Wayfair Inc. Q4 FY2022 Earnings Call

Good morning, and welcome to Wayfair's Fourth Quarter 2022 Earnings Conference Call. All participants are in a listen-only mode. After the speakers' presentations, we will conduct the question and answer session. As a reminder, this conference call is being recorded. I would now like to turn the call over to James Lamb, Head of Investor Relations. Thank you. Please go ahead, sir.

Good morning, and thank you for joining us. Today, we will review our fourth quarter 2022 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 first 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 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.

Thank you, James, and good morning, everyone. It's great to reconnect with you today to share the details of Wayfair's fourth quarter 2022 results. 2022 was a challenging year for our entire industry in more ways than one. As an ambitious technology-driven company, it is a challenge to manage all facets of growth and rapidly acknowledge when the facts on the ground change in real time and make the appropriate adjustments to business plans in response. You've seen us do this several times over the past year with our cost efficiency initiatives, and we feel confident that when we look back several years from now, we will view these pivots as difficult but both necessary and wise. This morning, we published our latest shareholder letter, which I would encourage you all to read on our Investor Relations site. Steve and I walked through the evolution of our business over the past three years, explaining the ups and downs that the pandemic and its aftereffects have brought to our category and to Wayfair. We concluded with a look at the future and did so through the lens of our view around capital allocation. We hope you'll find it illuminating, especially in light of the current macro environment. Our core focus is a return to our history as a company that operates in a lean and efficient manner. We note in the letter that scarcity is actually a good thing for Wayfair. Scarcity of resources drives faster alignment, more productivity and better execution, and we are beginning to see the payoff from those efforts in our Q4 results today. We reported $3.1 billion of net revenue and 11 million orders in the fourth quarter. While we always expect a sequential revenue increase in the holiday quarter, looking at sequential order volume tells the full story: more than 25% order growth compared to Q3 is a testament to the improvements we continue to make in every part of our flywheel, which facilitates our future momentum. We had a good holiday season with gross revenue over Cyber 5 matching what we did last year. Over the Thanksgiving weekend, we sold a mattress every 9.2 seconds. So many that if we stacked them all end to end, it would reach nearly 12 miles high. Our success at the end of the year is a strong proof point that the three major principles behind our current strategy: one, driving cost efficiency; two, nailing the basics; and three, earning customer and supplier loyalty are bearing fruit in the form of market share capture. To start, let's dive deeper into how we are driving cost efficiency and the latest developments there. Our journey on the path to cost efficiency started last spring as we swiftly reacted to a changing macro environment and put a hiring freeze in place. It became clear that 2022 was diverging from our original set of expectations. In August, we made a difficult decision to part ways with nearly 10% of our corporate employee population. As we then looked at our company priorities, team composition and the cost structure in aggregate, we ultimately moved fast on a comprehensive plan covering $1.4 billion of cost actions across the entire business. Our execution on this set of initiatives led to the hard but necessary decision to eliminate 1,750 additional roles, including approximately 1,200 roles or 18% of our corporate employees across the organization last month. It's easy to get wrapped up in the financial implications of a reduction in headcount and detach from the human element. So before I discuss the savings, let me say this. Steve and I are immensely grateful to have such a talented and enthusiastic team that we work with every day. Across all of our stakeholders, our employees are the most important because without them, we cannot effectively serve any of our other partners. We want to take the opportunity once more to say to all current and former Wayfair team members: thank you. In total, our labor reductions have driven over $750 million of annualized cost savings from when we started this effort in the second quarter of 2022. On top of that, we've made considerable progress across operational cost savings initiatives which we anticipate will total more than $500 million of annualized savings once fully realized later this year. We discussed these initiatives a bit last November, where I highlighted returns monetization as one of the many areas in which we're looking to drive more efficiency. While the savings all accrued to our cost of goods sold line, these initiatives stretch across all areas of the organization. For example, we've kicked off a promising supplier transfer program, where in select cases, we choose to pass on customer calls to suppliers to utilize their strong domain expertise to diagnose and resolve customer issues directly. Suppliers can usually identify the ideal resolution, for example, sending a specific replacement part rather than needing a full replacement, more quickly than one of our service representatives, resulting in a more efficient and less costly resolution for the customer and for Wayfair. Yet another initiative is leveraging our enormous database of orders to understand the relative rate of damage and other incident risk for items based on delivery location and to factor that into the amount of exposure that items receive on our platform, lowering cost and also improving the customer experience. The final piece of our $1.4 billion of global cost actions comes from over $150 million of annualized savings against our previously planned spend. We put every element of our 2023 spending plans under the microscope in order to think more deliberately about the value we were modeling for each new dollar spent and what we expect will continue to be a challenging customer environment. The combined result is a significant reduction across many of our remaining large cost areas, most notably advertising, capital expenditures and various G&A expenses. To offer an example in the advertising realm, we typically designate portions of our marketing spend that are used for testing and iterating across new channels. This is an