Good morning. My name is Krista and I will be your conference operator today. At this time, I would like to welcome everyone to the Wayfair Q1 2017 Earnings Release and Conference Call. [Operator Instructions]. Thank you. Julia Donnelly, Head of Investor Relations, you may begin your conference.

Good morning and thank you for joining us. Today, we will review our first quarter 2017 results. With me are, Niraj Shah, Co-Founder, Chief Executive Officer and Co-Chairman; Steve Conine, Co-Founder and Co-Chairman; and Michael Fleisher, Chief Financial Officer. We will all be available for Q&A following today's prepared remarks. I'd like to remind you that we will be making forward-looking statements during this call regarding future events and financial performance, including guidance for the second quarter of 2017. We cannot guarantee that any forward-looking statement will be accurate, although we believe that we have been reasonable in our expectations and assumptions. Our 10-K for 2016 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 these statements whether as a result of any new information, future events or otherwise. Also please note that during this call, we will discuss certain non-GAAP financial measures as we review the company's performance. These non-GAAP financial measures should not be considered replacements for and should be read together with GAAP results. Please refer to the Investor Relations section of our website to obtain a copy of our earnings release which contains descriptions of our non-GAAP financial measures and reconciliations of non-GAAP measures to the nearest comparable GAAP measures. This call is being recorded and a webcast will be available for replay on our IR website. Now I would like to turn the call over to Niraj.

Thanks, Julia and thank you all for joining us this morning. We're pleased to share our Q1 results with you today. We're thrilled about the momentum we're seeing in our business right now both in terms of revenue growth and profitability but also in terms of the progress we're making along the key strategic initiatives we have been investing in for about two years. Steve and I have watched this business go through many different stages of its growth. After adding over 1,800 net new employees over the course of 2016, we have been especially pleased to see how they and the initiatives they are driving have hit their stride. The ramp-up curve is always painful when you hit a spike in hiring. But now after fully integrating those 1,800 new hires, we feel like we've continued to assemble a truly impressive team that is firing on all cylinders. In Q1, we generated $940 million in Direct Retail net revenue, up 32% year-over-year and $961 million in total net revenue, up 29% year-over-year. First, I'd like to focus on our U.S. business which generated $838 million in Direct Retail net revenue, up 25% year-over-year and $4 million of positive adjusted EBITDA in Q1. We have several major initiatives in the U.S. as we continued to improve our overall offering to deliver an exceptional experience for our customer. One such initiative was taking some of those 1,800 new hires in 2016 and staffing up dedicated teams to go after categories in our total addressable market, where we're smaller relative to our market potential, such as home improvement, seasonal decor, housewares, wedding registry, mattresses and decorative accents. We're starting to see traction in these categories as we develop supplier relationships, enhance the visual merchandising and in some cases, develop specialized sales teams…

Thanks, Niraj. One of the unique characteristics of Wayfair has always been our hybrid business model. We offer the customer a high-quality, first-party retailer experience when it comes to our brand, website, customer service, shipping, delivery and returns. We also work with over 10,000 suppliers and integrate with them on the back end in order to provide the vast selection more typical of a third-party marketplace. We think this hybrid model delivers the best experience possible to the customer. But it requires a lot of work on our end to have it all work seamlessly. In order to offer the optimal browse and search experience for our customer, we need a lot of details about the products available-for-sale in our sites. This requires us to get product images and detailed product attributes from our suppliers, often above and beyond what other retailers they work with might require. Our customers are discerning and want to understand exactly what they are buying, particularly when they're not able to view the product in person before buying. So we want to be able to tell her details, such as whether the drawers on the TV stand she is looking at are soft-close or whether her 6-inch plastic storage bin will fit under the bedframe she is looking to buy. We know these types of specific details are helpful to customers, but they do create more work for our suppliers as they are introducing new products for us to sell on our sites. Our supplier actually helps us manage our relationships with over 10,000 suppliers every hour of every day. It is the one-stop shop for suppliers to manage their orders, add new products and manage promotional events with Wayfair. Over the last several quarters, we have invested deeper in our extranet to expand these…

