Wayfair Inc (W) 2015 Q3 法說會逐字稿

Good morning. I will be your operator on this call. At this time, I would like to welcome everyone to the Wayfair Q3 2015 earnings release and conference call.

(Operator Instructions)

Thank you 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 third-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 fourth 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 the 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, 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.

Thanks Kate, and thank you all for joining this morning. We're excited to announce that the business continued to experience accelerating revenue growth this quarter, with the total business up 76.7% year-over-year to $594 million in revenue. Our direct retail business grew 90.9% year-over-year to $545 million. This is the fastest year-over-year growth rate for the direct retail business since Q4 of 2013, and represents three quarters in a row of accelerating growth.

As a reminder, our direct retail business consists primarily of sales from the websites and apps of our five brands: Wayfair.com, Joss & Main, AllModern, Birch Lane and DwellStudio. Wayfair.com is by far our largest brand, and its trajectory is the primary driver behind the direct retail growth rate. Many factors contributed to this phenomenal growth rate, including the day-to-day improvements we make to our site, and our ongoing efforts to provide best-in-class customer experience from product selection to delivery, and also the improving strength of our brand.

This quarter, our aided brand awareness reached 67%. This is compared to 52% in these same quarter a year ago. Our multi-channel advertising efforts, including television, display and social are driving this steady increase, and while we are pleased with the improvement, we believe there is still significant opportunity to further grow our awareness.

We ended the quarter with 4.6 million active customers, an increase of 60.6% from Q3 2014, and a net increase of approximately 547,000 active customers from the prior quarter. This is almost 100,000 more net new active customers than were added last quarter. Orders from repeat customers represented 55.2% of total orders, and annual orders per customer -- per active customer, increased to 1.69 from 1.67 in the prior quarter.

Our history of driving new customer growth and repeat customer growth is continuing its phenomenal trajectory, as seen on the updated charts we have posted to our IR website. This quarter, we added a new chart to more clearly show the break out between orders from new and orders from repeat customers. In Q3, orders from repeat customers grew an incremental 173,000 over the prior quarter.

As we have said since before our IPO, our investment strategy is simple. On one hand, we are investing in advertising to acquire high-quality new customers, and concurrently, on the other, we are investing in the site experience, merchandising and operations to grow repeat orders. Combined, this creates the flywheel that drives our strong revenue growth, and the long term leverage in the business.

As just described, there are multiple ways we work to improve customer satisfaction, and in turn, drive repeat business. One specific lever is our loyalty program. Historically, this program was largely based on rewards dollars that customers could apply to future purchases. We knew we could offer a more comprehensive loyalty program to our shopper that is better tailored to her needs and desires.

In October, we took the first step in revamping this program with the launch of our private label credit card, which provides benefits such as rewards dollars and financing on purchases. We are particularly excited to be able to offer financing on large purchases. In our category, customers are frequently shopping high-ticket items, and it's customary for years in retail to offer a financing option.

Over time, we hope to roll out more specific benefits and personalized offerings to our cardholders. We have partnered with Alliance Data on the card, and as typical of these partnerships, Alliance qualifies the customers and takes all risk on payments. We think the private label card is a strong start to an enhanced loyalty program, and we're excited about the launch.

Before handing the call over to Steve, I want to touch on our holiday plans. Last year, we expanded our holiday promotions with improvements across assortment, merchandising, visual imagery, product discounts, and marketing activities, allowing us to unlock a previously-untapped seasonal sales lift. Historically, we had not viewed our category as one that had large seasonal potential. Furniture and decor are not traditionally gift items, and we are very excited about the work our team did last year to capture the seasonal demand.

We took the learnings from last holiday and used them to refine our overall promotional calendar for 2015 by adding events, developing proprietary imagery and content, and working with our suppliers to source the best products and prices for our customers. Accordingly, we've seen strong revenue growth from these seasonal events throughout 2015. Most recently, in Q3, we had a highly successful Labor Day weekend event. But of course, many of these seasonal promotions occur in the fourth quarter, and we're excited to build on the learnings from last year for this holiday season.

This year we started holiday events in early October, a few weeks earlier than in 2014, and we will be promoting a broader assortment of relevant offerings, including decorative accents, seasonal decor, and an extensive collection of housewares across a more in-depth and integrated marketing campaign that combines television, display, personalized email, and direct mail. We're excited about how this season has started, and we believe we have a fantastic line-up; however, since most of the revenue from holiday is generated later in the quarter, it's too early to tell how this season will compare to last year. We look forward to sharing the results with you on our Q4 call.

I would now like to hand the call over to Steve, to update everyone on some exciting engineering and technology developments.

Thanks, Niraj, and good morning, everyone. One of our goals at Wayfair is to offer the customer an easy and convenient shopping experience, wherever she may be. At home, at work, running errands, watching TV, an easy-to-use and engaging mobile site and app for each of our brands is a key part of this approach, and our engineers regularly refine our mobile product, and explore ways we can offer a unique experience to our customers on phones and tablets.

This approach is working. In Q3, 35.1% of the orders in our direct business were completed on a mobile device, compared with 28.7% in Q3 2014. Although we have mobile sites or apps for all our brands, much of this growth is due to the success of our Wayfair.com app.

Our iOS app was originally released in March 2014. In July of this year, we hit one million downloads. In recent months, we've seen accelerating app interest and are now approaching two million total downloads. The app has become a key channel for repeat customer engagement and sales.

From a technical and customer experience perspective, we are constantly innovating and updating our apps. We've updated our iOS app 30 times since launch, including as recently as last week, when we deployed a redesign that incorporates Apple Pay technology to further streamline the mobile shopping experience. Our android Wayfair app launched in May of this year, has already been updated 24 times.

