10-Q 1 a2017-09x30form10xq.htm 10-Q Document

 
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, 2017
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 Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes x   No o
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, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act. 
Large accelerated filer x
 
Accelerated filer o
Non-accelerated filer o
(Do not check if a smaller reporting company)
 
Smaller reporting company o
Emerging growth company o
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 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
Class
 
Outstanding at October 26, 2017
Class A Common Stock, $0.001 par value per share 
 
56,541,838
Class B Common Stock, $0.001 par value per share
 
31,289,628
 



WAYFAIR INC.
INDEX TO QUARTERLY REPORT ON FORM 10-Q
For the Quarterly Period Ended September 30, 2017
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

1


PART I
 
FINANCIAL INFORMATION


SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). 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.
Forward-looking statements are based on current expectations of future events. We cannot guarantee that any forward-looking statement will be accurate, although we believe that we have been reasonable in our expectations and assumptions. Investors should realize that if underlying assumptions prove inaccurate or that known or unknown risks or uncertainties materialize, actual results could vary materially from the Company’s expectations and projections. Investors are therefore cautioned not to place undue reliance on any forward-looking statements. These forward-looking statements speak only as of the date of this Quarterly Report on Form 10-Q and, 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.
Factors that could cause or contribute to differences in our future results include, without limitation, the following:
our ability to acquire new customers and sustain and/or manage our growth;
our ability to increase our net revenue per active customer;
our ability to build and maintain strong brands;
our international growth and expansion;
our ability to compete successfully;
the rate of growth of the Internet and e-commerce;
economic factors, such as interest rates, currency exchange fluctuations and changes in customer spending;
world events, natural disasters, public health emergencies, civil disturbances, and terrorist attacks; and
developments in, and the outcome of, legal and regulatory proceedings and investigations to which we are a party or are subject, and the liabilities, obligations and expenses, if any, that we may incur in connection therewith.
A further list and description of risks, uncertainties and other factors that could cause or contribute to differences in our future results include the cautionary statements herein and in our other filings with the Securities and Exchange Commission, including those set forth under Part II, Item 1A, Risk Factors of this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the fiscal year ended December 31, 2016. We qualify all of our forward-looking statements by these cautionary statements.


2


WAYFAIR INC.
CONSOLIDATED AND CONDENSED BALANCE SHEETS
(In thousands, except share and per share data)
(Unaudited)
 


September 30,
2017

December 31,
2016
Assets

 


 

Current assets

 

 
 

Cash and cash equivalents

$
553,721

 
$
279,840

Short-term investments

56,699

 
68,743

Accounts receivable, net of allowance of $4,507 and $3,115 at September 30, 2017 and December 31, 2016, respectively

27,521

 
19,113

Inventories

18,613

 
18,550

Prepaid expenses and other current assets

120,041

 
90,845

Total current assets

776,595

 
477,091

Property and equipment, net

318,873

 
239,354

Goodwill and intangible assets, net

3,386

 
4,230

Long-term investments

29,809

 
30,967

Other noncurrent assets

9,477

 
10,041

Total assets

$
1,138,140

 
$
761,683

Liabilities and Stockholders' Equity

 
 
 
Current liabilities

 
 
 
Accounts payable

$
381,661

 
$
379,493

Accrued expenses

121,218

 
67,807

Deferred revenue

86,219

 
65,892

Other current liabilities

61,151

 
44,028

Total current liabilities

650,249

 
557,220

Lease financing obligation
 
82,725

 
28,900

Long-term debt

327,950



Other liabilities

74,187

 
96,179

Total liabilities

1,135,111

 
682,299

Commitments and contingencies (Note 6)



 


Convertible preferred stock, $0.001 par value per share: 10,000,000 shares authorized and none issued at September 30, 2017 and December 31, 2016


 

Stockholders’ equity:



 
 

Class A common stock, par value $0.001 per share, 500,000,000 shares authorized, 56,355,606 and 49,945,202 shares issued and outstanding at September 30, 2017 and December 31, 2016, respectively

56

 
50

Class B common stock, par value $0.001 per share, 164,000,000 shares authorized, 31,290,483 and 35,885,692 shares issued and outstanding at September 30, 2017 and December 31, 2016, respectively

31

 
36

Additional paid-in capital

515,380

 
409,225

Accumulated deficit

(510,495
)
 
(329,940
)
Accumulated other comprehensive (loss) gain

(1,943
)
 
13

Total stockholders’ equity

3,029

 
79,384

Total liabilities and stockholders’ equity

$
1,138,140

 
$
761,683

 
The accompanying notes are an integral part of these Unaudited Consolidated and Condensed Financial Statements.


3


WAYFAIR INC.
CONSOLIDATED AND CONDENSED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
 
 
 
Three months ended September 30,
 
Nine months ended September 30,
 
 
2017
 
2016
 
2017
 
2016
Net revenue
 
$
1,198,198

 
$
861,525

 
$
3,281,879


$
2,395,801

Cost of goods sold
 
917,889

 
659,864

 
2,495,221

 
1,826,570

Gross profit
 
280,309

 
201,661

 
786,658

 
569,231

Operating expenses:
 
 

 
 

 
 

 
 

Customer service and merchant fees
 
42,949

 
33,872

 
117,132

 
91,286

Advertising
 
141,714

 
101,333

 
384,220

 
293,436

Merchandising, marketing and sales
 
56,934

 
48,550

 
160,033

 
129,679

Operations, technology, general and administrative
 
112,669

 
79,526

 
292,988

 
207,289

Total operating expenses
 
354,266

 
263,281

 
954,373

 
721,690

Loss from operations
 
(73,957
)
 
(61,620
)
 
(167,715
)
 
(152,459
)
Interest (expense) income, net
 
(2,008
)
 
(292
)
 
(3,857
)
 
791

Other (expense) income, net
 
(227
)
 
889

 
400

 
1,804

Loss before income taxes
 
(76,192
)
 
(61,023
)
 
(171,172
)
 
(149,864
)
Provision for (benefit from) income taxes
 
237

 
(83
)
 
671

 
555

Net loss
 
$
(76,429
)
 
$
(60,940
)
 
$
(171,843
)
 
$
(150,419
)
Net loss per share, basic and diluted
 
$
(0.88
)

$
(0.72
)

$
(1.98
)

$
(1.77
)
Weighted average number of common stock outstanding used in computing per share amounts, basic and diluted
 
87,283

 
85,105

 
86,679

 
84,779

 
The accompanying notes are an integral part of these Unaudited Consolidated and Condensed Financial Statements.


4


WAYFAIR INC.
CONSOLIDATED AND CONDENSED STATEMENTS OF COMPREHENSIVE LOSS
(In thousands)
(Unaudited)
 
 
 
Three months ended September 30,
 
Nine months ended September 30,
 
 
2017
 
2016
 
2017
 
2016
Net loss
 
$
(76,429
)
 
$
(60,940
)
 
$
(171,843
)
 
$
(150,419
)
Other comprehensive loss:
 
 
 
 
 
 
 
 
Foreign currency translation adjustments
 
(856
)
 
(240
)
 
(1,959
)
 
(875
)
Net unrealized (loss) gain on available-for-sale investments
 
(40
)
 
(163
)
 
3

 
465

Comprehensive loss
 
$
(77,325
)
 
$
(61,343
)
 
$
(173,799
)
 
$
(150,829
)
 
The accompanying notes are an integral part of these Unaudited Consolidated and Condensed Financial Statements.


5


WAYFAIR INC.
CONSOLIDATED AND CONDENSED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited) 
 
 
Nine months ended September 30,
 
 
2017
 
2016
Cash flows from operating activities
 
 

 
 

Net loss
 
$
(171,843
)
 
$
(150,419
)
Adjustments to reconcile net loss to net cash used in operating activities
 
 
 
 
Depreciation and amortization
 
62,588

 
38,528

Equity based compensation
 
46,740

 
35,188

Amortization of discount and issuance costs on convertible notes
 
874

 

Other non-cash adjustments
 
913

 
(134
)
Changes in operating assets and liabilities:
 
 
 
 
Accounts receivable
 
(8,697
)
 
(6,773
)
Inventories
 
(38
)
 
716

Prepaid expenses and other current assets
 
(27,776
)
 
(12,493
)
Accounts payable and accrued expenses
 
44,692

 
53,443

Deferred revenue and other liabilities
 
50,450

 
33,556

Other assets
 
(1,148
)
 
(2,292
)
Net cash used in operating activities
 
(3,245
)
 
(10,680
)
 
 
 
 
 
Cash flows from investing activities
 
 
 
 

Purchase of short-term and long-term investments
 
(47,639
)
 
(76,458
)
Sale and maturities of short-term investments
 
60,540

 
82,060

Purchase of property and equipment
 
(76,528
)
 
(81,844
)
Site and software development costs
 
(34,885
)
 
(21,444
)
Cash received from the sale of a business, net of cash sold
 

 
1,508

Other investing activities, net
 

 
(1,000
)
Net cash used in investing activities
 
(98,512
)
 
(97,178
)
 
 
 
 
 
Cash flows from financing activities
 
 
 
 

Proceeds from issuance of convertible notes, net of issuance costs
 
420,449

 

Premiums paid for capped call confirmations
 
(44,160
)
 

Taxes paid related to net share settlement of equity awards
 
(1,277
)
 
(18,426
)
Net proceeds from exercise of stock options
 
213

 
166

Net cash provided by (used in) financing activities
 
375,225

 
(18,260
)
Effect of exchange rate changes on cash and cash equivalents
 
413

 
286

Net increase (decrease) in cash and cash equivalents
 
273,881

 
(125,832
)
 
 
 
 
 
Cash and cash equivalents
 
 

 
 

Beginning of period
 
279,840

 
334,176

End of period
 
$
553,721

 
$
208,344

 
 
 
 
 
Supplemental disclosure of non-cash investing activities
 
 

 
 

Purchase of property and equipment included in accounts payable and accrued expenses and in other liabilities
 
$
9,255

 
$
5,744

Construction costs capitalized under finance lease obligation and other leases
 
$
16,153

 
$
29,726

 
The accompanying notes are an integral part of these Unaudited Consolidated and Condensed Financial Statements.

