Wayfair Inc.
Q1 2020 Earnings Call Transcript

Published: 5 May 2020

[Operator:]

Ladies and gentlemen, thank you for standing by, and welcome to the Wayfair Quarter One 2020 Earnings Release Conference Call. At this time, all participant lines are in listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised, today's conference is being recorded. I would now like to hand the conference over to Jane Gelfand, Head of Investor Relations. Please go ahead.

[Jane Gelfand:]

Good morning and thank you for joining us. Today, we will review our first quarter 2020 results. With me are Niraj Shah, Co-Founder, Chief Executive Officer and Co-Chairman; Steve Conine, Co-Founder and Co-Chairman; Michael Fleisher, Chief Financial Officer; and Thomas Netzer, Chief Operating Officer. We will all be available for Q&A following today's prepared remarks.

[Niraj Shah:]

Thanks, Jane, and good morning, everyone. We hope you are all safe and healthy. So much has clearly changed since we spoke with you last. The world's response to the threat of COVID-19 has united us all in our humanity and yet has presented each of us with unique challenges to contend with. I'm particularly proud of how Wayfair and our 16,000 employees have mobilized to keep our customers, our communities and each other as safe as possible. We are working relentlessly to continue to serve our customers across two continents as they navigate their new realities, while managing a global complex supply chain and doing whatever is in our power to support government and community efforts to fight the virus. Though we are all eager for return to normal, we do believe that this unprecedented situation has highlighted the many differentiated advantages we have built as the e-commerce leader in home over the last two decades. First, I want to briefly update you on the status of our operations. Thomas Netzer, our Chief Operating Officer, who also joins us on this call today will discuss the practical steps we have implemented within our logistics operation to keep them safe and efficient.

[Thomas Netzer:]

Thanks Niraj. Today we will focus on our proprietary operations including supply chain and customer service. Before we dive in let me share a bit of personal background. I joined Wayfair two years ago as Chief Operating Officer and Co-Leader of Europe and took over the global COO role almost a year ago. Prior to joining Wayfair, I spent 22 years at McKinsey where the global supply chains, serve e-commerce clients across Europe and Asia, and collate the global logistics leadership team. Let me quickly set up our conversation by outlining our operations and how far we have come already after which I want to share with you the future vision that we are working towards. I will wrap-up with a description of our response to COVID-19. Our supply chain combines two distinct elements

[Michael Fleisher:]

