Wayfair Inc. (W) FY 2021 MD&A

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

Forward-Looking Statements

This Annual Report on Form 10-K 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 Exchange Act. All statements other than statements of historical fact contained in this Annual Report on Form 10-K, including statements regarding our investment plans and anticipated returns on those investments, our future customer growth, our future results of operations and financial position, available liquidity and access to financing sources, our business strategy, plans and objectives of management for future operations, including our international expansion, omni-channel strategy and launch of physical retail stores, consumer activity and behaviors, developments in our technology and systems and anticipated results of those developments and the impact of the COVID-19 pandemic and our response to it, 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.

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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 Wayfair’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 Annual Report on Form 10-K 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 ability to manage our growth and expansion both internationally and into physical retail locations;

• our ability to compete successfully;

• the rate of growth of the Internet and e-commerce;

• economic factors, such as interest rates, inflation, the housing market, currency exchange fluctuations and changes in customer spending;

• disruptions or inefficiencies in our supply chain or logistics network, including any impact of the COVID-19 pandemic on our suppliers and third party carriers and delivery agents;

• potential impacts of the COVID-19 pandemic on our business, financial condition and results of operations;

• world events, natural disasters, public health emergencies (such as the COVID-19 pandemic), 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 I, Item 1A, Risk Factors, of this Annual Report on Form 10-K. We qualify all of our forward-looking statements by these cautionary statements.

Overview

Wayfair is 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 thirty-three million products from over 23,000 suppliers.

We believe an increasing portion of the dollars spent on home goods will be spent online and that there is an opportunity for acquiring more market share. Our business model is designed to grow our net revenue by acquiring new customers as well as stimulating repeat purchases from our existing customers. Through increasing brand awareness as well as paid and unpaid advertising, we attract new and repeat customers to our sites. We turn these customers into recurring shoppers by creating a seamless shopping experience across their entire journey — offering best-in-class product discovery, purchasing, fulfillment and customer service.

In fiscal year 2021, our business generated lower sales volumes compared to the previous year. As economies across the U.S. and the globe began to reopen with rising vaccination rates during the spring of 2021, spending patterns shifted as consumers moved back to spending on experiential categories and in physical stores. The combination of these changes in consumer

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spending and the global supply chain challenges, which also arose due to the COVID-19 pandemic, led to lower sales in the second half of the year as compared to the first. As of December 31, 2021, we had 27.3 million active customers over the last twelve months, and 76% of 2021 orders came from repeat buyers. We continued to manage our advertising spend according to a return on investment-oriented approach that carefully tracks and monitors the results of advertising campaigns to ensure the appropriate return targets are being met. We also leveraged operating costs such as infrastructure expenses and total compensation costs, particularly as the pace of hiring slowed and proved substantially below revenue growth.

COVID-19 Pandemic

We are continuing to closely monitor the impact of the COVID-19 pandemic on our business, results of operations and financial results. The situation surrounding the COVID-19 pandemic remains fluid and the full extent of the impact of the COVID-19 pandemic on our business will depend on certain developments including the duration and severity of the pandemic, the emergence of new variants that may continue to prolong the pandemic, the amount of time it will take for normal economic activity to resume, future government actions that may be taken, the impact on consumer activity and behaviors and the effect on our customers, employees, suppliers, partners and stockholders, all of which are uncertain and cannot be predicted. See Part I, Item 1A, Risk Factors for additional details. Our focus remains on promoting the health, safety and financial security of our employees and serving our customers.

In an effort to contain or slow the COVID-19 pandemic, authorities around the world have implemented various measures, some of which have been subsequently rescinded or modified, including travel bans, stay-at-home orders and shutdowns of certain business. We anticipate that these actions and the global health crisis caused by the COVID-19 pandemic, including any variants, will continue to negatively impact global economic activity. While it is difficult to predict all of the impacts the COVID-19 pandemic will have on our business, we believe the long-term opportunity that we see for shopping for the home online remains unchanged.

As the COVID-19 pandemic remains dynamic and subject to rapid and possibly material change, we will continue to actively monitor the situation and may take further actions that alter our business operations as may be required by federal, state, local or foreign authorities, or that we determine are in the best interests of our customers, employees, suppliers, partners, stockholders and communities.

Factors Affecting our Performance

We believe that our performance and future success depend on a number of factors that present significant opportunities for us but also pose risks and challenges, including those discussed in Part I, Item 1A, Risk Factors.