6


Notes to Consolidated and Condensed Financial Statements
(Unaudited)
 
1. Basis of Presentation
Wayfair Inc. (the “Company”) is one of the world's largest online destinations for the home. Through its e-commerce business model, the Company offers visually inspired browsing, compelling merchandising, easy product discovery and attractive prices for over eight million products from approximately 10,000 suppliers.
The consolidated and condensed financial statements and other disclosures contained in this Quarterly Report on Form 10-Q are those of the Company. The consolidated and condensed balance sheet data as of December 31, 2016 was derived from audited financial statements. The accompanying consolidated and condensed balance sheet as of September 30, 2017, the consolidated and condensed statements of operations, consolidated and condensed statements of comprehensive loss, and consolidated and condensed statements of cash flows for the periods ended September 30, 2017 and 2016 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, 2017 and statements of operations, comprehensive loss, and cash flows for the periods ended September 30, 2017 and 2016. The financial data and the other information disclosed in these notes to the consolidated and condensed financial statements related to these periods are unaudited.
The consolidated and condensed statements of operations, comprehensive loss, and cash flows for the period ended September 30, 2017 are not necessarily indicative of the results of operations and cash flows that may be expected for the year ending December 31, 2017, or for any other period. 
2. Summary of Significant Accounting Policies
The Company has identified the significant accounting policies that are critical to understanding its business and results of operations. The Company believes that there have been no significant changes during the nine months ended September 30, 2017 to the items disclosed in Note 2, Summary of Significant Accounting Policies, included in Part II, Item 8, Financial Statements and Supplementary Data, of the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.
3. Marketable Securities and Fair Value Measurements
Marketable Securities
As of September 30, 2017 and December 31, 2016, all of the Company’s marketable securities were classified as available-for-sale and their estimated fair values were $86.5 million and $99.7 million, respectively. The Company periodically reviews its available-for-sale securities for other-than-temporary impairment. The Company considers factors such as the duration, severity and the reason for the decline in value, the potential recovery period, and its intent to sell. As of September 30, 2017, the Company’s available-for-sale securities primarily consisted of corporate bonds and other government obligations that are priced at fair value. During the three and nine months ended September 30, 2017 and 2016, the Company did not recognize any other-than-temporary impairment losses. The maturities of the Company’s long-term marketable securities generally range from one to three years. The cost basis of a marketable security sold is determined by the Company using the specific identification method. During the three and nine months ended September 30, 2017 and 2016, we did not have any realized gains or losses.
 The following tables present details of the Company’s marketable securities as of September 30, 2017 and December 31, 2016 (in thousands):
 
 
September 30, 2017
 
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
Short-term:
 
 

 
 

 
 

 
 

Investment securities
 
$
56,719

 
$
12

 
$
(32
)
 
$
56,699

Long-term:
 
 
 
 
 
 
 


Investment securities
 
29,837

 
22

 
(50
)
 
29,809

Total
 
$
86,556

 
$
34

 
$
(82
)
 
$
86,508


7


 
 
December 31, 2016
 
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
Short-term:
 
 

 
 

 
 

 
 

Investment securities
 
$
63,135

 
$
7

 
$
(39
)
 
$
63,103

Commercial paper
 
5,641

 
1

 
(2
)
 
5,640

Long-term:
 
 
 
 
 
 
 
 
Investment securities
 
30,985

 
16

 
(34
)
 
30,967

Total
 
$
99,761

 
$
24

 
$
(75
)
 
$
99,710

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
This hierarchy requires the Company to use observable market data, when available, and to minimize the use of unobservable inputs when determining fair value. The Company measures its cash equivalents and short-term and long-term investments at fair value. The Company classifies its cash equivalents and restricted cash within Level 1 because the Company values these investments using quoted market prices. The fair value of the Company's Level 1 financial assets is based on quoted market prices of the identical underlying security. The Company classifies short-term and long-term investments within Level 2 because unadjusted quoted prices for identical or similar assets in markets are not active. The Company does not have any assets or liabilities classified as Level 3 financial assets.  
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, 2017 and December 31, 2016 based on the three-tier value hierarchy (in thousands):
 
 
September 30, 2017
 
 
Level 1
 
Level 2
 
Level 3
 
Total
Cash equivalents:
 
 

 
 

 
 

 
 

Money market funds and other funds
 
$
512,929

 
$

 
$

 
$
512,929

Short-term investments:
 
 
 
 
 
 
 


Investment securities
 

 
56,699

 

 
56,699

Restricted cash:
 
 
 
 
 
 
 
 
Certificate of deposit
 
5,000

 

 

 
5,000

Long-term:
 
 
 
 
 
 
 


Investment securities
 

 
29,809

 

 
29,809

Total
 
$
517,929

 
$
86,508

 
$

 
$
604,437


8


 
 
December 31, 2016
 
 
Level 1
 
Level 2
 
Level 3
 
Total
Cash equivalents:
 
 

 
 

 
 

 
 

Money market funds
 
$
200,867

 
$

 
$

 
$
200,867

Short-term investments:
 
 

 
 

 
 

 


Investment securities
 

 
63,103

 

 
63,103

Commercial paper
 

 
5,640

 

 
5,640

Restricted cash:
 
 
 
 
 
 
 
 
Certificate of deposit
 
5,000

 

 

 
5,000

Long-term:
 
 

 
 

 
 

 


Investment securities
 

 
30,967

 

 
30,967

Total
 
$
205,867

 
$
99,710

 
$

 
$
305,577

4. Intangible Assets and Goodwill
The following table summarizes intangible assets as of September 30, 2017 and December 31, 2016 (in thousands):
 
 
Weighted - Average Amortization
Period (Years)
 
September 30, 2017
 
 
 
Gross Carrying
Amount
 
Accumulated
Amortization
 
Net Book Value
Trademarks
 
5
 
$
1,900

 
$
(1,583
)
 
$
317

Technology
 
3
 
1,453

 
(525
)
 
928

Customer relationships
 
5
 
1,300

 
(1,083
)
 
217

Total
 
 
 
$
4,653

 
$
(3,191
)
 
$
1,462

 
 
Weighted - Average Amortization
Period (Years)
 
December 31, 2016
 
 
 
Gross Carrying
Amount
 
Accumulated
Amortization
 
Net Book Value
Trademarks
 
5
 
$
1,900

 
$
(1,298
)
 
$
602

Technology
 
3
 
1,453

 
(161
)
 
1,292

Customer relationship
 
5
 
1,300

 
(888
)
 
412

Total
 
 
 
$
4,653

 
$
(2,347
)
 
$
2,306

Amortization expense related to intangible assets was $0.3 million and $0.2 million for the three months ended September 30, 2017 and 2016, respectively, and $0.8 million and $0.6 million for the nine months ended September 30, 2017 and 2016, respectively.
Goodwill as of September 30, 2017 was $1.9 million, unchanged from December 31, 2016.

9


5. Property and Equipment, net
The following table summarizes property and equipment, net as of September 30, 2017 and December 31, 2016 (in thousands): 
 
 
September 30,
2017
 
December 31,
2016
Furniture and computer equipment
 
$
198,903

 
$
133,297

Site and software development costs
 
108,456

 
77,429

Leasehold improvements
 
80,512

 
62,090

Construction in progress
 
10,416

 
47,013

Buildings (leased - Note 6)
 
83,681

 
29,856

 
 
481,968

 
349,685

Less accumulated depreciation and amortization
 
(163,095
)
 
