Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
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ý | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2018
Or
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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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799 West Coliseum Way, Midvale, Utah | | 84047 |
(Address of principal executive offices) | | (Zip Code) |
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(801) 947-3100 |
(Registrant's telephone number, including area code) |
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), and (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 every Interactive Data File required to be submitted 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 such files). Yes ý No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth 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 |
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Emerging growth company o | | |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý
There were 32,146,065 shares of the Registrant's common stock, par value $0.0001, outstanding on November 6, 2018.
OVERSTOCK.COM, INC.
FORM 10-Q
For the quarterly period ended September 30, 2018
TABLE OF CONTENTS
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Item 1. | | |
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Item 2. | | |
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Item 3. | | |
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Item 4. | | |
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Item 1. | | |
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Item 1A. | | |
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Item 2. | | |
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Item 3. | | |
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Item 4. | | |
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Item 5. | | |
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Item 6. | | |
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
Overstock.com, Inc.
Consolidated Balance Sheets (Unaudited)
(in thousands)
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| September 30, 2018 | | December 31, 2017 |
Assets | |
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Current assets: | |
| | |
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Cash and cash equivalents | $ | 182,042 |
| | $ | 203,215 |
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Restricted cash | 1,395 |
| | 455 |
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Accounts receivable, net | 30,552 |
| | 30,080 |
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Inventories, net | 17,308 |
| | 13,703 |
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Prepaids and other current assets | 23,863 |
| | 17,744 |
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Total current assets | 255,160 |
| | 265,197 |
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Fixed assets, net | 133,425 |
| | 129,343 |
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Deferred tax assets, net | 135 |
| | — |
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Intangible assets, net | 25,140 |
| | 7,337 |
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Goodwill | 22,058 |
| | 14,698 |
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Equity investments | 57,436 |
| | 13,024 |
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Other long-term assets, net | 8,113 |
| | 4,216 |
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Total assets | $ | 501,467 |
| | $ | 433,815 |
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Liabilities and Stockholders' Equity | |
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Current liabilities: | |
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Accounts payable | $ | 93,277 |
| | $ | 85,406 |
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Accrued liabilities | 100,753 |
| | 82,611 |
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Deferred revenue | 39,917 |
| | 46,468 |
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Other current liabilities, net | 472 |
| | 178 |
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Total current liabilities | 234,419 |
| | 214,663 |
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Long-term debt, net | 3,069 |
| | — |
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Long-term debt, net - related party | — |
| | 39,909 |
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Other long-term liabilities | 5,934 |
| | 7,120 |
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Total liabilities | 243,422 |
| | 261,692 |
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Commitments and contingencies (Note 6) |
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Stockholders' equity: | |
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Preferred stock, $0.0001 par value authorized shares - 5,000 | |
| | |
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Series A, issued and outstanding - 127 and 127 | — |
| | — |
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Series B, issued and outstanding - 555 and 555 | — |
| | — |
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Common stock, $0.0001 par value | |
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Authorized shares -100,000 | |
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Issued shares - 35,138 and 30,632 | |
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Outstanding shares - 31,941 and 27,497 | 3 |
| | 3 |
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Additional paid-in capital | 651,482 |
| | 494,732 |
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Accumulated deficit | (413,395 | ) | | (254,692 | ) |
Accumulated other comprehensive loss | (587 | ) | | (599 | ) |
Treasury stock: | |
| | |
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Shares at cost - 3,197 and 3,135 | (66,709 | ) | | (63,816 | ) |
Equity attributable to stockholders of Overstock.com, Inc. | 170,794 |
| | 175,628 |
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Equity attributable to noncontrolling interests | 87,251 |
| | (3,505 | ) |
Total equity | 258,045 |
| | 172,123 |
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Total liabilities and stockholders' equity | $ | 501,467 |
| | $ | 433,815 |
|
See accompanying notes to unaudited consolidated financial statements.
Overstock.com, Inc.
Consolidated Statements of Operations (Unaudited)
(in thousands, except per share data)
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| | | | | | | | | | | | | | | |
| Three months ended September 30, | | Nine months ended September 30, |
| 2018 | | 2017 | | 2018 | | 2017 |
Revenue, net | |
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Direct | $ | 15,424 |
| | $ | 19,645 |
| | $ | 46,409 |
| | $ | 64,572 |
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Partner and other | 425,156 |
| | 404,362 |
| | 1,322,635 |
| | 1,223,894 |
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Total net revenue | 440,580 |
| | 424,007 |
| | 1,369,044 |
| | 1,288,466 |
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Cost of goods sold | |
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Direct(1) | 16,205 |
| | 19,577 |
| | 45,649 |
| | 61,687 |
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Partner and other | 337,659 |
| | 320,755 |
| | 1,051,067 |
| | 972,026 |
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Total cost of goods sold | 353,864 |
| | 340,332 |
| | 1,096,716 |
| | 1,033,713 |
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Gross profit | 86,716 |
| | 83,675 |
| | 272,328 |
| | 254,753 |
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Operating expenses: | |
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Sales and marketing(1) | 55,312 |
| | 45,153 |
| | 226,942 |
| | 126,068 |
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Technology(1) | 33,880 |
| | 28,746 |
| | 97,597 |
| | 85,982 |
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General and administrative(1) | 45,356 |
| | 21,651 |
| | 116,551 |
| | 66,622 |
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Total operating expenses | 134,548 |
| | 95,550 |
| | 441,090 |
| | 278,672 |
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Operating loss | (47,832 | ) | | (11,875 | ) | | (168,762 | ) | | (23,919 | ) |
Interest income | 383 |
| | 189 |
| | 1,547 |
| | 450 |
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Interest expense | (101 | ) | | (713 | ) | | (1,370 | ) | | (2,139 | ) |
Other income (expense), net | (1,848 | ) | | 5,882 |
| | (1,489 | ) | | 2,751 |
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Loss before income taxes | (49,398 | ) | | (6,517 | ) | | (170,074 | ) | | (22,857 | ) |
Benefit from income taxes | (141 | ) | | (5,412 | ) | | (445 | ) | | (7,727 | ) |
Consolidated net loss | $ | (49,257 | ) | | $ | (1,105 | ) | | $ | (169,629 | ) | | $ | (15,130 | ) |
Less: Net loss attributable to noncontrolling interests | (1,334 | ) | | (319 | ) | | (5,886 | ) | | (942 | ) |
Net loss attributable to stockholders of Overstock.com, Inc. | $ | (47,923 | ) | | $ | (786 | ) | | $ | (163,743 | ) | | $ | (14,188 | ) |
Net loss per common share—basic: | |
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Net loss attributable to common shares—basic | $ | (1.55 | ) | | $ | (0.03 | ) | | $ | (5.47 | ) | | $ | (0.55 | ) |
Weighted average common shares outstanding—basic | 30,279 |
| | 25,003 |
| | 29,256 |
| | 25,024 |
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Net loss per common share—diluted: | |
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Net loss attributable to common shares—diluted | $ | (1.55 | ) | | $ | (0.03 | ) | | $ | (5.47 | ) | | $ | (0.55 | ) |
Weighted average common shares outstanding—diluted | 30,279 |
| | 25,003 |
| | 29,256 |
| | 25,024 |
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________________________________________ |
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(1) Includes stock-based compensation as follows (Note 9): | |
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Cost of goods sold — direct | $ | 41 |
| | $ | 46 |
| | $ | 152 |
| | $ | 134 |
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Sales and marketing | 277 |
| | 109 |
| | 1,465 |
| | 318 |
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Technology | 583 |
| | 166 |
| | 1,725 |
| | 476 |
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General and administrative | 1,345 |
| | 703 |
| | 8,312 |
| | 2,081 |
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Total | $ | 2,246 |
| | $ | 1,024 |
| | $ | 11,654 |
| | $ | 3,009 |
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See accompanying notes to unaudited consolidated financial statements.
Overstock.com, Inc.
Consolidated Statements of Comprehensive Loss (Unaudited)
(in thousands)
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| Three months ended September 30, | | Nine months ended September 30, |
| 2018 | | 2017 | | 2018 | | 2017 |
Consolidated net loss | $ | (49,257 | ) | | $ | (1,105 | ) | | $ | (169,629 | ) | | $ | (15,130 | ) |
Other comprehensive loss: | | | | | | | |
Unrealized gain on cash flow hedges, net of expense for taxes of $0, $31, $0, and $71 | 4 |
| | 52 |
| | 12 |
| | 120 |
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Other comprehensive income | 4 |
| | 52 |
| | 12 |
| | 120 |
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Comprehensive loss | $ | (49,253 | ) | | $ | (1,053 | ) | | $ | (169,617 | ) | | $ | (15,010 | ) |
Less: Comprehensive loss attributable to noncontrolling interests | (1,334 | ) | | (319 | ) | | (5,886 | ) | | (942 | ) |
Comprehensive loss attributable to stockholders of Overstock.com, Inc. | $ | (47,919 | ) | | $ | (734 | ) | | $ | (163,731 | ) | | $ | (14,068 | ) |
See accompanying notes to unaudited consolidated financial statements.
Overstock.com, Inc.
Consolidated Statements of Changes in Stockholders' Equity (Unaudited)
(in thousands) |
| | | |
| Nine months ended September 30, 2018 |
Equity attributable to stockholders of Overstock.com, Inc. | |
|
Number of common shares issued | |
Balance at beginning of period | 30,632 |
|
Common stock issued upon vesting of restricted stock | 226 |
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Common stock issued for asset purchase | 147 |
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Exercise of stock warrants | 1,250 |
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Common stock sold through ATM offering | 2,883 |
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Balance at end of period | 35,138 |
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Number of treasury stock shares | |
Balance at beginning of period | 3,135 |
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Tax withholding upon vesting of restricted stock | 62 |
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Balance at end of period | 3,197 |
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Total number of outstanding shares | 31,941 |
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Common stock | $ | 3 |
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Number of Series A preferred shares issued and outstanding | 127 |
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Number of Series B preferred shares issued and outstanding | 555 |
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Preferred stock | $ | — |
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Additional paid-in capital | |
Balance at beginning of period | $ | 494,732 |
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Stock-based compensation to employees and directors | 7,614 |
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Common stock issued for asset purchase | 4,430 |
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Exercise of stock warrants | 50,562 |
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Sale of stock warrants | 25 |
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Common stock sold through ATM offering, net of offering costs | 94,624 |
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Other | (505 | ) |
Balance at end of period | $ | 651,482 |
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Accumulated deficit | |
Balance at beginning of period | $ | (254,692 | ) |
Cumulative effect of change in accounting principle | 5,040 |
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Net loss attributable to stockholders of Overstock.com, Inc. | (163,743 | ) |
Balance at end of period | $ | (413,395 | ) |
| |
Accumulated other comprehensive loss | |
Balance at beginning of period | $ | (599 | ) |
Net other comprehensive income | 12 |
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Balance at end of period | $ | (587 | ) |
| |
Treasury stock | |
Balance at beginning of period | $ | (63,816 | ) |
Tax withholding upon vesting of restricted stock | (2,893 | ) |
Balance at end of period | (66,709 | ) |
Total equity attributable to stockholders of Overstock.com, Inc. | $ | 170,794 |
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Continued on the following page
Overstock.com, Inc.
