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Overstock.com 10-Q 2005

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32
  5. Ex-32

 

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 September 30, 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
incorporation or organization)

 

(I.R.S.  Employer
Identification Number)

 

6350 South 3000 East

Salt Lake City, Utah 84121

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

 

Former address:

6350 South 3000 East

Salt Lake City, Utah 84121

 

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

 

Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2)

 

Yes o  No ý

 

There were 19,306,046 shares of the Registrant’s common stock, par value $0.0001, outstanding on November 7, 2005.

 

 




 

PART 1. FINANCIAL INFORMATION

 

ITEM 1.  FINANCIAL STATEMENTS

 

Overstock.com, Inc.

Consolidated Balance Sheets (unaudited)

(in thousands)

 

 

 

December 31,
2004

 

September 30,
2005

 

 

 

 

 

 

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

198,678

 

$

2,575

 

Marketable securities

 

88,802

 

74,225

 

Cash, cash equivalents and marketable securities

 

287,480

 

76,800

 

Accounts receivable, net

 

5,715

 

7,551

 

Inventories, net

 

45,279

 

94,601

 

Prepaid inventory

 

12,322

 

12,606

 

Prepaid expenses and other assets

 

3,444

 

9,319

 

 

 

 

 

 

 

Total current assets

 

354,240

 

200,877

 

 

 

 

 

 

 

Restricted cash

 

1,602

 

633

 

Property and equipment, net

 

16,122

 

59,561

 

Goodwill

 

2,784

 

13,169

 

Other long-term assets, net

 

1,516

 

15,335

 

 

 

 

 

 

 

Total assets

 

$

376,264

 

$

289,575

 

 

 

 

 

 

 

Liabilities, Redeemable Securities and Stockholders’ Equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

64,060

 

$

47,070

 

Accrued liabilities

 

22,917

 

45,278

 

Short-term borrowings

 

 

4,368

 

Capital lease obligations, current

 

595

 

6,638

 

 

 

 

 

 

 

Total current liabilities

 

87,572

 

103,354

 

 

 

 

 

 

 

Capital lease obligations, non-current

 

743

 

6,907

 

Convertible senior notes

 

116,251

 

84,596

 

 

 

 

 

 

 

Total liabilities

 

204,566

 

194,857

 

 

 

 

 

 

 

Commitments and contingencies (Note 13)

 

 

 

 

 

 

 

 

 

 

 

Redeemable common stock, $0.0001 par value, 460 shares issued and outstanding as of December 31, 2004 and September 30, 2005

 

3,166

 

3,306

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Preferred stock, $0.0001 par value, 5,000 shares authorized, no shares issued and outstanding as of December 31, 2004 and September 30, 2005 respectively Common stock, $0.0001 par value, 100,000 shares authorized, 19,390 and 20,526 shares issued and 19,355 and 18,837 shares outstanding as of December 31, 2004 and September 30, 2005 respectively

 

2

 

2

 

Additional paid-in capital

 

243,131

 

250,863

 

Accumulated deficit

 

(73,005

)

(94,034

)

Unearned stock-based compensation

 

(1,301

)

(493

)

Treasury stock, 35 and 1,689 shares at cost as of December 31, 2004 and September 30, 2005, respectively

 

(100

)

(65,333

)

Accumulated other comprehensive income (loss)

 

(195

)

407

 

 

 

 

 

 

 

Total stockholders’ equity

 

168,532

 

91,412

 

 

 

 

 

 

 

Total liabilities, redeemable securities and stockholders’ equity

 

$

376,264

 

$

289,575

 

 

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

 

3



 

Overstock.com, Inc.

