10-K 1 zu-12282014x10k.htm 10-K Zu-12.28.2014-10K
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-K
(Mark One)
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 28, 2014

¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                  to                 
Commission File Number 001-36188
zulily, inc.
(Exact name of registrant as specified in its charter)
Delaware
 
27-1202150
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification Number)

2601 Elliott Avenue, Suite 200
Seattle, WA 98121
(877) 779-5614

(Address, including zip code, and telephone number,
including area code, of registrant's principal executive offices)

Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
 
Name of Exchange on Which Registered
Class A Common Stock, par value $0.0001 per share
 
NASDAQ Global Select Market
Securities registered pursuant to Section 12(g) of the Act:
None

Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x    No ¨

Indicate by check mark whether the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨    No x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x    No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer x
 
Accelerated filer ¨
Non-accelerated filer ¨ (Do not check if a smaller reporting company)
 
Smaller reporting company ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x
 
The aggregate market value of voting and non-voting stock held by non-affiliates of the registrant as of June 29, 2014, the last business day of the registrant's most recently completed second fiscal quarter was approximately $1,594,631,642 based upon the closing price reported for such date on the NASDAQ Global Select Market.

As of February 20, 2015, there were 68,345,478 shares of the registrant’s Class A Common Stock, par value $0.0001 per share, and 56,644,920 shares of the registrant's Class B Common Stock, par value $0.0001 per share, issued and outstanding.

DOCUMENTS INCORPORATED BY REFERENCE
Part III incorporates certain information by reference from the definitive proxy statement to be filed by the registrant in connection with the 2015 Annual Meeting of Stockholders (the "Proxy Statement"). The Proxy Statement will be filed by the registrant with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of the registrant's fiscal year ended December 28, 2014.
 




ZULILY, INC.
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 28, 2014
TABLE OF CONTENTS

 
 
 
 
Page
Part I
 
Part II
 
Part III
 
Part IV
 
  
Unless the context suggests otherwise, references in this Annual Report on Form 10-K, or Annual Report, to "zulily," the "Company," "we," "us," and "our" refer to zulily, inc. and, where appropriate, its subsidiaries.

zulily, zulily, inc., the zulily logo and other trade names, trademarks or service marks of zulily appearing in this Annual Report are the property of zulily. Any trade names, trademarks and service marks of other companies appearing in this Annual Report are the property of their respective holders.


PART I

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Annual Report contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and Section 27A of the Securities Act of 1933, as amended (the "Securities Act"). All statements contained in this Annual Report other than statements of historical fact, including statements regarding our future results of operations and financial position, our business strategy and plans, and our objectives for future operations, are forward-looking statements. The words "believe," "may," "will," "estimate," "continue," "anticipate," "intend," "expect," "seek," and similar expressions are intended to identify forward-looking statements. We have based these forward-looking statements largely on our current expectations and projections about future events and trends that we believe may affect our financial condition, results of operations, business strategy, short-term and long-term business operations and objectives, and financial needs. These forward-looking statements are subject to a number of risks, uncertainties and assumptions, including those described in the "Risk Factors" section of this Annual Report. Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties, and assumptions, the future events and trends discussed in this Annual Report may not occur and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements.

You should not rely upon forward-looking statements as predictions of future events. The events and circumstances reflected in the forward-looking statements may not be achieved or occur. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, or achievements. We are under no duty to update any of these forward-looking statements after the date of this Annual Report or to conform these statements to actual results or revised expectations.

Item 1.    Business
Overview
zulily is an online retailer offering customers a fun and entertaining shopping experience with a fresh selection of new product styles launched each day. We launched the zulily website in January 2010 with the goal of revolutionizing the way moms shop. Today, we are one of the largest standalone e-commerce companies in the United States. Through our desktop and mobile websites and mobile applications, which we refer to as our “sites,” we help our customers discover new and unique products at great values that they would likely not find elsewhere. We provide customers a fun and entertaining shopping experience with a fresh selection of product styles offered on a typical day through flash sales events, which are limited-time curated online sales of selected products launched each day on our sites. We source our merchandise from thousands of vendors, including emerging brands and smaller boutique vendors, as well as larger national brands. By bringing together millions of customers and a daily selection of products chosen from our vendor base, we have built a large scale and uniquely curated marketplace.
We have organized our operations into two principal segments. The North America segment consists of amounts earned from retail and services sales through our U.S.-operated sites, including sales from the sites to customers in the United States, Canada, Australia and other foreign countries. The U.K. segment consists of amounts earned from retail and services sales through our U.K.-operated sites, including sales from the sites to customers in the United Kingdom and other countries in Europe. See Note 10: "Segment Information" and Note 14: "Subsequent Events" of the Notes to Consolidated Financial Statements within Item 8 of Part II of this Annual Report.
Business Strategies
Making shopping entertaining for our customers is core to who we are and what we do. We think beyond just offering what consumers are directly looking for and instead look to inspire purchasing by finding and offering a curated set of products from new and emerging brands that could not otherwise easily be found. Our customers are passionate about buying products for themselves and their kids that stand out and look special, particularly at

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affordable prices. Our goal is to be part of our customer's daily routine, allowing them to visit our sites and discover a selection of fresh, new and affordable merchandise curated for them every morning.
Every morning, we launch a variety of flash sales events. These events feature thousands of product styles from different vendors and typically last for 72 hours. The day’s events are kicked off by an early morning email to our email subscribers and “push” communication to users of our mobile applications. Offerings are only available for a limited time and in a limited quantity, creating urgency to browse and purchase. The majority of our products are sourced from emerging brands and smaller boutique vendors that our customers may not have heard of and whose products are not widely available online. We also offer larger nationally known brands that appeal to our customers and draw new customers to our sites.
Before we launch an event, our photography team typically photographs our merchandise in our in-house studios and our editorial team writes about our merchandise so that we can present each day’s selection of product in our fun and engaging voice. The experience, creativity, resourcefulness and efficiency of our merchandising, creative and operations teams enable us to feature thousands of product styles each quarter. We work to create the most compelling price points for our customers, with the average item on our sites offered for over 50% off the manufacturer’s suggested retail price. We then use our proprietary technology, data analytics and personalization tools to segment our audience, offering each customer a curated and optimized shopping experience that features brands, products and events that we believe are most relevant for that customer.
Our objective is to be the leading online retail destination for moms. We plan to attain this goal through the following key strategies:
Continue to Acquire New Customers.    We plan to grow our customer base by attracting visitors to our sites through targeted and cost-effective marketing campaigns and then converting these email subscribers into active customers. We test new marketing channels and campaigns aimed at attracting new email subscribers and converting existing email subscribers into customers, constantly and rigorously measuring the returns on these campaigns.
Continue to Increase Customer Loyalty and Repeat Purchasing.    Our goal is to maintain our leadership as a preeminent e-commerce company by continuing to offer a wide variety of new and unique products, refreshed daily and curated specifically for each customer, at compelling values and presented in a fun and entertaining format. Ultimately, we aim to become part of each of our customer’s daily routine by broadening the ways in which we interact with our customers, including via mobile, social and email channels. We also regularly introduce new categories, brands and products of interest to our customers, and work to maximize the relevance of the items we display, thereby improving customer satisfaction, increasing customer loyalty and driving higher repeat purchasing.
Continue to Add New Vendors and Strengthen Existing Vendor Relationships.    Our merchandising team is continually discovering new vendors with compelling and unique merchandise to add to our large base of existing repeat vendors. We use the substantial structural advantages in our business model to build strong long-term relationships with our vendor partners. Our platform creates a large-scale marketing, technology and distribution advantage that our vendors can leverage, efficiently and cost-effectively, to drive greater brand awareness and significant incremental sales. We will continue to develop tools and resources that allow us to provide our new and existing vendors with a compelling return on investment and a successful platform to scale their businesses. In the near term, we plan to continue to expand our vendor fulfillment services, consignment arrangements and other services to continue to strengthen vendor relationships.
Continue to Invest in Our Mobile Platform.    The e-commerce industry’s shift to mobile represents a key growth opportunity for us. We expect our mobile revenue to continue to grow as a percentage of our net sales.
Expand International Presence.    To date, we have primarily focused on growing our U.S. business and are just beginning to focus on our international strategy, which has included expanding into the United Kingdom, Canada, Australia and Ireland. We are gradually increasing the level of investment in our international expansion and plan to continue to understand, invest in and develop international markets, balanced with a continued focus on building the core U.S. market.
Opportunistically Pursue Strategic Acquisitions.    We may expand our business through opportunistic acquisitions that will allow us to enhance our customer offering, enter new geographies or leverage our existing platform capabilities, among other things.

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Product Offerings and Vendor Relationships

We offer merchandise primarily targeted at moms purchasing for their family, themselves and their homes. Our merchandise includes women’s, children’s and men's apparel, children's merchandise and other product categories such as kitchen accessories and home décor. Many of our customers initially purchase in one product category, but as they discover new products on our sites, they purchase from other categories as well. Our model of rapidly launching new styles allows us to easily experiment with new categories efficiently and cost-effectively. The average value of an order placed during the fiscal years ended December 28, 2014 and December 29, 2013 was $56.07 and $54.75, respectively. Our current categories include:
Category
Offering
Women’s Apparel
Apparel, Special Sizes, Maternity/Nursing, Intimates, Accessories, Shoes
 
 
Children’s Apparel
Infant, Two to Six Year Old Children, Tween Girls, Tween Boys, Accessories, Shoes
 
 
Men's Apparel
Apparel, Accessories, Shoes
 
 
Children’s Merchandise
Infant Gear, Sports Equipment, Toys, Books
 
 
Other Merchandise
Kitchen Accessories, Home Décor, Entertainment, Electronics, Pet Accessories, Health and Beauty Products
Our primary vendors are emerging brands and smaller boutique vendors. These are typically small-to-medium sized businesses. Since these vendors’ products are typically not available broadly online, the vendors generally work with us to gain brand awareness and generate incremental sales. We introduce these vendors to our large audience and help them tell their stories in a way that differentiates their products and properly reflects their brand attributes. Our entire operational infrastructure - photography studios, editorial writers, fulfillment operations and technology capabilities - is designed to showcase these emerging brands’ and smaller boutique vendors’ products in the most compelling, engaging and personalized way, providing great value to our customers and revenue to our vendors as cost-effectively as possible.
We serve as an important channel for our vendors because by working with us they eliminate wholesale, direct sales and fulfillment costs for the products they sell through our platform. Because of our minimal inventory, intermediary model and short event cycle, we are able to experiment with a broad range of new products and a wide variety of vendors on a regular basis. Our vendors typically provide us with first-run, in-season merchandise as they are incentivized to get their best products in front of the broadest potential customer base. We supplement our boutique brand offerings with events from larger national brands and often become a meaningful partner for these larger national brands as well, driving significant sales and vendor loyalty. We typically purchase merchandise from our vendors through purchase orders we issue as we conduct flash sales events.
Sales and Marketing
We acquire new email subscribers through a diverse set of paid and unpaid marketing channels, including affiliate channels and partners, customer referrals, direct navigation, display advertising, key word search campaigns, search engine optimization, social media and television ads. Core to our business model is that we acquire customers once via paid and unpaid sources, and then we drive engagement and repeat purchases from those customers over a long period of time through the sending of daily emails and mobile “push” communications.
We evaluate each of our marketing initiatives for its return on investment based on marketing spend measured against net sales and contribution margin generated. Although some of the visitors to our sites become customers when they first sign up, other visitors may sign up to receive our emails and “push” communications months before they make their first purchase. A portion of our marketing spend is meant to target these visitors for whom the conversion to purchasing comes after we have built a substantial relationship with them through regular contact and outreach over time.

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Technology
Continual innovation through investment in technology is core to our business. We use our technology platform to improve the experience of our customers and vendors, increase the purchase frequency and average order size of our customers and optimize the efficiency of our business operations. Our technology team is focused on rapid innovation through advanced agile software development processes. Our scalable platform uses custom-built and third-party technologies to support our specific customer and vendor requirements, including handling significant spikes in site traffic and transactions on a daily basis, and the rapid and complex order fulfillment needs that are unique to our flash sales and minimal inventory model. We believe we can quickly scale our infrastructure to accommodate significantly higher volumes of site traffic, customers, orders and the overall growth in our business.
We have built a comprehensive set of technology solutions, including:
•
e-Commerce Platform.    Our core e-commerce platform consists of our customer facing desktop website, our mobile website and applications, our order processing and customer service systems.
•
Mobile Platform and Applications.    Mobile is a key component of our long-term strategy. Our mobile website and applications for iPhone, iPad and Android-based devices were custom built for our unique needs and are powered by the same core platform that powers our e-commerce platform.
•
Relevancy and Personalization Systems.    Our system is designed to provide a customized and personalized experience in real time to each email subscriber and customer in order to maximize the relevancy of the products we present to them. To provide this personalized experience, we process and analyze the large amounts of data generated by our email subscribers’ and customers’ browsing and shopping patterns on our sites.
•
Customer Messaging.    Every morning we send millions of personalized emails and alerts to our email subscribers and users of our mobile applications. To do this we have built an advanced customized messaging platform leveraging both our own proprietary technology solutions and third-party software solutions. In addition, our systems manage standard e-commerce customer communications such as order and shipment confirmations on a routine basis.
•
Merchandising and Vendor Tools.    We have built tools, including vendor management, vendor portal, catalog and event management that leverage our own proprietary technology and open source technology to manage our event process from end-to-end. Our platform supports hundreds of internal users and thousands of vendors and is designed specifically to effectively support emerging brands and smaller boutique vendors who may have limited systems and technical expertise.
•
Fulfillment Management Systems.    Our fulfillment management system combines custom-built and third-party software to satisfy our unique needs in a flexible and efficient manner. Our system allows us to efficiently manage inventory, track orders, fulfill orders and deliver the products to our customers in a timely manner. Our fulfillment management systems are integrated with our customer messaging system in order to provide real time information on order status and expected delivery date.
Customer Service
Our goal in customer service is to “deliver magical service that inspires customers to be advocates for life.” We use both in-house operations and a U.S.-based third-party customer service provider which allows us to deliver high quality service at lower costs. Our goal is to deliver the highest quality of customer service to our customers, and our customer service operators are empowered to make the right decision for the customer and strengthen that customer's experience with zulily.
Fulfillment
To best serve our customers and vendors, we have in place a custom, fully integrated fulfillment infrastructure consisting of our receiving, sorting, inventory management and repackaging systems which are coordinated by our proprietary fulfillment management software. Our supply chain solution efficiently handles the small-to-medium lot sizes and high inventory turnover required by our constantly changing, limited-time product offerings. We operate a minimal inventory, intermediary model where we typically take customer orders before we purchase inventory from our vendors. As a result, we are able to offer a much larger selection of products to our

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customers and to generate greater sales for our vendors, who are able to match a broader range of their product supply to actual customer demand.
Seasonality
We believe our results are impacted by a pattern of increased sales during the back-to-school shopping season in the third quarter and holiday shopping season in the fourth quarter which has resulted in increased sales during a portion of the third quarter and the fourth quarter each fiscal year, which then results in lower sequential growth in the first quarter. The fourth quarter accounted for approximately 32.6% and 36.9% of our net sales in the fiscal years ended December 28, 2014 and December 29, 2013, respectively. See Item 1A, “Risk Factors” for further information regarding seasonality.
Competition
We view our target market broadly and we believe we are competitive with any retailer where our customers shop. We face significant competition from both online and offline retailers. Our customers have a wide variety of shopping options that include:
•
Direct e-Commerce Websites and Online Marketplaces.    These websites include pure play e-commerce companies, such as Amazon.com, Inc. and Alibaba Group, the e-commerce platforms of traditional retailers, such as Target Corporation, Toys“R”Us, Inc., and Wal-Mart Stores, Inc., and online marketplaces such as eBay Inc. A substantial number of flash sales sites have similar business models in related and unrelated market segments, including Gilt Groupe Holdings, Inc., HauteLook (which is owned by Nordstrom, Inc.), MyHabit (which is operated by Amazon.com), One Kings Lane Inc., Groupon, Inc., Wayfair LLC and RueLaLa.com (which is operated by Retail Convergence.com LP).

•
In-person Stores and Boutiques.    These include discount and mass-merchandisers, such as Ross Stores, Inc., Target Corporation, The TJX Companies, Inc., Toys“R”Us, Inc., and Wal-Mart Stores, Inc., as well as boutique sellers of women's, children’s and men's apparel, children's merchandise and other product categories such as kitchen accessories and home décor.

We compete based on: product curation and selection, personalization, value, convenience, ease of use, consumer experience, vendor satisfaction and shipping time and cost. While our industry is evolving rapidly and is becoming increasingly competitive, we believe that we compete favorably across these dimensions taken as a whole.
Intellectual Property
We rely on laws and regulations, contractual restrictions, copyrights, and trademarks to protect our intellectual property and proprietary rights. Our employees and contractors also typically enter into agreements to assign to us the inventions and content they produce in performing their jobs. We control access to our confidential information by entering into confidentiality agreements with our employees, contractors and third parties, such as vendors, service providers, individuals and entities that may be exploring a business relationship with us. Despite the protection of general intellectual property law and our contractual restrictions, it may be possible for a third party to copy or otherwise obtain and use our intellectual property without our authorization.
We have registered numerous Internet domain names related to our business. As of December 28, 2014, we had two pending patent applications directed to our technology in the United States. In addition, we pursue the registration of our trademarks in the United States and certain other locations outside of the United States; however, effective intellectual property protection or enforcement may not be available in every country in which our products and services are made available in the future. In the United States and certain other countries, we have registered or have applications pending for our key trademarks: zulily, the zulily design mark and the “Z” design associated with our mobile applications.

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Employees
As of December 28, 2014, we had 2,907 employees globally. Additionally, we rely on independent contractors and temporary personnel to supplement our workforce, primarily in our fulfillment centers. None of our employees are represented by a labor union or covered by a collective bargaining agreement. We consider our relationship with our employees to be good.
Fiscal Year
Our fiscal year ends on the Sunday closest to December 31 of the respective calendar year. Each fiscal year consists of four 13-week quarters, with one extra week added in the fourth quarter every five to six years.
Corporate Information
We were incorporated in 2009 in Delaware. zulily's principal executive office is located at 2601 Elliott Avenue, Suite 200, Seattle, WA 98121. We also operate a buying and studio office in Columbus, Ohio and a customer service office in Gahanna, Ohio and have fulfillment centers in McCarran, Nevada and Lockbourne, Ohio. Our telephone number is (877) 779-5614 and our website address is www.zulily.com. The information on, or that can be accessed through, our website, is not part of this Annual Report.
Available Information
Our investor relations website is http://investor.zulily.com and we encourage investors to use it as a way of easily finding information about us. We promptly make available on this website, free of charge, the reports that we file or furnish with the Securities and Exchange Commission (“SEC”), and corporate governance information (including our Code of Business Conduct and Ethics). We file annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy and information statements and amendments to reports filed or furnished pursuant to Sections 13(a), 14 and 15(d) of the Exchange Act. All material we file with the SEC is publicly available at the SEC's Public Reference Room at 100 F Street NE, Washington, DC 20549. You may obtain information on the operation of the SEC's Public Reference Room by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains a website at www.sec.gov that contains reports, proxy and information statements and other information regarding zulily and other issuers that file electronically with the SEC. Our website and the information contained therein or connected thereto are not a part of, or incorporated into, this Annual Report.

