Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

x

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

 

For the quarterly period ended March 31, 2013

 

Or

 

o

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

 

For the transition period from          to            

 

Commission file number: 000-49799

 

OVERSTOCK.COM, INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

87-0634302

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification Number)

 

6350 South 3000 East

Salt Lake City, Utah 84121

(Address, including zip code, of Registrant’s principal executive offices)

 

Registrant’s telephone number, including area code: (801) 947-3100

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), (2) has been subject to such filing requirements for the past 90 days. Yes x  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x  No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer o

 

Accelerated filer x

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

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

 

There were 23,650,146 shares of the Registrant’s common stock, par value $0.0001, outstanding on April 22, 2013.

 

 

 



Table of Contents

 

TABLE OF CONTENTS

 

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements (Unaudited)

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

 

Item 4. Controls and Procedures

 

PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings

 

Item 1A. Risk Factors

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

Item 3. Defaults upon Senior Securities

 

Item 4. Mine Safety Disclosures

 

Item 5. Other Information

 

Item 6. Exhibits

 

Signature

 

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Table of Contents

 

PART 1. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)

 

Overstock.com, Inc.

Consolidated Balance Sheets (Unaudited)

(in thousands)

 

 

 

March 31,

 

December 31,

 

 

 

2013

 

2012

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

81,895

 

$

93,547

 

Restricted cash

 

1,780

 

1,905

 

Accounts receivable, net

 

15,851

 

19,273

 

Inventories, net

 

21,535

 

26,464

 

Prepaid inventories, net

 

1,988

 

1,912

 

Prepaids and other assets

 

10,589

 

12,897

 

Total current assets

 

133,638

 

155,998

 

Fixed assets, net

 

25,937

 

21,037

 

Goodwill

 

2,784

 

2,784

 

Other long-term assets, net

 

2,867

 

2,166

 

Total assets

 

$

165,226

 

$

181,985

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

46,753

 

$

62,416

 

Accrued liabilities

 

46,871

 

47,674

 

Deferred revenue

 

31,531

 

38,411

 

Total current liabilities

 

125,155

 

148,501

 

Other long-term liabilities

 

2,049

 

2,522

 

Total liabilities

 

127,204

 

151,023

 

Commitments and contingencies (Note 5)

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Preferred stock, $0.0001 par value:

 

 

 

 

 

Authorized shares - 5,000

 

 

 

 

 

Issued and outstanding shares - none

 

 

 

Common stock, $0.0001 par value

 

 

 

 

 

Authorized shares - 100,000

 

 

 

 

 

Issued shares - 26,774 and 26,481

 

 

 

 

 

Outstanding shares - 23,650 and 23,451

 

2

 

2

 

Additional paid-in capital

 

357,647

 

356,895

 

Accumulated deficit

 

(239,399

)

(247,096

)

Treasury stock:

 

 

 

 

 

Shares at cost - 3,124 and 3,030

 

(80,228

)

(78,839

)

Total stockholders’ equity

 

38,022

 

30,962

 

Total liabilities and stockholders’ equity

 

$

165,226

 

$

181,985

 

 

See accompanying notes to consolidated financial statements.

 

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Table of Contents

 

Overstock.com, Inc.

Consolidated Statements of Income and Comprehensive Income

(Unaudited)

(in thousands, except per share data)

 

 

 

Three months ended 
March  31,

 

 

 

2013

 

2012

 

Revenue, net

 

 

 

 

 

Direct

 

$

41,942

 

$

40,897

 

Fulfillment partner

 

270,052

 

221,470

 

Total net revenue

 

311,994

 

262,367

 

Cost of goods sold

 

 

 

 

 

Direct(1)

 

37,149

 

37,630

 

Fulfillment partner

 

215,909

 

177,229

 

Total cost of goods sold

 

253,058

 

214,859

 

Gross profit

 

58,936

 

47,508

 

Operating expenses:

 

 

 

 

 

Sales and marketing(1)

 

18,705

 

14,475

 

Technology(1)

 

18,160

 

15,638

 

General and administrative(1)

 

15,088

 

14,822

 

Restructuring

 

(432

)

98

 

Total operating expenses

 

51,521

 

45,033

 

Operating income

 

7,415

 

2,475

 

Interest income

 

34

 

29

 

Interest expense

 

(51

)

(208

)

Other income, net

 

345

 

432

 

Income before income taxes

 

7,743

 

2,728

 

Provision for income taxes

 

46

 

9

 

Net income

 

$

7,697

 

$

2,719

 

Net income per common share—basic:

 

 

 

 

 

Net income attributable to common shares—basic

 

$

0.33

 

$

0.12

 

Weighted average common shares outstanding—basic

 

23,594

 

23,392

 

Net income per common share—diluted:

 

 

 

 

 

Net income attributable to common shares—diluted

 

$

0.32

 

$

0.12

 

Weighted average common shares outstanding—diluted

 

24,016

 

23,414

 

Comprehensive income

 

$

7,697

 

$

2,719

 

 

 

 

 

 

 

(1) Includes stock-based compensation as follows (Note 7):

 

 

 

 

 

Cost of goods sold — direct

 

$

48

 

$

60

 

Sales and marketing

 

25

 

101

 

Technology

 

124

 

176

 

General and administrative

 

555

 

476

 

Total

 

$

752

 

$

813

 

 

See accompanying notes to consolidated financial statements.

 

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Table of Contents

 

Overstock.com, Inc.

Consolidated Statements of Changes in Stockholders’ Equity

 (Unaudited)

(in thousands)

 

 

 

 

 

 

 

Additional

 

 

 

 

 

 

 

 

 

 

 

Common stock

 

Paid-in

 

Accumulated

 

Treasury stock

 

 

 

 

 

Shares

 

Amount

 

Capital

 

Deficit

 

Shares

 

Amount

 

Total

 

Balances at December 31, 2012

 

26,481

 

$

2

 

$

356,895

 

$

(247,096

)

3,030

 

$

(78,839

)

$

30,962

 

Net income

 

 

 

 

7,697

 

 

 

7,697

 

Stock-based compensation to employees and directors

 

 

 

752

 

 

 

 

752

 

Common stock issued upon vesting of restricted stock

 

293

 

 

 

 

 

 

 

Purchase of treasury stock

 

 

 

 

 

94

 

(1,389

)

(1,389

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at March 31, 2013

 

26,774

 

$

2

 

$

357,647

 

$

(239,399

)

3,124

 

$

(80,228

)

$

38,022

 

 

See accompanying notes to consolidated financial statements.

 

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Table of Contents

 

Overstock.com, Inc.

Consolidated Statements of Cash Flows (Unaudited)

(in thousands)

 

 

 

Three months ended 
March 31,

 

Twelve months ended
March 31,

 

 

 

2013

 

2012

 

2013

 

2012

 

Cash flows from operating activities:

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

7,697

 

$

2,719

 

$

19,647

 

$

(16,275

)

Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:

 

 

 

 

 

 

 

 

 

Depreciation and amortization

 

3,863

 

4,034

 

15,838

 

16,385

 

Realized gain from sale of marketable securities

 

(12

)

(7

)

(14

)

(7

)

Loss (gain) on disposition of fixed assets

 

 

85

 

(13

)

85

 

Stock-based compensation to employees and directors

 

752

 

813

 

3,466

 

2,988

 

Amortization of debt discount and deferred loan costs

 

5

 

35

 

43

 

128

 

Loss from early extinguishment of debt

 

 

 

 

1,226

 

Restructuring charges (reversals)

 

(432

)

98

 

(454

)

98

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

 

Restricted cash

 

125

 

(17

)

273

 

330

 

Accounts receivable, net

 

3,422

 

1,560

 

(3,910

)

(4,060

)

Inventories, net

 

4,929

 

6,348

 

(4,890

)

3,518

 

Prepaid inventories, net

 

(76

)

(883

)

(78

)

(124

)

Prepaids and other assets

 

1,462

 

3,156

 

(400

)

1,581

 

Other long-term assets, net

 

53

 

694

 

(908

)

244

 

Accounts payable

 

(15,729

)

(27,587

)

3,956

 

3,386

 

Accrued liabilities

 

(748

)

(12,211

)

11,004

 

(1,952

)

Deferred revenue

 

(6,880

)

(1,164

)

4,717

 

4,695

 

Other long-term liabilities

 

(84

)

93

 

449

 

411

 

Net cash provided by (used in) operating activities

 

(1,653

)

(22,234

)

48,726

 

12,657

 

Cash flows from investing activities:

 

 

 

 

 

 

 

 

 

Purchases of marketable securities

 

(75

)

(38

)

(119

)

(159

)

Purchases of intangible assets

 

 

 

(6

)

(4

)

Sales of marketable securities

 

152

 

117

 

189

 

117

 

Investment in precious metals

 

 

 

(1,397

)

 

Expenditures for fixed assets, including internal-use software and website development

 

(6,062

)

(2,127

)

(16,424

)

(9,192

)

Proceeds from sale of fixed assets

 

 

 

56

 

 

Net cash used in investing activities

 

(5,985

)

(2,048

)

(17,701

)

(9,238

)

Cash flows from financing activities:

 

 

 

 

 

 

 

 

 

Payments on capital lease obligations

 

(2,563

)

(77

)

(2,598

)

(735

)

Drawdowns on line of credit

 

 

 

 

17,000

 

Payments on line of credit

 

 

 

(17,000

)

 

Capitalized financing costs

 

 

 

 

(140

)

Proceeds from finance obligations

 

 

 

 

1,429

 

Payments on finance obligations

 

 

 

 

(23,939

)

Paydown on direct financing arrangement

 

(62

)

(57

)

(241

)

(221

)

Payments to retire convertible senior notes

 

 

 

 

(24,505

)

Purchase of treasury stock

 

(1,389

)

(464

)

(1,396

)

(479

)

Net cash used in financing activities

 

(4,014

)

(598

)

(21,235

)

(31,590

)

Net increase (decrease) in cash and cash equivalents

 

(11,652

)

(24,880

)

9,790

 

(28,171

)

Cash and cash equivalents, beginning of period

 

93,547

 

96,985

 

72,105

 

100,276

 

Cash and cash equivalents, end of period

 

$

81,895

 

$

72,105

 

$

81,895

 

$

72,105

 

Supplemental disclosures of cash flow information:

 

 

 

 

 

 

 

 

 

Cash paid during the period:

 

 

 

 

 

 

 

 

 

Interest paid

 

$

20

 

$

149

 

$

453

 

$

2,142

 

Taxes paid

 

283

 

2

 

580

 

2

 

Non-cash investing and financing activities:

 

 

 

 

 

 

 

 

 

Fixed assets, including internal-use software and website development, costs financed through accounts payable and accrued liabilities

 

$

116

 

$

121

 

$

497

 

$

12

 

Equipment acquired under capital lease obligations

 

2,563

 

 

2,563

 

 

Equipment acquired under finance obligations

 

 

 

 

4,532

 

Lapse of rescission rights of redeemable stock

 

 

 

 

398

 

 

See accompanying notes to consolidated financial statements.

 

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Table of Contents

 

Overstock.com, Inc.

Notes to Unaudited Consolidated Financial Statements

 

1. BASIS OF PRESENTATION

 

As used herein, “Overstock,” “Overstock.com,” “O.co,” “we,” “our” and similar terms include Overstock.com, Inc. and its subsidiaries, unless the context indicates otherwise. The accompanying unaudited consolidated financial statements have been prepared by us pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) regarding interim financial reporting. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements and should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and our audited annual consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2012. The accompanying unaudited consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, which are, in our opinion, necessary for a fair presentation of results for the interim periods presented. Preparing financial statements requires us to make estimates and assumptions that affect the amounts that are reported in the consolidated financial statements and accompanying disclosures. Although these estimates are based on our best knowledge of current events and actions that we may undertake in the future, actual results may be different from the estimates. The results of operations for the three months ended March 31, 2013 are not necessarily indicative of the results to be expected for any future period or the full fiscal year.

 

2. ACCOUNTING POLICIES

 

Principles of consolidation

 

The accompanying consolidated financial statements include our accounts and the accounts of our wholly-owned subsidiaries. All intercompany account balances and transactions have been eliminated in consolidation.