Consolidated Statements of Operations (unaudited)

(in thousands, except per share data)

 

 

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

 

 

2004

 

2005

 

2004

 

2005

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

 

 

 

 

 

 

 

 

Direct

 

$

43,928

 

$

68,449

 

$

123,621

 

$

196,397

 

Fulfillment partner

 

59,516

 

100,874

 

149,693

 

289,445

 

 

 

 

 

 

 

 

 

 

 

Total revenue

 

103,444

 

169,323

 

273,314

 

485,842

 

 

 

 

 

 

 

 

 

 

 

Cost of goods sold

 

 

 

 

 

 

 

 

 

Direct

 

38,594

 

60,939

 

110,196

 

171,246

 

Fulfillment partner

 

51,103

 

83,589

 

131,010

 

242,821

 

 

 

 

 

 

 

 

 

 

 

Total cost of goods sold

 

89,697

 

144,528

 

241,206

 

414,067

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

13,747

 

24,795

 

32,108

 

71,775

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Sales and marketing

 

9,398

 

17,960

 

20,380

 

49,280

 

Technology

 

2,268

 

8,082

 

5,469

 

18,271

 

General and administrative

 

5,108

 

9,989

 

13,725

 

24,853

 

Amortization (reversal) of stock-based compensation

 

18

 

(8

)

276

 

65

 

 

 

 

 

 

 

 

 

 

 

Total operating expenses

 

16,792

 

36,023

 

39,850

 

92,469

 

 

 

 

 

 

 

 

 

 

 

Operating loss

 

(3,045

)

(11,228

)

(7,742

)

(20,694

)

 

 

 

 

 

 

 

 

 

 

Interest income and other

 

168

 

(1,690

)

393

 

(150

)

Interest expense

 

(77

)

(1,264

)

(139

)

(4,226

)

Other income, net

 

3

 

11

 

5

 

4,181

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

(2,951

)

(14,171

)

(7,483

)

(20,889

)

Deemed dividend related to redeemable common stock

 

(47

)

(47

)

(141

)

(140

)

 

 

 

 

 

 

 

 

 

 

Net loss attributable to common shares

 

$

(2,998

)

$

(14,218

)

$

(7,624

)

$

(21,029

)

 

 

 

 

 

 

 

 

 

 

Net loss per common share — basic and diluted

 

$

(0.16

)

$

(0.75

)

$

(0.44

)

$

(1.08

)

Weighted average common shares outstanding — basic and diluted

 

18,284

 

18,844

 

17,517

 

19,468

 

 

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

 

4



 

Overstock.com, Inc.
Consolidated Statements of Stockholders’ Equity
and Comprehensive Income (unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

Additional

 

 

 

Unearned

 

 

 

 

 

Other

 

 

 

 

 

Common stock

 

Paid-in

 

Accumulated

 

stock-based

 

Treasury stock

 

Comprehensive

 

 

 

 

 

Shares

 

Amount

 

Capital

 

deficit

 

compensation

 

Shares

 

Amount

 

Income (loss)

 

Total

 

 

 

(amounts in thousands)

 

Balance at December 31, 2004

 

19,390

 

$

2

 

$

243,131

 

$

(73,005

)

$

(1,301

)

(35

)

$

(100

)

$

(195

)

$

168,532

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Exercise of stock options and warrants

 

1,136

 

 

6,881

 

 

 

 

 

 

6,881

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Issuance of common stock from treasury

 

 

 

381

 

 

 

8

 

21

 

 

402

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Purchase of treasury stock

 

 

 

 

 

 

(665

)

(24,133

)

 

(24,133

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Purchased call options for purchase of treasury stock

 

 

 

(47,507

)

 

 

 

 

 

(47,507

)

Settlement of purchased call options in exchange for cash

 

 

 

7,937

 

 

 

 

 

 

7,937

 

Settlement of purchased call options in exchange for treasury stock

 

 

 

41,121

 

 

 

(997

)

(41,121

)

 

 

Forfeitures of unearned stock-based compensation from options issued to employees

 

 

 

(56

)

 

56

 

 

 

 

 

Amortization of stock-based compensation

 

 

 

 

 

65

 

 

 

 

65

 

Stock-based compensation to consultants in exchange for services

 

 

 

(1,025

)

 

687

 

 

 

 

(338

)

Deemed dividend related to redeemable common stock

 

