Wayfair Inc. Q3 FY2020 Earnings Call

Ladies and gentlemen, thank you for standing by, and welcome to today’s Wayfair Q3 2020 Earnings Release and Conference Call. At this time, all participant lines are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. I would now like to turn the call over to Jane Gelfand, Head of Investor Relations & Special Projects. Please go ahead.

Good morning and thank you for joining us. Today, we will review our third quarter 2020 results. With me are Niraj Shah, Co-Founder, Chief Executive Officer, and Co-Chairman; Steve Conine, Co-Founder and Co-Chairman; and Michael Fleisher, Chief Financial Officer; and Martin Reiter, Vice President and Head of Europe. We will all be available for Q&A following today’s prepared remarks. I would like to remind you that we will make forward-looking statements during this call regarding future events and financial performance, including guidance for the fourth quarter of 2020. 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 2019, 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 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. These include measures such as adjusted EBITDA 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, which contains descriptions of our non-GAAP financial measures and reconciliation 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.

Thanks, Jane, and hello, everyone. We appreciate all of you joining us as we know there’s a lot happening on this Election Day morning. We are pleased to report the Q3 marked another quarter characterized by strong growth and continued profitability for Wayfair. Though the initial shock of the arrival of COVID-19 is arguably behind us, consumer behavior in both North America and in Europe is undeniably changed as a result of the pandemic. From a macro perspective, we’re encouraged by continued consumer resilience, though clearly much is still in flux. The home category is seeing broad-based demand as our customers reprioritize their spending on where and how they live, and away from other experiences like travel, entertainment, and dining. To the extent that de-urbanization trends continue to gain traction, these should in the near to intermediate term prove an additional tailwind for the category. As the e-commerce business focused purely on the home, Wayfair continues to benefit from both increased online penetration and heightened spending on the category. In Q3, this was reflected in continued elevated rates of new customer acquisition, and strong repeat order growth, which together translated to an incremental $1.5 billion in net revenue, or 67% growth year-over-year. The exceptional top-line momentum combined with our internal efficiency initiatives led to a second consecutive quarter of strong profitability. Our Q3 consolidated adjusted EBITDA came in at $371 million or 9.7% margin. Today, I want to discuss three main topics. First, I will speak briefly about momentum in the home category more recently, and looking out longer term. Second, I will comment on Wayfair’s trends, including during Way Day, and the work that we are doing to effectively respond to continued strong demand. This will be important for the upcoming holiday season, which promises to be unique for all of us. And finally, I will offer some thoughts on the progress we have made on our profitability journey and what’s ahead. Let’s begin with the home category. As is likely the case for you, we find it difficult to precisely pinpoint where overall category growth is in real time. But judging by the positive data points being reported across the industry, including by e-commerce players and reopened brick and mortar retailers, we believe it is safe to say that the category as a whole is growing well above average rates, which are typically in the low single digits. Against this backdrop, Wayfair continues to consolidate market share as dollars move online at an accelerated clip. Importantly, demand for home goods remains broad based. We continue to see that the vast majority of various subcategories, or classes of home are growing nicely. So while it may be tempting to attribute the recent strength of the category to so-called COVID classes, like home office furniture or outdoor furniture and places, the reality is quite different. Instead, we estimate that all of the other classes combined have driven more than three quarters of the growth we’ve experienced year to date. As the environment further normalizes, there’ll be some volatility period-to-period. But I think it’s important for us to zoom out and put things into a longer-term perspective across three key dimensions. First, the home category is vast, representing close to an $800 billion total addressable market in North America and Europe, split roughly evenly between the two, and despite the e-commerce step change we’ve seen over the last several months, the category remains quite underpenetrated relative to others, which began their migration online earlier. Second, the total addressable market can be further broken down into four different, large scale and relatively fragmented verticals, namely furniture and décor, housewares, home improvement and large appliances, and professional or B2B. We have a meaningful offering across each of these after the last several years of investment, and yet, are still quite small, even in the scheme of furniture and décor, which is our most developed set of classes. And third, we have a portfolio of platforms and specialty brands that help reach consumers spanning mass, upper mass, and luxury demographics and a variety of style and shopping preferences. The Wayfair and Perigold platforms help us reach the mass and luxury customer respectively, with a virtually endless catalog and then to facilitate our discovery of the perfect product. Meanwhile, we are more tightly curating selection via the AllModern, Birch Lane and Joss & Main specialty retail concepts to appeal to those customers who also approach the category with a very precise stylistic viewpoint, and to gravitate the curated specialty retailers. These different specialty retail brands, which together represent another billion-plus run rate revenue stream, allow us to effectively have more shelf space with our customer, as she looks across multiple brands in her search to find the perfect unique item for her home. Given the size of the market, our presence across the major verticals and our well-defined portfolio of retail concepts, we believe the runway for Wayfair’s growth is very, very well, and we continue to operate and build this business with a much larger profitable scale in mind. Turning now to what transpired in Q3. Even as competition in the form of brick-and-mortar returned to the market, Wayfair’s strong customer acquisition and retention trends continued. At nearly 29 million customers, our LTM active customer count was up 51% year-over-year. We saw average order values normalize some after a dip in Q2, with LTM net revenue per active