Wayfair's (W) CEO Niraj Shah on Q4 2016 Results - Earnings Call Transcript

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Wayfair (NYSE:W) Q4 2016 Earnings Conference Call February 23, 2017 8:00 AM ET


Julia Donnelly - Investor Relations

Niraj Shah - Co-Founder, CEO and Co-Chairman

Steve Conine - Co-Founder and Co-Chairman

Michael Fleisher - CFO


Seth Basham - Wedbush Securities

Matt Fassler - Goldman Sachs

Chris Horvers - JPMorgan

Oli Wintermantel - Evercore ISI

John Blackledge - Cowen and Company

Michael Graham - Canaccord Genuity


Good morning, ladies and gentlemen. My name is Melissa and I will be your host operator on this call. At this time, I would like to welcome everyone to the Wayfair Q4 2016 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. [Operator Instructions]

At this time, I would like to introduce Julia Donnelly, Head of Investor Relations at Way fair.

Julia Donnelly

Good morning and thank you for joining us. Today, we will review our fourth quarter and full year 2016 results. With me are Niraj Shah, Co-Founder, Chief Executive Officer and Co-Chairman; and Steve Conine, Co-Founder and Co-Chairman, and Michael Fleisher, Chief Financial Officer. We will all be available for Q&A following today’s prepared remarks.

I would like to remind you that we will make forward-looking statements during this call regarding future events and financial performance, including guidance for the first quarter of 2017. 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 SEC filings including our 10-K for 2016, which we expect to file in the near future identifies certain factors that could cause our actual results to differ materially from those projected in any forward-looking statements made today.

Except as required by law, we undertake no obligation to publicly update or revise these statements, whether as a result of any new information, future events or otherwise. Also please note that during this call, we will discuss certain non-GAAP financial measures as we review the company’s performance. These non-GAAP financial measures should not be considered replacements for and should be read together with GAAP results.

Please refer to the Investor Relations section of our website to obtain a copy of our earnings release, which contains descriptions of our non-GAAP financial measures and reconciliations of non-GAAP measures to the nearest comparable GAAP measures. This call is being recorded and a webcast is available for replay on our IR website.

Now, I would like to turn the call over to Niraj.

Niraj Shah

Thanks, Julia, and thank you all for joining the call. I’m pleased to share our fourth quarter and full year 2016 results with you this morning. I want to begin by telling you how proud and excited Steve and I are of what Wayfair accomplished in 2016. In part, that shows in the numbers we will share with you today.

But the results are larger than that. These calls are unfortunately focused on extraordinarily near-term results. To us 2016 showcases what we’ve been building for the last 15 years. At the end of the day it’s all tied to our focus on serving our customers and having an amazing team of over 5,000 people.

We just finished writing our annual shareholder letter that shares some of these thoughts. We posted this letter to our investor relations website today as part of our investor presentation. We cannot be more excited to continue the journey in 2017 and beyond.

For the full year 2016, we generated $3.4 billion of total net revenue, up $1.1 billion and up 50% from 2015. At $3.4 billion in revenue, we believe we are just starting to penetrate the approximately $600 billion market opportunity we have in the home category in the US, Canada and Europe.

In Q4 2016, we generated $959 million of net revenue in our direct retail business, up 40% year-over-year and $985 million of total net revenue, up 33% year-over-year. We saw a direct retail growth across our US and International businesses and across many categories of the products we sell, but there are four particular areas that I’d like to update you on, holiday, new categories, international and logistics.

The first is holiday, where we had another very successful season this year. As we have mentioned in the past, the holidays are a great time for us to attract new customers and invite purchases from repeat customers. This year in Q4 we offer twice as many holiday events with more than twice as many featured items as last year.

In addition to our expanded selection of seasonal décor, we also saw shoppers buying furniture and décor items to spruce up their homes and prepare for house guests, and buying storage and organizational items for the post-holiday cleanup. Some of our best-selling classes or TV stands bar stools, recliners, bedding, upholstered beds, mattresses, rugs and outdoor furnishings.

In the seasonal décor category, non-traditional Christmas trees like half trees and palm trees, and holiday lighting experienced particularly strong growth. We also saw our customers buying storage items such as artificial tree storage bags, ornament storage, [reet] boxes and string light organizers.

A significant percentage of seasonal décor sales in the quarter flowed through our CastleGate warehouses enabling us to offer next day and two day delivery for popular items including our five for $25 ornament shop.

As noted in our November press release direct-to-retail gross sales defined as dollars of order intake increased 52% year-over-year for the five day peak shopping period of Thanksgiving Day through Cyber Monday, with repeat customers accounting for 58% of holiday sales. We also saw strong new customer acquisition during this period, as it is typically a time of year when virtually all consumers are shopping on line.

The second area I would like to highlight is the ongoing growth in some of the newer categories we are focused on such as home improvement, housewares and mattresses. When we say home improvement, what we mean are the finished areas of plumbing, lighting and flooring. We focus on the items that target our customer; a woman aged 35 to 65 cares about and wants to pick out herself.

Think of fixtures like faucets and shower heads, bathroom vanities, sconces, kitchen back splash tile floors and not the building materials like dry wall, lumber insulation, pipes and wiring. Like building out a deeper product catalog, merchandising these items better on our side and hiring specialized sales and service teams in our customer service centers, we have seen an increase in our penetration of our these home improvement categories.

In our housewares, part of our approach involves building up our wedding registry offering, which Steve will discuss in more detail later in the call. Our mattress business is a good example of a category we historically had on the sight, but didn’t merchandize well or provide the right selection.