Consolidated Statements of Changes in Stockholders' Equity (Unaudited)
(in thousands)
|
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| Nine months ended September 30, 2018 |
Total equity attributable to stockholders of Overstock.com, Inc. | $ | 170,794 |
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Equity attributable to noncontrolling interests | |
Balance at beginning of period | $ | (3,505 | ) |
Proceeds from security token offering, net of offering costs (Note 2 - Noncontrolling Interest) | 82,610 |
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Stock-based compensation to employees and directors | 4,040 |
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Tax withholding upon vesting of restricted stock | (1,681 | ) |
Net loss attributable to noncontrolling interests | (5,886 | ) |
Fair value of noncontrolling interests at acquisition | 4,468 |
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Paid in capital for noncontrolling interest | 6,700 |
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Other | 505 |
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Total equity attributable to noncontrolling interests | $ | 87,251 |
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Total equity | $ | 258,045 |
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See accompanying notes to unaudited consolidated financial statements.
Overstock.com, Inc.
Consolidated Statements of Cash Flows (Unaudited)
(in thousands)
|
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| Nine months ended September 30, | | Twelve months ended September 30, |
| 2018 | | 2017 | | 2018 | | 2017 |
Cash flows from operating activities: | |
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Consolidated net loss | $ | (169,629 | ) | | $ | (15,130 | ) | | $ | (266,421 | ) | | $ | (12,369 | ) |
Adjustments to reconcile net loss to net cash used in operating activities: | |
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Depreciation of fixed assets | 19,437 |
| | 21,895 |
| | 26,390 |
| | 29,468 |
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Amortization of intangible assets | 3,596 |
| | 2,839 |
| | 4,756 |
| | 3,614 |
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Stock-based compensation to employees and directors | 11,654 |
| | 3,009 |
| | 12,722 |
| | 3,795 |
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Deferred income taxes, net | (383 | ) | | (8,682 | ) | | 73,498 |
| | (7,651 | ) |
Gain on investment in precious metals | — |
| | (1,907 | ) | | (64 | ) | | (2,108 | ) |
Impairment of cryptocurrencies | 9,641 |
| | — |
| | 9,641 |
| | — |
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Gain on sale of cryptocurrencies | (8,412 | ) | | (845 | ) | | (9,562 | ) | | (845 | ) |
Impairment of equity securities | 511 |
| | 4,500 |
| | 1,498 |
| | 4,500 |
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Early extinguishment costs of long term debts | 283 |
| | — |
| | 2,747 |
| | — |
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Other | 741 |
| | 420 |
| | 1,197 |
| | 569 |
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Changes in operating assets and liabilities, net of acquisitions: | |
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Accounts receivable, net | (73 | ) | | 3,814 |
| | (5,825 | ) | | (3,283 | ) |
Inventories, net | (1,833 | ) | | 5,375 |
| | (1,974 | ) | | 2,155 |
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Prepaids and other current assets | (4,806 | ) | | (5,950 | ) | | (1,655 | ) | | (680 | ) |
Other long-term assets, net | (4,120 | ) | | (121 | ) | | (6,306 | ) | | (551 | ) |
Accounts payable | 7,143 |
| | (35,794 | ) | | 21,942 |
| | (14,370 | ) |
Accrued liabilities | 18,044 |
| | (35,831 | ) | | 41,564 |
| | (10,217 | ) |
Deferred revenue | (1,511 | ) | | (275 | ) | | 3,452 |
| | 248 |
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Other long-term liabilities | (583 | ) | | 235 |
| | (673 | ) | | 280 |
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Net cash used in operating activities | (120,300 | ) | | (62,448 | ) | | (93,073 | ) | | (7,445 | ) |
Cash flows from investing activities: | |
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Purchases of intangible assets | (9,583 | ) | | — |
| | (10,006 | ) | | — |
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Proceeds from sale of precious metals | — |
| | 11,603 |
| | 314 |
| | 13,213 |
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Investment in precious metals | — |
| | — |
| | — |
| | (1,633 | ) |
Disbursement of note receivable | (2,700 | ) | | (750 | ) | | (2,700 | ) | | (1,368 | ) |
Investment in equity securities | (43,670 | ) | | (4,188 | ) | | (44,670 | ) | | (4,938 | ) |
Acquisitions of businesses, net of cash acquired | (12,912 | ) | | — |
| | (12,912 | ) | | 28 |
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Expenditures for fixed assets, including internal-use software and website development | (20,677 | ) | | (20,873 | ) | | (23,390 | ) | | (33,772 | ) |
Other | 34 |
| | (160 | ) | | 264 |
| | (179 | ) |
Net cash used in investing activities | (89,508 | ) | | (14,368 | ) | | (93,100 | ) | | (28,649 | ) |
Cash flows from financing activities: | |
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Payments on capital lease obligations | (372 | ) | | — |
| | (455 | ) | | — |
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Payments on interest swap | — |
| | — |
| | (1,535 | ) | | — |
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Proceeds from finance obligations | — |
| | — |
| | — |
| | 5,324 |
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Payments on finance obligations | — |
| | (2,436 | ) | | (12,880 | ) | | (2,988 | ) |
Proceeds from long-term debt | — |
| | — |
| | 40,000 |
| | 4,826 |
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Payments on long-term debt | (40,000 | ) | | (750 | ) | | (85,016 | ) | | (750 | ) |
Payments of preferred dividends | — |
| | — |
| | (109 | ) | | — |
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Proceeds from exercise of stock options | — |
| | 654 |
| | 10 |
| | 1,473 |
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Proceeds from rights offering, net of offering costs | — |
| | — |
| | — |
| | 7,591 |
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Proceeds from issuance and exercise of stock warrants | 50,587 |
| | — |
| | 157,046 |
| | — |
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Proceeds from security token offering, net of offering costs | 82,610 |
| | 3 |
| | 83,515 |
| | 3 |
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Proceeds from sale of common stock, net of offering costs | 94,624 |
| | — |
| | 94,624 |
| | — |
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Purchase of treasury stock | — |
| | (10,000 | ) | | — |
| | (10,000 | ) |
Paid in capital for noncontrolling interest | 6,700 |
| | — |
| | 6,700 |
| | — |
|
Payments of taxes withheld upon vesting of restricted stock | (4,574 | ) | | (1,104 | ) | | (4,699 | ) | | (1,207 | ) |
Payment of debt issuance costs | — |
| | (251 | ) | | (419 | ) | | (251 | ) |
Net cash provided by (used in) financing activities | 189,575 |
| | (13,884 | ) | | 276,782 |
| | 4,021 |
|
Net increase (decrease) in cash, cash equivalents and restricted cash | (20,233 | ) | | (90,700 | ) | | 90,609 |
| | (32,073 | ) |
Cash, cash equivalents and restricted cash, beginning of period | 203,670 |
| | 183,528 |
| | 92,828 |
| | 124,901 |
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Cash, cash equivalents and restricted cash, end of period | $ | 183,437 |
| | $ | 92,828 |
| | $ | 183,437 |
| | $ | 92,828 |
|
Continued on the following page
Overstock.com, Inc.
Consolidated Statements of Cash Flows (Unaudited)
(Continued)
(in thousands)
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| | | | | | | | | | | | | | | |
| Nine months ended September 30, | | Twelve months ended September 30, |
| 2018 | | 2017 | | 2018 | | 2017 |
Supplemental disclosures of cash flow information: | |
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Cash paid during the period: | |
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Interest paid, net of amounts capitalized | $ | 1,232 |
| | $ | 1,980 |
| | $ | 2,192 |
| | $ | 2,574 |
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Income taxes paid, net of refunds | 59 |
| | 492 |
| | 54 |
| | 624 |
|
Non-cash investing and financing activities: | |
| | |
| | |
| | |
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Fixed assets, including internal-use software and website development, costs financed through accounts payable and accrued liabilities | $ | 731 |
| | $ | 618 |
| | $ | 731 |
| | $ | 618 |
|
Equipment acquired under capital lease obligations | — |
| | — |
| | 1,421 |
| | 362 |
|
Capitalized interest cost | — |
| | — |
| | — |
| | (12 | ) |
Change in fair value of cash flow hedge | — |
| | (180 | ) | | (1,558 | ) | | (2,619 | ) |
Note receivable converted to equity investment | 200 |
| | 869 |
| | 699 |
| | 869 |
|
Acquisition of assets through stock issuance | 4,430 |
| | — |
| | 4,430 |
| | — |
|
See accompanying notes to unaudited consolidated financial statements.
Overstock.com, Inc.
Notes to Unaudited Consolidated Financial Statements
1. BASIS OF PRESENTATION
Overstock.com, Inc. is an online retailer and advancer of blockchain technology. As used herein, "Overstock," "the Company," "we," "our" and similar terms include Overstock.com, Inc. and its majority-owned subsidiaries, unless the context indicates otherwise.
We have prepared the accompanying unaudited consolidated financial statements pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC") regarding interim financial reporting. Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States ("GAAP") have been omitted in accordance with the rules and regulations of the SEC.
These financial statements should be read in conjunction with our audited annual consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2017. The accompanying unaudited consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, which are, in our opinion, necessary for a fair presentation of results for the interim periods presented. The results of operations for the three and nine months ended September 30, 2018 are not necessarily indicative of the results to be expected for any future period or the full fiscal year.
For purposes of comparability, the presentation of certain immaterial amounts in the prior periods have been conformed with the current period presentation. We retrospectively applied certain accounting standard updates as discussed in Note 2—Accounting Policies, Recently adopted accounting standards.
2. ACCOUNTING POLICIES
Principles of consolidation
The accompanying consolidated financial statements include our accounts and the accounts of our wholly-owned and majority-owned subsidiaries. All intercompany account balances and transactions have been eliminated in consolidation. The financial results of Verify Investor, LLC have been included in our consolidated financial statements from the date of acquisition on February 12, 2018. The financial results of Mac Warehouse, LLC have been included in our consolidated financial statements from the date of acquisition on June 25, 2018.
Use of estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent liabilities in our consolidated financial statements and accompanying notes. Estimates are used for, but not limited to, investment valuation, receivables valuation, revenue recognition, sales returns, incentive discount offers, inventory valuation, depreciable lives of fixed assets and internally-developed software, goodwill valuation, intangible asset valuation, equity investment valuation, income taxes, stock-based compensation, performance-based compensation, self-funded health insurance liabilities and contingencies. Although these estimates are based on our best knowledge of current events and actions that we may undertake in the future, actual results may differ materially from these estimates.
Cash equivalents
We classify all highly liquid instruments, including instruments with a remaining maturity of three months or less at the time of purchase, as cash equivalents. Cash equivalents were $20.1 million and $25.5 million at September 30, 2018 and December 31, 2017, respectively.
Restricted cash
We consider cash that is legally restricted and cash that is held as compensating balances for credit arrangements and self-funded health insurance as restricted cash.
