ETSY Inc

NASDAQ:ETSY

Earnings Call Transcript 2022-Q4

[Debra Wasser, Vice President, Investor Relations]

Hi, everyone, and welcome to Etsy's Fourth Quarter and Full-Year 2022 Earnings Conference Call. I'm Deb Wasser, VP of Investor Relations. Joining me today are Josh Silverman, CEO; Rachel Glaser, CFO; and Jessica Schmidt, Senior Director of Investor Relations.

Today's prepared remarks have been prerecorded. Once we are finished with Josh and Rachel's presentations, we will transition to a live video webcast Q&A session. Questions can be submitted via the Q&A chat window displayed on your screen. I'll be reading your questions, and I'll try to get to as many as we can.

Please keep in mind that our remarks today include forward-looking statements related to our financial guidance, our business and our operating results as noted in the slide deck posted to our website for your reference. Our actual results may differ materially. Forward-looking statements involve risks and uncertainties, some of which are described in today's earnings release and our most recent Form 10-Q and which will be updated in future periodic reports that 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, we'll present both GAAP and non-GAAP financial measures, which are reconciled to GAAP financial measures in today's earnings press release posted to our IR website, along with the replay of this call.

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

[Josh Silverman, Chief Executive Officer]

Thanks, Deb. We're happy to speak with you this evening to share our latest performance and our outlook for the business. Once again, in 2022, our team was able to significantly improve the Etsy customer experience and do so in ways that had a meaningful and demonstratively positive impact on our financial metrics. We believe it's no accident that Etsy's performance has remained healthy in a volatile environment.

We're also proud of the continued focus we've had over the past five years on profitable growth and cost discipline, which we believe serves us especially well today. Our ability to retain pandemic gains supports our belief in the relevancy of our Right to Win strategy, the focus and discipline of our investment strategy and the resiliency of our business model.

The Etsy marketplace ended the year on a high note with strong holiday performance and accelerating year over three-year GMS in the fourth quarter. Etsy and our sellers helped make the season bright. GMS grew year-over-year on a currency neutral basis during Cyber 5. We had particularly strong days on Small Business Saturday and Giving Tuesday, supporting our belief that buyers associate Etsy with shopping small and making a positive impact.

We pulled out all the stops to help our sellers have the best season possible, which included holiday ad campaigns in the U.S., U.K., and Germany, spotlighting well-crafted items for all budgets, types of people, and giftable moments, out-of-home campaigns in the U.K. and Germany; increased seller participation in our annual cyber sales event, educational moments, and optimized selling tools. And last, but certainly not least, our new Etsy purchase protection program, which enhances peace of mind for buyers and sellers.

This strong fourth quarter enabled us to finish 2022, having delivered consolidated GMS of $13.3 billion, down slightly from the prior year; record revenue of $2.6 billion, up about 10%; and non-GAAP adjusted EBITDA of about $717 million, essentially flat with the prior year as we reinvested most of the Etsy transaction fee increase back into the business. Rachel will, of course, review the financials later on.

From a top-line perspective, we're now nearly 3x the size we were pre-pandemic. And we've been careful about how we've grown our cost structure with an eye towards investing in the fewest, most important areas we believe will sustain and continue to grow the business. Visible in our profitable growth and strong free cash flow during what was undoubtedly a challenging year for e-commerce at large as well as for Etsy.

I'm truly proud of our performance. And importantly, while we don't have a crystal ball, it's this sustained performance that gives us the conviction to believe that our discipline, focus and the size of our market opportunity sets us up well no matter what business conditions lie ahead.

Investment in our core Etsy marketplace have really paid off, and you saw that as we went through 2022, maintaining most of our gains in the face of enormous headwinds. That performance is summed up here. We have nearly twice as many active buyers as we did in 2019. Shoppers are coming to us more frequently and spending more with Etsy, and we're continuing to build the Etsy habit.

In addition to earning our place in buyers' hearts, we believe we've also deepened our relationship with Etsy sellers. We've seen seller cohorts retain much of the gains achieved during the pandemic even as the world reopened and e-commerce headwinds increased. Etsy's mission is to keep commerce human, and we believe that these past two years have shown that the customer needs we meet are both powerful and enduring and that Etsy offers something different.

In addition to maintaining our gains, we did, in fact, grow in some very important ways last year. Just a few examples. Strategies to introduce more buyers who identify as men to the joys of Etsy resulted in 22 million male active buyers at year-end, up 124% since 2019 and now at our highest level yet. We reactivated 24 million buyers who lapsed over the prior 12 months, the most ever reactivated in one year.

Germany was a standout performer for Etsy in 2022, with GMS increasing at a healthy double-digit growth rate and now over 4x larger than in 2019. That's pretty remarkable, especially given macroeconomic conditions in that region of the world. We made real progress in our newest core market, India, growing to over 120,000 sellers with approximately 5 million listings, over 30% of which, thanks to our investments in local payment options, are now available to local buyers. We're making important strides as we methodically build the foundation for a vibrant two-sided marketplace.

We believe that these metrics are indicative of just how early we are in expanding our share of wallet in our estimated $2 trillion TAM and our mission to bring the world a true alternative to commoditized shopping.

I'm also incredibly proud, once again, of how we cared for our people, our communities, and our planet in 2022. We come to work grateful to be able to support creative entrepreneurs around the world. And as a result, we continue to attract and retain world-class talent.

Being part of a community means that when one part is suffering, the rest of us try to step up and offer our support. And even now as we start 2023, Etsy has already stepped up to support sellers impacted by the California floods and, of course, by the devastating earthquakes in Turkey.

As you'll see in our soon-to-be-filed 10-K, we continue to make excellent progress on our ESG goals, which remain very well aligned with our business goals. At our core, we believe people want to shop their values, and they want to work where they can make a difference. We know there's so much more we can do to connect our mission to keep commerce human to the impact our marketplaces make in the world. And we see this as an integral driver of growth for our entire house of brands.