Thanks, Steve and good morning, everyone. As always, I will highlight some of the key financial information for the quarter with more detailed information available in our earnings release and an updated set of charts in our investor presentation on our IR site. In Q1, our Direct Retail business increased 32% year-over-year to $940 million and our total net revenue increased 29% year-over-year to $961 million. Our other business which primarily includes revenue from our retail partners but also includes revenue from our small media business, decreased as expected to $20 million as we continue to ramp down our retail partner business. To put these revenue numbers in context, I'll remind you of 2 factors that are worth noting. The first item is that Q1 2016 was a difficult comp as it was the last in a series of 90-plus percent Direct Retail growth comps we saw in late 2015 and early 2016. Secondly, I'll point out that on our last earnings call on February 23, we explained that Direct Retail gross revenue for the first quarter was comping at approximately 30% quarter-to-date. And we were guiding 25% to 28% for the full first quarter. We finished the first quarter with Direct Retail revenue growth at 32% as a result of a particularly strong March in our U.S. Direct Retail business, momentum we have seen continue into April and May. In the U.S. specifically, our Direct Retail business increased to $838 million, up 25% year-over-year. We believe the online market for our categories is growing roughly 15% year-over-year. And we intend to continue taking share and growing at a rate that is well north of that market growth rate. There were some macro factors in our stronger-than-expected first quarter U.S. results for sure, including the catch up of tax refund…

Thanks, Michael. Before we wrap up, I want to reiterate how excited we're about where the business is and where it's heading. There has been a lot of hard work to continue realizing our ambitious goals, building out our house brands, growing new categories, scaling our logistics networks to enable more 2-day and next-day delivery, a differentiated large parcel delivery experience and lastly, scaling international business in Canada and Europe. All this work is focused on delivering for our customer, who has continued to respond to what we're building for her. This shows in our growing base of repeat customers. That is the highest praise our customers can give us, to come back to Wayfair and purchase again. Customer who comes back is the proof that our focus, ambitious goals and hard work are delivering something unique for her. We're honored when that happens and it drives us to find ever more ways to help her bring to life the aspiration she has for her home and to make it fun and easy to do so. All 5,708 of us at Wayfair are driven by delivering that and are excited to see it show up in our results. With that, I'll now ask the operator to open the line, so we can answer a few of your questions.

[Operator Instructions]. Your first question comes from the line of Peter Keith with Piper Jaffray.

I was hoping you could talk a little bit about the advertising strategy. You did see abnormally good leverage in Q1. And it's coming on the heels of discussion of maybe cranking up the U.S. advertising this year. Should we expect a bigger step-up as we go forward? Or do you feel happy about the allocation of that spend and the customers [indiscernible]?

Peter, it's Niraj. Thanks for your question. I guess the way to think about it, one of the things we mentioned in terms of the way we manage advertising is the primary things we focus on in advertising is really, number one, the payback period, so making sure that when we spend money to get new customers, we know the time frame in which we're getting paid back and we keep that to under a year. And you can kind of see that in that conservative calculation that we provide. The second thing is we care a lot about what effectively the IRR over time is of that spend. But we don't give out something we can calculate because so many of our efforts are focused on growing that IRR. And so that cohort curve that we showed you is effectively showing the value of that. So in terms of when you think year-over-year leverage, there are so many things that affect that. There's the mix shift of domestic versus international. There's the mix shift within the different businesses, within the domestic situation. So the way I would think about it is Q1 always has a higher ad spend relative to other quarters because we try to take advantage of the early-in-the-year buying which tends to be highly, highly efficient. And so when you think about what we were able to take advantage of last year versus what we're taking advantage this year, you end up seeing a lot of leverage. I wouldn't guide you to kind of expect a ton of leverage. But I wouldn't guide you to expect that it needs to go the other way. We think ad spend as a percentage of revenue at the levels we've been at or levels that allow us to build all our brands in all of the geographies, even with the negative mix shift effects that are in there, but I wouldn't look for lots of leverage because of those negative mix shift effects.

