SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q/A

Amendment No. 1

 

(Mark One)

 

 

 

x

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

 

 

 

For the quarterly period ended June 30, 2007

 

 

 

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 is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Exchange Act Rule 12b-2 of the Exchange Act).

 

Large accelerated filer  o

 

Accelerated filer  x

 

Non-accelerated filer  o

 

 

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

 

There were 23,715,197 shares of the Registrant’s common stock, par value $0.0001, outstanding on August 6, 2007.

 

 

 


 


 

EXPLANATORY NOTE

 

Overstock.com, Inc. (also referred to as the “Company,” “we,” or “our”) is filing this Amendment No. 1 (the “Amendment No. 1”) to our Form 10-Q for the quarterly period ended June 30, 2007 (the “Form 10-Q”), originally filed with the Securities and Exchange Commission on August 9, 2007, for the purpose of providing currently dated 302 and 906 certifications, as the dates on the 906 certifications were omitted from the original filing.

 

The information set forth in our financial statements and the footnotes thereto in this Amendment No. 1 has not been modified or updated in any way from the information in our financial statements and the related footnotes included in the Form 10-Q. This Amendment No. 1 speaks as of the original filing date of the Form 10-Q and reflects only the changes to the 302 and 906 certifications mentioned above. No other information included in this Form 10-Q/A, including the information set forth in Part II, has been modified or updated in any way.

 



 

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. Submission of Matters to a Vote of Security Holders

 

Item 5. Other Information

 

Item 6. Exhibits

 

Signature

 

2



 

PART 1. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

Overstock.com, Inc.

Consolidated Balance Sheets (unaudited)

(in thousands)

 

 

 

December 31,

 

June 30,

 

 

 

2006

 

2007

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

126,965

 

$

75,044

 

Marketable securities

 

 

17,982

 

Total cash and marketable securities

 

126,965

 

93,026

 

Accounts receivable, net

 

11,638

 

7,942

 

Note receivable

 

6,702

 

2,008

 

Inventories, net

 

20,274

 

15,425

 

Prepaid inventory

 

2,241

 

2,124

 

Prepaid expense

 

7,473

 

8,735

 

Current assets of held for sale subsidiary

 

4,718

 

 

Total current assets

 

180,011

 

129,260

 

Property and equipment, net

 

56,198

 

40,209

 

Goodwill

 

2,784

 

2,784

 

Other long-term assets, net

 

578

 

302

 

Note receivable (Note 4)

 

 

3,909

 

Long-term assets of held for sale subsidiary

 

16,594

 

 

Total assets

 

$

256,165

 

$

176,464

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

66,039

 

$

33,544

 

Accrued liabilities

 

40,142

 

28,615

 

Capital lease obligations, current

 

5,074

 

3,806

 

Current liabilities of held for sale subsidiary

 

3,684

 

 

Total current liabilities

 

114,939

 

65,965

 

Capital lease obligations, non-current

 

3,983

 

 

Other long-term liabilities

 

 

3,227

 

Convertible senior notes

 

75,279

 

75,451

 

Total liabilities

 

194,201

 

144,643

 

Commitments and contingencies (Notes 12 and 13)

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Preferred stock, $0.0001 par value, 5,000 shares authorized, no shares issued and outstanding as of December 31, 2006 and June 30, 2007

 

 

 

Common stock, $0.0001 par value, 100,000 shares authorized, 25,069 and 25,322 shares issued as of December 31, 2006 and June 30, 2007, respectively

 

2

 

2

 

Additional paid-in capital

 

325,771

 

329,357

 

Accumulated deficit

 

(198,694

)

(233,845

)

Treasury stock, 1,654 and 1,614 shares at cost as of December 31, 2006 and June 30, 2007, respectively

 

(64,983

)

(63,583

)

Accumulated other comprehensive loss

 

(132

)

(110

)

Total stockholders’ equity

 

61,964

 

31,821

 

Total liabilities and stockholders’ equity

 

$

256,165

 

$

176,464

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

3



 

Overstock.com, Inc.

Consolidated Statements of Operations (unaudited)

(in thousands, except per share data)

 

 

 

Three months ended
June 30,

 

Six months ended
June 30,

 

 

 

2006

 

2007

 

2006

 

2007

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

 

 

 

 

 

 

 

 

Direct

 

$

68,770

 

$

43,578

 

$

148,480

 

$

89,279

 

Fulfillment partner

 

90,422

 

105,389

 

188,756

 

217,618

 

 

 

 

 

 

 

 

 

 

 

Total revenue

 

159,192

 

148,967

 

337,236

 

306,897

 

 

 

 

 

 

 

 

 

 

 

Cost of goods sold:

 

 

 

 

 

 

 

 

 

Direct (1)

 

61,473

 

36,321

 

132,176

 

75,641

 

Fulfillment partner

 

75,411

 

86,343

 

158,998

 

179,638

 

 

 

 

 

 

 

 

 

 

 

Total cost of goods sold

 

136,884

 

122,664

 

291,174

 

255,279

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

22,308

 

26,303

 

46,062

 

51,618

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Sales and marketing (1)

 

11,911

 

7,962

 

24,570

 

19,246

 

Technology (1)

 

14,897

 

15,237

 

28,321

 

30,210

 

General and administrative (1)

 

11,050

 

10,429

 

22,900

 

21,118

 

Restructuring

 

 

6,194

 

 

12,283

 

 

 

 

 

 

 

 

 

 

 

Total operating expenses

 

37,858

 

39,822

 

75,791

 

82,857

 

 

 

 

 

 

 

 

 

 

 

Operating loss

 

(15,550

)

(13,519

)

(29,729

)

(31,239

)

 

 

 

 

 

 

 

 

 

 

Interest income

 

2,215

 

1,078

 

2,530

 

2,068

 

Interest expense

 

(1,275

)

(1,027

)

(2,542

)

(2,056

)

Other income, net

 

(1

)

 

(1

)

 

 

 

 

 

 

 

 

 

 

 

Loss from continuing operations

 

(14,611

)

(13,468

)

(29,742

)

(31,227

)

Loss from discontinued operations

 

(1,128

)

(300

)

(1,907

)

(3,924

)

 

 

 

 

 

 

 

 

 

 

Net loss

 

(15,739

)

(13,768

)

(31,649

)

(35,151

)

Deemed dividend related to redeemable common stock

 

(33

)

 

(66

)

 

 

 

 

 

 

 

 

 

 

 

Net loss attributable to common shares

 

$

(15,772

)

$

(13,768

)

$

(31,715

)

$

(35,151

)

 

 

 

 

 

 

 

 

 

 

Net loss per common share — basic and diluted:

 

 

 

 

 

 

 

 

 

Loss from continuing operations

 

$

(0.72

)

$

(0.57

)

$

(1.50

)

$

(1.32

)

Loss from discontinued operations

 

$

(0.06

)

$

(0.01

)

$

(0.10

)

$

(0.17

)

Net loss per common share — basic and diluted

 

$

(0.78

)

$

(0.58

)

$

(1.60

)

$

(1.49

)

Weighted average common shares outstanding — basic and diluted

 

20,159

 

23,689

 

19,774

 

23,642

 

 


(1) Includes stock-based compensation from options as follows:

 

 

 

 

 

 

 

 

 

Cost of goods sold — direct

 

$

109

 

$

114

 

$

205

 

$

221

 

Sales and marketing

 

$

79

 

$

85

 

$

149

 

$

163

 

Technology

 

$

181

 

$

188

 

$

340

 

$

365

 

General and administrative

 

$

719

 

$

750

 

$

1,352

 

$

1,461

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

4



 

Overstock.com, Inc.

Consolidated Statements of Stockholders’ Equity

and Comprehensive Loss (unaudited)

(in thousands)

 

 

 

Common stock

 

Additional
Paid-in

 

Accumulated

 

Treasury stock

 

Accumulated 
Other
Comprehensive

 

 

 

 

 

Shares

 

Amount

 

capital

 

Deficit

 

Shares

 

Amount

 

Loss

 

Total

 

Balance at December 31, 2006

 

25,069

 

$

2

 

$

325,771

 

$

(198,694

)

(1,654

)

$

(64,983

)

$

(132

)

$

61,964

 

Exercise of stock options

 

253

 

 

1,921

 

 

 

 

 

1,921

 

Treasury stock issued to employees as compensation

 

 

 

(685

)

 

40

 

1,400

 

 

715

 

Stock-based compensation from employee options

 

 

 

2,210

 

 

 

 

 

2,210

 

Stock-based compensation to consultants in exchange for services

 

 

 

140

 

 

 

 

 

140

 

Comprehensive loss:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

 

 

 

(35,151

)

 

 

 

(35,151

)

Net unrealized gain on marketable securities

 

 

 

 

 

 

 

1

 

1

 

Cumulative translation adjustment

 

 

 

 

 

 

 

21

 

21

 

Total comprehensive loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(35,129

)

Balance at June 30, 2007

 

25,322

 

$

2

 

$

329,357

 

$

(233,845

)

(1,614

)

$

(63,583

)

$

(110

)

$

31,821

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

5



 

Overstock.com, Inc.

Consolidated Statements of Cash Flows (unaudited)

(in thousands)

 

 

 

Three months ended

 

Six months ended

 

Twelve months ended

 

 

 

June 30,

 

June 30,

 

June 30,

 

 

 

2006

 

2007

 

2006

 

2007

 

2006

 

2007

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash flows from operating activities of continuing operations:

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

$

(15,739

)

$

(13,768

)

$

(31,649

)

$

(35,151

)

$

(50,334

)

$

(105,268

)

Adjustments to reconcile net loss to cash provided by (used in) operating activities of continuing operations:

 

 

 

 

 

 

 

 

 

 

 

 

 

Loss from discontinued operations

 

1,128

 

300

 

1,907

 

3,924

 

4,478

 

8,898

 

Depreciation and amortization

 

6,876

 

7,974

 

13,026

 

15,745

 

22,572

 

35,046

 

Realized (gain) loss from marketable securities

 

(1,868

)

 

(2,085

)

 

1,292

 

 

Realized loss on disposition of property and equipment

 

1

 

1

 

599

 

1

 

2,056

 

1

 

Stock-based compensation

 

1,088

 

1,137

 

2,046

 

2,210

 

2,045

 

4,284

 

Stock-based compensation to consultants for services

 

(9

)

135

 

34

 

140

 

60

 

129

 

Treasury stock issued to employees as compensation

 

105

 

113

 

612

 

715

 

744

 

890

 

Amortization of debt discount and deferred financing fees

 

139

 

86

 

278

 

172

 

475

 

311

 

Restructuring

 

 

6,194

 

 

12,283

 

 

17,957

 

Gain from retirement of convertible senior notes

 

 

 

 

 

(1,988

)

 

Changes in operating assets and liabilities, net of effect of acquisition and discontinued operations:

 

 

 

 

 

 

 

 

 

 

 

 

 

Accounts receivable, net

 

(977

)

(431

)

1,339

 

3,396

 

(2,970

)

