# NEIGHBORHOOD INTELLIGENCE, INC. (BBBY) FY 2022 MD&A

Verbatim Item 7 Management's Discussion and Analysis from NEIGHBORHOOD INTELLIGENCE, INC.'s 10-K for fiscal year 2022.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1130713/000113071323000014/ostk-20221231.htm
Accession: 0001130713-23-000014
Filing date: 2023-02-24
Report date: 2022-12-31
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary.
Confidence: high

Company profile: /company/BBBY/
All MD&A years: /company/BBBY/mda/
Previous year: /company/BBBY/mda/fy2021/ (FY 2021)
Next year: /company/BBBY/mda/fy2023/ (FY 2023)

ITEM 7.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis contains forward-looking statements relating to future events or our future financial or operating performance that involve risks and uncertainties, as set forth above under "Special Cautionary Note Regarding Forward Looking Statements." or in Item 1A under the heading "Risk Factors" or included elsewhere in this Annual Report on Form 10-K. In addition, our future results may be significantly different from our historical results.

Financial Reporting Presentation Relating to Discontinued Operations

Unless otherwise specified, disclosures throughout Management's Discussion and Analysis of Financial Condition and Results of Operations, including disclosures under “Liquidity and Capital Resources,” reflect continuing operations only. See Note 4—Discontinued Operations in the "Notes to Consolidated Financial Statements" included in Item 8 of Part II, "Financial Statements and Supplementary Data" of this Annual Report on Form 10-K for further information.

Overview

Overstock provides furniture and home furnishings to assist consumers in "Making Dream Homes Come True," particularly for our target customers—consumers who seek smart value on quality, stylish furniture and home furnishings at competitive prices, and who want an easy shopping experience. We believe that the furniture and home furnishings market, which is highly fragmented and has traditionally been served by brick-and-mortar stores, will continue transitioning to online sales as consumers become increasingly comfortable shopping online. We regularly update our product assortment to meet the evolving preferences of our customers and current trends. Our products include furniture, décor, area rugs, bedding and bath, home improvement, outdoor, and kitchen and dining items, among others. Our supply chain allows us to ship directly to our customers from our suppliers or from our warehouses. See Item 1—"Business—Our Business" for an additional overview on our business.

We are focused on growth drivers including, increasing our home assortment to improve our brand association with home, making it easier for our customers to find and view a broad assortment of products, increasing mobile app adoption driving higher customer retention and brand loyalty, optimizing our marketing efforts to grow Overstock consideration among home shoppers, growing our customer base in Canada, and gaining market share by strengthening our brand pillars of "Product Findability," "Smart Value," and "Easy Delivery and Support."

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Executive Commentary

This executive commentary is intended to provide investors with a view of our business through the eyes of our management. As an executive commentary, it necessarily focuses on selected aspects of our business. This executive commentary is intended as a supplement to, but not a substitute for, the more detailed discussion of our business included elsewhere herein. Investors are cautioned to read our entire "Management's Discussion and Analysis of Financial Condition and Results of Operations," and our interim and audited financial statements, and the discussion of our business and risk factors and other information included elsewhere or incorporated in this report. This executive commentary includes forward-looking statements, and investors are cautioned to read "Special Cautionary Note Regarding Forward-Looking Statements."

Our consolidated cash and cash equivalents balance decreased from $503.3 million as of December 31, 2021 to $371.3 million as of December 31, 2022, a decrease of $132.1 million, primarily as the result of repurchases of our common stock and Series A-1 preferred stock under the Repurchase Program of $80.1 million, purchases of equity securities of $18.9 million, expenditures of property and equipment of $14.9 million, and net cash outflows from operating activities of $12.5 million during the year ended December 31, 2022.

Revenue decreased 30% in 2022 compared to 2021. This decrease was primarily due to a 39% decrease in the number of customer orders, partially offset by a 15% increase in average order value driven by a continued product mix shift into furniture and home furnishings categories. This decreased order activity was largely driven by the absence of pandemic-related shopping behavior as seen in the prior year, the impact of macroeconomic factors including a heightened inflationary environment and uncertainty impacting consumer sentiment, a shift in consumer spending preferences, and our strategy to exit non-home categories.

