Etsy, Inc. (ETSY) Q4 2019 Earnings Report, Transcript and Summary

Good afternoon. My name is Cheryl, and I will be your conference operator today. At this time, I would like to welcome everyone to the Etsy Fourth Quarter 2019 Earnings Conference Call. [Operator Instructions]. I would now like to turn the call over to Deb Wasser, Vice President of Investor Relations. You may begin your conference.

Thank you. Good afternoon, and welcome to Etsy's Fourth Quarter and Full Year 2019 Earnings Conference Call. Joining me today are Josh Silverman, CEO; Rachel Glaser, CFO; and Gabe Ratcliff, our Senior Manager of Investor Relations. Before we get started, just a reminder that our remarks today include forward-looking statements relating to our financial guidance and key drivers thereof, anticipated product launches, our ability to bring buyers back to the Etsy marketplace, anticipated continued benefits of our migration to the cloud, anticipated benefit of our marketing strategy, anticipated investments in the timing and benefits of our seller initiatives and the strategic benefit and impact on our financial performance of our acquisition of Reverb. Our actual results may differ materially. Forward-looking statements involve risks and uncertainties, which are described in our press release, our 10-Q filed with the SEC on October 31, 2019, and our 2019 10-K that we expect to file with the SEC in the coming days. Any forward-looking statements that we make on this call are based on our beliefs and assumptions today, and we don't have any obligation to update them. Also during the call, we'll present both GAAP and non-GAAP financial measures. A reconciliation of non-GAAP to GAAP measures is included in today's earnings press release, which you can find on our Investor Relations website. The length of the replay of this call will also be available there, and if you prefer to access the replay via phone, you can find that information in the press release as well. We've created a slide presentation to accompany today's remarks and recommend you follow along. With that, I'll turn the call over to Josh.

