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Executives

Jonathan Johnson – President

Patrick Byrne – Chairman and Chief Executive

Steve Chesnut – Senior Vice President of Finance

Analysts

Nat Schindler – Bank of America/Merrill Lynch

[Larry Wyck – Morningstar]

Overstock.com Inc. (OSTK) Q1 2009 Earnings Call April 22, 2009 3:00 PM ET

Operator

I would like to welcome everyone to the Q1 2009 Overstock.com conference call. (Operator Instructions) I will now hand the floor to Mr. Jonathan Johnson, President.

Jonathan Johnson

We welcome our friends and owners to our first quarter 2009 conference call. Joining me on the call today are Dr. Patrick Byrne, Chairman and CEO of the company, and Steve Chesnut, the company's Senior Vice President of Finance. The following discussion and our responses to your questions reflect management's views as of today, April 22, 2009 only and will include forward-looking statements. Actual results may differ materially.

Additional information about factors that could potentially impact our financial results is included in today's press release and our filings with the SEC, including our 2008 annual report on Form 10-K. As you listen to today's call, I encourage you to have today's press release in front of you since our financial results, detailed commentary and the CEO's letter to shareholders are included and will correspond to much of the discussion.

During this call we'll discuss certain non-GAAP financial measures. Our press release, the slides accompanying this webcast and our filings with the SEC, each of which are posted on our investor relations website contain additional disclosures regarding these non-GAAP measures, including reconciliation of these measures to the most comparable GAAP measures. Lastly we expect to file our form 10-Q for the first quarter of the year in the near future and we encourage you to read it as well for additional information on our financial results.

With that preliminary business out of the way, let me turn the call over to Steve to review our financial results.

Steve Chesnut

Following is a brief review of our financial results for the first quarter ending March 31, 2009. Please refer to our earnings press release for the full financial statements and further details regarding our results. And keep in mind that unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2008.

Consumer sentiment remained fairly weak through the first quarter. While traffic to our website was high, conversion and average order size were lower than last year. As a result, revenue declined 8%. The sales mix was 81% fulfillment partner and 19% direct. Gross profit was $37.7 million an 11% increase in gross margin was 20.1%, a 337 basis point improvement over Q1 2008.

Like last quarter, our reported gross profit included some billing recoveries and freight refund related to earlier periods totaling $1.9 million, which reduced our cost of goods sold by approximately 103 basis points. Excluding these items, gross profit would have been $35.8 million, a 5% increase over last year, and gross margin would have been 19.1%.

Sales and marketing expense declined 10% from last year to $13.5 million. As a percent of revenue marketing costs were down 18 basis points to 7.2%. Contribution expanded 27% in Q1 to $24.2 million and contribution margin was 12.9%. Excluding the billing recoveries discussed above, contribution would have been $22.2 million and contribution margin would have been 11.9%.

Technology expenses fell 5% while G&A cost increased by 41% for the quarter. Combined technology and G&A expenses increased 13% to $27.2 million. Salaries and benefits related to an increase in headcount was a primary driver in higher G&A costs. In addition, we accrued and have paid a $1.25 million termination fee to James Joyce as a result of his consulting arrangement ending.

Operating loss for the quarter was $3.1 million compared to a loss of $5.1 million last year, a $2 million improvement. The net loss for the quarter was $2.1 million, a $2.7 million improvement over last year. The net loss per share for the quarter was $0.09. The net loss was $1 million less than the operating loss due mainly to the $1.9 million gain we recognized on the extinguishment of 4.9 million of our senior convertible notes that we bought at a discount.

Adjusted EBITDA was $2 million in Q1 and $14 million on a trailing 12-month basis. The depreciation and stock based compensation was $5 million for the quarter. Cash on hand at March 31, 2009 was $78.6 million. Inventories were down to $13.1 million and working capital was $33.7 million. Operating cash flows for the quarter were a negative $27.1 million, up from a negative $41 million last year.

Operating cash flows are typically at the lowest point in Q1 due to seasonality. On a trailing 12-month basis, however, operating cash flows were a positive $15.9 million. This compares to a $27.2 million during Q1 last year.

That concludes my financial summary, so I'll turn the call over to you, Patrick.

