Earnings Call Transcript - TDUP Q1 2023

Operator, Operator

Good afternoon, ladies and gentlemen, and welcome to the thredUP Q1 2023 Earnings Conference Call. This call is being recorded today, Tuesday, May 9, 2023. I would now like to turn the conference over to Lauren Frasch, Head of Investor Relations. Please go ahead.

Lauren Frasch, Head of Investor Relations

Good afternoon, and thank you for joining us on today's conference call to discuss thredUP's first quarter 2023 results. With me are James Reinhart, thredUP CEO and Co-Founder; and Sean Sobers, CFO. We posted our press release and supplemental financial information on our Investor Relations website at ir.thred.com. This call is being webcast on our IR website, and a replay of this call will be available on the site shortly. Before we begin, I'd like to remind you that we will make forward-looking statements during the course of this call, including, but not limited to, statements regarding our earnings guidance for the second fiscal quarter and full year of 2023, future financial performance, including our goal of reaching adjusted EBITDA breakeven, market demand, growth prospects, business strategies and plans, our ability to attract new buyers and the effects of inflation, increased interest rates, changing consumer habits and general global economic uncertainty. These forward-looking statements are not guarantees of future performance, involve known and unknown risks and uncertainties and our actual results could differ materially from any projections with the performance or results expressed or implied by such forward-looking statements. Words such as anticipate, believe, estimate and expect as well as similar expressions are intended to identify forward-looking statements. You can find more information about these risks, uncertainties and other factors that could affect our operating results in our SEC filings, earnings press release and supplemental information posted on our IR website. Any forward-looking statements that we make on this call are based on assumptions as of today, and we undertake no obligation to update the statements as a result of new information or future events. In addition, during the call, we will present certain non-GAAP financial measures. These non-GAAP financial measures should be considered in addition to, not as a substitute for or in isolation from GAAP measures. You can find additional disclosures regarding these non-GAAP measures, including reconciliations and comparable GAAP measures in our earnings press release and supplemental information posted on our IR website. Now I'd like to turn the call over to James Reinhart.

