Earnings Call Transcript - REAL Q4 2023

Operator, Operator

Good day and thank you for standing by. Welcome to the RealReal Fourth Quarter and Full Year 2023 Earnings Conference Call. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Caitlin Howe, Senior Vice President of Finance. Please go ahead.

Caitlin Howe, Senior Vice President of Finance

Thank you, operator. Joining me today to discuss our results for the period ended December 31, 2023, is our Chief Executive Officer, John Koryl; President and Chief Operating Officer, Rati Levesque; and Interim Chief Financial Officer and Chief Legal Officer, Todd Suko. 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 shareholder 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 earnings call. Today, we reported financial results for the fourth quarter and full year 2023. For the first time since our IPO in 2019, we reported a full quarter of positive adjusted EBITDA as well as our first-ever quarter of positive free cash flow. Our Q4 adjusted EBITDA exceeded the high end of our Q4 guidance range, and the Q4 GMV and revenue exceeded the midpoint of our guidance range. Importantly, we announced today a reworking of our capital structure, for which I'll provide further details later in my prepared remarks. Additionally, we recently announced two exciting leadership updates. First, our new CFO, Ajay Gopal, will join us in March. Ajay brings with him a strong background as an e-commerce CFO as well as extensive experience with a two-sided marketplace. We look forward to introducing Ajay in the near future. We also announced that Karen Katz, who is a current member of our Board and the former CEO at Neiman Marcus Group is our newly appointed Board Chairperson. Taken together, we believe that the RealReal is starting off 2024 with solid momentum from a business operations and organizational perspective. Our improved financial results in 2023 were driven by our strategic shift to refocus on our core consignment business. We refined our growth model with a focus on profitable supply. As part of these efforts, we reduced direct revenue by half, overhauled our consignor commission structure, and revamped our approach to sales and marketing. Looking ahead, our new initiative of drop ship consignment, previously referred to as virtual consignment, has the potential to unlock incremental supply from trusted partners. Operationally, our results in 2023 were a significant step forward on our path to profitability. We are beginning to deliver efficiencies from our investments in automation and artificial intelligence. In 2024, we are focused on enhancing our technological capabilities and processes to improve the product flow in our authentication centers and further automating our authentication. While these initiatives require a small investment in Q2 of this year, we are bullish on the long-term benefits. It will enable us to continue to enhance our best-in-class authentication and deliver a superior experience to our customers. Regarding our capital structure, today, we announced that we entered into private, separately negotiated debt exchange transactions with certain holders of our convertible senior notes due in 2025 and 2028. As a result of the debt exchange transactions, we reduced our total indebtedness by more than $17 million, creating substantial runway and capital structure flexibility for us to execute on our strategic vision. Looking forward, we project that we are on track to deliver a breakeven adjusted EBITDA year in 2024. Today, we provided Q1 2024 and full year 2024 financial guidance. Through growing profitable supply, driving operational efficiencies, and delivering exceptional service to our consignors and buyers, we believe we can continue to make significant progress on the bottom line as we reaccelerate growth in 2024. I'm excited about the trajectory of our business and believe we will continue to capitalize on our position as the leader in luxury resale. With that, let's open the call for questions.

Operator, Operator

Our first question comes from Mark Altschwager from Baird.

Mark Altschwager, Analyst

Congrats on the results this quarter. So bigger picture here over the past few months, there's been a lot of discussion about the slowdown in the aspirational consumer, a little bit more promotional intensity for luxury apparel, especially online. Do you view these trends as headwinds or tailwinds for your business and resale in general? And would love your perspective there, both as it relates to supply and, I should say, quality of supply of quality goods as well as buyer engagement.

Rati Levesque, President and COO

Yes. Thanks, Mark. This is Rati. So as far as the health of the consumer goes, in Q4, we saw a little blip. I think we spoke about it in October, but after that, it definitely picked up. I will say we talked about the consumer being slightly more promotional in October. We didn't see that for the rest of the quarter. And then going into Q1, I'm also quite happy with the consumer there, both on the supply and demand side. So both sides of the marketplace. Our top of the funnel looks very healthy. And again, we look at opportunities all the way to appointments to GMV and revenue, or/and the supply coming in.