Patrick Byrne

I'll be clicking through the slides starting on slide three. You've already hit some of the main events here. I like the $15.9 million trailing 12-month operating cash flow. Slide four, quarterly revenue growth you see that we turned a corner, another corner there. I understand Colin Sebastian has written in and said does this mean, what does this mean, in a quarter, etc.

What it actually means was in November we were shrinking the most and Jonathan or Steve, correct me if I get a month off here. November and early December, which was a shrink got at its worse and it's gradually inched its way back up. So no, it isn't that we had a downturn in this first quarter.

Jonathan or Steve, do you want to add some color on that?

Jonathan Johnson

Patrick that's correct. November was our, we had a significant downturn and it got better in December and the first quarter was pretty much flat as far as the amount we were decreasing.

Steve Chesnut

That's right.

Patrick Byrne

Yes, it's basically been holding steady around there. And again we are much more focused, as I've been saying for a couple of years, on contribution dollars, growth and contribution dollars. Please go to slide five, the quarterly gross profit growth is 11%, but since we are getting more and more efficient on marketing, go to slide six, you see 27% growth in contribution dollars.

Slide seven we had an all time high both in the margin and the contribution, margin at 20.1, contribution at 12.9. We, as Steve Chesnut points out, that there is some noise in that number, but we did get the benefit of a shipping billing benefit of some several hundred thousand dollars and so forth. But I think we actually had something like that in the first quarter last year.

Steve, did you want to give any more detail on what that was and why this would have been 19.1 without other various factors?

Steve Chesnut

Yes, I think when we decomposed that, obviously there was just as consistent with fourth quarter we were recouping some contractual payments that were due to us from our vendor community, partner community and then as part of our normal investigation we found an over billing from a freight partner that we've recaptured that. So just as part of good corporate diligence and governance we've found these items.

Patrick Byrne

We keep on just squeezing the tube of toothpaste thinner and thinner and finding new stuff to come out. I think running this at around 12% is probably the right place, just for those who are trying to model this themselves. Okay, slide eight, quarterly adjusted EBITDA trailing 12 months, we're holding our own. Slide nine, quarterly cash flows and operations, now how many is that, eight in a row, six, seven, eight, yes. So we're healthy eight quarters in a row, positive cash flows of operations.

Slide ten, we're now at a GAAP 41 annualized inventory turns that's slide ten. Of course, that's benefited from all the partner business, but just on the direct business itself, we're still now at nine, which is very healthy. And on a direct only and if you go to slide 11, you see our annualized GMROI is 106 on the direct and overall 899, which is fantastic.

Slide 12, Net Promoter Score we just keep on. We, again our people have seen or now the National Retail Federation and AMEX rated us number two in customer service in America. And a number I look at a lot is for people who had problems and they contact customer service, how do they rate us? Well, they still give us a Net Promoter Score of 31, all-time high.

And that's to be compared with the average American company, which receives an eight overall. That's their overall score comparable to our blue line up above. So we really just do have fantastic, I mean people, our customers do seem to love us and we love them.

Slide 13, highlight reel. Gross margin all-time high, even without the benefit of the factors that Steve found and revisiting contracts and finding that certain, for example, a shipper owed us some money back and so-on and so forth, even without that it was at an all-time high. We're just finding efficiencies and efficiency. I say every year, I say well there's another 100 or 200 basis points and we keep finding it.

Now, we give some of that back to our customers in form of our lower prices but we really just, and we still think there's another, I still think there's another 100, 150 basis points of clear just operating efficiency that we can keep on ironing out of our business, although how much of that we pass on, how much of that sticks to our ribs versus what we pass on to the consumer is a different matter. But we do, we just still keep finding places we can iron and get more and more efficient.

Contribution dollars I'm really pleased with, and, I'll stop there at these four graphs. I know we have, the only questions I'm aware of are Colin Sebastian sent that and Sam, my friend, Sam Antar [inaudible] never fails, never lets me down. He sent some questions. The only one that comes, springs to mind, by the way I'm on a cell phone from overseas so I'm not as, I'm not sitting at the table with all the paperwork in front of me.

But Sam's list of questions included a question on James Joyce. We paid him a $1.25 million bonus because he did great work. I think he's responsible for, we've leaned out our supply chain beautifully. He did great work and we paid him a nice big fat bonus to end his engagement with.