Thanks, Deb, and good afternoon, everyone. We believe Etsy is uniquely positioned to address a huge market opportunity. Last March, we described that opportunity and laid out our long-term strategy to capitalize on it, underpinned by our marketing, product and technology road map, which deepened our powerful rights to win, giving us the confidence to sign up to ambitious growth targets through 2023. We're off to a really strong start with our 2019 performance. At our Investor Day last March, we targeted a 5-year GMS growth CAGR of 16% to 20%, faster than e-commerce averages. And in the first year, our core Etsy marketplace delivered GMS growth of 20.4%, above the high end of the targeted range. We also said we expect revenue to grow slightly faster than GMS over that 5-year period, and in 2019, the core Etsy marketplace delivered revenue growth of 32%, significantly higher than GMS. Last August, we also completed the acquisition of Reverb, another very special marketplace, driving even more growth. Our full year GMS grew nearly 27%, and revenue grew almost 36% on a consolidated basis. And we had a very strong finish to the year. Etsy reported fourth quarter consolidated GMS up 33% to $1.7 billion, revenue up 35% to $270 million and consolidated adjusted EBITDA margins of approximately 23%. The core Etsy marketplace delivered strong growth with fourth quarter GMS up 20% year-over-year, revenue up 28% and our take rate reached 17.2%, all up from the high bar set in the prior year. We're proud to be one of the handful of companies simultaneously delivering very strong top line growth and EBITDA margins north of 20%. You've probably heard of the Rule of 40. It's an elite club. And heck, in 2019, we were Rule of 50. 2019 was a big year, and we've made meaningful strides in keeping commerce human. When I reflect on our efforts, I'm really proud that our team tackles complex challenges head-on with boldness and urgency. I'm also inspired by the team's dedication to bringing world-class experiences for our customers. We do the hard things that set us up for success now and for years to come. We're hyper-focused on doing the fewest things that can make the greatest impact. For example, we enhanced the buying experience to capitalize on our unique and defensible right to win by making search more personalized, elevating human connections, improving trust and giving sellers a path for growth. Etsy's mission is incredibly relevant and powerful. We stand for something different. We are just getting started, leveraging our strengths in the $100 billion-plus available market we've identified for Etsy's special merchandise, pulling our growth levers of more active buyers, improved frequency and higher AOV. We've done of all of this while continuing to make strong progress on our economic, social and ecological impact pools, which are deeply integrated into all aspects of our business. We apply the same focus and discipline to our impact metrics as we do to our financial metrics. And together, they make us stronger and more resilient, which is why we now publish an integrated annual report, including both our financial and impact metrics. In that report, you'll see that in 2019, the Etsy marketplace drove over $6 billion in U.S. seller economic output and created 1.7 million jobs in the independent worker economy, enough to employ the entire city of Phoenix, Arizona, the fifth largest city in the U.S. We continue to attract and retain world-class talent, strengthened through diversity, leading the industry in gender balance and exceeding our goal to double hiring for underrepresented minorities. And in 2019, we became the first global e-commerce company to offset 100% of our emissions from shipping with the introduction of carbon-neutral shipping in the Etsy marketplace. We believe being a great corporate citizen is an integral part of being a great business, and our results over the past year demonstrate that Etsy is leading from the front. Digging a little deeper into the drivers of our strong fourth quarter performance. Etsy.com and our sellers had a great holiday season. All of the work we've done to make Etsy a great destination for holiday shopping paid off. Etsy was ready for the holidays with an improved search experience, targeted multichannel marketing campaigns and product improvements, including on-site landing experiences, free shipping and more. And Etsy's sellers were ready, with seasonal merchandise across home decor and gifting and personalized items from toys to jewelry to leather goods, topping our best seller lists. As a result, Cyber Monday and Tuesday were Etsy.com's first and second highest GMS-driving days ever. In fact, we delivered approximately $20,000 in GMS per minute during each of these 2 days. Also, GMS for the 5 days from Thanksgiving through Cyber Monday was up 30% compared to last year. Marketing played a big role in our holiday success, enabling Etsy to reach more buyers and improve buyer frequency. Our TV holiday campaign drove strong results, attributable to increased efficiency, stronger performing creative and expanded reach. In fact, when measured by GMS per dollar of spend, Etsy's Q4 holiday campaign included our best-performing TV ads to date. It's also worth noting that Etsy's migration to the cloud enabled us to spin up servers and add capacity just hours before we needed it, compared with just 2 years ago when heavy investments in hardware were required in advance to get us through the holiday season. This cloud capacity is really important from a performance and site availability perspective. So fair to say, it's really an unsung hero of our excellent holiday performance. In 2019, Etsy made valuable long-term investments aligned with our right to win, leading to material improvements in the customer experience. Just a few examples. We made search and discovery better with our transition to nonlinear search models. We made e-commerce feel more human with investments in our core app experience and the introduction of new messaging functionality. And we leveraged buyer reviews to build trust in the Etsy marketplace. And we've become even more agile and efficient as a result of investments we've been making in our platform and infrastructure. As a result, product development velocity more than doubled year-on-year. We tackled some complex challenges for customers and are showing continued progress on many other fronts such as free shipping and Etsy Ads. I'll talk more about each of these in a moment. As I mentioned Etsy.com's transition to the cloud has played a key role in our product development efforts. And last week, we reported that the migration is now complete. During the migration we moved 5.5 petabytes of data to GCP, the equivalent of moving 22 times the data of the Library of Congress. We've increased our experiment velocity by fivefold over the past 3 years while roughly doubling the size of the engineering team. so while we are demonstrably more productive, we feel that there are meaningful opportunities to further improve performance and leverage machine learning to advance the customer experience, most importantly in search and discovery. Having successfully completed the cloud migration also means we can repurpose the people and time spent on migration for tech investments to keep experimentation high. I'd like to congratulate our engineering team for pulling off this large and extremely complex task so smoothly and on time and without any significant unplanned downtime. 2019 was also a big year for Etsy in marketing. We hired a CMO and expanded investments across the full marketing funnel. We've built a strong team, equipped them with better resources, and our investments are bearing fruit. In addition to the great progress we've made in TV and digital video, we've also begun to unlock and scale in paid social and search engine marketing. And we're hard at work improving our own channels, optimizing e-mail and push notifications through the buyer journey while building out an integrated buyer CRM strategy across channels and life cycles. We're confident that our marketing investments are fueling profitable growth with continued runway to scale and gain efficiency. Turning to an update on free shipping and Etsy Ads. We believe that by changing customer perceptions of shipping costs in the Etsy marketplace, we will increase conversion, increase frequency and drive growth on the marketplace, and we're making great progress. At the end of the fourth quarter, 74% of U.S. listing views were for items with free shipping. About 65% of U.S. buyer GMS shipped for free, and nearly half of all orders received by U.S. buyers were delivered with free shipping. At the time we launched our free shipping initiative last July, only about 24% of items were available to ship for free to the U.S. Now that free shipping has become commonplace on the Etsy marketplace, we can really focus on evolving customer perceptions. And there, it's still early days. In fact, in a survey conducted in January, only 12% of Etsy buyers were aware that we offer free shipping. We also have much more opportunity to help Etsy sellers do a better job incorporating free shipping into their pricing strategy. Now let's turn to Etsy Ads. More than many other features, our sellers ask for the ability to invest to drive their growth. So last August, we launched Etsy Ads, a product that combine our on-site promoted listings and off-site Google shopping services. Over the past 6 months, Etsy Ads has delivered positive returns for sellers and solid revenue growth for Etsy. As a result, we saw increased budgets and minimal seller churn throughout Q4. And we listened and learned a lot. While sellers viewed the advertising interfaces visually appealing and simple to use, many sellers perceive off-site advertising is risky. They're uncomfortable spending money upfront to buy traffic from off-site ads when they're less confident of a buyer's purchase intent. As a result, we could see that it was going to take longer than anticipated to scale the program. So in order to address this concern, we rapidly iterated to develop an innovative solution, which we believe will deliver strong value to sellers while mitigating their risk. As announced to our seller community earlier today, we're introducing 2 updates to our advertising products. First, we're introducing an expanded advertising service off-Etsy called Offsite Ads. Etsy will pay the upfront costs to promote sellers’ listings on sites, including Google, Facebook, Instagram, Pinterest and Bing. We'll leverage our performance marketing budget and expertise to drive traffic to sellers' shops. When a shopper clicks on an online ad featuring a seller's listing and purchases from their shop, the seller will pay an advertising fee on that order only when they make a sale. For sellers, this means that they will be getting a really competitive roll-offs of 6 to 8x, utilizing the benefits of our marketing budget and expertise promoting their listings off-site without the risk that it might not lead to a sale for them. For Etsy, this means that we can rapidly scale our off-site advertising program without any budget limitations, a win-win solution. Second, our on-site advertising program that you all know as Promoted Listings will now be called Etsy Ads. An optional advertising product, sellers can use to bring Etsy traffic to their shop. We'll be investing in Etsy Ads in 2020, continuing to add capabilities and functionality. Going forward, sellers' Etsy Ads budgets will only go towards advertising listings to shoppers on Etsy. We're excited to be able to accelerate our growth marketing investments, given we can now generate more leverage on our marketing dollars. Turning to 2020. We entered the year on strong footing with a clear strategy and a focused set of investments designed to drive growth in the near and medium term. We'll continue to deepen our right to win by focusing on the 4 strategic imperatives that serve as the foundation of our long-term strategy: search and discovery, human connections, trust and our sellers' unique collection of items. We plan to further deepen our competitive differentiation and our relationship with our customers, attract more new buyers and increase buyer engagement and frequency. And we feel really great about Reverb. We're rolling out the Etsy playbook to drive additional growth and success. It's a great brand, community and team. On the product side, we're investing in the right infrastructure to enable a more iterative experimentation process that delivers faster returns. And in marketing, we're focused on improving attribution models and developing integrated campaigns. A few weeks ago, Dave Mandelbrot brought joined Reverb as CEO, bringing more than 2 decades of marketplace leadership experience. We're extremely encouraged by the progress Etsy made in 2019. Our team has always been very balanced in our approach. We are a growth company focused on growing in a sustainable way. I'm highly confident in our ability to do that in 2020 and beyond. And with that, I'll turn the call over to Rachel.