Gross profit decreased 29% in 2022 compared to 2021 primarily due to decreased sales volume and partially offset by an increase in gross margin. Gross margin increased to 23.0% in 2022, compared to 22.6% in 2021, primarily due to merchandising actions, advertising revenue, and operational efficiencies. The increase was partially offset by higher promotional discounting and carrier costs.

Sales and marketing expenses as a percentage of revenue increased to 11.2% in 2022 compared to 11.0% in 2021, primarily due to increased brand advertising, partially offset by decreased performance marketing expenses.

Technology expenses decreased $1.8 million in 2022 compared to 2021, primarily due to decreased third party spend and staff-related expenses. The decrease was partially offset by increased licensing costs.

General and administrative expenses decreased $7.7 million in 2022 compared to 2021, primarily driven by reduced legal, third-party vendor, and facilities-related expenses, partially offset by increased staff-related expenses.

Additional commentary related to macroeconomic trends

We continue to monitor recent macroeconomic trends, including the impact caused by global developments such as the current conflict between Russia and Ukraine (including the related heightened geopolitical tensions and economic actions in response thereto by various countries), and their impact on our supply chain, customers, and employees. While we have no operations in or direct exposure to Russia or Ukraine, we believe the conflict between Russia and Ukraine combined with higher consumer price inflation has resulted in reduced consumer confidence and consumer spending which negatively impacted our sales during the year. In addition, we have experienced increased employee turnover, inflation in product costs, higher wages, higher share-based compensation expenses, and higher energy and fuel costs, each at a higher rate than what we have experienced in recent years. However, we continue to work with our partners to limit price increases in response to higher costs and have been able to improve gross margins year over year.

Due to the uncertain and constantly evolving nature and extreme volatility created by these disruptions in the capital markets, we cannot currently predict the long-term impact of these events on our operations and financial results. Nevertheless, as of December 31, 2022, the challenges arising from these events have not adversely affected our liquidity or capacity to service our debt, nor have these conditions required us to reduce our capital expenditures.

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Liquidity and Capital Resources

Overview

We believe that our cash and cash equivalents currently on hand and expected cash flows from future operations will be sufficient to continue operations for at least the next twelve months. We continue to monitor, evaluate, and manage our operating plans, forecasts, and liquidity considering the most recent developments driven by macroeconomic conditions, such as supply chain challenges, inflation, rising interest rates, and the current conflict between Russia and Ukraine. We proactively seek opportunities to improve the efficiency of our operations and have in the past and may in the future take steps to realize internal cost savings, including aligning our staffing needs based on our current and expected future levels of operations and process streamlining.

We periodically evaluate opportunities to repurchase our equity securities, obtain credit facilities, or issue additional debt or equity securities which may impact our future operations and liquidity. In addition, we may, from time to time, consider the investment in, or acquisition of, complementary businesses, products, services, or technologies to expand our business, any of which might affect our liquidity requirements or cause us to issue additional debt or equity securities that would be dilutive to shareholders.

Cash flows from discontinued operations are disclosed on our statement of cash flows as separate line items in the operating, investing, and financing activities sections. We anticipate that the absence of cash flows from discontinued operations will positively affect future liquidity and capital resources.

Current sources of liquidity

Our principal sources of liquidity are existing cash and cash equivalents, and accounts receivable, net. At December 31, 2022, we had cash and cash equivalents of $371.3 million and accounts receivable, net of $17.7 million.

Cash flow information is as follows (in thousands):

[[GREPCENT_TABLE]]
[["","Year ended December 31,"],["","2022","","2021"],["Cash provided by (used in):"],["Operating activities","$","(12,535)","","","$","98,047"],["Investing activities","(33,034)","","","(56,433)"],["Financing activities","(86,340)","","","(12,683)"]]
[[/GREPCENT_TABLE]]

At December 31, 2022, we had $150.0 million available under our "at the market" sales program which permits us to conduct "at the market" public offerings of our common stock under a sales agreement, dated June 26, 2020, with JonesTrading Institutional Services LLC ("JonesTrading") and D.A. Davidson & Co. ("D.A. Davidson"). We did not sell any shares under our at the market sales program during the years ended December 31, 2022 and 2021.