James Reinhart, CEO and Co-Founder

Good afternoon, everyone. I'm James Reinhart, CEO and Co-Founder of thredUP. Thank you for joining thredUP's First Quarter 2023 Earnings Call. We are excited to share thredUP's financial results and key business highlights from our first quarter. In addition to our financial results, we will provide an update on the current conditions for resale and how the thread of customer is faring in a stubbornly challenging macro environment. We will then discuss key company-specific initiatives we're pursuing to enable sustainable profits and growth, and we'll provide an update on our Resale-as-a-Service business and Remix. I will then hand it over to Sean Sobers, our Chief Financial Officer, to talk through our first quarter 2023 financials in more detail and provide our outlook for the second quarter of 2023. We'll close out today's call with a question-and-answer session. Let's begin with our Q1 results. We kicked off 2023 with a strong Q1, delivering revenue that exceeded the high end of our guidance. We achieved revenue of $75.9 million, increasing 4% year-over-year and gross profit of $51.1 million, increasing 2% year-over-year. Our consolidated gross margin was 67.3%, down from 69.1% a year ago. We attribute this to the continued growth of Remix in the more challenging promotional environment in Europe. However, we're proud to report record U.S. gross margins of 74.5%. Active Buyers and orders in Q1 remained steady quarter-over-quarter at $1.7 million and $1.5 million, respectively, with both declining slightly year-over-year. Importantly, we have seen active buyer trends improve each month of this year, and we expect buyer growth to turn positive year-over-year in Q2 and throughout the rest of 2023. We're proud to share our Q1 adjusted EBITDA of minus 8.7%, which was an improvement of over 900 basis points or $6 million year-over-year. And to put a fine point on our improving operating leverage. Our operations, product and technology costs were down by 8% year-over-year, while our revenue grew 4%. And typically on these calls, I'd like to take a moment to share our perspective on what we're seeing in the apparel landscape. For several quarters now, we have faced a combination of budget shoppers pulling back on discretionary purchases at the same time that retailers have been overperforming with apparel and leaning into promotions to get rid of excess inventory. As a result, Resale's value proposition has been weakened by the exceptional bargains being offered for new clothing. We've been running the business under the assumption that these headwinds did not abate in the near term. But despite this backdrop, we are managing the variables that are under our control across our marketplace. We are leveraging our data-driven insights to optimize our unit economics. We're evolving our consumer acquisition and retention playbooks to drive customer growth and focusing product and technology investments in areas we believe drive margin expansion. I'd also like to spend a few moments speaking to the budget shopper specifically. A few quarters ago, we provided insights on the budget shopper from our own data, and I'd like to provide an update on what we're seeing today. After pulling back on discretionary spend at the midpoint of last year, we've observed that by and large, the budget shopper has continued to stay on the sidelines into Q1. Compared to the midpoint of last year, we've seen a 300 basis point decline in the number of budget shoppers on thredUP. Comparatively, we've seen a 700 basis point increase in the number of upscale shoppers buying with us during that same time period. We're also continuing to see a clear bifurcation of thredUP customer purchasing behavior, with more premium shoppers leaning in and more value shoppers leaning out. Year-over-year, the average order value of our deep discount subsegment of thredUP customers declined 24%, while our upscale shoppers' average order value increased 6%. So while we are benefiting from some shoppers trading down, we're also facing the headwinds of budget shoppers sitting out. While thredUP still offers excellent value to budget shoppers, we have been adjusting our strategies in the near term to target the non-budget segment as they are currently more engaged in the apparel market. When macro conditions improve, and the retailer promotions normalize, we anticipate budget shoppers will return to our marketplace and provide a nice tailwind for growth. As I noted at the top of our call, we are beginning to see the signs of this budget shopper momentum with sequential improvements each month of this year. Now let me turn to the specific initiatives we're implementing to improve monetization in our marketplace and to optimize our unit economics. First, we're experimenting with a variety of levers around inventory acceptance. We've recently started testing a new fee for our Clean Out Service to improve the quality of supply in our marketplace. Initial results indicate that our bag yield of resellable items and the sell-through of items we've received have both increased since the changes have been implemented. We're also selecting high-margin fees that enable us to invest in a better Clean Out service for our sellers. Importantly, we've seen no reduction in demand for our Clean Out service. And this is no small feat. Better supply, better yield, better sell-through, and higher fees. Second, in conjunction with these fees, we're shaping inbound supply through seller incentives and messaging around the type of clothing we want. When that supply is being processed at our distribution centers, we're sculpting the inventory more aggressively to list a more desirable assortment online. Third, as we process cleanout kits, we are becoming more selective in our acceptance and merchandising. Our bag backlog has come down, now sitting at an average of 6 weeks, which is as low as 1 week if you paid for our VIP services. This is the lowest our backlog has trended since before the pandemic. With a tighter backlog, we can better incentivize the right sellers, flex our fees and payouts to accelerate the right mix of goods and lower the overall cost of managing long backlogs in terms of storage, customer service and seller satisfaction. Fourth, we are shaping a new vision for customer retention and returns reduction using our data platform. It's called the thrift guarantee. And with it, we boldly envision a customer journey that aims to achieve the highest levels of customer satisfaction on thredUP. The thrift guarantee enables this by intercepting customers when they are most likely to be unhappy with their experience on thredUP, offering them easy, immediate and automated resolutions that drive them back