Overstock.com 2004 Annual Report Download - page 46

Gross profits for our direct operations increased to $13.8 million for the year ended December 31, 2003, from $8.7 million recorded during the same
period in 2002. For our direct operations, gross profit dollars increased 59% on a year-over-year basis while sales increased 74%. 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.
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.
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