Wayfair Inc (W) 2016 Q4 法說會逐字稿

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

(Operator Instructions)

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

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

I would like to remind you that we will be making forward-looking statements during this call regarding future events and financial performance, including guidance for the first quarter of 2017. We cannot guarantee that any forward-looking statements will be accurate, although we believe that we have been reasonable in our expectations and assumptions.

Our SEC filings, including our 10-K for 2016, which we expect to file in the near future, identify certain factors that could cause our actual results to differ materially from those projected in any forward-looking statements made today. Except as required by law, we undertake no obligation to publicly update or revise these statements, whether as a result of any new information, future events, or otherwise.

Also, please note that during this call we will discuss certain non-GAAP financial measures as we review the Company's performance. These non-GAAP financial measures should not be considered replacements for, and should be read together with, GAAP results. Please refer to the Investor Relations section of our website to obtain a copy of our earnings release, which contains descriptions of our non-GAAP financial measures, and reconciliations of non-GAAP measures to the nearest comparable GAAP measures. This call is being recorded, and a webcast is available for replay on our IR website. Now I would like turn the call over to Niraj.

Thanks, Julia, and thank you all for joining the call. I'm pleased to share our fourth-quarter and full-year 2016 results with you this morning. I want to begin by telling you how proud and excited Steve and I are of what Wayfair accomplished in 2016. In part, that shows in the numbers we will share with you today; but it is also larger than that. These calls are unfortunately focused on extraordinarily near-term results.

To us, 2016 showcases what we have been building for the last 15 years. At the end of the day, it's all tied to our focus on serving our customer and having an amazing team of over 5,000 people. We just finished writing our annual shareholder letter that shares some of these thoughts. We posted this letter to our Investor Relations website today as part of our investor presentation. We could not be more excited to continue the journey into 2017 and beyond.

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

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

The first is holiday, where we had another very successful season this year. As we have mentioned in the past, the holidays are a great time for us to attract new customers, and invite purchases from repeat customers. This year in Q4, we offered twice as many holiday events, with more than twice as many featured items as last year. In addition to our expanded selection of seasonal decor, we also saw shoppers buying furniture and decor items to spruce up their homes and prepare for house guests, and buying storage and organizational items for the post-holiday cleanup. Some of our best-selling classes were TV stands, bar stools, recliners, bedding, upholstered beds, mattresses, rugs, and outdoor furnishings.

In the seasonal decor category, non-traditional Christmas trees like half trees and palm trees, and holiday lighting experienced particularly strong growth. We also saw customers buying storage items, such as artificial tree storage bags, ornament storage, wreath boxes, and string-like organizers. A significant percentage of seasonal decor sales in the quarter flowed through our CastleGate warehouses, enabling us to offer next day and two-day delivery for popular items, including our 5 for $25 ornament shop.

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

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

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

In housewares, part of our approach involves building up our wedding registry offering, which Steve will discuss in more detail later in the call. Our mattress business is a good example of a category we historically had on the site, but didn't merchandise well or provide the right selection. Over the last year, we have started to make those investments, and are now using a multi-pronged approach that includes inner-spring, foam, and bed-in-a-box mattresses across industry-leading brands, as well as our private-label Wayfair Sleep brand. Though we have still have much work to do here and a big opportunity ahead, today the mattress category is an over $100 million annualized run-rate category that is growing nicely.

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

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

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

The UK business is also experiencing significant traction in performing to our aggressive plan. In Europe, we needed to lay more groundwork with local carriers for transportation and delivery, and with local suppliers for the product catalog. At the European trade shows over the last six weeks, we saw increasing engagement from local suppliers who see us as a strong partner for them in e-commerce. Although CastleGate is newer in Europe with the launch of our first UK warehouse this past September, we are seeing strong initial interest from local suppliers, and anticipate that the penetration of CastleGate will follow a similar trajectory as in the US.

We are also taking advantage of our deep, long-term, and scaled relationships with US suppliers, and enabling some of them to enter the European market for the first time by shipping containers directly into our UK CastleGate warehouse. Similar to Canada, we ramped ad spend in the UK in 2016, and have seen aided awareness levels rise to approximately 30%.

