Wayfair Inc (W) 2015 Q2 法說會逐字稿

Good morning, ladies and gentlemen. My name is Chris, and I will be your host operator on this call. At this time I'd like to welcome, everyone to the Wayfair Q2, 2015 earnings release conference call.

(Operator Instructions)

At this time, I would like to introduce Kate Gulliver, Head of Investor Relations at Wayfair. Please go ahead.

Good morning and thank you for joining us. Today we will review our second-quarter 2015 results. With me are Niraj Shah, Co-Founder, Chief Executive Officer and Co-Chairman; Steve Conine, Co-Founder and Co-Chairman; and Michael Fleisher, Chief Financial Officer. 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 third quarter of 2015. These statements are only predictions based on assumptions that are believed to be reasonable at the time they are made and are subject to significant risks and uncertainties. You should not rely on these forward-looking statements as representing our views in the future.

Except as required by law, we undertake no obligation to publicly update or revise these statements. Our actual results may differ materially and adversely from any forward-looking statements discussed on this call. For a discussion of factors that could affect our future performance, results and business, please refer to our Annual Report, or Form 10-K, our quarterly report, or Form 10-Q, which we expect to file in the near future and other reports we have on file from time to time with the SEC.

Also, please note that during the course of this conference call we may discuss certain non-GAAP financial measures as we review the Company's performance. Please refer to the Investor Relations section of our website to obtain a copy of our earnings release and the slide accompanying this call 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 is available for replay on our IR website. Now I would like to turn the call over to Niraj.

Thanks, Kate. And thank you, everyone for joining us this morning. We are pleased to share our second-quarter results which show the ongoing strength of our business model.

The total business grew 66.4% year over year, to $491.8 million in revenue for the quarter. Our direct retail business, which in Q2 was almost 90% of the total, grew 80.8% year over year for total revenue of $440.3 million for the quarter. As a reminder, our direct retail business consists primarily of sales from the website and apps of our five brands -- Wayfair.com, Joss & Maine, AllModern, Birch Lane and DwellStudio.

The direct retail growth rate this quarter is the fastest growth we've seen since Q1, 2014 and reflects both the ongoing strength in new customers and the increasing repeat behavior from our existing customers. We ended the quarter with 4 million active customers, an increase of 53.5% from Q2, 2014, and a net increase of approximately 447,000 customers from the prior quarter.

While new customer growth is strong, we are particularly excited about the repeat behavior we see from our current customers. The percent of orders from repeat customers increased this quarter to 56.6%, up from 53.9% in the prior quarter. And annual orders per active customer increased to 1.67 from 1.64 in the prior quarter and 1.62 in the second quarter of 2014.

As we shared last quarter, we believe that the continued growth in both new customers and repeat behavior was partly a result of the strategic shift we made to our advertising strategy in early 2014 when we both increased our advertising spend and focused on attracting higher-value customers who we believe have a higher propensity to repeat. Accordingly, we have seen the second quarter in a row of increasing revenue growth combined with year-over-year ad spend leverage. Ad spend as a percent of sales in Q2 was 12.5%, a 190 basis points improvement from Q2, 2014.

We also believe that the sustained revenue growth we are seeing is a reflection of a truly differentiated customer experience from on-site discovery and selection through to delivery. As I talk to our customers one of the things they always comment on, in addition to our broad selection and our great prices, is our customer service team. Our customers really love being able to call up and get live customer service support to help them with their questions.

About a year ago we opened our third US customer service center in Orem, Utah. We now have close to 800 customer service representatives in four centers globally -- Galway, Ireland servicing our European customers, Boston, and Orem and Ogden, Utah servicing our North American customers. We believe that skilled and thoughtful customer service is a key part of the home goods buying experience.

The home category has a higher average order size, often more complex delivery and in general is a more considered purchase, which can lead to customer service calls across multiple points in the order process. We receive pre-order calls from customers looking for further information on everything from the firmness of a sofa to have their teak dining set will weather when left outdoors. Our talented employees are prepared to answer these questions, with highly specialized training in key categories. And they'll work with the customer to help her find the perfect item and ultimately help her place the order.

