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

Ready to go? All right. Thanks, everyone, for joining us. I'm Lauren Schenk, Morgan Stanley's small and mid-cap entrant analyst. I'm excited to be joined today by Rachel Glaser, Etsy's CFO. Thank you so much for being here. Before we begin, just one disclosure on my end. Please note that all important disclosures, including personal holding disclosures and Morgan Stanley disclosures, appear on the Morgan Stanley public website or at morganstanley.com\researchdisclosures or at the registration desk.

So maybe let's start bigger picture for those in the audience that may be less familiar with Etsy. Could you start off by speaking about Etsy's differentiation and market opportunity and strategy?

Yes. And before I do, as I promised my legal team and our IR team, Etsy's disclosure can be found on Etsy's IR website. I'm not going to read them out to you. So Etsy is a fairly unique marketplace. We have about 7 million sellers across all of our House of Brands, 5 million on the Etsy Marketplace, 100 million listings. But all of those listings are handcrafted, artisanal or vintage in some way. Most of our sellers, they're predominantly women. Most of them are businesses of one. A lot of them work from their homes. And we really differentiate on the what we call our 4 Rights to Win, that is being best-in-class search because when you have 100 million items, it's darn hard to find things. It's like going through a flea market but with 100 million items. Having a really trusted brand that you can trust that Etsy is behind the purchase of every item you find there even if you've never heard of the small individual seller. And that there's a human connection. Every item that you have will generally come with a handwritten note. There's a human being. You're helping support a small business from somebody around the world. And that all sits on a platform of the 100 million unique items. It's hard to think of another site exactly like Etsy where -- that has personalized, customized, unique items at scale. We think we're in about a $2 trillion total addressable market, and we're under 5% penetrated, 6 large categories, including home and living, apparel, jewelry, party and craft supplies and toys and games. So -- and a lot of other categories beyond that. So we've grown since the pandemic. We have about 90 million buyers. That's roughly double what it was since 2019. And we -- our sales have also grown significantly. We've -- since we're now in a reopening post pandemic period of time, we've held on to almost all of those gains we've made in buyers and in global merchandise sales and really pleased that people are now much more aware of the Etsy brand.

Okay. Great. Before we dive into the micro, I did want to touch on macro a bit. Could you talk about what you're seeing from a consumer trend perspective in the fourth quarter and the first quarter to date? And how are you factoring the macro uncertainty into your 1Q guide and your sort of investment plans for the year?

So great question. Interesting times. We had a great fourth quarter as we reported. And we had a very frothy beginning of Q1 into the first couple of weeks of January. And then when we did our call in February, we reported that we had started to see some what we would consider significant volatility or unusual pattern going on in the early parts of February. And when we look -- we use third-party data a lot to try to understand what's going on and what we could see was a couple of things. We were seeing a shift in consumer spending towards what you might think of as household essentials, things like milk and diapers at traditional retailers and a large shift to services like airfares. So it feels a little bit like the cross-section of a second reopening. We thought we had a reopening last year, but it seems to be a real, true reopening now and constrained consumer spending. So with people having fewer dollars to spend, they're placing -- they're using their money to do things that they haven't been able to do in quite a long time. Also remember that last year at this time, we started to see a pretty steep deceleration as we hit February and started to go through the first quarter and into the second quarter. And what we -- that has 2 effects. One is we're starting to lap lower comps. And secondly, it makes us think or one theory we have is that as we get to be larger, we might be a more seasonal business than we've been before because the decel from Q4 into Q1 is a bigger step down than it has been before. That kind of shows you the benefit of the people are aware that Etsy is the place to go to buy unique items during a special holiday time. It shows that we've made progress in being able to get -- we used to have our holiday season stop in early December because it takes longer to get Etsy products, but now they're able to continue shopping further into the month. It shows the effect of our promotional and marketing to really show up like other retailers with a strong Cyber 5 prominence. So there is some seasonality that we're starting to see. And the guide we gave on the call was that we'd be about negative 6% growth at the midpoint. And that assumes that we'd continue on this headwind trend we've been seeing in February through the end of March. We did not give a full year guide, but we did caution that there's a lot of unpredictability in the rest of the year. And recession, maybe. We don't know if there will be a recession and if there is, what impact that would have on Etsy. So we talked about mathematically because we had that decel last year and lower comps. Mathematically, sell side and buy side be tempted to model in growth even in the teens in the back half of the year. But we were cautioning that all of that growth may be wiped away by headwinds that we can't control during this macro environment.

