Earnings Call Transcript - REAL Q3 2023

Operator, Operator

Good day and thank you for joining us. Welcome to The RealReal's Third Quarter 2023 Earnings Conference Call. I would like to introduce your host for today’s call, Caitlin Howe, SVP of Finance. Please proceed.

Caitlin Howe, SVP of Finance

Thank you, operator. Joining me today to discuss our results for the period ended September 30, 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 to 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 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 third quarter of 2023. Today, we reported financial results for the third quarter of 2023. Revenue and adjusted EBITDA exceeded the high end of our Q3 guidance range, and GMV exceeded the midpoint of our guidance range. The third quarter of 2023 was our best quarter of adjusted EBITDA since the company's IPO in 2019. The improvement in our financial performance was largely driven by the consignor commission structure update we made late last year, our strategic decision to reduce direct revenue, and continued improvements in operational efficiency. If you recall, we overhauled our consignor rate card in November of 2022. This change helped us to do a couple of things. First, we were able to limit lower-priced items, which in turn reduced our variable costs and improved our contribution margin per item. Second, on the remaining portion of the lower value items and our mid-value items, we increased our take rate. You can see the impact of this change flowing through our P&L. The result in Q3 was that we grew consignment revenue by 10% while we purposely limited direct revenue, which over the course of the past few quarters has dramatically shifted the mix of our business and driven significantly higher gross margin. Finally, our operations team and our authentications centers delivered efficiencies through improved processes. In Q3, these actions combined to deliver a higher average order value, higher gross margin rate, higher gross profit dollars, lower variable costs, reduced company-owned inventory, and a significantly improved adjusted EBITDA result compared to the prior year. Over the past few quarters, we have made significant changes to our business strategy and tactics, and we are seeing the benefits of these changes in our operational and financial results. I couldn't be more proud of this team for the fantastic work they have put together throughout this year. In September, we announced that Robert Julian will step down from his role as CFO at the end of January or when a new CFO assumes the position. As a result, this will likely be Robert's last earnings call. I want to personally thank Robert for his many contributions to the business and wish him the best in his future endeavors. I am pleased to report that the search for his replacement is well underway. Looking forward, we continue to project that we are on track to deliver positive adjusted EBITDA on a full-year basis in 2024. In summary, our strategic shift to refocus on the higher margin portion of the consignment business is delivering significant progress in our results. Overall, I'm excited about the trajectory of our business. 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 Mark Altschwager from Baird. Mark, please unmute your line. If your line is muted, please unmute. Our next question comes from Marvin Fong from BTIG.

Marvin Fong, Analyst

Good evening. Thanks for taking my questions. So I guess I'd just like to start with, maybe just drilling a little bit deeper. Maybe you could just give us an update on the new revenue streams. So for example, I believe this past quarter, you tested, advancing some of those initiatives, like increasing traffic and things like that. So maybe you could just kind of give us an update on where things stand in terms of advertising and maybe the partnership strategy?

John Koryl, CEO

Yep. Marvin, thanks for the question. I'll start with that one. From an advertising perspective in Q3, we launched in July, and we did a lot of experimentation. It's still not any material result in Q3 whatsoever, and we have yet to launch warranty return insurance as well. We're looking more towards Q4 for both of those and then what we've referred to in past conversations as virtual inventory that is actually not planned to launch or make any material impact until 2024. So if you really look at it, this is a story that is all 100% about our core business and in getting our core business where we want it to be and building from that position of strength.

Marvin Fong, Analyst

Terrific and maybe just as a follow-up, I mean, it looks like in reflection of all the improvements you guys made. So ops and tech costs were down quite a bit, even though orders, I think, were up sequentially a little bit. So sounds like you're processing orders at a lower cost per order. Just could you drill down into that a little bit further? I mean, is there more that you can do there, in terms of automation or whatnot, or should we kind of think about you having to achieve your cost objectives there?

Robert Julian, CFO

Hey, Marvin. This is Robert. I'll take that one, and you're right. We have seen very considerable efficiencies in productivity in our operations, including in tech we've invested a lot in new technology and automation, and so on, and you're seeing it in our results. I don't know if there's another huge step function improvement from where we're at. We're always looking for productivity and efficiency. We've talked about in the past that 3% to 5% of productivity is a reasonable range, and we'll always be driving for that sort of in the spirit of continuous improvement, but you're right, we have seen good efficiency and productivity, and we've seen the results of the investments we've made.

