Q3 2019 Earnings Call
Good morning, Ladies and gentlemen, my name is Suzanne and I'll be your host operator on this call today at this time, we'd like to welcome everyone. The Wayfair Q3, 2019 earnings release and conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session.
If he would like to ask a question that during this time simply press star to the number one on your telephone keypad. If he would like to withdraw your question. Please press. The Penske. Thank you at this time I'd like to introduce Jane Gelfand head of Investor Relations at Wayfair. Please go ahead.
Good morning, and thank you for joining US today, we will review our third quarter 2019 result.
With me are neared Shaw co founder Chief Executive Officer, and co chairman.
We've called nine co founder and co Chairman and Michael Fleisher, Chief Financial Officer.
We will all be available for acuity following todays 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 2019.
We cannot guarantee that any forward looking statements will be accurate, although we believe that we have been reasonable in our expectations and assumptions.
Our 10-K for 2018 NR subsequent SEC filings identify certain factors that could cause the companys actual results could 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 replacement war and should be read together with GAAP result.
Please refer to the Investor Relations section of our website to obtain a copy of our earnings release, which contains description of our non-GAAP financial measures and reconciliations of non-GAAP measures to the nearest comparable GAAP measures.
This call is being recorded an a webcast will be available for replay on our IR website.
I would now like to turn the call over to marriage.
Thanks, Jane and thank you all for joining us this morning.
We're pleased to talk about the third quarter results and the many initiatives that continue to propel wayfairs momentum in our confidence in the future in Q3 direct retail net revenue grew by $607 million or 36% year over year.
Net revenue grew by 35% year over year.
Despite much debate about the hope the U.S. economy, and a mixed macro backdrop in Europe , we continued to see strong growth in both the U.S. and international segments.
Structural shift from offline to online marching steadily.
In the short term tariffs are injecting greater than expected volatility into our marketplace as customer consideration cycles are disrupted and larger than normal amounts of substitution occur in response to price change. We believe this is temporary in nature since our machine learning algorithms will adjust our site experience as customer preferences change.
But it does inject near term volatility.
As Michael will discuss in greater detail, we're optimistic that this noise will subside over the next several months.
Meanwhile, we remain as always focused on a longer term and the investment initiatives, we have in place to cement wayfairs positioning as the E Commerce leader in home goods.
These major initiatives include our logistics infrastructure build out international expansion and further penetrating our Tam across all categories of home goods today I'll provide updates on each of these pillars, including highlighting the successful approach we're taking in the core plumbing space.
But first I'll start with our logistics network.
We currently stand at approximately 15 million square feet globally. After having opened our second Cascade warehouse in the UK this past quarter.
This marks the first international Castlegate warehouse that spans over 1 million square feet, which is more similarly sized to the fulfillment centers here in the U.S.
And which reflects the high levels of demand, we now have in Europe .
Looking ahead to 2020, we also expect a similar size warehouse to come online in Germany.
The planned rollout of our network continues just last month, we opened a facility in later up.
In Northern California.
Other warehouse in Jacksonville, Florida to help sort of the major population center in the southeast is expected to open in January of 2020.
They threw up near San Francisco is a great example of how we optimized for speed and density.
Coastal warehouse was envisioned since we needed to add capacity.
But at the same time its location enabled us to reduce inbound shipping costs.
While unlocking more one and two day coverage.
Put a finer point on it areas in northern California, and the Pacific Northwest, which later up is now the closest warehouse should see a 50% lift in one and two day coverage. Thanks to the opening of this fulfillment center.
And we know the presence of such delivery speeds lift conversion meaningfully we've already built a strong competitive advantage through castlegate and the wafer delivery network and are excited by the plans in place to increase their sophistication and agility over the coming quarters. We've built out the coverage that we need in the United States and over the next year or planning to.
Moderate the pace of or logistics expansion, as we drive greater utilization and throughput in our existing footprint.
Last quarter, we highlighted one such moved to drive greater efficiency as we shifted to a seven day staffing model and some of our facilities from a five day staffing model. These kinds of moves have clear positive long term implications. So short term they may cause a step back in terms of efficiencies as we adjust and take time to grow into the extra capacity that weve unlocked.
We'll see more of this over the course of the next year as we seek to optimize the use of our current footprint.
And then by 2021 to keep up with our growth we expect to once again pick up our pace of square footage expansion in the U.S. in order to expand capacity.
All future warehouses, we will add deliver similar compounding benefits as I described in the case of lead through.
That is provide needed extra capacity faster delivery speeds and lower cost.
We also continued to be pleased with the progress, we're making in international and Canada, though the majority of goods, we sell cross the U.S. border. The team is focused on achieving market pricing and lower costs by driving higher cascade penetration in Minnesota, and leveraging our Asian consolidation operations to ship more product directly from Asia.
To Canada via full mix containers.
In Europe , we've doubled our assortment over the last 12 months and continue to optimize and enhance the site experience for our customers.
Just earlier this month, we debuted our first flagship house brand in Europe coal hike on building on the successful curated brand strategy. We've established here in the U.S. as we scale in Europe were also increasingly focused on tightening end to end execution to drive greater cost efficiencies across our entire supply chain.