Item 1A.    Risk Factors
Our operations and financial results are subject to various risks and uncertainties, including those described below. Before making an investment decision, you should carefully consider the risks described below and all other information contained in this Annual Report, including our consolidated financial statements and related notes, which could materially and adversely affect our business, results of operations or financial condition. Our business faces significant risks and the risks described below may not be the only risks we face. Additional risks not presently known to us or that we currently believe are immaterial may materially affect our business, results of operations, or financial condition. If any of these risks occur, the trading price of our Class A common stock could decline and you may lose all or part of your investment.
Risks Related to Our Business and Industry
Because we have a short operating history in an evolving industry, our past results may not be indicative of future performance, and our future performance may fluctuate materially and increase your investment risk.
We have a short operating history in a rapidly evolving industry that may not develop as expected, if at all. Our relatively short operating history makes it difficult to assess our future prospects. You should consider our business and prospects in light of the risks and difficulties we may encounter.
Our future success will depend in large part upon our ability to, among other things:

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•
cost effectively acquire new customers who purchase products from us at the same rate and of the same type as existing customers;
•
retain our existing customers and have them continue to purchase products from us at rates and methods consistent with their prior purchasing behavior;
•
encourage customers to expand the categories of products they purchase from us;
•
attract new vendors and retain our existing vendors to supply quality products that we can offer to our customers at attractive prices;
•
increase the awareness of our brand;
•
provide our customers and vendors with a superior experience;
•
fulfill and deliver orders in a timely way and in accordance with customer expectations, which may change over time;
•
respond to changes in consumer access to and use of the Internet and mobile devices;
•
deliver email and mobile alerts to our subscribers successfully;
•
react to challenges from existing and new competitors;
•
expand our business in new and existing markets, both domestic and international;
•
avoid interruptions or disruptions in our business;
•
develop a scalable, high-performance technology and fulfillment infrastructure that can efficiently and reliably handle increased usage globally, as well as the deployment of new features and the sale of new products and services;
•
respond to macroeconomic trends;
•
hire, integrate and retain talented merchandise buyers and other personnel; and
•
effectively manage rapid growth in our personnel and operations.

We experience seasonal trends in our business, and our mix of product offerings is highly variable from day-to-day and quarter-to-quarter. This variability makes it difficult to predict sales and can result in significant fluctuations in our net sales from period-to-period. We base our expense levels and investment plans on our estimates of net sales and gross margins. A significant portion of our expenses and investments is fixed, and we may be unable to adjust our spending quickly if our net sales or our gross margins are worse than expected.
The cumulative effects of these factors or our inability to manage any of the risks and difficulties identified above and elsewhere in this section could result in large fluctuations and unpredictability in our quarterly and annual operating results. As a result, comparing our operating results on a period-to-period basis may not be meaningful. You should not rely on our past results as an indication of our future performance. This variability and unpredictability could also result in our failing to meet the expectations of industry or financial analysts or investors for any period. If our net sales or operating results fall below the expectations of analysts or investors or below any forecasts we may provide to the market, or if the forecasts we provide to the market are below the expectations of analysts or investors, the price of our Class A common stock could decline substantially. Such a stock price decline could occur even when we have met any previously publicly stated net sales or earnings forecasts that we may provide.
If we fail to effectively manage our growth, our business, financial condition and operating results could be harmed.
To effectively manage our growth, we must continue to implement our operational plans and strategies, improve and expand our infrastructure of people and information systems and expand, train and manage our employee and contractor base. We have rapidly increased employee and contractor headcount since our inception to support the growth in our business, and we intend for this growth to continue for the foreseeable future. The number of our employees increased from 329 as of January 1, 2012 to 2,907 as of December 28, 2014, and we expect to add a number of employees during 2015. To support continued growth, we must effectively integrate, develop and motivate a large number of new employees, while maintaining our corporate culture. In particular, we intend to continue to make substantial investments to expand our merchandising and technology personnel. We face significant competition for personnel, particularly in the Seattle area where our headquarters is located. To

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attract top talent, we have had to offer, and believe we will need to continue to offer, competitive compensation and benefits packages before we can validate the productivity of those employees. Additionally, we may not be able to hire new employees quickly enough to meet our needs. If we fail to effectively manage our hiring needs or successfully integrate our new hires, our efficiency and ability to meet our forecasts and our employee morale, productivity and retention could suffer, which may have a material adverse effect on our business, financial condition and operating results.
Additionally, the growth and expansion of our business and our product offerings place significant demands on our management and mid-level management in particular. We produce new versions of our sites and emails and mobile alerts to our customers on a daily basis, which generally requires new products, photos and text every day. The growth of our business may require significant additional resources to meet these daily requirements, which may not scale in a cost-effective manner or may negatively affect the quality of our sites and customer experience. We are also required to manage multiple relationships with various vendors, customers and other third parties. If we fail to manage these third-party relationships or any business developments effectively, our business, financial condition and operating results may be materially and adversely affected. Further growth of our operations, our vendor base, our fulfillment centers, information technology systems or our internal controls and procedures may not be adequate to support our operations. If we are unable to manage the growth of our organization effectively, our business, financial condition and operating results may be materially and adversely affected.
We have incurred significant operating losses in the past, and we may not be able to generate sufficient net sales to achieve or maintain profitability. Our recent net sales growth may not be sustainable, and a failure to maintain an adequate growth rate will materially and adversely affect our business, financial condition and operating results.
While we achieved profitability on an annual basis for each of the fiscal years ended December 28, 2014 and December 29, 2013, we incurred net losses of $10.3 million and $11.3 million in the fiscal years ended December 30, 2012 and January 1, 2012, respectively, and had an accumulated deficit of $30.2 million as of December 28, 2014. We anticipate that our operating expenses will increase substantially in the foreseeable future as we continue to invest to increase our customer base, increase the number and variety of products we offer, expand our marketing channels, expand our operations, hire additional employees and managers, incur the costs of being a public company and develop our technology platform and fulfillment infrastructure. These efforts may prove more expensive than we currently anticipate. Although our net sales have grown rapidly, increasing from $695.7 million in the fiscal year ended December 29, 2013 to $1.2 billion in the fiscal year ended December 28, 2014, we may not be able to sustain this rate of net sales growth or to increase our net sales sufficiently to offset higher expenses. Some of our efforts to generate net sales from our business are new and unproven, and any failure to increase our net sales or improve our gross margins could prevent us from maintaining or increasing profitability. In addition, we expect to invest to fund longer term initiatives, which will likely impact profitability or other operating results. We cannot be certain that we will be able to maintain or increase profitability on a quarterly or annual basis. If we are unable to effectively manage these risks and difficulties as we encounter them, our business, financial condition and operating results may be materially and adversely affected.
We may be unable to accurately forecast net sales and appropriately plan our expenses in the future.
We may base our current and future expense levels on our operating forecasts and estimates of future net sales and gross margins. Net sales and operating results are difficult to forecast because they generally depend on the volume, timing and type of the orders we receive, as well as the rate of customer activation and repeat customer behavior, all of which are uncertain. Additionally, our business is affected by general economic and business conditions in the United States, the United Kingdom, Canada, Australia, Ireland and other international markets. A significant portion of our expenses is fixed, and as a result, we may be unable to adjust our spending in a timely manner to compensate for any unexpected shortfall in net sales. Any failure to accurately predict net sales or gross margins could cause our operating results in any given quarter, or a series of quarters, to be lower than expected, which could cause the price of our Class A common stock to decline substantially.
Our business is highly competitive. Competition presents an ongoing threat to the success of our business.
We expect competition in e-commerce generally, and with companies employing a flash sales model in particular, to continue to increase because there are no significant barriers to entry. We currently compete with and expect to increasingly compete with e-commerce businesses, such as Amazon.com, Inc. and Alibaba Group, the e-commerce platforms of traditional retailers, such as Target Corporation, Toys“R”Us, Inc. and Wal-Mart Stores, Inc.,

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and online marketplaces such as eBay Inc., particularly as some of these companies adopt flash sales business practices. A substantial number of flash sales sites have similar business models in related and unrelated market segments, including Gilt Groupe Holdings, Inc., Groupon, Inc., HauteLook (which is owned by Nordstrom, Inc.), MyHabit (which is operated by Amazon.com), One Kings Lane, Inc., RueLaLa.com (which is operated by Retail Convergence.com LP) and Wayfair LLC. We also compete with the traditional offline retail industry, including discount and mass merchandisers, such as Ross Stores, Inc., Target, The TJX Companies, Inc., Toys“R”Us and Walmart, as well as boutique sellers of women's, children’s and men's apparel, children's merchandise and other product categories such as kitchen accessories and home décor.
We believe that our ability to compete depends upon many factors both within and beyond our control, including:
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the size of the online retail market;
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the size and composition of our customer base and vendor base;
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the number of vendors and products we feature on our sites;
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selling and marketing efforts;
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the quality, price and reliability of products offered either by us or our competitors;
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the convenience and entertainment of the shopping experience that we provide;
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our ability to cost-effectively source, market and distribute our products and manage our operations; and
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our reputation and brand strength relative to our competitors.
Many of our current competitors have, and potential competitors may have, longer operating histories, larger fulfillment infrastructures, greater technical capabilities, significantly faster shipping times as well as free or low-cost shipping, significantly greater financial, marketing and other resources and larger customer bases than we do. These factors may allow our competitors to derive greater net sales and profits from their existing customer base, acquire customers at lower costs, use incentive programs to acquire our customers, or respond more quickly than we can to new or emerging technologies and changes in consumer habits. These competitors may engage in more extensive research and development efforts, undertake more far-reaching marketing campaigns and adopt more aggressive pricing policies, which may allow them to build larger customer bases or generate net sales from their customer bases more effectively than we do.
We depend on the continued growth of e-commerce in general and the flash sales model in particular.
The business of selling products over the Internet, particularly on the flash sales model, is dynamic and relatively new. The market segment for the flash sales model has grown significantly, and this growth may not be sustainable. If customers cease to find the flash sales model shopping experience fun, entertaining and a good value, or otherwise lose interest in shopping in this manner, we may not acquire new customers at rates consistent with historical or projected periods, and existing customers’ buying patterns and levels may be less than historical or projected rates. If the market segment for the flash sales model were to become saturated or decline overall, we may not be able to acquire new customers or engage existing customers, and our business, financial condition and operating results may suffer.
If we fail to acquire new customers or engage existing customers, we may not be able to increase net sales or maintain profitability.
We have made significant investments related to customer acquisition and expect to continue to spend significant amounts to acquire additional customers. We must continue to acquire customers and engage existing customers in order to increase net sales and maintain profitability. In order to expand our customer base, we must appeal to and acquire customers who have historically used other means of commerce to purchase products and may prefer alternatives to our offerings, such as in-store, the retailer’s own website or the websites of our competitors. In the United States, where we have achieved some level of market penetration, acquiring new customers may become more difficult and costly than it has been in the past. For example, in the fiscal year ended December 28, 2014, we saw an increase in customer acquisition costs compared to the prior year. We cannot assure you that the net sales from new customers we acquire will ultimately exceed the cost of acquiring those customers. If we fail to deliver an entertaining shopping experience, or if consumers do not perceive the products we offer to be of high value and quality or deliverable within a reasonable period of time, we may not be able to

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acquire new customers or engage existing customers. If we are unable to acquire new customers who purchase products in numbers sufficient to grow our business or consistent with previously acquired customers, or engage our existing customers, the net sales we generate may decrease, and our business, financial condition and operating results may be materially and adversely affected.
We believe that many of our new customers originate from word-of-mouth and other non-paid referrals from existing customers, and therefore we must ensure that our existing customers remain loyal to us in order to continue receiving those referrals. If our efforts to satisfy our existing customers are not successful, we may not be able to acquire new customers in sufficient numbers to continue to grow our business, or we may be required to incur significantly higher marketing expenses in order to acquire new customers. If the level of usage by our customer base declines or does not grow as expected, we may suffer a decline in customer retention or growth or net sales. A significant decrease in the level of usage or current or anticipated customer growth would have a material adverse effect on our business, financial condition and operating results.
We have relationships with social networking sites, such as Facebook, Pinterest, Twitter and Tumblr, online services, search engines, affiliate marketing websites, directories and other websites and e-commerce businesses to provide advertising and other links that direct customers to our sites. As e-commerce and social networking continue to rapidly evolve, we must continue to establish relationships with the channels that are used by our current and prospective customers and cost-effectively drive traffic to our sites. We rely on these relationships as significant sources of traffic to our sites and to generate new customers. If we are unable to develop or maintain these relationships on acceptable terms, our ability to attract new customers, engage existing customers and our financial condition would suffer.
We also conduct television branding and advertising campaigns. Such campaigns are expensive and may not result in the cost-effective acquisition of customers.
We base our decisions regarding expenditures in customer acquisition primarily on our analysis of the net sales generated from customers that we acquired in prior periods. Our estimates and assumptions may not accurately reflect our future results, and we may not be able to recover our customer acquisition costs.
Our success depends on our ability to attract customers in a cost-effective manner. Our decisions regarding investments in customer acquisition substantially depend upon our analysis of the net sales generated from customers we acquired in earlier periods. Our analysis regarding customer acquisition investment and net sales includes several assumptions, such as:
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Many customers sign-up as subscribers to our sites for varying periods of time before they make their first purchase and become active customers. We make various assumptions with respect to the level of additional marketing or other expenses necessary to activate these subscribers and how these expenses vary from those required to generate subscriptions. If our assumptions regarding such expenses are incorrect, our net sales relative to customer acquisition cost could be less favorable than we believe.
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We make various assumptions based on our historical data with respect to the repurchase rates of active customers. If our assumptions regarding such repurchase rates are incorrect, our net sales relative to customer acquisition cost could be less favorable than we believe.
If our assumptions regarding our customer acquisition investment and resulting net sales from these customers, including those relating to the effectiveness of our marketing expenditures, prove incorrect, our ability to generate net sales from our investments in new customer acquisitions may be less than we have assumed and have experienced in the past. In such case, we may need to increase expenses or otherwise alter our strategy, and our business, financial condition and operating results may be materially and adversely affected.
Our sales may be adversely affected if we fail to respond to changes in consumer preferences in a timely manner or are not successful in expanding our product offerings.
Our financial performance depends on our ability to identify, originate and define retail product trends, as well as to anticipate, gauge and react to changing consumer preferences in a timely manner. Our products must appeal to a broad range of moms and other consumers whose preferences cannot be predicted with certainty and are subject to change. Our business fluctuates according to changes in consumer preferences dictated in part by retail product trends, perceived product value and seasonal variations.

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We have broadened our product offering beyond children's apparel, to include women’s apparel, toys, infant gear, men's apparel, kitchen accessories, home décor and other categories. We continue to explore additional categories which may be accepted by our target customers. If we offer new products or categories that are not accepted by our customers or that adversely impact the customer experience, our sales may fall short of expectations, our brand and reputation could be adversely affected and we may incur expenses that are not offset by sales. If we expand into new categories, consumer demands may be different, and there is no assurance that the flash sales model will be successful in these new categories. We may make substantial investments in such new categories in anticipation of future net sales. If the launch of a new category requires investments greater than we expect, if we are unable to attract vendors that produce sufficient high quality, value-oriented products or if the sales generated from a new category grow more slowly or produce lower gross margins than we expect, our results of operations could be adversely impacted. Expansion of our product lines may also strain our management and operational resources, specifically the need to hire and manage additional merchandise buyers to source and curate these new products. We may also face greater competition in specific categories from Internet sites that are more focused on such categories. It may be difficult to differentiate our offering from other competitors as we offer additional product categories, and our customers may have additional considerations in deciding whether or not to purchase these additional product categories. In addition, the relative profitability, if any, of new product lines may be lower than what we have experienced historically, and we may not generate sufficient net sales from new product initiatives to recoup our investments in them. If any of these were to occur, it could damage our reputation, limit our growth and have a material adverse effect on our business, financial condition and operating results.
Our business relies heavily on email and mobile "push" notifications, and any restrictions on the sending of emails or mobile alerts or an inability to timely deliver such communications could adversely affect our net sales and business.
Our business is highly dependent upon email and mobile "push" notifications for promoting our sites and products. We provide daily emails and mobile alerts to subscribers informing them of what is available for purchase on our sites that day, and we believe these emails and mobile alerts are an important part of our customer experience and help generate a substantial portion of our net sales. If we are unable to successfully deliver emails or mobile alerts to our subscribers, or if subscribers decline to open our emails or mobile alerts, our net sales and profitability would be adversely affected. For example, our net sales growth in fiscal year 2014 as compared to fiscal year 2013 was partially constrained by email deliverability issues with some of our email subscribers during the third quarter of 2014 and our cautious stance regarding email marketing in the fourth quarter of 2014 in order to prevent any future email deliverability issues. Changes in how webmail application providers such as Google Inc., Yahoo! Inc., Microsoft Corporation, AOL Inc. and Comcast Corporation organize, prioritize, filter and deliver email may reduce the number of subscribers opening our emails. For example, Google Inc.’s Gmail service contains features that organize incoming emails into categories (such as primary, social, promotions, updates and spam). Such categorization or similar inbox organizational features or filtering by Google Inc. and other webmail application providers may result in our emails being delivered in a less prominent location in a subscriber’s inbox or viewed as “spam” by our subscribers and may reduce the likelihood of that subscriber opening our emails. Actions by third parties such as platform providers Apple App Store or Google Play Store to block, impose restrictions on or charge for the delivery of emails or mobile alerts could also materially and adversely impact our business. From time to time, Internet service providers, webmail applications or other third parties may block bulk email transmissions or otherwise experience technical difficulties that result in our inability to successfully deliver emails or mobile alerts to third parties or our subscribers. Changes in laws, regulations or third-party provider policies that limit our ability to send such communications or impose additional requirements upon us or our subscribers in connection with sending such communications would also materially and adversely impact our business. Our use of email and mobile alerts to send communications about our sites or other matters may also result in legal claims against us, which may cause us increased expenses, and if successful might result in fines and orders with costly reporting and compliance obligations or might limit or prohibit our ability to send emails or mobile alerts. We also rely on social networking messaging services to send communications and to encourage customers to send communications. Changes to the terms of these social networking services to limit promotional communications, any restrictions that would limit our ability or our customers’ ability to send communications through their services, disruptions or downtime experienced by these social networking services or decline in the use of or engagement with social networking services by customers and potential customers could materially and adversely affect our business, financial condition and operating results.
We rely on a third-party service for the delivery of all our daily emails, and delay or errors in the delivery of such emails or other messaging we send may occur and are beyond our control. For example, the delivery of our daily emails to subscribers has previously been delayed by two hours as a result of a third-party service error. We

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have also experienced technical issues that have resulted in shorter delivery delays of our daily emails to subscribers. Such delays could occur again in the future or be more severe, which could result in damage to our reputation or harm our business, financial condition and operating results. If we were unable to use our current email service or other messaging services, alternate services are available; however, we believe our sales could be impacted for some period as we transition to a new provider. Any disruption or restriction on the distribution of our emails or other messages, termination or disruption of our relationship with our messaging service providers, including our third-party service that delivers our daily emails, or any increase in our costs associated with our email and other messaging activities could materially and adversely affect our business, financial condition and operating results.
Customer growth and activity on mobile devices depends upon effective use of mobile operating systems, networks and standards that we do not control.
Purchases using mobile devices by consumers generally, and by our customers specifically, have increased significantly, and we expect this trend to continue. To optimize the mobile shopping experience, we are somewhat dependent on our customers downloading our specific mobile applications for their particular device as opposed to accessing our sites from an Internet browser on their mobile device. As new mobile devices and platforms are released, it is difficult to predict the problems we may encounter in developing applications for these alternative devices and platforms, and we may need to devote significant resources to the creation, support and maintenance of such applications. In addition, our future growth and our results of operations could suffer if we experience difficulties in the future in integrating our mobile applications into mobile devices or if problems arise with our relationships with providers of mobile operating systems or mobile application download stores, such as those of Apple Inc. or Google Inc., if our applications receive unfavorable treatment compared to competing applications, such as the order of our products in the Apple App Store, or if we face increased costs to distribute or have customers use our mobile app. We are further dependent on the interoperability of our sites with popular mobile operating systems that we do not control, such as iOS and Android, and any changes in such systems that degrade the functionality of our sites, block or impose restrictions on our delivery of mobile alerts or give preferential treatment to competitive products could adversely affect the usage of our sites on mobile devices. In the event that it is more difficult for our customers to access and use our sites on their mobile devices, or if our customers choose not to access or to use our sites on their mobile devices or to use mobile products that do not offer access to our sites, our customer growth could be harmed and our business, financial condition and operating results may be materially and adversely affected.