Operating activities

Cash received from customers generally corresponds to our net revenues as our customers primarily use credit cards to buy from us causing our receivables from these sales transactions to settle quickly. We have payment terms with our partners that generally extend beyond the amount of time necessary to collect proceeds from our customers.

The $12.5 million of net cash used by continuing operating activities during the year ended December 31, 2022 was primarily due to income from continuing operations, adjusted for non-cash items, of $67.8 million, offset by cash used by changes in operating assets and liabilities of $80.3 million.

The $98.0 million of net cash provided by continuing operating activities during the year ended December 31, 2021 was primarily due to income from continuing operations, adjusted for non-cash items, of $141.6 million, offset by cash used by changes in operating assets and liabilities of $43.6 million.

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Investing activities

The $33.0 million of net cash used in investing activities during the year ended December 31, 2022 was primarily due to purchases of equity securities of $18.9 million and expenditures for property and equipment of $14.9 million.

The $56.4 million of net cash used in investing activities during the year ended December 31, 2021 was primarily due to contributions for capital calls relating to our limited partnership interest in the Medici Ventures, L.P. fund of $41.1 million and expenditures for property and equipment of $13.6 million.

Financing activities

The $86.3 million net cash used in financing activities during the year ended December 31, 2022 resulted primarily from $80.1 million for repurchases of our common stock and Series A-1 preferred stock under the Repurchase Program, $3.7 million of payments of taxes withheld upon vesting of restricted stock, and $3.4 million of payments on long-term debt.

The $12.7 million net cash used in financing activities during the year ended December 31, 2021 resulted primarily from $8.3 million of payments of taxes withheld upon vesting of restricted stock and $3.0 million of payments on long-term debt.

Contractual Obligations and Commitments

The following table summarizes our contractual obligations as of December 31, 2022 and the effect such obligations and commitments are expected to have on our liquidity and cash flow in future periods (in thousands):

[[GREPCENT_TABLE]]
[["","","Payments due by period"],["Contractual Obligations","","Total","","Less than 1 year","","1-3 years","","3-5 years","","More than 5 years"],["Operating leases (1)","","$","8,718","","","$","4,816","","","$","3,569","","","$","333","","","$","\u2014"],["Loan agreements (2)","","49,331","","","5,264","","","3,261","","","2,968","","","37,838"],["Total contractual cash obligations","","$","58,049","","","$","10,080","","","$","6,830","","","$","3,301","","","$","37,838"]]
[[/GREPCENT_TABLE]]

 ___________________________________________

(1)    Represents the future minimum lease payments under non-cancellable operating leases. For information regarding our operating lease obligations, see Item 8 of Part II, "Financial Statements and Supplementary Data"—Note 11—Leases contained in the "Notes to Consolidated Financial Statements" of this Annual Report on Form 10-K.

(2)    Represents future interest and principal payments on our financing agreements. For information regarding our financing agreements, see Item 8 of Part II, "Financial Statements and Supplementary Data"—Note 10—Borrowings contained in the "Notes to Consolidated Financial Statements" of this Annual Report on Form 10-K.

Tax contingencies

We are involved in various tax matters, the outcomes of which are uncertain. As of December 31, 2022, and 2021, tax contingencies were $3.5 million and $3.2 million, respectively, which are included in our reconciliation of unrecognized tax benefits (see Item 8 of Part II, "Financial Statements and Supplementary Data"—Note 19—Income Taxes contained in the "Notes to Consolidated Financial Statements" of this Annual Report on Form 10-K). Changes in state, federal, and foreign tax laws may increase our tax contingencies. The timing of the resolution of income tax contingencies is highly uncertain, and the amounts ultimately paid, if any, upon resolution of issues raised by the taxing authorities may differ from the amounts accrued. It is reasonably possible that within the next 12 months we will receive additional assessments by various tax authorities. These assessments may or may not result in changes to our contingencies related to positions on prior years' tax filings.

