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THOMSON REUTERS STREETEVENTS

EDITED TRANSCRIPTZU - Zulily Inc Analyst Day

EVENT DATE/TIME: SEPTEMBER 11, 2014 / 4:30PM GMT

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C O R P O R A T E P A R T I C I P A N T S

Darrell Cavens zulily, inc. - President, CEO, and Co-founder

Bob Spieth zulily, inc. - COO

C O N F E R E N C E C A L L P A R T I C I P A N T S

Paul Bieber BofA Merrill Lynch - Analyst

Mark Mahaney RBC Capital Markets - Analyst

Mark Miller William Blair & Company - Analyst

Shawn Milne Janney Montgomery Scott - Analyst

Neil Doshi CRT Capital Group - Analyst

P R E S E N T A T I O N

Darrell Cavens - zulily, inc. - President, CEO, and Co-founder

Well, I'd love to first off just welcome everybody to our fulfillment center here in Columbus. Appreciate those of you here in person taking the timeand coming out here. I know it's not necessarily the easiest place to get to, but we think we've got something pretty special here to show you today.

So I'm going to walk through a set of slides on the business. And we've got a few new stats and updates that many of you have been asking us for.And we're going to show you a little more about what's going on behind the scenes.

And then I'm going to have Bob Spieth, my Chief Operating Officer, come up and spend a little time talking about fulfillment, what we've builthere, and then we're going to spend a little time out on the floor and show you the process of how a zulily order flows through and how we executeit.

So first off, my friendly handy-dandy lawyers have asked me to read this statement before we get started. I just want to spend a few seconds onthe special note regarding our forward-looking statements.

As with most presentations, the following discussion contains forward-looking statements and our actual results may differ materially from thosediscussed here. Additional information concerning factors that could cause such a difference can be found in our most recent annual and quarterlyreport filed with the SEC. Thanks for that.

So I think many of you that follow the business know this well, but just as I start talking to people about the business, I think it's always useful toreiterate what is special about zulily.

When Mark and I started this business back in 2009, 2010, what we had seen over the last 10 years was e-commerce be all about bringing thebig-box store online. And it was about more selection, more product, and if 50 of a product was great, 500 must be better. It was all about howthat broadened offering.

And we really thought that consumers would be open to a different way of shopping. We were seeing some kind of passion in the flash spacearound browse and discover experiences. Really kind of bringing that specialty retail experience online.

And I think what we have to realize is that customers come into our site every day, so the tens of thousands of people that have bought from usalready this morning -- they showed up not intending to buy. So they showed up to get in experience and discover what is fresh and new.

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They tend to find great product, unique product, differentiated that they couldn't find elsewhere and just at incredible value. And I think it's justworth reiterating that these customers are coming back to us again and again and again and really in a form of entertainment. To discover what'sthere. They're not showing up with purchase intent.

It's just so different than almost every other online retail experience out there. I think it's just a good thing to remember and recognize the foundationas we walk through the next set of data.

I think as you look at slide 5, what you'll see is I think our results really speak for themselves. In four and half years, this business has grown very,very rapidly. As of Q2, 4.1 million active customers.

And we've now got over 9000 styles of product we're launching a day on the site. You're going to see that as we walk out of the fulfillment center.The diversity of product that we are selling. Spend a little time on the site and you're just going to see a really unique set of product you're notgoing to find elsewhere.

We had 5.4 million orders placed in Q2. Over 19 million orders in the last 12 months -- trailing 12 months through Q2. Just before walking in here,I was just looking for comparison numbers.

I was just looking at the Wayfair S1 and seeing over their last year, they did 3.3 million orders. We did in that same period about 19 million. So thenumber of orders, incredibly high. And our average order, 2.5 items per order.

So you look at that and it's -- the number of units we're shipping: about 50 million units in the last 12 and trailing 12 months as of Q2. So incrediblylarge number of units and volume that we are working to execute.

We've got over 1700 people now that are employees of zulily and over 2000 associates in our warehouses. So you will see this building here inOhio has about 1100 people in it.

And we run that two shifts -- about 20 hours a day we are running to kind of -- this building. And so a tremendous amount of volume and haveduplicated that out in our Reno facility.

I want to start with marketing. And this is a story that we've told a lot of you about. But I think it's still continues to confuse people a little bit. Justwant to take a moment to explain that.

As we look at investing our marketing dollars, it's very much aimed at getting email subscribers to sign up to the site. And we then work very hardto get those subscribers to come in and buy over time.

So when we get a subscriber -- a new customer that -- or new member that signs up today, is highly unlikely to come in and purchase today. Wehave some that certainly do, but our customers activate over -- our members activate to customers over long periods of time.

And we're going to show you some data on how those customers behave, but I think it's critical when folks look at our marketing spend in anygiven quarter, realizing that unlike a off-line retailer, somebody like a Macy's, where they are showing you a TV ad today and trying to get you tocome in the store later today or tomorrow, that's not how our marketing dollars are being viewed by us. We are really trying to get that memberand then get them over time to convert to buyers.

Once we get those buyers in, we work really hard to turn them into repeat customers. I'm going to show you some data on that today about howour customers are behaving as repeat customers. And then we're also going to highlight some more data on how those repeat customer spendover time.

So starting with marketing, I would say one of the three most frequent questions we get from folks is where are you spending the marketing dollars?And so for the first time today, we're just giving a more detailed breakdown of where we are spending our marketing dollars.