Increasingly, we are looking to offer unique content and products on our apps. Beginning this year, Wayfair.com app users will have access to exclusive products and early access to our Black Friday and Cyber Monday sales.

Eventually, we believe the app can offer the customer novel ways to engage with us and enhance the shopping experience. We were able to maintain this pace of development and innovation across all our business, because of the scale and growing team of over 400 engineers and data scientists.

I will now turn the call back over to Niraj.

Thanks, Steve. Our apps help to round out the customer experience and support the strong direct retail growth rate. Overall, our efforts in merchandising, marketing, site experience, customer service, supplier integration and logistics, all powered by technology, are combining to offer a world-class customer experience across multiple platforms and geographies. I will now hand the call over to Michael to walk through the financials.

Thanks, Niraj, and good morning everyone. As always, I will highlight some of the key financial information for the quarter, with more detailed information available in our earnings release, which can be found on our IR site. In Q3, our total net revenue increased 76.7% year-over-year to $594 million. As Niraj described, this growth was driven by our direct retail business, which increased 90.9% over Q3 2014 to $545 million. Our other business, which includes revenue from our small media business and from our retail partners, declined as expected, 3.3% over Q3 2014 to $49 million.

Our gross profit for the quarter, which is net of all product costs, delivery and fulfillment expenses, was $141.4 million or 23.8% of total net revenue. This is compared to 23.5% in the same quarter last year, and 24.6% in Q2, 2015.

As we shared on the call last quarter, we believe gross margin should be between mid 23% to low 24% over the near-term, as it is the right long-term strategy for the business to invest in the customer experience today across price, delivery and service, to create even more loyal customers. Going forward, we expect margin to be similar to where it is this quarter.

The remaining financials I'll share on a non-GAAP basis, excluding the impact of equity based compensation and related taxes, which totaled $8 million in Q3 2015 and $0 in Q3 2014, as the IPO did not occur until early in the fourth quarter of 2014. Post the IPO, we recognized 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 site.

Customer service and merchant fees were 3.5% of sales, compared to 3.7% in Q2. This cost is largely variable, and should continue to run in the high 3% to 4% of sales going forward.

Advertising spend was 11.9% of revenue in the quarter, or $70.7 million. Year over year advertising spend as a percentage of sales improved 290 basis points from Q3 2014, when it was 14.8% of revenue. This continues the trend we've seen throughout 2015 of year-over-year ad spend leverage each quarter, as we benefit from the investments we made in advertising to build our brand and acquire new customers.

As you heard from Niraj, we added approximately 547,000 net new active customers this quarter, roughly 100,000 more than we added last quarter. We're excited about the success that we've seen with our marketing efforts to date, and will continue to invest where we see appropriate paybacks, as we believe it's the right long-term strategy for the business.

Overall, customer dynamics remain incredibly strong. LTM net revenue per active customer increased 8.5% to $371 annually. LTM orders per active customer grew to 1.69 from 1.65 a year ago. Orders from repeat customers were 55.2% of total orders, and up 173,000 orders sequentially.

As you can see in the updated cohort chart we posted to accompany this call, repeat dynamics across all our cohorts remain strong, with cohorts as old as 2011 and 2012 experiencing improving repeat dynamics due to the improvements in our site experience, merchandising, and customer experience. Even after four years, we are seeing an increase in the monthly revenue per customer over the last year, as they experience all the investments we continue to make in the site and customer experience. Our merchandising, marketing and sales spend on a non-GAAP basis was $23.7 million or 4% of net revenue, compared to $13.4 million or 4% of net revenue in Q3 2014.

Non-GAAP operations technology and G&A expense was $36.7 million for the quarter, or 6.2% of net revenue, compared to $25.2 million or 7.5% of net revenue in Q3 2014. As we explained last quarter, 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 the ongoing investment in our teams. As our expanded recruiting team has ramped up, we've been able to accelerate our hiring pace, adding over 390 net new employees in the third quarter.

Even with this increase in hiring, we did see overhead leverage, due to our significant revenue growth. We expect our headcount and operating expenses to continue to catch up some during the next quarter, as we have ramped up our hiring to meet the higher levels of growth of the last several quarters.

Adjusted EBITDA for the quarter was negative $1.4 million, or negative 0.2% of net revenue compared to negative $18.0 million, or negative 5.4% of net revenue in the same quarter a year ago. The year-over-year improvement in EBITDA margin was driven by the ongoing leverage in both advertising spend and operating expenses. As I stated on this call last quarter, I want to be clear that while we have seen greater flow through over the last few quarters, we plan to continue to invest in advertising and headcount to effectively grow and manage the business.

For the second quarter in a row, non-GAAP free cash flow was positive at $35.3 million. This positive free cash flow was driven by net cash from operations of $51.5 million, primarily as a result of the favorable working capital dynamics in our business. The strong free cash flow was despite our $16.2 million investment in capital expenditures for the quarter.

Our inventory level was $22.6 million, only 1.2% of LTM sales, roughly consistent with last quarter. It's important to note that while total net revenue increased over $250 million from last year, inventory only increased by $1.4 million.

Non-GAAP diluted net loss per share was negative $0.13, 83.9 million weighted average common shares outstanding. As of September 30, 2015, we had approximately $400 million of cash, cash equivalents and short and long-term investment. Overall, we're very excited with our third-quarter results and continued strong revenue growth from both our new and repeating customers.

Now, I'd like to discuss guidance for Q4 2015. The good news is, we have a business with extraordinary, strong, accelerating growth. The bad news is, this makes my job of giving guidance very difficult.

