You've Heard of Warby Parker. Have You Thought of Investing in It?

Join Motley Fool analysts Asit Sharma and Emily Flippen as they frame up what success could look like for this recently public company: Warby Parker (WRBY -2.38%).

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This video was recorded on Oct. 5, 2021.

Emily Flippen: Welcome to Industry Focus. Today is Tuesday, October 5th, and I'm your consumer goods host, Emily Flippen. Today I'm joined by Motley Fool senior analyst, Asit Sharma, to talk about the eye care specialist, Warby Parker (WRBY -2.38%). Asit, thank you for joining.

Asit Sharma: Emily, thank you as always for having me, I've been eyeing this company for a few days now, so eager to chat about it. [laughs]

Emily Flippen: I will say when you Slack messaged me and said we should do a show with Warby Parker, I recognized the name immediately. However, I do have to say I didn't know what their business was. The name sounded familiar, this is a newly public business, until I started digging into their S-1, it did occur to me, I said, this is the direct-to-consumer eye care company.

Asit Sharma: I had a similar experience in that I had heard about Warby Parker for years until finally realizing a few years ago that this is a company that sells eyeglasses. It's a familiar brand name, it has this ring of having been around for a while. We'll chat a bit about the name story, but they've got fairly decent brand recognition and that's always good. When we talk consumer goods companies that are investable, to me, especially in 2021, I'm paying attention. That goes for something, having a strong brand and an easily recognizable brand.

Emily Flippen: I will say that's one thing they did mention in their filings, that they're unaided brand awareness was 13 percent, meaning when they had their third-party go out to the market and they asked people, can you name a direct-to-consumer eyewear business? Thirteen percent of people pulled Warby Parker right out of their minds without any further acknowledgment. I think that's pretty impressive for this business. Maybe I'm wrong there, but as somebody who didn't recognize the name immediately, you wouldn't be able to be part of that 13 percent. It says to me, well, there's some customer loyalty but also some room for expansion.

Asit Sharma: Absolutely. I'm guessing that Ray-Ban scored really high on that, but of course, we don't buy sunglasses at the rate, or most of us don't, especially high-end sunglasses at the rate that we do regular eye wear.

Emily Flippen: Definitely. Tell us a little bit about this story, I guess. This is a founder-led company and also a company that is run by two co-CEOs. We've talked about this in the past. I always think that it's a fun and interesting dynamic.

Asit Sharma: Isn't it though? Yes. Warby Parker was founded about 10 years ago. Interestingly enough, this group of co-founders, they were actually four. I think they were grad students at the Wharton School of Business, which is a very great school. It usually ranks in the top three or so of business schools in the US. Two of these co-founders are now co-CEOs, Neil Blumenthal and Dave Gilboa have a cute founding story that a professor goes around and tells on a pretty regular basis. I think he must have put this in a Ted talk. But famously, when the founders came up with this business while they were at Wharton, they took a lot of time to launch the company. They tested out 2,000 names before they settled on Warby Parker. Warby Parker are two names extracted from the journals of novelists, Jack Kerouac, for you literary people out there. In fact, they were so methodical, Emily, that one of their professors, highly regarded Wharton professor, Adam Grant, passed on an early invitation to invest in this company. He didn't find it very promising that the founders hadn't dropped out of Wharton to go ahead and launch the company. [laughs] He calls passing on this investment the worst financial decision of his life. Now, his wife handles all of the couples' investments. [laughs] They grew fairly quickly when they finally did get started. I'll just mention one thing from their S-1 statement, their prospectus, which tells you a little bit about how fast they grew, and it also introduces something that you want to talk about as well. I will just quote verbatim here. "When we launched the business in February of 2010, less than 2.5 percent of glasses were sold online, yet we believe that if we offer high-quality, uniquely designed glasses for a reasonable price point with mechanisms to try them on, like our home try on program and outstanding customer service, people will be willing to buy eye wear online for the first time. We reached our first year sales target in three weeks, sold out of our top 15,000 in four weeks, and built a wait-list of thousands of customers for our first of its kind home try-on." I just want to point out here that the concept of trying on something at home and maybe spending it back seems second nature for a lot of subscription type services now, but it was an innovation in 2010.