Your next question comes from the line of Seth Basham with Wedbush Securities.

My first question is just on the acceleration and growth rate that you guys have seen in Direct Retail U.S. business recently. So other than the macro and the comparisons, is there anything that you can point to, 1 or 2 factors that are most significantly driving that upside?

Sure, Seth. It's Niraj. What I'd say -- so I guess the biggest thing I would go back to and we really did try to touch on this in the script, is that we added a very significant number of people in 2016, basically against all the initiatives that we've kind of continually described on these calls for the last year, 1.5 years, 2 years. But when you add a lot of new people, it takes a while for them to ramp up and then a while for them to work on the things they're working on. And then those things roll out in the market and then they start to grow. And so long story short, I think a lot of what you see today is the hard work of the last 1.5 years, 2 years paying off. And if you look at sort of -- if you break apart repeat customers from new customers, you'll see very good trends in both. If you add that up, you're seeing the overall trend. So the U.S. business, it's very hard to point to just 1 or 2 things because of the combinational effect of we have the faster delivery through CastleGate, the higher-quality large parcel delivery through WDN, the improved experience in merchandising because of the house brands or because of the category efforts, like seasonal decor or decorative accents. All these things add up. So I wouldn't point to any one thing. I would say that we're pretty bullish that the investments we've been making are working and we think that there's still a lot of those gains ahead of us.

Got it. That's helpful. And then secondly, given your outperformance on EBITDA margins in the quarter, as you look at to progress the year as comparisons ease and you annualize some of these investments, would you expect to see positive adjusted EBITDA by year-end?

Michael really likes to guide the next 6 weeks or so, so I'm going to let him give you a longer term guidance. What I'll just give you for general feeling is when we tried to explain a number of times, it's just we care a lot about the unit economics in our business and the way we've been managing the business, depending on what you -- which line of business [indiscernible], but you have a variable contribution margin in that 19%, 20% range. And so we spend a lot of money to get a customer, but then that repeat revenue stream has a very high flow-through on it. And you could see that repeat continue to grow faster than new for quite sometime. So despite the investments, what will happen is that flow-through sort of exceeds the investments and that you start seeing it flow through in terms of diminishing losses and then eventually you see a flow-through in terms of becoming profitable and then you see a flow-through to more and more higher levels of profitability despite good amount of continued investment, not increased amounts but good amount. What I'd tell you is the big thing we're focused on is we absolutely plan to self-fund the business and free cash flow-positive. It has been a near term goal and we feel very good about where we sit there. We grew the business by having it fund itself. And that's certainly a big area of focus. But Michael, if you have a specific comment?

No, I would echo the same thing which is our near term goal hasn't changed which is to get the business to free cash flow breakeven or positive going forward and be self-funding and remain self-funding. And I think we stated that as clearly as we possibly can. We're not going to put a date certain on it. We're not going to put a quarter certain on it. But at the same time, continued strength in the U.S. business, obviously what we're building here at this point is a business where at some point the U.S. profitability will outstrip the investments we're making in the international business. So continued strength which we're obviously seeing in the U.S. business, only aids that process.

Your next question comes from the line of John Blackledge with Cowen.

Just a couple of questions. Niraj, with the top line growth in the U.S. accelerating in 2Q, could you just talk about that in the context of the competitive environment and what you're seeing out there? And the second question for Michael would be any reason the revenue growth in 2Q would slow down kind of in the back half of the quarter?

Sure, John. So the first part, from a competitive standpoint, what I would say is we absolutely watch all the competition out there. But our general view has been and kind of remains that the market is pretty wide open. When you take a customer lens and what does a customer want and then you look at what's being provided for her, there's a pretty big gap. And we feel like we've always been closer to what she wants than most of the competitors we watch. And then frankly, those investments we talk about are not investments in terms of us trying to create anything. They're really investments in terms of us focusing on getting closer and closer to what we've identified as what she wants. So from a competitive standpoint, I tend to think that our advantages are growing and that from a competitive standpoint, we're becoming stronger relative to our competitors. But there's no specific thing we've noted where someone's gotten weaker and that helped us. It's more that we feel like we've gotten closer to the customer and that's helped us.

