Earnings Call Transcript
Rent the Runway, Inc. (RENT)
Earnings Call Transcript - RENT Q1 2022
Operator, Operator
Greetings. Welcome to the Rent the Runway First Quarter 2022 Earnings Call. Please note, this conference is being recorded. I will now turn the conference over to your host Janine Stichter, Vice President of Investor Relations. You may begin.
Janine Stichter, Vice President of Investor Relations
Good afternoon, everyone, and thanks for joining us to discuss Rent the Runway's first quarter 2022 results. Before we begin, we'd like to remind you that this call will include forward-looking statements. These statements include our future expectations regarding our financial results and guidance, market opportunities, and our growth. These statements are subject to various risks, uncertainties, and assumptions that 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 in 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'll 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. Reconciliations of GAAP to non-GAAP measures can be found in our press release, slide presentation posted on our investor website, and our SEC filings. And with that, I'll turn it over to Jenn.
Jenn Hyman, CEO
Hi, everyone. Thanks for joining us today. We are very proud of our strong Q1 performance, which showcases our accelerated business momentum, robust subscriber engagement, and improved year-over-year profitability. We exceeded our Q1 guidance across all key metrics, both on the top and bottom line. We grew revenue 100% year-over-year and grew gross margin by 9 points year-over-year. Adjusted EBITDA margin came in five points above Q1 2021. We finished Q1 with 135,000 ending active subscribers, hitting a new record high for quarterly ending active subscribers. Additionally, our subscribers are increasingly more profitable for three key reasons. One, the margins of our new subscription plans, whose rollout was completed last year in May 2021, are nearly double what they were in 2019. Two, subscribers are more loyal than pre-COVID. And three, they are highly engaged, evidenced by the rate at which they opt to pay for additional items in their subscriptions, meaning they rent many items from us for more use cases. In sum, we see continued evidence that the strategies we have in place are paying off and we are on track for a record 2022. We remain confident in achieving free cash flow profitability over the medium term with the cash we have on hand as we laid out in our Q4 earnings call as well as with our more near-term goal to cover our operating expenses over the next two to four quarters. In April, I laid out three key business strategies intended to drive top line and three intended to impact the bottom line in 2022. While these initiatives are just gearing up, I wanted to provide updates on our progress in Q1 and how they're impacting our financials. The first top line initiative is events. We believe the boom in events this year gives us the opportunity to build out our funnel of potential subscribers not just for 2022 but for years to come, taking advantage of one of the most unique aspects of the Rent the Runway business: our organic growth flywheel. For 12 years, over 80% of our customers have come to us via word-of-mouth. And as a result, we have not had to be as reliant as others in the consumer space on paid marketing. The reason why renting from us is so viral is because women rent very bold clothing from us. And when a customer walks into a restaurant, work, or an event wearing some sexy red knockout dress, the other women in the room notice them and the same conversation ensues: 'Wow, you look awesome. Where did you get that?' And the response is typically, 'Thanks, it's Rent the Runway.' Multiply this by the roughly 80 days per year when subscribers are in our clothing, and that's a lot of opportunities to share Rent the Runway organically. So why am I bringing this up right now? It's because Rent the Runway is benefiting from the fact that women are using fashion for self-expression as they emerge from COVID. In other words, fashion is bolder than ever. The shorter hemlines, cutouts, new trends, and colorful clothing women are wearing right now translate into highly cost-efficient customer acquisition for us. To this end, we've been taking a 360 approach to capturing this demand with dedicated teams focused on full-funnel marketing strategy and product experience. We've nearly tripled our events-focused content and creative across our own channels and continue to both market our reserve business and position subscription as a solution for multiple events. We're building out the addressable market for weddings through partnerships like our recent successful partnership with Zola and a strong pipeline of future tie-ins during the coming months as we head into peak wedding season. Black tie is to 2022 as sweatpants were to 2020. We are seeing our customers gravitate towards more formal looks with cocktail dresses and gowns having the highest utilization of any category in Q1 and reaching all-time highs. Customers are evidencing greater confidence in their upcoming plans. As an example, international travel as a use case for our new subscribers has almost doubled since fall 2021. Our second and third top line initiatives, search and discovery and fit, are more long term and iterative in nature. In Q1, we focused on back-end infrastructure and cloud investments that provide scaling and efficiency benefits and support our work to provide an enhanced search experience for the consumer which is expected to be rolled out over the coming quarters. Now shifting to our strategies impacting the bottom line. First, we remain extremely excited about the prospects for at-home