Earnings Call Transcript - ETSY Q1 2020

Debra Wasser, VP of Investor Relations

Hi everyone, and welcome to Etsy's First Quarter 2020 Earnings Conference Call. I'm Deb Wasser, Vice President of Investor Relations and joining me today are Josh Silverman, CEO; Rachel Glaser, CFO; and Gabe Ratcliff, our Director of Investor Relations. So we are trying something a little different, given our work from home status. Our first ever video earnings call. For quality purposes, our prepared remarks have been pre-reported along with the accompanying slides. The slide deck has been posted on our website for your reference. Once we are finished with Josh and Rachel's presentations, we will transition to a live video webcast Q&A session. Questions can be submitted by the Q&A chat window just laid on your screen. Feel free to use it at any time, as it will remain open throughout the entire conference call. I'll be reading your questions and Gabe will help me try to get to as many as we can. Please keep in mind that our remarks today include forward-looking statements related to our financial guidance for the second quarter of 2020 and key drivers thereof. The impact of investments on top-line growth and certain impacts that the COVID-19 pandemic may have on our business strategy, operating results, key metrics, financial condition, profitability, and cash flows and changes in overall level of consumer spending and volatility in the global economy and the impact of ongoing settlement of intercompany balances on future foreign exchange rate volatility. Our results - actual results may differ materially. Forward-looking statements involve risks and uncertainties, which are described in our press release and our 10-K filed with the SEC on February 27th and subsequent reports that we filed with the SEC. Any forward-looking statements that we make on this call are based on our beliefs and assumptions today and we don't have any obligation to update them. Also during the call, we'll present both GAAP and non-GAAP financial measures, reconciliation of non-GAAP to GAAP measures is included in today's earnings press release, which you can find on our IR website along with the replay of this call. With that, I'll turn it over to Josh.