 

 

 

(140

)

 

 

 

 

(140

)

Comprehensive income (loss):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

 

 

 

(20,889

)

 

 

 

 

(20,889

)

Unrealized gain on marketable securities

 

 

 

 

 

 

 

 

491

 

491

 

Cumulative translation adjustment

 

 

 

 

 

 

 

 

111

 

111

 

Total comprehensive loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(20,291

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at September 30, 2005

 

20,526

 

$

2

 

$

250,863

 

$

(94,034

)

$

(493

)

(1,689

)

$

(65,333

)

$

407

 

$

91,412

 

 

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

 

5



 

Overstock.com, Inc.

Consolidated Statements of Cash Flows (unaudited)

(in thousands)

 

 

 

Three months ended

 

Nine months ended

 

Twelve months ended

 

 

 

September 30,

 

September 30,

 

September 30,

 

 

 

2004

 

2005

 

2004

 

2005

 

2004

 

2005

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

$

(2,951

)

$

(14,171

)

$

(7,483

)

$

(20,889

)

$

(10,628

)

$

(18,408

)

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

 

 

 

 

 

 

 

 

 

 

 

 

 

Depreciation and amortization

 

1,061

 

4,901

 

2,707

 

9,466

 

3,429

 

10,696

 

Realized (gain) loss from marketable securities

 

(1

)

2,776

 

(1

)

2,361

 

(2

)

2,749

 

Loss on disposition of property and equipment

 

 

 

 

 

 

34

 

Amortization of unearned stock-based compensation

 

18

 

(8

)

276

 

65

 

438

 

149

 

Stock options issued to consultants for services

 

25

 

(312

)

594

 

(338

)

701

 

(43

)

Issuance of common stock from treasury

 

 

91

 

 

402

 

 

402

 

Amortization of debt discount and deferred financing fees

 

 

179

 

 

602

 

 

749

 

Gain from retirement of convertible senior notes

 

 

 

 

(4,170

)

 

(4,170

)

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Accounts receivable

 

4,101

 

(968

)

7,705

 

(965

)

5,200

 

(4,201

)

Inventories

 

(3,943

)

(34,818

)

(4,865

)

(49,322

)

(9,846

)

(59,810

)

Prepaid inventory

 

(5,137

)

(2,196

)

3,059

 

(284

)

(1,584

)

(284

)

Prepaid expenses and other assets

 

(2,980

)

(1,124

)

(13,606

)

(5,760

)

(3,336

)

(6,337

)

Other long-term assets, net

 

102

 

(424

)

(1,268

)

(435

)

(1,149

)

(523

)

Accounts payable

 

954

 

6,663

 

(7,887

)

(17,911

)

14,041

 

23,674

 

Accrued liabilities

 

7,824

 

19,503

 

8,419

 

21,997

 

12,268

 

27,177

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash provided by (used in) operating activities

 

(927

)

(19,908

)

(12,350

)

(65,181

)

9,532

 

(28,146

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

 

 

 

 

 

 

 

 

(Increase) decrease in restricted cash

 

 

200

 

(1,875

)

969

 

(1,875

)

1,242

 

Investments in marketable securities

 

(15,675

)

(21,552

)

(27,917

)

(183,543

)

(29,920

)

(248,503

)

Sales of marketable securities

 

1,470

 

34,062

 

3,944

 

196,250

 

12,206

 

207,679

 

Expenditures for property and equipment

 

(3,805

)

(12,190

)

(5,404

)

(36,466

)

(7,744

)

(39,796

)

Acquisition of Ski West (net of cash acquired)

 

 

(24,620

)

 

(24,620

)

 

(24,620

)

Proceeds from the sale of property and equipment

 

 

 

 

 

 

20

 

Expenditures for other long-term assets

 

 

 

 

 

(172

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash used in investing activities

 

(18,010

)

(24,100

)

(31,252

)

(47,410

)

(27,505

)

(103,978

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Payments on capital lease obligations

 

