Wayfair Inc. (NYSE:W) Q1 2023 Earnings Call Transcript May 4, 2023

Wayfair Inc. beats earnings expectations. Reported EPS is $-1.13, expectations were $-1.69.

Operator: Good day, and welcome to the Wayfair Q1 2023 Earnings Release Conference Call. [Operator Instructions]. And finally, I would like to provide all participants that this call is being recorded. Thank you. I’d now like to welcome James Lamb to begin the conference. James, over to you.

James Lamb: Good morning, and thank you for joining us. Today, we will review our first quarter 2023 results. With me are Niraj Shah, Co-Founder, Chief Executive Officer and Co-Chairman; Steve Conine, Co-Founder and Co-Chairman; and Kate Gulliver, Chief Financial Officer and Chief Administrative Officer. We will all be available for Q&A following today’s prepared remarks. I would like to remind you that our call today will consist of forward-looking statements, including, but not limited to, those regarding our future prospects, business strategies, industry trends and our financial performance, including guidance for the second quarter of 2023. All forward-looking statements made on today’s call are based on information available to us as of today’s date.

We cannot guarantee that any forward-looking statements will be accurate although we believe that we have been reasonable in our expectations and assumptions. Our 10-K for 2022, our 10-Q for this quarter and our subsequent SEC filings identify certain factors that could cause the company’s actual results to differ materially from those projected in any forward-looking statements made today. Except as required by law, we undertake no obligation to publicly update or revise any of these statements, whether as a result of any new information, future events or otherwise. Also, please note that during this call, we will discuss certain non-GAAP financial measures as we review the company’s performance, including adjusted EBITDA, adjusted EBITDA margin and free cash flow.

These non-GAAP financial measures should not be considered replacements for and should be read together with GAAP results. Please refer to the Investor Relations section of our website to obtain a copy of our earnings release and investor presentation, which contain descriptions of our non-GAAP financial measures and reconciliations of non-GAAP measures to the nearest comparable GAAP measures. This call is being recorded and a webcast will be available for replay on our IR website. I would now like to turn the call over to Niraj.

Niraj Shah: Thank you, James, and good morning, everyone. We’re pleased to reconnect with you today to share the details of our first quarter results. Last August, we shared a road map laying out our path to profitability. The first step was getting back to adjusted EBITDA breakeven. Through a focus on our 3 core initiatives of driving customer and supplier loyalty, nailing the basics and cost efficiency, we’ve made significant strides in improving our offering and customer experience while simultaneously reducing our cost structure. Collectively, these efforts have resulted in increasing market share and a significant reduction in operating expenses versus last quarter, getting us to nearly adjusted EBITDA breakeven in Q1. And we’re excited to share that we expect to have positive adjusted EBITDA in the second quarter.

We’ve always known and now we are clearly demonstrating that the Wayfair model is inherently profitable and that there is considerable opportunity in front of us to rapidly drive further margin expansion while investing for future growth. We’ve reached this profitability milestone in spite of the difficult macro environment our business has operated in for the better part of the year. Our category, in particular, has been impacted more than others with sales first turning down in March of 2022 and now contracting approximately 20% year-over-year according to many of the sources we follow. While traffic remains challenged, our conversion levels have held steady and our work on nailing the basics and driving customer and supplier loyalty is leading to sustained market share growth.

In the second quarter, we’re seeing improving year-over-year order trends, and we’re just coming off the back of our seventh Way Day event. At the beginning of the year, as we planned a denser promotional calendar for 2023 and we decided to try a 3-day format for Way Day. We are very pleased by the engagement from both our suppliers and our shoppers to the extra day. It’s a testament to the hard work and the quality of execution of the team that our model of fast delivery, great availability and sharp pricing, it’s firing on all cylinders, even as we are making meaningful adjustments to our cost base. As we’ve done for several quarters, I want to update you on different parts of the business in the lens of our 3 key initiatives, starting with cost efficiency.

As part of our $1.4 billion total annualized cost actions that we outlined in January, you’ve heard us refer to $500 million coming from operational cost savings. These cost savings initiatives are multifold and manifest across all aspects of our value chain as we’re now starting to see some of the benefits of these savings flow through in our gross margin, I want to take a few moments to share some further examples of these initiatives and provide you some more perspective on our progress. As we started down the road of driving cost efficiency, our overarching goal was to actually enhance the customer and supplier experience, even as we looked for areas of savings. One of the ways we do that is by reducing damage rates, both on specific products as well as in the aggregate.

