Q2 2022 Wayfair Inc Earnings Call
Corporate development and capital markets MS girlfriend, you May begin your conference.
Yeah.
Good morning, and thank you for joining us.
Today, We will review our second quarter 2022 results.
With me are nearing Shah cofounder, Chief Executive Officer, and co Chairman Steve.
<unk> co <unk> co founder and co Chairman, Michael Fleisher, Chief Financial Officer, and Kate Gulliver incoming Chief Financial Officer, and Chief administrative officer, we.
We will all be available for Q&A following today's prepared remarks.
I would like to remind you that we will make forward looking statements. During this call regarding future events and financial performance, including guidance for the third quarter of 2022.
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 2021, our 10-Q for this quarter and our subsequent SEC filings identify certain factors that could cause the companys 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 any of 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.
Including adjusted EBITDA, adjusted EBITDA margin and free cash flow.
These non-GAAP financial measures should not be considered a replacement 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 and Investor presentation, 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 will be available for replay on our Investor Relations website.
I would now like to turn the call over to <unk>.
Thank you Jane and good morning, everyone. We're pleased to reconnect with you today to share the details of wafer second quarter results.
2022 has proven to be a volatile year.
The fed and other central banks worked to curb inflation and stabilize the global economy, we remain squarely focused on our customers and our suppliers, making sure wayfarers there preferred platform for the home in any environment.
We're also very focused on controlling the controllable and steering wafer in a financially responsible manner through this period.
On each of these fronts, we're seeing positive traction and this is what I will talk to you about today.
Q2, net revenue climbed 10% quarter over quarter, but was still down 15% year over year.
So year ago comps will begin to normalize in the back half is unmistakable that consumer behavior is being impacted by inflationary pressures as well as by economic and geopolitical concerns.
Even so the emotional connection to one's home means that interest in our category is ongoing and we're seeing consumers remain engaged and responsive to the right combination of wide selection.
Deals and satisfying service.
Wafers platform model flexes to deliver this outcome across different macro environments and we're seeing it do so today.
For the last couple of years, we have indicated that wafer should now be at the scale to drive both growth and consistent profitability.
First half of this year and has admittedly been less robust than expected.
But let me be very clear that our intention is unchanged. We are laser focused on quickly getting back to this goal.
Priority over the coming quarters and looking into 2023 is to steer the business towards positive adjusted EBITDA and positive free cash flow.
But we will not stop there.
We're actively navigating wayfarer towards a mid single digit adjusted EBITDA margin, which should allow us to consistently generate cash and put us in a position to cover our costs such as equity compensation for our employees.
And Capex.
At this profitability level, we will continue to invest aggressively in the future given the still large gap versus the current embedded profitability in our model.
Once we get to mid single digit adjusted EBITDA, we intend to philosophically treat it as a lower bound for profitability, but not <unk>.
The end goal, we remain committed to our long term target of double digit adjusted EBITDA. The Covid period showed clearly that we can operate at these levels and we fully intend to scale beyond them overtime.
Even as we get sharper on our financial philosophy, our approach to the business is consistent with the last 20 years.
We are building for the long term, but coming in each day thinking about the next set of steps on the path there.
With an addressable market approaching one trillion that remains meaningfully underpenetrated online compared to other sectors of the retail universe. We are truly excited about what the future holds for wafer.
The pandemic changed e-commerce landscape in many ways, but one thing that remains unchanged due to the unique nature of our business.
And end to end platform dedicated to the home category.
The competitive advantage. This gives us across logistics assortment shopping experience brand building and more has only strengthened our standing in the post pandemic world. This.
This is a category where scale to get success and its actually difficult periods. Like this that can serve as a springboard to become an even larger share of the market.
Before Michael and I detailed the roadmap for a return to profitability, let me spend a few minutes walking through what we're seeing in the customer and competitive environment.
Inflation continues to be a meaningful presence in customers' lives at a broad level.
Our portfolio spans all income brackets, which is helpful. Since our professional specialty retail and luxury businesses are growing well and proving more resilient in this environment.
Customers in the U S also appear relatively less impacted than our European customers, who are navigating the pressures brought on by the war in Ukraine, and Brexit in tandem with inflationary pressures.
Regardless of geography, it is not surprising that our mass customers are being more deliberate about where their discretionary dollars are going as prices at the gas station and grocery store eat up a greater share of wallet.
For the past few months, we've also seen many of those discretionary dollars flow away from goods to services, especially travel as a slow to start spring turned quickly into summer.
Still the home remains an important pillar in our customers' lives and they remain in market looking for great deals.
Unlike in 2020 in 2021 promotions and events are mattering more again.
This is typical for our category and we're seeing strong incremental responses to well staged events like way day Memorial day fourth of July and other special offers.
Importantly, this is also translating into better everyday prices for our customers.
In this environment, our suppliers are looking to move product as quickly as possible and have transitioned from having a dearth of product to having to deal with excess goods on hand.
Through wafer they reach an engaged and enthusiastic customer audience.
When suppliers see success during key events, they're motivated to turn those promotional offers into everyday low prices by extending better wholesale terms and through taking advantage of other supplier facing services that can help them gain prominence on our platform.
All of this is happening as we speak.
A wide selection of products is also crucially important in moments like these.
