Overstock Annual Report 2006

Plain-text annual report

UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549FORM 10-K(Mark One)xx ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the fiscal year ended December 31, 2006ORoo TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the transition period from to Commission file number 000-49799OVERSTOCK.COM, INC.(Exact name of Registrant as specified in its charter)Delaware87-0634302(State or other jurisdiction of(I.R.S. Employerincorporation or organization)Identification Number) 6350 South 3000 EastSalt Lake City, Utah 84121(Address of principal executive offices including zip code)(801) 947-3100(Registrant’s telephone number, including area code)Securities registered pursuant to Section 12(b) of the Act: Common Stock, $0.0001 par value (title of class)Securities registered pursuant to Section 12(g) of the Act: NoneIndicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No xIndicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No xIndicate 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 preceding12 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 x No oIndicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’sknowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K, or any amendment to this Form 10-K. oIndicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer” in Rule 12b-2 of theExchange Act. (Check one):Large accelerated filer o Accelerated filer x Non-accelerated filer oIndicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the act). Yes o No xThe aggregate market value of voting and non-voting common equity held by non-affiliates of the registrant as of the last business day of the registrant’s most recentlycompleted second quarter (June 30, 2006), was approximately $143.8 million based upon the last sales price reported by NASDAQ. For purposes of this disclosure, shares ofCommon Stock held by persons who hold more than 5% of the outstanding shares of Common Stock and shares held by officers and directors of the registrant have been excludedin that such persons may be deemed to be affiliates. This determination is not necessarily conclusive.As of March 9, 2007 there were 23,612,071 shares of the registrant’s Common Stock outstanding.DOCUMENTS INCORPORATED BY REFERENCECertain information required by Part III of Form 10-K is incorporated by reference to the Registrant’s proxy statement for the 2007 Annual Stockholders Meeting, which willbe filed with the Securities and Exchange Commission. OVERSTOCK.COM, INC.ANNUAL REPORT ON FORM 10-KINDEXPagePart I.Special Note Regarding Forward-Looking Statements3Item 1.Business4Item 1A.Risk Factors15Item 1B.Unresolved Staff Comments34Item 2.Properties34Item 3.Legal Proceedings35Item 4.Submission of Matters to a Vote of Security Holders36Executive officers of the Registrant37Part II.Item 5.Market for the Registrant’s Common Equity, Related Stockholder Matters and IssuerPurchases of Equity Securities39Item 6.Selected Financial Data42Item 7.Management’s Discussion and Analysis of Financial Condition and Results ofOperation44Item 7A.Quantitative and Qualitative Disclosures About Market Risk69Item 8.Financial Statements and Supplementary Data69Item 9.Changes in and Disagreements with Accountants on Accounting and FinancialDisclosure69Item 9A.Controls and Procedures69Item 9B.Other Information70Part III.Item 10.Directors, Executive Officers and Corporate Governance70Item 11.Executive Compensation70Item 12.Security Ownership of Certain Beneficial Owners and Management and RelatedStockholder Matters70Item 13.Certain Relationships and Related Transactions, and Director Independence71Item 14.Principal Accounting Fees and Services71Part IV.Item 15.Exhibits, Financial Statement Schedules71Signatures76Financial StatementsF-1 Overstock.com is a registered trademark, and Worldstock.com, Club O and Overstock.com Wholesale are trademarks, of Overstock.com, Inc. TheOverstock.com logo and Worldstock.com logo are also trademarks of Overstock.com, Inc. Other service marks, trademarks and trade names referred to in thisForm 10-K are property of their respective owners.iiSPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTSThis Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the SecuritiesExchange Act of 1934. These statements are therefore entitled to the protection of the safe harbor provisions of these laws. These forward-looking statementsinvolve risks and uncertainties, and relate to future events or our future financial or operating performance. These statements include, but are not limited to,statements concerning:· the anticipated benefits and risks of our business relationships;· our ability to attract retail and business customers;· the anticipated benefits and risks associated with our business strategy;· our future operating results;· the anticipated size or trends of the market segments in which we compete and the anticipated competition in those markets;· potential government regulation;· our future capital requirements and our ability to satisfy our capital needs;· our expansion in international markets;· the potential for additional issuances of our securities;· our plans to devote substantial resources to our sales and marketing teams;· the possibility of future acquisitions of businesses, products or technologies;· the possibility of future sales of portions of our business and the anticipated associated benefits;· our belief that we can attract customers in a cost-efficient manner;· our strategy to develop strategic business relationships with additional wholesalers and distributors;· our strategy to reduce costs associated with our existing expense structure and the anticipated associated benefits;· our belief that current or future litigation will likely not have a material adverse effect on our business;· the anticipated anti-takeover effects of certain provisions of our charter documents;· the ability of our online marketing campaigns to be a cost-effective method of attracting customers;· the results of upgrades to our infrastructure and the likelihood that additional future upgrades can be implemented without disruption of our business;· our belief that manufacturers will recognize us as an efficient liquidation solution;· our belief that the increases we have made in the scope of our Books, Music and Video department offerings will be attractive to customers and willresult in increased sales of higher margin products;· our belief that we can meet our published product shipping standards even during periods of relatively high sales activity;· our belief that we can maintain or improve upon customer service levels that we and our customers consider acceptable;3· our belief that our information technology infrastructure can and will support our operations and will not suffer significant downtime;· our belief that we can maintain inventory levels at appropriate levels despite the seasonal nature of our business; and· our belief that we can successfully offer and sell a constantly changing mix of products and services.Furthermore, in some cases, you can identify forward-looking statements by terminology such as may, will, could, should, expect, plan, intend,anticipate, believe, estimate, predict, potential or continue, the negative of such terms or other comparable terminology. These statements are onlypredictions. Actual events or results may differ materially. In evaluating these statements, you should specifically consider the risks outlined in this Form 10-K, including those described in Item 1A under the caption “Risk Factors.” These factors may cause our actual results to differ materially from thosecontemplated by any forward-looking statement. Except as otherwise required by law, we expressly disclaim any obligation to release publicly any update orrevisions to any forward-looking statements to reflect any changes in our expectations or any change in events, conditions or circumstances on which any ofour forward-looking statements are based. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannotguarantee future results, levels of activity, performance or achievements.PART IITEM 1. BUSINESSThe following description of our business contains forward-looking statements relating to future events or our future financial or operatingperformance that involve risks and uncertainties, as set forth above under “Special Note Regarding Forward-Looking Statements.” Our actual results coulddiffer materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth in Section 1A under theheading “Risk Factors” and elsewhere in this Form 10-K.OverviewWe are an online “closeout” retailer offering discount brand name merchandise, including bed-and-bath goods, home décor, kitchenware, watches,jewelry, electronics and computers, sporting goods, apparel, designer accessories and travel services, among other products. We also sell books, magazines,CDs, DVDs, videocassettes and video games (“BMMG”), and we operate as part of our Website an online auction site—a marketplace for the buying andselling of goods and services.Our company, based in Salt Lake City, Utah, was founded in 1997, and we launched our first Website through which customers could purchase productsin March 1999. Our Websites offer our customers an opportunity to shop for bargains conveniently, while offering our suppliers an alternative inventoryliquidation distribution channel. We continually add new, limited inventory products to our Websites in order to create an atmosphere that encouragescustomers to visit frequently and purchase products before our inventory sells out. We offer approximately 36,000 products under multiple shopping tabs onour main website, plus almost 500,000 media products on our BMMG tab.Closeout merchandise is typically available in inconsistent quantities and prices and often is only available to consumers after it has been purchasedand resold by disparate liquidation wholesalers. We believe that the traditional liquidation market is therefore characterized by fragmented supply andfragmented demand. We utilize the Internet to aggregate both supply and demand and create a more efficient market for liquidation merchandise. Ourobjective is to provide a one-stop destination for discount shopping for products and services proven to be successfully sold through the Internet.4Industry OverviewManufacturers and retailers traditionally hold inventory to buffer against uncertain demand within their normal, “inline” sales channels. Inline saleschannels are manufacturers’ primary distribution channels, which are characterized by regularly placed orders by established retailers at or near wholesaleprices. In recent years, several dynamics have shifted inventory risk from retailers to manufacturers, including:· dominant retailers insist on just-in-time deliveries from manufacturers;· dominant retailers cancel orders mid-production and return unsold merchandise;· style, color or model changes quickly turn inventory into closeout merchandise;· incorrect estimates of consumer demand lead to overproduction; and· changes in a retailer’s financial situation or strategy result in cancelled orders.The disposal of excess, or overstock, inventory represents a substantial burden for many manufacturers, especially those who produce high-qualitybranded merchandise. Manufacturers seek to avoid liquidating through traditional retail channels where the manufacturer’s discounted products may be soldalongside other full-price products. This can result in weaker pricing and decreased brand strength, and is known as channel conflict or sales channelpollution. As a result, many manufacturers turn to liquidation wholesalers and discount retailers. These liquidation channels provide manufacturers limitedcontrol of distribution and are, we believe, unreliable and expensive to manage when compared with their inline channels.Despite the challenges encountered by manufacturers in the liquidation market, the proliferation of outlet malls, wholesale clubs, and discount chains isevidence of the strong level of consumer demand for discount and closeout merchandise. However, consumers face several difficulties in shopping forcloseout and overstock merchandise. For example, many traditional merchandise liquidation outlets are located in remote locations and have limitedshopping hours, which we believe makes shopping burdensome and infrequent for many consumers. In addition, the space available in a traditionalmerchandise liquidation outlet constrains the number of products that a traditional merchandise liquidation outlet can offer at any given time.However, we believe that the market for online liquidation is still early in its development and is characterized by only a limited number of competitors,some of which utilize an auction model to price their goods. Furthermore, we believe that there are no other dominant companies in the online liquidationmarket, and many of the companies that do offer overstock or liquidation merchandise are focused on single product lines.Lastly, small retailers are under competitive pressure from large national retailers. Small retailers generally do not have purchasing leverage withmanufacturers; consequently, they are more likely to pay full wholesale prices and are more likely to receive inferior service. We believe that small retailersgenerally do not have access to the liquidation market because liquidation wholesalers are most often interested in liquidating large volumes of merchandise,rather than the small quantities appropriate for small, local retailers.5The Overstock SolutionOverstock provides manufacturers with a one-stop liquidation channel to sell both large and small quantities of excess and closeout inventory withoutdisrupting sales through traditional channels. Key advantages for manufacturers liquidating their excess inventory through Overstock include:· Resolution of channel conflict. Channel conflicts arise when a manufacturer’s excess inventory is sold through the same channel as their otherproduct offerings. Since excess inventory is usually sold at a discount, sales of the manufacturer’s other product offerings may be impacted as aconsumer in a retail store may opt for the excess product or become confused by the pricing and model discrepancies. By using Overstock,manufacturers have an alternative and independent channel where they can sell excess inventory without the fear of hindering the sale of their otherproducts.· Single point of distribution. Manufacturers often use multiple liquidation sources to clear their excess inventory. Multiple sources create additionallogistics issues that they would rather avoid. By using Overstock, manufacturers have a single source for the distribution of excess inventory.· Improved control of distribution. By using Overstock, manufacturers can monitor what kind of customer, whether individual consumer or smallretailer, ultimately purchases their merchandise. In addition, a manufacturer can request that its products be offered in only one of our sales channelsin order to avoid sales channel pollution.· Improved transaction experience. By having a reliable inventory clearing channel, manufacturers are able to more quickly and easily dispense oftheir excess merchandise.Overstock also offers consumers a compelling alternative for bargain shopping. Key advantages for consumers include:· High quality and broad product selection. Much of the merchandise offered on our Websites is from well-known, brand-name manufacturers. Wetypically have approximately 36,000 non-BMMG products and almost 500,000 BMMG products (books, magazines, CDs, DVDs, video cassettes andvideo games) in eight major departments.· Convenient access on a secure site. Our customers are able to access and purchase our products 24 hours a day from the convenience of theircomputer. We do not sell any personal information about our customer base to third parties.· Responsive customer service and positive shopping experience. Our team of customer service representatives (which includes employees, temporaryemployees and outsourced staff) assists customers by telephone, instant online chat and e-mail. Our customer service staff answers approximately 85%of phone calls within 30 seconds, and responds to approximately 98% of its e-mails within one business day. For our consumer business, we include areturn shipment label in our customer’s shipment to facilitate product returns and, subject to certain conditions; we allow customers up to 30 daysfrom date of shipment to initiate the return of most purchased merchandise. In addition, we continually update and monitor our Websites to enhancethe shopping experience for our customers.Our objective is to become the dominant closeout Internet-based solution for holders of brand-name merchandise, allowing them to dispose of thatmerchandise discreetly and with high recovery values, and to ultimately become a one-stop Internet-based discount shopping destination. We are pursuingthis objective through the following key strategies:· Establish strong relationships with manufacturers. With the growth in the scale of our operations, we believe we are becoming an efficientliquidation channel for manufacturers and distributors.6With scale comes the ability to buy in volume, and we believe manufacturers appreciate our ability to liquidate their products without disturbing theirtraditional channels. Generally, manufacturers do not want their product offerings sold as heavily discounted, closeout products in brick-and-mortarretailers, as is common today. We believe that as manufacturers learn of our capabilities, they will increasingly recognize the attractiveness ofOverstock as an efficient liquidation solution.· Optimize inventory management through the use of technology. Our merchandise buyers are supported by proprietary software that providesinformation on product sales, margins and inventory levels. This technology enables us to make informed decisions and quickly change prices in aneffort to maximize sales volume, gross profits and return on inventory capital.· Optimize online marketing initiatives through the use of technology. Our marketing team is supported by proprietary software that enhances thelevel of service provided to our customers and takes advantage of the unique characteristics of online distribution. Our software provides usimmediate feedback on the effectiveness of various marketing campaigns, allowing us to optimize our online marketing expenditures.· Loyalty programs. In March 2004, we launched our frequent buyer’s club, Club O. Members of Club O pay an annual fee of $29.95 and receive a 5%discount on all non-travel and non-BMMG products and $1 shipping per order, along with access to a special customer service hotline. Additionally,in November 2005, we partnered with Chase Card Services to launch an Overstock.com Co-Branded Rewards Visa credit card program, offering ourcustomers a $30 store credit (for existing Club O members) or a free Club O membership for one year (for non-Club O members) and the opportunity toearn rewards certificates to redeem on our shopping and BMMG Websites.Our BusinessOverstock utilizes the Internet to create a more efficient market for liquidation merchandise. We provide consumers and businesses with quick andconvenient access to high-quality, brand-name merchandise at discount prices. Our shopping business includes both a “direct” business and a “fulfillmentpartner” business. During the years ended December 31, 2004, 2005 and 2006, no single customer accounted for more than 1% of our total revenue. Productsfrom our direct segment and fulfillment partner segment are available to both consumers and businesses through our Wholesale bulk purchase program.Direct businessOur direct business includes sales made to individual consumers and businesses, which are fulfilled from our warehouses in Salt Lake City, Utah or ouroutsourced warehouses located in Plainfield, Indiana. During the years ended December, 2004, 2005 and 2006, we fulfilled approximately 40%, 38%, and39%, respectively, of all orders through our warehouses. Our warehouses generally ship between 10,000 and 12,000 orders per day, and up to approximately34,000 orders per day during peak periods, using overlapping daily shifts.Fulfillment partner businessFor our fulfillment partner business, we sell merchandise of other retailers, cataloguers or manufacturers (“fulfillment partners”) through our Website. Weare considered to be the primary obligor for the majority of these sales transactions, and we assume the risk of loss on the returned items. As a consequence,we record revenue from the majority of these sales transactions involving our fulfillment partners on a gross basis. Our use of the term “partner” or“fulfillment partner” does not mean that we have formed any legal partnerships with any of our fulfillment partners. We currently have fulfillment7partner relationships with approximately 540 third parties which post approximately 26,000 non-BMMG products, as well as most of the BMMG productsand a portion of our current travel offerings, on our Websites.Our revenue from sales on our shopping site from both the direct and fulfillment partner businesses is recorded net of returns, coupons and otherdiscounts. Our returns policy for products other than those sold in our Electronics and Computers department provides for a $4.95 restocking fee and theprovision that we will accept product returns initiated within thirty days after the shipment date. We charge a 15% restocking fee (instead of the $4.95restocking fee) on all items returned for non-defective reasons from the Electronics and Computers department.Unless otherwise indicated or required by the context, the discussion herein of our financial statements, accounting policies and related matters, pertainsto our shopping sites (Shopping and BMMG) and not necessarily to our auction or travel tabs on our Websites.Wholesale businessIn August 2004, we merged our B2B site (www.overstockb2b.com) into our B2C site, and opened a “Club O Gold” membership program (into which ourB2B customers were grandfathered). During 2005, we integrated this program into our “Wholesale” tab. For this tab, we have added a number of suppliersspecific to various industry verticals, such as florist supplies, restaurant supplies, and office supplies.Travel businessWe operate a discount travel department as part of our Website. We use fulfillment partners to supply the travel products and services (flights, hotels,rental cars, etc.). We currently offer air, hotel and car reservation services as well as ski, cruise and vacation packages.On July 1, 2005, we acquired all the outstanding capital stock of Ski West, Inc. (“Ski West”), an on-line travel company whose proprietary technologyprovides easy consumer access to a large, fragmented, hard-to-find inventory of lodging, vacation, cruise and transportation bargains. The travel products areprimarily in popular ski areas in the U.S. and Canada, with more recent expansion into the Caribbean and Mexico, as well as cruises. We paid an aggregate of$25.1 million (including $111,000 of capitalized acquisition related costs) for Ski West, and we may be subject to additional earn-out payments (based on apercentage of its operating profits for each of the four calendar years beginning with 2006 as follows: 50%, 33.3%, 20%, and 10%, respectively), subject toreduction under certain circumstances, pursuant to a Stock Purchase Agreement dated June 24, 2005, as amended to date, among us, Ski West, and all of theformer shareholders of Ski West. Effective upon the closing, Ski West became our wholly-owned subsidiary, and we integrated the Ski West travel offeringswith our existing travel offerings and changed its name to OTravel.com, Inc.Business RestructuringDuring the fourth quarter of 2006, in an effort to improve future operating performance, we commenced implementation of a facilities consolidation andrestructuring program designed to reduce our overall expense structure (see Item 15 of Part IV, “Financial Statements”—Note 4—“Restructuring Expenses”).The planned actions include the termination of a co-location data center lease, marketing of the current office facilities for sub-lease, and marketing non-corebusinesses for sale. At December 31, 2006, we accrued a liability of $5.9 million associated with the facilities consolidation and restructuring program,including $5.5 million related to lease termination costs and $450,000 related to the asset retirement obligation (see Item 15 of Part IV, “FinancialStatements”—Note 9—“Asset Retirement Obligation”), all of which is to be paid during the first quarter of 2007.8As part of this program to reduce our expense structure and sell non-core businesses, we decided during the fourth quarter of 2006 to sell the Company’stravel subsidiary (“OTravel”), and we have received a non-binding letter of intent from a third-party to purchase this business. As a result, OTravel’soperations have been classified as a discontinued operation and therefore are not included in the results of continuing operations. The loss fromdiscontinued operations for OTravel was $6.9 million for the year ended December 31, 2006, including a goodwill impairment charge of $4.5 million.Auctions businessWe operate an online auction service as part of our Website. Our auction tab allows sellers to list items for sale, buyers to bid on items of interest, andusers to browse through listed items online. For these sales we record only our listing fees and commissions for items sold as revenue. From time to time, wealso sell items returned from our shopping site on our auction site, and for these sales, we record the revenue on a gross basis. Revenue from our auctionbusiness is included in the fulfillment partner segment, as it is not significant enough to segregate as its own segment.Cars listing businessWe operate an online site for listing cars for sale as a part of our Website. The cars listing service allows sellers to list vehicles for sale and allows buyersto review vehicle descriptions, post offers to purchase, and provides the means for purchasers to contact sellers for further information and negotiations on thepurchase of an advertised vehicle. Revenue from our cars listing business is included in the fulfillment partner segment, as it is not significant enough toseparate out as its own segment.Cost of goods soldCost of goods sold consists of the cost of the product, as well as inbound and outbound freight, warehousing and fulfillment costs (including payroll andrelated expenses), credit card fees, customer service costs and stock-based compensation.Operating expensesSales and marketing expenses consist of advertising, public relations and promotional expenditures, as well as payroll and related expenses, includingstock-based compensation, for personnel engaged in marketing and selling activities. Advertising expense is the largest component of our sales andmarketing expenses and is primarily attributable to expenditures related to online marketing activities and offline national radio and television advertising.For the years ended December 31, 2004, 2005 and 2006, our advertising expenses totaled approximately $39.2 million, $75.3 million and $68.1 million,respectively, representing 97%, 98% and 96%, respectively, of sales and marketing expenses.Technology expenses consist of wages and benefits, including stock-based compensation, for technology personnel, rent, utilities, connectivity charges,as well as support and maintenance and depreciation and amortization related to software and computer equipment.General and administrative expenses consist of wages and benefits, including stock-based compensation, for executive, legal, accounting,merchandising and administrative personnel, rent and utilities, travel and entertainment, depreciation and amortization of intangible assets and other generalcorporate expenses.We have recorded no provision or benefit for federal and state income taxes as we have incurred net operating losses since inception. We have provideda full valuation allowance on the net deferred tax assets, consisting primarily of net operating loss carryforwards, because of uncertainty regarding theirrealizability.9Both direct and fulfillment partner revenues are seasonal, with revenues historically being the highest in the fourth quarter, reflecting higher consumerholiday spending. We anticipate this will continue in the foreseeable future.Key RelationshipsManufacturer, Supplier and Distribution Relationships. It is difficult to establish closeout buying relationships with manufacturers. Trust andexperience gained through past interactions are important. We believe our business model reduces the risk to the manufacturer that its discounted productsare sold alongside its full-priced products. Our supplier relationships provide us with recognized, brand-name products. The table below identifies some ofthe brand names that generate significant revenues in various departments.Anne KleinHooverRandom HouseAOL Time WarnerJoseph AbboudRCABissellJVCSamsoniteBlue Ridge Home FashionsKodakSeikoCanonMaiSimon & SchusterCharles DavidMovadoSonyDysonNovicaSwiss ArmyFujiPanasonicSteve MaddenHewlett-PackardPhilipsToshiba To date, we have not entered into contracts with manufacturers or liquidation wholesalers that guarantee the availability of merchandise for a setduration. Our manufacturer and supplier relationships are based on historical experience with manufacturers and liquidation wholesalers and do not obligateor entitle us to receive merchandise on a long-term or short-term basis. In our direct business, we purchase the products from manufacturers or liquidationwholesalers using standard purchase orders. Generally, suppliers do not control any of the terms under which products are sold over our Websites.Sales and MarketingWe use a variety of methods to target our consumer audience, including online campaigns, such as advertising through portals, keywords, searchengines, affiliate marketing programs, banners and e-mail campaigns, and we are able to monitor and evaluate their results. We seek to identify and eliminatecampaigns that do not meet our expectations. We launched our national television and radio branding campaign in 2003, and have continued to develop it.We develop our branding campaigns internally and we believe that doing so is cost-effective.ProductsOnline ProductsOur products are organized into eight different product departments: FurnitureHomeBeddingSportsJewelery & WatchesElectronicsClothingEntertainmentOther Stores 10Each of these departments has multiple categories that more specifically define the products offered within that department. For example, the“Electronics” tab has the following product categories currently within the “Electronics & Computers” department:Audio & VideoComputers & HardwareCameras & OpticsCellular PhonesTelephonesMonitorsPrinters & ScannersHome Office EquipmentNew ArrivalsClearance Each category has several subcategories that further detail the product contained within. For example, under the “Computers & Hardware” category, wehave the following subcategories: ComputersPDA & HandheldsComputer AccessoriesHard DrivesUpgradesMore Individual products can be accessed and viewed from the category or subcategory pages. These specific product pages include detailed productdescriptions, a color picture and pricing information.The number of total products we offer has grown from less than 100 in 1999, to more than 36,000 non-BMMG products and almost 500,000 BMMGproducts (books, magazines, CDs, DVDs, video cassettes and video games) as of December 31, 2006. As the number of products and product categorieschange throughout the year, we periodically reorganize our departments and/or categories to better reflect our current product offerings.Our Worldstock Handcraft link found under the “Other Stores” tab is our socially-responsible, Internet marketplace through which artisans in the UnitedStates and around the world can sell their products and gain access to a broader market.Fulfillment OperationsGeneral. When customers place orders on our Websites, orders are fulfilled either by a third-party fulfillment partner or directly from our warehouses inSalt Lake City, Utah or our outsourced warehouses in Plainfield, Indiana. We monitor all of these sources for accurate order fulfillment and timely shipment.We currently charge $2.95 per order for basic ground shipping, but customers can choose from various expedited shipping services at their expense.Payment Terms. Generally, we require verification of receipt of payment or credit card authorization (including verifications from BillMeLater) beforewe ship products to consumers or business purchasers. From time to time we grant credit to our business purchasers with normal credit terms (typically 30days).11Fulfillment for Direct Business. During 2006, we fulfilled approximately 39% of all orders through our leased Salt Lake City, Utah warehouses or ouroutsourced warehouses in Plainfield, Indiana. During 2006, the Salt Lake City warehouse team generally shipped between 10,000 and 12,000 orders per day,and up to approximately 34,000 orders per day during peak periods, using overlapping daily shifts. We also process returns of direct and fulfillment partnermerchandise in the Salt Lake City warehouse. Our warehouses store approximately 10,000 non-BMMG products offered on our Websites. We operate the SaltLake City warehouse with an automated warehouse management system that tracks the receipt of the inventory items, distributes order-fulfillmentassignments to warehouse workers and obtains rates for various shipping options to ensure low-cost outbound shipping. Our Websites relay orders to thewarehouse management system throughout each day, and the warehouse management system in turn confirms to our Websites shipment of each order.Customers track the shipping status of their packages through links we provide on our Websites.Fulfillment Partner Business. During 2006, approximately 61% of our orders were for inventory owned and shipped by third-party fulfillment partners.We currently manage approximately 540 entities that collect orders through our Websites. These third parties perform essentially the same operations as ourwarehouse: order picking and shipping; however, beginning July 1, 2003, we began handling returns for these sales. These third parties relay shipmentconfirmations to our Websites where customers can review shipping and tracking information. From a customer’s point of view, shipping from ourwarehouses or from the warehouse of one of these third parties is indistinguishable.Customer ServiceWe are committed to providing superior customer service. We staff our customer service department with dedicated in-house and outsourcedprofessionals who respond to phone, instant online chat and e-mail inquiries on products, ordering, shipping status, and returns. Our customer service staffprocesses approximately 40,000 calls per week (and up to approximately 105,000 calls during peak periods).The same staff processes approximately 30,000 e-mail messages each week (and up to approximately 70,000 e-mail messages during peak periods), witha turnaround goal of one business day. We use automated e-mail and phone systems to route traffic to appropriate customer service representatives. Thedemands on our customer service staff increase significantly during peak periods, including the several weeks before and after Christmas.TechnologyWe use our internally developed Websites and a combination of proprietary technologies and commercially available licensed technologies andsolutions to support our operations. We use the services of XO Communications, Inc., Qwest Communications International, Inc. and Verizon, Inc. to obtainconnectivity to the Internet over multiple Gig-E and OC48 links. We currently store our data on several Oracle 10g database clusters using Dell and IBMcomputer hardware connected to multiple large scale EMCs for data storage. Currently, we use Dell and IBM servers for our Websites, which are connected tothe Oracle database and operate in a multi-processing Linux environment designed to accommodate large volumes of Internet traffic. During 2004 we movedour primary computer infrastructure to a co-location facility in Salt Lake City.In July 2005, we entered into a Colocation Center Agreement (the “Colocation Agreement”) to build out and lease 11,289 square feet of space at OldMill Corporate Center II in Salt Lake City for a data center and co-location facility. In November 2006, we made a determination to consolidate our facilitiesand began negotiations to terminate the lease of the new co-location facility (see Item 15 of Part IV—“Financial Statements”—Note 4 “RestructuringExpense”), and on February 1, 2007, we terminated the12lease agreement effective as of December 29, 2006. Currently, our primary computer infrastructure remains at our original co-location facility in Salt LakeCity.In addition to our co-location facility, we have computer facilities located at our principal corporate offices, which we use primarily for backups,redundancy, development, and testing. As we have made the determination to consolidate facilities, including marketing of the principal corporate officespace for sub-lease, we anticipate relocating these facilities during 2007.CompetitionThe online liquidation services market is new, rapidly evolving, intensely competitive and has relatively low barriers to entry, as new competitors canlaunch new Websites at relatively low cost. We believe that competition in the online liquidation market is based predominantly on:· price;· product quality and selection;· shopping convenience;· order processing and fulfillment;· customer service; and· brand recognition.Our liquidation services compete with other online retailers and traditional liquidation “brokers,” some of which may specifically adopt our methodsand target our customers. We currently or potentially compete with a variety of companies that can be divided into several broad categories:· liquidation e-tailers such as SmartBargains;· online retailers with discount departments such as Amazon.com, Inc., eBay, Inc. and Buy.com, Inc.; and· traditional retailers and liquidators such as Ross Stores, Inc., Walmart Stores, Inc., TJX Companies, Inc., Costco Wholesale Corporation, TargetCorporation and Best Buy Co., Inc., which may or may not also have an online presence.As the market for online liquidation grows, we believe that companies involved in online retail, as well as traditional retailers and liquidation brokers,will increase their efforts to develop services that compete with our online services. We also face potential competition from Internet companies not yetfocused on the liquidation market, and from retail companies both currently or not yet operating online. We are unable to anticipate which other companiesare likely to offer services in the future that will compete with the services we provide.In addition, many of our current and potential competitors have greater brand recognition, longer operating histories, larger customer bases andsignificantly greater financial, marketing and other resources than we do, and may enter into strategic or commercial relationships with larger, moreestablished and well-financed companies. Some of our competitors could enter into exclusive distribution arrangements with our vendors and deny us accessto their products, devote greater resources to marketing and promotional campaigns and devote substantially more resources to their Website and systemsdevelopment than our company. New technologies and the continued enhancement of existing technologies also may increase competitive pressures on ourcompany. We cannot ensure that we will be able to compete successfully against current and future competitors or address increased competitive pressures.See Item 1A—“Risk Factors”.13Intellectual PropertyWe regard our domain names and similar intellectual property as critical to our success. We rely on a combination of laws and contractual restrictionswith our employees, customers, suppliers, affiliates and others to establish and protect our proprietary rights. Despite these precautions, it may be possible fora third party to copy or otherwise obtain and use our intellectual property without authorization. In addition, we cannot ensure that others will notindependently develop similar intellectual property. Although we have registered and are pursuing the registration of our key trademarks in the UnitedStates, some of our trade names are not eligible to receive trademark protection. In addition, effective trademark protection may not be available or may notbe sought by us in every country in which our products and services are made available online, including the United States.From time to time, we receive claims of and become subject to consumer protection, employment, intellectual property and other commercial litigationrelated to the conduct of our business. Such litigation could be costly and time consuming and could divert our management and key personnel from ourbusiness operations. The uncertainty of litigation increases these risks. In connection with such litigation, we may be subject to significant damages orequitable remedies relating to the operation of our business and the sale of products on our websites. Any such litigation may materially harm our business,prospects, results of operations, financial condition or cash flows. However, we do not currently believe that any of our outstanding litigation will have amaterial adverse effect on our financial statements.In December 2003, we received a letter from Furnace Brook claiming that certain of our business practices and our website infringe a single patentowned by Furnace Brook. After diligent efforts to show that we do not infringe the patent and Furnace Brook’s continual demands that we enter intolicensing arrangements with respect to the asserted patent, on August 12, 2005, we filed a complaint in the United States District Court of Utah, CentralDivision, seeking declaratory judgment that we do not infringe any valid claim of the Furnace Brook patent. Furnace Brook filed a motion to dismiss ourcomplaint for lack of personal jurisdiction over Furnace Brook in Utah. On October 31, 2005, the United States District Court of Utah, Central Division,issued a decision to dismiss our complaint for lack of personal jurisdiction over Furnace Brook. On December 14, 2005, we filed an appeal of the Utahdecision with the United States Court of Appeals for the Federal Circuit. On August 18, 2006, the United States Court of Appeals for the Federal Circuitdenied the Company’s appeal. On August 18, 2005, shortly after we filed the complaint in Utah, Furnace Brook filed a complaint in the United States DistrictCourt for the Southern District of New York, alleging that certain of our business practices and our website infringe a single patent owned by Furnace Brook.On September 9, 2005, we filed an answer denying the material allegations in Furnace Brook’s claims. On September 27, 2006, the United States DistrictCourt for the Southern District of New York issued a memorandum and order, Markman Hearing, which substantially adopted the Company’s interpretationof the Furnace Brook patent. We filed motions for summary judgment relating to the litigation and on October 6, 2006, the United States District Court forthe Southern District of New York heard oral argument on those motions and on October 30, 2006, the United States District Court for the Southern District ofNew York granted summary judgment in favor of us, ruling that we do not infringe the Furnace Brook patent as a matter of law. On November 9, 2006,Furnace Brook filed a notice of appeal to the United States Court of Appeals for the Federal Circuit. On January 16, 2007, we filed a brief with the FederalCircuit Court and the appeal is now pending.In November 2006, the Company received a letter from Applied Interactive, claiming that certain of our business practices and our website infringe twopatents owned by Applied Interactive and offering to enter into a licensing agreement. After determining that we do not infringe the patents and rejecting theoffered licensing agreement, on February 2, 2007, we filed a complaint in the United States District Court, Southern District of New York, seeking declaratoryjudgment that we do not infringe any valid claim of the Applied Interactive patents. The complaint has been served and the case is in its initial stages. TheCompany intends to vigorously prosecute this action.14These and other types of claims could result in increased costs of doing business through legal expenses, adverse judgments or settlements or require usto change our business practices in expensive ways. In addition, litigation could result in interpretations of the law that require us to change our businesspractices or otherwise increase our costs.Third parties have in the past, and may in the future, recruit our employees who have had access to our proprietary technologies, processes andoperations. These recruiting efforts expose us to the risk that such employees will misappropriate our intellectual property.Additional litigation may be necessary in the future to enforce our intellectual property rights, to protect our trade secrets or to determine the validityand scope of the proprietary rights of others. Any litigation, regardless of outcome or merit, could result in substantial costs and diversion of management andtechnical resources, any of which could materially harm our business. See Item 1A - “Risk Factors”.Government RegulationAll of our services are subject to federal and state consumer protection laws including laws protecting the privacy of consumer non-public informationand regulations prohibiting unfair and deceptive trade practices. In particular, under federal and state financial privacy laws and regulations, we must providenotice to consumers of our policies on sharing non-public information with third parties, must provide advance notice of any changes to our policies and,with limited exceptions, must give consumers the right to prevent sharing of their non-public personal information with unaffiliated third parties.Furthermore, the growth and demand for online commerce could result in more stringent consumer protection laws that impose additional complianceburdens on online companies. These consumer protection