Earnings Call Transcript - REAL Q1 2023

Caitlin Howe, Senior Vice President of Investor Relations

Thank you, operator. Joining me today to discuss our results for the period ended March 31, 2023, are our Chief Executive Officer, John Koryl, President and Chief Operating Officer, Rati Levesque, and 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, both of which are 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 Q1 2023 earnings call. Today, we reported financial results for the first quarter with revenue exceeding the midpoint of our guidance and adjusted EBITDA exceeding the high end of our guidance range. The improvement in profitability was largely driven by our ability to continue to grow the higher-margin consignment business. During the first quarter, consignment revenue grew 22%, and direct revenue declined 49% year-over-year. This resulted in our gross margin improving 980 basis points compared to the prior year. In addition, during the quarter, we increased take rate, reduced our company-owned inventory balance, and narrowed our adjusted EBITDA loss in both dollars and percentage compared to the prior year. We also took steps to reduce our cost base during the quarter. Beyond our financial metrics, we saw positive trends with total active buyers reaching over 1 million for the first time in The RealReal’s history. We are also making progress on our customer satisfaction and consignor experience, which is critical to the long-term health of the business. Let me provide more details on our key initiatives. First, we made updates to our commission structure late last year, which are now starting to deliver results. If you remember, the goals of updating our commission structure were to optimize our take rate, limit consignment of lower-value items, and increase consignment of higher-value items. We believe the updates are mostly working exactly as we planned. Our Q1 take rate increased to 170 basis points. Lower value supply has decreased, and higher value supply has increased year-over-year. Therefore, the commission structure changes are doing well overall. One area we have more work to do is in mid-value supply. We are currently testing commission rates for different consignor cohorts at various price points to optimize our mid-value supply. In addition to supply, customer satisfaction and consignor experience continue to be a major focus area for the company. We have been busy rolling out our new consignor concierge team, which pairs each consignor with a small dedicated team of consignment customer service experts. With the rollout now complete, the initial feedback from our new approach has been overwhelmingly positive. Our customer service ratings have increased, and it's helped us improve our Net Promoter Score. Going forward, we will continue to look for ways to improve both the consignor and buyer experience. It’s critical that we continue to improve our consignor experience and manage our costs effectively. Over the past 2 months, we have assessed our cost base and believe there is further opportunity to reduce our operating expenses. Our company-wide focus on managing costs, particularly those that do not directly impact our consignors and buyers, will be one of our keys to achieving profitability. The other key initiatives of optimizing product pricing and pursuing new revenue streams are making progress, and we look forward to discussing them more in depth in the coming quarters. With all these in mind, we are confident these key initiatives will help move the business to profitability, and we believe they will be particularly impactful in the back half of this year or in the next. Overall, the business is headed in a positive direction. We’re growing our consignment revenue. We’re expanding both our gross margin and gross profit dollars, and we’re improving our customer satisfaction and the consignor experience. We are also managing costs as we drive toward profitability. Given our strong Q1 results and our partners on key initiatives, I reaffirm our belief that we will retain profitability on an adjusted EBITDA basis in the full year 2024. With that, let’s open the call for questions.

Operator, Operator

And our first question will come from Kunal Madhukar with UBS.

Kunal Madhukar, Analyst

One, on the order volume. So the order volumes increased 1.5% year-over-year. And then in conjunction with that, can you talk about what you're seeing in the market perspective? And what are you seeing in the market from a consignor perspective?

Rati Levesque, President and COO

Sorry, Kunal. Were you asking about the order, the number of orders?

Kunal Madhukar, Analyst

I was initially discussing the order volume increase of 1.1% to 1.5% year-over-year. I would like to understand what you observe in the market regarding demand and supply.

Rati Levesque, President and COO

We are observing several trends from both buyers and sellers. I always mention the importance of top-of-funnel engagement, whether it involves opportunities or leads from consignors. On the buyer side, key metrics such as sell-through rates, average selling price, and average order value are looking strong, with year-over-year growth in active buyers. Similarly, on the seller side, we continue to prioritize value and quality over quantity. Overall, we are seeing healthy engagement across the board.

Kunal Madhukar, Analyst

And as a quick follow-up, are trends in April any different from the trends that you saw in Q1?

Robert Julian, CFO

Yes, Kunal, this is Robert. We're not going to provide inter-quarter results for Q2, but our full Q2 guidance takes into account everything we've observed in April, which are actual figures at this stage.

Rati Levesque, President and COO

But I would say the trend has been pretty consistent on the seller’s engagement for buyers and consignors.