to shop. Our first project for the thrift guarantee has been centered around reshaping our returns experience with a feature called Keep-for-credit. With Keep-for-credit, we're offering customers who would like to return low-priced items the option to keep those items in exchange for shopping credit. With the Keep-for-credit approach, we've seen a positive impact on customer satisfaction and repurchase rates, as well as lower costs of returns for items whose price points don't justify the return and reprocessing costs. Across the thrift guarantee and Keep-for-credit, our overarching goal is to delight our customers, drive retention and improve the margin profile of our business. Early signals show these strategies have been very effective in accomplishing these goals. So to summarize, through the implementation of cleanout fees, supply shaping, and thrift guarantee experiments, we are unlocking new and better ways to acquire and retain our customers while simultaneously bolstering our unit economics and positioning our business for sustainable growth. We believe that the continued execution of these initiatives will result in enterprise value creation over time. Let me turn to Remix and provide an update on the progress we're making with our European resale business. It's been nearly 2 years since Remix became a part of thredUP, and we're impressed with how resilient the business has been despite high inflation, high energy costs, and the War in Ukraine. Q1 was a strong quarter for Remix. They continue to grow active buyers and net revenue year-over-year. Remix also officially launches their consignment offering in Q2, and our goal is to shift an increasing portion of the business to consignment over time. This marks the start of a long-term strategic shift for Remix that we expect to improve Remix's gross margins, generate further gross profit, and contribute to long-term free cash flow. All in all, we remain excited about Remix's positioning to take share in the second-hand market in Europe, a market which GlobalData expects to grow to $95 billion by 2027. Now I'd like to turn your attention to our Resale-as-a-Service business, also known as RaaS. We closed out 2022 serving 42 brand clients through RaaS, and strong momentum has carried into 2023 as more retailers look to adopt more circular business models and to attract and retain customers. Notably, we're seeing more global brands entering the resale ecosystem. We recently launched new programs with American Eagle, H&M, TOMS, and SoulCycle as one of the lead end-to-end resale providers. We're thrilled to enable resale for brands across the apparel ecosystem. We also recently announced an exciting partnership with the Container Store, where shoppers will be able to get a thredUP Clean Out Kit from any of the Container Store's 97 retail locations across the country. It's exciting to venture outside of the fashion industry and work with a nontraditional retailer to extend our impact by reaching a broader swath of American consumers looking to be more sustainable. This further cements thredUP's RaaS as the go-to destination for resale apparel, and we hope to expand our client roster with more strategic partnerships like this one. As a reminder, RaaS enables the world's leading brands and retailers to offer scalable resale experiences to their customers by leveraging thredUP's marketplace infrastructure. RaaS amplifies our supply advantage, increases our sell-through and return on assets, and expands our long-term profitability metrics by adding sources of recurring high-margin revenue. Next, I'd like to provide an update on our goal of reaching adjusted EBITDA breakeven. We have made significant progress each quarter since we announced our intention, and I want to reiterate our plan to achieve EBITDA breakeven on a quarterly basis and specifically in Q4 of 2023. The performance we've had in Q1 and what we're seeing in Q2 only confirms our confidence in achieving this milestone and, importantly, increases our confidence in achieving free cash flow breakeven shortly thereafter. With that in mind, I want to emphasize that as a management team, we have turned more of our attention to the opportunities in front of us to grow faster and to delight more customers over time. We see a number of ways to invest in growth this year that we believe will create improved free cash flow dynamics in the future. We've played good defense over the past year, and we look forward to sharing more of our offensive playbook in the quarters to come. While we remain steadfast in our progress towards profitability, we recognize that profits alone do not encompass the entirety of our mission. thredUP is a company that also has a strong sense of purpose which is evident in the impact we're making on the fashion industry and the planet. We take pride in our business and brand alignment with ESG strategy. Today, we reaffirm our commitment to balancing purpose and profit by dual listing on the Long-Term Stock Exchange or LTSE. The LTSE was designed to align businesses like ours with investors who support long-term value creation and good governance with a social and environmental conscience. Given the growth of the second-hand market, we see an opportunity for thredUP to make an outsized impact. We believe the next phase of generational enterprises will lie at the intersection of purpose and products, and we are excited to be at the forefront. So let me wrap up. But before I turn it over to Sean, I want to close by restating the strength of our Q1 results despite a choppy environment out there. In particular, I want to highlight the flexibility and strength of our marketplace business model. It is precisely the fact that we run a marketplace that has allowed us to react and flex everything from the customer mix to the supply mix to our monetization. Second, as I said in our earnings from a year ago, we will continue to balance the demand for near-term scrutiny with our commitment to investing for long-term value creation. I believe we are delivering on this commitment, and while we aren't done yet, I'm immensely proud of our progress. I want to take this opportunity to applaud the whole thredUP product team for their incredible work over the past 9 months, meeting every challenge with grit and grace. I want to give a high five to each of you for your creativity, your resilience, adaptability, and the relentless pursuit of profit for the purpose. I am looking forward to what we will invent next in our pursuit of a more sustainable future for fashion. It's an exciting time to be at thredUP right now, and I'm fired up about the road ahead. And with that, I will turn it over to Sean to go through our financial results and guidance in more detail.

