Etsy, Inc.'s (ETSY) CEO Josh Silverman on Q2 2022 Results - Earnings Call Transcript - Seeking Alpha

Summary

Etsy, Inc. (NASDAQ:ETSY) Q2 2022 Earnings Conference Call July 27, 2022 5:00 PM ET

Company Participants

Etsy, Inc. (NASDAQ:ETSY) Q2 2022 Earnings Conference Call July 27, 2022 5:00 PM ET

Company Participants

Deb Wasser – Vice President-Investor Relations and ESG Engagement

Josh Silverman – Chief Executive Officer

Rachel Glaser – Chief Financial Officer

Jessica Schmidt – Senior Director-Investor Relations

Conference Call Participants

Deb Wasser

Hi, everyone. And welcome to Etsy’s Second Quarter 2022 Earnings Conference Call. I'm Deb Wasser, VP of Investor Relations and ESG Engagement. And joining me today are Josh Silverman, Chief Executive Officer; Rachel Glaser, Chief Financial Officer; and Jessica Schmidt, Senior Director of Investor Relations. Today's prepared remarks have been prerecorded. The slide deck has also been posted to our website for your reference.

Once we are finished with Josh and Rachel's presentations, we will transition to a live video webcast, Q&A sessions. Questions can be submitted via this Q&A window chat displayed on your screen. Feel free to use it at any time as it will remain open throughout the entire conference call. I'll be reading your questions and Jessica will help me try to get as many as we can.

Please keep in mind that our remarks today include forward-looking statements related to our financial guidance and key drivers thereof. The global macroeconomic uncertainty, including the impacts of general market, political, economic and business conditions may have on our business strategy and operating results. Our opportunity, our levers for GMS growth and our plans for investments in our marketplaces and in our member support programs. The potential impact of our strategic marketing and product initiatives in the anticipated return on our investments and their ability to drive growth.

Our actual results may differ materially. Forward-looking statements involve risks and uncertainties, which are described in today's earnings release and in our Form 10-Q filed with the SEC on May 5, 2022 in which will be updated in any future periodic reports we file with the SEC. Any forward-looking statements that we make on this call are based on our beliefs and assumptions today. And we disclaim any obligation to update them. Also, during the call will present both GAAP and non-GAAP financial measures.

A reconciliation of non-GAAP to GAAP measures is included in today's earnings press release, which you can find on our IR website, along with the replay of this call. As a reminder, our 2021 financial results and KPIs for the second quarter did not include Depop and Elo7, which were acquired in the third quarter of 2021.

With that, I'll turn it over to Josh.

Josh Silverman

Thanks, Deb, and good evening, everyone. We continue to experience striking changes in the global economy and consumer behavior this year. And as a result, our forward visibility is not substantially clearer than it was a quarter ago. Consumers have more choices for where to spend their time and money and disposable income is under more pressure than it's been in a very long time. In spite of these headwinds, we're encouraged by the tens of millions of shoppers that return to Etsy spending only slightly less with us in the second quarter of 2022 than they did a year ago, when choices were far fewer and economic conditions were a lot different.

While markets naturally go through cycles, I'm energized by the agility of the Etsy team, the adaptability of our business model and our ability to deliver solid profitability in a quarter we're achieving top line growth was challenging. We have a lot of conviction that not only is e-commerce poised for meaningful growth over the medium term, but that each of the four Etsy marketplaces has a unique reason to succeed and scale, offering something truly important and different against a sea of sameness. That's why even through a challenging time, we've continued to invest in our people and our businesses. Making bold moves that we very much believe will set us up for continued future growth.

And we've been able to do this while delivering strong profitability, thanks to the benefit of our discipline, scale and business model. The headline for our second quarter results is that despite really meaningful headwinds, we continued to hold the vast majority of our top line pandemic gains, while delivering strong profitability. In other words, controlling the things we can control. Our consolidated GMS was $3 billion, basically flat year-over-year and up 2.6% on a currency neutral basis.

Also when adjusting for the currency impact, GMS for the Etsy marketplace was down only a few percentage points. Our consolidated revenue grew 10.6% and adjusted EBITDA margin was 28%. Before moving into our operating highlights for the quarter, I wanted to review our recently announced leadership changes with our Chief Product Officer, Kruti Patel Goyal moving to become CEO of Depop and Nick Daniel, VP of Product promoted to fill Kruti's former role. In her 11 years at Etsy, Kruti has led almost every function, including strategy, corporate development, international, trust and safety and seller services.

Four years ago, I asked her to run our product organization and she's done a stellar job. She together with Mike Fisher, our Chief Technology Officer spearheaded Etsy's product development culture, building focus, customer obsession, agility, and accountability into the fabric of our operating rhythms. She's also built an incredibly talented bench of leaders. She's ready to be CEO of a great marketplace brand. And in my opinion, there's no one better positioned to take Depop to the next level. Kruti will move to London next month to join Depop's very talented leadership team.

I'd also like to express my gratitude to de Depop's CEO, Maria Raga. Under her leadership, Depop has taken the world by storm and defined itself as a beloved culturally relevant brand. We wish her the best in her future endeavors. Nick Daniel joined Etsy eight years ago, and over the course of his tenure has led many of the most complex and value driving product initiatives in our portfolio.

For example, the development and growth of Etsy ads and our offsite advertising program, scaling Etsy's marketing technology capabilities and launching our major push into personalization. Nick has the strategy chops to set a vision, the technical chops to ensure good execution and the leadership chops to attract and develop world class talent.

I couldn't be more excited about these changes and I'm immensely proud of the depth of leadership talent we have at Etsy. We've been intentional about building and strengthening that bench over the years, putting on in a position to make moves like these. It also highlights the career adventure. We're able to offer our team and even more now with the addition of Reverb, Depop and Elo7. I believe that's one of the reasons why our engagement remains strong and attrition low, even in these more challenging times.

Nick will now partner with Mike Fisher to lead the teams driving Etsy's right to win product development roadmap. As we've explained on prior calls this year, we're organized around making Etsy feel more made for you, more efficient [Technical Difficulty] Etsy more reliable and continuing to support our sellers growth by offering them more agency and scalability. We've directed more product teams towards active buyer growth, accelerated efforts to deepen personalization in the buyer experience and resequenced roadmaps to pull forward higher confidence retention and frequency drivers.

Let's start with search. We currently have about 100 million items for sale in unimaginable selection. And none of it maps to a catalog. Most queries have more than 1,000 relevant search results. We need to get you to the good stuff fast, but each person has their own idea of what the good stuff is. That's why it's so critical that we not only have a world-class technology, but that we marry it with world-class personalization.

In this way, we can make Etsy feel truly made for you. And along the way, build a competitively differentiated value proposition. We used to have only one search engine, which was great at finding search results, using text from the listing title, but was limited since it needed to find an exact or near exact text match in order to retrieve results. What we've talked about as the semantic gap. Over the past six months, we've gotten significantly better at leveraging multiple search engines simultaneously, each with different strengths.

For example, some are better at head queries or tail queries or understanding the true meaning of phrases. We then intelligently blend the results, personalizing them with insights, from what you've done in the past. And as of very recently real-time data from the bread crumbs you've left during this particular [Technical Difficulty] the engines getting better, but we continue [Technical Difficulty] add to cart and search results made it easier and faster for buyers to find what they'd love, thereby creating a faster to purchase with less distractions.

This change drove improvements in conversion rate and average order value, a testament to the fact that we’ve improved the quality of search and the information provided on the search result page, enough that some people are ready to buy without even needing to visit the seller’s listing page.

Last quarter we mentioned that we have a portfolio of early stage visual discovery ideas. We’re testing to learn how we can engage buyers when they don’t know what they’re looking for and to make Etsy more visual, dynamic and inspirational, again, more made for you. In June, we held a live Etsy market shopping event on our app. In the days leading up to the event, buyers could watch trailer videos for each stream and set in-app reminders. The event featured 20 sellers streaming live from their studios, sharing their stories, process and styling tips. It’s a great example of ideas we’re testing and iterating on to help sellers reach buyers in new and authentic ways.

Another visual discovery app experience during the quarter focused on helping buyers gain confidence in a purchase decision by highlighting the experience of other buyers by enabling buyers to leave video reviews. We’ve just started to collect video reviews and make it easier for buyers to access and engage with this content. And we continue to iterate on the explore feed to make it even better. We know that reliability has been an important friction point for buyers. If they can trust that the item will arrive on time, undamaged and as described, we believe we can unlock significantly more purchases from each buyer. Fortunately, our sellers generally do a great job delivering quality items at a fair price and we’ve made major progress improving metrics like on time arrival over the past two years.

That’s why we couldn’t be more excited that our new Etsy Purchase Protection program goes into effect next week. It’s going to help make shopping and selling on Etsy far clearer, easier and more reliable. This program will protect sellers and buyers for qualifying orders up to $250 when the item doesn’t match the description, arrives damaged or never arrives. Etsy expects to invest approximately $25 million annually to cover refunds at no additional cost to sellers. And the refund process will become clearer, faster and easier for many buyers.

You’ll see us get louder on these new policies as we go through the rest of the year, building up to the all important holiday season in Q4. And we’ve been doing more than ever to help our sellers grow. We’ve created an entirely new, simple and we believe very lovable Sell on Etsy mobile app, more maintainable and extensible with improved usability versus our legacy seller app.

Key new features include the ability to purchase shipping labels and to receive a heads up when a repeat buyer is messaging you. We’ve incorporated new technology to enable the release of more functionality at a faster rate than ever before. Also during the quarter, we incorporated seller feedback into our Star Seller badge, making it more achievable for sellers that provide excellent customer support.

We continue to invest to help sellers who have the skill and the will to succeed on Etsy. And we’re proud of the results. Well, we’re on the subject of helping our sellers to grow. This quarter, I also want to shine a spotlight on Etsy Ads. Over the years, we’ve made meaningful improvements to the availability of ads on our marketplace, the relevancy of ads we show to buyers and the tools we offer sellers to manage their spend and how we bid on their behalf.

This product has been a win, win, win for our sellers, buyers and Etsy. Etsy Ads revenue has grown 516% over the last five years, even faster than Etsy Marketplace’s 253% GMS growth. We’ve continued to close the semantic gap by leveraging new machine learning techniques to capture intrinsic styles and properties, thereby providing more relevant ad inventory for buyers without compromising conversion rate.

We also recently expanded Etsy Ads inventory to the homepage, while maintaining listing relevance consistent with organic search results. Seller budgets are up 80% year to date and we’re maintaining strong rows for them as well. We’ve ramped our investments meaningfully in Etsy Ads, as it’s an area where we see a long runway for continued growth. As you know, we’ve been hyper-focused this year on driving engagement and frequency. And one area I’d like to highlight is how we’ve been working to engage low frequency buyers.

More engaged or habitual users are generally more adapted coming up with ideas and/or finding what they’re looking for, which is generally not how a low frequency buyer experiences Etsy. By making Etsy more accessible and hence giving novice buyers and experienced closer to that of habitual power users, we believe we can unlock significant frequency gains over time. And we’ve been making encouraging progress.

Recent examples of wins include a revamped more diverse presentation of items above the fold on the homepage to generate interest and engagement and a revamped user interface prompting signed out buyers to download the app. Once again, app downloads had impressive growth up 53% versus last year’s second quarter. Our research and experimentation are giving us creative ideas for layouts that work to encourage scrolling by incorporating trending shops, searches and categories. All of which, of course, get far more powerful when combined with the personalization investments discussed earlier. This work is just at its infancy and will continue to tell you more about it as we make additional progress.

Another important vector for our engagement and frequency work is our international efforts. Getting the flywheel turning in additional international markets, we believe we can unlock significant growth. Recall from the last call, the insight that penetration rates in the next 15 markets beyond the U.S. and UK are about 80% lower than those top two Etsy markets, a great data point to support our belief in just how early our growth journey really is.

