SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

 

Commission file number: 000-49799

OVERSTOCK.COM, INC.

(Exact name of registrant as specified in its charter)

 

6350 South 3000 East

Salt Lake City, Utah 84121

(Address, including zip code, of

Registrant’s principal executive offices)

Registrant’s telephone number, including area code: (801) 947-3100

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), (2) has been subject to such filing requirements for the past 90 days.  Yes   x      No   o

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

Large accelerated filer  o

Accelerated filer  x

Non-accelerated filer  o

 

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

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

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Item 4. Controls and Procedures
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Item 1A. Risk Factors
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 3. Defaults upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits
Signature

 

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PART 1. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

Overstock.com, Inc.

Consolidated Balance Sheets (unaudited)

(in thousands)

		December 31,			June 30,
		2006			2007
Assets
Current assets:
Cash and cash equivalents		$	126,965		$	75,044
Marketable securities		—			17,982
Total cash and marketable securities		126,965			93,026
Accounts receivable, net		11,638			7,942
Note receivable		6,702			2,008
Inventories, net		20,274			15,425
Prepaid inventory		2,241			2,124
Prepaid expense		7,473			8,735
Current assets of held for sale subsidiary		4,718			—
Total current assets		180,011			129,260
Property and equipment, net		56,198			40,209
Goodwill		2,784			2,784
Other long-term assets, net		578			302
Note receivable (Note 4)		—			3,909
Long-term assets of held for sale subsidiary		16,594			—
Total assets		$	256,165		$	176,464
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable		$	66,039		$	33,544
Accrued liabilities		40,142			28,615
Capital lease obligations, current		5,074			3,806
Current liabilities of held for sale subsidiary		3,684			—
Total current liabilities		114,939			65,965
Capital lease obligations, non-current		3,983			—
Other long-term liabilities		—			3,227
Convertible senior notes		75,279			75,451
Total liabilities		194,201			144,643
Commitments and contingencies (Notes 12 and 13)
Stockholders’ equity:
Preferred stock, $0.0001 par value, 5,000 shares authorized, no shares issued and outstanding as of December 31, 2006 and June 30, 2007		—			—
Common stock, $0.0001 par value, 100,000 shares authorized, 25,069 and 25,322 shares issued as of December 31, 2006 and June 30, 2007, respectively		2			2
Additional paid-in capital		325,771			329,357
Accumulated deficit		(198,694		)	(233,845		)
Treasury stock, 1,654 and 1,614 shares at cost as of December 31, 2006 and June 30, 2007, respectively		(64,983		)	(63,583		)
Accumulated other comprehensive loss		(132		)	(110		)
Total stockholders’ equity		61,964			31,821
Total liabilities and stockholders’ equity		$	256,165		$	176,464

 

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

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Overstock.com, Inc.

Consolidated Statements of Operations (unaudited)

(in thousands, except per share data)

		Three months ended June 30,						Six months ended June 30,
		2006			2007			2006			2007
Revenue
Direct		$	68,770		$	43,578		$	148,480		$	89,279
Fulfillment partner		90,422			105,389			188,756			217,618
Total revenue		159,192			148,967			337,236			306,897
Cost of goods sold:
Direct (1)		61,473			36,321			132,176			75,641
Fulfillment partner		75,411			86,343			158,998			179,638
Total cost of goods sold		136,884			122,664			291,174			255,279
Gross profit		22,308			26,303			46,062			51,618
Operating expenses:
Sales and marketing (1)		11,911			7,962			24,570			19,246
Technology (1)		14,897			15,237			28,321			30,210
General and administrative (1)		11,050			10,429			22,900			21,118
Restructuring		—			6,194			—			12,283
Total operating expenses		37,858			39,822			75,791			82,857
Operating loss		(15,550		)	(13,519		)	(29,729		)	(31,239		)
Interest income		2,215			1,078			2,530			2,068
Interest expense		(1,275		)	(1,027		)	(2,542		)	(2,056		)
Other income, net		(1		)	—			(1		)	—
Loss from continuing operations		(14,611		)	(13,468		)	(29,742		)	(31,227		)
Loss from discontinued operations		(1,128		)	(300		)	(1,907		)	(3,924		)
Net loss		(15,739		)	(13,768		)	(31,649		)	(35,151		)
Deemed dividend related to redeemable common stock		(33		)	—			(66		)	—
Net loss attributable to common shares		$	(15,772	)	$	(13,768	)	$	(31,715	)	$	(35,151	)
Net loss per common share — basic and diluted:
Loss from continuing operations		$	(0.72	)	$	(0.57	)	$	(1.50	)	$	(1.32	)
Loss from discontinued operations		$	(0.06	)	$	(0.01	)	$	(0.10	)	$	(0.17	)
Net loss per common share – basic and diluted		$	(0.78	)	$	(0.58	)	$	(1.60	)	$	(1.49	)
Weighted average common shares outstanding — basic and diluted		20,159			23,689			19,774			23,642

