The RealReal, Inc. (REAL) Earnings Call Transcript & Summary

All right. Thank you, everyone, for joining us this afternoon. My name is Lauren Cassel. I'm Morgan Stanley's small and mid-cap Internet analyst. And I'm thrilled to be joined this afternoon by Matt Gustke, The RealReal's Chief Financial Officer since April 2013. Prior to joining The RealReal, Matt served as the Chief Financial Officer and Head of Strategy at StubHub for over 3 years. So thank you so much for joining us. Before we get started, a few quick housekeeping. Please note that all important disclosures, including personal holdings disclosures and Morgan Stanley disclosures, appear on the Morgan Stanley public website at www.morganstanley.com/researchdisclosures or at the registration desk. And some of the statements that RealReal make today may be considered forward-looking. These statements involve a number of risks and uncertainties that could cause actual results to differ materially. Any forward-looking statements that REAL makes are based on assumptions as of today, and REAL undertakes no obligation to update them. Please refer to REAL's Form 10-K for a discussion of the risk factors that may affect its results. All right.

Thank you for that.

Sure, we're all set now.

Yes.

So maybe just starting off high level, for people who are less familiar with the story, how should we think about The RealReal differentiation amongst marketplaces, your market opportunity and sort of this near-term strategy?

Sure. So I guess I'll go all the way back. So the business that we operate in is luxury consignment. We're essentially a domestic-only business today, though certainly in the longer-term story, there are international ambitions. And this is ultimately like global business. Company was started about 8 years ago with -- and the business is largely a bigger and better version of the original concept, which was to take the work out of selling luxury goods by reducing friction and by establishing trust for buyers in the form of authentication. So those key attributes of the business were in place since day 1. Since then, things have evolved quite a bit. We're in more categories. We were originally in women's fashion, so today, men's fashion as well, a lot of fine jewelry, watches, even some home and art. But those aspects of the business that were in place from day 1 are still there today. We've only sort of reinforced a lot of the aspects on the service model for consignors. So there's multiple ways that someone can sell today, still most likely as us coming to your home and picking up goods. But in addition, we can send you a shipping label, and you can just send it to us directly or you can come to one of our stores. We have 3 as of today. Later this week, there will be 4. The San Francisco store opens Wednesday. So if you're still in town, it's walking distance on Post Street, just a few blocks from here. So very excited for that. And on the buyer side, trust has always been an underpinning of the business. We -- as we have done since day 1, we authenticate every item. Every item is in our possession, which allows us to kind of manage the end-to-end buyer experience, maintain world-class level NPS north of 70.

Great. How do you think about the TAM opportunity both from an online and an off-line perspective?

Right. So we think the domestic TAM is about $200 billion. We think that because Frost & Sullivan published it, and that's the data available in our S-1 as well. And what that means is there is approximately $200 billion worth of market value, current resell value trapped in U.S. consumers' homes today across the categories that we participate in. And our GMV last year was about $1 billion, just a little bit north of $1 billion. So that means that we're roughly 0.5% penetrated into the domestic TAM, and that's online and off-line.

Perfect. So you reported earnings last week. I think your first quarter guidance implies some GMV deceleration versus the third and fourth quarter. Maybe what's driving that deceleration? And then the guidance sort of implies relatively stable growth in 2020. What gives you confidence in that guidance?