customer hitting a new peak this past quarter. It’s also worth noting that in Q3, we did not see much deviation in sequential trends across our various geographies or various income demographics. While we will move away from regularly describing the behavior of any one specific cohort in the future, I will briefly mention that customers acquired during COVID still appear to look similar to other recent cohorts in terms of repeat trends. Looking beyond the acute pandemic period, we fully expect that Wayfair will benefit from having a relationship with each of these customers and being able to engage with them in highly personalized ways, as we’ve always done. We also worked hard this past quarter to ensure the best possible customer service and delivery experience in the midst of some industry challenges. Though inventory levels across the industry are still lower than usual, we believe the low point in product availability is now behind us. Importantly though, the inherent advantages of Wayfair’s differentiated model actually shine through in the midst of some of the lingering issues. Though our model is uniquely inventory light and we do not own the vast majority of the products we make available to our customers via our platform, we’re doing whatever we can to assist our supplier partners in mitigating bottlenecks. For example, we are working continuously on joint demand planning, as Steve described in detail last quarter. We’re leveraging our scale to procure additional space on cargo ships for our suppliers and seeing our ocean forwarding business grow considerably in the process. Post-order, our scale increasingly allows us to bypass the most congested points in common carriers networks and go straight to the last mile, thereby avoiding surcharges and delivery delays. And when it comes to those suppliers who drop ship to our customers, we are working hand in hand to share best practices on how to manage the complexities of elevated demand, even if we’re not directly handling the person. We’re also closely tracking our suppliers’ inventory positions and backlogs to diagnose and together troubleshoot logistics issues before they become bigger problems. Each of these measures is important to mitigate some of the supply chain disruption we’re seeing across the industry. But they’re not enough to completely shield the customer experience. In this environment, the inherent advantages of our model become even more pronounced. Consider the following. By virtue of offering approximately 18 million products on site in a mostly unbranded category, our customers are highly likely to find a product that fits their style and budget, even if some of the options are out of stock. During key promotional events, we can curate the selection so as to drive demand towards those products where availability and visibility to fast and reliable delivery are robust. We also offer maximum possible transparency and how long a product might take to arrive, so as to manage expectations upfront. And we’re conservatively estimating lead times. This is only made possible on the back of strong data integration with our suppliers, and proprietary technology throughout our CastleGate and WDN networks. There is a great example of the benefit of our long-term mentality around investing in building our own proprietary systems. Finally, our 100% in-house customer service operations are approaching more appropriate staffing levels to reflect the higher volumes we’re experiencing, so that customers may connect with Wayfair support without delay, or use self-service options to reach a quick resolution. Some of you have asked why we held Way Day when we did at the end of September. The main reason, of course, is that our customers are actively thinking about their homes, are passionate about this event, and we together with our supplier partners wanted to bring them the best possible deals at a time when they could really use it. Thanks to an extended 48-hour timeframe, Way Day drove the two biggest sales days in Wayfair history, inline with our internal forecasts and an impressive result, particularly when considered against the backdrop of several months of peak demand. To build on what I said earlier about the so-called COVID classes being a lesser part of the overall demand picture, the top five best selling categories during this Way Day were the same as the top five best selling categories during Way Day 2019, despite drastically different macro circumstances this year. Looking at the holidays, we think it’ll be even more important this year than usual. With customers likely staying in or close to home, perhaps limiting social gatherings, creating the right atmosphere will be key to capturing the spirit of the season. Like others in the industry, our marketing messaging will be more drawn out as a result, which should also help mitigate the extent of the Cyber Five peaks and potential ensuing congestion. Before I wrap up, I’ll offer a few thoughts on the track record of profitability that we’re beginning to establish. It is true that elevated volume is clearly driving heightened gross margin efficiencies for Wayfair. While some of these benefits will fade over time, we believe a good portion of the gains will persist, even as the growth rate eventually moderates to a new normal. Plus, there are multiple other drivers to gross margin expansion, all of which are detailed in the past that are also adding to the gains we’re seeing year-over-year. Further down the P&L, you’re witnessing our payback driven marketing approach drive maximum customer acquisition where it makes economic sense within a reasonable and measurable timeframe. Though the advertising markets continue to recover relative to Q2 and were more competitive this past quarter, we were able to operate efficiently while achieving good scale across an area of digital channels. Finally, despite our accelerated growth, we are demonstrating discipline in our hiring approach, an acknowledgment that we still have thousands of people staffed against future revenue and income streams. We will also remain thoughtful as we assess hiring needs into next year. We believe Wayfair is now positioned to deliver the rare combination of strong growth, improving profitability and smart, selective, and long-term oriented investments for many years to come. You’re seeing the benefits of our investment mindset play out in 2020, as we take advantage of an extraordinary and challenging set of circumstances. You’ve witnessed our long-term growth mindset at work since the IPO, and we see a very long runway ahead. Now, the sustained profitability inflection we foreshadowed back in late 2019, even before COVID, is also more clearly playing out. We expect to offer you more truth points of this over the coming period. And with that, I’d like to turn it over to Martin Reiter. Martin is our VP and Head of Europe and is our featured speaker, as we continue to introduce you to more of our executive team via this forum.

