Good afternoon and welcome to Revolve Group's Third Quarter 2019 Earnings Conference Call. Today's call is being recorded and we have allocated one hour for prepared remarks and Q&A. 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..

Good afternoon, everyone, and thanks for joining us to discuss Revolve’s third quarter 2019 results. Before we begin, I would like to mention that we have posted a presentation containing Q3 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.

These statements include our expectations regarding financial results and guidance, market opportunities, our growth and increased efficiencies, our owned brand mix, our inventory position, our dilutive share count, our investments in customer experiences and fulfillment centers, the impact of tariffs and our tariff mitigation efforts, and our lower price point offerings.

These statements, which are subject to various risks, uncertainties and assumptions, could cause our actual results to differ materially from these statements.

These risks, uncertainties and assumptions are detailed in this afternoon’s press release, as well as our filings with the SEC, including our registration statement on Form S-1 that was filed with the SEC, our Form 10-Q for the second quarter of 2019 that was filed with the SEC on August 12, 2019 and the Form 10-Q for the third quarter of 2019 that will be filed.

All of which could 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, free cash flow and adjusted diluted EPS.

We use non-GAAP measures in some of our financial discussions, as we believe they more accurately represent the true operational performance and underlying results of our business.

The presentation of 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, and our non-GAAP measures may be different from non-GAAP measures used by other companies.

Reconciliations of GAAP to non-GAAP measures, as well as the description, limitations and rationale for using each measure 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-CEO’s 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 the call over to Mike..

Thanks, Erik. Good afternoon, everyone. Thanks for joining us on our third quarter earnings call. We had another very solid quarter in Q3, delivering growth in net sales, profitability and free cash flow to achieve record results in any third quarter.

Net sales increased 22% with the Revolve business continuing to be the primary driver of growth, delivering a year-over-year increase in net sales of 24%.

We also made progress in the other areas of our business, and I’m excited to highlight that our international business accelerated to double digit sales growth this quarter, validating our many efforts to further improve the customer value proposition overseas. As a reminder, we localized the customer experience in the U.K.

last year by providing all-inclusive pricing, free shipping and free returns. We expanded this localization to Australia earlier this year and we continue to improve the experience around the world. For instance, we now ship to most major international regions within two to three days.

We're also encouraged by the progress we continue to make on the FORWARD business, which delivered year-on-year growth of 14% for the second quarter in a row, continued evidence of the success of our discipline to reposition this business.

We see several tailwinds in the works at FORWARD that Michael will talk about, including the recent launch of two coveted luxury brands and our first FORWARD owned brand set to launch later this month.

Across both segments, we are driving growth through the continued expansion of our customer base, further illustrating that we are in the early stages of penetrating a large global market opportunity. Total active customers for the trailing 12-month period surpassed 1.4 million during Q3, an increase of 33% year-over-year.

These customers placed 1.2 million orders in the third quarter, an increase of 26% year-over-year.

We delivered gross margin of 53.6% in the quarter, an increase of 90 basis points year-over-year that was driven primarily by a significantly improved gross margin on the FORWARD segment, as well as a change in accounting estimate that Jesse will talk about.

Supported by growing penetration of net sales from our Owned Brands, the Revolve segment gross margin remains healthy at 55.4% – yet declined by approximately 50 basis points year-over-year.

The decline in Revolve segment gross margin was primarily due to a slightly lower percentage of Revolve net sales at full price, compared to last year, which we view as a function of our inventory position rather than external factors.

As we invested in the rapid expansion of the owned brand platform in recent years, our overall inventory position has become higher than we would like. Even so, we still achieved our second highest third quarter full price mix ever, second only to the prior-year comparison in the third quarter of 2018.

This quarter, we reached our highest owned brand mix of Revolve segment net sales to date, and increased our portfolio to a total of 24 owned brands, following an exciting influencer collaboration launched earlier this month on superdown.

I should mention that the expansion of owned brands as a percentage of Revolve segment net sales has slowed in the past couple of quarters compared to the very fast expansion through the first quarter of 2019.

While we expect the moderation in owned brands net sales to continue in the near term, the owned brand platform is a key part of our value proposition, and we remain confident in the long-term opportunity to significantly increase our owned brand penetration over time.

As our results illustrate, we continue to operate in a disciplined manner, managing costs while at the same time making significant investments to support future growth and expansion. Most notably, we successfully launched further automation in our new warehouse, which began to drive efficiencies as we exited the quarter.

As illustrated by our warehouse automation, Revolve is a company focused on leveraging technology to drive efficiencies and improve the customer experience. We recently launched a powerful set of visual navigation capabilities on our Revolve iPhone app that allows our customers to quickly discover their preferred styles.

For example, customizing a search for dresses across various colors, lengths, necklines, sleeve options and more. As you may recall, we had previously launched this same functionality for our mobile website. We also continue to create solutions to drive deep relationships with and an even better experience for our customers.

Earlier this week, we launched what we call the Revolve Fitting Room, enabling our core Revolve customers to do home try-ons of an extra size at no additional cost.