Our German business is intentionally earlier in its build than Canada and the UK, reflecting our decision first to focus on English-speaking countries. However, we are seeing nice growth in Germany, as well, and we expect to spend more significant ad dollars there in the back half of 2017, as the offering improves closer to parity with the UK.

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

Our international business remains our most substantial investment area, and this quarter the adjusted EBITDA loss for our international segment was $24 million. The US business is obviously our larger business today. US adjusted EBITDA for full-year 2016 was roughly break even, despite the investments in new categories, logistics, and merchandising. For Q4, US adjusted EBITDA was modestly profitable, as you would expect, given our normal seasonal pattern.

In the US we are investing significantly in our logistics network, as well as in the newer categories like home improvement, seasonal decor, and housewares that I discussed earlier. Let me update you now on our logistics initiatives, including CastleGate and our Wayfair Delivery Network, or WDN for short.

In talking with many of you, there seems to be a bit of confusion about the differences between CastleGate and WDN, so I'll take just a few minutes here to clarify. Please also refer to our Investor Relations website, where we have added additional slides to our investor presentation to help illustrate the various parts of our logistics operation.

When we look at logistics, we think about the two classes of goods that we sell -- those that are small and light enough to fit through the UPS and FedEx networks for the last mile, or small parcel; and those that are too large to fit through those networks, and must instead be delivered by two people in a truck, or large parcel. This is our internal terminology for these items, but keep in mind the name small parcel for packages is all relative in the home category. Our small-parcel packages are actually quite large and bulky, measuring 3 cubic feet and weighing 30 pounds on average. Over time, small parcel typically represents 70% to 75% of our revenue, and large parcel typically represents 25% to 30% of our revenue.

Historically we would integrate with our suppliers' back-end technology to gain visibility into their warehouse inventory, and process orders automatically. When a consumer placed a small or large parcel order on the Wayfair site, the order would get automatically routed to a supplier warehouse where the supplier would fulfill the individual order, package it, and place it at the end of their loading dock for Wayfair to arrange shipment to the customer. For small-parcel shipment, we would leverage UPS or FedEx, and for large-parcel shipment we would use trucking carriers in combination with third-party, last-mile home delivery agents. This is our traditional drop-ship model for small parcel and large parcel.

Now, our CastleGate fulfillment network is a network of large warehouses where we operate effectively as a 3PL for our suppliers, allowing them to store their small-parcel and large-parcel inventory in our warehouses, and pay us storage, pick, and pack fees. These warehouses are strategically located, and utilize pre-sorting and dedicated transportation to speed up delivery of the small parcel and large parcel items. This delivery speed, which includes next-day and two-day delivery for small-parcel items, delights our customers with fast delivery, and benefits our suppliers and us with increased sales conversion.

Today, shipments from our CastleGate warehouses can reach 99% of the US population within two days. As we ramped our CastleGate warehouse capacity significantly over the course of 2016, and expect to continue in the first half of 2017, it is a drag on our P&L, as the warehouses are not yet at full capacity, and we bear the burden of unutilized rent expense.

Over time, however, we expect cost benefits as warehouses reach full capacity and utilization, and as we take advantage of scale benefits in transportation. On our last call, we noted that approximately 10% of our US net revenue at the time was promised to and delivered to the customer, either with next-day or two-day delivery. We expect that this percentage will continue to ramp quickly, as we expand our capacity and suppliers increasingly flow product to our CastleGate warehouses.

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

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

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

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

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

Delivery out to the customer's home is now provided by trained partners with Wayfair experience. We direct the routes that the trucks take, and have a feedback loop in incentives that drive behavior consistent with our brand, including bonuses based on the NPS score provided by the customer after they receive their delivery. At the end of 2016, we were operating six of the last-mile delivery facilities, and we plan to have 15 to 20 in operation at the end of 2017, covering approximately 60% of the US population.