Now turning our attention to the emerging categories I'd like to spend some time today, telling you about core plumbing, it's one of the categories against which we have deployed investment resources over the last couple of years as we cement our right to compete and win in these important parts of home goods retail as a result plumbing has grown into a formidable business for wayfair approaching three.
$800 million, an annualized gross revenue and growing both revenue and variable contribution dollars at greater than 50% rate year over year.
The market for the core plumbing categories in which we compete is vast and an estimated 20 billion dollar total addressable size in the U.S.
We define core plumbing spanning faucets and fixtures items, such as bathtubs toilets, bathroom, and kitchens thinks and faucets, but days and shower doors.
Market share in this category has historically been dominated by local showrooms regional specialty retailers as well as contractor and DIY focus national retailers.
We estimate online penetration at a relatively low 15%.
Show rapid growth at a roughly 20% clip.
At Wayfair, we want to win across all categories, where our customer is making the purchase decision and care deeply about how the product will look in her home.
And core plumbing is no different though the installation made times be pro assisted core plumbing products selection is still heavily influenced by style anaesthetic inspiration nuance in retailing. These products is that we also have to educate the homeowner in the technical considerations involve helping us to achieve this is our dedicated core plumbing team of approximate.
The 50 people, who represent a cross section of category engineering marketing and merchandising functions. They along with a dedicated specialized customer service team oral experts at finding ways to resonate with our core customer who may be less familiar with the complex facets of plumbing as they take on a project we want customers to turn to Wayfair is the death.
Autonation to inspire educate scope and fulfill their product needs in doing so we believe we will not only accelerate the plumbing category transition online, but also help grow the overall market by democratizing access to products formally in showrooms and materially increasing the ease of shopping.
No single venue for shopping the category today, effectively marries depth and breadth of assortment inspirational content accessible technical know, how and ease of use including fast and reliable shipping. We believe wafer can disrupt the current landscape a uniquely tailoring our site experience for core plumbing, while leveraging our strong logistics and customer service offering.
Our core pulling catalog is vast with nearly 100000 skews, including direct relationships with the key brand name manufacturers in the space such as Kohler Rowley American standard Mullen and Delta.
These customers seeking something specific can easily navigate to and explore well known brand pages in products that are full of rich visuals and detailed technical specifications to help customers know that they found the right item, but for the majority of our customers for whom the shopping occasion is on familiar and opaque. We're also dean.
Mystifying, the journey by helping them explore and find what they're looking for using imagery and visuals to supplement industry terminology and proactively offering key descriptive and technical staff in a digestible way buying guides trends articles and do it yourself tips on our site augment this further for instance, using our Super browse page.
For tubs showcases a well merchandise assortment of over 9000 items.
Featuring robust imagery and Threed models that help bring to life the unique characteristics of each product.
Before the customer even clicks on a single product we offer up important details fell from narrowed their selection for example, the material. It is made from whether there is a false it or not drain placement and soaking debt all the while explaining the industry jargon, such as therapy and installation type through pictures and quick to scripts.
We also operate tub buying guide to build the customers trust and awareness as she embarks on making her selection.
With every product class, we understand the common challenges in the shopping journey and tailor the site experience to mitigate them, giving our customers the confidence to buy and.
Another example of how we do this in core plumbing is by pre configuring complete plumbing kits and shower systems. So that our customers do not have to worry about compatibility or having to shop individually for complimentary sets of products.
We also highlight required related items as one shops, so that the customer has all the key components they need during installation.
Wayfair prides itself on exceptional customer service, including specialized sales support for our customers.
We employ more than 500 subject matter experts globally in technical categories, such as core plumbing.
And with their help offer customers a comparable assisted sales experience to a showroom, but with a far wider and more robust selection of products.
These representatives support longer consideration purchases and projects without necessarily pushing for sale, helping to reinforce customer trust in wayfair and the confidence to make a purchase decision when ready.
As you can imagine getting the right product damaged free and quickly is critical in the core plumbing category, particularly for customers who are on type project timelines.
The laser not just inconvenient and frustrating but are also expenses for our customer, we're leveraging our logistics infrastructure and closeness supplier relationships to drive down lead times and forward position key inventory through Castlegate.
Core plumbing sits among the top five categories at Wayfair for one and two day coverage, reflecting both castigate forward positioning.
And virtual Badging.
We also align closely with our supplier partners to improve packaging product design and shipping practices to drive don't incident rates and improved customer satisfied.
Plumbing is one of the categories, where we have invested in growing the team. So that we have the resources to go after the immense opportunity that is still ahead.
We talk often about how such investments over the last couple of years should yield increasing returns core plumbing as an example, where the team currently in place is now positioned to considerably scaled the already large business into the future without many incremental resources.
Many of our emerging categories are now reaching this stage of increasing productivity in leverage and we're excited to continue to update you on their progress over the coming years.
I'll now turn the call over to Steve. Thanks marriage today I want to talk about some of the technology that powers our supply chain and then also share. Some early observation post the opening of our first physical store location in late August at the heart of our logistic strategy is to transport a massive number of skews from a wide spectrum of.