We are observing some trade down behavior within various classes of home and the vast selection of our catalog ensures that we meet our customers' needs regardless of price point or style.
Our ability to offer this broad selection has been substantially boosted by the large growth in our suppliers' inventory levels.
We're seeing this play out in a couple of different ways.
First product availability has meaningfully improved versus this time last year when out of stocks are very long lead times on key items were a pronounced headwind.
Key items are back in stock more items are moving into our house brand collections.
And being extended to us with exclusivity features in.
In fact, roughly 40% of our unbranded U S sales now come from these products.
Double versus last year.
Second we're driving more throughput through our own logistics footprint.
Cascade penetration.
For the percentage of products sold that originates in a castle gate location is on track to recover rapidly to previous peaks and then exceed them.
This was in part buoyed by our Ocean freight forwarding service, where volume is slated to double from the prior ocean year.
As these logistics components come together into a streamlined end to end infrastructure.
We're able to make faster and more reliable delivery promises to our customers at a lower cost to us, which they then reward with higher conversion.
All of these elements combined are already bearing fruit for instance, our market share position recovered in 2022 relative to how it fell in the second half of 2021, when supply chain and availability issues clearly slowed us down cut.
Customer feedback also speaks to increase satisfaction with NPS scores up meaningfully year over year and brand surveys highlighting our seamless experience and unparalleled selection.
As I mentioned the industry suppliers have experienced a dramatic shift in their positioning over the course of the last few quarters.
From not having enough product to satisfy all of their customers.
So facing canceled orders from brick and mortar retailers and being over inventoried.
Wafer has long prided itself and the way we build supplier relationships.
And that partnership model is working to our advantage today.
The team and I have met in person at various markets with close to a thousand suppliers over the last several months.
It was very clear that they are leaning in with way fair, extending us more product and better wholesale costs and using more of our service offerings as.
And as they do so we surface more of their product and pass through lower wholesales to the end customer, helping them turn inventory and maximize cash flow faster, which is especially critical to the many small businesses that make up our supplier base.
However, unlike traditional retailers, whose cost basis weighs on their pricing decisions and can become a liability and a softening macro the advantage of our platform model is that by taking minimal inventory risk ourselves our gross margin can remain resilient.
We then have the ability to drive our gross margins higher through capturing incremental efficiencies and in this environment from some potential relief on transportation costs.
We're seeing some of this begin to play out in our financials. Today as was also the case in 2008 and 2009. This is critical as we think about navigating the path to profitability, which is the topic I would like to cover next.
As the macro environment shifts, we know that our operating and financial plans need to evolve.
Over the last few weeks, we articulated a clear set of goals to our entire organization, which include three key tenants.
One drive cost efficiency.
To deliver best in class execution by nailing the basics.
And three were in customer and supplier loyalty everyday.
Through this lens, we are making swift decisions.
Prioritizing clearly and looking to drive costs out of every pocket of the business.
Some of this is already visible to you.
And more will become apparent as time goes on.
This is an ongoing exercise and frankly, one that will serve us well and all sorts of environments as we evolve in the way, we operate and grow way fair.
An important advantage of our business model is that our P&L is highly variable lives.
Means that gross margins customer service and merchant fees and to a large degree advertising should be quite responsive to the trend in revenue.
Protecting wafers unit economics.
And leaving room for potential upside through incremental efficiencies.
In areas of more fixed spend predominantly opex and capex, we have the ability and willingness to prioritize and sequence differently if need be.
One visible example that many of you are aware of is the hiring pause that we implemented back in may.
This gives us the opportunity to step back assess how consumer demand is developing and to react accordingly.
Less visible to you our decisions such as pushing off market expansion plans in Europe in favor of reinforcing our focus on the UK and Germany.
Pausing the development of certain opportunities like registry.
Flushing, our planned logistics capex investments in response to changing revenue trajectory.
As I said, we are increasing our cost efficiency focus across all facets of weight there in an ongoing manner and.
And companies of our size and scale these opportunities take a quarter or two to begin to unlock.
But we are highly confident that they will not only help us reach our financial goals, but also make wafers execution even tighter.
Even as we reshuffle some priorities, we're not trading off an important future growth drivers and enablers the.
The profitability levels, we are targeting should allow us to both control our destiny and simultaneously invest for the long term, which has long been a key to wafer success.
While we tighten our belt and some places our support is fully behind high ROI initiatives that will set us up for years to come.
For instance, our technology organization continues to pursue the transformation agenda that our CTO Fiona Tan described last quarter.
We are expanding our fast delivery capabilities.
We are growing our flagship house brands and increasing more exclusive assortment.
And we are investing in top of funnel marketing channels and content to drive awareness and frequency among both new and loyal customers.
We're also sticking to our test and scale approach and physical retail.
In May we launched our first all modern store with a couple of additional locations under our specialty retail banners slated to open later this year.
Next year and on a limited basis, you will see us continue to experiment with new specialty retail formats.
Followed by a larger wafer branded store concept in 2024.
It is important to bear in mind that we are very much still in a learning stage here.
Our goal is to use these handful of stores as a testbed for new ideas around how and where to bring the core competencies of wafer to a physical shopping environment.
We believe the omnichannel opportunity for wafer is quite meaningful but.