John, it's Michael. So there's nothing that I would specifically point to that would say, "Here's the reason the back half of the quarter would be lighter than the first half of the quarter." I take a good bit of ribbing here for saying every quarter that we're in a business that the customer has to show up every day. But the truth is the customer has to show up every day. And so macro trends are impossible to call. We've seen the impact of macro trends certainly over the last year, so not just for us but everybody in retail. So I think we continue to try and be thoughtful in our guidance with the recognition that we're trying to peg the number 6 weeks into the quarter.

Your next question comes from the line of Matt Fassler with Goldman Sachs.

My first question relates to gross margin which beat your guidance and the year-ago number quite nicely and which you guided for Q2 well below the Q1 trend. Can you go into a little more detail about what drove that gross margin upside or whether there's anything in particular, other than that long term algorithm that would lead the margins to come down sequentially?

Matt, it's Niraj. Let me just start with the question and then Michael can tack on any thoughts. So gross margin, forecasted gross margin in our business, I think, is a little bit more complicated than many in the sense that what you have in there, right, you've got the product margin which you have a lot of -- we have newer categories we're focusing on developing, so you've got mixed shifts there. We've got the international versus U.S. And every country, they're in different stages on the maturity curve there, so there's mix shift there. And then you've got the shipping costs. And we're in the middle of rolling out a bunch of logistics networks. And so there's changes there that affect gross margin. And so what happens is a little bit of mix shift, a little bit of timing shift kind of moves it around from maybe where you thought exactly it would be. And I would describe the amount of movement we've seen, even though it may feel significant on the outside, as kind of in the range that I think for better or worse, you kind of feel comfortable that, that kind of movement is going to happen with the amount of change we're introducing and the number of concurrent things we're focusing on working on that would shift it to either up and down, even though each individual effort has very good unit economics. So it's not so much -- you mentioned the pricing algorithm. I wouldn't say that we're focusing on lowering price. I would say it's more the mix shift of the actual component parts of the orders.

Yes, I think that's right. I think one of the things we said for the last 2-plus years, right, is that we're going to continue to unlock margin through how we scale and the investments we're making, particularly in the logistics networks. At the same time, we've always said we intend to sort up share in that margin, in that unlocked margin with the customer. We think that actually creates a really powerful flywheel effect in our business both by sharing in terms of being appropriately market-priced but also sharing with the customer in terms of really great service, right, whether that's weekend deliveries or evening deliveries or having something that we're supposed to deliver in two days delivered next day. And so at the same time, you may unlock something in 1 quarter that may take you another quarter or 2 before you can sort of really start that sharing. And so I just think that there's a little bit of a balancing act there. But at the same time, I'm trying to make sure that everyone understands that what we're targeting is a 23% gross margin. We think that we'll be able to sort of strike the right balance to do that. And we've been obviously overachieving that for the last couple of quarters.

And then my second question, so you continue to talk about the new categories that you're rolling out. And I'm curious to the extent that you can discern it, the degree to which those new categories and the incremental assortments you have year-on-year are contributing to the revenue, particularly as revenue accelerates. And also if I could, whether you find those categories attracting new customers to the enterprise or whether they're enhancing your traction with the existing customers.

Sure, Matt. So a few thoughts. Kind of the newer things -- so in the U.S., these categories we're kind of building out decorative accent, seasonal decor, houseware, home improvement ones, they're not -- they're growing nicely, but they're not contributing that much because they're still very small. Same with international, I mean, international is growing at $60 million-ish year-over-year. We think it will keep growing like that. But that again is only a small piece of the total. So I think the way to think about it is just we're really happy with the progress. But the real contribution from those will be in the future, where as they get larger and they'll still, we think, grow at quite a good rate. But today, I would say they're more impacting -- they're really not about new customer acquisition. What they're doing is they're letting us for the current customers we get through the methods we use offer them a richer and better experience, meaning that a higher percent of the categories they may shop us for are stronger in terms of the merchandising, the selection and the offering. The ability for us to use our personalization technology, to put things in front of them that's interesting to them, increases as these categories get built out and fleshed out. And then in the future, these could be substantially large categories. But today, they're not.

