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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 


 

FORM 10-Q

 

(Mark One)

ý

 

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

 

 

 

 

 

 

 

 

For the quarterly period ended June 30, 2003

 

 

 

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
incorporation or organization)

 

(I.R.S.  Employer
Identification Number)

 

6322 South 3000 East, Suite 100
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 ý  No o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).

 

Yes ý  No o

 

There were 16,415,273 shares of the Registrant’s common stock, par value $0.0001, outstanding on August 11, 2003.

 

 



 

TABLE OF CONTENTS

 

 

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

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 2. Changes in Securities and the 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 and Reports on Form 8-K

 

Signature

 

i



 

PART 1. FINANCIAL INFORMATION

 

ITEM 1.  FINANCIAL STATEMENTS

 

Overstock.com, Inc.

Consolidated Balance Sheets

(in thousands)

 

 

 

December 31,
2002

 

June 30,
2003

 

 

 

 

 

(unaudited)

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

11,059

 

$

13,216

 

Marketable securities

 

21,603

 

18,448

 

Accounts receivable, net

 

6,994

 

8,220

 

Inventories, net

 

13,954

 

19,475

 

Prepaid expenses and other assets

 

2,333

 

7,500

 

 

 

 

 

 

 

Total current assets

 

55,943

 

66,859

 

 

 

 

 

 

 

Property and equipment, net

 

4,945

 

5,683

 

Goodwill

 

2,784

 

2,784

 

Other long-term assets, net

 

284

 

395

 

 

 

 

 

 

 

Total assets

 

$

63,956

 

$

75,721

 

 

 

 

 

 

 

Liabilities, Redeemable Securities and Stockholders’ Equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

13,731

 

$

7,502

 

Accrued liabilities

 

6,409

 

4,116

 

Capital lease obligations, current

 

124

 

87

 

 

 

 

 

 

 

Total current liabilities

 

20,264

 

11,705

 

Capital lease obligations, non-current

 

58

 

99

 

 

 

 

 

 

 

Total liabilities

 

20,322

 

11,804

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

Redeemable common stock, $0.0001 par value, 683 shares and 571 shares issued and outstanding as of December 31, 2002 and June 30, 2003, respectively

 

4,363

 

3,480

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Common stock, $0.0001 par value, 100,000 shares authorized, 13,866 shares and 15,867 shares issued as of December 31, 2002 and June 30, 2003, respectively

 

1

 

2

 

Additional paid-in capital

 

97,282

 

123,063

 

Accumulated deficit

 

(55,666

)

(60,898

)

Unearned stock-based compensation

 

(2,327

)

(1,654

)

Treasury stock, 35 shares at cost

 

(100

)

(100

)

Accumulated other comprehensive income

 

81

 

24

 

 

 

 

 

 

 

Total stockholders’ equity

 

39,271

 

60,437

 

 

 

 

 

 

 

Total liabilities, redeemable securities and stockholders’ equity

 

$

63,956

 

$

75,721

 

 

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

 

2



 

Overstock.com, Inc.

Consolidated Statements of Operations (unaudited)

(in thousands, except per share data)

 

 

 

Three months ended
June 30,

 

Six months ended
June 30,

 

 

 

2002

 

2003

 

2002

 

2003

 

 

 

 

 

 

 

 

 

 

 

Direct revenue

 

$

11,853

 

$

25,159

 

$

21,882

 

$

50,121

 

Commission revenue

 

2,230

 

3,431

 

3,889

 

7,397

 

Warehouse revenue

 

297

 

243

 

676

 

479

 

 

 

 

 

 

 

 

 

 

 

Total revenue

 

14,380

 

28,833

 

26,447

 

57,997

 

 

 

 

 

 

 

 

 

 

 

Cost of goods sold (1)

 

11,831

 

24,030

 

21,821

 

48,569

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

2,549

 

4,803

 

4,626

 

9,428

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Sales and marketing expenses (2)

 

1,313

 

2,572

 

2,532

 

6,420

 

General and administrative expenses (2)

 

2,195

 

3,367

 

4,997

 

7,912

 

Amortization of stock-based compensation

 

806

 

112

 

1,652

 

440

 

 

 

 

 

 

 

 

 

 

 

Total operating expenses

 

4,314

 

6,051

 

9,181

 

14,772

 

 

 

 

 

 

 

 

 

 

 

Operating loss

 

(1,765

)

(1,248

)

(4,555

)

(5,344

)

 

 

 

 

 

 

 

 

 

 

Interest income

 

49

 

142

 

71

 

294

 

Interest expense

 

(208

)

(55

)

(448

)

(62

)

Other income (expense), net

 

(442

)

25

 

(441

)

35

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

(2,366

)

(1,136

)

(5,373

)

(5,077

)

Deemed dividend related to redeemable common stock

 

(106

)

(78

)

(217

)

(155

)

Deemed dividend related to beneficial conversion feature of preferred stock

 

 

 

(6,607

)

 

 

 

 

 

 

 

 

 

 

 

Net loss attributable to common shares

 

$

(2,472

)

$

(1,214

)

$

(12,197

)

$

(5,232

)

 

 

 

 

 

 

 

 

 

 

Net loss per common share —  basic and diluted

 

$

(0.20

)

$

(0.07

)

$

(1.04

)

$

(0.33

)

Weighted average common shares outstanding — basic and diluted

 

12,280

 

16,384

 

11,728

 

15,938

 


(1) Amounts include stock-based compensation of:

 

$

96

 

$

13

 

$

199

 

$

52

 

 

 

 

 

 

 

 

 

 

 

(2) Amounts exclude stock-based compensation as follows:

 

 

 

 

 

 

 

 

 

Sales and marketing expenses

 

$

21

 

$

109

 

$

43

 

$

426

 

General and administrative expenses

 

785

 

3

 

1,609

 

14

 

 

 

 

 

 

 

 

 

 

 

 

 

$

806

 

$

112

 

$

1,652

 

$

440

 

 

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

 

3



 

Overstock.com, Inc.

Consolidated Statements of Cash Flows (unaudited)

(in thousands)

 

 

 

Six months ended
June 30,

 

 

 

2002

 

2003

 

Cash flows from operating activities:

 

 

 

 

 

Net loss

 

$

(5,373

)

$

(5,077

)

Adjustments to reconcile net loss to net cash used in operating activities:

 

 

 

 

 

Depreciation and amortization

 

937

 

1,018

 

Amortization of unearned stock-based compensation

 

1,851

 

492

 

Realized gain from marketable securities

 

 

(11

)

Stock options issued to consultants for services

 

38

 

151

 

Stock issued to employees

 

226

 

21

 

Amortization of debt discount

 

242

 

 

Selling shareholder fees

 

439

 

 

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts receivable, net

 

(477

)

(1,226

)

Inventories, net

 

(1,190

)

(5,521

)

Prepaid expenses and other assets

 

(1,500

) 

(5,167

)

Other long-term assets, net

 

45

 

(126

 )

Accounts payable

 

202

 

(6,229

 )

Accrued liabilities

 

(274

)

(2,293

)

 

 

 

 

 

 

Net cash used in operating activities

 

(4,834

)

(23,968

)

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Investments in marketable securities

 

 

(27,016

)

Sales of marketable securities

 

 

30,125

 

Expenditures for property and equipment

 

(731

)

(1,700

)

 

 

 

 

 

 

Net cash (used in) provided by investing activities

 

(731

)

1,409

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Payments on capital lease obligations

 

(144

)

(37

)

Payments on note payable

 

(4,500

)

 

Issuance of redeemable preferred stock

 

6,582

 

 

Issuance of common stock, net of issuance costs

 

27,522

 

23,968

 

Issuance of common stock and redeemable common stock

 

31

 

 

Payment of selling shareholder fees

 

(439

)

 

Exercise of stock options and warrants

 

51

 

785

 

 

 

 

 

 

 

Net cash provided by financing activities

 

29,103

 

24,716

 

 

 

 

 

 

 

Net (decrease) increase in cash and cash equivalents

 

23,538

 

2,157

 

 

 

 

 

 

 

Cash and cash equivalents, beginning of period

 

3,729

 

11,059

 

 

 

 

 

 

 

Cash and cash equivalents, end of period

 

$

27,267

 

$

13,216

 

 

 

 

 

 

 

Supplemental disclosures of cash flow information:

 

 

 

 

 

Interest paid

 

$

201

 

$

37

 

Deemed dividend for beneficial conversion feature

 

$

6,607

 

 

 

Deemed dividend on redeemable common stock

 

$

217

 

$

155

 

Lapse of rescission rights on redeemable common stock

 

$

586

 

$

1,038

 

 

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

 

4



 

Overstock.com, Inc.

Notes to Unaudited Consolidated Financial Statements

(amounts in thousands, except per share data)

 

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 Registration Statement on Form S-1 filed on February 12, 2003 with the Securities and Exchange Commission.  The accompanying unaudited consolidated financial statements reflect all adjustments, which are, in the opinion of management, necessary for a fair presentation 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 months and six months ended June 30, 2003 are not necessarily indicative of the results to be expected for any future period or the full fiscal year.

 

2. 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, 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 is 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 totaled $943 and $2,182 during the three months ended June 30, 2002 and 2003, respectively, and $1,593 and $5,691 for the six months ended June 30, 2002 and 2003, respectively.

 

3. MARKETABLE SECURITIES

 

The Company’s marketable securities consist of funds deposited into a capital management account managed by a financial institution.  The financial institution has invested these funds in municipal, government, and corporate bonds at June 30, 2003, as follows:

 

 

 

Cost Basis

 

Unrealized
Gains

 

Unrealized
Losses

 

FairValue

 

 

 

 

 

 

 

 

 

 

 

U.S. government and government agency securities

 

$

14,815

 

$

27

 

$

 

$

14,842

 

Asset-backed and agency securities

 

98

 

 

(1

)

97

 

Corporate securities

 

1,818

 

4

 

 

1,822

 

Money market securities

 

446

 

1

 

 

447

 

Mortgage based securities

 

1,247

 

 

(7

 )

1,240

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

18,424

 

$

32

 

$

(8

)

$

18,448

 

 

All marketable securities mature between 2003 and 2005.

 

5



 

4. SALE OF SERIES A PREFERRED STOCK

 

In March 2002, the Company sold approximately 959 shares of mandatorily redeemable convertible preferred stock (“preferred stock”) for approximately $6,582, net of issuance costs.  The preferred stock automatically converted to common stock on a 1:1 basis in connection with the initial public offering (see Note 8).  As the fair value of the common stock to be received upon conversion was greater than the conversion price of the preferred stock at the date the preferred stock was issued, a beneficial conversion feature resulted in the amount of $6,607, which was calculated in accordance with Emerging Issues Task Force No. 98-5 “Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios.” This beneficial conversion feature is reflected as a deemed dividend in the statement of operations.  Of the total deemed dividend recorded, $1,000 is attributable to preferred shares purchased by Haverford Internet, LLC, a related party controlled by the Company’s CEO, and $1,200 is attributable to preferred shares purchased by members of the board of directors.