Some recent international wins include the launch of the first version of Localized XWalk in all our non-U.S. markets. We’re now applying this powerful search engine technology to optimize results to find the perfect listing for our non-U.S. buyers. Our fulfillment team has been hard at work moving the needle on expected delivery date, postal code coverage for non-U.S. orders and other transparency and confidence building initiatives. And we recently added another eight countries to the list of places buyers can buy now and pay later. So making Etsy more made for you and reliable, no matter where you are.

Our research shows that one of the top reasons buyers don’t shop more often on Etsy is because we aren’t top of mind for enough purchase occasions or moments. That’s what gives us continued conviction in our marketing efforts. And I’m proud of the agility of our team, continuously adapting our strategies and creative to the market environment. With macro headwinds continuing to be strong in 2022, our team has modified our very successful Meant For You and Why Buy Boring campaigns to remind people of the many purchase occasions for which Etsy is relevant, that all important shoulder tap, while leaning into value and affordability.

So the what and the why to shop Etsy during these times. The message in a nutshell is Etsy has home decor, fashion, jewellery and gifts it’s affordable and better on Etsy. We’ve also incorporated the messaging about extraordinary and affordable into our earned media engagements, our social channels and the marketplace itself. Our team has been really creative during this time utilizing our CRM tools, app notifications, emails and other on and offline techniques to drive buyer engagement and frequency. And we also had some great brand building earned media during the quarter from tried and true features, such as the Etsy Design Awards.

Turning to our subsidiary brands. 2022 has been a challenging year for all three, each of whom faced reopening and other headwinds, similar to those faced by our core marketplace. Current business conditions, notwithstanding. We have a lot of conviction that we’re in the extremely early days of realizing value from our house of brands. Kruti will hit the ground running at Depop in September where she’ll be focused on incorporating our product development culture to increase product velocity with goals that will sound a lot like what she’s accomplished for the Etsy Marketplace, highlighting seller’s unique inventory, improving search and discovery, elevating the human connections on the Marketplace and making Depop more relevant to more of its target audience and building trust in the brand and of course, driving ROI focused marketing investments that deliver results. We believe Depop has fostered one of the most passionate communities in e-commerce and it has only scratched the surface when it comes to reaching its full potential.

Reverb and Elo7 each have responded to macro challenges with creative approaches designed to set themselves up for future growth. Reverb helped buyers find their perfect instrument with updates to onsite search algorithms, localization enhancements, and improved domestic discovery in the UK. To meet buyer expectations on free shipping and returns, they helped buyers connect with sellers, offering customer services like free two-day shipping and 30-day return policies. In addition, Reverb built SEO-optimized landing pages and drove adoption of my collection, a feature that helps buyers track the value of their music gear over time.

Elo7 improved the buyer experience by introducing signals and nudges into the purchasing journey, while expanding delivery carrier options for sellers to materially reduce shipping costs, increase speed, and improve transparency for buyers. Performance marketing remained an important focus as Elo7 continues to leverage the Etsy playbook for improving spent efficiency. Rachel will talk a bit about our business model, which we want to highlight today is one of the key factors that gives us comfort in uncertain times. We see multiple scenarios possible for the remainder of 2022, but even in downside scenarios, we believe we are well positioned to deliver healthy profitability.

We'll keep focusing on the things we can control, driving great customer experiences, investing with discipline and care and helping our team to minimize distractions and focus on getting the job done. It's not an easy time for the world, but we take heart in the fact that our work has purpose, delivering value and economic opportunity for millions of sellers and giving tens of millions of buyers experiences they can't find anywhere else and most of all, the chance to keep commerce human. Thank you for your time. And with that, I'll turn it over to Rachel.

Rachel Glaser

Thanks Josh. And thank you everyone for joining us for our second quarter earnings call. My commentary today will cover consolidated results, key drivers of performance and Etsy marketplace standalone results were appropriate. As a reminder, Reverb, Depop and Elo7 are all reflected in our consolidated financial results and KPIs for the second quarter of 2022, but Depop and Elo7 are not included in our second quarter 2021 results.

On a consolidated basis our second quarter GMS was basically flat year-over-year at $3 billion, while revenue increased 10.6% year-over-year to $585 million and adjusted EBITDA was $163 million with a 28% margin. The Etsy marketplace transaction fee increase and growth in Etsy ads drove strong revenue performance, and we delivered adjusted EBITDA margins ahead of our expectations due to disciplined marketing spend and solid profit flow through. On a currency neutral basis, GMS increased 2.6% year-over-year as FX was a 300 basis point headwind.

The second quarter featured challenging comparisons as our consolidated GMS increased 13% year-over-year in the second quarter of 2021 on top of a 146% expansion in the second quarter of 2020, fueled by the initial broad-based pandemic lockdowns. In contrast today, we are seeing mobility nearing 2019 levels, a challenging global macroeconomic environment and ongoing geopolitical uncertainties. I will dive into these factors shortly.

Marketplace revenue increased 11% year-over-year and services revenue expanded 9%. The growth in our marketplace revenue was largely driven by the Etsy marketplace transaction fee increase from 5% to 6.5% effective April 11, as well as the benefit from the inclusion of our acquisitions of Depop and Elo7. Within services revenue, consolidated ads revenue increased 12.1% year-over-year, primarily due to ongoing enhancements to Etsy ads relevance and click through rate, as well as more ad inventory throughout the buyer experience. Better than expected growth of Etsy ads also drove consolidated take rate to 19.3% ahead of the take rate implied by our guidance.

Our second quarter consolidated adjusted EBITDA margin was 28% above our expectations and above the 26% reported last year. The primary driver of the adjusted EBITDA margin improvement was disciplined marketing spend and the continued growth of Etsy ads. Consolidated EBITDA margins are also impacted by headwinds related to our two new lower margin subsidiaries that were not included in year ago financials. Our three subsidiaries were more than a 400 basis point headwind to our consolidated adjusted EBITDA margin, with Depop representing the primary drag. We have a lot of conviction that the strategic rationale for acquiring Depop and Elo7 is sound, providing us access to the large resale apparel market and opening up an untapped market opportunity in Brazil.