Fair value of financial instruments
We account for our assets and liabilities using a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect our market assumptions. These two types of inputs have created the fair-value hierarchy below. This hierarchy requires us to minimize the use of unobservable inputs and to use observable market data, if available, when determining fair value.
| |
• | Level 1—Quoted prices for identical instruments in active markets; |
| |
• | Level 2—Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets; and |
| |
• | Level 3—Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable. |
Under GAAP, certain assets and liabilities are required to be recorded at fair value on a recurring basis. Our assets and liabilities that are adjusted to fair value on a recurring basis are cash equivalents, trading securities, and deferred compensation liabilities, which fair values are determined using quoted market prices from daily exchange traded markets on the closing price as of the balance sheet date and are classified as Level 1. Our other financial instruments, including cash, restricted cash, accounts receivable, accounts payable, accrued liabilities, and debt are carried at cost, which approximates their fair value.
The following tables summarize our assets and liabilities measured at fair value on a recurring basis using the fair value hierarchy as of September 30, 2018 and December 31, 2017 as indicated (in thousands):
|
| | | | | | | | | | | | | | | |
p | Fair Value Measurements at September 30, 2018: |
| Total | | Level 1 | | Level 2 | | Level 3 |
Assets: | |
| | |
| | |
| | |
|
Cash equivalents - Money market mutual funds | $ | 20,055 |
| | $ | 20,055 |
| | $ | — |
| | $ | — |
|
Investments in equity securities, at fair value | 4,264 |
| | 4,264 |
| | — |
| | — |
|
Trading securities held in a "rabbi trust" (1) | 88 |
| | 88 |
| | — |
| | — |
|
Total assets | $ | 24,407 |
| | $ | 24,407 |
| | $ | — |
| | $ | — |
|
Liabilities: | |
| | |
| | |
| | |
|
Deferred compensation accrual "rabbi trust" (2) | $ | 93 |
| | $ | 93 |
| | $ | — |
| | $ | — |
|
Total liabilities | $ | 93 |
| | $ | 93 |
| | $ | — |
| | $ | — |
|
|
| | | | | | | | | | | | | | | |
| Fair Value Measurements at December 31, 2017: |
| Total | | Level 1 | | Level 2 | | Level 3 |
Assets: | |
| | |
| | |
| | |
|
Cash equivalents - Money market mutual funds | $ | 25,455 |
| | $ | 25,455 |
| | $ | — |
| | $ | — |
|
Trading securities held in a "rabbi trust" (1) | 74 |
| | 74 |
| | — |
| | — |
|
Total assets | $ | 25,529 |
| | $ | 25,529 |
| | $ | — |
| | $ | — |
|
Liabilities: | |
| | |
| | |
| | |
|
Deferred compensation accrual "rabbi trust" (2) | $ | 92 |
| | $ | 92 |
| | $ | — |
| | $ | — |
|
Total liabilities | $ | 92 |
| | $ | 92 |
| | $ | — |
| | $ | — |
|
___________________________________________
| |
(1) | — Trading securities held in a rabbi trust are included in Prepaids and other current assets and Other long-term assets, net in our consolidated balance sheets. |
| |
(2) | — Non-qualified deferred compensation in a rabbi trust is included in Accrued liabilities and Other long-term liabilities in our consolidated balance sheets. |
Accounts receivable, net
Accounts receivable consist primarily of trade amounts due from customers in the United States, uncleared credit card transactions at period end, and carrier rebates. Accounts receivable are recorded at invoiced amounts and do not bear interest. From time to time, we grant credit to some of our business customers on normal credit terms (typically 30 days). We maintain an allowance for doubtful accounts receivable based upon our business customers' financial condition and payment history, and our historical collection experience and expected collectability of accounts receivable. The allowance for doubtful accounts receivable was $1.9 million and $1.3 million at September 30, 2018 and December 31, 2017, respectively.
Concentration of credit risk
Three banks held the majority of our cash and cash equivalents at September 30, 2018. Two banks held the majority of our cash and cash equivalents at December 31, 2017. Our cash equivalents primarily consist of money market securities which are uninsured. We do not believe that, as a result of this concentration, we are subject to any unusual financial risk beyond the normal risk associated with commercial banking relationships.
Inventories, net
Inventories, net include merchandise purchased for resale, which 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 and net realizable value. Inventory valuation requires us to make judgments, based on currently available information, about the likely method of disposition, such as through sales to individual customers, returns to product vendors, or liquidations, and expected recoverable values of each disposition category.
Prepaids and other current assets
Prepaids and other current assets represent expenses paid prior to receipt of the related goods or services, including advertising, license fees, maintenance, packaging, insurance, prepaid inventories, other miscellaneous costs, and cryptocurrency-denominated assets ("cryptocurrencies"). See Cryptocurrencies below.
Cryptocurrencies
Cryptocurrency holdings are included in Prepaids and other current assets in our consolidated balance sheets and totaled $3.1 million and $1.5 million at September 30, 2018 and December 31, 2017, respectively. Cryptocurrency holdings are recorded at cost less impairment.
We recognize impairment on these assets caused by decreases in market value based upon Level 1 inputs. See Fair value of financial instruments above. Such impairment in the value of our cryptocurrencies is recorded in General and administrative expense in our consolidated statements of operations. Impairments on cryptocurrencies were $150,000 and $9.6 million for the three and nine months ended September 30, 2018. There was no impairment on cryptocurrencies during the three and nine months ended September 30, 2017.
Gains and losses realized upon sale of cryptocurrencies are also recorded in General and administrative expense in our consolidated statements of operations. We occasionally use our cryptocurrencies to purchase other cryptocurrencies. Gains and losses realized with these non-cash transactions are also recorded in General and administrative expense in our consolidated statements of operations. These non-cash transactions as well as gains (losses) from cryptocurrencies received through our tZERO security token offering are also presented as an adjustment to reconcile Consolidated net loss to Net cash used in operating activities in our consolidated statements of cash flows. Realized gains on sale of cryptocurrencies were $64,000 and $8.4 million for the three and nine months ended September 30, 2018. There were $3.6 million realized gains or losses on sale of cryptocurrencies during the three and nine months ended September 30, 2017.
Fixed assets, net
Fixed assets are recorded at cost and stated net of depreciation and amortization. Fixed assets are depreciated using the straight-line method over the estimated useful lives of the related assets or the term of the related capital lease, whichever is shorter, as follows:
|
| |
| Life (years) |
Building | 40 |
Land improvements | 20 |
Building machinery and equipment | 15-20 |
Furniture and equipment | 5-7 |
Computer hardware | 3-4 |
Computer software, including internal-use software and website development | 2-4 |
Leasehold improvements are amortized over the shorter of the term of the related leases or estimated useful lives.
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. Costs incurred related to design or maintenance of internal-use software are expensed as incurred.
During the three months ended September 30, 2018 and 2017, we capitalized $4.0 million and $2.2 million, respectively, of costs associated with internal-use software and website development, both developed internally and acquired externally. Amortization of costs for the same periods associated with internal-use software and website development was $3.4 million and $3.9 million, respectively. During the nine months ended September 30, 2018 and 2017, we capitalized $14.7 million and $8.0 million, respectively, of costs associated with internal-use software and website development, both developed internally and acquired externally. Amortization of costs associated with internal-use software and website development was $10.0 million and $12.2 million, respectively.
Depreciation expense is classified within the corresponding operating expense categories on our consolidated statements of operations as follows (in thousands):
|
| | | | | | | | | | | | | | | |
| Three months ended September 30, | | Nine months ended September 30, |
| 2018 | | 2017 | | 2018 | | 2017 |
Cost of goods sold - direct | $ | 85 |
| | $ | 72 |
| | $ | 252 |
| | $ | 230 |
|
Technology | 5,330 |
| | 5,940 |
| | 16,103 |
| | 18,802 |
|
General and administrative | 1,038 |
| | 974 |
| | 3,082 |
| | 2,863 |
|
Total depreciation, including internal-use software and website development | $ | 6,453 |
| | $ | 6,986 |
| | $ | 19,437 |
| | $ | 21,895 |
|
Total accumulated depreciation of fixed assets was $202.3 million and $186.4 million at September 30, 2018 and December 31, 2017, respectively.
Upon sale or retirement of assets, cost and related accumulated depreciation and amortization are removed from the balance sheet and the resulting gain or loss is reflected in our consolidated statements of operations.
Fixed assets included assets under capital leases of $1.8 million at September 30, 2018 and December 31, 2017. Accumulated depreciation related to assets under capital leases was $842,000 and $458,000 at September 30, 2018 and December 31, 2017, respectively.
Depreciation expense of assets recorded under capital leases was $120,000 and $1.1 million for the three months ended September 30, 2018 and 2017, respectively, and $384,000 and $3.5 million for the nine months ended September 30, 2018 and 2017, respectively.
Equity investments under ASC 321
At September 30, 2018, we held minority interests (less than 20%) in thirteen privately held entities accounted for under ASC Topic 321, Investments - Equity Securities ("ASC 321"), which are included in Equity investments in our consolidated balance sheets. One of these equity investments, which had a carrying value of $4.3 million at September 30, 2018, is carried at fair value based on Level 1 inputs. See Fair value of financial instruments above. The remaining equity investments lack readily determinable fair values and therefore the investments are measured at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or similar equity securities of the same issuer. Dividends received are reported in current earnings. We review our investments individually for impairment by evaluating if events or circumstances have occurred that may indicate the fair value of the investment is less than its carrying value. If such events or circumstances have occurred, we estimate the fair value of the investment and recognize an impairment loss equal to the difference between the fair value of the investment and its carrying value. In such cases, the estimated fair value of the investment is determined using unobservable inputs including assumptions by the investee's management including quantitative information such as lower valuations in recently completed or proposed financings. These inputs are classified as Level 3. Because several of our investees are in the early startup or development stages, these entities are subject to potential changes in cash flows, valuation, and inability to attract new investors which may be necessary for the liquidity needed to support their operations.
The carrying amount of our investments under ASC 321 was approximately $18.5 million and $6.5 million at September 30, 2018 and December 31, 2017, respectively. We recognized unrealized losses of $73,000 and unrealized gains of $1.8 million on investments carried at fair value during the three and nine months ended September 30, 2018, respectively. We recognized a $511,000 impairment loss during the three and nine months ended September 30, 2018. We recognized a $4.5 million impairment loss during the nine months ended September 30, 2017. Impairment loss and any unrealized gains or losses on our investments are recorded in Other income (expense), net on our consolidated statements of operations.
Equity method investments under ASC 323
At September 30, 2018, we held minority interests in nine privately held entities accounted for as equity method investments under ASC Topic 323, Investments - Equity Method and Joint Ventures ("ASC 323"), which are included in Equity investments in our consolidated balance sheets. We can exercise significant influence, but not control, over the investees through either holding more than a 20% voting interest in the entity or through our representation on the entity's board of directors. Based on the nature of our ownership interests, we have variable interests in certain of these entities. However, because we do not have power to direct the investee's activities and we are not the investee's primary beneficiary, we therefore do not consolidate the investee in our financial statements.
The carrying value of our equity method investments exceeded the amount of underlying equity in net assets of the investees and the difference was primarily related to goodwill and the fair value of intangible assets. The difference related to intangible assets is amortized over their estimated useful lives. We record our proportionate share of the net income or loss of the investee and the amortization of the basis difference related to intangible assets in Other income (expense), net in our consolidated statements of operations with corresponding adjustments to the carrying value of the investment.