Over the last year, we have started to make those investments and are now using a multi-pronged approach that includes innerspring, foam and Bed-in-a-Box mattresses across industry leading brands as well as our private label Wayfair suite brand. Though we still have much work to do here and a big opportunity ahead, today the mattress category is an over $100 million annualized run rate category that is growing nicely.

Now, I’ll move on to our international business in Canada, the UK and Germany. Total international net revenue for full year 2016 reached $270 million, up 136% year-over-year. In Q4 specifically, total international net revenue was $100 million, up 181% year-over-year. All of our international businesses leverage a lot of the technology infrastructure and the advertising playbook that we developed in the US.

Our Canadian business is further able to leverage the supplier relationship and the logistic infrastructure of our US business. While Canada represents a much smaller market opportunity than Europe, the Canadian business continues to perform even above our internal expectations due to the combination of a robust product catalog leveraging the US supplier base of Wayfair.com and the increasing amount of product shipping two day from our CastleGate warehouses and the Canadian home market that was frankly underserved by the competition.

We have grown our base of local Canadian suppliers too, with approximately 18% of Canada net revenue in Q4 sourced from local suppliers. Since launching wayfair.ca in January of 2016, our aided brand awareness in Canada has risen to approximately 50% today, as a result of the online ad spend and television campaigns we ramped up in Canada in 2016.

The UK business is also experiencing significant traction and performing to our aggressive plan. In Europe we needed to lay more ground work with local carriers for transportation and delivery and with local suppliers for the product catalog. With the European trade shows over the last six weeks, we saw increasing engagement from local suppliers; we see this as a strong partner for them in ecommerce.

Although CastleGate is newer in Europe with the launch of our first UK warehouse this past September, we’re seeing strong initial interest from local suppliers and anticipate that the penetration of CastleGate will follow a similar trajectory as in the US. We’re also taking advantage of our deep, long term and scaled relationships with US suppliers and enabling some of them to enter the European market for the first time by shipping containers directly in to our UK CastleGate warehouse.

To (inaudible) Canada we ramped ad spend in the UK in 2016 and have seen aided awareness levels rise to approximately 30%. Our German business is intentionally earlier in its build than Canada and the UK, reflecting our decision to focus first on English speaking countries. However, we are seeing nice growth in Germany as well and we expect to spend more significant ad dollars there in the back half of 2017, as the offering improves closer to parity with the UK.

We continue to be excited about the unique opportunity we have in front of us to continue gaining share in the US and to win in these new international markets that more than double the size of our total addressable market. Michael will take you through this in more detail later in the call. But starting this quarter, we will be providing additional financial information for our US and international segments.

Our international business remains our most substantial investment area. In this quarter, the adjusted EBITDA loss for our international segment was $24 million. The US businesses are obviously our larger business today. US adjusted EBITDA for full year 2016 was roughly breakeven, despite the investments in new categories, logistics and merchandizing.

For Q4, US adjusted EBITDA was modestly profitable, as you would expect given our normal seasonal pattern. In the US we are investing significantly in our logistics network as well as in the newer categories like home improvement, seasonal décor and housewares that I discussed earlier.

Let me update you now on our logistics initiatives including CastleGate and our Wayfair Delivery Network or WDN for short. In talking with many of you, there seems to be a bit of confusion about the differences between CastleGate and WDN. I’ll take just a few minutes here to clarify.

Please also refer to our investor relations website where we’ve added additional slides to our investor presentation to help illustrate the various parts of our logistics operation. When we look at logistics, we think about the two classes of goods that we sell, those that are small and light enough to fit through the UPS and FedEx networks for the last mile or small parcel, and those that are too large to fit through those networks and must instead be delivered by two people in a truck or large parcel. These are our internal terminology for these items, but keep in mind the names small parcel for package is all relative in the home category.

Our small parcel packagers are actually quite large and bulky, measuring three cubic feet and weighing 30 pounds on average. Overtime, small parcel typically represents 70% to 75% of our revenue and large parcels typically represents 25% to 30% of our revenue.

Historically, we would integrate with our suppliers back in technology to gain visibility in to their warehouse inventory and process orders automatically. When a consumer placed a small or a large parcel order on the Wayfair site, the order would get automatically routed to a supplier warehouse where the supplier would fulfill the individual order, package it and place it at the end of their loading dock for Wayfair to arrange shipment to the customers.

For small parcel shipment, we would leverage UPS or FedEx and for large parcel shipment we would use trucking carriers in combination with third party last mile home delivery agents. This is our traditional drop ship mile for small parcel and large parcels.

Now, our CastleGate fulfillment network is a network of large warehouses where we operate effectively as a three PL for our suppliers allowing them to store their small parcel and large parcel inventory in our warehouses and pay us storage, pick and pack fees. These warehouses are strategically located and utilize pre-sorting and dedicated transportation to speed up delivery of these small parcel and large parcel items.

This delivery speed which includes next day and two day delivery for small parcel items delights our customers with fast delivery and benefits or suppliers and us with increased sales conversion. Today shipments from our CastleGate warehouses can reach 99% of the US population within two days.

As we ramped our CastleGate warehouse capacity significantly over the course of 2016, and expect to continue in the first half of 2017, it is a drag on our P&L since the warehouses are not yet at full capacity and we bear the burden of unutilized rent expense. Overtime however, we expect cost benefits as warehouses reach full capacity and utilization and as we take advantage of scale benefits in transportation.