5

 

Inventories, net

 

6,529

 

1,237

 

18,447

 

4,849

 

(13,275

)

53,411

 

Prepaid inventory

 

5,592

 

477

 

6,386

 

117

 

7,163

 

1,119

 

Prepaid expenses and other assets

 

723

 

700

 

(1,171

)

(1,262

)

(1,557

)

913

 

Other long-term assets, net

 

(29

)

176

 

18

 

266

 

(2,122

)

744

 

Accounts payable

 

(1,603

)

5,467

 

(65,224

)

(32,592

)

(5,440

)

(2,568

)

Accrued liabilities

 

(8,384

)

5,141

 

(23,569

)

(18,114

)

(2,995

)

(6,460

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash provided by (used in) operating activities of continuing operations

 

(6,428

)

14,939

 

(79,006

)

(43,301

)

(39,796

)

9,412

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash flows from investing activities of continuing operations:

 

 

 

 

 

 

 

 

 

 

 

 

 

Change in restricted cash

 

55

 

 

253

 

 

833

 

 

Purchases marketable securities

 

 

(21,381

)

 

(21,381

)

(23,552

)

(21,381

)

Sales of marketable securities

 

49,475

 

3,400

 

56,756

 

3,400

 

110,833

 

3,400

 

Expenditures for property and equipment

 

(5,102

)

(1,439

)

(11,906

)

(1,916

)

(32,272

)

(13,450

)

Acquisition of Ski West

 

 

 

 

 

(25,111

)

 

Proceeds from the sale of discontinued operations, net of cash transferred

 

 

9,892

 

 

9,892

 

 

9,892

 

Decrease in cash resulting from deconsolidation of variable interest entity

 

 

 

 

 

 

(102

)

Payments received on note receivable

 

 

753

 

 

4,694

 

 

4,694

 

Expenditures for other long-term assets

 

 

 

(100

)

 

(100

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash provided by (used in) investing activities of continuing operations

 

44,428

 

(8,775

)

45,003

 

(5,311

)

30,631

 

(16,947

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash flows from financing activities of continuing operations:

 

 

 

 

 

 

 

 

 

 

 

 

 

Payments on capital lease obligations

 

(326

)

(4

)

(2,754

)

(5,251

)

(6,788

)

(5,454

)

Drawdown on line of credit

 

42,530

 

 

73,258

 

1,169

 

85,126

 

14,592

 

Payments on line of credit

 

(62,530

)

 

(73,258

)

(1,169

)

(85,126

)

(14,592

)

Payments to retire convertible senior notes

 

 

 

 

 

(7,735

)

 

Proceeds from the issuance of common stock, net of issuance costs

 

25,000

 

 

25,000

 

 

25,000

 

39,406

 

Settlement of call options for cash

 

 

 

 

 

7,937

 

 

Exercise of stock options and warrants

 

434

 

768

 

1,461

 

1,921

 

4,868

 

2,994

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net provided by (used in) financing activities of continuing operations

 

5,108

 

764

 

23,707

 

(3,330

)

23,282

 

36,946

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Effect of exchange rate changes on cash

 

(44

)

36

 

(29

)

21

 

83

 

84

 

Cash provided by (used in) operating activities discontinued operations

 

246

 

(614

)

70

 

(204

)

25

 

1,307

 

Cash used in investing activities of discontinued operations

 

(263

)

 

(304

)

(53

)

(402

)

(315

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net increase (decrease) in cash and cash equivalents

 

43,047

 

6,350

 

(10,559

)

(52,178

)

13,823

 

30,487

 

Change in cash and cash equivalents from discontinued operations

 

17

 

614

 

234

 

257

 

377

 

(993

)

Cash and cash equivalents, beginning of period

 

2,486

 

68,080

 

55,875

 

126,965

 

31,350

 

45,550

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents, end of period

 

$

45,550

 

$

75,044

 

$

45,550

 

$

75,044

 

$

45,550

 

$

75,044

 

Supplemental disclosure of cash flow information:

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest paid

 

1,531

 

1,585

 

1,809

 

2,236

 

4,424

 

1,661

 

Supplemental disclosures of non-cash flow information:

 

 

 

 

 

 

 

 

 

 

 

 

 

Deemed dividend on redeemable common shares

 

33

 

 

66

 

 

158

 

33

 

Lapse of rescission rights

 

319

 

 

873

 

 

1,019

 

2,431

 

Equipment and software acquired under capital leases

 

 

 

2,274

 

 

4,632

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair value of assets acquired, net of cash acquired

 

 

 

 

 

26,447

 

 

Fair value of liabilities assumed

 

 

 

 

 

(1,336

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash paid to purchase business

 

$

 

$

 

$

 

$

 

$

25,111

 

$

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

6


 


 

Overstock.com, Inc.

Notes to Unaudited Consolidated Financial Statements

 

1.   BASIS OF PRESENTATION

 

The accompanying unaudited consolidated financial statements have been prepared by Overstock.com, Inc. (the “Company”) pursuant to the rules and regulations of the Securities and Exchange Commission 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 the audited annual consolidated financial statements and related notes thereto included in the Annual Report on Form 10-K for the year ended December 31, 2006. The accompanying unaudited consolidated financial statements reflect all adjustments, consisting of normal recurring adjustments, which are, in the opinion of management, necessary for a fair statement of results for the interim periods presented. Preparing financial statements requires management 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 management’s best knowledge of current events and actions that the Company may undertake in the future, actual results may be different from the estimates. The results of operations for the three and six months ended June 30, 2007 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 the accounts of the Company and its wholly-owned subsidiaries. The consolidated financial statements include the accounts of the Company’s OTravel subsidiary through April 25, 2007 (Note 4).  The consolidated financial statements also include the accounts of a variable interest entity for which the Company was the primary beneficiary through November 30, 2006. All significant 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 management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

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 the business of the Company. As required by Statement of Position 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use, the Company capitalizes costs incurred during the application development stage of internal-use software and amortizes these costs over the estimated useful life of three years. Costs incurred related to design or maintenance of internal-use software are expensed as incurred.

 

During the three months ended June 30, 2006 and 2007, the Company capitalized $3.9 million and $226,000, respectively, of costs associated with internal-use software and website development, which are partially offset by amortization of previously capitalized amounts of $741,000 and $766,000 for those respective periods.  For the six months ended June 30, 2006 and 2007, the Company capitalized $12.0 million and $1.5 million, respectively, of costs associated with internal-use software and website development, which are partially offset by amortization of previously capitalized amounts of $1.3 million and $1.5 million for those respective periods.

 

Advertising expense

 

The Company recognizes advertising expenses in accordance with SOP 93-7 Reporting on Advertising Costs. As such, the Company expenses the costs of producing advertisements at the time production occurs or the first time the advertising takes place and expenses 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) during the period customers are acquired or 2) based on the number of clicks generated during a given period over the term of the contract. Advertising expense included in sales and marketing expenses totaled $11.5 million and $7.1 million during the three months ended June 30, 2006 and 2007, respectively.  For the six months ended June 30, 2006 and 2007, advertising expenses totaled $24.0 million and $17.7 million, respectively.

 

Stock-based Compensation

 

As of January 1, 2006, the Company adopted SFAS 123(R) Share-based Payment — an Amendment of FASB Statements No 123 and 95, which requires the Company to measure compensation expense for all outstanding unvested share-based awards at fair

 

7



 

value and recognize compensation expense over the service period for awards expected to vest. 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. Management considers many factors when estimating expected forfeitures, including types of awards, employee class, and historical experience. Actual results may differ substantially from these estimates.

 

Recent accounting pronouncements

 

In March 2006, the Emerging Issue Task Force reached a consensus on Issue No. 06-03 How Taxes Collected from Customers and Remitted to Government Authorities Should be Presented in the Income Statement (That Is, Gross versus Net Presentation)  (“EITF No. 06-03”).  The Company adopted the provisions of EITF No. 06-03 beginning January 1, 2007.  The adoption of EITF No. 06-03 did not have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

 

In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes — an Interpretation of FASB Statement No. 109 (“FIN 48”). FIN 48 prescribes a comprehensive model for how a company should recognize, measure, present, and disclose in its financial statements uncertain tax positions that it has taken or expects to take on a tax return.

 

The Company adopted the provisions of FIN 48 on January 1, 2007. As a result of a full valuation allowance, the Company does not have any unrecognized tax benefits and there is no effect on its financial condition or results of operations as a result of implementing FIN 48.  The Company is subject to audit by the IRS and various states for the prior 3 years.  The Company does not believe there will be any material changes in its unrecognized tax positions over the next 12 months. The Company’s policy is that it recognizes interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense. As of the date of adoption of FIN 48, the Company did not have any accrued interest or penalties associated with any unrecognized tax benefits, nor was any interest expense recognized during the three or six months ended June 30, 2007.

 

The Company recognized no income tax benefit from the net loss generated in the three or six months ended June 30, 2006 and 2007.  Statement of Financial Accounting Standards (“SFAS”) No. 109, “Accounting for Income Taxes,” requires that a valuation allowance be provided if it is more likely than not that some portion or all of a deferred tax asset will not be realized.  The Company’s ability to realize the benefit of its deferred tax asset will depend on the generation of future taxable income through profitable operations.  As of June 30, 2007, the Company has established a full valuation allowance against its deferred tax assets.

 

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. The provisions of this standard apply to other accounting pronouncements that require or permit fair value measurements. The Company will adopt SFAS 157 on January 1, 2008. The Company anticipates that the adoption of SFAS 157 will not have a material impact on the Company’s consolidated financial statements.

 

In February 2007, the FASB issued SFAS No. 159, or SFAS 159, The Fair Value Option for Financial Assets and Financial Liabilities — including an amendment of FASB Statement No. 115 . SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. Unrealized gains and losses on items for which the fair value option has been elected will be recognized in earnings at each subsequent reporting date. SFAS No. 159 is effective for the Company’s fiscal year beginning January 1, 2008. The Company anticipates that the adoption of SFAS No. 159 will not have a material impact on the Company’s consolidated financial statements.

 

Reclassifications

 

Certain prior year amounts have been reclassified to conform to the current year presentation. In addition, the Company has revised its consolidated statements of operations and consolidated statements of cash flows for the three and six months ended June 30, 2006 to present the loss from discontinued operations and the operating and investing portion of the cash flows attributable to discontinued operations on a separately identifiable basis.  The effect of these reclassifications had no impact on net income, total assets, total liabilities, or stockholders’ equity.

 

3.   RESTRUCTURING EXPENSE

 

During the fourth quarter of 2006, the Company commenced implementation of 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 should be substantially completed during calendar year 2007.

 

During the fiscal year 2006, the Company recorded $5.7 million of restructuring charges, of which $5.5 million, less the elimination of straight-line rent liability of $913,000, related to costs to terminate a co-location data center lease.  Other costs included in the restructuring charge related to $638,000 of accelerated amortization of leasehold improvements in the Company’s current office facilities that it is attempting to sublease and $450,000 of costs incurred to return these office facilities to their original condition as required by the Company’s lease agreement.

