10-Q 1 a14-22636_110q.htm 10-Q

Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

Form 10-Q

 


 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2014

 

OR

 

o         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: 001-36666

 


 

Wayfair Inc.

(Exact name of registrant as specified in its charter)

 

Delaware

 

36-4791999

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification Number)

 

 

 

4 Copley Place, 7th Floor, Boston, MA

 

02116

(Address of principal executive offices)

 

(Zip Code)

 

(617) 532-6100

(Registrant’s telephone number, including area code)

 

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 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 o   No x

 

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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x    No o

 

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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer o

 

Accelerated filer o

 

 

 

Non-accelerated filer x
(Do not check if a smaller reporting company)

 

Smaller reporting company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No  x

 

As of October 7, 2014, there were 12,650,000 shares of the registrant’s Class A common stock, par value $0.001 per share, and 70,265,213 shares of the registrant’s Class B common stock, par value $0.001 per share, outstanding.

 

 

 



Table of Contents

 

WAYFAIR INC.

 

FORM 10-Q

 

TABLE OF CONTENTS

 

PART I—

FINANCIAL INFORMATION

 

 

 

 

Item 1.

Interim Financial Statements (Unaudited)

5

 

 

 

 

Condensed Consolidated Balance Sheets

5

 

 

 

 

Condensed Consolidated Statements of Operations

6

 

 

 

 

Condensed Consolidated Statements of Comprehensive Loss

7

 

 

 

 

Condensed Consolidated Statements of Cash Flows

8

 

 

 

 

Notes to Condensed Consolidated Financial Statements

9

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

19

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

29

 

 

 

Item 4.

Controls and Procedures

30

 

 

 

PART II—

OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

31

 

 

 

Item 1A.

Risk Factors

31

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

51

 

 

 

Item 6.

Exhibits

51

 

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EXPLANATORY NOTE

 

The financial statements and other disclosures contained in this Quarterly Report on 10-Q are those of Wayfair LLC, which is a wholly-owned subsidiary of Wayfair Inc., the Corporation, which is the registrant. Prior to the effectiveness of the Corporation’s registration statement on Form S-1 related to its initial public offering in October 2014, Wayfair LLC was the principal operating entity. In connection with the initial public offering of the Corporation, Wayfair LLC completed an internal restructuring pursuant to which Wayfair LLC became a wholly-owned subsidiary of the Corporation, and the holders of equity interests in Wayfair LLC became stockholders of the Corporation. Because the internal restructuring was not completed as of September 30, 2014 and the Corporation had no substantial assets or activities (other than activities relating to its formation and initial public offering) as of such time, the Corporation believes it is informative to provide the consolidated financial statements and various other disclosures of Wayfair LLC as of September 30, 2014 and for the periods ended September 30, 2014 and 2013.

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

This Quarterly Report on Form 10-Q contains forward-looking statements. All statements other than statements of historical fact contained in this Quarterly Report on Form 10-Q, including statements regarding our future results of operations and financial position, business strategy and plans and objectives of management for future operations, are forward-looking statements.

 

In some cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “could,” “intends,” “target,” “projects,” “contemplates,” “believes,” “estimates,” “predicts,” “potential” or “continue” or the negative of these terms or other similar expressions. The forward-looking statements in this Quarterly Report on Form 10-Q are only predictions. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our business, financial condition and results of operations. These forward-looking statements speak only as of the date of this Quarterly Report on Form 10-Q and are subject to a number of risks, uncertainties and assumptions described in the “Risk Factors” section and elsewhere in this Quarterly Report on Form 10-Q. Because forward-looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified, you should not rely on these forward-looking statements as predictions of future events. The events and circumstances reflected in our forward-looking statements may not be achieved or occur and actual results could differ materially from those projected in the forward-looking statements. Except as required by applicable law, we undertake no obligation to publicly update or revise any forward-looking statements contained herein, whether as a result of any new information, future events or otherwise.

 

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Wayfair LLC

 

Condensed Consolidated Balance Sheets

(unaudited)

 

 

 

September 30,

 

September 30, 2014

 

December 31,

 

 

 

2014

 

Pro Forma (Note 1)

 

2013

 

 

 

(in thousands, except share and per share data)

 

Consolidated Balance Sheets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Assets

 

 

 

 

 

 

 

Current assets

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

30,307

 

$

265,959

 

$

65,289

 

Short-term investments

 

100,054

 

100,054

 

50,019

 

Accounts receivable, net of allowance

 

5,314

 

5,314

 

7,689

 

Inventories

 

21,118

 

21,118

 

14,963

 

Prepaid expenses and other current assets

 

37,839

 

37,839

 

25,167

 

Total current assets

 

194,632

 

430,284

 

163,127

 

Property and equipment, net

 

50,027

 

50,027

 

22,088

 

Intangible assets, net

 

3,099

 

3,099

 

3,919

 

Goodwill

 

4,629

 

4,629

 

5,165

 

Restricted cash

 

3,849

 

3,849

 

826

 

Other noncurrent assets

 

4,292

 

4,292

 

1,175

 

Total assets

 

$

260,528

 

$

496,180

 

$

196,300

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

 

 

Current liabilities

 

 

 

 

 

 

 

Accounts payable

 

$

87,686

 

$

87,686

 

$

102,153

 

Accrued expenses

 

32,697

 

34,484

 

19,239

 

Deferred revenue

 

21,828

 

21,828

 

13,397

 

Due to related party

 

1,787

 

 

1,878

 

Other current liabilities

 

12,587

 

12,587

 

8,342

 

Total current liabilities

 

156,585

 

156,585

 

145,009

 

Other liabilities

 

12,850

 

13,185

 

944

 

Total liabilities

 

169,435

 

169,770

 

145,953

 

 

 

 

 

 

 

 

 

Commitments and contingencies (Note 7)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Series A convertible redeemable preferred units, no par value per unit:21,551,801 units authorized at September 30, 2014 and December 31, 2013; 21,551,801 units issued at September 30, 2014 and December 31, 2013; no units authorized, issued and outstanding, pro forma; liquidation preference of $240.2 million at September 30, 2014.

 

240,234

 

 

241,186

 

Series B convertible redeemable preferred units, no par value per unit: 5,995,133 units authorized and issued at September 30, 2014 and no units authorized and issued at December 31, 2013; no units authorized, issued and outstanding, pro forma; liquidation preference of $157.2 million at September 30, 2014

 

157,229

 

 

 

Members’ deficit/Stockholders’ equity:

 

 

 

 

 

 

 

Common units, no par value per unit: 81,365,954 and 74,328,124 units authorized at September 30, 2014 and December 31, 2013, respectively; 43,784,060 units and 44,904,110 units issued outstanding at September 30, 2014 and December 31, 2013, respectively; no units authorized, issued and outstanding, pro forma

 

 

 

 

 

 

 

Class A common stock, $0.001 par value; no shares authorized, issued or outstanding, actual; 500,000,000 shares authorized, 12,650,000 shares issued and outstanding, pro forma

 

 

13

 

 

Class B common stock, $0.001 par value; no shares authorized, issued or outstanding, actual; 164,000,000 shares authorized, 70,265,213 shares issued and outstanding, pro forma

 

 

70

 

 

Additional paid-in capital

 

 

361,217

 

 

Common members’ (deficit)/Retained earnings

 

(305,983

)

(34,503

)

(190,511

)

Accumulated other comprehensive loss

 

(387

)

(387

)

(328

)

Total member’s deficit/stockholders’ equity

 

(306,370

)

326,410

 

(190,839

)

Total liabilities and stockholders’ equity

 

$

260,528

 

$

496,180

 

$

196,300

 

 

See notes to condensed consolidated financial statements.

 

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Wayfair LLC

 

Condensed Consolidated Statements of Operations

(unaudited)

 

 

 

Three months ended September 30,

 

Nine months ended September 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

 

 

(in thousands, except share and per share data)

 

 

 

(unaudited)

 

(unaudited)

 

Consolidated Statements of Operations:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net revenue

 

$

336,188

 

$

237,302

 

$

910,332

 

$

620,510

 

Cost of goods sold

 

257,161

 

178,656

 

697,644

 

466,993

 

Gross profit

 

79,027

 

58,646

 

212,688

 

153,517

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Sales and marketing

 

77,439

 

46,602

 

215,667

 

119,316

 

General and administrative

 

25,218

 

15,530

 

71,573

 

45,544

 

Amortization of acquired intangible assets

 

249

 

184

 

748

 

290

 

Total operating expenses

 

102,906

 

62,316

 

287,988

 

165,150

 

Loss from operations

 

(23,879

)

(3,670

)

(75,300

)

(11,633

)

Interest income, net

 

89

 

61

 

222

 

185

 

Other (expense) income, net

 

(304

)

579

 

(400

)

75

 

Loss before income taxes

 

(24,094

)

(3,030

)

(75,478

)

(11,373

)

Provision for income taxes

 

(49

)

(1

)

(66

)

4

 

Net loss

 

$

(24,143

)

$

(3,031

)

$

(75,544

)

$

(11,369

)

Accretion of convertible redeemable preferred units

 

(4,748

)

(4,673

)

(16,503

)

(20,621

)

Net loss attributable to common unit holders

 

(28,891

)

(7,704

)

(92,047

)

(31,990

)

 

 

 

 

 

 

 

 

 

 

Net loss attributable to common unit holders per unit - basic and diluted

 

$

(0.71

)

$

(0.19

)

$

(2.26

)

$

(0.77

)

 

 

 

 

 

 

 

 

 

 

Weighted average number of common units outstanding used in computing per share amounts - basic and diluted

 

40,512,544

 

41,367,115

 

40,721,540

 

41,304,048

 

 

See notes to condensed consolidated financial statements.

 

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Wayfair LLC

 

Condensed Consolidated Statements of Comprehensive Loss

(unaudited)

 

 

 

Three months ended September 30,

 

Nine months ended September 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

 

 

(in thousands)

 

Net loss

 

$

(24,143

)

$

(3,031

)

$

(75,544

)

$

(11,369

)

Other comprehensive loss:

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustments

 

(67

)

(754

)

(59

)

(170

)

 

 

 

 

 

 

 

 

 

 

Comprehensive loss

 

$

(24,210

)

$

(3,785

)

$

(75,603

)

$

(11,539

)

 

See notes to condensed consolidated financial statements.

 

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Wayfair LLC

 

Condensed Consolidated Statements of Cash Flows

(unaudited)

 

 

 

Nine months ended September 30,

 

 

 

2014

 

2013

 

 

 

(in thousands)

 

 

 

 

 

 

 

Cash flows from operating activities

 

 

 

 

 

Net loss

 

$

(75,544

)

$

(11,369

)

Adjustments to reconcile net loss to net cash provided by operating activities, net of acquisition:

 

 

 

 

 

Depreciation and amortization

 

14,438

 

9,352

 

Equity based compensation

 

5,528

 

 

Other non-cash adjustments

 

888

 

11

 

 

 

 

 

 

 

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts receivable and customer refunds payable

 

2,376

 

(6,840

)

Inventories

 

(6,155

)

(8,115

)

Prepaid expenses and other current assets

 

(12,721

)

(8,070

)

Due to related party

 

(96

)

(241

)

Accounts payable and accrued expenses

 

(1,012

)

9,095

 

Deferred revenue and other liabilities

 

24,578

 

9,483

 

Other assets

 

(3,117

)

269

 

Net cash used in operating activities

 

(50,837

)

(6,425

)

 

 

 

 

 

 

Cash flows from investing activities

 

 

 

 

 

Purchase of short-term investments

 

(110,000

)

(40,000

)

Sale and maturities of short-term investments

 

59,964

 

22,963

 

Purchase of property and equipment

 

(31,168

)

(4,421

)

Site and software development costs

 

(10,643

)

(6,412

)

Cash paid for acquisition

 

 

(3,741

)

Other investing activities, net

 

(3,015

)

(86

)

Net cash used in investing activities

 

(94,862

)

(31,697

)

 

 

 

 

 

 

Cash flows from financing activities

 

 

 

 

 

Net proceeds from issuance of Series B convertible redeemable preferred units

 

154,774

 

 

Repurchase of common units

 

(23,500

)

 

Dividends paid to Series A convertible redeemable preferred

 

(15,000

)

 

Repurchase of employee equity

 

(5,528

)

 

Net cash provided by financing activities

 

110,746

 

 

Effect of exchange rate changes on cash and cash equivalents

 

(29

)

5

 

Net decrease in cash and cash equivalents

 

(34,982

)

(38,117

)

Cash and cash equivalents

 

 

 

 

 

Beginning of period

 

65,289

 

77,861

 

End of period

 

$

30,307

 

$

39,744

 

 

 

 

 

 

 

Supplemental disclosure of cash flow information

 

 

 

 

 

 

 

 

 

 

 

Income tax payments

 

$

27

 

$

19

 

Supplemental disclosure of non-cash investing activities

 

 

 

 

 

Issuance of common units in connection with acquisition

 

 

1,194

 

Purchase of property and equipment included in accounts payable and accrued expenses and in other liabilities

 

2,079

 

396

 

Supplemental disclosure of non-cash financing activities

 

 

 

 

 

Accretion of preferred unit dividends

 

$

16,503

 

$

20,621

 

 

See notes to condensed consolidated financial statements.

