Overstock.com 2003 Annual Report Download - page 22

We are an online "closeout" retailer offering discount brand name merchandise, including bed-and-bath goods, kitchenware, watches, jewelry,
electronics, sporting goods, designer accessories and travel. Our company, based in Salt Lake City, Utah, was founded in 1997, and we launched our first
Website through which customers could purchase products in March 1999.
Our revenue is comprised of direct revenue, fulfillment partner revenue and warehouse revenue. During 2003 no single customer accounted for more
than 1% of our total revenue other than Safeway, Inc., which accounted for 9% of our total revenue. Direct revenue includes sales made to individual
consumers and businesses, which are fulfilled from our warehouse in Salt Lake City, Utah. We generate business-to-business (B2B) sales when we contact
retailers by phone and e-mail and offer them our merchandise below wholesale prices, allowing them an opportunity to be more price-competitive in their
local markets. After we establish a relationship with a B2B client, the client sometimes places subsequent orders directly through our B2B Website. Our B2B
calling effort began in October 2001, so our historical direct revenue has predominantly been based on individual consumer purchases made directly through
our consumer Website.
Our fulfillment partner revenue is derived from two sources, consumer fulfillment partner revenue and B2B fulfillment partner revenue. Consumer
fulfillment partner revenue is generated when we sell merchandise of other retailers, cataloguers or manufacturers ("fulfillment partners") through our
consumer Websites. Prior to July 1, 2003, we did not own or physically handle the merchandise we sold in these transactions, as the merchandise was shipped
directly by a third party vendor, which also handled all customer returns related to those sales. Beginning July 1, 2003, we took responsibility for all returned
items relating to these sales and we now handle the resale of any returned items. As a result, beginning July 1, 2003, we are considered to be the primary
obligor for these sales transactions, and we assume the risk of loss on the returned items. As a consequence, we now record revenue from sales transactions
involving our fulfillment partners (excluding travel products) on a gross basis, rather than recording a commission on sales as we did prior to July 1, 2003.
Similar to the manner in which we generate consumer fulfillment partner revenue, we generate B2B fulfillment partner revenue when
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we sell the merchandise of third parties through our B2B Website. 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.
During the fourth quarter of 2003, we added a discount travel store to our Website. We use fulfillment partners to supply the travel products (flights,
hotels, rental cars, etc.) in our store. For the products sold in our travel store, we do not currently have inventory risk or pricing control, and do not provide
customer service. Therefore, for these sales we are not considered to be the primary obligor, and record only our commission as revenue.
Our warehouse revenue is derived primarily from sales of products that cannot be economically sold on our Websites due to their low price points, bulk,
irregular size or other factors. Historically, we held our warehouse sales in various physical locations. We held our first warehouse sale from November 2000
to January 2001, primarily to liquidate residual products from the purchase of the entire inventory of a distressed toy retailer. We initiated a second warehouse
sale in February 2002, primarily to liquidate residual products from our acquisition of Gear.com. Sales from our warehouse store in 2003 accounted for less
than 1% of total revenue. We closed the warehouse store in January 2004.
Our revenue is recorded net of returns, coupons and other discounts. In February 2002, we implemented a policy intended to reduce the number of
returned products. This new policy provides for a $4.95 restocking fee and the provision that we will not accept product returns initiated more than fifteen
days after the shipment date. We charge a 15% restocking fee (instead of the $4.95 handling fee) on all returned items from the Electronics & Computers
department.
Cost of goods sold consists of the cost of the product, as well as inbound and outbound freight, fixed warehouse costs, warehouse handling costs, credit
card fees, and customer service costs. B2B gross margins are typically less than individual consumer gross margins. Therefore, future overall gross margins
will be impacted by the blend of net revenues from the consumer and B2B sales channels. Cost of goods sold also includes related stock-based compensation
for each respective period.
Sales and marketing expenses consist primarily of advertising, public relations and promotional expenditures, as well as payroll and related expenses for
personnel engaged in marketing and selling activities. Advertising expense is the largest component of our sales and marketing expenses and is primarily
attributable to expenditures related to online marketing activities and our offline national radio and television branding campaign launched during the third
quarter of 2003. For example, our advertising expenses totaled approximately $4.8 million, $7.0 million and $18.6 million during the years ended
December 31, 2001, 2002 and 2003, respectively. We expect our sales and marketing expenses to increase in future periods on an absolute dollar basis as we
expect to continue to increase our online marketing efforts.
General and administrative expenses consist of wages and benefits for executive, accounting, technology, merchandising and administrative personnel,
rents and utilities, travel and entertainment, depreciation and amortization and other general corporate expenses.
Amortization of goodwill during 2001 resulted from the acquisition of Gear.com, Inc. in November 2000. We adopted SFAS No. 142 for the fiscal year
beginning January 1, 2002. Under this pronouncement, the remaining goodwill is not amortized, but is evaluated at least annually for impairment. There were
no impairments of goodwill during the years ended December 31, 2002 and 2003.
We have recorded no provision or benefit for federal and state income taxes as we have incurred net operating losses since inception. As of
December 31, 2002 and 2003, we had $51.3 million and $62.4 million, respectively, of net operating loss carryforwards, of which $14.4 million is subject to
limitation for those respective years. These net operating loss carryforwards will begin to expire in 2019. We have provided a full valuation allowance on the
deferred tax asset, consisting primarily of net operating loss carryforwards, because of uncertainty regarding its realizability.
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