much.

Yeah, so on a sequential basis, we've been beginning to invest, you know, more and more in marketing with each month. revenue trends in October and how they were similar to what we saw in October. So, you know, I wouldn't say we've seen the fruits of those investments just yet, but there's a lot we do on the marketing side, particularly the brand marketing that's really, you know, kind of lagging and it's impacted in terms of, you know, how our marketing funnel works. And so, you know, not to mention that October is a very unusual month with both the COVID environment and also pre-election noise going on. So, you know, I wouldn't read too much into that. And then in terms of, you know, looking into the future, You know, we intend generally to invest just as much in marketing as we ever have. But, you know, we're also not dogmatic about things. We play every environment differently. If any information comes out that suggests to us it's better to adjust our strategy, we'll certainly do that. But, you know, we've said since we went public and it continues to be the case that marketing is very important to us for spreading our brand message, preceding awareness that we're in the early innings in terms of the customers that we can capture with just over 2% penetration of our target market. And so it's going to be a big part of our expenditures and strategy going forward.

Our next question is from Aaron Kessler with Raymond James. Your line is open.

Great. Thanks, guys. I have a couple of questions. First, on the promotional environment, any more color around that? Is it mostly traditional retailers? And second, based on the content marketing, I think you talked a little bit about that last quarter, gained some good traction there with the video. And I'd be interested in your thoughts on Instagram Reels, kind of that as a platform for you guys as well. Thank you.

Mike, do you want to maybe take the content marketing side of things?

Yeah, the content part, definitely. It's been quite interesting, and it's really kind of, it's crazy, it's super interesting, you know, as I was talking about own brands earlier, we were making moves, and this accelerated moves, and the same goes to our in-person events and such. You know, Revolve U was something that we were planning for, you know, it's been in the brainstorming sessions for, you know, maybe over a year or so. We thought that this would be the perfect time to execute something like that, where, you know, in-person parties and such are no longer relevant and such. So in the future, we'll definitely see a combination of these digital events that we're doing combined with in-person events and potentially integrate them. So very excited about that. Realt has been interesting, and I think we saw a tremendous boost in the outset. I think potentially there was a push there. We were seeing a lot of eyeballs, and we've seen things taper off a little bit. So we'll see how things evolve. I think it's, you know, We're very launching-minded, and I think Instagram Stories is a good example of something that, on the outset, wasn't particularly impactful, but really steadily grew into something that was very, very important for us. So we'll continue to invest in Reels, and hopefully the consumer will continue to gain traction there, and it'll be an important part of our component.

And then with regards to the promotional environment, we've certainly seen an easing of things, particularly on the luxury side. But I think if you look at Revolve versus the broader market, things have eased much more sharply and probably eases isn't the right word for our own markdown positions, where the consumer demand has shifted to be less Markdown focused than it was. But at the same time, an area of active discussion during the quarter was that we didn't have enough Markdown merchandise to meet the Markdown demand from our consumers. And that's a good problem to have, but it certainly had an impact on our revenue for the quarter.

Our next question is from Justin Post with Bank of America Merrill Lynch. Your line is open.

Thank you. I'm just wondering, you've had some real efficiencies on the cost side for the last couple quarters. Your guidance and outlook kind of discusses some of those maybe dissipating or making more investments. But when you think out a year or two, what are some of the lasting cost savings that might continue going forward? Thank you.

Yeah, sure. So I think, you know, if we just work down through the P&L, starting from the top, fulfillment is an area where we do see lasting efficiencies, combination of two factors there really over time, and again, thinking longer term. One, and we refer to this a lot because it is meaningful, but the efficiencies gained as a result of the automation investments that we've made over the last 18 months. And then also capacity. We invested in a new warehouse last year. They give this you know, 2 to 3x the capacity that we're at now. So we should just, we should see natural leverage on that line item over time. As we mentioned, there is a return rate component there. So, you know, we do anticipate returns to pick up slightly sequentially, you know, hopefully lower than our peak times last year in that 55% range. So we do hope some of that return dynamic does play out in a post-COVID world, but not banking on that one. Selling and distribution will continue to be pressured there as, you know, shipping costs go up year on year pretty consistently. We'll look to make, you know, improvements over time with an increasing AOV over the longer term, that should give us some easing there. Marketing, we talked about, will continue to make investments, but not banking on really any leverage on that line item over time. And then G&A, which is largely fixed. So with scale, we'll get leverage on that line item.

