Business Context and Reporting Period
Revolve Group, Inc. is an online fashion retailer serving Millennial and Generation Z consumers through the REVOLVE and FORWARD platforms. This unaudited Form 10-Q covers the three and nine months ended September 30, 2019, compared with the corresponding 2018 periods. Revolve completed its initial public offering in June 2019 and operates as a Delaware corporation with dual-class common stock.
Key Financial Metrics
| Metric | Q3 2019 | Q3 2018 | YTD 2019 | YTD 2018 |
|---|---|---|---|---|
| Net sales | $154.2 million | $125.9 million | $453.4 million | $371.0 million |
| Gross profit | $82.7 million | $66.4 million | $243.9 million | $196.2 million |
| Gross margin | 53.6% | 52.7% | 53.8% | 52.9% |
| Income from operations | $12.8 million | $9.5 million | $37.5 million | $31.1 million |
| Net income | $9.6 million | $7.1 million | $27.3 million | $22.9 million |
| Net income attributable to common stockholders | $9.6 million | $7.1 million | $(13.6) million | $23.0 million |
| Diluted earnings per share | $0.13 | $0.10 | $(0.25) | $0.33 |
| Adjusted EBITDA | $14.4 million | $10.3 million | $42.0 million | $34.6 million |
| Operating cash flow | $9.2 million | $2.4 million | $31.8 million | $28.0 million |
| Free cash flow | $7.4 million | $1.8 million | $20.4 million | $26.4 million |
Q3 net sales increased 22.5% year over year, while nine-month sales increased 22.2%. Operating margin was 8.3% in Q3 and 8.3% year to date. Net margin was 6.2% in Q3 and 6.0% year to date. The nine-month common-stockholder loss and negative per-share result primarily reflect the $40.8 million repurchase of Class B common stock associated with the IPO and corporate conversion; reported net income was $27.3 million.
- Cash and cash equivalents were $51.1 million at September 30, 2019, versus $16.4 million at December 31, 2018.
- Working capital was $85.8 million, compared with $56.9 million at year-end 2018.
- Inventory was $103.7 million, compared with $102.2 million at December 31, 2018.
- No borrowings were outstanding under the $75.0 million revolving credit facility. The facility may be increased by up to an additional $25.0 million subject to conditions.
- Property and equipment increased to $14.9 million from $5.9 million, reflecting fulfillment-center consolidation, automation and infrastructure investment.
Material Changes Versus Prior Comparable Period
- REVOLVE segment sales rose 23.7% in Q3 and 24.6% year to date; FORWARD sales rose 14.2% in Q3 and 6.2% year to date.
- Active customers increased 33.1% to 1.438 million, and orders placed increased 25.7% in Q3 and 31.4% year to date.
- Average order value declined to $275 in Q3 from $280 and to $270 year to date from $281.
- Gross margin improved by 90 basis points in Q3 and 90 basis points year to date, primarily from merchandise mix and a higher REVOLVE contribution.
- Fulfillment expense increased 53.8% in Q3 and 59.1% year to date, partly because fulfillment-center expansion and automation created temporary overcapacity and duplicative capacity.
- Selling and distribution expense increased faster than sales, reaching 14.6% of sales in Q3 versus 14.5% and 14.7% year to date versus 14.2%, driven by shipping, handling and merchant-processing costs.
- Marketing expense increased 22.0% in Q3 and 21.8% year to date, reflecting higher performance marketing and REVOLVE-branded event spending.
- Capital expenditures increased substantially to $11.5 million year to date from $1.7 million.
Guidance, Outlook, Risks and Unusual Items
- The filing does not provide specific revenue or earnings guidance. Management expects continued investment in technology, inventory, fulfillment, international expansion, owned brands and customer acquisition.
- Management believes cash, operating cash flow and available credit capacity will fund anticipated needs for at least the next 12 months, but notes that liquidity assumptions could prove incorrect and additional financing may be required.
- ASC 606 was adopted January 1, 2019 using the modified retrospective method. The adoption increased beginning retained earnings by $0.3 million and affected the classification of expected merchandise returns. Q3 reported sales included approximately $1.8 million of breakage revenue; the filing identifies approximately $1.5 million as resulting from a change in the store-credit breakage estimate.
- The company launched the lower-price-point superdown offering in 2019 and is expanding owned brands and international operations. These initiatives may affect customer acquisition, sales mix, margins and inventory levels.
- Key risks include fashion-demand and inventory forecasting, markdowns and returns, fulfillment capacity and execution, dependence on social media and influencers, competition, discretionary consumer spending, tariffs and overseas sourcing, privacy and cybersecurity, technology interruptions, regulatory compliance, and changing tax obligations.
- The company maintains a secured $75.0 million credit facility with restrictive covenants, including a prohibition on cash dividends. It was in compliance with the covenants at September 30, 2019.
- No material legal proceedings or material off-balance-sheet arrangements were reported. On November 6, 2019, the company awarded its chief operating officer a special bonus of $285,000.
- Management reported effective disclosure controls and procedures as of September 30, 2019 and no material changes in internal control during the quarter. The filing nevertheless describes historical public-company reporting and internal-control remediation risks.
Important Facts for Investors to Verify
- Separate the $40.8 million IPO-related stock repurchase effect from recurring operating profitability when analyzing nine-month EPS and common-stockholder earnings.
- Assess the sustainability of reported sales and margin growth excluding the store-credit breakage estimate change and the effects of ASC 606.
- Monitor inventory growth, return reserves, markdown activity, average order value and the impact of owned brands and superdown on gross margin.
- Evaluate whether fulfillment-center consolidation and automation reduce the temporary cost pressure reflected in fulfillment expense.
- Reconcile adjusted EBITDA and free cash flow to GAAP results, particularly given the year-to-date decline in free cash flow despite higher operating cash flow.
- Consider the liquidity and covenant implications of the secured credit facility, planned capital expenditures and potential need for future financing.
- Review the dual-class voting structure, concentrated control, upcoming Class B share resale eligibility and potential dilution from approximately 5.2 million outstanding options.