Liquidity Services, Inc. F3Q09 (Qtr end 7/31/09) Earnings Call Transcript

| About: Liquidity Services, (LQDT)

Liquidity Services, Inc. (NASDAQ:LQDT)

F3Q09 Earnings Call

August 4, 2009 5:00 pm ET


Julie Davis - Director of Investor Relations

William P. Angrick, III - Chairman of the Board, Chief Executive Officer

James M. Rallo - Chief Financial Officer, Treasurer


Shawn Milne - Janney Montgomery Scott LLC

Colin Sebastian (Paul, in for Colin) - Lazard Capital Markets

Heath Terry – FBR Capital Markets

Srinivas Anantha - Oppenheimer

Stephen Ju - RBC Capital Markets


Good day, ladies and gentlemen, and welcome to the third quarter 2009 Liquidity Services, Inc. earnings conference call. My name is Renesue and I will be your coordinator for today. (Operator Instructions)

I will now turn the presentation over to your host for today, Julie Davis, Director of Investor Relations. Please proceed.

Julie Davis

Good afternoon and welcome to Liquidity Services, Inc.’s earnings release conference call for the fiscal third quarter 2009 and the three months ending June 30, 2009. During this call, we will refer to Liquidity Services, Inc. as LSI.

Presenting today are Bill Angrick, our Chairman and Chief Executive Officer, and Jim Rollo, our Treasurer and Chief Financial Officer.

This conference call is also being broadcast through the internet and is available through the Investor Relation section of the Liquidity Services, Inc. website.

Before we begin, I’d like to remind you that matters discussed on this call contain forward-looking statements that involve risks and uncertainties concerning LSI’s expected financial performance as well as LSI’s strategic and operational plans. These forward-looking statements involve a number of risks and uncertainties that could cause actual results to differ materially from those anticipated by these forward-looking statements.

These risks and uncertainties include a variety of factors, some of which are beyond our control. These forward-looking statements speak as of today and you should not rely on them as representing our views in the future and we undertake no obligation to update these statements after this call.

Please refer to our SEC filings as well as our current earnings release posted a few minutes ago on our website for a more detailed description of the risk factors that may affect our results.

Copies of these documents may be obtained from the SEC or by visiting the Investor Relations section of our website.

To supplement the company’s consolidated financial statements presented in accordance with GAAP, we use certain non-GAAP measures. These non-GAAP measures include EBITDA, adjusted EBITDA, adjusted net income, and adjusted EPS. We believe these non-GAAP measures provide useful information to both management and investors. These measures, however, should not be considered a substitute for or superior to GAAP results.

A reconciliation of all non-GAAP measures included in this conference call to the nearest GAAP measure can be found in the financial tables included in the press release.

We also use certain supplemental operating data as a measure of certain components of operating performance, which we also believe is useful for management and investors. The supplemental operating data includes GMV and should not be considered a substitute for or superior to GAAP results.

At this time, I’d like to turn the presentation over to our CEO, Bill Angrick.

William P. Angrick

Thanks, Julie. Good afternoon and welcome to our Q3 earnings call. I’ll begin this session by reviewing our Q3 financial performance and then outline our progress against the major initiatives we established for the current fiscal year. Then I’ll turn over to Jim Rollo for more details on the quarter and on our business outlook for the year.

In summary, our team executed well during Q3, driving record profitability and strong operating cash flows. As we continue to gain market share and grow our transaction volume while managing through a very challenging economic environment and the startup of a major new contract with the DoD, our team’s execution allowed us to meet our profitability guidance on lower than forecasted GMV. I’m pleased to report that we generated a sharp improvement in profitability in Q3. Overall we grew consolidated adjusted EBITDA by 9% over the prior year’s comparable period and 64% sequentially.

Despite a 41% decline in our scrap business from the prior year due to a decrease in scrap metal prices, which appear to have stabilized.

Our adjusted EBITDA growth was driven by improved operating margins, resulting in record adjusted EBITDA margins equal to 15.4% of GAAP revenues and 9.9% of GMV.

Our buyer marketplace continues to deliver strong results for our sellers, as we ended the quarter with over 1,152,000 registered buyers, which is up approximately 22% over the prior year period, illustrating that our marketplace is increasingly attractive to buyers in a down economy.

Our continued focus on the key initiatives we laid out at the beginning of the year, driving operational efficiencies, investing in innovation, and enhancing value for our clients and buying customers, has positioned us well for long-term profitable growth and continued market leadership.

Let’s take a moment to review each of our businesses.

GMV in our U.S. commercial business grew approximately 1% over the prior year period. As our commercial GMV was impacted during the quarter by delays and commencing recently signed new programs and lower volumes with existing clients, due to continued weak consumer spending and a current economic environment. Even with these economic headwinds, we gained market share and grew commercial transaction volume by 23% during Q3 versus the prior year period.

