REAL - NASDAQ

Good day and thank you for standing by. Welcome to the RealReal Fourth Quarter and Full Year 2023 Earnings Conference Call. [Operator Instructions] 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.

Thank you, operator. Joining me today to discuss our results for the period ended December 31, 2023 and 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.

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 an extensive experience with 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 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 a 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 Instructions] Our first question comes from the line of Mark Altschwager from Baird.

Congrats on the results this quarter. So bigger picture here over the past few months, there's been a lot of discussion of 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.

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 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, 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.

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.

Yes. Thanks for the question, Mark. This is Caitlin. And so 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 kind of 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 kind of minimizing low value, minimizing direct. So I think you're going to see that as we accelerate throughout the year, too.

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

Congrats on profitability, guys. I wanted to check where the biggest upside came in the P&L versus the plan to reach profitability in the second quarter and -- in the fourth quarter, rather. And secondly, what's the timing of the new revenue streams that you guys have discussed as we go through the year. Maybe remind us where are you with sponsored ads and also the warranty opportunities.

Thanks, Anna. This is Caitlin again. Why don't I take the first one and then Koryl and the team can comment on the new revenue streams. So what we saw in Q4 versus our expectations, as Rati mentioned, October, I think there was some general kind of concern or just watching out for kind of demand trends more broadly. And so we weren't in an exception to that. What we did see is we saw a nice acceleration on the top line through Q4. And so I think from a top line perspective, we were pleased with where we ended up in Q4. And then from -- as we think about flow-through, I would say the beat versus our expectations was split roughly evenly between gross profit and OpEx. And so let's talk through that. So what helped us from a gross margin perspective in Q4, we had more favorability than expected and this mix direct and consign. We grew the consignment revenue while shrinking direct a little bit more than 50% in the quarter versus prior year which, again, is a purposeful change that we made earlier last year. And then the other thing that helped take rate was favorable in the quarter versus where we thought we'd land and that's a function of the commission structure change that we made in late 2022, combined with the mix of products that we sold within the quarter, I would say and then kind of order of importance, I would say shipping margin was a little bit more favorable than anticipated in and we continue to make progress on efficiencies in terms of inventory control, transportation costs, those types of things. On the OpEx, what I would say is that we were really favorable in terms of just being disciplined on the support OpEx. So when we talk about support versus sales and ops, we had a nice healthy supply quarter and so sales and ops came in -- come more or less where we expected, maybe but a little bit spending but that's an area where we like to spend, right, when supply is healthy and we were just really disciplined on the support OpEx.

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. And 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. So as much tailwind as we're seeing with our core business right now, we're really just focusing on that. And 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 means that 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.

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

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.

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. Its early, we're learning, it is a very small -- it has a very small impact for this year. We really are -- we're 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.

Got it. And then can you also help us with the cash flow mechanics following the debt refi 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?

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 a 1% coupon. And so still a significant portion of our capital structure on the debt side of our capital structure is very inexpensive debt. But interest rate environment has changed. And so there will be incremental cash expense that we'll have to pay. And Todd, I don't know if you have some commentary around that.

Yes. The incremental interest expenses, 8.75% cash, 4.25% PIK. And 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.

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

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

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

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

This is Jason on for Kunal from UBS. 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 4Q 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.

Yes. So the cost of the restructuring charge that we took in Q4 really had to do with exiting some real estate. And so we did incur additional expenses. So I would characterize it a little bit differently. I don't think that's what drove our favorability. It's -- 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.

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

Yes. So I assume you're talking there about owned inventory. So our inventory balance at the end of 2023 was about $22 million. And if you remember, we peaked at $75 million of owned inventory 12 to 18 months ago. So what I would say is that's really reflective of us minimizing the direct business, minimizing that owned inventory in those transactions. And so I would consider this to be more or less a new normal for us. So there are ways that we still acquire inventory and it's really through out-of-policy returns. So 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 that's -- we assume that will more or less grow with the business. It's a small, obviously, in all a small dollar amount. And then there are also some get paid now which is really, really a customer offering. So in certain circumstances, on very limited brands high-end categories, then high-end watches, a few categories of high-end bags. There is some situations where we will pay a consignor upfront and we typically pay them less. So we think 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 kind of during COVID to go out and buy inventory, that's 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.

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

Congratulations on the quarter. I guess I'd like to circle back to what Rati was saying about the improvement after the bumpy October. And I believe you said you're pretty happy with January, even though there were signs that elsewhere that the consumer kind of pull back. So I was just curious if you could -- do you have any thoughts on why it is that you guys saw that improvement? Was it something you guys yourselves are doing with your -- with marketing or anything like that? Or did you just kind of feel like it's the value proposition resonating with the consumer?

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. And what something that 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. Hey, 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. So 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 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. And as that in 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 a 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?

Well, I would just say also, our investments are working, right? We have the affiliate program. We have a referral program. We're offering more events, our consumer event. So like Koryl -- like John mentioned, marketing and sales are working better together, more efficiency and then kind of our investments and our tactics are working in -- we look forward to this year because now we have a full year of these investments. And I can't overemphasize the personalized promotions. Now we know we need and how to get it and who to get it from and that's been a game changer.

That's terrific. And maybe 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?

Sure. Yes, I can take that one, Marvin. So our active buyers did decelerate in Q4. We expected that. This is all the changes that we made moving out unprofitable inventory, low value, unprofitable categories, moving out of the direct business. So it's something that we have forecasted. You're going to see this kind of turn going into this year and definitely going into the back half of this year. And the same -- that's the same way we think about average order value of quality of the consumer, the quality of the product is really what we're focused on.