Large-parcel deliveries are a pain point across our entire industry. By working towards a future where the only people touching the product are Wayfair representatives who carry our culture of caring first and foremost about the customer, we intend to transform what can often be a negative consumer experience into an opportunity to continue delighting our customer. I will now turn the call over to Steve, who will give you an update on our private label credit card and our new wedding registry offering.

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

Benefits of the card include special financing offers, rewards points, and a discount off their initial order. We partner with Alliance Data for the card, and it's Alliance Data who bears all the credit risk, holds the receivables on their books, and handles the customer payment process.

Our results show that our private-label credit card customers visit Wayfair more frequently, and spend more than our average customer. We believe this is because the card attracts more loyal customers, and further increases their loyalty by spurring higher activation and repeat once they are a card holder. Though it is still early, private-label credit card sales in Q4 accounted for approximately 10% of our US direct revenue, and we expect that percentage will continue to grow.

We also recently introduced a financing offer, with Affirm to help those customers who wish to finance larger purchases, but do not want or qualify for our private-label credit card. Similar to the card, we do not bear any of the credit risk for these financing transactions. While Affirm is a relatively new offering, we are excited by the customer reaction so far. These programs are the beginning steps of our larger loyalty roll-out. For example, the private-label credit card is a great platform to give our best customers special benefits, which could include early access to new products or complementary services.

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

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

In addition to the potential revenue we can realize from the registry business, this offering has also been a great way to acquire new customers. Our early results show that almost half of registries created to date come from customers who are completely new to Wayfair, allowing us to reach new customers just as they reach the stage in their lives where they begin to spend a greater portion of their income on their home. In addition, we are introduced through registry to all of the wedding couple's friends and family, which is yet another source of customer acquisition. I will now turn the call over to Michael to walk through the financials.

Thanks Steve, and good morning, everyone. As always, I will highlight some of the key financial information for this quarter and full-year 2016. More detailed information is available in our earnings release, which can be found on our IR website. In Q4, our direct retail net revenue increased 40% to $959 million, and our total net revenue increased 33% year over year to $985 million. Our Other business, which includes revenue primarily from our retail partners, but also includes revenue from our small media business, continued to decline, reaching $26 million, as we continue to ramp down our retail partner business over time.

As Niraj mentioned, we are particularly pleased with our holiday execution this quarter, as well as the ongoing growth throughout the year from both existing and new categories, and from our US and international businesses. In full-year 2016, we reached $3.4 billion in total net revenue, adding $1.1 billion in net revenue compared to 2015. We believe our well-rounded consumer offering of extraordinary selection and visual merchandising, world class and personal customer service, and a great delivery experience are making it easier than ever before to buy home goods online, and we see that really resonating with our mass market customers.

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

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

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

Advertising spend was 11.8% of net revenue in the quarter, or $116 million. Year over year, advertising spend as a percentage of sales improved slightly by 10 basis points from Q4 2015, when it was 11.9% of net revenue.

As we have described in the past, revenue from repeat customers averages down our ad cost as a percent of net revenue, because it costs us much less to stimulate an order from a repeat customer than to acquire and stimulate an order from a new customer. Since our international business is newer than our US business, it does not yet have the benefit of substantial order volumes from repeat customers, and therefore runs at a higher ad cost as a percent of net revenues.

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

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

As we have mentioned in the past, we think of average order value more as an output and not an input. We want to grow our share of wallet, as measured by net revenue per active customer. All else being equal, we'd like to drive order frequency as measured by LTM orders per active customer. In any given quarter, however, mix shift as our international business accelerates, or mix shift across categories, as some of our categories grow more quickly, will influence our consolidated KPIs.

Q4 is usually a period of lower AOV, because holiday purchases tend to be lower ticket. As part of our overall goal of driving order frequency, we leaned in harder this quarter on higher-frequency, lower-ticket items, such as sheet sets or throws, and therefore saw a larger decrease in AOV.

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

We offer our customers over 8 million items, which makes managing AOV in any particular period impossible, and the reason we see it as an output and not an input. We're focused on striking the right balance between driving frequency, gaining wallet share, growth, profitability, and as always most importantly, showing our customer the right product for her from our vast selection. I anticipate there will continue to be some fluctuations in our various KPIs, as we have seen in the past, as we continue to grow international and newer categories, as well as strike the balance between frequency, AOV, and revenue per active customer.