Thanks, Josh. My commentary today will cover consolidated results as well as key drivers of performance, which include Etsy marketplace results where appropriate. You can find further details on Reverb's contributions in our press release and soon to be filed 10-K. On a consolidated basis, Etsy's fourth quarter GMS grew 33% to $1.7 billion. Revenue grew 35% to $270 million, and we delivered adjusted EBITDA of nearly $55 million, finishing a strong year where we delivered profitable growth while leveraging investments in products, technology and marketing. Etsy marketplace GMS growth in the fourth quarter on a constant currency basis was 19.7%. And for full year 2019, we accelerated GMS nearly 100 basis points to 21.3% compared to last year. On a 2-year basis, the GMS CAGR in the Etsy marketplace has been greater than 20% for 3 consecutive quarters. Etsy had an especially strong holiday season, lapping a very strong Q4 last year. Revenue for the core Etsy marketplace grew 28.4% year-over-year in the fourth quarter, and our take rate expanded 10 basis points sequentially to 17.2%, driven by growth in both marketplace and services revenue. In particular, we reported strong growth in advertising revenue related to Etsy Ads, primarily driven by Promoted Listings. Promoted Listings revenue has increased 30% or more for 10 consecutive quarters. Google Shopping contributed approximately $13 million to advertising revenue for the quarter but with 0 margin as it carries an equal offset in cost of revenue. Operating metrics for the Etsy marketplace continued to show signs of improvement throughout the year. For example, we made significant progress driving frequency on the platform. Etsy's GMS per active buyer on a trailing 12-month basis grew 3.8% year-over-year; and on a 2-year stacked basis, increased by over 6%, the highest ever increase in this metric since we've been a public company. Buyers who shop on Etsy for 2 or more purchase days in a year grew nearly 20% in 2019, driven by habitual buyers, which grew 23% in the fourth quarter of 2019, outpacing overall active buyer growth. The positive improvement in these metrics indicates that our investments in marketing and product development are delivering sizable returns and improving marketplace fundamentals. In Q4, active buyers on the Etsy marketplace grew to approximately 46 million, and active sellers grew 20% to over 2.5 million. Percent international GMS for the Etsy marketplace was approximately 37% of total GMS, up from 36% a year ago. There are three parts of our financial story I want to spend a few extra minutes on, as they are an integral part of our 2019 performance and will continue to be in 2020. These three parts are about profitability, the impact of our new off-site ads product on our financials and the performance of the free shipping initiative. So on profitability and how we think about our investments. Etsy has been investing for profitable growth, and this is evident in our adjusted EBITDA margins today. In 2019, we made material investments in people, primarily product and engineering, to drive growth in GMS and revenue. Our free shipping initiative, the launch of a new ad platform and continued advancements in search and machine learning are a few of the results of these investments. Revenue per average headcount for Etsy stand-alone was over $800,000 in 2019, up 11% compared to 2018 and above our peer benchmarks. This is one metric that provides evidence that our disciplined investment process generates solid returns. Another contribution to profitability is our marketing efficiency. We've been expanding at these marketing initiatives for about 1.5 years now, leaning in more heavily to new channels like paid social and have expanded our investments in upper funnel strategies like TV. Total marketing expense grew from $158 million to $203 million for Etsy on a stand-alone basis in 2019 and decreased as a percent of revenue by 80 basis points. Performance marketing spend also decreased as a percentage of revenue, and our frequency metrics continue to improve. This implies improved efficiency in our marketing investments. Overall, we grew adjusted EBITDA by 34% year-over-year and delivered margins of nearly 23%. In fact, if it's not for the accounting impact of Etsy Ads, our reduced overall level of capitalized labor and the 2019 impact from the shift to Google Cloud, which moves more infrastructure costs from the balance sheet to the P&L, we estimate adjusted EBITDA margins would have been approximately 300 basis points higher in 2019. And as you know, Reverb has also impacted our adjusted EBITDA margins. We've continued to convert a high amount of EBITDA into free cash flow. On a consolidated basis, Etsy's free cash flow conversion has been over 100% for the fifth consecutive quarter on a trailing 12-month basis, as seen on Slide 21. All in, in 2019, we generated $192 million in free cash flow, evidence of our financial discipline and strong business model. We leveraged our cash flow in 2019 to repurchase $177 million of stock or approximately 3.1 million shares. The second topic I want to unpack is our new ad platform. We launched the platform in late Q3, and it was live and active in all of Q4 and in Q1 of this year. In its current incarnation, the Offsite Ads component of the product, ads purchased on Google Shopping is accounted for as revenue with an equal offset in the cost of revenue. So it is revenue with 0 margin. In Q2, as Josh explained, we are evolving our Offsite Ads program to a cost-per-sale model. This means the seller only pays for the advertising if they have a successful transaction attributed to one of the ads we purchased, eliminating the risks they will pay for off-site advertising without them making a sale. Sellers will pay a 15% advertising fee in addition to the normal fees only on transactions attributed to a visit from an off-site ad. Certain sellers, depending on their size, will be required to participate in this program and are also eligible for discounted pricing. At the same time, this allows Etsy to scale our offsite advertising investments and fund the upper funnel marketing programs such as TV ads. Once we transition to our new advertising model, the accounting for the off-site portion will change. In Q2 and beyond, Etsy's investment in Offsite Ads will be accounted for as marketing expense, and you will see an increase in our marketing expense line. Offsetting some of this investment, we will earn incremental transaction revenue when a seller makes a sale that is attributed to one of the product listing ads we purchased. This new Offsite Ads model is accretive to EBITDA and EBITDA margins. Previously, as you recall, the Google Shopping component of our ad product had a dilutive effect to EBITDA margin but neutral to EBITDA dollars. We will continue to have Etsy Ads revenue, the product formerly called Promoted Listings, in our services revenue line as it has been all along. And last, the impact of the free shipping initiative on our P&L. GMS growth has benefited from the transfer of shipping costs into item price. Because some sellers have transferred less than 100% of the shipping cost into their item price, this has had the effect of reducing our overall take rate as we earn the 5% transaction on a smaller total order value. Despite this headwind to revenue, Etsy's take rate grew to 17.2% in the fourth quarter, an increase of about 70 basis points from the average in the first half of 2019. Expanding buyer awareness of free shipping options on Etsy and educating sellers on pricing strategies will take time, and our teams will continue to make improvements on both fronts. So a great Q4, capping off a really strong 2019. Looking forward, we are forecasting 2020 GMS growth in the range of 25% to 28%; revenue growth of 27% to 30%; and adjusted EBITDA in the range of $220 million to $235 million, which implies a margin of approximately 21% to 22%. We are targeting Etsy stand-alone GMS growth for 2020 to be in line with our long-term GMS target of 16% to 20%, with revenue growing at a faster rate. I'd like to provide some additional insights to help inform your 2020 model. We currently expect Etsy marketplace GMS growth will be higher in the first half of the year versus the second half due to the lapping of our free shipping initiative. In addition, keep in mind that our consolidated guidance for GMS includes lapping the Reverb acquisition in Q3 2020. While marketplace sales taxes did present a modest headwind to our 2019 GMS, we do not expect this to be a significant factor to our consolidated growth in 2020. As a reminder, we will anniversary the launch of many of these tax laws in Q4. Consolidated take rate will be approximately 16.7% for the full year. On a stand-alone basis, we expect the Etsy marketplace take rate will be approximately 17.5% on a full year basis in 2020. As you think about modeling our profitability, please remember that in Q1 of 2019, we conducted a number of experiments on our marketing portfolio to test the incrementality of certain performance channels. This resulted in a significant decrease in marketing expense in that quarter. We did not run any TV advertising in Q1 of 2019, but we did run a 5-week campaign for Etsy in January of this year. This means that we expect Q1 2020 consolidated marketing expense will be higher year-over-year, and adjusted EBITDA margins will be lower. Moving to costs. On a consolidated basis in 2020, we expect to gain leverage in cost of revenue and G&A. Product development expense will reflect our continued investments in product and engineering to support improvements to the customer experience on both the Etsy and Reverb marketplaces. The impact of lower capitalization of our internal development labor means we are forecasting product development to modestly delever in 2020. We expect marketing as a percent of revenue will increase based on the revamp at the ads model as well as our continued investment to grow both new buyers and increased frequency. And lastly, with many growth investments during the year, we continue to expect Reverb to achieve breakeven exiting 2020. We are really pleased with the growth we achieved in 2019 and have real confidence in the 2020 road map. We expect to continue to drive top line growth while also delivering attractive profit margins. Thank you all for your time today. Josh and I will now take your questions.