Our failure or the failure of third-party service providers to protect our sites, networks and systems against security breaches, or otherwise to protect our confidential information or the confidential information of our customers, could damage our reputation and brand and substantially harm our business and operating results.

Our business employs sites, networks and systems through which we collect, maintain, transmit and store data about our customers, vendors and others, including credit card information and personally identifiable information, as well as other confidential and proprietary information. We also employ third-party service providers that store, process and transmit proprietary, personal and confidential information on our behalf. We rely on encryption and authentication technology licensed from third parties in an effort to securely transmit confidential and sensitive information, including credit card numbers. Advances in computer capabilities, new technological discoveries or other developments may result in the whole or partial failure of this technology to protect transaction data or other confidential and sensitive information from being breached or compromised. More generally, we take steps to protect the security, integrity and confidentiality of the information we collect, store or transmit, but there is no guarantee that inadvertent or unauthorized use or disclosure will not occur or that third parties will not gain unauthorized access to this information despite our efforts. Our security measures, and those of our third-party service providers, may not detect or prevent all attempts to hack our systems, denial-of-service attacks, viruses, malicious software, break-ins, phishing attacks, social engineering, security breaches or other attacks and similar disruptions that may jeopardize the security of information stored in or transmitted by our sites, networks and systems or that we or our third-party service providers otherwise maintain. We and our service providers may not have the resources or technical sophistication to anticipate or prevent all types of attacks, and techniques used to obtain unauthorized access to or sabotage systems change frequently and may not be known until launched against us or our third-party service providers. In addition, security breaches can also occur as a result of non-technical issues, including intentional or inadvertent breaches by our employees or by persons with whom we have commercial relationships.


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Breaches of our security measures or those of our third-party service providers or cyber security incidents could result in unauthorized access to our sites, networks and systems; unauthorized access to and misappropriation of consumer information, including consumers’ personally identifiable information, or other confidential or proprietary information of ourselves or third parties; viruses, worms, spyware or other malware being served from our sites, networks or systems; deletion or modification of content or the display of unauthorized content on our sites; interruption, disruption or malfunction of operations; costs relating to breach remediation, deployment of additional personnel and protection technologies, response to governmental investigations and media inquiries and coverage; engagement of third party experts and consultants; and litigation, regulatory action and other potential liabilities. If any of these breaches of security occur, our reputation and brand could be damaged, our business may suffer, we could be required to expend significant capital and other resources to alleviate problems caused by such breaches and we could be exposed to a risk of loss, litigation or regulatory action and possible liability. Actual or anticipated attacks may cause us to incur increasing costs, including costs to deploy additional personnel and protection technologies, train employees and engage third-party experts and consultants. In addition, any party who is able to illicitly obtain a subscriber’s password could access the subscriber’s transaction data or personal information. Any compromise or breach of our security measures, or those of our third-party service providers, could violate applicable privacy, data security and other laws, and cause significant legal and financial exposure, adverse publicity and a loss of confidence in our security measures, which could have an adverse and material effect on our business, financial condition and operating results. Although we maintain privacy, data breach and network security liability insurance, we cannot be certain that our coverage will be adequate for liabilities actually incurred or that insurance will continue to be available to us on economically reasonable terms, or at all. We may need to devote significant resources to protect against security breaches or to address problems caused by breaches, diverting resources from the growth and expansion of our business.
Our business depends on a strong brand. We may not be able to maintain and enhance our brand, or we may receive unfavorable customer complaints or negative publicity, which could adversely affect our brand.
We believe that the brand we have built with our customers has significantly contributed to the success of our business. We also believe that maintaining and enhancing the “zulily” brand is critical to expanding our base of customers and vendors. Maintaining and enhancing our brand may require us to make substantial investments, and these investments may not be successful. If we fail to promote and maintain the “zulily” brand or if we incur excessive expenses in this effort, our business, operating results and financial condition may be materially and adversely affected. We anticipate that, as our market becomes increasingly competitive, maintaining and enhancing our brand may become increasingly difficult and expensive. Maintaining and enhancing our brand will depend largely on our ability to continue to provide reliable, trustworthy and high quality products that are timely delivered to our customers and a reliable, trustworthy and profitable market to our vendors, which we may not do successfully.
Our brand depends on effective customer support, which requires significant personnel expense. If not managed properly, this expense could impact our profitability. Failure to manage or train our own or outsourced customer support representatives properly could compromise our ability to handle customer complaints effectively.
Customer complaints or negative publicity about our sites, products, product delivery times, customer data handling and security practices or customer support, especially on social media platforms such as blogs and social media websites, could rapidly and severely diminish consumer use of our sites and consumer and vendor confidence in us and cause our reputation to suffer.

If we do not successfully optimize and operate our fulfillment centers, our business, financial condition and operating results could be harmed.

If we do not optimize and operate our fulfillment centers successfully and efficiently, it could result in excess or insufficient fulfillment capacity, an increase in costs or impairment charges or harm our business in other ways. If we do not have sufficient fulfillment capacity or experience a problem fulfilling orders in a timely manner, our customers may experience delays in receiving their purchases, which could harm our reputation and our relationship with our customers.

We have designed and built our own fulfillment center infrastructure, including customizing third-party inventory and package handling software systems, which is tailored to meet the specific needs of our business. As we continue to add fulfillment and warehouse volumes and capabilities, add new businesses or categories with different fulfillment requirements or change the mix in products that we sell, our fulfillment network will become

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increasingly complex and operating it will become more challenging. For example, in our prior outsourced third-party fulfillment center, operational difficulties were encountered as our shipping volumes increased dramatically, which resulted in shipping delays and customer dissatisfaction. Failure to successfully address such challenges in a cost-effective and timely manner could impair our ability to timely deliver our customers’ purchases and could harm our reputation and ultimately, our business, financial condition and operating results.

We may not successfully expand our fulfillment center capacity in a timely and cost-effective manner to address future growth, which could delay our shipping times and our business, reputation and operating results could be harmed.

Our current fulfillment center network has the capability to handle limited growth with the current mix of product offerings before additional capacity will be required. We commenced operations in a new Nevada fulfillment center in the third quarter of 2014. We also entered into a lease agreement for a new fulfillment center located in Bethlehem, Pennsylvania, which we expect to begin using in 2015. The expansion of our fulfillment center capacity will put pressure on our managerial, financial, operational, technology and other resources. We cannot assure you that we will effectively expand into the new Pennsylvania fulfillment center, that our customized inventory and package handling software systems meet our business needs, or that we will be able to execute on our expansion plans, or recruit qualified managerial and operational personnel necessary to support our expansion plans. If we are unable to expand our fulfillment operations, increase fulfillment center capacity or effectively control expansion-related expenses, our business, prospects, financial condition and operating results could be materially and adversely affected. If we grow faster than we anticipate, we may exceed our fulfillment center capacity sooner than we anticipate, we may experience problems fulfilling orders in a timely manner or our customers may experience delays in receiving their purchases, which could harm our reputation and our relationship with our customers, and we would need to increase our capital expenditures more than anticipated. Many of the expenses and investments with respect to our fulfillment centers are fixed, and any expansion of such fulfillment centers will require additional investment of capital. We may incur such expenses or make such investments in advance of expected sales, and such expected sales may not occur.

Our failure to adequately and effectively staff our fulfillment centers, through third-parties or with our own employees, or to integrate employees as we are transitioning from our third-party staffing organizations, could adversely affect our shipping times, business and results of operations.

We depend, in part, on a third party to provide staffing for our U.S. fulfillment centers. As of December 28, 2014, there were over 1,400 third-party associates in our U.S. fulfillment centers. By using a third-party staffing organization, we face additional risks that are outside of our control, such as employment claims, issues arising from failure to comply with labor or other laws, union organizing activities and any deterioration in the finance and operations of such organization. If our third-party staffing organization is unable to adequately staff our fulfillment centers or if the cost of such staffing is higher than historical or projected costs due to mandated wage increases or other factors, our operations could be harmed. We depend on a third party to provide fulfillment services for some of our sales outside the United States, and we face similar risks with that third party.

In the second quarter of 2014, we began staffing our U.S. fulfillment centers, in part, with our employees, many of whom we hired from our third-party staffing organization. If we do not effectively integrate these employees into our U.S. fulfillment centers or transition staffing from the third-party staffing organization, or if the cost of such employees is higher than historical or projected costs due to mandated wage increases or other factors, our operations could be harmed. In addition, we will face potential risks that were previously addressed by our third-party staffing organization, such as employment claims, issues arising from failure to comply with labor or other laws or union organizing activities. Any such issues may result in delays in shipping times and our reputation, business and results of operations may be harmed.

We generally do not hold inventory until products have been ordered by customers, which results in slower delivery time than other e-commerce retailers.

We generally do not order inventory from our vendors to be held in our fulfillment centers until after the products have been ordered by our customers. As a result, the time from when an order is placed on our sites to when the product is delivered to our customers is longer than for many other e-commerce retailers who generally carry significant inventory that enables them to expedite delivery. Our average order-to-ship time from our U.S. fulfillment centers in the fourth quarter of 2014 was 13.7 days. In an effort to reduce order-to-ship times without carrying additional inventory, we have expanded consignment and fulfillment services for our vendors. We may not

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achieve our anticipated improvement in delivery times if we are unable to effectively deploy these services or engage a sufficient number of vendors to adopt these services. Our relatively slower delivery times may place us at a competitive disadvantage to other e-commerce retailers and may cause customers to stop purchasing from us. If we are required to decrease our delivery times to address this competition or to meet customer demands, we may be required to incur additional shipping costs, which we may or may not be able to pass on to our customers, or to change our operations to carry additional inventory and face additional inventory risk, either of which could adversely affect our business, financial condition and operating results.
Uncertainties in global economic conditions and their impact on consumer spending patterns, particularly in the apparel, toys, infant gear, kitchen accessories and home décor categories, could adversely impact our operating results.
Our performance is subject to global economic conditions and their impact on levels of consumer spending worldwide, particularly spending on women's, children's and men's apparel, toys, infant gear, kitchen accessories and home décor. Some of the factors adversely affecting consumer spending include levels of unemployment, consumer debt levels, changes in net worth based on market changes and uncertainty, home foreclosures and changes in home values, fluctuating interest rates, credit availability, government actions, fluctuating fuel and other energy costs, fluctuating commodity prices and general uncertainty regarding the overall future economic environment. Consumer purchases of discretionary items, including our merchandise, generally decline during periods when disposable income is adversely affected or there is economic uncertainty. Adverse economic changes in any of the regions in which we sell our products could reduce consumer confidence and could negatively affect net sales and have a material adverse effect on our operating results.
Failure to continue to provide our customers with differentiated merchandise from vendors will harm our business.
Our net sales growth depends, in part, on our ability to continue to source unique merchandise in sufficient quantities at competitive prices from vendors. Offering a variety of brands, styles, categories and products at affordable price points is important to our ability to acquire new customers and to keep our existing customers engaged and purchasing products. Typically, our events feature thousands of product styles from different vendors and last for 72 hours, and we believe our business requires us to continue this rapid pace of product introduction. Growth in the number of our customers, as well as increased competition, may make it difficult to source additional brands and styles in sufficient quantities and on acceptable terms to meet the demand of our customers. Since launching our sites, we have purchased our merchandise from thousands of brands, with a particular focus on emerging brands and smaller boutique vendors. We believe our ability to offer our customers a high volume of merchandise from emerging brands and smaller boutique vendors is particularly important to our long-term success.
We have few contractual assurances of continued supply, pricing or access to new products, and vendors could change the terms upon which they sell to us or discontinue selling to us for future sales at any time. As we grow, continuing to identify a sufficient number of new emerging brands and smaller boutique vendors may become more and more of a challenge. If we are not able to identify and effectively promote these new brands, we may lose customers to our competitors. Even if we identify new vendors, we may not be able to purchase desired merchandise in sufficient quantities on terms acceptable to us in the future, and products from alternative sources, if any, may be of a lesser quality or more expensive than those from existing vendors. In addition, larger national brands may offer products that are less unique, and it may be easier for our competitors to offer such products at prices or upon terms that may be compelling to consumers. An inability to purchase suitable merchandise on acceptable terms or to source new vendors could have a material adverse effect on our business, financial condition and operating results.
Our merchandise approach and the flash sales model is challenging and, if not managed effectively, could adversely affect our operating results.
To support our large and diverse base of vendors and our flash sales model that requires constantly changing products, we must incur significant costs, including costs related to our merchandising team, photography studios and creative personnel. As our business grows, we may not be able to continue to expand our product offerings in a cost-effective manner. Expanding personnel in our merchandising and studio departments is challenging due to competition for such personnel, and expansion of our studio spaces may require fixed expenses and investments that will impact profitability and may not be recouped if sufficient additional net sales are not generated.

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In addition, the variety in size and sophistication of our vendors presents different challenges to our infrastructure and operations. Our emerging brands and smaller boutique vendors may be less experienced in manufacturing and shipping, which in the past has led to inconsistencies in quality, delays in the delivery of merchandise or additional fulfillment cost. Our larger national brands may impose additional requirements on us or offer less favorable terms than our smaller vendors related to margins and inventory ownership and risk and may also be unable to ship products timely. If we are unable to maintain and effectively manage our relationships with our emerging brands and smaller boutique vendors or our larger national brands, our business, financial condition and operating results could be materially and adversely affected.
Failure of our vendors to supply high quality and compliant merchandise in a timely manner may damage our reputation and brand and harm our business.
We depend on our vendors to supply high quality merchandise in a timely manner. The failure of our vendors to supply merchandise which meets our quality standards or the quality standards of our customers could damage our reputation and harm our business, financial condition and operating results.
Our vendors are subject to various risks, including raw material costs, inflation, labor disputes, union organizing activities, boycotts, financial liquidity, product merchantability, safety issues, inclement weather, natural disasters, disruptions in exports, trade restrictions, trade disruptions, currency fluctuations and general economic and political conditions that could limit the ability of our vendors to provide us with high quality merchandise on a timely basis and at prices and payment terms that are commercially acceptable. For these or other reasons, one or more of our vendors might not adhere to our vendor terms and conditions or their applicable contract or might stop providing us with high quality merchandise. If there are any deficiencies in the products our vendors have provided to us, we might not identify such deficiencies before products ship to our customers.
In addition, our vendors may have difficulty adjusting to our changing demands and growing business. As our business grows, our vendors will be required to provide us with a high volume of merchandise on a timely basis. Failure of our vendors to successfully address these increased volumes may result in shipping delays and customer dissatisfaction, which could harm our reputation and ultimately, our business, financial condition and operating results. Failure of our vendors to provide us with quality merchandise that complies with all applicable U.S. and international laws, including but not limited to product safety regulations and legislation, in a timely and effective manner could also damage our reputation and brand and could lead to an increase in customer litigation against us and an increase in our routine and non-routine litigation costs. Further, any merchandise could become subject to a recall, regulatory action or legal claim, which could result in increased legal expenses as well as damage to our reputation and brand and harm to our business. We cannot predict whether any of the countries in which our merchandise currently is manufactured or may be manufactured in the future will be subject to additional trade restrictions imposed by the United States and other foreign governments, including the likelihood, type or effect of any such restrictions. Such developments could have a material adverse effect on our business, financial condition and operating results.
Any failure by our vendors to comply with product safety, labor or other laws, or our standard vendor terms and conditions or to provide safe factory conditions for their workers, may damage our reputation and brand and harm our business.
Many of the products we sell on our sites are subject to regulation by the U.S. Consumer Product Safety Commission, the U.S. Food and Drug Administration and similar state and international regulatory authorities. As a result, such products have been and could be in the future subject to recalls and other remedial actions. Many of the products we sell are for children, and these products are often subject to enhanced safety concerns and additional scrutiny and regulation. Product safety concerns may require us to voluntarily remove selected products from our sites. Such recalls and voluntary removal of products can result in, among other things, lost sales, diverted resources, potential harm to our reputation and increased customer service costs and legal expenses, which could have a material adverse effect on our business, financial condition and operating results.
Some of the products we sell may expose us to product liability claims and litigation or regulatory action relating to personal injury, death or environmental or property damage. Although we maintain liability insurance, we cannot be certain that our coverage will be adequate for liabilities actually incurred or that insurance will continue to be available to us on economically reasonable terms, or at all. In addition, some of our agreements with our vendors may not indemnify us from product liability for a particular vendor’s products, or our vendors may not have sufficient resources or insurance to satisfy their indemnity and defense obligations.

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We purchase our merchandise from numerous vendors, including domestic and international manufacturers, resellers, wholesalers and consolidators. Our standard vendor terms and conditions require vendors to comply with applicable laws, as well as the intellectual property and proprietary rights of third parties. Failure of our vendors to comply with applicable laws, regulations and contractual requirements could lead to litigation against us, resulting in increased legal expenses and costs. In addition, the failure of any such vendors to provide safe and humane factory conditions and oversight at their facilities could damage our reputation with consumers or result in legal claims against us.
We may choose to expand or alter our operations by developing new sites or applications or by promoting new or complementary products, sales formats or services, which may increase our costs and may not be successful.
There can be no assurance that we will be able to expand or alter our operations in a cost-effective or timely manner or that any such efforts would be accepted by the market. Furthermore, any new business, website, application, product, promotion, sales format or service launched by us that is not favorably received by consumers could damage our reputation and brand. Any such expansion or alteration of our operations could also require significant additional expenses, management time and operations personnel that could impact our operating results. Any failure to generate satisfactory net sales from such expansion or alteration of our operations to offset their cost could have a material adverse effect on our business, financial condition and operating results.

