ThredUp Inc. (TDUP) Earnings Call Transcript & Summary

All right. I guess, technically, it's still a good morning, everyone. I'm Lauren Schenk, Morgan Stanley's small and mid-cap Internet analyst. I'm excited to be joined this morning by James Reinhart, thredUP's Founder and CEO; and Sean Sobers, CFO. One disclosure on my end. Please note that all important disclosures, including personal holding disclosures and Morgan disclosures, appear on the Morgan Stanley public website at morganstanley.com/researchdisclosures or at the registration desk.

So with that out of the way, James, for those that might be newer to the thredUP story, maybe talk about your founding vision for the business and how it's evolved over the past decade?

Yes. Sure. Yes. So the business was founded in 2009. The core thesis was the second-hand apparel market was sort of broken. People didn't have really convenient ways to get rid of the things they were wearing. People had to go to sort of smelly, stinky goodwill thrift stores, which nobody really liked. And so we thought there was this big opportunity to sort of reinvent how secondhand might work on the Internet. And that was a time when Spotify and Uber and Airbnb, all these sort of new consumer experiences were coming of age. And so we thought we could really build a big business in secondhand.

Okay. And obviously, resell apparel has been a very dynamic space over the past few years. How do you see the resale market evolving over the next couple of years and sort of the competitive positioning of thredUP within that?

Yes. I mean, for a number of years, I've been saying this sort of line of like, there were sort of 3 lanes in resale. You sort of had a luxury lane, which I think the RealReal has been in. You had a peer-to-peer lane, which Poshmark has been in. And you had thredUP as sort of a mass-managed marketplace. And honestly, I think things are playing out exactly as we thought, which is the biggest opportunity, the biggest TAM is in the managed sort of mass market in which we operate. And that peer-to-peer would have a real take rate race to the bottom, competitive dynamic that would be really hard. And that in the luxury space, it would be a really hard time acquiring inventory. And so I think from where we sit, we feel very good about the competitive positioning because I think as a 2-sided marketplace, it's all about supply. But I've been saying this for a long time. If you win the game -- if you win the supply game in a 2-sided market, you win the game. And I think we're winning in sort of every way you can imagine.

Great. Maybe following up on that. I think there are a lot of players that go after the higher-end resale space, in particular, because I think it's easier to think about how the unit economics could work.

Sure.

Maybe the middle and lower end gets a little bit more skepticism from investors because it's harder to make the math work. So explain how you're making the math work.

Yes. I mean I think people chase luxury because they can make the gross margins work. But what it fails to capture is the cost to acquire supply. And so our thesis has been that you could build a really big business and have superior unit economics if you had an unfair advantage in supply. And so from where we sit as a consignment business, we don't spend any money acquiring sellers, and we literally have to turn them away all the time, right? I mean, we have such demand for our cleanout service. And then we built these highly sophisticated distribution centers, sort of first of their kind, high throughput, low operating cost to do them. And so what that does is, in the U.S., because we now have a European business which we can talk about. But in the U.S., it's sort of a mid-70s gross margin business. And so I think we've done a very good job of building unit economics that have strong flow through, while at the same time, kind of scaling the business. But I think the lynchpin in there is that we don't pay to acquire supply and that you can do it at real sufficient scale to get the unit economics.

Great. Maybe let's pivot to macro. You've seen some volatility in the business over the past several months, you can talk about what you you've seen there, kind of what you're expecting over the coming year? And then in '08, '09, resell really wasn't a business. So we don't have really any frame of reference of how it performs in a potential recession. What is your sort of view in how it does perform in a recession?