Overall, we are pleased with the momentum in our commercial business, both in driving operation efficiencies and enhancing the quality of our new business pipeline with enterprise clients seeking more value and reverse supply chain during these difficult economic times.

Margins in our commercial business improved during the quarter, driven by superior operational throughput and improved by our participation compared to the same period last year. Simply put, we are turning inventory consigned to our marketplace more quickly and a higher margins than at any point in the last two years.

Inventory turnover and transaction cycle time have improved 58% and 18% respectively in Q3 compared to the prior year period. We are also retaining more buyers, leading to higher auction conversion rates, as the number of customer disputes to closed auctions has decreased 45% versus the prior year period.

We are also having great success in expanding our new business pipeline and market share. In these uncertain times, enterprises are increasingly looking to LSI as a full service provider with the financial strength and integrity to follow through on our commitments and deliver innovative services, both locally and globally to maximize financial returns.

Current market needs play to our strengths and we have signed several new programs during Q3, many with Fortune 500 companies that we believe will provide long-term recurring supply to our marketplace.

We believe the strength of our leading B to B marketplace,, combined with the launch of new value-added services, will enable us to further increase our market share with a world class roster of commercial clients moving forward. For example, as enterprise clients seek to consolidate vendors, streamline costs, and improve financial returns, we are being presented with opportunities to handle higher quality goods that have typically flowed directly to consumers and end users, such as new items that have been returned, out of season, our possess less than current technology. We have responded to these opportunities by developing new channel optimization services, which may include moving some of our clients new items in bulk through our leading B to B marketplace, as well as single items through other channels at the client’s request. These new value-added services have enabled us to expand the scope of property we manage for clients and further integrate with our clients to drive the highest recovery and lowest of cost.

GMV and our DoD surplus business was down 16% from the prior year. This business was operationally impacted during Q3 as a result of a significant inflow of property received during the quarter, due to a backlog of DoD surplus property created by the delay and the commencement of the new contract.

The high level of startup property flow constrained our ability to launch auctions during the most recent quarter as we allocated additional resources to receiving product, thus slowing down sales allotting activities.

We have adjusted our operations accordingly and auction throughput is improving. We are pleased with the recovery rates the team is achieving on the items being processed in sold. In addition, we are driving operating efficiencies as we wind down the old contract and operate from fewer locations under the new contract.

GMV and our DoD scrap business was down 41% from the prior year due to a decrease in scrap metal prices caused by the economic recession; however, volumes have remained steady and prices have stabilized recently resulting in a 44% sequential increase in scrap GMV, during Q3, the first sequential increase in three quarters. Continued improvement in the macro economy will likely have a positive impact on this part of our business.

GMV and our Govdeals business was flat versus the prior year period as GMV results were impacted during Q3 by lower prices on heavy equipment and rolling stocks versus the prior year period; however, we continue to gain market share and added 187 new municipal government agency sellers during the quarter. We are very pleased with the progress of our Govdeals business in addressing the $2 billion dollar municipal government surplus market. As during Q3 we achieved records for the number of active sellers, up 30% versus last year. Number of completed transactions, up 26% versus last year. Number of registered buyers, up 25% versus last year.

Awareness of our Govdeals brand continues to grow and municipal government agencies are increasingly using our marketplace to improve transparency around the sales process and recover more value from surplus and seized assets to address budgetary deficits.

We can sell virtually anything on our marketplace to help our clients raise cash. Recent examples include 1,350 confiscated machines for the city of Austin, Texas, sold for $388,000 or 288% above their reserve price. A 1981 Beech Aircraft sold to the state of Utah for $157,000 and a 1966 Chevrolet SS automobile sold for Butler, Ohio for $63,000 or 57% above their reserve price.

Our financial settlement services with municipal agencies has also been very successful resulting in a higher overall take rate for our option services and improved profitability.

GMV in our U.K. business suffered during Q3 due to the reorganization of one of our major U.K. clients in the current financial downturn, which led to a material decrease in volume. Progress has been made to replace this volume, but we continue to expect our U.K. business to be a drag on earnings in the near term.

We initiated cost savings in activities in our U.K. business during the current quarter, including replacing some senior members of our operating team with managers having more operational and business development experience. At the same time, we have made the necessary technology, finance, and back office investments to support our U.K. business for long-term growth.

Next, I would like to recap the key initiatives we outlined for fiscal year 2009 to position LSI for long-term growth.

Our first initiative is the successful launch for new DoD surplus contract. While the backlog property limited auction throughput during Q3, our team most importantly continues to provide a very high level of service to the DoD and has made the necessary adjustments to work through the backlog of property as we move forward.

Our second initiative is to improve operations and service levels in our commercial business. Earlier we discussed the operational improvements in our U.S. commercial business, which we expect to continue. We expect to realize the same efficiencies in our U.K. commercial business over the next year as we move to a single inventory management system to manage our entire business from a single global platform.

We’ve also recently strengthened the U.K. operations and account management teams to drive further improvements in operations and service levels, which will pay off in fiscal year 10.

