News Column

ZULILY, INC. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

May 9, 2014

The following discussion and analysis provides information that we believe is relevant to an assessment and understanding of our results of operation and financial condition. You should read this analysis in conjunction with the attached condensed consolidated financial statements and related notes thereto, and with our audited consolidated financial statements and the notes thereto, included in our Annual Report on Form 10-K for the year ended December 29, 2013, as filed with the Securities and Exchange Commission (the "SEC") on February 28, 2014. Special Note Regarding Forward-Looking Statements This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and Section 27A of the Securities Act of 1933, as amended (the "Securities Act"). All statements contained in this Quarterly Report other than statements of historical fact, including statements regarding our future results of operations and financial position, our business strategy and plans, and our objectives for future operations, are forward-looking statements. The words "believe," "may," "will," "estimate," "continue," "anticipate," "intend," "expect," "seek," and similar expressions are intended to identify forward-looking statements. We have based these forward-looking statements largely on our current expectations and projections about future events and trends that we believe may affect our financial condition, results of operations, business strategy, short-term and long-term business operations and objectives, and financial needs. These forward-looking statements are subject to a number of risks, uncertainties and assumptions, including those described in the "Risk Factors" section of this Quarterly Report. Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties, and assumptions, the future events and trends discussed in this Quarterly Report may not occur and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements. You should not rely upon forward-looking statements as predictions of future events. The events and circumstances reflected in the forward-looking statements may not be achieved or occur. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, or achievements. We are under no duty to update any of these forward-looking statements after the date of this Quarterly Report or to conform these statements to actual results or revised expectations. Overview We launched the zulily website in January 2010 with the goal of revolutionizing the way moms shop. Today, we are one of the largest standalone e-commerce companies in the United States. Through our desktop and mobile websites and mobile applications, which we refer to as our "sites", we help our customers discover new and unique products at great values that they would likely not find elsewhere. We provide our customers with a fun and entertaining shopping experience with a fresh selection of flash sales events with thousands of product styles offered on a typical day. We source these products from thousands of vendors, including emerging brands and smaller boutique vendors, as well as larger national brands. By bringing together millions of customers and a daily selection of products chosen from our vendor base, we have built a large-scale and uniquely curated marketplace. We sell our products through a flash sales model, with offerings typically only available for 72 hours and in a limited quantity, creating an urgency to browse and purchase. We sell children's apparel, women's apparel and other categories such as toys, infant gear, kitchen accessories and home dÉcor. Children's apparel is our largest merchandise category today; however, we have expanded our categories over time such that all non-children's apparel categories combined accounted for 61% of our North American units ordered in the three months ended March 30, 2014, up from 48% for the three months ended March 31, 2013. We focus on providing significant value to consumers across all of our categories; the average item on our sites is offered for over 50% off the manufacturer's suggested retail price. We plan to further grow our customer base by cost-effectively acquiring new email subscribers and users of our mobile applications through targeted marketing campaigns and then converting them into active customers. In 15