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It's one of the things that from day one I have loved about this business is that we don't have any one channel that represents -- as you look at this-- anywhere close to even 50% of our marketing spend. So it's very diverse.

And even within these channels you see here on slide 7, what you're seeing is that there are multiple partners and advertisers in each of thosebuckets. So when I look at the opportunity for growth going forward, it just points to me that we've got a lot of these channels that have a lot moreheadroom and that we can go very diverse.

We are not dependent on any single channel that if they change their model, if they change pricing in there, we can tell our story to customersacross a lot of different platforms and ways and get them to come back and engage with us.

So I think this is something that's pretty special about zulily relative to other e-commerce businesses. Many that I would anticipate if you go talkto others, they're going to talk about search as their number one channel. And that's because people are coming in with a directed product inmind.

They are saying I need a fill in the blank. For us, our customers, where we are able to get them, showing them a great photo about their kids or awomen's product, a home product, get them to engage with the site, and do that across a lot of different channels.

So as those customers and members sign up through that marketing, what we see is that these customers turn in to absolutely great long-termcustomers for us. So as you look at slide 8 here, what we're showing is customer cohort data.

So we just want to walk through that. A customer cohort is defined as a customer who made their first purchase in each of these years. This is alittle different than the cohort data we showed you in the S1, where we were focusing on member cohorts.

In the S1, we were looking at when a member signed up. And how they converted customers. This is those customers in their first -- they end upin the cohort when they made their first purchase. So I think -- a couple of things I want to point out here.

When you look at the North American sales by annual cohort, what you see is if you look at 2013, as an example -- sorry, the 2012 group -- and lookat their behavior into 2013, those customers -- if we had not acquired a single customer in 2013, we would have grown the business by about 13%.

So what we're finding is these customers come in, that repeat dynamic -- I'm going to show you a little more data on that -- is they end up comingin. They are spending more over time.

And we talked about this, but we've never show you the data. And we get a tremendous amount of questions on this, having people understandhow these customers are behaving.

And I think this data will help you see how consistent it's been -- even as we've added categories, as we have grown those cohorts in size, consistentbehavior continues to be there. And we think this is one of the things that makes our business and just the unique zulily brand experience special.

On the right-hand side, what you see is active customers by customer cohort. If you look at any given period -- so on annual period basis -- if wego acquire 100 customers, a year later, roughly 50% of those customers are still active with us.

After that period, they stay active for a long time. That customer group, that 50 customers, degrades in a very slow percentage. Low-single-digitpercentage after that year after year. And so we are able to take those customers and they stay with us over a long period of time.

What that translates to is a customer that's -- an active customer that buys more year after year. And so as you look at this first-year customer buyingabout $150 -- $167 in the first year, that was the FY 2013 group and how consistent they are.

I think when you look at these lines, they layer right over top of each other. And as we've grown the cohorts, as we've expanded the diversity ofproducts, the consistency here I think you'll see is pretty stunning.

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And this is what gives us the confidence to make these investments in these fulfillment centers -- in the infrastructure, in the hiring. Because as weacquire these customers, they are so stable over time. They stick with us and they buy more and it's that level of engagement that is just very uniqueand special here.

Yes, we think this is pretty unique and I think hopefully helps you all understand the business better. And as you look at the customer cohortbehaviors and the spend, I think it will help folks to be able to model the business better and understand the customer behaviors in a way that wehave talked around and we try to really explain in the S1, but the level of detail here is much more than we've ever given before.

And so breaking that data down just into some specific numbers for you -- so on slide 10, what we've got is each customer cohort, the number ofcustomers in that cohort, the cumulative sales that that cohort has driven, and then some marketing. And I'm going to kind of walk through this.

But if you look at the 2011 cohort -- so in 2011, we had 706,000 new customers that bought from us for the first time in 2011. Those customershave spent $435.7 million with us cumulative through Q2.

Now this isn't a great map here, because I just explained a few slides go about how marketing works, but just to give you a sense of marketing, wespent in 2011 $20 million in marketing.

Now some of that marketing dollar was around members that then activated in 2012 and 2013, but it helps to give you a view of how that marketingdollar ratios have grown and how the customer cohorts can even spend more and more and more over time.

So hopefully useful data for you to see. And as you look at the curves on the prior slide, will help you model and understand the customer behaviorsmuch, much better.

So all that customer data and that customer behavior leads to our need to be able to ship those products to customers. We started back in 2010.Our first fulfillment center was in the back of our office. It was actually in the back of Dan's office here -- he is in the room -- from [Maveron], wherewe first launched the business.

We were shipping out of their corporate DC office, which was -- he was very gracious to let us do that, but not a sustainable and scalable way. Andso we launched with a partner -- a first third-party logistics provider in February 2010.

The business grew very rapidly. We brought on another larger partner in 2011. And then late 2011 and 2012, we brought on our first two facilities.The first one in Reno and then in -- it was January of 2012, we launched this building here that you're in today. And have continued to grow.

Yes, Bob is going to talk about it a little more, but yesterday, we also announced that we will be opening a new roughly 800,000-square-foot facilityin Bethlehem, Pennsylvania.

And just as we look to expand the network -- again, Bob will walk through why we've chosen these locations. But continue to expand the facilitiesto be able to handle this level of volume.

