Overstock.com's (OSTK) CEO Patrick Byrne on Q2 2014 Results - Earnings Call Transcript

Jul.25.14 | About: Overstock.com, Inc. (OSTK)

Overstock.com, Inc. (NASDAQ:OSTK)

Q2 2014 Earnings Conference Call

July 24, 2014 11:30 AM ET

Executives

Stormy Simon - President

Robert Hughes - SVP, Finance and Risk Management

Patrick Byrne - CEO

Dave Nielsen - Co-President

Analysts

Scott Tilghman - B. Riley & Company

David Cannon - Aegis Capital

Arup Das - Loeb King

Mike Arnold - Invesco Plc

Operator

Good day ladies and gentlemen, and welcome to the Second Quarter 2014 Overstock.com Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct the question-and-answer session and instructions will be given at that time. (Operator Instructions) As a reminder today’s conference is being recorded.

I would now like to turn the call over to Stormy Simon, President over Overstock.com.

Stormy Simon

Thank you, Jamie. Good morning everyone and welcome to our second quarter 2014 earnings conference call. Joining me today are Dr. Patrick Byrne, our Founder and CEO; Dave Nielsen, our Co-President and Robert Hughes, Senior Vice President, Finance & Risk Management.

Now I will turn the call over to Rob and he will highlight some of the financial results.

Robert Hughes

Thank you, Stormy. Before I cover the financial highlights, let me remind you that the following discussion and our responses to your questions reflect management views as of today, July 24, 2014 and may 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 filed this morning, in the Form 10-K we filed on February 27, 2014 and the Form 10-Q that we filed on April 29, 2014.

During this call, we will also discuss certain non-GAAP financial measures. The slides accompanying this webcast and our filings with the SEC, each posted on our Investor Relations Web site, contain additional disclosures regarding these non-GAAP measures including reconciliations of these measures to the most comparable GAAP measures. Please review the Safe Harbor statement on Slide 2.

And now I’m going to turn to Slide 3.

Q2 total net revenue was 332.5 million a 13% increase from last year. Q2 gross profit dollars increased 8% to 62.6 million and gross margin decrease 90 basis points from last year to 18.8%. Q2 contribution was 39.1 million a 1% increase from last year and contribution margin was 11.8%. Q2 technology and G&A expenses combined increased 8% to 37.3 million. Pre-tax income for Q2 was 2.3 million a 1.7 million decrease from last year. Net income for Q2 was 1.9 million or $0.08 per diluted share.

Patrick, with that, let me turn the call over to you.

Patrick Byrne

Thank you. Slide 4, I’ll review the slides quickly leaving more time for questions if questions there be. Slide 4 quarterly revenue growth I think I told you last time that we -- I knew we have been in downward side but I thought in terms of growth -- but I thought we would able to reverse that. We have indeed reversed that and I feel optimistic going forward through the rest of this year.

Slide 5 quarterly gross profit growth, well we’ve arrested the slide haven’t really turned in yet usually the revenue is the first to turn then the gross profit then the contribution.

Slide 6, quarterly gross margin and contribution I’ve mentioned many time that I think 12.0% to 12.5% is the right number for our contribution margin. I actually think what happened was we stalled the plane, I stalled the plane a little bit I’m used to be a pilot and so I like aviation metaphors and whether we can view contribution margin grow last Q2 to 13.2 that has the effect of stalling the plane. It gave us a good quarter but it really sort of once it stalls we are -- there is fewer new customers coming in things aren’t -- well the plane stalls and we spend the rest of -- we spend Q3 and Q4 last year sort of having to recover out of the stall. So the fact that we are this -- I like it to be honest 11.8, 12.0 even 12.5 makes me nervous I just then realize that we tend to stall the plane want it gets too high.

And so the good news is that we had 13% more revenue this year than last year in the sense we were 13% higher and last year we were stalling the plane to get that high and this year we are in level flight and pardon all the aviation metaphors but we’re in level of flight and we’re still 13% higher. So that’s good news from my point of view it bodes well.

Just turning to the Slide 7, just how we would show you and we keep our numbers different than Amazon, differently than Amazon and just to show where that comes in, the Amazon’s contribution margin versus ours. We are really quite neck and we’re within a point of each other they moved logistics out of the cost of goods sold than of course they have a whole bunch of very higher margin revenue related to other services they’re selling now. But just in terms of the business that selling a toaster we have a very comparable business model and we just account for it quite a bit differently we put our cost of goods sold in our cost of goods sold whereas they put their logistics and as a sales and marketing expense. So when you straight back to the footnotes you get to the differences in how things are booked you see it is actually very similar model.

Slight 8, quarterly contribution, a little disappointed that we didn’t get this growing faster I do think that it will be -- if Q3 continues as it has so far, you will see this notch up nicely. But again the story is we broke the side, we have broken the compression in growth, it’s leveled off and now this is generally the last thing to turn for us when things are turning up. But I think you’ll have to wait a quarter or so to see this turn up sharply.

Technology and G&A expense, Slide 9. Slightly new format for this slide, we think it gives you more information. The red bar is G&A, and what you can see is that’s pretty well flat with the first quarter flat with -- flat or down from the second quarter and third quarter last year or flattish. And as a percentage of sales it’s at 4.8% we think that’s fine. The tech spending is growing, and we like this. We think it’s great to have good technologists as we have really, our technology has never been this crisp, this sharp, Bhargav Shah oversees it and we really we have gotten quite agile, we can get more agile. We’re really into the whole lean start up mode and we’re getting more and more that way. So our tech department is delivering a lots of useful products to us and I do not at all begrudge them growing in a 150 bps in percentage of our sales since the end of last year. So overall the tech and G&A expense at 11.2 I think is acceptable.