(153

)

(182

)

(507

)

(3,234

)

(532

)

(3,386

)

Borrowings on line of credit

 

 

4,368

 

1,000

 

4,368

 

1,000

 

4,368

 

Payments on line of credit

 

 

 

 

 

 

(1,000

)

Issuance of common stock, net of issuance costs

 

 

 

37,857

 

 

37,857

 

75,207

 

Issuance of convertible senior notes

 

 

 

 

 

 

116,251

 

Payments to retire convertible senior notes

 

 

 

 

(27,935

)

 

(27,935

)

Purchased call options for purchase of treasury stock

 

 

 

 

(47,507

)

 

(47,507

)

Settlement of call options for cash

 

 

7,937

 

 

7,937

 

 

7,937

 

Purchase of treasury stock

 

 

 

 

(24,133

)

 

(24,133

)

Exercise of stock options and warrants

 

596

 

2,973

 

3,555

 

6,881

 

3,848

 

7,615

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net provided by (used in) financing activities

 

443

 

15,096

 

41,905

 

(83,623

)

42,173

 

107,417

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Effect of exchange rate changes on cash

 

2

 

137

 

7

 

111

 

6

 

126

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net increase (decrease) in cash and cash equivalents

 

(18,492

)

(28,775

)

(1,690

)

(196,103

)

24,206

 

(24,581

)

Cash and cash equivalents, beginning of period

 

45,648

 

31,350

 

28,846

 

198,678

 

2,950

 

27,156

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents, end of period

 

$

27,156

 

$

2,575

 

$

27,156

 

$

2,575

 

$

27,156

 

$

2,575

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Supplemental cash flow information:

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest paid

 

$

77

 

$

76

 

$

139

 

$

2,569

 

$

146

 

$

2,595

 

Deemed dividend on redeemable common shares

 

$

47

 

$

47

 

$

141

 

$

140

 

$

190

 

$

187

 

Forfeitures on unearned stock-based compensation

 

$

105

 

$

10

 

$

192

 

$

56

 

$

267

 

$

64

 

Settlement of purchased call options for treasury stock

 

$

 

$

 

$

 

$

41,121

 

$

 

$

41,121

 

Equipment and software acquired under capital leases

 

$

 

$

193

 

$

1,835

 

$

15,390

 

$

120

 

$

15,390

 

Supplemental disclosure of non-cash activities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair value of assets acquired, net of cash acquired

 

$

 

$

25,956

 

$

 

$

25,956

 

$

 

$

25,956

 

Fair value of liabilities assumed

 

 

(1,336

)

 

(1,336

)

 

(1,336

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash paid to purchase businesses

 

$

 

$

24,620

 

$

 

$

24,620

 

$

 

$

24,620

 

 

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

 

6



 

Overstock.com, Inc.

Notes to Unaudited Consolidated Financial Statements

 

1. BASIS OF PRESENTATION

 

The accompanying unaudited consolidated financial statements have been prepared by Overstock.com, Inc. (the “Company”) pursuant to the rules and regulations of the Securities and Exchange Commission regarding interim financial reporting.  Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements and should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the audited annual consolidated financial statements and related notes thereto included in the Annual Report on Form 10-K for the year ended December 31, 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 and nine months ended September 30, 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 their 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 the instrument 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 September 30, 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 are generally: 1) during the period customers are acquired; or 2) based on the number of clicks generated during a given period over the term of the contract.  Advertising expense included in sales and marketing expenses totaled $9.0 million and $17.2 million during the three months ended September 30, 2004 and 2005, respectively, and $19.5 million and $47.7 million during the nine months ended September 30, 2004 and 2005, respectively.

 

Asset Retirement Obligation

 

In accordance with SFAS No. 143, Accounting for Asset Retirement Obligations, the Company establishes assets and liabilities for the present value of estimated future costs to return certain of our leased facilities to their original condition.  Such assets are depreciated over the lease period into operating expense, and the recorded liabilities are accreted to the future value of the estimated restoration costs.  At September 30, 2005, such amounts are not significant.