But we intend to pursue it with our usual approach of testing Iterating and proving out success before finally scaling.
Across everything I've discussed just now our goal has been to make clear the thoughtful and considered approach we're taking to the current environment.
We've always said that we run this business for the long term and nothing about that has changed.
The size of our category remains tremendous the field is fragmented the structural marches shopping more online we will continue.
And wafer is uniquely positioned to grow and consolidated share over many years to come.
We have a management team that has seen multiple cycles in all sorts of different businesses. We all recognize that in moments of macro volatility like we're living through today. It is just as important to focus on the here and now as we steer through this period as it is to look forward.
Doing so centers around returning to and sustainably operating in a free cash generative way.
Timeframe to get there will evolve with the macro environment and our response to it we're very focused on the variables that are in our control.
Arriving out excess costs, while being there for our customers and suppliers and driving the tightest execution possible.
We also take confidence that our platform model is designed with the flexibility to weather unpredictable moments like this and emerge stronger for it on the other side.
I'm going to hand things over to Michael for a review of our financials and outlook.
Thank you Nir and good morning, everyone.
Going to start today by walking through some of our high level planning as we look out to the remainder of 2022 and into next year.
Since late 2019, we have been focusing on becoming sustainably profitable and cash flow generative.
Our progress towards this goal accelerated during the pandemic.
But reversed somewhat over the last several quarters.
As soon as we started to see the macro environment.
Moving away from our going in expectations for 2022, we began taking swift action to reposition the business and a return to positive free cash flow in a timely and thoughtful manner.
This is a goal that the whole executive team shares, including Kate who is closely partnered with me as we continue the CFO transition in real time.
We are laser focused on what it takes to achieve this goal.
Which means not just returning to profitability on the adjusted EBITDA line, but getting back to a level that covers expenses like DNA and the cost of paying our employees in equity.
To do this we have undertaken a broad prioritization exercise across the organization include.
Including a timing shift in our semi annual planning process and taking a microscope to each part of the business as we reassess with the appropriate cadence of investments should be across a range of macro scenarios.
As you can imagine we're quickly buffeting projects across a range of priorities.
Focusing on uniting the organization against the most strategic items, while sequencing out other initiatives.
<unk> just listed off several of these earlier and Youll see us enact more changes in the second half of 'twenty two and in 2003.
Turning now to the second quarter results as you saw in our press release. This morning Q2 total net revenue was $3 3 billion.
Representing a 15% year over year decline and a 10% sequential increase from our net revenue in Q1.
The second quarter fared slightly better than where we had been trending as we gave our quarter to date disclosure back in early may.
As customers responded to promotional events in a positive way and our suppliers leaned in with more aggressive wholesales.
On a segment basis U S. Net revenue declined nine 7% from Q2, a year prior while international net revenues declined 35, 7% year over year and 34, 4% on a constant currency basis.
Clearly a far stronger U S dollar year over year as a translation negative for us as it is for other multinationals.
I'll now move further down the P&L as I do please note that I'll be referencing the remaining financials on a non-GAAP basis, which includes depreciation and amortization, but excludes stock based compensation related taxes and other adjustments.
I will use the same non-GAAP basis, when discussing our outlook as well.
Q2 gross margin was 27, 4%.
Which is consistent with the 27% to 28% range, we have targeted over the last several quarters.
Customer service and merchant fees were four 7% of net revenue for the second quarter in line with our guided range, reflecting higher compensation costs compared to last year.
Advertising as a percentage of net revenue was 11, 5% in Q2 slightly higher than our guidance of 10% to 11%.
We continue to spend efficiently across our paid channels.
But a set of mix effects drove the slightly higher outcome and advertising as a percent of net revenue this period.
These included first a shift in the share of direct versus paid traffic towards paid in this environment.
Second our conscious choice to continue to invest in top of funnel channels to drive greater awareness share of voice and ultimately share of wallet.
And third brand mix with our fastest growing brands operating at higher levels of spend thanks to also higher gross margin profiles.
Let me reassure you that we are paying close attention to the cross currents at play here and are continuously monitoring our efficiency parameters and the rois generated within them to make sure. We're striking the right balance in this fluid environment.
Our selling operations technology and G&A.
Our opex expenses totaled $567 million.
As we telegraphed back in May this was driven in large part by compensation for our existing team as well as new employees joining way fair.
The impact of the hiring freeze we implemented in may will be reflected more in the Q3 results as I'll discuss in a bit.
So we always speak to these numbers on a non-GAAP adjusted basis, you might also be wondering about the $40 million onetime noncash impairment charge this quarter.
Our requirements for corporate office space have changed post pandemic.
We now have more excess space to sublet out and since the commercial real estate market is soft.
The charge reflects our reassessment of the expected income stream from this property.
All combined Q2, adjusted EBITDA was negative $108 million were negative three 3% of net revenue in line with our guidance.
In the U S. Adjusted EBITDA was negative $28 million for a negative 1% margin, while the international segment booked adjusted EBITDA of negative $80 million for a negative 16, 4% margin.
Moving onto the balance sheet and cash flow, we ended the quarter with $1 7 billion of cash and highly liquid investments.
In Q2 net cash from operating activities was negative $115 million and free cash flow was negative $244 million.