Operator, Operator

And that will come from the line of Ike Boruchow with Wells Fargo.

Ike Boruchow, Analyst

I was just wondering from a demographic standpoint or income cohort, are you noticing any volatility or weakness at the higher tier part of the customer base? There's been some commentary out there from some of the luxury brands, just that the U.S. consumer is becoming a little bit more pressured, they're shifting their purchases elsewhere. Just kind of curious if you guys are seeing that in the business and how you think about that.

Rati Levesque, President and COO

Yes. So we are not seeing that right now. There’s a few different ways that we look at that. We look at that obviously because we’re in the market space, both on the buyer and seller side. On the buyer side, like I mentioned, we’re seeing average selling price and average order value going up. We’re really focused on that mid- and high-value product. As you know, Ike, and as far as the consignor is concerned, and those sellers that are giving us that product, those VIPs, as far as high and mid retail value is concerned, we are seeing pretty consistent across the board over the last few months. So it goes back to the health of the consumer in my mind. And we’re cautiously optimistic that we’ll see what happens over the next few months with recession? Are we in one? Are we not? But we can report on our own metrics. And again, we’re cautiously optimistic that we’re not seeing the trade down or average selling price decrease at this time.

Operator, Operator

That will come from the line of Rick Patel with Raymond James.

Rick Patel, Analyst

I was hoping you could help us understand the assumptions going forward for gross margin, very strong performance in the first quarter. I'm hoping you can help with the puts and takes going forward as we think about the sustainability of the improvement you had in the first quarter.

Robert Julian, CFO

Sure, this is Robert. I'll take that one. We saw significant year-over-year improvement in our gross margins, nearly 1,000 basis points. This change was primarily due to the shift in our revenue mix. Last year, direct revenue made up about 34% of our total revenue, and in Q1 of this year, we reduced that to 17% to 18%. This was part of our strategy to enhance profitability. The commission structure change that took effect in early November also contributed to an increase in our take rate. By focusing less on lower-margin items under $100, which were unprofitable, we strategically improved our gross margin. These changes are structural and likely permanent, providing us with more opportunities as we continue to minimize direct revenue while increasing direct gross margin. However, within the 1,000 basis point improvement, there are some challenges. We are currently discounting older inventory, which has negatively affected the gross margin in our direct business, as reflected in our Q1 results. This situation is temporary, and we estimate about $5 million to $10 million in inventory may still need discounting. Once we address that, we expect our gross margins to improve further. Looking ahead, we project continued gross margin improvement, potentially by a few hundred basis points each quarter, aiming for the high 60s by the end of the year.

Rick Patel, Analyst

Very helpful. And can you also talk about supply procurement as you make changes to your take rate and the retail strategy? How do you feel about the flow of new product coming onto the platform? And anything to call out in terms of getting more mid-level sellers on board?

Rati Levesque, President and COO

Yes, I can address that. We are concentrating on the quality and value of our products, particularly in the high to mid-value tier. Regarding our supply for the remainder of the year, we are maintaining the same strategies we've previously discussed and are anticipating some positive outcomes. We often say that what’s old becomes new again. The relationships we have and the profile of our luxury managers are crucial, as relationship-based sales teams tend to generate better retail value. Our referral program, which we launched a couple of months ago, is having a significant positive impact on Q1, and we plan to continue that. We are also taking a more personalized approach in our marketing efforts, focusing on lifetime value in our customer acquisition strategy and ensuring we attract the right sellers. We are maintaining a targeted approach that emphasizes quality over quantity, along with enhancing our partnerships and affiliate programs.

Operator, Operator

Next, we have Anna Andreeva from Needham.

Anna Andreeva, Analyst

Great. I wanted to follow up on the annual GMV guide from flat to down, which assumes a kind of similar flat to down trend in the back half. I was just hoping you could talk a bit more about what you are seeing with demand out there for your customer? And then secondly, John, I think you mentioned there are additional opportunities to reduce costs that you guys are finding in the business. Could you extrapolate on that? Are there additional buckets of opportunity that you're seeing? And what's the timing on how those are expected to flow through the P&L?