Okay. Maybe just putting a finer point on the 1Q guide. You said at the high end, it sort of improves, an improvement to the remainder of the quarter versus when you gave guidance. Is that on a 1-year basis or on a 3- or 4-year basis?

On a 1-year basis.

On a 1-year basis, okay. And I know you haven't given explicit guidance for 2023. You just give us some points there. But are you able to talk about sort of high-level commentary about how you would expect sequential trends for the year and the possibility of return to GMS growth?

Yes. So we're super excited about many opportunities that we see in our marketplace. One of my favorite data points was that -- this will be 2. In the fourth quarter, we saw new buyer growth, 51% in Q4 versus Q3 sequentially. And we saw a significant spike in reactivations. That means buyers that had not been to the site or purchased anything in 366 days or more. Overall, throughout 2022, we had 24 million reactivated buyers. That was an all-time record for us. And what's interesting about the reactivated buyers is that they're 30% to 40% higher lifetime value in the first year after reactivation than a brand-new buyer. So they're engageable. They had a good experience on Etsy. We got them back, and they're more likely to spend more over that -- [ the prospective ] lifetime. And we have 100 million lapsed buyers. We had so much growth during the pandemic period. So there's a huge pool of prospective reactivations that are yet to come. And on the comment on the new buyer growth is that we see that only 30% of the U.S. women have purchased anything in the last 12 months and only 10% of U.S. men. And if you put all 15 markets outside the U.S. and the U.K. together, they're less than 80% penetrated versus the U.S. So there's tons of opportunity in geographies and demographics that we haven't scratched the surface yet of. So how do we do that? We are -- when you go back to the Rights to Win that I talked about. We've continued to chip away and make advancements on Search. So using Search as an example, now 90% of purchases occur in the first page of search results. We've significantly increased conversion rate from -- on the original Search query. We have less than 2% -- about 1% to 2% have a dead end result, meaning you type something, we didn't have any relevant answer for you. So we're really making progress being able to navigate and sort through the 100 million items. And we're doing a lot of work on how to not just search with a query but to be able to have a discovery. Like I -- instead of knowing exactly what I want, I type in red cashmere scarf, I type in I need a gift for my mother and being able to put together more curated results through editor's picks and through collections and other ways that call down the 100 million items into things that you're more likely to convert on. We've also -- Etsy has an app. We call it Buy on Etsy internally, and we see that we have a higher percentage of habitual buyers. Those are buyers that shop 6 or more times in a year and spend $200 or more in a year. A significant -- a disproportionate number of habitual buyers on the app. The app is the highest converting channel. And we put features on the app that you can only find on the app that make the app much more sticky, and therefore, you get a virtuous flywheel that continues to bear fruit. On the marketing side, when you ask buyers, why didn't you shop on Etsy? Very often, one of the most cited answers to that is, "I just didn't think of it." And so it's the tap on the shoulder, the reminder of you remember, you got your mother a great Mother's Day present last year. Don't forget -- remember that you can buy lots of gifts on Etsy for mothers, daughters, fathers, whatever. And Halloween, I didn't think of it. What a better place to shop than on Etsy for the -- like a really unique Halloween costume, that reminder. And marketing really serves that purpose of doing the tap on the shoulder, the reminder why Etsy and when Etsy. So we've continued to invest in marketing with a sort of ROI-focused lens and do it pretty profitably.

Okay. Great. Maybe digging into the buyer cohorts, the habitual buyer cohort grew very impressively during COVID from about 5% of the buyer base to 9%, but they have been declining for the past 3 quarters. Maybe touch on what's driving that. And would you expect habitual buyers to resume growing in the second quarter?