Sure. So I guess it's kind of a few-part question. So Q3 of last year to Q4 was its own story. So Q3 definitely benefited from our IPO, which is right at the end of the second quarter. So we had several percentage points of a bump in Q3. 48% was our GMV growth in the third quarter. Q4 was a normalized level of 39%, more consistent with what we did in Q1 and Q2 of the year. But within that was definitely an element of some amount of impact from a significant reduction in marketing spend that we executed on in the fourth quarter as we had planned to the entire year. So if you go back a whole year before that into the fourth quarter of 2018 when we were setting our plans for '19, we made the determination that it was in our interest to optimize our marketing ROI in 2019, pulling forward some of the spend in Q4 that is relatively low ROI given the competition for attention, pull that forward to some extent into the third quarter and some extent even all the way back into the first quarter. So we executed on that strategy as planned. And the results were fantastic in terms of the literal marketing ROI. So our buyer acquisition cost or BAC, as we call it, decreased 20% -- nearly 20% year-over-year to an all-time record. As we look on it, look back at it in hindsight, I think we were perhaps a little bit -- so it's a little bit too single-minded on marketing ROI in the short term and ignored kind of the spillover effect it would have. So no doubt growth did come down at the very end of the quarter in December and continued on into January where we then ramped the spend back up. So as of the time of our earnings call last week, we indicated that's, in fact, what we saw. We were seeing a rebound in kind of leading metrics: traffic, member conversion, buyer, et cetera. And GMV ultimately was looking stronger in February than it was in January. So kind of all things are kind of back to normal. And what I think our approach is going to be going forward is to take a -- to balance marketing ROI with just growth in the business overall. And it's not so much that we just don't have kind of optically significant acceleration or deceleration in reported GMV growth, but it has real impacts on our operating efficiency. So when you have a period where you reduce your volume, unit volume in or demand, that means we have excess supply of people in our warehouses and our sales team, and it impacts our unit economics. Or on the flip side, if we have a dramatic acceleration in supply or demand that was unanticipated, we'll be unprepared for it, and our service levels could suffer. So for our customer experience and our operations and ultimately our path to profitability, it's in our best interest to have a more normalized level of growth. So that's the approach we're going to take this year, which is neither extreme -- either extreme, right? So if you kind of look back over the past couple of years, what you'd see is this year's pattern will be somewhere in the middle where we'll still lean away from spending heavily in Q4, but we'll definitely do more so than we did last year.

Okay. Great. And unfortunately, The RealReal was subject to some negative press around authenticity at the end of last year. I guess first, what is sort of the company's response to that? And do you think that had any negative impacts on the GMV growth?

Simple answer is no, had no impact on GMV growth at any point in time. This is -- conveniently, the CNBC piece that you're referring to was conveniently timed to be the day after we reported our Q3 earnings. So I won't provide any commentary around that. But in essence, the piece called into question our ability to authenticate at scale. It's a good question to raise because authenticity is core to our brand and to our consumer experience. So we feel -- felt very good about how we authenticated then and we feel even better now. The reality is we're very, very good at it. Every item that we sell has been authenticated by one of our staff. And we are every day pulling items that are fake, that never make it to the website. And there's no other marketplace out there that takes the care and attention to ensuring that takes -- stay after marketplace and helping prevent counterfeiters from succeeding and thriving in the world. Since then and frankly, just over the ordinary course of business, we always invest in authentication and getting better and better and staying ahead of counterfeiters because they're getting better -- fakes are getting better, and they're getting more creative. So over that time, we have benefited tremendously from some automation initiatives that we've put into place that have allowed us to take a lot of work out of doing things like pricing items and creating copy. And when we do that, we elect to bank some of that and flow it through to the bottom line and take some of that and reinvest it in ongoing quality initiatives, part of which is authentication and, just generally speaking, higher levels of quality of the copywritten (sic) [ copyrighted ] items. So we have been doing that, and we will continue to do that to stay one step ahead of the counterfeiters.

Great. One of the key positives from the print was the gross margin outlook. What's driving that expected 500 basis points of expansion in 2020? And then how should we think about gross margin progression -- progressing in the out years from there?

Yes. Okay. So gross margin is one metric that's up in that part of the P&L. We actually internally focus more on kind of the order economics and the gross profit dollars generated by a transaction because our revenue is a bit of a weird accounting hybrid where you have most of our revenue is recognized on a net basis, very high gross margin consignment revenue and a small portion that's booked at gross with corresponding cost of sales. That second component, we call it direct sales, has gross margins in the high teens and the consignment business is in the 70s. So obviously, the mix of those 2 has a pretty big impact on gross margin percent. That's one of the drivers of an increase in gross margin percent, is a lower mix of direct sales in 2020 than what we had in 2019. But if I go back to tracking gross profit dollars per order, there's kind of a couple of different stories. There's the backward-looking one and the forward-looking one. Looking backwards, we saw increases in -- from '17 to '18 and from '18 to '19 in gross profit per order driven largely by increases in average order value and in take rate. Those carried forward all through 2019 and will to some extent in the current quarter as well with higher AOVs and take rates. After that, we don't anticipate AOV will continue to increase at any appreciable rate and will sort of flatten out, plus or minus, product mix going forward. Take rate, same deal. We have not announced or don't plan to make any substantial changes to our take rate going forward, at least in the near term. So going forward, we do anticipate that there will be improvements in gross profit per order, however, but the source of the improvement is different. It's now shipping expense. We secured a new contract with our primary shipping partner, UPS, in December of 2019. So we've been seeing those improvements in rates, double-digit percent improvement in per parcel cost. So we'll see that this quarter. Now we'll have a full year of that, and that will get us into the high $90 per order gross profit range.

