Good day and welcome to the Wayfair Q1 2023 Earnings Release 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] And finally, I would like to advise all participants that this call is being recorded. Thank you.

I’d now like to welcome James Lamb to begin the conference. James, over to you.

James Lamb — Head-Investor Relations

Good morning, and thank you for joining us. Today, we will review our first-quarter 2023 results. With me are Niraj Shah, Co-Founder, Chief Executive Officer and Co-Chairman; Steve Conine, Co-Founder and Co-Chairman and Kate Gulliver, Chief Financial Officer and Chief Administrative Officer. We will all be available for Q&A following today’s prepared remarks.

I would like to remind you that our call today will consist of forward-looking statements, including but not limited to those regarding our future prospects, business strategies, industry trends and our financial performance, including guidance for the second quarter of 2023. All forward-looking statements made on today’s call are based on information available to us as of today’s date. 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 2022, our 10-Q for this quarter, 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 any of 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, including adjusted EBITDA, adjusted EBITDA margin and free-cash flow. 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 and investor presentation 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. I would now like to turn the call over to Niraj.

Niraj S. Shah — Chief Executive Officer, Co-Chairman & Co-Founder

Thank you, James, and good morning, everyone. We are pleased to reconnect with you today to share the details of our first-quarter results. Last August, we shared a roadmap laying out our path to profitability. The first step was getting back to adjusted EBITDA breakeven. Through our focus on our three core initiatives of driving customer and supplier loyalty, nailing the basics and cost efficiency, we’ve made significant strides in improving our offering and customer experience while simultaneously reducing our cost structure. Collectively, these efforts have resulted in increasing market share and a significant reduction in operating expenses versus last quarter, getting us to nearly adjusted EBITDA breakeven in Q1. And we’re excited to share that we expect to have positive adjusted EBITDA in the second quarter.

We’ve always known and now we are clearly demonstrating that the Wayfair model is inherently profitable, and that there is considerable opportunity in front of us to rapidly drive further margin expansion while investing for future growth. We’ve reached this profitability milestone in-spite of the difficult macro-environment our business has operated in for the better part of the year. Our category in particular has been impacted more than others with sales first turning down in March of 2022, and now contracting approximately 20% year-over-year, according to many of the sources we follow.

While traffic remains challenged, our conversion levels have held steady and our work on nailing the basics and driving customer and supplier loyalty is leading to sustained market share growth.

In the second quarter, we are seeing improving year-over-year order trends, and we’re just coming off the back of our 7th Way Day event. At the beginning of the year as we planned a denser promotional calendar for 2023, we decided to try a three-day format for Way Day. We are very pleased by the engagement of suppliers and our shoppers to the extra day.

It’s a testament to the hard work and the quality of execution of the team that our model of fast delivery, great availability and sharp pricing is firing on all cylinders, even as we are making meaningful adjustments to our cost base.

As we’ve done for several quarters, I want to update you on different parts of the business in the lens of our three key initiatives. Starting with cost-efficiency. As part of our $1.4 billion-dollar total annualized cost actions that we outlined in January, you’ve heard us refer to $500 million coming from operational cost savings. These cost-savings initiatives are multifold and manifest across all aspects of our value chain. As we’re now starting to see some of the benefits of the savings flow-through in our gross margin, I wanted to take a few moments to share some further examples of these initiatives and provide you some more perspective on our progress.

As we started down the road of driving cost-efficiency, our overarching goal was to actually enhance the customer and supplier experience even as we looked for areas of savings. One of the ways we do that is by reducing damage rates, both on specific products as well as in the aggregate. In instances where we see rising incident rates, we take a proactive stance in working with our suppliers to identify specific weak points and improve packaging.

Our strength in data science and technology allows us to take this to the next level using information on damage rates to compose better search results for shoppers. This is one of many factors that has driven our overall incident rate down by over 15% since last summer.

By prioritizing items that we know consistently delayed our shoppers, we create a better experience, save on after order service expenses, and drive a much higher likelihood of generating a repeat order in the future. Lower cost of delivery directly translates to lower retail prices for consumers. So, another area that we’ve focused on recently is optimization of our last mile costs. Every product sold on Wayfair is classified as either a small or large parcel, though the expectations are small parcels average 30 pounds and can actually go as high as 150 pounds in some cases.

Our small parcel orders are shipped through carriers like FedEx. And as you would expect, are less expensive to deliver than large parcel items, most of which are fulfilled through our middle and last mile Wayfair delivery network, where all trucks are staffed with two-person teams rather than just a single driver, due to the heavy and bulky nature of the products.

Many items will straddle the line between small or large. So, we’ve sharpened our data analytics tools that decide whether a product is classified as a large parcel or not. For some items, large parcel clearly makes sense. The higher cost of delivery is more than offset by the reduced damage rates from the extra care. In other cases, we may see that shipping times and damage rates are indifferent, in which case classifying the item as a small parcel, creates a more compelling retail price, while preserving the customer experience.

Our ability to optimize shipping cost has been further enhanced by our efforts to drive more suppliers through CastleGate, with multiple benefits that accrue to the customer and to Wayfair. Improved forward positioning means fewer logistical touch points, and therefore less fulfillment expense, while also resulting in a lower risk of damage and faster delivery times. In fact, the percentage of items on the site with speed badging hit a new record high in the first quarter of this year. These are just two examples across a multifaceted initiative with more than 70 distinct areas of savings, all of which adds up to the more than $500 million I mentioned earlier.

In a few minutes, Kate will talk more specifically about the financial flow-through here, but I want to acknowledge the speed and thoroughness with which our team has executed on these work streams. Since we started this process last summer, we’ve now achieved more than half of the targeted savings on an annualized basis, and are making steady progress towards completing the remainder by year end. These are durable process-oriented savings that we expect will create improved economic efficiency on every single order placed and which we believe will lead to higher savings when the volume growth returns.

I mentioned it earlier, but it bears repeating. We’re extremely proud that even as we have driven these considerable changes across our business, we are still seeing strong market share expansion.

