Etsy, Inc. (ETSY) Earnings Call Transcript & Summary

Great. Maybe using that as a segue to some of the fulfillment initiatives. Free shipping has been a big initiative for Etsy. You have companies like -- Baker is using it now as a distribution platform. So I guess could you touch on, I guess, first, the free shipping initiative, how that's progressing, how sellers are responding to that? And then maybe secondly, there's some initiatives around kind of the post-purchase experience that build excitement for buyers. Can you also touch on that as well?

Yes. I mean I think we've made a tremendous amount of progress over the past 3.5 years up-leveling the buying experience on Etsy. And I think there's a ton of room still to go to get better. And shipping and delivery is a great example of that. So 1.5 years ago, it was still the case that most items on Etsy charged additional costs for shipping. At a time when, at least in the United States, Etsy was very much the exception there, "free shipping" had become the norm. And to be clear, there's no such thing as free shipping. There's no parcel service on Earth that ships packages for free. So what that actually means is that shipping had been incorporated into the price as a cost of goods sold. And Etsy sellers were still breaking out the cost of shipping and sort of rubbing it in your face at checkout, if you will. And so we strongly encouraged sellers to incorporate shipping into the item price last year, and we made a lot of progress. So I think we shared that over 70% of item views now are for things that are free shipping or free shipping-eligible. So most of the time when you're shopping on Etsy, you're going to see things that are free shipping or free shipping-eligible, particularly when the items are at $35 or more in price. And so I think that's been incredibly helpful. And in this time of COVID, when a lot of people are discovering or rediscovering Etsy, the fact that shipping prices are more aligned with the buyer's expectations has been a critical part of our success. We are now turning our attention to other areas of fulfillment that we think would benefit from more attention. In particular, when can I expect this item to arrive? And what happens if I don't like it? And on Etsy today, we sometimes have a coverage of expected delivery date, we'll estimate it. But the estimates can be quite wide and not always extremely accurate. And many purchases on Etsy are date-driven. I need it by my Labor Day party, for example. And so that's a big area of focus for us. And I think as we make progress there, it's going to make the buyer experience a lot better. And the same thing with return policies, getting to more standardized return policies, where buyers know exactly what they can expect on Etsy is going to be important. And all of these, by the way, I think, really highlight the differentiation that Etsy has and therefore the competitive advantages that we can build. We don't store things in warehouses and ship them. And by the way, we really can't or it does -- it's not practical. For most of our sellers, they simply don't make and sell enough of any individual item to have it make sense to produce a lot in advance and store it in a warehouse. So warehousing is not something that we see as practical for Etsy sellers. That also means it's an advantage that Amazon has that's not relevant to our marketplace. It's not something that our sellers would be able to take advantage of even if we offered it. So things like being able to figure out what the shipping time would be and when a customer can expect it are -- work a little differently for Etsy than they would for other people that run their own logistics. And our ability to specialize in that and get really good at that, I think, is going to continue to set us apart in this world in areas that other people -- to the extent it's a hobby for eBay or Amazon or others to focus in this area, they'll never be able to be nearly as good at it as we are.

Great. That's -- maybe a follow-up on free shipping as sellers are moving the shipping cost and the cost of goods sold. Can you touch on how that's impacted AOV? And are sellers getting more comfortable kind of making that tradeoff when they're pricing their items?

So largely, we saw, I think, about 70% of all listings had free shipping incorporated into item -- had shipping costs incorporated into item price. And that's been maintained. And new sellers that were being onboarded all during this time, that education and that philosophy of incorporating free shipping into -- incorporating the shipping costs into the item price was coming about. So gradually, over time, we've seen that shift of -- a transfer of price into the top line presented price take hold. The -- we're about to lap that or we just -- we just lapped it in August. So you'll see that, that transfer of shipping into top line, we're going to pass it. So it's no longer going to be a factor. I think that needs to be tracked or measured in the models. And then we're moving on, as Josh just described, to thinking not only about cost of shipping as a thing that is a friction point but the entire fulfillment experience. So our internal focus on product development and effort with our sellers is much more on the other things we can do to make fulfillment a pleasing experience for customers.