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addition, we regularly introduce new categories, brands and products to our customers and work to maximize the relevance of the items we display, thereby improving customer satisfaction, increasing customer loyalty and driving repeat purchasing. Mobile is a large and growing part of our business. We have invested heavily in our mobile platform to optimize our sites for use on iPhones, iPads and Android-based devices. In the quarter ended March 30, 2014, approximately 47% of our North American orders were placed from a mobile device, up from approximately 45% in the fourth quarter of 2013, and approximately 39% in the first quarter of 2013. We have built a merchandising organization specifically designed to source, cultivate and manage relationships with thousands of vendors, including emerging brands and smaller boutique vendors as well as larger national brands. To date, we have featured and sold products from over 13,000 brands. To identify and support our vendors and effectively tell their stories to our customers, we have built a merchandising team and in-house photography studios, supported by a substantial and talented photo editing, copywriting and editorial team. By sourcing products from a large number of vendors and providing them with strong support, we are able to offer our customers a broad and unique selection of curated products that is refreshed on a daily basis. We typically take customer orders before we purchase inventory from our vendors, greatly reducing our inventory risk. The result of this dynamic is that we are able to offer a much larger range of products to our customers and to generate greater sales for our vendors, who are able to match a broader range of their product supply to actual customer demand. To best serve our customers and vendors, we have in place a custom, fully integrated fulfillment infrastructure. Our proprietary supply chain system enables us to efficiently handle the unique features of our flash sales model, including small to medium lot sizes and high inventory turnover. This allows us to sell lower price point products cost-effectively, without needing to pre-stock substantial inventory. Our business model together with our fulfillment infrastructure has enabled us to conduct successful events of all sizes, including smaller ones. In the three months ended March 30, 2014, 86% of our events generated less than $50,000 of North American product sales, and these smaller events accounted for approximately 47% of our North American product sales. As of March 30, 2014, we had 1.1 million square feet of leased fulfillment space at facilities in Nevada and Ohio. Our fulfillment operations regularly handle thousands of items a day from product styles that change each day and require different handling processes. Because we have deliberately established an intermediary model in which we do not pre-purchase substantial inventory, our shipping times are generally slower than e-commerce retailers that hold inventory. As a result of higher order volume than we had originally targeted, our order-to-ship times for sales of products in North America increased from an average of 11.3 days in the first quarter of 2013 to 13.2 days in the first quarter of 2014. We are continually investing in our systems and infrastructure to improve order-to-ship times for sales of products in North America. To date, we have primarily focused on expanding our North American business and are just beginning to focus on our international strategy. In April 2012, we launched our first international site, with a small team based in the United Kingdom. For the three months ended March 30, 2014 and March 31, 2013, we generated $3.5 million and $2.7 million in net sales from our U.K.-based sites, or 1% and 2% of total net sales, respectively. In addition, customers in foreign countries have the ability to make purchases on our North America-based sites and have had their orders fulfilled through a third-party service provider. These purchases are included in our North American net sales. Purchases made on our U.K.-based sites are included in U.K. net sales. We are gradually increasing our level of investment in international expansion and plan to continue to invest in and develop international markets, balanced with a continued focus on building the core North American business, which includes Canada. A summary of activity for the three months ended March 30, 2014, compared to the three months ended March 31, 2013, is as follows: For the three months ended March 30, 2014 and March 31, 2013, we



reported $237.9 million and $127.0 million in net sales, respectively,

representing growth of 87% from the three months ended March 31, 2013. As of March 30, 2014, we had 3.7 million active customers, or customers

who had purchased at least once in the last year, an increase of 93% from the 1.9 million active customers we had as of March 31, 2013.



For the three months ended March 30, 2014 and March 31, 2013, there were

total orders placed of 5.5 million and 2.9 million, respectively, representing an increase in total orders of 2.6 million or 91% from 16