(110,331
)
Property and equipment, net
 
$
318,873

 
$
239,354

Property and equipment depreciation and amortization expense was $22.6 million and $15.2 million for the three months ended September 30, 2017 and 2016, respectively, and $61.7 million and $37.9 million for the nine months ended September 30, 2017 and 2016, respectively. 
6. Commitments and Contingencies
Leases
The Company leases office and warehouse spaces under non-cancelable leases. These leases expire at various dates through 2029 and include discounted rental periods and fixed escalation clauses, which are amortized straight-line over the terms of the lease. Rent expense under operating leases was $10.6 million and $9.1 million in the three months ended September 30, 2017 and 2016, respectively, and $33.3 million and $23.9 million in the nine months ended September 30, 2017 and 2016, respectively. The Company has issued letters of credit for approximately $13.8 million and $10.6 million as security for these lease agreements as of September 30, 2017 and December 31, 2016, respectively.
As of December 31, 2016, the future minimum rental commitments under non-cancelable leases with initial or remaining terms in excess of one year totaled $568.7 million. Subsequent to December 31, 2016, the Company entered into additional non-cancelable leases in the United States ("U.S.") with initial or remaining terms in excess of one year with total future minimum lease commitments of $231.0 million. Future lease payments have not been reduced by minimum sublease rentals of $9.4 million due to the Company in the future under non-cancelable subleases through 2020.
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 takes 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 recognition under the sale-leaseback accounting guidance. If the Company continues to be the deemed owner, the facilities are accounted for as financing leases.
The construction of one warehouse lease arrangement was completed during the three months ended June 30, 2016, and because the Company concluded it had a letter of credit of $1.2 million, the Company did not meet the sale-leaseback criteria for derecognition of the building asset and liability. The construction of a second warehouse lease arrangement was completed in the three months ended March 31, 2017, and because the Company concluded it had a letter of credit of $0.8 million, the Company did not meet the sale-leaseback criteria for derecognition of the building asset and liability. The construction of a third warehouse lease arrangement was completed in the three months ended June 30, 2017, and because the Company concluded it had a letter of credit of $1.0 million, the Company did not meet the sale-leaseback criteria for derecognition of the building asset and liability. Accordingly, these leases were accounted for as financing obligations and $28.9 million, $12.6 million, and $41.2 million was recorded in "Lease financing obligation" in the Company’s unaudited consolidated and condensed balance sheets as of June 30, 2016, March 31, 2017, and June 30, 2017, respectively. The monthly rent payments made to the lessor under the lease agreement are recorded in the Company’s financial statements as land lease expense and principal and interest on the financing obligation. Interest expense on the lease financing obligation reflects the portion of the Company's monthly lease payments that is allocated to interest expense. For the three and nine months ended September 30, 2017, land lease expense was $0.2 million and $0.7 million, respectively, and interest expense on lease financing obligations was $2.0 million and $4.9 million, respectively. As of September 30, 2017, future minimum commitments related to the financing obligations were $6.7 million and $39.0 million for principal and interest, respectively, through September 30, 2022.

10


 Collection of Sales or Other Similar Taxes
In the U.S., Supreme Court decisions restrict states' rights to require remote sellers to collect state and local sales taxes (although some states are seeking to have the Supreme Court revisit these decisions). States have, and may again in the future, issued assessments and presented legal claims alleging that the Company is required to collect and remit sales or other similar taxes. The Company does not believe that it is obligated to collect and remit such taxes, and intends to vigorously defend its position. At this time, the Company believes any losses that may arise from these assessments and claims would be immaterial; however, no assurance can be given as to the outcomes and the Company could be subject to significant additional tax liabilities.
Legal Matters
In September 2016, a putative class action complaint was filed against the Company in the Superior Court of the province of Quebec (Naomi Zouzout v. Wayfair LLC, Case No. PQ 500-06-000809-166) by an individual on behalf of herself and on behalf of all other similarly situated individuals alleging violations of various Canadian consumer protection statutes. Among other remedies, this lawsuit seeks compensatory and punitive money damages, costs, and various fees. In June 2017, the Company entered into a settlement of the litigation, subject to judicial approval. The parties presented the settlement for review and approval by the court in September 2017. This settlement is not expected to have a material adverse effect on the Company's results of operation or financial condition.
From time to time the Company is involved in claims that arise during the ordinary course of business. Although the results of litigation and claims cannot be predicted with certainty, the Company does not currently believe that the outcome of any of these other legal matters will have a material adverse effect on the Company's results of operation or financial condition. Regardless of the outcome, litigation can be costly and time consuming, as it can divert management's attention from important business matters and initiatives, negatively impacting the Company's overall operations. In addition, the Company may also find itself at greater risk to outside party claims as it increases its operations in jurisdictions where the laws with respect to the potential liability of online retailers are uncertain, unfavorable, or unclear.
7. Equity-Based Compensation
The board of directors of the Company (the "Board") adopted the 2014 Incentive Award Plan ("2014 Plan") to grant cash and equity incentive awards to eligible participants in order to attract, motivate and retain talent. The 2014 Plan is administered by the Board with respect to awards to non-employee directors and by the compensation committee of the Board with respect to other participants and provides for the issuance of stock options, SARs, restricted stock, restricted stock units ("RSUs"), performance shares, stock payments, cash payments, dividend awards and other incentives. Prior to the adoption of the 2014 Plan, Wayfair LLC issued certain equity awards pursuant to the Wayfair LLC Amended and Restated Common Unit Plan (the “2010 Plan”), which was administered by the board of directors of Wayfair LLC. Awards issued under the 2010 Plan that remain outstanding currently represent Class A or Class B common stock of the Company.
8,603,066 shares of Class A common stock were initially available for issuance under awards granted pursuant to the 2014 Plan. The 2014 Plan also contains an evergreen provision whereby the shares available for future grant are increased on the first day of each calendar year beginning January 1, 2016 and ending on and including January 1, 2024. As of January 1, 2017, 8,389,750 shares of Class A common stock were available for future grant under the 2014 Plan. Shares or RSUs forfeited, withheld for minimum statutory tax obligations, and unexercised stock option lapses from the 2010 and 2014 Plans are available for grants of awards under the 2014 Plan. All equity awards granted prior to the initial public offering ("IPO") were subject to two vesting conditions: (i) a service period (typically five years) and (ii) a performance condition (a liquidity event in the form of either a change of control or an IPO, each as defined in the 2010 Plan). Employees were able to retain provisionally vested stock options and shares upon departure. The Company determined that a liquidity event was not probable until the closing of its IPO on October 7, 2014, and as such, no expense was recognized until that date. After the IPO, pre-IPO awards for employees that continued providing service continued to vest over the remaining service period. 2014 Plan awards are expected to vest over the service period.
The Company adopted Financial Accounting Standards Board ("FASB") Accounting Standards Update ("ASU") No. 2016-09, "Compensation - Stock Compensation" ("ASU 2016-09") as of January 1, 2017. For additional information, refer to Note 14, Recent Accounting Pronouncements.

11


The following table presents activity relating to stock options for the nine months ended September 30, 2017
 
 
Options
 
Weighted-
Average Exercise
Price
 
Weighted-
Average
Remaining
Contractual
Term (Years)
Outstanding at December 31, 2016
 
209,759

 
$
2.98

 
4.5
Options exercised
 
(72,296
)
 
$
2.92

 
 
Outstanding and exercisable at September 30, 2017
 
137,463

 
$
3.01

 
3.7
Intrinsic value of stock options exercised was $4.1 million for the nine months ended September 30, 2017. Aggregate intrinsic value of stock options outstanding and currently exercisable is $8.9 million. All stock options were fully vested at September 30, 2017.
The following table presents activity relating to restricted common stock for the nine months ended September 30, 2017
 
 
Shares
 
Weighted-
Average Fair Value
Outstanding at December 31, 2016
 
60,000

 
$
35.05

Unvested at September 30, 2017
 
60,000

 
$
67.40

Aggregate intrinsic value of restricted common stock unvested is $4.0 million as of September 30, 2017. Unrecognized equity based compensation expense related to unvested restricted common stock is $2.7 million with a weighted average remaining vesting term of 1.3 years as of September 30, 2017
The following table presents activity relating to RSUs for the nine months ended September 30, 2017
 
 
Shares
 
Weighted-
Average Grant
Date Fair Value
Outstanding at December 31, 2016
 
6,986,776

 
$
34.21

RSUs granted
 
2,271,235

 
$
52.39

RSUs vested
 
(1,766,511
)
 
$
32.30

RSUs forfeited/canceled
 
(1,117,090
)
 
$
37.53

Outstanding at September 30, 2017
 
6,374,410

 
$
41.04

The intrinsic value of RSUs vested was $99.3 million for the nine months ended September 30, 2017. Aggregate intrinsic value of RSUs outstanding is $429.6 million as of September 30, 2017. Unrecognized equity based compensation expense related to outstanding RSUs is $231.5 million with a weighted average remaining vesting term of 1.7 years at September 30, 2017.
8. Segment and Geographic Information
Operating segments are defined as components of an enterprise for which separate financial information is available that is evaluated on a regular basis by the Chief Operating Decision Maker (“CODM”) in deciding how to allocate resources to an individual segment and in assessing performance. The Company’s CODM is its Chief Executive Officer. 
Beginning the fourth quarter of 2016, the Company changed its operating and reportable segments to U.S. and International. These segments reflect the way the CODM allocates resources and evaluates financial performance, which is based upon each segment's Adjusted EBITDA. Adjusted EBITDA is defined as loss before depreciation and amortization, equity-based compensation and related taxes, interest and other income and expense, provision for income taxes, and non-recurring items. These charges are excluded from evaluation of segment performance because it facilitates reportable segment performance comparisons on a period-to-period basis. Refer to Note 2, Summary of Significant Accounting Policies for the accounting policies of segments.
The Company allocates certain operating expenses to the operating and reportable segments, including "Customer service and merchant fees," "Merchandising, marketing and sales," and "Operations, technology, general and administrative" based on the usage and relative contribution provided to the segments. It excludes from the allocations certain operating expense lines,

12


including "Depreciation and amortization, "Equity based compensation and related taxes," "Interest (income), net," "Other (income) expense, net," and "Provision for income taxes." There are no revenue transactions between the Company's reportable segments.
U.S.
The U.S. segment primarily consists of amounts earned through product sales through the Company's sites in the U.S. and through sites operated by third parties in the U.S.
International
The International segment primarily consists of amounts earned through product sales through the Company's international sites.
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. No individual country outside of the U.S. provided greater than 10% of total revenue.
The following tables present Direct Retail and Other net revenues and Adjusted EBITDA attributable to the Company's reportable segments for the periods presented (in thousands):
 
 
Three months ended September 30,
 
Nine months ended September 30,
 
 
2017
 
2016
 
2017
 
2016
U.S. Direct Retail
 
$
1,033,669

 
$
759,674

 
$
2,847,898

 
$
2,134,782

U.S. Other
 
16,975

 
28,127

 
57,843

 
91,613

U.S. segment net revenue
 
1,050,644

 
787,801

 
2,905,741

 
2,226,395

International Direct Retail
 
147,554

 
72,724

 
376,138

 
165,119

International Other
 

 
1,000

 

 
4,287

International segment net revenue
 
147,554

 
73,724

 
376,138

 
169,406

Total net revenue
 
$
1,198,198

 
$
861,525

 
$
3,281,879

 
$
2,395,801

 
 
Three months ended September 30,
 
Nine months ended September 30,
 
 
2017
 
2016
 
2017
 
2016
Adjusted EBITDA
 
 
 
 
 
 
 
 
U.S.
 