laws could result in substantial compliance costs and could interfere with the conduct of ourbusiness.In many states, there is currently great uncertainty whether or how existing laws governing issues such as property ownership, sales and other taxes, libeland personal privacy apply to the Internet and commercial online services. These issues may take years to resolve. In addition, new state tax regulationsmay subject us to additional state sales and income taxes. New legislation or regulation, the application of laws and regulations from jurisdictions whose lawsdo not currently apply to our business or the application of existing laws and regulations to the Internet and commercial online services could result insignificant additional taxes on our business. These taxes could have an adverse effect on our cash flows and results of operations. Furthermore, there is apossibility that we may be subject to significant fines or other payments for any past failures to comply with these requirements.EmployeesAs of December 31, 2006, we had 864 full-time employees, including 194 in customer service and fraud prevention, 189 in order fulfillment, 140 ininformation technology and Website production, 54 in marketing, 215 in merchandising (including auctions, cars and travel), 34 in accounting and finance,and 38 in our executive and administrative department. We have never had a work stoppage, and none of our employees are represented by a labor union. Weconsider our employee relationships to be positive.ITEM 1A. RISK FACTORSThese forward-looking statements are subject to risks and uncertainties that could cause actual results and events to differ materially . Any investmentin our securities involves a high degree of risk. Investors should consider carefully the risks and uncertainties described below, and all other information inthis Form 10-K and in any reports we file with the SEC after we file this Form 10-K, before deciding whether to purchase or hold our securities. Additionalrisks and uncertainties not currently known to us or that we currently deem immaterial may also become important factors that may harm our business. Theoccurrence of any of the following risks15could harm our business. The trading price of our securities could decline due to any of these risks and uncertainties, and investors may lose part or all oftheir investment.Risks Relating to OverstockWe have a history of significant losses. If we do not achieve profitability, our financial condition and our stock price could suffer.We have a history of losses and we may continue to incur operating and net losses for the foreseeable future. We incurred net losses attributable tocommon shares of $25.1 million and $101.9 million for the years ended December 31, 2005 and 2006, respectively. As of December 31, 2005 and 2006, ouraccumulated deficit was $96.8 million and $198.7 million, respectively. We will need to generate significant revenues to achieve profitability, and wemay not be able to do so. Even if we do achieve profitability, we may not be able to sustain or increase profitability on a quarterly or annual basis in thefuture. If our revenues grow more slowly than we anticipate, or if our operating expenses exceed our expectations, our financial results would be harmed.We will continue to incur significant operating expenses and capital expenditures as we:· enhance our distribution and order fulfillment capabilities;· further improve our order processing systems and capabilities;· develop enhanced technologies and features;· expand our customer service capabilities to better serve our customers’ needs;· expand or modify our product offerings;· rent or terminate warehouse and office space;· increase our general and administrative functions to support our operations; and· maintain or increase our sales, branding and marketing activities, including maintaining existing or entering into new online marketing arrangements,and continuing or increasing our national television and radio branding campaigns.Because we will incur many of these expenses before we receive any revenues from our efforts, our losses may be greater than the losses we would incurif we developed our business more slowly. Further, we base our expenses in large part on our operating plans and future revenue projections. Many of ourexpenses are fixed in the short term, and we may not be able to quickly reduce spending if our revenues are lower than we project. Therefore, any significantshortfall in revenues would likely harm our business, prospects, operating results and financial condition. In addition, we may find that these efforts are moreexpensive than we currently anticipate which would further increase our losses. Also, the timing of these expenses may contribute to fluctuations in ourquarterly operating results.If we fail to accurately forecast our expenses and revenues, our business, operating results and financial condition may suffer and the price of oursecurities may decline.Our limited operating history and the rapidly evolving nature of our industry make forecasting operating results difficult. We have recently completedseveral large, complex and expensive infrastructure upgrades in order to increase our ability to handle larger volumes of sales and to develop or increase ourability to perform a variety of analytical procedures relating to our business, and we are continuing the work to upgrade and further expand these and othercomponents of our infrastructure. We have experienced difficulties with the implementation of various aspects to the upgrades of our infrastructure, and haveincurred increased expenses as a result of these difficulties. As a result of these expenditures, our16ability to quickly reduce spending if our revenues are lower than we project is limited. Therefore, any significant shortfall in the revenues for which we havebuilt and are continuing to build our infrastructure would likely harm our business, prospects, operating results and financial condition and cause our resultsof operation to fall below the expectations of public market analysts and investors. If this occurs, the price of our securities may decline.We depend on our relationships with third party fulfillment partners for a large portion of the products that we offer for sale on our Websites. If we failto maintain these relationships, our business will suffer.At December 31, 2006, we had fulfillment partner relationships with approximately 540 third parties whose products we offer for sale on our Websites.These products accounted for approximately 72% of the non-BMMG products available. We do not have any long-term agreements with any of these thirdparties. Our agreements with third parties are terminable at will by either party immediately upon notice. In general, we agree to offer the third parties’products on our Websites and these third parties agree to provide us with information about their products, honor our customer service policies and ship theproducts directly to the customer. If we do not maintain our existing or build new relationships with third parties on acceptable commercial terms, we may notbe able to offer a broad selection of merchandise, and customers may refuse to shop at our Websites. In addition, manufacturers may decide not to offerparticular products for sale on the Internet. If we are unable to maintain our existing or build new fulfillment partner relationships or if other productmanufacturers refuse to allow their products to be sold via the Internet, our business and prospects would suffer severely.We are partially dependent on third parties to fulfill a number of our fulfillment, distribution and other retail functions. If such parties are unwilling orunable to continue providing these services, our business could be seriously harmed.In our fulfillment partner business, although we handle returned merchandise, we continue to rely on third parties to conduct a number of othertraditional retail operations with respect to their respective products that we offer for sale on our Websites, including maintaining inventory, preparingmerchandise for shipment to individual customers and timely distribution of purchased merchandise. We have no effective means to ensure that these thirdparties will continue to perform these services to our satisfaction or on commercially reasonable terms. In addition, because we do not take possession ofthese third parties’ products, we are unable to fulfill these traditional retail operations ourselves. Our customers could become dissatisfied and cancel theirorders or decline to make future purchases if these third parties are unable to deliver products on a timely basis. If our customers become dissatisfied with theservices provided by these third parties, our reputation and the Overstock.com brand could suffer.We rely on our relationships with manufacturers, retailers and other suppliers to obtain sufficient quantities of quality merchandise on acceptableterms. If we fail to maintain our supplier relationships on acceptable terms, our sales and profitability could suffer.To date, we have not entered into contracts with manufacturers or liquidation wholesalers that guarantee the availability of merchandise for a setduration. Our contracts or arrangements with suppliers do not provide for the continuation of particular pricing practices and may be terminated by eitherparty at any time. Our current suppliers may not continue to sell their excess inventory to us on current terms or at all, and we may not be able to establishnew supply relationships. For example, it is difficult for us to maintain high levels of product quality and selection because none of the manufacturers,suppliers and liquidation wholesalers from whom we purchase products on a purchase order by purchase order basis have a continuing obligation to provideus with merchandise at historical levels or at all. In most cases, our relationships with our suppliers do not restrict the suppliers from selling their respectiveexcess inventory to other traditional or online merchandise liquidators, which could in turn limit the selection of products17available on our Websites. If we are unable to develop and maintain relationships with suppliers that will allow us to obtain sufficient quantities ofmerchandise on acceptable commercial terms, such inability could harm our business, prospects, results of operation and financial condition.We depend upon third-party delivery services to deliver our products to our customers on a timely and consistent basis. Deterioration in ourrelationship with any one of these third parties could decrease our ability to track shipments, cause shipment delays, and increase our shipping costs andthe number of damaged products.We rely upon multiple third parties for the shipment of our products. We cannot be sure that these relationships will continue on terms favorable to us, ifat all. Unexpected increases in shipping costs or delivery times, particularly during the holiday season, could harm our business, prospects, financialcondition and results of operations. If our relationships with these third parties are terminated or impaired or if these third parties are unable to deliverproducts for us, whether through labor shortage, slow down or stoppage, deteriorating financial or business condition, responses to terrorist attacks or for anyother reason, we would be required to use alternative carriers for the shipment of products to our customers. In addition, conditions such as adverse weathercan prevent any carriers from performing their delivery services, which can have an adverse effect on our customers’ satisfaction with us. In any of thesecircumstances, we may be unable to engage alternative carriers on a timely basis, upon terms favorable to us, or at all. Changing carriers would likely have anegative effect on our business, prospects, operating results and financial condition. Potential adverse consequences include:· reduced visibility of order status and package tracking;· delays in order processing and product delivery;· increased cost of delivery, resulting in reduced gross margins; and· reduced shipment quality, which may result in damaged products and customer dissatisfaction.A significant number of merchandise returns could harm our business, financial condition and results of operations.We allow our customers to return products and, beginning July 1, 2003, we started accepting returns of products sold through our fulfillment partners.We modify our policies relating to returns from time to time, and any policies intended to reduce the number of product returns may result in customerdissatisfaction and fewer return customers. If merchandise returns are significant, our business, prospects, financial condition and results of operations couldbe harmed.If the products that we offer on our Websites do not reflect our customers’ tastes and preferences, our sales and profit margins would decrease.Our success depends in part on our ability to offer products that reflect consumers’ tastes and preferences. Consumers’ tastes are subject to frequent,significant and sometimes unpredictable changes. Because the products that we sell typically consist of manufacturers’ and retailers’ excess inventory, wehave limited control over the specific products that we are able to offer for sale. If our merchandise fails to satisfy customers’ tastes or respond to changes incustomer preferences, our sales could suffer and we could be required to mark down unsold inventory which would depress our profit margins. In addition,any failure to offer products in line with customers’ preferences could allow our competitors to gain market share. This could have an adverse effect on ourbusiness, prospects, results of operations and financial condition.18We face risks relating to our inventory.We directly purchase some of the merchandise that we sell on our Websites. We assume the inventory damage, theft and obsolescence risks, as well asprice erosion risks for products that we purchase directly. These risks are especially significant because some of the merchandise we sell on our Websites arecharacterized by rapid technological change, obsolescence and price erosion (for example, computer hardware, software and consumer electronics), andbecause we sometimes make large purchases of particular types of inventory. In addition, we often do not receive warranties on the merchandise we purchase.Further, beginning July 1, 2003, we started accepting returns of products sold through our fulfillment partners, and we have the risk of reselling the returnedproducts.In the recent past, we have recorded charges for obsolete inventory and have had to sell certain merchandise at a discount or loss. It is impossible todetermine with certainty whether an item will sell for more than the price we pay for it. To the extent that we rely on purchased inventory, our success willdepend on our ability to liquidate our inventory rapidly, the ability of our buying staff to purchase inventory at attractive prices relative to its resale valueand our ability to manage customer returns and the shrinkage resulting from theft, loss and misrecording of inventory. If we are unsuccessful in any of theseareas, we may be forced to sell our inventory at a discount or loss.Historically, we have grown quickly and if we fail to manage our growth, our business will suffer.Historically, we have rapidly and significantly expanded our operations, and anticipate that further significant expansion will be required to addresspotential growth in our customer base and market opportunities. This expansion has placed, and is expected to continue to place, a significant strain on ourmanagement, operational and financial resources. Some of our officers have no prior senior management experience at public companies. Our new employeesinclude a number of key managerial, technical and operations personnel, and we expect to add additional key personnel in the future. To manage theexpected growth of our operations and personnel, we will be required to improve existing and implement new transaction-processing, operational andfinancial systems, procedures and controls, and to expand, train and manage our already growing employee base. If we are unable to manage growtheffectively, our business, prospects, financial condition and results of operations will be harmed.The loss of key personnel or any inability to attract and retain additional personnel could affect our ability to successfully grow our business.Our performance is substantially dependent on the continued services and on the performance of our senior management and other key personnel,including Patrick M. Byrne, our Chief Executive Officer, and Jason C. Lindsey, our President and Chief Operating Officer. Our performance also depends onour ability to retain and motivate other officers and key employees. The loss of the services of any of our executive officers or other key employees for anyunforeseen reason, including without limitation, illness or call to military service, could harm our business, prospects, financial condition and results ofoperations. We do not have employment agreements with any of our key personnel and we do not maintain “key person” life insurance policies. Our futuresuccess also depends on our ability to identify, attract, hire, train, retain and motivate other highly-skilled technical, managerial, editorial, merchandising,marketing and customer service personnel. Competition for such personnel is intense, and we cannot assure you that we will be able to successfully attract,assimilate or retain sufficiently qualified personnel. Our failure to retain and attract the necessary technical, managerial, editorial, merchandising, marketingand customer service personnel could harm our revenues, business, prospects, financial condition and results of operations.We generally pay our senior management, including our executive officers, lower levels of cash compensation than we believe they might be able toearn elsewhere. Our stock option plan and performance share plan are intended to and do help us recruit and retain highly qualified personnel;19however, we sometimes have difficulty retaining senior level personnel. If we are unable to retain our senior management with our current compensationstructure and incentive plans, we may lose members of senior management and/or be required to modify our compensation structure and/or retention plans.We have a rapidly evolving business model.Our business model has evolved and continues to do so. In the past we have added additional types of services and product offerings, and in some caseswe have modified or discontinued those offerings. We may continue to try to offer additional types of products or services, and we cannot offer any assurancethat any of them will be successful. From time to time we have also modified aspects of our business model relating to our product mix and the mix ofdirect/fulfillment partner sourcing of the products we offer. We may continue to modify this aspect of our business as well as other significant aspects of ourbusiniess. We cannot offer any assurance that these or any other modifications will be successful.We may be unable to manage expansion into new business areas which could harm our business operations and reputation.Our long-term strategic plan involves expansion of our operations to offer additional types of products and services. We cannot assure you that ourefforts to expand our business in this manner will succeed. Because we were unable to generate significant traffic for our former B2B site, in the third quarterof 2004, we merged the B2B site into our main website, and opened our Wholesale bulk purchase program. We have also attempted to expand into otherareas, such as the “Other Frontiers” listed under the “Other Stores” link, and the results of these expansion efforts have not yet met our expectations. Ourfailure to succeed in these markets or businesses or in other product or service offerings may harm our business, prospects, financial condition and results ofoperation. We cannot assure you that we will be able to expand our operations in a cost-effective or timely manner or that our efforts to expand will besuccessful. Furthermore, any new business or Website we launch that is not favorably received by consumers could damage our reputation or theOverstock.com brand. We may expand the number of categories of products we carry on our Websites and these and any other expansions of our operationswould also require significant additional expenses and development and would strain our management, financial and operational resources. The lack ofmarket acceptance of such efforts or our inability to generate satisfactory revenues from such expanded services or products to offset their cost could harm ourbusiness, prospects, financial condition and results of operations.We may expand our international business, causing our business to become increasingly susceptible to numerous international business risks andchallenges that could affect our profitability.We have begun to expand into international markets, and in the future we may do so more aggressively. International sales and transactions are subjectto inherent risks and challenges that could adversely affect our profitability, including:· the need to develop new supplier and manufacturer relationships;· the need to comply with additional laws and regulations to the extent applicable;· unexpected changes in international regulatory requirements and tariffs;· difficulties in staffing and managing foreign operations;· longer payment cycles from credit card companies;· greater difficulty in accounts receivable collection;· potential adverse tax consequences;20· price controls or other restrictions on foreign currency; and· difficulties in obtaining export and import licenses.To the extent we generate international sales and transactions in the future, any negative impact on our international operations could negatively impactour business. In particular, gains and losses on the conversion of foreign payments into United States dollars may contribute to fluctuations in our results ofoperations and fluctuating exchange rates could cause reduced gross revenues and/or gross margins from non-dollar-denominated international sales.In order to obtain future revenue growth and achieve and sustain profitability we will have to attract customers on cost-effective terms.Our success depends on our ability to attract customers on cost-effective terms. We have relationships with online services, search engines, directoriesand other Websites and e-commerce businesses to provide content, advertising banners and other links that direct customers to our Websites. We rely onthese relationships as significant sources of traffic to our Websites and to generate new customers. If we are unable to develop or maintain these relationshipson acceptable terms, our ability to attract new customers and our financial condition could be harmed. In addition, certain of our online marketingagreements may require us to pay upfront fees and make other payments prior to the realization of the sales, if any, associated with those payments.Accordingly, if these agreements or similar agreements that we may enter into in the future fail to produce the sales that we anticipate, our results ofoperations will be adversely affected. We cannot assure you that we will be able to increase our revenues, if at all, in a cost-effective manner. We periodicallyconduct national television and radio branding and advertising campaigns. Such campaigns are expensive and may not result in the cost effective acquisitionof customers.Further, many of the parties with which we may have online-advertising arrangements could provide advertising services for other online or traditionalretailers and merchandise liquidators. As a result, these parties may be reluctant to enter into or maintain relationships with us. Failure to achieve sufficienttraffic or generate sufficient revenue from purchases originating from third parties may result in termination of these relationships by these third parties.Without these relationships, our revenues, business, prospects, financial condition and results of operations could suffer.We may not be able to compete successfully against existing or future competitors.The online liquidation services market is rapidly evolving and intensely competitive. Barriers to entry are minimal, and current and new competitors canlaunch new Websites at a relatively low cost. Our consumer Website currently competes with:·· liquidation e-tailers such as SmartBargains;· online retailers with discount departments such as Amazon.com, Inc., eBay, Inc. and Buy.com, Inc.; and· traditional retailers and liquidators such as Ross Stores, Inc., Walmart Stores, Inc., TJX Companies, Inc., Costco Wholesale Corporation, TargetCorporation and Best Buy Co., Inc., which may or may not also have an online presence.Our Website competes with liquidation “brokers” and retailers and online marketplaces such as eBay, Inc.We expect the online liquidation services market to become even more competitive as traditional liquidators and online retailers continue to developservices that compete with our services. In addition, manufacturers and retailers may decide to create their own Websites to sell their own excess inventoryand21the excess inventory of third parties. Competitive pressures created by any one of our competitors, or by our competitors collectively, could harm ourbusiness, prospects, financial condition and results of operations.Further, as a strategic response to changes in the competitive environment, we may from time to time make certain pricing, service or marketingdecisions or acquisitions that could harm our business, prospects, financial condition and results of operations. For example, to the extent that we enter newlines of businesses such as third-party logistics, or discount brick and mortar retail, we would be competing with large established businesses such as APLLogistics, and Ltd., Ross Stores, Inc., respectively. We have recently entered the online auctions and car listing businesses in which we compete with largeestablished businesses including eBay, Inc. and AutoTrader.com, Inc.Many of our current and potential competitors described above have longer operating histories, larger customer bases, greater brand recognition andsignificantly greater financial, marketing and other resources than we do. In addition, online retailers and liquidation e-tailers may be acquired by, receiveinvestments from or enter into other commercial relationships with larger, well-established and well-financed companies. Some of our competitors may beable to secure merchandise from manufacturers on more favorable terms, devote greater resources to marketing and promotional campaigns, adopt moreaggressive pricing or inventory availability policies and devote substantially more resources to Website and systems development than we do. Increasedcompetition may result in reduced operating margins, loss of market share and a diminished brand franchise. We cannot assure you that we will be able tocompete successfully against current and future competitors.Our operating results depend on our Websites, network infrastructure and transaction-processing systems. Capacity constraints or system failureswould harm our business, prospects, results of operations and financial condition.Any system interruptions that result in the unavailability of our Websites or reduced performance of our transaction systems would reduce ourtransaction volume and the attractiveness of the services that we provide to suppliers and third parties and would harm our business, prospects, operatingresults and financial condition.We use internally developed systems for our Websites and certain aspects of transaction processing, including customer profiling and order verifications.We have experienced periodic systems interruptions due to server failure, which we believe will continue to occur from time to time. If the volume of trafficon our Websites or the number of purchases made by customers substantially increases, we will need to further expand and upgrade our technology,transaction processing systems and network infrastructure. We have experienced and expect to continue to experience temporary capacity constraints due tosharply increased traffic during sales or other promotions and during the holiday shopping season. Capacity constraints can cause unanticipated systemdisruptions, slower response times, and degradation in levels of customer service, impaired quality and delays in reporting accurate financial information.Our transaction processing systems and network infrastructure may be unable to accommodate increases in traffic in the future. We may be unable toproject accurately the rate or timing of traffic increases or successfully upgrade our systems and infrastructure to accommodate future traffic levels on ourWebsites. In addition, we may be unable to upgrade and expand our transaction processing systems in an effective and timely manner or to integrate anynewly developed or purchased functionality with our existing systems. For example, in the third quarter 2005 we experienced difficulties with ourimplementation of infrastructure upgrades, which resulted in our inability to upload new products to our website for a period of approximately five weeks.Any such difficulties with our transaction processing systems or other difficulties upgrading, expanding or integrating various aspects of our systemsmay cause unanticipated system disruptions, slower response times, and degradation in levels of customer service,22additional expense, impaired quality and speed of order fulfillment or delays in reporting accurate financial information.If the facilities where substantially all of our computer and communications hardware is located fail, our business, results of operations and financialcondition will be harmed.Our success, and, in particular, our ability to successfully receive and fulfill orders and provide high-quality customer service, largely depends on theefficient and uninterrupted operation of our computer and communications systems. Substantially all of our computer and communications hardware islocated at a single co-location facility in Salt Lake City, Utah, with a partially redundant back-up system located at our corporate headquarters in Salt LakeCity. Although we have designed our back-up system in an effort to avoid or minimize service interruptions in the event of a failure of our main facility, oursystems and operations are vulnerable to damage or interruption from fire, flood, power loss, telecommunications failure, terrorist attacks, acts of war, break-ins, earthquake and similar events. We do not have a formal disaster recovery plan and our business interruption insurance may be insufficient to compensateus for losses that may occur. Despite the implementation of network security measures, our servers are vulnerable to computer viruses, physical or electronicbreak-ins and similar disruptions, which could lead to interruptions, delays, loss of critical data or the inability to accept and fulfill customer orders. Theoccurrence of any of the foregoing risks could harm our business, prospects, financial condition and results of operations.We may be unable to protect our proprietary technology or keep up with that of our competitors.Our success depends to a significant degree upon the protection of our software and other proprietary intellectual property rights. We may be unable todeter misappropriation of our proprietary information, detect unauthorized use and take appropriate steps to enforce our intellectual property rights. Inaddition, our competitors could, without violating our proprietary rights, develop technologies that are as good as or better than our technology.Our failure to protect our software and other proprietary intellectual property rights or to develop technologies that are as good as our competitors’ couldput us at a disadvantage to our competitors. In addition, the failure of the third parties whose products we offer for sale on our Websites to protect theirintellectual property rights, including their domain names, could impair our operations. These failures could harm our business, results of operations andfinancial condition.If we do not respond to rapid technological changes, our services could become obsolete and we could lose customers.To remain competitive, we must continue to enhance and improve the functionality and features of our e-commerce businesses. We may face materialdelays in introducing new services, products and enhancements. If this happens, our customers may forgo the use of our Websites and use those of ourcompetitors. The Internet and the online commerce industry are rapidly changing. If competitors introduce new products and services using new technologiesor if new industry standards and practices emerge, our existing Websites and our proprietary technology and systems may become obsolete. Our failure torespond to technological change or to adequately maintain, upgrade and develop our computer network and the systems used to process customers’ ordersand payments could harm our business, prospects, financial condition and results of operations.23We may not be able to obtain trademark protection for our marks, which could impede our efforts to build brand identity.We have filed trademark applications with the Patent and Trademark Office seeking registration of certain service marks and trademarks. There can be noassurance that our applications will be successful or that we will be able to secure significant protection for our service marks or trademarks in the UnitedStates or elsewhere as we expand internationally. Our competitors or others could adopt product or service marks similar to our marks, or try to prevent usfrom using our marks, thereby impeding our ability to build brand identity and possibly leading to customer confusion. Any claim by another party againstus or customer confusion related to our trademarks, or our failure to obtain trademark registration, could negatively affect our business.We may not be able to enforce protection of our intellectual property rights under the laws of other countries.As we continue to expand internationally, we are subject to risks of doing business internationally as related to our intellectual property, including:· legal uncertainty regarding liability for the listings and other content provided by our users, including uncertainty as a result of less Internet-friendlylegal systems, unique local laws, and lack of clear precedent or applicable law; and· differing intellectual property laws, which may provide insufficient protection for our intellectual property.Our business and reputation may be harmed by the listing or sale of pirated, counterfeit or illegal items by third parties, and by intellectual propertylitigation.We have received in the past, and we anticipate we will receive in the future, communications alleging that certain items listed or sold through ourWebsites infringe third-party copyrights, trademarks and trade names or other intellectual property rights or that we have otherwise infringed third parties’past, current or future intellectual property rights. For example, in October 2003, Tiffany (NJ) Inc. and Tiffany and Company filed a complaint against us inthe United States District Court for the Southern District of New York alleging that we have distributed counterfeit and otherwise unauthorized Tiffanyproduct in violation of federal copyright and trademark law and related state laws. In addition, in January and February 2005, Tiffany filed additionalcomplaints against us asserting similar claims. We reached a confidential agreement that settled all of these cases and all of the cases were dismissed onJuly 14, 2006.We may be unable to prevent third parties from listing unlawful goods, and we may be subject to allegations of civil or criminal liability for unlawfulactivities carried out by third parties through our Websites. In the future, we may implement measures to protect against these potential liabilities that couldrequire us to spend substantial resources and/or to reduce revenues by discontinuing certain service offerings. Any costs incurred as a result of liability orasserted liability relating to the sale of unlawful goods or the unlawful sale of goods could harm our revenues, business, prospects, financial condition andresults of operations.Resolving litigation or claims regarding patents or other intellectual property, whether meritorious or not, could be costly, time-consuming, causeservice delays, divert our management and key personnel from our business operations, require expensive or unwanted changes in our methods of doingbusiness or require us to enter into costly royalty or licensing agreements, if available. As a result, these claims could harm our business.Negative publicity generated as a result of the foregoing could damage our reputation, harm our business and diminish the value of our brand name.24Gradient Analytics and Rocker Partners, L.P. LitigationIn August 2005 we filed an unfair business practice lawsuit against Gradient Analytics, Rocker Partners, L.P. and others, alleging that the defendantshave conspired to denigrate Overstock’s business for personal profit. In October 2005 we filed an amended complaint alleging additional causes of actionand articulating in greater detail the allegations against the defendants. Overstock’s Chief Executive Officer, Dr. Patrick Byrne, has appeared on nationallysyndicated television programs and elsewhere to discuss the litigation. The use of management’s time and attention in connection with the litigation andrelated matters may reduce the time management is able to spend on other aspects of our business, which may have adverse effects on other aspects of ourbusiness. To the extent that any such adverse effects exceed any benefits we may realize from pursuing the litigation, our business, prospects, financialcondition and results of operation may suffer.Prime Broker LitigationIn February 2007, along with five shareholder plaintiffs, we filed a lawsuit in the Superior Court of California, County of San Francisco against MorganStanley & Co. Incorporated, Goldman Sachs & Co., Bear Stearns Companies, Inc., Bank of America Securities LLC, Bank of New York, Citigroup Inc., CreditSuisse (USA) Inc., Deutsche Bank Securities, Inc., Merrill Lynch, Pierce, Fenner & Smith, Inc., and UBS Financial Services, Inc. The use of management’s timeand attention in connection with the litigation and related matters may reduce the time management is able to spend on other aspects of our business, whichmay have adverse effects on other aspects of our business. To the extent that any such adverse effects exceed any benefits we may realize from pursuing thelitigation, our business, prospects, financial condition and results of operation may suffer.We may be liable if third parties misappropriate our customers’ personal information.If third parties are able to penetrate our network security or otherwise misappropriate our customers’ personal information or credit card information, or ifwe give third parties improper access to our customers’ personal information or credit card information, we could be subject to liability. This liability couldinclude claims for unauthorized purchases with credit card information, impersonation or other similar fraud claims. This liability could also include claimsfor other misuses of personal information, including unauthorized marketing purposes. These claims could result in litigation. Liability for misappropriationof this information could adversely affect our business. In addition, the Federal Trade Commission and state agencies have been investigating variousInternet companies regarding their use of personal information. We could incur additional expenses if new regulations regarding the use of personalinformation are introduced or if government agencies investigate our privacy practices.We rely on encryption and authentication technology licensed from third parties to provide the security and authentication necessary to effect securetransmission of confidential information such as customer credit card numbers. We cannot assure you that advances in computer capabilities, new discoveriesin the field of cryptography or other events or developments will not result in a compromise or breach of the algorithms that we use to protect customertransaction data. If any such compromise of our security were to occur, it could harm our reputation, business, prospects, financial condition and results ofoperations. A party who is able to circumvent our security measures could misappropriate proprietary information or cause interruptions in our operations.We may be required to expend significant capital and other resources to protect against such security breaches or to alleviate problems caused by suchbreaches. We cannot assure you that our security measures will prevent security breaches or that failure to prevent such security breaches will not harm ourbusiness, prospects, financial condition and results of operations.25We may be subject to product liability claims that could be costly and time consuming.We sell products manufactured for us by third parties, some of which may be defective. If any product that we sell were to cause physical injury or injuryto property, the injured party or parties could bring claims against us as the manufacturer and/or retailer of the product. Our insurance coverage may not beadequate to cover every claim that could be asserted. If a successful claim were brought against us in excess of our insurance coverage, it could adverselyaffect our business. Even unsuccessful claims could result in the expenditure of funds and management time and could have a negative impact on ourbusiness.We may face risks relating to the development of our travel business.We acquired all of the capital stock of Ski West, Inc., an on-line travel company, on July 1, 2005 and integrated Ski West with our travel operations toform OTravel.com, Inc (our travel business). There can be no assurance about the future performance of our travel business. If we are unsuccessful in disposingof our travel business, we may encounter unforeseen operating or other difficulties.We may face risks relating to the planned sale of our travel business.In the fourth quarter of 2006, we determined to reduce our expense structure and sell non-core businesses. We have taken steps to accomplish the sale ofOTravel (our travel business), and have classified it as a discontinued operation. As a result, we have implemented plans designed to reduce our travelbusiness’ operating expenses and maintain its core operations at current level of performance and have discontinued plans and operations designed toexpand this portion of our business. There can be no assurance that our plans to sell our travel business will succeed, or that we will achieve terms of salefavorable to us. Additionally, we may encounter problems associated with the sale which may reduce sales proceeds, cost us expenses or expose us tounanticipated litigation during or following the sale. The determination to discontinue expansion plans, and support our travel business operations at amaintenance level, may cause us to forego improvements and upgrades to its software platforms and business processes and procedures necessary to maintaina competivive operation. The sale of such a subsidiary may present these and other problems which may have a material, adverse effect on the remainder ofour business operations. We may not succeed in the sale and as a result, we may have to continue operations of our travel business for some time, and mayincur as a result unanticipated operational costs. We are exploring the possibility of selling some or all of our travel business. We may be unable to do so at aprice equal to the price we paid for the Ski West business or at a price we consider acceptable.We have significant indebtedness.In connection with our sale of our 3.75% Convertible Senior Notes (the “Senior Notes”) in November 2004, we incurred $120.0 million of indebtedness,due December 1, 2011. Under the repurchase program approved by our Board of Directors in 2005, we retired $33.0 million and $10.0 million of the SeniorNotes in June and November 2005 for $27.9 million and $7.8 million in cash, respectively. As a result of the note retirements, we recognized a gain of $6.2million for the year ended December 31, 2005, net of the associated unamortized discount of $1.2 million. As of December 31, 2006, $77.0 million of theSenior Notes remained outstanding. As a result of this indebtedness, our principal and interest payment obligations increased substantially. The degree towhich we are leveraged could materially and adversely affect our ability to obtain additional financing for working capital, acquisitions or other purposesand could make us more vulnerable to industry downturns and competitive pressures. Our ability to meet our debt service obligations is dependent upon ourfuture performance, which will be subject to financial, business and other factors affecting our operations, many of which are beyond our control.26We may be unable to generate sufficient cash flow to satisfy our debt service obligations.Our ability to generate cash flow from operations to make interest payments on our debt obligations will depend on our future performance, which willbe affected by a range of economic, competitive and business factors. We cannot control many of these factors, including general economic conditions andthe health of the internet retail industry. If our operations do not generate sufficient cash flow from operations to satisfy our debt service obligations, wemay need to borrow additional funds to make these payments or undertake alternative financing plans, such as refinancing or restructuring our debt, orreducing or delaying capital investments and acquisitions. Additional funds or alternative financing may not be available to us on favorable terms, or at all.Our inability to generate sufficient cash flow from operations or obtain additional funds or alternative financing on acceptable terms could have a materialadverse effect on our business, prospects, financial condition and results of operations.Risks Relating to