After factoring in $129 million of capital expenditures.
Let's now turn to the outlook.
I wanted to start as we have in quarters past with some details on quarter to date performance after which I'll walk through the rest of the P&L for Q3, while adding in some qualitative color on our expectations beyond that.
Across the third quarter, so far our gross revenue is down about 10% year over year.
Which would indicate a break from the typical seasonal pattern, where Q2 and Q3 are typically similarly sized.
Based on the current trend, we would expect Q3 net revenue to be below Q2 levels.
And surprisingly, we see this weakness being driven by the impact of macroeconomic forces on consumers.
And reflected in the growth of our category overall.
Moving to gross margins, we believe that we will have sequentially higher gross margin and would point you to the upper end of our 27% 28% range.
We remain confident in the sustainability of upside potential of this range even in a softer macro thanks to the multiple drivers we have in place and the inherent flexibility of our inventory life platform model.
We expect customer service and merchant fees as a percent of net revenue between four five and 5%.
And advertising as a percent of net revenue at approximately 11%.
We forecast <unk>, G&A or opex dollars between $550 million to $560 million in the third quarter.
We began a hiring freeze in may to slow Opex growth. So you are just beginning to see the financial impact start to flow through.
Simultaneously, we undertook a review of all the various costs driving this line and are Actioning multiple work streams to drive incremental savings across the board.
We will not be quantifying the expected savings and timing of these for you today.
But instead will speak to what's in flight next quarter and over time.
You should expect Opex dollars to decline further period over period in Q4.
If you follow through the guidance I outlined and assume that our quarter to date revenue trends persist for the remainder of Q3.
That would translate to adjusted EBITDA margins in the negative low to mid single digit range.
To be perfectly blunt, we are not satisfied with this outcome.
However course correcting a company of wafer size and in an environment that is changing as rapidly as this one requires some patience.
We are moving quickly to adjust our plans and we would expect you to see substantially more financial progress, which will flow through in Q4.
Let me quickly touch on a few housekeeping items for Q3 before moving to discussing our strategy for the quarters to come.
For Q3, please assume the following equity based compensation and related taxes of 127% to $132 million.
Depreciation and amortization of approximately 91% and $96 million.
Net interest expense of approximately $6 million to $7 million.
Weighted average shares outstanding equal to approximately $106 million.
And capex in a $110 million to $120 million range.
With that framing let me further illuminate how were planning to navigate wafer into 2023 and beyond.
We are diligently moving the business to generate positive free cash flow. So this will take some time and the path and actions required to get there will be dictated by how the macro evolves.
In the near term, we're planning for Q4 revenues to build on Q3 levels consistent with the typical holiday period.
Provided this occurs we would expect our adjusted EBITDA losses to narrow considerably before the end of the year.
And then to make substantially more progress towards our ultimate goal from there.
It is true that our timeline to get there will vary depending on how the topline fares in the macro environment.
But we're committed to moving steadfastly in this direction and our liquidity position enables us to proceed responsibly down this path.
And with no meaningful maturities until late 2024, we have sufficient time to ensure multiple options are at our disposal for how to manage our capital structure.
I want to wrap up by underscoring yet again.
Dynamic and tricky period. This is for any company to navigate.
It is also at moments like this we must acknowledge that our internal confidence is bound to build before yours on wall Street.
So let me be very clear we.
We are highly confident that our consumer and supplier focused platform model couple.
Coupled with our team's clear eyed assessment of the challenges and opportunities before us and our willingness to take action will only make way fair operationally and financially stronger as we proceed over the coming quarters.
And as I approach my retirement and as a shareholder myself what reinforces this view for me is the talented leadership team totally behind our goals.
Key among this group is Kate Gulliver, who is actively architects and underwriting these plans with me and the team and.
And who will be speaking to you next quarter about the progress we're making in her new capacity as CFO and chief administrative officer.
Next we're going to break from tradition slightly rather than having a deep dive on a single part of the business. We thought we'd speak to some of the key questions. We've heard from investors over the last few months.
So before proceeding to the live Q&A Neogen Kate are going to address these upfront so that we can get into other details later.
Let me hand, it back to Eric <unk>.
Thanks, Michael.
Over the past several months many of you have asked about the path to profitability and how long it will take us to reach our goals.
Let me first be clear about our financial priorities, we are steering wafer to be cash generative.
We're also establishing a lower bound on profitability that we will stick to all while working to drive margins even higher.
Why is this lower bound important.
Mid single digit adjusted EBITDA margin higher in the U S. As international continues to mature.
We should be able to cover expenses like depreciation and amortization associated with Capex.
And begin to mitigate the dilution associated with equity compensation.
All while continuing to invest in future growth initiatives.
While we are perhaps being more pointed about how we're talking about this this practice is not new to us.
<unk> operated this business in a cash generative way for more than a decade, when we started.
Turning to 2019, we have been moving wait there back in this direction.
Admittedly with a lot of volatility in between.
Which brings us to how and when we will get there.
You should expect to begin to see progress starting in Q4.
But the reality is that this is an iterative exercise.
We are philosophically committed to the set of financial goals, which means that we're constantly evaluating what's happening to the customer and the economy.