 

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Notes to Condensed Consolidated Financial Statements

(unaudited)

 

1. Summary of Business Operations and Basis of Presentation

 

Wayfair LLC is a Delaware limited liability company and a wholly-owned subsidiary of Wayfair Inc. (together with Wayfair LLC, the “Company”), which is the registrant filing this Quarterly Report on Form 10-Q. Prior to the effectiveness of Wayfair Inc.’s registration statement on Form S-1 related to its initial public offering in October 2014, Wayfair LLC was the principal operating entity. In connection with the initial public offering of the Company, Wayfair LLC completed an internal restructuring pursuant to which Wayfair LLC became a wholly-owned subsidiary of Wayfair Inc. and the holders of equity interests in Wayfair LLC became stockholders of Wayfair Inc. Because the internal restructuring was not completed as of September 30, 2014 and Wayfair Inc. had no substantial assets or activities (other than activities relating to its formation and initial public offering) as of such time, the consolidated financial statements and these accompanying notes refer primarily to Wayfair LLC, unless otherwise noted.  The Company is an e-commerce business offering visually inspiring browsing, compelling merchandising, easy product discovery and attractive prices for over seven million products from over 7,000 suppliers across distinct brands — Wayfair.com, Joss & Main, AllModern, DwellStudio, and Birch Lane. In addition to generating net revenue through Direct Retail sales, which includes all sales generated primarily through the Company’s websites, mobile-optimized websites, and mobile applications (“sites”), net revenue is also generated through sites operated by third parties and through third-party advertising distribution providers that pay the Company based on the number of advertisement related clicks, actions, or impressions for advertisements placed on the Company’s sites.

 

Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States (“GAAP”) and applicable rules and regulations of the Securities and Exchange Commission (“SEC”) regarding interim financial reporting. Certain information and note disclosures normally included in the financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. Therefore, these consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in the Company’s prospectus dated October 1, 2014 filed with the SEC pursuant to Rule 424(b) under the Securities Act of 1933, as amended, on October 2, 2014.

 

The consolidated balance sheet data as of December 31, 2013 was derived from audited financial statements. The accompanying consolidated balance sheet as of September 30, 2014, the consolidated statements of operations, consolidated statements of comprehensive loss, and consolidated statements of cash flows for the periods ended September 30, 2014 and 2013 are unaudited. The unaudited interim financial statements have been prepared on the same basis as the audited consolidated financial statements and in the opinion of management, reflect all adjustments, consisting of only normal recurring adjustments, necessary for the fair statement of the Company’s financial position as of September 30, 2014 and results of operations and cash flows for the periods ended September 30, 2014 and 2013. The financial data and the other information disclosed in these notes to the condensed consolidated financial statements related to these periods are unaudited. Operating results for the three and nine months ended September 30, 2014 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2014, or for any other period. The condensed consolidated results of operations and cash flows for the nine months ended September 30, 2014 are not necessarily indicative of the results of operations and cash flows that may be expected for the year ending December 31, 2014.

 

Unaudited Pro Forma Balance Sheet as of September 30, 2014

 

On October 7, 2014, the Company completed its initial public offering (the “IPO”) of 12,650,000 shares of its Class A common stock at a public offering price of $29.00  per share, of which 10,500,000 shares were sold by the Company and 2,150,000 shares were sold by selling stockholders, including 1,650,000 shares pursuant to the underwriters’ option to purchase additional shares, resulting in net proceeds to the Company of approximately $282.7 million, after deducting underwriting discounts and estimated offering expenses. The Company did not receive any proceeds from the sale of shares by the selling stockholders.

 

On October 1, 2014, in anticipation of the IPO, the Company completed an internal restructuring (the “corporate reorganization”). Pursuant to the corporate reorganization, Wayfair LLC became a wholly-owned subsidiary of Wayfair Inc., and the holders of equity interests in Wayfair LLC became stockholders of Wayfair Inc.  Wayfair Inc. was incorporated as a Delaware corporation on August 8, 2014. As of September 30, 2014, Wayfair Inc. had not engaged in any business or other activities except in connection with its formation and in preparation for the IPO.

 

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The unaudited pro forma balance sheet as of September 30, 2014, reflects the following:

 

(i) net proceeds from the IPO of $282.7 million after deducting the underwriting discount and estimated offering expenses, (ii) a net adjustment to deferred income tax liabilities of $0.3 million in connection with the Company’s corporate reorganization, (iii) an adjustment of $14.4 million to reduce the carrying value of the participating preferred units to reflect conversion value assuming the security was converted on the balance sheet date, (iv) a distribution of $24.5 million of cash to the Company’s Series A convertible preferred stockholders upon completion of the IPO equal to the members’ distribution payable balance, (v) an adjustment of $48.6 million to give effect to equity based compensation expense associated with common option units, deferred units and restricted common units that have satisfied the service condition and (vi) the net issuance of 1,129,095 shares of Class B common stock issuable upon the vesting of outstanding deferred units upon completion of the IPO, net of minimum tax withholding obligations and the associated payment of cash, which amount was approximately $22.6 million. All of the aforementioned adjustments have been reflected in the pro forma consolidated balance sheet as if these events all occurred on September 30, 2014 and (vii) the reclassification of $1.8 million from due to related party to accrued expenses to reflect the effect of consolidation of SK Retail, which was the majority member of Wayfair LLC prior to the corporate reorganization.

 

Summary of Significant Accounting Policies

 

Principles of Consolidation

 

The accompanying consolidated financial statements include the accounts of Wayfair LLC and its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated.

 

Use of Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities, at the date of the financial statements, and the reported amounts of revenue and expenses during the reported period. On an ongoing basis, management evaluates these estimates and judgments, including those related to revenue recognition, capitalization of site and software development costs, stock-based compensation, and inventory. Actual results could differ from those estimates.

 

Concentrations of Credit Risk

 

Financial instruments that subject the Company to credit risk consist of cash and cash equivalents, short-term investments, and accounts receivable. The risk with respect to cash and cash equivalents and short-term investments is minimized by the Company’s policy of investing in financial instruments (i.e., cash equivalents) with short-term maturities issued by highly-rated financial institutions. At times, these balances may exceed federally insured limits; however, to date, the Company has not incurred any losses on these investments. The risk with respect to accounts receivable is managed by the Company through its policy of monitoring the creditworthiness of its customers to which it grants credit terms in the normal course of business. As of September 30, 2014 and December 31, 2013, the Company had $1.4 million and $2.6 million, respectively, in banks located outside the United States.

 

Leases

 

The Company leases office space in several countries around the world under non-cancelable lease agreements. The Company generally leases its office facilities under operating lease agreements. Office facilities subject to an operating lease and the related lease payments are not recorded on the balance sheet. The terms of certain lease agreements provide for rental payments on a graduated basis, however, the Company recognizes rent expense on a straight-line basis over the lease period in accordance with authoritative accounting guidance. Any lease incentives are recognized as reductions of rental expense on a straight-line basis over the term of the lease. The lease term begins on the date the Company becomes legally obligated for the rent payments or when it takes possession of the office space, whichever is earlier.

 

The Company establishes assets and liabilities for the estimated construction costs incurred under lease arrangements where the Company is considered the owner for accounting purposes only, or build-to-suit leases, to the extent the Company is involved in the construction of structural improvements or take construction risk prior to commencement of a lease. Upon occupancy of facilities under build-to-suit leases, the Company assesses whether these arrangements qualify for sales

 

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recognition under the sale-leaseback accounting guidance. If the Company continues to be the deemed owner, the facilities are accounted for as financing leases.

 

Recent Accounting Pronouncements

 

In July 2013, the Financial Accounting Standards Board (“FASB”) issued a new accounting standard update that requires the presentation of certain unrecognized tax benefits as reductions to deferred tax assets rather than as liabilities in the consolidated balance sheets when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. The Company adopted this new standard on a prospective basis in the first quarter of fiscal 2014, and the adoption of this accounting standard update did not have a material impact on the Company’s condensed consolidated financial statements.

 

In May 2014, the FASB issued new accounting guidance regarding revenue recognition under GAAP. This new guidance will supersede nearly all existing revenue recognition guidance, and is effective for public entities for annual and interim periods beginning after December 31, 2016. Early adoption is not permitted. The Company is currently evaluating the impact of this new guidance on the Company’s condensed consolidated financial statements.

 

In August 2014, the FASB issued Accounting Standards Update No. 2014-15, “Presentation of Financial Statements - Going Concern”, which requires management to evaluate, at each annual and interim reporting period, whether there are conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date the financial statements are issued and provide related disclosures.  ASU 2014-15 is effective for annual periods ending after December 15, 2016 and interim periods thereafter.  Early application is permitted.  The adoption of ASU 2014-15 is not expected to have a material effect on the condensed consolidated financial statements.

 

2. Fair Value Measurements

 

The Company’s financial assets and liabilities are measured at fair value, which is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). The three levels of inputs used to measure fair value are as follows:

 

·                  Level 1 — Unadjusted quoted prices in active markets for identical assets or liabilities

 

·                  Level 2 — Unadjusted quoted prices in active markets for similar assets or liabilities, unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs other than quoted prices that are observable or can be corroborated by observable market data for substantially the full-term of the asset or liability

 

·                  Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the asset or liability

 

The following tables set forth the fair value of the Company’s financial assets measured at fair value on a recurring basis as of September 30, 2014 and December 31, 2013 based on the three-tier value hierarchy:

 

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September 30, 2014

 

 

 

Total

 

Level 1

 

Level 2

 

Level 3

 

 

 

(in thousands)

 

Cash equivalents

 

 

 

 

 

 

 

 

 

Money market funds

 

$

5,071

 

$

5,071

 

 

 

Certificates of deposit

 

 

 

 

 

 

Short-term investments:

 

 

 

 

 

 

 

 

 

Certificates of deposit

 

100,054

 

100,054

 

 

 

Restricted cash

 

 

 

 

 

 

 

 

 

Money market funds

 

3,848

 

3,848

 

 

 

Total

 

$

108,973

 

$

108,973

 

$

 

$

 

 

 

 

December 31, 2013

 

 

 

Total

 

Level 1

 

Level 2

 

Level 3

 

 

 

(in thousands)

 

Cash equivalents

 

 

 

 

 

 

 

 

 

Money market funds

 

$

32,560

 

$

32,560

 

 

 

Short-term investments:

 

 

 

 

 

 

 

 

 

Certificates of deposit

 

50,019

 

50,019

 

 

 

Restricted cash

 

 

 

 

 

 

 

 

 

Money market funds

 

346

 

346

 

 

 

Total

 

$

82,925

 

$

82,925

 

$

 

$

 

 

3. Acquisition, Intangible assets and Goodwill

 

Intangible assets consisted of the following as of September 30, 2014 and December 31, 2013 (in thousands):

 

 

 

Weighted-
Average

 

September 30, 2014

 

December 31, 2013

 

 

 

Amortization
Period
(Years)

 

Gross
Carrying
Value

 

Accumulated
Amortization

 

Net Book
Value

 

Gross
Carrying
Value

 

Accumulated
Amortization

 

Net Book
Value

 

Trademarks

 

5

 

$

2,008

 

$

(511

)

$

1,497

 

$

2,030

 

$

(219

)

$

1,811

 

Customer relationships

 

5

 

1,300

 

(303

)

997

 

1,300

 

(108

)

1,192

 

Non-compete agreements

 

3-5

 

109

 

(44

)

65

 

110

 

(19

)

91

 

Technology

 

5

 

768

 

(473

)

295

 

920

 

(430

)

490

 

Other intangibles

 

3

 

373

 

(131

)

242

 

373

 

(47

)

326

 

Domain names

 

5

 

2,684

 

(2,681

)

3

 

2,695

 

(2,686

)

9

 

Total

 

 

 

$

7,242

 

$

(4,143

)

$

3,099

 

$

7,428

 

$

(3,509

)

$

3,919

 

 

4. Property and Equipment, net

 

Property and equipment, net consists of the following:

 

 

 

September 30,

 

December 31,

 

 

 

2014

 

2013

 

 

 

(in thousands)

 

Furniture and computer equipment

 

$

43,087

 

$

26,218

 

Site and software development costs

 

32,239

 

23,715

 

Leasehold improvements

 

13,682

 

1,912

 

Construction in progress

 

25

 

184

 

 

 

89,033

 

52,029

 

Less accumulated depreciation and amortization

 

(39,006

)

(29,941

)

Property and equipment, net

 

$

50,027

 

$

22,088

 

 

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5. Accrued Expenses

 

Accrued expenses consist of the following:

 

 

 

September 30,

 

December 31,

 

 

 

2014

 

2013

 

 

 

(in thousands)

 

Employee compensation and related benefits

 

$

11,675

 

$

7,470

 

Marketing

 

6,979

 

5,329

 

Credit card

 

4,522

 

2,173

 

Audit, legal and professional fees

 

1,851

 

377

 

Accrued property, plant and equipment

 

1,248

 

 

Other accrued expenses

 

6,422

 

3,890

 

 

 

$

32,697

 

$

19,239

 

 

6. Commitments and Contingencies

 

Operating Leases

 

The Company leases office space under non-cancelable operating leases. These leases expire at various dates through 2024 and include discounted rental periods and fixed escalation clauses, which are amortized straight-line over the terms of the lease.

