Overstock.com 2002 Annual Report Download - page 20

Overview
We are an online "closeout" retailer offering discount brand name merchandise, including bed-and-bath goods, kitchenware, watches, jewelry,
electronics, sporting goods and designer accessories. Our company, based in Salt Lake City, Utah, was founded in 1997, and we launched our first Website
through which customers could purchase products in March 1999.
Our revenue is comprised of direct revenue, commission revenue and warehouse revenue. During 2002 no single customer accounted for more than 2%
of our total revenue other than Safeway, Inc., which accounted for 15.9% of our total revenue. Direct revenue includes sales made to individual consumers
and businesses, which are fulfilled from our warehouse in Salt Lake City, Utah. We generate business-to-business (B2B) sales when we contact retailers by
phone and email and offer them our merchandise below wholesale prices, allowing them an opportunity to be more price-competitive in their local markets.
After we establish a relationship with a B2B client, the client sometimes places subsequent orders directly through our B2B Website. Our B2B calling effort
began in October 2001, so our historical direct revenue has predominantly been based on individual consumer purchases made directly through our consumer
Website. In February 2002, we implemented a policy intended to reduce the number of returned products. This new policy provides that we will not accept
product returns initiated more than fifteen days after purchase.
Our commission revenue is derived from two sources, consumer commission revenue and B2B commission revenue. Consumer commission revenue is
generated when we receive commissions for selling the merchandise of other retailers, cataloguers or manufacturers through our consumer Website. We do
not own or physically handle the merchandise for these transactions, as the entities with which we have a commission-based, third-party relationship ship the
products directly to the end customer. Similar to the manner in which we generate consumer commission revenue, we generate B2B commission revenue
when we receive commissions for selling the merchandise of third parties through our B2B Website.
Our warehouse revenue is derived from sales that liquidate products that cannot be economically sold on our Websites due to their low price points, bulk,
irregular size or other factors. Historically, we held our warehouse sales in various physical locations. We held our first warehouse sale from November 2000
to January 2001, primarily to liquidate residual products from the purchase of the entire inventory of a distressed toy retailer. We initiated a second warehouse
sale in February 2002, primarily to liquidate residual products from our acquisition of Gear.com. Currently, we operate a warehouse store in our Salt Lake
City warehouse facility for customers to buy certain products directly. Sales from our warehouse store in 2002 accounted for less than 2% of total revenue.
Cost of goods sold for direct revenue primarily consists of the cost of the product, as well as inbound and outbound freight, fixed warehouse costs,
warehouse handling costs, credit card fees, and customer service costs. For commission revenue, cost of goods sold includes credit card fees and customer
service costs. As commission revenue grows in relation to direct revenue, gross margins improve because third party commissions have higher gross margins
than direct revenue. However, B2B gross margins are typically less than individual consumer gross margins. Therefore, future overall gross margins will be
impacted by the blend of net revenues from these sales channels. Cost of goods sold also includes related stock-based compensation for each respective
period.
Sales and marketing expenses consist primarily of advertising, public relations and promotional expenditures, as well as payroll and related expenses for
personnel engaged in marketing and selling activities. Advertising expense is the largest component of our sales and marketing expenses and is primarily
attributable to expenditures related to online marketing activities. For example, our advertising expenses totaled approximately $10.8 million, $4.8 million and
$7.0 million during the years ended December 31, 2000, 2001 and 2002, respectively. We expect our sales and marketing expenses to increase in future
periods on an absolute dollar basis as we expect to continue to increase our online marketing efforts.
General and administrative expenses consist of wages and benefits for executive, accounting and administrative personnel, rents and utilities, travel and
entertainment, depreciation and amortization and other general corporate expenses.
Amortization of goodwill during 2000 and 2001 resulted from the acquisition of Gear.com, Inc. in November 2000. We acquired Gear.com, an online
sporting goods company that was based in Seattle, Washington in November 2000 for 2.1 million shares of our common stock, options to purchase 181,000
shares of our common stock and the assumption of $3.4 million in liabilities. The acquisition of Gear.com was accounted for using the purchase method of
accounting, for which we recorded goodwill of approximately $6.2 million. The assets we acquired included cash, inventory, prepaid expenses and property
and equipment of $3.5 million, $3.6 million, $495,000 and $787,000, respectively. Following the acquisition date, we directed the traffic from the Gear.com
Website to the sporting goods section of the Overstock.com Website, the warehouse operations of Gear.com were closed and the inventory was moved to our
warehouse facility in Salt Lake City, Utah. Subsequent to the acquisition date, the operations of Gear.com ceased, and Gear.com was dissolved. In June 2001,
the Financial Accounting Standards Board (FASB) issued SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 142 addresses the initial
recognition and measurement of intangible assets acquired in a business combination and the accounting for goodwill and other intangible assets subsequent
to their acquisition. SFAS No. 142 provides that intangible assets with finite useful lives be amortized and that goodwill and intangible assets with indefinite
lives will not be amortized, but will rather be tested at least annually for impairment. We adopted SFAS No. 142 for the fiscal year beginning January 1, 2002.
Under this pronouncement, the remaining goodwill is not amortized, but is evaluated at least annually for impairment.
We have recorded no provision or benefit for federal and state income taxes as we have incurred net operating losses since inception. As of
December 31, 2002, we had $51.3 million of net operating loss carryforwards, of which $14.4 million is subject to limitation. These net operating loss
carryforwards will begin to expire in 2019. We have provided a full valuation allowance on the deferred tax asset, consisting primarily of net operating loss
carryforwards, because of uncertainty regarding its realizability (see Note 18 of Notes to Consolidated Financial Statements).
Both direct and commission revenue are seasonal, with revenues historically being the highest in the fourth quarter, reflecting higher consumer holiday
spending. We anticipate this will continue in the foreseeable future. With the exception of our acquisition of Gear.com, we have achieved our historical
growth from internal operations.
Critical Accounting Policies
Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America.
The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and
expenses. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual
results may differ from these estimates under different assumptions or conditions. Our critical accounting policies are as follows: