Warby Parker Inc. (WRBY) Earnings Call Transcript & Summary

Great. Okay. So for the fourth time today from me. If you don't know me yet, I'm Alex Straton and I co-lead branded apparel, footwear and softlines retail here at Morgan Stanley alongside Kimberly Greenberger. We're super happy you guys joined us for the conference today, and we're equally delighted to welcome Dave Gilboa, CEO of Warby Parker.

Thanks for having me.

Great. So I will start with just a quick background on Warby as a company, and then I'll introduce Dave more formally. So in a nutshell, Warby Parker is a direct-to-consumer provider of holistic vision care. The brand designs and sales high-quality eyewear at lower prices than many competitors. They had many competitors. And since its launch, it has introduced contacts as well as vision services like eye exams. Warby became a public company via direct listing in the fall of last year and is now roughly a $2 billion market cap company. While Warby initially started out as an online retailer, and digital still comprises about 40% of total revenue, the company now operates almost 200 retail stores. Since becoming a public company, Warby has delivered strong top line growth with 2022 year-to-date sales up over 10%. For the year, Warby is on track to deliver around $600 million in revenue with about mid-single-digit adjusted EBITDA margins. As I mentioned, today, we're joined by Warby Parker's Co-Founder and Co-CEO, Dave. Dave, co-founded, Warby Parker with business school classmates Andy Hunt, Jeff Raider and Neil Blumenthal in 2010. Neil and Dave have both served as Co-CEOs since then. And prior to founding Warby, Dave worked at Bain & Company as well as Allen & Company. So again, Dave, welcome. Thank you for joining us. And for the audience, we're just going to spend the session today in a fireside chat question-and-answer style format. And we've also reserved time to take your questions at the end, so be ready with those. Before we dive into the Q&A, I do need to remind everyone that for important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures.

So with that, all covered, a mouthful. Let's just kick this off with the first question. So maybe, Dave, given Warby is relatively new to the public markets, how about we just start with how you think about Warby compared to the other eyewear players, who you view as kind of the biggest competitors? And how would you describe Warby's positioning against them?

Yes. So the optical industry is pretty large, it's $44 billion in the U.S., serving over 200 million adults who need a form of vision correction. And the market is split roughly 50-50 between 2 segments. So on one hand, you have large retail chains. On the other hand, you have independent eye doctors' offices. And we believe we compete with and have been taking share from both of those segments. And there are some unique aspects of kind of each of those segments within the market. So on the retail chain side of things, you have a number of different large chains like LensCrafters, Pearle Vision, Sunglass Hut, Target Optical, Sears Optical, Macy's Optical. But what's unique about the category is that a lot of those retailers, including all the ones I just mentioned, are owned by the same company, EssilorLuxottica, who also owns a lot of the brands that -- brands of eyewear from Ray-Ban, Oakley, Oliver Peoples, Persol, Arnette. They license lots of other brands. They're largest lens company in the world. They own EyeMed, the second largest vision insurance provider. And so there's just a significant concentration of ownership and power within the category that's different from most other kind of consumer categories. And then on the other side, you have independent eye doctors. And optometry is unique within the world of human health care in that doctors can prescribe something to their patient and then sell what they're prescribing and make margin on it. So if you go to a medical doctor and they write you prescription for Lipitor or Ozempic, you're going to a third-party pharmacy. The doctor is not making margin on what they're prescribing. Within the world of optometry, it's the opposite. Where the patient comes in for an exam, 70% of those people then go on to buy glasses from that eye doctor and so it kind of exit to the gift shop. And there are these small practices that also double as retailers. And neither of these segments have really invested in technology or much innovation into. When we entered the market, less than 2% of glasses were sold online. Today, that's still less than 10%. It far trails most other consumer categories. And there's just been persistently high prices in category. So despite glasses having existed for 800 years, they cost 10x to 20x what they -- the consumer price is 10x to 20x what they cost to manufacturer. And that's really a result of limited competition and kind of having these optometrists as gatekeepers. And so when we entered the market, we wanted to operate pretty differently from kind of these existing segments. We want to create a brand that customers love by focusing on creating -- offering products at reasonable price points on prescription glasses, including lenses for $95 instead of charging several hundred dollars. Investing in e-commerce and digital tools like our Virtual Try-On or a Virtual Vision Test where our consumers and patients can renew their prescriptions from home in just a few minutes. And really kind of rethink the entire shopping and ownership experience around glasses. We believe that the glasses are really fun fashion accessory when they cost $600 people -- most people only can afford to own 1 pair, but the one that costs $95, it really kind of changes the purchase calculus around the category. And I think that's probably what's most evident in how we operate relative to kind of other players in the category. The overall Net Promoter Score in the optical industry is 27, which is the same as the airline industry. And ours has been around 80 for our entire history, and we've really focused on ensuring that we're delivering value and great experiences to customers and expect that over time that we'll pay off in loyalty and word of mouth. And we've seen that to date, but are still very early in our journey.

