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Geeknet, Inc. (NASDAQ:GKNT)

Q2 2014 Results Earnings Conference Call

August 1, 2014 11:00 a.m. ET

Executives

Jenny Lee Gillespie - Senior Vice President and General Counsel

Kathryn McCarthy - President, Chief Executive Officer and Chairman of the Board of Directors

Julie Pangelinan - Executive Vice President and Chief Financial Officer

Analysts

Dan Kurnos - The Benchmark Company

Justin Ruiss - Sidoti

Arthur Winston - Pilot Advisors

Ralph Weil - Weil Investment Management

Operator

Good day, ladies and gentlemen and welcome to the Second Quarter 2014 Financial Results Conference Call. (Operator Instructions) I would like to introduce your host for today's conference, Senior Vice President and General Counsel, Jenny Lee Gillespie. Ma'am, you may begin.

Jenny Lee Gillespie

Thank you, Vincent. Good morning, and welcome to Geeknet's conference call reviewing the second quarter 2014 financial results. Geeknet is the parent company of the online retailer ThinkGeek.com. Joining me today is Katy McCarthy, our Chief Executive Officer and Julie Pangelinan, our Chief Financial Officer.

We will make certain statements today with respect to our expected financial results, strategic plan and future growth, as well statements regarding the impact of our acquisition of the Treehouse Brand Stores business, GeekLabs exclusive and custom products, wholesale business, brand awareness and customer acquisitions plans, social media, mobile site, page search and affiliate market channels, site and business systems and quality and delivery processes. These statements, as well as other statements including words such as believes, expects, estimates, anticipates and other similar expressions are made pursuant to the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. Such comments are forward-looking and involve a number of risks and uncertainties that could cause actual results to differ materially.

Please note that these forward-looking statements reflect our opinion only as of the date of this call and we undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements in light of new information or future events. Please refer to our SEC filings, as well as our financial results press release for a more detailed description of the risk factors that may affect our results.

Please also be reminded that the content of this webcast contains time sensitive information that is accurate only as of the date of this live broadcast. Any redistribution, retransmission or rebroadcast of this call in any form without the express written consent of Geeknet is prohibited.

During our call today we will discuss adjusted EBITDA financial measures. In our press release and our filings with the SEC, each of which is posted on our Web site at geek.net and on the SEC's Web site at sec.gov, you will find additional disclosures regarding these adjusted EBITDA measures, including reconciliations of these measures with comparable GAAP measures.

With that, I'll turn the call over to Katy, our CEO.

Kathryn McCarthy

Thanks, Jenny, and welcome to everyone. ThinkGeek grew second quarter revenue by 6% year-over-year in a competitive resale environment. During second quarter, we delivered 474 new products to our customers, including 74 exclusive items. We also grew our wholesales but significant while delivering products to customers such as Target, Wal-Mart, Toys"R"Us, Nordstrom, Barnes & Noble and Hot Topic. Despite softer site revenues and promotional activities that impacted margins negatively, the entire team remains focused on delivering to the upcoming fall and holiday season.

We continue to execute our strategic plan while investing in future growth. A critical element of the strategic plan is to build our platform to increase our customer base. To support that important priority, I am pleased to announce the acquisition of the assets of Treehouse Brand Stores. Since 2009, Treehouse has worked directly with major video game publishers to engage fans with their unique and exclusive products. This acquisition enables Geeknet to establish official web stores under exclusive licenses. It also brings us additional creative talent and expertise and we are incredibly excited to welcome Jed Seigle and his entire team to the company.

I will now turn it over to Julie who will provide more specifics on the financial results. Later, I will provide an update on the business highlights and progress on our strategic plan. Julie?

Julie Pangelinan

Thanks, Katie. As we shared in our press release, ThinkGeek's second quarter revenue increased 6% to $23.4 million compared to $22 million in the second quarter of 2013. Our wholesale revenue grew 48%. Second quarter gross margin was down 5.2 points to 14.8% from 20% driven by increased promotions and clearance, unfavorable product mix, higher shipping costs and increased royalty fee.

Net loss from continuing operations from the second quarter was $4.1 million as compared to $1.5 million in 2013. The net loss per share for the second quarter was $0.62 compared to a net loss of $0.23 per share in the second quarter of 2013. Adjusted EBITDA for the second quarter was loss of $3 million compared to a loss of $356,000 last year. The second quarter also includes investment in the ERP system, a site technology platform and marketing programs designed to increase site traffic and conversion.

