Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Overstock.com, Inc. (NASDAQ:OSTK)

Q4 2009 Earnings Call

April 5, 2010 5:00 pm ET

Executives

Jonathan Johnson - President

Steve Chesnut - SVP, Finance

Patrick Byrne - Chairman and CEO

Analysts

Nat Schindler – Bank of America/Merrill Lynch

Brent Rystrom – Feltl & Co.

Tom O’Halloran – Lord Abbett

Michael Onghai – Ibis Capital

Operator

Welcome everyone to the fourth quarter 2009 Overstock.com conference call. (Operator instructions) I would now like to turn the call over to Mr. Jonathan Johnson, President of Overstock.com. Please go ahead, Sir.

Jonathan Johnson

Good afternoon and welcome to our fourth quarter and fiscal year-end 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 and risk management.

The following discussion and our responses to your questions reflect management's views as of today, April 5, 2010 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 the press release we issued on March 31, 2010 along with the 2009 10-K we filed with the SEC on the same day.

As you listen to todays 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 the discussion that follows. It would also be helpful to have our 10-K with you.

During the call we will 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 reconciliations of these measures to the most comparable GAAP measures.

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

Steve Chesnut

Thank you Jonathan. As you know at the end of December we engaged KPMG as our independent auditor and in late January we announced we were restating our fiscal year 2008 and Q1, Q2 and Q3 2009 financial statements. I concur and echo the feelings and sentiments that Patrick shared in his letter expressing appreciation for your patience as we work through this restatement and I would like to take a moment to explain some of the details of the restatement as well as the material weaknesses disclosed in the form 10-K we filed on March 31.

As we restated our results to correct errors relating to our accounting for partner billing and our accounting for expenses related to restricted stock units. While we had the books open we also made several other adjustments as part of this restatement. These other adjustments amount to $180,000 of net loss reduction in 2008 and $69,000 of additional net income in 2009. For a detailed explanation and full disclosure you can refer to the explanatory note contained in the first few pages of our 2009 form 10-K.

As a result of the errors we have corrected this restatement. We assessed the effectiveness of our internal controls for financial reporting at December 31, 2009 and we identified two material weaknesses. The first is we lacked the sufficient number of accounting professionals with the necessary knowledge, experience and training to adequately account for and review significant transactions. This resulted in our misapplication of GAAP.

The second is that our information technology change and deployment controls were inadequately designed to prevent changes in our accounting systems and this led to a failure to appropriately capture and accurately process data. While these material weaknesses have not been remediated prior to the end of 2009 we have been and continue to work diligently to correct these issues.

Some of the actions we have done and are taking include; we have hired and are continuing to hire additional experienced professionals in our accounting and internal audit department. We have reorganized our accounting and financial reporting department to improve supervisory review. We have reorganized our supply chain department to provide comprehensive oversight over our returns process and partner billing accuracy. We are reviewing the systems and controls in place to appropriately capture amounts to be paid to fulfillment partners. We are enhancing our IT testing capability to improve the completeness and accuracy of data provided by our IT systems and finally we have engaged a consulting firm to evaluate our IT systems for improvement opportunities.

Now we have made progress on these issues and will continue to focus on the implementation of our plan until these weaknesses have been remediated. Now let me take and focus some attention on the highlights from the 2009 financial results.

Revenue growth accelerated significantly in the fourth quarter. Q4 revenue grew 27% to $322 million and revenue for the year was $877 million, up 6% over the prior year. We also reported our first annual profit in 2009. Net income attributed to common shares was $12.7 million in Q4 and $7.7 million for the year. The strong contribution growth of 26% was an important driver while technology and G&A expenses grew by just 5%. Now this expense growth in technology and G&A included a $7.1 million reduction of legal expenses from the settlement of legal matters. I would encourage you to review the press release we filed on March 31st for a detailed and thorough analysis of these results.

So with that Patrick let me turn the time over to you.

Patrick Byrne

Thank you Steve. Thank you Jonathan. Jonathan it is amazing you never sound bored reading that introduction. I don’t know how you do it. I am going to start on slide three, 2009 results. Revenue is 27%, two times the industry growth. Gross profit is up 31%. Margin 17.1 versus 16.5% in the previous Q4.

