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Overstock.com Inc. (NASDAQ:OSTK)

Q3 2009 Earnings Call

November 03, 2009 16:30 p.m. ET

Executives

Jonathan Johnson - President

Steve Chesnut - SVP, Finance

Patrick Byrne - Chairman and CEO

Analysts

(Unidentified)

Presentation

Operator

Good afternoon. My name is Sarde and I will be your conference operator today. At this time, I would like to welcome everyone to the Q3, 2009 overstock.com conference call. All lines have been placed on mute to prevent any background noise. (Operator instructions). Thank you. Mr. Johnson I hand the call to you.

Jonathan Johnson

Sarde, thank you for that welcome and introduction and I say good afternoon and welcome to everybody on our third quarter 2009 conference call. Joining me on today's call are Dr. Patrick Byrne, Overstock's Chairman and CEO and Steve Chesnut, Overstock's Senior Vice President of Finance. Let me start by getting some legal details out of the way.

The following discussion and our responses to your questions reflect management's views as of today, November 3, 2009 only, and we'll 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/A. I encourage you to have today's press release in front of you, as you listen to today's call because our financial results are detailed and detailed commentary and Patrick's letter are included in that press release, and will correspond to much of today's discussion.

During the 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 financial measures, including reconciliations of these measures to the most comparable GAAP measures. Lastly, we expect to file our Form 10-Q for Q3, 2009 by next Monday and I encourage all of you to read it as well for additional information on our financial results.

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

Steve Chesnut

Hey, thanks Jonathan. We're going to go ahead and review the Q3 financials as Jonathan mentioned. The details of this quarter are in today's press release. So, I'm just going to summarize a few of the financial highlights for you, and as I go through and make these comparisons or remarks, we're going to be contrasting that back against the third quarter of 2008. So, let me go ahead and start through revenue.

Revenue for the quarter was $195.1 million which is up 4% from last year. If you remember in Q2, we showed a negative 7% revenue decline and so its nice now in Q3 to be seeing a positive revenue growth which is really now after three quarters of negative revenue growth is nice to see a positive quarter. Gross profit expanded to $37.7 million a 17% increase and gross margin was 19.3%. This is a 210 basis point improvement over last year and when you look at it, the improvement was largely driven because of supply chain process improvements offset by lower prices on many items.

Now let's take a look at operating income. Operating income was a mere $154,000 loss compared to a loss of $4.3 million last year. At the net loss level for the quarter, we showed $787,000 net loss. Now as a percent of sales, this is 0.4%. On a year-to-date basis our loss is just $2.5 million. Again, this is 0.4% as a percent of revenue. The other interesting thing to note is that this is $11.2 million improvement over last year.

Now, let's turn to the balance sheet real quick. Total cash and cash equivalents was $79.1 million at the end of Q3. Working capital was $34.1 million. This is an $865,000 improvement from the end of Q2 and as I look at this and as we're entering the fourth quarter, I am feeling pretty comfortable with where cash and working capital is for the business. So, with those brief financial remarks, I'll turn the call over to Patrick.

Patrick Byrne

Thank you, Steven. Nice summary. I am going to start as always with the slides and tell you when to advance them. We've read the Safe Harbor highlights pretty much; I'm not going to go through these again. Other than to just point out the operating cash flow, that $19.7 million adjusted EBITDA and I have mentioned before, I am not a big fan of EBITDA, because as evaluation metric. But, it was interesting in that period where things got a little tight for us, it was an interesting number to give to the world because we are trying to figure our what our cash generating ability was that was a good place to start. We're trailing $22.7 million operating cash flow over the last 12 months and $13 million free cash flow.

Let me go back to the contribution dollar growth. I've mentioned, number of times, over the past couple of years that in our view that's what we've measured ourselves on in terms of growth. That's really what we are looking at internally as the thing that we care the most about growing.

