10-K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
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ý | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2015
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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)
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Delaware | | 87-0634302 |
(State or other jurisdiction of incorporation or organization) | | (I.R.S. Employer Identification Number) |
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6350 South 3000 East Salt Lake City, Utah | | 84121 |
(Address of principal executive offices) | | (Zip code) |
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(801) 947-3100 |
(Registrant’s telephone number, including area code) |
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Securities registered pursuant to Section 12(b) of the Act: | | |
Title of Each Class | | Name of Each Exchange on Which Registered |
Common Stock, $0.0001 par value | | Nasdaq Global Market |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No ý
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No ý
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), (2) has been subject to such filing requirements for the past 90 days. Yes ý No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K, or any amendment to this Form 10-K. ý
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
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Large accelerated filer o | | Accelerated filer x |
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Non-accelerated filer o | | Smaller reporting company o |
(Do not check if a smaller reporting company) | | |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the act). Yes o No ý
The aggregate market value of voting and non-voting common equity held by non-affiliates of the registrant as of the last business day of the registrant's most recently completed second quarter (June 30, 2015), was approximately $274.3 million based upon the last sales price reported by Nasdaq. For purposes of this disclosure, shares of Common Stock held by persons who hold more than 5% of the outstanding shares of Common Stock and shares held by officers and directors of the registrant have been excluded in that such persons may be deemed to be affiliates. This determination is not necessarily conclusive.
There were 25,294,179 shares of the Registrant’s common stock, par value $0.0001, outstanding on March 1, 2016.
DOCUMENTS INCORPORATED BY REFERENCE
Certain information required by Part III of Form 10-K is incorporated by reference to the Registrant's proxy statement for the 2016 Annual Stockholders
Meeting, which will be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year to which this Report relates.
TABLE OF CONTENTS
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| Special Cautionary Note Regarding Forward-Looking Statements | |
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| Part I | |
Item 1. | Business | |
Item 1A. | Risk Factors | |
Item 1B. | Unresolved Staff Comments | |
Item 2. | Properties | |
Item 3. | Legal Proceedings | |
Item 4. | Mine Safety Disclosures | |
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| Part II | |
Item 5. | Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities | |
Item 6. | Selected Financial Data | |
Item 7. | Management's Discussion and Analysis of Financial Condition and Results of Operations | |
Item 7A. | Quantitative and Qualitative Disclosures About Market Risk | |
Item 8. | Financial Statements and Supplementary Data | |
Item 9. | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure | |
Item 9A. | Controls and Procedures | |
Item 9B. | Other Information | |
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| Part III | |
Item 10. | Directors, Executive Officers and Corporate Governance | |
Item 11. | Executive Compensation | |
Item 12. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters | |
Item 13. | Certain Relationships and Related Transactions, and Director Independence | |
Item 14. | Principal Accounting Fees and Services | |
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| Part IV | |
Item 15. | Exhibits, Financial Statement Schedules | |
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Signatures | |
Financial Statements | |
O, Overstock.com, O.com, O.co, Club O, Main Street Revolution, Worldstock and OVillage are registered trademarks of Overstock.com, Inc. O.biz and Space Shift are also trademarks of Overstock.com, Inc. Other service marks, trademarks and trade names referred to in this Annual Report on Form 10-K are the property of their respective owners.
SPECIAL CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K and the documents incorporated herein by reference, as well as our other public documents and statements our officers and representatives may make from time to time, contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, as amended. These statements are therefore entitled to the protection of the safe harbor provisions of these laws. These forward-looking statements involve risks and uncertainties, and relate to future events or our future financial or operating performance. The forward-looking statements include all statements other than statements of historical fact, including, without limitation, all statements regarding:
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• | the anticipated benefits and risks of our business and plans; |
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• | our beliefs regarding our ability to attract and retain customers in a cost-efficient manner; |
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• | the anticipated effectiveness of our marketing; |
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• | our future operating and financial results, including any projections of revenue, profits or losses, contribution, technology expense, general and administrative expense, cash flow, capital expenditures or other financial measures or amounts or non-GAAP financial measures or amounts or anticipated changes in any of them; |
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• | our plans and expectations regarding our design and construction of an office campus in Salt Lake City to serve as our corporate headquarters; |
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• | our beliefs and expectations regarding the adequacy of our office and warehouse facilities and our anticipated transition from our current facilities to our anticipated new facilities; |
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• | our expectations regarding the benefits and risks of the Construction Agreement and related agreements we entered into in connection with our construction of our planned corporate headquarters and of the credit facility we entered into for the purpose of, among other things, financing a portion of the costs of that construction; |
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• | our expectations regarding our ability to secure the additional financing that we will need to complete our corporate headquarters; |
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• | our future capital requirements and our ability to satisfy our capital needs; |
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• | our expectations regarding the adequacy of our liquidity; |
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• | our ability to retire or refinance any debt we may have or incur in the future; |
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• | the competition we currently face and will face in our business as the ecommerce business continues to evolve and to become more competitive, and as additional competitors, including competitors based in China or elsewhere, continue to increase their efforts in our primary markets; |
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• | the effects of government regulation; |
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• | our plans for international markets, our expectations for our international sales efforts and the anticipated results of our international operations; |
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• | our plans and expectations regarding Overstock Fulfillment Services and Supplier Oasis and our efforts to provide multi-channel fulfillment services; |
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• | our plans and expectations regarding our insurance product offerings and consumer finance offerings; |
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• | our plans and expectations regarding our recent acquisition of the assets and operations of a financial technology company and two registered broker dealers affiliated with the fintech business; |
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• | our expectations about our majority owned subsidiary Medici and its project to develop fintech and crypto software products and intellectual property including proprietary blockchain software and other future businesses, innovations and projects and the anticipated functionality and results of operations of each of them; |
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• | our plans for further changes to our business; |
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• | our beliefs regarding current or future litigation or regulatory actions; |
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• | our beliefs regarding the costs and benefits of our “spend and defend” policy under which we generally refuse to settle abusive patent suits brought against us; |
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• | our beliefs and expectations regarding existing and future tax laws and related laws and the application of those laws to our business including the assessments we recently received from the Department of Revenue of the State of Washington; |
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• | our beliefs regarding the adequacy of our insurance coverage; |
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• | our beliefs regarding the adequacy and anticipated functionality of our infrastructure, including our backup facilities and beliefs regarding the adequacy of our disaster planning and our ability to recover from a disaster or other interruption of our ability to operate our website at its highest level of functionality; |
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• | our beliefs regarding our cybersecurity efforts and measures and the costs we will incur in our ongoing efforts to avoid interruptions to our product offerings and other business processes from cyber attacks; |
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• | our belief that we can meet our published product shipping standards even during periods of relatively high sales activity; |
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• | our belief that we can maintain or improve upon customer service levels that we and our customers consider acceptable; |
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• | our beliefs regarding the adequacy of our order processing systems and our fulfillment and distribution capabilities; |
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• | our expectations regarding the costs and benefits of our other businesses, innovations and projects including our new and used car listing service, our Worldstock Fair Trade offerings, our Main Street Revolution offerings and our ecommerce marketplace channel offerings; |
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• | our expectations regarding the costs and benefits of various programs we offer, including Club O and programs pursuant to which we offer free or discounted participation in Club O or other programs we offer to members of the United States Armed Forces and/or to full-time, post-secondary students or others, and including our community site and our public service pet adoption program; |
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• | our expectations regarding the costs and benefits of transitioning some of our marketing efforts from coupons to rewards for our Club O members; |
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• | our belief that we and our partners will be able to maintain inventory levels at appropriate levels despite the seasonal nature of our business; |
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• | our belief that our sales through other ecommerce marketplace channels will be successful and will become an important part of our business; and |
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• | our belief that we can successfully offer and sell a constantly changing mix of products and services. |
Further, in some cases, you can identify forward-looking statements by terminology such as may, will, could, should, likely, expect, plan, seek, intend, anticipate, project, believe, estimate, predict, potential, goal, strategy, future or continue, the negative of such terms or other comparable terminology. These statements are only predictions. Actual events or results may differ materially from those contemplated by forward-looking statements for a variety of reasons, including among others:
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• | changes in U.S. and global economic conditions and consumer spending; |
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• | any downturn in the U.S. housing industry; |
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• | the rate of growth of the Internet and online commerce, and the occurrence of any event that would discourage or prevent consumers from shopping online or via mobile apps; |
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• | any failure to maintain our existing relationships or build new relationships with partners on acceptable terms; |
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• | any difficulties we may encounter maintaining optimal levels of product quality and selection or in attracting sufficient consumer interest in our product offerings; |
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• | any difficulties we may have with the quality or safety of the products we offer; |
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• | modifications we may make to our business model from time to time, including aspects relating to our product mix and the mix of direct/partner sourcing of the products we offer; |
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• | the mix of products purchased by our customers; |
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• | any problems we may have with cyber security or data breaches or Internet or other infrastructure or communications impairment problems or the costs of preventing or responding to any such problems; |
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• | any problems with or affecting our credit card processors, including cyber-attacks, Internet or other infrastructure or communications impairment or other events that could interrupt the normal operation of the credit card processors or any difficulties we may have maintaining compliance with the rules of the credit card processors; |
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• | any problems we may encounter as a result of the implementation in the U.S. of the EMV (Europay, MasterCard and Visa) standards for credit cards, which generally became effective in the U.S. in 2015, including any problems that may result from any increase in online fraud as a result of the implementation of the EMV standards; |
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• | problems with or affecting the facility where substantially all of our computer and communications hardware is located or other problems that result in the unavailability of our Website or reduced performance of our transaction systems; |
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• | difficulties we may have in responding to technological changes; |
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• | problems with the large volume of fraudulent purchase orders we receive on a daily basis; |
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• | problems we may encounter as a result of the listing or sale of pirated, counterfeit or illegal items by third parties; |
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• | difficulties we may have financing our operations or our expansion with either internally generated funds or external sources of financing; |
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• | any environmental or other difficulties we may encounter relating to the real estate we recently purchased, the design and construction of an office campus on that property to serve as our corporate headquarters, our financing of a substantial portion of the costs of designing and constructing the office campus and headquarters or of the interest rate swaps we entered into in connection with the financing of it, of financing it after construction, or the transition from our current facilities to the new facilities; |
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• | any difficulties we may encounter in connection with Overstock Fulfillment Services or Supplier Oasis or our efforts to provide multi-channel fulfillment services, our Farmers Market offerings, our insurance product offerings, our consumer finance offerings or other businesses or product or service offerings outside of our main shopping website offerings; |
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• | any difficulties we may encounter as a result of our reliance on third parties that we do not control for the performance of critical functions material to our business; |
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• | any difficulties we may encounter in connection with the rapid shift of ecommerce and online payments to mobile and multi-channel commerce and payments; |
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• | the extent to which we owe income or sales taxes or are required to collect sales taxes or report sales or to modify our business model in order to avoid being required to collect sales taxes or report sales or avoid the application of other types of taxes; |
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• | any difficulties we may encounter as a consequence of accepting or holding bitcoins or other cryptocurrencies, whether as a result of regulatory, tax or other legal issues, technological issues, value fluctuations, lack of widespread adoption of bitcoins or other cryptocurrencies as an acceptable medium of exchange or otherwise; |
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• | increasing competition, including competition from well-established competitors including Amazon.com, competition from competitors based in China or elsewhere, competition from companies willing to incur substantial losses in order to build market share, and from others including competitors with business models that may include delivery capabilities that we may be unable to match; |
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• | difficulties with the management of our growth and any periods in which we fail to grow in accordance with our plans; |
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• | fluctuations in our operating results; |
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• | difficulties we may encounter in connection with our international efforts; |
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• | difficulties we may encounter in connection with our efforts to offer additional types of services to our customers, including insurance products and consumer financing; |
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• | difficulties, including expense and any operational or regulatory issues we may encounter in connection with the integration or operation of the assets and operations of a financial technology company and two registered broker dealers affiliated with the fintech business that we recently acquired; |
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• | technical, operational, regulatory or other difficulties we may encounter in connection with Medici's efforts to develop fintech and crypto software products and intellectual property including proprietary blockchain software and other future businesses, or with the operation of Medici's system; |
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• | difficulties Medici may encounter with its fintech and crypto software products and intellectual property including proprietary blockchain software due to lack of market acceptance or as a result of competition from any of the numerous other competitors seeking to develop competing technologies or systems; |
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• | the outcomes of legal proceedings, investigations and claims, including the outcome of the judgment obtained by the District Attorneys of a number of California counties as described in this report; |
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• | our inability to optimize our warehouse operations; |
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• | risks of inventory management and seasonality; |
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• | the cost and availability of traditional and online advertising, the rapid changes in the online advertising business and the longer-term changes in the traditional advertising business, and the results of our various brand building and marketing campaigns; |
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• | risks that the amount of deferred tax assets we consider realizable could be reduced if estimates of future taxable income during the carryforward period are reduced; and |
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• | the other risks described in this report or in our other public filings. |
In evaluating all forward-looking statements, you should specifically consider the risks outlined above and in this Annual Report on Form 10-K in Part I, Item 1A under the caption “Risk Factors”, in Part II, Item 7 under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, and elsewhere in this report. These factors may cause our actual results to differ materially from those contemplated by any forward-looking statement. Although we believe that our expectations reflected in the forward-looking statements are reasonable, we cannot guarantee or offer any assurance of future results, levels of activity, performance or achievements or other future events.
Our forward-looking statements contained in this report 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 or any changes in our expectations or any change in any events, conditions or circumstances on which any of our forward-looking statements are based.
PART I
ITEM 1. BUSINESS
The following description of our business contains forward-looking statements relating to future events or our future financial or operating performance that involve risks and uncertainties, as set forth above under "Special Note Regarding Forward-Looking Statements." Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors described in this Annual Report on Form 10-K, including those set forth above in the Special Cautionary Note Regarding Forward-Looking Statements or in Section 1A under the heading "Risk Factors" or elsewhere in this Annual Report on Form 10-K.
Introduction
We are an online retailer offering a broad range of price-competitive brand name, non-brand name and closeout products, including furniture, home decor, bedding and bath, housewares, jewelry and watches, apparel and designer accessories, health and beauty products, electronics and computers, and sporting goods, among other products. We also sell hundreds of thousands of best seller and current run books, magazines, CDs, DVDs and video games (“BMMG”). We sell these products and services through our Internet websites located at www.overstock.com, www.o.co and www.o.biz (referred to collectively as the “Website”). Although our three websites are located at different domain addresses, the technology and equipment and processes supporting the Website and the process of order fulfillment described herein are the same for all three websites.
Our company, based in Salt Lake City, Utah, was founded in 1997. We launched our initial website in March 1999 and were re-incorporated in Delaware in 2002. As used herein, “Overstock,” “Overstock.com,”, “O.co,” “we,” “our” and similar terms include Overstock.com, Inc. and its subsidiaries, unless the context indicates otherwise.
Our Business
We deal primarily in price-competitive, new, replenishable and closeout merchandise and use the Internet to aggregate both supply and demand to create an efficient marketplace for selling these products. We provide our customers an opportunity to conveniently shop for a broad range of price-competitive products. We continually add new, and sometimes limited, inventory to our Website in order to create an atmosphere that encourages customers to visit frequently and purchase products before our inventory sells out. We provide suppliers with access to a large customer base and convenient services for order fulfillment, customer service, returns handling, and other services. The merchandise offered on our Website is from a variety of sources including well-known, brand-name manufacturers. We have organized our shopping business (sales of product offered through the Shopping Section of our Website) into two principal segments-a "direct" business and a "partner" business. We currently offer approximately 877,000 non-BMMG products and approximately 1.1 million BMMG products. Consumers and businesses are able to access and purchase our products 24 hours a day from the convenience of a computer, Internet-enabled mobile telephone or other Internet-enabled device. Our team of customer service representatives assists customers by telephone, instant online chat and e-mail. We also derive revenue from other businesses advertising products or services on our Website. Our sales are primarily to customers located in the United States. During the years ended December 31, 2015, 2014 and 2013 no single customer accounted for more than 1% of our total net revenue.
Direct business
Our direct business includes sales made to individual consumers and businesses, from our owned inventory, and that are generally fulfilled from our warehouses. During the year ended December 31, 2015, approximately 8% of our order volume was generated through our direct business. Our warehouses primarily fulfill orders from our direct business, but also fulfill orders on behalf of our partners through our Supplier Oasis offering described below. Our warehouses generally ship between 2,000 and 5,000 packages per day and up to approximately 16,000 packages per day during peak periods.
Partner business
For our partner business, we sell merchandise from manufacturers, distributors and other suppliers ("partners") primarily through our Website. We are considered to be the primary obligor for the majority of these sales transactions and we record revenue from the majority of these sales transactions on a gross basis. Our use of the term "partner" does not mean that we have formed any legal partnerships with any of our partners. We currently have relationships with approximately 3,700 third parties who supply approximately 870,000 non-BMMG products, as well as most of the BMMG products, on our Website. These third party partners generally perform the same fulfillment operations as our warehouses, such as order picking and shipping; however, we handle returns and customer service related to substantially all orders placed through our Website. Revenue generated from sales on our Shopping site from both the direct and partner businesses is recorded net of returns, coupons and other discounts.
Both direct and partner revenues are seasonal, with revenues historically being the highest in the fourth quarter, which ends December 31, reflecting higher consumer holiday spending. We anticipate this will continue for the foreseeable future. To the extent possible we maintain supplier relationships, and seek new supplier relationships, for both our direct and partner businesses, and also use our working capital, to ensure a continuous allotment of product offerings for our customers. Because a portion of our product offerings are closeout merchandise, some of our suppliers cannot supply products to us on a continuous basis.
Generally, we require verification of receipt of payment, or authorization from credit card or other payment vendors whose services we offer to our customers (such as PayPal and BillMeLater), before we ship products to consumers or business purchasers. From time to time we grant credit to our business purchasers with normal credit terms (typically 30 days). For sales in our partner business, we generally receive payments from our customers before our payments to our suppliers are due.
Other offerings
We offer additional products or services that may complement our primary offerings, but are not significant to our revenues. These include:
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• | Medici, doing business as tØ.com, through which we have developed various fintech and crypto software products and intellectual property, including proprietary blockchain software; |
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• | Worldstock Fair Trade, a store within our Website that offers handcrafted products made by artisans all over the world to help improve the lives of people in emerging economies; |
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• | Main Street Revolution, a store within our Website that features products from small businesses across the United States who offer their products using our national marketing and distribution channels; |
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• | Supplier Oasis, a single integration point through which our partners can manage their products, inventory and sales channels, while tapping into our distribution network; |
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• | ecommerce marketplace channels, where some of our products are offered for sale in on-line marketplaces of other Internet retailers' websites; |
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• | our international business where we offer products to customers outside the United States using U.S.-based third party logistics providers; |
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• | Pet Adoptions, a free service and tab within our Website that leverages our technology to display pets available for adoption from shelters across the United States; |
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• | Farmers Market, a tab within our Website where our customers can order locally grown fresh produce and other food products; |
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• | Insurance, a tab within our Website where our customers can shop for insurance from major carriers for both personal and business insurance policies; and |
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• | an online car listing service which allows sellers to list vehicles for sale and allows buyers to review vehicle descriptions and post offers to purchase, and provides the means for prospective purchasers to contact sellers for further information and negotiations on the purchase of an advertised vehicle. |
Manufacturer, Supplier and Distribution Relationships
Generally, we do not enter into contracts with manufacturers or other suppliers that guarantee the availability of merchandise for a set duration. Our manufacturer and supplier relationships are based on historical experience with manufacturers and other suppliers and do not obligate or entitle us to receive merchandise on a long-term or short-term basis. In our direct business, we purchase the products from manufacturers or other suppliers using standard purchase orders. Generally, suppliers do not control the terms under which products are sold through our Website.
Products
Our Website Shopping section is organized into product and service lines or featured categories, including: For the Home, Furniture, Bed & Bath, Women, Men, Jewelry, Watches, Health & Beauty, Electronics, Worldstock, Sports & Outdoors, Craft & Sewing, Luggage & Bags, Baby, Kids, Toys & Hobbies, Books Movies Music Games, Office, Pet Supplier, Liquidations, Farmers Market, As Seen on TV, Emergency Preparedness, Food & Gifts, Main Street Revolution, Pet Adoption, and Sales. From time to time, as the number of products and services and product or featured categories change, we may reorganize our departments and/or categories to better reflect our current product offerings.
For the years ended December 31, 2015, 2014 and 2013, the percentages of sales contributed by similar classes of products were as follows:
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Product Lines | | 2015 | | 2014 | | 2013 |
Home and garden(1) | | | | | | |
Furniture | | 33 | % | | 32 | % | | 31 | % |
Home decor | | 19 | % | | 18 | % | | 17 | % |
Other | | 25 | % | | 24 | % | | 24 | % |
Total home and garden | | 77 | % | | 74 | % | | 72 | % |
Jewelry, watches, clothing and accessories | | 11 | % | | 12 | % | | 13 | % |
BMMG, electronics and computers | | 3 | % | | 4 | % | | 4 | % |
Other | | 9 | % | | 10 | % | | 11 | % |
Total | | 100 | % | | 100 | % | | 100 | % |
(1) Home and garden includes furniture, home decor, garden and patio, kitchen and dining, bedding, home improvement, housewares and other related products.
Sales and Marketing
We use a variety of methods to target our consumer audience, including online campaigns, such as advertising through keywords, product listing ads, display ads, search engines, affiliate marketing programs, social coupon websites, portals, banners, e-mail, direct mail and viral and social media campaigns. We also do brand advertising through television, radio, print ads, and event sponsorships.
Customer Service
We are committed to providing superior customer service. We staff our customer service department with dedicated in-house and outsourced professionals who respond to phone, instant online chat and e-mail inquiries on products, ordering, shipping status, returns and other areas of customer inquiry.
Technology
We use our internally developed Website and a combination of proprietary technologies and commercially available licensed technologies and solutions to support our operations. We use the services of multiple telecommunications companies to obtain connectivity to the Internet. Currently, our primary computer infrastructure is located in a co-location facility in Utah. We also have other data centers which we use for backups, redundancy, development, testing, disaster recovery, and our corporate systems infrastructure.
Competition
Internet retail is intensely competitive and has relatively low barriers to entry. We believe that competition in this industry is based predominantly on:
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• | product quality and assortment; |
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• | website organization and load speed; |
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• | order processing and fulfillment; |
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• | website functionality on mobile devices; |
We compete with other online retailers, traditional retailers and liquidation "brokers," some of which may specifically adopt our methods and target our customers. We currently or potentially compete with a variety of companies that can be divided into several broad categories:
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• | online discount general retailers; |
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• | online private sale sites; |
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• | online specialty retailers; |
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• | liquidation e-tailers; and |
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• | traditional general merchandise and specialty retailers and liquidators, many of which have a significant online presence. |
Many of our current and potential competitors have greater brand recognition, longer operating histories, larger customer bases and significantly greater financial, marketing and other resources than we do. Further, any of them may enter into strategic or commercial relationships with larger, more established and well-financed companies, including exclusive distribution arrangements with our vendors or service suppliers that could deny us access to key products or needed services, or acquisitions of our suppliers or service providers, having the same effect. Many of them do or could devote greater resources to marketing and promotional campaigns and devote substantially more resources to their website and systems development than we do. Many have supply chain operations that decrease product shipping times to their customers, or have options for in-store product pick-up options or allow in-store returns and offer other delivery and returns options that we do not have. New technologies and the continued enhancement of existing technologies and developments in related areas, such as same-day product deliveries and the development of proprietary delivery systems, are also increasing competitive pressures on us. Our competitors include Amazon.com, Inc and Wayfair LLC. We cannot ensure that we will be able to compete successfully against current or future competitors or address increased competitive pressures (see Item 1A—"Risk Factors").