Jonathan, do you want to expand on that, or?

Jonathan Johnson

Yes, let me comment on that. Jim joined us with his consulting company in 2006 when we were tangled up, and Jim helped us untangle a lot of knots over the years and really helped us lean out several processes and improve as a company. And as his time wound up, we looked at the value he added and the bonus we gave him I think was well earned. And it was nice to have Jim here, it was nice to have him help untangle some knots, and we're better for having him with us.

Patrick Byrne

Right. Jim is an old, basically an old teacher of mine that shows up every once in a while in my life and helps me untangle things. Okay, have any more questions come in, gentlemen?

Jonathan Johnson

Let's ask, not that have come in by email, but (Latonya) you can queue up questions for us.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Nat Schindler - Bank of America/Merrill Lynch

Nat Schindler - Bank of America/Merrill Lynch

A question on the partner revenue and actually specifically the COGS around that, there was a tick-up in vamp though, I think that's a lot of that included the $1.9 million increase. Longer term, what do you think is a real rate that your customers will bear as a, or your partners will bear, as a basically commission functionally is what you're charging on the sales through that.

Right now, I think you're running a bit above Amazon but you're providing a more expanded service than Amazon. I wanted to know where you think that market will settle out, especially after all these kind of one-time gains go away.

Patrick Byrne

I think about that a lot. We have, and obviously it differs by category and in electronics people have quite a different view. It depends really what they're margins are. We have a roster of benefits that we think people get from being our partner instead of Amazons. And we hear from people who give us both a try.

Now, of course there's a self-selection issue there, but we certainly hear from a lot of people who give us both a try as to why they like what they get from our program that they don't get from Amazons. We have a roster of other benefits to give them for the money.

But all that said, I do not want to create a pricing umbrella, and we do think that there are improvements we can make there and that will benefit everybody, us and our partners. So I wouldn't expect to be seeing that expand. If anything, I would expect to see, I've been wrong before, but I would expect to see that being shaved down but growth coming back instead that more than makes up for it.

Nat Schindler - Bank of America/Merrill Lynch

Am I right in assuming that $1.9 million one-time gain went all into the partner COGS line?

Patrick Byrne

No, Steve Chesnut, do you want to comment?

Steve Chesnut

It clearly was in the COGS line but it was not all towards the partners because part of that UPS, or part of the freight billing fees would have been spread across the partner and core business.

Patrick Byrne

You might think slightly over half. You might think slightly over half had something to do with partners themselves.

Nat Schindler - Bank of America/Merrill Lynch

So, if I was going to try to get to a kind of a real partner margin, gross margin here its north of 20 it would look like. I think, I'm calculating 21.7% on the partner gross margin right now, but that included some of this gain. I wanted to know if you can maintain let's say 20%, is that a number that sounds reasonable?

Patrick Byrne

No, because I actually think you're going to see us get bigger in electronics over the course of this year and that's at a much lower margin so the blend is going to come down. But no, yes, I think that what you said might be reasonable for this year, but I should probably break there and say Steve Chesnut, do you have a comment?

Steve Chesnut

Yes, I think we'll continue as we grow the partner business. We'll see a mix shift that will probably give some delusion around that. So I mean…

Nat Schindler - Bank of America/Merrill Lynch

Is there any seasonality around the product categories?

Steve Chesnut

I think to Patrick's point, I think we'll continue to look for ways to shave our expense structure that we can then ultimately try and drive prices lower.

Patrick Byrne

But also, Nat, I should say yes that sounds a little high to me. That sounds a little high to me for long-term sustainability.

Jonathan Johnson

And Nat, there is seasonality around some this when we come into the holiday season at the end of the year, the product mix shifts and we historically have seen those margins go down just because of the shift in the product mix.

Nat Schindler - Bank of America/Merrill Lynch

And another question on this and a little bit around, it would seem reasonable that considering all the trouble that traditional retailers had in the fourth quarter, that this quarter they would have had a lot of excess inventory to get rid of. Did you see a bump in an ability to charge more and maintain a higher gross margin because of that, and was that part of the upside to gross margin on COGS here, the increase that you've seen over much of last year or was that, did that flow through?

