THE REALREAL, INC. The following discussion of our financial condition and results of operations should be read together with our condensed financial statements and related notes thereto included elsewhere in this Quarterly Report on Form 10-Q and our audited financial statements and related notes and our Annual Report on Form 10-K filed with theSecurities and Exchange Commission onMarch 11, 2020 . The following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. See the discussion under "Note Regarding Forward-Looking Statements" elsewhere in this Quarterly Report on Form 10-Q for more information. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and particularly in the section titled "Risk Factors" and elsewhere in this Quarterly Report on Form 10-Q. Our historical results are not necessarily indicative of the results that may be expected for any period in the future, and our interim results are not necessarily indicative of the results we expect for the full calendar year or any other period. Overview We are the world's largest online marketplace for authenticated, consigned luxury goods. We are revolutionizing luxury resale by providing an end-to-end service that unlocks supply from consignors and creates a trusted, curated online marketplace for buyers globally. Over the past nine years, we have cultivated a loyal and engaged consignor and buyer base through continuous investment in our technology platform, logistics infrastructure and people. We aggregate and curate unique, pre-owned luxury supply that is exclusive to TheRealReal across multiple categories, including women's, men's, kids', jewelry and watches, and home and art. We have built a vibrant online marketplace that we believe expands the overall luxury market, promotes the recirculation of luxury goods and contributes to a more sustainable world. We have transformed the luxury consignment experience by removing the friction and pain points inherent in the traditional consignment model. For consignors, we provide White Glove in-home consultation and pickup, drop off at one of our ten luxury consignment offices ("LCOs") four of which are located in our retail stores, or complimentary shipping directly to our merchandising and fulfillment facilities. We leverage our proprietary transactional database and market insights to deliver optimal pricing and rapid sell-through. For buyers, we offer highly coveted and exclusive authenticated pre-owned luxury goods at attractive values, as well as a high-quality experience befitting the products we offer. Our online marketplace is powered by our proprietary technology platform, including consumer facing applications and purpose-built software that supports our complex, individual stock keeping unit ("single-SKU") inventory model and merchandising operations.
The substantial majority of our revenue is generated by consignment sales. We also generate revenue from other services and direct sales.
• Consignment and service revenue. When we sell goods through our online
marketplace on behalf of our consignors, we retain a percentage of the
proceeds, which we refer to as our take rate. Take rates vary depending on
the total value of goods sold through our online marketplace on behalf of
a particular consignor as well as the category and price point of the
items. In the three months ended
take rate on consigned goods was 35.4% and 36.8%, respectively. In the
nine months ended
consigned goods was 35.9% and 36.3%, respectively. Additionally, we earn
revenue from shipping fees and from our subscription program, First Look,in which we offer buyers early access to the items we sell in exchange for
a monthly fee.
• Direct revenue. In certain cases, such as when we accept out of policy
returns from buyers, we take ownership of goods and retain 100% of the
proceeds when the goods subsequently resell through our online
marketplace.
We generate revenue from orders processed through our website, mobile app, LCOs,
and four retail stores located in New York , Los Angeles , and San Francisco . Our
omni-channel experience enables buyers to purchase anytime and anywhere. We have
a global base of more than 19.3 million members as of September 30, 2020 . We
count as a member any user who has registered an email address on our website or
downloaded our mobile app, thereby agreeing to our terms of service.
Our gross merchandise value ("GMV") decreased by 3% to $245.4 million from
$252.8 million in the three months ended September 30, 2020 and 2019,
respectively. Our GMV decreased by 3% to $685.7 million from $705.4 million in
the nine months ended September 30, 2020 and 2019, respectively. However, NMV
increased slightly as returns decreased year over year primarily due to a higher
mix of non-returnable items, including handbags and certain promoted items. Our
total revenue decreased by 4% to $78.1 million from $81.5 million in the three
months ended September 30, 2020 and 2019, respectively. Our total revenue
decreased by 5% to $213.7 million and $224.3 million in the nine months ended
September 30, 2020 and 2019, respectively. The decrease in revenue for both
periods was driven primarily by the decreases in GMV and take rate. In the three
months ended September 30, 2020 and 2019, our gross profit was $49.8 million and
$52.2 million , respectively, representing a decrease of 5%. In the nine months
ended September 30, 2020 and 2019, our gross profit was $134.8 million and
$140.7 million , respectively, representing a decrease of 4%. See "-Impact of
COVID-19 on our Business" below.