Yes. I mean 2022, for -- I think it's been well documented. It was sort of almost a tale of two halves, right? I think the first half of the year was fine, as some people would describe it. The back half of the year was not. And what's interesting is we just reported Q4, the business was down 2% overall. What doesn't get captured in that is the business was up 70% last Q4, right? And so we saw tremendous growth into -- at the end of '21, and the first part of '22 was fine, and then we had this back half that's not been great. But I don't think it sort of calls into question the structural long-term tailwinds of resale. I think you just have to sort of manage through this consumer mushiness. And my take has always been in a mild recession or when consumers are feeling pinched, like resell should do quite well. I think we were very precise in our earnings call when we think the setup for resale in '23 is actually quite favorable because we expect softness in the consumer with what will end up being lean inventories across the retail environment. The intersection of those 2 things, I actually think is really good. The deep recession, I think all bets are off, but I don't think we're there yet.

Okay. How do you think about trade down in your business? Have you seen any of that? Do you think that accelerates in a recession?

I do think trade down accelerates in a recession. And the challenging part for us, I think we've talked about this over the last couple of quarters is there is this whole segment of budget shoppers who I think are -- who sort of sat out the market. And so they're trading out. They're not trading down. And I think that's consistent with how other retailers have talked about it. So I think as you get more stabilization in the economy of those customers kind of move back in. And I actually think that's a bigger tailwind to our business than just the trade down. But remember, we were just living through 6, 9 months of the greatest liquidation environment in the history of retail. And I don't think people truly appreciate the cost. I mean, I don't know if you cover Kohl's, but Kohl's, in their earnings, were talking about quarter-over-quarter reduction in inventory. You know this probably better than I do, but it was like Q2 inventory was up 50%, Q3 was 25%, Q4 [ a year ] was 4%. Where do you think all that product went, right? They were giving it away for $1, right? And it's hard to compete. It's hard to compete when people are giving stuff away.

Okay. Let's maybe -- let's pivot to the core business. Currently, you only accept women's and kids. Any thought in terms of entering men's at some point? And does not having men's inventory or men's angle impact the ability to win RaaS clients, which we'll talk about in a minute.

No, I don't think we'll go into men's anytime soon. I think there are plenty of women out there to build the business on. I still lack conviction that there's an interesting business to be built in men's. And so for the reasons that many of you know. So men, we wear the same 4 colors, blue, black, brown, gray. Raise your hand if you're wearing something other than blue, black, brown, gray.

I try to cover them all.

Yes, great. That one always wins in a public audience of investors. Second is men wear their stuff out at a much higher rate. So by the end of all of this, nobody wants pit-stained polos and dress shirts and jeans that are worn out. And the third is men just don't shop at the same rates, right? We don't have the same interest in a new dress, a new pair of shoes. And so for those 3 reasons, I'm not long on men's in resale.

Okay. All right. So maybe I'll take a step back on my previous question in terms of RaaS. Maybe explain to the audience what RaaS means and how you're using technology to scale resale?

Yes. So RaaS stands for Resale as a Service. So it's a business venture that we launched kind of inside the company a few years ago, I think 2019. And the idea was that we could ultimately power brand resale for brands on their own websites. And so if you were to go, our 2 most recent clients are J.Crew and Kate Spade. So if you went to their website, if you go to J.Crew and you kind of go into the navigation, you'll see that's pre-loved and you click on the Pre-loved tab, and it brings up a totally curated modern resell experience of used J.Crew products. And all those products are thredUP products. They live on our site and they are co-listed on J.Crew's site. And the power of RaaS is that we can leverage everything we do at thredUP exceptionally well, like sourcing, sellers, operations, processing, data, all that, and bring that to bear for retailers in a way where they can turn on our resale experience without really doing anything. And so I think that's what's really exciting about RaaS. And to your point about men's, I think the only time we would enter into men's is if a RaaS partner, it was like a "hey, we'll pay you to do men's for us." In which case, the economics are a little bit different. But so like for Tommy Hilfiger, for example, Tommy Hilfiger has a large men's business, and we do some men's for them on a pay-to-play kind of basis.