For the second quarter, total operating expenses were $7.7 million, a 30% increase over the second quarter of 2013. Sales and marketing expenses grew 56% due to market research, paid search, investments to improve brand awareness and increased wholesale and affiliate commission. Technology and design expenses increased 39% driven the ERP implementation, investments to improve the infrastructure and functionality of our Web site and mobile experience and investments to support GeekLabs growth.

Regarding second quarter 2014 year-over-year site metrics, daily unique visitors were $18.2 million, a decrease of 11%. The number of orders shipped was up 3% to 304,000 and conversion rates increased to 1.67% from 1.44%. The average order value shipped decreased to $59 compared to $62 and mobile and tablet sales were up 23% for the quarter and up 32% year-to-date. We ended the quarter with cash and cash equivalents of $45.3 million, up from the first quarter balance of $44.3 million. We decreased our inventory balance while still purchasing for our growing wholesale business in second half product launches.

I will now turn the call back over to Katy, who will discuss our brand refresh, progress on the strategic plan and our second half priorities.

Kathryn McCarthy

Thanks, Julie. As we have discussed at ThinkGeek our vision is to create a world where everyone can embrace their inner geek, express their passions and connect with one another.

Two of our key strategic priorities are to increase brand awareness and improve the customer experience. And I am pleased to report our progress on both of these initiatives. To celebrate our 15th anniversary this month, we have launched a brand refresh campaign including a new logo and tagline as well as a redesign of our Web site. We believe the changes convey the energy and strong connections within our community.

The new site provides new entry points where different customer segments can get excited about the unique products we have to offer. The design offers a new home page layout and larger product images that enable customers to more easily find products. We have also introduced an enhanced mobile experience with better product highlights, easier to navigate tabs and an additional dropdown menu. The site improvements are one piece of an overall marketing strategy for the new brands.

As part of our major brand refresh, we are on a mission to get the world to hashtag Geek Out. We are launching the Join In, Geek Out campaign to connect with our core customers, as well as to broaden the customer base by telling a bigger story. We began our efforts at Comic Con last week and will be introducing a major public relations initiative. We will build upon our strong engagement in social media with more events and content, linking to social trends that target our 830,000 plus Facebook fans, our 830,000 Twitter followers and our 320,000 plus Google+ followers.

We also believe we have an opportunity to build upon our YouTube presence where year-to-date we have over 7.8 million YouTube views. We have expanded our social presence to include additional platforms such as Instagram, Wanelo, Vine and Pinterest.

In the second quarter, we also invested in new performance based media with the goal of accelerating new customer acquisition and second half growth. We took our customer segmentation study a step further by conducting in-depth focus groups. We are incorporating these learnings into our product planning, holiday marketing and our site improvements. Another strategic objective is to drive growth through new, exclusive products and new channels.

In the second quarter, our sales from GeekLabs exclusive and custom products continued to increase. We performed well in categories such as licensed collectibles, jewelry and bags and backpacks. However, we struggled in categories such as apparel which negatively impacted our product mix. We also experienced a highly promotional retail environment that put pressure on gross margin.

We have continued to invest in driving 2014 and future GeekLabs growth. We saw successful performances from the R2-D2 measuring cups, the light table barbecue fork, the Minecraft Creeper Backpack, the Giant Robot Slippers with sound, the Olde Book Pillow Classics, and the Tactical Lunch Kit. We also had success with the Hyperkin RetroN 5 Gaming System, Rampaging Kaiju Garden Gnome and the Game of Thrones fleece blanket.

We executed new licenses with Activision Blizzard, Sony and Warner Bros. We are very excited about our second half product launches and are deeply involved in preparing for the holiday season. We are intensely focused on our second half priorities. We need to increase gross margins and profitability by executing an aggressive schedule of GeekLabs product launches, rapidly expanding our apparel assortment and reducing our shipping and fulfillment cost.

We are implementing actions to increase our customer base and expand our partnerships. We continue to focus on improving our customer experience as part of our holiday planning. We are not satisfied with the second quarter results. However, we continue to be encouraged by the growth of GeekLabs, the expansion of our wholesales business and the improvements to our Web site, our team and our infrastructure. We believe we have a significant opportunity to grow by reaching new customers with authentic products you could only find at ThinkGeek.