Our second key initiative is driving customer and supplier loyalty every day, and the best evidence of our progress here comes from the market share picture. We collect market share data from several sources such as conversations with our suppliers, third-party research and credit card data. The picture we’re seeing across all sources has unified over the past several quarters with clear resounding winning share for Wayfair.

EpiData, one of the major credit card data providers, recently published their publicly available first-quarter home goods market share index for the United States, which shows us in the number-one position with ongoing share capture for several quarters. A similar story is playing out in our second-largest market, Canada, where we have seen robust share capture since last summer, as we’ve made big unlocks to speak more specifically to our shoppers in the region.

Across our efforts to drive customer loyalty, we recently launched filters to search for products fulfilled from Canada, which our customers in the region love, and highlighting items that are positioned within the country. Our Canadian customers appreciate the added benefit of surfacing items with faster delivery speeds, competitive retail prices and lower incidence rates.

We’ve also launched a best-in class French experience for our wayfair.ca shoppers, and host Canada specific promotional events like Victoria Day and Canada Day sales, speak more directly to our customers in the country. During these moments, we have partnered with Canadian influencers and celebrities to further connect with our shoppers and offer them items they will love.

As with the U.S., our core recipe in Canada has never been in a better place. Strong availability, competitive pricing and fast delivery have customers coming back, and this ties nicely to the third of our key initiatives nailing the basics. In that spirit, we recently enabled detailed end-to-end international tracking on Canadian orders that originate from the United States. Most shoppers previously could only see the detailed location of their northbound order once it had crossed the border, our Canadian customers now will have full visibility to where their items are at each stage of fulfillment, which reduces the volume of post order service inquiries.

On the theme of service, we’ve also strengthened our Canada based customer service team. We find that having domestic agents who understand the unique needs of their local shopper reduces the number of follow-ups and immediately improves the customer experience, the true meaning of nailing the basics.

As I wrap up, I want to zoom back out for a moment. For several quarters now, we’ve laid out a roadmap for our return to profitability. Along the way, we told you that we intend to be both thoughtful and expeditious as we chart out this journey. And while we still have more road ahead of us, we see our progress over the past nine months as a true proof point that the plan is working. We are as confident as we’ve ever been that Wayfair will emerge stronger for it on the other side.

Now with that, let me hand it over to Kate to walk through our financials for the quarter.

Kate S. Gulliver — Chief Financial Officer and Chief Administrative Officer

Thanks, Niraj, and good morning, everyone. I want to echo Niraj’s enthusiasm at the promising signs we are seeing for 2023. Our team has been working hard to execute the plan we outlined in 2022, and we couldn’t be more pleased to see the output now beginning to manifest in the results. So, let’s dive into the first-quarter figures.

Net revenue for the quarter came in at $2.8 billion, down 7.3% year-over-year. We are seeing a return to more traditional seasonality in our business, and are encouraged by the improving trends we see in order growth. As we shared before, we expected order volume and active customer count to pick up as inflationary prices abated, and we are starting to see evidence of this dynamic playing out. The picture between our geographic segments remains largely unchanged with net revenue in our U.S. segment down 5% year-over-year and our international segment down 14.4% excluding the impact of FX.

I’ll now move further down the P&L. As I do, please note that the remaining financials include depreciation and amortization, but excludes equity-based compensation related taxes and other adjustments. I will use the same basis when discussing our outlook as well.

Gross margin had another stellar quarter coming in at 29.7%, even as we maintained a robust promotional calendar. Our team continues to make meaningful headway on our operational cost-savings, as Niraj discussed, and you are beginning to see that flow-through to this line. Niraj described these savings as process-oriented, meaning they will hold, and in some cases improve as our volume increases, and he noted that we’ve achieved over half of our targeted annualized savings, some of which are starting to see show-up in gross margin, while the rest we have passed on to price. It’s important to note that we see these savings as structural margin expansion on the roadmap to our longer-term target gross margins in the mid 30s range.

Last quarter I mentioned that as we see the savings began to accrue, we may choose to reinvest some of them in the customer experience through sharper pricing. The mix will be dictated by the macro-environment we see over the duration of the year. However, I think one important point to make here is that our operative goal is to maximize the gross profit dollars generated across a multi-quarter horizon. We can do this in two ways, the first is passing the savings directly onto incremental gross profit, driving a higher gross margin. The second is to sharpen our pricing, letting the operational savings offset the impact from reduced take rates, effectively netting out to gross margin that remains unchanged, but one that results in more orders and more repeat business.

We will balance this dynamic to keep driving optimal outcomes overtime. Our plans are to reinvest some portion of further savings in price in order to drive more volume and maintain and grow our share position, while also balancing growth margin expansion.

Moving on to customer service and merchant fees, we saw this line come in at 4.7% of net revenue in the first quarter. Advertising was 11.8% of net revenue as we are driving even better efficiency out of our pay channels, while we continue to face the same headwinds on the volume of free and direct traffic that we’ve seen for several quarters now due to the macroenvironment.

Finally, our selling, operations, technology, general and administrative expenses totaled $484 million. As a reminder, the majority of this expense line is related to our people and the remainder are covered software and other G&A. You are seeing the majority of the savings from the January reduction in force reflected in this figure, and you should expect to see this number show further moderation in Q2 as we fully run-rate the cash compensation piece of the $750 million of annualized labor savings that we have now completed.

However, we don’t see this at the end of our cost-savings journey on SOT G&A and we plan to drive low-single digit sequential compression each quarter through year end on-top of what we’ve already accomplished. All combined, the outperformance on gross margin and advertising as well as strengthen the topline contributed to a significant improvement in adjusted EBITDA at negative $14 million this quarter or nearly breakeven, a substantial improvement compared to the negative $71 million in Q4 2022 and negative $113 million in Q1 2022.

Our U.S. business saw a second consecutive quarter of positive adjusted EBITDA at $29 million, and we nearly halved the international adjusted EBITDA losses compared to Q4. We are excited to see the tangible benefits of our cost-savings work materialize, and we remain tightly unified around our future profitability goal.