And so I'll move to slide four. Quarterly revenue growth, I thought we had all the issues in marketing fixed early last year. I think we averaged 27% for the first half of last year. We had caught the down draft and it definitely compressed our growth late, we have fought our way back to positive as Steve pointed out that it is nice because it's nice to be back in positive growth. But we didn't do that through reckless marketing spend our marketing dollars is just keep getting 15% to 20% more efficient year-after-year. If you look at our years as a whole you'll see that and so we didn't get there by panicking and goosing anything too much but we are, I think, pretty disciplined now. And how we are spending our marketing dollars and finding ways to get more revenue dollars with less and especially gross profit dollars with less spend.

Next slide, quarterly gross profit growth again this is nice we had that big spike in '07 and late '07 but that was really because of how end of '06 turned out. So it's easy to grow off that. So this is growing 17% but slide six tells the real story again this is what we are looking at is growing the contribution dollars. Whichever what we call nectar which is the gross profit minus the market expense. And there is a lot of reasons for that I won't recite them again here but I am happy to talk about our reasons for that in Q&A if anyone desires.

Slide seven; I think we have said publicly our most recent comment about contribution margin is to expect it to be within 12% to 15%. I am comfortable with that I think 13% may be in some quarters even 14% might be the right number, may be 13% is the correct number not, so I will just stick with our previous guidance may be even take it and set us in 12% to 14% for now is where we expect this to settle.

Slide 8 quarterly adjusted EBITDA, that's adjusted EBITDA. It's a non GAAP measure; it excludes stock-based compensation. Looks like we are going to have one more quarter of heavy negative to show in this in fact the truth is I am going to eventually stop as I have mentioned before again and again I really don't like EBITDA as a measure of much certainly when your talking of evaluation, which going forward would be the more appropriate target of using EBITDA because it looks like our situation where things got a little tight looks well behind us for now. I am not anticipating a return so the meaningfulness of this number disappears as that becomes less and again as there are no more negative numbers. As there aren't anymore negative numbers this isn't so meaningful to me as a positive number because people are trying to use that for evaluation. And I don't think EBITDA means very much for evaluation.

Slide nine, trailing twelve months cash flow from operations again $23 million at this point. We have a nice cash machine here. And slide 10, GAAP annualized inventory turns I think we got that to about 40 on a GAAP basis. It of course drops as we end the third quarter because we pack our warehouse and our inventory goes up substantially and so that drops. But our inventory management has gotten really, really good I think. And of course a better number that measure our internal inventory management is the non-GAAP number, the red line which is at 5.9. And again that drop is that's going to drop as we've built inventories for the period we and for the fourth quarter and then its going to squeeze up as we scored up as we finished the fourth quarter.

Okay, slide 11, GMROI all the same comments. And slide 12, very proud of this, should mention that we changed the technology with which we measured this, our customer satisfaction, again for those new to the story. This is a measure that Fred Reichheld promoted in his book The Ultimate Question. We think it's very good measure. On this measure, the average American company scores an 8% on their overall net promoter score. On that measure, we score well 66% this quarter. It bounces around in the high 60s, low 70s. We also measure the NPS of those who contact customer service. So, those that you would think would be have some unhappiness. They just get better and better. Our customers care department just love bonds them. We’ve has managed to squeeze those costs down nicely in front of [Helca]. The cost are being managed beautifully and yet the customer satisfaction, even for people who call customer service is just phenomenally, its far above what according to Reichheld, the average American company experiences overall. And then when you talk about our overall, it’s up there with the all stars with Apple and so on so forth and we're very proud that in the National Retail Federation American Express poll, we became a few years ago, the number four customer service ranked company in America and then number four again and then, now number two. Second only to L.L.Bean. So I think we have a phenomenal customer satisfaction. Starting with customer service but that actually goes through the whole supply chain and it's a measure of things that go on through the whole supply chain.