 

5. OTHER COMPREHENSIVE LOSS

 

The Company follows SFAS 130, Reporting Comprehensive Income.  This Statement establishes requirements for reporting comprehensive income and its components which includes the Company’s unrealized gain on marketable securities.  The Company’s comprehensive loss for the three months ended June 30, 2002 and 2003 is as follows:

 

 

 

Three months ended June 30,

 

Six months ended June 30,

 

 

 

2002

 

2003

 

2002

 

2003

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

$

(2,366

)

$

(1,136

)

$

(5,373

)

$

(5,077

)

Realized gain on marketable securities

 

 

(7

)

 

(11

)

Unrealized loss on marketable securities

 

 

(19

)

 

(46

)

 

 

 

 

 

 

 

 

 

 

Comprehensive loss

 

$

(2,366

)

$

(1,162

)

$

(5,373

)

$

(5,134

)

 

 

6. NET LOSS PER SHARE

 

Basic net loss per share is computed by dividing the net loss attributable to common shares for the period by the weighted average number of common shares outstanding during the period.  Diluted net loss per share is computed by dividing the net 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 and warrants, are included in the calculation of diluted net loss per share to the extent such shares are dilutive.  During the three and six month-periods ended June 30, 2002 and 2003, the effects of outstanding stock options were antidilutive and, accordingly, have been excluded from diluted loss per share.  There were 1,516 options and 1,102 warrants outstanding at June 30, 2003.

 

7. BUSINESS SEGMENTS

 

Segment information has been prepared in accordance with Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 131, “Disclosures about Segments of an Enterprise and Related Information.”  There were no inter-segment sales or transfers during the three months ended June 30, 2002 or 2003.  The Company evaluates the performance of its segments and allocates resources

 

6



 

to them based primarily on gross profit. The table below summarizes information about reportable segments for the three and six months ended June 30, 2002 and 2003:

 

 

 

Three months ended June 30,

 

Six months ended June 30,

 

 

 

Direct
operations

 

Commission
operations

 

Warehouse
operations

 

Consolidated

 

Direct
operations

 

Commission
operations

 

Warehouse
operations

 

Consolidated

 

2002

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

 11,853

 

$

 2,230

 

$

 297

 

$

 14,380

 

$

 21,882

 

$

 3,889

 

$

 676

 

$

 26,447

 

Cost of goods sold

 

10,714

 

516

 

601

 

11,831

 

19,912

 

948

 

961

 

21,821

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

$

 1,139

 

$

 1,714

 

$

 (304

)

2,549

 

$

 1,970

 

$

 2,941

 

$

 (285

)

4,626

 

Operating expenses

 

 

 

 

 

 

 

(4,314

)

 

 

 

 

 

 

(9,181

)

Other income (expense), net

 

 

 

 

 

 

 

(601

)

 

 

 

 

 

 

(818

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

 

 

 

 

 

 

$

 (2,366

)

 

 

 

 

 

 

$

 (5,373

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2003

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

 25,159

 

$

 3,431

 

$

 243

 

$

 28,833

 

$

 50,121

 

$

 7,397

 

$

 479

 

$

 57,997

 

Cost of goods sold

 

22,836

 

1,016

 

178

 

24,030

 

46,144

 

2,071

 

354

 

48,569

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

$

 2,323

 

$

 2,415

 

$

 65

 

4,803

 

$

 3,977

 

$

 5,326

 

$

 125

 

9,428

 

Operating expenses

 

 

 

 

 

 

 

(6,051

)

 

 

 

 

 

 

(14,772

)

Other income (expense), net

 

 

 

 

 

 

 

112

 

 

 

 

 

 

 

267

 

Net loss

 

 

 

 

 

 

 

$

 (1,136

)

 

 

 

 

 

 

$

 (5,077

 

 

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

 

The commission segment includes revenues, direct costs and cost allocations associated with the Company’s commission-based third party commission sales and are earned from selling the merchandise of third parties over the Company’s Websites.  Costs for this segment include credit card fees and customer service costs.

 

The warehouse segment includes revenues, direct costs and cost allocations associated with sales made to individual consumers at the Company’s warehouse store.  Costs for this segment include product costs, warehousing and credit card fees.

 

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

 

During the three and six month periods ended June 30, 2003 and 2002, virtually all sales were made to customers in the United States of America.  No individual geographical area accounted for more than 10% of net sales in any of the periods presented.  At June 30, 2003, all of the Company’s fixed assets were located in the United States of America.

 

8. PUBLIC OFFERINGS

 

On June 4, 2002, the Company closed its initial public offering, pursuant to which it sold 2,155 shares of common stock, and a selling shareholder sold 845 shares of common stock in an initial public

 

7



 

offering, with proceeds to the Company of approximately $24,880, net of $2,014 of issuance costs.  As part of the offering, the Company granted the underwriter the right to purchase up to 450 additional shares within thirty days after the offering to cover any over-allotments.  On June 27, 2002, the underwriter exercised its right and purchased an additional 101 shares of stock for $1,260.

 

In February 2003, the Company closed its follow-on public offering, pursuant to which it sold 1,725 shares of common stock, with proceeds to the Company of approximately $23,968, net of $613 of issuance costs.  The number of shares issued includes 225 additional shares which the Company granted the underwriter the right to purchase to cover any over-allotments.

 

9. STOCK-BASED COMPENSATION

 

The Company measures compensation expense to employees for its equity incentive plan using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and provides pro forma disclosures of net income as if the fair value based method prescribed by Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, had been applied.  The following table provides a reconciliation of net loss to pro forma net loss as if the fair value method had been applied to all awards.

 

 

 

Quarted ended June 30,

 

Six months ended June 30,

 

 

 

2002

 

2003

 

2002

 

2003

 

 

 

 

 

 

 

 

 

 

 

Net loss, as reported

 

$

(2,366

)

$

(1,136

)

$

(5,373

)

$

(5,077

)

Add:  Stock-based employee compensation expense included in reported net income net of related tax effects

 

968

 

125

 

2,077

 

513

 

Deduct:  Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects

 

(1,167

)

(536

)

(2,428

)

(1,342

)

 

 

 

 

 

 

 

 

 

 

Pro forma net loss

 

$

(2,565

)

$

(1,547

)

$

(5,724

)

$

(5,906

)

 

 

 

 

 

 

 

 

 

 

Net loss per common share

 

 

 

 

 

 

 

 

 

Basic and diluted - as reported

 

$

(0.20

)

$

(0.07

)

$

(1.04

)

$

(0.33

)

Basic and diluted - pro forma

 

$

(0.22

)

$

(0.10

)

$

(1.07

)

$

(0.38

)

 

 

10. COMMITMENTS AND CONTINGENCIES

 

The Company is subject to various legal proceedings and claims that arise in the ordinary course of business.  In February 2002, Microsoft Corporation filed a complaint against the Company alleging that the Company had distributed counterfeit and otherwise unauthorized Microsoft software in violation of federal copyright and trademark law and related state laws.  Effective April 18, 2003, the Company entered a settlement agreement with Microsoft that settled and resolved all claims between the companies.  Company management currently believes that resolution of its outstanding legal matters will not have a material adverse impact on the Company’s financial position, results of operations or cash flows.

 

11. 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

 

8



 

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 recourse to any claims arising from these indemnifications.

 

9



 

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 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 commission 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 belief 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 the B2B liquidation market and other markets, including international markets; our beliefs and intentions about entering into agreements to provide products and services to retail chains, including Safeway, and other businesses; development of new Websites; our beliefs, intentions and expectations regarding promotion of new or complimentary product and sales formats; our belief, 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; our beliefs about provisions in our charter documents and Delaware law; 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 differ materially. For a detailed discussion of these risks and uncertainties please see the “Factors That May Affect Future Results” section of this report. These forward-looking statements speak only as of the date that 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.

 

Overview

 

Overstock.com offers discount brand name merchandise, including bed-and-bath goods, kitchenware, watches, jewelry, electronics, sporting goods, media, clothing and designer accessories.  Our company is based in Salt Lake City, Utah, and was founded in 1997.

 

Our revenue is comprised of direct revenue, commission revenue and warehouse revenue.  Direct revenue includes sales made to individual consumers and businesses (B2C), which are fulfilled from our warehouse in Salt Lake City, Utah.  Business-to-business (B2B) sales are generated when we contact retailers and offer them our merchandise below wholesale prices.  After relationships are established with a B2B client, the client sometimes places subsequent orders directly through our B2B Website.  Our B2B calling effort began in October 2001, so our historical direct revenue has predominantly been based on individual consumer purchases made directly through our consumer Website.  In February 2002, we implemented a policy intended to reduce the number of returned products.  This new policy provides that we will not accept product returns initiated more than fifteen days after purchase.

 

Our commission revenue is derived from two sources, consumer commission revenue and B2B commission revenue.  Consumer commission revenue is generated when we receive commissions for selling the merchandise of other retailers, cataloguers or manufacturers (“fulfillment partners”) through our consumer Website.  We do not own or physically handle the merchandise for these transactions, as the entities with which we have a commission-based, third party relationship ship the products directly to the end customer.  Similar to the

 

10



 

manner in which we generate consumer commission revenue, we generate B2B commission revenue when we receive commissions for selling the merchandise of third parties through our B2B Website.

 

Beginning July 1, 2003, we changed our customer service and return policies and procedures related to sales transactions from our fulfillment partners to improve the overall shopping experience for our customers.  All customer returns will now be handled through our Salt Lake City warehouse, and the reselling of these returned products will be fulfilled through our warehouse (historically, these fulfillment partners handled their respective returns).  As a result of these changes, beginning July 1, 2003, we will be considered the primary obligor for these sales transactions and will assume risk of loss on returned inventory.  Therefore, we will record revenue from sales transactions from our fulfillment partners on a gross basis, instead of net (historically, only the net commission of the sales transaction was recorded as revenue).

 

Both direct and commission revenue 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.  With the exception of our acquisition of Gear.com in November 2000, we have achieved our historical growth from internal operations.

 

Our warehouse revenue is derived from sales that liquidate products that cannot be economically sold on our Websites due to their low price points, bulk, irregular size or other factors.  Historically, we held our warehouse sales in various physical locations.  Currently, we operate a warehouse store in our Salt Lake City warehouse facility for customers to buy certain products directly.  Sales from our warehouse store in 2002 accounted for less than 2% of total revenue.  We do not anticipate revenue from our warehouse store for 2003 to be more than 2% of total revenue.

 

Cost of goods sold for direct revenue primarily consists of the cost of the product, as well as inbound and outbound freight, fixed warehouse costs, warehouse handling costs, credit card fees, and customer service costs.  For commission revenue, cost of goods sold includes credit card fees and customer service costs.  As commission revenue grows in relation to direct revenue, gross margins improve because third party commissions have higher gross margins than direct sales.  However, B2B gross margins are typically less than individual consumer gross margins.  Therefore, future overall gross margins will be impacted by the blend of net revenues from these sales channels.  Cost of goods sold also includes stock-based compensation for customer service and warehouse-related personnel for each period.