Contribution dollars which I think we have been jumping up and down on this note for a couple of few years, you would see this grow. Well it grew 43% in Q4. Contribution margin which is a non-GAAP number is 11.3, up 120 basis points. $12.7 million in GAAP net income. Yippee Ka-Yay. Working capital at a comfortable $51 million that is well above what we think is the treetop level for this company so all is good.

Slide four, quarterly revenue growth. Let’s go to slide five, these are basically the same numbers I announced. Slide five, 31% in gross profit growth.

Jonathan Johnson

I think the nice thing about those last two slides Patrick is we see a nice trending up. They are in positive numbers and they are focused the right way.

Patrick Byrne

Right. Again I think measuring us, I don’t know what the future holds but I think that a nice managing…the industry is growing about 10-12% now depending on whom you listen to and managing numbers that are say two times that on the top line and better than that on the contribution line is great. Not sure. I will stop there. We won’t talk about the future.

Slide six; again these are the numbers I pretty much gave you. We do see lots of improvement still we can iron out of our supply chain. I have said that before and I think I said a few years ago we definitely saw hundreds of basis points. We have in fact steamed hundreds of basis points out of the supply chain. There is still more to go. The other thing to note is we have been giving a lot of that back to the consumers. Our prices have gotten quite sharp and we measure ourselves very carefully. If we can steam 100 basis points out of the system and we are giving 50 basis points or more back to the consumers in lower pricing, that might be the way to go.

It may not be 50/50 the right number. People have asked in writing in is the decline versus the previous quarter is that mix shift or what is it? The answer is yes. It is primarily mix shift. In the fourth quarter people buy books and electronics and the margins on that are just lower.

Slide seven, contribution dollars, once again 43% growth. Slide eight, the one I like. Cash flow from operations $46 million for the year. Do you want to say anything about that Steve or Jonathan?

Steve Chesnut

When you look at that $46 million it is phenomenal performance over where we were a year ago. Clearly this thing is generating cash.

Patrick Byrne

Slide nine, GAAP annualized inventory turns is five on an internal basis. I think we should be able to do better than 5.1. Some of this comes with getting into some new markets and learning about where the demand is and such but we are still okay with this in the five’s. I think we can do better, in the 28 on a GAAP basis of course a great number.

Ten, the [inaudible] 637%. Slide 11, besides the profitability and somebody at a Wall Street bank sent me a note earlier today saying “profit is noble” and I think that sounds like a Chinese saying or something but I am of course very proud we are profitable now on any basis; free cash flow, operating cash flow, GAAP, perhaps to the consternation of a few but I am very proud of that. I have to put slide 11 up there with or even beyond that. We are the second highest rated company for customer service retailer in America, above a number of other highly recognizable companies with long histories. LL Bean is going to be hard to ever pick off. I grew up in New England and LL Bean is a fantastic company is going to be hard to pick off. Jonathan?

Jonathan Johnson

I don’t think that is going to keep us from trying really hard. I know the day this ranking was announced folks in our customer care center were excited for the day to come and as the NRS and [Amex] announced the winners starting at 10 and counting up as we got closer to being not announced and knowing we were in the top ten we really expected to be number one. That group is so focused on serving our customers well that anything short of number one was viewed as disappointment.

Patrick Byrne

That said in New England I know LL Bean you could bring your grandpa’s duck boots and duck hunting rubber boots with a hole in them and they will replace them. So it is awful hard to capture LL Bean and of course they manufacture the stuff. It is nice. I have a lot of respect for Zappos and others on the list but it is nice to be even above that.

We still have lots of ways we can improve customer satisfaction. In fact, on slide 12 the red line here is a measure of the people who had a problem and have called us or contacted customer service. We pay a lot of attention to this number, just not the score of everyone who orders but everyone who orders who has some problem. Of course a customer who has called to complain is a customer who wants to be saved. We lavish them with customer service. This score has gotten…we are almost an NPS superstar just on the score of people who have already had a problem and called.

We still see ways and improvements we can make here. Our partner in this is Right Now, they provide us the technology and they have been a fantastic partner for Overstock.com. Also Stormy Simon who is over all of this and Brian [Inaudible] they have…we can’t say enough good things about the customer service team. In fact, in our company I think I have said before numerous times publicly they are the department that really speaks with the loudest megaphone into the rest of the company and makes the rest of the company hot. It has proven itself in the results.

