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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 March 31, 2005

 

 

 

Or

 

o

 

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

 

 

 

 

 

For the transition period from                      to                      

 

Commission file number: 000-49799

 

OVERSTOCK.COM, INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

87-0634302

(State or other jurisdiction of

 

(I.R.S.  Employer

incorporation or organization)

 

Identification Number)

 

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 20,307,575 shares of the Registrant’s common stock, par value $0.0001, outstanding on May 6, 2005.

 

 



 

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. Unregistered Sales of Equity Securities and Use of Proceeds

 

 

 

Item 3. Defaults upon Senior Securities

 

 

 

Item 4. Submission of Matters to a Vote of Security Holders

 

 

 

Item 5. Other Information

 

 

 

Item 6. Exhibits

 

 

 

Signature

 

 

i



 

PART 1. FINANCIAL INFORMATION

 

ITEM 1.  FINANCIAL STATEMENTS

 

Overstock.com, Inc.

Consolidated Balance Sheets

(in thousands)

 

 

 

December 31,
2004

 

March 31,
2005

 

 

 

 

 

(unaudited)

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

198,678

 

$

37,611

 

Marketable securities

 

88,802

 

155,157

 

Cash, cash equivalents and marketable securities

 

287,480

 

192,768

 

Accounts receivable, net

 

5,715

 

6,467

 

Inventories, net

 

45,279

 

48,956

 

Prepaid inventory

 

12,322

 

9,907

 

Prepaid expenses

 

3,444

 

9,746

 

 

 

 

 

 

 

Total current assets

 

354,240

 

267,844

 

 

 

 

 

 

 

Restricted cash

 

1,602

 

1,012

 

Property and equipment, net

 

16,122

 

42,725

 

Goodwill

 

2,784

 

2,784

 

Other long-term assets, net

 

1,516

 

1,940

 

 

 

 

 

 

 

Total assets

 

$

376,264

 

$

316,305

 

 

 

 

 

 

 

Liabilities, Redeemable Securities and Stockholders’ Equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

64,060

 

$

39,860

 

Accrued liabilities

 

22,917

 

23,263

 

Capital lease obligations, current

 

595

 

9,266

 

 

 

 

 

 

 

Total current liabilities

 

87,572

 

72,389

 

Capital lease obligations, non-current

 

743

 

7,118

 

Convertible senior notes

 

116,251

 

116,379

 

 

 

 

 

 

 

Total liabilities

 

204,566

 

195,886

 

 

 

 

 

 

 

Commitments and contingencies (Note 13)

 

 

 

 

 

 

 

 

 

 

 

Redeemable common stock, $0.0001 par value, 460 shares issued and outstanding as of December 31, 2004 and March 31, 2005

 

3,166

 

3,212

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Preferred stock, $0.0001 par value, 5,000 shares authorized, no shares issued and outstanding as of December 31, 2004 and March 31, 2005

 

 

 

Common stock, $0.0001 par value, 100,000 shares authorized, 19,390 shares and 19,491 shares issued as of December 31, 2004 and March 31, 2005, respectively

 

2

 

2

 

Additional paid-in capital

 

243,131

 

195,863

 

Accumulated deficit

 

(73,005

)

(77,254

)

Unearned stock-based compensation

 

(1,301

)

(777

)

Treasury stock, 35 and 31 shares at cost as of December 31, 2004 and March 31, 2005, respectively

 

(100

)

(87

)

Accumulated other comprehensive loss

 

(195

)

(540

)

 

 

 

 

 

 

Total stockholders’ equity

 

168,532

 

117,207

 

 

 

 

 

 

 

Total liabilities, redeemable securities and stockholders’ equity

 

$

376,264

 

$

316,305

 

 

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
March 31,

 

 

 

2004

 

2005

 

 

 

 

 

 

 

Revenue

 

 

 

 

 

Direct

 

$

38,580

 

$

67,884

 

Fulfillment partner

 

43,498

 

97,997

 

 

 

 

 

 

 

Total revenue

 

82,078

 

165,881

 

 

 

 

 

 

 

Cost of goods sold

 

 

 

 

 

Direct

 

34,816

 

58,153

 

Fulfillment partner

 

38,793

 

82,857

 

 

 

 

 

 

 

Total cost of goods sold

 

73,609

 

141,010

 

 

 

 

 

 

 

Gross profit

 

8,469

 

24,871

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

Sales and marketing

 

4,377

 

16,825

 

Technology

 

1,371

 

4,095

 

General and administrative

 

4,880

 

7,333

 

Amortization of stock-based compensation

 

135

 

20

 

 

 

 

 

 

 

Total operating expenses

 

10,763

 

28,273

 

 

 

 

 

 

 

Operating loss

 

(2,294

)

(3,402

)

 

 

 

 

 

 

Interest income

 

98

 

644

 

Interest expense

 

(16

)

(1,445

)

Other income, net

 

2

 

 

 

 

 

 

 

 

Net loss

 

(2,210

)

(4,203

)

Deemed dividend related to redeemable common shares

 

(48

)

(46

)

 

 

 

 

 

 

Net loss attributable to common shares

 

$

(2,258

)

$

(4,249

)

 

 

 

 

 

 

Net loss per common share — basic and diluted

 

$

(0.14

)

$

(0.21

)

Weighted average common shares outstanding — basic and diluted

 

16,646

 

19,862

 

 

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

 

3



 

Overstock.com, Inc.

Consolidated Statements of Cash Flows (unaudited)

(in thousands)

 

 

 

Three months ended
March 31,

 

 

 

2004

 

2005

 

Cash flows from operating activities:

 

 

 

 

 

Net loss

 

$

(2,210

)

$

(4,203

)

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

 

 

 

 

 

Depreciation and amortization

 

756

 

1,635

 

Amortization of unearned stock-based compensation

 

135

 

20

 

Realized gain from marketable securities

 

 

(1

)

Stock options issued to consultants for services

 

280

 

(400

)

Amortization of debt discount and deferred financing fees

 

 

307

 

Treasury shares issued in employee benefit plan

 

 

251

 

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts receivable, net

 

(1,016

)

(752

)

Inventories, net

 

(2,630

)

(3,677

)

Prepaid inventory

 

(264

)

2,415

 

Prepaid expenses and other assets

 

174

 

(6,302

)

Other long-term assets, net

 

(1,386

)

(614

)

Accounts payable

 

(15,778

)

(24,200

)

Accrued liabilities

 

152

 

346

 

 

 

 

 

 

 

Net cash used in operating activities

 

(21,787

)

(35,175

)

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Restricted cash

 

 

590

 

Investments in marketable securities

 

(2,558

)

(125,944

)

Sales of marketable securities

 

1,191

 

59,262

 

Expenditures for property and equipment

 

(400

)

(13,030

)

 

 

 

 

 

 

Net cash used in investing activities

 

(1,767

)

(79,122

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Payments on capital lease obligations

 

(20

)

(151

)

Purchased call options

 

 

(47,507

)

Exercise of stock options and warrants

 

2,167

 

906

 

 

 

 

 

 

 

Net cash provided by (used in) financing activities

 

2,147

 

(46,752

)

 

 

 

 

 

 

Effect of exchange rate changes on cash

 

(1

)

(18

)

 

 

 

 

 

 

Net decrease in cash and cash equivalents

 

(21,408

)

(161,067

)

 

 

 

 

 

 

Cash and cash equivalents, beginning of period

 

28,846

 

198,678

 

 

 

 

 

 

 

Cash and cash equivalents, end of period

 

$

7,438

 

$

37,611

 

 

 

 

 

 

 

Supplemental disclosures of cash flow information:

 

 

 

 

 

Interest paid

 

$

16

 

$

586

 

Deemed dividend on redeemable common shares

 

$

48

 

$

46

 

Forfeitures of unearned stock-based compensation

 

$

56

 

$

46

 

Equipment and software acquired under capital leases

 

$

20

 

$

15,197

 

 

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 Annual Report on Form 10-K for the year ended December 31, 2004.  The accompanying unaudited consolidated financial statements reflect all adjustments, consisting of normal recurring adjustments, which are, in the opinion of management, necessary for a fair statement of results for the interim periods presented.  Preparing financial statements requires management to make estimates and assumptions that affect the amounts that are reported in the consolidated financial statements and accompanying disclosures.  Although these estimates are based on management’s best knowledge of current events and actions that the Company may undertake in the future, actual results may be different from the estimates.  The results of operations for the three months ended March 31, 2005 are not necessarily indicative of the results to be expected for any future period or the full fiscal year.

 

2. ACCOUNTING POLICIES

 

Derivative instruments

 

SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS No. 133”), requires companies to recognize all of its derivative instruments, including certain derivative instruments embedded in other contracts, as either assets or liabilities in the balance sheet at fair value. The accounting for changes in the fair value of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship and further, on the type of hedging relationship. For those derivative instruments that are designated and qualify as hedging instruments, a company must designate the hedging instrument, based upon the exposure being hedged, as a fair value hedge, a cash flow hedge or a hedge of a net investment in an international operation. For derivatives designated as hedges, the changes in fair value are recorded in the balance sheet as an item in other comprehensive income.  Changes in the fair value of derivatives not designated as hedges are recorded in the statement of operations.  As of March 31, 2005, the Company had not designated any derivative instruments as hedges.

 

Advertising expense

 

The Company recognizes advertising expenses in accordance with SOP 93-7 Reporting on Advertising Costs.  As such, the Company expenses the costs of producing advertisements at the time production occurs or the first time the advertising takes place, and expenses the cost of communicating advertising in the period during which the advertising space or airtime is used.  Internet advertising expenses are recognized as incurred based on the terms of the individual agreements, which 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 $4,111 and $16,481 during the three months ended March 31, 2004 and 2005, respectively.

 

Recent accounting pronouncements

 

In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 123 (revised 2004) Share-Based Payment. This standard requires companies to measure and recognize the cost of employee services received in exchange for an award of

 

5



 

equity instruments based on the grant-date fair value. The effective date is the first annual reporting period beginning after June 15, 2005. The Company is currently evaluating pricing models and the transition provisions of this standard and will begin expensing stock options in the first quarter of 2006.

 

In November 2004, the FASB issued SFAS No. 151, Inventory Costs—an Amendment of ARB No. 43, Chapter 4. This standard provides clarification that abnormal amounts of idle facility expense, freight, handling costs, and spoilage should be recognized as current-period charges. Additionally, this standard requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The provisions of this standard are effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The adoption of this standard is not expected to have a material impact to the Company’s financial statements.

 

In March 2004, the FASB issued EITF Issue No. 03-1 (“EITF 03-1”), The Meaning of Other-than-Temporary Impairments and its Application to Certain Investments, which provides new guidance for assessing impairment losses on investments. Additionally, EITF 03-1 includes new disclosure requirements for investments that are deemed to be temporarily impaired. In September 2004, the FASB delayed the accounting provisions of EITF 03-1; however, the disclosure requirements remain effective for annual periods ending after June 15, 2004. The Company will evaluate the impact of EITF 03-1 once final guidance is issued.

 

On March 29, 2005, the SEC published Staff Accounting Bulletin (“SAB”) No. 107, which provides the Staffs views on a variety of matters relating to the interaction between Statement of Financial Accounting Standards Statement No. 123 (revised 2004), Share-Based Payment (“Statement 123R”) and certain Securities and Exchange Commission Rules and regulations.  The Company is currently evaluating the provisions of the SAB and will implement it when the Company begins expensing stock options under Statement 123R in the first quarter of 2006.