Post-order placement, we receive calls on delivery timing, product set up, and if necessary how to handle returns or damages. While we continually strive to make our on-site experience as complete as possible, we do believe that given the nature of the purchase there will always be some amount of customer support necessary. And we are not only happy to provide it, but we focus on meaningfully exceeding her expectations. As our organization grows, we continue to expand the customer service team and are currently evaluating locations for our next customer service center in the United States.

Another way we work to differentiate the experience for our customers is through a unique and growing private-label strategy. Over the past year we've launched several private label brands on Wayfair.com. This approach allows us to work with our existing supplier base to curate a specific look and feel with unique products and to scale this model without taking inventory.

Launched earlier this year, Three Posts is an example of one of these brands. It offers a traditional American aesthetic at a moderate price point. Three Posts offers over 500 different products across a range of categories which we've sourced from a variety of suppliers. We create these product assortments by selecting items, building the collection and merchandising the items, which includes shooting our own photography.

We're particularly excited about the engaging imagery the brand uses, allowing customers to really imagine how the product would look in their home. The Three Posts brand can only be found on Wayfair. Three Posts and brands like it enable us to provide the customer with a better shopping experience through unique products and curated stylings.

We're able to work with our suppliers to offer products that fit the style of price point our customers seek, while we're also building a differentiated selection on Wayfair. Similar to how we operate all the various facets of our business we are building these brands and selection without carrying inventory.

Now, before diving deeply into the numbers, I'd like to hand the call over to Steve to touch on engineering and technology development.

Thanks, Niraj. And good morning, everyone. As many of you likely saw from our press release in May, Jeremy Delinsky recently joined our team as Chief Technology Officer. As our engineering team has grown we now have over 350 engineers and data scientists. Niraj and I increasingly felt the need to bring someone in on the technology side with the experience to help us scale this critical part of our organization. We're very excited to have Jeremy join the team and help us in that endeavor.

Prior to working with us Jeremy was at athenahealth for over 10 years, one of the most innovative companies in the healthcare software services space where he was CTO for over four years and most recently Chief Product Officer. In his role as CTO at athenahealth, Jeremy oversaw the development of the R&D team from 200 to over 1,000 employees. His leadership helped the team to expand and scale their efforts in software development, user experience and technology structure. As CPO, he led the development and commercialization of athenahealth emerging products.

At Wayfair Jeremy will use his expertise in building teams, infrastructure and innovation to help us appropriately structure and scale the organization in this period of rapid growth. Jeremy will report to me and I will work closely with him on these initiatives on a day-to-day basis. But I'm also excited to be able to have some more time to focus on larger strategic issues for engineering and product development and the Company more broadly.

We're very excited to have Jeremy join the team and help us build THE leading site for the home. I'll now turn the call back over to Niraj.

Thanks, Steve. I'll echo Steve's enthusiasm about Jeremy. Our technology is really the backbone of our organization. We use it to power all facets of the business including merchandising, marketing and operations. Ensuring the success of this team is critical for our end-to-end customer experience. We're very excited to have Jeremy on board.

We're also pleased with our second-quarter performance, particularly the acceleration of the direct retail growth rate and the improvement in repeat behavior from our customers. The growth the business is experiencing is a result of the work we do on the front end to enhance the customer experience and the work we do on the back end to interface with suppliers and improve logistics. Combined these efforts are helping to create the ultimate shopping destination for the home.

I'll now hand the call over to Michael to walk you through the financials.

Thanks, Niraj. And good morning, everyone. As always, I will highlight some of the key financial information for this quarter now, with more detailed information available in our earnings release and the slide accompanying this call, which can be found on our IR website.

In Q2, our total net revenue grew 66.4% year over year, to $491.8 million. As Niraj described, this growth was driven by our direct retail business which grew 80.8% over Q2, 2014, to $440.3 million.

Our other business which includes revenue from our small media business and from our retail partners, declined 0.9% over Q2, 2014, to $51.5 million. This decline is consistent with our strategy to focus increasingly on our direct retail business, now almost 90% of the total business, where we own the customer relationship.

