Overstock.com 2003 Annual Report Download - page 25

however, that we will hire additional staff during 2004, and that we therefore may not realize a $1.5 million reduction in our 2004 compensation
expense compared with 2003. Further, we do not expect to make similar cost reductions in future years.
Commentary—Inventory, Liquidity and Related Matters
Inventory. We ended 2002 running low on inventory. An unexpectedly strong January 2003 depleted it further, and by February 2003 we believe
that our low inventory levels choked sales. In an effort to avoid a repeat of this situation, we ended 2003 with inventory sufficient to support
growth. We believe that our current inventory level and selection are appropriate, with the possible exception of our opportunistic purchase of
over $5 million of Franck Muller watches in the closing weeks of 2003. We have limited experience selling these watches, which typically sell
for over $15,000 each. We believe that we now offer them at some of the lowest prices in the world.
Cash and Marketable Securities. We ended 2003 with $40.3 million in cash and marketable securities, but at one point during the fourth quarter
our cash was down to $9.7 million. There is an aspect of the cash flow of our business that is different than most other businesses. A typical
business running at breakeven profitability absorbs cash as it grows to fund increased working capital needs, and releases cash as it shrinks as
working capital declines, all else being equal. Overstock is different: about half of our business is our "fulfillment partner" business, where we
sell a product through our website and collect the cash from a credit card transaction within a few days, but pay our fulfillment partner 15 to
30 days later. Because we collect cash for the sale before we pay our fulfillment partner, the fulfillment partner portion of our business generates
temporary liquidity that we call float-cash. If we were running at break-even profitability but our fulfillment partner business were growing, our
growth would generate float-cash. If we shrank, we would lose float-cash (again, all else being equal). This dynamic is the reverse of that
displayed by the typical business. Investors should understand that a portion of the $40.3 million cash and marketable securities we held at
December 31, 2003 was cash we owed to our fulfillment partners. Due to the seasonality of our business, our fulfillment partner business is
expected to shrink in the first quarter of 2004, so we expect our cash balance to decrease during the first quarter of 2004 approximately
proportionate with the decrease in sales by our fulfillment partners.
Capital Needs. In addition to the other matters discussed below under Liquidity and Capital Resources, management periodically analyzes our
capital resources, liquidity, and anticipated needs. One of the analyses our management performs periodically assumes that we will operate our
business at break-even and grow 100% each year, and then assesses our need for capital
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under those assumptions. As discussed above, since the fulfillment partner portion of our business generates float-cash as we grow, our need for
additional capital may be less than the need of other businesses. However, as mentioned above, at our lowest point in the fourth quarter, our cash
balance was as low as $9.7 million. That may be insufficient in the future. We are not yet at break-even, as our GAAP loss in the fourth quarter of
2003 was 2.5% of revenue. We will continue to look at our capital needs and try to position ourselves so that we will be able to raise capital if
circumstances are appropriate. In addition, we are in the process of obtaining an inventory line of credit.
Commentary—Strategic projects
Following is a brief update on some of our recent strategic projects, some of which are also discussed above.
Search Engine. As discussed above, we have implemented an "EasyAsk" search engine. We consider this superior to our old system, but believe
that we can continue to improve our search function substantially.
Branding Campaign. As discussed above, we launched our "Overstock.com—The Big O"-branding campaign through national television and
radio ads, and we believe that we realized significant benefits from this campaign.
Travel. We opened a travel department in the third quarter, which generated more than $1,000,000 of bookings in the fourth quarter. In 2003 we
included only the net commissions realized on travel bookings in our GAAP revenues and in our gross merchandise sales. In 2003 our net
commissions from the travel department were insignificant.
Commentary—Worldstock
One additional project to report on is our Worldstock department, which sells handmade goods made primarily in underdeveloped countries throughout
the world. While representing only a couple percentage points of our overall sales, Worldstock has generated about $5 million in revenue in the 27 months it
has been open, with approximately 15% gross profit margins. Based on assumptions management considers reasonable, we estimate that our Worldstock
department has lost a little less than $1 million since its inception (and its inventory now ties up approximately another $500,000 in cash). Worldstock
purchases products from about 4,000 artisans in the developing world and has been growing quickly.
The balance of our Management's Discussion and Analysis of Financial Condition and Results of Operation provides further information about the
matters discussed above and other important matters affecting our business.
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:
revenue recognition;
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