 

3. MARKETABLE SECURITIES

 

The Company’s marketable securities consist of funds deposited into capital management accounts managed by two financial institutions at March 31, 2005 as follows: 

 

 

 

Cost Basis

 

Unrealized
Gains

 

Unrealized
Losses

 

Realized
Losses

 

Fair Value

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. government and government agency securities

 

$

39,159

 

$

1

 

$

(172

)

$

 

$

38,988

 

Corporate securities

 

11,755

 

252

 

 

 

12,007

 

Foreign corporate securities (see Note 4)

 

49,937

 

 

 

(344

)

49,593

 

Money market securities

 

17,887

 

 

(5

)

 

17,882

 

Mortgage-backed securities

 

37,125

 

 

(438

)

 

36,687

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

155,863

 

$

253

 

$

(615

)

$

(344

)

$

155,157

 

 

All marketable securities mature between 2005 and 2029 and are classified as available-for-sale securities.  Available-for-sale securities are classified as current as they are deemed available for use, if needed for current operations.

 

4. DERIVATIVE INSTRUMENTS

 

During the first quarter of 2005, the Company purchased $49,937 of Foreign Corporate Securities (“Notes”) which fully mature in November 2006.  The Notes do not have a stated interest rate, but are structured to return the entire principal amount and a conditional coupon if held to maturity.  The conditional coupon will provide a rate of return dependent on the performance of a “basket” of eight Asian currencies against the U.S. dollar.  If the Company redeems the Notes prior to maturity, the Company may not realize the full amount of our initial investment.  At March, 31, 2005, the Notes had a fair value of $49,593.

 

Under SFAS No. 133, the Notes are considered to be derivative financial instruments and are marked to market quarterly.  Any unrealized gain or loss based on the quarterly mark-to-market valuation will be recorded in the income statement as a component of interest income.  The impact of the Notes’ mark-to-market valuation resulted in a loss of $344 for the quarter ended March 31, 2005.

 

6



 

The Company purchased the Notes to manage its foreign currency risks related to the strengthening of Asian currencies compared to the U.S. dollar, which would reduce the inventory purchasing power of the Company in Asia.  However, the Company determined that the Notes did not qualify as hedging derivative instruments.  Nevertheless, management believes that such instruments are useful in managing the Company’s associated risk.

 

5. OTHER COMPREHENSIVE LOSS

 

The Company follows SFAS No. 130, Reporting Comprehensive Income.  This Statement establishes requirements for reporting comprehensive income and its components.  The Company’s comprehensive loss for the three months ended March 31, 2004 and 2005 is as follows:

 

 

 

Three months ended
March 31,

 

 

 

2004

 

2005

 

 

 

 

 

 

 

Net loss

 

$

(2,210

)

$

(4,203

)

Unrealized gain (loss) on marketable securities

 

19

 

(327

)

Foreign currency translation adjustment

 

(1

)

(18

)

 

 

 

 

 

 

Other comprehensive loss

 

$

(2,192

)

$

(4,548

)

 

6. NET LOSS PER SHARE

 

Basic earnings (loss) per share is computed by dividing net income (loss) attributable to common shares for the period by the weighted average number of common shares outstanding during the period.  Diluted earnings (loss) per share assumes the exercise of all options and warrants which are dilutive, whether exercisable or not and is computed by dividing net income (loss) attributable to common shares for the period by the weighted average number of common and potential common shares outstanding during the period.  Potential common shares, composed of incremental common shares issuable upon the exercise of stock options, warrants and convertible senior notes, are included in the calculation of diluted net loss per share to the extent such shares are dilutive.  During the three-month periods ended March 31, 2004 and 2005, the effects of outstanding stock options, warrants and convertible senior notes were antidilutive and, accordingly, have been excluded from diluted loss per share.  There were 1,468 options and 863 warrants outstanding at March 31, 2005.  As of March 31, 2005, the Company had $120,000 of convertible senior notes outstanding (Note 12), which could potentially convert into 1,574 shares of common stock in the aggregate.

 

7. BUSINESS SEGMENTS

 

Segment information has been prepared in accordance with SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information.  There were no inter-segment sales or transfers during the three-month periods ended March 31, 2004 or 2005.  The Company evaluates the performance of its segments and allocates resources to them based primarily on gross profit. The table below summarizes information about reportable segments for the three months ended March 31, 2004 and 2005:

 

7



 

 

 

Three months ended March 31,

 

 

 

Direct
operations

 

Fulfillment
partner
operations

 

Consolidated

 

2004

 

 

 

 

 

 

 

Revenue

 

$

38,580

 

$

43,498

 

$

82,078

 

Cost of goods sold

 

34,816

 

38,793

 

73,609

 

 

 

 

 

 

 

 

 

Gross profit

 

$

3,764

 

$

4,705

 

8,469

 

Operating expenses

 

 

 

 

 

(10,763

)

Other income (expense), net

 

 

 

 

 

84

 

 

 

 

 

 

 

 

 

Net loss

 

 

 

 

 

$

(2,210

)

 

 

 

 

 

 

 

 

2005

 

 

 

 

 

 

 

Revenue

 

$

67,884

 

$

97,997

 

$

165,881

 

Cost of goods sold

 

58,153

 

82,857

 

141,010

 

 

 

 

 

 

 

 

 

Gross profit

 

$

9,731

 

$

15,140

 

24,871

 

Operating expenses

 

 

 

 

 

(28,273

)

Other income (expense), net

 

 

 

 

 

(801

)

 

 

 

 

 

 

 

 

Net loss

 

 

 

 

 

$

(4,203

)

 

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

 

The fulfillment partner segment includes revenues, direct costs and cost allocations associated with the Company’s third party fulfillment partner sales and are earned from selling the merchandise of third parties over the Company’s Websites. Costs for this segment include product costs, warehousing and fulfillment costs, credit card fees and customer service costs. This segment also includes revenues and direct costs associated with our on-line auctions business.

 

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

 

For the quarters ended March 31, 2004 and 2005, over 99% of 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 December 31, 2004 and March 31, 2005, all of the Company’s fixed assets were located in the United States of America.

 

8. PUBLIC OFFERINGS

 

In June 2004, the Company closed its second follow-on public offering, pursuant to which it sold 1,300 shares of common stock, with proceeds to the Company of approximately $37,857, net of $405 of issuance costs.

 

In November 2004, the Company closed an additional follow-on public offering, pursuant to which it sold 1,380 shares of common stock, with proceeds to the Company of approximately $75,207, net of $215 of issuance costs. Concurrently in November 2004, the Company issued convertible senior notes pursuant to which it received $116,199, net of $3,801 of initial purchaser’s discount and debt issuance costs.

 

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

 

8



 

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.

 

 

 

Three months ended March 31,

 

 

 

2004

 

2005

 

 

 

 

 

 

 

Net loss, as reported

 

$

(2,210

)

$

(4,203

)

 

 

 

 

 

 

Add:  Stock-based employee compensation expense included in reported net income

 

135

 

20

 

 

 

 

 

 

 

Deduct:  Total stock-based employee compensation expense determined under fair value based method for all awards

 

(1,108

)

(904

)

 

 

 

 

 

 

Pro forma net loss

 

$

(3,183

)

$

(5,087

)

 

 

 

 

 

 

Net loss per common share

 

 

 

 

 

Basic and diluted - as reported

 

$

(0.14

)

$

(0.21

)

Basic and diluted - pro forma

 

$

(0.19

)

$

(0.26

)

 

The fair value of options granted is estimated at the date of grant using the Black-Scholes option pricing model.  The Black-Scholes option pricing model requires the input of highly subjective assumptions, including the expected stock price volatility.  We use the historical stock price volatility of our common stock over the most recent period that is generally commensurate with the expected option life as the basis for estimating stock price volatility.  For options granted in each of the first quarters ended March 31, 2004 and 2005, the historical stock price volatility used was based on a daily stock price observation, using the closing price, which resulted in an expected stock price volatility of 105% and 95%, for those respective periods.  For purpose of the above pro forma disclosure, the fair value of options granted is amortized to stock-based employee compensation cost over the period(s) in which the related employee services are rendered.  Accordingly, the pro forma stock-based compensation cost for any period will typically relate to options granted in both the current period and prior periods.

 

10. SHARE BUYBACK PROGRAM

 

During January 2005, the Company’s Board of Directors authorized a stock buyback program under which the Company was authorized to repurchase up to $50,000 of its common stock through December 31, 2007.  On April 26, 2005, the Board of Directors increased the amount of the stock buyback program to $100,000. Pursuant to this stock buyback program, the Company has purchased some stock in the open market through May 6, 2005.

 

As of March 31, 2005, the Company had entered into several purchased call options, pursuant to which the Company may purchase up to 1,250 shares of its common stock at certain settlement dates during the quarter ending June 30, 2005.  In connection with these repurchase transactions; the Company has paid approximately $47,507, which has been recorded in shareholders’ equity in the consolidated balance sheet as of March 31, 2005.

 

Upon settlement, the Company, at its option, may elect to settle the contracts by physical settlement, net share settlement or net cash settlement.  Accordingly, the Company expects to receive either its capital investment returned with a premium or shares of our common stock, depending on whether the market price of the Company’s common stock is above or below a pre-determined price agreed in connection with each transaction.

 

9



 

11. BORROWINGS

 

In December 2004, the Company entered into an amendment to a credit agreement (“Amended Credit Agreement”) with Wells Fargo Bank, National Association. The existing credit agreement (originally executed in February 2004) provided the Company with a revolving line of credit for the purpose of issuing up to $10,000 of letters of credit for the purchase of inventory. The Amended Credit Agreement provides a revolving line of credit to the Company of up to $30,000 and expires December 31, 2005. The Company has an option to renew the Amended Credit Agreement annually. Included in the $30,000 Amended Credit Agreement is a $15,000 sub-limit for a revolving line of credit which the Company uses to obtain letters of credit to support inventory purchases. At March 31, 2005 the issuing bank or an affiliate of the bank had letters of credit totaling $11,082 issued on our behalf under this facility.

 

Interest on borrowings is payable monthly and accrues at either (i) one-half of one percentage point (0.50%) above LIBOR in effect on the first day of an applicable fixed rate term, or (ii) at a fluctuating rate per annum determined by the bank to be one half a percent (0.50%) above daily LIBOR in effect on each business day a change in daily LIBOR is announced by the bank. Unpaid principal, together with accrued and unpaid interest is due on the maturity date, December 31, 2005. Borrowings under the facility are collateralized by the Company’s cash and marketable securities deposited at Wells Fargo or its affiliates, and the Company is required to maintain balances with Wells Fargo or its affiliates of up to $37.0 million in order to have the full amount of the credit facility available. At March 31, 2005, there was no outstanding balance on this line.

 

The Amended Credit Agreement requires the Company to comply with certain covenants, including restrictions on mergers, business combinations or transfer of assets. The Company was in compliance with these covenants at March 31, 2005.

