Earnings Call Transcript - REAL Q2 2023

Operator, Operator

Hello and thank you for being here. Welcome to The RealReal's Second Quarter 2023 Earnings Conference Call. I will now turn the conference over to Caitlin Howe. You may begin.

Caitlin Howe, Host

Thank you, operator. Joining me today to discuss our results for the period ended June 30, 2023, Chief Executive Officer; John Koryl, President and Chief Operating Officer; Rati Levesque; Chief Financial Officer, Robert Julian. Before we begin, I would like to remind you that during today's call, we will make forward-looking statements which involve known and unknown risks and uncertainties. Our actual results may differ materially from those suggested in such statements. You can find more information about these risks, uncertainties and other factors that could affect our operating results in the company's most recent Form 10-K and subsequent quarterly reports on Form 10-Q. Today's presentation will also include certain non-GAAP financial measures, both historical and forward-looking for which historical financial measures, we have provided reconciliations to the most comparable GAAP measures in our earnings press release. In addition to the earnings press release, we issued a stockholder letter earlier today which is available on our Investor Relations website. I would now like to turn the call over to John Koryl, Chief Executive Officer of The RealReal.

John Koryl, CEO

Thanks, Caitlin and welcome to our earnings call. Today, we reported financial results for the second quarter of 2023. GMV and revenue exceeded the midpoint of our Q2 guidance and adjusted EBITDA exceeded the high end of our Q2 guidance range. The improvement in profitability was largely driven by our ability to maintain the higher-margin consignment business while we purposely limit direct revenue. Additionally, we continue to make progress on minimizing low-value consigned items. These actions resulted in higher average order value, a higher gross margin rate, reduced company-owned inventory and a smaller adjusted EBITDA loss compared to the prior year. Beyond our financial metrics, we are seeing positive trends in our Net Promoter Score and consignor satisfaction. The consignor concierge team that we implemented over the last 6 to 9 months is enabling us to deliver a truly luxury and personalized experience to our clients. In addition, during the second quarter, we added more than 1 million new members, taking our total membership base to over 33 million members. Through the first half of the year, we have been working on 3 key initiatives: first, grow profitable supply which is driven by our revamped consignor commission structure and could be augmented starting next year through new supply partnerships; second, improve efficiency through our pricing algorithms and technology improvements in our operational processes; third, pursue new revenue streams, including on-site advertising. I'm excited about some of the green shoots we are seeing in the business, especially in relation to our new revenue streams. We have started testing third-party ads on our website and the early indications are positive. These initiatives continue to drive improved financial and operational results. Today, we are updating our full year 2023 guidance. In addition, we continue to expect to be profitable on an adjusted EBITDA basis for full year 2024. Over the past few quarters, we have made significant changes to our business strategy and tactics and we believe we are well positioned to capitalize on our consignment business model as we continue to be the market-making leader in luxury resale. With that, let's open the call for questions.

Operator, Operator

Our first question comes from Kunal Madhukar with UBS.

Jason Napier, Analyst

This is Jason on for Kunal from UBS. I have a couple of questions. So the first question is I was wondering how you are thinking about the gross margins in the near term. You guys talked about the changes the company has been making to the business model which should yield gross margin improvement soon. So my question is actually about where will roughly the gross margin be exiting this year? And also, what would be the embedded gross margin target range for you to achieve the full-year profitability target for EBITDA in 2024?

Robert Julian, CFO

Sure. Thanks for the question, Jason. This is Robert Julian and I'll take that one. We have seen ongoing and continuous improvement in our gross margins primarily due to the change in the mix of our business where we have focused more on the very profitable consigned business and we have deemphasized the direct business. The consigned business generally is about an 85% margin business. And traditionally, the direct business has been more like a 15% business which looks in the first half of the year has been more flat as we've been trying to move the inventory that was less favorable and we've had to discount. So what you've seen is this change in mix and a significant improvement over 900 basis points again this quarter. For the first half of the year, we ended up at about 65% gross margin. We expect that to continue to improve in the second half of the year. I've said in the past that the gross margin could reach the high 60s, even potentially scare a 7 handle, but we haven't committed to that. That’s the trend you should expect: continued improvement and getting into the very high 60s, and that would be sustainable once we get to that rate because we continue to follow this strategy of focusing on the high-margin consigned business.

