Revolve Group Inc

NYSE:RVLV

Earnings Call Transcript 2023-Q1

[Operator]

Good day, everyone. My name is Lisa, and I will be your conference operator today. At this time, I would like to welcome everyone to Revolve's First Quarter 2023 Earnings Conference Call. [Operator Instructions].

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.

[Erik Randerson, VP, IR]

Good afternoon, everyone, and thanks for joining us to discuss Revolve's first quarter 2023 results. Before we begin, I'd like to mention we have posted a presentation containing Q1 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, including statements related to various business operations and marketing initiatives and investments, our inventory balance and management, economic conditions and their impact on consumer demand, the impact of our new fulfillment centers, our future growth and profitability, market opportunities, macroeconomic and industry trends and our outlook for net sales, gross margin, operating expenses and effective tax rate.

These statements are subject to various risks, uncertainties and assumptions that could cause our actual results to differ materially from these statements including the risks mentioned in this afternoon's press release as well as other risks and uncertainties disclosed under the caption Risk Factors and elsewhere in our filings with the Securities and Exchange Commission, including, without limitation, our annual report on Form 10-K for the year ended December 31, 2022, and our subsequent quarterly reports on Form 10-Q, all of which can 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 and free cash flow. We use non-GAAP measures in some of our financial discussions as we believe they provide valuable insights on our operational performance and underlying operating results. The presentation of this 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 non-GAAP measures to GAAP measures as well as the definitions of each measure, their limitations and our rationale for using them can be found in this afternoon's press release and in our SEC filings.

Joining me on the call today are co-Founders and co-CEOs, 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 it over to Mike.

[Michael Karanikolas, Co-Founder, Co-CEO & Chairman]

Hello, everyone, and thanks for joining us today. We reported mixed results for the first quarter of 2023 amidst an increasingly uncertain macro environment and against a very difficult prior year comparison. After a better-than-expected start to the first quarter of 2023 that we discussed in February on our fourth quarter earnings call, consumer demand decelerated for the remainder of the first quarter, consistent with the U.S. Department of Commerce data showing a meaningful deceleration in consumer spending from January to March. This led to a 1% year-over-year decrease in net sales for the first quarter.

On very positive front, however, we are making great progress on several key initiatives. We continue to make investments in the brand that we believe will benefit us over the long term. And despite the macro challenges, we made excellent progress on rebalancing our inventory position and generated exceptional free cash flow during the first quarter, further strengthening our balance sheet.

With that as an introduction, there are 3 key messages I want to focus your attention on today. First, despite a macro environment that became more challenging as the first quarter progressed, we achieved excellent progress towards recalibrating our inventory, and we believe we are on track with our objective of rebalancing our inventory position by the end of the second quarter of 2023. The spread between our inventory growth year-over-year, and our net sales decline year-over-year decreased by more than 50% in the first quarter on a sequential basis compared to the fourth quarter of 2022. These favorable dynamics give us confidence in our outlook for gross margins improving and the pressure levels we reported in the first quarter of 2023.

Second, our significantly improved inventory dynamics helped us generate $49 million in cash flow from operating activities in the first quarter, more than double our cash flow generation for the full year of 2022. Our strong profitability and cash flow generation truly stands out within the fashion e-commerce sector. And coupled with the $283 million in cash on the balance sheet at the end of the first quarter, we are in a position of strength to invest in our large market opportunity ahead of us at a time when many industry peers are forced to play defense. Challenging economic times like the current environment create opportunities for financially strong companies to prudently invest and further separate from the competition.

And third, we are executing on several important growth, brand-building and efficiency initiatives that we believe will further strengthen our foundation for profitable growth over the long term, particularly when the wind is at our backs once again. Michael and I will share our progress on several key initiatives throughout the organization, including technology, operations, marketing and international. In such a dynamic period, I'm pleased that our teams have remained laser-focused on the operational priorities I discussed on last quarter's conference call.

Now I'll shift gears to discuss highlights of our first quarter in more detail. Recall that during our Q4 2022 earnings call in February, we shared that our net sales in the first 7 weeks of the first quarter of 2023, it increased year-over-year by a mid-single-digit percentage compared to the same period in 2022. Trends decelerated later in the quarter, particularly in March, leading to our 1% year-over-year decrease in net sales for the first quarter of 2023.

The monthly slope of our first quarter was consistent with decelerating monthly apparel retail sales data from the U.S. Department of Commerce, which further supports our view that our core young consumer demographic is under more pressure today than she was just a few months ago. Also important to keep in mind our difficult prior year comparisons. Stepping back, our net sales have increased at a compound annual growth rate of 19% since the first quarter of 2019, the year of our IPO.

By region, net sales in the U.S. decreased 5% year-over-year, while international net sales increased 16% year-over-year in the first quarter. Bear in mind that our U.S. net sales growth in the first quarter of 2022 was exceptionally strong, creating a more difficult comparison. I'm very pleased by the healthy international results considering the continued currency headwinds in some of our larger markets such as Australia and the U.K.

Positive contributors to international growth in the first quarter included China, which is benefiting from the reopening of the Chinese economy as well as an easier year-over-year comparison from China lockdowns that began in the first quarter of 2022, the Middle East in emerging markets such as Mexico and India. I'm particularly excited about Mexico, our market enjoying exceptional growth with net sales almost doubling year-over-year, now ranking as one of our top 5 international markets.

We have a series of marketing activities planned to drive even greater awareness in Mexico. We already have the second largest social media following among our international markets. Net income for the first quarter was $14 million or $0.19 per diluted share, and adjusted EBITDA was $15 million. Our profitability was significantly lower than our performance in last year's first quarter primarily due to the nearly 5-point decrease in our gross margin year-over-year.

And while the macro environment remains uncertain, some of the pressure points on our P&L in recent periods should begin to ease in the coming quarters. The cost of air freight to import our own brands products from China has decreased significantly, shifting from a headwind in recent years to a tailwind in 2023 as we look forward. And our top line contributions from China have also shifted a headwind into a tailwind after the COVID restrictions were eased earlier this year. Lastly, it appears that we are now past the worst of the headwinds from variable fuel surcharges applied by major carriers to our customer shipments since the peak in jet fuel prices in the second quarter of 2022.