Marvin Fong, Analyst

Okay, great. Thanks for that, Robert, and good luck on your next endeavors.

Operator, Operator

Our next question comes from Mark Altschwager from Baird.

Mark Altschwager, Analyst

Good afternoon. Can you hear me alright? Wonderful. Thanks for taking the question and Robert best wishes to you. So I wanted to ask about active buyer growth that did decelerate this quarter, I think, close to flat or up 1% year-over-year. I know that's a metric that has been positive in recent quarters and cited as perhaps evidence that the resale buyer isn't slowing down. So I guess a couple of things. One, are you surprised by the trends? And maybe can you elaborate on any changes in buyer behavior that you're seeing? And two, any implications regarding how you're planning 2024 and the level of profitability you expect to achieve given some of the shifts that are happening there?

Rati Levesque, President and COO

Yes. Hi, Mark. I'm going to take the first part of the answer and I'll pass it along. So as far as active buyers are concerned, we did see a meaningful deceleration, but it was also expected. So remember the changes we made in the back half of 2022 were purposely decelerating our growth and shrinking those unprofitable categories and those unprofitable units. So a lot of those items under $100 and some of that volume and category. So again, it was expected that we would shrink our active buyers and again, driven out of that low value.

Caitlin Howe, SVP of Finance

Hey, Mark. The other thing, this is Caitlin. The other thing that I would just add is, one of the other metrics that we look at to assess the health of the business is just new members, right? And so that was up again, a million versus last quarter, and so we feel good, like, we still have momentum in the business and as Rati mentioned, the active buyers piece was something that we did expect in the near term.

John Koryl, CEO

Mark, you did ask at the very end of your question about how that might impact our expectations for 2024, and I would just say that we continue to reiterate that we're on track to be positive adjusted EBITDA in 2024 for all things considered.

Rati Levesque, President and COO

Yes. And to add on a little more to that, we are looking at, to Caitlin's point, the health of the business as far as the quality of those buyers, how much are they spending? What are they looking at mid and high value and so forth? So there's other measures we can look at there, as far as the health of the buyer.

Mark Altschwager, Analyst

Okay, and as a quick follow-up, and apologies if I missed that I was redialing in during the first question, but just regarding the Q4 outlook, you essentially held the EBITDA guide while the GMV and sales are a bit below what was implied in the prior outlook. I was hoping you could unpack that a bit more and just in terms of the unchanged EBITDA, how much of that is some incremental cost efficiencies you're finding versus any shifts in revenue mix or other factors?

Robert Julian, CFO

Yes, Mark, this is Robert. I'll take that. I would just say that our guidance for Q4 has a certain amount of uncertainty in the markets today. There's a lot going on globally and geopolitically with the economy. So we're just being a little bit prudent and cautious, I would say, in taking that all into account. There's nothing in our expected results for Q4 that indicates some kind of change in trend or any backtracking or anything else that might be negative other than just a little bit of uncertainty, and we'll see how things progress, but, just again, trying to be prudent and taking all of that into account. The improvements we've seen in Q3 are expected to continue, and they are largely structural, what you've seen in our results in Q3, and so there's nothing to be gleaned or nothing hidden in terms of the Q4 results. In terms of that progression going from Q3 to Q4.

Operator, Operator

Our next question comes from Ike Boruchow from Wells Fargo.

Ike Boruchow, Analyst

Couple of quick questions from me. Congrats on the gross margin this quarter, above 70%. That's great to see. Is that, I know there's some seasonality, but now that you've kind of improved the efficiencies in the business and got the gross margins up there, is that a run rate we should use? I think 3 months ago, you said you thought you could get to the high 60s exiting the year. Just kind of curious how we should think about gross margin in the fourth quarter. And then my second question is another reiteration of the adjusted EBITDA profitable by next year. Just be helpful if there's any guidance you can kind of give us that underpins that, whether it's AOV or gross margin, or just anything to help us understand what's underpinning that assumption that you guys continue to reiterate.

Robert Julian, CFO

This is Robert. I'll take that. Regarding the gross margin in Q3, as I mentioned earlier, the changes we made are largely structural and so we had a rate card change back in November, a structural change. We have reiterated eliminating the direct business and that is a permanent shift to a much lower proportion of our total revenue coming from direct, which improved our mix and improved gross margin. We've also seen in Q3, the beginning of a return to margin within the direct business improving. When we had some quarters where we were trying to get rid of the old inventory and work our inventory down, we were doing some pretty significant discounting of that direct-owned inventory and we had some quarters where we had zero or even negative reported gross margin. What you've seen is a return to positive margin for the direct business and that's also a return to normal and more structural. The idea, and I kind of think it's around, and maybe I'm a little coy about the potential of our gross margin, but I think this level of gross margin is the new normal. In fact, as we continue to see a little bit of improvement in the direct margin within that category, you may actually see a little bit of improvement in gross margin from this level. But I think it's largely something that you can model and expect in this low 70s range for gross margin.