Thank you, Thomas, and good morning, everyone. I will first briefly discuss our Q1 2020 results. As you know, our gross sales momentum accelerated in the last two weeks of March. But please recall that we only book net revenue and the order is delivered. So much of this momentum will benefit Q2. Therefore, as you think about our financial progress in Q1, it's important to keep in mind that COVID-19 related changes are minimal in the just reported quarter and will be much more impactful in Q2. As you saw in our press release and IR presentation, our Q1 total net revenue grew approximately 20% year-over-year with net revenues in the U.S. up 19% and international up 24%. International net revenue growth in constant currency was higher at 26% year-over-year. Last 12 months active customers surpassed 21 million this quarter, a 29% increase year-over-year with the share of orders from repeat customers now nearly 70% of the total mix. Other KPI metrics such as order frequency and net revenue per active customer edged up slightly year-over-year. As I move down the P&L, please note that I will be referencing the remaining financials on a non-GAAP basis. Gross margins expanded approximately 70 basis points year-over-year and 200 basis points sequentially to 24.9%, reflecting the early cumulative benefits of the multiple initiatives Niraj described both last quarter and earlier on this call. We also saw 70 basis points of leverage year-over-year and 40 basis points of leverage sequentially in advertising as a percentage of net revenue thanks to our effort to drive more efficiency in our spend. In line with our original expectations all of this work continues in Q2. Our selling, operations, technology and G&A or OpEx expenses came in at $412 million, excluding severance costs related to the February reduction in force. This was consistent with our expectation for sequentially steady dollar spend versus the fourth quarter. We are keenly focused on controlling each component of OpEx and you are seeing that begin to play out. You'll recall that the primary driver of SOTG&A is compensation expense and will note that we ended Q1 with approximately 600 fewer OpEx employees. Reflecting in large part the reduction in force we undertook as part of the plans put in place late last year. Adjusted EBITDA for Q1 was a negative $127 million or negative 5.5% of net revenue. We made sequential progress in driving a lower rate of losses in both the U.S. and international segments with adjusted EBITDA margins in the U.S. at negative 2.3% and a roughly $82 million loss in international. We ended the quarter with approximately $891 million in cash, cash equivalents and short-term investments including $100 million that we drew from our revolving credit line. We made the drawdown as a precautionary measure as market volatility spiked in mid-March and have since paid back the revolver balance. The March 31st balance does not include the proceeds from our recent convert financing. Our current cash and cash equivalent balance is approximately $1.5 billion. Non-GAAP free cash flow for the quarter was negative $355 million. As we mentioned back in February this is consistent with the typical seasonality in our cash flows. During, which first quarter outflows tend to be our largest and was made even more pronounced this year due to late Cyber 5 timing in 2019. This is also consistent with our operating cash flow seasonality with Q1 ending cash typically the low point in the year. We believe, we have an extremely strong balance sheet and can weather various forward economic scenarios. This is further bolstered by our execution, which is quickly driving company-wide profitability. Now turning to guidance. I want to first acknowledge that establishing guidance is never an easy feat even against the commerce of macroeconomic backdrops. As I say to you every quarter, our business is a highly dynamic one where our predominantly mass market customer has to show up every day. This is especially true as we all navigate through today's unchartered waters. So what we think is most prudent to offer you at this point is twofold. First, I will offer full transparency on our gross revenue performance quarter to date. I will not, however, speculate further by providing specific guidance ranges for Q2. Second, I want to provide a framework for how to think about the progress we are making on adjusted EBITDA profitability as we execute against the plans we set in motion late last year. To be clear this is not guidance, but instead is intended to give you a directional sense for our unit economics as they evolve outside of any COVID-19 related factors. Let's start with what we've seen thus far in Q2 and some additional color to help frame how things might evolve. Quarter-to-date, our gross revenue growth year-over-year is trending at roughly 90%, translating to over $800 million added year-over-year on a constant currency basis. This momentum is widespread across almost all categories and includes comping over Way Day last year, which we deferred into later this year. While we do not know how long these trends will persist, and thus will not provide a specific revenue forecast for the whole of Q2. We believe this period has certainly and permanently accelerated e-commerce adoption in our category. We are seeing not just robust new customer acquisition, but also strong repeat trends from both long-term loyal and recently added new customers. New customer behavior and their direct feedback suggests that these customers experience with Wayfair is leaving them very satisfied and motivated to shop again in both extraordinary times when they are quarantined and down the road when we will all be less restricted. Shifting gears to how we are executing against our internal profitability plans which were formulated late last year pre-COVID, and are predicated on 20% revenue growth rates. Our progress to date puts us on a trajectory to achieving positive consolidated adjusted EBITDA margin in Q2 without considering the revenue acceleration we are currently experiencing. As our various internal work streams continue to gain traction, we would expect approximately another 100 basis points of sequential leverage on gross margin to roughly 26%. As we continue to re-baseline and tighten our marketing efficiency targets, our plan calls for approximately more than 100 basis points of additional advertising leverage sequentially to roughly 10.5%. Finally, we would expect OpEx spend to be somewhat below $400 million in Q2, including depreciation and amortization. This is slightly lower relative to the first quarter continuing to reflect the tighter controls we have implemented here. This is all progress that we would expect to be sustainable on a go-forward basis at 20% revenue growth rates. From a segment perspective, given the relative maturity and size of the U.S. versus international, I'm sure you'll recognize that it is the U.S. business that will be the primary driver of delivering the profitability of the whole business. That said, in international, we are also seeing the benefits of scale and good execution against various plans to drive gains in gross margin, ad spend leverage and OpEx. Though we will not be providing more specific EBITDA guidance this quarter, as Niraj mentioned, any revenue upside in the quarter relative to how our internal plans are calibrated should flow through to the bottom line, with some additional leverage on OpEx as a percent of sales, given the more fixed nature of these expenses. Additionally, we could see more leverage to advertising as a percent of net revenue in Q2, because of competitive changes in the market due to COVID-19. To help you update your models on a few housekeeping items, please assume equity-based compensation and related tax expense of approximately $70 million to $72 million, depreciation and amortization of approximately $80 million and 95 million in average weighted shares outstanding in Q2. Capital expenditures are expected to be roughly flat in dollar terms with Q1. We live in a moment in time where there are too many variables to offer more specific guidance. And frankly, specific current period of guidance has always seemed counter to our long-term aspirations to serve our customers, communities and employees while delivering sustainable growth, profitability and free cash flow. I spoke last quarter about our desire and very specific execution plans to generate the unit economics to do just that. We're proud that we can be serving a rapidly growing set of customers during this unprecedented moment in time and doing so increasingly profitably as well. Certainly, we all know we will see more macro change in the months and quarters ahead. The competitive dynamics will change. We likely will deal with a recessionary environment and there will continue to be global and domestic turmoil. But we believe, we are now well positioned to thrive regardless. We are rapidly executing on our plans to run the business profitably while still investing for growth and serving our customers over the long-term. We have incredible brand awareness with very satisfied and engaged customers. We have a dedicated and focused team of employees around the world. We have a deep partnership with our suppliers and we have a very solid balance sheet. Also, we have the experience of our business in the last recession when we were able to grow each year even as the home market declined. While we do not know exactly how the world will play out, we know that times of massive change caused customers to seek new ways to purchase. And like what happened in 2008 and is happening now, accelerating the movement online in many categories including home. I'd now like to turn the call back to Niraj before we take your questions.