important part of our process to find the new breakthroughs that allow us to then scale up these new ad channels at positive ROI in the ever-evolving digital advertising landscape. However, over time, some of these test budgets have grown to a level that was disproportionately large relative to the goal of being modest test budgets. This type of prudent approach applied to all cost lines has added up to large savings. One of the most important points that I want to ensure is not missed is that across everything we are doing to drive cost efficiency in the organization, we are not sacrificing our large growth opportunities, and we're doing this while we are also lowering retail prices. We remain as excited as ever for all of the major initiatives that we are working towards including Wayfair Professional, our specialty retail brands, our luxury platform Perigold, catalog expansion efforts, physical retail stores and international markets, and how a return to our core operating philosophy will enable us to unlock these new growth vectors going forward. As confident as we are in the steps we have taken to get back to our roots, it's important to remember that the macro environment is still very uncertain. Consumer sentiment remains under pressure given the uneven state of the economy with multiple crosscurrents impacting the directions of interest rates, housing data and the mix of wallet share to services over goods. In spite of all the noise, we remain empowered by the elements of Wayfair that make us a unique and premier shopping destination for home, and as a result, the strength of our market share trajectory. Exiting 2022, we believe that we have now regained all of the share loss we experienced during the second half of 2021, driven by a myriad of factors related to our core recipe. The shareholder letter also explores this topic in more detail, but let me reiterate our belief that the key elements of availability, speed and price are responsible for our improving market share position. Coming back to our three key principles, I already touched on cost efficiency, and Kate will provide additional details on the numbers a little later. Now let's revisit the concept of nailing the basics. Inventory availability is just one example of how our offering has improved, particularly year-over-year. Exiting 2022, availability hit the highest point since the beginning of the pandemic, setting the stage to propel the rest of the flywheel. While this was primarily due to the easing of supply chain congestion and a demand slowdown in the spring of 2022, we have also driven this improvement across multiple dimensions including executing more efficient induction of goods strictly from Asia and offering improved inventory visibility within CastleGate, so suppliers can more easily track their products. To complement our in-stock position on goods, we've achieved stronger results on our speed metrics. In fact, over the course of 2022, we shaved a full day off of our average delivery speed. Tighter integration with carriers has enabled this acceleration while also helping diminish fulfillment costs. Along with other factors, the combination of better availability and faster speed helps to drive a better experience for our consumers on an everyday basis. Perigold is another area to highlight under nailing the basics as we continue to build the brand's assortment and customer reach with approximately 30% of Perigold customers new to Wayfair. We're also proud of our satisfaction scores for the brand, best measured by Net Promoter Score, now at all-time highs. Taking a higher-level view, the steady traction we have been building in this brand since its launch in late 2017 through today is a testament to our ability to effectively deploy capital back into our business. We test, iterate, and develop our Wayfair family of brands in ways to expand our opportunities while also making sure that we drive a healthy ROI. In fact, part of Perigold's success has been a growing presence within our Wayfair Professional business, which leads to our third key principle: earning customer and supplier loyalty every day. The business-to-business opportunity is a meaningful piece of the overall total addressable market in our category estimated to be nearly a couple of hundred billion dollars between North America and Western Europe. The differentiators of Wayfair's business-to-consumer platform give us unique advantages in our approach to the professional business and our ability to drive value for both customers and suppliers. Wayfair serves a wide array of customers on the professional side, ranging from interior designers to contractors, restaurants to offices to hospitality. We are focused on illustrating the full value proposition we can provide, supporting the very first steps of a project through our specialized designers as we partner a concept out of space, all the way to ensuring everything ordered arrives on site at the same time through our consolidated delivery. We're also utilizing our data science models to target leads more effectively with visible traction on prospect activations and other metrics. The result of these advances is a business that saw strong year-over-year growth in 2022 as customers increasingly rely on Wayfair Professional for the right combination of products and service. While a small base of shoppers, we saw the number of customers that spend more than $20,000 per year grow by 20% in 2022 compared to 2021. Our success within Professional is a microcosm of our mission to drive customer and supplier loyalty with opportunities for further progress across the broad Wayfair ecosystem. I want to wrap up by returning to where we started. The difficulties we faced in 2022 catalyzed several meaningful changes for Wayfair, enabling us to enter this new year as a lean execution-focused organization. 2023 will be a year of rigorous execution on the key priorities for the company, where we intend to build on the recent momentum highlighted in our Cyber 5 and January press releases. Although the short-term macroeconomic picture is unpredictable, we are optimistic in our ability to navigate the challenges based on a return to form in the core recipe and the flexibility of our business model compared to peers. And regardless of what happens on the top line, we are reaffirming our commitment to reaching adjusted EBITDA profitability soon. From there, our focus is on consistently generating and ultimately scaling positive free cash flow. Importantly, we consider these goals in the context of total shares outstanding with an emphasis on maximizing profitability and minimizing dilution. Thank you, and I'll now hand it over to Kate for a review of our financials.

