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

Overstock.com, Inc. (NASDAQ:OSTK)

Q1 2007 Earnings Call

April 25, 2007 11:00 am ET

Executives

David K. Chidester - Senior Vice President - Finance

Patrick M. Byrne - Chairman of the Board, Chief Executive Officer

Jason C. Lindsey - President, Chief Operating Officer, Director

Analysts

Aaron Kessler - Piper Jaffray

Doug Anmuth - Lehman Brothers

Justin Post - Merrill Lynch

Scott Devitt - Stifel Nicolaus

TRANSCRIPT SPONSOR
Wall Street Horizon Logo

Operator

Good day, ladies and gentlemen. Thank you for standing by and welcome to 2007 first quarter Overstock.com earnings conference call. At this time, all participants are in a listen-only mode. (Operator Instructions)

I would now like to turn the presentation over to your host for today’s call, Mr. David Chidester, Senior Vice President of Finance at Overstock. Please proceed, sir.

David K. Chidester

Thank you. Good morning and welcome to Overstock.com’s first quarter 2007 earnings conference call. Joining me on the call today is Dr. Patrick Byrne, Chairman and CEO; and Jason Lindsey, President and Chief Operating Officer.

Before I turn to the financial results, please keep in mind that the following discussion and the responses to your questions reflect management’s views as of today, April 25, 2007 only. As you listen to today’s call, I encourage you to have our press release in front of you since our financial results and detailed commentary are included and will correspond to much of the discussion that follows.

As we share information today to help you better understand our business, it is important to keep in mind that we will make statements in the course of this conference call that state our intentions, hopes, beliefs, expectations or predictions of the future. These constitute forward-looking statements for the purposes of the Safe Harbor provisions under the Private Securities Litigation Reform within the meaning of Section 27(NYSE:A) of the Securities Act of 1933 and Section 21(NYSE:E) of the Securities and Exchange Act of 1934.

These forward-looking statements involve certain risks and uncertainties that could cause Overstock.com’s actual results to differ materially from those projected in these forward-looking statements. Overstock.com disclaims any intention or obligation to revise any forward-looking statements. Additional information concerning important factors that could cause actual results to differ materially from those in the forward-looking statements is contained from time to time in documents that the company files with the SEC, including but not limited to its most recent reports on Forms 10-K, 10-Q, 8-K, and S-1.

I will now review the financial results for the first quarter of 2007. Please note that all comparisons will be against our results from the first quarter of 2006 unless otherwise stated.

Total revenue for the quarter was $158 million, down 11%. However, gross profit dollars were up 7%, as gross margins in the quarter were 16%, up 270 basis points from 13.3% last year.

Our total operating loss was $17.7 million, including $6.1 million of restructuring charges. Excluding restructuring charges, our operating loss was $11.6 million, down from a loss of $14.2 million last year.

Of the $6.1 million of restructuring charges included in operating expenses, $4.7 million for the cost of exiting our warehouse space in Indiana. We plan to completely phase out of operations there by August and we will begin to see a reduction in fixed warehouse costs from this second quarter forward. The remaining $1.4 million of restructuring was for the accelerated depreciation of facilities-related assets at our corporate offices.

The loss from discontinued operations from our travel business was $3.6 million, the result of a $3.8 million impairment of its assets. As we announced this morning, we completed the sale of our travel business. For accounting purposes, the final valuation of the business and the related impairment were based on the present value of the discounted cash payments to be received from the sale.

Our net loss was $21.4 million for the quarter, or $0.91 per share, compared to a net loss of $15.9 million or $0.82 per share last year.

We ended the quarter with $68 million of cash. However, we did receive an additional $11 million of cash today as part of the travel sale. Our operating cash flows were an outflow of $58 million for the quarter, but only an outflow of $12 million over the trailing 12 months.

This concludes my financial review. I will now turn the call over to Patrick.

TRANSCRIPT SPONSOR

Wall Street Horizon Logo

Do you get frustrated during earnings season?

Have you had trades go south because of bad earnings dates?