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--------------------------------------------------------------------------------Impact of COVID-19 on Our Business
InMarch 2020 , theWorld Health Organization categorized the outbreak of a novel coronavirus (COVID-19) as a pandemic. The COVID-19 pandemic has adversely impacted our business operations and results of operations in 2020 as described in more detail under "Comparison of the Three and Nine months endedSeptember 30, 2020 and 2019" below. Operations in the Company's fulfillment facilitates were initially limited in accordance with shelter-in-place orders resulting in operations below full capacity. However, operations capacity was no longer limited by restrictions related to COVID-19 during the three months endedSeptember 30, 2020 . Additionally, our retail stores and luxury consignment offices were temporarily closed for varying periods of time, but have been open during the entirety of three months endedSeptember 30, 2020 . In-person white glove consignment appointments were temporarily suspended and augmented with virtual appointments but remain an option for our consignor base. GMV was negatively impacted due to adverse impacts of the COVID-19 pandemic on our business, but GMV trends have improved significantly. InMarch 2020 , when many shelter-in-place directives went into effect, and continuing throughmid-April 2020 , GMV declined approximately 40%-45% year over year. In the three months endedSeptember 30, 2020 , GMV declined approximately 3% year over year. With the GMV recovery, we continued to invest in marketing and resumed hiring during the three months endedSeptember 30, 2020 . We expect the evolving COVID-19 pandemic to continue to have a materially adverse impact on our business operations and results of operations, including our net revenues, earnings and cash flows, including as a result of further spread of the disease, potential disruption in our fulfillment centers, further temporary closures of retail stores and luxury consignment offices, disruption to our supply acquisition, decreased productivity due to shelter-in-place orders, changes in buyer and consignor behaviors, and a slowdown in theU.S. economy and uncertain global economic outlook. It may result in changes in customer behaviors, including a potential reduction in consumer discretionary spending on our e-commerce site and in our retail stores. Travel and border closures do not significantly affect our business as we operate aU.S. focused marketplace. We have taken actions to help ensure that our business will continue uninterrupted through the COVID-19 pandemic, including enforcing social distancing in our fulfillment centers, enabling virtual consignment appointments, implementing curbside pick-up of products from our consignors, and implementing steps to enable employees to work remotely. The impact of these actions on our workforce are difficult to assess. However, we do not believe that these remote work arrangements have adversely affected our ability to maintain our financial reporting systems, internal control over financial reporting and disclosure controls and procedures. In addition, we do not expect to encounter any significant challenges to our ability to maintain these systems and controls. We also do not expect the pandemic to affect the assets on our condensed balance sheet and our ability to timely account for those assets. We evaluate our estimates and assumptions used in preparing our financial statements on an ongoing basis. We do not anticipate any material impairments with respect to long-lived assets, right-of-use assets or investments, or changes in accounting judgments that would have a material impact on our financial statements.
Other Factors Affecting Our Performance
Other key business and marketplace factors, independent of the health and economic impact of the COVID-19 pandemic, impact our business. To analyze our business performance, determine financial forecasts and help develop long-term strategic plans, we focus on the factors described below. While each of these factors presents significant opportunity for our business, collectively, they also pose important challenges that we must successfully address in order to sustain our growth, improve our operating results and achieve and maintain our profitability. Consignor growth and retention. We grow our sales by increasing the supply of luxury goods offered through our consignment online marketplace. We grow our supply both by attracting new consignors and by creating lasting engagement with existing consignors. We generate leads for new consignors principally through our advertising activity. We convert those leads into active consignors through the activities of our sales professionals,who are trained and incentivized to identify and source high-quality, coveted luxury goods from consignors. Our sales professionals form a consultative relationship with consignors and deliver a high-quality, rapid consigning experience. Our existing relationships with consignors allow us to unlock valuable supply across multiple categories within the home, including women's, men's, kids', jewelry and watches, and home and art. We leverage our proprietary transactional database and market insights based on more than 15.8 million item sales since inception to deliver consignors optimal pricing and rapid sell-through. Our growth has been driven in significant part by repeat sales by existing consignors concurrent with growth of our consignor base. The percentage of GMV from repeat consignors in the three and nine months endedSeptember 30, 2020 was 83% as compared to 81% for both the three and nine months endedSeptember 30, 2019 . Buyer growth and retention. We grow our business by attracting and retaining buyers. We attract and retain buyers by offering highly coveted, authenticated, pre-owned luxury goods at attractive values and delivering a high-quality, luxury experience. We measure our success in attracting and retaining buyers by tracking buyer satisfaction and purchasing activity over time. We have experienced high buyer satisfaction, as evidenced by our buyer net promoter score of 71 in 2019. 26 -------------------------------------------------------------------------------- We believe there is substantial opportunity to grow our business by having buyers also become consignors and vice versa. As ofSeptember 30, 2020 , 13% of our buyers had become consignors and 55% of our consignors had become buyers. If we fail to continue to attract and retain our buyer base to our online marketplace, our operating results would be adversely affected. Scaling operations and technology. To support the future growth of our business, we plan to expand our capacity through investments in physical infrastructure, talent and technology over the long term. We principally conduct our intake, authentication, merchandising and fulfillment operations in our four leased merchandising and fulfillment facilities located inCalifornia andNew Jersey comprising an aggregate of approximately 1 million square feet of space. The market for real estate to support operations centers such as ours is competitive, and we plan to continue to secure and efficiently bring online additional capacity to support future growth. The opening of our retail stores inNew York in late 2017 andLos Angeles in mid-2018 significantly contributed to the increase in operations and technology expense in 2018. We opened a second retail store inNew York inMay 2019 . We opened our fourth retail store inSan Francisco inMarch 2020 , and we intend to open additional retail stores in the future. After postponing the opening due to the negative impacts of COVID-19 to our business, ourChicago retail store opened inOctober 2020 . In addition to scaling our physical infrastructure, growing our single-SKU business operations requires that we attract, train and retain highly-skilled personnel for purposes of authentication, copywriting, merchandising, pricing and fulfilling orders. We invest substantially in technology to automate our operations and support growth. We continue to strategically invest in technology despite the difficult operating environment resulting from COVID-19, as innovation positions us to scale and support growth once the economy normalizes. Seasonality. Before the COVID-19 pandemic, we have observed trends in seasonality of supply and demand in our business. Specifically, our supply increases in the third and fourth quarters, and our demand increases in the fourth quarter. As a result of this seasonality, we typically see stronger average order value ("AOV"), and more rapid sell-through in the fourth quarter. We also incur higher operating expenses in the last four months of the year as we increase advertising spend to attract consignors and buyers and increase headcount in sales and operations to handle the higher volumes. However, the adverse impacts of COVID-19 on our business has made it difficult to evaluate the impact of seasonality in our business. While we expect supply will continue to be negatively impacted by COVID-19, we believe its growth will accelerate in the fourth quarter. Additionally, we expect higher advertising spend and demand increases in the fourth quarter.