[Operator Instructions]. The first question comes from Edward Yruma of KeyBanc Capital Markets.

Congratulations on a great quarter. Lots to unpack here. I guess first on Etsy Ads. I know one of the thought processes behind the legacy product was that you'd be able to pull back on SCM and spend more to top of funnel. I know that's part of the objective with the retool program, but help us understand. Do you think that you'll fund all of the SCM marketing today using the 15% you're charging in the new program? Or are you still expecting to kick some in as well?

Yes, great question. So the overall philosophy remains the same. That overall, sellers will take on primary funding for advertising their individual listing off-site, and that will allow Etsy to invest more in upper funnel things that only Etsy can do, like advertising the Etsy brand on TV or getting people to download the app or driving people to the homepage. In terms of the structure of the off-site advertising program in particular, we do anticipate that there will continue to be some subsidy of Etsy to the program. So the 15% and 12% fee will cover much, but not all, of the cost. And for example, if somebody clicks on a listing and doesn't buy, there's cost in that, and Etsy might absorb better that. And if they land on one seller's page and they end up buying from another seller. Those are things. But we think that, that's appropriate because if you think about it, it's the case that the seller makes an incremental sale, which is great and gets a happy customer that they might be able to resell to. But Etsy also has gained a customer. And so the idea that we are chipping in together with sellers to make this a great program, we think, is important. And we're really proud of this program. I do want to say that a 6% to 8% ROAS, we think, relative to what sellers would get if they had their own stand-alone shop is a really strong ROAS, and we take on the risk that the money they invest might not convert to a sale. And that's exactly the kind of thing that a platform can do, is pool the resources of the sellers together to deliver something that they each individually could never get on their own. So we're excited about this. We think it does deliver great value for sellers, and we think it's going to be really good for Etsy.