Slide 10, quarterly net income positive trend. Quarter net income 1.9 million, down a little bit from last year both we feel good about this. We’re spending; we’re really revving ourselves up as a tech company is what’s going on. And we want to keep ourselves in the black as we go but I think that this year, I said last quarter our operating income last year you could expect us to see the same operating income this year. I might even revise that a bit and say material operating notch up a bit this year versus last year.

In fact I would expect, as far I would expect it to notch up double-digit percent. But having that happen while we’re building out the teams and making the investments and I use the word investments in a more literal sense for some people, I really do think that the technology we’re developing as such. We’re developing I think one of the great sites on the Internet. And we’re doing this while keeping our nose above water, our nose above the horizon, referring to the aviation metaphor.

So very comfortable with this and I’ll again repeat or even reemphasize something I mentioned in the last quarterly call our operating income last year your pretax operating income you could expect us to see that same amount this year. I’ll now up that a little bit, say I’d expect that even go a little higher that’s even though we’re really dramatically increasing our technology expense.

Slide 11 operating and free cash flow; $50 million trailing 12 months cash flow from operations as free cash flow of 27 million. We have a nice machine here spinning off good cash flow. Slide 12 GAAP, trailing 12 months inventory turns 50, 49.9 and still would like to see our core loan inventory terms get above six. But we’re quite close.

Next slide, trailing 12 months came away 1,152%. Enough said again the 86% I won’t be happy to see that over 100 and I still think it’s certainly possible to get much higher. Unique customer Slide 14, slight notch up from last year, but as you’ll see the more valuable customers. Slide 15, they are costing us more $31 versus $26. But we’re really getting much, we had a sharp improvement and how we’re getting people to repeat. We’ve put a lot of time studying that problem and we’ve seen that start moving in the right direction rather nicely.

Customers and average order size Slide 16. You see our average order size 167 to 177 again a nice increase for the quarter. Gross profit per transaction has stayed basically flat. Slide 17, corporate employees, this is where you see a big difference. We have 150 more corporate employees than we did at this time last year. And Rob what do you want to say about that?

Robert Hughes

Well we talk about technology, I think there has been about an 80 headcount increase in the technology stand and other about 80 in G&A but the biggest chunk of that is in our supplier care area and we think those are great places to be growing our staff it’s important to our operations and to our partners.

Patrick Byrne

Okay, just a moment.

Okay. 19, key initiatives I think we were keeping the curtains closed over these, this coin of course got live, pets the great well we are up to about 14,000 pet adoptions on our Web site it is updated every day. Farmers market is still in alpha so -- and by the way, we love pets we are getting 100s of letters from people, you see these ads we’re running they test very nicely Stormy and I doing the ad. Actually there is a whole series of such ads in the can and Stormy and I just went and ad lit them and when we do quite a real testing in various forms of testing some of them are doing quite well and those are the ones that we’re promoting. So Stormy and I had also save some money on the production as we work for peanuts.

Stormy Simon

Yes.

Patrick Byrne

And she shows me no respect. But you will see more Stormy and Pat ads I think that they’re going to be like the Bartles and Jaymes ads of Overstock for a while. Okay. Farmers market are still in alpha, you will see something this quarter be added on that as more in line with our long-term vision for this and I think it could be I know that pets and Bitcoin aren’t about insurance, they’re not going to impact the bottom-line in any measurable way for some time. And farmers market I wanted to do impart because sort of a commitment to eating and I try to eat really well now and organic and local and such and that gave me an idea to do this but I’m actually beginning to think from some initial consumer feedback that this may turn into a sleeper, there may be a bigger market for what we’re going to do here than I had supposed.

SOFS, Supplier Oasis Fulfillment Service this is the platform we built to compete with Amazon fulfillment or fulfilled by the Amazon at a significantly lower cost to suppliers that came live that has, it’s not affecting our income statement for the second quarter but it is, we do have dozens of people have signed up and there are dozens of suppliers in there are sort of 100 more in the pipeline but everyone is just getting we’re doing integrations every day but there are containers being shift into our warehouses and there is all flowing through quite nicely but is not yet impacting, creating any impact that you will see then private label credit card that launched Monday night. Monday night?

Stormy Simon

Yes, Monday, or Tuesday.

Patrick Byrne

Yes. And this is a -- and you can come though your card apply for credit online, apply for credit with us we give you instantaneous approval or not, the approval rates are quite high and our first two days results are outstanding.

But, okay then Slide 20 questions, and why don’t we start Stormy you have a list of questions that have been sent in why don’t you go through them.

Stormy Simon

I d, do you want to comment on the initiatives such as SOFS or insurance and how that may affect margins?

Patrick Byrne

Well, they’re going to be very high margin, can be very high margin revenue, it is a question it would add a tremendous amount to the top-line but if it works well it will give us a significantly higher margin Rob do you want to comment?

Robert Hughes

Just that it will take some time that these are, all these initiatives have been start ups s within Overstock and they’re not of course materially yet to operations but well overtime grow nicely.

Patrick Byrne

And when they do that will make our margins richer by -- it is measured bps so maybe 100 bps or something would be a great goal but that would be, but it won’t be anything more dramatic than that at least for some time.

Stormy Simon

And do you want to talk about our new headquarters or coming building in the financing?

Patrick Byrne

I will talk about the cement Rob can talk about the money. We have selected a site we’re closing on the site there was an article Salt Lake Tribune about it $100 million peace sign looks like a peace sign from above looks like Roman coliseum from the side. I urge you to Google Salt Lake Tribune Overstock peace sign and you can see what we’re building. We actually think it will be significantly cheaper for us than having stay put and adding on additional space it gives us significant growth capacity but culturally it's going to be great for us because it gets us all to be consolidated into one building only office workers get to consolidate into a building located midpoint basically between the two buildings now. And we’ll be breaking ground in September, hope to be moving in by two years from now. Rob, why don’t you talk about the money?