Thanks, Niraj, and good morning, everyone. Before we take a look at our fourth quarter results, I want to take a moment to echo something Niraj said. We are tremendously grateful that so many talented and driven individuals share our vision for creating the world's best place to shop for the home. And so to everyone on the team, I want to say thank you as well. Now let's dive into the fourth quarter results, after which, I'll walk through the cost savings measures that Niraj discussed earlier in more financial detail before wrapping up with guidance and closing remarks. Net revenue for the fourth quarter of 2022 was $3.1 billion, down 5% year-over-year, but up 9% sequentially from the third quarter. This was slightly better than we had anticipated when we spoke last November. Earlier, Niraj highlighted the strength in order volume we saw with 11 million orders, up more than 25% from Q3 more than offsetting a decline in AOV of 13% from last quarter. We're very excited to see inflationary pressures reverting and order volume reacting positively as expected. Customers continue to show strong response to promotions, and we had a robust holiday calendar, starting with our second Way Day in October going all the way through the new year. The fourth quarter saw the trends between our U.S. and international segments stay largely consistent with what we observed during Q3, which was an improvement in comparison to the first half of the year. Net revenue in the U.S. outperformed the aggregate and was only down 2% compared to Q4 of 2021, while international was down 20% against last year as the macro pressure continues to weigh more heavily outside of the United States. 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. We saw another strong quarter on the gross profit line with gross margins of 28.9%, coming in at the high end of our guided range. The drivers here remain largely unchanged from last quarter, with more favorability in the transportation environment and strong levels of CastleGate penetration working to our advantage. In fact, we ended 2022 with considerably more suppliers leveraging CastleGate than we had at the end of 2021. As we saw for several quarters this year, our strength on the gross margin line persisted even in the presence of a considerably more promotional environment as suppliers continue to work through inventory stockpiles. Customer service and merchant fees were 5% of net revenue. Advertising came in at 13.1% of net revenue. As we've discussed at length in prior calls, the advertising margin continues to be pressured by lower free and direct traffic. While this will recover as a function of the macro, we remain steadfast behind the efficiency targets that drive every dollar that we spent here. Finally, our selling, operations, technology, general and administrative expenses totaled $508 million. You are now seeing the full impact of the cost efficiency actions we took in the second half of 2022 manifest. And as you know well, there is considerably more that we've done since. All combined, our Q4 adjusted EBITDA came in at negative $71 million or negative 2.3% of net revenue. You've heard us talk at length about the path to profitability as we look to get back to positive adjusted EBITDA and ultimately, free cash flow. It's worth calling out that we showed positive adjusted EBITDA in our U.S. segment of $11 million for the fourth quarter. We ended the year with $1.3 billion of cash and highly liquid investments on our balance sheet and $1.8 billion of total liquidity, including our revolving credit facility. Net cash from operations was a positive $98 million, while capital expenditures were $117 million, resulting in free cash flow during the quarter of negative $19 million. During our third quarter call, we discussed how the working capital dynamics of our business would lead to a cash inflow during the quarter with sequential revenue growth, and we saw that play out in our net working capital line items during Q4. Now before I turn to guidance, I want to spend a moment walking through some of the cost savings initiatives that we announced last month and what you can expect from a financial perspective. Starting with the labor savings, we have now taken action to drive approximately $750 million of annualized total savings compared to our baseline period of Q2 last year. $450 million of this came as a function of the workforce reduction in January. While the majority of those cost benefits will occur in Q1 of 2023, you'll see this fully manifest on the P&L by the second quarter of 2023. Across that annualized $450 million bucket, about $290 million is related to cash compensation that impacts the customer service line and our SOTG&A line compared to where we ended 2022. The