 

8



 

During the six months ended June 30, 2007, the Company accrued $8.0 million of restructuring charges related to the termination of a logistics services agreement, termination and settlement of a lease related to its vacated warehouse facilities in Indiana and abandonment and marketing for sub-lease office and data center space in the current corporate office facilities.  During the second quarter of 2007, the Company reached an agreement to terminate the Indiana warehouse facilities lease in its entirety effective August 15, 2007 for $1.9 million, resulting in a reversal of restructuring expense of approximately $1.0 million.

 

The Company also recorded an additional $2.4 million of restructuring charges related to accelerated amortization of leasehold improvements located in the abandoned office and co-location data center space and $2.0 million of other restructuring charges, primarily related to consolidation of office space in the current corporate office facilities, relocation of a data center and employee severance.

 

Restructuring liabilities along with charges to expense, cash payments or accelerated amortization of leasehold improvements associated with the facilities consolidation and restructuring program were as follows (in thousands):

 

 

 

Balance
12/31/2006

 

Charges to
expense

 

Cash
payment or
accelerated
amortization

 

Balance
6/30/2007

 

Lease and contract termination costs

 

$

5,499

 

$

7,950

 

$

(5,321

)

$

8,128

 

Asset retirement obligation

 

450

 

 

(450

)

 

Accelerated amortization of leasehold improvements

 

 

2,359

 

(2,359

)

 

Other restructuring expenses

 

 

1,974

 

(724

)

1,250

 

Total

 

$

5,949

 

$

12,283

 

$

(8,854

)

$

9,378

 

 

4.   SALE OF DISCONTINUED OPERATIONS

 

On July 1, 2005, the Company acquired all the outstanding capital stock of Ski West, Inc. (“Ski West”) for an aggregate of $25.1 million (including $111,000 of capitalized acquisition related expenses).

 

Ski West is an on-line travel company whose proprietary technology provides easy consumer access to a large, fragmented, hard-to-find inventory of lodging, vacation, cruise and transportation bargains. The travel offerings are primarily in popular ski areas in the U.S. and Canada, with more recent expansion into the Caribbean and Mexico, as well as cruises. Effective upon the closing, Ski West became a wholly-owned subsidiary of the Company, integrated the Ski West travel offerings with the Company’s existing travel offerings and changed its name to OTravel.com, Inc (“OTravel”).

 

During the fourth quarter of 2006, in conjunction with the facilities consolidation and restructuring program described in Note 3, management decided to sell OTravel.  The Company evaluated its plan to sell OTravel in accordance with SFAS 144, which requires that long-lived assets be classified as held for sale only when certain criteria are met. The Company has classified the OTravel assets and liabilities as “held for sale” as it has met these criteria as of December 31, 2006, which include: management’s commitment to a plan to sell the assets; availability of the assets for immediate sale in their present condition; an active program to locate buyers and other actions to sell the assets has been initiated; sale of the assets is probable and their transfer is expected to qualify for recognition as a completed sale within one year; assets are being marketed at reasonable prices in relation to their fair value; and unlikelihood  that significant changes will be made to the plan to the sell the assets. The travel business is not part of the Company’s core business operations and is no longer part of its strategic focus. The results of operations for the subsidiary were included in the fulfillment partner segment prior to being classified as discontinued operations.

 

The Company also determined that the OTravel subsidiary met the definition of a “component of an entity” and has been accounted for as a discontinued operation under SFAS 144.  The results of operations for this subsidiary have been classified as discontinued operations in all periods presented.  In conjunction with the discontinuance of OTravel, the Company performed an evaluation of the goodwill associated with the reporting unit pursuant to SFAS 142 and SFAS 144, Accounting for the Impairment of Long-Lived Assets and determined that goodwill of approximately $4.5 million was impaired as of December 31, 2006, based on a non-binding letter of intent from a third party to purchase this business.  During the quarter ended March 31, 2007, the Company received a revised offer from this third party to purchase its OTravel business and, in April 2007, the Company completed the sale of OTravel under these revised terms.  Accordingly, the Company evaluated its goodwill as of March 31, 2007 and, based on the estimated fair value of the discounted cash flows of the net proceeds from the sale, determined that an additional $3.8 million of goodwill was impaired.

 

On April 25, 2007, the Company completed the sale of OTravel.com to Castles Travel, Inc., an affiliate of Kinderhook Industries, LLC, and Castles Media Company LLC, for $17.0 million.  The Company received cash proceeds, net of cash transferred, of $9.9 million and two $3.0 million promissory notes.  The $3.0 million senior note matures three years from the closing date and bears interest, payable quarterly, of 4.0%, 10.0% and 14.0% per year in the first, second and third years, respectively.  The $3.0 million junior note matures five years from the closing date and bears interest of 8.0% per year, compounded annually, and is payable in full at maturity.

 

9



 

The following table is a summary of the Company’s discontinued operations for the six months ended June 30, 2006 and 2007 (in thousands):

 

 

 

Six months ended June 30,

 

 

 

2006

 

2007

 

Sales

 

$

2,938

 

$

2,226

 

Cost of sales

 

(844

)

(650

)

Gross profit

 

2,094

 

1,576

 

Sales and marketing

 

(777

)

(447

)

Technology

 

(273

)

(60

)

General and administrative

 

(2,951

)

(1,152

)

Goodwill impairment

 

 

(3,841

)

Loss from discontinued operations

 

$

(1,907

)

$

(3,924

)

 

The held for sale assets and liabilities consisted of the following (in thousands):

 

 

 

December 31,

 

 

 

2006

 

Assets of held for sale subsidiary:

 

 

 

Cash

 

$

1,365

 

Accounts receivable

 

3,267

 

Property and equipment, net

 

1,215

 

Goodwill and intangible assets, net

 

15,379

 

Other

 

86

 

Total assets of discontinued operations

 

$

21,312

 

Liabilities of held for sale subsidiary:

 

 

 

Current liabilities:

 

 

 

Accounts payable

 

$

2,947

 

Accrued liabilities

 

737

 

Total liabilities of discontinued operations

 

$

3,684

 

 

5. MARKETABLE SECURITIES

 

The Company’s marketable securities consist of funds deposited into a capital management account managed by a financial institution at June 30, 2007 as follows:

 

 

 

Amortized Cost
Basis

 

Unrealized 
Gains

 

Unrealized
Losses

 

Fair Value

 

 

 

 

 

 

 

 

 

 

 

Corporate debt securities

 

$

17,981

 

$

1

 

$

 

$

17,982

 

 

All marketable securities mature in 2007 and are classified as available-for-sale securities.  Available-for-sale securities are classified as current as they are deemed available for use.  There were no marketable securities at December 31, 2006.

 

Derivative instruments

 

During the first quarter of 2005, the Company purchased $49.9 million of Foreign Corporate Securities (“Foreign Notes”) which were scheduled to mature in November 2006. The Foreign Notes did not have a stated interest rate, but were structured to return the entire principal amount and a conditional coupon if held to maturity. The conditional coupon would provide a rate of return dependent on the performance of a “basket” of eight Asian currencies against the U.S. dollar. If the Company redeemed the Foreign Notes prior to maturity, the Company would not realize the full amount of its initial investment.

 

Under SFAS No. 133, the Foreign Notes are considered to be derivative financial instruments and were marked to market quarterly. Any unrealized gain or loss related to the changes in value of the conditional coupon was recorded in the income statement as a component of interest income or expense. Any unrealized gain or loss related to the changes in the value of the Foreign Notes was recorded as a component of accumulated other comprehensive income (loss).

 

The Company purchased the Foreign Notes to manage its foreign currency risks related to the strengthening of Asian

 

10



 

currencies compared to the U.S. dollar, which would reduce the inventory purchasing power of the Company in Asia. However, the Company determined that the Foreign Notes did not qualify as hedging derivative instruments. Nevertheless, management believes that such instruments are useful in managing the Company’s associated risk.

 

On April 26, 2006, the Company sold the Foreign Notes for $49.5 million resulting in a gain of $1.9 million, which the Company recognized in the second quarter of 2006 as a component of interest income. The Company had previously recorded $2.4 million of accumulated unrealized losses as a component of interest income over the period the Foreign Notes had been held.

 

6.   OTHER COMPREHENSIVE LOSS

 

The Company follows SFAS No. 130, Reporting Comprehensive Income. This Statement establishes requirements for reporting comprehensive income (loss) and its components. The Company’s comprehensive loss is as follows (in thousands):

 

 

 

Three months ended June 30,

 

Six months ended June 30,

 

 

 

2006

 

2007

 

2006

 

2007

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

$

(15,739

)

$

(13,768

)

$

(31,649

)

$

(35,151

)

Net unrealized gain on marketable securities

 

 

1

 

 

1

 

Unrealized gain on Foreign Notes

 

255

 

 

740

 

 

Reclassification adjustment for gains included in net loss

 

(1,868

)

 

(1,868

)

 

Foreign currency translation adjustment

 

(44

)

36

 

(29

)

21

 

 

 

 

 

 

 

 

 

 

 

Comprehensive loss

 

$

(17,396

)

$

(13,731

)

$

(32,806

)

$

(35,129

)

 

7.   EARNINGS (LOSS) PER SHARE

 

In accordance with SFAS 128 Earnings per share, basic earnings (loss) per share is computed by dividing net income (loss) attributable to common shares by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per share is computed by dividing net income (loss) 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, composed of incremental common shares issuable upon the exercise of stock options, warrants and convertible senior notes, are included in the calculation of diluted net loss per share to the extent such shares are dilutive.

 

The following table sets forth the computation of basic and diluted earnings (loss) per share for the periods indicated (in thousands, except per share amounts):

 

 

 

Three months ended June 30,

 

Six months ended June 30,

 

 

 

2006

 

2007

 

2006

 

2007

 

 

 

 

 

 

 

 

 

 

 

Loss from continuing operations

 

$

(14,611

)

$

(13,468

)

$

(29,742

)

$

(31,227

)

Deemed dividend related to redeemable common stock

 

(33

)

 

(66

)

 

Loss from continuing operations attributable to common shares

 

(14,644

)

(13,468

)

(29,808

)

(31,227

)

Loss from discontinued operations

 

(1,128

)

(300

)

(1,907

)

(3,924

)

 

 

 

 

 

 

 

 

 

 

Net loss attributable to common shares

 

$

(15,772

)

$

(13,768

)

$

(31,715

)

$

(35,151

)

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding—basic

 

20,159

 

23,689

 

19,774

 

23,642

 

Effective of dilutive securities:

 

 

 

 

 

 

 

 

 

Stock options

 

 

 

 

 

Convertible senior notes

 

 

 

 

 

Weighted average common shares outstanding—diluted

 

20,159

 

23,689

 

19,774

 

23,642

 

Net loss per common share—basic and diluted:

 

 

 

 

 

 

 

 

 

Loss from continuing operations

 

$

(0.72

)

$

(0.57

)

$

(1.50

)

$

(1.32

)

Loss from discontinued operations

 

$

(0.06

)

$

(0.01

)

$

(0.10

)

$

(0.17

)

Net loss per common share—basic and diluted

 

$

(0.78

)

$

(0.58

)

$

(1.60

)

$

(1.49

)

 

The stock options, warrants and convertible senior notes outstanding were not included in the computation of diluted earnings per share because to do so would have been antidilutive. The number of stock options outstanding at June 30, 2006 and 2007 was 1,225,000 and 1,290,000, respectively.  As of June 30, 2007, the Company had $77.0 million of convertible senior notes outstanding, which could potentially convert into 1,010,000 shares of common stock in the aggregate.