 

Due to the change in the recording of revenue generated from sales transactions from our fulfillment partners described above (recorded gross instead of net), beginning July 1, 2003, we anticipate that gross margins on these sales will more closely resemble the gross margins we receive from our direct revenue.  Cost of goods sold on future sales transactions from our fulfillment partners will include the cost of the product, outbound freight, warehouse handling costs, credit card fees and customer service costs.  Therefore, we anticipate that overall blended gross margins going forward will be significantly lower than they have historically been.  Gross profit dollars generated from these sales, however, will be unaffected by this change.

 

Sales and marketing expenses consist primarily of advertising, public relations and promotional expenditures, as well as payroll and related expenses 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.  For example, our advertising expense totaled approximately $943,000 and $2.2 million during the three months ended June 30, 2002 and 2003, respectively, and $1.6 million and $5.7 million during the six months ending the same dates.  Sales and marketing expenses will change in future periods on an absolute dollar basis in relation to the extent of our online marketing efforts.

 

General and administrative expenses consist of payroll and related expenses for executive, accounting, legal, technical support and administrative personnel, professional fees, rents and utilities, travel and entertainment, depreciation and amortization and other general corporate expenses.

 

11



 

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.

 

During the six months ended June 30, 2002, we recorded a deemed dividend of $6.6 million representing the beneficial conversion feature related to the issuance of 958,612 shares of Series A preferred stock.  The amount of the beneficial conversion feature was established at the date of issuance resulting from the difference between the sales price of $6.89 per share, which is also the conversion price since the shares of Series A preferred stock when issued were immediately convertible into shares of common stock on a one-to-one basis, and the deemed fair value of common shares of $14.00 per share on the date of issuance.  The difference of $7.11 per share of Series A preferred stock, or $6.8 million, would normally be the beneficial conversion feature, except that Emerging Issues Task Force Issue No. 98-5, “Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios,” limits the total amount of the beneficial conversion feature to the $6.6 million of proceeds from the sale of the 958,612 shares of Series A preferred stock.

 

Critical Accounting Policies

 

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.  The following critical accounting policies are significantly affected by judgments, assumptions and estimates used in the preparation of our consolidated financial statements:

 

      revenue recognition;

 

      estimating valuation allowances and accrued liabilities, specifically, the reserve for returns and the allowance for obsolete and damaged inventory;

 

      accounting for income taxes; and

 

      valuation of long-lived and intangible assets and goodwill.

 

Revenue recognition.  We derive our revenue from three sources:  (i) direct revenue, which consist of individual sales made to consumers and businesses; (ii) revenue generated through fulfillment partners, which includes consumer commission revenue and B2B commission revenue; and (iii) warehouse revenue, derived from liquidation sales of residual products from large bulk purchases of inventory.  Both direct revenue and commission revenue are recorded net of returns as well as coupons redeemed by customers, and other discounts.  For commission revenue, we only recognize the commission portion of the sale of merchandise owned by third parties, because we are acting as an agent in such transactions.  As described below, significant management judgments and estimates must be made and used in connection with the revenue recognized in any accounting period.

 

For sales transactions, we comply with the provisions of Staff Accounting Bulletin 101 “Revenue Recognition” which states that revenue should be recognized when the following four revenue recognition criteria are met:  (1) persuasive evidence of an arrangements exists; (2) the product has been shipped and the customer takes ownership and assumes the risk 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.  Any amounts received prior to when we ship the goods to customers are deferred.

 

12



 

We evaluate the criteria outlined in Emerging Issues Task Force (“EITF”) Issue No. 99-19, “Reporting Revenue Gross as a Principal Versus Net as an Agent,” in determining whether it is appropriate to record the gross amount of product sales and related costs or the net amount earned as commissions.  Generally, when we are the primary obligor in a transaction, are subject to inventory risk, have latitude in establishing prices and selecting suppliers, or have several but not all of these indicators, revenue is recorded gross as a principal.  If we are not the primary obligor and amounts earned are determined using a fixed percentage, a fixed-payment schedule, or a combination of the two, we generally record the net amounts as commissions earned.

 

Beginning July 1, 2003, we changed our customer service and return policies and procedures related to sales transactions from our fulfillment partners to improve the overall shopping experience for our customers.  All customer returns will now be handled through our Salt Lake City warehouse, and the reselling of these returned products will be fulfilled through our warehouse (historically, these fulfillment partners handled their respective returns).  As a result of these changes, beginning July 1, 2003, we will be considered the primary obligor for these sales transactions and will assume risk of loss on returned inventory.  Therefore, we will record revenue from sales transactions from our fulfillment partners on a gross basis, instead of net (historically, only the net commission of the sales transaction was recorded as revenue).

 

Reserve for returns and the allowance 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 and other allowances in any accounting period.  The reserve for returns was $410,000 at June 30, 2003.

 

Overstock writes down its 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.  Our inventory balance was $19.5 million, net of allowance for obsolescence or damaged inventory of $1.0 million as of June 30, 2003.  If we underestimate our reserves or allowances, our gross margins, and net income, if any, will be overstated (or our net loss, if any, will be understated).  Contrarily, if we overstate our reserves or allowances, our gross margins and net income, if any, will be understated (or our net loss, if any, will be overstated).

 

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 June 30, 2003, we have recorded a full valuation allowance of $23.2 million 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.  Effective January 1, 2002, we adopted SFAS No. 142 Goodwill and Other Intangible Assets. Under this standard, goodwill is no longer 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.  There were no impairments of goodwill or long-lived assets during 2002 or 2003.  Net intangible assets, long-lived assets and goodwill amounted to $3.2 million as of June 30, 2003.  We evaluated our intangible assets and determined that all such assets other than goodwill have determinable lives.

 

13



 

Results of Operations — 2003 compared to 2002

 

Revenue

 

Total revenue was $28.8 million for the three-month period ended June 30, 2003, a 101% increase from the $14.4 million recorded in the same period in 2002.  For the six-month period ended June 30, 2003, total revenue increased to $58.0 million from $26.4 million, a 119% increase.  The increase in total revenue was primarily a result of the growth of our B2C business as our customer base continues to expand from increased marketing efforts, increased sales to other businesses, including Safeway, Inc, as well as an increase in the number of both direct and commission orders.  Gross merchandise sales totaled $51.3 million and $26.5 million for the three-month periods ended June 30, 2003 and 2002, respectively, representing an increase of 94%.  For the six-month period ended June 30, 2003, gross merchandise sales increased to $103.6 million from $48.5 million, a 114% increase.  Gross merchandise sales differ from revenue reported under generally accepted accounting principles (“GAAP”) in that gross merchandise sales represent the gross sales price of goods sold by the Company, including those sales for which the Company only reports a commission under GAAP.

 

Reconciliation of total revenue (GAAP) to gross merchandise sales (non-GAAP)

 

 

 

 

Three months ended June 30,

 

Six months ended June 30,

 

 

 

2002

 

2003

 

2002

 

2003

 

 

 

 

 

 

 

 

 

 

 

Total revenue

 

$

14,380

 

$

28,833

 

$

26,447

 

$

57,997

 

Add:  Obligations payable to third parties upon sale of third-party merchandise

 

9,474

 

19,399

 

16,505

 

39,926

 

Add:  Sales returns and discounts

 

2,651

 

3,083

 

5,542

 

5,662

 

 

 

 

 

 

 

 

 

 

 

Gross merchandise sales (non-GAAP)

 

$

26,505

 

$

51,315

 

$

48,494

 

$

103,585

 

 

Direct revenue increased from $11.9 million for the three months ended June 30, 2002 to $25.2 million for the three months ended June 30, 2003, a growth of 112%.  Direct revenue also increased 129% from $21.9 million for the six months ended June 30, 2002 to $50.1 million for the six months ended June 30, 2003.  This increase is primarily due to the increase in the number of our B2C orders enhanced by B2C marketing efforts and progressive growth in our B2B business.

 

Revenue for our commission-based operations was $3.4 million and $2.2 million for the three months ended June 30, 2003 and 2002, respectively, representing growth of 54%.  The slowing of growth in commission-based revenue over the prior year quarter is due primarily to an increase in sales of media products (which include books, music, videos and other similar products) as a percentage of total commission-based sales, as media sales have historically had much lower commissions than other product categories.  For the six months ended June 30, 2003 and 2002, commission-based revenue was $7.4 million and $3.9 million, respectively, representing growth of 90%.  The overall six-month growth was due to an increase in the number of commission-based products offered for sale on our Websites as a percent of the total product selection and increased marketing efforts.

 

Beginning July 1, 2003, we changed our customer service and return policies and procedures related to sales transactions from our fulfillment partners to improve the overall shopping experience for our customers.  All customer returns will now be handled through our Salt Lake City warehouse, and the reselling of these returned products will be fulfilled through our warehouse (historically, these fulfillment partners handled their respective returns).  As a result of these changes, beginning July 1, 2003, we will be considered the primary obligor for these sales transactions and will assume risk of loss on returned inventory.  Therefore, we will record revenue from sales transactions from our fulfillment partners on a

 

14



 

gross basis, instead of net (historically, only the net commission of the sales transaction was recorded as revenue).

 

We recorded warehouse revenue of $243,000 during the second quarter of 2003 compared to warehouse revenue of $297,000 for the same period in 2002.  For the six-month periods ended June 30, 2003 and 2002, we recorded warehouse revenue of $479,000 and $676,000, respectively.  For the warehouse sale in 2002, we liquidated the remnants of the Gear.com inventory during the latter end of the first quarter and the first part of the second quarter of 2002.  Warehouse revenue in 2003 reflects the sales from our permanent warehouse store at our warehouse facility in Salt Lake City.

 

Cost of goods sold

 

Cost of goods sold was $24.0 million or 83% of total revenue for the second quarter of 2003, compared to $11.8 million, or 82% of total revenue during the second quarter of 2002.  This correlates to gross margins of 17% and 18% for the three months ended June 30, 2003 and 2002, respectively.  Cost of goods sold also includes stock-based compensation of $13,000 and $96,000 for the three months ended June 30, 2003 and 2002, respectively.  For the six months ended June 30, 2003 and 2002, cost of goods sold totaled $48.6 million and 21.8 million, representing gross margins of 16% and 17%, respectively.  Gross profits for our direct operations increased to $2.3 million and $4.0 million, from $1.1 million and $2.0 million, for the three and six months ended June 30, 2003 and 2002, respectively.  Gross profits for our direct operations as a percentage of direct revenue decreased from 10% for the quarter ended June 30, 2002 to 9% for the quarter ended June 30, 2003 and 9% for the six months ended June 30, 2002 to 8% for the six months ended June 30, 2003.  Our commission operations generated gross profits of $2.4 million (70% margins) and $1.7 million (77% margins) for the three months ended June 30, 2003 and 2002, respectively.  For the six months ended June 30, 2003 and 2002, our commission-based operations generated gross profits of $5.3 million (72% margins) and $2.9 million (76% margins), respectively.

