Good morning. My name is Dennis, and I will be your conference operator today. I would like to welcome everyone to the Wayfair Second Quarter 2023 Earnings Release and Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. I would now like to turn the conference over to James Lamb, Head of Investor Relations. Please go ahead.

Good morning, and thank you for joining us. Today, we will review our second quarter 2023 results. With me are Niraj Shah, Co-Founder, Chief Executive Officer and Co-Chairman; Steve Conine, Co-Founder and Co-Chairman; and Kate Gulliver, Chief Financial Officer and Chief Administrative Officer. We will all be available for Q&A following today's prepared remarks. I would like to remind you that our call today will consist of forward-looking statements, including, but not limited to, those regarding our future prospects, business strategies, industry trends and our financial performance, including guidance for the third quarter of 2023. All forward-looking statements made on today's call are based on information available to us as of today's date. We cannot guarantee that any forward-looking statements will be accurate, although we believe that we have been reasonable in our expectations and assumptions. Our 10-K for 2022, our 10-Q for this quarter and our subsequent SEC filings identify certain factors that could cause the company's actual results to differ materially from those projected in any forward-looking statements made today. Except as required by law, we undertake no obligation to publicly update or revise any of these statements whether as a result of any new information, future events or otherwise. Also, please note that during this call, we will discuss certain non-GAAP financial measures, as we review the company's performance, including adjusted EBITDA, adjusted EBITDA margin and free cash flow. These non-GAAP financial measures should not be considered replacements for and should be read together with GAAP results. Please refer to the Investor Relations section of our website to obtain a copy of our earnings release and investor presentation, which contain descriptions of our non-GAAP financial measures and reconciliations of non-GAAP measures to the nearest comparable GAAP measures. This call is being recorded, and a webcast will be available for replay on our IR website. I would now like to turn the call over to Niraj.

Thanks, James, and good morning, everyone. We're excited to reconnect with you today to share the details of our second quarter results. Last year, we laid out a plan to strengthen our business that included a path to sustainable and growing profitability with several key milestones. For the past few quarters, you've seen us execute against that plan to lower our costs, focus on the basics and earn more customer and supplier loyalty. And you've seen the tangible impact of this plan as our performance has continued to improve. I'm pleased to share today that we've passed one of our key milestones and are reporting positive adjusted EBITDA and positive free cash flow. This is in combination with a return to momentum in our top-line with positive year-over-year order growth and sequentially higher active customer count, all while investing into initiatives for future growth. This is how we ran the business for our first decade and how we'll continue to do so going forward, profitable, while investing for growth. We think we are now in a very exciting place, having scale, while remaining ambitious and entrepreneurial. We plan to take full advantage of this. Our work over the past year to drive more than $1 billion of run rate savings in our cost structure is playing out across our entire P&L, enabling our accelerated return to positive adjusted EBITDA and comes in tandem with our efforts to see improvement in our top level KPIs. Order growth is the leading indicator of our other major KPIs. Even as average order values normalize towards pre-COVID levels due to deflation, we expect to see net revenue return to positive year-over-year growth in the third quarter as our active customer count continues to climb sequentially. We're going to handle this earnings call in a slightly different format than usual because, as many of you know, next week, we will be hosting our first Investor Day. We'd encourage all of our investors to tune into the live stream, which will begin at 01:00 p.m. Eastern Time on Thursday, August 10th. We'll be using this as an opportunity to introduce you to more members of our leadership team, dive deeper into the core pillars of our business and take you through the major growth initiatives for the years ahead. Through that lens, today, we're going to keep our prepared remarks concise to leave more time for questions about this quarter's results that we can turn our full attention to our long-term strategy and key