Our non-GAAP merchandising, marketing and sales expense, and operations technology and G&A expense, are driven primarily by compensation costs. In Q4 these two line items combined were $116 million, roughly flat on a dollar basis when compared to Q3, as anticipated on a reduced level of hiring this quarter and last.

As we have indicated on the past calls, the first half of 2016 represented a catch-up period in hiring, and we now feel that our key strategic initiatives are well staffed. As a result, we added only 27 net new employees this quarter, bringing total head count to 5,637 employees as of December 31. In 2017, we intend to add additional head count in areas such as warehouse and customer service, which are the variable costs needed to keep up with growth, and in our OpEx areas to continue to support our key growth initiatives and investment areas.

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

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

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

On the one hand, our US business is providing the leverage for our international investments by delivering strong gross margins and ad spend leverage. On the other hand, we continue to make substantial investments in the US business to drive future growth.

As we've discussed, these investments include head count focused on new categories like home improvement, housewares, and mattresses; new businesses like registry and the roll-out of our logistics network, including CastleGate and WDN. The logistics investment also shows up as a drag on US OpEx, as the unutilized portion of warehouses is expensed there. The new categories also drive lower gross margins as they ramp to scale. The strong unit economics of our US business are funding these initiatives, and we believe that without these investments, the US business itself would be clearly profitable.

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

Ad cost as a percent of net revenue also runs higher than in the US, because the international business is newer, and does not yet have the benefit of significant repeat orders. Our OpEx is also meaningful, with 12% of our total head count located overseas as of December 31, 2016, as we build the local organization to manage the business, and plan for anticipated future growth. As Niraj mentioned, we continue to be very excited about the unique opportunity we have in front of us to continue gaining share in the US, and to win in these new international markets that roughly double the size of our total addressable market.

On a consolidated basis, non-GAAP free cash flow was $49 million for the quarter, driven by net cash provided by operations of $73 million, less total capital expenditures of $25 million, equal to 3% of net revenue. As a reminder, due to the seasonal impact of holiday sales, Q4 tends to be a quarter where our change in networking capital becomes a significant source of cash.

We expect CapEx to run at approximately 4% to 5% of net revenue per quarter for the first half of 2017, as we continue to build out CastleGate warehouses, and then moderate in the back half of the year. For the full year 2017, we expect CapEx to run at approximately 3% of net revenue. As of December 31, 2016, we had approximately $380 million of cash, cash equivalents, and short and long-term investments. Our near-term goal remains running the business at free cash flow break-even to positive, so that we will continue to be self-funding.

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

Last quarter, I mentioned that the state of the macro retail environment was unclear. I believe that is still the case today. Some retailers have reported weaker-than-expected results, and delayed IRS refunds to households that fit our customer demographic will have an impact on the timing of revenue during the remainder of the quarter. We have continued to see strength with our customers, and believe the transition from brick and mortar to online remains the key market driver for our growth. But at our scale, we will certainly feel the impact of any changes in consumer sentiment and behavior, both positively and negatively.

It's also worth noting that Q1 last year is an extraordinarily difficult comp. As such, we remain conservative in our guidance of growth rates. We forecast Other revenue to be between $15 million to $20 million, for total net revenue of $905 million to $930 million for the first quarter. For consolidated adjusted EBITDA, we forecast margins of negative 3.5% to negative 3.8% for Q1 2017.

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

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

One other item to update you on is the recent signing of a new banking relationship with CitiBank and Silicon Valley Bank. As you may recall, we previously worked with Bank of America for a variety of commercial banking services, including our unused line of credit and corporate credit card program. With this new deal, we were able to negotiate a better overall deal, including better terms on the credit card program, and a larger quantum on the line of credit. Now let me turn the call over to Niraj before we take your questions.

Thanks, Michael. In closing, I'd like to reiterate how proud I am of what we have accomplished in 2016, and how we are positioned going forward. Shopping for home goods is moving online in North America and in Europe, and we think we will continue to be the beneficiary of that secular trend. We have a large addressable market, and we are still in the early innings of online penetration, with approximately 9% of the category sold online today in the US.