And Nick, maybe as part of that question, too, there was a small tailwind -- if this is where you were going, there was a small tailwind in GMS over the past 12 months because when sellers incorporated their shipping price into the item price, that sort of inflated GMS a little bit. They also chose to just eat some of the cost of shipping more than we had frankly recommended, which was a headwind to GMS. But we've largely now lapped that. Effective like roughly now, we've lapped all of those puts and takes. And so going forward, it really shouldn't matter.

Great. That's really helpful. Maybe switching gears a little bit to Etsy's take rate. So a few components that come into play here that I think investors zero in on, there's the marketplace take rate, there's a transaction fee. Now we have offsite ads, which can contribute an additional 12% to 15%. How should investors think about take rate over time? How is offsite ads kind of progressing and contributing to kind of take rate expansion? Just kind of additional color around take rate dynamic kind of from here, I think, would be really helpful.

Sure. So first, let me talk about the offsite ads. So just for people that are not familiar, we announced a product that enables us to charge a transaction fee on the PLAs that we buy on behalf of sellers. When that specific listing results in a successful sale for a seller, we charge a 12% or 15% take rate depending on what category of seller they are for us. That is not a 12 -- and that's in addition to their existing 5% transaction fee. That does not mean that those sellers are now paying 17% to 20% take rate because much of their traffic is still coming organically from Etsy's own organic efforts. We talk about only about 20% of our GMS is from paid effort, so a large percentage of our traffic and the sellers benefit from is organic. So on a subset of all of their sales, they're paying a slightly higher transaction fee. That is effectively a take rate increase. Now we didn't get a full quarter of it in Q2 because we waived the first month of fees really during a very difficult time for sellers. We wanted to give them some relief, so we did not charge any fees until the beginning of May. And then the other sort of offset to that is that we had a former product that we called Google Shopping, where we did get some revenue from that product. And so this is netted against that. So that's the -- that is one take rate increase that we will expect to see hitting our numbers going forward. The other offset to take rate in the quarter that we talked about, we have another product that we sell to our sellers. And that's called -- currently, we call it Etsy Ads. That was formerly called Promoted Listings. And that gives a seller the ability to get premium placement on a listing page if they promote -- if they want to promote their listing. And that product has done extraordinarily well. It was up over 90% in the second quarter. But GMS did even better, GMS being the denominator in the take rate equation. So as relative to GMS, it almost looks like a take rate contraction. Other things that were impacting that is we made a decision to reduce the ad load on every page, so fewer ads per page. So we took away some inventory, which also contracted a little bit the contribution of Etsy Ads to our take rate. We were very specific about what we expected for take rate for the rest of the year, so in the high 16s is -- to low 17s is the take rate that we've got right now with the products that we have. And I think everybody should also bear in mind that when we report consolidated numbers and we have Reverb included, Reverb has a lower take rate than Etsy does. And that also is a slight drag on our overall take rate. It's worth noting that Reverb also did a transaction price increase in the beginning of August. We haven't reported on those numbers yet, but they're also optimizing their total take rate. And overall, we think the take rate where we have it today is pretty competitive, and we'll continue to work on things that provide value for sellers in exchange for which we might be able to think about optimizing our take rate going forward.

Great. So switching gears now to platform enhancements. Etsy has long been focused on kind of best-in-class search and discovery, human connections, being a trusted brand. Etsy has launched features like multi-shop checkout, wish lists, improving and bringing attention to chat functionality, an ongoing improvement in search and discovery. Can you touch on how or where Etsy is addressing these areas today and what's some of the exciting enhancements you've launched or are planning to launch that may improve the platform?