Now as mentioned earlier, I'll provide brief updates on key operating priorities that build on our foundation of growth and operating efficiency and further enhance our already best-in-class customer experience. First and foremost, we are extremely focused on driving cost efficiencies within our global shipping and logistics operations, help offset cost pressures including the impact from a higher return rate year-over-year. Our team has already delivered early wins in optimizing customer shipping costs to some international regions. We are pursuing a much larger scope of cost-saving initiatives that we believe has the potential to be impactful later this year. Jesse will talk more about this important effort in his remarks.

We are continuing to raise the bar on service levels for customers, even while we focus intently on driving cost efficiencies. The new Pennsylvania fulfillment center enables us to more quickly ship packages to East Coast customers, and we are also extending our best-in-class time frame for shipping orders the same day we receive them. For years, our service promise has been to process and ship orders on the same day if we receive them before 3:00 p.m. Eastern Time, and we're now extending that same day fulfillment window to even later in the afternoon.

We continue to expand the use of AI and machine learning across several key areas of our operations and customer experience, including fraud detection, personalized product recommendations, human recognition and product attribute tagging. As an exciting update on our progress, Michael and I will talk about how we leverage AI technology to develop an innovative marketing campaign featuring outdoor billboards for our flagship REVOLVE Festival event held last month. And using the same AI designs, we created a limited edition own brand product capsule.

We also leveraged our technology stack to enhance the product search results on our sites, elevating the user experience and conversion opportunities by enabling customers to more efficiently find what they're looking for among our curated assortment. We are also leveraging AI to develop even further enhancements to our search capabilities, and we are excited by internal demonstrations of further application of AI technology, we've shown a great deal of potential to drive impactful results in the future.

We have advanced our efforts to cross-sell the forward assortment to the much larger base of REVOLVE customers. Recently launched navigation enhancements on our REVOLVE website provide increased visibility to the FWRD assortment have shown promising early results. We've also leveraged our technology foundation to increasingly enable REVOLVE and FWRD to share inventory for key brands to offer products for sale on both sides, having more efficient inventory management and improved product availability.

We are investing further to elevate service levels in the international markets where we see a great deal of opportunity over the long term. We plan to deploy technology this quarter that we expect will accelerate website response time in key international markets advancing our localization efforts.

In the coming months, we are gearing up to expand our loyalty program to key international markets for the first time. Our loyalty program has been a great success domestically since introducing it 3 years ago. Like all companies, we face a myriad of challenges in the current environment, and we still have much more work to do. And yet, we are uniquely positioned with a profitable, capital-efficient and highly cash generative business model, we believe will allow us to continue to prudently invest in our long-term opportunity we are very excited about.

Before I turn it over to Michael, I'd like to once again thank all our hard-working team members for your agility resilience and dedication to exceeding our customers' expectations every day. Now over to Michael.

[Michael Mente, Co-Founder, Co-CEO & Director]

Thanks, Mike, and hello, everyone. As always, our strategic focus is to create a strong and growing business for the long term. At the center of everything we do is our unwavering focus on serving our customer incredibly well, helping her deliver best life through being her trusted source of fashion inspiration. So it is gratifying that our active customer base have continued to expand at a healthy rate, building on our future growth potential, considering the strong loyalty and retention characteristics of our customer base.

Our trailing 12-month active customers grew to 2.4 million in the first quarter and an increase of 4% sequentially and 19% higher than the first quarter of 2022, growing right through the very difficult record growth comparison in the prior year. Moving forward, we believe we have a large opportunity to expand our customer base within our target demographic, both in the U.S. and internationally. Even more impressive is that we delivered this healthy growth in active customers, while at the same time delivering better-than-expected marketing efficiency in the first quarter.

Shifting gears, I would like to discuss our culture of innovation at REVOLVE. A key contributor to our rapid and profitable growth over the past 20 years is our ability to identify important shifts and opportunities and leverage technology to create competitive moats around us. From our earliest days, our internally developed technology enabled us to embrace data-driven merchandising and drive the business in the ways that remains a significant competitive differentiator today.

Years later, we were pioneered the forefront of marketing innovation and partnering with influencers to create brand awareness and impact on social media, again, leveraging our internally developed technology to create a competitive advantage. And now today, I'm thrilled to acknowledge the pioneering efforts of our studio, technology and marketing teams for creating what we believe was the first AI-generated billboard campaign. Entitled Best Trip usually spending AI campaign celebrates our 20-year anniversary and with this [indiscernible] partnership with the AI studio based on Meta. Our AI innovation has generated meaningful buzz on social media and major press outlets such as Forbes, Vogue, The New York Post and Business of Fashion, further solidifying REVOLVE as a trailblazer in marketing innovation.

The Best Trip AI campaign debuted throughout April on several billboards along the highway headed DuPont Springs, strategically positioned to ensure that it would be seen by hundreds of thousands of festival goers driving the Coachella, Stagecoach and of course, REVOLVE Festival last month. It was great to see our aspirational lifestyle brand, proudly display front and center for such a large, targeted and relevant audience.

Also compelling is that we were able to efficiently produce and sell a limited edition capsule collection for the design-themed AI campaign. Our Own Brands team had already been testing ad design and related technology innovations to drive further efficiency and positive element. So it was really incredible to see our team leverage AI to bring product to life for the first time.

Over time, we believe AI design presents an exciting opportunity to create a more powerful, innovative and streamlined design process. Our conviction true excitement about the potential for AI technology across the organization led us to help launch the first-ever AI fashion week last month to promote greater experimentation and use of AI in a fashion. I encourage you to follow the updates on our social media channels and participate in buildings for the more than 400 AI fashion week content submissions through the AI fashion week. Of note, the 3 winners from the AI fashion week contest will have the opportunity to sell their AI capsule collections on REVOLVE. As a company, it's very important for us to stay at the cutting edge of technology development, testing and learning how to leverage these new technologies, which is ingrained in our cultural DNA.