pickup which is currently live in over 20 markets, covering well over one-third of the subscriber base. As a reminder, at-home pickup is not only more convenient for the consumer but also less expensive for us versus national carriers, thanks to pickup density and consolidation of inbound shipments back to our warehouses. We are well on our way to bringing this offering to more than half of our subscriber base by year-end. Customer adoption of home pickup during its initial pilot phase exceeded our plan with minimal marketing efforts. The way customers find out about at-home pickup today is via a sticker on her garment bag. We expect adoption to increase meaningfully as we integrate at-home pickup into the product experience of our app which is set to launch within the next few months. Second, we are continuing to build on the technology and automation investments in our warehouses in 2021 which drove a more than 30% year-over-year reduction in non-transportation fulfillment costs in 2021 and we see ongoing opportunity. We completed the full rollout of RFID on all of our rental products at the end of 2021 which affords us many opportunities to simplify processes within our warehouses, reduce labor expense, and gather more data. Prior to RFID, each returned item had to be individually scanned with a barcode 10 to 15 times throughout the reverse logistics process versus now, we can quickly scan units via RFID readers without human intervention. This has improved labor productivity, and we continue to see cost-saving benefits. RFID also enables us to use the hundreds of millions of data points we've gathered over the past decade to automatically sort our inventory into one of 26 distinct cleaning processes to improve garment quality and longevity. In Q1, we took another step in automating our processes and further utilize RFID by rolling out our digital issue tagging software. Now whenever we discover a garment quality defect, we can record it digitally which allows us to automate our decisions around processes like cleaning or restoration which is expected to reduce labor costs and improve product ROI. We also continued the rollout of new packaging in Q1 which is now being used for over 20% of shipments. Our packaging has always been reusable but we've improved upon it, making it waterproof and easier to pack for us and for our customers. The new packaging also doesn't need to be laundered which is more cost-efficient for Rent the Runway and supports our sustainability goals by reducing water usage compared to our current garment care. Third, we continue to grow Exclusive Designs and launched six new collections in Q1. We remain excited about the pipeline with nearly 20 exclusive design partners in 2022, around half of which are new. Share by RTR and Exclusive Designs are on track to represent a combined 60% of our product acquisition mix this year. We are within striking distance of the two-thirds that's embedded in our midterm plan to get to free cash flow profitability. Lastly, I'd like to touch on the macro environment which is on everyone's mind and very uncertain. To date, our business continues to grow and our outlook is positive which is reflected in our guidance this quarter. But I want to take this opportunity to speak a bit to the character of our team. Two years ago, when COVID hit and the U.S. was sheltering at home, our customer demand significantly declined. Our team reacted swiftly and made a series of tough and bold decisions to cut a significant amount of cost from every area of our business. We changed the way we financed our rental products with our vendor support because Rent the Runway matters to them. We nearly doubled the margins of our subscription programs. We transformed processes in our warehouses and added significant automation. We were focused on every dollar that we spent as the culture of frugality is embedded in our DNA. We have well-tested plans based on our COVID experience that give us confidence that we are prepared for macro challenges and can continue to drive our business to profitability and capture our long-term opportunity for a large and profitable business that changes how women get dressed. It's not business as usual, but I feel reassured that our team is battle tested, scrappy, innovative, and most importantly, resilient. That said, what we believe, interestingly, is that Rent the Runway is entering an environment that may be conducive to growth for our business. Rent the Runway stands to benefit as the share of consumers' wallet shift towards experiences over ownership. We've seen our data that the customer is yearning to get back out into the world, back to weddings, back to concerts and events, back to vacations, and even back to the office a few days a week. And we believe that all of this stands to benefit us. Given the significant cost savings she derives from renting, which is around 15% of retail price if she rents a la carte and around $20 an item in our subscription program, we believe that women will consider renting in a cost-conscious environment. During the 2008 recession, Americans continued to purchase about 65 articles of apparel per year. They just purchased them more often at off-price and value-focused retailers. At that time, rental and resale were not mainstream options for the consumer the way they are today. We can't predict how the consumer will be impacted by the macro environment, but we will aim to be part of the customer's larger cost-savings consideration set during these uncertain times. We plan to stay vigilant and are confident in our ability to react swiftly, take advantage of opportunities, and always keep our customer as our North Star. And with that, I'll turn it over to Scarlett.