Joshua Silverman, CEO

Thanks Deb, and hello everyone. Let me start by saying that our hearts go out to everyone that's been touched by the COVID crisis, and it's in this crisis that we're reminded ever more of the mission and the purpose of Etsy and how important we are in the lives of our sellers, our buyers, and our team. I hope you'll see in the course of this call that we take that responsibility really seriously and we are acting with urgency. In this moment, I think it's also demonstrating the resiliency and the agility of the Etsy model to rise to this crisis. We stood up a COVID crisis task force in January, we tested work from home in February, so that we were as prepared as we could be to be continuing and productive in an entirely work-from-home environment, and I'm pleased to say that so far we've seen productivity hold up really quite well. You'll see on the slide that, in fact, software releases are up 20% year-over-year in the first quarter in spite of all the changes, and that's really a testament to the hard work that the team has undertaken and the seriousness and urgency that they take in their work, and it's not without real personal stress on them. So I do want to take a moment to thank the team for all of their hard work. Now let's dive in. I know we're all very anxious to discuss the trends we've seen in April and our thoughts for the future, so I want to spend the bulk of my time talking about that. But because this is our first-quarter earnings call, let's hit the headlines very quickly. We delivered $1.4 billion in consolidated gross merchandise sales in the first quarter, a 32% year-over-year growth. Etsy standalone delivered 16% year-over-year growth in GMS. Revenue was about $228 million, and adjusted EBITDA was about $55 million, and Rachel is going to go into more detail about the first quarter and take you through that in a disciplined way. Now moving on to April. April was an extraordinary month, and I mean it in the sense of extraordinary very, very big and extraordinary very unusual. There were two separate things happening in April. The first was the effect of the sale of fabric face masks - Etsy sold about $133 million worth of fabric face masks in the month of April. In early April, the CDC changed its guidelines to recommend that Americans wear fabric face masks, and we saw a tremendous surge of demand for fabric face masks right away on our site. In fact, it was like waking up and discovering that it was Cyber Monday, except that everyone in the world wanted just one product, and that one product was in extremely limited supply. We needed to respond extremely quickly to that new reality. We had to change our search results so that when you search for fabric face masks, you actually saw masks. Previous searches for masks would return Halloween masks or other unrelated items. Thanks to our Google Cloud implementation, we've been able to respond much more quickly, providing very relevant results early on, which has been a big part of what earned us good rankings on Google SEO. In meeting that demand, we then suddenly had a lack of supply, so we put out a call to our sellers and were able to get thousands of sellers to begin making masks within a matter of days. At this point, there are over 60,000 sellers making and selling masks on Etsy. Not only did we need to recruit sellers to make masks, but we also needed to understand their delivery times, manage customer expectations, and distribute demand across sellers. This effort touched almost every team at Etsy. We sold over 12 million face masks in the month of April alone. If face masks were a standalone category, it would have been the second biggest category on Etsy in that month. As we look forward, our opportunity is to deepen our engagement with these buyers, showing them that Etsy can do much more than just sell fabric face masks. This story highlights the dynamism of the Etsy model and our sellers' ability to shift rapidly to meet new demands. However, April was about so much more than just masks. Non-mask sales on the Etsy core marketplace were up 79% year-over-year. The strength of Etsy sales came from a groundswell of demand across various categories, including home and living, craft supplies, self-care, toys and games, and gifting. This, combined with fewer alternatives in the marketplace due to many retail stores being closed, has created a meaningful opportunity for Etsy. The marketing team has been hard at work to develop and communicate the message that Etsy can fill these needs. We consistently remind our sellers that we have your back, communicating our commitment to supporting their businesses. Our merchandising strategy allows us to quickly iterate merchandise shown on our site to reflect current consumer demand. We've launched a targeted TV campaign to communicate our brand strategy. We're proud of this creative, which we feel stands out and resonates with our message to the market. There are millions of new shoppers on Etsy who may not have shopped with us before, and our task is to deepen our engagement and earn their loyalty over time with the new tools we've launched in April, enabling us to create targeted segments quickly across various channels. We remain committed to our four key pillars of our way to win, which continue to guide our efforts. In Q1, we launched a deep-learning model that significantly improves our search experience based on user intent. We’re also seeing many sellers become increasingly agile in responding to new demands, which highlights our team's hard work. Overall, I am proud of the Etsy team and our ability to rise to the challenge during these tough times.