Slide 13, 2009 results. No reason to read down this list. We will just flip through the slides. Slide 14, revenue grew 6% for the year. Slow start but a fast finish. Gross profit, slide 15, $164 million, up 18.8% for the year. Slide 16, contribution, $109 million up from $86 million. I look back at 2006 when we were at $18.9 million and who would have thought in three years we could take that from 18.9 to $109 million. That number actually somebody at Allen and Co. told me to think about focusing on this number. He had a pretty good theoretical argument. It was one of those conversations on Wall Street that was actually very useful for us. We have been focusing on this number and measuring what we call net [durable] or contribution dollars is really a very good way to sharpen the focus of lots of different processes in the company.

Slide 17, of course this is the best shot of the deck. It is the contribution versus all of the GAAP costs below the marketing line, technology and G&A the lines have crossed for the first time on an annual basis. Anything you want to say about this Steve or Jonathan?

Steve Chesnut

It is nice to see contribution being strong and expense control is there in place also.

Patrick Byrne

We really do have tight expense control. Jonathan what do you want to say about this? You have been here for a wild ride.

Jonathan Johnson

I think as Steve and Patrick have said expense control I think not that we have mastered it but we have gotten so that we feel pretty good about it and we think we can squeeze some more out of there. Watching contribution pick up I think is the most gratifying thing we have. It shows we are not only making sales but we are doing them at a good marketing cost.

Patrick Byrne

So ultimately our supply chain, the rest of the customers is adding value from the world’s point of view. Annual cash flow, slide 18. $46 million in free cash flow of $39 million. Nothing to sneeze at but I am not going to talk about the future.

Slide 19 is the highlights. So I will stop there and operator, let’s go to questions. Do you want to address any questions that have come in first on email? Operator, why don’t you open it up for questions.

Question and Answer Session

Operator

(Operator Instructions) The first question comes from the line of Nat Schindler – Bank of America/Merrill Lynch.

Nat Schindler – Bank of America/Merrill Lynch

I wanted to know if there was anything that changed in your usual fourth quarter mix and/or new category entrants or anything that stood out as a cause that really drove you to go to roughly 2X the Department of Commerce number for the fourth quarter?

Patrick Byrne

To be honest my question is our sense is why didn’t this happen earlier. It has been three years we were stuck at one level and as we fixed all of these things. I really did think a year or two earlier we should have started reflecting stuff like this. I guess we did in 2008. I think we were about 25% by the middle of 2008 but then we got caught in the downdraft like a lot of people but not like everyone.

To me the reason it has ticked up is all of these things we have been doing really for 3-4 years that really refine the way we treat customers, products, stripped costs out of the supply chain, passed price reductions back to the consumers.

Jonathan Johnson

To answer your question there wasn’t anything special about this Q4’s mix as opposed to past Q4’s. Q4 has always had a little bit heavier in books and media and electronics but it wasn’t any significantly different than it was in prior years. What I really think happened this year was all the progress we have made throughout 2008 and 2009 paid off and we didn’t get caught in the same downdraft we got caught in 2008 when every retailer became a discounter. We suffered in 2008. 2009 most retailers didn’t have excess inventory on their shelves and couldn’t offer the deals we were offering. We competed as a discounter and I think succeeded.

Patrick Byrne

In a way we were here a year earlier but the whole economy train wrecking it just didn’t manifest itself. Steve what do you want to add to that?

Steve Chesnut

I think as you watch quarter by quarter as we came through 2009 you continued to see building strength in all the initiatives around pricing and supply chain and it came together very nicely in the fourth quarter.

Nat Schindler – Bank of America/Merrill Lynch

Going to the gross margin line, Patrick you said earlier in the year when you were reporting north of 20% you felt that in general that gross margin was probably too high or it was around 20% particularly on the partner side and you probably attempt to give more of that back to customers, or you would like to drive revenue a little bit more by giving a little bit more of that back to customers. Fourth quarter typically is a lower gross margin quarter as you have said in the past largely because of mix. Is the drop off on the sequential basis to 17% entirely because of mix and as a normal seasonal variation or have you made any sort of purposeful decision to cut back in costs and give a little bit more to the customer in order to drive revenue?

