Good morning, my name is Kim, and I will be your conference operator today. At this time, I would like to welcome everyone to the Wayfair Q4 2018 Earnings Release and Conference Call. All lines have been placed on mute to prevent any background noise. [Operator Instructions] Joseph Wilson, Head of Investor Relations, you may begin your conference.

Good morning, and thank you for joining us. Today, we will review our fourth quarter 2018 results. I would like to remind you that we will make forward-looking statements during this call regarding future events and financial performance, including guidance for the first quarter of 2019. We cannot guarantee that any forward-looking statements will be accurate, although we believe that we have been reasonable in our expectations and assumptions. Our SEC filings, including our 10-K for 2018, which we expect to file in the near future, 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 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. With me are Niraj Shah, Cofounder, Chief Executive Officer and Co-Chairman; Steve Conine, Cofounder and Co-Chairman; and Julia Donnelly, Head of Corporate Finance. Before I turn the call over to Niraj, I want to let everyone know that Mike will not be with us for earnings today. He and his wife are at the hospital, about to give birth to their daughter. We wish him all the best on their new arrival. Julia will be providing the financial update and answering questions with Niraj and Steve. Now let me turn the call over to Niraj.

Thanks, Joe. Thank you all for joining us this morning. I am pleased to be sharing our fourth quarter and full year 2018 results with you today. Steve and I are delighted with the achievements of Wayfair in 2018 and the position that these accomplishments put our business in for the future, both in the U.S. and internationally. In this year's shareholder letter, which you can find on our IR site this morning, Steve and I talk in more depth about the ways in which our business is bringing customers and suppliers together on our platform in an increasingly powerful way. Building a platform that will win at scale with customers and suppliers requires a long-term approach to investments, and we could not be more proud of the steps our team of over 12,000 people continue to take in building the best possible destination to shop for the home online. For the full year 2018, we generated $6.8 billion of total net revenue, for a year-over-year growth rate of 44%. We added $2.1 billion in net revenue this year compared to $1.3 billion in 2017 and $1.1 billion in 2016. In the fourth quarter of 2018 specifically, we added $577 million of Direct Retail net revenue year-over-year, representing the largest dollar growth in a single quarter in our company's history. This outsized growth at scale is driven by the strength of our customer offering, with the number of active customers at the end of 2018 exceeding 15 million and dollar revenue growth in our U.S. business accounting for approximately 35% of the estimated dollar growth in our category online last year. This morning, I'll provide brief updates across a few key areas of our business, namely holiday, our increasing penetration in the lighting category and logistics before I hand the…

Thanks, Niraj. In prior earning calls, we've spoken about the success we are seeing with customers internationally as we put our proven U.S. playbook to work in Canada, the UK and Germany. Last quarter, we talked about the pace at which our Canadian business has developed, where we see continued gains ahead. Today, I want to talk about the exciting progress we are making in our least mature international region, namely Germany. I was in Germany twice this quarter to meet with suppliers at major trade shows in the country, and I was struck by the enthusiasm and commitment we are generating with them. Some of those suppliers were with us in 2015 when we had approximately 60,000 products on our site to today when we have approximately 600,000 products on our site. We are excited to be working with them to get to over 1 million products this year as we further accelerate the flywheel of our business there. Supplier engagement is essential to bringing customers the best possible offering. What I took away from those supplier interactions was the clear sense that partnering with us was much easier and more powerful than they had appreciated when I saw them 12 months earlier. Suppliers have transitioned from wanting to believe that our platform can transform their access to online shoppers to now being true believers and are really leaning in to make it work. Much like we saw in the U.S. business several years ago, suppliers are investing in their e-commerce teams and working very closely with us to learn how to be successful on our platform. They virtually underline how surprised they are by the deep level of support and collaboration they are seeing from our teams to help them scale their business on Wayfair. Much like the…

Thanks, Steve, and good morning, everyone. I will now provide some highlights of the key financial information for the quarter, with more detailed information available in our earnings release and in our investor presentation on our IR site. In Q4, our Direct Retail business increased 41% year over year to $1,996,000,000, representing year over year dollar growth of $577 million, which, as Niraj highlighted earlier, is the largest increase in our history. Our total net revenue increased 40% year over year to $2,014,000,000. Our KPIs, which we report on a consolidated global basis, demonstrated continued strength in Q4. As Niraj mentioned earlier, total active customers surpassed 15 million, up 38% year over year, with the addition of approximately 1.3 million net new customers in Q4, a new high watermark for net new customers. Often when we describe the continued investments and leaning in we are doing on ad spend, we mention that we expect ad spend in one quarter to lead to customer additions in future quarters. Last quarter, we described leaning in on ad spend as we were seeing good opportunities within our strict payback threshold. Those decisions and similar decisions throughout last year lead to this type of extraordinary growth in net new customers. Moreover, purchase frequency, as measured by LTM orders per active customer, grew for the eighth consecutive quarter, reaching a new high of 1.85 in Q4. Average order value was $227, which was lower than Q3, consistent with the seasonal trend of lower-ticket holiday items being purchased in Q4. Orders from repeat customers in Q4 grew 51% year over year, approximately twice the rate of orders from new customers, continuing the strength we saw throughout 2018. In the appendix of our investor presentation, you will see that, over the course of 2018, our Wayfair.com customer…