I think the thing on RaaS not to forget is that, that website on madewell.com or Athleta or whatever, is listing a bunch of stuff that is also listed on our core marketplace. So it's another channel. So just the ability to turn through that inventory or those items for sale that much quicker, which actually takes us to -- eventually, we'll talk about, I'm sure, CapEx spend and what we need in the DC -- not with network.

And just to give you a sense, in our distribution centers, our employees who -- they would have no idea where the stuff is going. So for them, they're just doing what they're doing. It just happens to be going to a customer that bought it on jcrew.com.

Okay. 2022 was a big year for RaaS. I think brand adoption was up more than 3x, and a lot of that was coming from new partnerships and white-label shops. Maybe talk about the roadmap for RaaS in '23 and any high-level ways to think about how RaaS impacts the P&L?

Yes, I don't think we have any news to make around the number of clients that we're targeting, but I think the business continues to gain momentum. I think retail, in this particular context, are their followers. So I think it's one of the things that the more brands we launch, the more brands are like hmm, right? And so we got a lot of inbound after the J.Crew and Kate Spade launches, and we've got another set of big launches coming in the next couple of months. So I think good, continued momentum in RaaS. The way it impacts the P&L is we monetize it in 3 ways. So first, we charge brands monthly recurring fees. RaaS does rhyme with sass for a reason, right? So we charge them monthly fees. It can vary from a few hundred dollars to many thousands. The second is that we power their cleanout programs, many of them. And so if you get a cleanout kit through one of our RaaS partners, Athleta, for example, is very successful at this. When you send this in, you get Athleta credit. We charge Athleta a fee to process that and turn that into a gift card. And then the third way is what Sean mentioned is we monetize through selling goods on other people's platform, which, the way that impacts our P&L, is we don't pay for any of that traffic, right? So not only does it generate return on assets for us, but it's sort of like free ad dollars.

Okay. Maybe let's switch gears to the expense side. Maybe talk about the path to profitability and the drivers to get there. And is there a minimum top line growth that you need to see to be able to achieve that?

Yes. So I think we previously talked about getting to breakeven EBITDA on the back half of this year '23 at $80 million to $85 million in revenue. So that's still very consistent in our message there. I think the piece that really simplify how do we go from where we are today to where we are breakeven, it's really simple: Growth and improved unit economics. And so you look from our annual guidance, we're growing revenue. We're actually investing in marketing. We're investing in operations. All of which are going to drive more growth. And then from a unit economics perspective, moving into Dallas, bigger, larger DC, moving into a more efficient DC in Bulgaria, and then actually implementing the automation that we've been working on throughout the years, in addition to the strategic initiatives that James already mentioned on the earnings call, the things around return rates, seller fees, all these things, sculpting, things that are going to just drive us to better overall unit economics, which means more money per item that drives us all to step 1, which is breakeven EBITDA; step 2, cash flow positive on operations; step 3, free cash flow, and I'll stop now because I'm going to keep going.

Okay. So you brought up Texas, a new distribution center DC07 just opened. How do you think about the ramp-up capacity there and the related costs through '23?

Yes. So we opened the first day is 2.5 million items, which brings our total U.S. network to 9 million plots or available space. Let's think of it that way. We're probably around 50% full. So we've got a good runway as far as before we need to build more. And we publicly stated over and over again that we don't believe we'll need any new DC CapEx spend until 2025 at the earliest. We're lowering CapEx spend from -- last year was $43 million, this year will be less than $15 million, will be front-end loaded. So I think we're really hyper-focused on that cash spend. But part of it is because we've made all this investment in the DC network. And then tying it back to RaaS is, as turns increase, we can just generate more revenue with the exact same footprint. Someday, we'll do a Phase 2 in Dallas, but at the earliest, it's 2025.

Okay. And then you talked on the earnings call also about the changes that you made on the cost of the cleanout kit. So we've added a $14.99 processing fee and $2.99, I think, for a mailbag. What drove those changes? And has it impacted supply at all?