Seasonality
Our business is affected by seasonality because of the holiday retail season, which historically has resulted in higher sales volume during our fourth quarter, which ends December 31. We recognized 29.0%, 31.4% and 30.5% of our annual revenue during the fourth quarter of 2015, 2014, and 2013, respectively.
Financial Information about Business Segments and Geographic Areas
See Item 15 of Part IV, "Financial Statements"—Note 20. Business Segments for information regarding our business segments and geographical areas.
Intellectual Property and Trade Secrets
We regard our domain names and similar intellectual property as critical to our success. We rely on a combination of laws and contractual restrictions with our employees, customers, suppliers, affiliates and others to establish and protect our proprietary rights, including the law pertaining to trade secrets. Despite these precautions, it may be possible for a third party to copy or otherwise obtain and use our intellectual property or trade secrets without authorization. In addition, we cannot ensure that others will not independently develop similar intellectual property. Although we have registered and are pursuing the registration of our key trademarks in the United States and some other countries, some of our trade names may not be eligible to receive registered trademark protection. In addition, effective trademark protection may not be available or we may not seek protection in every country in which we market or sell our products and services, including in the United States. Additionally, our efforts to protect our trade secrets may not succeed.
Third parties have in the past recruited and may in the future recruit our employees who have had access to our proprietary technologies, processes and operations. These recruiting efforts expose us to the risk that such employees and those hiring them will misappropriate and exploit our intellectual property and trade secrets.
Legal and Regulatory Matters
From time to time, we receive claims and become subject to regulatory investigations or actions, consumer protection, employment, intellectual property and other commercial litigation related to the conduct of our business. We also prosecute lawsuits to enforce our legal rights. Such litigation is costly and time consuming and can divert our management and key personnel from our business operations. The uncertainty of litigation increases these risks. In connection with such litigation, we may be subject to significant damages, associated costs, or equitable remedies relating to the operation of our business and the sale of products on our Website. Any such litigation may materially harm our business, prospects, results of operations, financial condition or cash flows.
These and other types of claims could result in increased costs of doing business in the form of legal expenses, adverse judgments or settlements or require us to change our business practices in expensive and significant ways. In addition, litigation could result in interpretations of the law that may limit our current or future business, require us to change our business practices, or otherwise increase our costs.
Additional litigation may be necessary in the future to enforce our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others. Any litigation, regardless of outcome or merit, could result in substantial costs and diversion of management and technical resources, any of which could materially harm our business (see Item 1A—"Risk Factors").
For further information, see the information set forth under Item 15 of Part IV, "Financial Statements"—Note 12. Commitments and Contingencies, Legal Proceedings, contained in the "Notes to Consolidated Financial Statements" of this Annual Report on Form 10-K.
Government Regulation
Our main business is subject to general business regulations and laws, as well as regulations and laws specifically governing the Internet, e-commerce and other services. Existing and future laws and regulations may result in increasing expense and may adversely affect our business. These regulations and laws may cover taxation, privacy, data protection, pricing, content, copyrights, distribution, supply chain monitoring and transparency, mobile communications, electronic device certification, electronic waste, energy consumption, environmental regulation, electronic contracts and other communications, competition, consumer protection, information reporting requirements, the design and operation of websites, and the characteristics and quality of products and services. New state tax regulations in states where we do not now collect state and local taxes may subject us to the obligation to collect and remit state and local taxes, or subject us to additional state and local sales and income taxes, or to requirements intended to assist states with their tax collection efforts. New legislation or regulations, the application of laws and regulations from jurisdictions whose laws do not currently apply to our business or the application of existing laws and regulations to the Internet and commercial online services could result in significant additional taxes on our business. These taxes or tax collection obligations could have an adverse effect on us. Further, there is a possibility that we may be subject to significant fines or other payments for any past failures to comply with these requirements. In addition, it is not clear how existing laws governing issues such as property ownership, libel, and personal privacy apply to the Internet, e-commerce and digital content. Laws and regulations may diminish the demand for our products and services and increase our cost of doing business. Certain of our services are subject to federal and state consumer protection laws, including laws protecting the privacy of consumer information and regulations prohibiting unfair and deceptive trade practices. In particular, under federal and state financial privacy laws and regulations, we must provide notice to consumers of our policies on sharing non-public information with third parties, advance notice of any changes to our policies and, with limited exceptions, we must give consumers the right to prevent sharing of their non-public personal information with unaffiliated third parties. Further, the growth and demand for online commerce could result in more stringent consumer protection laws that could impose additional compliance burdens on us. These consumer protection laws could result in substantial compliance costs.
In addition, the broker-dealers that Medici recently acquired are subject to additional extensive regulatory requirements under federal and state laws and regulations and self-regulatory organization (“SRO”) rules. Broker-dealers are subject to regulation, examination and disciplinary action by the SEC, FINRA and state securities regulators, as well as other governmental authorities and SROs with which they are registered or licensed or of which they are members. See Item 1A - “Risk Factors - Medici has acquired registered broker-dealers, which are subject to extensive regulation.”
Our efforts to expand our sales outside of the U.S. expose us to additional U.S. and foreign laws and regulations, including but not limited to, laws and regulations relating to taxation, business licensing or certification requirements, advertising practices, online services, the use of cryptocurrency, the importation of specified or proscribed items, importation quotas, consumer protection, intellectual property rights, consumer and data protection, data transfer across borders, privacy, encryption, restrictions on pricing or discounts, and the U.S. Foreign Corrupt Practices Act and other applicable U.S. and foreign laws prohibiting corrupt payments to government officials and other third parties.
Employees
At December 31, 2015, we had approximately 1,900 full-time employees. We seasonally augment our workforce with temporary employees during our fourth quarter to handle increased workload in both our warehouse and customer service operations. We have never had a work stoppage, and none of our employees are represented by a labor union. We consider our employee relationships to be good. Competition for qualified personnel in our industry is intense, particularly for software engineers and other technical staff.
Executive Officers of the Registrant
The following persons were executive officers of Overstock as of March 1, 2016:
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Executive Officers | | Age | | Position |
Patrick M. Byrne | | 53 | | Chief Executive Officer and Director |
Stormy D. Simon | | 47 | | President and Director |
Mitch L. Edwards | | 57 | | Senior Vice President and General Counsel |
Robert P. Hughes | | 56 | | Senior Vice President, Finance and Risk Management |
Carter P. Lee | | 46 | | Senior Vice President, Technology |
Natalie Malaszenko | | 37 | | Senior Vice President, Marketing |
Sam "Saum" Noursalehi | | 36 | | Senior Vice President |
Brian L. Popelka | | 49 | | Senior Vice President, Customer and People Care |
Alec S. Wilkins | | 38 | | Senior Vice President, Product Development and Chief Architect |
Dr. Patrick M. Byrne has served as our Chief Executive Officer (principal executive officer) and as a Director since 1999, and as Chairman of the board of directors from 2001 through 2005 and 2006 through March 2014. From 1997 to 1999, Dr. Byrne served as President and Chief Executive Officer of Fechheimer Brothers, Inc., a manufacturer and distributor of uniforms. From 1995 until its sale in September 1999, Dr. Byrne was Chairman, President and Chief Executive Officer of Centricut, LLC, a manufacturer and distributor of industrial torch parts. From 1994 to the present, Dr. Byrne has served as a Manager of the Haverford Group, an investment company and an affiliate of Overstock. Dr. Byrne has a Bachelor of Arts Degree in Chinese studies from Dartmouth College, a Master's Degree from Cambridge University as a Marshall Scholar, and a a doctorate in philosophy from Stanford University.
Ms. Stormy D. Simon has served as President since April 2014. Ms. Simon previously served as Co-President. Ms. Simon has also served as a member of our board of directors since 2011. Ms. Simon previously served as our Senior Vice President, Customer and Partner Care; Senior Vice President, Marketing; Vice President, BMMG; Travel and Off-Line Advertising; Chief of Staff and as our Director of B2B. Prior to joining Overstock in 2001, Ms. Simon worked in the media and travel industries.
Mr. Mitch L. Edwards has served as our Senior Vice President and General Counsel since joining Overstock in July 2015. Prior to joining Overstock, Mr. Edwards worked as a consultant for Tofana Partners from 2013 to 2015. Prior to his position at Tofana, Mr. Edwards held the position of CFO and General Counsel for Razer, Inc. from 2012 to 2013. Prior to working for Razer, Mr. Edwards served as CFO and General Counsel from 2010 to 2012 for Skullcandy. Mr. Edwards holds a Juris Doctorate from Stanford Law School and received an International Business Law Degree from Oxford University. Mr. Edwards also holds a bachelor's degree in Economics from Brigham Young University.
Mr. Robert P. Hughes (principal financial and accounting officer) has served as our Senior Vice President, Finance and Risk Management since February 2013. He previously served as Vice President and Controller. Prior to joining the Company in 2008, Mr. Hughes served as Chief Financial Officer and Chief of Staff of TenFold Corporation. Prior to working for TenFold, Mr. Hughes held a number of senior accounting and internal audit positions with Oracle Corporation. He holds a B.S. in Business Administration with an emphasis in accounting and finance from the University of California Berkeley, Haas School of Business, and is a certified public accountant (CA - inactive status).
Mr. Carter P. Lee has served as our Senior Vice President, Technology since February 2015. Prior to this, Mr. Lee was Vice President, Technology Operations from 2008 through January 2015, Director, Internal Systems from 2004 through 2007 and a Systems Engineer from 2001 through 2003. Prior to joining Overstock.com, Mr. Lee was a Systems Engineer for Hospice of the Valley and Vice President of Technology for Motherboard Discount Center in Phoenix, AZ.
Ms. Natalie Malaszenko joined us as our Senior Vice President, Marketing, in September 2015. Before joining Overstock, Ms. Malaszenko most recently served as the Vice President, Marketing and Digital Strategy, for Omni Hotels & Resorts since 2013. Prior to this, Ms. Malaszenko held leadership positions including Vice President, Global Digital Marketing for Hewlett-Packard after joining them in 2011, and Director of eCommerce for PETCO Animal Supplies after joining them in 2008. Ms. Malaszenko also served as the head of Global Operations for Dell, Inc.'s Communities and Conversations organization after joining them in 2006. Ms. Malaszenko holds a bachelor's degree in Psychology/Cognitive Neuroscience from the University of New Mexico.
Mr. Saum Noursalehi has served as a Senior Vice President since February 2015 in roles in our OLabs (a research and development group within the company), Marketing and Product Development departments. Mr. Noursalehi previously served as Vice President of OLabs and as Vice President of new product development. Prior to his appointment as a Vice President, Mr. Noursalehi was the Company’s senior director of website, mobile and search engine optimization. Mr. Noursalehi has been with Overstock since 2005. Prior to joining Overstock Mr. Noursalehi worked as a software developer. Mr. Noursalehi holds a bachelor's degree in Computer Science from the University of Utah.
Mr. Brian L. Popelka has served as our Senior Vice President, Customer and People Care since June 2013. Mr. Popelka previously served as Vice President of Customer Care. Since joining Overstock in 2002, Mr. Popelka has held several positions including the director of Books, Media, Movies and Games Department, and was the manager of the Business-to-Business Department. Mr. Popelka holds a bachelor's degree in Journalism, Broadcasting, Film and History from the University of Nebraska in Lincoln.
Mr. Alec S. Wilkins has served as our Senior Vice President, Product Development and Chief Architect since August 2015 after previously serving as our Vice President of Application Development beginning in July 2013. Mr. Wilkins founded WildBeard Technologies and served as a consultant for them beginning in June 2010. Mr. Wilkins attended the University of Utah.
Available Information
Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and other reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, are available free of charge through the Investor Relations section of our main website, www.overstock.com, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission. Our Internet Website and the information contained therein or connected thereto are not a part of or incorporated into this Annual Report on Form 10-K.
ITEM 1A. RISK FACTORS
Please consider the following risk factors carefully. If any one or more of the following risks were to occur, it could have a material adverse effect on our business, prospects, financial condition and results of operations, and the market price of our securities could decrease significantly. Statements below to the effect that an event could or would harm our business (or have an adverse effect on our business or similar statements) mean that the event could or would have a material adverse effect on our business, prospects, financial condition and results of operations, which in turn could or would have a material adverse effect on the market price of our securities. Although we have organized the risk factors below under headings to make them easier to read, many of the risks we face involve more than one type of risk. Consequently you should read all of the risk factors below carefully before making any decision to acquire or hold our securities.
Risks Related to Our Business and Industry - Infrastructure, Cyber Security, Data Breach and Related Risks
Our business depends on our Website, our mobile app, our network infrastructure and transaction-processing systems.
As an e-commerce company, we are completely dependent on our infrastructure and on the availability and reliability of the Internet and related systems. Any system interruption that results in the unavailability of our Website or our mobile app or reduced performance of our transaction systems could interrupt or substantially reduce our ability to conduct our business. If our Website or our mobile app or any of the many systems necessary to support the operation of either of them fail at any time to operate well and quickly enough to satisfy a potential customer, we may quickly lose the opportunity to convert that potential customer into an actual or regular customer. We have experienced periodic systems interruptions due to server failure, power failure and intentional cyber attacks in the past, which we expect will continue to occur from time to time. We have also experienced and may continue to experience temporary capacity constraints due to sharply increased traffic during sales or other promotions and during the holiday shopping season. Capacity constraints can cause system disruptions, slower response times, delayed page presentation, degradation in levels of customer service and other problems. In the past we have also experienced difficulties with our infrastructure upgrades. Our business and the various technologies necessary to support our business change rapidly, and we must upgrade our infrastructure virtually continuously. Any future difficulties with our transaction processing systems or difficulties upgrading, expanding or integrating aspects of our systems may cause system disruptions, slower response times, and degradation in levels of customer service, additional expense, impaired quality and speed of order fulfillment or other problems. The occurrence of any of the foregoing could have a material adverse effect on our business.
If the facility where substantially all of our computer and communications hardware is located fails, our business, prospects, financial condition and results of operations could be harmed.
If the facility where substantially all of our computer and communications hardware is located fails, or if we suffer an interruption or degradation of services at the facility for any reason, our business could be harmed. Our success, and in particular, our ability to successfully receive and fulfill orders and provide high-quality customer service, largely depends on the efficient and uninterrupted operation of our computer and communications systems. Substantially all of our computer and
communications hardware is located at a single co-location facility. In the event of an earthquake or other local disaster, or any other cause of interruption of service, both our primary and back-up sites could be adversely affected. Our systems and operations are vulnerable to damage or interruption from fire, flood, power loss, telecommunications failure, terrorist attacks, cyber-attacks, acts of war, break-ins, earthquake and similar events. In the event of a failure of our primary facility, the failover to our back-up facility would take at least several hours, during which time our Website would be completely shut down. Our back-up facility is not adequate to support sales at a high level. The back-up facility may not process effectively during time of higher traffic to our Website and may process transactions more slowly and may not support all of the functionality of our primary site. These limitations could have an adverse effect on our conversion rate and sales. Our disaster recovery plan may be inadequate, and we do not carry business interruption insurance sufficient to compensate us for the losses that could occur. Our servers are vulnerable to computer viruses, physical or electronic break-ins and similar disruptions, the occurrence of any of which could lead to interruptions, delays, loss of critical data or the inability to accept and fulfill customer orders. The occurrence of any of the foregoing risks could have a material adverse effect on our business.
We are subject to cyber security risks and risks of data loss or other security breaches, and may incur increasing costs in an effort to minimize those risks and to respond to cyber incidents.
Our business is entirely dependent on the secure operation of our Website and systems as well as the operation of the Internet generally. Our business involves the storage and transmission of users’ proprietary information, and security breaches could expose us to a risk of loss or misuse of this information, and to resulting claims and litigation. We have been subjected to a variety of cyber attacks, including denial of service attacks in which attackers attempt to block customers’ access to our Website. If we are unable to defend against a denial of service attack or other types of attacks for any significant period, we could sustain substantial revenue loss from lost sales and customer dissatisfaction. We may not have the resources or technical sophistication to anticipate or prevent rapidly evolving types of cyber-attacks. Cyber-attacks may target us, our customers, our suppliers, banks, credit card processors, delivery services, e-commerce in general or the communication infrastructure on which we depend. If an actual or perceived attack or breach of our security occurs, customer and/or supplier perception of the effectiveness of our security measures could be harmed and we could lose customers, suppliers or both. Actual or anticipated attacks and risks may cause us to incur substantial and increasing costs, including costs to deploy additional personnel and protection technologies, train employees, and engage third party experts and consultants. The occurrence of any of the foregoing could have a material adverse effect on our business.
A person who is able to circumvent our security measures might be able to misappropriate our or our users’ proprietary information, cause interruption in our operations, damage our computers or those of our users, or otherwise damage our reputation and business. Any compromise of our security could result in a violation of applicable privacy and other laws, significant legal and financial exposure, damage to our reputation, and a loss of confidence in our security measures, which could have a material adverse effect on our business.
Our dependence on credit or debit card payments increases our risks.
Most of our customers use credit cards to pay for their purchases. Under payment card rules and our contracts with our card processors, if there is a breach of payment card information that we store, we could be liable to the payment card issuing banks for their cost of issuing new cards and related expenses. In addition, if we fail to follow payment card industry security standards, even if there is no compromise of customer information, we could incur significant fines, higher transaction costs or lose our ability to give customers the option of using payment cards. If we were unable to accept payment cards, it would have a material adverse effect on our business.
Cyber-attacks affecting our partners, suppliers, delivery services or other service providers could adversely affect us.
We depend on our partners to provide a large portion of the product selection we offer and on vendors for the products we purchase and offer in our direct business. We also depend on delivery services to deliver products, and on other service providers, including suppliers of services which support Website operations, including payment systems, customer service support, and communications. Cyber-attacks affecting our delivery services or any of our most significant suppliers or affecting a significant number of our suppliers of products or services could result in our inability to source product or fulfill orders, our customers’ or suppliers’ inability to contact us or access our Website or call centers or chat lines, or the compromise of our customers’ confidential data. The occurrence of any of the foregoing could have a material adverse effect on our business.
Risks Related to Our Business and Industry - Competition
We face intense competition and may not be able to compete successfully against existing or future competitors.
The online retail market is rapidly evolving and intensely competitive. Barriers to entry are minimal, and current and new competitors can launch new websites at a relatively low cost. We currently compete with numerous competitors, including:
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• | online retailers with or without discount departments, including AliExpress (part of the Alibaba Group), Amazon.com, eBay, and Rakuten.com (formerly Buy.com); |
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• | online specialty retailers such as Blue Nile, Bluefly, Jet.com, Wayfair, Zappos.com, and Zulily; |
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• | private sale sites such as Groupon, Living Social and Rue La La; |
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• | furniture specialists including Ashley Furniture, Bob’s Discount Furniture, Havertys, Raymour & Flanigan and Rooms To Go; |
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• | traditional general merchandise and specialty retailers and liquidators including Barnes and Noble, Bed, Bath & Beyond, Best Buy, Costco Wholesale Corporation, Crate and Barrel, Ethan Allen, Gilt, Home Depot, HomeGoods, Hudson's Bay Company, IKEA, J.C. Penny Company, Kirkland's, Kohl's, Lands' End, Lowes, Macy’s, Nordstrom, Pier 1 Imports, Pottery Barn, Restoration Hardware, Ross Stores, Saks Fifth Avenue, Sears Holding Corporation, T.J. Maxx, Target Corporation, Wal-Mart and Williams-Sonoma, all of which also have an online presence; and |
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• | liquidation e-tailers such as SmartBargains. |
The intense and increasing competition we face from a wide variety of competitors, many of which have substantially greater resources than we do, and some of which are willing to incur losses in order to increase revenues, may result in our pricing of products or services below prices at which we can make a profit, may cause us to lose sales entirely, and may have a material adverse effect on our business.
Our competitors are rapidly developing a wide variety of services and other offerings, and we may be unable to provide more competitive offerings.
The online retail market has become far more competitive as traditional and online retailers continue to develop and improve services that compete with our services. Many traditional manufacturers and retailers have added or improved their e-commerce offerings, and we expect that more will do so and that they will all continue to improve their offerings. Traditional and predominantly online retailers may create proprietary, store-based distribution and returns channels that we may be unable to match, and may also be able to create their own traditional distribution and delivery services. Competitive pressures, including same-day delivery capabilities, from any of our competitors, many of whom have longer operating histories, larger customer bases, greater brand recognition and significantly greater financial, marketing and other resources than we do, could have a material adverse effect on our business.
In addition to the types of retailers described above, we are competing with specialty firms in several areas, many of which focus exclusively or primarily on the business in which we are competing.
In addition to the types of retailers described above, in many areas we face competition from numerous other businesses, many of which may specialize in the type of business in which we are competing. Our furniture offerings compete with more than 100 online retail furniture websites, in addition to many more traditional furniture retail specialists. We face the risk that potential furniture and other customers will choose traditional retailers where they can physically examine products prior to purchase. Our Supplier Oasis service faces substantial competition from third party logistics providers as well as from Amazon and eBay and other e-commerce service providers having substantially greater experience and resources than we have. We are currently offering insurance products, and as such face competition from small and large established businesses with substantially more experience.
Our majority-owned subsidiary Medici, Inc. is competing with a rapidly-growing group of companies in the financial industry as well as new entrants with significant resources from venture capital firms and other funding sources.
Our majority-owned subsidiary Medici, Inc., d/b/a tØ.com, is competing against a variety of companies with substantially greater financial resources and experience in financial technology than Medici has. The number of competitors in this area and the resources being devoted to the area by competitors are growing rapidly. We may be unable to compete successfully against these competitors or others that may not yet have publicly announced their business plans in this area.
Risks Related to Our Business and Industry - Dependence on Third Parties
As an e-commerce company, we depend on a number of other companies to perform functions critical to our ability to deliver products to our customers and to perform many of the related functions.
Our goal is to provide our customers with quality products at the best prices possible, while also providing our customers with a very high level of service. In our efforts to accomplish this, we depend on a number of other companies to perform functions critical to our ability to deliver products to our customers and to perform many of the related functions. Our business model involves a number of material risks related to our dependence on other companies, as described below.
We depend on our relationships with independent partners for substantially all of the products that we offer for sale on our Website. If we fail to maintain these relationships, our business will suffer.
At December 31, 2015, we had relationships with approximately 3,700 independent partners whose products we offer for sale on our Website. Sales through our partners accounted for approximately 92% of our net revenues for the year ended December 31, 2015. If we do not maintain our existing relationships or build new relationships with partners on acceptable commercial terms, we may not be able to maintain a broad selection of merchandise, and our business and prospects would suffer severely. Our agreements with partners are generally terminable at will by either party upon short notice. Our failure to maintain, replace or expand these relationships could have a material adverse effect on our business.
We depend on our partners to perform critical services regarding the products that we offer.