 

11



 

8.   BUSINESS SEGMENTS

 

Segment information has been prepared in accordance with SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. Segments were determined based on products and services provided by each segment. There were no inter-segment sales or transfers during the three and six months ended June 30, 2006 or 2007. The Company evaluates the performance of its segments and allocates resources to them based primarily on gross profit. The table below summarizes information about reportable segments for the three and six months ended June 30, 2006 and 2007 (in thousands):

 

 

 

Three months ended June 30,

 

Six months ended June 30,

 

 

 

Direct

 

Fulfillment 
partner

 

Consolidated

 

Direct

 

Fulfillment 
partner

 

Consolidated

 

2006

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

68,770

 

$

90,422

 

$

159,192

 

$

148,480

 

$

188,756

 

$

337,236

 

Cost of goods sold

 

61,473

 

75,411

 

136,884

 

132,176

 

158,998

 

291,174

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

$

7,297

 

$

15,011

 

22,308

 

$

16,304

 

$

29,758

 

46,062

 

Operating expenses

 

 

 

 

 

(37,858

)

 

 

 

 

(75,791

)

Other income (expense), net

 

 

 

 

 

939

 

 

 

 

 

(13

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loss from continuing operations

 

 

 

 

 

$

(14,611

)

 

 

 

 

$

(29,742

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2007

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

43,578

 

$

105,389

 

$

148,967

 

$

89,279

 

$

217,618

 

$

306,897

 

Cost of goods sold

 

36,321

 

86,343

 

122,664

 

75,641

 

179,638

 

255,279

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

$

7,257

 

$

19,046

 

26,303

 

$

13,638

 

$

37,980

 

51,618

 

Operating expenses

 

 

 

 

 

(39,822

)

 

 

 

 

(82,857

)

Other income (expense), net

 

 

 

 

 

51

 

 

 

 

 

12

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loss from continuing operations

 

 

 

 

 

$

(13,468

)

 

 

 

 

$

(31,227

)

 

The direct segment includes revenues, direct costs, and allocations associated with sales fulfilled from the Company’s warehouses. Costs for this segment include product costs, inbound and outbound 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 the Company’s third party fulfillment partner sales and are earned from selling the merchandise of third parties over the Company’s Website. The costs for this segment include product costs, warehousing and fulfillment costs, credit card fees and customer service costs.

 

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

 

For the three and six months ended June 30, 2006 and 2007, over 99% of sales were made to customers in the United States of America. No individual geographical area within the U.S accounted for more than 10% of net sales in any of the periods presented. At December 31, 2006 and June 30, 2007, all of the Company’s fixed assets were located in the United States of America.

 

9.   PERFORMANCE SHARE PLAN

 

In January 2006, the Board of Directors and Compensation Committee adopted the Overstock.com Performance Share Plan and approved grants to executive officers and certain employees of the Company. The Performance Share Plan provides for a three-year period for the measurement of the Company’s attainment of the performance goal described in the form of grant, but at the Company’s sole option the Company may make a payment of estimated amounts payable to a plan participant after two years.  An amendment to the Performance Share Plan to allow the Company to make payments in the form of common stock was approved by the shareholders on May 15, 2007.

 

The performance goal is measured by growth in economic value, as defined in the plan. The amount of payments due to participants under the plan will be a function of the then current market price of a share of the Company’s common stock, multiplied by a percentage dependent on the extent to which the performance goal has been attained, which will be between 0% and 200%. If the growth in economic value is 10% compounded annually or less, the percentage will be 0%. If the growth in economic value is 25% compounded annually, the percentage will be 100%. If the growth in economic value is 40% compounded annually or more, the percentage will be 200%. If the percentage growth is between these percentages, the payment percentage will be determined on the basis of straight line interpolation. Amounts payable under the plan are payable in cash or shares of common stock, at the Company’s election. During interim and annual periods prior to the completion of the three-year measurement period, the Company records compensation expense based upon the period-end stock price and estimates regarding the ultimate growth in economic value that is expected to occur. These estimates include assumed future growth rates in revenues, gross margins and other factors. If the

 

12



 

Company were to use different assumptions, the estimated compensation charges could be significantly different.

 

Approximately $500,000 and $400,000 of compensation expense under the plan was recorded in general and administrative expenses for the quarters ended June 30, 2006 and 2007, respectively. For the six months ended June 30, 2006 and 2007, compensation expense under the plan totaled $900,000 and $650,000, respectively.  As of June 30, 2007, the Company has accrued $1.5 million in total compensation expense under the plan.

 

10.   BORROWINGS

 

$30.0 million Amended Credit Agreement

 

On October 18, 2005, the Company entered into a sixth amendment to a credit agreement (“Amended Credit Agreement”) with Wells Fargo Bank, N.A. The Amended Credit Agreement provides a revolving line of credit to the Company of up to $30.0 million which the Company uses primarily to obtain letters of credit to support inventory purchases. The Amended Credit Agreement expires on December 31, 2007; however, the Company has an option to renew the Amended Credit Agreement annually. Interest on borrowings is payable monthly and accrued at either (i) 1.35% above LIBOR in effect on the first day of an applicable fixed rate term, or (ii) at a fluctuating rate per annum determined by the bank to be one half a percent (0.50%) above daily LIBOR in effect on each business day a change in daily LIBOR is announced by the bank. Unpaid principal, together with accrued and unpaid interest is due on the maturity date. The Amended Credit Agreement requires the Company to comply with certain covenants, including restrictions on mergers, business combinations or transfer of assets. The Company was in compliance with these covenants at June 30, 2007.

 

Borrowings and outstanding letters of credit under the Amended Credit Agreement are required to be completely collateralized by cash balances held at Wells Fargo Bank, N.A, and therefore the facility does not provide additional liquidity to the Company.

 

At June 30, 2007, no amounts were outstanding under the Amended Credit Agreement, and Letters of Credit totaling $7.3 million were issued on behalf of the Company.

 

$40.0 million WFRF Agreement

 

On December 12, 2005, the Company entered into a Loan and Security Agreement (the “WFRF Agreement”) with Wells Fargo Retail Finance, LLC and related security agreements and other agreements described in the WFRF Agreement.

 

The WFRF Agreement provides for advances to the Company and for the issuance of letters of credit for its account of up to an aggregate maximum of $40.0 million. The Company has the right to increase the aggregate maximum amount available under the facility to up to $50.0 million during the first two years of the facility. The amount actually available to the Company may be less and may vary from time to time, depending on, among other factors, the amount of its eligible inventory and receivables. The Company’s obligations under the WFRF Agreement and all related agreements are collateralized by all or substantially all of the Company’s and its subsidiaries’ assets. The Company’s obligations under the WFRF Agreement are cross-collateralized with its assets pledged under its $30.0 million credit facility with Wells Fargo Bank, N.A. The term of the WFRF Agreement is three years, expiring on December 12, 2008. The WFRF Agreement contains standard default provisions.

 

Advances under the WFRF Agreement bear interest at either (a) the rate announced, from time to time, within Wells Fargo Bank, N.A. at its principal office in San Francisco as its “prime rate” or (b) a rate based on LIBOR plus a varying percentage between 1.25% and 1.75%; however, the annual interest rate on advances under the WFRF Agreement will be at least 3.50%. The WFRF Agreement includes affirmative covenants as well as negative covenants that prohibit a variety of actions without the lender’s approval, including covenants that limit the Company’s ability to (a) incur or guarantee debt, (b) create liens, (c) enter into any merger, recapitalization or similar transaction or purchase all or substantially all of the assets or stock of another person, (d) sell assets, (e) change its name or the name of any of its subsidiaries, (f) make certain changes to its business, (g) optionally prepay, acquire or refinance indebtedness, (h) consign inventory, (i) pay dividends on, or purchase, acquire or redeem shares of, its capital stock, (j) change its method of accounting, (k) make investments, (l) enter into transactions with affiliates, or (m) store any of its inventory or equipment with third parties. The Company was in compliance with these covenants as of June 30, 2007.  At June 30, 2007, no amounts were outstanding under the WFRF Agreement.  As of June 30, 2007, availability under the WFRF Agreement was $4.4 million.

 

Capital leases

 

The Company leases certain software and computer equipment under three non-cancelable capital leases that expire at various dates through 2008.

 

Software and equipment relating to the capital leases totaled $17.7 million and $19.8 million at December 31, 2006 and June 30, 2007, respectively, with accumulated amortization of $12.4 million and $15.8 million at those respective dates.

 

Depreciation of assets recorded under capital leases was $1.8 million and $1.6 million for the three months ended June 30,

 

13



 

2006 and 2007, respectively.  For the six months ended June 30, 2006 and 2007, depreciation of assets recorded under capital leases was $3.6 million and $3.3 million, respectively.

 

Future minimum lease payments under capital leases are as follows (in thousands):

 

Twelve months ending June 30,

 

 

 

2008

 

$

4,096

 

Less: amount representing interest

 

(290

)

Present value of capital lease obligations

 

3,806

 

Less: current portion

 

(3,806

)

Capital lease obligations, non-current

 

$

 

 

11.   3.75% CONVERTIBLE SENIOR NOTES

 

In November 2004, the Company completed an offering of $120.0 million of 3.75% Convertible Senior Notes (the “Senior Notes”). Proceeds to the Company were $116.2 million, net of $3.8 million of initial purchaser’s discount and debt issuance costs. The discount and debt issuance costs are being amortized using the straight-line method which approximates the interest method. The Company recorded amortization of discount and debt issuance costs related to this offering totaling $86,000 during the three months ended June 30, 2006 and 2007. For the six months ended June 30, 2006 and 2007, amortization of discount and debt issuance costs totaled $172,000 for both periods.  Interest on the Senior Notes is payable semi-annually on June 1 and December 1 of each year. The Senior Notes mature on December 1, 2011 and are unsecured and rank equally in right of payment with all existing and future unsecured, unsubordinated debt and senior in right of payment to any existing and future subordinated indebtedness.

 

The Senior Notes are convertible at any time prior to maturity into the Company’s common stock at the option of the note holders at a conversion price of $76.23 per share or, approximately 1,010,000 shares in aggregate (subject to adjustment in certain events, including stock splits, dividends and other distributions and certain repurchases of the Company’s stock, as well as certain fundamental changes in the ownership of the Company). Beginning December 1, 2009, the Company has the right to redeem the Senior Notes, in whole or in part, for cash at 100% of the principal amount plus accrued and unpaid interest. Upon the occurrence of a fundamental change (including the acquisition of a majority interest in the Company, certain changes in the Company’s board of directors or the termination of trading of the Company’s stock) meeting certain conditions, holders of the Senior Notes may require the Company to repurchase for cash all or part of their notes at 100% of the principal amount plus accrued and unpaid interest.