We forecast direct retail revenue growth of $575 million to $610 million, a growth rate of approximately 66% to 76% year-over-year. As we did last quarter, I want to provide a little more color on this growth rate. Currently, Q4 quarter to date, we've experienced a similar retail growth rate as that in Q3. Of course, in the fourth quarter, revenue is more heavily weighted towards the back half of the quarter for holiday shopping. Therefore, it's difficult to predict the full quarter at this stage.

As you heard from Niraj, we anticipate very strong holiday performance based on all the work the team has done, but we also had an extremely good holiday last year, and will be comping off that strength. As always, we're attempting to be thoughtful in setting our guidance, based on what we've seen quarter to date, while also taking into account all the other factors of being a retailer where the customer has to show up every day.

We forecast other revenue to be between $50 million and $55 million for total net revenue of $625 million to $665 million. We forecast EBITDA margins of negative 0.75% to negative 1.25%. As I've said before, we're catching up on our operating expenses, as we've ramped hiring to meet the needs of the accelerating top line growth. We anticipate that our expanded recruiting team will continue to catch up during the fourth quarter, so we are guiding EBITDA margins, taking that into account, as well as our continued investment in ad spend.

For modeling purposes for Q4 2015, please assume equity based comp expense of $12 million, average weighted shares outstanding of 84.2 million, depreciation and amortization of approximately $10 million, and CapEx of approximately 3% to 4% of sales, roughly consistent with recent quarterly CapEx trends. As a reminder, because we don't invest in physical stores or inventory, our capital requirements are very low, resulting in strong free cash flow and enabling investment in high ROI initiatives like improvements in our site experience, and the speed, quality, and efficiency of our delivery process.

CapEx in the near term is primarily related to the scaling of our supply chain infrastructure, including warehouses and our distribution network, and of course, our ongoing engineering investments. Now let me turn the call over to Niraj before we take your questions.

Thanks, Michael. This call is our fifth earnings call as a public company following our IPO in October of last year. We are extremely pleased with the performance and trajectory of the business over these past five quarters. The direct recall businesses has continued to accelerate, with its fastest growth rate since Q4 of 2013.

Our customer base gets stronger every day, with increasing numbers of new customers trying our site for the first time, and existing customers engaging with greater frequency and increasing spend. All of this has occurred in the context of leveraging ad costs and improved profitability. As excited as we are about the past five quarters, we're even more excited about the future.

The home space represents an enormous market opportunity that we are just beginning to tap. And we believe that Wayfair can be the leading destination for all things home.

We would be happy to now take your questions, so I will turn the call over to the operator.

(Operator Instructions)

Neely Tamminga, Piper Jaffray.

Great. Good morning, and congratulations on a solid performance. I have a question and then a follow-up, if I may.

On the first question Niraj, we looked through the slides and we saw the slide referring to the 2011/2012 cohorts spending back up. It's really impressive. What we're trying to figure out, is she just naturally gravitating back to the site? Is she clicking through email? What is the customer cost of that reacquisition, or re-engagement or spending? I suppose is what we're trying to figure out.

Then I have a follow-up, if I may.

Sure, Neely. Thanks for your question. Yes, so the way to think about our business, obviously revenue is going very nicely, and you have seen revenue growth actually accelerate now for a few quarters in a row. Obviously that acceleration cannot continue forever, but the reason we been accelerating while ad cost as been coming down is actually because the repeat business actually runs at a very low ad cost, relative to new business. So what happens over time is just that that mix shift is actually what drives down the ad cost as a percentage, even though we actually have more dollars in an absolute amount to acquire more new customers.

For the 2011 and 2012 cohorts, those cohorts predate the Wayfair brand being known, and it's important to note that those cohorts have a much smaller number of people in them than 2013, which has less than the 2014, which has less than the 2015. So not only those lines going up, not only does that represent cohorts that are more valuable on a per-person basis, but actually frankly, the more recent cohorts are much larger than the older ones, so actually the momentum you see there is actually kind of multi-fold in terms of its value to us.

Neely, it's Michael. The only thing I might add is, you've seen us over the last year continue to make a huge investment in the site experience. And even our most, our oldest cohorts, those 2011 and 2012 customers, they are getting the benefit of that site experience. So when they come back, the ease of shopping, how easy it is to find things, all of those other great things that we've invested in, that's paying off in terms of lifting their revenue, as they sort of -- it's easier to find something, make that purchase sale.

That's helpful. It's logical, but it's helpful, just to make sure we have that framed up there.

And then just a follow up here. There's been some noise in the press recently, as I think last night related to a foreign vendor that I think your company and others carry. Could you comment on some of the overall situation as well as of whatever potential impact there is in your business? I guess just a bigger higher level question here is what is your general approach to vendors around safety and compliance type issues? Thanks.

Yes sure. Thanks for the question. We carry a big selection, as you know, 7 million items, and I think some of the other folks mentioned Walmart, Home Depot, these are all folks who carry a big assortment of items, along with Amazon. So our approach is actually to be very thorough in worrying about the safety the products we sell.

In order to do that, we do a few things. One is all our suppliers, we have supplier agreements with them, we have indemnification agreements with them, we have certificates of insurance from them, we have detailed product information which specifies down to the various regulatory bodies whether they be local, state or federal, what pieces they comply with, or if items don't comply, so that we can take the appropriate steps in terms of whether we offer them or not. And that's how we are able to make sure that the products are of high quality, and meet all the guidelines.