our Auctions Site BusinessOur auctions site is a new business.Our auctions site began operation in September 2004. The online auctions business is a new business for us, and we cannot ensure that our expansioninto the online auctions business will succeed. Our entry into the online auctions business will require us to devote substantial financial, technical,managerial and other resources to the business. It will also expose us to additional risks, including legal and regulatory risks, and it will require us to competewith established businesses having substantially greater experience in the online auctions business and substantially greater resources than we have.Our auction business may be subject to a variety of regulatory requirements.Many states and other jurisdictions, including Utah, where our company is located, have regulations governing the conduct of traditional “auctions”and the liability of traditional “auctioneers” in conducting auctions. Although the vast majority of these regulations clearly contemplated only traditionalauctions, not online auctions, the potential application of these types of regulations to online auction sites is not clear. We are aware that several states andsome foreign jurisdictions have attempted to impose such regulations on other companies operating online auction sites or on the users of those sites. Inaddition, certain states have laws or regulations that do expressly apply to online auction site services. Although we do not expect these laws to have asignificant effect on our auction site business, we will incur costs in complying with these laws, and we may from time to time be required to make changes inour business that may increase our costs, reduce our revenues, cause us to prohibit the listing of certain items in certain locations, or make other changes thatmay adversely affect our auctions business.Current and future laws could affect our auctions business.Like our shopping site business, our auction site business is subject to the same laws and regulations that apply to other companies conducting businesson and off the Internet. In addition, our auction site business may be affected by other laws and regulations, such as those that expressly apply to onlineauction site services. Further, because of the wide range of items that users of our auctions service may choose to list on the site, a variety of additional lawsand regulations may apply to transactions between users of our site, such as those requiring a license to sell or purchase certain items or mandating particulardisclosures in connection with an offer or sale of an item. To the extent that such current or future laws or regulations prevent users from selling items on ourauction site, they could harm our business.Our business may be harmed if our auction site is used for unlawful transactions.The law regarding the potential liability of an online auction service for the activities of its users is not clear. We prohibit the listing of numerouscategories of items in an effort to reduce the possibility that27users of our auction site will engage in an unlawful transaction. However, we cannot assure that users of the site will comply with all laws and regulationsapplicable to them and their transactions, and we may be subject to allegations of civil or criminal liability for any unlawful activities conducted by them.Any costs we incur as a result of any such allegations, or as a result of actual or alleged unlawful transactions utilizing our site, or in our efforts to prevent anysuch transactions, may harm our business. In addition, any negative publicity we receive regarding any such transactions or allegations may damage ourreputation, our ability to attract new customers to our main shopping site, and the Overstock.com brand name generally.Fraudulent activities using our auctions site and disputes between users of our auctions site may harm our business.We are aware that other companies operating online auction services have periodically received complaints from users alleging that they have notreceived the purchase price or the goods they expected to receive, and that in some cases users have been arrested and convicted for engaging in fraudulentactivities using those companies’ auction sites. We may receive similar complaints. We do not have the ability to require users of our services to fulfill theirobligations to make payments or to deliver items. We are aware that other companies periodically receive complaints from buyers about the quality of theitems they purchase, requests for reimbursement of amounts paid, and communications threatening or commencing legal actions against them. Wemay receive similar complaints, requests and communications in connection with our auctions site business.We are subject to risks associated with information transmitted through our service.The law relating to the liability of online services companies for information carried on or disseminated through their services is currently unsettled.Claims could be made against online services companies under both U.S. and foreign law for defamation, libel, invasion of privacy, negligence, copyright ortrademark infringement, or other theories based on the nature and content of the materials disseminated through their services. We are aware that privatelawsuits seeking to impose liability under a number of these theories have been brought against other companies operating auction sites. In addition,domestic and foreign legislation has been proposed that would prohibit or impose liability for the transmission over the Internet of certain types ofinformation. Our service permits users to make comments regarding other users. Although all such comments are generated by users and not by us, we areaware that claims of defamation or other injury have been made against other companies operating auction services in the past and could be made in thefuture against us for comments made by users. Recent court decisions have narrowed the scope of the immunity provided to Internet service providers like usunder the Communications Decency Act. This trend, if continued, may increase our potential liability to third parties for the user-provided content on oursite.Difficulties or negative publicity associated with our auctions business could affect our main shopping site business.Any significant operational or other difficulties we encounter with our auctions business could damage our reputation, our ability to attract newcustomers to our main shopping site, and the Overstock.com brand name generally. Negative publicity resulting from actual or alleged fraudulent ordeceptive conduct by users of our auctions site could also damage our reputation, our ability to attract new customers to our main shopping site, and theOverstock.com brand name generally.28Risks Relating to our Cars Site BusinessOur cars site is a new business.Our cars site began operation in December 2006. The cars site is a listing service for automobile sellers. The online car listing service is a new businessfor us. We cannot ensure that our expansion into the car listing business will succeed. Our entry into this business will require us to devote substantialfinancial, technical, managerial and other resources to the business. It will also expose us to additional risks, including legal and regulatory risks, and it willrequire us to compete with established businesses having substantially greater experience in the online car listing service business and substantially greaterresources than we have.Our car listing business may be subject to a variety of regulatory requirements.Many states and other jurisdictions, including Utah, where we are located, have regulations governing the conduct of car sellers and publicadvertisement for car sales. Generally, these regulations govern the conduct of those sellers advertising their automobiles for sale and are not directlyapplicable to those providing the medium through which the advertisement is made available to the public. Sellers are often subject to regulations in thenature of “truth in advertising laws.” The application of these regulations to online car listing service providers is not clear. Although we do not expect theselaws to have a significant effect on our car listing business, we will incur costs in researching and complying with these laws, and we may from time to timebe required to make changes in our business that may increase our costs, reduce our revenues, cause us to prohibit certain listing or advertising practices, ormake other changes that may adversely affect our cars listing business.Current and future laws could affect our car listing business.Like our shopping site business, our car listing business is subject to the same laws and regulations that apply to other companies conducting businesson and off the Internet. In addition, our car listing site business may be affected by other laws and regulations, such as those that expressly apply toadvertising automobiles for sale. To the extent that such current or future laws or regulations prevent users from selling items on our car listing site, theycould harm our business.Our business may be harmed if our car listing site is used for unlawful transactions.The law regarding the potential liability of an online listing service for automobile sales is not clear. The platform of the listing service will beaccessible to those subscribers who will have the ability to feature their cars for sale and will supply the text descriptions of the vehicles, including thegeneral condition of the vehicle and other important information. We will have no ability beforehand to know if the information sellers provide is correct.While our site terms and conditions of usage will prohibit unlawful acts, we cannot rule out the possibility that users of our cars listing site will engage in anunlawful transactions, or fail to comply with all laws and regulations applicable to them and their transactions, and we may be subject to allegations of civilor criminal liability for any unlawful activities conducted by them. Any costs we incur as a result of any such allegations, or as a result of actual or allegedunlawful transactions utilizing our site, or in our efforts to prevent any such transactions, may harm our business. In addition, any negative publicity wereceive regarding any such transactions or allegations may damage our reputation, our ability to attract new customers to our main shopping site, and theOverstock.com brand name generally.Fraudulent activities using our cars listing site and disputes between users of our car listing site may harm our business.We are aware that other companies operating online car listing services have periodically received complaints from users alleging improprieties inconnection with listings, and occasionally these complaints29may result in regulatory action. Particularly, with any online listing service there is the possibility that sellers may attempt to employ “bait and switch”techniques, attracting consumers with advertisements of low cost, good condition vehicles in hopes of switching buyer interest to another less favorablevehicle once a potential purchaser responds. Additionally, sellers may attempt to sell vehicles without accurate descriptions of the condition of the vehicles.We do not have the ability to require users of our services to fulfill their obligations to make accurate disclosures or comply with consumer laws prohibiting“bait and switch” or other prohibited seller tactics. We are aware that other companies providing similar services periodically receive complaints from vehiclepurchasers about the quality of the vehicles they purchase, requesting reimbursement of amounts they have paid, threatening or commencing legal actionsagainst the listing service for damages. We may receive similar complaints, requests and communications, and encounter similar legal actions in connectionwith our cars listing business, which may harm our business or reputation among consumers.Risks Relating to the Internet IndustryOur success is tied to the continued use of the Internet and the adequacy of the Internet infrastructure.Our future revenues and profits, if any, substantially depend upon the continued widespread use of the Internet as an effective medium of business andcommunication. Factors which could reduce the widespread use of the Internet include:· actual or perceived lack of security of information or privacy protection;· possible disruptions, computer viruses or other damage to the Internet servers or to users’ computers; and· governmental regulation.Customers may be unwilling to use the Internet to purchase goods.Our long-term future depends heavily upon the general public’s willingness to use the Internet as a means to purchase goods. E-commerce remains arelatively new concept, and large numbers of customers may not begin or continue to use the Internet to purchase goods. The demand for and acceptance ofproducts sold over the Internet are highly uncertain, and most e-commerce businesses have a short track record. If consumers are unwilling to use the Internetto conduct business, our business may not develop profitably.The security risks or perception of risks of e-commerce may discourage customers from purchasing goods from us.In order for the e-commerce market to develop successfully, we and other market participants must be able to transmit confidential information securelyover public networks. Third parties may have the technology or know-how to breach the security of customer transaction data. Any breach could causecustomers to lose confidence in the security of our Websites and choose not to purchase from our Websites. If someone is able to circumvent our securitymeasures, he or she could destroy or steal valuable information or disrupt our operations. Concerns about the security and privacy of transactions over theInternet could inhibit the growth of the Internet and e-commerce. Our security measures may not effectively prohibit others from obtaining improper access toour information. Third parties may target our customers directly with fraudulent identity theft schemes designed to appear as legitimate communications fromus. Any security breach or fraud perpetrated on our customers could expose us to increased costs and to risks of loss, litigation and liability and couldseriously disrupt our operations.30Credit card fraud could adversely affect our business.We do not carry insurance against the risk of credit card fraud, so the failure to adequately control fraudulent credit card transactions could reduce ournet revenues and our gross margin. We have implemented technology to help us detect the fraudulent use of credit card information. However, we may in thefuture suffer losses as a result of orders placed with fraudulent credit card data even though the associated financial institution approved payment of theorders. Under current credit card practices, we may be liable for fraudulent credit card transactions because we do not obtain a cardholder’s signature. If we areunable to detect or control credit card fraud, our liability for these transactions could harm our business, results of operation or financial condition.If one or more states successfully assert that we should collect sales or other taxes on the sale of our merchandise or the merchandise of third partiesthat we offer for sale on our Websites, our business could be harmed.We do not currently collect sales or other similar taxes for physical shipments of goods into states other than Utah and Indiana. One or more local, stateor foreign jurisdictions may seek to impose sales tax collection obligations on us and other out-of-state companies that engage in online commerce. Ourbusiness could be adversely affected if one or more states or any foreign country successfully asserts that we should collect sales or other taxes on the sale ofour merchandise.Existing or future government regulation could harm our business.We are subject to the same federal, state and local laws as other companies conducting business on the Internet. Today there are relatively few lawsspecifically directed towards conducting business on the Internet. However, due to the increasing popularity and use of the Internet, many laws andregulations relating to the Internet are being debated at the state and federal levels. These laws and regulations could cover issues such as user privacy,freedom of expression, pricing, fraud, quality of products and services, taxation, advertising, intellectual property rights and information security.Applicability to the Internet of existing laws governing issues such as property ownership, copyrights and other intellectual property issues, taxation, libel,obscenity and personal privacy could also harm our business. For example, United States and foreign laws regulate our ability to use customer informationand to develop, buy and sell mailing lists. The vast majority of these laws was adopted prior to the advent of the Internet, and do not contemplate or addressthe unique issues raised thereby. Those laws that do reference the Internet are only beginning to be interpreted by the courts and their applicability and reachare therefore uncertain. These current and future laws and regulations could harm our business, results of operation and financial condition.Laws or regulations relating to privacy and data protection may adversely affect the growth of our Internet business or our marketing efforts.We are subject to increasing regulation at the federal, state and international levels relating to privacy and the use of personal user information. Forexample, we are subject to various telemarketing laws that regulate the manner in which we may solicit future suppliers and customers. Such regulations,along with increased governmental or private enforcement, may increase the cost of growing our business. In addition, many jurisdictions have laws that limitthe uses of personal user information gathered online or offline or require companies to establish privacy policies. The Federal Trade Commission hasadopted regulations regarding the collection and use of personal identifying information obtained from children under 13. Proposed legislation in thiscountry and existing laws in foreign countries require companies to establish procedures to notify users of privacy and security policies, obtain consent fromusers for collection and use of personal information, and/or provide users with the ability to access, correct and delete personal information stored by us.Additional legislation regarding data security and privacy has been proposed in Congress. These data protection regulations may restrict our ability tocollect demographic and personal31information from users, which could be costly or harm our marketing efforts, and could require us to implement new and potentially costly processes,procedures and/or protective measures.Risks Relating to the Securities Markets and Ownership of Our SecuritiesThe price of our securities may be volatile and you may lose all or a part of your investment.Our common stock has been publicly traded only since May 30, 2002. The market price of our common stock has been subject to significantfluctuations since the date of our initial public offering. These fluctuations could continue. It is possible that in some future periods our results of operationsmay be below the expectations of public market analysts and investors. If this occurs, the market price of our securities may decline. Among the factors thatcould affect the market price of our securities are as follows:· changes in securities analysts’ recommendations or estimates of our financial performance or publication of research reports by analysts;· changes in market valuations of similar companies;· announcements by us or our competitors of significant contracts, acquisitions, commercial relationships, joint ventures or capital commitments;· general market conditions;· actual or anticipated fluctuations in our operating results;· intellectual property or litigation developments;· changes in our management team;· economic factors unrelated to our performance; and· our issuance of additional shares of stock or other securities.In addition, the securities markets have experienced significant price and trading volume fluctuations. These broad market fluctuations may adverselyaffect the trading price of our securities. In the past, following periods of volatility in the market price of a public company’s securities, securities class actionlitigation has often been instituted against that company. Such litigation could result in substantial cost and a diversion of management’s attention andresources.Our quarterly operating results are volatile and may adversely affect the market price of our securities.Our future revenues and operating results are likely to vary significantly from quarter to quarter due to a number of factors, many of which are outsideour control, and any of which could harm our business. As a result, we believe that quarterly comparisons of our operating results are not necessarilymeaningful and that you should not rely on the results of one quarter as an indication of our future performance. In addition to the other risk factors describedin this report, additional factors that have caused and/or could cause our quarterly operating results to fluctuate and in turn affect the market price of oursecurities include:· increases in the cost of advertising;· our inability to retain existing customers or encourage repeat purchases;· the extent to which our existing and future marketing agreements are successful;· price competition that results in lower profit margins or losses;· the amount and timing of operating costs and capital expenditures relating to the expansion of our business operations and infrastructure;32· the amount and timing of our purchases of inventory;· our inability to manage distribution operations or provide adequate levels of customer service;· our ability to successfully integrate operations and technologies from acquisitions or other business combinations;· entering into new lines of products;· our ability to attract users to our new auctions and car listing sites; and· our inability to replace the loss of significant customers.Our operating results may fluctuate depending on the season, and such fluctuations may affect the market price of our securities.We have experienced and expect to continue to experience fluctuations in our operating results because of seasonal fluctuations in traditional retailpatterns. Sales in the retail and wholesale industry tend to be significantly higher in the fourth calendar quarter of each year than in the preceding threequarters due primarily to increased shopping activity during the holiday season. However, there can be no assurance that our sales in the fourth quarter willexceed those of the preceding quarters or, if the fourth quarter sales do exceed those of the preceding quarters, that we will be able to manage the increasedsales effectively. Further, we generally increase our inventories substantially in anticipation of holiday season shopping activity, which has a negative effecton our cash flow. Securities analysts and investors may inaccurately estimate the effects of seasonality on our results of operations in one or more futurequarters and, consequently, our operating results may fall below expectations, causing the market price of our securities to decline.We do not intend to pay dividends on our non-redeemable common stock, and you may lose the entire amount of your investment in our common stock.We have never declared or paid any cash dividends on our non-redeemable common stock and do not intend to pay dividends on our non-redeemablecommon stock for the foreseeable future. We intend to invest our future earnings, if any, to fund our growth. Therefore, you will not receive any funds withoutselling your shares. We cannot assure that you will receive a positive return on your investment when you sell your shares or that you will not lose the entireamount of your investment.Our Amended and Restated Certificate of Incorporation, Amended and Restated Bylaws and the Delaware General Corporation Law contain anti-takeover provisions which could discourage or prevent a takeover, even if an acquisition would be beneficial to our stockholders.Several provisions of our Amended and Restated Certificate of Incorporation and Amended and Restated Bylaws could discourage potential acquisitionproposals and could delay or prevent a change in control of our company even if that change in control would be beneficial to our stockholders. For example,only one-third of our board of directors will be elected at each of our annual meetings of stockholders, which will make it more difficult for a potentialacquirer to change the management of our company, even after acquiring a majority of the shares of our common stock. These provisions, which cannot beamended without the approval of two-thirds of our stockholders, could diminish the opportunities for a stockholder to participate in tender offers, includingtender offers at a price above the then current market value of our common stock. In addition, our board of directors, without further stockholder approval,may issue preferred stock, with such terms as the board of directors may determine, that could have the effect of delaying or preventing a change in control ofour company. The issuance of preferred stock could also adversely affect the voting powers of the holders of common stock, including the loss of votingcontrol to others. We are also afforded the protections of Section 203 of the Delaware33General Corporation Law, which could delay or prevent a change in control of our company or could impede a merger, consolidation, takeover or otherbusiness combination involving our company or discourage a potential acquirer from making a tender offer or otherwise attempting to obtain control of ourcompany.Potential Stock ManipulationWe have filed an unfair business practice lawsuit against Gradient Analytics, Rocker Partners, L.P. and others, alleging that the defendants haveconspired to denigrate Overstock’s business for personal profit, as well as an amended complaint alleging additional causes of action and articulating ingreater detail the allegations against the defendants. We have also filed an unfair business practice lawsuit against Morgan Stanley & Co. Incorporated,Goldman Sachs & Co., Bear Stearns Companies, Inc., Bank of America Securities LLC, Bank of New York, Citigroup Inc., Credit Suisse (USA) Inc., DeutscheBank Securities, Inc., Merrill Lynch, Pierce, Fenner & Smith, Inc., and UBS Financial Services, Inc. We believe that the defendants in both of these lawsuitshave engaged in unlawful actions and have caused substantial harm to Overstock, and that certain of the defendants have made efforts to drive the marketprice of Overstock’s common stock down. To the extent that the defendants or other persons engage in any such actions or other take any other actions tointerfere with or destroy or harm Overstock’s existing and/or prospective business relationships with its suppliers, bankers, customers, lenders, investors,prospective investors or others, our business, prospects, financial condition and results of operation may suffer, and the price of our common stock may bemore volatile than it might otherwise be and/or may trade at prices below those that might prevail in the absence of any such efforts.Any investment in our securities involves a high degree of risk. Investors should consider carefully the risks and uncertainties described below, and allother information in this Form 10-K and in any reports we file with the SEC after we file this Form 10-K, before deciding whether to purchase or hold oursecurities. Additional risks and uncertainties not currently known to us or that we currently deem immaterial may also become important factors that mayharm our business. The occurrence of any of the risks described in this Form 10-K could harm our business. The trading price of our securities could declinedue to any of these risks and uncertainties, and investors may lose part or all of their investment.Available InformationOur Internet website address is http://www.overstock.com. Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports onForm 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free ofcharge through our Internet website as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. Our Internetwebsite and the information contained therein or connected thereto are not a part of or incorporated into this Annual Report on Form 10-K.ITEM 1B. UNRESOLVED STAFF COMMENTSNone.ITEM 2. PROPERTIESWe lease approximately 154,000 square feet of office space for our corporate headquarters, customer service operations and ancilliary computer facilitiesin Salt Lake City, Utah. We also lease space in a co-location facility to house our primary computer infrastructure in Salt Lake City.In July 2005, we entered into a Colocation Center Agreement (the “Colocation Agreement”) to build out and lease 11,289 square feet of space at OldMill Corporate Center II in Salt Lake City for a data center and co-location facility. In November 2006, we made a determination to consolidate our facilities34and began negotiations to terminate the lease of the new co-location facility (see Item 15—“Financial Statements”—Note 4 “Restructuring Expense”), andon February 1, 2007, we terminated the lease agreement effective as of December 29, 2006. Currently, our primary computer infrastructure remains at ouroriginal co-location facility in Salt Lake City.In addition to our co-location facility, we have computer facilities located in our principal corporate offices, which we use primarily for backups,redundancy, development, and testing. As we have made the determination to consolidate our facilities, including marketing of the principal corporate officespace for sub-lease, we anticipate relocating these facilities during 2007.We lease approximately 610,000 square feet in two warehouses and distribution facilities in Salt Lake City, Utah and approximately 540,000 square feetin two warehouses and distribution facilities in Plainfield, Indiana.We believe that these facilities will be sufficient for our needs for the next twelve months.ITEM 3. LEGAL PROCEEDINGSFrom time to time, we receive claims of and become subject to consumer protection, employment, intellectual property and other commercial litigationrelated to the conduct of our business. Such litigation could be costly and time consuming and could divert our management and key personnel from ourbusiness operations. The uncertainty of litigation increases these risks. In connection with such litigation, we may be subject to significant damages orequitable remedies relating to the operation of our business and the sale of products on our websites. Any such litigation may materially harm our business,prospects, results of operations, financial condition or cash flows. However, we do not currently believe that any of our outstanding litigation will have amaterial adverse effect on our financial statements.In December 2003, we received a letter from Furnace Brook claiming that certain of our business practices and our website infringe a single patentowned by Furnace Brook. After diligent efforts to show that we do not infringe the patent and Furnace Brook’s continual demands that we enter intolicensing arrangements with respect to the asserted patent, on August 12, 2005, we filed a complaint in the United States District Court of Utah, CentralDivision, seeking declaratory judgment that we do not infringe any valid claim of the Furnace Brook patent. Furnace Brook filed a motion to dismiss ourcomplaint for lack of personal jurisdiction over Furnace Brook in Utah. On October 31, 2005, the United States District Court of Utah, Central Division,issued a decision to dismiss our complaint for lack of personal jurisdiction over Furnace Brook. On December 14, 2005, we filed an appeal of the Utahdecision with the United States Court of Appeals for the Federal Circuit. On August 18, 2006, the United States Court of Appeals for the Federal Circuitdenied the Company’s appeal. On August 18, 2005, shortly after we filed the complaint in Utah, Furnace Brook filed a complaint in the United States DistrictCourt for the Southern District of New York, alleging that certain of our business practices and our website infringe a single patent owned by Furnace Brook.On September 9, 2005, we filed an answer denying the material allegations in Furnace Brook’s claims. On September 27, 2006, the United States DistrictCourt for the Southern District of New York issued a memorandum and order, Markman Hearing, which substantially adopted the Company’s interpretationof the Furnace Brook patent. We filed motions for summary judgment relating to the litigation and on October 6, 2006, the United States District Court forthe Southern District of New York heard oral argument on those motions and on October 30, 2006, the United States District Court for the Southern District ofNew York granted summary judgment in favor of us, ruling that we do not infringe the Furnace Brook patent as a matter of law. On November 9, 2006,Furnace Brook filed a notice of appeal to the United States Court of Appeals for the Federal Circuit. On January 16, 2007, we filed a brief with the FederalCircuit Court and the appeal is now pending.On August 11, 2005, along with a shareholder plaintiff, we filed a complaint against Gradient Analytics, Inc.; Rocker Partners, LP; Rocker Management,LLC; Rocker Offshore Management35Company, Inc. and their respective principals. We, along with a second shareholder plaintiff, filed the complaint in the Superior Court of California, Countyof Marin. On October 12, 2005, we filed an amended complaint against the same entities alleging libel, intentional interference with prospective economicadvantage and violations of California’s unfair business practices act. On March 7, 2006, the court denied the defendants demurrers to and motions to strikethe amended complaint. The defendants each filed a motion to appeal the court’s decision, we responded and the California Attorney General submitted anamicus brief supporting our view; the court has ruled that this appeal stays discovery in the case. The California Court of Appeals informed the parties that itis ready to rule on the appeal without oral argument; the defendants, however, have requested oral argument. The appeal has not yet been scheduled for oralargument. We intend to pursue this action vigorously.On May 9, 2006 we received a notice of an investigation and subpoena from the Securities and Exchange Commission, Salt Lake City District Office.The subpoena requested a broad range of documents, including, among other documents, all documents relating to our accounting policies, our targets,projections or estimates related to financial performance, our recent restatement of its financial statements, the filing of our complaint against GradientAnalytics, Inc., the development and implementation of certain new technology systems and disclosures of progress and problems with those systems,communications with and regarding investment analysts, communications regarding shareholders who did not receive our proxy statement in April 2006,communications with certain shareholders, and communications regarding short selling, naked short selling, purchases and sales of our stock, obtainingpaper certificates, and stock loan or borrow of our shares. We have responded to the subpoena.In November 2006, we received a letter from Applied Interactive, claiming that certain of our business practices and our website infringe two patentsowned by Applied Interactive and offering to enter into a licensing agreement. After determining that we do not infringe the patents and rejecting the offeredlicensing agreement, on February 2, 2007, we filed a complaint in the United States District Court, Southern District of New York, seeking declaratoryjudgment that we do not infringe any valid claim of the Applied Interactive patents. The complaint has been served and the case is in its initial stages. Weintend to vigorously prosecute this action.On February 2, 2007, along with five shareholder plaintiffs, we filed a lawsuit in the Superior Court of California, County of San Francisco againstMorgan Stanley & Co. Incorporated, Goldman Sachs & Co., Bear Stearns Companies, Inc., Bank of America Securities LLC, Bank of New York, CitigroupInc., Credit Suisse (USA) Inc., Deutsche Bank Securities, Inc., Merrill Lynch, Pierce, Fenner & Smith, Inc., and UBS Financial Services, Inc. The suit allegesthat the defendants, who control over 80% of the prime brokerage market, participated in an illegal stock market manipulation scheme and that thedefendants had no intention of covering short sell orders with borrowed stock, as they are required to do, causing what are referred to as “fails to deliver” andthat the defendants’ actions caused and continue to cause dramatic distortions within the nature and amount of trading in our stock as well as dramaticdeclines in the share price of our stock. The suit asserts that a persistent large number of “fails to deliver” creates significant downward pressure on the priceof a company’s stock and that the amount of “fails to deliver” has exceeded the company’s entire supply of outstanding shares. The suit accuses thedefendants of violations of California securities laws and common law, specifically, conversion, trespass to chattels, intentional interference with prospectiveeconomic advantage, violations of California’s Unfair Business Practices Act. We are seeking damages of $3.48 billion. The case is in its initial stages. Weintend to vigorously prosecute this action.ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERSNo matters were submitted to a vote of security holders during the fourth quarter of 2006.36EXECUTIVE OFFICERS OF THE REGISTRANTThe following persons were executive officers of Overstock.com as of March 1, 2007:Executive OfficersAgePositionPatrick M. Byrne44Chairman, Chief Executive OfficerJason C. Lindsey37President, Chief Operating Officer DirectorStephen P. Tryon45Senior Vice PresidentJonathan E. Johnson III41Senior Vice President, Corporate Affairs and LegalDavid K. Chidester35Senior Vice President, FinanceStormy Simon38Senior Vice President, Customer Care, PR and Branding Dr. Patrick M. Byrne has served as our Chief Executive Officer (principal executive officer) and as a Director since October 1999, as Chairman of theBoard from February 2001 through October 2005, and since July 2006. From September 1997 to May 1999, Dr. Byrne served as President and ChiefExecutive Officer of Fechheimer Brothers, Inc., a manufacturer and distributor of uniforms. From 1995 until its sale in September 1999, Dr. Byrne wasChairman, President and Chief Executive Officer of Centricut, LLC, a manufacturer and distributor of industrial torch parts. From 1994 to the present,Dr. Byrne has served as a Manager of the Haverford Group, an investment company and an affiliate of Overstock. Dr. Byrne has a Bachelor of Arts degree inChinese studies from Dartmouth College, a Master’s degree from Cambridge University as a Marshall Scholar, and a Ph.D. in philosophy from StanfordUniversity.Jason C. Lindsey is currently President, Chief Operating Officer and a Director of Overstock.com. He has served as a director since October 2005. Hepreviously served as a Director from June 1999 to October 2002, and as our Chief Financial Officer from June 1999 to August 2003 and as our President fromApril 2003 to August 2003. From June 1998 to present, Mr. Lindsey also serves as the Controller of the Haverford Group, an investment company and anaffiliate of Overstock. Prior to joining the Haverford Group, Mr. Lindsey was an auditor with PricewaterhouseCoopers LLP from January 1996 to June 1998.Mr. Lindsey has a Bachelor of Arts and a Master’s degree in accounting from Utah State University.Mr. Tryon joined Overstock.com in August 2004, and serves as Senior Vice President, with primary responsibility for logistics and supervision of theCompany’s warehouse operations. Prior to joining Overstock.com, Mr. Tryon was the Legislative Assistant to the Chief of Staff of the United States Army.During his 21 years with the Army, his assignments included director of plans for the 10th Mountain Division, Congressional Fellow for United StatesSenator Max Cleland, Assistant Professor of Philosophy at the United States Military Academy, and commander of a company of paratroopers. Mr.Tryonreceived a B.S. in Applied Sciences from the U.S. Military Academy in 1983 and a M.A. in Philosophy from Stanford University in 1992.Mr. Johnson joined Overstock.com in September 2002. He has served as our General Counsel and as our Vice President, Strategic Projects, andcurrently serves as our Senior Vice President, Corporate Affairs and Legal and as our Secretary. From May 1999 to September 2002, Mr. Johnson held variouspositions with TenFold Corporation, including positions as General Counsel, Executive Vice President and Chief Financial Officer. From October 1997 toApril 1999, Mr. Johnson practiced law in the Los Angeles offices of Milbank, Tweed, Hadley & McCloy and from September 1994 to September 1997, hepracticed law in the Los Angeles offices of Graham & James. From February 1994 to August 1994, Mr. Johnson served as a judicial clerk at the Utah SupremeCourt for Justice Leonard H. Russon, and prior to that, from August 1993 to January 1994, Mr. Johnson served as a judicial clerk at the Utah Court of Appealsfor Justice Russon. Mr. Johnson holds a Bachelor’s Degree in Japanese from Brigham Young University, studied for a year at Osaka University of ForeignStudies in Japan, and received his law degree from the J. Reuben Clark, Jr. Law School at Brigham Young University.37Mr. Chidester served as our Controller from August 1999 to August 2003, as our Acting Chief Financial Officer from August 2003 to January 2004, andis now our Senior Vice President, Finance (our principal financial and accounting officer). Prior to joining Overstock.com, Mr. Chidester was withPricewaterhouseCoopers LLP from December 1995 to August 1999. Mr. Chidester holds a Bachelor of Science Degree in Accounting and a Master’s Degreein Business Administration, both from the University of Utah.Ms. Simon currently serves as our Senior Vice President, Customer Care, PR and Branding. Ms. Simon previously served as our Vice President, BMMG,Travel and Off-Line Advertising, Chief of Staff and as our Director of B2B. Prior to joining Overstock.com in 2001, Ms. Simon worked in media and travel.There are no family relationships among any of the current officers and directors of the Company.38PART IIITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OFEQUITY SECURITIESOur common stock is traded on the Nasdaq Global Market under the symbol “OSTK.” Prior to May 30, 2002, there was no public market for our commonstock. The following table sets forth, for the periods indicated, the high and low sales prices per share for our common stock as reported by Nasdaq (1).CommonStock PriceHighLowYear Ended December 31, 2005First Quarter70.3541.50Second Quarter46.2533.62Third Quarter48.6535.60Fourth Quarter43.4028.02Year Ended December 31, 2006First Quarter35.0221.60Second Quarter30.6319.00Third Quarter22.9316.03Fourth Quarter19.0913.40(1) Prices shown above are sales prices. In prior reports we reported closing prices.As of March 1, 2007, there were approximately 240 holders of record of our common stock. Because many of our shares of common stock are held bybrokers and other institutions on behalf of shareholders, we are unable to estimate the total number of shareholders represented by these record holders.We have never declared or paid any cash dividends on our common stock. We currently intend to retain our earnings for future growth and do notanticipate paying any cash dividends in the foreseeable future. Any future determination to pay dividends will be at the discretion of our board of directorsand will depend on our results of operations, financial conditions, contractual and legal restrictions and other factors the board deems relevant. Our Loan andSecurity Agreement with Wells Fargo Retail Finance, LLC dated December 12, 2005 prohibits us from paying dividends without the consent of the lender.During January 2005, the Board of Directors authorized a stock repurchase program under which the Company was authorized to repurchase up to $50.0million of its common stock through December 31, 2007. On April 26, 2005, the Board of Directors increased the amount of the share repurchase program to$100.0 million. Additionally, on June 14, 2005, the Board of Directors authorized an amendment of its three-year stock repurchase program to include therepurchase of its Convertible Senior Notes.During 2005, we entered into several purchased call options, pursuant to which we could have been required to purchase up to 1.3 million shares of itscommon stock at certain settlement dates during the quarter ended June 30, 2005. In connection with these repurchase transactions; we paid approximately$47.5 million, which was recorded in shareholders’ equity in the consolidated balance sheet.At our option, the purchased call options were settled in cash or stock, based on the market price of our common stock on the date of the settlement.Upon settlement, we either had our capital investment returned with a premium or received shares of our common stock, depending, respectively, on whetherthe market price of our common stock was above or below a pre-determined price agreed in connection with each such transaction.39Under the share repurchase program, we repurchased approximately 665,000 shares of our common stock in open market transactions for $24.1 millionduring the year ended December 31, 2005. In addition, approximately 1.0 million shares of common stock were acquired as a result of the settlement of$41.1 million of structured stock repurchase transactions during the twelve months ended December 31, 2005. The purchased call options that did not settlein stock settled in cash totaling $7.9 million, which the Company received in July 2005.We have a 401(k) defined contribution plan which permits participating employees to defer up to a maximum of 25% of their compensation, subject tolimitations established by the Internal Revenue Code. Employees who have completed a half-year of service and are 21 years of age or older are qualified toparticipate in the plan. The Company matches 50% of the first 6% of each participant’s contributions to the plan. Participant contributions are immediatelyvested. Company contributions vest based on the participant’s years of service at 20% per year over five years. The Company’s matching contribution totaled$124,000, $261,000 and $389,000 during 2004, 2005 and 2006, respectively. In addition, for the 2004, 2005 and 2006 years, the board of directors approveda 2% (of salary) profit-share contribution to all employees eligible to participate in the plan.The Company’s board of directors adopted the Amended and Restated 1999 Stock Option Plan, the 2002 Stock Option Plan and the 2005 EquityIncentive Plan (collectively, the “Plans”), in May 1999, April 2002 and April 2005, respectively. Under these Plans, the Board of Directors may issueincentive stock options to employees and directors of the Company and non-qualified stock options to consultants of the Company, as well as other types ofawards under the 2005 Equity Incentive Plan. Options granted under these Plans generally expire at the end of either five or ten years and vest in accordancewith a vesting schedule determined by the Company’s Board of Directors, usually over four years from the grant date. As of the initial public offering, theAmended and Restated 1999 Stock Option Plan was terminated. Future awards will be made under the 2005 Equity Incentive Plan. As of December 31, 2006,1,112,000 shares were available for future grants under these Plans.The following is a summary of stock option activity:200420052006 SharesWeightedAverageExercisePriceSharesWeightedAverageExercisePriceSharesWeightedAverageExercisePrice Outstanding—beginning of year1,780$8.391,512$12.901,299$18.09Granted at fair value47424.1422044.4418322.47Exercised(468)6.75(298)8.56(276)9.19Canceled/forfeited(274)13.26(135)24.08(195)30.17Outstanding—end of year1,51212.901,29918.091,01118.97Options exercisable at year-end6087.5173911.3367915.74 During the last three years, except as previously reported in a Quarterly Report on Form 10-Q, Annual Report on Form 10-K or current Report on Form 8-K, the Company did not sell any equity securities that were not registered under the Securities Act.40STOCK PERFORMANCE GRAPHThe following graph shows a comparison of cumulative total stockholder return, calculated on a dividend reinvested basis, from the effective date of theinitial public offering of Overstock’s common stock (May 30, 2002) through December 31, 2006 for Overstock, Hemscott’s (formerly Media General’s)Nasdaq U.S. Index and Hemscott’s Internet Software and Services Index. The graph assumes that $100 was invested in Overstock’s common stock (at theinitial public offering price of $13.00 per share), and the above indices on May 30, 2002. Historic stock price performance is not necessarily indicative offuture stock price performance.41ITEM 6. SELECTED FINANCIAL DATAThe following selected consolidated financial data as of December 31, 2005 and 2006 and for each of the three years in the period ended December 31,2006, are derived from our consolidated financial statements and are included elsewhere in this Form 10-K. The consolidated financial data as ofDecember 31, 2002, 2003 and 2004 and for the years ended December 31, 2002 and 2003, are derived from audited consolidated financial statements, but arenot contained herein. The historical results do not necessarily indicate results expected for any future period. This information should be read in conjunctionwith “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements and the relatednotes thereto included elsewhere in this Form 10-K. Year ended December 31, 20022003200420052006(1) (in thousands, except per share data)Consolidated Statement of Operations Data:RevenueDirect revenue$79,405$138,134$213,210$324,875$303,202Fulfillment partner revenue12,379100,811281,425474,441484,948Total revenue91,784238,945494,635799,316788,150Cost of goods soldDirect70,736124,039184,964282,383284,943Fulfillment partner2,75589,190243,468400,057408,407Total cost of goods sold73,491213,229428,432682,440693,350Gross profit18,29325,71666,203116,87694,800Operating expenses:Sales and marketing8,88120,22840,55977,15570,897Technology2,4042,5498,50927,90165,158General and administrative10,82114,98722,02433,04346,837Restructuring(2)————5,674Total operating expenses22,10637,76471,092138,099188,566Operating loss(3,813)(12,048)(4,889)(21,223)(93,766)Interest income, net4034611,173(270)3,566Interest expense(465)(76)(775)(5,582)(4,765)Other (expense) income, net(444)115(49)4,72881Loss from continuing operations(4,319)(11,548)(4,540)(22,347)(94,884)Discontinued operations(3):Loss from discontinued operations———(2,571)(6,882)Net loss(4,319)(11,548)(4,540)(24,918)(101,766)Deemed dividend related to redeemablecommon stock(406)(262)(188)(185)(99)Deemed dividend related to beneficialconversion feature of preferred stock(6,607)————Net loss attributable to common shares$(11,332)$(11,810)$(4,728)$(25,103)$(101,865)Net loss per common share—basic and dilutedLoss from continuing operations$(0.86)$(0.73)$(0.26)$(1.16)$(4.67)Loss from discontinued operations———$(0.13)$(0.34)Net loss per common share—basic and diluted$(0.86)$(0.73)$(0.26)$(1.29)$(5.01)Weighted average common shares outstanding—basic and diluted13,10816,19817,84619,42920,332 42 As of December 31, 20022003200420052006 (in thousands)Balance Sheet Data:Cash and cash equivalents$11,059$28,846$198,678$55,875$126,965Marketable securities21,60311,50088,80255,799—Working capital36,15746,101267,94780,16265,072Total assets64,43498,549377,543325,913256,165Total indebtedness182161117,58984,67684,336Redeemable common stock4,3632,9783,1663,205—Stockholders’ equity39,74955,731169,81189,74961,964(1) Effective January 1, 2006, we adopted SFAS 123(R). We recognized stock-based compensation of $4.1 million in 2006.