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OSTK > SEC Filings for OSTK > Form 10-Q on 25-Oct-2012All Recent SEC Filings

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Form 10-Q for OVERSTOCK.COM, INC


25-Oct-2012

Quarterly Report


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

Special Note Regarding Forward-Looking Statements

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

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

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

†             the effectiveness of our marketing;

†             our future operating and financial results;

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

†             the effects of government regulation;

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

†             our expectations regarding the adequacy of our liquidity;

†             our ability to retire or refinance our debt;

†             our plans for international markets;

†             our plans for changes to our business;

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

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

†             our beliefs regarding the adequacy of our insurance coverage;

†             the adequacy of our infrastructure, including our backup
facilities and our disaster planning;

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

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

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

†             our beliefs regarding the adequacy of our customer service
capabilities;

†             our beliefs and expectations regarding the adequacy of our office

and warehouse facilities;

† our expectations regarding our travel shopping service, our insurance shopping service, our international sales efforts, our car listing service and our community site, and the anticipated functionality and results of operations of any of them;

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

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

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

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

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

†             world events;

†             the rate of growth of the Internet and online commerce;

†             any failure to maintain our existing relationships or build new

relationships with fulfillment partners on acceptable terms;

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

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

†             the mix of products purchased by our customers;

†             problems with cyber security or data breaches;

†             problems with or affecting our credit card processors, including

cyber-attacks, internet or other infrastructure or communications impairment or other events that could interrupt the normal operation of the credit card processors;

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

† difficulties we may have in responding to technological changes;


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                                       †

†             problems with fraudulent purchases;

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

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

†             the extent to which we owe income taxes or are required to collect

sales taxes or to modify our business model in order to avoid being required to collect sales taxes;

†             competition;

†             management of growth;

†             fluctuations in our operating results;

†             our efforts to expand internationally;

†             the outcomes of legal proceedings;

†             investigations and claims;

†             optimization of our warehouse operations;

†             risks of inventory management and seasonality.

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

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

Available Information

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

Overview

We are an online retailer offering discount brand name, non-brand name and closeout merchandise, including bed-and-bath goods, home dιcor, kitchenware, furniture, watches and jewelry, apparel, electronics and computers, sporting goods, and designer accessories, among other products. We sell hundreds of thousands of best seller and current run books, magazines, CDs, DVDs and video games ("BMMG"). We are also a channel through which customers can purchase cars, insurance and travel products, services and we sell advertising. We sell these products and services through our Internet websites located at www.overstock.com, www.o.co and www.o.biz ("Website") and also through other ecommerce marketplace websites. Although our three websites are located at different domain addresses, the technology and equipment and processes supporting the three websites and the process of order fulfillment described herein are the same for all three websites.

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

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


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Executive Commentary

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

Net income was $2.7 million in Q3 2012 versus a net loss of $7.8 million in Q3 2011. The $10.5 million year-over-year improvement in net income resulted primarily from revenue growth of 7%, a 220 basis point improvement in gross margin (taken together, leading to a $8.2 million increase in gross profit), and $2.3 million lower expenses.

Revenues in Q3 2012 increased 7% compared to Q3 2011. We continued to see an increase in the number of unique visitors to our website and average order size. These increases more than offset the impact of fewer customer orders due to lower conversion rates. Gross profit increased 21% compared to Q3 2011 primarily as a result of 7% revenue growth and a 220 basis point expansion in gross margin. Sales and marketing expenses remained flat at 5.8% of revenue in Q3 2012 compared to Q3 2011. As a result, we had a 29% increase in Contribution (see "Non-GAAP Financial Measures" below for a reconciliation of Contribution to Gross Profit) compared to Q3 2011. Contribution margin was 12.4%.

Technology expense in Q3 2012 decreased $1.1 million compared to Q3 2011, primarily due to decreases in compensation and recruiting-related costs largely associated with our lower technology headcount. General and administrative expenses in Q3 2012 decreased $1.5 million compared to Q3 2011, primarily due to a decrease in legal fees, partially offset by an increase in compensation related costs largely due to an increase in bonus expense.

Our fulfillment partner business continues to make up a large percentage of our total revenues, expanding to nearly 87% of total revenue in Q3 2012. As a result, we are converting revenues into cash on average nearly seven days before we pay our suppliers. This has reduced the capital requirements needed to operate our business, and has consistently helped us to generate positive operating cash flows on a trailing twelve month basis for the past several years. Our working capital improved from $(14.1) million at December 31, 2011 to $(4.5) million at September 30, 2012.

Our Financing Agreement with U.S. Bank expires on December 31, 2012. We do not anticipate entering into a new agreement with U.S. Bank. As a result, we expect to repay the $17 million that is currently outstanding from our operating cash by December 31, 2012.