Thanks, Niraj, and hello, everyone. I’m glad to be joining you today to discuss our exciting business in Europe. To share a bit of background, I joined Wayfair seven years ago and have held a variety of leadership roles inside the Company. For the last five years, I’ve overseen the European business. Prior to Wayfair, I built out Airbnb’s global presence across four continents, as Head of International, having worked with Groupon and McKinsey before that. Since I joined Wayfair, we’ve come a long way. Wayfair’s European business has grown about a hundred-fold since. It is now over a $1 billion run rate revenue business and growing quite rapidly in the UK and Germany on the back of a pan-European infrastructure. Our headquarters in Berlin are the Company’s second global headquarters, now taking issues universal to Wayfair and exporting best practices to Boston and vice versa. Europe represents a tremendous opportunity for us, with the total addressable market rivaling the size of North America at roughly $300 billion in B2C sales, another $100 billion opportunity in B2B and even lower e-commerce penetration that’s relative to the U.S. We see the same structural tailwinds and the long runway for profitable growth ahead. Today, we are in the UK and Germany, which together represent nearly 45% of the European total addressable market, and we operate here with the Wayfair brand only. Like in the U.S., Wayfair Europe is focused on the mass market consumer and helping her find the perfect item for her home by bringing the whole of the industry’s collections to her via a rich visually engaging online platform and through an industry-leading service and delivery experience. Our positioning is clearly resonating. In the UK, our aided awareness is now in the mid-70s. Wayfair is already the e-commerce leader in the home category, and we’re the leader on the same trajectory in Germany, though we are at an earlier stage there, having turned on our marketing engine only towards the end of 2018. As always, our success is driven by a partnership mindset with our suppliers and the same inventory-light approach. We now feature approximately 4,000 suppliers on our European platforms, tracking closely along the trajectory we follow-up as the U.S., scale. Importantly, the suppliers are local, regional and global players, representing products from over 30 countries. In Europe, we have supplier-facing teams fluent in more than 10 languages, which work hand-in-hand with our category managers to build strong relationships across the trade. We’re also seeing some of our U.S.-based suppliers follow us across the Atlantic to reach the European market for Wayfair. As a result, we are able to offer our British and German customers unparalleled selection. Over the last 12 months alone, our assortment has grown nearly 30% to more than 4.2 million products. In merchandising and pricing, we employ the same data-driven approach as we do in the U.S. with several hundred out of Wayfair’s 3,300 engineers and data scientists working out of Berlin, we’re working jointly with Boston to develop proprietary global technology platforms and algorithms as we seek to balance our growth and profit aspirations at the class level and encourage lower wholesale costs. Meanwhile, analytical insights and semi-automated creation are fueling the creation of numerous flagship brands, specific style focus, unique product and red carpet merchandising. Though we’re earlier in the journey than we are in the U.S., this already represents close to 20% of European gross revenue. In Europe too, we are focused on introducing win-win-win solutions for the customer, the supplier, and Wayfair. This includes the recent introduction of supplier services, which enable our suppliers’ success on the platform. For instance, just this summer, we launched media solutions, such as sponsored listings in Europe. Over time, this will result in new margin-accretive profit streams for Wayfair. Perhaps furthest along are our CastleGate, Wayfair Delivery Network and International Supply Chain logistics offerings. These are designed individually and together to minimize time and cost in getting the product from the factory to customer, or put another way, to maximize what we call cost-efficient perfect orders. You’ll recall this concept and the various initiatives behind it is what Thomas Netzer, Wayfair’s COO, described in detail on the Q1 call back in May. Let me give you a sense of how far along we are in building out our logistics reach through a few statistics. In 2020 thus far, about every third container inbounded into one of our CastleGate warehouses in Europe has been shipped from Asia by Wayfair. We are currently operating two fulfillment centers with CastleGate penetration in Europe already on par with U.S. levels. In the UK, we opened a 1.1 million square-foot facility in Lutterworth about a year ago. It is actually the largest warehouse in the UK, thanks to 60-foot ceiling. We currently operate a smaller-scale warehouse in Germany. And in 2021, we’re planning to upgrade to a larger 1 million square foot fulfillment center in Lich to accommodate our continued growth. Given the greater population density in both markets, we are already able to deliver to our customers quickly from our existing footprint. So, incremental square footage is and will continue to be motivated primarily by capacity constraints and over time, market expansion. Having achieved sufficient scale in the UK, in 2019, we began operating a middle mile and last mile delivery network, our WDN, which is uniquely optimized for delivering the largest home products to our customers. In total, we now employ about 1,400 frontline employees in Europe, in roles spanning from customer service to logistics. Over the course of the last 12 months, we have made significant structural gains when it comes to our profitability in Europe, though your ability to discern this is admittedly somewhat marred by COVID-related tailwinds in 2020, and because Europe is only a portion of our international segment. So, I’ll reframe the discussion by preemptively addressing a related question you might naturally have. That is whether there are any structural differences between Europe and the U.S. that would ultimately translate into a materially different financial profile. The quick answer to that is, no. In fact, as we plot Europe’s progress relative to the U.S. on a variety of dimensions, from revenue ramp to suppliers onboarding to advertising and repeat trends, the time index lines look very similar, which gives us additional confidence in our progress. Our unit economics are already attractive. It should continue to improve as we scale. There are, for sure, some nuances to each market, but ultimately, our gross margin drivers remain the same as those Niraj described earlier for the overall company. Our marketing strategy, which is quantitative and payback-driven, closely mirrors what you’re familiar with in the U.S. In Europe, because of our earlier life stage, we have a lower base of repeat than we do in the U.S., which translates into higher advertising costs as a percentage of net revenue. Still, we’ve already seen hundreds of basis points of improvement here over time. And as I just mentioned, our customer cohort curves and repeat revenue maintenance costs are closely tracking our experience in the U.S. Over the last several years, we have invested aggressively in our people and processes, all of which should translate into additional leverage as our European business scales from here. We now have roughly 1,000 office employees, the majority of whom reside in Berlin and only roughly 100 of which still in the UK to tailor our offering to the local customer. Thanks to our team’s hard work and vision, we’ve truly established a pan-European infrastructure and position Berlin as an equally strong talent hub to Boston. Simply said, the flywheel is firmly turning in both the UK and Germany, and there is a huge opportunity ahead in both of these markets. To be sure, there will come a time when it will be also appropriate for us to pursue new frontiers in Europe. We’re confident that Wayfair’s value proposition will strongly resonate in other country markets. And there are also white spaces within home for us to consider over time, such as certain additional classes or B2B, where we already have significant expertise and scale in the U.S. What we ultimately choose to do next and when to do it will be rigorous, analytical, and sequenced. Importantly, thanks to the infrastructure and processes we’ve already put in place in Europe, we expect the operational and financial lift from any such move to be much smaller than the investment that was initially required for us to get the UK and Germany right. With that, I will turn it over to Michael.