Great. And one follow-up, if I may. You hinted at some innovations or some work you're doing around Promoted Listings, or I guess, what you're now calling Etsy Ads. And then also we've obviously been impressed that you've grown as strong as you have over the past 10 quarters. I guess with these innovations, do you think it's likely that you continue the 30%-type growth trajectory? Or are you starting to hit the ceiling from an availability perspective?

Thanks, Ed. So we're not going to give specific guidance on how much we think Promoted Listings will continue to grow. It's a really strong, one might call it, a workhorse product for our sellers. They love the product. And we've been able to improve - continue to improve the efficacy of it for them by making the Promoted Listings terms more and more relevant so that the - even though they're promoted ads, they're very relevant to the search query. And so that gets them a better ROI because they're getting more clicks from the placement of their ad. And we have - Josh has referenced to continuing to innovate would be that because we're investing in machine learning and our search engineering team to continue to make those results higher - more and more valuable and higher and higher ROI.

Your next question comes from Kunal Madhukar of Deutsche Bank.

A quick clarification, Josh, on what you just said, the 6 to 8x ROAS. And you also said that the money they invest may not convert into a sale, that's a risk. So does that mean that the seller will pay for the click and the traffic, regardless of whether there is a sale? Or will they still have to pay - or will they not pay if there is no sale?

Thanks for that question. It's a really important clarification. No, the seller will only pay if they make a sale for Offsite Ads, and we think that's really important. What we heard from sellers is that they're really nervous to put their money upfront for Offsite Ads, where they just don't know the intent of a buyer who's on Google or Facebook or other places. And so Etsy is taking on that risk for them and sort of pooling that risk, if you will. So they will only pay the 12% or 15% fee when the click converts to a sale.

Okay. Great. And then on the Promoted Listing side, I wanted to understand how that growth has kind of trended in the fourth quarter. And you mentioned that there was like only modest churn - or actually no churn in - modest churn in the sellers as far as Promoted Listing is concerned. What did you hear from them in terms of their experience with Etsy Ads that led you to go in and come up with this new Etsy Offsite Ads program?

Great. So let me start with churn. It's the case that, in any given month, there will be some level of churn in the program. There's just natural. It's a very dynamic market. We've got sellers coming in and sellers coming out. What I would say is that we did not see a material increase in churn through the fourth quarter, and so churn did not materially change, and budgets went up. So we think that the program in that way was successful, and yet we are responsive to what we hear from sellers. And what we heard was that a limitation to them continuing to enter the program and grow their budget was this fear that they're going to spend money upfront and not have it convert to a sale. And not just a fear, I mean, that's a reality for sellers that some of them will invest money and have it not converted to a sale. And so when we looked at that and said, at the pace we want to scale this program, not something that's going to limit us, this is a very reasonable concern that sellers have. And we, as a platform, are positioned to take that on. So we think this is kind of an innovative program, but we think it's a great example of innovating to meet the needs of sellers in a way that's a real win-win for Etsy as well.

Great. And a quick one, if I could squeeze this. There has been increasing concern about the impact of - or the potential impact of coronavirus and if it could impact supply chain and product availability. As you think of the products that are available on Etsy, what do you think is the estimate on like the original raw material might have emerged from China, which could potentially disrupt - what percentage of the GMV do you think that could potentially disrupt if there is a disruption?

So a very, very small percentage of both our supply and our demand is in China, where the majority of coronavirus has been sighted. We obviously keep a very close watch on all of this, and we think there's no impact to Etsy at this point. In fact, when you think about the responses that some of the CDC and others have talked about, which is remote - ability to work remotely if needed, we have most - probably one of the largest remote workforces in the world when you think about our sellers being - already working from their homes. So they're uniquely set up to continue business as usual. Of course, any macro - major macro trend that happens, I think Etsy would be subjected to the waves of that as well. But thus far, we haven't seen any impact to our business.

Your next question comes from Shweta Khajuria of RBC Capital Markets.

Great. Let me try two, please. First, on the guidance, Rachel, for 2020. Could you help us understand or give some direction on how much you're thinking the Reverb contributions is for the full year? And then on the - and the second question is on EBITDA margins for 2020. Give some - can you help with modeling for where you expect leverage and deleverage? Help us understand what the puts and takes are with Reverb, with the cloud expenses, with Etsy Ads, with the Offsite product. There are quite a few things moving around, and some of them likely are onetime that can potentially allow for greater margin expansion in 2021 and beyond. So there are a few moving pieces, I want to make sure it's clarified.

Yes. So for starters, we did say - to give you some sense of how much Etsy's stand-alone business is growing in 2020, we said that - we believe that Etsy on a stand-alone basis will grow in line with our long-term guidance that we gave at our Investor Day of 16% to 20% for GMS. And we were very specific on take rate as well. So we said take rates will be about 17.5% for Etsy on a stand-alone basis for - on average for the full year. So that sort of helps you with the revenue and GMS for the Etsy stand-alone basis. And I think you've got enough data to figure out back into Reverb's GMS from that and Reverb's take rate can be applied to develop their revenue. We've also said that Reverb's EBITDA is going to be breakeven as we exit 2020. So there is some headwind on EBITDA margins coming from Reverb. The other headwinds to margin, we did go into some detail on which things would gain leverage on in 2020 and which things would delever. So because of the Etsy Ads movement in all of Q1 and a portion of Q2, we have basically the old accounting treatment for Etsy Ads, which would be revenue with a corresponding equal amount of cost of revenue, so it's dilutive to margins. But going forward, it would actually be incremental marketing expense that would show up in Etsy's marketing line. And because of that, we think we'll see a little bit of deleverage in the marketing line, but accretive to EBITDA margins and EBITDA dollars. Product development, we said might be modestly dilutive to our EBITDA margins because we are investing there, and we're also capitalizing less of our labor. We're also taking a fair amount of the incremental revenue we expect from the new format at the ads, and reinvesting that as we did when we did our pricing change last year in upper funnel marketing and back into our business to continue to do product development. So we think both the marketing line and the product development line will have a small - a modest amount of deleverage, but we're going to gain leverage in cost of revenue because of the change to Etsy Ads and in our G&A function.