No Etsy presentation would be complete without our Right to Win slide. The strategy we unveiled in 2019, which remains robust and relevant today. We're confident that this strategy has enabled us to deepen our competitive advantages and gain market share over time and that our disciplined ROI-focused approach to investments in product, marketing, technology, and people has and will continue to pay off.

Each year, we pick a select set of customer experiences where we believe we can make material improvements in ways that result in materially better experiences for buyers, more sales for sellers and better returns for investors. Etsy teams, often working in what we call a squad, are tasked with a single customer experience to improve in ways that achieve a specific financial target.

For example, in 2022, we tasked the Etsy Ads team to make ads more relevant for buyers, while keeping seller ROAS above our target levels, which drove over $100 million in incremental annualized revenue, while improving the experience for our customers. Squads have a great deal of freedom to test fast and learn fast and a strong bias to action. They often push more than one release per week, typically to 50% of Etsy's audience, so we can quickly measure whether that release has demonstrably lifted GMS or moved the target metric.

Importantly, we meet monthly to review the progress made by each squad. By doing this across our entire portfolio of work, we're able to understand the degree of payback we're getting or not from our investments. How they're impacting daily performance and adjust our work accordingly to ensure we're moving the ball forward to improve customer experiences and meet our targets.

It's important to note, and as shown on this slide, that our teams work not only on the core buyer and seller experiences, we take the same approach across member services, trust and safety, payments, fulfillment, our Martech stack, site performance and enablement and so on.

Last year, we said in order to earn a greater share of wallet, we'd centered our Right to Win investments on inspiration, having fun and engaging experiences that keep you coming back for more. Efficiency, helping you quickly and easily get in, buy and get out when you already know what you want; and reliability, ensuring a stress-free and dependable purchase.

I'm going to run through some very tangible examples of how the approach I've just outlined shows up in our performance. A great example of how we made Etsy more inspirational is with buyer collections, a way for users to organize items into groups, which are easy to share or come back to later.

In 2021, we set a goal to increase the number and usability of collections. And that year, 29 million collections were created. In 2022, we shifted focus from creation to display to make collections a more useful part of the buyer journey and to develop ways for our community to inspire each other.

Our teams delivered excellent results, including a 20% increase in items being added to collections a 36% increase in the number of shop follows, and a 12% increase in the number of items favored it. All of this makes our work to engage buyers and personalize their experiences even more powerful.

In 2023, we plan to focus on making collections more inspiring and shoppable, building new avenues for buyers to discover, save and purchase items as well as to find and follow shops to get targeted sales and personalized updates.

We made the Etsy buying experience more efficient. Improvements in the search experience drove lifts in site-wide conversion rate and average buyer spend. We improved the buyer experience in so many ways. One of my favorite examples from last year was putting an Add to Cart button directly on the search result page based on the insight that some buyers now feel they have enough information on the search result page to buy without needing to visit the detailed listing page. This made the buying experience faster and more convenient for those shoppers, while improving conversion rate and hence driving more sales for our sellers.

Our team is particularly excited about last year's work to improve site performance. For example, we reduced page load times in search, which were cut by nearly one full second. These and other performance wins in 2022 drove nearly $100 million in incremental site-wide GMS. And we made so much progress making the Etsy experience more trusted and reliable. This included our continued efforts to provide more transparency around delivery times and launching clear listing level return policies.

At the end of 2022, over 30% of Etsy listings had a policy of accept returns clearly visible at the listing level, up from less than 10% when we started focusing on clarity of seller return policies in the fall. And Etsy purchase protection is already impacting the customer experience. Resolution times for customer issues dropped materially as our customer effort score improved from 70% to nearly 90%.

We have an equally disciplined approach to the payback we get on our marketing investments. Dollars spent in highly targeted and strategic ways to differentiate our brand, build awareness, attract new buyers, fuel engagement, and get buyers coming back.

As you know, since 2018, we've leaned more heavily into upper funnel brand strategies through TV and digital video, to capture the hearts of millions of global buyers and create a flywheel that elevates the effectiveness of our other marketing channels. As you can see, these efforts have significantly moved the needle on brand awareness and loyalty and, in particular, on purchase intent, a critical leading indicator.

While we've become a top 10 marketplace in the majority of our core markets, we continue to see so much opportunity to help buyers associate Etsy with more specific purchase occasions throughout the year. And to do so, both among those who already shop Etsy and those who don't.

We've been getting strong returns from our brand spend in terms of in-period GMS as well as lifetime value of buyers. In addition to top of funnel brand work, we've deepened our investments and elevated effort throughout the funnel. Our team delivered $100 million in incremental annualized GMS by improving the data feeds to our advertising partners and affiliate channels, improving search engine optimizations.

And fun fact, we drove about $100 million in incremental annualized GMS just from improving our e-mail campaigns. We're seeing positive returns from new channels like out-of-home and podcasting. We'll continue to lean into these carefully, testing and measuring ROI before going deeper.

With all this progress, investors often ask if there's still more opportunity to improve the Etsy marketplace. Absolutely. We believe there are many millions of potential buyers around the world who should be shopping on Etsy, but aren't yet, and so much more opportunity to build the Etsy habit for those who already know and love us.

For 2023, we've centered our Right to Win strategy and our team's work on these objectives. First, welcoming new buyers to the joy of Etsy. When we think about how we can foster continued growth over the coming years, we see new buyer growth as an important lever. We intend to meet new buyers where they are in the channels in which they're spending time and help them feel at home, no matter their interests or tastes the country they come from or how they came to us.

Second, deepening buyer curiosity and engagement. This is really about how the Etsy experience gets better the more you visit, the more you engage, and the more you shop, such as advancing our personalization to delight you with our inventory and our purchase suggestions.

Third, building trust when transacting with us. When you shop on Etsy, you're buying from one of 5 million creative entrepreneurs around the world. We want to make sure both new and existing buyers have peace of mind when buying on Etsy. Among other initiatives, we'll build on the foundation of Etsy purchase protection to help buyers and sellers have even more confidence in us, while we continue to invest in ensuring a trusted and safe platform.