John Koryl, CEO

Yes, I couldn't agree more, Robert. And also, as it relates to your 2024 question, Ike, I think basically what you can take from what you've seen from us in terms of gross margin and the efficiencies that we've introduced to the core business and say, okay, we've said low double-digit growth, so somewhere around 10% growth. You add to that the new revenue streams and virtual inventory that complements our core business so well, and that's where we are very pleased with the potential progress that we can make and deliver on that commitment.

Operator, Operator

Our next question comes from Tom Nikic from Wedbush Securities.

Tom Nikic, Analyst

So the changes you made to the model, I guess, we're pretty much lapping it now. Do you think that you'll continue to see benefits from the changes? Like, do you think you'll continue to see a pay grade move higher? You'll continue to see a lower mix of the low-value items or now that we've kind of lapped it, we've kind of picked the low-hanging fruit and then from here, you know, further improvement is going to come from other initiatives?

Robert Julian, CFO

Hey, Tom. This is Robert. Thanks for the question. One thing that I would say embedded in your question is the idea that we are now lapping the changes that we've made, and I'm not sure that's quite accurate. If you think about some of the changes we've made, I do think that even Q1 of 2024 is going to have comparisons to a Q1 from this year, and there is still a pretty big year-over-year change. We made the commission structure of the rate card change on November 1st. We've been working down our direct revenue as a percentage of revenue pretty consistently for the last few quarters, but we have not fully lapped that either. I do think that there's still improvement, and we talked about at the beginning of this year that the changes we have made were going to really impact the second half of 2023, and that has proven to be very true and accurate. The first half of 2023 still has some impact on a year-over-year basis going into 2024. Therefore, you should expect some improvement with what I would call a rollover effect of getting the full year effect of the things we did in 2023 reflected in the 2024 results, and that'll come in Q1 and Q2. So there's still a little ways to go in terms of lapping the entire impact of the changes we've made to the business model.

Tom Nikic, Analyst

Thanks very much, and Robert, best of luck in your future endeavors.

Operator, Operator

Our next question comes from Edward Yruma from Piper Sandler.

Edward Yruma, Analyst

Hey, good afternoon, guys. Thanks for taking the question. I guess first, now that you're pushing fewer units through the authentication facilities, are you seeing any kind of inefficiencies as a result of that? And then just as a follow-up back on the macro commentary, were you actually observing softer trends quarter to date which drove the guidance revision, or is it simply just lots of stuff in the press and just concern about holiday spend overall? And then maybe one other follow-up. I know historically you have had out-of-policy returns that kind of juice the direct numbers post the holiday season? Have there been any changes to return policy?

Rati Levesque, President and COO

So I'll start with your last question first. Out-of-policy returns, because that's an easy one. We're not seeing any changes there at this time, so pretty flat compared to what we've seen in the past as far as historic numbers go. The first question on fewer units coming through, are you seeing less efficiency? No. We are not seeing less efficiency in specifically our operations, and I'm talking about, and that's because a lot of what we did and a lot of the investments, like Robert mentioned earlier, was around accelerating operations and their efficiencies. Transportation, you've heard us talk about carrier diversification. All of that is coming to fruition. Inventory control, making sure that we're getting tighter about each item coming through the process, also adds efficiency. So we really feel good about the direction and the impact that we've had there with our investments. And then as far as on the macro piece, and I'll let Koryl and Robert add in, as far as the prudent kind of guidance. So it's a little bit of a mix as far as what we're seeing on buyer behavior. First of all, I want to say supply is really healthy and good. We always said we were a supply-constrained business. That is solid right now, and we're feeling really good about where we're going there. The consumer is quite healthy in buying jewelry, watches, handbags, those key products. So that is good news. Where we are seeing some softness is in ready-to-wear. So it's kind of a category-specific answer, and we're seeing the consumer be a little more price-sensitive to that. So we're watching for that, and again, nothing that we're alarmed about, but we think it's the right thing to do to be prudent in our guidance.

