Revolve Group, Inc. — Form 10-Q Summary
Business Context and Reporting Period
Revolve is a next-generation online fashion retailer serving Millennial and Generation Z consumers through the REVOLVE and FORWARD segments. The company sells apparel, footwear, accessories and beauty products through its websites and mobile applications, supported by influencer marketing, proprietary technology and data analytics.
This unaudited Form 10-Q covers the quarter and six months ended June 30, 2019, compared with the corresponding 2018 periods. The company completed its initial public offering in June 2019 and became a Delaware corporation through a corporate conversion.
Financial Performance and Key Metrics
| Metric | Q2 2018 | Q2 2019 | Six Months 2018 | Six Months 2019 |
|---|---|---|---|---|
| Net sales | $131.8 million | $161.9 million | $245.1 million | $299.2 million |
| Gross profit | $73.3 million | $90.4 million | $129.8 million | $161.2 million |
| Gross margin | 55.6% | 55.8% | 52.9% | 53.9% |
| Income from operations | $14.1 million | $17.7 million | $21.6 million | $24.6 million |
| Net income | $10.5 million | $12.7 million | $15.8 million | $17.7 million |
| Net income attributable to common stockholders | $10.5 million | $(28.1) million | $15.8 million | $(23.1) million |
| Diluted EPS | $0.15 | $(0.57) | $0.23 | $(0.51) |
| Adjusted EBITDA | $15.6 million | $19.0 million | $24.3 million | $27.5 million |
| Operating cash flow | $13.5 million | $6.8 million | $25.6 million | $22.7 million |
| Free cash flow | $12.8 million | $2.0 million | $24.6 million | $12.9 million |
Q2 net sales increased 22.8%, while six-month sales increased 22.1%. Active customers increased 36.2% to 1.359 million, and orders placed increased 30.8% in Q2 and 34.4% for the six-month period. Average order value declined from $281 to $275 in Q2 and from $281 to $268 for the six months.
The Q2 operating margin was approximately 11.0%, compared with 10.7% in the prior-year quarter. Six-month operating margin declined to approximately 8.2% from 8.8%. Net margin was approximately 7.9% in both Q2 periods and declined to 5.9% from 6.4% for the six months.
At June 30, 2019, cash and cash equivalents were $44.8 million, working capital was $78.0 million, and total assets were $215.6 million. Inventory was $102.5 million and the returns reserve was $36.4 million. The company had no borrowings under its $75.0 million secured revolving credit facility, which expires in 2021 and may be increased by up to $25.0 million under specified conditions.
Material Changes Versus the Prior Comparable Period
- REVOLVE segment sales increased 24.0% in Q2 and 25.1% for the six months; FORWARD sales increased 14.4% in Q2 but only 2.0% for the six months.
- Gross margin improved because of a higher mix of REVOLVE and owned-brand merchandise.
- Fulfillment expense increased 62.5% in Q2 and 62.1% for the six months, reaching 3.3% of sales versus 2.5%, primarily due to fulfillment-center expansion, overcapacity and duplicative capacity.
- Selling and distribution expense increased faster than sales, reaching 14.6% of Q2 sales and 14.8% of six-month sales, driven by shipping, handling and payment-processing costs.
- Marketing expense increased 17.7% in Q2 and 21.6% for the six months, while marketing as a percentage of sales declined modestly.
- Operating cash flow and free cash flow declined because of unfavorable working-capital changes, higher inventory investment and substantially higher capital expenditures.
- The company adopted ASC 606 on January 1, 2019 using the modified retrospective method. The adoption increased beginning retained earnings by approximately $0.3 million and affected the presentation of expected merchandise returns and breakage revenue.
IPO, Capital Structure and Unusual Items
In June 2019, Revolve sold 3.382 million Class A shares at $18.00 per share and received approximately $53.3 million of net proceeds after underwriting discounts and offering costs. It used $40.8 million to repurchase 2.401 million Class B shares associated with the preference amount of former Class T units. This repurchase was treated as a dividend-like reduction in income available to common stockholders, producing reported common-stockholder losses and negative EPS despite positive net income.
Following the corporate conversion and IPO, the company had 13.5 million Class A shares and 55.3 million Class B shares outstanding at June 30, 2019. Class B shares carry ten votes per share and are convertible into Class A shares, resulting in substantial voting control by pre-IPO holders and management affiliates.
Outlook, Management Commentary and Risks
- Management expects existing cash, operating cash flow and available revolver capacity to fund anticipated needs for at least the next 12 months, but notes that liquidity assumptions could prove incorrect.
- Near-term capital spending is expected to remain focused on fulfillment-center expansion, technology and infrastructure. Management expects current capacity to support near-term growth but acknowledges transition-related pressure and possible additional facility consolidation.
- Management expects fulfillment expenses to rise in the near term because of facility expansion, with potential improvement as capacity is utilized. Selling, distribution, marketing and general and administrative expenses are expected to rise in absolute dollars as the business scales.
- The company launched the lower-price-point superdown offering in 2019 and is continuing international expansion, particularly in Europe, Australia, Canada and Asia-Pacific. These initiatives may require additional investment and could cannibalize existing sales.
- Key risks include fashion and demand forecasting, inventory obsolescence and markdowns, returns, customer acquisition costs, competition, reliance on influencers and third-party suppliers, fulfillment execution, cybersecurity and privacy compliance, international operations, tariffs on China-sourced goods, labor costs, tax changes and economic weakness affecting discretionary spending.
- The filing states that there were no material legal proceedings and no material off-balance-sheet arrangements. Management concluded that disclosure controls were effective as of June 30, 2019, with no material changes in internal control during the quarter.
- The company previously identified a material weakness in internal control over financial reporting related to insufficient review resources and reported that its remediation plan had been implemented; investors should continue monitoring whether remediation remains effective as the company operates as a public issuer.
Important Facts for Investors to Verify
- Reconcile positive net income with the reported common-stockholder loss and negative EPS caused by the $40.8 million Class B share repurchase.
- Assess whether customer growth and order growth can continue despite declining average order value.
- Monitor fulfillment-center utilization, capital expenditures and the effect of excess or duplicative capacity on margins and cash flow.
- Review inventory levels, returns reserves and markdown activity for potential fashion or demand risk.
- Evaluate the sustainability of adjusted EBITDA and free cash flow, including the company’s non-GAAP definitions and one-time adjustments.
- Consider the effects of ASC 606 adoption when comparing 2019 results with 2018 results, which were not restated.
- Review the dual-class voting structure, potential future sales of restricted Class B shares, outstanding options and related dilution.
- Monitor tariff, supply-chain, privacy, cybersecurity, regulatory and international-expansion developments.