 

For both our direct and commission operations, the increase in cost of goods sold as a percentage of total revenue, and the resulting decrease in gross margins, are primarily a result of the growth of our media business which has lower margins than other product offerings.  In addition, during the last half of the first quarter of 2003, consumer spending behavior changed, and in an effort to maintain sales momentum, we lowered prices which also led to lower margins.

 

Due to the change in the recording of revenue generated from sales transactions from our fulfillment partners described above (recorded gross instead of net), beginning July 1, 2003, we anticipate that gross margins on these sales will more closely resemble the gross margins we receive from our direct revenue.  Cost of goods sold on future sales transactions from our fulfillment partners will include the cost of the product, outbound freight, warehouse handling costs, credit card fees and customer service costs.  Therefore, we anticipate that overall blended gross margins going forward will be significantly lower than they have historically been.  Gross profit dollars generated from these sales, however, will be unaffected by this change.

 

Operating expenses

 

Sales and marketing.  Sales and marketing expenses were $2.6 million and $1.3 million, representing 9% of total revenue for the three months ended June 30, 2003 and 2002, respectively.  For the six months ended June 30, 2003 and 2002, sales and marketing expenses totaled $6.4 million and $2.5 million, respectively, representing 11% and 10% for the corresponding periods.  The increased marketing dollars reflects increased online marketing efforts.  The increase in sales and marketing expense as a percentage of total revenue is primarily a reflection of advertising programs that became less effective during the first quarter of 2003, as vendors made changes that reduced the value of their advertising product.  We expect total marketing expenses to continue to increase in the future as a result of the expenses related to online marketing agreements that we have recently entered into and similar online or offline branding agreements that we may enter into in the future.

 

15



 

General and administrative.  General and administrative expenses were $3.4 million and $2.2 million for the three months ended June 30, 2003 and 2002, respectively, representing 12% and 15% of total revenue for the corresponding periods.  Included in general and administrative expenses are insurance proceeds received in the second quarter relating to the settlement of litigation with Microsoft that occurred in the first quarter of 2003.  For the six months ended June 30, 2003 and 2002, general and administrative expenses totaled $7.9 million and $5.0 million, respectively, representing 14% and 19% for the corresponding periods.  The increase in absolute dollars of general and administrative costs for each comparative period is primarily attributable to additional infrastructure, costs associated with our experimental relationship with a refurbishing company, and increased personnel costs from increased headcount as well as legal expenses that included the settlement of the Microsoft litigation offset by insurance proceeds received relating to this settlement.

 

Amortization of stock-based compensation.  Prior to the Company’s initial public offering in May 2002, the Company recorded unearned stock-based compensation related to stock options granted below the fair market value of the underlying stock.  Since the initial public offering, the Company has not granted any additional stock options below fair market value.  Amortization of stock-based compensation was approximately $112,000 and $806,000 for the three months ended June 30, 2003 and 2002, respectively and $440,000 and $1.7 million for the six months ended June 30, 2003 and 2002, respectively.

 

Non-operating income

 

Interest income was $142,000 during the quarter ended June 30, 2003 versus $49,000 during the quarter ended June 30, 2002.  For the six-month period ended June 30, 2003, interest income was $294,000 compared to $71,000 recorded in the same period in 2002.  The increase in interest income resulted from our increased cash and cash equivalents and marketable securities received from our public offerings.  Interest expense decreased from $208,000 to $55,000 for the quarters ended June 30, 2002 and 2003, respectively.  Interest expense also decreased from $448,000 for the six-month period ended June 30, 2002 to $62,000 recorded in the same period of 2003.  Interest expense decreased as a result of our debt elimination.  Other income (expense), net resulted in the recognition of income of $25,000 for the quarter ended June 30, 2003 and expense of $442,000 for the quarter ended June 30, 2002.  For the six-month periods ended June 30, 2003 and 2002, other income (expense), net resulted in income of $35,000 and expense of $441,000, respectively.

 

We incurred net operating losses during the quarters ended June 30, 2003 and 2002, and consequently paid insignificant amounts of federal, state and foreign income taxes.  As of June 30, 2003, we had $43.2 million of net operating loss carryforwards, of which $14.4 million is subject to limitation.  These net operating loss carryforwards will begin to expire in 2019.

 

Recent Accounting Pronouncements

 

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities” (“SFAS 149”).  SFAS No. 149 amends and clarifies the accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” SFAS No. 149 is generally effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003.  The adoption of this statement is not expected to have a material impact on the Company’s financial condition or results of operations.

 

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity” (“SFAS 150”).  SFAS 150 establishes standards on the classification and measurement of certain financial instruments with characteristics of both liabilities and equity.  The provisions of SFAS 150 are effective for financial instruments entered into or modified after May 31, 2003 and to all other instruments that exist as of the beginning of the first interim financial reporting period beginning after June 15, 2003.  The Company is currently evaluating the effects this statement may have on its financial statements.

 

16



Seasonality

 

Financial results for Internet retailers are generally seasonal.  Based upon the Company’s historical experience, increased revenues typically occur during the fourth quarter because of the Christmas retail season.  The actual quarterly results for each quarter could differ materially depending upon consumer preferences, availability of product and competition, among other risks and uncertainties.  Accordingly, there can be no assurances that seasonal variations will not materially affect the Company’s results of operations in the future.  The following table reflects the Company’s revenues for each of the quarters available since 2000 (in thousands):

 

 

 

First
Quarter

 

Second
Quarter

 

Third
Quarter

 

Fourth
Quarter

 

 

 

 

 

 

 

 

 

 

 

2003

 

$

29,164

 

$

28,833

 

 

N/A

 

 

N/A

 

 

 

 

 

 

 

 

 

 

 

2002

 

12,067

 

14,380

 

$

 23,808

 

$

 41,529

 

 

 

 

 

 

 

 

 

 

 

2001

 

9,578

 

7,407

 

8,744

 

14,274

 

 

 

 

 

 

 

 

 

 

 

2000

 

2,257

 

3,795

 

4,339

 

15,132

 

 

Liquidity and Capital Resources

 

Prior to the second quarter of 2002, we financed our activities primarily through a series of private sales of equity securities, warrants to purchase our common stock and promissory notes.  During the second quarter of 2002, we completed our initial public offering pursuant to which we received approximately $26.1 million in cash, net of underwriting discounts, commissions, and other related expenses.  Additionally, in February 2003, we completed our follow-on offering pursuant to which we received approximately $24.0 million in cash, net of underwriting discounts, commissions, and other related expenses.  Our cash and cash equivalents balance was $13.2 million at June 30, 2003.  We also had marketable securities of $18.4 million at June 30, 2003.

 

Our operating activities resulted in net cash outflows of $24.0 million and $4.8 million for the six months ended June 30, 2003 and 2002, respectively.  The primary use of cash and cash equivalents during the six months ended June 30, 2003 was to fund our normal operations, including net losses, and changes in accounts receivable, inventories, prepaid assets, accounts payable and accrued liabilities.

 

Cash used in investing activities included expenditures for property and equipment and investments in marketable securities, offset by sales of marketable securities.  During the six months ended June 30, 2003 and 2002 cash provided by (used in) investing activities amounted to $1.4 million and $(731,000), respectively.

 

Net cash provided by financing activities during the six months ended June 30, 2003 was $24.7 million, consisting primarily of net proceeds of $24.0 million received from our follow-on public offering which occurred in February 2003 and approximately $785,000 received from the exercise of stock options and warrants.  Net cash provided by financing activities during the six months ended June 30, 2002 was $29.1 million, consisting primarily of proceeds from our initial public offering in May 2002 and the issuance of preferred stock in March 2002, offset by the repayment of $4.5 million of notes payable.  On March 4, 2002, we sold 958,612 shares of our Series A redeemable, convertible, preferred stock at $6.89 per share for $6.6 million, net of issuance costs.  As the fair value of the common stock to be received upon conversion of the preferred stock was greater than the conversion price of the preferred stock at the date the preferred stock was issued, a beneficial conversion feature resulted in a non-cash charge of approximately $6.6 million which was recorded in the first quarter of 2002.  This non-cash charge was recorded as a deemed dividend, of which $3.7 million is attributable to shares sold to the following related parties;

 

17



 

John J. Byrne Jr., a former director of Overstock; Contex Limited, an entity controlled by Mark Byrne, a brother of Patrick M. Byrne; Haverford Internet LLC, an entity controlled by Patrick M. Byrne; The Gordon S. Macklin Family Trust, a trust controlled by a director of Overstock; and Rope Ferry Associates, Ltd., an entity owned by John J. Byrne III and Dorothy M. Byrne, the brother and mother of Patrick M. Byrne.  The remaining purchasers of our Series A preferred stock are unrelated parties that are friends and acquaintances of our officers and directors.

 

Contractual Obligations and Commitments.  The following table summarizes our contractual obligations as of June 30, 2003 and the effect such obligations and commitments are expected to have on our liquidity and cash flow in future periods:

 

 

 

Payments Due by Period
(in thousands)

 

Contractual Obligations

 

Total

 

Less than 1
Year

 

1-3 Years

 

4-5 Years

 

After
5 years

 

Long-term debt arrangements

 

$

 

$

 

$

 

$

 

$

 

Capital lease obligations

 

186

 

87

 

63

 

36

 

 

Operating leases

 

4,265

 

1,536

 

2,303

 

426

 

 

Total contractual cash obligations

 

$

4,451

 

$

1,623

 

$

2,366

 

$

462

 

$

 

 

 

 

Amounts of Commitment Expiration Per Period
(in thousands)

 

Other Commercial Commitments

 

Total
Amounts
Committed

 

Less than 1
Year

 

1-3 Years

 

4-5 Years

 

Over
5 years

 

Lines of credit

 

$

 

$

 

$

 

$

 

$

 

Redeemable common stock

 

3,480

 

596

 

881

 

2,003

 

 

Total commercial commitments

 

$

3,480

 

$

596

 

$

881

 

$

2,003

 

$

 

 

15

 

The estimated amount of redeemable common stock is based solely on the statute of limitations of the various states in which stockholders may have rescission rights and may not reflect the actual results.  We do not have any unconditional purchase obligations, other long-term obligations, guarantees, standby repurchase obligations or other commercial commitments.

 

We believe that the cash and marketable securities currently on hand will be sufficient to continue operations for at least the next twelve months.  While we anticipate that, beyond the next twelve months, our cash flows from operations will be sufficient to fund our operational requirements, we may require additional financing.  However, there can be no assurance that if additional financing is necessary it will be available, or, if available, that such financing can be obtained on satisfactory terms.  Failure to generate sufficient revenues or raise additional capital could have a material adverse effect on our ability to continue as a going concern and to achieve our intended business objectives.  Any projections of future cash needs and cash flows are subject to substantial uncertainty.  See “Factors that May Affect Future Results.”