growth drivers next week. Now let me give you a view of where our business stands as we move through the summer. Q2 proved to be a quarter of two continuing themes for Wayfair, share capture and cost efficiency. I'll start with the share capture piece and the results really speak for themselves. Wayfair meaningfully outperformed the competition this spring with net revenue down 3% year-over-year in Q2 compared to a category that continues to be down 10% to 20% for widely tracked estimates in credit card and email receipt data. Our team spent significant time at various trade shows over the past few months, and we have heard resounding feedback from our suppliers that the platform they want to lean into is Wayfair. Benefits of our enormous marketing reach, considerable merchandising investments and proprietary logistics capabilities make Wayfair an unparalleled partner to our suppliers. Since last fall, we have seen strong market share capture on the back of our core recipe. The combination of broad availability, fast delivery and sharp pricing continues to be a powerful flywheel to drive both customer and supplier engagement. And across the board, we're setting new benchmarks on these metrics. Availability and speed badging continue to climb in Q2. And with further wholesale cost normalization as well as our operational cost savings efforts, we now consistently see ourselves as a price leader across our most popular items. Our recipe is back intact. We've been extremely encouraged by the recent data we're seeing on customer behavior with a noticeable upswing across all of our customer cohorts and sequential growth in our active customer count. It's crucial to know that this improvement in order momentum is not a function of isolated success in any particular class or with a specific group of shoppers, but it's been broad-based across both our customer file and our catalog. We see this as an important point of validation for our customer acquisition strategy, which looks to build lifetime shoppers to make Wayfair a core part of their shopping habits. We approach earning customer loyalty through many vectors. Our work around promotions is a great example. In this environment, our promotional activity is a marketing lever that piques customer curiosity and draws them to visit. Once on the site, they purchase a variety of promoted and non-promoted products. In fact, during sale events in the second quarter, non-featured items drove over two-thirds of our gross revenue. And it's worth noting that in our customer survey work, we've seen no change to the share of shoppers that indicated they would only shop Wayfair during a sale. As we do across every facet of the business, we're continuously testing these levers, measuring the results and iterating. For example, earlier this summer, we ran a series of promotions to encourage shoppers to use our app, and we saw a remarkable engagement. Mobile app revenue had its largest ever share, and we saw App Store rankings reach the highest they have been since the pandemic due to significant lifts in downloads. This is just one exciting way we're growing engagement with our app, free loyalty and free traffic driver. At the outset, I mentioned two themes for this quarter, share capture and cost efficiency. And we've talked at length about share capture and the major driving factors. I want to touch on cost efficiency briefly before passing it over to Kate, who will talk through this theme in more detail. The second quarter saw gross margins exceed 30%, a milestone we've only previously accomplished during the peak pandemic period of 2020. Unlike three years ago, the improvement in gross margin and its impact on our unit economics is durable, driven by the considerable work our team has done to execute across the set of more than 70 operational cost savings initiatives that we've talked about in recent quarters. Moving back to where we started. This highlights a key point from our shareholder letter. Wayfair is at the stage where we can both invest for growth, while demonstrating considerable and improving profitability. Q2 was a quarter where we were able to achieve adjusted EBITDA margins of over 4%, while also leading into growth initiatives. I'm excited to talk more about our ongoing growth opportunities at our Investor Day next week. We continue to lean into physical retail, including opening two stores this summer to invest into our international business and to pursue new technologies like Generative AI to name just a few areas. You will hear a focus on the opportunity ahead for growth as well as a continued commitment to operational discipline and expanding profitability directly from the senior leadership team that's driving us there every day. Thank you. And with that, let me turn it over to Kate for a review of our financials for the quarter.