Our gross profit for the quarter, which is net of all product costs, delivery and fulfillment expenses, was $120.8 million or 24.6% of net revenue. This is compared to 23.2% in the same quarter last year and 24.2% in Q1, 2015. The change in gross margin on a quarterly basis is a result of normal fluctuation due to the wide range of products that we sell, and the benefits of larger scale.

As we've shared with you before, we believe the appropriate gross margin threshold for the business in the near term is mid 23% to low 24%. It is not our intention to remain at this quarter's gross margin level of 24.6%. So, we are giving some of this margin back to the customer in the form of price, delivery and customer service.

The remaining financials I'll share on a non-GAAP basis, excluding the impact of equity-based compensation and related taxes which totaled $7.1 million in Q2, 2015 and $974,000 in Q2, 2014. As a reminder, prior to the IPO, we only had equity-based compensation expenses recognized in relation to tender offers. Post the IPO, we recognize equity-based compensation each quarter in all line items that have headcount. For a reconciliation of GAAP to non-GAAP reporting, please refer to our earnings release on our Investor Relations website and the slide that accompanies this call.

Customer service and merchant fees were 3.7% of sales, compared to 4% in the same period last year, and consistent with Q1. In general, we view this cost as a variable expense that will stay fairly consistent over time. As Niraj pointed out earlier, the small portion of this expense that represents our customer service team generates nice returns in terms of customer satisfaction and repeat buying behavior.

Advertising spend was 12.5% of revenue in the quarter, or $61.5 million. Year-over-year advertising spend as a percentage of sales improved 190 basis points from 14.4% of revenue in Q2, 2014, and improved 120 basis points over Q1, 2015.

As we described on the last two calls, we anticipate ongoing year-over-year leverage in ad spend as repeat buying continues to grow. We spend far less on advertising to get our existing customers to buy again than to acquire a new customer. Therefore, as orders from the existing customers become a larger portion of the base, we anticipate continued improvement in ad spend leverage.

This quarter we did see higher than anticipated leverage due to our strong revenue performance. As we've described before, we carefully manage ad spend throughout the quarter and we only spend when we believe we get the right ROI and visibility on payback. And our view and target on these metrics have not changed.

Therefore with the revenue outperformance this quarter, we saw some incremental flow-through resulting in increased leverage. I do want to make clear that we remain committed to aggressively spending to gain new customers and we'll lean in any time we have opportunities to scale customer acquisitions in a way that hits our ROI and payback goals.

As Niraj highlighted in his remarks, we saw particular strength in the repeat business this quarter, with orders from repeat customers up to 56.6% of total orders. LTM net revenue per active customer grew 7.5% to $357 annually, and LTM orders per active customer grew to 1.67 from 1.62 a year ago. While we do anticipate quarterly fluctuations in repeat metrics, we're excited about the strength in our core customer base.

We also saw strength in new customer acquisitions this quarter. We added approximately 447,000 net new customers, more than we've ever added before. We believe our growing brand awareness and the investment we've made in brand advertising, both through TV and online, have helped to drive new customer acquisitions.

Our merchandising, marketing and sales spend on a non-GAAP basis was $20.6 million or 4.2% of net revenue compared to $13.1 million or 4.4% of net revenue in Q2 last year. Non-GAAP operations technology in G&A expense was $32.8 million for the quarter, or 6.7% of sales compared to $23 million or 7.8% of sales in Q2 last year. These two line items are primarily headcount, and the increase in spend both on a year-over-year basis and on a quarterly basis is due to ongoing investment in our teams.

Our hiring efforts continued to scale in the second quarter, where we added over 225 net new employees. Even with over 225 net new people starting, we saw a greater leverage on operating expenses as the pace of hiring was not as fast as we'd like to keep up with the revenue growth. We continue to add to our recruiting team to help increase the speed of hiring in the upcoming quarters as we believe it's important to invest in our team now to meet the growing needs of our business.

Adjusted EBITDA for the quarter was negative $5 million or negative 1% of net revenue compared to negative $17.6 million or negative 6% of net revenue in the same quarter a year ago. The year-over-year improvement in EBITDA margin was driven by leverage in advertising spend and headcount, as I just described. Although we increased total advertising dollars spent and rapidly expanded the team in the second quarter, revenue growth outpaced our ability to invest and hire, contributing to more flow-through than originally forecast.