We are subject to payment-related risks.
We accept payments using a variety of methods, including credit card, debit card, PayPal and gift cards. As we offer new payment options to consumers, we may be subject to additional regulations, compliance requirements and fraud. For certain payment methods, including credit and debit cards, we pay interchange and other fees, which may increase over time and raise our operating costs and lower profitability. We are also subject to payment card association operating rules and certification requirements, including the Payment Card Industry Data Security Standard and rules governing electronic funds transfers, which could change or be reinterpreted to make it difficult or impossible for us to comply. If we fail to comply with the rules or requirements of any provider of a payment method we accept, among other things, we may be subject to fines or higher transaction fees and may lose, or face restrictions placed upon, our ability to accept credit and debit card payments from consumers or facilitate other types of online payments. If any of these events were to occur, our business, financial condition and operating results could be materially and adversely affected.
We also may incur significant losses from fraud. We may incur losses from claims that the consumer did not authorize the purchase, from merchant fraud, from erroneous transmissions and from consumers who have closed bank accounts or have insufficient funds in them to satisfy payments. In addition to the direct costs of such losses, if they are related to credit card transactions and become excessive, they could potentially result in our losing the right to accept credit cards for payment. In addition, under current credit card practices, we are liable for fraudulent credit card transactions because we do not obtain a cardholder’s signature. We do not currently carry insurance against this risk. To date, we have experienced minimal losses from credit card fraud, but we continue to face the risk of significant losses from this and other types of fraud. Our failure to adequately control fraudulent transactions could damage our reputation and brand and result in litigation or regulatory action, causing an increase in legal expenses and fees and substantially harm our business, financial condition and operating results.
Government regulation of the Internet and e-commerce is evolving, and unfavorable changes or failure by us to comply with these regulations could substantially harm our business and results of operations.
We are subject to general business regulations and laws as well as regulations and laws specifically governing the Internet and e-commerce. Existing and future regulations and laws could impede the growth of the Internet, e-commerce or mobile commerce. These regulations and laws may involve taxes, tariffs, privacy and data security, anti-spam, text messages, content protection, electronic contracts and communications, consumer protection and gift cards. For example, the Federal Trade Commission’s Mail or Telephone Order Merchandise Rule requires compliance with certain rules of conduct relating to shipping dates, shipping delays, customer notifications, cancellations and refunds. It is not clear how existing laws governing issues such as property ownership, sales and other taxes and consumer privacy apply to the Internet as the vast majority of these laws were adopted prior to the advent of the Internet and do not contemplate or address the unique issues raised by the Internet or e-commerce. It is possible that general business regulations and laws, or those specifically governing the Internet or e-commerce, may be interpreted and applied in a manner that is inconsistent from one jurisdiction to another and may conflict with other rules or our practices.

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We cannot guarantee that our practices have complied, comply or will comply fully with all such laws and regulations. Any failure, or perceived failure, by us to comply with any of these laws or regulations could result in damage to our reputation, a loss in business and proceedings or actions against us by governmental entities or others. Any such proceeding or action could hurt our reputation, force us to spend significant amounts in defense of these proceedings, distract our management, increase our costs of doing business, decrease the use of our sites by consumers and vendors and may result in the imposition of monetary liability. We may also be contractually liable to indemnify and hold harmless third parties from the costs or consequences of non-compliance with any such laws or regulations. In addition, it is possible that governments of one or more countries may seek to censor content available on our sites or may even attempt to completely block access to our sites. Adverse legal or regulatory developments could substantially harm our business. In particular, in the event that we are restricted, in whole or in part, from operating in one or more countries, our ability to retain or increase our customer base may be adversely affected, and we may not be able to maintain or grow our net sales and expand our business as anticipated.
Failure to comply with federal, state and international laws and regulations relating to privacy, data protection and consumer protection, or the expansion of current or the enactment of new laws or regulations relating to privacy, data protection and consumer protection, could adversely affect our business and our financial condition.
A variety of federal, state and international laws and regulations govern the collection, use, retention, sharing and security of consumer data. Laws and regulations relating to privacy, data protection and consumer protection are evolving and subject to potentially differing interpretations. We strive to comply with all applicable laws, regulations and other legal obligations relating to privacy, data protection and consumer protection, including those relating to the use of data for marketing purposes. It is possible, however, that these requirements may be interpreted and applied in a manner that is inconsistent from one jurisdiction to another or may conflict with other rules or our practices. We cannot guarantee that our practices have complied, comply or will comply fully with all such laws, regulations, requirements and obligations. Any failure, or perceived failure, by us to comply with our posted privacy practices or with any federal, state or international privacy or consumer protection-related laws, regulations, industry self-regulatory principles, industry standards or codes of conduct, regulatory guidance, orders to which we may be subject or other legal obligations relating to privacy or consumer protection could adversely affect our reputations, brand and business, and may result in claims, proceedings or actions against us by governmental entities or others or other liabilities. Any such claim, proceeding or action could hurt our reputation, brand and business, force us to incur significant expenses in defense of such proceedings, distract our management, increase our costs of doing business, result in a loss of customers and vendors and may result in the imposition of monetary liability. We may also be contractually liable to indemnify and hold harmless third parties from the costs or consequences of non-compliance with any laws, regulations or other legal obligations relating to privacy or consumer protection or any inadvertent or unauthorized use or disclosure of data that we store or handle as part of operating our business.
Federal, state and international governmental authorities continue to evaluate the privacy implications inherent in the use of third-party “cookies”, "web beacons", and other methods of online tracking for behavioral advertising and other purposes. U.S. and foreign governments have enacted, considered or are considering legislation or regulations that could significantly restrict the ability of companies and individuals to engage in these activities, such as by regulating the level of consumer notice and consent required before a company can employ cookies or other electronic tracking tools. Additionally, some providers of consumer devices and web browsers have implemented, or announced plans to implement, means to make it easier for Internet users to prevent the placement of cookies, web beacons, or to block other tracking technologies, which could if widely adopted result in the use of third-party cookies, web beacons, and other methods of online tracking becoming significantly less effective. The regulation of the use of these cookies, web beacons, and other current online tracking and advertising practices or a loss in our ability to make effective use of services that employ such practices could increase our costs of operations and limit our ability to acquire new customers on cost-effective terms and consequently, materially and adversely affect our business, financial condition and operating results.
Foreign data protection, privacy and other laws and regulations are often more restrictive than those in the United States. The European Union, for example, traditionally has imposed stricter obligations under its laws and regulations relating to privacy, data protection and consumer protection than the United States. Individual EU member countries have had discretion with respect to their interpretation and implementation of these laws, resulting in variation of privacy standards from country to country. Legislation and regulation in the European Union and some EU member states require companies to obtain specific types of notice and consent from consumers before using cookies or other tracking technologies. International expansion of our operations may require changes

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in the way we use consumer information in operating our business. Compliance with such laws and regulations will result in additional costs and may necessitate changes to our business practices, which may adversely affect our business and financial condition. Further, there is no harmonized approach to legal compliance in many of these regions, and there is little regulatory guidance. Consequently, we could be at risk of non-compliance with applicable foreign data protection laws as we continue our international expansion.
In addition, various federal, state and foreign legislative and regulatory bodies, or self-regulatory organizations, may expand current laws or regulations, enact new laws or regulations or issue revised rules or guidance regarding privacy, data protection and consumer protection. Any such changes may force us to incur substantial costs or require us to change our business practices. This could compromise our ability to pursue our growth strategy effectively and may adversely affect our ability to acquire customers or otherwise harm our business, financial condition and operating results.
Changes in tax treatment of companies engaged in e-commerce may adversely affect the commercial use of our sites and our financial results.
Due to the global nature of the Internet, it is possible that various states or foreign countries might attempt to impose additional or new regulation on our business or levy additional or new sales, income or other taxes relating to our activities. Tax authorities at the international, federal, state and local levels are currently reviewing the taxation of e-commerce companies and transactions of companies engaged in e-commerce. New or revised international, federal, state or local tax regulations may subject us or our customers to additional sales, income and other taxes. We cannot predict the effect of current attempts to impose sales, income or other taxes on e-commerce. New or revised taxes and, in particular, sales taxes, VAT and similar taxes would likely increase the cost of doing business online and decrease the attractiveness of advertising and selling products over the Internet. New taxes could also create significant increases in internal costs necessary to capture data and collect and remit taxes. Any of these events could have a material and adverse effect on our business, financial condition and operating results.
Taxing authorities may successfully assert that we should have collected or in the future should collect sales and use, VAT or similar taxes, and we could be subject to liability with respect to past or future sales, which could adversely affect our operating results.
We do not collect sales and use, VAT and similar taxes in every jurisdiction in which we have sales, based on our belief that such taxes are not applicable. Sales and use, VAT and similar tax laws and rates vary greatly by jurisdiction. Certain jurisdictions in which we do not collect such taxes on our sales may assert that such taxes are applicable, which could result in tax assessments, penalties and interest, and we may be required to collect such taxes in the future. Such tax assessments, penalties and interest or future requirements may materially and adversely affect our business, financial condition and operating results.
We may experience fluctuations in our tax obligations and effective tax rate, which could materially and adversely affect our operating results.
We are subject to taxes in the United States and numerous international jurisdictions. We record tax expense based on current tax payments and our estimates of future tax payments, which may include reserves for estimates of probable settlements of international and domestic tax audits. At any one time, multiple tax years and jurisdictions are subject to audit by various taxing authorities. The results of these audits and negotiations with taxing authorities may affect the ultimate settlement of these issues. As a result, we expect that throughout the year there could be ongoing variability in our quarterly tax rates as taxable events occur and uncertain tax positions are re-evaluated or resolved. Further, our effective tax rate in a given financial statement period may be materially impacted by changes in tax laws, changes in the mix and level of earnings by taxing jurisdiction, changes to existing accounting rules or regulations or by changes to our ownership or capital structures. Fluctuations in our tax obligations and effective tax rate could materially and adversely affect our results of business, financial condition and operating results.
In addition, we are evaluating and may adopt a corporate structure to more closely align with our international operations and any future international expansion, which will require us to incur expenses but could fail to achieve the intended benefits. This proposed corporate structure may result in a reduction in our overall effective tax rate through changes in how we use our intellectual property, international procurement and sales operations. This proposed corporate structure may also allow us to obtain financial and operational efficiencies. If we adopt this revised structure, it will require us to incur expenses in the near term for which we may not realize related benefits. If the intended structure is not accepted by the applicable taxing authorities, changes in domestic and international

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tax laws negatively impact the proposed structure, including proposed legislation to reform U.S. taxation of international business activities or we do not operate our business consistent with the proposed structure and applicable tax provisions, we may fail to achieve the financial and operational efficiencies that we anticipate as a result of the proposed structure, and our business, financial condition and operating results may be materially and adversely affected.
Our business depends on network and mobile infrastructure, our single third-party data center hosting facility, other third-party providers, and our ability to maintain and scale our technology and provide a personalized site experience. Any significant interruptions or delays in service on our sites or any undetected errors or design faults could result in limited capacity, reduced demand, processing delays and loss of customers or vendors.
A key element of our strategy is to generate a high volume of traffic on, and use of, our sites. Our reputation and ability to acquire, retain and serve our customers are dependent upon the reliable performance of our sites and the underlying network infrastructure. As our customer base and the amount of information shared on our sites continue to grow, we will need an increasing amount of network capacity and computing power. We have spent and expect to continue to spend substantial amounts on data centers and equipment and related network infrastructure to handle the traffic on our sites. The operation of these systems is expensive and complex and could result in operational failures. In the event that our customer base or the amount of traffic on our sites grows more quickly than anticipated, we may be required to incur significant additional costs to enhance the underlying network infrastructure. Interruptions or delays in these systems, whether due to system failures, computer viruses, physical or electronic break-ins, undetected errors, design faults or other unexpected events or causes, could affect the security or availability of our sites and prevent our customers from accessing our sites.
In order to enhance relevance for our customers, we have developed extensive data collection and analytics capabilities which allow us to anticipate the shopping preferences of our customers and then personalize their site experience. Any failure of our data analytics and personalization tools could result in reduced demand and loss of customers, which could materially and adversely affect our business, financial condition and operating results.
We depend on the development and maintenance of the Internet and mobile infrastructure. This includes maintenance of reliable Internet and mobile networks with the necessary speed, data capacity and security, as well as timely development of complementary products, for providing reliable Internet and mobile access and services.
We primarily utilize a single third-party data center hosting facility located in the United States. Nearly all of our data storage and analytics are conducted on, and the data and content we create associated with sales on our sites are processed through, servers in one facility. If we were to transition to additional servers, failure to effectively transfer our data could result in interruptions in the availability or functionality of our sites. We also rely on third-party email service providers, bandwidth providers, Internet service providers and mobile networks to deliver our email and mobile “push” communications to subscribers and to allow subscribers to access our sites. Any damage to, or failure of, the systems of our third-party data center or our other third-party providers could result in interruptions to the availability or functionality of our sites. If for any reason our arrangements with our data center or third-party providers are terminated or interrupted, such termination or interruption could adversely affect our business. We exercise little control over these providers, which increases our vulnerability to problems with the services they provide. We could experience additional expense in arranging for new facilities, technology, services and support. In addition, the failure of our data center or any other third-party providers to meet our capacity requirements could result in interruptions in the availability or functionality of our sites.
The occurrence of a natural disaster, an act of terrorism, vandalism or sabotage, a decision to close the third-party data center on which we normally operate or the facilities of any third-party provider without adequate notice or other unanticipated problems at these facilities could result in lengthy interruptions in the availability of our solutions. While we have some limited disaster recovery arrangements in place, they have not been tested under actual disasters or similar events and may not effectively permit us to continue to provide our products in the event of any problems with respect to our data center or any other third-party facilities. To date, we have not experienced these types of events, but we cannot provide any assurances that they will not occur in the future. If any such event were to occur to our business, the delivery of our products could be impaired and our business, financial condition and operating results may be materially and adversely affected.
Our business is subject to seasonal sales fluctuations which could result in volatility or have an adverse effect on the market price of our Class A common stock.

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We believe our results are impacted by a pattern of increased sales during the back-to-school shopping season in the third quarter and holiday shopping season in the fourth quarter which has resulted in increased sales during a portion of the third quarter and the fourth quarter each fiscal year, which then results in lower sequential growth in the first quarter. For example, net sales in the first quarter of 2014 decreased when compared with net sales in the fourth quarter of 2013. We also believe that we have experienced slower growth in orders placed during the late spring and early summer months. Shifts in product mix, when combined with seasonality, could further affect our overall operating results or growth rates. Our historical growth rates and limited operating history make it difficult to discern the impact of any seasonality in our business. To the extent the growth of our business slows, or our product mix changes, these seasonal fluctuations may become more evident. Seasonality may cause our working capital cash flow requirements to vary from quarter-to-quarter depending on the variability in the volume and timing of sales. These factors, among other things, make forecasting more difficult and may adversely affect our ability to manage working capital and to predict financial results accurately, which could result in volatility or adversely affect the market price of our Class A common stock.
We may from time to time pursue acquisitions, which could have an adverse impact on our business, as could the integration of the businesses following acquisition.
As part of our business strategy, we may acquire other companies or businesses. Acquisitions involve numerous risks, any of which could harm our business, including: difficulties in integrating the technologies, operations, existing contracts and personnel of an acquired company; difficulties in supporting and transitioning vendors, if any, of an acquired company; diversion of financial and management resources from existing operations or alternative acquisition opportunities; failure to realize the anticipated benefits or synergies of a transaction; failure to identify all of the problems, liabilities or other shortcomings or challenges of an acquired company or technology, including issues related to intellectual property, regulatory compliance practices, revenue recognition or other accounting practices or employee or customer issues; risks of entering new markets in which we have limited or no experience; potential loss of key employees, customers and vendors from either our current business or an acquired company’s business; inability to generate sufficient net sales to offset acquisition costs; additional costs or equity dilution associated with funding the acquisition; and possible write-offs or impairment charges relating to acquired businesses.
Growth and expansion of our international business will require management attention and resources, involves additional risks, and may be unsuccessful, which could harm our future business development and existing domestic operations.
We have conducted limited international business in the United Kingdom, Canada, Australia and Ireland, but plan to grow our business in these countries and to further expand into new international markets in order to grow our overall business. These growth and expansion plans will require management attention and resources and may be unsuccessful. We have limited experience in selling our products to conform to different local cultures, standards and policies, and the flash sales model we employ and the products we offer may not appeal to customers in the same manner, if at all, in the United Kingdom, Canada, Australia, Ireland and other geographies. In addition, we may need to vary our practices in ways with which we have limited or no experience or which are less profitable or carry more risk to us. For example, we permit customer returns in the United Kingdom and expect that we may be required to adopt similar policies in other jurisdictions. We may have to compete with local companies which understand the local market better than we do. In addition, to deliver satisfactory performance for customers in international locations, it may be necessary to locate physical facilities, such as fulfillment centers in foreign markets, and we may have to invest in these facilities before the success or lack thereof of our international business. We may not be successful in growing our United Kingdom, Canada, Australia and Ireland business and expanding into any other international markets or in generating desired levels of net sales from our international business. Furthermore, different privacy, censorship, liability, intellectual property and other laws and regulations in foreign countries may cause our business, financial condition and operating results to be materially and adversely affected.
Our future results could be adversely affected by a number of factors inherent in international business, including:
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localization of our product offerings, including compliance with product safety regulatory schemes as well as translation into foreign languages and adaptation for local practices;
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different consumer demand dynamics, which may make the flash sales model less successful compared to the United States;

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unexpected changes in regulatory requirements, taxes, trade laws, tariffs, export quotas, custom duties or other trade restrictions;
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risks resulting from changes in currency exchange rates;
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more stringent regulations relating to data security and the unauthorized use of, or access to, commercial and personal information, particularly in the European Union;
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reluctance to allow personally identifiable data related to non-U.S. citizens to be stored in databases within the United States, due to concerns over the U.S. government’s right to access information in these databases or other concerns;
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changes in a specific country’s or region’s political or economic conditions;
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differing labor regulations where labor laws may be more advantageous to employees as compared to the United States;
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challenges inherent in efficiently managing an increased number of employees over large geographic distances, including the need to implement and monitor appropriate systems, policies, benefits and compliance programs;
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limitations on our ability to reinvest earnings from operations in one country to fund the capital needs of our operations in other countries;
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different or lesser intellectual property protection; and
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exposure to liabilities under anti-corruption and anti-money laundering laws, including the U.S. Foreign Corrupt Practices Act and similar laws and regulations in other jurisdictions.
Conducting business internationally requires significant management attention and financial resources. We cannot be certain that the investment and additional resources required to establish and expand our international business will produce desired levels of net sales or profitability. If we invest substantial time and resources to establish and expand our international business and are unable to do so successfully and in a timely manner, our overall business, financial condition and operating results may be materially and adversely affected.
We rely on the performance of members of management and highly skilled personnel, and if we are unable to attract, retain and motivate well-qualified employees, our business could be harmed.
We believe our success has depended, and continues to depend, on the efforts and talents of Darrell Cavens, one of our founders and our president and chief executive officer, Mark Vadon, one of our founders and chairman of the board of directors, and other members of our management team. Our success also depends on our highly skilled team of employees, including our merchandising and technology personnel. Our future success depends on our continuing ability to attract, develop, motivate and retain highly qualified and skilled employees, particularly mid-level managers and merchandising and technology personnel. The market for such positions is competitive. Qualified individuals are in high demand, and we may incur significant costs to attract them. In addition, the loss of any of our senior management or key employees or our inability to recruit and develop mid-level managers could materially and adversely affect our ability to execute our business plan, and we may not be able to find adequate replacements. All of our officers and other U.S. employees are at-will employees, meaning that they may terminate their employment relationship with us at any time, and their knowledge of our business and industry would be extremely difficult to replace. If we do not succeed in attracting well-qualified employees or retaining and motivating existing employees, our business, financial condition and operating results may be materially and adversely affected.
Adverse litigation judgments or settlements resulting from legal proceedings in which we may be involved could expose us to monetary damages or limit our ability to operate our business.
We may become involved from time to time in private actions, collective actions, investigations and various other legal proceedings by customers, employees, suppliers, competitors, government agencies or others. The results of any such litigation, investigations and other legal proceedings are inherently unpredictable and expensive. Any claims against us, whether meritorious or not, could be time-consuming, result in costly litigation, damage our reputation, require significant amounts of management time and divert significant resources. If any of these legal proceedings were to be determined adversely to us, or we were to enter into a settlement arrangement, we could be exposed to monetary damages or limits on our ability to operate our business, which could have a material adverse effect on our business, financial condition and operating results.