Patrick Byrne

I would say it is mostly seasonal. We have a bigger and better electronics department than we have ever had and electronics, books and [BMG] do pull this down in Q4 historically. If you look at line six they pull it down every Q4 but we do have a better electronics department. I am not sure I can say did the percentage of sales in electronics was it bigger. I would have to go back and look at the numbers to be absolutely sure.

It is partially we are sharpening our prices. We are getting more aggressive on pricing. We are analyzing our pricing versus the world and we see not 100%, we want to be cheaper than everybody, but we see a very high number close to 100% on everything we measure is cheaper than the world and we want it to stay that way. We are consciously passing more discounts or lower pricing on to the consumer. It is mostly; I think the drop off of this more than half of it is explained from the normal Q4 mix shift. Steve?

Steve Chesnut

That is correct. Probably a clean way to characterize it is like 70% associated with mix. 30% of it is associated with pricing and supply chain efficiency we have created.

Patrick Byrne

We definitely have a conscious effort to drop pricing now to consumers. We think we can and we think that is money well invested so to speak. As I said we still see a couple of hundred basis points we think we can pull out at our cost structure. You may not see that. You won’t see all that show up in the margin because we are going to just keep passing it to the consumer and we think we can take our pricing, we already have our pricing below where just about anyone can follow. Our point is if we can keep stripping out costs and keep passing it on to people we can take our pricing to the point no one can follow.

Nat Schindler – Bank of America/Merrill Lynch

Going a little further down the line, you said in the pat technology and G&A would add up to in 2010 and going forward you would look to add that up to around $110 million as technology kind of moderates the declines you have had because of depreciation coming off and starting to tick back up again by more people is that still a number you think is an appropriate number?

Patrick Byrne

No I actually don’t. I am not going to say too much because we don’t want to talk about the future because we just don’t want to comment on the future. However, I would cancel that expectation. We used to think of ourselves as a lemonade stand with a computer in it. Primarily a retailer. We are now seeking opportunities for a way to be more of a technology player. We have a great IT department; much stronger than it has ever been. They are partially responsible for this. They are a big part of the equation. Incidentally another huge part of the equation is our human capital team led by Steve [Trion] who have just built this, someday when the story is told, what we have done in human capital development is I think going to be Chapter One of what this fellow, this Army colonel who joined us has done.

Our technology team has gotten much more I would say leading edge. We see opportunities we don’t want to miss. I had previously thrown out a number like $110 million. We hit it. We stayed there for awhile but I would say I would cancel that expectation. I think you can still expect us to remain profitable but we see ways where we can invest in technology and be more leading edge there than we have ever been in the past. What else do you want to say Jonathan?

Jonathan Johnson

I think that is right. I don’t know that I would stand by that number we have put out there in the past. I know every time we do look to increase our G&A expense we are looking for the return on investment. It is not a willy-nilly growth there. It is looking at how the technology is going to boost the top line and the bottom line.

Patrick Byrne

We do think in terms now of investing more in technology and letting this grow but within the constraint of staying profitable on a yearly level as our governor. We see ways in some ways we were playing catch up. We figured out a few things along the way, maybe earlier than others. A few things we missed and they figured out first. In a lot of ways technology we were playing catch up. We are developing things that nobody else has done yet. It is nice we have a nice cash flow and profit stream we can invest in those niches we don’t see anyone else in.

Steve Chesnut

I think as we come out with the Q1 results the picture will continue to play out.

Patrick Byrne

You never know the future.

Nat Schindler – Bank of America/Merrill Lynch

You said you didn’t want to talk about the future but Q1 is the past. How was growth in Q1?

Patrick Byrne

Q1 is unreported and so thus Q1 remains the future. You may have heard I have been in a little bit of hot water…

Jonathan Johnson

We just went through a healthy and good start with our new auditors. We are going to go through our first quarterly review with them. At this point both the prudent and right thing to do is to announce Q1 when we have everything scrubbed.

Operator

The next question comes from the line of Brent Rystrom – Feltl & Co.

Brent Rystrom – Feltl & Co.