The carrying amount of our equity method investments was approximately $39.0 million and $6.5 million at September 30, 2018 and December 31, 2017, respectively, and the difference between the carrying value and the amount of underlying equity in net assets of each investee was not significant. Our proportionate share of the net income or loss of our equity method investees was approximately $1.2 million in losses and $74,000 in losses for the three months ended September 30, 2018 and 2017, respectively, and approximately $2.5 million in losses and $74,000 in losses for the nine months ended September 30, 2018 and 2017, respectively.
Noncontrolling interests
Our wholly-owned subsidiary, Medici Ventures, Inc. ("Medici Ventures"), conducts its primary business through its majority-owned subsidiary, tZERO Group, Inc. ("tZERO"), formerly tØ.com, Inc., which includes a financial technology company, two related registered broker dealers, a registered investment advisor, and an accredited investor verification company. tZERO and its consolidated subsidiaries are included in our consolidated financial statements. Intercompany transactions have been eliminated and the amounts of contributions and gains or losses that are attributable to the noncontrolling interests are disclosed in our consolidated financial statements.
On December 18, 2017, tZERO launched an offering (the "security token offering") of the right to acquire tZERO Preferred Equity Tokens (the "tZERO Security Token") through a Simple Agreement for Future Equity ("SAFE"). The security token offering closed on August 6, 2018. At September 30, 2018, the SAFEs were classified as equity by tZERO. At September 30, 2018, cumulative proceeds, net of withdrawals, from the security token offering totaling $104.8 million, have been classified as a component of noncontrolling interest within our consolidated financial statements. As of September 30, 2018, tZERO has incurred $21.3 million of offering costs associated with the security token offering that are classified as a reduction in proceeds within noncontrolling interest of our consolidated financial statements. On October 12, 2018, tZERO issued the tZERO Security Tokens in settlement of the SAFEs. The tZERO Security Tokens are subject to a 90 day trading lock-up period.
During the first quarter of 2018, tZERO purchased 65.8% of ES Capital Advisors, LLC ("ES Capital"), a registered investment advisor under the Investment Advisers Act of 1940, which was accounted for as an asset acquisition. tZERO operates the ES Capital business under the name tZERO Advisors and offers automated investment advisory services under the FinanceHub tab on our Website. tZERO also purchased 81.0% of Verify Investor, LLC, an accredited investor verification company. This transaction is described further in Note 3—Acquisitions, Goodwill, and Acquired Intangible Assets. These entities are included in our consolidated financial statements.
Medici Land Governance Inc., a Delaware public benefit corporation ("MLG"), was recently formed by Medici Ventures with our President and Chief Executive Officer, Dr. Patrick M. Byrne ("Dr. Byrne"). Pursuant to the Subscription Agreements dated September 21, 2018, Medici Ventures contributed certain of its assets, including intellectual property relating to technologies regarding land governance and property rights, to MLG in exchange for 510,000 shares of MLG common stock and at the same time Dr. Byrne personally contributed $6.7 million in cash to MLG in exchange for 390,000 shares of MLG common stock. As a result of the transactions described above, Medici Ventures holds approximately 57% of the outstanding capital stock of MLG, and Dr. Byrne, holds approximately 43% of the outstanding capital stock of MLG.
Leases
We account for lease agreements as either operating or capital leases depending on certain defined criteria. In certain of our lease agreements, we receive rent holidays and other incentives. We recognize lease costs on a straight-line basis without regard to deferred payment terms, such as rent holidays, that defer the commencement date of required payments. Additionally, tenant improvement allowances are amortized as a reduction in rent expense over the term of the lease. Leasehold improvements are capitalized at cost and amortized over the lesser of their expected useful life or the life of the lease, without assuming renewal features, if any, are exercised.
Treasury stock
We account for treasury stock under the cost method and include treasury stock as a component of stockholders' equity.
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 the fair value of a reporting unit 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.
We test for impairment of goodwill annually or when we deem that a triggering event has occurred. There were no impairments to goodwill recorded during the nine months ended September 30, 2018 and 2017.
For nine months ended September 30, 2018, we recognized $7.4 million in goodwill related to a business acquisition as described in Note 3—Acquisitions, Goodwill, and Acquired Intangible Assets. The change in goodwill relates to a non-reportable segment, included in Other as described in Note 10—Business Segments.
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. Indefinite lived intangible assets include intellectual property and investment advisor licenses purchased in connection with our tZERO Advisors and Medici Ventures' portfolio company in the blockchain property titling businesses. Certain licenses are subject to annual renewal terms with immaterial fees which are expensed as incurred. Indefinite-lived intangible assets are tested for impairment annually or more frequently when events or circumstances indicate that the carrying value more likely than not exceeds its fair value. In addition, we routinely evaluate the remaining useful life of intangible assets not being amortized to determine whether events or circumstances continue to support an indefinite useful life, including any legal, regulatory, contractual, competitive, economic, or other factors that may limit their useful lives. Definite lived intangible assets 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. Definite lived intangible 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.
Intangible assets, net consist of the following (in thousands):
|
| | | | | | | |
| September 30, 2018 | | December 31, 2017 |
Intangible assets subject to amortization, gross (1) | $ | 28,347 |
| | $ | 17,779 |
|
Less: accumulated amortization of intangible assets subject to amortization | (14,040 | ) | | (10,442 | ) |
Intangible assets subject to amortization, net | 14,307 |
| | 7,337 |
|
Intangible assets not subject to amortization | 10,833 |
| | — |
|
Total intangible assets, net | $ | 25,140 |
| | $ | 7,337 |
|
___________________________________________
| |
(1) | — At September 30, 2018, the weighted average remaining useful life for intangible assets subject to amortization, excluding fully amortized intangible assets, was 5.69 years. |
Amortization of intangible assets other than goodwill is classified within the corresponding operating expense categories in our consolidated statements of operations as follows (in thousands):
|
| | | | | | | | | | | | | | | |
| Three months ended September 30, | | Nine months ended September 30, |
| 2018 | | 2017 | | 2018 | | 2017 |
Technology | $ | 885 |
| | $ | 905 |
| | $ | 2,534 |
| | $ | 2,715 |
|
Sales and marketing | 119 |
| | 22 |
| | 442 |
| | 62 |
|
General and administrative | 542 |
| | 21 |
| | 620 |
| | 62 |
|
Total amortization | $ | 1,546 |
| | $ | 948 |
| | $ | 3,596 |
| | $ | 2,839 |
|
Estimated amortization expense for the next five years is: $1.3 million for the remainder of 2018, $4.7 million in 2019, $2.2 million in 2020, $1.8 million in 2021, $892,000 in 2022, and $3.5 million thereafter.
Impairment of long-lived assets
We review property and equipment and other long-lived assets, including amortizable intangible assets other than goodwill, 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 nine months ended September 30, 2018 and 2017.
Other long-term assets, net
Other long-term assets, net consist primarily of long-term prepaid expenses.
Revenue recognition
We derive our revenue primarily from retail merchandise sales on our Website. We also earn revenue from advertising on our Website and from other sources. We have organized our operations into two principal reporting segments based on the primary source of revenue: (i) direct revenue and (ii) partner and other revenue. Net revenue from contracts with customers is further disaggregated by Retail and Other net revenue as disclosed in Note 10—Business Segments.
On January 1, 2018, we adopted ASU 2014-09, Revenue from Contracts with Customers (Topic 606). See Recently adopted accounting standards, below. Under Topic 606, revenue is recognized when control of the product passes to the customer or the service is provided and is recognized in an amount that reflects the expected consideration to be received in exchange for such goods or services. Shipping and handling is considered a fulfillment activity and fees charged to customers are included in net revenue upon completion of our performance obligation. We present revenue net of sales taxes, discounts, and expected refunds. 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.
Generally, we require authorization from credit card or other payment vendors whose services we offer to our customers (such as PayPal), or verification of receipt of payment, 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.
We evaluate the criteria outlined in ASC 606-10-55, Principal versus Agent Considerations, in determining whether it is appropriate to record the gross amount of merchandise sales and related costs or the net amount earned as commissions. When we are the principal in a transaction and control the specific good or service before it is transferred to the customer, revenue is recorded gross; otherwise, revenue is recorded on a net basis. Currently, the majority of both direct revenue and partner revenue is recorded on a gross basis.
Revenue related to merchandise sales is recognized upon transfer of control to our customers which generally occurs upon delivery of the product to our customers. As such, customer orders are recorded as deferred revenue prior to delivery of products or services ordered. 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, those warehouses we control, 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.
During the nine months ended September 30, 2018, we recognized $37.8 million of net revenue included in Deferred revenue at December 31, 2017.
The allowance for returns was $12.4 million and $17.4 million at September 30, 2018 and December 31, 2017, respectively.
We evaluate the revenue recognition criteria above for our broker dealer subsidiaries and we recognize revenue based on the gross amount of consideration that we expect to receive on securities transactions (commission revenue) on a trade date basis.
Direct revenue
Direct revenue is derived from merchandise sales of our owned inventory to individual consumers and businesses. Direct revenue comes from merchandise sales that occur primarily through our Website, but may also occur through offline and other channels.
Partner and other revenue
Partner and other revenue is derived primarily from merchandise sales of inventory sourced through our partners which are generally shipped directly to our consumers and businesses. Through contractual terms with our partners, we have the ability to control the promised goods or services and as a result record the majority of our partner revenue on a gross basis. Partner and other revenue comes from merchandise sales that occur primarily through our Website, but may also occur through offline and other channels, including through our broker dealer subsidiaries in our Other segment.
Club O loyalty program
We have a customer loyalty program called Club O Gold for which we sell annual memberships. For Club O Gold memberships, we record membership fees as deferred revenue, and we recognize revenue ratably over the membership period. The Club O Gold loyalty program allows members to earn Club O Reward dollars for qualifying purchases made on our Website. We also have a co-branded credit card program which provides Club O Gold members additional reward dollars for purchases made on our Website, and from other merchants.
Earned Club O Reward dollars may be redeemed on future purchases made through our Website. We recognize revenue for Club O Reward dollars when customers redeem such rewards as part of a purchase on our Website. We account for these transactions as multiple element arrangements and allocate the transaction price to separated performance obligations using their relative fair values. We include the fair value of reward dollars earned in deferred revenue at the time the reward dollars are earned. Club O Reward dollars expire 90 days after the customer's Club O Gold membership expires. We recognize estimated reward dollar breakage, to which we expected to be entitled, over the expected redemption period in proportion to actual redemptions by customers. Upon adoption of Topic 606, Revenue Contracts with Customers, on January 1, 2018, we began classifying the breakage income related to Club O Reward dollars and gift cards as a component of revenue in our consolidated statements of operations rather than as a component of Other income (expense), net. Breakage included in revenue was $1.3 million and $4.2 million for the three and nine months ended September 30, 2018. We also recognized a cumulative adjustment that reduced Accumulated deficit by approximately $5.0 million upon adoption related to the unredeemed portion of our gift cards and loyalty program rewards.