Key Financial and Operating Metrics
The key operating and financial metrics that we use to assess the performance of our business are set forth below for the three and nine months endedSeptember 30, 2020 and 2019. Three Months Ended Nine Months Ended September 30, September 30, September 30, September 30, 2020 2019 2020 2019 (In thousands, except AOV and percentages) GMV$ 245,355 $ 252,766 $ 685,732 $ 705,358 NMV (1)$ 189,059 $ 186,617 $ 513,481 $ 511,937 Number of Orders 550 577 1,562 1,581 Take Rate 35.4 % 36.8 % 35.9 % 36.3 % Active Buyers 617 543 617 543 AOV $ 446 $ 438 $ 439 $ 446 (1) The basis for calculation of NMV has been consistently applied for all reporting periods, however the definition of the NMV operating metric was modified to clarify the manner in which it was determined. The modification of the definition does not materially change the reported operating metric. GMV GMV represents the total amount paid for goods across our online marketplace in a given period. We do not reduce GMV to reflect product returns or order cancellations. GMV includes amounts paid for both consigned goods and our inventory net of platform-wide discounts and excludes the effect of certain buyer incentives, shipping fees and sales tax. Buyer incentives consist of coupons or promotions that offer credits in connection with purchases on our platform. We believe this is the primary measure of the scale and growth of our online marketplace and the key indicator of the health of our consignor ecosystem. We monitor trends in GMV to inform budgeting and operational decisions to support and promote growth in our business and to monitor our success in adapting our business to meet the needs of our consignors and buyers. While GMV is the primary driver of our revenue, it is not a proxy for revenue or revenue growth. See Note 2 - Summary of Significant Accounting Policies -Revenue Recognition - Consignment and Service Revenue. 27 --------------------------------------------------------------------------------
NMV
NMV, or net merchandise value, represents the value of sales from both consigned goods and our inventory net of platform-wide discounts less product returns and order cancellations and does not take into account the effect of certain buyer incentives, shipping fees and sales tax. We believe NMV is a supplemental measure of the scale and growth of our online marketplace. Like GMV, NMV is not a proxy for revenue or revenue growth.
Number of Orders
Number of orders means the total number of orders placed across our online marketplace in a given period. We do not reduce number of orders to reflect product returns or order cancellations.
Take Rate
Take rate is a key driver of our revenue and provides comparability to other marketplaces. The numerator used to calculate our take rate is equal to GAAP consignment and service revenue, excluding certain buyer incentives, shipping and subscription service revenue, and other adjustments. The denominator is equal to the numerator plus consignor commissions. We exclude direct revenue from our calculation of take rate because direct revenue represents the sale of inventory owned by us, which costs are included in cost of direct revenue. See the subsection titled "-Components of our Operating Results-Revenue" for further discussion of consignment and service revenue and direct revenue. Our take rate reflects the high level of service that we provide to our consignors across multiple touch points and the consistently high velocity of sales for their goods. Our take rate structure is a tiered commission structure for consignors, where the more they sell the higher percent commission they earn. Consignors start at a 55% commission (which equals a 45% take rate for us) and can earn up to a 70% commission. This tiered structure applies unless it is overridden by a commission exception. Commission exceptions are used to incentivize our sales team, optimize supply and drive take rate changes. Examples of current commission exceptions include a flat 40% commission on all items under$145 , and an 85% commission on watches over$2,500 . Management assesses changes in take rates by monitoring the volume of GMV and take rate across each discrete commission grouping, encompassing commission tiers and exceptions.
Active Buyers
Active buyers include buyerswho purchased goods through our online marketplace during the 12 months ended on the last day of the period presented, irrespective of returns or cancellations. We believe this metric reflects scale, brand awareness, buyer acquisition and engagement.
Average Order Value ("AOV")
Average order value ("AOV") means the average value of all orders placed across
our online marketplace, excluding shipping fees and sales taxes. Our focus on
luxury goods across multiple categories drives a consistently high AOV. Our AOV
reflects both the average price of items sold as well as the number of items per
order. Our high AOV is a key driver of our operating leverage.