Robert Julian, CFO

Yes. No, I think it's a real opportunity. Honestly, Edward, for us to like, we were a lot more precise in the promotions we were running to incentivize supply. When we made the commission changes, we really saw a pullback not only in low value, but we also had some softness in some mid-value. So we became a little bit promotional there. We have a more surgical approach now, talking to specific customers about specific actions. With that capability, it was built in such a way that when we're building the personalization, we can use the exact same personalization capabilities to solicit demand. So you haven't heard us talk about demand much, not at all since I've been here, where we've always talked about being a supply-constrained business. Now, there are certain elements in certain categories and certain price points where we actually do have to adjust our prices right, and where we do have to actually become a little bit more promotional. The good news is we have a very large pool of members to draw from, and we can actually see a lot of their behavior, even in the absence of transactions; we can see many people who are obsessing over certain products and how many people are visiting the site on a regular basis. We're observing all those macro and micro trends together to ascertain what we have to do to ensure we keep the throughput going through the business at the right pace.

Edward Yruma, Analyst

Maybe just as a follow-up to that, does that mean you're adjusting the payouts? I mean, not the grid obviously, but kind of what you initially expect to pay out to the consignors?

Robert Julian, CFO

When we had to be a little more promotional to drive supply earlier in the year, we had some promotional activity there. This is more on the actual buyer side now. So to reinitiate a lapsed customer, to get somebody to buy in a category that they haven't bought before, that's the type of promotions I'm talking about, Edward.

Operator, Operator

Our next question comes from Ashley Owens from KeyBanc Capital Markets.

Ashley Owens, Analyst

Hi. Thanks for taking the question. Just wanted to ask about marketing dollars as they came down during the quarter. Was this an intentional pullback, or did you see some efficiencies? And then just any color on how we should think about the rate going forward would be helpful as well.

Rati Levesque, President and COO

Yeah. Thank you for that question. As far as marketing efficiency, that wasn't an intentional pullback some of the areas, but again, driven out of efficiencies. So we were able to segment out our base, again, from low value, mid value, high value, consignors and customers really targeting them in the right areas. You've heard us talk about mid value and how that was soft. The marketing team is doing a great job to continue to find those efficiencies in general. I'm sorry. Was there a second part, a question?

Ashley Owens, Analyst

Oh, yeah. Just how we should be thinking about the rate going forward.

Rati Levesque, President and COO

We continue to offer and operationalize that and find efficiencies. So, you know, like any other department, whether it's operations, marketing, sales, we'll continue to find efficiencies there.

Operator, Operator

Our next question comes from Rick Patel from Raymond James.

Rick Patel, Analyst

Good afternoon. Can you talk about what guidance assumes for the size of the direct business in the fourth quarter? And any thoughts on the right way to think about the size of the direct business in 2024 and to what degree you see it impacting GMV and revenue going forward?

Robert Julian, CFO

Rick, this is Robert. I'll take that one. You saw in Q3 that our direct revenue as a percent of total revenue was in the low teens, and to be honest, that's gotten down to a pretty low level. As we have mentioned before, there will always be some direct business. There are out-of-policy returns to drive direct business, and there's found inventory that sometimes creates direct business. We have more or less stopped the open-to-buy generally, although there are some very specific items, very high demand items, whether it's Rolex watches or Hermes handbags or so on, that we may continue to do some purchases, and so there will always be some direct revenue. But this current level in the low teens is probably getting to be around the new normal, and so I think what you should expect is something very similar to that in Q4 and also going into next year.

Rati Levesque, President and COO

The good news about us is that we're quite dynamic when it comes to supply. Our sales team does a really nice job of bringing in the supplies that the merchants need or the customers need at the right time. We are looking at supply versus units, as we've talked about in the past, to retail value. So that quality, that higher-end product, the sales team gets more points for, for example. So as far as watches, handbags, and jewelry, we feel quite healthy when I look at, again, mid and high-value product year-over-year as far as inventory to sell. So, the team does feel good about supply through the end of the year. So that puts us in a good place in Q1 as well.

Operator, Operator

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

John Koryl, CEO

Thank you. Thank you for joining us today. Before closing the call, I want to take a moment to thank our team at The RealReal. I am humbled to work with such a dedicated, passionate, and professional workforce. Thank you for your daily efforts to fulfill our mission of sustainability, live out our values of excellence, and move our business forward. I'd also like to thank our more than 34 million members that are joining us on our mission to extend the life of luxury and make fashion more sustainable. Thank you.

Operator, Operator

This concludes today's teleconference.