Robert Hughes

We ran a competitive RFP type process with a number of banks to get financing proposals for the building and received very attractive offers and now we agreed on key terms for the financing for the portion of the building and also related for equipment. And we’re now working with the banks on bringing those agreements to terms and getting them through the due diligence, they are still on drafts and not final yet.

Stormy Simon

Great.

Patrick Byrne

And as far as somebody has asked about the note, we assured $200 million note. To allow for financing the headquarters for 75 million and $125 million buyback, that sounds nice, but at the end of the day I think that this building is going to cost -- it's currently few million dollars less than 100 million all in including the property the land and everything.

We’ll be putting in 20 million to 25 million of equity over time 20 million or even a little less. And they’re going to we’ll have 70 million financed, 77 financed. We can get that financing at a very attractive rate, much more attractive than the rate we would have to pay on $150 million or $200 million, so at least 300 bps, 400 bps lower than what a bond would cost. So it seems to make sense to not do this with just one big bond and in fact people really don’t like issuing or buying bonds when you’re just going to grow still the headquarters. So we think it’s best to get the layer of capital and real commercial real-estate capital against this property at an attractive rate.

And then on top of that if we could issue some debt and buying some stock I’d still be open to it, I would be open to it. But we think the more prudent thing to do is get a level of debt directly against this property and save 300 or 400 basis points, and then think about maybe some debt on top of that if possible to facilitate a buyback.

Stormy Simon

A question regarding on insurance model and how the revenue model would work, is it a one-time commission or reoccurring revenue streams?

Patrick Byrne

Reoccurring, if we get the upfront commission on the first year and then the reoccurring revenue stream after that, so again we’ve sold policies so far a small number of policies but it’s just be gone and we think it really ties in, we don’t anticipate putting up insurance policies and having them sell like if we put up a new model of microwaves, how it’s going to sell. We view this, we’re really kind of become more and more part of our consumers our clients lives. We really think we can change people’s lives by the things that we’re bringing online. So this is long-term play, you can’t just sell somebody a new insurance policy today like you could a new microwave because they already have policies in place and there is roll over and things like that.

But this is a big long-term play for us, insurance and financial products and there are other ones we can bring to the table. So it’s followed a lot of study where our client’s pocket books are and what they send money on and where we think we can add value. But I wouldn’t expect to see this for a year or so if we don’t even talk about this. It’s one of those things that just will spin up slowly in the background. And then at some point start out. But other things have been like that. For example cars, cars is a nice business for us, it generates an addition to our bottom line and that’s not rounding, and it doesn’t require much work once we had it operated. But it took a couple of years for it to spin up to that point and I say insurance is being the same.

Stormy Simon

Two more questions. Could management comment on the large increase in capital expenditures?

Robert Hughes

That’s primarily from those technology initiatives that we talked about earlier, capitalizing portion of it, salaries of the developers, working on this strategic project until they go live.

Patrick Byrne

Remember I have said many times our preference would be to expanse all development as we do it. And fortunately there are these rules that say you can’t do that. We have to capitalize, but in the interest of maintaining a bullet proof balance sheet which is our matter here, we would always like to be conservative and expense things when we can. However in the last two years especially we’ve gotten much more precise about, not a question of precision but we’ve got much more clear and capitalizing more of that developments. That really does reflect the fact that we have transformed into a real tech company. We’re doing all kinds of leading edge stuff.

How we fit the industry, I can tell you is we’re the largest company that does a lot of it is opened to third party integrations. So there is all kinds of third parties out there with great products like well let us handle your recommendations, let us handle your search engine whether it handle things like this and we had a lot that and people really liked dealing with us because we were the -- guys like Amazon and eBay built all that internally. So there are very good companies like virtual events who are as good as they, they are the industry leaders and in that sort of third party stuff.

But we got to the point where we can develop our own products that we test all these third parties against it and I’m talking about very big well known brands that you know of that they come in and they want, they have some very high-end technology that we want to plug into our site and we do and we integrate but generally we reach the point that we can. Our stuff is better than anything you can sort of buy of the shelf from third parties. So where that showing up so that means we’ve gone from seven years ago we were we had like 12 developers now we have over 330 or something and we are building all of these we have built a lot of these big systems ourselves and some of their work have to capitalize unfortunately and that’s what showing up in why the CapEx numbers has gone up.

Stormy Simon

We just had a question come in.

Patrick Byrne

Go ahead.

Stormy Simon

You mentioned last quarter there could be a level change in contributions on our growth at some point, what you think could be the biggest drivers of that growth in the coming year.

Patrick Byrne

Improvements in marketing, and in particular from all I think Club O is just getting going what the 276,000 Club O members is growing quite quickly now quite a bit faster than our non Club O side and we have a lot of, Club O is building a platform from which we can hang up all kinds of largest for our customers. And we give our customers largest in a lot of ways, low prices we give a lot of coupons such and we’re fairly well in my view we’re way too promiscuous and how we get that largest out and we are focusing, we built Club O so it could be a channel that could handle shifting more and more with that largest to it. Now there is only so much generosity you can show to 276,000 people.

So it’s not yet big enough to shift all the largest we give away to that but it’s growing quickly so its capacity is growing. And my goal is to really is to make one more profitable to be a Club O member and that more and more of our general generosity get shifted into that channel that create incentive for people who move into Club O.

So as you see our Club O numbers grow and which I think you will in the quarters ahead understand that that has to do with bunch of these changes we are making that will I think really dramatically increase the willingness of people and the number of people who will make that kind of commitment to us, make the Club O commitment to us. And that’s where I see the real likely inflection point coming on contribution dollars.