Mark Altschwager, Analyst

Excellent. And maybe a follow-up with respect to the guidance. Over the past few years, Q1, I think, has marked the low point of the year from an EBITDA perspective with improvement in the back half, especially Q4. The initial guide here doesn't seem to imply much improvement. I think a $4 million loss at the midpoint in Q1, but breakeven at the midpoint for the full year. Maybe walk us through some of the dynamics this year that are different, especially with the revenue guide, I think implying some nice acceleration after Q1.

Caitlin Howe, Senior Vice President of Finance

Yes. Thanks for the question, Mark. This is Caitlin. What I would say there is the midpoint of the Q1 guidance is negative 6%. And so what we're expecting for this year is really a return to our typical cadence, our typical seasonality, which we are more of a back half type of loaded business in terms of both top line and bottom line. And so I think you're going to see that, right? So historically, kind of excluding last year which had some anomalies because of the changes we were making in the business. When you look back over the course of the time that we've been a public company, Q1 and Q2 are typically pretty even between top line and bottom line, and then it accelerates kind of throughout the year. So I think that's kind of how we're thinking about it this year too. So I think we're feeling good about where we are, but I do think we expect that we would see some acceleration through the year. And then the other factor we have is just because of our comps, we had a tough comp in Q1 of last year. We brought in a lot of low-value supply that we've moved through, right? As we were minimizing low value, minimizing direct. So I think you're going to see that as we accelerate throughout the year, too.

Operator, Operator

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

Anna Andreeva, Analyst

Congratulations on achieving profitability. I wanted to understand where the main gains in the profit and loss statement came in compared to the plan to reach profitability in the second quarter, and in the fourth quarter as well. Additionally, what is the timeline for the new revenue streams you discussed for this year? Can you also update us on the status of sponsored ads and the warranty opportunities?

Caitlin Howe, Senior Vice President of Finance

Thanks, Anna. This is Caitlin again. I'll take the first question, and then Koryl and the team can address the new revenue streams. In Q4, compared to our expectations, we observed some general concerns regarding demand trends, which affected us as well. However, we experienced a solid acceleration in our top-line results during Q4, which we were pleased with. As we evaluate flow-through, the positive variance from our projections was roughly evenly divided between gross profit and operating expenses. Looking at gross margin in Q4, we encountered more favorable conditions than we anticipated, influenced by both direct and consignment sales. We increased our consignment revenue while reducing direct sales by over 50% compared to the previous year, reflecting a strategic shift we implemented earlier last year. Additionally, the take rate was positively impacted by better-than-expected results, thanks to the commission structure changes made in late 2022 and the product mix sold during the quarter. Notably, shipping margin performed slightly better than we expected, and we continue to improve efficiencies in inventory control and transportation costs. Regarding operating expenses, we maintained disciplined spending in support-related expenses. While sales and operations were in line with our expectations, we did spend a bit more, which is something we prefer to do when supply is healthy. Overall, we were very disciplined with our support operating expenses.

John Koryl, CEO

And in terms of the new revenue, drop ship is a Q1 launching capability. So that didn't impact Q4 at all that we reported. So you will see a little bit of that. Not a huge impact whatsoever in 2024. But from an advertising perspective, it was not material at all in our Q4 results. We've been learning for probably half a year. What I've learned is we need to spend all of our time focusing on our core business, right? It's a nice side business, but at the end of the day, anything that distracts from the core business from a site experience perspective is something that we have to be very careful with. As much tailwind as we're seeing with our core business right now, we're really just focusing on that. Again, making sure that we're investing in our sales team and investing in marketing in the right way and providing all the operational efficiency we need on the warehouse and authentication side. So this is truly not only Q4 but our 2024 outlook is a story about our core business.

Operator, Operator

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

Rick Patel, Analyst

Can you unpack the opportunity for drop ship consignment? Just curious if you can provide any context on how much volume this can touch in the first quarter versus where it can ramp to by the end of the year. And then secondly, just curious if you can help us understand the economics of drop ship as you think about the positive contribution towards profitability.

