W - NYSE

Good morning. My name is Dennis, and I will be your conference operator today. At this time, I would like to welcome everyone to the Wayfair Second Quarter 2023 Earnings Release and Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers remarks, there will be a question-and-answer session. [Operator Instructions]. I would now like to turn the conference over to James Lamb, Head of Investor Relations. Please go ahead.

Good morning, and thank you for joining us. Today, we will review our second quarter 2023 results. With me are Niraj Shah, Co-Founder, Chief Executive Officer and Co-Chairman; Steve Conine, Co-Founder and Co-Chairman; and Kate Gulliver, Chief Financial Officer and Chief Administrative Officer. We will all be available for Q&A following today's prepared remarks. I would like to remind you that our call today will consist of forward-looking statements, including, but not limited to, those regarding our future prospects, business strategies, industry trends and our financial performance, including guidance for the third quarter of 2023. All forward-looking statements made on today's call are based on information available to us as of today's date. 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 2022, our 10-Q for this quarter and our subsequent SEC filings identify certain factors that could cause the company's 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 replacements for and should be read together with GAAP results. Please refer to the Investor Relations section of our website to obtain a copy of our earnings release and investor presentation, which contain descriptions of our non-GAAP financial measures and reconciliations of non-GAAP measures to the nearest comparable GAAP measures. This call is being recorded, and a webcast will be available for replay on our IR website. I would now like to turn the call over to Niraj.

Thanks, James, and good morning, everyone. We're excited to reconnect with you today to share the details of our second quarter results. Last year, we laid out a plan to strengthen our business that included a path to sustainable and growing profitability with several key milestones. For the past few quarters, you've seen us execute against that plan to lower our costs, focus on the basics and earn more customer and supplier loyalty. And you've seen the tangible impact of this plan as our performance has continued to improve. I'm pleased to share today that we've passed one of our key milestones and are reporting positive adjusted EBITDA and positive free cash flow. This is in combination with a return to momentum in our top-line with positive year-over-year order growth and sequentially higher active customer count, all while investing into initiatives for future growth. This is how we ran the business for our first decade and how we'll continue to do so going forward, profitable, while investing for growth. We think we are now in a very exciting place, having scale, while remaining ambitious and entrepreneurial. We plan to take full advantage of this. Our work over the past year to drive more than $1 billion of run rate savings in our cost structure is playing out across our entire P&L, enabling our accelerated return to positive adjusted EBITDA and comes in tandem with our efforts to see improvement in our top level KPIs. Order growth is the leading indicator of our other major KPIs. And even as average order values normalize towards pre-COVID levels due to deflation, we expect to see net revenue return to positive year-over-year growth in the third quarter as our active customer count continues to climb sequentially. We're going to handle this earnings call in a slightly different format than usual because, as many of you know, next week, we will be hosting our first Investor Day. We'd encourage all of our investors to tune into the live stream, which will begin at 01:00 p.m. Eastern Time on Thursday, August 10th. We'll be using this as an opportunity to introduce you to more members of our leadership team, dive deeper into the core pillars of our business and take you through the major growth initiatives for the years ahead. Through that lens, today, we're going to keep our prepared remarks concise to leave more time for questions about this quarter's results that we can turn our full attention to our long-term strategy and key growth drivers next week. Now let me give you a view of where our business stands as we move through the summer. Q2 proved to be a quarter of two continuing themes for Wayfair, share capture and cost efficiency. I'll start with the share capture piece and the results really speak for themselves. Wayfair meaningfully outperformed the competition this spring with net revenue down 3% year-over-year in Q2 compared to a category that continues to be down 10% to 20% for widely tracked estimates in credit card and e-mail receipt data. Our team spent significant time at various trade shows over the past few months, and we have heard resounding feedback from our suppliers that the platform they want to lean into is Wayfair. Benefits of our enormous marketing reach, considerable merchandising investments and proprietary logistics capabilities, make Wayfair an unparalleled partner to our suppliers. Since last fall, we have seen strong market share capture on the back of our core recipe. The combination of broad availability, fast delivery and sharp pricing continues to be a powerful flywheel to drive both customer and supplier engagement. And across the Board, we're setting new benchmarks on these metrics. Availability and speed badging continue to climb in Q2. And with further wholesale cost normalization as well as our operational cost savings efforts, we now consistently see ourselves as a price leader across our most popular items. Our recipe is back intact. We've been extremely encouraged by the recent data we're seeing on customer behavior with a noticeable upswing across all of our customer cohorts and sequential growth in our active customer count. It's crucial to know that this improvement in order momentum is not a function of isolated success in any particular class or with a specific group of shoppers, but it's been broad-based across both our customer file and our catalog. We see this as an important point of validation for our customer acquisition strategy, which looks to build life time shoppers to make Wayfair a core part of their shopping habits. We approach earning customer loyalty through many vectors. Our work around promotions is a great example. In this environment, our promotional activity is a marketing lever that piques customer curiosity and draws them to visit. Once on the site, they purchase a variety of promoted and non-promoted products. In fact, during sale events in the second quarter, non-featured items drove over two-thirds of our gross revenue. And it's worth noting that in our customer survey work, we've seen no change to the share of shoppers that indicated they would only shop Wayfair during a sale. As we do across every facet of the business, we're continuously testing these levers, measuring the results and iterating. For example, earlier this summer, we ran a series of promotions to encourage shoppers to use our app, and we saw a remarkable engagement. Mobile app revenue had its largest ever share, and we saw App Store rankings reach the highest they have been since the pandemic due to significant lifts in downloads. This is just one exciting way we're growing engagement with our app, free loyalty and free traffic driver. At the outset, I mentioned two themes for this quarter, share capture and cost efficiency. And we've talked at length about share capture and the major driving factors. I want to touch on cost efficiency briefly before passing it over to Kate, who will talk through this theme in more detail. The second quarter saw gross margins exceed 30%, a milestone we've only previously accomplished during the peak pandemic period of 2020. Unlike three years ago, the improvement in gross margin and its impact on our unit economics is durable, driven by the considerable work our team has done to execute across the set of more than 70 operational cost savings initiatives that we've talked about in recent quarters. Moving back to where we started. This highlights a key point from our shareholder letter. Wayfair is at the stage where we can both invest for growth, while demonstrating considerable and improving profitability. Q2 was a quarter where we were able to achieve adjusted EBITDA margins of over 4%, while also leading into growth initiatives. I'm excited to talk more about our ongoing growth opportunities at our Investor Day next week. We continue to lean into physical retail, including opening two stores this summer to invest into our international business and to pursue new technologies like Generative AI to name just a few areas. You will hear a focus on the opportunity ahead to growth as well as a continued commitment to operational discipline and expanding profitability directly from the senior leadership team that's driving us there every day. Thank you. And with that, let me turn it over to Kate for a review of our financials for the quarter.