As you look at what we're doing in these facilities, we think that it is pretty unique. With 9000 new styles of product a day being launched, whatyou see on the receiving dock everyday is entirely different than what you saw yesterday and is highly different than the day before.

And we work with an incredibly diverse group of vendors. Everything from the folks that are sending us multiple truckloads and container loadsof product to those folks that are putting it in some boxes they got down at their local UPS store, dropped it in, put some tape around it, and stucka label on it, and sent it to us. And everything in between.

And so we've got a lot of technology and processing -- processes that allow us to do that very, very efficiently. And the average order -- our averageorder is, again, about $55. Our average unit is about $18. So when you look at those price points, we've got to be very efficient in how we do it.

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And so we make sure that whether we are single units, multi-units, that we are able to move them through this building very rapidly. When anitem comes in one side of this building, many of those items are shipping out the other side on the same day or next day.

And so a lot of work in this building -- we move very fast. And we can talk later about the full supply chain timeline, but once we get it into ournetwork, we are able to move them through very, very rapidly. And we talked before about just the volumes that we're then handling.

CapEx and where we are spending our CapEx is a question that has come up a lot over the last year. And so here today showing you for the firsttime a little more detail on where we are spending our capital expenditures.

So if you look at 2014, we've got 78% of our planned CapEx going to our fulfillment and distribution. We've got 10% in just our general corporateoffice space. Back in Seattle, we are in our sixth office in four years. We continue to grow very rapidly there.

And then 12% of our investment going into technology. Most of that being into internally developed software from our technology organization.

So if you look at this building here in Ohio, to build this building out, we've spent about $35 million. And as I look at the end of this year, betweenour two facilities, we are shipping about 50% out of each. So about 50% out of Nevada and 50% out of here in Ohio.

And as I look at the end of the year, we think we'll be at about 60% capacity in both facilities, which -- so if you take simple math here and say themid-range of guidance at $1.212 billion and about 60% capacity, that means that we've got about $1 billion in capacity in this building that we'vespent $35 million to $40 million on.

And so as we think about future capital investments, I think the thing for folks to look at and model on is not to be focused on CapEx as a percentof revenue, but rather CapEx going towards dollar growth.

And so as we look at a $35 million to $40 million investment to drive about $1 billion in sales, we think that's a fairly linear CapEx. As we add moresales, the amount of CapEx we're going to need from a fulfillment and distribution is really focused on the growth of dollars going forward asopposed to on a percent of sales.

Just a moment on how we work with our vendors and our technology investment. As you look at -- on slide 14 for those listening in -- what yousee here is a screenshot of our vendor portal, where our vendors can come in and help manage the relationship with us.

We've got over 15,000 vendors and brands that work with us today. And so we put a lot of technology investment into making sure that thatexperience is great and that they can work with us in the way that suits them best.

And so whether it's them coming in and auditing their inventory on what we're going to run. Or looking at their sales history of what we run, thespecifics. Being able to come in and print labels, auto-invoicing -- we've done a lot of work over the last 18 months to enable the vendors to bemuch more self-service and to allow them to interact with us in a way that works most valuable for them.

This technology as well as the technology you're going to see out on the floor in the warehouse here has been almost entirely custom-built. So weuse very little in the way of off-the-shelf technology.

What we've found is that our systems and our processes are just different. When we are looking at this diversity of product, the number of brandsis just not something that others have done and there isn't off-the-shelf software that we can just go pull from.

As we look forward with our vendors, we think there's a lot of opportunity to continue to integrate more with them. With these 15,000 vendors,it's everything from that small mom down the street here in Ohio that's got a home-based business to large multinationals that we are workingwith.

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And with that diversity, a lot of them don't necessarily have things like planning. So we've built a merchandising planning organization now in-houseand have hired a great group of people that doesn't look like any traditional merch planning organization you going to see.

Our planning org is much more focused on helping our vendors grow. It's helping our vendors understand what over the next year they need todo to move them from a $2 million vendor to a $10 million, $20 million vendor. And so a lot of effort there, we think, helping them with theirfulfillment and logistics.

And so whether that is working with them to find somebody that can scale better and work with us better. Partnering with them on things likeconsignment is something that we started doing more of in the last year. Bringing goods in advance so that we can ship them more rapidly. Wethink there's a lot of future investment here that can help drive that relationship with the vendor.

It's equally critical -- that relationship with our customer -- as with our vendor. We put a tremendous amount of effort into both of them.

Just want to touch a minute on slide 16 on the -- our fulfillment center team that we've built. We've got -- between the two buildings and our teamin Seattle focused on a supply chain and logistics, well over 2000 people.

What you see up on screen here is the leadership team in fulfillment. Bob, who I mentioned a moment ago, is going to talk -- joined us about twoyears ago from -- or he is the President of OHL logistics, one of the largest third-party logistics providers here in the US, and has a tremendousamount of experience there.

But you see that we've brought in talent that has done this at scale. And that follows down to the next level down in the organization as well,whether it's in the technology area or in the buildings to make sure that we've got capability to scale and grow much, much larger than we aretoday.

Just in the way of wrap up, I think we've got something pretty special here. I think we've got incredible unit-level economics. We've got a set oftechnology infrastructure that is unique to us and hard to replicate. And I think that relationship with vendors and the team just makes what weare doing special.

So with that, I'll turn it over to Bob and he's going to walk you through how we actually do this.

