Good morning, ladies and gentlemen. My name is Suzanne and I will be your host operator on this call today. At this time, I would like to welcome everyone to the Wayfair Q3 2019 Earnings Release and Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. At this time, I would like to introduce Jane Gelfand, Head of Investor Relations at Wayfair. Please go ahead.

Good morning and thank you for joining us. Today we will review our third quarter 2019 results. With me are Niraj Shah, Co-founder, Chief Executive Officer and Co-Chairman; Steve Conine, Cofounder and Co-Chairman; and Michael Fleisher, Chief Financial Officer. We will all be available for Q&A following today's prepared remarks. I would like to remind you that we will make forward-looking statements during this call, regarding future events and financial performance, including guidance for the fourth 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 10-K for 2018 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. I would now like to turn the call over to Niraj.

Thanks, Jane, and thank you all for joining us this morning. We're pleased to talk about the third quarter results and the many initiatives that continue to propel Wayfair's momentum and our confidence in the future. In Q3, Direct Retail net revenue grew by $607 million or 36% year-over-year. Total net revenue grew by 35% year-over-year. Despite much debate about the health of the U.S. economy and a mixed macro backdrop in Europe, we continue to see strong growth in both the U.S. and international segments, as the structural shift from offline to online marches steadily on. In the short term, tariffs are injecting greater-than-expected volatility into our marketplace, as customer consideration cycles are disrupted and larger than normal amounts of substitution occur in response to price changes. We believe this is temporary in nature since our machine learning algorithms will adjust our site experience as customer preferences change, but it does inject near-term volatility. As Michael will discuss in greater detail, we are optimistic that this noise will subside over the next several months. Meanwhile we remain, as always, focused on the longer term and the investment initiatives we have in place to cement Wayfair's positioning as the e-commerce leader in home goods. These major initiatives include our logistics infrastructure build-out, international expansion and further penetrating our TAM across all categories of home goods. Today I'll provide updates on each of these pillars, including highlighting the successful approach we are taking in the core plumbing space. But, first, I'll start with our logistics network. We currently stand at approximately 15 million square feet globally after having opened our second CastleGate warehouse in the U.K. this past quarter. This marks the first international CastleGate warehouse that spans over one million square feet, which is more similarly sized to the fulfillment…

Thanks, Niraj. Today I want to talk about some of the technology that powers our supply chain and then also share some early observation post the opening of our first physical store location in late August. At the heart of our logistic strategy is to transport a massive number of SKUs from a wide spectrum of suppliers to the right place at the right quantity and also at the lowest cost possible for our customers, our suppliers and, therefore, ourselves. To drive the most efficient product flow into our network, we leverage a piece of software called Buyfair, which is a machine learning-based optimization and supplier collaboration platform. This is a proprietary solution that we built over the last three years in the absence of compelling third-party options. In close collaboration with our suppliers, Buyfair allows us to influence the product's journey directly from the manufacturing site, all the way to our warehouses. It offers recommended quantities of each products for both CastleGate and dropship models and directs which SKUs should travel to which CastleGate warehouse locations across North America and Europe. With Buyfair, we can also route them as efficiently as possible over land and sea contemplating every step along the way. Buyfair effectively ensures availability to the customer while minimizing time, distance traveled touch points and damage involved that is at the lowest possible cost to all parties. What makes the Buyfair technology both differentiated and challenging is that in order for it to do its job properly we must optimize not just across our own network, but also across our suppliers' networks. We seek to understand their manufacturing and logistics capabilities, including production quantities, time line and locations, and then figure out how to best complement them with ours. This is a potent example of what is…

Thanks Steve and good morning. Before we discuss the details of our third quarter financial performance and expectations for the end of the fiscal year, I want to take a step back and provide a bit more context on how our business is managing through the latest tariff-related volatility. Since the beginning of the year, more than 90% of our suppliers who are subject to China tariffs have raised wholesale prices, which have resulted in higher retail prices. As retail prices on the site fluctuate, we observed that our customers' consideration cycle gets disrupted and is effectively lengthened. This has always been true. Changing prices up or down lengthens customer decision-making. Traffic to our site remains healthy and average order value steady, but customers are taking more time to consider their options across the site before purchasing. In many cases, our most popular highly rated products with extensive review count and great imagery are now slightly more expensive than extremely similar products that have lower review counts, often not burdened with a tariff. Customers require more time to build confidence that the price they are being asked to pay is right and to actively assess alternate product. As products shift in popularity, the sort order changes. In turn, we have seen suppliers then revert and lower their pricing in order to optimize their share in the marketplace, which then again contributes to customer experiences being altered and so on. All of this creates short-term dissonance for the customer, which we expect will go away as the marketplace inevitably rebalances. Tariffs are having a secondary effect as well. As you know our marketplace model is unique in that we do not own the vast majority of inventory we sell. This is almost always a substantial multifaceted advantage with perhaps the sole…

