Overstock.com, Inc.

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Overstock.com, Inc.

6350 South 3000 East
Salt Lake City, Utah 84121
U.S.A.
Telephone: (801) 947-3100
Toll Free: (800) 989-0135
Fax: (801) 944-4629
Web site: http://www.overstock.com

Public Company
Founded: 1997 as D2-Discounts Direct
Employees: 426
Sales: $494.6 million (2004)
Stock Exchanges: NASDAQ
Ticker Symbol: OSTK
NAIC: 423220 Home Furnishing Merchant Wholesalers; 423910 Sporting and Recreational Goods and Supplies Merchant Wholesalers; 423940 Jewelry, Watch, Precious Stone, and Precious Metal Merchant Wholesalers; 423990 Other Miscellaneous Durable Goods Merchant Wholesalers

Overstock.com, Inc. is an online retailer that sells excess inventory at discounted prices. The company, akin to an outlet store that sells the closeout merchandise of manufacturers, distributors, and other retailers, offers brand name bed-and-bath goods, home deécor, furniture, kitchenware, watches, jewelry, computers and electronics, sporting goods, and apparel. Overstock.com also sells books, magazines, CDs, DVDs, videocassettes, and video games, items that are classified as "BMV" products. The company sells approximately 500,000 BMV products and 50,000 non-BMV products. Merchandise is obtained either by buying excess inventory, referred to as the company's "direct" business, or by selling the merchandise of other retailers, catalogue companies, and manufacturers on a commission basis, referred to as its "fulfillment partner" business. Overstock.com has fulfillment partner relationships with roughly 380 clients, who supply nearly all of the BMV products and 80 percent of the non-BMV products sold on the company's web site. Overstock.com also maintains an online auction site that allows consumers to buy and sell merchandise, and it operates an online travel store, which sells cruise vacations.

Origins

Overstock.com did not assume a recognizable national profile until the company's path crossed with that of a dynamic and gifted businessman named Patrick Byrne. The company was founded in May 1997 as D2-Discounts Direct, a limited liability company that became a C Corporation at the end of 1998. Byrne first learned of the company's existence in the spring of 1999 when its founder approached him, asking for capital. The company, which had generated slightly more than $500,000 in revenue the previous year by liquidating excess inventory online, was struggling, forcing its founder to ask for Byrne's help. The meeting introduced Byrne to a business idea he would make his own, inspiring him to bring a massive outlet-store concept to the burgeoning world of e-tailing.

Byrne was 36 years old when he became aware of D2-Discounts Direct, having spent the first three decades of his life developing into a singularly accomplished person. His father, Jack Byrne, was an executive of note, serving as chief executive officer of GEICO, Fireman's Fund Insurance, and Fund America, distinguishing himself sufficiently to earn the trust and friendship of the legendary investor from Omaha, Nebraska, Warren Buffett. Buffett met Jack Byrne not long after he became chief executive officer of GEICO, which at the time was a troubled company. Buffett was impressed by Byrne, impressed to the point that he soon bought 500,000 shares in GEICO, and the two became friends. Buffett met Patrick Byrne when he was 13 years old and offered business advice to the teenager in the form of a baseball analogy. "There was no one calling balls and strikes," Byrne recounted in a February 7, 2000 interview with Fortune, "and I could take as many pitches as I wanted." Buffett's advice followed: "Every year or two, the perfect pitch comes along and you swing from the heels."

In the years after meeting Buffett, Byrne established a record of excellence, compiling a lengthy list of accomplishments. He received his undergraduate degree from Dartmouth College, translating Lao Tse's Way of Virtue during his senior year. He earned a master's degree at Cambridge University as a Marshall Scholar, where he studied moral philosophy, and he received a doctorate in philosophy from Stanford University. Byrne spoke four foreign languages, including Mandarin, earned black belts in hapkido and tae kwon do, and bicycled across the United States three times. He successfully battled cancer, surviving three appearances of seminoma and 20 surgeries between 1985 and 1988, an ordeal that left the six-foot-five-inch, 240-pound Byrne weighing only 164 pounds. He also possessed an impressive memory, a skill he demonstrated with a deck of cards. After several minutes of studying the cards, he could remember their sequence, one by one, in either direction. Remarkably, Byrne could recall the precise order of the deck six months after performing the trick.