Now let me shift gears and recap our highly successful REVOLVE Festival event held last month at an exceptional new venue. This year was particularly special for Mike and I because the timing of REVOLVE Festival coincided with our 20-year anniversary. We kicked off the week of REVOLVE Festival with an intimate 20th anniversary celebration in Los Angeles attended by A-Listers, VIPs and brands, including key fashion partners who have been with us since the earliest phase. In true REVOLVE fashion, the event grabbed headlines, particularly focused on Kendall Jenner's [indiscernible] highlighted by a sheet white form-fitting Allia dress from our FWRD assortment that sold out almost immediately after all the favorable press. Once again, illustrating our powerful marketing effect that our brand partners are increasingly excited about.

It was clear from the conversations and [indiscernible] our intimate gathering, just how much brand loyalty we have earned with emerging brands and content-creator partners over the years from our mutually beneficial relationships. We are truly grateful for the relationships we have built and to see the many businesses have grown with us in our journey. We are a strong brand, our focus on the customer, our technology and data-driven foundation and the support of our partners, we have nearly [indiscernible] the business from roughly $300 million in revenue in 2015 to $1.1 billion today.

REVOLVE Festival was held over 2 days in mid-April, and it was an incredible event that the Wall Street Journal called Coachella's most lavish party and was better than a day at Coachella according to article from Insider. The aspirational lifestyle event was very successful in elevating our brands and exciting and delighting our community of VIPs, brands, influencers, partners and fans who are fortunate enough to attend [indiscernible] activation.

This year's event featured an even more exclusive and intimate setting while delivering a high energy vibe that was inspired by [indiscernible]. Headline performers included 21 Savage, Don Toliver, City Girls, PinkPantheress, Coi Leray, Zack Bia, Amaarae, Ayra Starr and the trending Ice Spice and her first live performance since releasing a hit single with Nicki Minaj that debuted at #1 on the Billboard charts.

An important driver of impact and awareness was incredible attendance across the diverse range of personalities, including musicians, actors, celebrities, designers, athletes, content creators and TikTok stars. Team who wrote that it seems as though every celebrity and influencer panel was in attendance. Notable VIPs at our event included Kendall Jenner, Dixie and Charli D'Amelio, Hailey Bieber, Leonardo DiCaprio, Emma Roberts, Travis Kelce, Lewis Hamilton, Storm Reed, Lori Harvey, Saweetie, Leon Bridges, Camila Morrone, Madison Bailey, Suki Waterhouse, Natalia Bryant, Irina Shayk, Shay Mitchell, Noah Beck, David Dobrik, Christina Milian and Tyga.

To illustrate the scale of favorable impact on our brand, the week of REVOLVE Festival generated approximately 7 billion press impressions, our highest ever for any campaign or event. Our investment in REVOLVE Festival and other experiential events over many years has created a truly powerful lifestyle brand, which has resulted in increasing opportunities to partner with top brands and celebrities. For example, mobile icon Jennifer Lopez and her team were very excited to partner with REVOLVE because of the strength of our brand and strong connection with the next-generation consumers.

We recently launched an exclusive shoe collection called JLo Jennifer Lopez and holds an impactful marketing event with JLo that attracted more press than any launch in our history. It was all made possible by the combined strength of our brands.

Shifting to an update on FRWD. We have some exciting marketing plans related this year, so stay tuned for details in the coming months. One of the areas that has been a real bright spot is our recently introduced FRWD venue. The section of FRWD dedicated to circular luxury shopping where we saw preowned hand bags from [indiscernible] luxury brands. Built from this early effort grew more than 50% on a sequential basis in the first quarter, in the fourth quarter of 2022, and renewal has attracted many new customers to the FRWD brand.

I'm also excited by our efforts to encourage our leading premium beauty brands on REVOLVE to call us in for this year. Some of our largest beauty brands in REVOLVE are in the queue to make their beauty products available on FRWD as well, expanding our opportunity.

I'll wrap up with an update on beauty where our year-over-year growth in the first quarter remained solid in the low double digits. The major focus of our beauty strategy for the near term is to extract the right selection of beauty brands in the site. I'm confident that having the optimal beauty assortment will drive an exciting growth opportunity over the long term, simply because our customer loves REVOLVE, and we consistently exceed our expectations. As context, you know that when we launch a major beauty brand, it moves the needle as a small number of beauty brands currently drive a high share of our beauty volume.

We are very excited about the pipeline and high-impact beauty brands we expect to be onboarded this year. An exciting development was the launch of Kourtney Kardashian's wellness brand, Lemme, on REVOLVE in February, a month before distribution to any major beauty retailers. The launch of REVOLVE has done very well in the early going, helped by Kourtney really leaning into marketing on our social channels. As an example, we enforced a powerful REVOLVE brand, community-trusted relationships we have built with Tastemakers.

In closing, it is clear to me that we remain in a highly uncertain operating environment, as Mike alluded to. Not surprisingly, consumers are dealing with persistent inflation pressures, which has led to some reduction in our customers' propensity to spend, evident in our average spending per active customer. Despite the challenging macro environment, we are continuing to play offense, building on our already solid foundation that will support our future growth when the environment improves and our spending returns.

I'm super energized by the energy and level of innovation throughout the company. continue to push the boundaries, leveraging new technologies and marketing techniques. Our attributional team cultures and full force as we pursue our goal of being the fashion destination for the next-generation consumer.

Now I'll turn it over to Jesse for a discussion of the financials.

[Jesse Timmermans, CFO]

Thanks, Michael, and hello, everyone. We encountered our share of challenges in the first quarter on top of a very difficult prior year comparison. In such a dynamic environment, I am pleased that our operating discipline enabled us to achieve significant progress in recalibrating our inventory position while generating exceptional cash flow, further strengthening our already pristine balance sheet.

I'll start by recapping our first quarter results. Net sales were $280 million, a year-over-year decrease of 1%, then shared on our earnings conference call for the fourth quarter of 2022, the first quarter of 2023 began on a high note with year-over-year net sales growth in the mid-single digits through the first 7 weeks. However, our net sales trajectory decelerated in the last 6 weeks of the first quarter of 2023. Consistent with a variety of public data sources reporting softer consumer spending on discretionary items during February, and particularly during March.