(2) During the fourth quarter of 2006, we commenced implementation of a facilities consolidation and restructuring program designed to reduce the overallexpense structure in an effort to improve future operating performance (Item 15 of Part IV, “Financial Statements”—Note 4—“Restructuring Expense”).The planned actions include the termination of a co-location data center lease, marketing of the current office facilities for sub-lease and marketing non-core businesses for sale.(3) As part of the program to reduce our expense structure and sell non-core businesses, we decided during the fourth quarter of 2006 to sell our travelsubsidiary (“OTravel”) , and we have received a non-binding letter of intent from a third-party to purchase this business. As a result, OTravel’s operationshave been classified as a discontinued operation and therefore are not included in the results of continuing operations.The loss from discontinuedoperations for OTravel was $6.9 million for the year ended December 31, 2006, including a goodwill impairment charge of $4.5 million. 43ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONThe following Management’s Discussion and Analysis of Financial Condition and Results of Operation should be read in conjunction with ourConsolidated Financial Statements and the related Notes thereto. This discussion contains forward-looking statements based upon current expectationsthat involve risks and uncertainties, such as our plans, objectives, expectations and intentions, as set forth under “Special Note Regarding Forward-Looking Statements.” Our actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as aresult of several factors, including those set forth in the following discussion and under “Risk Factors” and elsewhere in this Form 10-K.Recent DevelopmentsDuring the fourth quarter of 2006, in an effort to improve future operating performance, we commenced implementation of a facilities consolidation andrestructuring program designed to reduce our overall expense structure (see Item 15 of Part IV, “Financial Statements”—Note 4—“Restructuring Expense”).The planned actions include the termination of a co-location data center lease, marketing of the current office facilities for sub-lease, and marketing non-corebusinesses for sale. At December 31, 2006, we accrued a liability of $5.9 million associated with the termination of the co-location data center lease and othercosts related to our facilities consolidation plan, including $5.5 million related to lease termination costs and $450,000 related to the asset retirementobligation (see Item 15 of Part IV, “Financial Statements”—Note 9—“Asset Retirement Obligation”).As part of this program to reduce our expense structure and sell non-core businesses, we decided during the fourth quarter of 2006 to sell our travelsubsidiary (“OTravel”), and we have received a non-binding letter of intent from a third-party to purchase this business. As a result, OTravel’s operations havebeen classified as a discontinued operation and therefore are not included in the results of continuing operations. The loss from discontinued operations forOTravel was $6.9 million for the year ended December 31, 2006, including a goodwill impairment charge of $4.5 million.Please see the “Executive Commentary” below as well as the rest of Management’s Discussion and Analysis for discussion of other recent developments.OverviewWe are an online “closeout” retailer offering discount brand name merchandise, including bed-and-bath goods, home décor, kitchenware, watches,jewelry, electronics and computers, sporting goods, apparel, designer accessories and travel services, among other products. We also sell books, magazines,CDs, DVDs, videocassettes and video games (“BMMG”), and we operate as part of our Website an online auction site—a marketplace for the buying andselling of goods and services.Our company, based in Salt Lake City, Utah, was founded in 1997, and we launched our first Website through which customers could purchase productsin March 1999. Our Websites offer our customers an opportunity to shop for bargains conveniently, while offering our suppliers an alternative inventoryliquidation distribution channel. We continually add new, limited inventory products to our Websites in order to create an atmosphere that encouragescustomers to visit frequently and purchase products before our inventory sells out. We offer approximately 36,000 products under multiple shopping tabs onour main website, plus almost 500,000 media products on our BMMG tab.Closeout merchandise is typically available in inconsistent quantities and prices and often is only available to consumers after it has been purchasedand resold by disparate liquidation wholesalers. We believe that the traditional liquidation market is therefore characterized by fragmented supply andfragmented demand. We utilize the Internet to aggregate both supply and demand and create a more44efficient market for liquidation merchandise. Our objective is to provide a one-stop destination for discount shopping for products and services proven to besuccessfully sold through the Internet.Our BusinessOverstock utilizes the Internet to create a more efficient market for liquidation merchandise. We provide consumers and businesses with quick andconvenient access to high-quality, brand-name merchandise at discount prices. Our shopping business includes both a “direct” business and a “fulfillmentpartner” business. During the year ended December 31, 2006, no single customer accounted for more than 1% of our total revenue. Products from our directsegment and fulfillment partner segment are available to both consumers and businesses through our Wholesale bulk purchase program.Direct businessOur direct business includes sales made to individual consumers and businesses, which are fulfilled from our warehouses in Salt Lake City, Utah or ouroutsourced warehouses located in Plainfield, Indiana. During the year ended December 31, 2006, we fulfilled approximately 39% of all orders through ourwarehouses. Our warehouses generally ship between 10,000 and 12,000 orders per day, and up to approximately 34,000 orders per day during peak periods,using overlapping daily shifts.Fulfillment partner businessFor our fulfillment partner business, we sell merchandise of other retailers, cataloguers or manufacturers (“fulfillment partners”) through our Website. Weare considered to be the primary obligor for the majority of these sales transactions, and we assume the risk of loss on the returned items. As a consequence,we record revenue from the majority of these sales transactions involving our fulfillment partners on a gross basis. Our use of the term “partner” or“fulfillment partner” does not mean that we have formed any legal partnerships with any of our fulfillment partners. We currently have fulfillment partnerrelationships with approximately 540 third parties which post approximately 26,000 non-BMMG products, as well as most of the BMMG products and aportion of our current travel offerings, on our Websites.Our revenue from sales on our shopping site from both the direct and fulfillment partner businesses is recorded net of returns, coupons and otherdiscounts. Our returns policy for products other than those sold in our Electronics and Computers department provides for a $4.95 restocking fee and theprovision that we will accept product returns initiated within thirty days after the shipment date. We charge a 15% restocking fee (instead of the $4.95restocking fee) on all items returned for non-defective reasons from the Electronics and Computers department.Unless otherwise indicated or required by the context, the discussion herein of our financial statements, accounting policies and related matters, pertainsto our shopping sites (Shopping and BMMG) and not necessarily to our auction or travel tabs on our Websites.Wholesale businessIn August 2004, we merged our B2B site (www.overstockb2b.com) into our B2C site, and opened a “Club O Gold” membership program (into which ourB2B customers were grandfathered). During 2005, we integrated this program into our “Wholesale” tab. For this tab, we have added a number of suppliersspecific to various industry verticals, such as florist supplies, restaurant supplies, and office supplies.45Travel businessWe operate a discount travel department as part of our Website. We use fulfillment partners to supply the travel products and services (flights, hotels,rental cars, etc.). We currently offer air, hotel and car reservation services as well as ski, cruise and vacation packages.On July 1, 2005, we acquired all the outstanding capital stock of Ski West, Inc. (“Ski West”), an on-line travel company whose proprietary technologyprovides easy consumer access to a large, fragmented, hard-to-find inventory of lodging, vacation, cruise and transportation bargains. The travel products areprimarily in popular ski areas in the U.S. and Canada, with more recent expansion into the Caribbean and Mexico, as well as cruises. We paid an aggregate of$25.1 million (including $111,000 of capitalized acquisition related costs) for Ski West, and we may be subject to additional earn-out payments (based on apercentage of operating profits for each of the four calendar years beginning with 2006 as follows: 50%, 33.3%, 20%, and 10%, respectively), subject toreduction under certain circumstances, pursuant to a Stock Purchase Agreement dated June 24, 2005, as amended to date, among us, Ski West, and all of theformer shareholders of Ski West. Effective upon the closing, Ski West became our wholly-owned subsidiary, and we integrated the Ski West travel offeringswith our existing travel offerings and changed its name to OTravel.com, Inc.As part of a program to reduce our expense structure and sell non-core businesses, we decided during the fourth quarter of 2006 to sell OTravel, and wehave received a non-binding letter of intent from a third-party to purchase this business (see Item 15 of Part IV, “Financial Statements”—Note 5—“Acquisition and Subsequent Discontinued Operations”).Auctions businessWe operate an online auction service as part of our Website. Our auction tab allows sellers to list items for sale, buyers to bid on items of interest, andusers to browse through listed items online. For these sales we record only our listing fees and commissions for items sold as revenue. From time to time, wealso sell items returned from our shopping site on our auction site, and for these sales, we record the revenue on a gross basis. Revenue from our auctionbusiness is included in the fulfillment partner segment, as it is not significant enough to segregate as its own segment.Cars listing businessWe operate an online site for listing cars for sale as a part of our Website. The cars listing service allows sellers to list vehicles for sale and allows buyersto review vehicle descriptions, post offers to purchase, and provides the means for purchasers to contact sellers for further information and negotiations on thepurchase of an advertised vehicle. Revenue from our cars listing business is included in the fulfillment partner segment, as it is not significant enough toseparate out as its own segment.Cost of goods soldCost of goods sold consists of the cost of the product, as well as inbound and outbound freight, warehousing and fulfillment costs (including payroll andrelated expenses), credit card fees, customer service costs and stock-based compensation.Operating expensesSales and marketing expenses consist primarily of advertising, public relations and promotional expenditures, as well as payroll and related expenses,including stock-based compensation, for personnel engaged in marketing and selling activities. Advertising expense is the largest component of our salesand marketing expenses and is primarily attributable to expenditures related to online marketing activities and46offline national radio and television advertising. For the years ended December 31, 2005 and 2006, our advertising expenses totaled approximately $75.3million and $68.1 million, respectively, representing 98% and 96%, respectively, of sales and marketing expenses.Technology expenses consist of wages and benefits, including stock-based compensation, for technology personnel, rent, utilities, connectivity charges,as well as support and maintenance and depreciation and amortization related to software and computer equipment.General and administrative expenses consist of wages and benefits, including stock-based compensation, for executive, legal, accounting,merchandising and administrative personnel, rent and utilities, travel and entertainment, depreciation and amortization of intangible assets and other generalcorporate expenses.We have recorded no provision or benefit for federal and state income taxes as we have incurred net operating losses since inception. We have provideda full valuation allowance on the net deferred tax assets, consisting primarily of net operating loss carryforwards, because of uncertainty regarding theirrealizability.Both direct and fulfillment partner revenues are seasonal, with revenues historically being the highest in the fourth quarter, reflecting higher consumerholiday spending. We anticipate this will continue in the foreseeable future.Executive CommentaryThis executive commentary is intended to provide investors with a view of our business through the eyes of our management. As an executivecommentary, it necessarily focuses on selected aspects of our business. This executive commentary is intended as a supplement to, but not a substitute for, themore detailed discussion of our business included elsewhere herein. Investors are cautioned to read our entire “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations”, as well as our interim and audited financial statements, and the discussion of our business and risk factorsand other information included elsewhere in this report. This executive commentary includes forward-looking statements, and investors are cautioned to readthe “Special Note Regarding Forward-Looking Statements” included elsewhere in this report.Commentary—Revenue Decrease and Website Conversion. Our fourth quarter revenue declined 7%, the same percentage decline we experienced in Q3,and our annual revenue was down 1%. We believe that these decreases were primarily the result of our infrastructure upgrades in the last half of 2005, whichresulted in an unsatisfactory shopping experience for many of our customers and affected both repeat and new customer revenue in 2006. We believe that akey to future revenue growth is to increase our Website conversion rate—defined as the percentage of visitors to the website who make a purchase. The areasof our business that most directly affect conversion rate, including personalization of the website, customer retention, e-mail marketing, and site design andlayout, are the responsibility of our internal marketing department. Within each of these areas, we have identified and made progress on initiatives that webelieve can improve conversion. We have also outsourced to third-party providers certain aspects of the functionality on the website, including the enginethat provides product recommendations to customers visiting product pages and the gift center that went live during the fourth quarter.Commentary—Operations Summary. We made significant improvements to our operations in 2006. We continue to closely measure and reduce“customer aggravation points” within our order process. In addition, we have seen cost improvements over the course of the year in both warehouse handlingand customer service costs. We believe these improvements have improved the overall customer shopping experience, and believe that this is evidenced byour continued high reported Net Promoter Score (“NPS”). Also, our new systems easily handled the fourth quarter volume this year.47Commentary—Gross Margins. We consciously and aggressively discounted older inventory during the fourth quarter, and as a result, our direct grossmargins were negatively impacted. However, we did this to significantly clean and reduce our inventory in an effort to reduce the overall SKU (stock keepingunit) count on our website and to refine our product selection to categories that turn faster and have higher profitability. We believe that we can run ourdirect business with less inventory than we have had in the past, while filling in product selection using fulfillment partners, rather than acquiring theinventory directly. As a result of these efforts, we believe that we should see a significant improvement in direct and overall gross margins beginning in thefirst quarter of 2007. With reduced inventory levels, we now have excess warehouse capacity, and we are therefore making efforts to reduce warehouse space.We believe that we will see additional improvement to direct gross margins if and when we are able to successfully do this.Commentary—Marketing. Our intent in 2006 was to keep marketing expense as a percent of sales at approximately 7%, and we had accomplished thisover the first six months of the year. We entered the third quarter with our systems and processes running smoothly, and our customer satisfaction ratings backto where they had been prior to the system issues we experienced at the end of 2005. As a result, we increased both online and offline marketing expendituresin the last half of 2006 in an effort to create sales momentum in Q4 2006 and into 2007. However, we did not see a corresponding increase in revenue,primarily as a result of visitor conversion rates, and marketing expense ended at 9% of sales for the year.We believe that our marketing expenditures were also less efficient due to overall increases in online marketing rates, as well as the expiration ofmarketing agreements we had with several large portals, including MSN, Yahoo and AOL, which are either no longer available or are too expensive for us tojustify. In an effort to offset this, we have internally developed a search engine optimization tool that we believe will help us manage keyword purchasesmore efficiently. We intend to reduce our marketing expenditures as a percent of sales in 2007 below the 9% we spent in 2006.Commentary—Technology and G&A costs. Through 2004, we were growing rapidly (over 80% year-over-year) and had reached $495 million inrevenue, yet we had invested less than $25 million into our systems and infrastructure. We believed that we would continue to see rapid growth and thereforemade significant investments into our facilities, system infrastructure and warehouse space, just as sales growth stopped. As a result, our expense structure ishigher than is necessary for our current revenue level, and therefore we have begun efforts to decrease our operating expenses. We have reduced ourheadcount from 864 at December 2006 to 725 at February 2007. We have terminated an expensive computer co-location facility lease. We are in the processof significantly reducing additional facilities and warehouse lease costs and other expenses. Among other things, we intend to move our corporate officesinto existing space in our main Salt Lake City warehouse. As a result of these efforts, we expect our technology and G&A costs to decrease in 2007.Commentary—Balance Sheet Items—We ended 2006 with $20 million of inventory, significantly lower than the $93 million we had at the end of 2005.From this lower inventory level, we expect to turn our inventory much more efficiently. We have entered 2007 with more attractive, higher margin inventory,and as a result, we expect our gross margins in 2007 to increase significantly over 2006 levels. In addition to converting much of our inventory into cash, wealso raised $40 million in common equity in December (for a total of $64 million in common equity raised during 2006), greatly improving our cashposition, which ended the year at $127 million. At current inventory levels, we anticipate that we may require less capital to run our business in 2007.However, whether we will need to raise additional capital will depend on, among other things, our revenues, gross margins, product sales mix and expenses.The balance of our Management’s Discussion and Analysis of Financial Condition and Results of Operations provides further information about thematters discussed above and other important matters affecting our business.48Critical Accounting Policies and EstimatesOur 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 andexpenses. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, theresults of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actualresults may differ from these estimates under different assumptions or conditions. Our critical accounting policies are as follows:· revenue recognition;· estimating valuation allowances and accrued liabilities, specifically, the reserve for returns, the allowance for doubtful accounts and the reserve forobsolete and damaged inventory;· internal use software;· accounting for income taxes;· valuation of long-lived and intangible assets and goodwill; and· stock based compensation and performance share plan.Revenue recognition. We derive our revenue primarily from two sources: (i) direct revenue, which consists of merchandise sales made to consumers andbusinesses that are fulfilled from our warehouses; and (ii) fulfillment partner revenue, which consists of revenue from the sale of merchandise supplied andshipped by fulfillment partners directly to consumers and other businesses. This also includes listing fees and commissions collected from products beinglisted and sold through the Auctions tab of our Website as well as advertisement revenue derived from our cars listing business. All sources of revenue arerecorded net of returns, coupons redeemed by customers, and other discounts. Revenues from our auction services were not material in 2004, 2005 and 2006and therefore are included in fulfillment partner revenue.We record revenue from the majority of these sales transactions involving our fulfillment partners (excluding auctions ) on a gross basis. Similar to ourdirect revenue segment, fulfillment partner products are available to both consumers and businesses.For sales transactions, we comply with the provisions of Staff Accounting Bulletin 104 “Revenue Recognition”, which states that revenue should berecognized when the following revenue recognition criteria are met: (1) persuasive evidence of an arrangement exists; (2) the product has been shipped or theservice provided and the customer takes ownership and assumes the risk of loss; (3) the selling price is fixed or determinable; and (4) collection of theresulting receivable is reasonably assured. We generally require payment by credit card at the point of sale. Amounts received prior to when we ship thegoods or provide the services to customers are recorded as deferred revenue. In addition, amounts received in advance for gift cards, Club O memberships andmarketing royalties related to our co-branded credit card program are recorded as deferred revenue and recognized in the period earned.Reserve for returns, allowance for doubtful accounts and the reserve for obsolete and damaged inventory. Our management must make estimates ofpotential future product returns related to current period revenue. Management analyzes historical returns, current economic trends and changes in customerdemand and acceptance of our products when evaluating the adequacy of the sales returns reserve and other allowances in any accounting period. The reservefor returns was $5.6 million and $3.6 million as of December 31, 2005 and 2006, respectively.From time to time, we may grant credit to certain of our business customers on normal credit terms (typically 30 days). We perform ongoing creditevaluations of our customers’ financial condition and49maintain an allowance for doubtful accounts receivable based upon our historical collection experience and expected collectibility of all accountsreceivable. We maintained an allowance for doubtful accounts receivable of $1.8 million and $2.1 million as of December 31, 2005 and 2006, respectively.We write down our inventory for estimated obsolescence or damage equal to the difference between the cost of inventory and the estimated market valuebased upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management,additional inventory write-downs may be required. Once established, the original cost of the inventory less the related inventory reserve represents the newcost basis of such products. Reversal of these reserves is recognized only when the related inventory has been sold or scrapped. At December 31, 2005, ourinventory balance was $93.3 million, net of reserve for obsolescence or damaged inventory of $5.2 million. As of December 31, 2006, our inventory balancewas $20.3 million, net of allowance for obsolescence or damaged inventory of $6.6 million.Internal-Use Software and Website Development. Included in fixed assets is the capitalized cost of internal-use software and website development,including software used to upgrade and enhance our websites and processes supporting our business. As required by Statement of Position 98-1, “Accountingfor the Costs of Computer Software Developed or Obtained for Internal Use,” we capitalize costs incurred during the application development stage ofinternal-use software and amortize these costs over the estimated useful life of three years. Costs incurred related to design or maintenance of internal-usesoftware are expensed as incurred.During the years ended December 31, 2005 and 2006, we capitalized $24.4 million and $15.0 million, respectively, of costs associated with internal-usesoftware and website development, which are partially offset by amortization of previously capitalized amounts of $3.9 million and $14.6 million for thoserespective periods.Accounting for income taxes. Significant management judgment is required in determining our provision for income taxes, our deferred tax assets andliabilities and any valuation allowance recorded against our net deferred tax assets. As of December 31, 2005 and 2006, we have recorded a full valuationallowance of $36.6 million and $74.4 million, respectively, against our net deferred tax asset balance due to uncertainties related to our deferred tax assets asa result of our history of operating losses. The valuation allowance is based on our estimates of taxable income by jurisdiction in which we operate and theperiod over which our deferred tax assets will be recoverable. In the event that actual results differ from these estimates or we adjust these estimates in futureperiods, we may need to change the valuation allowance, which could materially impact our financial position and results of operations.Valuation of long-lived and intangible assets and goodwill. Under SFAS 142, Goodwill and Other Intangible Assets, goodwill is not amortized, butmust be tested for impairment at least annually. Other long-lived assets must also be evaluated for impairment when management believes that an asset hasexperienced a decline in value that is other than temporary. Future adverse changes in market conditions or poor operating results of underlying investmentscould result in losses or an inability to recover the carrying value of the asset that may not be reflected in an asset’s current carrying value, thereby possiblyrequiring an impairment charge in the future. Goodwill totaled $2.8 million as of December 31, 2005 and 2006. There was no impairment of goodwill orlong-lived assets during the year ended December 31, 2005. In conjunction with the decision to sell OTravel, our travel subsidiary, we performed anevaluation of its goodwill , pursuant to SFAS 144, Accounting for the Impairment Long-Lived Assets, and SFAS 142, Goodwill and Other Intangible Assets,and determined that goodwill was subject to an impairment loss of approximately $4.5 million in the year ended December 31, 2006.Stock-based compensation. As of January 1, 2006, we adopted SFAS 123(R), which requires us to measure compensation cost for all outstandingunvested share-based awards at fair value and recognize compensation over the service period for awards expected to vest. The estimation of stock awardsthat will50ultimately vest requires judgment, and to the extent actual results differ from our estimates, such amounts will be recorded as an adjustment in the periodestimates are revised. We consider many factors when estimating expected forfeitures, including types of awards, employee class, and historical experience.Actual results may differ substantially from these estimates. We have utilized a Black-Scholes-Merton valuation model to estimate the value of stock optionsgranted to employees. Several of the primary estimates used in measuring stock-based compensation are as follows:Expected Volatility: The fair value of stock options were valued using a volatility factor based on the Company’s historical stock prices.Expected Term: The Company’s expected term represents the period that the Company’s stock options are expected to be outstanding and wasdetermined based on historical experience of similar awards, giving consideration to the contractual terms and vesting provisions of the stock-basedawards.Expected Dividend: The Company has not paid any dividends and does not anticipate paying dividends in the foreseeable future.Risk-Free Interest Rate: The Company bases the risk-free interest rate used on the implied yield currently available on U.S. Treasury zero-couponissues with remaining term equivalent to the expected term of the options.Estimated Pre-vesting Forfeitures: When estimating forfeitures, the Company considers voluntary and involuntary termination behavior.Performance Share Plan. In January 2006 the Board and Compensation Committee adopted the Overstock.com Performance Share Plan, and approvedgrants to executive officers and certain employees of the Company. The Performance Share Plan provides for a three-year period for the measurement of theCompany’s attainment of certain performance goals, but at the Company’s sole option the Company may make a payment of estimated amounts payable to aplan participant after two years.The performance goal is measured by growth in economic value, as defined in the plan. The amount of payments due to participants under the plan willbe a function of the then current market price of a share of the Company’s common stock, multiplied by a percentage dependent on the extent to which theperformance goal has been attained, which will be between 0% and 200%. If the growth in economic value is 10% compounded annually or less, thepercentage will be 0%. If the growth in economic value is 25% compounded annually, the percentage will be 100%. If the growth in economic value is 40%compounded annually or more, the percentage will be 200%. If the percentage growth is between these percentages, the payment percentage will bedetermined on the basis of straight line interpolation. Amounts payable under the plan will be payable in cash. During interim and annual periods prior to thecompletion of the three-year measurement period, we record compensation expense based upon the period-end stock price and estimates regarding theultimate growth in economic value that is expected to occur. These estimates include assumed future growth rates in revenues, gross margins and otherfactors. If we were to use different assumptions, the estimated compensation charges could be significantly different.As of December 31, 2006, the Company has accrued $900,000 in total compensation expense under the performance share plan which is included ingeneral and administrative expenses.Recent Accounting Pronouncements.In March 2006, the Emerging Issue Task Force reached a consensus on Issue No. 06-03 “How Taxes Collected from Customers and Remitted toGovernment Authorities Should be Presented in the Income Statement (That Is, Gross versus Net Presentation)” (“EITF No. 06-03”). We are required to adoptthe provisions of EITF No. 06-03 beginning its fiscal year 2007. We do not expect the provisions of EITF No. 06-03 to have a material impact on ourconsolidated financial position, results of operations or cash flows.51In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an Interpretation of FASB StatementNo. 109,” (FIN 48). FIN 48 prescribes a comprehensive model for how a company should recognize, measure, present, and disclose in its financial statementsuncertain tax positions that it has taken or expects to take on a tax return. FIN 48 is effective for us on January 1, 2007. We are currently evaluating theimpact of this interpretation and do not expect the adoption of FIN 48 to have a material impact on our consolidated financial statements.In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108 (SAB 108). SAB 108 was issued to provideinterpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current yearmisstatement. The provisions of SAB 108 are effective for us for the December 31, 2006 year-end. The adoption of SAB 108 did not have a material impacton our consolidated financial statements.In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” (SFAS 157). SFAS 157 defines fair value, establishes a framework formeasuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. The provisions of this standardapply to other accounting pronouncements that require or permit fair value measurements. SFAS 157 becomes effective for us on January 1, 2008. Uponadoption, the provisions of SFAS 157 are to be applied prospectively with limited exceptions. We do not expect the adoption of SFAS 157 to have a materialimpact on our consolidated financial statements.Results of OperationsThe following table sets forth our results of operations expressed as a percentage of total revenue for 2004, 2005 and 2006. Years ended December 31, 2004 2005 2006 (as a percentage oftotal revenue) RevenueDirect revenue43.1%40.6%38.5%Fulfillment partner revenue56.959.461.5Total revenue100.0100.0100.0Cost of goods soldDirect37.435.336.2Fulfillment partner49.250.151.8Total cost of goods sold86.685.488.0Gross profit13.414.612.0Operating expenses:Sales and marketing8.29.79.0Technology1.73.58.3General and administrative4.54.15.9Restructuring——0.7Total operating expenses14.417.323.9Operating loss(1.0)(2.7)(11.9)Interest income, net0.2(0.0)0.5Interest expense(0.1)(0.7)(0.6)Other (expense) income, net(0.0)0.60.0Loss from continuing operations(0.9)%(2.8)%(12.0)% 52Comparison of Years Ended December 31, 2005 and 2006RevenueDuring the year ended December 31, 2005 and 2006, total revenue decreased 1%, from $799.3 million in 2005 to $788.2 million in 2006. During thesame period, direct revenue decreased 7%, from $324.9 million in 2005 to $303.2 million in 2006, while fulfillment partner revenue experienced 2% growth,from $474.4 million in 2005 to $484.9 million in 2006.Our fourth quarter revenue declined 7%, the same percentage decline we experienced in Q3, and total revenue was down 1% for the year. We believe thatthese decreases were primarily the result of our infrastructure upgrades in the last half of 2005, which resulted in an unsatisfactory shopping experience formany of our customers and affected both repeat and new customer sales in 2006. We believe that a key to future revenue growth is to increase our Websiteconversion rate—defined as the percentage of visitors to the website who make a purchase. The areas of our business that most directly affect conversion rate,including personalization of the website, customer retention, e-mail marketing, and site design and layout, are the responsibility of our internal marketingdepartment. Within each of these areas, we have identified and made progress on initiatives that we believe can improve conversion, including outsourcingto third-party providers certain aspects of the functionality on the website, such as the engine that provides product recommendations to customers visitingproduct pages and the gift center that went live during the fourth quarter.Gross MarginsTotal Gross Margins—For the years ended December 31, 2005 and 2006, total cost of goods sold increased $10.9 million or 2%, from $682.4 million in2005 to $693.4 in 2006, resulting in a decrease in gross profits of 19% (from $116.9 million in 2005 to $94.8 million in 2006) during the same periods. As apercent of total revenue, cost of goods sold increased from 85% to 88% for those respective periods, resulting in decreased gross margins of 14.6% and 12.0%for the years ended December 31, 2005 and 2006, respectively. Cost of goods sold also included stock-based compensation related to the adoption ofSFAS 123(R) in 2006 of $412,000 during the year ended December 31, 2006 compared to $6,000 of stock-based compensation in 2005.Generally, our overall gross margins fluctuate based on several factors, including our product mix of sales; sales volumes mix by our direct business andfulfillment partners; changes in vendor pricing; lowering prices for customers, including competitive pricing and inventory management decisions within thedirect business; warehouse management costs; customer service costs; and our discounted shipping offers. Discounted shipping offers reduce shippingrevenue, and therefore reduce our gross margins on retail sales.Direct Gross Margins—For the years ended December 31, 2005 and 2006, gross profits for our direct business decreased 57% from $42.5 million in 2005to $18.3 million in 2006. Gross margins for our direct business decreased from 13.1% to 6.0% for those respective periods. The lower gross marginsexperienced by the direct business are primarily the result of lowering prices to our customers in an effort to significantly reduce inventory levels, whichdecreased from $93.3 million at the end of 2005 to $20.3 million at the end of 2006. As a result, we anticipate that we will see significant improvements inour direct gross margins in 2007, particulary if we are able to successfully reduce warehouse space.Fulfillment Partner Gross Margins—For the years ended December 31, 2005 and 2006, our fulfillment partner business generated gross profits of$74.4 million and $76.5 million, respectively, an increase of 3%, also resulting in increased gross margins of 15.7% and 15.8% for those respective periods.53Fulfillment costsFulfillment costs include all warehousing costs, including fixed overhead and variable handling costs (excluding packaging costs), as well as credit cardfees and customer service costs, all of which we include as costs in calculating gross margins. We believe that some companies in our industry, includingsome of our competitors, account for fulfillment costs within operating expenses, and therefore exclude fulfillment costs from gross margins. As a result, ourgross margins may not be directly comparable to others in our industry.The following table has been included to provide investors additional information regarding our classification of fulfillment costs and gross margins,thus enabling investors to better compare our gross margins with others in our industry:Year ended December 31, 200420052006 Total revenue$494,635100%$799,316100%$788,150100%Cost of goods soldProduct costs and other cost of goods sold394,15480%622,50978%632,49480%Fulfillment costs34,2787%59,9317%60,8568%Total cost of goods sold428,43287%682,44085%693,35088%Gross profit$66,20313%$116,87615%$94,80012% As displayed in the above table, fulfillment costs during the years ended December 31, 2004, 2005 and 2006 were $34.3 million, $59.9 million and$60.9 million, respectively, or 6.9%, 7.5% and 7.7% of total revenue for those respective periods. Fulfillment costs as a percentage of sales may vary due toseveral factors, such as our ability to manage costs at our warehouses, significant changes in the number of units received and fulfilled, the extent we utilizethird party fulfillment services and warehouses, and our ability to effectively manage customer service costs and credit card fees.Operating expensesSales and marketing. For the years ended December 31, 2005 and 2006, sales and marketing expenses totaled $77.2 million and $70.9 million (8%decrease), respectively. As a percentage of total revenue, sales and marketing expenses decreased slightly from 10% in 2005 to 9% in 2006. We directcustomers to our Websites primarily through a number of targeted online marketing channels, such as sponsored search, affiliate marketing, portaladvertising, e-mail campaigns, and other initiatives. We also utilize channels such