We ended the quarter with just over $1 billion of cash and highly-liquid investments on our balance sheet, and over $1.6 billion of total liquidity when including our revolving credit facility capacity. Net cash from operations was a negative $147 million and capital expenditures were $87 million, resulting in free-cash flow of negative $234 million. As a reminder, the first quarter is almost always a seasonal cash outflow quarter for our business given the negative cash conversion cycle of our working capital following Q4 holiday peak.

Now let’s turn to guidance for the second quarter. Quarter-to-date gross revenue has been trending in the negative high-single-digit year-over-year, and we expect improvement due to the easier compares in May and June. We’ve also spoken recently to you about sequential trends in seasonality, and this trend would imply Q1 to Q2 sequential growth of just below positive 10% for net revenue. Despite the highly uncertain macro-environment and the reduction in AOV due to deflation, we are excited by the ongoing improving trends in order volume and are seeing promising signs in the business.

On [Indecipherable] we would guide you to the 29% to 30% range that I framed earlier. We continue to expect customer service and merchant fees to be between 4% to 5% of net revenue and advertising to be between 12% and 13% for Q2. We forecast SOT G&A or opex excluding equity-based compensation and related taxes to come in between $460 million and $470 million, showing some further improvement from Q1 levels as we fully run-rate the savings from earlier in the year.

So finally, as we’ve said several times already, if you follow the guidance I’ve just outlined, you should see positive adjusted EBITDA margins in the 0.5% to 1.5% range for the second-quarter. Based on that range, on adjusted EBITDA and the working capital dynamics as we move into the spring, you should see a sizable sequential improvement in free-cash flow for Q2 relative to Q1.

We are now reaching the first stage along our profitability path that we set out last August. So, I want to touch on how we are thinking about the next-stage, reaching mid-single-digit adjusted EBITDA margins and positive free-cash flow.

Let me provide an illustrative model to frame the full pro-forma impact of the cost-savings that you’re seeing starting to flow through. To be clear, this isn’t meant to be official guidance, but a framework to think about our cost initiatives holistically. For simplicity, let’s use our revenue level from 2022, roughly $12.25 billion dollar topline, and applied a pro-forma annualized impact of our cost-savings initiatives that are already well underway and will be fully enacted by the end of 2023. At that level, we would expect to see adjusted EBITDA margins in the low-to mid-single-digit range as gross margins exceed 30% and SOT G&A reaches between 14% to 15% of net revenue due to the ongoing savings work, I mentioned above.

At that point, we have a cost model that is geared for significant leverage from revenue growth in the future, and we expect that many of our operational efforts will enable the next set of improvements on our roadmap.

As we’ve said several times in the past, once we hit a mid-single-digit adjusted EBITDA margin range, we intend to treat that as a philosophical floor on profitability for the business from which we will then balance any growth in investment spending with a desire to also continually increase profitability.

Now, let me translate that into cash flow. As many of you know, there are two major bridging items between adjusted EBITDA and free-cash flow for our business, working capital and capital expenditures. Our business operates on a negative cash conversion cycle, so working capital as a source of cash when revenue grows sequentially and vice-versa. Thus, the impact of working capital will be entirely a function of your assumptions on revenue. If you assume capital expenditures at plus or minus $90 million per quarter and the $12.25 billion dollar run-rate would also translate to positive free-cash flow as well adds into working capital dynamics.

Now let me touch on a few housekeeping items for the second quarter, please assume the following. Equity-based compensation and related taxes of roughly $170 million to $200 million. This will be above-trend in Q2 as a function of the seasonality of our compensation cycle. As a reminder, equity-based compensation is expense that the share price as of the day the grants are originally approved, as a result a portion of this is related to historical grants that remain in the P&L at elevated share prices given the [Technical Issues] we have experienced, and the remainder will hit the P&L depending on the trajectory of the share price going forward on the date new grants are approved.

Depreciation and amortization of approximately $102 million to $107 million. Net interest expense of approximately $5 million to $6 million, weighted-average shares outstanding equal to approximately $112 million and capex in a $90 million to $100 million range.

Before I wrap up, I want to take this opportunity to commend our entire team. Over the last nine months, we delivered tremendous cost efficiency while at the same time bringing our offering to the strongest place it has been in years. We are excited about the improvements we are seeing in profitability and optimistic that the success of our core recipe will continue to drive our share gains deeper into 2023.

Thank you, and with that, Niraj, Steve and I will take your questions.

Question & Answers

Operator

[Operator Instructions] Your first question comes from the line of Alexandria Steiger from Goldman Sachs. Your line is open.

Alexandria Steiger — Goldman Sachs — Analyst

Thank you for taking my questions. I do want to double-click on the comments around your Q2 revenue growth. How do you think about the key drivers here what create upside versus downside in the trajectory for Q2, including the contribution from an extra day for Way Day or put differently, could you maybe walk us through the assumption around customer growth, order growth that went into your guide. Thank you so much.

Niraj S. Shah — Chief Executive Officer, Co-Chairman & Co-Founder

Hi Alexandria, thanks for your question. Yeah, so I guess the way to think about it is, in general the first-half of this year the promotional calendar we’ve picked-up more dense one, we did that in the back half of last year, that’s in response to kind of the consumer environment and sort of what consumers are reacting to. And so, when we plan that out at the beginning of this year, one of the things we did is we tried different formats. Last year we ran a few Way Day events, other times we have ran eight-day, six-day, five-day, three-day, we have had different sale links. So, this year we decided to try that sort of Way Day format of the two days and then a surprise extension, and we are happy with how that went. That’s just one of kind of the many things we’ve done on the promotional calendar side in response to the macro.