Okay. Slide 13 are just the highlights, revenue growth has gone back into the black. Contribution dollars are growing 26% adjusted EBIDTA. Hence, we’re almost out of even trailing any negatives over a two year basis at which point you'll see me discontinue that. I'm mentioning that now just so somebody doesn't read any notorious motive into that. Gross margin has stabilized. We do keep finding ways to squeeze cost out of the supply chain and Steve Chesnut and Steve Tryon are heading that effort. It's been very successful so far. If I told you how many hundreds of basis points we still think we can squeeze out, I'm sure Jonathan will grab my knuckles.

But you don't see them all because as we squeeze cost out, there's a great deal of passing on to the consumer. So, recently I had caused to look at some statements of mine from four or five years ago, I think our gross margins had dropped 13 and we were saying we could add 200 or 300 basis points. In fact we've added 600 or 700 basis points and in fact, what we've did is we squeezed far more than that out of the supply chain, but we just keep passing that on to the consumer and dropping prices and as we squeeze hundreds of basis points more out of the supply chain, we should be able to just keep dropping our prices. We want to be able to take them into a place that nobody else can follow.

Okay. Well that's the end of my 13 slides. I will say we are prepared for a rip roaring Christmas. If we do have one, I don't want there to be any tears and people be surprised I think we're going to have a great Q4 and I am both top line and the bottom line. So, I'll stop, Jonathan or Steve do you have anything else you would like to add.

Jonathan Johnson

No. I think that's all. I want to turn it over to questions.

Patrick Byrne

Are you suggesting I over stayed my welcome? Go ahead and turn it over to questions.

Jonathan Johnson

Absolutely not Patrick. We always liked your commentary.

Patrick Byrne

Okay. Let's go to questions. Do we have any?

Question-and-Answer Session

Operator

(Operator Instructions). We'll pause for just a moment to compile the Q&A roster. Your first question comes from Brent Ryerson of (inaudible) & Company.

Unidentified Analyst

Couple of quick questions for you. Any thoughts that you want to offer us on the book pricing war with Wal-Mart, Barnes & Noble, Borders.

Patrick Byrne

Well I just saw a good analysis come out from somebody. I just saw it this afternoon that really hit the nail on the head in terms of what you could expect us to cost Amazon versus what you could the benefit and I made some assumptions about how much they loose per book on Sarah Palin's book and things like that, I am not sure the assumptions were dead on. But anyway, I think Wal-Mart does this for different reasons than Amazon. I think Wal-Mart does it just sort of to general, the way they use toys in their store. They generate excitement and pull people in where as it’s more of course bread and butter to Amazon's business. I don't know, do you have any comments there? Any smart thoughts?

Unidentified Analyst

Are you seeing it show on your side, the media side of the business as far as an impact. So far has it been benign or has it been hurting you at all?

Patrick Byrne

Well it’s in such a narrow range of titles, yeah of course its hurting us in that range of titles but we do price below Amazon on books, movies music games everything essentially across the board. I mean we haven’t a million titles, there is about 120,000 titles that mattered any given time. And they pick out 10 right in the belly of the bell curve and said they are just going to loose $5 lets say on each one of those and we are not following them there that's not our plan. But its okay we still beat them on 99.999% of the SKUs in that area.

Jonathan Johnson

I will just comment on that Brent ,BMVGs for the third quarter was about 3% of our revenue which was up a little bit from Q2 but down from 4% last year it's a pretty small part of our business so as Wal-Mart and Amazon and others do get out there it doesn't really have that big an effect on us.

Unidentified Analyst

Virtually meaningless in other words. Virtually not impactful. Looking at the model the margins on the fulfillment business looked really decent the margins on direct we'll go a little bit later what I was looking for any thoughts on that?