 

In March 2014, the Company expanded the lease of office space in Boston, MA to a total of approximately 275,000 square feet in order to accommodate the expansion of the Company’s headquarters.  The Company began occupying this space in June 2014 and expects to begin occupying additional space with the expansion occurring in June 2015.  This space will result in additional operating lease obligations of $52.1 million payable through 2024. The Company has an option to extend the lease for two successive 5 year periods.

 

In September 2014, the Company signed a lease to expand its warehouse space in Ogden, UT by an additional 180,000 square feet which it plans to occupy in 2015. This space will result in additional operating lease obligations of $9.1 million payable through 2022.

 

Collection of Sales or Other Similar Taxes

 

Based on the location of the Company’s current operations, it collects and remits sales tax in Kentucky, Massachusetts, New York and Utah. The Company does not currently collect sales or other similar taxes for the sale of goods in states where no obligation to collect these taxes is required under applicable law. Several states have presented the Company with assessments, alleging that it is required to collect and remit sales or other similar taxes. The aggregate amount of claims from these states is approximately $11.7 million. The Company does not believe that it was obligated to collect and remit such taxes, and intends to vigorously defend its position. At this time, the Company believes a loss is not probable hence a liability has not been recorded, however, no assurance can be given as to the outcome of this situation.

 

Legal Matters

 

The Company is subject to legal proceedings and claims in the ordinary course of business. However, the Company is not currently aware of any legal proceedings or claims that it believes will have, individually or in the aggregate, a material adverse effect on the Company’s financial position, results of operations or cash flows.

 

7. Equity-Based Compensation

 

In July 2010, the Company established the CSN Stores LLC 2010 Common Unit Plan (the “CSN Plan”). Effective July 1, 2011, the CSN Plan was amended and restated as the Wayfair LLC Amended and Restated 2010 Common Unit Plan (the “2010 Plan”). The 2010 Plan was administered by the board of directors of Wayfair LLC and provided for the issuance of option units, deferred units, and restricted units (all common units), which currently represent Class B common stock of the Company. As of September 30, 2014, the 2010 Plan authorized up to 12,405,879 units to be issued, of which 603,769 units and 1,206,547 units were available for issuance at September 30, 2014 and December 31, 2013, respectively.

 

Under the 2010 Plan, the deferred units, common unit options, and restricted common units are subject to two vesting triggers: a service period (typically five years) and the occurrence of a liquidity event, which is defined in the 2010 Plan as

 

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either a change of control or an initial public offering. Employees are able to retain provisionally vested units (defined as service period completed) upon departure. The Company made a policy election to consider the liquidity event a performance condition. The Company has determined that the liquidity event performance condition was met upon the Company’s IPO in October 2014 and the Company will recognize approximately $48.6 million related to the provisionally vested units in the fourth quarter of 2014. The common unit options have a contractual life of ten years from the date of issuance, and deferred units have a seven-year life. The restricted common units have no contractual life. All outstanding equity incentive units of Wayfair LLC outstanding immediately prior to the reorganization automatically converted into (i) options to purchase Class B common stock, (ii) shares of our Class B common stock subject to vesting and repurchase provisions or (iii) restricted stock units for our Class B common stock.

 

In connection with the reorganization and the IPO in October 2014, the board of directors of Wayfair Inc. took over administration of the 2010 Plan and adopted the 2014 Incentive Award Plan (“2014 Plan”) to grant cash and equity incentive awards to eligible service providers in order to attract, motivate and retain the talent for which the Company competes. The 2014 Plan is administered by the board of directors of Wayfair Inc. with respect to awards to non-employee directors and by the compensation committee with respect to other participants and provides for the issuance of stock options, SARs, restricted stock, RSUs, performance shares, stock payments, cash payments, dividend awards and other incentives.  The 2014 Plan authorizes up to 8,603,066 shares of Class A common stock to be issued, of which no shares had been issued as of September 30, 2014.

 

A summary of the status and activity for awards of common option units under the 2010 Plan for the nine months ended September 30, 2014, is as follows:

 

 

 

Common
Option
Units

 

Weighted-
Average
Exercise Price

 

Weighted-Average
Remaining
Contractual Term
(Years)

 

Outstanding at December 31, 2013

 

664,232

 

$

2.99

 

6.7

 

Repurchased

 

(9,028

)

$

2.93

 

 

 

Forfeited/cancelled

 

(12,201

)

$

3.22

 

 

 

Outstanding at September 30, 2014

 

643,003

 

$

2.98

 

5.9

 

Provisionally vested at September 30, 2014

 

578,868

 

$

2.98

 

5.9

 

 

A summary of the status and activity for awards of restricted common units under the 2010 Plan for the nine months ended September 30, 2014, is as follows:

 

 

 

Restricted
Common
Units

 

Weighted-
Average Grant
Date Fair Value

 

Outstanding at December 31, 2013

 

3,490,968

 

$

4.75

 

Repurchased

 

(202,757

)

$

4.75

 

Forfeited/cancelled

 

(16,695

)

$

4.75

 

Outstanding at September 30, 2014

 

3,271,516

 

$

4.75

 

Provisionally vested at September 30, 2014

 

2,865,700

 

$

4.75

 

 

A summary of the status and activity for awards of deferred units under the 2010 Plan for the nine months ended September 30, 2014, is as follows:

 

 

 

 

Deferred
Common
Units

 

Weighted-
Average Grant
Date Fair Value

 

Weighted-Average
Remaining
Contractual Term
(Years)

 

Outstanding at December 31, 2013

 

5,255,113

 

$

7.95

 

6.0

 

Granted

 

1,953,227

 

$

27.07

 

 

 

Forfeited/cancelled

 

(278,856

)

$

12.29

 

 

 

Outstanding at September 30, 2014

 

6,929,484

 

$

14.42

 

5.6

 

Provisionally vested at September 30, 2014

 

1,749,626

 

$

5.95

 

4.8

 

 

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8. Segment and Geographic Information

 

The Company considers operating segments to be components of the Company in which separate financial information is available that is evaluated regularly by our chief operating decision maker (“CODM”) in managing and accessing the business. The CODM for the Company is the Chief Executive Officer. The CODM reviews financial information presented on a consolidated basis for purposes of making operating decisions, allocating resources and evaluating financial performance. Accordingly, the Company has determined that it has one operating and reportable segment. No country outside of the United States provided greater than 10% of total revenue.

 

The Company generates net revenue from Direct Retail sales derived through the Company’s sites and Other sales derived through sites operated by third parties and fees from third-party advertising distribution providers as set forth below:

 

 

 

Three months ended September 30,

 

Nine months ended September 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

 

 

(in thousands)

 

Net revenue

 

 

 

 

 

 

 

 

 

Direct Retail

 

$

285,502

 

$

181,693

 

$

755,036

 

$

450,058

 

Other

 

50,686

 

55,609

 

155,296

 

170,452

 

Net revenue

 

$

336,188

 

$

237,302

 

$

910,332

 

$

620,510

 

 

Revenue from external customers for each group of similar products and services are not reported to the CODM. Separate identification of this information for purposes of segment disclosure is impractical, as it is not readily available and the cost to develop it would be excessive.

 

The following table sets forth revenue and long-lived assets by geographic area:

 

 

 

Three months ended September 30,

 

Nine months ended September 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

 

 

(in thousands)

 

Geographic net revenue:

 

 

 

 

 

 

 

 

 

United States

 

$

314,754

 

$

221,421

 

$

851,585

 

$

581,073

 

International

 

21,434

 

15,881

 

58,747

 

39,437

 

Total

 

$

336,188

 

$

237,302

 

$

910,332

 

$

620,510

 

 

 

 

September 30,

 

December 31,

 

 

 

2014

 

2013

 

 

 

(in thousands)

 

Geographic long-lived assets:

 

 

 

 

 

United States

 

$

48,920

 

$

21,451

 

International

 

1,107

 

637

 

Total

 

$

50,027

 

$

22,088

 

 

9. Income Taxes

 

Wayfair LLC is organized as a limited liability company and taxed as a partnership under the Internal Revenue Code, and accordingly, no provision for federal or state and local income taxes is made on income since the members are individually liable for federal and state and local income taxes on their share of the Company’s earnings. However, the Company is responsible for distributing monies to pay tax liabilities to its members if due, including SK Retail, which was its majority member prior to the corporate reorganization. In addition, the Company is responsible for making distributions to SK Retail for

 

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Table of Contents

 

corporate taxes imposed by the Commonwealth of Massachusetts. Due to the Company incurring a taxable loss during the periods ended September 30, 2014 and 2013, the Company would not have been subject to additional income tax had it paid federal income taxes at the corporate level.

 

The Company’s foreign subsidiaries are subject to income tax in those jurisdictions.  The (provision) benefit amounted to $(49,000), $(1,000), $(66,000) and $4,000 in the three and nine months ended September 30, 2014 and 2013 respectively and related to various minimum foreign income tax assessments.

 

Upon the completion of the corporate reorganization described in note 1, the Company, will be subject to corporate tax on income.  The Company prepared and provided the unaudited pro forma consolidated balance sheet as if the reorganization from a limited liability company to a corporation in connection with this offering occurred on September 30, 2014. Pro forma deferred income taxes reflect the net tax effects of temporary differences between the pro forma carrying amounts of our tax assets and liabilities calculated for financial reporting purposes and the amounts that would have been calculated for our income tax returns in accordance with tax regulations and the net pro forma tax effects of operating loss and tax credit carryforwards if we had been a taxable entity.

 

The ultimate realization of deferred tax assets depends on the generation of sufficient taxable income of the appropriate character and in the appropriate taxing jurisdictions during the future periods in which the related temporary differences become deductible. The Company determined the valuation allowance on pro forma deferred tax assets is in accordance with the accounting standard for income taxes, which require weight of both positive and negative evidence in order to ascertain whether it is more likely than not that the pro forma deferred tax assets would be realized. The Company evaluated all significant available positive and negative evidence, including the existence of cumulative net income, benefits that could be realized from available tax strategies and forecasts of future taxable income, in determining the need for a valuation allowance on pro forma deferred tax assets. After applying the evaluation guidance of the accounting standard for income taxes the Company determined that it was more likely than not that $28.8 million of the pro forma deferred tax assets will not be realized, and as such, a valuation allowance of $28.8 million was required.

 

As of September 30, 2014, pro forma tax effected deferred tax assets, net of valuation allowance, and deferred tax liabilities were $7.0 million and $7.3 million respectively. Accordingly the pro forma net deferred tax liability as of September 30, 2014 was determined to be $0.3 million.

 

10. Members’ Deficit

 

Corporate Reorganization

 

On October 1, 2014, in anticipation of the IPO, the Company completed a corporate reorganization. Pursuant to the reorganization, Wayfair LLC became a wholly-owned subsidiary of Wayfair Inc., and the holders of equity interests in Wayfair LLC became stockholders of Wayfair Inc.  Wayfair Inc. was incorporated as a Delaware corporation on August 8, 2014. As of September 30, 2014, Wayfair Inc. had not engaged in any business or other activities except in connection with its formation and in preparation for this IPO.

 

Preferred Units

 

As of September 30, 2014, Wayfair LLC had 21,551,801 Series A convertible redeemable preferred units (“Series A units”) and 5,995,133 million Series B convertible redeemable preferred units (“Series B units”) issued and outstanding. Each holder of Series A and Series B units was entitled to certain rights and privileges. Upon the reorganization and in connection with the IPO in October 2014, all of the outstanding shares of Series A units and Series B units were ultimately converted into 27,546,934 shares of Class B common stock in Wayfair Inc.

 

Preferred Stock

 

As of September 30, 2014, Wayfair Inc. had no shares of undesignated preferred stock issued or outstanding.  Upon the closing of the IPO in October 2014, Wayfair Inc. authorized 10,000,000 shares of preferred stock, $0.001 par value per share, for future issuance.

 

Common Units

 

As of September 30, 2014 the Company had 43,784,060 shares of common units outstanding. Upon the corporate reorganization, and in connection with the IPO, all of the outstanding common units were exchanged for shares of common

 

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Table of Contents

 

stock and further reclassified into 43,784,060 shares of Class B common stock.  In addition, upon the closing of the IPO in October 2014, Wayfair Inc. issued 1,129,095 shares of Class B common stock upon the vesting of outstanding restricted stock units, net of minimum tax withholding obligations.

 

Common Stock

 

As of September 30, 2014, Wayfair Inc. had authorized 1,000 shares of common stock all of which were outstanding. Upon the closing of the IPO in October, 2014, Wayfair Inc. authorized 500,000,000 shares of Class A common stock, $0.001 par value per share, and 164,000,000 shares of Class B common stock, $0.001 par value per share, of which 12,650,000 shares of Class A common stock and 70,265,404 shares of Class B common stock were outstanding.  The rights of the holders of Class A common stock and Class B common stock are identical, except with respect to voting and conversion rights. Each share of Class A common stock is entitled to one vote per share. Each share of Class B common stock is entitled to ten votes per share and is convertible into one share of Class A common stock.  Each share of Class B common stock may be converted into one share of Class A common stock at the option of its holder and will be automatically converted into one share of Class A common stock upon transfer thereof, subject to certain exceptions. In addition, upon the date on which the outstanding shares of Class B common stock represent less than 10% of the aggregate number of shares of the then outstanding Class A common stock and Class B common stock, or in the event of the affirmative vote or written consent of holders of at least 662/3% of the outstanding shares of Class B common stock, all outstanding shares of Class B common stock shall convert automatically into Class A common stock.   Subject to preferences that may apply to any shares of preferred stock outstanding at the time, the holders of common stock are entitled to receive dividends out of funds legally available if the Board, in its discretion, determines to issue dividends and then only at the times and in the amounts that the Board may determine.