 

Factors That May Affect Future Results

 

Any investment in our common stock involves a high degree of risk.  Investors should consider carefully the risks and uncertainties described below, and all other information in this Form 10-Q and in any reports we file with the SEC after we file this Form 10-Q, before deciding whether to purchase or hold

 

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our common stock. Additional risks and uncertainties not currently known to us or that we currently deem immaterial may also become important factors that may harm our business. The occurrence of any of the following risks could harm our business. The trading price of our common stock could decline due to any of these risks and uncertainties, and investors may lose part or all of their investment.

 

Risks Relating to Overstock

 

Because we have a limited operating history, it is difficult to evaluate our business and future operating results.

 

We were originally organized in May 1997 and began posting a list of our merchandise on our Website in August 1998. In March 1999, we launched the first version of our Website through which customers could purchase products. Our limited operating history makes it difficult to evaluate our business and future operating results.

 

We have a history of significant losses. If we do not achieve profitability, our financial condition and our stock price could suffer.

 

We have a history of losses and we may continue to incur operating and net losses for the foreseeable future.  We incurred net losses attributable to common shares of $1.2 million and $2.5 million for the quarters ended June 30, 2003 and 2002, respectively.  As of June 30, 2003, and December 31, 2002, our accumulated deficit was $60.9 million and $55.7 million, respectively.  We will need to generate significant revenues to achieve profitability, and we may not be able to do so.  Even if we do achieve profitability, we may not be able to sustain or increase profitability on a quarterly or annual basis in the future. If our revenues grow more slowly than we anticipate, or if our operating expenses exceed our expectations, our financial results would be severely harmed.

 

We will continue to incur significant operating expenses and capital expenditures as we:

 

enhance our distribution and order fulfillment capabilities;

further improve our order processing systems and capabilities;

develop enhanced technologies and features;

expand our customer service capabilities to better serve our customers’ needs;

expand our product offerings;

rent additional warehouse and office space;

increase our general and administrative functions to support our operations; and

increase our sales branding and marketing activities, including maintaining existing or entering into new online marketing arrangements requiring upfront payments or entering into off-line marketing arrangements requiring upfront or significant payments.

 

Because we will incur many of these expenses before we receive any revenues from our efforts, our losses may be greater than the losses we would incur if we developed our business more slowly. Further, we base our expenses in large part on our operating plans and future revenue projections. Many of our expenses are fixed in the short term, and we may not be able to quickly reduce spending if our revenues are lower than we project. Therefore, any significant shortfall in revenues would likely harm our business, operating results and financial condition. In addition, we may find that these efforts are more expensive than we currently anticipate, which would further increase our losses. Also, the timing of these expenses may contribute to fluctuations in our quarterly operating results.

 

Our quarterly operating results are volatile and may adversely affect our stock price.

 

Our future revenues and operating results are likely to vary significantly from quarter to quarter due to a number of factors, many of which are outside our control, and any of which could severely harm our business. As a result, we believe that quarterly comparisons of our operating results are not necessarily

 

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meaningful and that you should not rely on the results of one quarter as an indication of our future performance. In addition to the risk factors described in this report, additional factors that have caused and/or could cause our quarterly operating results to fluctuate include:

 

increases in the cost of advertising;

our inability to retain existing customers or encourage repeat purchases;

difficulties developing our B2B operations;

the extent to which our existing and future marketing agreements are successful;

price competition that results in lower profit margins or losses;

the amount and timing of operating costs and capital expenditures relating to the expansion of our business operations and infrastructure;

the amount and timing of our purchases of inventory;

our inability to manage distribution operations or provide adequate levels of customer service;

our ability to successfully integrate operations and technologies from acquisitions or other business combinations;

entering into new lines of products;

loss of significant B2B customer, including Safeway;

the success of our warehouse store sales; and

the mix between direct revenue versus commission revenue.

 

If we fail to accurately forecast our expenses and revenues, our business, operating results and financial condition may suffer and the price of our stock may decline.

 

Our limited operating history and the rapidly evolving nature of our industry make forecasting quarterly operating results difficult. We may not be able to quickly reduce spending if our revenues are lower than we project. Therefore, any significant shortfall in revenues would likely harm our business, operating results and financial condition and cause our results of operation to fall below the expectations of public market analysts and investors. If this occurs, the price of our common stock may decline.

 

We have grown quickly and if we fail to manage our growth, our business will suffer.

 

We have rapidly and significantly expanded our operations, and anticipate that further significant expansion will be required to address potential growth in our customer base and market opportunities. This expansion has placed, and is expected to continue to place, a significant strain on our management, operational and financial resources. Some of our officers have no prior senior management experience at public companies. Our new employees include a number of key managerial, technical and operations personnel who have not yet been fully integrated into our operations, and we expect to add additional key personnel in the near future. To manage the expected growth of our operations and personnel, we will be required to improve existing and implement new transaction-processing, operational and financial systems, procedures and controls, and to expand, train and manage our already growing employee base. If we are unable to manage growth effectively, our business, prospects, financial condition and results of operations will be seriously harmed.

 

In order to obtain future revenue growth and achieve and sustain profitability we will have to attract customers on cost-effective terms.

 

Our success depends on our ability to attract customers on cost-effective terms. We have relationships with online services, search engines, directories and other Websites and e-commerce businesses to provide content, advertising banners and other links that direct customers to our Websites. We expect to rely on these relationships as significant sources of traffic to our Websites and to generate new customers. If we are unable to develop or maintain these relationships on acceptable terms, our ability to attract new customers and our financial condition could be harmed. In addition, certain of our existing online marketing agreements require us to pay upfront fees and make other payments prior to the realization of the sales, if any, associated with those payments. Accordingly, if these agreements or similar

 

20



 

agreements that we may enter into in the future fail to produce the sales that we anticipate, our results of operations will be adversely affected. We cannot assure you that we will be able to increase our revenues, if at all, in a cost-effective manner.  We may in the future engage in more traditional off-line branding and advertising campaigns.  Such campaigns are often expensive and may not result in the cost effective acquisition of customers.

 

Further, many of the parties with which we may have online-advertising arrangements could provide advertising services for other online or traditional retailers and merchandise liquidators. As a result, these parties may be reluctant to enter into or maintain relationships with us. Failure to achieve sufficient traffic or generate sufficient revenue from purchases originating from third parties may result in termination of these relationships by these third parties. Without these relationships, our revenues, business, financial condition and results of operations could suffer.

 

The loss of key personnel or any inability to attract and retain additional personnel could affect our ability to successfully grow our business.

 

Our performance is substantially dependent on the continued services and on the performance of our senior management and other key personnel, particularly Patrick M. Byrne, our Chief Executive Officer and Chairman of the Board. Our performance also depends on our ability to retain and motivate other officers and key employees.  The loss of the services of any of our executive officers or other key employees for any unforeseen reason, including without limitation, illness or call to military service, could harm our business, prospects, financial condition and results of operations. We do not have long-term employment agreements with any of our key personnel and we do not maintain “key person” life insurance policies.  Our future success also depends on our ability to identify, attract, hire, train, retain and motivate other highly-skilled technical, managerial, editorial, merchandising, marketing and customer service personnel. Competition for such personnel is intense, and we cannot assure you that we will be able to successfully attract, assimilate or retain sufficiently qualified personnel.  Our failure to retain and attract the necessary technical, managerial, editorial, merchandising, marketing and customer service personnel could harm our business, prospects, financial condition and results of operations.

 

Our operating results may fluctuate depending on the season, and such fluctuations may affect our stock price.

 

We expect to experience fluctuations in our operating results because of seasonal fluctuations in traditional retail patterns.  Sales in the retail and wholesale industry tend to be significantly higher in the fourth calendar quarter of each year than in the preceding three quarters due primarily to increased shopping activity during the holiday season.  However, there can be no assurance that our sales in the fourth quarter will exceed those of the preceding quarters or, if the fourth quarter sales do exceed those of the preceding quarters, that we will be able to manage the increased sales effectively.  Further, we may increase our inventories substantially in anticipation of holiday season shopping activity, which may have a negative effect on our cash flow. Securities analysts and investors may inaccurately estimate the effects of seasonality on our results of operations in one or more future quarters and, consequently, our operating results may fall below expectations, causing our stock price to decline.

 

We depend on our relationships with third parties for a large portion of the products that we offer for sale on our Websites. If we fail to maintain these relationships, our business will suffer.

 

During the quarter ended June 30,2003, we had commission-based relationships with approximately 190 third parties whose products we offer for sale on our Websites.  At June 30, 2003, these products accounted for approximately 63% of the products available on our Websites.  We do not have any long-term agreements with any of these third parties.  Our agreements with third parties are terminable at will by either party immediately upon notice. In general, we agree to offer the third parties’ products on our Websites and these third parties agree to provide us with information about their products, honor our customer service policies and ship the products directly to the customer.  If we do not maintain our existing

 

21



 

or build new relationships with third parties on acceptable commercial terms, we may not be able to offer a broad selection of merchandise, and customers may refuse to shop at our Websites.  In addition, manufacturers may decide not to offer particular products for sale on the Internet.  If we are unable to maintain our existing or build new commission-based relationships or if other product manufacturers refuse to allow their products to be sold via the Internet, our business would suffer severely.

 

We are partially dependent on third parties to fulfill a number of our customer service and other retail functions.  If such parties are unwilling or unable to continue providing these services, our business could be seriously harmed.

 

In our commission business we rely on third parties to conduct a number of other traditional retail operations with respect to their respective products that we offer for sale on our Websites, including maintaining inventory, preparing merchandise for shipment to individual customers and timely distribution of purchased merchandise.  We have no effective means to ensure that these third parties will continue to perform these services to our satisfaction or on commercially reasonable terms.  In addition, because we do not take possession of these third parties’ products, we are unable to fulfill these traditional retail operations ourselves.  Our customers could become dissatisfied and cancel their orders or decline to make future purchases if these third parties are unable to deliver products on a timely basis.  If our customers become dissatisfied with the services provided by these third parties, our reputation and the Overstock brand could suffer.

 

We rely on our relationships with manufacturers, retailers and other suppliers to obtain sufficient quantities of quality merchandise on acceptable terms.  If we fail to maintain our supplier relationships on acceptable terms, our sales and profitability could suffer.

 

To date, we have not entered into contracts with manufacturers or liquidation wholesalers that guarantee the availability of merchandise for a set duration.  Our contracts or arrangements with suppliers do not provide for the continuation of particular pricing practices and may be terminated by either party at any time. Our current suppliers may not continue to sell their excess inventory to us on current terms or at all, and we may not be able to establish new supply relationships.  For example, it is difficult for us to maintain high levels of product quality and selection because none of the manufacturers, suppliers and liquidation wholesalers from whom we purchase products on a purchase order by purchase order basis have a continuing obligation to provide us with merchandise at historical levels or at all.  In most cases, our relationships with our suppliers do not restrict the suppliers from selling their respective excess inventory to other traditional or online merchandise liquidators, which could in turn limit the selection of products available on our Websites.  If we are unable to develop and maintain relationships with suppliers that will allow us to obtain sufficient quantities of merchandise on acceptable commercial terms, such inability could harm our business, results of operation and financial condition.