 

(1) Includes stock-based compensation from options as follows:
Cost of goods sold — direct		$	109		$	114		$	205		$	221
Sales and marketing		$	79		$	85		$	149		$	163
Technology		$	181		$	188		$	340		$	365
General and administrative		$	719		$	750		$	1,352		$	1,461

 

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

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Overstock.com, Inc.

Consolidated Statements of Stockholders’ Equity

and Comprehensive Loss (unaudited)

(in thousands)

		Common stock					Additional Paid-in			Accumulated			Treasury stock					Accumulated  Other Comprehensive
		Shares		Amount			capital			Deficit			Shares		Amount			Loss			Total
Balance at December 31, 2006		25,069		$	2		$	325,771		$	(198,694	)	(1,654	)	$	(64,983	)	$	(132	)	$	61,964
Exercise of stock options		253		—			1,921			—			—		—			—			1,921
Treasury stock issued to employees as compensation		—		—			(685		)	—			40		1,400			—			715
Stock-based compensation from employee options		—		—			2,210			—			—		—			—			2,210
Stock-based compensation to consultants in exchange for services		—		—			140			—			—		—			—			140
Comprehensive loss:
Net loss		—		—			—			(35,151		)	—		—			—			(35,151		)
Net unrealized gain on marketable securities		—		—			—			—			—		—			1			1
Cumulative translation adjustment		—		—			—			—			—		—			21			21
Total comprehensive loss																					(35,129		)
Balance at June 30, 2007		25,322		$	2		$	329,357		$	(233,845	)	(1,614	)	$	(63,583	)	$	(110	)	$	31,821

 

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

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Overstock.com, Inc.

Consolidated Statements of Cash Flows (unaudited)

(in thousands)