Suppliers to the right place at the right quantity and also at the lowest cost possible for our customers our suppliers in there for ourselves.
To drive the most efficient product flow into our network, we leverage a piece of software called by fair.
Which is a machine learning based optimization and supplier collaboration platform.
This is the proprietary solutions that we built over the last three years in the absence of compelling third party options.
In close collaboration with our suppliers by fair allows us to influence the products journey directly from the manufacturing site all the way to our warehouses.
It offers recommended quantities of each product for both Castlegate and dropship models, and directs which skews should traveled to which castlegate warehouse locations across North America and Europe .
With bike there, we can also rather than as efficiently as possible overland and see contemplating every step along the way.
By fair effectively insurers availability to the customer while minimizing time distance traveled touch points and damage involved.
That is at the lowest possible cost to all parties.
What makes the by fair technology goes differentiated and challenging is that in order for it to do its job properly we must optimize not just across our own network, but also across our suppliers now.
We seek to understand their manufacturing and logistics capabilities.
Including production quantities timelines and locations and then figure out how to best complement them with ours.
This is a potent example of what is possible given our unique partnership model with our suppliers in implementing by fair, we rely on our supplier partners to offer transparency around sourcing in production that they may include forward and proprietary information.
And return they can leverage our analytics insights to maximize their product velocities, while minimizing costs by engaging with us in the planning processes that by fair facilitates suppliers are showcasing their trust in US we in turn closely guard that confidence and aim to drive our business in ways that always benefit them while.
Also advantaging our customers.
If you think about the quantity and diversity of the skews we service all over the places they originated in travel to the various means we have to get them, there and what other products they might travel with the bipolar exercise has to run through hundreds of thousands if not millions of decisions to arrive at the optimize recommendation for our suppliers.
This is complex math, which was developed and is supported in house by a cross functional team of engineers data scientists and operations expertise. It also continues to evolve as our network Rose for instance, one can see how is it consolidation our initiative to optimally pool products across our various suppliers close to where it is sourced will.
Integrated into by fair suggestions.
This is a natural extension of the effort to forward locate and managed product flow at the lowest cost.
Hi, Fair is a core enabler of greater speed and lower costs for the full spectrum of suppliers.
It is agile enough to consider those suppliers, who have finely tuned logistics network of their own or in combination with other offerings, such as ocean freight drayage and domestic freight pickup.
Fair can also take the headache out of logistics and transportation planning for other suppliers, who prefer to concentrate solely on designing and producing the best possible. Good.
Similarly, followed by fair is a key input into the inventory planning conversations we are continuously having with our key suppliers today overtime. It will be available as a self service solution.
Given the sheer quantity of product we sell into many supplier partners participated castlegate keeping everything in stock in the right place at a low cost is no small task.
The proprietary solution, we have developed and by far is another great example of the partner focused data driven tech centric approach on which we pride ourselves.
As you May know, we opened our first full service physical retail store on August Onest in Natick, Massachusetts, just a few miles from our headquarters in Boston.
Our journey into the physical retail began with two holiday pop up stores at the end of 2018 in Massachusetts, and New Jersey.
After a successful run we expanded to four additional pop ups across models in Pennsylvania, Virginia, Illinois, and North Carolina This past summer.
Learnings for each of these experiences informed how we went to market with our first permanent location.
Our next door is relatively small at 3700 square feet of retail space and the mix of products. We offer ranges from small items when combined carry out to showroom items. One can experience in the store and then purchase online the vignettes on display inspire our shoppers to go onto the site and explore the many other product options available to them in.
In the store. There's also an experience will component via our home bar, which offers complimentary design consultations as well as augmented reality virtual reality and design tools to showcase the feature at home goods retail and how it can interact with their personalized space.
We can't emphasize enough that the store is a dynamic exercise we designed the space to be flexible and are already iterative on how it might look and what we might offer to align better with our customers needs and expectations.
That said our initial observations have been encouraging while it is too early to highlight any numbers I will share that traffic and interest levels head of exceeded our expectations.
The high proportion of our native customers, our first time wafer shoppers, who subsequently discover our online marketplace. We're also seeing customers come back to the store multiple times and shop across the product catalog, making purchases ranging from furnishings for the living room and bedroom two wall art decorative accents and housewares.
As we experiment with the physical store format and assess ROI is we will judge its success on the basis of it representing a different former marketing channel not a widespread distribution channel as this is not our aspiration as always we remain focused on attractive payback metrics and building a sustainable profitable business over the long term.
And that extends offline and online outlet.
With that I'll pass the call onto Michael to discuss our Q3 financials and forward looking expectations.
Thanks, Steve and good morning.
Before we discuss the details of our third quarter financial performance and expectations for the ended the fiscal year I want to take a step back and provide a bit more context on how our business is managing through the latest tariff related volatility.
Since the beginning of the year more than 90% of our suppliers, who are subject to China terrorists have raised wholesale prices, which have resulted in higher retail prices.
As retail prices on the site fluctuate we observed that our customers consideration cycle gets disrupted and is effectively lengthened.
This has always been true changing prices up or down lengthens customer decision, making traffic to our site remains healthy and average order value steady, but customers are taking more time to consider their options across the site before purchasing in many cases are most popular highly rated products.