Our overall offering is increasingly complete, with house private-label brands, a significant Wayfair brand presence, and superior customer service. Our key investment areas will help us up our game even further, by expanding next-day and two-day delivery coverage, adding new categories for our consumer to buy from us, and expanding into new geographies, where we can leverage our experience. We are looking forward to a great 2017. We would be happy now to take your questions, so I'll turn the call over to the operator.

Thank you.

(Operator Instructions)

Seth Basham, Wedbush Securities.

Thanks a lot, and good morning.

Good morning, Seth.

My question is just around the cadence of your sales for the last four months. It seems like, after your last conference call, you indicated you're running north of 40% in terms of direct retail revenue growth. You had a very strong Cyber5. And based on your quarterly result, it suggests a slow-down in December and then a further slow-down in January, based on what you said. Can you help us understand what might be driving this slow-down, and how you think about the outlook over the course of 2017?

Sure, Seth, it's Niraj. Thanks for joining the call. In terms of your question, I think the Cyber5 period is always a particularly strong period, so you've got to view that a little bit in isolation versus like a trajectory data point as you're mapping through the numbers. I think what you've been seeing us guide is that growth from a year ago, where we were approximately 100% growth, has decelerated more to normal numbers, where we're taking a significant share but at a rate a lot lower than that. That trajectory has been playing out.

I would just view the guidance as part of that trend where you're settling into a rate that's a good growth rate, particularly in light of the fact that the bulk of the money we're investing is actually for long-cycle investments that aren't showing up in the growth rate today. I don't think there's anything acute in the last few months where one month or two months are showing a very deteriorating trend or something like that. I'll let Michael comment, because there's always some uncertainty about macro, based on what we hear from others, but to be honest, we usually have a pretty hard time reading it, except in arrears.

Yes, I think that's right. Set, just to be clear, last quarter I think we said that we were growing, quarter to date at the time of earnings, about 40%. I don't think we implied that we were north of that. I think we came in pretty much where we were growing at that time through the balance of the quarter.

Obviously, you're trying to figure out what's going on in your own business, and then also what's going on in the macro environment. As I noted in my comments, I personally believe the macro environment for retail is unclear. There's certainly some things out there that look like the macro environment is quite strong, and then there's other factors that look like it's not -- the consumer is not as strong.

The one piece I'd note that makes this quarter for us, one macro piece I'm watching certainly is the IRS getting early refund checks out to consumers. If you think about the nature of our consumer, a 45-year-old woman with an $80,000 household income, she is someone who might have a $500 bedroom set in her idea board ready to purchase when she gets her IRS $1,000 refund check.

Okay, that's helpful. As you think about the outlook for 2017, moving to the EBITDA line, would you expect an inflection to positive at some point this year?

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

Seth, the thing I might point you to is, obviously this quarter we've now broken out two segments, the US business and the international business. Obviously, the international business is a substantial investment. You can see that it's now -- we're investing in that business at the EBITDA line in a fairly consistent way. I think it's fair to assume that's going to continue.

At the same time, I think the US business, as I noted on my prepared remarks, was profitable in the fourth quarter. It makes sense; it's a big quarter for us, and there's some holiday seasonal inflection. I expect that business, the US business, to swing to a modest EBITDA, adjusted EBITDA loss in Q1.

But you can see now in the economics of that business, is that as that business continues to grow at this pace, the flow-through will be there. I think it's not hard to run out the numbers of what's going on in the US business, the investment levels we're making, and the international business, and get to a place where you can see the inflection point first that the US business will be running at a profitable basis, and then, over time, for the US business's profitability to be high enough to be covering off the international investment.

Greats, thanks for the color. I'll turn it over.

Matt Fassler, Goldman Sachs.

Thanks a lot. Good morning to you. I've got a quick two-parter on gross margin. The first relates to your comments on the promotional environment. You might be the only company in years to say that it wasn't as bad as you feared. That was obviously borne out in the gross margin, but a little more color on what was better and where you saw the lack of pressure would be helpful?