It's also fair to say that given current significant macroeconomic headwinds, both companies have to-date performed below the financial expectations that we had a year ago. That said we remain confident in the long-term growth models for each of these businesses and believe it is early days in unlocking that value. Other factors contributing to our bottom line results include investments in headcount growth and increased compensation, including stock based compensation with the largest portion in product development, where the majority of our engineers sit. I will dig deeper into headcount growth in a moment.

In the second quarter, our stock-based compensation increased sequentially due to the annual refresh grants that were priced in March and therefore had a full quarter of impact. Finally, we had higher cloud computing costs related to greater development activity on a year-over-year basis. As you know, our marketplace operates with minimal capital requirements and there are relatively few expense items we designate as fixed. These would include our leases, the minimum obligations associated with our cloud computing costs, certain portions of our compensation and our public company costs. The vast majority of our consolidated expenses are variable or semi-variable.

Variable expenses, such as performance marketing move dynamically with revenue. Semi-variable costs are less dynamic, but are those we can moderate by tapering up or down as business demands, rise and fall. So for example, we significantly slowed new hiring this past quarter in order to better align with our pace with top line trends. That decision enabled us to invest appropriately in our existing team and stay the course on marketing and other investments while maintaining healthy profit margins.

Moving to product development, in the second quarter, consolidated product development spend was $102 million up 65% year-over-year, largely driven by headcount growth, including the Depop and Elo7 acquisitions. Our product development expenses as a percentage of revenue moved sharply lower when revenue rose dramatically in 2020 and 2021. Meanwhile, during this time we hired at a steady pace in order to scale in a more sustainable way. Product development as a percentage of revenue is now at a healthier level of spent similar to our pre-pandemic percentage, which we believe is appropriate to enable future growth.

On a trailing 12 month basis, revenue per average full-time headcount for Etsy marketplace was in excess of $1.1 million, which we estimate to be our peer group average. Our product development resources, including stock based compensation and cloud computing costs are factored into our measurement of ROI for product investment. So when we add incremental people, we also increase our GMS and revenue targets and maintain our expectation that product investment is ROI positive in the portfolio within about two years. We continue to make strategic investments that do not directly generate incremental GMS, but help us to scale our business, optimize development capabilities and keep the marketplace safe.

During the second quarter, consolidated marketing spend declined 2% from the prior year to $164 million. And as a percentage of revenue, quarterly marketing spent has been relatively consistent overall for a couple of years. Our performance marketing spend declined year-over-year driven by our improving model and data feed efficiencies combined with softer consumer demand and weaker Google search trends for our related terms. This was partially offset by a higher LTV related to our transaction fee increase, which allowed us to spend more. Our brand marketing spend increase 4% year-over-year in the second quarter, as Etsy was on air in our top three core markets with spending somewhat elevated versus the same time last year.

So to summarize while we modestly pulled back our performance marketing spend during the quarter, the ongoing improvements to our marketing models allowed us to deliver greater profitability with minimal impact to our GMS.

Moving to our Etsy marketplace performance metrics, we have maintained the vast majority of our pandemic gains with GMS increasing 141% on a year over three-year basis. For context, we delivered $2.6 billion in GMS this quarter compared to $1.1 billion in the second quarter of 2019. It’s a nice reminder to also look at how well we are doing today compared with the second quarter of 2020, when we had such a large impact from sales of face masks.

From a geographic perspective, 44% of Etsy marketplace GMS in the second quarter of 2022 was from transactions were either the buyer or the seller or both were outside the United States. Non-U.S. GMS was up 3% year-over-year on a currency neutral basis, which was driven in part by strength in Germany, where we’ve intentionally built our brand over the past few years, offsetting weakness in the UK, which continues to face difficult comparisons, primarily due to strict lockdowns in that country a year ago.

It’s also worth noting that we continue to see that our mobile app share GMS, which crossed desktop to become the highest GMS contributor in the first quarter of this year, climb as a percentage of GMS in the second quarter.

Let me take a moment to unpack the various macro factors impacting the Etsy marketplace. Starting at the top, the Etsy marketplace declined about 6% in this quarter versus prior year. Meaning we kept 94% of our GMS in the same quarter a year ago. As a reminder, in the second quarter of 2021, we continued to experience elevated GMS levels related to economic stimulus payments in the U.S., high COVID case counts and low vaccination rates. In contrast, today, we are seeing the mobility indices approach 2019 levels, as people continue to spend more time out of their home, leaving less time and money for at home shopping.

This slide shows a walk for Etsy marketplace GMS on a year over three-year view from mid-January through June. Based on third party data and our own estimates, we believe there has been a very high inverse correlation between Etsy U.S. GMS trends and U.S. retail and recreation mobility trends, particularly given our exposure to pandemic winning categories such as home and living and craft supplies.

On this chart, we’ve estimated that about 75% of our year-to-date declines can be attributed to these factors. We attribute the remainder of the decline to FX pressures, macroeconomic factors impacting consumer discretionary spending, including inflation as well as the ongoing crisis in Ukraine, which was a supply side factor for us throughout the second quarter.

Overall, consumers have many more places to spend their money and less disposable income, which is driven week-to-week volatility in our business. Similar to our commentary last quarter, we have only seen a modest impact from inflation on the price of goods on Etsy.com. As it appears, our sellers remain largely hesitant to increase prices and they often offset pricing increases with discounting.

Diving a bit deeper into categories. Reopening headwinds have specifically pressured the home and living and craft supply categories, which collectively represented over 40% of our second quarter GMS and were meaningful beneficiaries of stay at home related consumer purchasing trends during the pandemic. Trends remain positive in paper and party and apparel categories, as consumers continue to shift to in-person events and activities. Demand was also strong for travel related needs, including luggage tags, travel wallets, and fanny packs. Weddings and parties remained bright spots, especially wedding favors as larger in-person weddings resumed.

