Overstock.com 2006 Annual Report Download - page 55

Fulfillment costs
Fulfillment costs include all warehousing costs, including fixed overhead and variable handling costs (excluding packaging
costs), as well as credit card fees and customer service costs, all of which we include as costs in calculating gross margins. We believe
that some companies in our industry, including some of our competitors, account for fulfillment costs within operating expenses, and
therefore exclude fulfillment costs from gross margins. As a result, our gross margins may not be directly comparable to others in our
industry.
The following table has been included to provide investors additional information regarding our classification of fulfillment costs
and gross margins, thus enabling investors to better compare our gross margins with others in our industry:
Year ended December 31,
2004 2005 2006
Total revenue $494,635 100% $799,316 100% $788,150 100%
Cost of goods sold
Product costs and other cost of goods sold 394,154 80% 622,509 78% 632,494 80%
Fulfillment costs 34,278 7%59,931 7%60,856 8%
Total cost of goods sold 428,432 87%682,440 85%693,350 88%
Gross profit $ 66,203 13%$116,876 15%$ 94,800 12%
As displayed in the above table, fulfillment costs during the years ended December 31, 2004, 2005 and 2006 were $34.3 million,
$59.9 million and $60.9 million, respectively, or 6.9%, 7.5% and 7.7% of total revenue for those respective periods. Fulfillment costs
as a percentage of sales may vary due to several factors, such as our ability to manage costs at our warehouses, significant changes in
the number of units received and fulfilled, the extent we utilize third party fulfillment services and warehouses, and our ability to
effectively manage customer service costs and credit card fees.
Operating expenses
Sales and marketing. For the years ended December 31, 2005 and 2006, sales and marketing expenses totaled $77.2 million and
$70.9 million (8% decrease), respectively. As a percentage of total revenue, sales and marketing expenses decreased slightly from
10% in 2005 to 9% in 2006. We direct customers to our Websites primarily through a number of targeted online marketing channels,
such as sponsored search, affiliate marketing, portal advertising, e-mail campaigns, and other initiatives. We also utilize channels such
as nation-wide television, print and radio advertising campaigns. Our marketing expense is variable and is measured as a percentage of
overall sales.
Our intent in 2006 was to keep marketing expense as a percent of sales at approximately 7%, and we had accomplished this over
the first six months of the year. However, we entered the third quarter with our systems and processes running smoothly, and our
customer satisfaction ratings back to where they had been prior to the system issues we experienced at the end of 2005. As a result, we
increased both online and offline marketing expenditures in the last half of 2006 in an effort to create sales momentum in Q4 2006 and
into 2007. However, we did not see a corresponding increase in sales, primarily as a result of visitor conversion rates, and marketing
expense was 10% of sales in the fourth quarter, bringing it to 9% of sales for the year.
We believe that our marketing expenditures were less efficient due to overall increases in online marketing rates, as well as the
expiration of marketing agreements that we had with several large portals, including MSN, Yahoo and AOL, which are either no
longer available or are too expensive for us to justify. In an effort to offset this, we have internally developed a search engine
optimization tool that we believe will help us manage keyword purchases more efficiently. We intend to reduce marketing
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