Thank you, Martin, and good morning, everyone. As usual, I will first cover the financial details of the third quarter to complement what Niraj has already said, and then will turn to our Q4 outlook. As you saw in our press release and IR presentation, our Q3 total net revenue grew approximately 67% or $1.5 billion year-over-year. Growth rates were similar across the U.S. and international segments, reflecting a somewhat faster normalization, post the initial COVID shock in our international markets as compared to the U.S. Excluding the boost from Way Day, which occurred in Q3 this year, but not in the year-ago period, we saw net revenue growth rates sequentially moderate towards the back half of the quarter. Even so, the absolute growth rates remained very robust and well above pre-COVID levels. This moderation ex Way Day was consistent with our expectations and makes sense as customers strive to return to some kind of new normal. Way Day ended up benefiting Q3 net revenue slightly more than we had estimated, thanks to some of the things we are doing to mitigate shipping congestion, though more than half of the net revenue will still fall in Q4. This is to say that the gap between gross and net revenue growth rates we mentioned last quarter persisted in Q3, though the magnitude did narrow. We do not expect it to fully close in Q4 as delivery speeds will still likely prove slower than usual through the holidays. Because Niraj discussed many of the KPIs we track earlier, I’ll now jump to gross margin. As I move down the P&L, please note that I’ll be referencing the remaining financials on a non-GAAP basis, which includes depreciation and amortization but excludes stock-based compensation. Gross margin came in at 30%, showing about 650 basis points of leverage year-over-year but about 70 basis points lower than Q2. The sequential move reflects less volume throughput through our logistics network relative to last quarter, though there are still significant efficiencies accruing to us as volume remains robust. More importantly, the year-on-year expansion is also supported by internal gains made through all of our other initiatives, like merchandising and margin-accretive supplier services. We will speak more about this in a bit, but it’s fair to say that we expect gross margin to settle out substantially higher than where we entered pre-COVID, regardless of the net revenue growth rate. The customer service and merchant fee line item normalized sequentially too and came in at 3.5% of net revenue. This reflected more appropriate staffing within the customer service organization to calibrate against elevated order levels, and therefore, increased call volume. Moving on to advertising, we saw 325 basis points of leverage year-over-year and another 70 basis points of leverage sequentially. Though media costs increased relative to Q2, they are still favorable year-over-year, and online traffic remains elevated. This combination helped us run our various marketing channels at good scale, while of course sticking to our efficiency goals. We also saw a greater share of repeat orders this period, and these ran at a lower advertising cost as a percent of net revenue. To be clear, though we’re pleased with the exceptional results, we wouldn’t extrapolate Q3 as being indicative of a new run rate for advertising as a percent of net revenue, given some of the still existing irregularities in the market. Consistent with what we said last quarter, we believe that a very low double digit, 10% to 11% type range, for this line is a more prudent assumption going forward. Our selling operations technology and G&A or OpEx expenses came in at $373 million and in line with our expectations. Recall that compensation represents a significant portion of this line item, and our OpEx headcount will be down for the year. Because as many of you have asked about our headcount plans for 2021, I will just offer that we remain disciplined and expect net hiring and OpEx to grow somewhat but remain at a relatively low level. As always, we will flex variable hiring commensurate with growth, but these employees’ compensation runs elsewhere through the P&L, namely through COGS and customer service. To wrap up on Q3, adjusted EBITDA for the quarter was $371 million or 9.7% of net revenue. In the U.S., adjusted EBITDA margin equaled 11.5%, while the international segment posted modestly negative adjusted EBITDA at negative $6 million. As we’ve said before and as Martin just described, Wayfair is at an earlier stage in international, and therefore, we are comfortable with the different margin profiles across our segments for now and see no reason why they could not be similarly positive over the long term. In general, we are pleased to report a second consecutive quarter of positive adjusted EBITDA performance for the Company in Q3 and to have moved into positive EPS territory on a year-to-date basis. We ended Q3 with $2.6 billion of cash and highly liquid investments on our balance sheet, and free cash flow for the quarter was $255 million. While this too represents the second consecutive