And fourth, being the platform sellers love to sell on, creative entrepreneurs have so much to juggle. We'll keep investing to help them manage their shops as efficiently and effectively as possible, so they get the absolute most out of their time and money while delivering the best possible experience to buyers. We have so much on our road map that we're excited to tell you about as we go through 2023.

In 2022, we worked to integrate Depop and Elo7, which joined Reverb and Etsy in our House of Brands. While the performance of each marketplace differed, given their various stages of evolution and specific marketplace dynamics, we're excited to unlock the potential of each.

In 2022, Reverb invested in optimizing conversion rate, delivering a more customized experience to different types of music makers and driving international growth. Similar to Etsy, Reverb maintained the vast majority of its pandemic gains in 2022 and continued to meaningfully outpace the musical instrument market on a three-year basis, yet still represents less than 4% of the total musical instrument market.

Depop has become a community-powered fashion marketplace to buy and sell unique fashion with approximately 30 million registered users. While reopening, competitive dynamics, exchange rate fluctuations and other factors impacted Depop's 2022 performance, we believe it's still very early days for the resale opportunity. Kuthy and her team are focused on reigniting top-line growth by improving the core economics of the business, including the reach and relevance of search and discovery, improving the web buyer experience, embedding value signals and establishing trust to transact.

For Elo7, the easing of the COVID-19 pandemic in Brazil last year led to a resumption of consumer mobility and, therefore, a return to in-person celebration in events, Elo7 sweet spot, and the business began to see some performance improvement.

Key areas of investment for Elo7 during 2022, including conversion rate improvements and giving sellers access to faster and more affordable shipping. Elo7 also began testing an online marketing campaign aimed at driving brand awareness as it builds a broader marketing strategy.

Similar to Etsy, we believe that Elo7 can expand its consideration set in the mind of Brazilian consumers, becoming a destination they turn to more frequently for more of life's special moments.

Last year, we said it was our aspiration to make Etsy a starting point for your e-commerce journey. I feel even more confident that I did a year ago that this bold statement is the right aspiration for us. In our quest to achieve this, we'll remain hyper focused on doing something different enough that is better enough and matters often enough to win sustained customer loyalty.

I want to thank our incredible global team for all your hard work making our marketplaces better places to sell and shop in 2022 and to our shareholders for your continued support. While the world remains a fairly unpredictable place, we've proven our differentiation and resilience, and that gives us a lot of comfort as we keep our eye on the prize.

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

[Rachel Glaser, Chief Financial Officer]

Thanks, Josh. And thank you, everyone, for joining us. My commentary today will cover consolidated results for our House of Brands, key drivers of performance, and Etsy marketplace stand-alone results where appropriate.

Fourth quarter consolidated GMS declined 4% year-over-year to $4 billion, nearly flat on a currency-neutral basis. Revenue increased 12.6% year-over-year to $807 million. And we delivered adjusted EBITDA of $227 million, representing a very healthy 28% margin. Foreign exchange headwinds moderated in the fourth quarter to 330 basis points, down from 400 basis points in the third quarter.

We're pleased that the Etsy marketplace successfully anniversaried the incredibly strong prior year period, which included pandemic lockdowns and supply chain issues. In addition, we saw some acceleration in Etsy marketplace GMS growth on a year-over three-year basis, which I'll discuss more in a few minutes. Our three subsidiary marketplaces had a tougher time than Etsy with some weakness in the quarter that weighed on consolidated results.

Drilling into fourth quarter revenue growth. Marketplace revenue increased 11% year-over-year, primarily driven by the Etsy marketplace transaction fee increase from 5% to 6.5%. Services revenue outpaced marketplace growth up 17.7% year-over-year with consolidated ads revenue increasing 20% year-over-year.

While we had expected to see normal seasonal headwinds for Etsy Ads on higher organic traffic during the fourth quarter, continued product enhancements drove better-than-anticipated performance. This included utilization of neural network embeddings, a type of machine learning advancement to increase ad relevance, which drove more clicks and purchases. We also launched a more visually engaging ad experience with videos on the homepage that increase conversion and return on ad spend for sellers.

We delivered another quarter of strong profitability in the fourth quarter, with adjusted EBITDA increasing year-over-year from $219 million to $227 million driven by the higher revenue. As you can see in the chart on the left, consolidated adjusted EBITDA margin declined on a year-over-year basis in the fourth quarter, primarily due to higher marketing spend and to a lesser extent, increased G&A expense and product development spend, which drove our margin down to 28.1% from 30.5%.

It's important to note that a significant portion of product and marketing investments generally do not see payback in period, which I will discuss in more detail. As you can see from the chart on the right, we have delivered very strong bottom-line profitability over the last five years, both in margin percentage and even more importantly in adjusted EBITDA dollars.

I'd also like to highlight that since 2017, our capital light business model and disciplined expense management has allowed us to convert nearly 100% of our EBITDA to free cash flow. And we have used a portion of this cash to repurchase shares to offset dilution resulting from stock-based compensation. During this period, our free cash flow has grown meaningfully, and our share count has remained flat.

Our consolidated product development spend increased 36% year-over-year to $113 million in the fourth quarter, primarily driven by headcount additions for the Etsy marketplace. As a reminder, our product development expense line is where most of our engineers sit and represents the largest portion of our headcount growth since 2020.

We ended 2022 with approximately 2,790 employees, an increase of 16% on a consolidated basis compared to 2021. As you know and can see on the chart on the left, we began to slow hiring as our growth rate slowed in the second quarter of 2022, and we also experienced very strong levels of employee retention.

Fourth quarter consolidated headcount was essentially flat to third quarter. For 2022, our revenue per average full-time headcount for Etsy marketplace was $1.4 million, which is well above the approximately $800,000 for the Etsy marketplace in 2019 as we've hired at a pace significantly below our revenue growth rate.