Non-GAAP free cash flow for the quarter was positive $11 million. This positive free cash flow was driven by net cash from operations of $28.5 million, primarily as a result of the favorable working capital dynamics in our business. The positive cash flow from operations was offset by $17.5 million in capital expenditures for the quarter.

Non-GAAP diluted net loss per share was negative $0.15 on 83.6 million weighted average common shares outstanding. As of June 30, we had $366.7 million of cash, cash equivalents and short- and long-term investments.

Our inventory level was just $21.3 million or 1.3% of LTM sales. It's worth noting that although the overall business has grown 66.4%, inventory has stayed fairly constant at just $19.8 million in the same period last year. Overall we're very excited with our second-quarter results and the continued strong revenue growth from both our new and repeating customers.

I'd now like to offer guidance for Q3, 2015. We forecast direct retail revenue of $445 million to $475 million, a growth rate of approximately 56% to 66% over the same quarter last year. Given the extraordinary growth that we've recently seen in the direct retail business, I want to give a little more context for this guidance than we typically do.

The 56% to 66% growth rate is faster than the guidance we gave on our last earnings call, but still below the nearly 81% growth in the direct retail business in Q2. In our business, growth is ultimately based on the customer showing up every day. So it's very difficult to forecast that the recent growth rate sustain, particularly as we enter a period with increasingly higher sales on a dollar basis in the prior year.

We're trying to manage the guidance process to be transparent and not give an outsized beat, as happened in the last quarter. But we also want to be prudent as we are only midway through the quarter. Recently in Q3, we have experienced a direct retail growth rate above our guidance of 56% to 66%, but at a rate that is lower than the Q2 direct retail growth rate of 80.8%.

We expect other revenue to be between $45 million to $50 million for total net revenue of $490 million to $525 million. We forecast EBITDA margins of negative 2.5% to negative 3%. We will continue to invest in the business to create sustained growth in the long run, and do not expect to see the level of flow-through that we saw on last quarter's revenue beat.

As I previously described, we will invest this coming quarter in advertising as long as we can get an efficient, timely ROI and hiring where we continue to grow our team to both support our current scale, and invest to staff all the initiatives that will drive our future growth. For modeling purposes for Q3, 2015, please assume equity-based compensation expense of $11 million, average weighted shares outstanding of 83.9 million, and depreciation and amortization of approximately $8.3 million.

Before turning the call back over to the Niraj I want to touch briefly on our announcement in July about the sale of our Australian business. As a reminder, our International business as a whole is less than 6% of total revenue, the vast majority of which is our European business. We see significant opportunity in the US and Europe, and, as we scale, we want to focus our efforts on growth in these large markets.

The divestiture of the Australian business helps us to strategically align our resources with these priorities. As the sale occurred in July, the proceeds from the sale, which are immaterial, will be accounted for in our third-quarter financials.

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

Thanks, Michael. We're excited about our second-quarter results and the continued momentum in our brand. We believe these results are a direct reflection of the strategic shift we made in advertising in 2014, and the ongoing investments we are making every day to make Wayfair the leading destination for all things home. Strong customer loyalty is driving higher growth and improving leverage which will ultimately help us deliver long-term value to our shareholders. We think the home space represents a fantastic market opportunity and we look forward to sharing more good news with you throughout the year.

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

(Operator Instructions)

Matt Nemer, Wells Fargo Securities.

Congrats on a great quarter. My first question is on gross margin. Just curious if you can talk to the factors that led that to jump a little bit outside of your target band. Is it a function of mix, private label, or something else? And then, secondly, as you reinvest some of that upside, will we see that in prices or shipping speed or some other part of the customer experience?

Matt, it's Niraj. You basically answered the question, I think. The gross margin increase, private label certainly helps and we're trying to aggressively grow private label. Mix obviously affects it. The other thing I'll just point to is that we've talked about transportation costs efficiencies in the past, and a lot of the things that will benefit us with transportation costs and supplier leverage come out of scale. And obviously we're growing, which helps. In terms of where we'll reinvest it, there's obviously multiple places to reinvest it and different aspects of the customer service experience. You talked about fast shipping, you talked about lower prices. Effectively, we collect a lot of information and then we reinvest it in multiple areas where we think we get the most benefit.