 

Use of estimates

 

The preparation of financial statements in conformity with generally accepted accounting principles requires estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent liabilities in the consolidated financial statements and accompanying notes. Estimates are used for, but not limited to, investment valuation, receivables valuation, revenue recognition, sales returns, incentive discount offers, inventory valuation, depreciable lives of fixed assets and internally-developed software, goodwill valuation, intangible valuation, income taxes, stock-based compensation, performance-based compensation, restructuring liabilities and contingencies. Actual results could differ materially from those estimates.

 

Cash equivalents

 

We classify all highly liquid instruments, including money market funds with a remaining maturity of three months or less at the time of purchase, as cash equivalents. Cash equivalents were $56.1 million and $76.2 million at March 31, 2013 and December 31, 2012, respectively.

 

Restricted cash

 

We consider cash that is legally restricted and cash that is held as a compensating balance for letter of credit arrangements as restricted cash. Restricted cash was $1.8 million and $1.9 million at March 31, 2013 and December 31, 2012, respectively, and was held primarily in cash or money market accounts.

 

Fair value of financial instruments

 

Our financial instruments, including cash, cash equivalents, restricted cash, accounts receivable, accounts payable and accrued liabilities are carried at cost, which approximates their fair value because of the short-term maturity of these instruments.

 

We account for our assets and liabilities using a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect our market assumptions. These two types of inputs have created the following fair-value hierarchy:

 

·                  Level 1—Quoted prices for identical instruments in active markets;

 

·                  Level 2—Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets; and

 

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Table of Contents

 

·                  Level 3—Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.

 

This hierarchy requires us to minimize the use of unobservable inputs and to use observable market data, if available, when determining fair value.

 

The fair value of these financial instruments was determined using the following levels of inputs as of March 31, 2013 (in thousands):

 

 

 

Fair Value Measurements at March 31, 2013:

 

 

 

Total

 

Level 1

 

Level 2

 

Level 3

 

 

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

Cash equivalents - Money market mutual funds

 

$

56,070

 

$

56,070

 

$

 

$

 

Trading securities held in a “rabbi trust” (1)

 

200

 

200

 

 

 

Total assets

 

$

56,270

 

$

56,270

 

$

 

$

 

Liabilities:

 

 

 

 

 

 

 

 

 

Deferred compensation accrual “rabbi trust” (2)

 

$

255

 

$

255

 

$

 

$

 

Restructuring (3)

 

620

 

 

 

620

 

Total liabilities

 

$

875

 

$

255

 

$

 

$

620

 

 

The fair value of these financial instruments was determined using the following levels of inputs as of December 31, 2012 (in thousands):

 

 

 

Fair Value Measurements at December 31, 2012:

 

 

 

Total

 

Level 1

 

Level 2

 

Level 3

 

Assets:

 

 

 

 

 

 

 

 

 

Cash equivalents - Money market mutual funds

 

$

76,248

 

$

76,248

 

$

 

$

 

Trading securities held in a “rabbi trust” (1)

 

264

 

264

 

 

 

Total assets

 

$

76,512

 

$

76,512

 

$

 

$

 

Liabilities:

 

 

 

 

 

 

 

 

 

Deferred compensation accrual “rabbi trust” (2)

 

$

266

 

$

266

 

$

 

$

 

Restructuring (3)

 

65

 

 

 

65

 

Total liabilities

 

$

331

 

$

266

 

$

 

$

65

 

 


(1)     — Trading securities held in a rabbi trust are included in Other current and long-term assets in the consolidated balance sheets

 

(2)   — Non qualified deferred compensation in a rabbi trust is included in Accrued liabilities and Other long-term liabilities in the consolidated balance sheets.

 

(3)     — The fair value was determined based on the income approach, in which we used internal cash flow projections over the life of the underlying lease agreements discounted based on a credit adjusted risk-free rate of return. See the roll forward related to the restructuring accrual at Note 3—Restructuring Expense.

 

Restricted investments

 

In December 2009, we implemented a Non Qualified Deferred Compensation Plan (the “NQDC Plan”) for senior management. Deferred compensation amounts are invested in mutual funds held in a “rabbi trust” and are restricted for payment to the participants of the NQDC Plan. We account for our investments held in the trust in accordance with Accounting Standards Codification (“ASC”) No. 320 “Investments — Debt and Equity Securities”. The investments held in the trust are classified as trading securities. The fair value of the investments held in the trust totaled $200,000 at March 31, 2013 and are included in Other current and long-term assets in the consolidated balance sheets. Our gains and losses on these investments were immaterial for the three months ended March 31, 2013 and 2012.

 

Accounts receivable

 

Accounts receivable consist primarily of trade amounts due from customers and from uncleared credit card transactions at period end. Accounts receivable are recorded at invoiced amounts and do not bear interest.

 

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Allowance for doubtful accounts

 

From time to time, we grant credit to some of our business customers on normal credit terms (typically 30 days). We perform credit evaluations of our business customers’ financial condition and payment history and maintain an allowance for doubtful accounts receivable based upon our historical collection experience and expected collectability of accounts receivable. The allowance for doubtful accounts receivable was $875,000 and $797,000 at March 31, 2013 and December 31, 2012, respectively.

 

Concentration of credit risk

 

Cash equivalents include short-term, highly liquid instruments with maturities at date of purchase of three months or less. At March 31, 2013 and December 31, 2012, two banks held the majority of our cash and cash equivalents. We do not believe that, as a result of this concentration, we are subject to any unusual financial risk beyond the normal risk associated with commercial banking relationships.

 

Financial instruments that potentially subject us to significant concentrations of credit risk consist primarily of cash equivalents and receivables. We invest our cash primarily in money market securities which are uninsured.

 

Our accounts receivable are derived primarily from revenue earned from customers located in the United States. We maintain an allowance for doubtful accounts based upon the expected collectability of accounts receivable.

 

Valuation of inventories

 

Inventories, consisting of merchandise purchased for resale, are accounted for using a standard costing system which approximates the first-in-first-out (“FIFO”) method of accounting, and are valued at the lower of cost or market. We write down our inventory for estimated obsolescence and to lower of cost or market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required. Once established, the original cost of the inventory less the related inventory allowance represents the new cost basis of such products. Reversal of the allowance is recognized only when the related inventory has been sold or scrapped.

 

Prepaid inventories, net

 

Prepaid inventories represent inventories paid for in advance of receipt. Prepaid inventories were $2.0 million and $1.9 million at March 31, 2013 and December 31, 2012, respectively.

 

Prepaids and other assets

 

Prepaids and other assets represent expenses paid prior to receipt of the related goods or services, including advertising, license fees, maintenance, packaging, insurance, and other miscellaneous costs, as well as investments in precious metals. Total prepaids and other assets were $10.6 million and $12.9 million at March 31, 2013 and December 31, 2012, respectively.

 

Fixed assets

 

Fixed assets, which include assets such as technology infrastructure, internal-use software, website development, furniture and fixtures and leasehold improvements, are recorded at cost and depreciated using the straight-line method over the estimated useful lives of the related assets or the term of the related capital lease, whichever is shorter, as follows:

 

 

 

Life
(years)

 

Computer software

 

2-4

 

Computer hardware

 

3-4

 

Furniture and equipment

 

3-5

 

 

Leasehold improvements are amortized over the shorter of the term of the related leases or estimated useful lives.

 

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Depreciation and amortization expense is classified within the corresponding operating expense categories on the consolidated statements of income as follows (in thousands):

 

 

 

Three months ended

 

 

 

March 31,

 

 

 

2013

 

2012

 

Cost of goods sold - direct

 

$

104

 

$

108

 

Technology

 

3,416

 

3,598

 

General and administrative

 

343

 

328

 

Total depreciation and amortization, including internal-use software and website development

 

$

3,863

 

$

4,034

 

 

Internal-use software and website development

 

Included in fixed assets is the capitalized cost of internal-use software and website development, including software used to upgrade and enhance our Website and processes supporting our business. We capitalize costs incurred during the application development stage of internal-use software and amortize these costs over the estimated useful life of two to three years. Costs incurred related to design or maintenance of internal-use software are expensed as incurred.

 

During the three months ended March 31, 2013 and 2012, we capitalized $3.0 million and $1.5 million, respectively, of costs associated with internal-use software and website development, both developed internally and acquired externally. Amortization of costs associated with internal-use software and website development was $1.7 million and $2.2 million for those respective periods.

 

Leases

 

We account for lease agreements as either operating or capital leases depending on certain defined criteria. In certain of our lease agreements, we receive rent holidays and other incentives. We recognize lease costs on a straight-line basis without regard to deferred payment terms, such as rent holidays that defer the commencement date of required payments. Additionally, tenant improvement allowances are amortized as a reduction in rent expense over the term of the lease. Leasehold improvements are capitalized at cost and amortized over the lesser of their expected useful life or the life of the lease, without assuming renewal feature, if any, are exercised.

 

Treasury stock

 

We account for treasury stock under the cost method and include treasury stock as a component of stockholders’ equity.

 

Other long-term assets

 

Other long-term assets consist primarily of long-term prepaid expenses.

 

Impairment of long-lived assets

 

We review property and equipment and other long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset group may not be recoverable. Recoverability is measured by comparison of the assets’ carrying amount to future undiscounted net cash flows the asset group is expected to generate. Cash flow forecasts are based on trends of historical performance and management’s estimate of future performance, giving consideration to existing and anticipated competitive and economic conditions. If such asset group is considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds their fair values. There were no impairments to long-lived assets recorded during the three months ended March 31, 2013 and the year ended December 31, 2012.

 

Goodwill

 

Goodwill represents the excess of the purchase price paid over the fair value of the tangible net assets acquired in business combinations.

 

Goodwill is not amortized but is tested for impairment at least annually. When evaluating whether goodwill is impaired, we make a qualitative assessment to determine if it is more likely than not that its fair value is less than its carrying amount. If the qualitative assessment determines that it is more likely than not that its fair value is less than its carrying amount, we compare the fair value of the reporting unit to which the goodwill is assigned to its carrying amount. If the carrying amount exceeds its fair value, then the amount of the impairment loss must be measured. The impairment loss, if any, is calculated by comparing the implied fair value of the goodwill to

 

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its carrying amount. In calculating the implied fair value of goodwill, the fair value of the reporting unit is allocated to the other assets and liabilities within the reporting unit based on estimated fair value. The excess of the fair value of a reporting unit over the amount allocated to its other assets and liabilities is the implied fair value of goodwill. An impairment loss is recognized when the carrying amount of goodwill exceeds its implied fair value.

 

In accordance with this guidance, we test for impairment of goodwill in the fourth quarter or when we deem that a triggering event has occurred. Goodwill totaled $2.8 million at March 31, 2013 and December 31, 2012. There were no impairments to goodwill recorded during the three months ended March 31, 2013 and the year ended December 31, 2012.

 

Revenue recognition

 

We derive our revenue primarily from direct revenue and fulfillment partner revenue from merchandise sales. We also earn revenue from advertising on our shopping and other pages. We have organized our operations into two principal segments based on the primary source of revenue: direct revenue and fulfillment partner revenue (see Note 8—Business Segments).

 

Revenue is recognized when the following revenue recognition criteria are met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or the service has been provided; (3) the selling price or fee revenue earned is fixed or determinable; and (4) collection of the resulting receivable is reasonably assured. Revenue related to merchandise sales is recognized upon delivery to our customers. As we ship high volumes of packages through multiple carriers, it is not practical for us to track the actual delivery date of each shipment. Therefore, we use estimates to determine which shipments are delivered and, therefore, recognized as revenue at the end of the period. Our delivery date estimates are based on average shipping transit times, which are calculated using the following factors: (i) the type of shipping carrier (as carriers have different in-transit times); (ii) the fulfillment source (either our warehouses or those of our fulfillment partners); (iii) the delivery destination; and (iv) actual transit time experience, which shows that delivery date is typically one to eight business days from the date of shipment. We review and update our estimates on a quarterly basis based on our actual transit time experience. However, actual shipping times may differ from our estimates.

 

We evaluate the criteria outlined in ASC Topic 605-45, Principal Agent Considerations, in determining whether it is appropriate to record the gross amount of product sales and related costs or the net amount earned as commissions. When we are the primary obligor in a transaction, are subject to inventory risk, have latitude in establishing prices and selecting suppliers, or have several but not all of these indicators, revenue is recorded gross. If we are not the primary obligor in the transaction and amounts earned are determined using a fixed percentage, revenue is recorded on a net basis. Currently, the majority of both direct revenue and fulfillment partner revenue is recorded on a gross basis, as we are the primary obligor. We present revenue net of sales taxes.