Sean Sobers, CFO

Thanks, James, and again, thanks, everyone, for joining us on our first quarter 2023 earnings call. I'll begin with an overview of our results and follow up with guidance for the second quarter and full year. I will discuss non-GAAP results throughout my remarks. Our GAAP financials and a reconciliation between GAAP and non-GAAP are found in our earnings release, supplemental financials, and our 10-Q filing. We are very proud of our Q1 results. For the first quarter of 2023, revenue totaled $75.9 million, an increase of 4% year-over-year. Consignment revenue was down 2% year-over-year, while product revenue grew 17%. The outsized growth in product revenue is attributable to a mix shift driven by the growth in our European business and our RaaS supply. Currently, the majority of revenue from both RaaS and the European business falls under product revenue. But we are at different points in the process of transitioning each of these businesses toward consignment. We expect the majority of our RaaS clients to operate on a consignment basis by the end of the year, while the process of transitioning Europe to U.S. levels of consignment will take place over the next few years. As a result of these changes, we would expect consignment trends to improve in the second half. While the transition of these businesses to consignment should be a tailwind to gross margins over time, we would expect it to slightly mute revenue growth due to the accounting treatment. As a reminder, consignment payouts used net revenue, while payouts are in COGS and reduce gross margins. Active buyers declined to $1.7 million, a decrease of 3% for the trailing 12 months, while orders declined to $1.5 million, a decrease of 8%. These declines were due to a difficult macro environment in which our budget customer remains on the sidelines as well as a reduction in our Q1 marketing spend. As we expect to see the promotional environment subside and the return on these dollars improved in the second half, we plan to increase our marketing spend on a year-over-year basis. For the first quarter of 2023, gross margin was 67.3%, a 180 basis point decline over the same quarter last year. We are proud to report that our U.S. gross margin reached a record 74.5% despite an aggressive promotional environment. The decline in our consolidated gross margin was entirely due to dynamics driven by our European business. The continued outperformance of Europe's lower-margin operating model continues to pressure our consolidated results as it becomes a larger portion of our total revenue. We are excited to preserve the meaningful growth opportunity in Europe, even though it will come with a near-term drag on gross margins. However, when we look down the road at expanding our consignment revenue base and driving sustainable profits, we believe this is the right strategy for our long-term goals. For the first quarter of 2023, GAAP net loss was $19.8 million compared to a GAAP net loss of $20.7 million in the same quarter last year. Adjusted EBITDA loss was $6.6 million or negative 8.7% of revenue for the first quarter of 2023. This represents an approximate 910 basis point improvement compared to the same quarter last year as we tightly manage expenses and leverage our investments on higher revenue. In fact, we are proud to report that our hard work drove a 4% year-over-year revenue increase on a 7% decline in operating expenses. Turning to the balance sheet, we began the first quarter with $111 million in cash and marketable securities and ended the quarter with $99.5 million. Our cash usage from operations was $4.5 million, while we spent $5.7 million on CapEx as we wind down the first phase of investments in our Dallas distribution center. Based on our Q1 progress and strategic initiatives we are executing in our business, we now believe that we'll be able to reach adjusted EBITDA breakeven in the fourth quarter of 2023. For us, reaching breakeven is just a waypoint on our path to free cash flow and profitability. We believe this timeline balances our commitment to breakeven with foundational investments in our long-term goals of growth and expanding profits. When modeling our cash flow, adjusted EBITDA and our CapEx spend are the key drivers of positive cash flow, given that our working capital needs are minimal. We believe that both of these will improve materially in the second half of 2023. We significantly reduced our cash burn by nearly half in Q1 versus the previous quarter and expect this spend level to decrease even more significantly in the second half of the year. Our plan to reduce cash usage will be driven by diminishing CapEx needs and improving EBITDA as we implement a number of strategic initiatives across our business, streamline our cost structure, and leverage our investments. After spending $43 million of CapEx in 2022, we continue to plan to significantly reduce our CapEx in '23 to about $15 million and then to maintenance levels until 2025. We currently expect to spend approximately $6 million in Q2 and then ramp down to maintenance levels of about $1 million per quarter in the second half of the year. Due to our significantly reduced CapEx needs and our ability to manage our expense structure, we expect to be able to fund the core business through our existing cash. As a result, we want to reiterate that we do not anticipate our cash and marketable securities balance falling below $50 million before reaching free cash flow positive nor do we expect to turn to the capital markets or draw on our existing debt before then. We are pleased to provide guidance that reflects both our ability to operate in a challenging environment and the strengths of our marketplace model. While the promotional landscape remains competitive and the stability of our consumer remains uncertain, we are not only flexing the advantages of our marketplace, but also executing on strategic improvements and managing expenses to ensure that we adapt to this environment and emerge a stronger, more profitable business. Turning to guidance. For the second quarter, we expect revenue in the range of $80 million to $82 million; gross margins in the range of 64.5% to 66.5%, due to our growth in our European business; adjusted EBITDA loss of 9.5% to 7.5% of revenue; and basic weighted average shares outstanding of approximately 104 million. For the full year of 2023, we now expect revenue in the range of $320 million to $330 million, gross margins in the range of approximately 65% to 67% as we now expect our European business to grow faster than originally anticipated; and adjusted EBITDA loss of approximately 7.5% to 5.5% of revenue; and weighted average shares outstanding of approximately 106 million. In closing, we believe that our first quarter performance demonstrates our ability to flex our marketplace model in response to a highly dynamic environment. Our model allows us to react to the environment in which we find ourselves, a feature we believe has allowed our results to distinguish themselves in the current landscape. We are also excited to deliver a Q2 outlook and a full year guidance that convey confidence in our ability to make substantial progress towards breakeven and ultimately profitability. We believe that Q1's results and our Q2 plan demonstrate our capacity to execute on a variety of strategic initiatives that enable us to control our destiny even amidst the challenging consumer environment. James and I are now ready to take your questions. Operator, please open the line.