On our last call, we noted that approximately 10% of our US net revenue at the time was promised to and delivered to the customer either with next day or two day delivery. We expect that this percentage will continue to ramp quickly, as we expand our capacity and suppliers increasingly flow product to our CastleGate warehouse.

The Wayfair Delivery Network or WDN describes several different areas of our large parcel network where we have started to take direct operating control of our transportation and delivery, instead of relying on contracted third party operators. Examples include our Wayfair operated consolidation centers, cross-docks, line-haul and last mile home delivery facilities.

Historically, we have relied on various third parties to operate our large parcel delivery network. Five years ago we relied on a single national delivery partner for all orders. As we got more scale, we were able to contract directly with third party LTL carriers and third party last mile home delivery agents to reduce cost and provide a better overall delivery experience to the customers.

Today, with the additional volume and scale we have, we can now operate our own consolidation centers and cross-docks and run our own full truck loads between those points. By taking more direct control of so-called middle mile of putting large parcel orders as they crisscross the US, we can increase the average speed of delivery, reduce transportation cost, and reduce damage since there are fewer touch points per order.

We can also influence damage rates by installing a culture where everyone who touches the product turns about delivering it damage free to the Wayfair customer who ordered it. By the end of 2017, we expect to have approximately 90% of our large parcel shipments flowing through the Wayfair controlled middle mile.

Today, we have also started to operate our own last mile home delivery facility in major metropolitan areas so that we can increase customer satisfaction on large parcel deliveries. Inside the four walls of the last mile home delivery facility, Wayfair employees are handling the products and interacting with customers to schedule deliveries or answer questions. These facilities also use our proprietary technology.

Delivery out of the customers’ home is now provided by trained partners with the Wayfair experience. We direct the routes that the trucks take and have a feedback loop and incentive that drive behavior consistent with our brand including bonuses based on the NPS score provide by the customer after they receive their delivery.

At the end of 2016, we were operating six of these last mile delivery facilities and we plan to have 15 to 20 in operation at the end of 2017, covering approximately 60% of the US population. Large parcel deliveries are pinpoint across our entire industry. By working towards a future where the only people touching the product are Wayfair representatives who carry our culture of caring first and foremost about the customer, we intend to transform what can often be a negative consumer experience in to an opportunity to continue delighting our customers.

I’ll now turn the call over to Steve, who’ll give you an update on our private label credit card and our new wedding registry offering.

Steve Conine

Thanks Niraj and good morning everyone. We are always thinking of new ways to increase loyalty across our customer base. One example is our private label credit card, which fully launched in early 2016. We market the Wayfair credit card to our customer base by pre-screening customers at checkout to notify them if they are preapproved and through banner ads on our site and on our television commercials.

Customers can also apply directly for the card through our site. Benefit of the card includes special financing offers, reward points and a discount off their initial order. We partner with Alliance Data for the card and its Alliance Data who bears all the credit risk, holds the receivables on their books and handles the customer payment process.

Our results show that our private label credit card customers visit Wayfair more frequently and spend more than our average customer. We believe this is because the card attracts more loyal customers and further increases their loyalty by spurring higher activation and repeat once they are our card holder.

Though it is still early, private label credit card sales in Q4 accounted for approximately 10% of our US direct revenue, and we expect that percentage will continue to grow. We also recently introduced a financing offer with a firm to help those customers who wish to finance larger purchases, but do not want or qualify for our private label credit card. Similar to the card, we do not bear any of the credit risk with these financing transactions.

While the firm is a relatively new offering, we are excited by the customer reaction so far. These programs are the beginning steps of our larger loyalty rollout. For example, the private label credit is a great platform to give our best customers special benefits which could include early access to new products or complimentary services.

I also wanted to provide an update on our wedding registry offering. As we’ve said before, it is still early days for the registry, as it typically follows a seasonal pattern with the majority of revenue realized later in the year as weddings take place. We are encouraged by the early customer response so far, with 50,000 registries created since launching in September.

We’re also excited to see early evidence of customers taking advantage of the full Wayfair selection with customers registering both for traditional registry items like housewares and for larger ticket items like couches and dining room tables. Alongside building our registry offering, we have also built out our housewares offering with top brands now available on our site.

In addition to the potential revenue we can realize from the registry business, this offering has also been a great way to acquire new customers. Our early results show that almost half of registries created to date, come from customers who are completely new to Wayfair allowing us to reach new customers just as they reach a stage in their lives where they begin to spend a greater portion of their income on their home.

In addition, we are introduced through registry to all the wedding couples friends and family, which is yet another source of customer acquisition.

I’ll now turn the call over to Michael to walk through the financials.

Michael Fleisher

Thanks Steve and good morning everyone. As always, I will highlight some of the key financial information for this quarter and full year 2016. A more detailed information is available in our earnings release which can be found on our IR website.

In Q4, our direct retail net revenue increased 40% to 959 million, and our total net revenue increased 33% year-over-year to 985 million. Our other business which includes revenue primarily from our retail partners, it also includes revenue from our small media business continued to decline, reaching 26 million as we continue to ramp down our retail partner business overtime.

As Niraj mentioned, we are particularly pleased with our holiday execution this quarter, as well as the ongoing growth throughout the year for both existing and new categories and from our US and International businesses. In full year 2016, we reached 3.4 billion in total net revenue adding $1.1 billion in net revenue compared to 2015.