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the three months ended March 31, 2013. Of the total North American orders placed during the three months ended March 30, 2014, 83% were placed by customers who had previously purchased from us in the last year. Components of Our Results of Operations Net Sales Net sales consist primarily of sales of children's apparel, women's apparel and other product categories, such as toys, infant gear, kitchen accessories and home dÉcor. We recognize product sales at the time title transfers to the customer, which is generally at delivery. Net sales represent the sales of these items plus shipping and handling charges to customers, net of estimated returns and promotional discounts. Net sales are primarily driven by growth in our active customers, the frequency with which customers purchase and average order value. Net sales also include sales generated from the sale of services events, which are primarily electronic vouchers or access codes for our customers to redeem directly with the vendor. Net sales of services events have not been material to date. Cost of Sales Cost of sales consists of our purchase price for merchandise sold to customers, inbound and outbound shipping and handling costs, shipping supplies and fulfillment costs. Fulfillment costs represent those costs incurred in operating and staffing the fulfillment centers, including costs attributed to receiving, inspecting, picking, packaging and preparing customer orders for shipment. Cost of sales also includes direct and indirect labor costs for fulfillment center oversight, including payroll and related benefit costs and stock-based compensation expense. Cost of sales are primarily driven by growth in orders placed by customers, the mix of the product available for sale on our sites and transportation costs related to delivering orders to our customers. Marketing Expenses Marketing expenses consist primarily of targeted online marketing costs, such as display advertising, key word search campaigns, search engine optimization and social media, and offline marketing costs, such as print, radio and television advertising. Marketing expenses also include payroll and related benefit costs and stock-based compensation expense for our employees involved in marketing activities. Marketing expenses are primarily driven by investments to grow and retain our customer base. In the longer term, we expect marketing expenses to decline as a percentage of net sales. Selling, General and Administrative Expenses Selling, general and administrative expenses consist primarily of payroll and related benefit costs and stock-based compensation expense for our employees involved in general corporate functions including customer service, merchandising, studio and technology, as well as costs associated with the use by these functions of facilities and equipment, including depreciation and rent. Selling, general and administrative expenses are primarily driven by increases in headcount required to support business growth. In the longer term, we expect selling, general and administrative expenses to decline as a percentage of net sales. Interest Income (Expense)-Net Interest income (expense)-net consists primarily of interest earned on cash, cash equivalents and short-term investments held by us. Other Income (Expense)-Net Other income (expense)-net consists primarily of income earned from our corporate purchasing card and foreign currency gains (losses). RESULTS OF OPERATIONS We have organized our operations into two principal segments: North America and the U.K. We present our segment information along the same lines that our Chief Executive Officer reviews our operating results in assessing performance and allocating resources. 17



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Table of Contents Net Sales Three Months Ended March 30, March 31, 2014 2013 $ Change % Change (dollars in thousands) Net sales: North America $ 234,360$ 124,324$ 110,036 88.5 % U.K. 3,521 2,688 833 31.0 % Consolidated $ 237,881$ 127,012$ 110,869 87.3 % The increase in North America net sales for the three months ended March 30, 2014 compared to the three months ended March 31, 2013 was primarily driven by an increase of 1.7 million active customers, or a 94.9% increase, and an increase in total orders placed of 2.6 million, or a 93% increase, offset by a 2.9% decrease in revenue per active customer. The increase in U.K. net sales for the three months ended March 30, 2014 compared to the three months ended March 31, 2013 was primarily driven by an overall increase of 0.1 million active customers. Cost of Sales Three Months Ended March 30, March 31, 2014 2013 $ Change % Change (dollars in thousands) Cost of sales $ 174,147$ 90,400$ 83,747 92.6 %



Percentage of net sales 73 % 71 %

Of the increase in cost of sales, $60.0 million was due to the increase in products sold to our larger customer base. In addition, shipping and fulfillment costs increased $24.0 million as a result of the increase in products sold during the period.

The increase in cost of sales as a percentage of net sales during the three months ended March 30, 2014 as compared to the three months ended March 31, 2013 was driven primarily from increased volume and timing of order activity. A higher than expected order volume increased our order-to-ship times from an average of 11.3 days in the first quarter of 2013 to 13.2 days in the first quarter of 2014 and required incremental labor at our fulfillment centers resulting in increased shipping and fulfillment costs. In addition, the timing of the increased orders within the quarter resulted in an increase in deferred revenue for the period. We expect the incremental deferred revenue will be recognized as net sales in the second quarter of 2014. Marketing expenses Three Months Ended March 30, March 31, 2014 2013 $ Change % Change (dollars in thousands)



Marketing expenses $ 23,085$ 15,439$ 7,646 49.5 % Percentage of net sales 10 % 12 %

The increase in marketing expenses for the three months ended March 30, 2014 compared to the three months ended March 31, 2013 was primarily due to increased spending on paid online marketing channels, including display advertising, key word search campaigns, search engine optimization and social media. As a result 18