Operator, Operator

Your first question will come from Ike Boruchow at Wells Fargo.

Ike Boruchow, Analyst

One for James, and I have a follow-up for Sean. James, at a high level, the retail environment is clearly slowing and people are struggling, but your company seems to be going against the trend, raising revenue guidance for the year. Can you speak to the confidence you're gaining in real time? Additionally, what leads you to expect further growth in revenue for the second half of the year?

James Reinhart, CEO and Co-Founder

Yes, sure. Yes, I mean, I think, look, we've said for a number of years, we don't think about ourselves as a retailer. It really is a marketplace. And I think what's working is all the elements of our marketplace business model. And so I would say it's all the stuff we're doing internally around everything from sellers and improving the merchandise to how we're changing the mix to address what buyers want to the curation that we're working on the site, and the improvements we've made in returns with our Keep-for-credit initiative. So I think it's really just showing the power and flexibility of the business model at a time like this, which I think is causing that distinction from a traditional retail environment. And I think all those things are still relatively early in their cycle for how they're impacting our P&L. And so I think all those internal improvements compounded with what we're seeing with sequential improvements on the buyer front, I think, are giving us increased confidence that the pieces are coming together for the business to really work quite well, even despite a choppy environment in the back half. So I think the team is pretty confident in the guide and what we're thinking for the back half of the year. You said you had a follow-up.

Ike Boruchow, Analyst

Yes. James, I'm not sure if this is for you or Sean. I want to ensure that I fully understand the details of the profit and loss statement. You've been discussing a run rate of $80 million to $85 million for nearly a year, which you expect to lead to adjusted EBITDA breakeven in the fourth quarter. However, you are guiding for $80 million to $82 million in the second quarter, which still reflects an EBITDA loss. I'm trying to reconcile this because I assumed that with that revenue run rate, breaking even would be achievable sooner. Is there a seasonal aspect to the second quarter's costs that differs from the latter half of the year? That's my question.

James Reinhart, CEO and Co-Founder

Yes. I'll take it, and Sean, you can jump in if there's anything else. As we mentioned in our prepared remarks, we see opportunities to invest in the business, particularly in customer acquisition and the trends we are observing with budget shoppers returning to the platform. There are additional opportunities to enhance our operations that could improve unit economics over the next several quarters. We believe we have two strategies to consider. One option is to be more conservative and meet breakeven targets based on our previous communications. However, we see potential to build a stronger business not just for the upcoming quarter, but for the next couple of years. Given our confidence in our cash position and reaching breakeven in Q4, I informed the team that we feel assured we can accelerate our efforts. This is what's driving our strategy to lean in.

Operator, Operator

Your next question comes from Tom Nikic at Wedbush.

Tom Nikic, Analyst

James, Sean, it seems you're quite pleased with Remix's progress, and you mentioned that you anticipate faster growth than you previously expected. Can you clarify how we should view Remix's profitability compared to your earlier expectations? When you made the acquisition, you indicated that while the gross margin was lower, they were EBITDA profitable due to being slightly underinvested. Are you discovering that you can stimulate Remix's growth with less investment than you initially believed, which is aiding its path to profitability?

James Reinhart, CEO and Co-Founder

Yes, Tom, I mean, I think Remix continues to exceed our expectations. And I think given the relative size of that business and the opportunities for the size of the market in Europe, we see continued ways to deploy capital to grow that business very similar to what we did in the U.S. Because there was a time when thredUP wasn't a fully consignment business either, we could acquire a lot of customers and then sort of expand margins over time as we moved more and more to consignment, and we see a similar playbook can come to fruition in Europe. And so we don't want to turn down opportunities to really grow that business given the paybacks that we're seeing and how the customer LTVs are playing out. And so I think we're leaning into the European business and believing that we have the playbook to improve gross margins over time. I don't know, Sean, if there's anything on that.