Emily Flippen: It's challenging for consumers as well. It's one of those reasons why less than two-and-a-half percent of all eyeglasses sales were made online back in 2010 and still is really low today, and we could talk about that. But it's one of those things where you want to get it right. A lot of times people don't know exactly what they need, whether that be a style or a specific type of lens until they have the opportunity to actually put it on their faces. Warby Parker has taken an interesting model, obviously going direct-to-consumer, trying to undercut a lot of the more expensive brands out there, letting people do this home try-on where they send back any ones that they don't want to keep, but also combining that with the retail approach. They do have, I believe it's 145 retail stores across the United States where people can walk into, try on glasses there, make purchases and also get an in-house eye exam, that sort of thing. It's a hybrid model, but really focused on online sales, at converting in-store purchases to digital.

Asit Sharma: Yeah. I think that this online model, direct-to-consumer, has a lot of legs. To me, it almost seems like it's early innings. Although the company has been around for a long time, we'll return to this question by the time we finish this podcast. Home try-on, you mentioned when we were preparing for the show that this has been pretty big for them. You can order five pairs to try on at home, you send the rejected ones back. That reminds me a little bit of Stitch Fix. It helped them grow in 2020 by six percent their sales, even though they weren't profitable in 2020, during the pandemic. They had that as a fallback. I'm looking at the results of Luxottica, which is the mammoth player in the space. They dominate the eye wear industry. They were on track to hit 10 billion in sales and just were not able to be as resilient because they're so store-based, retail-based. Very nice active customer base, two million active customers. Customers make at least one purchase or have made at least one purchase in the last 12 months and they had just over two million orders in 2020, so a very decent base there. The revenue split is primarily one that favors glasses. They get 95 percent of revenue from glasses, two percent from contacts, one percent from eye exams, and two percent from accessories. Maybe some room to expand there in the future, but clearly, the core business is this glasses business. The fact that the average eye wear consumer replaces their glasses every 2.5 years, obviously, I wasn't included in that data set. [laughs]

Emily Flippen: Do you replace it more frequently or less frequently?

Asit Sharma: Well, what happens, the pair that I had, that I kept in my glove compartment for years, after a while they made their way out of my glove compartment. I've never replaced a pair yet. Maybe I'll go back. I always walk a little wistfully past the eye exam cubicles when I'm in a big box or they have these used stuff to the side of your vision. You can go and walk in and take an eye exam. Maybe I should do that. I'm guessing that would be a 4-5 year replacement data point for them. [laughs] But let's talk about the financials. Let's move on to the business. What can you tell us about this company's financial makeup and what you liked about it?

Emily Flippen: I liked so much about this. I was shocked for the data that this business provides. I love good data on things like customer acquisition costs, average order value. I love it even more when you can present that information in graph form and with lots of pretty colors, which is exactly what Warby Parker did, which made this S-1 really enjoyable to read. If you're a burgeoning investor who's looking for a pretty easy S-1 to sift through, I would say Warby Parker is a great example. I loved reading through it. Anyway, [laughs] their average order value is just over a $180, which is impressive considering their base overall prices start at 95. This is largely because they're able to upgrade people to sell on the specialty lenses, but what really stood out to me was two things. I mentioned that their average order value was 180. Their average revenue per user is just over $200, but their customer acquisition cost is around $40. They're immediately profitable on bringing that customer in and more importantly, they are able to retain sales over the course of a number of years, and that two-and-a-half repeat purchase number is important to remember because you can actually track sales retention as they do by the customer cohort. They have a nearly 100 percent sales retention per cohort over two years, which says that while not everybody will repurchase, a large number of people come back to the platform after a couple of years and make another eye wear purchase, selling and paying a bit more for that experience.

Asit Sharma: Yes. I think it's a little different, but the net effect is the same. I think it might be within four years, it's 100 percent.

Emily Flippen: Yeah, I apologize. I said two years, I meant four years.