Our total deferred revenue related to the outstanding Club O Reward dollars was $6.6 million and $8.7 million at September 30, 2018 and December 31, 2017, respectively. The timing of revenue recognition of these reward dollars is driven by actual customer activities, such as redemptions and expirations.
Advertising Revenue
Advertising revenues is derived primarily from sponsored links and display advertisements that are placed on our Website, distributed via email, or sent out as direct mailers. Advertising revenue is recognized in net revenue when the advertising services are rendered. Advertising revenues were less than 2% of total net revenues for all periods presented.
Cost of goods sold
Cost of goods sold includes product costs, warehousing costs, outbound shipping costs, handling and fulfillment costs, customer service costs and credit card fees, and is recorded in the same period in which related revenues have been recorded.
Cost of goods sold, including product cost and other costs and fulfillment and related costs are as follows (in thousands):
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three months ended September 30, | | Nine months ended September 30, |
| 2018 | | 2017 | | 2018 | | 2017 |
Total revenue, net | $ | 440,580 |
| | 100 | % | | $ | 424,007 |
| | 100 | % | | $ | 1,369,044 |
| | 100 | % | | $ | 1,288,466 |
| | 100 | % |
Cost of goods sold | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
|
Product costs and other cost of goods sold | 334,156 |
| | 76 | % | | 321,678 |
| | 76 | % | | 1,039,518 |
| | 76 | % | | 977,827 |
| | 76 | % |
Fulfillment and related costs | 19,708 |
| | 4 | % | | 18,654 |
| | 4 | % | | 57,198 |
| | 4 | % | | 55,886 |
| | 4 | % |
Total cost of goods sold | 353,864 |
| | 80 | % | | 340,332 |
| | 80 | % | | 1,096,716 |
| | 80 | % | | 1,033,713 |
| | 80 | % |
Gross profit | $ | 86,716 |
| | 20 | % | | $ | 83,675 |
| | 20 | % | | $ | 272,328 |
| | 20 | % | | $ | 254,753 |
| | 20 | % |
Advertising expense
We expense the costs of producing advertisements the first time the advertising takes place and expense the cost of communicating advertising in the period during which the advertising space or airtime is used. Internet advertising expenses are recognized as incurred based on the terms of the individual agreements, which are generally: 1) a commission for traffic driven to our Website that generates a sale or 2) a referral fee based on the number of clicks on keywords or links to our Website generated during a given period. Advertising expense is included in Sales and marketing expenses and totaled $49.7 million and $41.2 million during the three months ended September 30, 2018 and 2017, respectively. For the nine months ended September 30, 2018 and 2017, advertising expenses totaled $207.5 million and $114.6 million, respectively. Prepaid advertising (included in Prepaids and other current assets in the accompanying consolidated balance sheets) was $1.2 million and $987,000 at September 30, 2018 and December 31, 2017, respectively.
Stock-based compensation
We measure compensation expense for all outstanding unvested share-based awards at fair value on the date of grant and recognize compensation expense over the service period for awards at the greater of a straight-line basis or on an accelerated schedule when vesting of the share-based awards exceeds a straight-line basis. When an award is forfeited prior to the vesting date, we recognize an adjustment for the previously recognized expense in the period of the forfeiture. See Note 9—Stock-Based Awards.
Self-funded health insurance
We have a partially self-funded health insurance plan for our employees. We maintain a stop-loss insurance policy through an insurance company that limits our losses both on a per employee basis and an aggregate basis. Although we intend to maintain this plan indefinitely, we may terminate, modify, suspend, or discontinue this plan at any time and for any reason.
We are responsible for estimating our liability for unpaid costs of insured events that have occurred, which includes known cases on a case-by-case basis, and also for events that have occurred, but have not yet been reported. The accrued liability related to the self-funded health insurance plan was $1.5 million and $1.0 million at September 30, 2018 and December 31, 2017, respectively, and is included in Accrued liabilities in the accompanying consolidated balance sheets. Actual claims may differ from the amount accrued and any difference could be significant.
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 Note 6—Commitments and Contingencies).
Income taxes
Our income tax provision for interim periods is determined using an estimate of our annual effective tax rate adjusted for discrete items, if any, for relevant interim periods. We update our estimate of the annual effective tax rate each quarter and make cumulative adjustments if our estimated annual effective tax rate changes.
Our quarterly tax provision and our quarterly estimate of our annual effective tax rate are subject to significant variations due to several factors including variability in predicting our pre-tax and taxable income and the mix of jurisdictions to which those items relate, relative changes in expenses or losses for which tax benefits are not recognized, how we do business, fluctuations in our stock price, and changes in law, regulations, and administrative practices. Our effective tax rate can be volatile based on the amount of pre-tax income. For example, the impact of discrete items on our effective tax rate is greater when pre-tax income is lower.
Each quarter we assess the recoverability of our deferred tax assets under ASC Topic 740. 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 limited carryback ability and do not have significant taxable temporary differences to recover our existing deferred tax assets, therefore we must rely on future taxable income, including tax planning strategies, to support their realizability. We have established a valuation allowance for our deferred tax assets not supported by carryback ability or taxable temporary differences, primarily due to uncertainty regarding our future taxable income. We have considered, among other things, the cumulative loss incurred over the three-year period ended September 30, 2018 as a significant piece of objective negative evidence. We intend to continue maintaining a valuation allowance on our net deferred tax assets until there is sufficient evidence to support the reversal of all or some portion of these allowances. The amount of the deferred tax asset considered realizable could be adjusted if objective negative evidence in the form of cumulative losses is no longer present and additional weight may be given to subjective evidence such as long-term projections for growth. We will continue to monitor the need for a valuation allowance against our remaining deferred tax assets on a quarterly basis.
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. On December 22, 2017, the President signed into law Public Law No. 115-97, commonly referred to as the Tax Cuts and Jobs Act ("TCJA"), following its passage by the United States Congress. The TCJA made significant changes to U.S. federal income tax laws, mostly effective for tax years beginning after December 31, 2017. Among many other changes, the new law lowers the corporate tax rate from 35% to 21% for tax years beginning in 2018, transitions U.S international taxation from a worldwide tax system to a territorial system, and includes a one-time transition tax on the mandatory deemed repatriation of cumulative foreign earnings as of December 31, 2017. Staff Accounting Bulletin No. 118 ("SAB 118") was issued to address the application of US GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the TCJA. As noted at year-end, however, we were able to reasonably estimate certain effects and, therefore, recorded adjustments associated with the remeasurement of certain deferred tax assets and liabilities and the mandatory deemed repatriation of cumulative foreign earnings.
Our accounting for the following elements of the TCJA is complete. The expense related to the remeasurement of certain deferred tax assets and liabilities, based on the rates at which they are expected to reverse in the future, was $25.2 million. The expense related to the one-time transition tax on the mandatory deemed repatriation of cumulative foreign earnings was $47,000. We did not make any measurement-period adjustments related to these items during the quarter because there were no significant changes to our provisional amounts, and therefore, there is no impact to our effective tax rate due to measurement-period adjustments.
The TCJA includes a provision to tax global intangible low-taxed income ("GILTI") of foreign subsidiaries beginning in 2018. Under GAAP, we can make an accounting policy election to either treat taxes due on the GILTI inclusion as a current period expense, or factor such amounts into our measurement of deferred taxes. We will elect to treat any potential GILTI inclusions as a period cost as we are not projecting any material impact from GILTI inclusions and any deferred taxes related to any inclusion would be immaterial.
The TCJA included a mandatory deemed repatriation of cumulative foreign earnings for the year ended December 31, 2017, for which we accrued U.S. tax expense. However, we would still need to accrue and pay various other taxes on this amount if repatriated, which we have not provided for because we intend to indefinitely reinvest these earnings outside the U.S. We have begun expansion of operations outside of the U.S. and have plans for additional expansion for which we have incurred
and will continue to incur capital requirements. We have considered ongoing capital requirements of the parent company in the U.S.
We are subject to taxation in the United States and several state and foreign jurisdictions. Tax years beginning in 2013 are subject to examination by taxing authorities, although net operating loss and credit carryforwards from all years are subject to examinations and adjustments for at least three years following the year in which the attributes are used. We are under audit by the Ireland Revenue Agency for the calendar year 2016. We expect the audit to continue during 2018.
Net loss per share
In 2016, we issued shares of our Blockchain Voting Series A Preferred Stock and our Voting Series B Preferred Stock (collectively the "preferred shares"). These shares are considered participating securities, and as a result, net loss per share is calculated using the two-class method. Under this method, we give effect to preferred dividends and then allocate remaining net loss attributable to our stockholders to both common shares and participating securities (based on the percentages outstanding) in determining net loss per common share.
Basic net loss per common share is computed by dividing net loss attributable to common shares (after allocating between common shares and participating securities) by the weighted average number of common shares outstanding during the period.
Diluted net loss per share is computed by dividing net loss attributable to common shares (after allocating between common shares and participating securities) by the weighted average number of common and potential common shares outstanding during the period (after allocating total dilutive shares between our common shares outstanding and our preferred shares outstanding). Potential common shares, comprising incremental common shares issuable upon the exercise of stock options, warrants, and restricted stock awards are included in the calculation of diluted net loss per common share to the extent such shares are dilutive. Net loss attributable to common shares is adjusted for options and restricted stock awards issued by our subsidiaries when the effect of our subsidiary's diluted earnings per share is dilutive.
The following table sets forth the computation of basic and diluted net loss per common share for the periods indicated (in thousands, except per share data):
|
| | | | | | | | | | | | | | | |
| Three months ended September 30, | | Nine months ended September 30, |
| 2018 | | 2017 | | 2018 | | 2017 |
Net loss attributable to stockholders of Overstock.com, Inc. | $ | (47,923 | ) | | $ | (786 | ) | | $ | (163,743 | ) | | $ | (14,188 | ) |
Less: Preferred stock dividends - declared and accumulated | 27 |
| | 27 |
| | 80 |
| | 80 |
|
Undistributed loss | (47,950 | ) | | (813 | ) | | (163,823 | ) | | (14,268 | ) |
Less: Undistributed loss allocated to participating securities | (1,055 | ) | | (22 | ) | | (3,728 | ) | | (386 | ) |
Net loss attributable to common shares | $ | (46,895 | ) | | $ | (791 | ) | | $ | (160,095 | ) | | $ | (13,882 | ) |
Net loss per common share—basic: | |
| | |
| | |
| | |
|
Net loss attributable to common shares—basic | $ | (1.55 | ) | | $ | (0.03 | ) | | $ | (5.47 | ) | | $ | (0.55 | ) |
Weighted average common shares outstanding—basic | 30,279 |
| | 25,003 |
| | 29,256 |
| | 25,024 |
|
Effect of dilutive securities: | |
| | |
| | |
| | |
|
Stock options and restricted stock awards | — |
| | — |
| | — |
| | — |
|
Weighted average common shares outstanding—diluted | 30,279 |
| | 25,003 |
| | 29,256 |
| | 25,024 |
|
Net loss attributable to common shares—diluted | $ | (1.55 | ) | | $ | (0.03 | ) | | $ | (5.47 | ) | | $ | (0.55 | ) |
The following shares were excluded from the calculation of diluted shares outstanding as their effect would have been anti-dilutive (in thousands):
|
| | | | | | | | | | | |
| Three months ended September 30, | | Nine months ended September 30, |
| 2018 | | 2017 | | 2018 | | 2017 |
Stock options and restricted stock units | 498 |
| | 192 |
| | 578 |
| | 165 |
|
Common shares issuable under stock warrant | — |
| | — |
| | 28 |
| | — |
|
Warrants
On November 8, 2017, we issued warrants to purchase up to a combined aggregate of 3,722,188 shares of our common stock to two purchasers in privately negotiated transactions, for an aggregate purchase price of $6.5 million, net of issuance costs. The exercise price for the warrants was $40.45 per share of common stock. On December 29, 2017, one of the warrant holders exercised its warrant in full and purchased a total of 2,472,188 shares of common stock for $100.0 million. On January 17, 2018, the other warrant holder exercised its warrant in full and purchased 1,250,000 shares of common stock for $50.6 million.
