Rent the Runway, Inc. (RENT) Earnings Call Transcript & Summary

Alright. Good afternoon, everyone. I'm Lauren Schenk, Morgan Stanley's small and mid-cap Internet analyst and I'm thrilled to be joined this afternoon by Jen Hyman, Rent the Runway's Founder and CEO; and Scarlett O'Sullivan, CFO. Before we begin, one disclosure on my side, please note that all important disclosures, including personal holding disclosures and Morgan Stanley disclosures appear on the Morgan Stanley public website at morganstanley.com/researchdisclosures or at the registration desk.

So with that out of the way, Jen, for those that might be newer to the Rent the Runway's story, can you talk about what inspired you to start the business and how it's evolved since inception?

Yes. So like all women, I think I've always been a shopaholic. I had recognized that how we bought clothes was entirely inefficient. 50% of the U.S. closet is worn 3x or less, and that's across gender. So you can make an assumption that women are using even less of their closets. And I started thinking about not only is the closet inefficient, but in 2008, when I had this idea for Rent the Runway, I was like, the closet is dead. It's filled with things that don't fit you anymore that are no longer in style, that are no longer relevant. And the idea for Rent the Runway was what if the closet were alive and it could actually change with you as your size changed and your life changed, your taste change. And so I came up with this idea of a closet in the cloud, which would enable women to have unlimited access to whatever they wanted to wear without having to buy it. This was a radical idea for when we launched in November of 2009. And now that secondhand clothing and wearing it is part of the norm and you have businesses as big as Amazon who're saying that secondhand is the future. We're in a completely different time in terms of the tailwinds for the business that we're in.

Okay. We know that Rent the Runway's number one goal right now is to get to profitability. Maybe give us an update of where you are on that timeline.

Yes. I think we can both address this. So we're really proud of the financial transformation we've made in our business over the last few years. So we've done 3 main things. Number one is we've doubled our gross margin since we IPO-ed 18 months ago. We now have gross margins above 40% and those gross margins are inclusive of all of our cost of inventory and all of our cost of fulfillment. Number 2 is we executed a restructuring last year that will save the business between 25 and $27 million in SG&A against where we were in Q2 of '22. And third is that we restructured our debt in January of this year, pushed out our maturity by 2 years into October 2026, and we saved $20 million in cash interest expense over the next 2 years. So that puts us into a place where we feel very comfortable with the cost structure of our business. We feel great about the margin profile of where we are. And the thing that will drive our business to profitability right now is growing. And we believe that our growth strategy is all about investment into the customer experience to deliver even more value to customers and do a better job at retaining the customers we already have and converting more of the traffic that we already have.

And then maybe just to give a little bit more flavor on profitability. So our very first goal was to our operating -- and we were able to do that in Q2 of last year. And then as Jen just mentioned, on top of that, we then announced. Thanks. I'll start again. So what I was saying is that the very first goal was to cover our operating expenses, and we ended up doing that in Q2 of last year. It was quite a bit ahead of what we had originally stated. And that was actually before the restructuring that Jen just announced. So on top of that now, we have a fixed cost base that is $25 million to $27 million less than it was at that time, and that will really benefit the business in terms of driving more adjusted EBITDA profitability for the business. And so really, as you think about going forward, how do we breakeven and get to free cash flow, as Jen mentioned, a big part of it is growth. And the way that growth impacts our free cash flow is that now every additional dollar of revenue that we bring in the door, we get $0.40 that flows straight through to free cash flow, right? So in a much better position than we were, and we're really excited about what that does in terms of cash burn for this year, meaning 2023 versus where we were last year, and we'll see a significant improvement. We're going to go into more detail on that on our Q4 call.

Great. Then you foreshadowed a little bit. You had a big announcement on Monday. Maybe what did you launch? What was the rationale behind it?