 

Accounting for merchant and agency revenues for Travel subsidiary

 

The determination of gross versus net revenue presentation is based principally on the Company’s consideration of Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements” and Emerging Issues Task Force Issue No. 99-19, “Reporting Revenue Gross as a Principal versus Net as an Agent,” including the weighing of the relevant qualitative factors regarding the Company’s status as the primary obligor, and the extent of pricing latitude and inventory risk.  The method of merchant revenue presentation by the Company does not impact operating profit, net income, or cash flows, but rather revenues and cost of sales.

 

The principle factor in determining gross versus net presentation by the Company’s travel subsidiary, OTravel.com, Inc.

 

7



 

(“OTravel.com” – see Note 4) is the consideration of who is the primary obligor in the relationship with the customer.  Our Travel business provides extensive customer service and support for its customers; however, the supplier hotel is principally liable to its merchant hotel customers in all situations where the customer does not receive the hotel services booked through OTravel.com.  In this case, OTravel.com provides customer service support to help resolve issues, even though such customer support could typically involve issues for which OTravel.com is not principally liable.

 

OTravel.com generates both merchant hotel revenues and agency air, hotel, car and cruise revenues.  Merchant hotel revenues are recognized as net revenue at the time of booking since all transactions are billed directly to customers, are nonrefundable and generally noncancelable, and require no significant post-delivery obligations for OTravel.com.  A reserve for chargebacks and cancellations is recorded at the time of the transaction based on historical experience.

 

Agency revenues are derived from airline ticket transactions, certain hotel transactions as well as cruise and car rental reservations.  Agency revenues are recognized on a net basis on air transactions when the reservation is made and secured by a credit card. A cancellation allowance is recognized on these revenues based on historical experience. OTravel.com recognizes agency revenues on hotel reservations, cruise and car rental reservations, either on an accrual basis for payments from a commission clearinghouse or on receipt of commissions from an individual supplier.

 

Recent accounting pronouncements

 

In March 2005, the Financial Accounting Standards Board (“FASB”) issued FIN 47 which clarifies guidance provided by Statement No. 143, “Accounting for Asset Retirement Obligations.”  FIN 47 is effective for the Company beginning the quarter ending March 31, 2006.  The adoption of FIN 47 is not expected to have a significant impact on the Company’s financial position, results of operations or cash flows.

 

In December 2004, the “FASB” issued Statement of Financial Accounting Standard (“SFAS”) No. 123 (revised 2004) Share-Based Payment (“Statement 123R”). This standard requires companies to measure and recognize the cost of employee services received in exchange for an award of 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 all stock-based compensation in the first quarter of 2006.

 

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 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.

 

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 June 7, 2005, the FASB issued Statement No. 154, “Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20, Accounting Changes, and Statement No. 3, Reporting Accounting Changes in Interim Financial Statements” (“FAS 154”). FAS 154 changes the requirements for the accounting and reporting of a change in accounting principle. Previously, most voluntary changes in accounting principles were required to be recognized by way of a cumulative effect adjustment within net income during the period of the change. FAS 154 requires retrospective application to prior periods financial statements, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. FAS 154 is effective for accounting changes made in fiscal years beginning after December 15, 2005; however, the Statement does not change the transition provisions of any existing accounting pronouncements. We do not believe adoption of FAS 154 will have a material effect on our consolidated financial position, results of operations or cash flows.

 

3. MARKETABLE SECURITIES

 

The Company’s marketable securities consist of funds deposited into capital management accounts managed by two financial institutions at September 30, 2005 as follows (in thousands):

 

 

 

Cost Basis

 

Recognized Loss
On Derivative
Securities

 

Unrealized
Gains (Losses)

 

Fair Value

 

 

 

 

 

 

 

 

 

 

 

U.S. government and government agency securities

 

$

23,997

 

$

 

$

(165

)

23,832

 

Mortgage-backed securities

 

2,150

 

 

(4

)

2,146

 

Foreign corporate securities

 

49,937

 

(2,350

)

660

 

48,247

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

76,084

 

$

(2,350

)

$

491

 

$

74,225

 

 

8



 

All marketable securities mature between 2005 and 2034 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.