Scarlett O’Sullivan, CFO
Thanks, Jenn, and thanks again, everyone, for joining us. I will provide an overview of our first quarter results for fiscal '22 and then follow with guidance for the second quarter and full year. I want to reiterate the financial framework provided in our last call to grow revenue while driving towards profitability. We are focused on growing revenue by growing subscribers and average revenue per user (ARPU) and also generating revenue from our reserve and resale businesses which are important funnels into subscription. We continue to move towards free cash flow profitability by increasing expense leverage in our three major cost buckets which are fulfillment, operating expenses, and investments in rental products. Phase one is to cover our operating expenses, and we maintain our target to reach adjusted EBITDA breakeven in the next two to four quarters with free cash flow breakeven to follow in the midterm. Q1 revenue of $67.1 million was up 100% year-over-year. We saw a strong post-Omicron bounce-back in subscriber activity after the fiscal year-end with a 17% quarter-over-quarter increase in active subscribers, ending the quarter with 135,000 active subscribers. Total subscribers increased to 177,000, up 11% quarter-over-quarter and up 70% year-over-year with paused subscribers as a percentage of total at 24% compared with 28% at the end of last quarter. I'd now like to provide an update on the price increase we rolled out in Q1. Thus far, the impact has been within our expectations. This speaks to the significant value we offer to our subscription which we think is strengthened in an inflationary environment where the cost of buying new clothing continues to rise. ARPU, defined as average monthly subscription rental revenue per subscriber in Q1, was ahead of our expectations, benefiting from continued success of add-ons. 28% of active subscribers paid for one or more add-ons in Q1 which we were pleased to see in a period of high seasonal acquisition and a higher proportion of new subscribers, resulting in 86% of revenue being generated by subscribers. As a reminder, these add-on items are margin-accretive as they are generally added to an existing shipment with minimal incremental cost to us. We reiterate our outlook for ARPU to be approximately up 5% for fiscal year 2022 versus last year. We also saw reserve and resale benefit from the post-Omicron bounce-back. Customers plan for social events in earnest which led to a beat of over 20% of our reserve revenue relative to our expectations. And we also saw subscribers in particular buy more units than anticipated, boosting our resale revenue above our forecast. Our Q1 gross margin rose 9 points year-over-year to 34%. The significant improvement is due to higher revenue per shipment versus last year and rental product depreciation and revenue share costs at 32% of revenue versus 50% in Q1 '21 as higher subscriber counts and therefore higher revenue absorbed product costs. In addition, revenue share as a percent of revenue was favorable versus our forecast as some Share by RTR items are hitting their max on performance-based payout after which revenue is no longer shared with brands. We expect gross margin to be slightly higher for full year '22 compared with full year '21. Fulfillment costs were 34% of revenue in Q1 compared with 26% in Q1 last year as we generally expected, largely due to transportation cost increases. We knew these increases were coming starting in H2 last year and have been steadily diversifying our shipping partners which helped to mitigate these costs. In addition, warehouse productivity improvement helped to partly offset the shipping increases. In terms of comping against last year, Q1 '21 still had higher unlimited subscription pricing and subscribers were less engaged given the COVID environment, resulting in lower fulfillment costs as a percentage of revenue last year. We maintain our prior expectation of fulfillment costs as a percentage of revenue at approximately 34% for full year '22. Adjusted EBITDA for Q1 was negative $8.8 million versus negative $6.2 million in Q1 last year, representing negative 13.1% margin and a five-point improvement versus negative 18.5% last year, giving us the confidence to reiterate our target of getting to adjusted EBITDA breakeven in the next two to four quarters. Our total operating expenses, marketing, technology, and G&A, represented 77% of revenue compared with 93% in Q1 '21, demonstrating our ability to absorb fixed costs with higher revenue even as we invested in the business in Q1. I want to call out again our investments in technology that provide scaling and efficiency benefits for search, fit, and discovery which you saw in our Q4 '21 results continuing into Q1 '22, which we expect into the rest of the year. Marketing in Q1 was 13% of revenue and 11% excluding employee costs in a quarter when we grew subscribers significantly and spend was lower than forecasted due to strong organic growth. We intend to keep marketing dollars in our plan for the rest of this year and maintain our target for marketing expense, excluding employee-related costs, at approximately 10% of revenue for the year. Moving to free cash flow. We continue to anticipate rental product CapEx, our largest cash expenditure, at approximately $60 million of fiscal '22 and remind you that seasonally, Q1 and Q3 spend tends to be higher. We are on track in our expectations for the free cash flow margin this year to be slightly lower than in fiscal '21 in a more normalized year of product acquisition. Free cash flow should be measured annually due to the seasonality of product spend. And we remain on our path to reach free cash flow breakeven in the midterm as we previously laid out with the cash we have on hand. As we look at the remainder of 2022, we are very mindful of the macro environment and are closely monitoring. And as Jenn noted, our outlook is reflected in our guidance this quarter. A reminder that Rent the Runway started in a recessionary environment and we believe our subscription and a la carte services provide even more financial value and a way to save cost in a cost-conscious environment. We also just navigated two years of COVID impact and we are ready and able to act with effective tools and experience to respond to a negative impact on our business. In particular, a significant portion of our costs are variable and we have demonstrated we can manage our fixed costs and investments in a downturn. Turning to Q2 and the rest of year guidance. I want to reiterate the historical seasonality of subscriber acquisition. We just reported on what is typically one of our stronger periods for the year for acquisition when customers naturally think about changing over their wardrobes. This means that in the summer months, we generally see slower acquisition and higher rates of pause, and that is reflected in our guidance for Q2. In addition, we expect a continuation of the strong environment for events that we saw benefit our reserve and resale businesses in Q1. And though Rent the Runway has shown greater resilience to COVID variants over time, we continue to closely watch variants and potential impact, and we have incorporated similar patterns to the prior two years in our expectations for the second half of this year, which means we expect Q4 revenue to be only slightly higher than Q3. For Q2, we expect revenue of $72 million to $74 million, representing 56% year-over-year growth at the midpoint versus Q2 '21. For adjusted EBITDA in Q2, we expect negative $4 million to negative $3 million. In terms of full year, we are reiterating our revenue guidance of $295 million to $305 million, representing 45% to 50% growth versus full year '21. We continue to believe that longer term, we can sustainably grow revenue in excess of 25% annually. We are actively managing to free cash flow dollars and margins and maintain our prior guidance of negative 6% to negative 5% adjusted EBITDA margin for fiscal '22. From a quarterly progression standpoint, a reminder of the pre-COVID seasonality of our profitability with Q3 typically impacted by higher marketing when we lean on seasonal customer acquisition and also by higher product spend and revenue share. We would therefore expect Q3 profitability to be lower than Q2 profitability. We continue to be intently focused on balancing robust growth with profitability and we'll seek to strike the right balance to attain both objectives and maximize the long-term value of Rent the Runway. With that, we are happy to open it up for questions.