 

We periodically provide incentive offers to our customers to encourage purchases. Such offers include current discount offers, such as percentage discounts off current purchases and other similar offers, which, when used by customers, are treated as a reduction of revenue.

 

Based upon our historical experience, revenue typically increases during the fourth quarter because of the holiday retail season.

 

Direct revenue

 

Direct revenue is derived from merchandise sales to individual consumers and businesses that are fulfilled from our warehouses. Direct revenue comes from merchandise sales that occur primarily through our Website, but may also occur through offline and other channels.

 

Fulfillment partner revenue

 

Fulfillment partner revenue is derived from merchandise sales through our Website which fulfillment partners ship directly to consumers and businesses from warehouses maintained by our fulfillment partners.

 

Consignment

 

We offer a consignment service to suppliers where the suppliers’ merchandise is stored in and shipped from our warehouses. We pay the consignment supplier upon shipment of the consigned merchandise to the consumer. Revenue from consignment service business was less than 1% of total net revenues as of March 31, 2013 and March 31, 2012, and is included in fulfillment partner segment on a gross basis.

 

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International business

 

At March 31, 2013, we were offering products to customers in over 100 countries and non-U.S. territories. We do not have sales operations outside the United States, and are using a U.S. based third party to provide logistics and fulfillment for all international orders. Revenue generated from our international business is included in either direct or fulfillment partner revenue, depending on whether the product is shipped from our warehouses or from a fulfillment partner. Less than 1% of our revenues as of March 31, 2013 and March 31, 2012 were from international customers.

 

Total revenues from International sales were $2.9 million and $2.3 million at March 31, 2013 and March 31, 2012 respectively.

 

Ecommerce marketplace channels

 

During 2012, we began offering some of our products for sale in online marketplaces of other Internet retailers’ websites, which allows us to reach a broader potential customer base. Under the terms of our agreements with these ecommerce marketplace retailers, the retailers typically earn a fee that is a percentage of the selling price of the orders they send us. Revenue generated from these ecommerce marketplace channels is included in either direct or fulfillment partner revenue, on a gross basis, depending on whether the product is shipped from our warehouses or from a fulfillment partner. Ecommerce marketplace channels were less than 3% and less than 1% of our total net revenues for the three months ended March 31, 2013 and March 31, 2012, respectively.

 

Other businesses

 

We operate an online site for listing cars for sale as a part of our Website. The cars listing service allows dealers to list vehicles for sale and allows buyers to review vehicle descriptions and post offers to purchase, and provides the means for prospective purchasers to contact sellers for further information and negotiations on the purchase of an advertised vehicle. Revenue from the cars listing business is included in the fulfillment partner segment on a net basis. Revenue from our other businesses is less than 1% of total net revenues.

 

Club O loyalty program

 

We have a customer loyalty program called Club O for which we sell annual memberships. We record membership fees as deferred revenue and we recognize revenue ratably over the membership period. The Club O loyalty program allows members to earn reward dollars for qualifying purchases made on our Website. We also have a co-branded credit card program (see “Co-branded credit card revenue” below for more information). Co-branded cardholders are also Club O members and earn additional reward dollars for purchases made on our Website, and from other merchants. Reward dollars earned may be redeemed on future purchases made through our Website. Club O reward dollars expire 90 days after the customer’s Club O membership expires. We account for these transactions as multiple element arrangements and allocate revenue to the elements using their relative fair values. We include the value of reward dollars earned in deferred revenue and we record it as a reduction of revenue at the time the reward dollars are earned.

 

We recognize revenue for Club O reward dollars when customers redeem their reward dollars as part of a purchase at our Website. We recognize other income when Club O reward dollars expire or the likelihood of reward dollars being redeemed by a customer is remote (“reward dollar breakage”). Due to the program’s short history, currently no reward dollar breakage is recognized until the reward dollars expire.

 

In instances where customers receive free Club O reward dollars not associated with any purchases, we account for these transactions as sales incentives such as coupons and record a reduction of revenue at the time the reward dollars are redeemed.

 

Co-branded credit card program

 

We have a co-branded credit card agreement with a commercial bank for the issuance of credit cards bearing the Overstock.com brand, under which the bank pays us fees for new accounts and for customer usage of the cards. The agreement also provides for a customer loyalty program offering reward points that customers will accrue from card usage and can use to make purchases on our Website (See “Club O loyalty program” above for more information). New account fees are recognized as revenue on a straight-line basis over the estimated life of the credit card relationship. Credit card usage fees are recognized as revenues as actual credit card usage occurs.

 

Deferred revenue

 

Customer orders are recorded as deferred revenue prior to delivery of products or services ordered. We record amounts received for Club O membership fees as deferred revenue and we recognize it ratably over the membership period. We record Club O reward

 

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dollars earned from purchases as deferred revenue at the time they are earned and we recognize it as revenue upon redemption. If reward dollars are not redeemed, we recognize other income upon expiration. In addition, we sell gift cards and record related deferred revenue at the time of the sale. We sell gift cards without expiration dates and we recognize revenue from a gift card upon redemption of the gift card. If a gift card is not redeemed, we recognize other income when the likelihood of its redemption becomes remote based on our historical redemption experience. We consider the likelihood of redemption to be remote after 36 months.

 

Sales returns allowance

 

We inspect returned items when they arrive at our processing facility. We refund the full cost of the merchandise returned and all original shipping charges if the returned item is defective or we or our fulfillment partners have made an error, such as shipping the wrong product.

 

If the return is not a result of a product defect or a fulfillment error and the customer initiates a return of an unopened item within 30 days of delivery, for most products we refund the full cost of the merchandise minus the original shipping charge and actual return shipping fees. However, we reduce refunds for returns initiated more than 30 days after delivery or that are received at our returns processing facility more than 45 days after initial delivery.

 

If our customer returns an item that has been opened or shows signs of wear, we issue a partial refund minus the original shipping charge and actual return shipping fees.

 

Revenue is recorded net of estimated returns. We record an allowance for returns based on current period revenues and historical returns experience. We analyze actual historical returns, current economic trends and changes in order volume and acceptance of our products when evaluating the adequacy of the sales returns allowance in any accounting period.

 

The allowance for returns was $6.7 million and $10.6 million at March 31, 2013 and December 31, 2012 respectively. The decrease in allowance for returns at March 31, 2013 compared to December 31, 2012 is primarily due to decreased revenues mostly due to seasonality.

 

Credit card chargeback allowance

 

Revenue is recorded net of credit card chargebacks. We maintain an allowance for credit card chargebacks based on current period revenues and historical chargeback experience. The allowance for chargebacks was $130,000 and $182,000 at March 31, 2013 and December 31, 2012, respectively.

 

Cost of goods sold

 

Cost of goods sold includes product costs, warehousing costs, outbound shipping costs, handling and fulfillment costs, customer service costs and credit card fees, and is recorded in the same period in which related revenues have been recorded. Cost of goods sold, including product cost and other costs and fulfillment and related costs are as follows (in thousands):

 

 

 

Three months ended 
March 31,

 

 

 

2013

 

2012

 

Total revenue, net

 

$

311,994

 

100

%

$

262,367

 

100

%

Cost of goods sold

 

 

 

 

 

 

 

 

 

Product costs and other cost of goods sold

 

239,197

 

77

%

201,793

 

77

%

Fulfillment and related costs

 

13,861

 

4

%

13,066

 

5

%

Total cost of goods sold

 

253,058

 

81

%

214,859

 

82

%

Gross profit

 

$

58,936

 

19

%

$

47,508

 

18

%

 

Advertising expense

 

We expense the costs of producing advertisements the first time the advertising takes place and expense the cost of communicating advertising in the period during which the advertising space or airtime is used. Internet advertising expenses are recognized as incurred based on the terms of the individual agreements, which are generally: 1) a commission for traffic driven to the Website that generates a sale or 2) a referral fee based on the number of clicks on keywords or links to our Website generated during a given period. Advertising expense is included in sales and marketing expenses and totaled $16.5 million and $12.5 million during the three months ended March 31, 2013 and 2012, respectively. Prepaid advertising (included in Prepaids and other assets in the accompanying consolidated balance sheets) was $569,000 and $1.2 million at March 31,

 

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2013 and December 31, 2012, respectively.

 

Stock-based compensation

 

We measure compensation expense for all outstanding unvested share-based awards at fair value on date of grant and recognize compensation expense over the service period for awards expected to vest on a straight line basis. The estimation of stock awards that will ultimately vest requires judgment, and to the extent actual results differ from estimates, such amounts will be recorded as an adjustment in the period estimates are revised. We consider many factors when estimating expected forfeitures, including types of awards, and historical experience. Actual results may differ substantially from these estimates (see Note 7—Stock-Based Awards).

 

Loss contingencies

 

In the normal course of business, we are involved in legal proceedings and other potential loss contingencies. We accrue a liability for such matters when it is probable that a loss has been incurred and the amount can be reasonably estimated. When only a range of probable loss can be estimated, the most probable amount in the range is accrued. If no amount within this range is a better estimate than any other amount within the range, the minimum amount in the range is accrued. We expense legal fees as incurred.

 

Restructuring

 

Restructuring expenses are primarily comprised of lease termination costs. ASC Topic 420, Accounting for Costs Associated with Exit or Disposal Activities, requires that when an entity ceases using a property that is leased under an operating lease before the end of the contractual term, the termination costs should be recognized and measured at fair value when the entity ceases using the facility. Key assumptions in determining the restructuring expenses include the terms that may be negotiated to exit certain contractual obligations (see Note 3—Restructuring Expense).

 

Income taxes

 

Income taxes are accounted for under the asset and liability method. Deferred income taxes arise from temporary differences between the tax and financial statement recognition of revenue and expenses. In evaluating our ability to recover our deferred tax assets within the jurisdiction from which they arise, we consider all available positive and negative evidence, including projected future taxable income, scheduled reversals of our deferred tax liabilities, tax planning strategies and results of recent operations.

 

At March 31, 2013 and December 31, 2012, we have a full valuation allowance against our deferred tax assets, net of expected reversals of existing deferred tax liabilities, as we believe it is more likely than not that these benefits will not be realized. Significant judgment is required in making this assessment, and it is very difficult to predict when our assessment may conclude that the remaining portion of the deferred tax assets is realizable.

 

We have tax deductions from stock-based compensation that exceed the stock-based compensation recorded for such instruments. To the extent such excess tax benefits are ultimately realized, they will increase shareholders’ equity. We utilize the with-and-without approach in determining if and when such excess tax benefits are realized, and under this approach excess tax benefits related to stock based compensation are the last to be realized.

 

Earnings per share

 

Basic earnings per share is computed by dividing net income attributable to common shares by the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed by dividing net income attributable to common shares for the period by the weighted average number of common and potential common shares outstanding during the period. Potential common shares, comprising incremental common shares issuable upon the exercise of stock options, restricted stock awards and convertible senior notes are included in the calculation of diluted earnings per common share to the extent such shares are dilutive.

 

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The following table sets forth the computation of basic and diluted net income per common share for the periods indicated (in thousands, except per share data):

 

 

 

Three months ended 
March 31,

 

 

 

2013

 

2012

 

Net income attributable to common shares

 

$

7,697

 

$

2,719

 

Net income per common share—basic:

 

 

 

 

 

Net income attributable to common shares—basic

 

$

0.33

 

$

0.12

 

Weighted average common shares outstanding—basic

 

23,594

 

23,392

 

Effect of dilutive securities:

 

 

 

 

 

Stock options and restricted stock awards

 

422

 

22

 

Weighted average common shares outstanding—diluted

 

24,016

 

23,414

 

Net income attributable to common shares—diluted

 

$

0.32

 

$

0.12

 

 

The following shares were excluded from the calculation of diluted shares outstanding as their effect would have been anti-dilutive (in thousands):

 

 

 

Three months ended
March 31,

 

 

 

2013

 

2012

 

Stock options and restricted stock units

 

575

 

1,375

 

 

3. RESTRUCTURING EXPENSE

 

During the fourth quarter of 2006, we began a facilities consolidation and restructuring program designed to reduce the overall expense structure in an effort to improve future operating performance. The facilities consolidation and restructuring program was substantially completed by the end of the second quarter of 2007.