With extensive review counts and great imagery are now slightly more expensive than extremely similar products that have lower review counts often not burdened with the terra customers require more time to build confidence that the price. They are being asked to pay is right.
And to actively assess alternative products.
As product shift in popularity disorder changes.
In turn we've seen suppliers that revert and lower their pricing in order to optimize for share in the marketplace.
Which then again contributes to customer experience is being altered and so on all of this creates short term distance to the customer, which we expect will go away as the marketplace inevitably rebalances.
Tariffs are having a secondary effect as well as you know our marketplace model is unique in that we do not own the vast majority of inventory. We sell this is almost always a substantial multifaceted advantage with perhaps the sole exception being in periods of widespread cost increases like we're seeing now as supply.
Irrs communicate pricing decisions to us our pricing algorithms seek to maintain a balance between factoring in our higher wholesale costs.
And keeping us market priced in practice. This also translates to a lot of dynamism on the site and means that for a short period of time inventory carrying retailers may have a slight cost advantage. This should dissipate over the next couple of quarters as the market Rebalances pre tariff inventory is deploy.
You did.
All retailers incur higher wholesale costs reflective of terrorists.
The reality is that our business as a value added platform for the home goods industry will continue to be advantage as data around the new reality builds in the algorithms and behaviors all stabilize our marketplace will also rebalance the most popular items accounting for customer preference of which price is only one of many drive.
Yes.
So this whole process may take a couple of quarters to play out we will as always remain steadfastly focused on the longer term initiatives that continue to widen our competitive mode.
And we'll not shift our investment course in reaction to this near term volatility.
Now, let's turn to the details of the Q3 results in Q4 guidance.
Our press release and Investor presentation, which include GAAP to non-GAAP reconciliations are complements to this discussion and may be found on our investor site.
In Q3, our direct retail net revenue grew 36% year over year to $2.300 billion.
Other words, we added approximately $610 million in sales year over year.
In the U.S. direct retail net revenue increased to $1.961 billion up 34% for $500 million year over year direct retail net revenue in the international segment increased 46% year over year to $339 million.
Excluding foreign currency translation headwinds direct retail net revenue growth in international was up 50% year over year in constant currency terms.
Our capesize remained healthy LTM active customers totaled 19.1 million this quarter up 38% year over year, reflecting successful customer acquisition and healthy engagement and repeat behavior.
LTM net revenue per active customer reached a new high a $449.
On an LTM orders per active customer were about flat sequentially at 1.85.
In North America, LTM net revenue per active customer increased sequentially, but we experienced a slight moderation in average order frequency, reflecting the longer consideration cycles that I referenced earlier.
In Europe were tariffs are not a factor we did not see the same dynamic.
In the quarter orders from repeat customers represented 67% of the consolidated mix.
As we move down the Pinedale I'll be referencing the remaining financials on a non-GAAP basis, excluding the impact of equity based compensation and related taxes, which totaled $65 million in Q3 2019.
Our gross profit for the quarter was $541 million for 23.5% of net revenue.
Gross margins expanded 40 basis points year over year.
The gross margins were in line with our guidance for 23% to 24%. This was admittedly a bit lower than the past few quarters and primarily reflects some of the short term tariff related pressures in the U.S.
Advertising spend was $282 million were 12.2% of net revenue in Q3.
This is approximately 35 basis points higher year over year.
This is due to continued negative mix shift as our international business, which operates at higher levels of advertising as a percent of sales outpaces us growth rates and continued AD spend to add new customers in the us within our ROI payback threshold.
We are highly payback driven in our marketing spend decisions and that is no different as we scale in Europe than our approach us.
As you analyze our results you'll also see that the average cost of customer acquisition for CAC.
Has risen modestly in the quarter. So I run to remind you that we are focused on acquiring high quality customers, who will not necessarily transact in the same quarter, we engaged with them.
We continue to target an average 12 month payback period on the variable contribution dollars. These customers will bring in relative to the cost of acquisition.
As we have done since wayfairs inception.
Fundamentally we expect advertising costs to drop as a percent of net revenue as the repeat customer base grows faster than the new customer base.
Given that repeat customers run at approximately a 7% add cost as a percent of net revenue.
This has been our long term trend over the last five years and we expect it will continue over time.
Our non-GAAP selling operations technology, and Gionee expenses in Q3 totaled $365 million.
As a reminder, much of this line item is attributable to compensation costs and the third quarter as expected was a heavier hiring quarter due to the timing of campus recruiting in total we added approximately 1500 employees in the third quarter with roughly 800 of these in variable cost areas of our business.
Where we are mostly in sourcing work previously done by third party logistics partners and keeping our customer service teams staffed to our scale the balance or about 700 employees is accounted for on the Opex line and represents employees in worked areas such as engineering marketing and merchandising.
Our campus recruits made up more than half of these 700 net new employees.
We have added really talented new people from highly respected undergraduate MBJ engineering and data science programs, a testament to the strong employer brand, we have built on undergrad and graduate campuses.
Now turning to profitability adjusted EBITDA for Q3 was negative $144 million or negative 6.3% of net revenue.