remainder are reductions to steady-state equity-based compensation. Turning to the operational cost efforts, as we've mentioned several times, these savings will ultimately come in the form of reductions to our cost of goods sold line. Last quarter, we talked about $200 million of annualized opportunity here, but previewed that there were several hundred million more in total savings that we are working toward on top of that. As part of the announcement in January, you saw that we have now grown that figure to $500 million of annualized savings here, all as part of the initiatives Niraj touched on earlier. While these savings will build over the course of 2023, we intend to reinvest a healthy portion back into the customer experience in the form of merchandising investments. The exact mix will be a function of the macro environment that we see play out over the course of the year. The end result of all the actions we've taken so far is to pull up our timetable in reaching adjusted EBITDA breakeven as the first step on the path to a self-funded state. You can see this path clearly laid out as part of a new slide in our refreshed investor presentation. As we started to map out this journey last August, we said that we'd be profitable by Q4 of 2023 at the latest. With the actions we've taken in January, we feel confident we'll reach this goal earlier than originally planned. And while we believe we have taken the necessary steps to deliver on this commitment, we are prepared to take additional actions depending on the state of the macro environment. Now let's turn to guidance for the first quarter. Quarter-to-date gross revenue has been trending down about 10% year-over-year. However, we are seeing a return to traditional seasonality in the core business, and we expect net revenue to end the quarter down in the high single digit. On gross margins, we continue to guide you to the 28% to 29% range that we used for Q4. We expect customer service and merchant fees to be around 5% of net revenue and advertising to be 12% to 13% for the first quarter. This guidance mirrors what we said in Q4 as we largely see the same drivers impacting these lines right now. We forecast SOTG&A or OpEx, excluding equity-based compensation, related taxes and restructuring charges, to come in between $475 million and $485 million for the first quarter. You're seeing the majority of the labor cost savings flow during Q1, and the entire value will manifest in the Q2 SOTG&A figure. If you follow through the guidance I've just outlined, that should translate to adjusted EBITDA margins in the negative low single digits for the first quarter. While we don't guide on free cash flow, I thought it would be helpful to offer a reminder around the working capital dynamics for our business. Our negative cash conversion cycle means that in quarters where revenue grows sequentially, working capital proves to be a source of cash and vice versa for revenue declines from the prior period. As with normal seasonality, this Q1 is poised to be down sequentially from Q4, so we would expect working capital to become a use of cash this period. As many of you know, the seasonality of our business typically shows sequential growth starting in Q2. So we would expect working capital to become a source of cash as we get further into the year. Now let me touch on a few housekeeping items for Q1. Please assume the following: equity-based compensation related taxes of $145 million to $155 million, depreciation and amortization of approximately $102 million to $107 million, net interest expense of approximately $4 million, weighted average shares outstanding equal to approximately $111 million and CapEx in a $90 million to $100 million range. As I wrap up, I wanted to take a moment to highlight something Niraj and Steve included in their shareholder letter. Investors often ask us about our views on return on investment, especially in an environment where capital is much less readily available than it was just a few years ago. To sum up our response, a core part of our organizational DNA is taking a deliberate, considered approach to every dollar we spend across the company. And you see it as manifest in the improvement to unit economics that we've seen over the past several years. We have confidence in our ability to reach breakeven adjusted EBITDA margins, to aggressively ramp to a mid-single-digit adjusted EBITDA range which we view as a philosophical floor and then continue to our target beyond 10% because of this very DNA and the team operating behind it. Above all, we are measuring our success by growing free cash flow while at the same time, limiting and ultimately offsetting dilution. Thank you. And now Niraj, Steve, and I will take your questions.