Then also briefly on gross margin, as your mix tilts slightly towards some of those newer categories, if you could discuss the implications for gross margin and contribution margin, if you could get it down to that level, for those new businesses? Thanks so much.

Okay, hi, Matt. It's Niraj. Thanks for your questions.

Hi.

On the gross margin, the first question about the promotional environment, the way we think of about that, holiday is the most acute time of the year for promotions, although to be honest we live in an environment where promotions are always running, and that's part of your merchandising strategy. When you enter Q4, you really don't know what your competitors are planning to do. You can have cases where competitors, frankly, are giving away goods in certain areas just to stimulate their overall business or, frankly, drive a certain business line or whatever. You're not sure what you're going to see. You have your own plan that you really like; you feel like you know what your customers want. You feel like you know where you have good value to show.

What happens is, you have a lot more uncertainty than you have at other times of the year. What we're saying is just that when we led with the offers we thought were great -- we obviously have the benefit of a huge supplier base. We don't carry the inventory, but we work with our key partners to plan on what we think will work well. We've just seen great success. What we didn't see was cases where competitors were just giving away items just to try to drive that volume. It seemed like a healthy environment to us, where people were focused on making money, and there wasn't that oddity.

In terms of how new categories play out in gross margin, in contribution margin, I'd almost tell you the thing to think about is exactly what you said, it's the contribution margin. And the reason is -- when you have a new category, its gross margin is going to be quite low, and then, frankly, its volume is going to be quite low. Its drag on gross margin isn't that big. Then you will have a period of time where it starts ramping.

While your gross margin is going up, your actual drag on your Company's gross margin percent will become bigger, but your gross margin is actually getting better and better, and it might even be producing a little bit of contribution margin maybe from a place where it's producing zero contribution dollars. And then as it gets bigger and bigger, it actually will have a gross margin much more in line with the mature parts of the business, and will have really good contribution margins.

If you focus on the contribution dollars portion of the contribution margin, you actually have really nice curves where you start off not expecting much, and then as you ramp it, you're basically putting in the logistical finesse, you're getting the buying power, you're getting the volume with suppliers, and all of a sudden you are getting profit dollars out. And the journey there, you need to not worry about the gross margin percentage drag it creates because it doesn't really create a dollar drag if you do it right. That's the way I think about it.

As we have more and more of these take off, we hope in the not too distant future, it might create wings in the gross margin percentage, but if you look at the variable contribution margin dollars, you should see the trends you want to see where we continue to grow that nicely. And to be honest, the more you have some of these take off, the more, not so many quarters out, you can see it be nice pops in the contribution dollars.

Thank you so much, Niraj; I appreciate it.

Thank you, Matt.

Chris Horvers, JPMorgan.

Thanks, good morning, guys. A couple follow-up questions, first on Matt. On the gross margin, it was up [40 basis points]; you had modeled it down, I think, 23% to 25%, so, roughly 100 basis point swing. Would you say the delta versus plan was evenly split between the promotional environments and the vendor support?

And related to that, could you talk a bit more about what exactly vendor support is? Is that scaling the Business? Is that exclusive items and private label volumes that you're offering and helping the mix and so forth?

Yes, it's Michael. Thanks, Chris. It's a little hard to split it between the two because in some ways they work hand in hand. What I mean by that, on the supplier side, is that we have gotten better and better, and our relationships with our suppliers have gotten larger and larger, where we are much earlier in the year now planning with our key suppliers which products we think are going to have big value with our customers during the holiday. And therefore, making sure that they have enough inventory on hand, but even more importantly to this discussion, that we are getting the sharpest possible wholesale on those items that we're going to go highlight to our customers as part of those promotions.

Remember, we've talked on previous calls about shooting some of the photography and the imagery and doing the initial merchandising much, much earlier in the year to be really prepared for that. I think part of that is those relationships and negotiations with the supplier to get your best possible wholesale, and that's really what helps in this environment because you already are in a place where you're running at a great price for the customer, but you've got enough margin for us and enough margin for the supplier to make it work all the way through the chain.