 

Restructuring liabilities along with charges (credits) to expense and payments associated with the facilities consolidation and restructuring program are as follows (in thousands):

 

 

 

Balance at

 

Accretion

 

Net Cash

 

 

 

Balance at

 

 

 

12/31/2012

 

Expense

 

Payments

 

Adjustments

 

3/31/2013

 

Lease and contract termination costs

 

$

1,197

 

$

29

 

$

(111

)

$

(432

)

$

683

 

 

We reversed $432,000 of lease termination costs during the three months ended March 31, 2013 due to changes in our restructuring accrual as a result of our reoccupation of a portion of formerly restructured office space. We incurred $98,000 of lease termination costs liability during the three months ended March 31, 2012 due to changes in the estimate of sublease income as a result of our entering into a revised agreement with a sub lessee and ceasing the use of one of our office facilities.

 

4. BORROWINGS

 

U.S. Bank Agreement

 

On December 26, 2012, we entered into a $3.0 million cash-collateralized line of credit agreement (the “Credit Agreement”) with U.S. Bank National Association (“U.S. Bank”) for the issuance of letters of credit. Advances under the Credit Agreement bear interest at one-month LIBOR plus 1.0%. The Credit Agreement matures on December 31, 2013. There were no amounts outstanding on the Credit Agreement at March 31, 2013 and December 31, 2012.

 

At March 31, 2013 and December 31, 2012, letters of credit totaling $1.8 million and $1.8 million, respectively, were issued on our behalf collateralized by compensating cash balances held at U.S. Bank, which are included in Restricted cash in the accompanying consolidated balance sheets.

 

Until December 31, 2012, we were party to a Financing Agreement with U.S. Bank (the “Financing Agreement”). In November 2012, we repaid all amounts outstanding under the Financing Agreement. As of December 31, 2012, no amounts were outstanding under the Financing Agreement. The Financing Agreement expired in accordance with its terms on December 31, 2012. The maximum credit potentially available under the revolving facility was $20 million. Our obligations under the Financing Agreement and all related agreements were secured by all or substantially all of our assets, excluding our interest in certain litigation.

 

Advances under the Financing Agreement bore interest at one-month LIBOR plus 2.5%. We had also entered into an interest rate cap agreement with U.S. Bank with an effective date of October 1, 2011 which limited our exposure for one-month LIBOR at 0.5% for the term of the Financing Agreement.

 

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U.S. Bank Commercial Purchasing Card Agreement

 

We have a commercial purchasing card (the “Purchasing Card”) agreement with U.S. Bank. We use the Purchasing Card for business purpose purchasing and must pay it in full each month. At March 31, 2013, $4.8 million was outstanding and $200,000 was available under the Purchasing Card. At December 31, 2012, $3.9 million was outstanding and $1.1 million was available under the Purchasing Card.

 

Capital leases

 

In March 2013, we entered into a capital lease arrangement for $2.6 million of computer equipment that will expire in 2017. Subsequent to entering into the lease we paid the entire $2.6 million in order to obtain discounted pricing. As such, we have no future payment obligations under capital leases at March 31, 2013.

 

Fixed assets included assets under capital leases of $4.2 million and $1.7 million and accumulated depreciation related to assets under capital leases of $1.7 million and $1.7 million, at March 31, 2013 and December 31, 2012, respectively. Depreciation expense of assets recorded under capital leases was $1,000 and $129,000, for the three months ended March 31, 2013 and 2012, respectively.

 

5. COMMITMENTS AND CONTINGENCIES

 

Summary of future minimum lease payments for all operating leases

 

Minimum future payments under all operating leases as of March 31, 2013, are as follows (in thousands):

 

Payments due by period

 

 

 

2013 (remainder)

 

$

7,297

 

2014

 

9,899

 

2015

 

8,320

 

2016

 

1,630

 

2017

 

183

 

Thereafter

 

 

 

 

$

27,329

 

 

Rental expense for operating leases totaled $2.1 million and $2.2 million for the three months ended March 31, 2013 and 2012, respectively. Estimated sublease income of $87,000 is anticipated to be received in the next 12 months.

 

Legal Proceedings

 

From time to time, we are involved in litigation concerning consumer protection, employment, intellectual property and other commercial matters related to the conduct and operation of our business and the sale of products on our Website. In connection with such litigation, we may be subject to significant damages. In some instances other parties may have contractual indemnification obligations to us. However, such contractual obligations may prove unenforceable or non-collectible, and in the event we cannot enforce or collect on indemnification obligations, we may bear the full responsibility for damages, fees and costs resulting from such litigation. We may also be subject to penalties and equitable remedies that could force us to alter important business practices. Such litigation could be costly and time consuming and could divert or distract our management and key personnel from our business operations. Due to the uncertainty of litigation and depending on the amount and the timing, an unfavorable resolution of some or all of these matters could materially affect our business, results of operations, financial position, or cash flows.

 

On February 2, 2007, along with five shareholder plaintiffs, we filed a lawsuit in the Superior Court of California, County of San Francisco against Morgan Stanley & Co. Incorporated, Goldman Sachs & Co., Bear Stearns Companies, Inc., Bank of America Securities LLC, Bank of New York, Citigroup Inc., Credit Suisse (USA) Inc., Deutsche Bank Securities, Inc., Merrill Lynch, Pierce, Fenner & Smith, Inc., and UBS Financial Services, Inc., and later amended the complaint to add Lehman Brothers Holdings Inc. as a defendant. The suit alleged that the defendants, who controlled over 80% of the prime brokerage market, participated in an illegal stock market manipulation scheme and that the defendants had no intention of covering short sell orders with borrowed stock, as they are required to do, causing what are referred to as “fails to deliver” and that the defendants’ actions caused and continued to cause dramatic declines in the share price of our stock and that the amount of “fails to deliver” often exceeded our entire supply of outstanding shares. The suit accused the defendants of violations of California securities laws and common law and violations of California’s Unfair

 

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Business Practices Act. After it filed for bankruptcy on September 2008, we elected not to pursue our claims against Lehman Brothers Holdings. On July 23, 2009, the court sustained defendants’ demurrer to our amended causes of action for conversion and trespass to chattels. On December 15, 2010, we and the other plaintiffs in the case entered into a settlement agreement with certain of the defendants requiring these defendants to pay in the aggregate $4.5 million to plaintiffs. Other terms of settlement are confidential. At that time, remaining defendants in the suit were Goldman Sachs Group, Inc., Goldman Sachs & Co., Goldman Sachs Execution & Clearing L.P., (“Goldman Defendants”) Merrill Lynch, Pierce, Fenner & Smith, Inc., Merrill Lynch Professional Clearing Corporation (“Merrill Lynch Defendants), and Bank of America Securities LLC. On December 15, 2010, we filed a motion to amend our complaint against the Goldman and Merrill Lynch Defendants to add a cause of action based on the New Jersey Racketeer Influenced and Corrupt Organization (RICO) Act. Defendants challenged the RICO claim by demurrer and eventually the court sustained the demurrer. We thereafter entered a settlement agreement with Bank of America Securities LLC, the terms of which are confidential, and have dismissed the action as to that defendant. On August 19, 2011, the remaining defendants filed a motion for summary judgment. On January 10, 2012, the court granted the motion for summary judgment as to all remaining defendants and the judgment has been entered. We have appealed. The defendants applied to the court for reimbursement from us of their allowable court costs in the collective amount of $2.4 million. We challenged the application as excessive under California law, and, following hearing, the amount was reduced to $689,471, which will be payable only if we do not succeed on our appeal of the summary judgment. The nature of the loss contingencies relating to any court costs ordered against us are described above.

 

On May 30, 2008, we filed a complaint in New York state court against the New York State Department of Taxation and Finance, its Commissioner, the State of New York and its governor, alleging that a New York state tax law is unconstitutional. The effect of the New York law is to require Internet sellers to collect and remit New York sales taxes on their New York sales even if the seller has no New York tax “nexus” other than with New York based independent contractors who are Internet advertising affiliates. The complaint asks for the court to declare the law unconstitutional and enjoin its application to us. New York filed a motion to dismiss. We responded to the motion and filed a motion for summary judgment, and both motions were heard simultaneously. On January 12, 2009, the court granted New York’s motion to dismiss and denied our motion for summary judgment. We appealed the decision and the New York Appellate Division upheld part of the lower court’s ruling rejecting our claims that the law is unconstitutional on its face, but remanded our claims that the law is unconstitutional as applied, for further discovery and proceedings in the lower court. We filed with the New York State Court of Appeals a motion of leave to appeal the portions of the decision upholding the lower court’s ruling. On March 15, 2011, the Appellate Division of the New York State Court of Appeals denied our motion for leave to appeal to the New York State Court of Appeals. We determined not to pursue at the trial court level our claims that the law is unconstitutional as applied and proceeded with an appeal to the New York State Court of Appeals of the Appellate Division’s ruling on our claim that the statute is unconstitutional on its face. On March 28, 2013, New York State Court of Appeals denied the appeal. We intend to appeal to the Supreme Court of the United States.

 

On August 12, 2008, we along with seven other defendants, were sued in the United States District Court for the Northern District of California, by Sean Lane, and seventeen other individuals, on their own behalf and for others similarly in a class action suit, alleging violations of the Electronic Communications Privacy Act, Computer Fraud and Abuse Act, Video Privacy Protection Act, and California’s Consumer Legal Remedies Act and Computer Crime Law. The complaint relates to our use of a product known as Facebook Beacon, created and provided to us by Facebook, Inc. Facebook Beacon provided the means for Facebook users to share purchasing data among their Facebook friends. The parties extended by agreement the time for defendants’ answer, including our answer, and thereafter, the Plaintiff and Facebook proposed a stipulated settlement to the Court for approval, which would resolve the case without requirement of financial contribution from us. On March 17, 2010, over objections lodged by some parties, the Court entered an order accepting settlement. Various parties appealed and on September 20, 2012, the Federal Appeals Court for the 9th Circuit upheld the settlement. Appealing parties have petitioned for a rehearing. On February 26, 2013, the Court denied the petition. The nature of the loss contingencies relating to claims that have been asserted against us are described above.

 

On November 14, 2008, we filed suit in Ohio state court against the Ohio Tax Commissioner, the Ohio Attorney General and the Governor of Ohio, alleging the Ohio Commercial Activity Tax is unconstitutional. Enacted in 2005, Ohio’s Commercial Activity Tax is based on activities in Ohio that contribute to production or gross income for a company whether or not the company has a physical presence in or nexus within the state. Our complaint asked for a judgment declaring the tax unconstitutional and for an injunction preventing any enforcement of the tax. The defendants moved to dismiss the case. On July 28, 2009, the trial court ruled that there was no justiciable controversy in the case, as we had not yet been assessed a tax, and it granted the defendants’ motions to dismiss. In September 2009, we received a letter of determination from the Ohio Department of Taxation noting the Department’s determination that we are required to register for remitting of the Commercial Activity Tax, and owe $612,784 in taxes, interest, and penalties as of June 30, 2009. The Ohio Department of Taxation issued additional estimated assessments of estimated tax, interest and penalties totaling $158,246 as of March 31, 2013. We have filed protests to challenge the Department’s Assessments on constitutional grounds and the matter is currently pending before the Ohio Department of Taxation’s Legal Division for administrative review and determination. A hearing on these matters was held November 18, 2011. No administrative ruling has been issued following the hearing. The nature of the loss contingencies relating to claims that have been asserted against us are described above. We believe the determinations to be unlawful and erroneous and are vigorously contesting the determination.

 

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On March 10, 2009, we were sued in a class action filed in the United States District Court, Eastern District of New York. Cynthia Hines, the nominative plaintiff on behalf of herself and others similarly situated, seeks damages under claims for breach of contract, common law fraud and New York consumer fraud laws. The Plaintiff alleges we failed to properly disclose our returns policy to her and that we improperly imposed a “restocking” charge on her return of a vacuum cleaner. We filed a motion to dismiss based upon assertions that our agreement with our customers requires all such actions to be arbitrated in Salt Lake City, Utah. Alternatively, we asked that the case be transferred to the United States District Court for the District of Utah, so that arbitration may be compelled in that district. On September 8, 2009, the motion to dismiss or transfer was denied, the court stating that our browsewrap agreement was insufficient under New York law to establish an agreement with the customer to arbitrate disputes in Utah. On October 8, 2009, we filed a Notice of Appeal of the court’s ruling. The appeal was denied. On December 31, 2010, Hines filed an amended complaint. The amended complaint eliminated common law fraud claims and breach of contract claims and added claims for breach of Utah’s consumer protection statute and various other state consumer protection statutes. The amended complaint also asks for an injunction. We filed motions to dismiss and to decertify the class. The court has not ruled on these motions. The nature of the loss contingencies relating to claims that have been asserted against us are described above. However, no estimate of the loss or range of loss can be made. We intend to vigorously defend this action.

