Overstock.com 2005 Annual Report Download - page 41

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prioritized customer-facing issues (processing orders, shipping products and handling returns) over internal operational issues,
including the inability to upload new product descriptions to our site for a five-week period during the third quarter. This gradually
reduced the number of products on site, resulting in lower conversion rates and decreased sales. Once we were able to upload new
products, sales and conversion rates increased to previous levels. However, as a result of these issues, we grew slower overall in the
third and fourth quarters than we expected.
In addition, other IT projects that we expected to benefit gross margins through improved efficiencies in logistics and customer
service were either late or remain incomplete because the work required to address the ERP implementation monopolized our
development resources. Other projects that we expected to improve marketing effectiveness (such as Website personalization,
optimization and design) also went unfinished. We now believe that the ERP processes are working properly, and therefore, we plan
to address these unfinished IT projects during 2006.
Commentary—Growth in Revenue. Total revenue was $803.8 million in 2005, a 63% increase from the $494.6 million recorded
in 2004. However, growth slowed significantly in the second half of the year, with 64% and 44% year-over-year growth in the third
and fourth quarters of 2005.
Commentary—Improved Gross Margins and Growth in Gross Profits. Gross margins increased from 13.4% in 2004 to 15.0%
in 2005. Quarterly gross margins during the periods from the fourth quarter of 2004 through the fourth quarter of 2005 were relatively
consistent: 15.3%, 14.9%, 15.1%, 15.7% and 14.6%, respectively.
In 2005, we were able to maintain the efficiencies we had gained in gross margins by the end of 2004. Margins also benefited
(and are expected to benefit in the future) from the higher gross margins of the growing travel and auctions businesses. Overall, the
improvements in gross margins over the past two years are a result of efficiencies gained in several areas. In particular, we believe our
buying has become more efficient as we continue to grow, allowing us to make larger inventory purchases and obtain more favorable
pricing. Our total cost per package shipped (including outbound freight) has decreased due to better process management, lower
packaging costs, and increased sales volumes. Additionally, we have made improvements to the cost of processing returns, customer
service costs and credit card fees. Management believes that additional improvements can be made in gross margins; particularly in
the customer service, order fulfillment and returns areas of the business.
Commentary—Marketing. Sales and marketing expenses increased 97% from $40.5 million in 2004 to $79.7 in 2005,
representing 8% and 10% of total revenue for each respective period.
In an effort to improve the overall customer experience, we plan to reduce marketing expenditures over the first six to nine
months of 2006 as we work to harden existing systems and put process improvements in place, including enhancements to our
Website. As a result, we anticipate year-over-year growth to slow to industry rates (10%-15%) while we turn our focus from growth to
system and process improvements. We believe that these improvements will help increase conversion rates and the overall
effectiveness of our marketing expenditures.
Commentary—Technology expenses. Technology costs increased 233%, from $8.4 million in 2004 to $28.1 million in 2005,
representing 2% and 3% of total revenue for each respective period.
We incurred a "stair-step" increase in technology costs during 2005 in an effort to prepare us for growth we anticipate over the
next few years. The increase in expenditures was attributable to the increase in hardware, software and personnel costs, and
depreciation associated with the development of the new infrastructure, including the ERP implementation, expansion of corporate
systems and a database site license. The increase in technology expenses also included the costs associated with strategic projects,
including the development of an enterprise data warehouse and customer analytics system, completion of
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