$
4,531

 
$
(7,857
)
 
$
28,684

 
$
(11,816
)
International
 
(27,203
)
 
(22,992
)
 
(74,498
)
 
(64,850
)
Total reportable segments Adjusted EBITDA
 
(22,672
)
 
(30,849
)
 
(45,814
)
 
(76,666
)
Less: reconciling items (1)
 
(53,757
)
 
(30,091
)
 
(126,029
)
 
(73,753
)
Net loss
 
$
(76,429
)
 
$
(60,940
)
 
$
(171,843
)
 
$
(150,419
)
(1) Adjustments are made to reconcile total reportable segments Adjusted EBITDA to consolidated net loss including the following (in thousands):
 
 
Three months ended September 30,
 
Nine months ended September 30,
 
 
2017
 
2016
 
2017
 
2016
Depreciation and amortization (1)
 
$
22,913

 
$
15,463

 
$
62,588

 
$
38,528

Equity based compensation and related taxes
 
19,598

 
15,308

 
50,539

 
37,265

Interest expense (income), net
 
2,008

 
292

 
3,857

 
(791
)
Other expense (income), net
 
227

 
(889
)
 
(400
)
 
(1,804
)
Provision for (benefit from) income taxes
 
237

 
(83
)
 
671

 
555

Other (1)
 
8,774

 

 
8,774

 

Total reconciling items
 
$
53,757

 
$
30,091

 
$
126,029

 
$
73,753


13


(1) The Company recorded $9.6 million of one-time charges in the three and nine months ended September 30, 2017 in "Operations, technology, general and administrative" in the unaudited consolidated and condensed statements of operations related to a warehouse the Company vacated in July 2017. Of the $9.6 million charges, $8.8 million was included in "Other" and related primarily to the excess of the Company's estimated future remaining lease commitments through 2023 over its expected sublease income over the same period, and $0.8 million was included in "Depreciation and amortization" related to accelerated depreciation of leasehold improvements in the warehouse.
The following table presents the activity related to the Company’s 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 (in thousands):
 
 
Three months ended September 30,
 
Nine months ended September 30,
 
 
2017
 
2016
 
2017
 
2016
Net revenue
 
 

 
 

 
 

 
 

Direct Retail
 
$
1,181,223

 
$
832,398

 
$
3,224,036

 
$
2,299,901

Other
 
16,975

 
29,127

 
57,843

 
95,900

Net revenue
 
$
1,198,198

 
$
861,525

 
$
3,281,879

 
$
2,395,801

The following table presents long-lived assets by segment (in thousands):
 
 
September 30,
2017
 
December 31,
2016
Geographic long-lived assets
 
 

 
 

U.S.
 
$
311,565

 
$
233,099

International
 
7,308

 
6,255

Total
 
$
318,873

 
$
239,354

9. Income Taxes
Income tax expense (benefit) was $0.2 million and $(0.1) million for the three months ended September 30, 2017 and 2016, respectively, and $0.7 million and $0.6 million for the nine months ended September 30, 2017 and 2016, respectively. The income tax expense recorded in the three and nine months ended September 30, 2017 and 2016 is primarily related to various foreign income tax assessments, state income taxes and to a lesser extent the amortization of goodwill for tax purposes for which there is no corresponding book deduction.
Deferred income taxes reflect the impact of temporary differences between the amounts of assets and liabilities for financial reporting purposes and such amounts as measured by tax laws. The Company has deferred tax assets related to its net operating loss carryforwards accumulated since the fourth quarter of 2014 and related to net operating loss carryforwards of certain of its foreign subsidiaries. A valuation allowance against net deferred tax assets is required if, based upon the available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. The Company reassesses the valuation allowance on a quarterly basis and has provided a valuation allowance for the full amount of its net deferred tax assets.
The Company had no unrecognized tax benefits as of September 30, 2017 and December 31, 2016. The Company’s policy is to recognize interest and penalties related to unrecognized tax benefits as a component of income tax expense. 

14


10. Stockholders’ Equity (Deficit)
Preferred Stock
The Company authorized 10,000,000 shares of undesignated preferred stock, $0.001 par value per share, for future issuance. As of September 30, 2017, the Company had no shares of undesignated preferred stock issued or outstanding.
Common Stock
The Company 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 56,355,606 and 49,945,202 shares of Class A common stock and 31,290,483 and 35,885,692 shares of Class B common stock were outstanding as of September 30, 2017 and December 31, 2016, respectively. 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 and each share of Class B common stock is entitled to ten votes per share. 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 66 2/3% 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. Since the IPO through September 30, 2017, 43,039,105 shares of Class B common stock were converted to Class A common stock. 
11. Credit Agreement
On February 22, 2017, the Company entered into a $40 million credit card program and a credit agreement consisting of a $100 million secured revolving credit facility (the "Revolver") with Citibank, N.A. ("Citibank"). The Citibank credit facility replaced the Company's existing credit facility with Bank of America, N.A. ("Bank of America"), which was terminated on February 22, 2017 as described below. On September 11, 2017, the Citibank credit agreement was amended with a new letter of credit sublimit ($25 million) and to make clarifying edits to the mandatory prepayment provisions of the credit agreement.
The Citibank Revolver has a $25 million letter of credit sublimit and a $10 million swing line sublimit, and a final maturity date of February 21, 2020. Wayfair LLC is the borrower (the "Borrower") under the Citibank credit agreement. Subject to certain conditions, the Borrower has the right to increase the Revolver by $25 million. Borrowings under the Revolver will bear interest through maturity at a variable rate based upon, at the Borrower’s option, either the Eurodollar rate or the base rate (which is the highest of (x) Citibank's prime rate, (y) one-half of 1.00% in excess of the federal funds effective rate, and (z) 1.00% in excess of the one-month Eurodollar rate), plus, in each case an applicable margin. From closing until September 30, 2019, the applicable margin for Eurodollar rate loans is 1.75% per annum and the applicable margin for base rate loans is 0.75% per annum. After September 30, 2019, the applicable margin is subject to specified changes depending on the applicable consolidated leverage ratio. Any amounts outstanding under the Revolver are due at maturity. In addition, subject to the terms and conditions set forth in the credit agreement, the Borrower is required to make certain mandatory prepayments prior to maturity.
The Citibank credit agreement contains affirmative and negative covenants customarily applicable to senior secured credit facilities, including covenants that, among other things, will limit or restrict the ability of the Company and its subsidiaries, subject to negotiated exceptions, to incur additional indebtedness and additional liens on their assets, engage in mergers or acquisitions or dispose of assets, pay dividends or make other distributions, voluntarily prepay other indebtedness, enter into transactions with affiliated persons, make investments, and change the nature of their businesses. In addition, the Citibank credit agreement requires the Company to maintain certain financial ratios. As of September 30, 2017, the Company was in compliance with its covenants under the Revolver.
The Company previously had a credit agreement with Bank of America, which was replaced by the Citibank credit agreement on February 22, 2017. The Bank of America credit agreement provided the Company with a $20.0 million revolving line of credit to support direct borrowings and letters of credit, provided that a maximum of $5.0 million could be applied to direct borrowings under the revolving line of credit, plus an additional $45.0 million credit card program (which the Company continued to utilize on a transitional basis as of September 30, 2017), for a maximum aggregate commitment of $65.0 million. Subject to the terms and conditions of the Bank of America credit agreement, advances under the line of credit, if any, would bear interest at the LIBOR rate, plus 1.75%. The Bank of America credit agreement also required the Company to maintain certain covenants, including debt service coverage, tangible net worth and unencumbered liquid assets.