 

On September 23, 2009, SpeedTrack, Inc. sued us along with 27 other defendants in the United States District Court in the Northern District of California. We are alleged to have infringed a patent covering search and categorization software. We believe that certain third party vendors of products and services sold to us are contractually obligated to indemnify us in this action. On November 11, 2009, the parties stipulated to stay all proceedings in the case until resolution of a reexamination of the patent in question, and also until a previously filed infringement action against Wal-Mart Stores, Inc. and other retailers resulted either in judgment or dismissal. Subsequently, the parties agreed to extend the time for defendants’ complaint answer until 21 days following a court order to lift the stay to which the parties stipulated. The United States Patent and Trademark Office resolved the reexamination of the patent in question in favor of SpeedTrack, Inc. The case remains stayed, pending the outcome and appeal of the infringement action against Wal-Mart Stores, Inc. and other retailers. On February 22, 2012, the court in the Wal-Mart Stores case granted Wal-Mart Stores’ motion for summary judgment of non-infringement. The court also granted Speedtrack’s motion for summary judgment on patent validity. Speedtrack is appealing the ruling. It is not known whether the summary judgments granted in the Wal-Mart Stores case will have an effect on the Speedtrack case in which we are named as one of the defendants. The nature of the loss contingencies relating to claims that have been asserted against us are described above. However no estimate of the loss or range of loss can be made. We intend to vigorously defend this action and pursue our indemnification rights with our vendors.

 

On or about September 25, 2009, Alcatel-Lucent USA, Inc. filed suit against us and 12 other defendants in the United States District Court in the Eastern District of Texas. We are alleged to have infringed three patents purportedly related to a communications protocol between a user and server terminals, text input functionalities and search processes. We believe a third party vendor of search products and services sold to us is contractually obligated to indemnify us in this action as it pertains to the search patent. On October 14, 2011, a jury returned a verdict in our favor, finding non-infringement on all asserted claims, on all patents, and finding of invalidity of the Alcatel-Lucent patent, having to do with a communications protocol. On November 29, 2011, Alcatel-Lucent filed a motion for a new trial which was denied. Alcatel-Lucent has filed an appeal which we have opposed. The appeal is set for hearing May 10, 2013.

 

On September 29, 2010, a trustee in bankruptcy filed against us an adversary proceeding in the matter of In re: Petters Company, Inc., a case filed in United States Bankruptcy Court, in the District of Minnesota. The complaint alleges principal causes of action against us under various Bankruptcy Code sections and the Minnesota Fraudulent Transfer Act, to recover damages for alleged transfers of property from the Petters Company occurring prior to the filing of the case initially as a civil receivership in October 2008. The trustee’s complaint alleges such transfers occurred in at least one note transaction whereby we transferred at least $2.3 million and received in return transfers totaling at least $2.5 million. The trustee does not specify a date for the transactions; however we believe that any alleged transaction with the Petters Company would have taken place in excess of seven years from the date of the filing of the adversary proceeding. The case is in its early stages. We filed a motion to dismiss on statute of limitations and other grounds. The court has not ruled upon the motion to dismiss. The nature of the loss contingencies relating to claims that have been asserted against us are described above. However, no estimate of the loss or range of loss can be made. We intend to vigorously defend this action.

 

On November 17, 2010, we were sued in the Superior Court of California, County of Alameda, by District Attorneys for the California Counties of Alameda, Marin, Monterey, Napa, Santa Clara, Shasta and Sonoma County, and the County of Santa Cruz joined the suit. These district attorneys seek damages and an injunction under claims for violations of California consumer protection laws, alleging we made untrue or misleading statements concerning our pricing, price reductions, sources of products and shipping charges. The complaint asks for damages in the amount of not less than $15 million. The suit is in the discovery stage. Trial has been set tentatively for September 9, 2013. The nature of the loss contingencies relating to claims that have been asserted against us are described above. We intend to vigorously defend this action.

 

On September 11, 2011, Droplets, Inc. filed suit against us and eight other defendants in the United States District Court in the Eastern District of Texas for infringement of a patent covering strings of programming code downloaded from a server to a client computer. We have answered the complaint. The case is in its early stages. The nature of the loss contingencies relating to claims that

 

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have been asserted against us are described above. However, no estimate of the loss or range of loss can be made. We intend to vigorously defend this action and pursue our indemnification rights with our vendors.

 

On September 13, 2011, Select Retrieval, LLC filed suit against us and 79 other defendants in the United States District Court for the District of Delaware for infringement of a patent covering the hierarchical display of interactive links on a webpage. We filed a motion to dismiss which was denied. The case is in its early stages. The nature of the loss contingencies relating to claims that have been asserted against us are described above. However, no estimate of the loss or range of loss can be made. We intend to vigorously defend this action and pursue our indemnification rights, if any, with our vendors.

 

On November 18, 2011, Smartfit Solutions, LLC filed suit against us and 43 other defendants in the United States District Court for the Eastern District of Texas for infringement of a patent covering certain “methods for presenting exercise protocols to a user and evaluating the effectiveness of the same.” We tendered the defense of this action to an indemnitor which accepted the defense. We have answered the complaint. The case is in its early stages. The nature of the loss contingencies relating to claims that have been asserted against us are described above. However, no estimate of the loss or range of loss can be made. We intend to vigorously defend this action and pursue our indemnification rights with our vendors.

 

On January 27, 2012, Pragmatus Telecom, LLC filed suit against us in the United States District Court for the District of Delaware for infringement of two patents covering a system for coordinating data and voice communications via customer contact channel changing system using voice over IP and infringement of one patent for coordinating data and voice communications via customer contact channel changing system. We have answered the complaint. We tendered the defense of the case to an indemnitor. The case against us was stayed July 10, 2012, pending resolution of the declaratory action. The nature of the loss contingencies relating to claims that have been asserted against us are described above. However, no estimate of the loss or range of loss can be made. We intend to vigorously defend this action and pursue our indemnification rights with our vendors.

 

On March 1, 2012, H-W Technology, L.C. filed suit against us in the United States District Court in the Northern District of Texas for infringement of a patent entitled “Internet Protocol (IP) Phone with Search and Advertising Capability.” We have answered the complaint. The case is in discovery. On January 28, 2013, we filed a motion for summary judgment for invalidity on two claims of the patent. The court has yet to rule on the motion. The nature of the loss contingencies relating to claims that have been asserted against us are described above. However, no estimate of the loss or range of loss can be made. We intend to vigorously defend this action and pursue our indemnification rights, if any, with our vendors.

 

On May 2, 2012, Execware LLC filed suit against us in the United States District Court for the District of Delaware for infringement of a patent entitled: “Integrated Dialog Box for Rapidly Altering Presentation of Parametric Text Data Objects on a Computer Display.” We have answered the complaint. The case is in its early stages. The nature of the loss contingencies relating to claims that have been asserted against us are described above. However, no estimate of the loss or range of loss can be made. We intend to vigorously defend this action and pursue our indemnification rights with our vendors.

 

On July 16, 2012, Digitech Image Technologies, LLC filed against us and forty-five other defendants in the United States District Court for the Central District of California for infringement of a patent covering the imaging technology that facilitates prediction of color and location within digital cameras. We tendered defense of the case to an indemnitor which accepted the defense. Following a ruling in our favor, the case was dismissed and in September 2012, Digitech filed a new complaint in the same court on the same infringement claims. In the new action, our indemnitor continues to defend the case and has filed a motion to stay on our behalf. The case is in its early stages. The nature of the loss contingencies relating to claims that have been asserted against us are described above. However, no estimate of the loss or range of loss can be made. We intend to cooperate with our indemnitor and vigorously defend this action.

 

On July 19, 2012, Data Carriers, LLC filed suit against us in the United States District Court for the District of Delaware for infringement of a patent covering the “autocomplete” features of our website. We believe a third party vendor is contractually obligated to indemnify us in this action. We have answered the complaint. The case is in its early stages. The nature of the loss contingencies relating to claims that have been asserted against us are described above. However, no estimate of the loss or range of loss can be made. We intend to vigorously defend this action and pursue our indemnification rights with our vendors.

 

On February 11, 2013, RPost Holdings, Inc., RPost Communications Limited, and RMail Limited, filed suit against us in the United States District Court in Eastern District of Texas for infringement of patents covering products and services that verify the delivery and integrity of email messages. We tendered defense of the case to an indemnitor which accepted the defense. We have not answered the complaint. The case is in its early stages. The nature of the loss contingencies relating to claims that have been asserted against us are described above. However, no estimate of the loss or range of loss can be made.

 

On April 23, 2013, Eclipse IP, LLC filed suit against us in the United States District Court in Eastern District of Texas for infringement of patents covering “secure notification messaging systems and methods using authentication indicia.”  We are presently examining whether we are indemnified by any vendor. We have not yet been served nor answered the complaint. The nature of the loss contingencies relating to claims that have been asserted against us are described above. However, no estimate of the loss or range of loss can be made.

 

We establish liabilities when a particular contingency is probable and estimable. At March 31, 2013, we have accrued $3.0 million in light of these probable and estimable liabilities. It is reasonably possible that the actual losses may exceed our accrued

 

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liabilities. We have other contingencies which are reasonably possible; however, the reasonably possible exposure to losses cannot currently be estimated.

 

6. INDEMNIFICATIONS AND GUARANTEES

 

During our normal course of business, we have made certain indemnities, commitments, and guarantees under which we may be required to make payments in relation to certain transactions. These indemnities include, but are not limited to, indemnities to various lessors in connection with facility leases for certain claims arising from such facility or lease, and indemnities to our directors and officers to the maximum extent permitted under the laws of the State of Delaware. The duration of these indemnities, commitments, and guarantees varies, and in certain cases, is indefinite. In addition, the majority of these indemnities, commitments, and guarantees do not provide for any limitation of the maximum potential future payments we could be obligated to make. As such, we are unable to estimate with any reasonableness our potential exposure under these items. We have not recorded any liability for these indemnities, commitments, and guarantees in the accompanying consolidated balance sheets. We do, however, accrue for losses for any known contingent liability, including those that may arise from indemnification provisions, when future payment is both probable and reasonably estimable.

 

7. STOCK-BASED AWARDS

 

We have equity incentive plans that provide for the grant to employees of stock-based awards, including stock options and restricted stock.

 

Stock-based compensation expense was as follows (in thousands):

 

 

 

Three months ended
March 31,

 

 

 

2013

 

2012

 

Stock options

 

$

 

$

3

 

Restricted stock awards

 

752

 

810

 

Total stock-based compensation expense

 

$

752

 

$

813

 

 

Restricted stock awards

 

During the three months ended March 31, 2013, the Compensation Committee of the Board of Directors approved grants of 240,000 restricted stock awards to our officers, board members and employees. The restricted stock awards vest over three years at 40% at the end of the first year, 30% at the end of the second year and 30% at the end of the third year and are subject to the employee’s continuing service to us. At March 31, 2013, there were 801,000 unvested restricted stock awards that remained outstanding.

 

The cost of restricted stock awards is determined using the fair value of our common stock on the date of the grant, and compensation expense is either recognized on a straight line basis over the three-year vesting schedule or on an accelerated schedule when vesting of restricted stock awards exceeds a straight-line basis. The cumulative amount of compensation expense recognized at any point in time is at least equal to the portion of the grant date fair value of the award that is vested at that date. The weighted average grant date fair value of restricted stock awards granted during the three months ended March 31, 2013 was $14.68.