I’m personally very excited about this initiative as it provides a great experience for customers and since our experience has proven that customers who order more than one size of a style have a materially higher ‘Keep Rate’ than customers who order just one size of a style.

Another important innovation that is ideally suited for our digitally native, mobile first customer base is our progressive web application set for a test launch later in Q4.

The progressive web app enables mobile websites to offer a highly engaging, app-like experience, which we expect will drive a higher conversion rate than standard mobile web sites. Now, I'll turn the call over to Jesse to provide additional detail on our third quarter results..

Thanks, Mike. As Mike mentioned, we delivered another very good quarter highlighted by growth on all fronts. Net sales, profitability and cash flow.

Before I get into the numbers, I want to point out that our Q3 2019 financial results reflect $1.5 million in net sales realized as a result of a change in estimate related to the recognition of store credit breakage. Now, starting with the top line. Total net sales for the third quarter were $154.2 million, an increase of 22.5% year-over-year.

The Revolve segment remained the key growth driver, delivering segment net sales of $135.4 million, an increase of 23.7% year-over-year. Turning to FORWARD, we are very pleased that our FORWARD segment delivered another solid quarter of double-digit revenue growth following the inventory reset.

FORWARD net sales were $18.8 million, an increase of 14.2% year-over-year. Our top line growth continues to be driven by the combination of new customer additions and continued loyalty from our existing customers.

Our active customers during the trailing 12-month period grew to 1,438,000, an increase of 33% year-over-year and total orders placed in the quarter increased 26% year-over-year. Average Order Value, or AOV, was $275 in the third quarter, illustrating the premium nature of our offering.

On a comparative basis, AOV was unchanged sequentially from the second quarter, and down 1.8% year-on-year, slightly offsetting the significant increase in orders placed. The decrease in AOV year-over-year is the smallest decline for the past eight quarters, even as we recently launched our lower price point offerings.

International net sales for the quarter were $26 million, a year-over-year increase of 14.7%, and a meaningful acceleration from the 4.3% growth in the second quarter.

Australia was a key success story in driving the stronger performance internationally, resulting from our efforts to improve service levels, drive faster shipping and provide expanded payment options. We also experienced growth in other regions where we have previously made investments, such as the U.K. and Western Europe.

During Q3, we also began to see stabilization in greater China and some moderation in foreign currency headwinds. Finally, this was the first full quarter comping the incremental Goods and Services tax on Australian imports, that was implemented in July of 2018. Moving to gross profit.

Consolidated gross margin was 53.6% for the third quarter, an increase of 90 basis points over the prior year.

FORWARD segment gross margin was 41%, an increase of 970 basis points year-over-year and our highest ever third quarter gross margin, as a result of the successful repositioning of this business, as well as a favorable comp as a result of discrete items that negatively impacted the prior year.

By comparison, the Revolve segment gross margin contracted by about 50 basis points year-over-year, as continued growth in Owned Brand penetration was more than offset by a reduction in the percentage of Revolve segment net sales at full price. We mainly attribute the increased markdowns to our inventory dynamics rather than external factors.

As we have invested in the rapid expansion of owned brands and the launch of superdown, our inventory has increased at a greater rate than that of net sales.

Looking ahead, we expect the fourth quarter dynamics to be similar to the third quarter with continued strength in FORWARD Segment gross margin offset by a year-over-year decrease in the Revolve segment gross margin, as the expansion of owned brand mix as a percentage of Revolve segment net sales begins to moderate and as we work to more closely align growth in inventory with growth in net sales.

Now, we’ll move down the P&L and give you some color on the expense line items. Fulfillment, which reflects the costs incurred to staff and operate our distribution centers, totaled $5.1 million. Expressed as a percentage of net sales, fulfillment costs grew to 3.3% from 2.6% a year ago.

The 70-basis point increase in fulfillment expense reflects temporary duplicate costs and inefficiencies incurred in implementing our new warehouse automation technology.

As with any new warehouse technology system, gearing up for the new process and providing employee training for a new way of doing things, while continuing to meet the fulfillment needs of our customers, required significant overtime and duplicate costs in the early going. We experienced the peak of temporary inefficiencies during the month of July.

In August, we began to realize some efficiencies, particularly in the last two weeks of the month. And by the time September rolled around, the process had become much more efficient, exiting the quarter with fulfillment costs as a percentage of net sales a full point lower than where we started in July.

The takeaway is that we exited Q3 on a much-improved run rate for fulfillment efficiency. Most important, our new fulfillment center infrastructure provides not only significant growth capacity, but further opportunities for operational efficiencies and enhancements to our customer experience going forward.

Selling and distribution costs, which consist primarily of shipping, merchant processing fees and customer service, were $22.6 million, or 14.6% of net sales, an increase of 10 basis points year-over-year.

We are very pleased with our ability to manage efficiency on this line item, despite macro cost headwinds and the pressure that has come from an outsized number of orders, units and customer touches in relation to net sales.