 

11. Net Loss per Common Unit/Share

 

Basic and diluted net (loss) income per common unit is presented using the two class method required for participating securities. Holders of the Series A and Series B units are entitled to receive cumulative dividends payable prior and in preference to any dividends on any of the common units of Wayfair LLC. The Company considers its Series A and Series B units to be participating securities and, in accordance with the two class method, earnings allocated to Series A and Series B units and the related number of outstanding participating securities would be excluded from the computation of basic and diluted net income (loss) per common unit.

 

Under the two class method, net (loss) income attributable to common unit holders is determined by allocating undistributed earnings between common units and participating securities. Undistributed earnings are calculated as net income (loss) less distributed earnings and accretion of Series A and Series B units. As holders of Series A and Series B units do not have a contractual obligation to share in the losses of Wayfair LLC, the net loss attributable to common unit holders for each period is not allocated between common units and participating securities. Accordingly, Series A and Series B units are excluded from the calculation of basic and diluted net loss per common unit. The Company’s basic and diluted net loss per common unit are the same because the Company has generated net loss to common unit holders and common unit equivalents are excluded from diluted net loss per share because they have an antidilutive impact.

 

The following table presents the calculation of basic and diluted net loss per common unit:

 

 

 

Three months ended September 30,

 

Nine months ended September 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

 

 

(in thousands, except share amount)

 

 

 

 

 

 

 

 

 

 

 

Numerator:

 

 

 

 

 

 

 

 

 

Net loss

 

$

(24,143

)

$

(3,031

)

$

(75,544

)

$

(11,369

)

Accretion of preferred units to redemption value

 

$

(4,748

)

$

(4,673

)

$

(16,503

)

$

(20,621

)

Net loss attributable to common unit holders per unit - basic and diluted

 

$

(28,891

)

$

(7,704

)

$

(92,047

)

$

(31,990

)

Denominator:

 

 

 

 

 

 

 

 

 

Weighted average units used for basic and diluted net loss per unit computation

 

40,512,544

 

41,367,115

 

40,721,540

 

41,304,048

 

 

 

 

 

 

 

 

 

 

 

Net loss per common unit attributable to common unit holders:

 

 

 

 

 

 

 

 

 

Basic and Diluted

 

$

(0.71

)

$

(0.19

)

$

(2.26

)

$

(0.77

)

 

The following have been excluded from the computation of basic and diluted net loss per share attributable to common stockholders as their effect would have been antidilutive:

 

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Table of Contents

 

 

 

Three months ended September 30,

 

Nine months ended September 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

 

 

 

 

 

 

 

 

 

 

Series A convertible redeemable preferred units

 

21,551,801

 

21,551,801

 

21,551,801

 

21,551,801

 

Series B convertible redeemable preferred units

 

5,995,133

 

 

5,995,133

 

 

Common option units

 

643,003

 

665,377

 

643,003

 

665,377

 

Restricted common units

 

3,271,516

 

3,495,010

 

3,271,516

 

3,495,010

 

Deferred common units

 

6,929,484

 

3,959,773

 

6,929,484

 

3,959,773

 

 

 

38,390,937

 

29,671,961

 

38,390,937

 

29,671,961

 

 

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Table of Contents

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

You should read the following discussion of our financial condition and results of operations in conjunction with the condensed consolidated financial statements and the notes thereto included elsewhere in this Quarterly Report on Form 10-Q and in our prospectus dated October 1, 2014 filed pursuant to Rule 424(b) under the Securities Act of 1933, as amended, or the Securities Act, with the Securities and Exchange Commission, or the SEC, on October 2, 2014. This discussion contains forward-looking statements that involve risks and uncertainties. As a result of many factors, such as those set forth under the sections in this Quarterly Report on Form 10-Q titled “Special Note Regarding Forward-Looking Statements” and “Risk Factors,” our actual results may differ materially from those anticipated in these forward-looking statements.

 

Overview

 

Through our e-commerce business model, we offer visually inspiring browsing, compelling merchandising, easy product discovery and attractive prices for over seven million products from over 7,000 suppliers across five distinct brands — Wayfair.com, Joss & Main, AllModern, DwellStudio and Birch Lane. We have built one of the largest online selections of furniture, home furnishings, décor and goods.

 

We founded our company in May 2002 and have since delivered over 13 million orders. From 2003 to 2011, we grew our net revenue organically from $7.7 million to $517.3 million, representing a 69.2% CAGR. In late 2011, we made the strategic decision to close and permanently redirect over 240 of our niche websites into Wayfair.com to create a one-stop shop for furniture, home furnishings, décor and goods and to build brand awareness, drive customer loyalty and increase repeat purchasing. We also changed our name from CSN Stores LLC to Wayfair LLC.

 

We plan to grow our customer base by attracting more unique visitors to our sites through two main strategies — increasing brand awareness and expanding direct online marketing — and then converting those visitors to active customers. Our online efforts are focused on building brand awareness to drive visitor traffic via direct navigation, search engine optimization and email marketing campaigns. In addition, we have made significant investments to improve the consumer experience on our sites, such as creating highly engaging visual imagery and merchandising, as well as easy-to-use navigation tools and personalization features that enable better product discovery. We plan to continue investing in our infrastructure, including enhancing our merchandising, data, analytics, and technology platform, as well as developing additional logistics and transportation solutions, self-service tools for our suppliers, fulfillment offerings and enhancing our development, testing and deployment systems.

 

Until late 2012, we were primarily focused on growing our U.S. business. In 2012, we began laying the groundwork for our international business by building our international infrastructure, developing deeper country-specific knowledge, building international supplier networks and establishing our brand presence in select international regions. We currently deliver products to customers in a number of countries, including the United States, the United Kingdom, Canada, Australia, Germany, France, Austria, Ireland and New Zealand. We intend to expand in these countries, especially Joss & Main, which we launched in the United Kingdom, France and Germany in 2014. In the three and nine months ended September 30, 2014, we generated net revenue outside of North America of $15.1 million and $40.3 million, or 4.5% and 4.4% of our total net revenue, respectively.

 

In the three and nine months ended September 30, 2014, we generated net revenue of $336.2 million and $910.3 million, respectively, up 41.7% and 46.7% over the three and nine months ended September 30, 2013, respectively. Our net revenue in the three and nine months ended September 30, 2014 included $285.5 million and $755.0 million, respectively, from Direct Retail, which we define as sales generated primarily through the sites of our five brands and $50.7 million and $155.3 million, respectively, from Other, which we define as net revenue generated primarily online through third parties, which we refer to as our retail partners and net revenue from third-party advertisers. In the three months ended September 30, 2014, we generated a net loss of $24.1 million and Adjusted EBITDA of $(18.3) million, increases of $21.1 million and $18.2 million, respectively, over the three months ended September 30, 2013. In the nine months ended September 30, 2014, we generated a net loss of $75.5 million and Adjusted EBITDA of $(55.3) million, increases of $64.2 million and $53.1 million, respectively, over the nine months ended September 30, 2013. Our net loss and Adjusted EBITDA results were driven primarily by our increased investment in advertising in the three and nine months ended September 30, 2014. See “Key Financial and Operating Metrics” below for further discussion of Adjusted EBITDA, our use of this measure, the limitations of this measure as an analytical tool and the reconciliation of Adjusted EBITDA to net loss, the most directly comparable GAAP financial measure.

 

On October 7, 2014, we completed our IPO of 12,650,000 shares of its Class A common stock at a public offering price of $29.00 per share, of which 10,500,000 shares were sold by us and 2,150,000 shares were sold by our selling

 

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stockholders, including 1,650,000 shares pursuant to the underwriters’ option to purchase additional shares, resulting in net proceeds to us of approximately $282.7 million, after deducting underwriting discounts and estimated offering expenses. We did not receive any proceeds from the sale of shares by the selling stockholders.

 

Key Financial and Operating Metrics

 

We measure our business using both financial and operating metrics. Our net revenue, Adjusted EBITDA and free cash flow metrics are measured on a consolidated basis. All other key financial and operating metrics are derived and reported from our Direct Retail sales, which includes sales generated primarily through the sites of our five distinct brands. These metrics do not include net revenue derived from the sites operated by our retail partners. We do not have access to certain customer level information on net revenue derived through our retail partners and therefore cannot measure or disclose it.

 

We use the following metrics to assess the near-term and longer-term performance of our overall business.

 

 

 

Three months ended September 30,

 

Nine months ended September 30,

 

% Change three
months ended
September 30,

 

% Change nine
months ended
September 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

2013 to 2014

 

2013 to 2014

 

 

 

(in thousands, except Average Order Value and LTM Net Revenue Per Active Customer)

 

 

 

 

 

Consolidated Financial Metrics

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Revenue

 

$

336,188

 

$

237,302

 

$

910,332

 

$

620,510

 

41.7

%

46.7

%

Adjusted EBITDA

 

$

(18,332

)

$

(181

)

$

(55,334

)

$

(2,281

)

 

 

 

 

Free Cash Flow

 

(22,398

)

(3,982

)

(92,648

)

(17,258

)

 

 

 

 

Direct Retail Financial and Operating Metrics

 

 

 

 

 

 

 

 

 

 

 

 

 

Direct Retail Net Revenue

 

$

285,502

 

$

181,693

 

$

755,036

 

$

450,058

 

57.1

%

67.8

%

Active Customers

 

2,858

 

1,775

 

2,858

 

1,775

 

61.0

%

61.0

%

LTM Net Revenue Per Active Customer

 

$

342

 

$

315

 

$

342

 

$

315

 

8.6

%

8.6

%

Orders Delivered

 

1,314

 

884

 

3,536

 

2,141

 

48.6

%

65.2

%

Average Order Value

 

$

217

 

$

206

 

$

214

 

$

210

 

5.3

%

1.9

%

 

Non-GAAP Financial Measures

 

Adjusted EBITDA

 

To provide investors with additional information regarding our financial results, we have disclosed here and elsewhere in this Quarterly Report on Form 10-Q Adjusted EBITDA, a non-GAAP financial measure that we calculate as earnings (loss) before depreciation and amortization, equity-based compensation, interest and other income and expense and taxes. We have provided a reconciliation below of Adjusted EBITDA to net loss, the most directly comparable GAAP financial measure.

 

We have included Adjusted EBITDA in this Quarterly Report on Form 10-Q because it is a key measure used by our management and board of managers 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. 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 managers.

 

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 the compensation charge associated with a tender offer we completed in April 2014 as described in the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources,”

 

·                  Adjusted EBITDA does not reflect changes in our working capital;

 

·                  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.

 

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Because of these limitations, you should consider Adjusted EBITDA alongside other financial performance measures, including various cash flow metrics, net (loss) income and our other GAAP results.

 

The following table reflects the reconciliation of net loss to Adjusted EBITDA for each of the periods indicated:

 

 

 

Three months ended September 30,

 

Nine months ended September 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

 

 

(in thousands)

 

Reconciliation of Adjusted EBITDA

 

 

 

 

 

 

 

 

 

Net loss

 

$

(24,143

)

$

(3,031

)

$

(75,544

)

$

(11,369

)

Depreciation and amortization

 

5,547

 

3,489

 

14,438

 

9,352

 

Equity based compensation

 

 

 

5,528

 

 

Interest income, net

 

(89

)

(61

)

(222

)

(185

)

Other (expenses) income, net

 

304

 

(579

)

400

 

(75

)

Taxes

 

49

 

1

 

66

 

(4

)

Adjusted EBITDA

 

$

(18,332

)

$

(181

)

$

(55,334

)

$

(2,281

)

 

Free Cash Flow

 

To provide investors with additional information regarding our financial results, we have also disclosed here and elsewhere in this Quarterly Report on Form 10-Q free cash flow, a non-GAAP financial measure that we calculate as net cash (used in) provided by operating activities less net cash used to purchase property and equipment including leasehold improvements and site and software development costs. We have provided a reconciliation below of free cash flow to net cash (used in) provided by operating activities, the most directly comparable GAAP financial measure.

 

We have included free cash flow in this Quarterly Report on Form 10-Q because it is an important indicator of our business performance as it measures the amount of cash we generate. 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.

 

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 (used in) provided by operating activities, capital expenditures and our other GAAP results.

 

The following table presents a reconciliation of free cash flow to net cash provided by operating activities for each of the periods indicated:

 

 

 

Three months ended September 30,

 

Nine months ended September 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

 

 

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

Net cash provided by operating activities, net of acquisition

 

$

(11,066

)

$

(517

)

$

(50,837

)

$

(6,425

)

Purchase of property, equipment, and leasehold improvements

 

(6,837

)

(1,120

)

(31,168

)

(4,421

)

Site and software development costs

 

(4,495

)

(2,345

)

(10,643

)

(6,412

)

Free cash flow

 

$

(22,398

)

$

(3,982

)

$

(92,648

)

$

(17,258

)

 

Key Operating Metrics (Direct Retail)

 

Active Customers

 

As of the last date of each reported period, we determine our number of active customers by counting the total number of individual customers who have purchased at least once directly from our sites during the preceding twelve-month period. The change in active customers in a reported period captures both the inflow of new customers as well as the outflow of existing customers who have not made a purchase in the last twelve months. We view the number of active customers as a key indicator of our growth.