In instances where we see rising incident rates, we take a proactive stance in working with our suppliers to identify specific weak points and improved packaging. Our strength in data science and technology allows us to take this to the next level, using information on damage rates to compose better search results for shoppers. This is one of many factors that has driven our overall incidence rate down by over 15% since last summer. By prioritizing items that we know consistently delayed our shoppers we create a better experience, save on after order service expenses and driving a much higher likelihood of generating a repeat order in the future. Lower cost of delivery directly translates to lower retail prices for consumers. So another area that we focused on recently is optimization of our last mile costs.

Every product sold on Wayfair is classified as either a small or large parcel. Though to expectations, our small parcels average 30 pounds and can actually go as high as 150 pounds in some cases. Our small parcel orders are shipped through carriers like FedEx and as you would expect, are less expensive to deliver than large parcel items, most of which are fulfilled through our middle and last mile Wayfair delivery network, where all trucks are staffed with 2-person teams rather than just a single driver due to the heavy and bulky nature of the products. Many items will straddle the line between small or large. So we’ve sharpened our data analytics tools that decide whether a product is classified as a large parcel or not. For some items, large parcel clearly makes sense.

The higher cost of delivery is more than offset by the reduced damage rates from the extra care. In other cases, we may see that shipping times and damage rates are indifferent, in which case class finding item as a small parcel creates a more compelling retail price while preserving the customer experience. Our ability to optimize shipping costs has been further enhanced by our efforts to drive more suppliers through CastleGate with multiple benefits that accrue to the customer and to Wayfair. Improved forward positioning means fewer logistical touch points and therefore, less fulfillment expense, while also resulting in a lower risk of damage and faster delivery times. In fact, the percentage of items on the site with speed badging hit a new record high in the first quarter of this year.

These are just 2 examples across a multifaceted initiative with more than 70 distinct areas of savings. All of which adds up to the more than $500 million I mentioned earlier. In a few minutes, Kate will talk more specifically about the financial flow-through here, but I want to acknowledge the speed and thoroughness with which our team has executed on these work streams. Since we started this process last summer, we’ve now achieved more than half of the targeted savings on an annualized basis and are making steady progress towards completing the remainder by year-end. These are durable process-oriented savings that we expect will create improved economics and efficiency on every single order placed and which we believe will lead to higher savings when the volume growth returns.

I mentioned it earlier, but it bears repeating. We’re extremely proud that even as we have driven these considerable changes across our business, we are still seeing strong market share expansion. Our second key initiative is driving customer and supplier loyalty every day. And the best evidence of our progress here comes from the market share picture. We collect market share data from several sources, such as conversations with our suppliers, third-party research and credit card data. The picture we are seeing across all sources has unified over the past several quarters, a clear and resounding win in share for Wayfair. Lipid data, one of the major credit card data providers, recently published their publicly available first quarter home goods market share index for the United States, which shows us in the #1 position with ongoing share capture for several quarters.

A similar story is playing out in our second largest market, Canada, where we have seen robust share capture since last summer as we made big unlocks to speak more specifically to our shoppers in the region. Across our efforts to drive customer loyalty, we recently launched filters to search for products fulfilled from Canada, which our customers in the region love and are highlighting items that are positioned within the country. Our Canadian customers appreciate the added benefit of surfacing items with faster delivery speeds, competitive retail prices and lower incidence rates. We’ve also launched a best-in-class French experience for our Wayfair.ca shoppers and host Canada-specific promotional events like Victoria Day and Canada Day sales to speak more directly to our customers in the country.

During these moments, we have partnered with Canadian influencers and celebrities to further connect with our shoppers and offer them items they will love. As with the U.S., our core recipe in Canada has never been in a better place, strong availability, competitive pricing and fast delivery have kept customers coming back. And this ties nicely to the third of our key initiatives, nearing the basics. In that spirit, we recently enabled detailed end-to-end international tracking on Canadian orders that originate from the United States. Most shoppers previously could only see the detailed location of their northbound order once it did cross the border. Our Canadian customers now have full visibility to where their items are at each stage of fulfillment, which reduces the volume of post-order service inquiries.

On the theme of service, we’ve also strengthened our Canada-based customer service team. We find out having domestic agents who understand the unique needs of their local shopper, reduces the number of follow-ups and immediately improves the customer experience. the true meaning of nailing the basics. As I wrap up, I want to zoom back out for a moment. For several quarters now, we’ve laid out a road map for a return to profitability. Along the way, we told you that we intend to be both thoughtful and expeditious as we chart out this journey. And while we still have more road ahead of us, we see our progress over the past 9 months as a true proof point that the plan is working. We’re as confident as we’ve ever been that Wayfair will emerge stronger for it on the other side.