Rati Levesque, President and COO

Sure. Rick, it's Rati again. So like Koryl mentioned, with other revenue streams, that's how we're thinking about drop ship as well. It's early; we're learning. It has a very small impact for this year. We really are excited about it, and we are confident that this can generate a new channel for us when we think about growth in the next few years. But this year, it really is a test and learn, and you're not going to see a huge forecast baked in '24.

Rick Patel, Analyst

Got it. And then can you also help us with the cash flow mechanics following the debt refinance as we think about the impact of the changes in aggregate? What will be the impact on cash interest expense in 2024 and beyond? And is there anything to contemplate from a modeling perspective for the share count going forward?

Caitlin Howe, Senior Vice President of Finance

Yes. So from a refi perspective, and Todd, you led a lot of that, so feel free to jump in here. But from a modeling perspective, clearly, we had really inexpensive debt. We still have a large portion of that, especially in the 2028. So those are at a 1% coupon. And so still a significant portion of our capital structure on the debt side remains very inexpensive debt. But the interest rate environment has changed. So there will be incremental cash expenses that we'll have to pay. And Todd, I don't know if you have some commentary around that.

Todd Suko, Interim CFO and Chief Legal Officer

Yes. The incremental interest expenses are 8.75% cash and 4.25% PIK. We think our average weighted cost of debt stays reasonably low at about 4.8% in the first year. I'm not sure if that answers your question.

Rick Patel, Analyst

Yes. That's helpful context. And anything to think about for the share count going forward?

Todd Suko, Interim CFO and Chief Legal Officer

For sure. So I would just say that it's in the agreement, but the total amount of warrants that were issued were about 7.9 million, approximately. So there's a little bit over 7% dilution when you use the year-end share count.

Caitlin Howe, Senior Vice President of Finance

And Rick, the only other thing I would add is just we were able to deleverage a little bit through the transaction, which we saw as favorable.

Operator, Operator

Our next question comes from the line of Kunal Madhukar from UBS.

Jason Napier, Analyst

This is Jason on for Kunal from UBS. A couple of questions. So the first one is on the modeling side of things. I see the footnote in the press release, but could you please provide some details around the underlying components of the $6 million restructuring charge in Q4 that pretty much drove the better-than-expected EBITDA compared to your guidance? And speaking of which, how can we think about this line item for 2024 in terms of dollars and year-on-year change? And I have a follow-up.

Caitlin Howe, Senior Vice President of Finance

Yes. So the cost of the restructuring charge that we took in Q4 really had to do with exiting some real estate. We did incur additional expenses. So I would characterize it a little bit differently. I don't think that's what drove our favorability. You exclude those types of things when you're spending to exit real estate because it's not part of your ongoing operations. So that's how I would characterize it.

Jason Napier, Analyst

Got it. Second question is how can we think about sort of the inventory levels and gross margin levels compared to 2023 for this year? Any color on that would be really helpful.

Caitlin Howe, Senior Vice President of Finance

Yes. So I assume you're talking there about owned inventory. Our inventory balance at the end of 2023 was about $22 million. If you remember, we peaked at $75 million of owned inventory 12 to 18 months ago. What I would say is that's really reflective of us minimizing the direct business, minimizing that owned inventory in those transactions. I would consider this to be more or less a new normal for us. There are ways that we still acquire inventory, and it's really through out-of-policy returns. If somebody returns something, we've already paid out the consignor, then we will take that back onto our balance sheet in certain circumstances. We're really good repeat buyers. So we assume that will more or less grow with the business, although it's a small dollar amount. There are also some get paid now, which is really a customer offering. In certain circumstances, on very limited brands in high-end categories, like high-end watches, a few categories of high-end bags, there are situations where we will pay a consignor upfront, and we typically pay them less, believing that if you consign with us, you'll end up earning more. But those are really low risk of having to discount those goods. So those two will continue, but what we did during COVID to go out and buy inventory is really minimized and done at this point. So how we're thinking about total inventory and owned inventory going forward is more or less as a percent of revenue; it's 4% to 5% right now. We assume that it will stay in that range going forward.