Adjusted EBITDA for the U.S. business was negative $63 million or negative 3.2% segment EBITDA margin and adjusted EBITDA for the international business was negative $81 million.
Our level of investments in international was consistent with our expectations, but the U.S. losses were slightly greater than anticipated.
non-GAAP free cash flow for the quarter was negative $181 million based on negative $76 million in net cash from operating activities and $104 million and capital expenditures Capex was 4.5% of net revenue in Q3, and we expect Q4 capex to run approximately 4% to 5% of net revenue.
As of September 32019, we had approximately $1.3 billion of cash cash equivalents and short and long term investments.
Let's now turn to guidance for Q4 2019.
Thus far into the quarter, our direct retail gross revenue growth year over year is trending at just under 30%.
So our growth has moderated some relative to the first half.
As we are closely monitoring our business drivers, we see underlying fundamentals as broadly healthy. We also feel very well positioned for the holiday period that is right in front of US as you know our guidance philosophy varies quarter to date performance full quarter expectations and a healthy dose of prudence as a result.
We are setting our guidance for overall revenue growth below our current quarter to date performance as we typically do.
We especially think this approach makes sense in a period when visibility is somewhat compromised by terrorists related uncertainty.
And the fact that as I like to remind you every quarter. We're in a mass market consumer business, where the customer has to show up every day.
We forecast direct retail net revenue of $2.475 billion to $2.515 billion, representing approximately $480 million to $520 million of direct retail dollar growth year over year.
Or a growth rate of approximately 24% to 26%.
For the U.S. business, we forecast direct retail net revenue growth in the range of 23% to 25% year over year and expect international direct retail net revenues to be up 27% to 30% year over year on a constant currency basis, we're forecasting international growth between 30, and 33% year on year.
Recall that Canada represents the majority of our international revenue.
Terrorists are a factor here as well given our current sourcing structure.
We forecast other net revenue to be in the range of $5 million to $10 million for total net revenue of 2.48 to $2.5 billion to $5 billion for the fourth quarter. We expect Q4 gross margins to once again land in the 23% 24% territory.
We continue to see multiple upward drivers to get us beyond this range over the mid and longer term, we expect to contend with some of the same dynamics as we saw in Q3 as it relates to tariff related trade offs and normal quarter to quarter variability as our supply chain optimization progressive.
We also anticipate about 50 to 100 basis points of deleverage year over year in advertising as a percent of net revenue.
That said our advertising decisions will ultimately be determined by our marketing team in a bottoms up approach as they monitor channel specific opportunities vis-a-vis, our 12 month payback threshold in real time, and assess whether to increase or decrease their spend in specific markets and channels based on the returns they are seeing moving on.
For the core components of selling operations technology, and DNA expense or Opex, our hiring plans contemplate that our pace of net employee additions will moderate back to first half levels.
As an organization, we are focused on driving towards operating expense leverage and though it may take a few quarters to play out those efforts start to take root with a more normalized hiring pace quarter over quarter.
Unutilized rent is expected to remain in the $15 million to $20 million range in line with the third quarter.
At the consolidated level, we forecast fourth quarter adjusted EBITDA margins in a negative seven to negative 7.5% range with the U.S. adjusted EBITDA margins in negative 4.25 to negative 4.75% territory.
In international investments translating to an $85 million to $95 million loss.
For modeling purposes for Q4. Please also assume equity based compensation related tax expense of approximately $69 million to $71 million average weighted shares outstanding of 93.3 million and depreciation and amortization of approximately $60 million to $62 million.
In Q3, we demonstrated that shorter term headwinds from tariffs or otherwise are something we can effectively manage.
So these may take several more months to work through we remain more focused on the long term drivers to our success partnering with our supplier partners to provide customers with a massive selection across all classes of home goods exceptional customer service and an easy fast and seamless delivery experience. Our continued momentum not only reflects the.
Structural move from brick and mortar retail to an e-commerce world, but also the unique competitive advantages we have cultivated to capture a disproportionate share of the dollars moving online. So we're privileged to have a healthy balance sheet to allow us to continue to invest in our business for the long term. We are also confident that wayfairs compare.
One unit economics, and ROI orientation will become increasingly evident across all lines of the personnel overtime.
I'd now like to turn the call back to marriage before we take your questions.
Thanks, Michael.
Though our momentum remains impressive despite tariff infuse volatility is moments like this that underscore the value of our long term orientation. Our team of over 16000 employees is appropriately focused on our customers the long and substantial runway for growth still ahead and the many initiatives underway to capture.
Unit share of that opportunity.
As we approach the holidays were truly excited by the impressive lineup and service we have planned for our customers and we're committed to always being customer focused execution oriented and to think long term in nature.
We'll now go to Q in a so that we may answer your questions.
Thank you and just a reminder, in order to ask a question star one on your telephone keypad that is star one on your telephone keypad ask your question.
Our first question comes from the line of Peter Keith Piper Jaffray. Your line is open.
Hi, Thanks, good morning, everyone.
I did want to dig a little bit more into some of the tariff dynamics. So first talked about it with July seeing some price increases. So we're now four months in to maybe at a price increase environment.