Operator, Operator
And our first question comes from the line of Lauren Schenk with Morgan Stanley.
Lauren Schenk, Analyst
I just want to ask a little bit more explicitly. Given the better Q1 results and the better second quarter outlook, is the maintained full year guidance just assuming some conservatism given the more uncertain macro backdrop? And is it fair to say you're not embedding any potential upside from sort of a trade-down benefit, if you will? And then just one on at-home pickup. I guess, how much of the transportation cost savings or margin benefit are you seeing from that? And then ultimately, what percentage of the subscription base do you ultimately think you can serve with at-home pickup long term?
Scarlett O’Sullivan, CFO
Yes. Thanks, Lauren, for the question. Why don't I start with the guidance? So we just reported a strong quarter. We feel really good about the guidance that we're giving for Q2. And given the volatile macro environment and potential COVID impact for the rest of the year, and it's really based on what we've seen in the last two years and also the fact that we're really early in the year, we think it's best to maintain our prior guidance for the full year. So that's really why we're keeping the guidance where it is. And then in terms of at-home pickup, Jenn, do you want to maybe answer that one around what our potential targets could be there?
Jenn Hyman, CEO
I mean we continue to see both very high engagement with at-home pickup and stronger growth in markets in getting this activated than we had planned. It's going to be embedded into our app over the next few quarters. And again, this is a cheaper way for us to pick up the units from customers versus the customers kind of shipping them back via a national carrier. So I think that it remains to be seen how big it can get but we are looking for this to get as big as possible for as many subscribers as possible to have access. We had given a goal that 50% of subscribers would have access to at-home pickup by the end of the year. We hope to be able to beat that. And for customers, this is just a much more convenient experience.
Scarlett O’Sullivan, CFO
Yes. And I would say, we also just don't know yet what it will mean to have the experience in the app. But right now, we're hoping the customers are seeing the stickers on the bag and we've seen good pickup there but we're excited about the opportunity when we really build that into the app over the next few months.
Operator, Operator
And our next question comes from the line of Ike Boruchow with Wells Fargo.
Ike Boruchow, Analyst
I'm curious, Scarlett or Jenn, you were founded after the last recession. It feels like we're almost predicting a recession based on your discussions. If we were to encounter an economic slowdown, could you elaborate on the measures you could take? Scarlett, I believe you mentioned this in your prepared remarks. More specifically, how might it impact your path to profitability?
Jenn Hyman, CEO
Thanks, Ike. So first, to date, our business continues to grow. Our outlook is positive and that's reflected in our guidance this quarter. But we're closely monitoring. So I want to remind you again that we just navigated two years of COVID impact, where we were significantly impacted by customers in the U.S. sheltering at home. And when people were sheltering at home, wearing primarily their pajamas, they had less need for variety in their wardrobe and therefore, for a subscription to fashion. So during that period of time, we reacted incredibly quickly. We made lots of tough decisions to cut costs across every area of our business. And we think that we're ready and able to act with effective tools, with experience to respond to any negative impact on the business. Now kind of also going back to 2020, it's really important to understand that data is core to Rent the Runway. We monitor and analyze data real time. So we have this unique advantage in that subscribers come to our app over three times a week. They're highly engaged. So as soon as there's a change in their behavior, we see it. So we started to see data in early March 2020 that led us to make those really swift and bold decisions to cut costs throughout the business very early on. And we didn't hesitate in making the right decisions for the business. So we know early on when there are shifts in behavior. Now interestingly, right now, we are seeing a shift in behavior in the sense that our customers are actually shifting into more celebratory clothing than we've ever seen before. She is really showing us with what she's renting and how she's engaging that she is ready to get back out into the world. And whether it's for work, whether it's for the weekends, whether it's for special events, she wants to feel happy and she wants to use fashion as a way to show up and feel that way.