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--------------------------------------------------------------------------------Adjusted EBITDA
Adjusted EBITDA means net loss before interest income, interest expense, other
(income) expense net, provision for income taxes, and depreciation and
amortization, further adjusted to exclude stock-based compensation and certain
one-time expenses. Adjusted EBITDA provides a basis for comparison of our
business operations between current, past and future periods by excluding items
that we do not believe are indicative of our core operating performance.
Adjusted EBITDA is a non-GAAP measure. The following table provides a
reconciliation of net loss to Adjusted EBITDA (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
2020 2019 2020 2019
Adjusted EBITDA Reconciliation:
Net loss $ (43,305 ) $ (25,274 ) $ (124,489 ) $ (75,371 )
Depreciation and amortization 4,917 3,545 13,673 9,537
Stock-based compensation 7,372 2,520 16,911 4,916
Legal settlement - - 1,110 -
Restructuring charges 72 - 514 -
Compensation expense related to stock
sales by current
and former employees - - - 819
Interest income (448 ) (1,902 ) (2,350 ) (2,918 )
Interest expense 2,406 60 2,810 572
Other expense, net - 119 89 2,106
Provision (benefit) for income taxes (17 ) (8 ) 38 51
Adjusted EBITDA $ (29,003 ) $ (20,940 ) $ (91,694 ) $ (60,288 ) Components of our Operating Results
Revenue
Our revenue is comprised of consignment and service revenue and direct revenue.
• Consignment and service revenue. We generate the substantial majority of
our revenue from the sale of pre-owned luxury goods through our online
marketplace on behalf of consignors. For consignment sales, we retain a
percentage of the proceeds received, which we refer to as our take rate.
We recognize consignment revenue, net of allowances for product returns,
order cancellations and certain buyer incentives. Additionally, we
generate revenue from shipping fees we charge to buyers. We also generate
service revenue from subscription fees paid by buyers for early access to
products, but to date our subscription revenue has not been material.
• Direct revenue. We generate direct revenue from the sale of items that we
own, which we refer to as our inventory. We generally acquire inventory
when we accept returns from buyers after title has transferred for
returned goods from the consignor to the buyer. As such, growth in direct
sales is generally a byproduct of growth in our consignment business. We
recognize direct revenue based on the gross purchase price paid by buyers,
net of allowances for product returns and certain buyer incentives.
Cost of Revenue
Cost of consignment and services revenue consists of shipping costs, credit card
fees, packaging, customer service personnel-related costs, and website hosting
services. Cost of direct revenue consists of the cost of goods sold, credit card
fees, packaging, customer service personnel-related costs, and website hosting
services.
Marketing
Marketing expense comprises the cost of acquiring new consignors and buyers,
including the cost of television, digital and direct mail advertising. Marketing
expense also includes personnel-related costs for employees engaged in these
activities.
Operations and Technology
Operations and technology expense principally includes personnel-related costs
for employees involved with the authentication, merchandising and fulfillment of
goods sold through our online marketplace, as well as our general information
technology expense. Operations and technology expense also includes allocated
facility and overhead costs, costs related to our retail stores, facility
supplies and depreciation of hardware and equipment, as well as research and
development expense for technology associated with
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managing and improving our operations. We capitalize a portion of our
proprietary software and technology development costs. As such, operations and
technology expense also includes amortization of capitalized technology
development costs. While we have implemented cost saving measures to address the
challenges from the COVID-19 pandemic, we expect operations and technology
expense to increase over the long term to support our growth, including bringing
on additional merchandising and fulfillment facilities and continuing to invest
in automation and other technology improvements to support and drive efficiency
in our operations. These expenses may vary from period to period as a percentage
of revenue, depending primarily upon when we choose to make more significant
investments. We expect these expenses to decrease as a percentage of revenue
over the longer term.
Selling, General and Administrative
Selling, general and administrative expense is principally comprised of personnel-related costs for our sales professionals and employees involved in finance and administration. Selling, general and administrative expense also includes allocated facilities and overhead costs and professional services, including accounting and legal advisors.
Provision for Income Tax
Our provision for income taxes consists primarily of state minimum taxes inthe United States . We have a full valuation allowance for our net deferred tax assets primarily consisting of net operating loss carryforwards, accruals and reserves. We expect to maintain this full valuation allowance for the foreseeable future.