The timeframe over which we can responsibly get to these levels and adjusting as needed.
The macro can help or slowest down some but we are not relying on solely the topline to get us there as.
As I mentioned earlier, we're in a fortunate position where large parts of our platform business are variable designed to move more or less in tandem with revenue.
Other fronts youre seeing us adjusting in real time, and we will continue to do so.
Thinking through our options, we're balancing moving quickly with.
With doing so responsibly for the company with nothing sacrosanct.
But also a strong awareness of the elements that make us unique today and will set us up for success in the years to come.
Next let's tackle a slightly different question, having to do with how customer acquisition costs are trending.
As many of you know when we studied CAC. We are looking at whether we are staying efficient and paid advertising channels.
More transactional ones like search and <unk>.
And upper funnel channels, such as TV.
Our approach to deploying advertising spend it's based on efficiency targets we.
We are orienting around an effective payback target in each channel.
So if we can't deploy dollars within that payback envelope, we won't spend them.
This means that we're constantly controlling for CAC by channel.
That said there are mix effects that layer on top of this that happened to be headwinds to overall CAC in this moment.
Michael spoke about a few of these mixed elements earlier, but.
So let me expand.
First upper funnel channels like TV and online video and catalog are scaling.
So that it can have longer lead times. These channels are important vehicles to drive brand and category awareness.
As a category leader, we have a unique opportunity during this time to be visible to new and repeat customers, which should translate into a higher share of voice as others pull back and ultimately to market share gains.
Secondly, and softer macro periods, we unsurprisingly see the volume of free and direct traffic to site decrease.
This will optically make advertising grow as a percentage of net revenue.
Though we are still deploying dollars against paid channels efficiently.
It is also a temporary phenomena.
When category demand recovers direct traffic trends will reverse and drive incremental leverage in advertising.
Third our fast growing brands are those that operate at higher levels of advertising.
For example, <unk>, which grew net revenue at approximately 30% year over year in Q2 and is scaling quickly and general operates at a higher advertising level in percentage terms than does wafer.
Part of that is due to its smaller repeat base and its higher cost of brand marketing as a percentage of revenue, but it is also because of its higher level of profitability, which justifies our ability to pay more to acquire customers, while remaining well within our efficiency parameters.
Overall, our unit economics remain very sound and well above pre pandemic levels, even after accounting for these moving parts to the near term cost of customer acquisition.
Our variable contribution margins are substantially higher driven by gross margins, which means we can spend more to acquire and stay well within our payback parameters. So.
So we think we are striking the right balance between the elements that we explicitly control like efficiency targets and some of the outlets that are less controllable like mix.
We're also continuously monitoring and adjusting from a top down perspective, if necessary for.
For instance, we are sharpening our efficiency targets in areas like top of funnel to account for lower predictability in this environment.
And rest assured we will always closely monitor and react to trends across all of our channels.
Now I will hand, it over to Kate to discuss our latest thinking on liquidity.
Thanks, Eric and good morning, everyone I'm excited to meet some of you and to reconnect with others over the coming months as I step into the CFO role.
One question, we know like top of mind for many investors right now is our liquidity profile and capital structure.
As we sit here today, we see our liquidity position is healthy.
Ended the quarter with north of $1 7 billion of cash and short term investments on our balance sheet.
And don't forget that we also have a revolving credit line of an additional half a billion dollars available to us.
So where we are right now at two two to $2 $3 billion in total liquidity and with no meaningful near term maturity is a relatively comfortable place to be.
But as you also heard US say, we're very focused on getting to a state of positive cash flow as quickly as practicable to the total liquidity can rally.
We have the benefit of our cost structure that is highly variable options on how to control elements like Opex and Capex and also the benefit of a networking capital flows that typically work in our favor.
Getting to a position where we are sustainably generating cash is very important to us but it is not an overnight thing for a business of our size.
However, we are aiming to make steady progress over the coming quarters, which will begin to show up in our financials in Q4.
We hope this is helpful additional color to frame our thinking let's now move to the open Q&A. Please feel free to direct your question to nourish, Steve Michael Anthony.
Okay.
At this time I would like to remind everyone in order to ask a question Press Star then the number one on your telephone keypad.
Ask that you please limit yourself to one question and one follow up question and we will pause for just a moment to compile the Q&A roster.
Yeah.
And we will take our first question.
Pardon me from Steve Forbes with Guggenheim Securities. Your line is open.
Yes.
Good morning, and thank you all for the color today.
I wanted to start with.
The supplier base rate you mentioned, how the suppliers are using more wafer services offering.
Maybe if you could just expand on how they are engaging.
And what's different today than than than last year, whether they're competing for certain services via lower wholesale costs, just any additional color that helps us better understand how the supplier community is viewing way fair today.
Yeah, great. Thanks, Steve.
Yes, so what I would say is.
If you think about our platform business model one of the things we mentioned a couple of quarters ago.
Generally as an advantaged model the only time, it's disadvantage would've been the example in the back half of last year. When there is too little inventory relative to demand, which basically almost never happens. Let's comment is that there is roughly a balance of the two or in these kind of tougher macro scenarios, where there is far more inventory the demand well that's actually there.