Scarlett O’Sullivan, CFO
And Ike, in terms of the more financial side of the equation, let me take the last question first which is that we are laser-focused on staying on our path to profitability even with a recessionary environment. And then more practically speaking, the way that we would get there is really to remind you a bit about the kind of structure of the business and the business model that we have. A significant portion of our operating costs are largely variable, and they represent approximately 60% of our cash operating costs, which means that they either will vary with demand automatically or we have high flexibility and discretion to adjust as we did throughout COVID. So these would be things like our fulfillment expenses, our customer service costs, clearly, credit card fees, revenue share payments that are performance-based, and marketing. And then the remaining cash cost, which is about 40%, the rest of it, is fixed or largely fixed. And that's mostly in G&A and tech, as you've heard me mention before. And I'd say that within the second bucket, approximately 30% are employee-related costs which we could reduce in a lower-growth scenario. And we demonstrated in 2020 at the onset of COVID that we had levered also on capital expenditures, which would be the product and the PP&E CapEx if we saw a change in demand. But I also just want to remind you that our business is different than other businesses because we're able to monetize our products over many years as opposed to other retailers or e-comm companies that could be stuck with their inventory; we have that ability and you just saw us do that over the last couple of years. So we feel good about the cost structure of the business and our ability to react in a kind of a downturn environment.
Jenn Hyman, CEO
One other thing that I would add is that our consumer is slightly different. So 80% of our subscribers have household incomes over $100,000. So this consumer may be less sensitive to changes in the macro environment, and we'll continue to monitor that.
Operator, Operator
Our next question comes from the line of Ross Sandler with Barclays.
Ross Sandler, Analyst
I wanted to follow up on the macro question. Jenn, you mentioned that during times when consumers may be trading down, the value proposition of the significant savings from Rent the Runway could become more apparent if we face a recession. I'm interested in what other areas of your business could benefit from this—I'm assuming customer acquisition costs would improve significantly if competition in the ad auctions decreases. Additionally, what other positive recession-related effects might you anticipate, like changes in conversations with designers if they suddenly experience many returns from their clients? Could you elaborate on that? Scarlett, you noted that a significant portion of the Share by RTR inventory reached a threshold requiring you to pay revenue share. Is this a notable percentage of the Share by RTR? How should we view this moving forward now that we've permanently crossed that threshold, and how will that benefit us in the future?
Jenn Hyman, CEO
I came up with the idea for Rent the Runway in 2008 and became deeply interested in the trends during the recession. I found it intriguing that during the last recession, customers were still purchasing around 65 apparel items a year, which was comparable to their buying habits before the recession. At that time, we noticed that consumers were not only shopping at other retailers like T.J. Maxx and Burlington, but there was also a rise in flash sale sites and significant growth in value-oriented retail such as fast fashion. This indicated that customers were still looking for variety and maintaining high purchase volumes, but at lower price points. In this context, I believe we could shift more of our inventory acquisition towards consignment, which allows our brands to share in the revenue instead of having to deeply discount their products or sell them to off-price retailers at lower returns. As observed during COVID, we moved to revenue share agreements with many designers. When the pandemic began in 2020, those designers began receiving their wholesale costs back over time, which built their trust in the consignment channel. I believe we could enhance our consignment model further in a recession. Additionally, I think we will have greater negotiating power concerning paid marketing expenditures. More importantly, we may gain leverage in negotiations with transportation partners. Transportation costs rose in 2021, so we took proactive steps by expanding our partnerships from about two to over a dozen, as more partners provide more negotiating strength. We also initiated a consolidation strategy, including consolidation centers and home pickups. As e-commerce rates may decline, I believe transportation partners may be more willing to negotiate now after a lengthy period.
Scarlett O’Sullivan, CFO
And Ross, in terms of the questions related to Share by RTR, so I'm not disclosing the exact percentage of units that hit their cap, but it did positively impact our gross margins, and we were really pleased with the results that were better than we had forecasted. In terms of going forward, it's possible it's an ongoing benefit. It's really going to depend on the proportion of Share by RTR products that our customers choose and how close those products are to hitting their caps already, which can vary. But I would certainly take a look at what I said on the call, which is that we do expect the gross margin to increase slightly this year versus last year.
Operator, Operator
And our next question comes from the line of Eric Sheridan with Goldman Sachs.