In addition I’d say in marketing we are there is always opportunities in marketing and I said about three-fourths of the chimneys or two-thirds of the chimneys were really, really good. There still about a third of the chimneys that we can get by chimney I mean say paid search or SEO or affiliate marketing. About two thirds of chimneys were in my view really, really good always wiling for improvement but at this point just fine tuning. About third of the chimneys still need some significant work and there is the whole overall change strategy and we are working on that this quarter. And so I think there also and that’s where the big update improvement can come from but then underlying it all in time all together is Club O.

And as we move one more of our generosity as we focus it into our Club O members I think you will see that channel while I’m hoping you will see that channel explode.

Stormy Simon

So that’s all the questions that were sent in. I don’t know if anyone is on the line with the question.

Patrick Byrne

Mark any questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Scott Tilghman from B. Riley.

Scott Tilghman - B. Riley & Company

Thanks. Good morning everyone.

Patrick Byrne

Hi Scott.

Scott Tilghman - B. Riley & Company

I have a short list of questions here, first off just from a modeling perspective, thinking about the headquarters, thinking about some of the technology capitalization; how should we think about CapEx for this year and next year?

Patrick Byrne

CapEx to technology will continue to grow as we did talk about. This year for the headquarters project will be only by the land and will have some other costs that probably in the range of 16 million in our contribution. And then over the course of building the course next year there will be a significant component for the construction of the building and so forth until we occupy it.

Robert Hughes

Can we be a little more clearer I can be a little more clearer on those numbers. The whole cost of the building should be 95sh plus or minus. 15 for the land, building it’s also about 60, 65 the building and then there is furniture.

Patrick Byrne

And. the rest of the campus, so we should think of it, this is a campus the large central building but there is an auxiliary building or a gym and day care and so forth, there is a parking garage of course, there is landscape in healthcare, invest your all end cost for the architecture fees and everything that you’re talking about.

Scott Tilghman - B. Riley & Company

And how much of that can be capitalized?

Patrick Byrne

Really all of it.

Robert Hughes

And that will be over 24 months.

Scott Tilghman - B. Riley & Company

The second thing, you mentioned wanting to keep a bulletproof balance sheet. With that in mind and having a relatively small amount of cash carved out for the building process, the rest being financed, are you looking at any other uses of that cash or do you really want to just keep building for now?

Patrick Byrne

No there are only two uses I think of. One is a stock buyback, which is of course in my DNA. I don’t see much reason at stock at this price and us doing about work how we’re doing. I don’t see much reason to keep more cash than we have on the balance sheet. On the other hand I am quite nervous about the stay at the world and the day may come when cash is king again.

The other thing that’s happening is we’re really getting back in the liquidation game; a lot of people are coming to us. And we’re doing sort of multimillion dollar deals, $3 million for jewelry for this for that, it’s like the early days of Overstock. And we really can’t reemphasize that side of our business. We have -- Stormy do you want to talk at all about?

Stormy Simon

No I think just that, Overstock was built on a liquidation business and we’re back in the game stronger than we’ve been in years past. I love spending our money there, I think it’s a great investment; we get a good ROI on it.

Patrick Byrne

A lot of the things we’re not really supposed to tell out their names, but if you go on our site you’ll see the names -- can you say the name of the first company.

Stormy Simon

It’s a growing business and we’re playing it.

Patrick Byrne

People don’t like it we’ll stop getting calls if we tell too much but if you go in there and say you will see all kinds of products from people who have gone bankrupt late. And we blow through this stuff and they’re calling us and we’ve hired somebody Seth March [ph] is a fellow from this world with deep contacts in this world. And we really spent years knock down these doors. We had trouble keeping those doors open; it’s a very insular world the world of true close out with bankruptcy kind of buying. But we’re back in that world. So I could imagine if the right $25 million deal came along, I could imagine doing it. The right $50 million deal came along and it was a real commodity product that we could figure out we knew that it was electronics or something we could it.

But in general we’re sticking to one to three I think we’re working on $6 million or $7 million deal. So that’s one use of cash and the other would be we’re always looking at the stock buyback. I think it’s best that we get our capital in place for this building. As I said we’re breaking ground in September or early October by then all the financing will be arranged. And when that’s all locked down and what I think of is a lot of surplus cash, Rob is winking as I say those words. But it’s a constant tension to bring Rob and myself in the Board that I would like to go out and use cash.

The Board has really two purposes, one is to figure out when to replace me and secondly to handle the balance sheet to approve the balance sheet of the business. Those are the two functions of any Board of Directors. And I think that we probably want to get the ground broken on the building and all that financing in place before we get serious thinking about before we pull the trigger on the buyback. And then it’s going to depend on the price of the stock as such.

Scott Tilghman - B. Riley & Company

Okay. The other area I wanted to touch on was advertising. You talked about evaluation of the chimneys and using your words the Bartles and Jaymes campaign, love the retro thinking there. I was wondering if number one, you have any measuring tools to determine where the unique customer growth is coming from; be it search, be it some other on-air advertising; and if you're finding that certain platforms are more successful in getting the user numbers up or the customer numbers up versus others?

Patrick Byrne

Yes we measure everything, everything that comes just online is measures and analyzed and future value and all that kind of stuff we do. That’s where I saw we’re about I think about 85% is good. I mean people have come in from third party, coming and looking what we’re doing and often generally say basically we can’t touch in. We hope to be developing in two years this thing that you’re now.

Not that we’re the very best at it but really good at a lot of that stuff. Now when somebody comes directly, not clicking on a link somewhere they have to impute various assumptions about what’s driving that. But there are even ways to test that, there are ways to figure that out and then our branding and our TV we do a lot of real testing which is, am I saying too much Stormy?