Asit Sharma: No problem, you meant four years. But this is extremely interesting because if the average replacement is two-and-a-half years, if you think about that in one-person's experience, what it means is that most people are going to be replacing glasses within four years. For Warby Parker, it also means that there are a number of people in a starting cohort that will try another brand within that four years. But by the time four years is up, they buy another pair, if I'm parsing that correctly. I think that this shows why the brand may be sticky in the future. I say maybe it has some legs. Emily, you spent a lot of time looking at average revenue per customer. As we all know, regular listeners to this podcast know that Emily loves to break down customer acquisition cost versus the revenue that's being brought in. I'm impressed by just the small increases they were able to make in that average revenue per customer and the fact that it only cost them 40 bucks. I'm going to agree with you there, that's the basis for a good financial equation when we push that out to the income statement. We'll get to that in just a second here. What did you tell us about margins as of late?

Emily Flippen: Yes. Margins for this business have been interesting. They were compressed during 2020, still pretty impressive. I will say they're not profitable yet, but when you look at their average revenue per customer and how that breaks out for costs, it's still decent during 2020. That compression was largely because a majority of their sales were actually happening through their retail channels. In 2020, there was a 60-40 split online compared to retail for sales. That was because their retail stores were shut down. Prior to 2020, it was actually the opposite. It was 40 percent online, 60 percent in-store. The fact that they were able to maintain it still around the 20 percent margin after all those costs are considered per customer in 2020 was impressive. That was down a bit from the 26 percent margin they had in 2019. But this has continuously gotten better. Again, heading out of the pandemic, their adjusted EBITDA margin, I believe was just over seven percent over the past six months, which is an all-time high for this business.

Asit Sharma: As we see, this is occurring company, it's throwing off losses, but overtime, I think those losses are decreasing. They haven't yet turned a profit, but I feel like they're getting close. You were pointing out to me, Emily, that they've got a lot of stock-based compensation and marketing costs. When you take the books on a GAAP basis, that is according to Generally Accepted Accounting Principles, they're still in the red. They generally generate positive operating cash flow. It depends in part on some heavy spending in that holiday quarter, in the fourth-quarter. When I think kids are home, parents are taking kids part of-

Emily Flippen: I was wondering why [inaudible 02:39:28] buys for themselves?

Asit Sharma: I was thinking too, I guess the first thing that comes to mind when I think about the holidays and what I might buy. But of course, kids are home from school, they're home from middle-school, elementary school, high school, even college, and that's a great time for parents who in many cases have high insurance and need to use it before the year-end to get that done. I think that might be driving that as well. I think that the company can be positive on a net income basis. They nearly made it in 2019 before the pandemic. I liked that they've got a split product model. They own their own labs, they do their own research and development, they do their own proprietary lens design. They do that all-in house. Then they also own their fulfillment layer. They own the fulfillment of their products, that whole process. But in between, of course, you have the manufacturing. That's contracted out to third-parties which they've been working with since they went public. What you get out of this is a pretty consistent gross profit of 60 percent due to that nice balance between the high revenue per customer and the smaller acquisition costs in the marketing side, some of those costs are below the line. Of course, they don't have to do with the gross profit. When you look at the bottom line, the fixed costs are pretty full. That research and development element that isn't allocated above in the costs and sales, cost of sales, so the part that's mostly on the bottom, increases at a consistent but manageable rate. I think the selling and marketing costs they have also are pretty logical. You've got a company which if you can keep on sales cadence can probably be profitable. I would take a wage or it might be profitable for this year and that's going out on a limb. But I'll tell you, if you take the 2019 revenue and then extrapolate what they could do this year, if you double the revenue [laughs] from the first six months.. I know this is a poor way to do it, but look, it's a podcast. [laughs] It will take some numbers. Just throw those two numbers in a compounded annual growth rate calculator, you'll get a two-year CAGR of 20 percent. They're growing their top-line 20 percent year-over-year. That accounts for that COVID year. It normalizes for it. Quick stat forward a few years. There's no way that they won't become positive on a net income basis, unless they start to pour a lot more to research and development, or take the decision to start manufacturing some of their own product. In which case, you go down to a thumbnail of 50 percent in an industry like this, and it's going to be a few more years, but they control some manufacturing. I think that the picture still could look good even though this feels like a story where you want to ask, are the best days behind, is this a really great brand? They took off like a rocket, but yet it's ten years later, the industry is fragmented outside that one big player, Luxottica. The more I look at it, the more I think, no, they could grow. They could do pretty well.