Our next question is from Bob Derpel with Guggenheim Partners. Your line is open.

Hey, guys. Good afternoon. Just a couple of quick questions for you. I think the first one is when you talk about September trends, October trends, and then November, with the performance of international, can you maybe give us a little color on what you saw on the international markets? That's my first question. And the second question is are you partnering with any of the top TikTokers as you think about how the world is changing these days versus Instagram? That would be helpful. Thanks.

Yeah, so with regards to international markets, we saw strength in the third quarter, particularly in our Western markets, you know, so in Western Europe, in Australia, and uh we saw double-digit gains in those markets so we feel very good about our progress and trajectory there you know certainly in the near term with with uh resurgence in covet in europe and exercise some kind of near-term caution to kind of get into the current quarter but feel great about the trajectory there and then you know also advise some weakness in Asia uh you know Asia is an area where we're starting to make I think some more meaningful investments and have some interesting uh partnerships uh that we're working on uh but but you know not quite there yet and so hopefully uh you know as those things come to fruition we'll see some games there and then also you know Hong Kong uh has always been or has been for for a while our most important uh uh Asian market in in that region has has been They're very troubled for a number of quarters now with the coronavirus.

Yeah. When it comes to TikTok, I would probably say that we haven't worked with the top TikTokers, but we have worked with the top fashion TikTokers, where we see the top TikTokers getting tens of millions of views and creating insane numbers. But the content really isn't fashion-focused. It really isn't quite aligned with our brand. But the top fashion TikTokers are very, very much in alignment with our brand. And we have worked with them and we plan to work with them much, much more. We see the content to be a little bit more in-depth compared to Instagram, where it's really numerous kind of like styling tips and outfits and a lot of richer content. To me, it's a little bit more akin to YouTube than Instagram, which I think is right in between is very, very exciting. And we will continue to do a lot more. The only disadvantage with TikTok being an earlier platform is that the access to data and kind of like our tools aren't as developed as the Instagram tools, you know, that we've had for, you know, nearly 10 years now. So whether it be our in-house things or that, you know, the numbers that TikTok lets us see in-house or lets, you know, third-party APIs have won't be as robust as Instagram for a little bit. But the encouraging numbers that we have are, you know, very exciting and no doubt we'll see a lot more, you know, revolve on TikTok.

The next question is from Roxanne Mayer with MKM Partners. Your line is open.

Great. Good afternoon, and thanks for taking my questions. My first question is on addresses, wondering if you could provide a little bit of color about the performance. You know, obviously you've got quite a number of subcategories, so curious if they have all been week or there have been pockets of strength in some of them. Also curious, you know, what percent of 4Q dresses typically represent and perhaps how they're positioned this year given your investment in other categories?

Yeah, when it comes to categorization and subcategorization, it becomes like a very, very complex situation because the way we look at categories is multidimensional. Of course, overall, we see dresses down quite a bit compared to our other categories. But within dresses, there's subcategories and there's end uses that are doing very, very well. So we kind of will sometimes share high-level category data to kind of illustratively tell the story of how the business is performing. But as you go deep and deep, there's strong pockets of success across the board. I think one thing is that this is an interesting, fun one to me, that we saw that activewear justice was extremely strong. It's kind of like this weird cross-pollination of activewear, which, of course, everyone loves. In this pandemic time period, we're doing extremely well with the traditional revolve category. So that's something that's very, very exciting to us. But I'll be small. But, Jesse, do you want to talk about, you know, Q4 dynamics in terms of categorization and such? It's, you know, definitely, you know, going out dressed, and there's certain categories we have various degrees of going out dressed that I'm sure will suffer, but there's also other categories that are very holiday-oriented that will be, you know, which we anticipate, such as, you know, sweaters and knits and such.

Yeah, yeah, sure. Just to give some more context, maybe even beyond Q4 on the dress mix, historically it's been at or slightly greater than a third of our business. Then in Q2, you saw that drop off meaningly to closer to 20%. We did see some recovery into Q3, so dresses did improve sequentially. And I think the most exciting part about that sequential improvement is that that came from full-price dress sales. As we commented on the prepared remarks, we saw a significant decrease in the amount of markdown dress sales from Q2 to Q3. So exciting to see that dresses come back in a full-price way. And then the Q4 skew is slightly higher on dresses compared to other quarters of the year, just given that occasion wear dynamic. you know, but not meaningfully. So, you know, we'll continue to see similar pressure on dresses as we have in the last quarter or two until we get into a real post-COVID world.

