Revolve Group - Q1 2023

Transcript

Operator (participant)

Good day, everyone. My name is Lisa. I will be your conference operator today. At this time, I would like to welcome everyone to Revolve's first quarter 2023 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there'll be a question and answer session. If you would like to ask a question during this time, simply press star followed by one on your telephone keypad. If you would like to withdraw your question, it's star one again. At this time, I would like to turn the conference over to Erik Randerson, Vice President of Investor Relations at Revolve. Thank you. You may begin.

Erik Randerson (VP of Investor Relations)

Good afternoon, everyone, thanks for joining us to discuss Revolve's first quarter 2023 results. Before we begin, I'd like to mention we have posted a presentation containing Q1 financial highlights to our investor relations website, located at investors.revolve.com. I would also like to remind you that this conference call will include forward-looking statements, including statements related to various business operations and marketing initiatives and investments, our inventory balance and management, economic conditions and their impact on consumer demand, the impact of our new fulfillment centers, our future growth and profitability, market opportunities, macroeconomic and industry trends, and our outlook for net sales, gross margin, operating expenses, and effective tax rate.

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 filings with the Securities Exchange Commission, including, without limitation, our annual report on Form 10-K for the year ended December 31, 2022, and our 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 provide valuable insights on our operational performance and underlying operating results. The presentation of this non-GAAP financial information is not intended to be considered in isolation or as a substitute for or superior to the financial information prepared and presented in accordance with GAAP. Our non-GAAP measures may be different from non-GAAP measures used by other companies. Reconciliations of non-GAAP measures to GAAP measures as well as the definitions of each measure, their limitations and our rationale for using them, 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 Karanikolas 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 it over to Mike.

Mike Karanikolas (co-Founder and co-CEO)

Hello, everyone. Thanks for joining us today. We reported mixed results for the first quarter of 2023 amidst an increasingly uncertain macro environment and against a very difficult prior year comparison. After a better than expected start to the first quarter of 2023 that we discussed in February on our fourth quarter earnings call, consumer demand decelerated for the remainder of the first quarter, consistent with the U.S. Department of Commerce data showing a meaningful deceleration in consumer spending from January to March. This led to a 1% year-over-year decrease in net sales for the first quarter. On very positive fronts, however, we are making great progress on several key initiatives. We continue to make investments in the brand that we believe will benefit us over the long term.

Despite the macro challenges, we made excellent progress on rebalancing our inventory position and generated exceptional free cash flow during the first quarter, further strengthening our balance sheet. With that as an introduction, there are three key messages I wanna focus your attention on today. First, despite a macro environment that became more challenging as the first quarter progressed, we achieved excellent progress towards recalibrating our inventory, and we believe we are on track with our objective of rebalancing our inventory position by the end of the second quarter of 2023. The spread between our inventory growth year-over-year and our net sales decline year-over-year decreased by more than 50% in the first quarter on a sequential basis compared to the fourth quarter of 2022.

These favorable dynamics give us confidence in our outlook for gross margins improving from the pressured levels we recorded in the first quarter of 2023. Second, our significantly improved inventory dynamics helped us generate $49 million in cash flow from operating activities in the first quarter. More than double our cash flow generation for the full year of 2022. Our strong profitability and cash flow generation truly stands out within the fashion e-commerce sector. Coupled with the $283 million in cash on the balance sheet at the end of the first quarter, we're in a position of strength to invest in our large market opportunity ahead of us, at a time when many industry peers are forced to play defense. Challenging economic times like the current environment create opportunities for financially strong companies to prudently invest and further separate from the competition.

Third, we are executing on several important growth, brand building, and efficiency initiatives that we believe will further strengthen our foundation for profitable growth over the long term, particularly when the wind is at our backs once again. Michael and I will share our progress on several key initiatives throughout the organization, including technology, operations, marketing, and international. In such a dynamic period, I am pleased that our teams have remained laser-focused on the operational priorities I discussed on last quarter's conference call. I'll shift gears to discuss highlights of our first quarter in more detail. Recall that during our Q4 2022 earnings call in February, we shared that our net sales in the first seven weeks of the first quarter of 2023 had increased year-over-year by a mid-single-digit percentage compared to the same period in 2022.

Trends decelerated later in the quarter, particularly in March, leading to our 1% year-over-year decrease in net sales for the first quarter of 2023. The monthly slope of our first quarter was consistent with decelerating monthly apparel retail sales data from the U.S. Department of Commerce, which further supports our view that our core young consumer demographic is under more pressure today than she was just a few months ago. It's also important to keep in mind our difficult prior year comparison. Stepping back, our net sales have increased at a compound annual growth rate of 19% since the first quarter of 2019, the year of our IPO. By region, net sales in the U.S. decreased 5% year-over-year, while international net sales increased 16% year-over-year in the first quarter.

Bear in mind that our U.S. net sales growth in the first quarter of 2022 was exceptionally strong, creating a more difficult comparison. I'm very pleased by the healthy international results, considering the continued currency headwinds in some of our larger markets, such as Australia and the U.K. Positive contributors to international growth in the first quarter included China, which is benefiting from the reopening of the Chinese economy, as well as an easier year-over-year comparison from China lockdowns that began in the first quarter of 2022, the Middle East, and emerging markets such as Mexico and India. I'm particularly excited about Mexico, our market enjoying exceptional growth with net sales almost doubling year-over-year, now ranking as one of our top five international markets. We have a series of marketing activities planned to drive even greater awareness in Mexico.

We already have the second largest social media following among our international markets. Net income for the first quarter was $14 million or $0.19 per diluted share, and Adjusted EBITDA was $15 million. Our profitability was significantly lower than our performance in last year's first quarter, primarily due to the nearly five-point decrease in our gross margin year-over-year. While the macro environment remains uncertain, some of the pressure points on our P&L in recent periods should begin to ease in the coming quarters. The cost of air freight to import our own brands products from China has decreased significantly, shifting from a headwind in recent years to a tailwind in 2023 as we look forward. Our top line contributions from China have also shifted from a headwind into a tailwind after the COVID restrictions were eased earlier this year.