 

The indenture governing the Senior Notes requires the Company to comply with certain affirmative covenants, including making principal and interest payments when due, maintaining the Company’s corporate existence and properties, and paying taxes and other claims in a timely manner. The Company was in compliance with these covenants at June 30, 2007.

 

In June and November 2005, the Company retired $33.0 million and $10.0 million of the Senior Notes for $27.9 million and $7.8 million in cash for each respective retirement. As a result of the note retirements in June and November, the Company recognized gains of $4.2 million and $2.0 million, net of the associated unamortized discount of $1.2 million during the quarters ended June 30, 2005 and December 31, 2005, respectively. As of June 30, 2007, $77.0 million of the Senior Notes remained outstanding.

 

12.   COMMITMENTS AND CONTINGENCIES

 

Commitments

 

Corporate office space

 

Through July 2005, the Company leased 43,000 square feet of office space at Old Mill Corporate Center I for its principal executive offices under an operating lease which was originally scheduled to expire in January 2007. Beginning July 2005, this lease was terminated and replaced with a lease for approximately 154,000 rentable square feet in the Old Mill Corporate Center III in Salt Lake City, Utah for a term of ten years.

 

The Company and Old Mill Corporate Center III, LLC (the “Lessor”) entered into a Tenant Improvement Agreement (the “OMIII Agreement”) relating to the office building in February 2005. The OMIII Agreement sets forth the terms on which the Company paid the costs of certain improvements to the leased office space. The amount of the costs was approximately $2.0 million. The OMIII Agreement also required the Company to provide a letter of credit in the amount of $500,000 to the Lessor to provide funds for the removal of certain improvements upon the termination of the lease.

 

During the fourth quarter 2006, the Company commenced implementation of a facilities consolidation and restructuring program. The Company recorded a liability of $450,000 for the costs to dismantle and dispose of an escalator system and to return the leased facilities to their original condition under the Tenant Improvement Agreement and incurred additional amortization expense in connection with the revised useful life of certain leasehold improvements.  In the second quarter of 2007, the Company

 

14



 

abandoned and began marketing for sub-lease office and data center space in the current corporate office facilities and recorded an additional $2.4 million of restructuring charges related to accelerated amortization of leasehold improvements located in the abandoned office and data center space and $2.0 million of other restructuring charges, primarily related to consolidation of office space in the current corporate office facilities, relocation of a data center and employee severance (see Note 3).

 

Logistics and warehouse space

 

In July 2004, the Company entered into a logistics service agreement (the “Logistics Agreement”) wherein the handling, storage and distribution of some of the Company’s prepackaged products is performed by a third party.  The Logistics Agreement and subsequent amendment set forth terms on which the Company paid various fixed fees based on square feet of storage and various variable costs based on product handling costs for a term of five years.

 

In December 2005, the Company entered into a warehouse facilities lease agreement (the “License Agreement”) to license approximately 400,000 square feet of warehouse space in Indiana.  The License Agreement was subsequently amended, reducing the amount of lease space to approximately 300,000 and extending the term to 2011.

 

In the first quarter of 2007, the Company terminated the Logistics Agreement and gave notice of intent to sublease the Indiana warehouse facilities under the License Agreement.  During the second quarter of 2007, the Company reached an agreement to terminate the Indiana warehouse facilities lease in its entirety effective August 15, 2007 for $1.9 million (see Note 3).

 

The Company leases 610,000 square feet for its warehouse facilities in Utah under operating leases which expire in August 2012.

 

Co-location data center

 

In July 2005, the Company entered into a Co-location Center Agreement (the “Co-location Agreement”) to build out and lease 11,289 square feet of space at Old Mill Corporate Center II for an IT co-location data center. The Co-location Agreement set forth the terms on which the Lessor would incur the costs to build out the IT co-location data center and the Company would commence to lease the space upon its completion for a term of ten years. In November 2006 however, the Company made the determination to consolidate its facilities and to not occupy the IT co-location data center, and the Co-location Agreement was terminated effective December 28, 2006 (see Note 3).

 

In December 2006, the Company entered into a Co-location Data Center Agreement (the “OM I Co-location Agreement”) to lease 3,999 square feet of space at Old Mill Corporate Center I for an IT co-location data center to allow the Company to consolidate other IT data center facilities at the Old Mill Corporate Center II and at the Company’s current corporate offices facilities.

 

Operating leases

 

In June 2005 and 2006, the Company entered into non-cancelable operating leases for certain computer equipment expiring in April 2008 and June 2008. It is expected that such leases will be renewed by exercising purchase options or replaced by leases of other computer equipment.

 

Minimum future payments under these leases are as follows (in thousands):

 

Twelve months Ending June 30,

 

 

 

2008

 

$

9,154

 

2009

 

6,234

 

2010

 

6,273

 

2011

 

5,726

 

2012

 

5,881

 

Thereafter

 

13,530

 

 

 

$

46,798

 

 

Rental expense for operating leases totaled $1.7 million and $2.1 million for the three months ended June 30, 2006 and 2007, respectively.  For the six months ended June 30, 2006 and 2007, rental expense totaled $3.0 million and $3.7 million, respectively.

 

Redeemable Common Stock

 

The estimated amount of redeemable common stock is based solely on the statutes of limitations of the various states in which stockholders may have had rescission rights and may not reflect the actual results. The stock is not redeemable by its terms. The Company does not have any unconditional purchase obligations, other long-term obligations, guarantees, standby repurchase obligations or other commercial commitments. These rescission rights fully expired prior to the end of the third quarter of 2006, leaving no outstanding redeemable common stock as of September 30, 2006.

 

15



 

Legal Proceedings

 

From time to time, the Company receives claims of and become subject to consumer protection, employment, intellectual property and other commercial litigation related to the conduct of the Company’s business. Such litigation could be costly and time consuming and could divert our management and key personnel from its business operations. The uncertainty of litigation increases these risks. In connection with such litigation, the Company may be subject to significant damages or equitable remedies relating to the operation of its business and the sale of products on the Company’s website. Any such litigation may materially harm its business, prospects, results of operations, financial condition or cash flows. However, the Company does not currently believe that any of its outstanding litigation will have a material adverse effect on its financial statements.

 

In December 2003, the Company received a letter from Furnace Brook claiming that certain of the Company’s business practices and its website infringe a single patent owned by Furnace Brook. After diligent efforts to show that the Company does not infringe the patent and Furnace Brook’s continual demands that the Company enter into licensing arrangements with respect to the asserted patent, on August 12, 2005, the Company filed a complaint in the United States District Court of Utah, Central Division, seeking declaratory judgment that it does not infringe any valid claim of the Furnace Brook patent. Furnace Brook filed a motion to dismiss that complaint for lack of personal jurisdiction over Furnace Brook in Utah. On October 31, 2005, the United States District Court of Utah, Central Division, issued a decision to dismiss the Company’s complaint for lack of personal jurisdiction over patent troll Furnace Brook. On December 14, 2005, the Company filed an appeal of the Utah decision with the United States Court of Appeals for the Federal Circuit. On August 18, 2006, the United States Court of Appeals for the Federal Circuit denied the Company’s appeal. On August 18, 2005, shortly after the Company filed the complaint in Utah, Furnace Brook filed a complaint in the United States District Court for the Southern District of New York, alleging that certain of the Company’s business practices and its website infringe a single patent owned by Furnace Brook. On September 9, 2005, the Company filed an answer denying the material allegations in Furnace Brook’s claims. On September 27, 2006, the United States District Court for the Southern District of New York issued a memorandum and order in a Markman Hearing which substantially adopted the Company’s interpretation of the Furnace Brook patent.  The Company filed motions for summary judgment relating to the litigation and on October 6, 2006, the United States District Court for the Southern District of New York heard oral argument on those motions and on October 30, 2006, the United States District Court for the Southern District of New York granted summary judgment in favor of the Company, ruling that the Company does not infringe the Furnace Brook patent as a matter of law. On November 9, 2006, Furnace Brook filed a notice of appeal to the United States Court of Appeals for the Federal Circuit and on January 16, 2007, the Company filed a responsive brief with the Federal Circuit Court. On May 23, 2007 the Court upheld the summary judgment ruling of the lower court in favor of the Company.  On May 31, 2007, Furnace Brook filed a Petition for a Rehearing, which the Company answered, and on July 5, 2007, the Court denied Furnace Brook’s Petition for Rehearing.

 

On August 11, 2005, along with a shareholder plaintiff, the Company filed a complaint against Gradient Analytics, Inc.; Rocker Partners, LP; Rocker Management, LLC; Rocker Offshore Management Company, Inc. and their respective principals in the Superior Court of California, County of Marin. On October 12, 2005, the Company filed an amended complaint against the same entities alleging libel, intentional interference with prospective economic advantage and violations of California’s unfair business practices act. On March 7, 2006, the court denied the defendants demurrers to and motions to strike the amended complaint. The defendants each filed a motion to appeal the court’s decision, the Company responded and the California Attorney General submitted an amicus brief supporting the Company’s view; the court has ruled that this appeal stays discovery in the case. On April 10, 2007, the California Court of Appeals heard oral argument on the appeal.  On May 30, 2007 the California Court of Appeals upheld the lower court’s ruling in the Company’s favor.  Defendants filed motions for rehearing, which the Court of Appeals summarily denied on June 27, 2007.  Defendants have filed Petitions for Review before the California Supreme Court and the Company filed its response to those petitions on July 30, 2007.  The Company intends to continue to pursue this action vigorously.

 

On May 9, 2006 the Company received a notice of an investigation and subpoena from the Securities and Exchange Commission, Salt Lake City District Office. On May 17, 2006, Patrick Byrne also received a subpoena from the Securities and Exchange Commission, Salt Lake City District Office.  These subpoenas requested a broad range of documents, including, among other documents, all documents relating to the Company’s accounting policies, the Company’s targets, projections or estimates related to financial performance, the Company’s recent restatement of its financial statements, the filing of its complaint against Gradient Analytics, Inc., the development and implementation of certain new technology systems and disclosures of progress and problems with those systems, communications with and regarding investment analysts, communications regarding shareholders who did not receive the Company’s proxy statement in April 2006, communications with certain shareholders, and communications regarding short selling, naked short selling, purchases and sales of Company stock, obtaining paper certificates, and stock loan or borrow of Company shares. The Company and Mr. Byrne have responded to these subpoenas and each continues to cooperate with the Securities and Exchange Commission on this matter.

