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

Good afternoon, everyone. And thank you for joining us. My name is Lauren Schenk. I am Morgan Stanley small and mid-cap Internet analyst. And I'm very excited to be joined this afternoon by Matt Gustke, The RealReal's Chief Financial Officer. So thank you, Matt, for being with us today. Before we begin, just a few housekeeping items. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. And as a reminder, we will be taking audience Q&A towards the end of the session. So please enter your questions at the bottom of the screen throughout the presentation, and we will get those answered in a bit.

So Matt, thanks so much for joining us. For those listening who may be slightly newer to The Real's story, maybe just spend a few minutes walking us through what Julie's original vision was for the company. What did she identify was missing in the market? And how has that evolved over the last couple of years?

Yes, sure. Thanks for having me. So the company started in 2011 and founded by Julie Wainwright, remains our CEO. And her aha moment was when shopping with a friend of hers in a boutique in African. It was primarily a new product boutique as most of them are, but her friend kind of beelined back to the back, where there was some Gucci, Louis Vuitton products in a resell area. And Julie is like, "Why are you going there?" And she said, "Why wouldn't I? I trust the seller. They are beautiful products at great value. Why wouldn't I do this?" So she -- that was the [indiscernible] moment for her. And that purchase showed her 2 things: first, that people will buy a preowned product if the seller is trusted, if the product is merchandised beautifully and the road map to the brand is retained. And then second, that there's a big segment of products probably sitting in people's homes because some of the sellers don't want to do the hassle of selling. So in this case, the products came from individuals that were sold to or consigned with this boutique. So the vision was built to build an infrastructure that aimed to take the friction out of selling to unlock this supply, starting with women's fashion because of the sheer volume of products out there that could create critical mass and generate marketplace velocity. The vision was always to expand into other categories like jewelry and watches and lens, all of which are -- that we have today. So some infrastructure included sales people who made in-home visits and a full suite of operations and merchandising that did all the rest of the work of selling. And of course, included an authentication infrastructure with experts to take the risk of the fakes off the table for buyers. So nothing has really changed. Now it was the original vision, and we've really just been building on that, unlocking supply in people's homes from sellers who don't want to do the work of selling and ensuring trusted buyers through an authentication infrastructure across multiple categories.

Okay. Very helpful. There's been increased investor focus on the retail segment of the market, given new and emerging competitors like public or looking to go public. So how do you think about Real's competitive landscape? What are the competitive moats around the business from both the supply and a demand perspectives? And I guess, how do you think about the sustainability of the take rates, not necessarily the super high-end items, where I know that you're very competitive, but more of the mid-tier ready-to-wear product?