Lastly, it appears that we are now past the worst of the headwinds from variable fuel surcharges applied by major carriers to our customer shipments since the peak in jet fuel prices in the second quarter of 2022. As mentioned earlier, I'll provide brief updates on key operating priorities that build on our foundation of growth and operating efficiency and further enhance our already best-in-class customer experience. We are extremely focused on driving cost efficiencies within our global shipping and logistics operations to help offset cost pressures, including the impact from a higher return rate year-over-year. Our team has already delivered early wins in optimizing customer shipping costs to some international regions. They are pursuing a much larger scope of cost-saving initiatives that we believe has the potential to be impactful later this year.

Jesse will talk more about this important effort in his remarks. We are continuing to raise the bar on service levels for customers, even while we focus intently on driving cost efficiencies. Our new Pennsylvania fulfillment center enables us to more quickly ship packages to East Coast customers, and we're also extending our best in class timeframe for shipping orders the same day we receive them. For years, our service promise has been to process and ship orders on the same day if we receive them before 3:00 P.M. Eastern Time, and we're now extending that same day fulfillment window to even later in the afternoon. We continue to expand the use of AI and machine learning across several key areas of our operations and customer experience, including fraud detection, personalized product recommendations, image recognition, and product attribute tagging.

As an exciting update on our progress, Michael and I will talk about how we leveraged AI technology to develop an innovative marketing campaign featuring outdoor billboards for our flagship REVOLVE Festival event held last month. Using these same AI designs, we created a limited edition own brand product capsule. We also leveraged our technology stack to enhance the product search results on our sites, elevating the user experience and conversion opportunities by enabling customers to more efficiently find what they're looking for among our curated assortment. We are also leveraging AI to develop even further enhancements to our search capabilities, and we are excited by internal demonstrations of further application of AI technology, which have shown a great deal of potential to drive impactful results in the future. We have advanced our efforts to cross-sell the FWRD assortment to the much larger base of REVOLVE customers.

Recently launched navigation enhancements on our Revolve website provide increased visibility to the FWRD assortment, have shown promising early results. We've also leveraged our technology foundation to increasingly enable REVOLVE and FWRD to share inventory for key brands that offer products for sale on both sites, handling more efficient inventory management and improved product availability. We are investing further to elevate service levels in international markets, where we see a great deal of opportunity over the long term. We plan to deploy technology this quarter that we expect will accelerate website response time in key international markets, advancing our localization efforts. In the coming months, we are gearing up to expand our loyalty program to key international markets for the first time. Our loyalty program has been a great success domestically since introducing it three years ago.

Like all companies, we face a myriad of challenges in the current environment, and we still have much more work to do. Yet, we are uniquely positioned with a profitable, capital efficient, and highly cash generative business model that we believe will allow us to continue to prudently invest in our long-term opportunity we are very excited about. Before I turn it over to Michael, I'd like to once again thank all our hardworking team members for your agility, resilience, and dedication to exceeding our customers' expectations every day. Over to Michael.

Michael Mente (co-Founder and co-CEO)

Thanks, Mike. Hello, everyone. As always, our strategic focus is to create a strong and growing business for the long term. At the center of everything we do is our unwavering focus on serving our customer incredibly well, helping her to live her best life through being her trusted source of fashion inspiration. It is gratifying that our active customer base have continued to expand at a healthier rate, building on our future growth potential, considering the strong loyalty and retention characteristics of our customer base. Our trailing twelve-month active customers grew to $2.4 million in the first quarter in an increase of 4% sequentially and 19% higher than the first quarter of 2022, growing right through the very difficult record growth comparison in the prior year.

Moving forward, we believe we have a large opportunity to expand our customer base within our target demographics, both in the U.S. and internationally. Even more impressive is that we delivered this healthy growth in active customers, while at the same time delivering better than expected marketing efficiency in the first quarter. Shifting gears, I would like to discuss our culture of innovation at REVOLVE. A key contributor to our rapid and profitable growth over the past 20 years is our ability to identify important shifts and opportunities and leverage technology to create competitive moats around us. From our earliest days, our internally developed technology enabled us to embrace data-driven merchandising and drive the business in ways that remain a significant competitive differentiator today.

Years later, we were a pioneer at the forefront of marketing innovation and partnering with influencers to create brand awareness and impact on social media, again, leveraging our internally developed technology to create a competitive advantage. Now today, I'm thrilled to acknowledge the pioneering efforts of our studio, technology and marketing teams for creating what we believe was the first AI-generated billboard campaign. Entitled Best Trip, visually stunning AI campaign celebrates our 20-year anniversary and was designed in partnership with the AI studio based on Meta. Our AI innovation has generated meaningful buzz on social media and major press outlets such as Forbes, Vogue, the New York Post and The Business of Fashion, further solidifying REVOLVE as a trailblazer in marketing innovation.

The Best Trip AI campaign debuted throughout April on several billboards along the highway headed to Palm Springs, strategically positioned to ensure that it would be seen by hundreds of thousands of festival goers driving to Coachella, Stagecoach, and of course, REVOLVE Festival last month. It was great to see our aspirational lifestyle brand proudly displayed front and center for such a large, targeted and relevant audience. Also compelling is that we were able to efficiently produce and sell a limited edition capsule collection from the designs seen in the AI campaign. Our own brands team had already been testing AI design and related technology innovations to drive further efficiency and product development, so it was really incredible to see our team leverage AI to bring product to life for the first time.

Over time, we believe AI design presents an exciting opportunity to create a more powerful, innovative and streamlined design process. Our conviction and true excitement about the potential for AI technology across the organization led us to help launch the first-ever AI Fashion Week last month to promote greater experimentation and use of AI in fashion. I encourage you to follow the updates on our social media channels and participate in the votings for the more than 400 AI Fashion Week contest submissions through the AI Fashion Week app. Of note, the three winners from the AI Fashion Week contest will have the opportunity to sell their AI capsule collections on REVOLVE. As a company, it's very important for us to stay at the cutting edge of technology development, testing and learning how to leverage these new technologies, which is ingrained in our cultural DNA.

Now let me shift gears and recap our highly successful REVOLVE Festival event held last month at an exceptional new venue. This year was particularly special for Mike and I because the timing of REVOLVE Festival coincided with our 20-year anniversary. We kicked off the week of REVOLVE Festival with an intimate 20th anniversary celebration in Los Angeles, attended by A-listers, VIPs and brands, including key fashion partners who have been with us since the earliest days. In true REVOLVE fashion, the event grabbed headlines, particularly focused on Kendall Jenner's stunning ensemble, highlighted by a sheer white form-fitting Alaïa dress from our FWRD assortment that sold out almost immediately after all the favorable press. Once again, illustrating our powerful marketing impact that our brand partners are increasingly excited about.