Your next question comes from Nick Jones of Citi.

One on the Offsite Ads. I think I read on a blog and the seller handbook that every seller would be opted into this. Is there any color you can give around what you think kind of the roll-off will be? And how we should think about how that would touch - circle throughout the year from launch to when sellers may decide to opt out for this product?

Yes. So I'd start by saying we always start with what do we think is in sellers' best interest. And when we look at the program, we think generally, at large, this is going to be a great program for most sellers. But when we spent time with sellers - and we spend a lot of time with them and try to know them pretty well. Sellers that are relatively small, maybe early in their life cycle or for whom this is something they don't dedicate a ton of time to, sometimes tell us, and this might be a little counterintuitive, but that they really don't want to grow more than a certain size. And so they actually may not want incremental sales. And that's true of some sellers. And by the time they hit about $10,000 of annualized sales, they've sort of demonstrated a scale and well and desire to be growing. And so the threshold where we said under $10,000, you have the ability to opt out of the program because we've seen some sellers who've said that growth is actually something that they're not necessarily ready for. By the time they've hit $10,000, we see that growth is something they're typically ready for. It's something they're typically wanting. And frankly, the program works better when they're all in it together. We have more data and more ability to work together with partners like Google and Facebook and others to really scale that program. So it lifts up the whole program to have all of the larger sellers in the program. So we allow for an opt out for sellers under $10,000, and they have a 15% fee. For sellers over $10,000, they have a 12% fee, but they don't have the ability to opt out. And we think that opt out rates for sellers under $10,000 will be very manageable. We're not sure what they'll be, but it will be manageable for the program.

And I'll just add a comment because we have a room set up for the announcement day where we have a very robust cross-functional team monitoring forum. Our member support organization has been ready to take calls and respond to e-mails immediately. And the - so I've been spending time with them there today, and the overall tone and tenor has been, we've been very pleased with - not everybody loves it, just as we expected. But there's, I'd say, more positive than dissention and positive in the extreme. So we're very pleased with how the communication is going thus far.

Your next question comes from Heath Terry of Goldman Sachs.

Just wanted to get maybe back to some of the work that you're doing on customer frequency. As you look at the components of that, that you're working on, personalization, marketing, some of the search and really, technology investments that you're making, can you give us a sense of sort of the progress that you feel like you've made so far? And where - as you look at the pipeline for the year ahead, sort of where you see the biggest opportunities? And if there are specific road marks or initiatives that you've got that we should be watching for this year, which ones you would call out?

I mean I'd start by saying that we're really pleased with the progress we saw in 2019, and Rachel shared that like in the fourth quarter, habitual buyers were our fastest-growing segment yet again, growing 23% year-over-year. GMS per active buyer was up yet again. On the two year stack, it was up 6%. The percentage of people who shopped two or more days in the year was up again. So we're very pleased with a lot of these leading indicators that show that we are, in fact, driving frequency. And I'm happy with the way you've led in the question, speaking about both product and marketing levers, because they're both important. We are making search better. We've talked about some of the things we've done, like nonlinear models and leveraging the cloud to just use more data and more robust models to deliver better search, and that drives more conversion. And nothing gets someone more likely to come back than having bought and been happy with that purchase. So as conversion rate goes up, you get turn visitors into buyers and buyers come back more often. Life cycle marketing is a big opportunity for us. So we are bringing in a new set of technology around life cycle marketing that's going to allow us to be much more segmented and much more personalized in how we communicate through our own channels, things like e-mail and on the app, and we're really excited to be able to take that to another level in 2020. And then if you look at the paid marketing that we are doing, we're pleased with the progress that we're seeing there. And that's all the way through the funnel. So for example, if you look at our television commercials, they really don't do anything to explain what Etsy is. They're not really designed with someone who's never heard of Etsy in mind. They're designed for someone who's already generally familiar with Etsy to trigger very specific purchase occasions. So you're seeing very specific merchandise and purchase occasions, and we're seeing benefits from that. The mid-funnel work that we're doing as well, so things like advertising on Facebook and other channels with ads and video that might target, for example, people who are just entering a wedding process. We're also seeing us triggering that I should have had a V8 moment of, oh, gosh, of course, yes, I should think of Etsy for that. So it's a combination of the product work and the marketing work that we're doing to come together and drive that metric.

Your next question comes from Maria Ripps of Canaccord.

I wanted to ask about ROI related to Offsite Ads. With 6 to 8x ROI sort of guaranteed to sellers, how are you thinking about your own ROI around this initiative? In fact, you remain sort of all other revenue associated with the transaction? And I guess what's a reasonable ROI range for Etsy that you'd be considered - that you'll be willing to consider here?