And in terms of the customer -- sorry, go ahead, Michael.

No, finish your question. I was going to cycle back to gross margin.

Sure. In terms of the customer that they're appealing to, is this attracting a new customer to Wayfair? Or do you find that this is getting traction with your existing customer base?

It's traction with the existing customer base.

Yes. And Matt, just to cycle back on gross margin, I do want to also just remind everybody that the international business runs at a lower gross margin, right? So as it increases in the mix, it weighs on gross margin, right? And as we continue to sort of make the investments in these categories that we're expanding in, we often aren't at the same level of scale that we're in other more traditional categories for us. And therefore, those have a weight on gross margin as well. So those would be some of the other factors when you start to think about why it could be at a lower gross margin over the next couple of quarters.

And your next question comes from the line of Chris Horvers with JPMorgan.

I wanted to follow up on the advertising question. As you get beyond 2Q, you'll have rolled out the supply chain efforts in the United States. You talked about last year, holding back a bit on advertising because you were funding the expenses related to supply chain and wanted to stay self-funding. So given the momentum in the business and the sunsetting of the supply chain efforts, why wouldn't you step on the advertising to push on new customer acquisition?

Yes, sure, Chris. So this is Niraj. So our ad strategy has always been to max out the spend within a certain amount of payback period and to do that across every channels. So we developed really strong relationships with Google and Facebook and Pinterest and all these folks to really work on new ad units with them and know where everything is headed in terms of direct mail capability and television advertising capability for our mass brand for Wayfair. Sheryl Sandberg was in our office last week. And in the Facebook earnings call, they mentioned an ad unit that we were working on with them. So we're not looking to be shy on ad costs, don't get me wrong there. We're going to be quite aggressive. That said, we think we're going to be able to continue to acquire customers and max out that payback period while as a percentage of revenue, the ad spend won't necessarily delever which is what I was trying to articulate. We don't necessarily think we'll get a lot of leverage either, but we think that the absolute dollars can grow nicely and as a percentage of revenue, that's a fair amount of money will show, we think, really great performance on that. And we don't necessarily think there will be a lot of opportunity to delever, meaning to spend that kind of increasing amount of dollars [indiscernible], we think we could keep the payback targets that we have in mind for every channel and every ad unit in line. So we don't chase that because we don't want to move that payback period out. So I just don't want you to be confused around how we think about it. We're not looking to be shy. We're looking to be quite aggressive. It's just that the ad costs -- we don't envision needing to delever to do that.

Understood. So maybe thinking about it another way. So it was always your intent to spend a certain amount of dollars. And now you have this new momentum in the business or reemergent momentum in the business. And thus, that's really driving how you're describing what the rate looks like.

I mean, we usually don't target the dollar. So we target kind of an economic return on the ad spend and then that can be any amount of dollars. And then we had a period of time where we're funding the logistics buildup, the international business, the advertising. And we see more from a free cash standpoint, we just didn't love the amount of free cash that we're spending. So we said, "Hey, it would be better to be a little prudent for a little while and manage that." And the place we chose to slow that, because international and logistics are both good, long cycle investments, was the ad cost for a little period of time. Because ad costs, you lose money in the near term period when you max that out, right, but you get paid back in less than a year. But that was like a transitory period. I mean, in general, we basically view the ad costs as having an infinite amount of budget within fairly tight payback constraints.

Understood. And then just in terms of the acceleration, was there any quality characteristics or demand textures that you could share with us? Existing versus new, certain categories, any geographic comment would be really helpful.