Yes. So we started off our year with a huge change on Monday to our subscription programs, where we basically are now offering 25% more value to all of our subscribers for the same price. So our most popular subscription plan has been a plan that people pay $144 a month for. And before Monday, they received 8 items a month in that subscription. And our change is that we -- they are now receiving 10 items a month for that $144. So thank you -- so why did we do that? Well, we did that because we have seen and tested over the last, actually, 5 years, what is the impact of giving people more items per shipment. And the impact across every different economic climate that we tested this in is that it significantly improved loyalty rate. It improves your rejoin rate, meaning people who'd formally turned come back to at a higher rate. And it also makes a lot more happy customers who refer other customers more who have given more customer reviews. So it really boosts up organic acquisition into the business. So the question would be, if you've known this and if you've known this for 5 years, why the hell did it take you so long to implement against 5 items at a time. And the answer there is that we couldn't afford it in the past, right? We had to actually make these massive changes to the way we acquire inventory, where now our product cost is only 30% of revenue because we're acquiring 60% of our product via consignment, meaning we don't pay for it upfront or we're manufacturing it ourselves. We had to change the fulfillment expenses of our business, fulfillment expense as a percentage of revenue a few years ago was 46% of revenue. It's now 30% of revenue. So we're now in a place where we can offer 25% more value to the subs with minimal impact to our gross margins. So just a simpler way to think about this is we've always shared that most of our churn happens in the first 90 days of people subscription. And within that, most of that happens in month one. Now why? You've never subscribed to fashion before you've never rented close. You sign up for Rent the Runway. You have a first shipment, you get 4 items from us in that first shipment before we made this change. Let's just say 2 of the items don't fit you. You don't like 2 of the items. Instead of a traditional response to e-commerce, which would be let me just return the 2 items that I didn't like. Our user who's new to rental, there's a risk that she thinks, well, maybe rental isn't for me. And so what we found is that just by giving her more items in that first month in that first shipment, there's a higher probability that she wears more items from us. And not only does she wear more items, but when she has more items to choose, she tends to pick some casual items in her shipment. She's not just renting dresses from us anymore. She'll rent a pair of jeans. She'll rent a blazer, shell rent to sweater, 2 positives that come with that. Number one, casual clothing fit her more often than the dresses. And 2, she can wear this blazer more than once over the month. So she's actually teaching herself the utility and the meaning of the subscription product. So the goal of this launch is really to have more of our customers start to behave like our best customers. Now we already have customers who received 5 items at a time. We've shared that over 30% of our subscribers pay for one or more additional units into their subscription. And those customers who already received 5 items at a time have doubled the loyalty rate of those that are in our one-swap-4-item program. So we think that this launch, and it's been received incredibly well by our customers will just help to ignite our growth at the beginning of the year, but by no means is this the only change that we're making to the customer experience this year, all of 2023 and beyond is going to be about how do we invest more into the customer experience so that we can further loyalty and further conversion.

Great. And we've got one as a follow-up. I think sort of the market's initial question was how does this impact profitability? Does this change the timeline at all? So maybe you can help put a finer point on that?

Sure. And I think putting a little bit more of a fine point on what Jen just said we expect to see minimal impact in our gross margins. How is that possible? If you think about the gross margin, you break it down. The first piece is the fulfillment cost. And there are 2 pieces within that, transportation and then the labor cost. The shipment's already going out to the customer. So there's actually not additional transportation costs, right? So that gets absorbed into the existing transportation costs. And then from a labor standpoint, we've just become much more efficient, and we're able to see very minimal impact when it comes to the labor cost as well. And then on the product side, right, one might think, wow, you have to spend 25% more to get the additional item for the customer. And what we do there is we optimize on inventory mix, right? So as Jen just said, we've done a lot over the years to really change how we acquire inventory. So not have to pay for the item upfront, right? So that last year, we said we expected to see 60% of our inventory spend be through these new innovative channels that were consignment or the ability to acquire items through manufacturing that we do ourselves at 50% of the cost. So continuing to optimize the mix of the acquisition, and we have more we can do there is a way that we help to fund this. And then finally, I would say, because of the fact that she's getting more items, she thinks of using us in a different way. So we expect to see kind of higher utilization of the items, more items that are out with the customer rather than sitting in our warehouse. And that's really why we feel really good about being able to fund this in a way that does not change our gross margin too much and also has -- there's an impact on our kind of original timing of what we think about in terms of free cash flow.