quarter of positive free cash flow, I’d like to remind you that working capital swings will affect our free cash flow results quarter-to-quarter. We operate with a negative cash conversion cycle, which is, on the whole, a significant advantage. However, this also means that the sequential change in our revenue and order growth can cause swings in our cash flow generation period to period. Now, turning to the Q4 outlook. Recognizing that we remain in a highly fluid environment, it’s too early to provide official guidance from top to bottom line. Instead, I will continue to offer transparency on gross revenue growth thus far into the quarter with some additional qualitative thoughts about what’s to come. I will also share some perspective on the progression of the various expense lines in the P&L. Quarter-to-date, our gross revenue growth is trending at roughly 50% year-over-year. As I mentioned earlier, we did see moderation in growth in the latter half of Q3, excluding Way Day. And we still expect strong growth for the whole of Q4 and obviously well above pre-COVID levels. Though we’re optimistic that holiday demand for the category will prove healthy and expect that many will prefer to shop online, there are still tremendous unknowns. We are a mass-oriented business where the customer has to show up every day. Between ongoing economic and individual uncertainty, and a serious health crisis still underway, there is plenty of room for volatility and distraction, and we need to appropriately calibrate in the way we plan and model, and we would urge you to do the same. One side note before we move on to the rest of the P&L. Because our plans this year call for an extended period of holiday programming and less concentration on Cyber Five specifically, we will not be publishing our typical post-Cyber Five press release in Q4. Comparability issues would simply make it meaningless. Moving on to gross margins. Even as volume growth normalizes from Q2 peaks, we are continuing to unlock structural gains along several key dimensions. These include logistics efficiencies, pricing leverage on the back of merchandising and house and flagship brand investments, positive mix as supplier services grow and scale benefits across the entire wholesale and supply chain cost structure. After multiple years of investments behind these initiatives, 2019 marked a turning point as we started to see associated returns start to more meaningfully flow through. And this is continuing through 2020. As a result, for Q4, we would point you to a gross margin range somewhere between 26% and 28%. When you think about the other P&L line items, please refer back to some of my earlier remarks and consider the following. Customer service and merchant fees should continue to move towards the 4% of net revenue that we typically target for this expense item. Advertising as a percentage of net revenue should normalize further from Q2 and Q3 levels. We continue to view 10% to 11% as a more appropriate range to target here. And finally, our SOTG&A dollars, excluding stock-based compensation, are estimated to be approximately $400 million in Q4, which is down modestly year-over-year, reflecting our higher trajectory this year. To help you with a few more housekeeping items, please assume equity-based compensation and related tax expenses of approximately $86 million to $88 million, and depreciation and amortization of approximately $73 million to $78 million. We expect basic weighted average shares outstanding to equal approximately 99 million, though our diluted weighted average shares outstanding will ultimately be driven by the net income results in Q4. You will recall that we discussed the accounting mechanics of this in detail when we reported last quarter. Finally, we expect CapEx in a $75 million to $85 million range, subject to expected timing. These various moving parts should produce another quarter of strong and profitable growth to round out 2020. As I wrap up, I want to acknowledge that Wayfair has been fortunate to be well positioned thus far during this extraordinary and at times, difficult year. But it is not by accident a business can add literally billions of dollars in revenue over a short period and can do this relatively smoothly while navigating enormous complexity. Thanks to our long-term-oriented philosophy, Wayfair has been built to scale while remaining ambitious and agile. We saw the benefits of this approach in 2020, and this flexibility will prove crucial as there are still many uncertainties ahead over the coming months and quarters, with still high potential for disruption and opportunity. We are staying prudent as we plan for 2021 and are prepared to adjust as necessary. That said, the long-term orientation that got us here remains firmly intact. We are laser-focused on the huge home category TAM, reinforcing our winning platform for both customers and suppliers, and on effectively balancing growth, profitability, and high ROI investments for many years to come. Now, I’ll turn the call back to Niraj for some closing remarks before we take your questions.