GMS per active buyer on a trailing 12-month basis for the Etsy marketplace was $136 in the second quarter down slightly on a sequential basis. On a cohort basis, spend levels for all of our cohorts remain ahead of pre pandemic levels, as all of our buyer cohorts remain more valuable today than before the pandemic. As an example, we looked at our 2020 cohort, which was first acquired during the pandemic compared to our 2017 cohort, which is an example of a typical cohort short-term performance pre pandemic.

Slide 26 shows that our 2020 cohort materially outperforms that earlier cohort in terms of value. We also monitor the spending trends of by buyer demographic, specifically income level. So far this year, we have seen fairly consistent GMS distribution across income levels, although it has shifted slightly away from lower income buyers as we continue to lap last year’s stimulus check benefits, similar to trends we are seeing reported across retail.

Encouragingly, our buyer metrics remained largely stable across active, repeat and habitual. We ended the quarter with nearly 8 million habitual buyers down 2% sequentially and 1% versus last year. These loyal buyers accounted for 46% of our GMS in the second quarter. Habitual buyer growth in core non-U.S. markets was a bright spot, particularly in Germany and Australia. We continue to have a high conviction that moving the needle further on frequency will unlock significantly more value. We added 6.4 million new buyers in the quarter, nearly 50% higher than in pre pandemic periods. Still this was down 20% from the prior year and as expected creates a material headwind to our growth.

We, again, reactivated about 5 million lapsed buyers in the second quarter. The composition of our lapsed buyer segment is increasingly compelling. Recently lapsed buyers those that made their last purchase between 13 and 24 months ago now represent about 40% of the lapsed buyer total. We believe these buyers are right for reactivation with strategic product and marketing investments, particularly given our improved CRM tools.

Moving to the balance sheet. As of June 30, we had $1.1 billion in cash, cash, equivalents and short and long-term investments and a $200 million revolver that is currently undrawn. During the second quarter, we were repurchased $62.2 million in stock under our $250 million December 2020 Board authorized repurchase program, which we completed in early July. As noted in our 10-Q in May 2022, the Board authorized a new $600 million repurchase program.

Operating cash flow for the quarter was a healthy $125.8 million. Now turning to the outlook. First, I want to highlight that our guidance assumes currency exchange rates remain unchanged at current levels. As a reminder in the third quarter of 2021, Etsy reported consolidated GMS growth of 18% on a year-over-year basis. And GMS increased 159% from the third quarter in 2019.

We currently estimate our third quarter 2022 consolidated GMS to be approximately $2.8 billion to $3 billion down about 7% to 8% at the midpoint compared to the third quarter of last year and up about 140% compared to the third quarter of 2019. For the Etsy marketplace, this implies a decline of mid to high single digits. Set another way at the midpoint of our guidance, we expect to deliver GMS of around $2.9 billion compared to $1.2 billion in the third quarter of 2019, nearly 2.5 times larger than before the pandemic. We are forecasting revenue of $540 million to $575 million up about 5% at the midpoint compared to the third quarter of last year and up about 180% compared to the third quarter of 2019.

Our two new subsidiaries also contributed to growth in the third quarter of last year. And we passed the anniversaries of these acquisitions a few weeks ago. We currently expect an adjusted EBITDA margin of approximately 26% with investment in Etsy purchase protection and higher compensation costs related to a full quarter of our now larger employee base, being the primary factors in the sequential decline.

We are encouraged to see that the year over three-year deceleration we have experienced in the past two quarters has shown signs of slowing significantly over the past eight to 10 weeks as you can see on this chart. In our view, it appears the curve has started to flatten. However, we have not yet seen a return to growth on a year-over-year basis, nor are we certain that year-over-year growth rates have bottomed given the present macro uncertainty and would therefore recommend you consider these trend lines when you are modeling fourth quarter GMS. Recall that in the fourth quarter of 2021, Etsy reported consolidated GMS growth of 17% on a year-over-year basis. And GMS increased 154% from the fourth quarter of 2019 very high comp hurdles to be sure.

It’s also fair to say that we are now more cautious than we were on our last earnings call, given continued macro pressures, particularly on consumer discretionary spending, the strong correlation between our business and mobility and the inflation factors described earlier. In less macroeconomic factors become significantly more volatile, we believe the fourth quarter will track historical holiday seasonality as our largest GMS quarter for the year.

Lastly, for your models, we substantially adjusted our hiring plans during the second quarter, which will result in a slower pace of hiring in the second half. However, our second half P&L will reflect the additional headcount we have already added. In terms of marketing spend, we generally spend more in marketing in the second half of the year versus the first in particular leaning into brand marketing during the holiday season.

Our performance marketing investment is largely variable with demand and we continue to set ROI thresholds for our spend that keep the last marginal dollar spend at or above those thresholds. We currently expect consolidated take rate for the second half of the year to be largely in line with the second quarter.

Thank you all for your time today. And I’ll now turn the call back to Deb to take your questions.

Question-and-Answer Session

A - Deb Wasser

Hi everyone. Good evening. First I want to start by saying, I know there were a couple of issues during the recording being played back. So if you go to our site later this evening, you should be able to find a fully loaded video with all the audio clear. And with that, I will start into the Q&A. Thank you all for submitting the questions. We’ll get to as many as we can. So I’ll start with Ed Yruma from Piper Sandler. Has there been a change in the seller base since you increased fees? I’ll start with that one for Josh.

Josh Silverman

Yes, thanks for the question. We haven’t seen any noticeable change in the seller base that we can track to the change in fees. In fact, I’m happy to report that seller sentiment has rebounded pretty significantly since the fee change went into effect. And I think that’s testament to the fact that we’re doing exactly as we said and reinvesting back in the community. So we’ve got some great TV campaigns going. I think that the purchase protection program is a great testament to the kinds of things we’re doing to invest that sellers really care about. So they know we have their back and buyers care about to bring more buyers back. The refreshed seller app that we’ve launched and the refresh of the Star Seller badge and lots of other good things. So we’re encouraged by that and we’ll keep building.