Thank you, Niraj, and good morning, everyone. We've got a lot of exciting progress to report from this quarter, so let's jump into it. Net revenue for the quarter came in at $3.2 billion, down 3.4% year-over-year, but up 14.3% from Q1, following a more traditional seasonal pattern. While we had a slow start to the spring weather, the outdoor shopping season picked up rapidly as we move through the back part of the quarter, and we saw both customers and suppliers leaning into several well-received promotional events. Niraj spoke at length about the growth we saw in order volume, both year-over-year and quarter-over-quarter, which came in conjunction with continued deflation in AOV as we lap some of the peak periods of inflation last year. The top-line success we saw in Q2 was driven in large part by the U.S. segment, which saw net revenue come in 15.3% higher than Q1. I'll now move further down the P&L. As I do, please note that the remaining financials include depreciation and amortization, but exclude equity-based compensation, related taxes and other adjustments. I will use the same basis when discussing our outlook as well. Gross margin had an outstanding quarter, coming in at 31.1%. This is the highest gross margin we've ever printed as a business. And as Niraj discussed comes not from an unusual surge in demand, but from structural improvements we've been driving across our operations. We're pleased with the results our operational cost savings initiatives have produced so far, but do want to note that this quarter exceeded even our own expectations with some timing benefits flowing through in the period. It's worth reiterating that we have been thoughtful about the share of these savings and reinvest in the top line as we navigate the consumer environment and we'll continue to take a very tactical and dynamic approach to balancing this mix through the remainder of 2023. Before moving to advertising, I'll quickly mention customer service and merchant fees, which showed nice leverage this quarter coming in at 4.3% of net revenue, a reflection of our cost reduction efforts from earlier in the year. Advertising had another strong quarter at 11.1% of net revenue for the period. As we've discussed at length over many quarters, we are being prudent about driving higher efficiency from our paid channels in the face of depressed free and direct traffic. One of the ways we can improve our efficiency is through channel tests, and we ran several in the second quarter. These tests provide key insights and former channel mix going forward. They also drove outperformance on the advertising line in Q2 and will correspondingly leave some revenue on the table for the third quarter as we held back spending in various channel segments. This is a perfect example of the sophistication we bring to advertising, which is one of the areas we'll focus on during our Investor Day next week. You can look forward to a much deeper dive into how we think about managing our channel mix and efficiency targets as part of that event. Finally, our selling, operations, technology, general and administrative expenses totaled $473 million in the period. While we are seeing nice quarter-on-quarter progress in this line item and significant year-over-year reduction as a result of our cost actions over the past 12 months, we continue to monitor this cost area closely. This quarter, we did see some lower-than-anticipated attrition. While there are some near-term headwinds on the whole, this is something we're pleased with. We've seen considerable excitement among our team members in the past few months as the success we've had with our customers and suppliers resonate throughout the business. In total, the revenue strength in conjunction with the considerable cost actions we've taken across our entire P&L, led to adjusted EBITDA of $128 million for the second quarter, a 4% margin on net revenue. Our U.S. segment saw adjusted EBITDA come in at $161 million for a 5.8% margin while international losses showed further compression to negative $33 million of adjusted EBITDA. We ended the quarter with $1.3 billion of cash and highly liquid investments on our balance sheet, and over $1.8 billion of total liquidity when including our revolving credit facility capacity. Net cash from operations was $217 million, offset by $89 million of capital expenditures, which resulted in free cash flow of $128 million for the quarter. We're thrilled with this progress. As you know, our free cash flow is driven by 3 components: adjusted EBITDA, working capital and CapEx. Adjusted EBITDA was a strong contributor this quarter as was working capital, we saw a healthy sequential revenue growth, which is a driver of cash flow to our business given our negative cash conversion cycle. I'll get into guidance momentarily, but in the lens of typical seasonality, we would not expect working capital to contribute meaningfully to cash flow in the third quarter. Let's now turn to guidance for Q3. Quarter-to-date gross revenue has been trending positive low single digits year-over-year, and we would expect net revenue growth in the mid-single digits for the full quarter, in part, weighed by the impact of the advertising channel test I mentioned previously. As we've shared before, we intend to continue to invest some of our cost savings in the customer experience as we maximize multi-quarter gross profit dollars. Therefore, we expect gross margins between 29.5% to 30.5% for the quarter as we balance the ongoing structural improvements in gross margin and optimize for investment into the customer experience. Moving on to customer service and merchant fees, this line should once again be between 4% and 5% of net revenue. We would expect advertising to be between 11.5% and 12.5% of net revenue, a bit above Q2 given the factors I mentioned before around our testing cadence in the early summer and our continued efforts to drive efficiency across our channel mix. We forecast SOTG&A or OpEx, excluding equity-based compensation and related taxes to come in between $460 million and $470 million, this largely follows the trajectory we laid out last quarter, adjusted for the timing impact of the lower attrition rates in the second quarter. If you follow the guidance outlined above, we would expect to have positive adjusted EBITDA margin in the low single-digit range for Q3. This implies the third quarter margin slightly lower than Q2, given the overperformance on gross margin advertising in the quarter, which shows a clear trajectory towards a sustainable mid single-digit adjusted EBITDA margin and positive free cash flow we've outlined in the past. To that last point, you should expect the more modest EBITDA dollars in Q3 and some sequential compression on net revenue translates to a free cash flow figure that is roughly breakeven, plus or minus. Now let me touch on a few housekeeping items for the third quarter. Please assume the following: equity-based compensation and related taxes of roughly $150 million to $170 million. Depreciation and amortization of approximately $102 million to $107 million, net interest expense of approximately $5 million to $6 million, weighted average shares outstanding of approximately $116 million and CapEx in an $80 million to $90 million range. As I wrap up, I want to take a moment to recognize how far we've come. A year ago, we first discussed the shape of what our path to profitability would look like and message a plan for breakeven adjusted EBITDA by the end of 2023. Today, we've achieved that goal driving over $1.4 billion of cost actions across the business to reach our profitability milestone months earlier than planned. Last August, we reported an adjusted EBITDA loss of $108 million. This quarter, on a revenue basis, that is approximately 3% smaller, we've driven $128 million of positive adjusted EBITDA. Of course, our tremendous progress wouldn't be possible without the dedication and commitment of everyone on the Wayfair team. We're thrilled to introduce you to the leaders of that team next week at our Investor Day, and showcase everything that makes Wayfair special. As we've outlined before, we remain committed to driving meaningful growth, while improving profitability and free cash flow generation and are excited about the future. Thank you. And now Niraj, Steve, and I will take your questions.