Josh explained how we carefully measure payback from the product development expense line, which we generally see within about 18 months. In addition, returns per core product headcount also remain in line with a year ago levels, an indication that we remain efficient even with a significantly larger size of our team. Product development spend as a percentage of revenue was 16% for 2022, which, as you can see on the right, is now similar to our pre-pandemic range and at what we believe is in a healthy range for sustainable growth and profitability.

During the fourth quarter, we increased our consolidated marketing spend by 20% year-over-year to $245 million, primarily driven by a 29% increase in performance marketing, which represents the majority of our spend. Consolidated brand spend increased 12% year-over-year as we ran new Etsy TV and digital video campaigns in our top three core markets during the important holiday selling season.

The vast majority of our spend across our marketing channels is for the Etsy marketplace, but also includes spending for our subsidiary marketplaces. And for those of you who compute a customer acquisition cost from the marketing spend numbers we disclosed, please remember that our attribution models use the lifetime value of a buyer, not just a 30-day view. So some of the return occurs in a later period.

For the full-year, consolidated marketing spend increased only modestly, including increases in both brand and performance spend. And we delivered 40 basis points of leverage in 2022, with our consolidated marketing spend as a percentage of revenue decreasing to 27.7%. We continue to gain efficiencies in marketing.

And as you know, our offsite ads revenue offset approximately 35% of Etsy marketplace performance marketing spend, allowing us to put more dollars to work on behalf of our sellers. For the Etsy marketplace specifically, performance marketing spend drove approximately $2.5 billion in annualized GMS in 2022, up from $2.3 billion in 2021.

Moving to Etsy marketplace performance on a stand-alone basis. During the fourth quarter, Etsy marketplace GMS declined 3.5% year-over-year and was largely flat on a currency-neutral basis. We saw accelerating trends on a year-over three-year basis and growth on a currency neutral basis during the all-important Cyber 5, with our December strength being a key factor in delivering GMS at the top end of our guidance.

When looking at full-year performance trends shown on this slide, it is gratifying that we have far surpassed the 16% to 20% compounded annual growth rate target we set for the Etsy marketplace back in 2019.

From a geographic perspective, 45% of fourth quarter Etsy marketplace GMS was from transactions, where either the buyer or the seller or both were outside of the U.S. This GMS was up 5% year-over-year on a currency neutral basis, driven in part by the continued strength in Germany.

Our non-U.S. active buyers reached an all-time high of 34 million in the fourth quarter, continuing to outpace U.S. active buyer growth trends. The strong U.S. dollar drove growth in the U.S. imports for the Etsy marketplace, providing additional support for our non-U.S. sellers.

Moving to category performance. During the fourth quarter, we saw strong trends in apparel and items such as bags, purses and other gifts as well as in paper and party, driven by more in-person holiday gatherings this year. Top selling items during the holiday included personalized gifts such as custom named necklaces and jewelry boxes.

This slide shows full-year 2022 Etsy marketplace GMS in our top six categories, representing 86% of total Etsy marketplace GMS in 2022. Toys and games overtook beauty and personal care by a bit to end the year as a top six category. We believe our breadth of listings remains an important competitive advantage, allowing the Etsy marketplace to seamlessly respond to shifting consumer demand.

As you saw from our reporting throughout the year, weakness in home and living and craft supplies was generally offset by strength in apparel and paper and party supplies. We ended the year with 89.4 million active buyers, which was down slightly from the prior year, but has held up very well through reopening and other headwinds. Our active buyers have slightly increased on a sequential basis in each of the last two quarters.

We added 9.5 million new buyers in the fourth quarter. While this figure is down about 6% from the prior year, it grew 51% on a sequential basis from Q3 2022 to Q4 2022. This is a spectacular number, significantly higher than the 44% sequential growth in new buyers in the prior year. On a full-year basis, we acquired 55% more new buyers in 2022 than in 2019.

Lapsed buyers are defined as existing Etsy buyers who have not made a purchase in at least a year. In the fourth quarter, we reactivated a record number of lapsed buyers, nearly 9 million. Adding that to our strong performance in the first three quarters of 2022, we reactivated a record 24 million buyers for the year, up 24% from 2021 and 87% from 2019. We'll continue to focus on this fertile growth opportunity in 2023.

We ended the quarter with 7.4 million habitual buyers, a 194% increase from the fourth quarter of 2019, and they accounted for 40% of our Etsy marketplace GMS in the fourth quarter of 2022. The largest share of new habitual buyers came from Germany and Australia, a promising testament to our growing brand awareness in these markets.

Our repeat buyer count remained largely unchanged from the prior year at approximately 36 million in 2022, despite the reopening headwinds, with fourth quarter repeat buyer strength coming from Germany and France.

As of December 31, we had $1.2 billion in cash, cash equivalents, and short and long-term investments and a $200 million revolver that is currently undrawn. During the fourth quarter, we repurchased $150 million in stock under our $600 million May 2022 Board authorized repurchase program.

Our free cash flow for the quarter was a healthy $286 million, converting 126% of EBITDA to free cash flow. I also want to point out that the capped call relating to our mostly retired 2018 convertible notes will be settled in shares on March 1. As a result, we expect to receive shares valued at approximately $157 million.

Now turning to outlook. So far this quarter, we have continued to see significant volatility in GMS on a week-to-week basis, which led us to bake a fairly broad range of outcomes into our Q1 guidance. In addition, credit card and other third-party data shows that there may be an overall shift in consumer demand to services and household supplies like groceries and away from discretionary categories.

With that in mind, we currently estimate our first quarter 2023 consolidated GMS to be approximately $2.95 billion to $3.15 billion. Revenue to be about $600 million to $640 million and with an adjusted EBITDA margin of 26% to 27%.

As we attempt to look past the first quarter, I'll remind you that last year, we had a very strong January. We started to see rather steep GMS deceleration in the latter half of the first quarter with this deceleration continuing until about May.