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of the increased spend, we grew our active customer base by 1.8 million or 93% as of March 30, 2014, as compared to March 31, 2013. Selling, general and administrative expenses

Three Months Ended March 30, March 31, 2014 2013 $ Change % Change (dollars in thousands) Selling, general and administrative expenses $ 43,600$ 22,786$ 20,814 91.3 % Percentage of net sales 18 % 18 % Of the increase in selling, general and administrative expenses of $20.8 million for the three months ended March 30, 2014 compared to the three months ended March 31, 2013, $11.7 million was due to the increase in salaries and related benefits and stock-based compensation expense as we continued to increase our headcount across functions to support business growth. To a lesser extent, this increase was attributable to a $1.9 million increase in our professional services costs as a result of business growth and a related increase in business complexity due to being a public company, a $2.9 million increase in our rent, depreciation and other facilities expense as a result of our business and headcount growth, and a $3.0 million increase in our merchant processing fees driven by sales volume increase, which increase in total dollars as sales increase.



Interest Income (Expense), Net

Interest income (expense), net is primarily derived from interest income related to the investment of our cash and cash equivalents and short-term investments. Interest income (expense), net for the three months ended March 30, 2014 and March 31, 2013, totaled $54,000 and $32,000, respectively. Other Income (Expense), Net Other income (expense), net consists of income earned from our corporate purchasing card and foreign currency gains (losses). Other income (expense), net for the three months ended March 30, 2014 and March 31, 2013 totaled $(53,000) and $(14,000), respectively. Income Taxes We use the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized by applying the statutory tax rates in effect in the years in which the differences between the financial reporting and tax filing bases of existing assets and liabilities are expected to reverse. We have considered past operating results, our limited operating history and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance against our deferred tax assets. For all periods presented, we recorded a valuation allowance based on the amount of tax assets and loss carry-forwards that we believe are more likely than not to go unused. 19



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KEY FINANCIAL AND OPERATING MEASURES We measure our business using both financial and operating metrics. We use these metrics to assess the progress of our business, make decisions on where to allocate capital, time and technology investments and assess the near-term and longer-term performance of our business. The key financial and operating metrics we use are: Three Months Ended March 30, March 31, 2014 2013 Change % Change (in thousands, except revenue per active customer and average order value) Adjusted EBITDA $ 2,626 $ 452 $ 2,174 481.0 % Free cash flow $ 1,645 $ 604 $ 1,041 172.4 % Non-GAAP diluted net loss per share $ (0.02 ) $ (0.01 ) $ (0.01 ) 100 % Active customers 3,684 1,906 1,778 93 % Revenue per active customer $ 65 $ 67 $ (2 ) (3.0 )% Total orders placed 5,490 2,881 2,609 90.6 % Average order value $ 55.34 $ 53.05 $ 2.29 4.3 % Adjusted EBITDA To provide investors with additional information regarding our financial results, we have disclosed in the table above Adjusted EBITDA, a non-GAAP financial measure that we calculate as earnings (loss) before interest and other income and expense, taxes, depreciation, amortization and stock-based compensation expense. We have provided a reconciliation below of Adjusted EBITDA to net 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 and, in the case of exclusion of the impact of stock-based compensation, excludes an item that we do not consider to be indicative of our core operating performance. Accordingly, we believe that Adjusted EBITDA provides useful information to investors and others in understanding and evaluating our operating results in the same manner as our management and board of directors. Adjusted EBITDA has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are: although depreciation and amortization are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future, and Adjusted EBITDA does not reflect cash capital



expenditure

requirements for such replacements or for new capital



expenditure

requirements; Adjusted EBITDA does not reflect changes in, or cash



requirements

for, our working capital needs; Adjusted EBITDA does not consider the potentially dilutive



impact of

equity-based compensation; Adjusted EBITDA does not reflect tax payments that may



represent a

reduction in cash available to us; and other companies, including companies in our industry, may



calculate

Adjusted EBITDA differently, which reduces its usefulness as a comparative measure.