This is Niraj; one thing I will just jump in with, Chris, I think it's important to note that a large amount of what you see when you look at our total Company gross margin, you see it move around, is actually mix. You have mix from the different international businesses that are on different places in their lifecycle, different gross margin levels. You see mix between the different things happening in the US, different categories and the different retail brands.

There's a huge amount of swing that actually, if you had all of the component parts, you would say it's just a mix of that. And then if you isolated it and you dove into one area, you get into what Michael was really discussing. But, yes, I think I would be careful not to try to bucket it into those two buckets you have because it's not that clean a read.

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

We have always said that there's a lot of opportunity in gross margin from three things, and one is transportation savings. If you think about last year, you look at the Business, transportation, advertising, and OpEx headcount were all around about $400 million in costs. That transportation $400 million, as you add a lot of finesse, as you have volume, you can add finesse in terms of how you bring the product in more efficiently, how you manage the whole cost from the origin location of the back [brake] in to bring it into the domestic market that you're selling it in, getting it closer to the end customer, how the transportation through to the last mile works. There's a significant amount of efficiency you get there.

The second is buying power with suppliers, as you mentioned. And the third, you also touched on, which is, if things are private label or house brands, you start getting a lot more pricing leverage, per se, in the sense that there's not direct matches on those items in the market. And so all of those unlock gross margin.

And then what you tend to do is you are giving some of that also back to the customer in various ways, whether that be loyalty programs or that be certain types of -- you might do things to reduce damage that have net cost savings but basically may look in the near term that it's hurting your gross margin, the long term actually is good. So there's all kinds of different puts and takes, but we do think there's continued gross margin to get at the very significant magnitude.

And, Chris, to your point on near term, I think we are still targeting the 23%s; I think that's where we would like to be priced. So as Niraj just mentioned, that litany of all of these things that are positive to gross margin, we also want to then make sure we are using those to be priced well in the market, and that balancing act is in terms of driving growth, penetration, and customer satisfaction.

Understood, thank you very much.

Thank you, Chris.

Ollie Wintermantel, Evercore ISI.

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

Sure. It was a little hard to hear, but I think the question is about CapEx and then international versus the US. There's really two primary buckets from a CapEx perspective that generally -- the logistics where house build out, which is primarily racking. Remember, we have a very low capital intensity around these warehouses we are building; we don't have a lot of automation and conveyors, et cetera. There's that piece.

And then the other piece is what I would call the more normal CapEx of technology and infrastructure. The vast majority of that deployed has been in the US. We have our first CastleGate warehouse facility in the UK now, and obviously we have invested on the technology and infrastructure side in Europe as we've built out a data center and people there. But I would say the vast majority, it doesn't look -- I don't have it in front of me, but I'm guessing it doesn't look that dramatically different than the revenue split right now.

Okay, great, and then translating that into maybe on the EBITDA level, so you mentioned the US swing to a slight negative in the first quarter and then assuming that probably in the fourth-quarter 2017 it should turn positive again like the last two years. Is it then the cadence also that maybe the second and third quarter, we are rough around breakeven or slightly down, and then turning positive in the fourth quarter, is that fair?

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

Thanks very much.

Thanks, Ollie.

John Blackledge from Cowen and Company.

Great, thanks for the questions. With a strong repeat customer rate in the fourth quarter, how should we think about potential ad leverage in the US in 2017? Any sense of US ad spend as a percent of total revenue?

And then secondly, on registry, it's seasonal, we have been hearing about it for a while, it should help in 2Q and 3Q. Is there any way to frame or quantify the impact to the US business this year? Thanks?

It's Niraj. So on your first question about strong repeat customer rate, how does that translate into ad spend in the US, a couple of thoughts there. One, one of the things we've mentioned a couple times is that if you look back over the last year, we've actually been constraining the US ad spend to actually even less than the pay-back period that we generally would allow it to go to. Because what we have been doing is allocating more ad spend to international, while overall looking for leverage on the ad spend line as a total Company. And so, you can say that's shortsighted in the sense that we should spend more in the US, but we think it's the best outcome for the long run, to actually build these international businesses. That's been a long-run benefit straight off we have made for the short term less benefit in the US business.