 

Derivative instruments

 

During the first quarter of 2005, the Company purchased $49.9 million of Foreign Corporate Securities (“Notes”) which fully mature for $50.0 million in cash 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 its initial investment.  At September 30, 2005, the Notes had a fair value of $48.2 million.

 

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

 

For the quarter and nine months ended September 30, 2005 changes in the value of the conditional coupon resulted in losses of $2.1 million and $2.4, respectively.  The changes in the value of the Notes resulted in a gain of $660,000 which was recorded as a component of other comprehensive income (loss) for the quarter and nine months ended September 30, 2005.

 

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.

 

4.  ACQUISITIONS

 

On July 1, 2005, the Company acquired all the outstanding capital stock of Ski West, Inc. (“Ski West”) for an aggregate of $25.1 million (including $111,000 of capitalized acquisition related expenses).  In addition, the Company may be subject to additional earn out payments (based on a percentage of operating profits for each of the next four years as follows: 50%, 33.3%, 20%, and 10%, respectively), subject to reduction under certain circumstances, pursuant to a Stock Purchase Agreement dated June 24, 2005 among the Company, Ski West, and all of the shareholders of Ski West.

 

Ski West is an on-line travel company whose proprietary technology provides easy consumer access to a large, fragmented, hard-to-find inventory of lodging, vacation, cruise and transportation bargains. The travel offerings are primarily in popular ski areas in the U.S. and Canada, with more recent expansion into the Caribbean and Mexico, as well as cruises.

 

Effective upon the closing, Ski West became a wholly-owned subsidiary of the Company, integrated the Ski West travel offerings with the Company’s existing travel offerings and changed its name to OTravel.com, Inc.

 

Purchase Price Allocations

 

The following table summarizes the estimated fair values of the assets acquired and liabilities assumed on July 1, 2005.  The initial purchase price allocations may be adjusted within one year of the purchase date for changes in estimates of the fair value of assets acquired and liabilities assumed (in thousands):

 

 

 

July 1, 2005

 

Cash

 

$

491

 

Current assets

 

986

 

Property and equipment

 

263

 

Goodwill

 

10,385

 

Intangible assets

 

14,313

 

Other assets

 

9

 

Assets acquired

 

26,447

 

Liabilities assumed

 

(1,336

)

Net assets acquired

 

$

25,111

 

 

9



 

The excess of the purchase price over the fair values of assets acquired and liabilities assumed was allocated to goodwill.  Any required earn out payments would further increase goodwill at the time the target operating results for the next four years are successfully achieved.  Of the $10,385 recorded in goodwill, the full amount is expected to be deductible for tax purposes, to the extent the Company has sufficient taxable income in the future.

 

The amounts allocated to intangible assets, and their estimated useful lives, were based on independent appraisal and were attributed to the following categories (in thousands):

 

 

 

 

 

Years

 

Enterprise information system

 

$

860

 

5

 

Customer list

 

2,339

 

4

 

Supplier contracts

 

6,271

 

12

 

Web sites and destination portal

 

2,887

 

5

 

Non-competition agreements

 

1,956

 

2

 

 

 

$

14,313

 

 

 

 

During the quarter ended September 30, 2005, the Company recorded amortization expense attributable to the above intangible assets of approximately $700,000.

 

Pro forma results of operations have not been presented because the effect of the acquisition was not material to the results of prior periods presented.

