Warby Parker Inc.

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 3/5

Warby Parker is a direct-to-consumer eyewear company that designs, manufactures, and sells prescription glasses, contact lenses, and eye exams through its website and retail locations.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Warby Parker disrupts the traditional eyewear industry with its direct-to-consumer model, cutting out middlemen and offering stylish, affordable eyewear. They control the process from design to manufacturing, allowing them to offer high-quality products at lower prices than traditional retailers. This is a very brand-oriented company focusing on millennials and gen z.

Revenue Distribution:

Eyeglasses: The majority of revenue is generated from the sale of prescription eyeglasses, including both frames and lenses.
Eyewear Accessories : Accessories like cases and cleaning supplies are a small but important add-on to sales.
Contact Lenses: A growing part of the business consists of sales in contact lenses and is expanding.
Eye Exams: A smaller but growing revenue stream is from eye exams provided at their retail stores and is also part of a “holistic vision care offering.”

Industry Trends:

The eyewear market is large and growing globally, driven by factors like an aging population, increasing awareness of vision correction, and increased screen time leading to a higher need for blue light glasses. However, the market is highly competitive and is subject to changing consumer preferences, and also susceptible to disruptive technologies. This is evident by the entrance of online-only sellers like Warby Parker which have lowered the average prices in the industry.

Margins: Warby Parker’s gross margins have historically been quite strong (roughly 60% at a steady rate over the last few years), due to their direct-to-consumer model, which cuts out middlemen and allows for lower prices.

Operating margin is at around -10%, but management aims to have it positive in the short-to-medium term.

Competitive Landscape:

The eyewear industry is fragmented and competitive, with players ranging from large conglomerates to small independent boutiques. Major competitors include Luxottica, EssilorLuxottica, and VSP Global. The rise of online retailers has also increased competition and lowered the barrier to entry.
Warby Parker competes using an online focus and having a value for money approach.

What Makes Warby Parker Different:

Direct-to-Consumer Model: Warby Parker’s business model allows for lower prices than the competition because they own the whole process and the customer doesn’t have to buy from intermediaries.
Brand Identity: They have a strong brand identity geared towards millennials and Gen Z, appealing to their need for affordable yet stylish eyewear.
Social Mission: As a public benefit corporation, Warby Parker emphasizes their commitment to social responsibility, including programs that provide eyewear for people in need. They also seem to focus on being transparent.

Financials Deep Dive

Revenues: Warby Parker’s net revenue increased 12.8% in 2023 compared to 2022, while gross profit rose by 13.1% to $340 million. While revenues increased 12.8% year-over-year, they actually decreased by 6.3% QoQ in Q4 2023 and this should be a concern.

Their average revenue per customer increased by 6% in 2023 and their revenue retention rate was 54%, a good indicator that their customers tend to stay.
They also seem to be focusing more on their physical stores rather than their online division as their physical sales rose up to 5% higher than 2022 while their online segment sales decreased by 7%.
Average revenue per active customer was $284 in 2023, which was up 6.2%.
They have 2.33 million active customers.

Margins: Gross margin was 57.3% in 2023, but they had a net loss of $158.3 million. Also, their net loss as percentage of revenues in 2023 was 26.6%. Which are indicators that they are far away from their profitability goals.

This has improved from a loss of 45.5% in 2022.

Cash Flow: Cash burn seems to be improving, as they had a free cash flow of -$17.5 million in Q4 2023, compared to -47.6 million in Q3 2023. Free cash flow for 2023 was -$138.6 million compared to -$208.2 million in 2022.

Operating loss has also reduced from -$100.6 million in 2022 to -$29.6 million in 2023.
They spent $46 million on capital expenditure.

Balance Sheet: Warby Parker’s balance sheet is reasonably healthy, but it shows that the company is still far from being profitable.

They have $231.9 million in cash and cash equivalents.
Total liabilities are at $171 million while net assets are at $333 million. Their assets include almost $450 million in intellectual property.
Long term debt was $67.3 million.

The company has been able to reduce its losses, increase revenues, and retain customers, but it still needs to figure out how to improve their margin and become profitable. The growth seems to be slowing down and the fact that they are shifting focus from their online sales to their retail stores has to be closely watched.

Moat Rating: 2/5

Warby Parker possesses a narrow moat due to a combination of brand recognition and some customer switching costs.

Brand Recognition: They have a distinctive brand that resonates with younger consumers, which can create some preference. However, brands in the retail sector are extremely volatile and preferences change over time as well, so this is not the strongest moat.
Customer Switching Costs: Switching costs in this case are the slight inconvenience that customers incur in purchasing new glasses or contact lenses from an unknown company. However, switching costs are not that strong as they are easy to overcome with proper marketing, and this can vary for different people as well. There are competitors like Eye Buy Direct and Zenni Optical that offer similar services at even lower prices.
Lack of network effects: there are no network effects in this business.
Lack of cost advantages: The costs structure of the business isn’t special enough to create any significant cost advantages for a sustainable period.
Lack of unique assets: They do not have any unique assets and their production and process is easy to copy as well.