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Key Financial and Operating Metrics

We measure our business using key financial and operating metrics, as well as Adjusted EBITDA, Free Cash Flow and Adjusted Diluted Earnings (Loss) per Share (see “Non-GAAP Financial Measures”). Our Free Cash Flow and Adjusted Diluted Earnings (Loss) per Share are measured on a consolidated basis, while our Adjusted EBITDA is measured on a consolidated and reportable segment basis. All other key financial and operating metrics are derived and reported from our consolidated net revenue.

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

(1) The number of active customers represents 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.

(2) LTM net revenue per active customer represents our total net revenue 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.

(3) Orders delivered represents the total 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.

(4) We define average order value as total 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.

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(5) Adjusted Diluted Earnings (Loss) per Share reflects our January 1, 2021 adoption of ASU 2020-06, further discussed in Note 1, Summary of Significant Accounting Policies, included in Part II, Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K. Prior periods have not been restated. Under legacy accounting, Adjusted Diluted Earnings per Share for the year ended December 31, 2021 would have been $1.11.

Results of Consolidated Operations

Net revenue

In 2021, net revenue decreased by $437 million, or 3.1% compared to 2020, which reflects some normalization in consumer behavior since the onset of the COVID-19 pandemic. The decrease in net revenue was driven by lower orders, partially offset by higher average order values. There was a decrease in order frequency, with LTM orders per active customer decreasing by 3.6% in 2021 compared to 2020. LTM net revenue per active customer increased 10.6% in 2021 compared to 2020 driven by higher average order value due in part to inflationary pressures in the supply chain. Our U.S. net revenue decreased 5.5% in 2021 from 2020, while our International net revenue increased 9.6% year over year. International Net Revenue Constant Currency Growth (see “Non-GAAP Financial Measures” below) was 2.1% in 2021 from 2020.

For more information on our segments, see Note 13 to the consolidated financial statements, Segment and Geographic Information, included in Part II, Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.

Cost of goods sold

Cost of goods sold is sensitive to many factors, including quarter-to-quarter variability in product mix, pricing strategies, changes in wholesale, shipping and fulfillment costs and fees earned for supplier services rendered. In 2021, cost of goods sold decreased by $220 million, or 2.2%, compared to 2020. The decrease in cost of goods sold is primarily driven by a decrease in the number of orders delivered partially offset by higher fulfillment costs.

The increase in cost of goods sold as a percentage of net revenue is partly due to lower operational efficiency from fewer orders and inflationary pressures in the supply chain relative to the same period in 2020.

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Operating expenses

Operating expenses are comprised of customer service and merchant fees, advertising, selling, operations, technology, general and administrative expenses and customer service center impairment and other charges. We disclose separately the equity-based compensation and related taxes that are included in customer service and merchant fees and selling, operations, technology and general and administrative expenses.

(1) Includes equity-based compensation and related taxes as follows:

Our equity-based compensation and related taxes included in customer service and merchant fees and selling, operations, technology, general and administrative increased by $75 million in 2021 compared to 2020 as a result of increased restricted stock units awarded in 2021 at a higher average grant date fair value than in 2020.

The following table summarizes operating expenses as a percentage of net revenue, excluding equity-based compensation and related taxes:

Customer Service and Merchant Fees

Expenses for customer service and merchant fees, including and excluding the impact of equity-based compensation and related taxes and as a percentage of net revenues, increased in the year ended December 31, 2021, as compared to the same period in 2020, due to increased compensation costs and a decrease in net revenue.

Advertising

Our advertising expenses decreased by $34 million in 2021 compared to 2020, which reflects our response to changing market conditions as we sought to maintain our efficiency targets across various channels. As a percentage of net revenue, advertising expenses remained relatively constant in 2021 compared to 2020, as we aimed to deploy advertising dollars within our efficiency parameters.

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Selling, operations, technology, general and administrative

Excluding the impact of equity-based compensation and related taxes, our expenses for selling, operations, technology, general and administrative activities increased by $121 million in 2021 compared to 2020. The increase is primarily attributable to higher personnel costs, and to a lesser extent higher information technology costs and depreciation and amortization. As a percentage of net revenue, total selling, operations, technology, general and administrative expenses increased to 14.7% in 2021 compared to 12.9% in 2020, primarily due to the decrease in net revenue.