In terms of the Q2 revenue guide, we are guiding revenue-based on what we’re seeing happen and a lot of that has to do with also underlying drivers in the business unit, because it’s the revenue level, but you have kind of what’s happening, you mentioned that kind of order count and customer count, and what we’ve been seeing, and you can see in our active customer numbers, sequentially we are seeing the sequential pattern hold and sequentially we are seeing strength in the business in the core drivers. And so, for example, if you look at order growth, f you look at our largest brand wayfair.com, it has positive quarter-to-date in Q2 year-over-year order growth. And so, there’s a lot of different metrics that sort of we’re able to see that led to that effect the guidance we give.

Alexandria Steiger — Goldman Sachs — Analyst

Very helpful. Thank you.

Operator

Your next question comes from the line of Chris Horvers of J.P. Morgan. Your line is open.

Chris Horvers — J.P. Morgan — Analyst

Thanks, and good morning. So just touching on that seasonality point, as you think about what you’re seeing now, especially compared to a lot of other retailers, I think when all is said and done, we are going to have a pretty tough first quarter here, how are you thinking about that seasonality and the prospect of returning to revenue growth at the enterprise level over the next year.

Niraj S. Shah — Chief Executive Officer, Co-Chairman & Co-Founder

Chris, thanks for your question. Let me throw out a couple of thoughts and may be Kate can chime in with some more thoughts of hers as well. I think the biggest thing to keep in mind when we talk about returning to growth is through the first half of this year, we still have unusual revenue compares, because we didn’t see kind of normal seasonality and normal, kind of we didn’t see revenue come normalize after sort of the wonky COVID years until the middle of last year. So, once you get to the middle of this year, if you go to the second-half of this year, you now, when you think about year-over-year revenue, you have that kind of a base from a year ago that’s normal, and you have what’s happening now. And as I mentioned in the quarter-to-date, for example on wayfair.com, orders are up year-over-year, and while that’s not the entire enterprise and that’s just one metric, it’s sort of gives you a feel of what’s happening as we’re getting to more of those normalized comp.

So, I think honestly, it’s the key is that our recipe is working. So, what is that, that is availability, speed of delivery, great value, we continue to make a lot of improvements in the customer experience. We’re seeing good traction and customer reaction to that. We are then, I think, doing a good job from a kind of what are we offering to the customer in terms of I mentioned the promotional events, and how are we sort of responding to what the macro climate is, and working with our suppliers to create that excitement. And then I think from a technical point, you need the normal year-ago period in order to have the revenue kind of play out where the sort of if the business is growing, you see growth, and if it’s not growing, you don’t see growth. You kind of need last year to be normal too.

Kate S. Gulliver — Chief Financial Officer and Chief Administrative Officer

Yeah, I guess what I’d add to that, though, I think you touched on some of the seasonality pieces. We are also obviously seeing ongoing, sustained market share gains, and I think that really speaks to the strength of the core offering. And so, to your point, Chris, the macro-environment remains somewhat uncertain. We feel very good about our ability to continue to capture share in that market and the strength of the core offering as evidenced by things like order volume and wayfair.com U.S. turning positive quarter-to-date.

Chris Horvers — J.P. Morgan — Analyst

Yeah, and then on the pricing front, can you — can you talk about how you think about your strategy overall now, and is it different from what it used to be, i.e., you have these very fulsome savings on the cost of goods line. I think you said, try to price to market and not necessarily lead the market on price. How are you thinking about your pricing strategy relative to the overall market level now.

Niraj S. Shah — Chief Executive Officer, Co-Chairman & Co-Founder

Yeah, Chris, so I don’t know that our pricing philosophy is super different than what it’s been for a long-time, but just to be clear on what it is for. So, we measure — in fact the customer’s reaction to our price levels. So, the price elasticity by different types of goods, different tranches of price, that is a factor in deciding what margin levels we use in different areas of the catalog. One of the inputs to that is understanding competitively where the field is in terms of competitors at price because obviously that affects the price elasticity kind of dynamic as well. When goods get to be more heavily branded, though elasticity tends to reflect the need to be very tight to market on price as goods get to be less branded and increasingly also exclusive, then there is a factor of kind of you guys need to offer the customer price value but there’s a wider band of how you can price. So, we try to do that quite scientifically, and then the underlying thing we’ve been doing which you cited is, we’ve been focusing on taking out as much cost as possible so that we can have the margin we want at retail prices we like, and that’s what we’ve been doing. And so, a lot of our ability — you have seen the gross margin has held.

The gross margin kind of the way we’ve been able to improve the gross margin was by structural savings. So, they are not things that are leading at all, and we feel like we can continue to actually unlock value in terms of savings, then we can choose should we pass those to the customer and get sharper on price or do we put some of that into our margin, and there is a balance of what we’ll do. But our philosophy hasn’t changed, but we are in a much stronger position than we would have been when the inventory availability was poor, or frankly even before we did some of the things that we’ve done that is of advantage to us.

Kate S. Gulliver — Chief Financial Officer and Chief Administrative Officer

Yeah, I think the thing that I would add to that, Chris, is as Niraj mentioned, we’re really seeing nicely in Q1 the benefit of those operational cost savings that we laid out in January, and that continues to be a lever for us that we can pull throughout the rest of the year as we balance both maintaining and ensuring ongoing price competitiveness in this market, but also flowing some of that through to the gross margin line. And as we said on the call, we’re very focused on generating gross profit dollars over a multi-quarter period. I think you’ll see some of that balance play out through the rest of the year.

Chris Horvers — J.P. Morgan — Analyst

Got it, thank you very much.

Operator

Your next question comes from the line of Brian Nagel of Oppenheimer and Co. Your line is open.

Brian Nagel — Oppenheimer and Co. — Analyst

Hi, good morning. Congrats on the progress here. Nice work.

Kate S. Gulliver — Chief Financial Officer and Chief Administrative Officer

Thanks Brian.

Niraj S. Shah — Chief Executive Officer, Co-Chairman & Co-Founder

Thank you.