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


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Results of Operations



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



                                     Three months ended        Nine months ended
                                       September 30,             September 30,
                                     2012         2011         2012         2011
                                        (as a percentage of total net revenue)
Revenue, net
Direct                                  13.4 %       14.5 %       14.4 %       15.7 %
Fulfillment partner                     86.6         85.5         85.6         84.3
Total net revenue                      100.0        100.0        100.0        100.0
Cost of goods sold
Direct                                  12.0         13.5         13.1         14.3
Fulfillment partner                     69.8         70.5         68.8         68.4
Total cost of goods sold                81.8         84.0         81.9         82.7
Gross profit                            18.2         16.0         18.1         17.3
Operating expenses:
Sales and marketing                      5.8          5.8          5.7          5.8
Technology                               6.3          7.2          6.2          6.8
General and administrative               5.4          6.4          5.7          6.8
Restructuring                              -            -            -            -
Total operating expenses                17.5         19.4         17.6         19.4
Operating income (loss)                  0.7         (3.4 )        0.5         (2.1 )
Interest income                            -            -            -            -
Interest expense                        (0.1 )       (0.3 )       (0.1 )       (0.3 )
Other income, net                        0.5          0.2          0.3          0.1
Net income (loss) before income
taxes                                    1.1         (3.5 )        0.7         (2.3 )
Provision (benefit) for income
taxes                                    0.1         (0.1 )          -            -
Net income (loss)                        1.1 %       (3.4 )%       0.7 %       (2.3 )%

Comparisons of Three Months Ended September 30, 2012 to Three Months Ended September 30, 2011, and Nine Months Ended September 30, 2012 to Nine Months Ended September 30, 2011.

Revenue



The following table reflects our net revenues for the three and nine months
ended September 30, 2012 and 2011 (in thousands):



                        Three months ended                               Nine months ended
                          September 30,                                    September 30,
                         2012        2011      $ Change    % Change      2012        2011      $ Change    % Change
Revenue, net
Direct                $   34,215   $  34,749   $    (534 )     (1.5 )% $ 109,048   $ 116,353   $  (7,305 )     (6.3 )%
Fulfillment partner      221,137     204,989      16,148        7.9 %    648,207     623,847      24,360        3.9 %
Total revenue, net    $  255,352   $ 239,738   $  15,614        6.5 %  $ 757,255   $ 740,200   $  17,055        2.3 %

The primary reasons for increased total net revenue for the three and nine months ended September 30, 2012 were increases in unique visitors and average order size, partially offset by lower conversion rates, resulting in fewer unique customers and orders compared to last year.

The primary reason for decreased direct revenue for the three and nine months ended September 30, 2012 was a shift in sales mix, particularly in clothing and shoes, from a direct inventory-based model to a fulfillment partner-based model to reduce exposure from seasonal inventory and mark downs, partially offset by an increase in sales of home and garden products.

The primary reason for the increase in fulfillment partner revenue for the three and nine months ended September 30, 2012 was an increase in sales of home and garden products.


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The shift of business from direct to fulfillment partner (or vice versa) is an economic decision based on the economics of each particular product offering at the time and we do not have particular goals for "appropriate" mix or percentages for the size of either. We believe that the mix of the business between direct and fulfillment partner is consistent with our strategic objectives for our business model in the current economic environment and with the exception of a transition of our direct clothing and shoes category to a fulfillment partner model to reduce our seasonal inventory risks, we do not currently foresee any material shifts in mix.

Total revenues from international sales were $2.3 million and $2.2 million for the three months ended September 30, 2012 and 2011, respectively and $6.6 million and $6.2 million for the nine months ended September 30, 2012 and 2011, respectively.

Change in estimate of average transit times (days)

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

The following table shows the effect that hypothetical changes in the estimate of average shipping transit times would have had on the reported amount of revenue and net income for the three months ended September 30, 2012 (in thousands):

                             Three months ended
                             September 30, 2012
Change in the            Increase        Increase
Estimate of Average     (Decrease)    (Decrease) Net
Transit Times (Days)     Revenue          Income
2                      $    (10,911 ) $        (1,813 )
1                      $     (4,887 ) $          (792 )
As reported             As reported       As reported
-1                     $      3,028   $           501
-2                     $      5,945   $           977

See "Executive Commentary" above for additional discussion regarding revenue.

Gross profit and gross margin

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

The following table reflects our net revenues, cost of goods sold and gross profit for the three and nine months ended September 30, 2012 and 2011 (in thousands):