[Niraj Shah:]

Thanks, Michael. As I conclude, I want to speak for both Steve and myself and once again thank Wayfair employees around the world for their hard work and dedication in the midst of trying and uncertain personal times. The countless ways in which you have risen to the challenge and supported each other and our many local communities make us both exceptionally proud and speak volumes to the strength of Wayfair's culture. Now Steve, Thomas, Michael and I will be happy to take any questions. We're doing this remotely so bear with us if there are any glitches.

[Operator:]

Thank you And our first question is going to come from the line of Peter Keith, Piper Sandler.

[Peter Keith:]

Hey. Good morning, everyone and thanks for all the details on today’s call. Obviously with everything that's going on it's fairly exciting what you're seeing in your business. One question I've had is just on constraints to the growth. We have heard from the channel that there's out-of-stock issues even maybe some capacity constraints with your third-party deliverers of small parcel. So 90% growth obviously, quarter-to-date impressive, but is that being hindered at all by any inventory or delivery constraints, because certainly that's not a number that you guys had planned for two months ago.

[Niraj Shah:]

Peter, it's Niraj. Thank you. Thank you for the comments and the questions. To answer them so first in terms of constraints to the growth, the way I would describe it is that we're actually incredibly well positioned to handle this type of unanticipated surge and the reason is a few fold. First, to your first question about inventory. If you think about our platform, we work with 10000-plus suppliers who are all listing the wide range of products they have and the inventory they have available. So in this particular situation you could have a small number of them who perhaps specialize in e-commerce who see unprecedented volume and may have some shortages, but there'll be quite a few who work across multiple different channels and they'll see their brick-and-mortar business be slow and their other channels perhaps not moving as fast. So their inventory availability will flex up in a way that they didn't anticipate and it could be puts and takes countries of origin and so on and so forth. The net is we have availability across all of that inventory. So we're a beneficiary. We're able to keep items broadly in stock. And just remember we have 10000-plus table lamps. And so inventory on a particular individual one might get hampered. But overall the breadth of availability we have right now is better than it normally would be simply because what's happening is demand in a lot of channels is off. On the second question about logistics capacity, there's no question that this type of surge which is a kind of peak holiday search that is still unabated that's continuing day after day and week after week is not something that just – you can just turn on. We're seeing the carriers we work with doing incredible things to flex up their capacity. But again we're advantaged because if you think of our 15 million square feet of logistics capacity across 65 buildings, a lot of that capacity, we're not just storing goods and tendering them to a small parcel carrier for their local store. We also do a lot of sortation in our buildings, allowing us to run direct injection lanes. And as we get more volume we can dynamically turn on additional lanes. What this does is it obviates some of the constrained spots in the carrier networks, allowing us to take advantage of the ability to inject volume that they couldn't otherwise have. And so long story short, it's not easy to necessarily handle a surge when you're plus 90% when you didn't plan for it. But our operations team have done an incredible job of bobbing and flexing. Our suppliers have done an incredible job the way in which our team who run all our buildings have done just an incredible job on safety as well as handling the capacity. And as a result we have not been constrained.