Thank you, Niraj, and good morning, everyone. We've got a lot of exciting progress to report from this quarter, so let's jump into it. Net revenue for the quarter came in at $3.2 billion, down 3.4% year-over-year, but up 14.3% from Q1, following a more traditional seasonal pattern. While we had a slow start to the spring weather, the outdoor shopping season picked up rapidly as we move through the back part of the quarter, and we saw both customers and suppliers leaning into several well-received promotional events. Niraj spoke at length about the growth we saw in order volume, both year-over-year and quarter-over-quarter, which came in conjunction with continued deflation in AOV as we lap some of the peak periods of inflation last year. The top-line success we saw in Q2 was driven in large part by the U.S. segment, which saw net revenue come in 15.3% higher than Q1. I'll now move further down the P&L. As I do, please note that the remaining financials include depreciation and amortization, but exclude equity-based compensation, related taxes and other adjustments. I will use the same basis when discussing our outlook as well. Gross margin had an outstanding quarter, coming in at 31.1%. This is the highest gross margin we've ever printed as a business. And as Niraj discussed comes not from an unusual surge in demand, but from structural improvements we've been driving across our operations. We're pleased with the results our operational cost savings initiatives have produced so far, but do want to note that this quarter exceeded even our own expectations with some timing benefits flowing through in the period. It's worth reiterating that we have been thoughtful about the share of these savings and reinvest in the top line as we navigate the consumer environment and we'll continue to take a very tactical and dynamic approach to balancing this mix through the remainder of 2023. Before moving to advertising, I'll quickly mention customer service and merchant fees, which showed nice leverage this quarter coming in at 4.3% of net revenue, a reflection of our cost reduction efforts from earlier in the year. Advertising had another strong quarter at 11.1% of net revenue for the period. As we've discussed at length over many quarters, we are being prudent about driving higher efficiency from our paid channels in the face of depressed free and direct traffic. One of the ways we can improve our efficiency is through channel tests, and we ran several in the second quarter. These tests provide key insights and former channel mix going forward. They also drove outperformance on the advertising line in Q2 and will correspondingly leave some revenue on the table for the third quarter as we held back spending in various channel segments. This is a perfect example of the sophistication we bring to advertising, which is one of the areas we'll focus on during our Investor Day next week. You can look forward to a much deeper dive into how we think about managing our channel mix and efficiency targets as part of that event. Finally, our selling, operations, technology, general and administrative expenses totaled $473 million in the period. While we are seeing nice quarter-on-quarter progress in this line item and significant year-over-year reduction as a result of our cost actions over the past 12 months, we continue to monitor this cost area closely. This quarter, we did see some lower-than-anticipated attrition. While there are some near-term headwinds on the whole, this is something we're pleased with. We've seen considerable excitement among our team members in the past few months as the success we've had with our customers and suppliers resonate throughout the business. In total, the revenue strength in conjunction with the considerable cost actions we've taken across our entire P&L led to adjusted EBITDA of $128 million for the second quarter, a 4% margin on net revenue. Our U.S. segment saw adjusted EBITDA come in at $161 million for a 5.8% margin while international losses showed further compression to negative $33 million of adjusted EBITDA. We ended the quarter with $1.3 billion of cash and highly liquid investments on our balance sheet, and over $1.8 billion of total liquidity when including our revolving credit facility capacity. Net cash from operations was $217 million, offset by $89 million of capital expenditures, which resulted in free cash flow of $128 million for the quarter. We're thrilled with this progress. As you know, our free cash flow is driven by 3 components: adjusted EBITDA, working capital and CapEx. Adjusted EBITDA was a strong contributor this quarter as was working capital, we saw a healthy sequential revenue growth, which is a driver of cash flow to our business given our negative cash conversion cycle. I'll get into guidance momentarily, but in the lens of typical seasonality, we would not expect working capital to contribute meaningfully to cash flow in the third quarter. Let's now turn to guidance for Q3. Quarter-to-date gross revenue has been trending positive low single digits year-over-year, and we would expect net revenue growth in the mid-single digits for the full quarter, in part, weighed by the impact of the advertising channel test I mentioned previously. As we've shared before, we intend to continue to invest some of our cost savings in the customer experience as we maximize multi-quarter gross profit dollars. Therefore, we expect gross margins between 29.5% to 30.5% for the quarter as we balance the ongoing structural improvements in gross margin and optimize for investment into the customer experience. Moving on to customer service and merchant fees, this line should once again be between 4% and 5% of net revenue. We would expect advertising to be between 11.5% and 12.5% of net revenue, a bit above Q2 given the factors I mentioned before around our testing cadence in the early summer and our continued efforts to drive efficiency across our channel mix. We forecast SOTG&A or OpEx, excluding equity-based compensation and related taxes to come in between $460 million and $470 million, this largely follows the trajectory we laid out last quarter, adjusted for the timing impact of the lower attrition rates in the second quarter. If you follow the guidance outlined above, we would expect to have positive adjusted EBITDA margin in the low single-digit range for Q3. This implies the third quarter margin slightly lower than Q2, given the overperformance on gross margin advertising in the quarter, which shows a clear trajectory towards a sustainable mid single-digit adjusted EBITDA margin and positive free cash flow we've outlined in the past. To that last point, you should expect the more modest EBITDA dollars in Q3 and some sequential compression on net revenue translates to a free cash flow figure that is roughly breakeven, plus or minus. Now let me touch on a few housekeeping items for the third quarter. Please assume the following: equity-based compensation and related taxes of roughly $150 million to $170 million. Depreciation and amortization of approximately $102 million to $107 million, net interest expense of approximately $5 million to $6 million, weighted average shares outstanding of approximately $116 million and CapEx in an $80 million to $90 million range. As I wrap up, I want to take a moment to recognize how far we've come. A year ago, we first discussed the shape of what our path to profitability would look like and messaged a plan for breakeven adjusted EBITDA by the end of 2023. Today, we've achieved that goal driving over $1.4 billion of cost actions across the business to reach our profitability milestone months earlier than planned. Last August, we reported an adjusted EBITDA loss of $108 million. This quarter, on a revenue basis, that is approximately 3% smaller, we've driven $128 million of positive adjusted EBITDA. Of course, our tremendous progress wouldn't be possible without the dedication and commitment of everyone on the Wayfair team. We're thrilled to introduce you to the leaders of that team next week at our Investor Day and showcase everything that makes Wayfair special. As we've outlined before, we remain committed to driving meaningful growth while improving profitability and free cash flow generation and are excited about the future. Thank you. And now Niraj, Steve, and I will take your questions.