Jason Napier, Analyst

Got it. My second question is on your growth outlook beyond Q3. I mean, obviously, things seem to be decelerating in the near term, but could you please comment on the puts and takes to achieve your 2024 guidance after Q3? Like how much of your guidance, would you say, is related to your assumption around macro improvement in 2024 versus company-specific drivers?

Robert Julian, CFO

We're adopting a comprehensive portfolio strategy this year, which we've described as a reset year focused on reducing direct business, enhancing the profitability of our consigned business, and exploring new revenue opportunities. We've moved away from lower-value merchandise priced under $100. In my nearly six months here, we've discussed various revenue options including advertising and potential new streams like warranty and return insurance. We've also been looking into different forms of inventory. I was surprised to find that we had taken possession of all inventory types. Moving forward, we aim to feature authenticated merchandise on our site without needing to hold the inventory until it sells. For instance, a watch retailer can keep their used watches on-site, list them on our platform, and ship them to us for authentication after a sale. This strategy supports our core business of consignment while incorporating new supply partnerships and revenue streams to create a profitable portfolio for 2024.

John Koryl, CEO

Jason, I’d like to provide some additional details for modeling purposes. In the first half of the year, our direct business has seen a 50% decline. We have discussed this being a reset year, where we are intentionally reducing our direct business, and this trend will persist in the second half of the year. Furthermore, we have shifted away from items priced under $100 and exited certain categories, such as home and kids. This approach will continue throughout the year as part of our reset strategy. It’s crucial to look beyond the headlines concerning overall GMV and revenue trends, which may appear negative due to the decline. However, this is a deliberate decision, evidenced by a 900 basis point improvement in gross margin and a significant reduction in our adjusted EBITDA losses year-over-year. Eventually, we aim to establish a new normal and baseline post-reset, allowing us to return to being a growth company with double-digit growth in the future. For now, it is essential to move beyond the headlines of declining GMV and revenue figures.

Jason Napier, Analyst

Got it. A quick follow-up on that one. So as you're moving away from the company-owned inventory model, how can we think about the new run rate of inventory days for 2024, for example?

Robert Julian, CFO

We own very little inventory, and we've significantly reduced it year-over-year, resulting in a small inventory balance. We still have further reductions to make in what has traditionally been vendor-purchased inventory. We're buying inventory for resale in a traditional retail model, and this portion of our total inventory, which is about $26 million, amounts to roughly $7 million. Our goal is to eventually reduce that to zero. After that, we will maintain a nominal inventory level that reflects out-of-policy returns and some other categories. At that point, you can expect our inventory balance to grow in line with business growth. We've nearly reached a new normal for our inventory balance, which is significantly lower than a year ago; at the end of Q2 last year, it was around $73 million or $74 million, and now it's down to $26 million. We have nearly completed this transition to a new normal for owned inventory.

Operator, Operator

Our next question comes from the line of Rick Patel, Raymond James.

Rick Patel, Analyst

Can you update us on where you are in terms of marketplace monetization? Are you comfortable with the commission structure you have in place? Or do you see room to take it higher? And also, I think you touched on augmenting the commission structure in 2024. Hoping you can expand on those comments.

Rati Levesque, CRO

Thank you for the question. I'll start by addressing the commission structure, which is likely what you're referring to. We made changes back in November of last year with the goal of focusing on higher value items, reducing low-value inventory under $100, and maintaining our mid-value offerings. We are continuously optimizing and refining the commission structure, testing and iterating as we go. The high-value items are performing well, which is positive news. We are also working on reducing inventory under $100. The commission structure has supported this strategy. However, we do need to adjust the mid-value segment as I mentioned on the last call. We are becoming more sophisticated and strategic in our approach, utilizing various tools and methods to personalize our promotional efforts. You may have noticed some win-back campaigns aimed at retaining sellers in the mid-value segment.

Robert Julian, CFO

And I guess I would add to that, Rati. This is Robert, Rick. There's no finish line. There is no final commission structure that we're trying to achieve. It will be dynamic. We will continue to test and iterate to find the right balance and react and be nimble. I think we have done pretty well in the first change that we made, the mass change that we did on November 1; maybe we got it 80% or 90% there. But I don't think we'll ever be 100% there per se. It will continue to be dynamic and we will test and iterate as the market changes.