[Operator Instructions]. And the first question is from the line of Christopher Horvers with JPMorgan. Please go ahead.

Thanks and good morning everybody. So my first question is, as you think about the promotionality that you had in the first half of the year, we get a lot of questions on whether that promotionality is driving any sort of unsustainable market share gains. Can you talk about that, especially in the context of how you're thinking about balancing some of the gross margin investment versus the outperformance that you saw in the second quarter?

Sure, Chris. Thanks for the question and good morning. On promotions, I think the way that think about it as promotions are really more a marketing message than like a pricing strategy when you think about like your comment about being unsustainable. So the way I think to think about it is in this period where promotions have been a more frequent occurrence. The bulk of the volume is still not the items on promotion, just like it is in a normal time where the promotional cadence is a little less strong and the difference in the frequency of promotions is less about needing the discount to drive volume, a little more about the marketing messages resonate with the customers. So when you think about sustainability, we think the momentum we have in the business is very sustainable. And we also think that prices as we kind of get to a fully normal environment will actually be lower than they are today, because the inflation that's coming out still has a little ways to go before it's fully out. And so when you kind of think about from a customer value proposition standpoint, I think your question gets like, hey, are you offering prices that you're not going to be able to offer in the future, and we don't think that's the case. So we feel quite good about it. The other thing on market share, I would just point to is the market share gains we're getting are from pretty much across the Board. So they're not coming on the back of any particular customer or any particular product category or segment, it's very broad-based. And I think what it shows you is that our recipe is back intact, which is the breadth of selection, the fast delivery, the kind of availability of the bestsellers. And these are things that were under strain in that COVID period where supply chain congestion was there, a lot of inflation was there. And what we're seeing is that as the recipe is fully intact. This is the cycle that we just used to compound our business over in the 20 years, and that's what's driving the success here.

And then my follow-up question is, as you flip here early to free cash flow in the second quarter, Kate, can you help us think about how you think about use of cash and how you think about sort of the debt structure and the balance sheet structure over a longer-term basis?

Yes. Thank you. Good morning, Chris. So a few thoughts there. Obviously, we are very excited by the free cash flow generation this quarter, and we intend to continue to be at a sort of sustainable free cash flow generation place going forward. As far as the overall capital structure, as I think you're aware, we have a number of converts. The first convert is that 2024 convert of about $117 million remaining. We feel very good about our ability to manage through that. The next convert is at 2025 convert of about $755 million remaining. And as we go forward, we think there'll be multiple structures for us to manage that convert as well. So when we look at the balance sheet, we feel very good about our position today, and we intend to keep being free cash flow generative and adding that back.

Our next question is from the line of Maria Ripps with Canaccord. Please go ahead.

Great. Good morning. And thanks so much for taking my questions. First, can you maybe just talk about some of the competitive dynamics that are happening in this space, given sort of all the recent developments, it seems like you've been clearly gaining market share. So how do you see sort of the competitive landscape developing here going forward?