Sean Sobers, CFO

Yes, I want to emphasize that they are surpassing our original expectations in a challenging environment. Additionally, the returns on their marketing investments are very encouraging, and everything looks promising. That's how we are managing to achieve these results.

Operator, Operator

Your next question comes from Dylan Carden at William Blair.

Dylan Carden, Analyst

I would like to explore the fees business further. Can you provide an overview of how extensive that trial has been? It's somewhat surprising that, despite your comments indicating that it hasn't significantly influenced demand, it seems like there are net improvements in the business. Could you clarify how this affects the business model, how broad the impact is, and its potential for expansion based on your initial observations?

James Reinhart, CEO and Co-Founder

Yes. Dylan, it's still early in the deployment of fees across the business. So we expect to continue to generate more fees over time from sellers, but I would still categorize it in the experimental phase. But we are seeing really promising results. And I think what it points to is just how strong a product-market fit the thredUP cleanout experience really is. Consumers are willing to pay the fees because they value the service so highly. And so I think we're starting to process more bags, increase our processing times, and sellers really appreciate that. So we see the fees as a nice tailwind over the next few years. And yes, while it may seem counterintuitive that there would be no pushback. Remember that people really value the cleanout service for its convenience and it's not necessarily just about making money. And so I think for a period over the last few years where we had to turn sellers away on a regular basis, many are really glad to have the service available at all times for them, even with a little bit of this fee involved itself. So yes, I think it's all around really positive for our seller community and it impacts the P&L in a positive way.

Sean Sobers, CFO

Dylan, I want to provide some clarity for those looking to understand the model. Keep in mind that Europe does not charge fees, and our RaaS suppliers are not being charged fees either. Therefore, there is a segment of the population that is not included in terms of fee coverage. Additionally, we are still in the testing phase, so things are not at full capacity. As you consider projections for '24 and '25, please keep these two points in mind when estimating potential fee revenue from sellers.

Dylan Carden, Analyst

And it's at the back end, right? So it's actually deducted from, I guess, how it functions as well. There's some nuance, right?

Sean Sobers, CFO

So you don't give your credit card upfront or anything like that. It comes out of your payout. So there is no friction on the front end other than you get to know that you're going to pay some of your payout for the seller fees or the supply piece. What's really good about that is we've found out is, not only does it really create more items at a given kit or a given bag, this is actually higher quality items. So what we're able to accept out of a bag is a higher number. So it's been really fruitful not just from a fee generation test, but also on the quality of supply and the amount we get out of per shipment.

Dylan Carden, Analyst

Great. And then just quickly on the sort of budget versus higher-income customer. Can you just remind us kind of how your customer base has historically skewed between those two buckets? And I guess following on from the fee initiative, is the intention here? Or is the actuality that you're kind of shifting that further up the demographics?

James Reinhart, CEO and Co-Founder

I mean I think when we talked last year, I think we communicated that about 1/3 of our customers fell into that budget shopper segment. And I think now the budget shopper makes up a smaller portion of our customer base because I think many of them are getting squeezed on a discretionary basis, given inflation. So a number of those, I think, are sitting out. But the goal isn't to become a luxury business by any means, but subtly shift the mix of goods that we're getting to be a slightly more premium shopper. And again, I think that speaks to the power of our marketplace, which is we can evolve subtly the customer mix both on the buyer side and the seller side. We can subtly shift the mix of goods and the price points to meet sort of the moment of where we are in the cycle. But we feel very confident that as the budget shopper returns, we will have an incredible assortment to meet their needs as well. But I think it speaks to the power and flexibility in the business right now.

Operator, Operator

Your next question comes from Anna Andreeva at Needham & Company.

Anna Andreeva, Analyst

We had two quick questions, I guess. To Sean first. I wanted to understand the gross margin pressure a bit that you're expecting in the second quarter. Is that entirely driven by Remix and are the U.S. gross margins expected to be up? And then what's driving the recovery in the back half as implied by the annual guidance? I guess especially if Remix now is growing faster than you previously thought, which is great. And then secondly, with processing times, I think you're at 6 weeks currently. Is that the right number to think of for the second quarter? And curious on the fees, what are some of the learnings when the seller picks up the rush option? I think that's about $23 in cost currently. Is the rush growing as a percentage of the mix?