On that note.
You said, a little more confident about working through the temporary disruption. So the two questions that have on this topic would be first off when have you seen a majority of the price increases is that being a more recently or was it more front end loaded towards said July .
Secondly.
When you look at consumer behavior, how long do you think this disruption or or pause dynamic last so we can get a better sense of when your sales growth might start to reaccelerate. Thank you.
Thanks Peter.
Yes, let me try to answer those too and I do think.
They are obviously highly inner linked so.
The terrorists the bulk of our goods were in the trucks were 10%. The first 10% happened last year, and then that 10% 25. This summer and then we have a smaller amount of goods, where they went from zero to 10 in that the summertime front really focused on the part that went from 10 to 25, what we found was that the 10% largely was absorbed so the pricing.
Increases that came through lasher were really minor or non existent when the 10 went to 25.
That's really what created a lot of volatility instead, they basically what's happened is theres no clean date when people started passing through price increases and what you find is actually folks at all kinds of different things some folks decided to try to hold price either for a while are permanently some folks held price because they're in the middle Resourcing. The goods elsewhere, but then the goods may have gone out of.
Stock for a while other trying to bring new supply sources online.
But then the thing that took us by surprise and the thing that I think we underestimated was that there was a repetitive cycle of volatility in what we mean by that is that some suppliers they raise their price.
Then they would see the volume drop off be steeper than they've been than expected because of the nature of our marketplace, which basically a little allows them to compete with other suppliers to the consumer they would then cut their price, but when they cut their prices still creates new cycle volatility in that case is positive form, but it disrupts the buying cycle again for the consumer as they consider this other item that which came better price.
Vice versa than we have a lot of those suppliers you try to pass through a price increase our past one price increase then weighted to while pass through another once they try to trickle it in but each time, they trickled summing it created some volatility. So what's happened is if you sort of look at what's happened over time Theres a lot of disruption of the cycles sum up some down so and so forth.
And that sort of what we underestimated was just the just the amount of changes and the fact that they'd be ongoing in terms of timing, we do view it as all transitory and a lot of the metrics, we have which show how the business is performing around loyal customers coming back and the repeat metrics in the early repeat three and seven day type repeat metrics and.
We have a whole body instead of data we're always looking at basically show that the customer we think we're having great momentum with the customer they are coming back and so we think is transitory and we feel like over a couple of quarters is going to pass and we're kind of in the middle of it.
So from a timeframe perspective is very hard to be literal on exact date per se, but we see a passing through and we feel pretty comfortable at then so don't think the consumer behavior as a pause per se, but just think of it is disruption kind of just kind of just keeps kind of throwing small delays into things and that that cycle hasn't ended yet, but as we work.
That will be what causes the growth tend to kind of kit to pick up.
Okay. Thank you for that color and then secondly.
We've had some conversations with investors around advertising in the rising customer acquisition cost.
Theres likely some influence of that that rising cash from the lower sales growth but.
It starts elevating in Q1 in Q2 before the Paris kicked in.
Could you give us a just a little bit of color on what might be driving that that CAC on an aggregated basis. If it has to do with some of the international or is there a leading it on on new customers any additional color would help us. Thank you.
Yes sure. So let me just first by trying to just clarify one that CAC calculation that kept the CAC calculation, we try to help illustrate how repeat is much less expensive the new and we sort of give you a way to kind of calculate that out but at the end of the day that cap number you get the $58 is still not the actual cash we're paying for.
New customers in the quarter, it's simply all the AD cost.
Basically.
The actual AD cost were spending for new customers, we get those new customers over time. So we use a few customers in the quarter. It doesn't tie out with the money spent for new customers in the quarter and the reason that matters. You mentioned internationally basically we have is you have different they have different geographies on different points time in the curve, Germany. As an example, we just started to brand Mark.
Cutting campaigns for Germany earlier this year, so thats a costs that will look very expensive relative to your customer adds in Germany in the beginning and then as you run through time, it'll start looking very efficient.
We also have brands like Parago our goals.
That two to two and half three years in but it's now hitting its starting to really scale and has a significant amount of money being spent on it again. It would look quite expensive. If you took the parable that spend for new customers looked at specific to new customers because that type of brand building expense in the beginning is quite quite expenses.
And so that challenge of these different brands different geographies at different points in maturation create a lot of mix and even within a brand you have different channels and certain channels that get you higher quality customers may have a 400 day payback that we'll manage against a more transactional channel we might have a 60 day or 30 day payback, we're going to manage against that and that manage.
She's out to that timeframe that we kind of tail pays back and under a year, which is true but the reality is there still mix shift within it and so what you're seeing is the mix shift. This year. If you think about Jeremy think about Parago do you see it going against the.
The overall CAC calculation when you get into next year when I look at the estimates and when I think makes it look like I think as you go roll through next year, even start seeing leverage again, so CAC is getting less expensive again that won't necessarily be true then either it will really be that mix effect. The CAC is actually being managed very tightly. We then each brand within each channel so that if thats true now.
Now when you see going up and will be to later when you see going down and then one thing because we can anticipate that might be a questions I just.
Yup.