Marketing costs were $23.1 million and remained at a relatively consistent efficiency level as the prior year at 15% of net sales, a decrease of 10 basis points year-on-year. We increased our brand marketing investment in the quarter, while realizing year-over-year efficiencies in our digital performance marketing efforts.

The constant flow of events, social media and influencer-based marketing, combined with more traditional performance marketing enables us to cost effectively acquire and retain customers, build on the Revolve brand and build each of the unique brands within our portfolio of Owned Brands – all with a long-term view towards driving customer lifetime value.

General and administrative costs, which primarily consist of salaries and wages, were $19 million. G&A costs as a percentage of net sales improved to 12.3% of net sales in the third quarter from 12.9% of net sales in the prior year.

With our platform largely built, we are able to gain efficiencies with scale, while at the same time, making investments in our team and infrastructure to support future growth and to operate as a public company. The combination of top-line line growth and a well-managed cost structure resulted in strong bottom-line results in Q3.

Net Income was $9.6 million, an increase of 34% year-over-year, and adjusted EBITDA grew to $14.4 million, an increase of 40%. Adjusted EBITDA margin expanded to 9.4% of net sales, up 120 basis points over the prior year. Diluted earnings per share, or EPS, was $0.13 per share, up from $0.10 in the third quarter of 2018.

All of the profitability measures benefitted from the $1.5 million in net sales realized as a result of the change in estimate mentioned earlier. For the quarter, we had 72.7 million diluted shares outstanding, which is a reasonable number to use for modeling earnings per share for the next few quarters as well.

I would like to remind everyone that we are reporting our Q3 earnings per share and EPS going forward on a GAAP basis, without adjustment. The only instance where we will report Non-GAAP earnings per share is to adjust for the corporate conversion discussed last quarter that occurred in connection with our initial public offering.

Moving to the cash flow statement, we operate a highly capital efficient business that positions us to generate positive free cash flow. In the third quarter, we generated $9.2 million in cash flow from operations and $7.4 million in free cash flow, approximately 4x greater than the prior-year quarter on both measures.

The favorable comparisons resulted from an increase in net income and Adjusted EBITDA and also benefitted from the timing of tax payments that I spoke about on last quarter’s conference call. For the past few quarters, the build out of our new fulfillment infrastructure has been a headwind to free cash flow.

These investments are now largely behind us, so we are well positioned for cash flow generation going forward. This healthy cash flow generation has further strengthened our balance sheet. As of September 30, we had no debt and cash and cash equivalents of $51.1 million, an increase of 14% from June 30 of this year.

We ended the September quarter with $103.7 million in inventory, as compared to $89.8 million at the end of the third quarter of 2018. As a reminder, with the adoption of the new revenue recognition standard, we reclassified a portion of our inventory to prepaid and other current assets starting in 2019.

The amount of this reclass on the September 30, 2019 inventory balance was $14 million. Before I move to a discussion of the outlook, and since we have received many questions about the impact of tariffs and our China supply chain, I’ll provide an update regarding our tariff exposure.

The incremental tariffs imposed starting on September 1 did not have a meaningful impact on the quarter, and similarly, we do not expect the tariffs to have a significant impact to the remainder of 2019 given the timing of the tariffs, our inventory position, and our inventory turns.

Importantly, we have made significant progress towards our stated tariff mitigation effort of negotiating pricing with our current vendors, and we continue to explore diversification of the supply chain.

We have not increased prices to the end consumer in response to the tariff situation, and while this remains a lever we could choose to pull in the future, at this time, we don’t anticipate a meaningful change in retail pricing in response. With that, I’ll turn to our full year 2019 guidance. And just as a quick reminder about our seasonality.

Revolve does not follow a traditional retail seasonal cadence that results in a disproportionate amount of revenue in the holiday quarter. In fact, for the past three years, Q4 has averaged close to 25% of the annual net sales. Given that we are down to just one quarter left in the year, we are narrowing our guidance ranges.

We expect net sales to be between $598 million and $606 million, which represents growth over fiscal 2018 of between 20% and 22%. Adjusted EBITDA is expected to be between $51 million and $55 million, which represents growth of 10% to 18% over fiscal 2018. This equates to an adjusted EBITDA margin of 8.5% to 9.1%, as compared to 9.3% in 2018.

Now, I’ll turn it over to Michael..

Thanks, Jesse. Hi everyone. A quarter is such a short period of time, especially when we manage the business with such a long-term view, consistent with how we have managed the business for the last 16 years. Nonetheless, we had another solid quarter on a number of fronts.

Starting with marketing, where we had another very active and impactful few months. Along with the efficient performance marketing that comprises most of our spend, Revolve is recognized as a pioneer in building our brand through our disruptive social marketing.

Working with influencers since the earliest days has played a critical role in enabling us to develop authentic connections with the next-generation of consumers. The events we host each quarter create the experiences that excite, inspire, and engage our community.

We kicked off the third quarter with a RevolveSummer event in Cuixmala, Mexico and August brought us to Revolve around the World in Canada before traveling to fashion shows in New York and Paris in September.