 

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LTM Net Revenue Per Active Customer

 

We define LTM net revenue per active customer as our total net revenue derived from Direct Retail sales in the last twelve months divided by our total number of active customers for the same preceding twelve-month period. We view LTM net revenue per active customer as a key indicator of our customers’ purchasing patterns, including their initial and repeat purchase behavior.

 

Orders Delivered

 

We define orders delivered as the total Direct Retail orders delivered in any period, inclusive of orders that may eventually be returned. As we ship a large volume of packages through multiple carriers, actual delivery dates may not always be available, and as such we estimate delivery dates based on historical data. We recognize net revenue when an order is delivered and therefore orders delivered, together with average order value, is an indicator of the net revenue we expect to recognize in a given period. We view orders delivered as a key indicator of our growth.

 

Average Order Value

 

We define average order value as total Direct Retail net revenue in a given period divided by the orders delivered in that period. We view average order value as a key indicator of the mix of products on our sites, the mix of offers and promotions and the purchasing behavior of our customers.

 

Factors Affecting our Performance

 

We believe that our performance and future success depend on a number of factors that present significant opportunities for us but also pose risks and challenges, including those discussed below and in the section titled “Risk Factors”.

 

Growth in Brand Awareness and Visitors to our Sites

 

We intend to continue investing in our brand awareness strategy and direct online marketing efforts. In late 2011, we made a strategic decision to close and permanently redirect over 240 of our niche websites into Wayfair.com. Since late 2011, we have marketed our brands, in particular Wayfair.com, through TV advertising, display advertising, paid search advertising, social media advertising and direct mail, catalog and print advertising. Failure to cost effectively attract new visitors to our sites and convert them into customers would adversely affect our net revenue growth and operating results.

 

Growth in Customer Acquisition and Customer Retention

 

Our goal is to convert visitors into active customers and then encourage repeat purchases because it increases our operating leverage since it costs more to acquire a customer than to retain one. Our continued investments in infrastructure, including enhancing our merchandising, data, analytics, and technology platform, allow us to deliver increasingly tailored and personalized shopping experiences for customers across our sites. We believe our focus on a personalized shopping experience drives sales from new customers as well as repeat customers.

 

Revenue Growth Through Mobile Platform

 

Mobile is an increasingly important part of our business, especially for Joss & Main. We launched our mobile applications for Joss & Main in 2012 and Wayfair.com in 2014. Due to the relative newness of smartphones, tablets, and mobile shopping in general, we do not know if this increase in mobile use will continue.

 

Investment In Growth

 

We have aggressively invested in the growth of our business and this investment will continue. We anticipate that our operating expenses will increase substantially as we continue to increase our advertising spending, hire additional personnel primarily in merchandising, technology, operations, customer service and general and administrative functions and continue to develop features on our sites. In 2013, we signed a lease to increase our office space, and in 2014 we further increased the office space to accommodate the anticipated growth of our headcount in our corporate headquarters. These investments are expected to increase our losses near term and yield returns in the long term, but there is no guarantee that we will be able to realize the return on our investments.

 

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Components of Our Results of Operations

 

Net Revenue

 

Net revenue consists primarily of sales of product from our sites and through the sites of our online retail partners and includes related shipping fees. We deduct cash discounts, allowances, rewards and estimated returns from gross revenue to determine net revenue. We recognize product revenue upon delivery to our customers. Net revenue is primarily driven by growth of new and active customers and the frequency with which customers purchase. The products offered on our sites are primarily fulfilled with product we ship to our customers directly from our suppliers and, to a lesser extent, from our fulfillment centers.

 

We also generate net revenue through third-party advertisers that pay us based on the number of advertisement related clicks, actions, or impressions for advertisements placed on our sites. Net revenue earned under these arrangements is included in net revenue and is recognized in the period in which the click, action or impression occurs. This revenue has not been material to date.

 

We maintain a membership rewards program that allows enrolled customers to earn points which can be redeemed on future purchases. We defer the portion of our revenue associated with rewards which are expected to be redeemed prior to its expiration.

 

Cost of Goods Sold

 

Cost of goods sold consists of the cost of product sold to customers, shipping and handling costs and shipping supplies and fulfillment costs. Fulfillment costs include costs incurred in operating and staffing the fulfillment centers, such as costs attributed to receiving, inspecting, picking, packaging and preparing customer orders for shipment. Cost of goods sold also includes direct and indirect labor costs for fulfillment center oversight, including payroll and related benefit costs. The increase in cost of goods sold is primarily driven by growth in orders delivered, the mix of the product available for sale on our sites and transportation costs related to delivering orders to our customers.

 

We earn rebates on our incentive programs with our suppliers. These rebates are earned upon shipment of goods. Amounts due from suppliers as a result of these rebate programs are included as a receivable and are reflected as a reduction of cost of goods sold on the consolidated statements of operations. We expect cost of goods sold expenses to remain relatively stable as a percentage of net revenue but some quarterly fluctuations are expected due to the wide variety of products we sell.

 

Sales and Marketing

 

Sales and marketing expenses consist primarily of direct response performance marketing costs, such as television advertising, display advertising, paid search advertising, social media advertising, search engine optimization, comparison shopping engine advertising, direct mail, catalog and print advertising. Sales and marketing expenses also include labor-related costs for our employees involved in sales and marketing and customer service activities, merchant processing fees and partner advertising fees. Sales and marketing expenses are primarily driven by investments to grow and retain our customer base. We expect marketing expenses to continue to increase but decrease as a percentage of net revenue over time.

 

General and Administrative

 

General and administrative expenses consist primarily of labor-related costs for administrative, engineering, merchandising, human resources, finance and accounting personnel, professional service fees including audit and legal fees, insurance and other corporate expenses, including depreciation and rent. We anticipate that we will incur additional personnel expenses, professional service fees, including audit and legal, investor relations, costs of compliance with securities laws and regulations, and higher director and officer insurance costs related to operating as a public company. In addition, as we continue to grow as a company, we expect that our general and administrative expenses will continue to increase but decrease as a percentage of net revenue over time.

 

Amortization of Acquired Intangible Assets

 

We have recorded identifiable intangible assets in conjunction with our acquisitions and are amortizing those assets over their estimated useful lives. We perform impairment testing of goodwill and intangibles with definite lives annually and whenever events or circumstances indicate that impairment may have occurred.

 

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Table of Contents

 

Interest (Expense) Income, Net

 

Interest (expense) income, net consists primarily of interest earned on cash, cash equivalents and short-term investments held by us.

 

Other (Expense) Income, Net

 

Other (expense) income, net consist primarily foreign currency gains (losses).

 

Results of Consolidated Operations

 

Comparison of three months ended September 30, 2014 and 2013

 

Net revenue

 

 

 

Three months ended September 30,

 

% Change

 

 

 

2014

 

2013

 

2014 to 2013

 

 

 

(in thousands)

 

 

 

Direct Retail

 

$

285,502

 

$

181,693

 

57.1

%

Other

 

50,686

 

55,609

 

-8.9

%

Net revenue

 

$

336,188

 

$

237,302

 

41.7

%

 

In the three months ended September 30, 2014, net revenue increased by $98.9 million, or 41.7% compared to the three months ended September 30, 2013, primarily as a result of an increase in Direct Retail net revenue. In the three months ended September 30, 2014, Direct Retail net revenue increased by $103.8 million, or 57.1% compared to the three months ended September 30, 2013. The increase in Direct Retail net revenue was primarily due to sales to a larger customer base, as the number of active customers increased 61.0% in the three months ended September 30, 2014 compared to the three months ended September 30, 2013. Additionally, LTM net revenue per active customer increased 8.6% in the three months ended September 30, 2014 compared with the three months ended September 30, 2013. The decrease in Other revenue was primarily due to decreased sales through our retail partners.

 

Cost of Goods Sold

 

 

 

Three months ended September 30,

 

% Change

 

 

 

2014

 

2013

 

2014 to 2013

 

 

 

(in thousands)

 

 

 

Cost of goods sold

 

$

257,161

 

$

178,656

 

43.9

%

As a percentage of net revenue

 

76.5

%

75.3

%

 

 

 

In the three months ended September 30, 2014, costs of goods sold increased by $78.5 million, or 43.9%, compared to the three months ended September 30, 2013. Of the increase in cost of goods sold, $63.2 million was due to the increase in products sold to our larger customer base. In addition, shipping and fulfillment costs increased $15.3 million as a result of the increase in products sold during the period. Costs of goods sold as a percentage of net revenue increased in the three months ended September 30, 2014 compared to the three months ended September 30, 2013 as a result of changes in the mix of the products sold, shipping costs and our expansion of more favorable return policies.

 

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Operating Expenses

 

 

 

Three months ended September 30,

 

% Change

 

 

 

2014

 

2013

 

2014 to 2013

 

 

 

(in thousands)

 

 

 

Sales and marketing

 

$

77,439

 

$

46,602

 

66.2

%

General and administrative

 

25,218

 

15,530

 

62.4

%

Amortization of acquired intangible assets

 

249

 

184

 

35.3

%

 

 

$

102,906

 

$

62,316

 

65.1

%

As a percentage of net revenue

 

 

 

 

 

 

 

Sales and marketing

 

23.0

%

19.6

%

 

 

General and administrative

 

7.5

%

6.5

%

 

 

Amortization of acquired intangible assets

 

0.1

%

0.1

%

 

 

 

 

30.6

%

26.3

%

 

 

 

In the three months ended September 30, 2014, sales and marketing expenses increased by $30.8 million, or 66.2%, compared to the three months ended September 30, 2013. The increase in marketing expenses was primarily due to our efforts to grow and retain our customer base. We increased our advertising expenses by $21.4 million from $28.4 million in the three months ended September 30, 2013 to $49.8 million in the three months ended September 30, 2014, primarily driven by an increase in television and display advertising. Our customer service costs and merchant processing fees increased by $4.5 million from $9.7 million in the three months ended September 30, 2013 to $14.2 million in the three months ended September 30, 2014. The remainder of the increase resulted primarily from sales and marketing labor costs for product development, operations, and marketing personnel.

 

In the three months ended September 30, 2014, general and administrative expense increased by $9.7 million, or 62.4%, compared to the three months ended September 30, 2013. This increase was primarily attributable to personnel costs, rent, amortization and depreciation expenses and continued investment in our technology platform.

 

Interest Income, net

 

In the three months ended September 30, 2014 and the three months ended September 30, 2013, interest income, net, was $0.1 million.

 

Other (Expense), Income, net

 

In the three months ended September 30, 2014, other (expense), net, increased by $0.9 million from $0.6 million in the three months ended September 30, 2013 to $(0.3) million in the three months ended September 30, 2014 primarily attributed to changes in foreign currency.

 

Comparison of nine months ended September 30, 2014 and 2013

 

Net revenue

 

 

 

Nine months ended September 30,

 

% Change

 

 

 

2014

 

2013

 

2014 to 2013

 

 

 

(in thousands)

 

 

 

Direct Retail

 

$

755,036

 

$

450,058

 

67.8

%

Other

 

155,296

 

170,452

 

-8.9

%

Net revenue

 

$

910,332

 

$

620,510

 

46.7

%

 

In the nine months ended September 30, 2014, net revenue increased by $289.8 million, or 46.7% compared to the nine months ended September 30, 2013, primarily as a result of an increase in Direct Retail net revenue. In the nine months ended September 30, 2014, Direct Retail net revenue increased by $305.0 million, or 67.8% compared to the nine months ended September 30, 2013. The increase in Direct Retail net revenue was primarily due to sales to a larger customer base, as the number of active customers increased 61% in the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013. Additionally, LTM net revenue per active customer increased 8.6% in the nine months ended September 30, 2014 compared with the nine months ended September 30, 2013. The decrease in Other revenue was primarily due to decreased sales through our retail partners.

 

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Cost of Goods Sold

 

 

 

Nine months ended September 30,

 

% Change

 

 

 

2014

 

2013

 

2014 to 2013

 

 

 

(in thousands)

 

 

 

Cost of goods sold

 

$

697,644

 

$

466,993

 

49.4

%

As a percentage of net revenue

 

76.6

%

75.3

%

 

 

 

In the nine months ended September 30, 2014, costs of goods sold increased by $230.7 million, or 49.4%, compared to the nine months ended September 30, 2013. Of the increase in cost of goods sold, $184.3 million was due to the increase in products sold to our larger customer base. In addition, shipping and fulfillment costs increased $46.4 million as a result of the increase in products sold during the period. Costs of goods sold as a percentage of net revenue increased in the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013 as a result of changes in the mix of the products sold, shipping costs and our expansion of more favorable return policies.