Okay. Great. Maybe talk a little about the technology and automation investments that you've made over the past year and then any key investments that we should be looking at in 2020. And then will those drive incremental efficiencies in 2020 and beyond?

Yes. As I made reference to a little bit earlier, we have made a number of investments to automate certain parts of our operational processes, and those have been working. Namely, the first area we focused on was pricing. And at the end of last year, 61% of our items had an algorithmically -- were algorithmically priced, always still with human oversight, and that will always be the case. And then later on in the year, we began automating certain parts of copyrighting, specifically the title and the description as well as photo retouching. So both -- that's about 1/4 of the items between those 2 by the end of the fourth quarter. So those second -- the second and third of -- those 2, we'll continue to see an increasing penetration as we get through this year. It'll probably catch up to pricing, and then all 3 of them have further room to go, and they'll never get to 100%. But those automation progress allows us to, of course, drive unit economic and expense productivity. But it also, of course, means that we require fewer humans to scale the business and to grow going forward. It just fundamentally improves and increases the scalability of our operations and strips out a lot of the complexity of having to ensure that you have the right number of people in the right locations with the right category focus in order to grow and sustain growth. So that will continue to be a source of investment over this year and beyond. But frankly, most of the progress that we'll make and those automation efforts will happen by the end of this year. Beyond that, as we think about our technology investment broadly, it's always going to be in 1 of 3 areas: consignor experience, buyer experience or we call kind of employee tools, under which the automation sort of fits there, kind of the efficiency of our operations. So in the coming weeks and months, you -- expect to see some consignor-focused -- consignor experience-focused projects that we think will help significantly improve or reduce the remaining friction that exists in the consignment experience.

Okay. You talked about the San Francisco store. One of the highlights of the growth story has been the retail store footprint, not only from a GMV perspective but also from a supply perspective. And on the call, you talked about how the SoHo store in New York year 3 is still growing GMV north of 36%, which is pretty impressive. I guess what are some of the key learnings that you've gained from opening these stores? And then if they're doing so well, why not open more?

That's a really good question when we -- we ask ourselves a lot. So let me start with a few of the key learnings for stores. So the SoHo store you referenced was our third Q4 and -- that we just passed and still growing nicely. Since that store, we have opened one in L.A. in West Hollywood, that was the middle of 2018, and then a smaller footprint store on the Upper East Side, New York in late Q2 of last year. So that's kind of -- we ended the year with those 3. What's consistent across all 3 stores is, one, we sell -- we acquire lots of new customers to the store. Still about half of the people who transact in the store are new to us. They buy higher-price point products, on average, roughly 2x what we sell online. It's a higher mix of jewelry, watches, handbags, and it's higher-end fashion, and that's been consistent over time as well. And other things that are nice little benefits like return rates in the store are lower. So there's a lot of metrics that are very good for us. And on the flip side, also very good is -- and what surprised us and continues, frankly, to surprise us is how much supply is generated through the stores. So we had a disclosure in Q4 that actually there's more value created from the supply that's coming into the stores than just what we sell there, which is fantastic. So wherever we open a store, we immediately see a very noticeable acceleration in consignor growth. And perhaps it's not surprising when you consider that to the extent that we have competition for supply, it is from brick-and-mortar consignment stores. So the incumbent consignment model, to the extent people were participating, they were generally bringing their stuff to a brick-and-mortar location and dropping it off. So our stores happen to be nice and attractive to do that. But to the extent that consignors were not participating in brick-and-mortar, they were generally doing nothing. So the store also does a nice job at kind of increasing our awareness, at least on a local market basis. So that all sounds great, and it is. And if we were principally in the business of operating and opening retail stores, we'd do them a lot faster than we are. Our intent, our current plan is to open about 2 a year, maybe 3, maybe 1 and -- but being opportunistic about store openings because we do not require new stores for achievement of our growth objectives. They're nice but not necessary. And second, when compared against the alternative, which is to just invest more in our existing online operations through marketing investments, it's a pretty tough comparison because our marketing efficiency's at such a high level already and improving so rapidly that it's tough to sort of keep pace with that. So we're going to elect to just have a balance of the 2 approaches because ultimately, it's nice. The more growth levers you have, the more diversified your portfolio is. So we're going to do that and ultimately get to probably 10 to 15 stores in the U.S.