 

Capital leases

 

Future minimum lease payments under capital leases are as follows:

 

Year Ending
March 31,

 

 

 

2006

 

$

9,982

 

2007

 

4,851

 

2008

 

3,004

 

2009

 

2

 

 

 

 

 

Total minimum lease payments

 

17,839

 

Less: amount representing interest

 

(1,455

)

 

 

 

 

Present value of capital lease obligations

 

16,384

 

Less: current portion

 

(9,266

)

 

 

 

 

Capital lease obligations, non-current

 

$

7,118

 

 

12. 3.75% CONVERTIBLE SENIOR NOTES

 

In November 2004, the Company completed an offering of $120,000 of 3.75% Convertible Senior Notes (the “Senior Notes”). This includes $20,000 of additional Senior Notes issued to the initial purchaser upon exercise of its 30-day purchase option to cover over-allotments. Proceeds to the Company were $116,199, net of $3,801 of initial purchaser’s discount and debt

 

10



 

issuance costs. The discount and debt issuance costs are being amortized using the straight-line method which approximates the interest method. During the first quarter of 2005, the Company recorded amortization of discount and debt issuance costs related to this offering totaling $307. Interest on the Senior Notes is payable semi-annually on June 1 and December 1 of each year, beginning June 1, 2005. The Senior Notes mature on December 1, 2011 and are unsecured and rank equally in right of payment with all existing and future unsecured, unsubordinated debt and senior in right of payment to any existing and future subordinated indebtedness.

 

The Senior Notes are convertible at any time prior to maturity into the Company’s common stock at the option of the note holders at a conversion price of $76.23 per share or approximately 1,574 shares in aggregate (subject to adjustment in certain events, including stock splits, dividends and other distributions and certain repurchases of the Company’s stock, as well as certain fundamental changes in the ownership of the Company). Beginning December 1, 2009, the Company has the right to redeem the Senior Notes, in whole or in part, for cash at 100% of the principal amount plus accrued and unpaid interest. Upon the occurrence of a fundamental change (including the acquisition of a majority interest in the Company, certain changes in the Company’s board of directors or the termination of trading of the Company’s stock) meeting certain conditions, holders of the Senior Notes may require the Company to repurchase for cash all or part of their notes at 100% of the principal amount plus accrued and unpaid interest.

 

The indenture governing the Senior Notes requires the Company to comply with certain affirmative covenants, including making principal and interest payments when due, maintaining our corporate existence and properties, and paying taxes and other claims in a timely manner. The Company was in compliance with these covenants at March 31, 2005.

 

13. COMMITMENTS AND CONTINGENCIES

 

The Company leases 43 square feet of office space under an operating lease which was originally scheduled to expire in January 2007. However, this lease will be terminated and replaced with a lease agreement the Company entered into in December 2004 for a new office building in the Old Mill Corporate Center III in Salt Lake City, Utah. Pursuant to this agreement, the Company will lease approximately 143 rentable square feet for a term of 10 years beginning when the Company occupies the premises, which the Company expects to be in the summer of 2005 when construction is completed. On February 11, 2005, the Company and Old Mill Corporate Center III, LLC (the “Lessor”) entered into a Tenant Improvement Agreement (the “OMIII Agreement”) relating to the office building. The OMIII Agreement sets forth the terms on which the Company will pay the costs of certain improvements to the leased office space. The amount of the costs is estimated to be approximately $2,000. The OMIII Agreement requires the Company to reimburse the Lessor for the amount of the costs within 30 days after presentation of invoices or written requests for reimbursement. The OMIII Agreement also requires the Company to provide either a cash deposit or a letter of credit in the amount of $500 to the Lessor to provide funds for the removal of the improvements upon the termination of the lease.

 

The Company also leases 354 square feet for its warehouse facility in Salt Lake City, Utah under an operating lease which expires in August 2012.

 

Minimum future payments under these leases are as follows:

 

Year Ending
March 31,

 

 

 

2006

 

$

4,754

 

2007

 

5,295

 

2008

 

4,846

 

2009

 

4,977

 

2010

 

5,112

 

Thereafter

 

25,037

 

 

 

 

 

 

 

$

50,021

 

 

11



 

Rental expense for operating leases totaled $390 and $644 for the quarters ended March 31, 2004 and 2005, respectively.

 

From time to time, the Company receives claims of and becomes subject to consumer protection, employment, intellectual property and other commercial litigation related to the conduct of the Company. 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 the Company’s, prospects, results of operations, financial condition or cash flows. However, the Company does not currently believe that any of its outstanding litigation will have a material impact on its financial statements.

 

In October 2003, Tiffany (NJ) Inc. and Tiffany and Company filed a complaint against the Company in the United States District Court for the Southern District of New York alleging that the Company had distributed counterfeit and otherwise unauthorized Tiffany product in violation of federal copyright and trademark law and related state laws. The complaint seeks statutory and other damages in an unspecified amount and injunctive relief. In January and February 2005, Tiffany (NJ) Inc. and Tiffany and Company filed five additional complaints against the Company in the United States District Court for the Southern District of New York alleging that the Company had distributed counterfeit and otherwise unauthorized Tiffany product in violation of federal copyright and trademark law and related state laws. These complaints also seek statutory and other damages in an unspecified amount and injunctive relief. Although the Company has filed answers to these complaints and the Company believes it has defenses to the allegations and intends to pursue them vigorously, the Company does not have sufficient information to assess the validity of the claims or the amount of potential damages alleged in these suits.

 

In July 2004, Printmaker International, Ltd. filed a complaint against the Company in the United States District Court for the Southern District of New York alleging that the Company has distributed counterfeit and otherwise unauthorized product in violation of federal copyright and trademark law and related state laws. During the quarter ended March 31, 2005, Printmaker International, Ltd. dismissed the complaint with prejudice.  The Company did not admit to any liability or make any settlement payment.

 

In May 2004, the Company filed a complaint against TLMT Holdings, Inc (f/k/a LastMinuteTravel.com, Inc.) in the Superior Court of the State of Delaware alleging that it breached its contract with the Company. In July 2004, TLMT Holdings filed a counterclaim against the Company alleging that the Company had breached the contract. The counterclaim seeks damages in an unspecified amount. During the quarter ended March 31, 2005, the parties dismissed the claims against each other.  While the terms of the settlement agreement are confidential, the Company did not admit to any liability and did not make any settlement payment.

 

In January 2003, the Company received a letter from NCR Corporation claiming that certain of its 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 the Company does not agree to enter into licensing arrangements with respect to the asserted patents. On January 31, 2003, the Company filed a complaint in the United States District Court of Utah, Central Division, seeking declaratory judgment that the Company did 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, the Company filed an answer denying the material allegations in NCR’s counterclaims. On May 12, 2003, the parties entered into

 

12



 

a standstill agreement, agreeing 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 reserved all claims and counterclaims. In August 2004, NCR notified the Company of its intent to terminate the standstill agreement. On September 2, 2004, the Company re-filed our complaint in the United States District Court of Utah, Central Division, seeking declaratory judgment that the Company does not infringe any valid claim of the patents asserted by NCR. On October 4, 2004, NCR filed an answer and counterclaims alleging that certain of our business practices and information technology systems infringe patents owned by NCR. On October 12, 2004, the Company filed an answer denying the material allegations in NCR’s counterclaims.  In March 2005, the parties entered into a confidential settlement agreement which dismissed the complaint and counterclaims with prejudice.  The Company did not pay any damages as part of the settlement.

 

In September 2004, the Company received a letter from BTG International Inc. claiming that certain of its business practices and online marketing information technology systems infringe patents owned by BTG. On September 14, 2004, without engaging in any meaningful discussion or negotiation with the Company, BTG filed a complaint in the United States District Court of Delaware alleging that certain of the Company’s business practices and online marketing information technology systems infringe a single patent owned by BTG. On October 21, 2004, the Company filed an answer denying the material allegations in BTG’s claims. Although the Company has filed an answer and believes it has defenses to the allegations and intends to pursue them vigorously, the BTG lawsuit is in the early stages of discovery, and the Company does not have sufficient information to assess the validity of the claims or the amount of potential damages.

 

14. INDEMNIFICATIONS AND GUARANTEES

 

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

 

15. VARIABLE INTEREST ENTITY

 

In August 2004, the Company entered into an agreement which allows the Company to lend up to $10,000 to an entity for the purpose of buying inventory, primarily to supply a new category within our jewelry store which allows customers purchasing diamond rings to select both a specific diamond and ring setting. In November 2004, the Company loaned the entity $8,400. The promissory note bears interest at 3.75% per annum. The Company will also receive fifty percent (50%) of any profits of the entity. Interest shall be due and payable quarterly on the fifteenth day of February, May, August and November, commencing on November 15, 2004 until the due date of November 30, 2006, on which all principal and interest accrued and unpaid thereon, shall be due and payable. The promissory note is collateralized by all of the assets of the entity.

 

13



 

The Company has a ten year option to purchase (“Purchase Option”) 50% of the ownership and voting interest of the entity. The exercise price of the Purchase Option is the sum of (a) one thousand dollars, and (b) $3.0 million, which may be paid, at the Company’s election, in cash or by the forgiveness of $3.0 million of the entity’s indebtedness to the Company.

 

The entity was evaluated in accordance with FASB Interpretation No. 46 (Revised), Consolidation of Variable Interest Entities—an Interpretation of ARB No. 51, and it was determined to be a variable interest entity for which the Company was determined to be the primary beneficiary. As such, the financial statements of the entity are consolidated into the financial statements of the Company.

 

The carrying amount and classification of the consolidated assets that are collateral for the entity’s obligations include:

 

 

 

March 31,
2005

 

Cash

 

$

287

 

Accounts receivable

 

35

 

Inventory

 

7,862

 

Prepaid expenses

 

63

 

Property and equipment

 

264

 

 

 

 

 

 

 

$

8,511

 

 

14



 

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 fulfillment partner revenue; our beliefs regarding the sufficiency of our capital resources; planned distribution and order fulfillment capabilities; our beliefs, intentions and expectations regarding improvements of our order processing systems and capabilities; our intentions regarding the development of enhanced technologies and features; our intentions regarding the expansion of our customer service capabilities; our beliefs and intentions regarding improvements to our general and administrative functions; our beliefs and intentions regarding enhancements to our sales and marketing activities; our beliefs regarding the potential for growth in our customer base; our beliefs and intentions regarding our expansion into new markets, including international markets; our beliefs and intentions about entering into agreements to provide products and services to retail chains and other businesses; our belief regarding potential development of new Websites; our beliefs, intentions and expectations regarding promotion of new or complimentary products and sales formats; our beliefs, intentions and expectations regarding the expansion of our product and service offerings; our beliefs and intentions regarding expanding our market presence through relationships with third parties; our beliefs regarding the pursuit of complimentary businesses and technologies; our beliefs regarding the adequacy of our insurance coverage; our beliefs, intentions and expectations regarding litigation matters and other legal proceedings,and our defenses and responses to such matters; our beliefs and expectations regarding our existing cash and cash equivalents, cash requirements and sufficiency of capital; and our beliefs and expectations regarding interest rate risk, our investment activities and the effect of changes in interest rates.