Our first question comes from Christopher Horvers from JPM. Please go ahead. Your line is open.

My first question is about the top line. You're currently in a better position with improved inventory levels compared to a year ago as the supply chain has become more manageable. Can you discuss when you expect to start comparing those numbers? Additionally, looking at the bigger picture, can you give guidance for the year regarding sales? How are you approaching it? Are you considering historical seasonality as you project for the first quarter?

Yes. Chris, thanks for the question. This is Niraj. So a couple of thoughts on that. First, we are seeing the traditional seasonal cadence playing out so far, not just at the start of this year, but the shape of Q4 into Q1. In that sense, we do feel like there is a trend there. But to take a step back to answer your question, where you started about the top line relative to availability getting better. Remember the timeline on that. Availability got poor starting in '21 based on the production shutdowns and the supply chain congestion, et cetera. It's got better starting in the spring of '22. So in spring of '22 availability gets good. In fact, supply chain eases up to where some suppliers have ample availability. Then in the summer, the speed of delivery gets better because suppliers are positioning goods to maximize sales. By the time you get to the fall, retail prices improve because the inflation that we particularly got hit with has abated. When you look at this year, think about the comps; if you're doing it year-over-year, we're in a period where last year, we had elevated demand. The first part of the year had elevated demand. This was the time of Omicron last year, et cetera. So we're comping against that. Now we're in the first half of last year, where you see that elevated demand come out of the market, then you see it normalize in the second half. We typically don’t start by looking year-over-year; we look at it seasonally. That's why the shape of Q4 into Q2 with December into January and January into February is meaningful for us. What we're seeing is demand holding up quite nicely compared to that seasonal pattern. This is what we thought and saw last year. However, last year, as I mentioned, it weakened in the spring, which we didn't foresee. In our case, we were able to use that to get the recipe back intact, which is why we started taking share starting in Q4. Ever since then, we're seeing a nice tight kind of seasonal pattern holding. Modestly, we’re excited about that. That is what we're seeing right now. On the profitability point, we feel like we can achieve profitability in a range of outcomes, so we're pretty happy about that as well.

I have a follow-up regarding SOTG&A. You mentioned the range of $475 million to $485 million, and that we would see the full run rate in the second quarter. Can you tell me how much is remaining and how you view the run rate moving past the first quarter?

Yes. Kate, would you like to address that?

Yes. I think it's important to remember that, that savings we talked about seeing on the SOTG&A line, we also expect to see some of that through the customer service and merchant fee lines. We took headcount out of both of those cost buckets. The majority of that actually flowed through in Q1. As a reminder, January 20th was the date of our layoffs, so think about a little more than two-thirds of that quarter did not have the cost of those folks in it. So you'll see the entirety in Q2, but the majority of it will already be hitting in Q1 as is in that guide. The other thing I would note is that when you look at SOTG&A, about half of that is related to compensation costs. What we're talking about here. The remainder are things like software costs and travel and entertainment. There are some other puts and takes there that you could see in the other cost buckets on that line item as you look at Q1 and Q2.

Our next question comes from Curtis Nagle from Bank of America. Please go ahead. Your line is open.

Great. Just wanted to quickly focus on the COGS line. So that will take just a little bit longer to flow through because it's operational stuff. Just one, I just wanted to make sure I heard this correctly that the $500 million gross cuts will be realized by the end of the year? And I guess, number two, could you give a little more detail in terms of the extent of the reinvestment? And let's just say things from a macro perspective kind of stay where they are, would that equate to something like 50% reinvestment? Or what's the framework there?

Sure, thanks for the question. I'll share some thoughts, and then Kate can add more insights. There are significant operational cost savings that we've identified, which are very realistic, with projects currently in progress aimed at reducing waste without affecting the experience of suppliers or customers. This is a major advantage. If we choose to pass these savings on, it results in lower retail prices. However, if we retain them, it contributes to profit. As we mentioned, we've identified over $500 million in potential savings, which is substantial, and we are quite enthusiastic about it. We haven't decided in advance how to distribute these savings. It's one of the many tools we use to manage the business. The progress in identifying these costs is going very well, but there isn't a definite answer on how we will implement this. Kate, do you have anything else to add?