The first question is from Christopher Horvers with JPMorgan. Please go ahead.

Thanks and good morning, everybody. So my first question is, as you think about the promotionality that you had in the first half of the year, we get a lot of questions on whether that promotionality is driving any sort of unsustainable market share gains. Can you talk about that, especially in the context of how you're thinking about balancing some of the gross margin investment versus the outperformance that you saw in the second quarter?

Sure, Chris. Thanks for the question and good morning. On promotions, I think the way that think about it as promotions are really more a marketing message than like a pricing strategy when you think about like your comment about being unsustainable. So the way I think to think about it is in this period where promotions have been a more frequent occurrence. The bulk of the volume is still not the items on promotion, just like it is in a normal time where the promotional cadence is a little less strong and the difference in the frequency of promotions is less about needing the discount to drive volume, a little more about the marketing messages resonate with the customers. So when you think about sustainability, we think the momentum we have in the business is very sustainable. And we also think that prices as we kind of get to a fully normal environment will actually be lower than they are today, because the inflation that's coming out still has a little ways to go before it's fully out. And so when you kind of think about from a customer value proposition standpoint, I think your question gets like, hey, are you offering prices that you're not going to be able to offer in the future, and we don't think that's the case. So we feel quite good about it. The other thing on market share, I would just point to is the market share gains we're getting are from pretty much across the board. So they're not coming on the back of any particular customer or any particular product category or segment, it's very broad-based. And I think what it shows you is that our recipe is back intact, which is the breadth of selection, the fast delivery, the kind of availability of the bestsellers. And these are things that were under strain in that COVID period where supply chain congestion was there, a lot of inflation was there. And what we're seeing is that as the recipe is fully intact, this is the cycle that we just used to compound our business over in the 20 years, and that's what's driving the success here.

And then my follow-up question is, as you flip here early to free cash flow in the second quarter, Kate, can you help us think about how you think about use of cash and how you think about sort of the debt structure and the balance sheet structure over a longer-term basis?

Yes. Thank you. Good morning, Chris. So a few thoughts there. Obviously, we are very excited by the free cash flow generation this quarter, and we intend to continue to be at a sort of sustainable free cash flow generation place going forward. As far as the overall capital structure, as I think you're aware, we have a number of converts. The first convert is that 2024 convert of about $117 million remaining. We feel very good about our ability to manage through that. The next convert is at 2025 convert of about $755 million remaining. And as we go forward, we think there'll be multiple structures for us to manage that convert as well. So when we look at the balance sheet, we feel very good about our position today, and we intend to keep being free cash flow generative and adding that back.

Our next question is from the line of Maria Ripps with Canaccord. Please go ahead.

Great. Good morning. And thanks so much for taking my questions. First, can you maybe just talk about some of the competitive dynamics that are happening in this space, given sort of all the recent developments, it seems like you've been clearly gaining market share. So how do you see sort of the competitive landscape developing here going forward?

Thank you, Maria. As we've noted previously, we face numerous competitors in a highly fragmented market. In the home segment alone, there are various subcategories, each with its own set of competitors, whether it's furniture, lighting, or plumbing. We're pleased to see that we're gaining market share across the board, not just from specific competitors. In the e-commerce landscape, the larger platforms are the main contenders. In the U.S., we closely monitor large competitors like Amazon, Walmart, Target, Home Depot, Lowe's, and Costco, as they possess the scale to offer advanced logistics and reach a wide customer base. Our operations, including our team of approximately 3,000 engineers, product managers, and data scientists, along with our significant logistics capabilities and proprietary parcel delivery, are capabilities that smaller players struggle to compete with. These assets enhance the customer experience that consumers have come to expect. Each competitor focuses on different business segments and utilizes their scale effectively, whether delivering building materials or groceries. We specialize in the home market, leveraging our scale for those specific needs. Smaller competitors are likely to continue losing market share, as it's increasingly challenging to provide a compelling value proposition in e-commerce without the necessary resources.

Got it. That's very helpful. Could you discuss how much of the operational savings you've achieved are being reinvested into pricing? How has this influenced the top-line performance this quarter, and how should we consider the percentage reinvested moving forward?

Yes. I’d like to share a few quick thoughts before handing it over to Kate for more details on the numbers you just mentioned. One key point to highlight is that we have outlined an ambitious plan, and as we progress, we continue to expand on it. The operational cost savings have been significant, and there’s more to come. I would also emphasize that part of our success is due to our competitiveness on key items we provide, which is largely possible because we're back in a normal operating environment. Kate, do you have anything you’d like to add?

Yes. I think Niraj covered most of it on our philosophy here. So Maria, as you know, last quarter, we referenced that of that $500 million that we had originally outlined, we said we'd already achieved half of that by last quarter or sort of coming out of that quarter. Obviously, you saw ongoing improvements and in fact, an acceleration on that gross margin line. So I think you can infer from that that we picked up continued operational cost savings and, in fact, a little bit faster than we had intended to. As we think about the reinvestment, what we're really balancing is flow-through on that to the bottom line with improvements in the customer experience overall, and that's really designed to generate multi-quarter gross profit dollars. And that's how we're thinking about that ongoing investment. And you, of course, see that a little bit in the guide on gross margin, which is up obviously, but takes into account some of that investment.

Your next question is from the line of John Blackledge with TD Cowen. Please go ahead.

Great. Thanks. Two questions. First, could you just talk about key drivers of the order growth? And is that sustainable over the next several quarters? And just any general color on the consumer demand for the home category. And second question on Gen AI, just potential uses of Gen AI to drive the business going forward? Thank you.

Thanks, John. I'll start with the order growth. The order growth dynamic reflects that we have restored our offering with a wide selection, good in-stock availability, fast delivery, and competitive prices. This combination is effective, and customers are responding positively. Even more encouraging is that we are observing improvements in repeat metrics; customers are returning and making additional purchases. This creates a compounding effect as we attract more engaged customers. Additionally, from a pricing perspective, we expect prices to become even more competitive as suppliers adjust to future costs and inflation decreases, with ocean freight costs returning to pre-COVID levels. This dynamic is driving momentum in our business, and we anticipate continued growth. Kate, do you have anything to add regarding order growth?