Eric Sheridan, Analyst
Maybe two if I can. One, is there anything to call out in terms of geographic differences you're seeing in the business in terms of either gross additions or customer behavior that might give us a better sense of how the return to office might be playing into some of the dynamics in the business that could promote future growth? That would be number one. And on prior calls, we've talked a lot about your automation efforts for the long term. Anything to add there as an update about how we should be thinking about automation as a driver of margins over the long term?
Jenn Hyman, CEO
There aren't significant differences in customer behavior across different regions. We observe that customers are returning to the office a few days each week and are showing greater resilience to the impacts of COVID in all areas. An interesting point about the return to the office in a hybrid model is that many employees are not going back full-time, which affects their purchasing decisions for workwear. If they are unsure about their dress code and won’t be in the office every day, it makes less sense to buy new clothing. Consequently, renting work attire for the office is becoming a more practical option than before. Interestingly, a recession might encourage more employees to return to the office more frequently, as employers may have greater leverage to require their presence. During the pandemic, many people were confined at home and were not attending events or social activities. However, even in a recession, events like weddings and New Year celebrations continue, and people still go into the office, perhaps even more often. Therefore, we are concentrating on positioning Rent the Runway as a cost-effective solution for customers looking for varied wardrobe options. We believe that as we move into this potential economic climate, our services will appeal to a larger consumer base.
Scarlett O’Sullivan, CFO
Eric, and then in terms of your second question, we absolutely think that there is a lot more that we can get out of the automation. As Jenn mentioned on the call, we just finished the rollout of RFID. We just are implementing digital issue tagging which should make us much more efficient when it comes to cleaning and restoration. So this is really why we think that there are good benefits ahead of us, why we feel confident in what we have said last call which is that we believe that the fulfillment cost can get back down to below 30% of revenue over the next few years.
Operator, Operator
Our next question comes from the line of Michael Binetti with Credit Suisse.
Michael Binetti, Analyst
I would like to inquire about the marketing strategy. You mentioned a decrease from 13% to 10% for the year, with 13% in the first quarter and 10% for the rest of the year. We've been informed that this is the largest wedding season in decades, as indicated by department store earnings calls and diamond jewelers. In this context, it raises concerns about how to manage significant comparisons for next year. I am curious about your perspective on whether this summer presents a unique opportunity for the reserve business that might encourage you to focus on converting some of those one-time reserve customers into the more profitable long-term value of subscription customers.
Jenn Hyman, CEO
We feel really good about our plan to continue to spend about 10% of our revenue on marketing this year, excluding employee-related expenses because, number one, we continue to benefit from this really strong organic growth flywheel. We're doing a lot of marketing that doesn't actually involve paid marketing. So we talked about content. We talked about partnerships. We talked about product improvements that might enhance the virality of our business. So we completely agree with you that this is a really important period of time for us to build the funnel for both current subscribers and subscribers for many years to come. And we're really pleased with our success in Q1 in terms of our reserve business, beating by 20% versus our expectations. We also have this really large first-party database. And we're able to engage with customers from the past who rented for an event and our prospects to really convert them into coming back to rent a la carte again or coming back to a subscription. So we think that we can balance growth with profitability that we don't have to spend more than 10% and that our number one goal is driving the business to free cash flow profitability.
Michael Binetti, Analyst
I'd like to follow up on your recent sample sale in New York during the first quarter, which may have contributed to your impressive resale figures. Can you share if that was a positive experience for you? Is it something you would consider doing again this year to enhance the brand's presence and engage with consumers while also monetizing some of the products you want to move into retail?
Jenn Hyman, CEO
Yes. So I'm glad that you asked that because I think it's really important to distinguish between sample sales which are part of our liquidation revenue for inventory and resale. So as you know, we are monetizing inventory over multiple years. We depreciate that inventory over three years straight line and then there's a salvage value that is associated with our apparel that is tested every single year by our accountants. That salvage value is related to how much we can kind of sell the inventory for at the end of its useful life. Now a useful life means to us that it no longer looks brand-new. So once the unit of inventory is not in kind of rentable condition which we consider like new condition, we will take it out of our rentable inventory and we will clear that inventory. Sample sales are one of the channels from which we clear inventory and that really goes into salvage value. But that's not our resale revenue. So resale revenue is the revenue we make from subscribers when they decide to keep units that they already have at home. So as part of their subscription, they have these four units at home. I have a dress at home. I decide I love it. We're dynamically pricing that dress and I can click to purchase it and/or any person can come to our site at any time and see a dynamic price with which to buy the unit which is still in like-new condition, and that's our resale revenue.
Scarlett O’Sullivan, CFO
And just to double-click on that a little bit more, Michael. We've been doing sample sales for years, right? This is not a new strategy. This is something that we've always done and has always been a really successful strategy. It really points to the fact that our items even at end of life are still valued by customers. And I just want to double-click on something that Jenn said which is that sample sale revenue does not hit the revenue line. That is recognized as a gain or sale because we've already finished depreciating the product and is at the end of its useful life. So that's actually not reflected in our resale line.