I think that's fair. I guess I would add a few points. We've seen gross margin improve nicely throughout the course of the past year, and we do expect to continue to build on some of those gains. We want to hold this back as an operating lever for us, which gives us a fair amount of flexibility in this environment, which is an advantage. We will make the decision iteratively throughout the year as we see opportunities to invest in the customer experience, we can use it that way. If we see an opportunity to flow through, we can use it that way. But irrespective of that, you've seen nice improvement in gross margin in 2022, and you should expect to see some of that in 2023 as well.

Our next question comes from Ygal Arounian from Citigroup. Please go ahead. Your line is open.

I want to discuss the macro environment in more detail, particularly the trends between the U.S. and Europe. I recognize that Europe faces more challenges at the moment, but how can we interpret the positive factors emerging in the U.S.? Additionally, how can we build on that moving forward? We've mentioned the impact of promotional activity during the holidays. Is that still a significant factor, and how should we consider it?

Sure. Let me field that, and I don't know if Kate or Steve want to chime in. The international segment, in the way we report is everything outside the United States, so that also includes Canada. But I'd say Canada is in the same situation as the U.K. and Germany, where the macro is significantly more difficult and challenged than in the United States. In addition to that, the comp — so the elevated demand was heightened in those countries in the first half of last year relative to how the U.S. was heightened. So they're all heightened, but to different degrees. So there's a normalization period that you need to go through before you get to normalized comps in the back half, where the shape of the curve looks a little different in those different countries for the first half of the year. So it's important to highlight that. Next thing is on the inflation, the inflation that came into goods: some was raw materials, some was labor, and a lot of it was ocean freight. What's happened is it's clear that ocean freight has substantially reversed. For replenishment costs, it's significantly lower for suppliers than the cost basis they brought goods in at last year. They're dropping wholesales to maximize those margins. The U.S. trajectory for prices is not increasing; it follows the shape of the curve down. In Canada, the U.K., and Germany, the storyline is a little different where cost of energy is involved and the foreign exchange costs, because goods coming out of Asia are denominated in U.S. dollars. Those factors have eroded a lot of ocean freight savings. There’s less savings on replenishment costs than there is in the U.S. The curve on costing coming down also being slower, so those dynamics make the macro environment in this country slower to play out than in the U.S. On your point about promotional environment, I encourage you to think about that as more of a marketing phenomenon than a margin phenomenon, which you see in our gross margin. Suppliers have had an excessive amount of goods; they know that they can bring in goods at a much lower price which helps them win share. We’re seeing that reflected in our order count as a proxy for engaged customers. Overall, the recipe being intact and everything we’re doing to lead in customer value is working.

A quick follow-up. Kate, we're pulling a lot of costs out of the system here. I want to dig into your comments that you're prepared to take additional actions depending on the environment, but how you think about where your cost profile is now versus where it might be? Where else is there room left to pull some levers if you decide to do that?

Yes. We feel very good about our current cost cutting. We've taken out about $1.4 billion of costs out of the business — actually over $1.4 billion. As we've done that, we've looked across every line item of the P&L, and from our gross margin line all the way down to our SOTG&A line. What we've tried to do and I think we’ve been thoughtful about is removing places where we were inefficient. You heard Niraj speak about this. We've taken out management layers. We've taken out places where teams were focused on lower order priorities. We have not impacted any of our growth vectors, which is very important to underscore. In an environment where you see a need to cut further, I think that will come in the form of sequencing. Right now, our work has all been around improving efficiency, and we're excited about gains we believe we'll get from that improvement. I don’t know, Niraj, if you have anything else to add.

The only thing I would add is that the decisions we've already made and the actions we've taken actually get us to our profitability and free cash flow goals in a wide range of revenue outcomes already. So I wouldn't say we've underwritten a sort of bullish case that needs to play out on the top line to get there. We feel very good about where we sit.

Our next question comes from Atul Maheswari from UBS. Please go ahead. Your line is open.