Thanks, Julia. I would like to reiterate how proud Steve and I are of what the business achieved in 2018 and the position that we have put ourselves in to take advantage of the opportunity we see ahead of us, both in the U.S. and internationally. Dollars in the home category are continuing to move online, and we believe we can keep taking an outsized share by delivering the best customer experience with vast selection, inspiring visual merchandising, fast and convenient delivery and world-class customer service. We are seeing customers increasingly reward us with their dollars, and we are delighted to be investing behind this strength. With that, I will now turn the call over to the operator so that we can take some of your questions.

[Operator Instructions] Your first question comes from Peter Keith from Piper Jaffray. Your line is open.

Hey, good morning, everyone. Congratulations again on the solid results here. I did want to dig in on one topic that wasn't brought up in the prepared remarks, and that is on the sponsored advertising. Because we're seeing that ramp on your site quite nicely just in the last couple of months since it was launched, what I was curious about is where that will show up on the income statement. How have you reported – whether it's revenue or as an offset to overall advertising. And do you think it had any impact overall on this most recent quarter? Thank you very much.

Thanks Peter. I'm going to let Julia explain where it shows up on the P&L and how it's accounted for. But the one thing I just want to highlight, we're actually thrilled with how it's going, but it's still very much early days. So the actual – the dollar volume of the impact is quite small, but we're very optimistic about where it will go, and the reaction we've had from suppliers has been incredibly positive. So we think it can be fantastic, but it is early. But Julia, why don't you address the accounting?

Yes. So Peter, on sponsored SKUs, we're required to report that as a contra COGS line item, so that's where it will appear on the income statement.

Okay, great. And actually, if I can sneak in one more for Niraj. You have mentioned around the Asia freight. I think it was that the inbound would be about 40% of the CastleGate sales/revenue. Was that something that you plan on getting to this year? Or is that a target over time? And then, correspondingly, where would, within operating metrics, do you think, that ramp will start to show improvement?

Yes. So I think, if I can just explain what the 40% number is. So 80% of the volume in CastleGate facilities comes in container direct from the origin, which generally is Asia. The other 20% is coming into our CastleGate facilities from domestic supplier warehouses. That 80% I've said that's coming in container direct is much more efficient from a logistics cost standpoint, and that is very attractive to the supplier, their ability to pass through a lower wholesale and obviously, therefore, us to have a lower retail. If you look at CastleGate, that volume 40% of the container volume, so half of that 80% is from suppliers who are using us for some piece of that inbound supply chain, so drayage or ocean or both. And the reason they use us for that is they have the chance to save money, the chance to improve in-stock availability and it helps with the visibility, it speed up the chain. And so that's where we're at today. So basically, half the volume that's coming in today, we already have suppliers using us for some form of inbound. And so we are just citing that to just show that the inbound services which we piloted a year ago have now started to really take off.

Okay, thank you very much. That’s helpful. Thanks and good luck.

Thank you.

Your next question comes from John Blackledge from Cowen and Company. Your line is open.

Thanks. Just two questions. On the gross margin, I think it was 24% in the quarter. Your commentary suggested it would run at like 23%. So just any color on the upside there. And more generally, as we head into 2019, just thoughts on gross margin and potential levers for upside. And Niraj, thanks for the color on logistics and fulfillment. The question will be, given the long-term opportunity, how should we think about kind of where we are in the CastleGate and WDN build-out? What inning are we in for these respective fulfillment programs? And for CastleGate, what is the difference in conversion for a CastleGate good versus a non-CastleGate product? Thank you.