Results of Operations
The following tables set forth our results of operations (in thousands) and such data as a percentage of revenue for the periods presented:
Three Months Ended Nine Months Ended
September 30, September 30,
2020 2019 2020 2019
Revenue:
Consignment and service revenue $ 64,407 $ 69,245 $ 176,570 $ 184,890
Direct revenue 13,645 12,271 37,111 39,417
Total revenue 78,052 81,516 213,681 224,307
Cost of revenue:
Cost of consignment and service revenue 16,304 19,446 47,253 52,592
Cost of direct revenue 11,964 9,842 31,678 31,056
Total cost of revenue 28,268 29,288 78,931 83,648
Gross profit 49,784 52,228 134,750 140,659
Operating expenses:
Marketing 15,186 13,390 37,747 36,838
Operations and technology 40,578 37,407 117,858 103,271
Selling, general and administrative 35,384 28,436 103,047 76,110
Total operating expenses 91,148 79,233 258,652 216,219
Loss from operations (41,364 ) (27,005 ) (123,902 ) (75,560 )
Interest income 448 1,902 2,350 2,918
Interest expense (2,406 ) (60 ) (2,810 ) (572 )
Other income (expense), net - (119 ) (89 ) (2,106 )
Loss before provision for income taxes (43,322 ) (25,282 ) (124,451 ) (75,320 )
Provision (benefit) for income taxes (17 ) (8 ) 38 51
Net loss $ (43,305 ) $ (25,274 ) $ (124,489 ) $ (75,371 )
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Three Months Ended Nine Months Ended
September 30, September 30,
2020 2019 2020 2019
Revenue:
Consignment and service revenue 82.5 % 84.9 % 82.6 % 82.4 %
Direct revenue 17.5 15.1 17.4 17.6
Total revenue 100.0 100.0 100.0 100.0
Cost of revenue:
Cost of consignment and service revenue 20.9 23.9 22.1 23.4
Cost of direct revenue 15.3 12.0 14.8 13.9
Total cost of revenue 36.2 35.9 36.9 37.3
Gross profit 63.8 64.1 63.1 62.7
Operating expenses:
Marketing 19.5 16.4 17.7 16.4
Operations and technology 52.0 45.9 55.2 46.1
Selling, general and administrative 45.3 34.9 48.2 33.9
Total operating expenses 116.8 97.2 121.1 96.4
Loss from operations (53.0 ) (33.1 ) (58.0 ) (33.7 )
Interest income 0.6 2.3 1.1 1.3
Interest expense (3.1 ) (0.1 ) (1.3 ) (0.3 )
Other income (expense), net - (0.1 ) (0.1 ) (0.9 )
Loss before provision for income taxes (55.5 ) (31.0 ) (58.3 ) (33.6 )
Provision (benefit) for income taxes - - - -
Net loss (55.5 )% (31.0 )% (58.3 )% (33.6 )%
Comparison of the Three and Nine Months Ended
Consignment and Service Revenue
Consignment and service revenue decreased by$4.8 million , or 7%, in the three months endedSeptember 30, 2020 compared to the three months endedSeptember 30, 2019 . The decrease in revenue was driven primarily by the decreases in GMV and take rate. Supply was negatively impacted inNew York City andLos Angeles , our largest markets. Decreased traffic at our retail stores and LCOs also negatively impacted consignment levels during the three months endedSeptember 30, 2020 . Consignment and service revenue decreased by$8.3 million , or 4% in the nine months endedSeptember 30, 2020 compared to the nine months endedSeptember 30, 2019 . At the beginning the pandemic, limited operations in our fulfillment facilities and the temporary closures of our luxury consignment offices and retail stores in accordance with shelter-in-place directives significantly impacted GMV. Both supply and demand were adversely impacted by limited operations in our fulfillment facilities, the temporary closures of our luxury consignment offices and retail stores, and disruption in ourNew York City andLos Angeles markets. InMarch 2020 , when many shelter-in-place directives went into effect, and continuing throughmid-April 2020 , GMV declined approximately 40%-45% year over year. Since then, GMV trends have improved significantly. GMV declined approximately 3% in the three months endedSeptember 30, 2020 compared to the same period last year. Our take rate decreased to 35.4% from 36.8% in the three months endedSeptember 30, 2020 compared to the same period last year. Take rate decreased due to the higher sales mix of lower take rate categories such as handbags and jewelry, and a higher mix of consignors earning higher commissions. Our take rate decreased to 35.9% from 36.3% in the nine months endedSeptember 30, 2020 compared to the same period last year. Constraints on our ability to source supply consequently negatively impacted consumer demand. The continuation of the outbreak may result in changes in customer behaviors, including a potential reduction in consumer discretionary spending on our e-commerce site and in our retail stores.
Direct Revenue
Direct revenue increased by$1.4 million , or 11%, in the three months endedSeptember 30, 2020 compared to the three months endedSeptember 30, 2019 . The increase was driven by the higher sales mix of company-owned inventory and higher sales of aged inventory. Direct revenue decreased by$2.3 million , or 6%, in the nine months endedSeptember 30, 2020 compared to the nine 31 -------------------------------------------------------------------------------- months endedSeptember 30, 2019 . The decrease was driven in part by COVID-19 adverse impacts to our business noted above. We recognize direct revenue on a gross basis upon shipment of the purchased good to the buyer. We expect direct revenue as a percent of total revenue to vary from period to period.