		Three months ended						Six months ended						Twelve months ended
		June 30,						June 30,						June 30,
		2006			2007			2006			2007			2006			2007
Cash flows from operating activities of continuing operations:
Net loss		$	(15,739	)	$	(13,768	)	$	(31,649	)	$	(35,151	)	$	(50,334	)	$	(105,268	)
Adjustments to reconcile net loss to cash provided by (used in) operating activities of continuing operations:
Loss from discontinued operations		1,128			300			1,907			3,924			4,478			8,898
Depreciation and amortization		6,876			7,974			13,026			15,745			22,572			35,046
Realized (gain) loss from marketable securities		(1,868		)	—			(2,085		)	—			1,292			—
Realized loss on disposition of property and equipment		1			1			599			1			2,056			1
Stock-based compensation		1,088			1,137			2,046			2,210			2,045			4,284
Stock-based compensation to consultants for services		(9		)	135			34			140			60			129
Treasury stock issued to employees as compensation		105			113			612			715			744			890
Amortization of debt discount and deferred financing fees		139			86			278			172			475			311
Restructuring		—			6,194			—			12,283			—			17,957
Gain from retirement of convertible senior notes		—			—			—			—			(1,988		)	—
Changes in operating assets and liabilities, net of effect of acquisition and discontinued operations:
Accounts receivable, net		(977		)	(431		)	1,339			3,396			(2,970		)	5
Inventories, net		6,529			1,237			18,447			4,849			(13,275		)	53,411
Prepaid inventory		5,592			477			6,386			117			7,163			1,119
Prepaid expenses and other assets		723			700			(1,171		)	(1,262		)	(1,557		)	913
Other long-term assets, net		(29		)	176			18			266			(2,122		)	744
Accounts payable		(1,603		)	5,467			(65,224		)	(32,592		)	(5,440		)	(2,568		)
Accrued liabilities		(8,384		)	5,141			(23,569		)	(18,114		)	(2,995		)	(6,460		)
Net cash provided by (used in) operating activities of continuing operations		(6,428		)	14,939			(79,006		)	(43,301		)	(39,796		)	9,412
Cash flows from investing activities of continuing operations:
Change in restricted cash		55			—			253			—			833			—
Purchases marketable securities		—			(21,381		)	—			(21,381		)	(23,552		)	(21,381		)
Sales of marketable securities		49,475			3,400			56,756			3,400			110,833			3,400
Expenditures for property and equipment		(5,102		)	(1,439		)	(11,906		)	(1,916		)	(32,272		)	(13,450		)
Acquisition of Ski West		—			—			—			—			(25,111		)	—
Proceeds from the sale of discontinued operations, net of cash transferred		—			9,892			—			9,892			—			9,892
Decrease in cash resulting from deconsolidation of variable interest entity		—			—			—			—			—			(102		)
Payments received on note receivable		—			753			—			4,694			—			4,694
Expenditures for other long-term assets		—			—			(100		)	—			(100		)	—
Net cash provided by (used in) investing activities of continuing operations		44,428			(8,775		)	45,003			(5,311		)	30,631			(16,947		)
Cash flows from financing activities of continuing operations:
Payments on capital lease obligations		(326		)	(4		)	(2,754		)	(5,251		)	(6,788		)	(5,454		)
Drawdown on line of credit		42,530			—			73,258			1,169			85,126			14,592
Payments on line of credit		(62,530		)	—			(73,258		)	(1,169		)	(85,126		)	(14,592		)
Payments to retire convertible senior notes		—			—			—			—			(7,735		)	—
Proceeds from the issuance of common stock, net of issuance costs		25,000			—			25,000			—			25,000			39,406
Settlement of call options for cash		—			—			—			—			7,937			—
Exercise of stock options and warrants		434			768			1,461			1,921			4,868			2,994
Net provided by (used in) financing activities of continuing operations		5,108			764			23,707			(3,330		)	23,282			36,946
Effect of exchange rate changes on cash		(44		)	36			(29		)	21			83			84
Cash provided by (used in) operating activities discontinued operations		246			(614		)	70			(204		)	25			1,307
Cash used in investing activities of discontinued operations		(263		)	—			(304		)	(53		)	(402		)	(315		)
Net increase (decrease) in cash and cash equivalents		43,047			6,350			(10,559		)	(52,178		)	13,823			30,487
Change in cash and cash equivalents from discontinued operations		17			614			234			257			377			(993		)
Cash and cash equivalents, beginning of period		2,486			68,080			55,875			126,965			31,350			45,550
Cash and cash equivalents, end of period		$	45,550		$	75,044		$	45,550		$	75,044		$	45,550		$	75,044
Supplemental disclosure of cash flow information:
Interest paid		1,531			1,585			1,809			2,236			4,424			1,661
Supplemental disclosures of non-cash flow information:
Deemed dividend on redeemable common shares		33			—			66			—			158			33
Lapse of rescission rights		319			—			873			—			1,019			2,431
Equipment and software acquired under capital leases		—			—			2,274			—			4,632			—
Fair value of assets acquired, net of cash acquired		—			—			—			—			26,447			—
Fair value of liabilities assumed		—			—			—			—			(1,336		)	—
Cash paid to purchase business		$	—		$	—		$	—		$	—		$	25,111		$	—

 

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

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Overstock.com, Inc.

Notes to Unaudited Consolidated Financial Statements

1.   BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements have been prepared by Overstock.com, Inc. (the “Company”) pursuant to the rules and regulations of the Securities and Exchange Commission regarding interim financial reporting. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements and should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the audited annual consolidated financial statements and related notes thereto included in the Annual Report on Form 10-K for the year ended December 31, 2006. The accompanying unaudited consolidated financial statements reflect all adjustments, consisting of normal recurring adjustments, which are, in the opinion of management, necessary for a fair statement of results for the interim periods presented. Preparing financial statements requires management to make estimates and assumptions that affect the amounts that are reported in the consolidated financial statements and accompanying disclosures. Although these estimates are based on management’s best knowledge of current events and actions that the Company may undertake in the future, actual results may be different from the estimates. The results of operations for the three and six months ended June 30, 2007 are not necessarily indicative of the results to be expected for any future period or the full fiscal year.

2.   ACCOUNTING POLICIES

Principles of consolidation

The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. The consolidated financial statements include the accounts of the Company’s OTravel subsidiary through April 25, 2007 (Note 4).  The consolidated financial statements also include the accounts of a variable interest entity for which the Company was the primary beneficiary through November 30, 2006. All significant intercompany account balances and transactions have been eliminated in consolidation.

Use of estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Internal-Use Software and Website Development

Included in fixed assets is the capitalized cost of internal-use software and website development, including software used to upgrade and enhance our Website and processes supporting the business of the Company. As required by Statement of Position 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use, the Company capitalizes costs incurred during the application development stage of internal-use software and amortizes these costs over the estimated useful life of three years. Costs incurred related to design or maintenance of internal-use software are expensed as incurred.