 

The following table summarizes restricted stock award activity during the three months ended March 31, 2013 (in thousands):

 

 

 

Three months ended
March 31, 2013

 

 

 

 

 

Weighted Average

 

 

 

 

 

Grant Date

 

 

 

Units

 

Fair Value

 

Outstanding—beginning of year

 

1,003

 

$

8.81

 

Granted at fair value

 

240

 

14.68

 

Vested

 

(293

)

9.58

 

Forfeited

 

(149

)

9.37

 

Outstanding—end of period

 

801

 

$

10.19

 

 

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8. BUSINESS SEGMENTS

 

Segment information has been prepared in accordance with ASC Topic 280 Segment Reporting. Segments were determined based on how we manage the business. There were no inter-segment sales or transfers during the three months ended March 31, 2013 and 2012. We evaluate the performance of our segments and allocate resources to them based primarily on gross profit. The table below summarizes information about reportable segments for the three months ended March 31, 2013 and 2012 (in thousands):

 

 

 

Three months ended
March 31,

 

 

 

Direct

 

Fulfillment
partner

 

Total

 

2013

 

 

 

 

 

 

 

Revenue, net

 

$

41,942

 

$

270,052

 

$

311,994

 

Cost of goods sold

 

37,149

 

215,909

 

253,058

 

Gross profit

 

$

4,793

 

$

54,143

 

$

58,936

 

Operating expenses

 

 

 

 

 

(51,521

)

Other income (expense), net

 

 

 

 

 

328

 

Provision for income taxes

 

 

 

 

 

46

 

Net income

 

 

 

 

 

$

7,697

 

 

 

 

 

 

 

 

 

2012

 

 

 

 

 

 

 

Revenue, net

 

$

40,897

 

$

221,470

 

$

262,367

 

Cost of goods sold

 

37,630

 

177,229

 

214,859

 

Gross profit

 

$

3,267

 

$

44,241

 

$

47,508

 

Operating expenses

 

 

 

 

 

(45,033

)

Other income (expense), net

 

 

 

 

 

253

 

Provision for income taxes

 

 

 

 

 

9

 

Net income

 

 

 

 

 

$

2,719

 

 

The direct segment includes revenues, direct costs, and cost allocations associated with sales fulfilled from our warehouses. Costs for this segment include product costs, freight, warehousing and fulfillment costs, credit card fees and customer service costs.

 

The fulfillment partner segment includes revenues, direct costs and cost allocations associated with sales fulfilled from warehouses maintained by our fulfillment partners. Costs for this segment include product costs, outbound freight and fulfillment costs, credit card fees and customer service costs.

 

Assets have not been allocated between the segments for our internal management purposes and, as such, they are not presented here.

 

For the three months ended March 31, 2013 and 2012, over 99% of sales were made to customers in the United States of America. At March 31, 2013 and December 31, 2012, all of our fixed assets were located in the United States of America.

 

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

 

Special Note Regarding Forward-Looking Statements

 

This Quarterly Report on Form 10-Q and the documents incorporated herein by reference contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements are therefore entitled to the protection of the safe harbor provisions of these laws. These forward-looking statements involve risks and uncertainties, and relate to future events or our future financial or operating performance. The forward-looking statements include all statements other than statements of historical fact, including, without limitation, all statements regarding:

 

·                        the anticipated benefits and risks of our business and plans;

·                        our ability to attract and retain customers in a cost-efficient manner;

·                        the effectiveness of our marketing;

·                        our future operating and financial results;

·                        the competition we face and will face in our business;

·                        the effects of government regulation;

·                        our future capital requirements and our ability to satisfy our capital needs;

·                        our expectations regarding the adequacy of our liquidity;

·                        our ability to retire or refinance any debt we may have;

·                        our plans for international markets, our expectations for our international sales efforts and the anticipated results of international operations;

·                        our plans for changes to our business;

·                        our beliefs regarding current or future litigation or regulatory actions;

·                        our beliefs and expectations regarding existing and future tax laws and related laws and the application of those laws to our business;

·                        our beliefs regarding the adequacy of our insurance coverage;

·                        the adequacy of our infrastructure, including our backup facilities, cyber-security and our disaster planning;

·                        our belief that we can meet our published product shipping standards even during periods of relatively high sales activity;

·                        our belief that we can maintain or improve upon customer service levels that we and our customers consider acceptable;

·                        our beliefs regarding the adequacy of our order processing systems and our fulfillment and distribution capabilities;

·                        our beliefs and expectations regarding the adequacy of our office and warehouse facilities;

·                        our expectations regarding our car listing service and our community site, and the anticipated functionality and results of operations of them;

·                        our belief that we and our fulfillment partners will be able to maintain inventory levels at appropriate levels despite the seasonal nature of our business;

·                        our belief that our sales through other ecommerce marketplace channels will be successful and become an important part of our business; and

·                        our belief that we can successfully offer and sell a constantly changing mix of products and services.

 

Further, in some cases, you can identify forward-looking statements by terminology such as may, will, could, should, expect, plan, intend, anticipate, believe, estimate, predict, potential or continue, the negative of such terms or other comparable terminology. These statements are only predictions. Actual events or results may differ materially from those contemplated by forward-looking statements for a variety of reasons, including among others:

 

·                        changes in U.S. and global economic conditions and consumer spending;

·                        world events;

·                        the rate of growth of the Internet and online commerce, and the occurrence of any event that would discourage or prevent consumers from shopping online;

·                        any failure to maintain our existing relationships or build new relationships with fulfillment partners on acceptable terms;

·                        any difficulties we may encounter maintaining optimal levels of product quality and selection or in attracting sufficient consumer interest in our product offerings;

·                        modifications we may make to our business model from time to time, including aspects relating to our product mix and the mix of direct/fulfillment partner sourcing of the products we offer;

·                        the mix of products purchased by our customers;

·                        problems with cyber security or data breaches or the costs of preventing or responding to any such problems;

·                        problems with or affecting our credit card processors, including cyber-attacks, Internet or other infrastructure or communications impairment or other events that could interrupt the normal operation of the credit card processors;

·                        problems with the facility where substantially all of our computer and communications hardware is located or other problems that result in the unavailability of our Website or reduced performance of our transaction systems;

 

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·                        difficulties we may have in responding to technological changes;

·                        problems with fraudulent purchases;

·                        problems we may encounter as a result of counterfeit items or the listing or sale of pirated, counterfeit or illegal items by third parties;

·                        difficulties we may have financing our operations or expansion with either internally generated funds or external sources of financing;

·                        the extent to which we owe income taxes or are required to collect sales taxes or to modify our business model in order to avoid being required to collect sales taxes;

·                        competition;

·                        difficulties with the management of our growth;

·                        fluctuations in our operating results;

·                        our efforts to expand internationally;

·                        the outcomes of legal proceedings, investigations and claims;

·                        our inability to optimize our warehouse operations;

·                        risks of inventory management and seasonality; and

·                        the other risks described in our public filings.

 

In evaluating all forward-looking statements, you should specifically consider the risks outlined above and those described in Item 1A under the caption “Risk Factors” included in this Form 10-Q for the three months ended March 31, 2013. These factors may cause our actual results to differ materially from those contemplated by any forward-looking statement. Except as otherwise required by law, we expressly disclaim any obligation to release publicly any update or revisions to any forward-looking statements to reflect any changes in our expectations or any change in events, conditions or circumstances on which any of our forward-looking statements are based. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements or other events.

 

These forward-looking statements speak only as of the date of this report and, except as required by law, we undertake no obligation to update forward-looking statements to reflect events or circumstances occurring after the date of this report.

 

Available Information

 

Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and other reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge through the Investors Relations section of our main website www.overstock.com as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission. Our Internet Website and the information contained therein or connected thereto are not a part of or incorporated into this Quarterly Report on Form 10-Q.

 

Overview

 

We are an online retailer offering discount brand name, non-brand name and closeout merchandise, including furniture, home décor, bedding and bath, housewares, jewelry and watches, apparel and designer accessories, electronics and computers, and sporting goods, among other products. We sell hundreds of thousands of best seller and current run books, magazines, CDs, DVDs and video games (“BMMG”). We sell these products and services through our Internet websites located at www.overstock.com, www.o.co and www.o.biz (“Website”). Although our three websites are located at different domain addresses, the technology and equipment and processes supporting the Website and the process of order fulfillment described herein are the same for all three websites.

 

Our company, based in Salt Lake City, Utah, was founded in 1997. We launched our initial website in March 1999. Our Website offers our customers an opportunity to shop for bargains conveniently, while offering our suppliers an alternative inventory liquidation or sales channel. We continually add new, and sometimes limited, inventory to our Website in order to create an atmosphere that encourages customers to visit frequently and purchase products before our inventory sells out. We sell products primarily in the United States, with a small amount of products (less than 1% of our total net revenue) sold internationally.

 

As used herein, “Overstock,” “Overstock.com,”, “O.co,”  “we,” “our” and similar terms include Overstock.com, Inc. and its subsidiaries, unless the context indicates otherwise.

 

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Executive Commentary

 

This executive commentary is intended to provide investors with a view of our business through the eyes of our management. As an executive commentary, it necessarily focuses on selected aspects of our business. This executive commentary is intended as a supplement to, but not a substitute for, the more detailed discussion of our business included elsewhere herein. Investors are cautioned to read our entire “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, as well as our interim and audited financial statements, and the discussion of our business and risk factors and other information included elsewhere or incorporated in this report. This executive commentary includes forward-looking statements, and investors are cautioned to read the “Special Note Regarding Forward-Looking Statements” at the beginning of Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

Net income was $7.7 million in Q1 2013 compared to $2.7 million in Q1 2012. The $5.0 million year-over-year improvement in net income resulted primarily from revenue growth of 19% and an 80 basis point improvement in gross margin (together, resulting in an $11.4 million increase in gross profit). This increase in gross profit was partially offset by a $6.5 million increase in operating expenses.

 

Revenues in Q1 2013 increased 19% compared to Q1 2012. The growth in revenue was primarily due to a 21% increase in average order size, from $126 to $153, largely due to a sales mix shift into the home and garden category, partially offset by a small decrease in the number of customer orders.

 

Gross profit increased 24% compared to Q1 2012 primarily as a result of that revenue growth and a shift in product sales mix into higher margin home and garden products, as well as lower warehousing costs, partially offset by higher freight costs.

 

Sales and marketing expenses increased as a percentage of revenue to 6.0% in Q1 2013 from 5.5% in Q1 2012 primarily due to increased expenditures in the sponsored search marketing channel due to a higher portion of our revenue being generated through that channel.

 

As a result, we had a 22% increase in Contribution (see “Non-GAAP Financial Measures” below for a reconciliation of Contribution to Gross Profit) compared to Q1 2012. Contribution margin was 12.9%, for Q1 2013, up from 12.6% in Q1 2012

 

Technology expense in Q1 2013 increased $2.5 million compared to Q1 2012, primarily due to an increase in staff-related costs. General and administrative expenses in Q1 2013 remained relatively flat compared to Q1 2012.

 

Working capital improved from $7.5 million at December 31, 2012 to $8.5 million at March 31, 2013.

 

The balance of our Management’s Discussion and Analysis of Financial Condition and Results of Operations provides further information about the matters discussed above and other important matters affecting our business.

 

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Results of Operations

 

The following table sets forth our results of operations expressed as a percentage of total net revenue:

 

 

 

Three months ended
March 31,

 

 

 

2013

 

2012

 

 

 

(as a percentage of total net
revenue)

 

Revenue, net

 

 

 

 

 

Direct

 

13.4

%

15.6

%

Fulfillment partner

 

86.6

 

84.4

 

Total net revenue

 

100.0

 

100.0

 

Cost of goods sold

 

 

 

 

 

Direct

 

11.9

 

14.3

 

Fulfillment partner

 

69.2

 

67.6

 

Total cost of goods sold

 

81.1

 

81.9

 

Gross profit

 

18.9

 

18.1

 

Operating expenses:

 

 

 

 

 

Sales and marketing

 

6.0

 

5.5

 

Technology

 

5.8

 

6.0

 

General and administrative

 

4.8

 

5.6

 

Restructuring

 

(0.1

)

 

Total operating expenses

 

16.5

 

17.2

 

Operating income

 

2.4

 

0.9

 

Interest income

 

 

 

Interest expense

 

 

(0.1

)

Other income, net

 

0.1

 

0.2

 

Net income before income taxes

 

2.5

 

1.0

 

Provision for income taxes

 

 

 

Net income

 

2.5

%

1.0

%

 

Comparisons of Three Months Ended March 31, 2013 to Three Months Ended March 31, 2012

 

Revenue

 

The following table reflects our net revenues for the three months ended March 31, 2013 and 2012 (in thousands):

 

 

 

Three months ended
March 31,

 

 

 

 

 

 

 

2013

 

2012

 

$ Change

 

% Change

 

Revenue, net

 

 

 

 

 

 

 

 

 

Direct

 

$

41,942

 

$

40,897

 

$

1,045

 

2.6

%

Fulfillment partner

 

270,052

 

221,470

 

48,582

 

21.9

%

Total revenue, net

 

$

311,994

 

$

262,367

 

$

49,627

 

18.9

%

 

Total net revenue for the three months ended March 31, 2013 increased 19% primarily due to a 21% increase in average order size, partially offset by a small decrease in number of customer orders.