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We may not be able to adequately protect our intellectual property rights.
We regard our subscriber list, marks, domain names, copyrights, patents, trade dress, trade secrets, proprietary technology and similar intellectual property as critical to our success, and we rely on trademark, copyright and patent law, trade secret protection, agreements and other methods with our employees and others to protect our proprietary rights. We might not be able to obtain effective intellectual property protection in every country in which we sell products. The protection of our intellectual property rights may require the expenditure of significant financial, managerial and operational resources. Moreover, the steps we take to protect our intellectual property may not adequately protect our rights or prevent third parties from infringing or misappropriating our proprietary rights. Any of our patents, marks, copyrights or other intellectual property rights may be challenged by others or invalidated through administrative process or litigation. Our patent applications may never be granted. Additionally, the process of obtaining patent protection is expensive and time-consuming, and we may not be able to prosecute all necessary or desirable patent applications at a reasonable cost or in a timely manner. Even if issued, there can be no assurance that these patents will adequately protect our intellectual property, as the legal standards relating to the validity, enforceability and scope of protection of patent and other intellectual property rights are uncertain. We also cannot be certain that others will not independently develop or otherwise acquire equivalent or superior technology or intellectual property rights.
We might be required to spend significant resources to monitor and protect our intellectual property rights. We may not be able to discover or determine the extent of any infringement, misappropriation or other violation of our intellectual property rights and other proprietary rights. We may initiate claims or litigation against others for infringement, misappropriation or violation of our intellectual property rights or proprietary rights or to establish the validity of such rights. Despite our efforts, we may be unable to prevent third parties from infringing upon, misappropriating or otherwise violating our intellectual property rights and other proprietary rights. Any litigation, whether or not it is resolved in our favor, could result in significant expense to us and divert the efforts of our technical and management personnel, which may materially and adversely affect our business, financial condition and operating results.
We may be accused of infringing intellectual property rights of third parties.
We may be subject to litigation and disputes related to our intellectual property rights and technology, as well as disputes related to intellectual property and product offerings of third-party vendors featured by us. The costs of supporting such litigation and disputes are considerable, and there can be no assurances that favorable outcomes will be obtained.
The e-commerce industry is characterized by vigorous protection and pursuit of intellectual property rights, which has resulted in protracted and expensive litigation for many companies. We are subject to claims and litigation by third parties that we infringe their intellectual property rights, and we expect additional claims and litigation with respect to infringement to occur in the future. As our business expands and the number of competitors in our market increases and overlaps occur, we expect that infringement claims may increase in number and significance. Any claims or proceedings against us, whether meritorious or not, could be time-consuming, result in costly litigation, require significant amounts of management time or result in the diversion of significant operational resources, any of which could materially and adversely affect our business, financial condition and operating results.
Legal claims regarding intellectual property rights are subject to inherent uncertainties due to the oftentimes complex issues involved, and we cannot be certain that we will be successful in defending ourselves against such claims. In addition, some of our larger competitors have extensive portfolios of issued patents. Many potential litigants, including patent holding companies, have the ability to dedicate substantially greater resources to enforce their intellectual property rights and to defend claims that may be brought against them. Furthermore, a successful claimant could secure a judgment that requires us to pay substantial damages or prevents us from conducting our business as we have historically done or may desire to do in the future. We might also be required to seek a license and pay royalties for the use of such intellectual property, which may not be available on commercially acceptable terms, or at all. Alternatively, we may be required to develop non-infringing technology or intellectual property, which could require significant effort and expense and may ultimately not be successful.

We have received in the past, and we anticipate receiving in the future, communications alleging that certain items posted on or sold through our sites violate third-party copyrights, marks and trade names or other intellectual property rights or other proprietary rights. Brand and content owners and other proprietary rights owners have actively asserted their purported rights against online companies, including zulily. In addition to litigation from rights

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owners, we may be subject to regulatory, civil or criminal proceedings and penalties if governmental authorities believe we have aided and abetted in the sale of counterfeit or infringing products.
Such claims, whether or not meritorious, may result in the expenditure of significant financial, managerial and operational resources, injunctions against us or the payment of damages by us. We may need to obtain licenses from third parties who allege that we have violated their rights, but such licenses may not be available on terms acceptable to us, or at all. These risks have been amplified by the increase in third parties whose sole or primary business is to assert such claims.
The inability to acquire, use or maintain our “zulily” mark and domain names for our sites could substantially harm our business and operating results.
We currently are the registrant of the “zulily” mark in numerous jurisdictions and are the registrant of the Internet domain name for our website, zulily.com, as well as various related domain names. However, we have not registered the mark or domain name in all major international jurisdictions. Domain names generally are regulated by Internet regulatory bodies and are also controlled by trademark and other related laws of each country. If we do not have or cannot obtain on reasonable terms the ability to use our “zulily” mark in a particular country, or to use or register our domain name, we could be forced either to incur significant additional expenses to market our products within that country, including the development of a new brand and the creation of new promotional materials and packaging, or to elect not to sell products in that country. Either result could materially and adversely affect our business, financial condition and operating results.
Furthermore, the regulations governing domain names and laws protecting marks and similar proprietary rights could change in ways that block or interfere with our ability to use relevant domains or our current brand. Also, we might not be able to prevent third parties from registering, using or retaining domain names that interfere with our consumer communications or infringe or otherwise decrease the value of our marks, domain names and other proprietary rights. Regulatory bodies have established and may create additional generic or country-code top-level domains or may allow modifications of the requirements for registering, holding or using domain names. As a result, we might not be able to register, use or maintain the domain names that utilize the name zulily in all of the countries in which we currently or intend to conduct business.
Some of our software and systems contain open source software, which may pose particular risks to our proprietary software and solutions.
We use open source software in our software and systems and will use open source software in the future. The licenses applicable to open source software typically require that the source code subject to the license be made available to the public and that any modifications or derivative works to open source software continue to be licensed under open source licenses. From time to time, we may face claims from third parties claiming infringement of their intellectual property rights, or demanding the release or license of the open source software or derivative works that we developed using such software (which could include our proprietary source code) or otherwise seeking to enforce the terms of the applicable open source license. These claims could result in litigation and could require us to purchase a costly license, publicly release the affected portions of our source code, be limited in the licensing of our technologies or cease offering the implicated solutions unless and until we can re-engineer them to avoid infringement or change the use of the implicated open source software. In addition to risks related to license requirements, use of certain open source software can lead to greater risks than use of third-party commercial software, as open source licensors generally do not provide warranties, indemnities or other contractual protections with respect to the software (for example, non-infringement or functionality). Our use of open source software may also present additional security risks because the source code for open source software is publicly available, which may make it easier for hackers and other third parties to determine how to breach our sites and systems that rely on open source software. Any of these risks could be difficult to eliminate or manage, and, if not addressed, could have a material and adverse effect on our business, financial condition and operating results.
Our results could be adversely affected by natural disasters, public health crises, political crises or other catastrophic events.
Our principal offices are located in Seattle, Washington, an area that has experienced earthquakes in the past, and are thus vulnerable to damage. We also operate a buying and studio office in Columbus, Ohio and a customer service office in Gahanna, Ohio and have fulfillment centers in McCarran, Nevada and Lockbourne, Ohio. Natural disasters, such as hurricanes, tornadoes, floods, earthquakes and other adverse weather and climate conditions; unforeseen public health crises, such as pandemics and epidemics; political crises, such as terrorist

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attacks, war and other political instability; or other catastrophic events, whether occurring in the United States or internationally, could disrupt our operations in any of our offices and fulfillment centers or the operations of one or more of our vendors. In particular, these types of events could impact our product supply chain, including our ability to ship products to customers, from or to the impacted region and could impact our ability or the ability of third parties to operate our sites and ship products. In addition, these types of events could negatively impact consumer spending in the impacted regions or depending upon the severity, globally. To the extent any of these events occur, our business, financial condition and operating results could be materially and adversely affected.
Our ability to raise capital in the future may be limited, and our failure to raise capital when needed could prevent us from growing or responding to competitive pressures.
In the future, we could be required to raise capital through public or private financing or other arrangements. Such financing may not be available on acceptable terms, or at all, and our failure to raise capital when needed could harm our business. We may sell Class A common stock, convertible securities and other equity securities in one or more transactions at prices and in a manner as we may determine from time to time. If we sell any such securities in subsequent transactions, investors may be materially diluted. New investors in such subsequent transactions could gain rights, preferences and privileges senior to those of holders of our Class A common stock. Debt financing, if available, may involve restrictive covenants and could reduce our operational flexibility or profitability. For example, we currently have a credit facility which requires that we meet certain customary covenants that include restrictions on, among other things, indebtedness, liens, investments, mergers, dispositions, dividends or other distributions. In addition, such credit facility contains certain financial covenants. If we cannot raise funds on acceptable terms, we may not be able to grow our business or respond to competitive pressures.
Risks Related to Ownership of our Class A Common Stock
Our stock price has been and will likely continue to be volatile and may decline regardless of our operating performance, resulting in substantial losses for investors.
The trading price of our Class A common stock has been, and is likely to continue to be, volatile for the foreseeable future. For example, since shares of our Class A common stock were sold in our initial public offering ("IPO") in November 2013, at a price of $22.00 per share, through February 20, 2015, our Class A common stock's daily closing price on the NASDAQ Global Select Market has ranged from a low of $14.20 to a high of $72.75. On February 20, 2015, the closing price of our Class A common stock was $14.40.
The market price of our Class A common stock may fluctuate significantly in response to numerous factors, many of which are beyond our control, including the factors listed below and other factors described in this "Risk Factors" section:
•
actual or anticipated fluctuations in our results of operations;
•
the financial projections we may provide to the public, any changes in these projections or our failure to meet these projections;
•
failure of securities analysts to maintain coverage of our company, changes in financial estimates or ratings or negative commentary by any securities analysts who follow our company or our failure to meet these estimates or the expectations of investors;
•
announcements by us or our competitors of significant technical innovations, acquisitions, strategic partnerships, joint ventures, operating results or capital commitments;
•
changes in operating performance and stock market valuations of other technology or retail companies generally, or those in our industry in particular;
•
price and volume fluctuations in the overall stock market, including as a result of trends in the economy as a whole;
•
changes in our board of directors or management;
•
sales of large blocks of our Class A common stock, including sales by our executive officers, directors and significant stockholders;
•
lawsuits threatened or filed against us;
•
changes in laws or regulations applicable to our business;
•
changes in our capital structure, such as future issuances of debt or equity securities;

25

•
short sales, hedging and other derivative transactions involving our capital stock;
•
general economic conditions in the United States and abroad;
•
other events or factors, including those resulting from war, incidents of terrorism, public health crises or responses to these events; and
•
the other factors described in this section of our Annual Report captioned, “Risk Factors.”
In addition, stock markets have experienced extreme price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many technology companies, including e-commerce companies. Stock prices of many technology companies, including e-commerce companies, have fluctuated in a manner unrelated or disproportionate to the operating performance of those companies. In the past, stockholders have instituted securities class action litigation following periods of market volatility. If we were to become involved in securities litigation, it could subject us to substantial costs, divert resources and the attention of management from our business and materially and adversely affect our business, financial condition and operating results.
Substantial future sales of shares of our Class A common stock could cause the market price of our Class A common stock to decline.
Sales of a substantial number of shares of our Class A common stock in the public market or a conversion of a substantial number of shares of our Class B common stock into Class A common stock, or the perception that these sales or conversions might occur, could depress the market price of our Class A common stock and could impair our ability to raise capital through the sale of additional equity securities. We are unable to predict the effect that such sales or conversions may have on the prevailing market price of our Class A common stock.
In addition, as of December 28, 2014, there were 751,762 shares of Class A common stock and 11,327,185 shares of Class B common stock subject to outstanding options and 365,130 shares of Class A common stock subject to unvested restricted stock unit awards. All of the shares of Class A common stock issuable upon exercise of options (or upon conversion of Class B common stock issued upon exercise of options) and vesting of restricted stock unit awards have been registered for public resale under the Securities Act. Accordingly, these shares will be able to be freely sold in the public market upon issuance as permitted by any applicable vesting requirements, subject to compliance with applicable securities laws.
As of December 28, 2014, holders of approximately 43.4 million shares of our common stock have rights, subject to some conditions, to require us to file registration statements for the public resale of Class A common stock issued or issuable upon conversion of Class B common stock or to include such shares in registration statements that we may file for zulily or other stockholders.
The dual class structure of our common stock and the existing ownership of capital stock by our executive officers and directors have the effect of concentrating voting control with our executive officers and directors for the foreseeable future, which will limit your ability to influence corporate matters.
Our Class B common stock has ten votes per share, and our Class A common stock has one vote per share. Given the greater number of votes per share attributed to our Class B common stock, the holders of Class B common stock collectively will continue to be able to control a majority of the voting power even if their stock holdings represent as few as approximately 9.1% of the outstanding number of shares of our common stock. As of December 28, 2014, the holders of Class B common stock collectively own shares representing approximately 91.3% of the voting power of our outstanding capital stock. Our executive officers and directors, collectively, continue to beneficially own shares representing a majority of the voting power of our outstanding capital stock. This concentrated control will limit your ability to influence corporate matters for the foreseeable future and may cause us to make strategic decisions or pursue acquisitions that could involve risks to you or may not be aligned with your interests. For example, these stockholders will be able to control elections of directors, amendments of our certificate of incorporation or bylaws, increases to the number of shares available for issuance under our equity compensation plans or adoption of new equity compensation plans and approval of any merger or sale of assets for the foreseeable future. This control may adversely affect the market price of our Class A common stock.
Future transfers by holders of Class B common stock will generally result in those shares converting on a 1:1 basis to Class A common stock, which will have the effect, over time, of increasing the relative voting power of those holders of Class B common stock who retain their shares in the long-term, which may include our executive officers and directors.

26

If securities or industry analysts do not publish research or reports about our business, or publish negative reports about our business, our share price and trading volume could decline.
The trading market for our Class A common stock will depend in part on the research and reports that securities or industry analysts publish about us or our business, our market and our competitors. We do not have any control over these analysts. If one or more of the analysts who cover us downgrade our shares or change their opinion of our shares, our share price would likely decline. If one or more of these analysts cease coverage of our company or fail to regularly publish reports on us, we could lose visibility in the financial markets, which could cause our share price or trading volume to decline.
The requirements of being a public company may strain our resources, divert management’s attention and affect our ability to attract and retain additional executive management and qualified board members.
As a public company, we are subject to the reporting requirements of the Exchange Act, the Sarbanes-Oxley Act, the Dodd-Frank Act, the listing requirements of the NASDAQ Global Select Market and other applicable securities rules and regulations. Compliance with these rules and regulations has increased our legal and financial compliance costs, made some activities more difficult, time-consuming or costly and has increased demand on our systems and resources. The Exchange Act requires, among other things, that we file annual, quarterly and current reports with respect to our business and results of operations. The Sarbanes-Oxley Act requires, among other things, that we maintain effective disclosure controls and procedures and internal control over financial reporting. We are required to disclose changes made in our internal control and procedures on a quarterly basis. In order to maintain and, if required, improve our disclosure controls and procedures and internal control over financial reporting to meet this standard, significant resources and management oversight may be required. As a result, management’s attention may be diverted from other business concerns, which could adversely affect our business and results of operations. Although we have already hired additional employees to comply with these requirements, we may need to hire additional employees or engage outside consultants, which will increase our costs and expenses.
In addition, changing laws, regulations and standards relating to corporate governance and public disclosure are creating uncertainty for public companies, increasing legal and financial compliance costs and making some activities more time-consuming. These laws, regulations and standards are subject to varying interpretations, in many cases due to their lack of specificity, and, as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. This could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices. We intend to invest resources to comply with evolving laws, regulations and standards, and this investment may result in increased general and administrative expenses and a diversion of management’s time and attention from revenue-generating activities to compliance activities. If our efforts to comply with new laws, regulations and standards differ from the activities intended by regulatory or governing bodies due to ambiguities related to their application and practice, regulatory authorities may initiate legal proceedings against us, and our business may be adversely affected.
Being a public company and these new rules and regulations have made it more expensive for us to obtain director and officer liability insurance, and in the future, we may be required to accept reduced coverage or incur substantially higher costs to obtain coverage. These factors could also make it more difficult for us to attract and retain qualified members of our board of directors, particularly to serve on our audit committee and compensation committee, and qualified executive officers.
As a result of disclosure of information in our filings with the SEC, our business and financial condition have become more visible, which we believe may result in threatened or actual litigation, including by competitors and other third parties. If such claims are successful, our business and results of operations could be adversely affected, and even if the claims do not result in litigation or are resolved in our favor, these claims, and the time and resources necessary to resolve them, could divert the resources of our management and materially and adversely affect our business, financial condition and operating results.

If we fail to maintain proper and effective internal control over financial reporting, our ability to produce accurate and timely financial statements could be impaired and such failure may adversely affect investor confidence in our company and, as a result, the value of our Class A common stock.