Deb Wasser

Great. Thanks, Josh. Next one came in from Kunal Madhukar from UBS. Given such a challenge, how easy or tough it is to scale into different languages and countries?

Josh Silverman

Great question. Thank you. The techniques that we use are generally language agnostic. These are quite advanced machine learning and neural network techniques that work regardless of the language. Of course, it does take work to make the models adapt. We need data and then the size of the training sets matter. But we have recently expanded many of the techniques into many of our international markets and we do definitely see gains.

One example we talked about last time was translation engines. I don’t mean literal translation from Spanish to English, for example, as I said, but understanding the context of a word. So for example, tiesto in English, mostly people are referring to the DJ. DJ Tiesto. If you’re in Spain, the word tiesto actually means flower pots. And so we’re using models that are sophisticated enough to understand what you meant, not just what you said, and that can be particularly powerful when we’re talking about going from one market to another.

Deb Wasser

Okay, great. Thanks, Josh. I’m going to give Kunal another one. The wallet may be early for the buyers you have added in the past two quarters in 2022. Is there behavior different from the new buyers you added during COVID? And how has behavior changed new buyers pre COVID to today? I think we had that one’s a good one for Josh. And then Rachel can add if you’d like.

Josh Silverman

Sure. So Rachel showed in her prepared remarks that the cohorts we’ve acquired since the pandemic actually are more valuable or spending more than the cohort than what pre pandemic cohorts were doing before the pandemic. And that’s continued to be true over the past six months or so since we’ve really felt the reopening come on much more strongly.

So we’re really encouraged by that. And we continue to acquire a lot of new users who are great new buyers. We are acquiring new buyers, not as fast as we were during the peak of the pandemic. That’s for sure, but we’re still acquiring them faster than we were before we entered the pandemic. We’re also reactivating lapsed buyers, and we think there continues to be a big opportunity there.

Deb Wasser

Okay, great. Rachel, well, you’re okay with that one, I think. Yes, we’ll go to the next one, okay. The next one is from Ed Yruma from Piper Sandler. Can you talk about the dynamics driving the reduction in GMS per active buyer? Is this a function of mix or are you seeing signs of a trade down? That one, I'll give to Rachel.

Rachel Glaser

Sure. Hi Ed. Nice to have you back in the Etsy team here. We – what we’ve said on the call was that GMS for trailing 12 month buyer in the quarter was up year-over-year, down slightly sequentially, but it was really down just a bit. GMS for active buyer in the quarter, meaning the actual number of active buyers in the quarter was basically flat year-over-year. So there's a slight decline in the total number of active buyers on a trailing 12 month basis who were active in Q2, which basically explains that sequential decline on the trailing 12 month number.

Josh Silverman

If I can just jump in on that. So if you look at the total number of people who bought in the second quarter and divide the GMS from them by the number of buyers that were active. Year-over-year, it's about flat. And we think that's actually really encouraging in spite of reopening and in spite of inflation and all of the other economic headwinds, the buyers that are buying with us are spending about as much year-over-year. And that's roughly flat. We are seeing a very slight decline in the number of active buyers in Q2 relative to trailing 12 month.

And again, no surprise that when people have a lot more options for where to shop and their pocket books are tighter, we might see some contraction in the number of active buyers, but actually all things considered were pretty encouraged by how those trends are holding up as well.

Deb Wasser

Okay, great. Thanks, Josh and Rachel. Next one is from Rick Patel at Raymond James. Also, back in the saddle. Can you talk about inflation, have your sellers begun to pass along higher prices in response to their input costs being up, if not, do you see an opportunity to educate the seller community on driving higher GMS like you did with the merits of offering free shipping in the past? Josh, do you want to start with that one?

Josh Silverman

Sure. The short answer is no, we are not seeing sellers take up their net prices to account for the higher input prices that they have. And so providing them more education and tools might well be a strategy. And it's certainly something we're taking a hard look at right now. We are also seeing a lot of discounting in the market, Walmart reported yesterday that they've got oversupply. And so they're having to do a lot of discounting it, it's moments like that when I continue to be grateful that our model does not require us to spend billions of dollars buying inventory in advance on the hopes that there will be demand for it when it finally arrives weeks or months later.

But nonetheless, there is a lot of discounting in the market. So here's what we've seen. We've seen over the past five years, sellers take their headline list price up by about 9%. Now 9% a year in total, over five years, item prices have gone up by about 9%. We've also launched a lot of sales and promotion tools that our sellers can use to put things on sale and our sellers are using those tools and they're using them with increasing frequency. The result of that is actually that it completely offsets the increase in item prices, meaning that the net item price has been basically flat for five straight years.

Now, our sellers, it also means our sellers are armed with the kinds of tools that they might need in a time like now, where there's a lot of heavy discounting and promotion where they can compete for that. And so we're happy that we're giving them tools to be able to compete and win, but it does mean that while many other retailers might be promoting, might be reporting revenue in GMS numbers that are benefiting from price inflation. Our sellers do not appear to be doing that at this time.

Deb Wasser

Okay. Thanks Josh. The next one comes from Tom Fort, D.A. Davidson. How should investors think about your staffing levels, given comments by your e-commerce peers, such as Amazon and Shopify suggesting that they are currently overstaffed for today's level of e-commerce demand with Shopify going so far as to implement a 10% reduction in force, Josh?

Josh Silverman

Yes. Thanks for the question. I think that our staffing level is just about right. We're at about the right size and shape right now. We feel pretty good about it. And just to give some context, when our revenues more than doubled overnight in the second quarter of 2020, and then stayed at those elevated levels and grew. We did not throw caution to the wind and suddenly go on a massive hiring spree and hire super quickly. There's a certain cadence at which you can interview people well, make sure you're getting high quality people, make sure that they have a job. That's a clear, redefined job that their manager's ready for them. That they're well trained. There's a certain cadence at which we think you can responsibly hire. And so we let revenues lead. And what we said quarter-after-quarter is margins are higher than we like and we are more leveraged than we like.