15


The Company did not borrow any amounts under the Revolver or the Bank of America credit agreement during the nine months ended September 30, 2017 and the year ended December 31, 2016.
12. Convertible Debt
On September 15, 2017, the Company issued $431.25 million aggregate principal amount of 0.375% Convertible Senior Notes due 2022 (the "Notes"), which includes the exercise in full of the $56.25 million over-allotment option, to Citigroup Global Markets Inc. and Goldman Sachs & Co. LLC as the initial purchasers of the Notes (the "Initial Purchasers").
The net proceeds from the sale of the Notes were approximately $420.4 million, after deducting the Initial Purchasers’ discounts and the estimated offering expenses payable by the Company. The Company used approximately $44.2 million of the net proceeds from the offering to pay the cost of the capped call transactions, as further described below, with three financial institutions (the "Option Counterparties"). The Company intends to use the remainder of the net proceeds for working capital and general corporate purposes.
The Notes were issued pursuant to an indenture, dated September 15, 2017 (the "Indenture"), between the Company and U.S. Bank National Association, as trustee. The Company will pay interest on the Notes semiannually in arrears at a rate of 0.375% per annum on March 1 and September 1 of each year commencing on March 1, 2018. The Notes are convertible based upon an initial conversion rate of 9.61 shares of the Company’s Class A common stock per $1,000 principal amount of Notes (equivalent to a conversion price of approximately $104.06 per share of the Company’s Class A common stock). The conversion rate will be subject to adjustment upon the occurrence of certain specified events, including certain distributions and dividends to all or substantially all of the holders of the Company’s Class A common stock, but will not be adjusted for accrued and unpaid interest. The Company will settle any conversions of the Notes in cash, shares of the Company’s Class A common stock or a combination thereof, with the form of consideration determined at the Company’s election.
The Notes will mature on September 1, 2022, unless earlier purchased, redeemed or converted. Prior to June 1, 2022, holders may convert all or a portion of their Notes only under the following circumstances: (1) during any calendar quarter commencing after the calendar quarter ending on December 31, 2017 (and only during such calendar quarter), if the last reported sale price of the Company’s Class A common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on, and including, the last trading day of the immediately preceding calendar quarter is greater than or equal to 130% of the conversion price on each applicable trading day; (2) during the five business day period after any ten consecutive trading day period (the "measurement period") in which the trading price per $1,000 principal amount of Notes for each trading day of the measurement period was less than 98% of the product of the last reported sale price of the Company’s Class A common stock and the conversion rate on each such trading day; (3) with respect to any Notes called for redemption by the Company, at any time prior to the close of business on the second scheduled trading day immediately preceding the redemption date; or (4) upon the occurrence of specified corporate events. On and after June 1, 2022 until the close of business on the second scheduled trading day immediately preceding the maturity date, holders may convert their Notes at any time, regardless of the foregoing circumstances. Holders of Notes who convert their Notes in connection with a make-whole fundamental change or a notice of redemption (each as defined in the Indenture) may be entitled to a premium in the form of an increase in the conversion rate of the Notes.
The Company may not redeem the Notes prior to September 8, 2020. On or after September 8, 2020, the Company may redeem for cash all or part of the Notes if the last reported sale price of the Company’s Class A common stock equals or exceeds 130% of the conversion price then in effect for at least 20 trading days (whether or not consecutive), including at least one of the five trading days immediately preceding the date on which the Company provides notice of redemption, during any 30 consecutive trading days ending on, and including the trading day immediately preceding the date on which the Company provides notice of the redemption. The redemption price will be 100% of the principal amount of the Notes to be redeemed, plus accrued and unpaid interest, if any.
Upon the occurrence of a fundamental change (as defined in the Indenture), holders may require the Company to repurchase all or a portion of their Notes for cash at a price equal to 100% of the principal amount of the Notes to be repurchased plus any accrued but unpaid interest to, but excluding, the fundamental change repurchase date.
The Indenture contains customary terms and covenants, including that upon certain events of default occurring and continuing, either the Trustee or the holders of not less than 25% in aggregate principal amount of the Notes then outstanding may declare the entire principal amount of all the Notes plus accrued interest, if any, to be immediately due and payable.
The Notes are general unsecured obligations of the Company. The Notes rank senior in right of payment to any of the Company’s future indebtedness that is expressly subordinated in right of payment to the Notes; rank equal in right of payment to the Company’s existing and future unsecured indebtedness that is not so subordinated; are effectively subordinated in right of payment to any of the Company’s secured indebtedness to the extent of the value of the assets securing such indebtedness; and are structurally subordinated to all existing and future indebtedness and liabilities of the Company’s subsidiaries.

16


In accounting for the issuance of the Notes, the Company separated the Notes into liability and equity components. The carrying amount of the liability component was calculated by measuring the fair value of a similar liability that does not have an associated convertible feature. The carrying amount of the equity component, representing the conversion option, was determined by deducting the fair value of the liability component from the par value of the Notes. The difference between the principal amount of the Notes and the liability component represents the debt discount, which is recorded as a direct deduction from the related debt liability in the consolidated and condensed balance sheet and amortized to interest expense using the effective interest method over the term of the Notes. The equity component of the Notes of approximately $95.8 million is included in additional paid-in capital in the consolidated and condensed balance sheet and is not remeasured as long as it continues to meet the conditions for equity classification. The Company allocated transaction costs related to the Notes using the same proportions as the proceeds from the Notes. Transaction costs attributable to the liability component were recorded as a direct deduction from the related debt liability in the consolidated and condensed balance sheet and amortized to interest expense over the term of the Notes, and transaction costs attributable to the equity component were netted with the equity component in shareholders’ equity.
Interest expense related to the Notes for the three and nine months ended September 30, 2017 was $0.9 million and $0.9 million, respectively, which is also comprised of the amortization of debt discount and debt issuance costs and the contractual coupon interest. Accrued interest related to the Notes as of September 30, 2017 was $0.9 million and is recorded in "Accrued expenses" in the unaudited consolidated and condensed balance sheet.
The estimated fair value of the Notes was $415.0 million as of September 30, 2017. The estimated fair value of the Notes was determined through consideration of quoted market prices. The fair value is classified as Level 2, as defined in Note 3, Marketable Securities and Fair Value Measurements.
On September 11, 2017, the Company entered into privately negotiated capped call transactions (the "Base Capped Call Transactions") with the Option Counterparties and, in connection with the exercise in full of the over-allotment option by the Initial Purchasers, on September 14, 2017 entered into additional capped call transactions (such additional capped call transactions, the "Additional Capped Call Transactions" and, together with the Base Capped Call Transactions, the "Capped Call Transactions") with the Option Counterparties. The Capped Call Transactions are expected generally to reduce the potential dilution and/or offset the cash payments the Company is required to make in excess of the principal amount of the Notes upon conversion of the Notes in the event that the market price per share of the Company’s Class A common stock is greater than the strike price of the Capped Call Transactions (which initially corresponds to the initial conversion price of the Notes and is subject to certain adjustments under the terms of the Capped Call Transactions), with such reduction and/or offset subject to a cap based on the cap price of the Capped Call Transactions. The Capped Call Transactions have an initial cap price of $154.16 per share of the Company’s Class A common stock, which represents a premium of 100% over the last reported sale price of the Company’s Class A common stock on September 11, 2017, and is subject to certain adjustments under the terms of the Capped Call Transactions. Collectively, the Capped Call Transactions cover, initially, the number of shares of the Company’s Class A common stock underlying the Notes, subject to anti-dilution adjustments substantially similar to those applicable to the Notes.
The Capped Call Transactions are separate transactions, in each case, entered into by the Company with the Option Counterparties, and are not part of the terms of the Notes and will not affect any holder’s rights under the Notes. Holders of the Notes will not have any rights with respect to the Capped Call Transactions. The Capped Call Transactions do not meet the criteria for separate accounting as a derivative as they are indexed to the Company's stock. The premiums paid for the Capped Call Transactions have been included as a net reduction to additional paid-in capital within shareholders’ equity.
13. Net Loss per Share
Basic and diluted net loss per share is presented using the two class method required for participating securities: Class A and Class B common stock. The rights of the holders of Class A and Class B common stock are identical, except with respect to voting and conversion. For more information on the rights of Class A and Class B common stockholders, see Note 10, Stockholders' Equity (Deficit).
Basic net loss per share attributable to common stockholders is computed using the weighted-average number of shares of common stock outstanding during the period. Diluted net loss per share attributable to common stockholders is computed using the weighted-average number of shares of common stock and, if dilutive, common stock equivalents outstanding during the period. The Company's common stock equivalents consist of shares issuable upon the release of restricted stock units and unvested restricted stock, the exercise of stock options and potential shares from instruments convertible into common stock. The dilutive effect of these common stock equivalents is reflected in diluted earnings per share by application of the treasury stock method. The Company's basic and diluted net loss per share are the same because the Company has generated net loss attributable to common stockholders and common stock equivalents are excluded from diluted net loss per share because they have an antidilutive impact.

17


The Company allocates undistributed earnings between the classes on a one-to-one basis when computing net loss per share. As a result, basic and diluted net loss per Class A and Class B shares are equivalent.
The following table presents the calculation of basic and diluted net loss per share (in thousands, except per share data): 
 
 
Three months ended September 30,
 
Nine months ended September 30,
 
 
2017
 
2016
 
2017
 
2016
Net loss
 
$
(76,429
)
 
$
(60,940
)
 
$
(171,843
)
 
$
(150,419
)
Weighted average common shares used for basic and diluted net loss per share computation
 
87,283

 
85,105

 
86,679

 
84,779

Net loss per share:
 
 
 
 
 
 
 
 
Basic and Diluted
 
$
(0.88
)
 
$
(0.72
)
 
$
(1.98
)
 
$
(1.77
)
Dilutive common stock equivalents, representing potentially dilutive common stock options, restricted stock and restricted stock units, of 6.6 million for the three and nine months ended September 30, 2017 and 6.8 million for the three and nine months ended September 30, 2016, were excluded from diluted earnings per share calculations for these periods because of their anti-dilutive effect. For the three and nine month periods ended September 30, 2017, the Company also excluded the potentially dilutive impact to Class A shares from the issuance of the Notes, since their effect would have been anti-dilutive. The Capped Call Transactions are designed to reduce potential dilution of our Class A shares upon conversion of the Notes. For more information on the Notes and the Capped Call Transactions, see Note 12, Convertible Debt.