Thanks, Maria. Yes. So I think as we've referred to in the past, we have many competitors. So this is a very fragmented category. And inside home, there's even many subcategories that would have a different set of competitors, whether you're looking at a segment of furniture or you look at something like lighting or plumbing, different competitors will come to mind as you go through those different categories. We're excited that we're taking share and we're taking share very broadly. So it's not coming from any particular set of competitors. But I think the big thing in the landscape of what you see in e-commerce is that -- it's primarily the larger platforms are the ones that are able to really compete. And so when we look at competitors in the United States, the main competitors we would watch the closest are the larger ones. The Amazon, Walmart and Target, Home Depot and Lowe's, Costco because those folks have a scale to participate in offering advanced logistics, they have the scale to reach the customers. And these are things that, if you're much smaller as we've talked about having around about 3,000 engineers, product managers, data scientists or you talking about the 25-ish million square feet of logistics space we have and all the different types of specialized operations we run, including our own proprietary large parcel delivery. These are things that you just can't do without the scale. And I think these are things that offer the customer experience that they are increasingly getting accustomed to and require or desire in order to buy from. And so each competitor that we watch focus on different segments of the business, they take advantage of their scale to do that, whether they're delivering building materials to job sites rather than delivering groceries to consumers, we focus on home and so we use our scale for that type of specialized capabilities. I think the smaller folks are the ones that are losing share in a way that's going to be ongoing, because I think it's harder in e-commerce to provide that value prop if you don't have the kinds of assets I just referenced.

Got it. That's very, very helpful. And then just on gross margin. Could you maybe just talk about how much of the operational savings you have achieved that being sort of reinvested back into price? And how sort of -- how that may have influenced the top-line outperformance this quarter? And how should we think about the percent reinvested kind of on a go-forward basis?

Yes. Let me just share a couple of quick thoughts and then pass it over to Kate to get into more specifics on the numerics that you just asked for. The one thing I would highlight is we laid out an ambitious plan. And as we go along the plan, we keep adding to it. So the operational cost savings have been tremendous. There's still more to come. And I would say that from a price standpoint, we're also part of the reason we're doing really well is we are very competitive on the key items that we offer. And that -- a lot of that is because we're back to a normal environment where we have the strength to do that. But Kate, maybe anything you want to add?

Yes. I think Niraj covered most of it on our philosophy here. So Maria, as you know, last quarter, we referenced of that $500 million that we had originally outlined, we said we'd already achieved half of that by last quarter or sort of coming out of that quarter. Obviously, you saw ongoing improvements and in fact, an acceleration on that gross margin line. So I think you can infer from that that we picked up continued operational cost savings and, in fact, a little bit faster than we had intended to. As we think about the reinvestment, what we're really balancing is flow through on that to the bottom-line with improvements in the customer experience overall, and that's really designed to generate multi-quarter gross profit dollars. And that's how we're thinking about that ongoing investment. And you, of course, see that a little bit in the guide on gross margin, which is up obviously, but takes into account some of that investment.

Your next question is from the line of John Blackledge with TD Cowen. Please go ahead.

Great. Thanks. Two questions. First, could you just talk about key drivers of the order growth? And is that sustainable over the next several quarters? And just any general color on the consumer demand for the home category. And second question on Gen AI, just potential uses of Gen AI to drive the biz going forward? Thank you.

Thanks, John. I'll start with the order growth. So the order growth dynamic, I think it's -- what I was referring to earlier about us being in a position where the recipe is back intact in the offering the breath of selection, the in-stock availability, the fast delivery, the competitive prices. That flywheel is there, customers are reacting to it. And then what's even more exciting than that is we're seeing it in the repeat metrics, we're seeing their engagement post order, they're coming back post order, the buying again, working. And that's a cycle that compounds. And everything in the business would imply that that should be a something that grows over time, because in the customers to come back, that's a compounding factor as you add in more engaged customers. And as I mentioned on the pricing standpoint, the prices can get even sharper as suppliers are able to fully move to kind of the future cost, where the inflation has come out, the ocean freight is not what it was at the peak. It's much more like what it was pre-COVID, et cetera. So that's sort of the dynamic, and that's why you see the momentum in the business, and we see it growing. I don't know, Kate on the order growth, anything you'd want to...

Yes. I think those are the key pieces. I mean, it's really the dynamic that I believe we foreshadowed a few quarters ago, which is as deflation continues to come out of the prices and as our availability and speed got better, we would ultimately be seeing order growth offset some of that deflation as customers were able to reengage in the category. I think your next question was...

Gen AI.

Was on Gen AI, yes.

Yes. Yes, a couple of thoughts on that. So there's a number of use cases of Gen AI that we're actually already taking advantage of and building capabilities on and honing a lot of which have to do with reducing workload or making work much more efficient. An example of something that we actually have already piloted is -- as you know, we have thousands of customer service agents who talk with our customers, but will also engage with our customers on chat and answer questions via e-mail. So something like chat and e-mail, one of the things that we've done is run a pilot where we have software that basically creates what it believes the answer to be. And then with that answer, an agent can review it very quickly, edit it as they think is needed and sent it back. So that's a cost savings method that actually increases the quality of the answers. We found that actually the customer satisfaction, the aggregate response go up while in fact, the cost, the cost to answer for a given question goes down. And there's like four or five use cases like that, that we already have underway. Some of the other ones have to do with how we draft product descriptions, how we do product tagging. And so there's a variety of things that we do that we have tremendous amounts of people or cost revolver that we can reduce and while improving efficiency and accuracy. Then there's a set of activism on Gen AI that get to sort of how it could change the customer experience in the future. So say those are the ones that are a little more on pilot stage, a little more R&D is involved. We announced one of the things we're working on just the other day, which is to clarify -- and so I would just encourage you if you're curious about that to just check that out because there's a link available to that, and you can just try it yourself. And it gives you a taste and a feel of what's available and where things are headed. And we think that will take longer to play out in some of the cost savings type things that we think we can ramp more quickly, but we think that the power of what you could do with Gen AI is very significant. And I think it plays to our strength where we've been very actively using data science for years, and this is sort of the latest incarnation of that, but it plays to a strength that we've had. And so we feel like we're in a very good position to continue to be a technology leader and aggressive adopter of technology.