Yes. I think those are the key pieces. I mean, it's really the dynamic that I believe we foreshadowed a few quarters ago, which is as deflation continues to come out of the prices and as our availability and speed got better, we would ultimately be seeing order growth offset some of that deflation as customers were able to reengage in the category. I think your next question was...

Gen AI.

Was on Gen AI, yes.

Yes, I have a few thoughts on that. We are actively leveraging various use cases of Generative AI to enhance our capabilities, primarily focusing on reducing workloads and improving efficiency. For instance, we've piloted a program where our customer service agents, who interact with clients through chat and email, utilize software that generates proposed answers. Agents can quickly review and modify these responses before sending them out. This method not only saves costs but also enhances the quality of our answers. We’ve observed an increase in customer satisfaction while simultaneously reducing the costs associated with responding to inquiries. There are several similar initiatives we have in progress, such as drafting product descriptions and product tagging, where we can minimize labor and expenses while boosting efficiency and accuracy. Moreover, we have ongoing projects related to how Generative AI could transform the customer experience in the future, which are currently in the pilot and research stages. We recently announced a project that exemplifies this, and I encourage you to check it out as there's a link available where you can explore it yourself and get a sense of the potential and direction of our efforts. While we expect some of these projects to take longer to realize, we believe the possibilities with Generative AI are substantial. Our extensive experience with data science places us in a strong position as an innovative leader and proactive adopter of technology.

Thank you.

Your next question is from the line of Alexandra Steiger with Goldman Sachs. Please go ahead.

Great, thank you for taking my questions. I do want to ask about international. So while you obviously saw a nice improvement in the U.S. international growth is still lagging. So wondering if there's anything you're calling out, whether you refocused your international efforts or do you prioritize some initiatives that led to the lower revenue growth? Or is this more a sign of a weakening consumer demand in international versus the U.S.?

Thank you, Alexandra. Regarding international, there are two main points to consider. First, the macroeconomic conditions vary by country, and in some of the markets within our International segment, the economic situation is indeed weaker than in the United States. Second, when we outlined the $1.4 billion in cost actions, we mentioned our focus on advertising, emphasizing tight payback metrics and reducing more speculative ad spend. Additionally, we are prioritizing strong unit economics, which may slightly reduce short-term revenue but will ultimately strengthen these businesses for the long term. This is reflected in the significant improvement in EBITDA for the International segment. While these strategies may impact revenue now, they are beneficial for profits in the long run. It's important to consider that the situation is not solely about macroeconomic factors.

Great, thank you. Very helpful.

Your next question is from the line of Curtis Nagle with Bank of America. Please go ahead.

Good morning. Thanks for taking the question. So the first one, I guess, would be on the pace of active customer growth. I think you saw the first instance of quarter-over-quarter growth in some like two years, where is it coming from? Is it new? Is it reactivated? And how should we think about the pace going through the rest of the year?

Thank you for the question, Curtis. We are very excited about the momentum we are seeing. The order growth is significant, and there are a mix of new customers and those who are reengaging. While some metrics may not reflect this yet, we are thrilled about the strengthening repeat purchase rates. For example, we are monitoring the percentage of customers who buy again within 30 to 90 days. These repeat rates are improving, which serves as a positive indicator of our business trajectory. There are two key reasons for this. First, these rates contribute to a compounding cycle that enhances growth sustainability. Second, they reflect our success in satisfying customers. If we provide great selection, pricing, delivery, and merchandising, customers will make a purchase. However, their true satisfaction comes after they receive and use the product. It is at that stage that they decide to buy again. Therefore, these repeat purchase metrics reveal customer satisfaction and engagement, and we are observing a noticeable improvement. Kate, do you have anything to add?

Yes, I think that addresses it well. I want to remind you that the active customer count is based on the last twelve months. Therefore, you will notice the orders are improving ahead of the active customer figure. This quarter, we saw that sequential growth, and those indicators appear first before it takes some time to reflect positively in the active customer count. Overall, we are very encouraged by the trends, especially regarding order volume and the underlying repeat behavior.

Got it. Okay. And then just as a quick follow-up. So the commentary in terms of some of the relative share gains for 2Q, we're definitely helpful. At the end of the quarter, maybe going to 3Q, any evidence that you're seeing a pickup in the category? Or is this sort of a continuation of you guys really outperforming that's the primary driver of 3Q?

Yes. I would share a few thoughts. From our perspective on market share and overall demand in the category, we don’t see significant strengthening. It appears to be steady. Both the credit card data we access and recent conversations with suppliers at the Las Vegas market indicate we are gaining market share. This is evident across the board, and suppliers often mention specific competitors. The feedback aligns with our understanding from the credit card data. Overall demand trends they describe suggest that demand remains relatively weak and steady, yet we are standing out and capturing share broadly.