 

5.  COMPREHENSIVE INCOME (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 and nine months ended September 30, 2004 and 2005 is as follows (in thousands):

 

 

 

Three months ended September 30,

 

Nine months ended September 30,

 

 

 

2004

 

2005

 

2004

 

2005

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

$

(2,951

)

$

(14,171

)

$

(7,483

)

$

(20,889

)

Net unrealized gain (loss) on marketable securities

 

6

 

312

 

(56

)

(173

)

Unrealized gain on foreign bonds

 

 

660

 

 

660

 

Foreign currency translation adjustment

 

2

 

137

 

7

 

111

 

 

 

 

 

 

 

 

 

 

 

Comprehensive loss

 

$

(2,943

)

$

(13,062

)

$

(7,532

)

$

(20,291

)

 

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 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- and nine-month periods ended September 30, 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 1.3 million options and no warrants outstanding at September 30, 2005.  As of September 30, 2005, the Company had $87.0 million of convertible senior notes outstanding (Note 12), which could potentially convert into 1.2 million shares of common stock in the aggregate.

 

7.  BUSINESS SEGMENTS

 

Segment information has been prepared in accordance with Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 131, “Disclosures about Segments of an Enterprise and Related Information.”  There were no inter-segment sales or transfers during the three- or nine-month periods ended September 30, 2004 or 2005.  The Company

 

10



 

evaluates the performance of its segments and allocates resources to them based primarily on gross profit. The table below summarizes information about reportable segments for the three and nine months ended September 30, 2004 and 2005 (in thousands):

 

 

 

 

Three months ended September 30,

 

Nine months ended September 30,

 

 

 

Direct
operations

 

Fulfillment
partner
operations

 

Consolidated

 

Direct
operations

 

Fulfillment
partner
operations

 

Consolidated

 

2004

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

43,928

 

$

59,516

 

$

103,444

 

$

123,621

 

$

149,693

 

$

273,314

 

Cost of goods sold

 

38,594

 

51,103

 

89,697

 

110,196

 

131,010

 

241,206

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

$

5,334

 

$

8,413

 

13,747

 

$

13,425

 

$

18,683

 

32,108

 

Operating expenses

 

 

 

 

 

(16,792

)

 

 

 

 

(39,850

)

Other income (expense), net

 

 

 

 

 

94

 

 

 

 

 

259

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

 

 

 

 

$

(2,951

)

 

 

 

 

$

(7,483

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2005

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

68,449

 

$

100,874

 

$

169,323

 

$

196,397

 

$

289,445

 

$

485,842

 

Cost of goods sold

 

60,939

 

83,589

 

144,528

 

171,246

 

242,821

 

414,067

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

$

7,510

 

$

17,285

 

24,795

 

$

25,151

 

$

46,624

 

71,775

 

Operating expenses

 

 

 

 

 

(36,023

)

 

 

 

 

(92,469

)

Other income, net

 

 

 

 

 

(2,943

)

 

 

 

 

(195

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

 

 

 

 

$

(14,171

)

 

 

 

 

$

(20,889

)

 

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

 

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

 

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

 

For the three and nine-month periods ended September 30, 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 September 30, 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 1.3 million shares of common stock, with proceeds to the Company of approximately $37.9 million, net of $405,000 of issuance costs.

 

In November 2004, the Company closed an additional follow-on public offering, pursuant to which it sold 1.4 million shares of common stock, with proceeds to the Company of approximately $75.2 million, net of $215,000 of issuance costs. Concurrently in November 2004, the Company issued convertible senior notes pursuant to which it received $116.2 million, net of $3.8 million 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 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 (in thousands)

 

11



 

 

 

Three months ended September 30,

 

Nine months ended September 30,

 

 

 

2004

 

2005

 

2004

 

2005

 

 

 

 

 

 

 

 

 

 

 

Net loss, as reported

 

$

(2,951

)

$

(14,171

)

$

(7,483

)

$

(20,889

)

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

 

18

 

(8

)

276

 

65

 

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

 

(710

)

(1,033

)

(2,654

)

(2,948

)

 

 

 

 

 

 

 

 

 

 

Pro forma net loss

 

$

(3,643

)

$

(15,212

)

$

(9,861

)

$

(23,772

)

 

 

 

 

 

 

 

 

 

 

Net loss per common share

 

 

 

 

 

 

 

 

 

Basic and diluted - as reported

 

$

(0.16

)

$

(0.75

)

$

(0.44

)

$

(1.08

)

Basic and diluted - pro forma

 

$

(0.20

)

$

(0.81

)

$

(0.57

)

$

(1.23

)

 

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 during the three months ended September 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 76.43%.  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.  Effective January 1, 2006, the Company will record stock compensation expense in accordance with FAS 123R.