Now with that, let me hand it over to Kate to walk through our financials for the quarter.

Kate Gulliver: Thanks, Niraj, and good morning, everyone. I want to echo Niraj’s enthusiasm at the promising signs we are seeing for 2023. Our team has been working hard to execute the plan we outlined in 2022, and we couldn’t be more pleased to see the output now beginning to manifest in the results. So let’s dive into the first quarter figures. Net revenue for the quarter came in at $2.8 billion, down 7.3% year-over-year. We are seeing a return to more traditional seasonality in our business and are encouraged by the improving trends we see in order growth. As we shared before, we expected order volume and active customer count to pick up as inflationary prices abated, and we are starting to see evidence of this dynamic playing out.

The picture between our geographic segments remains largely unchanged with net revenue in our U.S. segment down 5% year-over-year, and our international segment down 14.4%, excluding the impact of FX. I’ll now move further down the P&L. As I do, please note that the remaining financials include depreciation and amortization, but exclude equity-based compensation, related taxes and other adjustments. I will use the same basis when discussing our outlook as well. Gross margin had another stellar quarter, coming in at 29.7%, even as we maintained a robust promotional calendar. Our team continues to make meaningful headway on our operational cost savings, as Niraj discussed, and you are beginning to see that flow through to this line. New York described these savings is process oriented, meaning they will hold and, in some cases, improve as our volume increases, and he noted that we’ve achieved over half of our targeted annualized savings.

Some of which you’re starting to see show up in gross margin, while the rest we have passed on to price. It’s important to note that we see these savings as structural margin expansion on the road map to our longer-term target gross margins in the mid-30s range. Last quarter, I mentioned that as we see these savings begin to accrue, we may choose to reinvest some of them in the customer experience through sharper pricing. The mix will be dictated by the macro environment we see over the duration of the year. However, I think one important point to make here is that our operative goal is to maximize the gross profit dollars generated across a multi-quarter horizon. We can do this in 2 ways. The first is passing the savings directly on to incremental gross profit, driving a higher gross margin.

The second is to sharpen our pricing, letting the operational savings offset the impact from a reduced take rate, effectively netting out to a gross margin that remains unchanged, but on the results in more orders and more repeat business. We will balance this dynamic to keep driving optimal outcomes over time. Our plans are to reinvest some portion of further savings in price in order to drive more volume and maintain and grow our share position while also balancing gross margin expansion. Moving on to customer service and merchant fees. We saw this line come in at 4.7% of net revenue in the first quarter. Advertising was 11.8% of net revenue as we are driving even better efficiency out of our paid channels, while we continue to face the same headwinds on the volume of free and direct traffic that we’ve seen for several quarters now due to the macro environment.

Finally, our selling, operations, technology, general and administrative expenses totaled $484 million. As a reminder, the majority of this expense line is related to our people and the remainder covers software and other G&A. You are seeing the majority of the savings from the January reduction in force reflected in this figure. And you should expect to see this number show further moderation in Q2 as we fully run rate the cash compensation piece of the $750 million of annualized labor savings that we have now completed. However, we don’t see this at the end of our cost savings journey on SOTG&A and we plan to drive low single-digit sequential compression each quarter through year-end on top of what we’ve already accomplished. All combined, the outperformance on gross margin and advertising as well as strength in the top line contributed to a significant improvement in adjusted EBITDA and negative $14 million this quarter or nearly breakeven a substantial improvement compared to the negative $71 million in Q4 2022 and negative $113 million in Q1 2022.

Our U.S. business saw a second consecutive quarter of positive adjusted EBITDA at $29 million, and we nearly have the international adjusted EBITDA losses compared to Q4. We are excited to see the tangible benefits of our cost savings work materialize and we remain tightly unified around our future profitability goals. We ended the quarter with just over $1 billion of cash and highly liquid investments on our balance sheet and over $1.6 billion of total liquidity when including our revolving credit facility capacity. Net cash from operations was a negative $147 million and capital expenditures were $87 million, resulting in free cash flow of negative $234 million. As a reminder, the first quarter is almost always a seasonal cash outflow quarter for our business given the negative cash conversion cycle of our working capital following Q4 holiday peak.