Rati Levesque, CRO

And a more personalized approach, right?

Robert Julian, CFO

More precise.

John Koryl, CEO

Could you please repeat the first part of your question? You had a question, and I'm not sure if it was about the market or data monetization. Could you clarify your original question?

Rick Patel, Analyst

Yes. The original was just around marketplace monetization and how comfortable you are with the updated commission structure you have in place and whether you saw room to take the commission structure even higher versus what you have right now?

John Koryl, CEO

Yes. I think we covered that one.

Rick Patel, Analyst

Great. And then can you also touch on product acquisition in the markets where you've closed retail locations? Have you been able to pick up supply through other means? And what's your comfort level with product availability going into the back half?

Rati Levesque, CRO

Yes, for sure. To remind everyone again, we closed a few locations, 2 flagship stores, 2 neighborhood stores, and a couple of luxury consignment offices. Again, another dynamic strategy based on what stores are doing well and what maybe have opportunity and not as much EBITDA when we look at the P&L that are store specific. We're still quite bullish on stores, I'll say that firstly. We're seeing continued demand, with new consignors coming through the store; the average item value coming through the store is quite high, and we find that the sellers are quite sticky when they're working with our retail and salespeople. We're continuing to look at new locations like we expect to add 1 to 2 stores a year, and we'll continue to evaluate that. As far as the stores that we closed, I'd say it's by market decision and result. So the flagship stores were the right decision based on the rent that we were paying in some of those locations, and we were able to move most of that business into our in-home channel. We're also assessing some of the other luxury consignment offices and considering opportunities in other markets. We want to get back into Miami, for example, Chicago, and San Francisco. The neighborhood store is definitely the winning recipe, and we have a playbook for this, so we expect to see more of these in the future, but we'll operate quite prudently considering the operating expenses and lease negotiations.

Operator, Operator

Our next question comes from the line of Ike Boruchow with Wells Fargo.

Ike Boruchow, Analyst

Two questions. First, just at a high level, could you talk a little bit more about the consumer buckets that you guys are dealing with? Are you seeing any additional pressure on the higher-tier consumer? There have been some data points on U.S. luxury trends softening over the prior couple of months, and I'm curious if you've seen anything of that nature inside your business.

Rati Levesque, CRO

Sure. I can start. As far as macro is concerned, I'm always looking at the top of the funnel. I'm looking at traffic, leaves, and the seller conversion which is flat to the page. When I look at conversion on high value, it's also flat. That said, new members are up 16% year-on-year, and active buyers are up. So all of our leading indicators are not showing a sign of slowdown on the buyer side. That said, we're always supply constrained. I have confidence that if we get the supply, we can sell it, and we're seeing the health of the consumer being quite strong. Our focus is ensuring we get the right fly-in.

Ike Boruchow, Analyst

Got it. And then maybe a follow-up for Rob. When you look at the balance sheet, can you share your overall views on cash burn for the rest of this year and next year? Have you begun discussions on how to address the 2025 notes that are coming due? I'm curious if you can discuss that.