We believe our well-rounded consumer offering of extraordinary selection and visual merchandising, world class and personal customer services and a great delivery experience are making it easier than ever before to buy home goods online and we see that really resonating with our mass market customers.

The remaining financials I’ll share on a non-GAAP basis excluding the impact of equity based compensation and related taxes which totaled 14.7 million in Q4 2016. For a reconciliation of GAAP to non-GAAP reporting, please refer to our earnings release on our investor relations website.

Our gross profit for the quarter, which is net of all product cost, delivery and fulfillment expenses, was 239 million or 24.2% of total net revenue. Gross margin percentage ran a bit higher than we had initially expected for the quarter.

We typically entered Q4 prepared for an intense promotional environment and even though our business model does not necessitate lowering prices and margin to move product like inventory based retailers, we usually anticipate we will need to price accordingly, a combination of a less intense pricing environment and really great work with our supplier partners to have the sharpest wholesales on our most popular items, led to a higher gross margin yield than our current target of about 23%.

Advertising spend was 11.8% of net revenue in the quarter or 116 million. Year-over-year advertising spend as a percentage of sales improved slightly by 10 basis points from Q4 2015, when it was 11.9% of net revenue. As we’ve described in the past, revenue from repeat customers averages down our ad cost as a percent of net revenue because it costs us much less to stimulate an order from a repeat customer than to acquire and stimulate an order from a new customer.

Since our international business is newer than our US business, it does not yet have the benefit of substantial order volumes from repeat customers and therefore runs at a higher ad cost as a percent of net revenues.

As our international business continues to grow rapidly, it puts upward pressure on the consolidated ad cost as a percent of revenue. That upward pressure is being offset by the US business and therefore results in a consolidated ad spend as a percent of net revenue for the quarter that is roughly flat year-over-year as anticipated.

In Q4, we added approximately 888,000 net new active customers making it the largest quarter of net new customer acquisition to date. We ended the quarter with 8.3 million active customers, up 54% from Q4 2015. Of the total orders in Q4, 58% came from repeat customers and 43% were made from a mobile device.

As we’ve mentioned in the past, we think of average order value more as an output and not an input. We want to grow our share of wallet as measured by net revenue per active customers and all else being equal we’d like to drive order frequency as measured by LTM orders per active customers.

In any given quarter, however, mix shift as our international business accelerates will mix shift across categories as some of our new categories grow more quickly will influence our consolidated KPIs. Q4 is usually a period of lower AOV because holiday purchases tend to be lower ticket. As part of our overall goal of driving order frequency, we leaned-in harder this quarter on higher frequency, lower ticket items, such as sheep sack (inaudible) and therefore saw a larger decrease in AOV.

You can see this trend across several of our KPIs this quarter, with repeat orders up 41% versus last quarter, LTM orders per active customer back up to 1.7 from 1.69 last quarter, and AOV down 17% versus last quarter. The combination of this and the continued increasing mix of our international business that stores a much lower revenue for active customer cause that metric to decline 3% sequentially to $395.

We offer our customers over 8 million items, which makes managing AOV in any particular period impossible, and the reason we see it as an output and not an input. We’re focused on striking the right balance between driving frequency, gaining wallet share, growth, profitability and as always most importantly showing our customer the right product for her from our vast selection.

I anticipate there will continue to be some fluctuations in our various KPIs, as we’ve seen in the past as we continue to grow international and newer categories, as well as strike the balance between frequency, AOV and revenue per active customer. Our non-GAAP merchandising, marketing and sales expense and operations technology and G&A expense are driven primarily by compensation costs.

In Q4, these two line items combined were $116 million, roughly flat on a dollar basis when compared to Q3 as anticipated on a reduced level of hiring this quarter and last. As we’ve indicated on the past calls, the first half of 2016 represented a catch-up period in hiring and we now feel that our key strategic initiatives are well staffed. As a result, we added only 27 net new employees this quarter, bringing total headcount to 5637 employees as of December 31.

In 2017, we intend to add additional headcount in areas such as warehouse and customer services, which is a variable cost needed to keep up with growth, and in our OpEx areas to continue to support our key growth initiatives and investment areas.

Adjusted EBITDA for the quarter was negative 12 million or negative 1.2% of net revenue on a consolidated basis. As Niraj noted earlier, this quarter we will begin breaking out our direct revenue, other revenue and adjusted EBITDA separately for our US segment and for our international segment. Those numbers are in our press release and our investor deck on our IR website and will also be available in the 10-K when it is filed in the next few days.

I will walk you through the highlights now. But please note that we do not intend to provide additional segment level information including KPI information, except that we will continue to provide qualitative commentary on some of the drivers in our quarterly earnings calls as we’ve done in the past.

For our US segment in Q4, direct retail net revenue reached $859 million, up 31% year-over-year and total net revenue reached 884 million, up 26% year-over-year. US adjusted EBITDA was $12 million in Q4 2016 and 0.2 million for the full year 2016. This compares to US adjusted EBITDA of 18 million in Q4 2015 and 31 million in full year 2015. As you can see, the US business is essentially breakeven today.

On the one hand, our US business is providing the leverage for our international investments by delivering strong gross margins and ad spend leverage. On the other hand, we continue to make substantial investments in the US business to drive future growth. As we’ve discussed these investments include headcount focused on new categories like home improvement, housewares and mattresses. New businesses like registry and the rollout of our logistics network include CastleGate and WDN.

