Overstock.com 2006 Annual Report Download - page 54

Comparison of Years Ended December 31, 2005 and 2006
Revenue
During the year ended December 31, 2005 and 2006, total revenue decreased 1%, from $799.3 million in 2005 to $788.2 million
in 2006. During the same period, direct revenue decreased 7%, from $324.9 million in 2005 to $303.2 million in 2006, while
fulfillment partner revenue experienced 2% growth, from $474.4 million in 2005 to $484.9 million in 2006.
Our fourth quarter revenue declined 7%, the same percentage decline we experienced in Q3, and total revenue was down 1% for
the year. We believe that these decreases were primarily the result of our infrastructure upgrades in the last half of 2005, which
resulted in an unsatisfactory shopping experience for many of our customers and affected both repeat and new customer sales in 2006.
We believe that a key to future revenue growth is to increase our Website conversion rate—defined as the percentage of visitors to the
website who make a purchase. The areas of our business that most directly affect conversion rate, including personalization of the
website, customer retention, e-mail marketing, and site design and layout, are the responsibility of our internal marketing department.
Within each of these areas, we have identified and made progress on initiatives that we believe can improve conversion, including
outsourcing to third-party providers certain aspects of the functionality on the website, such as the engine that provides product
recommendations to customers visiting product pages and the gift center that went live during the fourth quarter.
Gross Margins
Total Gross Margins—For the years ended December 31, 2005 and 2006, total cost of goods sold increased $10.9 million or 2%,
from $682.4 million in 2005 to $693.4 in 2006, resulting in a decrease in gross profits of 19% (from $116.9 million in 2005 to
$94.8 million in 2006) during the same periods. As a percent of total revenue, cost of goods sold increased from 85% to 88% for those
respective periods, resulting in decreased gross margins of 14.6% and 12.0% for the years ended December 31, 2005 and 2006,
respectively. Cost of goods sold also included stock-based compensation related to the adoption of SFAS 123(R) in 2006 of $412,000
during the year ended December 31, 2006 compared to $6,000 of stock-based compensation in 2005.
Generally, our overall gross margins fluctuate based on several factors, including our product mix of sales; sales volumes mix by
our direct business and fulfillment partners; changes in vendor pricing; lowering prices for customers, including competitive pricing
and inventory management decisions within the direct business; warehouse management costs; customer service costs; and our
discounted shipping offers. Discounted shipping offers reduce shipping revenue, and therefore reduce our gross margins on retail
sales.
Direct Gross Margins—For the years ended December 31, 2005 and 2006, gross profits for our direct business decreased 57%
from $42.5 million in 2005 to $18.3 million in 2006. Gross margins for our direct business decreased from 13.1% to 6.0% for those
respective periods. The lower gross margins experienced by the direct business are primarily the result of lowering prices to our
customers in an effort to significantly reduce inventory levels, which decreased from $93.3 million at the end of 2005 to $20.3 million
at the end of 2006. As a result, we anticipate that we will see significant improvements in our direct gross margins in 2007, particulary
if we are able to successfully reduce warehouse space.
Fulfillment Partner Gross Margins—For the years ended December 31, 2005 and 2006, our fulfillment partner business generated
gross profits of $74.4 million and $76.5 million, respectively, an increase of 3%, also resulting in increased gross margins of 15.7%
and 15.8% for those respective periods.
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