The RealReal: A Look At Its Path To Profitability

Summary

• The company continues to improve on its adjusted EBITDA and margin.
• Management laid out its path for profitability in its earnings report.
• A major change in its commission structure will be the key to achieving profitability over the next couple of years.

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RealReal, Inc. (NASDAQ:REAL), which provides an online marketplace for consigned luxury goods, has had its share price crushed over the last couple of years, dropping from its two-year high of approximately $30.00 per share on February 22, 2021, to a 52-week low of $1.04 on December 27, 2022. It has since bounced off the low to trade at $1.50 per share as I write.

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In its latest earnings report it showed improvement with its adjusted EBITDA and margin, while laying out its path to profitability over the next couple of years.

Among the four changes put forth were a change in its commission structure, optimization of its dynamic pricing model, getting more aggressive concerning its cost base, and capitalizing on potential new revenue streams.

Of the four, the one that will have the most impact on the performance on the company over the long term will be the change in its commission structure and the implications of that on the top and bottom lines of REAL.

In this article we'll look at some of the numbers in its latest earnings report and how the company has been trending, and a closer look at the change in commission structure and what it means for the company over the long-term if it can successfully execute on the plan.

Some of the numbers

Revenue in the third quarter of 2022 was $142.7 million, compared to revenue of $118.9 million in the third quarter of 2021. Revenue in the first nine months of 2022 was $444 million, compared to revenue of $322.6 million in the third quarter of 2021. Revenue guidance for the fourth quarter was for a range of $145 million to $165 million.

Cost of revenue in the reporting period was $57 million, compared to cost of revenue of $48 million in the same quarter last year. Cost of revenue in the first nine months of 2022 increased to $191.8 million, compared to $129.7 million in the first nine months of 2021.

Operating expenses in the third quarter were $131.3 million, compared to $122.2 million in the third quarter of 2021. Operating expenses in the first nine months of 2022 came in at $403 million, up from $361.6 million in operating expenses in the first nine months of 2021.

The ongoing increase in cost of revenue and operating expenses has been one of the major reasons the stock has been hit so hard, along with it being considered an unfavorable tech stock in a high interest rate environment.

Loss from operations in the reporting period was $(45.5) million, compared to loss of operations of $(57.2) million in the third quarter of 2021. Loss from operations in the first nine months of 2022 was $(158) million, compared to loss from operations of $(183.8) in the first nine months of 2021.

Net loss in the third quarter of 2022 was $(47.3) million, compared to a net loss of $(57.2) million in the third quarter of 2021. Net loss in the first nine months of 2022 was $(157.8) million, compared to a net loss of $(183.9) million in the first nine months of 2021.

The company has shown progress in both loss from operations and net loss over the last year, most likely from the improvement in its adjusted EBITDA and margin. Gross margin has improved over the last three quarters, Gross margin in the first quarter of 2022 was approximately 53.5 percent. In the second quarter of 2022, it was almost 57 percent, and in the third quarter it was 60 percent.

Adjusted EBITDA in the third quarter was negative $(28.2) million, compared to adjusted EBITDA of negative $(31.5) million last year in the same quarter. Guidance for adjusted EBITDA in the fourth quarter of 2022 was to be in a range of negative $(27) million to negative $(23) million. On an adjusted EBITDA basis, the company says it will be profitable sometime in 2024. At the same time, the changes being instituted will probably result in a decline in revenue.

At the end of the third quarter of 2022 the company had cash and cash equivalents of $300 million, compared to cash and cash equivalents of $418 million at the end of calendar 2021.

Path to profitability

Earlier in the article I mentioned the four changes the company is implementing to accelerate its path to profitability. Of the four mentioned, managing its costs and changes in its commission structure will have the most short and long-term impact on the performance of the company, with changes in its commission structure being the most important in the quarters and years ahead. What the company is changing in its commission structure is disincentivize low value products offered on the site, or to put it another way, lower commissions on them; those products are unprofitable. At the same time, it's incentivising high value products by raising commissions. In the mid-tier products, there were no changes made on rates.

The desired end result is to reduce the number of unprofitable products offered on the site while encouraging more high-value items to be listed and sold.

Another step it's taking is to deemphasize specific categories like art, home and kids, which have little or no profitability.

If the company successfully executes on the strategy, the end result will include a decline in revenue going forward, but a significant improvement in profitability.

The real impact on the performance of the company won't be known until it works through inventory associated with the previous commission structure and the low-value items still on the platform. If successful, the company believes it'll be able to operate at breakeven or possibly slightly better in 2024.

That said, as for the normalized growth rate of the company will be after the changes, management said when asked about it on the earnings call that it won't be near the 35 percent CAGR growth rate included in the original vision 2025 plan, but much less than that.

It was also made clear that the reality is, there will be no clarity on normalized growth until the numbers come in after the new changes were implemented. I think it's going to take a couple of quarters before we know what the new normal growth rate of the company will be, and how quickly the changes will improve margin and the bottom line.

So to reiterate the changes in rates, it's to incentivize consignment of high value items, significantly cut the number of low-value unprofitable items on the platform, and no longer emphasize categories with little or no profitability.

One important caveat I want to mention is, the company is currently searching for a new CEO, and it's not known at this time, once the position is filled, whether or not the changes being instituted at this time will remain in place once the leadership change is made.

Conclusion

Investors will have to change the way they think about REAL because it's rapidly changing from a growth-at-any-cost company to a more disciplined firm that is now focusing primarily on accelerating its path to profitability.

With the changes in its commission structure, it's going to result in a decline in revenue growth, but an improvement in margin in the quarters and years ahead.

Concerning the short term, gross margin isn't likely to improve much, if at all, because of the need to work through inventory the company owns that is set at prior commission levels, which will probably have to be discounted in order to move it quicker. Once that process advances, it'll start to have the desired impact on margin.

As for the buyer side of the equation, the number of active buyers as of the third quarter of 2022, were up 23 percent year-over-year. That will be an important metric to watch as impact of the changes in commission rates are revealed.

I think with lower inventory offered on the site, that the number of active buyers will likely decline. That's especially true with lower-costs, lower-value products being significantly reduced.

How the share price of the company does in the near term will depend upon how the market responds to what looks to be much lower revenue, which probably means a decline in active users on the site, against the expected improvement in margin and earnings.

Further out, if the company successfully executes on its strategy, it could start to sustainably move up from a profitable base that has promise to deliver steady growth.

The share price of REAL has jumped quickly from its low, but there really is no visibility at this time that would point to it being sustainable. The initial numbers from the changes made need to come in before we know what the potential growth trajectory of the company will be.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.