Maybe you could from a civilian perspective to technically explain what some of the systems things you are going to work on this year and maybe the timing for them?

Patrick Byrne

Our website, you can see for yourself our website is getting slicker and slicker. There are more and more features. Beyond that I really don’t want to say. Is there anything we can say before we…We have 2-3 of what I think are really nice ideas for this year to make the website better to increase conversion. Two things that I think are money in the bank ideas and one of them is something nobody else has done yet. Jonathan doesn’t want me talking about the future.

Jonathan Johnson

I think until we execute on these things, we are trying to be just a little more conservative in what we are predicting.

Brent Rystrom – Feltl & Co.

Looking at and maybe a different way to ask about a different subject, the inventories obviously you had the inventory build in 4Q, a little bit higher than maybe you would have expected. I am guessing it had to do with things you saw in the direct business as far as the first and second quarter. Any particular comments on categories that look particularly appealing? Or particular inventory areas that look appealing as far as the direct side of the business?

Patrick Byrne

Apparel looks interesting to me. It is growing very nicely. It is clearly a very difficult business to figure out on a direct basis. The SKU proliferation in fashion and changing tastes, so it is a tough business to figure out. That might make it the right kind of business for us. The toughest part of the business to figure will have the fewest or weakest competitors.

Let me go back a step on your question. One of the things that has really helped this business is in the early days we were largely a product push business. We were making these fantastic deals and pushing them to the consumer. We got starting with all these systems we implemented in 2005 and 2006 we started to have a lot more business intelligence and could figure out where the demand was and then go and buy to that demand. I would say going back to the technology question metaphorically it is the same. We have figured out more of what the consumer needs to shop successfully and to convert and then we are building features into our site that lets them do that thing they are trying to do.

It is just in general becoming more demand pull rather than product push. That is true both on the kinds of inventory we have and the technology. As far as new categories, we are developing new categories but the thing that looks to me like…now that we have as much business intelligence as we do have in our systems we see all kinds of unmet demand we think we can reach out and fulfill.

Brent Rystrom – Feltl & Co.

You are basically seeing unmet demand in the existing categories as opposed to seeing new opportunities?

Patrick Byrne

We are. We are seeing a lot of unmet demand really across…it is more concentrated in some categories than others, but we are able to see now where the unmet demand is and that is what we are working towards.

Jonathan Johnson

That is part of the reason we had a little bit bigger of an inventory build at the end of the fourth quarter. We wanted to make sure we had [inaudible] for the January, February and going forward demand.

Brent Rystrom – Feltl & Co.

On the inventory side, does apparel by nature imply a slightly higher margin business than the rest of your business historically?

Jonathan Johnson

It implies a lot of things. Sometimes it is higher margins. Sometimes it is higher returns.

Patrick Byrne

Certainly higher costs.

Jonathan Johnson

Certainly higher capital. You throw it all into a mixing bowl and mix it up, it is like everything else.

Patrick Byrne

It is not there yet is what I am saying. It is not there yet in terms of where we think it should get. In terms of both offering to the consumers and what our financial returns should be on it. Steve?

Steve Chesnut

As you can imagine the apparel business does have the potential to produce above-average. The question is how we manage the back end as we get out of seasons. That is I think where we are continuing to learn.

Brent Rystrom – Feltl & Co.

The realized merchandise margin versus your IMU?

Steve Chesnut

That is right.

Patrick Byrne

It reminds me, there is an internet guru named Seth Godin who wrote a book called “The Dip” which is sort of a book of personal advice you try to find out a hurdle to get over that…it is the biggest thing you can get over but it is big enough other people can’t. You try to pick that and get over it and that is how you separate from the pack.

We think in apparel and in some other areas it is so hard to do right. My sympathies, I used to be in the apparel manufacturing business and I thought that was tough. This is vying for apparel and is so hard to do right I think the companies who can get the business intelligence and planning down best will have such an edge on the people who are going about it the old fashioned way. I think of that as a dip I am hoping we can get across and the results now are kind of in line, although it is growing very quickly but the financial results should be able to get much better. I think that is a reflection of how hard it is to do it right so if we start doing it right we should just be able to take a nice dent into the marketplace.

Brent Rystrom – Feltl & Co.