Your next question is from the line of Steven Forbes with Guggenheim Securities. Please go ahead.

Good morning, Niraj, Kate.

Good morning.

I wanted to start by discussing CastleGate penetration. Can you provide any insights on where you expect to end the year in terms of small and large parcel penetration? What are your current thoughts on CastleGate's capacity as we look ahead to 2024 and 2025?

Yes. Thanks for the question. What I would say is that CastleGate penetration as we go through time, we're quite excited about where we think it will go based on what we're hearing from suppliers' interest to flow goods in as they increasingly flow new goods out of Asia. So we've been at a period of time where suppliers are kind of working their way through excess stock. But they're now getting to a point where they're bringing in their best sellers, and I mentioned the Las Vegas market recently. I'd say a substantial number of the suppliers are now bringing in large new product introductions for the first time in three years. So it's sort of like a moving forward thing going on in the business, which is particularly exciting, I think, plays to our strengths, but also from the standpoint of flowing fresh goods out of Asia, that will speak to increasing CastleGate penetration. From a capacity standpoint, what I would say is we've built that network out over the last few years to have a very good footprint, but with a lot of unutilized space because the idea we had is we wanted to have the footprint. And then as we get more volume through it, it will then get utilized which will then be a situation where we'll only need to add new locations down the road when we have capacity constraints, which is not the case right now.

Yes. I would add to that. We've obviously shared the CastleGate penetration stat in the past as one metric on our overall logistics improvements and ongoing efficiency that we're seeing there, which you can clearly see in that gross margin line and we'll certainly speak next week at our Investor Day more broadly to our logistics network and the efficiency and the value that drives for our customers and our suppliers. CastleGate is an important piece of that. And within CastleGate, of course, the penetration is a component, but there are multiple factors at play here.

I appreciate that. Just a quick follow-up. Maybe we'll get this next week. I keep thinking about the total logistics cost, which you've mentioned in the past as being around $0.20 of every dollar. I'm curious about where the total logistics costs stand today and your outlook on them as different parts of the supply chain begin to normalize.

I don't have a specific number to share, but we have been focusing on optimizing logistics costs. The main factor in this optimization is the direct shipment of goods from their manufacturing location, which helps reduce the excess miles that need to be covered in the destination country. The final mile of delivery is typically the most expensive part of the logistics process. Additionally, we are looking at how to further optimize that final mile, such as through our sortation practices in our buildings that can reduce hub touches. For the large parcels we deliver ourselves, we're also focused on efficiency—whether that means increasing the number of deliveries in a day, for example. The initiatives we have around our fulfillment center footprint, consolidation efforts, and improvements in our last mile delivery network all contribute to reducing costs. As we continue to utilize capacity beyond what we currently use and as volume increases, we have a significant opportunity to drive down costs, which will happen as our network grows and volumes increase on a proprietary basis.

Your next question is from the line of Jonathan Matuszewski with Jefferies. Please go ahead.

Good morning and thanks for taking my questions. One of your online competitors is highlighting elevated trade down over the last couple of months with customers who used to buy better SKUs, sign more good SKUs, would you say trade down was more pronounced in 2Q relative to 1Q? And how much did that impact your AOV this quarter? Thanks.

Yes, thanks, Jon. We are definitely observing a trade down, which is quite common during a recessionary cycle. We experienced a similar pattern in 2009 and 2010, and it's relatively straightforward to quantify and track. However, the main factor driving the average order value is deflation, particularly concerning ocean freight inflation decreasing. There are also some impacts from raw materials and production costs. While trade down does contribute to the average order value, it is not the primary factor.

Yes. I would just add that I think also trade down is an area where our broad selection benefits us. And so the customer can continue shopping with us. And if our budget is tighter, she can still find that product with us. We certainly saw that behavior play out in the 2009, 2010 period as well.

That's helpful. And just my follow-up question. Kate, I think you alluded to some investments in customer experience contributing to a lower gross margin in Q3 relative to Q2. Can you elaborate on some of those enhancements and the returns you expect to see from them?

Yes. Great question. So when we talk about investing in the customer experience, I think it's important to note that across multiple factors, right? So often, folks will go to price, price is a component but so is delivery speed, delivery experience, just spoke about some of the last-mile delivery efforts that we made, the returns experience, incident management, etc. All of those, we think drive an overall better customer experience, and that leads to ongoing repeat behavior. So when we think about quantifying the value of those investments, we're looking at, as I mentioned previously, this multi-quarter growth in gross profit dollars and ongoing improvement there from driving that customer experience. As a result, yes, we are going to be reinvesting some this quarter we landed at 31.1%. The midpoint of our guide is about 30%, but we've continued to step up that gross margin. And I think you'll see ongoing improvements throughout the year and going forward in gross margin. We've previously outlined that path to sort of a mid-30s gross margin. We're very pleased with the progress that we're making there.

Your next question is from the line of Anna Andreeva with Needham. Please go ahead.

Great. Thank you so much. Good morning and congrats on nice momentum in the business.

