Overstock.com 2012 Annual Report Download - page 58

Table of Contents
Google Inc. notified us that it was penalizing us in natural search results for noncompliance with some of Google's natural search guidelines. During
this penalty period, we dropped significantly in some Google natural search result rankings. We made changes to conform to Google's guidelines and,
on April 21, 2011, Google ended its penalization of our natural search results. We were able to offset some of the negative impact to revenue by
increasing expenditures in other marketing channels.
Revenues were hurt by a shift of marketing resources into our Club O loyalty program and away from coupons and other site-wide promotions,
which were less effective in generating revenues during the second and third quarter of 2011.
We also believe that our efforts to rebrand ourselves from Overstock.com to O.co hurt revenue growth in 2011 as it confused some prospective
customers who had trouble finding our website.
Revenues declined by 22% in our direct business due primarily to a transition of some of our clothing and shoes category to a fulfillment partner
model. Revenue from our fulfillment partner business increased by 1%. The direct business declined to 16% of total revenue in 2011 from 19% in
2010, while our fulfillment partner business generated 84% of our total revenue in 2011 compared to 81% in 2010.
Gross profit declined by 6% while gross margin declined by 40 basis points from 2010 to 2011. Direct gross margin declined by 220 basis points
due largely to fixed costs increasing as a percentage of revenue due to declining direct revenues, higher inbound and outbound freight and higher
product costs of returned goods due to a sales mix shift to the home and garden category. Fulfillment partner gross margin declined by 50 basis points,
largely due to competitive pricing initiatives.
Sales and marketing expenses as a percentage of revenue increased by 30 basis points in 2011. This was largely due to an increase in online search
marketing throughout the year. We increased our online search marketing in the first and second quarter of 2011 to help offset the lower natural search
revenue following the Google penalty, and online marketing spending increased in the second half of the year to compensate for lower revenues as a
result of the customer confusion from our O.co rebranding campaign.
Operating expense outpaced gross profit and Contribution (see "Non-GAAP Financial Measures" below for a reconciliation of Contribution to
Gross Profit) in 2011. Contribution declined by 9% due to lower gross profit and higher sales and marketing expenses, while combined technology and
general and administrative expenses increased by 18% driven by increases in technology-related personnel growth, depreciation expense and higher
legal fees. As a result, we incurred a net loss of $19.4 million for 2011.
We completed the redemption of our Senior Notes on September 21, 2011 through a combination of cash on hand and a $17 million borrowing
under our Financing Agreement with U.S. Bank National Association.
On December 27, 2011, we terminated our Master Lease Agreement dated September 17, 2010 and all related schedules with U.S. Bancorp
Equipment Finance, Inc.—Technology Finance Group. We paid approximately $20.1 million to terminate the agreement, including approximately
$1.2 million in prepayment premiums.
We ended the year with $97.0 million of cash and cash equivalents and working capital of ($14.1) million. This includes the $17.0 million
borrowed under the Financing Agreement with U.S. Bank that matures on December 31, 2012.
We experienced a $21.1 million year over year increase in free cash flow (See "Non-GAAP Financial Measures" below for a reconciliation of Free
Cash Flow to net cash provided by operating activities), from ($4.2) million in 2010 to $16.9 million in 2011. This was due primarily to a $9.3 million
improvement in operating cash flows and an $11.8 million reduction in capital expenditures in 2011.
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