Justification:

The moat is narrow because the company is successful at creating a brand that people like and the switching costs are somewhat beneficial, but competitors can easily copy the business model and the brand value can easily change as trends change. These companies’ success is also often tied to particular management who do a good job of marketing to specific segments. They don’t have any patents or regulations to protect their business and a competitor can enter and offer similar services for a much lower price.

Risks to the Moat and Business Resilience

Increased Competition: The eyewear market is highly competitive, with new online retailers and traditional players offering similar products and at lower prices. Warby Parker can’t compete on price, so has to rely on branding which can be extremely volatile. This means they need to constantly spend a lot on marketing which adds pressure to operating costs.
Changing Consumer Preferences: Fashion and consumer preferences can quickly change, which might affect demand for Warby Parker’s glasses.
Reliance on Brand: Warby Parker relies heavily on its brand identity for sales. If the brand loses its appeal, sales might decrease significantly.
Dependence on the Internet: Warby Parker is a primarily online business. Any changes in the e-commerce landscape might affect their business.
Inability to control production They rely on third party manufacturers, primarily in China. Which if something is to go wrong with the supply chain, they might face losses.
Difficulty Achieving Profitability: The path to profitability is taking longer than originally anticipated.
Macroeconomic Vulnerabilities: The company remains vulnerable to economic downturns or high inflation, which can lead to lower demand for their products and less capital to invest in growth.

Business Resilience: Despite the risks above, Warby Parker has some positive aspects that increase its resilience:

Strong brand affinity, making their customers loyal
Direct-to-consumer model provides good control over operations
They have good financial backing, which would make it easier for them to survive for a few years with losses.

Understandability: 2/5

Warby Parker’s business model is relatively easy to understand (buy direct from them, get good value) as a customer. However, understanding their full value proposition and how they can grow and become profitable is quite difficult.

Complexity of competition: There are a lot of competitors that are all offering the same or a similar product. Also, some of these competitors can copy Warby Parkers approach which adds uncertainty.
Dependence on brand: The company has created its brand for specific segments of the market. These segments change and it is hard to know the next “in” thing.
Accounting complexity: The company is a public benefit corporation and does have some accounting rules to follow. This can make the financial statements a bit more complex to understand.
Growth strategies: It’s hard to pinpoint what growth strategies will actually work for the company and if they’ll actually generate the desired results.

Balance Sheet Health: 3/5

Warby Parker’s balance sheet health is moderate. While they have a good cash position and low debt, their inability to achieve profitability is a major problem.

Good liquidity: As noted earlier, they have cash of $230 million, which gives them a good cushion
Low Debt: Their long-term debt is relatively low at $67.3 million.
Negative Operating Profit the company isn’t able to create profits, and this might affect its future growth. Also, having a loss of 26% of revenues is not sustainable.
Reliance on investment to grow: A high amount of cash has to be used for inventory and other fixed costs, and might hinder their cash balance.
Reliance on goodwill/intangible assets: they have a good amount of assets in terms of their intellectual property which should help them scale down the business.

** Justification:** The company’s balance sheet is not bad, but it shows a lack of ability to create profits and this needs to be addressed before the company becomes financially healthy. The cash position does make it relatively resilient and can survive some temporary losses. They also need to make sure the brand power is maintained as it is one of their biggest selling points and core value.

Recent Concerns, Controversies, and Management’s Response

Slowing growth: Recent quarters have shown a decrease in growth, including the decrease in revenue QoQ of -6.3%. This slowdown could indicate increased competition or that the brand is not as popular as it was before. Management has acknowledged this and is taking steps to address it.
Lack of Profitability: The company has yet to achieve a consistent profit and is still making losses, and its margins need more work. Management is working towards improving margins by reducing expenses and increasing efficiency.
High reliance on operating leases: A large number of their assets come from long-term leases. These are an obligation that management has and this must be taken into account when considering their valuation.
Need for consistent Innovation: They need to constantly innovate on new designs to remain competitive and maintain their brand image.

Management has addressed the concerns on these issues by saying that they are focused on cutting costs, enhancing their customer experience, and improving inventory management. Also, the revenue from new products seems to be strong and they are hoping this will lead to an increase in profitability. They mentioned on their latest conference call, that they are focusing on a holistic approach to improve their brand awareness by having physical locations for customer experience and also focusing more on contact lenses as a revenue stream. They also mentioned that management is trying to change their strategy to improve operating margins.

Overall, Warby Parker has a unique and interesting business model that disrupted the industry. However, as an investment, the company still has a lot of risks, including achieving profitability and dealing with competition. The company is still not profitable and has to undergo various processes to increase operating profits before they can become a truly great investment.