Across all of these events in Q3, we dressed hundreds of influencers and generated billons of impressions showcasing our merchandise in a way that resonates with our target customer.

These events define our aspirational global lifestyle brand that is Revolve, while the massive social reach continuously drives traffic to our sites in a very cost-effective way. Our strong partnerships with influencers are increasingly extending into the development of new collections leveraging our owned brand platform.

Coming on the heels of the successful collaborations with Aimee Song and Camila Coelho in the second quarter, in October we launched an exclusive owned brand collaboration with Draya Michele for superdown. An actress and style icon, Draya is an ideal ambassador of the superdown lifestyle to her 7.6 million Instagram followers.

The debut collection will be followed by additional styles over the next several months. Now, I would like shift to an update on superdown more broadly. Earlier this year, we launched superdown as a dedicated new website targeting younger consumers with on trend apparel at lower price points.

We are excited to further expand our addressable market to include Gen Z consumers. We see a compelling ‘customer lifecycle’ opportunity to convert a younger superdown customer of today into a more affluent REVOLVE customer over time. We are encouraged by the early results.

Despite making only limited marketing investments to date, we experienced a steady uptick in traffic, engagement, conversion and spend per website session on superdown in the third quarter. For instance, Instagram followers on superdown now exceeds 140,000, about twice as many as we had at this time last quarter.

We have a lot more testing, refinement and iteration ahead of us to optimize for this new initiative that remains in the early stages. Nonetheless, we are excited about the long-term opportunity to create an additional growth driver for the company.

On the opposite end of the price spectrum, we couldn’t be happier with the continuing progress at FORWARD, our website focused on luxury offerings for the more affluent consumers.

Aside from the improved top-line growth trajectory and margin strength, we are making great progress in creating an even more coveted selection of iconic luxury brands on FORWARD. In September, we launched a full collection of apparel and handbags from the French luxury brand Balenciaga. Early customer response has been very encouraging.

Adding to our merchandise momentum in October, we launched a full collection of handbags, shoes and accessories from Gucci.

Also, very exciting is that third-party luxury designers have become more aware of our increased scale, the value of our customer base and the impact of our marketing strategy and, as a result, have partnered with us to develop styles exclusively for the FORWARD customer.

In fact, last month we partnered with French luxury house Givenchy to launch a luxury handbag exclusively through FORWARD. We also collaborated with luxury designers during the recent Paris Fashion week when Alexandre Vauthier, David Koma and Peter Dundas each launched exclusive collections for FORWARD customers at premiere Fashion Week events.

And last, but not least, we are excited to introduce our first FORWARD owned brand at a launch event next week. The collection will initially feature elegant evening dresses starting at price points of around $900, just in time for the holidays and for our Annual Revolve Awards event next week.

As you can see, we continue to be relentless in our goal of being the trusted premium lifestyle brand and go-to source for discovery and inspiration for millennial and Gen Z consumers. We're proud of our continued success and more excited than ever about what's ahead. I want thank our team for all of your valued contributions to our success.

Your dedication makes all the difference in maintaining our focus on executing against the opportunities ahead. Now, we'll gladly take your questions. Let’s go to Q&A..

[Operator Instructions] And our first comes from Oliver Chen with Cowen and Company. Your line is open..

Hi. You’ve been real pioneers at using machine learning to drive the inventory decisions. So, could you brief us on what happened with respect to your inventory levels and how are you feeling now going forward about where you are in the composition and what the prospect is for promotions? Thank you..

Yes, definitely. This is Mike Karanikolas here. We’ve been making investments in inventory in recent periods, particularly on the low price and own brand side.

And so the inventory positions and those decisions are kind of more strategic decisions versus algorithmic decisions in terms of the magnitude of the investments and so, our inventory positions is little bit elevated compared to where we’d – I really to be, but at the same time I think it is really important to note, the third price, full price sales figure was actually the second highest for a third quarter ever.

So, we do think in general we are repeating better and better what we do. There is going to be some fluctuations quarter-to-quarter in a year, but we feel very good about the trajectory of the business as a whole.

And then with regards to the elevated inventory position, in general, it is the sort of thing that we think can take us a few quarters to work our way through, but we feel like our results are still very favorable at this time..

Okay.

And regarding the modeling, and as we think about customer lifetime value, how should we expect orders per customer to trends? And will the AOV stay in the $275 range? Would love your thoughts about the medium-term modeling around those trends?.

Yes. Sure, Oliver. This is Jesse. So, I think, consistent with what we've talked about on the previous calls and just to set the stage a little bit, if we recall back to the back-half of 2018, we had significant customer and order growth.

So, we're starting to come through that and that's where you see the slightly moderation – slight moderation in the order growth. And then also important to note that the orders is a quarterly metric and then the active customers is a trailing 12-month metric.

So, if you look at the trailing 12 months of orders and compare that to the active customers, you'll see a slight uptick over time in the number of orders per customer. So that goes back to the customer lifetime value and that customer ordering, both more frequently and at higher AOVs over time.

So, to your question on AOVs, we’d expect some moderation in the coming quarters. There is some seasonality there.

