Overstock.com 2003 Annual Report Download - page 28

growth in sales of BMV products, which account for approximately 12% of total revenue in 2003, compared to less than 1% in 2002. These combined
changes correlate to gross margins of 20% and 11% for the years ended December 31, 2002 and 2003, respectively. Cost of goods sold also includes stock-
based compensation of $373,000 and $90,000 for the years ended December 31, 2002 and 2003, respectively.
Gross profits for our direct operations increased to $13.5 million for the year ended December 31, 2003, from $8.9 million recorded during the same
period in 2002. For our direct operations, gross profit dollars increased 51% on a year-over-year basis while sales increased 75%. Gross profits for our direct
operations, as a percentage of direct revenue decreased from 11% in 2002 to 10% in 2003. This was primarily due to increased costs related to capacity
expansion at the warehouse, as well as an increase in warehouse handling expense as we ramped up staffing and packaging in anticipation of sales increases.
Additionally, overall returns costs increased significantly as we increased capacity and staffing for increased returns volumes due to the returns policy change,
and due to process inefficiencies that were identified and fixed during the third and fourth quarters.
Cost of goods sold on sales transactions from our fulfillment partners now includes the cost of the product, warehousing and fulfillment costs, credit card
fees and customer service costs. Therefore, beginning in the third quarter of 2003, overall blended gross margins will be significantly lower than they have
historically been. Now that the costs related to the initial implementation and process refinement of the fulfillment partner returns process have been absorbed
in the third quarter, future gross profit dollars generated from these sales should not be significantly affected by this change.
Our fulfillment partner operations generated gross profits of $11.6 million (12% margins) and $9.6 million (78% margins) for the years ended
December 31, 2003 and 2002, respectively. The increase in the gross profit dollars for our fulfillment partner operations was due to the general growth of the
consumer business during the year, and an increase in the number of fulfillment partner products offered on our Websites. The decrease in gross margins for
our fulfillment partner operations is largely due to the change in our business operations described above as well as an increase in BMV sales from 2% of
fulfillment partner revenue in 2002 to 25% in 2003. Margins for BMV products have historically been much lower than those of other product categories.
Operating Expenses
Sales and marketing. Sales and marketing expenses totaled $8.7 million and $20.2 million for the years ended December 31, 2002 and 2003,
representing 9% and 8% of total revenue, respectively. The increased marketing expense reflects increased online marketing efforts, particularly with the large
portals (MSN, Yahoo & AOL), and with our affiliate marketing program. In addition, during 2003 we initiated our first national radio and television
campaign, which added approximately $5.5 million to the marketing expense in the current year over the previous year. We expect total marketing expenses
to continue to increase in the future as a result of the expenses related to online marketing agreements that we have recently entered into and similar online or
offline radio, television, or other similar agreements that we may enter into in the future. The decrease in sales and marketing as a percentage of total revenue
was due to the increase in total revenue in 2003 which was a result of the fulfillment partner returns policy change that occurred beginning the third quarter of
2003.
General and administrative. General and administrative expenses increased from $10.8 million in 2002 to $16.9 million in 2003, representing 12% and
7% of total revenue, respectively. The increase in absolute dollars was primarily attributable to costs associated with building infrastructure, including
expansion of corporate systems and additional personnel costs from increased corporate headcount. The decrease in general and administrative expenses as a
percentage of total revenue was due to the increase in total revenue in 2003 which was a result of the fulfillment partner returns policy change that occurred
beginning the third quarter of 2003.
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Amortization of goodwill. Effective January 2002, we adopted SFAS No. 142, which requires that goodwill no longer be amortized. Hence, we did not
record any goodwill amortization during the years ended December 31, 2002 and 2003.
Amortization of stock-based compensation. Prior to the Company's initial public offering in May 2002, the Company recorded unearned stock-based
compensation related to stock options granted below the fair market value of the underlying stock. Since the initial public offering, the Company has not
granted any additional stock options below fair market value. Amortization of stock-based compensation was approximately $2.9 million and $756,000 for the
years ended December 31, 2002 and 2003, respectively.
Interest income, interest expense and other income (expense). The increase in interest income from $403,000 in 2002 to $461,000 in 2003 is due to the
increase in our cash and marketable securities from our follow-on offering in the first quarter of 2003. Interest expense decreased from $465,000 in 2002 to
$76,000 in 2003, primarily as a result of our termination of our inventory lines of credit in June 2002 and the reduction in our capital leases. Other income
(expense) changed from expense of $444,000 in 2002 to income of $115,000 in 2003 primarily because the company paid $439,000 of selling costs on behalf
of a selling shareholder as part of the initial public offering in 2002.
Income taxes. We incurred net operating losses in 2002 and 2003, and consequently paid insignificant amounts of federal, state and foreign income
taxes. As of December 31, 2003, we had $62.4 million of net operating loss carryforwards, of which $14.4 million is subject to limitation. These net operating
loss carryforwards will begin to expire in 2019.
Comparison of Years Ended December 31, 2001 and 2002
Revenue. Total revenue grew from $40.0 million in 2001, to $91.8 million in 2002, representing growth of 129%. During this same period, direct
revenue increased from $35.2 million to $77.9 million or a 121% growth, and fulfillment partner (formerly "commission") revenue grew from $4.0 million to
$12.4 million representing growth of 212%. Warehouse revenue was $795,000 in 2001 and $1.5 million in 2002, representing growth of 84%. The increase in
total revenue was due primarily to an increase in the number of both direct and commission orders and in the average order size. This increase was also a
result of the growth of our B2C business due to increased marketing efforts and increased sales to other businesses, including Safeway, Inc. The increase in
warehouse revenue from 2001 to 2002 was due primarily to an establishment of a permanent location for our warehouse store at our warehouse facility in July
of 2002. For the warehouse sale in 2001, we liquidated part of a large inventory purchase from Toytime.com during January of that year. For the warehouse
sale in 2002, we liquidated the remnants of the Gear.com inventory that occurred during the latter end of the first quarter and the first part of the second