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

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

Three Months Ended March 30, 2014 March 31, 2013 (in thousands) Net loss $ (2,950 )$ (1,595 ) Excluding: Interest (income) expense-net 54 (32 ) Other (income) expense-net (53 ) 14 Taxes - - Depreciation and amortization 2,401 1,167 Stock-based compensation expense 3,174 898 Adjusted EBITDA $ 2,626 $ 452 Free Cash Flow To provide investors with additional information regarding our financial results, we have also disclosed in the table above free cash flow, a non-GAAP financial measure that we calculate as net cash provided by (used in) operating activities less net cash used in capital expenditures. We have provided a reconciliation below of free cash flow to net cash provided by 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 a key measure used by our management and board of directors. We believe free cash flow is an important indicator of our business performance because it measures the amount of cash we generate. Free cash flow also reflects changes in working capital. Accordingly, we believe that free cash flow provides useful information to investors and others in understanding and evaluating our operating results in the same manner as our management and board of directors. Free cash flow has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP. There are limitations to using non-GAAP financial measures, including that other companies, including companies in our industry, may calculate free cash flow differently. Because of these limitations, you should consider free cash flow alongside other financial performance measures, including net cash provided by operating activities, capital expenditures and our other GAAP results.



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

Three Months Ended March 30, 2014 March 31, 2013 (in thousands) Net cash provided by operating activities $ 17,406 $ 3,509 Capital expenditures (15,761 ) (2,905 ) Free cash flow $ 1,645 $ 604 Net cash used in investing activities $ (50,757 ) $ (2,824 ) Net cash (used in) provided by financing activities $ (319 ) $ 45 Non-GAAP diluted net loss per share To provide investors with additional information regarding our financial results, we have also disclosed in the table below, a non-GAAP diluted net loss per share financial measure which assumes the conversion of all outstanding shares of preferred stock at the beginning of the reporting period for periods prior to our IPO in November 2013. Our non-GAAP diluted net loss per share also assumes all vesting of restricted stock occurred at the beginning of the applicable reporting periods. Assuming the conversion of preferred stock and the vesting of restricted stock at the beginning of the applicable reporting periods, the result is the use of GAAP net loss as the 21



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numerator and the denominator representing the weighted-average shares outstanding on an if-converted basis in the calculation of non-GAAP diluted net loss per share for each period presented. We have included non-GAAP diluted net loss per share in this Quarterly Report on Form 10-Q because it is a key measure used by our management and board of directors. We believe non-GAAP diluted net loss per share is an important indicator of our business performance as this measure facilitates comparisons on a period-to-period basis, which provides useful information to our management, board of directors and investors in understanding our past financial performance and future results. Accordingly, we believe that non-GAAP net loss per share provides useful information to investors and others in understanding and evaluating our operating results in the same manner as our management and board of directors. A reconciliation of non-GAAP net loss attributable to common stockholders to GAAP net loss attributable to common stockholders, the most directly comparable GAAP financial measure, and non-GAAP dilutive shares to GAAP dilutive shares, the most directly comparable GAAP financial measure, in order to calculate non-GAAP dilutive net loss per share, is as follows: Three Months Ended March 30, 2014 March 31, 2013 (in thousands except share and per share amounts) GAAP net loss attributable to common stockholders $ (2,950 ) $ (4,126 ) Add: Accretion of convertible redeemable preferred stock - 2,531 Non-GAAP net loss attributable to common stockholders $ (2,950 ) $ (1,595 ) GAAP weighted average shares used to compute diluted net loss per Class A and Class B common share 123,878,592 46,422,029 Add: Convertible preferred stock - 60,621,233 Add: Unvested restricted stock 51,711 8,154,884 Non-GAAP weighted average shares used to compute diluted net loss per Class A and Class B common share 123,930,303