Operator, Operator

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

Marvin Fong, Analyst

Congratulations on the quarter. I would like to revisit what Rati mentioned regarding the improvement following the challenging October. You indicated that you were quite pleased with January, despite signs that consumers were pulling back. I am curious if you have any insights into the reasons behind this improvement. Was it related to your marketing efforts or do you believe it was the value proposition connecting better with consumers?

John Koryl, CEO

Marvin, thanks for the question. I think it's all of the above. I think what people forget is we didn't have a lot of capabilities on how to personalize our relationship with the customer. What we've gotten really good at now is a year ago, we couldn't say, 'Hey, we haven't heard from Marvin in a while. Let's offer him something to make it so that he can consign.' We now have that capability. We have the exact same capability on the customer side. That's just one example on the marketing side. On the other side of the coin, we're seeing a lot of efficiency from our sales team. Rati and the team have done an incredible job of increasing the tenure of our sales representatives. We always knew we were in the relationship business, but that's really coming through in the past year. As that tenure increases, the relationship increases, and the stick-to-itiveness of the RealReal's relationship with the consignor and ultimately, the customer is really good. We still have a lot of opportunities of turning customers into consignors and even consignors into customers. But a lot of those relationships from a marketing and sales perspective have made it so we're a lot stickier, and we're seeing a lot more continuity as the business goes forward. Anything to add, Rati?

Rati Levesque, President and COO

I would just say that our investments are proving effective. We have launched an affiliate program, a referral program, and are hosting more events, including our consumer event. As Koryl and John mentioned, marketing and sales are collaborating more efficiently, and the tactics we are implementing are yielding positive results. We are optimistic about this year since we now have a full year of these investments. I cannot stress enough the importance of personalized promotions. We now understand what we need, how to obtain it, and the sources to acquire it, which has been a significant change for us.

Marvin Fong, Analyst

That's terrific. And maybe a follow-up. So you guys obviously provided full year guidance and then I observed that the active buyers were down in the fourth quarter. So first part is, is that just a final flush of kind of the low-value buyers finally cycling out of the active buyer count? And just secondly, could you just kind of talk about what you're thinking about active buyer growth versus AOV growth as you went through providing your full year GMV guidance?

Rati Levesque, President and COO

Certainly. Our active buyers did decrease in the fourth quarter as we anticipated. This is a result of the changes we implemented, such as eliminating unprofitable inventory and low-value categories and stepping back from the direct business. We forecasted this decline, and you can expect this trend to continue into this year, particularly in the latter half. We view the average order value and consumer quality similarly; our focus is on the quality of the products we offer.

Operator, Operator

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

Ike Boruchow, Analyst

I have two questions. First, regarding demand. I've been listening to other consumer and soft lines companies this earnings season, and I wonder if you've observed similar volatility in your business during the first quarter. Many companies have mentioned a decline in late January and early February, followed by some recovery in February. I'm just interested in whether that reflects your experience or how your business activity has been trending.

Caitlin Howe, Senior Vice President of Finance

Yes. I think we're going to resist the urge to give kind of the month-by-month or week-by-week news. But I think the general principle is what we saw. We saw an acceleration throughout Q4, and we've seen good momentum so far in Q1. Overall, we're feeling pretty optimistic, maybe cautiously optimistic about where the business is.

Ike Boruchow, Analyst

Got it. And then if I can shift just to the margins and the guidance on revenue. So first on the margin. I think the last call, you had said like a low 70s gross margin, I think you said it's like the new normal. You obviously had a great gross margin in Q4. Should we be expecting low 70s throughout the year? Is there seasonality we should think of as we model the gross margin? And then, Caitlin, just on the revenue versus GMV guide, can you just help us with the moving pieces between those two? Maybe some take rate guidance for Q1 of the full year or direct revenue? How is that supposed to trend through the year? Any help on those line items would be great.