Though logistics investment also shows up as a drag on US OpEx, as the unutilized of warehouses is expensed there. The new categories also drive lower gross margins, as they ramp to scale. The strong unit economics of our US business are funding these initiatives and we believe that without these investments the US business itself would be clearly profitable.

For our international segment in Q4, total net revenue reached $100 million, up 181% year-over-year. International adjusted EBITDA was negative $24 million in Q4 2016 and negative $89 million for the full year 2016. As we’ve described on prior calls, gross margin is lower internationally as we are subscale and do not have the same negotiating leverage with suppliers on wholesale cost or efficiencies in transportation and delivery as we do in the US.

Ad cost as a percent of net revenue also runs higher than in the US, because the international business is newer and does not yet have the benefit of significant repeat orders. Our OpEx is also meaningful with 12% of our total headcount located overseas as of December 31, 2016 as we build the local organization to manage the business and plan for anticipated future growth.

As Niraj mentioned, we continue to be very excited about the unique opportunity we have in front of us to continue gaining share in the US and to win in these new international markets that roughly double the size of our total addressable market.

On a consolidated basis, non-GAAP free cash flow was $49 million for the quarter, driven by net cash provided by operations at 73 million less total capital expenditures of 25 million equal to 3% of net revenue.

As a reminder, due to the seasonal impact of holiday sales, Q4 tends to be quarter where our change in networking capital becomes a significant source of cash. We expect CapEx to run at approximately 4% to 5% of net revenue per quarter for the first half of 2017, as we continue to build out CastleGate warehouses, and the moderate in the back half of the year. For the full year 2017, we expect CapEx to run at approximately 3% of net revenue.

As of December 31, 2016, we had approximately $380 million of cash, cash equivalents and short and long term investments. Our near-term goal remains running the business at free cash flow breakeven to positive so that we will continue to be self-funding.

Now let me turn to guidance for Q1 2017. We forecast direct retail revenue of $890 million to $910 million, a growth rate of approximately 25% to 28%. As I’ve done in the past to provide transparency, our direct retail gross revenue quarter-to-date is growing approximately 30%. As always, we aim to set guidance in a prudent fashion that takes in to account that we are in a mass market consumer business where our customer needs to show up every day.

Last quarter I mentioned that the state of the macro retail environment was unclear. I believe that is still the case today. Some retailers have reported weaker than expected results and delayed IRS refund to household that fit our customer demographic will have an impact on the timing of revenue during the remainder of the quarter.

We’ve continued to see strength with our customers and believe the transition from brick and mortar to online remains the key market driver for our growth. But at our scale we will certainly feel the impact of any changes in consumer sentiment and behavior both positively and negatively. It’s also worth noting that Q1 last year is an extraordinarily difficult time. As such, we remain conservative in our guidance of growth rate. We forecast other revenue to be between $15 million to $20 million with total net revenue of $905 million to $930 million for the first quarter.

For consolidated adjusted EBITDA, we forecast margins of negative 3.5% to negative 3.8% for Q1 2017. We expect adjusted EBITDA for the international business to continue its recent trajectory, as we continue to invest. We expect EBITDA for the US business to swing to a modest loss in Q1, following the modest profit in Q4 due to typically lower sequential revenue following the Q4 holiday and higher sequential ad cost as a percent of revenue, since we generally lean in on advertising this time of the year to take advantage of very attractive market pricing.

We continue to feel our strategic initiatives are well staffed and anticipate only a modest amount of higher in the quarter consistent with recent trends. For modeling purposes, for Q1 2017, we assume equity based comp and related tax expense of 17 million, average weighted shares outstanding of 86 million and depreciation and amortization of approximately 20 million.

One other item to update you on is the recent signing of a new banking relationship with Citibank and Silicon Valley Bank. As you may recall, we previously worked with Banc of America for a variety of commercial banking services including our unused line of credit and corporate credit card program. With this new deal, we were able to negotiate a better overall deal including better terms on the credit card program and a larger quantum on the line of credit.

Now let me turn the call over to Niraj, before we take your questions.

Niraj Shah

Thanks Michael. In closing, I’d like to reiterate how proud I am of what we have accomplished in 2016 and how we are positioned going forward. Shopping for home goods is moving online in North America and in Europe, and we think we will continue to be the beneficiary of that secular trend.

We have a large addressable market and we are still in the early innings of online penetration, with approximately 9% of the category sold online today in the US. Our overall offering is increasingly complete with house private label brands, a significant Wayfair brand presence, and superior customer services.

Our key investment areas will help us up our game even further by expanding next day and two day delivery coverage, adding new categories for our consumer to buy from us and expanding in to new geographies where we can leverage our experience. We are looking forward to a great 2017.

We’d be happy now to take your questions, so I’ll turn the call over to the operator.

Question-and-Answer Session


[Operator Instructions] Your first question comes from the line of Seth Basham from Wedbush Securities. Your line is open.

Seth Basham

My question is just around the cadence of your sales for the last four months. It seems like through your last conference call you indicated you’re running north of 40% in terms of direct retail revenue growth. You had a very strong Cyber 5 and based on your quarterly results you suggest a slowdown in December and then a further slowdown in January basically you said. Could you help us understand what might be driving this slowdown and how you think about the outlook over the course of 2017?

Niraj Shah

Seth its Niraj thanks for giving us a call. In terms of your question, I think the Cyber 5 period is always a particularly strong period. So you got to just view that a little bit in isolation versus like a trajectory data point as you’re mapping through the numbers. I think what you’ve been seeing us guide is that growth from Europe where we have approximately 100% growth has decelerated more to sort of normal numbers, but we are taking the significant share but at a rate lot lower than that.

