Edgar Filing: OVERSTOCK.COM, INC

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

	For the quarterly period ended September 30, 2007

Or

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

	For the transition period from to

Commission file number: 000-49799

OVERSTOCK.COM, INC.

(Exact name of registrant as specified in its charter)

Delaware		87-0634302
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification Number)

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 23,805,937 shares of the Registrant’s common stock, par value $0.0001, outstanding on November 2, 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

PART 1. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

Overstock.com, Inc.

Consolidated Balance Sheets (unaudited)

(in thousands)

	December 31,			September 30,
	2006			2007
Assets
Current assets:
Cash and cash equivalents	$	126,965		$	74,145
Marketable securities	—			16,842
Total cash and marketable securities	126,965			90,987
Accounts receivable, net	11,638			7,607
Notes receivable	6,702			1,506
Inventories, net	20,274			22,400
Prepaid inventory	2,241			5,003
Prepaid expense	7,473			10,257
Current assets of held for sale subsidiary	4,718			—
Total current assets	180,011			137,760
Property and equipment, net	56,198			33,450
Goodwill	2,784			2,784
Other long-term assets, net	578			197
Notes receivable (Note 4)	—			4,045
Long-term assets of held for sale subsidiary	16,594			—
Total assets	$	256,165		$	178,236
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	66,039		$	38,504
Accrued liabilities	40,142			26,499
Capital lease obligations, current	5,074			3,801
Current liabilities of held for sale subsidiary	3,684			—
Total current liabilities	114,939			68,804
Capital lease obligations, non-current	3,983			—
Other long-term liabilities	—			3,113
Convertible senior notes	75,279			75,537
Total liabilities	194,201			147,454
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 September 30, 2007	—			—
Common stock, $0.0001 par value, 100,000 shares authorized, 25,069 and 25,390 shares issued as of December 31, 2006 and September 30, 2007, respectively	2			2
Additional paid-in capital	325,771			332,899
Accumulated deficit	(198,694		)	(238,549		)
Treasury stock, 1,654 and 1,609 shares at cost as of December 31, 2006 and September 30, 2007, respectively	(64,983		)	(63,435		)
Accumulated other comprehensive loss	(132		)	(135		)
Total stockholders’ equity	61,964			30,782
Total liabilities and stockholders’ equity	$	256,165		$	178,236

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

Overstock.com, Inc.

Consolidated Statements of Operations (unaudited)

(in thousands, except per share data)

	Three months ended September 30,						Nine months ended September 30,
	2006			2007			2006			2007

Revenue
Direct	$	56,564		$	39,446		$	205,044		$	128,725
Fulfillment partner	100,321			122,484			289,077			340,102

Total revenue	156,885			161,930			494,121			468,827

Cost of goods sold:
Direct (1)	51,037			33,160			183,213			108,801
Fulfillment partner	84,483			100,509			243,481			280,147

Total cost of goods sold	135,520			133,669			426,694			388,948

Gross profit	21,365			28,261			67,427			79,879

Operating expenses:
Sales and marketing (1)	17,282			8,835			41,852			28,081
Technology (1)	16,157			14,576			44,478			44,786
General and administrative (1)	11,078			9,724			33,978			30,842
Restructuring	—			—			—			12,283

Total operating expenses	44,517			33,135			120,308			115,992

Operating loss	(23,152		)	(4,874		)	(52,881		)	(36,113		)

Interest income	459			1,291			2,989			3,359
Interest expense	(1,096		)	(1,029		)	(3,638		)	(3,085		)
Other income, net	(6		)	(92		)	(7		)	(92		)

Loss from continuing operations	(23,795		)	(4,704		)	(53,537		)	(35,931		)
Loss from discontinued operations	(708		)	—			(2,615		)	(3,924		)

Net loss	(24,503		)	(4,704		)	(56,152		)	(39,855		)
Deemed dividend related to redeemable common stock	(33		)	—			(99		)	—

Net loss attributable to common shares	$	(24,536	)	$	(4,704	)	$	(56,251	)	$	(39,855	)

Net loss per common share — basic and diluted:
Loss from continuing operations	$	(1.16	)	$	(0.20	)	$	(2.71	)	$	(1.52	)
Loss from discontinued operations	$	(0.03	)	$	—		$	(0.13	)	$	(0.16	)
Net loss per common share – basic and diluted	$	(1.19	)	$	(0.20	)	$	(2.84	)	$	(1.68	)
Weighted average common shares outstanding — basic and diluted	20,600			23,726			19,774			23,671

(1) Includes stock-based compensation from options as follows:

Cost of goods sold — direct	$	103	$	117	$	308	$	338
Sales and marketing	$	77	$	85	$	225	$	248
Technology	$	173	$	195	$	513	$	560
General and administrative	$	689	$	779	$	2,042	$	2,240

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

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	321	—		2,182			—			—		—			—			2,182
Treasury stock issued to employees as compensation	—	—		(620		)	—			45		1,548			—			928
Stock-based compensation from employee options	—	—		3,386			—			—		—			—			3,386
Stock-based compensation to consultants in exchange for services	—	—		280			—			—		—			—			280
Stock-based compensation related to performance shares	—	—		1,900			—			—		—			—			1,900
Comprehensive loss:
Net loss	—	—		—			(39,855		)	—		—			—			(39,855		)
Net unrealized gain on marketable securities	—	—		—			—			—		—			2			2
Cumulative translation adjustment	—	—		—			—			—		—			(5		)	(5		)
Total comprehensive loss																		(39,858		)
Balance at September 30, 2007	25,390	$	2	$	332,899		$	(238,549	)	(1,609	)	$	(63,435	)	$	(135	)	$	30,782

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

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,
	2006			2007			2006			2007			2006			2007

Cash flows from operating activities of continuing operations:
Net loss	$	(24,503	)	$	(4,704	)	$	(56,152	)	$	(39,855	)	$	(62,435	)	$	(85,469	)
Adjustments to reconcile net loss to cash provided by (used in) operating activities of continuing operations:
Loss from discontinued operations	708			—			2,615			3,924			3,830			8,191
Depreciation and amortization	7,776			7,080			20,802			22,825			25,447			34,350
Realized gain from marketable securities	—			—			(2,085		)	—			(1,095		)	—
Realized loss on disposition of property and equipment	—			—			599			1			2,056			1
Stock-based compensation	1,042			1,176			3,088			3,386			3,095			4,418
Stock-based compensation to consultants for services	(3		)	140			31			280			(20		)	272
Stock-based compensation relating to performance shares	—			350			—			350			—			350
Treasury stock issued to employees as compensation	67			213			679			928			720			1,036
Amortization of debt discount and deferred financing fees	139			86			417			258			435			258
Restructuring	—			—			—			12,283			—			17,957
Gain from retirement of convertible senior notes	—			—			—			—			(1,988		)	—
Notes receivable accretion	—			(136		)	—			(136		)	—			(136		)
Changes in operating assets and liabilities, net of effect of acquisition and discontinued operations:
Accounts receivable, net	1,541			335			2,880			3,731			(461		)	(1,201		)
Inventories, net	6,040			(6,975		)	24,487			(2,126		)	29,352			40,396
Prepaid inventory	(781		)	(2,879		)	5,605			(2,762		)	8,578			(979		)
Prepaid expenses	455			(1,522		)	(716		)	(2,784		)	22			(1,064		)
Other long-term assets, net	(123		)	100			(105		)	366			(1,821		)	967
Accounts payable	11,745			4,960			(53,479		)	(27,632		)	(358		)	(9,353		)
Accrued liabilities	(3,339		)	(566		)	(26,908		)	(18,680		)	(25,837		)	(3,689		)
Other long-term liabilities	—			(114		)	—			(114		)				(114		)

Net cash provided by (used in) operating activities of continuing operations	764			(2,456		)	(78,242		)	(45,757		)	(20,480		)	6,191

Cash flows from investing activities of continuing operations:
Change in restricted cash	—			—			253			—			633			—
Purchases marketable securities	—			(7,783		)	—			(29,164		)	(2,000		)	(29,164		)
Sales of marketable securities	—			8,924			56,756			12,324			76,280			12,324
Expenditures for property and equipment	(7,769		)	(316		)	(19,675		)	(2,232		)	(27,851		)	(5,998		)
Proceeds from the sale property and equipment	1			—			1			—			1			—
Proceeds from the sale of discontinued operations, net of cash transferred	—			—			—			9,892			—			9,892
Decrease in cash resulting from deconsolidation of variable interest entity	—			—			—			—			—			(102		)
Payments received on note receivable	—			502			—			5,196			—			5,196
Expenditures for other long-term assets	—			—			(100		)	—			(100		)	—

Net cash provided by (used in) investing activities of continuing operations	(7,768		)	1,327			37,235			(3,984		)	46,963			(7,852		)

Cash flows from financing activities of continuing operations:
Payments on capital lease obligations	(124		)	(5		)	(2,878		)	(5,256		)	(6,730		)	(5,335		)
Drawdown on line of credit	5,245			—			78,503			1,169			86,003			9,347
Payments on line of credit	(5,245		)	—			(78,503		)	(1,169		)	(90,371		)	(9,347		)
Payments to retire convertible senior notes	—			—			—			—			(7,735		)	—
Proceeds from the issuance of common stock	—			—			25,000			—			25,000			39,406
Exercise of stock options	806			261			2,267			2,182			2,701			2,449