Okay. Great. And then, secondly, I'm just wondering if you're seeing any pressures on the business given the higher-than-expected growth. You talked about trying to push a little bit harder on hiring. Any movement in customer service metrics given the revenue upside in terms of speed to pick up a call or time to ship, anything like that that may have been impacted by the outsized revenue growth?

We've always been a very customer service oriented organization. For our first few years the only way we hired people into the Company is you actually started in customer service. Steve and I answered calls for probably the first four years of the business. We still do a lot of customer work. We definitely are very keenly focused on those metrics. Needless to say, as we grow faster we obviously need to scale our customer service organization faster. But we are well attuned to that. I think one of the things you heard on the call, we're going to be opening another customer service center in the not too distant future. So, we try to stay ahead of it with our planning. That's the key way to think about it. We actually brought in a new head of customer service just a few months ago, Liz, who is off to a great start. Long story short, I think there will always be bumps in the road and we do our best to stay ahead of them. The growth we're seeing now, the benefit of it is we've always been attuned to growth and trying to stay ahead of it. So, that's a little bit of the life we lead.

And just to finish up, I realize that Wayfair is far and away the biggest brand, but any commentary on how the different brands may be performing?

We don't really give breakouts of the brands, but the way to think about it is exactly what we said in the past, which is Wayfair is by far and away our biggest brand. So, at the end of the day, when you look at our overall direct results, there's no way that Wayfair could be far away from that in either direction.

Got it. Great. Congrats again. Thank you.

Neely Tamminga, Piper Jaffray.

Congratulations on a great quarter, guys. Just wanted to ask a little bit more on the repeat behavior. It sounds like that's really very much a call out, Niraj. If you dig deeper into the data, we're just wondering if you have some qualitative or common distinctives across the board with some of these repeat customers, their buying behavior? For instance, do they crescendo or escalate in their frequency? What does their average ticket look like? How are they behaving, your daters versus the people who are marrying you in terms of your brand? And are they assimilating into other categories? Any qualitative commentary you could offer there would be really helpful. Thanks.

There's no acute reason the repeat overall is growing. It's a combination of the two key things. One is that a higher percentage of people who buy for the first time come back and buy again, coupled with the fact that the people who buy again buy more than they did previously. Both of those axes are advancing and we view that as a good sign. Our business is not one that's really about whales. It's not a super small population driving a very large percentage of revenue. So, say, you have bigger customers, smaller customers, but it's really much more broad-based, which is why we look at things like the ongoing growth in the brand strength of Wayfair. We think Wayfair's on its way to becoming a national brand. And, so, we look at awareness and favorability and a whole series of things to measure that. We look at the sources of our traffic and we're getting an increasing amount where people are coming, they're either directly typing in Wayfair or they're directly engaging with us, whether it's through our app or through our e-mail or what have you. There's a lot of things we look at. All of those I think are effectively leading indicators for this continued growth in repeat and we believe we're on a continued good trajectory there.

Great. Thanks. One follow-up question, just more on the final mile delivery program. Could you just remind us where you are in your process in terms of, do you have physically Wayfair trucks in that final mile delivering? Are you in all the key MSAs you want to be in? Or where are you again on that process, just as an update?

Sure. The way I would describe that is it's not a finite journey that we started and will end. It's something that we've continued to make it better over time over many years. But the phase we're in now is we're increasingly moving to dedicated delivery operations. Whether it's us operating it or a partner operating it, it's dedicated to Wayfair orders. And by dedicating it to Wayfair orders, they can follow our procedures and our service levels for every order on the truck every day, which then allows the drivers to specialize and it allows us to use our technology around scheduling and things like this. That's the phase we're in now. And I would say we're not that far into that phase. There are some markets that are operating in that manner but we're still in the early days of fully rolling that out.

That's helpful, Niraj. Good luck, you guys, here in Q3.

Deb Schwartz, Goldman Sachs.