Yes. I mean it's still experimental, right? It's not being -- and not everybody is in that sort of experiment. And we're continuing to kind of test sort of elasticity around that. What's really fascinating about it is -- so I was skeptical of the -- how much we could charge for this. But what I have found in the sort of a qualitative research is that what people really love is the fact that thredUP is open for business. And so when you talk to consumers, they're like, I don't really care about the $10, but I love that I can just send you something whenever I want. And that's like a really important insight of just how much we become part of people's lives and kind of what they do and how much dissatisfaction there was. Last year, when people were like, "I don't care what it costs. Can I just send my stuff to you because I feel good about it?" And so the results have been really encouraging. And so people are sending us stuff. They love it. The second piece is that -- and this is sort of obvious when you say it out loud. You charge people more money, they try and put as many things as possible in the bag, obviously, right? And so you're getting more items per bag, which when you spread across your logistics cost, means your cost per item of inbound was down. So not only do you get fees going up, but your cost per item goes down because you're loading over more items. And then the third piece is that there's some weird psychology of when you're paying, right, you kind of inspect your stuff a little bit more. And so we've seen yields and quality improve. And so to be honest, Lauren, it's like a home run across those 3 things. And so what that's done has now allowed us to figure out like Kate, when Kate sends us a bag, and it's a great bag, we can say, thanks so much, Kate, we're waiving your fee. And then she feels even better about it. And like -- and so there's real power in this that I -- frankly, like I did not anticipate how great it could be. So you can tell I'm pretty bullish on the opportunity.

Great. And you also mentioned some iterations or changes to the returns. Maybe elaborate a little bit on that, too?

Yes. So we made it so easy for you to load up your cart on thredUP that it created some negative behavior. I don't know if you ever did this, but people do. They buy a lot of stuff and then they return half of it because it's so easy to return. And so we started to put some guardrails around restocking fees. We made incrementally more items final sale. So we did some of the sort of basics. And then we're testing something that for just to a few set of customers, which is sort of a credit return system where we let you keep the item. And that's in its earliest days. But all of that has sort of brought return rates back to like where they were historically because you had this sort of weird -- for 10 years, return rates were where they were. The pandemic, they went way down because people were worried about touching stuff and going through it, right? And then back half of last year, they kind of surged as consumers got pickier, and I think we're now back to the more normal environment.

Okay. Gross margin has seen some pressure, but largely as you've seen a shift from consignment to product. Maybe talk about how that trends through '23 and when that should kind of reach equilibrium?

Yes. I think we ended the year with basically not open for business for the average customer, so which is all of our consignment supply. So it was mostly RaaS, which is mostly owned or a portion of it's owned. And then you also had kind of an uptick in European performance, which is all owned. So that kind of skewed Q4's results. We move into January 1, things are back to normal from a supply perspective. We still have to go through that RaaS supply. But I think you'll see a slight uptick in gross margin as you go through '23 as well as the mix shift towards consignment. I think you start to see a bigger mix shift to consignment once we start '24 and moving the European business more to consignment.

Okay. Maybe let's spend a minute on the European business remix. So after acquiring the business, you made a lot of progress and improvements there in 2022. Maybe talk about what you've improved since the acquisition and kind of what's the strategy going forward?

Yes, I mean it was a business I tracked for probably 5 years before we made the acquisition. So I was close to the founders. I understood could have like how they were operating the business. And they were managing to achieve what they were doing despite having such a rudimentary understanding of how you could apply software and analytics, right? I mean this was a company doing $35 million a year without really an e-mail function. Just let that sink in, right? You're like, what, right? Like no real -- they didn't have a single person doing retention. They didn't have a single data scientist. And so I looked at that, I was like, well, we know a lot about that. And so they spent the last year bringing data around pricing and promotions, e-mail marketing retention, like when do you hit a customer with a coupon or not, like all kinds of basic stuff, but that stuff that we had spent a bunch of years sort of cracking. So we did a lot of that last year. We started to begin this consignment transition. So most of their product is direct, as Sean mentioned. So we're sort of beginning that consignment transition we expect will take a few years. And the business has done well. I mean, on a constant currency basis, really exceeded our expectations. Obviously, the dollar moved against them, but I'm quite bullish on that business in Europe, in general.