Net cash provided by (used in) financing activities of continuing operations	682			256			24,389			(3,074		)	8,868			36,520

Effect of exchange rate changes on cash	40			(26		)	11			(5		)	(14		)	18
Cash provided by (used in) operating activities discontinued operations	42			—			112			(204		)	67			1,265
Cash used in investing activities of discontinued operations	(39		)	—			(343		)	(53		)	(441		)	(276		)

Net increase (decrease) in cash and cash equivalents	(6,279		)	(899		)	(16,838		)	(53,077		)	39,963			35,866
Change in cash and cash equivalents from discontinued operations	(3		)	—			231			257			374			(989		)
Cash and cash equivalents, beginning of period	45,550			75,044			55,875			126,965			3,931			39,268

Cash and cash equivalents, end of period	$	39,268		$	74,145		$	39,268		$	74,145		$	39,268		$	74,145
Supplemental disclosure of cash flow information:
Interest paid	192			142			2,001			2,378			4,540			4,054
Supplemental disclosures of non-cash flow information:
Deemed dividend on redeemable common shares	33			—			99			—			144			33
Lapse of rescission rights	2,431			—			3,304			—			3,450			—
Equipment and software acquired under capital leases	—			—			2,274			—			2,322			—

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

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 nine months ended September 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

The Company includes in fixed assets the capitalized cost of internal-use software and website development, including software used to upgrade and enhance its Website and processes supporting the Company’s business. 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. The Company expenses costs incurred related to design or maintenance of internal-use software as incurred.

During the three months ended September 30, 2006 and 2007, the Company capitalized $7.3 million and $209,000, respectively, of costs associated with internal-use software and website development, which are partially offset by amortization of previously capitalized amounts of $3.6 million and $3.2 million for those respective periods. For the nine months ended September 30, 2006 and 2007, the Company capitalized $19.3 million and $1.7 million, respectively, of costs associated with internal-use software and website development, which are partially offset by amortization of previously capitalized amounts of $9.9 million and $10.3 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) a commission for traffic driven to the Website that generates a sale 2) based on the number of clicks on keywords or links to our Website generated during a given period. Advertising expense included in sales and marketing expenses totaled $17.1 million and $7.8 million during the three months ended September 30, 2006 and 2007, respectively. For the nine months ended September 30, 2006 and 2007, advertising expenses totaled $41.1 million and $25.5 million, respectively.

Stock-based Compensation

As of January 1, 2006, the Company adopted Statement of Financial Accounting Standards (“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 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 positions 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 positions, nor was any interest expense recognized during the three or nine months ended September 30, 2007.

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, 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 period amounts have been reclassified to conform to the current period’s presentation. In addition, the Company has revised its consolidated statements of operations and consolidated statements of cash flows for the three and nine months ended September 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 was substantially completed by the end of the second quarter of 2007. There were no restructuring expenses during the third quarter of 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.

During the first nine months of 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 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 9/30/2007
Lease and contract termination costs	$	5,499	$	9,424	$	(10,139	)	$	4,784
Asset retirement obligation	450		—		(450		)	—
Accelerated amortization of leasehold improvements	—		2,359		(2,359		)	—
Other restructuring expenses	—		500		(200		)	300
Total	$	5,949	$	12,283	$	(13,148	)	$	5,084

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 classified the OTravel assets and liabilities as “held for sale” as it 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.

The following table is a summary of the Company’s discontinued operations for the nine months ended September 30, 2006 and the period ended April 25, 2007 (in thousands):

	Nine months ended September 30, 2006			Year-to-date period ended April 25, 2007
Sales	$	4,780		$	2,226
Cost of sales	(1,103		)	(650		)
Gross profit	3,677			1,576
Sales and marketing	(1,312		)	(447		)
Technology	(377		)	(60		)
General and administrative	(4,603		)	(1,152		)
Goodwill impairment	—			(3,841		)
Loss from discontinued operations	$	(2,615	)	$	(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 September 30, 2007 as follows:

	Amortized Cost Basis		Unrealized Gains		Unrealized Losses		Fair Value

Corporate debt securities	$	16,840	$	2	$	—	$	16,842

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 were 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 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 September 30,						Nine months ended September 30,
	2006			2007			2006			2007

Net loss	$	(24,503	)	$	(4,704	)	$	(56,152	)	$	(39,855	)
Net unrealized gain on marketable securities	—			1			—			2
Unrealized gain on Foreign Notes	—			—			740			—
Reclassification adjustment for gains included in net loss	—			—			(1,868		)	—
Foreign currency translation adjustment	40			(26		)	11			(5		)