Okay. That's a super helpful overview of the competitive landscape you guys are in and how you fit in. Maybe let's just dig into the business model. So you initially started as an online business, but I think pretty quickly pivoted to opening stores. Can you just walk us behind the rationale between that channel mix and then how you think about the opportunity in the 2 channels going forward?

Yes. So we launched in 2010 out of our apartments when we were full-time students. We launched online for a couple of reasons. One, we thought there was a really interesting opportunity -- a unique opportunity to build a brand online and leverage the power of the Internet to really reach a large consumer base. Over the last 12-plus years there have been lots of other brands that have been launched online, but back then it was a novel proposition. The other reason was that we were full-time students, we bootstrapped the business. We didn't have a balance sheet. No landlord in the right mind would let us sign a lease. But we -- so we launched online. We always thought ourselves as a brand that is channel-agnostic, but really focused on delivering the most value to customers. And we -- while our online business was growing quickly and continues to scale, we realized that if we want to reach the most consumers, the vast majority of people still feel most comfortable shopping for glasses in stores and so it made sense for us to open stores. We opened our first store in 2013. By the end of this year, we'll have 200 stores. We'd opened 40 this year. And we find that those stores are great mechanisms to attract new customers, so they serve as kind of billboards and inherent marketing for our brand. And we find that customers love the experience of shopping in those stores. They become kind of great vectors for word-of-mouth. And the stores themselves are very capital efficient and profitable. So our stores pay back in less than 20 months. We've mentioned that our target 4-wall margins are 35%. And we've seen those numbers hold up even throughout the pandemic when we've seen kind of depressed traffic across our category. And so we are still really big believers in physical retail. We think that the best brands and the best retailers need to have seamless omnichannel experiences. And really the only player in our category that has a true omnichannel offering at scale. And in particular, we're excited that going forward, our stores enable us to attract a different type of customer base, namely progressive customers. So most people after they turn 45 need bifocals or progressive, that's a large part of our business. So that continues to increase as our overall product mix each quarter. We're still massively underpenetrated. So about 20% of our products are sold as progressive. That's relative to close to 50% of the overall market. And as we open more stores, we're able to attract more progressive customers. It's our highest price point and highest gross margin product, and so provides lift on both the top line and bottom line. Having stores also enables us to have eye doctors and have eye exam rooms, and that's been a really big area of investment for us over the last year. Prior to that we kind of forced our customers to go to a non-Warby Parker doctor to get their exam. They had the awkward conversation with them about why they're not buying glasses from that doctor, get their prescription come to one of our stores or go to our website, buy glasses from us and then go somewhere else to buy contact lenses. And now we're really focused on bringing all those aspects together and having stores conveniently located throughout the country is kind of a core part of that overall strategy.