18


14. Recent Accounting Pronouncements
Stock Compensation
In March 2016, the FASB issued ASU No. 2016-09, "Compensation - Stock Compensation" ("ASU 2016-09"). This ASU revises the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and an option to recognize gross stock compensation expense with actual forfeitures recognized as they occur, as well as certain classifications on the statement of cash flows. This ASU is effective for annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting year, and early adoption is permitted.
The Company adopted ASU 2016-09 as of January 1, 2017 using a modified retrospective approach with the option to recognize gross stock compensation expense with actual forfeitures recognized as they occur, with a cumulative-effect adjustment to retained earnings recognized as of January 1, 2017 of $8.7 million. The adoption of ASU 2016-09 also requires all income tax adjustments to be recorded in the consolidated and condensed statements of operations.
Revenue Recognition
In May 2014, the FASB issued ASU No. 2014-09, "Revenue from Contracts with Customers" ("ASU 2014-09"). This ASU is a comprehensive new revenue recognition model that requires a company to recognize revenue to depict the transfer of goods or services to a customer at an amount that reflects the consideration it expects to receive in exchange for those goods or services. This ASU was originally effective for annual reporting periods beginning after December 15, 2016 and early adoption was not permitted.
In August 2015, the FASB issued ASU No. 2015-14, "Revenue from Contracts with Customers – Deferral of the Effective Date" (ASU-2015-14), which defers the effective date of ASU 2014-09 for one year and permits early adoption as early as the original effective date of ASU 2014-09. Accordingly, ASU 2014-09 is now effective for annual reporting periods beginning after December 15, 2017 and early adoption is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting year.
In March 2016, the FASB issued ASU No. 2016-08, "Revenue from Contracts with Customers - Principal versus Agent Considerations" ("ASU 2016-08"). This ASU clarifies the implementation guidance for principal versus agent considerations in ASU 2014-09. This ASU is effective at the same period as ASU 2015-14 and ASU 2014-09.
Management expects to adopt ASU 2014-09, ASU 2015-14, and ASU 2016-08 (collectively, the "Revenue Recognition Accounting Pronouncements") for annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting year. While management is still in its assessment process, management generally expects to identify substantially similar performance obligations after adoption of the Revenue Recognition Accounting Pronouncements as compared with deliverables and separate units of accounting under previous revenue recognition guidance. Therefore, the Company generally does not expect the impact of the adoption of the Revenue Recognition Accounting Pronouncements to be significant to its consolidated financial statements, processes, or systems. As we continue to evaluate the impact of the Revenue Recognition Accounting Pronouncements, we have identified no material changes to our current revenue recognition accounting policy for product sales generated through the Company's sites, or Direct Retail, which we identified as our most significant revenue stream. Management expects to apply the Revenue Recognition Accounting Pronouncements retrospectively with the cumulative effect of initially applying the Revenue Recognition Accounting Pronouncements recognized at the date of initial application recorded as an adjustment to retained earnings, referred to as the "Modified Retrospective Approach."
Leases
In February 2016, the FASB issued ASU No. 2016-02, "Leases" ("ASU 2016-02"). This ASU revises the accounting related to leases by requiring lessees to recognize a lease liability and a right-of-use asset for all leases. The new lease guidance also simplifies the accounting for sale and leaseback transactions. This ASU is effective for annual reporting periods beginning after December 15, 2018 and early adoption is permitted. Management expects to adopt ASU 2016-02 for annual reporting periods beginning after December 15, 2018. Management is currently evaluating the impact of the adoption of this ASU on the Company’s consolidated financial statements, and expects it will have a material impact on our consolidated financial statements, primarily the consolidated balance sheets and related disclosures.


19


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of our financial condition and results of operations should be read in conjunction with the consolidated and condensed financial statements and the notes thereto included elsewhere in this Quarterly Report on Form 10-Q and our audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2016. This discussion contains forward-looking statements that involve risks and uncertainties. As a result of many factors, such as those included in the Special Note Regarding Forward Looking Statements and in Part II, Item 1A, Risk Factors, of this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the year ended December 31, 2016, our actual results may differ materially from those anticipated in these forward-looking statements.
The following discussion includes financial information prepared in accordance with generally accepted accounting principles ("GAAP"), as well as certain adjusted or non-GAAP financial measures such as Adjusted EBITDA, non-GAAP diluted net loss per share and free cash flow. Generally, a non-GAAP financial measure is a numerical measure of financial performance, financial position or cash flows that excludes (or includes) amounts that are included in (or excluded from) the most directly comparable measure calculated and presented in accordance with GAAP. Management believes the use of these non-GAAP measures on a consolidated and reportable segment basis assists investors in understanding the ongoing operating performance of our business by presenting comparable financial results between periods. For more information on these non-GAAP financial measures, including reconciliations to the most directly comparable GAAP financial measures, see "Non-GAAP Financial Measures" below.
Unless the context requires otherwise, references in this Quarterly Report on Form 10-Q to "Wayfair," "the Company," "we," "us" or "our" refer to Wayfair Inc. and its consolidated subsidiaries. 
Overview
We are one of the world's largest online destinations for the home. Through our e-commerce business model, we offer visually inspired browsing, compelling merchandising, easy product discovery and attractive prices for over eight million products from approximately 10,000 suppliers. Because of the large market opportunity we see in front of us, we are currently investing across our business, including investments to expand our international business, to build our proprietary logistics network and to continue developing various product categories.
Beginning in the fourth quarter of 2016, we changed our operating and reportable segments from one segment to two operating and reportable segments, U.S. and International. The following table presents Direct Retail and Other net revenues attributable to the Company’s reportable segments for the periods presented (in thousands):
 
 
Three months ended September 30,
 
Nine months ended September 30,
 
 
2017
 
2016
 
2017
 
2016
U.S. Direct Retail
 
$
1,033,669

 
$
759,674

 
$
2,847,898

 
$
2,134,782

U.S. Other
 
16,975

 
28,127

 
57,843

 
91,613

U.S. segment net revenue
 
1,050,644

 
787,801

 
2,905,741

 
2,226,395

International Direct Retail
 
147,554

 
72,724

 
376,138

 
165,119

International Other
 

 
1,000

 

 
4,287

International segment net revenue
 
147,554

 
73,724

 
376,138

 
169,406

Total net revenue
 
$
1,198,198

 
$
861,525

 
$
3,281,879

 
$
2,395,801

For more information on our segments, see Note 8, Segment and Geographic Information, included in Part I, Item 1, Unaudited Consolidated and Condensed Financial Statements, of this Quarterly Report on Form 10-Q.

20


Key Financial and Operating Metrics
We measure our business using both financial and operating metrics. Our free cash flow metric is measured on a consolidated basis. Our net revenue and Adjusted EBITDA metrics are measured on a consolidated and segment basis. See Note 8, Segment and Geographic Information, included in Part I, Item 1, Unaudited Consolidated and Condensed Financial Statements, of this Quarterly Report on Form 10-Q. All other key financial and operating metrics are derived and reported from our Direct Retail sales, which includes sales generated primarily through our sites. 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 (in thousands, except LTM Net Revenue per Active Customer and Average Order Value):  
 
 
Three months ended September 30,
 
 
 
 
2017
 
2016
 
% Change
Consolidated Financial Metrics
 
 

 
 

 
 

Net Revenue
 
$
1,198,198

 
$
861,525

 
39.1
%
Adjusted EBITDA
 
$
(22,672
)
 
$
(30,849
)
 
 

Free cash flow
 
$
(18,463
)
 
$
(13,968
)
 
 

Direct Retail Financial and Operating Metrics
 
 
 
 
 
 

Direct Retail Net Revenue
 
$
1,181,223

 
$
832,398

 
41.9
%
Active Customers
 
10,250

 
7,362

 
39.2
%
LTM Net Revenue per Active Customer
 
$
408

 
$
406

 
0.5
%
Orders Delivered
 
4,719

 
3,417

 
38.1
%
Average Order Value
 
$
250

 
$
244

 
2.5
%
 
 
Nine months ended September 30,
 
 
 
 
2017
 
2016
 
% Change
Consolidated Financial Metrics
 
 

 
 

 
 

Net Revenue
 
$
3,281,879

 
$
2,395,801

 
37.0
 %
Adjusted EBITDA
 
$
(45,814
)
 
$
(76,666
)
 
 

Free cash flow
 
$
(114,658
)
 
$
(113,968
)
 
 

Direct Retail Financial and Operating Metrics
 
 
 
 
 
 

Direct Retail Net Revenue
 
$
3,224,036

 
$
2,299,901

 
40.2
 %
Active Customers
 
10,250

 
7,362

 
39.2
 %
LTM Net Revenue per Active Customer
 
$
408

 
$
406

 
0.5
 %
Orders Delivered
 
13,209

 
9,343

 
41.4
 %
Average Order Value
 
$
244

 
$
246

 
(0.8
)%
 
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 income (loss) before depreciation and amortization, equity-based compensation and related taxes, interest and other income and expense, provision for income taxes, and non-recurring items. 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 directors to evaluate our operating performance, generate future operating plans, and make strategic decisions regarding the allocation of capital. In particular, the exclusion of certain expenses in calculating Adjusted EBITDA facilitates operating performance comparisons on a period-to-period basis. Accordingly, we believe that Adjusted EBITDA