Our third initiative is to make our marketplaces more flexible and easier to use for sellers and buyers. We have recently introduced an enhanced version of our marketplace, which we call seller self service, which makes it easier for sellers to list and sell goods directly through our platform from their own retail store or warehouse location. Clients are responding. As a number of small and midsize accounts which sold through our platform during the quarter was up 27% versus to the prior year period.

We also are advancing several projects to make our online marketplace more convenient for buyers to find and purchase goods. We are currently testing and expect to launch this fall an enhanced version of our marketplace that will further customize the buyer/user experience based on their product interest, type of business, and geographic location.

Ultimately, this will further improve conversion and retention of buyers and auction results for our sellers. These changes have been made possible by a redesign of the underlying architecture of our e-commerce platform, which will enable us to introduce the same enhancements to our public sector and U.K. marketplaces over time.

Our fourth initiative is to expand and further segment our seller and buyer base to increase their participation in our marketplace. With over 2 million annual auction participants and growing, we are the largest and most transparent marketplace for surplus goods and thus have a tremendous opportunity to further expand our base of sellers.

Notwithstanding the difficulty economy, we are growing market share. On a consolidated basis for the first three quarters of fiscal year 2009, the number of completed transactions and number of auction participants in our marketplace is up 33% and 24% respectively versus the prior year period. As we ramp up our business development efforts, we are seeing increased interest in our service in all segments of the supply chain, including retailers, manufacturers, and reverse logistic service providers.

We believe this is a great time for LSI to be in the market telling our story. As large organizations are focused on the quality, where liability and financial capability of the companies we deal with, we believe they are more receptive to LSI’s solutions.

This combination of strong buyer demand and increase supply will continue to fuel LSI’s growth.

Now I will turn it over to Jim for more details on the quarter and our business outlook.

James M. Rallo

Thanks, Bill.

The amount of gross merchandise volume or GMV decreased $13.6 million or 13.1% to $90.6 million for the three months ended June 30, 2009 from $104.2 million for the three months ended June 30, 2008, primarily due to a 40.7% decrease in our scrap business, which utilizes the profit sharing model as a result of decreasing commodity prices.

Revenue decreased $13.5 million or 18.8% to $58 million for the three months ended June 30, 2009 from $71.5 million for the three months ended June 30, 2008, primarily due to decrease in our scrap business which generated 23.7% of our revenue and 15.2% of our GMV for the three months ended June 30, 2009 as compared to the 32.4% and 22.2% respectively for the three months ended June 30, 2008.

GMV and revenue continue to diversify and as a result, the percentage of GMV and revenue derived from our DoD contracts during the three months ended June 30, 2009 decreased to 34.9% and 54.4% respectively compared to 42.6% and 62.2% respectively for the three months ended June 30, 2008.

Costs of goods sold excluding amortization increased $1.1 million or 5.8% to $27.7 million for the three months ended June 30, 2009 from $19.6 million for the three months ended June 30, 2008.

As a percentage of revenue, cost of goods sold excluding amortization increased to 35.6% from 27.4%. These increases are primarily due to one, the decrease in our scrap business, which utilizes the profit sharing model, and two the new surplus contract which had its first full quarter of operations and utilizes the purchase model.

Profit sharing distribution has decreased $16.1 million or 66.6% to $8.1 million for the three months ended June 30, 2009 from $24.2 million for the three months ended June 30, 2008. As a percentage of revenue, profit sharing distribution has decreased to 13.9% from 33.9%. These decreases are primarily due to one, a 40.7% decrease in our scrap business, and two, the new surplus contract, which has no provision for distributions.

Technology and operation expenses increased $1 million or 9.6% to $11.4 million for the three months ended June 30, 2009 from $10.4 million for the three months ended June 30, 2008. As a percentage of revenue due to the expenses increased to 19.7% from 14.6%. These increases are primarily due to one, the decrease of 40.7% revenue from our scrap business while incurring similar operational costs as pounds of scrap sold during the two periods were not materially different, and two, expenses of $100,000 associated with our commercial business.

Sales and marketing spend decreased $100,000 or 1.6% to $4.4 million for the three months ended June 30, 2009 from $4.5 million for the three months ended June 30, 2008. As a percentage of revenue, these expenses increased to 7.6% from 6.3%, primarily due to the decrease in revenue from our scrap business.

General and administrative expenses increased $400,000 or 5.7% to $6.2 million for the three months ended June 30, 2009 from $5.8 million for the three months ended June 30, 2008. As a percentage of revenue, these expenses increased to 10.6% from 8.2%. These increases are primarily due to one, expenses of $300,000 associated with stock compensation, and two, the decrease in revenue as a result of our scrap business.

The company had strong cash flow generation and growth during the quarter. LSI generated $7.1 million of operating cash flow for the three months ended June 30, 2009, an increase of $1.6 million or 29.2% over the $5.5 million of operating cash flow during the three months ended June 30, 2008.