Bob Spieth - zulily, inc. - COO

Sure. Thanks, Darrell, and thanks, everyone, for joining us here today to see the Ohio fulfillment center. I'd like to start off -- operations at zulilyencompasses a number of functions.

It includes our studios; it includes our customer service, our facilities. Here today, we're really going to focus on fulfillment, which is our two fulfillmentcenters, soon to be three. And then our transportation and vendor operations.

Really stepping back to our supply chain and walking through the steps in that. We are really built around the event at zulily. And an event is really-- as Darrell mentioned earlier, every day we will go live with 100 events at 6 AM in the morning.

That event process starts with a buyer, building a relationship with a vendor, getting samples, having those sent to one of our three merchantoffices. And then curating the event -- deciding exactly which items we're going to launch on the site, inspecting them for quality, and then turningthem over to one of our studios for photography.

And at either studio is at that scale. We are running 50 studios across three different sites, photographing thousands of styles each day. And thephotos both show up on the site.

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They are also a key part of our process. As you walk through the processes out on the floor, you'll see most of our functions have photos of theproducts involved in that, because of the diversity of SKUs we're handling, because of the number of items we're handling that don't have a barcodeon them, because of the number of small vendors. We make that a part of the process.

We then go on to the event launch. The event launches at 6 AM and at that point, customers start ordering. After customers are ordering, we'rethen beginning to place purchase orders with our vendors.

One or more purchase orders over the course of that 72-hour event are placed with our vendors. Our vendors are then preparing the items forshipment and as soon as they are ready to ship, they are calling zulily or notifying us on the web and saying the items are ready and we are thenarranging transportation from there.

So zulily takes it from there. We manage the carriers, we bring it in to our fulfillment centers, and we're doing that in order to have the visibility andhave the speed and control that part of the process.

The items then flow through the fulfillment center. If it's a single item -- if the customer has just ordered one item -- it will typically flow throughwithin a matter of hours. It comes in, goes right back out -- you'll see that process.

If it's multiple items, then we will hold the one item, waiting for the other items of the order to arrive, and then ship it all out together.

We are often asked about the order-to-ship process. What takes time in the order-to-ship process. And the majority of the time, it's sitting in thisstep. It's in the step where we are placing the purchase order, the vendor is preparing items for shipment, and getting those ready for shipment,then calling on zulily to bring them to our fulfillment centers.

That's really the place where the time is consumed. And as Darrell alluded to earlier, that's where we've got a lot of effort focused on how do wework more tightly with our vendors to shrink that time, to pull time out, and to reduce variability?

Going on to slide 21 -- in the last 12 months, we've had 19 million orders. That's 52,000 orders a day. So we are operating at scale, operating withtremendous complexity.

9000 new product styles every day. Large diversity of products -- from large furniture items to jewelry to apparel. Over 100 vendors a day rangingfrom very large companies you've heard of to mom-and-pops operating out of their garage. And then multiple purchase orders per vendor. So avery complex distribution network.

We did announce yesterday that we are opening a new fulfillment center in Bethlehem, Pennsylvania, in the first half of next year. That will be800,000 square feet, slightly larger than both our Ohio and Nevada fulfillment centers.

The reason we chose Bethlehem is reasonably obvious, looking at the map. This is our customer density. And as you'd expect, a large percentageof customers are in the Northeast.

So by adding fulfillment capacity there, we will both reduce transportation costs, we will speed that final shipment to the customer, and we willalso be operating closer to some of our vendors. So it's adding capacity in a location that will help us from an efficiency standpoint.

Unidentified Audience Member

(inaudible - microphone inaccessible)

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First half of next year. First half of 2015.

I would now like to turn to slide 23, orienting you to our fulfillment center in Ohio, which we will be walking through later and giving you a senseof some of the key parts of it as well as some of the differences from other FCs you may have walked through in the past.

One of the most significant differences is the ratio of storage space to processing space. So in the building you will see, we have an active storagearea on the floor and then we have a new mezzanine that we have just finished putting in.

In total, our storage space is a relatively small percentage of the building compared to the processing space, which makes up most of the centerof the building. And the reason for that is very simply our inventory turns. We are turning inventory 47 times a year.

In most other distribution centers, you are turning inventory 12 times a year, 4 times a year. There's much more space associated with actuallystoring goods, less space associated with processing.

The processes within the building that we will walk through. Product comes in through the receiving area. And then if it's a single item, as I talkedabout earlier, it will go straight to packing, shipping, sorting, and ship out the door. So a simple three step process if the customer ordered just oneitem.

If the customer ordered multiple items, then after the product is received, it will get sent to one of the active storage areas and then when the restof the items are received, it will go to packing and ship out the door. So that's the process.

What you are catching us right in the cusp of is a transition from a manual process to a more automated process. So I'm going to walk throughsome of the differences between our manual processes and more automated and explain some of the benefits we're going to see out of that andsome of the things you are going to see as you walk through.

Start off with receiving and sorting. So this is as product first comes in the building. So we are getting product in for the manufacturers or vendorsand they're typically packing it in cases.

So they are packing it is if is going into a normal retailer, going onto a shelf. And in the receiving process, we're taking it and we are turning it intounits. We are turning into eaches. We are turning it into the way our customers order it.

Our old process was entirely manual. We would detrash it, pull it out of the packaging, put it into totes, and then it would manually move throughthe building. In the new process, which we are 100% converted over to, the product gets taken out of its packaging, put into totes, immediatelyput on conveyor, and by conveyor, it's then transported to where it's needed next in the process. Pulls a lot of walking out, pulls a lot of humantransport through the building out, and improves our efficiency.