Looking at our first quarter of 2023 results over a longer time horizon, our net sales have increased at a 4-year compound annual growth rate of 19% when compared to the first quarter of 2019. REVOLVE segment net sales decreased 3% and FRWD segment net sales increased 5% year-over-year in the first quarter.

By territory, domestic net sales decreased 5% and international net sales increased 16% year-over-year. The U.S. faced a much harder comparison as the U.S. grew more than twice as fast as our international business in the first quarter of 2022. Active customers, which is a trailing 12-month measure, increased by a healthy 84,000 customers during the first quarter. This growth expanded our active customer count to 2.4 million, an increase of 19% year-over-year. Our customers placed 2.3 million orders in the first quarter, an increase of 6% year-over-year. Average order value was $288, flat year-over-year.

Shifting to gross profit. Consolidated gross margin was 49.8% at the high end of our guidance range, and a decrease of 468 basis points year-over-year, primarily due to a lower mix of net sales at full price compared to the first quarter of 2022. We exited the first quarter with a more balanced inventory position, which gives us confidence in the improving gross margin outlook in future quarters.

Moving on to operating expenses. Fulfillment costs deleveraged by 67 basis points year-over-year, directionally consistent with our outlook commentary, primarily due to a year-over-year increase in our return rate as well as increased labor costs and investments made to expand our fulfillment network. The softer revenue trend was also a headwind for fulfillment efficiency year-on-year due to decreased utilization of our expanded fulfillment center capacity.

Selling and distribution costs deleveraged 2 points year-over-year and were higher than expected, primarily due to elevated costs for customer shipments caused by a higher return rate year-over-year and continued year-over-year growth in variable fuel surcharges. We are very focused on reducing the significant negative impact on our profitability from these increased shipping costs with several initiatives in place and more being developed and tested.

Marketing was more efficient than the outlook we provided on last quarter's conference call. Our marketing investments represented 13.7% of net sales in the first quarter, an improvement of 225 basis points year-over-year. General and administrative costs were $28 million, slightly lower than our outlook provided last quarter. Our effective tax rate was 25%, 3 points higher than in the first quarter of 2022. Net income was $14.2 million or $0.19 per diluted share, a decrease of 37% year-over-year. It was impacted by the lower gross margin and growth in operating expenses, partially offset by an increase in other income due primarily to an insurance reimbursement. Adjusted EBITDA was $15 million, a decrease of 52% year-over-year.

Moving to the balance sheet and cash flow statement. Our cash flow in the first quarter was exceptional, and benefited from favorable working capital dynamics. Net cash provided by operating activities was $49 million and free cash flow was $48 million, which was our second highest for any first quarter, that declined compared to the first quarter of 2022, primarily due to lower net income year-over-year.

In just the first quarter of 2023, we have already generated more than twice the amount of operating cash flow than all of 2022. The strong cash flow generation has further strengthened our balance sheet and liquidity. Cash and cash equivalents as of March 31, 2023, were $283 million, an increase of $49 million or 21% from year-end 2022 and an increase of $13 million or 5% year-over-year. Our balance sheet as of March 31, 2023, remains debt free.

Inventory at March 31, 2023, was $190 million, a sequential quarter decrease of $25 million from year-end 2022. As a result of the significant inventory reduction in the first quarter, our inventory moderated to a 6% year-over-year increase, narrowing the unfavorable spread between our year-over-year inventory growth and year-over-year net sales growth to only 7 points. We remain confident that we are on track to rebalance our inventory by the end of the second quarter.

Now let me update you on some recent trends in the business since the first quarter ended, and provide some direction on our cost structure to helping your modeling of the business. Starting from the top. The top line pressure we experienced late in the first quarter has continued as net sales for the month of April 2023 decreased by approximately 7% year-over-year. We believe the uncertain macro environment is increasingly weighing on our customers' purchasing behavior.

Shifting to gross margin. We expect gross margin in the second quarter of 2023 of between 53% and 53.5%, up from the first quarter of 2023 gross margin reported today, yet lower year-over-year as we expect a reduced mix of net sales at full price this year. Importantly, the year-over-year decline in gross margin implied by our outlook for the second quarter of 2023 is about 2 points lower than the year-over-year decline in gross margin reported for the first quarter announced today. For the full year 2023, we continue to expect gross margin of between 52% and 53%.

Fulfillment, primarily as a result of the increased top line uncertainty, we are taking a slightly more conservative view of fulfillment efficiency. We now expect fulfillment as a percentage of net sales to be around 3.2% for the second quarter of 2023. We continue to expect slight sequential improvement on fulfillment efficiency in the second half of the year, resulting in fulfillment as a percentage of net sales of approximately 3.1% for the full year 2023.

Selling and distribution, we expect selling and distribution costs to represent around 18.7% of net sales for the second quarter of 2023 and 18% of net sales for the full year 2023. The increase from our prior full year guidance primarily reflects a higher-than-expected return rate that we believe is influenced by the challenging macro environment. As a result, we are now assuming a higher return rate in 2023 than was embedded in our prior guidance.

Importantly, our outlook for the full year implies sequential improvement in the back half of the year. There are 3 key drivers of the sequential improvement we expect in the back half of the year for selling and distribution. First, we expect variable fuel surcharges to decline year-over-year starting in the second quarter after several quarters of significant growth. Second, we expect to begin to realize efficiencies from our new Pennsylvania fulfillment center as its volume scales. And third, we expect to begin to realize early efficiencies resulting from a variety of other shipping and logistics efficiency measures we are pursuing. However, we are factoring in an elevated return rate in the near term, which will partially offset some of our efficiency measures and contribute to continued pressure on shipping costs.

Marketing. Our marketing efficiency in the first quarter of 2023 was partially due to a reduction in brand marketing events this year compared to the very active events calendar in the first quarter of 2022. By comparison, we expect the second quarter of 2023 to include a larger investment in brand building events year-over-year when compared to the second quarter of 2022. As a result, and consistent with our commentary from last quarter, we expect our marketing investment to be the highest of the year in the second quarter of 2023 and to represent approximately 18.5% of net sales. For the full year 2023, we expect marketing to be within the range previously communicated, of 16% to 16.5% of net sales.

General and administrative. We expect G&A expense of approximately $29 million in the second quarter of 2023 and between $113 million to $115 million for the full year 2023, unchanged from our prior full year outlook.

And lastly, touching on our tax rate. We continue to expect our effective tax rate to be around 24% to 26%, consistent with the past several quarters.

To retail. While the current environment is challenging, led by Mike and Michael's long-term mindset, our leadership team is energized behind a wide range of exciting initiatives that we believe will benefit REVOLVE for years to come. After delivering exceptional growth in the past 2 years, our key focus is our active evaluation of how we can leverage our technology, data-driven approach and operating excellence to take advantage of our increased global scale and driving further operating efficiencies across the organization.

Now we'll open it up for your questions.

[Operator]

[Operator Instructions]. Your first question comes from Oliver Chen with TD Cowen.

[Oliver Chen, TD Cowen]

Regarding the softer revenue trends and what you see ahead, what classifications were more concerning? And also your inventory spread is better, but what do you think about going forward in terms of the promotions and markdown cadence and what risk factors are you monitoring there in terms of what's embedded in your guidance. Do you expect the trends on an ongoing basis to continue to be fairly volatile.

[Michael Karanikolas, Co-Founder, Co-CEO & Chairman]

Yes. So with regard to classifications, Oliver, are you just wanting more color on kind of across different segments, whether it's geographies or types of merchandise or what are you referring to there?

[Oliver Chen, TD Cowen]

Yes. I think the categories that were softer and if they followed patterns, that would help us get a feel for what's happening with the customer and what's driving some of the softer trends.

[Michael Karanikolas, Co-Founder, Co-CEO & Chairman]

Yes, definitely. So if you look at my kind of category as well as customer segment, there's a couple of call-outs. One would be that certainly the aspirational customers versus the high-end customers, there was a bit more softness there. But we also emphasize the softness was fairly broad-based. So it's not to say we didn't see impact on the high end.

Within the merchandise category, I think if you look at apparel that's more going out oriented, there was a bit of an overshoot or peak last year, and so we saw some rebound in the opposite direction. This -- for this particular quarter. And then if you look at nonapparel categories like beauty, they performed relatively well in comparison. Obviously, that's a long-term growth area for us. But we're happy to have delivered a solid beauty growth during the period.

[Oliver Chen, TD Cowen]

Okay. And promotional markdowns, what should we know about what's embedded in the forecast and the degree of inventory that you have now and the freshness of the current inventory as we think about risk factors there, given the softer top line?

[Michael Karanikolas, Co-Founder, Co-CEO & Chairman]

Yes. We feel good about our inventory position. We made great progress on it in the quarter. Obviously, we would have liked profitability to have been stronger, and revenue tends to be stronger. But we did what we needed to do on the inventory position as far as bringing it down substantially getting to a place much closer to imbalance. And again, we feel like at the end of the second quarter, that we'll be feeling good about where that position is, and the result was exceptional cash generation, which is something that we're focused on. Obviously, in an uncertain macro environment, there is continued risk around inventory levels and gross margins and things of that nature. But it's something that we're laser-focused on and being very active on.

[Oliver Chen, TD Cowen]

Okay. Last question, Mike, on customer acquisition trends. And what you saw, was it more concerning in terms of new versus existing cohorts and/or there's been a lot of volatility in CAC and also less productivity in the performance marketing. Is there any color in terms of what you've been seeing with that?

[Michael Karanikolas, Co-Founder, Co-CEO & Chairman]

Yes. So the first quarter was actually good by a number of marketing metrics, particularly CAC was favorable versus prior periods. New customers were generally strong. It was just, again, kind of offset by a broader-based weakness. And as you saw in the numbers, we pulled back on marketing a bit in the first quarter, which certainly had some impact on the overall trends. We didn't want -- we hadn't wanted to pull back on marketing too much until we felt the inventory position was in a better place. And again, we feel good about the progress there.

So that's when we had some impact on the trends. And also an increased level of kind of new marketing techniques and marketing experimentation had a little bit of an impact also. That's something that we didn't want to play with too much when inventory levels were elevated before, but we were a little bit more free to do that in the first quarter, which is -- has some -- I'll call it minor impact in the current quarter, but is overall good for the long term.

[Operator]

Your next question comes from the line of Mark Altschwager with Baird.

[Mark Altschwager, Robert W. Baird & Co.]

So the valuation landscape for DTC brands has certainly shifted versus a couple of years ago and your cash balance is building. Curious how you're thinking about opportunistic acquisitions in this landscape? What would an ideal target look like? And are you seeing any attractive opportunities out there that multiples you would deem reasonable?

[Michael Karanikolas, Co-Founder, Co-CEO & Chairman]

Yes. It's certainly interesting. And as we've talked about in past calls, it's something that we're always actively thinking about. And certainly, as valuations get more attractive, it's -- the possibility of an opportunity there becomes more realistic. That said, our answer would be the same as previous periods where, again, it's just something that we're always actively monitoring and considering. And we'll let you know if there's any updates there. But -- and that's how we'd characterize it at this point.

[Mark Altschwager, Robert W. Baird & Co.]

Just a quick follow-up just regarding the top line. Obviously, the macro is more challenging, but you did speak to some opportunities to maybe go on offense in this sort of environment. Could you maybe elaborate on that a bit?

[Michael Karanikolas, Co-Founder, Co-CEO & Chairman]

Yes. There's a number of areas that were going on offense and maybe I'll mention a couple, but I'll also let Michael dive in here because he's very active in a number of them. But obviously, continue to build our brand. We continue to make impactful long-term brand marketing investments and REVOLVE as what we think was a very big success this year. I think importantly, on the technology side, obviously, with the recent AI development, that's a very hot area. It's an area that we've been actively working on and actually deploying in practice for multiple years now.

And things are just moving faster. We view that as a huge opportunity. We're increasing our investments there. At times, others are pulling back. I know there was some news of other medium retailers pulling back on overhead, and we're hiring engineers at this point. And obviously, do need in a prudent cost-efficient way as we always do, but overall, increasing investments in AI and tech, and we think it's a huge opportunity over the coming quarters and the coming year and excited to hopefully every quarter have something new to share with you there.

[Michael Mente, Co-Founder, Co-CEO & Director]

The only other thing that I would add on top of that, all of that, and I clearly agree with is all very exciting, is leaning into some of the really nascent categories, I think coming up for REVOLVE Gallery, which will be in H2, will be the first time we integrate where you know men's as well as the first time we integrate beauty as well. So there's longer-term categories that we think will be very, very crucial to our long-term success over the last 10 years or some that we are beginning to always [indiscernible] with our core activities and getting more serious about it. So there'll be a lot more of that. We won't be looking [indiscernible] long-term opportunities during things like this.

[Michael Karanikolas, Co-Founder, Co-CEO & Chairman]

Sure. And the only other thing I might layer in without getting, I guess, too detailed, but there's areas of the business, whether it's like the marketing experiments that I alluded to in the first quarter, and also other areas related to kind of cost efficiencies and other opportunities that we're increasing our investments in. And in the short term, are more likely to have a slightly negative effect, right, whenever you're doing something new, it takes time to kind of work out the kings to figure out exactly how to use something right or get it working in the right way. And we're investing prudently, but we're increasing our investments in those areas. And obviously, between the cash balance and where technology is going, it's just an exciting time, I think, for all of us to be active.

[Operator]

And we'll take our next question from Randy Konik with Jefferies.

[Randal Konik, Jefferies]

I guess, Jesse, maybe you could give us some perspective on just how -- I'm trying to think about various outcomes for top line. I know you don't want to -- you're not going to get a quantification specifically. But is there a way you could give us some perspective on how you should -- how we should be thinking about differences in a range of outcomes and average order value number of orders or something to that effect that we can kind of get a sense of how you're thinking about a range of outcomes for the top line? That would be super helpful -- for the year...

[Jesse Timmermans, CFO]

Yes. It is still highly uncertain out there, as we've talked about. And that's why we're only giving the kind of actual results through April, which were down 7%. And that's some additional color. I think we're still confident that AOV can have a modest increase this year. We are pleased with the flat AOV year-on-year with the significant decrease in full price mix. As expected, full price mix shifted down significantly year-over-year, coming off those record highs of last year. So to get a flat AOV in this quarter, we are pretty pleased about. And then we're already seeing the full price mix shift back with the inventory rebalancing.

So we feel good there. Customer acquisition has been healthy. Cash has been healthy. The majority of the new customers that we acquired were at full price. That said, the growth really came from the markdown given the shift to markdown that we saw this quarter. And then I think the uncertainty out there is real. And given that we're starting off at a minus 7% for the quarter, we're kind of in the zone of -- it could be slightly negative to slightly positive for the second quarter, depending on how these next 2 months play out.

Comps do get easier on a 1-year basis, but on a multiyear basis, if you look back '22 versus 2019, they're still tough. So I think we just got to keep -- stay on the offense, keep doing what we're doing and kind of work through this moment in time we're in.

[Randal Konik, Jefferies]

Got it. And then you gave us a good perspective on how you're thinking about the selling and distribution line as a percent of revenue for the year, I assume. So when you think about maybe stepping back and looking at the return rate as an impact this line item. How are you -- where -- can you just give us some perspective of where we are in that return rate cycle? And how should we be thinking about that over the coming years? Is there a meaningful opportunity to over time and what is that return rate? Just how should we be thinking about that, not for just the balance of this year, just kind of thinking out more into the long-term future, you guys have a very sizeable impact or it doesn't impact on the margin.

[Jesse Timmermans, CFO]

Yes, maybe I'll address the first part and just kind of talking about the current quarter and return rate and what we've factored into the guidance and then kick it over to Mike for the long-term opportunity on return rate. We did see an elevated return rate for the quarter, higher than we had initially expected, and we did see it increase as the quarter progressed. I think just a couple of things more granular on the seasonality. We typically see March about 20% higher in dollar terms than January. We didn't see that this quarter.

It was only about 10% higher than January on a gross basis. And then when you factor in the return rate, March was actually 6% lower than January. So you can see the impact not only of the macro consumer impact in March, but also that increased return rate as the quarter progressed. And then we also saw increased return rate across segment and then across categories as well, even the lower return rate categories like handbags and then even beauty saw an increased return rate.

So we do attribute a lot of this kind of near-term pressure to the macro environment. And that's why we've taken up the fulfillment a little bit, and we've taken up the selling and distribution pretty meaningfully in our guidance. And as a reminder, 2/3 of that selling and distribution is freight and that return rate does have a significant impact on that.

And as mentioned in our prepared remarks, we are still seeing that fuel surcharge meaningfully higher to the tune of 30% higher year-on-year this quarter. We do expect that to subside at least on a year-over-year basis, and we're starting to see some softening there that will give us some benefit as we look ahead. And then maybe over to Mike for the longer term.

[Michael Karanikolas, Co-Founder, Co-CEO & Chairman]

Yes. So over the longer term, I'll start my comments with remarks there may be similar to what I made before, and then also kind of provide an update on top of that. So from a strategic standpoint, we're going to continue to focus on making it easier for customers to return to lead within the industry in that process. And that's certainly something that we're not going to compromise.

We feel like there's a lot of long-term opportunity there. It's something that we've repeatedly said, but it hasn't been the biggest area of active focus. Like there's been some focus on it. But obviously, with the increase in return rate that focuses shifting, and there's going to be a lot more internal work on that and investments kind of going back to the playing offense and investing remarks from earlier, we're increasing our investments there. And we're confident that over the long term, and hopefully, earlier than that, we can make some impactful changes that reduced return rate in a win-win wafer for the consumer and for us.

On top of that, certainly, Jesse talked about the transactional cost efficiency that we're focused on, we're laser-focused on that. That's one of our key priorities this year, and we're looking to drive those down significantly.

[Operator]

Our next question comes from the line of Lorraine Hutchinson with Bank of America.