Adjusted earnings before interest, taxes, depreciation, and amortization or adjusted EBITDA increased $700,000 or 9.2% to a record $8.9 million for the three months ended June 30, 2009 from $8.2 million for the three months ended June 30, 2008.

Adjusted net income decreased $200,000 or 5.5% to $4.3 million for the three months ended June 30, 2009 from $4.5 million for the three months ended June 30, 2008.

Adjusted diluted earnings was consistent at $0.16 for the three months ended June 30, 2009 and 2008 based on approximately $27.6 and $28.2 million diluted weighted average shares outstanding respectively.

I will now discuss the company’s other key operating metrics as I’ve already touched on GMV, which management believes allows us to monitor the success of our marketing programs as well as our allotting and merchandising strategies.

During the last 12 months, we also benefited from our abilities to more effectively market assets to potential buyers. Our marketing efforts resulted in a 21.6% increase in registered buyers to approximately $1,052,000 at June 30, 2009 from approximately $948,000 at June 30, 2008.

Auction participants increased to $548,000 for the three months ended June 30, 2009, representing an increase of $49,000 or 10% over the 499,000 auction participants for the three months ended June 30, 2008.

Completed transactions increased $13,000 or 11.9% to approximately $121,000 for the three months ended June 30, 2009 from approximately $108,000 for the three months ended June 30, 2008.

The company continues to have a strong balance sheet. At June 30, 2009, LSI had $61.3 million of cash, current assets of $88.4 million, and total assets of $136.2 million. The company continues to be debt free with current liabilities of $30.8 million and long term liabilities of $3.3 million, for total liabilities of $34.1 million at June 30, 2009.

Stockholders’ equity totaled $102.1 million at June 30, 2009. Capital expenditures during the three months ended June 30, 2009 were $1 million. We expect capital expenditures to be about $3.5 to $4 million for the fiscal year ended September 30, 2009.

The management team is providing the following guidance for the next quarter and fiscal year 2009. While we are pleased with our recent progress, our overall outlook remains cautious through the economic environment and its impact on the retail supply chain.

We are in a period of economic uncertainty and unprecedented market volatility, which makes it more difficult for us to forecast business trends and the timing of selected new programs resulting in a wider than usual guidance range.

In the short term, we believe the changes in consumer spending patterns may reduce overall supply of goods and the volume and value of goods sold in our commercial marketplace.

In the longer term, we expect our business to benefit from the following trends.

One, as consumers trade down and see greater value, we anticipate stronger buyer demand for the surplus merchandise sold in our marketplaces.

Two, as corporations and public sector agencies focus on reducing costs, improving transparency, and working capital flows by outsourcing reverse supply chain activities, we expect our seller base to increase.

And three, as corporation and public sectors increasingly prefer service providers with a proven track record and demonstrated financial strength.

As we improve operating efficiencies and service, we expect our competitive position to strengthen. The following forward-looking statements reflect the following trends and assumptions for the next quarter and fiscal year 2009.

One, reduce commodity prices, which will continue to result in decreases in the GMV and profit realized in our scrap business compared to fiscal year 2008.

Two, lower average sales prices, realizing our commercial state and local government marketplaces compared to fiscal year 2008.

Three, new business rules under our new DoD surplus contract, which will remove selected items from the product folder we have historically handled and sold resulting in lower GMV in our surplus business.

Four, cost associated with launching our new DoD surplus contract, including the hiring of new staff and the opening of two new warehouses totaling 665,000 square feet in Columbus, Ohio and Oklahoma City, Oklahoma.

Five, our expectations that we will continue to achieve less than optimal sales volumes under our new surplus contract in the fourth quarter of fiscal 2009 as we continue to process the initial surge of property.

Six, the continued sales throughout the fourth quarter property issued prior to December 18, 2008, under our original surplus contract.

Seven, improved operations and service levels in our commercial business, which we expect will continue to improve margins during the fourth quarter.

Eight, our expectation that we will achieve less than optimal result in our U.K. business in the near term as we replace the lost volume from one of our major clients, which restructured their business.

Nine, an increase in our expected effective income tax rate from 43% in fiscal year 2008 to 46% for fiscal year 2009 as a result of non-deductible stock based compensation costs increasing in proportion to our U.S. based taxable income.

Our results may be materially affected by changes in business trends and their operating environment and by other factors such as investments in infrastructure and value-added services to support new business in both commercial and public sector markets.

Our scrap contract with the DoD includes an incentive feature, which can increase the amount of profit sharing distribution we receive from 23% up to 25%. Payments under this incentive feature are based on the amount of scrap we sell for the DoD to small businesses as of June 30 of each year. We earned approximately $975,000 under this incentive feature for the 12 months ended June 30, 2009 and we recorded this amount in the quarter ended June 30, 2009.

We expect GMV for fiscal year 2009 to range from $350 million to $360 million, which is down from our previous estimate of $355 to $370 million. We expect GMV for the fiscal fourth quarter of 2009 to range from $86 million to $96 million.