Thank you.

Your next question is from the line of Alexandra Steiger with Goldman Sachs. Please go ahead.

Great, thank you for taking my questions. I do want to ask about international. So while you obviously saw a nice improvement in the U.S. international growth is still lagging. So wondering if there's anything you're calling out, whether you refocused your international efforts or do you prioritize some initiatives that led to the lower revenue growth? Or is this more a sign of a weakening consumer demand in international versus the U.S.? Thank you.

Thanks, Alexandra. What I would say on international, so sort of there's two parts to answer that question. One certainly is the macro is different by country. And there are, I would say, in some of the markets that we're in, in our International segment, certainly a weaker macro than in the United States. So I think that's a piece of it. I think the other piece of it, though, is when we laid out the $1.4 billion in cost actions, one of the buckets we talked about, for example, was some of the things we were doing around advertising and where we're going to make sure that the advertising we did, we kept it really tight inside paybacks and some of the more speculative advertising we cut back. And one of the other things we talked about is like how -- being tight on unit economics. And so in some of the International segments, I would say that we've taken a position to strengthen our unit economics, which comes at the cost of near-term revenue, but we think fundamentally sets up those businesses in the longer term to be much stronger. And you see that when you look at the EBITDA of the International segment, you can see that it's improved dramatically. And so some of those things, while they would hurt on revenue, they would be quite good from a profit standpoint, and so if you take a longer-term view, it creates a much better outcome. And so that's the other thing I think you need to make sure you keep in mind. It's not just the story of the macro.

Great, thank you. Very helpful.

Your next question is from the line of Curtis Nagle with Bank of America. Please go ahead.

Good morning. Thanks for taking the question. So the first one, I guess, would be on the pace of active customer growth. I think you saw the first instance of quarter-over-quarter growth in some like two years, where is it coming from? Is it new? Is it reactivated? And how should we think about the pace going through the rest of the year?

Curtis, thanks for the question. Yes, I'd say we're very excited about that momentum. And I think if you think about orders and the order growth is significant, not sure there's a lot of customers who are getting to your point, some are new and some are reengaged. But you see them coming. And then what I was addressing earlier is something that you can't see in the metrics, but is happening, and we're very excited, which is the repeat metrics underneath. So someone who buys what percentage of them buy again in the next 30 days or 90 days. These types of repeat rates. Those are actually strengthening quite nicely, and that's a really good leading indicator of where the business is headed. And it's kind of for two reasons. One is that creates the compounding cycle. So mathematically, that's how growth really get strong, stay strong increases. But also it shows you the kind of how well are we doing in impressing the customer? Because in other words, if you have a great selection, great pricing, great delivery, great merchandising they'll buy. But then ultimately, once they buy, they get the product at their house, it's been delivered to them. They didn't have the product and they're using the product only then if they're really happy what they buy again. And so it kind of -- those repeat rates kind of take everything and kind of show you where the customer is then voting, how happy are they? And are they then acting on that, and we're seeing that strengthening. Kate, I don't know if you have anything?

Yes. I would just add, I think that speaks to it very well. I would add that -- as a reminder, the active customer number is an LTM active number. And so you're going to see the orders number as we are seeing improve ahead of that active customer number. You'll see that sequential growth, which, to your point, we saw this quarter, and those indicators will come first, and then it will take a little bit of time to sort of grow through and get to that positive active customer number. But overall, we're very encouraged by the trends, particularly around order volume. And as Niraj said, sort of underlying repeat behavior.

Got it. Okay. And then just as a quick follow-up. So the commentary in terms of some of the relative share gains for 2Q, we're definitely helpful. At the end of the quarter, maybe going to 3Q, any evidence that you're seeing a pickup in the category? Or is this sort of a continuation of you guys really outperforming. That's the primary driver of 3Q?

Yes. I would say -- a few thoughts. So based on what we see from a market share standpoint and what we see overall demand in category, we're seeing it kind of -- we don't really see the category particularly strengthening. We see it kind of bumping along. We believe we see that in both the credit card data that we have access to, but also, for example, last few days, I was at the Las Vegas market. I talked to a lot of suppliers, and it's what we're hearing from them. We're hearing from them that we're picking up share. It's broad-based. And then any given supplier will give us some flavor about named specific named competitors. And what we're hearing would be consistent with what we believe we're seeing in the credit card data. And then what they're telling us about their overall demand trends will be consistent, which is demand is relatively weak. It's bumping along. We're stand out and taking share, and it's very broad-based.

Okay. That's very helpful.

Your next question is from the line of Steven Forbes with Guggenheim Securities. Please go ahead.

Good morning, Niraj, Kate.

Good morning.

I wanted to maybe start with -- wanted to start with CastleGate penetration. So curious if you can give us any color on where you expect to end the year in terms of penetration of small and large parcel? And what the current thoughts are around capacity for CastleGate as we look out to '24 and '25?