Operator, Operator
Okay. Very helpful clarification. And congrats again on a nice quarter.
Jenn Hyman, CEO
Thank you.
Operator, Operator
And our next question comes from the line of Abbey Zvejnieks with Piper Sandler.
Abbey Zvejnieks, Analyst
Going a little bit off of Michael's question with wedding season being the highest it's been in decades. What do you see in the mix of like customers that are coming to Rent the Runway for events? Are they going into the reserve business? Or do you see them convert to subscribers later? Or because you get a discount in like your first two months of subscribing, do you see them going directly into the subscription business? Like what's the mix there?
Jenn Hyman, CEO
Well, we've done a better and better job over time, and this is intentional, about positioning subscription as a solution for multiple events and trying to drive first-time renters into subscription before they even try renting for a special event. And so we are seeing a healthy amount of new customers come directly into subscription. We see based on the inventory that they rent that some of them may be event intending. So this is certainly kind of a reason why people are signing up for subscription this year. That being said, our reserve business continues to be such a critical funnel for us because even though over 80% of our revenue comes from subscribers, the majority of our customers continue to be people that come in a few times a year, rent a la carte, and buy from us resale. And that continues to have a really healthy funnel of people that we can tap into as our future subscribers. So we're kind of agnostic. We just want you to come in, try renting, see the depth and breadth of our inventory, see that we carry aspirational designer brands, that we deliver an incredible customer experience. And once you use Rent the Runway, of course, it's our job over time to try to convince you that a subscription is a smarter and more sustainable way to get dressed for your everyday life.
Operator, Operator
Our next question comes from the line of Andrew Boone with JMP Securities.
Andrew Boone, Analyst
I'd like to start with paused subscriptions. As we consider the normalization of COVID, can we discuss what percentage of paused subscriptions we should expect? In other words, are you continuing to see an impact from COVID in terms of paused accounts, and how should we approach this in the future? Additionally, regarding the price increase, what are your thoughts on the potential for future price hikes? I'm not asking for specific guidance on whether this will happen next year or over multiple years, but rather how your experiences from this past price increase shape our perspective moving forward.
Jenn Hyman, CEO
So paused subscriptions are a natural aspect of how our customers use the service, providing them with flexibility that fosters loyalty. It's important to note that the group of subscribers on pause this month differs from those who will be paused next month. People tend to fluctuate in and out of the subscription based on their life circumstances, and we recognize that there’s a seasonal element to our business. Customers tend to focus more on their wardrobes and fashion between March and May, as well as September and November, which are traditional times for purchasing new clothes. During these periods, we see increased engagement from customers who utilize the subscription for new styles and variety. In contrast, during the winter months such as January, when people tend to stay cozy in their sweaters, we might see higher pause rates. Regarding the percentage of customers on pause now compared to pre-COVID times, the current landscape is quite different from 2019. Our product offerings and programs now feature margins that are nearly double those from 2019. Additionally, our customers are using our service for a broader range of purposes than they did back then. Honestly, we are uncertain about what the baseline percentage of paused subscribers will be in this new post-COVID environment. We know the proportion from 2019, but we will need to observe the data over the next few quarters to determine if it settles around 20% or remains closer to 24%. Our primary focus is on ensuring that both active and total subscribers continue to grow because paused subscribers represent the lowest point in our sales funnel, as they are automatically billed again after 30 days. We appreciate the flexibility this offers, and we are pleased to report that we achieved a record number of active subscribers at the end of Q1.
Scarlett O’Sullivan, CFO
Thank you for your question about the price increase, Andrew. I believe you’re inquiring about potential increases in average revenue per user over time and how we can achieve that. We are confident that we can increase ARPU over time, which is, in part, driven by customer engagement. We've observed strong add-on activity, and we believe this trend will continue. We do not have a specific plan for annual price increases, but we might implement some mid-single-digit pricing adjustments when appropriate, especially as we continue to enhance customer experience and provide more value. Looking ahead, the price increase you observed this year is likely higher than what we would normally do, as it accounts for broader inflationary trends.
Operator, Operator
Our next question comes from the line of Ashley Helgans with Jefferies.
Ashley Helgans, Analyst
Congrats on the nice quarter. Just a quick one for us. We wanted to follow up and see if you could just provide a little bit more color on the nice gross margin expansion.