In a stable macro environment, the math would suggest a return to GMS growth rates in the teens in the second half of this year. However, the data and information we are seeing so far in 2023 related to consumer spending shifts and pressure from the macro environment makes us very cautious. It is possible that the benefit we would expect from moving beyond the prior-year steep comps could be negated by increasing recessionary factors. It's just really tough for us to call right now.

So how do we plan in these uncertain times? We do a lot of scenario planning internally with a forecasting approach that starts with baseline trends from existing buyers and then layers on incremental growth from both new product initiatives and marketing. We also benefit from a marketplace model that operates with minimal capital requirements and relatively few fixed expenses. In fact, the majority of our consolidated expenses are either entirely variable or semi-variable with revenue trends.

As I mentioned earlier, we started to meaningfully slow down our pace of hiring in the second quarter of last year, commensurate with the GMS run rate we were experiencing. Now with possible recession looming and the unpredictable way this could impact us, we are maintaining this prudent approach in 2023. We're still hiring but focused on the fewest, most critical roles and tightening our belt significantly in other discretionary areas.

And as you have heard today, we have a lot in our pipeline that we are excited about. So while there is clearly an opportunity cost associated with this decision, we think it's the right thing to do given the very volatile macro conditions.

Etsy's strong acquisition of new buyers and reactivation of lapsed buyers last year are just two proof points of the strength of our brand, representative of a through line, so to speak, that cuts across volatility that we have seen and may continue to see in 2023. We highly value the agility and resilience of our team in our marketplaces, which have served us so well, enabling us to lean into critical growth investments while also protecting our margins. We believe that, that puts us in a position of relative strength, and it's our goal to do that again in 2023.

Being raised in California, I've always loved the saying that you can't stop the waves, but you can learn how to surf. We have proven we know how to surf even through choppy waters, and we hope that gives you as much comfort as it does to us.

Thank you all for your time today, and now I'll turn the call back to Deb to take your questions.

[Debra Wasser, Vice President, Investor Relations]

Hi, everyone. Nice to see you all again. Thank you for joining us. I'm going to kick it off right away with some questions. We've got quite a few in the queue.

Start with Maria Ripps from Canaccord. This one is going to be for Josh. Investing in search functionality has consistently been a pillar of the Etsy growth strategy. Looking out over the next two to three years, what are your top investment priorities as it relates to search? With all the recent momentum in AI and large language models, could we see some type of chat-based search functionality integrated into Etsy at some point? And then briefly, how has your image search feature been trending?

[Josh Silverman, Chief Executive Officer]

Great questions. Thanks very much. So as you said, investing in search and discovery is a very, very core part of Etsy's present and our future with over 120 million or about 120 million live listings. Getting you to the good stuff is really important.

Looking back at just 2022, the search team launched about 120 developments that were ramped up, meaning experiments that worked that we ramped up. And the -- some examples of those included Etsy Lens, as you referenced; better neural models; XWalk. And when we think about what those did, Etsy Lens is an example of something that allows you to talk with pictures instead of talking with words.

So how do you tell the search engine what you want in really new and novel ways? XWalk helps you to process massive amounts of information, and neuro models help you to make sense of what people mean not what they say. And in fact, the neuro models we're using use the same kind of underlying algorithms that ChatGPT uses. So we're already using some of the underlying technologies that you're seeing from great innovators like Open AI, and it's having great impact.

By the way, the search team is also doing more prosaic things that are having a lot of impact. For example, search results are now getting good enough that we could put a Buy button right on search results and allow people to buy directly from search results without having to go all the way to listing page, and that's been a great collaboration of our team to figure out exactly what information you need on the search results page in order to give someone the confidence to buy. So we made a ton of progress in 2022 in ways that improve the customer experience and drove the bottom line. We're really excited about our road map in 2023 and beyond.

And I would say that similarly figuring out more novel ways to talk to our search engine, to tell it what you want, so multimodal search through maybe pictures and words, is going to be very important. Show me things of the following style that would match well with this couch. And so those kinds of things, I think open up a huge opportunity for Etsy.

Having multiple objective functions has been very helpful. How do I do something which drives conversion rate but also drives repeat visit rate? Those two actually might not be the same in terms of search results. So training our models to solve for more than one thing at one time.

Something I'm particularly interested in is how can we get better at quality. Everyone has their own view of what great looks like and what a really good item on Etsy looks like. So how can we start to better anticipate what's right for you? How can we get more personalized so that you see only the best of Etsy as according to you? We have a great road map, and I'm really excited about the work that the team is doing.

To your specific question of could we see some kind of chat-like interface, very possibly, yes. I would say that we are constantly testing what's on the frontier. And if it makes our experience better and it does it in a way that's profitable, we're going to do it.

One other thing I just want to say is every time that search team develops a new model, a new algorithm, we look at how much extra processing power has it used. And therefore, how much extra cost has it added? And how much does it improve conversion rate and the lifetime value of the buyers? And is that profitable to ramp-up? And we only ramp-up things where the benefit it adds is greater than the cost.

Lastly, on your question about Etsy Lens, it's very early days. We're pretty subtle in terms of where we promote it in the search bar because we're just trying to learn how do people use it and make sure that the search result quality that we get is really good. But it's -- I'm very excited by the early results we're seeing, and I think there's a big future in the opportunity to talk in pictures and not just in words.

And while we're on that topic, I think there's a lot of opportunities. One for Generative AI. One is in search, no doubt. You might see it in the seller experience and making it easier for sellers to make listings. You might see it in the member services experience and having a better opportunity to get customer support. Our developers may be able to use it to make themselves more productive.

So there's lots of opportunity. We have a working group looking at all of it. There's also a lot of potentially adverse consequences. We're of course, also concerned about that. So we're going to be thoughtful. We're going to test our way in, but I'm optimistic that all of these new technologies open up new possibilities to make our experience better for our customers.

[Debra Wasser, Vice President, Investor Relations]

Great. Thanks, Josh.