The second part of the process is where inventory gets stored. So the storage. The old style, which you will see, is that the product would get putaway into shelving units, which we would later then pick out of.

That was on manual. People on carts moving carts through 17 acres of floor space and putting product away and then picking through again thesame 17 acres of floor space to pick orders.

Our new processes, which are 25% live at this point, is that the product is delivered via conveyor to a zone and then the operator is entirely workingwithin that zone. So they are working in a much smaller area, walking less, more efficient, both zones on the floor and then zones in a new mezzanine.And that works from both a put away and a picking standpoint.

The older picking process -- and you'll see these carts as you walk through -- an operator was picking 20 orders at a time with a very large cart,walking across 700,000 square feet -- 17 acres.

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When we would strap a pedometer to our -- some of our operators would wear pedometers -- and at the end of the day it would be I walked 8miles. I walked 10 miles. It was that kind of walking over the course of a day.

In the new process, an operator stays within a zone. They pick within a zone, they put the product on conveyor, and it then goes to a consolidationarea. And in the consolidation area, the orders are then consolidated. So much more efficient process.

Throughout -- the conveyor is largely transporting product, 6 miles of conveyor throughout. And again, all up and operating. We are in the processof transitioning over the course of the next month from one process to the other.

From an outbound standpoint, we were using manual labeling before. We've switched that to an automated labeling -- again, to reduce chanceof error and improve efficiency. With that labeling, we are automatically going in and seeing where the customer is based, when they expectdelivery, and sourcing the best carrier for the most efficient process.

To summarize, as Darrell said earlier, strong unit level economics with the investments; we expect that to continue and to increase. We've built acustom infrastructure that is built around our very low inventory model. Large number of vendors. It's rapidly changing SKUs. The technology you'llsee is all proprietary, built in house, and experienced operational team. Thank you.


And with that, I've got Mark Vadon, my cofounder here and our Chairman; Marc Stolzman, our Chief Financial Officer, and happy to take anyquestions here if you guys would like.

Unidentified Company Representative

Before we take the first question, I just wanted to clarify one number mentioned earlier in the presentation. Mark and I were feeding Darrell anumber off-mic.

The 2010 revenue per active customer was $117. And by comparison, the 2011, 2012, and 2013 were all -- you can see on the chart that they wereall very similar, at approximately $150 just slightly up, over, and slightly under.

So that first year had a little bit different pattern because it was the first year of revenue and was very backloaded. But that number, $117, thenumber after that ranging very close to $150 for each of those three annual cohorts.

Q U E S T I O N S A N D A N S W E R S

Paul Bieber - BofA Merrill Lynch - Analyst

Hi, Paul Bieber from Bank of America Merrill Lynch. With the automation that you've put in, what does that do to the throughput of the fulfillmentcenter? How much more efficient is it, just big picture?

And then secondly on the merchandising side, how much of the inventory, whether it's the sales or revenue, is liquidation versus in season?


So I will do the second one first and then jump to the other one. If you look at the site today, what you're going to see is the majority of goodsbeing in-season goods. While we certainly have some overstock and liquidation -- and I would say that's where we started thinking in the earlydays back in 2010 -- what we are finding now is most of our vendors are bringing us current in-season goods.

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Many of them are now out manufacturing goods for us and planning with us, where we've got vendors that are planned 12 or 18 months in advancewhat that calendar needs to look like.

And so if you go to the site today -- so it's September -- you're going to find a lot of fall jackets and winter items. And while we will certainly haveother items that are out of season, the majority is in-season, first-run goods.

On the efficiency side, I will let Bob jump in here as well, but we think that this is a meaningful impact on our productivity and throughput intobuilding a kind of capacity in the building as well.

So you think about this building here, and as we walk through, you'll see with 1000 people in it, it works okay. But even as you are walking thosecarts through, if you've got five people with a cart in an aisle, it gets kind of congested and jammed up.

If we were to double the headcount there, it would turn into chaos. So there's some amount of just general process improvement by allowing usto get more throughput out of the square footage. But the other thing I would point to is our gross margin trends and our gross margin target thatwe've had out there.

So we've said in the past that we think the right gross margin level is about 30%. And in fact, we've had quarters where we've come right at that.Over the last few quarters, we've seen some degradation on the gross margin where it's declined a little bit.

We think that has been entirely driven by our fulfillment and processing costs here. We think with this new process going forward, it allows us toget more efficient and reduce the unit cost economics to handle an item over time.

I don't know that we've got specific numbers, other than to say we remain very confident in that long-term 30% target gross margin. I don't knowif you guys would add anything.


The only thing I would add and it was just the extension of Darrell's earlier math indicating about $1 billion support per facility, so that would leadto approximately 150,000 units per day is what we're moving to. And if you look at the current volume in the current facilities, we are substantiallybelow that today.

Mark Mahaney - RBC Capital Markets - Analyst

Mark Mahaney at RBC. Two questions. Bob, I know a long time ago, you talked about the steps that would be required to bring that order-to-shipperiod down. Can you just give us an update on how far down you think you can bring that time period and how you do that?

And then secondly, maybe a broader question for Darrell and Mark, which is you talk about these two types of shopping at the very beginning. Ithink you said directed product search.