Comprehensive loss	$	(24,463	)	$	(4,729	)	$	(57,269	)	$	(39,858	)

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 September 30,						Nine months ended September 30,
	2006			2007			2006			2007

Loss from continuing operations	$	(23,795	)	$	(4,704	)	$	(53,537	)	$	(35,931	)
Deemed dividend related to redeemable common stock	(33		)	—			(99		)	—
Loss from continuing operations attributable to common shares	(23,828		)	(4,704		)	(53,636		)	(35,931		)
Loss from discontinued operations	(708		)	—			(2,615		)	(3,924		)

Net loss attributable to common shares	$	(24,536	)	$	(4,704	)	$	(56,251	)	$	(39,855	)

Weighted average common shares outstanding—basic	20,600			23,726			19,774			23,671
Effective of dilutive securities:
Stock options	—			—			—			—
Convertible senior notes	—			—			—			—
Weighted average common shares outstanding—diluted	20,600			23,726			19,774			23,671
Net loss per common share—basic and diluted:
Loss from continuing operations	$	(1.16	)	$	(0.20	)	$	(2.71	)	$	(1.52	)
Loss from discontinued operations	$	(0.03	)	$	—		$	(0.13	)	$	(0.16	)
Net loss per common share—basic and diluted	$	(1.19	)	$	(0.20	)	$	(2.84	)	$	(1.68	)

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 September 30, 2006 and 2007 was 1,093,000 and 1,176,000, respectively. As of September 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.

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 nine months ended September 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 nine months ended September 30, 2006 and 2007 (in thousands):

	Three months ended September 30,							Nine months ended September 30,
	Direct		Fulfillment partner		Consolidated			Direct		Fulfillment partner		Consolidated
2006
Revenue	$	56,564	$	100,321	$	156,885		$	205,044	$	289,077	$	494,121
Cost of goods sold	51,037		84,483		135,520			183,213		243,481		426,694

Gross profit	$	5,527	$	15,838	21,365			$	21,831	$	45,596	67,427
Operating expenses					(44,517		)					(120,308		)
Other income (expense), net					(643		)					(656		)

Loss from continuing operations					$	(23,795	)					$	(53,537	)

2007
Revenue	$	39,446	$	122,484	$	161,930		$	128,725	$	340,102	$	468,827
Cost of goods sold	33,160		100,509		133,669			108,801		280,147		388,948

Gross profit	$	6,286	$	21,975	28,261			$	19,924	$	59,955	79,879
Operating expenses					(33,135		)					(115,992		)
Other income (expense), net					170							182

Loss from continuing operations					$	(4,704	)					$	(35,931	)

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, partners’ 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 nine months ended September 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 September 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.

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 were originally payable in cash. During interim and annual periods prior to the third quarter of 2007, the Company recorded 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 included assumed future growth rates in revenues, gross margins and other factors. If the Company were to use different assumptions, the estimated compensation charges could be significantly different.

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. In the third quarter of 2007, the Company engaged an independent third party valuation group to determine the fair value of the awards on the amendment date. Based on the independent third party valuation, the Company made the determination on August 7, 2007 to make the payments in the form of common stock, rather than cash. Therefore, the Company reclassified from their current status as liability awards to equity awards in accordance with FAS 123(R).

The Company reclassified a liability of approximately $1.5 million related to performance share awards granted prior to the determination to additional-paid-in-capital and recognized additional compensation of approximately $350,000 of compensation expense under the plan in general and administrative expenses for the quarter ended September 30, 2007, based on changes in the Company’s estimates regarding the ultimate growth in economic value expected to occur. During the quarter ended September 30, 2006, compensation expense under the Plan was reduced by $100,000. For the nine months ended September 30, 2006 and 2007, compensation expense under the plan totaled $800,000 and $1.0 million, respectively. As of September 30, 2007, the Company has recognized $1.9 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 September 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 September 30, 2007, no amounts were outstanding under the Amended Credit Agreement, and Letters of Credit totaling $2.7 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 September 30, 2007. At September 30, 2007, no amounts were outstanding and availability under the WFRF Agreement was $8.8 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 $19.8 million at December 31, 2006 and September 30, 2007, with accumulated amortization of $12.4 million and $17.4 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 September 30, 2006 and 2007, respectively. For the nine months ended September 30, 2006 and 2007, depreciation of assets recorded under

capital leases was $5.4 million and $4.9 million, respectively.