It was clear from the conversations and toasts at our intimate gathering just how much brand loyalty we have earned with emerging brands and content creator partners over the years from our mutually beneficial relationships. We are truly grateful for the relationships we have built and to see the many businesses that have grown with us in our journey. Through our strong brand, our focus on the customer, our technology and data-driven foundation, and the support of our partners, we have nearly quadrupled the business from roughly $300 million in revenue in 2015 to $1.1 billion today. REVOLVE Festival was held over two days in mid-April, and it was an incredible event that The Wall Street Journal called Coachella's most lavish party, and was better than a day at Coachella, according to an article from Insider.

The aspirational lifestyle event was very successful in elevating our brand and exciting and delighting our community of VIPs, brands, influencers, partners and fans who were fortunate enough to attend the invite-only activation. This year's event featured an even more exclusive and intimate setting while delivering a high energy vibe that was inspired by our outstanding lineup of musical acts. Headline performers included 21 Savage, Don Toliver, City Girls, PinkPantheress, Coi Leray, Zack Bia, Amaarae, Ayra Starr, and the trending Ice Spice in her first live performance since releasing a hit single with Nicki Minaj that debuted at number one on the Billboard charts. An important driver of impact and awareness was incredible event attendance across a diverse range of personalities, including musicians, actors, celebrities, designers, athletes, content creators, and TikTok stars.

Teen Vogue wrote that it would seem as though every celebrity and influencer on the planet was in attendance. Notable VIPs at our event included Kendall Jenner, Dixie and Charli D'Amelio, Hailey Bieber, Leonardo DiCaprio, Emma Roberts, Travis Kelce, Lewis Hamilton, Storm Reid, Lori Harvey, Saweetie, Leon Bridges, Camila Morrone, Madison Bailey, Suki Waterhouse, Natalia Bryant, Irina Shayk, Shay Mitchell, Noah Beck, David Dobrik, Christina Milian, and Tyga. To illustrate the scale of favorable impact on our brand, the week of REVOLVE Festival generated approximately 7 billion press impressions, our highest ever for any campaign or event.

Our investment in REVOLVE Festival and other experiential events over many years has created a truly powerful lifestyle brand, which has resulted in increasing opportunities to partner with top brands and celebrities. Global icon Jennifer Lopez and her team were very excited to partner with REVOLVE because of the strength of our brand and strong connection with the next generation consumers. We recently launched an exclusive shoe collection called JLO Jennifer Lopez, and hosted an impactful marketing event with JLO that attracted more press than any launch event in our history. It was all made possible by the combined strength of our brands. Shifting to an update on FWRD, we have some exciting marketing plans related this year, so stay tuned for details in the coming months.

One of the areas that has been a real bright spot is our recently introduced FWRD Renew, the section of FWRD dedicated to circular luxury shopping, where we sell pre-owned handbags from coveted luxury brands. Sales from this early effort grew more than 50% on a sequential basis in the first quarter from the fourth quarter of 2022, Renew has attracted many new customers to the FWRD brand. I'm also excited by our efforts to encourage our leading premium beauty brands on REVOLVE to co-list in FWRD this year. Some of our largest beauty brands on REVOLVE are in the queue to make their beauty products available on FWRD as well, expanding our opportunity. I'll wrap up with an update on beauty, where our year-over-year growth in the first quarter remains solid in the low double digits.

Our beauty strategy for the near term is to attract the right selection of beauty brands on the site. I'm confident that having the optimal beauty store will drive an exciting growth opportunity over the long term, simply because our customer loves REVOLVE and we consistently exceed her expectations. Context, we know that when we launch a major beauty brand, it moves the needle. A small number of beauty brands currently drive a high share of our beauty volume. We are very excited about the pipeline of high-impact beauty brands we expect to be onboarded this year. An exciting development was the launch of Kourtney Kardashian's wellness brand, Lemme, on REVOLVE in February, months before distribution through any major beauty retailers. Launch on REVOLVE has done very well in the early going, helped by Kourtney really leaning into marketing on her social channels.

This example reinforce the powerful REVOLVE brand, community, trusted relationships we have built with tastemakers. In closing, it is clear to me that we remain in a highly uncertain operating environment, as Mike alluded to. Not surprisingly, consumers are dealing with persistent inflation pressures, which has led to some reduction in our customers propensity to spend, evident in our average spending per active customer. Despite the challenging macro environment, we are continuing to play offense, building on our already solid foundation that will support our future growth when the environment improves and our spending returns. I'm super energized by the energy and level of innovation throughout the company. Continue to push the boundaries, leveraging new technologies and marketing techniques. Our entrepreneurial team culture is in full force as we pursue our goal of being the fashion destination for the next generation consumer.

Now I'll turn over to Jesse for a discussion of the financials.

Jesse Timmermans (CFO)

Thanks, Michael. Hello, everyone. We encountered our share of challenges in the first quarter on top of a very difficult prior year comparison. In such a dynamic environment, I am pleased that our operating discipline enabled us to achieve significant progress in recalibrating our inventory position while generating exceptional cash flow, further strengthening our already pristine balance sheet. I'll start by recapping our first quarter results. Net sales were $280 million, a year-over-year decrease of 1%. As shared on our earnings conference call for the fourth quarter of 2022, the first quarter of 2023 began on a high note, with year-over-year net sales growth in the mid single digits through the first seven weeks.

Our net sales trajectory decelerated in the last six weeks of the first quarter of 2023, consistent with a variety of public data sources reporting softer consumer spending on discretionary items during February, and particularly during March. Looking at our first quarter of 2023 results over a longer time horizon, our net sales have increased at a four-year compound annual growth rate of 19% when compared to the first quarter of 2019. REVOLVE segment net sales decreased 3%, and FWRD segment net sales increased 5% year-over-year in the first quarter. By territory, domestic net sales decreased 5%, and international net sales increased 16% year-over-year. The U.S. faced a much harder comparison as the U.S. grew more than twice as fast as our international business in the first quarter of 2022.