You generally see Q2 at a higher AOV than the other quarters, but plus minus with some mix shift with forward in the lower price points, you should see that moderate different from what you've seen in the past few quarters with the decline..

Okay, that's now really helpful. And just lastly, I would love your take on the environment that you see out there that department stores have been – having a more challenging time in our view and the calendar is more difficult, and there's different kinds of bankruptcies happening.

But how are you feeling about your customer and the environment at large? Thank you..

Hi, Oliver, Michael Mente here. Overall, it really depends on what lens you're viewing and where we're looking at, this month it is quarter over the long-term. But we're always looking over the long-term. We feel incredibly great about the way things are going.

We've seen a lot of legendary companies, the companies that we’ve looked up to and the companies that we’ve learned from when we were founding this business struggle, as they fail to adjust to the changing times of the next-generation of consumer.

And I think that everything that's going on really does reflect us doing what we do best, connect with the next-generation of consumers executing well in our challenging time. So, feeling better than ever and maybe we can both get them liquidated in due course with some of these other guys..

Thank you very much. Best regards..

Thanks, Chen..

Your next question comes from Ross Sandler with Barclays. Your line is open..

Hi, guys, couple of questions from me. So, you nicely beat your 3Q revenue and EBITDA, but you're taking the high-end of the range down a tad.

So, is there anything in 4Q that you want to flag? There has been a lot of questions about the fewer shopping days for e-commerce between Thanksgiving and Christmas this year, is that going to have an impact? And, Mike, you mentioned that PWA is going to launch in 4Q and I think we've talked about higher conversion rates in the past from that.

So, is that going to be from material thing, or just something nice to have them? Then I guess, my second question, why don’t we go to that now? I'll ask second question later..

Sure. Yes, I'll start, this is Jesse, on the guidance front. To your point, the guidance range is the same slightly tightened and tightened at the top-end. And that reflects general trends that we’ve to date. But as well as to your point, the shortened holiday season and the fewer number of shopping days. Now that said, we're not overly seasonal.

As we said in the prepared remarks, Q4 is generally been 25% of the total year mix. That said, it's a little bit uncertain on what it does to just the macro kind of consumer spending habits, given that shorter holiday shopping season. So, we’re remaining cautious there. And then maybe I'll pass it over to Mike to talk about the progressive web app..

Yes, thanks. Yes, so with regard to the progressive web app, we're certainly hopeful that that will have a positive impact for us. It's something we haven't done yet. We don't for sure know what the impact is going to be. And so, in general, that's not something that we take into account when you're coming up with our forecast.

It's also important to note that, while we're getting very close to launching it, there's going to be certain periods of time like Black Friday, Cyber Monday week, where we don't really want to launch something new.

And so, the time is going to be a little bit tricky just in terms of how many days of the quarter, where we can have this launch to a segment of our customer base in kind of a beta mode initially..

Got it. Okay. And then I guess, the second one is, Jesse, I guess, thanks for the breakout of the segment gross margins. And you guys mentioned that Revolve gross margins down a bit on, I think I heard two factors that own brand mix and the lower full price sell-through. So, which is the bigger contributor.

And can – on the ladder, the lower full price sell-through, is that at the lower price points around the superdome launch of core Revolve and any additional color on the work that's happening? Thanks..

Yes, sure. So maybe, again, to give some context. The own brand mix expanded again this quarter, and we hit a record high there, as we said in the prepared remarks. And just to kind of frame it up a little bit more, we're at 15% mix in 2016, went up to 30% for full-year of 2018, and then was 36% in Q1 of 2019.

So, we've seen some explosive growth there in the mix of own brands on the Revolve segment and still an increase this quarter again. So, if we think about the year-over-year margin impact on Revolve, it was – it wasn't due to that own brand mix, given – even though it did moderate slightly.

So, it's largely a function of that full price mix that declined year-on-year. But again, as Mike mentioned, that's coming off of an all-time high. So, still a really strong number that just came off of that, that all-time high.

And if we think – if we kind of break that up a little bit more, we won't call out specifics regarding which segments it related to, but it was on Revolve and just a factor of really that slightly elevated inventory position rather than kind of external macro factors..

Operator. Next question, please..

Your next question comes from Bob Drbul with Guggenheim. Your line is open..

Hi, guys, good afternoon.

I guess, it's – on the expectation for the moderation in the own brands, Jesse, I guess, could you just talk a little bit more around like the testing that you've done? And is pricing a factored in terms of what you're seeing from a slowdown? And then the other piece of it from our standpoint is, can you talk a little bit about different cohorts and some of the new customers versus your older customers and how that the different groups are trending? Thanks..

Yes, sure. So, maybe I'll start with a couple of the more tactical items and then pass over to Michael to talk about longer-term own brands. So, to your own brand question and I called up the mix movement over time, and it's really just a factor of that. We've had really explosive growth in that own brand mix over the last couple of years.