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Results of Operations

Net revenue, costs of goods sold, gross profit and gross margin

The following table summarizes our net revenue, costs of goods sold, gross profit and gross margin for the years ended December 31, 2022 and 2021 (in thousands):

[[GREPCENT_TABLE]]
[["","Year ended December 31,"],["","2022","","2021"],["Net revenue","$","1,929,334","","","$","2,756,446"],["Cost of goods sold"],["Product costs and other cost of goods sold","1,409,197","","","2,026,363"],["Merchant fees, customer service, and other","76,793","","","106,181"],["Total cost of goods sold","1,485,990","","","2,132,544"],["Gross profit","$","443,344","","","$","623,902"],["Year-over-year percentage changes"],["Net revenue","(30.0)","%"],["Gross profit","(28.9)","%"],["Percent of total net revenue"],["Cost of goods sold"],["Product costs and other cost of goods sold","73.0","%","","73.5","%"],["Merchant fees, customer service, and other","4.0","%","","3.9","%"],["Total cost of goods sold","77.0","%","","77.4","%"],["Gross margin","23.0","%","","22.6","%"]]
[[/GREPCENT_TABLE]]

The 30% decrease in net revenue for the year ended December 31, 2022, as compared to the same period in 2021, was primarily due to a 39% decrease in the number of customer orders, partially offset by a 15% increase in average order value driven by a continued product mix shift into furniture and home furnishings categories. This decreased order activity was largely driven by the absence of pandemic-related shopping behavior as seen in the prior year, the impact of macroeconomic factors including a heightened inflationary environment and uncertainty impacting consumer sentiment, a shift in consumer spending preferences, and our strategy to exit non-home categories.

We cannot estimate the impact that macroeconomic conditions, such as supply chain challenges, inflation, rising interest rates, or the current conflict between Russia and Ukraine will have on our business in the future due to the unpredictable nature of the ultimate development and duration of these conditions.

International net revenues were less than 1% of total net revenues for 2022 and 2021.

Estimate of unearned product revenue on undelivered product

Our revenue related to merchandise sales is recognized upon delivery to our customers. As we ship high volumes of packages through multiple carriers, it is not practical for us to track the actual delivery date of each shipment. Therefore, we use estimates to determine which shipments are delivered and, therefore, recognized as revenue at the end of the period. Our delivery date estimates are based on average shipping transit times. We review and update our estimates on a quarterly basis based on our actual transit time experience. However, actual shipping times may differ from our estimates, which can be further impacted by uncertainty, volatility, and any disruption to our carriers caused by certain macroeconomic conditions, such as supply chain challenges, inflation, rising interest rates, or the current conflict between Russia and Ukraine.

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The following table shows the effect that hypothetical changes in the estimate of average shipping transit times would have on the reported amount of revenue and income before taxes (in thousands):

[[GREPCENT_TABLE]]
[["","Year Ended December 31, 2022"],["Change in the Estimate of Average Transit Times (Days)","Increase (Decrease) Revenue","","Increase (Decrease) Income Before Income Taxes"],["2","$","(8,819)","","","$","(1,810)"],["1","$","(5,794)","","","$","(1,189)"],["As reported","As reported","","As reported"],["(1)","$","3,702","","","$","760"],["(2)","$","6,776","","","$","1,392"]]
[[/GREPCENT_TABLE]]

Gross profit and gross margin

Our overall gross margins fluctuate based on competitive pricing; inventory management decisions; sales coupons and promotions; product mix of sales; advertising revenue and our marketing allowance program; and operational and fulfillment costs. Merchant fees, customer service, and other (previously labeled "Fulfillment and related costs") include merchant processing fees associated with customer payments made by credit cards and other payment methods and other variable fees, customer service costs, costs incurred to operate and staff our warehouses, including rent and depreciation expense associated with these facilities, costs to receive, inspect, pick, and prepare customer order for delivery, and direct and indirect labor costs including payroll, payroll-related benefits, and stock-based compensation, all of which we include as costs in calculating gross margin. Merchant fees, customer service, and other as a percentage of sales may vary due to several factors, such as our ability to effectively manage merchant fees, customer service costs, and warehouse costs. We believe that some companies in our industry, including some of our competitors, account for merchant fees, customer service, and other costs within operating expenses, and therefore exclude merchant fees, customer service, and other costs from gross margin. As a result, our gross margin may not be directly comparable to others in our industry.