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

Two questions from me. First, on the demand side. Just curious listening to other soft lines and consumer companies thus far this earnings season. Have you seen -- do you talk about the volatility you've seen intra-quarter to start Q1. A lot of companies have talked to softness in late January, early February, some stabilization coming out of February. Just not to get too granular but I'm just kind of curious, is that mirror kind of what you're seeing? Or I'm just kind of curious how your business has flowed.

Yes. I think we're going to resist the urge of giving kind of the month by month or week by week lose. And I think this is it, Bobby. But I think the general principle is what we saw, right? We saw an acceleration throughout Q4, we've seen good momentum so far Q1. And I think overall, we're feeling pretty optimistic, maybe cautiously optimistic about where the business is.

Got it. And then if I can shift just to the margins and the guidance on revenue. So just 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 4Q, should we be kind of expecting low 70s throughout the year? Is there seasonality we should think of as we kind of 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.

Yes, absolutely. Great question. So if you think about GMV flowing through the total revenue, kind of a couple of factors there that you hit on. So take rate and then also mix of product. And so when I say mix, I'm talking about consignment versus direct. Direct flows through dollar for dollar from GMV to revenue. And so you saw a little bit of headwind this year -- sorry last year 2023 as we exited direct. I still think there's a little bit of that. You're going to see in Q1 that direct is still going to, we believe, will shrink. But then once we start comping a lower percent of total direct. I think you're going to see a more consistent flow through Bobby, from GMV to total revenue. So again, I think Q1, a little bit of noise there just as we continue to exit the direct business but then I think it should normalize. Take rate going forward, right, you saw we were up 150 basis points in take rate. And really, that was mostly driven by the consignor commission rate card change that we made at the end of 2022. And so we had to sell through the product that came in under the old rate card in the first half of the year. But then we saw -- you saw you guys see kind of a clean P&L in the back half of 2023. So what I would say is take rate is this new normal at a higher level. And now from here, what will change is just the mix of product that's sold within a given quarter. And so as ASP or AOV goes a little bit higher, it tends to be higher in Q2. It tends to be the highest out of the year in Q4, you're going to see a little pressure on take rate. But what you end up getting is good flow-through on those units. So that's kind of top line. And then, the other piece that you asked about was margin -- gross margin. And here's what I would say is we were pretty pleased with our gross margin in Q4. And I think we would say that 70% plus is kind of that low 70s is the new normal. Again, it will vary quarter-to-quarter based on the mix of products that we sell. But I think we're feeling pretty good about that. Consignment business has a high -- has a pretty high gross margin inherently. And so as we mix more into that return to growth on the consignment and overall top line, I think we feel pretty good about where the gross margin will be.

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

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

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

Great. So we talked about the changes that have been made to the business, really encouraging to see the positive EBITDA this quarter. Just given this in the guidance today, 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 gives 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.

Yes. Sure. Actually, I'll start and I'll let John add anything that I missed. We feel pretty confident, I would say, 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, high value is strong. And then it all starts with supply for us. So 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. And then we talked about all of the programs that we are launching that we've tested in Q4 that works 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, that realignment of value and quality between the sales and marketing team is really working for us. So we're seeing these investments pay off and we're seeing that kind of growth continue into Q1.

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, 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. So 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.

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

I wanted to ask about the debt transaction. So now that you've done this, essentially, do you feel like this kind of set like you're good now like at least like 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?

Yes. Tom, I'll talk about it, this is John Carl. 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 give us the runway to prove that our model is the right model. And what you've seen in this quarter and the previous honestly, 5 quarters is we're on the right path, give us the time to prove it. Give us the time so that we could be adjusted EBITDA breakeven or better. And then what can we do in '25 and how can we build on that? And then what they were able to do was give us 3-plus years to prove this out. And that is what was incredibly important to me in my role. So the specifics of the transaction, I'll turn that over to Todd. But we got exactly what we will want it out of the deal in terms of the timing of being able to prove the business going forward.

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

All right. Great. And if I could just ask a quick follow-up. I just want to make sure I kind of 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 the...

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

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

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? And I know your consignment but how has it impacted revenue growth?

Yes. So I'll take the first part. So the face value of the 2025 notes was $172.5 million. And we took out $145.8 million of those plus another $6.5 million of the '28 to replace that with $135 million senior secured note. And that's how we get the $17 million of deleverage.

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 of attribution and pricing. And so we feel really good about continuing to kind of test higher and higher prices, better for the consignor. It's better for the RealReal. And our pricing algorithm and models are now expanding over more and more categories throughout this year. So we're happy about the progress there. As far as our luxury items and where we're seeing the consumer like I mentioned before, fine jewelry is quite healthy, ready-to-wear is back. We're doing well with high value overall.

Yes. I have to pile on. I think it's still amazing. I've only been here a year but in all honesty, the amount of pricing power and knowledge that we have in putting all this data together, seeing a million unique SKUs every month. it's 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 and category by category. We can actually push up the pricing try it, then we get a lot of signal from our website from our 3 billion, 3.5 billion website visitors per year. So you have this wonderful combination of you have an algorithm that builds on top of but then you actually have the experience of seeing the actual product perform in the while, how many people obsess it, how many people add it to their cart, all of those type of things. And I think we've been able to offset a lot of softness with -- in all honesty, a lot of competitive intelligence on our side.

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

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

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

Yes, it's plus the PIK. Yes, correct. It's plus the PIK.

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

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.