That's great. And it's a nice segue kind of into the Vision Care. I feel you answered it quite well already. So maybe a follow-up from me on the channel mix. I think digital is about 40% or so of the business. How do you envision that evolving longer term as you open more stores?

Yes, if you look at the kind of our channel mix, we really view our customer journey as integrated across digital and physical. And we find that upwards of 70% of customers who shop in our stores have started that shopping journey online by downloading our app, using our Virtual Try-On and creating favorites. And we find that a lot of customers, they may find that there's a store located nearby. They try on a few pairs of glasses, but then they want to come home, get advice from their husband or wife, they want to check their vision insurance benefits, and check out online. And so we do find that there's a lot of interplay. We don't really view them as separate channels. But we do track where transactions take place. And what we found is that pre-pandemic, about 2/3 of transactions were taking place in our physical stores, 1/3 online. During the pandemic, we've seen some pretty wild swings in that channel mix, where when we closed all of our stores, say 100% of our transactions were coming through e-com. And then we've seen a shift back into our stores. And now that mix shift looks fairly similar to what it did pre-pandemic, and we're expecting consistency in that mix going forward.

Okay. That's great. I think maybe zooming out a little bit, insurance is a different aspect or maybe a unique aspect of this market that we don't see as much in apparel and footwear or have to maybe consider. So it seems like Warby making inroads with some of these employer-sponsored health care providers is really pivotal for long-term success. So can you just walk us through that dynamic, how to think about it and where you guys are in your journey with that?

Sure. Yes. So vision insurance is an actual insurance. It doesn't cover any catastrophic events. It's really a prepaid plan that gives people defined discounts on exams, glasses and contacts. And so it's much more like Amazon Prime than medical insurance or other types of insurance. But it is -- has been kind of embedded within the category and has been a mechanism for retailers and independent eye doctors to have very high sticker prices on their glasses, then you apply some vision insurance discount and the customer feels like they're getting a good deal, even though they're still paying hundreds of dollars out of pocket. And there was a recent study that showed that customers who go in network through their vision insurance provider end up still paying $220 out of pocket to buy a pair glasses. Conversely, our losses start at $95, including prescription lenses and all the coatings. And so we have been kind of educating the market that even if you have vision insurance benefits and even if we're not in-network, you're still going to be paying less coming to us. And I think that message has been resonating. The majority of our customers, so over 60% of customers who shop with Warby Parker have vision insurance benefits. Not all of them end up getting reimbursed because we're not in-network with some of the largest carriers. But we are working to develop a lot of those relationships. And so we're now in-network with all United HealthCare customers, we're in-network with some large employers like GE and Boeing who have approached us, because their employees are kind of asking or demanding their benefits manager that Warby Parker be added as a benefit. And we have kind of a clear path to adding lots of incremental covered lives through those mechanisms. We currently have 16 million in network covered lives and expect to add to that total. We're also kind of, yes, just creating a lot of education that people can use their out-of-network benefits with us. And in almost every case, they're going to be paying less out-of-pocket as little as $0 by leveraging those out-of-network benefits with us versus going in-network somewhere else.

Okay. That's a super helpful insurance overview, a quick sheet about how it works. So thank you.

And yes, I would just add, and say probably insurance is the kind of most common topic that we get asked about by public market investors who maybe have questions around, are we addressing the total TAM if we're not in-network with VSP or EyeMed. And we really don't view that as a limiting factor to reach the whole market. The majority of our customers today have VSP or EyeMed, and they're still choosing to come to us. And so I think there are ways that we can continue to expand those in-network relationships, but we really don't view it as kind of a gating factor for us at scale.

Okay. Maybe pivoting to more P&L type of question. Can you just talk to us about, I think it's a 20% plus adjusted EBITDA margin target over time. What are the levers to getting there? It's everyone's favorite question for the direct-to-consumer brands, time line, when are you going to be profitable? What's going on? So maybe start there.