Thanks, Michael. Though our momentum remains impressive despite tariff-infused volatility, it's moments like this that underscore the value of our long-term orientation. Our team of over 16,000 employees is appropriately focused on our customers, the long and substantial runway for growth still ahead and the many initiatives underway to capture a disproportionate share of that opportunity. As we approach the holidays, we're truly excited by the impressive lineup and service we have planned for our customers and we are committed to always being customer-focused, execution-oriented and to think long term in nature. We'll now go to Q&A so that we may answer your questions.

Thank you. [Operator Instructions] Our first question comes from the line of Peter Keith of Piper Jaffray. Your line is open.

Hi, thanks. Good morning everyone. I did want to dig a little bit more into some of the tariff dynamics. So you first talked about it with July seeing some price increases, so we're now four months into maybe a price increase environment. On that note, you do sound a little bit more confident about working through the temporary disruptions. So the two questions I have on this topic would be first off when have you seen a majority of the price increases? Has that been more recently or was it more front-end loaded towards July? And secondly, when you look at consumer behavior, how long do you think this disruption and/or pause dynamic lasts, so we can get a better sense of when your sales growth might start to reaccelerate? Thank you.

Thanks, Peter. Yes. So let me try to answer those two and I do think they are obviously highly interlinked. So the tariffs -- the bulk of our goods were in the tranche where 10% -- the first 10% happened last year and then the 10% went to 25% this summer. And then we have a smaller amount of goods where they went from zero to 10% in that -- this summer time frame. Really, if you focused on the part that went from 10% to 25%, what we found was that the 10% largely was absorbed. So the price increases that came through last year were really minor or nonexistent. When the 10% went to 25% that's really what created a lot of volatility. And so basically what's happened is there's no clean date when people started passing through price increases and what you find it's actually focused at all kinds of different things. Some folks decided to try to hold price either for a while or permanently. Some folks held price because they're in the middle of resourcing the goods elsewhere, but then the goods may have gone out of stock for a while, while they're trying to bring new supply sources online. But then the thing that took us by surprise and the thing that I think we underestimated was that there was a repetitive cycle of volatility. What I mean by that is that some suppliers they'd raised their price and then they would see the volume drop-off be steeper than expected, because of the nature of our marketplace, which basically allows them to compete with other suppliers for the consumer. They would then cut their price, but when they cut their price, it still creates a new cycle of volatility. In that case, it's positive…

Okay. Thank you for that color. And just secondly, we've had some conversations with investors around advertising and the rising customer acquisition cost. There's likely some influence of that -- to that rising CAC from the lower sales growth, but it did start to elevate in Q1 and Q2 before the tariffs kicked in. Could you give us just a little bit of color on what might be driving that CAC on an aggregated basis if it has to do with some of the international? Or is there a leaning in on new customers? Any additional color would help us. Thank you.

Yeah, sure. So let me just first by -- turn and just clarify the CAC calculation. The CAC calculation, we try to help illustrate how repeat is much less expensive than new and we start to give you a way to kind of calculate that out. But at the end of the day that CAC number you get to $58 is still not the actual CAC we're paying for new customers in the quarter. It's simply all the ad costs. Basically the actual ad costs we're spending for new customers, we get those new customers over time. So when you use the new customers in the quarter, it doesn't tie out with the money spent for new customers in the quarter. And the reason that matters -- you mentioned international, basically what you have is you have different geographies on different points of time in the curve. Germany is an example. We just started the brand marketing campaigns for Germany earlier this year. So that's a cost that will look very expensive relative to new customer adds in Germany in the beginning and then as you run through time, it will start looking very efficient. We also have brands like Perigold. That Perigold's about two to 2.5, three years in, but it's now hitting -- it's starting to really scale and there's a significant amount of money being spent on it. But again, it would look quite expensive if you took the Perigold ad spend for new customers looked at specific to new customers, because that type of brand-building expense in the beginning is quite expensive. And so that challenge of these different brands, different geographies and different points in maturation create a lot of mix. And even within a brand, you have different channels. The sort of channels that…

Okay. Thank you very much. Yeah, that's very helpful and good luck with the holiday season.