The other thing we do though, that not many people do, is that we do not source items directly from the factories that they are made overseas. So we are sourcing from folks who are the distributors and the actual product designers, who are generally American and European companies who are then sourcing in Asia. So we have an additional layer of QA, QC that a lot of the other retailers who are directly sourcing may not have, except through their own QC personnel, who would be on site. And so that's our approach, it's been pretty thorough, it's worked quite well.

In terms of that article, that refers to laminate wood flooring, and that's a category that's been featured prominently in the press because of Lumber Liquidators, who I think had a fairly extensive problem of their own sourced product. And for us it's important to know, laminate flooring's a really small category, so laminate flooring, it's 0.02% of our sales, so that's 2/100 of a percent of our sales, which is about -- the number have is just under $400,000 year to date in that whole category.

A lot of that product comes from large producers like Armstrong and Mohawk, and so Ark, for example, which the brand that article mentioned, we have had 10 orders from Ark in total in total for this type of product, and similar to what we always do, we made sure that the product complied, and then there's a point in time where the manufacturer actually told us that they were discontinuing the product, so we actually pulled it at that point, which was even before the New York Times got interested in the product. So we would like to be very thorough there, and that process which we set up and honed over the years, we think has worked very well, had millions and millions of orders, and we've been able to really avoid problems.

Thanks Niraj. Best wishes to you this holiday. Thanks.

Matt Nemer, Wells Fargo.

Congrats on a great quarter. My first question was, I wanted to talk about the potential residual impact of the unseasonably warm weather in the US. It doesn't seem like it's impacting you, but we are seeing a lot of promotional activity in terms of fall decor and decorative accessories. I'm just wondering if you think that will impact the overall home furnishings complex this fall, given that we're breaking fifty-year records on temperatures?

Yes, sure, Matt. Thanks for your question. A few thoughts I will give you on that.

One is obviously, we can be much more agile and nimble than most other retailers, because we do not take inventory positions. So in other words, if we take an inventory position and we are an inventory-based retailer and we made a mistake where the weather friends don't support the right product mix relative to what we thought, we then are stuck with that inventory, we have to put in front and center in our stores until we can get rid of it, and so we may then be pushing the wrong goods. We don't do that, right?

So we focus and we actually assort on a personal basis for folks using our personalization technology, and we put a tremendous amount of content. So as a result, what happens is we're always leaning forward on the right product for the customer, regardless of what that may be, and regardless of how that may change.

But the bigger point I will tell you is that, whether it's the weather seasonal patterns, or whether as housing getting stronger or slowing, none of that in our mind affects anyone in online. Everyone in online has the benefit of basically a market that's growing at a 15% growth rate versus a brick-and-mortar market that's growing on an average year at 2% and a good year maybe at 3% or 3.5%. And if you're growing at 2% or 3%, that rate is so low that you frankly get affected by those things.

But if the overall average is 15%, and online, where there's folks who are going to take big share and folks who are not going to get that share, frankly it's all about whether or not you're the person doing the best job. And so here, where our direct business grew at 90%, which would be 6 times the online growth rate, you're not going to really see swings affected very much by a seasonal weather pattern or by these very micro-specific effects, or even by the macroeconomic effects, because, frankly, whether the market grows at 2% to 3%, that 15% is basically saying that people are stopping going to brick-and-mortar stores, and they are increasingly going online, because of all the benefits. And so we just can't, we just don't see trends like that, and we don't believe they affect us very much.

Makes sense. It doesn't sound like an issue. And then secondly, I am wondering how big of a hurdle to conversion financing has been historically, as you survey your customers, and how much of a benefits the new ADS program could be, particularly in terms of larger orders?

Sure, it's always hard to know the answer on something like that. Basically, what we know is that financing obviously is an additive. So for some folks, it doesn't matter to them, and for other folks it does matter. And for the folks for whom it does matter, you're giving them another tool with which they can buy from you.

In terms of the size of that, we have done work to understand our customers' interest in financing, but I wouldn't say we've been able to turn that into a size-type number that is precise at all. What we know is that there is just things that increase the customer experience with us, that offer the customer more options and more benefits. This is one of them.

And we know that our loyalty in general, we have a pretty good road map of where we want to take it, and we know that the version we had in the past is a pretty basic one, where we're simply offering straight up rewards everybody for buying from us. It's a relatively weak version on a relative basis to what we're now working on, so we know the new program is a significant benefit. But I really don't have a sizing estimate for you.

I guess put it another way, is it fair to say that in the month of October, since you launched that program, you have seen a benefit to conversion from it? Do you get offered the card at some point in the funnel?

Sure. So we're now offering the card to folks. But just like anything new, its current effect is tiny, right? So the effects of these things tend to grow over time. Today's effect is actually very, very small.

Okay. Makes sense. Good luck during the holiday.

Seth Basham, Wedbush.

My first question is on your guidance. I just want to make sure I understand it. It looks like from a revenue standpoint, you are looking for higher revenues versus the third quarter, but from an EBITDA margin standpoint, a little bit lower.

I understand that you're investing in people. I'm trying to understand where else there's a big delta between Q3 and Q4 on EBITDA margins.

I think the biggest delta, Seth, is in people, as we continue to accelerate our pace of hiring. As we mentioned last quarter, we're adding -- we added to our recruiting team, and this past quarter in Q3, we added 390 net new people, so you can sort of see that ramp growing as we try to meet the needs of the accelerating growth rate of the business. So I think piece number one is catch up there.

And then the second thing is, we will continue to spend on the ad spend line. We've talked about that before. We expect to continue to see leverage there, as we've noted before.

But we think that the customers we're bringing in, and you can see that in the cohort work and the number of repeat orders, all the customers we're bringing in are doing exactly, if not even better than we anticipated. And so, continuing to spend on the ad spend line in order to bring in more of those customers makes a lot of sense.

That's helpful. So you're still on track for at least breakeven EBITDA in 2016?

Yes. I think what we said in the past is, by the end of 2016, that's our goal.

Got it. Okay and secondly, my follow-up is on shipping. There's been a lot of talk in the marketplace around FedEx and UPS raising shipping rates, particularly for companies that have a lot of people with third parties associated with shipping. Can you give us some insight into whether or not you think there's going to be a big effect on your business?

Sure. This is Niraj. I will tell you that, so we're obviously a large shipper. We are large shipper of both small parcel items for which we use UPS and FedEx, and for large parcel items, for which we have a different freight network. And as you would expect, at the scale that we ship at, we have deep relationship with these folks. We have very nuanced contracts, we have our own transportation operation where we move product in advance of tendering into these carriers.

So what I will tell you is that these types of developments that you're seeing where they are changing rates, the effect that they would have on us as not something that we would tell you gives us any pause, in the sense that we tend to think about where these things are headed well in advance, we understand them, and how we operate with these carriers is not the same off the street rate structure that someone gets if they sign up for a new account.

Got it, that's helpful. Thanks a lot, and good luck in the fourth quarter.

Oliver Wintermantel, Evercore ISI.

I had a question on the average order value. It increased by about 8 points, just over 8%. That was the fastest growth that we've seen so far. It was flat in the second quarter. Can you give us some more details on what drove that growth?

Yes sure. So, what I will tell you, here's the thing. We don't really worry about the AOV, and by that, what I mean is we are doing a tremendous amount of things to be the customer's go-to for larger parcel items like sofas and bedroom sets, and things that would drive up the AOV. We're also doing a tremendous amount to really become a leader and be the go-to place in categories like basics and seasonal decor and decorative accents and housewares, and all these things drive down the AOV.

So the number we're really interested in is, if you look on slide 20 in the slide deck we posted, and we've updated this every quarter, we derive this net revenue per active customer, annual net revenue per active customer, we're really looking to grow that. So we're looking to grow our share of the customer's wallet with us, and whether we do that by adding some incremental small purchases, or by adding incremental large purchases, we are pretty agnostic, because we want to just be a customer's go-to at home.

So what I think has been driving up the AOV is that the strength of the Wayfair brand and some of the things we've done in the merchandising side and on the delivery and logistics side have increasingly made us the go-to place for furniture and larger decor items. At the same time, we are having really good success in these smaller items, and so these gains largely offset each other. They drive up this total net revenue per active customer, the green bars on the bottom of slide 20.

And they cause the repeat really metrics to look great, which is what accelerated growth in the direct business to the 91% to 90.9%. But the numbers we really care about is we care about the customer spend with us and the retention, the repeat characteristics, and as long as those keep going the right way, whether AOV goes up or down, we think doesn't matter.

Okay great, thanks. And I just had one on the equity based compensation. That was the last two quarters was about $3 million shy of what you guided to, and the third quarter looks like there's a step up from the guidance. Can you explain why the numbers were $3 million lower in the first and second quarter? Thanks.

Sure. I think the equity base comp pieces, we're trying to give a big round number for everybody for modeling purposes, and then the actual obviously is tied to all the movements in and out of people. There was a little bit of, with the Australia deal, we sold the Australia business in the second quarter, and then some into the third quarter. Of some of the that equity based comp rolling in during that period, because we accelerated some of those people's equity. But otherwise, there's no other sort of unusual or anomalies there.

Thanks, good luck.

Paul Bieber, Bank of America Merrill Lynch.

Congratulations on a good quarter. I was hoping you could provide some color on accelerating growth of active customers. Are you finding efficient online marching channels or do you think the TV advertising is contributing to the acceleration?

And then, secondly, by my calculations, the contribution margins improved year-over-year. Can you provide some color and context on what's driving the improvement in contribution margins?

Sure. Let me answer the first part around accelerating revenue growth in the active customer numbers. I think it's important to note there are a couple of things.

One is, I wouldn't talk about TV per se, but I would talk about the brand awareness, right? Which is a function, TV is one of the main drivers of that. And the aided brand awareness, we cited that during the call, and the 67% there, that's continued to climb over time, and we think that obviously has very strong benefits for our folks decided to buy from us and folks thinking of us top of mind.

That said, the other thing I will point out is just the way that you think about active customers. You actually give credit when they first buy, but if you think about, from a marketing standpoint, the way it works is at some point, they see our advertising, they become aware of us. Then they start visiting the site, perhaps they download the app, or perhaps they sign up for the email list or bookmark our site. And they start coming back, and eventually they make that first purchase.

And so the timeframe that they are engaged before they buy from us is a period of time that generally the quantitative metrics don't look at. And so what I would point out is just, as we are engaged with more and more people and they are coming back to our site more and more often, the brand getting stronger and stronger, it seems logical that more and more would tip towards buying from us, particularly as they more likely have a friend who has bought from us, who had a great experience and told them about it or what not.

And then obviously if they have good experience and they really enjoyed it, and then it's reinforced by what their friends are saying, and is reinforced by what they are seeing, they're obviously going to become more likely to come back, and if we are doing a good job merchandising all these categories and improving the delivery experience and everything, it becomes more likely they'll become back more and more often, right? So that whole continuum is the story, and that beginning piece really starts before they first buy and so I think that's sort of why it seems more stark when you just look at it as a quarter standalone because you not thinking of the accumulated benefit.

Paul, it's Michael. On the contribution margin question, if you look year over year, gross margin this quarter 23.8%, we talked a lot about this last quarter, is now kind of in the place we think it should be, but I think we've been clear, mid 23% up to 24% so I think we're right in that zone right now, I feel good about that. Obviously, that's a little bit better performance than Q3 last year, which was 23.5%.