Recently adopted accounting standards
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606), 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. We adopted the new standard on January 1, 2018 with a cumulative adjustment that reduced Accumulated deficit by approximately $5.0 million as opposed to retrospectively adjusting prior periods. The adjustment primarily relates to the unredeemed portion of our gift cards and loyalty program rewards, which we will recognize over the expected redemption period, rather than waiting until the likelihood of redemption becomes remote or the rewards expire. We have also updated revenue disclosures in the notes to our financial statements as required under the new standard.
The implementation did not impact our gross and net recognition for our revenue transactions. In addition, we continue to recognize revenue related to merchandise sales upon delivery to our customers. However, we now present breakage on our Club O Rewards and gift cards in Partner and other revenue in our consolidated statement of operations rather as a component of Other expense, net.
In January 2016, the FASB issued ASU 2016-01, Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, which requires equity investments previously recognized under the cost method to be measured at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or similar investment of the same issuer. We adopted the changes under the new standard on January 1, 2018 on a prospective basis. The implementation of ASU 2016-01 did not have a material impact on our consolidated financial statements and related disclosures.
In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash, which requires amounts generally described as restricted cash be included with cash and cash equivalents when reconciling beginning-of-period and end-of-period total amounts shown in the statement of cash flows. We adopted the new standard on January 1, 2018 retrospectively to each period presented in the statement of cash flows. The implementation of ASU 2016-18 did not have a material impact on our consolidated financial statements and related disclosures.
In January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business, which provides guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. We adopted the changes under the new standard on January 1, 2018 on a prospective basis. The implementation of ASU 2017-01 did not have a material impact on our consolidated financial statements and related disclosures.
Recently issued accounting standards
In February 2016, the FASB issued ASU 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, with early adoption permitted. We plan to adopt this ASU beginning on January 1, 2019. 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.
In June 2018, the FASB issued ASU 2018- 07, Compensation-Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting; which aligns the measurement and classification guidance for share-based payments to nonemployees with the guidance for share-based payments to employees, with certain exceptions. Under the guidance, the measurement of equity-classified nonemployee awards will be fixed at the grant date. The new standard becomes effective for us on January 1, 2019, with early adoption permitted. We plan to adopt this ASU beginning on January 1, 2019. We do not expect the adoption to have a material impact on our consolidated financial statements and related disclosures.
3. ACQUISITIONS, GOODWILL, AND ACQUIRED INTANGIBLE ASSETS
Verify Investor, LLC
On February 12, 2018, tZERO acquired 81% of the total equity interests of Verify Investor, LLC, an accredited investor verification company, for a total purchase price of $12.0 million in cash. With the acquisition of the majority interest in Verify Investor, LLC, tZERO plans to integrate the software and technology of Verify Investor, LLC with the Token Trading System that tZERO plans to develop and deploy. We estimated the fair value of the acquired assets based on Level 3 inputs, which were unobservable (see Note 2—Accounting Policies, Fair value of financial instruments). These inputs included our estimate of future revenues, operating margins, discount rates, royalty rates and assumptions about the relative competitive environment.
The fair values of the assets acquired and liabilities assumed at the acquisition date are as follows (in thousands):
|
| | | |
Purchase Price | Fair Value |
Cash paid, net of cash acquired | $ | 11,769 |
|
Allocation | |
Intangible assets | $ | 7,400 |
|
Goodwill | 7,360 |
|
Other assets acquired | 3 |
|
Other liabilities assumed | (179 | ) |
Total net assets, net of cash acquired | 14,584 |
|
Less: noncontrolling interest | (2,815 | ) |
Total net assets attributable to tZERO, net of cash acquired | $ | 11,769 |
|
The following table details the identifiable intangible assets acquired at their fair value and estimated useful lives as of September 30, 2018 (amounts in thousands):
|
| | | | | |
Intangible Assets | Fair Value | | Estimated Useful Life (in years) |
Technology and developed software | $ | 6,300 |
| | 10 |
Trade name | 700 |
| | 10 |
Customer relationships | 400 |
| | 0.5 |
Total acquired intangible assets at the acquisition date | 7,400 |
| | |
Less: accumulated amortization of acquired intangible assets | 904 |
| | |
Total acquired intangible assets, net | $ | 8,304 |
| | |
The expense for amortizing intangible assets acquired in connection with this acquisition was $302,000 and $904,000 for the three and nine months ended September 30, 2018, respectively.
Acquired intangible assets primarily include technology, trade name, and customer relationships. As described above, we determined the fair value of these assets using an income approach method to determine the present value of expected future
cash flows for each identifiable intangible asset. This method was based on discount rates which incorporate a risk premium to take into account the risks inherent in those expected cash flows. The expected cash flows were estimated based on the company's historical operating results.
The acquired assets, liabilities, and associated operating results were consolidated into our financial statements at the acquisition dates, or the dates on which we obtained control of the acquired assets or interests.
Mac Warehouse, LLC
On June 25, 2018, we acquired 100% of the total equity interests of Mac Warehouse, LLC, an electronics retailer of refurbished Apple products, for a total purchase price of $1.2 million in cash. With the acquisition of Mac Warehouse, LLC, we plan to integrate the inventory and business processes of Mac Warehouse, LLC in our direct retail business. We estimated the fair value of the acquired assets based on Level 3 inputs, which were unobservable (see Note 2—Accounting Policies, Fair value of financial instruments). These inputs included our estimate of future revenues, operating margins, discount rates, royalty rates and assumptions about the relative competitive environment.
Determination and allocation of the purchase price to net tangible and intangible assets is based upon preliminary estimates. These preliminary estimates and assumptions could change significantly during the measurement period as we finalize the valuations of the net tangible and intangible assets acquired and liabilities assumed. Any change could result in variances between our future financial results and the amounts recognized in the financial information presented below, including variances in fair values recorded, as well as expenses associated with these items.
The preliminary estimated fair values of the assets acquired and liabilities assumed at the acquisition date are as follows (in thousands):
|
| | | |
Purchase Price | Fair Value |
Cash paid, net of cash acquired | $ | 1,143 |
|
Allocation | |
Accounts receivable, net | $ | 399 |
|
Inventories, net | 1,772 |
|
Prepaids and other current assets | 29 |
|
Fixed assets | 154 |
|
Intangible assets | 2,763 |
|
Accounts payable | (682 | ) |
Accrued liabilities | (223 | ) |
Long-term debt, net | (3,069 | ) |
Total net assets, net of cash acquired | $ | 1,143 |
|
Acquired intangible assets primarily include trade name and customer relationships which have an estimated useful life of 18 months.
The acquired assets, liabilities, and associated operating results were consolidated into our financial statements at the acquisition dates, or the dates on which we obtained control of the acquired assets or interests.
The following unaudited pro forma financial information presents our results as if the current year acquisitions of Mac Warehouse, LLC had occurred at the beginning of 2017 (amounts in thousands):
|
| | | | | | | | | | | | | | | |
| Three months ended September 30, | | Nine months ended September 30, |
| 2018 | | 2017 | | 2018 | | 2017 |
Total revenue | $ | 440,580 |
| | $ | 428,309 |
| | $ | 1,373,228 |
| | $ | 1,300,365 |
|
Consolidated net loss | $ | (49,257 | ) | | $ | (778 | ) | | $ | (171,673 | ) | | $ | (14,472 | ) |
The unaudited pro forma financial information is not intended to represent or be indicative of our consolidated results of operations that would have been reported had the acquisition been completed during the periods indicated, nor should it be taken as indicative of our future consolidated results of operations.
4. ACCRUED LIABILITIES
Accrued liabilities consist of the following (in thousands):
|
| | | | | | | |
| September 30, 2018 | | December 31, 2017 |
| | | |
Sales and other taxes payable | $ | 20,254 |
| | $ | 2,363 |
|
Accounts payable accruals | 16,393 |
| | 16,614 |
|
Accrued compensation and other related costs | 16,200 |
| | 10,716 |
|
Accrued marketing expenses | 13,446 |
| | 25,959 |
|
Allowance for returns | 12,448 |
| | 17,391 |
|
Accrued loss contingencies | 10,304 |
| | 608 |
|
Accrued freight | 6,754 |
| | 5,040 |
|
Other accrued expenses | 4,954 |
| | 3,920 |
|
Total accrued liabilities | $ | 100,753 |
| | $ | 82,611 |
|
5. BORROWINGS
High Bench Senior Credit Agreement
On June 25, 2018, we became party to a senior credit agreement, as amended, with High Bench-Mac Warehouse-Senior Debt, LLC ("High Bench Loan"), in connection with our acquisition of Mac Warehouse, LLC. Under the amended agreement, the loan carries an annual interest rate of 11.0% and a default rate of 18.0%. The High Bench Loan is subject to monthly interest only payments with the remaining principal amount and any then unpaid interest due and payable on April 18, 2020. The High Bench Loan is subject to mandatory prepayment under certain circumstances, and is prepayable at our election at any time without penalty or premium. There are no financial covenants associated the High Bench Loan. At September 30, 2018, our outstanding balance on the High Bench Loan was $3.1 million.
Letters of credit
At September 30, 2018 and December 31, 2017, letters of credit totaling $280,000 and $355,000, respectively, were issued on our behalf collateralized by compensating cash balances held at a bank, which are included in Restricted cash in our consolidated balance sheets.
Commercial purchasing card agreement
We have a commercial purchasing card (the "Purchasing Card") agreement. We use the Purchasing Card for business purpose purchasing and must pay it in full each month. At September 30, 2018, $107,000 was outstanding and $893,000 was available under the Purchasing Card. At December 31, 2017, $822,000 was outstanding and $4.2 million was available under the Purchasing Card.
Capital lease
During the year ended December 31, 2017, we entered into a capital lease arrangement of computer equipment for $1.4 million. The arrangement will expire in 2020. At September 30, 2018, the outstanding balance under the capital lease was $1.0 million and is included in Other current liabilities, net and Other long-term liabilities on our consolidated balance sheets. Future payment obligations, including interest, under the capital lease are $124,000, $496,000 and $413,000 for the rest of 2018, 2019 and 2020, respectively.