Sure. Yes. So we, like everyone else, have had to adjust kind of the realities of the pandemic and what's going on in the economy over the course of 2022. And we had initially kind of built our expense base and our team to reflect much higher growth coming out of the pandemic. And now we're facing kind of some unusual headwinds in our category on demand where for the first 10 years of our business and going back much further than that. Before we were in business, there was really a lot of steady, predictable behavior in our category that led to steady, predictable growth. People got their eye exams on a regular cadence, bought their glasses on a regular cadence. And what we've seen over the last couple of years, largely due to the pandemic is that, there have been -- there's been kind of a major disruption to those patterns. And so, we're kind of -- we have adjusted our business to those new realities that we're seeing. And last quarter reported 8% year-over-year growth, which is abnormally low for us and low relative to kind of our long-term expectations. We're still taking share. And our kind of other -- kind of public peers in our category many have reported kind of negative year-over-year sales. And so on a relative basis, we're doing okay, but we have made some adjustments to our business to reflect kind of the lower growth environment that we're currently seeing, including a riff earlier this year, taking a hard look at kind of all our G&A expenses and kind of rightsizing our business with the intent of ensuring that we're able to improve profitability regardless of kind of what the growth environment looks like. And some of those changes have been reflected in our most recent earnings and will continue to benefit from some of the changes that we've made kind of reducing marketing, reducing the size of our team as we enter 2023 and beyond. And we do feel confident that we don't need to add materially to kind of our corporate overhead to continue to scale our business. And as we continue to open more stores, and those stores have 35%-plus 4-wall margins, we'll be able to support those stores with expense base that looks largely similar to the one that we have today. We also expect that our customer economics will continue to improve. So as more of our customers shift to buying progressives, they become higher value as more of those customers, in addition to buying glasses are buying contacts and getting eye exams from us. Those become higher value customers to us, and we don't expect that we'll need to pay materially more to acquire those customers. And so kind of all those factors will lead to consistent improvements in our margins over the next few quarters and years.

Okay. I do want to unpack a little bit about what you said on the eye care market being a very consistent grower historically, becoming more unpredictable in the last couple of years. It feels like there was perhaps massive spending last year as the world reopened and then a bit of an air pocket this year. What do you think about kind of that picture? Is that how you think about it? And then how do you plan now looking ahead, given how this has all changed?

Yes. So the category, overall, historically has been very predictable and that goes back to the great financial crisis and kind of prior recessions where certainly showed a lot more resilience than other categories. But I think the right way to think about it is that there is some spend in the category that's driven by the necessity and some that's more discretionary in nature. And when that discretionary spend is delayed for too long, then it kind of becomes a necessity, right. The physiology of the human eye doesn't kind of change depending on economic cycles. And so if people are not getting exams or not buying new glasses, that's going to catch up at some point. And what we saw in 2020 was that a lot of people delayed kind of activity in the space. People didn't feel comfortable getting exams. Lots of eye doctor offices were closed, lots of retailers were closed. And so there was a lot of pent-up demand that in early 2021, when people got vaccines, the world opened up, a lot of that demand was fulfilled. And most people don't need a new exam, don't need a new pair of glasses every year. And so kind of that cohort of customers and activity hasn't necessarily flowed through the system just yet. And as we survey our customers and consumers, we find that the people who are getting exams today and are buying glasses are people that are primarily concerned about their eye health. So the kind of casual shoppers, the people who just wanted to update their look were seeing kind of less of that activity across the category. And again, we're kind of still -- we're still growing while others are seeing declining year-over-year sales. But overall, there's just kind of less -- there are fewer exams, there's less activity that's happening in the space. We do believe that that's creating more pent-up demand that will need to flow through the system at some point, but we're not kind of building our expense base and we're not kind of predicting that that's going to happen in the near term until we see it materialize, but we do believe that we're better positioned to kind of capture that demand than others in the category when it does start to materialize.