 

These forward-looking statements are subject to risks and uncertainties that could cause actual results and events to differ materially. For a detailed discussion of these risks and uncertainties please see 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

 

We are an online “closeout” retailer offering discount brand name merchandise, including bed-and-bath goods, home décor, kitchenware, watches, jewelry, electronics, sporting goods, apparel, designer accessories and travel, among other products.  We also sell books, magazines, CD’s, DVD’s, videocassettes and video games (“BMV”). Our company, based in Salt Lake City, Utah, was founded in 1997, and we launched our first Website through which customers could purchase products in March 1999. In September 2004, we launched an online auction site as part of our Website – an online marketplace for the buying and selling of goods between our customers.

 

Our revenue is comprised of direct revenue and fulfillment partner revenue. During the quarter ended March 31, 2005, no single customer accounted for more than 1% of our total revenue. Direct revenue includes sales made to individual consumers and businesses, which are fulfilled from our warehouse in Salt Lake City, Utah or our outsourced warehouse located in Plainfield, Indiana.

 

Our fulfillment partner revenue is generated when we sell merchandise of other retailers, cataloguers or manufacturers (“fulfillment partners”) through our Website.  We are considered to be the primary obligor for the majority of these sales transactions, and we assume the risk of loss on the returned items. As a consequence, we record revenue from the majority of these sales transactions involving our fulfillment partners (excluding travel products) on a gross basis,.  Similar to our direct segment, fulfillment partner products are available to both consumers and businesses through our Club O frequent buyers club program and our Club O Gold bulk purchase program.  Our use of the term “partner” or “fulfillment partner” does not mean that we have formed any legal partnerships with any of our fulfillment partners.

 

15



 

During the fourth quarter of 2003, we added a discount travel store to our Website. We used fulfillment partners to supply the travel products and services (flights, hotels, rental cars, etc.). For the products and services sold in our travel store, we did not have inventory risk or pricing control, and did not provide customer service. Therefore, for these sales we were not considered to be the primary obligor, and recorded only our commission as revenue. For the first and second quarters of 2004, our revenues from the Travel department were insignificant.  During May of 2004, our travel store was closed so we could work to make improvements to the travel product offerings.  In January 2005, we re-opened the travel store on our Website with cruise offerings, and we plan to offer additional travel services later this year.

 

During September 2004, we added an online auction service to our Website.  Our auction tab allows sellers to list items for sale, buyers to bid on items of interest, and users to browse through listed items online.  We are not the seller of the items sold on the auction site and we have no control over the pricing of those items. Therefore, for these sales we record only our listing fees and commission for items sold as revenue. Unless otherwise indicated or required by the context, the discussion herein of our financial statements, accounting policies and related matters, pertains to our shopping site and not necessarily to our auction site. Revenue from our auctions business is included in the fulfillment partner segment 2005, as it is not large enough to separate out as its own segment at this early stage of the business.

 

Our revenue from sales on our shopping site is recorded net of returns, coupons and other discounts. Our returns policy for all products other than those sold in our Electronics and Computers department provides for a $4.95 restocking fee and the provision that we will not accept product returns initiated more than twenty days after the shipment date. We charge a 15% restocking fee (instead of the $4.95 restocking fee) on all items returned for non-defective reasons from the Electronics and Computers department.

 

Cost of goods sold 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. Within the direct revenue channel, our gross margins on sales through our Club O frequent buyers club, our Club O Gold bulk purchases program and our BMV products tend to be lower than margins on our consumer sales, and our overall gross margins will be impacted by the blend of Club O, Club O Gold, and BMV sales as a percentage of our direct revenue.

 

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 and our offline national radio and television advertising. Our advertising expenses totaled approximately $4.1 million and $16.5 million for the three months ended March 31, 2004 and 2005, respectively, which represent 94% and 98% of sales and marketing expenses for the respective periods. We expect our sales and marketing expenses to increase in future periods on an absolute dollar basis as we expect to continue to increase our advertising efforts.

 

General and administrative expenses consist of wages and benefits for executive, accounting, technology, merchandising and administrative personnel, rents and utilities, travel and entertainment, depreciation and amortization and other general corporate expenses.

 

Goodwill is not amortized, but is evaluated at least annually for impairment. There were no impairments of goodwill during the three months ended March 31, 2004 and 2005.

 

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.

 

16



 

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

 

Executive Commentary

 

The following executive commentary is intended to provide investors with a view of our business through the eyes of our management. As an executive commentary, it necessarily focuses on selected aspects of our business. This executive commentary is intended as a supplement to, but not a substitute for, the more detailed discussion of our business included elsewhere herein. Investors are cautioned to read our entire Management’s Discussion and Analysis of Financial Condition and Results of Operation, as well as our audited financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2004 and our unaudited financial statements included in this Quarterly Report on Form 10-Q as well as the discussion of our business and risk factors and other information included elsewhere in this Form 10-Q. This executive commentary includes forward-looking statements, and investors are cautioned to read the Special Note Regarding Forward-Looking Statements included in this Form 10-Q.

 

Commentary—Growth in Revenue.  Total revenue grew from $82.1 million during the first quarter of 2004 to $165.9 million in 2005, representing growth of 102%. During this same period, direct revenue increased from $38.6 million to $67.9 million (76% growth) and fulfillment partner revenue grew from $43.5 million to $98.0 million (125% growth).  Our total revenue continues to expand from increased marketing efforts, including nationwide television commercials and radio advertising campaigns. Additionally, for the entire month of March 2005 we implemented a promotional $1 shipping campaign, where we charged customers shipping of $1 per order versus the normal $2.95.  The increase in total revenue is also a reflection of our ability to acquire new customers, as evidenced by the addition of 796,000 new customers during the first quarter of 2005 compared to 429,000 new customers in 2004, an increase of 86%.

 

Commentary—Increases in Gross Bookings.  Management believes that to understand the year-over-year growth of our business and the results reflected in our financial statements, investors should understand the difference between our total revenue, as recorded under generally accepted accounting principles (“GAAP”), and the non-GAAP measure we call gross bookings.  Gross bookings represents the gross selling price of all transactions, including those for which we only record a commission under GAAP, before returns, sales discounts. Gross bookings grew 97% in the first quarter of 2005, from $93.4 million last year to $184.2 million in the first quarter this year.

 

Commentary—Improved Gross Margins and Growth in Gross Profits.  Quarterly gross margins during the last five quarterly periods from the first quarter of 2004 through the first quarter of 2005 were: 10.3%, 11.3%, 13.3%, 15.2% and 15.0%, respectively.

 

The improvements in gross margins are a result of the progress we achieved and efficiencies gained in several areas over the last five quarters.  In particular, we believe our buying has become more effective as we continue to grow, allowing us to make larger inventory purchases and obtain more favorable pricing. Our total cost per package shipped has decreased due to better process management and lower packaging costs, and as a result of increased sales volumes. Fulfillment costs during the first quarter of 2004 and 2005 were $6.8 million and $11.8 million, respectively, representing 8% and 7% of total revenue for those respective periods. As a result of increased volumes and improved vendor relationships, we have obtained decreases in both inbound and outbound shipping costs. Additionally, we have also made improvements to the cost of processing returns, customer service costs and credit card fees.

 

Management continues to believe that additional improvements can be made in shopping margins; however, no assurance can be given that this will occur.

 

With revenue up 102% (from $82.1 million in Q1 2004 to $165.9 million in Q2 2005), and gross margins increasing from 10.3% in Q1 2004 to 15.0% in Q1 2005, the mathematical product resulted in an

 

17



 

increase in gross profits growth of 194%.  In absolute dollars, gross profits increased from $8.5 million for the quarter ended March 31, 2004 to $24.9 million recorded during the same period in 2005.

 

Management considers a continued increase in gross profit dollars to be an important aspect of the Company’s results.  In addition, management believes the growth in gross profit dollars versus the growth in operating expenses is an important financial metric for the Company, with the goal to have gross profit dollars growing at a higher rate than operating expenses.  While gross profits grew 194% year-over year, operating expenses grew 163%.

 

Commentary—General and Administrative Expenses and Technology Costs.  General and administrative expenses increased from $4.9 million in the first quarter of 2004 to $7.3 million during the first quarter of 2005, an increase of 50%, which represents 6% and 4% of total revenue, respectively.  Technology costs increased 199%, from $1.4 million in the first quarter of 2004 to $4.1 million in the first quarter of 2005.  The increase in absolute dollars in our general and administrative expenses and our technology costs was primarily attributable to costs associated with building infrastructure, including expansion of corporate systems, consulting and support fees, related depreciation expenses, as well as additional personnel costs from increased corporate headcount.

 

Commentary—Marketing.  Sales and marketing expenses totaled $4.4 million and $16.8 million for the quarters ended March 31, 2004 and 2005, respectively, representing 5% and 10% of total revenue for each those respective quarters.  During the first quarter of 2005, we continued to spend marketing dollars aggressively in both on-line and off-line areas. In particular, we spent aggressively with the large portals (MSN, Yahoo & AOL) and in keyword search (Google), as well as in TV and radio advertising, which resulted in an increase in our sales and marketing expenses.

 

During the quarter ended March 31, 2005, we spent approximately $2.6 million of our television advertising on a targeted campaign outside of our normal advertising budget that we believe returned disappointing results and reduced overall return on our marketing investment in the quarter.

 

Management believes that our extensive marketing efforts directly resulted in a significant increase in March 2005 Website traffic (172% year over year).  However, much of the increase has been in lower-converting traffic as well as traffic to our auctions tab, and thus, sales did not increase in proportion to increases in traffic.

 

Commentary—Strategic Projects.  Following is a brief update on some of our recent strategic projects:

 

1) Auctions— Our Auctions continue what we believe to be a robust start, as we are able to maintain approximately 1% of the listings of eBay’s domestic business. We have found goodwill and support in the serious auction community, which is guiding us regarding the features and programs it wants us to develop.

 

2) Propeller —Our collaborative filtering initiative is live and we believe it is providing some sales lift. However, it still requires fine tuning, and we believe it will be more fully functional by the end of the summer.

 

3) Travel —While cruises are live, the date for completion of the tab (including other services such as flights, hotels, car rentals, etc.) slid from April to June.

 

4) Design Your Own Jewelry™ —We have added the ability on our website for a customer to design an engagement ring to their own specifications.  This department ran at a loss in the first quarter, and we expect that loss to continue for at least one or two more quarters. While we intend to run this with minimal inventory in the long term, we came across a large diamond buying opportunity (over $7 million of loose diamonds) that came to us just before we launched this

 

18



 

program.  As a result, the diamonds are a large portion of our inventory balance at the end of the quarter.

 

Critical Accounting Policies and Estimates

 

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

 

                  revenue recognition;

 

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

 

                  accounting for income taxes

 

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

 

                  derivative instruments

 

Revenue recognition.  We derive our revenue from three sources: (i) direct revenue, which consists of merchandise sales made to consumers and businesses that are fulfilled from our warehouse; (ii) fulfillment partner revenue, which consists of revenue from the sale of merchandise shipped by fulfillment partners directly to consumers and other businesses, as well as fee revenue collected from the products listed and sold through the auction tab of our Website; and (iii) commission revenue from our auctions and travel operations. All sources of revenue are recorded net of returns, coupons redeemed by customers, and other discounts. Revenue from our auction and travel services were not material in 2004 and therefore are included in fulfillment partner revenue.

 

We record revenue from the majority of these sales transactions involving our fulfillment partners (excluding auction and travel products) on a gross basis. Similar to our direct revenue segment, fulfillment partner products are available to both consumers and businesses through our Club O frequent buyers club and our Club O Gold bulk purchase program.

