Cara Schembri; Chief Legal & Administrative Officer; Rent the Runway Inc
Jennifer Hyman; Co-Founder, Chief Executive Officer and Chair; Rent the Runway Inc
Siddharth Thacker; Chief Financial Officer; Rent the Runway Inc
Matt O'Connor; Analyst; Citizens JMP Securities, LLC
Ashley Helgans; Analyst; Jefferies
Operator
Welcome to Rent the Runway second-quarter 2024 earnings results conference call. (Operator Instructions) If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As reminder, this conference is being recorded. I would now like to turn the call over to Rent the Runway's Chief Legal and Administrative Officer, Cara Schembri. Thank you. You may begin.
Cara Schembri
Good afternoon, everyone, and thanks for joining us today. During this call, we will make references to our Q2 2024 earnings presentation, which can be found in the events and presentations section of our Investor Relations website.
Before we begin, we'd like to remind you that this call will include forward looking statements. These statements include our future expectations regarding financial results, guidance and targets, market opportunities, and our growth. These statements are subject to various risks, uncertainties and assumptions which could cause our actual results to differ materially.
These risks, uncertainties, and assumptions are detailed in this afternoon's press release as well as our filings with the SEC, including our Form 10-Q that will be filed within the next few days. We undertake no obligation to revise or update any forward-looking statements or information except as required by law.
During this call, we will also reference certain non-GAAP financial information. The presentation of this non-GAAP financial information is not intended to be considered in isolation or as a substitute for financial information presented in accordance with GAAP. Reconciliation of the GAAP to non-GAAP measures can be found in our press release, slide presentation posted on our investor website and in our SEC filings. And with that, I'll turn it over to Jen.
Jennifer Hyman
Thanks, Cara, and thank you, everyone for joining. On our last two earnings calls, I highlighted our two big goals for 2024: getting to free cash flow breakeven, and returning to growth. I'm excited to report results for Q2 that beat our expectations. And as a result, we are raising revenue guidance for the full year.
What you're seeing in our results is momentum. We've dramatically simplified our internal goals and organizational structure so that we can aggressively pursue the biggest opportunity areas for our business. We believe that the business is demonstrating that it's at an exciting inflection where continued growth and free cash flow breakeven this year are squarely within our reach.
Q2 '24 revenue was $78.9 million, up 4.2% year over year, exceeding the high end of our $76 million to $78 million guidance. Adjusted EBITDA was $13.7 million or 17.4% of revenue, our ninth consecutive quarter of positive EBITDA and exceeding the high end of our 14% to 15% margin guidance.
Moving on to Q3, we are guiding to an acceleration in revenue growth with Q3 revenue expected to increase 3% to 6% year over year. Finally, we are reiterating our goal to be free cash flow breakeven in full year '24.
One of the areas of our business where we believe that the momentum is most probable is in our special event rental business reserve. The reserve business is what we launched the company with 15 years ago. It's a simple value proposition. Every woman has to buy outfits for events, a wedding, a prom, a gala, a holiday party that she rarely wears again. So we give her the ability to rent dresses and accessories à-la carte for around 15% -- 10% to 15% of the retail price.
The addressable market for event rentals is large, and we are still the only company of scale is operating in this space. As we have discussed on past calls, reserve revenue has been declining for a few years, and we've been focused on reinvigorating it.
In June. We dedicated a new cross-functional pod under new leadership to focus on building reserve over the next few years. By July, orders were up around 10% year over year. Ended August, orders have been up around 20% year over year.
Equally exciting new customer growth into reserve is up around 50% year over year. This is without any marketing changes or incremental marketing dollars whatsoever. Just a deep focus on improving the end-to-end customer experience and ensuring that we optimize inventory availability for our customers.