Robert Julian, CFO

Sure. Yes, happy to, Ike. The first part of your question on cash and cash burn, it will certainly be a tale of 2 halves for us. We've talked about that in the past, and you can see it reflected in the difference in projected actual adjusted EBITDA in the first half of the year and projected adjusted EBITDA in the second half of the year. If you take the midpoint of our guidance, adjusted EBITDA is about a $49 million loss in the first half and at the midpoint of our guidance, closer to $20 million. You'll see a change just naturally from the improvement in profitability of the business. There were also some aspects on a cash burn basis in the first half of the year that were a little unusual; there were some restructuring expenses incurred as we closed some retail stores and exited some office space. We had a bit of cash burn associated with that, which will not proceed in the second half of the year. And then finally, I would like to look at our CapEx timing in the first half versus the second half. We were a little heavy on CapEx in the first half of the year where we put in a significant PIC module in our authentication center in Phoenix, added some conveyance to the warehouse, and installed idle packaging machines and other forms of improvement that produce more efficiency going forward. However, this was heavy from a cash perspective in the first half of the year. So we expect the cash burn to be significantly lower in the second half of this year. We also expect it to be even better next year, as we have committed to being adjusted EBITDA positive in 2024 and beyond. So I think you're going to see very positive trends in that regard, and I'm not overly concerned about the cash position or our cash burn at the moment. Now the second part of your question is about our capital structure and we have talked about that. We announced our intention to address the capital structure in the convertible notes. The 2025 notes have a due date of mid-2025, while the '28 notes are due early '28. We continue to work on that quite actively. The management team is in conjunction with our Board, looking at our options and different ways to find the ideal capital structure and additional runway, to prevent anything from coming current. We remain committed to addressing that in the short term. In past discussions, we mentioned working towards a solution by the end of the year, and I'm still hopeful that we could address it then. If for some reason it’s not by the end of the year, it would be very soon after that. Therefore, I would estimate within the next 3 to 6 months, we will certainly have a solution and I genuinely feel optimistic that we are identifying good options and addressing our capital structure and convertible notes, and you'll hear more from us on that soon.

Operator, Operator

Our next question comes from the line of Anna Andreeva with Needham.

Anna Andreeva, Analyst

Great. Two questions from us. On marketing spend, it's been coming down the last couple of quarters. And I know you talked about reducing some of the TV spend. But can you talk about where you're finding efficiencies? And how are you thinking about marketing as a percent of sales as implied in the guidance this year? Should it keep coming down as a percent of sales while reaching profitability goals for next year? And then secondly, the number of buyers declined slightly sequentially. Is that the result of the low value reduction? And how are the gross adds performing in the business?

John Koryl, CEO

Yes. I'll start on the marketing side, Anna. Thank you for the question. What we're doing is really narrowing the target down to knowing exactly who our customer is. As we've always talked about, we're a supply-constrained business. So demand happens, right? We cannot take it for granted. However, in terms of where we need our dollars to work hardest, it's actually finding the consignors and getting that supply on the website and into the stores. You saw us likely move away from mass marketing and towards much more personalized advertising at the top. There are a lot of targeting capabilities available through digital marketing. We're getting better from a television perspective, including over-the-top advertising. So we're doing a more effective job targeting the supply and buyers that can become consignors in the mid- and upper part of the funnel. We are also closely examining how our marketing dollars change behavior. Rati talked a minute ago about adjusting the commission structure in a more personalized manner. Our primary goal is to see how our marketing dollars can work harder to drive more velocity or more units, or even higher value units to elicit better behavior from customers. What you're seeing is a lot of experimentation. We had to take significant funds out of broader spend to fund that extensive testing. As of now, I believe there are 20 to 30 concurrent tests happening in Q3. The results so far have been positive, and if they keep yielding results, we can lower our marketing spend as a percentage of revenue while growing with a company that's evolving to lower double-digit growth instead of the previous 30% to 40%. They're entirely different investment profiles, and we believe the marketing spend is adjusting to the profile of what we want to be: a smaller, but much more profitable growing company moving forward. Rati, do you have anything else to add to that?

Rati Levesque, CRO

I think that's great. Our attribution model, to your point, is getting much more sophisticated and personalized. Regarding your second question, about the number of buyers, yes, we expected that to happen based on our previous discussions about de-emphasizing items under $100. It was minimal; when you look at the declining numbers, you'll see that play out for the back half of the year.

John Koryl, CEO

I think you had a third question, was related to ads. I'm happy to address that as well. We have had some initial successes there; however, as we've mentioned multiple times, it’s still early days. Our goal is to ensure that the ad experience we deliver does not negatively impact the core experience of our buyers and consignors. We launched advertising on one page type in early July and only for about 5% of the population. We didn't see any negative outcomes. We then moved to 25%, and now we're at 50%. We will continue to evolve ad placements and consider additional avenues for monetization through ads on various page types, potentially into email and the app as well. We have various sources of traffic, including mobile web, the app, desktop, and tablet. As long as we ensure that the ad experience is favorable and can effectively monetize that traffic, we aim to expand this offering. That being said, we are taking a measured approach, and our aim is to maintain the integrity of our core business while monetizing effectively.