Emily Flippen: This is the area where think I found myself scratching my head about whether or not the opportunity was just this incredibly massive market where we are just never going to see the digitization of eyeglass sales. I know never say never, and the idea of not moving toward digital in the world where we have iBuying of houses, for instance, seems crazy. I suppose I lean toward the market opportunity being massive. But some of the numbers that Warby Parker pulled out in their S-1 really were interesting. One of the things that stood out to me was that more than 50 percent of total eyeglass sales go to local, independent optical retailers. It is a very, I guess, what's the word I'm looking for, spread apart, fragmented market.

Asit Sharma: Fragmented, sure.

Emily Flippen: Only eight percent. Even during the pandemic, when everybody was staying home, everybody was ordering online, only eight percent of eyewear sales happened online, peak in 2020. I'm not sure why. I can speak anecdotally. I know my boyfriend actually a couple of months ago made an eyewear purchase for the first time in probably five or six years, replaced his eyeglasses, ended up buying from a competitor of Warby Parker, Zenni, which we can get to, but had to return them because the prescription was a little bit off. Ultimately ended up with a pair of glasses that doesn't work though. I'm not sure I'd buy into the idea that you can never order glasses online. I think it's just going to be a transition where we have to educate, or Warby Parker has to educate their core consumer that you can buy glasses online, and that just because you get your eye exam done in a certain location, doesn't mean you also have to buy the glasses from that location as well.

Asit Sharma: I think for them, there's maybe a cap ultimately on the kinds of profits they can make because of what you're pointing out. Not to make a pun here, but this is a high-touch industry. [laughs] You have to have the glasses adjusted. It's not just the eye exam, but it's going back afterwards to have professional adjusted glasses. I know in our case, we've had one experience with Warby Parker. I will admit to being a bad dad here and that my wife was much more involved. This was with our third child who's now just recently off to college. But he recently picked up a pair of Warby Parkers, and he went to the store, went back to the store when his glasses came in and had them adjusted. That's always going to be there. Because you have this, it comes down to, I think, which of these companies that employs more of a direct model can offer the kind of customer service that Warby Parker is offering. Those high net promoter scores that are in the low 80s, sky-high customer satisfaction. Part of that's because they've got this retail footprint as well, and you can go in there and the customer service component is amped up. They're trained to please and to be patient. My wife thought the experience was really nice. Tell us a little bit though about that, Emily. We've mentioned Luxottica on a global scale as a big player. But there's some direct-to-consumer challengers as well. There's Zenni as one.

Emily Flippen: Zenni and EyeBuyDirect are probably the two largest. They were businesses that also saw the opportunity that the co-founders of Warby Parker did, which was glasses don't need to be as expensive as they are. If we go and we cut out the middleman, we can provide direct-to-consumer approach that offers glasses much cheaper. EyeBuyDirect, out of all those three probably offers the cheapest average price, but the quality goes down as well. Things like customer service, free returns, there's no try-on period. You get what you pay for in a sense. I'd probably say Zenni is in the middle, more expensive than EyeBuyDirect but better service. I will say Warby Parker is the only one that combines it with both a retail footprint, so you have stores that you can go into, to your point, get them adjusted if you need to get them adjusted as so many people need to do with their glasses. But also they're the only ones that offer a free try home program at home where you can have glasses delivered to you, try them on, then send back the ones you don't like, which I think as somebody who doesn't wear glasses, I suppose I can't say this, but sounds attractive to me as a consumer. That $95 price point isn't exorbitantly higher than any of these other competitors. The competition, while certainly notable, I almost feel like Warby Parker set itself apart. I did go to my boyfriend, say, "Why did you use Zenni? What led you to Zenni over these other options?" Trying to get a sense of the market and got the very unsatisfying answer of, "Oh, I don't know." Probably the first thing that pops up when he Google search. Maybe there's something to be said about the SEO with Warby Parker. But either way, the competition's there, but the market opportunity seems to be large enough to support more than one winner.