So we're always very focused on, if we spend $1, are we getting more than $1 back on a risk-adjusted basis? And this program, we have the ability to operate and decide how much to invest on a daily and weekly basis. And in fact, it's much easier to operate than the program it's replacing. So if you think about the program that the offsite advertising is replacing, we had a couple of hundred - hundreds of thousands of individual seller campaigns that we were executing, and each one of them had its own budget. And on any given day, sellers are hitting their budget, and we're having to manage that. And so this new iteration of Offsite Ads allows us to run one campaign that pulls the data and is, therefore, more effective and drives better roll-offs overall for our sellers, so they benefit from that. It's also much easier for us to manage, and we now have one budget we can spend. And like we always do, we'll be paying very careful attention to what is the return on the next dollar that we spend in performance marketing. This will change the ROI curve a little bit. It will allow us to invest a little more. With sellers kicking in, it allows us to invest more profitably to drive growth, and we're excited about that. And you do see that a bit in the margins when Rachel talked about the fact that we'll be taking up marketing a little bit, and so we'll be seeing a little bit of deleverage in marketing. It's because the take rate has changed, and we're getting more ROI as we invest.

And I just want to underscore 2 points there. One is that it is an effective take rate increase. And just like when we did the pricing change last summer, taking up the take rate creates a larger LTV, so we can invest more at the same or higher ROI. So that's one thing. The second thing is the margin expense goes up, not only because we're reinvesting, but also because of the accounting. So we the way this is accounted for now is our spend will hit the marketing expense line. And formally, the portion of the spend that was for Google Shopping was hitting cost of revenue.

And actually, to draw that comparison out a little bit. A couple of years ago, we changed the commission on Etsy. But we told sellers, we're going to be reinvesting the substantial majority of that money back into the platform, in marketing to grow traffic, and then product to make the customer experience better. And we live to that. We did reinvest most of that money back, and it has delivered growth. We've seen great growth over the next - over the past couple of years. And Etsy Ads and Offsite Ads, the idea is we will now be able to invest more, and we will use this money to reinvest in the business to drive growth because we are chasing what we believe is an absolutely enormous TAM. We think the opportunity for this business is huge, and we are in the early stages of unpacking it, and we see great opportunities to invest profitably for growth, and we want to make sure we're capturing those.

The next question is from Tom Forte of D.A. Davidson.

So my first question is, how should we think about your own advertising efforts, and presumably, the higher cost of TV and digital advertising during an election year?

Yes. Well, first, let me say, we like what we're seeing. So the results have been good, and they were strong in the fourth quarter. So TV is always a little harder to measure precisely, but we use multiple different statistical techniques, and they point to that having been a good investment in the fourth quarter. We're also learning. I think our creative is becoming more effective. I think our media strategies are becoming more effective. We're starting to buy upfronts, which means we get better prices. There's a lot happening in TV now that's getting us more and more efficient. You're right that the election is - throws some uncertainty into the year in several ways for us. We did do some upfronts for 2020. So we've locked in some capacity already, and we're glad we did. And we'll have to see how the election cycle plays out. But we have built some buffer in for that as we've thought about the guidance, we've given you.

Great. And then for my follow-up question, I know you said that online sales tax law changes was not a big headwind. But I was curious if you noticed any noticeable trends such as lower conversion rates on higher-priced items after online sales taxes were rolled out.

Yes. We definitely do see a bigger impact to higher AOV items. So Etsy has a number of categories where that would apply to, and Reverb also because their average order value is significantly higher than Etsy's average order value. It did see more impact than Etsy core marketplace did. With that said, we think that's completely de minimis - Reverb relative to Etsy's overall size is completely de minimis to our overall consolidated results. And so we - that's why we said we don't believe there's any material impact from the Etsy sales going forward, and the impact that we called out in the past year is going to be lapped by the time we get to October 1, 2020.

Your next question comes from Marvin Fong of BTIG.

I jumped on the call a little late, I apologize if these have been asked already. But just wanted to drill down further on the repeat buyers, I think - or the people who shop twice somewhere a year. It looks like it grew about in line with the total buyer population or actually a little bit better. If you could just comment on what you're seeing there and why you think the habitual buyer growth rate - the delta between that and the total pool of active buyers continue to widen, that would be great.

Yes. So we said, habitual buyers are growing 23% this year to about 2.5 million. I think the chart in the slide deck shows it, is that it's - in the quarter, we actually had some pretty big uptick in what we think that - one of the metrics we use for frequency, which is GMS - trailing 12-month GMS per active buyer, which grew over - almost 4% in the quarter, and it's over 6% in a 2-year stack basis. So we're starting to see - if you were to plot those things, I think it was about 130 basis points of growth in the quarter, whereas previous quarters have been smaller than that, and in some quarters, it hasn't increased at all. So we're starting to see some material inroads. And I think the important part is that the habitual buyers who are really the most valuable buyers for Etsy are the fastest-growing segment. So we're making - the message is resonating with the buyers that we care most about.

Great. And then my follow-up, I was just kind of noodling around on the community forms and what you guys published about the Offsite Ads. I think you said you expect it to be about 10% of typical seller's volume. If you could just kind of elaborate on - is that kind of based on your experience with the GPLA? And is there any upside to that possible? I know you guys are actually expanding this to other platforms besides Google. So if you could just kind of comment on that, that would be great.

Yes, it is based on our existing experience with PLA programs, and so we're just trying to dimensionalize for sellers what kind of impact this might be because they've got to think about pricing strategies and other things. And we want to reassure them that, for most sellers, this is going to be a very small part of their sales. And so we don't want them to jump to conclusions around things before they have a chance to experience it. We're also going to give them a couple of weeks of sort of free trial period, where they will actually get to experience it. And I think for folks who think that this is going to be a large part of their sales, that will typically be reassuring.

Your next question comes from Darren Aftahi of Roth Capital Partners.