115,198,146

Non-GAAP diluted net loss per share attributable to Class A and Class B common stockholders $ (0.02 ) $ (0.01 ) Active Customers We define an active customer as an individual customer who has purchased from us at least once in the last year. In any particular period, we determine our number of active customers by counting the total number of customers who have made at least one purchase in the preceding 12 month period, measured from the last date of such period. We view the number of active customers as a key indicator of our growth, the reach of our sites, the value proposition and consumer awareness of our brand, the continued use of our sites by our customers and their desire to purchase our products. Our number of active customers drives both net sales and our appeal to vendors. Revenue Per Active Customer We define revenue per active customer as our total net sales divided by our total number of active customers in any particular period. We view revenue per active customer as a key indicator of our customers' pattern of use of our sites to purchase our products and a measure of our customers' demand. Total Orders Placed We define total orders placed as the total number of customer orders placed by our customers in any period. We view total orders placed as a key indicator of the velocity of our business and an indication of the desirability of our products and sites to our customers. 22



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Average Order Value We define average order value as the sum of the total order values (including shipping and handling charges) in a given period divided by the total orders placed in that period. We view average order value as a key indicator of the desirability of our products and sites to our customers. LIQUIDITY AND CAPITAL RESOURCES We believe that our existing cash and cash equivalents, together with cash generated from operations and the revolving credit facility entered into during January 2014, will provide sufficient liquidity to meet our operational needs for the foreseeable future. However, our liquidity assumptions may prove to be incorrect, and we could exhaust our available financial resources sooner than we currently expect. In addition, we may elect to raise additional funds at any time through equity, equity-linked or debt financing arrangements. Our future capital requirements and the adequacy of available funds will depend on many factors, including those described in the section of this Quarterly Report on Form 10-Q captioned "Risk Factors." We may not be able to secure additional financing to meet our operating requirements on acceptable terms, or at all. At March 30, 2014, our cash and cash equivalents balance was $256.4 million, with an additional $53.0 million held in short-term investments. Cash and cash equivalents primarily consist of cash deposits and money market funds. Cash held internationally as of March 30, 2014 was not material. Prior to our IPO, we financed our operations and capital expenditures through private sales of preferred stock and cash flows from our operations. On November 20, 2013, we closed our IPO, in which 13,225,000 shares of common stock were sold to the public (including 7,334,125 shares of common stock sold by us). The public offering price of the shares sold in the IPO was $22.00 per share. We did not receive any proceeds from the sale of shares by the selling stockholders. The total net proceeds from the offering to us were $147.5 million after deducting the underwriting discount with respect to the shares offered by us of approximately $10.5 million and offering expenses totaling $3.3 million.



Cash flow information is as follows:

Three Months Ended March 30, March 31, 2014 2013 (in thousands) Cash provided by (used in): Operating activities $ 17,406$ 3,509 Investing activities (50,757 ) (2,824 ) Financing activities (319 ) 45 Operating Activities Our cash flow provided by operating activities is significantly impacted by volume of customer orders from an increased active customer base as compared to prior periods. The impact of the increase in active customers and higher volume of orders resulted in net sales growth of 87% in the three months ended March 30, 2014 as compared to the three months ended March 31, 2013. The increased order volumes drive increased inventory purchases, increased fulfillment activities and a greater investment in infrastructure including human capital. The below noted timing differences are a result of the significant increase in order volumes and net sales experienced in the three months ended March 30, 2014 as compared to the three months ended March 31, 2013. The increase in deferred revenue was primarily due to an increase in customer orders during the period which had not been delivered as of the end of the period. The changes in inventory were primarily due to changes in the number of items sold, which were either in the fulfillment centers awaiting shipment to customers or in-transit to customers. The increase in accounts payable and accrued expenses was primarily due to the growth in the business during the period, which primarily relate to amounts owed to vendors for products sold on our sites, transportation expenses for products being shipped into and out of our fulfillment centers and member and customer acquisition marketing expenses. 23