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

Advertising expense

The Company recognizes advertising expenses in accordance with SOP 93-7 Reporting on Advertising Costs. As such, the Company expenses the costs of producing advertisements at the time production occurs or the first time the advertising takes place and expenses the cost of communicating advertising in the period during which the advertising space or airtime is used. Internet advertising expenses are recognized as incurred based on the terms of the individual agreements, which are generally: 1) during the period customers are acquired or 2) based on the number of clicks generated during a given period over the term of the contract. Advertising expense included in sales and marketing expenses totaled $11.5 million and $7.1 million during the three months ended June 30, 2006 and 2007, respectively.  For the six months ended June 30, 2006 and 2007, advertising expenses totaled $24.0 million and $17.7 million, respectively.

Stock-based Compensation

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

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value and recognize compensation expense over the service period for awards expected to vest. The estimation of stock awards that will ultimately vest requires judgment, and to the extent actual results differ from estimates, such amounts will be recorded as an adjustment in the period estimates are revised. Management considers many factors when estimating expected forfeitures, including types of awards, employee class, and historical experience. Actual results may differ substantially from these estimates.

Recent accounting pronouncements

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

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

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

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

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

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

Reclassifications

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

3.   RESTRUCTURING EXPENSE

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

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

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

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

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

		Balance 12/31/2006			Charges to expense			Cash payment or accelerated amortization			Balance 6/30/2007
Lease and contract termination costs		$	5,499		$	7,950		$	(5,321	)	$	8,128
Asset retirement obligation		450			—			(450		)	—
Accelerated amortization of leasehold improvements		—			2,359			(2,359		)	—
Other restructuring expenses		—			1,974			(724		)	1,250
Total		$	5,949		$	12,283		$	(8,854	)	$	9,378

 

4.   SALE OF DISCONTINUED OPERATIONS

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

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

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

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

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

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

		Six months ended June 30,
		2006			2007
Sales		$	2,938		$	2,226
Cost of sales		(844		)	(650		)
Gross profit		2,094			1,576
Sales and marketing		(777		)	(447		)
Technology		(273		)	(60		)
General and administrative		(2,951		)	(1,152		)
Goodwill impairment		—			(3,841		)
Loss from discontinued operations		$	(1,907	)	$	(3,924	)

 

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

		December 31,
		2006
Assets of held for sale subsidiary:
Cash		$	1,365
Accounts receivable		3,267
Property and equipment, net		1,215
Goodwill and intangible assets, net		15,379
Other		86
Total assets of discontinued operations		$	21,312
Liabilities of held for sale subsidiary:
Current liabilities:
Accounts payable		$	2,947
Accrued liabilities		737
Total liabilities of discontinued operations		$	3,684

 

5. MARKETABLE SECURITIES

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

		Amortized Cost Basis			Unrealized  Gains			Unrealized Losses			Fair Value
Corporate debt securities		$	17,981		$	1		$	—		$	17,982

 

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

Derivative instruments

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

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

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

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

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

6.   OTHER COMPREHENSIVE LOSS

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

		Three months ended June 30,						Six months ended June 30,
		2006			2007			2006			2007
Net loss		$	(15,739	)	$	(13,768	)	$	(31,649	)	$	(35,151	)
Net unrealized gain on marketable securities		—			1			—			1
Unrealized gain on Foreign Notes		255			—			740			—
Reclassification adjustment for gains included in net loss		(1,868		)	—			(1,868		)	—
Foreign currency translation adjustment		(44		)	36			(29		)	21
Comprehensive loss		$	(17,396	)	$	(13,731	)	$	(32,806	)	$	(35,129	)

 

7.   EARNINGS (LOSS) PER SHARE

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

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

		Three months ended June 30,						Six months ended June 30,
		2006			2007			2006			2007
Loss from continuing operations		$	(14,611	)	$	(13,468	)	$	(29,742	)	$	(31,227	)
Deemed dividend related to redeemable common stock		(33		)	—			(66		)	—
Loss from continuing operations attributable to common shares		(14,644		)	(13,468		)	(29,808		)	(31,227		)
Loss from discontinued operations		(1,128		)	(300		)	(1,907		)	(3,924		)
Net loss attributable to common shares		$	(15,772	)	$	(13,768	)	$	(31,715	)	$	(35,151	)
Weighted average common shares outstanding—basic		20,159			23,689			19,774			23,642
Effective of dilutive securities:
Stock options		—			—			—			—
Convertible senior notes		—			—			—			—
Weighted average common shares outstanding—diluted		20,159			23,689			19,774			23,642
Net loss per common share—basic and diluted:
Loss from continuing operations		$	(0.72	)	$	(0.57	)	$	(1.50	)	$	(1.32	)
Loss from discontinued operations		$	(0.06	)	$	(0.01	)	$	(0.10	)	$	(0.17	)
Net loss per common share—basic and diluted		$	(0.78	)	$	(0.58	)	$	(1.60	)	$	(1.49	)