Any litigation timing updates as far as when are the next events we should be looking for?

Jonathan Johnson

Our case against the prime brokers has a trial date set in September of 2011.

Patrick Byrne

The O.J. trial of the financial world. September 11th. San Francisco. Reserve your seat now.

Jonathan Johnson

We are in discovery. We are starting to take depositions in the upcoming months. That one now has a trial date and we are eager frankly to race to the courthouse steps on that one. I guess some of the other…

Patrick Byrne

Slim chance that might be able to be moved up, right?

Jonathan Johnson

Slim. We are waiting for a decision from the New York Appellate Court on the affiliate tax law. We think we are in the right but either way we have modified our behavior so a decision for us or against us isn’t really going to change things.

Patrick Byrne

I love the affiliates. We have talked about them for years. It is the word of the fleas against the elephants to work with the affiliates. We are just going to cut any affiliate program in any state that passes a law that says affiliates create [excess] which I think is a ridiculous and probably unconstitutional thing for them to say. Any other states that pass this we are just going to end our affiliate programs in those states. I think Amazon just did something recently thematically similar if not exactly the same.

Brent Rystrom – Feltl & Co.

When are you going to release first quarter earnings?

Jonathan Johnson

Don’t know yet. I would guess in April. A number that starts with a 2. Sometime in the 20’s.

Brent Rystrom – Feltl & Co.

Not a 3?

Jonathan Johnson

I hope not a 3.

Patrick Byrne

These folks have been for four months burning the midnight oil and not just Steve Chesnut and his team but KPMG to whom I think some props are due. Even to get this in by last Wednesday which was the final date we could without…well to me the SEC deadline and even there it was a herculean task for these folks. We thought we would actually be able to beat it by a couple of weeks but they really had to cough up a lung to get there last Wednesday. Props to KPMG. We have had a wire brushed to us but as an outsider to the process they look like they have done great work and added a lot of value to the company.

Jonathan Johnson

I would say probably mid to late 20’s. 25th or 26th.

Steve Chesnut

We have to put a big asterisk.

Jonathan Johnson

It could be in May but hopefully the last week of April.

Operator

The next question comes from the line of Tom O’Halloran – Lord Abbett.

Tom O’Halloran – Lord Abbett

In view of what we have been through in terms of the economic downturn and apparent movement of many consumers towards greater value I am curious as to how the competitive landscape is changing for Overstock and how the brand is evolving and what opportunities you see in both fronts in the coming year or two?

Patrick Byrne

Our brand has become part of the American psyche. We do all this testing, all these surveys, unprompted name recollection and everything. Our brand has become part of the psyche. I love that when folks in the press write about the Internet they used to write about Amazon, EBay and sometimes they included Overstock. Now they write about Amazon, EBay and Overstock as a matter of course. We have really become part of the psyche. We think that brand is intangible. It is hard to manage the effect of our spending. We think we have ways that measure the effect loosely of our television and radio and print spending.

As far as the competitive landscape, Jonathan will you let me say what our competitive pricing is or should I not? No. I’m not going to say but we think the vast majority of our products are what we call competitive which is either at or below anywhere else you can find them. As far as a real change in the competitive landscape, I would say some of these private sale sites or the ODAT sites, one deal at a time sites, are coming on strong. They are good sites with good executives behind them.

I think that is an interesting model. As I measure it we are about 1% of e-commerce and I think some of those are about half of a percent. It isn’t like we are eating into each other’s business yet. There is a big world of e-commerce and a big world of brick and mortar that hasn’t shifted to e-commerce. That is where I would see some competitive pressures emerge. Again, I think we are at a place where we can just keep on driving our prices below where anyone else can follow. Steve Chesnut you are a strategic thinker, what do you want to add to that?

Steve Chesnut

I think we are still very much almost a $900 million business but we are small in a big, big pond. The consumer is continually gravitating towards the convenience of the internet space. I think this just continues to bode well for us strategically.

Jonathan Johnson

I think in addition to consumers gravitating towards the internet consumers are gravitating towards discounts. When folks are looking for a way to stretch their nickel and maintain their standard of living I think they see Overstock as a real alternative there. Frankly that is what I attribute a portion of our growth to is we are beneficiaries of people wanting to or in some cases needing to stretch their nickel.