Thanks and congrats on the quarter. Two questions, if I may. First on average order value, it was flattish year over year but up sequentially quarter over quarter. Can you help us understand if there's seasonality in that metric and how we should think about it going forward? And then, secondly, just to follow up on purchase frequency, any changes you've been making in terms of personalization or recommendations or even retention advertising spending that has been additional drivers of that metric in the quarter?

Sure. On your first question about average order value, what I would say there is two different things. One is it does bounce around some. I realize that's not a super gratifying answer but there is some truth in that. The second specifically there is some seasonality, so that is a piece of it. The other thing is we did have an exceptionally strong outdoor season and outdoor furniture does tend to pull up the average order value. But obviously we had outdoor season last year but we had a very good season this year, so that helps. But it will, I think, just from an expectation standpoint bounce around a little bit. So, that's why we've tried to say obviously that's a number you can always derive because we give you the number of orders and revenue. We try to focus you to not focus on that as a particularly key metric because that's more just an outcome of everything else that's happened versus something we're trying to deliver at any particular number.

In terms of your second question, which I think was around what's driving purchase frequency, purchase frequency I think is being driven up by a few things. One is the increasing brand strength where we're becoming a customer's go to for more and more things. Obviously we're doing more and more with personalization. That obviously is helping us be more relevant to customers and I think that helps drive it up. We're doing more with seasonal events and seasonal merchandising which helps us be relevant, obviously, which helps, as well. And then there's certain categories we've been pushing into like seasonal decor and decorative accents and some other categories that historically have not been as big for us that we think have a naturally higher frequency than some categories we are strong in. Obviously that will help as we become the go to in categories we're known for, and then we add category strength in categories we're less known for.

Great. Thanks, Niraj.

Michael Graham, Canaccord Genuity.

It's Austin on for Mike. Are you able to give any guidance around ad spend leverage like you've done in the past two quarters, and maybe what you're expecting? And then I know you've mentioned a little in the past but can you update on the ad spend, the split between existing versus new customers and how that's changing maybe? Thanks.

Sure, Austin. It's Michael. I think the best way to say it on ad spend in terms of going forward is we continue to expect annual year-over-year improvement and I think you'll see that. You've seen that the last two quarters and I think that will continue. But we're not going to guide it more tightly than that. And then what was the second part of your question?

Just on the split between existing and new customer ad spend?

As we talked about before, we obviously spend a lot less to get a customer to come back and buy again. Obviously you can see that the mix in our business orders from repeat customers is up again this quarter. So, obviously there's a bigger mix there, as well, because that's where we're spending it, but we spend a much lower percentage of revenue to get a customer to come back than obviously bringing a new customer into the fold.

John Blackledge, Cowen and Company.

A couple questions. For private label goods, how do you determine which types of goods to offer and how should we think about the rising mix of private label SKUs over time? Also if you can comment on the margin differential for private label. And then the other question would be, just remind us long-term EBITDA margin profile and any particular changes with the business growing better. Thank you.

Sure. John, Niraj. On private label what I'd say there is we're taking a fairly aggressive approach to private label. In terms of what types of goods I would say the main area that we're focused on is furniture and decor. By that I mean we are not focused on plumbing fixtures or flooring or some of our home-improvement renovation areas. We're doing a small amount in housewares, but in furniture and decor we're fairly broadly aggressively going after private label, meaning a wide variety of styles as well as a wide variety of categories. Now, it's important to note private label for us is slightly different than for others because the way we scale it is we do not take inventory. They not taking inventory and the breadth of our supplier relationships let us do a lot more in parallel at a much faster speed. And because we're not taking inventory, it obviously changes the cash dynamics of being aggressive in private label. We believe having a much bigger selection is far more powerful than having a narrow selection. That's kind of a key tenet of our private-label strategy. Long story short, we are going pretty aggressively after it.

In terms of margin, what I would say there is the margin profile of private label is meant to be higher -- it's one of the reasons our gross margin will rise over time -- than the gross margin of our in-line goods. But the main goal of private-label is not necessarily to maximize margin. We're really trying to shift the business increasingly to this broad assortment that's private-label but we're not necessarily -- some folks talk about how it's 20 percentage points higher in private label or something like that. We're not trying to get anything like that. It's a much more modest increase.