In the months before Byrne first became involved in D2-Discounts Direct, he divided his time between running an investment firm and lending his talents to Buffett. Buffett's Berkshire Hathaway controlled scores of companies, including a uniform manufacturer in Cincinnati named Fechheimer Brothers. The company was struggling, and Buffett asked Byrne to step in as temporary chief executive officer in 1998. Byrne led Fechheimer Brothers for 18 months, gaining admirers who described him as "the greatest motivator ever" and critics who accused him of being "too quick on the trigger," according to reports in the February 7, 2000 issue of Fortune. Byrne primarily occupied himself professionally by operating a personal investment company called High Plains Investments, the entity D2-Discounts Direct's founder approached for money. Through High Plains, Byrne had amassed a $100 million portfolio, which gave him more than ample resources to invest in D2-Discounts Direct. "The financials were a joke," High Plains' chief financial officer said in a February 7,2000 interview with Fortune, referring to his initial assessment of D2-Discounts Direct. "But buried in all that was this billion-dollar idea." Byrne was entranced by the potential for an online "closeout" retailer and invested $7 million for a 60 percent stake in the company in the spring of 1999. By September, his faith in the management team had faded, and he stepped in to take over as chief executive officer, renaming the company Overstock.com the following month. Byrne's active presence delivered immediate results, triggering sales growth that saw the company's monthly revenue volume swell from $70,000 in August to $1 million by December.

Liquidated Inventories Giving Overstock.com Its Initial Merchandise Base

Once at the helm, Byrne's principal objective was to expand Overstock.com. At the end of 1999, a year in which the company generated $1.8 million in gross merchandise sales, Overstock.com offered fewer than 100 items, a selection that needed to become exponentially larger if Byrne was to succeed in his goal of making the company larger than Amazon.com, Inc. within five years. The company added to its merchandise selection in two ways, either by acquiring excess inventory for resale, its "direct" business, or by selling other parties' excess inventory for a commission, its "commission" business (later renamed "fulfillment partner"). Overstock.com dealt with manufacturers, distributors, importers, retailers, catalog companies, and e-tailers, giving each type of company a way to get rid of its excess inventory. Initially, Byrne acquired the inventories of failing dot-com companies, which were in great supply during Overstock.com's first years in business. The struggling companies were in desperate need of cash, enabling Byrne to acquire merchandise at heavily discounted prices. During his first two-and-a-half years in charge, Byrne liquidated 18 moribund dot-com companies, giving Overstock.com a product selection that supported its claim of being an outlet store for the nation. In a two-month period in 2000, for instance, Byrne acquired inventories valued at $44 million retail for prices far below retail. (Typically, Overstock.com customers paid wholesale prices.) He paid $860,000 for Adornis.com's jewelry inventory, gaining merchandise that had a retail value of $5 million and a wholesale value of $2.2 million. He paid $50,000 for the inventory of BabyStripes.com, gaining a selection of 500 baby-related products that retailed for $450,000 and had a wholesale value of $180,000. He purchased more than 2,000 hats from eHats.com, paying $70,000 for $550,000 worth of hats.

The liquidation of failing or failed dot-coms provided Byrne with a merchandise selection large enough to justify Overstock.com's debut on Wall Street. The company completed its initial public offering (IPO) of stock at the end of May 2002, when Overstock.com shares debuted at $13 per share, raising $39 million. With the proceeds obtained from the IPO, Byrne continued to broaden the company's offerings, sending representatives to search for bargain buys to build Overstock.com's direct business. He recruited former catalog buyers, traditional retail buyers, and, on some occasions, he hired ticket scalpers he met at rock concerts. "It's people who can think on their feet," Byrne said, referring to the company's buyers in a July 17, 2003 interview with Investor's Business Daily. Each purchase completed by a buyer gave the company greater revenue-generating potential, fueling the company's sales growth. Between 2000 and 2003, Overstock.com's revenues increased from $25.5 million to $91.7 million. Profits, however, proved harder to come by. The company lost nearly $40 million between 2000 and 2002, despite generating net income in its first two fiscal quarters as a publicly traded company. Some analysts blamed Overstock.com's profitability problems on Byrne's reliance on a word-of-mouth marketing strategy, but he was not to be swayed. "We're betting the ranch on that," he stated in a July 17, 2003 interview with Investor's Business Daily. "We can price cheaper and count on customers to spread the word," he added. "I don't want to spend $200 million on advertising and price it into the products." He later changed his mind about the company's marketing tactics, at least as demonstrated by the enormous attention the company was attracting midway through the decade by turning to expensive television commercials, but before the company hit the airwaves it began to record surging revenue growth.