Stormy Simon

No I think they’re kind of real as it, I would say that we have and about for 15 years out of the tools that major advertising and we are deeply engaged in everyone of the channel I think there is a lot room for improvement.

Patrick Byrne

The improvement is the synergy among the channels, figuring us synergy among the channels is where some time and we get good added and then things shifts and we still have week for a year or two but picking up the synergy among the channels is really the, but careful in branding an example the kind of testing we can do as we do a quite a real. So we’re doing that and then we’re taken ad to call that that A and then you taken an ad from Wal-Mart, Target, Sears, Amazon, and you show them to 1000 people A,B,C,D and then you show another 1000 B,D,C,E,A in terms of what they’re ready scrabble it and again we have lots of questions and we see what people and we do that kind of testing with our commercials and use that to hone our message and select the best commercial.

So everything I’d like to say that everything that can be tested, we test for the truth as we are about, like I said 85% but we’re bringing more people. We always trying to up our gain there but I don’t see a room for huge improvement there.

Stormy Simon

I actually see a huge room for improvement in our social channel.

Patrick Byrne

Yes.

Stormy Simon

So we have it, I think there is improvement in each of the channels to be made in great opportunities but socially I would say the opportunities are biggest gain. And greatly and as everyone knows the measuring tools for everything that you do on Facebook or Twitter, Instagram you can absolutely return to an ROI. So we’ll be increasing our presence across the board there.

Patrick Byrne

And so far our social has been a lot of following advertisers on Facebook and other site, but as you they have developed tools over the last two years we can get a lot more out the social media than just that you’re following advertisements from the traffic there is a lot information to be gleaned that you can just get through their APIs that make your recommendations smarter, do all kinds of clever things and we’re working on, we’re building up that team now and Stormy is right that’s a place there could be a significant inflection.

Scott Tilghman - B. Riley & Company

Thank you. That’s all very helpful. I’ll get back in the queue.

Patrick Byrne

Thanks Scott.

Operator

(Operator Instructions) The next question comes from David Cannon from Aegis Capital.

David Cannon - Aegis Capital

Good morning. Thanks for your time. First question, I just want to be clear on the cost of the building. Did you say that you're going to deploy approximately $20 million of your cash and then the balance of the total cost of $95 million would be financed essentially?

Patrick Byrne

Yes, all over 24 months.

David Cannon - Aegis Capital

Okay. And then my follow-up to that is the financing costs, how will that compare versus what you're paying in rent expense on an annual basis?

Patrick Byrne

It should be somewhere, put in this way, if we financed the whole $96 million, if we finance in that way and I've got a friend in Omaha who I saw about this and he said the way to analyze this is borrowing all the money for what was that cost and compare that to these expense so if you assume we were borrowing a whole 96 and what we and then by the interest rate we believe we’re getting on the capital, that would come out about $1 million, $0.5 million to $1 million a year or less and if we just extended leasing our current headquarters and for that we end up with the capacity for about twice as many seats.

So the savings of $500,000 a year and the ability to grow into between our current facility and our what we call Castle both the warehouse and a customer care center and centers, between the two now we have about 1200 seats and with this new facility and our seats castle will have total about 2200 seats and we have nearly double as many, we have about twice as many seats and we’ll be savings that 500,000 in year maybe 1 million.

David Cannon - Aegis Capital

Okay. Thanks for clarifying that. In terms of I want to get my head around operating costs going forward as you invest in these growth initiatives and what kind of leverage we can get to the bottom line. First, when I look at the quarter, I see gross profit increased almost $5 million and then technology expense was up $3.5 million so that took away a lot of that leverage and then with the sales and marketing being up $4.3 million, it took it all away. Where are the opportunities over time to expand the operating margin? Is it tech expense? Does that come down or does that level off and as revenues continue to grow, we've got the expansion and what about sales and marketing, will that continue to run at the same rate more or less?

Patrick Byrne

Well I look at it and I don’t think we can look at it on a quarter-by-quarter basis; we look at it on an annual basis. And if you look at contribution, the way we model it but I recommend modeling it, the growth and contribution dollars. How many of those flow through? And I think it is fair to expect that about 60% of each -- $0.60 on each new contribution dollar getting taken up in increased expense on an annual basis for say this year but for next year and going forward 50-50 is probably the right number. We add $30 million to contribution dollars expect us to add about $15 million to in expense structure.

David Cannon - Aegis Capital

And then I know CapEx is going to go up with constructing even new campus and so forth. However if I just look at technology specifically will that increase year-over-year the CapEx budget?

Robert Hughes

Yes it I think I will with the growth we’ve had in tech expenses, tech headcounts and the projects that we’ve capitalized cost on, that depreciation has gone up a bit. There is nothing else in the tech infrastructure that I am aware in terms of large replacements, we had some this year that I can think up for next year. I think we try to keep our technology infrastructure robust and up to date.

Patrick Byrne

Let me add a footnote on that. Just to put some hard numbers on it in 2006 we had 12 developers and at the end of 2006 which was horrible year. Basically there were two paths in front of us, one was to cut and there was literally discussion of cutting from 12 developers to seven developers. And the other path was building the development team and we went with building the development team as now like I say 330 but think about 60 of those are contractors so it’s not a permanent part of our structure.

Point is though I think that between 300 to 330 developers I think it’s ample. We don’t have this crave anymore if only we had more developers. We now have an appropriate amount of developers who can keep up with maintaining what we have improving it and also the new projects that were constant and some of these are very major projects, things like SOFS. That’s a major, major system that’s been built. And so my point is I don’t think we’ve got to grow to 330 to 600 and 900. At 330 it seems basically ample; there is not just the sense of backlog, constant backlog all the time.