We expect adjusted EBITDA for fiscal year 2009 to range from $23 million to $24.5 million, which is in the range of our previous estimate.

We expect adjusted EBITDA for the fiscal fourth quarter of 2009 to range from $6.5 million to $8 million. We estimate adjusted earnings per diluted share for fiscal year 2009 to range from $0.38 to $0.40, which is down from our previous estimate of $0.45 to $0.47.

For the fiscal fourth quarter of 2009, we estimate adjusted earnings per diluted share to be $0.10 to $0.13. This guidance reflects the impact of higher than expected depreciation in the second half of fiscal year 2009 due to recent investments made in our technology infrastructure and online marketplaces, lower than expected interest income compared to the previous guidance and our stock repurchase program under which we purchased 707,462 shares for approximately $3.9 million during the second quarter; however, it does not assume we will continue to repurchase shares with approximately $6.1 million yet to be spent on the program.

Adjusted EBITDA and diluted EPS, which we estimate to be approximately $1.6 to $1.7 million for the fourth quarter.

I will now turn our discussion back over to Bill for closing comments.

William P. Angrick

Thanks, Jim. Before I close, I would like to take a moment to note that our colleague, friend, and LSI co-founder, Jaime Mateus-Tique, will retire at the end of the end of the current fiscal year after nearly ten years of service to LSI. Jaime has been critical in helping guide LSI from initial startup to the leading online auction marketplace for surplus assets with an impressive roster of commercial and government clients.

He has played an integral role in helping LSI to expand and strengthen its senior management team over the past several years to make this transition seamless. In particular, Jim Rollo, CFO and Treasurer, Eric Dean, Chief Information Officer, Tom Burton, President of our DoD Division, and Casey Roy, EDP and President of LSI’s commercial asset recovery division, have worked closely with Jaime and myself to provide strong leadership going forward as we pursue our vision of scaling to a billion dollar-plus enterprise.

Jaime’s leadership, creativity, and passion for the business have made him a role model for all LSI employees and we are pleased to have his continued involvement with LSI as an active member of our board as we explore the many exciting growth opportunities that lie ahead.

In summary, as we noted at the beginning of the year, we expect to build a stronger business as a result of the recent actions we have taken in support of our strategic initiatives for fiscal 2009.

Our team is executing well and we have a more diversified, higher margin, overall business. We have favorable cash flow dynamics with negative working capital requirements and excellent returns on invested capital.

We have built the leading e-commerce market places and brands with the largest buyer base addressing the $100 billion dollar reverse supply chain market opportunity and we have the financial strength and operating discipline to invest in future growth to create long-term value for our stockholders.

The bottom line is that we have a very strong competitive position that we expect to further strengthen during the balance of fiscal 2009.

Thank you. That concludes our comments and we are happy to take questions at this time.

Question-and-Answer Session


(Operator Instructions) Our first question comes from Shawn Milne with Janney Montgomery Scott.

Shawn Milne - Janney Montgomery Scott LLC

If you could spend a little bit more time talking about the commercial business. The transaction volume slowed down from what you had reported in the prior quarters. Then, of course, you had lower retail pricing. What changed from what we saw in the prior quarter to this quarter? You talked about having some delays in new programs, but what changed on the market place and if you could talk about the quarterly flow. There was some indication that transaction volume was likely higher than what you reported, at least in the month of June.

Secondly, Jim, if you look at the volume, your GMV guidance for the fourth quarter, it’s not dissimilar to what you just reported in the third quarter. How much more spending going up, that’s driving the uptick in depreciation in the fourth quarter. It just seems like the dislocation from EBITDA down to earnings is too steep. I’m just trying to get my arms around that. Thank you.

James M. Rallo

I think the reality is that current retail clients have reduced volumes and sell through in retail and that’s driven primarily by consumer psychology and the fact that consumer spending has continued to be weak and at some level the recurring replenishment of goods in reverse supply chain will realize that impact. And so, we’ve done a terrific job retaining and growing the categories within our existing accounts, but they are not immune to that secular decline in retail, which has created some softness in GMV on an apples-to-apples basis in the June quarter. I would say June in particular. The month of June did reflect that.

I’d also add that the price points that retailers are taking to the market have come off since September of last year.

I think it’s good to note that our large relationships are with retailers that have fared quite well in the downturn and that over time we think we’ll expand our own market share, which is good for our overall business and growth.

With respect to our business development activities, we’ve had a lot of success sitting down with retailers to sign new programs. We have a view that over the long-term, we’re going to grow our market share and pipeline and the number of recently signed new business includes national grocery chains, national big box retailer, and national high end department store chain, national broad line retailer, and online retailer of consumer electronics, manufacture of networking equipment and accessories. We bought two business development people online in March. They’ve had roughly three months to get out there and tell the story and it’s being well received.