 

Our business may be harmed by the listing or sale of pirated, counterfeit or illegal items by third parties.

 

We have received in the past, and we anticipate we will receive in the future, communications alleging that certain items listed or sold through our Websites infringe third-party copyrights, trademarks and trade names or other intellectual property rights.  For example, in February 2002, Microsoft Corporation filed a complaint against us alleging that we have distributed counterfeit and otherwise unauthorized Microsoft software in violation of federal copyright and trademark law and related state laws. This litigation matter has been resolved;  however, future claims could result in increased costs of doing business through legal expenses, adverse judgment or settlement or require us to change our business practices in expensive ways. In addition, litigation could result in interpretations of the law that require us to change our business practices or otherwise increase our costs.

 

In addition, we may be unable to prevent third parties from listing unlawful goods, and we may be subject to allegations of civil or criminal liability for unlawful activities carried out by third parties through

 

22



 

our Websites.  In the future, we may implement measures to protect against these potential liabilities that could require us to spend substantial resources and/or to reduce revenues by discontinuing certain service offerings.  Any costs incurred as a result of liability or asserted liability relating to the sale of unlawful goods or the unlawful sale of goods could harm our business.

 

Our business may be harmed by fraudulent activities on our Websites.

 

We have received in the past, and anticipate that we will receive in the future, communications from customers who did not receive goods that they purchased.  We also periodically receive complaints from our customers as to the quality of the goods purchased and services rendered.  Negative publicity generated as a result of fraudulent or deceptive conduct by third parties could damage our reputation, harm our business and diminish the value of our brand name.  We expect to continue to receive from customers requests for reimbursement or threats of legal action against us if no reimbursement is made.

 

We depend upon third-party delivery services to deliver our products to our customers on a timely and consistent basis. A deterioration in our relationship with any one of these third parties could decrease our ability to track shipments, cause shipment delays, and increase our shipping costs and the number of damaged products.

 

Although we operate our own fulfillment center, we rely upon multiple third parties for the shipment of our products.  Because we do not have a written long-term agreement with any of these third parties, we cannot be sure that these relationships will continue on terms favorable to us, if at all. Unexpected increases in shipping costs or delivery times, particularly during the holiday season, could harm our business, prospects, financial condition and results of operations.  If our relationships with these third parties are terminated or impaired or if these third parties are unable to deliver products for us, whether through labor shortage, slow down or stoppage, deteriorating financial or business condition, responses to terrorist attacks or for any other reason, we would be required to use alternative carriers for the shipment of products to our customers.  We may be unable to engage alternative carriers on a timely basis or upon terms favorable to us.  Changing carriers would likely have a negative effect on our business, operating results and financial condition.  Potential adverse consequences include:

 

reduced visibility of order status and package tracking;

delays in order processing and product delivery;

increased cost of delivery, resulting in reduced gross margins; and

reduced shipment quality, which may result in damaged products and customer dissatisfaction.

 

Our operating results depend on our Websites, network infrastructure and transaction-processing systems. Capacity constraints or system failures would harm our business, results of operations and financial condition.

 

Any system interruptions that result in the unavailability of our Websites or reduced performance of our transaction systems would reduce our transaction volume and the attractiveness of the services that we provide to suppliers and third parties and would seriously harm our business, operating results and financial condition.

 

We use internally developed systems for our Websites and certain aspects of transaction processing, including customer profiling and order verifications.  We have experienced periodic systems interruptions due to server failure, which we believe will continue to occur from time to time. If the volume of traffic on our Websites or the number of purchases made by customers substantially increases, we will need to further expand and upgrade our technology, transaction processing systems and network infrastructure.  We have experienced and expect to continue to experience temporary capacity constraints due to sharply increased traffic during sales or other promotions, which cause unanticipated system disruptions, slower response times, degradation in levels of customer service, impaired quality and delays in reporting accurate financial information.

 

23



 

Our transaction processing systems and network infrastructure may be unable to accommodate increases in traffic in the future.  We may be unable to project accurately the rate or timing of traffic increases or successfully upgrade our systems and infrastructure to accommodate future traffic levels on our Websites.  In addition, we may be unable to upgrade and expand our transaction processing systems in an effective and timely manner or to integrate any newly developed or purchased functionality with our existing systems. Any inability to do so may cause unanticipated system disruptions, slower response times, degradation in levels of customer service, impaired quality and speed of order fulfillment or delays in reporting accurate financial information.

 

We may be unable to manage expansion into new business areas which could harm our business operations and reputation.

 

Our long-term strategic plan involves expansion into the B2B merchandise liquidation market, entering into agreements to provide products and services to retail chains and other businesses, such as our agreement with Safeway, Inc. and possible expansion into additional markets and product lines.  We cannot assure you that our efforts to expand our business in this manner will succeed or that we will be successful in managing or maintaining agreements to provide products and services to retail chains and other businesses, such as our agreement with Safeway, Inc.  To date, we have expended significant financial and management resources developing our B2B operations. Our failure to succeed in this market or other markets may harm our business, prospects, financial condition and results of operation.  Furthermore, the exclusivity provisions of our Safeway agreement prevents us from providing similar products to stores having greater than 400 stores in the drug, mass merchandising, grocery, club or warehouse store categories, which may adversely affect our ability to grow and expand our B2B business. In addition, we may choose to expand our operations by developing new Websites, promoting new or complementary products or sales formats, expanding the breadth and depth of products and services offered or expanding our market presence through relationships with third parties.  In addition, we may pursue the acquisition of new or complementary businesses or technologies.  We cannot assure you that we would be able to expand our efforts and operations in a cost-effective or timely manner or that any such efforts would increase overall market acceptance.  Furthermore, any new business or Website we launch that is not favorably received by consumers could damage our reputation or the Overstock brand.  We may expand the number of categories of products we carry on our website, and these and any other expansions of our operations would also require significant additional expenses and development and would strain our management, financial and operational resources.  The lack of market acceptance of such efforts or our inability to generate satisfactory revenues from such expanded services or products to offset their cost could harm our business, prospects, financial condition and results of operations.

 

We may not be able to compete successfully against existing or future competitors.

 

The online liquidation services market is new, rapidly evolving and intensely competitive. Barriers to entry are minimal, and current and new competitors can launch new Websites at a relatively low cost. Our consumer Website currently competes with:

 

other online liquidation e-tailers, such as SmartBargains;

traditional retailers and liquidators, such as Ross Stores, Inc., Walmart Stores, Inc. and TJX Companies, Inc.; and

online retailers and marketplaces such as Amazon.com, Inc., Buy.com, Inc. and eBay, Inc., which have discount departments.

 

Our B2B Website competes with liquidation “brokers” and retailers and online marketplaces such as eBay, Inc.

 

We expect the online liquidation services market to become even more competitive as traditional liquidators and online retailers continue to develop services that compete with our services. In addition, manufacturers and retailers may decide to create their own Websites to sell their own excess inventory and

 

24



 

the excess inventory of third parties.  Competitive pressures created by any one of our competitors, or by our competitors collectively, could severely harm our business, prospects, financial condition and results of operations.

 

Further, as a strategic response to changes in the competitive environment, we may from time to time make certain pricing, service or marketing decisions or acquisitions that could harm our business, prospects, financial condition and results of operations.  For example, to the extent that we enter new lines of businesses such as third-party logistics, online auction services or discount brick and mortar retail, we would be competing with large established businesses such as APL Logistics, Ltd., eBay, Inc., Ross Stores, Inc. and TJX Companies, Inc., respectively.

 

Many of our current and potential competitors described above have longer operating histories, larger customer bases, greater brand recognition and significantly greater financial, marketing and other resources than we do.  In addition, online retailers and liquidation e-tailers may be acquired by, receive investments from or enter into other commercial relationships with larger, well-established and well-financed companies.  Some of our competitors may be able to secure merchandise from manufacturers on more favorable terms, devote greater resources to marketing and promotional campaigns, adopt more aggressive pricing or inventory availability policies and devote substantially more resources to Website and systems development than we do.  Increased competition may result in reduced operating margins, loss of market share and a diminished brand franchise.  We cannot assure you that we will be able to compete successfully against current and future competitors.

 

A significant number of merchandise returns could harm our business, financial condition and results of operations.

 

We allow our customers to return products and beginning in July 1, 2003, we have begun to accept returns of products sold through our fulfillment partners.  Our ability to handle a large volume of returns is unproven.  In addition, any policies intended to reduce the number of product returns may result in customer dissatisfaction and fewer return customers.  If merchandise returns are significant, our business, financial condition and results of operations could be harmed.

 

If the products that we offer on our Websites do not reflect our customers’ tastes and preferences, our sales and profit margins would decrease.

 

Our success depends in part on our ability to offer products that reflect consumers’ tastes and preferences.  Consumers’ tastes are subject to frequent, significant and sometimes unpredictable changes. Because the products that we sell typically consist of manufacturers’ and retailers’ excess inventory, we have limited control over the specific products that we are able to offer for sale.  If our merchandise fails to satisfy customers’ tastes or respond to changes in customer preferences, our sales could suffer and we could be required to mark down unsold inventory which would depress our profit margins.  In addition, any failure to offer products in line with customers’ preferences could allow our competitors to gain market share.  This could have an adverse effect on our business, results of operations and financial condition.

 

If the single facility where substantially all of our computer and communications hardware are located fails, our business, results of operations and financial condition will be harmed.

 

Our success, and, in particular, our ability to successfully receive and fulfill orders and provide high-quality customer service, largely depends on the efficient and uninterrupted operation of our computer and communications hardware systems.  Substantially all of our computer and communications hardware is located at a single leased facility in Salt Lake City, Utah.  Our systems and operations are vulnerable to damage or interruption from fire, flood, power loss, telecommunications failure, terrorist attacks, acts of war, break-ins, earthquake and similar events.  We do not presently have redundant systems in multiple locations or a formal disaster recovery plan and our business interruption insurance may be insufficient to compensate us for losses that may occur.  Despite the implementation of network security measures, our

 

25



 

servers are vulnerable to computer viruses, physical or electronic break-ins and similar disruptions, which could lead to interruptions, delays, loss of critical data or the inability to accept and fulfill customer orders. The occurrence of any of the foregoing risks could harm our business, prospects, financial condition and results of operations.

 

We may be unable to protect our proprietary technology or keep up with that of our competitors.

 

Our success depends to a significant degree upon the protection of our software and other proprietary intellectual property rights.  We may be unable to deter misappropriation of our proprietary information, detect unauthorized use and take appropriate steps to enforce our intellectual property rights. In addition, our competitors could, without violating our proprietary rights, develop technologies that are as good as or better than our technology.

 

Our failure to protect our software and other proprietary intellectual property rights or to develop technologies that are as good as our competitors’ could put us at a disadvantage to our competitors. In addition, the failure of the third parties whose products we offer for sale on our Websites to protect their intellectual property rights, including their domain names, could impair our operations.  These failures could harm our business, results of operations and financial condition.