So, what will happen this coming year is that, I don't know that we are interested in constraining it to the point where we are really leaving a lot of low-hanging fruit out there. Ad spend is not necessarily the place that I think you should look to see a lot of leverage. I think we want to continue to acquire customers at a really nice fast pace where, frankly, we're getting really good payback. We're not looking to add a huge amount of deleverage either, but we're not looking to squeeze ourselves to where we are not taking advantage of good opportunities. So that's the -- .

The one thing I would add to that, too, as the international businesses continue to mature, and we are obviously making substantial investments there still, but we would hope that as those businesses get -- start to get a repeat base of customers and start to build, that even though as their mix grows it hurts ad spend as a percent of revenue in total, their level of ad spend as a percent of revenue is getting better and, therefore, it weighs less and, therefore, the US has to make up less of that.

The registry, the thing I'd point out on registry, the registry is a longer-cycle thing, right? Because you're marketing to folks now, they set up their registry, they get married in the spring and summer, and that's really when the purchases occur. And because this is our first real annual cycle, what we are doing there is, frankly, we are marketing it, we are advertising, but it's one of those things where we have quite a good plan. It's reasonably ambitious, but should it work well, then what you would do is you would increase it substantially, but that would be for the following year, because it really is an annual cycle. You don't have the ability, like we do with most of our ad channels, to continually adjust and increase it, because you have one specific period when you get to customers, and then it takes quite a few months for you to see what the payback was and then adjust it again.

That one I would not expect to see huge impacts on the US financial performance this year from it, because it's so new and it takes a little while for that feedback cycle to work. We really do like that business because if you think about those customers, and you talk about the millennials, 70 million people between 17 and 34, they are just starting to get married. They are the folks who then, for the next 20 years, will be homegood buyers as they start their families and they buy their house and all of this. That's really the strategic benefit of it. It will take a few years for that to really cycle up, in terms of our share of the registry market and things like that.

Thank you.

Thanks, John. I think we have time for maybe one more, operator.

Michael Graham, Canaccord.

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

Yes, sure, Mike, so a couple of thoughts. First, I don't have, obviously, your model in front of me, but some of the numbers you're throwing out strike me as perhaps being a little low.

But the way I would phrase it is, remember, what we have been doing here is we've been allocating money away from the US into international. And then within the US, we have been allocating money disproportionately more into longer-cycle benefits than near-term benefits. Longer cycle meaning building up these new categories, meaning these two logistics networks, CastleGate and the Wayfair delivery network, which actually are proving to have very substantial benefits, but they take longer to roll out and really scale to affect a large percentage of the Business. We think that -- that's actually -- we have been working on these things for a 1.5 years, 2 years in some cases, and they are starting to really take share and grow quite well.

To answer your questions, there are significant things that should affect the US business's ability to grow, to drive repeat, to drive new customer acquisition, the overall growth rate, that are continuing to come online that we would expect to be very stimulative. That said, I also think your numbers are a little low, and so the way I would characterize where we would like to be is, we want to be a significant share taker. If you believe the overall market is growing at 15%, you would then want to be meaningfully above that. If you believe the total market was growing 10%, you want to be meaningfully above that, and if the total market was growing at 20%, you want to be meaningfully above that.

We think the overall market online is growing around 15%, plus or minus. And so, we wouldn't be very happy if we were growing at 15% for any sort of prolonged period of time. We want to be growing at a very significant rate above that, while still preserving our unit economics, not using advertising to be stimulative to it, not using pricing to be stimulative to it, rather through the strategic things like the logistics and the merchandising, building up these categories, the customer experience on mobile, all of these types of things. I realize that's not maybe specific guidance for you, but that's the way we think about it, and that's the way we look for it to play out.

Okay, that's helpful, thank you.

Well, everyone, I think that wraps up the questions, so I will turn it over to the operator, but thank you for joining us this morning.

Thank you. This does conclude today's conference call. You may now disconnect.