Okay. I'll ask one more, and then we can open it up for Q&A in the audience. The 2020 guidance for the EBITDA margin implies a loss in the 15% to 16% range, which is 700 to 800 basis points of leverage, which is more than what you delivered in 2019. We talked about a few of the key pieces of shipping, but any other big drivers that are sort of accelerating that expansion? And then how should we think about the path to profitability and the time line there?

Sure. So you're right. So our guidance for this year implies more leverage this year than we saw last year. And further, if you kind of break that apart, right about 500 basis points of leverage this year comes in the gross margin line and most of the rest from continuing marketing leverage in part due to our assumption that our acquisition costs will continue to go down, albeit at a more modest level than we saw in 2019 but largely based on the assumption that we'll continue to see retention trends consistent with what they've been historically. 83% of our GMV last year came from repeat buyers. And that's been a long-standing trend of that number kind of increasing modestly year-by-year. So we expect to see that continue supporting strong operating leverage on the marketing side. We do expect more gains to come from automation benefits, some of which we'll reinvest in quality initiatives in technology. And then the deleverage that we've seen in SG&A, we expect will continue this quarter and, to a lesser extent, next quarter. But after that, we've lapped the IPO. And the reality is it's very expensive to be a public company, but a lot of those costs are sort of just binary in nature. And once they're there, they level out, and we start to drive leverage. So exiting this year, we would expect to see leverage happening in each of the key operating expense areas as well as continuing leverage on the top line as expressed in gross profit per order. So that means -- obviously, I'm not guiding beyond this year, but the way to kind of think about our path to profitability, it's nothing new. It's not like we woke up this past quarter and said, "Hey, let's focus on getting to profitability." That's something that has always been present in our thinking and our planning. Number one driver of leverage and profitability is growth. So we need to maintain healthy rates of top line growth to stay on the path that we've declared officially as Q1 of '21 being our breakeven quarter in full year '22. That sort of implies a more or less linear path of margin expansion. And the other thing I'd say about our profitability, it's -- certainly, internally, we've always been of the mindset that ultimately, our objective is to generate cash flows and be -- generate substantial profits for business. So there's never been and never will be a "growth at all costs" mentality in the company. Doesn't actually, frankly, make sense in the context of a 2-sided marketplace like ours to have a unilateral focus on one thing or the other. They need to be hand in glove to be most successful.

Great. Any questions from the audience?

Yes, 2 questions. One is, what's your relationship with the brand owners? And the other one, what would identification through technology do to your business model and competitive advantage? For example, RFID authentication or something like that?