[Peter Keith:]

Okay. That's very interesting and helpful. I guess I could ask a bunch of different questions but maybe focusing on gross margin because it was impressive in Q1, be more impressive in Q2. Can you maybe just highlight some of the key drivers that you're seeing right now for that year-on-year improvement?

[Niraj Shah:]

Yes. So I think the most important thing to just remember about gross margin because we've been talking about this for years, the range we've been in for a long time which was about 300 basis points away from the range that we've guided to in our long-term model, can give only cited multiple levers that could close the entire gap. We said that suppliers flexing into our platform could close the entire gap. We said that logistics efficiencies based on the logistics, network we're building and reducing damage and reducing shipping cost could close the entire gap. And we said that what we were doing on merchandising investments with the red carpet merchandising and the house brands and a growing percentage of these items being exclusive vis-à-vis some of our competitors could close the entire gap. And then we added a fourth pillar, which is supplier services. So that's CastleGate and Wayfair-sponsored products. And that's early on but that's on other very large one. And so we have multiple levers that could each close a few hundred point gap. And so if you think about that, if the gap is 300 basis points and you have most levers, you're talking about 1000 basis points of theoretical potential. We've been investing against that in years. And so we're now at a point where we can start to harness some of those gains. And so what you're seeing with the step-up in this past quarter and the guidance Michael gave, you just see us starting to harness the gains. And some of these are short-cycle gains and then there will be additional one to long cycle. And so the gross margin trajectory, which we've talked about you're just seeing it start to manifest in the P&L. And so this is again, this is not really COVID related. This is more part of that multiyear strategy we've had in investing into these things that will manifest as gross margin gains are now seeing a show up.

[Peter Keith:]

Great. Thank you very much. Good luck.

[Operator:]

Thank you. Our next question will come from the line of Chuck Grom, Gordon Haskett.

[Chuck Grom:]

Hi. Thanks. Good morning. I hope everyone is doing well. Just wondered if you guys could speak to how your basket composition has evolved over the past six weeks in terms of exactly what consumers have been purchasing from you? And then Michael, is there a way to think about the flow-through on the better direct revenue trends? You've stated that you expect positive EBITDA even with pre-COVID sales levels quarter-to-date up 90%. But just is there a way to think about the flow through? Thank you.

[Niraj Shah:]

Chuck, this is Niraj. Let me answer the first question, and then I'll turn it over to Michael. On the first question in terms of basket composition, what I would say is if you think about the seven-week period now the first couple of weeks in kind of mid- to late March, there were certain categories that accelerated first. And these are ones you associate with staying at home and working at home and the kids being at home, home office and cooking at home, home office, kitchen, large appliances, small electrics, storage and organization, children's playroom, children's furniture, outdoor recreation. But what we saw during that period is we saw then it start to spread pretty widely. The outdoor category started to take off, the decor category started to take off, the renovation category started to take off. So really the concentration in growth is not anywhere specific. In fact, it is very broad-based and that's what we're seeing. So I wouldn't – if you look at what's happening right now there is no concentration in certain categories. And frankly, you don't really see categories being left behind either. I'm going to let Michael answer your question on flow through. But the one point, I just want to make on that, before I turn it over to Michael is just, we're running the business around a plan to be sustainably profitable at a growth rate we were already at pre the COVID crisis. And so if you just think about the investments these have been multiple year investments. And if you think about the parts that we accelerated they go back to a plan that we honed in November of last year six months ago. And that's why you've seen step-ups in Q1 and different actions we took in Q1 and you're seeing additional in the guidance for Q2. It's not really specific to COVID. But in terms of your flow through, I'll let Michael answer how that can manifest.