A number of these programs are subject to the internal client views of their own business and the delays that we experience are typically due to internal client matters related to IT. We share a lot of information with these clients and it takes time to bring their IT people to the table.

Some of these clients have had management reorg, so changes of their own. In some cases, they’ve changed the size or even closed facilities. In other cases, we’ve literally taken away business from incumbents and they’re transitioning out some current contracts.

So all of those taken together can result in some delay outside of our control when you’re elephant hunting for enterprise clients. That’s fine. From our perspective, as long as we create market share growth and the recovery of the goods we sell in our marketplace is superior to any other alternative.

Shawn Milne - Janney Montgomery Scott LLC

Clearly, the delays of new clients, understand there can always be delays in that kind of arena. Secondly, if you look at the delta between the volume that you reported and the GMV, so pricing, it looks like it got a little bit worse than the prior quarter. That may be out of your control. What I’m concerned about is the transaction volume. Again, if consumer is weak, that to me would mean that there’s more inventory to come back to you. So I’m stuck on why the programs or the existing volume with clients actually declined from the last quarter, because that one would seem to me would be a better metric for the health of that business going forward.

William P. Angrick

Shawn, it’s important to decompose transaction volume and growth. On an overall consolidated basis, you’re right. Number of completed transactions in the growth rate decelerated to 12% year-over-year from the prior period. That’s principally due to the DoD surplus business. The DoD surplus business is putting up, at least in this last quarter, few options for two reasons. One, the DMB property has been removed from that contract. So roughly 20% of that property is no longer being brought to market. So we’re not trading options and attracting participants for that segment of the property.

Two, our team had to create essentially a second shift during the last 45 days of the quarter to deal with aberrational volume of property coming in from the startup of this new contract.

Shawn Milne - Janney Montgomery Scott LLC

Understood. The DoD is well understood. It’s the transaction volume slowdown in commercial. We can follow up offline, if need be.

William P. Angrick

Commercial is growing at a 22% year-over-year clip in transaction volume, which is quite robust and we feel that the buyer participation and conversion has continued to improve. The conversion of our open auctions to close transactions is actually uptick. So that business is very healthy for us.

Is there a little bit of seasonality in the month of June? Perhaps, but the overall reach to the buyer base has been quite good.

The second half of your question I believe related to the capital expenditures and Jim can address that.

James M. Rallo

Shawn, just a quick follow-up to Bill’s point. You’re talking about a 3% decrease in transaction volume this quarter on the commercial marketplace. To get to your second question, which was basically how much spending are we going to have in the fourth quarter and the differentiation between how do you get from EBITDA to earnings and why the discrepancy over historical translations between those two numbers. One, we’d expect capital expenditures to be similar in the fourth quarter than they were this quarter. So I’m going to say approximately a million dollars.

I’ve basically guided to the year of CapEx in $3.5 to $4 million this year. That was a record year for us. As a reminder, CapEx last year was $1.8 million, which was frankly unusually low for us. I mean CapEx usually runs somewhere between $2.5 and $3 million. So I think we were a little light last year. We’re a little ahead of plan this year, because frankly we’ve accelerated investments particularly in the U.K. as well as our commercial business. You know, many of those Bill talked about earlier. The self service module is a prime example of that. There’s a new buyer experience that will be rolling out soon. It’s an opportunity for LSI to really stand alone at the top and differentiate itself from many of our competitors.

Secondly, as far as getting from EBITDA and earnings and what’s happened there, you’ve had really two things going on. One, on a basically similar cash balance year-over-year, we’re earning a quarter of the interest income that we earned last year. Now we definitely anticipated a significant decrease in interest income, but not a 75% decrease. I think we’ve been very conservative with investments. We obviously haven’t needed to write off any of our cash. We have access to it all, but it is in very safe investments that frankly are not earning hardly any money.

Two, depreciation is up significantly because of the CapEx. So when you look at depreciation lat year, we ended the year at about $2.9 million and we’re probably going to end the year at $4 million of depreciation. So that extra million dollars of depreciation this year, a lot of which is coming into play in the back half of the year, primarily because of the things we’re doing, have really more like a three-year life to them versus a five-year life. We’re using a three to five year.

So again, those two things combined are creating that translation adjustment, if you would between EBITDA and earnings compared to last year.


Your next question comes from Colin Sebastian with Lazard Capital Markets.

Colin Sebastian - Lazard Capital Markets

This is Paul for Colin. Can you help me understand what portion of the GMV shortfall came from, the DoD delay. What portion came from the delay with new partners in the commercial business.

Thirdly, what part of it was from the reorganization of the U.K. partner.

And can you give us some color into what degree those three issues are behind you now?

James M. Rallo

So when you look at the GMV shortfall, there was a similar shortfall that effected the commercial and the DoD business. Both of those were several million dollars of GMV. I think Bill went through in detail the reasons for both of those. Obviously the DoD is a timing issue as well as the commercial business. We expect the DoD to really have to correct itself over the next two quarters and I would say the same for the commercial business.