Yes. Thanks for the question. What I would say is that CastleGate penetration as we go through time, we're quite excited about where we think it will go based on what we're hearing from suppliers' interest to flow goods in as they increasingly flow new goods out of Asia. So we've been at a period of time where suppliers are kind of working their way through excess stock. But they're now getting to a point where they're bringing in their best sellers, and I mentioned the Las Vegas market recently. I'd say a substantial number of the suppliers are now bringing in large new product introductions for the first time in three years. So it's sort of like a moving forward thing going on in the business, which is particularly exciting, I think, plays to our strengths, but also from the standpoint of flowing fresh goods out of Asia, that will speak to increasing CastleGate penetration. From a capacity standpoint, what I would say is we've built that network out over the last few years to have a very good footprint, but with a lot of unutilized space because the idea we had is we wanted to have the footprint. And then as we get more volume through it, it will then get utilized which will then be a situation where we'll only need to add new locations down the road when we have capacity constraints, which is not the case right now.

Yes. I would add to that. We've obviously shared the CastleGate penetration stat in the past is one metric on our overall logistics improvements and ongoing efficiency that we're seeing there, which you can clearly see in that gross margin line and we'll certainly speak next week at our Investor Day more broadly to our logistics network and the efficiency and the value that drives for our customers and our supplier. CastleGate is an important piece of that. And within CastleGate, of course, the penetration is a component, but there are multiple factors at play here.

I appreciate that. Maybe just a quick follow-up. Maybe we'll get this next week. But I keep thinking back to the total logistics cost, right? I think you've referenced in the origin in the past around $0.20 of every dollar. So curious if you can sort of talk to where that -- where the total logistic costs are today and where you sort of see them going as various aspects of the supply chain normalize here?

Yes. So I don't have a -- I don't like a crisp number to tell the 20 is not or anything like that. But I guess, the way to think about it is that logistics cost, we've been focusing on optimizing it. The biggest factors that would optimize it -- or basically, when you think about CastleGate penetration is, if goods come in directly from wherever they're manufactured, and get forward position from the get-go. That's the single biggest driver of taking out logistics cost because all the excess miles that would need to happen in the destination country really get minimized. That's the most expensive leg is the final mile leg. The second most expensive thing is also -- is around on that final mile. How can you optimize it past just the miles. And so this is where we get into what we do in some of our buildings around sortation and where you could take out things like hub touches, you can also for the large parcel levels that we deliver ourselves, how do we optimize that. So then again, whether you do 17 deliveries in a day instead of 16 or something like that, that could be a very big driver of cost. So if you think about the activities we have around the fulfillment center footprint around the consolidation and the things we're doing abroad that facilitates the ocean freight to be very efficient at loading to begin with and then what we're doing on our last mile delivery network, these things kind of add up to tackling those costs. And then one of the things I mentioned is where we have capacity pass what we use today. So as volumes increase, there's a tremendous opportunity to drive down costing. And that will happen as the volumes grow and the volume in that network on a proprietary basis grows.

Your next question is from the line of Jonathan Matuszewski with Jefferies. Please go ahead.

Good morning and thanks for taking my questions. One of your online competitors is highlighting elevated trade down over the last couple of months with customers who used to buy better SKUs, sign more good SKUs, would you say trade down was more pronounced in 2Q relative to 1Q? And how much did that impact your AOV this quarter? Thanks.

Yes. Thanks, Jon. I would say that we're definitely -- we definitely see trade down. Trade down, in a recessionary cycle, trade down is very common. And we kind of saw that cycle play out in 2009, 2010. It's a very -- it's actually relatively easy to kind of quantify that cycle and track it. That said, the bulk of what's driving the AOV is that deflation. It's that ocean freight, in particular, inflation coming back out. There's also a little bit that had to do with raw materials and some of the production costs. And so that's the primary driver of AOV, the vast majority of it. Trade down is a piece on the AOV, but it's not the bulk of it.

Yes. I would just add that I think also trade down is an area where our broad selection benefits us. And so the customer can continue shopping with us. And if our budget is tighter, she can still find that product with us. We certainly saw that behavior play out in the 2009, 2010 period as well.

That's helpful. And just my follow-up question. Kate, I think you alluded to some investments in customer experience contributing to a lower gross margin 3Q relative to 2Q. Can you elaborate on some of those enhancements and the returns you expect to see from them?

Yes. Great question. So when we talk about investing in the customer experience, I think it's important to note that across multiple factors, right? So often, folks will go to price, price is a component but so is delivery speed, delivery experience, just spoke about some of the last mile delivery efforts that we made, the returns experience, incident management, et cetera. All of those, we think drive an overall better customer experience, and that leads to ongoing repeat behavior. So when we think about quantifying the value of those investments, we're looking at, as I mentioned previously, this multi-quarter growth in gross profit dollars and ongoing improvement there from driving that customer experience. As a result, yes, we are going to be reinvesting some this quarter we landed at 31.1%. The midpoint of our guide is about 30%, but we've continued to step up that gross margin. And I think you'll see ongoing improvements throughout the year and going forward in gross margin. We've previously outlined that path to sort of a mid-30s gross margin. We're very pleased with the progress that we're making there.

Your next question is from the line of Anna Andreeva with Needham. Please go ahead.

Great. Thank you so much. Good morning and congrats on nice momentum in the business.

Good morning, Anna.

We had a couple of quick ones. I wanted to follow-up on the monthly cadence during the second quarter. So you guys provided an update in early June for the business to be down mid-single. So was June overall positive for the company? I just wanted to make sure that math is correct. And obviously, a lot of initiatives are working, which is great. But anything specific that drove improvement to low singles that you're currently running? And can you help bridge how we should think about getting to mid-single for the third quarter?