Ensuring that we have adequate internal financial and accounting controls and procedures in place so that we can produce accurate financial statements on a timely basis is a costly and time-consuming effort that needs to

27

be re-evaluated frequently. Section 404 of the Sarbanes-Oxley Act requires us to furnish a report by management on, among other things, the effectiveness of our internal control over financial reporting for the fiscal year. This assessment includes disclosure of any material weaknesses identified by our management in our internal control over financial reporting, as well as a statement that our independent registered public accounting firm has issued an opinion on our internal control over financial reporting.
We and our independent registered public accounting firm previously identified a material weakness in our internal control over financial reporting, subsequent to the issuance of our consolidated financial statements for the fiscal years ended December 30, 2012, and January 1, 2012. A material weakness is a deficiency, or combination of control deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the annual or interim consolidated financial statements will not be prevented or detected on a timely basis. The material weakness identified related to the lack of sufficient technical accounting skills within our accounting and finance organization. During the three months ended March 30, 2014, we implemented steps to address the previously identified material weakness. Based on the steps implemented, which included increasing the size, depth and experience within our accounting and finance organization, as well as designing and implementing improved processes and internal controls, we concluded that we remediated the previously identified material weakness.
In future periods, if during the evaluation and testing process, we identify any other material weaknesses in our internal control over financial reporting, we will be unable to assert that our internal control over financial reporting is effective. If we are unable to assert that our internal control over financial reporting is effective, or if our independent registered public accounting firm is unable to express an opinion on the effectiveness of our internal control, investors could lose confidence in the accuracy and completeness of our financial reports, which would cause the price of our Class A common stock to decline, and we may be subject to investigation or sanctions by the SEC.
Anti-takeover provisions in our charter documents and under Delaware law and Washington law could make an acquisition of our company more difficult, limit attempts by our stockholders to replace or remove our current management and limit the market price of our Class A common stock.
Provisions in our certificate of incorporation and bylaws may have the effect of delaying or preventing a change of control or changes in our management. Our certificate of incorporation and bylaws include provisions that:
•
establish a classified board of directors so that not all members of our board of directors are elected at one time;
•
permit the board of directors to establish the number of directors and fill any vacancies and newly created directorships;
•
provide that directors may only be removed for cause;
•
require super-majority voting to amend some provisions in our certificate of incorporation and bylaws;
•
authorize the issuance of “blank check” preferred stock that our board of directors could use to implement a stockholder rights plan;
•
eliminate the ability of our stockholders to call special meetings of stockholders;
•
prohibit stockholder action by written consent, which requires all stockholder actions to be taken at a meeting of our stockholders;
•
provide that the board of directors is expressly authorized to make, alter or repeal our bylaws;
•
restrict the forum for certain litigation against us to Delaware;
•
reflect the dual class structure of our common stock, as discussed above; and
•
establish advance notice requirements for nominations for election to our board of directors or for proposing matters that can be acted upon by stockholders at annual stockholder meetings.
These provisions may frustrate or prevent any attempts by our stockholders to replace or remove our current management by making it more difficult for stockholders to replace members of our board of directors, which is responsible for appointing the members of our management. In addition, because we are incorporated in Delaware,

28

we are governed by the provisions of Section 203 of the Delaware General Corporation Law, which generally prohibits a Delaware corporation from engaging in any of a broad range of business combinations with any holder of at least 15% of our capital stock for a period of three years following the date on which the stockholder became a 15% stockholder. Likewise, because our principal executive offices are located in Washington, the anti-takeover provisions of the Washington Business Corporation Act may apply to us under certain circumstances now or in the future. These provisions prohibit a “target corporation” from engaging in any of a broad range of business combinations with any stockholder constituting an “acquiring person” for a period of five years following the date on which the stockholder became an “acquiring person.”
Our certificate of incorporation also provides that the Court of Chancery of the State of Delaware is the exclusive forum for substantially all disputes between us and our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers or employees.
Our certificate of incorporation provides that the Court of Chancery of the State of Delaware is the exclusive forum for any derivative action or proceeding brought on our behalf; any action asserting a breach of fiduciary duty; any action asserting a claim against us arising pursuant to the Delaware General Corporation Law, our certificate of incorporation or our bylaws; or any action asserting a claim against us that is governed by the internal affairs doctrine. The choice of forum provision may limit a stockholder’s ability to bring a claim in a judicial forum that it finds favorable for disputes with us or our directors, officers or other employees, which may discourage such lawsuits against us and our directors, officers and other employees. Alternatively, if a court were to find the choice of forum provision contained in our certificate of incorporation to be inapplicable or unenforceable in an action, we may incur additional costs associated with resolving such action in other jurisdictions, which could adversely affect our business and financial condition.


29

Item 1B.    Unresolved Staff Comments

None.
Item 2.    Properties
Our principal executive offices are located at 2601 Elliott Avenue, Suite 200, Seattle, Washington. The lease for our principal executive offices is for 303,804 square feet and expires in 2024, and provides for a right to terminate in January 2021, subject to satisfaction of certain payment obligations. We lease an approximately 737,000 square foot fulfillment center in Lockbourne, Ohio, pursuant to a lease that expires in May 2017. We also lease an approximately 28,700 square foot corporate office which houses a merchandising team and production studios in Columbus, Ohio, pursuant to a lease that expires in May 2017. We lease an approximately 32,500 square foot corporate office in Gahanna, Ohio, which houses a customer service team, pursuant to a lease that expires in August 2015. We lease an approximately 707,010 square foot fulfillment center in McCarran, Nevada, pursuant to a lease that expires in August 2026. We also entered into an 86-month lease in September 2014 for approximately 800,250 square feet of ground floor space in Bethlehem, Pennsylvania. We lease an approximately 7,000 square foot office space in the United Kingdom, pursuant to a lease that expires in June 2015. We believe that our facilities are suitable and adequate to meet our current needs. We intend to add new facilities and fulfillment centers or expand existing facilities and fulfillment centers as needed as we add employees and expand operations. We believe that suitable additional or substitute space will be available as needed to accommodate any such expansion of our operations.
Item 3.    Legal Proceedings

See Note 5: "Commitments and Contingencies" of the Notes to Consolidated Financial Statements within Item 8, of Part II of this Annual Report for information regarding legal proceedings.
Item 4.    Mine Safety Disclosures

None.

Item 5.    Market for Registrant's Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities
Market for Our Common Stock
Our Class A common stock has traded on the NASDAQ Global Select Market under the symbol “ZU” since November 15, 2013. Prior to that date, there was no public market for our Class A common stock. There is no public trading market for our Class B common stock. The following table sets forth the high and low intra-day sales prices per share for our Class A common stock on the NASDAQ Global Select Market.

Common Stock Price

2014
 
2013

High

Low
 
High*

Low*
1st Quarter
$
73.50


$
35.08

 
N/A

 
N/A

2nd Quarter
$
56.81


$
28.75

 
N/A

 
N/A

3rd Quarter
$
41.89


$
31.88

 
N/A

 
N/A

4th Quarter
$
41.75


$
22.61

 
$
44.96

 
$
34.19

 
 
 
 
 
 
 
 
*Beginning November 15, 2013

30

Holders of Record
As of February 20, 2015, there were 26 stockholders of record of our Class A common stock and 105 stockholders of record of our Class B common stock. The actual number of stockholders is greater than this numbers of record holders, and includes stockholders who are beneficial owners, whose shares are held of record by banks, brokers, and other financial institutions.
Dividends
We have never declared or paid dividends on our capital stock except for the deemed dividend to preferred stockholders in our fiscal year 2012. We do not intend to declare or pay cash dividends on our capital stock in the foreseeable future. Any future determination to pay dividends will be made at the discretion of our board of directors subject to applicable laws, and will depend upon, among other factors, our results of operations, financial condition, contractual restrictions and capital requirements.
Our future ability to pay cash dividends on our stock is limited by the terms of our January 2014 credit facility that restricts our ability to make certain restricted payments, which include the payment of cash dividends, other than certain exceptions set forth in such credit agreement. We have the ability to make future cash dividend payments under the terms of the credit agreement if, at the time of and on a pro forma basis immediately after making such cash dividend payment, we remain in compliance with certain financial covenants set forth in such credit agreement. We may be further limited by the terms of any future debt or preferred securities.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
During the quarter ended December 28, 2014, we repurchased the following shares from a former employee by exercising our right to repurchase unvested shares upon termination of employment at a price equal to the original purchase price paid by such employee for such shares:
 
 
 
 
 
(c)
Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs
 
(d)
Maximum Number (or Approximate Dollar Value) of Shares (or Units) That May Yet Be Purchased Under the Plans or Programs
 
(a)
Total Number of Shares (or Units) Purchased
 
(b) Average Price Paid per Share (or Unit)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
September 29 - October 28, 2014
—

 
N/A

 
N/A
 
N/A
October 29 - November 28, 2014
4,558

 
$
0.728

 
N/A
 
N/A
November 29 - December 28, 2014
—

 
N/A

 
N/A
 
N/A
Total
4,558

 
$
0.728

 
N/A
 
N/A
Sales of Unregistered Securities
None.
Use of Proceeds from Public Offering of Common Stock

Our registration statement on Form S-1 (File No. 333-191617) for our IPO was declared effective by the SEC on November 14, 2013.

There has been no material change in the planned use of proceeds from our IPO as described in our final prospectus filed with the SEC on November 15, 2013 pursuant to Rule 424(b) under the Securities Act. However, a portion of the proceeds may be used to effect repurchases of our common stock under the repurchase program described elsewhere in this Annual Report. As of December 28, 2014, we had not used any proceeds from our IPO. Pending the uses described, we maintain the cash received in cash and cash equivalents as well as short-term investments.


31

Stock Performance Graph
The following shall not be deemed “filed” for purposes of Section 18 of the Exchange Act, or incorporated by reference into any of our other filings under the Exchange Act or the Securities Act, except to the extent we specifically incorporate it by reference into such filing.
This graph compares the cumulative total return on our Class A common stock with that of the NASDAQ Composite Index and the S&P 500 Retailing Index. The chart assumes $100 was invested at the close of market on November 15, 2013 in our Class A common stock or October 31, 2013 in the NASDAQ Composite Index and the S&P 500 Retailing Index, and assumes the reinvestment of any dividends. The stock price performance on the following graph is not necessarily indicative of future stock price performance.
The closing price of our Class A common stock on December 26, 2014, the last trading day of fiscal 2014, was $23.28 per share.
Item 6.    Selected Financial and Other Data
The selected consolidated statements of operations data for the fiscal years ended December 28, 2014, December 29, 2013 and December 30, 2012 and the consolidated balance sheet data as of December 28, 2014 and December 29, 2013 are derived from our audited consolidated financial statements appearing elsewhere in this Annual Report. The consolidated balance sheet data for the fiscal year ended December 30, 2012 and the consolidated statements of operations data for the fiscal years ended January 1, 2012 and December 31, 2010 are derived from audited consolidated financial statements that are not included in this Annual Report. Our historical results are not necessarily indicative of the results that should be expected in the future. The selected consolidated financial and other data should be read in conjunction with the sections entitled Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 8, "Financial Statements and Supplementary Data."

32

 
Year Ended
 
December 28,
2014
 
December 29,
2013
 
December 30,
2012
 
January 1,
2012
 
December 31,
2010
 
 
 
 
 
 
 
 
 
 
 
(in thousands, except share and per share data)
Consolidated Statements of Operations Data
 
 
 
 
 
 
 
 
 
Net sales
$
1,200,079

 
$
695,709

 
$
331,240

 
$
142,545

 
$
18,376

Cost of sales(1)
875,633

 
502,318

 
240,943

 
104,949

 
12,574

Gross profit
324,446

 
193,391

 
90,297

 
37,596

 
5,802

Operating expenses:
 
 
 
 
 
 
 
 
 
Marketing expenses(1)
100,730

 
59,667

 
37,780

 
20,228

 
4,897

Selling, general and administrative expenses(1)
207,986

 
120,695

 
63,071

 
28,905

 
7,112

Total operating expenses
308,716

 
180,362

 
100,851

 
49,133

 
12,009

Income (loss) from operations
15,730

 
13,029

 
(10,554
)
 
(11,537
)
 
(6,207
)
Interest income (expense)—net
317

 
136

 
43

 
20

 
(169
)
Other income (expense)—net
(46
)
 
99

 
176

 
203

 
(627
)
Net income (loss) before provision for income taxes
16,001

 
13,264

 
(10,335
)
 
(11,314
)
 
(7,003
)
Provision for income taxes
1,109

 
356

 
—

 
—

 
—

Net income (loss)
$
14,892

 
$
12,908

 
$
(10,335
)
 
$
(11,314
)
 
$
(7,003
)
Net income (loss) attributable to Class A and Class B common stockholders
$
14,892

 
$
—

 
$
(46,822
)
 
$
(13,233
)
 
$
(7,448
)
Net income (loss) per Class A and Class B common share(2):
 
 
 
 
 
 
 
 
 
Basic
$
0.12

 
$
—

 
$
(1.23
)
 
$
(0.55
)
 
$
(0.46
)
Diluted
$
0.11

 
$
—

 
$
(1.23
)
 
$
(0.55
)
 
$
(0.46
)
Shares used in computing net income (loss) per Class A and Class B common share:
 
 
 
 
 
 
 
 
 
Basic
124,679,716

 
59,450,186

 
37,976,724

 
24,102,780

 
16,347,656

Diluted
132,317,357

 
59,450,186

 
37,976,724

 
24,102,780

 
16,347,656


Year Ended

December 28,
2014
 
December 29,
2013
 
December 30,
2012
 
January 1,
2012
 
December 31,
2010
 
 
 
 
 
 
 
 
 
 

(in thousands, except revenue per active customer and average order value)
Other Financial and Operational Data

 

 

 

 
 
Adjusted EBITDA(3)
$
43,727

 
$
27,046

 
$
(5,920
)
 
$
(8,871
)
 
$
(3,734
)
Free cash flow(4)
$
62,257

 
$
53,514

 
$
8,425

 
$
3,749

 
$
(1,164
)
Active customers(5)
4,887

 
3,172

 
1,580

 
810

 
157

Revenue per active customer(6)
$
246

 
$
219

 
$
210

 
$
176

 
$
117

Total orders placed(7)
23,624

 
14,144

 
6,950

 
2,998

 
384

Average order value(8)
$
56.07

 
$
54.75

 
$
53.37

 
$
53.48

 
$
52.52


33

 
As of
 
December 28,
2014
 
December 29,
2013
 
December 30,
2012
 
 
 
 
 
 
 
(in thousands)
Consolidated Balance Sheet Data
 
 
 
 
 
Cash and cash equivalents
$
242,292

 
$
290,089

 
$
96,998

Short-term investments
131,528

 
18,014

 
8,000

Working capital
219,165

 
220,820

 
62,605

Total assets
492,378

 
356,087

 
130,737

Deferred revenue
44,243

 
23,250

 
9,653

Convertible redeemable preferred stock(9)
—

 
—

 
128,714

Total stockholders’ equity (deficit)(9)
275,963

 
242,203

 
(55,750
)

______________
(1)Stock-based compensation included in the statements of operations data above was as follows:

Year Ended

December 28,
2014
 
December 29,
2013
 
December 30,
2012
 
January 1,
2012
 
December 31,
2010
 
 
 
 
 
 
 
 
 
 

(in thousands)
 
 
Cost of sales
$
210

 
$
70

 
$
26

 
$
2

 
$
—

Marketing expenses
790

 
327

 
142

 
62

 
2

Selling, general and administrative expenses
13,548

 
7,380

 
1,097

 
2,015

 
2,396

Total stock-based compensation expense
$
14,548

 
$
7,777

 
$
1,265

 
$
2,079

 
$
2,398

(2)
Basic and diluted net loss per common share attributable to common stockholders for the fiscal year ended December 30, 2012 includes a deemed dividend distribution of $32.1 million. Such dividend is included as it represents distributed earnings attributable to participating securities.
(3)
Adjusted EBITDA is a non-GAAP financial measure that we calculate as earnings (loss) before interest and other income and expense, taxes, depreciation, amortization and stock-based compensation expense. See “Non-GAAP Financial Measures—Adjusted EBITDA” below for more information and for a reconciliation of Adjusted EBITDA to net income (loss), the most directly comparable financial measure calculated and presented in accordance with GAAP.
(4)
Free cash flow is a non-GAAP financial measure that we calculate as net cash provided by (used in) operating activities less net cash used in capital expenditures. See “Non-GAAP Financial Measures—Free Cash Flow” below for more information and for a reconciliation of free cash flow to net cash provided by (used in) operating activities, the most directly comparable financial measure calculated and presented in accordance with GAAP.
(5)
Represents individual customers who have purchased from us at least once in the last year. In any particular period, we determine our number of active customers by counting the total number of customers who have made at least one purchase in the preceding 12 month period, measured from the last date of such period. For more information, see "Management's Discussion and Analysis of Financial Condition and Results of Operations—Key Financial and Operating Metrics—Active Customers."
(6)
Represents our total net sales divided by our total number of active customers in any particular period. For more information, see "Management's Discussion and Analysis of Financial Condition and Results of Operations—Key Financial and Operating Metrics—Revenue Per Active Customer."
(7)
Represents the total number of customer orders placed by our customers in any period. For more information, see "Management's Discussion and Analysis of Financial Condition and Results of Operations—Key Financial and Operating Metrics—Total Orders Placed."
(8)
Represents the sum of the total order values (including shipping and handling charges) in a given period divided by the total orders placed in that period. For more information, see "Management's Discussion and Analysis of Financial Condition and Results of Operations—Key Financial and Operating Metrics—Average Order Value."
(9)
Outstanding convertible redeemable preferred stock converted to Class B common shares following the close of our IPO.

Non-GAAP Financial Measures
Adjusted EBITDA
To provide investors with additional information regarding our financial results, we have disclosed in the table above and elsewhere in this Annual Report Adjusted EBITDA, a non-GAAP financial measure that we calculate as earnings (loss) before interest and other income and expense, taxes, depreciation, amortization and stock-based compensation expense. We have provided a reconciliation below of Adjusted EBITDA to net income (loss), the most directly comparable financial measure under accounting principles generally accepted in the United States ("GAAP").

34

We have included Adjusted EBITDA in this Annual Report because it is a key measure used by our management and board of directors to evaluate our operating performance, generate future operating plans and make strategic decisions regarding the allocation of capital. In particular, the exclusion of certain expenses in calculating Adjusted EBITDA facilitates operating performance comparisons on a period-to-period basis and, in the case of exclusion of the impact of stock-based compensation, excludes an item that we do not consider to be indicative of our core operating performance. Accordingly, we believe that Adjusted EBITDA provides useful information to investors and others in understanding and evaluating our operating results in the same manner as our management and board of directors.
Adjusted EBITDA has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are:
•
although depreciation and amortization are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future, and Adjusted EBITDA does not reflect cash capital expenditure requirements for such replacements or for new capital expenditure requirements;
•
Adjusted EBITDA does not reflect changes in, or cash requirements for, our working capital needs;
•
Adjusted EBITDA does not consider the potentially dilutive impact of equity-based compensation;
•
Adjusted EBITDA does not reflect tax payments that may represent a reduction in cash available to us; and
•
other companies, including companies in our industry, may calculate Adjusted EBITDA differently, which reduces its usefulness as a comparative measure.
Because of these limitations, you should consider Adjusted EBITDA alongside other financial performance measures, including various cash flow metrics, net income (loss) and our other GAAP results.
The following table reflects the reconciliation of net income (loss) to Adjusted EBITDA for each of the periods indicated:
 
  
Year Ended
 
December 28,
2014
 
December 29,
2013
 
December 30,
2012
 
January 1,
2012
 
December 31,
2010
 
 
 
 
 
 
 
 
 
 
 
(in thousands)
Reconciliation of Adjusted EBITDA:
 
 
 
Net income (loss)
$
14,892

 
$
12,908

 
$
(10,335
)
 
$
(11,314
)
 
$
(7,003
)
Excluding:
   
 
 
 
 
 
 
 
 
Interest (income) expense—net
(317
)
 
(136
)
 
(43
)
 
(20
)
 
169

Other (income) expense—net
46

 
(99
)
 
(176
)
 
(203
)
 
627

Taxes
1,109

 
356

 
—

 
—

 
—

Depreciation and amortization
13,449

 
6,240

 
3,369

 
587

 
75

Stock-based compensation expense
14,548

 
7,777

 
1,265

 
2,079

 
2,398

Adjusted EBITDA
$
43,727

 
$
27,046

 
$
(5,920
)
 
$
(8,871
)
 
$
(3,734
)
Free Cash Flow
To provide investors with additional information regarding our financial results, we have also disclosed in the table above and elsewhere in this Annual Report free cash flow, a non-GAAP financial measure that we calculate as net cash provided by (used in) operating activities less net cash used in capital expenditures. We have provided a reconciliation below of free cash flow to net cash provided by (used in) operating activities, the most directly comparable GAAP financial measure.
We have included free cash flow in this Annual Report because it is a key measure used by our management and board of directors, which we believe is an important indicator of our business performance because it measures the amount of cash we generate. Free cash flow also reflects changes in working capital. Accordingly, we believe that free cash flow provides useful information to investors and others in understanding and evaluating our operating results in the same manner as our management and board of directors.