Scenario, we're in now so suppliers basically up too much inventory and so what we're seeing happen is our inventory availability levels have gone up suppliers have too much and they want to sell that inventory. So what do we see them do we see them using some of the pricing tools, we have on our platform to basically allow them to control their price to be aggressive where they want to move inventory.
That creates value for the end customer drives up conversion.
Seeing them become increasingly large adopters of castle Gate Castle gave basically facilitates them getting high speed Badging, which drives up conversion. It also facilitates lower retail prices because the outbound ship cost drops which also drives up our conversion as an example, there are two day speed batching is up about 10 percentage points.
So we're seeing them lean in on aspects of the model and other piece of the model, that's still pretty small for us relative to others is advertising and thats something that has been growing over time, but frankly, we're seeing a lot of growth in interest there too as we're adding sophistication of the product, but frankly its suppliers are in a position where they want to sell more goods. So these are kind of the types of things that are happening there advantage.
As we have relative to others and frankly, it's why we.
The inherent strength of the business model.
Helpful and then just.
A quick follow up.
It really about international right given the comments about balancing the long term investment in.
And the path of achieving a mid single digit EBITDA margin. So curious just.
It's just additional high level comments on how youre thinking about the broader international opportunity.
It Hasnt changed should we expect you to sort of.
Pause.
<unk> for.
A multi year period of time into new markets and really just focus on on the core that you're in I mean is there any how.
Are you seeing anything that deters the opportunity that you see in the U K or Germany, any higher level color as you're thinking about the broader opportunity international.
Yeah. Thanks, Steve Yeah, right now there's no question that the macro environment in the international markets, where it is tougher than even in the macro environment in the United States and then that is certainly not great for that segment of our business.
One of the things I did mentioned in the prepared remarks is we have been very thoughtful about in this period of time, what do we focus on and what does that mean, we need to pause or where do we narrow our focus and frankly in the European market. We said, let's focus on the U K and Germany, we built a leadership position in the U K. We're on the road to that were not there in Germany, well, let's pause.
Moving to other international markets in Europe , let's pause our expansionary focus in Europe , let's focus on our core.
That's what we're doing there and the way we think about it is.
There is no. There is nothing that we decided yesterday that will automatically remained committed to today. So we're going to constantly reassess what were doing but we feel very good about the strategic long term focus that we have in the company, but we're also very cautious given the macro of making sure that we're not expanding them and in fact, if anything we're going to continue to do that we think makes sense in light.
Of how we're thinking about the P&L, how we want to drive the EBITDA profitability, how we want to drive the free cash flow and we want to show that steady progress there and get there frankly in a timeframe.
We think quite fast and so this is the balance that we're taking.
Thank you.
Okay.
And we will take our next question from Peter Keith with Piper Sandler Your line is open.
Okay.
Hey, Thanks, Good morning, everyone I appreciate all the extra commentary.
On the mid single digit low threshold.
EBITDA margin target.
Obviously, putting a timeframe on that is going to be a possible, but what are the thoughts on the revenue growth needed to achieve it. It could you show significant progress over the coming year, if revenues remain flat year on year.
To reach that goal.
Yes, Peter So I think on one hand, youre absolutely right. The macro does affect it however, I will say our plan on making progress to get to EBITDA profitability and positive free cash flow is not contingent on expecting the overall revenue to expand so does the shape of the curve get affected by the macro absolutely, but it is our plan hinging on revenue grew.
It's not so well.
Why do we why do we say it that way well do we expect to see us take share and get revenue growth. We do however, the macro is very murky. So to bet on a plan that requires a certain out revenue growth, we would view as risky.
So the core of the problem, we say youre going to see steady progress that does not assume that the market turns right around.
Okay. That's helpful.
As a follow up question, maybe to what Steve ask just around the supplier services.
I'm wondering if there's any quantification you can provide this to show us some progress that youre, making castigate revenues have come down to about 20% of total at least that was as of Q4, maybe update us on where you stand today, and then and any quantification too on that the sponsors to advertising.
And maybe how that's increasing as a percent of revenue would be very helpful.
Sure. So on Castle gate, what I'll say is castigate penetration is ramping and it's been all year have been increasing at a nice pace and so when we said that it's on track to hit record highs to meet old record highs and then exceed them, we see that happening not over the long term, but rob.
Over the near term so we're seeing very good adoption. There frankly that adoption was taking place even before the demand really started to turn down and then it's only accelerated since then so suppliers are very interested in benefiting from the speed badging benefiting from the lower retails to lower outbound ship caused the customer conversion.
And so that Cascade penetration is I'd.
I'd say meaningfully higher than where it was at the beginning of the year and it's on track for these types of records that I mentioned on advertising, we havent given out an exact number on that but.
This is not super helpful for you to quantify but I'll just say it is certainly growing faster than the overall business is growing.
Very very fast relative to the overall business, but it's still small quite small relative to what we think the potential is so it's still very much in its early days.
Yes.
Rising it's still there's still a huge upside on gross margin in that product.
Okay. Thanks, so much very helpful.
Okay.
And we will take our next question from John Blackledge with Cowen Your line is open.
Great. Thank you two questions first on just the revenue trend.
Thus far could you just discuss the drivers of the current revenue pacing in <unk>, if I heard it correctly, Michael I think you referenced that <unk> net revenue will likely be up.