And that trajectory is playing out. I would just view that guidance is sort of part of that trend where you’re settling in to rate that’s good a growth rate, particularly in light of the fact that a bulk of the money we’re investing is actually for a long cycle investments that aren’t showing up in the growth rate today. And so I don’t think there’s anything cute in the last few months where a one month or two months are showing a very deteriorating trend or something like that.

I’ll let Michael comment, because there’s always some uncertainty about macro based on what we hear from others, but to be honest we usually have a pretty hard time reading it (inaudible).

Michael Fleisher

I think that’s right, and just to be clear last quarter I think we said that we were growing quarter-to-date at the time of earnings about 40%. I don’t think we implied that we were north of that. I think we came in pretty much where we growing at that time through the balance of the quarter. And obviously you try and pickup sort of what’s going in your own business and then also what’s going on in the macro environment.

As I noted in my comments, I personally believe the macro environment for retail is unclear. There’s certainly something out there that looked like the macro environment is quite strong, and there’s other factors that looked like the consumer is not as strong. And the one piece I’d love to make this quarter for us, one macro piece I’m watching certainly is the IRS is getting early refund checks out to consumers.

If you think about the nature of our consumer write a 45 year old woman with an $80,000 household income, she is someone might have a $500 bedroom set in her idea or ready to purchase when she gets here IRS $1,000 refund [done].

Seth Basham

And as you think about the outlet for 2017 moving to the EBITDA line, would you expect an inflection deposited at some point this year?

Niraj Shah

Michael loves it when I give out guidance, so I generally leave that to him. But what I’ve said a number of times, we absolutely want to be in a position where we are self-financing the business. We’ve been there for over a decade of our history. So that’s the way I would describe it. Michael do you want to give some --?

Michael Fleisher

So the thing I might point to is, obviously this quarter we’ve now broken out two segment, the US business and the international business, obviously the international business with substantial investment. You could see that its now - we are investing in that business at the EBITDA line in a fairly consistent way, and so I think it’s fair to assume that that’s going to continue.

And it’s the same time I think the US business as I noted on my prepared remarks that was profitable in the fourth quarter and makes sense it’s a big quarter for us and there’s certain stuff holiday with no inflexion. I expect the US business to swing to a modest adjusted EBITDA loss in Q1.

But you can see now in the economics of that business is that as that business continues to grow at this pace the flow-through will be there. So I think it’s not hard to rent out the numbers, what’s going on in the US business, the investment bubbles we’re making and the international business sort of get to a place where you can see the inflexion point first the US business to be riding at a profitable basis and the overtime the US business profitability in the higher cost recover it off the international cost.


Your next question comes from the line of Matt Fassler from Goldman Sachs. Your line is open.

Matt Fassler

I’ve got a quick two-parter on gross margin. The first relates to your comments on the promotional environment. You might be the only company in years to say that it wasn’t as bad as you fear. That was obviously worn out in the gross margin. But a little more color on what was better and where you saw the lack of pressure will be helpful. And then just also briefly on gross margin, as your mix tilts slightly towards some of those newer categories, if you could discuss the implications of our gross margin and contribution margin if you can get it down to that level for those new businesses.

Niraj Shah

Matt its Niraj. On the gross margin, the first question about the promotional environment. I guess the way we think about that holiday is the most acute time of the year for promotions. Although to be honest we live in an environment where promotions are always running and that’s part of your merchandising strategy.

And when you enter Q4, you really don’t know what your competitors are planning to do and you can have cases where competitors frankly are giving away goods in certain areas just to stimulate their overall business or frankly drive a certain business line or whatever.

So you’re not sure what you’re going to see. You have your own plan that you really like if you know what your customers want, if you like to know where you have the valued show. But what happens is you have a lot more uncertainty than you have with other times of the year. And what we’re saying is just that when we led with offers we thought we were great. We have saved the best of a huge supplier base. We don’t carry the inventory, but we work with our key partners to plan on what we think will work well.

And we’ve just seen great success and what we didn’t see was a case where competitors were just giving away items, just try to buy that volume. And so it seems like a healthy environment to us where people were focused on making money and there wasn’t kind of that [attitude].

On the terms that (inaudible) in gross margin and in contribution margins, I’d almost tell you it’s a thing to think about exactly what you said is contribution margin. And the reason is, when you have a new category gross margin is going to be quite low and then frankly its volume is going to be quite low. So its drag on gross margin is not [fixed].

Then you will have a period of time where such ramping, while your gross margin is going up your actual drag on your company’s gross margin percent will become bigger. But your gross margin is actually getting better and better and it might even be producing a little bit of contribution margin maybe from a place where its producing zero contribution dollar.

The minute it gets bigger and bigger it will actually have a gross margin much in line with the mature parts of the business and have really good contribution margin. So you focus on the contribution dollars portion of the contribution margin, you actually have really nice curves where you kind of start off not expecting much and then as you ramp it, you’re putting in the logistical finesse, you’re getting the buying power or you’re getting the volume with the suppliers are all of a sudden you are getting that profit [percentage] out.

And the journey there you kind of need to not worry about the gross margin percentage drag it creates, because it doesn’t really create a dollar drag on the (inaudible) price. And so that’s the way I’d think about it.

So as we have more and more of these pick-offs, we hope in the not too distant future it might create swing with the gross margin percentage. But if you look at the variable contribution margin in dollars, you should see the trends you want to see where we continue to grow that nicely. And to be honest the more you have some of these pick-offs, the more not so many quarters out you see a nice ups in the contribution dollar.