Robert Julian, CFO

So Anna, this is Robert. I'll just start with the numbers, just sort of reinforcing what you said. We see a very unusual pattern in our projected GMV this year that is not typical for our business, and it has been done quite purposefully. And so it's important to remember that the reduction in our direct business, which was a reduction of 50% year-over-year, will continue for some time. Now direct business did peak in Q1. It started to flatten out maybe in Q2, and it really started to decline in Q3 and Q4. And so we're anniversarying that in terms of the headwind on overall GMV. And we talked about deemphasizing items under $100. So we very intentionally reset the baseline. And we've talked about this being a reset year, but it's quite unusual to see our GMV and revenue decline from Q1 to Q2. Usually, each quarter sequentially is a little better than the quarter before, ending with Q4 being the highest quarter. And so I think we'll get back to flattish in Q4, although, again, we haven't given guidance for the out quarters. But we are going to see this unusual trend of GMV and revenue going down instead of up from Q1, and it is quite purposeful and intentional. It's what's driving our higher gross margin. It creates what happened in Q1, where you see higher gross profit dollars on lower revenue dollars. And then I'll let the rest of the team talk to what we're expecting in terms of supply and demand and how that all washes out.

John Koryl, CEO

Anna, thanks for the question. From a cost perspective, as you’d have any new CEO, you’d expect them to have their own perspective as they come to the table and have help from a third party to review everything. And the good news is, Rati and Robert had done a great job before I got here. And we just had tweaking quite honestly. And some of it has to do also with the nature of our business. We're moving from a hyper-growth maybe not as profitable as we needed to be, to a huge emphasis on profitability. And with that, it's coming to some lower volumes. So we had to optimize some pools not only on the support side but on the operations side. So we're constantly trying to maintain flexibility. And you don't want to cut bone and muscle, but at the same time, you need to really optimize your costs to make sure that we can be profitable in the near term. And we're seeing a lot of benefits. Sometimes the costs can't change as quickly as the revenue is changing or the GMV is changing, but we're trying to keep pace as quickly as we can, and you'll see further optimizations in future quarters on that.

Operator, Operator

And that will come from the line of Noah Zatzkin with KeyBanc Capital Markets.

Unidentified Analyst, Analyst

This is actually Ashley on for Noah. Just with the ongoing macro pressure. I wanted to see how you're thinking about that trade-down effect you previously called out for the remainder of 2023? And then any opportunities you're currently seeing around new buyers?

Rati Levesque, President and COO

Yes, sure, Ashley. As far as the trade-down effect that we saw earlier in the year and say that – we’re not seeing that right now. We are seeing an average selling price, if anything, go up for like-for-like items. The good thing about our business, as you know, consigned business. So if we do need to discount, our margins don’t get squeezed. So we aren’t seeing that. And as our mix starts to change as far as higher-value goods, more mid and high value, the AOV, ASP, all continued upside. And we do see a little bit more upside throughout the year there.

Operator, Operator

And that will come from the line of Marvin Fong with BTIG.

Marvin Fong, Analyst

I would like to better understand if you are seeing a decrease in the number of transactions for low-value goods due to a decline in supply. Are we observing this impact in your first quarter numbers and full year guidance? Additionally, how much of your guidance for the latter half of the year is influenced by the decrease in direct revenue and other factors? I’m trying to determine how much of the situation is related to having fewer low-priced items available on the platform. Please elaborate on this.

Robert Julian, CFO

Yes. Marvin, this is Robert. So as we mentioned earlier, it is true that we have intentionally reduced volume on low-priced items, and we have intentionally deemphasized and, for the most part, stopped buying vendor in wholesale or inventory. So we do expect that to continue and that is reflected in our full year guidance. But again, it is totally done as a strategic initiative to increase profitability and to focus on the things that are better for our business and our path to profitability. So it is reflected in our guidance, and it is expected to continue. It's part of the reason that I had mentioned earlier why our gross margin is expected to continue to increase. And again, we are going to be generating more gross profit dollars and higher gross margin on lower revenue. And that makes our business less complex. There's less things to go wrong. It allows us to get a cost structure that matches that level of activity. All of that is very intentional and part of our focus on profitable growth and the path to profitability.

Marvin Fong, Analyst

Got you. Great. Robert, I guess maybe another question for you or John. But as I look at your guidance, if I just look at the consolidated take rate, it looks like it's coming down a little bit compared to the first quarter. So should I just think of that as primarily driven by direct revenue coming down quarter-over-quarter and the marketplace take rate climbing? Or is the marketplace take rate increases kind of gone through the system and we should...