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Net cash provided by operating activities was $17.4 million for the three months ended March 30, 2014, as a result of net loss of $3.0 million, adding back non-cash charges of $5.7 million and changes in our operating assets and liabilities that provided $14.7 million in positive cash flow. Non-cash charges primarily consisted of stock-based compensation expense of $3.2 million and depreciation and amortization of $2.4 million. The net changes in our operating assets and liabilities was a result of increased deferred revenue of $29.8 million, accrued expenses and other liabilities of $5.4 million offset by increases in inventories of $13.4 million, accounts receivable of $5.0 million and prepaid expenses and other assets of $2.1 million. The increases in accounts receivable, inventory, deferred revenue and accrued expenses and other liabilities were primarily due to growth in events, orders and net sales during the period along with an increase to our deferred rent liability. In addition, a higher than expected order volume increased our order-to-ship times from an average of 11.3 days in the first quarter of 2013 to 13.2 days in the first quarter of 2014 and required incremental labor at our fulfillment centers resulting in increased shipping and fulfillment costs. In addition, the timing of the increased orders within the quarter resulted in an increase in deferred revenue for the period. We expect the incremental deferred revenue will be recognized as net sales in the second quarter of 2014. Net cash provided by operating activities was $3.5 million for the three months ended March 31, 2013, as a result of a net loss of $1.6 million, adding back non-cash charges of $2.1 million and changes in our operating assets and liabilities that provided $3.0 million in positive cash flow. Non-cash charges primarily consisted of stock-based compensation expense of $0.9 million and depreciation and amortization of $1.2 million. The net changes in our operating assets and liabilities was a result of increased accounts payable of $0.3 million, and deferred revenue of $6.6 million, partially offset by a $2.4 million increase in inventories, $0.6 million increase in prepaid expenses and other assets, and a $0.8 million increase in accounts receivable. The increase in inventory, deferred revenue, pre-paid expenses and other assets and accounts payable was primarily due to the growth in the business during the period. The increase in accounts receivable represented funds collected from our credit card processor, which were in-transit to us. Investing Activities Our investing activities have consisted of purchases of property and equipment to support our fulfillment centers and our overall business growth as well as short-term investments of our excess cash. Purchases of property and equipment may vary from period-to-period due to timing of our expansion of our operations. Additionally, we have invested some of our excess cash balances in money market funds and commercial paper. Net cash used in investing activities was $50.8 million in the three months ended March 30, 2014. This was primarily attributable to purchases of short-term investments related to excess cash of $60.0 million and $15.8 million in capital expenditures offset by $25 million in proceeds from the sale of available-for-sale securities. The capital expenditures related to additional equipment for our fulfillment centers, leasehold improvements at our new corporate office space in Seattle, as well as software purchases and internally developed software. Net cash used in investing activities was $2.8 million in the three months ended March 31, 2013. This was primarily attributable to capital expenditures, which related to equipment for our fulfillment centers, software purchases, internally developed software and hardware purchases for employees and general operations. Capital expenditures are expected to range between $45.0 million and $55.0 million in fiscal 2014, primarily for our fulfillment centers to support our growth as we continue to scale as well as continued investment in technology. Financing Activities Net cash used in financing activities was $0.3 million in the three months ended March 30, 2014. This was primarily attributable to debt and stock issuance costs of $0.5 million offset by the receipt of $0.2 million in proceeds from the exercise of stock options. During the three months ended March 31, 2013, there was minimal cash provided by financing activities. Credit Facility On January 23, 2014, we entered into a $50 million revolving credit facility pursuant to a Credit Agreement with certain lenders. Borrowings under the Credit Agreement will mature on January 23, 2016. The Credit Agreement includes a letter of credit sub-limit of up to $15.0 million. 24