The U.K. piece was smaller and we would expect that to pick up again really starting in calendar year 2010 as we bring new clients into the marketplace.

Colin Sebastian - Lazard Capital Markets

Can you provide some color on the rebound in scrap pricing and what you’re seeing in the marketplace in July?

James M. Rallo

Sure. We’ve seen a slight rebounding in scrap. Just as a reminder for folks, about 60% of the scrap metal we sell is aluminum and steel and that has lagged a little bit in the rebound. That being said, it is clearly off of its bottom lows, which were about four months ago, but we have not seen the gains we have seen in some other categories. We do sell copper, brass, and some high tinsel alloids. Those have picked up, as you all probably read in the press, a little better than just the steel and aluminum. But again, 60% of our business is aluminum and steel.

So we have seen some improvement. Not a huge amount of improvement. We do anticipate at this point maintaining those levels or potentially a little better.

Colin Sebastian - Lazard Capital Markets

Does the guidance for 50% decline in scrap still stand that you have provided before?

James M. Rallo

When you’re talking about year-over-year? Yes.


Your next question is from the line of Heath Terry – FBR Capital Markets

Heath Terry – FBR Capital Markets

I was wondering if you could just give us a sense, we saw a slight increase in inventory this quarter and it’s been kind of a trend. To what extent should we expect these kind of inventory increases if you’re doing more of the purchase business with the DoD or is there something else that’s driving that?

James M. Rallo

Good point, Heath. This is Jim. You’re right. Overall, the inventory balances are up. Actually in our commercial business, our inventory balance dropped a little bit. What’s really driving that is what Bill indicated as the huge surge of property flow we’re received from the DoD.

Right now, based on what we can see, we expect that those volumes have normalized. So we don’t expect to get another surge of property at least in the next quarter or two.

I would anticipate as we roll out some of these new commercial programs that we would increase our inventory levels slightly, but these are not what I would say significant levels. I would say several million type, not five or ten million dollars.

William P. Angrick

Let me add, Heath. The business arrangement with DoD, with whom we’ve worked the last ten years and for which we have sold this whole range of property for ten years, is quite favorable.

We have 120 days in the rears payable for over half the purchase price. So from a cash flow conversion perspective, we expect to sell items received within 60 to 90 days and we will pay, in this case the client DoD, a good share of those proceeds within 120 days.

So as we move forward, we expect to have negative working capital requirements on that part of the business.


Your next question comes from Srinivas Anantha - Oppenheimer

Srinivas Anantha - Oppenheimer

Bill, just looking back. Let’s say looking at the company six months ago or eight months ago, would you have imagined that the commercial opportunity, which at least everyone and we were expecting it to be a big contributor, but certainly it’s been a pretty choppy last quarter was better than expected, this quarter came in slightly below expectations. I think it’s partly because of the lower ASPs, but why are the volumes not picking up? Is it just the case that you guys are not getting more inventory or is it just all related to ASPs?

Could you also give us an update where you stand relative to new customers signing and what the opportunity presence there over the next 12 months?

James M. Rallo

In a marketplace in the last quarter, whether you’re looking at online market places, you will have a real headwind in this environment. Consumers aren’t spending as much, so the products that are being sold are being sold at discount historical prices. So yes, ASPs on an apples-to-apples basis have been down and I don’t know that we’ve ever experienced in the space of three to six months the type of price declines. We’ve seen things ranging from heavy equipment and vehicles down 17% over the prior year period and in cases of apparel, 30 to 40% down year-over-year. High end electronics, up to 50% down year-over-year. So yes, that’s a fundamental, but I believe somewhat interim phenomena. The bottom line for the commercial business is we are growing the number of clients, aligning their business with our marketplace; therefore, the number of auctions that we’re processing is improving. We’re also able to continue to grow the number of buyer participants in this marketplace, which is ultimately reinforcing to one another.

Our business development pipeline, which I touched on briefly, Sri, it’s quite robust, but we understand if you’re going to sell to Fortune 500 companies, it’s a pretty busy time for them as well. I mean they are rethinking what’s their core business. They are making decisions on where to place their bets, exiting certain businesses, reassessing their physical footprint. Their skus that they’re carrying in the stores.

To some degree, we’re the tail on the dog of when they make those decisions and come to some resolution, then they will move forward with us, and we are patient. We understand that once we sign a national big retailer or a national department store chain or an international manufacturer and they’ve moving goods to our facilities, to our marketplace, it’s a very sticky solution. The switching costs are quite high for them. So we’re willing to invest the time upfront to integrate our IT systems to really understand the terms and conditions of sale, what type of information we can move back and forth, how to reduce the total supply chain cost and transportation cost, because once we do that, we’ve got this supply locked in on a recurring basis year-over-year.