Customer service center impairment and other charges

During the year ended December 31, 2021, we enacted a plan to consolidate certain customer service centers in identified U.S. locations. As a result, we recorded a charge of $12 million during the year ended December 31, 2021, which included $6 million for the non-cash impairment of ROU assets, $5 million for the non-cash accelerated depreciation of fixed assets and the remainder for other items.

Interest (expense), net

Our interest expense, net decreased by $114 million in 2021 compared to 2020, primarily attributable to the adoption of ASU 2020-06 on January 1, 2021.

Other (expense), net

We incurred other (expense), net of $4 million primarily as a result of the fair value losses related to the adjustments of our warrants of $3 million and our net foreign currency revaluation losses of $1 million. We incurred $9 million other (expense), net, in 2020, primarily attributable to the $13 million loss for the extinguishment of debt for the 2022 Note partially offset by net foreign currency revaluation gains of $4 million.

Provision for income taxes, net

Our provision for income taxes, net decreased by $19 million in 2021 compared to 2020, primarily related to reduced income earned in the U.S. and certain foreign jurisdictions and the recognition of a tax benefit related to excess tax benefits on equity awards for U.S. employees, offset by the increase in our valuation allowance.

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Liquidity and Capital Resources

Sources of Liquidity

At December 31, 2021, our principal source of liquidity was cash and cash equivalents and short-term investments totaling $2.4 billion. In addition, on March 24, 2021, Wayfair and certain of its subsidiaries entered a new credit agreement and $600 million senior secured revolving credit facility that matures on March 24, 2026 (the “Revolver”). The Revolver replaced our previous $200 million senior secured revolving credit facility, which was set to mature on February 21, 2022. Wayfair had outstanding letters of credit, primarily as security for certain lease agreements, for approximately $59 million as of December 31, 2021, which reduced the availability of credit under the Revolver. Excluding liquidity available through our Revolver, the following table shows sources of liquidity as of December 31, 2021 and 2020:

We believe that our existing cash and cash equivalents and investments, cash generated from operations and the borrowing availability under our Revolver 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. Further, we may from time to time seek to retire, restructure, repurchase or redeem, or otherwise mitigate the equity dilution associated with our outstanding convertible debt through cash purchases, stock buybacks of some or all of the shares underlying convertible notes and/or exchanges for equity or debt in open-market purchases, privately negotiated transactions or otherwise. Such repurchases, exchanges or liability management exercises, if any, will be upon such terms and at such prices and sizes as we may determine, and will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors. The amounts involved may be material.

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 in Part I, Item 1A, Risk Factors. In addition, the COVID-19 pandemic and related measures to contain its impact have caused disruption in the global capital markets, which could make obtaining financing more difficult and/or expensive. As a consequence, we may not be able to secure additional financing to meet our operating requirements on acceptable terms, or at all. If we raise additional funds through the issuance of equity, equity-linked or debt financing arrangements, those securities and instruments may have rights, preferences or privileges senior to the rights of our common stock, and the holders of our equity securities may experience dilution. We will continue to monitor our liquidity during this time of historic disruption and volatility in the global capital markets due to the COVID-19 pandemic.

Credit Agreement and Convertible Debt

Under the terms of our Revolver, we may use proceeds to finance working capital and to provide funds for permitted acquisitions, repurchases of equity interests and other general corporate purposes. Any amounts outstanding under the Revolver are due at maturity.

As of December 31, 2021, we had $3.1 billion of indebtedness outstanding. The conditional conversion features of the 2022 Notes, 2024 Notes and 2026 Notes were triggered during the fourth quarter of 2021, and the 2022 Notes, 2024 Notes and 2026 Notes therefore are convertible in the first quarter of 2022 pursuant to the applicable last reported sales price conditions. The conditional conversion feature of the 2025 Notes was not triggered during the fourth quarter of 2021, and the 2025 Notes are therefore not convertible in the first quarter of 2022 pursuant to the applicable last reported sales price conditions. The 2025 Accreting Notes are convertible at any time prior to the second business day immediately preceding the maturity date.

During 2021, holders of the 2022 Notes and 2026 Notes converted $15 million of aggregate principal and received 147,414 shares of Wayfair’s Class A common stock, and GHEP VII Aggregator, L.P ("Great Hill") converted $253 million of accreted principal of the 2025 Accreting Notes and received 3,490,175 shares of Wayfair's Class A common stock.