Stormy Simon

And just to add onto what Patrick said, this faster supplier, it wasn’t just building a new system but maintaining and improving the system we were built on 15 years ago. So some of the projects that we do, in order to them we have to optimize the technology we’ve had for 14 years. And I think that’s something that anybody that stayed on the ecommerce game as long as we have. It’s something they have to address technology just keeps getting better but our foundation was 14 years old. So we always invest in keeping that stable and up to date with the new offerings in the tech world.

Robert Hughes

When you say we have filled in a lot of technical debt as, we have filled in a lot of technical debt.

Stormy Simon

Yes and that’s part of the investment, we talk about making investments in our technology.

David Cannon - Aegis Capital

Rob can you give me an explanation of the significant drop in payables? Why that occurred and do you expect working capital to generate a lot of cash in the back half of the year?

Robert Hughes

Well I think what you’re looking at is the normal seasonal change you see from this, if you’re looking at December to June that’s the seasonal build up the holiday season and then paid off as you get to the next part of the year. As we noted earlier it builds up a little larger at the end of last year because of the timing of certain holidays. So in this case the cyber Monday was later than the prior year. So payments to our supplier for that fell into January rather than December. So you’ll see some of this described in our 10-Q. And some of our marketing accruals were higher at the end of last year than the prior years. And then go through the rest of the year and throw off nice operating cash flow.

David Cannon - Aegis Capital

Final question then I’ll turn it back in queue. On your growth initiatives that you’ve invested in what are the top two that you believe will impact revenue and contribution margin over the next 12 to 24 months, in order if I make?

Patrick Byrne

Club O and other marketing projects Stormy, would you want identify the second?

Stormy Simon

Well I think just as far as opportunity I think our mobile platform and the investments we’re making there will provide update.

Patrick Byrne

Mobile is growing unbelievably and we already have, we won the award last year the best mobile app Android. We used to have a system where we developed for the site and then when we had time we reported earlier our mobile now is all fused, everything is fused, everything we do we bringing out together. And it’s growing I don’t like numbers on but like if the typical e-commerce company 20% of its traffic is mobile in our case it’s 40, is double what the difficult has and it’s growing very quickly.

So Club O mobile I also think Stormy is right about social media and I think there is some still that 15% that we squeezed out of our current chimneys there we still have improvements to make on it on say the CRM side of things of really understanding our customer and molding our message making a unique each customer.

So Club O mobile CRM that applies to sales in contribution dollars. Those three are my top two.

David Cannon - Aegis Capital

Right, thank you. Good luck.

Operator

Thank you. The next question comes from Arup Das from Loeb King.

Arup Das - Loeb King

Hi guys good morning.

Patrick Byrne

Hi Arup, how are you?

Arup Das - Loeb King

I’m good, doing well. So, the 13% revenue growth this quarter was in part due to a 6% increase in average order size. I know in the last call you had told us that that looks to be flattening out. So, how do we think about that going forward?

Patrick Byrne

I don’t get surprise that we still growing like this often it’s been furniture in the big screen TVs such driving this, part of it is Club O, the growth in Club O, Club O owners tend to be bigger and Club O is growing quite a bit faster so more than twice as fast the rest of the side is now mid teen percentage of our revenue and I expect you’ll start to seeing 20% of our revenue pretty soon probably by year end. So those orders coming in they are bigger orders that’s part of it, but also the shift we’ve got really good at home and everything for home, furniture, bedroom all that stuff and those are big order. So I myself am a bit surprised to see it move up to 177 but we’re taking.

Arup Das - Loeb King

Right. And then I know you told us that we should look at the business in terms of contribution dollars. So how should we think about that because now we've had two quarters of I guess 1% percent growth, which is not exactly matching the revenue growth there's about 8% to 10% disparity there so how do we think about the growth in contribution dollars going forward?

Patrick Byrne

Well I would say tell if you feel the same way after this third quarter, what’s really happened in the second quarter of last year the only way I can describe this I know it drive some people hear nuts is with the metaphor and this metaphor is, last year we tipped the nose of the plane up and gained some quick attitude but install the plane and this year we along and that goes on the contribution number two, contribution dollars, and because we solve the plane the third quarter sort of was a bit of down turn the fourth was quite disappointing.

Now we’ve got the plane back flying nice smooth in level and we’re still 1% higher than last year what that means as we lap quarters three and four I think we get a lot of sort of natural tailwind. And nothing the same accomplishment but if there is an accomplishment there is the fact that we reach the same altitude in this Q2 are 1% higher without installing the plane we’re keeping the plane in smooth and level flight so it’s a better flight system than it was a year ago it doesn’t show in the second quarter numbers because we let that contribution margin get significantly too high last year in Q2 and that stalled and hurt our subsequent quarters. But if anything at this point it still even maybe 20 basis points below where I start feeling okay about it 20.

Arup Das - Loeb King

Okay. That makes sense. And then I just have one last question. I know we've touched on it a little bit, but now that we've had two quarters of incrementally positive operating results in 2014 when the stock is still down 50% in this time, is it now the time to conduct a large scale share repurchase as a vote of confidence in an organized fashion, a Dutch tender for example and this is notwithstanding obviously the $20 million of equity that needs to be contributed towards the facility?

Patrick Byrne

Well you are preaching to the choir but Rob likes to keep positive working capital, what is our working capital as you calculate around.

Robert Hughes

I think it’s about 27 million.

Patrick Byrne

But is that including the precious metals?

Robert Hughes

That does not.

Patrick Byrne

I would say you have to include the precious metals. So as we’ve disclosed, how much have we disclosed?

Robert Hughes

It’s almost 10 million from the balance sheet.