Scarlett O’Sullivan, CFO
Thanks for the question, Ashley. I'll take that one. So we've talked a lot in the past about some of the very transformative changes that we've made to the business model, like changing the program, changing the way that we acquire products, and that was really intended to benefit the gross margin. And now that we see revenue scaling out of COVID, we're really seeing these changes show up even more in our numbers. If I break down the reasons why gross margin was so much higher this year versus last year, I'd say there's a couple of reasons. One, our revenue was up 100% in Q1 versus last year. And then you'll see that the product depreciation dollars are actually pretty similar to last year. So that basically means that those costs now represent about half as much as a percentage of revenue as what they did last year. So that's one significant reason which we've been talking about, but it's really nice to see it show up in the numbers today. Two, we mentioned the higher ARPU than we had expected, obviously, because of what I just said it, which is the strong add-on activity and that always is going to improve margin for us. And then three is what we also discussed which is the revenue share as a percent of revenue was favorable versus our forecast because of those maximum payouts where we no longer have to pay the brand. So those are really the three elements that contributed to the gross margin being substantially better than it was last year. And maybe, Jenn, maybe I'll hand it off to you a little bit if you want to talk about product depreciation and the dynamic of the longevity of our items which is really unique to our business model.
Jenn Hyman, CEO
One important observation I've made based on feedback over recent months is the common misconception about how Rent the Runway monetizes clothing over time. In the fashion industry, there's a belief that items go out of style rapidly, as the retail model has traditionally involved launching products and then discounting them quickly. However, our data from the past 12 years shows that items don't necessarily become outdated after one season. We can monetize our inventory for several years. Customers care more about wearing something new to them each time they use Rent the Runway, regardless of whether the item is a current runway piece or from previous seasons, as long as it’s new to them. This insight drives our significant investment in personalization, allowing us to present our customers with a continually fresh selection. Additionally, the longevity of a garment is more closely linked to its usage and cleaning frequency than to its age in terms of seasons. How long an item lasts is not dependent on fashion trends, but rather on our ability to restore it to like-new condition and how often it has been cleaned. We have inventory from 2018 and 2019 that is still generating revenue in the first quarter, even though it has already been fully depreciated. We can continue to profit from these items because customer demand remains strong, and their usage during COVID was lower than we initially expected. Understanding how personalization contributes to our ability to profit from inventory over time is crucial to grasping the core of Rent the Runway's business model.
Operator, Operator
And our next question comes from the line of Dana Telsey with Telsey Advisory Group.
Dana Telsey, Analyst
As you think about the product costs which have been coming down, what do you see the opportunity in product costs going forward? It certainly seems like, obviously, it's been product costs reduced by 20% of revenue year-over-year. Where could that come from and why? And then very interesting on the home, any data points on the 20 markets that you have it in so far, what you're learning from that it all enhances the next 20 markets you put it in? Any learnings there?
Jenn Hyman, CEO
We've mentioned that our goal to drive to free cash flow profitability was to move non-wholesale product acquisitions. So non-wholesale for us is our consignment business Share by RTR and Exclusive Designs, to move that from 60% of our product acquisition to 66%. And as a reminder, we only started non-wholesale acquisition in Q4 of 2018. So we've gone from 0% of our acquisition being non-wholesale to 66% in 3.5 years. So we feel highly confident in our ability to kind of move product acquisition from 60% to 66% over the short to midterm.
Scarlett O’Sullivan, CFO
Maybe I can add something to that.
Jenn Hyman, CEO
Yes.
Scarlett O’Sullivan, CFO
So regarding your follow-up question about the percentage of revenue that product CapEx represents, our guidance indicates that we expect to spend around $60 million on product CapEx at the midpoint of our range, which would be about 20% of revenue. We are confident that this number will decrease over time due to a shifting mix, as well as an increase in the percentage of Exclusive Designs, which positively impacts both total dollars and the revenue percentage. We remain optimistic about this, and it is a critical factor in achieving free cash flow breakeven in the medium term.
Jenn Hyman, CEO
The main takeaway from the launch of at-home pickup is the strong demand from customers. It was a straightforward launch, and currently, the only way customers know that we will pick up their orders at home is through a sticker on the garment bag, which can often go unnoticed. Once customers do notice the sticker, they are fully onboard with the idea of having their orders picked up at home, as it greatly enhances convenience and allows for better scheduling. This is particularly relevant for our typical customer, who is a busy woman juggling work, family, and social activities. We are working to streamline the Rent the Runway experience by reducing friction. We expect to gather substantial data in the upcoming months as we integrate at-home pickup into our website and app. Given the high customer satisfaction rates, we are expanding the service more broadly than initially planned. As noted, it is now available in more markets than expected by the end of Q1, and we aim to provide access to over half of our subscribers by year-end. We are excited about this progress and anticipate valuable insights once the feature is operational on our app and website.
Operator, Operator
And we have reached the end of the question-and-answer session. I will now turn the call back over to management for closing remarks.
Jenn Hyman, CEO
So thanks so much to everyone who joined us today. I'm excited about our continued momentum. I'm energized by the plans we have in place. And we look forward to continuing to update you on our progress on our Q2 2022 call. So thanks again for joining us.
Operator, Operator
And this concludes today's conference and you may disconnect your lines at this time. Thank you for your participation.