as nation-wide television, print and radio advertising campaigns. Ourmarketing expense is variable and is measured as a percentage of overall sales.Our intent in 2006 was to keep marketing expense as a percent of sales at approximately 7%, and we had accomplished this over the first six months ofthe year. However, we entered the third quarter with our systems and processes running smoothly, and our customer satisfaction ratings back to where theyhad been prior to the system issues we experienced at the end of 2005. As a result, we increased both online and offline marketing expenditures in the lasthalf of 2006 in an effort to create sales momentum in Q4 2006 and into 2007. However, we did not see a corresponding increase in sales, primarily as a resultof visitor conversion rates, and marketing expense was 10% of sales in the fourth quarter, bringing it to 9% of sales for the year.We believe that our marketing expenditures were less efficient due to overall increases in online marketing rates, as well as the expiration ofmarketing agreements that we had with several large portals, including MSN, Yahoo and AOL, which are either no longer available or are too expensive forus to justify. In an effort to offset this, we have internally developed a search engine optimization tool that we believe will help us manage keywordpurchases more efficiently. We intend to reduce marketing54expenditures as a percent of sales in 2007, and we currently have multiple projects in development that are intended to help improve conversion rates and ouroverall marketing efficiency.While costs associated with our discounted shipping promotions are not included in marketing expense (they are accounted for as a reduction ofrevenue), we consider discounted shipping promotions as an effective marketing tool, and intend to continue to offer them as we deem appropriate.Sales and marketing expenses also included stock-based compensation related to the adoption of SFAS 123(R) in 2006 of $301,000 during the yearended December 31, 2006 compared to $4,000 of stock-based compensation in 2005.Technology expenses. Technology expenses increased 134%, from $27.9 million for the year ended December 31, 2005 to $65.2 million for the sameperiod in 2006, representing 3% and 8% of total revenue for those respective periods. Technology expenses also included stock-based compensation relatedto the adoption of SFAS 123(R) in 2006 of $684,000 during the year ended December 31, 2006, compared to $11,000 of stock-based compensation in 2005.We have incurred a “stair-step” increase in technology costs over the past two years, as we have made significant investments in all of our major systems,with approximately $60 million of capital expenditures in 2005 and an additional $26 million in 2006 (including increases to capital leases). The increasesin expense are related primarily to increased depreciation expense, as well as increases in maintenance and support costs, and increased IT personnel,including consultants. These increased expenses resulted in a significant increase in technology expenses as a percent of sales for the full-year 2006.However, we plan to reduce capital expenditures to $10 million or less in 2007, and we believe that overall technology costs will begin to decrease goingforward.General and administrative expenses. General and administrative (“G&A”) expenses increased 42%, from $33.0 million during the year endedDecember 31, 2005 to $46.8 million during the same period in 2006, representing 4% and 6% of total revenue for each of the respective periods. We incurredstock-based compensation within general and administrative expenses of approximately $2.7 million for the year ended December 31, 2006 compared to$51,000 in stock-based compensation in 2005.The increase in G&A expenses in 2006 compared to 2005 relates to increases in payroll-related expenses, professional fees, merchandising, legal andfinance costs, and also due to increased costs related to our relocation of our corporate offices to larger facilities in the third quarter of 2005. However, in ourefforts to cut costs, our current office space is being marketed for sublease, and we plan to move our corporate offices into existing space in our main SaltLake City warehouse during 2007. We believe that overall our G&A costs will decrease in 2007.A large portion of our technology and general and administrative expenses are now non-cash expenses. Total depreciation and amortization (includingamortization of stock-based compensation) in 2006 was $36 million, and we estimate that total depreciation and amortization in 2007 will be approximately$35 million. This compares to only $14 million of similar non-cash expenses in 2005.Restructuring expenses. During the fourth quarter of 2006, in an effort to improve future operating performance, we commenced implementation of afacilities consolidation and restructuring program designed to reduce our overall expense structure (see Item 15 of Part IV, “Financial Statements”—Note 4—“Restructuring Expense”). The planned actions include the termination of a co-location data center lease, marketing of the current office facilities for sub-lease, and marketing non-core businesses for sale. Of the $5.7 million of charges related to the facilities consolidation and restructuring program,$4.6 million relates to technology expenses and $1.1 million relates to general and administrative expenses. At December 31, 2006, we accrued a liability of$5.9 million associated with the facilities consolidation and reconstructuring program, including $5.5 million related to lease termination costs and$450,000 related to asset retirement obligation, all of which is to be paid during the first quarter of 2007.55Non-operating income (expense)Interest income, interest expense and other income (expense). Interest income is derived from the investment of our excess cash in short-terminvestments and marketable securities. In 2005, we incurred a large expense related to the valuation of the conditional coupon of our foreign bonds.Consequentially, interest income increased from $270,000 negative interest income related to a decrease in the valuation of the conditional coupon of ourforeign bonds in 2005, to a positive $3.6 million of interest income for the year ended December 31, 2006, including a $1.9 million gain recognized in 2006as a result of selling the foreign bonds.Interest expense is largely related to our convertible notes, capital leases and our credit lines. Interest expense decreased slightly from $5.6 millionduring the year ended December 31, 2005 to $4.8 million during the same period in 2006. The decrease in interest expense is related to the reduction ofconvertible notes outstanding related to the retirement of $43.0 million of Senior Notes in June and November of 2005. See Item 15 of Part IV, “FinancialStatements”—Note 13—“3.75% Convertible Senior Notes”.Under SFAS No. 133, the Foreign Notes were considered to be derivative financial instruments and were marked to market quarterly. Any unrealizedgain or loss related to the changes in value of the conditional coupon was recorded in the income statement as a component of interest income or expense.Any unrealized gain or loss related to the changes in the value of the Notes was recorded as a component of other comprehensive income (loss). On April 26,2006, we sold the Foreign Notes for $49.5 million, resulting in the gain on the bond instrument of $1.9 million. See Item 15 of Part IV, “FinancialStatements”—Note 6—”Marketable Securities”.Other income for the year ended December 31, 2005 relates primarily to the retirement of $43.0 million of Senior Notes for $35.7 million, which resultedin a recognized gain of $6.2 million.Discontinued operationsAs part of the program to reduce our expense structure and sell non-core businesses, we decided during the fourth quarter of 2006 to sell our travelsubsidiary (“OTravel”) , and we have received a non-binding letter of intent from a third-party to purchase this business. As a result, OTravel’s operationshave been classified as a discontinued operation and therefore are not included in the results of continuing operations. The loss from discontinuedoperations for OTravel was $6.9 million for the year ended December 31, 2006, including a goodwill impairment charge of $4.5 million.Income taxesIncome taxes. For the year ended December 31, 2005 and 2006, we incurred net operating losses, and consequently paid insignificant amounts offederal, state and foreign income taxes. As of December 31, 2005 and 2006, we had net operating loss carryforwards of approximately $58.0 million and$145.2 million, respectively, which may be used to offset future taxable income. An additional $21.9 million of net operating losses are limited underInternal Revenue Code Section 382 to $799,000 a year. These net operating loss carryforwards will begin to expire in 2018.Supplemental Information about Stock-Based CompensationPeriods prior to the adoption of SFAS 123(R)Prior to January 1, 2006, the Company accounted for stock-based awards under the intrinsic value method, which followed the recognition andmeasurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employee,and related interpretations. The intrinsic value method ofaccounting resulted in compensation expense for stock options to the extent option exercise prices were set below market prices on the date of grant. Also, tothe extent stock awards were forfeited prior to vesting, any previously recognized expense was reversed as an offset to operating expenses in the period offorfeiture.56The following table illustrates the effects on net loss and net loss per share as if the Company had applied the fair value recognition provisions of SFAS123, Accounting for Stock Based Compensation, as amended by SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure tooptions granted under the Company’s stock-based compensation plans prior to the adoption. For purposes of this pro forma disclosure, the value of theoptions was estimated using the Black-Scholes-Merton (“BSM”) option-pricing formula and amortized on a straight-line basis over the respective vestingperiods of the awards. Disclosure for the year ended December 31, 2006 is not presented because stock-based payments were accounted for under SFAS 123(R)’s fair value method during this period.Year ended December 31,20042005Net loss, as reported$(4,540)$(24,918)Add: Stock-based employee compensation, as reported36072Deduct: Total stock-based employee compensation expensedetermined under fair value based method for all awards(3,747)(3,996)Pro forma net loss$(7,927)$(28,842)Net loss per common shareBasic and diluted—as reported$(0.26)$(1.29)Basic and diluted—pro forma$(0.44)$(1.48) Adoption of SFAS 123(R)As of January 1, 2006, the Company adopted SFAS No. 123(R) using the modified prospective method, which requires measurement of compensationcost for all stock-based awards at fair value on date of grant and recognition of compensation over the service period for awards expected to vest. The fairvalue of stock options is determined using the BSM valuation model, which is consistent with our valuation techniques previously utilized for options infootnote disclosures required under SFAS No. 123. Such value is recognized as expense over the service period, net of estimated forfeitures, using thestraight-line method under SFAS 123(R).The adoption of SFAS 123(R) did not result in a cumulative benefit from accounting change, which reflects the net cumulative impact of estimatingfuture forfeitures in the determination of period expense, rather than recording forfeitures when they occur as previously permitted, as we did not haveunvested employee stock awards for which compensation expense was recognized prior to adoption of SFAS No. 123(R).Prior to the adoption of SFAS 123(R), cash retained as a result of tax deductions relating to stock-based compensation was presented in operating cashflows, along with other tax cash flows, in accordance with the provisions of the Emerging Issues Task Force (“EITF”) Issue No. 00-15, Classification in theStatement of Cash Flows of the Income Tax Benefit Received by a Company upon Exercise of a Nonqualified Employee Stock Option. SFAS123(R) supersedes EITF 00-15, amends SFAS 95, Statement of Cash Flows, and requires tax benefits relating to excess stock-based compensation deductionsto be prospectively presented in the statement of cash flows as financing cash inflows. As of the adoption of SFAS 123(R), we had fully reserved against anytax benefits resulting from stock-based compensation deductions in excess of amounts reported for financial reporting purposes.On March 29, 2005, the SEC published Staff Accounting Bulletin (“SAB”) No. 107, which provides the Staff’s views on a variety of matters relating tostock-based payments. SAB 107 requires stock-based compensation be classified in the same expense line items as cash compensation. The Company hasreclassified stock-based compensation from prior periods to correspond to current period presentation within the same operating expense line items as cashcompensation paid to employees.57The application of SFAS 123(R) had the following effect on the year ended December 31, 2006 reported amounts relative to amounts that would havebeen reported using the intrinsic value method under previous accounting (in thousands, except per share amounts):SFAS 123(R) Adjustments Year ended December 31, 2006Operating loss$(4,120)Net loss$(4,120)Net loss per common share—basic and diluted$(0.20) SeasonalityBased upon the Company’s historical experience, increased revenues typically occur during the fourth quarter because of the Christmas retail season.The actual quarterly results for each quarter could differ materially depending upon consumer preferences, availability of product and competition, amongother risks and uncertainties. Accordingly, there can be no assurances that seasonal variations will not materially affect the Company’s results of operationsin the future. The following table reflects the Company’s revenues for each of the quarters available since 2004 (in thousands):FirstQuarterSecondQuarterThirdQuarterFourthQuarter2006$178,044$159,192$156,885$294,0292005165,881150,638167,779315,018200482,07887,792103,444221,321 Comparison of Years Ended December 31, 2004 and 2005RevenueTotal revenue grew from $494.6 million in 2004, to $799.3 million in 2005, representing growth of 62%. During this same period, direct revenueincreased from $213.2 million to $324.9 million (52% growth) and fulfillment partner revenue grew from $281.4 million to $474.4 million (69% growth).The significant increase in total revenue was due primarily to the increase in the number of orders (including both direct and fulfillment partner orders),which grew from 5.8 million in 2004 to 8.4 million in 2005 as a result of increased marketing efforts. Additionally, fulfillment partner revenue grew as aresult of an increase in the number of fulfillment partners, which grew from 380 in 2004 to 460 in 2005. The increase in total revenue is also a reflection ofour ability to acquire new customers from our marketing efforts, as evidenced by the addition of 3.8 million new customers during the year endedDecember 31, 2005 compared to 2.5 million new customers in the same period of 2004, an increase of 52%.Gross bookings totaled $535.7 million and $868.0 million for the years ended December 31, 2004 and 2005, respectively, representing an increase of62%. Gross bookings differ from GAAP revenue in that gross bookings represent the gross sales price of goods sold by the Company before returns, salesdiscounts and before payments to fulfillment partners prior to July 1, 2003.Gross MarginsTotal Gross Margins—Cost of goods sold increased $254.0 million or 59% in absolute dollars, from $428.4 million during the year ended December 31,2004 to $682.4 million during the year ended December 31, 2005. In comparing the years 2004 and 2005, total revenue increased 62% (from $494.6 millionto $799.3 million) while gross profit dollars increased 77% (from $66.2 million to $116.9 million) during the same periods. As a percent of total revenue, costof goods sold decreased from 87% to 85% for those respective periods resulting in improved gross margins of 13.4% and 14.6% for the years endedDecember 31, 2004 and 2005, respectively.58Direct Gross Margins—Gross profits for our direct business increased 50% from $28.2 million for the year ended December 31, 2004 to $42.5 millionrecorded during the same period in 2005. Direct revenue increased 52% from $213.2 million during the year ended December 31, 2004 to $324.9 millionduring the year ended December 31, 2005. Gross profits as a percentage of direct revenue were 13.2% and 13.1% for the years ended December 31, 2004 and2005, respectively.In 2005, we were able to maintain the efficiencies we had gained in gross margins by the end of 2004. Margins also benefited (and are expected tobenefit in the future) from the higher gross margins of the auctions business. Overall, the improvements in gross margins over the past two years are a result ofefficiencies gained in several areas. In particular, we believe our buying has become more efficient as we continue to grow, allowing us to make largerinventory purchases and obtain more favorable pricing. Our total cost per package shipped (including outbound freight) has decreased due to better processmanagement, lower packaging costs, and increased sales volumes. Additionally, we have made improvements to the cost of processing returns, customerservice costs and credit card fees. Management believes that additional improvements can be made in gross margins, particularly in the customer service,order fulfillment and returns areas of the business.Fulfillment Partner Gross Margins—Our fulfillment partner business generated gross profits of $38.0 million and $74.4 million for the years endedDecember 31, 2004 and 2005, respectively, an increase of 96%. Gross profits as a percentage of fulfillment partner revenue increased from 13.5% for the yearof 2004 to 15.7% for 2005.The increase in gross profit dollars for our fulfillment partner operations was due to the general growth of the consumer business during the year, and anincrease in the number of fulfillment partner products offered on our Websites. The increase in gross margins is largely due to improvements in product costsand credit card fees, as well as a decrease in BMMG gross bookings as a percentage of fulfillment partner revenue, from 22% in 2004 to 17% in 2005. Grossmargins for BMMG products have historically been much lower than those of other product categories; however, we have made improvements in BMMGmargins in 2005, which, in turn, increased the gross profit margin for the overall fulfillment partner operations.FulfillmentFulfillment costs during the years ended December 31, 2004 and 2005 were $34.3 million and $59.9 million, respectively, or 7% of total revenue forthose respective periods. Fulfillment costs include warehousing costs (excluding packaging costs), customer service costs and credit card fees. Fulfillmentcosts as a percentage of sales may vary due to several factors, such as such as significant changes in the number of units received and fulfilled, the extent weutilize third party fulfillment services and warehouses, and our ability to effectively manage customer service costs and credit card fees.Year ended December 31, 20042005 Total revenue$494,635100%$799,316100%Cost of goods soldProduct costs and other cost of goods sold394,15480%622,50978%Fulfillment costs34,2787%59,9317%Total cost of goods sold428,43287%682,44085%Gross profit$66,20313%$116,87615% Operating expensesSales and marketing. Sales and marketing expenses totaled $40.6 million and $77.2 million for the years ended December 31, 2004 and 2005,respectively, representing an increase of 90%. For the year59ended December 31, 2004 and 2005, sales and marketing expenses equaled 8% and 10%, respectively, of total revenue.We direct customers to our websites primarily through a number of targeted online marketing channels, such as sponsored search, portal advertising, e-mail campaigns, and other initiatives. We also utilize channels such as nation-wide television, print and radio advertising campaigns. Our marketing expenseis variable and is measured as a percentage of overall sales.Overall online marketing expenditures has increased in absolute terms during the year ended December 31, 2005 compared to prior years as a result ofincreased online marketing rates during 2004 and 2005, and an increase in our ongoing online marketing efforts, particularly with the large portals (MSN,Yahoo & AOL), and keyword search (Google). In addition, we continued our television, print and radio campaigns throughout 2005. Our marketing costshave also increased as a percentage of sales due to marketing efforts in our auctions business. Since we record revenues in this business on a net basis, ittypically has higher marketing expenses as a percent of total revenue.While costs associated with our discounted shipping promotions are not included in marketing expense (they are accounted for as a reduction ofrevenue), we consider discounted shipping promotions as an effective marketing tool, and intend to continue to offer them as we deem appropriate.Sales and marketing expenses have been reclassed to include stock-based compensation related to the adoption of SFAS 123(R) in 2005 of $26,000 and$4,000 during the years ended December 31, 2004 and 2005, respectively.Technology expenses. Technology expenses increased 228%, from $8.5 million in the year ended December 31, 2004 to $27.9 million in same periodended December 31, 2005, representing 2% and 3% of total revenue for those respective periods..We incurred a “stair-step” increase in technology costs during 2005 in an effort to prepare us for growth we anticipate over the next few years. Theincrease in expenditures was attributable to the increase in hardware, software and personnel costs, and depreciation associated with the development of thenew infrastructure, including the ERP implementation, expansion of corporate systems and a database site license. The increase in technology expenses alsoincluded the costs associated with the strategic projects, including the development of an enterprise data warehouse and customer analytics system,completion of our auctions tab, reconstruction of our travel website, and development of our search engine and keyword management application.Technology expenses have been reclassed to include stock-based compensation related to the adoption of SFAS 123(R) in 2005 of $60,000 and $11,000during the years ended December 31, 2004 and 2005, respectively.General and administrative expenses. General and administrative expenses increased 50% from $22.0 million during year ended December 31, 2004 to$33.0 million during the year ended December 31, 2005, representing 4% of total revenue for each of the respective periods.The increase in general and administrative expenses in the year ended December 31, 2005 compared to the year ended December 31, 2004 related to theincreases in primarily in payroll-related expenses, professional fees, merchandising, legal and finance costs. Also in the third quarter of 2005, we relocatedour corporate offices to larger facilities to allow for future growth. As a result we now incur an additional rent expense of approximately $1.0 millionquarterly.General and administrative expenses have been reclassed to include stock-based compensation related to the adoption of SFAS 123(R) in 2005 of$238,000 and $51,000 during the years ended December 31, 2004 and 2005, respectively.60Non-operating income (expense)Interest income, interest expense and other income (expense).The primary component of our net interest income (expense) relates to the interest derived from the investment of our excess cash in marketablesecurities offset by interest expense related to the convertible debt, letters of credit, capital leases, and other related fees. Additionally, we incurred a largeexpense during the year related to the valuation of the conditional coupon of our foreign bonds. Interest income decreased from $1.2 million in the yearended December 31, 2004 to $270,000 negative interest income in the year ended December 31, 2005 due to the decreased valuation of our foreign bonds.During the first quarter of 2005, we purchased $49.9 million of Foreign Corporate Securities (“Foreign Notes”) which were scheduled to fully mature for$50.0 million in cash in November 2006. The Foreign Notes did not have a stated interest rate, but were structured to return the entire principal amount and aconditional coupon if held to maturity. The conditional coupon would provide a rate of return dependent on the performance of a “basket” of eight Asiancurrencies against the U.S. dollar. At December 31, 2005, the Foreign Notes had a fair value of $48.5 million.Under SFAS No. 133, the Foreign Notes were considered to be derivative financial instruments and were marked to market quarterly. Any unrealizedgain or loss related to the changes in value of the conditional coupon was recorded in the income statement as a component of interest income or expense.Any unrealized gain or loss related to the changes in the value of the Foreign Notes was recorded as a component of other comprehensive income (loss). Forthe year ended December 31, 2005, the combined overall fair value of the Foreign Notes decreased $1.5 million. The decrease was attributable to changes inthe fair value of the conditional coupon resulting in a loss of $2.6 million, which was recorded in net income, and changes in fair value of the bondinstrument resulting in a gain of $1.1 million, which was recorded as a component of other comprehensive income (loss) in the Balance Sheet. See Item 15 ofPart IV, “Financial Statements”—Note 6—”Marketable Securities”.Interest expense is comprised largely of interest expense related to our convertible notes, capital leases and our line of credit. Interest expense increasedfrom $775,000 during the year ended December 31, 2004 to $5.6 million during the year ended December 31, 2005, primarily as a result of the interestexpense related to our convertible senior notes issued in November 2004.We recorded other expense, net of $49,000 and other income, net of $4.7 million for the years ended December 31, 2004 and 2005, respectively. Thegain realized during the year ended December 31, 2005 resulted from the retirement of $43.0 million of the 3.75% Convertible Senior Notes which occurredduring the second and fourth quarters of 2005, resulting in a combined net gain of $6.2 million. See Item 15 of Part IV, “Financial Statements”—Note 13—”3.75% Convertible Senior Notes”.Discontinued operationsThe results of operations for fiscal 2005 for the OTravel subsidiary have been reclassified to loss from discontinued operations. The loss from operationsfor the OTravel subsidiary was $2.6 million for the year ended December 31, 2005.Income taxesIncome taxes. For the years ended December 31, 2004 and 2005, we incurred net operating losses, and consequently paid insignificant amounts offederal, state and foreign income taxes. As of December 31, 2004 and 2005, we had net operating loss carryforwards of approximately $50.5 million and$58.0 million, respectively, which may be used to offset future taxable income. An additional $14.4 million of net operating losses are limited under InternalRevenue Code Section 382 to $799,000 a year. These net operating loss carryforwards will begin to expire in 2019.61Quarterly Results of OperationsThe following tables set forth our unaudited quarterly results of operations data for the eight most recent quarters for the period ended December 31,2006, as well as such data expressed as a percentage of our total revenue for the periods presented. The information in the table below should be read inconjunction with the Consolidated Financial Statements and the Notes thereto included elsewhere in this Form 10-K. We have prepared this information onthe same basis as the Consolidated Financial Statements and the information includes all adjustments, consisting only of normal recurring adjustments, thatwe consider necessary for a fair statement of our financial position and operating results for the quarters presented. Our quarterly operating results have variedsubstantially in the past and may vary substantially in the future. You should not draw any conclusions about our future results from the results of operationsfor any particular quarter. Three Months Ended Mar. 31,2005 June 30,2005 Sept. 30,2005 Dec. 31,2005 Mar. 31,2006 June 30,2006 Sept. 30,2006 Dec. 31,2006 (in thousands, except per share data)Consolidated Statement of OperationsData:RevenueDirect revenue$67,884$60,064$68,449$128,478$79,710$68,770$56,564$98,158Fulfillment partner revenue97,99790,57499,330186,54098,33490,422100,321195,871Total revenue165,881150,638167,779315,018178,044159,192156,885294,029Cost of goods soldDirect58,26251,56759,169113,38570,70361,47351,037101,730Fulfillment partner82,85776,37583,317157,50883,58775,41184,483164,926Total cost of goods sold141,119127,942142,486270,893154,290136,884135,520266,656Gross profit24,76222,69625,29344,12523,75422,30821,36527,373Operating expenses:Sales and marketing16,82614,49917,03928,79112,65911,91117,28229,045Technology4,0996,1037,9609,70213,42414,89716,15720,680General and administrative7,3467,5668,3979,77111,85011,05011,07812,859Restructuring———————5,674Total operating expenses28,27128,16833,39648,26437,93337,85844,51768,258Operating loss(3,509)(5,472)(8,103)(4,139)(14,179)(15,550)(23,152)(40,885)Interest income, net644896(1,690)(120)3152,215459577Interest expense(1,445)(1,517)(1,264)(1,356)(1,267)(1,275)(1,096)(1,127)Other income (expense), net—4,17011547—(1)(6)88Loss from continuing operations(4,310)(1,923)(11,046)(5,068)(15,131)(14,611)(23,795)(41,347)Discontinued operations:Loss from discontinued operations——(1,356)(1,215)(779)(1,128)(708)(4,267)Net loss(4,310)(1,923)(12,402)(6,283)(15,910)(15,739)(24,503)(45,614)Deemed dividend related to redeemablecommon stock(46)(47)(47)(45)(33)(33)(33)—Net loss attributable to common shares$(4,356)$(1,970)$(12,449)$(6,328)$(15,943)$(15,772)$(24,536)$(45,614)Net loss per common share—basic and dilutedLoss from continuing operations$(0.22)$(0.10)$(0.59)$(0.27)$(0.78)$(0.73)$(1.16)$(1.95)Loss from discontinued operations$—$—$(0.07)$(0.06)$(0.04)$(0.05)$(0.03)$(0.20)Net loss per share—basic and diluted$(0.22)$(0.10)$(0.66)$(0.33)$(0.82)$(0.78)$(1.19)$(2.15)Weighted average common sharesoutstanding—basic and diluted19,86219,70918,84419,31119,38520,15920,60021,163 62 Three Months Ended Mar. 31,2005June 30,2005Sept. 30,2005Dec. 31,2005Mar. 31,2006June 30,2006Sept. 30,2006Dec. 31,2006 Additional OperatingData(1):Gross bookings (inthousands)(2)$184,215$163,775$179,480$340,489$200,900$172,091$170,590$319,621Number of orders(3)1,915,0001,588,0001,768,0003,176,0001,856,0001,568,0001,529,0003,061,000Number of new B2Ccustomers(4)796,000611,000703,0001,370,000638,000520,000540,0001,157,000Average customeracquisition cost(5)$19.50$22.10$22.92$20.51$19.49$22.98$31.22$25.56(1) The additional operating data sets forth certain operating data relating to our business for the eight most recent quarters for the period ended December 31, 2006. While webelieve that the information in the table above facilitates an understanding of our business and results of operations for the periods presented, such information is not inaccordance with generally accepted accounting principles and should be read in conjunction with the quarterly results of operations data set forth above.(2) Gross bookings excludes bookings related to the auctions and travel businesses (shopping business only). We believe that gross bookings is a metric widely used in our industryand by making this metric available to investors, we believe investors are able to compare our performance against others in our industry. We believe that investors may use theaverage customer acquisition cost metric to determine how efficiently we are able to achieve growth, if any. Again, we believe this metric is widely used in our industry, andproviding these values to investors enables them to make more meaningful comparisons.(3) Number of orders represents the number of individual orders for merchandise through our Websites excluding B2B orders.(4) Number of new B2C customers represents the number of valid new customer accounts. To establish a valid customer account, a person must provide us with the followinginformation and purchase merchandise on our B2C Website: a unique e-mail address; a unique password; and a verified credit card account number.(5) Average customer acquisition cost represents total shopping sales and marketing expense divided by the number of new shopping customers for the period presented (excludingboth new customers and marketing costs for the auctions business).Three Months Ended Mar. 31,2005June 30,2005Sept. 30,2005Dec. 31,2005Mar. 31,2006June 30,2006Sept. 30,2006Dec. 31,2006 (as a percentage of total revenue) RevenueDirect revenue40.9%39.9%40.8%40.8%44.8%43.2%36.1%33.4%Fulfillment partner revenue59.160.159.259.255.256.863.966.6Total revenue100.0100.0100.0100.0100.0100.0100.0100.0Cost of goods soldDirect35.134.235.336.039.738.632.534.6Fulfillment partner49.950.749.650.047.047.453.956.1Total cost of goods sold85.084.984.986.086.786.086.490.7Gross profit15.015.115.114.013.314.013.69.3Operating expenses:Sales and marketing10.19.610.29.17.17.511.09.9Technology2.54.14.73.17.59.410.37.0General and administrative4.45.05.03.16.76.97.14.4Restructuring———————1.9Total operating expenses17.018.719.915.321.323.828.423.2Operating loss(2.0)(3.6)(4.8)(1.3)(8.0)(9.8)(14.8)(13.9)Interest income0.40.6(1.0)(0.0)0.21.40.30.2Interest expense(0.9)(1.0)(0.8)(0.5)(0.7)(0.8)(0.7)(0.4)Other income (expense), net—2.80.00.2—(0.0)(0.0)0.0Loss from continuing operations(2.5)%(1.2)%(6.6)%(1.6)%(8.5)%(9.2)%(15.2)%(14.1)% Total operating expenses has gradually increased as a percentage of total revenue each quarter since the beginning of 2006 primarily as a result ofincreases in marketing costs and our investment in an improved technology infrastructure.63Due to the foregoing factors, in one or more future quarters our operating results may fall below the expectations of securities analysts and investors. Insuch an event, the trading price of our common stock would likely be materially adversely affected.Off-Balance Sheet ArrangementsWe do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company’s financialcondition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that would bematerial to investors.Liquidity and Capital ResourcesPrior to the second quarter of 2002, we financed our activities primarily through a series of private sales of equity securities, warrants to purchase ourcommon stock and promissory notes. During the second quarter of 2002, we completed our initial public offering pursuant to which we receivedapproximately $26.1 million in cash, net of underwriting discounts, commissions, and other related expenses. Additionally, we completed follow-onofferings in February 2003, May 2004 and November 2004, pursuant to which we received approximately $24.0 million, $37.9 million and $75.2 million,respectively, in cash, net of underwriting discounts, commissions, and other related expenses. In November 2004, we also received $116.2 million inproceeds from the issuance of our convertible senior notes in a transaction event exempt from registration under the Securities Act. During 2006, we received$64.4 million from two stock offerings in May and December. At December 31, 2006, our cash and cash equivalents balance was $127.0 million.Our operating activities resulted in a net cash outflows of $6.1 million and $26.3 million for the years ended December 31, 2005 and 2006, respectively.The primary use of cash and cash equivalents during the year ended December 31, 2006 was to fund our operations, including net losses of $101.8 million(which includes $43.3 million of loss from discontinued operations and other net non-cash activity), as well as changes in accounts receivables, accountspayables and accrued liabilities of $2.1 million, $35.2 million and $6.2 million, respectively. This was offset by the cash provided from changes in inventory,prepaid inventory, prepaid expenses, and other long-term assets of $67.0 million , $7.4 million, $1.0 million and $496,000, respectively. For the year endedDecember 31, 2005, the primary use of cash and cash equivalents was to fund our operations, including net losses of $24.9 million, and changes ininventories ($46.7 million), prepaid expenses ($5.0 million), receivables ($4.3 million) and other long-term assets ($2.2 million). This was offset by thechange in prepaid inventory ($2.7 million), accounts payable ($35.2 million) and accrued liabilities ($23.1 million).We have payment terms with our fulfillment partners that extend beyond the amount of time necessary to collect proceeds from our customers. As aresult, following our seasonally strong fourth quarter sales, at December 31 of each year, our cash, cash equivalents, marketable securities and accountspayable balances typically reach their highest level (other than as a result of cash flows provided by or used in investing and financing activities). However,our accounts payable balance normally declines during the first three months following year-end, which normally results in a decline in our cash, cashequivalents, and marketable securities balances in the first quarter each year.Investing activities resulted in cash outflows of $37.7 million for the year ended December 31, 2005 and cash inflows of $33.4 million for the year endedDecember 31, 2006. The cash inflows of $33.4 million from investing activities in 2006 resulted from the sale of marketable securities of $56.8 million,including the sale of our foreign notes of $49.5 million in April, offset by expenditures for property and equipment of $23.4 million. Cash outflows frominvesting activities in 2005 resulted from investments in marketable securities of $185.5 million, expenditures for property and equipment of $44.6 millionand the acquisition64of Ski West, Inc. for $25.1 million. This was offset by sales of marketable securities of $216.3 million. We plan to reduce capital expenditures to $10.0million or less in 2007.Financing activities resulted in cash outflows of $99.1 million for the year ended December 31, 2005 and cash inflows of $64.0 million for the yearended December 31, 2006. The cash inflows of $64.0 million in 2006 primarily are the result of $64.4 million received from the sale of our common stockand $2.5 million received from the exercise of employee stock options, offset by payments on capital lease obligations of $3.0 million. Cash outflows forfinancing activities in 2005 were primarily from capital lease payments of $7.1 million, payments of $35.7 million to retire our convertible senior notes,$24.1 million to purchase our common stock, and $47.5 million to purchase call options to purchase our common stock. These outflows in 2005 were offsetby $7.9 million related to the settlement of call options for cash and $7.3 million from the exercise of stock options and warrants.Certain prior-year amounts have been reclassified to conform to the current year’s financial statement presentation. In addition, we have revised ourconsolidated statements of cash flows for the year ended December 31, 2005 to present the operating and investing portion of the cash flows attributable todiscontinued operations on a separately identifiable basis. We had previously recorded these amounts on a combined basis.While we believe that the cash and marketable securities currently on hand, amounts available under our credit facility and expected cash flows fromfuture operations will be sufficient to continue operations for at least the next twelve months, we may require additional financing. However, there can be noassurance that if additional financing is necessary it will be available, or, if available, that such financing can be obtained on satisfactory terms. Failure togenerate sufficient revenues, generate profitability or raise additional capital could have a material adverse effect on our ability to continue as a goingconcern and to achieve our intended business objectives. Any projections of future cash needs and cash flows are subject to substantial uncertainty.Contractual Obligations and Commitments. The following table summarizes our contractual obligations as of December 31, 2006 and the effect suchobligations and commitments are expected to have on our liquidity and cash flow in future periods:Payments Due by PeriodContractual Obligations TotalLess than1 Year1-3 Years4-5 YearsAfter5 years(in thousands)Long-term debt arrangements$77,000$—$—$77,000$—Interest on convertible senior notes14,4382,8885,7755,775—Capital lease obligations10,0255,9974,028——Operating leases48,6668,71812,84110,86716,240Purchase obligations14,49614,496———Line of credit—————Total contractual cash obligations$164,625$32,099$22,644$93,642$16,240 Amounts of Commitment Expiration Per PeriodOther Commercial Commitments TotalAmountsCommittedLess thanYear 11-3 Years4-5 YearsOver5 years(in thousands)Letters of credit$7,130$7,130$—$—$—Redeemable common stock—————Total commercial commitments$7,130$7,130$—$—$— 653.75% Convertible Senior NotesIn November 2004, we completed an offering of $120.0 million of 3.75% Convertible Senior Notes (the “Senior Notes”). Interest on the Senior Notes ispayable semi-annually on June 1 and December 1 of each year. The Senior Notes mature on December 1, 2011 and are unsecured and rank equally in right ofpayment with all existing and future unsecured, unsubordinated debt and senior in right of payment to any existing and future subordinated indebtedness.The Senior Notes are convertible at any time prior to maturity into our common stock at the option of the note holders at a conversion price of $76.23 pershare (subject to adjustment in certain events, including stock splits, dividends and other distributions and certain repurchases of our stock, as well as certainfundamental changes in the ownership of the Company).Beginning December 1, 2009, we have the right to redeem the Senior Notes, in whole or in part, for cash at 100% of the principal amount plus accruedand unpaid interest. Upon the occurrence of a fundamental change (including the acquisition of a majority interest in the Company, certain changes in theCompany’s board of directors or the termination of trading of our stock) meeting certain conditions, holders of the Senior Notes may require us to repurchasefor cash all or part of their notes at 100% of the principal amount plus accrued and unpaid interest.In 2005, under the Share Repurchase Program discussed below, we retired $43.0 million of the Senior Notes for $35.7 million in cash. As a result of thenote retirements, we recognized a gain of $6.2 million, net of the associated unamortized discount of $1.2 million for the year ended December 31, 2005. Asof December 31, 2006, $77.0 million of Senior Notes and unamortized debt discount of $1.7 million remain outstanding.Lease and Purchase ObligationsThe lease obligations include our obligations under a ten-year lease agreement we entered in December 2004 for approximately 154,000 square feet ofoffice space in Salt Lake City. We took possession of the new office space in July of 2005, and terminated our lease obligations under our previous officelease agreements at the same time. The total lease obligation over the ten-year term of the new lease is $39.6 million, of which approximately $4.2 million ispayable in the next twelve months. In connection with the preparation of the new office space, we provided a letter of credit for $500,000 to provide funds forthe removal of the improvements upon termination of the new sublease and have also paid approximately $2.0 million for leasehold improvements. We paidfor the majority of the leasehold improvements during 2005 and paid the remainder in 2006.In November 2006, we made the determination to consolidate our facilities and began marketing of the office facilities lease for sub-lease. We recorded aliability of $450,000 for the costs to dismantle and dispose of an escalator system and to the return the leased facilities to their original condition (see Item 15of Part IV, “Financial Statements”—Note 9—“Asset Retirement Obligation”) and incurred additional depreciation in connection with the revised useful lifeof certain leasehold improvements.In July 2005, we entered into a Colocation Center Agreement (the “Colocation Agreement”) to build out and lease 11,289 square feet of space at OldMill Corporate Center II in Salt Lake City for an IT data center and co-location facility. The Colocation Agreement set forth the terms on which the lessorwould incur the costs to build out the IT data center and co-location facility and we would commence to lease the space upon its completion for a term of tenyears. In November 2006, we made the determination to consolidate facilities and to not occupy the IT data center and co-location facility and begannegotiations with the lessor to terminate the lease agreement (see Item 15 of Part IV, “Financial Statements”—Note 4—“Restructuring Expense”).66We lease 610,000 square feet for its warehouse facilities in Utah under operating leases which expire in August 2012.The amount of purchase obligations shown is based on assumptions regarding the legal enforceability against us of purchase orders we had outstandingat December 31, 2006. Under different assumptions regarding our rights to cancel our purchase orders or different assumptions regarding the enforceability ofthe purchase orders under applicable law, the amount of purchase obligations shown in the table above would be less.Borrowings$30.0 million Amended Credit AgreementOn October 18, 2005, the Company entered into a sixth amendment to a credit agreement (as amended to date, the “Amended Credit Agreement”) withWells Fargo Bank, National Association. The Amended Credit Agreement provides a revolving line of credit to the Company of up to $30.0 million whichwe use primarily to obtain letters of credit to support inventory purchases. Borrowings and outstanding letters of credit under the credit agreement arecollateralized by cash balances held at Wells Fargo Bank, National Association. The Amended Credit Agreement expires on December 31, 2007, however, wehave an option to renew the Amended Credit Agreement annually. Interest on borrowings is payable monthly and accrued at either (i) 1.35% above LIBOR ineffect on the first day of an applicable fixed rate term, or (ii) at a fluctuating rate per annum determined by the bank to be one half a percent (0.50%) abovedaily LIBOR in effect on each business day a change in daily LIBOR is announced by the bank. Unpaid principal, together with accrued and unpaid interestis due on the maturity date.The Amended Credit Agreement requires us to comply with certain covenants, including restrictions on mergers, business combinations or transfer ofassets. We were in compliance with these covenants at December 31, 2006.At December 31, 2006, no amounts were outstanding under the Amended Credit Agreement, and letters of credit totaling $7.1 million were issued on ourbehalf.