Thanks. Thank you Peter.

And our next question comes from the line of Brian Nagel of Oppenheimer. Your line is open.

Hi. Good morning.

Good morning.

Good morning.

I too want to just dive a little deeper into the tariffs issue. I guess a question for Michael. The deceleration in sales growth now from -- through what you gave us in the fourth quarter is rather significant, okay, and I hear what you're saying with regard to tariffs. Looking at all the data you have, is there something you can give us that helps to explain further that it truly is a tariff issue and there's not something else why with regard to how consumers react on your website?

Hey, Brian, I don't think, we can give you sort of a more specifics set of data point to look in set of data constantly as to what customers are doing on the site. What their conversion rate looks like? How much time they're spending? And how many times they come back? Right, all of the sort of the actual, sort of, functioning of what these customers are doing every day and I will say, we will say one other piece on this is that we know from well before tariffs, that we've done a lot of work to try and understand what price changing -- what price changes on the site? How they impact customers. And one of the most interesting pieces of work, I think, we've done over a long period of time is that, if you change prices up or down right, it impacts the customer purchase cycle. So you would think logically that, if you lowered prices customers would be -- it wouldn't slow their conversion. But even a lowering price slows their conversion because it makes the customer question "Am I getting the best price? Is this sort of exactly the -- do I need to go look elsewhere? Or do I need to look at other products?" And so I think that, notion of sort of price changing and sort of constant price changing impacts customers is something we've seen in the past as well.

And Brian, this is Niraj. Just to chime in. One thing I'd say is, we obviously look at our own data. We also try to make sure we're well attuned to what's happening in the market. And what we're seeing is our selection merchandising advantage relative to competitor is actually expanding not contracting. I was at High Point just a couple weeks ago. And I talked with dozens of our suppliers. And what we're hearing from what they're seeing on the demand side both in their total business. And then specifically the online component is that, their view is actually that we're doing quite well. So -- and I think there's a little bit of volatility that is not just us, but online platforms that have the same dynamic, which is where the volume is are going to have the same kind of volatility. And what we are seeing, if you look at kind of our customer data. That's why we feel pretty comfortable with where we're headed. But I'd echo, Michael. There's no kind of clean external data point that makes it super easy for you to see that aggregated up.

That's helpful. Let me ask this question. So you mentioned, in your prepared comments that, a large portion of the products you sell are susceptible to tariffs. You also mentioned and we've seen it in our work too that traffic to your site has remained quite good. So if you look at products -- I understand this might be getting a little narrow focused, but if you look at products -- maybe the select products where tariffs are not a factor. And prices have not had increased has the sales velocity on those products stayed the same?

Yes. So the goods we sell roughly 60% 6-0% of them are made in China. And something like 80-something percent are made in Asia. And that 60%, there are certain class of goods like, lighting that are almost entirely made in China. But, there are a lot of classes of goods like lower-end upholstery -- or even upholstery all the way through low to high end. But really low-end upholstery is where I was going to focus. Well there's a significant production component domestically in the United States as well as a significant component that's imported from China. So, there's quite a mix. And then, the vast majority of our goods were in the ones that went from 10% to 25%. There's a small portion of our business that's in the 0% to 10% in terms of what happened this past summer. So, when you look across classes of goods and you can look at ones where you have a mix that's domestic in China. You can look at ones that are just China. There's very few that are zero China. But you can kind of look across them. What we're seeing is -- you kind of see what you'd expect. I mean, basically there's disruption in most places. Its different forms of disruption, certain classes of goods it's generally inflationary because, they're all coming out of China, but different suppliers are choosing to pass through the increases in different ways. And some are absorbing them. So you still see a lot of mix shift volatility. And then, you have other ones where the natural mix shift would be the Chinese production which has a tariff going up in costs relative to the domestic production which is not changing. But then you find as a result, some of the Chinese producers basically find a way to absorb that cost, because they don't want to disadvantage themselves. So again, you have this mix of volatility. So we're seeing that kind of across the board. There's not -- and so it's playing out the way you would expect. It's not like clean like "Oh! look outdoor furniture is not in China and indoor furniture is in China." There's no real set of classes like that.

Got it.

Most thank you for looking to our details. Just move on to the next question.

Thanks, Brian.

And our next question comes from the line of Jonathan Matuszewski of Jefferies. Your line is open.

Yes. Thanks for taking my question. I guess, I would just start off with, have you seen any material issues as it relates to some of the production shift from your suppliers, looking to avoid China tariffs? So, is there any link between some of the supply chain shift of your vendors moving production, impacting any customer satisfaction or anything like that? Thanks.