In general, we agree to offer the partners’ products on our Website and these partners agree to conduct a number of other traditional retail operations such as maintaining inventory, preparing merchandise for shipment to our customers and delivering purchased merchandise on a timely basis. We have no ability to ensure that these third parties will continue to perform these services to our satisfaction or on terms we or our customers consider reasonable. In addition, because we do not take possession of these fulfillment partners’ products (other than on the return of such products), we are generally unable to fulfill these traditional retail operations ourselves. If our customers become dissatisfied with the services provided by these third parties, our business and reputation and brand would suffer, which could have a material adverse effect on our business.
We depend upon third party fulfillment and delivery services to fulfill and deliver products to our customers on a timely and consistent basis. Deterioration in our relationship with any one of these third parties could decrease our ability to track shipments, cause shipment delays, and increase our shipping costs and the number of damaged products.
We rely upon third party fulfillment and delivery providers for the shipment of products to customers. We cannot be sure that these relationships will continue on terms we find acceptable, or at all. Increases in shipping or fulfillment costs or delivery times, particularly during the holiday season, could harm our business. For example, in June 2015, UPS announced that it would discontinue offering discounts for its customers on oversize packages during the holiday season. If our relationships with these third parties are terminated or impaired or if these third parties are unable to deliver products for us on terms we find acceptable, whether as a result of adverse weather conditions, labor shortage, slow down or stoppage, deteriorating financial or business condition, fulfillment facilities impairment, terrorist attacks, cyber-attacks, Internet or other infrastructure or communications impairment, natural disasters, unexpectedly high shipping volumes, an increase in shipping rates, or for any other reason, we may be required to use alternative fulfillment service providers or carriers for the shipment of products to our customers, if such alternatives were available. If under such circumstances there were no alternatives available, we may be forced to accept fulfillment services which may have an adverse effect on our customers' satisfaction with us, which may materially increase our shipping costs, or both. Conditions such as adverse weather or natural disasters can prevent any carrier from performing its delivery services, which can also have an adverse effect on our customers’ satisfaction with us. In any of these circumstances, we may be unable to engage alternative fulfillment services or carriers on a timely basis, upon terms we find acceptable, or at all. Changing fulfillment services or carriers, the absence of fulfillment services or carrier availability, or increases in the shipping rates of our current fulfillment service or carrier providers could have a material adverse effect on our business.
We depend upon our credit card processors and payment card associations.
Our customers primarily use credit cards to buy from us. We are dependent upon our credit card processors to process the sales transactions and remit the proceeds to us. The credit card processors have the right to withhold funds otherwise payable to us to establish or increase reserves based on their assessment of the inherent risks of credit card processing and their assessment of the risks of processing our customers’ credit cards at any time, and have done so from time to time in the past. We are also subject to payment card associations’ operating rules, certification requirements and rules governing electronic funds transfers, which could change or be reinterpreted to make it difficult or impossible for us to comply. If we fail to comply with these rules or requirements, we may be subject to fines and higher transaction fees and lose our ability to accept credit and debit card payments from our customers, process electronic funds transfers, or facilitate other types of online payments. In addition, events affecting our payment card processors, including cyber-attacks, Internet or other infrastructure or
communications impairment or other events that could interrupt the normal operation of the payment card processors, could have a material adverse effect on our business.
We rely upon paid and natural search engines including Google, Bing, and Yahoo! to rank our product offerings.
We rely on paid and natural search engines to attract consumer interest in our product offerings. Potential and existing customers use search engines provided by search engine companies, including, but not limited to, Google, Bing, and Yahoo! See “Risks Related to Our Business and Industry - Marketing Risks - We rely upon paid and natural search engines including Google, Bing, and Yahoo! to rank our product offerings. Our financial results may suffer if search engines change their ranking algorithms and our product offerings are ranked lower, and we may at times be subject to ranking penalties if the operators of search engines believe we are not in compliance with their guidelines,” below.
Risks associated with the suppliers from whom our products are sourced and the safety of those products could adversely affect our financial performance.
Global sourcing of many of the products we sell is an important aspect of our business. We depend on our ability to access products from qualified suppliers in a timely and efficient manner. Our ability to find qualified suppliers who meet our standards and supply products in a timely and efficient manner is a significant challenge, especially with respect to goods sourced from outside the U.S. Political and economic instability, the financial stability of suppliers, suppliers’ ability to meet our standards, labor problems experienced by our suppliers, the availability of raw materials, merchandise quality issues, currency exchange rates, transport availability and cost, transport security, inflation, and other factors relating to the suppliers and the countries in which they are located or from which they may source materials or products are beyond our control. We also largely rely on our suppliers’ representations of product content and quality. Concerns regarding product content or quality, or the safety of products that we source from our suppliers, could cause shoppers to avoid purchasing certain products from us, or to seek alternative sources of supply for all of their needs, even if the basis for the concern is outside of our control. Any lost confidence on the part of our customers would be difficult and costly to reestablish. As such, any issue regarding the safety of any items we sell, regardless of the cause, could adversely affect our financial performance. Further, if any product we sell were to cause physical injury or injury to property, the injured party or parties might bring claims against us. Any indemnity agreement we may have with the supplier may be inadequate or inapplicable, and any insurance coverage we may carry may not be adequate to cover claims that could be asserted. Even unsuccessful claims could result in the expenditure of funds and management time and could have a negative impact on our business. The occurrence of any of the foregoing could have a material adverse effect on our business.
We depend upon third parties for all or substantially all of the services we offer.
In addition to the many third parties we rely on in connection with our sale and the delivery of products to our customers, we depend upon third parties for all or substantially all of the services we offer, including our insurance offerings, our consumer financing offerings, our new and used car listings, our car-related services and our pet adoption services. Services offerings are inherently different from product offerings, and we may encounter difficulties with our services offerings that may be different from the types of issues we face with our product offerings. Any such difficulties could have a material adverse effect on our business.
Manufacturers may refuse to sell to us or through our site.
We rely upon our partners and other suppliers for the product offerings sold on our website and other products and services we use to run our business. Our ability to retain or attract new partners and other suppliers may depend in part on our financial performance. Poor financial performance could result in suppliers choosing to limit or suspend doing business with us or require us to prepay for our purchases. Further, some manufacturers are unwilling to offer products for sale on the Internet or on sites like ours. Our inability to source and offer popular products could be a significant problem for us and could have a material adverse effect on our business.
Risks Related to Our Business and Industry - Marketing Risks
Our business depends on effective marketing, and we change our advertising and marketing programs often.
We depend on effective marketing and high customer traffic. We have many initiatives in this area, and often change our advertising and marketing programs. The results of our advertising and marketing programs vary. We constantly evaluate where we spend marketing dollars. From time to time, certain competitors may bid up the cost of certain marketing channels, such as paid keywords. At such times, we may reduce the amounts we spend in those marketing channels, which may lead to
decreased visitors to our site for a time. If we are unable to develop, implement and maintain effective and efficient advertising and marketing programs, it could have a material adverse effect on our business.
We rely upon paid and natural search engines including Google, Bing, and Yahoo! to rank our product offerings. Our financial results may suffer if search engines change their ranking algorithms and our product offerings are ranked lower, and we may at times be subject to ranking penalties if the operators of search engines believe we are not in compliance with their guidelines.
We rely on paid and natural search engines to attract consumer interest in our product offerings. Potential and existing customers use search engines provided by search engine companies, including, but not limited to, Google, Bing, and Yahoo!, which use algorithms and other devices to provide users a natural ranked listing of relevant Internet sites matching a user’s search criteria and specifications. Generally, Internet sites ranked higher in the paid and natural search results attract the largest visitor share among similar Internet sites, and often benefit from increased sales. Natural search engine algorithms use information available throughout the Internet, including information available on our site. Search engine companies change their natural search engine algorithms periodically, and our ranking in natural searches may be adversely affected by those changes. When this occurs, our financial results may suffer from reduced revenues and from increased marketing expenses, as we believe we have experienced during 2015 and some prior periods, as we seek to replace lost revenues by using other sources.
Rules and guidelines of these natural search engine companies govern our participation on their sites and how we share relevant Internet information that may be considered or incorporated into the algorithms used by these sites. If these rules and guidelines change, or if we fail to present, or improperly present, our site information for use by natural search engine companies, or if any of these natural search engine companies determine that we have violated their rules or guidelines, as Google did in 2011, or if others improperly present our site information to these search engine companies, we may fail to achieve an optimum ranking in natural search engine listing results, or we may be penalized in a way that could harm our business.
In addition, large marketplace websites and sites which aggregate marketplace sellers with a large product selection are becoming increasingly popular, and we may not be able to place our products on these sites to take advantage of their internal search platforms. Further, some shoppers may begin their searches at a competitor's website, and may not utilize traditional search engines at all. Our inability to place products on or access these sites may have a material adverse effect on our business.
Our business relies heavily on email, and reduced utilization of email in general and any restrictions on the sending of commercial email could have a material adverse effect our business.
We depend on email to promote our site and offerings. We provide daily emails to potential customers about our offerings, and email promotions are an important part of our marketing and help generate a substantial portion of our net revenue. If a significant portion of our target customers no longer utilize email, or if we are unable to effectively deliver email to our potential customers, our business, financial condition and operating results would be harmed. Changes in webmail applications’ organization or prioritization of email could reduce the number of potential customers opening our email. For example, email inbox organization or prioritization features may result in our emails being delivered in a less prominent location in a subscriber’s inbox or viewed as “spam” by our subscribers and may reduce the likelihood of that subscriber opening our emails. Anything, including legal or regulatory restrictions, that blocks, imposes restrictions on or imposes charges for the delivery of email could also harm our business. We also rely on social networking messaging services to send communications and to encourage customers to send communications. Changes to the terms of these social networking services to limit promotional communications, any restrictions that would limit our ability or our customers’ ability to send communications through their services, disruptions or downtime experienced by these social networking services or decline in the use of or engagement with social networking services by customers and potential customers could have a material adverse effect on our business.
We are experimenting with reductions in the number of coupons we offer to our customers and with increases in the amount of Club O Rewards we offer to Club O members, which may have adversely affected our revenue growth and may continue to do so.
Although our business has historically relied heavily on coupons to generate sales, we are experimenting with reductions in our coupon marketing and are attempting to substitute increased Club O Rewards for a portion of our coupon marketing. We believe that the changes we have made recently have adversely affected our revenue growth. We are continuing to attempt to increase the attractiveness of our Club O offerings, but have not yet achieved the results we are seeking, and there
can be no assurance that we will be able to do so. If we are unable to generate sales from Club O members at rates equal to or better than the rates we were generating through our coupon marketing to non-Club O members, our revenue growth could be adversely affected or reversed, and our business, financial condition and operating results could be materially adversely affected.
Risks Related to Our Business and Industry - Fraud Risks
Credit card fraud and our response to it could adversely affect our business.
We routinely receive orders placed with fraudulent credit card data. If we fail to adequately control fraudulent credit card transactions it could reduce our net revenues and our gross profit or cause credit card or payment system companies to disallow their cards’ use for customer payments on our website. We may suffer losses as a result of orders placed with fraudulent credit card data even if the associated financial institution approved payment of the orders. Under current credit card practices, we may be liable for fraudulent credit card transactions because we do not obtain a cardholder’s signature. If we are unable to detect or control credit card fraud, claims against us for these transactions could harm our business, prospects, financial condition and results of operation. Further, to the extent that our efforts to prevent fraudulent orders result in our inadvertent refusal to fill legitimate orders, we would lose the benefit of legitimate potential sales and risk the alienation of legitimate customers. The occurrence of any of the foregoing could have a material adverse effect on our business.
Implementation of the EMV credit card standards in the U.S. during 2015 may increase fraud efforts against U.S. online retailers, including us.
Credit card issuers in the United States began replacing traditional credit cards with credit cards meeting the EMV (Europay, MasterCard and Visa) standards during 2015. Cards meeting the EMV standards contain a chip which makes the cards more difficult to counterfeit than the traditional magnetic stripe-only cards widely used in the U.S. However, to the extent that the EMV standards make card-duplication fraud more difficult, the new standards may drive more fraud efforts against online retailers, including us. Consequently, as an online retailer, we may be subject to increasing levels of fraudulent orders and other types of criminal activities. Increased levels of fraud and other criminal activities could have a material adverse effect on our business.
Risks Related to Our Business and Industry - Certain Specific Risks
We have a history of significant losses. If we do not maintain profitability, our financial condition and our stock price could suffer.
We have a history of losses, and we may incur operating and net losses in the foreseeable future. At December 31, 2015, our accumulated deficit was $166.4 million. We need to generate significant revenues to maintain profitability, and we may not be able to do so. Although we have generated positive net income in recent years, we incurred a net loss of $19.4 million in 2011, and we incurred a net loss of $2.1 million during Q3 2015. We may be unable to maintain profitability in the future. If our revenues grow more slowly than we anticipate or decline, or if our expenses exceed our expectations, our financial results would be harmed and our business, prospects, financial condition and results of operations could fall below the expectations of public market analysts and investors. The occurrence of any of the foregoing could have a material adverse effect on our business.
If we fail to accurately forecast our expenses and revenues, our business, prospects, financial condition and results of operations may suffer and the price of our securities may decline.
The rapidly evolving nature of our industry and the constantly evolving nature of our business make forecasting operating results difficult. We periodically implement large, complex and expensive infrastructure upgrades in order to increase our ability to handle larger volumes of sales and to develop or increase our ability to perform a variety of analytical procedures relating to our business. We are continuing to upgrade and further expand these and other components of our infrastructure, and are in the process of integrating infrastructure relating to the fintech company and broker-dealers we recently acquired. We are also in the process of constructing a facility to serve as our corporate headquarters. In the past, we have experienced difficulties with upgrades of our infrastructure, and have incurred increased expenses as a result of these difficulties. As a result of expenditures on our infrastructure and headquarters, our ability to reduce our expenditures is and will be limited. Therefore, any significant shortfall in the revenues for which we have built and are continuing to build our business could have a material adverse effect on our business.
Natural disasters, pandemics, and geo-political events could adversely affect our business.
Natural disasters, including hurricanes, cyclones, typhoons, tropical storms, floods, earthquakes and tsunamis, weather conditions, including winter storms, droughts and tornados, whether as a result of climate change or otherwise, pandemics, and geo-political events, including civil unrest or terrorist attacks, that affect us or our delivery services, suppliers, credit card processors or other service providers could adversely affect our business.
Our insurance coverage and indemnity rights may not adequately protect us against loss.
The types, coverage, or the amounts of any insurance coverage we may carry from time to time may not be adequate to compensate us for any losses we may actually incur in the operation of our business. Further, any insurance we may desire to purchase may not be available to us on terms we find acceptable or at all. We are not indemnified by all of our suppliers, and any indemnification rights we may have may not be enforceable or adequate to cover actual losses we may incur as a result of our sales of their products. Actual losses for which we are not insured or indemnified, or which exceed our insurance coverage or the capacity of our indemnitors or our ability to enforce our indemnity agreements, could have a material adverse effect on our business.
We face risks relating to our inventory.
In our direct business, we sell merchandise that we have purchased and hold in inventory. We assume the risks of inventory damage, theft and obsolescence, as well as risks of price erosion for these products. These risks are especially significant because some of the merchandise we sell is characterized by seasonal trends, fashion trends, rapid technological change, obsolescence and price erosion, and because we sometimes make large purchases of particular types of inventory. Subject to our returns policies, we accept returns of products sold through our partners as well as products we sell in our direct business, and we have the risk of reselling the returned products. In the past we have recorded charges for obsolete inventory and have had to sell certain merchandise at a discount or loss. To the extent that we rely on purchased inventory, our success will depend on our ability to sell our inventory rapidly, the ability of our buying staff to purchase inventory at attractive prices relative to its resale value and our ability to manage customer returns and other costs. If we are unsuccessful in any of these areas, we may be forced to sell our inventory at a discount or loss. Further, we purchase some of our inventory from foreign suppliers and pay for inventory with U.S. dollars. If the dollar weakens with respect to foreign currencies, foreign suppliers may require us to pay higher prices for products, which could negatively affect our profit margins. The occurrence of any of the foregoing could have a material adverse effect on our business.
If we do not successfully optimize and operate our warehouse and customer service operations, our business could be harmed.
We have expanded, contracted and otherwise modified our warehouse and customer service operations from time to time in the past, and expect that we will continue to do so. We also contract with third parties to receive returns and process orders. If we or our third party providers do not successfully optimize and operate our warehouse and customer service operations, it could significantly limit our ability to meet customer demand, customer shipping or return time expectations, or result in excessive costs and expenses for the size of our business. Because it is difficult to predict demand, we may not manage our facilities in an optimal way, which may result in excess or insufficient inventory or warehousing capacity. We may also fail to staff our fulfillment and customer service centers at optimal levels. Our failure to do so could negatively impact our operating results and customer experience, and could have a material adverse effect on our business.
The seasonality of our business places increased strain on our operations.
A disproportionate amount of our sales normally occur during our fourth quarter. If we do not stock or are otherwise unable to source products sufficient to meet customer demand, our business would be adversely affected. If we liquidate products, as we have in the past, we may be required to take significant inventory markdowns or write-offs, which could reduce gross profits. We may experience an increase in our net shipping cost due to complimentary upgrades, split-shipments, and additional long-zone shipments necessary to ensure timely delivery for the holiday season. If too many customers access our Website within a short period of time due to increased holiday demand, we may experience system interruptions that make our Website unavailable or prevent us from efficiently fulfilling orders, which may reduce the volume of goods we sell and the attractiveness of our products and services. In addition, we may be unable to adequately staff our fulfillment and customer service centers during peak periods, and delivery services and other fulfillment companies and customer service providers may be unable to meet the seasonal demand. The occurrence of any of the foregoing could have a material adverse effect on our business.
Significant merchandise returns could harm our business.
We allow our customers to return products, subject to our returns policies. If merchandise returns are high, our business, prospects, financial condition and results of operations could be harmed. Further, we modify our policies relating to returns from time to time, and policies intended to reduce the number of product returns may result in customer dissatisfaction and/or fewer repeat customers. The occurrence of any of the foregoing could have a material adverse effect on our business.
Our pricing strategy may not meet customers’ price expectations or result in net income.
Demand for our products is generally highly sensitive to price. Our pricing strategies have had, and may continue to have, a significant impact on our net sales and net income. We often offer discounted prices, and free or discounted shipping as a means of attracting customers and encouraging repeat purchases. Such offers and discounts reduce our margins. In addition, our competitors’ pricing and marketing strategies are beyond our control and can significantly affect the results of our pricing strategies. If we fail to meet our customers’ price expectations, or if we are unable to compete effectively with our competitors when they engage in aggressive pricing strategies or other competitive activities, it could have a material adverse effect on our business.
If the products that we offer do not reflect our customers’ tastes and preferences, our sales and profit margins would suffer.
Our success depends in part on our ability to offer products that reflect consumers’ tastes and preferences. Consumers’ tastes are subject to frequent, significant and sometimes unpredictable changes. Because some of the products that we sell consist of manufacturers’ and retailers’ excess inventory, we have limited control over some of the products that we are able to offer for sale. If our merchandise fails to satisfy customers’ tastes or respond to changes in customer preferences, our sales could suffer and we could be required to mark down unsold inventory, as we have in the past, which would depress our profit margins. In addition, any failure to offer products in line with customers’ preferences could allow our competitors to gain market share. The occurrence of any of the foregoing could have a material adverse effect on our business.
The loss of key personnel or any inability to attract and retain additional personnel could affect our ability to successfully grow our business.
Our performance is substantially dependent on the continued services and on the performance of our senior management and other key personnel. Our performance also depends on our ability to retain and motivate our officers and key employees. The loss of the services of any of our executive officers or other key employees for any reason could harm our business. Occasionally, members of senior management or key employees may find it necessary to take a leave of absence due to medical or other causes. In early 2013 our Chief Executive Officer and then Chairman of the Board, Dr. Patrick M. Byrne, took a two-month personal leave of absence for medical reasons. Leaves of absence for temporary or extended periods may harm our business. We do not have employment agreements with any of our key personnel and we do not maintain “key person” life insurance policies. Our future success also depends on our ability to identify, attract, hire, train, retain and motivate other highly-skilled technical, managerial, editorial, merchandising, marketing and customer service personnel. Competition for such personnel is intense. Our failure to retain and attract the necessary technical, managerial, editorial, merchandising, marketing, and customer service personnel could have a material adverse effect on our business.
In order to obtain future revenue growth and sustain profitability, we must attract and retain customers on cost-effective terms.
Our success depends on our ability to attract and retain customers on cost-effective terms. We have relationships with online services, search engines, affiliate marketing websites, directories and other website and e-commerce businesses to provide content, advertising banners and other links that direct customers to our Website. We rely on these relationships as significant sources of traffic to our Website and to generate new customers. In the past we have terminated affiliate marketing websites as a result of efforts by certain states to require us to collect sales taxes based on the presence of those third party Internet advertising affiliates in those states, and we are likely to do so again in the future if necessary. If we are unable to develop or maintain these relationships, or develop and maintain new relationships for newly developed and necessary marketing services on acceptable terms, our ability to attract new customers and our financial condition would suffer. In addition, certain of our online marketing agreements may require us to pay upfront fees and make other payments prior to the realization of the sales, if any, associated with those payments. Current or future relationships or agreements may fail to produce the sales that we anticipate. We periodically conduct television and radio branding and advertising campaigns. Such campaigns are expensive and may not result in the cost-effective acquisition of customers. Other means of utilizing social media campaigns to attract or retain customers are expensive and may not result in cost-effective acquisition or retention of customers. The occurrence of any of the foregoing risks or our inability to attract and retain customers on cost-effective terms could have a material adverse effect on our business.
Mobile commerce and our Club O offerings are becoming increasingly significant to us.
Mobile commerce and our Club O offerings are becoming increasingly significant to us. Customers who use mobile devices and customers who join Club O may behave differently from our other customers. For example, the conversion rate of purchases from mobile devices is lower than from other sources. If our mobile customers or our Club O customers are less profitable to us than our other customers, it could have a material adverse effect on our business.
Risks Related to Our Business and Industry - Tax and Regulatory Risks
If one or more states successfully assert that we should collect sales or other taxes on the sale of our merchandise or the merchandise of third parties that we offer for sale on our Website, or that we should pay commercial activity taxes, our business could be harmed.
We do not currently collect sales or other similar taxes on sales of goods into states where we have no duty to do so under federal court decisions construing applicable constitutional law. One or more local, state or foreign jurisdictions may seek to impose sales tax collection obligations on us because we are engaged in online commerce, even though to do so would be contrary to existing court decisions. The future location of our fulfillment or customer service centers networks, or any other operation, service contracts with third parties located in another state, channel distribution arrangements or other agreements with third party sellers, or any act that may be deemed by a state to have established a physical presence in states where we are not now present, may result in additional sales and other tax obligations. New York and other states have passed so-called “Internet affiliate advertising” statutes, which require a remote seller, regardless of whether it has any physical presence in the state, to collect state sales tax if the remote seller contracted for advertising services with an Internet advertiser in that state. In New York and states passing similar laws, we have terminated our use of locally based Internet advertisers. Many other states currently have passed similar laws and others have legislative proposals under consideration. We may discontinue valuable marketing through the use of affiliates based in those states, or we may begin to collect taxes in those states. In either event, or if one or more states or any foreign country where we do not or did not collect sales or other taxes successfully asserts that we should do so or have done so, it could have a material adverse effect on our business.