Operator, Operator

Our next question comes from Tom Nikic with Wedbush Securities.

Austin Ferner, Analyst

Austin Ferner is asking about the plans for the convertible debts. He wants to know if the company intends to take advantage of the current trading discounts in the near future and if they plan to act on that by the end of the year or wait to refinance in 2025. He is seeking clarification on their strategy regarding this matter.

Robert Julian, CFO

So Austin, this is Robert. There are multiple options and ways to address our convertible notes. Taking some out and capitalizing on the discounts is one option. However, I will not commit to any specific strategy we are pursuing at this point. We are exploring every alternative and are committed to finding the best solution for the company and shareholders to position us favorably going forward in terms of our capital structure and liquidity. But I will not commit to any one of those strategies at this moment. As mentioned earlier, ideally, we aim for a solution by the end of the year. If it’s not by then, it will be very soon after. So usually, I would say within the next 3 to 6 months, we will finalize a solution, and I genuinely feel positive that we have some excellent options available to address our capital structure and convertible notes. You will hear more from us on this shortly.

Operator, Operator

Our next question comes from the line of Marvin Fong with BTIG.

Marvin Fong, Analyst

So for the first question on guidance, if I break it down between the third and fourth quarters, using the midpoint, the fourth-quarter guidance seems to indicate a GMV of around $480 million, which would represent a significant year-over-year improvement compared to the third quarter. It appears there is a bit more optimism for the fourth quarter. Can you confirm if my calculations are correct? If they are, what factors are contributing to your outlook for the fourth quarter? For the second question, you mentioned having 33 million members but less than 1 million active buyers. What do you think is key to converting these members into active buyers? Any insights on that would be appreciated.

Robert Julian, CFO

Marvin, this is Robert. I'll just start by confirming your math; your implied Q4 GMV is indeed correct. The normal sequence of our GMV and revenue is that Q4 is always the highest quarter. If you looked at last year or most other years, you will see a significant improvement in GMV from Q3 to Q4. Although I would note that, on a year-over-year basis, it still represents a decline. Perhaps not as severe a decline as we observed in Q2 or what is implied in the midpoint of our guidance in Q3, but it’s still a year-over-year decline due to our ongoing efforts to deemphasize the direct business and the focus on items under $100. Your math is correct. In terms of the Q4 guidance we gave, that takes into consideration what’s currently working and what’s not in the business while deemphasizing the lower-value endeavors.

Rati Levesque, CRO

It's all about the supply. So as far as our supply initiatives, as Koryl spoke about marketing, we are focusing on targeting the right items and sellers. We're also developing a more outbound sales organization, personalized promotions, and our retail efforts are also integral to this strategy. We are seeing good returns on our efforts. The forecast takes into consideration current strengths and weaknesses in the supply area.

Robert Julian, CFO

Regarding your second question on members, it’s correct you asked about buyers and not consignors. The ratio between the two parties has improved from about 10% a few years ago to around 15% recently. Our strategy moving forward will continue to target bringing those buyers into our consignment funnel, and we will optimize that further.

Operator, Operator

Our next question comes from the line of Nathan Feather with Morgan Stanley.

Nathaniel Feather, Analyst

This is Nathan Feather on for Lauren. Some really encouraging results on the bottom line. I understand that this year is a reset year with the pullback in $100 items, vendor purchases, etc. If we strip out some of those one-time impacts, how should we think about what GMV would be growing? Any way to quantify that would be helpful. And then on the advertising side, any thoughts on the take rate you're aiming to achieve as you roll that out? Any reason why you couldn't get to kind of industry rates?

Robert Julian, CFO

Nathan, I'll start and I'll perhaps reframe the question a bit. I won't speculate on what our growth rate would have been in 2023, had we not changed our strategy or exited direct or items under $100 categories. It may be better to frame the question by considering what we think our ongoing growth rate might be as we reset and establish a new baseline of good business with the proper balance of consigned and direct business. I still feel confident that we can achieve a double-digit growth rate of around 10% once this reset is complete.