Some numbers if you actually look at in the quarter, we spent $282 million on advertising when you add up all the geography result brands brand marketing the more transactional the online that the direct mail everything in the $282 million is.
When you break it out a new versus repeat you see we added just under 3 million new customers in the quarter, you basically see that you get that $58 since the 170 $273 million.
Most of spend on new customers in order to get the cap to kind of just not just to basically be flattish.
The 280 million. If you spent 16 million less you would have had it you to added play out like that 16 million on a 282, we could have pulled 60 million out and not impacted revenue in the quarter, but what would happen as you would have given up getting customers that turned out to be very valuable customers that are paying back very nicely and not building up the brands in terms of awareness at the same rate.
That we know its financial and productive and so thats why we don't manage to the cat number it's more an outcome and output of the way, we manage and that's why I'm kind of tell you now as you see that leverage will through next year to be honest won't be from doing anything different. It's again. This is the mix will start to workforce.
Okay. Thank you very much George its very helpful and good luck with the holiday season.
Alright, Thanks Peter.
Our next question comes lineup, Brian Nagel of Oppenheimer. Your line is open.
Hi, good morning.
Good morning, good morning, I too.
Two wondering just double deeper into the terrorists issue I guess it question maybe for Michael.
The.
Deceleration in sales growth now from.
Through which gave us in the fourth quarters, Roger significant okay, I hear what you're seeing with regard to Joe's looking at all the data you have is there something you could give us that.
Helps to explain further that that's where we use.
During this year when there is not something else are right.
With regard to how consumers react on your website.
Hey, Brian .
I don't think we can give you a sort of up more specific set of data points other than sort of the health of all the sort of built in Cape size and.
As we look at look we're obviously looking at a set of data constantly as to what customers are doing on the site.
What their conversion rate looks like how much time, they're spending how many times they come back right all of the sort of the actual sort of functioning of what the customers are doing everyday and I do sit well say one of the piece on this is that we know from well before tariffs that we've done a lot of work to try and understand what.
Price changing what price changes on the site, how they impact customers and one of the messaging piece of work I think we've done over long period of time is that if you change prices up or down right impacts the customer purchase cycle. So you would think logically that give you lowered prices customers would be.
I wouldnt slow their conversion, but even a lowering price those their conversion because it makes the customer question about getting the best price is this sort of exactly the you do I need to go look elsewhere or do I need to look at other products and so.
So I think that.
I think that that notion of sort of price changing and sort of constant price changing impacts customers is something we've seen in the past as well and Brian is nearing shouldn't just to chime in one of things that says we obviously look at our own data. We also try to make sure we're well attune to what's happening in the market and what we're seeing.
I mean is our selection merchandising advantage relative to competitors actually expanding not contracting I was at high point, just a couple of weeks ago, and I talked with dozens of our suppliers and what we're hearing from what they're seeing on the demand side. Both in their total business and then specifically the online component is that their view is actually that where we are doing quite well. So I think theres a.
Little bit of volatility that it's not just us but online platforms that have the same dynamic.
Which is really where the volume is are going to have the same kind of volatility and what we're seeing if you look at kind of into our customer data.
That's why we feel pretty comfortable where we're headed but I'd echo Michael if there is no kind of clean external data point that makes a super easy to see that aggregated up.
Well it's helpful. Let me let me ask this question Doug.
So you mentioned in your prepared comments that.
A large portion of the products you sell our separately tariffs you also mentioned that we've seen in our work to get trapped at your side has remained quite good. So if you look at products I understand this maybe getting a little narrow focus but if we if you look at product maybe the select products were tariffs are not a factor and prices have had not had increased as a sales velocity on the.
Next stayed the same.
Yes, so the goods, we sales roughly 66 zero percent of them are made in China and something like 80 something percent are made in Asia.
And that 60% there are certain classes of goods like lighting, they're almost entirely made in China, but there's a lot of class of goods like lower end upholstery or even a poster all the way through low to high end, but really low end upholstery frozen focus where there's a significant production component domestically in the United States as well as a significant component that's import from China. So theres eight.
Quite a mix and then the vast majority of our goods were in the ones and went from 10% to 25%. There's a small portion of our business. That's in the zero to 10.
Present in terms of what happened this past summer. So when you look across for platinum. Good. Jim you can look at ones, where you have a mix that domestic and China, even with the ones that are just China. There's very few that are zero, China, but you can kind of look across them. What we're seeing you kind of see what you'd expect a minute.
Yes, basically there's disruption in most places it's different forms of disruption certain classes of goods, it's generally inflationary because they're all coming out of China, but different suppliers are choosing to pass through the increases in different ways and some are absorbing so you still see a lot of mix shift volatility and then you have other ones, where the natural mix shift will be the Chinese production, which has a terrific.
Showing up in costs relative to the domestic production, which is not changing but then you fund as a result, some of the Chinese producers basically find a way to absorb that cost because they don't want it disadvantaged himself. So again you have this mix of volatility so.
We're seeing that kind of across the board theres not.
And so it's playing out the way you'd expect it's not like clean like go look outdoor furniture is not in China and indoor furniture is in China. This no there's no real asset classes like that.