Asit Sharma: Emily, I have to say here that you are an [inaudible 02:47:45] non-fashionista, and I think you're rubbing off on your boyfriend. But it's part of a larger point that I want to make here. Warby Parker, you gave the elements, a $95 entry-price point, but they're known out in the larger world for being stylish. Warby Parkers are very aesthetically pleasing.

Emily Flippen: Are they?

Asit Sharma: Yeah. I hate to bring this up, but in the same [laughs] sense of not knowing who Roger Federer was last week, [laughs] I think here's yes, something that maybe because I have kids so I shouldn't be upon you too much for this. Maybe because I have kids, I know this fact. But yeah, they're known for being stylish. Folks write in, if you're listening to the podcast, if you're online with us today, let us know in the Q&A what you think of that. But I think this combination of style and quality, their in-house design, the proprietary design, the nice frames give them something of an edge that's also helping build their brand, and that's an attribute that you have to pay attention to. But we just have a couple of minutes left. Emily, what did you find in here that seems like a risk to you besides the competition, anything worth mentioning?

Emily Flippen: Yeah, I mentioned this earlier, but the fact that 2/3 of all glasses purchases happen at the same location where consumers get eye exams is just to me says, Warby Parker has to do a lot to disrupt this entrenched industry, and there's also an added bonus at this point. I think it should be the default assumption if I don't say otherwise, but there are issues regarding internal controls with this business, newly public. If you're looking for a job and you're a socks expert, head to Warby Parker because they're hiring. But they don't have it right now, so that's always going to be a risk for investors.

Asit Sharma: That surprised me a little bit. I didn't expect to find that they would have internal control issues given that the founders went to Wharton, they've been around for a long time, they've funded lots of venture capital before this. But boy, it just seems to be the theme for this year with smaller companies coming to market, doesn't it, Emily?

Emily Flippen: It does. I don't know if smaller companies prior to maybe the last few years have taken the time to hire on expertise before going public to avoid this type of disclosure or if investors just stopped caring or if these companies are headed to market faster. I can understand why you wouldn't necessarily employ somebody who is an expert in things like internal controls when you don't have a need to attest to the quality of them. But I am also surprised that we're seeing businesses that are a decade plus older, businesses in some cases that are really profitable and have been consistently funding their own operations for so long, still not have the needed expertise to really be public business when it comes to their accounting standards. But what do I know? I'm nitpicking. [laughs]

Asit Sharma: Yeah. Maybe you're nitpicking and we don't have much time here, but the last point here that I think it shows that many of these companies just didn't expect to take this avenue. Why would you spend time building up robust Sarbanes-Oxley compliance if you didn't really have it on your radar screen to go public then overnight you see so much capital going to the markets, you see direct listings, SPACS, you start to consider, maybe we should tap into this capital before it all dries up[laughs] and goes away. Maybe that's some of what we're seeing.

Emily Flippen: Well, either way, I think out of all the businesses we've talked about recently, this one does make me really excited. I know we didn't mention that much, but I think we will get the inevitable question of what about the contacts industry and it's actually going to disrupt eyewear, but I think we've seen over the past few decades that there's always going to be demand for things like eyeglasses, especially when you think about the international market opportunity, even among people who otherwise wear contact. I like the market, I will keep my eye on it. To your point, I want to see them be profitable this year, that would be really impressive if they're able to do that, but out of all the businesses we've talked about recently, I find myself excited for this one.

Asit Sharma: This one certainly caught your eye. Emily. [laughs]

Emily Flippen: It almost went over my head.

Asit Sharma: Mine too. [laughs] We're always full of bad puns.

Emily Flippen: Thanks much for joining.

Asit Sharma: Thank you.

Emily Flippen: Listeners, that does it for this episode of Industry Focus. If you have any questions or just want to reach out to say, hey, shoot us an email at [email protected] or tweet us @MFIndustryFocus. As always, people on the program may own companies discussed on the show and The Motley Fool may have formal recommendations for or against any stocks mentioned. Don't buy or sell anything based solely on what you hear. Thanks to Tim Sparks for his work behind the screen today. For Asit Sharma, I'm Emily Flippen. Thanks for listening and fool on.