Now let’s turn to guidance for the second quarter. Quarter-to-date gross revenue has been trending in the negative high single digits year-over-year, and we expect improvement due to the easier compares in May and June. We’ve also spoken recently to you about sequential trends and seasonality, and this trend would imply Q1 to Q2 sequential growth of just below positive 10% for net revenue. Despite the highly uncertain macro environment and the reduction in AOV due to deflation, we are excited by the ongoing improving trends in order volume and are seeing promising signs in the business. On gross margin, we would guide you to the 29% to 30% range that I framed earlier. We continue to expect customer service and merchant fees to be between 4% to 5% of net revenue and advertising to be between 12% and 13% for Q2.

We forecast SOTG&A or OpEx, excluding equity-based compensation and related taxes, to come in between $460 million and $470 million showing some further improvement from Q1 levels as we fully run rate the savings from earlier in the year. So finally, as we’ve said several times already, if you follow the guidance I’ve just outlined, you should see positive adjusted EBITDA margins in the 0.5% to 1.5% range for the second quarter. Based on that range on adjusted EBITDA and the working capital dynamics as we move into the spring, you should see a sizable sequential improvement in free cash flow for Q2 relative to Q1. We are now reaching the first stage along our profitability path that we set out last August. So I want to touch on how we were thinking about the next stage, reaching mid-single-digit adjusted EBITDA margins and positive free cash flow.

Let me provide an illustrative model to frame the full pro forma impact of the cost savings that you’re seeing starting to flow through. To be clear, this isn’t meant to be official guidance, but a framework to think about our cost initiatives holistically. For simplicity, let’s use our revenue level from 2022, roughly $12.25 billion top line and apply the pro forma annualized impact of our cost savings initiatives that are already well underway and will be fully enacted by the end of 2023. At that level, we would expect to see adjusted EBITDA margins in the low to mid-single-digit range as gross margins exceed 30% and SOTG&A reaches between 14% to 15% of net revenue due to the ongoing savings work I mentioned above. At that point, we have a cost model that is geared for significant leverage when revenue grows in the future, and we expect that many of our operational efforts will enable the next set of improvements on our road map.

As we’ve said several times in the past, once we hit a mid-single-digit adjusted EBITDA margin range, we intend to treat that as a philosophical floor on profitability for the business from which we will then balance any growth in investment spending with a desire to also continually increase profitability. Now let me translate that into cash flow. As many of you know, there are 2 major bridging items between adjusted EBITDA and free cash flow for our business, working capital and capital expenditures. Our business operates on a negative cash conversion cycle. So working capital is a source of cash when revenue grows sequentially and vice versa. Thus, the impact of working capital will be entirely a function of your assumptions on revenue. If you assume capital expenditures at plus or minus $90 million per quarter, then the $12.25 billion run rate would also translate to positive free cash flow as well, absent the working capital dynamics.

Now let me touch on a few housekeeping items for the second quarter. Please assume the following: equity-based compensation and related taxes of roughly $170 million to $200 million. This will be above trend in Q2 as a function of the seasonality of our compensation cycle. As a reminder, equity-based compensation is expensed at the share price as of the day the grants are originally approved. As a result, a portion of this is related to historical grants that remain in the P&L at elevated share prices given the share price volatility we have experienced. And the remainder will hit the P&L depending on the trajectory of the share price going forward on the date new grants are approved. Depreciation amortization of approximately $102 million to $107 million, net interest expense of approximately $5 million to $6 million, weighted average shares outstanding equal to approximately 112 million and CapEx in a $90 million to $100 million range.

Before I wrap up, I want to take this opportunity to commend our entire team. Over the last 9 months, we’ve delivered tremendous cost efficiency, while at the same time bringing our offering to the strongest place it has been in years. We are excited about the improvements we are seeing in profitability and optimistic that the success of our core recipe will continue to drive our share gains deeper into 2023. Thank you. And with that, Niraj, Steve and I will take your questions.

Q&A Session

Operator: [Operator Instructions]. Your first question comes from the line of Alexandra Steiger from Goldman Sachs.

Operator: Your next question comes from the line of Chris Horvers of JPMorgan.

Operator: Your next question comes from the line of Brian Nagel of Oppenheimer & Co.

Operator: Your next question comes from the line of Ygal Arounian from Citigroup.

Operator: Next question comes from the line of Oliver Wintermantel from Evercore ISI.

Operator: Your next question comes from the line of Anna Andreeva from Needham.

Operator: And our last question comes from the line of Curtis Nagle from Bank of America Merrill Lynch.

Niraj Shah: Thank you, everybody. Talk to you next quarter.

Operator: That does conclude our conference for today. Thank you for participating. You may now all disconnect.