Okay, great. That was a really great overview of the announcement. Maybe taking a step back, what makes Rent the Runway so different from other retail models?

Well, I think, first and foremost, we're doing something in retail that's the opposite of what everyone else is doing. So if you are a retailer or a brand, your job is to get people to buy more stuff, whether or not the customer needs more stuff. And our job is to get the customer to buy less stuff. And to say, you know what, if you want variety, if you want to wear a new outfit every time you go out, there's a smarter way to do that. And you can have that variety way more affordably, way more sustainably through Rent the Runway. Think about what we are doing today. The majority of our subscribers are now getting 10 designer items a month for $144. That means its $14 an item. That's Shein-type pricing. And for that $144, she's receiving $5,000 worth of value. So we know that the customer wants variety. We see that in the success of models like Shein and other fast fashion businesses. And we're now providing an alternative with the real thing, with the real designer product. So that's one major difference. The second major difference is a best-in-class retailer, maybe you're going to that fashion site twice a year. Maybe you're buying one or 2 units from that company. Our customer is coming and picking 120 different products per year, which means that we cannot have an at par experience to traditional e-commerce. And I would say today that our experience is at par to traditional e-commerce, right? Like we have great filtering and great search, but we cannot be at par because she's coming to our app 2 to 3x a week -- this is a utility product for her. So we have to be so much better at serving a product in a more efficient, more delightful way. We have to be so much better at curating the assortment for her to -- and personalizing the assortment for her. And that's so much of what this year is going to be focused on and how we think about customer value. We have to feel more like our user -- to our user like a Spotify feels, where you go to their home page and you see all of the different ways that you can jump into a whole universe of content.

Great. How are Rent the Runway customers using the products today? How you've been able to respond to how women are addressing differently post pandemic? And within that, have you adjusted your inventory acquisition?

Yes. Well, first of all, thank God, we're not in the pandemic anymore because the pandemic was the worst thing that could have ever happened to Rent the Runway because the use case of Rent the Runway is leaving your home. I don't care what you do when you leave your home, but you got to leave your home to find utility to Rent the Runway. So the great thing about where we are right now is that they're using the product in the intended way, which is that over 50% of how she uses the subscription is for everyday casual use cases. She is renting jean. She's renting top. She's renting jacket. She's renting sweaters. 25% is she's dressing for the office again. She's dressing for work and actually work wear has doubled year-over-year. And we continue to see opportunities there as more people are going back to the office. And then the rest, so about 20% of her use case is dressing for event she has at night, everything from a date to a dinner to a party. And so she's really using this as an everyday utility. And the more that we can teach new customers that she can rent for work and she can rent for casual use cases, the more we're able to convert the customer. I think that because we were a business that launched around rent a dress for a special occasion, there's still a perception out there that, that's what Rent the Runway is for. And the more that we can build this viral subscriber base that uses us in her everyday life and is able to share with her friends and her colleagues that you can use Rent the Runway for work, you can use it for your everyday life, that's what actually grows our business.

Great. What secular trends related to the business have changed since the founding of it?

Why don't you start with that?

So, so many different trends. First of all, you have to remember when we launched the business the sharing economy did not exist, right? So even starting with something as basic as the kind of accessing as opposed to owning something, we really had to teach the behavior of what that meant. Of course, rental was clearly not something that existed when it came to clothing. You think about all the stigma that you had to overcome renting something that someone had worn before we had to convince not only the customers, but the brands as well. And so we've come such a long way, Jen told the story much better than I do from like the original, I think its 30 brands that we had, where we literally had to beg to get them on to our site. And then obviously, over the years now, we work with 800 brands, and we work with them in such different ways. So, so many things that have changed there that have really driven the business. But I would say above all is what Jen already touched on, which is really variety, right? I think the kind of pressing need for variety has really been one of the things that has driven kind of why people want to have so many items and have consumed so many items, and we offer just such a better way to do that but also to get the real thing.