Patrick Byrne

It is hard to be a discounter and get great customer service. One asterisk to Jonathan’s point is it ratchets. As people adopt the internet it isn’t a pendulum that swings back and forth. Once they adopt it and get used to it they ratchet there. This downturn drove people onto the internet. You are seeing I think it is pretty standard at this point that the internet is growing 10-12% faster than normal retail. If you look over the last five years that spread has stayed constant and if you are somewhat pessimistic about what the long-term GDP growth is going to be even in a world where the U.S. is zero or has zero growth there is still real opportunity for e-commerce to keep growing.

If you look back at page 11 and you see this list of all the people up there with us we are the only discounter I think. So you have a list of the best 10 companies for customer service in America I think we are the only discounter. Amazon definitely has good pricing but I am not sure if I would call anyone else here on this list a discounter.

Jonathan Johnson

Maybe QVC. I don’t know. I feel like if we are not the only discounter we are the most identifiable discounter.

Patrick Byrne

As a pure discounter and to be at the top of customer satisfaction is a pretty hard thing to juggle.

Tom O’Halloran – Lord Abbett

I would agree. Secondly, on the inventories they were down slightly year-over-year. Was that because you sold a bit more than you thought in the fourth quarter and how are you thinking about inventory levels going forward?

Steve Chesnut

I think if I look at the team managing the inventory we had great demand management going into the fourth quarter. We did a great job of forecasting and predicting and then doing a great job of managing our way out of the season.

Patrick Byrne

I think there are two offsetting items so the number and the ratios probably all stay about the same. One is all things being equal I would say let’s run inventory a little bit fatter because there have been times in our past that we just had a surge of growth beyond what we had anticipated deplete our inventories and then our keel touched bottom and it disrupted our growth cycle. I want to say ahead of that and run inventory a little bit fatter.

On the other hand, our demand management team and our buyers have gotten so good and their business intelligence is much better, and by that I mean the business intelligence system, it has gotten much better so that should be a pebble on the other side of the scale. How the two balance each other they just about cancel each other out. I don’t think you will see the ratios change. Internally I want to run, we probably could lean out…what all that adds up to is we could lean out the inventory more than we are now but I want to run it a little bit fatter so we don’t have that problem of touching the keel in the mud again.

Tom O’Halloran – Lord Abbett

Lastly, on corporate cash levels I think I recall you have about $140 million give or take a million in cash. Then about $60 million outstanding remaining on the convert I believe and you generated close to 40 this year. What are your thoughts on cash levels you would be comfortable with and the priorities for the cash going forward?

Patrick Byrne

I will answer part of that. We pay a lot of attention to the working capital. We didn’t want t hat to get below $30 million. That was sort of where things didn’t stop working too well if it got below that. That was Steve’s number. We have seen that rebound from 30 to $51 million now. Jonathan what do you want to say about the future?

Jonathan Johnson

I think our business is generating cash. You asked about the senior notes. They are out there. There is about $60 million of them that come due a year from this December so December 2011. We have bought some back in the market in the past. We are generating cash. I am not really concerned about it.

Patrick Byrne

Still wish we could buy some more.

Jonathan Johnson

We would love to buy some more. If you know folks that are selling let us know.

Patrick Byrne

The last pricing I heard on it for some months it has been way, way out of line of where I think the pricing would be that we would be interested in.

Jonathan Johnson

That is correct.

Steve Chesnut

The number I keep Patrick focused on is net working capital because our cash cycle spins pretty quick so cash can pay off payables very quick so we keep a close eye on net working capital. We will continue to watch that as we go through the year and in theory keep building on it.

Patrick Byrne

I know the $60 million note this December…

Jonathan Johnson

December 2011.

Patrick Byrne

December 2011, but this December will convert to a short-term. I am not troubled by that. We are spinning off enough cash that we can I think comfortably just pay this off and be good. If somebody had a realistic price I wouldn’t mind taking some off their hands.

I am going to add one more thought on that. What are your thoughts on maybe replacing some of that convertible note with a more permanent layer of straight debt?