Our next question is from Matt Corando with Roth Capital. Your line is open.

Hey, guys. Thanks. Two for me. The first one is just overall orders per active customer look a little lower on a like-for-like basis year-over-year and sequentially, so it's understandable. that you've got certain existing customers that may pull back in this period, but any detail you can provide on sort of order frequency between older and newer cohorts and what you're seeing in terms of differences between those would be helpful.

Yeah, sure. Sorry, go ahead. Do you have more?

Yeah, the other one was on return rates. I get they're headed higher and in the short term it depends on mix, but is there anything you guys can do structurally to bring those levels down and take advantage of kind of the lower rates that you've enjoyed over the last quarter or two here in the pandemic?

Yeah, yeah. I'll take the first one there, and then Mike can comment on longer-term return dynamics. You know, we did see that order of frequency come down, but keep in mind that sequentially it did kick up very slightly from Q2 to Q3, so we're encouraged about that. And, you know, we're still running higher than our historical averages if you look back, you know, pre-2019, late 2018, so still a very active customer. And it came from both the new and the repeat side. Really, the customer dynamics, to a large extent, mirror the results on our financials, where you see her purchasing at lower AOVs, shifting from dresses into beauty. You saw, as we discussed earlier, a large markdown component in Q2 that shifted to a large full-price component in Q3. Also a grade that we're seeing, you know, beauty represent the percentage of beauty products from new customers doubled this quarter compared to the prior year. You saw an offset there in dresses, but, you know, kind of largely the customer still behaves relatively consistently with how she has in the past and, you know, just some quarter-to-quarter dynamics with shifting merchandising mix and AOVs.

And then in terms of the longer-term trajectory with return rates, it's very difficult even for us to disaggregate the impact of COVID and some of the longer-term things we're working on. But we're certainly hopeful that some of the things we've been working on will hopefully hold up post-COVID, not to the same level certainly we're seeing here on return rate, but that we're hoping we'll get some gains on the return rate dynamics, various factors, including some category mix shifts that should potentially stay post-COVID due to investments we've been making on our side in terms of product quality and presenting the product and inaccurately, and kind of other things we've been working on internally, as well as some other, I guess, more proprietary levers that were hopefully will have an impact. It just so happens a lot of those things came to fruition at the same time as COVID hit. So, you know, we'll have to see post-COVID to what extent those initiatives hold up. And then long, long term, we're very bullish on return rate improvements. You know, we think there's a lot that can be done in the online world to, you know, better communicate to customers what products are the products she's going to love. not just on the site, but when she gets them in person and when she tries them on. And so that's always an area that we're investing in.

We have time for one more question. Our last question is from Ralph Shecker with William Blair. Your line is open.

Great. Thanks for squeezing me in. Two questions if I could. Jesse, you talked about September declines in the high single-digit range. Can you maybe give us some perspective on the linearity of the declines in September and then, you know, did this really change or the trajectory change in October? You know, did you see more deceleration? Acceleration wasn't fairly steady. And then just in terms of when a vaccine rolls out and the world starts to open again, what's the lead time you need to plan your larger in-person events? Thank you.

Yeah, on the September, October dynamic, it was pretty consistent across a few months. Of course, there's day to day and week to week dynamics. But for September and October, you know, largely similar, you know, with a lot, a lot of dynamics at play in those couple months with, you know, the second wave of COVID and a lot of, you know, just macro pressures and external pressure. And then on the large-scale events, you know, the team can react very quickly. You saw that as we headed into COVID and their ability to quickly pull back on events and restructure and recreate kind of and move into this live streaming and content. So we're optimistic and, you know, they can move really fast to get into events when the time is right.

Yeah, Michael here. Just, you know, additional commentary is that there's a number of events that are really, you know, on the shelf, ready to go. It's really about a matter of, you know, which one do we pull when and kind of, you know, buying that, you know, through, you know, maybe the next couple of months into the early next year. We are very ready to go and very looking forward to it. And I think it will continue as, you know, the vaccine or that maybe pre-vaccine will have some activities going post-vaccine. We are locked and loaded with the capital and with the plans and the desire to go. So very excited.

And there are no further questions at this time. I'll now turn the call back to management for closing remarks.

Well, thank you, everyone, for joining us today. Thanks again to our team. And on this Veterans Day, a very special thanks to those that have served our country. Thank you for your sacrifice.

This concludes today's conference call and you may now