Thanks, Michael. I just want to express a quick but very sincere thank you to our nearly 17,000 employees. Whether on the front lines or working from home, we are prioritizing our customers and our suppliers in ways that will drive value well beyond the COVID period. We’re demonstrating resilience in the midst of difficult circumstances. And together, we are looking forward to making this upcoming holiday season a strong success as the home becomes even more important to get just right. Michael, Martin, Steve and I will now turn to your questions. We’ll have a hard stop at 9:00 a.m. so that you can all go vote, if you haven’t already. Thank you.

Your first question goes to Peter Keith from Piper Sandler.

Hi. Thank you. Good morning. Congrats, everyone, for the continued success. And Michael, thanks for the early peek on headcount for 2021. We do get questions on if 2021 is going to be an investment year. And so, maybe I’ll focus specifically on your supply chain and logistics network. How do you feel about the current capacity within the network, given the buildout that’s occurred in recent years? I know you’ve done some reracking to add space. But, with 60% sales growth year-to-date, are you starting to reach full capacity where you’re going to have to jump start the buildout as we look out to 2021, either domestic or international?

Peter, this is Niraj. Thanks for the question. Let me jump in and answer part of it, and then Michael can chime in as well. In terms of how you should think about 2021 and forward on logistics, I think the way to think about it is, the 18 million square feet of logistics we have built has still a tremendous amount of capacity we can add. And some of that, as you mentioned, is adding additional racking, which we’ve been doing. Some of it is what we’ve been able to do with sortation and methods to increase throughput through the buildings. But as a result, we still have capacity that we can ramp to for actually some time to come. The fulfillment centers, the way to think about them is they typically have a lead time that’s kind of in the roundabout, call it, two to three-year timeframe between doing the deal, getting the permitting done, building the building, getting it up and running, and so they have relatively long lead times. Because of the capacity we have, we don’t foresee having any constraints despite what we expect to be a tremendous amount of growth in the volumes through them over the next couple of years. And so right now, the only things we have in the plans for the next couple of years, we have a building opening in Germany next year, and then there is one potential additional building that would open in the next two-year timeframe. And then really, what we’re working on now are the buildings that would come online in sort of years three, four, five from now. At that point, we do envision needing more buildings, but it will really be for capacity reasons due to aggressive scaling. But we think the kind of near-term, the next couple of years worth of scaling, we can actually do with the buildings we already have, due to the large investments we’ve already previously made. Michael, do you want to add any color on that?

No. I guess, the only thing I would add, Peter, and we talked about this over the last couple of quarters is, we just feel like we’re in a really strong position at this point to both be making the continued investments we need to make to grow the business for the long term and delivering really good positive financial results. And so, I think the balance between those should continue, and we feel really good about that going forward.