 

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

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8.   BUSINESS SEGMENTS

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

		Three months ended June 30,									Six months ended June 30,
		Direct			Fulfillment  partner			Consolidated			Direct			Fulfillment  partner			Consolidated
2006
Revenue		$	68,770		$	90,422		$	159,192		$	148,480		$	188,756		$	337,236
Cost of goods sold		61,473			75,411			136,884			132,176			158,998			291,174
Gross profit		$	7,297		$	15,011		22,308			$	16,304		$	29,758		46,062
Operating expenses								(37,858		)							(75,791		)
Other income (expense), net								939									(13		)
Loss from continuing operations								$	(14,611	)							$	(29,742	)
2007
Revenue		$	43,578		$	105,389		$	148,967		$	89,279		$	217,618		$	306,897
Cost of goods sold		36,321			86,343			122,664			75,641			179,638			255,279
Gross profit		$	7,257		$	19,046		26,303			$	13,638		$	37,980		51,618
Operating expenses								(39,822		)							(82,857		)
Other income (expense), net								51									12
Loss from continuing operations								$	(13,468	)							$	(31,227	)

 

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

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

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

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

9.   PERFORMANCE SHARE PLAN

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

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

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

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

10.   BORROWINGS

$30.0 million Amended Credit Agreement

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

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

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

$40.0 million WFRF Agreement

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

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

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

Capital leases

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

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

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

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

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

Twelve months ending June 30,
2008		$	4,096
Less: amount representing interest		(290		)
Present value of capital lease obligations		3,806
Less: current portion		(3,806		)
Capital lease obligations, non-current		$	—

 

11.   3.75% CONVERTIBLE SENIOR NOTES

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

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

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

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

12.   COMMITMENTS AND CONTINGENCIES

Commitments

Corporate office space

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

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

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

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

Logistics and warehouse space

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

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

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

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

Co-location data center

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

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

Operating leases

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

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

Twelve months Ending June 30,
2008		$	9,154
2009		6,234
2010		6,273
2011		5,726
2012		5,881
Thereafter		13,530
		$	46,798

 

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

Redeemable Common Stock

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

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Legal Proceedings

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

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

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

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

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

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

On February 2, 2007, along with five shareholder plaintiffs, the Company filed a lawsuit in the Superior Court of California, County of San Francisco against Morgan Stanley & Co. Incorporated, Goldman Sachs & Co., Bear Stearns Companies, Inc., Bank of America Securities LLC, Bank of New York, Citigroup Inc., Credit Suisse (USA) Inc., Deutsche Bank Securities, Inc., Merrill Lynch, Pierce, Fenner & Smith, Inc., and UBS Financial Services, Inc. The suit alleges that the defendants, who control over 80% of the prime brokerage market, participated in an illegal stock market manipulation scheme and that the defendants had no intention of covering short sell orders with borrowed stock, as they are required to do, causing what are referred to as “fails to deliver” and that the defendants’ actions caused and continue to cause dramatic distortions with in the nature and amount of trading in the Company’s stock as well as dramatic declines in the share price of the Company’s stock.  The suit asserts that a persistent large number of “fails to deliver” creates significant downward pressure on the price of a company’s stock and that the amount of “fails to deliver” has exceeded the company’s entire supply of outstanding shares. The suit accuses the defendants of violations of California securities laws and common law, specifically, conversion, trespass to chattels, intentional interference with prospective economic advantage, and violations of California’s Unfair Business Practices Act. The Company is seeking damages of $3.48 billion. On April 6, 2007 defendants filed a demurrer and motion to strike the Company’s complaint.  The Company has opposed the demurrer and motion to strike.  On July 17, 2007 the court substantially denied defendants’ demurrer and motion to strike. The Company intends to vigorously prosecute this action.

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

13.   INDEMNIFICATIONS AND GUARANTEES

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

14.   STOCK OFFERINGS

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

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