The next one is for you as well as from Jason Helfstein at Oppenheimer. There was a report out about items on your marketplace violating IP. It's probably something we've never paid much attention to since it's not why buyers go to Etsy, but a quick search looks like there could be some counterfeit items. Could you talk about what you were doing about IP violation? Most of us probably don't understand what a violation is. For example, if someone is selling a knit beanie with a Swiss logo or the word Nike, is that an IP violation?

[Josh Silverman, Chief Executive Officer]

Thanks a lot for the question. I appreciate it. First, let me say that Etsy is about special. It's about things that are made by hand or vintage items, and so you're absolutely right that it is not what buyers think of for mass-produced items. I also want to state very definitively that trust is the bedrock of our marketplace, and there's no place for counterfeit items in our marketplace. And we work very hard and invest very hard to make sure that we have a clean and safe marketplace. I think we have more skin in the game than most in terms of having trust as the bedrock of our brand because our sellers are five million independent largely unbranded sellers. And so they rely on Etsy to be a trusted brand to lift them up, which is why we invest so much in this space.

Branded items make up a very small and not growing portion of Etsy's traffic and sales. So let me be even more specific about that. When we look at -- we looked at over 800 of the most popular brands in our ecosystem, and we saw that those brands were referenced in low single-digit numbers of our search queries and our sales.

I also want to be clear about the fact that the fact that they were referenced in a search by no means, means that they're IP violations. There are many legitimate reasons why a brand might be referenced in a search. It may be a vintage item. It may be fair use, and the questions you were asking were all questions about fair use.

If you use a logo on a beanie, is that legit or not? The answer is it's complicated, and it comes to something called fair use that's very difficult to adjudicate. The seller might actually have a license to that brand. They may be referencing. It is fair, for example, to reference that this item is an accessory that would fit. Like this is a handmade phone case that would be compatible with the following branded phone. Or it's legitimate to alter an item, for example, to monogram an item or to take a pair of jeans and paint something hand-painted on that. All of those are legitimate uses. So we believe that many of the times that an item or a search reference is a brand, it is actually legitimate and not violating.

That said, we care a lot about making sure that anything that is violating we get off the site. In fact, we invested more than $50 million in 2022 alone on trust and safety efforts, working closely with brands to make sure that it's very easy to identify, report and then we will take down anything that is a violation.

One example, we launched a rights holders portal that makes it very easy for rights holders to register, do searches and report to us anything that's violating so that we can work even more closely with them taking our items down. We're also very transparent in this area. So we've published a transparency report each year, and I would encourage you to go take a look at that, where we talk about the number of reports that we see in our takedown efforts. So we take this very seriously. We care a lot about having a clean and well-lighted store, and we're very proud of our efforts in this space.

[Debra Wasser, Vice President, Investor Relations]

Thanks, Josh. The next one, I'm going to start with Rachel, and I think Josh might want to add on to this one a little bit.

It's from Laura Champine of Loop Capital. What was the margin impact in Q4 of Etsy Purchase Protection? And then how do you expect it to impact the first quarter? And then maybe, Josh, we can have come back to you, and you can talk about Etsy Purchase Protection a little bit. Rachel?

[Rachel Glaser, Chief Financial Officer]

Hi, Laura, thank you for the question. So we've said in the past that we expected Etsy Purchase Protection to be about a $25 million expense on an annualized basis. We launched Etsy Purchase Protection in early August. So Q4 was our first full quarter of that $25 million that is -- so it's a small portion of the $25 million.

We're trending well within that envelope that we had previously quoted. The -- it's really early days yet to see how much GMS lift this might ultimately have, how much increase in trust that this initiative might have. We're not promoting it separately to a large extent. We're promoting it is on checkout. There is a reference there, and that comes to us at no extra cost. So I feel -- we feel good about the cost. We didn't break out any margin impact, specifically, but I'm giving you a range of magnitude on the impact to our P&L.

[Debra Wasser, Vice President, Investor Relations]

Josh, did you want to add anything else on Etsy Purchase Protection?

[Josh Silverman, Chief Executive Officer]

Yes. Just that when we look at the opportunity in frequency, when we ask people, do you intend to come back soon, and for the people who say they don't intend to come back soon, why not? Etsy has my back is a leading indicator, where they aren't confident that Etsy will have their back. And so that's why we think that leaning into trust is so important.

We're really proud of the fact that, as Rachel said, Etsy Purchase Protection is coming in right around our cost estimates, maybe even a little less. And that suggests that our sellers are doing a great job. They are shipping on time. The item is as described. It is arriving not damaged to the vast majority of the time. So we don't have as many chances to prove that we have your back because of the fact that sellers are generally doing a great job.

But the fact that the time to fix an issue has gone down so dramatically just in the past few months as a result of the Etsy Purchase Protection Program, we think is really powerful. We've gone from days to hours in terms of how long it takes to resolve an issue. And as a customer, that's a great experience. You have an issue, you contact customer support. And in the first contact, it's resolved, we give you a refund, and you move on.

We think that over time, it's not like that's a light switch that flips and suddenly your brand is perceived differently. But the next day, you go to coffee with your friends and you say, "Look, what happened to me, it was a great experience on Etsy." And over time, you build that brand. So we're very excited about the early performance of the purchase protection and want to keep investing in having our customers back, both buyers and sellers because we think it's really important.

[Debra Wasser, Vice President, Investor Relations]

Great. Thanks, both of you. I'm going to start this next one with Rachel, just to give us some stats, and then I'll turn it to Josh a little bit as well.

From Lee Horowitz at Deutsche Bank. Now that we are through what is presumably the last COVID comp, should the expectation be that habitual buyers can grow from here? And what do you see as the key areas of product improvement in 2023 that you expect to drive cross-category shopping in habitual buyer growth? Maybe, Rachel, you want to start by just kind of reiterating what we said about habitual buyers.