Gross margins for the past eight quarterly periods and years ending December 31, 2022 and 2021 were:

[[GREPCENT_TABLE]]
[["","Q1","","Q2","","Q3","","Q4","","FY"],["2022","23.4","%","","22.9","%","","23.3","%","","22.1","%","","23.0","%"],["2021","23.3","%","","22.0","%","","22.7","%","","22.7","%","","22.6","%"]]
[[/GREPCENT_TABLE]]

Gross profit for the year ended December 31, 2022 decreased 29% compared to the same period in 2021, primarily due to decreased sales volume and partially offset by an increase in gross margin. Gross margin increased to 23.0% for the year ended December 31, 2022, compared to 22.6% for the same period in 2021, primarily due to merchandising actions, advertising revenue, and operational efficiencies. The increase was partially offset by higher promotional discounting and carrier costs.

Operating expenses

Sales and marketing expenses

We use a variety of online advertising channels to attract new and repeat customers, including search engine marketing, personalized emails, mobile app, loyalty program, affiliate marketing, display banners, and social media. We also build our brand awareness through linear and streaming TV.

Costs associated with our discounted shipping and other promotions, such as coupons, are not included in sales and marketing expense. Rather, they are accounted for as a reduction in revenue as they reduce the amount of consideration we expect to receive in exchange for goods or services and therefore affect net revenues and gross margin. We consider discounted shipping and other promotions, such as our policy for free shipping on orders, as an effective marketing tool.

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The following table summarizes our sales and marketing expenses for the years ended December 31, 2022 and 2021 (in thousands):

[[GREPCENT_TABLE]]
[["","Year ended December 31,"],["","2022","","2021"],["Sales and marketing expenses","$","215,477","","","$","302,430"],["Advertising expense included in sales and marketing expenses","205,523","","","289,019"],["Year-over-year percentage change"],["Sales and marketing expenses","(28.8)","%"],["Advertising expense included in sales and marketing expenses","(28.9)","%"],["Percentage of net revenue"],["Sales and marketing expenses","11.2","%","","11.0","%"],["Advertising expense included in sales and marketing expenses","10.7","%","","10.5","%"]]
[[/GREPCENT_TABLE]]

The 20 basis point increase in sales and marketing expenses as a percent of net revenues for the year ended December 31, 2022, as compared to the same period in 2021, was primarily due to increased brand advertising, partially offset by decreased performance marketing expenses.

Technology expenses

We seek to deploy our capital resources efficiently in technology to support operations including private and public cloud, web services, customer support solutions, and product search, and in technology to enhance the customer experience, including machine learning algorithms, improving our process efficiency, modernizing and expanding our systems, and supporting and expanding our logistics infrastructure. We expect to continue to incur technology expenses to support these efforts and these expenditures may continue to be material.

The frequency and variety of cyberattacks on our Website, enterprise systems, services, and on third parties we use to support our technology continues to increase. The impact of such attacks, their costs, and the costs we incur to protect ourselves against future attacks have not been material to date. However, we consider the risk introduced by cyberattacks to be serious and will continue to incur costs related to efforts to protect ourselves against them.

The following table summarizes our technology expenses for the years ended December 31, 2022 and 2021 (in thousands):

[[GREPCENT_TABLE]]
[["","Year ended December 31,"],["","2022","","2021"],["Technology expenses","$","121,158","","","$","123,001"],["Year-over-year percentage change"],["Technology expenses","(1.5)","%"],["Technology expenses as a percent of net revenue","6.3","%","","4.5","%"]]
[[/GREPCENT_TABLE]]

The $1.8 million decrease in technology expenses for the year ended December 31, 2022, as compared to the same period in 2021, was primarily due to decreased third party spend and staff-related expenses. The decrease was partially offset by increased licensing costs.

