Home Wayfair Aims for Profitability Against Revenue Headwinds
September 9, 2022
Wayfair Aims for Profitability Against Revenue Headwinds

By Mike Duff

Contributing Editor

Wayfair posted a loss in the second quarter that got people buzzing about its ability to operate profitably and advance its business model in the middle and long term. The company, however, just detailed some near-term initiatives intended to turn around its numbers so that cash generation, adjusted EBITDA and earnings all trend positive.

In a second-quarter conference call that also shed some light on the company’s approach to 2023, Niraj Shah, Wayfair’s co-founder, co-chairman and CEO, said the company expects traction in its efforts, despite a macro-environment that makes revenue gains problematic.

“We have a plan to get to EBITDA positive and then to free cash flow positive that really is not counting on revenue growth being the reason and the way we get there,” he said as noted in a Wayfair transcript.

What concerns some observers is Wayfair’s ability to generate profits got a significant boost from the restrictions the COVID-19 pandemic imposed and subsequent purchasing to make the home a better place to ride out the crisis.

Now, COVID-19 is less of an acute problem and there has been a glut of general merchandise bloating a retail sector in which many players over-purchased in response to supply chain constraints. As the pandemic turned milder, spotty shelves filled just as consumers began to think about travel and eating in restaurants again. At the same time, inflation arising from the same macroeconomic conditions that had helped tie up logistics in the first place began to accelerate.

Under the circumstances, consumers started shifting their purchasing at retail from general merchandise to services, consumables and food. Lower- middle-income consumers began to become more cautious about spending on non-consumables they didn’t immediately need. General merchandise spending, including in many home categories, with outdoor being something of an exception, got knocked back. As such, Wayfair was one, although certainly not the only, retailer to see its sales take a substantial hit.

Niraj Shah

Over the last few weeks, we articulated a clear set of goals to our entire organization, which include three key tenets: One, drive cost efficiency; two, deliver best-in-class execution by nailing the basics; and three, earn customer and supplier loyalty every day.

– Niraj Shah, Wayfair co-founder, co-chairman and CEO

Now, Shah said, Wayfair plans to get back on track… and fast.

“Over the last few weeks, we articulated a clear set of goals to our entire organization, which include three key tenets: One, drive cost efficiency; two, deliver best-in-class execution by nailing the basics; and three, earn customer and supplier loyalty every day,” Shah said.

The Wayfair business model has advantages it can leverage in making the turn back to profitability, Shah said. The P&L has many variables, for one, meaning that Wayfair can configure gross margins, customer service, merchant fees, and, to a large degree, advertising to revenue trends. The P&L’s structure protects Wayfair’s unit economics and leaves room for potential upside through incremental efficiencies in fixed spending such as operating and capital expenses, he said.

Already, Wayfair has implemented a hiring pause as it has been assessing how consumer demand is developing and determining how to respond. The company has also reassessed its European expansion, deciding to focus primarily on Germany and the United Kingdom. It also is slowing down registry and logistical investments in response to a changing retail environment.

“In areas of more fixed spend, predominantly OpEx and CapEx, we have the ability and willingness to prioritize and sequence differently if need be,” Shah said. “One visible example that many of you are aware of is the hiring pause that we implemented back in May. This gives us the opportunity to step back, assess how consumer demand is developing and react accordingly. Less visible to you are decisions such as pushing off market expansion plans in Europe in favor of reinforcing our focus on the U.K. and Germany, pausing the development of certain opportunities like registry and flexing our planned logistics CapEx investments in response to a changing revenue trajectory.”

Although it may take a couple of quarters to affect results, Shah said Wayfair is convinced the review of expenses it has been conducting will lead to better results and even tighter execution in critical quarters. At the same time, Wayfair will continue to invest in those functions that will drive and enable growth, including technology. The company is investing in fast delivery capability, flagship house brands, funnel marketing channels and content. Wayfair also will continue testing and developing brick-and-mortar store operations, culminating in a Wayfair-branded concept it has planned for a 2024 opening.

“The profitability levels we are targeting should allow us to both control our destiny and simultaneously invest for the long-term, which has long been a key to Wayfair’s success,” Shah said. “While we tighten our belt in some places, our support is fully behind high ROI initiatives that will set us up for years to come.”

Although it might require making significant internal changes, Michael Fleisher Wayfair CFO, noted the overall direction the company is going hasn’t ultimately changed.

“Since late 2019, we have been focusing on becoming sustainably profitable and cash flow generative. Our progress towards this goal accelerated during the pandemic, but reversed somewhat over the last several quarters,” he said. “As soon as we started to see the macro environment moving away from our going-in expectations for 2022, we began taking swift action to reposition the business and a return to positive free cash flow in a timely and thoughtful manner.”

Since late 2019, we have been focusing on becoming sustainably profitable and cash flow generative. Our progress towards this goal accelerated during the pandemic but reversed somewhat over the last several quarters. As soon as we started to see the macro environment moving away from our going-in expectations for 2022, we began taking swift action to reposition the business and a return to positive free cash flow in a timely and thoughtful manner.

– Michael Fleisher, Wayfair CFO

Michael Fleisher

The idea is not just returning to profitability on the adjusted EBITDA line but getting back to a level that “covers expenses such as depreciation and amortization, “and the cost of paying our employees in equity,” Fleisher said

Wayfair has undertaken a broad prioritization exercise across the business, including a timing shift in its semi-annual planning process and initiated an exacting review of each part of the business “as we reassess what the appropriate cadence of investment should be across a range of macro scenarios,” he said.

Wayfair into 2023 is going to push the generation of positive free cash flow, although doing so will take time with the macro-economic environment influencing action and duration, Fleischer said.