Got it thank you.
A couple onto the next question.
Thanks Barry.
And our next question comes lot of Jonathan Maciejewski of Jefferies. Your line is open.
Yes, thanks for taking my question.
I guess I would just start off with it have you seen any material issues as it relates to some of the production shifts.
From your suppliers.
Looking to avoid China tariff. So is there any link between some of the supply chain shifts of your vendors moving production.
Impacting any customer satisfaction or anything like that.
Yeah.
Yes, Thanks, and then there's a significant impact from production ships is less about customer satisfaction I think in general the quality control processes are good to make sure that production volumes high before significant before they really start exporting the volume, but the impact is actually.
What you'd expect given that that's true which is folks want to move production quickly and the aimed to do it without being out of stock for very long period of time, and then inevitably what happens is it takes longer to get the new production up and running at the volumes that need to what happens as they end up out of stocks you take a good selling item that supplier decides they are going to resources in a new new geography.
And they think that they can either do it without being on stock or with only being out of stock for a very short period time, and then the zero out of stock turns into three or six months of out of stock and so and so forth. So what happens you have a good selling item, it's not a lot of stock insourcing cannibalized by a different item thats in stock.
That could also happen if one price goes up relative to the other that other item that gets momentum than this other item comes back in stock and then is trying to cost way back up to that disruption cycle on the consumer side, which is a lot about substitution basically gets driven not just by price changes for buy stock availability and that stock availability has actually been a real challenge.
Gotcha. That's helpful. And then just a quick follow up on the same topic.
It sounds like different suppliers have been doing different things with pricing.
Yes, well, we've seen is that the the 10, the first 10% more or less could get absorbed and again, it's a 10% going to 25% on the suppliers costs, which anything about our retail than we buy at wholesale. The wholesale then of course is the is the revenue line for that supplier and they've got their costs. So its 25% on what.
Not a lot of places to absorb that by and large so the bulk of that's getting pass through you're finding a lot of suppliers, though saying hey.
I might do some now in some after holiday or I'm going to absorbent, while I resource this item out of China, which for certain items, where the raw material supply chain and the tooling in China is not quite as critical they are moving that.
Thanks.
And your next question has lot of comment was the Dutch Bank. Your line is open.
Hi, Thanks for taking my question.
Couple of different.
With regard to the logistics side.
Okay.
Since 2020.
Second we've been seeing a little.
The competitive landscape with online as well as off line.
Are you seeing any impact on.
Yes. Thanks.
Great.
Let me first talk about logistics and how we see cost leverage as we get into 2020. So.
Im logistics one of the things we tried to highlight in the prepared remarks is that we've been pretty aggressive building out our castlegate footprint and so obviously, we opened a very large building in the UK, that's going to service quite well for a while we have one that will open in Germany next year. When you switch over to North America North America between what we just opened recently in Savannah.
In late threw up and what we have opening in January in Jacksonville.
A significant amount of additional capacity and at that point it will be because of capacity reasons, meaning that our utilization our network will will be much higher than it is today and so that will utilize rent will also get to freight. So one of the things we see as we go through 2020, I mentioned earlier that my expectation of mix, we will see AD cost levers, we get into 2020 an increase.
As we go through the year, we've talked a lot about opex on head count side, how we added a lot of headcount last year as we anniversary this year, because we've been hiring a much lower rate on the Opex side. This year and we expect that to continue so as we as we get intent you can see that hiring rate continue to moderate and when we get into the back half of next year, you'll see opex lever.
Out of that those things start to play through and the benefit of logistics as we get into a phase where we're only adding for capacity is that the annualized rent will start to be a lot less because when the out of billing for capacity you can fill it much quicker if not for building footprints that sort of what we expect there.
On the TV advertising.
Second question.
On Amazon and then you said online offline competitors, how do we think about those I mean, obviously, we keep an eye on everybody and what we've seen is that while whether it be Amazon or home depot or Walmart. This everyone sort of viewed home is a kind of open opportunity. What we see is that in home, we actually are seeing our traction with the consumer our awareness and.
Our preference continue to tick up with consumers and the research we do.
And the compared competition allows us folks have amongst one another primarily focused on consumable so think of dish cellphone display batteries and where we're seeing as there is pretty frenetic competition in those categories, but the nice thing from our perspective, we don't compete in those categories and we've always thought the two categories that are fundamentally different one is fashion and one is home and we.
Don't focus on fashion on a focus on home those two are very different consumers want unique items. They want to find that special item the aesthetic matters theres the complexity and understand what the item is and Thats, what we really cater to the delivery and logistics is complex and unique and so we keep an eye and everybody, but we're not seeing the competitive feels really.
Take any ground it doesn't mean that we get all the share but you can see even with the note that revenues decelerate a little bit if you look at the math of the share taking we're still taking pretty significant share of the dollars that are moving online and frankly, we expect that to actually grow over time. So when you assume real and you can sale you took 600 million this quarter and it's not great compared to last quarter well last call.
Thank you.
Yes.
Someone just mentioned we are going wrap ups I just want to thank everyone for joining us today and thanks for your interest in wafer.
And this concludes today's conference call you may now disconnect.