[Rachel Glaser, Chief Financial Officer]

Yes, so what we said on the call was that habitual buyers is about 8% of our total buyers represent 40% of our GMS actually for the full-year in 2022, it represented 44% of our GMS. And just as a reminder, habitual buyers are those buyers that come six or more times a year and spend $200 or more in a year. It was a little bit of a step-down, but those buyers are not churning out. They're actually becoming repeat buyers, and I think they follow the same trend line as all of the other headwinds we might experience during reopening, during recession, periods of time where consumers have less discretionary spend. And so it's very reasonable that we'd see some step-down from that. These numbers are significantly higher than they were pre-pandemic when habituals represented only about 5% of our total GMS.

[Debra Wasser, Vice President, Investor Relations]

Josh, do you want to talk a little bit about initiatives focused on habituals and cross-category and all that?

[Josh Silverman, Chief Executive Officer]

Work. Yes, it's a big focus of ours, and so the team is working on it in a couple of ways. Let me start with the product experience, and then I can talk about the marketing experience. In the product experience, we want to make it easy for you to pick up a thread when you're in the middle of a mission and then easy to start a new mission when you're done with the mission that you're on. And so starting to understand an intuit, are you trying to complete a mission or start a new one is one path of work the team is working on.

And then when we think about completing a mission, some of the work we talked about in the call about collections is a good example, where when you're on Etsy, you're thinking, well, maybe I want this or maybe I want that. Maybe you're planning a wedding, what are different ways I could set the table? So you might put all of those into one collection. What are some bridal gowns I might use? You might put that into a different collection that, by the way, tells us a lot about you that's very interesting. And now you've curated collections that some other buyer might also find very useful. So you've laid breadcrumbs to make it easy for you to come back and you've made it easier for us to get to know you better and in getting to know you better to become more personalized and to serve other customers as well.

And then picking up the next mission is where things like recommendation algorithms get very important and where our better understanding of things like style and taste concepts that were very difficult to understand, even using just technology five years ago that are suddenly getting much, much easier to understand, that's where I think the cutting edge is. And we're very optimistic that we can continue to do a much better job understanding your tastes, understanding what our inventory is and matching you with good recommendations.

We continue to do a good job with singles and nudges as well that continues to be a fruitful area for what are nudges we'd give you, for example, badges in the app, that would be a worthwhile reason to want to come back. Something you added to a collection might have just gone on sale, for example, or a seller or something you added to a collection might have just put something new in her shop.

So these are all different things we're doing on the site itself. Off the site, we're getting better and better at targeted marketing. So broad scale, we're launching a new television campaign in the next week or two, and you're going to see us really talk about home, fashion and gifting very explicitly. Etsy is a place to come for home, fashion and gifting. That's not exhaustive. Etsy is about -- even though those are very, very big categories and opportunities, Etsy is about so much more than even those, but trying to plant very specific associations in the minds of the consumer about when they should be thinking about Etsy.

Because we know that broad scale, they have a lot of love for the Etsy brand on average. But over the course of the day when a shopping mission comes up, they don't always associate it with Etsy. So that breadcrumb, creating that clear association is very important. CLC, this most recent campaign really leaned into those three purchase occasions, very specifically to try to build that habit.

And then we're getting even better with things like PLA, with things like SEM non-brand. We're actually seeing some really interesting progress right now with what we call mid-funnel video, for example, YouTube videos of being able to understand who are customers that we might have interacted with before and what's going on in their life. Maybe they're having a wedding, and this would be a good time to show them advertisements about the kinds of wedding offerings that we have. So there's a lot of off-site marketing we're doing as well that I'm very excited about in terms of what that can do to get people who already like us to want to think of us more often and come back more often.

[Debra Wasser, Vice President, Investor Relations]

Okay. Great, Josh. Thanks. Planning a wedding for my daughter, so all the collections are happening right now. I'm going to go to Rachel.

We got a question from Kunal Madhukar from Deutsche -- UBS, sorry. I want to make sure we clarify something we said on our prerecorded remarks, so this is going to be for Rachel. As you look for teams GMS growth in the second half, how much of that will come from growth in buyer count versus growth and spend per buyer. So I think we want to clarify what we actually said about the second half.

[Rachel Glaser, Chief Financial Officer]

Yes, so first of all, we didn't give guidance for the full-year. So we always -- we've been very cautiously, during unpredictable times, giving one quarter at a time. but we do like to give some sort of tea leaves or some suggestions of what -- how to think about in the second half. And so this time, what we said was -- I'm going to quote another CFO, who said on a call last quarter or the quarter before that, time heals all the lapping. And you would expect that time would heal all the lapping, if not for what we're seeing is pretty volatile headwinds right now from reopening, from constrained consumer balance sheets from inflationary pressures and that what we're seeing is some what I call characterized as choppy waters. And so that volatility or headwind may actually negate what we would say could be growth in the teens if not -- just because of the lapping, if not for this headwind that we're getting from the sort of exogenous factors.

[Debra Wasser, Vice President, Investor Relations]

Okay. Great. Thanks, Rachel.

The next one I'm going to get to Josh to talk about a question we got from Ed Yruma at PSC. Can you talk about the drivers of new buyer growth in the Q4. Obviously, that was a good number. How can you lean into the strengths and drive strong new buyer growth again in 2023?

[Josh Silverman, Chief Executive Officer]

Yes. Thanks for the question. So we're proud of our marketing efforts, and we think bringing new buyers to the site, the team did a really good job in the fourth quarter, both in the U.S. and in international. We continue to make gains in the U.S. And we talked about, for example, increasing male buyer penetration and investing more in different channels to do that. We talked about NFL ads in a recent call. We're also doing a better and better job in our marketing on Google and Facebook to be able to speak to male audiences in a more personalized way, and we're seeing that really pay off.

And then internationally, we've been fertilizing some of those fields, and we're starting to see really great results from that. So we've talked about the U.K. a lot. Germany was a great performer in 2022. And in both of those markets now, we have greater than 70% of purchases come from sellers in the same market. So we've got a really vibrant two-sided marketplace. And now in both the U.K. and Germany, we're a top 10 e-commerce site. That's the result of investing for a number of years to lay that foundation. So we're really excited in some of the other core markets we have now and how we can see growth there to continue to bring new buyers onto Etsy as we also continue to invest in the U.S.