Okay, great. Maybe even a separate topic, I want to also just ask about the competitive backdrop. How do you feel about the competitive nature of the environment right now? And on a related note, there are rumors out there that your biggest U.S. competitor is diminishing the home furnishings inventory at its own DC network. Are you seeing more suppliers reach out to you to take advantage of the CastleGate network?

On the competitive front, we’ve noticed an increasing number of suppliers adopting CastleGate. With the enhancements we've introduced, such as our Asian induction operations and ocean freight forwarding business, it's becoming more accessible for suppliers to utilize CastleGate cost-effectively. The advantages of using CastleGate, like improved delivery speed and conversion rates, are evident, leading to more suppliers embracing it. Regarding competitors, we have many, with major players including Amazon, Walmart, Target, Home Depot, and Lowe’s. Depending on the category, some of these are our primary competitors, but within the various subcategories we operate, there are numerous others. The market is quite fragmented. Currently, we don't observe significant changes in competition compared to the past, and no single competitor seems to have the ability to substantially influence our business, whether on the customer or supplier side. Therefore, we generally don't experience sharp fluctuations based on a competitor's actions. Instead, we continue to see steady progress as we enhance self-service capabilities on our platform, Partner Home, making it increasingly straightforward for suppliers to engage with us. For instance, earlier this year, CastleGate introduced a standard rate card in North America, simplifying the process for suppliers and reducing the need for negotiations over contracts. Initiatives like this help suppliers adopt our programs more easily. I’m not sure if Steve or Michael would like to add anything.

No, I think you covered that.

Your next question will come from Steven Forbes from Guggenheim Securities.

Good morning. Niraj, could you elaborate on your comments regarding the rapid shift of demand to online platforms and the challenges in assessing overall demand growth this year? Also, I would appreciate your insights on how COVID has affected Wayfair’s online sales capture rate this year in comparison to the 35% to 38% rate we've seen over the last few years. Additionally, do you have any thoughts on the sustainability of this newly elevated capture rate moving forward?

At a fundamental level, COVID has significantly accelerated the adoption of e-commerce. We are not just seeing this trend at home, but also in categories like grocery. Once customers start shopping online, particularly in categories like home, it's unlikely they will revert to not shopping online in the future. We have observed this in our numbers, with last quarter showing a 109% growth in new customer orders. Although this quarter saw a drop to 48.7%, we have still acquired millions of new customers. As these customers continue to make repeat purchases, the share of spending we receive from them increases each year. In this quarter, repeat order growth was up 84.5%, returning to our typical pattern. We heavily market to attract customers, but once they experience our offerings—ranging from selection to customer service—they tend to return. Over time, we anticipate continued market share growth as we onboard more customers to our experience. We currently have 29 million active customers, which, while not guaranteed, behaves somewhat like an annuity if we keep enhancing their experience. These cohorts tend to spend slightly more each year. Our investments are tailored specifically for the home market, including improvements in 3D models, exclusive selections, and logistics suited for large and fragile items. We're making transactions easy and convenient for customers, which is crucial since home goods aren't just commodities that can be easily replaced elsewhere. The advantages we're creating are not immediately visible in our numbers, but they play a significant role in our growth.

And then, as a follow-up, maybe for Martin. As we look at the international segment performance and think about the investment ramp over the past couple of years and the needs going forward, any comment on how we should think about the timeline behind that margin unlock? Should it be more accelerated than what we saw here in the U.S. or should we expect it to be flattish for a time period? Any color would be appreciated.

Thank you. So, we believe that we have reached kind of critical mass with our offering in Europe. As I elaborated before, we have a few thousand suppliers across Europe. We have a few million products that we offer to customers, we have a pan-European supply chain, and we have digested these investments. So we think that we have quite some runway in terms of scaling on that. In terms of the margin ramp, we’re happy with our unit economics. They have improved nicely every year, in line with our internal predictions and more or less tracking the U.S. time shifted by a few years very closely.

And your next question will come from Brian Nagel from Oppenheimer.

Good morning. It was a strong quarter, congratulations. My first question is about the gross margin, which you both mentioned. It has clearly increased significantly, and based on your guidance for the fourth quarter, it seems likely to continue. I would like to understand what has changed since a few quarters ago when the gross margin was much lower. Additionally, I would like some clarity regarding the sales run rate you mentioned for the fourth quarter, which is at 50% due to Way Day’s impact late in the third quarter. Did the spillover from Way Day contribute to that 50%, or is it no longer a factor?