And then on the customer service and merchant fees piece, obviously, also rolling in contribution margin, I think last year Q3 was a bit of a high water mark. This quarter 3.5%, as I noted in the talk track, I think is a little bit low, and I think people should anticipate that will be sort of high 3% to just under 4%, and that's the normal range. It really is a variable cost, but it's somewhat tied to how many people you have on board, and how you're staffing your customer service operation in anticipation of upcoming holidays or additional staffing and teams you want to put in place. So there's a little bit of lumpiness in that, as well.

Okay, thank you.

Aaron Kessler, Raymond James.

First, can you talk about what percentage proprietary products are (technical difficulties) today, and where you view that going longer term? And second, maybe in terms of traffic sources, direct versus indirect traffic, and how that's been changing over the last year? Thank you.

Sure, Aaron. This is Niraj. A couple of thoughts. So on the proprietary product assortment, I think we've referenced that on prior calls. We didn't gave a specific update on this call, but what we've said in the past is that is a relatively small portion of total revenue, but growing it at a good speed, and that's from a verbal, that the same thing I would say today, is that's continuing to grow nicely. We're certainly very much believers that's a great opportunity for us.

I will highlight, we do it in a way that does not have us carry inventory, which we believe is very novel and unique, and will accrue significant benefit to us. And we believe it's actually proving that it does. But we don't have a specific number to update you on this call, but we will periodically give you update on where that is quantitatively, and we're very happy with how it's growing.

On the traffic side, the direct versus indirect, again, I don't have specific numbers for you, but the thing I would tell you is that a lot of what you are seeing in the numbers is because it's being driven by the repeat. The repeat is driven by a low ad expense, as I mentioned, which is what drops ad expense. The reason it's driven by low ad expense is because a lot of these folks are just proactive with coming back to our site, either because they've downloaded the app, they go to it automatically, or they have app notifications, or they are on the email list and they're getting emails, or we're just more top of mind, or they are engaging in our editorial content. So this combination of things basically causes the direct to continue to grow.

We obviously do advertise a fair bit, so that supports the indirect, but frankly, the direct is taking share. You can almost think of it as direct being something of a proxy of repeat, and indirect being a proxy of new. That's not technically correct, but that's similar, philosophically, to what's happening.

And if you look at slide 21, if you download that presentation, which is a new slide we added, all we did there was chart the number of orders that are new versus the number of orders that are repeat by quarter, which technically would have been numbers that were available, but we never turned it into a chart. What you see there is you do see the repeat line really break out on trajectory from the new line. The new line keeps the same trajectory it's had, but you how repeat is really inflecting up, and I think that's, even though it's not the answer, it's almost the answer to your question about traffic sources.

Great, and finally, any product categories you would highlight in the quarter that were strong, or is it across the board strength in the quarter? Thank you.

I would say it's across the board strength.

Got it, okay. Thanks. Good quarter.

John Blackledge, Cowen and Company.

Just a couple questions. So just to clarify, in Q4 quarter to date, direct retail revenue was growing in line with Q3 growth, or around 91%. And also, do you think the increased focus around the holidays and an integrated marketing campaign could perhaps strive accelerating top line growth from this point through quarter end? And then just for the 4Q EBITDA guide, what are the biggest swing factors for to possibly be positive? Thank you.

So John, I'm really excited to hear how Michael answers that question, so I'm going to turn it over to him.

John, so yes that is what I said in my talk track about how Q4 is running quarter-to-date versus Q3's performance. I think the swing factor -- I think on the holiday, the reality is, we don't know. We've done a ton of great work. The team has done an amazing job getting us ready for holiday. Obviously, early results in the quarter to date look fantastic.

But as I noted in the talk track, we are comping off a really strong holiday last year, when we really got focused on holiday promotions. So it's just too early to tell at this point exactly what the impact is going to be of that. And then look, I think on the EBITDA side, obviously revenue upside has the potential to flow through to a higher rate to the EBITDA line.

At the same time we are, we continue to be very aggressive in terms of our hiring plans, in order to make sure that we've got all the team staffed to continue to serve our customers in the way we are used to serving our customers. And continue to invest for the future, as well, particularly on the ad spend line. As everyone is aware, the ad dollars we spend today aren't necessarily generating customer instantaneously. We're introducing a customer to Wayfair who buys over time and then continues to buy and repeat. And so, there's that side of it.

And then the other side of it is, continuing to invest in people so the OpEx line, whether it's engineers who were building the next pieces to our product or new product additions, or making the customer site experience even been better and better, and those are people that we're going to add today that are going to really show up in repeat rate of customers a quarter from now, two quarters from now, three quarters from now. So that investment is going to continue. So that's really what you're seeing in the Q4 EBITDA guide.

Okay, great. And just maybe just one follow-up, longer term, given that the repeat customer rate I think it accelerated from a growth perspective this quarter, that's better maybe than what you thought a year ago. Longer term, you have always said 8% to 9% EBITDA margin is the right number to think about. Is it perhaps better with theoretically better repeat customers than you thought a year ago, or when you talked about that number?

And then also just much higher top line. The top line trajectory and market share is much greater. Thank you.

So our long term EBITDA margin target has been 8% to 10%, and there's nothing we would see that would change our view that's sort of where we are driving to over the long term. And I think the repeat metrics we're seeing, how customers are coming back, how they are recognizing the great site experience and customer service experience, all of that is as we anticipated when we put those together.