21


provides useful information to investors and others in understanding and evaluating our operating results in the same manner as our management and board of directors.
Adjusted EBITDA has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are: 
Although depreciation and amortization are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future, and Adjusted EBITDA does not reflect cash capital expenditure requirements for such replacements or for new capital expenditure requirements;
Adjusted EBITDA does not reflect equity based compensation and related taxes;
Adjusted EBITDA does not reflect changes in our working capital;
Adjusted EBITDA does not reflect income tax payments that may represent a reduction in cash available to us;
Adjusted EBITDA does not reflect depreciation and interest expenses associated with the lease financing obligations; and
Other companies, including companies in our industry, may calculate Adjusted EBITDA differently, which reduces its usefulness as a comparative measure.
Because of these limitations, you should consider Adjusted EBITDA alongside other financial performance measures, including various cash flow metrics, net loss and our other GAAP results.
The following table reflects the reconciliation of net loss to Adjusted EBITDA for each of the periods indicated (in thousands): 
 
 
Three months ended September 30,
 
Nine months ended September 30,
 
 
2017
 
2016
 
2017
 
2016
Reconciliation of Adjusted EBITDA
 
 

 
 

 
 

 
 

Net loss
 
$
(76,429
)
 
$
(60,940
)
 
$
(171,843
)
 
$
(150,419
)
Depreciation and amortization (1)
 
22,913

 
15,463

 
62,588

 
38,528

Equity based compensation and related taxes
 
19,598

 
15,308

 
50,539

 
37,265

Interest expense (income), net
 
2,008

 
292

 
3,857

 
(791
)
Other expense (income), net
 
227

 
(889
)
 
(400
)
 
(1,804
)
Provision for (benefit from) income taxes
 
237

 
(83
)
 
671

 
555

Other (1)
 
8,774

 

 
8,774

 

Adjusted EBITDA
 
$
(22,672
)
 
$
(30,849
)
 
$
(45,814
)
 
$
(76,666
)
(1) We recorded $9.6 million of one-time charges in the three and nine months ended September 30, 2017 in "Operations, technology, general and administrative" in the unaudited consolidated and condensed statements of operations related to a warehouse we vacated in July 2017. Of the $9.6 million charges, $8.8 million was included in "Other" and related primarily to the excess of our estimated future remaining lease commitments through 2023 over our expected sublease income over the same period, and $0.8 million was included in "Depreciation and amortization" related to accelerated depreciation of leasehold improvements in the warehouse.
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 provided by (used in) operating activities less net cash used to purchase property and equipment and site and software development costs. We have provided a reconciliation below of free cash flow to net cash provided by (used in) operating activities, the most directly comparable GAAP financial measure.
We have included free cash flow in this 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.

22


Free cash flow has limitations as an analytical tool because it omits certain components of the cash flow statement and does not represent the residual cash flow available for discretionary expenditures. Further, other companies, including companies in our industry, may calculate free cash flow differently. Accordingly, you should not consider free cash flow in isolation or as a substitute for analysis of our results as reported under GAAP. Because of these limitations, you should consider free cash flow alongside other financial performance measures, including net cash provided by (used in) operating activities, capital expenditures and our other GAAP results.
The following table presents a reconciliation of free cash flow to net cash provided by (used in) operating activities for each of the periods indicated (in thousands):
 
 
Three months ended September 30,
 
Nine months ended September 30,
 
 
2017
 
2016
 
2017
 
2016
Net cash provided by (used in) operating activities
 
$
24,752

 
$
15,621

 
$
(3,245
)
 
$
(10,680
)
Purchase of property and equipment
 
(30,980
)
 
(20,408
)
 
(76,528
)
 
(81,844
)
Site and software development costs
 
(12,235
)
 
(9,181
)
 
(34,885
)
 
(21,444
)
Free cash flow
 
$
(18,463
)
 
$
(13,968
)
 
$
(114,658
)
 
$
(113,968
)
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.
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 set forth under Part II, Item 1A, Risk Factors, of this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the year ended December 31, 2016.

23


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 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 fulfilled with product we ship to our customers directly from our suppliers and, increasingly, from our CastleGate warehouses.
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 net revenue through our third-party advertisers is recognized in the period in which the click, action or impression occurs. This revenue has not been material to date.
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, including equity-based compensation, 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 and condensed statements of operations. We also perform logistics services for suppliers through our CastleGate solution, which are earned upon completion of preparing customer orders for shipment and are reflected as a reduction of cost of goods sold on the consolidated and condensed statements of operations. We expect cost of goods sold expenses to remain relatively stable as a percentage of net revenue but some fluctuations are expected due to the wide variety of products we sell.
Customer Service and Merchant Fees
Customer service and merchant fees consist of labor-related costs, including equity-based compensation, of our employees involved in customer service activities and merchant processing fees associated with customer payments made by credit cards and debit cards. Increases in our customer service and merchant fees are driven by the growth in our revenue and are expected to remain relatively consistent as a percentage of revenue.
Advertising
Advertising consists of direct response performance marketing costs, such as display advertising, paid search advertising, social media advertising, search engine optimization, comparison shopping engine advertising, television advertising, direct mail, catalog and print advertising. We expect advertising expense to continue to increase but decrease as a percentage of net revenue over time due to our increasing base of repeat customers.
Merchandising, Marketing and Sales
Merchandising, marketing and sales expenses include labor-related costs, including equity-based compensation, for our category managers, buyers, site merchandisers, merchants, marketers and the team who executes our advertising strategy. Sales, marketing and merchandising expenses are primarily driven by investments to grow and retain our customer base. We expect merchandising, marketing and sales expenses to continue to increase as we grow our net revenue.
Operations, Technology and General and Administrative
Operations, technology, general and administrative expenses primarily include labor-related costs, including equity-based compensation, of our operations group that leads our supply chain and logistics function, our technology team, which builds and supports our sites, and our corporate general and administrative, which includes human resources, finance and accounting personnel. Also included are administrative and professional service fees including audit and legal fees, insurance and other corporate expenses, including depreciation and rent. We expect operations, technology, general and administrative expenses will continue to increase as we grow our net revenue and operations.

24


Interest (Expense) Income, Net
Interest (expense) income, net consists primarily of interest earned on cash, cash equivalents and short-term and long-term investments held by us and partially offset by interest expense on the lease financing obligations.
Other (Expense) Income, Net
Other (expense) income, net consists primarily of foreign currency (losses) gains.
Results of Consolidated Operations (in thousands)
Comparison of the three months ended September 30, 2017 and 2016
Net revenue 
 
 
Three months ended September 30,
 
 
 
 
2017
 
2016
 
% Change
Direct Retail
 
$
1,181,223

 
$
832,398

 
41.9
 %
Other
 
16,975

 
29,127

 
(41.7
)%
Net revenue
 
$
1,198,198

 
$
861,525

 
39.1
 %
In the three months ended September 30, 2017, net revenue increased by $336.7 million, or 39.1% compared to the same period in 2016, primarily as a result of an increase in Direct Retail net revenue. In the three months ended September 30, 2017, Direct Retail net revenue increased by $348.8 million, or 41.9% compared to the same period in 2016, primarily due to sales to a larger customer base, as the number of active customers increased 39.2% as of September 30, 2017 compared to September 30, 2016. The $12.2 million or 41.7% decrease in Other revenue in the three months ended September 30, 2017 as compared to the same period in 2016 was primarily due to decreased sales through our retail partners, as we continue to focus more on our Direct Retail business over time.
Cost of goods sold
 
 
Three months ended September 30,
 
 
 
 
2017
 
2016
 
% Change
Cost of goods sold
 
$
917,889

 
$
659,864

 
39.1
%
As a percentage of net revenue
 
76.6
%
 
76.6
%
 
 

In the three months ended September 30, 2017, cost of goods sold increased by $258.0 million, or 39.1%, compared to the same period in 2016. Of the increase in cost of goods sold, $201.9 million was due to the increase in products sold to our larger customer base. In addition, shipping and fulfillment costs increased $56.1 million as a result of the increase in products sold during the period. Cost of goods sold as a percentage of net revenue was consistent in the three months ended September 30, 2017 compared to the same period in 2016.