Q over Q I, just want to check on that and then on the <unk> gross margin what are kind of the drivers that provide confidence that gross margin will come in kind of at the high end of the 27% 28% range. Thank you.
Great. So, let's say revenue trends first let me say some thoughts and Michael can comment on on his quote but I think everything you said is correct. So revenue trend. So we said in the script the quarter to date is down.
Roughly 10%.
The revenue trends.
Frankly, we are seeing.
Yeah.
Well I'd say I don't know I described good traction on revenue, meaning we're seeing customers being engaged the macro so clearly softening does.
It's been a shift from goods to services, but.
Things like for example.
The percentage of revenue coming through the App is it's at an all time high except for the first two COVID-19 quarters, and so there's things like that that are happening that we think are positive things that we're seeing with our customer base that is engaged engaged within the context at homegoods is not top of the agenda right. Now. We're also seeing that our suppliers are leaning in on the platform to <unk>.
Sell goods as I mentioned are over inventoried theyre lowering in retail is what we're finding is that that creates an opportunity for customers to get more value. The speed of delivery of these items is up which is a great customer.
Kind of.
Experienced driver, where then creating these sale events and these promotional events for example, we.
Launched one a couple of weeks ago called Flash Youll Fridays, it's only two weeks old.
And it will build up over time, but it's off to a very good start and so what we're doing for showcasing that value to customers.
Customers are then quite curious we're getting good reaction from customers coming in browsing and buying and so this is a playbook that we've used in the past and it works very well because customers. It's not that they don't have money, but they sort of need an excuse to spend it so when they see value when they see something interesting when they don't want to pass it up that's when they buy so we're seeing positive momentum.
Tim on revenue based.
Based on that we expect of course fourth quarter to be bigger, but Michael anything I don't know exactly what youre.
I would just confirm what I said in the in the prepared remarks, John that we do expect that the fourth quarter. The fourth quarter is always a better quarter, a bigger quarter for us. Its a share is the biggest share quarter. Obviously, the macro environment is super uncertain, but we feel pretty bullish about when we look out from Q3 to Q4 and is near just sort of talk.
A couple of times now I think.
The underlying.
The business model that we have and how that performs in this kind of environment.
Sets us up extremely well both to serve our suppliers, but also serve our customers when they are looking for the best deal.
On something that they need.
And I think that's the other so to your other question about like why do we feel confident sort of talking about the upper end of our 27% to 8% gross margin range. It's really because this is sort of where our business model can shine when there's sort of an oversupply in the marketplace and we are the best place for suppliers to sort of move that product and we are the best place for customers to come.
Find deals on the things that they want to buy.
And then on the second part of your question John about gross margin so.
We talked about starting years ago, we talked about there being like a 1000 basis point runway that we could quantify between four being leavers one being as we grow in volume the efficiency associated with growing in volume. The second pillar was around as items become increasingly exclusive and we lean on red carpet merchandising. The demand response curves there and the price elasticity third was a pillar.
Around logistics and the fourth was the pillar around supplier services of which Cascade advertising through the supplier services.
Back then I think our gross margin was more like 25%.
So obviously, where we are today is higher than that but there's still a lot of runway left and so what youre going to see happen like when we talk about being at the high end of the range will some of these pillars like I talked a little bit about how supplier service adoption is growing.
Earlier in the call and other examples and logistics.
Expense had grown something like over the road trucking you can see with theirs.
There is an index of dry van rates, you could see how that grew and how that's falling now at a fairly fast pace and some of the congestion is behind us and so pricing is loosening. So theres a bunch of drivers around efficiency around transportation that will accrue to our gross margin and I think it's important to just remind people that in our platform model. Unlike a retailer who bought inventory.
X months ago to sell it today and so they're locked in at some price and they're locked in with a certain set of goods and so if they want to discount that comes out of their margin of course, it helps them in supply constrained environments like the end of last year, but those are pretty rare generally it hurts. It will just be example, where it hurts you.
They need to choose between discounting and taken out of their margin or trying to sell it based on the price they bought it at a price they expected prior to sell it at what happens in our model is we don't own the inventory so of course that hurt us last year, but it helps us this year. So our gross margin has this inherent stability of the platform model, but then it adds these benefits that we can take advantage of and I just want to remind you. This.
Still a long runway past that.
Thank you. Thanks, so much thanks.
Thanks, John .
We will take our next question from Oliver Winter mental with Evercore ISI. Your line is open.
Alright, Thank you, yeah, and Michael Thanks, very much for all the help over the years and looking forward to working with you again.
So my question was just a clarification question from from the guidance for next year.
When you said EBITDA positive.
Right.
Most of that should probably come just from reduced costs and most of that from from the Opex line is that correct.
So let me just make a comment and then I'll turn it over to Kate or Michael maybe specifically answer your question on what they said for the guidance but.
What I would say is the way to think about it is we have a plan to get to EBITDA positive and then the free cash flow positive that really is not counting on revenue growth being the reason and the way we get there.
So in that sense, you would say there obviously is.
The internal drivers pass revenue growth now I will highlight cost is one element of it and.
Cost can manifest as lower Opex for example, they can manifest also for example is higher gross margin and we just talked a little bit about gross margin. So I think about all the different aspects, adding together.