Good morning, Anna.

We had a couple of quick ones. I wanted to follow-up on the monthly cadence during the second quarter. So you guys provided an update in early June for the business to be down mid-single. So was June overall positive for the company? I just wanted to make sure that math is correct. And obviously, a lot of initiatives are working, which is great. But anything specific that drove improvement to low singles that you're currently running? And can you help bridge how we should think about getting to mid-single for the third quarter?

Thank you, Anna. I want to share a quick thought before passing it over to Kate to address your question. One important concept to keep in mind is compounding. When you acquire customers, they show interest, make purchases, and are satisfied, leading them to return. This is evident in various indicators, such as the increase in repeat purchases and the Wayfair app, which has seen a rise in downloads and usage. Typically, the app is utilized by increasingly loyal and engaged users. There are several metrics available that highlight this trend. The idea of compounding is fundamental to our growth, but let me hand it over to Kate for more specific insights.

Yes. I think that covers how you can think about the second quarter. Obviously, we don't provide month-on-month breakouts. As you sort of move into the third quarter, I think your question was, how do we get from low single-digits that we're seeing today to that mid-single digit. One factor that I'd point you to is that marketing test that straddled two quarters. So the test itself occurred in the second quarter. That means we've pulled back on some spend in the second quarter and left some revenue dollars on the table that would have hit in the early part of the third quarter. So that's a little bit of how you might see some of that. And then, of course, ongoing momentum that we would expect to see because of those underlying factors that Niraj mentioned orders obviously beget future customers and future orders. And as we've seen that order volume growth, we'll continue to see that why we will improve.

Okay, terrific. That's super helpful. And Kate, just as a follow-up. This was very helpful on the gross margin, but did you guys quantify the timing benefit in the second quarter? Thank you again.

Yes, we did not. We did say things hit a bit faster than originally anticipated, and we're excited about the ongoing tight execution from the team there.

Your next question is from the line of Ygal Arounian with Citigroup. Please go ahead.

Good morning everyone. So maybe just to dig in a couple of these points. First on the gross margin, great to see and understand kind of puts and takes with the reinvestment. On the upside and what drove upside to what you're expecting this quarter or just in general, the strength, can you talk about which pieces were the largest contributors to that? Like what's been coming in better than expected? And then on the advertising, again really interesting to see and hear about the kind of the pullbacks on the testing. Can you share a little bit more about what that was, what you saw that led you to pull back some of the things you're looking for there and how to think about that as we kind of move forward? Thanks.

Thanks, Ygal. I think Kate will probably be able to answer your questions, but the one point I just want to make before I pass it over to Kate is a lot of the gross margin improvement, if you go back to that $1.4 billion cost action plan. We kind of talked through a bunch of components of what we were planning to do. I think a lot of what you're seeing in the results is an outcome of a lot of the things we said we were going to do that we've been since done, and that are kind of driving a lot of the improved performance. And then on advertising, I guess the point I would make there is the testing we do is really to get data that then we use to hone the data science models that drive the spend in a way where we have high confidence that we know what ROI we're getting. And so it's something that we just need to regularly do to kind of hone these models. And because of kind of the unusual behavior during COVID, the last set of tests were run in 2019, which is quite a long time ago, you typically would run them much more frequently than a four-year period, but that's sort of the last normal period we had. And so what we're doing is make sure we hone these models. So even though that hurt performance from a revenue standpoint in Q2 because you're not spending a bunch of advertising that you believe is productive. It's the only way to get the data back that hones the model. And so it's more kind of an ongoing thing you would do to just make sure that you're kind of able to be very specific and accurate in how you advertise. Kate?

Yes. Regarding your question about gross margin, we've previously mentioned that we are working on over 70 initiatives aimed at operational cost savings and efficiency. What we're seeing now is that these initiatives are delivering results more quickly than we expected, which contributed to the gross margin improvement in Q2. It's important to note that many of these changes are structural, providing ongoing savings. The updated guidance suggests a midpoint of 30% gross margin compared to the 31% we achieved, primarily due to reinvestments in enhancing customer experience. We anticipate that these improvements will be sustained. On the advertising tests, I agree completely with Niraj; these tests are crucial for us to maintain confidence in our spending strategies. We evaluate spending and efficiency on a channel-by-channel basis, which we've discussed before, and testing is a standard and necessary approach for us. We are enthusiastic about resuming these tests regularly, which reassures us about effectively investing in those channels moving forward. However, it does mean that we might miss out on some revenue while conducting these tests.

Your next question is from the line of Atul Maheswari with UBS. Please go ahead.

Good morning, this is Michael Lasser for Atul Maheswari. Thank you so much for taking our questions. Niraj, I want to give you an opportunity to respond to some of the pushback from the skeptics that we've been hearing. One of their arguments is many of the vendors really globally are still heavy on inventory. So they're using third-party marketplaces as a channel to still right size their inventory and then dispose of excess inventory. In addition, they're benefiting from lower freight costs, which is allowing them to be a bit more promotional, which is driving some of the improvement. How would you respond to that?