[Lorraine Hutchinson, Bank of America Merrill Lynch]

I just wanted to follow up on the return rate. But maybe taking a little bit of a different approach, asking the international business, how much of an impact does that continue to have on return rate. And can you talk through any progress you've made on making that fulfillment and return process a little bit more margin efficient, globally?

[Jesse Timmermans, CFO]

Yes. Yes. On a year-over-year basis, the kind of shift to international or kind of the localization of international didn't have a meaningful impact. We continue to make improvements there for the customer, but the big shift there were over a multiyear period. So if you look kind of a pre-COVID 2018, '19 compared to 2023. That's where you see the significant impact from the international localization. But on a year-over-year basis, we saw relatively consistent increase in return rate, again, across segments and geos and in categories. So I wouldn't call that out as a big factor this quarter.

And we continue to make progress on those in this kind of cost reduction initiatives when it comes to kind of the refulfillment or the shipping back and forth of the returns. On the domestic level, Pennsylvania is continuing to ramp. So we expect to get some efficiencies there, starting this quarter but really in the back half of the year. And then there's a number of initiatives, both domestically and internationally, but really internationally to reduce those costs and optimize the shipping range. Again, not expecting huge impacts this quarter more towards the back half of the year and just really setting us up well for 2024.

[Operator]

And we'll take our next question from Rick Patel with Raymond James.

[Rakesh Patel, Raymond James & Associates]

Can you provide additional color on international performance? If we put China aside, are you seeing changes in consumer behavior that you think is noteworthy and keeping an eye on? And we're particularly interested in Europe.

[Michael Karanikolas, Co-Founder, Co-CEO & Chairman]

Yes. So with regards to the international regions, China, as we mentioned in the comments, was a really nice story for the quarter, a big growth driver in the quarter, coming off of certainly a difficult comparison, but just in general, we saw a lot of great momentum there.

Europe has been a market that's been struggling a bit as with other western markets, whether it's certainly domestically, our sales momentum is not where we want it to be, other western markets like Australia and the U.K., also kind of not where we want them to be. So I think within those Western markets, things have just generally been soft from a macro standpoint. But more broadly, globally, there's definitely those bright spots, including Middle East and Latin America, where we've been making investments, and it's really nice to see those investments paying off in regions that don't have the same currency headwinds or some of the same economic headwinds as the Western markets.

[Rakesh Patel, Raymond James & Associates]

And also a question on AI. Can you talk about the potential use of AI beyond marketing engagement? I'm just curious what kind of role you see it playing from an operational perspective? And whether this has the potential to be a needle-mover in the next year or 2 or if you see it as an event?

[Michael Mente, Co-Founder, Co-CEO & Director]

Yes. My thesis is that AI can clearly every aspect of the business as you [indiscernible] there. So we think that there's possibilities in some departments for a strong needle mover within the next 12 months for sure, but also anticipate continued acceleration across the board. We live on to every aspect of organization. And we think some of the first place that impact of the business most is going to be in our fashion design zone. We've really started to leverage some of the generative AI tools for fashion design. And it's still early stages, we're seeing week-to-week these tool gets improve but the design team has been happy with what they've been able to do with kind of like semi-permanent generative tools. So super exciting there.

I think that there's a lot of things that can link ultimately as we fast forward a few years into the future, I think that things could be dramatically different for us. So it's a really exciting time. I think Mike and I are really reminded of the 20, 25 years ago, early Internet days where it saw the clear long-term trend was there. The specifics of having to pay out, of course, will evolve over the ages, but we think that we're positioned well to take advantage of the excellent way of technology.

[Operator]

We'll take our next question from Edward Yruma with Piper Sandler.

[Edward Yruma, Piper Sandler & Co.]

I wanted to click down a little bit more on FRWD. Obviously, I know you guys are excited about the longer-term growth opportunity there. Could you kind of click down a little bit on inventory there? How you feel -- I know you said kind of from the entity level, you'll be kind of clean by the end of the second quarter. But how do you feel about Ford's inventory level? And kind of have you seen any impact from some of the promotions that we've seen across the luxury space?

[Jesse Timmermans, CFO]

Yes. Yes. I think consistent with what we've talked about before, it does take longer to write the shift on the FRWD side than it is on REVOLVE. So we feel really good on the REVOLVE side. FRWD still has a little ways to go, and that's where we're sticking to the end of Q2 before we feel like we're in a kind of a rebalanced position. So right now, FRWD inventory does over index relative to the kind of the sales mix on REVOLVE and FRWD. And then yes, I think promotions do have an impact -- have had an impact, and I think it will continue to have an impact as everybody works through their inventory, the uncertain and challenging macro environment. But we're working through that, and we typically don't respond on a kind of a head-to-head one-to-one basis on the promotion, but it's more about working through our inventory and getting it in the right place.

[Edward Yruma, Piper Sandler & Co.]

Maybe one other follow-up. I guess have you seen enough from a weakening consumer macro perspective that makes you want to tilt your assortment within core REVOLVE to more entry price point or lower price point versus kind of where it had been migrated to?

[Michael Karanikolas, Co-Founder, Co-CEO & Chairman]

Yes. So we're always mindful of consumer shopping behavior. And there's certainly not going to be any shifts that dramatically change our position in the marketplace. But certainly at the edges as we kind of [indiscernible] react to where consumer demand is strongest versus softest. We're constantly optimizing the mix, and that will continue to be the case.

[Operator]

We'll take our next question from Jim Duffy with Stifel.

[James Duffy, Stifel, Nicolaus & Company]

I wanted to start asking about inventory and promotion. Q1 showed some aggressive actions on the inventory. I'm curious, did the inventory progress exceed your expectations in the quarter? And then even with leaner inventories, do you expect you'll need to sustain promotion to remain competitively relevant?

[Jesse Timmermans, CFO]

Yes. I would say the inventory progress is roughly in line with our expectations despite softening on the top line that we did not expect late in the quarter. So I think we're really pleased with the inventory progress despite the softening top line. And we'll just have to kind of read the landscape as we go through the year. I feel good about the inventory, we'll feel like we rebalanced at the end of Q2, and we'll kind of manage accordingly. But again, we typically don't respond again, head-to-head or in direct response to individual promotions from others. It's all about kind of working through our inventory at the right pace. And if things pick up, we're confident, we can chase into demand in the right categories as well.