Active customers, which is a trailing 12-month measure, increased by a healthy 84,000 customers during the first quarter. This growth expanded our active customer count to 2.4 million, an increase of 19% year-over-year. Our customers placed 2.3 million orders in the first quarter, an increase of 6% year-over-year. Average order value was $288, flat year-over-year. Shifting to gross profit. Consolidated gross margin was 49.8% at the high end of our guidance range, and a decrease of 468 basis points year-over-year, primarily due to a lower mix of net sales at full price compared to the first quarter of 2022. We exited the first quarter with a more balanced inventory position, which gives us confidence in the improving gross margin outlook in future quarters. Moving on to operating expenses.

Fulfillment costs deleveraged by 67 basis points year-over-year, directionally consistent with our outlook commentary, primarily due to a year-over-year increase in our return rate, as well as increased labor costs and investments made to expand our fulfillment network. The softer revenue trend was also a headwind for fulfillment efficiency year-on-year due to decreased utilization of our expanded fulfillment center capacity. Selling and distribution costs deleveraged two points year-over-year and were higher than expected, primarily due to elevated costs for customer shipments caused by a higher return rate year-over-year and continued year-over-year growth in variable fuel surcharges. We are very focused on reducing the significant negative impact on our profitability from these increased shipping costs with several initiatives in place and more being developed and tested. Marketing was more efficient than the outlook we provided on last quarter's conference call.

Our marketing investments represented 13.7% of net sales in the first quarter, an improvement of 225 basis points year-over-year. General and administrative costs were $28 million, slightly lower than our outlook provided last quarter. Our effective tax rate was 25%, 3 points higher than in the first quarter of 2022. Net income was $14.2 million or $0.19 per diluted share, a decrease of 37% year-over-year that was impacted by the lower gross margin and growth in operating expenses, partially offset by an increase in other income due primarily to an insurance reimbursement. Adjusted EBITDA was $15 million, a decrease of 52% year-over-year. Moving to the balance sheet and cash flow statement. Our cash flow in the first quarter was exceptional and benefited from favorable working capital dynamics.

Net cash provided by operating activities was $49 million, and free cash flow was $48 million, which was our second highest for any first quarter, yet declined compared to the first quarter of 2022, primarily due to lower net income year-over-year. In just the first quarter of 2023, we have already generated more than twice the amount of operating cash flow than all of 2022. The strong cash flow generation has further strengthened our balance sheet and liquidity. Cash and cash equivalents as of March 31st, 2023 were $283 million, an increase of $49 million or 21% from year end 2022, and an increase of $13 million or 5% year-over-year.

Our balance sheet as of March 31st, 2023 remains debt-free. Inventory at March 31st, 2023 was $190 million, a sequential quarter decrease of $25 million from year-end 2022. As a result of this significant inventory reduction in the first quarter, our inventory moderated to a 6% year-over-year increase, narrowing the unfavorable spread between our year-over-year inventory growth and year-over-year net sales growth to only seven points. We remain confident that we are on track to rebalance our inventory by the end of the second quarter. Let me update you on some recent trends in the business since the first quarter ended and provide some direction on our cost structure to help in your modeling of the business. Starting from the top.

The top line pressure we experienced late in the first quarter has continued as net sales for the month of April 2023 decreased by approximately 7% year-over-year. We believe the uncertain macro environment is increasingly weighing on our customers' purchasing behavior. Shifting to gross margin. We expect gross margin in the second quarter of 2023 of between 53% and 53.5%, up from the first quarter of 2023 gross margin reported today, yet lower year-over-year as we expect a reduced mix of net sales at full price this year. Importantly, the year-over-year decline in gross margin implied by our outlook for the second quarter of 2023 is about two points lower than the year-over-year decline in gross margin reported for the first quarter announced today.

For the full year 2023, we continue to expect gross margin of between 52% and 53%. Fulfillment. Primarily as a result of the increased top-line uncertainty, we are taking a slightly more conservative view of fulfillment efficiency. We now expect fulfillment as a percentage of net sales to be around 3.2% for the second quarter of 2023. We continue to expect slight sequential improvement on fulfillment efficiency in the second half of the year, resulting in fulfillment as a percentage of net sales of approximately 3.1% for the full year 2023. Selling and distribution. We expect selling and distribution costs to represent around 18.7% of net sales for the second quarter of 2023, and 18% of net sales for the full year 2023.

The increase from our prior full year guidance primarily reflects a higher than expected return rate that we believe is influenced by the challenging macro environment. As a result, we are now assuming a higher return rate in 2023 than was embedded in our prior guidance. Importantly, our outlook for the full year implies sequential improvement in the back half of the year. There are three key drivers of the sequential improvement we expect in the back half of the year for selling and distribution. First, we expect variable fuel surcharges to decline year-over-year starting in the second quarter after several quarters of significant growth. Second, we expect to begin to realize efficiencies from our new Pennsylvania fulfillment center as its volume scales.

Third, we expect to begin to realize early efficiencies resulting from a variety of other shipping and logistics efficiency measures we are pursuing. However, we are factoring in an elevated return rate in the near term, which will partially offset some of our efficiency measures and contribute to continued pressure on shipping costs. Marketing. Our marketing efficiency in the first quarter of 2023 was partially due to a reduction in brand marketing events this year compared to the very active events calendar in the first quarter of 2022. By comparison, we expect the second quarter of 2023 to include a larger investment in brand-building events year-over-year when compared to the second quarter of 2022.

As a result, and consistent with our commentary from last quarter, we expect our marketing investment to be the highest of the year in the second quarter of 2023, and to represent approximately 18.5% of net sales. For the full year 2023, we expect marketing to be within the range previously communicated of 16%-16.5% of net sales. General and Administrative. We expect G&A expense of approximately $29 million in the second quarter of 2023, and between $113 million-$115 million for the full year 2023, unchanged from our prior full year outlook. Lastly, touching on our tax rate. We continue to expect our effective tax rate to be around 24%-26%, consistent with the past several quarters.

To recap, while the current environment is challenging, led by Mike and Michael's long-term mindset, our leadership team is energized behind a wide range of exciting initiatives that we believe will benefit REVOLVE for years to come.

After delivering exceptional growth in the past two years, our key focus is our active evaluation of how we can leverage our technology, data-driven approach, and operating excellence to take advantage of our increased global scale in driving further operating efficiencies across the organization. Now we'll open it up for your questions.