It's just that we can only hire at a certain pace. We also said, traffic is also doubled so every new product release that our team does has twice the impact because we're driving conversion rate on twice the traffic. And so revenues have led headcount, but headcount is caught up and Rachel showed a slide showing that now product development expense as a percent of revenue is roughly back to where it was before the pandemic.

I do want to point out that those numbers include the acquisitions of Elo7 and Depop, both of those are earlier staged companies earlier in their life cycles. So they're not as leveraged as Etsy. But I think that when we benchmark us to our peers, we look good. And I think especially if you look at the Etsy standalone business, we think that we benchmark quite well relative to the peer set.

So we're happy that we have been thoughtful and careful as we've gone. We've never been a growth at all cost company. We've always been disciplined about investments. But we think we're about the right size and shape right now. So we have slowed hiring as business conditions have slowed. We started to significantly slow hiring in the third quarter. We don't have a hiring freeze. We are still hiring but not at the same pace that we were in the first half of this year. And we think that's appropriate.

Deb Wasser

Okay, great. Next one, I think these two I'll give back to back for Rachel. First one is related to performance marketing from Lee Horowitz, Deutsche Bank. On the performance marketing spend declines in the quarter with much of those declines being driven by internal initiatives across your marketing team. How should we think about how performance marketing should evolve for the second half of the year?

Rachel Glaser

So thank you for the question. Performance marketing, as we’ve said, many times for us varies dynamically with demand. When we did our transaction fee increase, we were able to increase lifetime value. And so our models dynamically adjusted at higher lifetime value, we can spend more and spend deeper into the ROI curve. And on the other side – on the other hand, when demand is softer, it will dynamically pull back. So we saw both of those things happening in the second quarter where we had some decreased spending because of lower demand and on the other hand, being able to spend a bit more because of higher LTV.

Said another way we would’ve spent less had we not had the higher LTV. So flash forward going forward, we have continued – we have this continued higher lifetime value. We can continue to lean into that ROI curve. And we will expect to – what we said on the call, we would expect to be spending more – we typically spend more in the second half of the year than we do in the first, a lot of that driven by the seasonality of higher demand as we get toward the second half of the third quarter and into the holiday season in the fourth quarter. And we also said that in addition to performance marketing, we would typically spend more on brand marketing in the fourth quarter also because demand is higher at that time.

Deb Wasser

Thanks, Rachel. And the follow up I’ll ask one from Anna Andreeva at Needham. How should we think about Etsy brand marketing spend in the second half as you start going against the pullback and marketing in Q3 of 2021 and Q4 of 2021? Can you also talk about the offsite ads and how’s that’s been trending in line or ahead of expectations?

Rachel Glaser

Thank you, Anna. Let me take the offsite ads question first. Basically offsite ads is trending in line, it’s been about 1 percentage point of take rate improvement, give or take a little bit here and there, but we’re trending roughly in that same neighbourhood. On brand marketing, like I said, we typically do spend more on brand marketing in the fourth quarter, so relative – sequentially relative to the first half of the year. In the second half, we would expect to spend a little bit more on brand marketing year-over-year.

I don’t think we’ve given a guide on that specific number, but we aren’t necessarily doubling down because we try to make brand marketing as dynamic as we do with performance marketing, meaning where demand – when demand is there, we’ll spend more. We did expand from the U.S. into the UK and Germany as well in the last year. We’ll continue with that because we’ve seen very high ROI on that spend as well as very positive brand marketing results with how well we resonate top of mind in those markets. So we attribute a lot of that to the success of the brand campaigns.

Deb Wasser

Great. Thanks Rachel. Next one I’ll give to Josh from Noah Zatzkin at KeyBanc. Are there any actions you’re taking in the near-term to improve performance at Depop and/or Elo7? How are you thinking about the long-term opportunity for your house of brands?

Josh Silverman

Thanks to the question. We continue to think it’s early days and that Depop is a great brand with a great community and a great space. So we think that e-commerce is going to continue to be a big and important space, and we think Gen-Z is the place to be, and Depop is the choice of Gen -Z. So we continue to be excited and its early days for Depop and Elo7 as well. We think Brazil is a really exciting economy, a really exciting market. And having a foothold there we think is really important. We made these investments with an eye to the long-term, not the short-term and we are absolutely investing to have an impact there. So I think Kruti coming over to Depop brings tremendous knowhow.

I talked in the call about her 11 years of tenure and almost every role at Etsy. We’ve also taken Etsy Alumni now run the technology team and the product teams and very talented leaders. I think it really speaks to the bench of talent that we have at Etsy that we’re able to do this kind of knowledge transfer and talent transfer. But they’re hard at work right now on accelerating the velocity and the measurability of the product work that we’re doing.

One of the core cadences of Etsy that’s been so effective is really being able to look at what’s truly driving impact in GMS and focus our work on things that are truly unlocking gains. We’re building a lot of that into Depop really working on building performance marketing systems at Depop that can accelerate growth where we can be more measurable and attribute to ROI there. And so we’re encouraged by the work there and then more in search and discovery that we can do.

And Elo7 also, there’s been a really terrific partnership. So for example, they’re making a lot of gains right now, getting shipping costs down through negotiations with carriers. They’re also seeing real gains with performance marketing and our ability to help them be more thoughtful about how and where to do their performance marketing. And so we’re very encouraged by our opportunity to add value. We think it’s early days and we’re excited for the future.

Deb Wasser

Great. I wanted to ask Rachel this one from Rick Patel at Raymond James. How should we think about lower EBITDA margins in Q3 given the upside you had in Q2? Is there something specific about Q3 or the timing of investments that would cause the downward pressure sequentially?