Rachel Glaser, CFO

Thanks, Josh, and hello everyone. I hope you're all doing well and staying safe and comfortable during this uncertain time. My commentary today will cover consolidated results as well as key drivers of performance, which includes Etsy's standalone results where appropriate. Heads up, I'm going to be reading my prepared remarks since there are quite a few numbers and I want to make sure I get them all right. We've got a lot to tell you about Q2 financial performance, but before I go there, Q1 was a very strong quarter, and I want to walk you through those results first. Despite the headwinds caused by COVID-19, primarily during the month of March, we delivered a solid quarter. On a consolidated basis, Etsy's first-quarter GMS grew 32% to $1.4 billion, revenue grew 35% to $228 million, and we delivered adjusted EBITDA of nearly $55 million or margins of 24%. As mentioned on our update call in early April, consolidated GMS growth during January and February was very strong, trending at 41% for the quarter. Etsy's standalone GMS growth for the first quarter was 16%, reflecting a strong January and February with a significant deceleration in March compared to last year and last quarter. Q1 revenue was driven by growth in both marketplace and services revenue, as our consolidated intake rate expanded 60 basis points sequentially to 16.9%. We reported strong growth in revenue related to advertising, which was up approximately 70% year-over-year. Google Shopping contributed about $11 million to advertising revenue for the quarter. As a reminder, in the first quarter, we recorded our old Etsy Ads model, which reflected Google Shopping products of zero margin, as it carried an equal offset in cost of revenue. As planned during the quarter, we transitioned the Etsy Ads product, separating Offsite Ads to standalone products and introducing the transaction fee on every product listing ad that resulted in a successful sale for our sellers. This new product ramped during the second half of March and into early April. Sellers had the chance to see advertising for their products in action. We began billing for this product on May 4th, having waived the first month of fees for sellers during the turbulence of the COVID-19 environment. Waiving the first month of fees is part of a basket of initiatives we implemented to provide relief to our seller community. Reminder going forward, Etsy Ads is now our name for promoted listings and Etsy advertising products. In Q1, we tested our PLA channel, which has been excluded from the incrementality testing we did in 2019. This had the effect of reducing our performance marketing spend in the quarter. Q1 marketing expense was $49 million or 21% of revenue, which was flat compared to Q1 2019. Of that, performance marketing from the Etsy Marketplace was $26 million, delivering 16% of overall GMS. Despite the deceleration in GMS we described in March and the consolidation of Reverb into our financials, our Q1 adjusted EBITDA margins expanded 400 basis points sequentially. Our cost structure is highly variable to revenue, and we've continued to take measures to optimize and scale our business. I'll talk about operating expenses and the variability of our cost base in more detail shortly. Net income in the first quarter was $12.5 million with diluted earnings per share of $0.10. Net income was primarily impacted by non-cash foreign exchange losses of $9.3 million or $0.08 loss per share. Foreign exchange fluctuations on our P&L are primarily related to intercompany activity between our U.S. and foreign entities. The ongoing settlement of these balances, which we completed in Q1, reduces future foreign exchange volatility on our P&L. Key operating metrics for the Etsy Marketplace were relatively stable during the first quarter. We maintained our momentum in driving frequency on the platform. Etsy's GMS per active buyer on a trailing 12-month basis grew 4% year-over-year and on a 2-year stacked basis increased 6%, flat compared to last quarter. On a consolidated basis in Q1, active buyers grew 16% to 48 million and active sellers grew 26% to over 2.8 million. Present international GMS was approximately 36% of total GMS, up 27% year-over-year on a constant currency basis. Now, turning to April, as Josh said, April has been an extraordinary month, and I'm going to dimensionalize that for you. During the month, we saw an increase in demand for face masks and other self-care products significantly impacting GMS growth and our Q2 financials. Etsy standalone GMS for the month of April was over 100%, resulting in $780 million of GMS. Of that, masks were 17% of Etsy's standalone GMS for the month. We're also seeing demand for masks driving engagement with new buyers and buyers that have not purchased for a year or more. During the month of April, we acquired nearly four million new buyers, which was up 160% year-over-year; 22% of mask-related GMS was from new buyers. Year-over-year growth in overall GMS from new buyers accelerated from 5% in Q1 to over 130% in April. We've also re-engaged 2.5 million buyers that have not purchased in a year or more, an increase of 186% year-over-year. Overall, 32% of buyers who purchased a face mask returned within 14 days to make an additional purchase, with the majority coming through Etsy's direct channels, which is free. Our new and older cohorts saw inflection higher in April, and we've shown you our cohorts before and historically, they've been stable and predictable, but we're now experiencing a disruptive change to the positive. This is a brand-new cohort acquired during an extraordinary time, and we don't have any basis to believe they will perform similarly to our existing cohorts. However, they could provide a tailwind to future growth. This is an unprecedented time for us and we are unsure when these trends will stabilize. In addition to masks, we're also seeing additional momentum in other categories. Excluding face mask-related items, Etsy's standalone GMS growth was 79% during the month of April. Of course, these results are likely magnified by broader industry tailwinds, specifically a shift from offline to online. According to external industry data, online retail sales for major marketplaces have risen dramatically in April. On the supply side, new sellers that joined the platform in April accounted for 13% of mask-related GMS. Over the past three years, we've shifted one of the largest fixed expenditures to variable costs with our migration to Google Cloud. Both Etsy and Reverb have highly variable cost structures, so in an environment where top-line growth contracts, a large portion of our expenses can dynamically adjust with growth. In response to the rapidly changing macro environment, we took a thorough look at operating expenses and implemented actions to reduce costs where it makes sense while continuing to invest for long-term growth and pursue opportunities. We recognize that this is a moment for Etsy, where we are uniquely meeting the needs of millions of buyers and sellers. We want to embrace that as a potential inflection point for consumer behavior and habits and invest into it. As of 03/31, we had almost $900 million of cash, cash equivalents, and short and long-term investments in addition to a $200 million revolver that's currently undrawn. We've now paused share repurchases in light of the current macro environment. With minimal CapEx and muted working capital needs, we believe we can continue to deliver a very high percentage of our adjusted EBITDA into free cash flow. Let me provide some background about how we forecast our business given all the uncertainty right now. We built our internal models and looked at cohort data to establish baseline trends and layer in the impact of our investments in marketing and product, which drive incremental growth. In addition, we evaluate a lot of external economic data, closely monitoring headwinds and tailwinds to develop a range of scenarios that could play out. Thus far, we believe we are extremely well situated to execute on our strategy in this environment with the marketplace model allowing us to scale our investments and respond to changing conditions very rapidly. We have a disciplined investment approach and an agile team, ready to rise to the challenge.