Jonathan Johnson

We would be interested. If the terms were right. We don’t feel like we need to take it and do so at onerous terms but if good market terms I don’t mind having some debt on the balance sheet.

Patrick Byrne

A fellow name Nick, I won’t read your whole name, but somebody asked should they email questions or just call in on the call. We will do them both ways. It is a little bit easier sometimes if people email them. He asks what steps are being taken to reduce legal risk to the company from patent infringements, products placed on your site and what plans to reduce this going forward?

Jonathan Johnson

I really think there are two kinds of patent infringement cases. One is for products being sold on site which Nick has referred to here. We have good indemnification agreements with our drop ship partners. I think we are fairly well covered there. The other is from patent trolls claiming to have patented the internet. Some business prospects and those come and go. I think we have benefited and have a well earned reputation of fighting those tooth and nail. We have invalidated patent troll patents in the past, spending a good deal of money to do it. I think that has been a tactic that wards those suits off.

Patrick Byrne

Jonathan has spent $1 million rather than settle something for $100,000 and has a few invalidated patents on his trophy wall.

Jonathan Johnson

We will keep doing that. It is a matter of principle.

Patrick Byrne

The other question is what are we doing to reduce returns as a percentage of sales? We actually have a very low returns rate compared to most people in our industry and we have focused on the cost of the returns not on the absolute rate. We do think that is where quite a few basis points are waiting to be ironed out of the system. Steve, that is one of Steve’s pet projects.

Steve Chesnut

We have a whole team that is focused on working with partners, looking at the return rate, working back with them to solve return problems, quality problems and all of those things. We are seeing nice traction around that.

Patrick Byrne

Reverse logistics is a difficult thing to do right. A company that came out…I think that companies that the real cost of taking returns are much higher for say people outside the industry generally know and if an entrepreneur who came up with a business that really could strip out and reverse logistics costs successfully and I know there are a lot of people who claim they have those businesses but we are not convinced at this point having worked with some of them, it is really a nut waiting to crack.

It is more costly than you would believe to take returns. Fortunately we have a very low return rate and we do think we can pull that percentage down quite markedly.

Operator

The next question comes from the line of Michael Onghai – Ibis Capital.

Michael Onghai – Ibis Capital

If I were to think about maintenance CapEx of your business I know you use very rapid depreciation so I am quite sure your maintenance CapEx is a lot lower than your D&A. I wanted to see if you could give me some guidance as to how I should think about it.

Patrick Byrne

Jonathan, can I answer that or not?

Steve Chesnut

I think we are to the point now where our depreciation and our capital spending will start to approximate themselves on a go-forward basis.

Patrick Byrne

That includes what are really the reinvestments in developing new businesses if we just, for example last year it I know the numbers on an internal basis…I always want to double check before I say on a GAAP basis. What was our CapEx?

Steve Chesnut

We were about $9 million.

Patrick Byrne

I thought it was 7.7. I know we count some things internally. So about half of what the GAAP depreciation was. That was I think $15 million a year is a good number but that really includes what is almost, I wouldn’t say venture capital but it includes an investment in new projects not related directly…some things we are going to bolt-on to the business. So $15 million going forward both covers our real depreciation and some of these projects we want to do. We were thinking about maybe…do we want to talk about the purchase we just made or was that a Q1 event?

We just bought a new teradata system which is great. All this time I am talking about business intelligence I am really talking largely about teradata underneath that. We just sunk a few million into a new, it follows Moore’s law. It just gets cheaper and cheaper for more and more power. We thought about having a disaster recovery system that would have cost a substantial amount but we have realized we have ways to do that without seeing a big lump go through in CapEx. Including maybe cloud solutions. Also even with the money we are spending we roll off of some of our technology equipment and that becomes kind of our back up system.

So if you just assume $15 million I think you know as much as we do and that number is probably not going to be too far off.

Jonathan Johnson

We have hit an hour. We appreciate everyone that called in and also appreciate your patience for letting us get our Q4 numbers out at March 31. We look forward to talking to everyone at the end of the month or the first part of May.

Patrick Byrne

These guys have one last push to get out the Q1 numbers and then they can take their vacations.

Operator

This concludes today’s conference call. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Overstock.com, Inc. Q4 2009 Earnings Call Transcript
This Transcript
All Transcripts