Historically, new customer growth into reserve was a healthy source of repeat orders and upsells into subscription. We plan to use our reinvigorated lifecycle marketing function to reignite this flywheel. In 2H, you can also expect to see us focus on SEO for reserve to drive organic traffic here simplifying the UX of the experience, reinforcing our fixed guarantee, improving our upsell experience and focusing on turning our units as efficiently as possible to maximize revenue. We are very optimistic about continued growth in reserve in H2.
From a product perspective, we completed several big tech projects in Q2 that were aimed at improving important parts of the prospect funnel and making the site even faster across surfaces. We also made several changes designed to simplify our checkout process that have in total almost doubled checkout completion rate compared to the first half of the year.
We believe that this should have positive impacts on conversion throughout the second half of the year. We upgraded the speed and performance of all the key pages on the site significantly. Our grids, for example, are loading almost 10 times faster now than they were at the beginning of the year, which has lowered our bounce rates on these pages by around 30%.
As we updated performance, we've been able to more easily update the UI of the site, such as making our product detail pages even more compelling, which is the increase to add to bag rate and very importantly allows us to recognize gains in SEO faster. We plan to invest significantly into SEO in the second half of the year, geared towards making recognizable gains to organic traffic as a result.
Finally, we've made our photo review process more seamless, which has continued to dramatically improve the amount of reviews were receiving per product. Our customer reviews are critical tool in helping new customers determine whether an item will fit them and increased comfort with sizing, which again drives conversion.
We believe that the work completed in first half marks a significant milestone for Rent the Runway as many of the major tech projects we embarked on, in some cases several years ago to upgrade our site and funnel performance, have either been completed or in good shape. We therefore feel confident shifting the way we work into a simplified structure where we have aligned behind the top three priorities for the next few years and have aggressively stacked cross-functional teams against these business goals.
We also believe that our cross-functional teams are well positioned and with the right skill sets to execute, speed, and agility, and operate akin to a mini startup. These goals include growing our reserve business and therefore our customer funnel into the company increasing subscriber loyalty, in particular, during for onboarding experience and increasing organic traffic to Rent the Runway.
Turning next to marketing. With a new team in place, we have continued to make quarter-over-quarter progress in diversifying our marketing channels, overhauling and modernizing our creative to make all of our touch points more aspirational, and getting the brand back out in front of consumers. We have evolved our content development so that is more rapid and agile as we believe that timely and engaging content is critical to improving the performance of all of our channels, including social and our paid performance.
You can expect to see new organic content launch on our channels with much higher frequency. In Q2, we saw tax improve year over year by nearly 15%. Some of this can be attributed to diversifying our channel mix. We've seen some early success marketing on TikTok and Pinterest, given our target demographics.
In the second half of the year, we're focused on turning back on brand marketing, which alongside SEO, we hope will catalyze growth in organic traffic. One of the elements of our strategy are monthly icon campaigns. We plan to partner with buzzy celebrity talent for activations focused on curating their iconic closets and offering it as rentable to Rent the Runway subscribers. This furthers our mission of celebrating real talented, fashionable women, all over the world and telling their stories.
Later this month, we're taking Rent the Runway on the road to some of the biggest college campuses in one of our fastest growing regions for RTR, the South. We'll visit campuses like the University of Texas, Ole Miss, and University of Georgia, where the social culture is strong and we see an opportunity to bring RTR to the women on-campus who need a resource for Greek life and their many events.
This program is expected to include in real-life activations on campus and will involve college influencers and the relaunch of our college ambassador program, which was a source of tremendous brand awareness for Rent the Runway pre-COVID. And right on deck are some fun, social first activations for Fashion Week in New York.
We believe our designer assortment is one of the biggest competitive advantages, so reinforcing Rent the Runway is positioned as the rental company that allows you to rent pieces straight from the runway is important.
On inventory, this is an important and exciting time of the year where we get to plan our 2025 buy. For 2024, we successfully executed on our debt strategy and have seen outsized demand for the 2024 buy in the first half of the year.