Debra Wasser, VP of Investor Relations

Now I will start with a question from Kunal Madhukar at Deutsche Bank. As you think about marketing spend in Q2, what is your strategy with regard to brand versus performance, search versus social versus TV, and then Offsite Ad-supported versus own spend? That one, I think is for you, Josh.

Joshua Silverman, CEO

Great. As with all of our investments, we try to have a very disciplined framework around how we make those investments. Let me start with performance marketing because performance marketing is a natural shock absorber that rises and falls with consumer demand. We've talked a lot about our ROI threshold, and we're very disciplined in looking at the next dollar spent and whether we see that next dollar spent is going to deliver a good return. For all of our performance marketing budgets that continues now just as it did before the crisis, which includes both our Google performance marketing spend as well as performance marketing spends on Facebook and a couple of other places. In terms of the question about Offsite Advertising, which gets billed back to the seller versus the part that is Etsy-funded, overall there is still a subsidy in performance marketing where Etsy is paying a portion of the performance marketing budget through several means. If someone goes to Google and they see a search result for Etsy and they click through, they may not buy from that particular store, and neither of the sellers gets charged for offsite advertising. We think that's a great partnership with our sellers, as the seller is selling a product and gaining a new customer, which is great for both the seller and Etsy. Therefore, the performance marketing spend will vary naturally with demand and the portion that is seller-funded versus Etsy-funded will vary somewhat as well. I expect it to be consistent with earlier guidance provided before the crisis in terms of Offsite Ads versus Etsy-funded portions. I believe performance marketing spend is elevated right now due to elevated demand. Now, let's talk about brand, mid, and upper funnel advertising. We look at reach and frequency against our target audiences and think about what GRP points are needed to stand out above the noise. This is a great moment for Etsy to communicate our message to millions of people who may be trying Etsy for the first time or realizing they can turn to Etsy for different needs, and we want to create that emotional connection. We also look at video on social channels with an eye on meaningful reach and frequency. Overall, this is a fantastic time for Etsy to increase these investments, but these are variable spends, allowing us to pull back easily if conditions change significantly.

Debra Wasser, VP of Investor Relations

Next one is from Shweta Khajuria from RBC. I understand that you aren't guiding to the full year, but can you please talk about the general philosophy, strategy, and how you plan to manage costs this year with respect to top-line growth and what are some of the places you plan to continue leaning into and where you'll see cost savings? Will it be more areas to pull back on costs, you talked about the three scenarios you mentioned during our intra-quarter COVID update, do those scenarios still stand?