 

If we do not respond to rapid technological changes, our services could become obsolete and we could lose customers.

 

To remain competitive, we must continue to enhance and improve the functionality and features of our e-commerce businesses.  We may face material delays in introducing new services, products and enhancements.  If this happens, our customers may forgo the use of our Websites and use those of our competitors.  The Internet and the online commerce industry are rapidly changing.  If competitors introduce new products and services using new technologies or if new industry standards and practices emerge, our existing Websites and our proprietary technology and systems may become obsolete.  Our failure to respond to technological change or to adequately maintain, upgrade and develop our computer network and the systems used to process customers’ orders and payments could harm our business, prospects, financial condition and results of operations.

 

Issuances of our securities are subject to federal and state securities laws, and certain holders of common stock issued by us may be entitled to rescind their purchases.

 

Issuances of securities are subject to federal and state securities laws.  From November 1999 through September 2000, we offered and sold common stock to investors in various states.  Certain of those offerings may not have complied with various requirements of applicable state securities laws.  In such situations a number of remedies may be available to regulatory authorities and the investors who purchased common stock in those offerings, including, without limitation, a right of rescission, civil penalties, seizure of our assets, a restraining order or injunction, and a court order to pay restitution and costs.  As a result, certain investors in our common stock may be entitled to return their shares to Overstock and receive from us the full price they paid, plus interest, which we estimate to be an aggregate amount of approximately $3.5 million at June 30, 2003.

 

We face risks relating to our inventory.

 

We directly purchase some of the merchandise that we sell on our Websites.  We assume the inventory damage, theft and obsolescence risks, as well as price erosion risks for products that we purchase directly.  These risks are especially significant because some of the merchandise we sell at our Websites are characterized by rapid technological change, obsolescence and price erosion (for example, computer hardware, software and consumer electronics), and because we sometimes make large purchases of particular types of inventory. In addition, we often do not receive warranties on the merchandise we purchase.

 

26



 

In the recent past, we have recorded charges for obsolete inventory and have had to sell certain merchandise at a discount or loss.  It is impossible to determine with certainty whether an item will sell for more than the price we pay for it.  Because we rely heavily on purchased inventory, our success will depend on our ability to liquidate our inventory rapidly, the ability of our buying staff to purchase inventory at attractive prices relative to its resale value and our ability to manage customer returns and the shrinkage resulting from theft, loss and misrecording of inventory.  If we are unsuccessful in any of these areas, we may be forced to sell our inventory at a discount or loss.

 

We may be liable if third parties misappropriate our customers’ personal information.

 

If third parties are able to penetrate our network security or otherwise misappropriate our customers’ personal information or credit card information, or if we give third parties improper access to our customers’ personal information or credit card information, we could be subject to liability.  This liability could include claims for unauthorized purchases with credit card information, impersonation or other similar fraud claims.  This liability could also include claims for other misuses of personal information, including unauthorized marketing purposes.  These claims could result in litigation. Liability for misappropriation of this information could adversely affect our business.  In addition, the Federal Trade Commission and state agencies have been investigating various Internet companies regarding their use of personal information.  We could incur additional expenses if new regulations regarding the use of personal information are introduced or if government agencies investigate our privacy practices.

 

We rely on encryption and authentication technology licensed from third parties to provide the security and authentication necessary to effect secure transmission of confidential information such as customer credit card numbers.  We cannot assure you that advances in computer capabilities, new discoveries in the field of cryptography or other events or developments will not result in a compromise or breach of the algorithms that we use to protect customer transaction data.  If any such compromise of our security were to occur, it could harm our reputation, business, prospects, financial condition and results of operations.  A party who is able to circumvent our security measures could misappropriate proprietary information or cause interruptions in our operations.  We may be required to expend significant capital and other resources to protect against such security breaches or to alleviate problems caused by such breaches. We cannot assure you that our security measures will prevent security breaches or that failure to prevent such security breaches will not harm our business, prospects, financial condition and results of operations.

 

We may expand our business internationally, causing our business to become increasingly susceptible to numerous international business risks and challenges that could affect our profitability.

 

In the future, we may expand into international markets. International sales and transactions are subject to inherent risks and challenges that could adversely affect our profitability, including:

 

the need to develop new supplier and manufacturer relationships;

unexpected changes in international regulatory requirements and tariffs;

difficulties in staffing and managing foreign operations;

longer payment cycles from credit card companies;

greater difficulty in accounts receivable collection;

potential adverse tax consequences;

price controls or other restrictions on foreign currency; and

difficulties in obtaining export and import licenses.

 

To the extent we generate international sales and transactions in the future, any negative impact on our international operations could negatively impact our business.  In particular, gains and losses on the conversion of foreign payments into United States dollars may contribute to fluctuations in our results of operations and fluctuating exchange rates could cause reduced gross revenues and/or gross margins from non-dollar-denominated international sales.

 

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We are subject to intellectual property litigation.

 

Third parties have, from time to time, claimed and may claim in the future that we have infringed their past, current or future intellectual property rights.  We may become more vulnerable to such claims as laws such as the Digital Millennium Copyright Act are interpreted by the courts.  We may be increasingly subject to infringement claims as the number of services and competitors in our segment grow.

 

In February 2002, Microsoft Corporation filed a complaint against us in the United States District Court for the Northern District of California alleging that we have distributed counterfeit and otherwise unauthorized Microsoft software in violation of federal copyright and trademark law and related state laws. Effective April 18, 2003, we entered a Confidential Settlement Agreement and Mutual General Release with Microsoft that settled and resolved all claims between the companies.

 

In January 2003, we received a letter from NCR Corporation claiming that certain of our business practices and information technology systems infringe patents owned by NCR.  The letter further stated that NCR would vigorously protect its intellectual property rights if we did not agree to enter into licensing arrangements with respect to the asserted patents.  On January 31, 2003, we filed a complaint in the United States District Court of Utah, Central Division, seeking declaratory judgment that we do not infringe any valid claim of the patents asserted by NCR.  On March 24, 2003, NCR filed an answer and counterclaims alleging that certain of our business practices and information technology systems infringe patents owned by NCR.  On April 8, 2003, we filed an answer denying the material allegations in NCR’s counterclaims.  On May 12, the parties agreed to the dismissal of the complaint and counterclaims without prejudice to either party’s ability to renew its claims at a later date.  On May 19, 2003, the court entered an order dismissing the complaint and counterclaims without prejudice.  The parties each reserve all claims and counterclaims.  Resolving litigation or claims regarding patents or other intellectual property, whether meritorious or not, could be costly, time-consuming, cause service delays, divert our management and key personnel from our business operations, require expensive or unwanted changes in our methods of doing business or require us to enter into costly royalty or licensing agreements, if available.  As a result, these types of claims could harm our business.

 

We may be subject to product liability claims that could be costly and time consuming.

 

We sell products manufactured by third parties, some of which may be defective.  If any product that we sell were to cause physical injury or injury to property, the injured party or parties could bring claims against us as the retailer of the product.  Our insurance coverage may not be adequate to cover every claim that could be asserted.  If a successful claim were brought against us in excess of our insurance coverage, it could adversely affect our business.  Even unsuccessful claims could result in the expenditure of funds and management time and could have a negative impact on our business.

 

We may not be able to obtain trademark protection for our marks, which could impede our efforts to build brand identity.

 

We have filed trademark applications with Patent and Trademark Office seeking registration of certain service marks or trademarks.  There can be no assurance that our applications will be successful or that we will be able to secure significant protection for our service marks or trademarks. Our competitors or others could adopt product or service marks similar to our marks, or try to prevent us from using our marks, thereby impeding our ability to build brand identity and possibly leading to customer confusion.  Any claim by another party against us or customer confusion related to our trademarks, or our failure to obtain trademark registration, could negatively affect our business.

 

Risks Relating to the Internet Industry

 

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Our success is tied to the continued use of the Internet and the adequacy of the Internet infrastructure.

 

Our future revenues and profits, if any, substantially depend upon the continued widespread use of the Internet as an effective medium of business and communication.  Factors which could reduce the widespread use of the Internet include:

 

actual or perceived lack of security of information or privacy protection;

possible disruptions, computer viruses or other damage to the Internet servers or to users’ computers; and

excessive governmental regulation.

 

Customers may be unwilling to use the Internet to purchase goods.

 

Our long-term future depends heavily upon the general public’s willingness to use the Internet as a means to purchase goods.  The failure of the Internet to develop into an effective commercial tool would seriously damage our future operations.  E-commerce is a relatively new concept, and large numbers of customers may not begin or continue to use the Internet to purchase goods.  The demand for and acceptance of products sold over the Internet are highly uncertain, and most e-commerce businesses have a short track record. If consumers are unwilling to use the Internet to conduct business, our business may not develop profitably.

 

The security risks of e-commerce may discourage customers from purchasing goods from us.

 

In order for the e-commerce market to develop successfully, we and other market participants must be able to transmit confidential information securely over public networks.  Third parties may have the technology or know-how to breach the security of customer transaction data.  Any breach could cause customers to lose confidence in the security of our Websites and choose not to purchase from our Websites. If someone is able to circumvent our security measures, he or she could destroy or steal valuable information or disrupt our operations.  Concerns about the security and privacy of transactions over the Internet could inhibit the growth of the Internet and e-commerce.  Our security measures may not effectively prohibit others from obtaining improper access to our information.  Any security breach could expose us to risks of loss, litigation and liability and could seriously disrupt our operations.

 

Credit card fraud could adversely affect our business.

 

We do not carry insurance against the risk of credit card fraud, so the failure to adequately control fraudulent credit card transactions could reduce our net revenues and our gross margin.  We have implemented technology to help us detect the fraudulent use of credit card information.  However, we may in the future suffer losses as a result of orders placed with fraudulent credit card data even though the associated financial institution approved payment of the orders.  Under current credit card practices, we may be liable for fraudulent credit card transactions because we do not obtain a cardholder’s signature.  If we are unable to detect or control credit card fraud, our liability for these transactions could harm our business, results of operation or financial condition.

 

If one or more states successfully assert that we should collect sales or other taxes on the sale of our merchandise or the merchandise of third parties that we offer for sale on our Websites, our business could be harmed.

 

We do not currently collect sales or other similar taxes for physical shipments of goods into states other than Utah.  One or more local, state or foreign jurisdictions may seek to impose sales tax collection obligations on us and other out-of-state companies that engage in online commerce.  Our business could be adversely affected if one or more states or any foreign country successfully asserts that we should collect sales or other taxes on the sale of our merchandise.

 

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Existing or future government regulation could harm our business.