We know what it's like. We’ve been there. We’re Wall Street Horizon and we work with some of the largest firms on Wall Street.

Founded by former Fidelity Investments executives, we understand the power of trading on good information and the pain and suffering of trading otherwise. We obsess about earnings and economic events calendars so you don’t have to. Accurate. On time. Guaranteed.

Let us help.

Get Smart

Get Wall Street Horizon.

View our Free 30-day trial for investment professionals

To sponsor a Seeking Alpha transcript click here.

Patrick M. Byrne

Good morning. That was of course referring to -- much of that was referring to slide 2. Please advance your own slides. Slide 3. We have 15 slides we will go through. My general point is Jason and I both feel I think that we are back on the rails. I think I mentioned the last phone call I have never seen him so giddy. You are going to see why in these slides.

On slide 3 of 15, I mentioned back in November that we should have one more stair step in what we should be able to get out of our inventory. I think that shows. On a GAAP basis, we are now running at 32 turns. Even on a reality basis, i.e. just considering that direct business alone, the core, what we call the core, we are running at 12 turns.

Now, this is all going to lead into why we think that margin and return on capital should be sustainable and even likely to go up from here.

Next slide, slide 4. I am going to spend a moment on this to remind folks that there is the GAAP gross margin and then what we call “Juice”. The difference is basically the fixed warehouse cost and a little bit of coupons we -- internally we have already accounted for that differently. Coupons and shipping promotions we account as a marketing cost but under GAAP it is a reduction of revenue.

So anyway, the main event is the difference between what we call core juice and core gross margins is the fixed warehouse costs. That -- we overbuilt our infrastructure, and these are our core versus our -- in both cases these are core, what we call, or what on a GAAP basis is called direct, so this is not including the partner business. So you see the improvement it has made in the last quarter. It can actually I think go up from there.

What is interesting is the spread, the size of the blue bar in between the two. That is a reflection of how much we overbuilt our infrastructure. We really overbuilt it for two reasons; one is that we plotted two years ago to have been $2 billion by now. We did not expect, of course, to come to such a rapid slowdown in sales, so we had overbuilt anyway and then on top of that, we have gotten about four times more efficient at running our inventory, so we just do not need all this infrastructure.

There is our core margins, about almost 7.5 points of margin are getting eaten up in that. It is possible to reduce that by about half, and it is twice overbuilt. It is overbuilt by a factor of two. So if you go to slide 5, you see it. Once you mix in partner revenue, which of course does not eat up any of that infrastructure, you see the difference between the gross margins and the juice, and so the juice is how we think of our marginal gross profit on the next dollar of sales. You see that there is basically a 2% spread there. Again, I think that is about twice what it needed to be.

As we have gotten out of some of our warehouse space in this last quarter, we charge for it, and even what of our excess space, we have sub-leased about half of that of what remains. So I think of that blue bar, there is about half of it that we can pick up.

Going on to slide 6, sales and marketing expense as a percentage of revenue, you see what really happened back in 2004. We actually had it down to 5%. As we reached this slow-down which -- well, in 2005 in the middle is when the slow-down really started occurring. I should just say the rate of increase went down, and all through 2006 we gunned marketing spend really probably too much in an attempt to claw our way back onto that hyper growth curve. Mistake, and we do not intend to do that again. We brought it down considerably. It might even come down a little bit from where it is here.

Going on to slide -- before we go on to slide 7, I will just mention that spike, that attempt to claw our way back on to the hyper growth curve, we not only realized that that was -- well, not going to do it again but the main event is we had to fix stuff and 2006 was the year of fixing things -- fixing the way we run inventory, fixing the way we do customer service, all those things. Well, they are largely fixed as you will be seeing through these slides.

That does not mean we are going to gas it again but I think it means that there are smarter ways to market. In fact, I look back over our history and our early history was a history of figuring things out first. I think I mentioned this in the last call or the one before that. I really do look back at 2000, 2001 and we would figure something out and we would ride it for a year or a year-and-a-half before other people figured it out. We would figure something else out. We sort of figured three or four things out first.