Joshua Silverman, CEO

Thanks, Shweta. Maybe I'll start, and then Rachel can fill in the gaps. In our April 2nd call, we talked about how we took some swift action to review our operating costs. We've always been very disciplined about our cost structure. If you look back at our earnings call from the previous quarter, we've pointed out that we have some of the highest revenue per headcount in our peer group. So, we entered this crisis with quite a bit of fiscal discipline and are continuously looking at how we can improve and ensure every dollar spent goes toward its best and highest purpose, minimizing waste is a core value for us. We aim not to make short-term decisions based only on short-term trends. Thankfully, we did not overreact in late March. Our team performed excellently in April, stepping up to the challenge, and maintaining our investments allowed us to respond effectively when needed. As Rachel mentioned, we’ll hope for the best but plan for the worst. By this, we mean being disciplined around our fixed costs while leaning into variable investments likely to yield good payback. This could be an inflection point for Etsy, so we want to embrace that moment and take full advantage. Our product roadmap coming into 2020 is still relevant. We continue prioritizing our high-value projects related to our four pillars of our right to win, without starting over. We've pivoted toward urgent needs while also taking advantage of longer-term investment opportunities. For instance, we're focusing on improving search quality and data pipelines, which will strengthen our search and recommendations in the medium to long term.

Rachel Glaser, CFO

Yes, if I can, I'll jump in with a few additional notes, specifically around margins. I want you to remember that we've consolidated Reverb into our financials now, which creates much more revenue on the top line with potentially zero margin. In Q1, our accounting for Etsy Ads resulted in marginal drag on overall margins that we expect to improve in Q2 and beyond. Additionally, we've spent fairly heavily on television brand marketing in Q1 that we didn't have in the prior year. This will continue into Q2 as I mentioned. While we've been judicious in managing costs, the impact of our advertising spend and product development labor has changed how we report. While we have reduced some expenses, remember the other factors influencing our margins.

Debra Wasser, VP of Investor Relations

Thanks, Rachel. The next one is from Darren Aftahi at Roth. You said masks would have been the number two category in April if it was its own category, what was number one?

Joshua Silverman, CEO

Number one, as has often been the case, was Home and Living. Everything around making your home comfortable was our top category. This speaks to the enormous opportunity for Etsy, particularly as many retail categories are underrepresented. Other robust categories included craft supplies, toys and games, and gifting, so we have many relevant opportunities, especially as buyers become more familiar with what Etsy offers.

Debra Wasser, VP of Investor Relations

Next one comes from Laura Champine from Loop. In Q2, should Services' revenue grow faster or slower than GMS and what are the drivers?

Joshua Silverman, CEO

I would expect Services' revenue to grow slightly slower in Q2 than GMS for a unique reason. GMS is growing rapidly on the Marketplace, but GMS is composed of visits, conversion rate, and average order value (AOV). Right now we're seeing visits grow quickly, but AOV is slightly down from historical averages. If visits are growing slightly slower than GMS, then Etsy Ads might grow slower than GMS overall. However, we still think Etsy Ads is performing well.

Rachel Glaser, CFO

May I add one thing to that, Josh's response? In the first part of April, during the surge in mask sales, we took Etsy Ads off the mask listing pages. Now it’s back, but for a portion of the month of April, there were no promoted listings there.

Debra Wasser, VP of Investor Relations

We have a couple of questions that are guidance-related. I'm going to go with this one from John Colantuoni, I hope I said that right John, from Jefferies. Q2 GMS guidance implies a high level of growth in May and June. Can you talk about some key assumptions in your internal model that lead you to the quarter forecast?

Joshua Silverman, CEO

I’ll start by reiterating that forecasting is incredibly difficult right now, and we had many discussions about whether we should provide guidance. We've tried to be transparent without over-promising. The range given details a bit of uncertainty, with both tailwinds and anticipated headwinds. Factors include rising demand and fewer alternatives, but we also recognize the potential for significant economic downturns we need to be prepared for. We believe our recent performance and the strength we saw in April will support solid growth for the quarter.