Caitlin Howe, Senior Vice President of Finance

Yes, great question. When considering the flow of GMV through total revenue, there are a couple of factors to keep in mind: the take rate and the product mix. By product mix, I mean the difference between consignment and direct sales. Direct sales translate dollar for dollar from GMV to revenue, and we've experienced a slight headwind this past year as we reduced direct sales. I believe there will still be some impact in Q1, as direct sales will continue to decline. However, once we start comparing against a lower percentage of total direct sales, I anticipate a more consistent flow from GMV to total revenue. Thus, while Q1 might have some fluctuations as we phase out the direct business, normalization is expected afterward. As for the take rate, it increased by 150 basis points, primarily due to changes in the consignor commission rate card made at the end of 2022. We needed to sell through products priced under the old rate in the first half of the year, but by the second half of 2023, the financial picture looked clearer. I believe the higher take rate is now the new baseline. However, the product mix sold each quarter will vary. Typically, we see higher Average Selling Price or Average Order Value in Q2, reaching its peak in Q4, which may create some pressure on the take rate but should still result in good flow-through on those units. Regarding gross margin, we were quite pleased with our performance in Q4, and I would suggest that low 70s is the new standard. This figure will fluctuate from quarter to quarter depending on the product mix sold, but we feel optimistic about this level. The consignment business inherently features a high gross margin, and as we return to growth in the consignment sector and overall revenue, we are confident about where our gross margin is headed.

Ike Boruchow, Analyst

Got it. Caitlin, it's actually Ike. I made the call; don't worry.

Caitlin Howe, Senior Vice President of Finance

Thanks, Ike. It's good talking to you.

Operator, Operator

Our next question comes from the line of Ashley Owens from KeyBanc Capital Markets.

Ashley Owens, Analyst

Great. So we talked about the changes that have been made to the business; it's really encouraging to see the positive EBITDA this quarter. Just given this in the guidance today, do you think the growth trajectory here is a little bit more firm? And what are you seeing on the website in terms of shopper behaviors today that kind of give you the confidence that we'll see that mid-single-digit to low double-digit revenue growth range this year and that momentum will kind of persist?

Rati Levesque, President and COO

Yes. Sure. Actually, I'll start and let John add anything I missed. We feel pretty confident, going into the year based on where we are, based on the funnel, like I mentioned earlier, based on the consumer and the health of the consumer; fine jewelry is quite strong, and high value is strong. Then it all starts with supply for us. When we look at the supply, we're seeing really healthy growth going into Q1. I won't give any more guidance than that in Q1, but we are quite optimistic. We talked about all of the programs that we are launching that we tested in Q4 that worked for us. Those investments, like I mentioned, around marketing and sales, that tenure of the sales rep is quite healthy going into Q1. It all started in Q4. The realignment of value and quality between the sales and marketing team is really working for us. We're seeing these investments pay off and we're seeing that kind of growth continue into Q1.

John Koryl, CEO

No, I think it's really well said. We're a supply-constrained business, and the team is doing a really good job of developing supply. We definitely see this as, I said, a low double-digit grower. We're up against some pretty tough comps, obviously, in Q1 from last year with a lot of low-value goods and clearing out the direct goods. So we even did a negative margin last year. The comps in terms of growth aren't going to be easy, but from there, especially in the back half of the year, as we've said, we see this as being the longer-term sustainable, much more profitable model of our business than we've been running to date.

Operator, Operator

Our next question comes from the line of Tom Nikic from Wedbush.

Tom Nikic, Analyst

I wanted to ask about the debt transaction. So now that you've done this, essentially, do you feel like this kind of sets like you're good now like at least for a couple of years until the next big tranches come? Or is this kind of step one, and then you kind of need to do another transaction to get the capital structure exactly where you want it to be?

John Koryl, CEO

Yes. Tom, I'll talk about it; this is John Koryl. From a runway perspective, and then I'll let Todd get into the particulars. But from my perspective, what I challenge the team and our partners with is to give us the runway to prove that our model is the right model. What you've seen in this quarter and the previous five quarters is that we're on the right path; give us the time to prove it. Allow us the opportunity to become adjusted EBITDA breakeven or better, and then what can we do in '25, and how can we build on that? What they were able to do was give us 3-plus years to prove this out, and that was incredibly important to me in my role. The specifics of the transaction, I'll turn that over to Todd, but we got exactly what we wanted out of the deal in terms of the timing to be able to prove the business going forward.