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

Twelve months ending September 30,
2008	$	4,091
Less: amount representing interest	(290		)
Present value of capital lease obligations	3,801
Less: current portion	(3,801		)
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 $139,000 and $86,000 during the three months ended September 30, 2006 and 2007, respectively. For the nine months ended September 30, 2006 and 2007, amortization of discount and debt issuance costs totaled $417,000 and $258,000, respectively. 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 September 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 September 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 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 effective August 15, 2007 for $1.9 million (see Note 3).

The Company leases 561,000 square feet for its warehouse facilities in Utah under operating leases which expire in August 2012. The Company has also temporarily leased an additional 251,000 square feet of warehouse space in Utah under operating leases for the seasonal increase in inventory during the fourth quarter of 2007.

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, respectively. 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 September 30,
2008	$	8,422
2009	6,228
2010	6,117
2011	5,764
2012	5,812
Thereafter	12,261
	$	44,604

Rental expense for operating leases totaled $4.3 million and $3.2 million for the three months ended September 30, 2006 and 2007, respectively. For the nine months ended September 30, 2006 and 2007, rental expense totaled $7.3 million and $6.9 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.

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.

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 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 which the California Supreme court denied on September 19, 2007. On October 1, 2007, the Court of Appeals remitted the case back to the Superior Court. The parties have begun discovery in this case. 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.

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. In September 2007, the Company filed an amended complaint adding two plaintiff shareholders, naming Lehman Brothers Holdings Inc. as a defendant, eliminating the previous claim of intentional interference with prospective economic advantage and clarifying various points of other claims in the original complaint. 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. In April 2007 defendants filed a demurrer and motion to strike the Company’s complaint. The Company opposed the demurrer and motion to strike. In July 2007 the court substantially denied defendants’ demurrer and motion to strike. The parties have begun discovery in this case. The Company intends to vigorously prosecute this action.

On March 29, 2007, the Company, along with 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 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.

On October 5, 2007 the Company was served as defendant in a case alleging violations of the Fair and Accurate Transaction Act (the “Act”). The plaintiff alleges that, because the Company followed an industry practice of displaying to the customer on a confirmation page the expiration date of the customer’s credit card while the customer was online and logged into the customer’s own account, the Company has violated certain provisions of the Act which prohibit a merchant from printing the credit card expiration date on a receipt. Filed in the U.S. District Court, Southern District of Illinois, the case is styled as a class action lawsuit on behalf of the nominative plaintiff and all others similarly situated. The case is in its preliminary stages. The Company believes it

has substantial defenses to the suit, including that the law does not apply to the alleged facts, and 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.

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

In addition to historical information, this Quarterly Report on Form 10-Q contains forward-looking statements. These statements relate to our, and in some cases our customers’ or other third parties’, future plans, objectives, expectations, intentions and financial performance and the assumptions that underlie these statements. These forward-looking statements include, but are not limited to, statements regarding the following: our beliefs and expectations regarding the seasonality of our direct and fulfillment partner revenue; our beliefs regarding the sufficiency of our capital resources; planned distribution and order fulfillment capabilities; our beliefs, intentions and expectations regarding improvements of our order processing systems and capabilities; our intentions regarding the development of enhanced technologies and features; our intentions regarding the expansion of our customer service capabilities; our beliefs and intentions regarding improvements to our general and administrative functions; our beliefs and intentions regarding enhancements to our sales and marketing activities; our beliefs regarding the potential for growth in our customer base; our beliefs and intentions regarding our expansion into new markets; our beliefs regarding potential development of new Websites or additions to our Websites; our beliefs, intentions and expectations regarding promotion of new or complimentary product and sales formats; our beliefs, intentions and expectations regarding the expansion of our product and service offerings; our beliefs and intentions regarding expanding our market presence through relationships with third parties; our beliefs regarding the adequacy of our insurance coverage; our beliefs, intentions and expectations regarding litigation matters and legal proceedings, our defenses to such matters and our contesting of such matters; our beliefs and expectations regarding our existing cash and cash equivalents, cash requirements and sufficiency of capital; our beliefs and expectations regarding interest rate risk, our investment activities and the effect of changes in interest rates; and all other statements except statements of historical fact.

These forward-looking statements are subject to risks and uncertainties that could cause actual results and events to differ materially from management’s expectations. For a discussion of some, but not all of these risks and uncertainties, please see Item 1A — Risk Factors and the description of risk factors set forth in our Annual Report on Form 10-K for the year ended December 31, 2006. These forward-looking statements speak only as of the date of this report and, except as required by law, we undertake no obligation to update forward-looking statements to reflect events or circumstances occurring after the date of this report.