So, it's at the point where that is still growing this quarter, but it's just moderating somewhat. We should expect to see that for the next few quarters is be kind of moderate that growth and then, sorry, and then on pricing, sorry, your question on pricing, not – nothing significant on pricing related to own brands.

And then let me pass over to Michael..

Yes, with regards to own brands, as Jesse mentioned, as I'm sure, a lot of you on the call are super familiar, the growth has been really explosive through the past many years. And now in an exciting position of investment, we – the last two, three lines that we've launched, have been incredibly successful, will continue to build from there.

And we have a very robust pipeline through 2020 in terms of additional line. So, really in a position of investment to really expand our offering across our entire consumer offerings, so it's a very exciting time for us..

Sorry. And then, Bob, I’ll jump in again, because I forgot about your last part there on the customers and the economics. We don't disclose on a quarter-to-quarter basis, because it is a longer-term metric. But those that LTV to CAC dynamic has remained relatively consistent, feel good about the – kind of the strength of the customer.

And you can see that in, again, if you look at the orders per active customer over time increasing..

Got it. And just a couple more quick ones. In terms of superdown, can you talk a little bit about this superdown conversion and are you seeing any cannibalization from the Revolve business in terms of superdown? Thanks..

Yes. So, we're seeing healthy increases in a lot of our key metrics on superdown. So, we're encouraged by the trends that we see there. And then from a cannibalization standpoint, we don't think it's cannibalistic of Revolve.

There's certainly overlap, particularly given that the superdown kind of clothing line brand itself launched on Revolve initially and was there for several quarters. So that's kind of where it first built its awareness. But we're seeing that overlap decrease with each passing quarter. So that we think over time, the overlap will be fairly minimal..

Yes, I think this is something where the cannibalization risk factors, something we're very, very focused on. And I think that, if done well, it's quite the opposite, it ends up being a long-term customer migration platform, where we ensure that the merchandising mix minimally overlaps, but also complements each other.

So, we can attract a younger consumer and grow with there for many, many years from when she is college years to when she has the big bucks to spend on forward..

Great. Thank you very much..

Your next question comes from Kimberly Greenberger with Morgan Stanley. Your line is open..

Oh, great. Thank you so much. I just want to make sure that I understand the inventory and gross margin dynamic. I think you indicated that whilst their price selling was down year-over-year.

Did you say it was the third – highest third quarter rate of full price selling?.

I indicated it was the second highest ever, and just to clarify, it's the second highest in the past decade, at least. I have the team hold [indiscernible] at least that far. So, just to clarify, be a second highest within at least the past decade..

Okay, great..

…for the third quarter..

Okay, great.

For the third quarter, right?.

Yes, yes, for any third quarter, not for pending quarter..

Okay. And it looks like with the markdowns in the third quarter, you were able to move through some inventory. If I adjust your inventory to be apples-to-apples with the way it was reported last year, it looks like it was about a 31% growth rate here at the end of Q3 and that's down nicely from the low-40% growth that we saw at the end of Q1 and Q2.

So, it looks like some of that inventory was cleared out. I'm wondering – it sounds like what you're saying is, you expect a little bit more of this activity in the fourth quarter.

Would you then expect inventory at the end of Q4 to be growing in line with sales? So, is it sort of one more quarter of the inventory clean out, or does this continue into early 2020?.

Yes. So, I think it's going to take a few quarters, which we'll say more than one. So, yes, we do expect to continue in the 2020. But at the same time, we feel like it's a manageable situation, as you mentioned, the dynamics did close a little bit in the third quarter. So, we feel like it's on the right path..

Great.

And Mike, where would you like to see your inventory turn? Get to over the next year or so, what are your kind of medium to long-term targets on inventory turnover?.

Yes. So, I think that the medium-term target is to be a three-year better. That's where we'd like to be. Now, three years kind of on the lower-end of the range of where we’d like to be. But it's within the range, we're more comfortable and we're a bit below that right now. So, that's kind of our near to mid-term goal is to get back to three or better.

And then, longer-term, I think, the mid-3s is kind of where we'd like to be..

Okay., great. My last question. It looks like international sales accelerated nicely here in the third quarter, if I have it, right, 15% growth versus looks like 4% growth in the second quarter.

Was there something that sort of triggered that acceleration? And what – if any view you have for the fourth quarter?.

Yes, definitely. So, I think the acceleration is a result of the investments we've been making internationally. We were dealing with some very tough headwinds in Q2. I mean, some of those headwinds continue into Q3 and beyond with regards to currencies, but they've moderated a little bit.

So, Australia, in particular, was a key success story for us in the third quarter.

We've been making investments in the past six months really localizing the experience, improving the service levels, upgrading local payment options, but we're facing a difficult year-over-year comp issue with a 10% tax increase on foreign Internet retailers compared to the prior year. And so that comp issue went away in the third quarter.

We also saw in a lot of our longer tail countries; some acceleration is we've invested in increasing the service levels and shipping times in the longer tail countries. So, it's a healthy trend that we'd like to see more of..

Fantastic. Thank you..

Your next question comes from Justin Post from Bank of America Merrill Lynch. Your line is open..