We talked about this I believe on the previous call about with you, Patrick we talked about the time it takes for the retail supply chain to rationalize after a shock to its system like this is beneficial to you. Is that part of what's driving this quarter?

Patrick Byrne

I don't think so to be frank. I really don't. I can talk about the dynamics that going on this quarter, a portion of that question. But, no, I think this has to do more with other things going on within the company and services with partners and mix shift and so on and so forth and pricing on our side and us sort of testing different pricing approaches.

But what's really going as far as the retail dynamics are that I mentioned last time we really don't get much inventory from retailers. It's usually people farther up the supply chain who've gotten stuck who call us. But when the retailers get plugged up, yes, of course the people up the supply chain are calling us.

On the other hand there's still been a surprising amount of pricing pressure this quarter, maybe as much as there was in the fourth quarter, maybe it's trailing off, it started to trail off in March. But people were still, there's tremendous pricing pressure from inline retailers who have been just cutting prices drastically. I'll tell you probably after February that wasn't as bad.

So that was actually hurting our margins more than a bit. We are I guess a very competitive pricing environment, so it's cutting both ways. I think it's starting to clear itself out though, for example, I'm still hearing from the buyers that the fantastic, I mean we're just getting in some, a few months ago it was across the board but now it's getting more niche by niche.

But there are just, there are people in certain parts of the retail industry who are calling us who never, especially with high end, I'd say, I don't want to give anything away, but just high end brands that had never been open to selling us before are calling and willing to sell. We're trying to explore a consignment model, which would be, it's only going to take a few manufacturers or distributors to give it a try before people see the virtue of it.

But at this point we have the capacity to sort of take in what anybody wants and liquidate it on whatever timeframe they tell us. And then they'd have to accept, it would be a different kind of deal than any we've structured before. But we're trying to get the manufacturers to give it a try this way where if they've got to shrink out some inventory, they could truck it to us.

They tell us we want all of this, they can tell us we want the last purse or the last pair of jeans or whatever sold in 47 days, and whatever they tell us we can turn the knob up and down until we get just that sales rate. But we're not having, it's not as easy talking the manufacturers into giving that a try as I had hoped.

Nat Schindler - Bank of America/Merrill Lynch

Just one last question, I want to just go a little bit deeper into the question Colin Sebastian sent in. You said the linearity was pretty smooth across the quarter but I remember on the Q1 call, the Q4 call you said in January you were running at about down 3% and ended at about down 8%. Where was the, where did the downturn occur?

Jonathan Johnson

Let me comment on that one, Patrick, if I may? When we were talking on the Q4 call we were looking at internal numbers, non-GAAP numbers. And when the month closed and we closed our books on GAAP basis, it was closer to 8% and we've been pretty flat for the quarter.

Nat Schindler - Bank of America/Merrill Lynch

Okay, so pretty just March and January pretty much the same place?

Steve Chesnut

Same story across all months.

Operator

(Operator Instructions) Your next question comes from [Larry Wyck – Morningstar]

[Larry Wyck – Morningstar]

Just have a quick question regarding your contribution margin you mentioned the current number around 12% or 13% is a reasonable number to think about for our models. But I think in the past you had mentioned that your internal goal is closer to 15%. Has something fundamentally changed?

Patrick Byrne

Well that's a good I know we said at some point we've said 20, 5, 5 and 5 was the model. I don't really know. I'm afraid I have said 15% before. I think that 20% margin may be too rich a pricing umbrella and we'd be better with off taking a lower margin and having lower marketing costs.

I guess I should be more I would be more accurate to say the range of opinion within our executive team at this point is the right place for that to be is 12% to 15% and can't get any, if we did a prediction market across the whole team that would be the window that would come up.

I tend to I think favor the lower end of that. I don't think we're ready to get there yet. We need to iron some more costs out of our system, and then I think we can actually, I think we should be dropping the price. Keep on squeezing the costs out of our system and dropping the price, drive growth and getting the contribution dollars flowing that way, and not have too much starch in the price just in the interest of the long-term value of the brand.

So I probably misspoke when I said 12% to 13% that was my personal opinion. I think that the generally accepted range within our executive team at this point is 12% to 15% is the right number there.