Patrick Byrne

I think that our system, I am sort of -- I mean that seem kind of guy, I think that is far more risk there in the system than people understand. And I’d like us to be robust for the case of a sharp contraction. But as a 10% contraction or worse, I want our system to be robust. So we keep some precious metals. I think that we might accumulate a small amount, maybe about $10 million of precious metals we can get our hands on quickly. So we got to add that in to the working capital, 37 million of working capital. Rob doesn’t want to see us, I'm fine operating with negative working capital because that's me. But Rob why don’t you answer, why won’t you let me go spend that 37 million buying in 2 million shares of stock?

Robert Hughes

Well I am the guy who has to manage that. And as you said earlier I think we should get to the building financing in place and so forth then revisit this and see how we’re doing at that point.

Patrick Byrne

But believe this is in every Board meeting and we have one next week, every Board meeting this is thoroughly discussed. We did get ourselves a little bit upside down seven years ago with an overly aggressive stock buying back coupled with sharp, some deteriorating results from us. And the crash of ‘08 made things really tight, and we had to do layoffs. And we don’t like doing that, it does come down to will, it comes down to -- I mean we have demonstrated to ourselves on several occasions when push comes to shove, we’ll do whatever we’ll have to take to keep things in flow and keep ourselves cash all positive.

So we know we have the will to do it. Should we get over extended and bought 3 million or 4 million shares and what’s negative on the working capital but then we’re down turn they would have to cut. And we’ve lived through that, every start up does, we’ve lived through it three or four times but we don’t want to -- we're thrice shy I guess, twice been four times shy. But I am kind of with you so anyway this would be discussed next week. And I would love to see us buying, and we introduced the votes of confidence or signals the market, that stuff. We do things based on economics and I myself think that it be a great use of capital. But we’re about to go build this $100 million building and until we get all that locked down, it would be prudent to proceed for the buyer.

Operator

The next question comes from Scott Tilghman from B. Riley.

Scott Tilghman - B. Riley & Company

I had one follow-up question going from my notes here in your discussion around technology development and spending. I was wondering if any of the products that you're working on or developing are for arm's length use by your suppliers, your business customers, or if everything is for work in-house. In other words, are you developing anything along the lines of what an eBay enterprise or a PFSweb is doing or is most of this really geared towards your own sell through?

Patrick Byrne

Well SOFS is to supplier will support, isn’t just for sell through. Stormy do you comment on that how SOFS applies to even if somebody isn’t selling on Overstock?

Stormy Simon

There is an aspect in SOFS when suppliers integrate with us that allows him to sell on other channels similar there are competitors out there that do this. So it’s useful, there is a service attached to it and also a channel management and a catalogue management that goes beyond Overstock.

Patrick Byrne

In addition it is my plan you may see us, there is agitation within the company for given that we now have developed technology that we know is better than third party products out there, we test their products against ours. And whenever someone needs our, we buy theirs, I mean we use theirs. So now we know we have for example really good recommendation technology, really good search engine technology. Better than we think is commercially available. And so there is quite an interest within the company and Enterprise 2.0, we’ve developed some Enterprise 2.0 stuff to support our own innovation. We have an innovation management system we build in house and other E2.0technologies.

discussion of why don’t we go commercialize these are better than anything that’s available that we see in the market place I don’t want to, I can get distracted now but what are the reasons for building the new building with this much space to grow is once we’re in it two years from now that’s kind on the money the top of my list of things do will probably be to start another company whose goal is to commercialize Overstock’s technology. But I just don’t want to do it for 10 years we got enough thing turnaround all the year.

Scott Tilghman - B. Riley & Company

Understood. Thank you.

Operator

The next question comes from Mike Arnold.

Mike Arnold - Invesco Plc

Hi guys, congratulations on a nice quarter.

Patrick Byrne

Thanks Mike.

Mike Arnold - Invesco Plc

Congratulations on the nice quarter. I just wanted to applaud you guys for thinking about yourselves as a web startup still 15 years into it and thinking about new ways to monetize the platform. So I guess my question really is how active are you at looking at the competition out there? I know there's the Amazons of the world. If I look out there at Web 2.0, I see houzz.com and 11main.com which I believe is a new sort of 3P platform that's sort of backed by Alibaba. Just sort of curious how you look at the competitive environment and if there's any sort of business models out there you think about replicating with your new software developers?

Patrick Byrne

Well, good question Stormy is especially attuned to the market I would say because of her management partner care and we think Stormy took long ways we built what is widely recognized in the industry the best customer care on the Internet. We won all these awards. Actually not just the Internet best customer care and retail Stormy built a parallel organization that we stop the supply chain partner care that her actions been source for lot of the market awareness of what is competitors are doing it such just because it's just a source of lot of awareness.

We see people tell us not as competition but as opportunities for what’s that MBA term these days, competition or something competition that, I mean we say a lot of that as opportunities for us to do something with and what we’re trying to do is get better in low identifying them while there is still small and doing deals with them while they're still small so it brings something to them. For a small struggling company that taking you a big deal with us you can them and get a big commitment from us but on the other hand we get in on the ground floor. So for example we work with Houzz, we work with lot of other companies that are really doing well Houzz is the great website that we love and is right up our alley. So we view a lot of those as opportunities for operation.

Stormy Simon

And I would add that very aware the competitive landscape and those entering like 11main every day. So I think what Overstock is also focused on is defining what make us different which is really value we have such value oriented customer and we’ve delivered for 15 years on now we don’t planning move away from that but I do think we can complimented with a broader assortment and in some other ways. Another thing to about I really think it lost our messaging app and we look forward to pushing it a little more as we have sold. We have all village we have world stock, we are actually making a difference in the world outside of our selling posters and I know that’s all qualitative and touchy stuff by I’m a female consumer and I know that that matters to me.

Patrick Byrne

It’s hard to replicate.

Stormy Simon

Yes, it’s hard to replicate. You can’t just go by so you got to build that and we’ve been building it for 15 years. So I was just let everyone know that we are acutely aware of the competition and the landscape and we are addressing proactively reacting.