Okay. Maybe let's stay on data. I have to ask the obligatory AI question that comes up in every fireside over the last 4 days. To what extent do you use AI in the business today? And where do you think you see the greatest opportunity as large language models and others gain traction over the next couple of years?

I mean we're using intelligent features in lots of stuff we do. Scott Belsky, who's like the founder of Behance and now runs a big part of Adobe, he's asked a bunch of people like, "Hey, have you ever used AI on Adobe products?" And only half of the audience said yes. "Have you ever used the auto-correct function?" Everyone was like, "Yes." He's like, "Well, you're using artificial intelligence." So it's part of so much that we do. I don't think we brand it internally as AI, although maybe we should start. But I think we're getting smarter and smarter about how to use our very large data models to improve how we price and how we promote and what we mark down and how we segment our customers. And so a lot of that is feeding into personalization.

Okay. I don't know if there's any questions in the audience. If not, I have a couple more. They want to use the mic, yes.

No concerns around differentiated supply, maybe some thoughts on buyer demand. What percent of accepted inventory is unsold after 90 days? And how has that ratio trended over the last few quarters?

What percent of accepted inventory? Yes, I don't know if we -- we don't disclose it publicly, but like the turns have been fine. And I think -- but the way to think about that is that we -- it's more that we manage the inbound. So unlike a traditional retailer who's got tons of stuff kind of coming and they're sort of forced to kind of push it through the system, if we see in our business that, hey, demand for swimwear, demand for athleisure is declining, right, what we do is we then stop accepting as much athleisure or as much swimwear. And so we can hit our turns target more by stopping the inbound piece. And I think that's, again, power of the marketplace and not a like traditional -- is our ability to control kind of both sides. And remember that we're using data constantly where -- so let's imagine there's a lululemon item that comes in, and we expect that item to sell in 12 days. And it turns out that it sits around for 24 days. I think the data system says, oh, there's something about this category at this moment in time, it's not turning as fast. So the next lululemon item we get in, it changes the price, it can change the payout. And so the constant might be an AI learning system, right, that's helping us hit those turns.

I guess maybe I'll wrap with each of you with the 2-parter maybe. One, what are you most excited about heading into 2023? And two, what do you think is most underappreciated or misunderstood about the business by investors?

I think we're asking about the stock-based comp. I want to talk about stock-based comp, Lauren. What am I most excited about? I mean, as I said on the earnings call, it just feels great to be in a position where there's a new normal and we kind of understand the field of play. And that was really hard in the back half of last year because you're just, like all of us were like, is it going to keep getting -- where is, like stasis, right? And so I think it's really nice to be back to being, okay, I know the rules of the game that we're playing right now, and I can now make changes. So I'm really excited about all the work the team is doing now that we know the new normal. And I'm very bullish about a bunch of these initiatives. There's a bunch of that we haven't talked about publicly yet that we'll talk about next quarter. And so I think '23 is a good setup for resale, and I think we're going to be able to play some offense this year.

Okay. Anything to add?

Okay. I have 2 on my head. He takes them both, of course. But I do think the impact of all the things that we've done over the last 2 years, above and beyond just the strategic initiatives, they all have been a little muted because of the environment has been tough. And so I think as you start to get to the new normal and then get into '24 and say that's a newer normal or a better normal, I think the impact of all those things we've done are really going to start to inflect and make the financials that much better. So I have to focus on the [ financial ].

Excellent. All right. Thank you, guys, so much for joining us, and thanks, everyone, for being here.

Yes, thank you.

Thank you.