6. COMMITMENTS AND CONTINGENCIES
Summary of future minimum lease payments for all operating leases
Minimum future payments under all operating leases as of September 30, 2018, are as follows (in thousands):
|
| | | | |
Payments due by period | | |
2018 (Remainder) | | $ | 1,757 |
|
2019 | | 7,446 |
|
2020 | | 5,648 |
|
2021 | | 6,038 |
|
2022 | | 6,156 |
|
Thereafter | | 17,515 |
|
| | $ | 44,560 |
|
Rental expense for operating leases totaled $1.9 million and $2.1 million for the three months ended September 30, 2018 and 2017, respectively, and $5.3 million and $7.0 million for the nine months ended September 30, 2018 and 2017, respectively.
Legal proceedings and contingencies
From time to time, we are involved in litigation concerning consumer protection, employment, intellectual property, claims under the securities laws, and other commercial matters 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. In some instances, other parties may have contractual indemnification obligations to us. However, such contractual obligations may prove unenforceable or non-collectible, and if we cannot enforce or collect on indemnification obligations, we may bear the full responsibility for damages, fees and costs resulting from such litigation. We may also be subject to penalties and equitable remedies that could force us to alter important business practices. Such litigation could be costly and time consuming and could divert or distract our management and key personnel from our business operations. 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 materially affect our business, results of operations, financial position, or cash flows. The nature of the loss contingencies relating to claims that have been asserted against us are described below.
On September 23, 2009, SpeedTrack, Inc. sued us along with 27 other defendants in the United States District Court in the Northern District of California. We are alleged to have infringed a patent covering search and categorization software. We believe that certain third-party vendors of products and services sold to us are contractually obligated to indemnify us, and we have tendered defense of the case to an indemnitor who accepted the defense. On April 21, 2016, the court entered an order partially dismissing the claims against us. On May 4, 2016, the plaintiff filed an amended complaint, and we filed our answer. No estimate of the possible loss or range of loss can be made. We intend to vigorously defend this action and pursue our indemnification rights with our vendors.
On February 11, 2013, RPost Holdings, Inc., RPost Communications Limited, and RMail Limited, filed suit against us in the United States District Court in the Eastern District of Texas for infringement of patents covering products and services that verify the delivery and integrity of email messages. We tendered defense of the case to an indemnitor who accepted the defense. No estimate of the possible loss or range of loss can be made. We intend to vigorously defend this action and pursue our indemnification rights with our vendors.
On September 20, 2018, a jury returned a verdict against us in our Delaware unclaimed property case, which is expected to result in a judgment against us in the amount of approximately $7.3 million (for certain unredeemed gift card balances, treble damages, and penalties) plus attorneys’ fees and costs. Our estimated liability for these amounts has been included in Accrued liabilities as of September 30, 2018 and the expense associate with these litigation charges are included in general and administrative expense in our consolidated statement of operations for the three and nine months ended September 30, 2018. William French ("French") and the State of Delaware ("Delaware") sued us, along with numerous other defendants, in the Superior Court of the State of Delaware for alleged violations of Delaware's unclaimed property laws. French and Delaware alleged that we knowingly refused to fulfill obligations under Delaware's Abandoned Property Law by failing to report and deliver unclaimed gift card funds to the State of Delaware, and knowingly made, used or caused to be made or used, false
statements and records to conceal, avoid or decrease an obligation to pay or transmit money to Delaware in violation of the Delaware False Claims and Reporting Act. We intend to file an appeal once the judgment has been entered by the court.
On June 21, 2018, the U.S. Supreme Court issued an opinion in our South Dakota sales tax case and ruled against us. The State of South Dakota sued us along with three other defendants in the Sixth Judicial Circuit Court of South Dakota alleging that U.S. constitutional law should be revised to permit South Dakota to require out-of-state e-commerce websites to collect and remit sales tax in South Dakota in accordance with South Dakota's sales tax statute. Under the U.S. Supreme Court’s ruling, the longstanding Quill Corp v. North Dakota sales tax case was overruled, and states may now require remote sellers to collect sales tax under certain circumstances. We began collecting sales tax in all 45 states that have sales tax. Pursuant to South Dakota’s statute, we are not required to pay sales tax retroactively. The U.S. Supreme Court’s opinion vacated and remanded the case back to the South Dakota Supreme Court for further proceedings.
On July 7, 2017, the State of Wyoming sued us along with five other defendants in the Second Judicial District Court of Wyoming. Wyoming alleged that U.S. constitutional law should be revised to permit Wyoming to require out-of-state e-commerce retailers to collect and remit sales tax in Wyoming in accordance with Wyoming's sales tax statute. After the U.S. Supreme Court’s ruling in our South Dakota case listed above, we began collecting sales tax in Wyoming. Wyoming’s statute does not require us to pay sales tax retroactively. The Wyoming case has not yet been dismissed.
On August 28, 2017, the State of Indiana sued us along with one other defendant in the Superior Court of Indiana, Marion County. Indiana alleged that U.S. constitutional law should be revised to permit Indiana to require out-of-state e-commerce retailers to collect and remit sales tax in Indiana in accordance with Indiana's sales tax statute. After the U.S. Supreme Court’s ruling in our South Dakota case listed above, we began collecting sales tax in Indiana. Indiana’s statute does not require us to pay sales tax retroactively. The Indiana case was dismissed August 16, 2018.
In February 2018, the Division of Enforcement of the SEC informed tZERO and subsequently informed us that it is conducting an investigation and requested that we and tZERO voluntarily provide certain information and documents related to tZERO and the tZERO security token offering in connection with its investigation. We are cooperating fully with the SEC in connection with its investigation.
tZERO's broker-dealer subsidiaries are, and any broker-dealer subsidiaries that it acquires or forms in the future will be, subject to extensive regulatory requirements under federal and state laws and regulations and self-regulatory organization ("SRO") rules. Each of SpeedRoute and PRO Securities is registered with the SEC as a broker-dealer under the Exchange Act and in the states in which it conducts securities business and is a member of FINRA and other SROs (as applicable). In addition, PRO Securities owns and operates the PRO Securities ATS, which is registered with the SEC as an alternative trading system. Each of SpeedRoute and PRO Securities is 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 it is registered or licensed or of which it is a member. On February 22, 2018, the SEC's New York Regional Office notified PRO Securities that it is conducting an examination of PRO Securities, and on March 6, 2018 the SEC's Boston Regional Office notified tZERO Advisors that it is conducting an examination of tZERO Advisors. These examinations remain open.
As a result of tZERO's projects seeking to apply distributed ledger technologies to the capital markets, tZERO's subsidiaries have been, and remain involved in, ongoing discussions with regulatory authorities. While certain of the discussions have been relatively informal, tZERO's broker-dealer subsidiaries have also received and responded to several written inquiries from FINRA relating to such projects. While tZERO considers these continuing inquiries to be ordinary course in light of the non-traditional nature of tZERO's distributed ledger projects, any failure by tZERO's broker-dealer subsidiaries to satisfy their regulatory authorities that they are in compliance with all applicable rules and regulations could have a material adverse effect on tZERO and on us.
In addition, in December 2017, SpeedRoute received a letter from FINRA stating that the Department of Enforcement at FINRA has received a referral from the staff of FINRA's Department of Market Regulation relating to rules applicable to supervision and required supervisory procedures for review of certain potential trading activity, such as pre-arranged trades or wash trades. In addition, SpeedRoute continues to have discussions with FINRA about several matters, including a matter related to potential violations of FINRA rules relating to Order Audit Trail System reporting and trading practice matters, and has received document requests from FINRA in connection with certain ongoing matters. SpeedRoute has received and responded to inquiries from FINRA and the SEC. In an unrelated matter, SpeedRoute and PRO Securities have been named in a FINRA investigatory matter in which FINRA has conducted on the record interviews of certain senior officers of SpeedRoute and PRO Securities, who are also senior officers of tZERO.
On March 29, 2018, a purported securities class action lawsuit was filed against us and two of our executives in the United States District Court in the Central District of Utah, alleging violations of the Securities Exchange Act of 1934 ("Exchange Act"). On April 6, 2018, a substantially similar lawsuit was filed in the same court also naming the Company, and two of our executives as defendants, bringing the same claims under the Exchange Act, and seeking substantially similar relief. On June 20, 2018, the Court consolidated the two cases and appointed a lead plaintiff in the case. On August 7, 2018, the plaintiffs voluntarily dismissed the lawsuit without prejudice.
We have recognized liabilities for contingencies deemed probable and estimable totaling $10.3 million and $608,000 at September 30, 2018 and December 31, 2017, which are included in Accrued liabilities in our consolidated balance sheets. It is reasonably possible that the actual losses may exceed our accrued liabilities.
7. INDEMNIFICATIONS AND GUARANTEES
During our normal course of business, we have made certain indemnities, commitments, and guarantees under which we may be required to make payments in relation to certain transactions. These indemnities include, but are not limited to, indemnities to various lessors in connection with facility leases for certain claims arising from such facility or lease, the environmental indemnity we entered into in favor of the lenders under our prior loan agreements, customary indemnification arrangements in underwriting agreements and similar agreements, and indemnities to our directors and officers to the maximum extent permitted under the laws of the State of Delaware. The duration of these indemnities, commitments, and guarantees varies, and in certain cases, is indefinite. In addition, the majority of these indemnities, commitments, and guarantees do not provide for any limitation of the maximum potential future payments we could be obligated to make. As such, we are unable to estimate with any reasonableness our potential exposure under these items. We have not recorded any liability for these indemnities, commitments, and guarantees in the accompanying consolidated balance sheets. We do, however, accrue for losses for any known contingent liability, including those that may arise from indemnification provisions, when future payment is both probable and reasonably estimable.
8. STOCKHOLDERS' EQUITY
Common Stock
Each share of common stock has the right to one vote. The holders of common stock are also entitled to receive dividends declared by the Board of Directors out of funds legally available, subject to prior rights of holders of all classes of stock outstanding having priority rights as to dividends. No dividends have ever been declared or paid on our common stock.
Preferred Stock
Each share of Series A Preferred and each share of Series B Preferred (collectively the "preferred shares") is intended to have voting and dividend rights similar to those of one share of common stock. Preferred shares rank senior to common stock with respect to dividends. Holders of the preferred shares will be entitled to an annual cash dividend of $0.16 per share, in preference to any dividend payment to the holders of the common stock, out of funds of the Company legally available for payment of dividends and subject to declaration by our Board of Directors. Holders of the preferred shares are also entitled to participate in any cash dividends we pay to the holders of the common stock and are also entitled to participate in non-cash dividends we pay to holders of the common stock, subject to potentially different treatment if we effect a stock dividend, stock split or combination of the common stock. There are no arrearages in cumulative preferred dividends. We declared and paid a cash dividend of $0.16 per share on our preferred stock during 2017.