Operator (participant)

Thank you. At this time, I would like to remind everyone in order to ask a question, please press star, then the one on your telephone keypad. We'll pause for a moment just to compile the Q&A roster. Your first question comes from Oliver Chen with TD Cowen.

Oliver Chen (Analyst)

Hi, Mike, Michael and Jesse. Regarding the softer revenue trends and what you see ahead, which classifications were more concerning? Also, your inventory spread's better, but what do you think about going forward in terms of the promotions and markdown cadence, and what risk factors are you monitoring there in terms of what's embedded in your guidance? Do you expect the trends on an ongoing basis to continue to be fairly volatile? Thank you.

Mike Karanikolas (co-Founder and co-CEO)

Yeah. With regards to classifications, Oliver, are you just wanting more color on kind of across different segments, you know, whether it's geographies or types of merchandise or what are you referring to there?

Oliver Chen (Analyst)

Yeah. I think, the categories that were softer and if they followed, patterns that would help us get a feel for what's happening with the customer and what's driving, some of the softer trends.

Mike Karanikolas (co-Founder and co-CEO)

Yeah, definitely. You know, if you look at the kind of, category as well as customer segment, there's a couple of call-outs. You know, one would be that certainly the aspirational customers versus the high-end customers, there was a bit more softness there. We'd also emphasize the softness was fairly broad-based, so it's not to say we didn't see impact on the high end. You know, within the merchandise category, you know, I think, you know, if you look at, apparel that's more going out oriented, you know, there was a bit of an overshoot or peak last year and so we saw some rebound in the opposite direction, you know, this way, for this quarter.

You know, if you look at non-apparel categories like beauty, you know, they performed relatively well in comparison. Obviously, that's a long-term growth area for us, but we're happy to have delivered solid beauty growth during the period.

Oliver Chen (Analyst)

Okay. Promos and markdowns, which we know about, you know, what's embedded in forecast and the degree of inventory that you have now and the freshness of the current inventory as we think about risk factors there, given the softer top line.

Mike Karanikolas (co-Founder and co-CEO)

Yeah. We feel good about our inventory position. We made great progress on it in the quarter. Obviously we would have liked profitability to have been stronger and revenue trends to be stronger, but we did what we needed to do on the inventory position as far as bringing it down substantially, getting to a place much closer to in balance. Again, we feel like at the end of the second quarter, that then we'll be feeling good about where that position is and the result was exceptional cash generation, which is something that we're focused on. Obviously, in an uncertain macro environment, there is, you know, continued risk around inventory levels and gross margins and things of that nature, but it's something that we're laser focused on and being very active on.

Oliver Chen (Analyst)

Okay. Last question, Mike, on customer acquisition trends. What you saw, was it more concerning in terms of new versus existing cohorts, and/or there's been a lot of volatility in CAC and also less productivity in the performance marketing? Is there any color in terms of what you've been seeing with that?

Mike Karanikolas (co-Founder and co-CEO)

The first quarter was actually, you know, good by a number of marketing metrics. You know, quickly CAC, you know, was favorable versus prior periods. New customers were generally strong. You know, it was just again, kind of offset by a broader-based weakness. As you saw in the numbers, we pulled back on marketing a bit in the first quarter, which, you know, certainly had some impact on the overall trends. We hadn't wanted to pull back on marketing too much until we felt the inventory position was in a better place. Again, we feel good about the progress there. You know, that's when we had some impact on the trends.

Also an increased level of kind of new marketing techniques and marketing experimentation had a little bit of an impact also. That's something that we didn't wanna play with too much when inventory levels were elevated before, but we were a little bit more free to do that in the first quarter, has some, you know, I'll call it minor impact in the current quarter, but is overall good for the long term.

Operator (participant)

Your next question comes from the line of Mark Altschwager with Baird.

Mark Altschwager (Analyst)

Good afternoon. Thanks for taking the question. The valuation landscape for DTC brands has certainly shifted versus a couple of years ago, and your cash balance is building. Curious how you're thinking about opportunistic acquisitions in this landscape. You know, what would an ideal target look like, and are you seeing any attractive opportunities out there at multiples you would deem reasonable?

Mike Karanikolas (co-Founder and co-CEO)

Yeah. It's certainly interesting and, you know, as we've talked about on past calls, it's something that we're always actively thinking about. Certainly as valuations get more attractive, it's, you know, the possibility of an opportunity there becomes more realistic. You know, that said, our answer would be the same as previous periods where, again, it's just something that we're always actively monitoring and considering and, you know, we'll let you know if there's any updates there. You know, that's how we'd characterize it at this point.

Mark Altschwager (Analyst)

Thank you. Just a quick follow-up, just regarding the top line. You know, obviously the macro is more challenging, but you did speak to some opportunities to maybe go on offense in this sort of environment. Could you maybe elaborate on that a bit?

Mike Karanikolas (co-Founder and co-CEO)

Yeah, there's a number of areas, we're going on offense and, you know, maybe I'll mention a couple, but I'll also let Michael dive in here, 'cause he's very active in a number of them. You know, obviously continue to build our brand. We continue to make impactful long-term brand marketing investments, and REVOLVE Festival, I think, was a very big success this year. I think importantly on the technology side, obviously, you know, with, the recent AI developments, that's a very hot area. It's an area that we've been actively, you know, working on and actually deploying in practice for multiple years now. Things are just moving faster. We view that as a huge opportunity. We're increasing our investments there at times others are pulling back.

You know, I know there's some news of other media retailers pulling back on overhead and we're hiring engineers at this point. Obviously doing it in a prudent, cost-efficient way, as we always do. But overall, increasing investments in AI and tech and we think it's a huge opportunity over the coming quarters and coming year and excited to hopefully every quarter have something new to share with you there.

Michael Mente (co-Founder and co-CEO)

The, the only other things I would add on top of that, you know, all of that I completely agree with, it's all very exciting, is leaning into some of the really nascent categories. I think, you know, coming up for REVOLVE Gallery, which will be in H2, will be the first time we integrate, you know, men's, as well as the first time we integrate beauty as well. There's, you know, longer term categories that we think will be, you know, very, very crucial to our long-term success over the next 10 years or so that we are beginning to always with our core activities and getting more serious about. There'll be a lot more of that. We won't, we're definitely not shy away from long-term opportunities during, you know, like this.