You mentioned that you guys are still growing while some competitors are down, and that's a nice segue, I think, to some of the near-term trends we're seeing. I think revenue was up 8%-ish for you guys in the latest quarters and compared to some peers that were declining year-over-year. So maybe walk us through what drove that outcome? Why you think you're outperforming peers in this type of environment?

Yes, I think it -- throughout our history, we've taken share in both good times and bad. And I think that's reflective of our brand resonating the value proposition, price point, the experience that we deliver, Net Promoter Score, word of mouth. But kind of more specifically around some of the areas that we've seen more significant growth even in this environment, one is progressive. So our mentioned, we remain highly underpenetrated in progressives in every quarter. We continue to see an increasing mix of our business coming from those progressive customers. Second is contact lenses, where this is a category that we launched in 2019. It's still a relatively small part of our business, but it's scaling quickly, growing North of 50% year-over-year. And it's an area where that was kind of the most requested product that we didn't offer our customers prior to launch. Upwards of 40% of our customers wear contacts regularly, and so now they're able to, in addition to buy glasses from us, also buy contacts. What's also been, I think, a positive surprise is that we're attracting lots of new to Warby Parker customers where their first purchase is contact lenses, and then many of those customers go on to buy glasses from us. I mean, what we've seen in this type of environment is that the contacts market has held up relatively well. When people run out of contacts, they need to buy a new pair. It's not really optional. Most people who have glasses, they can go another kind of 6 to 12 months. They can see reasonably well out of those glasses even if their prescription has changed a bit. And so we've kind of continued to see strength in our contacts business. And then eye exams, just as we've added dozens of new doctors across the country as we've invested in telemedicine, we've seen really significant growth in our exam business. And so all those kind of factors have provided some lift even kind of in this market with overall headwinds on activity.

I think one follow-up on revenue outperformance versus peers aside that we've gotten consistently post earnings is how to reconcile the active customer growth, the average revenue per customer. I think those are like mid-single-digit to high single-digit levels with the store growth at 20%. So can you just talk about the delta there and how you think about that difference?

Yes. So there are a couple of factors at play. So one is that -- well, this year we'll open 40 stores, and those stores take time to ramp. And so there's a -- it's a highest percentage increase we've seen in our store fleet. And so a pretty significant part of that fleet is not at maturity yet, and so that's kind of one factor. The second is, there has been a pretty big swing back from e-com to retail stores. So you've seen this across lots of categories. We're not immune to that, and we've seen kind of a similar effect in our business. And so while we're kind of comping off some COVID periods, we have seen e-comm with negative year-over-year sales throughout kind of the first 3 quarters of this year. We're expecting kind of that to abate as we move kind of past some of the COVID comps. And so those factors, combined with overall headwinds on demand, just kind of less shopping activity, less traffic into stores kind of bridges the gap between the new store count and the revenue growth that we've seen.

Okay. One more on revenue, and I promise I'll get off of your back after this. Is just Warby is unique and that December is really important for the business in a way that isn't necessarily the same for a lot of apparel and footwear retailers that many of us are perhaps more familiar with. So can you just talk about why December is such an important month specifically as it relates to like FSA and HSA that dynamic?

Sure. Yes. So we see some pretty unique patterns in our business were by far the busiest days of the year between Christmas and New Year's, and New Year's Eve is generally depending on kind of day of the week it falls. It's generally by far the biggest sales day of the year as people scramble to use their FSA benefits that are expiring, their vision insurance benefits, their HSA dollars. And we kind of are expecting a similar dynamic this year. Last year, Omicron hit kind of its was like a precision missile right at the worst time of the year for us. And so we didn't see quite as much lift that week as we're used to. The other kind of factors the last couple of years, FSA dollars, the kind of the government allowed those to roll over to the following year, the full balance in 2020 and 2021. That's not the case this year. And so we are -- our team is gearing up for a very active kind of holiday shopping period, but specifically kind of that last week of the year when kind of everyone else has taken a breather.