Yes. Thanks. There's a significant impact from production shifts. It's less about customer satisfaction. I think, in general, the quality control processes are good to make sure that production quality is high before significant -- before they really start exporting the volume. But the impact is actually, what you'd expect, given that that's true, which is, folks want to move production quickly and they aim to do it without being out-of-stock for a very long period of time. And then inevitably what happens is, it takes longer to get the new production up and running at the volumes they need. So what happens is they end up out-of-stock. So you take a good selling item. That supplier decides they're going to resource it in a new geography and they think that they can either do it without being out-of-stock or with only being out-of-stock for a very short period of time. And then, the zero out-of-stock turns into three or six months of out-of-stock and so on and so forth. So what happens, you have a good selling item, it's now out-of-stock it starts to be cannibalized by a different item that's in-stock. That could also happen if one price goes up relative to the other. That other item then gets momentum and then this other item comes back in stock and then it's trying to claw its way back up. So that disruption cycle on the consumer side, which is a lot about substitution, basically gets driven, not just by price changes but by stock availability and that stock availability has actually been a real challenge.

Got you. That's helpful. And then just a quick follow-up on the same topic. It sounds like different suppliers have been doing different things with pricing. It's probably tough to say at this point, but just from your vantage point what do you see most suppliers doing on a net basis with pricing over the next few months?

What we've seen is that the 10 -- the first 10%, more or less, could get absorbed. And again, it's a 10% going to 25% on the supplier's cost. And so, when you think about our retail -- that we buy wholesale, the wholesale then of course is the revenue line for that supplier and then we've got their cost. So it's 25% on what might be 40% of our revenue dollars, so it's -- or less, because the transportation doesn't have a tariff. So you end up with sort of -- if they pass it all through, it's something like a mid to high single-digit percentage of our revenue line of type of cost impact. What you'll find is that, that 10% that's going to 25%, there really is not a lot of places to absorb that by and large. So the bulk of that’s getting passed through. You're finding a lot of suppliers though saying, hey, I might do some now and some after holiday, or I'm going to absorb it while I resource this item out of China, which for certain items where the raw material supply chain and the tooling in China is not quite as critical they are moving that. And so you're seeing a mix of folks. So I would say that kind of costing increases, where you are seeing them, are in that kind of mid-single-digit type range. And then you have a subset of suppliers who are opting not to pass that through or to pass through just 1% or 2% because they think they can either absorb it or defray it through resourcing or through other methods.

Great. Thank you.

Thanks, Jonathan.

And our next question comes from the line of Kunal Madhukar [ph] of Deutsche Bank. Your line is open.

Hi. Thanks for taking the question. A couple, if I may. One, with regard to the logistics side. In terms of -- you talked about deriving operational efficiencies in company [ph]. How should we kind of view your potential spend on CastleGate and the other warehouses? And then second, we've been seeing a lot of TV advertising as far as Amazon is concerned. How are you seeing the competitive landscape, both online as well as offline? And are you seeing any impact on the customer behavior?

Yes. Thanks. Great. Let me first talk about logistics and how we see costs levering as we get into 2020. So on logistics, one of the things we tried to highlight in the prepared remarks is that we've been pretty aggressive in building out our CastleGate footprint. And so, obviously, we opened a very large building in the U.K. that's going to serve us quite well for a while. We have one that will open in Germany next year. When you switch over to North America -- and North America, between what we just opened recently in Savannah and Lathrop and what we have opening in January in Jacksonville, that capacity along with the buildings we have and some of the things we can do to drive more utilization of those existing buildings, we think give us really the capacity to get the yield in 2020 to really scale CastleGate and yet not need additional buildings past that really in 2020. So we'll continue to hone that plan, but really we think it will take until 2021 before we'll need significant amount of additional capacity. And at that point, it will be because of capacity reasons, meaning that our utilization on our network will be much higher than it is today. And so, that unutilized rent will also get to freight. So one of the things we see as we go through 2020, I mentioned earlier that, my expectation of mix where you'll see ad cost lever as we get into 2020 and increases as we go through the year. We've talked a lot about OpEx on the head count side how we've added a lot of head count last year and as we anniversaried this year because we've been hiring at a much lower rate on the OpEx side…

Thank you.

All right. I -- someone just mentioned we're going to wrap up. So I just want to thank everyone for joining us today and thanks for your interest in Wayfair.

And this concludes today's conference call. You may now disconnect.