So I guess the question would be do you envision at some point you would want have the capability to have directed product search fulfillmenthere i.e. be half-pregnant? For some categories, take on some inventory and broaden the total addressable market and the value proposition?


I think we've kind of consistently said our long-term target for order-to-ship is to get to a seven-day order-to-,ship so that's the target that we arefocused on and we think that the area that we are working against that is really around the vendors.

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So it really is around how do we tighten our links with the vendors, how do we tighten electronic communication, EDI, our integration with thevendor so that there are fewer handoffs, that the handoffs are not manual, so that some of the longer-term planning and forecasting elementswith the vendors are tighter so that there are -- so that we work much more seamlessly with our vendors to bring that time down much moretightly. And that's really where we expect the vast majority of the gains to come from.


On the in-stock items that ship, if you go to the site today, there's actually -- if you go to -- I forget the tab name at the top there -- but you go there,there's a section called ready to ship on the site.

You order that item today, the guys in this building or in Reno are going to ship that out today and you can get it as fast as tomorrow. So we havethat product out there.

And in fact, we had -- I think about even this week, we had a Tom's Shoe event two days ago and we had units that shipped out yesterday andtoday through that. And that has been going on for 24 months as we look to have some inventory available to ship out, depending on the eventand depending on the partner.

So we're constantly driving that down. I think if you look at search functionality on the side of how customers use the site, if you are out -- I thinkwe use this example on the road show -- but if you're out there looking for a fire truck for your son, we are probably not a great place to comebecause it's highly unlikely today that we have that exact particular fire truck.

So much of the excitement of zulily is about what's new; it's about what's fresh. It's differentiated, unique product. And so I don't see the day thatwe have -- we try to be the everything store.

We are very much focused on that boutique shopping experience, where you are coming in and you're discovering unique and different product.And it's worth your while to come today, because you're going to find something special.

We just -- I was talking earlier. We just sent out a note to a bunch of our members that tomorrow, for example, we've got American Girl. If you'relooking for American Girl as a particular item, it's -- I'd say, historically, probably not been the place to come.

But tomorrow we got something special. Come check it out and it's going to be unique and differentiated. And is that storytelling and entertainmentmuch more like media engagement than your typical shopping.

And so I don't see us changing the model. I think we'll keep getting better and better at shipping. I think we'll have great offerings. If you needsomething for a birthday party this weekend for your son, we're going to make sure we have a way to get it there if you really want to buy it fromus.

But we're not going to change the model. You see the numbers -- it's been working pretty well, we're going to stay focus there.

Mark Miller - William Blair & Company - Analyst

Mark Miller with William Blair. Can you share with us your thinking about potential movement towards an infinity program? So as you are becomingmore sophisticated in the FCs and options around consignment -- so preferred shipping, preferred terms.

And I'm also asking in the context of proliferation of alternatives for consumers -- other flash sites. And so why wouldn't you want to have a deeperrelationship with your most important customers?

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I think when you look at -- there's a lot in there, but when you look at the data that we just showed today on kind of the repeat and customerengagement, I would tell you those customers that come in are highly engaged with us. So I don't need to put a gimmicky program out there toget them to be more engaged.

That being said, we are always testing and trying new programs to see what we can do to add a value to the customer, drive that, make thatexperience better, and testing different programs. So we've always got some programs out in the wild that we are trying to understand.

And is it great for the customer? We want to make sure that that experience is -- what we have found again and again and again is that a focus onthe basics pays off so much more than going in chasing other random marketing-led programs.

Not to say we won't try. If we find something great there, we will double down and we are very analytical and we will invest in it, but we've foundthat those investments in shipping, those investments in the site design experience, the technology optimization to get you the right products toyou has been -- has paid off much, much more than the affinity-type programs that we've tested.

But we will keep testing. And if we find the one that works great for us, we will double down on.


Yes, I think one of the most amazing things in customer data is just the consistency of how the customer cohorts layer over each other. And it goesdown -- you break it apart to the next level and you look at quarterly cohorts or monthly cohorts. And they just layer. Like a customer, for us X, likecustomer despite when they started buying and I think there is --


And what's amazing is as you added categories, as we've added --


Exactly.


It has stayed consistent.


So if you look at -- those cohorts have very different mixes of first purchase of product. The old cohorts were much more kids' products; the newerones, much stronger in women's apparel, yet they behave the same way.

So mix of what they purchase first doesn't seem to impact them. We would love to kink that curve up even stronger, so we are always actuallytesting different promotions and affinity progress.

We have a lot of focus on trying different things there. I think what we're seeing is a great customer behaves like a great customer and it's hard topush them up or down from that level. We will keep playing with it and trying to find stuff.

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Mark Miller - William Blair & Company - Analyst

And then I have a follow-up question. So I know you do a lot of market research with your customers and it's in the context of one of your competitorscoming to the public market and presumably amping up the marketing.

Have you been able to learn about your customers as they become affiliated with multiple sites, their time resources might go to multiple sites?Has that ever been found to affect your customer spend or have you determined absolutely not?


Yes, I don't think we've ever actually looked at or tried to understand how many different sites a customer's shopping on and how that impactstheir value. I would say -- like if you look at it from a flash model again. If you look year after year, there's probably less flash sales sites, not moreover time. And yet, there's no change in a customer behavior.