[Larry Wyck – Morningstar]

I have a follow-on question if that's okay. Just a question regarding e-Bay's intentions at their Analysts Day to focus more on the liquidation and overstock market. Do you expect see increased competition to get merchants on their platform, and how do you think that affects your business?

Patrick Byrne

Well, e-Bay has a great business and any time I try to answer one of these competitive questions it always shows up like I'm saying nasty things. I'm not saying nasty things. They obviously have a great business, but there are some real differences and five or six years ago I think we went through this cycle once before, and they were saying the same thing and it really didn't work out for them. And there's a couple of reasons, one is the English auction is a lousy way to move large amounts of homogenous goods.

If you've got 1,000 North Face parkas and you put them up at auction, the first one may clear at 50 bucks and the next at 48, then at 46. Pretty soon they're going for five or ten bucks a piece, and you've got the problem of if you do three auctions a day, one closing every eight hours, It still takes you a year to get through them, so the English auction doesn't work for large amounts of homogenous goods.

So then they go say to fixed price, well the problem with fixed price for them is it's been some years since I've done this calculation, but when I used to do it we had something like literally it was something like 100 or 200 times the traffic of e-Bay per product. And you've got to do it per product and when you're talking about fixed price it would be liquidation. It comes down to, how many eyeballs do you get in front of the product until the price finds its sort of true, [inaudible] market clearing price.

Well we have, obviously they have more traffic than we do I think it's about six times the traffic or something, but they have 100 times still the products or some things. So the traffic per product is still much lower than us. So that's the bind that they're in.

I think they could do it if they opened up an overstock store limited within e-Bay, if they opened up an area of e-Bay that was a store like ours. I don't know there's probably ways they could go about it and maybe they have cracked that nut. But I guess my point is the route they're taking now is the same thing that six or seven years they were saying they were going to do. It didn't work. They did not take over this market like they thought they were.

In particular the areas that we play I'd say there's a third dynamic, which is you're [Time Square] watches, are you really going to start liquidating on e-Bay and what is your own distribution system going to do if you did that. What is it going to revolt? So there's these different dynamics that make it, although they're a great company and a powerhouse and everything, it's not as much a slam dunk for them to do as you might think.

Jonathan Johnson

Patrick, if I could add to that one other dynamic I think that plays into this is e- Bay's brand. E-Bay has a wonderful brand but people look to it for something different than they do for overstock. You go to e-Bay to find beanie babies or pez dispensers or grandpa's duck decoy. I wish them good luck with it but I think they've got some hills to climb there.

Operator

At this time, there are no further questions. I will now hand the floor to Dr. Patrick Byrne for closing remarks.

Patrick Byrne

Thank you very much, [Tonya] and it's 8:32 no reason to continue. If there will be no more questions, it's a pleasure working for everybody still. We feel good about we did come through some tough times and we have a nice positive cash flow going. We have a number, I like to call them, well I won't even say what I call them, but last year we had a few triggers to pull that really accelerated our growth and got up to 27% for the first half of the year.

And then we hit August mid-August and it all sort of fizzled out on us and we have another really four things we'll be trying and they don't all have to work, but any one or two of them could make a significant difference. And we'll just keep experimenting and trying new things and we like the direction our income statement's going.

Jonathan, do you want to say anything else, anything on the bonds? That was another issue.

Jonathan Johnson

Well, we did purchase back, we purchased back some bonds in the first quarter. The board authorized $20 million to purchase back the bonds. We spent about $3 million of that in the first quarter so we've still got money to spend on the bonds when we think the price is right, and we watch it and look at it frequently.

Patrick Byrne

Okay, Mr. Chesnut?

Steve Chesnut

It's been a great Q1 and we look forward to a great balance of the year.

Patrick Byrne

Yes, I actually feel pretty good. I feel pretty good and I'm excited about the different projects and, again, the number I'm just going to keep focusing on is contribution dollars. Just look for the growth in contribution dollars that's what we're about, along with expense control, of course, but the real value of the business is going to be determined in that contribution dollar number. I look forward to talking with everybody in a few months and those that are going to come out in May for the shareholders meeting I look forward to seeing you.

Operator

This concludes today's Q1 2009 overstock.com conference call. You may now disconnect.

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