Sure. A few questions in this. Let me start with kind of the landscape as we see it. As you noted, there's several players who've gotten some prominence recently, some of them have gone public recently. Some of them are still private, some that, I think, have been public for a long time and have kind of renewed interest in pushing growth in the categories that overlap with us. And I think that's -- they're just all bringing attention to resell, frankly. We operate in a massive TAM, we think, at least $200 billion domestically that have secular tailwinds around sustainability and resell generally. So competition is naturally going to happen, and that's fundamentally a healthy thing. We're still so early in the development of the market that this competition is serving primarily to accelerate the development of it. Of the market, some people are speculating that resale could become as large as the primary market over the next 10-plus years. And I'd love that to be the case because I think we're very well positioned. All of these players, and I'm not naming them one by one, but if you kind of inspect it, they all serve different segments of the market. We're, obviously, focused on the higher end segment with authenticated luxury. So this gives us a very high average order value relative to these other players and does require a high level of involvement and hard work on our end and investment to build a scalable infrastructure. So you talked -- so we're talking about moats. So that's part of it. So there are several aspects of the moat for us and a piece between the buyer side and the seller side and then actually sticks together. So on the seller side, I've already mentioned, we offer full service, and we take -- we aim to take all the friction of the selling process. And that includes a network of hundreds of salespeople. No other marketplace has that sales infrastructure. We emphasize that we sell fast and our buyers trust us. So we can sell at higher prices than can be realized in these other marketplaces. I'm going to come back to that point on the take rate discussion. The buyer side -- I mean, the starting point is trust. And trust is driven by authentication. We authenticate every item that comes through our operation centers. And being across multiple categories that scaled over the years, we have an unparalleled selection of these products that are at great value with luxury service and overall luxury field to the shopping experience. So all of this stuff is underpinned by a massive data asset that allows us to do a lot of things, including automating numerous processes in operation, optimized pricing, et cetera, all of which are making us more efficient and harder to catch. And by the way, we're omnichannel. So as we've grown, we've added a small network of stores that's growing and is proving to be a really powerful way to unlock supply. So we have a number of aspects of the business that are making the moat broader, deeper as we go. So we really like our positioning in the full service, high-end segment of resale. So that brings us to take rates. So you noted we are -- we're not only competitive across the high end parts of the market with things like watches and jewelry and bags, we're actually competitive across the full spectrum and the full service side of the market. If people are bringing several products to us through a consignment, they generally don't want to cherry-pick the lower end pieces and do the work themselves in a self-posting site to just save a few bucks. We tend to get kind of all or nothing. And our system incentivizes them to give us everything. Because of the higher volume, sellers can earn their way to higher commission rates, because they sell more. That's sort of a built-in loyalty aspect. And the reality is that, that take-rate differential versus self-posting is, on average, more than offset with our ability to sell the products at a higher price and faster. So sellers who try both ways end up realizing that and they become very loyal to us. As I think you know, more than 80% of our GMV comes from our repeat sellers. So actually like where our take rate is and feel that it's sustainable. Hopefully, I covered it all.

Yes. Excellent. You got all that. So that's a really excellent high-level overview. Maybe just spend a few minutes talking about how the business performed during COVID, and what the company's 1 or 2 greatest learnings have been as a result.

Well, the first and most obvious learning is that our business does not belt for a pandemic, that much is for sure. But good things have come out of it. COVID forced us to innovate and react with urgency. We ended up developing or enhancing new sales channels, which ended up diversifying our supply acquisition. So we weren't able to go in-home, which is our single-largest source of supply acquisition, to make a pivot to virtual appointments. So that was new for us. And that virtual all is going to play a role going forward. We found that as COVID started to lessen a little bit, but people still didn't want us coming into their homes, and that was still disruptive, but people were willing to come drop off. It, maybe, seem like a nuance, but that's true for me as well. I'm more comfortable going somewhere than I am having people come to me. So retail, and in particular, our neighborhood stores look very promising. So that accelerated and kind of our strategy evolved to emphasize a little bit faster growth there. And then our vendor channel has grown as well and went from rounding error in our overall supply acquisition strategy to 5%-ish or about 5% of our GMV, upwards to trending towards like 15% to 20%. So that all adds up to having more levers and having a more balanced supply acquisition vehicle. So that's great. COVID also forced us to push harder and faster on automation. We've made really good progress. So that actually helps us and enables us to accelerate our expansion into Arizona, which we expect to open this summer, which is going to drive cost leverage as we scale. And I guess the final thing that I would say on this point is that COVID hasn't been our friend. It's been a headwind. It's been a tailwind for many others in e-commerce. But I think that tailwind that they have enjoyed is about to come to an end and our tailwind is about to begin.

Okay. Excellent. So digging in into that supply point a little bit more finely, I think pre-COVID nearly half of your supply was coming from that in-home white-glove service. That, obviously, was under pressure in 2020. You mentioned upwards of 20% of supply coming from vendor or B2B. And then is sort of a mid-20 percentage from stores the right way to think about it? And where ultimately do you think that in-home mix sort of settles out?

