Investors reacted harshly to Wayfair's (W -6.50%) third-quarter report, sending shares sharply lower this week despite good news on the growth front. Specifically, the e-commerce specialist surpassed management's forecast for the period to mark its third consecutive beat in fiscal 2018. However, Wall Street pros were more concerned with spiking costs and the potential for a brutally competitive holiday season ahead.
CEO Niraj Shah and his team, in a conference call with analysts, addressed those worries in the context of Wayfair's broader growth plans. Below are a few highlights from that discussion.
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Market share growth
"We're delighted to see our offering engage more and more people with 13.9 million shoppers buying from us over the last year and [12-month trailing] net revenue per active customer continuing to grow, reaching an all-time high this quarter of $443." -- Shah
Sales growth clocked in at 43% overall and improved 40% in the core U.S. market. Both of those results were above the top end of the guidance range that executives had issued, and they imply healthy market share gains.
Other customer engagement metrics, including the proportion of repeat business, the base of active customers, and average spending per customer, support the idea that Wayfair is building a valuable position in its industry niche. "We're thrilled to see customers increasingly shopping with us," CFO Michael Fleisher added.
Cost spike
"We think it would be extremely shortsighted to forego the high [return on investment] opportunities that we have put ourselves in a position to be able to capture." -- Fleisher
Wayfair reported a surprising jump in its spending rate in two key areas. First, selling and development expenses shot up to 12.2% of sales from 11.2% in the prior quarter, despite the 40% revenue spike. Executives pinned the blame on the wide opportunities they've identified for capturing growth in markets like Germany and new shopping categories like mattresses. They didn't hesitate to allocate funds toward those causes, especially by hiring people across the engineering, merchandising, and logistics areas.
The more concerning cost bump was in advertising, which climbed to 11.9% of sales from 10.7% in the prior quarter. Management said that the spike wasn't an indication of increased competition, but instead reflected attractive trade-offs for faster sales growth. "As Q3 progressed," Fleisher explained, "we saw compelling opportunities to lean in and invest further advertising spend behind the strength of our customer [spending]."
Looking ahead
"We expect gross margins consistent with the 23% level of recent quarters. But we will remain [price competitive] to serve our customers and as such there is some risk across profit margins could fall below that level [in the fourth quarter]." -- Fleisher
Wayfair issued a conservative holiday season growth outlook that left room for the negative impact of a potential shift in consumer confidence. The company also noted that it has sourced plenty of discounted products for the fourth quarter but might still be forced to slash prices if traditional retailers go that route.
At the same time, costs, including for advertising, should be elevated over the holidays. As a result, adjusted losses will likely balloon just as they did in the most recent quarter.
The good news is that these expenses are mostly within the company's control and thus reflect management's rising confidence that they can capture a bigger piece of the $600 billion home furnishings market. The bad news is that these expense trends suggest it could be quite some time before Wayfair's growth starts delivering concrete profits.