Sean Sobers, CFO

Thanks, Anna. I'll begin and then James can conclude. Regarding the gross margin pressure, you're right; it's primarily the mix from Europe that's impacting Q2 and somewhat for the entire year. This isn't solely due to the size of our business; the promotional landscape in Europe also plays a role. Therefore, we are experiencing a dual impact from Europe. However, looking ahead to Q3 and Q4, we expect an improvement in gross margins in Q3, mainly because the U.S. business is anticipated to make up a larger portion relative to Q2. This is a key factor. Additionally, Europe is generally seeing improved gross margins, which also contributes positively. As we consider Q4, we should note that it is our largest quarter, so there may be some slight regression there due to the larger European business. Consequently, if you expect Q3 to perform better than Q2, then Q4 might be a bit lower than Q3.

James Reinhart, CEO and Co-Founder

Yes. And on the processing times, I think, Anna, we've said in the past, we really want to look at that 2- to 3-week window is being ideal. And I think that still remains true. I think being under a month is probably the right timeline for the consumer, and we continue to make progress. But we have found that just even getting down to 6 weeks has been a really nice positive sign that we're hearing from sellers. So that's sort of the target. And on the VIP side for rush processing, that has always been a modest part of what we do. And that tends to be a seller who is more professional and tends to have higher-end luxury items and they're trying to monetize them at a higher rate. They're less of our normal selling population. They're really looking for convenience. And so we want to meet the needs of that seller. But we're really focused on the majority of our sellers, which are looking to clean out their whole profit and do it in the most convenient way.

Operator, Operator

Your next question comes from Alexandra Steiger at Goldman Sachs.

Alexandra Steiger, Analyst

Congrats on making progress on a number of initiatives. So as a follow-up to the first question on revenue trends, can you maybe comment on the month-over-month cadence for Q1 specifically the exit rate versus January levels as it relates to some broader consumer trends but also some of the internal KPIs you're tracking? And then second, I also want to follow up on the cost reduction initiatives you've laid out. Can you give us an update on where we are? And have you eventually identified any opportunities that could end up being incremental?

James Reinhart, CEO and Co-Founder

Sure, I'll start with the first couple of points and then pass it to Sean for the cost reduction aspect. We observed that January was relatively strong initially, while February and March were a bit slower compared to January. This observation is more about the larger economic picture. However, much of our internal efforts were designed to counteract these macro trends. The initiatives we launched towards the end of Q4, focusing on sculpting, improving returns, and promoting keep-for-credit, began to gain traction as we progressed through the first quarter and have continued into the second quarter. The internal dynamics and marketplace dynamics we are leveraging on both fronts are allowing us to perform better than conventional retailers. We remain optimistic about how these trends will evolve into Q2 and throughout the year. Sean, do you have anything to add regarding the cost side?

Sean Sobers, CFO

Yes. Regarding costs, what we outlined at the end of last year is now fully in effect. This is affecting the first quarter and will also impact the second quarter. We are being very cautious with every new dollar we spend, including new hires and travel, and we are highly focused on managing costs. Additionally, while we often discuss how improved returns enhance revenue, there is also a cost component to consider. By reducing returns, we decrease the costs associated with processing those returns, which is a positive outcome.

Operator, Operator

Your next question comes from Trevor Young at Barclays.

Trevor Young, Analyst

First one for James. Regarding the RaaS model, as more retailers and brands see it as an opportunity, when brands approach you or you reach out to them, what are the main reasons they might choose another partner or prefer more direct involvement over you handling it for them? The second question is about new buyers; are they changing their purchasing behavior in terms of average order value, number of items per order, or purchase frequency? I'm curious if there's been any shift due to broader market trends or changes in your inventory focus away from the typical shopper.

James Reinhart, CEO and Co-Founder

Yes, Trevor. On the RaaS side, when a brand chooses another partner, it typically comes down to two main reasons. First, they may want to experiment in a peer-to-peer setting and prefer a completely hands-off approach. However, we are seeing that brands exploring this route often find insufficient liquidity in those marketplaces due to seller-side friction. Consequently, some of these brands and retailers are reaching out to us for support after their initial attempts prove unsuccessful. The second reason involves brands committed to refurbishment and repair, seeking a more premium experience. However, we believe scaling in these refurbishing models is challenging and often not lucrative, so we are not pursuing those deals. These are the primary reasons why we tend to lose certain opportunities. On the buyer side, the new customers entering our marketplace are showing positive unit economics and performance dynamics. They are purchasing at price points that benefit us, have good lifetime values, and their return rates are strong. We are pleased with the customers we are attracting. To support them, we need the right product mix, which has improved with supply changes. Additionally, we have a strong selection for budget shoppers, and we feel confident in catering to them whenever they return in the coming quarters.

Operator, Operator

Your next question comes from Rick Patel at Raymond James.