35

Free cash flow has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP. There are limitations to using non-GAAP financial measures, including that other companies, including companies in our industry, may calculate free cash flow differently. Because of these limitations, you should consider free cash flow alongside other financial performance measures, including net cash provided by (used in) operating activities, capital expenditures and our other GAAP results.
 
The following table presents a reconciliation of free cash flow to net cash provided by (used in) operating activities for each of the periods indicated:
 
Year Ended
  
December 28,
2014
 
December 29,
2013
 
December 30,
2012
 
January 1,
2012
 
December 31,
2010
 
 
 
 
 
 
 
 
 
 
 
(in thousands)
Reconciliation of Free Cash Flow:
 
Net cash provided by (used in) operating activities
$
130,014

 
$
73,120

 
$
16,283

 
$
8,864

 
$
(656
)
Capital expenditures
(67,757
)
 
(19,606
)
 
(7,858
)
 
(5,115
)
 
(508
)
Free cash flow
$
62,257

 
$
53,514

 
$
8,425

 
$
3,749

 
$
(1,164
)
Net cash used in investing activities
$
(181,205
)
 
$
(28,936
)
 
$
(139
)
 
$
(21,615
)
 
$
(608
)
Net cash provided by financing activities
$
3,453

 
$
148,931

 
$
52,493

 
$
31,955

 
$
9,903

Diluted net income (loss) per share
To provide investors with additional information regarding our financial results, we have also disclosed in the table below and elsewhere in this Annual Report, a non-GAAP diluted net income (loss) per share financial measure which assumes the conversion of all outstanding shares of preferred stock at the beginning of the reporting period for periods prior to our IPO in November 2013. Our non-GAAP diluted net income (loss) per share also assumes all vesting of restricted stock occurred at the beginning of the applicable reporting periods. The numerator of the non-GAAP diluted net income (loss) per share calculation also excludes the effect of the deemed dividend which resulted from a preferred stock repurchase in the fourth quarter of 2012. Assuming the conversion of preferred stock and the vesting of restricted stock at the beginning of the applicable reporting periods, as well as the exclusion of the deemed dividend, the result is the use of GAAP net income (loss) as the numerator and the denominator representing the weighted-average shares outstanding on an if-converted basis in the calculation of non-GAAP diluted net income (loss) per share for each period presented. In reports filed with the SEC for the periods preceding the period ended June 29, 2014, we did not add back stock-based compensation expense when calculating our non-GAAP diluted net income (loss) per share financial measure. Beginning in our quarterly report for the period ended June 29, 2014 and continued in this Annual Report, we have modified our non-GAAP diluted net income (loss) per share financial measure to add back stock-based compensation expense for all periods presented. We do not add back tax adjustments related to stock-based compensation, as we have a limited history of taxable income and applicable effective tax rates, which makes inclusion of such adjustments less useful to investors and others.
We have included non-GAAP diluted net income (loss) per share, inclusive of the change noted above, in this Annual Report because it is a key measure used by our management and board of directors, which we believe is an important indicator of our business performance as this measure is more comparable in understanding our past financial performance and future results. We believe that adding back stock-based compensation expense to our non-GAAP diluted net income (loss) per share financial measure for all periods presented provides a more meaningful comparison between our operating results from period to period because of varying available valuation methodologies, subjective assumptions, the variety of equity instruments that can impact a company's non-cash expenses and the inability of the expense to directly relate to performance in any particular period. Accordingly, we believe that non-GAAP diluted net income (loss) per share provides useful information to investors and others in understanding and evaluating our operating results in the same manner as our management and board of directors.

36

A reconciliation of non-GAAP net income (loss) attributable to common stockholders to GAAP income (loss) attributable to common stockholders, the most directly comparable GAAP financial measure, and non-GAAP dilutive shares to GAAP dilutive shares, the most directly comparable GAAP financial measure, in order to calculate non-GAAP diluted net income (loss) per share, is as follows:

Year Ended
  
December 28, 2014
 
December 29, 2013
 
December 30,
2012
 
January 1,
2012
 
December 31,
2010
 
 
 
 
 
 
 
 
 
 
 
(in thousands except share and per share amounts)

 
 
 
GAAP net income (loss) attributable to common stockholders
$
14,892

 
$
—

 
$
(46,822
)
 
$
(13,233
)
 
$
(7,448
)
Add: Preferred stock deemed dividend
—

 
—

 
32,112

 
—

 
—

Add: Accretion of convertible redeemable preferred stock
—

 
8,975

 
4,375

 
1,919

 
445

Add: Undistributed earnings attributable to participating securities
—

 
3,933

 
—

 
—

 
—

Add: Stock-based compensation
$
14,548


$
7,777


$
1,265


$
2,079

 
$
2,398

Non-GAAP net income (loss) attributable to common stockholders
$
29,440

 
$
20,685

 
$
(9,070
)
 
$
(9,235
)
 
$
(4,605
)
 
 
 
 
 
 
 
 
 
 
GAAP Weighted average shares used to compute diluted net income (loss) per Class A and Class B common share
132,317,357

 
59,450,186

 
37,976,724

 
31,010,515

 
10,051,637

Add: Convertible preferred stock
—

 
53,293,392

 
55,846,208

 
75,346,500

 
33,188,453

Add: Unvested restricted stock
—

 
3,644,546

 
16,468,775

 
22,938,969

 
43,417,113

Add: Additional dilutive effect of stock options
—

 
3,989,507

 
—

 
—

 
—

Add: Additional dilutive effect of restricted stock unit awards
—


—


—


—

 
—

Non-GAAP Weighted average shares used to compute diluted net income (loss) per Class A and Class B common share
132,317,357

 
120,377,631

 
110,291,707

 
129,295,984

 
86,657,203

Non-GAAP diluted net income (loss) per share attributable to Class A and Class B common stockholders
$
0.22

 
$
0.17

 
$
(0.08
)
 
$
(0.07
)
 
$
(0.05
)

Item 7.    Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes appearing elsewhere in this Annual Report. This discussion contains forward-looking statements that reflect our plans, estimates and beliefs, and involve risks and uncertainties. Our actual results and the timing of certain events could differ materially from those anticipated in these forward-looking statements as a result of several factors, including those discussed in the section titled “Risk Factors” included under Part I, Item 1A and elsewhere in this Annual Report. See “Special Note Regarding Forward-Looking Statements” in this Annual Report.
Overview
We launched the zulily website in January 2010 with the goal of revolutionizing the way moms shop. Today, we are one of the largest standalone e-commerce companies in the United States. Through our desktop and mobile websites and mobile applications, which we refer to as our “sites”, we help our customers discover new and unique products at great values that they would likely not find elsewhere. We provide our customers with a fun and entertaining shopping experience with a fresh selection of flash sales events with thousands of product styles

37

offered on a typical day. We source these products from thousands of vendors, including emerging brands and smaller boutique vendors, as well as larger national brands. By bringing together millions of customers and a daily selection of products chosen from our vendor base, we have built a large-scale and uniquely curated marketplace.
We sell our products through a flash sales model, with offerings typically only available for 72 hours and in a limited quantity, creating an urgency to browse and purchase. We sell women's, children’s and men's apparel, children's merchandise and other product categories such as kitchen accessories and home décor. We focus on providing significant value to consumers across all of our categories; the average item on our sites is offered for over 50% off the manufacturer’s suggested retail price.
We plan to further grow our customer base by cost-effectively acquiring new email subscribers and users of our mobile applications through targeted marketing campaigns and then converting them into active customers. In addition, we regularly introduce new categories, brands and products to our customers and work to maximize the relevance of the items we display, thereby improving customer satisfaction, increasing customer loyalty and driving repeat purchasing.
Mobile is a large and growing part of our business. We have invested heavily in our mobile platform to optimize our sites for use on iPhones, iPads and Android-based devices. In the fourth quarter of 2014, approximately 51% of our North American orders were placed from a mobile device, up from approximately 45% in the fourth quarter of 2013.
We have built a merchandising organization specifically designed to source, cultivate and manage relationships with thousands of vendors, including emerging brands and smaller boutique vendors as well as larger national brands. To identify and support our vendors and effectively tell their stories to our customers, we have built a merchandising team and in-house photography studios, supported by a substantial and talented photo editing, copyrighting and editorial team. By sourcing a large number of vendors and providing them with strong support, we are able to offer our customers a broad and unique selection of curated products that is refreshed on a daily basis.
We typically receive customer orders before we purchase inventory from our vendors, greatly reducing our inventory risk. The result of this dynamic is that we are able to offer a much larger range of products to our customers and to generate greater sales for our vendors, who are able to match a broader range of their product supply to actual customer demand. To best serve our customers and vendors, we have in place a custom, fully integrated fulfillment infrastructure. Our proprietary supply chain system enables us to efficiently handle the unique features of our flash sales model, including small to medium lot sizes and high inventory turnover. This allows us to sell lower price point products cost-effectively, without needing to pre-stock substantial inventory. Our business model together with our fulfillment infrastructure has enabled us to conduct successful events of all sizes, including smaller ones.
As of December 28, 2014, we occupy approximately 1.4 million square feet of leased fulfillment space at facilities in Nevada and Ohio. The decrease of 0.4 million square feet from the quarter ended September 28, 2014 is a result of the lease term for our old Nevada facility ending during the fourth quarter of 2014. We anticipate the square footage we occupy for fulfillment space to increase to 2.2 million square feet as a result of our new facility in Bethlehem, Pennsylvania. Our fulfillment operations regularly handle thousands of items a day from product styles that change each day and require different handling processes. Because we have deliberately established an intermediary model in which we do not typically pre-purchase substantial inventory, our shipping times are generally slower than e-commerce retailers that hold inventory. Our average order-to-ship time from our U.S. fulfillment centers was 13.7 days in the fourth quarter of 2014, up from 11.6 days in the third quarter of 2014. We are continually investing in our U.S. fulfillment systems and infrastructure, which includes automating the shipping process, increasing capacity, reducing shipping costs and improving order-to-ship times. We have also expanded consignment and fulfillment services for our vendors in an effort to further reduce our order-to-ship times.
To date, we have primarily focused on expanding our North American business, which includes all sales made through our U.S.-operated sites, including sales made to customers in Canada, Australia and other foreign countries. For the fiscal year ended December 28, 2014 and the fiscal year ended December 29, 2013, we generated $18.6 million and $13.9 million in net sales, respectively, from our U.K.-operated sites, representing growth of 34%. In late January 2015, we decided to close the U.K. office and source orders from the U.S. In conjunction with the decision to close the U.K. office, we began migrating the U.K. members and customers from the U.K.-operated sites onto the U.S.-operated sites to better align our strategy in the United Kingdom with our other foreign operations.

38

We are gradually increasing our level of investment in international expansion and plan to continue to invest in and develop international markets. During the fiscal year ended December 28, 2014, we began marketing our U.S.-operated sites to Australian and Irish subscribers, similarly to how we structured our Canadian business in 2013. Our international strategy is focused primarily on marketing U.S. vendors to subscribers globally. We also occasionally market international boutique vendors on our U.S.-operated sites. Customers in foreign countries that purchase on our U.S.-operated sites are included in our North America net sales. During the fiscal year ended December 28, 2014, our products were shipped to over 80 countries.

A summary of activity for the quarter and fiscal year ended December 28, 2014, compared to the quarter and fiscal year ended December 29, 2013, is as follows:
•
For the three months ended December 28, 2014 and December 29, 2013, we reported $391.3 million and $257.0 million in net sales, representing growth of 52%.
•
For the fiscal year ended December 28, 2014 and December 29, 2013, we reported $1.2 billion and $695.7 million in net sales, representing growth of 72%.
•
As of December 28, 2014, we had 4.9 million active customers, or customer who had purchased at least once in the last year, an increase of 54% from the 3.2 million active customers we had as of December 29, 2013.
•
For the three and twelve months ended December 28, 2014, there were total orders placed of 6.8 million and 23.6 million, respectively, representing an increase in total orders of 2.0 million and 9.5 million, respectively, or 42% and 67%, respectively, from the three and twelve months ended December 29, 2013.
•
For the fiscal year ended December 28, 2014, 86% of our North America orders were placed by customers who had previously purchased from us.
Factors Affecting Our Performance
Ability to Attract Site Visitors at Reasonable Cost
To increase our sales, expand our market presence and grow our business profitably, we must continue to acquire email subscribers, users of our mobile applications and customers at reasonable costs. We use a wide range of paid and unpaid marketing channels, including affiliate channels and partners, customer referrals, direct navigation, display advertising, key word search campaigns, search engine optimization, social media and television ads, to attract potential new customers to our sites. We must maintain reasonable costs for these marketing efforts relative to the net sales we expect to derive from these visitors, once we convert them to customers. Our customer activation costs have varied from period to period and we experienced an increase in such costs during the fiscal year ended December 28, 2014. Failure to effectively attract new visitors, email subscribers and users of our mobile applications and convert them into customers on a cost-efficient basis would adversely affect our sales growth and operating results.
Customer Activation and Repeat Behavior
Once we have attracted potential new customers to our sites, and enrolled them as email subscribers or users of our mobile applications, our goal is to convert them into active customers and then encourage repeat purchases. We do this through a combination of strategies, including email and mobile “push” communications, personalized retargeting email messaging and other broad-based advertising campaigns. Our ability to retain active customers and encourage repeat purchases depends on a number of factors, and any decrease in customer retention may adversely affect our sales growth and operating results.
Product Mix
Our products and categories have a range of margin profiles. Historically, variations in product mix and product or category margins have not generally been a significant driver of our business results. Going forward, however, shifts in product mix due to seasonality, purchasing trends, results of individual events or changes in the product margins of certain categories could affect our overall operating results or growth rates in a positive or negative manner. Internationally, we have limited results to evaluate whether product mix and product or category margins will be similar to those in our North American business and to the extent they are different, we may see an impact to our operating results.

39

Growth of Mobile Commerce
We expect that our customers will increasingly access our sites using mobile devices. From inception through December 28, 2014, customers who access our sites through a mobile device have typically had a higher lifetime value. Due to the relative newness of smartphones, tablets and mobile shopping in general, we do not know if this trend will continue or whether it is a result of our mobile interface or simply indicative of a customer demographic that is an early adopter of mobile commerce. If we are unable to continue to attract customers who are predisposed to engage in mobile shopping or if over the longer term mobile shoppers are not more active than other customers, our sales growth rate and operating results could be negatively affected.
Investment in Growth
We anticipate that our operating expenses will increase as we continue to expand our organization size in general, and our merchandising, technology, studio and fulfillment operations in particular. These increased expenses will result primarily from hiring additional employees, further developing our technology and scaling our fulfillment centers as our business grows. In addition, we may invest in infrastructure or capabilities that we believe will yield returns in the long term but for which there is not a near-term return.
Key Financial and Operating Metrics
We measure our business using both financial and operating metrics. We use these metrics to assess the progress of our business, make decisions on where to allocate capital, time and technology investments and assess the near-term and longer-term performance of our business. The key financial and operating metrics we use are:
 
 
Fiscal Years
 
2014
 
2013
 
2012
 
2011
 
2010
 
 
 
 
 
 
 
 
 
 
 
(in thousands, except revenue per active customer and average order value)
Adjusted EBITDA
$
43,727


$
27,046


$
(5,920
)

$
(8,871
)
 
$
(3,734
)
Free cash flow
$
62,257


$
53,514


$
8,425


$
3,749

 
$
(1,164
)
Active customers
4,887


3,172


1,580


810

 
157

Revenue per active customer
$
246


$
219


$
210


$
176

 
$
117

Total orders placed
23,624


14,144


6,950


2,998

 
384

Average order value
$
56.07


$
54.75


$
53.37


$
53.48

 
$
52.52

Non-GAAP diluted net income (loss) per share
$
0.22


$
0.17


$
(0.08
)

$
(0.07
)
 
$
(0.05
)
Adjusted EBITDA
Adjusted EBITDA is a non-GAAP financial measure that we calculate as earnings (loss) before interest and other income and expense, taxes, depreciation, amortization and stock-based compensation expense. Adjusted EBITDA is a key measure used by management to evaluate our operating performance, generate future operating plans and make strategic decisions regarding the allocation of capital. In particular, the exclusion of certain expenses in calculating Adjusted EBITDA facilitates operating performance comparisons on a period-to-period basis and, in the case of exclusion of the impact of stock-based compensation, excludes an item that we do not consider to be indicative of our core operating performance. Adjusted EBITDA is not a measure calculated in accordance with GAAP. Please see the section of this Annual Report captioned “Selected Financial and Other Data—Non-GAAP Financial Measures—Adjusted EBITDA” for a discussion of the limitations of Adjusted EBITDA and a reconciliation of Adjusted EBITDA to net income (loss) the most comparable GAAP measurement, for the periods presented.
Free Cash Flow
Free cash flow is a non-GAAP financial measure that we calculate as net cash provided by (used in) operating activities less net cash used in capital expenditures. We believe free cash flow is an important indicator of our business performance because it measures the amount of cash we generate. Free cash flow also reflects changes in working capital. Please see the section of this report captioned “Selected Financial and Other Data—Non-GAAP Financial Measures—Free Cash Flow” for a discussion of the limitations of free cash flow and a

40

reconciliation of free cash flow to net cash provided by (used in) operating activities, the most directly comparable GAAP financial measure.
Non-GAAP diluted net income (loss) per share
Non-GAAP diluted net income (loss) per share is a financial measure which assumes the conversion of all outstanding shares of preferred stock at the beginning of the reporting period for periods prior to our IPO in November 2013. Our non-GAAP diluted net income (loss) per share also assumes all vesting of restricted stock occurred at the beginning of the applicable reporting periods. The numerator of the non-GAAP diluted net income (loss) per share calculation also excludes the effect of the deemed dividend which resulted from a preferred stock repurchase in the fourth quarter of 2012. Assuming the conversion of preferred stock and the vesting of restricted stock at the beginning of the applicable reporting periods, as well as the exclusion of the deemed dividend, the result is the use of GAAP net income (loss) as the numerator and the denominator representing the weighted-average shares outstanding on an if-converted basis in the calculation of non-GAAP diluted net income (loss) per share for each period presented. In reports filed with the SEC for the periods preceding the period ended June 29, 2014, we did not add back stock-based compensation expense when calculating our non-GAAP diluted net income (loss) per share financial measure. Beginning in our quarterly report for the period ended June 29, 2014 and continued in this Annual Report, we have modified our non-GAAP diluted net income (loss) per share financial measure to add back stock-based compensation expense for all periods presented. We do not add back tax adjustments related to stock-based compensation, as we have a limited history of taxable income and applicable effective tax rates, which makes inclusion of such adjustments less useful to investors and others. We believe this measure is more comparable in understanding our past financial performance and future results. Please see the section of this report captioned “Selected Financial and Other Data—Non-GAAP Financial Measures—Non-GAAP Diluted Net Income (Loss)” for a discussion of the limitations of non-GAAP diluted net income (loss) and a reconciliation of GAAP diluted net income (loss) per share, the most directly comparable GAAP financial measure, to non-GAAP diluted net income (loss) per share.