Sure. Brian, I’ll address the second part first. Consider Way Day as an event in Q3, but from an accounting perspective, some of that revenue won’t be recognized until Q4. Therefore, that revenue will appear in Q4, but in terms of demand, treat it as a Q3 event. For Q4 revenue, the 50% quarter-to-date is meant to provide transparency regarding demand. The holiday season typically has a stronger performance due to its significance. Even though demand remains high, Way Day has shown considerable volume, exceeding the general peak demand we’ve observed. We anticipate significant holiday sales, but the exact scale is uncertain as it depends on consumer behavior, such as staying home more and entertaining only close family without traveling, which could drive increased investment in home improvements. Demand has been broad-based rather than concentrated in specific product categories; people are focused on enhancing their home experience. During the holiday season, there are numerous applicable categories like seasonal décor, core furniture, and items that facilitate better home entertaining, such as ping pong tables or preparations for the outdoor season, which typically peaks starting in March. As for margins, I want to reiterate that we’ve laid out a plan for a thousand basis points improvement in gross margin, which we initially outlined several years ago. This roadmap spans multiple years, with some gains being reflected in gross margin while some will be passed on to customers in the form of benefits, enhancing repeat business. We still have a large portion of that roadmap ahead. It's difficult to pinpoint our exact position within this plan since we anticipate continuously unlocking additional opportunities that could further benefit us. However, we are currently in a phase influenced by COVID, which has introduced unique dynamics in our business. One such dynamic is the increase in volume leading to efficiency gains that positively affect gross margin, but we don’t expect these gains to sustain if demand returns to a more typical level. Michael’s guidance aims to set realistic expectations for gross margin, recognizing current gains while also indicating that some COVID-related gains may diminish. Nevertheless, there remains a wealth of opportunity ahead of us. Let me check if Michael has any additional comments on this.

Niraj, I believe you addressed it well. I just want to clarify that when we mention 50% quarter-to-date, it refers to gross revenue. It does not include Way Day, which occurred in previous quarters. Some net revenue from Way Day will appear in Q4. This is a typical scenario where revenue from the prior quarter is recognized in the following quarter. This is just part of our normal operations.

Your next question will come from John Blackledge from Cowen.

Two questions. So, Niraj and Michael, you both indicated a more drawn-out marketing message in 4Q. So, kind of expecting perhaps a longer holiday season. Are you doing anything different during the holidays, either on the promotional side and/or kind of focusing on any key categories? And then, secondly, for ad expense, as we look into next year, just given the influx of new customers this year, should there be natural kind of leverage? Understand big opportunity to add more customers, but just given the influx and the repeat is cheaper on the ad side, how should we kind of think about that? Thank you.

In terms of the holidays, we are doing things differently by introducing our Black Friday deals earlier than in previous years to provide a preview for the season. We believe that all major retailers are following this trend, allowing consumers to become aware of the holiday season sooner. We anticipate that this will help extend the holiday season, although the extent of that is still uncertain. Personally, I think it could be quite significant, but it's difficult to predict right now. Regarding ad spend, we see two key factors. First, repeat customers continue to grow and represent a larger share of our total sales, which provides leverage since repeat purchases are more economical. In fact, repeat orders reached an all-time high this past quarter at just under 72%. Although some may have noticed fluctuations in this figure previously, repeat purchases grew by 84.5% this quarter, reinforcing that growth. We are continuously working to attract new customers and we operate on a payback model, which typically spans several hundred days. This means that while we may increase our spending on advertising, it leads to acquiring a significant number of new customers. Additionally, our newer businesses, such as Germany and Perigold, are still early in their development and have a smaller repeat customer base to support their numbers. Overall, the mix of these elements drives our performance, as media costs in the market have normalized with ample demand. It’s not about a lack of inventory affecting our costs; rather, it’s the economic structure of our business that enables us to engage new customers effectively. Michael, do you have anything to add?

No. I think you covered it.

And your next question will come from Oliver Wintermantel from Evercore.

Hi. Thanks, guys. I had a question regarding the buybacks this quarter. Was that just an anomaly to offset some of the options, or should we expect to get some of buybacks in the future? Just from a capital structure, shareholder returns, what your guidance is there for the next couple of quarters?

Yes. Thanks, Oliver. It’s Michael. I think, on buybacks this quarter, it was really sort of cleaning up the remaining 2022 notes and sort of offsetting the dilution from the remaining notes that did not convert as part of the new convert deal we did in August. And then, on a going-forward basis, we’ve obviously left ourselves the room to sort of do buybacks on a go-forward basis. And I think what you should expect is, we’ll continue to be smart and thoughtful and pragmatic as we look out at our future convert maturities and make sure, as you’ve heard me say multiple times before, we want to sort of minimize the dilution impact from that borrowing. And so, I think we’ll be thoughtful about that going forward.

That brings us to the end of today’s Q&A session. I turn the call back over to our presenters for closing remarks.

Thanks everybody for calling in. We certainly appreciate your time. Have a great holiday season.

Thank you, everyone. This will conclude today’s conference call. You may now disconnect.