This week's earnings release offered clues as to when profitability might arrive, but the question remains largely unanswered, even as sales growth continues to be off the charts.
More importantly, signs of an elusive moat continue to emerge -- offering hope for long-term shareholders that the company's money-losing ways will be well worth it.
Wayfair earnings: The raw numbers
Before diving into all of the moving parts at Wayfair, let's look at the headline numbers for the company.
|Metric||Q2 2018||Q2 2017||YOY Change|
|Revenue||$1,655 million||$1,123 million||47%|
|Non-GAAP earnings per share||($0.77)||($0.26)||N/A|
|Free cash flow||($7.5 million)||($27.2 million)||N/A|
There are a lot of moving pieces to unpack here. First, while the free cash flow numbers look impressive, virtually all the improvement came from accounts payable. In other words, Wayfair owes lots of money to suppliers and has yet to pay them. On the one hand, this could be a sign of operational leverage. On the other, it's not a pattern that's clearly established itself yet.
And while investors should love the sales growth, they could be justifiably worried about widening losses. On that front, it's important to see why losses expanded. Here's what happened, after backing out stock-based compensation:
- Gross margins for direct retail contracted 72 basis points to 23.3%. This is expected as the company expands its international efforts -- which are still in the very early innings and have less leverage.
- Headcount (total employees) increased massively from the year-ago quarter -- up 61% to 9,713. These investments were split between full-time technology and sales positions and variable employment for logistics and delivery.
- This increased headcount led Selling, Operations, Technology, General & Administrative costs -- a catch-all category for everything that isn't advertising or customer service -- to rise 55% to $211 million.
Have we reached an inflection point?
As huge as these increases in spending are, management revealed that Wayfair's U.S. operations have continued to hover near break-even. For the quarter, adjusted EBITDA came in at $7.2 million -- despite all of the investments in logistics.
This continues a pattern present since the beginning of 2017. Over the last six quarters, Wayfair's U.S. operations have generated $35 million in adjusted EBITDA. These gains, however, have been offset by losses of $184 million in the International segment over that same time frame.
Investors should get used to the investments creating short-term profit losses, however. As CEO and cofounder Niraj Shah said, "Our long-term investments in further developing our logistics networks, international business, and in scaling headcount to improve our product and service offerings are resonating strongly with new and returning customers."
Signs of widening moat
There are a couple of data points I like to track every quarter with Wayfair. All of them showed considerable growth:
|Metric||Q2 2018||Q2 2017||Growth|
|Active customers||12.8 million||9.6 million||34%|
|Orders delivered||6.5 million||4.3 million||51%|
|Orders delivered to repeat customers||4.3 million||2.6 million||62%|
The last data point might be the most important, as it helps show signs of the company building a moat around itself. For the quarter, 66% of all orders came from repeat customers -- up from 62% the same time last year. This is important for a few reasons: The company doesn't have to spend money on advertising on these customers; it's a sign that the customers are pleased with Wayfair, which adds to the company's brand value.
Because Wayfair hasn't yet figured out a way to lock in high switching costs (the customers can order from whomever they want without facing a real headache), such signs are enormously important.
Equally important are the company's investments in its fulfillment network. The logistics of moving large pieces of furniture around the continent are different than for your standard e-commerce network. Wayfair has seven CastleGate warehouses in North America, the U.K., and Germany -- with one more to come online in the U.S. this year. Its Wayfair Delivery Network also has operations in 25 cities throughout the U.S. and Canada.
While expensive, these investments help lower the internal costs of quick delivery of furniture. As more time passes without serious threat from other logistics companies -- Amazon chief among them -- Wayfair's advantage widens -- no one can deliver what you order as quickly or as cheaply.
What else happened during the quarter?
Here's a quick rundown of everything else that happened during the second quarter:
- U.S. Direct Retail revenue grew 43% to $1.4 billion, representing roughly 85% of all revenue.
- International revenue -- primarily Canada, the U.K., and Germany -- grew 94% to $244 million.
- The company ended the quarter with $585 million in cash and investments versus $342 million in long-term debt.
- Wayfair held its first-ever furniture and decor holiday -- Way Day -- with record one-day sales.
Wayfair has made it clear that it will continue to invest in building its brand -- internationally and at home -- as well as its logistics network. Management talked at length on the conference call about expanding its logistics to help suppliers deliver their goods to Wayfair fulfillment centers. Over the long run, investors should not expect such expenses to markedly fall anytime soon.
For the third fiscal quarter, total direct retail revenue is expected to grow at a mid-point of 37.5% to $1.63 billion. Within that, U.S. sales are expected to grow between 34% and 36%, while international growth jumps 50% to 60%.