Sure. So let me start with technology and authentication. We use technology to supplement our humans, and there always will be a human being looking at and authenticating every item but using technology where it makes sense to help. So I'll give you a handful of examples where we do that today. In some cases, technology can actually improve our efficiencies greatly. So we have a partnership with the University of Arizona that provides us with sort of proprietary technology and software in the area of gemstones that allow us to measure accurately a gemstone without taking it out of its mount, which obviously we'd never do. So the alternative is to do a bunch of math and have 2 separate people doing a bunch of math and then averaging out. That's kind of how people do this thing. So we see some great promise to be able to take advantage of that. And then some product-specific context like in sneakers, there's some technology you can use called light box that helps. It doesn't say, "Absolutely, this is real," but it can say, "Absolutely, this is fake," which is why you need to have kind of multi-point inspections that are specific to a specific brand or our product category. So what we started doing recently -- we've always authenticated products, and we've kind of swim-laned the different products based on their risk profile, higher-priced products, certain brands, certain product categories or just higher risk of being counterfeit. So we've always kind of leapfrogged the process and put them to the most highly trained experts that we have. In addition to that, we're starting to not authenticate but risk-score consignors as well. So even a low-risk item may jump to the high risk queue based on certain factors that are similar to how you would risk-score a buyer for potential fraud. So supplementing those 2 things together, I think, is just helping us kind of take what's already world-class and moving forward. First question was with respect to brands. So we have an existing relationship with Burberry, a -- which is a great partnership for both of us. And I think it just -- it helps validate that brands are increasingly taking sustainability more seriously. And it's important to them today and for the future for their growth. Obviously, I can't talk about things that aren't done and dusted. But I would say the general direction that brands are heading is more in favor of sustainability and in favor of resale. So over the course of the next 12 to 24 months, I would be surprised if almost all of the major brand or brand groups weren't sort of public with their intentions what they were going to do in the resale space. Some will elect to work with us. Others will elect to try something on their own, either one of which is fine because that means they're supporting the development of resale. And that's ultimately good for the industry and for us because we think we're very well positioned to continue taking a disproportionate share of the growth. But also importantly, it means that they're not actively going to be on the side of trying to fight resale, which one notable brand does continue to do.

How many of your buyers are also consignors or vice versa. Sorry. How many of your buyers are also consignors? And what's the opportunity for creating that community? I guess just any economics you can share on that?

Sure, sure. It's a good question. Actually, it's one of the things that's still largely unique to our marketplace, having a high level of 2-sided participation. It's very rare for a marketplace certainly at scale to have people still actively buying and selling. About a little over half of our consignors are actively buying as well, 54% to be specific. And that's good in a lot of ways. Obviously, if you acquire someone on one side of the marketplace and are able to convert them to the other, that's generating marketing efficiency. But just as importantly, perhaps more importantly, when you get that switch over, the totality of their activity increases fourfold. So put that in specific numbers. So you have on average, a trailing 12-month basis, a buyer is going to generate about $1,700 in GMV, $1,733 most recently. Someone who also consigns is 4x more active as a buyer. And when you then expand that to what does that mean in total for the business, people who are participating in both sides of the marketplace is about 13% of our total buyer population but 44% of GMV of the business. So a relatively small number of people doing an incredibly high volume of transactions.

Okay. Any last questions? I have one last one over here.

When you think about the rise of specialized marketplaces, and this kind of fragmentation of eBay is one way of looking at it, how do you think you can compete with people like Chrono24 on watches and StockX on sneakers as opposed to just sticking with your core fashion exposure?

Well, it's kind of a -- it's a broad question. I'll take the short answer here. Fashion is where we began. We're already, to your point, in those categories that you mentioned. So we participate in men's and sneakers and watches and jewelry and home and art. So we -- that's actually one of the advantages that we have, is being cross-category already. So typically, what a really narrowly focused vertical player will do is compete on take rate. So they're a handbag specialist, and they're a watch specialist, and you named a couple of them. And typically, their take rates are very low, and that -- they can build a business that can sustain, that's fine because the price points are sufficiently high that they can sort of make it work. But they don't tend to get a lot of vibrancy in the market where people are coming back frequently and purchasing frequently and participating cross-category, one. And two, they are limited in take rate because they're obviously so high already. We are -- we're competitive in take rate with all those vertical marketplaces. But because we're across all the -- these categories, we're able to fund that by blending our take rate higher over time and still being competitive in some of those kind of high-ticket verticals. So specifically, how we've been able to do that has been increasing our take rate on lower-priced product and specifically under $145 where we have a 60% take rate. So that -- I think we're well positioned to be able to sort of withstand anything that anyone's going to do because there's really not that much more room to go on a take rate basis.

Right. Thank you so much for joining us today. We really appreciate it.

Thank you.