$40.0 million WFRF AgreementOn December 12, 2005, we entered into a Loan and Security Agreement (the “WFRF Agreement”) with Wells Fargo Retail Finance, LLC and relatedsecurity agreements and other agreements described in the WFRF Agreement.The WFRF Agreement provides for advances to us and for the issuance of letters of credit for its account of up to an aggregate maximum of $40.0million. We have the right to increase the aggregate maximum amount available under the facility to up to $50.0 million during the first two years of thefacility. The amount actually available to us may be less and may vary from time to time, depending on, among other factors, the amount of our eligibleinventory and receivables. Our obligations under the WFRF Agreement and all related agreements are collateralized by all or substantially all of our and oursubsidiaries’ assets. Our obligations under the WFRF Agreement are cross-collateralized with our assets pledged under our $30.0 million credit facility withWells Fargo Bank, National Association. The term of the WFRF Agreement is three years, expiring on December 12, 2008. The WFRF Agreement containsstandard default provisions.Advances under the WFRF Agreement bear interest at either (a) the rate announced, from time to time, within Wells Fargo Bank, National Association atits principal office in San Francisco as its “prime rate” or (b) a rate based on LIBOR plus a varying percentage between 1.25% and 1.75%; however, theannual interest rate on advances under the WFRF Agreement will be at least 3.50%. The WFRF Agreement includes affirmative covenants as well as negativecovenants that prohibit a variety of actions67without the lender’s approval, including covenants that limit our ability to (a) incur or guarantee debt, (b) create liens, (c) enter into any merger,recapitalization or similar transaction or purchase all or substantially all of the assets or stock of another person, (d) sell assets, (e) change our name or thename of any of our subsidiaries, (f) make certain changes to our business, (g) optionally prepay, acquire or refinance indebtedness, (h) consign inventory,(i) pay dividends on, or purchase, acquire or redeem shares of, our capital stock, (j) change our method of accounting, (k) make investments, (l) enter intotransactions with affiliates, or (m) store any of our inventory or equipment with third parties. We were in compliance with these covenants as of December 31,2006. At December 31, 2006, no amounts were outstanding under the WFRF Agreement. As of December 31, 2006, availability under the WFRF Agreementwas $11.9 million.Redeemable Common StockThe estimated amount of redeemable common stock is based solely on the statutes of limitations of the various states in which stockholders may haverescission rights and may not reflect the actual results. The stock is not redeemable by its terms. We do not have any unconditional purchase obligations,other long-term obligations, guarantees, standby repurchase obligations or other commercial commitments. These rescission rights, if any, fully expired priorto the end of 2006, leaving no outstanding redeemable common stock as of December 31, 2006.Share Repurchase ProgramDuring January 2005, our Board of Directors authorized a share repurchase program under which we were authorized to repurchase up to $50.0 million ofour common stock through December 31, 2007. On April 26, 2005, the Board of Directors increased the amount of the share repurchase program to $100.0million. Additionally, on June 14, 2005, the Board of Directors authorized an amendment of our three-year share repurchase program to include therepurchase of our Convertible Senior Notes. Under the repurchase program, we repurchased approximately 665,000 shares of our common stock in openmarket transactions for $24.1 million during the year ended December 31, 2005. In addition, approximately 1.0 million shares of common stock wereacquired as a result of the settlement of $41.1 million of structured stock repurchase transactions during the year ended December 31, 2005. The purchasedcall options that did not settle in stock settled in cash totaling $7.9 million, which we received in July 2005. We also repurchased convertible senior noteshaving an aggregate principal amount of $43.0 million. As of December 31, 2006, we have utilized all of the $100.0 million authorized by the board ofdirectors under the share repurchase program.Shelf RegistrationIn April 2005, we filed a registration statement with the Securities and Exchange Commission using a “shelf” registration or continuous offering process.Under this shelf process, we may, from time to time, sell any or all of the securities described in the prospectus in one or more offerings up to a total dollaramount of $500.0 million. On May 1, 2006, we issued approximately 1,042,000 shares of common stock for an aggregate price of approximately $25.0million. Additionally, on December 12, 2006, we issued approximately 2,734,000 shares for an aggregate price of approximately $39.4 million.While we believe that the cash and marketable securities currently on hand, amounts available under our credit facility and expected cash flows fromfuture operations will be sufficient to continue operations for at least the next twelve months, we may require additional financing. However, there can be noassurance that if additional financing is necessary it will be available, or, if available, that such financing can be obtained on satisfactory terms. Failure togenerate sufficient revenues, generate profitability or raise additional capital could have a material adverse effect on our ability to continue as a goingconcern68and to achieve our intended business objectives. Any projections of future cash needs and cash flows are subject to substantial uncertainty.ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKWe do not use derivative financial instruments in our investment portfolio and have no foreign exchange contracts. Our financial instruments consist ofcash and cash equivalents, marketable securities, trade accounts and contracts receivable, accounts payable and long-term obligations. We considerinvestments in highly-liquid instruments purchased with a remaining maturity of 90 days or less at the date of purchase to be cash equivalents. Our exposureto market risk for changes in interest rates relates primarily to our short-term investments and short-term obligations; thus, fluctuations in interest rates wouldnot have a material impact on the fair value of these securities.At December 31, 2006, we had $127.0 million in cash and cash equivalents. A hypothetical increase or decrease in interest rates of one hundred basispoints would have an estimated impact of approximately $1.3 million on our earnings or loss, or the fair market value or cash flows of these instruments.At December 31, 2006, we had approximately $77.0 million of convertible senior notes outstanding which bear interest at a fixed rate of 3.75%. Inaddition, at December 31, 2006, there were no borrowings outstanding under our lines of credit and letters of credit totaling $7.1 million were outstandingunder our credit facilities.The fair value of the convertible senior notes is sensitive to interest rate changes. Interest rate changes would result in increases or decreases in the fairvalue of the convertible senior notes, due to differences between market interest rates and rates in effect at the inception of the obligation. Unless we elect torepurchase our convertible senior notes in the open market, changes in the fair value of convertible senior notes have no impact on our cash flows orconsolidated financial statements. The estimated fair value of our 3.75% Convertible Senior Notes of December 31, 2005 and 2006 was $54.7 million and$56.3 million, respectively.ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATAThe financial statements and supplementary data required by this item are included in Part IV, Item 15 of this Form 10-K and are presented beginning onpage F-1.ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURENone.ITEM 9A. CONTROLS AND PROCEDURESAs required by Rule 13a-15 under the Securities Exchange Act of 1934, we carried out an evaluation under the supervision and with the participation ofour management, including the Chief Executive Officer (principal executive officer) and Senior Vice President, Finance (principal financial officer), of theeffectiveness of the design and operation of our disclosure controls and procedures.There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and thecircumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonableassurance of achieving their control objectives. Based upon our evaluation, our Chief Executive Officer (principal executive officer) and Senior VicePresident, Finance (principal financial officer) concluded that our disclosure controls and procedures were effective to provide reasonable assurance thatinformation required to be disclosed by us in the reports that we file or submit under the Securities69Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the applicable rules and forms, and that it isaccumulated and communicated to our management, including our Chief Executive Officer (principal executive officer) and Senior Vice President, Finance(principal financial officer), as appropriate, to allow timely decisions regarding required disclosure.Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financialreporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements forexternal reporting purposes in accordance with accounting principles generally accepted in the United States of America. Because of its inherent limitations,internal control over financial reporting may not prevent or detect misstatements. Our management has assessed the effectiveness of our internal control overfinancial reporting as of December 31, 2006. In making its assessment, management has utilized the criteria set forth by the Committee of SponsoringOrganizations (COSO) of the Treadway Commission in Internal Control—Integrated Framework. Our management concluded that based on its assessment,our internal control over financial reporting was effective as of December 31, 2006. Our management’s assessment of the effectiveness of our internal controlover financial reporting as of December 31, 2006 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, asstated in their report which appears in this Form 10-K.There has been no change in our internal control over financial reporting during the quarter ended December 31, 2006 that has materially affected, or isreasonably likely to materially affect, our internal control over financial reporting.ITEM 9B. OTHER INFORMATIONNone.PART IIIITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCEExcept as set forth herein, the information required by this Item is incorporated by reference to the Company’s definitive proxy statement for the 2007annual meeting of stockholders.The Company has adopted a Code of Business Conduct and Ethics, which is applicable to all employees of the Company, including the principalexecutive officer, principal financial officer, and principal accounting officer. The Code includes provisions that are specifically applicable to our seniorfinancial officers. We intend to disclose any amendments to these provisions and any waivers from any of these provisions granted to our principal executiveofficer, principal financial officer or principal accounting officer on our Website, www.overstock.com. We will provide a copy of the relevant portion to anyperson without any charge upon request in writing addressed to Overstock.com Attn: Kevin Moon, 6350 South 3000 East, Salt Lake City, UT 84121.ITEM 11. EXECUTIVE COMPENSATIONThe information required by this Item is incorporated by reference to the Company’s definitive proxy statement for the 2007 annual meeting ofstockholders.ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND RELATED STOCKHOLDER MATTERSThe information required by this Item is incorporated by reference to the Company’s definitive proxy statement for the 2007 annual meeting ofstockholders.70ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONSThe information required by this Item is incorporated by reference to the Company’s definitive proxy statement for the 2007 annual meeting ofstockholders.ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICESThe information required by this Item is incorporated by reference to the Company’s definitive proxy statement for the 2007 annual meeting ofstockholders.ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES(a) 1. Financial StatementsINDEX TO CONSOLIDATED FINANCIAL STATEMENTSPageReport of Independent Registered Public Accounting FirmF-2Consolidated Balance SheetsF-4Consolidated Statements of OperationsF-5Consolidated Statement of Stockholders’ Equity and Comprehensive IncomeF-6Consolidated Statements of Cash FlowsF-7Notes to Consolidated Financial StatementsF-8Schedule II Valuation and Qualifying AccountsF-36 2. Financial Statement SchedulesSchedule II Valuation and Qualifying Accounts listed in (a)(1) above is included herein. Schedules other than those listed above have been omitted asthey are either not required, not applicable, or the information has otherwise been shown in the consolidated financial statements or notes thereto.3. ExhibitsThe exhibits listed below are filed as part of, or incorporated by reference into, this Form 10-K.ExhibitNumber Description of Document3.1(a)Amended and Restated Certificate of Incorporation.3.2(a)Amended and Restated Bylaws.4.1(b)Form of specimen common stock certificate.4.2(b)Investor Rights Agreement, dated March 4, 2002.10.1(b)Form of Indemnification Agreement between Overstock.com, Inc. and each of its directors andofficers.10.2(b)Amended and Restated 1999 Stock Option Plan and form of agreements thereunder.10.3(b)2001 Stock Purchase Plan and form of agreements thereunder.10.4(b)Gear.com, Inc. Restated 1998 Stock Option Plan and form of agreements thereunder.10.5Form of agreements under 2002 Stock Option Plan, as amended (incorporated by reference toExhibit 10.5 to our Registration Statement on Form S-1 (File No. 333-83728), which becameeffective on May 29, 2002).71 10.6(b)Agreement and Plan of Merger dated November 3, 2000 by and between Overstock.com, Inc. andGear.com, Inc.10.7Lease Agreement dated January 23, 2002 between Overstock.com, Inc. and Holladay Building EastL.L.C. (incorporated by reference to Exhibit 10.8 to our Registration Statement on Form S-1 (FileNo. 333-83728), which became effective on May 29, 2002).10.8Lease Agreement dated November 27, 2001 between Overstock.com and Holladay Building EastL.L.C. (incorporated by reference to Exhibit 10.9 to our Registration Statement on Form S-1 (FileNo. 333-83728), which became effective on May 29, 2002).10.9First Lease Extension Agreement dated January 25, 2002 by and between Overstock.com, Inc. andHolladay Building East L.L.C (incorporated by reference to Exhibit 10.10 to our RegistrationStatement on Form S-1 (File No. 333-83728), which became effective on May 29, 2002).10.10Lease Agreement by and between Overstock.com, Inc. and Marvin L. Oates Trust dated March 15,2000 (incorporated by reference to Exhibit 10.12 to our Registration Statement on Form S-1 (FileNo. 333-83728), which became effective on May 29, 2002).10.11Severance Package Agreement with Douglas Greene dated June 17, 1999 (incorporated by referenceto Exhibit 10.13 to our Registration Statement on Form S-1 (File No. 333-83728), which becameeffective on May 29, 2002).10.12Intellectual Property Assignment Agreement with Douglas Greene dated February 28, 2002(incorporated by reference to Exhibit 10.14 to our Registration Statement on Form S-1 (File No. 333-83728), which became effective on May 29, 2002).10.13Amendment No. 1, dated April 29, 2002 to Intellectual Property Assignment Agreement datedFebruary 28, 2002 by and between Overstock.com, Inc. and Douglas Greene. (incorporated byreference to Exhibit 10.18 to our Registration Statement on Form S-1 (File No. 333-83728), whichbecame effective on May 29, 2002).10.14Form of Warrant to purchase Overstock.com, Inc. common stock. (incorporated by reference toExhibit 10.20 to our Registration Statement on Form S-1 (File No. 333-83728), which becameeffective on May 29, 2002).10.15Lease Amendment #1 by and between Overstock.com, Inc. and Marvin L. Oates Trust, datedAugust 28, 2000. (incorporated by reference to Exhibit 10.22 to our Registration Statement onForm S-1 (File No. 333-102763), which became effective on February 12, 2003).10.16Commencement of Lease Amendment #1 by and between Overstock.com, Inc. and Marvin L. OatesTrust, dated October 25, 2000 (incorporated by reference to Exhibit 10.23 to our RegistrationStatement on Form S-1 (File No. 333-102763), which became effective on February 12, 2003).10.17Lease Amendment #2 by and between Overstock.com, Inc. and Marvin L. Oates Trust, datedNovember 12, 2001.(incorporated by reference to Exhibit 10.24 to our Registration Statement onForm S-1 (File No. 333-102763), which became effective on February 12, 2003).10.18Lease Amendment #3 by and between Overstock.com, Inc. and Marvin L. Oates Trust, dated July 23,2002.(incorporated by reference to Exhibit 10.25 to our Registration Statement on Form S-1 (FileNo. 333-102763), which became effective on February 12, 2003).10.19Lease Amendment #4 by and between Overstock.com, Inc. and Marvin L. Oates Trust, datedAugust 19, 2002.(incorporated by reference to Exhibit 10.26 to our Registration Statement onForm S-1 (File No. 333-102763), which became effective on February 12, 2003).72 10.20Lease Amendment #5 by and between Overstock.com, Inc. and Marvin L. Oates Trust, datedOctober 11, 2002.(incorporated by reference to Exhibit 10.27 to our Registration Statement onForm S-1 (File No. 333-102763), which became effective on February 12, 2003).10.21Lease Amendment #6 by and between Overstock.com, Inc. and Marvin L. Oates Trust, datedDecember 23, 2002.(incorporated by reference to Exhibit 10.28 to our Registration Statement onForm S-1 (File No. 333-102763), which became effective on February 12, 2003).10.22Old Mill Corporate Center First Amendment to the Lease Agreement by and betweenOverstock.com, Inc. and Holladay Building East L.L.C., dated September 1, 2002.(incorporated byreference to Exhibit 10.29 to our Registration Statement on Form S-1 (File No. 333-102763), whichbecame effective on February 12, 2003).10.23Credit Agreement dated February 13, 2004 between Overstock.com, Inc. and Wells Fargo BankNational Association (incorporated by reference to Exhibit 10.31 to our Annual Report on Form 10-Kfor the year ended December 31, 2003 filed on February 24, 2004).10.24Amendment to Credit Agreement by and between Overstock.com, Inc., and Wells Fargo Bank,National Association dated December 22, 2004. (incorporated by reference to Exhibit 99.1 to ourReport on Form 8-K filed on December 27, 2004).10.25Term sheet executed February 18, 2005 with Lehman Brothers OTC Derivatives Inc.(incorporated byreference to Exhibit 99.1 to our Report on Form 8-K filed on February 24, 2005).10.26Tenant Improvement Agreement by and between Overstock.com, Inc. and old Mill Corporate CenterIII, LLC entered on February 11, 2005 (incorporated by reference to Exhibit 99.1 to our Report onForm 8-K filed on February 11, 2005).10.27Sublease Agreement by and between Overstock.com, Inc., Old Mill Technology Center, LLC, andOld Mill Building LLC. (incorporated by reference to Exhibit 99.1 to our Report on Form 8-K/A filedon December 7, 2004).10.28Sublease Agreement by and between Overstock.com, Inc., Document Controls Systems, Inc., and OldMill Building LLC.(incorporated by reference to Exhibit 99.2 to our Report on Form 8-K/A filed onDecember 7, 2004).10.29Sublease Agreement by and between Overstock.com, Inc., Information TechnologyInternational, Inc., and Old Mill Building LLC. (incorporated by reference to Exhibit 99.3 to ourReport on Form 8-K/A filed on December 7, 2004).10.30Old Mill Corporate Center Fourth Amendment to the Lease Agreement. (incorporated by reference toExhibit 99.4 to our Report on Form 8-K/A filed on December 7, 2004).10.31Co-location Center Agreement. (incorporated by reference to Exhibit 99.5 to our Report on Form 8-K/A filed on December 7, 2004).10.32Indenture, dated November 23, 2004, between Overstock.com, Inc. and Wells Fargo Bank, N.A., astrustee. (incorporated by reference to Exhibit 10.1 to our Report on Form 8-K filed on November 24,2004).10.33Registration Rights Agreement, dated November 23, 2004 by and among Overstock.com, Inc.,Lehman Brothers., Piper Jaffray & Co., Legg Mason Wood Walker Incorporated and WR Hambrecht +Co, LLC (incorporated by reference to Exhibit 10.2 to our Report on Form 8-K filed on November 24,2004).73 10.34Purchase Agreement dated November 17, 2004 with Lehman Brothers Inc. as Representative(incorporated by reference to Exhibit 10.34 to our report on Form 10-K for the year endedDecember 31, 2004 filed on March 16, 2005).10.35Underwriting Agreement dated November 17, 2004 with Lehman Brothers Inc. as Representative(incorporated by reference to Exhibit 1.1 to our Report on Form 8-K filed on November 18, 2004)10.36Underwriting Agreement dated May 13, 2004 with WR Hambrecht & Co., LLC and JMP SecuritiesLLC. as Representatives (incorporated by reference to Exhibit 1.1 to our Report on Form 8-K filed onMay 14, 200410.372002 Stock Option Plan, as amended (incorporated by reference to Exhibit 99.6 to our Report onForm 8-K filed May 7, 2004)10.38(c)Summary of Compensation Arrangements Applicable to Named Executive Officers.10.39(c)Summary of Compensation Arrangements Applicable to Non-employee Directors.10.402005 Equity Incentive Plan (incorporated by reference to Appendix B to Overstock.com, Inc.’sdefinitive proxy statement filed with the SEC on March 29, 2005.10.41Term sheet executed March 14, 2005 with IXIS Derivatives Inc. (incorporated by reference toExhibit 99.1 to our Report on Form 8-K filed on March 16, 2005)10.42Stock Purchase Agreement dated June 24, 2005 with Ski West, Inc. and its shareholders (incorporatedby reference to Exhibit 99.1 to our Form 8-K filed on June 24, 2005)10.43Letter of Intent dated June 20, 2005 with Ski West, Inc. and certain of its shareholders (incorporatedby reference to Exhibit 99.2 to our Form 8-K filed on June 24, 2005)10.44Fifth Amendment dated June 21, 2005 to Credit Agreement with Wells Fargo Bank, NationalAssociation (incorporated by reference to Exhibit 99.1 to our Form 8-K filed on June 27, 2005)10.45First Modification dated June 21, 2005 to Promissory Note payable to Wells Fargo Bank, NationalAssociation (incorporated by reference to Exhibit 99.2 to our Form 8-K filed on June 27, 2005)10.46Colocation Center Agreement dated July 1, 2005 between OMTek, LLC and Overstock.com, Inc.(incorporated by reference to Exhibit 99.1 to our Form 8-K filed on July 7, 2005)10.47Sixth Amendment dated October 18, 2005 to Credit Agreement with Wells Fargo Bank, NationalAssociation (incorporated by reference to Exhibit 10.1 to our Form 8-K filed on October 21, 2005)10.48Second Modification dated October 18, 2005 to Promissory Note payable to Wells Fargo Bank,National Association (incorporated by reference to Exhibit 10.2 to our Form 8-K filed on October 21,2005)10.48Seventh Amendment dated December 31, 2005 to Credit Agreement with Wells Fargo Bank, NationalAssociation (incorporated by reference to Exhibit 10.1 to our Form 8-K filed on January 6, 2006)10.49Revolving Line of Credit Note dated January 1, 2006 payable to Wells Fargo Bank, NationalAssociation (incorporated by reference to Exhibit 10.2 to our Form 8-K filed on January 1, 2006)10.50Loan and Security Agreement dated as of December 12, 2005 with Wells Fargo Retail Finance, LLC(incorporated by reference to Exhibit 10.1 to our Form 8-K filed on December 12, 2005)74 10.51Revolving Credit Note dated as of December 12, 2005 relating to Loan and Security Agreementdated as of December 12, 2005 payable to Wells Fargo Retail Finance, LLC (incorporated byreference to Exhibit 10.2 to our Form 8-K filed on December 12, 2005)10.52Performance Share Plan adopted by the Compensation Committee and Board of Directors ofOverstock.com, Inc. on January 23, 2006 (incorporated by reference to Exhibit 10.1 to our Form 8-Kfiled on January 23, 2006)10.53Form of Grant relating to Performance Share Plan adopted by the Compensation Committee andBoard of Directors of Overstock.com, Inc. on January 23, 2006 (incorporated by reference toExhibit 10.2 to our Form 8-K filed on January 23, 2006)10.542006 Bonus Plan adopted by the Compensation Committee of the Board of Directors ofOverstock.com, Inc. on January 23, 2006 (incorporated by reference to Exhibit 10.3 to our Form 8-K/A filed on January 31, 2006)10.55Amendment No. 1 dated March 1, 2006 to Stock Purchase Agreement with Ski West, Inc. and itsshareholders (incorporated by reference to Exhibit 10.1 to our Form 8-K filed on March 6, 2006)10.56Letter of Agreement dated June 30, 2006 to Stock Purchase Agreement with Ski West, Inc. and itsshareholders (incorporated by reference to Exhibit 10.1 to our Form 8-K filed on July 5, 2006)10.57Colocation Center Termination Agreement executed February 1, 2007 and effective December 29,2006 (incorporated by reference to Exhibit 10.1 to our Form 8-K filed on February 5, 2007)21Subsidiaries of the Registrant23.1Consent of Independent Registered Public Accounting Firm24.1Power of Attorney (see signature page)31.1Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer31.2Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer32.1Section 1350 Certification of Chief Executive Officer32.2Section 1350 Certification of Chief Financial Officer(a) Incorporated by reference to exhibits of the same number filed with our Form 10-Q (File No. 000-49799), filed on August 13, 2002.(b) Incorporated by reference to exhibits of the same number filed with our Registration Statement on Form S-1 (File No. 333-83728), which becameeffective on May 29, 2002.(c) Management contract or compensatory plan or arrangement.75SIGNATURESPursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, the registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized, on March 14, 2007.OVERSTOCK.COM, INC.By:/s/ PATRICK M. BYRNEPatrick M. ByrneChief Executive Officer POWER OF ATTORNEYKNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints each of Patrick M. Byrne,Jonathan E. Johnson III and David K. Chidester, his or her attorneys-in-fact, each with the power of substitution, for him or her in any and all capacities, tosign any amendments to this Annual Report on Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith, with theSecurities and Exchange Commission, hereby ratifying and conforming all that said attorney-in-fact, or his or their substitute or substitutes, may do or causeto be done by virtue hereof.Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of theregistrant and in the capacities and on the dates indicated.Signature TitleDate /s/ PATRICK M. BYRNEChief Executive Officer (Principal ExecutiveMarch 14, 2007Patrick M. ByrneOfficer), Chairman of the Board/s/ DAVID K. CHIDESTERSenior Vice President, Finance (PrincipalMarch 14, 2007David K. ChidesterFinancial Officer and Principal Accounting Officer)/s/ JASON C. LINDSEYDirector, President & COOMarch 14, 2007Jason C. Lindsey/s/ ALLISON H. ABRAHAMDirectorMarch 14, 2007Allison H. Abraham/s/ RAY GROVESDirectorMarch 14, 2007Ray Groves 76INDEX TO CONSOLIDATED FINANCIAL STATEMENTSReport of Independent Registered Public Accounting FirmF-2Consolidated Balance SheetsF-4Consolidated Statements of OperationsF-5Consolidated Statement of Stockholders’ Equity and Comprehensive IncomeF-6Consolidated Statements of Cash FlowsF-7Notes to Consolidated Financial StatementsF-8Schedule II Valuation and Qualifying AccountsF-36 F-1Report of Independent Registered Public Accounting FirmTo the Board of Directors and Stockholders of Overstock.com, Inc.:We have completed integrated audits of Overstock.com, Inc.’s consolidated financial statements and of its internal control over financial reporting as ofDecember 31, 2006, in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits,are presented below.Consolidated financial statements and financial statement scheduleIn our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position ofOverstock.com, Inc. and its subsidiaries at December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the three years inthe period ended December 31, 2006 in conformity with accounting principles generally accepted in the United States of America. In addition, in ouropinion, the financial statement schedule listed in the accompanying indexpresents fairly, in all material respects, the information set forth therein when readin conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of theCompany’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. Weconducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessingthe accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe thatour audits provide a reasonable basis for our opinion.As discussed in Note 2 to the consolidated financial statements, the Company changed the manner in which it accounts for stock-based compensation in2006.Internal control over financial reportingAlso, in our opinion, management’s assessment, included in Management’s Report on Internal Control Over Financial Reporting appearing under Item9A, that the Company maintained effective internal control over financial reporting as of December 31, 2006 based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects,based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as ofDecember 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by the COSO. The Company’s management isresponsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financialreporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Company’s internal control over financialreporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whethereffective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includesobtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design andoperating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our auditprovides a reasonable basis for our opinions.F-2 A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financialreporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’sinternal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail,accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded asnecessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of thecompany are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assuranceregarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on thefinancial statements.Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluationof effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree ofcompliance with the policies or procedures may deteriorate./s/ PRICEWATERHOUSECOOPERS LLPSalt Lake City, UtahMarch 12, 2007 F-3Overstock.com, Inc.Consolidated Balance Sheets(in thousands)December 31,20052006AssetsCurrent assets:Cash and cash equivalents$55,875$126,965Marketable securities55,799—Cash, cash equivalents and marketable securities111,674126,965Accounts receivable, net10,02111,638Note receivable (Note 26)—6,702Inventories, net93,26920,274Prepaid inventory9,6332,241Prepaid expense8,4777,473Current assets of held for sale subsidiary2,0544,718Total current assets235,128180,011Restricted cash253—Property and equipment, net60,85056,198Goodwill2,7842,784Other long-term assets, net3,333578Long-term assets of held for sale subsidiary23,56516,594Total assets$325,913$265,165Liabilities, Redeemable Securities and Stockholders’ EquityCurrent liabilities:Accounts payable$100,188$66,039Accrued liabilities45,93440,142Capital lease obligations, current6,6835,074Current liabilities of held for sale subsidiary2,1613,684Total current liabilities154,966114,939Capital lease obligations, non-current3,0583,983Convertible senior notes74,93575,279Total liabilities232,959194,201Commitments and contingencies (Notes 12, 13 and 14)Redeemable common stock, $0.0001 par value, 446 shares outstanding as ofDecember 31, 2005. No shares outstanding as of December 31, 2006.3,205—Stockholders’ equity:Preferred stock, $0.0001 par value, 5,000 shares authorized, no shares issued andoutstanding as of December 31, 2005 and 2006——Common stock, $0.0001 par value, 100,000 shares authorized, 20,571 and 25,069shares issued as of December 31, 2005 and 2006, respectively22Additional paid-in capital250,939325,771Accumulated deficit(96,829)(198,694)Treasury stock, 1,687 and 1,654 shares at cost as of December 31, 2005 and 2006,respectively(65,325)(64,983)Accumulated other comprehensive income (loss)962(132)Total stockholders’ equity89,74961,964Total liabilities, redeemable securities and stockholders’ equity$325,913$265,165 The accompanying notes are an integral part of these consolidated financial statements.F-4Overstock.com, Inc.Consolidated Statements of Operations(in thousands, except per share data) Year ended December 31, 200420052006RevenueDirect revenue$213,210$324,875$303,202Fulfillment partner revenue281,425474,441484,948Total revenue494,635799,316788,150Cost of goods soldDirect(1)184,964282,383284,943Fulfillment partner243,468400,057408,407Total cost of goods sold428,432682,440693,350Gross profit66,203116,87694,800Operating expenses:Sales and marketing(1)40,55977,15570,897Technology(1)8,50927,90165,158General and administrative(1)22,02433,04346,837Restructuring——5,674Total operating expenses71,092138,099188,566Operating loss(4,889)(21,223)(93,766)Interest income, net1,173(270)3,566Interest expense(775)(5,582)(4,765)Other (expense) income, net(49)4,72881Loss from continuing operations(4,540)(22,347)(94,884)Discontinued operations (Note 5):Loss from discontinued operations—(2,571)(6,882)Net loss(4,540)(24,918)(101,766)Deemed dividend related to redeemable common stock(188)(185)(99)Net loss attributable to common shares$(4,728)$(25,103)$(101,865)Net loss per common share—basic and diluted:Loss from continuing operations$(0.26)$(1.16)$(4.67)Loss from discontinued operations$—$(0.13)$(0.34)Net loss per common share—basic and diluted$(0.26)$(1.29)$(5.01)Weighted average common shares outstanding—basic and diluted17,84619,42920,332 (1) Includes stock-based compensation from employee options as follows:Cost of goods sold—direct$36$6$412Sales and marketing264301Technology6011684General and administrative238512,723 The accompanying notes are an integral part of these consolidated financial statements.F-5Overstock.com, Inc.Consolidated Statements of Stockholders’ Equityand Comprehensive Income(in thousands) Common stock AdditionalPaid-in Accumulated Treasury stock AccumulatedOtherComprehensiveIncome Shares Amount capital Deficit Shares Amount (Loss) TotalBalance at December 31, 200316,060$2$122,840$(66,998)(35)$(100)$(13)$55,731Exercise of stock options and warrants650—4,288————4,288Issuance of common stock in follow-on offerings2,680—113,064————113,064Amortization of stock-based compensation——360————360Stock-based compensation to consultants in exchange for services——1,278————1,278Deemed dividend related to redeemable commonstock———(188)———(188)Comprehensive income (loss):Net loss———(4,540)———(4,540)Net unrealized loss on marketable securities——————(204)(204)Cumulative translation adjustment——————2222Total comprehensive loss(4,722)Balance at December 31, 200419,3902241,830(71,726)(35)(100)(195)169,811Exercise of stock options and warrants1,167—7,315————7,315Treasury stock issued to employees as compensation——414—1029—443Purchase of treasury stock————(665)(24,133)—(24,133)Purchased call options for purchase of treasury stock——(47,507)————(47,507)Settlement of purchased call options in exchange for cash——7,937————7,937Settlement of purchased call options in exchange for treasury stock——41,121—(997)(41,121)——Amortization of stock-based compensation——72————72Stock-based compensation to consultants in exchange for services——(389)————(389)Deemed dividend related to redeemable commonstock———(185)———(185)Lapse of rescission rights on redeemable commonstock14—146————146Comprehensive income (loss):Net loss———(24,918)———(24,918)Net unrealized loss on marketable securities——————(54)(54)Unrealized gain on foreign notes——————1,1251,125Cumulative translation adjustment——————8686Total comprehensive loss(23,761)Balance at December 31, 200520,5712250,939(96,829)(1,687)(65,325)96289,749Issuance of common stock in offerings3,776—64,406————64,406Exercise of stock options276—2,534————2,534Treasury stock issued to employees as compensation——445—33342—787Stock-based compensation from employee options——4,120————4,120Stock-based compensation to consultants in exchange for services——23————23Deemed dividend related to redeemable commonstock———(99)———(99)Lapse of rescission rights on redeemable commonstock446—3,304————3,304Comprehensive income (loss):Net loss———(101,766)———(101,766)Unrealized (loss) on marketable securities——————(1,128)(1,128)Cumulative translation adjustment——————3434Total comprehensive loss(102,860)Balance at December 31, 200625,069$2$325,771$(198,694)(1,654)$(64,983)$(132)$61,964 The accompanying notes are an integral part of these consolidated financial statements.F-6Overstock.com, Inc.Consolidated Statements of Cash Flows(in thousands)Year ended December 31,200420052006Cash flows from operating activities of continuing operations:Net loss$(4,540)$(24,918)$(101,766)Adjustments to reconcile net loss to net cash provided by (used in) operating activities of continuing operations:Loss from discontinued operations—2,5716,882Depreciation and amortization3,93714,11132,327Realized loss (gain) on marketable securities(2)3,351(2,085)Loss on disposition of property and equipment341,457599Stock-based compensation360724,120Stock-based compensation to consultants for services1,278(389)23Issuance of common stock from treasury—443787Amortization of debt discount and deferred financing fees147620417Gain from retirement of convertible senior notes—(6,158)—Changes in operating assets and liabilities, net of effect of acquisition and discontinued operations:Accounts receivable, net4,468(4,306)(2,052)Inventories, net(15,815)(46,711)67,009Prepaid inventory(9,376)2,6897,388Prepaid expenses(1,807)(5,022)1,004Other long-term assets(944)(2,151)496Accounts payable33,69735,210(35,200)Accrued liabilities13,60123,068(6,242)Net cash provided by (used in) operating activities of continuing operations25,038(6,063)(26,293)Cash flows from investing activities of continuing operations:Change in restricted cash(1,602)1,349253Purchases of marketable securities(92,877)(185,543)—Sales of marketable securities15,373216,26556,756Expenditures for property and equipment(8,734)(44,642)(23,441)Acquisition of Ski West—(25,111)—Proceeds from the sale of property and equipment20—1Other investments——(100)Decrease in cash resulting from de-consolidation of variable interest entity——(102)Net cash (used in) provided by investing activities of continuing operations(87,820)(37,682)33,367Cash flows from financing activities of continuing operatons:Payments on capital lease obligations(658)(7,086)(2,957)Drawdown on line of credit1,00011,86886,681Payments on line of credit(1,000)(11,868)(86,681)Payments of deferred financing fees(301)——Proceeds from the issuance of convertible senior notes116,199——Payments to retire convertible senior notes—(35,670)—Issuance of common stock in offerings, net of issuance costs113,064—64,406Purchase of treasury stock—(24,133)—Purchased call options for purchase of treasury stock—(47,507)—Settlement of call options for cash—7,937—Exercise of stock options and warrants4,2887,3152,534Net cash provided by (used in) financing activities of continuing operations232,592(99,144)63,983Effect of exchange rate changes on cash228634Cash (used in) provided by operating activies of discontinued operations—(45)1,581Cash (used in) provided by investing activities of discontinued operations—(98)(566)Net increase (decrease) in cash and cash equivalents169,832(142,946)72,106Less change in cash and cash equivalents from discontinued operations—143(1,016)Cash and cash equivalents, beginning of year28,846198,67855,875Cash and cash equivalents from continuing operations, end of year$198,678$55,875$126,965Supplemental disclosures of cash flow information:Interest paid$165$5,108$3,677Equipment and software acquired under capital leases1,83515,4382,273Asset retirement obligation——450Deemed dividend on redeemable common stock18818599Lapse of rescission rights on redeemable common stock—1463,304Settlement of purchased call options for treasury stock—41,121—Promissory note received in exchange for deconsolidation of variable interest entity——6,702Supplemental disclosure on non-cash investing activities:Fair value of assets acquired—26,447—Fair value of liabilities assumed—(1,336)—Cash paid to purchase business$—$25,111$— The accompanying notes are an integral part of these consolidated financial statements.F-7Overstock.com, Inc.Notes to Consolidated Financial Statements1. BUSINESS AND ORGANIZATIONOverstock.com, Inc. (the “Company”) is an online “closeout” retailer offering discount, brand-name merchandise for sale primarily over the Internet. TheCompany’s merchandise offerings include bed-and-bath goods, home décor, kitchenware, watches, jewelry, electronics and computers, sporting goods,apparel, designer accessories and travel services, among other products. The Company also sells books, magazines, CDs, DVDs, videocassettes and videogames (“BMMG”). The Company’s online auction site was launched in September 2004 as part of the Company’s Website—which acts as an onlinemarketplace for the buying and selling of goods and services.The Company was formed on May 5, 1997 as D2—Discounts Direct, a limited liability company. On December 30, 1998, the Company was reorganizedas a C Corporation in the State of Utah and reincorporated in Delaware in May 2002. On October 25, 1999, the Company changed its name toOverstock.com, Inc. On November 20, 2000, the Company acquired Gear.com, Inc. On July 23, 2003, the Company formed Overstock Mexico, S. de R. L. deC.V., a wholly owned subsidiary, to distribute products in Mexico. On July 1, 2005, the Company acquired SkiWest, Inc. (“SkiWest”) and integrated theSkiWest travel offerings with the Company’s existing travel offerings.2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIESPrinciples of consolidationThe accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. The consolidatedfinancial statements also include the accounts of a variable interest entity for which the Company was the primary beneficiary through November 30, 2006(Note 26). All significant intercompany account balances and transactions have been eliminated in consolidation.Use of estimatesThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statementsand the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.Fair value of financial instrumentsThe Company’s financial instruments, including cash, cash equivalents, accounts receivable, accounts payable and accrued liabilities are carried at cost,which approximates their fair value because of the short-term maturity of these instruments. The estimated fair value of the Company’s 3.75% ConvertibleSenior Notes at December 31, 2005 and 2006 was $54.7 million and $56.3 million, respectively.Marketable securities consist of funds deposited into capital management accounts managed by two financial institutions. The Company generallyinvests excess cash in “A” rated or higher short- to intermediate-term fixed income securities and money market mutual funds. The financial institutions haveinvested these funds in municipal, government and corporate bonds and money market securities which are classified as cash or cash equilvalents, oravailable-for-sale marketable securities on the consolidated balance sheets and are reported at fair value using the specific identification method. Realizedgains and losses are included in other income (expense), net in the Consolidated Statements of Operations.F-8Unrealized gains and losses are excluded from earnings and reported as a component of other comprehensive income (loss), net of related estimated taxprovisions or benefits.The Company periodically evaluates whether declines in fair values of its investments are other-than-temporary. This evaluation consists of a review ofqualitative and quantitative factors, including quoted market prices, if available, other publicly available information, or other conditions that bear on thevalue of our investments. At December 31, 2005 and 2006, gross unrealized losses on marketable securities were $54,000 and zero, respectively, and weredetermined to be temporary based on the Company’s assessment of the qualitative and quantitative factors discussed above.Accounts receivableAccounts receivable consist of trade amounts due from customers and from uncleared credit card transactions at period end. Accounts receivable arerecorded at invoiced amounts and do not bear interest. The Company evaluates its allowance for doubtful accounts monthly. Account balances are written-offagainst the allowance when it is probable that the receivable will not be recovered. The Company recorded an allowance for doubtful accounts of $1.8million and $2.1 million at December 31, 2005 and 2006, respectively.Concentration of credit riskCash equivalents include short-term, highly liquid instruments with original maturities of 90 days or less. At