I think we really stopped figuring out the new things about 2004, 2005. We have figured out something we missed, something really big -- well, I think it is really big. We are working on it diligently. A lot of it is actually coming together this quarter.

But I am not going to make the mistake I made in past years, which was to tell the world what we have figured out, so I am not going to mention what it is. But we did -- we see now that we missed something big that had happened on the Internet and we have been working hard really for about six months to fix that.

Slide 7, contribution; and here you have my quote from the last July’s conference call where I talked about, we have something here call nectar. The official term is GAAP and that is just the gross profit minus the marketing spend. I said back then that it would get over 10 by the first quarter. Now, we have a -- and this is what it has done, and if we take the juice minus the marketing spend, you get nectar and that did get to 10.5%.

Jason points out that contribution is a GAAP term. Do you want to make -- anything to say to this, Jason?

Jason C. Lindsey

Well, you are referring to our bet. This came from when Scott Devitt, we were talking about this and he was asking how this was going to change, and you said that our -- well, it says right here: “Our gross profit minus our marketing expense, I’d like to see this over 10” and that is when we bet our steak dinner and you asked Scott to please remind you of this in the first quarter and what was it, and I asked Scott to please ask me how my steak was, because I was quite convinced we were not going to do this. Although I would have taken the under on even quite a bit smaller number, so I am surprised this is as high as it is as well -- pleasantly surprised.

Patrick M. Byrne

In my view, our nectar got over 10. Jason wants to use GAAP nectar rather than nectar, but that is --

Jason C. Lindsey

If Scott is listening, I have not had my steak because he does not think he lost the bet.

Patrick M. Byrne

Well, our nectar is over 10%. I did not know nectar was a GAAP term. By the way, we are in separate cities, Jason and I, so -- anyway, we thought that this would be -- we knew by the middle of last year. We had our game plan. Really, we had our game plan as of Q1 last year of what was going to have to happen.

We knew things were going to get really ugly and the company was going to have take medicine but that we could come out of it a far better company, and that medicine was going to be in the form of some expenses, it was going to be in the form of dumping a bunch of inventory as we figured out really how to take our inventory management to the next level -- all kinds of things. We knew it was going to get ugly. Maybe not as ugly as it got but we thought we would come out in the first quarter smelling like a rose operationally and this is exactly what we -- what I at least thought was going to happen in the first quarter.

Slide -- and again, this spread between, which is now 1.6, that includes a lot of excess warehouse space. Jason, as long as we are on it, do you want to talk about that on this slide? Anything about the excess warehouse space?

Jason C. Lindsey

Well, you can see it in our restructuring. We have approximately 800,000 square feet in Indiana that we really do not need now because our inventory has dropped from $100-plus million to $20 million range. It is a high-class problem but a problem nonetheless. We have a whole bunch more space than we need to hold the inventory that we need.

So we have too much warehouse space and we are doing everything we can as quickly as we can to get rid of it.

Patrick M. Byrne

What are we making public about what you have done already with that?

Jason C. Lindsey

I think it is in the financials. We have paid an exit fee to get out of half of it and then we have abandoned the other half and we have made some estimates about what we think it is going take to get out of the rest of it and we have accrued that in this quarter. So we are still in the half that we have paid the exit fee on and we will be in that half until August, so you will still see the cost of being in that warehouse until August 15th and then you will not see those costs at all anymore.

So in other words, our warehouse costs are going to drop for that particular warehouse, will be cut in half or not quite in half, starting April 1st, so it has already happened, and then the rest of it will fall out starting August 15th.

Patrick M. Byrne

Let me clarify -- when Jason said abandoned, he did not mean in the legal sense. He means we have stopped shipping new inventory into it. Instead, we are just directing it to Salt Lake and we are actually sub-leasing that other space. I think we have -- I think we have basically sub-leased about half of that remaining half, but it is not long-term leases and so on and so forth.

Jason C. Lindsey

That’s right.