Yes. So the biggest thing is also a math problem. It's like what we're doing is because it's a trailing 12-month metric, when we had such a peak in growth from the pandemic period, we're churning out those older cohorts. We -- the other good news and sort of top line statement I can answer is that habitual buyers are not churning out of Etsy. The vast majority of them are turning into repeat buyers and then a very small -- this is looking at Q4 versus Q3 and then a very small percentage of them are churning out altogether or just becoming active, meaning just 1 time a year. They are still a significantly larger cohort than they were pre-pandemic. So it's -- I think pre-pandemic, it was something in the 5 to 6 percentage of our GMS range, and now it's in the 8 to 9 percentage of our GMS range. And so they're very valuable even though they're the minority of our total buyers. It's sort of very logical to us that there's something to buy on Etsy once a month, not once a year. By the way, habituals shop on average 13 times a year, and that really hasn't changed. The decrease in that number has decreased very minutely. So our focus will be on really getting people to think -- moving people into the -- to be thinking -- about 50% of our buyers are what we call repeat. They come 2 times a year. Moving that 2 times more to 4 times, like gradually getting people from where they're sitting now, where on average, they're shopping 2 times a year to bring them up to 4 times a year and using marketing as one of the levers to do that tap on the shoulder.

Okay. Maybe let's move to frequency. Frequency declined in 2022 as we came off COVID. What initiatives are you doing in '23 to reaccelerate frequency growth, particularly as you think about recent advancements in large language models and natural language processing?

Yes. So as I was just talking about with frequency a bit. First of all, repeat buyers come or what we define as 2 times a year. They, on average, shopped 5.2 times a year across that whole category of repeat, and it decreased ever so slightly to 5.1. So it's a very small decline. But we -- there's so much more room to go on frequency when we have so many initiatives. I think that the 2 biggest on the product side have a lot to do with Search, and let me put a pin in that for a second and a lot to do with the post-purchase experience where we've made a lot of investments in that once you purchased, what is your experience like with shipping and returns. On Search, a lot of you have heard of GPT 3.5, also known as large language models. And we've been really investing in all of those things for quite some time. We're pretty heavily invested in machine learning. And those things have been able to give us AI type of experiences like XWalk, and we talk about image search, where you can take a picture of an item and find all of the items on Etsy that are -- I can take a picture of you, Lauren, and it would show me a bunch of things that are similar to Lauren. And we'll continue to make investments in there. Large language models are also really good for things like search assist, like type ahead and spelling correction and query classification. And there's lots of -- it's the gift that will keep on giving for a while because we have so much more to do there. We will invest in the new models that are out there or test them. Like we do with everything, we experiment with everything. But we don't necessarily believe we have to reinvent the wheel there. There's companies that have spent billions of dollars developing those models, and we think we can really leverage what's been built. We also always use the lens of ROI positive. So we wouldn't be investing heavily in something that we didn't believe the return was there for. So -- and the last thing I'll say is we always invest in the vital few. We separate the worthwhile many from the vital few. And we would potentially be investing incrementally in those areas by redirecting some of our resources to those things, not necessarily layering on more and more incremental resources to really invest there. Long story short, we do believe that some of the latest technology and advances in AI are very, very beneficial, huge opportunity for Etsy. But we'll do that with -- we'll invest forward there with the same ROI as we have on other things. On -- still on product, on the post-purchase experience, we have invested a lot in making shipping fair or free. So we've worked with our sellers. We can acquire them to make things free, but we've worked with sellers in that. Well over 70% of our listings are free shipping-eligible. We've looked a lot on the timeliness of shipping. We'll probably never be a site where you can just push the button, and you'll have your items same day or next day. But to be able to make it clear, what items are available to [indiscernible] is much clearer on the site. We have much improved expected delivery date so that an item that you purchased and you bought it for your child's birthday is actually going to arrive in time for your child's birthday. The percentage of on-time delivery has significantly improved. And we've recently invested in Etsy Purchase Protection to have our sellers' and our buyers' back when something doesn't go right in the shipping. Maybe it gets damaged on the way or it gets stolen off the porch, that's nobody's fault. But we don't want our buyers to be left holding the bag. I mentioned these things because this entire post-purchase experience is one of the friction points in the Etsy purchase journey and is one of the things cited by buyers when we ask them why didn't you buy on Etsy? I -- the shipping was too expensive or I was afraid it wasn't going to get there on time and those kinds of things we've been gradually chipping away at to improve. Lots more to be done, both on search and the post-purchase experience. And then there's marketing, which we've talked a lot about. But we do -- we invest in marketing in the full funnel all the way from -- at the bottom where it's performance marketing to the top where we use above-the-line marketing. We have pretty sophisticated quantitative models that help us live by our philosophy that we will only spend until the last marginal dollar of spend is not hitting our ROI threshold. And we've been able to lean into performance marketing in some of the international markets, which is why we've really seen some real growth in some of those markets, and we expect to be able to do that more going forward.