December 31, 2005 and 2006, two banksheld the Company’s cash and cash equivalents. The Company does not believe that, as a result of this concentration, it is subject to any unusual financial riskbeyond the normal risk associated with commercial banking relationships.Financial instruments that potentially subject the Company to significant concentrations of credit risk consist primarily of cash equivalents, investmentsecurities, and receivables. The Company invests its cash primarily in money market, government and corporate securities which are uninsured.The Company’s accounts receivable are derived primarily from revenue earned from customers located in the United States. The Company maintains anallowance for doubtful accounts based upon the expected collectibility of accounts receivable.InventoriesInventories, consisting of merchandise purchased for resale, are accounted for using a standard costing system which approximates the first-in-first-out(“FIFO”) method of accounting, and are valued at the lower of cost or market value. The Company establishes reserves for estimated obsolescence or damageequal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions.Once established, the original cost of the inventory less the related reserve represents the new cost basis of such products. Reversal of these reserves isrecognized only when the related inventory has been sold or scrapped.Until the time of shipping, inventory ownership related to product sales by third parties through the Company’s website is maintained by the thirdparties.Prepaid inventoryPrepaid inventory represents inventory paid for in advance of receipt. Prepaid inventory at December 31, 2005 and 2006 was $9.6 million and $2.2million, respectively.F-9Prepaid expensesPrepaid expenses represent expenses paid prior to receipt of the related goods or services, including advertising, maintenance, packaging, insurance andother miscellaneous costs. Total prepaid expenses at December 31, 2005 and 2006 were $8.5 million and $7.5 million, respectively.Property and equipmentProperty and equipment, which includes capitalized leases, are recorded at cost and depreciated using the straight-line method over the estimated usefullives of the related assets or the term of the related lease, whichever is shorter, as follows:YearsComputer software3Computer hardware3Furniture and equipment3-5 Leasehold improvements are amortized over the shorter of the term of the related leases or estimated service lives. Upon sale or retirement of assets, costand related accumulated depreciation are removed from the balance sheet and the resulting gain or loss is reflected in the consolidated statement ofoperations.Internal-Use Software and Website DevelopmentIncluded in fixed assets is the capitalized cost of internal-use software and website development, including software used to upgrade and enhancewebsites and processes supporting the business of the Company. As required by Statement of Position 98-1, Accounting for the Costs of Computer SoftwareDeveloped or Obtained for Internal Use, the Company capitalizes costs incurred during the application development stage of internal-use software andamortizes these costs over the estimated useful life of three years. Costs incurred related to design or maintenance of internal-use software are expensed asincurred.During the years ended December 31, 2005 and 2006, the Company capitalized $24.4 million and $15.0 million, respectively, of costs associated withinternal-use software and website development, which are partially offset by amortization of previously capitalized amounts of $3.9 million and $14.6million for those respective periods.Asset Retirement ObligationIn accordance with the Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standard (“SFAS”) No. 143, Accounting forAsset Retirement Obligations, the Company establishes assets and liabilities for the present value of estimated future costs to return certain of our leasedfacilities to their original condition. Such assets are depreciated over the lease period into operating expense, and the recorded liabilities are accreted to thefuture value of the estimated restoration costs (see Note 9).Other long-term assetsOther long-term assets include deposits, intangibles, deferred financing and issuance costs and the fees associated with the acquisition of Overstock.comand other related domain names. The cost of the domain names is being amortized using the straight-line method over 5 years.F-10Impairment of long-lived assetsThe Company reviews property and equipment and other long-lived assets for impairment whenever events or changes in circumstances indicate that thecarrying amount of an asset may not be recoverable. Recoverability is measured by comparison of the assets’ carrying amount to future undiscounted net cashflows the assets are 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 assets are considered to be impaired, the impairment to berecognized is measured by the amount by which the carrying amount of the assets exceeds the projected discounted future cash flows arising from the assetsor their fair values, whichever is more determinable. The Company did not record any impairment of long-lived assets during 2004, 2005 and 2006.GoodwillGoodwill represents the excess of the purchase price paid over the fair value of the tangible net assets acquired in business combinations.In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and Other Intangible Assets, goodwill is not amortizedbut tested for impairment at least annually. When evaluating whether goodwill is impaired, the Company compares the fair value of the reporting unit towhich 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 is calculated by comparing the implied fair value of the goodwill to its carrying amount. In calculating the implied fair value ofgoodwill, the fair value of the reporting unit is allocated to all the other assets and liabilities within the reporting unit based on fair value. The excess of thefair 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 isrecognized when the carrying amount of goodwill exceeds its implied fair value. The Company evaluated its goodwill during 2004 and 2005, anddetermined that no impairment charge should be recorded.In conjunction with the discontinuance of the Company’s travel subsidiary (“OTravel”), the Company performed an evaluation of the goodwillassociated with the reporting unit pursuant to SFAS 142, and SFAS 144, Accounting for the Impairment of Long-Lived Assets and determined that goodwill ofapproximately $4.5 million was impaired in 2006 (see Note 5).Revenue recognitionThe Company derives its revenue primarily from two sources: direct revenue and fulfillment partner revenue, including listing fees and commissionscollected from products being listed and sold through the Auctions tab of its Website as well as advertisement revenue derived from its cars listing business.Both direct revenue and fulfillment partner revenue are recorded net of returns, coupons redeemed by customers, and other discounts. Revenue is recognizedwhen the following revenue recognition criteria are met: (1) persuasive evidence of an arrangement exists; (2) the product has been shipped and the customertakes ownership and assumes the risk of loss or the service has been provided; (3) the selling price or fee revenue earned is fixed or determinable; and(4) collection of the resulting receivable is reasonably assured. The Company generally requires payment by credit card at the point of sale. Amountsreceived prior to shipment of products or service is recorded as deferred revenue. In addition, amounts received in advance for Club O membership fees arerecorded as deferred revenue and recognized ratably over the membership period. The Company maintains a reserve for returns based on estimates of futureproduct returns related to current period revenues.F-11Direct revenueDirect revenue consists of merchandise sales made to individual consumers and businesses that are fulfilled from the Company’s leased warehouses.The Company generally requires payment by credit card at the point of sale. From time to time, the Company grants credit to its business customers onnormal credit terms. Amounts received prior to shipment of goods to customers are recorded as deferred revenue. Direct revenue is recorded net ofestimated returns, chargebacks and coupons redeemed by customers and other discounts to obtain such sales.Fulfillment partner revenueFulfillment partner revenue consists of merchandise sold through the Company’s Website and shipped by third parties directly to consumers andother businesses, and is recognized when services have been rendered (generally when verification of the shipment of the product is communicated tothe Company from the third party that shipped the product).During September 2004, the Company added an online auction service to its Website. The Auctions tab allows sellers to list items for sale, buyers tobid on items of interest, and users to browse through listed items online. The Company is not considered the seller of the items sold on the auction siteand has no control over the pricing of those items. Therefore, for these sales, only the listing fees for items listed and commissions for items sold arerecorded as revenue during the period items are listed or items are sold. Our auction business revenues were insignificant in 2004, 2005 and 2006.Revenue from the auctions business has been included in the fulfillment partner segment, as it is not large enough to separate out as its own segment atthis early stage of the business.During December 2006, the Company added an online site for listing cars for sale as a part of its Website. The cars listing service allows sellers tolist vehicles for sale and allows buyers to review vehicle descriptions, post offers to purchase, and provides the means for purchasers to contact sellers forfurther information and negotiations on the purchase of an advertised vehicle. Revenue from its cars listing business is included in the fulfillmentpartner segment, as it is not significant enough to separate out as its own segment.Fulfillment partner revenue is reduced by the impact of estimated returns, chargebacks and coupons redeemed by customers and other discounts toobtain such sales.Total revenue is recorded net of estimated returns, coupons and other discounts. The returns policy for all products other than those sold in theElectronics and Computers department provides for a $4.95 restocking fee and the provision that the Company will not accept product returns initiatedmore than thirty days after the shipment date. There is a 15% restocking fee (instead of the $4.95 restocking fee) on all items returned for non-defectivereasons from the Electronics and Computers department.Cost of goods soldCost of goods sold include product costs, warehousing costs, inbound and outbound shipping costs, handling and fulfillment costs, customer servicecosts and credit card fees, and are recorded in the same period in which related revenues have been recorded. Fulfillment costs include warehouse handlinglabor costs, fixed warehouse costs, credit card fees and customer service costs. For the years ended December 31, 2004, 2005 and 2006, fulfillment coststotaled $34.3 million, $59.9 million and $60.9 million, respectively.Advertising expenseThe Company recognizes advertising expenses in accordance with SOP 93-7, Reporting on Advertising Costs. As such, the Company expenses the costsof producing advertisements at the time production occursF-12or the first time the advertising takes place, and expenses the cost of communicating advertising in the period during which the advertising space or airtime isused. Internet advertising expenses are recognized as incurred based on the terms of the individual agreements, which are generally: 1) during the periodcustomers are acquired; or 2) based on the number of clicks generated during a given period over the term of the contract. Advertising expense included insales and marketing expenses totaled $39.2 million, $75.3 million and $68.1 million during the years ended December 31, 2004, 2005 and 2006,respectively.Stock-based CompensationAs of January 1, 2006, we adopted SFAS 123(R), Share-based Payment—an Amendment of FASB Statements No 123 and 95, which requires theCompany to measure compensation expense for all outstanding unvested share-based awards at fair value and recognize compensation expense over theservice period for awards expected to vest. The estimation of stock awards that will ultimately vest requires judgment, and to the extent actual results differfrom estimates, such amounts will be recorded as an adjustment in the period estimates are revised. Management considers many factors when estimatingexpected forfeitures, including types of awards, employee class, and historical experience. Actual results may differ substantially from these estimates (seeNote 18).RestructuringRestructuring expenses are primarily comprised of lease termination costs and the costs incurred for returning leased facilities back to their originalcondition, including the removal of an escalator system, in anticipation of subleasing current office space. SFAS 146, Accounting for Costs Associated withExit or Disposal Activities, requires that when an entity ceases using a property that is leased under an operating lease before the end of its term contract, thetermination costs should be recognized and measured at fair value when the entity ceases using the facility. Key assumptions in determining the restructuringexpenses include the terms that may be negotiated to exit certain contractual obligations (See Note 4).Income taxesIncome taxes are accounted for under the asset and liability method. Deferred income tax assets and liabilities are recognized for the future taxconsequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basisusing enacted tax rates in effect for the year in which the differences are expected to affect taxable income. Income tax expense (benefit) is the tax payable(receivable) for the period and the change during the period in the deferred tax assets and liabilities.SFAS 109, Accounting for Income Taxes, requires that deferred tax assets be evaluated for future realization and be reduced by a valuation allowance tothe extent the deferred tax asset will not be realized. The Company considers many factors when assessing the likelihood of future realization of our deferredassets including expectations of future taxable income, the carry-forward periods available for tax reporting purposes, and other relevant factors. AtDecember 31, 2005 and 2006, the Company has established a full valuation allowance against it deferred tax assets. Significant judgement is required inmaking this assessment, and it is very difficult to predict when, if ever, our assessment may conclude that the remaining portion of the deferred tax assets arerealizable.Foreign currency translationFor the Company’s subsidiary located in Mexico, the subsidiary’s local currency is considered its functional currency. As a result, all of the subsidiary’sassets and liabilities are translated into U.S. dollars at exchange rates existing at the balance sheet dates, revenue and expenses are translated at weightedaverage exchange rates, and stockholders’ equity is recorded at historical exchange rates. The resultingF-13foreign currency translation adjustments are recorded as a separate component of stockholders’ equity in the consolidated balance sheets as part ofaccumulated other comprehensive income (loss). Transaction gains and losses are included in other income (expense) in the consolidated financialstatements and have not been significant for any periods presented.Derivative instrumentsSFAS No. 133, Accounting for Derivative Instruments and Hedging Activities requires companies to recognize their derivative instruments, includingcertain derivative instruments embedded in other contracts, as either assets or liabilities in the balance sheet at fair value. The accounting for changes in thefair value of a derivative instrument depends on whether the instrument has been designated and qualifies as part of a hedging relationship and further, on thetype of hedging relationship. For those derivative instruments that are designated and qualify as hedging instruments, a company must designate the hedginginstrument, based upon the exposure being hedged, as a fair value hedge, a cash flow hedge or a hedge of a net investment in an international operation. Forderivatives designated as hedges, the changes in fair value are recorded in the balance sheet as an item in other comprehensive income. Changes in the fairvalue of derivatives not designated as hedges are recorded in the statement of operations. As of December 31, 2005 and 2006, the Company had notdesignated any derivative instruments as hedges.Earnings (loss) per shareIn accordance with SFAS 128, Earnings per share, basic earnings (loss) per share is computed by dividing net income (loss) attributable to commonshares by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per share is computed by dividing netincome (loss) attributable to common shares for the period by the weighted average number of common and potential common shares outstanding during theperiod. Potential common shares, composed of incremental common shares issuable upon the exercise of stock options, warrants and convertible senior notes,are included in the calculation of diluted net loss per share to the extent such shares are dilutive.The following table sets forth the computation of basic and diluted earnings (loss) per share for the periods indicated (in thousands):Year ended December 31,200420052006Loss from continuing operations$(4,540)$(22,347)$(94,884)Deemed dividend related to redeemable common stock(188)(185)(99)Loss from continuing operations attributable to common shares(4,728)(22,532)(94,983)Loss from discontinued operations—(2,571)(6,882)Net loss attributable to common shares$(4,728)$(25,103)$(101,865)Weighted average common shares outstanding—basic17,84619,42920,332Effective of dilutive securities:Stock options and warrants———Convertible senior notes———Weighted average common shares outstanding—diluted17,84619,42920,332Net loss per common share—basic and diluted:Loss from continuing operations$(0.26)$(1.16)$(4.67)Loss from discontinued operations$—$(0.13)$(0.34)Net loss per common share—basic and diluted$(0.26)$(1.29)$(5.01) F-14The stock options, warrants and convertible senior notes outstanding were not included in the computation of diluted earnings per share because to doso would have been antidilutive. The number of shares of stock options outstanding at each year-end was 2.4 million shares, 1.3 million shares and1.0 million shares for 2004, 2005 and 2006, respectively. As of December 31, 2006, the Company had $77.0 million of convertible senior notes outstanding(see Note 13), which could potentially convert into 1.0 million shares of common stock in the aggregate.Recently issued accounting pronouncementsIn March 2006, the Emerging Issue Task Force reached a consensus on Issue No. 06-03, How Taxes Collected from Customers and Remitted toGovernment Authorities Should be Presented in the Income Statement (That Is, Gross versus Net Presentation), (EITF No. 06-03). The Company is required toadopt the provisions of EITF No. 06-03 beginning its fiscal year 2007. The Company does not expect the provisions of EITF No. 06-03 to have a materialimpact on its consolidated financial position, results of operations or cash flows.In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes - an Interpretation of FASB Statement No. 109,(FIN 48). FIN 48 prescribes a comprehensive model for how a company should recognize, measure, present, and disclose in its financial statements uncertaintax positions that it has taken or expects to take on a tax return. FIN 48 is effective for us on January 1, 2007. The Company does not expect the provisions ofFIN 48 to have a material impact on its consolidated financial position, results of operations or cash flows.In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108 (SAB 108). SAB 108 was issued to provideinterpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current yearmisstatement. The provisions of SAB 108 are effective for the Company for the December 31, 2006 year-end. The adoption of SAB 108 did not impact theCompany’s consolidated financial position, results of operations or cash flows.In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, (SFAS 157). SFAS 157 defines fair value, establishes a framework formeasuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. The provisions of this standardapply to other accounting pronouncements that require or permit fair value measurements. SFAS 157 becomes effective for the Company on January 1, 2008.Upon adoption, the provisions of SFAS 157 are to be applied prospectively with limited exceptions. The Company does not expect the provisions of SFAS157 to have a material impact on its consolidated financial position, results of operations or cash flows.ReclassificationCertain balances of the prior years have been reclassified to conform to the current year’s presentation. These reclassifications had no effect on net loss ortotal assets.3. STOCK OFFERINGSIn June 2004, the Company closed its second follow-on public offering, pursuant to which it sold 1.3 million shares of common stock, with proceeds tothe Company of approximately $37.9 million, net of $405,000 of issuance costs.In November 2004, the Company closed another follow-on public offering, pursuant to which it sold 1.4 million shares of common stock, with proceedsto the Company of approximately $75.2 million, net of $215,000 of issuance costs. Concurrently in November 2004, the Company issued convertible seniornotesF-15pursuant to which it received $116.2 million, net of $3.8 million of initial purchaser’s discount and debt issuance costs.During 2006, the Company closed two offerings under an existing “shelf” registration statement, pursuant to which it sold 1.0 million shares of commonstock in May and 2.7 million shares of common stock in December, with proceeds to the Company of approximately $25.0 million and $39.4 million,respectively, net of $594,000 of issuance costs.4. RESTRUCTURING EXPENSEDuring the fourth quarter of 2006, the Company commenced implementation of a facilities consolidation and restructuring program designed to reducethe overall expense structure in an effort to improve future operating performance. The planned actions include the termination of a co-location data centerlease, marketing the current office facilities for sub-lease and marketing non-core businesses for sale. The facilities consolidation and restructuring programshould be substantially completed during calendar year 2007.In 2006, the charges associated with the facilities consolidation and restructuring program are as follows:Lease termination costs$5,499Elimination of straight-line rent liability associated with terminated lease(913)Accelerated amortization of leasehold improvements and asset retirementobligation (Note 9)1,088Total$5,674 The Company is in the process of reducing facilities and warehouse lease costs and other expenses. Among other things, the Company intends to moveits corporate offices into existing space in its main Salt Lake City warehouse.Lease termination costs relate primarily to the termination of leases in conjunction with the consolidation of the IT data center and co-location facilities.The accelerated amortization of leasehold improvements relates to our current office facilities that we are attempting to sublease. In addition, we are incurringcosts to return these office facilities to their original condition as required by our lease agreement, including the removal of an escalator system. AtDecember 31, 2006, the accrued liability associated with the restructuring program was approximately $5.9 million, including $5.5 million related to leasetermination costs and $450,000 for the asset retirement obligation (see Note 9), all of which is to be paid during the first quarter of 2007.5. ACQUISITION AND SUBSEQUENT DISCONTINUED OPERATIONSOn July 1, 2005, the Company acquired all the outstanding capital stock of Ski West, Inc. (“Ski West”) for an aggregate of $25.1 million (including$111,000 of capitalized acquisition related expenses). In addition, the Company may be subject to additional earn out payments (based on a percentage ofoperating profits for each of the next four years beginning in 2006 as follows: 50%, 33.3%, 20%, and 10%, respectively), subject to reduction under certaincircumstances, pursuant to a Stock Purchase Agreement dated June 24, 2005 and the First Amendment to that Stock Purchase Agreement among theCompany, Ski West, and all of the shareholders of Ski West dated March 1, 2006.Ski West is an on-line travel company whose proprietary technology provides easy consumer access to a large, fragmented, hard-to-find inventory oflodging, vacation, cruise and transportation bargains. The travel offerings are primarily in popular ski areas in the U.S. and Canada, with more recentexpansion into the Caribbean and Mexico, as well as cruises. These factors contributed to a purchase price in excess of theF-16fair value of net tangible and intangible assets acquired from Ski West and as a result, the Company recorded goodwill in connection with this transaction.Effective upon the closing, Ski West became a wholly-owned subsidiary of the Company, integrated the Ski West travel offerings with the Company’sexisting travel offerings and changed its name to OTravel.com, Inc.Purchase Price AllocationsThe following table summarizes the estimated fair values of the assets acquired and liabilities assumed on July 1, 2005 (in thousands): July 1,2005Cash$491Current assets986Property and equipment263Goodwill10,385Intangible assets14,313Other assets9Assets acquired26,447Liabilities assumed(1,336)Net assets acquired$25,111 The excess of the purchase price over the fair values of assets acquired and liabilities assumed was allocated to goodwill. Any required earn outpayments would further increase goodwill at the time the target operating results for the next four years are successfully achieved. Of the $10.4 millioninitially recorded in goodwill, the full amount is expected to be deductible for tax purposes, to the extent the Company has sufficient taxable income in thefuture.The amounts allocated to intangible assets, and their estimated useful lives, was determined by management with the assistance of an independentappraisal and were attributed to the following categories (in thousands): YearsEnterprise information system$8605Customer list2,3394Supplier contracts6,27112Web sites and destination portal2,8875Non-competition agreements1,9562$14,313 During the years ended December 31, 2005 and 2006, the Company recorded amortization expense attributable to the above intangible assets ofapproximately $1.3 million and $2.7 million, which is included in loss from discontinued operations.Pro forma results of operations have not been presented because the effect of the acquisition was not material to the results of prior periods presented.Discontinued OperationsDuring the fourth quarter of 2006, in conjuction with the facilities consolidation and restructuring program described in Note 4, management decided tosell OTravel within a twelve month period, and theF-17Company has received a non-binding letter of intent from a third-party to purchase this business. The Company evaluated its plan to sell OTravel inaccordance with SFAS 144, which requires that long-lived assets be classified as held for sale only when certain criteria are met. The Company has classifiedthe OTravel assets and liabilities as “held for sale” as it has met these criteria as of December 31, 2006, which include: management’s commitment to a planto sell the assets; the availability of the assets for immediate sale in their present condition; an active program to locate buyers and other actions to sell theassets has been initiated; the sale of the assets is probable and their transfer is expected to qualify for recognition as a completed sale within one year; theassets are being marketed at reasonable prices in relation to their fair value; and the unlikelihood that significant changes will be made to the plan to the sellthe assets. The travel business is not part of the Company’s core business operations or its strategic focus. The results of operations for the subsidiary wereincluded in the fulfillment partner segment prior to being classified as discontinued operations.The Company also determined that the OTravel subsidiary meets the definition of a “component of an entity” and has been accounted for as adiscontinued operation under SFAS 144. The results of operations for this subsidiary have been classified as discontinued operations in all periods presented.The loss from operations for the OTravel subsidiary was approximately $2.6 million and $6.9 million for the fiscal years ended December 31, 2005 and 2006,respectively, including a goodwill impairment charge of $4.5 million in 2006.The following table is a summary of the Company’s discontinued operations for the years ended December 31, 2005 and 2006 (in thousands): Year ended December 31, 2005 2006 Sales$4,506$8,217Cost of sales(832)(1,848)Gross profit3,6746,369Sales and marketing(2,500)(1,888)Technology(242)(481)General and administrative(3,503)(6,422)Goodwill impairment—(4,460)Loss from discontinued operations$(2,571)$(6,882) The held for sale assets and liabilities consisted of the following (in thousands):December 31,20052006Assets of held for sale subsidiary:Cash$349$1,365Accounts receivable1,6743,267Property and equipment, net1,0641,215Goodwill and intangible assets, net22,50115,379Other3186Total assets of discontinued operations$25,619$21,312Liabilities of held for sale subsidiary:Current liabilities:Accounts payable$1,249$2,947Accrued liabilities912737Total liabilities of discontinued operations$2,161$3,684 F-186. MARKETABLE SECURITIESThe Company’s marketable securities consist of funds deposited into capital management accounts managed by two financial institutions. The financialinstitutions have invested these funds in municipal, government, and corporate bonds at December 31, 2005, as follows (in thousands): CostBasis RecognizedLoss onDerivativeSecurity UnrealizedGains(Losses) EstimatedMarket ValueU.S. government and government agency securities$3,299$—$(15)$3,284Money market securities2,000——2,000Mortgage based securities2,091—(39)2,052Foreign corporate securities49,949(2,611)1,12548,463$57,339$(2,611)$1,071$55,799 The Company had no marketable securities at December 31, 2006.The components of realized gains and losses on sales of marketable securities for the years ended December 31, 2004, 2005 and 2006 were (inthousands): Year endedDecember 31, 2004 2005 2006Gross gains$2$—$56Gross losses—(3,351)(2,141)Net realized gain (loss) on sales of marketable securities$2$(3,351)$(2,085) Derivative instrumentsDuring the first quarter of 2005, the Company purchased $49.9 million of Foreign Corporate Securities (“Foreign Notes”) which were scheduled tomature for $50.0 million in cash in November 2006. The Foreign Notes did not have a stated interest rate, but were structured to return the entire principalamount and a conditional coupon if held to maturity. The conditional coupon would provide a rate of return dependent on the performance of a “basket” ofeight Asian currencies against the U.S. dollar. If the Company redeemed the Foreign Notes prior to maturity, the Company would not realize the full amountof its initial investment.The Company purchased the Foreign Notes to manage its foreign currency risks related to the strengthening of Asian currencies compared to the U.S.dollar, which would reduce the inventory purchasing power of the Company in Asia. However, the Company determined that the Foreign Notes did notqualify as hedging derivative instruments.Under SFAS No. 133, the Foreign Notes are considered to be derivative financial instruments and were marked to market quarterly. Any unrealized gainor loss related to the changes in value of the conditional coupon was recorded in the income statement as a component of interest income or expense. Anyunrealized gain or loss related to the changes in the value of the Foreign Notes was recorded as a component of accumulated other comprehensive income(loss).For the year ended December 31, 2005, the combined overall fair value of the Foreign Notes decreased $1.5 million. The decrease was attributable tochanges in the fair value of the conditional coupon resulting in a loss of $2.6 million, which was recorded in net income, and changes in fair value of thebond instrument resulting in a gain of $1.1 million, which was recorded as a component of accumulated other comprehensive income (loss) in the BalanceSheet. At December 31, 2005, the Foreign Notes had a fair value of $48.5 million.F-19In March 2006, the Foreign Notes had a fair value of $47.6 million when the Company sold them for $49.5 million resulting in a gain on the bondinstrument of $1.9 million, which the Company recognized in the second quarter of 2006 as a component of interest income. The Company had previouslyrecorded $2.4 million of accumulated unrealized losses as a component of interest income over the period the bonds had been held.The Company had pledged its Foreign Notes as collateral for a $30.0 million revolving line of credit. Subsequent to the sale of the Foreign Notes, theborrowings under the Amended Credit Agreement (see Note 12) are now collateralized by cash balances held at Wells Fargo Bank, National Association.7. INVENTORIESInventories consist of the following (in thousands):December 31,20052006Product inventory$98,510$26,859Less: reserve for obsolescence(5,241)(6,585)$93,269$20,274 8. PROPERTY AND EQUIPMENTProperty and equipment consists of the following (in thousands):December 31,20052006Computer hardware and software$72,243$95,385Furniture and equipment8,86011,538Leasehold improvements1,9602,16583,063109,088Less: accumulated depreciation and amortization(22,213)(52,890)$60,850$56,198 Depreciation and amortization of property and equipment totaled $3.9 million, $14.0 million, and $32.2 million for the years ended December 31, 2004,2005 and 2006, respectively. The Company incurred additional depreciation and amortization expense related to decrease in useful life of certain fixed assetsand leasehold improvement in connection with the Company’s facilities consolidation.Property and equipment included assets under capital leases of $15.4 million and $17.7 million at December 31, 2005 and 2006, respectively andaccumulated amortization related to assets under capital leases of $8.4 million and $12.4 million, respectively.9. ASSET RETIREMENT OBLIGATIONAt December 31, 2006, the Company made the determination to sub-lease certain facilities and recorded a liability of $450,000 for the costs to dismantleand dispose of an escalator system and to return the leased facilities to their original condition as is required under the related lease agreement. The Companyalso recorded an asset equal to the liability which will be depreciated over the remaining useful life of the escalator system.F-2010. OTHER LONG-TERM ASSETSOther long-term assets consist of the following (in thousands):December 31,20052006Domain names$667$466Intangibles87926Less: accumulated amortization(369)(435)1,17757Deferred financing fees, net208173Deposits and long-term prepaids1,948348$3,333$578 Amortization of domain names and intangibles totaled $61,000, $142,000 and $110,000 for the years ended December 31, 2004, 2005 and 2006,respectively.11. ACCRUED LIABILITIESAccrued liabilities consist of the following (in thousands): December 31, 20052006Inventory received but not invoiced$9,614$243Allowance for returns5,5763,615Accrued payroll and other related costs6,5327,952Deferred revenue1,9332,650Accrued marketing expenses10,16110,835Merchant processing fee accrual841818Accrued freight202554Accrued professional expenses8491,410Accrued tax expenses2,4712,075Lease termination costs—5,499Lease termination costs—450Other accrued expenses7,7554,041$45,934$40,142 12. BORROWINGS$30.0 million Amended Credit AgreementOn October 18, 2005, the Company entered into a sixth amendment to a credit agreement (“Amended Credit Agreement”) with Wells Fargo Bank,National Association. The Amended Credit Agreement provides a revolving line of credit to the Company of up to $30.0 million which the Company usesprimarily to obtain letters of credit to support inventory purchases. The Amended Credit Agreement expires on December 31, 2007, however, the Companyhas an option to renew the Amended Credit Agreement annually. Interest on borrowings is payable monthly and accrued at either (i) 1.35% above LIBOR ineffect on the first day of an applicable fixed rate term, or (ii) at a fluctuating rate per annum determined by the bank to be one half a percent (0.50%) abovedaily LIBOR in effect on each business day a change in daily LIBOR is announced by the bank. Unpaid principal, together with accrued and unpaid interestis due on the maturity date. The Amended Credit Agreement requires the Company to comply with certainF-21covenants, including restrictions on mergers, business combinations or transfer of assets. The Company was in compliance with these covenants atDecember 31, 2006.At December 31, 2006, borrowings and outstanding letters of credit under the Amended Credit Agreement are collateralized by cash balances held atWells Fargo Bank, National Association.At December 31, 2006, no amounts were outstanding under the Amended Credit Agreement, and Letters of Credit totaling $7.1 million were issued onbehalf of the Company.$40.0 million WFRF AgreementOn December 12, 2005, the Company entered into a Loan and Security Agreement (the “WFRF Agreement”) with Wells Fargo Retail Finance, LLC andrelated security agreements and other agreements described in the WFRF Agreement.The WFRF Agreement provides for advances to the Company and for the issuance of letters of credit for its account of up to an aggregate maximum of$40.0 million. The Company has the right to increase the aggregate maximum amount available under the facility to up to $50.0 million during the first twoyears of the facility. The amount actually available to the Company may be less and may vary from time to time, depending on, among other factors, theamount of its eligible inventory and receivables. The Company’s obligations under the WFRF Agreement and all related agreements are collateralized by allor substantially all of the Company’s and its subsidiaries’ assets. The Company’s obligations under the WFRF Agreement are cross-collateralized with itsassets pledged under its $30.0 million credit facility with Wells Fargo Bank, National Association. The term of the WFRF Agreement is three years, expiringon December 12, 2008. The WFRF Agreement contains standard default provisions.Advances under the WFRF Agreement bear interest at either (a) the rate announced, from time to time, within Wells Fargo Bank, National Association atits principal office in San Francisco as its “prime rate” or (b) a rate based on LIBOR plus a varying percentage between 1.25% and 1.75%; however, theannual interest rate on advances under the WFRF Agreement will be at least 3.50%. The WFRF Agreement includes affirmative covenants as well as negativecovenants that prohibit a variety of actions without the lender’s approval, including covenants that limit the Company’s ability to (a) incur or guarantee debt,(b) create liens, (c) enter into any merger, recapitalization or similar transaction or purchase all or substantially all of the assets or stock of another person,(d) sell assets, (e) change its name or the name of any of its subsidiaries, (f) make certain changes to its business, (g) optionally prepay, acquire or refinanceindebtedness, (h) consign inventory, (i) pay dividends on, or purchase, acquire or redeem shares of, its capital stock, (j) change its method of accounting,(k) make investments, (l) enter into transactions with affiliates, or (m) store any of its inventory or equipment with third parties. The Company was incompliance with these covenants as of December 31, 2006. As of December 31, 2006, $11.9 was available under the WFRF Agreement.At December 31, 2005 and 2006, there were no amounts drawn nor were there any outstanding letters of credit on the WFRF Agreement.Capital leasesThe Company leases certain software and computer equipment under three non-cancelable capital leases that expire at various dates through 2008. TheCompany expects that in the normal course of business, the leases will expire.F-22Future minimum lease payments under capital leases are as follows (in thousands):Year Ending December 31, 2007$5,99720084,028Thereafter—Total minimum lease payments10,025Less: amount representing interest(968)Present value of capital lease obligations9,057Less: current portion(5,074)Capital lease obligations, non-current$3,983 13. 