Looking ahead to 2025, we want to solidify rental runways position as the fashion leader in the rental space by refreshing our assortment and leaning into our strength in dresses. We plan to overhaul our brand matrix to provide our customer an even more elevated, aspirational, emotional, and fashion-forward experience.
We see opportunity across print, color and emotional pieces and plan to maintain depth, but also increased breadth to ensure that we are not only serving our sophisticated core customer but offering an assortment that will attract new customers.
In conclusion, I will say the simplification of goals within the company and focus on implementation of the few things that will lead to significant growth has created an energy and excitement inside the company that is palpable and feels great after some difficult years. We're motivated by our momentum and ready to continue growing by continuing to improve our customer offering and experience and getting to our goal of free cash flow breakeven this year. With that, I'll turn it over to Sid.
Siddharth Thacker
Thanks, Jen, and thank you, everyone, for joining us. We continued to make good progress in the second quarter. Both Q2 revenue and adjusted EBITDA exceeded the high end of our guidance range. Our Q3 2024 revenue guidance of $75 million to $77 million or 3% to 6% revenue growth versus Q3 2023 implies a continued acceleration of revenue growth versus Q1 and Q2 of fiscal 2024 at the midpoint of the guidance range.
As I will discuss further, we are also raising our revenue guidance for fiscal year 2024 and reiterating our commitment to reach free cash flow breakeven for the full year. In short, we expect to grow revenue and significantly improve profitability this year.
I would like to take a moment to discuss the year-over-year decline in Q2, ending active subscribers. We believe the primary reason for this year-over-year decline is the significant reductions in promotions this quarter versus last year's second quarter. In fact, excluding subscribers generated from the highest level of promotions in Q2 '23, our year-over-year subscriber growth would have been much better than the 6% decline we reported as of Q2 '24.
Notably, ending active subscribers as of September 1, 2024, were already roughly flat year over year. We also believe that our stronger revenue performance in Q2 2024, despite lower ending active subscribers, demonstrates the success of our strategy to be less promotional.
As Jen outlined, we are focused on driving innovation and enhancements to the customer experience across nearly every aspect of our business. We are excited by our second half plan. The underlying financial position of the company and our go-forward expectations are considerably stronger versus last year with growing revenue and meaningful improvement in cash flow, which I will walk through in more detail.
Our Q3 and full year 2024 guidance of positive indicators of further financial progress. We are growing revenue while spending less on promotions. Our reserve business is demonstrating stronger trends on a year-over-year basis and resale is growing at high levels versus last year.
Let me now review our financial results for the quarter. We ended Q2 '24 with 129,073 ending active subscribers, down 6.2% year over year. Average active subscribers during the quarter were 137,455 versus 141,393 subscribers in the prior year, a decrease of 2.8%. Ending active subscribers decreased from 145,837 subscribers at the end of Q1 2024, due primarily to seasonally weaker acquisitions.
Total revenue for the quarter was $78.9 million, up $3.2 million or 4.2% year over year and up $3.9 million or 5.2% quarter over quarter. Subscription and reserve rental revenue was up slightly year over year in Q2 '24, primarily due to growth in reserve and higher average revenue per subscriber as a result of lower promotional spending. Although revenue increased 35.1% or $2.7 million year-over-year due to increased focus on our resale business, which drove incremental cash flow and customer loyalty.
Fulfillment costs were $20.6 million in Q2 '24 versus $22.5 million in Q2 '23 and $20.6 million in Q1 '24. Fulfillment costs as a percentage of revenue were lower year over year at 26.1% of revenue in Q2 '24 compared to 29.7% of revenue in Q2 '23.
Fulfillment costs benefited from a new transportation contract with UPS, continued warehouse efficiencies and higher revenue per order, primarily from our resale business. Gross margins were 41.1% in Q2 '24 versus 43.9% in Q2 '23.