Mike Karanikolas (co-Founder and co-CEO)

For sure. The only other thing I might layer in without getting, I guess, too detailed, but there's areas of the business, whether it's like the marketing experiments that I alluded to in the first quarter, and also other areas related to, you know, kind of cost efficiencies or other opportunities that we're increasing our investments in that in the short term are more likely to have a slightly negative effect, right? Whenever you're doing something new, it takes time to kind of work out the kinks to figure out exactly how to use something right or get it working in the right way. We're investing prudently, but we're increasing our investments in those areas.

Obviously between the cash balance and where technology is going, it's just an exciting time, I think, for all of us to be active.

Operator (participant)

We'll take our next question from Randal Konik with Jefferies.

Randal Konik (Analyst)

Hey, thanks for taking my questions. I guess, Jesse, maybe you could give us some perspective on just how... In trying to think about various outcomes for top line, I know you don't wanna... you're not gonna give a quantification specifically, but is there a way you could give us some perspective on how we should be thinking about, you know, differences in a range of outcomes in average order value, number of orders or something to that effect that we can kinda get a sense of how you're thinking about a range of outcomes for the top line? That would be super helpful for the year.

Jesse Timmermans (CFO)

Yeah. Yeah. You know, it is still highly uncertain out there, as we've talked about. That's why we're only giving the kind of actual results through April, which we're down 7%. You know, that said, some additional color. I think, you know, we're still confident that AOV can have a modest increase this year. We're pleased with the flat AOV year-on-year, with the significant decrease in full price mix. You know, as expected, full price mix shifted down significantly year-over-year coming off those record highs of last year. To get a flat AOV in this quarter, we are pretty pleased about. Then we're already seeing the full price mix shift back with the inventory rebalancing. We're still good there. Customer acquisition has been healthy, CAC has been healthy.

The majority of the new customers that we acquired were at full price. That said, the growth really came from the markdown, given the shift to markdown that we saw this quarter. I think the uncertainty out there is real. Given that we're starting off at a -7 for the quarter, we're kind of in the zone of, it could be slightly negative to slightly positive for the second quarter, depending on how this next two months play out. Comps do get easier on a one-year basis, but on a multi-year basis, if you look back 2022 versus 2019, they're still tough.

You know, I think, you know, we just gotta keep, you know, stay on the offense, keep doing what we're doing and kind of work through this moment in time we're in.

Randal Konik (Analyst)

Got it. Then you gave us good perspective on how you're thinking about the selling and distribution line as a percent of revenue, you know, for the year, I assume. When you think about maybe stepping back and looking at the return rate, as an impacting, you know, impact to this line item, Can you just give us some perspective on where we are in that return rate cycle and how should we be thinking about that over, like, the coming year? Is there any meaningful opportunity to, over time, improve that return rate? Just how should we be thinking about that? Not for, you know, just the balance this year, just kinda thinking out more into the long term future.

It does have a sizable impact on the margin.

Jesse Timmermans (CFO)

Yeah, maybe I'll address the first part and just kind of talking about the current quarter and return rate and what we've factored into the guidance, then kick it over to Mike for the long-term opportunity on return rate. We did see an elevated return rate for the quarter, higher than we had initially expected, we did see it increase as the quarter progressed. I think just a couple of things, you know, more granular on the seasonality. We typically see March, you know, about 20% higher in dollar terms than January. We didn't see that this quarter. It was only about 10% higher than January on a growth basis. Then when you factor in the return rate, March was actually 6% lower than January.

You can see the impact not only of the macro consumer impact in March, but also that increased return rate as the quarter progressed. Then we also saw increased return rate across segment and then across categories as well. Even the lower return rate categories like handbags and then even beauty saw an increased return rate. We do attribute a lot of this, you know, kind of near term pressure, to the macro environment. That's why we've taken up the fulfillment a little bit, and we've taken up the selling and distribution pretty meaningfully in our guidance. As a reminder, two-thirds of that selling and distribution is freight, and that return rate does have a significant impact on that.

As mentioned in our prepared remarks, we are still seeing that fuel surcharge, meaningfully higher to the tune of 30% higher year-over-year this quarter. We do expect that to subside at least on a year-over-year basis, and we're starting to see some softening there, that will give us some benefit, as we look ahead. Then maybe over to Mike for the longer term.

Mike Karanikolas (co-Founder and co-CEO)

Yeah. On the longer term, you know, I'll start my comments with remarks that may be similar to what I made before and then also kind of provide an update on top of that. From a strategic standpoint, you know, we're gonna continue to focus on making it easier for customers to return to lead within the industry in that process. That's generally something that we're not going to compromise. You know, we feel like there's a lot of long-term opportunity there. You know, it's something that we've repeatedly said, but it hasn't been the biggest area of active focus. Like, there's been some focus on it.

Obviously with the increase in return rates, that focus is shifting, and there's gonna be a lot more internal work on that and investments kinda going back to the, you know, playing offense and investing, you know, remarks from earlier. We're increasing our investments there. We're confident that over the long term and hopefully earlier than that, we can make some impactful changes that reduce return rates in a win-win way for the consumer and for us. On top of that, you know, certainly Jesse talked about the transactional cost efficiency that we're focused on. We're laser focused on that. That's one of our key priorities this year, and we're looking to drive those down significantly.

Operator (participant)

Our next question comes from the line of Lorraine Hutchinson with Bank of America. Please go ahead.

Lorraine Hutchinson (Analyst)

Thank you. Good afternoon. I just wanted to follow up on the return rate, but maybe taking a little bit of a different approach asking the international business, how much of an impact does that continue to have on return rate? Can you talk through any progress you've made on making that fulfillment and return process a little bit more margin efficient globally? Thank you.

Jesse Timmermans (CFO)

Yeah. Yeah. On a year-over-year basis, the kind of shift to international or kind of the localization of international didn't have a meaningful impact. You know, we continue to make improvements there for the customer, but the big shifts there were over a multiyear period. If you look kind of a pre-COVID, you know, 2018, 2019 compared to 2023, that's where you see the significant impact from the international localization. On a year-over-year basis, we saw, you know, relatively consistent increase in return rate again across segments and geos and categories. I wouldn't call that out as a big factor this quarter.

