Overstock.com 2007 Annual Report Download - page 51

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From our inception through the third quarter of 2007, we recorded revenue based on product ship date. In the fourth quarter of 2007, we determined that
we should not have recorded revenue until the delivery date. We performed a detailed analysis of this error and the impact of recording the cumulative effect
of the error in the fourth quarter of 2007, and have determined that the impact of the correction is immaterial to the full year and fourth quarter of 2007 and to
all prior periods.
We recorded the cumulative effect of this correction in the fourth quarter of 2007. This change resulted in a deferral of $13.7 million of revenue
(including $3.7 million of direct revenue and $10.0 million of fulfillment partner revenue), and a decrease in cost of goods sold of $11.6 million ($3.1 million
direct and $8.5 million fulfillment partner), which reduced gross profit and increased net loss by $2.1 million (see Item 15 of Part IV, "Financial
Statements"—Note 2—"Summary of Significant Accounting Policies"—"Revenue Recognition").
NOTE: all results presented in this commentary and throughout Management's Discussion and Analysis of Financial Condition and Results of Operations
include this cumulative adjustment.
Commentary—Revenue. Total revenue decreased 4% for the fiscal year 2007 to $760.2 million and 1% for Q4 2007 to $291.3 million. The fulfillment
partner business, which accounted for 74% of total revenue, grew 16% for the full year, and 15% in Q4 2007, an improvement from the 2% and 5% growth
during the same periods in 2006, respectively. Our direct business, on the other hand, shrunk 35% for the year and 32% in Q4, compared to shrinking 7% and
24% during the same periods in 2006.
Although our revenue base declined from 2006 levels, we did show progress toward returning to positive revenue growth throughout the year (Q1: -11%,
Q2: -6%, Q3: 3%, and Q4: -1%). This was driven primarily through our efforts to become more efficient in our marketing activities, and by nearly doubling
our product selection through adding new fulfillment partners, as well as increasing the number of items offered by existing fulfillment partners. This
initiative increased the number of products listed on our website to 63,000 non-BMMG products at December 31, 2007 compared to 36,000 at the end of
2006.
We also announced during the fourth quarter that we are planning to begin selling products in international markets in 2008, first in Canada, and then
potentially into other markets. Our initial approach will be to leverage existing partners in each country or region rather than opening our own distribution
facilities outside of the United States.
Commentary—Gross Profit and Gross Margin. Gross profit dollars increased 35% to $127.6 million in 2007. Gross margin expanded to 16.8% from
12.0%, a 480 basis point improvement, and a historical best for the company. Gross profit improved 74% in the fourth quarter, while total revenue decreased
by 1%. Gross margins for each of the quarters and fiscal years during 2006 and 2007 were:
Q1 2006 Q2 2006 Q3 2006 Q4 2006 FY 2006 Q1 2007 Q2 2007 Q3 2007 Q4 2007 FY 2007
13.3% 14.0% 13.6% 9.3% 12.0% 16.0% 17.7% 17.5% 16.4% 16.8%
The improvement in gross margin is primarily due to significant expansion in our direct margins, which were up 1,000 basis points to 16% in fiscal 2007
from 6% in 2006. We significantly reduced our inventory in 2006, and in 2007, we maintained lower levels of inventory by refining the selection of products
that we purchase directly to those that turn faster and have higher profitability. We believe that we can continue to do so, while filling in product selection
using fulfillment partners, rather than acquiring the inventory directly. As a result of these efforts, we have seen a substantial improvement in direct and
overall gross margin in 2007. With reduced inventory levels, we have also successfully reduced our warehouse space and the related costs, which we expect
will assist in our efforts to further improve our direct gross margin.
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