When we talk to them one-on-one and we ask them about other flash sales sites, they don't see them as substitutes for what we're doing. Theyalmost -- when you start asking them about it, they almost get confused. If you asked them if we didn't exist, where else would you do this? Theyjust --


Or you ask them like what other site is like zulily? And often times, you will hear -- it's kind of a comical answer -- but they are like there's anotherone? That becomes the -- they don't look at us against other sites exactly the same way.

They talk about the large big-box department stores. They talk about Amazon; they talk about going to Google and trying to find something. That'sthe competitive set that I think we're up against.


They are much more Middle America. If you compared us to other fashion retail, we are probably less coastal, more middle America.


My guess is if you took that chart that Bob showed in here and you put it against the US population, you would see a skew to the -- what we'veseen is a skew to the center of the country.


Midwest, Southeast. And you know, you asked them where -- they're Middle America -- and there's all different pockets within there. We definitelyhave some affluent customers. We definitely have a lot of urban customers.

But the skew is more Middle America. And you ask them where they are shopping, they talk about Target, they talk about Walmart, they talk about-- and I think what they're doing with us is trying to find more special, meaningful products and -- in a world that is increasingly mass merchandise.

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Thanks. So going back to your cohort analysis -- and thank you for providing that -- when you think about driving wallet share within your customersand particularly for some of the later cohorts, do you find that if someone comes to the site for women's apparel or some of the newer categoriesthat you are driving depth of purchase behavior within that category?

Or is it purchases activity sort of across your categories? And then is there a point in time when you sort of think about shifting your marketingspend focus from new customer acquisition to driving repeat purchases of your customers?


I'd say, customers, no matter what -- when you look at them aggregate, no matter where they come in -- because we track actually not only whereyour first purchase was, but what the creative of the advertisement was that drove you win.

So if we run a plus-sized women ad, we then look at what's your product mix on the first purchase and then over the lifetime of your experience.I think what you see, customers across the board in the product areas, they go horizontal very fast.

Actually when you're out walking the floor, one of the amazing things in the fulfillment center to me is looking at the shelves and just seeing thecrazy diversity of products. Or going over to the put wall and actually looking in the slots.

So in each of those slots is a single customer order. And you see this crazy mix of products bought together right. So they definitely go very, veryhorizontal. That being said, they always have a bias towards their original category.

So if you're -- if the creative for you was women's apparel and your first purchase was women's apparel, when we look at the lifetime purchasesfrom that cohort, it's always going to have a stronger skew towards women apparel from the business as a whole.

So you always have some affinity towards your starting category. But across the board, we don't see any category where they stay in their category.They all migrate across the board.


Your second question on marketing and spending money on remarketing versus new acquisition, we see opportunity to invest in remarketing.Candidly, we will get the cohort behavior, we haven't needed to.

Do I think there's opportunity they will list that curve? Yes. But there's a challenge -- one of our constraints in marketing has just been enoughpeople in marketing to spend that well. And so I think that the remarketing -- there's opportunity.

You just got to be really careful. I see others out there talk about their payback on remarketing and oftentimes forgetting they already paid oncefor that customer and now you've got to add those to get -- so you got to look at how those costs add together.

And I think if we see payback there and if you look at those -- I talked about those, for example, 100 customers and then 50 of them with us -- nowthere is a 50 that drop off -- I think there's some real remarketing opportunities to go chase some of those and understand better why.

We see folks like -- when we run a big brand, we see a group of customers that internally we call big brand activators, where they activate first ona big brand. And there's some sets of those customers that are -- they are big brand-affinity that buy less frequent.

I think is opportunity to do different marketing to them. And we're doing some of that. There's certainly more. It's just a balance for us to where toinvest each incremental dollar to go chase.

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There's a ton of effort in e-commerce around retargeting, remarketing. What you're trying to do is remind people of you as a retailer. Our customershave given us permission to email them on a high, high --


Or [push method] frequency.


-- frequency basis or push on their phones. And so that really, for us, I think is the bulk of the remarketing effort is that daily email or push notificationcommunication that happens from there.

Darrell touched on one of the things I wanted to touch on -- big brand activators. When you look at our cohorts, one of the things you'll see is youbring in 100 and then 50 there, say, five quarters later. And then there's a slow low-single-digit churn rate out of the business going forward fromthere.

That drop in 50 is different for different -- like we will have some brands that they bring people in. But the people are coming in not because theylove this kind of entertainment version of shopping, it's because there's something they really want. It's akin to the product-directed e-commerce.

It's great. We will have them. It's good volume. We make money. But it tends to be at the smaller, more nichey brands aren't bringing in peoplewho are one-and-done and gone. Those are the ones that are more -- higher probability of being loyal long-term active customers.


Great. And then one other question on gross margins, if I may. So you mentioned long-term target 30%. Can you just talk about what we shouldexpect for the impacts on gross margins from the Pennsylvania facility?


I think -- the Pennsylvania facility -- the first thing that will occur is obviously, the lease will take effect and we will begin to pay rent on the facility.That is actually inside of our G&A.

So the variable fulfillment, variable shipping component, won't occur until we begin to ship from the facility, as Bob said opening in the first half.So I don't think we'll see anything material in the first part of the year in terms of effect on our business.

These facilities on a rent-per-square foot are not Class I office space; they are fulfillment. So much less and less P&L impact. And then I don't expectyou to see anything significant in the numbers.

What Darrell mentioned, the work we are doing with the automation and the work we're doing both here and in Reno is supporting our progresstowards our 30% long-term goals. We have said we had headwinds in the first part of this year.