 

Operating Expenses

 

 

 

Nine months ended September 30,

 

% Change

 

 

 

2014

 

2013

 

2014 to 2013

 

 

 

(in thousands)

 

 

 

Sales and marketing

 

$

215,667

 

$

119,316

 

80.8

%

General and administrative

 

71,573

 

45,544

 

57.2

%

Amortization of acquired intangible assets

 

748

 

290

 

157.9

%

 

 

$

287,988

 

$

165,150

 

74.4

%

As a percentage of net revenue

 

 

 

 

 

 

 

Sales and marketing

 

23.7

%

19.2

%

 

 

General and administrative

 

7.9

%

7.3

%

 

 

Amortization of acquired intangible assets

 

0.1

%

0.0

%

 

 

 

 

31.6

%

26.6

%

 

 

 

In the nine months ended September 30, 2014, sales and marketing expenses increased by $96.4 million, or 80.8%, compared to the nine months ended September 30, 2013. The increase in marketing expenses was primarily to grow and retain our customer base. We increased our advertising expenses by $64.9 million from $71.6 million in the nine months ended September 30, 2013 to $136.5 million in the nine months ended September 30, 2014, primarily driven by an increase in television and display advertising. Our customer service costs and merchant processing fees increased by $12.6 million from $25.8 million in the nine months ended September 30, 2013 to $38.4 million in the nine months ended September 30, 2014. We also incurred equity based compensation expense of $4.3 million recorded in sales and marketing in the nine months ended September 30, 2014 associated with our tender offer. The remainder of the increase was primarily in sales and marketing labor costs for product development, operations, and marketing personnel.

 

In the nine months ended September 30, 2014, general and administrative expense increased by $26.0 million, or 57.2%, compared to the nine months ended September 30, 2013. This increase was primarily attributable to personnel costs, rent, amortization and depreciation expenses and continued investment in our technology platform.

 

In the nine months ended September 30, 2014, amortization of purchased intangible assets increased by $0.5 million, or 157.9%, compared to the nine months ended September 30, 2013. The increase in amortization expense for the nine months ended September 30, 2014 was primarily the result of our acquisition of DwellStudio in July of 2013.

 

Interest Income, net

 

In the nine months ended September 30, 2014 and the nine months ended September 30, 2013, interest income, net, was $0.2 million.

 

Other (Expense), Income, net

 

In the nine months ended September 30, 2014, other (expense), net, increased by $0.5 million from $0.1 million in the three months ended September 30, 2013 to $(0.4) million in the three months ended September 30, 2013 primarily attributed to changes in foreign currency.

 

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Liquidity and Capital Resources

 

Sources of Liquidity

 

 

 

September 30,

 

September 30,

 

December 31,

 

 

 

2014

 

2014

 

2013

 

 

 

 

 

Pro forma

 

 

 

 

 

(in thousands)

 

Cash and cash equivalents

 

$

30,307

 

$

265,959

 

$

65,289

 

Short-term investments

 

100,054

 

100,054

 

50,019

 

Accounts receivable, net

 

5,314

 

5,314

 

7,689

 

Working capital

 

$

38,047

 

$

273,699

 

$

18,118

 

 

Historical Cash Flows

 

 

 

Nine months ended September 30,

 

 

 

2014

 

2013

 

 

 

(in thousands)

 

 

 

 

 

 

 

Net loss

 

(75,544

)

(11,369

)

Net cash used in operating activities

 

(50,837

)

(6,425

)

Net cash used in investing activities

 

(94,862

)

(31,697

)

Net cash provided by financing activities

 

110,746

 

 

 

Since our inception, we have financed our operations, capital expenditures and acquisitions primarily through cash flows generated by operations and, since 2011, also through private sales of convertible redeemable preferred units and common units. Since inception through September 30, 2014, we have raised a total of approximately $363.1 million from the sale of preferred stock, net of costs and expenses associated with such financings, or approximately $195.4 million, net of repurchases of our securities.

 

On October 7, 2014, we completed our IPO, of 12,650,000 shares of its Class A common stock at a public offering price of $29.00  per share, of which 10,500,000 shares were sold by the Company and 2,150,000 shares were sold by selling stockholders, including 1,650,000 shares pursuant to the underwriters’ option to purchase additional shares, resulting in net proceeds to us of approximately $282.7 million, after deducting underwriting discounts and estimated offering expenses. We did not receive any proceeds from the sale of shares by the selling stockholders.  We used these proceeds to distribute $24.5 million of cash to our Series A convertible preferred stockholders and pay $22.6 million in minimum tax withholding obligations on the vesting of our deferred units.  The pro forma presentation above reflects the proceeds from the IPO after these payments.

 

We believe that our existing cash and cash equivalents, proceeds from the IPO together with cash generated from operations, will be sufficient to meet our anticipated cash needs for at least the foreseeable future. However, our liquidity assumptions may prove to be incorrect, and we could exhaust our available financial resources sooner than we currently expect. In addition, we may elect to raise additional funds at any time through equity, equity linked or debt financing arrangements. Our future capital requirements and the adequacy of available funds will depend on many factors, including those described in the section titled “Risk Factors”. We may not be able to secure additional financing to meet our operating requirements on acceptable terms, or at all.

 

Operating Activities

 

Cash provided by operating activities consisted of net loss adjusted for certain non-cash items including depreciation and amortization, and certain other non-cash expenses, as well as the effect of changes in working capital and other activities.

 

Cash used in operating activities in the nine months ended September 30, 2014 was $50.8 million, an increase in cash outflow of $44.4 million compared to the nine months ended September 30, 2013. Cash used in operating activities was driven primarily by net loss of $75.5 million, adjusted for certain non-cash items including depreciation and amortization expense of

 

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$14.4 million, equity based compensation of $5.5 million and other non-cash items of $0.9 million and cash provided by operating assets and liabilities of $3.8 million. Operating cash flows can be volatile and are sensitive to many factors, including changes in working capital and our net loss.

 

Investing Activities

 

Our primary investing activities consisted of purchases of property and equipment, particularly purchases of servers and networking equipment, investment in our sites and software development, purchases and disposal of marketable securities, leasehold improvements for our facilities and acquisitions of businesses.

 

Cash used in investing activities in the nine months ended September 30, 2014 was $94.9 million, an increase in cash outflow of $63.2 million compared to the nine months ended September 30, 2013. The increase in cash outflow was primarily driven by net purchases of short-term investments of $50.0 million, purchases of property and equipment of $31.2 million, site and software development costs of $10.6 million and net increase in restricted cash of $3.0 million. The purchases of property and equipment includes $2.1 million, primarily related to leasehold improvements, for which cash has not been paid as of September 30, 2014.

 

Financing Activities

 

Our primary financing activities consisted of private sales of convertible redeemable preferred units in 2014. Cash provided by financing activities in the nine months ended September 30, 2014 was $110.7 million and was primarily due to net proceeds from issuance of Series B convertible redeemable preferred units partially offset by the dividend distribution to our Series A preferred unit holders, the repurchase of our securities and our 2014 tender offer. There were no financing activities in the nine months ended September 30, 2013.

 

Credit Agreement

 

We have a credit agreement with a lender which provides us with a line of credit for up to $25.0 million, with the committed amounts of $10.0 million to be used for a revolving line of credit and $15.0 million to be used to support our corporate credit card program. We are required to maintain certain covenants, including debt service coverage, tangible net worth, and unencumbered liquid assets. As September 30, 2014 and December 31, 2013, we did not have any borrowings outstanding and were in full compliance with the credit agreement. The credit agreement is renewable on an annual basis. We renewed this agreement on June 6, 2014 and it will mature on July 31, 2015.

 

Off-Balance Sheet Arrangements

 

We do not engage in any off-balance sheet activities. We do not have any off-balance sheet interest in variable interest entities, which include special purpose entities and other structured finance entities.

 

Contractual Obligations

 

We lease office space under non-cancelable operating leases. These leases expire at various dates through 2024 and include discounted rental periods and fixed escalation clauses, which are amortized straight-line over the terms of the lease. We recognize rent expense on a straight-line basis over the lease periods. We do not have any debt or material capital lease obligations and all of our property, equipment and software have been purchased with cash.

 

In March 2014, we expanded our lease of office space in Boston, MA, to a total of approximately 275,000 square feet in order to accommodate the growth of our new corporate headquarters. We began occupying this space in June 2014 and expect to begin occupying additional space with the expansion occurring in June 2015. This lease will result in additional operating lease obligations of $52.1 million payable through 2024.

 

In September 2014, we signed a lease to expand our warehouse space in Ogden, UT by an additional 180,000 square feet which we plan to occupy in 2015. This space will result in additional operating lease obligations of $9.1 million payable through 2022.

 

Critical Accounting Policies

 

Our condensed consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles, or GAAP. The preparation of these condensed consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses, and related disclosures. These

 

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estimates form the basis for judgments we make about the carrying values of our assets and liabilities, which are not readily apparent from other sources. We base our estimates and judgments on historical experience and on various other assumptions that we believe are reasonable under the circumstances. On an ongoing basis, we evaluate our estimates and assumptions. Our actual results may differ from these estimates under different assumptions or conditions.

 

We believe that the assumptions and estimates associated with revenue recognition, income taxes and share-based compensation have the greatest potential impact on our condensed consolidated financial statements. Therefore, we consider these to be our critical accounting policies and estimates.

 

There have been no material changes to our critical accounting policies and estimates as compared to the critical accounting policies and estimates described in our prospectus dated October 1, 2014 filed with the SEC pursuant to Rule 424(b) under the Securities Act on October 2, 2014.

 

Recent Accounting Pronouncements

 

In July 2013, the Financial Accounting Standards Board (“FASB”) issued a new accounting standard update that requires the presentation of certain unrecognized tax benefits as reductions to deferred tax assets rather than as liabilities in the consolidated balance sheets when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. We adopted this new standard on a prospective basis in the first quarter of fiscal 2014, and the adoption of this accounting standard update did not have a material impact on our condensed consolidated financial statements.

 

In May 2014, the FASB issued new accounting guidance regarding revenue recognition under GAAP. This new guidance will supersede nearly all existing revenue recognition guidance, and is effective for public entities for annual and interim periods beginning after December 31, 2016. Early adoption is not permitted. We are currently evaluating the impact of this new guidance on our condensed consolidated financial statements.

 

In August 2014, the FASB issued Accounting Standards Update No. 2014-15, “Presentation of Financial Statements - Going Concern”, which requires us to evaluate, at each annual and interim reporting period, whether there are conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date the financial statements are issued and provide related disclosures.  ASU 2014-15 is effective for annual periods ending after December 15, 2016 and interim periods thereafter.  Early application is permitted.  The adoption of ASU 2014-15 is not expected to have a material effect on our condensed consolidated financial statements.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

We have operations both within the United States and internationally, and we are exposed to market risks in the ordinary course of our business, including the effects of foreign currency fluctuations, interest rate changes and inflation. Information relating to quantitative and qualitative disclosures about these market risks is set forth below.

 

Interest Rate Sensitivity

 

Cash and cash equivalents and short-term investments were held primarily in cash deposits, certificates of deposit and money market funds. The fair value of our cash, cash equivalents and short-term investments would not be significantly affected by either an increase or decrease in interest rates due mainly to the short-term nature of these instruments. Interest on the revolving line of credit incurred pursuant to the credit agreement described above would accrue at a floating rate based on a formula tied to certain market rates at the time of incurrence; however, we do not expect that any change in prevailing interest rates will have a material impact on our results of operations.

 

Foreign Currency Risk

 

Most of our sales are denominated in U.S. dollars, and therefore, our revenue is not currently subject to significant foreign currency risk. Our operating expenses are denominated in the currencies of the countries in which our operations are located, and may be subject to fluctuations due to changes in foreign currency exchange rates, particularly changes in the British Pound, Australian Dollar and Euro. Fluctuations in foreign currency exchange rates may cause us to recognize transaction gains and losses in our statement of operations. To date, foreign currency transaction gains and losses have not been material to our financial statements, and we have not engaged in any foreign currency hedging transactions.

 

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Inflation

 

We do not believe that inflation has had a material effect on our business, financial condition or results of operations. We continue to monitor the impact of inflation in order to minimize its effects through pricing strategies, productivity improvements and cost reductions. If our costs were to become subject to significant inflationary pressures, we may not be able to fully offset such higher costs through price increases. Our inability or failure to do so could harm our business, financial condition and results of operations.

 

ITEM 4. CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures

 

Our management, with the participation of our principal executive officer and principal financial officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act), as of the end of the period covered by this Quarterly Report on Form 10-Q. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q our principal executive officer and principal financial officer have concluded that as of such date, our disclosure controls and procedures were effective.

 

Changes in Internal Control Over Financial Reporting

 

There were no changes in our internal control over financial reporting identified in connection with the evaluation required by Rule 13a-15(d) or 15d-15(d) of the Exchange Act during the period covered by the Quarterly Report on Form 10-Q that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II

OTHER INFORMATION

 

Item 1.                     Legal Proceedings.

 

From time to time we are involved in legal proceedings arising in the ordinary course of our business. Although the results of litigation and claims cannot be predicted with certainty, we currently believe that there is no litigation pending that is likely to have a material adverse effect on our business. Regardless of the outcome, legal proceedings can have an adverse impact on us because of defense and settlement costs, diversion of management resources and other factors.

 

Information pertaining to legal proceedings can be found in “Item 1. Financial Statements and Supplementary Data - Note 6. Commitments and Contingencies” of this Quarterly Report on Form 10-Q, and is incorporated by reference herein.

 

Item 1A.            Risk Factors.