Okay. Take rate has stepped up meaningfully over the past couple of years. What do you think is the right long-term take rate for Etsy? And are there any clear opportunities to increase maybe over the next 12 months?

Yes. So we didn't give any further guidance on take rate for the year other than what we guided to in Q1. We didn't give any reason for that to be modeled higher this year. Looking backwards, I think pretty much every year, we've taken take rate up one way or another. Sometimes that's through a transaction fee increase, which we did in April of this last year. So we went from 5% transaction fee to 6.5%. But we've also been able to get growth in the take rate through expanding Etsy payments into more markets, through introduction of offsite ads which was effectively a 1% take rate increase, through expansion of Etsy Ads which has continued to expand our take rate. So we feel good about getting growth in take rate in a way that benefits both the sellers and the marketplace and Etsy. We have -- we're not dogmatic about we will never do another transaction fee increase or we will always do one every year. We're always looking for what we call the fair exchange of value where there's an additional service or benefit we can provide to the sellers for which we will extract our fair share. And every time we've done one of these transaction fee increases, we've reinvested in the marketplace, meaning when you take -- when your take rate goes up, you can invest more in marketing because the LTV increases and still deliver the same ROI. And that actually drives more sales for our sellers. So it really benefits sellers and it benefits Etsy. And we'll always use that as the guideline for how we think about that. I mean, we can all think of services that Etsy doesn't offer today that other companies do. And so I think there is more room for Etsy to add services and have a fair exchange of value if we add those services, but we haven't announced any of that for 2023.

Okay. Maybe moving over to expenses and circling back on your previous comments on marketing. How should we think about marketing spend this year and balancing ultimated CAC officially, given the uncertain top line outlook? And have you considered expanding the percentage of GMS that's going through offsite ads?

Yes. So great. Those are great questions. Let me take the first one, and then I'll talk about offsite ads in a second. First, on the first one, last year on the Etsy Marketplace, so excluding our House of Brands, we spent approximately the same amount on performance marketing year-over-year and had a slight increase in the GMS from paid GMS. So that just implies that there is pretty stable efficiency. So we will -- we're very rational about this, and we'll just keep on spending. Dynamically, we'll -- our model will let us spend more or less depending on the demand side and the CPM side of the equation. When you try to calculate a CAC from what we spend and how many buyers we got, there's always a few important things to remember. One is that we are not just buying buyers in period. We're buying buyers for a lifetime, and there's a tail on that spend. A second important thing to remember is that we -- some of the marketing that we spend in session comes back to us as direct, meaning it's not -- it's helping support the sort of brand awareness, top-of-mind awareness, and the buyer will come back later in a session where they're just typing in etsy.com, and we don't count that as paid GMS. Another thing to remember is for about 35% of our performance marketing spend is offset by the offsite ads, which I will define and talk about in just a moment. And then some of the spend is -- comes back to us as revenue, not a GMS through things like Etsy Ads. So it's a little bit hard to come back to a definitive CAC. I think we've done the math for you before, and we're getting something like -- somewhere in the range of $5 to $7 per dollar -- of GMS per dollar spent on performance marketing, we feel really, really good about that. Offsite ads, just briefly defined, is when we do -- Etsy spends its P&L on PLA ads primarily on Google but a number of other channels. And if there's a successful sale on that specific listing, the seller will pay a slightly higher transaction fee. So we get more revenue for that sale. Sometimes there is a successful sale, but it wasn't on that seller's listing. Like somebody will click on brown shoes, and they don't like the brown shoes for that listing, but they find something else while they're at it. In that case, nobody is paying that extra fee. So we don't collect it on every single sale, but we do offset about 35%. We've been able to make improvements in offsite ads by adding more channels. So we've gradually started to add some affiliate channels in there and then improving the feed themselves. So today, if you look for brown shoes, you see a PLA for brown shoes, tomorrow, you might see the listing for the brown shoes, the seller's star rating status, they're -- something about their reviews and that the item is on sale or has a discount. So we'll start to add more. And that improvement improve the click and the conversion rate on that PLA.