Overview

We are an online “closeout” retailer offering discount brand name merchandise, including bed-and-bath goods, home décor, kitchenware, watches, jewelry, electronics and computers, sporting goods, apparel, and designer accessories, among other products. We also sell books, magazines, CDs, DVDs, videocassettes and video games (“BMMG”). We also operate as part of our Website an online auction site—a marketplace for the buying and selling of goods and services — as well as an online site for listing cars for sale.

Our company, based in Salt Lake City, Utah, was founded in 1997, and we launched our first Website through which customers could purchase products in March 1999. Our Website offers our customers an opportunity to shop for bargains conveniently, while offering our suppliers an alternative inventory liquidation distribution channel. We continually add new, limited inventory products to our Website in order to create an atmosphere that encourages customers to visit frequently and purchase products before our inventory sells out. We offer approximately 54,000 products under multiple stores under the shopping tab on our main Website, and offer almost 724,000 media products in the Entertainment store on our Website.

Closeout merchandise is typically available in inconsistent quantities and prices and often is only available to consumers after it has been purchased and resold by disparate liquidation wholesalers. We believe that the traditional liquidation market is therefore characterized by fragmented supply and fragmented demand. We utilize the Internet to aggregate both supply and demand and create a more efficient market for liquidation merchandise. Our objective is to provide a one-stop discount shopping destination products and services proven to be successfully sold through the Internet.

Our Business

We utilize the Internet to create a more efficient market for liquidation, closeout and other discount merchandise. We provide consumers and businesses with quick and convenient access to high-quality, brand-name merchandise at discount prices. Our shopping business includes both a “direct” business and a “fulfillment partner” business. Products from our direct segment and fulfillment partner segments are also available in bulk to both consumers and businesses through the Wholesale product category on our Website. During the nine months ended September 30, 2007, no single customer accounted for more than 1% of our total revenue.

Direct business

Our direct business includes sales made to individual consumers and businesses, which are fulfilled from our warehouses in Salt Lake City, Utah. During the nine months ended September 30, 2007, we fulfilled approximately 26% of all orders through our warehouses. Our warehouses generally ship between 5,000 and 8,000 orders per day and up to approximately 34,000 orders per day during peak periods, using overlapping daily shifts.

Fulfillment partner business

For our fulfillment partner business, we sell merchandise of other retailers, cataloguers or manufacturers (“fulfillment partners”) through our Website. We are considered to be the primary obligor for the majority of these sales transactions and we assume the risk of loss on returned items. As a consequence, we record revenue from the majority of these sales transactions involving our fulfillment partners on a gross basis. Our use of the term “partner” or “fulfillment partner” does not mean that we have formed any legal partnerships with any of our fulfillment partners. We currently have fulfillment partner relationships with approximately 580 third parties which post approximately 39,000 non-BMMG products, as well as most of the BMMG products on our Website.

Our revenue from sales on our shopping site from both the direct and fulfillment partner businesses is recorded net of returns, coupons and other discounts. During the third quarter, we updated our returns policy to one that we believe is more consistent with industry practices. For products other than computers, electronics and mattresses the returns policy provides for a full refund of the cost of the merchandise and all shipping charges if the item shipped is returned unopened within 30 days of delivery. If the item is returned after 30 days of delivery, opened or shows signs of wear, the transaction may only be subject to partial refund. For items shipped from our Computers and Electronics department, returns must be initiated within 20 days of the purchase date and must be received in the original condition within 30 days of purchase. Computer and Electronics items returned opened or received at our warehouse after 30 days may only qualify for up to a 70 percent refund. Damaged or defective mattresses qualify for a full refund only if the items are refused at the time of delivery.

Unless otherwise indicated or required by the context, the discussion herein of our financial statements, accounting policies and related matters, pertains to our shopping sites (Shopping and BMMG) and not necessarily to our wholesale, auction, or cars tabs on our Website.

Wholesale business

Our Wholesale store allows consumers and businesses to purchase selected products in bulk quantities. For this store, we sell products from similar product categories as our shopping tab, as well as products from various industry verticals, such as florist supplies, restaurant supplies, and office supplies.

Auctions business

We operate an online auction service as part of our Website. Our auction tab allows sellers to list items for sale, buyers to bid on items of interest, and users to browse through listed items online. We record only our listing fees and commissions for items sold as revenue. From time to time, we also sell items returned from our shopping site on our auction site, and for these sales, we record the revenue on a gross basis. Revenue from our auction business is included in the fulfillment partner segment, as it is not significant enough to segregate as its own segment.

Car listing business

We operate an online site for listing cars for sale as a part of our Website. The car listing service allows sellers to list vehicles for sale and allows buyers to review vehicle descriptions, post offers to purchase, and provides the means for purchasers to contact sellers for further information and negotiations on the purchase of an advertised vehicle. Revenue from our car listing business is included in the fulfillment partner segment, as it is not significant enough to separate out as its own segment.