We are enthusiastic about the acquisition of the assets of Treehouse Brand business and look forward to working together to deliver more unique and exclusive merchandize to passionate videogame fans. We have created the capacity to build out new platforms and expand partnerships and we are excited for the second half and the future.

With that, let's open the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Dan Kurnos of The Benchmark Company. Your line is open, sir.

Dan Kurnos - The Benchmark Company

Let me start on the top line here. Apparel has been kind of challenging category I think for you guys the past couple of quarters now. And in general it's been a highly promotional category. You guys are talking about getting more aggressive and expanding your skews in that vertical. And I am wondering, just how much of the, I guess relative to expectations, just how much of the shortfall for you guys was related to apparel and what gives you confidence that it's a vertical that won't be overly promotional and you can continue to make an impact on.

Kathryn McCarthy

Hi, Dan. Let me take that question in a couple of parts. So first, we believe the first half was impacted by a couple of things. One, there were some things that we talked about that were seasonally related, that created promotions. So, for example, not selling as much of the winter items that we wanted to in first quarter impacted apparel. But I would say more importantly we need to increase the number of skews, particularly in T-shirts where we have nice margins and get a good reception from our customer particularly around some our licensed T-shirt products. So the goal in the second half is to increase the number of skews of those particular products where we believe we have the margins to [absorb] (ph) them at a promotion that customers have come to expect in apparel.

Dan Kurnos - The Benchmark Company

Got it. That’s really help. And then just in terms -- again, for this quarter you did mention a clearance, some higher loyalty fees and some of the things impacting the gross margins. Look, the promotional environment in general is not go away, it is helpful to hear maybe you shit upstream in terms of AOV and move to those higher margins items. I mean do you think that there is still the kind of leverage that we were seeing previously. As we get into the back half of the year, it's not going to get any less promotional. So just your thoughts on how that plays out from a margin perspective.

Kathryn McCarthy

What I would say is that we don’t expect it to get less promotional in terms of the overall retail environment. Clearly we feel good about our inventory position heading into the second half. We typically see more GeekLabs products launches in the second half versus the first half, which has helped us from a margin standpoint and that certainly is planned for this year. So we are conscious of the fact that the gross margins absolutely need to go up in the second half and feel like more GeekLabs and more excluding products are a part of the key to doing that.

Dan Kurnos - The Benchmark Company

And then in term of the site, the traffic being down. Actually the refresh looks nice so I commend you on that on the site. Curious, I know that you are really still early in the data analytics stages. But do you have any sense of the traffic that you lost? Was that relatively transitory or onetime purchasers? Did you lose repeat buyers and how do feel about sort of core audience before you start getting more aggressive and going after new customers.

Kathryn McCarthy

So I think we have said this previously but we did see a decline due to some of the changes in social platforms, especially Facebook. The brand refresh campaign and PR campaign is targeted at increasing visitors through other social platforms as well as through media in general. We do see that we are improving the quality of the traffic as conversions did go up. But it's hard for me to say how much came from onetime customers. In ecommerce in general there are many onetime customers and our goal is to make those two-time and three-time and repeat purchasers.

Dan Kurnos - The Benchmark Company

And could you just give us an update on where you are on the ERP rollout?

Julie Pangelinan

Hi, Dan, this is Julie. I'd be happy to. So we implemented the first phase of the ERP in the first quarter and we went live with our core financials module and we are seeing benefits from that projects. In the second quarter, we spend about $500,000 on the ERP implementation and year-to-date we have spent about $700,000. The second phase of the implementation which is the procure-to-pay and inventory module, will go live this quarter.

Dan Kurnos - The Benchmark Company

Great. That’s really helpful. One more from me and I will let other people ask questions. Just on the deal, if there are any particular metrics that you can give us in terms of top line or bottom line impact and how you see integration going into the holiday period relative to your offering. Thanks.

Kathryn McCarthy

So we will be filing later historical financials. In terms of the drivers of top line and bottom line, we see, is this enables us to have official web stores with exclusive licenses with companies such as Bethesda game studio's, The Elder Scrolls, Wolfenstein and Doom, and Electronic Arts games such Mass Effect, Dragon Age and Plants vs. Zombies. And Treehouse has created unique and exclusive products for these titles that passionate video game fans are always excited about. And given our success with certain licenses in this space, we feel like the company is our natural fit and can help each other. They also have a strong apparel business which we think we can learn from them and they can learn from us and it should be positive for the future in terms of revenue and profitability.