Whether any of the Non-Accreting Notes will be convertible in future quarters will depend on the satisfaction of the applicable last reported sales price condition or another conversion condition in the future. If one or more holders elect to convert

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their Non-Accreting Notes at a time when any such Non-Accreting Notes are convertible, unless we elect to satisfy our conversion obligation by delivering solely shares of our Class A common stock (other than paying cash in lieu of delivering any fractional share), we would be required to settle a portion or all of our conversion obligation through the payment of cash, which could adversely affect our liquidity.

For information regarding our credit agreement and convertible notes, see Note 6, Debt and Other Financing included in Part II, Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.

Stock Repurchase Program

On August 21, 2020, the Board authorized the repurchase of up to $700 million of Wayfair’s Class A common stock in the open market, through privately negotiated transactions, or otherwise, including pursuant to a Rule 10b5-1 plan (the “2020 Repurchase Program”). On August 10, 2021, the Board authorized a new $1.0 billion share repurchase program on the same terms (the “2021 Repurchase Program” together with the 2020 Repurchase Program, the “Repurchase Programs”). There is no stated expiration for the share repurchase programs. Wayfair will begin repurchasing shares under the 2021 Repurchase Program upon the completion of the 2020 Repurchase Program.

The Repurchase Programs do not obligate Wayfair to purchase any shares of Class A common stock and have no expiration but may be suspended or terminated by the Board at any time. The actual timing, number and value of shares repurchased under the Repurchase Programs in the future will be determined by Wayfair in its discretion and will depend on a number of factors, including market conditions, applicable legal requirements, our capital needs and whether there is a better alternative use of capital. As of December 31, 2021, Wayfair has repurchased 1,806,318 shares of Class A common stock for approximately $537 million under the Repurchase Programs. In 2022, Wayfair repurchased 548,173 shares of Class A common stock for approximately $75 million under the Repurchase Programs at an average price of $136.80 per share.

Trends and Historical Cash Flows

Operating Activities

Cash flows in connection with operating activities consisted of net (loss) income 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) income.

Cash flows from operating activities in 2021 decreased by $1.0 billion from 2020 primarily due the decrease in net (loss) income of $316 million, decrease in cash from operating assets and liabilities of $673 million, decrease in amortization of discount and issuance costs related to our convertible notes of $127 million, and decrease in other non-cash items of $7 million, partially offset by the increase in depreciation and amortization expense of $36 million, increase in equity-based compensation of $68 million and loss on impairment of $12 million.

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Investing Activities

Cash flows for investing activities in 2021 increased $279 million from 2020 due to the increase in purchases of short- and long-term investments of $508 million and increase of site and software development costs of $30 million, partially offset by the increase in sales and maturities of short- and long-term investments of $169 million, decrease in purchases of property and equipment of $85 million, and increase in other investing activities of $5 million. Purchases of property and equipment and site and software development costs (collectively, "Capital Expenditures") were 2.0% of net revenue for the year ended December 31, 2021 and related primarily to equipment purchases and improvements for leased warehouses within our expanding logistics network and ongoing investments in our proprietary technology and operational platform. On an absolute dollar basis, we expect Capital Expenditures for the first quarter of 2022 to be within the range of $95 million to $105 million as we continue to build out our technology and logistics network.

Financing Activities

Cash flows for financing activities in 2021 was $303 million due to the repurchase of Class A common stock under the Repurchase Programs of $300 million in the period, as well as other financing activities of $3 million. This compared to $353 million of cash flows from financing activities in 2020, primarily due to the $2.0 billion of proceeds from the issuance of convertible notes, net of issuance costs, partially offset by an aggregate payment of $1.0 billion to partially extinguish convertible debt, $255 million of premiums paid for capped call confirmations and the repurchase of Class A common stock of $380 million during the period.

Off-Balance Sheet Arrangements

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

Contractual Obligations

The following table summarizes our contractual obligations as of December 31, 2021:

(1) Represents future interest and principal payments on the Notes. For information regarding our convertible notes, see Note 6, Debt and Other Financing, in the notes to the consolidated financial statements included in Part II, Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.

(2) Represents the future minimum lease payments under non-cancellable leases. For information regarding our lease obligations, see Note 5, Leases, in the notes to the consolidated financial statements included in Part II, Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.

(3) Represents the future payments for enforceable and legally binding software license and freight commitments. For information regarding our purchase obligations, see Note 7, Commitments and Contingencies, in the notes to the consolidated financial statements included in Part II, Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.

(4) Represents the future minimum lease payments for additional, non-cancellable operating leases, primarily related to build-to-suit warehouse and retail leases that have not yet commenced. This amount includes $18 million of total expected reimbursements related to tenant improvements under such leases. For more information see Note 5, Leases, in the notes to the consolidated financial statements included in Part II, Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.