In 2013 the United States Senate passed the Marketplace Fairness Act of 2013 (“MFA”), but it failed to pass in the House of Representatives. Efforts continue to enact similar legislation, which would permit qualifying states to force remote sellers like us to collect taxes in states where we have no physical presence. The enactment of legislation similar to the MFA could have a material adverse effect on our business.
Other states have enacted forms of economic taxes to which we may be subject. We have been subject to and in the past contested an audit by one such state of an economic tax assessment and settled the audit demand by payment of a diminished assessment without penalty or interest. In Q3 2015, we received a Tax Assessment from the Department of Revenue of the State of Washington asserting that we had nexus with Washington during the period January 1, 2008 to May 31, 2015 and assessing approximately $31.5 million in taxes, interest, and/or penalties asserted to be due, subject to future field verification by the Department of Revenue, for the period. We also recently received an additional Tax Assessment for the period of June 2015 through November 2015 in the amount of approximately $2.5 million in taxes, interest and/or penalties. If we were ultimately held liable for all or substantially all of the amounts assessed against us by the Washington Department of Revenue, or for any large claims by any other states or their revenue departments, it would have a material adverse effect on our business.
Several other states have enacted laws requiring remote vendors to notify resident purchasers in those states of their obligation to pay a use tax on their purchases and, in some instances, to report untaxed purchases to the state tax authorities. Other states have enacted legislation to require retailers without a physical presence in the state to collect and remit state sales taxes if they engage in any activity in connection with the selling, leasing or delivery of tangible personal property or taxable services within the state. More states may enact these laws, or other laws to force or encourage through economic pressures remote retailers to collect and remit sales tax. Such laws could harm our business by imposing unreasonable notice burdens upon us, by interposing burdensome transaction notices that negatively affect conversion, or by discouraging customer purchases by requiring detailed purchase reporting. The occurrence of any of the foregoing could have a material adverse effect on our business.
Economic pressure on states could harm our business.
Economic circumstances affecting many states have increased the pressures on state legislatures and agencies to find ways to increase state revenues. States may continue to increase sales and use tax rates, create new tax laws covering previously untaxed activities, increase existing license fees or create new fees, any or all of which may directly or indirectly
harm our business. Similarly, administrative agencies may apply more rigorous enforcement efforts or take aggressive positions respecting the laws they administer, especially if the laws permit the imposition of monetary penalties and fines which either the state or the administrative agency may use to balance their budgets or otherwise fund operations. The occurrence of any of the foregoing could have a material adverse effect on our business.
Existing or future government regulation could harm our business.
We are subject to regulation at the federal, state and international levels, including regulation relating to privacy, security, retention, transfer and use of personal user information and telemarketing laws. Increasing regulation, along with increased governmental or private enforcement, may increase the cost of our business. Compliance with existing and new privacy and security laws may be difficult and costly and may further restrict our ability to collect demographic and personal information from users, which could harm our marketing efforts, and could require us to implement new and potentially costly processes, procedures and/or protective measures. The expansion of these and other laws, both in terms of their number and their applicability to the Internet could also harm our business. Many laws, adopted prior to the advent of the Internet, do not contemplate or address the unique issues raised thereby. Consequently, courts or regulators may apply these laws to Internet commerce in ways that may present difficult or impossible compliance challenges. Laws that do reference the Internet generally remain subject to interpretation by the courts and their applicability and reach are therefore not always clear. Moreover, Internet advances and innovations may result in new questions about the applicability and reach of these laws. Additionally, laws governing the permissible contents of products may adversely affect us, and we are subject to federal and state consumer laws, including those governing advertising, product labeling, product content requirements and product safety. The laws may cause us to incur losses for any non-compliant items in our inventory, or which we may previously have sold. We may be subject to claims related to personal injury, death, environmental or property damage. We have in the past and may from time to time be required to participate in product recalls. We may incur expense in connection with any of the foregoing or other matters or actions which may not be covered, in whole, in part or at all, by any liability insurance we may carry. These current and future laws and regulations could have a material adverse effect on our business.
Public statements we or our Chief Executive Officer, Patrick M. Byrne, have made or may make in the future may antagonize regulatory officials or others.
We and our Chief Executive Officer, Dr. Patrick M. Byrne, have from time to time made public statements regarding our or his beliefs about matters of public interest, including statements regarding naked short selling and regulatory capture. Some of those public statements have been critical of the Securities and Exchange Commission and other regulatory agencies. These public statements may have consequences for us, whether as a result of increased regulatory scrutiny or otherwise. Additionally, other officers may make public statements that could have adverse consequences and these statements could have a material adverse effect on our business.
Risks Related to Our Business and Industry - Macroeconomic Risks
Economic factors, including our increasing exposure to the U.S. housing industry, may adversely affect our financial performance.
Economic conditions may adversely affect our financial performance. In the United States, weakness in the housing market, changes in interest rates, changes in fuel and other energy costs, inflation or deflation or expectations of either inflation or deflation, actual or anticipated levels of unemployment, unavailability or limitations of consumer credit, higher consumer debt levels or efforts by consumers to reduce debt levels, higher tax rates and other changes in tax laws, overall economic slowdown, changes in consumer desires affecting demand for the products and services we sell and other economic factors could adversely affect consumer demand for the products and services we sell. Any of these factors may change the mix of products we sell to a mix with a lower average gross margin and/or result in slower inventory turnover and/or greater markdowns on inventory. Higher interest rates, transportation costs, inflation, higher costs of labor, insurance and healthcare, foreign exchange rates fluctuations, higher tax rates and other changes in tax laws, changes in other laws and regulations and other economic factors in the United States may increase our cost of sales and operating, may increase our selling, general and administrative expenses, and may otherwise adversely affect our operations and operating results. These factors may affect not only our operations, but also the operations of suppliers from whom we purchase goods, which may also result in increases in the cost to us of the goods and services we sell. The occurrence of any of the foregoing could have a material adverse effect on our business.
Over the last few years the percentage of our sales from home and garden products has increased substantially. We believe that our sales of home and garden products are affected by the strength of the U.S. housing industry, and that downturns in the U.S. housing industry could have a material adverse effect on our business.
Decreases in discretionary consumer spending may have an adverse effect on us.
A substantial portion of the products and services we offer are products or services that consumers may view as discretionary items rather than necessities. As a result, our results of operations are sensitive to changes in macro-economic conditions that impact consumer spending, including discretionary spending. Difficult macro-economic conditions, particularly high levels of unemployment or underemployment, also impact our customers’ ability to obtain consumer credit. Other factors, including consumer confidence, employment levels, interest rates, tax rates, consumer debt levels, and fuel and energy costs could reduce consumer spending or change consumer purchasing habits. Slowdowns in the U.S. or global economy, or an uncertain economic outlook, could materially adversely affect consumer spending habits and could have a material adverse effect on our business.
Risks Related to Our Business and Industry - Risks of Changes in the Industry and in Our Business Generally
If we do not respond to rapid technological changes, our services could become obsolete, and we could lose customers.
The Internet and the online commerce industry are changing rapidly. To remain competitive, we must continue to enhance and improve the functionality and features of our e-commerce businesses. If we fail to do so, we may lose customers. If competitors introduce new products or services using new technologies or if new industry standards and practices emerge, our Website, our mobile app and our proprietary technology and systems may become obsolete. Our failure to respond to technological change or to adequately maintain, upgrade and develop our Website, our mobile app, our infrastructure and the numerous systems we use to process customers’ orders and payments and to perform important related functions could have a material adverse effect on our business.
We have an evolving business model, which increases the complexity of our business.
Our business model has evolved in the past and continues to do so. In prior years we have added additional types of services and product offerings and in some cases we have modified or discontinued those offerings. We intend to continue to try to offer additional types of products or services, and we cannot offer any assurance that any of them will be successful. From time to time we have also modified aspects of our business model relating to our product mix and the mix of direct/partner sourcing of the products we offer. We may continue to modify this aspect of our business as well as other significant aspects of our business. We cannot offer any assurance that these or any other modifications will be successful or will not result in harm to the business. The additions and modifications to our business have increased the complexity of our business and placed significant strain on our management, personnel, operations, systems, technical performance, financial resources, and internal financial control and reporting functions. Future additions to or modifications of our business are likely to have similar effects. We may not be able to manage growth effectively, which could damage our reputation, limit our growth and negatively affect our operating results. Further, any new business or website we launch that is not favorably received by consumers could damage our reputation or our brand. The occurrence of any of the foregoing could have a material adverse effect on our business.
Acquisitions we make will increase costs and regulatory and integration risks.
From time to time we acquire other businesses. Integrating an acquired business involves a number of risks and financial, managerial and operational challenges. The acquisition of a business and the integration of a business requires us to allocate significant management time and attention to the matter. We have incurred significant expenses in connection with acquisitions we have made recently, and may incur additional expenses in connection with those acquisitions or in connection with other acquisitions we may make in the future. Our overall profitability would be adversely affected if our investments and expenses associated with any investments we have made or may make in the future are not matched or exceeded by the revenues that are derived from such investment or growth. Further, acquisitions may also create a need for additional accounting, tax, compliance, documentation, risk management and internal control procedures, and may require us to hire additional personnel to implement, perform and/or monitor such procedures. To the extent our procedures are not adequate to appropriately implement, perform and/or monitor all necessary procedures relating to any new or expanded business, we could be exposed to a material loss or regulatory sanction.
Risks Related to Our Business and Industry - International Risks
We are attempting to expand our international business, which may cause our business to become increasingly susceptible to numerous risks and challenges that could affect our profitability.
We sell products in international markets, and are attempting to expand into some of these markets. International sales and transactions, and our efforts to expand them, are subject to inherent risks and challenges that could adversely affect our profitability, including:
•the need to develop new supplier and manufacturer relationships;
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• | the need to comply with additional U.S. and foreign laws and regulations to the extent applicable, including but not limited to, restrictions on advertising practices, regulations governing online services, regulations governing or prohibiting the use of cryptocurrency such as bitcoin, restrictions on importation of specified or proscribed items, importation quotas, consumer protection laws, laws regarding intellectual property rights, laws dealing with consumer and data protection, privacy, encryption, and restrictions on pricing or discounts; |
•changes in international laws, regulatory requirements, taxes and tariffs;
•geopolitical events, such as war and terrorist attacks;
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• | our limited experience with different local cultures and standards; |
•the risk that the products we offer may not appeal to customers in international markets; and
•the additional resources and management attention required for such expansion.
To the extent we generate international sales transactions in the future, any negative impact on our international operations could negatively impact our business. To date, most of our international sales have been denominated in U.S. dollars, and we have not had significant foreign currency risk on those sales. However, in the future, gains and losses on the conversion of foreign payments into U. S. dollars may contribute to fluctuations in our results of operations and fluctuating exchange rates could cause reduced gross revenues and/or gross profit percentages from non-dollar-denominated international sales. Additionally, penalties for non-compliance with laws applicable to international business and trade, including the U.S. Foreign Corrupt Practices Act, or laws governing or prohibiting the use of cryptocurrencies, could have a material adverse effect on our business.
Foreign data protection, privacy and other laws and regulations are often more restrictive than those in the United States. The European Union, for example, traditionally has imposed stricter obligations under its laws and regulations relating to privacy, data protection and consumer protection than the United States. Individual EU member countries have discretion with respect to their interpretation and implementation of these laws and the penalties for breach and have their own regulators with differing attitudes towards enforcement, which results in varying privacy standards and enforcement risk from country to country. Legislation and regulation in the European Union and some EU member states require companies to give specific types of notice and in some cases seek consent from consumers before using their data for certain purposes, including some marketing activities. In the majority of EU member countries, consent must be obtained prior to setting cookies or other tracking technologies. Outside of the European Union, there are many countries with data protection laws, and new countries are adopting data protection legislation with increasing frequency. Many of these laws may require consent from consumers for the use of data for various purposes, including marketing, which may reduce our ability to market our products, unless we obtain consent from customers in a manner that complies with the laws of each country. In addition, even if we initially receive such consent, many countries have laws in place that allow consumers to revoke their consent. This imposes multiple obligations around tracking, auditing, and updating consumer consents, as well as the activities that required the consent, such as marketing. There is no harmonized approach to these laws and regulations globally. Consequently, we increase our risk of non-compliance with applicable foreign data protection laws and regulations as we continue our international expansion. We may need to change and limit the way we use consumer information in operating our business and may have difficulty maintaining a single operating model that is compliant. Compliance with such laws and regulations will result in additional costs and may necessitate changes to our business practices and divergent operating models, which may adversely affect our business and financial condition.
In October 2015 the European Court of Justice overturned the European Commission's long-standing decision finding that the privacy principles of the EU-U.S. safe harbor provide an adequate level of protection of the data of EU citizens. We have relied on the safe harbor in order to receive personal information from the EU to enable us to provide goods and services to our customers and users in the EU, process payments, maintain customer and user accounts, personalize and improve the functionality of our website, and to take other actions in connection with these activities. If the safe harbor is not reinstated, or if we are unable to comply with any successor safe harbor or equivalent, we could be required to make costly changes to our business and could be required to avoid sales in some countries. The occurrence of any of the foregoing could have an adverse effect on our business.
In addition, various federal, state and foreign legislative and regulatory bodies, or self-regulatory organizations, may expand current laws or regulations, enact new laws or regulations or issue revised rules or guidance regarding privacy, data protection and consumer protection.
Our foreign brand domain name may cause confusion.
In 2010, we attempted to associate our brand globally with the domain address: www.O.co. We did this in part because in many foreign markets the word “Overstock” lacked a good foreign cognate. Following a period of testing for the O.co brand and domain address, we returned to the Overstock.com name as our primary brand domestically because domestic consumer acceptance did not occur as quickly as we had hoped. While we have returned domestically to the Overstock.com brand and principal domain address, we continue to use the O.co address and brand outside of the United States and plan to use it or another domain address and brand domestically as well. There is no assurance that the use of Overstock.com or O.co will gain acceptance or have success in foreign markets or that other domain addresses or brands we may use domestically will be successful. Any such difficulties with any of our brands could have a material adverse effect on our business.
Risks Related to Our Business and Industry - Risks relating to our Future Headquarters
We have purchased land to build a facility to serve as our future headquarters, and consequently have environmental and other risks, and may incur environmental expense and liabilities, in connection with the project, and under the environmental indemnity agreement we entered into in connection with our credit facility.
In the third quarter of 2014, we purchased land in Salt Lake City, Utah in preparation for our construction of our future headquarters. In purchasing the land, we became subject to the risks of owning real estate, including the risks of environmental liabilities and the requirements for compliance with applicable laws, rules, regulations, ordinances and other requirements. The land we purchased is part of the Midvale Slat Superfund Site (“Site”), a former Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA") superfund site that was remediated pursuant to CERCLA prior to our purchase. As purchaser of the property, O.com Land, LLC is required to follow certain requirements of the CERCLA statute and the consent decree governing remediation of the Site. Its failure to do so could expose us to environmental liabilities which could be material. Further, in connection with the credit facility we entered into with U.S. Bank and other banks, we entered into a broad environmental indemnity agreement pursuant to which we made detailed representations about the environmental status of the land and agreed to indemnify and defend U.S. Bank and other banks and other persons against a broad array of potential environmental claims, liabilities and exposures relating to the property we purchased and the headquarters we are building. Any such environmental liabilities, and any liabilities under the environmental indemnity agreement, could be material and could have a material adverse effect on our business.
We have entered into contracts and plan to spend approximately $99 million to build, equip and furnish a facility to serve as our future headquarters, and expect to incur risks, expense and debt in connection with the project.
We are building our new headquarters in Salt Lake City, and are incurring the risks and expense of doing so. The design and construction of the headquarters are complicated. We may encounter unanticipated developments affecting our estimates regarding the expense of the project. We may also encounter delays in the construction of the facility. Any such difficulties could result in our default under the Loan Agreement and related agreements we have entered into with U.S. Bank and other banks, and could result in material liabilities and expense and could have a material adverse effect on our business.
In connection with the construction of our new headquarters, we have entered into a syndicated senior secured credit facility, and may need to obtain additional financing as well.
Our current estimate of the total cost of the development and construction and related equipment and furniture of our new headquarters is approximately $99 million. We have entered into a syndicated senior secured credit facility with U.S. Bank and other banks that is intended to provide us with construction and term financing of $45.8 million. The facility is designed to convert to an approximately 6.75-year term loan upon completion of construction. We will need to maintain compliance with the requirements governing the facility, including compliance with financial and other covenants, certain of which may be subject to events outside of our control. If we fail to comply with any of such covenants, we may be unable to obtain or utilize the financing contemplated by the facility. If the financing we anticipate under the facility is not fully available to us for any reason, it would have a material adverse effect on our liquidity and could have a material adverse effect on our business.
We have pledged the land and our new headquarters and all related assets, as well as our inventory and accounts receivable and related assets, to secure our obligations under the syndicated senior secured credit facility.
We have pledged all of our assets relating to the new headquarters and the site on which it is to be located, as well as our inventory, accounts receivable and related assets, and most of our deposit accounts, to secure our obligations under the syndicated senior secured credit facility. The real estate loan and the revolving loan facilities included within the facility are
cross-collateralized and cross-defaulted. If we were to default on either loan or have an Event of Default under the facility, the lenders would have the right to, among other things, foreclose on the collateral for our obligations under the facility, which would have a material adverse effect on our liquidity and could have a material adverse effect on our business.
We have entered into long-term interest rate swaps covering a period of approximately nine years.
In connection with the syndicated senior secured credit facility described above, we have entered into interest rate swaps with U.S. Bank and Compass Bank. The interest rate swaps are intended to manage the interest rate risk on the indebtedness we incurred in 2015 and expect to incur in 2016 for the Real Estate Loan. However, if for any reason the notional amounts of the swaps fail to substantially match our indebtedness for the Real Estate Loan at any time until the October 2023 maturity of the swaps, we could potentially be exposed to liabilities under the loan agreement that may not be substantially offset by the interest rate swap. If the lenders under the senior secured credit facility were to fail to fund the Real Estate Loan for any reason, we would remain liable for payments due under the swaps unless we were to settle the swaps. If we were to settle the swaps at a time when interest rates have fallen (relative to the swaps' inception), the price to settle the swaps could be material. Any such adverse developments could result in material liabilities and expense and could have a material adverse effect on our business.
We may fail to qualify for hedge accounting treatment.
In connection with the financing we obtained to fund a portion of the construction of our new corporate headquarters, we have entered into interest rate swap transactions with certain of our lenders intended to minimize our exposure to various interest rate risks. At inception in 2014 we designated these swaps as cash flow hedges in accordance with Accounting Standards Codification (“ASC”) 815, Derivatives and Hedging. However, in the future, we may fail to qualify for hedge accounting treatment under these standards for a number of reasons, including if we fail to satisfy hedge documentation and hedge effectiveness assessment requirements or if our derivative instruments are not highly effective. If we fail to qualify for hedge accounting treatment, losses on the swaps caused by the change in their fair value would be recognized as part of net income, rather than being recognized as part of other comprehensive income. Additionally, although our derivative instruments may be highly effective, ineffectiveness in such instruments would also be recognized as part of net income, rather than other comprehensive income. Any such adverse developments could result in material liabilities and expense and could have a material adverse effect on our business.
We have entered into a Construction Agreement relating to the construction of the new headquarters; however, many aspects of the proposed construction remain subject to future agreement.
In October 2014, we entered into a Construction Agreement (the “Construction Agreement”) with Okland Construction Company Inc. (“Okland”) regarding preconstruction and construction services to be provided in connection with the construction of our corporate headquarters, together with related facilities and improvements. Okland has agreed that the work contemplated by the Construction Agreement will be performed for the Guaranteed Maximum Price (as defined in the Construction Agreement and as established in the First Amendment to the Agreement dated July 31, 2015) and in accordance with the Construction Schedule (as defined in the Construction Agreement). However, both the Guaranteed Maximum Price and the Construction Schedule remain subject to change. Because many aspects of the proposed construction remain subject to future agreement, there is a risk of difficulties under the Construction Agreement, any of which if not resolved to the satisfaction of us and Okland could cause difficulties with the construction of our headquarters, any of which in turn could cause us to default under the syndicated senior secured credit facility we recently entered into with U.S. Bank and other banks. Any such adverse developments could result in material liabilities and expense and could have a material adverse effect on our business.
Risks Related to Our Business and Industry - Risks relating to Indebtedness and Potential Stock Repurchases
We expect to incur substantial indebtedness.
At December 31, 2015, we had incurred secured indebtedness of $9.5 million under the syndicated senior secured credit facility we recently entered into with U.S. Bank and other banks. We expect to incur substantial additional indebtedness under the facility in connection with the completion of our headquarters. In addition, we may incur up to the full $10.0 million of indebtedness potentially available to us under the revolving credit facility included in the senior secured credit facility, and we may also incur additional indebtedness, subject to the limitations set forth in the Loan Agreement governing our senior secured credit facility. All such indebtedness will increase our business risks substantially, including our vulnerability to industry downturns and competitive pressures. Further, the Loan Agreement and related agreements governing the senior secured credit facility contain numerous requirements, including affirmative and negative financial and other covenants. If we
are unable to maintain compliance with all of them, we will be in default, the consequences of which could materially harm our business. Further, to the extent that we incur additional indebtedness, we may be subject to additional requirements. The degree to which we are ultimately leveraged could materially and adversely affect our ability to obtain additional financing for working capital, acquisitions or other purposes and could make us more vulnerable to industry downturns and competitive pressures. Our ability to meet our debt service obligations will be dependent upon our future performance, which will be subject to financial, business and other factors affecting our operations, many of which are beyond our control.
Our Board has authorized a stock repurchase program and repurchases under the program would reduce our liquidity and increase our risks.
In May 2015 our Board authorized a stock repurchase program under which we may repurchase shares of our outstanding common stock for up to $25 million at any time through December 31, 2017. Any such repurchases would reduce our liquidity and could increase our vulnerability to industry downturns and competitive pressures. A material decrease in our liquidity could have a material adverse effect on our business.
We may be unable to generate sufficient cash flow to satisfy our debt service obligations.
Our ability to generate cash flow from operations to make interest and principal payments on our debt obligations will depend on our future performance, which will be affected by a range of economic, competitive and business factors. We cannot control many of these factors, including general economic conditions and the health of the Internet retail industry. If our operations do not generate sufficient cash flow from operations to satisfy our debt service obligations and all of our other obligations, we may need to borrow additional funds to make these payments or undertake alternative financing plans, such as refinancing or restructuring our debt, or reducing or delaying capital investments and other expenses. Additional funds or alternative financing may not be available to us on favorable terms, or at all. Our inability to generate sufficient cash flow from operations or obtain additional funds or alternative financing on acceptable terms could have a material adverse effect on our business.
Risks Related to Our Business and Industry - Risks relating to our Finance and Accounting Systems and Estimates
We may need to implement additional finance and accounting systems, procedures and controls as we grow our business and organization and to satisfy new reporting requirements.
We are required to comply with a variety of reporting, accounting and other rules and regulations. Compliance with existing requirements is expensive. We will have to ensure that the reporting, accounting, records maintenance and other systems in place at the fintech company and broker dealers we recently acquired are compliant and adequate. These and future requirements may increase our costs and require additional management time and resources. We may need to implement additional finance and accounting systems, procedures and controls to satisfy our reporting requirements. If our internal control over financial reporting is determined to be ineffective, such failure could cause investors to lose confidence in our reported financial information, negatively affect the market price of our common stock, subject us to regulatory investigations and penalties, and could have a material adverse effect on our business.