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General and administrative expenses

The following table summarizes our general and administrative expenses for the years ended December 31, 2022 and 2021 (in thousands):

[[GREPCENT_TABLE]]
[["","Year ended December 31,"],["","2022","","2021"],["General and administrative expenses","$","79,701","","","$","87,399"],["Year-over-year percentage change"],["General and administrative expenses","(8.8)","%"],["General and administrative expenses as a percent of net revenue","4.1","%","","3.2","%"]]
[[/GREPCENT_TABLE]]

The $7.7 million decrease in general and administrative expenses for the year ended December 31, 2022, as compared to the same period in 2021, was primarily driven by reduced legal, third-party vendor, and facilities-related expenses, partially offset by increased staff-related expenses.

Other income (expense), net

The $76.3 million decrease in other income (expense), net for the year ended December 31, 2022, as compared to the same period in 2021, was primarily due to a $76.5 million decrease in income recognized on our equity method securities.

Income taxes

Our effective tax rate for the years ended December 31, 2022 and 2021 was (4.1)% and (39.6)%, respectively. Our effective tax rate is affected by recurring items such as research tax credits and non-recurring items such as changes in valuation allowances. We record valuation allowances against deferred tax assets when there is uncertainty about our ability to generate future income in relevant jurisdictions. The impact that macroeconomic conditions, such as supply chain challenges, inflation, rising interest rates, or the current conflict between Russia and Ukraine will have on our business in the future make estimates of future income more challenging due to the unpredictable nature of the ultimate development and duration of these conditions. It is also affected to a lesser extent by tax rates in foreign jurisdictions and the relative amount of income we earn in those jurisdictions, which we expect to be fairly consistent in the near term. Our low effective tax rate is primarily attributable to an increase in our valuation allowance for capital loss deferred tax assets associated with unrealized losses on our equity method securities. Our tax expense increased as compared to the same period in 2021 primarily due to the fact we no longer maintain a valuation allowance on most of our federal and state deferred tax assets.

We have indefinitely reinvested foreign earnings of $7.1 million at December 31, 2022. We would need to accrue and pay various taxes on this amount if repatriated. We do not intend to repatriate these earnings.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles ("GAAP") requires estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities in the consolidated financial statements and accompanying notes. The SEC has defined a company's critical accounting policies as the ones that are most important to the portrayal of the company's financial condition and results of operations, and which require the company to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Based on this definition, we have identified the critical accounting policies, estimates and judgments addressed below. We also have other key accounting policies, which involve the use of estimates, judgments, and assumptions that are significant to understanding our results. For additional information, see Item 8 of Part II, "Financial Statements and Supplementary Data"—Note 2—Accounting Policies and Supplemental Disclosures. We believe that our estimates, assumptions, and judgments are reasonable. We evaluate our estimates and assumptions on an ongoing basis. Actual results may differ significantly from these estimates. Our critical accounting policies are as follows:

•valuation of certain equity method securities carried at fair value.

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Valuation of certain equity method securities carried at fair value

We measured certain equity method securities at fair value at the reporting date. In the absence of quoted market prices (e.g., a privately held entity), the fair value was determined in good faith under our valuation policy and process using generally accepted valuation approaches. We utilized an independent third party valuation firm to assist us in determining the fair value of our direct minority interest in tZERO using a market approach. The market approach relied upon market transaction valuations of the subject company, adjusted for enterprise value changes in guideline public companies. The fair value determination of our direct minority interest in tZERO required the use of significant unobservable inputs (Level 3 inputs) as shown in the table within Note 2—Accounting Policies and Supplemental Disclosures, Equity securities accounted for under the equity method under ASC 323. Due to the inherent uncertainty of determining the fair value of Level 3 securities that do not have a readily available market value, the determination of fair value required significant judgment or estimation and changes in the estimates and assumptions used in the valuation models could materially affect the determination of fair value for these assets.

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