Cost of Consignment and Service Revenue
Cost of consignment and service revenue decreased by$3.1 million , or 16%, in the three months endedSeptember 30, 2020 compared to the three months endedSeptember 30, 2019 and by$5.3 million , or 10%, in the nine months endedSeptember 30, 2020 compared to the same period last year. The decrease was primarily due to lower revenue in connection with COVID-19 related business interruptions. Gross margin increased by 2.8% in the three months endedSeptember 30, 2020 compared to the three months endedSeptember 30, 2019 and increased by 1.7% in nine months endedSeptember 30, 2020 compared to the nine months endedSeptember 30, 2019 . The increase was primarily attributable to an overall improvement in shipping costs relating to more favorable terms with our shipping carrier. Cost of Direct Revenue Cost of direct revenue increased by$2.1 million , or 22%, in the three months endedSeptember 30, 2020 compared to the three months endedSeptember 30, 2019 and by$0.6 million , or 2%, in the nine months endedSeptember 30, 2020 compared to the nine months endedSeptember 30, 2019 . Gross margin decreased by 7.5% and 6.6% for the three and nine months endedSeptember 30, 2020 compared to the same periods last year, primarily due to lower product margins on sales of aged inventory.
Marketing
Marketing expense increased by$1.8 million , or 13%, in the three months endedSeptember 30, 2020 compared to the three months endedSeptember 30, 2019 as we increased our marketing investments with the improving GMV trends. Marketing expense increased by$0.9 million , or 2%, in the nine months endedSeptember 30, 2020 compared to the nine months endedSeptember 30, 2019 primarily due to higher stock-based compensation expense. As a percent of revenue, marketing expense increased to 19.5% from 16.4% in the three months endedSeptember 30, 2020 and 2019, respectively. As a percent of revenue, marketing expense increased to 17.7% from 16.4% in the nine months endedSeptember 30, 2020 and 2019, respectively. Our marketing efficiency was offset by the significant adverse impact of COVID-19 on our revenue. We will continue to evaluate our marketing strategy during the COVID-19 pandemic.
Operations and Technology
Operations and technology expense increased by$3.2 million , or 8%, in the three months endedSeptember 30, 2020 compared to the three months endedSeptember 30, 2019 . The increase was primarily due to higher employee compensation related expenses, including stock-based compensation expense and higher occupancy costs. Operations and technology expense increased by$14.6 million , or 14%, in the nine months endedSeptember 30, 2020 compared to the nine months endedSeptember 30, 2019 . The increase was primarily due to higher employee compensation related expenses, including stock-based compensation, higher occupancy costs, and higher technology costs. While there were employee furloughs, the average headcount was higher year over year primarily in our authentication, merchandising and technology teams. As a percent of revenue, operations and technology expense increased to 52.0% from 45.9% in the three months endedSeptember 30, 2020 and 2019, respectively and to 55.2% from 46.1% in the nine months endedSeptember 30, 2020 and 2019, respectively. This increase is primarily due to higher fixed occupancy costs compared to lower revenue as a result of COVID-19's negative impact on revenue during the three and nine months endedSeptember 30, 2020 . While we have implemented cost saving measures to address the challenges from the COVID-19 pandemic, we continued to invest in automation, consignor services including virtual appointments and self-scheduling, and other technology improvements to support and drive efficiency in our operations and to support our growth.
Selling, General and Administrative
Selling, general and administrative expense increased by$6.9 million , or 24%, in the three months endedSeptember 30, 2020 compared to the three months endedSeptember 30, 2019 . The increase was primarily due higher employee compensation related expenses, including stock-based compensation expense, increased COVID-19 related expenses to implement health and safety measures, and higher legal and accounting fees. Selling, general and administrative expense increased by$26.9 million , or 35%, in the nine months endedSeptember 30, 2020 compared to the nine months endedSeptember 30, 2019 . The increase was primarily due to higher employee compensation related 32 --------------------------------------------------------------------------------
expenses, including stock-based compensation due to an increase in average
headcount, increased COVID-19 related expenses to implement health and safety
measures, and higher accounting and legal fees including legal settlement
charges of
As a percent of revenue, selling, general and administrative expense increased to 45.3% from 34.9% in the three months endedSeptember 30, 2020 and 2019, respectively and to 48.2% from 33.9% in the nine months endedSeptember 30, 2020 and 2019, respectively as we invested in the growth of the sales organization and expanded our finance and administrative functions as a public company. This increase is primarily due to higher fixed general and administrative costs compared to lower revenue as a result of COVID-19's negative impact on revenue, which we expect will continue to some extent until the COVID-19 pandemic has ended and our operations normalize.
Interest Income
Interest income decreased$1.4 million , or 76%, for the three months endedSeptember 30, 2020 as compared to the three months endedSeptember 30, 2019 . Interest income decreased$0.6 million , or 19%, in the nine months endedSeptember 30, 2020 as compared to the nine months endedSeptember 30, 2019 due to lower rates and lower average investment balances.
Interest Expense
Interest expense increased$2.3 million , or 3910%, for the three months endedSeptember 30, 2020 compared to the three months endedSeptember 30, 2019 and increased$2.2 million , or 391%, in the nine months endedSeptember 30, 2020 as compared to the nine months endedSeptember 30, 2019 , primarily due to the contractual interest expense and amortization of the debt discount related to the 3.00% convertible senior notes issued inJune 2020 .