 

For sales transactions, we comply with the provisions of Staff Accounting Bulletin 104 “Revenue Recognition”, which states that revenue should be recognized when the following revenue recognition criteria are met: (1) persuasive evidence of an arrangement exists; (2) the product has been shipped or the service provided and the customer takes ownership and assumes the risk of loss; (3) the selling price is fixed or determinable; and (4) collection of the resulting receivable is reasonably assured. We generally require payment by credit card at the point of sale. Amounts received prior to when we ship the goods or provide the services to customers are recorded as deferred revenue. In addition, amounts received in advance for Club O and Club O Gold membership fees are recorded as deferred revenue and recognized over the membership period.

 

Reserve for returns, allowance for doubtful accounts 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 reserve and other

 

19



 

allowances in any accounting period. The reserve for returns was $781,000 and $1.9 million as of March 31, 2004 and 2005, respectively.

 

From time to time, we may grant credit to certain of our business customers on normal credit terms. We perform ongoing credit evaluations of our customers’ financial condition and maintain an allowance for doubtful accounts receivable based upon our historical collection experience and expected collectibility of all accounts receivable. We maintained an allowance for doubtful accounts receivable of $750,000 and $899,000 as of December 31, 2004 and March 31, 2005, respectively.

 

We write down our inventory for estimated obsolescence or damage equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required. Our inventory balance was $45.3 million, net of allowance for obsolescence or damaged inventory of $1.3 million as of December 31, 2004. At March 31, 2005, our inventory balance was $49.0 million, net of reserve for obsolescence or damaged inventory of $1.3 million.

 

Accounting for income taxes.  Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. As of December 31, 2004 and March 31, 2005, we have recorded a full valuation allowance of $28.5 million and $30.1 million, respectively, against our net deferred tax asset balance due to uncertainties related to our deferred tax assets as a result of our history of operating losses. The valuation allowance is based on our estimates of taxable income by jurisdiction in which we operate and the period over which our deferred tax assets will be recoverable. In the event that actual results differ from these estimates or we adjust these estimates in future periods, we may need to change the valuation allowance, which could materially impact our financial position and results of operations.

 

Valuation of long-lived and intangible assets and goodwill.  Under SFAS 142, Goodwill and Other Intangible Assets, goodwill is 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 the quarter ended March 31, 2005. Goodwill totaled $2.8 million as of December 31, 2004 and March 31, 2005.

 

Derivative instruments.  SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS No. 133”), requires companies to recognize all of its derivative instruments, including certain derivative instruments embedded in other contracts, as either assets or liabilities in the balance sheet at fair value. The accounting for changes in the fair value of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship and further, on the type of hedging relationship. For those derivative instruments that are designated and qualify as hedging instruments, a company must designate the hedging instrument, based upon the exposure being hedged, as a fair value hedge, a cash flow hedge or a hedge of a net investment in an international operation. For derivatives designated as hedges, the changes in fair value are recorded in the balance sheet as an item in other comprehensive income.  Changes in the fair value of derivatives not designated as hedges are recorded in the statement of operations.  As of March 31, 2005, the Company had not designated any derivative instruments as hedges.

 

20



 

Results of Operations — 2004 compared to 2005

 

Revenue

 

Total revenue grew from $82.1 million during the first quarter of 2004 to $165.9 million in 2004, representing growth of 102%. During this same period, direct revenue increased from $38.6 million to $67.9 million (76% growth) and fulfillment partner revenue grew from $43.5 million to $98.0 million (125% growth).  Our total revenue continues to expand from increased marketing efforts, including new nationwide television commercials and radio advertising campaigns. Additionally, for the entire month of March 2005, we experimented with a $1 shipping campaign, in which we charged customers $1 versus the normal $2.95 per order.  The increase in total revenue is also a reflection of our ability to acquire new customers, as evidenced by our addition of 796,000 new customers during the first quarter of 2005 compared to 429,000 new customers in the first quarter of 2004, an increase of 86%.

 

Gross bookings totaled $93.4 million and $184.2 million for the quarters ended March 31, 2004 and 2005, respectively, representing an increase of 97%. Gross bookings differ from GAAP revenue in that gross bookings represent the gross sales price of goods sold by the Company before returns and sales discounts.

 

Cost of goods sold

 

Cost of goods sold increased in absolute dollars, from $73.6 million during the first quarter of 2004 to $141.0 million in 2005. In comparing the first quarters of 2004 and 2005, total revenue increased 102% (from $82.1 million to $165.9 million) while gross profit dollars increased 194%.  However, as a percent of total revenue, cost of goods sold decreased from 90% to 85% for those respective periods resulting in gross margins of 10% and 15% for the quarters ended March 31, 2004 and 2005, respectively. Quarterly gross margins during the last five quarterly periods from the first quarter of 2004 through the first quarter of 2005 were: 10.3%, 11.3%, 13.3%, 15.2% and 15.0%, respectively.  The improvements in gross margins are a result of the progress we achieved and efficiencies gained in several areas.  In particular, we believe our buying has become more effective as we continue to grow, allowing us to make larger inventory purchases and obtain more favorable pricing. In addition, we have made improvements to our fulfillment costs. Fulfillment costs during the first quarter of 2004 and 2005 were $6.8 million and $11.8 million, respectively, representing 8% and 7% of total revenue for those respective periods. Fulfillment costs include warehousing (excluding packaging costs), customer service costs and credit card fees. In addition, as a result of increased volumes and improved vendor relationships, we have obtained decreases in both inbound and outbound shipping costs.

 

 

 

Quarter ended March 31,

 

 

 

2004

 

2005

 

 

 

 

 

 

 

 

 

 

 

Total revenue

 

$

82,078

 

100

%

$

165,881

 

100

%

Cost of goods sold

 

 

 

 

 

 

 

 

 

Product costs, freight costs, and other cost of goods sold

 

66,788

 

81

%

129,161

 

78

%

Fulfillment costs

 

6,821

 

8

%

11,849

 

7

%

Total cost of goods sold

 

73,609

 

89

%

141,010

 

85

%

Gross profit

 

$

8,469

 

11

%

$

24,871

 

15

%

 

Gross profits for our direct operations increased from $3.8 million for the quarter ended March 31, 2004 to $9.7 million recorded during the same period in 2005. For our direct operations, gross profit dollars increased 159% on a year-over-year basis while sales increased 76%. Gross profits for our direct operations, as a percentage of direct revenue increased from 10% during the first quarter of 2004 to 14% during the first quarter of 2005. This was primarily due to the efficiencies received including more favorable pricing and effective buying as well as decreases in outbound and inbound shipping costs.

 

Our fulfillment partner operations generated gross profits of $4.7 million (11% margins) and $15.1 million (15% margins) for the quarters ended March 31, 2004 and 2005, respectively. The increase in the gross profit dollars for our fulfillment partner operations was due to the general growth of the consumer

 

21



 

business during the year, and an increase in the number of fulfillment partner products offered on our Websites. The increase in gross margins for our fulfillment partner operations is largely due to improvements in buying, customer service costs and credit card fees, as well as a decrease in BMV sales from 28% of fulfillment partner revenue during the first quarter of 2004 to 20% during the first quarter of 2005. Gross margins for BMV products have historically been much lower than those of other product categories.

 

Operating expenses

 

Sales and marketing.  Sales and marketing expenses totaled $4.4 million and $16.8 million for the quarters ended March 31, 2004 and 2005, respectively, representing 5% and 10% of total revenue for each those respective quarters. During 2004, online marketing rates generally increased. This increase coupled with our decision to increase our ongoing online marketing efforts, particularly with the large portals (MSN, Yahoo & AOL), and keyword search (Google) resulted in the increase in our sales and marketing expenses. In addition, we continued our television and radio campaigns through the first quarter of 2005.

 

General and administrative expenses and technology costs.  General and administrative expenses increased 50% from $4.9 million in the first quarter of 2004 to $7.3 million during the first quarter of 2005, representing 6% and 4% of total revenue, respectively.  Technology costs increased 199%, from $1.4 million in the first quarter of 2004 to $4.1 million in first quarter of 2005.  The increase in absolute dollars was primarily attributable to costs associated with building infrastructure, including expansion of corporate systems and additional personnel costs from increased corporate headcount. The increase in general and administrative expenses also included the costs associated with the strategic projects of 2005, namely, completion our auctions tab, reconstruction of our travel department and the development of our search engine. The 2005 increase also reflects significant increases in technology, legal and accounting costs over 2004.

 

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 $135,000 and $20,000 for the quarters ended March 31, 2004 and 2005, respectively.

 

Non-operating income (expense)

 

Interest income, interest expense and other income (expense).  The increase in interest income from $98,000 during the first quarter of 2004 to $644,000 during the first quarter of 2005 is due to the increase in our cash and marketable securities from our equity and debt offerings during 2004. Interest income was also offset by a loss due to changes in the fair value of our foreign corporate securities (Note 4).  Interest expense increased from $16,000 during the first quarter of 2004 to $1.4 million during the first quarter of 2005, primarily as a result of the interest expense from our convertible senior notes issued in November 2004. We recorded other income (expense) of $2,000 during the first quarter of 2004 and zero in 2005.

 

Income taxes

 

Income taxes.  At March 31, 2004 and 2005, we had net operating loss carryforwards of approximately $70.6 million and $82.8 million, respectively, which may be used to offset future taxable income. An additional $21.9 million of net operating losses are limited under Internal Revenue Code Section 382 to $799,000 a year. These carryforwards begin to expire in 2019.

 

Recent Accounting Pronouncements

 

In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 123 (revised 2004) Share-Based Payment. This standard requires companies to measure and recognize the cost of employee services received in exchange for an award of

 

22



 

equity instruments based on the grant-date fair value. The effective date is the first annual reporting period beginning after June 15, 2005. We are currently evaluating pricing models and the transition provisions of this standard and will begin expensing stock options in the first quarter of 2006.

 

In November 2004, the FASB issued SFAS No. 151, Inventory Costs—an Amendment of ARB No. 43, Chapter 4. This standard provides clarification that abnormal amounts of idle facility expense, freight, handling costs, and spoilage should be recognized as current-period charges. Additionally, this standard requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The provisions of this standard are effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The adoption of this standard is not expected to have a material impact to our financial statements.

 

In March 2004, the FASB issued EITF Issue No. 03-1 (“EITF 03-1”), The Meaning of Other-than-Temporary Impairments and its Application to Certain Investments, which provides new guidance for assessing impairment losses on investments. Additionally, EITF 03-1 includes new disclosure requirements for investments that are deemed to be temporarily impaired. In September 2004, the FASB delayed the accounting provisions of EITF 03-1; however, the disclosure requirements remain effective for annual periods ending after June 15, 2004. We will evaluate the impact of EITF 03-1 once final guidance is issued.

 

On March 29, 2005, the SEC published Staff Accounting Bulletin (“SAB”) No. 107, which provides the Staffs views on a variety of matters relating to the interaction between Statement of Financial Accounting Standards Statement No. 123 (revised 2004), Share-Based Payment (“Statement 123R”) and certain Securities and Exchange Commission Rules and regulations.  The Company is currently evaluating the provisions of the SAB and will implement it when the Company begins expensing stock options under Statement 123R in the first quarter of 2006.