Yes. It's really hard to say. But I think I'll just try to cover the pieces one at a time at a high level. So starting, yes, you're correct, about half the supply pre-COVID came from in-home consignment appointments. That was severely disrupted, and it still is. We are aiming to go back into homes in most markets starting this month. And hopefully, there won't be any setbacks there. We've been -- in the meantime, we've been able to offset a large portion of that with virtual. So virtual certainly has a role going forward. As they see kind of how the pieces fit together, virtual is good for some things, but it's not great as a -- it's not a one-for-one replacement for in-home. And really in-home can only service large consignments well. So if you have 50, 100-plus items, virtual is still too much friction for that sort of thing because we have to, like, go through each item one at a time. It's much easier if we can come in your home, and we can kind of go through that and you can go about your business. So I think virtual is going to end up sitting somewhere in between in the middle part of the spectrum, in between direct shipping, where we give you a shipping label, where you get 5 to 7 items, and in-home where we got in the neighborhood of -- maybe it's 20-plus going forward. So I think virtual is going to be that sweet spot in the middle. And the mix between those 3 is still TBD. But virtual, like -- because it's going to be something, it provides a path to improving sales productivity across that, you think that broadly as a direct channel. So [indiscernible] about 18% of supply in 2019. And most recently, they've been driving about 30% of our new consignors. So it's pretty clear, people are responding to the ability to drop off. And they can do some shopping while they're at it. We are very excited about neighborhood stores, and we're on track to have 10 of them open by the end of the second quarter. Now they as well as our other brick-and-mortar locations are still subject to capacity constraints. In San Francisco, for example, we're still at 25% capacity. So it's going to be interesting to see what happens as those restrictions are relaxed, and we keep adding more stores. So this one is the big wild card in the whole mix. If they continue performing like they have, the neighbored stores, I mean, we'll be likely to open more beyond those first 10. So I think, safely, I think 30% of total supply from retail is a pretty safe floor, possibly higher. You've got the vendor channel, which, I think, we've already talked about, that goes to 15% to 20%. And we think we can sustain at that share from there and across all of the channels. This is a broad-based thing, where we are stepping up what -- our consumer-facing brand in here is called Get Paid Now. And it's a strategy of offering upfront payments for certain items, as focused in higher price categories, bags, jewelry, watches, et cetera. As it -- by leaning in here, this has the effect of boosting average selling prices overall and increasing the product margins for those things where we buy upfront. And it is more directly competitive with some of the single category resell marketplaces out there. We haven't really actively marketed this yet. We've been offering it, but not actively marketing it, but we will. And this could be a helpful driver of profitable growth over time.

Okay. Excellent. You touched on a little bit, but how should we think about these supply changes impacting the business from a cost perspective? Obviously, the neighborhood stores are clearly unlocking higher-quality supply, but they do add incremental fixed and variable cost of the model. So how should we think about the different economics of the different supplies?

Sure. I think it's important to remember that stores have always been a part of the strategy. But what's changed is moving away from larger format, more expensive stores that tend to have longer leases towards smaller, less expensive short leases. We've been planning to open 2 to 3 of the larger format stores per year, but our strategy has sort of shifted toward the neighborhood stores. So for the same or lower cost, we can open about 10 stores a year. And given that the relationship between store size and supply generation is not at all linear, meaning that in these smaller footprint stores that are 1/3 to 1/4 of the size, we can still get the majority of the supply that a larger format store can offer. So it's possible that our portfolio of stores will be significantly more productive for the same cost. And then in the vendor channel, we do have some near-term investments in people and processes and systems to enable this channel to scale. But after that, it can be a highly productive channel and actually a driver of profitable growth over time. It's too soon to say in virtual, but on the surface, it could be neutral at worse from a cost perspective versus direct shipping and in-home combined, possibly better. So you kind of add all those up and each of the big kind of blocks actually provide a path to superior economics over time.