Todd Suko, Interim CFO and Chief Legal Officer

Tom, this is Todd. I think to your question about how we see the capital structure going forward. Right now, we have plenty of flexibility to deal with that in the future. As this improves, I think that we'll have lots of good options for making decisions.

Tom Nikic, Analyst

All right, great. If I could just ask a quick follow-up. I just want to make sure I understand the terms. So the total interest rate on the debt is 8.75%, of which 4.25% is PIK, and 4.5% is cash? Is that...

Todd Suko, Interim CFO and Chief Legal Officer

No, Tom, it's 8.75% cash and 4.25% PIK.

Operator, Operator

Our next question comes from the line of Edward Yruma from KWM, LLC.

Edward Yruma, Analyst

It's Edward Yruma from Piper Sandler. A couple of quick ones for me. Just first, a housekeeping question. If I recall, the '25 converts were, I think, $150 million notional. So I assume this largely takes them out, the $146 million. And then I guess what triggers a PIK versus cash interest? And then maybe a bigger picture question. We've seen easing pricing of kind of hard luxury, even some promotions on things like watches. I guess, have you seen deterioration in pricing? I know you're consignment, but how has it impacted revenue growth?

Todd Suko, Interim CFO and Chief Legal Officer

Yes. The face value of the 2025 notes was $172.5 million. We took out $145.8 million of those plus another $6.5 million of the '28 to replace that with a $135 million senior secured note. That's how we get the $17 million of deleverage.

Rati Levesque, President and COO

And then I take the second part of that, Edward. The pricing piece of it and where we're seeing the consumer as far as squeezing there. Our average selling price for like-for-like items have gone up. We're getting smarter as far as ML is concerned. We've got 13 years of data on attribution and pricing. We feel really good about continuing to test higher and higher prices, better for the consignor and better for the RealReal. Our pricing algorithm and models are now expanding over more categories throughout this year, so we're happy about the progress there. As for our luxury items and where we're seeing the consumer, like I mentioned before, fine jewelry is quite healthy, ready-to-wear is back, and we're doing well with high-value overall.

John Koryl, CEO

Yes. I have to pile on. It's still amazing. I've only been here a year, but in all honesty, the amount of pricing power and knowledge we've acquired in putting all this data together, seeing a million unique SKUs every month, is really providing a lot of benefits. Not only the history of the 13 years, but the million unique SKUs per month makes it so we've seen just about everything before. Category by category, we can actually push up the pricing, try it, then we receive a lot of signal from our website from our 3 billion, 3.5 billion website visitors per year. You have this wonderful combination of an algorithm built on top, plus the experience of seeing the actual product perform in real-time. We can observe how many people obsess over it and how many people add it to their cart, all of those types of things. We've been able to offset a lot of softness using a lot of competitive intelligence on our side.

Edward Yruma, Analyst

And just on the cash versus PIK interest, what makes you tabulate? Is it your discretion? Is it?

Todd Suko, Interim CFO and Chief Legal Officer

No, it's not discretion. So it's 8.75% cash, and the PIK just accrues.

Edward Yruma, Analyst

Was 8.7% plus the PIK? I'm sorry, maybe I...

Todd Suko, Interim CFO and Chief Legal Officer

Yes, it's plus the PIK.

Operator, Operator

At this time, I would now like to turn the conference back over to John Koryl, CEO, for closing remarks.

John Koryl, CEO

Yes. Thank you for joining us today. Before closing the call, we'd like to thank our entire team at the RealReal for their hard work and dedication in delivering significant progress in our operations and results in 2023. To the team, we honestly couldn't have accomplished any of these milestones without your relentless efforts to deliver the preeminent luxury resale experience to our consignors and buyers. I look forward to the next phase of our growth in 2024 and beyond. We'd also like to thank our more than 35 million members as they join us on our mission to extend the life of luxury and make fashion more sustainable. Thank you.

Operator, Operator

This concludes today's conference call. Thank you for participating. You may now disconnect.