 

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 Quarterly Report on Form 10-Q, including the section titled “Special Note Regarding Forward-Looking Statements” and 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

 

Our recent growth rates may not be sustainable or indicative of our future growth.

 

In late 2011, we closed and permanently redirected over 240 of our niche websites into Wayfair.com. Additionally, we launched Joss & Main. In 2013, we acquired DwellStudio, and in 2014, we launched Birch Lane. Because we launched most of our brands recently, we have a limited amount of information regarding the purchasing patterns of our customers on these websites. We depend heavily on this information to plan and forecast our business, including anticipated customer acquisition costs, net revenue per active customer and other key performance metrics. If our assumptions prove to be wrong, we may spend more than we anticipate to acquire and retain customers or may generate less net revenue per active customer than anticipated, any of which could have a negative impact on our business and results of operations. In addition, our historical growth rates may not be sustainable or indicative of future growth.

 

We believe that our continued revenue growth will depend upon, among other factors, our ability to:

 

·                  build our brands and launch new brands;

 

·                  acquire more customers;

 

·                  develop new features to enhance the consumer experience on our websites, mobile-optimized websites and mobile applications, which we collectively refer to as our sites;

 

·                  increase the frequency with which new and repeat customers purchase products on our sites through merchandising, data, analytics and technology;

 

·                  add new suppliers and deepen our relationships with our existing suppliers;

 

·                  enhance the systems our consumers use to interact with our sites and invest in our infrastructure platform;

 

·                  expand internationally; and

 

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·                  pursue strategic acquisitions.

 

We cannot assure you we will be able to achieve any of the foregoing. Our customer base may not continue to grow or may decline as a result of increased competition and the maturation of our business. Failure to continue our revenue growth rates could have a material adverse effect on our financial condition and results of operations. You should not rely on our historical rate of revenue growth as an indication of our future performance.

 

If we fail to manage our growth effectively, our business, financial condition and operating results could be harmed.

 

To manage our growth effectively, 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 base. We have rapidly increased employee 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 1,558 full-time equivalents as of December 31, 2013 to 2,213 full-time equivalents as of September 30, 2014, and we expect to continue to add a significant number of employees in 2015. To support continued growth, we must effectively integrate, develop and motivate a large number of new employees. We face significant competition for personnel, particularly in the Boston, Massachusetts area where our headquarters are located. Failure to manage our hiring needs effectively or successfully integrate our new hires may have a material adverse effect on our business, financial condition and operating results.

 

Additionally, the growth of our business places significant demands on our management and other employees. For example, we typically launch hundreds of promotional events across thousands of products each month on Wayfair.com, in addition to hundreds of promotional events — or “Daily Events” — on Joss & Main in which we promote thousands of products via emails, “push” notifications and personalized displays. These events require us to produce updates of our sites and emails to our customers on a daily basis with different products, photos and text. 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 relationships with a growing number of suppliers, customers and other third parties. For example, in 2013, we added over 800 new suppliers. Our information technology systems and our internal controls and procedures may not be adequate to support future growth of our supplier base. If we are unable to manage the growth of our organization effectively, our business, financial condition and operating results may be materially adversely affected.

 

If we fail to acquire new customers, or fail to do so in a cost- effective manner, we may not be able to increase net revenue per active customer or achieve profitability.

 

Our success depends on our ability to acquire customers in a cost-effective manner. In order to expand our customer base, we must appeal to and acquire customers who have historically used other means of commerce to purchase home goods and may prefer alternatives to our offerings, such as traditional brick and mortar retailers, the websites of our competitors or a supplier’s own website. We have made significant investments related to customer acquisition and expect to continue to spend significant amounts to acquire additional customers. For example, we have recently expanded our national U.S. television branding and advertising campaigns. Such campaigns are expensive and may not result in the cost-effective acquisition of customers. We cannot assure you that the net profit from new customers we acquire will ultimately exceed the cost of acquiring those customers. If we fail to deliver a quality shopping experience, or if consumers do not perceive the products we offer to be of high value and quality, we may not be able to acquire new customers. If we are unable to acquire new customers who purchase products in numbers sufficient to grow our business, we may not be able to generate the scale necessary to drive beneficial network effects with our suppliers, our net revenue may decrease, and our business, financial condition and operating results may be materially adversely affected.

 

We believe that many of our new customers originate from word-of- mouth and other non-paid referrals from existing customers. 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.

 

We also utilize paid and non-paid advertising. Our paid advertising includes search engine marketing, display advertising, paid social media and television advertisements. Our non-paid advertising efforts include search engine optimization, non-paid social media, mobile “push” notifications and email. We obtain a significant amount of traffic via search engines and, therefore, rely on search engines such as Google, Bing and Yahoo!. Search engines frequently update and change the logic that determines the placement and display of results of a user’s search, such that the purchased or algorithmic placement of links to our sites can be negatively affected. Moreover, a search engine could, for competitive or other purposes, alter its search algorithms or results, causing our sites to place lower in search query results. A major search engine could change its algorithms in a manner that negatively affects our paid or non-paid search ranking, and competitive dynamics could impact the effectiveness of search engine marketing or search engine optimization. We also obtain a significant amount of

 

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traffic via social networking websites or other channels used by our current and prospective customers. As e-commerce and social networking continue to rapidly evolve, we must continue to establish relationships with these channels and may be unable to develop or maintain these relationships on acceptable terms. If we are unable to cost-effectively drive traffic to our sites, our ability to acquire new customers and our financial condition would suffer.

 

Our success depends in part on our ability to increase our net revenue per active customer. If our efforts to increase customer loyalty and repeat purchasing as well as maintain high levels of customer engagement and average order values of our customers are not successful, our growth prospects and revenue will be materially adversely affected.

 

Our ability to grow our business depends on our ability to retain our existing customer base and generate increased revenue and repeat purchases from this customer base, and maintain high levels of customer engagement. To do this, we must continue to provide our customers and potential customers with a unified, convenient, efficient and differentiated shopping experience by:

 

·                  providing imagery, tools and technology that attract customers who historically would have bought elsewhere;

 

·                  maintaining a high-quality and diverse portfolio of products;

 

·                  managing over 7,000 suppliers to deliver products on time and without damage; and

 

·                  continuing to invest in our mobile platforms.

 

If we fail to increase net revenue per active customer, generate repeat purchases or maintain high levels of customer engagement and average order value, our growth prospects, operating results and financial condition could be materially adversely affected.

 

Our business depends on our ability to build and maintain strong brands. We may not be able to maintain and enhance our existing brands if we receive unfavorable customer complaints, negative publicity or otherwise fail to live up to consumers’ expectations, which could materially adversely affect our business, results of operations and growth prospects.

 

We currently offer five distinct brands to our customers, but we have a limited operating history with most of these brands. Maintaining and enhancing these brands are critical to expanding our base of customers and suppliers. However, a significant portion of our customers’ brand experience depends on third parties outside of our control, including suppliers and logistics providers such as FedEx, UPS and the U.S. Postal Service. If these third parties do not meet our or our customers’ expectations, our brand may suffer irreparable damage. In addition, maintaining and enhancing these brands may require us to make substantial investments, and these investments may not be successful. If we fail to promote and maintain our brands, or if we incur excessive expenses in this effort, our business, operating results and financial condition may be materially adversely affected. We anticipate that, as our market becomes increasingly competitive, maintaining and enhancing our brands may become increasingly difficult and expensive. Maintaining and enhancing our brands will depend largely on our ability to provide high quality products to our customers and a reliable, trustworthy and profitable sales channel to our suppliers, which we may not do successfully.

 

Customer complaints or negative publicity about our sites, products, product delivery times, customer data handling and security practices or customer support, especially on blogs, social media websites and our sites, could rapidly and severely diminish consumer use of our sites and consumer and supplier confidence in us and result in harm to our brands.

 

Our efforts to launch new brands and expand our existing brand portfolio internationally may not be successful.

 

Our business success depends to some extent on our ability to expand our customer offerings by launching new brands and expanding our existing brand portfolio into new geographies. For example, in 2014 we launched Birch Lane in the United States and Canada, and we launched our Joss & Main brand in the United Kingdom, France and Germany. Launching new brands or expanding our existing brand portfolio internationally requires significant upfront investments, including investments in marketing, information technology and additional personnel. Expanding our brands internationally is particularly challenging because it requires us to gain country-specific knowledge about consumers and regional competitors, construct home goods catalogs specific to the country, build local logistics capabilities and customize portions of our technology for local markets. We may not be able to generate satisfactory revenue from these efforts to offset these upfront costs. Any lack of market acceptance of our efforts to launch new brands or expand our existing brand portfolio could have a material adverse effect on our business, prospects, financial condition and results of operations.

 

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Expansion of our international operations 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 believe international expansion represents a significant growth opportunity for us. Today, we deliver products to customers in a number of countries, including the United States, the United Kingdom, Canada, Australia, Germany, France, Austria, Ireland and New Zealand. We plan to expand into other international markets in order to grow our business, which will require significant management attention and resources. For example, we have made and will continue to make significant investments in information technology, logistics, supplier relationships, merchandising and marketing in the foreign jurisdictions in which we operate or plan to operate. We have limited experience in selling our products to conform to different local cultures, standards and regulations, and the products we offer may not appeal to customers in the same manner, if at all, in other geographies. We may have to compete with local companies which understand the local market better than we do and/or may have greater brand recognition than we do. In addition, to deliver satisfactory performance for customers in international locations, it may be necessary to locate physical facilities, such as consolidation centers, in foreign markets, and we may have to invest in these facilities before we can determine whether or not our foreign operations are successful. We have limited experience establishing such facilities internationally. We may not be successful in expanding into additional international markets or in generating net revenue from foreign operations. 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 adversely affected.

 

Our future results could be materially adversely affected by a number of factors inherent in international operations, including:

 

·                  localization of our product offerings, including translation into foreign languages and adaptation for local practices;

 

·                  the 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;

 

·                  unexpected changes in regulatory requirements, taxes, trade laws, tariffs, export quotas, custom duties or other trade restrictions;

 

·                  differing labor regulations where labor laws may be more advantageous to employees as compared to the United States;

 

·                  more stringent regulations relating to data privacy and security, including the use of commercial and personal information, particularly in the European Union;

 

·                  changes in a specific country’s or region’s political or economic conditions;

 

·                  the rising cost of labor in the foreign countries in which our suppliers operate, resulting in increases in our costs of doing business internationally;

 

·                  challenges inherent in efficiently managing an increased number of employees over large geographic distances, including the need to implement appropriate systems, policies, benefits and compliance programs and maintain our corporate culture across geographies;

 

·                  risks resulting from changes in currency exchange rates;

 

·                  limitations on our ability to reinvest earnings from operations in one country to fund the capital needs of our operations in other countries;

 

·                  different or lesser intellectual property protection;

 

·                  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;

 

·                  import/export controls; and

 

·                  logistics and sourcing.

 

Operating 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 operations will produce desired levels of net revenue or profitability. If we invest substantial time and resources to establish and expand our international

 

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operations and are unable to do so successfully and in a timely manner, our business, financial condition and operating results may be materially adversely affected.

 

We have a history of losses and expect to have increasing operating losses and negative cash flow as we continue to expand our business.

 

We have a history of losses, and we have accumulated $306.0 million in common members’ deficit as of September 30, 2014.  We expect our operating losses and negative cash flow to increase significantly in the near-term as we increase investment in our business. Because the market for purchasing home goods online is rapidly evolving and has not yet reached widespread adoption, it is difficult for us to predict our future operating results. As a result, our losses may be larger than anticipated, and we may never achieve profitability. We expect our operating expenses to increase over the next several years as we increase our advertising budget, hire additional personnel and continue to develop features on our sites. In particular, we intend to continue to invest substantial resources in marketing to acquire new customers. In addition, as we grow as a newly public company, we have and will continue to incur additional significant legal, accounting and other expenses that we did not previously incur as a private company. Furthermore, if our future growth and operating performance fail to meet investor or analyst expectations, or if we have future negative cash flow or losses resulting from our investment in acquiring new customers, our financial condition and stock price could be materially adversely affected.

 

System interruptions that impair customer access to our sites or other performance failures in our technology infrastructure could damage our business, reputation and brand and substantially harm our business and results of operations.

 

The satisfactory performance, reliability and availability of our sites, transaction processing systems and technology infrastructure are critical to our reputation and our ability to acquire and retain customers, as well as maintain adequate customer service levels.

 

We currently utilize two third-party data center hosting facilities. If the main facility where substantially all of our computer and communications hardware is located fails, or if we suffer an interruption or degradation of services at our main facility, we could lose customer data and miss order fulfillment deadlines, which could harm our business. Our systems and operations are vulnerable to damage or interruption from fire, flood, power loss, telecommunications failure, terrorist attacks, cyber-attacks, data loss, acts of war, break-ins, earthquake and similar events. In the event of a failure of our main facility, the failover to our back-up facility could take substantial time, during which time our sites could be completely shut down. Our back-up facility is designed to support transaction volume at a level slightly above our average daily sales, but is not adequate to support spikes in demand. The back-up facility may not process effectively during time of higher traffic to our sites and may process transactions more slowly and may not support all of our sites’ functionality.