25


Operating expenses  
 
 
Three months ended September 30,
 
 
 
 
2017
 
2016
 
% Change
Customer service and merchant fees (1)
 
$
42,949

 
$
33,872

 
26.8
%
Advertising
 
141,714

 
101,333

 
39.8
%
Merchandising, marketing and sales (1)
 
56,934

 
48,550

 
17.3
%
Operations, technology, general and administrative (1)
 
112,669

 
79,526

 
41.7
%
 
 
$
354,266

 
$
263,281

 
34.6
%
As a percentage of net revenue:
 
 

 
 

 
 

Customer service and merchant fees (1)
 
3.6
%
 
3.9
%
 
 

Advertising
 
11.8
%
 
11.8
%
 
 

Merchandising, marketing and sales (1)
 
4.8
%
 
5.6
%
 
 

Operations, technology, general and administrative (1)
 
9.4
%
 
9.2
%
 
 

 
 
29.6
%
 
30.5
%
 
 

(1) Includes equity-based compensation and related taxes as follows:  
 
 
Three months ended September 30,
 
 
 
 
2017
 
2016
 
 
Customer service and merchant fees
 
$
636

 
$
627

 
 
Merchandising, marketing and sales
 
$
8,849

 
$
6,588

 
 
Operations, technology, general and administrative
 
$
9,831

 
$
7,881

 
 
The following table summarizes operating expenses as a percentage of net revenue, excluding equity-based compensation and related taxes:
 
 
Three months ended September 30,
 
 
 
 
2017
 
2016
 
 
 
 
 

 
 

 
 
Customer service and merchant fees
 
3.5
%
 
3.9
%
 
 
Merchandising, marketing and sales
 
4.0
%
 
4.9
%
 
 
Operations, technology, general and administrative
 
8.6
%
 
8.3
%
 
 
Excluding the impact of equity based compensation and related taxes, customer service costs and merchant processing fees increased by $9.1 million in the three months ended September 30, 2017 compared to the same period in 2016, primarily due to the increase in net revenue during the three months ended September 30, 2017.
Our advertising expenses increased by $40.4 million in the three months ended September 30, 2017 compared to the same period in 2016, primarily as a result of an increase in online and television advertising. Advertising was consistent as a percentage of net revenue in the three months ended September 30, 2017 compared to the same period in 2016.
Excluding the impact of equity based compensation and related taxes, merchandising, marketing and sales expenses increased by $6.1 million in the three months ended September 30, 2017 compared to the same period in 2016, primarily due to the increase in headcount to grow and retain our customer base.
Excluding the impact of equity based compensation and related taxes, operations, technology, general and administrative expense increased by $31.1 million in the three months ended September 30, 2017 compared to the same period in 2016. As our revenue continues to grow, we have invested in headcount in both operations and technology to continue to deliver a great experience for our customers. The increase in operations, technology, general and administrative expense was primarily attributable to personnel costs, rent, information technology, and depreciation and amortization.

26


Comparison of the nine months ended September 30, 2017 and 2016
Net revenue 
 
 
Nine months ended September 30,
 
 
 
 
2017
 
2016
 
% Change
Direct Retail
 
$
3,224,036

 
$
2,299,901

 
40.2
 %
Other
 
57,843

 
95,900

 
(39.7
)%
Net revenue
 
$
3,281,879

 
$
2,395,801

 
37.0
 %
In the nine months ended September 30, 2017, net revenue increased by $886.1 million, or 37.0% compared to the same period in 2016, primarily as a result of an increase in Direct Retail net revenue. In the nine months ended September 30, 2017, Direct Retail net revenue increased by $924.1 million, or 40.2% compared to the same period in 2016, primarily due to sales to a larger customer base, as the number of active customers increased 39.2% as of September 30, 2017 compared to September 30, 2016. The $38.1 million or 39.7% decrease in Other revenue in the nine months ended September 30, 2017 as compared to the same period in 2016 was primarily due to decreased sales through our retail partners, as we continue to focus more on our Direct Retail business over time.
 Cost of goods sold
 
 
Nine months ended September 30,
 
 
 
 
2017
 
2016
 
% Change
Cost of goods sold
 
$
2,495,221

 
$
1,826,570

 
36.6
%
As a percentage of net revenue
 
76.0
%
 
76.2
%
 
 

In the nine months ended September 30, 2017, cost of goods sold increased by $668.7 million, or 36.6%, compared to the same period in 2016. Of the increase in cost of goods sold, $527.0 million was due to the increase in products sold to our larger customer base. In addition, shipping and fulfillment costs increased $141.7 million as a result of the increase in products sold during the period. Cost of goods sold as a percentage of net revenue decreased in the nine months ended September 30, 2017 compared to the same period in 2016 as a result of changes in the mix of the products sold.

27


Operating expenses  
 
 
Nine months ended September 30,
 
 
 
 
2017
 
2016
 
% Change
Customer service and merchant fees (1)
 
$
117,132

 
$
91,286

 
28.3
%
Advertising
 
384,220

 
293,436

 
30.9
%
Merchandising, marketing and sales (1)
 
160,033

 
129,679

 
23.4
%
Operations, technology, general and administrative (1)
 
292,988

 
207,289

 
41.3
%
Total operating expenses
 
$
954,373

 
$
721,690

 
32.2
%
As a percentage of net revenue
 
 

 
 

 
 

Customer service and merchant fees (1)
 
3.6
%
 
3.8
%
 
 

Advertising
 
11.7
%
 
12.2
%
 
 

Merchandising, marketing and sales (1)
 
4.9
%
 
5.4
%
 
 

Operations, technology, general and administrative (1)
 
8.9
%
 
8.7
%
 
 

 
 
29.1
%
 
30.1
%
 
 

(1) Includes equity-based compensation and related taxes as follows:  
 
 
Nine months ended September 30,
 
 
 
 
2017
 
2016
 
 
Customer service and merchant fees
 
$
1,866

 
$
1,488

 
 
Merchandising, marketing and sales
 
$
24,014

 
$
16,910

 
 
Operations, technology, general and administrative
 
$
24,027

 
$
18,510

 
 
The following table summarizes operating expenses as a percentage of net revenue, excluding equity-based compensation and related taxes:
 
 
Nine months ended September 30,
 
 
 
 
2017
 
2016
 
 
As a percentage of net revenue
 
 

 
 

 
 
Customer service and merchant fees
 
3.5
%
 
3.7
%
 
 
Merchandising, marketing and sales
 
4.1
%
 
4.7
%
 
 
Operations, technology, general and administrative
 
8.2
%
 
7.9
%
 
 
Excluding the impact of equity based compensation and related taxes, customer service costs and merchant processing fees increased by $25.5 million in the nine months ended September 30, 2017 compared to the same period in 2016, primarily due to the increase in net revenue during the nine months ended September 30, 2017.
Our advertising expenses increased by $90.8 million in the nine months ended September 30, 2017 compared to the same period in 2016, primarily as a result of an increase in online and television advertising. Advertising decreased as a percentage of net revenue in the nine months ended September 30, 2017 compared to the same period in 2016 primarily due to increased leverage from our growing base of repeat customers, and television advertising expense not increasing at the same rate as revenue growth in the U.S., partially offset by advertising investments in Europe and Canada.
Excluding the impact of equity based compensation and related taxes, merchandising, marketing and sales expenses increased by $23.2 million in the nine months ended September 30, 2017 compared to the same period in 2016, primarily due to an increase in headcount to grow and retain our customer base.
Excluding the impact of equity based compensation and related taxes, operations, technology, general and administrative expense increased by $80.2 million in the nine months ended September 30, 2017 compared to the same period in 2016. As our revenue continues to grow, we have invested in headcount in both operations and technology to continue to deliver a great experience for our customers. The increase in operations, technology, general and administrative expense was primarily attributable to personnel costs, rent, information technology, and depreciation and amortization.

28


Liquidity and Capital Resources
 Sources of Liquidity 
 
 
September 30,
2017
 
December 31,
2016
 
 
(in thousands)
Cash and cash equivalents
 
$
553,721

 
$
279,840

Short-term investments
 
$
56,699

 
$
68,743

Accounts receivable, net
 
$
27,521

 
$
19,113

Long-term investments
 
$
29,809

 
$
30,967

Working capital
 
$
126,346

 
$
(80,129
)
 Historical Cash Flows 
 
 
Nine months ended September 30,
 
 
2017
 
2016
 
 
(in thousands)
Net loss
 
$
(171,843
)
 
$
(150,419
)
Net cash used in operating activities
 
$
(3,245
)
 
$
(10,680
)
Net cash used in investing activities
 
$
(98,512
)
 
$
(97,178
)
Net cash provided by (used in) financing activities
 
$
375,225

 
$
(18,260
)
At September 30, 2017, our principal source of liquidity was cash and cash equivalents and short- and long-term investments totaling $640.2 million, which includes $420.4 million net proceeds from the issuance of our convertible notes in September 2017, partially offset by $44.2 million in premiums paid at the same time for separate capped call transactions. We believe that our existing cash and cash equivalents and investments, together with cash generated from operations and the cash available under our revolving credit facility, 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. 
Capital expenditures were 3.8% of net revenue for the year ended December 31, 2016, and related primarily to putting a new data center online, our ongoing investments in our technology infrastructure, and equipment purchases and improvements for leased warehouses within our expanding supply chain network. Capital expenditures were 3.6% of net revenue for the quarter ended September 30, 2017, consistent with our forecast of above 3.0%, primarily due to the planned build out of our logistics network. For the full year 2017, we expect capital expenditures to be approximately 3.0% of net revenue. 
Our future capital requirements and the adequacy of available funds will depend on many factors, including those described herein and in our other filings with the SEC, including those set forth under in Part II, Item 1A, Risk Factors, of this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the year ended December 31, 2016. We may not be able to secure additional financing to meet our operating requirements on acceptable terms, or at all. 
Operating Activities
Cash used in operating activities consisted of net loss adjusted for certain non-cash items including depreciation and amortization, equity-based compensation, and certain other non-cash expenses, as well as the effect of changes in working capital and other activities. Operating cash flows can be volatile and are sensitive to many factors, including changes in working capital and our net loss.
Cash used in operating