We continue to make progress on those, and just kind of cost reduction initiatives when it comes to kind of the refulfillment or the, you know, the shipping back and forth of the returns. On the domestic level, Pennsylvania is continuing to ramp, so we expect to get some efficiencies there, you know, starting this quarter, but really in the back half of the year. There's, you know, a number of initiatives both domestically, internationally, but really internationally to reduce those costs and optimize the shipping lanes. Not expecting huge impacts this quarter, more towards the back half of the year and just really setting us up well for 2024.

Operator (participant)

We'll take our next question from Rakesh Patel with Raymond James.

Rakesh Patel (Analyst)

Thank you. Good afternoon, everyone. Can you provide additional color on international performance? If we put China aside, are you seeing changes in consumer behavior that you think is noteworthy and keeping an eye on? We're particularly interested in Europe.

Mike Karanikolas (co-Founder and co-CEO)

Yeah. With regards to the international regions, you know, China, as we mentioned in the comments, was a really nice story for the quarter, a big growth driver in the quarter. You know, coming off of, you know, certainly a difficult comparison, just in general, we saw a lot of great momentum there. Europe has been a market that's been struggling a bit as with other Western markets, whether it's, you know, certainly domestically, our sales momentum's not what we want it to be. Other Western markets like Australia, in the U.K., you know, also kinda not where we want them to be. I think within those Western markets, you know, things have just generally been soft from a macro standpoint.

You know, more broadly globally, there's definitely those bright spots, including Middle East and Latin America, where we've been making investments, and it's really nice to see, you know, those investments paying off in regions that don't have the same currency headwinds or some of the same economic headwinds as the Western markets.

Rakesh Patel (Analyst)

Also a question on AI. Can you talk about the potential use of AI beyond marketing engagement? I'm just curious what kind of role you see it playing from an operational perspective and whether this has the potential to be a needle mover, in the next year or two, or if you see it as an out year event.

Michael Mente (co-Founder and co-CEO)

Our thesis is that AI can contribute every aspect of the business, you know, as we kind of see with kind of like whiteboarding and brainstorm there. We think that, you know, there's possibilities in some departments for a strong needle mover, you know, within the next 12 months for sure, but also anticipate, you know, continued acceleration across the board. We've literally gone through, you know, every aspect of the organization, and we think some of the first places that will impact the business the most is gonna be in our fashion design zone. We've already started to leverage some of the generative AI tools for, you know, fashion design, it's still early stages. We're seeing week to week these toolsets improve.

The design team has been happy with what they've been able to do with kind of like semi-primitive, you know, generative tools. You know, super exciting there. I think that there's a lot of things that can link ultimately, and as we fast-forward, you know, a few years into the future, I think that things could be dramatically different for us. It's a really exciting time. I think Mike and I are really reminded of the, you know, 25 years ago, early internet days where it's like saw the clear long-term trend was there. The specifics of how things will play out, of course, will evolve over the ages, but we think that we're positioned well to take advantage of this next wave of technology.

Operator (participant)

We'll take our next question from Edward Yruma with Piper Sandler.

Edward Yruma (Analyst)

Hey, guys. Thanks for taking the question. I wanted to click down a little bit more on FWRD. Obviously, I know you guys are excited about the longer term growth opportunity there. Could you kind of click down a little bit on inventory there? How you feel. I know you said kind of from the entity level, you'll be kind of clean by the end of the second quarter. How do you feel about FWRD's inventory level, and kind of have you seen any impact from some of the promotions that we've seen across the luxury space? Thank you.

Jesse Timmermans (CFO)

Yeah, I think consistent with what we've talked about before, it does take longer to right the ship on the FWRD side than it does on REVOLVE. You know, we feel really good on the REVOLVE side. FWRD still has a little ways to go, and that's why. That's where we're sticking to the, you know, the end of Q2 before we feel like we're in, you know, a kind of a rebalanced position. Right now, FWRD inventory does over-index relative to the kind of the sales mix on REVOLVE and FWRD. I think promotions do have an impact, have had an impact, and I think will continue to have an impact as everybody works through their inventory, the uncertain and challenging macro environment.

We're working through that, and we typically don't respond on a kind of a head-to-head, one-to-one basis on the promotion. It's more about, you know, working through our inventory and getting it in the right place.

Edward Yruma (Analyst)

Maybe one other follow-up. I guess, have you seen enough from a weakening consumer macro perspective that makes you wanna tilt your assortment within core REVOLVE to more entry price point or lower price point versus kind of where it had been migrated to? Thank you.

Michael Mente (co-Founder and co-CEO)

Yeah. We're always mindful of consumer shopping behavior and, you know, there's certainly not gonna be any shifts that, you know, dramatically change our position in the marketplace. You know, certainly at the edges as we kind of tactically react to where consumer demand is strongest versus softest, we're constantly optimizing the mix and that'll continue to be the case.

Edward Yruma (Analyst)

Thank you.

Operator (participant)

We'll take our next question from Jim Duffy with Stifel.

Jim Duffy (Analyst)

Thank you. Good afternoon. I wanted to start asking about inventory and promotion. Q1 showed some aggressive actions on the inventory. I'm curious, did the inventory progress exceed your expectations in the quarter? Even with leaner inventories, do you expect you'll need to sustain promotion to remain competitively relevant?

Jesse Timmermans (CFO)

Yeah. I would say, you know, The inventory progress is roughly in line with our expectations, despite, you know, softening on the top line that we did not expect late in the quarter. I think, you know, we're really pleased with the inventory progress despite the softening top line. And, you know, we'll just have to kinda read the landscape as we go through the year. I feel good about the inventory. We'll feel, you know, like we're rebalanced at the end of Q2, and we'll kind of manage accordingly. Again, we typically don't respond, head-to-head or, you know, in direct response to individual promotions from others. It's all about, you know, kind of working through our inventory at the right pace.

You know, if things pick up, we're confident we can chase into demand in the right categories as well.

Jim Duffy (Analyst)

I'm curious, just the consumer response to promotions. Have the consumers been embracing the promoted merchandise more than you would expect at the expense of full price sales? You know, what are you seeing in the mix between full price and promoted goods?