Changes in accounting standards and subjective assumptions, estimates and judgments by management related to complex accounting matters could significantly affect our financial results.
Generally accepted accounting principles and related accounting pronouncements, implementation guidelines and interpretations with regard to a wide range of matters that are relevant to our business, including but not limited to revenue recognition, estimating valuation allowances and accrued liabilities (including allowances for returns, credit card chargebacks, doubtful accounts and obsolete and damaged inventory), internal use software and website development (acquired and developed internally), accounting for income taxes, valuation of long-lived and intangible assets and goodwill, stock-based compensation and loss contingencies, are highly complex and involve many subjective assumptions, estimates and judgments by our management. Changes in these rules or their interpretation or changes in underlying assumptions, estimates or judgments by our management could significantly change our reported or expected financial performance, and could have a material adverse effect on our business.
Our income tax provisions and the amounts we reserve for tax contingencies are estimates and are subject to variations and adjustments. The amounts we ultimately pay may exceed the amounts estimated or accrued.
Our quarterly tax provision, and our quarterly estimate of our annual effective tax rate, is subject to significant variation due to several factors, including variability in accurately predicting our pre-tax and taxable income and loss and the
mix of jurisdictions to which they relate, changes in how we do business, changes in law, regulations, and administrative practices, and relative changes of expenses or losses for which tax benefits are not recognized. Additionally, our effective tax rate can be more or less volatile based on the amount of pre-tax income. For example, the impact of discrete items and non-deductible expenses on our effective tax rate is greater when our pre-tax income is relatively low.
Changes in state, federal, and foreign tax laws may increase our tax contingencies. The timing of the resolution of income tax examinations is highly uncertain, and the amounts ultimately paid, if any, upon resolution of the issues raised by the taxing authorities may differ from the amounts accrued. It is reasonably possible that within the next 12 months we will receive assessments by various tax authorities or possibly reach resolution of income tax examinations in one or more jurisdictions. These assessments or settlements may result in changes to our contingencies related to positions on prior years’ tax filings. The volatility of our quarterly tax provision or the resolution of matters related to our tax contingencies could have a material adverse effect on our financial results.
We have reversed the valuation allowance for our deferred tax assets, and we may not be able to realize these assets in the future. Our deferred tax assets may also be subject to additional valuation allowances, which could adversely affect our operating results.
From our inception to December 31, 2013, we established a valuation allowance for our deferred tax assets, primarily due to realized losses and uncertainty regarding our future taxable income. Determining whether a valuation allowance for deferred tax assets is appropriate requires significant judgment and an evaluation of all positive and negative evidence. At each reporting period, we assess the need for, or the sufficiency of, a valuation allowance against deferred tax assets. At December 31, 2013, based on the weight of all the positive and negative evidence, we concluded that it was more likely than not that we will realize our net deferred tax assets based upon future taxable income. Therefore we reversed the valuation allowance at December 31, 2013.
Our conclusion at December 31, 2013 that it is more likely than not that we will realize our net deferred tax assets was based primarily on our estimate of future taxable income. Our estimate of future taxable income is based on internal projections which primarily consider historical performance, but also include various internal estimates and assumptions as well as certain external data. We believe all of these inputs to be reasonable, although inherently subject to significant judgment. If actual results differ significantly from these estimates of future taxable income, we may need to reestablish a valuation allowance for some or all of our deferred tax assets. Establishing an allowance on our net deferred tax assets could have a material adverse effect on our financial condition and operating results.
Risks Related to Our Business and Industry - Risks relating to our Holdings of Precious Metals, Cryptocurrencies, Cash and Short-Term Investments
We may be adversely affected by fluctuations in precious metal prices.
At December 31, 2015 our investment in precious metals was $9.7 million. Our financial results may be adversely affected by declines in the price of precious metals. The prices of precious metals may fluctuate widely in the future and are affected by numerous factors beyond our control such as interest rates, exchange rates, inflation or deflation, fluctuation in the value of the United States dollar and foreign currencies, global and regional supply and demand, and the political and economic conditions of mineral producing countries throughout the world. Our investment consists of actual precious metals, rather than financial instruments. We store our precious metals off-site in a third party facility. Consequently, we are subject to the risks of physical storage with a third party that we do not control. Any loss of these assets or substantial decline in their value could have a material adverse effect on our business.
Our decision to accept and hold cryptocurrency, such as bitcoins, may subject us to exchange risk and additional tax and regulatory requirements.
In January 2014, we began accepting bitcoins as a form of payment for purchases on our website. Bitcoin is a cryptocurrency that uses cryptography to control the creation and transfer of the currency between individual parties. Bitcoin is not considered legal tender or backed by any government. Since inception in 2009, bitcoins have experienced price volatility, technological glitches and various law enforcement and regulatory interventions. At present we do not accept bitcoin payments directly, but use a third party vendor to accept bitcoin payments on our behalf. That third party vendor then immediately converts the bitcoin payments into U.S. dollars so that we receive payment for the product sold at the sales price in U.S. dollars.
In September 2014 we launched an updated international checkout system which allows us to accept bitcoin globally. The use of cryptocurrency such as bitcoin has been prohibited or effectively prohibited in some countries. Authorities in other countries have issued statements or regulations prohibiting financial institutions or others from holding or dealing in cryptocurrency. Authorities in some countries have issued statements or regulations to the effect that cryptocurrency is not legal tender. Authorities in many other countries have issued warnings about their perceptions of the risks of dealing in bitcoin or other cryptocurrency and/or announcing that cryptocurrency is subject to money laundering or other laws or to taxation, or that the authorities are studying the legality of cryptocurrency. If we fail to comply with prohibitions applicable to us, we could face regulatory or other enforcement actions and potential fines and other consequences.
We also hold bitcoin and other cryptocurrency directly. Consequently, we have exchange rate risk on the amounts we hold as well as the risks that regulatory or other developments may adversely affect the value of the cryptocurrency we hold. In the future, we may transact in cryptocurrency directly or increase our cryptocurrency holdings. This will subject us to additional exchange risk and other risks as described above, which may have an adverse effect on our results. There is also uncertainty regarding the future legal and regulatory requirements relating to cryptocurrency or transactions utilizing cryptocurrency. These uncertainties, as well as future accounting and tax developments, or other requirements relating to cryptocurrency could have a material adverse effect on our business.
Our cash, cash equivalents and short-term investments are subject to a risk of loss based upon the solvency of the financial institutions in which they are maintained.
We maintain the majority of our cash, cash equivalents and short-term investments in accounts with a small number of major financial institutions within the United States, in the form of demand deposits, money market accounts, time deposits, U.S. Treasury Bills and other short-term investments. Our deposits in these institutions are generally substantially in excess of the amounts of insurance provided by the FDIC, and some deposits may not be covered by insurance at all. If any of these institutions were to become insolvent or subject to regulatory action, we could lose some, or all, of such deposits, which would have a material adverse effect on our business.
Risks Related to Our Business and Industry - Risks relating to Intellectual Property Rights and Disputes
We may be unable to protect our proprietary technology or keep up with that of our competitors.
Our success depends to a significant degree upon the protection of our software and other proprietary intellectual property rights. We may be unable to deter misappropriation of our proprietary information, detect unauthorized use or take appropriate steps to enforce our intellectual property rights. In addition, our competitors may now have or may in the future develop technologies that are as good as or better than our technology without violating our proprietary rights. Our failure to protect our software and other proprietary intellectual property rights or to utilize technologies that are as good as our competitors’ could put us at a disadvantage to our competitors. In addition, the failure of the third parties whose products we offer for sale on our Website to protect their intellectual property rights, including their domain names, could impair our operations. These failures could have a material adverse effect on our business.
We may not be able to obtain trademark protection for our marks, which could impede our efforts to build brand identity.
We have filed trademark applications with the Patent and Trademark Office seeking registration of certain service marks and trademarks. There can be no assurance that our applications will be successful or that we will be able to secure significant protection for our service marks or trademarks in the United States or elsewhere as we expand internationally. Our competitors or others could adopt product or service marks similar to our marks, or try to prevent us from using our marks, thereby impeding our ability to build brand identity and possibly leading to customer confusion. Any claim by another party against us or customer confusion related to our trademarks, or our failure to obtain trademark registration, could have a material adverse effect on our business.
We may not be able to enforce protection of our intellectual property rights under the laws of other countries.
We sell products internationally and consequently we are subject to risks of doing business internationally as related to our intellectual property, including:
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• | legal uncertainty regarding liability for the listings and other content provided by our users, including uncertainty as a result of less Internet-friendly legal systems, unique local laws, and lack of clear precedent or applicable law; and |
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• | differing intellectual property laws, which may provide insufficient protection for our intellectual property. |
Any such difficulties could have a material adverse effect on our business.
We may be accused of infringing intellectual property rights of third parties.
Other parties have claimed and may claim that we infringe their intellectual property rights. We have been and are subject to, and expect to continue to be subject to, legal claims of alleged infringement of the intellectual property rights of third parties. The ready availability of damages, royalties and the potential for injunctive relief has increased the defense litigation costs of patent infringement claims, especially those asserted by third parties whose sole or primary business is to assert such claims. Such claims, even if not meritorious, may result in significant expenditure of financial and managerial resources, and the payment of damages or settlement amounts. Additionally, we may become subject to injunctions prohibiting us from using software or business processes we currently use or may need to use in the future, or requiring us to obtain licenses from third parties when such licenses may not be available on financially feasible terms or terms acceptable to us or at all. In addition, we may not be able to obtain on favorable terms, or at all, licenses or other rights with respect to intellectual property we do not own in providing e-commerce services to other businesses and individuals under commercial agreements. Any such difficulties could have a material adverse effect on our business.
Our business and reputation may be harmed by the offering or sale of pirated, counterfeit or illegal items by third parties, and by intellectual property litigation.
We have received in the past, and we anticipate we will receive in the future, communications alleging that items offered or sold through our Website infringe third party copyrights, trademarks and trade names or other intellectual property rights or that we have otherwise infringed third parties’ past, current or future intellectual property rights. We may be unable to prevent third parties from offering and selling unlawful goods, and we may be subject to allegations of civil or criminal liability for unlawful activities carried out by third parties through our Website. We may implement measures in an effort to protect against these potential liabilities that could require us to spend substantial resources and/or to reduce revenues by discontinuing certain service offerings. Any costs incurred as a result of liability or asserted liability relating to the sale of unlawful goods or the unlawful sale of goods could harm our business. Resolving litigation or claims regarding patents or other intellectual property, whether meritorious or not, could be costly, time-consuming, cause service delays, divert our management and key personnel from our business operations, require expensive or unwanted changes in our methods of doing business or require us to enter into costly royalty or licensing agreements, if available. As a result, these claims and any negative publicity generated as a result of any of the foregoing could damage our reputation, diminish the value of our brand name, and have a material adverse effect on our business.
Risks Related to Our Business and Industry - Risks relating to Certain Specific Businesses and Recent or Planned Changes to our Business
A subsidiary of Medici has acquired the assets and business of a financial technology company and Medici has acquired two registered broker-dealers; Medici does not have any prior experience with the operation of a fintech company or of a registered broker-dealer, and the businesses that Medici is pursuing are novel.
In August 2015, a subsidiary of Medici acquired the assets and business of a financial technology ("fintech") company and in January 2016 Medici closed the acquisitions of two registered broker-dealers (the “BDs” or our “broker-dealer subsidiaries”) that were affiliated with the fintech company. Medici subsequently hired all or substantially all of the employees of the fintech company. However, Medici does not otherwise have any experience with the operation of a fintech company or of a registered broker-dealer, and will be dependent upon the new employees for the expertise necessary to operate the fintech company and the registered broker dealers. Further, Medici, the fintech company and the broker-dealers have developed proprietary blockchain software and related expertise relating to the use of the blockchain in connection with a system for the public trading of securities. All of these are areas in which we do not have substantial, or any, experience, and all of them are subject to the risks of new and novel businesses, including operational risk, financial risk, regulatory and legal risk, and reputational risk. Further, even assuming the resolution of all technical, legal and regulatory constraints, Medici faces the risks that it may be unable to market, license or sell its technology successfully or profitably. Any significant problems Medici encounters with these projects could have a material adverse effect on our business.
Medici’s efforts to create a novel system able to provide short sellers of publicly-traded securities with evidence of their identification of securities available to be borrowed is in an area in which it has limited or no experience, and the project may be expensive and is subject to significant technical, legal and regulatory constraints and other risks.
Our majority-owned subsidiary Medici has created a novel system able to provide short sellers of publicly-traded securities with evidence of their identification of securities available to be borrowed. Although Medici has conducted limited initial tests, this project is novel and Medici has limited or no experience in this area. The system is subject to technical, legal and regulatory requirements. Further, Medici faces the risk that it may be unable to market, license or sell its technology successfully or profitably. Any significant problems Medici encounters with this project could have a material adverse effect on our business.
Medici has acquired registered broker-dealers, which are subject to extensive regulation.
Broker-dealer and other financial services firms are subject to extensive regulatory requirements under federal and state laws and regulations and self-regulatory organization (“SRO”) rules. The broker-dealers Medici acquired in January 2016 are registered with the SEC as broker-dealers under the Exchange Act and in the states in which they conduct securities business and are members of the Financial Industry Regulatory Authority (“FINRA”) and other SROs. They are subject to regulation, examination and disciplinary action by the SEC, FINRA and state securities regulators, as well as other governmental authorities and SROs with which they are registered or licensed or of which they are members.
The SEC, FINRA and other governmental authorities and SROs may bring enforcement proceedings against firms and place other limitations on firms subject to their jurisdiction, as well as their officers, directors, employees and independent contractors, whether arising out of an examination or otherwise, for violations of the securities laws, regulations and rules. Sanctions can include cease-and-desist orders, censures, fines, civil monetary penalties and disgorgement, limitations on a firm’s business activities, suspension, revocation of FINRA membership or expulsion of the firm from the securities industry. Criminal actions are referred to the appropriate criminal law enforcement agency. Any such proceeding against any of the broker-dealers that Medici has acquired, or any of their associated persons, could harm our reputation, cause them to lose clients or fail to gain new clients and have a material adverse effect on our business.
Financial services firms are subject to numerous conflicts of interest or perceived conflicts of interest. The SEC, FINRA and other governmental authorities and SROs have increased their scrutiny of potential conflicts of interest. The broker dealers have adopted and will regularly review and update, policies, procedures and controls designed to address or limit actual or perceived conflicts, but there can be no assurance of the effectiveness of these protocols. Addressing conflicts of interest adequately is complex and difficult and our reputation could be damaged if we fail, or appear to fail, to identify and successfully manage these conflicts of interest. The development and implementation of policies, procedures and controls to address or limit actual or perceived conflicts may also result in increased costs. Failure to identify and successfully manage conflicts of interest procedures could subject the broker-dealers or Medici or us to disciplinary sanctions or litigation or could harm our reputation.
Financial services firms are also subject to rules and regulations relating to the prevention and detection of money laundering. The USA PATRIOT Act of 2001 (the “PATRIOT Act”) mandates that financial institutions, including broker-dealers and investment advisers, establish and implement anti-money laundering (“AML”) programs reasonably designed to achieve compliance with the Bank Secrecy Act of 1970 and the rules thereunder. Financial services firms must maintain AML policies, procedures and controls, designate an AML compliance officer to oversee the firm’s AML program, implement appropriate employee training and provide for annual independent testing of the program. Failure to comply with AML requirements could subject the broker-dealers and/or us to disciplinary sanctions and other penalties.
Financial services firms must also comply with applicable privacy and data protection laws and regulations. Any violations of laws and regulations relating to the safeguarding of private information could subject the broker-dealers and/or us to fines and penalties, as well as to civil action by affected parties.
Our ability to comply with applicable laws, rules and regulations is largely dependent on our establishment and maintenance of compliance, supervision, recordkeeping and reporting and audit systems and procedures, as well as our ability to attract and retain qualified compliance, audit and risk management personnel. While the broker dealers have adopted policies and procedures intended to comply with applicable laws, rules and regulations, these systems and procedures may not be fully effective, and there can be no assurance that regulators or third parties will not raise material issues with respect to their past or future compliance with applicable regulations.
We Could Be Liable for Fraudulent or Unlawful Activities of Sellers
The law relating to the liability of providers of online payment services is currently unsettled. In addition, governmental agencies could require changes in the way this business is conducted. Under our seller programs, we may be unable to prevent sellers from collecting payments, fraudulently or otherwise, when buyers never receive the products they
ordered or when the products received are materially different from the sellers’ descriptions. We also may be unable to prevent sellers on our sites or through other seller sites from selling unlawful goods, selling goods in an unlawful manner, or violating the proprietary rights of others, and could face civil or criminal liability for unlawful activities by our sellers.
Our car listing service may be subject to a variety of regulatory requirements and risks.
Many states and other jurisdictions, including Utah, where we are located, have regulations governing the conduct of car sellers and public advertisement for car sales. Generally, these regulations govern the conduct of those sellers advertising their automobiles for sale and are not directly applicable to those providing the medium through which the advertisement is made available to the public. Sellers are often subject to regulations in the nature of “truth in advertising laws.” We have no ability to know whether the information sellers provide is correct. While our site terms and conditions of usage prohibit unlawful acts, we cannot assure that sellers will comply with all laws and regulations applicable to them and their transactions. The application of these regulations to online car listing service providers is not clear. Although we do not expect these laws to have a significant effect on our listing service, we will incur costs in complying with these laws, and we may from time to time be required to make changes in our service that may increase our costs, reduce our revenues, cause us to prohibit certain listing or advertising practices, or make other changes that may adversely affect our car listing service. Further, like our shopping business, our car listing service is subject to most of the same laws and regulations that apply to other companies conducting business on and off the Internet. To the extent that current or future laws or regulations prevent users from selling items on our car listing site, they could harm our business. In addition, any negative publicity we receive regarding any allegations of unlawful or deceptive conduct may damage our reputation, our ability to attract new customers to our main shopping site, and our brand name generally. The occurrence of any of the foregoing could have a material adverse effect on our business.
Our Supplier Oasis offering, including its fulfillment services, faces competition from other distribution networks and will require substantial resources.
We recently launched Supplier Oasis, a single integration point through which partners can manage their products, inventory and sales channels, which includes multi-channel fulfillment services to sellers, suppliers, and partners. The marketplace for these services is highly competitive, and many of our current and potential competitors in this area have greater brand recognition, longer operating histories, larger customer bases and significantly greater financial, marketing and other resources than we do. Our continued development of Supplier Oasis may require substantial investments over a lengthy period of time. Further, most of the risks applicable to our business generally are also applicable to the business of Supplier Oasis. If we are unable to generate sufficient revenues and gross profits from Supplier Oasis, it could have a material adverse effect on our business.
Our recently-launched Farmers Market faces competition from a variety of competitors.
In late 2014 we launched Farmers Market, a tab within our website from which our customers can order locally grown fresh produce and other food products. Farmers Market competes with a wide variety of businesses nationwide, many of which have greater brand recognition, longer operating histories, larger customer bases and significantly greater financial, marketing and other resources than we do. Our continued development of Farmers Market may involve delivery and other issues that may be different from those we face in connection with the sale and delivery of non-perishable products. Further, most of the risks applicable to our business generally are also applicable to our Farmers Market business. Any significant difficulties we encounter with our Farmers Market offering could have a material adverse effect on our business.
Our insurance offerings face competition from traditional insurance brokers and direct insurance marketing organizations.
In 2014 we launched a tab offering insurance for vehicle, residential and small businesses on our website. The tab allows consumers to compare live quotes for insurance on residential, vehicle, and small business insurance, and to bind (pay for and have go into effect) insurance policies. The insurance business is highly competitive, and many of our current and potential competitors in this area have greater brand recognition, longer operating histories, larger customer bases and significantly greater financial, marketing and other resources than we do. Further, most of the risks applicable to our business generally are also applicable to our insurance offerings business. Any significant difficulties we encounter with our insurance offerings could have a material adverse effect on our business.
Risks Related to Our Business and Industry - Risks relating to Litigation
We are involved in substantial litigation.
From time to time we receive claims of and become subject to consumer protection, employment, intellectual property and other commercial litigation related to the conduct and operation of our business and the sale of products on our Website. In connection with such litigation, we may be subject to significant damages or equitable remedies. In addition, we have in the past been and in the future may be, involved in substantial litigation in which we are the plaintiff, including litigation regarding the constitutionality of certain state tax laws. Any of such litigation, whether as plaintiff or defendant, could be costly and time consuming and could divert management and key personnel from our regular business operations. We do not currently believe that any of our outstanding litigation will have a material adverse effect on our business, prospects, financial condition or results of operations. However, due to the uncertainty of litigation and depending on the amount and the timing, an unfavorable resolution of some or all of these matters could have a material adverse effect on our business.
Risks Related to Our Business and Industry - Risks relating to our Common Stock
The price of our common stock and any other securities may be volatile and you may lose all or a part of your investment.
The market price of our common stock historically has been subject to significant fluctuations. These fluctuations could continue. It is possible that in future periods our results of operations may be below the expectations of public market analysts and investors. If this occurs, the market price of our securities may decline substantially. Any of the foregoing could have a material adverse effect on our business and particularly on our ability to raise capital.
Our quarterly operating results are volatile and may adversely affect the market price of our securities.
Our future revenues and operating results have varied in the past and may continue to vary significantly from quarter to quarter due to a number of factors, many of which are outside our control, and any of which could harm our business. As a result, we believe that quarterly comparisons of our operating results are not necessarily meaningful and that you should not rely on the results of one quarter as an indication of our future performance. In addition to the other risk factors described in this report, additional factors that have caused and/or could cause our quarterly operating results to fluctuate and in turn affect the market price of our securities include:
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• | increases in the cost of advertising and changes in our sales and marketing expenditures; |
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• | our inability to retain existing customers or encourage repeat purchases; |
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• | the extent to which our existing and future marketing campaigns are successful; |
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• | price competition that results in losses or lower profit margins; |
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• | the amount and timing of operating costs and capital expenditures relating to the expansion of our business operations and infrastructure including those relating to our construction of our new corporate headquarters; |
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• | the amount and timing of our purchases of inventory; |
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• | our inability to manage distribution operations or provide adequate levels of customer service; |
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• | increases in the cost of fuel and transportation; |
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• | our ability to successfully implement technology changes or to integrate operations and technologies from acquisitions or other business combinations; |
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• | our efforts to offer new lines of products and services; and |
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• | our ability to attract users to our shopping and other sites. |
Any of the foregoing could have a material adverse effect on our business.
Our operating results may fluctuate depending on the season, and such fluctuations may affect the market price of our securities.
We have experienced and expect to continue to experience fluctuations in our operating results because of seasonal fluctuations in traditional retail patterns. Sales in the retail and wholesale industry tend to be significantly higher in the fourth calendar quarter of each year than in the preceding three quarters due primarily to increased shopping activity during the holiday season. However, there can be no assurance that our sales in the fourth quarter will exceed those of the preceding quarters or, if the fourth quarter sales do exceed those of the preceding quarters, that we will be able to manage the increased sales effectively. Further, we generally increase our inventories substantially in anticipation of holiday season shopping activity, which has a negative effect on our cash flow. Securities analysts and investors may inaccurately estimate the effects of seasonality on our results of operations in one or more future quarters and, consequently, our operating results may fall below expectations, causing the market price of our securities to decline. Any of the foregoing could have a material adverse effect on our business.