Nice quarter. Just two here. Just could you comment - in the release, you talked about the listings in the U.S. and then orders with free shipping, just a disparity between the 74% and 48% for orders. And then on the Offsite Ads piece, Josh, you made some commentary in the call about subsidizing. I'm just kind of curious what kind of inherent risk does this move have. And what are your kind of hedges in place to make sure that this doesn't kind of get out of hand in terms of subsidizing?

Yes. So on the first question, maybe I'll take the first [indiscernible]. On the first one, the difference between 74% and 48% - and that's a good catch, thanks for catching that. The items under $35 typically don't ship for free. And so - and those have a fairly high conversion rate and kind of high velocity because they're pretty cheap. So that would explain the difference between 74% of listing views offer free shipping eligible, but only 48% of orders arriving are because of free shipping. The delta there is really about lower-priced items, particularly items under $35.

On the - I'm going to - you let me know if I don't answer this the way you are expecting because I'm not quite sure what you were getting at. We think that the new version of our Offsite Ads program is actually much lower risk for sellers because they're not going to pay for the ad unless they make a sale, but also lower risk for Etsy in a lot of ways. Because we had a performance PLA program before, and we were buying PLAs and driving GMS for sellers, but also GMS for Etsy. The way this is designed now - and then we did our first version of Etsy Ads where we were basically asking sellers to opt-in or adopt their own but - assign their own budgets to PLAs. And as Josh said, we saw a nice, healthy uptick in budgets and really minimal churn. But we needed the right sellers in the program to make the market, and we saw that it was going to take a bit of time to get to that scale that we needed to actually take over Etsy's footprint and what we were buying for PLA. And so this is a much - it's almost instant. We continue our PLA program. We also are able to do it cooperatively with our sellers. They make money when there's a successful sale, and it achieves the same result where it - we are in some - to some extent subsidizing that we can divert more of our dollars at the upper funnel brand marketing as we had always intended to.

Your last question comes from Ygal Arounian of Wedbush Securities.

So just on the Offsite Ads, just maybe you could give a little bit more color on, as you expand this, and you're - you'll be spending more marketing, where are you right now in terms of social? And how does that fit into your overall performance budget? So I guess what I really mean by that is you've been, I think, exclusively or mostly spending on Google PLAs, and now you're going to be stepping into Facebook and Instagram and some of the other performance sites, moving mid funnel a little bit. So is there - dollars are going to be coming off of Google? Is that budget just going to be expanding while Google remains flat? And can all this lead to - you've had - you had 17% of GMS being driven by paid traffic. Can that expand meaningfully as you expand your performance in social budgets?

Great questions. All right. So let's start. Let me try to attack these one at a time. So your - one of the questions you asked is, is this going to come at the expense of Google? And no, we don't think so. As long as the next dollar we spend on Google is a profitable dollar, we'll keep spending. So it's - and not an or, right? We're looking at how can we find more ways to put money to work that drive profitable growth for Etsy and for our sellers. And the more the better, as long as they're providing a good ROI. So on social, your next question was, how are we doing on social? And on social, I would say it's still early days, and I'm excited about that because that means that there's real upside potential for us to do more. The tactic that we've unlocked over the course of the past couple of quarters that does seem to really be working for us is retargeting. So finding people who came to Etsy found something they like and didn't buy and then retargeting to Facebook, it's turning out to be an effective strategy that is helpful to drive incremental purchases in an ROI-positive way. We are working on other strategies in social that are sort of bottom of the funnel and would love to unlock more that would be part of the offsite advertising program. And again, to be part of the offsite advertising program, we have to be listing a specific listing of individual sellers on a third-party site like Google or Facebook. So now let's move to mid funnel. This would not count as off-site advertising. But showing videos to people who have different life events, talking about Etsy and what we have available for them. Or it doesn't have to be video. It could be static content. That's an area that we are just starting to learn more about and leverage, and I'm excited about that. Life cycle events make a big impact on Etsy. If you just moved home or had a baby or gotten engaged, these are important moments in your life and moments for which Etsy is relevant. And so starting to target more specific content for people in those moments is something that we're very encouraged by. But it's early days, and we are just beginning to learn how to make that an effective part of our media mix. Using influencers more to promote the brand is something that we are just learning to use more. And then even in TV, we're getting more effective. But we are newbies at this. And so I think there's opportunity to continue to become more efficient and effective as we scale and grow. And leverage things like DRTV more and more, which - DRTV is still a pretty light part of our budget. Most of our TV budget right now is cable. So I am excited about the opportunity to continue to scale with Google and the Offsite Ads program, but I'm equally excited about the opportunity to grow social and mid-funnel and upper funnel channels as well.

I know we're running late, but just one more I really want to ask, and it's a little bit bigger picture. And just going back to the growth rates in GMS during the quarter. And so you have 30% growth in Cyber 5 and then you have 20% growth for the whole quarter. I'm just wondering, was there - what drove that gap? Is that normal seasonality? Was it the things that you put into place during that period that really drove the growth rate higher? And are those things that you can implement over the course of a full quarter to drive that gap kind of closer between the 20% for the whole quarter, 30% for the holiday?

Q4 was an exciting quarter. I think for Etsy, like most peer, the folks that we've heard talk about the quarter, I think many of us have had a very common experience, which is the shift in Thanksgiving moving had a pretty big impact on consumer behavior at large. So November was slow, and December was strong. And net-net, it seems like consumers spend about the same. And we did great, and we feel great about how we did in the fourth quarter. But the pacing of it was very different this year than it was last year. Thanks, everyone, for your time. We really appreciate it.

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