Other Income (Expense), Net
Other expense decreased$0.1 million , or 100%, in the three months endedSeptember 30, 2020 as compared to the three months endedSeptember 30, 2019 due to a franchise tax charge in 2019. Other expense decreased$2.0 million , or 96%, in the nine months endedSeptember 30, 2020 as compared to the nine months endedSeptember 30, 2019 , primarily due to remeasurement of the warrant liability in 2019 as there were no warrants outstanding after the Company's IPO inJuly 2019 .
Liquidity and Capital Resources
As ofSeptember 30, 2020 , we had unrestricted cash, cash equivalents and short-term investments of$395.2 million and an accumulated deficit of$479.0 million . InMarch 2019 , the Company issued Series H redeemable convertible preferred stock and convertible preferred stock to new and existing investors for aggregate net proceeds of$69.8 million . InJuly 2019 , we received net proceeds of$315.5 million upon completion of our IPO onJuly 2, 2019 . InJune 2020 , we received net proceeds of$143.3 million from the issuance of 3% convertible senior notes due 2025 and the related cap call transactions. Since inception, we have generated negative cash flows from operations and have primarily financed our operations through several rounds of venture capital financing. In addition, proceeds from our IPO and convertible senior notes will be used to finance our operations. We expect that operating losses and negative cash flows from operations could continue in the foreseeable future as we navigate the challenges presented by COVID-19 and invest in expansion activities in the longer term. At the beginning of the pandemic, we implemented measures to realign our cost structure and preserve liquidity including deferring certain capital investments, renegotiating certain vendor contracts, and reducing payroll costs, including through headcount reductions, employee furloughs and reduced executive salaries. With improving GMV trends we began to strategically reinvest in growth; however, we continue to monitor opportunities to strengthen our financial flexibility and preserve liquidity. The Company believes that its financial resources, along with managing discretionary expenses, will allow us to manage the anticipated impact of COVID-19 on the Company's business operations for the foreseeable future. We believe our existing cash and cash equivalents and short-term investments as ofSeptember 30, 2020 will be sufficient to meet our working capital and capital expenditures needs for at least the next 12 months. Our future capital requirements will depend on many factors, including, but not limited to, our ability to grow our revenues and the timing of investments to support growth in our business, such as the build-out of new fulfillment centers and, to a lesser extent, the opening of new retail stores. We may seek additional equity or debt financing. In the event that additional financing is required from outside sources, we may not be able to raise it on terms acceptable to us or at all. If we are unable to raise additional capital when desired, our business, financial condition and results of operations could be adversely affected. 33
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Cash Flows
The following table summarizes our cash flows for the periods indicated.
Nine Months Ended
September 30,
2020 2019Net cash provided by (used in):
Operating activities$ (96,017 ) $ (58,119 ) Investing activities 134,544 (952 ) Financing activities 150,119 378,439
Net increase in cash, cash equivalents and restricted cash
During the nine months endedSeptember 30, 2020 , net cash used in operating activities was$96.0 million , which consisted of a net loss of$124.5 million , adjusted by non-cash charges of$44.4 million and cash outflows due to a net change of$16.0 million in our operating assets and liabilities. The net change in our operating assets and liabilities was primarily the result of cash outflows due to a decrease of$8.7 million in operating lease liability, a decrease of$8.3 million in accrued consignor payable, an increase of$4.6 million in prepaid and other current expenses, partially offset by a decrease of$4.4 million in inventory. During the nine months endedSeptember 30, 2019 , net cash used in operating activities was$58.1 million , which consisted of a net loss of$75.4 million , adjusted by non-cash charges of$18.7 million and cash outflows due to a net change of$1.4 million in our operating assets and liabilities. The net change in our operating assets and liabilities was primarily the result of cash outflows due to a$2.6 million increase in accounts receivable driven by the timing of settlement of credit card purchases relative to year-end sales and a$3.5 million increase in inventory, and a$3.4 million increase in prepaid expenses and other current assets partially offset by a$4.6 million increase in accrued consignor payable and a$1.4 million increase in other noncurrent liabilities, and a$1.4 million increase in accounts payable.
During the nine months endedSeptember 30, 2020 , net cash provided by investing activities was$134.5 million , which consisted of$222.2 million proceeds from maturities on short-term investments and$7.9 million in sales of short-term investments partially offset by$73.3 million for purchases of short-term investments,$15.7 million for purchases of property and equipment, net, including leasehold improvements and$6.6 million for capitalized proprietary software development costs.
During the nine months ended
Net Cash Provided by Financing Activities
During the nine months endedSeptember 30, 2020 , net cash provided by financing activities was$150.1 million , which primarily consisted of proceeds of$166.3 million from the issuance of the convertible senior notes, net of issuance costs,$7.1 million from the exercise of stock options and warrants partially offset by$22.5 million for the purchase of capped calls related to the Notes issuance. During the nine months endedSeptember 30, 2019 , net cash provided by financing activities was$378.4 million , which primarily consisted of proceeds of$315.5 million from the initial public offering, net of issuance costs,$69.8 million from the issuance of redeemable convertible preferred stock and convertible preferred stock, net of issuance costs, and proceeds of$2.4 million from the exercise of stock options and warrants partially offset$9.3 million for repayment of debt.