[Michael Fleisher:]

Thanks, Niraj. Thanks Chuck for the question. I think, what I tried to highlight in the prepared remarks is you can think about OpEx cost for the quarter is basically fixed, right? So incremental is going to flow through that completely. I think from a gross margin ad spend perspective, we noted that, in ad spend the COVID situation may drive incremental leverage on ad spend, but we'll see how the rest of the quarter plays out. And I think the gross margin you can think about as the gross margin as Niraj has mentioned that, we've been sort of making all these investments in for a long time and starting to see the flow-through of that. So I think you should be able to continue to see these kind of gross margin levels that, I noted on the call the 26% as sort of flow-through from incremental revenue as well.

[Chuck Grom:]

Okay. That's helpful. And then just as a follow-up when you look at the cost components in your P&L gross margin advertising OpEx how would you force strength the greatest areas of opportunity to get to that 8% to 10% long-term target that you guys have been talking to for a number of years?

[Niraj Shah:]

This is Niraj. Let me just make a couple of quick comments and then Michael can chime in. I think he has an additional. I think the key thing is to think of it is in hand. So we – and in the long-term model slide we try to highlight that. But basically, going from the bottom-up OpEx is we already have in the OpEx cost number a huge amount of investments into the future. So we're not doing anything around cutting our long-term investments, but rather the thousands of people we added they're working on those things. We just don't need to add additionally to actually drive significant progress. So that's just as revenue grows you see the OpEx lever and that's where we are right now. Ad cost, we talked a lot about our attribution technology in ways we're driving efficiency there. That gets benefit as repeat grows as a percentage of the total. The repeat revenue is actually runs at a very low ad cost. And then gross margin, I just talked about that a minute ago. There's obviously a huge runway there. So if you're saying which one is the largest of the three, it would be gross margin. It's also the biggest number of the three and has the most levers of the three. So rather than focus on that being the biggest, I just think of this as an hand, where you should see gains everywhere. And Michael, do you – anything you wanted to add, Michael?

[Michael Fleisher:]

No. I think you covered it well.

[Operator:]

Thank you. Our next question will come from the line of John Blackledge with Cowen.

[John Blackledge:]

Thank you. On the demand environment, I recognize the situation is fluid. But as we round towards second half maybe Niraj or Michael, how are you thinking about kind of the puts and takes of the demand environment just given the current demand surge and then U.S. slowly reopening coupled with a looming bad macro given the job losses and then maybe alongside potential fears that the people have going into retail stores. So, just any – it's like kind of a crystal ball, but any -- there's a lot of puts and takes. Just curious how you guys are thinking about it, and then I just have -- on the gross margin, my other question would be, you guys have said 25 to 27 longer term, but I think Niraj cited a lot of levers. So like when we think longer term, could it be even above that 25, 27? Thank you.

[Niraj Shah:]

Thanks, John. I'll just do them in reverse order. I will let Michael chime in at the end. On gross margin, just keep in mind, as we unlock benefits in gross margin we have a choice with what to do with those gains. We can take it into profit, which then gives us cash flow that we can invest in the future whether we return it to shareholders or we buy back the stock or we invest into something new or what have you. And if we invest into customers, we can lower retail prices or we can make service quality better. We can do things that cause us to get more lifetime value at the improving unit economics that create future cash flows. And so there are different things you can do as you unlock these levers. And some would grow the gross margin percentage and some wouldn't, but all of which would actually accrue to our financial benefit long term. But I'll let Michael comment on that in a second, but let me go back to your macro question. So I think the sentence you said in there sums it up the best, which is there are a lot of puts and takes. But I guess what I would leave you with is a few key things. One is

[Michael Fleisher:]

The only thing I'd add, John, on the long-term targets, obviously, we set those long-term targets in place five plus years ago, and since then, we've made a huge set of investments around some initiatives. If you think about what we've built in logistics as an example, that are going to drive -- that have the potential to drive huge opportunity in unlocking gross margin. And obviously, we set those targets five years ago and put them in place. We didn't know what the investments were going to look like or what the world was going to look like today. So I do think there's upside throughout the P&L as we sort of start to see all the investments we've made over the last few years bear fruit over the coming years.

[Operator:]

And our next question is going to come from the line of Justin Post, Bank of America-Merrill Lynch.