 

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 2002 (in thousands):

 

 

 

First
Quarter

 

Second
Quarter

 

Third
Quarter

 

Fourth
Quarter

 

 

 

 

 

 

 

 

 

 

 

2005

 

$

165,881

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2004

 

82,078

 

$

87,792

 

$

103,444

 

$

221,321

 

 

 

 

 

 

 

 

 

 

 

2003

 

29,164

 

28,833

 

57,788

*

123,160

 

 

 

 

 

 

 

 

 

 

 

2002

 

12,067

 

14,380

 

23,808

 

41,529

 

 


* Note that beginning in the third quarter of 2003, total revenue reflects the change in the Company’s returns policy, as a result of which sales by fulfillment partners are now recorded “gross” instead of “net” as in prior quarters.

 

23



 

Off-Balance Sheet Arrangements

 

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

 

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, we completed follow-on offerings in February 2003, May 2004 and November 2004, pursuant to which we received approximately $24.0 million, $37.9 million and $75.2 million, respectively, in cash, net of underwriting discounts, commissions, and other related expenses. In November 2004, we also received $116.2 million in proceeds from the issuance of our convertible senior notes in a transaction exempt from registration under the Securities Act. At March 31, 2005, our cash and cash equivalents balance was $37.6 million and our marketable securities totaled $155.2 million.

 

Our operating activities resulted in net cash outflows of $21.8 million and $35.2 million for the quarters ended March 31, 2004 and 2005, respectively. The primary operating uses of cash and cash equivalents during the first quarter of 2005 was to fund our operations, including net losses of $4.2 million, and changes in accounts payable ($24.2 million), prepaid expenses ($6.3 million) and inventory ($3.7 million). This was offset by the change in prepaid inventory of $2.4 million.

 

Cash used in investing activities included $13.0 million in capital expenditures for property and equipment and a net decrease of $66.7 million from the purchase and sales of marketable securities. For the quarters ended March 31, 2004 and 2005, net cash used in investing activities amounted to $1.8 million and $79.1 million, respectively.

 

Net cash used in financing activities during the quarter ended March 31, 2005 amounted to $46.8 million, consisting primarily of purchased call options totaling $47.5 million and payments on capital lease obligations of $151,000, offset by proceeds from the exercise of stock options and warrants of $906,000.  Net cash provided by financing activities during the quarter ended March 31, 2004 was $2.1 million, primarily from the exercise of stock options and warrants.

 

Contractual Obligations and Commitments

 

The following table summarizes our contractual obligations as of March 31, 2005 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

 

$

120,000

 

$

 

$

 

$

 

$

120,000

 

Interest on convertible senior notes

 

31,588

 

4,588

 

9,000

 

9,000

 

9,000

 

Capital lease obligations

 

17,839

 

9,982

 

7,855

 

2

 

 

Operating leases

 

50,021

 

4,754

 

10,141

 

10,089

 

25,037

 

Purchase obligations

 

54,702

 

54,702

 

 

 

 

Total contractual cash obligations

 

$

274,150

 

$

74,026

 

$

26,996

 

$

19,091

 

$

154,037

 

 

24



 

 

 

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

 

Letters of credit

 

$

11,082

 

$

11,082

 

$

 

$

 

$

 

Redeemable common stock

 

3,212

 

 

3,212

 

 

 

Total commercial commitments

 

$

14,294

 

$

11,082

 

$

3,212

 

$

 

$

 

 

In November 2004, we completed an offering of $120.0 million of 3.75% Convertible Senior Notes (the “Senior Notes”). Interest on the Senior Notes is payable semi-annually on June 1 and December 1 of each year, beginning June 1, 2005. The Senior Notes mature on December 1, 2011 and are unsecured and rank equally in right of payment with all existing and future unsecured, unsubordinated debt and senior in right of payment to any existing and future subordinated indebtedness. The Senior Notes are convertible at any time prior to maturity into our common stock at the option of the note holders at a conversion price of $76.23 per share or approximately 1,574,000 shares (subject to adjustment in certain events, including stock splits, dividends and other distributions and certain repurchases of our stock, as well as certain fundamental changes in the ownership of the Company).

 

Beginning December 1, 2009, we have the right to redeem the Senior Notes, in whole or in part, for cash at 100% of the principal amount plus accrued and unpaid interest. Upon the occurrence of a fundamental change (including the acquisition of a majority interest in the Company, certain changes in the Company’s board of directors or the termination of trading of our stock) meeting certain conditions, holders of the Senior Notes may require us to repurchase for cash all or part of their notes at 100% of the principal amount plus accrued and unpaid interest.

 

The lease obligations include our obligations under a ten-year lease agreement we entered in December 2004 for approximately 143,000 square feet of office space in Salt Lake City. We expect to take possession of the new office space in the summer of 2005, and to terminate our lease obligations under our current office lease agreements at the same time. The total lease obligation over the ten-year term of the new lease is $39.6 million, of which approximately $1.9 million will be payable in 2005. In connection with the preparation of the new office space, we have agreed to provide a letter of credit for $500,000 to provide funds for the removal of the improvements upon termination of the new sublease and have also agreed to pay approximately $2.0 million for leasehold improvements. We expect to pay this entire amount for leasehold improvements during 2005.

 

The amount of purchase obligations shown is based on assumptions regarding the legal enforceability against us of purchase orders we had outstanding at March 31, 2005. Under different assumptions regarding our rights to cancel our purchase orders or different assumptions regarding the enforceability of the purchase orders under applicable law, the amount of purchase obligations shown in the table above would be less.

 

In December 2004, we replaced our senior secured credit facility with an amendment to a credit agreement (“Amended Credit Agreement”) with Wells Fargo Bank, National Association. The existing credit agreement (originally executed in February 2004) provided the Company with a revolving line of credit for the purpose of issuing up to $10.0 million of letters of credit for the purchase of inventory. The Amended Credit Agreement provides us a revolving line of credit of up to $30.0 million and expires December 31, 2005. We have an option to renew the Amended Credit Agreement annually. Included in the $30.0 million Amended Credit Agreement is a $15.0 million sub-limit for a revolving line of credit which we use to obtain letters of credit to support inventory purchases. At March 31, 2005 the issuing bank or an affiliate of the bank had letters of credit totaling $11.1 million issued on our behalf under this facility.

 

Interest on the facility is payable monthly and accrues at either (i) one-half of one percentage point (0.50%) above LIBOR in effect on the first day of an applicable fixed rate term, or (ii) at a fluctuating rate

 

25



 

per annum determined by the bank to be one half a percent (0.50%) above daily LIBOR in effect on each business day a change in daily LIBOR is announced by the bank. Unpaid principal, together with accrued and unpaid interest is due on December 31, 2005. Borrowings under the facility are collateralized by our cash and marketable securities deposited at Wells Fargo or its affiliates, and we are required to maintain balances with Wells Fargo or its affiliates of up to $37.0 million in order to have the full amount of the credit facility available to us. Consequently, although the facility provides us with some flexibility, it does not increase our liquidity. The Amended Credit Agreement requires us to comply with certain covenants, including restrictions on mergers, business combinations or transfers of assets. We were in compliance with these covenants at March 31, 2005. At March 31, 2005, there was no outstanding balance under the facility except for the outstanding letters of credit.

 

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

 

In January 2005, the Company’s Board of Directors authorized a stock buyback program under which we may repurchase up to $50.0 million of our common stock through December 31, 2007. In April 2005, the Company’s Board of Directors authorized an increase to the stock buyback program from $50.0 million to a total of $100.0 million.  Under the program, shares may be purchased as determined by management, from time to time and within certain guidelines, in the open market or in privately negotiated transactions, including privately negotiated structured stock repurchase transactions and through transactions in the options markets. Depending on market conditions and other factors, these purchases may be commenced or suspended at any time or from time to time without prior notice. Pursuant to the stock buyback program, the Company has purchased some stock in the open market through May 6, 2005.

 

In February and March 2005, in connection with the buyback program, we entered into several purchased call options, pursuant to which we may purchase up to 1,250,000 shares of our common stock at certain settlement dates during the quarter ending June 30, 2005. In connection with these repurchase transactions, we have paid approximately $47.5 million. Upon settlement, we, at our option, may elect to settle the contracts by physical settlement, net share settlement or net cash settlement. Accordingly, we expect to receive either our capital investment returned with a premium or shares of our common stock, depending on whether the market price of our common stock is above or below pre-determined prices agreed in connection with each such transaction.

 

To the extent that shares of common stock are delivered to us as a result of the transactions described above, the aggregate amount the Company pays or paid for the repurchase of the shares as a result of these transactions will reduce the amount we might otherwise have spent to directly repurchase shares from time to time under the stock repurchase program.

 

We believe that the cash and marketable securities currently on hand, amounts available under our credit facility and expected cash flows from operations will be sufficient to continue operations for at least the next twelve months. While we anticipate that, beyond the next twelve months, our expected 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, generate profitability 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.”

 

Government Regulation

 

All of our services are subject to federal and state consumer protection laws including laws protecting the privacy of consumer non-public information and regulations prohibiting unfair and deceptive trade practices. In particular, under federal and state financial privacy laws and regulations, we must provide

 

26



 

notice to consumers of our policies on sharing non-public information with third parties, must provide advance notice of any changes to our policies and, with limited exceptions, must give consumers the right to prevent sharing of their non-public personal information with unaffiliated third parties. Furthermore, the growth and demand for online commerce could result in more stringent consumer protection laws that impose additional compliance burdens on online companies. These consumer protection laws could result in substantial compliance costs and could interfere with the conduct of our business.

 

In January 2005, we received an inquiry from the Federal Trade Commission (“FTC”) regarding our shipping policies and systems and other matters. We are cooperating fully with the FTC’s inquiry. We are currently unable to determine the potential outcome of this inquiry.

 

In many states, there is currently great uncertainty whether or how existing laws governing issues such as property ownership, sales and other taxes, libel and personal privacy apply to the Internet and commercial online services. These issues may take years to resolve. In addition, new state tax regulations may subject us to additional state sales and income taxes. New legislation or regulation, the application of laws and regulations from jurisdictions whose laws do not currently apply to our business or the application of existing laws and regulations to the Internet and commercial online services could result in significant additional taxes on our business. These taxes could have an adverse effect on our cash flows and results of operations. Furthermore, there is a possibility that we may be subject to significant fines or other payments for any past failures to comply with these requirements.

 

Factors that May Affect Future Results

 

Any investment in our securities 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 our other filings with the SEC including those we file after we file this Form 10-Q, before deciding whether to purchase or hold our securities.  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 securities could decline due to any of these risks and uncertainties, and investors may lose part or all of their investment.

 

Risks Relating to Overstock

 

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 $2.3 million and $4.2 million for the quarters ended March 31, 2004 and 2005, respectively. As of December 31, 2004, and March 31, 2005, our accumulated deficit was $73.0 million and $77.3 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 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, including our auctions site, our travel site and our custom design jewelry site;

rent additional warehouse and office space;

 

27



 

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

maintain or increase our sales, branding and marketing activities, including maintaining existing or entering into new online marketing arrangements, and continuing or increasing our national television and radio branding campaigns.

 

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, prospects, 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.