Brian Nagel — Oppenheimer and Co. — Analyst

So, a couple of questions. First off, you discussed in your comments, I guess the [Indecipherable] kind of capital needs here, but recognizing you haven’t necessarily given longer-term guidance, but while we’re looking at the business model and the business model continue to evolve here. I mean, how should we think about kind of longer-term capital needs of the business.

Kate S. Gulliver — Chief Financial Officer and Chief Administrative Officer

Yeah, thanks Brian for the question. So, I want to frame-up how we think about capex and the components of it. There are three key components to capex — one is that line-item that you see that in software development costs, capitalized technology and labor of our tech team, and you should see that line continue to moderate a bit based on the reduction in-force that you’ve seen in the ongoing efficiency in our labor force, and I think you saw that show up a bit this quarter, that’s about 60% of the total capex expenditure in the quarter. The remainder, the PP&E is really related to two things. One, ongoing investments in our logistics infrastructure that’s really designed to provide increased efficiency out of that network, and two, the build-out of our physical retail network. So, in this year that Wayfair store that will open in the spring of 2024, as well as two specialty retail brands that will open this year. The sort of mix of those is roughly equal for the remainder of the capex.

You obviously saw that line moderate a bit in the first-quarter, and we remain as we do with every line-item here, we are very focused on driving efficiency there and continuing to run that as tightly as possible.

Brian Nagel — Oppenheimer and Co. — Analyst

Okay, that’s great, that’s very helpful. And then my second question, unrelated, but you talked about just the [Indecipherable] improving consumer metrics here that we’re seeing early in 2023. Obviously, a lot going on with the Wayfair and a lot of initiatives, especially step-back, how much of what you’re seeing right now in terms of improved consumer interaction you think is a function of specific efforts on the part of Wayfair versus maybe some easing on the external pressures in this space.

Niraj S. Shah — Chief Executive Officer, Co-Chairman & Co-Founder

Well, so let me answer that a couple of different ways. So, we’re clearly taking market-share, so I think the outcome is relative to competitors, we’re clearly doing meaningfully better, that’s kind of like I guess the definition of kind of the market share. As to the why are we doing better than competitors. I think it’s less about what the competitors are doing and it’s more about what we’re doing. And so, when we mentioned that recipe again, great availability, fast delivery, great retail prices, and then kind of coupling that with all the things we’re known for around customer service and motive shopping experience and product discovery and being tailored for home and kind of proprietary delivery advantage on heavy bulky items, that’s kind of what we’ve built the business on over 20 years. We had a disruptive couple of years in the middle if you go back a couple of years ago because the COVID phenomenon, while the beginning was a nice boon for our business, very quickly it turned into a tough stretch when availability got tight, there’s a lot of inflation, supply-chain kind of drove shortages of goods, and our platform model didn’t have the advantage that it has in normal times and in recession times, and most times are normal times of recession times where you could argue whether we’re in recession time now because there is an overstock of goods or whether we’re in kind of more of a normal time because consumers do have money. And so that could be semantics, because clearly the goods — the home goods market is not kind of on fire right, it’s down year-over-year and it’s tough, but we have a great value proposition. And then as the market gets healthier, we’re set up for that to be a big tailwind because of kind of how we operate. So, I do think it’s due to our actions.

Chris Horvers — J.P. Morgan — Analyst

I appreciate, thank you.

Operator

Your next question comes from the line of Ygal Arounian from Citigroup. Your line is open.

Ygal Arounian — Citigroup — Analyst

Hey, good morning. Wanted to dig into the gross margins, nice to see the outperformance. Steven, maybe you got a better picture, so, I may have misunderstood, but I believe that you guys talked about the cost efforts is that there would be more back-half weighted, and it looks like you’re starting to see some of those benefits right now. So just maybe on the cost and the cost efforts versus kind of organic improvements around pricing or normalization within that. And then if increased [Indecipherable] adoption is driving some improvement there as well.

Steven K. Conine — Co-Chairman and Co-Founder

Great, thanks for the question. Let me start the answer and then maybe Kate can also jump in on and thought she wants to add. And let me start by describing sort of the gross margin evolution over-time, because if you go back four or five years, we had a gross margin that was more like a 24% type number. And back then what we were describing to folks is that we had, and originally we described three pillars, and then we updated to four pillars, that was a runway of over 1,000 basis-points. And what those four pillars we’re — one was what we were doing in logistics, which was building out our own proprietary logistics, which today comprises of both the inbound ocean freight leg through CastleGate forwarding, the CastleGate fulfillment operations, which is our warehousing capability and fulfillment capability, and then what we’re doing on last mile transportation, whether it be with partners through sortation and induction or whether that would be ourselves on the heavy bulky items. And that that could take out a lot of cost, because excess miles both slows down deliveries, increases damage, but frankly drives up cost. So, it’s a very complicated, but exciting area because of how you impact, not just the customer getting an item faster but you take out costs.

The second of the four pillars was what we’re doing around our house brands, which were basically our private-label brands, where we’re creating curation, creating better merchandising experiences, and also increasingly doing that with items that are exclusive or semi-exclusive to us, and that allowed us back to the question about how do we price and price elasticity, that allows us to have a wider band and deciding how we price and drives up conversion as well.

The third was just around how as we concentrate volume with suppliers and as their volume goes up, they can actually lower the price of the goods, they sell while driving up their profit dollars, and so it’s a win-win for them and for us and for the customer, because in that sense, we can basically choose to keep some gross margin or pass it on, and that creates a very good dynamic.

And then the last which the pillar we added, was around supplier services, and this was as we started to offer services to suppliers outside of just us buying at wholesale and selling at retail and selling their item, and outside of what we’re doing on CastleGate on logistics offerings. The most notable one of which is our advertising offering where suppliers can advertise on our platforms to kind of drive their outcomes, and that’s an ancillary high-margin revenue stream for us, which is still frankly in its early days. It’s growing nicely, but it’s still early.

So those four topic areas we said had hundreds of basis-points in them each, and over time we’re going to unlock them and then choose what have that we put into our gross margin, what have that we passed on to the consumer, which would allow us obviously to drive long-term profits, because the lower prices drives more conversion, drives future orders, repeat orders, dollars per customer per year. etc.