Patrick M. Byrne

Moving on to slide 8, GMROI, we know a lot of retail investors like to look at GMROI, gross margin return on investment. It actually reached -- because we are able to operate with so much less capital now, even on a real basis we reached 31% for Q1 on a real basis, meaning the physical basis of the goods we are buying, holding and then selling. When you do it on a GAAP basis, meaning all of our goods, it comes to 121% for the quarter.

Slide 9, customer satisfaction. Again, if you go back a couple of years you can see what happened. The dip is the -- Q3 is where we basically outgrew one set of clothes and hadn’t really gotten into the other set sewn. But it has come back. The NPS measure, which is out of that Fred Reichheld book, The Ultimate Question. He says that the average American company has an 8% or a 5% to 10% I think he says. Even people who contact customer service with us now have higher NPS scores than that. In fact, there are occasional days it is in -- even the bottom line is in the 30s.

Jason C. Lindsey

One would assume that the people who contact customer service are the sample that actually had some type of a problem, so I am encouraged by that number.

Patrick M. Byrne

Yes, I am very encouraged. And then at the high end is up in the 60s, which puts us, according to him, according to that book, in the very top rank of the all-stars of corporate America. The all-stars for him is defined I think from 38 to 70 or something.

Our customer satisfaction has come back and it is actually -- we see ways to make the next breakthrough. Stormy Simon is running that. There is another evolution that she is finishing up and we actually see some of the benefits of that already.

Slide 10, this is what Jason and I are so excited about. This is our EBITDA going back to 2004. And 2004 was the last year that was right on game plan. It was a year of great growth, small EBITDA losses during the first three quarters, and then making most of it back in the fourth quarter.

That was just the game plan, to grow like that and be able to be -- and let all that balance out. Three quarters of small losses and then a nice win in the fourth quarter. It happened again in Q5 [sic], but it was in Q5 [sic] of course that we, starting in about Q3, that we started having problems. Even though we did come back in the fourth quarter, Q6 -- or 2006 turned into a rout, increasing losses all through the year.

Now what’s happened though in 2007 is -- well, you can see the EBITDA still is the minus $8 million, but of that $6 million is restructuring. It is $2 million of EBITDA loss. I assume I do not have to tell folks, and even that I can tell you has $1.5 million, $2 million of things that, or more, that just -- not mistakes but things that we were -- we were tightening bolts down all through the fourth quarter and really did not get everything tight until mid- to late-February.

I do not have to tell you -- in our view, our dream has always been to be able to be EBITDA break-even in the first quarter, because if we can do that and then hold that for three quarters, you know what happens in the fourth. So we are substantially back to that point, basically the same, setting aside the restructuring charge, which is a real charges.

Jason C. Lindsey

I also like this so much in the first quarter and in ’07 because we are not spending what we were spending on CapEx. Even if you look back at ’05, you would say that was a pretty good year. Well, if you think about how much cash we were running through, it was not such a great year because we were just spending so much money on our infrastructure.

The reason EBITDA break-even is so exciting now is our depreciation really is so much more than what we are spending on new CapEx projects, and so it is much closer to a cash number than it used to be.

Patrick M. Byrne

Right, and in fact I had a slide in there. Did the lawyers take that slide out on the CapEx and the depreciation?

Jason C. Lindsey

No, it’s in there.

Patrick M. Byrne

Okay. So I -- this is why -- you may wonder why Jason and I say the business is back on the rails and sort of at some superficial glance or -- shouldn’t be judgmental. Some people are going to say this isn’t any good. This is exactly what we dreamed of a year we could make happen. We think we are back there. This is very encouraging to us and again, if we can just hold some numbers like this through the first three quarters, then the fourth quarter should be a nice big surprise.

Jason C. Lindsey

Another way of saying all that is this is an indicator that our cash burn number has decreased dramatically and that is obviously very important to us.

Patrick M. Byrne

Slide 11 -- we have been restructuring. You see our corporate headcount, so this is non-seasonal. Of course, during the fourth quarter we have more warehouse and more customer service. This is the real corporate side of the business and we probably -- well, you see that we have reduced back to about where we were almost to Q2 of two years ago.