 

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

 

Our limited operating history and the rapidly evolving nature of our industry make forecasting 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, prospects, 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 securities may decline.

 

We depend on our relationships with third party fulfillment partners 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 first quarter of 2005, we had fulfillment partner relationships with approximately 405 third parties whose products we offer for sale on our Websites. At March 31, 2005, these products accounted for approximately 62% of the non-BMV 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 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 fulfillment partner relationships or if other product manufacturers refuse to allow their products to be sold via the Internet, our business and prospects would suffer severely.

 

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

 

In our fulfillment partner business, although we handle returned merchandise, we continue to 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.com brand could suffer.

 

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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, prospects, results of operation and financial condition.

 

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.

 

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. In addition, conditions such as adverse weather can prevent any carriers from performing their delivery services, which can have an adverse effect on our customers’ satisfaction with us. In any of these circumstances, we may be unable to engage alternative carriers on a timely basis, upon terms favorable to us, or at all. Changing carriers would likely have a negative effect on our business, prospects, 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.

 

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 July 1, 2003, we started accepting returns of products sold through our fulfillment partners. We modify our policies relating to returns from time to time, and 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, prospects, 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.

 

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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, prospects, results of operations and financial condition.

 

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 on 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. Further, beginning July 1, 2003, we started accepting returns of products sold through our fulfillment partners, and we have the risk of reselling the returned products.

 

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 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, and we expect to add additional key personnel in the 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 harmed.

 

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 President 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 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

 

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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 revenues, business, prospects, financial condition and results of operations.

 

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 of our operations to offer additional types of products and services. We cannot assure you that our efforts to expand our business in this manner will succeed. Because we were unable to generate significant traffic for our former B2B site, in the third quarter of 2004, we merged the B2B site into our main website, and opened our “Club O Gold” bulk purchase program. Our failure to succeed in this market or other markets or other product or service offerings may harm our business, prospects, financial condition and results of operation. We cannot assure you that we will be able to expand our operations in a cost-effective or timely manner or that our efforts to expand will be successful. Furthermore, any new business or Website we launch that is not favorably received by consumers could damage our reputation or the Overstock.com brand. We may expand the number of categories of products we carry on our Websites, 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 expand our international business, causing our business to become increasingly susceptible to numerous international business risks and challenges that could affect our profitability.

 

We have begun to expand into international markets, and in the future we may do so more aggressively. 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;

the need to comply with additional laws and regulations to the extent applicable;

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.

 

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 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

 

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and our financial condition could be harmed. In addition, certain of our online marketing agreements may 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 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 periodically conduct national television and radio branding and advertising campaigns. Such campaigns are 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, prospects, financial condition and results of operations could suffer.

 

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 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 the excess inventory of third parties. Competitive pressures created by any one of our competitors, or by our competitors collectively, could 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, or discount brick and mortar retail, we would be competing with large established businesses such as APL Logistics, Ltd., Ross Stores, Inc. and TJX Companies, Inc., respectively. We have recently entered the online auctions business in which we compete with large established businesses including eBay, Inc.

 

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

 

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share and a diminished brand franchise. We cannot assure you that we will be able to compete successfully against current and future competitors.

 

Our operating results depend on our Websites, network infrastructure and transaction-processing systems. Capacity constraints or system failures would harm our business, prospects, 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 harm our business, prospects, 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 and during the holiday shopping season. Capacity constraints can cause unanticipated system disruptions, slower response times, degradation in levels of customer service, impaired quality and delays in reporting accurate financial information.

 

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.

 

If the facilities where substantially all of our computer and communications hardware is located fail, 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 systems. Substantially all of our computer and communications hardware is located at a single co-location facility in Salt Lake City, Utah, with a partially redundant back-up system located at our corporate headquarters in Salt Lake City. Although we have designed our back-up system in an effort to avoid or minimize service interruptions in the event of a failure of our main facility, 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 have 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 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,

 

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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.

 

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 the 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 in the United States or elsewhere as we expand internationally. 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.

 

We may not be able to enforce protection of our intellectual property rights under the laws of other countries.

 

As we continue to expand internationally, we are subject to risks of doing business internationally as related to our intellectual property, including:

 

legal uncertainty regarding liability for the listings and other content provided by our users, including uncertainty as a result of less Internet-friendly legal systems, unique local laws, and lack of clear precedent or applicable law; and

differing intellectual property laws, which may provide insufficient protection for our intellectual property.

 

Our business and reputation may be harmed by the listing or sale of pirated, counterfeit or illegal items by third parties, and by intellectual property litigation.

 

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 or that we have otherwise infringed third parties’ past, current or future intellectual property rights. For example, in October 2003, Tiffany (NJ) Inc. and Tiffany and Company filed a complaint against us in the United States District Court for the Southern District of New York

 

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alleging that we have distributed counterfeit and otherwise unauthorized Tiffany product in violation of federal copyright and trademark law and related state laws. In addition, in January 2005, Tiffany filed additional complaints against us asserting similar claims. See “Legal Proceedings” for additional information regarding our lawsuits with Tiffany and other third parties.

 

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 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 revenues, business, prospects, financial condition and results of operations.

 

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 claims could harm our business.

 

Negative publicity generated as a result of the foregoing could damage our reputation, harm our business and diminish the value of our brand name.

 

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 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

 

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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 have significant indebtedness.

 

In connection with our sale of our 3.75% Convertible Senior Notes (the “notes”) in November 2004, we incurred $120,000,000 of indebtedness. As a result of this indebtedness, our principal and interest payment obligations increased substantially. The degree to which we will be leveraged could materially and adversely affect our ability to obtain additional financing for working capital, acquisitions or other purposes and could make us more vulnerable to industry downturns and competitive pressures. Our ability to meet our debt service obligations will be dependent upon our future performance, which will be subject to financial, business and other factors affecting our operations, many of which are beyond our control.

 

We may be unable to generate sufficient cash flow to satisfy our debt service obligations.

 

Our ability to generate cash flow from operations to make interest payments on our debt obligations will depend on our future performance, which will be affected by a range of economic, competitive and business factors. We cannot control many of these factors, including general economic conditions and the health of the internet retail industry. If our operations do not generate sufficient cash flow from operations to satisfy our debt service obligations, we may need to borrow additional funds to make these payments or undertake alternative financing plans, such as refinancing or restructuring our debt, or reducing or delaying capital investments and acquisitions. Additional funds or alternative financing may not be available to us on favorable terms, or at all. Our inability to generate sufficient cash flow from operations or obtain additional funds or alternative financing on acceptable terms could have a material adverse effect on 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.com and receive from us the full price they paid, plus interest, which we estimate to be an aggregate amount of approximately $3.2 million at March 31, 2005.

 

Risks Relating to our Auctions Site Business

 

Our auctions site is a new business.

 

Our auctions site began operation in September 2004. The online auctions business is a new business for us, and we cannot assure you that our expansion into the online auctions business will succeed. Our entry into the online auctions business will require us to devote substantial financial, technical, managerial and other resources to the business. It will also expose us to additional risks, including legal and regulatory risks, and will require us to compete with established businesses having substantially greater experience in the online auctions business and substantially greater resources than we do.

 

Our auction business may be subject to a variety of regulatory requirements.

 

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Many states and other jurisdictions, including Utah, where our company is located, have regulations governing the conduct of traditional “auctions” and the liability of traditional “auctioneers” in conducting auctions. Although the vast majority of these regulations clearly contemplated only traditional auctions, and did not contemplate online auctions, the potential application of these types of regulations to online auction sites is not clear. We are aware that several states and some foreign jurisdictions have attempted to impose such regulations on other companies operating online auction sites or on the users of those sites. In addition, certain states have laws or regulations that do expressly apply to online auction site services. Although we do not expect these laws to have a significant effect on our auction site business, we will incur costs in complying with these laws, and we may from time to time be required to make changes in our business that may increase our costs, reduce our revenues, cause us to prohibit the listing of certain items in certain locations, or make other changes that may adversely affect our auctions business.

 

Current and future laws could affect our auctions business.

 

Like our shopping site business, our auction site business is subject to the same laws and regulations as apply to other companies conducting business on and off the Internet. In addition, our auction site business may be affected by other laws and regulations, such as those that expressly apply to online auction site services. Further, because of the wide range of items that users of our auctions service may choose to list on the site, a variety of additional laws and regulations may apply to transactions between users of our site, such as those requiring a license to sell or purchase certain items or mandating particular disclosures in connection with an offer or sale of an item. To the extent that such current or future laws or regulations prevent users from selling items on our auction site, they could harm our business.

 

Our business may be harmed if our auction site is used for unlawful transactions.

 

The law regarding the potential liability of an online auction service for the activities of its users is not clear. We prohibit the listing of numerous categories of items in an effort to reduce the possibility that users of our auction site will engage in an unlawful transaction. However, we cannot assure that users of the site will comply with all laws and regulations applicable to them and their transactions, and we may be subject to allegations of civil or criminal liability for any unlawful activities conducted by them. Any costs we incur as a result of any such allegations, or as a result of actual or alleged unlawful transactions utilizing our site, or in our efforts to prevent any such transactions, may harm our business. In addition, any negative publicity we receive regarding any such transactions or allegations may damage our reputation, our ability to attract new customers to our main shopping site, and the Overstock.com brand name generally.

 

Fraudulent activities using our auctions site and disputes between users of our auctions site may harm our business.

 

We are aware that other companies operating online auction services have periodically received complaints from users alleging that they have not received the purchase price or the goods they expected to receive, and that in some cases users have been arrested and convicted for engaging in fraudulent activities using those companies’ auction sites. We may receive similar complaints. We do not have the ability to require users of our services to fulfill their obligations to make payments or to deliver items. We are aware that other companies periodically receive complaints from buyers about the quality of the items they purchase, requests for reimbursement of amounts paid, and communications threatening or commencing legal actions against them. We may receive similar complaints, requests and communications in connection with our auctions site business.

 

We are subject to risks associated with information transmitted through our service.

 

The law relating to the liability of online services companies for information carried on or disseminated through their services is currently unsettled. Claims could be made against online services companies under both U.S. and foreign law for defamation, libel, invasion of privacy, negligence, copyright or trademark infringement, or other theories based on the nature and content of the materials

 

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disseminated through their services. We are aware that private lawsuits seeking to impose liability under a number of these theories have been brought against other companies operating auction sites. In addition, domestic and foreign legislation has been proposed that would prohibit or impose liability for the transmission over the Internet of certain types of information. Our service permits users to make comments regarding other users. Although all such comments are generated by users and not by us, we are aware that claims of defamation or other injury have been made against other companies operating auction services in the past and could be made in the future against us for comments made by users. Recent court decisions have narrowed the scope of the immunity provided to Internet service providers like us under the Communications Decency Act. This trend, if continued, may increase our potential liability to third parties for the user-provided content on our site.

 

Difficulties or negative publicity associated with our auctions business could affect our main shopping site business.

 

Any significant operational or other difficulties we encounter with our auctions business could damage our reputation, our ability to attract new customers to our main shopping site, and the Overstock.com brand name generally. Negative publicity resulting from actual or alleged fraudulent or deceptive conduct by users of our auctions site could also damage our reputation, our ability to attract new customers to our main shopping site, and the Overstock.com brand name generally.