Sales by our significant stockholders could have an adverse effect on the market price of our stock.
Several of our stockholders own significant portions of our common stock. If one or more of our stockholders were to sell all or a portion of their holdings of our common stock, the market price of our common stock could be negatively impacted. The effect of such sales, or of significant portions of our stock being offered or made available for sale, could result in strong downward pressure on our stock price. Investors should be aware that they could experience significant short-term volatility in our stock if any one or more of such stockholders were to decide to sell all or a portion of their holdings of our common stock at once or within a short period of time. In addition, the transfer of ownership of a significant portion of our outstanding shares within a three-year period could adversely affect our ability to use our net operating losses to offset future taxable net income. Any of the foregoing could have a material adverse effect on our business.
We do not intend to pay dividends on our common stock and you may lose the entire amount of your investment in our common stock.
We have never declared or paid any cash dividends on our common stock and do not intend to pay dividends on our common stock for the foreseeable future. We intend to invest our future earnings, if any, to fund our growth. Therefore, you will not receive any funds without selling your shares. We cannot assure that you will receive a positive return on your investment when you sell your shares or that you will not lose the entire amount of your investment.
Provisions in our amended and restated certificate of incorporation and bylaws and Delaware law might discourage, delay or prevent a change of control of our company or changes in our management.
Our amended and restated certificate of incorporation and bylaws contain provisions that could discourage, delay or prevent a change in control of our company or changes in our management that the stockholders of our company may deem advantageous. These provisions among other things:
| |
• | permit the board of directors to establish the number of directors; |
| |
• | provide that only one-third of our board of directors is elected at each of our annual meetings of stockholders (and our amended and restated certificate of incorporation prohibits cumulative voting in the election of directors); |
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• | mean that directors may be removed by the affirmative vote of the holders of the outstanding shares of common stock only “for cause;” |
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• | authorize the issuance of “blank check” preferred stock that our board could use to implement a stockholder rights plan (also known as a “poison pill”); |
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• | eliminate the ability of our stockholders to call special meetings of stockholders; |
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• | prohibit stockholder action by written consent, which requires all stockholder actions to be taken at a meeting of our stockholders; |
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• | provide that the board of directors is expressly authorized to make, alter or repeal our bylaws; |
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• | establish advance notice requirements, including specific requirements as to the timing, form and content of a stockholder’s notice, for nominations for election to our board or for proposing matters that can be acted upon by stockholders at annual stockholder meetings; |
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• | provide that special meetings of our stockholders may be called only by the board of directors, the chairman of the board, the chief executive officer or the president; and |
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• | provide that stockholders are permitted to amend the bylaws only with the approval of the holders of sixty-six and two-thirds percent (66-2/3%) of the voting power of outstanding capital stock entitled to vote at an election of directors. |
In addition, Section 203 of the Delaware General Corporation Law may discourage, delay or prevent a change in control of our company. In general, Section 203 prohibits a publicly held Delaware corporation from engaging in a “business combination” with an “interested stockholder” for a period of three years following the date the person became an interested stockholder, subject to certain exceptions.
We may issue preferred stock as authorized by our amended and restated certificate of incorporation without further stockholder approval for purposes unrelated to any stockholder rights plan, and any such preferred stock could entitle the holders to rights superior to those of the holders of our common stock .
Our amended and restated certificate of incorporation authorizes our Board to designate and issue preferred stock on such terms as may be approved by the Board without further stockholder approval. In addition to the possibility that the Board could do so in connection with the adoption of a stockholder rights plan as described above, the Board could do so for a variety of other purposes.
The price of our stock may be vulnerable to manipulation.
The practice of “abusive naked short selling” places our stock at risk for manipulative attacks by large investment pools and prime brokers. Abusive naked short selling is the practice by which short sellers place large short sell orders for shares without first borrowing the shares to be sold, or without having first adequately located such shares and arranged for a firm contract to borrow such shares prior to the delivery date set to close the sale. While selling broker dealers are by rule required to deliver shares to close a transaction by a certain date, and while purchasing broker-dealers are obligated by rule to purchase the sold quantity of shares when they are not delivered to close the sale, these rules are often ignored. Abusive naked short selling has a depressive effect on share prices when it is allowed to persist because the economic effect of abusive naked short selling is the oversupply of counterfeit stock to the market. We believe the regulations designed to address this abusive practice are both inadequately structured and inadequately enforced. Consequently, we believe that without the enactment of adequate regulations and the enforcement necessary to curb these abuses, the manipulations achieved through abusive naked short selling are likely to continue. We believe that our stock has been subject to these abusive practices by those attempting to manipulate its price downward. To the extent that our stock is subject to these practices in the future, our stock may be more volatile than it might otherwise be and/or may trade at prices below those that might prevail in the absence of such abuses.
In the past, our stock has consistently been on the Regulation SHO threshold list.
Regulation SHO requires the stock exchanges to publish daily a list of companies whose stock has failures-to-deliver above a certain threshold. It also requires mandatory close-outs for open fail-to-deliver positions in threshold securities persisting for over 13 days, with the aim that no security would appear on the threshold for any extended period. Despite that aim, our common stock has frequently appeared on the Regulation SHO threshold list for extended and continuous periods and, while we do not currently appear on the Regulation SHO threshold list, in the past our stock has been on the list for more trading days than any other company.
Any investment in our securities involves a high degree of risk. Investors should consider carefully the risks and uncertainties described above, and all other information in this Form 10-K and in any reports we file with the SEC after we file this Form 10-K, before deciding whether to purchase or hold our securities. Additional risks and uncertainties not currently known to us or that we currently deem immaterial may also become important factors that may harm our business. The occurrence of any of the risks described in this Form 10-K could harm our business. The trading price of our securities could decline due to any of these risks and uncertainties, and investors may lose part or all of their investment.
We generally have not received significant coverage by securities analysts, and the lack of coverage may adversely affect our share price and trading volume.
We generally have not received significant coverage by securities analysts, and the lack of coverage may adversely affect our share price and trading volume. The lack of coverage may cause our share price or trading volume to be lower than they might be if more analysts covered us.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
As of December 31, 2015, we operated the following facilities:
Corporate office space
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• | We lease approximately 150,000 square feet of office space in the United States for general corporate purposes. We are continuing the construction of our new corporate headquarters in Salt Lake City, Utah and we expect to complete and occupy our new headquarters in 2016. |
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• | We lease approximately 3,000 square feet of office space in Ireland. |
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• | We lease approximately 3,000 square feet of office space in China. |
Warehouse, fulfillment and customer service space
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• | We lease approximately 1.4 million of square feet in the United States for warehouse, fulfillment, customer service, and other operations. |
Data centers
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• | We lease approximately 9,000 square feet in the United States for various data centers. |
We use the above facilities in both our direct and partner business segments and we believe that these facilities will be sufficient for our needs for at least the next twelve months, subject to potential seasonal requirements for additional warehouse and customer service space during the fourth quarter.
ITEM 3. LEGAL PROCEEDINGS
The information set forth under Item 15 of Part IV, "Financial Statements—Note 12. Commitments and Contingencies, subheading Legal Proceedings," contained in the "Notes to Consolidated Financial Statements" of this Annual Report on Form 10-K is incorporated by reference in answer to this Item.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market information
Our common stock is traded on the Nasdaq Global Market under the symbol "OSTK." The following table sets forth, for the periods indicated, the high and low sales prices per share for our common stock as reported by Nasdaq.
|
| | | | | | |
| | Common Stock Price |
| | High | | Low |
Year Ended December 31, 2014 | | | | |
First Quarter | | 29.80 |
| | 18.57 |
|
Second Quarter | | 20.35 |
| | 14.69 |
|
Third Quarter | | 18.50 |
| | 13.96 |
|
Fourth Quarter | | 27.06 |
| | 15.35 |
|
Year Ended December 31, 2015 | | | | |
First Quarter | | 24.22 |
| | 21.33 |
|
Second Quarter | | 25.79 |
| | 20.68 |
|
Third Quarter | | 23.24 |
| | 17.16 |
|
Fourth Quarter | | 17.66 |
| | 12.04 |
|
Stock Performance Graph
The stock performance graph is included in Part III, Item 12.
Holders
As of February 26, 2016 there were 157 holders of record of our common stock. Many of our shares of common stock are held by brokers and other institutions on behalf of the beneficial owners.
Dividends
We have never declared or paid any cash dividends on our common stock. We currently intend to retain any earnings for future growth and do not anticipate paying any cash dividends in the foreseeable future. Any future determination to pay dividends will be at the discretion of our board of directors and will depend on our results of operations, financial conditions, contractual and legal restrictions and other factors the board of directors deems relevant.
Recent sales of unregistered securities
During 2015, we maintained a Non-Qualified Deferred Compensation plan for senior management. The plan allows eligible members of senior management to defer their receipt of compensation, subject to the restrictions contained in the plan. To the extent that interests in the plan constitute securities, we believe that any issuance of interests was exempt from the registration requirements of the Securities Act of 1933, as amended, pursuant to Section 4(a)(2) thereof and/or Rule 506 of Regulation D thereunder as a transaction not involving a public offering. Any interests issued were not sold for cash or other consideration, and there were no proceeds to us.
Issuer purchases of equity securities
We had no purchases made by us or on our behalf or any "affiliated purchaser" as defined in Rule 10b-18(a)(3) under the Securities Exchange Act of 1934, as amended, of shares of our common stock during the fourth quarter of 2015.
Stock based compensation
Stock options
Our board of directors adopted the 2005 Equity Incentive Plan in April 2005, and it was most recently amended and restated and re-approved by the stockholders on May 3, 2012 (as so amended and restated, the "Plan"). Under the Plan, the board of directors may issue non-qualified and incentive stock options to our employees and directors and non-qualified stock options to our consultants, as well as restricted stock units and other types of equity awards. Options granted under the Plan generally expire at the end of ten years and vest in accordance with a vesting schedule determined by our board of directors, usually over four years from the grant date. At December 31, 2015, 2.5 million shares of stock remained available for future grants under the Plan.
The following is a summary of stock option activity (amounts in thousands, except per share data):
|
| | | | | | | | | | | | | | | | | | | | | |
| | 2015 | | 2014 | | 2013 |
| | Shares | | Weighted Average Exercise Price | | Shares | | Weighted Average Exercise Price | | Shares | | Weighted Average Exercise Price |
Outstanding—beginning of year | | 224 |
| | $ | 17.27 |
| | 273 |
| | $ | 17.30 |
| | 364 |
| | $ | 17.34 |
|
Exercised | | (16 | ) | | 16.94 |
| | (30 | ) | | 17.08 |
| | (89 | ) | | 17.45 |
|
Expired/Forfeited | | (4 | ) | | 18.26 |
| | (19 | ) | | 18.00 |
| | (2 | ) | | 17.08 |
|
Outstanding—end of year | | 204 |
| | $ | 17.27 |
| | 224 |
| | $ | 17.27 |
| | 273 |
| | $ | 17.30 |
|
Options exercisable at year-end | | 204 |
| | $ | 17.27 |
| | 224 |
| | $ | 17.27 |
| | 273 |
| | $ | 17.30 |
|
Stock options vest over four years at 28% at the end of the first year and 2% each month thereafter. The most recent stock options were granted in May 2008 and have fully vested. There was no stock based compensation related to stock options recorded during the years ended December 31, 2015, 2014 and 2013.
Restricted stock units activity
During the years ended December 31, 2015, 2014 and 2013, we granted 239,000, 242,000 and 275,000 restricted stock units, respectively, under the Plan. The cost of restricted stock units is determined using the fair value of our common stock on the date of the grant and compensation expense is either recognized on a straight line basis over the vesting schedule or on an accelerated schedule when vesting of restricted stock awards exceeds a straight line basis. The weighted average grant date fair value of restricted stock units granted during the years ended December 31, 2015, 2014 and 2013 was $24.60, $28.24 and $16.12, respectively.
The following is a summary of restricted stock unit activity (amounts in thousands, except per share data):
|
| | | | | | | | | | | | | | | | | | | | | |
| | 2015 | | 2014 | | 2013 |
| | Units | | Weighted Average Grant Date Fair Value | | Units | | Weighted Average Grant Date Fair Value | | Units | | Weighted Average Grant Date Fair Value |
Outstanding—beginning of year | | 578 |
| | $ | 16.70 |
| | 704 |
| | $ | 10.79 |
| | 1,003 |
| | $ | 8.81 |
|
Granted at fair value | | 239 |
| | 24.60 |
| | 242 |
| | 28.24 |
| | 275 |
| | 16.12 |
|
Vested | | (377 | ) | | 12.34 |
| | (301 | ) | | 11.87 |
| | (339 | ) | | 10.23 |
|
Forfeited | | (91 | ) | | 24.35 |
| | (67 | ) | | 17.70 |
| | (235 | ) | | 9.38 |
|
Outstanding—end of year | | 349 |
| | $ | 24.80 |
| | 578 |
| | $ | 16.70 |
| | 704 |
| | $ | 10.79 |
|
Restricted stock units granted in 2015 and 2014 vest over three years at 33.3% at the end of each of the first, second and third year. Restricted stock units granted in 2013 vest over three years at 40% at the end of the first year, 30% at the end of the second year and 30% at the end of the third year. Each restricted stock unit represents the right to one share of common stock upon vesting. During the years ended December 31, 2015, 2014 and 2013, we recorded stock based compensation related to restricted stock units of $3.5 million, $4.0 million and $3.3 million, respectively.
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial data presented below should be read in conjunction with the consolidated financial statements of Overstock.com, Inc. and related footnotes included elsewhere in this Annual Report on Form 10-K and the discussion under Item 7—"Management's Discussion and Analysis of Financial Condition and Results of Operations." The selected consolidated financial data has been derived from our audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K. The historical financial and operating information may not be indicative of our future performance.
|
| | | | | | | | | | | | | | | | | | | | |
| | Year ended December 31, |
| | 2015 | | 2014 | | 2013 (1) | | 2012 | | 2011 |
| | (in thousands, except per share data) |
Consolidated Statement of Operations Data: | | | | | | | | | | |
Revenue, net | | | | | | | | | | |
Direct | | $ | 137,783 |
| | $ | 147,460 |
| | $ | 156,032 |
| | $ | 155,516 |
| | $ | 163,609 |
|
Partner and other | | 1,520,055 |
| | 1,349,643 |
| | 1,148,185 |
| | 943,773 |
| | 890,668 |
|
Total net revenue | | 1,657,838 |
| | 1,497,103 |
| | 1,304,217 |
| | 1,099,289 |
| | 1,054,277 |
|
Cost of goods sold | | | | | | | | | | |
Direct | | 128,077 |
| | 129,253 |
| | 136,282 |
| | 140,536 |
| | 149,660 |
|
Partner and other | | 1,225,107 |
| | 1,088,791 |
| | 920,275 |
| | 760,323 |
| | 725,529 |
|
Total cost of goods sold | | 1,353,184 |
| | 1,218,044 |
| | 1,056,557 |
| | 900,859 |
| | 875,189 |
|
Gross profit | | 304,654 |
| | 279,059 |
| | 247,660 |
| | 198,430 |
| | 179,088 |
|
Operating expenses: | | | | | | | | | | |
Sales and marketing | | 124,468 |
| | 109,461 |
| | 91,609 |
| | 63,467 |
| | 61,813 |
|
Technology | | 98,533 |
| | 86,258 |
| | 71,788 |
| | 65,467 |
| | 67,043 |
|
General and administrative | | 82,187 |
| | 71,777 |
| | 68,169 |
| | 57,259 |
| | 67,766 |
|
Restructuring (2) | | — |
| | (360 | ) | | (471 | ) | | 76 |
| | — |
|
Total operating expenses | | 305,188 |
| | 267,136 |
| | 231,095 |
| | 186,269 |
| | 196,622 |
|
Operating income (loss) | | (534 | ) | | 11,923 |
| | 16,565 |
| | 12,161 |
| | (17,534 | ) |
Interest income | | 155 |
| | 152 |
| | 127 |
| | 116 |
| | 161 |
|
Interest expense | | (140 | ) | | (39 | ) | | (113 | ) | | (809 | ) | | (2,485 | ) |
Other income (expense), net | | 3,634 |
| | 1,169 |
| | (235 | ) | | 3,686 |
| | 278 |
|
Income (loss) before income taxes | | 3,115 |
| | 13,205 |
| | 16,344 |
| | 15,154 |
| | (19,580 | ) |
Provision (benefit) for income taxes | | 1,895 |
| | 4,404 |
| | (68,034 | ) | | 485 |
| | (142 | ) |
Consolidated net income (loss) | | $ | 1,220 |
| | $ | 8,801 |
| | $ | 84,378 |
| | $ | 14,669 |
| | $ | (19,438 | ) |
Less: Net loss attributable to noncontrolling interests | | (1,226 | ) | | (53 | ) | | — |
| | — |
| | — |
|
Less: Deemed dividend related to redeemable common stock | | — |
| | — |
| | — |
| | — |
| | 12 |
|
Net income (loss) attributable to stockholders of Overstock.com, Inc. | | $ | 2,446 |
| | $ | 8,854 |
| | $ | 84,378 |
| | $ | 14,669 |
| | $ | (19,450 | ) |
Net income (loss) per common share—basic: | | | | | | | | | | |
Net income (loss) attributable to common shares—basic | | $ | 0.10 |
| | $ | 0.37 |
| | $ | 3.56 |
| | $ | 0.63 |
| | $ | (0.84 | ) |
Weighted average common shares outstanding—basic | | 24,612 |
| | 23,999 |
| | 23,714 |
| | 23,387 |
| | 23,259 |
|
Net income (loss) per common share—diluted: | | | | | | | | | | |
Net income (loss) attributable to common shares—diluted | | $ | 0.10 |
| | $ | 0.36 |
| | $ | 3.47 |
| | $ | 0.62 |
| | $ | (0.84 | ) |
Weighted average common shares outstanding—diluted | | 24,703 |
| | 24,317 |
| | 24,294 |
| | 23,672 |
| | 23,259 |
|
See the footnotes beneath the balance sheet data on the following page.
|
| | | | | | | | | | | | | | | | | | | | |
| | As of December 31, |
| | 2015 | | 2014 | | 2013 (1) | | 2012 | | 2011 |
| | (in thousands) |
Balance Sheet Data: | | | | | | | | | | |
Cash and cash equivalents | | $ | 170,262 |
| | $ | 181,641 |
| | $ | 148,665 |
| | $ | 93,547 |
| | $ | 96,985 |
|
Restricted cash | | 430 |
| | 580 |
| | 1,580 |
| | 1,905 |
| | 2,036 |
|
Working capital | | (10,308 | ) | | 15,260 |
| | 25,425 |
| | 7,497 |
| | (14,129 | ) |
Total assets | | 429,129 |
| | 376,865 |
| | 315,636 |
| | 181,985 |
| | 179,559 |
|
Total indebtedness | | 22,056 |
| | 4,843 |
| | 3,155 |
| | 1,848 |
| | 18,619 |
|
Stockholders' equity | | 149,361 |
| | 129,220 |
| | 118,760 |
| | 30,962 |
| | 13,237 |
|
(1) Our consolidated financial statements for the year ended December 31, 2013 include an immaterial revision to current and long-term deferred tax assets and our provision (benefit) for income taxes in the fourth quarter of 2013. The effect of the revision was to reduce current and long-term deferred tax assets by $284,000 and $3.8 million, respectively, with an offsetting increase of $4.1 million to our provision (benefit) for income taxes in 2013. We evaluated these changes in accordance with Staff Accounting Bulletin No. 99, Materiality ("SAB 99"), and Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements ("SAB 108"), and determined that the revisions are not material to the prior period.
(2) During the fourth quarter of 2006, we commenced implementation of a facilities consolidation and restructuring program designed to reduce the overall expense structure in an effort to improve future operating performance. There was no restructuring liability at December 31, 2015 or 2014.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis contains forward-looking statement relating to future events or our future financial or operating performance that involve risks and uncertainties, as set forth above under "Special Cautionary Note Regarding Forward-Looking Statements." Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors described in this Annual Report on Form 10-K, including those set forth above under "Special Cautionary Note Regarding Forward-Looking Statements" or in Item 1A under the heading "Risk Factors" or elsewhere in this Annual Report on Form 10-K.
Introduction
We are an online retailer offering a broad range of price-competitive brand name, non-brand name and closeout products, including furniture, home decor, bedding and bath, housewares, jewelry and watches, apparel and designer accessories, health and beauty products, electronics and computers, and sporting goods, among other products. We also sell hundreds of thousands of best seller and current run books, magazines, CDs, DVDs and video games (“BMMG”). We sell these products and services through our Internet websites located at www.overstock.com, www.o.co and www.o.biz (referred to collectively as the “Website”). Although our three websites are located at different domain addresses, the technology and equipment and processes supporting the Website and the process of order fulfillment described herein are the same for all three websites.
Our company, based in Salt Lake City, Utah, was founded in 1997. We launched our initial website in March 1999 and were re-incorporated in Delaware in 2002. As used herein, “Overstock,” “Overstock.com,”, “O.co,” “we,” “our” and similar terms include Overstock.com, Inc. and its subsidiaries, unless the context indicates otherwise.
Our Business
We deal primarily in price-competitive, new, replenishable and closeout merchandise and use the Internet to aggregate both supply and demand to create an efficient marketplace for selling these products. We provide our customers an opportunity to conveniently shop for a broad range of price-competitive products. We continually add new, and sometimes limited, inventory to our Website in order to create an atmosphere that encourages customers to visit frequently and purchase products before our inventory sells out. We provide suppliers with access to a large customer base and convenient services for order fulfillment, customer service, returns handling, and other services. The merchandise offered on our Website is from a variety of sources including well-known, brand-name manufacturers. We have organized our shopping business (sales of product offered through the Shopping Section of our Website) into two principal segments-a "direct" business and a "partner" business. We currently offer approximately 877,000 non-BMMG products and approximately 1.1 million BMMG products. Consumers and businesses are able to access and purchase our products 24 hours a day from the convenience of a computer, Internet-enabled mobile telephone or other Internet-enabled device. Our team of customer service representatives assists customers by telephone, instant online chat and e-mail. We also derive revenue from other businesses advertising products or services on our Website. Our sales are primarily to customers located in the United States. During the years ended December 31, 2015, 2014 and 2013 no single customer accounted for more than 1% of our total net revenue.
Direct business
Our direct business includes sales made to individual consumers and businesses from our owned inventory and that are fulfilled primarily from our warehouse in Salt Lake City, Utah. During the year ended December 31, 2015, we fulfilled approximately 8% of our order volume through our warehouse, which generally ships between 2,000 and 5,000 packages per day and up to approximately 16,000 orders per day during peak periods, using overlapping daily shifts.
Partner business
For our partner business, we sell merchandise from manufacturers, distributors and other suppliers ("partners") primarily through our Website. We are considered to be the primary obligor for the majority of these sales transactions and we record revenue from the majority of these sales transactions on a gross basis. Our use of the term "partner" does not mean that we have formed any legal partnerships with any of our partners. We currently have relationships with approximately 3,700 third parties who supply approximately 870,000 non-BMMG products, as well as most of the BMMG products, on our Website. These third party partners generally perform the same fulfillment operations as our warehouses, such as order picking and shipping; however, we handle returns and customer service related to substantially all orders placed through our Website. Revenue generated from sales on our Shopping site from both the direct and partner businesses is recorded net of returns, coupons and other discounts.