Jesse Timmermans (CFO)

Yeah, I mean, you know, generally, you know, I'd say they're responding as we would expect to the markdowns. I think also responding on the flip side as we're now shifting back into full price. We're already seeing a pretty meaningful, you know, kind of, reversion back to that full price. Not to the record levels we were at last year, of course, but you can see that in our gross margin guidance that we gave for Q2. You know, again, just managing accordingly and responding to the customer.

Operator (participant)

We'll take our next question from Chad Tevebaugh with Needham & Company.

Chad Tevebaugh (Analyst)

Hi, it's Chad on for Anna. Just on the better FWRD growth in the quarter, can you talk about what's embedded for 2Q and what you're seeing with the more luxury consumer? Additionally, with the moderating inventory at the end of 2Q, should we think about inventory being more in line with sales in the back half of the year? Thank you.

Jesse Timmermans (CFO)

Yeah. No comment really on the expectation for FWRD, you know, beyond what we saw in April, which, you know, was a, you know, kind of a slight sequential improvement on a one-year basis versus March. Again, on a multi-year basis, still, you know, still a detail across the board. FWRD is just, you know, much more volatile on a month-to-month and quarter-to-quarter basis, which is, you know, why we wanna stay away from giving too much color on the expectations there for the balance of the year. Inventory in line with sales, you know, again, that was our expectation that is around, you know, the middle of this year that, you know, those two would converge closer.

Operator (participant)

All right, we'll move on to our next question from Janine Stichter with BTIG.

Janine Stichter (Analyst)

Hi, everyone. Can you talk to own brand penetration, where it sits currently? Would we expect to see it ramp as we get inventory more aligned in the back half? Also on that, can you speak to where margins are currently on private brands versus historical and where you see them trending? I know you mentioned the lower inbound freight starting to kick in. Anything else to call out there just on the costing environment? Thank you.

Jesse Timmermans (CFO)

Yeah. For the own brand mix, I wouldn't expect, you know, a meaningful increase in the mix this year versus last year. I think that is more of a, you know, probably a 2024 dynamic. In times like this when we're rebalancing inventory, and given the depths that we need to produce into on the own brands, you know, that has a more meaningful pullback than on the third party side. Not expecting a meaningful increase this year on a full year basis. More kinda comparable, even, you know, throughout the balance of this year, to what we had last year. The margins are holding strong. That inbound freight on own brands has returned close to pre-pandemic levels.

Keep in mind that given the higher price point that we operate at, that premium price point, the freight is a much smaller percentage of the cost of goods sold, than maybe for others. It does have a positive impact, you know, but it's not as meaningful as you might otherwise think. That margin is still, you know, significantly higher than a third party margin.

Operator (participant)

We'll take our next question from Tom Nikic with Wedbush Securities.

Tom Nikic (Analyst)

Hey, guys. Thanks for taking my question. Jesse, the gross margin for Q2 is, you know, implied to get much better sequentially. Is that just a function of less discounting or full price mix getting back to normal or closer to normal? Is there anything else like mix-related we should think about that starts becoming a good guy? Just, can you just help us sort of understand the progression of gross margins here?

Jesse Timmermans (CFO)

Yeah. No, that is the primary driver. Shifting back to a healthier full price mix in Q2. We see that, you know, that's typical for any year, but especially this year as we made significant progress on the inventory in Q1 and then in a healthier place in Q2. There's both a seasonal aspect and then our inventory coming back in check that also helps that. You know, mix across categories is relatively consistent. We think we're back to, you know, call it plus or minus normal with, you know, that 30% being dresses. Dresses does tick up a little bit in Q2, as does that fashion apparel. You know, there's a little bit there, but I would say the primary driver is that full price mix component.

Tom Nikic (Analyst)

Got it. Thanks, Jesse.

Operator (participant)

We'll take our next question from Matt Koranda with ROTH MKM. Please go ahead.

Matt Koranda (Analyst)

Hey, guys. Good afternoon. Thanks. A lot have been asked and answered. Just wanted to cover engagement. In what categories are you seeing new customers enter the active user base? Anything that's changed there, any callouts just given the different economic environment we're in?

Mike Karanikolas (co-Founder and co-CEO)

Yeah. I wouldn't say there's any major changes from some of the trends we've seen in earlier quarters, but a couple of callouts. One would be that markdown products were particularly strong in new customer acquisition, and that's generally true historically. You know, so that was certainly, you know, one reason we saw strong new customer growth in the first quarter. Then also beauty. Again, the same quarter as previous quarters, beauty's been a growth area for us, and that area is typically more efficient for us in driving new customers, and so we saw strength there as well.

Operator (participant)

We have time for one more question. We have Simeon Siegel with BMO Capital Markets.

Simeon Siegel (Analyst)

Thanks. Hey, everyone. Good afternoon. I understand it's trailing 12 months, perhaps it's a little different than what would've been this quarter. Just from what we can see, you're still showing impressive active customer growth, especially versus revenues. I'm curious, I appreciate the tougher macro, do you think the new customers are any different than the existing ones? I'm just wondering if they might be partially driving lighter productivity, just whether it's the returns, the margin, the AOV, et cetera. Just curious if you're seeing anything interesting learning wise or discrepancies with the new cohorts. Thank you.

Mike Karanikolas (co-Founder and co-CEO)

Yeah. We're not seeing anything particularly different from the new cohorts versus previous cohorts. You know, certainly depending on how we bring in a new customer, there can be some, you know, some differences over time. In general, what we're seeing is consistent with what we've seen historically as far as our expectations from those consumers. As it relates to return rate, typically new customers actually tend to have a lower return rate than returning customers. That wasn't, you know, that didn't have any impact on the increase in return rate in the first quarter.

Simeon Siegel (Analyst)

Okay. Great. Thanks a lot, guys. Best of luck for the rest of the year.

Mike Karanikolas (co-Founder and co-CEO)

Thank you.

Operator (participant)

That's all the time we have for questions today. I'll turn the call back to management for closing remarks.

Jesse Timmermans (CFO)

Thanks for joining us for the quarter, guys. Obviously, you know, a lot going on in the business, a lot going on in the world, but very excited for what with the organization. Looking forward to next quarter to show you continued results, both operationally as well as financially.

Operator (participant)

Thank you, and that does conclude today's presentation. Thank you for your participation, and you may now disconnect.