 

Risks Relating to the Internet Industry

 

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. E-commerce remains 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 or perception of 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. Third parties may target our

 

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customers directly with fraudulent identity theft schemes designed to appear as legitimate communications from us. Any security breach or fraud perpetrated on our customers could expose us to increased costs and 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 or Indiana. 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.

 

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 was 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 and the CAN-SPAM Act of 2003, 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

 

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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 Securities

 

The price of our securities 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, the market price of our securities may decline. Among the factors that could affect the market price of our securities 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;

changes in our management team;

economic factors unrelated to our performance; and

our issuance of additional shares of stock or other securities.

 

In addition, the securities markets have experienced significant price and trading volume fluctuations. These broad market fluctuations may adversely affect the trading price of our securities. 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.

 

Our quarterly operating results are volatile and may adversely affect the market price of our securities.

 

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 harm our business. As a result, we believe that quarterly comparisons of our operating results are not necessarily meaningful and that you should not rely on the results of one quarter as an indication of our future performance. In addition to the other risk factors described in this report, additional factors that have caused and/or could cause our quarterly operating results to fluctuate and in turn affect the market price of our securities include:

 

increases in the cost of advertising;

our inability to retain existing customers or encourage repeat purchases;

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;

 

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entering into new lines of products;

our ability to attract users to our new auctions site; and

our inability to replace the loss of significant customers.

 

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

 

We have experienced and expect to continue 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 generally increase our inventories substantially in anticipation of holiday season shopping activity, which has 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 the market price of our securities to decline.

 

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

 

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.

 

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ITEM 3.                                     QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Our financial instruments consist of cash and cash equivalents, marketable securities, 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.

 

In January 2005, the Company purchased $49.9 million in foreign corporate securities (“Notes”) which mature in September and November 2006.  The Notes have a conditional coupon rate indexed to a basket of eight Asian currencies.  At maturity, the Company will receive back its total initial investment in the Notes, plus additional coupon interest depending on the performance of the Asian currencies to the dollar.  For example, if the Asian currencies strengthen in relation to the US dollar over the life of Notes, the coupon interest will be greater.  If the inverse is true, the Company receives only a small interest payment in addition to its original investment.  If the Company redeems the Notes prior to maturity, we may not realize the full amount of our initial investment.

 

Under SFAS No. 133, the Notes are considered to be derivative financial instruments and are marked to market quarterly.  Any unrealized gain or loss based on the quarterly mark-to-market valuation will be recorded in the income statement as a component of interest income.  The impact of the Notes’ mark-to-market valuation resulted in a loss of $344,000 for the quarter ended March 31, 2005.

 

At March 31, 2005, we had $37.6 million in cash and cash equivalents and $155.2 million in marketable securities (including the foreign Notes). A hypothetical increase or decrease in interest rates of one hundred basis points would have an estimated impact of approximately $1.9 million on our earnings or loss, or the fair market value or cash flows of these instruments.

 

At March 31, 2005, we had approximately $120.0 million of convertible senior notes outstanding which bear interest at a fixed rate of 3.75%. In addition, at March 31, 2005, there were no borrowings outstanding under our line of credit and letters of credit totaling $11.1 million were outstanding under our credit facility.

 

The fair value of the convertible senior notes is sensitive to interest rate changes. Interest rate changes would result in increases or decreases in the fair value of the convertible senior notes, due to differences between market interest rates and rates in effect at the inception of the obligation. Unless we elect to repurchase our convertible senior notes in the open market, changes in the fair value of convertible senior notes have no impact on our cash flows or consolidated financial statements. The estimated fair value of the convertible senior notes was $120.0 million at March 31, 2005.

 

In January 2005, our Board of Directors authorized a stock repurchase program under which we can repurchase up to $50.0 million of our common stock through December 31, 2007. In April 2005, the Board of Directors increased the stock repurchase program to $100.0 million.  Under the program, shares may be purchased as determined by management, from time to time and within certain guidelines, in the open market or in privately negotiated transactions, including privately negotiated structured stock repurchase transactions and through transactions in the options markets. Depending on market conditions and other factors, these purchases may be commenced or suspended at any time or from time to time without prior notice.

 

In February and March 2005, we entered into several purchased call options, pursuant to which we may purchase up to 1,250,000 shares of our common stock at certain settlement dates during the quarter ending June 30, 2005. In connection with these repurchase transactions, we have paid approximately

 

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$47.5 million. Upon settlement, we, at our option, may elect to settle the contracts by physical settlement, net share settlement or net cash settlement. Accordingly, we expect to receive, either our capital investment returned with a premium or shares of our common stock, depending on whether the market price of our common stock is above or below pre-determined prices agreed in connection with each such transaction.

 

As a result of these structured stock repurchase transactions, we have market risk exposure to the trading price of our common stock. The objective and general strategy of the transactions is to implement a portion of the stock repurchases authorized by our Board of Directors. We may enter into similar transactions in the future.

 

ITEM 4.                                     CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures

 

Under the supervision and with the participation of our management, including our principal executive officer and our principal financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934.  Based on this evaluation, our principal executive officer and our principal financial officer concluded that the Company maintained effective disclosure controls and procedures as of the end of the period covered by this report.

 

Changes in Internal Control over Financial Reporting

 

During the three-month period ended March 31, 2005, there was no change in the Company’s internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

PART II.  OTHER INFORMATION

 

ITEM 1.                                     LEGAL PROCEEDINGS

 

From time to time, we receive claims of 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, prospects, results of operations, financial condition and cash flows. However, we do not currently believe that any of our outstanding litigation will have a material impact on our financial statements.

 

In October 2003, Tiffany (NJ) Inc. and Tiffany and Company filed a complaint against us in the United States District Court for the Southern District of New York alleging that we have distributed counterfeit and otherwise unauthorized Tiffany product in violation of federal copyright and trademark law and related state laws. The complaint seeks statutory and other damages in an unspecified amount and injunctive relief. In January and February 2005, Tiffany (NJ) Inc. and Tiffany and Company filed five additional complaints against us in the United States District Court for the Southern District of New York alleging that we have distributed counterfeit and otherwise unauthorized Tiffany product in violation of federal copyright and trademark law and related state laws. These complaints also seek statutory and other damages in an unspecified amount and injunctive relief. Although we have filed answers to these complaints and we believe we have defenses to the allegations and intend to pursue them vigorously, we do not have sufficient information to assess the validity of the claims or the amount of potential damages alleged in these suits.

 

In July 2004, Printmaker International, Ltd. filed a complaint against us in the United States District Court for the Southern District of New York alleging that we have distributed counterfeit and otherwise unauthorized product in violation of federal copyright and trademark law and related state laws. During this

 

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quarter, Printmaker International, Ltd. dismissed the complaint with prejudice.  We did not admit to any liability or make any settlement payment.

 

In May 2004, we filed a complaint against TLMT Holdings, Inc (f/k/a LastMinuteTravel.com, Inc.) in the Superior Court of the State of Delaware alleging that it breached its contract with us. In July 2004, TLMT Holdings filed a counterclaim against us alleging that we have breached the contract. The counterclaim seeks damages in an unspecified amount. During this quarter, the parties dismissed the claims against each other.  While the terms of the settlement agreement are confidential, we did not admit to any liability or make any settlement payment.

 

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, 2003, the parties entered into a standstill agreement, agreeing 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 reserved all claims and counterclaims. In August 2004, NCR notified us of its intent to terminate the standstill agreement. On September 2, 2004, we re-filed our 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 October 4, 2004, NCR filed an answer and counterclaims alleging that certain of our business practices and information technology systems infringe patents owned by NCR. On October 12, 2004, we filed an answer denying the material allegations in NCR’s counterclaims.  In March 2005, the parties entered into a confidential settlement agreement which dismissed the complaint and counterclaims with prejudice.  We did not pay any damages as part of the settlement.

 

In September 2004, we received a letter from BTG International Inc. claiming that certain of our business practices and online marketing information technology systems infringe patents owned by BTG. On September 14, 2004, without engaging in any meaningful discussion or negotiation with us, BTG filed a complaint in the United States District Court of Delaware alleging that certain of our business practices and online marketing information technology systems infringe a single patent owned by BTG. On October 21, 2004, we filed an answer denying the material allegations in BTG’s claims. Although we have filed an answer and believe we have defenses to the allegations and intend to pursue them vigorously, the BTG lawsuit is in the early stages of discovery, and we do not have sufficient information to assess the validity of the claims or the amount of potential damages.

 

ITEM 2.                                     UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

During the quarterly period ended March 31, 2005, we issued 23,493 shares of our common stock upon the exercise of warrants with a weighted average exercise price of $6.94 per share.  The issuance of these securities was deemed to be exempt from registration under Section 4(2) of the Securities Act of 1933 as a transaction by an issuer not involving a public offering.

 

The following table sets forth all purchases made by or on behalf of the Company or any “affiliated purchaser” as defined in Rule 10b-18(a)(3) under the Exchange Act, of shares of the Company’s common stock made during each month within the first quarter of 2005, including all purchases made pursuant to publicly announced plans or programs and those not made pursuant to publicly announced plans or programs.  Column (a) sets forth the total number of shares purchased, and the footnotes to the table disclose the number of shares purchased other than pursuant to a publicly announced plan or program and the nature of any such purchases.  Column (b) sets forth the average price paid per share.  Column (c) sets forth the total number of shares purchased as part of publicly announced repurchase plans or programs.

 

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Column (d) sets forth the maximum number (or approximate dollar value) of shares that may yet be purchased under the plans or programs.  The footnotes to the table indicate the date each plan or program was announced, the dollar amount or share amount approved, the expiration date, if any, of each plan or program, each plan or program that has expired during the period covered by the table, and each plan or program the Company has determined to terminate prior to expiration, or under which the Company does not intend to make further purchases.

 

Period

 

(a) Total Number of
Shares (or Units)
Purchased

 

(b)
Average Price Paid
per Share or Unit

 

(c) Total Number
of Shares (or
Units) Purchased
as Part of
Publicly
Announced Plans
or Programs

 

(d) Maximum
Number (or
Approximate Dollar
Value) of Shares (or
Units) that May Yet
Be Purchased Under
the Plans or
Programs

 

 

 

 

 

 

 

 

 

 

 

January 1, 2005 To January 31, 2005

 

 

 

 

$

100,000,000

 

February 1, 2005 to February 28, 2005

 

20,000

(1)

$

48.61

 

 

$

100,000,000

 

March 1, 2005 to March 31, 2005

 

 

 

 

$

100,000,000

 

Total

 

20,000

 

$

48.61

 

 

$

100,000,000

 

 


(1)  All 20,000 shares were purchased by the Company’s President Patrick M. Byrne, who may be deemed to be an “affiliated purchaser”“ as defined in Rule 10b-18(a)(3) under the Exchange Act.  None of the shares purchased were purchased by the Company.

 

ITEM 3.                                     DEFAULTS UPON SENIOR SECURITIES

 

None.

 

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

 

None

 

ITEM 5.                                     OTHER INFORMATION

 

None.

 

ITEM 6.                                     EXHIBITS

 

(a)                                  Exhibits

 

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

32                                    Section 1350 Certifications

 

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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/ David K. Chidester

 

 

David K. Chidester

 

 

Senior Vice President, Finance

 

 

Dated:  May 10, 2005

 

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