 

The primary reason for increased direct revenue for the three months ended March 31, 2013 was a continued shift in sales mix particularly into our home and garden products, partially offset by a decrease in sales of clothing and shoes due to our continued shift from a direct inventory-based model to a fulfillment partner-based model to reduce exposure from seasonal inventory and mark downs.

 

The primary reason for the increase in fulfillment partner revenue for the three months ended March 31, 2013 was an increase in sales of home and garden products.

 

The shift of business from direct to fulfillment partner (or vice versa) is an economic decision based on the economics of each

 

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particular product offering at the time and we do not have particular goals for an “appropriate” mix or percentage for the size of either. We believe that the mix of the business between direct and fulfillment partner is consistent with our strategic objectives for our business model in the current economic environment and with the exception of a transition of our direct clothing and shoes category to a fulfillment partner model to reduce our seasonal inventory risks, we do not currently foresee any material shifts in mix.

 

Total revenues from international sales were $2.9 million and $2.3 million for the three months ended March 31, 2013 and 2012, respectively.

 

Change in estimate of average transit times (days)

 

Revenue related to merchandise sales is recognized upon delivery to our customers. As we ship high volumes of packages through multiple carriers, it is not practical for us to track the actual delivery date of each shipment. Therefore, we use estimates to determine which shipments are delivered and, therefore, recognized as revenue at the end of the period. Our delivery date estimates are based on average shipping transit times. We review and update our estimates on a quarterly basis based on our actual transit time experience. However, actual shipping times may differ from our estimates.

 

The following table shows the effect that hypothetical changes in the estimate of average shipping transit times would have had on the reported amount of revenue and net income for the three months ended March 31, 2013 (in thousands):

 

 

 

Three months ended
March 31, 2013

 

Change in the
Estimate of Average
Transit Times (Days)

 

Increase
(Decrease)
Revenue

 

Increase
(Decrease) Net
Income

 

2

 

$

(12,367

)

$

(2,084

)

1

 

$

(4,991

)

$

(834

)

As reported

 

As reported

 

As reported

 

-1

 

$

3,450

 

$

581

 

-2

 

$

6,925

 

$

1,167

 

 

See “Executive Commentary” above for additional discussion regarding revenue.

 

Gross profit

 

Our overall gross margins fluctuate based on our sales volume mix between our direct business and fulfillment partner business; changes in vendor and / or customer pricing, including competitive pricing; inventory management decisions within the direct business; sales coupons and promotions; product mix of sales; and operational and fulfillment costs.

 

The following table reflects our net revenues, cost of goods sold and gross profit for the three months ended March 31, 2013 and 2012 (in thousands):

 

 

 

Three months ended
March 31,

 

 

 

 

 

 

 

2013

 

2012

 

$ Change

 

% Change

 

Revenue, net

 

 

 

 

 

 

 

 

 

Direct

 

$

41,942

 

$

40,897

 

$

1,045

 

2.6

%

Fulfillment partner

 

270,052

 

221,470

 

48,582

 

21.9

%

Total net revenues

 

$

311,994

 

$

262,367

 

$

49,627

 

18.9

%

Cost of goods sold

 

 

 

 

 

 

 

 

 

Direct

 

$

37,149

 

$

37,630

 

$

(481

)

(1.3

)%

Fulfillment partner

 

215,909

 

177,229

 

38,680

 

21.8

%

Total cost of goods sold

 

$

253,058

 

$

214,859

 

$

38,199

 

17.8

%

Gross Profit

 

 

 

 

 

 

 

 

 

Direct

 

$

4,793

 

$

3,267

 

$

1,526

 

46.7

%

Fulfillment partner

 

54,143

 

44,241

 

9,902

 

22.4

%

Total gross profit

 

$

58,936

 

$

47,508

 

$

11,428

 

24.1

%

 

Gross margins for the past five quarterly periods and fiscal year ending 2012 were:

 

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Q1 2012

 

Q2 2012

 

Q3 2012

 

Q4 2012

 

FY 2012

 

Q1 2013

 

Direct

 

8.0

%

8.3

%

10.3

%

11.5

%

9.6

%

11.4

%

Fulfillment Partner

 

20.0

%

19.6

%

19.4

%

18.9

%

19.4

%

20.0

%

Combined

 

18.1

%

18.0

%

18.2

%

17.9

%

18.1

%

18.9

%

 

The 340 basis point increase in direct gross margin for the three months ended March 31, 2013 compared to the three months ended March 31, 2012 is primarily due to a shift in sales mix into higher margin home and garden products, as well as lower warehousing costs, partially offset by higher freight costs.

 

Fulfillment partner gross margin remained flat for the three months ended March 31, 2013 compared to the three months ended March 31, 2012.

 

Cost of goods sold includes stock-based compensation expense of $48,000 and $60,000 for the three months ended March 31, 2013 and 2012, respectively.

 

See “Executive Commentary” above for additional discussion.

 

Fulfillment costs

 

Fulfillment costs include all warehousing costs, including fixed overhead and variable handling costs (excluding packaging costs), as well as credit card fees and customer service costs, all of which we include as costs in calculating gross margin. We believe that some companies in our industry, including some of our competitors, account for fulfillment costs within operating expenses, and therefore exclude fulfillment costs from gross margin. As a result, our gross margin may not be directly comparable to others in our industry.

 

The following table has been included to provide investors additional information regarding our classification of fulfillment costs, gross profit and margin, thus enabling investors to better compare our gross margin with others in our industry (in thousands):

 

 

 

Three months ended
March 31,

 

 

 

2013

 

2012

 

Total revenue, net

 

$

311,994

 

100

%

$

262,367

 

100

%

Cost of goods sold

 

 

 

 

 

 

 

 

 

Product costs and other cost of goods sold

 

239,197

 

77

%

201,793

 

77

%

Fulfillment and related costs

 

13,861

 

4

%

13,066

 

5

%

Total cost of goods sold

 

253,058

 

81

%

214,859

 

82

%

Gross profit

 

$

58,936

 

19

%

$

47,508

 

18

%

 

Fulfillment costs as a percentage of sales may vary due to several factors, such as our ability to manage costs at our warehouses, significant changes in the number of units received and fulfilled, the extent to which we use third party fulfillment services and warehouses, and our ability to effectively manage customer service costs and credit card fees. Fulfillment and related costs decreased from 5% to 4% during the three months ended March 31, 2013 primarily due to a decrease in warehousing costs.

 

See “Gross profit” above for additional discussion.

 

Operating expenses

 

Sales and marketing expenses

 

We advertise through a number of targeted online marketing channels, such as sponsored search, affiliate marketing, portal advertising, e-mail campaigns, and other initiatives. We also use nationwide television, print and radio advertising campaigns to promote sales.

 

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The following table reflects our sales and marketing expenses for the three months ended March 31, 2013 and 2012 (in thousands):

 

 

 

Three months ended
March 31,

 

 

 

 

 

 

 

2013

 

2012

 

$ Change

 

% Change

 

Sales and marketing expenses

 

$

18,705

 

$

14,475

 

$

4,230

 

29.2

%

Sales and marketing expenses as a percent of net revenues

 

6.0

%

5.5

%

 

 

 

 

 

Sales and marketing expenses as a percentage of revenue increased from 5.5% to 6.0% for the three months ended March 31, 2013 primarily due to increased expenditures in the sponsored search marketing channel due to a larger portion of our revenue being generated through that channel.

 

Sales and marketing expenses include stock-based compensation expense of $25,000 and $101,000 for the three months ended March 31, 2013 and 2012, respectively.

 

Costs associated with our discounted shipping and other promotions, such as coupons, are not included in marketing expense. Rather they are accounted for as a reduction of revenue and therefore affect revenues and gross margin. We consider discounted shipping and other promotions, such as our new policy of free shipping on orders over $50 introduced in early January 2013, as an effective marketing tool, and intend to continue to offer them as we deem appropriate as part of our overall marketing plan.

 

Technology expenses

 

We seek to invest efficiently in technology, including web services, customer support solutions and website search, and in expansion of new and existing product categories, and in investments in technology to enhance the customer experience, improve our process efficiency and support our logistics infrastructure.

 

The following table reflects our technology expenses for the three months ended March 31, 2013 and 2012 (in thousands):

 

 

 

Three months ended
March 31,

 

 

 

 

 

 

 

2013

 

2012

 

$ Change

 

% Change

 

Technology expenses

 

$

18,160

 

$

15,638

 

$

2,522

 

16.1

%

Technology expenses as a percent of net revenues

 

5.8

%

6.0

%

 

 

 

 

 

The $2.5 million increase for the three months ended March 31, 2013 is primarily due to an increase in staff-related costs.

 

Technology expenses include stock-based compensation expense of $124,000 and $176,000 for the three months ended March 31, 2013 and 2012, respectively.

 

General and administrative expenses

 

The following table reflects our general and administrative expenses for the three months ended March 31, 2013 and 2012 (in thousands):

 

 

 

Three months ended
March 31,

 

 

 

 

 

 

 

2013

 

2012

 

$ Change

 

% Change

 

General and administrative expenses

 

$

15,088

 

$

14,822

 

$

266

 

1.8

%

General and administrative expenses as a percent of net revenues

 

4.8

%

5.6

%

 

 

 

 

 

General and administrative expenses (“G&A”) for the three months ended March 31, 2013 remained relatively flat compared to March 31, 2012.

 

G&A expenses include stock-based compensation expense of approximately $555,000 and $476,000 for the three months ended March 31, 2013 and 2012, respectively.

 

Restructuring

 

We reversed $432,000 of lease termination costs during the three months ended March 31, 2013 due to changes in our restructuring accrual as a result of our reoccupation of a portion of formerly restructured office space. We incurred $98,000 of lease

 

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termination costs liability during the three months ended March 31, 2012 due to changes in the estimate of sublease income as a result of our entering into a revised agreement with a sub lessee and ceasing the use of one of our office facilities.

 

Depreciation expense

 

Depreciation expense is classified within the corresponding operating expense categories on the consolidated statements of operations as follows (in thousands):

 

 

 

Three months ended

 

 

 

March 31,

 

 

 

2013

 

2012

 

Cost of goods sold - direct

 

$

104

 

$

108

 

Technology

 

3,416

 

3,598

 

General and administrative

 

343

 

328

 

Total depreciation and amortization, including internal-use software and website development

 

$

3,863

 

$

4,034

 

 

Non-operating income (expense)

 

Interest income

 

Interest income is primarily derived from the investment of our cash in cash and cash equivalents. Interest income for the three months ended March 31, 2013 and 2012 totaled $34,000 and $29,000, respectively.

 

Interest expense

 

Interest expense is primarily related to interest incurred on line of credit and our capital leases. Interest expense for the three months ended March 31, 2013 and 2012 totaled $51,000 and $208,000, respectively. The decrease is primarily due to our repayment of the $17.0 million in advances under the U.S. Bank Financing Agreement in November 2012.

 

Other income, net

 

Other income, net for the three months ended March 31, 2013 and 2012 totaled $345,000 and $432,000, respectively. The decrease was primarily due to a decrease in gift card breakage.

 

Income taxes

 

Our provision (benefit) for income taxes for the three months ended March 31, 2013 and 2012 of $46,000 and $9,000 is for federal alternative minimum tax, state taxes and certain income tax uncertainties, including interest and penalties. As of March 31, 2013 and December 31, 2012 we had federal net operating loss carry forwards of approximately $173.8 million and $174.1 million, respectively, and state net operating loss carry forwards of approximately $151.8 million and $151.6 million, respectively, which may be used to offset future taxable income. We are currently reviewing whether we had any ownership changes. Ownership changes under Internal Revenue Code Section 382 would limit the amount of net operating losses that could be used in any annual period. Our net operating loss carry forwards will begin to expire in 2019.