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Non-GAAP Financial Measures

Adjusted EBITDA

To provide investors with additional information regarding our financial results, we have disclosed here and elsewhere in this Annual Report on Form 10-K Adjusted EBITDA, a non-GAAP financial measure that we calculate as net (loss) income before depreciation and amortization, equity-based compensation and related taxes, interest expense, net, other (expense) income, net, provision for income taxes, net, non-recurring items and other items not indicative of our ongoing operating performance. We have provided a reconciliation below of Adjusted EBITDA to net (loss) income, the most directly comparable GAAP financial measure.

We have included Adjusted EBITDA in this Annual Report on Form 10-K because it is a key measure used by our management and the Board 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 as these costs may vary independent of business 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 the Board.

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 interest expenses associated with our borrowings;

•Adjusted EBITDA does not include other items not indicative of our ongoing performance; 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) income and our other GAAP results.

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

(1) In the year ended December 31, 2021, we recorded $12 million of customer service center impairment and other charges related to our plan to consolidate customer service centers. During the year ended December 31, 2020, we

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recorded a $4 million charge in selling, operations, technology, general and administrative expenses for severance costs associated with February 2020 workforce reductions.

Free Cash Flow

To provide investors with additional information regarding our financial results, we have also disclosed here and elsewhere in this Annual Report on Form 10-K Free Cash Flow, a non-GAAP financial measure that we calculate as net cash flows from or for operating activities less Capital Expenditures. We have provided a reconciliation below of Free Cash Flow to net cash flows from or for operating activities, the most directly comparable GAAP financial measure.

We have included Free Cash Flow in this Annual Report on Form 10-K because it is an important indicator of our business performance as it measures the amount of cash we generate. Accordingly, we believe that Free Cash Flow provides useful information to investors and others in understanding and evaluating our operating results in the same manner as our management.

Free Cash Flow has limitations as an analytical tool 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 flows from or for operating activities, Capital Expenditures, and our other GAAP results.

The following table presents a reconciliation of net cash flows from or for operating activities to Free Cash Flow for each of the periods indicated:

Net Revenue Constant Currency Growth

To provide investors with additional information regarding our financial results, we have disclosed in this Annual Report on Form 10-K Net Revenue Constant Currency Growth, a non-GAAP financial measure that we calculate by translating the current period local currency net revenue by the currency exchange rates used to translate our financial statements in the comparable prior-year period.

Net Revenue Constant Currency Growth is included in this Annual Report on Form 10-K because it is an important indicator of our operating results. Accordingly, we believe that Net Revenue Constant Currency Growth provides useful information to investors and others in understanding and evaluating trends in our operating results in the same manner as our management.

Net Revenue Constant Currency Growth 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. For example, Net Revenue Constant Currency Growth rates, by their nature, exclude the impact of foreign exchange, which may have a material impact on net revenue.

Adjusted Diluted Earnings (Loss) per Share

To provide investors with additional information regarding our financial results, we have disclosed in this Annual Report on Form 10-K Adjusted Diluted Earnings (Loss) per Share, a non-GAAP financial measure that we calculate as net (loss) income plus equity-based compensation and related taxes, provision for income taxes, net, non-recurring items, other items not indicative of our ongoing operating performance, and, if dilutive, interest expense associated with convertible debt instruments under the if-converted method divided by the weighted-average number of shares of common stock used in the computation of diluted (loss) earnings per share. Accordingly, we believe that these adjustments to our adjusted diluted net income (loss) before calculating per share amounts for all periods presented provides a more meaningful comparison between our operating results from period to period.

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Adjusted Diluted Earnings (Loss) per Share 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. For example, Adjusted Diluted Earnings (Loss) per Share, by their nature, excludes equity-based compensation and related taxes, provision for income taxes, net, non-recurring items, other items not indicative of our ongoing operating performance, and, if dilutive, interest expense associated with convertible debt instruments under the if-converted method.

Because of these limitations, you should consider Adjusted Diluted Earnings (Loss) per Share alongside other financial performance measures.