Rick Patel, Analyst

Well done on the progress. Question on the mix shift between budget and upscale shoppers, how much of this reflects natural market conditions as budget consumers get squeezed? And how much of it is by design as thredUP markets to those consumers more specifically?

James Reinhart, CEO and Co-Founder

Yes, I believe it's a combination of both factors. We're noticing that customers who fit the trade-down narrative are seeking well-known brands at more affordable prices. These customers respond particularly well to that value proposition. We have a variety of products that help improve conversion rates among these shoppers, meaning our platform seems to attract those who are trading down. For budget shoppers, the issue isn't that our mix is unappealing; rather, it’s challenging for them to take the plunge as new customers in the current discretionary spending environment. Ultimately, we offer 35,000 brands across 100 categories, and we aim to ensure our platform caters to this wide range of customers. That’s our long-term goal. However, in the short term, it seems likely we'll lean a bit more towards slightly more premium shoppers based on data trends.

Rick Patel, Analyst

And can you also provide a little more color on what's embedded in guidance for both Q2 and the year for the OpEx line items? So as we think about ops and tech, marketing, SG&A. How should we think about modeling those? And if the momentum that you have does get disrupted, how do you feel about finding new expense savings?

Sean Sobers, CFO

Yes, Rick, this is Sean. I think on the operational and technology side and marketing is very tied to revenue. It's consistently variable. So how you've been modeling it previously as revenue goes up, it's fairly linear at that point. I think you get a lot of leverage out of SG&A. And then I think your broader question is if the market, let's say, is more challenged, do we have levers and dials to turn to make sure that we continue to improve because of breaking EBITDA? And the answer is yes. Not only is it the variable side that we talked about already, but I think there's overall improvement, efficiency and cost reductions that we can do that we haven't done yet to help us get there if we need to. That's kind of how I'd answer that.

Operator, Operator

Your next question comes from Ed Yruma at Piper Sandler.

Ed Yruma, Analyst

Back on the topic of this more upscale customer, I know you guys do have some authentication capability, but as you think about the upscale customer, are you talking about kind of more premium brands or true luxury that has to go through an authentication process? And then as a follow-up, in terms of that lower-end customer, are you seeing an increase in performance if you run more promos or sharper price points? Or anything you can do kind of in this environment to stimulate that lower-income consumer to consume more?

James Reinhart, CEO and Co-Founder

We are definitely not shifting towards luxury products that require authentication; that's not part of our strategy. Instead, we're focusing on accepting brands and curating items that appeal to a slightly more premium shopper, but still not in the luxury category. We are targeting what could be considered Bridge brands, which are resonating well with customers looking to trade down. Regarding customer response to promotions, we are definitely seeing some sensitivity to discounts and promotional offers. As traditional retailers' inventory decreases and prices begin to rise due to sold-out stock, the thredUP value proposition is starting to gain more traction. Our offerings, with discounts up to 70% or 80% off traditional retail prices, are becoming increasingly appealing as we progress through the year. We believe that once retailer inventories stabilize, the value of thredUP will become even clearer, presenting opportunities throughout the year.

Operator, Operator

Your next question will come from Lauren Schenk at Morgan Stanley.

Lauren Schenk, Analyst

I wanted to follow up on the first question. In the last quarter, we mentioned aiming for EBITDA profitability in the second half of the year, but now it seems more likely in the fourth quarter. Are there any specific timing shifts in your expected investments, or is this more about the strategy we discussed earlier regarding increasing our efforts? Any insights on this would be appreciated.

James Reinhart, CEO and Co-Founder

Yes, Lauren, we've always anticipated the latter part of the year and specifically Q4. We wanted to clarify because we were receiving numerous questions about whether it was Q3 or Q4. So to be clear, it is Q4. Currently, we see several opportunities to invest across the business that should yield better returns not only this year but also as we approach 2024. We want to capitalize on the current operating conditions, which I believe is evident in our guidance and the results throughout the year. We're very optimistic about the opportunity to reach breakeven in Q4 and even more confident about our ability to keep growing free cash flow as we enter 2024.

Operator, Operator

There are no other questions. So I will turn the conference back to James Reinhart for any closing remarks.

James Reinhart, CEO and Co-Founder

Yes. Thanks, everyone, for joining us for our Q1 earnings call, asking thoughtful questions and your continued interest in thredUP's business. We'll see you next time. Thanks.

Operator, Operator

Ladies and gentlemen, this does conclude your conference call for this afternoon. We would like to thank you all for participating and ask you to please disconnect your lines.