Patrick Byrne

Well we are looking at on the direct business we are measuring it, we got to look at both margin and turn on an annualized basis and we think its approaching, we think its gotten to be a good business. Yeah the margins are a little bit lighter, its where we still think we can squeeze lots of percentage points out of our cost structure and keep that reducing. I am very comfortable where the core business is going. In fact I think we've gotten, although we stay agnostic and we want it to grow versus partner and so forth. Our information has gotten so good that I think it makes sense for I really do expect it to grow substantially. It's actually growing nicely right now. And I will say that much about the fourth quarter its the core business, we know what to buy better than we've ever known before. And I really do expect to see the core business to have significant growth next year. Jonathan, do you want to jump on and say anything to follow that up?

Jonathan Johnson

Yeah, Patrick this is Steve let me just comment, so if we look back at kind of third quarter last year we were roughly just mid-tens on direct gross margins because the supply chain efficiency better buy better demand management where we pushed that up to just north of 12. So that just speaks loudly to what you have just said where we've got people focused on supply chain, we are thinking about demand, we are doing better buys, that's starting to translate into improved gross profit rate.

Patrick Byrne

Let me add to that, just in terms of capacity its now given that we've taken down the whole of a much bigger warehouse in Salt Lake. There is a good 75 basis points that are going to unused capacity at this point. Isn't that about right unused other than in the fourth quarter it will largely be used but so there is you can think of there being a 75 basis points sort of handicap on that margin that as we grow the direct business that's where some tens of basis points going to fall out. Jonathan I touch you off but…

Jonathan Johnson

I was going to say, I agree, we do have a little bit of a head wind given the extra warehouse capacity but we think there is more money to squeeze out of that process, we also think we are getting pretty good at the pick, pack, and ship game and we begun to approach folks to offer a consignment models that we can make use of our warehouse space and our skills as pick, pack, and shippers and so that's the nascent project but I think it's a place that we have some potential.

Patrick Byrne

Absolutely, and we've lived that up, we've got that going even more slowly and carefully than other projects in the past but we have developed nice software package so we can do that to get the accounting rate et cetera. And we are really looking for our first few big vendors who want to reduce their own warehousing costs and have some excess inventory to liquidate and just want to send it to us.

So, I think the consignment model ultimately should be a good business for us. By the way I want to give citation to the report I refer to is that when they came out today from JPMorgan, is the one about the Amazon, Wal-Mart, book pricing.

Okay Brent do you have another question?

Unidentified Analyst

Yeah, one final question for you. The cash build in the quarter was a pleasant surprise. Any highlight on that, what drove that? It was several million higher than I would expect it. And then implications for cash at the end of the fourth quarter?

Patrick Byrne

Steve why don't you start off?

Steve Chesnut

I think that the key driver was the fundamental P&L itself when you got the top line growing and you are managing expenses and you are managing the marketing spend. You start to see that cash-flow and start to come out and then kind of a key measure that we watch as where working capital is going to sometime you get little bit of swings between cash on hand and payables. So, when we saw the up-tick also on working capital that was spoke loudly that this thing had nice cash flow coming through the quarter.

Unidentified Analyst

And fourth quarter?

Patrick Byrne

I think it should, I am optimistic that it's going to spit out quite a bit of cash for this fourth quarter, and you probably won't see our working capital dip down into, if things goes planned you shouldn't see our working capital dip down into the 30s again. Well, again, but short of some balance sheet anything we do on the balance sheet or buying or something like that. We are comfortable, we have been operating within the low 30s but should get over 40 and then we like to probably keep it there.

Unidentified Analyst

That imply cash over a 100 in the fourth quarter?

Patrick Byrne

Steve?

Steve Chesnut

Brian, you have to be real careful because it probably will be north of a 100 is clear but then we pay down payables pretty fast after that. That's why we watch working capital because we get more of a consistent pattern of what's happening with the underlying business.

Operator

(Operator Instructions). You have no further questions at this time.

Jonathan Johnson

Patrick, there has been a couple of questions that have been e-mailed in and I would like to read to you we can answer. One is short of an economic meltdown, do we foresee overstock as being profitable for the entire year after Q4 and then the second one from this investor is international growing faster than domestic.