Thanks, Anna. I'll just want to quick thought and then pass it over to Kate to answer your question, but it's -- the thing I would -- one thing just to make sure you keep in mind is the concept of compounding, right? So you get customers, they are interested, they buy, they're happy, and then they come back. And there's a bunch of things you can see there that show you that compounding, you see repeat ticking up, the Wayfair app, for example, has seen increased downloads and usage. That's typically, the app is used by people who are increasingly loyal and engaged. And so there's a bunch of different metrics I think you have access to where you'd see that. And that concept of compounding is really how the growth occurs, but let me pass over to Kate for your specific.

Yes. I think that covers how you can think about the second quarter. Obviously, we don't provide month-on-month breakouts. As you sort of move into the third quarter, I think your question was, how do we get from low single-digits that we're seeing today to that mid-single digit. One factor that I'd point you to is that marketing test, that straddled two quarters. So the test itself occurred in the second quarter. That means we've pulled back on some spend in the second quarter and left some revenue dollars on the table that would have hit in the early part of the third quarter. So that's a little bit of how you might see some of that. And then, of course, ongoing momentum that we would expect to see because of those underlying factors that Niraj mentioned orders obviously beget future customers and future orders. And as we've seen that order volume growth, we'll continue to see that why we will improve.

Okay. Terrific. That's super helpful. And Kate, just as a follow-up. This was very helpful on the gross margin, but did you guys quantify the timing benefit in the second quarter and thank you again.

Yes, we did not. We did say things hit a bit faster than originally anticipated, and we're excited about the ongoing tight execution from the team there.

Your next question is from the line of Ygal Arounian with Citigroup. Please go ahead.

Good morning everyone. So maybe just to dig in a couple of these points. First on the gross margin, great to see and understand kind of puts and takes with the reinvestment. On the upside and what drove upside to what you're expecting this quarter or just in general, the strength, can you talk about which pieces were the largest contributors to that? Like what's been coming in better than expected? And then on the advertising, again really interesting to see and hear about the kind of the pullbacks on the testing. Can you share a little bit more about what that was, what you saw that led you to pull back some of the things you're looking for there and how to think about that as we kind of move forward? Thanks.

Thanks, Ygal. I think Kate will probably be able to answer your questions, but the one point I just want to make before I pass it over to Kate is a lot of the gross margin improvement, if you go back to that $1.4 billion cost action plan. We kind of talked through a bunch of components of what we were planning to do. I think a lot of what you're seeing in the results is an outcome of a lot of the things we said we were going to do that we've been since done, and that are kind of driving a lot of the improved performance. And then on advertising, I guess the point I would make there is the testing we do is really to get data that then we use to hone the data science models that drive the spend in a way where we have high confidence that we know what ROI we're getting. And so it's something that we just need to regularly do to kind of hone these models. And because of kind of the unusual behavior during COVID, the last set of tests were run in 2019, which is quite a long time ago, you typically would run them much more frequently than a four-year period, but that's sort of the last normal period we had. And so what we're doing is make sure we hone these models. So even though that hurted performance from a revenue standpoint in Q2 because you're not spending a bunch of advertising that you believe is productive. It's the only way to get the data back that hones the model. And so it's more kind of an ongoing thing you would do to just make sure that you're kind of able to be very specific and accurate in how you advertise. Kate?

Yes. So circling back to your gross margin question on sort of what was the largest driver there. We've outlined before there's over 70 different initiatives that we are pursuing on the operational cost savings and operational efficiency. And what you're really seeing is the combination of those initiatives hitting a bit faster than we anticipated. And that's what drove that Q2 gross margin. One thing I'd point out is that many of those are structural improvements that we've made. And so those savings are enduring and will be ongoing. That sort of light guide at the midpoint being at 30% versus the 31% that we hit is really just because of that reinvestment in the customer experience. We expect the improvements to hold. On the advertising test now I'd echo everything Niraj just said -- these are important things for us to do to be able to have that ongoing conviction in how we spend. We think about spend and efficiency on a channel-by-channel basis, as you've heard us speak about before and testing is a sort of traditional and appropriate thing for us to do. We're excited to be back on the offensive and able to actually do those tests in a normal cadence. And that gives us the conviction to spend effectively into those channels going forward. Of course, the result is that you do lose a little bit of revenue on the table when you run those tests.

Your next question is from the line of Atul Maheswari with UBS. Please go ahead.

Good morning, this is Michael Lasser for Atul Maheswari. Thank you so much for taking our questions. Niraj, I want to give you an opportunity to respond to some of the pushback from the skeptics that we've been hearing. One of their arguments is many of the vendors really globally are still heavy on inventory. So they're using third-party marketplaces as a channel to still right size their inventory and then dispose of excess inventory. In addition, they're benefiting from lower freight costs, which is allowing them to be a bit more promotional, which is driving some of the improvement. How would you respond to that?

Well, in terms of the deflation that's happening, I think that is happening. I do think the freight costs are not likely to revert to those kind of pandemic type prices that were there. So I don't think that's a temporal thing. And I don't think that's really promotional. I think that's -- items reflecting kind of a more normalized cost that will continue. And that's being, I think that's true for everybody, right? So that's like kind of a normal market phenomenon that I don't think is specific to any particular retailer. In terms of excess inventory, I'd say the peak of excess inventory was the summer of 2022, and suppliers have been working down that inventory. Since then, we have a number of suppliers who are back to very healthy stock levels. And we have some who are still trying to work through that excess stock. We have not really seen suppliers discounting in general past the price of what they can price goods at on an ongoing basis. So in other words, there's the replacement cost if you flow that item today from Asia, what would that cost? And we're seeing suppliers price perhaps all the way down to that level even if they have excess that they brought in a higher cost basis or still be above that level with a plan to get down to that level as they can flow more and more fresh goods. So we're not seeing anything that would kind of say any of the supplier behavior is something that's very temporal. What we're seeing is that they're reverting to normal. And I think what you're seeing is that, just like in 2019 or 2018, 2017, it's a competitive field of retailers out there. There's a lot of folks doing different things. And folks who provide the customer with the best experience win. And that's a little different than the behavior during 2020 and 2021, where there's a very booming market. There was excess demand. There's a lot of stimulus spending. There's a lot of supply chain congestion. There's all kinds of different pricing, that's a more unusual period. And I think that we've now got that in the rearview mirror.