And on the third part of your question, nothing's changed in our long-term EBITDA margin goals of 8% to 10%. And I think everything we're seeing in the business gives us continued confidence that that's the right place to be targeting long-term.

Thanks so much. Thank you.

Oliver Wintermantel, Evercore.

Can you talk a little bit about the seasoning of the repeat customer or, in other words, how did your repeat customers last year behave compared to the relatively new season repeat customers? I'm talking about frequency and the average spend.

We have a chart that we've put out in the past and we continue to update it periodically -- so the next time we put it out we will update it -- where we show different cohorts and their spending over time. And on that chart, what you do is you see a clear market increase from year to year, meaning the 2011 cohorts are lower over all periods going out than the 2012. We launched the brand just in late 2011. And 2013 are higher than 2012. 2014 is higher than 2013. And the thing you'll see the next time we update it is that 2015 is higher than 2014, and these lines, the trends continue. The shift we had in advertising to acquire higher-value customers we think has worked very well, it's been very productive. But it's also been augmented by the fact that the site experience keeps getting stronger, the delivery network keeps getting stronger, the merchandising keeps getting stronger, the brand keeps getting stronger. So, long story short, we expect this trend to continue.

Okay. Great. And then on the customer acquisition cost, by our math it's down about 8% in the first quarter and down another 8% in the second quarter. That low to mid -$60 range, do you think that's sustainable for the second half and then going forward? Are there any specific drivers that should change that going forward?

We gave out the method to calculate that. And we did that just to try to show that in this very conservative calculation, customer acquisition cost is effectively flattish, is the way I would describe it. So, while it's bouncing around, it's bouncing around in a range that effectively makes it look flat over time, in our view. What I would tell you is that, in truth, that's not a great way to calculate it because what you're doing is you're taking the brand spend on TV, that $40-million-odd a year, you're taking the money being spent, the low percentage ad cost money being spent on repeat customers, and you're putting all of that in with the money spent for new customers and just putting it all against new customer acquisition. Which obviously is not an entirely great way to look at it but it's a very conservative way of looking at it. And when you look at it that way and you see that payback, effectively that one-year timeframe, it gives you comfort that we have the horizon insight. So when I tell you to expect that -- we expect that number to be flattish in the same way it's been flattish since the beginning of 2014. But what we'd tell you is the way we manage it internally is more nuanced than that.

Thanks very much.

Paul Bieber, Bank of America Merrill Lynch.

First off, can you provide some color on the active customer acceleration? Are we seeing the strength from several quarters of TV advertising? Or are you finding more efficient online marketing channels?

Paul, it's Niraj. Obviously the brand getting stronger helps everything. But one thing I'll point out, just remember, our advertising cost is, by and large, being spent on new customer acquisition. So, only a small portion of it's repeat customer oriented. That $40 million, which sounds like a lot of money for TV, in some respects, is not very much when you look at our overall size of our business and the overall money we spend on advertising. We spend a fair amount of money getting new customers. It's being very productive, so we're getting a great number of new customers. In truth, the number of active customers we have is still pretty small, it's just over 4 million. So, what I would tell you is we still think there's a lot of running room before there's any headwinds on us getting the next set of customers because we think there's about 60 million customers for whom we would be a great fit in the US alone. So, we think that it's still early days in that regard.

Okay. And one quick follow-up, I think last Q4 you benefited from some very strong merchandising execution. Any big plans for this holiday season from a merchandising perspective?

We always have big plans. We have ambitious plans. When we report Q4 with the benefit of hindsight we'll be able to tell you how it went. We think there's a lot of opportunity on many axes and merchandising's certainly one of the -- we actually are just setting up a relatively large photo studio just outside of Boston, 50,000 square-foot studio that opens very shortly. There's a lot we're going to keep investing in, in the right merchandising or the right product assortment for the right kind of technology on the site to make a great shopping experience, whether you're using a browser or the app, as well as what we do for visual imagery and all of this. So, yes, we're excited about what we're doing this holiday.

Okay. Thanks. Great quarter.

Mark May, Citi.