Both direct and partner revenues are seasonal, with revenues historically being the highest in the fourth quarter, which ends December 31, reflecting higher consumer holiday spending. We anticipate this will continue in the foreseeable future.
Generally, we require verification of receipt of payment, or authorization from credit card or other payment vendors whose services we offer to our customers (such as PayPal and BillMeLater), before we ship products to consumers or business purchasers. From time to time we grant credit to our business purchasers with normal credit terms (typically 30 days). For sales in our partner business, we generally receive payments from our customers before our payments to our suppliers are due.
Other offerings
We offer additional products or services that complement our primary offerings, but are not significant to our revenues. These include:
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• | Medici, doing business as tØ.com, through which we have developed various fintech and crypto software products and intellectual property, including proprietary blockchain software; |
| |
• | Worldstock Fair Trade, a store within our Website that offers handcrafted products made by artisans all over the world to help improve the lives of people in emerging economies; |
| |
• | Main Street Revolution, a store within our Website that features products from small businesses across the United States who offer their products using our national marketing and distribution channels; |
| |
• | Supplier Oasis, a single integration point through which our partners can manage their products, inventory and sales channels, while tapping into our distribution network; |
| |
• | ecommerce marketplace channels, where some of our products are offered for sale in on-line marketplaces of other Internet retailers' websites; |
| |
• | our international business where we offer products to customers outside the United States using U.S.-based third party logistics providers; |
| |
• | Pet Adoptions, a free service and tab within our Website that leverages our technology to display pets available for adoption from shelters across the United States; |
| |
• | Farmers Market, a tab within our Website where our customers can order locally grown fresh produce and other food products; |
| |
• | Insurance, a tab within our Website where our customers can shop for insurance from major carriers for both personal and business insurance policies; and |
| |
• | an online car listing service which allows sellers to list vehicles for sale and allows buyers to review vehicle descriptions and post offers to purchase, and provides the means for prospective purchasers to contact sellers for further information and negotiations on the purchase of an advertised vehicle. |
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with U.S. generally accepted accounting principles ("GAAP") requires estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities in the consolidated financial statements and accompanying notes. The Securities and Exchange Commission ("SEC") has defined a company's critical accounting policies as the ones that are most important to the portrayal of the company's financial condition and results of operations, and which require the company to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Based on this definition, we have identified the critical accounting policies, estimates and judgments addressed below. We also have other key accounting policies, which involve the use of estimates, judgments, and assumptions that are significant to understanding our results. For additional information, see Item 15 of Part IV, "Financial Statements"—Note 2. Accounting Policies. Although we believe that our estimates, assumptions, and judgments are reasonable, they are based upon information presently available. Actual results may differ significantly from these estimates. Our critical accounting policies are as follows:
| |
• | estimating valuation allowances and accrued liabilities (specifically, the allowances for returns and obsolete and damaged inventory); |
| |
• | internal use software and website development (acquired and developed internally); |
| |
• | accounting for income taxes; |
| |
• | the valuation and impairment evaluation of long-lived assets including goodwill and intangible assets other than goodwill; and |
Revenue recognition
We derive our revenue primarily from direct revenue and partner revenue from merchandise sales. We also earn revenue from advertising on our shopping and other pages. We have organized our operations into two principal segments based on the primary source of revenue: direct revenue and partner revenue (see Item 15 of Part IV, "Financial Statements"—Note 20. Business Segments).
Revenue is recognized when the following revenue recognition criteria are met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or the service has been provided; (3) the selling price or fee revenue earned is fixed or determinable; and (4) collection of the resulting receivable is reasonably assured. Revenue related to merchandise sales is recognized upon delivery to our customers. As we ship high volumes of packages through multiple carriers, it is not practical for us to track the actual delivery date of each shipment. Therefore, we use estimates to determine which shipments are delivered and, therefore, recognized as revenue at the end of the period. Our delivery date estimates are based on average shipping transit times, which are calculated using the following factors: (i) the type of shipping carrier (as carriers have different in-transit times); (ii) the fulfillment source (either our warehouses or those of our partners); (iii) the delivery destination; and (iv) actual transit time experience, which shows that delivery date is typically one to eight business days from the date of shipment. We review and update our estimates on a quarterly basis based on our actual transit time experience. However, actual shipping times may differ from our estimates.
Based upon our historical experience, revenue typically increases during the fourth quarter because of the holiday retail season.
The following table shows the effect that hypothetical changes in the estimate of average shipping transit times would have had on the reported amount of revenue and income before taxes for the year ended December 31, 2015 (in thousands):
|
| | | | | | | | |
| | Year Ended December 31, 2015 |
Change in the Estimate of Average Transit Times (Days) | | Increase (Decrease) Revenue | | Increase (Decrease) Income Before Tax |
2 | | $ | (6,892 | ) | | $ | (905 | ) |
1 | | $ | (2,282 | ) | | $ | (307 | ) |
As reported | | As reported |
| | As reported |
|
(1) | | $ | 8,917 |
| | $ | 1,117 |
|
(2) | | $ | 15,397 |
| | $ | 1,952 |
|
When we are the primary obligor in a transaction, are subject to inventory risk, have latitude in establishing prices and selecting suppliers, or have several but not all of these indicators, revenue is recorded gross. If we are not the primary obligor in the transaction and amounts earned are determined using a fixed percentage, revenue is recorded on a net basis. Currently, the majority of both direct revenue and partner revenue is recorded on a gross basis, as we are the primary obligor. In our statements of operations, we present revenue net of sales taxes.
We periodically provide incentive offers to our customers to encourage purchases. Such offers include current discount offers, such as percentage discounts off current purchases and other similar offers, which, when used by our customers, are treated as a reduction of revenue.
Deferred revenue
Customer orders are recorded as deferred revenue prior to delivery of products or services ordered. We record amounts received for Club O Gold membership fees as deferred revenue and we recognize it ratably over the membership period. We record Club O Reward dollars earned from purchases as deferred revenue at the time they are earned and we recognize it as revenue upon redemption. If reward dollars are not redeemed, we recognize other income upon expiration. In addition, we sell gift cards and record related deferred revenue at the time of the sale. We sell gift cards without expiration dates and we recognize revenue from a gift card upon redemption of the gift card. If a gift card is not redeemed, we recognize other income when the likelihood of its redemption becomes remote based on our historical redemption experience. We consider the likelihood of redemption to be remote after 36 months.
We periodically enter into agreements with other parties to jointly market ancillary products or services on our website. As a result of those agreements, we sometimes receive payments in advance of performing our obligations under those agreements. Such payments received before we perform our obligations are initially recorded as deferred revenue and then recognized over our service period.
Sales returns allowance
We inspect returned items when they arrive at our processing facility. We refund the full cost of the merchandise returned and all original shipping charges if the returned item is defective or we or our partners have made an error, such as shipping the wrong product.
If the return is not a result of a product defect or a fulfillment error and the customer initiates a return of an unopened item within 30 days of delivery, for most products we refund the full cost of the merchandise minus the original shipping charge and actual return shipping fees. However, we reduce refunds for returns initiated more than 30 days after delivery or that are received at our returns processing facility more than 45 days after initial delivery.
If our customer returns an item that has been opened or shows signs of wear, we issue a partial refund minus the original shipping charge and actual return shipping fees.
Revenue is recorded net of estimated returns. We record an allowance for returns based on current period revenues and historical returns experience. We analyze actual historical returns, current economic trends and changes in order volume and acceptance of our products when evaluating the adequacy of the sales returns allowance in any accounting period.
The allowance for returns was $17.9 million and $15.5 million at December 31, 2015 and 2014, respectively.
Valuation of inventories
Inventories, consisting of merchandise purchased for resale, are accounted for using a standard costing system which approximates the first-in-first-out (“FIFO”) method of accounting, and are valued at the lower of cost or market. We write down our inventory for estimated obsolescence and to the lower of cost or market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required. Once established, the original cost of the inventory less the related inventory allowance represents the new cost basis of such products. Reversal of the allowance is recognized only when the related inventory has been sold or scrapped.
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 our business. We capitalize costs incurred during the application development stage of internal-use software and amortize these costs over the estimated useful life of two to three years. Costs incurred related to design or maintenance of internal-use software are expensed as incurred.
Accounting for income taxes
We are subject to taxation from federal, state and international jurisdictions. A significant amount of judgment is involved in preparing our provision for income taxes and the calculation of resulting deferred tax assets and liabilities.
We account for income taxes in accordance with ASC Topic 740, Income Taxes (“ASC 740”), which requires the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between tax and financial reporting. Deferred tax assets and liabilities are measured using the currently enacted tax rates that apply to taxable income in effect for the years in which those tax assets are expected to be realized or settled. We use the with-and-without approach for determining the period in which tax benefits for excess share-based deductions are recognized.
We assess the available positive and negative evidence to estimate whether we will generate sufficient future taxable income to use our existing deferred tax assets. We have concluded based on all available evidence that it is more likely than not that our deferred tax assets as of December 31, 2015 arising from ordinary income and deductions and tax credits will be realized in the future, with the exception of current year operating losses generated by separate tax-filing subsidiaries in domestic and foreign jurisdictions and foreign deferred tax assets recorded as part of an acquisition. We have also concluded
that it is unlikely that our deferred tax asset arising from unrealized capital losses will be realized in the future. Therefore, it is appropriate to record a valuation allowance related to the deferred tax assets for net operating losses generated in domestic and foreign separate filing jurisdictions, unrealized capital losses, and foreign deferred tax assets recorded as part of an acquisition. In reaching these conclusions we considered, among other things, our recent financial and operating results (three years of cumulative income and revenue growth during those periods), along with our forecasted growth rates, projected future taxable income, including the impact of any costs associated with our recent acquisition, and tax planning strategies. We perform multiple sensitivity analyses to address how potential changes in significant assumptions would impact our ability to generate the minimum amount of taxable income required. We give the most weight to objective evidence related to our more recent financial results. Based upon the level of historical taxable income and projections for future taxable income, including the impact of any acquisition costs, and planned tax strategies over the periods in which the deferred tax assets are deductible, we believe it is more likely than not that we will realize the benefits of these deduction differences, net of existing valuation allowances. However, it is possible that certain state tax credits could ultimately expire unused if estimates of future apportioned taxable income during the carryforward period are reduced. We will continue to monitor the need for a valuation allowance against our federal and state deferred tax assets on a quarterly basis.
ASC 740 clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements in accordance with GAAP. ASC 740 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This statement also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, and disclosure.
The calculation of our tax liabilities is subject to legal and factual interpretation, judgment, and uncertainty in a multitude of jurisdictions. This includes addressing uncertainties in the application of complex tax regulations. We recognize liabilities for uncertain tax positions in the U.S. and other tax jurisdictions based on recognition and measurement criteria prescribed by ASC 740. The liabilities are periodically reviewed for their adequacy and appropriateness. Changes to our assumptions could cause us to find a revision of estimates appropriate. Such a change in measurement would result in the recognition of a tax benefit or an additional charge to the tax provision.
Tax laws and regulations themselves are subject to change as a result of changes in fiscal policy, changes in legislation, the evolution of regulations, and court rulings. We recognize potential liabilities for anticipated tax audit issues in the U.S. and other tax jurisdictions based on our estimate of whether, and the extent to which, additional taxes and interest will be due. We record an amount as an estimate of probable additional income tax liability at the largest amount that we determine is more likely than not, based upon the technical merits of the position, to be sustained upon audit by the relevant tax authority.
As of December 31, 2015, we were under audit by the Internal Revenue Service for our 2013 federal income tax return. The IRS has not indicated or communicated any deficiencies. We expect the audit to conclude in 2016. Tax periods within the statutory period of limitations not previously audited are potentially open for examination by the tax authorities. Potential liabilities associated with these years will be resolved when an event occurs to warrant closure, primarily through the completion of audits by the tax jurisdictions and/or the expiration of the statutes of limitation. To the extent audits or other events result in a material adjustment to the accrued estimates, the effect would be recognized during the period of the event. We believe that an appropriate estimated liability has been established for potential exposures.
Our uncertain tax positions related to state income taxes represent a cash settlement contingency and are recorded as a liability in our consolidated balance sheets. To the extent interest and penalties would be assessed by taxing authorities on any underpayment of income taxes, such amounts are accrued and classified as a component of income tax expense on our consolidated statement of operations and comprehensive income (loss). Realization of the unrecognized tax benefits results in a favorable impact to the effective tax rate.
Valuation of goodwill
Goodwill represents the excess of the purchase price paid over the fair value of the net assets acquired in business combinations.
Goodwill is not amortized but is tested for impairment at least annually. When evaluating whether goodwill is impaired, we make a qualitative assessment to determine if it is more likely than not that its fair value is less than its carrying amount. If the qualitative assessment determines that it is more likely than not that its fair value is less than its carrying amount, we compare the fair value of the reporting unit to which the goodwill is assigned to its carrying amount. If the carrying amount exceeds its fair value, then the amount of the impairment loss must be measured. The impairment loss, if any, is calculated by comparing the implied fair value of the goodwill to its carrying amount. In calculating the implied fair value of goodwill, the
fair value of the reporting unit is allocated to the other assets and liabilities within the reporting unit based on estimated fair value. The excess of the fair value of a reporting unit over the amount allocated to its other assets and liabilities is the implied fair value of goodwill. An impairment loss is recognized when the carrying amount of goodwill exceeds its implied fair value.
In accordance with this guidance, we test for impairment of goodwill in the fourth quarter or when we deem that a triggering event has occurred. Goodwill totaled $15.4 million and $2.8 million at December 31, 2015 and 2014. There were no impairments to goodwill recorded during the years ended December 31, 2015, 2014 and 2013.
Intangible assets other than goodwill
We capitalize and amortize intangible assets other than goodwill over their estimated useful lives unless such lives are indefinite. Intangible assets other than goodwill acquired separately from third-parties are capitalized at cost while such assets acquired as part of a business combination are capitalized at their acquisition-date fair value. Intangible assets other than goodwill are amortized using the straight line method of amortization over their useful lives, with the exception of certain intangibles (such as acquired technology, customer relationships, and trade names) which are amortized using an accelerated method of amortization based on cash flows. These assets are reviewed for impairment whenever events or changes in circumstances indicate that their carrying amount may not be recoverable as described below under Impairment of long-lived assets.
During the year ended December 31, 2015, we acquired $15.8 million of intangible assets other than goodwill related to an asset acquisition. Aggregate amortization expense for intangible assets other than goodwill was $1.6 million for the year ended December 31, 2015. Amortization expense for intangible assets other than goodwill was not significant for the years ended December 31, 2014 and 2013.
Intangible assets consist of the following (in thousands):
|
| | | | | | | |
| December 31, |
| 2015 | | 2014 |
Acquired intangible assets | $ | 15,776 |
| | $ | — |
|
Intangible assets, other | 1,355 |
| | 1,130 |
|
| 17,131 |
| | 1,130 |
|
Less: accumulated amortization of intangible assets | (2,475 | ) | | (895 | ) |
Total intangible assets, net | $ | 14,656 |
| | $ | 235 |
|
Impairment of long-lived assets
We review property and equipment and other long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset group may not be recoverable. Recoverability is measured by comparison of the assets’ carrying amount to future undiscounted net cash flows the asset group is expected to generate. Cash flow forecasts are based on trends of historical performance and management’s estimate of future performance, giving consideration to existing and anticipated competitive and economic conditions. If such asset group is considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds their fair values. There were no impairments to long-lived assets recorded during the years ended December 31, 2015, 2014 and 2013.
Loss contingencies
In the normal course of business, we are involved in legal proceedings and other potential loss contingencies. We accrue a liability for such matters when it is probable that a loss has been incurred and the amount can be reasonably estimated. When only a range of probable loss can be estimated, the most probable amount in the range is accrued. If no amount within this range is a better estimate than any other amount within the range, the minimum amount in the range is accrued. We expense legal fees as incurred (see Item 15 of Part IV, "Financial Statements"—Note 12. Commitments and Contingencies).
Recently issued accounting standards
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. In July 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, which
deferred the effective date for us to January 1, 2018. Early adoption is permitted, but not before the original effective date. The standard permits the use of either the retrospective or cumulative effect transition method. There have also been other Proposed Accounting Standards Updates which may further modify ASU 2014-09. We are evaluating the effect that ASU 2014-09 will have on our consolidated financial statements and related disclosures. We have not yet selected a transition method nor have we determined the effect of the standard on our ongoing financial reporting.
In April 2015, the FASB issued ASU No. 2015-03, Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs, which requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The new standard becomes effective for us on January 1, 2016. Early adoption is permitted. The standard requires entities to apply this change on a retrospective basis for the periods presented. The adoption of this standard will cause us to reclassify certain debt issuance costs currently classified in other assets to a direct reduction of the related debt liability.
In July 2015, the FASB issued ASU No. 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory, which requires inventory to be measured at the lower of cost and net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The new standard becomes effective for us on January 1, 2017. Early adoption is permitted. The standard requires entities to apply this change prospectively to the measurement of inventory after the date of adoption. We do not intend to adopt the standard before the effective date. We are evaluating the effect that ASU 2015-11 will have on our consolidated financial statements and related disclosures.
In August 2015, the FASB issued ASU No. 2015-15, Interest-Imputation of Interest (Subtopic 835-30): Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements-Amendments to SEC Paragraphs Pursuant to Staff Announcement at June 18, 2015 EITF Meeting (SEC Update), which states that the SEC staff would not object to an entity deferring and presenting debt issuance costs as an asset and subsequently amortizing the deferred debt issuance costs ratably over the term of the line-of-credit arrangement. The new standard becomes effective for us on January 1, 2016. We do not expect that ASU 2015-15 will have a material impact on our consolidated financial statements or related disclosures.
In September 2015, the FASB issued ASU No. 2015-16, Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments, which requires an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined and eliminates the requirement to retrospectively account for those adjustments. The new standard becomes effective for us on January 1, 2016. Early adoption is permitted. The standard requires entities to apply this change prospectively to adjustments to provisional amounts that occur after the effective date of this update. We do not expect that ASU 2015-16 will have a material impact on our consolidated financial statements and related disclosures.
In November 2015, the FASB issued ASU No. 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes, which requires that deferred tax assets and liabilities be classified as noncurrent in a classified balance sheet. The new standard becomes effective for us on January 1, 2017. Early adoption is permitted. The standard requires entities to apply this change on either a prospective or retrospective basis for the periods presented. We do not intend to adopt the standard before the effective date. We have not yet selected a transition method. The adoption of this standard will cause us to reclassify our current deferred tax assets to long-term deferred tax assets in our consolidated financial statements.
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which, among other things, requires lessees to recognize most leases on their balance sheets related to the rights and obligations created by those leases. The new standard also requires new disclosures to help financial statement users better understand the amount, timing, and uncertainty of cash flows arising from leases. The new standard becomes effective for us on January 1, 2019. Early adoption is permitted. The amendments in this update should be applied under a modified retrospective approach. We are evaluating the effect that ASU 2016-02 will have on our consolidated financial statements and related disclosures.
Comparison of Years Ended December 31, 2015 and 2014
Executive Commentary
This executive commentary is intended to provide investors with a view of our business through the eyes of our management. As an executive commentary, it necessarily focuses on selected aspects of our business. This executive
commentary is intended as a supplement to, but not a substitute for, the more detailed discussion of our business included elsewhere herein. Investors are cautioned to read our entire “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” as well as our interim and audited financial statements, and the discussion of our business and risk factors and other information included elsewhere or incorporated in this report. This executive commentary includes forward-looking statements, and investors are cautioned to read “Special Cautionary Note Regarding Forward-Looking Statements.”
Revenues in 2015 increased 11% compared to 2014. The growth in revenue was primarily due to an 8% increase in orders, coupled with a 4% increase in average order size, from $169 to $175. Although our average order size has increased in recent years, we expect the rate of increase to lessen as our sales mix shift into home and garden products becomes fully realized. In addition, the percentage of revenue we defer from orders taken but not delivered was less due to the timing of year end. These increases were partially offset by increased promotional activities including coupons, site sales, and Club O Rewards (which we recognize as a reduction of revenue) due to our driving a higher proportion of our sales using such promotions, and by an increase in returns.
During the second half of 2015, we experienced some slowing of our overall revenue growth which we believe was due in part to changes that Google made in its natural search engine algorithms, to which we are responding. While we worked to adapt to Google’s changes, we increased our emphasis on other marketing channels, such as sponsored search and display ad marketing, which generated revenue growth but with higher associated marketing expenses than natural search.
In 2015, we transitioned a significant number of customers into our Club O Silver program and began to shift coupon offers into Club O rewards. We believe that the shift from coupons to rewards will benefit us in the long-term, but we have experienced some difficulties with the transition, and in the short-term we believe it slowed our revenue growth as customers take time to become accustomed to this change. We are continuing to test and refine our approach in this transition.
Gross profit in 2015 increased 9% compared to 2014 primarily as a result of revenue growth. Gross margin decreased to 18.4% in 2015 compared to 18.6% in 2014. The decrease in gross margin was primarily due to increased promotional activities including coupons, site sales, and Club O Rewards (which we recognize as a reduction of revenue) due to our driving a higher proportion of our sales using such promotions, partially offset by a continued shift in sales mix into higher margin home and garden products.
Sales and marketing expenses as a percentage of revenue increased from 7.3% to 7.5% during 2015 as compared to 2014, primarily due to increased spending in the display ad and brand marketing channels.
As a result of these factors, we had a 8.2% increase in Contribution in 2015 compared to 2014 (see Non-GAAP Financial Measures below for a reconciliation of Contribution to Gross Profit). Contribution margin was 11.2% in 2015 and 11.5% in 2014. In 2015, we changed our calculation of contribution and contribution margin to include Club O Rewards and gift card breakage as described below in Non-GAAP Financial Measures. To improve the comparability between periods, the amounts disclosed for prior years reflect this change.
Technology expenses in 2015 increased $12.3 million compared to 2014, primarily due to an increase in depreciation of $6.1 million and an increase in staff-related costs of $4.9 million.
General and administrative expense in 2015 increased $10.4 million compared to 2014, primarily due to an increase of $5.9 million in staff and travel related costs, an increase in management consulting services of $2.9 million, a $1.0 million expense for a contract termination fee, and an increase in depreciation and amortization of $932,000 (including amortization of intangible assets related to our recent acquisition).
In January 2016, we entered into a settlement agreement in our long-standing prime broker litigation. The defendants agreed to pay us and our co-plaintiffs $20 million, which will conclude the litigation in its entirety. We will recognize the settlement in Q1 2016.
In Q3 2015, our majority-owned subsidiary Medici (dba tØ.com) entered into agreements to acquire the assets and business of a financial technology company and three related registered broker-dealers for approximately $30.3 million as part of its initiatives to develop fintech and crypto software products and intellectual property including proprietary blockchain software. Medici closed on the acquisition of the financial technology company's assets in 2015 and on the acquisition of two of the broker-dealers in January 2016. Medici related expenses (including acquisition transaction costs) were $7.7 million in 2015. We are exploring possible synergies between Medici and our retail business, and also considering other alternatives for Medici including a spin-off or raising capital in Medici.
Although we made efforts to reduce expenses in Q4 2015, we continue to seek opportunities for growth by expanding our sales and distribution footprint, through Medici's crypto-initiatives, and through other means. As a result of these and other initiatives, we may continue to incur additional COGS, sales and marketing, technology and/or G&A expenses. These expenses may be material, and, coupled with the seasonality of our business, may lead to reduced income as compared to prior periods or to losses in some periods.