[James Duffy, Stifel, Nicolaus & Company]

And I'm curious, just the consumer response to promotions. Have the consumers been embracing the promoted merchandise more than you would expect at the expense of full-price sales? Or what are you seeing in the mix between full price and promoted goods?

[Jesse Timmermans, CFO]

Yes. I think generally, I'd say they're responding as we would expect to the markdowns. And I think also responding on the flip side as we're now shifting back into full price. And we're already seeing a pretty meaningful kind of reversion back to that full price, not to the record levels we were at last year, of course, but you can see that in our gross margin guidance that we gave for Q2. So again, just managing accordingly and responding to the customer.

[Operator]

We'll take our next question from Chad Tevebaugh with Needham & Company.

[Charles Tevebaugh, Needham & Company]

It's Chad on for Anna. Just on the better forward growth in the quarter. Can you talk about what's embedded for 2Q and what you're seeing with the more luxury consumer? And then additionally, with the moderating inventory at the end of 2Q, should we think about inventory being more in line with sales in the back half of the year?

[Jesse Timmermans, CFO]

Yes. No comment really on the expectation for FRWD beyond what we saw in April, which was a kind of a slight sequential improvement on a 1-year basis versus March, but again, on a multiyear basis, still a detail across the board. And then -- and FRWD is just much more volatile on a month-to-month and quarter-to-quarter basis, which is why we want to stay away from giving too much color on the expectations there for the balance of the year. And then inventory in line with sales, again, that was our expectation that is around the middle of this year that those 2 would converge closer.

[Operator]

And we'll move on to our next question from Janine Stichter with BTIG.

[Janine Stichter, BTIG]

Can you talk to own brand penetration where it sits currently? And then would we expect to see it ramp as we get inventory more aligned in the back half? And then also on that, can you speak to where margins are currently on private brands versus historical? And where you see them trending? I know you mentioned the lower inbound freight starting to kick in. Anything else to call out there just on the costing environment.

[Jesse Timmermans, CFO]

Yes. For the owned brand mix, I wouldn't expect a meaningful increase in the mix this year versus last year. I think that is more of a -- probably a 2024 dynamic in times like this when we're rebalancing inventory, and given the depth that we need to produce into our owned brands that has a more meaningful pullback than on the third-party side. So not expecting a meaningful increase this year on a full year basis, more kind of comparable even throughout the balance of this year to what we had last year.

And then the margins are holding strong. Freight has that -- inbound freight on owned brands has returned close to pre-pandemic levels. But keep in mind that given the higher price points that we operate at, that premium price point, the freight is a much smaller percentage of the cost of goods sold than maybe for others. It does have a positive impact, but it's not as meaningful as you might otherwise think. And that margin is still significantly higher than a third-party margin.

[Operator]

We'll take our next question from Tom Nikic with Wedbush Securities.

[Tom Nikic, Wedbush Securities]

Jesse, the gross margin for Q2 is implied to get much better sequentially. Is that just a function of, I don't know, less discounting or full price mix getting back to normal or closer to normal? Is there anything else like mix related, we should think about that starts becoming a good guy? Just -- can you just help us sort of understand the progression of gross margins here?

[Jesse Timmermans, CFO]

Yes. No, that is the primary driver, shifting back to a healthier full price mix in Q2. And we see that that's typical for any year, but especially this year as we made significant progress on the inventory in Q1 and then in a healthier place in Q2. So there's both a seasonal aspect and then our inventory coming back in check that also helps that. Mix across categories is relatively consistent. We think we're back to, call it, plus or minus normal with that 30% being dresses. Dresses does tick up a little bit in Q2 as does that fashion apparel. So there's a little bit there, but I would say the primary driver is that full price mix component.

[Operator]

We'll take our next question from Matt Koranda with ROTH MKM.

[Matthew Koranda, ROTH MKM]

A lot have been asked and answered. But just wanted to cover engagement. And what categories are you seeing new customers enter the active user base? Anything that's changed there? Any callouts as given the different economic environment we're in?

[Michael Karanikolas, Co-Founder, Co-CEO & Chairman]

Yes, I wouldn't say there's any major changes from some of the trends we've seen in earlier quarters, but a couple of callouts. One would be that markdown products were particularly strong in new customer acquisition, and that's generally true historically. So that was certainly one reason we saw a strong new customer growth in the first quarter. And then also beauty. And again, the same quarter as previous quarters, it has been a growth area for us. And that area is typically more efficient for us in driving new customers, and so we saw a strength there as well.

[Operator]

And we have time for one more question. And we have Simeon Siegel with BMO Capital Markets.

[Simeon Siegel, BMO Capital Markets]

I understand it's trailing 12 months, so perhaps it's a little different than what would have been this quarter. But just from what we can see, you're still showing impressive active customer growth, especially versus revenues. So I'm curious. I appreciate the tougher macro, but do you think the new customers are any different than the existing ones. I'm just wondering if they might be partially driving lighter productivity, just whether it's the returns, the margin, the AOV, et cetera. So just curious if you're seeing anything interesting learning-wise or discrepancies with the new cohorts.

[Michael Karanikolas, Co-Founder, Co-CEO & Chairman]

Yes. We're not seeing anything particularly different from the new cohorts versus previous cohorts. Certainly, depending on how we bring in new customers. There can be some differences over time. But in general, what we're seeing is consistent with what we've seen historically as far as our expectations from those consumers. As it relates to return rate, typically, new customers actually tend to have a lower return rate than returning customers. So that wasn't -- that didn't have any impact on the increase in return rate in the first quarter.

[Operator]

And that's all the time we have for questions today. I'll turn the call back to management for closing remarks.

[Michael Mente, Co-Founder, Co-CEO & Director]

Thank you for joining us for this quarter guys. Obviously, a lot going on in the business, lot going on in the world, but I'm very excited to look at the organization, looking forward to next quarter to show you continued results both operational results financially.

[Operator]

Thank you. And that does conclude today's presentation. Thank you for your participation, and you may now disconnect.