Okay. Great. I guess that's a good segue to margins. Like, the path to profitability has always changed on the $100 of gross profit contribution per order metric. That obviously came down a bit in 2020, given COVID. I think the end of the year is around $83. So what are the key drivers to close that gap? And do you think you can get there by the end of 2021?

So the simple answer is yes. We do see the potential to get to $100 gross profit per order in the next 12 to 18 months. We were at $92 in 2019. And at that point, all that was left was getting better shipping costs and getting growth to leverage the essentially fixed cost in gross profit. We got the shipping cost improvement as of December of 2019. So really, all that was left was just annualizing that and driving scale. Then COVID hit, and through a number of drivers of gross profit per order off as supply took a big hit, that impacted our average order value substantially. Our take rate went down as product mix shifted. We had to lean more into buyer incentives, and we lost the benefit to scale. So simply, as supply recovers, all of those should normalize. We've actually had some additional breakthroughs in the shipping side, so that's actually getting better. And we're seeing strong average order values due to product mix, even as supply is still recovering. So overall, on balance, I feel really good about this.

Okay. Great. You talked earlier a little bit about technology and the automation investments that you've made over the past several years. What should we look forward to on those fronts in 2021, particularly as it relates to the New Arizona Authentication Center?

Yes. We're quite pleased with the progress we've made to automate several steps in our automation process. I think people hear, mostly know, we talked about this a lot. But at this point, more than 80% of our items have automated pricing, copywriting and retouched photos. That automation, of course, drives down cost, but just as importantly, and maybe even more importantly, reduces the complexity of our operations and improves the quality and consistency of our operations. So it's going to make it easier for us to scale and less dependent on linear growth of human capital. We're nearing the end state of automating those particular processes. There might be a little bit more that we can do, those diminishing returns. And going forward, we're going to shift our focus to other areas to drive automation. This year's focus is a couple of areas, primarily in authentication. So leveraging the same data asset and the same computer vision technology we've been able to leverage for pricing and copywriting. We can leverage that to better spot takes or flag or risk store items before a human lays eyes on it. So that's going to help us scale our authentication processes as well. We're also going to make progress on price optimization, so the flip side. So we think we can realize net-net higher prices, leveraging the data that we have and in very granular way in taking the next step in this area. And then all of that helps us accelerate the move into Arizona, kind of derisks the need to have large numbers of people and experts doing all the stuff. So the more automated the processes are, the easier it is to expand in new locations and lower locations. It happens to have the benefit of being close to the University of Arizona that produces more gemologists than any university in the world. So we're actually going to -- we have an existing partnership with the University of Arizona. And we're going to leverage that and actually create a pipeline of gemologists instead of a training and onboarding program. So we'll have a steady stream of people coming in the gemology area and -- as well as working on some interesting technology that's going to actually help us in our operations and authentication of numerous gemstones.

Excellent. Obviously, a lot has changed since the IPO. You've embedded more automation, rolled out faster. You've also, I think, invested a little bit more in real estate and in salespeople. I guess stepping back, has the GMV amount on a dollar basis needed for profitability increased or decreased versus the time of the IPO? And I guess, when we get back to normalized supply and demand, hopefully, this summer, how should we think about the time line to profitability?

Yes. First of all, hopefully, that -- things are kind of normal by summertime. Unfortunately, I can't get deeply specific here as, obviously, there's still a fair amount of uncertainty ahead. But to build on some of my other comments, stores have always been in the plan. I don't think there's much difference in overall cost there, vis-à-vis the IPO model and maybe better on the supply side. And more stores should bring more awareness in more local markets. So that could help support our marketing efficiency goals. And those should track to the IPO model. Expanding in Arizona is significantly less expensive than the rest of our portfolio. The per square foot costs are roughly half of the rest of our portfolio. So that should be a net benefit from a fixed cost perspective as we scale. And our automation efforts are on track. So getting cost leverage in operations, that's also on track. We talked about sales, economics and all of the new sales channels and bigger expectations for channels like vendor, so that should be neutral at worst to the cost structure. Yes, all of this stuff that all requires more technology investment, so that's a bit of an offset. So there's, obviously, puts and takes. But on balance, there's nothing here that would lead to a reset of our internal expectations other than the timing of when we get to the scale needed to break even. We, obviously, lost some time in 2020, but we're back on a growth trajectory, and hopefully, that continues to build. And once we get back to more predictable, strong high rates of growth, I think we'll be in a better position to provide an update on that.