Your next question comes from Chris Horvers from JPMorgan. Your line is open.

Chris Horvers

A couple of follow-up questions, first on math; so on the gross margin it was up 40 and you had modeled it down 23 to 25, roughly a 100 basis points swing. Would you say that delta versus plan was evenly split between the promotional environment and the vendor support and related to that could you talk a bit more about what exactly vendor support is? Is that scaling the business, is that exclusive items and private label items that you’re offering and helping the mix and so forth.

Michael Fleisher

It’s Michael. It’s a little hard to split it between the two because in some ways they work hand in hand. What I mean by that on the supplier side is that, we’ve gotten better and better and our relationship with our [partners] have got larger and larger, where we are much earlier in the year now planning with our key suppliers which products we think are going to have big value with our customers during the holiday and therefore (inaudible) that they have enough inventory on hand, but even more important related to this discussion is that we’re getting the sharpest possible wholesale on those items that we’re going to go highlighting to our customer as part of those promotions.

And remember we talked on previous calls about during the some of the photography and the imagery during the initial merchandising much, much earlier in the year, so we’d be really prepared for that. So part of that is the relationship negotiations the supplier get through best possible wholesale and that’s really what helps in this environment because you already are in a place where you’re running at a great price for the customer, but you’ve got enough margin for us and enough margin for the supplier to make it work all the way through the chain.

Niraj Shah

This is Niraj, let me now just jump in with Chris. I think it’s important to note that a larger math of what you see when you look at our total company gross margin you see a little ground is actually a mix. You have mix from the differential international businesses that are in different places in their lifecycle, their reverse margin levels. You see mix between the different things happening in the US, different categories and the different retail brands.

So there’s a huge amount of swing that actually, if you had all the counterparts you’d say it’s just a mix effect. And then if you isolated it and you’ve been to one area, you get in to what Michael was really discussing. But I think I’d be careful not to try to bucket it in to the (inaudible) that you have because it’s not factor related.

Chris Horvers

Understood. And as we think about going forward, do you continue to advance the planning process with the vendors such that we could see continued gross margin improvement in 2017?

Niraj Shah

There’s a lot of opportunity in gross margin for three things. One is transportation savings; if you think about last or you look at the business, transportation, advertising and OpEx headcount were all round about $400 million cost. With that transportation $400 million, as you add a lot of finesse, as you have volume you can add finesse in terms of how you bring the product in more efficiently, how you manage the whole cost from the [ForEx] and location of the [back break] and to bring it in to the domestic market that you’re selling it in and getting it closer to the end customer and how about transportation through to the last mile. So there’s a significant amount of efficiency you get there.

You’re expecting this fine car with suppliers as you mentioned. And the third, you also touched on, which is, if things are private label or your house brand, you start getting a lot more pricing leverage per statements that’s not (inaudible) on those items in the market. And so all of those unlock gross margin, and then what you tend to do is you’re giving some of that also back to the customer in various ways whether that be loyalty programs or that be certain types of - you might do things to reduce damage that have net cost savings, but basically may look in the near term as part of your gross margin a long term.

So there’s all kinds of different puts and takes, but we do think there’s continued gross margin to get it’s a very significant magnitude.

Michael Fleisher

And I think Chris to your point on near term I think we are still targeting the 23, I think that’s where we’d liked to be priced. So as Niraj just mentioned that through a litany of all these things that are positive to gross margins, we also want to then make sure we are sort of using those to price well in the market and that obviously there’s that balancing act in terms of driving growth penetration and customer satisfaction.


Your next question comes from the line of Oli Wintermantel from Evercore ISI. Your line is open.

Oli Wintermantel

Michael you mentioned CapEx is going to be 4% to 5% of revenue in the first half and then for the full year about 3%. Can you maybe help us break that out for international versus the US?

Michael Fleisher

Sure. I’m little hard to hear, but I think the questions’ about CapEx and then sort of thinking about international versus the US. There’s probably sort of two primary bucket from a CapEx perspective, generally it’s the logistics where how its build out which is primarily - you know last thing I remember we had sort of a very low capital to be around these warehouses or building. You don’t have a lot of automation and can (inaudible) etcetera. And so there’s that piece. And then the other piece is sort of what I would call the more normal CapEx technology and infrastructure.

The vast majority of that deployed has been in the US. We have sort of first CastleGate warehouse facility in the UK now and obviously we’ve invested on the technology infrastructure side in Europe as we’ve sort of built out a datacenter and sort of people there. But I would say the vast majority, it doesn’t look, I don’t have in front of me but I’m guessing it doesn’t look that dramatically different than the revenues for the right deal.

Oli Wintermantel

And then translating that in to maybe on the EBITDA level, so you mentioned the US swing to is slight negative in the first quarter and then assuming that probably in the fourth quarter of ’17 it should turn positive again like the last two years. Is it than the cadence also that maybe the second and third quarter we are wrapped around breakeven or slightly down and then turning positive fourth quarter, is that fair?

Michael Fleisher

I’m going to be extra careful not be guiding the next few quarters as oppose to just guiding the current quarter that we are in. One of the reasons we gave everybody eight quarters back that’s what between US and international so that you can see some of the seasonal pattern. Obviously somewhat that interrupted by investments we’ve made. So you can see that investment line both international and US in the 2016 number. But I think it’s sort of a reasonable pattern when you start to think about what the business might look like going forward.