Cost of goods sold

Cost of goods sold consists of the cost of the product, as well as inbound and outbound freight, warehousing and fulfillment costs (including payroll and related expenses), credit card fees, customer service costs and stock-based compensation.

Operating expenses

Sales and marketing expenses consist primarily of advertising, public relations and promotional expenditures, as well as payroll and related expenses, including stock-based compensation, for personnel engaged in marketing and selling activities.

Advertising expense is the largest component of our sales and marketing expenses and is primarily attributable to expenditures related to online marketing activities and offline national radio and television advertising. Our advertising expenses totaled approximately $17.1 million and $7.8 million for the three months ended September 30, 2006 and 2007, respectively, representing 99% and 89% of sales and marketing expenses for those respective periods. For the nine months ended September 30, 2006 and 2007, our advertising expense totaled approximately $41.1 million and $25.5 million, respectively, representing 98% and 91% of sales and marketing expenses for those respective periods.

Technology expenses consist of wages and benefits, including stock-based compensation, for technology personnel, rent, utilities, connectivity charges, as well as support and maintenance and depreciation and amortization related to software and computer equipment.

General and administrative expenses consist of wages and benefits, including stock-based compensation, for executive, legal,

accounting, merchandising and administrative personnel, rent and utilities, travel and entertainment, depreciation and amortization of intangible assets and other general corporate expenses.

We have recorded no provision or benefit for federal and state income taxes as we have incurred net operating losses since inception. We have provided a full valuation allowance on the net deferred tax assets, consisting primarily of net operating loss carryforwards, because of uncertainty regarding their realizability.

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

Executive Commentary

Commentary—Revenue and Marketing. Our third quarter revenue increased 3% compared to the third quarter of 2006, and declined 5% for the nine months of 2007 compared to 2006. We believe we are making progress in our efforts to grow revenue, achieving positive incremental improvement over the past two quarters (from revenue shrinking 11% in the first quarter to revenue growth of 3% in the third quarter), even while significantly reducing the dollars spent on marketing (down 33% to $28.1 million in the first nine months of 2007 from $41.9 million in 2006). We have also spent marketing dollars more efficiently over the first nine months of 2007 (6.0% of sales versus 8.5% in 2006).

To further assist in our efforts to generate positive revenue growth, we continue to increase the number of products available on our Website both by increasing the number of items offered by existing fulfillment partners, and by adding new fulfillment partners to sell product on our site. In addition, early in the fourth quarter we launched a new television advertising campaign, and we recently decided to invest more heavily in television, radio and print advertising during the fourth quarter than in the first nine months of 2007 (we intend to spend an incremental $5 million over the amount we had originally anticipated) to both strengthen our brand and enhance revenue growth.

Commentary—Gross Margins. Although revenue only increased 3% in the third quarter, gross profit dollars increased 32% to $28.3 million. Gross margins were 17.5% in the third quarter, up 383 basis points over the third quarter of 2006. The gains in gross margins are primarily due to significant improvement in our direct margins, which are up 610 basis points year-over-year to 15.9%. We significantly reduced our inventory over the course of 2006 in an effort to refine the selection of products that we purchase directly to categories that turn faster and have higher profitability. We believe that we can run our direct business with significantly less inventory than we have had in the past, while filling in product selection using fulfillment partners, rather than acquiring the inventory directly. As a result of these efforts, we have seen a significant improvement in direct and overall gross margins in the first nine months of this year over the same period in 2006. With reduced inventory levels, we have also successfully reduced our warehouse space and the related costs, which we expect will assist in our efforts to further improve our direct gross margins. We also had a 210 basis point improvement in our fulfillment partner margins in the quarter from 15.8% in 2006 to 17.9%.

Commentary—Contribution and Contribution Margin. Contribution (gross profit dollars less sales and marketing expense) increased $15.3 million (or 376%) to $19.4 million for the third quarter of 2007 versus $4.1 million recorded during the same quarter in 2006. This was due to the improvements we made in gross margins (up 383 basis points to 17.5%) combined with an $8.4 million reduction in sales and marketing dollars spent. This equates to contribution margin of 12.0% versus 2.6% in 2006. For the nine months ended September 30, 2006 and 2007, contribution increased 103% or $26.2 million to $51.8 million from $25.6 million, representing contribution margins of 5.2% and 11.0%, respectively, a 580 basis point improvement. The following table represents our calculation of contribution (in thousands):