 

In November 2006, the Company received a letter from Applied Interactive, claiming that certain of the Company’s business practices and its website infringe two patents owned by Applied Interactive and offering to enter into a licensing agreement. After determining that it does not infringe the patents and rejecting the offered licensing agreement, on February 2, 2007, the Company filed a complaint in the United States District Court, Southern District of New York, seeking declaratory judgment that it did not infringe any valid claim of the Applied Interactive patents. The Company and Applied Interactive have reached a confidential

 

16



 

agreement in principal to settle this matter for an immaterial amount, and the action was dismissed on May 29, 2007.

 

On February 2, 2007, along with five shareholder plaintiffs, the Company 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. The suit alleges that the defendants, who control 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 continue to cause dramatic distortions with in the nature and amount of trading in the Company’s stock as well as dramatic declines in the share price of the Company’s stock.  The suit asserts that a persistent large number of “fails to deliver” creates significant downward pressure on the price of a company’s stock and that the amount of “fails to deliver” has exceeded the company’s entire supply of outstanding shares. The suit accuses the defendants of violations of California securities laws and common law, specifically, conversion, trespass to chattels, intentional interference with prospective economic advantage, and violations of California’s Unfair Business Practices Act. The Company is seeking damages of $3.48 billion. On April 6, 2007 defendants filed a demurrer and motion to strike the Company’s complaint.  The Company has opposed the demurrer and motion to strike.  On July 17, 2007 the court substantially denied defendants’ demurrer and motion to strike. The Company intends to vigorously prosecute this action.

 

On March 29, 2007, the Company, along with 63 other defendants, was sued in United States District Court for the Eastern District of Texas, Tyler Division, by Orion IP, LLC.  The suit alleges that the Company and the other 63 defendants infringe two patents owned by Orion that relate to the making and using supply chain methods, sales methods, sales systems, marketing methods, marketing systems, and inventory systems.   On April 30, 2007, the Company filed an answer denying Orion’s allegations and a counterclaim asserting that Orion’s patent is invalid.  The case is in its initial stages. As it has consistently done with similar suits filed by patent trolls, the Company intends to vigorously defend this action.

 

13.   INDEMNIFICATIONS AND GUARANTEES

 

During its normal course of business, the Company has made certain indemnities, commitments, and guarantees under which it 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 directors and officers of the Company 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 the Company could be obligated to make. As such, the Company is unable to estimate with any reasonableness its potential exposure under these items. The Company has not recorded any liability for these indemnities, commitments, and guarantees in the accompanying consolidated balance sheets. The Company does, 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. The Company carries specific and general liability insurance policies that the Company believes would, in most circumstances, provide some, if not total coverage for any claims arising from these indemnifications.

 

14.   STOCK OFFERINGS

 

During 2006, the Company closed two offerings under an existing “shelf” registration statement, pursuant to which it sold 1.0 million shares of common stock in May and 2.7 million shares of common stock in December, with proceeds to the Company of approximately $25.0 million and $39.4 million, respectively, net of $594,000 of issuance costs.  The Company has had no offerings in 2007.

 

17


 


 

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

 

In addition to historical information, this Quarterly Report on Form 10-Q/A contains forward-looking statements. These statements relate to our, and in some cases our customers’ or other third parties’, future plans, objectives, expectations, intentions and financial performance and the assumptions that underlie these statements. These forward-looking statements include, but are not limited to, statements regarding the following: our beliefs and expectations regarding the seasonality of our direct and fulfillment partner revenue; our beliefs regarding the sufficiency of our capital resources; planned distribution and order fulfillment capabilities; our beliefs, intentions and expectations regarding improvements of our order processing systems and capabilities; our intentions regarding the development of enhanced technologies and features; our intentions regarding the expansion of our customer service capabilities; our beliefs and intentions regarding improvements to our general and administrative functions; our beliefs and intentions regarding enhancements to our sales and marketing activities; our beliefs regarding the potential for growth in our customer base; our beliefs and intentions regarding our expansion into new markets, including international markets; our beliefs and intentions about entering into agreements to provide products and services to retail chains and other businesses; our beliefs regarding potential development of new Websites; our beliefs, intentions and expectations regarding promotion of new or complimentary product and sales formats; our beliefs, intentions and expectations regarding the expansion of our product and service offerings; our beliefs and intentions regarding expanding our market presence through relationships with third parties; our beliefs regarding the pursuit of complimentary businesses and technologies; our beliefs regarding the adequacy of our insurance coverage; our beliefs, intentions and expectations regarding litigation matters and legal proceedings, our defenses to such matters and our contesting of such matters; our beliefs and expectations regarding our existing cash and cash equivalents, cash requirements and sufficiency of capital; and our beliefs and expectations regarding interest rate risk, our investment activities and the effect of changes in interest rates.

 

These forward-looking statements are subject to risks and uncertainties that could cause actual results and events to differ materially. For a detailed discussion of these risks and uncertainties please see Item 1A — Risk Factors and the description of risk factors set forth in our Annual Report on Form 10-K for the year ended December 31, 2006. 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.

 

Recent Developments

 

During the fourth quarter of 2006, we commenced a facilities consolidation and restructuring program designed to reduce our overall expense structure in an effort to improve future operating performance.  The facilities consolidation and restructuring program should be substantially completed during calendar year 2007.

 

As of December 31, 2006, we recorded $5.7 million of restructuring charges, of which $5.5 million, less the elimination of straight-line rent liability of $913,000, related to costs to terminate a co-location data-center lease.  Other costs included in the restructuring charge related to $638,000 of accelerated amortization of leasehold improvements in our current office facilities that we are attempting to sublease and $450,000 of costs incurred to return these office facilities to their original condition as required by the lease agreement.

 

During the six months ended June 30, 2007, we accrued $8.0 million of restructuring charges related to the termination of a logistics services agreement, an agreement to terminate a lease related to vacated warehouse facilities in Indiana and abandonment and marketing for sub-lease office and data center space in our current corporate office facilities.  We also recorded an additional $2.4 million of restructuring charges related to accelerated amortization of leasehold improvements located in the abandoned office and data center space and $2.0 million of other restructuring charges, primarily related to consolidation of office space in the current corporate office facilities, relocation of a data center and employee severance (see Financial Statements—Note 3—“Restructuring Expense”).

 

As of December 31, 2006, we classified $21.3 million of assets and $3.7 of liabilities as “held for sale” related to our OTravel subsidiary.  In conjunction with the sale of OTravel, we performed an evaluation of the goodwill associated with the reporting unit pursuant to SFAS 142, and SFAS 144,  Accounting for the Impairment of Long-Lived Assets  and determined that goodwill of approximately $4.5 million was impaired as of December 31, 2006 based on a non-binding letter of intent to sell this business.

 

On April 25, 2007, we completed the sale of OTravel for cash proceeds of $9.9 million, net of cash transferred, and $6.0 million of notes. Based on the estimated fair value of the discounted cash flows of the net proceeds from the sale, we recorded an additional goodwill impairment of $3.8 million as of March 31, 2007 (see Financial Statements—Note 4—“Sale of Discontinued Operations”).

 

Please see the “Executive Commentary” below as well as the rest of Management’s Discussion and Analysis for discussion of other recent developments.

 

18



 

Overview

 

We are an online “closeout” retailer offering discount brand name merchandise, including bed-and-bath goods, home décor, kitchenware, watches, jewelry, electronics and computers, sporting goods, apparel, and designer accessories, among other products. We also sell books, magazines, CDs, DVDs, videocassettes and video games (“BMMG”). We also operate as part of our Website an online auction site—a marketplace for the buying and selling of goods and services — as well as an online site for listing cars for sale.

 

Our company, based in Salt Lake City, Utah, was founded in 1997, and we launched our first Website through which customers could purchase products in March 1999. Our Website offers our customers an opportunity to shop for bargains conveniently, while offering our suppliers an alternative inventory liquidation distribution channel. We continually add new, limited inventory products to our Website in order to create an atmosphere that encourages customers to visit frequently and purchase products before our inventory sells out. We offer approximately 43,000 products under multiple stores under the shopping tab on our main Website, and offer almost 745,000 media products in the Entertainment store on our Website.

 

Closeout merchandise is typically available in inconsistent quantities and prices and often is only available to consumers after it has been purchased and resold by disparate liquidation wholesalers. We believe that the traditional liquidation market is therefore characterized by fragmented supply and fragmented demand. We utilize the Internet to aggregate both supply and demand and create a more efficient market for liquidation merchandise. Our objective is to provide a one-stop destination for discount shopping for products and services proven to be successfully sold through the Internet.

 

Our Business

 

Overstock utilizes the Internet to create a more efficient market for liquidation merchandise. We provide consumers and businesses with quick and convenient access to high-quality, brand-name merchandise at discount prices. Our shopping business includes both a “direct” business and a “fulfillment partner” business. Products from our direct segment and fulfillment partner segments are also available in bulk to both consumers and businesses through the Wholesale product category on our Website.  During the six months ended June 30, 2007, no single customer accounted for more than 1% of our total revenue.

 

Direct business

 

Our direct business includes sales made to individual consumers and businesses, which are fulfilled from our warehouses in Salt Lake City, Utah or our outsourced warehouses located in Plainfield, Indiana. During the six months ended June 30, 2007, we fulfilled approximately 27% of all orders through our warehouses. Our warehouses generally ship between 5,000 and 8,000 orders per day and up to approximately 34,000 orders per day during peak periods, using overlapping daily shifts.

 

Fulfillment partner business

 

For our fulfillment partner business, we sell merchandise of other retailers, cataloguers or manufacturers (“fulfillment partners”) through our Website. We are considered to be the primary obligor for the majority of these sales transactions and we assume the risk of loss on the returned items. As a consequence, we record revenue from the majority of these sales transactions involving our fulfillment partners on a gross basis. Our use of the term “partner” or “fulfillment partner” does not mean that we have formed any legal partnerships with any of our fulfillment partners. We currently have fulfillment partner relationships with approximately 550 third parties which post approximately 39,000 non-BMMG products, as well as most of the BMMG products on our Website.

 

Our revenue from sales on our shopping site from both the direct and fulfillment partner businesses is recorded net of returns, coupons and other discounts. Our returns policy for products other than those sold in our Electronics and Computers department provides for a $4.95 restocking fee and the provision that we will accept product returns initiated within thirty days after the shipment date. We charge a 15% restocking fee (instead of the $4.95 restocking fee) on all items returned for non-defective reasons from the Electronics and Computers department.

 

Unless otherwise indicated or required by the context, the discussion herein of our financial statements, accounting policies and related matters, pertains to our shopping sites (Shopping and BMMG) and not necessarily to our wholesale, auction, or cars tabs on our Website.

 

Wholesale business

 

Our Wholesale store allows consumers and businesses to purchase selected products in bulk quantities. For this store, we sell products from similar product categories as our shopping tab, as well as products from various industry verticals, such as florist supplies, restaurant supplies, and office supplies.

 

Auctions business

 

We operate an online auction service as part of our Website. Our auction tab allows sellers to list items for sale, buyers to bid on items of interest, and users to browse through listed items online. For these sales we record only our listing fees and commissions

 

19



 

for items sold as revenue. From time to time, we also sell items returned from our shopping site on our auction site, and for these sales, we record the revenue on a gross basis. Revenue from our auction business is included in the fulfillment partner segment, as it is not significant enough to segregate as its own segment.