I had two, if I could. I just wanted to clarify -- I believe in Michael's prepared remarks he guided to not expect further gross margin improvement from here. I think the timing was maybe in the second half. But with your aggressive focus on private label and the scale benefits on shipping costs that you referenced earlier, just wondering why wouldn't you continue to see gross margin expansion even in the near term? And then, secondly, I think your recent marketing initiatives clearly appear to be paying off, including more efficient acquisition. But you alluded to possible deleverage in the second half in your guidance. So, just curious why you'd expect the recent ad spend leverage trend that you've been seeing of late not to continue in the second half. Are there some specific changes in channel or other initiatives that you're expecting? Thanks.

I think on the ad spend side, to be clear, we expect to see continued leverage year over year. I was really more talking to not expecting sequential ad spend leverage. But year over year, as we've said all along, we expect to continue to see ad spend leverage throughout the course of the year, including in the back half. On the gross margin question, yes, as we scale there's gross margin opportunity. And the private label products create that, as well. But, again, as we've said all along, our goal is to create gross margin improvement and then share some of that back with the customer. When we think about our long-term growth strategy and what we're really trying to drive in the business, that sharing is a super important piece of that. So we're tightly targeted in that high 23%s, low to mid 24%s as the place where gross margin should be. It's obviously crept up some now because of some of those benefits, and now we'll give some of that back to the customer. And that's the way we've handled it over the last several years and we'll continue to do that going forward as we work towards those long-term gross margin targets of 25% to 27%.

And, Michael, if I could just follow up on that, the way you're giving it back, is that through pricing, like product pricing, or is it other initiatives? I assume it's mostly on product pricing. Do you need to do that? Do you see competitors that are coming in with lower, more aggressive pricing? Or why do you feel the need to give back or lower prices?

Mark, it's Niraj. It's not really competitive. As you can see in this last quarter, we just had pretty high gross margin relative to what we've had in the recent past. And we had pretty large revenue growth acceleration. Obviously if pricing was critical to driving growth, then the outcome we just had would seem unlikely. So, obviously, what you're seeing is that you can have higher gross margin and significantly inflect up the growth rate while getting the marketing costs to come down significantly. But our view, we take a long-term view. There's certain things that we think would be nice long-term boons for the business, and sometimes that's the way in which you might use pricing in a relatively new category where you don't yet have supplier leverage. There might be certain things you want to do on the transportation logistics side that in the long run save you money, but when you first roll it out in the immediate near term, you don't have it fully rolled out to where you have the efficiency gains right away. So, there's a series of things you do that keep playing for the long-term big wins, but are opportunities in the near term to accelerate that where it may cost you a little bit of money. So, it's a mix of things. But it's not really competitive reaction on price.

Great. Congrats.

Aaron Kessler, Raymond James.

A couple questions. Good quarter. First, from a marketing perspective to existing customers, anything you're changing on your end to maybe increase repeat purchase behavior such as different types of e-mail marketing? Second, any sense that the business is maybe becoming more seasonal? I know you historically said it's not that seasonal but we saw both 19% sequential growth and it goes much stronger than last year. And any vertical specifically driving the stronger growth in Q2? I think you mentioned outdoor furniture. Anything else? Thank you.

I think, Aaron, on the marketing side there really isn't anything that's changed. I do think all the work we've been doing and the investments we've made around personalization, all the work we're doing and investment we've made in the site experience, and how we're communicating and talking to that existing customer, I think we're seeing the benefit of all that hard work by all of our folks. And I don't think that there's anything that's changing in terms of seasonality. As we've talked about before, we're getting better and better at taking advantage of seasonal promotional opportunities. But I don't think that that's going to dramatically change the mix quarter to quarter of the business from a seasonality perspective.

Got it. Finally, I noticed the operations tech in G&A was probably the biggest increase on your expense line. I know you talked about increased hiring there. Anything specific you would point to in terms of driving the higher expenses across that category?

Obviously one of the most important investments we're making is continuing to add engineers and grow the technology base of our business. It's what really powers and undermines the whole business. And then also continued investments in the operations side of the business, all of the delivery and logistics and all of that, as well. So all of that is an important place to be investing.

Okay. Great. Thanks a lot.

Thanks, everyone for joining us for the call. Look forward to talking to you next quarter. Take care. goodbye, everyone.

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.