And as Niraj mentioned earlier, there's obviously a much, much, much lower cost of advertising to get a customer to come back, because we know who they are, we have their email, we can connect with through them through the email and apps, I think that follows along, and to us, in many ways starts to prove out we believe that the long term thesis, when we understand and dig into what it costs to get the customer to come back. It really proves out the long term thesis around being able to get to that 6% to 8% ad spend in the long term model.

Thank you.

Debra Schwartz, Goldman Sachs.

Congrats on the quarter. Two quick questions. First on vendor services, can you talk a little bit about some of the initiatives that you have around fulfillment and vendor services? How far along are you, what you expect the impact to be on ship times, and particularly into holiday?

And then second, question on free cash flow, Michael, you're now free cash flow positive. Any reason to think that you're not sustainably free cash positive from here? Thanks.

Deb, it's Niraj, I will answer the first part and then turn it over to Michael. Yes, so on your question around vendor services, fulfillment, ship times and the like, and we actually have a multi-year track record now of decreasing ship times, and I think when we went public, people were surprised that our leave time for something to leave a warehouse was already down to just over two days, and that was considered really good.

In our mind, we wanted to get it down further and further over time, and we continue to march along that road map. And we also obviously think about when it delivers, and we're working on really reducing that significantly.

And so, a lot of what we are doing on the operations side is around that delivery experience, which is basically a function of the time it takes for delivery. On large parcel, it's a function of also how it's delivered and the customer experience associated with that. And on the small parcel side, absolutely, we use UPS and FedEx for that. And so it's really being tightly integrated with them. And so we keep making tremendous headway there.

Deb, on the free cash flow question, so obviously as we're running right at or very close to breakeven at this point, the business is comfortably free cash flow positive. The one thing I would note, though, is we do have a working capital cycle and a seasonality to that. Particularly in Q4 where we sell a lot towards the end of the quarter, and then end up paying out to suppliers in January. And so there tends to be a larger positive free cash flow, because the working capital swings in Q4, and then the negative working capital outflow in Q1. But other than that, I think we are, based on where we are at from an EBITDA perspective, I think we feel pretty good about the positive free cash flow we're putting on the boards.

That's helpful, thanks. And just a quick follow up to the first question. Niraj, what I'm referring to a little bit more is some initiatives we've been hearing from vendors about storing inventory in your fulfillment centers. Can you talk about how much of a focus that is for you?

Yes sure. So the way we think about the world is that a lot of traditional retailers focus on just going directly to the factories and sourcing goods themselves. They orient around a narrow selection, they take inventory and that traditional model focuses on lowering their first costs as much as possible, and basically try to push the gross margin up as much as possible.

The thing about that, that is predicated on a world where narrow selection is efficient. Our belief online is that wide selection is much more beneficial. So our whole model is about being tightly integrated with suppliers, to where we can have a much wider selection.

We can lean on the supplier to basically do a lot of product development and do the sourcing, procurement, and do that into the supply chain. And then the place where we meet is the domestic logistics, and then, obviously, we're doing all the marketing, merchandising, customer service and that end experience for the customer.

And that partnership with these key supplier partners of ours, we think is a big piece of what's fueling our success, in terms of giving the customer such a good experience. So to that end, one of the things we do is we do provide a lot of the distribution logistics services to basically provide that seamless end-to-end experience because that's the integration point where we work with these suppliers, and so we have definitely have been ramping that up over time, and for really the suppliers we're tight with, we do focus on basically providing that operational capability to them in the same way that we don't want them doing customer service, we don't want them needing to do a lot of merchandising work, we want to do that. We similarly want to control this piece of the experience and let them focus on what they're great at, which is really this product sourcing and product development piece. And so we have been growing that substantially.

Great, thank you.

Michael Graham, Canaccord Genuity.

Two questions, please. The first, just the bigger question one on the addressable market. If you could just give us a quick refresher on the $60,000 to $175,000 household, how many households do you think that is in the US, and how deeply do you think you can penetrate that? And maybe just, do you have any comfort that you're not about to hit an early adopter cliff, which I don't take you are, but some are saying that?

And then second question is just, if I could ask on 2016, for any kind of preliminary content or comment, you're growing revenue in the 90% range, looks like consensus has you growing in the high 20% next year, and I'm just wondering as to anything structural in the business that would make the growth rate slow down that much? Thanks.

Sure Mike. This is Niraj. On the addressable market question, let me just give you a couple of numbers. First, the wider definition we would use the addressable market is $50,000 household income to $250,000. If you use that, it is 60 million households. If you narrow it into what you mentioned, which is $60,000 to $175,000, you would narrow it into about 45 million households.

So the way to think about it roughly is that 4.6 million active customers and you then think about the US household I mentioned, we really do not have very much penetration at all, particularly when you think about what we are. Wayfair is an everyday store. The everyday store model is the primary commerce model that captures the bulk of the market, so specialty models tend to play at the fringes, but they have a hard time scaling up. So a lifestyle retail play like a Pottery Barn, a Restoration, they tend to get small pieces of the market.

Something like online, these private sale models, they tend to get small pieces of the market. But then if you look at like the Targets and the Home Depot and these mass retailers, they tend to get big chunks of the market, and it's because of the everyday store nature of it. And so we have a variety of models but Wayfair is an everyday store, so we tend to think that it, based on its also ability to provide the selection, the merchandising and the experience, can be the customer's go-to in-home.

So in other words, when we start thinking about the 60 million households, we think that we can be the customer's go-to in the majority of those households. So at 4.6 million, we think we're still pretty in the early days.

The other thing I will point to that supports that is slide 18. If you look at the cohorts on slide 18, I agree with you that you always would worry about a diminishing return on your next customer, and at some point you know that you're saturating your TAM.