 

Car listing business

 

We operate an online site for listing cars for sale as a part of our Website. The car listing service allows sellers to list vehicles for sale and allows buyers to review vehicle descriptions, post offers to purchase, and provides the means for purchasers to contact sellers for further information and negotiations on the purchase of an advertised vehicle. Revenue from our car listing business is included in the fulfillment partner segment, as it is not significant enough to separate out as its own segment.

 

Cost of goods sold

 

Cost of goods sold consists of the cost of the product, as well as inbound and outbound freight, warehousing and fulfillment costs (including payroll and related expenses), credit card fees, customer service costs and stock-based compensation.

 

Operating expenses

 

Sales and marketing expenses consist primarily of advertising, public relations and promotional expenditures, as well as payroll and related expenses, including stock-based compensation, for personnel engaged in marketing and selling activities.

 

Advertising expense is the largest component of our sales and marketing expenses and is primarily attributable to expenditures related to online marketing activities and offline national radio and television advertising.  Our advertising expenses totaled approximately $11.5 million and $7.1 million for the three months ended June 30, 2006 and 2007, respectively, representing 94% and 89% of sales and marketing expenses for those respective periods.  For the six months ended June 30, 2006 and 2007, our advertising expense totaled approximately $24.0 million and $17.7 million, respectively, representing 95% and 92% of sales and marketing expenses for those respective periods.

 

Technology expenses consist of wages and benefits, including stock-based compensation, for technology personnel, rent, utilities, connectivity charges, as well as support and maintenance and depreciation and amortization related to software and computer equipment.

 

General and administrative expenses consist of wages and benefits, including stock-based compensation, for executive, legal, accounting, merchandising and administrative personnel, rent and utilities, travel and entertainment, depreciation and amortization of intangible assets and other general corporate expenses.

 

We have recorded no provision or benefit for federal and state income taxes as we have incurred net operating losses since inception. We have provided a full valuation allowance on the net deferred tax assets, consisting primarily of net operating loss carryforwards, because of uncertainty regarding their realizability.

 

Both direct and fulfillment partner revenues are seasonal, with revenues historically being the highest in the fourth quarter, reflecting higher consumer holiday spending. We anticipate this will continue in the foreseeable future.

 

Executive Commentary

 

Commentary—Revenue and Marketing.  Our second quarter revenue declined 6% from the second quarter of 2006, an improvement from the 11% year-over-year sales decline in the first quarter, leaving sales down 9% over the first six months of 2007.  We believe that the 9% decrease in total revenue is primarily the result of a reduction in traffic to the Website due to a significant reduction in marketing expenditures both in dollars (down 22% to $19.2 million from $24.6 million in 2006) and as a percent of sales (6.3% versus 7.3% in 2006).

 

In an effort to improve revenue growth, we are in the process of increasing the number of products available on our Website (particularly in areas where we believe our product selection needs enhancing) by increasing the number of fulfillment partners selling product on our site. To do this, we have integrated a third-party technology that enhances our ability to add new fulfillment partners. In addition, we are in the process of integrating directly with a large fulfillment partner whose products would expand our product selection.

 

Commentary—Gross Margins.  Although sales were down 6% in the second quarter, gross profit dollars were up 18% to $26.3 million. Gross margins expanded to an all-time high of 17.7%, up 370 basis points over last year and 170 basis points sequentially. The gains in gross margins are primarily due to significant improvement in our direct margins, which are up 610 basis points year-over-year to 16.7%. We significantly reduced our inventory over the course of 2006 in an effort to refine the selection of products that we purchase directly to categories that turn faster and have higher profitability.  We believe that we can run our direct business with significantly less inventory than we have had in the past, while filling in product selection using fulfillment partners, rather than acquiring the inventory directly. As a result of these efforts, we saw a significant improvement in direct and overall gross margins beginning in the first quarter of 2007. With reduced inventory levels, we have excess warehouse capacity, and therefore we

 

20



 

have begun reducing our warehouse space and the related costs, which we expect will assist in our efforts to further improve our direct gross margins.  We also had a 150 basis point improvement in our fulfillment partner margins in the quarter to 18.1%.

 

Commentary—Contribution and Contribution Margin.  Contribution is defined as gross profit dollars less sales and marketing expense. Although sales were down 6%, we were able to increase contribution dollars by $7.9 million (or 76%) to $18.3 million this year versus $10.4 million recorded during the same quarter in 2006.  This was due to the improvements we made in gross margins (up 370 basis points to 17.7%) and a $3.9 million reduction in sales and marketing dollars spent. This equates to contribution margin of 12.3% this year versus 6.5% in 2006. The following table represents our calculation of contribution (in thousands):

 

 

 

Three months ended
June 30,

 

Six months ended
June 30,

 

 

 

2006

 

2007

 

2006

 

2007

 

Total revenue

 

$

159,192

 

$

148,967

 

$

337,236

 

$

306,897

 

Cost of goods sold

 

136,884

 

122,664

 

291,194

 

255,279

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

22,308

 

26,303

 

46,042

 

51,618

 

Less: Sales and marketing expense

 

11,911

 

7,962

 

24,570

 

19,246

 

 

 

 

 

 

 

 

 

 

 

Contribution

 

$

10,397

 

$

18,341

 

$

21,472

 

$

32,372

 

Contribution margin

 

6.5

%

12.3

%

6.4

%

10.5

%

 

Commentary—Technology and G&A costs.  We terminated a long-term computer co-location facility lease in December 2006 and we have reduced corporate headcount during the year. We are in the process of significantly reducing additional facilities costs and other expenses, including the reduction of space in our corporate offices. Although our combined technology and G&A costs in the first six months of 2007 were flat year-over-year, we expect these costs to decrease overall in 2007.

 

Commentary—Operating loss.  Our operating loss for the second quarter was $13.5 million, down from $15.6 million in 2006. Over the first six months of the year, our operating loss was $31.2 million, up from $29.7 million over the same period last year. However, the 2007 operating loss includes $12.3 million of restructuring costs ($6.1 million in Q1 and $6.2 million in Q2). Before restructuring costs, the operating loss was $19.0 million over the first half of this year, a $10.7 million year-over-year improvement. Restructuring costs primarily represent our efforts to reduce our overall expense structure through the consolidation of our corporate office, data centers and warehouse facilities. Therefore, we believe that discussing our operating loss before restructuring costs (a non-GAAP measure) provides useful information to us and investors because it is a representation of the expense structure of the company if we had not originally incurred these costs. We use this measure to monitor our progress in reducing our overall expense structure, including the comparison of operating results in the current year to similar periods in the previous year. See the following table for operating loss before restructuring costs (in thousands):

 

 

 

Three months ended
June 30,

 

Six months ended
June 30,

 

 

 

2006

 

2007

 

2006

 

2007

 

 

 

 

 

 

 

 

 

 

 

Operating loss

 

$

(15,550

)

$

(13,519

)

$

(29,729

)

$

(31,239

)

Add back: restructuring

 

 

6,194

 

 

12,283

 

 

 

 

 

 

 

 

 

 

 

Operating loss before restructuring

 

$

(15,550

)

$

(7,325

)

$

(29,729

)

$

(18,956

)

 

Commentary—EBITDA (non-GAAP).  EBITDA for the second quarter of 2007 was $(4.2 million), an improvement from $(7.5 million) in Q2 2006.  For the first six months of the year, EBITDA was $(12.4 million), $1.6 million better than the $(14.0 million) in the previous year. We believe that discussing EBITDA at this stage of our business is useful to us and investors, because our current capital expenditures are significantly lower than our depreciation levels. During 2005 and 2006, we made significant investments in our systems and overall infrastructure, and as a result will have approximately $30 million of related depreciation expense in 2007.  However, we expect to spend less than $5 million in new capital expenditures during 2007, and therefore we use EBITDA as a reasonable measure of actual cash used or cash generated by the operations of the business.

 

Although EBITDA was negative $4.2 million in the second quarter, EBITDA excluding restructuring costs (“adjusted EBITDA”, a non-GAAP measure) was a positive $2.0 million in the second quarter, and $(146,000) year-to-date. We believe that discussing adjusted EBITDA also provides useful information to us and investors, as we use this measure as a representation of cash used or cash generated from the operations of the business if we had not originally incurred these costs.  For further details on EBITDA and adjusted EBITDA, see the reconciliation of these non-GAAP measures to GAAP operating loss as follows (in thousands):

 

21



 

 

 

Three months ended
June 30,

 

Six months ended
June 30,

 

 

 

2006

 

2007

 

2006

 

2007

 

Operating loss

 

$

(15,550

)

$

(13,519

)

$

(29,742

)

$

(31,239

)

Add:Depreciation and amortization

 

6,876

 

7,974

 

13,026

 

15,745

 

Stock-based compensation expense

 

1,088

 

1,137

 

2,046

 

2,210

 

Stock-based compensation to consultants for service

 

(9

)

135

 

34

 

140

 

Treasury stock issued to employees as compensation

 

105

 

113

 

612

 

715

 

EBITDA

 

(7,490

)

(4,160

)

(14,024

)

(12,429

)

Add: Restructuring

 

 

6,194

 

 

12,283

 

Adjusted EBITDA

 

$

(7,490

)

$

2,034

 

$

(14,024

)

$

(146

)

 

Commentary—Balance Sheet Items.  We ended the second quarter with just over $15 million of inventory, significantly lower than the $75 million of inventory we had at the end of the second quarter of 2006, and down from $20 million at the end of 2006. From this lower inventory level, we were able to turn our inventory much more efficiently in the second quarter, while maintaining more attractive, higher margin products.

 

We ended the quarter with $93 million in cash, cash equivalents and marketable securities, up $25 million from the end of the first quarter. This was the result of $10 million received as part of the proceeds from the sale of our OTravel subsidiary (see Financial Statements - Note 4) combined with $15 million of positive operating cash flow in the quarter. We anticipate that we will require less capital to run our business in the near future than we required in the recent past.  However, whether we will need to raise additional capital will depend on, among other things, our revenues, gross margins, product sales mix and expenses.

 

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.

 

Critical Accounting Policies and Estimates

 

Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Our critical accounting policies are as follows:

 

·    revenue recognition;

 

·    estimating valuation allowances and accrued liabilities (specifically, the reserve for returns, the allowance for doubtful accounts and the reserve for obsolete and damaged inventory);

 

·    internal use software;

 

·    accounting for income taxes;

 

·    valuation of long-lived and intangible assets and goodwill; and

 

·    stock based compensation and performance share plan.