We are continuing the construction of our new corporate headquarters in Salt Lake City, Utah and we expect to complete the project in 2016. We estimate that the total project will cost approximately $99 million, and as of December 31, 2015 we have incurred approximately $55.7 million in costs. In connection with this project, we entered into a $46 million term loan agreement and a master lease agreement for up to $20 million. We began borrowing under these agreements in 2015. The construction project and related financing is discussed in further detail in the Liquidity and Capital Resources, Borrowings section below.
The balance of our Management’s Discussion and Analysis of Financial Condition and Results of Operations provides further information about the matters discussed above and other important matters affecting our business.
Results of Operations
The following table sets forth our results of operations expressed as a percentage of total net revenue for the years ended December 31, 2015, 2014 and 2013:
|
| | | | | | | | | |
| | Year ended December 31 |
| | 2015 | | 2014 | | 2013 |
| | (as a percentage of total revenue) |
Revenue, net | | |
| | |
| | |
|
Direct | | 8.3 | % | | 9.8 | % | | 12.0 | % |
Partner and other | | 91.7 |
| | 90.2 |
| | 88.0 |
|
Total net revenue | | 100.0 |
| | 100.0 |
| | 100.0 |
|
Cost of goods sold | | | | | | |
Direct | | 7.7 |
| | 8.6 |
| | 10.4 |
|
Partner and other | | 73.9 |
| | 72.7 |
| | 70.6 |
|
Total cost of goods sold | | 81.6 |
| | 81.3 |
| | 81.0 |
|
Gross profit | | 18.4 |
| | 18.7 |
| | 19.0 |
|
Operating expenses: | | | | | | |
Sales and marketing | | 7.5 |
| | 7.3 |
| | 7.0 |
|
Technology | | 5.9 |
| | 5.8 |
| | 5.5 |
|
General and administrative | | 5.0 |
| | 4.8 |
| | 5.2 |
|
Total operating expenses | | 18.4 |
| | 17.9 |
| | 17.7 |
|
Operating income | | — |
| | 0.8 |
| | 1.3 |
|
Interest income | | — |
| | — |
| | — |
|
Interest expense | | — |
| | — |
| | — |
|
Other income, net | | 0.2 |
| | 0.1 |
| | — |
|
Income before income taxes | | 0.2 |
| | 0.9 |
| | 1.3 |
|
Provision (benefit) for income taxes | | 0.1 |
| | 0.3 |
| | (5.2 | ) |
Consolidated net income | | 0.1 | % | | 0.6 | % | | 6.5 | % |
Revenue
The following table reflects our net revenue for the years ended December 31, 2015 and 2014 (in thousands):
|
| | | | | | | | | | | | | | | |
| | Year ended December 31, | | | | |
| | 2015 | | 2014 | | $ Change | | % Change |
Revenue, net | | |
| | |
| | |
| | |
|
Direct | | $ | 137,783 |
| | $ | 147,460 |
| | $ | (9,677 | ) | | (6.6 | )% |
Partner and other | | 1,520,055 |
| | 1,349,643 |
| | 170,412 |
| | 12.6 | % |
Total revenue, net | | $ | 1,657,838 |
| | $ | 1,497,103 |
| | $ | 160,735 |
| | 10.7 | % |
The primary reason for increased total net revenue for the year ended December 31, 2015, as compared to the same period in 2014, was an 8% increase in orders, coupled with a 4% increase in average order size, from $169 to $175. Although our average order size has increased in recent years, we expect the rate of increase to lessen as our sales mix shift into home and garden products becomes fully realized. In addition, the percentage of revenue we defer from orders taken but not delivered was less due to the timing of quarter end. These increases were partially offset by increased promotional activities including coupons, site sales, and Club O Rewards (which we recognize as a reduction of revenue) due to our driving a higher proportion of our sales using such promotions, and by an increase in returns.
The primary reason for decreased direct revenue for the year ended December 31, 2015, as compared to the same period in 2014, was a decrease in sales of home and garden products in addition to increased promotional activities including
coupons, site sales, and Club O Rewards (which we recognize as a reduction of revenue) due to our driving a higher proportion of our sales using such promotions, and by an increase in returns.
The increase in partner revenue for the year ended December 31, 2015, as compared to the same period in 2014, was primarily due to an increase in sales of home and garden products. In addition, the percentage of revenue we defer from orders taken but not delivered was less due to the timing of quarter end. These increases were partially offset by increased promotional activities including coupons, site sales, and Club O Rewards (which we recognize as a reduction of revenue) due to our driving a higher proportion of our sales using such promotions, and by an increase in returns.
The shift of business from direct to partner (or vice versa) is an economic result based on the economics of each particular product offering at the time and we generally do not have particular goals for an “appropriate” mix or percentage for the size of either. Although we have experienced a trend from direct revenue to partner revenue in recent years, we believe that the mix of the business between direct and partner remains consistent with our strategic objectives for our business model in the current economic environment and we do not currently foresee any material shifts in this trend.
The product lines we offer, and their respective percentages of our revenue, are based on many factors including customer demand, our marketing efforts, promotional pricing and joint-marketing offered by our suppliers, and the types of inventory we are able to obtain. These factors change frequently and affect the mix of the product lines we sell. While we have experienced a trend toward our home and garden category in recent years, our business model is to deal primarily in price-competitive, replenishable and closeout merchandise, which includes a wide variety of product offerings. While we do not currently expect any material shifts in our product line mix, the relative amounts of the product lines we sell is an economic result of the factors described above, which may change from time to time.
We continue to seek increased participation in our Club O loyalty program. We recently enhanced the program by adding a two-tiered structure that includes our current standard Club O paid membership, which is now called Club O Gold, and an introductory membership, called Club O Silver, for customers who agree to receive promotional emails. In 2015, we transitioned a significant number of customers into the Club O Silver program and began to shift coupon offers into Club O rewards. This shift may adversely impact our revenues if the incremental sales from our Club O members as a result of this change are less than any decrease in the incremental sales from our current coupon program. For additional information regarding our Club O loyalty program see Item 15 of Part IV, Financial Statements—Note 2. Accounting Policies, Club O loyalty program.
Gross profit and gross margin
Our overall gross margins fluctuate based on our sales volume mix between our direct business and partner business; changes in supplier cost and / or sales price, including competitive pricing; inventory management decisions within the direct business; sales coupons and promotions; product mix of sales; and operational and fulfillment costs.
The following table reflects our net revenues, cost of goods sold and gross profit for the years ended December 31, 2015 and 2014 (in thousands):
|
| | | | | | | | | | | | | | | |
| | Year ended December 31, | | | | |
| | 2015 | | 2014 | | $ Change | | % Change |
Revenue, net | | |
| | |
| | |
| | |
|
Direct | | $ | 137,783 |
| | $ | 147,460 |
| | $ | (9,677 | ) | | (6.6 | )% |
Partner and other | | 1,520,055 |
| | 1,349,643 |
| | 170,412 |
| | 12.6 | % |
Total net revenue | | 1,657,838 |
|
| 1,497,103 |
| | 160,735 |
| | 10.7 | % |
Cost of goods sold | | |
| | |
| | |
| | |
|
Direct | | 128,077 |
| | 129,253 |
| | (1,176 | ) | | (0.9 | )% |
Partner and other | | 1,225,107 |
| | 1,088,791 |
| | 136,316 |
| | 12.5 | % |
Total cost of goods sold | | 1,353,184 |
| | 1,218,044 |
| | 135,140 |
| | 11.1 | % |
Gross Profit | | |
| | |
| | |
| | |
|
Direct | | 9,706 |
| | 18,207 |
| | (8,501 | ) | | (46.7 | )% |
Partner and other | | 294,948 |
| | 260,852 |
| | 34,096 |
| | 13.1 | % |
Total gross profit | | $ | 304,654 |
| | $ | 279,059 |
| | $ | 25,595 |
| | 9.2 | % |
Gross margins for the past eight quarterly periods and years ending December 31, 2015 and 2014 were:
|
| | | | | | | | | | | | | | | |
| | Q1 2015 | | Q2 2015 | | Q3 2015 | | Q4 2015 | | FY 2015 |
Direct | | 10.0 | % | | 9.3 | % | | 4.9 | % | | 3.8 | % | | 7.0 | % |
Partner and other | | 19.8 | % | | 19.9 | % | | 19.8 | % | | 18.3 | % | | 19.4 | % |
Combined | | 18.9 | % | | 19.0 | % | | 18.5 | % | | 17.3 | % | | 18.4 | % |
|
| | | | | | | | | | | | | | | |
| | Q1 2014 | | Q2 2014 | | Q3 2014 | | Q4 2014 | | FY 2014 |
Direct | | 13.0 | % | | 11.3 | % | | 12.5 | % | | 12.5 | % | | 12.3 | % |
Partner and other | | 19.5 | % | | 19.7 | % | | 19.7 | % | | 18.7 | % | | 19.3 | % |
Combined | | 18.8 | % | | 18.8 | % | | 19.0 | % | | 18.2 | % | | 18.6 | % |
The 530 basis point decrease in direct gross margin for the year ended December 31, 2015, as compared to the same period in 2014, was primarily due to increased warehousing costs due to additional warehouse space and increased promotional activities including coupons, site sales, and Club O Rewards (which we recognize as a reduction of revenue) due to our driving a higher proportion of our sales using such promotions.
The 8 basis point increase in partner gross margin for the year ended December 31, 2015, as compared to the same period in 2014 was primarily due to a continued shift in sales mix into higher margin home and garden products, partially offset by increased promotional activities including coupons, site sales, and Club O Rewards (which we recognize as a reduction of revenue) due to our driving a higher proportion of our sales using such promotions.
Cost of goods sold includes stock-based compensation expense of $179,000 and $181,000 for the years ended December 31, 2015 and 2014, respectively.
Fulfillment costs
Fulfillment costs include all warehousing costs, including fixed overhead and variable handling costs (excluding packaging costs), as well as credit card fees and customer service costs, all of which we include as costs in calculating gross margin. We believe that some companies in our industry, including some of our competitors, account for fulfillment costs within operating expenses, and therefore exclude fulfillment costs from gross margin. As a result, our gross margin may not be directly comparable to others in our industry.
The following table has been included to provide investors additional information regarding our classification of fulfillment costs, gross profit and margin, thus enabling investors to better compare our gross margin with others in our industry (in thousands): |
| | | | | | | | | | | | |
| | Year ended December 31, |
| | 2015 | | 2014 |
Total revenue, net | | $ | 1,657,838 |
| | 100% | | $ | 1,497,103 |
| | 100% |
Cost of goods sold | | |
| | | | |
| | |
Product costs and other cost of goods sold | | 1,279,766 |
| | 77.2% | | 1,152,489 |
| | 77.0% |
Fulfillment and related costs | | 73,418 |
| | 4.4% | | 65,555 |
| | 4.4% |
Total cost of goods sold | | 1,353,184 |
| | 81.6% | | 1,218,044 |
| | 81.4% |
Gross profit | | $ | 304,654 |
| | 18.4% | | $ | 279,059 |
| | 18.6% |
Fulfillment costs as a percentage of sales may vary due to several factors, such as our ability to manage costs at our warehouses, significant changes in the number of units received and fulfilled, the extent to which we use third party fulfillment services and warehouses, and our ability to effectively manage customer service costs and credit card fees. Fulfillment and related costs remained relatively flat during the year ended December 31, 2015 as compared to 2014.
See Gross profit and gross margin above for additional discussion.
Operating expenses
Sales and marketing expenses
We use a variety of methods to target our consumer audience, including online campaigns, such as advertising through keywords, product listing ads, display ads, search engines, affiliate marketing programs, social coupon websites, portals, banners, e-mail, direct mail and viral and social media campaigns. We also do brand advertising through television, radio, print ads, and event sponsorships.
The following table reflects our sales and marketing expenses for the years ended December 31, 2015 and 2014 (in thousands):
|
| | | | | | | | | | | | | | | |
| | Year ended December 31, | | | | |
| | 2015 | | 2014 | | $ Change | | % Change |
Sales and marketing expenses | | $ | 124,468 |
| | $ | 109,461 |
| | $ | 15,007 |
| | 13.7 | % |
Sales and marketing expenses as a percent of net revenues | | 7.5 | % | | 7.3 | % | | |
| | |
|
The 20 basis point increase in sales and marketing expenses as a percentage of revenue for the year ended December 31, 2015, as compared to the same period in 2014, was primarily due to increased spending in the display ad and brand marketing channels.
Sales and marketing expenses include stock-based compensation expense of $217,000 and $336,000 for the years ended December 31, 2015 and 2014, respectively.
Costs associated with our discounted shipping and other promotions, such as coupons, are not included in marketing expense. Rather, they are accounted for as a reduction of revenue and therefore affect sales and gross margin. We consider discounted shipping and other promotions, such as our policy of free shipping on orders over $50, as an effective marketing tool, and intend to continue to offer them as we deem appropriate as part of our overall marketing plan.
We constantly evaluate where we spend our sales and marketing dollars. From time to time, certain competitors may bid up the cost of certain marketing channels, such as paid keywords. At such times, we may reduce the amounts we spend in those marketing channels, which may lead to decreased visitors to our site for a time. In Q4 2015, the number of unique visitors to our site decreased by approximately 8% as compared to Q4 2014, in part we believe as a result of such changes.
Technology expenses
We seek to invest efficiently in technology, including web services, customer support solutions, website search, expansion of new and existing product categories, and in investments in technology to enhance the customer experience, improve our process efficiency and support and expand our logistics infrastructure. We may increase our technology expenses to support these initiatives and these increases may be material.
We have noted increases in the frequency and variety of cyber attacks on our Website. The impact of these attacks and the costs we incur to protect our Website against future attacks have not been material. However, we consider the threat from cyber attacks to be serious and will continue to incur costs relating to them.
The following table reflects our technology expenses for the years ended December 31, 2015 and 2014 (in thousands):
|
| | | | | | | | | | | | | | | |
| | Year ended December 31, | | | | |
| | 2015 | | 2014 | | $ Change | | % Change |
Technology expenses | | $ | 98,533 |
| | $ | 86,258 |
| | $ | 12,275 |
| | 14.2 | % |
Technology expenses as a percent of net revenues | | 5.9 | % | | 5.8 | % | | |
| | |
|
The $12.3 million increase in technology costs for the year ended December 31, 2015, as compared to the same period in 2014, was primarily due to an increase in depreciation of $6.1 million and an increase in staff-related costs of $4.9 million.
Technology expenses include stock-based compensation expense of $646,000 and $751,000 for the years ended December 31, 2015 and 2014, respectively.
General and administrative expenses
The following table reflects our general and administrative expenses ("G&A") for the years ended December 31, 2015 and 2014 (in thousands):
|
| | | | | | | | | | | | | | | |
| | Year ended December 31, | | | | |
| | 2015 | | 2014 | | $ Change | | % Change |
General and administrative expenses | | $ | 82,187 |
| | $ | 71,777 |
| | $ | 10,410 |
| | 14.5 | % |
General and administrative expenses as a percent of net revenues | | 5.0 | % | | 4.8 | % | | |
| | |
|
The $10.4 million increase in general and administrative expenses (“G&A”) for the year ended December 31, 2015, as compared to the same period in 2014, was primarily due to an increase of $5.9 million in staff and travel related costs, an increase in management consulting services of $2.9 million, a $1.0 million expense for a contract termination fee, and an increase in depreciation and amortization of $932,000 (including amortization of intangible assets related to our recent acquisition).
G&A expenses include stock-based compensation expense of approximately $2.5 million and $2.8 million for the years ended December 31, 2015 and 2014, respectively.
Although we made efforts to reduce expenses in Q4 2015, we continue to seek opportunities for growth by expanding our sales and distribution footprint, through Medici's crypto-initiatives, and through other means. As a result of these and other initiatives, we may continue to incur additional COGS, sales and marketing, technology and/or G&A expenses. These expenses may be material, and, coupled with the seasonality of our business, may lead to reduced income as compared to prior periods or to losses in some periods.
Depreciation expense
Depreciation expense is classified within the corresponding operating expense categories on the consolidated statements of operations as follows (in thousands):
|
| | | | | | | | |
| | Year ended December 31, |
| | 2015 | | 2014 |
Cost of goods sold - direct | | $ | 283 |
| | $ | 282 |
|
Technology | | 22,126 |
| | 16,651 |
|
General and administrative | | 1,107 |
| | 1,028 |
|
Total depreciation, including internal-use software and website development | | $ | 23,516 |
| | $ | 17,961 |
|
Non-operating income (expense)
Interest income
Interest income is primarily derived from the investment of our cash in cash equivalents and short-term investments. Interest income for the years ended December 31, 2015 and 2014 totaled $155,000 and $152,000, respectively.
Interest expense
Interest expense for the year ended December 31, 2015 is primarily related to our cryptobond transactions. Interest expense for the years ended December 31, 2015 and 2014 totaled $140,000 and $39,000, respectively.
Other income (expense), net
Other income, net for the year ended December 31, 2015 was $3.6 million as compared to $1.2 million in 2014. The increase is primarily due to increased Club O Rewards breakage of $3.9 million due to increased participation in the Club O Rewards program, including our recently introduced Club O Silver program, partially offset by costs of $850,000 related to our cryptobond transactions.
Income taxes
Our effective tax rate for the years ended December 31, 2015 and 2014 was 60.8% and 33.4%, respectively. Our effective tax rate is affected by recurring items such as research tax credits and non-recurring items such as changes in valuation allowances. It is also affected to a lesser extent by tax rates in foreign jurisdictions and the relative amount of income we earn in jurisdictions, which we expect to be fairly consistent in the near term. The increase in the 2015 effective tax rate relative to the 2014 effective tax rate is primarily attributable to current year operating losses generated by separate tax-filing subsidiaries in domestic and foreign jurisdictions for which a valuation allowance has been established. Our current year valuation allowance is primarily attributable to our majority-owned subsidiary Medici (dba tØ.com). In Q3 2015, we acquired an additional interest in Medici for a total ownership of 81%. Tax losses incurred prior to our acquisition of the additional interest could not be used to offset our consolidated taxable income and were therefore fully valued. Medici's operating losses following the additional interest acquisition do not require a valuation allowance. We do not expect increases in the Medici operating loss valuation allowance in future years. The increase in the 2015 effective tax rate is also attributable to an increase in the valuation allowance related to our deferred tax asset for unrealized capital losses. We have indefinitely reinvested foreign earnings of $366,000 at December 31, 2015. We would need to accrue and pay U.S. income tax on this amount if repatriated. We do not intend to repatriate these earnings.
Seasonality
Based upon our historical experience, revenue typically increases during the fourth quarter because of the holiday retail season and gross margin decreases due to increased sales of certain lower margin products, such as electronics. The actual quarterly results for each quarter could differ materially depending upon consumer preferences, availability of product and competition, among other risks and uncertainties. Accordingly, there can be no assurances that seasonal variations will not materially affect our results of operations in the future.
The following table reflects our total net revenues for each of the quarters in 2015, 2014 and 2013 (in thousands):
|
| | | | | | | | | | | | | | | | |
| | First Quarter | | Second Quarter | | Third Quarter | | Fourth Quarter |
2015 | | $ | 398,344 |
| | $ | 388,013 |
| | $ | 391,211 |
| | $ | 480,270 |
|
2014 | | $ | 341,207 |
| | $ | 332,545 |
| | $ | 352,991 |
| | $ | 470,360 |
|
2013 | | $ | 311,994 |
| | $ | 293,204 |
| | $ | 301,426 |
| | $ | 397,593 |
|
Comparison of Years Ended December 31, 2014 and 2013
Executive Commentary
This executive commentary is intended to provide investors with a view of our business through the eyes of our management. As an executive commentary, it necessarily focuses on selected aspects of our business. This executive commentary is intended as a supplement to, but not a substitute for, the more detailed discussion of our business included elsewhere herein. Investors are cautioned to read our entire “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” as well as our interim and audited financial statements, and the discussion of our business and risk factors and other information included elsewhere or incorporated in this report. This executive commentary includes forward-looking statements, and investors are cautioned to read “Special Cautionary Note Regarding Forward-Looking Statements.”
Revenues in 2014 increased 15% compared to 2013. The growth in revenue was primarily due to a 10% increase in orders, coupled with a 7% increase in average order size, from $158 to $169. These increases were partially offset by increased promotional activities including coupons, site sales, and Club O Rewards (which we recognize as a reduction of revenue) due to our driving a higher proportion of our sales using those channels. The increases were also partially offset by an increase in the revenue we defer from orders taken but not delivered at year end due to higher average daily sales in the last week of the quarter.
Gross profit in 2014 increased 13% compared to 2013 primarily as a result of revenue growth. Gross margin decreased to 18.6% in 2014 compared to 19.0% in 2013. The decrease in gross margin was largely due to increased promotional activities including coupons, site sales, and Club O rewards due to our driving a higher proportion of our sales using those channels.
Sales and marketing expenses as a percentage of revenue increased from 7.0% to 7.3% during 2014 as compared to the same period in 2013, primarily due to our increased spending in the sponsored search and display ads marketing channels due to our driving a higher proportion of our sales through those channels.
As a result of these factors, we had a 9% increase in Contribution in 2014 compared to 2013 (see Non-GAAP Financial Measures below for a reconciliation of Contribution to Gross Profit). Contribution margin decreased to 11.5% for 2014 from 12.1% for 2013.
Technology expense in 2014 increased $14.5 million compared to 2013, primarily due to increases in staff-related costs, depreciation, and technical consulting.
General and administrative expense in 2014 increased $3.6 million compared to 2013, primarily due to an increase in staff and travel related costs and professional fees, partially offset by a decrease in legal costs.
Provision (benefit) for income taxes in 2014 was $4.4 million compared to ($68.0) million in 2013. The large income tax benefit in 2013 was due to a $75.5 million deferred tax asset valuation release in 2013 after we concluded that it was more likely than not that we will realize our deferred tax assets.
The balance of our Management’s Discussion and Analysis of Financial Condition and Results of Operations provides further information about the matters discussed above and other important matters affecting our business.
Results of Operations
The following table sets forth our results of operations expressed as a percentage of total net revenue for the years ended December 31, 2014, 2013 and 2012:
|
| | | | | | | | | |
| | Year ended December 31 |
| | 2014 | | 2013 | | 2012 |
| | (as a percentage of total revenue) |
Revenue, net | | |
| | |
| | |
|
Direct | | 9.8 | % | | 12.0 | % | | 14.1 | % |
Partner and other | | 90.2 |
| | 88.0 |
| | 85.9 |
|
Total net revenue | | 100.0 |
| | 100.0 |
| | 100.0 |
|
Cost of goods sold | | | | | | |
Direct | | 8.6 |
| | 10.4 |
| | 12.8 |
|
Partner and other | | 72.7 |
| | 70.6 |
| | 69.2 |
|
Total cost of goods sold | | 81.3 |
| | 81.0 |
| | 81.9 |
|
Gross profit | | 18.7 |
| | 19.0 |
| | 18.1 |
|
Operating expenses: | | | | | | |
Sales and marketing | | 7.3 |
| | 7.0 |
| | 5.8 |
|
Technology | | 5.8 |
| | 5.5 |
| | 6.0 |
|
General and administrative | | 4.8 | |