Hello, this is Joanna Zhao for Justin Post. Thanks for taking my question. So, just to follow-up on the international question, it's a great job for the Q3.

And just to think about the trend for 2020 and in terms of the growth and investments in the international markets, anything that you can highlight there? And also, you mentioned that you've launched this free delivery even for international markets.

And with a quick turnaround, and how do you foresee that impact margins, especially international segment going forward?.

Yes. So, I think the majority of our shipping in investments, I don't want to say are complete, right? Because it's an ever-ongoing thing, even in the U.S., right, continue to improve service levels. But I think from a margin standpoint, we've seen fairly minimal impact to margins.

We've been able to negotiate some great rates on our shipping contracts. Localized returns is something that affects margins a little bit more, but we think ultimately helps us build huge businesses internationally.

In markets, where we've rolled out free localized returns, we're seeing some of our highest customer conversion rates and some of our highest retention rates ever. So, the UK and Australia, in particular, we saw our highest numbers ever in those regions.

So, we think the investments make sense and we're excited to continue to pursue upgrades around the world..

Okay, great. Thanks. And then my next question is around macro factors that going forward in 2020.

And I’m just trying to get a sense on what is your thought on the consumer sensitivity to price increase or decrease? So, if any – if macro factors come in for next year, more so on a recessionary scenario, what are the strategies that you have to place? Do you foresee potentially lower the price on your items? And so, the percentage of full price items will go down in reaction to that?.

Yes, maybe I'll start with Alan. So, I guess, maybe to start off, we're not guiding to 2020 yet or providing a lot there. And it's really hard to speculate what could happen in 2020 with respect to a recession or anything else.

But just to call out a couple of stats that maybe differentiate us, about 70% of our product is either our own brands or you can't find anywhere else or an emerging brand, which is really hard to find. So, maybe some of the pricing dynamics that you would see in other retailers you wouldn't see here.

So, I think we're comfortable with where we're at, we feel like we have a great offering to the customer. The – this millennial customer continues to take the purchasing power and things are shifting digital. So, again, we feel like we're well-positioned, but not commenting much more beyond this quarter..

Okay, great. And then my last question is on the return rate. So, it seems that you have a nicer return – higher – sorry, higher – lower return rate relative to last quarter.

Anything you could highlight that maybe have triggered the decline in the return rate?.

So, there's a little bit of a seasonality to the return rate from quarter-to-quarter. So, in, as you know, we don't disclose return rates specifically, but whatever number you're backing into probably reflects just some seasonal trends that typically occur from Q2 to Q3..

Okay. Thank you..

Your next question comes from Michael Binetti with Credit Suisse. Your line is open..

Hi, guys, thanks for taking our questions here. Could you, Jesse, could you speak to, let's try and do a little modeling here to what you see in some of the dynamics in the P&L, help us with the modeling for fourth quarter.

In particular, I think the guidance you gave embeds scenario at the low-end or EBITDA would actually be negative year-over-year in the fourth quarter, and trying to get my head around what those – what some of the drivers on the P&L would look like in that scenario?.

Yes, yes, sure. And so, I guess, maybe to start from the top. We are seeing some margin pressure on the Revolve side, which we called out for Q3 and we expect that to continue into Q4. So, that's a part of it and that's coming off some really healthy margins last year.

And then if you work down through the P&L, again, we're investing in the fulfillment centers. So, there's some incremental costs there still in Q4 this year versus Q4 last year. Now, let's start to see that dissipate, as we head into 2020 and other investments largely behind us. So, that's probably the other one.

Marketing, call it, plus, minus, we're not – we continue to invest there in factoring in any significant efficiencies and G&A is largely a fixed cost and we continue to build on the platform there and gain efficiencies..

Okay. And I know that we've gone through inventory quite a bit. I want to ask about the tariff comments.

I guess, the read – is the read that the inventory that would be impacted by tariffs is still a very low percent of the mix that's made it to your books now and through year-end, or are there tariff headwinds ahead as you bring in more inventory after the end of the year that could be affected by those tariffs? And then I guess, just backing up a little bit, maybe you could speak a little bit more to why you think the inventory builds? I mean, you're asked, because you’re trending well above what we expect on active customers.

So, I'm curious what you think the customer is going to the site and seeing is that maybe some of the low productivity skews, any kind of the dynamics that you're seeing there that you think led to the inventory build in the – on the demand side? Thanks..

Yes, sure. We'll try to capture all those, but jump in again, if we missed anything. So, starting with tariffs, and this is specific to the tariffs that were put into place on September 1, which, as of this morning, we'll see what happens there. And it sounds like they might be pulled back, which would be great, but not counting on that quite yet.

So, the reason you don't see a significant impact this quarter is, one, due to timing. They were just put into place in September 1. And so, there's only a limited amount of receipts that came in with those tariffs applied.

And then, second, we've made a really good progress towards our mitigation efforts there, as I mentioned in the prepared remarks, and the number one was negotiating some concessions with our existing suppliers, which we've been really successful with.