Why can we get there without.
Revenue, perhaps are growing dramatically and then obviously, we do expect revenue to grow as well and.
Frankly, there's more gross margin and more things over time that we expect to get also so theres a number of pieces that add together to the trajectory that we say youll see steady and continued progress and we talked about a level, obviously much higher than EBITDA zero that we're working towards but Michael or Kate I don't know if you want to add it first of all Ali Thanks for the thanks for the nice comment.
So I do think that.
As I mentioned in the prepared remarks, we think theres a lot of opportunity to really examine everything in our cost structure and understand where we can run in a more efficient way.
At the same time still protecting the investments, we're making that are really critical to have sort of a long term growth in the long term success.
Our business and the opportunity and so.
I want to be careful not to sort of say it's like in this one line right. It's like not just opex are not just capex, but rather this is a more holistic view looking at everything we're doing understand what's the most important priorities are and making sure that we've got all of our people and teams and resources focused off against those.
And then on the things that we can either push off to the future or cut out completely but how do we do that and do that in a pretty thoughtful way.
You can't do all of that instantly, which is why youre not seeing.
The change in the results in the Q3 guide, but when we look out over the back half of 'twenty two into 'twenty, three I think thats when youll start to see some of that performance flow through.
Okay, great. Thank you.
The only one follow quickly is on customer retention.
Looking at the active.
Active customer trends and how you try to reverse that and what you've seen in retention rates. Thank you.
Yes, and so they're what I would say is theres definitely.
When we say the macro is soft and home goods that then has an effect to our customer base the degree to which they are proactively engaged in searching but what I would say is we're seeing.
There's kind of the.
The active customer trend requires them to buy within 12 months.
His predecessor trends around like are they still engaged meaning are they opening are they opening the email do they have the app are they engaging in the app are they visiting the site or they clicking on E mails or clicking on App notifications and like for example, we have 60 million people who have downloaded the app.
And so we kind of can measure. These things we have we have numbers that make us feel good about how we're doing relative to the macro demand, but the truth is the macro demand is soft as well so.
I think thats, what youre seeing in that numbers that net of the two.
Got it thanks, very much and good luck. Thanks Ali.
Okay.
We will take our next question from Anna <unk> with Needham Your line is open.
Great. Thank you so much and thank you for all the color this morning.
Two quick questions just on quarter to date.
Follow up I'm curious what kind of trend.
And <unk> dot com in the U S.
I said previously provided that color and then secondly, you mentioned that Youre seeing some trade down in the portfolio can you talk specifically what categories.
<unk> and are you adjusting prices lower as a result, thank you so much.
Yeah. Thanks Shannon.
On quarter to date, I mean, one thing I would say wafer dot com is a particularly large piece of our business and so it's very hard for the total business to move Super far away from wafer and I'll comment presented last quarter. The U S segment I think it was down like nine 7% wafer dot com was down just a tick higher than that right. So even though we have other pieces growing in the U S.
And so we for Dot Com, obviously is a piece of shrinking.
It can't be far from it the total U S number well international is still performing far worse than the U S is so when you take the quarter to date number you can kind of use a kind of international U S splits that you've been seeing and kind of think about it that way and then that U S numbers basically going to tell you a wafer dot com numbers. So.
I think thats the way you should think about that.
And we're obviously pay keen attention on the trade down the way to think about that is when we talk about trade and what we do is we don't look at total ELV, we look within a class of goods. So in other words, the average price of a bed or the average price of a rubber that moving down and so.
What you see is generally youre looking for kind of a pattern across the board, which is what we see in times like this so it's not that specific types of goods traded down and other types of goods arent.
It's more a little bit across the board now in terms of pricing. This is again the benefit of our platform model the way pricing gets reactions that suppliers decide what they want to do on their wholesale pricing, we're seeing suppliers basically leaning in a discounting their wholesale price because they have too much in the way of goods and they want to sell those goods. We then pass that along to the customers the cost.
We're getting that benefit then when suppliers adopt something like castle gate, which increases speed to the customer, but also lowers the outbound ship costs that manifests also has a lower retail with customers. So that growing cascade penetration helps drive down retails and this can all be consistent with our gross margin rising which is the other thing I was talking about and that's the key thing that kind of linked together customers are good.
Better value for sure.
And at the same time, our gross margin is rising.
The only other thing I'd add there is that I do think that.
In a trade down moment is where you really see the benefit of our model of having extraordinarily broad assortment right and letting suppliers effectively compete in the marketplace right. So that you can offer the customer who wants to trade down both the lower priced <unk>.
Version of that product, but also for the supplier who might have.
Over inventoried at the higher priced version of that product if they want to push the wholesales lower and compete at that trade down level. They have the ability to do that across the platform.
And I think thats part of what we're seeing as well.
Great. Thanks, so much.
Thank you.
And ladies and gentlemen that concludes our question and answer session for today at this time I would like to turn the call back over to management for any additional or closing remarks.
Oh, great. Thank.
You everybody for joining us today, we are happy to spend the time with you and excited about your continued interest in wafer.
Very much.
Yes.
And ladies and gentlemen. This concludes today's conference call. We thank you for your participation you may now disconnect.
Okay.
Yes.
Yes.
Yes.