 

We use complex proprietary software in our technology infrastructure, which we seek to continually update and improve. We may not always be successful in executing these upgrades and improvements, and the operation of our systems may be subject to failure. In particular, we have in the past and may in the future experience slowdowns or interruptions in some or all of our sites when we are updating them, and new technologies or infrastructures may not be fully integrated with existing systems on a timely basis, or at all. Additionally, if we expand our use of third-party services, including cloud-based services, our technology infrastructure may be subject to increased risk of slowdown or interruption as a result of integration with such services and/or failures by such third-parties, which are out of our control. Our net revenue depends on the number of visitors who shop on our sites and the volume of orders we can handle. Unavailability of our sites or reduced order fulfillment performance would reduce the volume of goods sold and could also materially adversely affect consumer perception of our brand. We may experience periodic system interruptions from time to time. In addition, continued growth in our transaction volume, as well as surges in online traffic and orders associated with promotional activities or seasonal trends in our business, place additional demands on our technology platform and could cause or exacerbate slowdowns or interruptions. If there is a substantial increase in the volume of traffic on our sites or the number of orders placed by customers, we will be required to further expand and upgrade our technology, transaction processing systems and network infrastructure. There can be no assurance that we will be able to accurately project the rate or timing of increases, if any, in the use of our sites or expand and upgrade our systems and infrastructure to accommodate such increases on a timely basis. In order to remain competitive, we must continue to enhance and improve the responsiveness, functionality and features of our sites, which is particularly challenging given the rapid rate at which new technologies, customer preferences and expectations and industry standards and practices are evolving in the e-commerce industry. Accordingly, we redesign and enhance various functions on our sites on a regular basis, and we may experience instability and performance issues as a result of these changes.

 

Any slowdown or failure of our sites and the underlying technology infrastructure could harm our business, reputation and our ability to acquire, retain and serve our customers, which could materially adversely affect our results of operations. Our disaster recovery plan may be inadequate, and our business interruption insurance may not be sufficient to compensate us for the losses that could occur.

 

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Our business is highly competitive. Competition presents an ongoing threat to the success of our business.

 

Our business is rapidly evolving and intensely competitive, and we have many competitors in different industries. Our competition includes: furniture stores, big box retailers, department stores, specialty retailers, and online home goods retailers and marketplaces, including:

 

·                  Furniture Stores:  Ashley Furniture, Bob’s Discount Furniture, Havertys, Raymour & Flanagan and Rooms To Go;

 

·                  Big Box Retailers:  Bed, Bath & Beyond, Home Depot, IKEA, Lowe’s, Target and Walmart;

 

·                  Department Stores:  JCPenney and Macy’s;

 

·                  Specialty Retailers:  Crate and Barrel, Ethan Allen, HomeGoods, Pottery Barn and Restoration Hardware; and

 

·                  Online Home Goods Retailers and Online Marketplaces:  Amazon, eBay and One Kings Lane.

 

We expect competition in e-commerce generally to continue to increase. We believe that our ability to compete successfully depends upon many factors both within and beyond our control, including:

 

·                  the size and composition of our customer base;

 

·                  the number of suppliers and products we feature on our sites;

 

·                  our selling and marketing efforts;

 

·                  the quality, price and reliability of products offered either by us;

 

·                  the convenience of the shopping experience that we provide;

 

·                  our ability to distribute our products and manage our operations; and

 

·                  our reputation and brand strength.

 

Many of our current competitors have, and potential competitors may have, longer operating histories, greater brand recognition, larger fulfillment infrastructures, greater technical capabilities, faster and less costly 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 revenue and profits from their existing customer base, acquire customers at lower costs 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 revenue from their customer bases more effectively than we do.

 

Purchasers of home goods may not choose to shop online, which would prevent us from growing our business.

 

The online market for home goods in the United States is less developed than the online market for apparel, consumer electronics and other consumer products in the United States and, we believe, only accounts for approximately 7% of the market as a whole. If the online market for home goods does not gain acceptance, our business may suffer. Our success will depend, in part, on our ability to attract consumers who have historically purchased home goods through traditional retailers. Furthermore, we may have to incur significantly higher and more sustained advertising and promotional expenditures in order to attract additional online consumers to our sites and convert them into purchasing customers. Specific factors that could impact consumers’ willingness to purchase home goods from us include:

 

·                  concerns about buying products, and in particular larger products, without a physical storefront, face-to-face interaction with sales personnel and the ability to physically examine products;

 

·                  delivery time associated with online orders;

 

·                  actual or perceived lack of security of online transactions and concerns regarding the privacy of personal information;

 

·                  delayed shipments or shipments of incorrect or damaged products;

 

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·                  inconvenience associated with returning or exchanging items purchased online; and

 

·                  usability, functionality and features of our sites.

 

If the shopping experience we provide does not appeal to consumers or meet the expectations of existing customers, we may not acquire new customers at rates consistent with historical periods, and existing customers’ buying patterns and levels may be less than historical rates.

 

We may be subject to product liability claims if people or property are harmed by the products we sell.

 

Some of the products we sell or have manufactured for us may expose us to product liability claims and litigation or regulatory action relating to personal injury, death or environmental or property damage. Some of our agreements with our suppliers and international manufacturers may not indemnify us from product liability for a particular supplier’s or international manufacturer’s products, or our suppliers or international manufacturers may not have sufficient resources or insurance to satisfy their indemnity and defense obligations. 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.

 

Risks associated with the suppliers from whom our products are sourced could materially adversely affect our financial performance as well as our reputation and brand.

 

We depend on our ability to provide our customers with a wide range of products from qualified suppliers in a timely and efficient manner. Political and economic instability, the financial stability of suppliers, suppliers’ ability to meet our standards, labor problems experienced by suppliers, the availability of raw materials, merchandise quality issues, currency exchange rates, transport availability and cost, transport security, inflation, and other factors relating to the suppliers are beyond our control.

 

Our agreements with most of our suppliers do not provide for the long-term availability of merchandise or the continuation of particular pricing practices, nor do they restrict such suppliers from selling products to other buyers. There can be no assurance that our current suppliers will continue to seek to sell us products on current terms or that we will be able to establish new or otherwise extend current supply relationships to ensure product acquisitions in a timely and efficient manner and on acceptable commercial terms. Our ability to develop and maintain relationships with reputable suppliers and offer high quality merchandise to our customers is critical to our success. If we are unable to develop and maintain relationships with suppliers that would allow us to offer a sufficient amount and variety of quality merchandise on acceptable commercial terms, our ability to satisfy our customers’ needs, and therefore our long-term growth prospects, would be materially adversely affected.

 

We also are unable to predict whether any of the countries in which our suppliers’ products are currently manufactured or may be manufactured in the future will be subject to trade restrictions imposed by the U.S. or foreign governments or the likelihood, type or effect of any such restrictions. Any event causing a disruption or delay of imports from suppliers with international manufacturing operations, including the imposition of additional import restrictions, restrictions on the transfer of funds or increased tariffs or quotas, could increase the cost or reduce the supply of merchandise available to our customers and materially adversely affect our financial performance as well as our reputation and brand. Furthermore, some or all of our suppliers’ foreign operations may be adversely affected by political and financial instability, resulting in the disruption of trade from exporting countries, restrictions on the transfer of funds or other trade disruptions.

 

In addition, our business with foreign suppliers, particularly with respect to our international sites, may be affected by changes in the value of the U.S. dollar relative to other foreign currencies. For example, any movement by any other foreign currency against the U.S. dollar may result in higher costs to us for those goods. Declines in foreign currencies and currency exchange rates might negatively affect the profitability and business prospects of one or more of our foreign suppliers. This, in turn, might cause such foreign suppliers to demand higher prices for merchandise in their effort to offset any lost profits associated with any currency devaluation, delay merchandise shipments, or discontinue selling to us altogether, any of which could ultimately reduce our sales or increase our costs.

 

We may be unable to source additional or strengthen our relationships with suppliers.

 

As of September 30, 2014, we had relationships with over 7,000 suppliers. Our agreements with suppliers are generally terminable at will by either party upon short notice. If we do not maintain our existing relationships or build new relationships with suppliers on acceptable commercial terms, we may not be able to maintain a broad selection of merchandise, and our business and prospects would suffer severely.

 

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In order to attract quality suppliers to our platform, we must:

 

·                  demonstrate our ability to help our suppliers increase their sales;

 

·                  offer suppliers a high quality, cost-effective fulfillment process; and

 

·                  continue to provide suppliers a dynamic and real-time view of our demand and inventory needs via powerful data and analytics capabilities.

 

If we are unable to provide our suppliers with a compelling return on investment and an ability to increase their sales, we may be unable to maintain and/or expand our supplier network, which would negatively impact our business.

 

We depend on our suppliers to perform certain services regarding the products that we offer.

 

As part of offering our suppliers’ products for sale on our sites, these suppliers generally agree to conduct a number of traditional retail operations with respect to their respective products, including maintaining inventory and preparing merchandise for shipment to our customers. We may be unable to ensure that these suppliers will continue to perform these services to our or our customers’ satisfaction in a manner that provides our customer with a unified brand experience or on commercially reasonable terms. If our customers become dissatisfied with the services provided by our suppliers, our business, reputation and brands could suffer.

 

We depend on our relationships with other third parties, including our retail partners, and changes in our relationships with these parties could adversely impact our revenue and profits.

 

In the nine months ended September 30, 2014 and 2013, approximately 17% and 27.5%, respectively, of our net revenue was generated from other operations, consisting primarily of revenue generated online by third parties, which we refer to as our retail partners. Our relationships with our retail partners allow consumers to purchase products offered by us though their websites and mobile applications. Because our agreements with our retail partners are generally terminable at will, we may be unable to maintain these relationships, and our results of operations could fluctuate significantly from period to period depending on the performance of our retail partners and their willingness to continue to offer and/or promote our products. Our agreements with our retail partners may also restrict our ability to market certain products, and not all of our suppliers may permit us to market through all of our retail partners’ sites. Because some of our retail partners are competitors or potential competitors in the home goods market, some or all of our retail partners may in the future determine they no longer wish to do business with us or may decide to take other actions that could harm our business. We may also determine that we no longer want to do business with them. Because we do business with a small number of retail partners, if any one of our contracts with our retailer partners were to terminate, our revenue from our retail partners may decline and our relationships with our suppliers may be adversely affected.

 

Because we rely on FedEx, UPS and the U.S. Postal Service to deliver most of the small parcel products we offer on our sites, we are subject to shipping delays or disruptions caused by inclement weather, natural disasters, labor activism, health epidemics or bioterrorism. In addition, because we rely on national and regional major transportation companies for the delivery of some of our other products, we are also subject to risks of breakage or other damage during delivery by any of these third parties. We also use and rely on other services from third parties, such as our telecommunications services, and those services may be subject to outages and interruptions that are not within our control. For example, failures by our telecommunications providers have in the past and may in the future interrupt our ability to provide phone support to our customers. If these products are not delivered in a timely fashion or are damaged during the delivery process, or if we are not able to provide adequate customer support, our customers could become dissatisfied and cease buying products through our sites, which would adversely affect our operating results.

 

If our internal control over financial reporting or our disclosure controls and procedures are not effective, we may not be able to accurately report our financial results, prevent fraud or file our periodic reports in a timely manner, which may cause investors to lose confidence in our reported financial information and may lead to a decline in our stock price.

 

We were a private company for 12 years prior to our initial public offering in October 2014 and, as such, have not historically had the internal control and financial reporting requirements that are required of a publicly-traded company. We are required to comply with the requirements of The Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, following the later of the date we are deemed to be an “accelerated filer” or a “large accelerated filer,” each as defined in the Securities Exchange Act of 1934, as amended, or the Exchange Act, or the date we are no longer an “emerging growth company,” as defined in the JOBS Act, which could be as early as 2015. The Sarbanes-Oxley Act requires that we maintain effective internal control over financial reporting and disclosure controls and procedures. In particular, we must perform system and process evaluation, document our controls and perform testing of our key control over financial reporting to allow management and our

 

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independent public accounting firm to report on the effectiveness of our internal control over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act. Our testing, or the subsequent testing by our independent public accounting firm, may reveal deficiencies in our internal control over financial reporting that are deemed to be material weaknesses. If we are not able to comply with the requirements of Section 404 in a timely manner, or if we or our accounting firm identify deficiencies in our internal control over financial reporting that are deemed to be material weaknesses, the market price of our stock would likely decline and we could be subject to lawsuits, sanctions or investigations by regulatory authorities, which would require additional financial and management resources.

 

We continue to invest in more robust technology and in more resources in order to manage those reporting requirements. Implementing any appropriate changes to our internal controls may distract our officers and employees, result in substantial costs if we implement new processes or modify our existing processes and require significant time to complete. For example, we plan to transition from our current accounting system to a new reporting system that is expected to integrate better with our other existing systems. Any difficulties or delays in implementing the system could impact our ability to timely report our financial results. In addition, we currently rely on a manual process in some areas which increases our exposure to human error or intervention in reporting our financial results. For these reasons, we may encounter difficulties in the timely and accurate reporting of our financial results, which would impact our ability to provide our investors with information in a timely manner. As a result, our investors could lose confidence in our reported financial information, and our stock price could decline.

 

In addition, any such changes do not guarantee that we will be effective in maintaining the adequacy of our internal controls, and any failure to maintain that adequacy could prevent us from accurately reporting our financial results.

 

We may be unable to