In planning for the fourth quarter, Wayfair will work to build revenues on and beyond third-quarter activities consistent with holiday spending. The expectation is the company will narrow adjusted EBITDA losses considerably before the end of the year and then make substantially more progress toward its financial goals from there.

“It is true that our timeline to get there will vary depending on how the top line fares in the macro environment,” Fleisher said. “But we’re committed to moving steadfastly in this direction, and our liquidity position enables us to proceed responsibly down this path. And with no meaningful maturities until late 2024, we have sufficient time to ensure multiple options are at our disposal for how to manage our capital structure.”

As the holiday season approaches, Wayfair suppliers have the option of using the company’s Castlegate logistics network to adjust prices and speed product to the end consumer at a time when they might be over-inventoried. Shah maintained Wayfair has seen its vendor partners lowering retail prices. With accelerated delivery and new promotions, such as one dubbed Flash Deal Friday, Wayfair is working to further entice consumer purchasing.

Immediate considerations aside, Shah reiterated Wayfair’s goals through the year ahead.

“We are steering Wayfair to be cash generative,” he said.” We are also establishing a lower bound on profitability that we will stick to, all while working to drive margins even higher. Why is this lower bound important? At a mid-single-digit adjusted EBITDA margin, higher in the U.S. as international continues to mature, we should be able to cover expenses like depreciation and amortization associated with CapEx and begin to mitigate the dilution associated with equity compensation, all while continuing to invest in future growth initiatives,” Shah said, adding, “The macro can help or slow us down some, but we are not relying on solely the top line to get us there.”

Shah also made the point that Wayfair’s liquidity isn’t a worry and remains sufficient for the company to meet its goals. Wayfair ended the quarter with more than $1.7 billion of cash in short-term investments on its balance sheet, and it has a revolving credit line of an additional $500 million available.

“So, where we are right now at $2.2 billion to $2.3 billion in total liquidity and with no meaningful near-term maturities is a relatively comfortable place to be,” Shah said.

In a research note, Pulse Ratings analyst E.A. Kratzman cited that liquidity figure in maintaining that Wayfair isn’t facing any imminent problems. However, the firm lowered its credit rating for the company.

The rating downgrade to “speculative risk,” Kratzman pointed out, “reflects the company’s EBITDA losses, cash burn, deteriorating credit metrics, and worsening tangible net worth deficit. Despite operational headwinds, the Speculative Risk rating is supported by [an about] $2.3 billion liquidity position. Results for the quarter reflect some normalization in consumer behavior since the onset of the COVID-19 pandemic, as well as recent macroeconomic pressures felt by consumers. This had a negative effect on Wayfair’s financial results.”

In looking ahead, Kratzman added, “While Wayfair is not expected to generate positive free cash flow in the coming quarters, its liquidity appears adequate to meet short-term capital requirements, with no meaningful near-term debt maturities. However, management will need to control critical elements like operating expenses, CapEx, and working capital amid topline uncertainty to mitigate cash burn and ensure liquidity does not become a significant concern over the medium term.”

While Wayfair is not expected to generate positive free cash flow in the coming quarters, its liquidity appears adequate to meet short-term capital requirements, with no meaningful near-term debt maturities. However, management will need to control critical elements like operating expenses, CapEx, and working capital amid topline uncertainty to mitigate cash burn and ensure liquidity does not become a significant concern over the medium term.

– E.A. Kratzman, Pulse Ratings analyst

In response to a HomePage News query about how Wayfair plans to begin working toward the goals Shah and Fleisher set, a company spokesperson pointed to the August 19 letter Shah sent to employees in the United States announcing the company was eliminating 900 jobs.

The letter read, in part: “We were seeing the tailwinds of the pandemic accelerate the adoption of e-commerce shopping, and I personally pushed hard to hire a strong team to support that growth. This year, that growth has not materialized as we had anticipated. Our team is too large for the environment we are now in, and unfortunately, we need to adjust. I take responsibility for the impact this decision will have on the nearly 900 Wayfairians who will be told today they are no longer a part of building our company’s future.”

The letter stated changes the company had in the works included thinning out management layers so employees could focus on execution, aligning tasks better with strategic priorities; and adjusting functional areas that have grown faster than revenue trajectory can support.

In a research note, Morningstar analyst Jaime Katz asserted the Wayfair labor structure rightsizing, building off of the hiring freeze it had imposed in May, could be regarded as a prudent response to post-pandemic demand normalization, which has led to top-line pressure on home merchandise-oriented retailers. Still, Katz said Morningstar views the difficulties currently suffered as transitory and, in Wayfair’s case, the Wall Street response regarding the company’s share price, down from just over $190 in January to an open of $52.81 on Monday, August 29, as creating an opportunity to own the stock at an attractive discount.

Katz added, “Wayfair should be able to continue to take share in the fragmented home goods market, which it believes represents a more than $800 billion global opportunity between North America and Europe. The firm’s differentiation comes by way of product breadth, and its logistics network, which permits faster delivery of both small and large parcels than most of its peers.”

In addition, the Wayfair inventory-light business model drives inventory turns and frees capital to spend on customer acquisition and retention. The model has produced 24 million active users as of June who spend more than $500 per year, which suggests Wayfair’s product mix and marketing are resonating with consumers.

The flip side, Katz stated, is Wayfair’s broad range of targeted customers, from low-income to affluent, that place the company in competition with a wide range of rivals, making it difficult for the company to remain top of mind in a market with low switching costs.

As such, it’s fair to say Wayfair has room and time to affect a turnaround, but it needs to gain traction near term to ensure the company meets its goals in a timeframe that doesn’t make investors impatient and crimps its plans to gain customers and market share.

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