 

Revenue recognition.  We derive our revenue primarily from two sources: (i) direct revenue, which consists of merchandise sales made to consumers and businesses that are fulfilled from our warehouses; and (ii) fulfillment partner revenue, which consists of revenue from the sale of merchandise supplied and shipped by fulfillment partners directly to consumers and other businesses. Fulfillment partner revenue also includes listing fees and commissions collected from products being listed and sold through the Auctions tab of our Website as well as advertisement revenue derived from our cars listing business. All sources of revenue are recorded net of returns, coupons redeemed by customers, and other discounts. Revenues from our auction services and cars listing business were not material during the three and six months ended June 30, 2006 and 2007, and therefore are included in fulfillment partner revenue.

 

We record revenue from the majority of these sales transactions involving our fulfillment partners (excluding auctions) on a gross basis. Similar to our direct revenue segment, fulfillment partner products are available to both consumers and businesses.

 

For sales transactions, we comply with the provisions of Staff Accounting Bulletin 104, Revenue Recognition, which states that revenue should be recognized when the following revenue recognition criteria are met: (1) persuasive evidence of an arrangement exists; (2) the product has been shipped or the service provided and the customer takes ownership and assumes the risk

 

22



 

of loss; (3) the selling price is fixed or determinable; and (4) collection of the resulting receivable is reasonably assured. We generally require payment by credit card at the point of sale. Amounts received prior to when we ship the goods or provide the services to customers are recorded as deferred revenue. In addition, amounts received in advance for gift cards, Club O memberships and marketing royalties related to our co-branded credit card program are recorded as deferred revenue and recognized in the period earned.

 

Reserve for returns, allowance for doubtful accounts and the reserve for obsolete and damaged inventory.  Our management must make estimates of potential future product returns related to current period revenue. Management analyzes historical returns, current economic trends and changes in customer demand and acceptance of our products when evaluating the adequacy of the sales returns reserve and other allowances in any accounting period. The reserve for returns was $3.6 million and $2.3 million as of December 31, 2006 and June 30, 2007, respectively.

 

From time to time, we may grant credit to certain of our business customers on normal credit terms (typically 30 days). We perform ongoing credit evaluations of our customers’ financial condition and maintain an allowance for doubtful accounts receivable based upon our historical collection experience and expected collectibility of all accounts receivable. We maintained an allowance for doubtful accounts receivable of $2.1 million and $2.0 million as of December 31, 2006 and June 30, 2007, respectively.

 

We write down our inventory for estimated obsolescence or damage equal to the difference between the cost of inventory and the estimated 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 reserve represents the new cost basis of such products. Reversal of these reserves is recognized only when the related inventory has been sold or scrapped. At December 31, 2006, our inventory balance was $20.3 million, net of allowance for obsolescence or damaged inventory of $6.6 million.  At June 30, 2007, our inventory balance was $15.4 million, net of allowance for obsolescence or damaged inventory of $3.8 million.

 

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. As required by Statement of Position 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use, we capitalize costs incurred during the application development stage of internal-use software and amortize these costs over the estimated useful life of three years. Costs incurred related to design or maintenance of internal-use software are expensed as incurred.

We capitalized $3.9 million and $226,000 of costs associated with internal-use software and website development during the three months ended June 30, 2006 and 2007, respectively, which are partially offset by amortization of previously capitalized amounts of $741,000 and $766,000 for those respective periods.  During the six months ended June 30, 2006 and 2007, we capitalized $12.0 million and $1.5 million, respectively, which are partially offset by amortization of previously capitalized amounts of $1.3 million and $1.5 million for those respective periods.

 

Accounting for income taxes.  Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. As of December 31, 2006 and June 30, 2007, we have recorded a full valuation allowance of $74.4 million and $81.4 million, respectively, against our net deferred tax asset balance due to uncertainties related to our deferred tax assets as a result of our history of operating losses. The valuation allowance is based on our estimates of taxable income by jurisdiction in which we operate and the period over which our deferred tax assets will be recoverable. In the event that actual results differ from these estimates or we adjust these estimates in future periods, we may need to change the valuation allowance, which could materially impact our financial position and results of operations.

 

Valuation of long-lived and intangible assets and goodwill.  Under SFAS 142, Goodwill and Other Intangible Assets, goodwill is not amortized, but must be tested for impairment at least annually. Other long-lived assets must also be evaluated for impairment when management believes that an asset has experienced a decline in value that is other than temporary. Future adverse changes in market conditions or poor operating results of underlying investments could result in losses or an inability to recover the carrying value of the asset that may not be reflected in an asset’s current carrying value, thereby possibly requiring an impairment charge in the future. Goodwill totaled $2.8 million as of December 31, 2006 and June 30, 2007.

 

In conjunction with the decision to sell OTravel, our travel subsidiary, we performed an evaluation of its goodwill, pursuant to SFAS 144, Accounting for the Impairment Long-Lived Assets, and SFAS 142, Goodwill and Other Intangible Assets, and determined that goodwill was subject to an impairment loss of approximately $4.5 million during year ended December 31, 2006 and $3.8 million during the six months ended June 30, 2007 (see Financial Statements—Note 4—“Sale of Discontinued Operations”). These have been recorded as a component of the loss from discontinued operations.

 

Stock-based compensation. As of January 1, 2006, we adopted SFAS 123(R), which requires us to measure compensation cost for all outstanding unvested share-based awards at fair value and recognize compensation over the service period for awards expected to vest. The estimation of stock awards that will ultimately vest requires judgment, and to the extent actual results differ

 

23



 

from our 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, employee class, and historical experience. Actual results may differ substantially from these estimates. We have utilized a Black-Scholes-Merton valuation model to estimate the value of stock options granted to employees. Several of the primary estimates used in measuring stock-based compensation are as follows:

 

Expected Volatility:  The fair value of stock options were valued using a volatility factor based on our historical stock prices.

 

Expected Term:  The expected term represents the period that our stock options are expected to be outstanding and was determined based on historical experience of similar awards, giving consideration to the contractual terms and vesting provisions of the stock-based awards.

 

Expected Dividend:  We have not paid any dividends and do not anticipate paying dividends in the foreseeable future.

 

Risk-Free Interest Rate:  We base the risk-free interest rate used on the implied yield currently available on U.S. Treasury zero-coupon issues with remaining term equivalent to the expected term of the options.

 

Estimated Pre-vesting Forfeitures:  When estimating forfeitures, we consider voluntary and involuntary termination behavior.

 

Performance Share Plan.  In January 2006 the Board and Compensation Committee adopted the Overstock.com Performance Share Plan, and approved grants to executive officers and certain employees. The Performance Share Plan provides for a three-year period for the measurement of our attainment of certain performance goals, but at our sole option we may make a payment of estimated amounts payable to a plan participant after two years.  An amendment to the Performance Share Plan to allow us to make payments in the form of common stock was approved by the shareholders on May 15, 2007.

 

The performance goal is measured by growth in economic value, as defined in the plan. The amount of payments due to participants under the plan will be a function of the then current market price of a share of our common stock, multiplied by a percentage dependent on the extent to which the performance goal has been attained, which will be between 0% and 200%. If the growth in economic value is 10% compounded annually or less, the percentage will be 0%. If the growth in economic value is 25% compounded annually, the percentage will be 100%. If the growth in economic value is 40% compounded annually or more, the percentage will be 200%. If the percentage growth is between these percentages, the payment percentage will be determined on the basis of straight line interpolation. Amounts payable under the plan are payable in cash or common stock, at our election. During interim and annual periods prior to the completion of the three-year measurement period, we record compensation expense based upon the period-end stock price and estimates regarding the ultimate growth in economic value that is expected to occur. These estimates include assumed future growth rates in revenues, gross margins and other factors. If we were to use different assumptions, the estimated compensation charges could be significantly different.

 

Compensation expense of approximately $500,000 and $400,000 under the plan was recorded in general and administrative expenses for the three months ended June 30, 2006 and 2007, respectively. For the six months ended June 30, 2006 and 2007, compensation expense of approximately $900,000 and $650,000 was recorded under the plan.  As of June 30, 2007, we have accrued $1.5 million in total compensation expense under the plan.

 

Recent Accounting Pronouncements.

 

In March 2006, the Emerging Issue Task Force reached a consensus on Issue No. 06-03 How Taxes Collected from Customers and Remitted to Government Authorities Should be Presented in the Income Statement (That Is, Gross versus Net Presentation)  (“EITF No. 06-03”).  We adopted the provisions of EITF No. 06-03 beginning January 1, 2007.  The adoption of EITF No. 06-03 did not have a material impact on our consolidated financial position, results of operations or cash flows.

 

In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes — an Interpretation of FASB Statement No. 109 (“FIN 48”). FIN 48 prescribes a comprehensive model for how a company should recognize, measure, present, and disclose in its financial statements uncertain tax positions that it has taken or expects to take on a tax return.

 

We adopted the provisions of FIN 48, on January 1, 2007. As a result of a full valuation allowance, we do not have any unrecognized tax benefits and there is no effect on our financial condition or results of operations as a result of implementing FIN 48.  We are subject to audit by the IRS and various states for the prior 3 years.  We do not believe there will be any material changes in its unrecognized tax positions over the next 12 months. Our policy is that we recognize interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense. As of the date of adoption of FIN 48, we did not have any accrued interest or penalties associated with any unrecognized tax benefits, nor was any interest expense recognized during the quarter ended June 30, 2007.

 

24



 

We recognized no income tax benefit from the net loss generated in the three and six months ended June 30, 2006 and 2007.  Statement of Financial Accounting Standards (“SFAS”) No. 109,  Accounting for Income Taxes, requires that a valuation allowance be provided if it is more likely than not that some portion or all of a deferred tax asset will not be realized.  Our ability to realize the benefit of our deferred tax asset will depend on the generation of future taxable income through profitable operations.  As of June 30, 2007, we have established a full valuation allowance against our deferred tax assets.

 

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. The provisions of this standard apply to other accounting pronouncements that require or permit fair value measurements. We will adopt SFAS 157 on January 1, 2008. We anticipate that the adoption of SFAS 157 will not have a material impact on our consolidated financial statements.

 

In February 2007, the FASB issued SFAS No. 159, or SFAS 159, The Fair Value Option for Financial Assets and Financial Liabilities — including an amendment of FASB Statement No. 115 . SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. Unrealized gains and losses on items for which the fair value option has been elected will be recognized in earnings at each subsequent reporting date. SFAS No. 159 is effective for our fiscal year beginning January 1, 2008. We anticipate that the adoption of SFAS No. 159 will not have a material impact on our consolidated financial statements.

 

Results of Operations

 

The following table sets forth our results of operations expressed as a percentage of total revenue for the three and six months ended June 30, 2006 and 2007:

 

 

 

Three months ended June 30,

 

Six months ended June 30,

 

 

 

2006

 

2007

 

2006

 

2007

 

 

 

(as a percentage of total revenue)

 

Revenue

 

 

 

 

 

 

 

 

 

Direct

 

43.2

%

29.3

%

44.0

%

29.1

%

Fulfillment partner

 

56.8

 

70.7

 

56.0

 

70.9

 

Total revenue

 

100.0

 

100.0

 

100.0

 

100.0

 

Cost of goods sold

 

 

 

 

 

 

 

 

 

Direct

 

38.6

<