Active Customers
We define an active customer as an individual customer who has purchased from us at least once in the last year. In any particular period, we determine our number of active customers by counting the total number of customers who have made at least one purchase in the preceding 12 month period, measured from the last date of such period. We view the number of active customers as a key indicator of our growth, the reach of our sites, the value proposition and consumer awareness of our brand, the continued use of our sites by our customers and their desire to purchase our products. Our number of active customers drives both net sales and our appeal to vendors.

Revenue Per Active Customer
We define revenue per active customer as our total net sales divided by our total number of active customers in any particular period. We view revenue per active customer as a key indicator of our customers’ pattern of use of our sites to purchase our products and a measure of our customers’ demand. It is important to note that the sum of the quarterly revenue per active customer amounts does not match our annual revenue per active customer amount. Each quarter has a different number of active customers which makes the sum of the quarterly calculations result in a different amount than the annual calculation.
Total Orders Placed
We define total orders placed as the total number of customer orders placed by our customers in any period. We view total orders placed as a key indicator of the velocity of our business and an indication of the desirability of our products and sites to our customers. We recognize revenue when an order is delivered and therefore total orders placed, together with average order value, is an indicator of the net sales we expect to recognize in a given period. Total orders placed and total orders delivered in any given period may differ slightly due to orders that are in transit at the end of any particular period.
Average Order Value
We define average order value as the sum of the total order values (including shipping and handling charges) in a given period divided by the total orders placed in that period. We view average order value as a key indicator of the desirability of our products and sites to our customers.

41

Components of Our Results of Operations
Net Sales
Net sales consist primarily of sales of women's, children's and men's apparel, children's merchandise and other product categories such as kitchen accessories and home décor. We recognize product sales at the time all revenue recognition criteria has been met, which is generally at delivery. Net sales represent the sales of these items plus shipping and handling charges to customers, net of estimated returns and promotional discounts. Net sales are primarily driven by growth in our active customers, the frequency with which customers purchase and average order value. Net sales also include sales generated from the sale of services events, which are primarily electronic vouchers or access codes for our customers to redeem directly with the vendor. Net sales of services events have not been material to date.
Cost of Sales
Cost of sales consists of our purchase price for merchandise sold to customers, inbound and outbound shipping and handling costs, shipping supplies and fulfillment costs. Fulfillment costs represent those costs incurred in operating and staffing the fulfillment centers, including costs attributed to receiving, inspecting, picking, packaging and preparing customer orders for shipment. Cost of sales also includes direct and indirect labor costs for fulfillment center oversight, including payroll and related benefit costs and stock-based compensation expense. Cost of sales are primarily driven by growth in orders placed by customers, the mix of the product available for sale on our sites and transportation costs related to delivering orders to our customers.
Marketing Expenses
Marketing expenses consist primarily of targeted online marketing costs, such as display advertising, key word search campaigns, search engine optimization and social media, and offline marketing costs, such as print, radio and television advertising. Marketing expenses also include payroll and related benefit costs and stock-based compensation expense for our employees involved in marketing activities. Marketing expenses are primarily driven by investments to grow and retain our customer base. In the longer term, we expect marketing expenses to decline as a percentage of net sales.
Selling, General and Administrative Expenses
Selling, general and administrative expenses consist primarily of payroll and related benefit costs and stock-based compensation expense for our employees involved in general corporate functions including customer service, merchandising, studio and technology, as well as costs associated with the use by these functions of facilities and equipment, including depreciation and rent. Selling, general and administrative expenses are primarily driven by increases in headcount required to support business growth. In the longer term, we expect selling, general and administrative expenses to decline as a percentage of net sales.

Interest Income (Expense)—Net
Interest income (expense)—net consists primarily of interest earned on cash, cash equivalents and short-term investments held by us.
Other Income (Expense)—Net
Other income (expense)—net consists primarily of income earned from our corporate purchasing card and foreign currency gains (losses).
Provision for Income Taxes
Provision for income taxes is calculated as the amount of our taxable income multiplied by enacted federal, state and foreign tax rates, as adjusted for allowable credits and deductions. Further, the provision for income taxes includes deferred income taxes and changes in related valuation allowance reflecting the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.

42

RESULTS OF OPERATIONS
For the periods presented below, we have organized our operations into two principal segments: North America and the U.K. We will organize our operations into only one principal segment beginning in the period ending March 29, 2015. We present our segment information along the same lines that our Chief Executive Officer reviews our operating results in assessing performance and allocating resources. See Note 10: "Segment Information" and Note 14: "Subsequent Events" of the Notes to Consolidated Financial Statements within Item 8 of Part II of this Annual Report.
Net Sales
 
Fiscal Years
 
Change
 
2014
 
2013
 
2012
 
2014 to 2013
 
2013 to 2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(dollars in thousands)
Net sales:
 
 
 
 
 
 
 
 
 
 
 
 
 
North America
$
1,181,501

 
$
681,826

 
$
326,349

 
$
499,675

 
73.3%
 
$
355,477

 
108.9%
U.K.
18,578

 
13,883

 
4,891

 
4,695

 
33.8%
 
8,992

 
183.8%
Consolidated
$
1,200,079

 
$
695,709

 
$
331,240

 
$
504,370

 
72.5%
 
$
364,469

 
110.0%
2014 Compared to 2013
The increase in North America net sales for the fiscal year ended December 28, 2014 compared to the fiscal year ended December 29, 2013 was primarily driven by an increase of 1.7 million active customers, or a 54% increase, an increase in total orders placed of 9.5 million, or a 67% increase, and a 2% increase in average order value. We believe our growth was partially constrained by a decrease in the rate of new customer activations and retention of existing customers. Further constraining our growth was email deliverability issues with some of our email subscribers during the third quarter of 2014 and our cautious stance regarding email marketing in the fourth quarter of 2014 in order to prevent any future email deliverability issues.

The increase in U.K. net sales for the fiscal year ended December 28, 2014 compared to the fiscal year ended December 29, 2013 was primarily driven by an overall increase in orders and active customers.
2013 Compared to 2012
The increase in North America net sales for the fiscal year ended December 29, 2013 compared to the fiscal year ended December 30, 2012 was primarily driven by an increase of 1.5 million active customers, or a 100.0% increase, and a 4.2% increase in revenue per active customer.
The U.K. segment launched in April of 2012 and operated for eight months in fiscal year 2012 versus twelve months in fiscal year 2013. For the fiscal year ended December 29, 2013 compared to the fiscal year ended December 30, 2012, the increase in revenue was primarily driven by the additional four months of operating activities as well as an increase in active customers of 0.1 million, or a 126.2% increase, and an increase in revenue per active customer of 26.0%.
Cost of Sales
 
Fiscal Years
 
Change
 
2014
 
2013
 
2012
 
2014 to 2013
 
2013 to 2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(dollars in thousands)
Cost of sales
$
875,633

 
$
502,318

 
$
240,943

 
$
373,315

 
74.3%
 
$
261,375

 
108.5%
Percentage of net sales
73.0
%
 
72.2
%
 
72.7
%
 
 
 
 
 
 
 
 
2014 Compared to 2013
The increase in cost of sales in absolute dollars in 2014 from 2013 is primarily due to increased product and shipping costs from increased product sales and orders. Of the increase in cost of sales, $266.3 million was due to the increase in products sold to our larger customer base. In addition, shipping and fulfillment costs increased $107.0 million as a result of the increase in products sold during the period. During the first half of 2014, we

43

experienced an increase in cost of sales as a percentage of net sales driven primarily by increases in our shipping and fulfillment costs to support the continuing order volume growth. Specifically, during the first half of 2014 we added incremental labor in our fulfillment centers to support higher unit volumes as well as launched process improvement initiatives to meet order volume growth and improve our order-to-ship times. Our increase in cost of sales as a percentage of net sales was impacted by higher fulfillment costs as we began operating the new Nevada fulfillment center and automated our Ohio facility, both in the second half of 2014. During the fourth quarter of 2014, our fulfillment center automation did not deliver the expected unit cost improvements as fast as we had anticipated, which resulted in lower gross margins than previous years.
2013 Compared to 2012
Of the increase in cost of sales, $188.8 million was due to the increase in products sold to our larger customer base. In addition, shipping and fulfillment costs increased $72.6 million as a result of the increase in products sold during the period.
Marketing Expenses
 
 
Fiscal Years
 
Change
 
2014
 
2013
 
2012
 
2014 to 2013
 
2013 to 2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(dollars in thousands)
Marketing expenses
$
100,730

 
$
59,667

 
$
37,780

 
$
41,063

 
68.8%
 
$
21,887

 
57.9%
Percentage of net sales
8.4
%
 
8.6
%
 
11.4
%
 
 
 
 
 
 
 
 
2014 Compared to 2013
The increase in marketing expenses in absolute dollars for the fiscal year ended December 28, 2014 compared to the fiscal year ended December 29, 2013 was primarily due to increased spending on paid online marketing channels, including display advertising, keyword search campaigns, search engine optimization and social media. Our marketing expenses are largely variable and based on growth in sales and changes in subscriber acquisition costs which are primarily market driven. Marketing expenses also increased as a result of higher subscriber acquisition costs in the fiscal year ended December 28, 2014 as compared to the prior year, which was partially offset by decreased marketing spend in 2014.
2013 Compared to 2012
The increase in marketing expenses was primarily due to the increased number of new email subscribers acquired through paid online marketing channels, including display advertising, key word search campaigns, search engine optimization and social media, partially offset by a decrease in the average cost to acquire a new subscriber.
Selling, General and Administrative Expenses
 
 
Fiscal Years
 
Change
 
2014
 
2013
 
2012
 
2014 to 2013
 
2013 to 2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(dollars in thousands)
Selling, general and administrative expenses
$
207,986

 
$
120,695

 
$
63,071

 
$
87,291

 
72.3%
 
$
57,624

 
91.4%
Percentage of net sales
17.3
%
 
17.3
%
 
19.0
%
 
 
 
 
 
 
 
 
2014 Compared to 2013
Of the increase in selling, general and administrative expenses of $87.3 million, $44.4 million was due to the increase in salaries and related benefits and stock-based compensation expense as we continued to increase our headcount across functions to support business growth. Additionally, this increase was attributable to a $16.2 million increase in our rent, depreciation and other facilities expense as a result of our business growth, including square footage occupied, and headcount growth and a $10.9 million increase in our merchant processing fees driven by sales volume increases, which increase in total dollars as sales increase. To a lesser extent, this increase was attributable to a $7.2 million increase in our professional services costs and a $4.9 million increase in technology

44

related costs as a result of business growth and a related increase in business complexity due to being a public company.
2013 Compared to 2012
Of the increase in selling, general and administrative expenses, $30.9 million was due to the increase in salaries and related benefits and stock-based compensation expense as we continued to increase our headcount across functions to support business growth. To a lesser extent, this increase was attributable to a $8.6 million increase in our professional services costs as a result of business growth, being a public company and a related increase in business complexity, a $6.0 million increase in our rent, depreciation and other facilities expense as a result of our business and headcount growth, and a $8.6 million increase in our merchant processing fees, which increase in total dollars as sales increase.

Interest Income (Expense)—Net

Interest income (expense)—net is primarily derived from interest income related to the investment of our cash and cash equivalents. Interest income (expense)—net for the fiscal year ended December 28, 2014, the fiscal year ended December 29, 2013 and the fiscal year ended December 30, 2012 totaled $0.3 million, $0.1 million and $0.0 million, respectively.
Other Income (Expense)—Net
Other income (expense)—net consists of income earned from our corporate purchasing card and foreign currency gains (losses). Other income (expense)—net for the fiscal year ended December 28, 2014, the fiscal year ended December 29, 2013 and the fiscal year ended December 30, 2012 totaled $0.0 million, $0.1 million and $0.2 million, respectively.
Income Taxes
 
Fiscal Years
 
Change
 
 
 
2014
 
2013
 
2012
 
2014 to 2013
 
2012 to 2011
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(dollars in thousands)
Income tax expense
$
1,109

 
$
356

 
$
—

 
753

 
211.5
%
 
356

 
100
%
Effective tax rate
7.0
%
 
2.7
%
 
—
%
 
 
 
 
 
 
 
 
2014 Compared to 2013
For the fiscal years ended December 28, 2014 and December 29, 2013, our effective tax rates were 7.0% and 2.7%, respectively. In the fiscal year ended December 28, 2014, we released our valuation allowance described below and utilized our research and development credits, which benefited our effective tax rate below the federal statutory rate. The benefits from our valuation allowance and research and development credits were offset by increases primarily related to the non-deductible portion of stock-based compensation. In comparison, during the fiscal year ended December 29, 2013, we utilized $4.7 million of the tax loss carryforwards, eliminating all income tax expense for the period, except for alternative minimum tax.
2013 Compared to 2012
Our income tax expense increased from 2012 to 2013 as a result of having to pay alternative minimum tax during the fiscal year ended December 29, 2013. For both years when we considered past operating results, our limited operating history and feasible tax planning strategies, we determined that a full valuation allowance against our deferred tax assets was necessary.



    

45

Quarterly Results of Operations and Other Financial and Operations Data

The following tables set forth selected unaudited quarterly results of operations and other financial and operations data for the eight quarters ended December 28, 2014, as well as the percentage that each line item represents of net sales. The information for each of these quarters has been prepared on the same basis as the audited annual financial statements included elsewhere in this Annual Report and in the opinion of management, includes all adjustments, which include only normal recurring adjustments, necessary for the fair statement of our consolidated results of operations for these periods. This data should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this Annual Report. Our quarterly results of operations will vary in the future. These quarterly operating results are not necessarily indicative of our operating results for any future period.
 
Quarters Ended
 
Dec. 28, 2014
 
Sept. 28, 2014
 
June 29,
2014
 
March 30,
2014
 
Dec. 29, 2013
 
Sept. 29, 2013
 
June 30,
2013
 
March 31,
2013
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(in thousands, except per share amounts)
Net sales
$
391,349

 
$
285,836

 
$
285,013

 
$
237,881

 
$
257,033

 
$
166,655

 
$
145,009

 
$
127,012

Cost of sales
290,282

 
207,147

 
204,057

 
174,147

 
188,658

 
122,154

 
101,106

 
90,400

Gross profit
101,067

 
78,689

 
80,956

 
63,734

 
68,375

 
44,501

 
43,903

 
36,612

Operating expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Marketing expenses
28,485

 
24,878

 
24,282

 
23,085

 
16,960

 
14,651

 
12,617

 
15,439

Selling, general and administrative expenses
60,913

 
54,474

 
48,999

 
43,600

 
38,493

 
32,133

 
27,283

 
22,786

Total operating expenses
89,398

 
79,352

 
73,281

 
66,685

 
55,453

 
46,784

 
39,900

 
38,225

Income (loss) from operations
11,669

 
(663
)
 
7,675

 
(2,951
)
 
12,922

 
(2,283
)
 
4,003

 
(1,613
)
Interest income (expense)—net
79

 
92

 
92

 
54

 
50

 
22

 
32

 
32

Other income (expense)—net
(58
)
 
76

 
(11
)
 
(53
)
 
137

 
10

 
(34
)
 
(14
)
Net income (loss) before provision for income taxes
11,690

 
(495
)
 
7,756

 
(2,950
)
 
13,109

 
(2,251
)
 
4,001

 
(1,595
)
Provision for income taxes
809

 
300

 
—

 
—

 
356

 
—

 
—

 
—

Net income (loss)
$
10,881

 
$
(795
)
 
$
7,756

 
$
(2,950
)
 
$
12,753

 
$
(2,251
)
 
$
4,001

 
$
(1,595
)
Net income (loss) attributable to Class A and Class B common stockholders
$
10,881

 
$
(795
)
 
$
7,756

 
$
(2,950
)
 
$
4,526

 
$
(4,819
)
 
$
—

 
$
(4,126
)
Net income (loss) per share attributable to Class A and Class B common stockholders:


 

 

 

 

 

 

 

Basic
$
0.09

 
$
(0.01
)
 
$
0.06

 
$
(0.02
)
 
$
0.05

 
$
(0.09
)
 
$
—

 
$
(0.09
)
Diluted
$
0.08

 
$
(0.01
)
 
$
0.06

 
$
(0.02
)
 
$
0.05

 
$
(0.09
)
 
$
—

 
$
(0.09
)

 

46

 
Quarters Ended
 
Dec. 28, 2014
 
Sept. 28, 2014
 
Jun. 29, 2014
 
Mar. 30, 2014
 
Dec. 29, 2013
 
Sept. 29, 2013
 
Jun. 30, 2013
 
Mar. 31, 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net sales
100.0
 %
 
100.0
 %
 
100.0
%
 
100.0
 %
 
100.0
%
 
100.0
 %
 
100.0
%
 
100.0
 %
Cost of sales
74.2

 
72.5

 
71.6

 
73.2

 
73.4

 
73.3

 
69.7

 
71.2

Gross profit
25.8

 
27.5

 
28.4

 
26.8

 
26.6

 
26.7

 
30.3

 
28.8

Operating expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Marketing expenses
7.3

 
8.7

 
8.5

 
9.7

 
6.6

 
8.8

 
8.7

 
12.2

Selling, general and administrative expenses
15.5

 
19.0

 
17.2

 
18.3

 
15.0

 
19.3

 
18.8

 
17.9

Total operating expenses
22.8

 
27.7

 
25.7

 
28.0

 
21.6

 
28.1

 
27.5

 
30.1

Income (loss) from operations
3.0

 
(0.2
)
 
2.7

 
(1.2
)
 
5.0

 
(1.4
)
 
2.8

 
(1.3
)
Interest income (expense)—net
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

Other income (expense)—net
—

 
—

 
—

 
—

 
0.1

 
—

 
—

 
—

Net income (loss) before provision for income taxes
3.0

 
(0.2
)
 
2.7

 
(1.2
)
 
5.1

 
(1.4
)
 
2.8

 
(1.3
)
Provision for income taxes
0.2

 
0.1

 
—

 
—

 
0.1

 
—

 
—

 
—

Net income (loss)
2.8
 %
 
(0.3
)%
 
2.7
%
 
(1.2
)%
 
5.0
%
 
(1.4
)%
 
2.8
%
 
(1.3
)%

 
Quarters Ended
 
Dec. 28, 2014
 
Sept. 28, 2014
 
Jun. 29, 2014
 
Mar. 30, 2014
 
Dec. 29, 2013
 
Sept. 29, 2013
 
Jun. 30, 2013
 
Mar. 31, 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(in thousands, except revenue per active customer and average order value)
Other Financial and Operations Data
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Adjusted EBITDA(1)
$
20,263

 
$
6,391

 
$
14,449

 
$
2,624

 
$
17,786

 
$
1,791

 
$
7,017

 
$
452

Free cash flow(2)
$
29,310

 
$
31,213

 
$
89

 
$
1,645

 
$
36,990

 
$
20,764

 
$
(4,844
)
 
$
604

Active customers
4,887

 
4,531