Robert Julian, CFO

Yes. Thanks for the question, Marvin. Just one thing. Direct business has no impact whatsoever on take rate. Take rate is entirely associated with our consigned business. Now typically, what we’ve said in the past is when you see a move in our take rate, in the past, it’s always been strictly a question of mix. When we sell higher price point, lower take rate items, proportionally more of that, take rate goes down. When we sell lower price point items with higher take rate, take rate goes up on average. And so it’s not necessarily a bad thing to see take rate decline. It may just be an indication we’re selling more high-value goods at lower take rate. Now the exception to that, unfortunately, there’s always something weird in our results to explain. You saw a tremendous increase in take rate in Q1. And that was not mix. That was the commission change. So we had 2 variables moving at the same time in Q1. We had made this commission structure change in November. And that did have an impact to raise take rates sort of across the board at every price point more or less. Now more so on low-value items and less so and high-value items, but we did see a change in take rate due to a structural change in our commission structure. And what you’ll see from this new normal of mix, then you’ll see take rate moving just based on are we selling more high-value goods or low-value goods with the associated lower or higher take rates. So that’s what you’re seeing going forward. Q1 is a little bit of an anomaly because it also had that one-time change of raising take rate across the board on average.

Operator, Operator

That will come from the line of Edward Yruma with Piper Sandler.

Edward Yruma, Analyst

Could you clarify what you mean by mid-value? It’s a new term for you, so does it refer to specific brands or price points? Additionally, when it comes to promoting more mid-value inventory, was there anything in the pricing changes that might have downplayed those products? Finally, John, I would appreciate any insights you might have. You mentioned costs and some ongoing initiatives, but are there any other operational observations you can share, particularly regarding the user interface and customer processes that you could apply from your past experiences to RealReal?

Rati Levesque, President and COO

Yes, thank you for the question. Mid-value is a newer term we're currently using. Regarding the commission structure, we made changes in November to test the elasticity of our service. The good news is it performed as expected for high-value products, attracting more high-value items while reducing the low-value ones. However, we needed to make some adjustments in the mid-value category. We initially went a bit too far with mid-value, and we're now fine-tuning that range, resulting in improved numbers. For us, mid-value refers to products worth between $200 million and $750 million, while high-value products are those worth over $750 million. We've always indicated that this strategy would be dynamic, and we're continuously adjusting the commission structure. That's where we currently stand in terms of optimization.

Robert Julian, CFO

I would say that between $100 million and $200 million is considered low value, while anything under $100 million is categorized as very low value. We have primarily focused on eliminating very low value offerings. We do have some low value items in the $100 million to $200 million range, which will remain part of our offering for various reasons. I hope this provides the definition you were looking for, Edward, regarding the price tranches. We define it in terms of these price categories.

Rati Levesque, President and COO

Exactly. And as we tweak and kind of test is mid-value based on different commission structures, we're seeing some upside there. So we're getting that just right in that area. And then I think you asked John about the other thing.

John Koryl, CEO

From an observation perspective, a lot of marketplaces, obviously, it’s supply and demand, right? Supply is king here. So I’ve spent a lot of my time learning and doing anything I can to contribute to help increase the amount of supply that we can bring to this marketplace. A lot of it’s taking care of your consignors and forming emotional connections with them. A lot of my luxury background is really built around that. How do we form the relationship between the luxury manager and the consignor so that there's a great lifetime value there? We're not churning out these customers. But it’s not just the sales team or the retail team that directly interacts with the first consignment or subsequent consignments. It’s actually how are the goods handled and processed through the pipeline? So we’ve gotten a lot better at operational efficiency, getting things on the site from an SLA perspective, making sure any pricing discrepancies, things like that are addressed in a timely manner. It was a very minor highlight of my speech, but this concierge pod that works directly with the consignors and the luxury managers, now you actually basically have a team working together to resolve any issues. And normal retail businesses, you buy things from a company and sell them to a person. This as a person at both ends. But there’s different levels of sophistication, different levels of complexity. We have to work through all that together, and we’re getting so much better at it and having those teams work together. I think the word that Rati just used in her answer with more testing and testing on commission structure changes and things like that. I think that’s another thing that I’m going to bring from my background. We made a dramatic change to the commission structure in Q4 last year. My goal is to not do as many dramatic things because they have big risk to them. You can’t really do that and reaffirm the belief that we’re going to be profitable in 2024 if we make – take a dramatic swing and miss. So what you’re going to see is a lot more tweaking, a lot more testing. From the day I got here, we need – we talked about the registration gate on the site. You can go to 1 page, but you can’t go to any subsequent pages. That’s the type of thing that we need to test. But again, that’s more on the demand orientation. All my initial focus has been based on supply. And quite frankly, with some of the customers, improve the experience and build a better business. That’s what it comes down to.

Operator, Operator

And that will come from the line of Tom Nikic with Wedbush Securities.