And so, what we’ve been doing is unlocking that roadmap, and what I mentioned earlier, is you have a couple year disruption in here in ’21 and ’22, due to how COVID played out. And so, the roadmap we have from before that is still the roadmap we have now. We are back along it and moving along it aggressively, and that is creating a lot of benefit. So then specifically now to zoom in on the kind of over $1.4 billion of cost actions or specifically the over $500 million of operational cost savings, which is part of that road-map and how that plays out, what that is is that as a reflection of us both being aggressive on the long-term roadmap we’ve had, and specifically also addressing a lot of inefficiencies that have crept in a lot of which during the COVID period, which again had thrown for a loop, but we’re sort of well past now in terms of executing tightly, and we’re unlocking those savings and you’re seeing those manifest in the way that we described where we choose what we put into our margin versus what we do on the retail price. But again, unlocking them structural way so we can keep this, so they just build on each other versus kind of ebb and flow.

And so that’s kind of how we think about how it’s playing out. Kate, do you want to add anything to?

Kate S. Gulliver — Chief Financial Officer and Chief Administrative Officer

Yeah, I think you hit on it nicely in terms of the broad picture and specific to the quarter, to your question on CastleGate, what I would add there is that the cost-savings that we’re talking about in the operational network go across the entire logistics infrastructure. So that would of course include the CastleGate piece of that logistics infrastructure, and we’re very pleased with how that’s manifesting.

The other point that I’d make on gross margin, while we’re talking about it is, and I think it’s a little bit unique to Wayfair is that we are able to improve this gross margin during what has been a highly promotional period for the customer, and I think that shows the strength of our model and our ability to pass on that value to the customer, to support frankly our suppliers, who want to pass on that value to the customer, but do that well, actually, raising gross margins throughout 2022 and obviously you know significant gross margin improvement this quarter, and we expect that to sustain and grow from here.

Ygal Arounian — Citigroup — Analyst

Great. Really helpful and I want to follow-up on the capital allocation question a little bit more. And maybe balanced it. You mentioned the physical store, the security investments there. Just trying to understand on that front, what is the kind of ultimate goal is when — and what level of physical infrastructure is the right level that helps build off the online business. And then maybe second, on the international rate margins there continue certainly an improvement quarter-over quarter, and nice improvement, but continuing to be well below the North American business. So just, how you think about the international business and their [Indecipherable] thank you very much.

Kate S. Gulliver — Chief Financial Officer and Chief Administrative Officer

Sure, Ygal, why don’t I start on the capex question, and then Niraj can certainly chime in. So, on the physical retail piece just a level-set on where we are today, we have two specialty retailers, three specialty retail stores open, the first is a small format sort of testing and helping us learn the model of physical retail. The first large-format we mentioned will open in the spring of 2024, and we’re opening two additional specialty retail stores this year. As with all new initiatives, we are really in a test and iterate phase. So, we want to be prudent and thoughtful about how we roll this out, learn from these first few stores, and then determine further expansion based on that.

But I think what you’re seeing now is really us testing the model and starting to put a few players on the board there. I think Niraj probably can jump in on physical retail, and I’m happy to go back to your second question on the international margin trajectory.

Niraj S. Shah — Chief Executive Officer, Co-Chairman & Co-Founder

I think I’m going to touch on it slightly differently, which is also just to kind of zoom in on the beginning, when you asked capital allocation questions, and by that, one way I think to answer your question is to think about this. The $1.4 billion cost action plan that we outlined was a plan that we think gets us back to being very focused, prioritizing the right actions, being very aggressive with that, making sure the recipe, but what it didn’t do was we didn’t try to say, hey, how do you cut the cost structure to really optimize the business to maximize profitability today. What we left in is a very significant amount of expense on things that do not drive productive economic return today, but we think could be meaningful in the future, and International for example is losing money as a segment, but we actually believe that we have real potential there. We have a household brand in two of the international markets we’re in. We have input metrics we like in those markets. We have a bit more challenging macro and some of those. Physical retail, Kate mentioned super early, there there’s a lot of reason and a lot of external proof around how omnichannel drives value. But we’re in the early days, so we’re going to right now, for example, we have a lot of capex going to open the first Wayfair large-format store.

Obviously that store today produces zero revenue. It’s not opened yet, right, and so that’s an expense that we have. And so, there’s areas of the business where we are aggressively investing for the future, and we think that’s wise, but we think we can actually be meaningfully profitable while doing that, and that’s kind of the way we balance, and so we’re gonna be careful not to have too many places that we’re investing because each one needs appropriate amount of focus and prioritization in order to really have a shot at succeeding and breaking through, but we’re also — we also are keeping that board of strategic initiatives that could be meaningful, kind of there and investing in them in a healthy way, so that they actually are set up to flourish, and that’s kind of the way I think about it.

Kate S. Gulliver — Chief Financial Officer and Chief Administrative Officer

Yeah, the overall goal is invest and be profitable, right. We want to be driving profitable growth and you’ll see that sort of first marker on that in the adjusted EBITDA positive in Q2.

On international margins specifically this quarter obviously what you’ve seen there is significant reduction in the losses, we just about halved the losses there. As we said on the last call, the cost takeouts that we’ve done has been across-the-board, we are focused on driving to profitability everywhere that we operate, and if Niraj mentioned, we’re pleased with some of the efforts that we see there. We spoke about Canada on the call and the market-share gains in Canada and our prominence there. The last thing I would add on those margins just to keep in mind that we’ve spoken about this before, but we do have overhead allocation that goes both to the U.S. and our international business, and so as we reduce our overhead costs, which we’ve been obviously working very hard on, you’ll see some of that benefit flow-through the international EBITDA margins as well.

Ygal Arounian — Citigroup — Analyst

Great, thank you so much.

Operator

The next question comes from the line of Oliver Wintermantel from Evercore ISI. Your line is open.