Rachel Glaser, CFO

I just want to add a couple of points. We've seen early May trends hold and expect May to decelerate. We discussed our expectations for acceleration in June. Lastly, remember that our guidance is consolidated, with Reverb's smaller percentage playing a role as Etsy’s reported performance may dominate our totals.

Debra Wasser, VP of Investor Relations

Okay. Thanks, Rachel. The next question is from Nick Jones at Citi. Though it is still early days in this crisis, what are you learning about your habitual buyers, active buyers, and occasional buyers? Are you seeing early trends indicating that each of these groups are growing?

Joshua Silverman, CEO

Yes, breaking it down, our habitual buyers are essentially growing as expected. We've seen a growth in those who purchase more frequently. The big opportunity lies with less frequent buyers and those having never shopped on Etsy before but are discovering us now. We’re encouraged by the frequency gains in lapsed buyers during this time.

Debra Wasser, VP of Investor Relations

Okay. Next one is from Maria Ripps of Canaccord. When you think about your Q2 guidance, can you discuss the relative contribution from new customers versus engagement from existing customers? It seems like with this much visibility, you must be seeing a lot of activity from your existing customers, but can you elaborate further?

Joshua Silverman, CEO

Sure, I’ll start and Rachel can jump in. We define new customers as those who we have never seen before. We're witnessing strong growth in brand-new buyers, which is exciting given that many still don't shop online. We're increasingly seeing lapsed buyers returning and shopping more frequently, presenting us opportunities to capture their attention.

Rachel Glaser, CFO

To reiterate, we activated 6.5 million new buyers in April, which constitutes about half of all April buyers. This cohort represents a significant portion of our growth prospects as we lean into effective marketing and outreach strategies.

Debra Wasser, VP of Investor Relations

Thank you. Next is from Naved Khan at SunTrust. What kind of uplift do you think you may be seeing from the increase in consumer spending due to government support stimulus?

Joshua Silverman, CEO

Yes, we have been observing this and while it is hard to pinpoint the exact impact, the growth we've observed suggests support from the stimulus checks has played a role. However, we believe sustained growth remains. Moving forward, we expect that without these checks, growth may decelerate, experiencing the economic hardships that will become more evident.

Debra Wasser, VP of Investor Relations

Next is from Jason Helfstein at OpCo. Are you seeing better seller demand for your new ad products and/or seller re-engagement with those products? Any way to quantify that?

Joshua Silverman, CEO

We're very happy with our Offsite Ads. The team did a commendable job getting it launched. Early metrics indicate that sellers are receptive, and opt-out rates are low. Etsy Ads, formerly promoted listings, also continues to perform well with strong engagement from sellers. All early signs are encouraging.

Rachel Glaser, CFO

Just to add a note, since the product was live for some time before we began billing, sellers saw the value of the ads and their associated costs waived. They’ve had a chance to evaluate results, which has yielded positive feedback overall.

Debra Wasser, VP of Investor Relations

Thank you. We went over time here a little bit. I'm going to squeeze in one more high-level question and anybody else whose questions are stuck in the queue, we'll make sure we get back to you. This one is for Josh from Tom Forte of D.A. Davidson. As a long-time industry participant, what are your thoughts on e-commerce next coming out of the Coronavirus outbreak? For example, the home category online mix today is about 40% versus 20% last year. How much does the increase mix hold near term as physical stores reopen?

Joshua Silverman, CEO

I think this will be an inflection point for e-commerce that is both meaningful and lasting. Many people who previously relied on offline shopping are now discovering the convenience and benefits of online shopping. This dramatic shift could create lasting behavior changes. Etsy is well positioned to be a notable alternative to Amazon, catering to various customer needs. With all of our sellers showcasing unique offerings, we have a significant opportunity to demonstrate and strengthen our market presence during this pivotal moment.

Debra Wasser, VP of Investor Relations

Great. Thanks, Josh. And thank you everyone for joining us. We hope you stay safe, and we'll talk to you soon. Thank you so much.