In terms of the deflation occurring, I believe it is indeed happening. I don't think freight costs will return to the pandemic-level prices. This change seems permanent and not merely promotional. It reflects a return to more normalized costs that will likely persist. This trend appears to affect all retailers, indicating it is a common market phenomenon. Regarding excess inventory, I would say the peak occurred in the summer of 2022, and suppliers have been working to reduce that inventory since then. Many suppliers have returned to healthy stock levels, although some are still addressing excess stock. Generally, we have not observed suppliers discounting beyond what they can consistently price their goods at. For instance, if an item were sourced from Asia today, that cost would inform their pricing. Suppliers are pricing down to replacement cost levels, even if they initially procured excess stock at higher prices. We are not witnessing behavior from suppliers that suggests anything temporary; they are adjusting back to a normal state. The retail landscape today resembles what we saw in 2017, 2018, and 2019, marked by competition among retailers. Those who deliver the best customer experience will succeed. This contrasts with the market conditions of 2020 and 2021, characterized by excess demand, significant stimulus spending, and supply chain issues, which created unusual pricing circumstances. I believe we have moved past that period.

Okay. And our follow-up question is you've got a wonderful purview on two of the most important elements of the domestic economy right now, which is the consumer and housing market. So if you could provide a little insight what you're seeing from a category perspective to illuminate what consumers are interested in buying, what where purchase cycles are already normalizing? For example, there are signs that flooring as a category remains under pressure, yet appliance demand is starting to stabilize. So what big themes or trends are you seeing that really indicate where the consumer stands right now from a category perspective?

Thank you for your question. In our numbers, we are seeing strong demand across the board. However, our market presence varies among categories. For example, we are more established in entertainment furniture, which is where we began in 2002, compared to newer categories like appliances and flooring that we have entered in recent years. In these newer categories, we have a smaller market share, allowing for growth from a smaller base. While we hold a significant market share in larger categories, there is still potential for growth due to our established position. Therefore, we may not fully reflect the overall performance of certain categories in our numbers, but we do hear anecdotal feedback from our suppliers, which aligns with the kind of data you have access to.

Today's final question will come from the line of Colin Sebastian with Baird. Please go ahead.

Great. Thank you for accommodating me. Good morning. I wanted to follow up on Average Order Values and the effects of deflation in a bit more detail. Specifically, what do you anticipate for the financial profile of the business regarding gross margins and operating margins if we experience a reversion to historical levels? Additionally, Niraj, perhaps this can be addressed next week, but I want to follow up on the question about Gen AI or AI in general. Considering the various factors around the internal efficiency gains you've mentioned, as well as external product development and potentially increased infrastructure costs related to AI, how should we view the impact of those investments in research and development and technology? Thank you.

Thank you, Colin. Regarding the AOV question related to deflation, the main change has been in ocean freight, which has reverted back to pre-COVID levels. Suppliers that manage their inventory effectively are bringing in new goods with costs aligned more closely to what they were before COVID, rather than during it. This adjustment is reflected in wholesale prices, which then influences retail prices. Our gross margins, akin to our take rate, are holding steady, and competitive offerings are driving customer engagement, as evidenced by an increase in order count and active customers. Over time, this compounds as engaged customers return, which is evident in our repeat metrics, although it may not be immediately visible. Our unit economics remain strong, and despite challenging market conditions, our volume is growing. As the market stabilizes and eventually grows, we anticipate an even faster growth trajectory.

Yes. Our margins are healthy and growing even with the AOV compression. And I would not expect a drag on the margin from AOV compression. We're seeing that, of course, offset with orders, which is a more positive thing for our flywheel.

Regarding your question on Gen AI, I view it as a means to enhance efficiency, which translates to cost savings. Reflecting on our $1.4 billion cost action plan, there are numerous cost savings strategies we are pursuing. The integration of Gen AI can lead to additional efficiencies, enabling us to offer more competitive retail prices and invest in various initiatives. Regarding the technology expenditure you mentioned, it's important not to view our approach as the same as those with large language models who offer them as a service, like Google or OpenAI. These companies make substantial capital investments, which they recoup by allowing us to utilize their models. We then build upon these using our first-party data, which sets us apart from smaller platforms. Our access to extensive first-party data significantly enhances the effectiveness of Gen AI applications. Notably, our costs remain relatively low since we are only paying for the usage, which is modest. We continually add capabilities to our software applications while optimizing costs elsewhere. I believe our clusters are not a concern in this regard.

Yes. I think that nothing to worry about in the near-term in the cost structure over time in the cost structure. And of course, there should be ongoing cost savings, as Niraj mentioned earlier. As we wrap up, we just want to remind you all of our Investor Day next Thursday. We look forward to seeing many of you there. Thank you for joining us this morning.

Yes. Thank you. Look forward to seeing hopefully a bunch of you next Thursday. Take care.

Thank you all for joining today's conference call. We appreciate your participation. You may now disconnect.