                     Three months ended                               Nine months ended
                       September 30,                                    September 30,
                      2012        2011      $ Change    % Change      2012        2011      $ Change    % Change
Revenue, net
Direct             $   34,215   $  34,749   $    (534 )     (1.5 )% $ 109,048   $ 116,353   $  (7,305 )     (6.3 )%
Fulfillment
partner               221,137     204,989      16,148        7.9 %    648,207     623,847      24,360        3.9 %
Total net
revenues           $  255,352   $ 239,738   $  15,614        6.5 %  $ 757,255   $ 740,200   $  17,055        2.3 %
Cost of goods
sold
Direct             $   30,684   $  32,472   $  (1,788 )     (5.5 )% $  99,422   $ 105,733   $  (6,311 )     (6.0 )%
Fulfillment
partner               178,126     168,893       9,233        5.5 %    520,614     506,240      14,374        2.8 %
Total cost of
goods sold         $  208,810   $ 201,365   $   7,445        3.7 %  $ 620,036   $ 611,973   $   8,063        1.3 %
Gross Profit
Direct             $    3,531   $   2,277   $   1,254       55.1 %  $   9,626   $  10,620   $    (994 )     (9.4 )%
Fulfillment
partner                43,011      36,096       6,915       19.2 %    127,593     117,607       9,986        8.5 %
Total gross
profit             $   46,542   $  38,373   $   8,169       21.3 %  $ 137,219   $ 128,227   $   8,992        7.0 %


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Gross margins for the past seven quarterly periods and fiscal year ending 2011 were:

                      Q1 2011   Q2 2011   Q3 2011   Q4 2011   FY 2011   Q1 2012   Q2 2012   Q3 2012
Direct                   10.7 %     9.6 %     6.6 %     7.0 %     8.5 %     8.0 %     8.3 %    10.3 %
Fulfillment Partner      20.7 %    18.1 %    17.6 %    17.8 %    18.5 %    20.0 %    19.6 %    19.4 %
Combined                 18.9 %    16.9 %    16.0 %    16.2 %    17.0 %    18.1 %    18.0 %    18.2 %

The 370 basis point increase in direct gross margin for the three months ended September 30, 2012 when compared to the same period in 2011 is primarily due to pricing initiatives and lower credit card fees, partially offset by higher return-related and freight costs, and increased coupons and promotions. The 30 basis point decrease in direct gross margin for the nine months ended September 30, 2012 when compared to the same period in 2011 is primarily due to higher return-related, freight and warehouse costs, partially offset by pricing initiatives and lower credit card fees.

The 180 and 80 basis point increases in fulfillment partner gross margin for the three and nine months ended September 30, 2012 when compared to the same periods in 2011 are primarily due to a shift in sales mix into higher margin home and garden products, pricing initiatives and lower credit card costs, partially offset by higher return-related and freight costs and increased coupons and promotions.

Cost of goods sold includes stock-based compensation expense of $74,000 and $47,000 for the three months ended September 30, 2012 and 2011, respectively and $200,000 and $134,000 for the nine months ended September 30, 2012 and 2011, respectively.

See "Executive Commentary" above for additional discussion.

Operating expenses

Sales and marketing expenses

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

The following table reflects our sales and marketing expenses for the three and nine months ended September 30, 2012 and 2011 (in thousands):

                     Three months ended                               Nine months ended
                       September 30,                                    September 30,
                      2012         2011      $ Change    % Change      2012        2011     $ Change    % Change
Sales and
marketing
expenses           $    14,899   $ 13,822   $    1,077        7.8 % $   42,886   $ 42,902   $     (16 )     (0.0 )%
Sales and
marketing
expenses as a
percent of net
revenues                   5.8 %      5.8 %                                5.7 %      5.8 %

Sales and marketing expenses as a percentage of revenue remained relatively flat for the three and nine months ended September 30, 2012 when compared to the same period in 2011.

Sales and marketing expenses include stock-based compensation expense of $108,000 and $80,000 for the three months ended September 30, 2012 and 2011, respectively and $260,000 and $289,000 for the nine months ended September 30, 2012 and 2011, respectively.

In May 2012, Google, Inc. ("Google") announced that it is discontinuing providing its free Google Base product listing service to retailers by the fall of 2012 and offering retailers a new fee based product listing service. Depending on our level of participation in the new program, this change may result in higher advertising expense in the future; however, we cannot determine the impact until we gain experience with Google's new program. We are constantly evaluating the performance of our marketing channels and adjust our advertising expense to optimize performance.

Costs associated with our discounted shipping and other promotions, such as coupons, are not included in marketing expense. Rather they are accounted for as a reduction of revenue and therefore affect sales and gross margin. We consider discounted shipping and other promotions as an effective marketing tool, and intend to continue to offer them as we deem appropriate as part of our overall marketing plan.


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Technology expenses

The following table reflects our technology expenses for the three and nine months ended September 30, 2012 and 2011 (in thousands):

                    Three months ended                               Nine months ended
                      September 30,                                    September 30,
                     2012         2011     $ Change    % Change       2012        2011     $ Change    % Change
Technology
expenses          $    16,085   $ 17,171   $  (1,086 )     (6.3 )% $   46,845   $ 50,639   $  (3,794 )     (7.5 )%
Technology
expenses as a
percent of net
revenues                  6.3 %      7.2 %                                6.2 %      6.8 %

The $1.1 million and $3.8 million decreases for the three and nine months ended September 30, 2012, respectively, are primarily due to decreases in compensation and recruiting-related costs primarily from lower headcount.

Technology expenses include stock-based compensation expense of $218,000 and . . .

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