[Debra Wasser, Vice President, Investor Relations]

Great. Thanks, Josh.

I'm going to move to a question from Rick Patel at Raymond James, concerning our subsidiaries starting with Josh and then Rachel will come back to you afterwards. Can you expand on the most recent developments, Josh, for Reverb and Depop? And though Elo7, he didn't ask about it, and maybe touch on some new initiatives there. And then, Rachel, circle back with the profit question.

[Josh Silverman, Chief Executive Officer]

Sure. So let's see, starting with Reverb. Reverb appears to be gaining share versus the musical instrument market, broadly speaking, over time. We feel really good about that. They have a brand that's highly differentiated in the space. Some of the things that they've been working on recently that I think are really cool is partnering directly with brands, so that those brands are launching limited-edition exclusives on the Reverb site. That's really exciting. It can be a channel for the brands over time, and it gives you a reason to want to go to Reverb because there's a lot of only on Reverb kinds of things or opportunities for brands to move inventory that didn't sell at really deep discounts. So for those of you who are musicians, keep an eye on Reverb because there's a lot of cool stuff going on there.

Another insight that they've had is that not all of the inventory is priced right because we saw so much inflation through 2021, and supply chain is backing up, and now prices have settled back down again for many items. And sellers may not have gotten the memo, and so they may have items that are priced for what looked like an attractive price nine months ago that looks very expensive today. And so they're doing a lot on value right now. How do we help coach sellers for what the current price looks like? That's the kind of thing that's really cool that's hard for Etsy to do because we don't have catalog of things for sale that all have SKU numbers. But at Reverb, they do, and they can do more of what is the current market price and help sellers make good decisions there. So that's very exciting.

At Depop, first, Kruti and the team have done a really good job of accelerating product velocity with using a lot more data to determine which parts of what they're launching are working. So that's really core to the Etsy playbook. We talked about this in our prepared remarks. Having the team broken down into small squads that each work very independently and very urgently to fix a customer problem and measure every launch they do is that actually making the customer experience better in a way that's driving more GMS. So we've been successfully installing that playbook, and velocity of the team at Depop is up substantially.

Similar to Reverb, actually, affordability is a big area that they are working on and making sure that sellers are selling items at prices that feel good to buyers. The competitive landscape for Depop is more challenging. Right now, there is a lot of competition in the recycled clothing market. And the U.K. economy has been a headwind.

It's no secret that the things are tougher and discretionary spending in the U.K. economy is tight. So those have been headwinds for Depop. But they are, I think, focused on exactly the right things. With making sure the customer experience continues to be world-class, making sure the brand continues to be a leading brand. Investing also in the U.S. where we're a huge market opportunity, much earlier for Depop, where we see some encouraging trends. And that team will keep focused as we do with all of our brands on profitable growth, doing things that drive profitable growth.

And last but not least, Elo7. Elo7 is more weighted to events and activities than the other Etsy brands. So for example, having pinatas or having birthday parties or weddings, things like that. And so as they come through COVID in Brazil, we think that's going to provide tailwinds for them to continue driving the Elo7 business in Brazil.

[Debra Wasser, Vice President, Investor Relations]

Rachel, do you want to just touch on the profitability question?

[Rachel Glaser, Chief Financial Officer]

Yes. Just -- I think the second part of the question was just on getting profitability through those subsidiaries. And first, I just want to remind you that the subsidiaries are 12% or less of our total GMS. So they're very, very small. Reverb is just at about hovering around breakeven. Elo7 is not yet profitable, but they're also too tiny to matter or make any kind of material impact to our overall margins. And Depop, we're investing for growth. It would be really the wrong thing to do to starve them at this point. But I will also say, even if they were all three breakeven or better, they would still be dilutive to our margins at this point just because they're all subscale, and so their margins would be lower. And when you factor that into Etsy's very high margins, it just brings them down by a bit.

[Debra Wasser, Vice President, Investor Relations]

Thanks, Rachel. I know we're out of time, but we're going to squeeze in one more because we want to get to it.

We got a question from Sean Dunlop at Morningstar, and it's really just about how -- what we're seeing in India. And can we talk about the early results and the road map from here, Josh, especially getting it to be going from a one-sided marketplace to two-sided?

[Josh Silverman, Chief Executive Officer]

Yes. We are really excited about the Indian market. It has a wonderful history of artisanship, craftsmanship, handmade, very aligned with the culture of India; and also the priorities of the government, which we think is great. Our ability to lift up and support Indian sellers in their own market, we think is something that we're very well aligned on, all of us together.

We have about 120,000 sellers now in India with about five million live listings, so we think that's a really encouraging start. And the big asset we bring is the opportunity for the sellers to export to other markets in a very affordable way. For $0.20, you can open a store in India and sell to the world, and so that's how we've been able to get a good number of sellers and listings. Now we are building the belt-and-suspenders to allow for a buyer experience in India as well.

And that requires shipping providers, that requires payments infrastructure. Making sure that we have all the right trust and safety, infrastructure for the Indian culture in the Indian market. And so that's the investment we've been making and the work that we've been doing. We're encouraged by the progress that we're making, and we're very excited about the future.

I do want to say we want to invest in India in a sustainable way, and so making sure that we do it in a way that supports organic growth over time and doesn't just flood the market with a lot of investment that either succeeds or fails in a short amount of time. And then if it doesn't work, we pull out with our tail between our legs. How do we sort of bit by bit, step by step invest organically in the market in a way that is very sustainable over the long-term and builds a great market? So we're excited about that. We think we have a lot to offer to the Indian market and excited by the progress we've made.

[Debra Wasser, Vice President, Investor Relations]

Great. Thanks, Josh. And with that, I'm going to call it. We look forward to seeing everyone on the road back in real life out there soon. Thank you all for joining us.

[Josh Silverman, Chief Executive Officer]

Thank you.

[Rachel Glaser, Chief Financial Officer]

Thanks, everyone.