Okay. And our follow-up question is you've got a wonderful purview on two of the most important elements of the domestic economy right now, which is the consumer and housing market. So if you could provide a little insight what you're seeing from a category perspective to illuminate what consumers are interested in buying, what where purchase cycles are already normalizing? For example, there are signs that flooring as a category remains under pressure, yet appliance demand is starting to stabilize. So what big themes or trends are you seeing that really indicate where the consumer stands right now from a category perspective?

Yes. Thanks for that question. I mean what I would say, what we're seeing -- obviously, you can see in our numbers, we're seeing nice demand. That demand is pretty across the board. Obviously, we're a larger player in some categories than in other categories. So something like appliances, as you mentioned, flooring, these are really some of the newer categories we entered into over the last number of years as opposed to we started our company in 2002 with a focus on entertainment furniture. So that's where we've been in by far the longest. And so our market position varies in terms of how much market share we have. And so I think as a result, some of these newer categories, we're smaller in and so we can grow it off of a smaller base. So these bigger categories they're in, we have much market share, but we can still grow because of such a large position we have. So I don't know that we could see in our numbers, the category overall performance that you're alluding to. We hear about some of it from our suppliers. So we hear it anecdotally, but it's the same kind of data you would have access to.

Today's final question will come from the line of Colin Sebastian with Baird. Please go ahead.

Great. Thanks for fitting me in. Good morning. Just wanted to follow-up on AOVs and the impact from deflation a little bit more. Maybe to understand specifically what you'd expect to happen in the financial profile of the business with gross margins and operating margins. If we do see a scenario where there is a reversion maybe back to historical levels? And then maybe Niraj, part of this maybe say, for next week, but -- following up on the Gen AI question or AI in general. But on the expense structure, I mean, given some of the crosscurrents around the internal efficiency gains you mentioned, but also external facing product development and maybe higher infrastructure costs associated with the AI. What should we think about in terms of the impact from those investments in R&D and technology? Thank you.

Thanks, Colin. On the AOV question on the deflation, I think I've kind of mentioned -- I think really the main thing that's happened is the ocean freight, which is the primary driver, again has returned back to sort of pre-COVID levels suppliers, if they work through their goods and get to newer goods are then bringing those goods over with kind of the costing looking much more like it did pre-COVID than it did during COVID. And they're reflecting that in the wholesale prices, which then get reflected into the retail prices. You can see from our margin, effectively our gross margins is kind of like our take rate, you're seeing that that's holding fine. And you're seeing that having a competitive offer really drives customer engagement, what you're seeing in sort of the order count number and the sequential increase in active customers. And then if you roll that forward, you get that effect that I've described a couple of times around that compounding, which happens with engaged customers coming back. And that's seen in repeat metrics that I think is the one piece that's hard for you to see. You see it play out over time in results, but you wouldn't have those repeat metrics, but that's -- we can see it and it's working well. So I think the margins become -- margins, you can see our unit economics are strong. And what you're seeing is that our volume is growing, and it's growing in what's a really tough market today. And so you can imagine as the market stabilizes and then increases over time as you roll out over the years, like it makes it easier for us to grow even faster.

Yes. Our margins are healthy and growing even with the AOV compression. And I would not expect a drag on the margin from AOV compression. We're seeing that, of course, offset with orders, which is a more positive thing for our flywheel.

And then on your Gen AI question, I think the way I think about it, obviously, where we can become more efficient that's a form of cost savings. We talk -- if you think back to that $1.4 billion cost actions plan, there are a lot of different cost savings we said we're going after. You can create another set of activities that using Gen AI can help us go after and that obviously makes us more efficient, lets us offer sharper retail prices, lets us invest in different areas. That's all very productive. That infrastructure cost question you had in there about the kind of technology spend. I wouldn't -- don't think about us as really incurring that in the same way. The folks who have the big LLMs and provide those as a service. So in this case, Google or OpenAI would be two that we work with, for example, they have a very large capital investment they make that they then get back by letting you use their models as a service, and you're then putting your own layers on top of it using your own first-party data, which is then a reason why we and the other large platforms is going to benefit, the smaller platforms don't, which is the depth and breadth of your first-party data, which is really the difference in how well you can design a Gen AI type application. But your cost is not particularly high because again, you're paying for your usage is a modest amount. And so there's always different pieces of our software application where we're adding capability and then there's always over pieces you're optimizing lower cost in. So I don't know Kate maybe address it. But I think our clusters, there's nothing for you to worry about there, I guess, on that point.

Yes. I think that nothing to worry about in the near-term in the cost structure over time in the cost structure. And of course, there should be ongoing cost savings, as Niraj mentioned earlier. As we wrap up, we just want to remind you all of our Investor Day next Thursday. We look forward to seeing many of you there. Thank you for joining us this morning.

Yes. Thank you. Look forward to seeing hopefully a bunch of you next Thursday. Take care.