What slide 18 shows that I think is really interesting is that despite the size, the $2.4 billion run rate we are now at, as of this last quarter, if you look at that slide, you will see that the newer cohorts are far more productive than the older cohorts, and that's been sustainably proven over a period of time. That chart now runs out right at about just under five years of history. And so, what I think you're seeing is that we're still in the early part of that adoption curve, and there are still far more households to get before we reach any diminishing return problem, which would imply that saturation is a real thing.

On 2016, I will let Michael answer it more fulsome, but I think to be honest, the biggest thing is, while revenue growth can't keep accelerating, I don't think most of the folks who cover us have updated their models for 2016.

I think the key thing is, I guess I'm hopeful that with the Q3 numbers now on done and Q4 guidance out there, that everyone will start to really look at their 2016 number. To your question, there's nothing structural that would cause a lower, that lower rate in 2016. And I think, what you really have a is a situation where most of those models haven't been updated in quite some time. But hopefully now everybody has got a clear picture of what 2015 looks like, and then can start to figure out what they want to put out there for 2016.

Okay, thank you and congrats.

Mark May, Citi.

I think most of them have been addressed, but just a couple. On the non-Wayfair brands, can you talk about the level of investment, and what the trend has been in terms of profitability or improvements, or expansion in investment, or losses in those brands? And then, I think there were some changes in the quarter related to Google and the search algorithm.

I wonder if you could talk a little bit about any benefit that you may have derived from that in the quarter? And then how an improved ranking in the Google search engine could impact growth and profitability in Q4 and into 2016? Thanks.

Sure Mark. Thanks for your questions. So the first question on the non-Wayfair brands, the other four brands, Joss & Main, Birch Lane, AllModern, DwellStudio, as you know, we don't break out the numbers for all of them, but the way I would describe them is, I referenced a minute ago actually, different merchandising models versus the everyday store, and what I would point out the two that are everyday stores are Wayfair and AllModern, but AllModern is cut by a very specific style, so right there, it become specialty in a way. And then you have two that are lifestyle retailers in Birch Lane and DwellStudio, and you have one that operates as a lifestyle retailer with that very heavy engagement merchandising model, which is Joss & Main.

So the way we think about these specialty brands, we know they will all have different market sizes that are all much smaller than the Wayfair opportunity. So the way we tend to think about them is that they either need be growing well with good unit economics in a productive way, that means that every dollar invested is getting us the economic return we want, meaning that quick payback, good lifetime value, good profits on the long-term value of the customer, or as the growth is coming off, they need to be glide pathing into the profitability we want them to have long-term.

And what I will say about each of them is that they are all run that way. And so, while they are in different stages, each one is in a different stage of its evolution, that is a consistent story across all five of our brands. Now what you see in total, because Wayfair so big, relative to the rest, you really see the profile of Wayfair.com coming through in the total. But that philosophy that we described for Wayfair.com, you can take as applying to all five, which is why we think the overall business is stronger by having all of them.

On the second question, about Google change in the quarter, our general experience, and this is a multi-year comment, is that Google continues to make changes to their algorithm, making their algorithm more and more reflective of what customers actually show interest in. So what are customers most excited to see, what sites do they want to go to, where are they happiest, where are they most likely to purchase, where they most likely to repeat visit, and so on and so forth. And they've kept enhancing that.

I will tell you that we've continued, in general, to be a beneficiary along the way, where we see ourselves benefiting from a competitive standpoint in garnering that traffic. But despite that, what I would tell you is that natural search traffic, while it's a nice piece of traffic in the sense that it's free and it's incremental, it's actually a pretty modest portion of the total. So it's not that big.

So we obviously want to keep gaining in search results, but we believe the way we do that is because we're making the experience better and better, and we just think Google is frankly getting better and better at measuring that. And what's happening is we're getting favored, but because it's not that big a source of traffic, even though we are getting favored, it doesn't help you, it doesn't move you up that fast in terms of your total business. So it's a nice thing to have, and we think we will be benefiting, but it's not going to be a primary driver.

Thanks.

Jason Helfstein, Oppenheimer.

Thanks. Just dig a little, Michael, into your comments around next year and profitability. I mean you commented that you expect to be positive EBITDA by the end of the year. It would seem that you could be profitable in the first half of the year. If you don't, it's because you choose not to be.

So maybe help us understand, are those more investments around continued investments around marketing, is that more of the other engineering-driven investments? Just maybe talk about how your decision-making around that kind of profit pivot? Thanks.

Thanks, Jason. Look, I think to your point, we could be more profitable now if we wanted to be, and we are making a very conscious set of decisions. I think we've been clear about this from the time of our IPO. And I think maybe more importantly, everybody is now seeing the benefit of those investment decisions and the accelerating growth rate, and the incredible repeat that we're seeing with our customers, including the old cohorts.

And so, I think there's real clarity now for everyone that the investments are worthwhile and have great ROI, and so for us, it's a matter of managing that, but also managing our commitment to getting the profitability by the end of the year. And so we are working those two off of against each other.

But there is a very long list of places where we think there's a huge opportunity on the engineering side, and adding engineering talent and other headcount talent that can really build the business and deliver great new experiences for customers. And we continue to see great results on the ad spend, and so I think you will continue to see us lean in on both of those, again, as we go into 2016, but making sure that we are doing that in a thoughtful and measured way.

Thanks.

This concludes today's questions. I would now like to turn the call back to Niraj Shah. Please go ahead.

Thanks, everyone, for calling in. We hope you have a great holiday season, and we look forward to talking to you next quarter.

This concludes today's conference call. You may now disconnect.