Yes. Let me talk about each of those pillars. And for those who aren't as familiar, we laid out, gosh, maybe 1.5 years ago or so our right to win, which is organized around our unique -- our sellers' unique collection of items with a best-in-class search and discovery for the ultra-long tail while building real human connection between the buyer and seller and building trust because you're buying unbranded products from sellers that you don't know personally. And those 4 collectively create, we think, a sustainable competitive advantage for Etsy that is enduring into the future. And so when we look at each of those, search and discovery, we don't need to be the best in the world at search. We don't even need to be the best in the world at product search, but we need to be the best at product search for the ultra-long tail, particularly product search for things that don't map to a catalog. Every other e-commerce site is focused on taking SKUs in, mapping them to a product catalog and then comparing apples-to-apples. But our products don't have a product catalog. They're each unique. That's what makes them special. So we've got to be great at sorting through 200,000 coasters to show you the 24 that make most sense for you. And where I think we've made tremendous progress over the past 3.5 years, if you know the words to describe what you're looking for, our search engine is now much, much better at finding items that match those words. But often, we don't know how to describe in words what we want. And so the browse capability of Etsy, visual search or browse, are things we are only now just beginning to turn our attention to. And I think over the next multiple years, we're going to be able to make massive progress in that area. And I think that's important because a lot of people come to Etsy with a very specific idea of what they want. And a lot of people come to Etsy with a generalized notion that I'm looking for a gift for my partner or something nice for my home or I'm just looking to be inspired. And in each of those areas, we can do much, much better. Another area of search and discovery, where we are just beginning to tap our potential, is in personalization, recognizing your sense of style, your taste and finding things that match your taste. We have so much available for sale that, again coasters, there's 200,000 of them on Etsy. Which are the 20 that match your taste? Now we're very likely to only show your coasters and not non-coasters in search results. But how do we pick the right ones for you? That's search and discovery. On trust, we've already started to talk about some of the elements of trust. So having the shipping price aligned with my expectations is very important for trust. But will it arrive on time and what happens if I don't like it are other big areas of trust, where we are only just beginning now to dive in. And I think there's a lot of value to be unlocked in the years to come. And then the human connection on Etsy, what is so special about Etsy is the product is made just for you, but you also are connecting directly with the person who made it. And that human connection, we think, is very important. Practically, it's important because you're often discussing, "Can you design it for me this way? I like it, but can you do short sleeves instead of long sleeve or this color instead of that color?" And then also just the social element of feeling connected to people and feeling like you're making a positive contribution, we think, is important and very different, one of the areas Etsy is most different from Walmart or Amazon. You're never going to describe Walmart or Amazon as human, even if you're buying from a third-party seller. And so there, we've been investing in things like chat functionality so that the buyer and seller can communicate and chat more easily. But we launched, just last quarter, video, so that the seller can upload videos of their product or maybe how they made their product, the making process to really bring that to life. And again, I think the fact that we're only just launching video now just goes to show that we are in the very early stages of tapping that opportunity.

Maybe to follow up on search and discovery specifically, can you maybe touch on Etsy's search and discovery challenges compared to maybe Amazon, where they have SKUs and maybe it's easier to index and also touch on Etsy's ability to iterate on search and discovery kind of from a couple of years ago to today?