 

Seasonality

 

Based upon our historical experience, revenue typically increases during the fourth quarter because of the holiday retail season. The actual quarterly results for each quarter could differ materially depending upon consumer preferences, availability of product and competition, among other risks and uncertainties. Accordingly, there can be no assurances that seasonal variations will not materially affect our results of operations in the future.

 

The following table reflects our total net revenues for each of the quarters in 2013, 2012 and 2011 (in thousands):

 

 

 

First
Quarter

 

Second
Quarter

 

Third
Quarter

 

Fourth
Quarter

 

2013

 

$

311,994

 

$

N/A

 

$

N/A

 

$

N/A

 

2012

 

$

262,367

 

$

239,536

 

$

255,352

 

$

342,034

 

2011

 

$

265,470

 

$

234,992

 

$

239,738

 

$

314,077

 

 

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Liquidity and Capital Resources

 

Current sources of liquidity

 

While we believe that the cash and cash equivalents currently on hand and expected cash flows from future operations will be sufficient to continue operations for at least the next twelve months; we may require additional financing. Although we may attempt to obtain additional financing, there can be no assurance that we will be able to do so. There can be no assurance that if additional financing is necessary it will be available, or, if available, that such financing can be obtained on satisfactory terms. Our failure to generate sufficient revenues or profits or to obtain additional financing or raise additional capital could have a material adverse effect on our operations and on our ability to achieve our intended business objectives. Any projections of future cash needs and cash flows are subject to substantial uncertainty.

 

Our principal sources of liquidity are cash flows generated from operations, and our existing cash and cash equivalents. At March 31, 2013, our only available credit facility was a $3.0 million facility solely to support letters of credit. At March 31, 2013, our cash and cash equivalents balance was $81.9 million.

 

Cash flow information is as follows:

 

 

 

Three months ended
March 31,

 

Twelve months ended
March 31,

 

 

 

2013

 

2012

 

2013

 

2012

 

Cash provided by (used in):

 

 

 

 

 

 

 

 

 

Operating activities

 

$

(1,653

)

$

(22,234

)

$

48,726

 

$

12,657

 

Investing activities

 

(5,985

)

(2,048

)

(17,701

)

(9,238

)

Financing activities

 

(4,014

)

(598

)

(21,235

)

(31,590

)

 

Free Cash Flow.

 

“Free Cash Flow” (a non-GAAP measure) for the three months ended March 31, 2013 and 2012, was $(7.7) million and $(24.4) million, respectively and $32.3 million and $3.5 million for the twelve months ended March 31, 2013 and 2012, respectively. See “Non-GAAP Financial Measures” below for a reconciliation of Free Cash Flow to net cash provided by (used in) operating activities.

 

Cash flows from operating activities.

 

For the three months ended March 31, 2013 and 2012, our operating activities resulted in net cash outflows of $1.7 million and $22.2 million, respectively.

 

Cash received from customers generally corresponds to our net revenues as our customers primarily use credit cards to buy from us causing our receivables from these sales transactions to settle quickly. We have payment terms with our fulfillment partners that generally extend beyond the amount of time necessary to collect proceeds from our customers. As a result, following our typically seasonally strong fourth quarter sales, at December 31 of each year, our cash, cash equivalents and accounts payable balances normally reach their highest level (other than as a result of cash flows provided by or used in investing and financing activities). However, our accounts payable balance normally declines during the first three months following year-end, which normally results in a decline in our cash and cash equivalents balances from the year-end balance. The seasonality of our business causes payables and accruals to grow significantly in the fourth quarter, and then decrease in the first quarter when they are typically paid.

 

The $1.7 million of net cash used in operating activities during the three months ended March 31, 2013 was primarily for payments of accounts payable of $15.7 million following the holiday season and a decrease in deferred revenue of $6.9 million, partially offset by a combined increase in inventory and accounts receivable of $8.4 million, net income of $7.7 million, and non-cash depreciation, amortization and stock compensation expense of $4.6 million.

 

The $22.2 million of net cash used in operating activities during the three months ended March 31, 2012 was primarily for payments of accounts payable of $27.6 million following the holiday season and a decrease in accrued liabilities of $12.2 million, partially offset by a decrease of $6.3 million in inventories, a decrease of $3.2 million in prepaid and other assets and net income of $2.7 million.

 

Cash flows from investing activities.

 

Cash provided by investing activities corresponds with purchases, sales, and maturities of marketable securities and cash expenditures for fixed assets, including internal-use software and website development costs. For the three months ended March 31, 2013 and 2012, investing activities resulted in net cash outflows of $6.0 million and $2.0 million, respectively, resulting primarily from

 

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expenditures for fixed assets.

 

Cash flows from financing activities.

 

For the three months ended March 31, 2013 and 2012, financing activities resulted in net cash outflows of $4.0 million and $598,000, respectively.

 

The $4.0 million used in financing activities during the three months ended March 31, 2013 resulted primarily from $2.6 million for prepayment of capital leases for computer equipment and $1.4 million for the purchase of shares of our common stock withheld for minimum tax withholdings upon the vesting of a portion of certain restricted stock award grants.

 

The $598,000 used in financing activities during the three months ended March 31, 2012 resulted primarily from $464,000 for the purchase of shares of our common stock withheld for minimum tax withholdings upon the vesting of a portion of certain restricted stock award grants.

 

Contractual Obligations and Commitments

 

The following table summarizes our contractual obligations as of March 31, 2013 and the effect such obligations and commitments are expected to have on our liquidity and cash flow in future periods (in thousands):

 

 

 

Payments Due by Period

 

Contractual Obligations

 

Remainder
of 2013

 

2014

 

2015

 

2016

 

2017

 

Thereafter

 

Total

 

Operating leases

 

7,297

 

9,899

 

8,320

 

1,630

 

183

 

 

27,329

 

Naming rights

 

1,273

 

1,311

 

1,351

 

1,391

 

 

 

5,326

 

Purchase obligations

 

14,375

 

 

 

 

 

 

14,375

 

Other

 

1,974

 

2,366

 

107

 

 

 

 

4,447

 

Total contractual cash obligations

 

$

24,919

 

$

13,576

 

$

9,778

 

$

3,021

 

$

183

 

$

 

$

51,477

 

 

 

 

Amounts of Commitment Expiration Per Period

 

Other Commercial Commitments

 

2013

 

2014

 

2015

 

2016

 

2017

 

Thereafter

 

Total

 

Letters of credit

 

$

1,780

 

$

 

$

 

$

 

$

 

$

 

$

1,780

 

 

Operating Leases

 

From time to time we enter into operating leases for facilities and equipment for use in our operations.

 

Naming Rights

 

During 2011, we entered into a six-year agreement with the Oakland-Alameda County Coliseum Authority (“OACCA”) for the right to name Oakland Alameda County Coliseum (now known as “O.co Coliseum”). Amounts represent annual payments due OACCA for the naming rights. We have the right to terminate this agreement at our sole option, subject to payment of a termination fee.

 

Purchase obligations

 

The amount of purchase obligations shown above is based on assumptions regarding the legal enforceability against us of purchase orders we had outstanding at March 31, 2013. Under different assumptions regarding our rights to cancel our purchase orders or different assumptions regarding the enforceability of the purchase orders under applicable law, the amount of purchase obligations shown in the table above would be less.

 

Other

 

From time to time we enter into long-term contractual agreements for marketing, technology, or other services.

 

Tax Contingencies

 

Our contractual obligations presented above exclude unrecognized tax contingencies, including interest and penalties, of $332,000 for which we cannot make a reasonably reliable estimate of the amount and period of payment.

 

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Table of Contents

 

Borrowings

 

U.S. Bank Agreements

 

In November 2012, we repaid all amounts outstanding under our Financing Agreement with U.S. Bank National Association (“U.S. Bank”). At December 31, 2012, no amounts were outstanding under the Financing Agreement. The Financing Agreement expired in accordance with its terms on December 31, 2012; and we entered into a $3 million cash-collateralized line of credit agreement (the “Credit Agreement”) with U.S. Bank for the issuance of letters of credit. Advances under the Credit Agreement bear interest at one-month LIBOR plus 1.0%. The Credit Agreement matures on December 31, 2013. There were no amounts outstanding on the Credit Agreement at March 31, 2013 and December 31, 2012.

 

At March 31, 2013 and December 31, 2012, letters of credit totaling $1.8 million and $1.8 million, respectively, were issued on our behalf collateralized by compensating cash balances held at U.S. Bank, which are included in Restricted cash in the accompanying consolidated balance sheets.

 

U.S. Bank Commercial Purchasing Card Agreement

 

We have a commercial purchasing card (the “Purchasing Card”) agreement with U.S. Bank. We use the Purchasing Card for business purpose purchasing and must pay it in full each month. At March 31, 2013, $4.8 million was outstanding and $200,000 was available under the Purchasing Card. At December 31, 2012, $3.9 million was outstanding and $1.1 million was available under the Purchasing Card.

 

Capital leases

 

In March 2013, we entered into a capital lease arrangement for $2.6 million of computer equipment that will expire in 2017. Subsequent to entering into the lease we paid the entire $2.6 million in order to obtain discounted pricing. As such, we have no future payment obligations under capital leases at March 31, 2013.

 

Off-Balance Sheet Arrangements

 

We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that would be material to investors.

 

Critical Accounting Policies and Estimates

 

The preparation of our financial statements requires that we make estimates and judgments. We base these on historical experience and on other assumptions that we believe to be reasonable. Our critical accounting policies are discussed in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of our Annual Report on Form 10-K for the year ended December 31, 2012. There have been no material changes to the critical accounting policies previously disclosed in that report.

 

Non-GAAP Financial Measures

 

Regulation G, Conditions for Use of Non-GAAP Financial Measures, and other SEC regulations regulate the disclosure of certain non-GAAP financial information.

 

Contribution and Contribution Margin.

 

Contribution (a non-GAAP financial measure) (which we reconcile to “Gross profit” in our statement of operations) consists of gross profit less sales and marketing expense and reflects an additional way of viewing our results. Contribution Margin is Contribution as a percentage of revenues. When viewed together with our GAAP results, we believe Contribution and Contribution Margin provide management and users of the financial statements information about our ability to cover our operating costs, such as technology and general and administrative expenses. Contribution and Contribution Margin are used in addition to and in conjunction with results presented in accordance with GAAP and should not be relied upon to the exclusion of GAAP financial measures. You should review our financial statements and publicly-filed reports in their entirety and not rely on any single financial measure. The material limitation associated with the use of Contribution is that it is an incomplete measure of profitability as it does not include all operating expenses or non-operating income and expenses. Management compensates for these limitations when using this measure by looking at other GAAP measures, such as operating income and net income.

 

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For further details on Contribution and Contribution Margin, see the calculation of these non-GAAP financial measures below (in thousands):

 

 

 

Three months ended
March 31,

 

 

 

2013

 

2012

 

Total net revenue

 

$

311,994

 

100

%

$

262,367

 

100

%

Cost of goods sold

 

253,058

 

81.1

%

214,859

 

81.9

%

Gross profit

 

58,936

 

18.9

%

47,508

 

18.1

%

Less: Sales and marketing expense

 

18,705

 

6.0

%

14,475

 

5.5

%

Contribution and contribution margin

 

$

40,231

 

12.9

%

$

33,033

 

12.6

%

 

Free Cash Flow.

 

Free cash flow (a non-GAAP financial measure) reflects an additional way of viewing our cash flows and liquidity that, when viewed with our GAAP results, provides a more complete understanding of factors and trends affecting our cash flows and liquidity. Free cash flow, which we reconcile to “Net cash provided by (used in) operating activities”, is cash flows from operations reduced by “Expenditures for fixed assets, including internal-use software and website development.” We believe that cash flows from operating activities is an important measure, since it includes both the cash impact of the continuing operations of the business and changes in the balance sheet that impact cash. However, we believe free cash flow is a useful measure to evaluate our business since purchases of fixed assets are a necessary component of ongoing operations and free cash flow measures the amount of cash we have available for mandatory debt service and financing obligations, changes in our capital structure, and future investments after we have paid all of our operating expenses. Therefore, we believe it is important to view free cash flow as a complement to our entire consolidated statements of cash flows as calculated below (in thousands):

 

 

 

Three months ended
March 31,

 

Tw