We haven't gone to the last level we can pull, which is pressing some of that cost increase on to the consumer. So, the minimal impact is largely related to timing and just the timing of inventory receipts. To put it into context a little bit and to kind of a refresher, the area we're focused on with tariffs is that own brand component.

So, if you think about, call it, roughly a third of the business is own brands. Of that 75 plus, minus is sourced from China. So, that's the population we're thinking about there. And then on inventory, I think, we covered it for the most part.

If you think about the investments that we've made, that's what's really led to the slightly elevated inventory position not being own brands over the last several years, and then maybe lower price points superdown in the back-half of 2018.

And if you try to calibrate that with active customers, like you said, active customer growth has been really strong. But again, important to think about that as a trailing 12 months number. So, you're still picking up that really robust customer growth in the back-half of 2018.

So, you'll start to see – which you have started to see over the last couple of quarters that active customer growth starts to converge with net sales growth, AOVs is moderating and things kind of balancing out after that growth in customers and orders and the decrease in AOV we saw last year..

I guess just to add on that really quickly, have you – with the gross margin pressures you saw on Revolve is the read that, was there a change in the trend line on the conversion metrics quarter-to-quarter that – did that feed into it at all?.

Yes. I mean, so the third quarter is historically a little bit of a slower turning quarter for us. Then the second quarter – and then also, there's individual dynamics between different kind of segments and the individual products. And so, the markdowns are actually algorithmic driven.

And so, to your point, the algorithms are going to react to try to optimize margin. And so, there's a little bit of a shift in dynamics there. But, again, I think it's important to us within the context, but it was still a really healthy quarter historically.

It's just compared to a record full price sales number – or record was in the past decade anyway [indiscernible] in the third quarter of last year..

Okay. Thanks a lot, guys..

Thanks..

Your next question comes from Ralph Schackart with William Blair. Your line is open..

Good afternoon. Just first on the call, you talked about some updates the apps just in terms of customization and some more functionality. Just curious for the receptiveness of the customer base, an engagement trends that you saw, and maybe more broadly how you're thinking about mobile on a go-forward basis? And then I have a follow-up..

Yes, definitely. We've seen a really great reaction from our customers as we've rolled out new features and in terms of providing a better user experience for them. And that's really, we're focused on creating a better experience for the customers. That's going to keep them happier and have them ordering more.

So, we're really happy with the roll outs that we've done there. Progressive web app, as we talked about, we're really excited about. The fitting room that that I mentioned. Right now, that's not on the app and mobile yet, it's just on the desktop.

We've already received and it really just launched to about half of our customer base yesterday and we've already received a number of raves from our customers unsolicited coming in with regards to that feature, I just got an e-mail 20 minutes ago about that. So, we're really excited about the message we're making.

And to your point on mobile, right, we're in a mobile-first world. And so, mobile's area, we're really going to focus on heavily in the upcoming year. And, again, we think the progressive web app is a really important step for us to capitalize on that opportunity..

Great. One more, if I could. Few days ago, the FCC issued some new rules for disclosures, bad for social media influencers. And I know it's a fairly recent.

But just curious if you had a chance to sort of digest the news and if there's any potential implications for the business?.

Ye. So, it's not something that we've fully digested at this point, but certainly, we’ll review kind of the latest updates internally. And if we feel like it has any implications on our business is something that we'll chat about..

Great. Thanks, Mike..

And our final question comes from Aaron Kessler with Raymond James. Your line is open..

Great. Thank you, Mike. A couple of questions. I noticed quickly back to their own inventory, was there any specific brands that you would call out, or was the more across the Board? And then just in terms of some of the newer verticals as well besides superdown, maybe if you could any update on Men’s beauty traction, as well. Thank you..

Yes, nothing specific to call out there on the kind of category or brand level. And to your question on some of the different categories, I guess, the one thing we haven't talked about here in the Q&A is the forward segment, which had a second quarter of really healthy growth those – there.

So, we’re confident in our research that we conducted last year and how that's paying off, beauty and men's is still there a really small component of business, but still some healthy growth. but nothing more specific to color..

Got it. I mean, just on own, is there a good way to think about kind of long-term mix that you guys are thinking of, or I mean, obviously you to maximize that given the higher margins.

But is there a good a framework that you're thinking about in terms of what percentage of the business that could be longer-term?.

Yes, no specific target there. And we've been careful not to put a number on it, because we do optimize for what's right for the customer. That said, we do see meaningful upside there. Over the long-term, it's just –, we're careful not to put a specific number on it..

Okay, great. Thank you..

And ladies and gentlemen, this does conclude the Q&A period. I'll now turn it back over to management for any closing remarks..

Hi, guys, thanks for joining us for our second quarter as a public company, it's been fun and exciting as always. I think for us sitting here, I know we're running the business for many, many years. The consistent profitable growth continues to be a historic theme and we’ll continue to be a long-term theme for us.

We're excited and appreciate all the time energy you guys have spent with us and we're excited to continue this for many, many years to come. Looking forward to talk in greater detail soon..

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation, and you may now disconnect..