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Borrowings under the Credit Agreement bear interest, at our option, in an amount equal to (i) in the case of base rate loans, 1.50% plus the highest of (a) the Federal Funds Rate plus one-half of one percent (0.50%), (b) the prime rate, and (c) the eurodollar rate plus two percent (2.00%), or (ii) in the case of eurodollar loans, for any interest period, LIBOR plus 2.50%. An undrawn commitment fee shall be payable to the lenders in an amount equal to 0.175% times the actual daily amount by which the aggregate commitments exceed the sum of the outstanding amount of loans and the outstanding amount of letter of credit obligations, calculated on a quarterly basis in arrears. We are permitted to make voluntary prepayments at any time without payment of a premium, provided that we will be subject to a breakage indemnity in the case of prepayments of LIBOR loans. The Credit Agreement contains customary representations and warranties and customary affirmative and negative covenants, in each case applicable to us and our subsidiaries. The negative covenants include restrictions on, among other things, indebtedness, liens, investments, mergers, dispositions, dividends and other distributions. The Credit Agreement contains certain financial covenants that require us and our subsidiaries to, among other things, maintain a minimum fixed charge coverage ratio of 1.35 to 1.0 and minimum quick ratio of 1.1 to 1.0, and requires us to maintain a senior leverage ratio not in excess of 2.0 to 1.0. The Credit Agreement includes customary events of default, including a change of control and a cross-default on our or any subsidiary's material indebtedness. Our obligations under the Credit Agreement are secured by substantially all of our and our subsidiaries' assets, and the Company's obligations under the Credit Agreement will be guaranteed by certain of our subsequently acquired or organized direct and indirect domestic subsidiaries.



As of the filing date of this Quarterly Report on Form 10-Q, no amounts have been drawn down under the revolving credit facility.

Off Balance Sheet Arrangements We did not have any off balance sheet arrangements in the three months ended March 30, 2014, except for operating leases as discussed below. Contractual Obligations Our contractual obligations consist of non-cancelable operating leases for equipment, office facilities, fulfillment centers and corporate headquarters. There have been no material changes to our contractual obligations disclosed in tabular format in our Annual Report on Form 10-K for the fiscal year ended December 29, 2013 other than the following: On January 24, 2014, we entered into a lease agreement for a new Nevada fulfillment center. The 12-year lease is for approximately 48 acres of land, including a fulfillment center containing approximately 707,010 square feet of ground floor, to be constructed by the landlord. The property is located in McCarran, Nevada. We expect to begin operating the new Nevada fulfillment center in the third quarter of 2014. The initial term of this lease is estimated to commence on the earlier of completion of the fulfillment center or the date we commence business operations from the leased property. We will be obligated to pay approximately $1.3 million in annual base rent in the first year, which shall increase by 1.75% each year. We will also be obligated to pay operating expenses, including property management fees. Additionally, a letter of credit in the amount of $3.0 million was delivered during the first quarter of 2014. Pursuant to this lease, if we provide at least six (6) months' notice prior to the expiration of the then-current term, we have the option to extend this lease for three (3) additional five-year terms, with certain increases in base rent. Critical Accounting Policies and Estimates Our management's discussion and analysis of our financial condition and results of operations is based on our condensed consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these condensed consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, net sales, expenses and related disclosures. We evaluate our estimates and assumptions on an ongoing basis. Our estimates are based on historical experience and various 25



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other assumptions that we believe to be reasonable under the circumstances. Our actual results could differ from these estimates. We believe that the assumptions and estimates associated with revenue recognition, income taxes and stock-based compensation have the greatest potential impact on our condensed consolidated financial statements. Therefore, we consider these to be our critical accounting policies and estimates. For a summary of all of our significant accounting policies, see Note 2, Summary of Significant Accounting Policies in the Notes to the Consolidated Financial Statements in our Annual Report on Form 10-K for the fiscal year ended December 29, 2013. In our Annual Report on Form 10-K, we provide additional analysis of our significant accounting policies in Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies and Estimates.


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