Company Perspectives:

Closeout merchandise is typically available in inconsistent quantities and prices and often is only available to consumers after it has been purchased and resold by disparate liquidation wholesalers. We believe that the traditional liquidation market is therefore characterized by fragmented supply and fragmented demand. Overstock utilizes the Internet to aggregate both supply and demand and create a more efficient market for liquidation merchandise. We provide consumers and businesses with quick and convenient access to high-quality, brand-name merchandise at discount prices.

The merchandise foundation supporting Overstock.com had been established almost exclusively through direct acquisition deals. In the years immediately following its IPO, the company recorded its greatest financial growth by forging commissioned-based deals with manufacturers, other retailers, catalogue companies, distributors, and importers. Overstock.com, once it established itself as a legitimate, trustworthy player in the e-commerce sector, was able to form partnerships with companies such as Hewlett-Packard, Kenneth Cole, Simon & Schuster, Samsonite, and Cuisinart. These fulfillment partners, constituting the former commission side of Overstock.com's business, drove the company's revenue growth following its IPO. In 2000, fulfillment partner agreements accounted for $867,000 of the company's $25.5 million in revenue. In 2002, fulfillment partner agreements accounted for $12.3 million of the company's $91.7 million in revenue. In 2003, fulfillment partner revenue skyrocketed to $100.8 million, pushing overall revenue to $238.9 million, before eclipsing the direct side of the company's business in 2004, when partnership agreements generated $281.4 million of the company's $494.6 million in revenue collected during the year.

Post-IPO Diversification

Against the backdrop of energetic revenue growth, the company added new dimensions to its business during the period immediately following its IPO. In July 2003, Overstock Mexico, S. de R.L. de C.V. was formed, a wholly owned subsidiary created to distribute products in Mexico. Several months later, a discount travel store was added to the Overstock.com web site, part of Byrne's plan to provide a one-stop destination for discount shopping for products and services. The travel store was shut down in May 2004, but after improvements were made in the types of services offered, it returned in January 2005, enabling users to book reservations for flights, hotels, cars, and cruises. In September 2004, the company launched a bold bid to take away some of eBay Inc.'s business by adding an online auction function to its web site. Like eBay, Overstock.com operated the site strictly as a consumer-to-consumer marketplace.

As Overstock.com prepared for the second half of the decade, several positive developments mitigated the company's problems with profitability. The company lost $11.8 million in 2003 and $5 million in 2004, but investors hardly seemed to care. During the fourth fiscal quarter of 2004, the company's stock reached a record high of $76.05 per share, an enormous increase from the debut price of $13 per share. Part of the confidence expressed by Wall Street stemmed from the success of the company's marketing campaign midway through the decade, one that strayed far from Byrne's commitment to word-of-mouth advertising. The campaign featured a 41-year-old model, Sabine Ehrenfeld, dressed in white and surrounded by white consumer items and the tagline, "Have you discovered the secret of the Big O?" The television and radio commercials proved to be surprisingly successful, exceeding the hopes of Overstock.com executives. In a market survey conducted in November 2004, brand awareness of the Overstock.com name reached 46 percent, up substantially from the 12 percent recorded in 2003. "We never expected this kind of interest," the company's vice-president of branding said in a March 5, 2005 interview with the Salt Lake Tribune. "This is just bizarre—in a good way," he added.

With public interest stirred and its revenue increasing robustly, Overstock.com stood poised to clear the one hurdle it had been unable to clear during its first six years in business: consistent profitability. Byrne maintained that the company's failure to record steady profits was based in large part on his emphasis on expansion, suggesting that if he ratcheted back growth plans Overstock.com would soon become profitable. Byrne, however, was committed to expansion for the near-term, as he pressed forward with acquiring inventories and forming fulfillment partner agreements, seeking to make Overstock.com the dominant player in re-selling closeout merchandise online.

Principal Subsidiaries

Overstock Mexico, S. de R.L. de C.V.

Principal Competitors

Amazon.com, Inc.; Buy.com Inc.; SmartBargains, Inc.

Key Dates:

1997:: Overstock.com's predecessor, D2-Discounts Direct, is formed.
1999:: Patrick Byrne acquires a 60 percent stake in D2-Discounts Direct and changes its name to Overstock.com.
2000:: Byrne begins acquiring the inventories of ailing dot-com companies.
2002:: Overstock.com completes its initial public offering of stock.
2003:: Overstock Mexico, a subsidiary, is formed to distribute merchandise in Mexico.
2004:: The company launches an online auction site.