Thank you. The reason why you're not providing a firm timeline on EBITDA breakeven, whether it's in the second quarter or third quarter, is that you're providing that because there is a lot of uncertainty in the macro, so you don't know how your top line is going to play out? Or are there other moving pieces that could move this timing out?

While there are always moving pieces, I think we have a pretty firm view of how it will play out. We've just stuck with our traditional stance for 8 years now of really not trying to provide a lot in the way of guidance. We comment on the current quarter and focus on sharing where we're headed, the trajectory, the decisions we're making, and the priorities we have. We're not trying to spend a lot of time providing guidance on quarters because we believe it’s better to focus on how the business will play out over time.

Yes, Atul, this is Kate. I want to emphasize that we are confident in reaching adjusted EBITDA breakeven. We are concentrating on our cost items. Clearly, revenue could play a significant role, but even without it, we are dedicated to achieving this goal sooner than we previously indicated during the Q3 call in November. We are reiterating what we stated in our press release in January.

And then just a quick one on free cash flow. You've reiterated that the EBITDA breakeven is going to be earlier than the fourth quarter. Should we expect free cash flow to be positive by at least the fourth quarter?

So again, we don't guide on free cash flow, but let me give you a few thoughts on that which may help how you frame your thinking. First, I'd point you to this quarter, where we were essentially free cash flow breakeven, down only about $19 million. Some of that is due to the working capital seasonality of our business. We operate on a negative working capital cycle. In sequential revenue growth quarters, working capital will be a source of cash. In this Q1, which is historically a period of sequential revenue decline, working capital will become a use of cash once again. As you model out a year, consider both the working capital dynamics and how those may play out based on our traditional seasonality and the work we're doing to aggressively manage operating cash flow while managing down those costs. So I would think about those two factors together when considering free cash flow going forward.

Our next question comes from Seth Basham from Wedbush Securities. Please go ahead. Your line is open.

Thanks a lot, and good morning. There's still nice improvement in orders per customer, but we're also seeing still elevated customer churn. How are you thinking about customer churn rates in 2023 relative to the last couple of quarters here in '22?

Yes, Seth, thanks for the question. We're actually seeing very nice traction with our customers. Order count will be your proxy for customers being engaged where folks are basically buying. An order is the best proxy for a future order. Currently, when the recipe was not intact, it was less compelling for customers to return. Now the recipe is back intact. Availability improved in the spring last year. Speed improved in the summer. Retail prices improved in the fall. You've seen in the fourth quarter, customer count and order count grow. That is a trajectory continuing. If you play that out over time, you will see the numbers go in the direction we want them to go.

I would clarify one thing, Seth. I think you're looking at our active customer count. As a reminder, that's a last twelve months figure. What you'll see happen is customers cycle out as we anniversary some of those COVID periods that were still elevated in the past 12 months. You're seeing declines moderate in the fourth quarter, and that is part of the elevated order counts. We also disclosed a statistic in our investor presentation which we updated today, building on our total customer file of customers that have ever purchased from us at being $80 million strong, our email lists are far greater than that. We continue to see this as a source of strength: particularly in an environment where first-party marketing becomes important, we can reacquire customers from this group. That active customer number is a little tricky in terms of an LTM figure.

We think there's actually a lot of folks we have not yet captured, because remember, that $80 million includes not just households or consumers, it includes B2B customers and our Wayfair Professional business, which leads to opportunities across our geographies and verticals.

Our next question comes from Steven Forbes from Guggenheim Partners. Please go ahead. Your line is open.

I wanted to start with international profitability. I'm curious if you could reframe how you're thinking about the near-term and medium-term opportunity for free cash flow needs to support those initiatives. Also, Kate, if you can help us frame how the cost actions impact the segment disclosures, in essence, as we think about international profitability into the first quarter.

Yes. The way to think about that — so first of all, the international segment is the compilation of Canada, Germany, and the U.K. Those three countries are at different stages of maturity. Canada is the most mature household brand, significant penetration there. The U.K. is in second place with very nice penetration, not quite as high as Canada. Germany is the least mature — not quite a household brand at this stage. Each of those countries is in a different macroeconomic environment. However, all three are more challenged than the U.S. In addition to the comp, the elevated demand was heightened last year in the first half. So the normalization period needs to happen before we get to normalized comps in the back half, where the shape of the curve looks a little different for the different countries in the first half. The trajectory on international profitability for each of those countries has a nice path to get there. Regarding the cost cutting, those actions reflect across our entire portfolio of brands and geographies. It wasn't exclusive to any particular one. So costs cut also apply in Europe.