Patrick Byrne

My answer to those, the first one is, may I permission counselor to answer the first question?

Jonathan Johnson

You know I don't want too much guidance but yes you have permission to answer on this one.

Patrick Byrne

The first one the answer is yes. I do think that after the fourth quarter we should have a GAAP profitable year. I am hopeful of that without an economic meltdown and so forth. International is growing but its percentage growth is high but of course that's based because the denominator is small. Its not yet you are not seeing 1% of our sales yet be international, however that could change and its really I think next I just came from Europe and looking at the opportunities to do things there. And it is a place where international general is a place that will, we intend to focus and what we are focusing now. And it’s spinning up, its spinning up at a very high percentage rate, but it'll be less than 1% of sales for this calendar year.

Jonathan or Steve do you want to add something to that?

Jonathan Johnson

Yeah I would agree I see big, I see nice potential in international, but its such a small percentage of the business now its not that meaningful. Also I think will be careful in dipping our toe in the international water to do it prudently and carefully and not dive head first into something and we feel like that's the right thing to do because we better controls the cost and the exposures and things, so I am very pleased with where international is. How we are approaching it and hopeful its going to do well.

Two other questions have come in one is how does management weigh benefits of driving faster operating margins versus benefits of various losses announced in conjunction with the question that says it looks like our legal expenses are limiting improvements in our gross margins and what point will those legal expenses stop increasing?

Patrick Byrne

Well legal expenses did have increased and did weigh down on operating margin. We are scheduled to be going to court in the first case in [Meran] in February and Jonathan why don't I let you answer part of those?

Jonathan Johnson

Okay. We are picking up more legal expenses, some of them do relate to out suits in California our suit against Rocker Partners and then again Prime Brokers we have also seen an increase in Patent Troll suits which I think is to be expected as we maintain being a player in this field we have taken aggressive stance in fighting those. I think we'll see legal expenses grow in or be significant or kind of levels they are at in Q4, and may be through the first half of the year as we go to trial, trials always an expensive endeavor, but we are at a point where that's all is so close, its definitely worth spending and getting cured because we are still good about where we and what the possible result there.

Patrick Byrne

Steve Chesnut, do you have anything to add?

Steve Chesnut

Yeah, I think the other piece is that sitting on the balance sheet right now we've got a little over $800,000 of that settlement money of two and three quarters million that will also be used to help offset some of these future expenditures round legal suits. So we've got a little bit of a hedge sitting there.

Patrick Byrne

Jonathan, do you want to expand on that? Have you explained that to the public yet?

Jonathan Johnson

I think its there in our disclosures of how far as we did follow with our DNO insurer and we have a sum that we earn out as we spend legal expenses and so part of our expenses are offset by that insurance pool and like Steve said there is little less than a $1 million left in there we are running through that over the next several quarters.

Well I would say we put out a press release last week one of our lawyers John O'Quinn who was a lion of a man, unfortunately was killed in a car accident last week, it's a sad situation but we are still plowing forward and are prepared to take both the cases he was helping us with to completion.

Patrick Byrne

Yes, condolences to O'Quinn he was a great colleague for Overstock and as Jonathan says a lion of a man. He was a good, a wonderful fellow.

Jonathan Johnson

Well Patrick I think that's all the questions, do you want to say any closing?

Patrick Byrne

No. Just I really do look forward to speaking with folks in January or February, when the next conference call as I feel very good about this quarter. And I just feel very good about the quarter we are in, things are going well, we've really positioned ourselves tightly, we've stumbled occasionally before, but I think things are looking pretty good for us right now.

Jonathan Johnson

Okay we'll put our shoulder back to wheel and start working for our owners again.

Patrick Byrne

Its nice working for smart owners. Thanks.

Jonathan Johnson

Thanks Patty.

Operator

You are welcome sir. This concludes today's conference call. You may now disconnect.

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Source: Overstock.com Inc. Q3 2009 Earnings Conference Call
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