Q2 '24 gross margins reflect higher rental product costs due to increased investment in inventory in fiscal year '23, offset partially by improved fulfillment costs. Increased investment in inventory reflects last year's depth adjustments to increase inventory in-stock rates in fiscal '23 and beyond.
Q2 '24. Gross margins increased quarter over quarter to 41.1% from 37.9% in Q1 '24 due to seasonally lower revenue share payments and improved fulfillment costs as a percentage of revenue. Operating expenses were 17.7% lower year over year, due primarily to the favorable impact of our cost reduction efforts and lower stock-based compensation expenses.
Total operating expenses, which include technology, marketing, and G&A were 49% of revenue in Q2 '24 versus 62.1% of revenue in Q2 '23 and 55.2% of revenue in Q1 '24. Adjusted EBITDA for the quarter was $13.7 million or 17.4% of revenue versus $7.7 million or 10.2% of revenue in the prior year.
Adjusted EBITDA for the six months ending July 31, 2024, was approximately $20.2 million or 13.1% of revenue versus $12.2 million or 8.1% of revenue in the prior year. Adjusted EBITDA improvement year over year reflects the impact of our fixed cost reduction efforts, higher revenue, and lower fulfillment costs, partially offset by higher revenue share payments due to a greater proportion of revenue share units.
Free cash flow for Q2 '24 was negative $4.5 million versus negative $17.5 million in Q2 '23, due primarily to lower cost of rental product and higher profitability. Free cash flow for the six months ending July 31, 2024, was negative $5.9 million versus negative $29.6 million in the six months ending July 31, 2023.
Free cash flow in the second half of fiscal 2024 is expected to be approximately positive $6 million. We expect that the improvement will primarily be due to lower operating expenses and lower capital expenditures in the second half versus the first half of fiscal 2024.
Lower operating expenses are driven largely by first half weighted marketing expenses. We also expect improved working capital and higher revenue in the second half of fiscal '24 versus the first half of fiscal '24. We expect that the majority of the improvement in second half free cash flow will be driven by timing of operating and capital expenditures, where we have good visibility.
I will now discuss guidance for Q3 '24 and fiscal year 2024. Let me start with Q3. We expect revenue to be between $75 million and $77 million and. Adjusted EBITDA margins to be between 13% and 15% of revenue. As outlined earlier, Q3 revenue guidance implies 3% to 6% growth versus Q3 '23, continuing an improving revenue growth trajectory at the midpoint of the guidance range.
As a reminder, revenue growth was negative 6.3% year over year in Q3 '23, approximately flat year over year in Q4 '23, positive 1.1% year over year in Q1 '24, positive 4.2% year over year in Q2 '24, and is expected to be between 3% and 6% year over year in Q3 '24.
Our current business performance gives us the confidence to increase our full year 2024 revenue guidance to between 2% and 6% growth versus fiscal '23. This increase reflects improving trends in our reserve business, solid progress on growing our retail business, and improved revenue per subscriber versus fiscal '23.
We continue to expect adjusted EBITDA margins of between 15% and 16% of revenue. We also continue to expect to be free cash flow breakeven for fiscal '24, as mentioned previously. Thank you, and we will now take your questions.
Operator
Matt O'Connor, Citizen's JMP Securities.
Matt O'Connor
Great. Thank you for taking my questions. And my first one is just on resurrecting past users. Can you just talk about what you're seeing there currently? And then maybe just talk about the broader opportunity.
Jennifer Hyman
So we're seeing strength in rejoin rates of past customers. I think that we've always seen that as we make improvements in customer experience, the first people to notice are people who are actively engaged on our marketing, kind of coms list, people who have been customers before. So we're seeing that that's actually a tremendous source of growth for us now are re-joiners.
And then just the opportunity for us is big. You know, obviously, the market is growing very quickly. It has gone from being an early adopter behavior to being a behavior rental, being a behavior that's way more mainstream. And over the past few years, that Rent the Runway until 2024, we have been heavily focused on cost and profitability.