Convertible Senior Notes
As ofSeptember 30, 2020 , we had 3.00% convertible senior notes due 2025 outstanding in an aggregate principal amount of$172.5 million . A portion of the net proceeds from the sale of these convertible senior notes was used to fund the net cost of entering into the capped call transactions described below. We intend to use the remainder of the net proceeds for general corporate purposes. 34 -------------------------------------------------------------------------------- The convertible senior notes are convertible into cash, shares of our common stock or a combination of cash and shares of our common stock, at the our election, at an initial conversion rate of 56.2635 shares of our common stock per$1,000 principal amount of the convertible senior notes, which is equivalent to an initial conversion price of approximately$17.77 per share of our common stock. The initial conversion price of the notes represents a premium of approximately 27.5% over the$13.94 closing price of our common stock onJune 10, 2020 . In connection with the convertible senior notes, we entered into privately negotiated capped call transactions, with certain of the initial purchasers or their affiliates. The capped call transactions cover, subject to anti-dilution adjustments, the number of shares of common stock underlying the convertible senior notes sold in the offering. The capped call transactions are generally expected to reduce potential dilution to our common stock upon any conversion of the notes and/or offset any cash payments we are required to make in excess of the principal amount of converted notes, as the case may be, with such reduction and/or offset subject to a cap. The cap price of the capped call transactions is initially$27.88 per share, which represents a premium of 100.0% over the closing price of our common stock of$13.94 per share onJune 10, 2020 , and is subject to certain adjustments under the terms of the capped call transactions. For additional details related to our convertible senior notes, please see "Note 6 - Debt and Convertible Preferred Stock Warrants" to the condensed financial statements included in this report.
Contractual Obligations and Commitments
As of
Term Loans
We were party to a loan and security agreement that included a term loan facility, which consisted of a$7.5 million term loan with a maturity date ofJanuary 1, 2020 and a$7.5 million term loan maturing atJanuary 31, 2021 (together the "Term Loans"). OnJuly 26, 2019 , we fully repaid the principal amount of our term loans. The Term Loans bear interest on the outstanding daily balance thereof at a variable annual rate equal to 0.35% above the prime rate then in effect. As ofSeptember 30, 2020 andDecember 31, 2019 , we had zero outstanding under the Term Loans. The Term Loans were secured by liens on substantially all of our present and future assets. The Term Loans included affirmative, negative and financial covenants that restrict our ability to, among other things, incur additional indebtedness, make investments, sell or otherwise dispose of assets, pay dividends or repurchase stock. With the repayment of the term loans, we were no longer subject to the debt covenants as ofSeptember 30, 2020 .
Off-Balance Sheet Arrangements
We did not have during the periods presented, and we do not currently have, any off-balance sheet financing arrangements or any relationships with unconsolidated entities or financial partnerships, including entities sometimes referred to as structured finance or special purpose entities, that were established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
Critical Accounting Policies and Estimates
Our management's discussion and analysis of our financial condition and results of operations is based on our financial statements, which have been prepared in accordance withUnited States generally accepted accounting principles. The preparation of these financial statements requires our management to make judgments and estimates that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported revenue generated, and expenses incurred during the reporting periods. Our estimates are based on our historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these judgments and estimates under different assumptions or conditions and any such differences may be material. We believe that the accounting policies discussed below are critical to understanding our historical and future performance, as these policies relate to the more significant areas involving management's judgments and estimates. 35 --------------------------------------------------------------------------------
Revenue Recognition
Consignment and Service Revenue
We generate the majority of our revenue from consignment services for the sale of pre-owned luxury goods on behalf of consignors through our online consignment marketplace. For consignment sales, we retain a portion of the proceeds received, which we refer to as our take rate, and remit the balance to the consignors. We recognize consignment revenue upon purchase of the goods by the buyer based on our take rate, net of allowances for product returns and order cancellations and certain incentives.
Direct Revenue
We also generate revenue from the sales of company-owned inventory. We recognize direct revenue upon shipment of the goods through our online marketplace, based on the gross purchase price net of allowances for product returns and certain buyer incentives.
Recent Accounting Pronouncements
For more information on recently issued accounting pronouncements, see Note 2 to our unaudited condensed financial statements "Summary of Significant Accounting Policies" in this Quarterly Report on Form 10-Q.
JOBS Act Accounting Election
We are an "emerging growth company," as defined in the JOBS Act. Under the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards issued subsequent to the enactment of the JOBS Act until such time as those standards apply to private companies. We have elected to use this extended transition period to enable us to comply with new or revised accounting standards that have different effective dates for public and private companies until the earlier of the date we (1) are no longer an emerging growth company or (2) affirmatively and irrevocably opt out of the extended transition period provided in the JOBS Act. As a result, our financial statements may not be comparable to companies that comply with new or revised accounting pronouncements as of public company effective dates. Because the market value of the Company's common stock held by non-affiliates exceeded$700 million as ofJune 30, 2020 , the Company will be deemed a "large accelerated filer" under the Exchange Act and will lose emerging growth company status as ofDecember 31, 2020 .
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