[Justin Post:]

Hey, thanks for taking my question. Interestingly, 90% surge, can you just tell us how the warehouses are holding up with that kind of surge and how you could possibly be prepared for that kind of volume uptick? Impressive to be able to handle that. And then secondly, I think your number one online competitor, Amazon, might be focusing more on consumables right now. Can you talk about progress you might be making in the category with your suppliers right now and how you can kind of maintain those relationships and really help you over the long term? Thank you.

[Niraj Shah:]

Thanks, Justin. Let me answer the two. So in terms of the warehouses, one of the things that's important to remember is, our network is somewhat different than some other e-commerce optimized networks. First of all, there's only a few large-scale e-commerce optimized networks. Ours is optimized for home goods an din home goods, you find there's a huge selection Pareto, and there's clearly items that ship out of our buildings. And then there are items that we ship from our suppliers because there's quite a long tail. And unlike AA batteries where everyone is buying the same exact items as each other, the Duracell or Energizer, the 9 pack or the 18 pack or maybe the house brand, here, there's actually 10,000 table lamps and that's quite a spread. So what we do is we have a portion of the volume that comes out of our buildings, and that's around about 30% of the volume, and then we have a portion, about 70% of the volume, that ships from the suppliers' warehouses. The 10,000-plus suppliers have warehouses, and then they're all shipping. And as you can imagine their volumes in aggregate are -- their other channels have slowed down. So they have capacity. And then, what we've done is we flexed up capacity. Thomas mentioned, we added over 1,000 people. We've moved to multiple shifts. And so we've done a bunch of things that allow us to take on more volume. And then, frankly a lot of what we do is sortation. There's other things we do that add benefit. So while we couldn't anticipate the surge, I think our model and the flexible nature of our model, let us lean in better. In terms of the question about competition, Amazon, I think Amazon has probably seen a spike in consumables. They're certainly oriented around that, and they are one of our competitors for sure. I will just remind you, we do have quite a few competitors though that we compete with, and I've just seen some of the reports about some of the brick-and-mortar stores that they've been doubling their e-commerce business. Now it may go from 10% of their volume to 20% and what have you, but there's a lot of different competition out there. So we're pretty happy with our performance, but it is a competitive landscape. That said, what you're putting about suppliers is an important point. I think we've long since had some of the strongest supplier relationships out there. And what we're seeing is that this is only having suppliers lean in even more, because they believe that e-commerce was really fundamentally their only growing channel and a lot of their other channels were going to slow over time. But this is sort of putting a point on it and we're seeing them flex in. And I think they view our platform as an ideal one for home, because their goal was not to commoditize their offering. Their goal really is to have that breadth, and have it well merchandised and reach the customers with a home-type focus. And we're able to provide that. And so we've had gaining momentum with suppliers as the years gone by, and we've certainly seen this kind of continue to further accelerate that.

[Justin Post:]

Great. Thank you.

[Niraj Shah:]

Yeah. Thanks, Justin. And Thomas, I just didn't know if you wanted to add anything about any of the logistics operations, how we've been able to flex up because that question came up a couple of times. I thought maybe -- anything you want to add?

[Thomas Netzer:]

No, I can only echo what you said Niraj. I think the one thing which we benefit from is obviously our unique setup as you rightly laid out given that we can fulfill A, from our own warehouses, and B, leverage our drop ship suppliers. But I think the other thing which is important to note is that, when we think about the current growth and how to deal with this, it is less a matter of storage in our warehouses. It's much more model throughput. For storage, we have actually made significant investments over the last years. So that's why we have more than €10 million of square footage available. And when it comes to throughput, we have the ability and also the experience to flex up and down our workforce. And this is what we are currently doing. We just put more people into our warehouses, which then have the throughput capacity for the current loans. And therefore, we are not struggling right now. We are rather in a very competitive position to still fulfill the orders the customer place.

[Operator:]

Thank you. That concludes the Q&A portion of today's conference call. I'll turn the call over to Niraj Shah for closing comments.

[Niraj Shah:]

Hey, everybody. We just want to thank you for dialing in today. And we just -- the 16,000 people here at Wayfair are really proud of how we've been able to help the community, help each other and take care of our customers. And we couldn't be more proud of how things are developing, and thank you for your interest in the company.

[Operator:]

Thank you. Once again, we'd like to thank you for participating on today's conference call. You may now disconnect your lines. Thank you.