Operator

Thank you. And our next question comes from Justin Ruiss of Sidoti. Your line is open.

Justin Ruiss - Sidoti

I kind of want to talk more, a little bit about the acquisition as well too. Just looking at that, when you are integrating, I guess these suite of Web site, is there going to be cross -- I guess, cross buying when it comes to having their products on your Web site versus vice versa?

Kathryn McCarthy

Justin, thanks for the question. So it's early days in terms of integration planning of the two companies. I mean right now the stores that Treehouse runs are for the license partners. But those will remain the storefront as they should. But we will look at opportunities in the future to work together on cross-selling. So it's really early days but we will be happy to update everybody as the planning progresses and our opportunities for synergies are better identified.

Justin Ruiss - Sidoti

Got you. And when it comes to the customer base, I mean do you feel that it's a highly leveragable customer base to what you are experiencing now or do you think that there is, maybe just a wide variety out there that is not necessarily being attacked by Geeknet yet and then you can kind of capture that market.

Kathryn McCarthy

Well, I think what we have learned through the work we have done around our brand awareness and focus groups and looking at our demographics of the customer base or potential customer base is there is a huge opportunity out there amongst people who through their likes, such as liking video games or certain fan bases should know who ThinkGeek is and Geeknet is, but they don’t necessarily. So we view that as opportunity. And by reaching into this customer base we feel like we have an opportunity to build upon that brand awareness. So, yes, we certainly think there is an opportunity.

Justin Ruiss - Sidoti

Got you. And then just lastly. It seems -- what you said before, it seems like a natural fit. I mean do you see or if you are out there looking, are there more, I guess more of these types of deals out there that you are seeing or is it just kind of the -- just the right fit at the right time.

Kathryn McCarthy

Well, I think as I have said previously, we look at our cash balance, we try to utilize that to deliver the current year growth but also have kept our eyes open for acquisition opportunities and we are always evaluating best use of cash. So our goal is to, as part of the strategic plan, is to build out the platform. So there is currently nothing additional planned at the moment but we keep our eyes open and our mind open to ways to build out the Geeknet platform.

Operator

Thank you. And our next question comes from Arthur Winston of Pilot Advisors. Your line is open.

Arthur Winston - Pilot Advisors

I assume that there is zero probability of selling the Web site to somebody else and trying to put your products to their Web site and concentrating to really make full core presence in the wholesale business. It's just not in the cards, is it?

Kathryn McCarthy

Arthur, how are you? I just want to make sure I understand your question. Your question was about the ThinkGeek Web site or the Web sites that are coming in...?

Arthur Winston - Pilot Advisors

The ThinkGeek Web site. Basically, make this a wholesale company.

Kathryn McCarthy

No. I mean that’s not the strategy. That’s not the plan. We believe strongly that we can drive growth on the sales in the site through the products that we are selling. And we are serving different audiences with the Web site versus the wholesale customer.

Arthur Winston - Pilot Advisors

Okay. So I thought. With the elevation in cost to this new plateau or the cost to finish going up or they are going to continue to elevate from this current plateau, the operating cost?

Julie Pangelinan

Yes. Hi, Arthur, this is Julie. So I think as we have mentioned in the past, we are making some significant investments this year and some of those investments, for instance, we spend about $500,000 in the quarter on brand awareness. So that project is over. We just started to rollout our new brand on the site this week and we will continue to have some additional P/R going forward on that. So we think we will reap the benefits in the future. Again, our investments on the ERP are happening this year and should be over by the end of the third quarter. So, so many investments we are making will not occur in 2015 whereas other investments, specifically in marketing, will continue to occur to increase our sales.

Kathryn McCarthy

Yes. The work going on site redesign, ERP, those are 2014 onetime investments that we don’t see recurring.

Arthur Winston - Pilot Advisors

So the future expense growth should be more gentle than what we have seen so far, more than likely?

Kathryn McCarthy

Other than those that are volume related. So you are going to see cost, when we go the fourth quarter historically we always have had higher revenues. We will see certain higher cost associated with those revenues to drive that growth. But things like some of the technology investments and the sales and marketing these onetime investments we are making, we made in the first half really for second half and future growth.