 

10.  SHARE BUYBACK PROGRAM

 

During January 2005, the Company’s Board of Directors authorized a stock repurchase program under which the Company was authorized to repurchase up to $50.0 million 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 $100.0 million. Additionally, on June 14, 2005, the Board of Directors authorized an amendment of its three-year stock repurchase program to include the repurchase of its Convertible Senior Notes.

 

During 2005, the Company entered into several purchased call options, pursuant to which the Company could have been required to purchase up to 1.3 million shares of its common stock at certain settlement dates during the quarter ended June 30, 2005.  In connection with these repurchase transactions; the Company paid approximately $47.5 million, which was recorded in shareholders’ equity in the consolidated balance sheet.

 

At the Company’s option, the purchased call options were settled in cash or stock, based on the market price of our common stock on the date of the settlement.  Upon settlement, the Company either had its capital investment returned with a premium or received shares of its common stock, depending, respectively, on whether the market price of its common stock was above or below a pre-determined price agreed in connection with each such transaction.

 

Under the buyback program, the Company repurchased approximately 665,000 shares of our common stock in open market transactions for $24.1 million during the nine months ended September 30, 2005.  In addition, approximately 1.0 million shares of common stock were acquired as a result of the settlement of $41.1 million of structured stock repurchase transactions during the nine months ended September 30, 2005.  The purchased call options that did not settle in stock settled in cash totaling $7.9 million, which the Company received in July 2005.

 

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 original 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. As amended to date, the Amended Credit Agreement provides a revolving line of credit to the Company of up to $30.0 million and expires December 31, 2005. The Company has the 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 the Company uses to obtain letters of credit to support inventory purchases.

 

At September 30, 2005 $4.4 million was outstanding on the line and letters of credit totaling $6.9 million were issued on our

 

12



 

behalf under this facility.

 

Prior to October 18, 2005, interest on borrowings was payable monthly and accrued 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 was due on the maturity date. Borrowings under the facility were collateralized by the Company’s cash and marketable securities deposited at Wells Fargo or its affiliates, and the Company was required to maintain balances with Wells Fargo or its affiliates of up to $21.1 million in order to have the full amount of the credit facility available.

 

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 September 30, 2005.

 

On October 18, 2005, we entered into a sixth amendment to the credit agreement (“Sixth Amended Credit Agreement”).  The Sixth Amended Credit Agreement eliminated the requirement that the Company maintain specified cash balances with Wells Fargo as a condition to the availability of advances under the facility, and substituted collateral consisting of foreign bond securities owned by the Company in an aggregate principal amount of $50.0 million to secure the Company’s obligations under the facility. The $15.0 million sub-limit used to obtain letters of credit to support inventory purchases remained the same. We have an option to renew the Sixth Amended Credit Agreement annually.  The Sixth Amendment increased the interest rate on fixed rate advances under the credit facility to 1.35% above LIBOR on the first day of each fixed rate term.

 

Capital leases

 

The Company leases certain software and computer equipment under three non-cancelable capital leases that expire at various dates through 2008.  The Company expects that in the normal course of business the leases will expire.  Software and equipment acquired relating to the capital leases were $1.8 million and $16.3 million at December 31, 2004 and September 30, 2005, respectively, with accumulated depreciation and amortization of $395,000 and $2.9 million at those respective dates.  Depreciation of assets recorded under capital leases was zero and $2.5 million for the nine months ended September 30, 2004 and 2005, respectively.

 

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

 

Year Ending September 30,

 

 

 

2006

 

$

7,202

 

2007

 

4,634

 

2008