So your other big expense bucket is headcount. You slowed hiring in the back half of '22. You talked about being more tempered or sort of taking that same sort of pace in '23. With a lot of other tech firms doing layoff, how do you think about balancing cost discipline with the increase in available tech talent out there?

Yes. Well, I think Etsy has been pretty disciplined throughout. So we started this slow hiring over a year ago when we saw that top line was starting to dance around a little bit. And we said, let's just hire at the rate that's commensurate with our top line growth. And I've always said that the easiest layoff you can do is to just not hire the people that you haven't hired yet. And so the way we operate is to try to be sort of careful and judicious with the rate of hiring so that we don't end up in a situation where we have to layoff any of our team. So I think we've been successful there. And early in this year, we just continued with our sort of slower pace of hiring. And we can -- that forces -- I love it -- what is it? Necessity is the mother of invention. I love the forcing function of having us to really think about what are the fewest possible things that are going to drive the highest possible yield. So that has been working really effectively at Etsy. The supply-demand function helps us in another way. So last year and the year before, resources were really constrained. We, every year go do a market assessment to make sure that we are paying competitively, and sometimes that results in a market adjustment. So we might have to increase our base compensation. And last year, as an example, we also increased the use of equity to bring in and retain the talent that we needed to actually produce the greatest product. Well, when it goes the other way on us, we don't reduce anybody's wages, but we don't have to pay as much to bring in the next batch of talent to the door. And in that way, I think we are always staying at the right percentile for competitiveness in pay, but it also helps us manage compensation cost. The last thing I'll say about it is we've diversified. We have a very successful robust development organization in Mexico City. So we've been able to diversify our talent pipeline, and we also have development going on in Dublin. And the pay grades vary a little bit by those in those markets. Conversely, Etsy pays everybody to a New York wage regardless of where they're located in the U.S., and that makes us very competitive in terms of an attractive place to work and a place to hire great talent.

Great. We should touch on the House of Brands, Reverb, Depop, Elo7. I think you invested roughly $50 million across those businesses in 2022. What's the road map to get those to profitability and return the brands to growth?

So Reverb is already -- hovers around breakeven. So just putting a point in that. That still then become dilutive to our margins because it's lower-margin revenue coming into the portfolio. Elo7 is not mature enough to be profitable. We want to keep investing there, but they're so small. It's not worth belaboring that point. Depop is a little larger. They're also very small. We want to be investing there. They have a brand-new CEO of that business that actually is an Etsy veteran. Kruti Patel Goyal was at -- was our Head of Product at Etsy for a long time, super brilliant, really strategic. And she's made some great progress in her -- in the way she's refocused the team there. They've been able to significantly accelerate product development velocity, which is fantastic. The focus right now is on product. And once the product feels a little bit more robust, we can turn on more of the marketing there. We've introduced things like "Make an Offer." We've introduced Depop payments. There's a lot going on here. She's forming her team, and we're really super excited about what she's been able to do so far.

Okay. All right. We've got a little over 2 minutes left. Let's wrap up on capital allocation. You generate more than $600 million of free cash flow per year. How should we think about capital allocation between additional M&A, buybacks and reinvestment?

Well, first of all, on the M&A point, I think we are -- we're still in a digestion period. Our focus right now is reinvesting in the subsidiaries we've already acquired. We're constantly looking at what's going on in the market. We keep our [indiscernible] on the pulse of what opportunities are out there. But right now, our focus is on our house -- the House of Brands we already have. We convert the majority of our EBITDA into free cash flow. So you're right, it's a big number. And we have a balance sheet philosophy where we want to maintain the right leverage ratio to -- at any point in time, we could go out and get -- raise capital at a nice rating if we wanted to go that route. And then we take some of the capital, and we buy back our own stock because we do use equity as a form of compensation, and that isn't free. And so we want to offset the dilution that, that equity creates by giving equity to our employees. So right now, we're operating under a $600 million share repurchase authorization from our Board. And actually, when you go back over time, you can look at our shares outstanding have stayed flat for the last 5 years, and our free cash flow has continued to increase. So the ratio of the free cash flow to shares outstanding is pretty nice. We see a very high return on investment from that share buybacks that we've been doing.

Okay. Excellent. I think we can wrap it there. Thank you so much for your time. Thank you, everyone, for joining us today.

Thank you.