Now, we have that clear vision to free cash flow breakeven, and we've reoriented the entire company around growth. We've hired the right people, we've reignited marketing creative. We've simplified our goals. And these actions give me the confidence and you can see it demonstrated in our metrics that growth is coming for RTR.
We have momentum, and we have momentum across all different aspects of our business right now. It's not just in one area. So I'm really excited about second half. And I'm particularly excited about how our strategies that we've deployed, where we put these cross-functional mini start-ups on really simplified business goals are going to help us into 2025 and 2026 ignite tremendous growth for RTR.
Matt O'Connor
Great. That's very helpful. And then my second one is just on the reserve business. Going off of your point on just the cross-functional teams, understood that that's contributing to the success that you guys are having there. But maybe just from a product perspective, what do you see that these teams are coming up with that's really driving the acceleration in that business?
Jennifer Hyman
So the teams are focused on the full end to end experience for reserves. So to be clear, until quite recently, until June, there had been no dedicated focus of a cross-functional team to reserve in many years. And we hadn't seen that business decline for the past few years.
Just by nature of focus on our special event business, we were able to go from declining year over year revenues to up 10% year over year in July. And what I mentioned up 20% year over year in August with new customers, importantly, up close to 50% year over year.
Some of the things that the team are focused on are maximizing our inventory availability to make sure that our units can turn as many times as possible and hit as many customers as possible. They're focused on our booking windows. They're focused on the UX and UI of the experience. They're focused on making sure that all of our customers understand that we give them a big guarantee. So they have nothing to fear in coming to RTR will always ensure that they have something often to wear for their event.
So you will see us make agile changes to this business over second half. And I feel very confident in improved momentum in this business, and in importantly, having this be a tremendous funnel of new customers into RTR.
Matt O'Connor
Thank you so much.
Operator
Ashley Helgans, Jefferies.
Ashley Helgans
Hi, it's Don Bradley. Thanks for taking our question. Wondering to start off with marketing. You talked about several different exciting marketing initiatives. Can you discuss your willingness to lean into marketing to stimulate sales growth, kind of depending on what ROIs you see? And maybe if you could kind of talk about what you're most excited about in terms of your marketing initiatives in the second half?
Siddharth Thacker
Yeah. Look, I think the important thing to realize here is we historically have never even had a Chief Marketing Officer. We have not really had people focused on this area in a way that consider the entirety of the marketing experience. It's not marketing for us, historically, has been very heavily focused on pay channel, on a few pay channels in particular.
And I think what we're trying to do now is evaluate very critically what is the return we're getting on each of those paid channels, how much can we broaden out those channels to increase the kind of returns we're getting there? Can we build out new channels using whether it's affiliates, whether it's influencers, just new ways in which we can reach customers.
Now as a result of doing some of this work, what we're finding is that there are opportunities to improve efficiency, take some of the dollars that were probably not working as hard for us, and reinvest those in exciting brand initiatives and other other initiatives that Jen mentioned, a college truck and so on that really allow us to go on to the world and get people excited about what we have to offer.
Jennifer Hyman
And just to clarify, one thing that said that we and very much did have chief marketing officers and full funnel marketing approach really until COVID. And it's in the post COVID years that the focus had really been, as I've mentioned in previous calls, more on bottom of the funnel and on things that we knew what the ROI was, the very next day.
We, by nature of hiring new talent here, new leadership, new team, we are -- that was the first indication of our desire and willingness to reinvest into marketing in a new way. And reinvesting means diversifying our channels. It means pulling up from being a solely bottom of funnel marketer to now being mid-funnel and full funnel, which is what we did for the first 10, 11, 12 years of the business.
It is fundamentally to us one of the key goals of our company. As I mentioned, we have three goals, we're aligning behind. One of those three goals is increasing organic traffic. The way that you increase organic traffic is yes, SEO is a component of it. But the other larger component is making customers fall in love with you again so that they come to your site directly.