John Koryl, CEO

Yes. It's a combination of our traditional consignment business and the new supply partnerships we mentioned. The positive aspect of these partnerships is that if we wait and authenticate goods only after a sale, it changes the cost profile of implementing these partnerships. In our supply-constrained business, identifying these partnerships becomes essential. If we can monetize the right partnerships while maintaining high standards for authenticity, then we are in a very favorable situation. We are keen to partner with those who can provide authentic goods and assist in meeting our customers’ high expectations for a premium service marketplace.

Robert Julian, CFO

Regarding your advertising question, we expect to deploy advertising synergistically throughout the site. We seek brands that align well with our ethos for advertising. We have extensive traffic across various platforms, and the focus will lie in how we monetize this effectively without detrimentally impacting our core business. We are carefully evaluating how we can achieve this while ensuring promotional advertising does not adversely affect customer experience. We would anticipate seeing a different mix in take rates but overall maintaining healthy gross margins.

Operator, Operator

Our next question comes from Edward Yruma with Piper Sandler.

Edward Yruma, Analyst

I guess, first, I know you said you have certainly no dearth of buyers. But just kind of curious, have you changed pricing or is your outlook changing pricing given some of the weakness in some of those entry-level pricing as well as maybe some of the softness in the gray market? And then just as a follow-up, I know historically, you have excelled at managing inventory down. You seem to have a lot of returns in the fourth quarter that kind of fall into the first quarter. So do we expect inventory levels to tick back up, at least seasonally?

Rati Levesque, CRO

I'll take the first question on pricing. No, we're not lowering prices. If anything, like-for-like items have increased due to market dynamics based on the item and the corresponding demand. We will continue to optimize pricing in alignment with market trends.

Robert Julian, CFO

Ed, I'll take the second question on returns and seasonality from Q4 to Q1. Generally speaking, returns do not impact our owned inventory. The returns only affect owned inventory if it is out of policy, and we agreed to take it back after the consignor already has been paid. However, most of our inventory is consigned items and therefore not on our balance sheet. Maybe there’s a correlation if you get more returns, but generally, I’m not concerned about those affecting our owned inventory levels.

Operator, Operator

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

Mark Altschwager, Analyst

A couple of follow-ups regarding some of these new revenue streams that you're targeting. Just first with the B2B opportunity you outlined previously, any high-level aspirations you can share on where you think that can get in terms of the percentage of your GMV over time, some of those supply relationships where you're not taking consignment. How should we think about the overall margin profile of that business considering both take rate and the fact that the cost structure is a bit different? So that's number one. Secondly, understanding that it's still early days, but as we think about the plan for breakeven EBITDA in 2024, are you assuming material contribution from things like advertising and some of these newer supply relationships?

John Koryl, CEO

I'm starting with advertising. It's early days, but it is part of our plan to achieve EBITDA positive results in 2024. That's why we're testing as much as possible in 2023. We can't provide specific numbers but that is included in our plan. Regarding the margin profile of what we are calling supply partnerships, our goal is to ensure the net margin is as close as possible to our consignment business, which would yield favorable outcomes. If we can limit costs like photography, writing product descriptions, and shipping multiple times, by collaborating with our partners, those are initiatives that could improve our cost structure. We do not want to engage in a margin erosion strategy if these partnerships grow to constitute a significant part of our business. Our strategy is to maintain robust gross margins while optimizing adjusted EBITDA.

Robert Julian, CFO

It's a very good point, Mark. It’s crucial to acknowledge that these partnerships may yield a different take rate profile, meaning our traditional take rates might decline slightly. However, this situation should not be construed negatively. At the bottom line, on an adjusted EBITDA basis, these partnerships could prove to be quite beneficial, even if the take rate decreases. We are prepared to discuss the nuances of our P&L regarding how this all functions, and this dynamic will be crucial as we navigate these partnerships effectively.

Operator, Operator

I'm showing no further questions in the queue. I would now like to turn the call back over to John Koryl for closing remarks.

John Koryl, CEO

Thank you for joining us today. In closing, I want to thank our team at The RealReal for their efforts to fulfill our mission, live out our values and move our business forward. Your contributions to making our business run smoothly and deliver exceptional service to our clients are remarkable and inspiring. Finally, I'd like to thank our more than 33 million members who are joining us in our mission to extend the life of luxury and make fashion more sustainable. Thank you.

Operator, Operator

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.