One from the audience. If you were to fast-forward to all of your planned brick-and-mortar locations being fully operational, how would the cost of authentication, for example, shipping the product to your centers compare to the cost of authentication if someone does not use a physical store?

The -- like, when people drop off, the -- it's not really authentication, but it's more like a logistics and shipping expense sort of topic, I think. So the authentication doesn't happen in the stores. That always happens in our authentication centers in the warehouses. But on the transportation side, it's more advantageous when people drop off because then, of course, we can aggregate that and either shipped that -- those larger aggregated shipments via UPS. But all of our stores are going to be supported by our own internal transportation network of vans that shuttle in between the stores and the authentication centers. So that's a net positive, actually.

Okay. One of the most interesting things I think over the last year or so has been the announcement of partnerships with some of the luxury brands. Can you just spend a couple of minutes helping us understand how some of those partnerships came about, how they work and sort of how that amplifies the efforts of sort of the long-term vision of the company?

Sure. We have numerous partnerships and we've had them over time. So to keep it relatively simple, the typical form of a partnership with a brand is the brand introduces their buyers to us, encouraging them to consign their products and then take the proceeds of that consignment and go back into retail with them. So they offer incentive to go back and buy new. So kind of reinforcing a healthy luxury ecosystem. So that has worked well for all the brands that we've worked with. Our partnership with Gucci was a little bit of an evolution of that, where they not only encourage their buyers to consign and sell their stuff, but they actually encourage people to buy preowned as well because they see the value of a healthy resale economy and supporting their brand values and their efforts to become more sustainable. I think brand partnerships for us, they tend to be slow to develop. I'm not anticipating any kind of major ones in the immediate future. But over time, it's certain that the entire luxury industry and every brand is going to have to have a resale strategy. And as they dig in, I think they will find that this is hard. It's a complex business. And even if they have an e-commerce infrastructure to support their overall digital business, this is a different business. It's essentially a massive reverse logistics business where every product is unique. So it's incredibly complicated. So I think we're going to be pretty well positioned to be the partner of choice because we -- again, we stand alone in the full-service segment of the market with a very robust authentication infrastructure. So that's where the brands are -- like, they're motivated to work with people who keep fakes off the marketplace and kind of reinforce their brand value. So I think more to come over time, but whether it's working with us or trying things on their own, all of it stimulates the growth of the resale market, and that ultimately is good for us.

Okay. Great. One last one for me before we wrap it up. I guess as we look out to 2021, aside from, hopefully, the world is resuming to some sort of normal supply coming back and that leading demand. What are the 1 or 2 opportunities or changes that you're most excited about for Real this year?

Sure. I guess 2 immediately spring to mind. First is having a more diversified supply mix. And we talked a lot about that. That really helps derisk our business and gives us more levers to pull, and ultimately, more sources to unlock supply faster. So supply drives our business. So the better, more diversified sort of tools we have is great. We have COVID to think for that. And then second, I think I'm very excited about the prominent role that we play in the circular economy. Sustainability is at the core of what we do. And increasingly, this is not just about doing good for the planet, but it's also part of a big secular shift driven by younger consumers, but really embraced by people across all demographic spectrums. And it's increasingly going to be good for our business as well. So kind of looked into that, but being a sustainable business at the core is going to serve us well, I think.

Okay. Excellent. Well, we really appreciate your time, Matt. Thanks so much for joining us. Thanks, everyone, for listening in, for sending your questions, and we hope everyone has a great rest of the day. Thanks so much.

Thanks.