Yes. So in terms of the challenges and opportunities, again our products don't map to a catalog. And so Amazon and others, Walmart, eBay, they're all -- effectively, they all sell the same stuff. So let's start with that. It's the exact -- literally often, the exact same product. And so they ingest a set of data that says, "This is the product, this is the SKU number, this is the size, this is the color, these are the variations." And then they show you, this is the exact same product and here's 8 people who can sell it. And the more they compete with each other on that, the more it's a race to the bottom of who can sell that product cheaper and ship it faster. And anyone who's trying to compete by selling the exact same product, good luck to them. Etsy, fortunately, we're not selling that same product. They're selling a blue shirt and we're selling a blue shirt. But our blue shirt is not mass-manufactured with a SKU number. It's literally made just for you. And so we don't get structured data from the seller in that way. And even if we do, it's not very reliable. So for example, self-reported, the #1 material used to make products on Etsy is love. Cute but not useful for our search engine. And so we need to interpret what that product is and the attributes of that product. And this is an area where machine learning has really exploded our capability in a good way to meet that need. The ability to look at an image and say, "We think it's this and here's the attributes of it," is something that's really developed a tremendous amount in the past few years. And where Etsy is now investing is understanding the relationships between items and the relationships between people. This item has got this stone, which is related with the birth month of that month. And therefore, people who are looking for gifts for someone born in that month should think about things with this stone, for example, one small example, among many. Interpreting style and taste are things we can now do with machine learning. And Etsy has been investing a lot. And the size of the team that works on this, the machine learning team, is probably fourfold what it was 3 years ago. Our movement to the cloud is allowing us to process so much more data in so much more of an agile way, using much more sophisticated algorithms. And the state of the art in this world moves monthly. And so we're making great gains, but the state of the art is moving just as fast. And there's huge opportunity, I think, for us to continue to get better. What gets me excited is yet again it's an area where Etsy is investing a lot to be the best in the world at this very specific challenge that we have, which is much less important for others. And so I just think that the search experience on Etsy over time should become more and more differentiated from people like Walmart and Amazon and eBay and others, who, as capable as they are, it's just too small a part of their business for them to really invest in the way that we do.

Great. We have about 4 minutes left here. Maybe we could talk about capital allocation plans as Etsy is a profitable company with the recent capital injection. Maybe, Rachel, you could touch on the capital allocation strategy from here. Are there other opportunities that maybe look like Reverb about there that could potentially hit your radar?

Yes. So thank you for the question. And for those of you that didn't see it, we did raise $650 million of capital through convertible bond issuance 2 weeks ago now. And so one of the things we love about our business model is that we are -- our capital needs are light. So we don't own any part of the distribution or fulfillment apparatus that traditional retailers have to have. Our transactions happen really between a seller and a buyer. So we don't have warehouses, we don't hold inventory. And therefore, a large percentage of our EBITDA converts to free cash flow. So we generated about 100 -- over $150 million of EBITDA in the quarter and over 100% of that went to the balance sheet in cash. So we are cash-generative and we have, I think, a good balance sheet philosophy, where we've got ourselves enough dry powder to make our -- to create optionality for us and put us in a position to have capital if we choose to need it. We did a slide in our investor presentation about -- now it's 18 months ago or so in March of 2019. And we just laid out sort of the academic look at what are the ways -- what do you use capital for. So there's organic things that we've talked about having invested in Google Cloud. We've invested in marketing. So we use cash for investments that we think are important to optimize our business. There's M&A. So you saw us do Reverb a year ago. 2 years ago, we had a transaction with a company called DaWanda. That was a geographic expansion, where they have a marketplace very similar to Etsy in Germany. So we brought them into our -- integrated those -- them into our marketplace. And then a few years before that, we did more of an IP acquisition, where we bought a company called Blackbird Technologies, which really accelerated our machine learning capabilities. So along a number of different vectors we think about when is it appropriate to be doing M&A rather than building something ourselves. And then the third category is return of capital. So we've done share repurchase. We have an open and existing authorization from our Board for $200 million of share repurchase. I think there's about $75 million remaining on that authorization. And we do that because we like to offset the dilution that's created when we issue equity to our employees as part of their compensation. We feel like that's a good sort of rigor and discipline to have because that equity is free to us. So those are the range of things that we could do. And we think with the liquidity that we have and the high generation of free cash flow, we're in a good position to continue pursuing any of those things as we go forward.

Great. Well, I think that brings us to the end of the session here. Josh, Rachel, thank you so much for joining us today virtually.

Thank you for having us.

Thanks for having us.

Yes. Take care, everybody.

Thanks, Nick.