Q3 is a transition period for us as we have work through these two facilities. And we anticipate as move into Q4 and beyond that we will start seeingthe progress towards our margin improvement and I don't anticipate the third fulfillment center is going to have an impact on that.

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Standing up a new facility is so much more -- so much less impact on operating expense and kind of -- than doing -- when you walk out, you'reseeing -- you see it in those photos -- construction while those pick carts are running around the people while we are installing big steel and whilewe are having to move from Nevada from one building to another building while maintaining shipping volume. Like there's -- that overheadexpense comes from that dual operation more than standing up any one.


And over any meaningful time period. If you get beyond the quarters and look at it from a -- not even long term, but any medium term -- and Darrellor Bob will definitely correct me if I'm wrong here.

But a more -- a larger, more robust fulfillment network -- as long as you have the volume to fill it, it is going to drive costs down. You've got facilitiesthat are -- it will drive costs down and it will drive speed up, because you have facilities closer to the customer.

Shawn Milne - Janney Montgomery Scott - Analyst

Hey, Darrell. Shawn Milne from Janney. One thing you didn't talk about was mobile. Does that skew any of your cohort data if you bring in someonefrom iOS first and can you talk a little bit about that?

And some of the other players have mentioned that screen size, certainly in mobile, directly proportional to conversion rates. Do you think youmight see a little bit of a bump from some of your iOS customers? Thanks.


I think as we look at mobile, what we find is our customers are engaging with us anywhere they happen to be. So we see a lot of customers acrossdual screens, where they may be visiting us at home in their kitchen, on the computer. Then while they are waiting at the doctor's office, they arepulling it up on mobile. So we see a lot of cross-platform engagement.

I don't know that there's anything meaningfully different. I will say there's things we're doing, for example, in our image optimization that we'vetalked about before where we are serving up different images to different cluster groups of people as well as different -- the versions of the site.Serving up now 1 million different versions of a site every day and optimizing that experience.

And then what we find is that an image -- across an event, we actually can optimize them across small screen and large screen formats now. So Ican take a -- an event like a shoe event, for example, and something that shows awesome at home on your 27-inch monitor with three shoes anda fancy patterned background -- it's an amazing photo and our studio team does a great job doing that. That doesn't always perform so well on asmall iPhone-sized screen.

Often as what we find is that a single shoe on a simpler background might actually perform. So we put in technology to optimize the experienceacross those platforms and devices.

I would say it is 100 little things of optimizations like that, though, leading to behavior gains that we see, but I don't think there's anything meaningfulto share on differences between engagement or purchasing behavior on mobile, other than mobile just continues to grow over time.

And we think that in Q2, we were at 49%, up from 42% a year ago. I don't think it's unreasonable to think in a future quarter here we're going tobe talking about transitioning to a majority of orders coming from mobile. One more question and then --

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Neil Doshi - CRT Capital Group - Analyst

My name is Neil Doshi with CRT Capital. As you work with vendors, what are you doing on the vendor side that's been really impactful to get themto ship the product faster to you guys and what are some things that you can do to really speed up that process?


Sure. So with the diversity of vendors we work with, it's across the board. And Bob mentioned things like EDI. If I step back and think about simpleexamples, it's similar to mobile.

It's 100 little things more than 3 big, but simple examples might be -- when you are a small vendor and we are sending you a purchase order in aformat that suits us well, you then -- and some of these purchasers are like a shoe vendor, it could be a 30-page purchase order with 1000, 2000lines on it.

So now you hand that over to your accounting department, who goes and retypes it into their system. And errors happen. It sometimes takes thema while to enter that in, and that can be -- so now through the portal, giving them opportunities to, for example, expert that PO into differentformats.

With our larger vendors now, we've got hundreds and hundreds of vendors now on EDI, so we can real-time both handle inventory transactionsas well as purchase orders to them.

We've got -- and the portal over the last six months rolled out functionality like allowing them to schedule the trucks to come pick them up. Weused to have to have them call into one of our vendor support folks, who would then go work with one of our transportation carriers to bid thatout and then schedule them.

We now do that in an automated way. They can go in to type in I need a truck here at 3 o'clock. We can bid it out to some vendors, we can get thatback, and schedule a truck real-time for them and say confirmed, we will have a truck there at 3.

There's a lot of those things. In some cases, it's working with them on their 3PL, where they may have a 48-hour SLA with their third-party logisticsprovider to ship their packages and say, we need you to renegotiate that. We're going to help you do that. We're going to help you -- or we're goingto help find you another 3PL that can guarantee us a four-hour SLA.

And so it is very diverse -- other things you would -- but it's a lot -- Bob has got a team of about 40, 45 vendor specialists that are there workingwith these vendors to help them improve their experience every day.

And it's knocking them down and it's having a conversation with them, making sure they are ready. In some of these small vendors, it can be assimple as saying you should probably get -- hire two temps on Tuesday when our purchase order comes in so that you can pack them faster. It canbe the small things like that to just --


Even bringing in select products ahead of time. So bringing those in ahead of time. You may see some of that when you are walking through onthe floor. So they will have some product in-house ahead of the event and doing that on a very selective basis.

So just -- but as Darrell says, it's a lot of very small things. Each incrementally adds up to make a big difference.

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All right, and with that --


Thank you. That concludes the webcast portion of today's presentation. Thank you.


Thanks, everybody.

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