Arthur Winston - Pilot Advisors

Is this substantial improving in the response rate, which is up really nicely, correlated to the low gross margins? In other words, there was kind of a liquidation of inventory and that’s why people who do get on this site put more at lower price [within] (ph) lower traffic to the company? Is that what happened?

Kathryn McCarthy

Yes. I mean we do believe our ALV went down slightly in the quarter primarily driven by the clearance that we held in April. We are happy with where we are with inventory levels. We are down 4 million from the end of the first quarter and so feel like we have the right amount of inventory that we need at this time and we do expect ALV to increase going forward.

Arthur Winston - Pilot Advisors

So the gross margin has hit bottom for (indiscernible)? At 9%....

Kathryn McCarthy

I mean we certainly don’t play it -- we certainly don’t plan to have that. The gross margin, obviously, there's several things that affect gross margin. In any particular quarter it fluctuates over time but our goal as a team is to improve the gross margin.

Arthur Winston - Pilot Advisors

Okay. And just one last question. Could you just refresh me as to what the tax loss carry-forward situation is or isn't?

Kathryn McCarthy

We have currently $18.9 million of net operating loss carry-forwards that we disclosed in our 10-Q.

Operator

(Operator Instructions) Our next question comes from [Gary Stiperstein] (ph) of [Elliot Rose] (ph). Your line is open.

Unidentified Analyst

Just in terms of valuation with the stock having come down to $11 from $20. With almost $7 a share in cash, $3 per share in NOL carry-forwards and an enterprise value of about 25%-30% of sales. And that’s current sales and I just saw you are looking to grow this. It seems kind of obvious that you guys use some of the cash in a buyback program. Could you comment on that?

Kathryn McCarthy

Hi, Gary. So as I said before, we are looking at many different uses of our cash, from investments on the growth of the business, we will look for acquisitions. The board of directors and we are always looking at a potential for a buyback or some other use of the cash. But we don’t have anything to announce at this moment.

Unidentified Analyst

Okay. Just to follow up a little bit. I mean you have been sitting with a large cash balance for a long time. So [sorting] (ph) out some cash, then you use all your horsepower on a buyback, you don’t want to make some smart accretive acquisitions and expand the site and the revenue potential. But it seems, as part of your capital allocation process, you have been sitting overweighed with cash and clearly we haven't gotten any credit for that in the marketplace. So with a lot of M&A in the space, Internet retailers happening at onetime sales, two, three, four time sales. Even other Internet retailers that are losing money. It just seems with a ridiculously low valuation, your enterprise value versus your sale, that part of your cash could go to that.

Kathryn McCarthy

Well, I think that’s good input and it's something as I said we had under advisement, we will talk about. But I don’t have anything to announce at this point.

Operator

And our next question comes from Ralph Weil of Weil Investment Management. Your line is open.

Ralph Weil - Weil Investment Management

You have been growing significant in the ThinkGeek business in prior years and you seem to have hit a wall in the past year or so. What simplistically, and I know you have gone over some of this, but simplistically if you could just talk about what has really caused this. And I know you are doing a number of things to get back on track but what do you feel at this moment are still your biggest obstacles to overcome.

Kathryn McCarthy

Hello, Ralph. So we talked about the traffic and that’s something that we want to reverse the trend on and increase while ensuring that this traffic is quality traffic. So to address that, in addition to the PR campaign, the work we have done on the site, rebrand, which we feel will help converge in as well as attract new visitors. We are investing in advertising online, performance-based media, to accelerate new customer acquisitions. I mean that’s one of the biggest -- those are biggest efforts we have going on at this point. We also continue to focus on only at ThinkGeek. Some of the improvements to our site have been to highlight that there are certain products you can only get ThinkGeek. We have actually increased that, presented over the last few years and want to continue to do so. And so we feel like have launched some excellent products, typically we launch more in the second half than we do in the first half. But that GeekLabs and ThinkGeek is a key part of the strategy to drive new customers to our site and to drive growth.

Operator

And at this time I see no other questions. I would like to turn the call back over to you, Ms. McCarthy.

Kathryn McCarthy

I would like to thank everybody for joining us today and wish you a good day.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This concludes your program. You may all disconnect. Everyone have a great day.

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