Rachel Glaser

Happy to answer that question. So there’s one main reason I can cite that is suggests the sequential decline in Q3 margins from the guidance that we gave. And that’s because as I said on the call and as Josh reiterated here, even though we have slowed hiring for the rest of the year, we have been hiring steady as she goes for the last four to six quarters. And so we have sequentially more headcount, full quarter of more headcount in the third quarter than we did in the second quarter, including the headcount we acquired with the acquisitions of Depop and Elo7.

In addition, we try to stay very competitive on our compensation. We do annual market assessment and we adjust compensation relative to what we learn from that market assessment and so we've stayed competitive in higher compensation costs and more people in Q3 versus Q2 drives the primary reason for the deceleration that's offset by a higher flow through of revenue from a higher transaction fee. We get a full quarter of that in Q3 as well.

Deb Wasser

Rachel, also the purchase protection?

Rachel Glaser

That's good. And I think we have another question coming up with, yeah,

Deb Wasser

I was going to ask that one next, but go ahead.

Rachel Glaser

So we've talked a lot about this purchase – buyer purchase protection that we've recently just, just launched. We've talked about that being about a $25 million investment off our P&L on an annualized basis. So we'll be getting a partial quarter of that in Q3 that we did not have in Q2. That is something that has not to-date we haven't done a large marketing or promotional push, so that buyers better understand that we're offering as purchase protection. So right now that's a full expense on our P&L, and not necessarily being offset in the near-term with GMS. It is something over the long term that as we build trust in our brand, that we would expect to see some benefit that's the reason that we're doing is higher trust in the marketplace will remove one of the big friction points we have in repeat frequency and new buyers coming to the site.

Deb Wasser

Yeah, that's great Rachel, thank you. I was actually going to follow up with Josh on the question from the [indiscernible] from trust about just in general about purchase protection and how we see that as a long term growth driver. I don't know if you want to add anything to that Josh?

Josh Silverman

Only that I don't think it's a silver bullet that all of a sudden changes things, but brands that are known to have your back in gender loyalty and frequency. And we know that nagging voice in your head off what if it doesn't arrive or what if I don't like it, can be a real friction point on Etsy, particularly when you're buying, the nature of Etsy as you're buying an unbranded product from an unbranded seller. So we think that by backing it with the full faith and trust of Etsy we can give you the confidence and we think earn more frequency.

If you think about the brands that are really famous for this didn't happen overnight. It's something you earn and people have an experience and you have their back and they tell their friends and it grows. But fortunately this is affordable for us, because our sellers generally do a great job and people as a percentage of our total volume, don't have a lot of really bad experiences, which is what makes it feasible for us to step into this gap.

Deb Wasser

Great. We're going to go a couple minutes over, because, you know, our remarks were a little bit long. So one is for you Rachel on guidance from John Clatoni from Jefferies and I'm going to shorten the question a little bit. Can you just sort of talk about the midpoint of the Q3 GMS guidance and what's implied on a sequential basis? I think that would be sort of the core of the question?

Rachel Glaser

Yes. So there, it hits two of my favorite charts in the slide deck. I'm not sure if you've been able to see them, but on one slide we did outline the walk for Q2, what we thought the primary drivers of the GMS decline was. And by far the largest decel was coming from what we call mobility. We're almost at all the way back to the mobility level, according to Google's mobility index that we were in Q2 of 2019 or well before the pandemic. So people are out, they're dining out, they're shopping online, they're traveling and that was the biggest decline in what we saw in Q2. And we would expect – we have no reason to believe at this point that there would be a big difference in that on our Q3 numbers.

Now, the second favorite chart was the Q3 the monthlies that we gave implying where we are, that we're seeing this flattening between May and June, between June and July. And so at the high-end of our guidance, we're basically flat year-over-year on year-over-three year rather on GMS and at the low end of the guide, we see a continued slight deceleration, but at a slow on a softer slope.

Deb Wasser

Great. Thanks, Rachel. And I'm going to just take one more from Sean Dunlop at Morningstar and this one I'll ask Josh talk about, are we fully penetrated in terms of ad load, now that we've added ads to the homepage, what are the future growth opportunities for Etsy ads?

Josh Silverman

Great question. One thing I'll just say on top of Rachel's question, of course everything she said. FX is also something of a headwind, it's several percentage points in fact of a headwind to GMS. So just something to think about, I think in light of that even more encouraged by how well we're holding up. Considering part of this is just FX. So the ad load, we're really excited about the continued opportunity for Etsy ads over time. That team has just done a great job. And when we think about head count and hiring, by the way, we had a tiny group of people, one squad on that for the longest time, and now there's a few squads, but for a business that generates the kind of benefits that it does for the community, the kinds of revenue and profit, it's still a very small team.

And so the question of ad load, have we covered every surface we could on Etsy, actually it's more complicated than it sounds because the answer is it depends on the quality of ads, right? If the quality of ads are as good as organic search results then you could imagine ad load being very high. If the quality of the ad product is much worse than organic, then anywhere you put ads comes at the expense of organic listings which would be better. So the relevance of the ads that we serve has gotten dramatically better over time. And as a result, there's less variance. In fact, there's often no variance between the GMS produced by an ad or the GMS produced by an organic listing. And as the relevance of ads gets better, as sellers – more sellers take up their budget that allows us to actually expand, ad coverage or ad load even more.

They actually go hand-in-hand. There was a question asked about seller budgets, seller budgets are up 80% year-over-year on aggregate. So that I take is a nice testament that sellers are getting good ROAs relative to their expectations and what they want need from the program. That's an aggregate. But in fact, some sellers still achieve their full daily budget in the first hours of the morning. And so there's still room to go on getting more sellers to increase their budget. We still think there's a lot more we can do to make the search engine even more relevant. And as we do those things, we can expand ad coverage or add load even more.

Deb Wasser

Okay, great. We went over by a few minutes. So I'd like to thank everybody for your time and we will talk to you all soon. Thanks, Josh. Thanks Rachel.

Josh Silverman

Thank you.

Etsy, Inc.'s (ETSY) CEO Josh Silverman on Q2 2022 Results - Earnings Call Transcript - Seeking Alpha
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