Yes, we're not leaving a world ever where people want variety in their wardrobes. Social media has created an atmosphere where you are constantly on display. And therefore, the number of units purchased per year over the last 20 years has accelerated dramatically due to the growth of TikTok and Instagram and all of the channels in which we are -- we've become brands. So therefore, the winners in the fashion industry have been retailers that can offer high quantity at low prices. So that's fast fashion or mass priced fashion, off-price fashion. And so we're here saying, okay, if you want variety, we're going to give you a way to access it at those fast fashion price points, but give you the real thing, do it in an efficient manner, make it high end, etcetera. Now the other interesting trend that's happening is what's happened in the world of brands. And for a brand, it's been much harder for them to acquire new customers. Cost of customer acquisition has gone up. Physical retail distribution has diminished. And you're seeing that they have lots of competition from that fast fashion and from the off-price fashion. So one of the major things that's changed in our business over the last few years is that our brand partners perceive Rent the Runway more and more as being a marketing partner for them. What we're really doing is we're taking all of this incredible designer product. We're providing access to women in their teens, 20s, 30s and 40s to that product. They're wearing that product for the first time, and they're able to experience it, and many of them become full-price customers of the brand. So when brands think about working with Rent the Runway, they're comparing us to the cap that they would get of putting an ad up on Facebook or putting an ad up on Google. So they could buy an ad on Facebook to acquire a customer or they could put a unit on inventory up on Rent the Runway, have dozens of women wear that unit and have a percentage of those women become full-price customers of the brand. So I think that the change in consumer behavior has been a tailwind for us and the change in how brands are functioning is a tailwind.

Great. I understand you haven't reported fourth quarter yet, but maybe you can give us a little bit of a preview on your strategy heading into 2023.

Yes. So what we shared on Monday is that our strategy right now is driving the business to profitability through growth and how we're going to grow is by investing in the customer experience. We are not going to be investing more in bringing more traffic to the site. We actually have a lot of traffic that comes to Rent the Runway, and we believe we can do a much better job of converting the traffic we already have and making more of our customers behave like our best customers. So there's really 3 tenets to our strategy. One is getting her more of the inventory that she wants when she wants it. The second is doing a much better job about making it easy for her to find the inventory that she wants on the platform. And the third is making the experience easier and more efficient. So an example of that third bucket that we launched in '22 was at home pickup, making it so that when you were returning your order to Rent the Runway, you can just have -- you used to have to put all of your garments in a bag, find a UPS, drop it off at UPS, there's a lot of labor involved in having a subscription to Rent the Runway. Now 60% of our subscribers can say, hey, come pick it up in my house for free. And that removes friction from the experience, and we've proven out recently that, that enhances loyalty. So we're going to be doing more things like that, that take this friction out of the experience of having the subscription.

Great. Maybe just dialing in on the home pickup, 60% of subscribers, where do you think that can get to over time? And maybe Scarlett can talk a little bit about the financial benefit of it.

Sure. So what Lauren is referring to is this at-home pickup where it's so much more convenient for the customer to be able to decide that she wants someone to come to her house and pick up her shipment as opposed to going down to a UPS. So we now offer what within our Q3 call is we now offer that capability to about 55% of our subscribers, and we've seen tremendous adoption of this. So in the ZIP codes where we offer this, we've seen adoption go from 29% to 39%. So that's great for her, right? It means that we've made it much more convenient for her. But it's actually really great for us, too, because it's actually a cost play for us too. And the reason it is, is because otherwise, it's a one-for-one shipment, right? So she is sending one single shipment back to us via UPS historically. Whereas here, what we're doing is it's a consolidation play. So we are able to aggregate shipments in a single area and then bulk ship them back. So it's really great for us from a cost standpoint. And then what's really interesting about it is that we now offer what we call live swap, which means that not only can she choose to have someone come over to pick up her shipment, she can also schedule the delivery of her new shipment at the same time as well, right? So that you can do both transactions at the same time, about 30% of our at-home shipments as of Q3 were simultaneous. And therefore, that's even better for us because now we're saving not just on one way, but on the other side as well.

Great. And then you mentioned you recently went through a restructuring of your existing debt facility. Maybe talk about the impetus for that?