How do you do that? It's via investment into brand? It's via investment into in real life events, into investor networks, into influencer networks, into things that we did very successfully in the past that we're bringing back modernizing them for 2024.
And we're really excited because the brand awareness of Rent the Runway is extremely high. The brand love for this company is incredibly high. And we're just looking to reactivate some of that kind of lead and love that's out there.
We mentioned on the last call that we had done these in real life events in New York and Atlanta. And we saw hundreds and hundreds and hundreds of women standing on lines around the block to get into in our PR events. That is just demonstration of the palpable emotion that people have towards this brand.
We haven't given our customers a way to demonstrate that palpable emotion over the last few years because of how bottom of the funnel focus we have been. And so by reigniting everything around marketing, I think that it drive -- not will not only drive higher organic traffic, but higher customer engagement and higher customer virality.
So just be on the lookout for an enormous amount of activity in the second half of the year that we mentioned in the call is on deck, and we're back.
Siddharth Thacker
I think the meat of the meeting, one interesting point to highlight here is if you actually examine all of the decisions we've made in the past, we spend a lot of time addressing costs -- addressing the cost structure. We spent a lot of time thinking about inventory and making sure inventory in-stock rates were appropriate for our customers in fiscal fiscal '23.
If you look at all of the decisions we've made post that point in time, it should give you a pretty good indication of how much we're interested in leaning into growth and into marketing and into the kinds of things that will make customers fall in love with.
So if you think about the events we're doing in real life, if you think about the New York City store, if you think about the college tour, I mean, all of the things that're broadening our channel, all of the work we're doing is really critically focused on just growth and driving growth.
Ashley Helgans
That's really helpful. And then wanted to revisit in light of kind of challenged consumer wanted to revisit your decision to reduce promos? And just kind of talk about learnings from that decision so far and how you're thinking about your price points.
Siddharth Thacker
Sure. So just a quick recap of what we've discussed previously. Historically, we used to have a lot of promotions that were multi-month in nature, so we would do two- and three-month promotions. We have gone out and changed all of those promotions to largely be single month focus or one-month focused promotions.
The other thing we discussed when last year at the time was we tested a variety of different promotional strategies, some low, some high in Q2 of '23. And what we have learned is to discontinue some of the promotions that were not returning adequate dollars to us that were not beneficial to retention and so on and to continue promotions to targeted customer segments that we thought were beneficial to bringing customers in.
And so what you're seeing in terms of the sub count for Q2 '24 versus Q2 '23 is really just a reflection of discontinuing and not repeating some of the particularly high levels of promotions that we weren't particularly satisfied with. And so as we pointed out in September, sub count is roughly flat year over year.
So clearly those promotions didn't have a strong retention element to them. And I think where we are now is pretty satisfied with where the promotional cadence of the business is. We think it's in a healthy place. And we are really spending all of our time not focused on promotion, but really focused on all of the other ways to drive growth and retention for our customers.
Jennifer Hyman
And I think that the reserve business and the momentum that we've had there, where again, we've seen 50% new customer growth into that business in August is testament that without incremental marketing dollars, without promotions without detriment in price in those arenas, by nature of improving the customer experience and focusing on maximizing our inventory availability, you can drive a lot more customers into RTR.
And I think that that's due to the product market fit this business and it's due to the value that we already give the customer by nature of enabling her to rent a designer dress for around 10% to 15% of the retail price. That is huge value that makes our price points more competitive with fast fashion then with traditional designer fashion.
Ashley Helgans
That's great color. Thanks so much. And best of luck.
Operator
Thank you. There are no further questions at this time. I would now like to turn the call back over to management for any closing thoughts.
Jennifer Hyman
Thanks for joining us today. We're really excited about the second half of the year and hope you stay tuned.
Siddharth Thacker
Thank you so much.
Operator
And this concludes today's conference, and you may disconnect your lines at this time.