Patrick Byrne

We look at Wayfair for example and there is a huge overlap in the products between 80,000 product or so on both side. And we know how much cheaper we sell the native and we’ve seen many guys come along and there is a flash and so forth and lot of them won the flash sales like sold. We show our prices as we understand our prices to be about 12% lower on competitive products there and I think we’re about 10% lower than Amazon on competitive products all kind of areas we are, I mean I don’t think we get enough credit for that yet in the market place from the consumers, but if you do price to price comparisons all on 10,000 products which we do algorithmically, we're substantially cheaper. So I think that they can start off and makes flash until they figure out how to, they took years to get the supply chain cost down and save our things from the supply chain our cost structure so that we could have our pricing be that much lower. And so that for me is a big part for the competition we’re 12% lower than way there, so that overtime we had a big marketing budget, strategic relationships which have been responsible for great deal of their growth. We think that that’s the vulnerability for them in the long run. But anyways Stormy is totally paranoid. Stormy calls me up in the middle of the night to tell me about some new site and want to talk about it and so forth.

Stormy Simon

I would say aware and a little aggressive over paranoid but I am aware that we do have a mode to protect. And the online landscape is very different than it was in 1999. But the good news there is, we understand it since 1999, and that there is definitely the comfort.

Patrick Byrne

Good news is we’ve gotten much more agile. We can see these things that we’re not playing catch up, we can get ahead of the pack we can see where the puck is going to be not where it is.

Mike Arnold - Invesco Plc

I think you guys have done a great and I'm happy to be a shareholder and I look forward to see what you guys do in the next couple of years.

Stormy Simon

I think we have time, see if there is one more person on the line or we just cut it off at that, Dave Cannon is on the line.

David Cannon - Aegis Capital

Last question in regard to Oasis. What was the contribution in the second quarter if at all and what do you think the incremental revenue opportunity is over the next three years from Oasis?

Patrick Byrne

In the second quarter it was almost none that was in the thousands of dollars. We have 46 contracts signed. A 100 more people in the pipeline and we’re turning on -- we’re integrating everyday new people every day. But really to phase where people are shipping us their containers or goods and I am sure we have some products live on the site.

Stormy Simon

Sure we do, and it is a multi-year play to get the big bang out of it. But Dave Nielsen's on the line and we haven’t heard from him. So I am going to say hi to Dave and see if you want to add anything to this.

Dave Nielsen

To play Oasis as what Stormy said and Patrick has expressed. We’re very bullish on it, we’ve seen great response out of the gate like Patrick said we just launched it back in May of this year. Products and containers full of products are on their way to these warehouses right now. We see this being a 2015 play more on the revenue side as we get this all worked out and this network built out. But the software a large chunk of it has being built; we still have quite a bit to do.

But we’re seeing great response out of the gate. SOFS also provides us the ability to get closer to our customers and improve that delivery in messaging. And as one caller brought up earlier not only as is it advantageous for us to get there quickly and to explain it but this also gives those partners who do business on other web sites. The flexibility of putting their product in a warehouse where they can have access to multiple channels. And that seems to be one of the biggest drives of our partners that we provide them the ability to work with us and also to service their other channels.

Patrick Byrne

When you say on the revenue side, SOFS is going to be high margin revenue, we’re not going to be booking at GMS level unless it goes to our site. So I am not sure it makes a big difference on the revenue level in 2015 but it should make a difference on the gross profit dollar level. And it’s very competitive with Amazon’s fulfillment service at a far lower price. When people see what we’re, Stormy do you want to characterize how much lower the pricing is or Dave?

Stormy Simon

Dave?

Dave Nielsen

Yes we priced this to be as Patrick mentioned on the previous quarter’s call. We priced this to be disruptive. 305 to 40% there is a lot of different services that you have within SOFS. If you want to you can have all of your inventory in the drop ship, direct to consumer capability and then you decide you have a one side sale to one retailer, we can do that for you. Any one of those services has a different variation or benefit but I guarantee you across all of these services the prices are disruptive. To give you 1 percentage because there are so many services within SOFS would be somewhat misleading. But I am confident as why we have so many partners in the pipeline and so many contracts integrations going on daily. We’re very confident, the numbers speak for themselves and people signing up that is price disruptive.

Patrick Byrne

I think the guy who claims Christiansen the whole disruptive thing is about giving a product that’s 80% as good for 20% of the price. I think that we’re giving a product versus Amazon Fulfillment that’s about 130% as good for something like 405, 50%, 60% of the price, somewhere in the there, depending on what service you’re talking about. So it is a disruptive technology. Remember Amazon, if you go through Amazon Fulfillment services and you are a supplier, you put your products in the warehouse and they fulfill, they want you to fulfill through Amazon. And if you do something like, if you want them to support your sales on eBay they will lag you but they charge through the nose for that. We're not doing it that way, we're agnostic our SOFS really is agnostic. So it’s the so much better deal for the partners who go with it. So now you know everything we know and I'd love to know next quarter you come back and tell us what the possibilities with this is. Okay. I think we’re going to call it out.

Stormy Simon

Thank you for that last question Dave and thanks Nielsen.

Patrick Byrne

Yes, thanks both Daves. Okay. We've been on for an hour and 15 minutes. We have company stand ups and other things to do partner or so. We will look forward to talking you in three months. Thanks for letting us work for smart owners.

Stormy Simon

Thanks for your participation.

Operator

Ladies and gentlemen, that does conclude the conference for today. Again thank you for your participation. You may all disconnect. Have a good day.

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!

Overstock.com (NASDAQ:OSTK): Q2 EPS of $0.08 misses by $0.02. Revenue of $332.5M (+13.4% Y/Y) beats by $17.25M.