Yes. So we had a debt facility that had a maturity date of October 2024. And as a result, a lot of investors have not even been interested in hearing the story because the assumption was that if you don't do something about that, the business could not be here. So we restructured the debt. We pushed out our maturity by 2 years. We reduced our cash interest payment by $20 million over the next 2 years. And I think that this was a real testament to the fact that the partner that actually knows us the most, our debt provider, Temasek has been a Board observer and has sat on our Board since 2018. They know every move that we've made in the business and they had all the leverage. And instead of taking that, they believe that the outcome of rental runway is going to be much bigger, and they gave us incredible terms to restructure this debt and give us an opportunity to really prove to the market that this is a business that will be profitable, that will have great margins and will be a much bigger business in the future than we are today. So we're really excited not only by the restructuring, but by the sign of confidence that this gave from the partner that knows us the most.

Great. We have a few minutes left. I don't know if there's any questions in the audience. There's a mic coming.

As I was saying, I love Rent the Runway. But when I tell friends to use it, my biggest feedback is like, oh, I don't know, it's kind of gross maybe or wearing other people's clothes. Do you guys -- and maybe do you have this on the website, but more insight like what cleaning products you use, how it's done, how different things get and stuff like that? Because that's the biggest thing I always hear when I tell people to use it. It's like I don't know if I want to wear it.

Yes. I would say that when we launched the business in November 2009 that, that concern was even more ubiquitous than it might be right now. And if you think about the growth of secondhand clothing over the past decade plus, where you not only have what Rent the Runway has built, but you've had incredible businesses like Poshmark and thredUP and the RealReal have normalized the behavior of buying, renting and subscribing to secondhand clothing. We have even gotten to the point where the biggest retailers in the world like Amazon, have said that secondhand is going to be a major part of their strategy on a go-forward basis. So I think that the tailwinds behind wearing secondhand have never been higher. I think that there's opportunity for Rent the Runway to do an even better job at taking people into what is one of our biggest competitive advantages, which is our operation and showing them how much we care for our product and clean it and restore it. And I would invite all of you to come visit one of our facilities because you could really see the moat that we've built from there. But I'm so encouraged by the tailwinds here, the fact that a few months ago, we had Kate Middleton, who rented a address. I mean to think even 5 years ago that the future Queen of England would rent a dress and talk about it, that's a really big deal in terms of how normalized this behavior is, how smart it feels to the consumer.

Great. A few minutes. Maybe each of you just talk a little bit about what you're most excited about for 2023.

Yes. So I am most excited about getting back to what I love to do most, which is deliver more value to the customer and transform the customer experience. Honestly, the past few years for Rent the Runway has been about surviving COVID, which was a very difficult time for our business, and it's been about financially transforming the company and getting to a margin structure where we actually can be profitable and can be profitable and show significant progress towards that in '23. So I'm excited that we're going to start making the kinds of innovations and transformations that we had continuously made prior to COVID, it's coming back, and we're going to be able to make those investments. And one of the things that I did on Monday, when we announced these new subscription plans to our subscribers is I actually got in front of the subscribers. And there's a video that went out to all of our subscribers on the homepage of our app right now, where I have made a promise to all of our subscribers to say, hey, you're going to hear from me all the time this year, every month we're going to come back to you and tell you what we've done to make your experience better and how we have added more value into your subscription. And so I think that by nature of refocusing the entire company on the consumer experience and on to providing value, and we're doing that by shifting more resources into consumer than we've had in years, and we can do that right now that we're going to be able to make a massive impact to the experience and therefore, to growth.

Well, the cliche thing to say would be that I'm excited to see the impact show up in our numbers of everything that we've done over the last few years. And I certainly am, but I am really excited about exactly what Jen is saying, which is this focus on the customer, not only everything we're doing from a customer experience standpoint, we obviously have early previews of everything that's happening from an assortment standpoint, the inventory that we're bringing on board for her, and I'm really excited to see her reaction to that, especially because we're going to make it easier for you to figure out where it is and how to find it and find the same that's right for her.

Excellent. That's a great place to wrap up. Thank you both so much for your time. Thanks, everyone, for coming.