	Three months ended September 30,						Nine months ended September 30,
	2006			2007			2006			2007
Total revenue	$	156,885		$	161,930		$	494,121		$	468,827
Cost of goods sold	135,520			133,669			426,694			388,948

Gross profit	21,365			28,261			67,427			79,879
Less: Sales and marketing expense	17,282			8,835			41,852			28,081

Contribution	$	4,083		$	19,426		$	25,575		$	51,798
Contribution margin	2.6		%	12.0		%	5.2		%	11.0		%

Commentary—Technology and G&A costs. We terminated a long-term computer co-location facility lease in December 2006 and we have reduced corporate headcount over the first nine months of 2007. We have also significantly reduced facilities costs and other expenses by reducing our corporate office space. As a result, our combined technology and G&A costs were down 11% or $2.9 million in the third quarter of 2007 versus 2006.

Overall, our operating expenses were down 26% in the third quarter over the previous year, while revenue was up 3% and gross profit dollars were up 32%.

Commentary—Operating loss. Our operating loss for the third quarter was $4.9 million, down 79% from $23.2 million in 2006. Over the first nine months of the year, our operating loss was $36.1 million, down 32% from $52.9 million over the same period last year. The 2007 operating loss includes $12.3 million of restructuring costs ($6.1 million in Q1 and $6.2 million in Q2). Before restructuring costs, the operating loss was $23.8 million for the nine months ended September 30, 2007, a $29.1 million year-over-year improvement. Restructuring costs primarily represent our efforts to reduce our overall expense structure through the consolidation of our corporate office, data centers and warehouse facilities. Therefore, we believe that discussing our operating loss before restructuring costs (a non-GAAP measure) provides useful information to us and investors because it is a representation of the expense structure of the company if we had not originally incurred these costs. We use this measure to monitor our progress in reducing our overall expense structure, including the comparison of operating results in the current year to similar periods in the previous year. See the following table for operating loss before restructuring costs (in thousands):

	Three months ended September 30,						Nine months ended September 30,
	2006			2007			2006			2007

Operating loss	$	(23,152	)	$	(4,874	)	$	(52,881	)	$	(36,113	)
Add back: restructuring	—			—			—			12,283

Operating loss before restructuring	$	(23,152	)	$	(4,874	)	$	(52,881	)	$	(23,830	)

Non-GAAP Financial Measure

Regulation G, Conditions for Use of Non-GAAP Financial Measures, and other SEC regulations regulate the disclosure of certain non-GAAP financial information. Our measure of “EBITDA” is a non-GAAP financial measure. EBITDA, which we reconcile to “Operating loss” in our income statement, is earnings before interest, taxes, depreciation, amortization and stock-based compensation. EBITDA is used in addition to and in conjunction with results presented in accordance with GAAP and should not be relied upon to the exclusion of GAAP financial measures. EBITDA reflects an additional way of viewing our results that, when viewed with our GAAP results, provides a more complete understanding of factors and trends affecting our results. You should review our financial statements and publicly-filed reports in their entirety and not rely on any single financial measure. Our discussion below (i) explains why management believes that presentation of EBITDA provides useful information to investors regarding our financial condition and results of operations, (ii) to the extent material, discloses the additional purposes, if any, for which management uses this non-GAAP measure, and (iii) provides a reconciliation of this measure to our operating losses.

Commentary—EBITDA (non-GAAP). EBITDA for the third quarter of 2007 was $4.1 million, an improvement from $(14.4 million) in Q3 2006. For the first nine months of the year, EBITDA was $(8.3 million), $20.0 million better than the $(28.3 million) in the previous year. We believe that, because our current capital expenditures are significantly lower than our depreciation levels, discussing EBITDA at this stage of our business is useful to us and investors. During 2005 and 2006, we made significant investments in our systems and overall infrastructure, and as a result will have approximately $30 million of related depreciation expense in 2007. However, we expect to spend less than $5 million in new capital expenditures during 2007, and therefore we use EBITDA as a reasonable measure of actual cash used or cash generated by the operations of the business.

For further details on EBITDA, see the reconciliation of this non-GAAP measure to our GAAP operating loss as follows (in thousands):

	Three months ended September 30,						Nine months ended September 30,
	2006			2007			2006			2007
Operating loss	$	(23,152	)	$	(4,874	)	$	(52,881	)	$	(36,113	)
Add: Depreciation and amortization	7,776			7,080			20,802			22,825
Stock-based compensation expense	1,042			1,176			3,088			3,386
Stock-based compensation to consultants for service	(3		)	140			31			280
Stock-based compensation relating to performance shares	—			350			—			350
Treasury stock issued to employees as compensation	67			213			679			928
EBITDA	$	(14,270	)	$	4,085		$