When you think about cost savings, you should think about them as being broad-based. We're scrutinizing every area of the business. The cost cuts that we're talking about also apply to our European business and our international portfolio as a whole.

Maybe just a quick follow-up on Seth's question. I took you guys putting that slide in there in the presentation — the customer file of $80 million. I'm not sure if you're trying to indicate something, but maybe Niraj, you can speak to your reactivation efforts of the lapsed customer base? Most importantly, as we think about that LTM number that gets disclosed, have we reached a point where you can predict or foresee internally the return to active customer growth as that disclosure is defined?

A few thoughts. First, regarding the LTM number — if you believe that order count and the recipe being intact have turned — and take a full 12 months before that number reflects a full year's worth. Second, keep in mind, the definition of active customers includes those who bought in the last 12 months. There are different levels of engagement; some have not shown up at all, while others visit regularly. Hence, there were 3 billion visits last year. If you divide the active customer number by visit number, you'd get an incredibly high number of visits per customer, meaning many have visited who haven't yet bought. The conclusion would be that there's a lot of other customers getting more engaged and coming behind them. We’re focused on reactivation, especially in light of the unusual shape during the COVID period with spikes. However, we believe the recipe is back intact, and you're seeing success reflected in that in our metrics.

Our next question comes from Anna Andreeva from Needham. Please go ahead. Your line is open.

We wanted to follow up on the guidance. You said you're seeing normal seasonality but the 1Q guide implies a trend that's below the historic seasonality for the business. So should we take away that January perhaps started off slow, but the trend has improved in February? Any comment on how President's Day laid out for the business?

Let me answer a couple of thoughts, and then I'll let Kate opine. If you look at the year, if you forget about what happened last year, you're seeing a very nice seasonal pattern strong since the beginning of the year. If you compare it year-over-year, the percentages shift, not because of this year but the shape of the COVID-related excess demand, such as Omicron’s spike last year. But from a predictive standpoint, traditional seasonal cadence tells you more than the Omicron calculations. March usually marks the outdoor season for us, guiding a pickup. We also had a very positive outcome during President's Day, which saw success.

I would just point out that we described seasonality in our core business, particularly in our U.S. Wayfair business. As you think about our U.S. business, the outdoor season starts up in March, guiding that pickup we're seeing. That’s how we end up at the guide of negative high single digits versus where we are quarter-to-date.

Additionally, we were very happy with President's Day, so that did go well.

Our next question comes from John Blackledge from Cowen. Please go ahead. Your line is open.

Two questions. The ad expense as a percentage of revenue has been elevated the last few quarters and into 1Q as well. What are the drivers? How should that track over the course of the year? And could you discuss the key drivers of the market share gains in Q4? Do you think you're holding those share gains thus far in Q1? What would it take for Wayfair to get back to the pre-COVID incremental market share gains, which at times, I think you disclosed were as high as 20% or 30%?

Thanks, John. On your first question about ad costs, I believe you're looking at ACR as a percentage of revenue. The best way to think about that is that percentage reflects free traffic, which has zero cost — folks coming directly to Wayfair via app, website or email — versus paid traffic, which includes paid media spend. In periods of time where the category is less top-of-mind since last summer, demand easing has shifted discretionary spending to travel, leisure, and entertainment. This results in this category being below trend since demand has eased. You will see the ACR improve as we cut out speculative ad spend, as referenced in the $1.4 billion total cost actions. However, free traffic as a proxy for recovery will be crucial. So you’ll see ACR improve, but it’s dependent on how the category captures attention. Lastly, the market share gained in Q4 isn't just a one-time gain but is an ongoing effort aided by our loyal supplier partnerships.

No, I think that covers it. And I think that was our last question.

We are out of time for questions today. I would like to turn the call back over to the Wayfair team for closing remarks.

Thanks, everybody. I'll endeavor to have my voice back for the next call. And thank you all for joining today.

Thanks all.

Thanks.

This concludes today's conference call. Thank you for your participation. You may now disconnect.