 

We are subject to the same federal, state and local laws as other companies conducting business on the Internet.  Today there are relatively few laws specifically directed towards conducting business on the Internet. However, due to the increasing popularity and use of the Internet, many laws and regulations relating to the Internet are being debated at the state and federal levels.  These laws and regulations could cover issues such as user privacy, freedom of expression, pricing, fraud, quality of products and services, taxation, advertising, intellectual property rights and information security.  Applicability to the Internet of existing laws governing issues such as property ownership, copyrights and other intellectual property issues, taxation, libel, obscenity and personal privacy could also harm our business.  For example, United States and foreign laws regulate our ability to use customer information and to develop, buy and sell mailing lists.  The vast majority of these laws were adopted prior to the advent of the Internet, and do not contemplate or address the unique issues raised thereby.  Those laws that do reference the Internet, such as the Digital Millennium Copyright Act, are only beginning to be interpreted by the courts and their applicability and reach are therefore uncertain.  These current and future laws and regulations could harm our business, results of operation and financial condition.

 

Laws or regulations relating to privacy and data protection may adversely affect the growth of our Internet business or our marketing efforts.

 

We are subject to increasing regulation at the federal, state and international levels relating to privacy and the use of personal user information.  For example, we are subject to various telemarketing laws that regulate the manner in which we may solicit future suppliers and customers.  Such regulations, along with increased governmental or private enforcement, may increase the cost of growing our business. In addition, several states have proposed legislation that would limit the uses of personal user information gathered online or require online services to establish privacy policies.  The Federal Trade Commission has adopted regulations regarding the collection and use of personal identifying information obtained from children under 13.  Bills proposed in Congress would extend online privacy protections to adults. Moreover, proposed legislation in this country and existing laws in foreign countries require companies to establish procedures to notify users of privacy and security policies, obtain consent from users for collection and use of personal information, and/or provide users with the ability to access, correct and delete personal information stored by us.  We could become a party to a similar enforcement proceeding. These data protection regulations and enforcement efforts may restrict our ability to collect demographic and personal information from users, which could be costly or harm our marketing efforts.

 

Risks Relating to the Securities Markets and Ownership of Our Common Stock

 

Our stock price may be volatile and you may lose all or a part of your investment.

 

Our common stock has been publicly traded only since May 30, 2002. The market price of our common stock has been subject to significant fluctuations since the date of our initial public offering.  These fluctuations could continue. It is possible that in some future periods our results of operations may be below the expectations of public market analysts and investors.  If this occurs, our stock price may decline. Among the factors that could affect our stock price are as follows:

 

changes in securities analysts’ recommendations or estimates of our financial performance or publication of research reports by analysts;

changes in market valuations of similar companies;

announcements by us or our competitors of significant contracts, acquisitions, commercial relationships, joint ventures or capital commitments;

general market conditions;

actual or anticipated fluctuations in our operating results;

intellectual property or litigation developments; and

economic factors unrelated to our performance.

 

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In addition, the stock markets have experienced significant price and trading volume fluctuations. These broad market fluctuations may adversely affect the trading price of our common stock.  In the past, following periods of volatility in the market price of a public company’s securities, securities class action litigation has often been instituted against that company.  Such litigation could result in substantial cost and a diversion of management’s attention and resources.

 

We do not intend to pay dividends on our non-redeemable common stock, and you may lose the entire amount of your investment.

 

We have never declared or paid any cash dividends on our non-redeemable common stock and do not intend to pay dividends on our non-redeemable common stock for the foreseeable future.  We intend to invest our future earnings, if any, to fund our growth.  Therefore, you will not receive any funds without selling your shares.  We cannot assure that you will receive a positive return on your investment when you sell your shares or that you will not lose the entire amount of your investment.

 

Our Amended and Restated Certificate of Incorporation, Amended and Restated Bylaws and the Delaware General Corporation Law contain anti-takeover provisions which could discourage or prevent a takeover, even if an acquisition would be beneficial to our stockholders.

 

Several provisions of our Amended and Restated Certificate of Incorporation and Amended and Restated Bylaws could discourage potential acquisition proposals and could delay or prevent a change in control of our company even if that change in control would be beneficial to our stockholders.  For example, only one-third of our board of directors will be elected at each of our annual meetings of stockholders, which will make it more difficult for a potential acquirer to change the management of our company, even after acquiring a majority of the shares of our common stock.  These provisions, which cannot be amended without the approval of two-thirds of our stockholders, could diminish the opportunities for a stockholder to participate in tender offers, including tender offers at a price above the then current market value of our common stock. In addition, our board of directors, without further stockholder approval, may issue preferred stock, with such terms as the board of directors may determine, that could have the effect of delaying or preventing a change in control of our company.  The issuance of preferred stock could also adversely affect the voting powers of the holders of common stock, including the loss of voting control to others.  We are also afforded the protections of Section 203 of the Delaware General Corporation Law, which could delay or prevent a change in control of our company or could impede a merger, consolidation, takeover or other business combination involving our company or discourage a potential acquirer from making a tender offer or otherwise attempting to obtain control of our company.

 

ITEM 3.              QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

We are exposed to market risk for the effect of interest rate changes and changes in the market values of our investments.  Currently we do not utilize interest rate swaps, forward or option contracts on foreign currencies or commodities or other types of derivative financial instruments.  Our financial instruments consist of cash and cash equivalents, trade accounts and contracts receivable, accounts payable and long-term obligations.  We consider investments in highly-liquid instruments purchased with a remaining maturity of 90 days or less at the date of purchase to be cash equivalents.  Our exposure to market risk for changes in interest rates relates primarily to our short-term investments and short-term obligations; thus, fluctuations in interest rates would not have a material impact on the fair value of these securities.  We do not believe that the future market risks related to the above securities will have a material adverse impact on our financial position, results of operations or liquidity.

 

At June 30, 2003, we had $31.7 million in cash and marketable securities.  At that same date we had no notes payable.  A hypothetical 10% increase or decrease in interest rates would not have a material impact on our earnings or loss, or the fair market value or cash flows of these instruments.

 

 

 

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Interest Rate Risk

 

Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio.  All of our cash equivalents and marketable securities are designated as available-for-sale securities and, accordingly, are presented at fair value on our balance sheets.  We generally invest our excess cash in A-rated or higher short- to intermediate-term fixed income securities and money market mutual funds.  Fixed rate securities may have their fair market value adversely affected due to a rise in interest rates, and we may suffer losses in principal if forced to sell securities that have declined in market value due to changes in interest rates.

 

 

ITEM 4.                                           CONTROLS AND PROCEDURES

 

Based on their evaluation of the company’s disclosure controls and procedures as of June 30, 2003, the Chief Executive Officer and Chief Financial Officer have concluded that such controls and procedures are effective.  During the three-month period ended June 30, 2003, there were no changes in the company’s internal controls over financial reporting identified in connection with the evaluation required by Rule 13a-15(d) or Rule 15d-15(d) that has materially affected, or is reasonably likely to materially affect, the internal controls over financial reporting.

 

 

PART II.  OTHER INFORMATION

 

ITEM 1.                                           LEGAL PROCEEDINGS

 

From time to time, we receive and/or assert claims and become subject to consumer protection, employment, intellectual property and other commercial litigation related to the conduct of our business. Such litigation could be costly and time consuming and could divert our management and key personnel from our business operations. The uncertainty of litigation increases these risks. In connection with such litigation, we may be subject to significant damages or equitable remedies relating to the operation of our business and the sale of products on our websites. Any such litigation may materially harm our business, results of operations and financial condition.

 

In February 2002, Microsoft Corporation filed a complaint against us in the United States District Court for the Northern District of California alleging that we have distributed counterfeit and otherwise unauthorized Microsoft software in violation of federal copyright and trademark law and related state laws. Effective April 18, 2003, we entered a Confidential Settlement Agreement and Mutual General Release with Microsoft that settled and resolved all claims between the companies.

 

In January 2003, we received a letter from NCR Corporation claiming that certain of our business practices and information technology systems infringe patents owned by NCR. The letter further stated that NCR would vigorously protect its intellectual property rights if we did not agree to enter into licensing arrangements with respect to the asserted patents. On January 31, 2003, we filed a complaint in the United States District Court of Utah, Central Division, seeking declaratory judgment that we do not infringe any valid claim of the patents asserted by NCR.  On March 24, 2003, NCR filed an answer and counterclaims alleging that certain of our business practices and information technology systems infringe patents owned by NCR.  On April 8, 2003, we filed an answer denying the material allegations in NCR’s counterclaims.  On May 12, the parties agreed to the dismissal of the complaint and counterclaims without prejudice to either party’s ability to renew its claims at a later date.  On May 19, 2003, the court entered an order dismissing the complaint and counterclaims without prejudice.  The parties each reserve all claims and counterclaims.

 

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ITEM 2.                                           CHANGES IN SECURITIES AND USE OF PROCEEDS

 

None.

 

ITEM 3.                                           DEFAULTS UPON SENIOR SECURITIES

 

None.

 

ITEM 4.                                           SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

 

Our Annual Meeting of Stockholders (the “Annual Meeting”) was held on April 29, 2003.  A total of 14,436,979 shares of common stock, par value $0.0001 per share (the “Common Stock”), were present at the Annual Meeting, either in person or by proxy, representing 88% of the votes that all stockholders of the Company are entitled to cast, constituting a quorum.  The matters voted upon at the Annual Meeting by the stockholders consisted of the two proposals set forth in our definitive Proxy Statement, dated March 21, 2003.

 

The first proposal related to the election of two (2) Class I directors of Overstock.com, Inc., to serve a term of three (3) years and hold office until their respective successors have been elected and qualified or until their following nominees for reelection as directors.  The nominees were each elected and received, the following votes:

 

Director

 

For

 

Withheld

 

John A. Fisher

 

14,380,019

 

56,960

 

Patrick M. Byrne

 

14,012,066

 

424,913

 

 

The second proposal was to ratify the selection of PricewaterhouseCoopers LLP as the Company’s independent accountants for the fiscal year ending December 31, 2003.  This proposal was approved with 14,406496 shares of the Company’s common stock that voted at the meeting voting in favor of, 30,483 shares voting against, and no shares abstaining from ratification of the appointment of PricewaterhouseCoopers LLP to audit the financial statements of the Company and its subsidiaries for the fiscal year ending December 31, 2003.

 

 

ITEM 5.                                           OTHER INFORMATION

 

On April 28, 2003, Jason C. Lindsey, our Chief Financial Officer was named President and Chief Financial Officer.

 

ITEM 6.                                           EXHIBITS AND REPORTS ON FORM 8-K

 

(a)                                          Exhibits

 

31                              Rule 13a-15(d)/15d-15(d) Certifications

32                              Section 1350 Certifications

10.31               Old Mill Corporate Center Second Amendment to the Lease Agreement by and between Overstock.com, Inc. and Holladay Building East L.L.C., dated March 31, 2003.

 

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(b)                                          Reports on Form 8-K

 

Form 8-K filed on April 28, 2003 to announce earnings results for the quarterly period ending March 31, 2003.

 

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SIGNATURE

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

OVERSTOCK.COM, INC.

 

 

 

        /s/ Jason C. Lindsey

 

Jason C. Lindsey

 

President and Chief Financial Officer

 

 

Dated:  August 12, 2003

 

 

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