Tom Nikic, Analyst

I apologize if this has been asked already. I'm trying to keep track of multiple earnings calls. The average order value seems to have increased by about 2%. Given the effort to phase out lower-priced items, I would have expected a more significant rise in the average order value. Is the mix shift not as impactful as I assumed, or could there be other factors within the assortment, such as category changes, that might be influencing the average order value?

Rati Levesque, President and COO

Yes. The average order value is about $500 in Q1. I would like to mention a couple of points regarding that. As we implement our new strategy to focus less on low-value items and more on mid and high-value ones, I believe we will see more growth in the upcoming quarters. Additionally, while we may experience an increase in average selling price, it could lead to a slight decrease in the number of units per transaction, as there is an inverse relationship between the two. However, I anticipate continued growth in average order value throughout the quarters.

Robert Julian, CFO

Yes. The $500 is not so bad either Tom, as you think about it as an absolute number. I know it didn't change much year-over-year or sequentially. But I think it's moving in the right direction. It's a pretty healthy number. We saw average order value peak, I think, around 2, 3 of last year when we were really seeing people, especially during COVID, buying higher price point items like watches, and handbags, and jewelry. And so there was an expectation that average order value and average selling price would go down if that normalized. And what we've seen is a pretty decent result in Q1 at nearly $500 average order value. And again, the average selling price is increasing, not decreasing. And as Rati said, we expect that trend to continue.

Tom Nikic, Analyst

Okay. If I could just follow up there. When we think about getting to EBITDA profitability next year, is there more benefit that you expect to see next year from the elimination of low-value items? Or will the improvement in profitability next year be more driven by top-line growth?

Robert Julian, CFO

Yes. I think it’s going to – this is Robert. I think it’s going to be both, Tom. At some point, we will anniversary the effect of reducing our direct business down to, call it, 15% to 18% of total revenue, and really eliminating as much as possible items under $100. That will anniversary itself at some point. There will be a, what I would call, rollover effect into next year as you get a full year impact of us being at that better mix level versus what’s coming down during the course of this year. But I think you’ll see benefit from both. We do expect to continue to grow this consigned business, as I said, in a very wide range we’re providing at the moment, 10% to 20%. And so that will have benefits, it will create leverage and it will be more profitable revenue and growth. And so all of those things come into effect in our projection that we’re going to be positive adjusted EBITDA in 2024. You’re also going to – by the way, you’re going to get a full year effect of some of the cost-cutting actions that we have more recently taken. Again, there’ll be some point – some rollover effect of getting a full year impact of that in 2024 versus a partial order impact in 2023.

Operator, Operator

One moment for our next question. That will come from the line of Lauren Schenk with Morgan Stanley.

Lauren Schenk, Analyst

I just had two, if I can. The first was whether or not the shift away from some of the lower value items has impacted buyer retention at all? And then the second is, if there's anything more you can share on the new revenue opportunities that you've identified and whether or not there's any upside from that contemplated in the full year guide.

Rati Levesque, President and COO

Lauren, I'll address the first part of your question and then hand it over to John for the second part. Regarding the low value items and the brands we are deemphasizing, we haven't observed much effect on retention. We approached this carefully, assessing which items or brands to scale back on, and we also examined both the seller and buyer baskets to ensure a strong connection with the brands we chose to cut. So, there’s nothing concerning regarding retention.

John Koryl, CEO

Yes. And from an advertising perspective, there’s minimal impact to 2023. A lot of it is – back to the testing comment that I just made a moment ago, some of it is listening to our customers. We need to offer products where we don’t take returns on handbags right now. What if we actually offered return insurance, right? Those are the types of things that the market is asking for, we’re going to bring those forward. At the same time, we have 32 million members, and we have a lot of active members, and we have a lot of page views, and we haven’t monetized that from an advertising point of view. So I don’t want to talk about things that we haven’t done yet. We’ve done enough that we have plenty to talk about there. But you will see a big commitment from us to turn on those type of things and bring those to green from a testing perspective and then hopefully have an outsized impact in 2024 when we’re doing it in a conscious and judicious way in the back half of this year. Yes. Thank you for joining us today. Before we close the call, I want to take a moment to thank The RealReal team. You have all welcomed me into the organization and have already taught me a lot about the business. Thank you for your openness and enthusiasm and commitment to our mission. We are excited about the direction of the business and look forward to partnering with you to keep making a difference in luxury resale and for the planet. Finally, I’d like to thank our more than 32 million members that are joining us on our mission to extend the life of luxury and make fashion more sustainable. Thank you very much.

Operator, Operator

Thank you all for participating. This concludes today's program. You may now disconnect.