Oliver Wintermantel — Evercore ISI — Analyst

Yeah, thanks. If I look at the orders delivered, they are back to pre-pandemic levels using 1Q ’20 as that. But the order value is still bigger, there’s probably still some inflation in there. If you look at that orders delivered number, is that now a good way to look at the business that back to pre-pandemic levels. And then on the order value, how much of that was inflation? Thank you.

Niraj S. Shah — Chief Executive Officer, Co-Chairman & Co-Founder

Yeah, I’m trying to think what would be helpful to you. I mean, I guess the way to think about it is on the inflation front, there is significant inflation. That inflation is well on its way of coming back out. And so, one of things we have mentioned is that, starting a year ago, basically last summer, is really when the rest got back intact. It started with availability getting better in the spring of last year. But as you went through the summer, speed got better, and then by late summer, price has gotten better. And what was really happening there is a lot of that was suppliers recognizing that shipping costs, in particular, ocean freight had abated and starting to price goods reflecting what their replacement cost of those items would be. Now that’s going to take long, because there’s a lot of excess inventory that are in their way through, and they don’t price it at all to the future price right away, but the debt deflation is coming through. So, there will be some deflation. The thing I will point out though is that this has been a question that we got on our prior calls as well. Well, won’t then the AOB decline be a drag on revenue. And one of the things we pointed out is that what we’ve seen historically is actually that that is an accelerant on conversion effectively on order count and customer count. And so, when you’re creating the revenue outlook, you got to take kind of customers orders multiply that by AOB, right, to get revenue, and while it’s not kind of the easiest math to kind of think through, there’s a very direct correlation there and that’s what we’re seeing play out, and we mentioned orders for example in wayfair.com or are quarter-to-date. And I think some of what is missed [Phonetic] is that again last year first-half had wonky comps, as those ease, will start easing here, and you get to the normal period the back-half of last year, that plays through, but I think, these are I think the different moving parts.

Kate S. Gulliver — Chief Financial Officer and Chief Administrative Officer

Yeah, I would just reiterate to your question, we should see order volume improvement, right. So as the AOB, as you pointed out is still inflated, as that starts to moderate, we should see that order volume grow and that then translates into customer growth. Those are the right underlying fundamental, right. We’d rather have order volume and customer growth and AOB growth on a sustained period as we can then re-market to those customers, and they become engaged in the platform. So that is a trend that we are encouraged by.

Oliver Wintermantel — Evercore ISI — Analyst

Got it and then maybe in that regard on the gross margin side, have you seen any price elasticity there, like your gross margins have gone up, which revenues is still down, is there still way for you to maybe re-invest more in price and get the revenues and orders up, or have you not seen the price elasticity when you reduce prices.

Niraj S. Shah — Chief Executive Officer, Co-Chairman & Co-Founder

Well, this is what I tried to address earlier when I said about gross margin, that opportunity is definitely there, but that’s what we’re doing. So, in other words, we’re continuing to unlock cost-savings. We are then deciding what we put into price, lowering price, and what we put into our gross margin. And there’s kind of a pretty heavy road-map there. So, there is definitely opportunity for us to continue, and the plan is for us to continue to do that as we go through time.

Kate S. Gulliver — Chief Financial Officer and Chief Administrative Officer

Yeah, Oliver, you know, we have a very sophisticated pricing model mechanisms and this is something that we constantly are pressure testing. We said we achieved about half of those operational cost-savings, so there’s more to go there, and we can make real-time decision on how much of that flowed through to price to your point and generate future orders, and how much of that flowed directly through to gross margin, and that will depend a little bit on the market and what we’re seeing with our customer.

Oliver Wintermantel — Evercore ISI — Analyst

Got it, thanks very much and good luck.

Kate S. Gulliver — Chief Financial Officer and Chief Administrative Officer

Thanks, Oliver.

Operator

Your next question comes from the line of Anna Andreeva from Needham. Your line is open.

Anna Andreeva — Needham — Analyst

Great, thank you so much and good morning, guys. I had two questions, one on active customers. You’ve seen some stability at the enterprise level in the last couple of quarters already. Just curious, what does that number look like for U.S. only. Just any color, what are you seeing in terms of gross adds and churn in the U.S. as some of the promo initiatives are clearly resonating with the consumer. And then secondly, I wanted to follow up on advertising. So, your sales came in on plan and advertising was below the range you had provided. Could you talk about what you’re seeing there with the efficiencies and what is working specifically.

Niraj S. Shah — Chief Executive Officer, Co-Chairman & Co-Founder

Yeah, on the first question around active customers, I think we’ve tried to point out that sequentially, you’re seeing that number start to stabilize, and we mentioned quarter-to-date on wayfair.com, for example, order count is up quarter-to-date. In terms of the active customer count for the U.S., I will have Kate come in and then I don’t know [Speech Overlap]

Kate S. Gulliver — Chief Financial Officer and Chief Administrative Officer

We actually we don’t disclose the breakout, but I think you’re pointing to a trend that you can see in the revenue breakout across the U.S. and the international business, and certainly we’ve already mentioned the order piece in the U.S. that would probably naturally equate to customer improvements in the U.S. business relative to the international business.

I think your second question was on ACNR leverage and how we’re looking at that quarter.

Niraj S. Shah — Chief Executive Officer, Co-Chairman & Co-Founder

Kate, can I just jump in on that and then you can maybe add thoughts to it. Yeah, so advertising, again, that $1.4 billion, kind of over $1.4 billion set of cost actions that we outlined in January to help folks try to understand everything we’ve been talking about since last summer. But put it into context. We cited advertising on there as one of the items and it was the third item on the list as in a [Indecipherable]. On advertising, I think it’s important to understand how we think about the ad cost, because I think there’s sometimes some misconception. And so, I think the easiest way to think about is, think of it as having three buckets of that cost. And the first bucket, which is by far the largest bucket, think of that as kind of evergreen, and by evergreen what I mean is these are different advertising channels that are highly measurable that are run to very tight paybacks, and that we are looking to increase our spend there, but within that payback constraint that’s very tight and very measurable, and how can we do that? We can do that with targeting, we can do that with different creative ad units, we can do that by upping the conversion on the traffic. And so that we’re continuing to maximize.