Thanks John. On your first question, so gross margin, so we've talked a lot over the years about how we think gross margin – we have a long-term model, which is basically unchanged since we went public in 2014. We show a gross margin number of 25% to 27%. And what we've described is that the path there is actually much more straightforward and simple than people might ascribe because there's some levers built into the business automatically that play out over time. And we cite three things that will drive it up, and I'm going to mention a fourth. So the three that we mentioned a number of times, one is that, just with more and more volume, basically, suppliers are willing to operate on a lower margin in order to drive throughput, and that's a source of gross margin benefit. The second we talked about is as the house brands that we've launched take share that dense price competition, the way we add value, that allows for gross margin expansion. The house brands, by the way, we just referenced, haven't grown dramatically. And so if you look at that, it's just under 70% for the year last year. It's higher than that on a run-rate basis now. So you can see that that's actually worked over the last three years, and that leads to the ability to take margin. And the third is that the transportation and logistics efficiencies – transportation and logistics cost amounts to about $0.20 of every revenue dollar if you take the piece we pay plus the pieces our supplier pays. So as we can address more and more of those and add efficiency, those basically are savings that can accrue. And so all of those things are playing out, and there's huge upside,…

That's great. Thanks so much.

Thanks, John.

Your next question comes from Maria Ripps from Canaccord. Your line is open.

Great. Thank you for taking my question. It seems like you have been experimenting with physical store locations over the holidays. And with the permanent location that just opened in Kentucky, can you maybe just talk about your strategy here and how this brick-and-mortar sort of strategy complements your online strategy?

Sure. Thanks, Maria. So let me kind of mention a few things when we think about stores. First, let me just start with we think about stores in a way we think about marketing channels. And so we've always talked a lot about our advertising spend, and we've talked about how we measure that on payback basis. So rather than using a budget or some prescribed percentage of revenue we're going to allocate to marketing, instead we measure it in what I think is really the only pragmatic quantitative way to measure it, which is the contribution margin that, that effort generates needs to cover all of that cost in a very finite period of time because that's the only way you know that you're actually spending wisely. Well, we used to only do online advertising. And then, as we forayed into television and indirect mail and direct mail, for example, now that being, I don't know, roughly, say, 10% of our total ad spend and TV might be on the order of 15%, we figured out how to measure each one of these so that we use the same kind of framework. When we think about physical stores, we similarly would focus on having a way to measure the impact in a way that doesn't allow for double counting and to make sure that we're only going to scale a model if, in fact, it drives that same kind of quantitative payback. Now why do we have an interest in stores? Well, as you think about, for example, television, well, a 30-second television spot can tell a story in a way that an online text ad can't or an online display ad can't. Well, that's the value add of television. So there's certain things you can do. Well, how…

That's very helpful. Thank you.

Your next question comes from Brian Nagel from Oppenheimer. Your line is open.

Hi. Good morning. Thank you for taking my question. Nice quarter. So I have two questions that maybe I'll merge into one. First off, just with regard to the macro environment. And I know, Julia, you had mentioned some of the risks out there. But from a retail perspective, there's clearly been, the last several weeks or so, choppiness brought on, in part, by the government shutdown. So the question I have, and we clearly can't see it in your reported results, but did you – was there an effect to Wayfair's business? Or were you able to sort of, say, act in sort of ways to offset this? And the second question I have, with respect to gross margin and a bit of a follow-up from a prior question, but Niraj, you talked about, in your prepared comments, the relationship or the way you're working with your suppliers now to manage promotion. Is this – should we think about this now – is this similar to a paradigm shift in terms of driving gross margin better? Or is that just a normal course of business for Wayfair? Thank you.

Thanks, Brian. So first, let me answer your second question first, then I'll go to the first question. On gross margin, and you're talking about managing promotions with suppliers, we've always done that, so there's nothing new there. And if anything, it's not only normal course of business, but we just focused on how do we make it easier and better, like better planning, better planning tied to inventory availability, how do we plan to look farther ahead, how do we give suppliers self-service tools. Like, for example, one of the things we launched last year is a clearance area on our site. So suppliers can just, through the extranet, launch items into the clearance area by passing through a discount to help manage their overstocked inventory. And that's more productive for them, for example, than the other ways they have to liquidate. So we think about promotion as very multifaceted. There's like planning for the major events. There's these types of things which could be day in, day out event. And so – but that's the normal course of business. And it's part of – I think what's been different is we really partner with suppliers, and that's a very unusual approach for a retailer. And one of the things actually – I just wanted to mention this, and then I'll come back to your questions. On the IR website today, we posted, obviously, the red letter, the press release, what you're accustomed to; the updated presentation, which I want to touch on in a second; but also, our annual shareholder letter. And I would encourage everyone to just take a couple minutes, download that shareholder letter and read it if you are interested because we tried to talk in some detail about – in that about how we…

Thank you.

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