A reconciliation of the numerator and denominator for diluted (loss) earnings per share, the most directly comparable GAAP financial measure, and the numerator and denominator for Adjusted Diluted Earnings (Loss) per Share, is as follows:

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Critical Accounting Policies

Our financial statements are prepared in accordance with accounting principles generally accepted in the U.S. The preparation of our financial statements and related disclosures requires us to make estimates, assumptions and judgments that affect the reported amount of assets, liabilities, net revenue, costs and expenses and related disclosures. We believe that the estimates, assumptions and judgments involved in the accounting policies described below have the greatest potential impact on our financial statements and, therefore, we consider these to be our critical accounting policies. Accordingly, we evaluate our estimates and assumptions on an ongoing basis. Our actual results may differ from these estimates under different assumptions and conditions. See Note 1, Summary of Significant Accounting Policies, in the notes to the consolidated financial statements included in Part II, Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K for information about these critical accounting policies, as well as a description of our other significant accounting policies.

Revenue Recognition

We generate net revenue through product sales generated primarily through our family of sites.

We recognize revenue using the gross method for product sales generated through our family of sites only when we have concluded that Wayfair controls the product before it is transferred to the customer. Wayfair controls products when it is the entity responsible for fulfilling the promise to the customer and takes responsibility for the acceptability of the goods, assumes inventory risk from shipment through the delivery date, has discretion in establishing prices and selects the suppliers of products sold. We recognize net revenue when the product has been delivered to the customer.

We ship a large volume of packages through multiple carriers. When delivery dates are not available, we estimate delivery dates based on historical data. Net revenue from product sales includes shipping costs charged to the customer and is recorded net of taxes collected from customers, which are remitted to governmental authorities. Cash discounts and rebates earned by customers at the time of purchase are deducted from gross revenue in determining net revenue. Allowances for sales returns are estimated and recorded based on prior returns history, recent trends and projections for returns on sales in the current period.

We recognize gift cards and site credits in the period they are redeemed. Unredeemed gift cards and site credits not subject to requirements to remit balances to governmental agencies are recognized as net revenue based on historical redemption patterns, which are substantially within twenty-four months of issuance.

We maintain a membership rewards program for purchases made with our private label Wayfair credit card and co-branded Mastercard ("Credit Card Program"). Enrolled customers earn points that may be redeemed for future purchases. We defer a portion of our revenue associated with rewards that are ultimately expected to be redeemed.

As part of the Credit Card Program, in exchange for providing intellectual property, we receive payments based on spending activity and the profitability of the card. Revenue based on the spending activity of the underlying accounts is recognized as the respective card purchases occur and profit share is recognized based on the performance of the underlying portfolio.

Leases

We generally lease office and warehouse facilities under noncancelable agreements. Upon each agreement's commencement date, we determine if the agreement is part of an arrangement that is or that contains a lease, determine the lease classification and recognize ROU assets and lease liabilities for all leases with the exception of leases with terms of 12 months or less. We have arrangements with lease and non-lease components, and we account for lease and non-lease components as a single lease component for our corporate headquarters and field offices. For all other lease arrangements, we account for lease and non-lease components separately. As of December 31, 2021 and 2020 we did not have material finance lease arrangements.

Lease liabilities and their corresponding ROU assets are recorded based on the present value of lease payments over the expected lease term at the lease commencement date. As most of our leases do not provide an implicit rate, we use an estimated incremental borrowing rate (“IBR”) based on the information available at the commencement date to determine the present value of future payments. The determination of the IBR requires judgment and is primarily based on publicly-available information for companies within the same industry and with similar credit profiles. We adjust the rate for the impact of collateralization, the lease term and other specific terms included in each lease arrangement. The IBR is determined at the lease commencement and is subsequently reassessed upon a modification to the lease arrangement. The ROU asset also includes any lease payments made prior to the commencement date and excludes lease incentives and initial direct costs incurred.

Lease expense for minimum lease payments is recognized on a straight-line basis over the lease term. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise that option.

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We review ROU assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the ROU asset may not be recoverable. When such events occur, we compare the carrying amount of the ROU asset to the undiscounted expected future cash flows related to the ROU asset. If the comparison indicates that an impairment exists, the amount of the impairment is calculated as the difference between the excess of the carrying amount over the fair value of the ROU asset. If a readily determinable market price does not exist, fair value is estimated using discounted expected cash flows attributable to the ROU asset.

For additional information regarding our lease arrangements, see Note 5, Leases, in the notes to the consolidated financial statements included in Part II, Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.

Recent Accounting Pronouncements

For information about recent accounting pronouncements, see Note 1, Summary of Significant Accounting Policies, in the notes to the consolidated financial statements included in Part II, Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.