Then there is second bucket, which is generally top of funnel type advertising, so television would be kind of the poster child of this, but there’s other things in this bucket. Those are channels that we can measure, but the error band around measurement there is larger, that you can’t measure them quite as precisely as you can measure that first bucket. So, the measurement methods there are more triangulating on what you believe the values there, so inside that band you could spend at the low-end of the band or the high-end of the band, and it would be within the band that you think is productive for the spend, But again, there is an error band there, and there what we’ve done is we’ve biased towards being lower in the band, rather than being higher in the band, and we’re getting good results from that.

And then think of the third bucket as an R&D bucket. So, these are advertising channels that do not yet operate at the payback we want them to, but we believe they could. So, we are experimenting in these channels, figuring out — trying to find breakthroughs of what works, what doesn’t work. And once you get to a productive approach there, we are getting the payback you want, you would then scale it and these channels would then go in either bucket, bucket one to bucket two, depending on what kind of advertising channel it is. There, what we’ve done is we’ve taken a top-down approach saying, hey, what percent of our ad budget or how many dollars are we willing to put into R&D. And then we take — we are now taking that amount and deciding well which of these opportunities we see do we want to invest in to get breakthroughs. And we’re kind of doing that top-down rather than bottoms-up because bottoms-up, you could end-up with many different opportunities with many different ideas of what to test, and it could add-up to being a higher percentage of your total ad spend than you would like. It will obviously delever your ACNR, because it’s running at a very-high ACNR percentage, it’s not payback yet. And so, by deciding top-down again, as [Indecipherable] really excited, that’s what we did, that’s still a nice good amount of money to spend, but it’s defined to make payment, sure it doesn’t grow to be too high percentage by doing it top down. And that has also driven benefit from ACNR. So ACNR, we’ve been able to make more efficient without hurting our ability to strategically use advertising to grow.

And then remember, this is all with the headwind of the prepaid mix which we talked about on prior calls, which is the easiest way to think about this as the category is currently out favor, right. We tried to the category being down 20% year-over-year. Well, the category, it’s a discretionary category and its interest will ebb and flow with the kind of broader economy, and then frankly, it has a bigger ebb and flow when you think about the COVID sort of boom at the very beginning of COVID, and then that kind of boom that followed it and the thing that people had bust it which was travel, entertainment, restaurant spend. Both of these, boom bust cycles will normalize out. They typically are more correlated to each other around the economy. And as it does, that prepaid mixture turning to being a tailwind, because we were just aptly [Phonetic] more interested in the category.

The easiest illustrative example is if travel is in a boom cycle and homes not, if you get an email from booking.com and an email from Wayfair, which one are you more likely to click on, simply put. And that’s kind of like that prepaid mix. So that’s still a headwind. So that’s kind of — the ad cost has got much more efficient due to what I described about the three buckets. And that’s despite the headwind.

Anna Andreeva — Needham — Analyst

Okay, okay. That’s really helpful. I appreciate it guys, and best of luck.

Kate S. Gulliver — Chief Financial Officer and Chief Administrative Officer

Thank you. I think we just have time for one more question.

Operator

And our last question comes from the line of Curtis Nagle from BOfA. Your line is open.

Curtis Nagle — BOfA — Analyst

Great, thanks so much. I guess two quick ones. Just one, how to think about I guess the inventory flow in the industry coming through the rest of the year. It seems like that’s been a nice tailwind for you guys to think that continues, and maybe as surplus is cleaning up a little bit. And then just any commentary in terms of, and just the latest thinking on addressing the 25 converts and kind of what’s the strategy around that. Thanks.

Niraj S. Shah — Chief Executive Officer, Co-Chairman & Co-Founder

Yeah, great. Let me answer the first part of about inventory flow, then maybe I’ll turn it over to Kate to answer the second question about the convert. So, on the inventory flow since last spring suppliers have had excess inventory, and that depending on the supplier and how aggressive they were on it and where they started from, some worked their way through it, some are still working their way through it. Some believe they still will take them into early next year to work their way through it. I’d be cautionary around thing of that as a temporary sort of tailwind, or temporary help. The way to think about it is actually the way the business model works. Our model works very well, whether there is a kind of an appropriate amount of inventory or an excess amount of inventory, because what it does is it basically allows the suppliers to lean in and compete against one another to put value in front of the customer. The excess inventory actually is a bit of a challenge right now because it came in at such a high-cost basis. Suppliers are not in a great position to necessarily be as aggressive as they would like to be. And as it normalizes, they then bring goods in that are at a more normal level. Actually, the wholesale costs and therefore the retail cost will continue to decline as it normalizes out, not increase.

So that’s kind of a nuance based on the dynamic of what happened a year ago, but it’s an important one to appreciate because as we get farther into this cycle, we believe that our competitive position actually gets advantaged more, not disadvantaged.

Kate S. Gulliver — Chief Financial Officer and Chief Administrative Officer

Just to touch on your question around the capital structure. So, you’re referencing 2025, so just remind everyone that the late 2025 maturity and we believe we have multiple options at our disposal for how to manage this going-forward, and will continue to be opportunistic there. So, [Indecipherable] to our September transaction, which is a liability management transaction, we pushed out some of the 2024 and 2025 maturities as the kind of thing that we might do going-forward. I think that’s a good example of how we look at it.

Curtis Nagle — BOfA — Analyst

Okay, thank you.

Kate S. Gulliver — Chief Financial Officer and Chief Administrative Officer

Great. With that, thank you everyone for joining.

Niraj S. Shah — Chief Executive Officer, Co-Chairman & Co-Founder

Thank you everybody. Talk to you next quarter.

Operator

[Operator Closing Remarks]

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WAYFAIR INC

Q1 2023

Earnings Transcript

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