Great. Okay. So one more question on the near term kind of your latest financial results. I know you, I think, had an intentional pullback in marketing spend. So can you just walk us through the rationale of why, how you're thinking about it going forward? That would be super helpful.

Sure. Yes, I think the main factor is just the kind of channel mix shift that we saw throughout the pandemic, where, as I mentioned, our stores are great marketing tools on their own. They serve as great customer acquisition mechanisms. And so in 2019, pre-pandemic, when our mix was around 2/3 of transactions in stores, 1/3 online. Our marketing spend as a percent of revenue was in the low double digits on 12%, 13%. During the pandemic, when we shut down all of our stores and saw our mix go 100% to e-comm and then remain north of 50% for several quarters. We needed some additional marketing to support that e-comm business. And one of those reasons is that we have our Home Try-On program, where we'll send customers 5 frames for free, include shipping -- free shipping both ways, enable people to try on our glasses before they have to make a purchase. We consider that a marketing expense. So that sits in the marketing line item. And so as we see more elevated e-comm activity, we kind of require more marketing spend to support that business. Now that we've seen our mix shift return similar to pre-pandemic levels, we thought it was prudent to bring our marketing down back to pre-pandemic levels. And so in Q3, it was 10% of revenue. We do think that there's opportunity for us to drive some additional growth and maybe increase that a little bit, but are expecting it to be quite similar to that 12% to 13% number that we saw pre-pandemic.

So that covers my questions on the near term. I know I promised audience questions. You have a couple of minutes left. So if anyone has anything, please feel free to raise your hand.

On your most recent earnings call, you guys gave a preliminary framework, I guess, trying to think about margins for next year, which was a fairly specific range while also talking about some of the uncertainty in the industry that we've discussed today. So I was wondering if you could just kind of contextualize the -- whether there's an underlying assumption about the top line there or you're confident that you can deliver that kind of margin range in a variety of environments or just any other color on kind of what's giving you confidence at this point and the pretty substantial improvement you're expecting for next year?

Yes. So when we went public, we had communicated that we were expecting to increase adjusted EBITDA by 100 to 200 basis points per year. And then there are some bunch of curveballs that came our way, including Omicron and inflation and all the other factors that are impacting consumers. And so our Q1 and Q2 margins were below kind of our targets. And we committed to ensuring that regardless of what we're seeing from a demand standpoint that we continue to improve those margins. And so I wanted to use the second half of this year as kind of the new base for that margin improvement and build 100 to 200 basis points off of that. And the -- yes, I guess the short answer is that we're committed to doing that regardless of what we see on the top line. And we're cautiously optimistic that there's maybe some pent-up demand that will flow through the system at some point, but we're not counting on that. And so we're expecting kind of more of a continuation of what we've seen from a demand standpoint this year and do feel confident that we can continue to improve our margins under that scenario.

All right. Any other? If not maybe one final one for me that we're asking everybody at the conference. So how are you assessing kind of consumer health at the moment? And have you seen any signs of strain or stretching that you can speak to?

Within the people who are shopping at our stores and online, we're not seeing kind of any signs of kind of weakness or trading down. We continue to see people kind of increase mix towards our more expensive products. I'd say where we are seeing weakness is just fewer kind of random passerbys, just retail shoppers that maybe had been at a store down the street who are walking by and kind of popped in that hadn't been planning a visit who end up buying. And so what we're finding is that our shoppers are very intentional. That they're making a trip specifically to come get an exam or come to buy a new pair of glasses from us. It might be the only stop that they're making on that retail journey. And so I think there is less kind of browsing and kind of casual shopping that we're used to seeing. But within the kind of types of transactions within our business, we're not really seeing any weakness there.

That's helpful. And that covers everything. We're up on time. So thank you all for joining, and thanks for doing this with me, Dave.

Great. Thank you so much.