Well, the one thing I'd say, Michael, I think, commented on this in the earnings script before we got into Q&A. But international continued to perform well. And I mentioned it's like $60-odd million year-over-year kind of growing at. But we've seen a lot of nice momentum in the U.S. And so the one thing I would point to is that the U.S. is doing quite well. I think the reason I'm commenting on it is a quarter ago, I think there's a lot of concerns that the U.S. business was slowing and what does that mean and where does it slow down to. And we tried to be articulate around, look, it's going to -- we're doing so many things concurrently, it's going to maybe not a smooth, exact glide path that we think we expect to grow significantly above market on an ongoing basis. We still believe that. And I think what I'm trying to comment on today is just that, that's happening. Within that though, we're seeing pretty good performance across the board. There's no concentration in a particular category or one business line or what have you.

Your next question comes from the line of Oliver Wintermantel with Evercore ISI.

I had a question regarding -- you gave repeat customers, new customers, all of that, for the global business. Can you maybe break that out into the U.S. versus international and then also maybe comment on the customer acquisition costs and how that is trending in the U.S. versus international?

Yes. Thanks, Oli. I mean, we're not for now going to split out the KPIs on a U.S. or international basis. I think the color commentary remains the same as it has in the past, right which is we have a smaller -- we have a much bigger base of repeating customers obviously in the U.S. than international. And therefore, most of the KPI metrics from an international basis look worse than the average we're showing you. I noted on the call that the revenue per active customer would have actually shown a little bit of growth if you looked at just the U.S. sequentially. So you can sort of see that whether it's revenue per active customer, gross margin we're generating, the repeat rates, et cetera, they're all lower internationally which is typical and what we would have expected if you looked at what our U.S. business looked like 5 years ago. And then from a customer acquisition cost perspective, there aren't sort of vast differences. We're still -- we turned on the ad spend in Canada and the U.K. Those markets are sort of ramping and scaling quite nicely now. We're starting to get -- see the efficiencies we want. But we're not yet at a sort of scale basis where you have the repeat driving sort of the really great yields on the yet.

Okay, great. And then just a clarification, the CastleGate and WDN. When you build your distribution facilities or transportation in Europe, are you using the same CastleGate and WDN? Or is that a second stage, where we can expect some costs down the line? Or are you building that right now?

Yes. So they're both like kind of functions of scale and volume. So today, for CastleGate, we've got operations in the United States. We also have a CastleGate warehouse in the United Kingdom. We'll continue to build out warehouses in Canada, Germany, over time. WDN, the asset base, large parcel network basically is a function of volume that will be -- we'll continue to build out. So it's not -- think of that as incremental as we go. So there's no like, "Okay, well, now we need to build out international, so it's big new round." We're kind of doing it as we go.

And your final question comes from the line of Michael Graham with Canaccord Genuity.

I just wanted to ask two. One, on your house brands or I guess your private label, you've given a metric in the past about what portion of Wayfair sales that was. Just wondering if you want to update that. And can you talk about whether those suppliers tend to be exclusive with you or not? And then I just wanted to ask on CastleGate versus WDN in the U.S. Can you just comment on which one of those do you think will be sort of more fully complete earlier versus having a longer tail that might continue to scale in the long term with volume?

Sure, Mike. So to answer your question, first, on house brands, actually there was a comment on that in the script. And so I think you might have just missed it. But we gave an update. And we said that it was now up to 45% of the Wayfair.com business was the revenue coming from our house brands. And that was up from the update 2 quarters ago fairly significantly which was up very significantly from the first update. So that's continued to grow. In terms of exclusive nature of it, the way we work is like rather than doing private label, where we design the product, it's a very narrow range, we then source it from manufacturers in Asia or wherever and we try to inventory our balance sheet, what we do instead is we work with hundreds of our suppliers who are key partners. And we basically take the newer introductions in particular and we put those into these brands. We do the work of curating them and the work of the visual imagery and the merchandising of it. And through that process, we think we add a lot of value to it. We also help the customer in navigation. We do fair amount of work that way. So there's definitely -- I wouldn't say you could think of the whole program one way or the other. But there's a lot of product that we're very thoughtful about, where we don't mind it being distributed and where we wouldn't want it being distributed and our core partners work with us on that. And that's kind of the way to think about, how we think about exclusivity versus maybe a traditional kind of idea of 1,000 items just for us. In terms of CastleGate and WDN, I mean, they…

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