And so, maybe we’re a symptom of the fact that we want to serve every Fortune 500 company that makes a retail finished goods and there’s a longer sales cycle with that, but when it does come to fruition, it’s very high barriers for the client and given the resources we’ve invested, that’s really helped us advance with a number of these prospects. We’ve signed agreements that now we believe will be coming to fruition.

I think that the notion of forecasting with precision in the current environment doesn’t exist, because these large companies are in some cases managing their business month-to-month.

So we have to appropriate have to risk adjust our outlook for how these large enterprises are managing their own business. We do think, Sri, we’re making great progress. The recovery value that we realize for the sale of consumer electronics and apparel and building tools and housewares is very good. Clients have told us. We also have noted sort of a change in the philosophy of a lot of these large corporations. They want to work with business partners that they know are financially capable, that have a transparent balance sheet, that are reliable, that will be in business next month, next year, next five years, and that’s playing to the strengths of LSI, and that’s going to ultimately allow us to have much better market share over time.

Srinivas Anantha - Oppenheimer

Bill, any comments on potential M&A opportunities. I know in the past you mentioned that seller’s expectations have been coming down. Maybe if you could talk to the users of free cash flow apart from the share buyback and when should we expect any kind of an acquisition here?

William P. Angrick

I think it is important to focus on business that has strong returns on invested capital and I tip my hat to our team, because they have taken a real close look at, you know, does each and every program that we have standards on to generate new positive return invested capital. M&A, you know, acquisitions is something we’re always looking at and when we can see either domain expertise or human capital personnel, we’re very receptive to that. We have a constant pipeline that we’re looking at, nothing that’s imminent, but things that we’ve looked at from time to time that should reinforce the core of our business.

So I think that’ll just be something that will unfold over time. I think the reality is that we’ve looked at a lot of these acquisition candidates and there’s not a lot there. So we feel really good about our competitive position. We really feel that we are able to organically execute on a lot of these market opportunities and don’t need to acquire businesses. Over four or five years of hard work, we’ve closed a lot of the gaps that were there so we can move forward and execute more organically.


Your next question comes from Steven Ju with RBC Capital Market.

Stephen Ju - RBC Capital Markets

I’m looking at the wider than usual guidance range for fourth quarter and thinking the surplus and the scrap segments usually have a fairly high level of visibility versus the other segments. So I’m wondering where the variability in your guidance is coming from, which segment specifically and what needs to go right in order for you to reach the high end of guidance and what can go wrong?

William P. Angrick

Let me just provide some context. I think the scrap business has historically not been very easy to forecast, because while we do operate a few of these scrap yards, we don’t have forward visibility as to when these military units are actually going to be destructively scrapping items and making those available and released to us.

While the surplus business has had historically pretty good visibility, the scrap business has had limited visibility. I think the other notion here is that in some cases, you have almost sort of binary things that may or may not hit a particular calendar quarter. If a client says well, you know, our CIO has just moved integration with your marketplace down one rung on their priority list, it’s going to slip 45-60 days. That means the entire volume from that program is not going to show up in a particular quarter. So you get into binary things at the margin that could effect guidance.

I think if I were to comment on we’d see upsides in our business because of visibility, it’d probably be around surplus and the commercial business and that’s the way it’s been in the past and I would say same in the future.

Stephen Ju - RBC Capital Markets

Okay, so for the DoD surplus, you guys did mention there was a greater than usual intake of volume this quarter which kind of disrupted the business. Should we expect that segment to rebound to sort of historical runway to somewhere around $20 million? Would that pushing through too much volume through the platform currently?

James M. Rallo

I think you’ve got two things here, Stephen. One, we will CVR or the new surplus contract will have higher volume next quarter, but the volume coming from the old contract is dropping off significantly and so that’s going away and when you look at the two combined, that will be I would say about the same or slightly down next quarter and that business is never going to get back up to a $21 million run rate at least in the near term, Stephen. When we start looking out past two or three quarters, we’ll have to see how that program rolls out, but as Bill indicated earlier today from one of the questions, we have lost the DMB property. What that means to you is we have lost about 20% of the property in that contract. We don’t expect to get to those $20 million dollar levels in the near term.

William P. Angrick

Let’s also make sure we understand that the DoD surplus is purely sort of a GMV story. It’s an operational efficiency operating a leverage story too, because we used to have demand, you know, over 60 locations to receive property under the old contract and we’ve consolidated most of the sales activities to two hubs, one in Oklahoma City, one in Columbus, Ohio, and as a result we’re getting efficiencies.

Point two is as we segment and sort the property, it’s now getting more focus and attention. We believe that over time we can improve the recovery rate realizing the sales process and so those two major prongs give us opportunity to grow the margin from that business, notwithstanding lower GMV.


At this time, there are no other questions in the queue. I’d like to turn the call back over to Julie Davis for closing remarks.

Julie Davis

Thanks, everyone, for attending our Q3 earnings call. If you have additional questions, please contact myself or Jim Rallo.


Thank you all for your participation in today's conference call. This concludes the presentation and you may now disconnect and have a great day.

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