Your next question comes from the line of John Blackledge from Cowen and Company. Your line is open.

John Blackledge

So with the strong repeat customer rate in the fourth quarter, how should we think about potential ad leverage in the US in 2017, any kind of sense of US ad spend as a percentage of total revenue? And then secondly on registry its seasonal, we’ve been hearing about it for a while, it should help in 2Q and 3Q. Is there any way to kind of frame or quantify the impact to the US business this year?

Niraj Shah

So on your first question about strong repeat customer rate and how does that translate in to ad spend in the US, so a couple of thoughts there. So one of the things we’ve mentioned a couple of times that if you look back over the last year, we actually have been constraining the US ad spend to actually even less in the payback period than we generally would allow it to go to. Because what we’ve been doing is we’ve been allocating more ad spend to international while overall looking for leverage on the ad spend line as a total company.

And so you can that short sighted in the sense that we should spend more in the US, but we think it’s the best outcome for the long run to actually build these international businesses that’s been a long run benefit straight off we’ve made for the short term, less benefit in the US business.

So what will happen in this coming year is that, I don’t know that we are interested in constraining it to the point where we’re really leaving a lot of low hanging fruit up there. So ad spend is not necessarily a place that I think you should look to see a lot of leverage. I think we want to continue to acquire customers at a really fast pace, where frankly we’re getting a really good payback.

So, we’re not looking to add a huge amount deleverage either, but we’re not looking to squeeze ourselves to where we’re not taking advantage of good opportunities. So that’s business.

Michael Fleisher

The one thing I’d add to it. As the international businesses continue to mature and we’re obviously making substantial investment there still. But we would hope that as those businesses start getting repeat base of customers and start to feel that even though as their mix grows it hurts ad spend as a percent of revenue in total. Their level of ad spend as a percentage of revenue is getting better and therefore if we lessen that with US has to pick up lots of value.

Niraj Shah

The thing I’d point out on registry, the registry is a longer cycle of things, because you’re marketing post (inaudible). They set up their registry, they get married in the spring and summer and that’s really when the purchases occur. And because it is our first real annual cycle, what we’re doing there is we are frankly we are marketing it, we are advertising. But it’s one of the things where we have a quite a good plan, its reasonably ambitious. But should have worked well and then what you would do is you would increase it substantially, but that would be for the following year, because it really is an annual cycle. You don’t have the ability like we do it most of our adjustments is continually adjust and increase it because you kind of one specific period when you get the customers and then it takes quite a few months for you to see what the payback was and then adjust it again.

So that one I wouldn’t expect to see huge impacts on the US financial performance this year, probably it’s because it’s so new and it takes a little while for that feedback cycle to work. But we really do like that business, because if you think about those customers and you talk about the millennial, 70 million people between 17 and 34, well they are just starting to get married. They are the folks who then for the next 20 years will be holding good buyers as they start their families and they buy their house and all of that.

So, that’s really a strategic benefit of it, but I don’t think a few years it has to really (inaudible) in terms of our share of registry market and things like that.


Your last question comes from the line of Michael Graham from Canaccord. Your line is open.

Michael Graham

Just wanted to ask on growth in the domestic business just going back to something. We first rough-in on a number for Q1, we sort of get high-teens growth for direct retail revenue for the domestic business. And I know Q1 last year was another tough comp. Wondering if you have line of sight on things that could help that domestic business reaccelerate at may be some of these new categories or new offerings that get big enough in the mix or do you more see the domestic business on a glide path to mid-teens and lower. Just any color there in general terms would be helpful.

Niraj Shah

A couple of thoughts, first, I don’t have obviously your model in front me. But some of those numbers you’re throwing out slightly is perhaps being a little low. The way I would rephrase it is, what we’ve been doing here is we’ve been allocating money away from the US in to international and then within the US we’ve been allocating money just proportionally more in the longer cycle of benefit than near-term benefits.

Longer cycle meaning they’ll be up in these new categories, evenly switched two logistics network, cascade the way for delivery network, which actually are proving to have very substantial benefit, but they take longer to rollout and really scale back to a large percent of the business. But we think that and that’s actually we’ve been working on these things for a year and a half, two years in some cases and they’re starting to really take share quite well.

So to answer your question, there are significant things that should affect US businesses build (inaudible) to drive repeat, to drive new customer acquisition, the overall corporate and that will continue to come on line that we would expect to be very simulative.

That said, I also think your numbers are a little low and the way I would characterize where we would like to be is, we want to be a significant share taker. So if you believe that the overall market is growing at 15%, you would then want to be meaningfully above that. If you live to a market that’s growing at 10%, you want to be meaningfully above that. If the total market’s growing at 20%, you want to be meaningfully above that.

We think the overall market online is growing around 15 plus (inaudible), and so we wouldn’t be very happy if we were growing at 15 raised or for a long period of time. We won’t be growing at a very significant rate above that while still preserving our unit economic, not using advertising to be cumulative to it, not using pricing to be cumulative to it. Rather through the strategic things like the logistics and like the merchandizing, building up these categories, the customer experience and mobile all of these types of things.

So really that’s not may be a specific guidance for you, but that’s the way we think about it and that’s the way we look for it to play out.

Michael Graham

Okay, that’s helpful. Thank you.

Niraj Shah

Everyone I think that wraps up the question. I’ll turn it over to the operator. But thank you for joining us this morning.


This does conclude today’s conference call. You may now disconnect.

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