Neither the Series A Preferred or Series B Preferred is convertible into or exchangeable for shares of our common stock or any other entity; however, at our sole discretion, we may convert the Series A Preferred shares into Series B Preferred shares at any time on a one-to-one basis. Until the third anniversary of the original issuance date, we may redeem, at our discretion, both the Series A and Series B Preferred shares for an amount equal to the highest of the following: (1) the subscription price plus any accrued but unpaid dividends, (2) 105% of the average trading price of our common stock during a five-trading-day period and (3) 105% of the average trading price of the series of preferred shares during the same five-day-trading period. In the event of any liquidation, any amount available for distribution to stockholders after payment of all liabilities will be distributed proportionately, with each share of Series A Preferred and each share of Series B Preferred being treated as though it were a share of our common stock.
JonesTrading Sales Agreement
In August 2018, we entered into a sales agreement with JonesTrading Institutional Services LLC ("JonesTrading"), under which we conducted "at the market" public offerings of our common stock during the quarter ended September 30, 2018 and may conduct additional "at the market" public offerings of our common stock from time to time. Under the sales agreement, JonesTrading, acting as our agent, may offer our common stock in the market on a daily basis or otherwise as we request from time to time. We have no obligation to sell additional shares under the sales agreement, but expect to do so from time to time. We will pay JonesTrading up to a 2.0% sales commission on all sales. The sales agreement contemplates sales of up to $150 million of our common stock over a period of up to three years. As of September 30, 2018, we had sold 2,883,344 shares of our common stock pursuant to the sales agreement and have received $94.6 million in proceeds, net of $2.6 million of offering costs, including commissions paid to JonesTrading. The average price per share of stock sold pursuant to the sales agreement during the quarter ended September 30, 2018, excluding offering costs, was $33.71.
JonesTrading Standby Equity Agreement
In August 2018 we also entered into a standby equity underwriting agreement with JonesTrading. We did not sell any shares under the standby equity underwriting agreement, and the agreement terminated in accordance with its terms during the quarter ended September 30, 2018. Under the standby underwriting agreement, we had the right, but no obligation, to sell up to $50 million of our common stock to JonesTrading, as underwriter, for sale to the public in a firm commitment public offering. We paid a 1% commitment fee to JonesTrading for entering into the underwriting agreement.
GSR Agreements
As previously announced, in August 2018, Overstock signed a Token Purchase Agreement with GSR Capital Ltd., a Cayman Islands exempted company ("GSR"), and a term sheet contemplating a sale of Overstock common stock to GSR. Concurrently, tZERO signed a term sheet contemplating a sale of tZERO common stock to GSR.
The Token Purchase Agreement sets forth the terms on which GSR agreed to purchase, for $30 million, on May 6, 2019 or such other date as may be agreed by the parties, security tokens at a price of $6.67 per security token. These security tokens were issued by tZERO to Overstock in satisfaction of $30 million of tZERO's indebtedness to Overstock. We may be required to obtain additional tokens in order to fulfill our obligations under the agreement. The agreement states that the obligations of GSR to complete the transaction described will be subject to conditions, some of which are unidentified.
Overstock, tZERO and GSR are currently negotiating definitive agreements for GSR's purchase of Overstock common stock and tZERO common stock. Although we continue to negotiate the terms, GSR has proposed purchasing fewer shares and at a lower price per share than those described in the Overstock term sheet. We believe that if a definitive agreement is reached regarding the purchase of tZERO shares, the terms, including the post money valuation of tZERO, may be less favorable than those described in the tZERO term sheet. Both the Overstock and tZERO term sheets constitute binding agreements for the parties to negotiate in good faith the terms of the transaction documents; however, the obligation to negotiate in good faith terminates on December 15, 2018, if any of the closing conditions, one of which is the negotiation, execution and delivery of mutually acceptable transaction documents, have not been satisfied. While we expect to complete these transactions, there can be no assurance that Overstock, tZERO or GSR will enter into definitive agreements regarding either of the proposed transactions.
9. STOCK-BASED AWARDS
We have equity incentive plans that provide for the grant to employees and board members of stock-based awards, including stock options and restricted stock. Stock-based compensation expense was as follows (in thousands):
|
| | | | | | | | | | | | | | | |
| Three months ended September 30, | | Nine months ended September 30, |
| 2018 | | 2017 | | 2018 | | 2017 |
Overstock restricted stock awards | $ | 1,779 |
| | $ | 1,015 |
| | $ | 6,863 |
| | $ | 3,000 |
|
Medici Ventures stock options | 138 |
| | 9 |
| | 273 |
| | 9 |
|
tZERO equity awards | 329 |
| | — |
| | 4,518 |
| | — |
|
Total stock-based compensation expense | $ | 2,246 |
| | $ | 1,024 |
| | $ | 11,654 |
| | $ | 3,009 |
|
Overstock restricted stock awards
The Overstock.com, Inc. Amended and Restated 2005 Equity Incentive Plan provides for the grant of restricted stock units and other types of equity awards of the Company. The restricted stock awards generally vest over three years at 33.3% at the end of the first year, 33.3% at the end of the second year and 33.3% at the end of the third year; subject to the recipient's continuing service to us.
The following table summarizes restricted stock award activity during the nine months ended September 30, 2018 (in thousands): |
| | | | | | |
| Nine months ended September 30, 2018 |
| Units | | Weighted Average Grant Date Fair Value |
Outstanding—beginning of year | 540 |
| | $ | 17.05 |
|
Granted at fair value | 360 |
| | 68.85 |
|
Vested | (226 | ) | | 17.29 |
|
Forfeited | (109 | ) | | 43.63 |
|
Outstanding—end of period | 565 |
| | $ | 44.82 |
|
Medici Ventures stock options
The Medici Ventures, Inc. 2017 Stock Option Plan provides for the grant of options to employees and directors of and consultants to Medici Ventures to acquire up to 10% of the authorized shares of Medici Ventures' common stock. During the nine months ended September 30, 2018, Medici Ventures granted 19,700 stock options with a cumulative grant date fair value of $1.7 million which vest over a three year period. During the year ended December 31, 2017, Medici Ventures granted 74,750 stock options to certain Medici Ventures and Overstock employees with a cumulative grant date fair value of $91,000 which will be expensed on a straight-line basis over the vesting period of three years.
tZERO equity awards
The tZERO.com 2017 Equity Incentive Plan provides for grant of options to employees and directors of and consultants to tZERO to acquire up to 5% of the authorized shares of tZERO's common stock. In January 2018, tZERO granted stock awards under the equity incentive plan for an aggregate of approximately 1.0% of tZERO's common stock all of which vested on January 23, 2018. In January 2018, tZERO recognized $4.0 million in compensation expense associated with these awards, which was the entire estimated fair value at the grant date. Accordingly, there is no expense to be recognized in future periods related to these awards. As a result of these vested awards, our indirect ownership interest in tZERO was reduced from 81% to approximately 80%. During the nine months ended September 30, 2018, tZERO granted awards to acquire 382 shares of its stock with a cumulative grant date fair value of $3.1 million which will be expensed on a straight-line basis over the vesting period of two to three years. No awards were issued during the year ended December 31, 2017.
10. BUSINESS SEGMENTS
Segment information has been prepared in accordance with ASC Topic 280 Segment Reporting. We determined our segments based on how we manage our business, which, in our view, consists primarily of our Retail and Medici businesses. Our Retail business consists of our Direct and Partner reportable segments. We use gross profit as the measure to determine our reportable segments because there is not discrete financial information available below gross profit for our Direct and Partner segments. As a result, our Medici business is not significant as compared to our Direct and Partner segments and is included in Other. Our Other segment consists of Medici Ventures and its subsidiaries, including tZERO. Although our Direct and Partner segments both relate to our Retail business, we do not combine these segments because they have dissimilar economic characteristics, such as gross profit margins. We do not allocate assets between our segments for our internal management purposes, and as such, they are not presented here. There were no significant inter-segment sales or transfers during the three and nine months ended September 30, 2018 and 2017.
The following table summarizes information about reportable segments for three and nine months ended September 30, 2018 and 2017 (in thousands):
|
| | | | | | | | | | | | | | | | | | | |
| Three months ended September 30, |
| Direct | | Partner | | Retail Total | | Other | | Total |
2018 | |
| | |
| | | | | | |
|
Revenue, net | $ | 15,424 |
| | $ | 420,351 |
| | $ | 435,775 |
| | $ | 4,805 |
| | $ | 440,580 |
|
Cost of goods sold | 16,205 |
| | 334,446 |
| | 350,651 |
| | 3,213 |
| | 353,864 |
|
Gross profit | $ | (781 | ) | | $ | 85,905 |
| | $ | 85,124 |
| | $ | 1,592 |
| | $ | 86,716 |
|
Operating expenses | |
| | |
| | 124,571 |
| | 9,977 |
| | 134,548 |
|
Interest and other expense, net (1) | |
| | |
| | (515 | ) | | (1,051 | ) | | (1,566 | ) |
Pre-tax loss | | | | | (39,962 | ) | | (9,436 | ) | | (49,398 | ) |
Provision for (benefit from) income taxes | |
| | |
| | (155 | ) | | 14 |
| | (141 | ) |
Net loss (2) | |
| | |
| | $ | (39,807 | ) | | $ | (9,450 | ) | | $ | (49,257 | ) |
| | | | | | | | | |
2017 | |
| | |
| | | | | | |
|
Revenue, net | $ | 19,645 |
| | $ | 400,419 |
| | $ | 420,064 |
| | $ | 3,943 |
| | $ | 424,007 |
|
Cost of goods sold | 19,577 |
| | 318,121 |
| | 337,698 |
| | 2,634 |
| | 340,332 |
|
Gross profit | $ | 68 |
| | $ | 82,298 |
| | $ | 82,366 |
| | $ | 1,309 |
| | $ | 83,675 |
|
Operating expenses | |
| | |
| | 90,592 |
| | 4,958 |
| | 95,550 |
|
Interest and other income (expense), net (1) | |
| | |
| | 5,375 |
| | (17 | ) | | 5,358 |
|
Pre-tax loss | | | | | (2,851 | ) | | (3,666 | ) | | (6,517 | ) |
Benefit from income taxes | |
| | |
| | (3,993 | ) | | (1,419 | ) | | (5,412 | ) |
Net income (loss) (2) | |
| | |
| | $ | 1,142 |
| | $ | (2,247 | ) | | $ | (1,105 | ) |
|
| | | | | | | | | | | | | | | | | | | |
| Nine months ended September 30, |
| Direct | | Partner | | Retail Total | | Other | | Total |
2018 | |
| | |
| | | | | | |
|
Revenue, net | $ | 46,409 |
| | $ | 1,307,045 |
| | $ | 1,353,454 |
| | $ | 15,590 |
| | $ | 1,369,044 |
|
Cost of goods sold | 45,649 |
| | 1,039,834 |
| | 1,085,483 |
| | 11,233 |
| | 1,096,716 |
|
Gross profit | $ | 760 |
| | $ | 267,211 |
| | $ | 267,971 |
| | $ | 4,357 |
| | $ | 272,328 |
|
Operating expenses | |
| | |
| | 399,540 |
| | 41,550 |
| | 441,090 |
|
Interest and other income (expense), net (1) | |
| | |
| | 654 |
| | (1,966 | ) | | (1,312 | ) |
Pre-tax loss | | | | | (130,915 | ) | | (39,159 | ) | | (170,074 | ) |
Benefit from income taxes | |