3.75% CONVERTIBLE SENIOR NOTESIn November 2004, the Company completed an offering of $120.0 million of 3.75% Convertible Senior Notes (the “Senior Notes”). Proceeds to theCompany were $116.2 million, net of $3.8 million of initial purchaser’s discount and debt issuance costs. The discount and debt issuance costs are beingamortized using the straight-line method which approximates the interest method. During 2005 and 2006, the Company recorded amortization of discountand debt issuance costs related to this offering totaling $620,000 and $417,000. Interest on the Senior Notes is payable semi-annually on June 1 andDecember 1 of each year. The Senior Notes mature on December 1, 2011 and are unsecured and rank equally in right of payment with all existing and futureunsecured, unsubordinated debt and senior in right of payment to any existing and future subordinated indebtedness.The Senior Notes are convertible at any time prior to maturity into the Company’s common stock at the option of the note holders at a conversion priceof $76.23 per share or approximately 1.0 million shares in aggregate (subject to adjustment in certain events, including stock splits, dividends and otherdistributions and certain repurchases of the Company’s stock, as well as certain fundamental changes in the ownership of the Company). BeginningDecember 1, 2009, the Company has the right to redeem the Senior Notes, in whole or in part, for cash at 100% of the principal amount plus accrued andunpaid interest. Upon the occurrence of a fundamental change (including the acquisition of a majority interest in the Company, certain changes in theCompany’s board of directors or the termination of trading of the Company’s stock) meeting certain conditions, holders of the Senior Notes may require theCompany to repurchase for cash all or part of their notes at 100% of the principal amount plus accrued and unpaid interest.The indenture governing the Senior Notes requires the Company to comply with certain affirmative covenants, including making principal and interestpayments when due, maintaining our corporate existence and properties, and paying taxes and other claims in a timely manner. The Company was incompliance with these covenants at December 31, 2006.In June and November 2005, the Company retired $33.0 million and $10.0 million of its Senior Notes for $27.9 million and $7.8 million, respectively.As a result of the note retirements in June and November, the Company recognized a gain of $6.2 million, net of the associated unamortized discount of $1.2million for the year ended December 31, 2005. As of December 31, 2006, $77.0 million of the Senior Notes remained outstanding.14. COMMITMENTS AND CONTINGENCIESCommitmentsThrough July 2005, the Company leased 43,000 square feet of office space at Old Mill Corporate Center I for its principal executive offices under anoperating lease which was originally scheduled toF-23expire in January 2007. Beginning July 2005, this lease was terminated and replaced with a lease for approximately 154,000 rentable square feet in the OldMill Corporate Center III in Salt Lake City, Utah for a term of ten years.In February 2005, the Company and Old Mill Corporate Center III, LLC (the “Lessor”) entered into a Tenant Improvement Agreement (the “OMIIIAgreement”) relating to the office building. The OMIII Agreement sets forth the terms on which the Company would pay the costs of certain improvements tothe leased office space. The amount of the costs was approximately $2.0 million. The OMIII Agreement also required the Company to provide a letter ofcredit in the amount of $500,000 to the Lessor to provide funds for the removal of certain improvements upon the termination of the lease.During the fourth quarter 2006, the Company commenced implementation of a facilities consolidation and restructuring program (Note 4). TheCompany recorded a liability of $450,000 for the costs to dismantle and dispose of an escalator system and to the return the leased facilities to their originalcondition under the Tenant Improvement Agreement (see Note 9) and incurred additional amortization expense in connection with the revised useful life ofcertain leasehold improvements. In January 2007, the Company began marketing its leased office facilities for sub-lease.In July 2005, the Company entered into a Colocation Center Agreement (the “Colocation Agreement”) to buildout and lease 11,289 square feet of spaceat Old Mill Corporate Center II for an IT data center and co-location facility. The Colocation Agreement set forth the terms on which the Lessor would incurthe costs to build out the IT data center and co-location facility and the Company would commence to lease the space upon its completion for a term of tenyears. In November 2006, the Company made the determination to consolidate its facilities and to not occupy the IT data center and co-location facility andbegan negotiations with the Lessor to terminate the lease agreement (see Note 4).The Company leases 610,000 square feet for its warehouse facilities in Utah under operating leases which expire in August 2012.In June 2005 and 2006, the Company entered into non-cancelable operating leases for certain computer equipment expiring in April 2008 andJune 2008. It is expected that such leases will be renewed by exercising purchase options or replaced by leases of other computer equipment.Minimum future payments under these leases are as follows (in thousands):Year Ending December 31, 2007$8,71820087,11920095,72220105,53220115,335Thereafter16,240$48,666 Rental expense for operating leases totaled $1.9 million, $4.0 million and $11.5 million for the years ended December 31, 2004, 2005 and 2006,respectively.Legal ProceedingsFrom time to time, the Company receives claims of and become subject to consumer protection, employment, intellectual property and other commerciallitigation related to the conduct of our business. Such litigation could be costly and time consuming and could divert our management and key personnelfrom our business operations. The uncertainty of litigation increases these risks. In connection with suchF-24litigation, the Company may be subject to significant damages or equitable remedies relating to the operation of our business and the sale of products on ourwebsites. Any such litigation may materially harm our business, prospects, results of operations, financial condition or cash flows. However, the Companydoes not currently believe that any of its outstanding litigation will have a material adverse effect on its financial statements.In December 2003, we received a letter from Furnace Brook claiming that certain of our business practices and our website infringe a single patentowned by Furnace Brook. After diligent efforts to show that we do not infringe the patent and Furnace Brook’s continual demands that we enter intolicensing arrangements with respect to the asserted patent, on August 12, 2005, we filed a complaint in the United States District Court of Utah, CentralDivision, seeking declaratory judgment that we do not infringe any valid claim of the Furnace Brook patent. Furnace Brook filed a motion to dismiss ourcomplaint for lack of personal jurisdiction over Furnace Brook in Utah. On October 31, 2005, the United States District Court of Utah, Central Division,issued a decision to dismiss our complaint for lack of personal jurisdiction over Furnace Brook. On December 14, 2005, we filed an appeal of the Utahdecision with the United States Court of Appeals for the Federal Circuit. On August 18, 2006, the United States Court of Appeals for the Federal Circuitdenied the Company’s appeal. On August 18, 2005, shortly after we filed the complaint in Utah, Furnace Brook filed a complaint in the United States DistrictCourt for the Southern District of New York, alleging that certain of our business practices and our website infringe a single patent owned by Furnace Brook.On September 9, 2005, we filed an answer denying the material allegations in Furnace Brook’s claims. On September 27, 2006, the United States DistrictCourt for the Southern District of New York issued a memorandum and order, Markman Hearing, which substantially adopted the Company’s interpretationof the Furnace Brook patent. We filed motions for summary judgment relating to the litigation and on October 6, 2006, the United States District Court forthe Southern District of New York heard oral argument on those motions and on October 30, 2006, the United States District Court for the Southern District ofNew York granted summary judgment in favor of us, ruling that we do not infringe the Furnace Brook patent as a matter of law. On November 9, 2006,Furnace Brook filed a notice of appeal to the United States Court of Appeals for the Federal Circuit. On January 16, 2007, we filed a brief with the FederalCircuit Court and the appeal is now pending.On August 11, 2005, along with a shareholder plaintiff, we filed a complaint against Gradient Analytics, Inc.; Rocker Partners, LP; Rocker Management,LLC; Rocker Offshore Management Company, Inc. and their respective principals. We, along with a second shareholder plaintiff, filed the complaint in theSuperior Court of California, County of Marin. On October 12, 2005, we filed an amended complaint against the same entities alleging libel, intentionalinterference with prospective economic advantage and violations of California’s unfair business practices act. On March 7, 2006, the court denied thedefendants demurrers to and motions to strike the amended complaint. The defendants each filed a motion to appeal the court’s decision, we responded andthe California Attorney General submitted an amicus brief supporting our view; the court has ruled that this appeal stays discovery in the case. The CaliforniaCourt of Appeals informed the parties that it is ready to rule on the appeal without oral argument; the defendants, however, have requested oral argument. Theappeal has not yet been scheduled for oral argument. We intend to pursue this action vigorously.On May 9, 2006 the Company received a notice of an investigation and subpoena from the Securities and Exchange Commission, Salt Lake City DistrictOffice. The subpoena requested a broad range of documents, including, among other documents, all documents relating to the Company’s accountingpolicies, the Company’s targets, projections or estimates related to financial performance, the Company’s recent restatement of its financial statements, thefiling of its complaint against Gradient Analytics, Inc., the development and implementation of certain new technology systems and disclosures of progressand problems with those systems, communications with and regarding investment analysts, communications regarding shareholders who did not receive theCompany’s proxy statement in April 2006, communicationsF-25with certain shareholders, and communications regarding short selling, naked short selling, purchases and sales of Company stock, obtaining papercertificates, and stock loan or borrow of Company shares. The Company has responded to the subpoena.In November 2006, the Company received a letter from Applied Interactive, claiming that certain of our business practices and our website infringe twopatents owned by Applied Interactive and offering to enter into a licensing agreement. After determining that we do not infringe the patents and rejecting theoffered licensing agreement, on February 2, 2007, we filed a complaint in the United States District Court, Southern District of New York, seeking declaratoryjudgment that we do not infringe any valid claim of the Applied Interactive patents. The complaint has been served and the case is in its initial stages. TheCompany intends to vigorously prosecute this action.On February 2, 2007, along with five shareholder plaintiffs, the Company filed a lawsuit in the Superior Court of California, County of San Franciscoagainst Morgan Stanley & Co. Incorporated, Goldman Sachs & Co., Bear Stearns Companies, Inc., Bank of America Securities LLC, Bank of New York,Citigroup Inc., Credit Suisse (USA) Inc., Deutsche Bank Securities, Inc., Merrill Lynch, Pierce, Fenner & Smith, Inc., and UBS Financial Services, Inc. The suitalleges that the defendants, who control over 80% of the prime brokerage market, participated in an illegal stock market manipulation scheme and that thedefendants had no intention of covering short sell orders with borrowed stock, as they are required to do, causing what are referred to as “fails to deliver” andthat the defendants’ actions caused and continue to cause dramatic distortions with in the nature and amount of trading in the Company’s stock as well asdramatic declines in the share price of the Company’s stock. The suit asserts that a persistent large number of “fails to deliver” creates significant downwardpressure on the price of a company’s stock and that the amount of “fails to deliver” has exceeded the company’s entire supply of outstanding shares. The suitaccuses the defendants of violations of California securities laws and common law, specifically, conversion, trespass to chattels, intentional interference withprospective economic advantage, and violations of California’s Unfair Business Practices Act. The Company is seeking damages of $3.48 billion. The case isin its initial stages. The Company intends to vigorously prosecute this action.15. REDEEMABLE SECURITIESRedeemable common stock relates to warrants and securities that were subject to rescission. Sales of 858,000 shares of the common stock and theissuance of 185,000 warrants to certain individuals did not fully comply with certain requirements under applicable State Blue Sky Laws. The offer and saleof these securities were not made pursuant to a registration statement and the Securities Act of 1933, nor were the offer and sale registered or qualified underany state security laws. Although the Company believed at the time that such offers, sales and conversion were exempt from such registration or qualification,they may not have been exempt in several states. As a result, purchasers of our common stock in some states had the right under federal or state securities lawsto rescind their purchases for an amount equal to the purchase price paid for the shares, plus interest from the date of purchase until the rescission offerexpired, at the annual rate mandated by the state in which such shares were purchased. These interest rates ranged from 8% to 10% per annum. The rescissionrights lapsed on various dates through September 2006.At December 31, 2005, there were 446,000 shares of common stock and no warrants subject to rescission rights outstanding. The Company has classified$3.2 million at December 31, 2005 related to the rescission rights outside of shareholders’ equity, because the redemption features were deemed not withinthe control of the Company. Interest attributable to these securities was recorded as a deemed dividend and reflected as a deduction from net loss to arrive atnet loss attributable to common shares in the Statements of Operations.F-26No amount has been classified outside of shareholders’ equity as of December 31, 2006 as these rescission rights, if any, fully expired prior to the end of2006, leaving no outstanding redeemable common stock as of December 31, 2006.16. STOCKHOLDERS’ EQUITYReincorporationIn May 2002, the Company reincorporated in Delaware. As a result of the reincorporation, the Company is authorized to issue 100.0 million shares of$0.0001 par value common stock and 5.0 million shares of $0.0001 par value preferred stock. The Board of Directors may issue the undesignated preferredstock in one or more series and determine preferences, privileges and restrictions thereof.Common StockEach share of common stock has the right to one vote. The holders of common stock are also entitled to receive dividends whenever funds are legallyavailable and when declared by the Board of Directors, subject to prior rights of holders of all classes of stock outstanding having priority rights as todividends. No dividends have been declared or paid on the Company’s common stock through December 31, 2006.WarrantsIn 2000, the Company issued warrants to certain shareholders in connection with the purchase of additional shares of common stock. At December 31,2005 and 2006, there were no warrants outstanding to purchase common stock of the Company. During 2004, 2005 and 2006, the number of warrantsexercised was 182,000, 870,000 and 0, respectively.17. SHARE REPURCHASE PROGRAMDuring January 2005, the Company’s Board of Directors authorized a share repurchase program under which the Company was authorized to repurchaseup to $50.0 million of its common stock through December 31, 2007. On April 26, 2005, the Board of Directors increased the amount of the share repurchaseprogram to $100.0 million. Additionally, on June 14, 2005, the Board of Directors authorized an amendment of its three-year share repurchase program toinclude the repurchase of its Convertible Senior Notes.During 2005, the Company entered into several purchased call options, pursuant to which the Company could have been required to purchase up to 1.3million shares of its common stock at certain settlement dates during the quarter ended June 30, 2005. In connection with these repurchase transactions; theCompany paid approximately $47.5 million, which was recorded in shareholders’ equity in the consolidated balance sheet.At the Company’s option, the purchased call options were settled in cash or stock, based on the market price of its common stock on the date of thesettlement. Upon settlement, the Company either had its capital investment returned with a premium or received shares of its common stock, depending,respectively, on whether the market price of its common stock was above or below a pre-determined price agreed in connection with each such transaction.Under the repurchase program, the Company repurchased approximately 665,000 shares of its common stock in open market transactions for $24.1million during the year ended December 31, 2005. In addition, approximately 1.0 million shares of common stock were acquired as a result of the settlementof $41.1 million of structured stock repurchase transactions during the twelve months ended December 31, 2005. The purchased call options that did notsettle in stock settled in cash totaling $7.9 million, which the Company received in July 2005.F-2718. STOCK OPTION PLANSPeriods prior to the adoption of SFAS 123(R)Prior to January 1, 2006, the Company accounted for stock-based awards under the intrinsic value method, which followed the recognition andmeasurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employee , and related interpretations. The intrinsic value method ofaccounting resulted in compensation expense for stock options to the extent option exercise prices were set below market prices on the date of grant. Also, tothe extent stock awards were forfeited prior to vesting, any previously recognized expense was reversed as an offset to operating expenses in the period offorfeiture.The following table illustrates the effects on net loss and net loss per share as if the Company had applied the fair value recognition provisions of SFAS123, Accounting for Stock Based Compensation, as amended by SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure tooptions granted under the Company’s stock-based compensation plans prior to the adoption. For purposes of this pro forma disclosure, the value of theoptions was estimated using the Black-Scholes-Merton (“BSM”) option-pricing formula and amortized on a straight-line basis over the respective vestingperiods of the awards. Disclosure for the year ended December 31, 2006 is not presented because stock-based payments were accounted for under SFAS 123(R)’s fair value method during this period. Year ended December 31, 20042005Net loss, as reported$(4,540)$(24,918)Add: Stock-based employee compensation, as reported36072Deduct: Total stock-based employee compensation expense determinedunder fair value based method for all awards(3,747)(3,996)Pro forma net loss—SFAS 123 fair value adjusted$(7,927)$(28,842)Net loss per common shareBasic and diluted—as reported$(0.26)$(1.29)Basic and diluted—pro forma$(.044)$(1.48) Adoption of SFAS 123(R)As of January 1, 2006, the Company adopted SFAS No. 123(R) using the modified prospective method, which requires measurement of compensationcost for all stock-based awards at fair value on date of grant and recognition of compensation over the service period for awards expected to vest. The fairvalue of stock options is determined using the BSM valuation model, which is consistent with our valuation techniques previously utilized for options infootnote disclosures required under SFAS No. 123 . Such value is recognized as expense over the service period, net of estimated forfeitures, using thestraight-line method under SFAS 123(R).The adoption of SFAS 123(R) did not result in a cumulative benefit from accounting change, which reflects the net cumulative impact of estimatingfuture forfeitures in the determination of period expense, rather than recording forfeitures when they occur as previously permitted, as we did not haveunvested employee stock awards for which compensation expense was recognized prior to adoption of SFAS No. 123(R).Prior to the adoption of SFAS 123(R), cash retained as a result of tax deductions relating to stock-based compensation was presented in operating cashflows, along with other tax cash flows, in accordance with the provisions of the Emerging Issues Task Force (“EITF”) Issue No. 00-15, Classification in theStatement of Cash Flows of the Income Tax Benefit Received by a Company upon Exercise of a Nonqualified Employee Stock Option. SFAS123(R) supersedes EITF 00-15, amends SFAS 95, Statement of Cash Flows, and requires tax benefits relating to excess stock-based compensation deductionsto be prospectivelyF-28presented in the statement of cash flows as financing cash inflows. As of the adoption of SFAS 123(R), we had fully reserved against any tax benefits resultingfrom stock-based compensation deductions in excess of amounts reported for financial reporting purposes.On March 29, 2005, the SEC published Staff Accounting Bulletin (“SAB”) No. 107, which provides the Staff’s views on a variety of matters relating tostock-based payments. SAB 107 requires stock-based compensation be classified in the same expense line items as cash compensation. The Company hasreclassified stock-based compensation from prior periods to correspond to current period presentation within the same operating expense line items as cashcompensation paid to employees.The application of SFAS 123(R) had the following effect on the year ended December 31, 2006 reported amounts relative to amounts that would havebeen reported using the intrinsic value method under previous accounting (in thousands, except per share amounts):SFAS 123(R) Adjustments Year ended December 31, 2006Operating loss$(4,120)Net loss$(4,120)Net loss per common share—basic and diluted$(0.20) Valuation Assumptions for Stock OptionsDuring the twelve months ended December 31, 2006, 182,500 options were granted to employees with an estimated total grant-date fair value of $2.4million. Of this amount, the Company estimated that the stock-based compensation for the awards not expected to vest was $643,000. During the year endedDecember 31, 2006, the Company recorded stock-based compensation related to stock options of $4.1 million.The fair value for each stock option granted during the twelve months ended December 31, 2004, 2005 and 2006 was estimated at the date of grant usingthe BSM option-pricing model, assuming no dividends and the following assumptions. Year ended December 31, 200420052006 Average risk-free interest rate2.61%4.44%4.77%Average expected life (in years)3.03.73.5Volatility100.6%73.3%65.1% Expected Volatility: The fair value of stock based payments were valued using a volatility factor based on the Company’s historical stock prices.Expected Term: The Company’s expected term represents the period that the Company’s stock-based awards are expected to be outstanding andwas determined based on historical experience of similar awards, giving consideration to the contractual terms and vesting provisions of the stock-basedawards.Expected Dividend: The Company has not paid any dividends and does not anticipate paying dividends in the foreseeable future.F-29Risk-Free Interest Rate: The Company bases the risk-free interest rate used on the implied yield currently available on U.S. Treasury zero-couponissues with remaining term equivalent to the expected term of the options.Estimated Pre-vesting Forfeitures: When estimating forfeitures, the Company considers voluntary and involuntary termination behavior.Stock Option ActivityThe Company’s board of directors adopted the Amended and Restated 1999 Stock Option Plan, the 2002 Stock Option Plan and the 2005 EquityIncentive Plan (collectively, the “Plans”), in May 1999, April 2002, and April 2005 respectively. Under these Plans, the Board of Directors may issueincentive stock options to employees and directors of the Company and non-qualified stock options to consultants of the Company. Options granted underthese Plans generally expire at the end of five years and vest in accordance with a vesting schedule determined by the Company’s Board of Directors, usuallyover four years from the grant date. As of the initial public offering, the Amended and Restated 1999 Stock Option Plan was terminated, and as of April 2005the 2002 Stock Option Plan was terminated (except with regard to outstanding options). Future shares will be granted under the 2005 Equity Incentive Plan.As of December 31, 2006, 1.1 million shares are available for future grants under the 2005 Equity Incentive Plan. The Company settles stock option exerciseswith newly issued common shares. The following is a summary of stock option activity (in thousands, except per share data): 200420052006 SharesWeighted Average Exercise PriceSharesWeighted Average Exercise PriceSharesWeighted Average Exercise PriceOutstanding—beginning of year1,780$8.391,512$12.901,299$18.09Granted at fair value47424.1422044.4418322.47Exercised(468)6.75(298)8.56(276)9.19Canceled/forfeited(274)13.26(135)24.08(195)30.17Outstanding—end of year1,51212.901,29918.091,01118.97Options exercisable at year-end6087.5173911.33679$15.74 The following table summarizes information about stock options as of December 31, 2006 (in thousands, except per share data): Options Outstanding Options ExercisableRange of Exercise Prices Shares Weighted Average Exercise Price Weighted Average Remaining Contract Life Aggregate Intrinsic Value Shares Weighted Average Exercise Price Weighted Average Remaining Contract Life Aggregate Intrinsic Value$2.00-$4.9944$4.910.81$71344$4.910.81$713$5.00-$6.991685.070.082,7001685.070.082,700$7.00-$11.996310.620.706585910.770.65606$12.00-$17.9920713.601.801,55415613.361.481,212$18.00-$58.3052927.652.9951425227.372.433721,01118.972.026,13967915.741.375,603 Total unrecognized compensation costs related to nonvested awards was approximately $6.2 million as of December 31, 2006. These nonvested awardsare expected to be exercised over the weighted average period of 3. 5 years.F-30The aggregate intrinsic value in the table above represents the total pretax intrinsic value, based on the Company’s average stock price of $21.12 duringthe year ended December 31, 2006, which would have been received by the option holders had all option holders exercised their options as of that date. Thetotal number of in-the-money options exercisable as of December 31, 2006 was 573,468.The weighted average exercise price of options granted during the year ended December 31, 2006 was $22.47 per share. The total fair value of the sharesvested during the year ended December 31, 2006 was $3.1 million. The total intrinsic value of options exercised during the year ended December 31, 2006was $3.3 million. The total cash received from employees as a result of employee stock option exercises during the year ended December 31, 2006 wasapproximately $2.5 million. In connection with these exercises, there was no tax benefit realized by the Company due to the Company’s current lossposition.19. PERFORMANCE SHARE PLANIn January 2006, the Board and Compensation Committee adopted the Overstock.com Performance Share Plan, and approved grants to executive officersand certain employees of the Company. The Performance Share Plan provides for a three-year period for the measurement of the Company’s attainment ofcertain performance goals, but at the Company’s sole option the Company may make a payment of estimated amounts payable to a plan participant after twoyears.The performance goal is measured by growth in economic value, as defined in the plan. The amount of payments due to participants under the plan willbe a function of the then current market price of a share of the Company’s common stock, multiplied by a percentage dependent on the extent to which theperformance goal has been attained, which will be between 0% and 200%. If the growth in economic value is 10% compounded annually or less, thepercentage will be 0%. If the growth in economic value is 25% compounded annually, the percentage will be 100%. If the growth in economic value is 40%compounded annually or more, the percentage will be 200%. If the percentage growth is between these percentages, the payment percentage will bedetermined on the basis of straight line interpolation. Amounts payable under the plan will be payable in cash. During interim and annual periods prior to thecompletion of the three-year measurement period, the Company records compensation expense based upon the period-end stock price and estimatesregarding the ultimate growth in economic value that is expected to occur. These estimates include assumed future growth rates in revenues, gross marginsand other factors. If the Company were to use different assumptions, the estimated compensation charges could be significantly different. As of December 31,2006, the Company has accrued $900,000 in total compensation expense under the plan.20. EMPLOYEE RETIREMENT PLANThe Company has a 401(k) defined contribution plan which permits participating employees to defer up to a maximum of 25% of their compensation,subject to limitations established by the Internal Revenue Code. Employees who have completed a half-year of service and are 21 years of age or older arequalified to participate in the plan. The Company matches 50% of the first 6% of each participant’s contributions to the plan. Beginning in 2006, theCompany’s matching contribution is comprised of common stock issued from treasury to employees. Participant contributions are immediately vested.Company contributions vest based on the participant’s years of service at 20% per year over five years. The Company’s matching contribution totaled$124,000, $261,000 and $389,000 during 2004, 2005 and 2006, respectively. In addition, the Company made a discretionary contribution of $235,000,$342,000 and $409,000 during 2004, 2005 and 2006 to eligible participants as of the end of each respective calendar year.F-3121. OTHER INCOME (EXPENSE), NETOther income (expense), net consisted of the following (in thousands):Year ended December 31, 200420052006Gain from early retirement of convertible senior notes$—$6,158$—Loss on disposal of software—(1,457)—Other(49)2781Other income (expense), net$(49)$4,728$81 22. INCOME TAXESThe components of the Company’s deferred tax assets and liabilities as of December 31, 2005 and 2006 are as follows (in thousands):December 31,20052006Deferred tax assets:Net operating loss carryforwards$28,006$62,191Temporary differences:Accrued expenses6,0715,722Reserves and other4,1474,78838,22472,701Deferred tax liabilities:Temporary differences:Depreciation(1,639)1,689Valuation allowance(36,585)(74,390)Net asset$—$— As a result of the Company’s history of losses, a valuation allowance has been provided for the full amount of the Company’s net deferred tax assets. Inmanagement’s opinion, it is more likely than not that such benefits will be realized.At December 31, 2005 and 2006, the Company had net operating loss carryforwards of approximately $58.0 million and $145.2 million, respectively,which may be used to offset future taxable income. An additional $21.9 million of net operating losses are limited under Internal Revenue Code Section 382to $799,000 a year. These carryforwards begin to expire in 2018.The income tax benefit differs from the amount computed by applying the U.S. federal income tax rate of 35% to loss before income taxes for thefollowing reasons (in thousands): Year ended December 31, 200420052006U.S. federal income tax benefit at statutory rate$1,589$8,702$35,618State income tax benefit, net of federal expense1488473,444Stock compensation expense(127)(25)—Other525389(1,257)Unrecognized benefit due to valuation allowance(2,135)(9,135)(37,805)Income tax benefit$—$—$— F-3223. RELATED PARTY TRANSACTIONSOn occasion, Haverford-Valley, L.C. (an entity owned by the Company’s Chairman and Chief Executive Officer) and certain affiliated entities maketravel arrangements for our executives and pay the travel related expenses incurred by our executives on Company business. In 2004, 2005, and 2006 wereimbursed Haverford-Valley L.C. $256,000, $274,000, and $267,000, respectively, for these expenses.24. BUSINESS SEGMENTSSegment information has been prepared in accordance with SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information.Segments were determined based on products and services provided by each segment. Accounting policies of the segments are the same as those described inNote 2. There were no inter-segment sales or transfers during 2004, 2005 or 2006. The Company evaluates the performance of its segments and allocatesresources to them based primarily on gross profit. The table below summarizes information about reportable segments (in thousands):DirectFulfillmentpartnerConsolidated 2004Revenue$213,210$281,425$494,635Cost of goods sold184,964243,468428,432Gross profit28,24637,95766,203Operating expenses(71,092)Other income (expense), net349Loss from continuing operations$(4,540)2005Revenue$324,875$474,441$799,316Cost of goods sold282,383400,057682,440Gross profit42,49274,384116,876Operating expenses(138,099)Other income (expense), net(1,124)Loss from continuing operations$(22,347)2006Revenue$303,202$484,948$788,150Cost of goods sold284,943408,407693,350Gross profit18,25976,54194,800Operating expenses(188,566)Other income (expense), net(1,118)Loss from continuing operations$(94,884) The direct segment includes revenues, direct costs, and allocations associated with sales fulfilled from our warehouse. Costs for this segment includeproduct costs, inbound freight, warehousing, and fulfillment costs, credit card fees and customer service costs.The fulfillment partner segment includes revenues, direct costs and cost allocations associated with the Company’s third party fulfillment partner salesand are earned from selling the merchandise of third parties over the Company’s Websites. The costs for this segment include product costs, warehousing andfulfillment costs, credit card fees and customer service costs.Assets have not been allocated between the segments for management purposes, and as such, they are not presented here.F-33During the years 2004 through 2006, over 99% of sales were made to customers in the United States of America. At December 31, 2005 and 2006, all ofthe Company’s fixed assets were located in the United States of America.25. INDEMNIFICATIONS AND GUARANTEESDuring its normal course of business, the Company has made certain indemnities, commitments, and guarantees under which it may be required to makepayments in relation to certain transactions. These indemnities include, but are not limited to, indemnities to various lessors in connection with facility leasesfor certain claims arising from such facility or lease, and indemnities to directors and officers of the Company to the maximum extent permitted under thelaws of the State of Delaware. The duration of these indemnities, commitments, and guarantees varies, and in certain cases, is indefinite. In addition, themajority of these indemnities, commitments, and guarantees do not provide for any limitation of the maximum potential future payments the Company couldbe obligated to make. As such, the Company is unable to estimate with any reasonableness its potential exposure under these items. The Company has notrecorded any liability for these indemnities, commitments, and guarantees in the accompanying consolidated balance sheets. The Company does, however,accrue for losses for any known contingent liability, including those that may arise from indemnification provisions, when future payment is both probableand reasonably estimable. The Company carries specific and general liability insurance policies that the Company believes would, in most circumstances,provide some, if not total recourse to any claims arising from these indemnifications.26. DECONSOLIDATION OF VARIABLE INTEREST ENTITYIn April 2005, the Company entered into an agreement which allowed the Company to lend up to $10.0 million to an entity for the purpose of buyingdiamonds and other jewelry, primarily to supply a new category within the jewelry store which allowed customers purchasing diamond rings to select both aspecific diamond and ring setting. Under the agreement, the Company was to receive fifty percent (50%) of any profits of the entity. In addition, theCompany had a ten year option to purchase (“Purchase Option”) 50% of the ownership and voting interest of the entity. The exercise price of the PurchaseOption was the sum of (a) one thousand dollars, and (b) $3.0 million, which may have been paid, at the Company’s election, in cash or by the forgiveness of$3.0 million of the entity’s indebtedness to the Company.The entity was evaluated in accordance with FASB Interpretation No. 46 Revised, Consolidation of Variable Interest Entities—an Interpretation of ARBNo. 51, and it was determined to be a variable interest entity for which the Company was determined to be the primary beneficiary. As such, the financialstatements of the entity were consolidated into the financial statements of the Company.In November 2004, the Company loaned the entity $8.4 million. The promissory note bore interest at 3.75% per annum. Interest on the loan was due andpayable quarterly on the fifteenth day of February, May, August and November, commencing on November 15, 2004 until the due date of November 30,2006, on which all principal and interest accrued and unpaid thereon, was due and payable. The promissory note was collateralized by all of the assets of theentity.In November 2006, an unrelated third party purchased the Company’s interests in the variable interest entity by executing a promissory note to theCompany in exchange for termination of all agreements between the Company and the variable interest entity. The promissory note is equal to the net assetsof the entity or $6.7 million and bears no interest. The first payment on the note receivable was due and paid on February 1, 2007 in the amount of $3.7million with remainder of balance due in twelve equal monthly payments of $251,000 beginning on March 1, 2007. As of March 1, 2007, the Company hadreceived payments on the note totaling $3.9 million.F-34As a result of the agreement, the Company deconsolidated certain assets related to the variable interest entity effective November 30, 2006. Theoperating results through November 30, 2006 relating to variable interest entity are included in the consolidated statements of operations. As a result of thedeconsolidation, the following assets were removed from the Company’s accounts (in thousands):Cash$102Accounts Receivable435Inventory5,986Prepaids4Other Long-term assets175Total$6,702 27. QUARTERLY RESULTS OF OPERATIONS (unaudited)The following tables set forth our unaudited quarterly results of operations data for the eight most recent quarters for the period ended December 31,2006. We have prepared this information on the same basis as the Consolidated Statements of Operations and the information includes all adjustments,consisting only of normal recurring adjustments, that we consider necessary for a fair statement of our financial position and operating results for the quarterspresented.Three Months EndedMar. 31,2005June 30,2005Sept. 30,2005Dec. 31,2005Mar. 31,2006June 30,2006Sept. 30,2006Dec. 31,2006(in thousands, except per share data)Consolidated Statement ofOperations Data:RevenueDirect revenue$67,884$60,064$68,449$128,478$79,710$68,770$56,564$98,158Fulfillment partner revenue97,99790,57499,330186,54098,33490,422100,321195,871Total revenue165,881150,638167,779315,018178,044159,192156,885294,029Cost of goods soldDirect58,26251,56759,169113,38570,70361,47351,037101,730Fulfillment partner82,85776,37583,317157,50884,58775,41184,483164,926Total cost of goods sold141,119127,942142,486270,893154,290136,884135,520266,656Gross profit24,76222,69625,29344,12523,75422,30821,36527,373Operating expenses:Sales and marketing16,82614,49917,03928,79112,65911,91117,28229,045Technology4,0996,1037,9609,70213,42414,89716,15720,680General and administrative7,3467,5668,3979,77111,85011,05011,07812,859Restructuring———————5,674Total operating expenses28,27128,16833,39648,26447,93337,85844,51768,258Operating loss(3,509)(5,472)(8,103)(4,139)(14,179)(15,550)(23,152)(40,885)Interest income, net644896(1,690)(120)3152,215459577Interest expense(1,445)(1,517)(1,264)(1,356)(1,267)(1,275)(1,096)(1,127)Other income (expense), net—4,17011547—(1)(6)88Loss from continuing operations(4,310)(1,923)(11,046)(5,068)(15,131)(14,611)(23,795)(41,347)Discontinued operations:Loss from discontinued operations——(1,356)(1,215)(779)(1,128)(708)(4,267)Net loss(4,310)(1,923)(12,402)(6,283)(15,910)(15,739)(24,503)(45,614)Deemed dividend related to redeemablecommon stock(46)(47)(47)(45)(33)(33)(33)—Net loss attributable to common shares$(4,356)$(1,970)$(12,449)$(6,328)$(15,943)$(15,772)$(24,536)$(45,614)Net loss per common share—basic anddilutedLoss from continuing operations$(0.22)$(0.10)$(0.59)$(0.27)$(0.78)$(0.73)$(1.16)$(1.95)Loss from discontinued operations$—$—$(0.07)$(0.06)$(0.04)$(0.05)$(0.03)$(0.20)Net loss per share—basic and diluted$(0.22)$(0.10)$(0.66)$(0.33)$(0.82)$(0.78)$(1.19)$(2.15)Weighted average common sharesoutstanding—basic and diluted19,86219,70918,84419,31119,38520,15920,60021,163 F-35Schedule IIValuation and Qualifying Accounts(dollars in thousands) Balance atBeginning ofYearCharged toExpenseDeductionsBalance atEnd of Year Year ended December 31, 2004Deferred tax valuation allowance$25,315$2,135$—$27,450Allowance for sales returns1,11036,97535,2502,835Reserve for inventory obsolescence1,1381,0088231,323Allowance for doubtful accounts650976876750Year ended December 31, 2005Deferred tax valuation allowance$27,450$9,135$—$36,585Allowance for sales returns2,83562,17859,4375,576Reserve for inventory obsolescence1,3234,7067885,241Allowance for doubtful accounts7502,2021,1411,811Year ended December 31, 2006Deferred tax valuation allowance$36,585$37,805$—$74,390Allowance for sales returns5,57661,40163,3623,615Reserve for inventory obsolescence5,2414,4713,1276,585Allowance for doubtful accounts1,8112,3952,0712,135 F-36Exhibit 10.38Summary of Unwritten Compensation ArrangementsApplicable to Named Executive Officers of Overstock.com, Inc.The Compensation Committee (the “Committee”) of the Board of Directors of Overstock.com, Inc. (the “Company”) oversees and reviews theCompany’s executive compensation policies and programs and approves the form and amount of compensation to be paid to the Company’s executiveofficers.Annual Compensation—Base salaries, bonuses and stock option grantsThe Company is not a party to any written employment agreement with any of its named executive officers.The Company pays each of its named executive officers (as defined in Item 402(a)(3) of Regulation S-K) base salaries at the annual rate of $200,000,except for its President, Jason C. Lindsey, who is paid a base salary of $300,000. The Company does not pay its Chief Executive Officer, Patrick M. Byrne,any base salary. Additionally, the Compensation Committee of the Board of Directors of the Company approved stock option grants to named executiveofficers under the Company’s 2005 Equity Incentive PlanOn February 7, 2007, the Committee approved bonus payments to the named executive officers as a result of the officers’ performance in 2006 asfollows:Name and Title Bonus2007 SalaryStock OptionGrant (1)(shares)Patrick M. Byrne, Chief Executive Officer (2)000Jason Lindsey, President and Chief Operating Officer$180,000$300,00080,000Jonathan E. Johnson III, Senior Vice President, Corporate and Legal Affairs$120,000$200,00040,000Stormy Simon, Senior Vice President, Branding and Customer Care$120,000$200,00040,000David Chidester, Senior Vice President, Finance$120,000$200,00035,000Stephen Tryon, Senior Vice President, Logistics$120,000$200,00035,000Russell (Tad) Martin, Senior Vice President of Merchandising and Operations (3)$120,00000 (1) Options vest as to 28% on the first anniversary of the grant and 2% each month thereafter and have a ten-year term.(2) The Chief Executive Officer of the Company, Dr. Patrick M. Byrne, declined to accept any bonus payment relating to 2006, any salary for 2007, orany stock option grant.(3) As previously reported, Mr. Martin resigned effective January 11, 2007.Exhibit 10.39Summary of Unwritten Compensation ArrangementsApplicable to Non-Employee Directors of Overstock.com, Inc.Overstock.com, Inc. (the “Company”) pays its non-employee directors $20,000 annually at the rate of $5,000 per quarter, and reimburses its non-employee directors for out-of-pocket expenses incurred in connection with attending Board and committee meetings.The Company maintains its 2005 Equity Incentive Plan, under which the Board of Directors has the power to grant options and other awards tomembers of the Board. During 2006 the Board granted options to non-employee directors as follows:NameGrant DateExercisePrice ($)Number of Options GrantedJohn J. Byrne(1)April 25, 200627.405,000Gordon Macklin(2)April 25, 200627.405,000Allison AbrahamApril 25, 200627.405,000John Fisher(3)April 25, 200627.405,000Ray GrovesApril 25, 200627.405,000 (1) Mr. Byrne resigned from the Company’s board of directors on July 31, 2006.(2) Mr. Macklin passed away January 30, 2007.(3) Mr. Fisher resigned from the Company’s board of directors on February 23, 2007.Exhibit 21SUBSIDIARIES OF THE REGISTRANTNameJurisdiction ofFormationTrade Names Overstock Mexico, S. de R.L. de C.V.MexicoOverstock MexicoOTravel.com, Inc.UtahOTravel.comOverstock.com TravelOTravel Exhibit 23.1CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMWe hereby consent to the incorporation by reference in the Registration Statements on Form S-3 (Nos. 333-122904 and 333-122086), and in theRegistration Statements on Form S-8 (Nos. 333-89890 and 333-115806) of Overstock.com, Inc. of our report dated March 12, 2007 relating to the financialstatements, financial statement schedule, management’s assessment of the effectiveness of internal control over financial reporting and the effectiveness ofinternal control over financial reporting, which appears in this Form 10-K./s/PricewaterhouseCoopers LLPSalt Lake City, UtahMarch 14, 2007 Exhibit 31.1CERTIFICATIONI, Patrick M. Byrne, certify that:1. I have reviewed this Annual Report on Form 10-K of Overstock.com, Inc.;2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined inExchange Act Rules 13a-15(e) and 15(d)-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15(d)-15(f)) for the registrant and have:(a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensurethat material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this report is being prepared;(b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under oursupervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles;(c) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectivenessof the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and(d) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscalquarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect,the registrant’s internal control over financial reporting; and5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to theregistrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):(a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonablylikely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and(b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control overfinancial reporting.Date: March 14, 2007/s/ PATRICK M. BYRNEPatrick M. ByrneChief Executive Officer (principal executiveofficer) Exhibit 31.2CERTIFICATIONI, David K. Chidester, certify that:1. I have reviewed this Annual Report on Form 10-K of Overstock.com, Inc.;2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined inExchange Act Rules 13a-15(e) and 15(d)-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15(d)-15(f)) for the registrant and have:(a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, toensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within thoseentities, particularly during the period in which this report is being prepared;(b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under oursupervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements forexternal purposes in accordance with generally accepted accounting principles;(c) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about theeffectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and(d) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recentfiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely tomaterially affect, the registrant’s internal control over financial reporting; and5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to theregistrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):(a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonablylikely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and(b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control overfinancial reporting.Date: March 14, 2007/s/ DAVID K. CHIDESTERDavid K. ChidesterSenior Vice President, Finance (principal financial officer) EXHIBIT 32.1CERTIFICATION OF CHIEF EXECUTIVE OFFICERPURSUANT TO18 U.S.C. SECTION 1350,AS ADOPTED PURSUANT TOSECTION 906 OF THE SARBANES-OXLEY ACT OF 2002I, Patrick M. Byrne, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the AnnualReport of Overstock.com, Inc. on Form 10-K for the year ended December 31, 2006 fully complies with the requirements of Section 13(a) or 15(d) of theSecurities Exchange Act of 1934, as applicable, and that information contained in such Report fairly presents in all material respects the financial conditionand results of operations of Overstock.com, Inc./s/ PATRICK M. BYRNEName: Patrick M. ByrneTitle: Chief Executive Officer (principal executive officer) EXHIBIT 32.2CERTIFICATION OF CHIEF FINANCIAL OFFICERPURSUANT TO18 U.S.C. SECTION 1350,AS ADOPTED PURSUANT TOSECTION 906 OF THE SARBANES-OXLEY ACT OF 2002I, David K. Chidester, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the AnnualReport of Overstock.com, Inc. on Form 10-K for the year ended December 31, 2006 fully complies with the requirements of Section 13(a) or 15(d) of theSecurities Exchange Act of 1934, as applicable, and that information contained in such Report fairly presents in all material respects the financial conditionand results of operations of Overstock.com, Inc./s/ DAVID K. CHIDESTERName: David K. ChidesterTitle: Senior Vice President, Finance (principal financial officer)

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