These cuts are -- the riffs are over. The real reduction, the waves, reduction in forces are over. This actually understates what happened too, because if you went to 2005 as we made all these changes, we had armies of either consultants or technicians, from 70 people or more, and generally very expensive people, as we have made the prop to jet conversion, as we moved from homegrown systems to the Oracle and Teradata Systems.

Besides the headcount that showed up here, we had a massive amount of expense for headcount that was not technically on our payroll, and that has been cut essentially to nothing now. So if you really added the two together, we probably were up near 500 at some point and now we are down to 349 as a real number.

Jason, do you have any comment on that?

Jason C. Lindsey

Yes, for example, in 2006 we spent just in IT consultants alone, we spent almost $7 million in the year 2006. That number in 2007 will be almost zero, so instead of just corporate headcount, if you had corporate plus consultant headcount, this graph would look like a mountain top. It has dropped dramatically.

Patrick M. Byrne

Yes, in fact that is -- our IT payroll used to be X plus that $6 million or $7 million, and now it is just -- including consultants, and now it is just X plus $1 million with no consultants, so it is a good trade. Plus there are a lot -- I like working, I like employees better than the consultants, for the most part.

Slide -- I think that we are both -- we’ll show this slide I guess next quarter and then probably stop showing it because the reduction in headcount, there is no more massive cuts to be done.

Slide 12, as a result of the restructuring and all these other changes, improvements in gross margins and the decrease in marketing expense, the contribution dollars per corporate employee in each quarter, you see that it actually reached $1,100 in Q4. Obviously you cannot do that forever.

Well, it’s back. It is higher than it’s ever been and -- higher than it’s ever been. Any comments on this, Jason?

Jason C. Lindsey

No.

Patrick M. Byrne

Okay. That’s new for you. Slide 13, restructuring. Why don’t you talk about the charges?

Jason C. Lindsey

Well, we had $6 million in the quarter. Again, $4.7 of that relates to our Indiana warehouse, which I think we have walked through. Dave, why don’t you walk through this?

David K. Chidester

Well, I think you’ve already really hit these points. This is -- these are the charges we took for getting out of the warehouse. There are some additional charges that we are taking as we are trying to scale back on our corporate headquarters as well, and so those two things combined get you to your number.

I think the big restructuring charges related to the warehouse are done, and so all that is left is really any restructuring charges we have in conjunction with what we do with our corporate headquarters.

Jason C. Lindsey

The other -- not restructuring charges, but discontinued operations charges which add up to be a total of what was it, $11 million, Dave, of non-operating losses. Those relate to the travel business, which we officially have now sold. You will not see that in the future either because we have sold it.

Patrick M. Byrne

It was a shame to sell that little jewel but we wish the buyer the best of luck. Jason -- okay. I know it is in the 8-K that people can read.

Slide 14, this is depreciation and amortization of our currently owned assets. I am emphasizing; so this is not a projection in the sense of I really don’t expect it to go to zero after 2009. There we are in 2005, it was nice and tight. It was under $2 million a quarter. We went out and bought these huge, honking systems and it has swollen to $9 million a quarter now of non-cash depreciation, of -- well, depreciation. It has come down a little bit, a little over $8 million now.

We depreciate as quickly as we can. In fact, our fights are usually that we want to depreciate and write-off as quickly as we can, so most of this stuff is three years or less.

To Jason’s point, I hate EBITDA as a measure normally because you do have CapEx, but we so overbuilt our systems -- in the case of our warehouse, we overbuilt so much that we are getting rid of some, but in terms of technology we have just massive systems that we could grow and grow and grow and not use up.

We do not really have that much capital expense now. For us at this point, doing a $350,000 CapEx is a big deal. It is something we all know about. We are back in that very tight-fisted mode, having built the big infrastructure.

So while in reality our depreciation and amortization will not do this, it won’t go all the way to zero, it is going to do this plus whatever we depreciate on new things we buy where there is very little of that.

Have you put out an estimate, Jason, on what we were doing in CapEx?

Jason C. Lindsey

We have not but I think it is clear that this big drop you saw in our depreciation in the first quarter is real and we are not spending anything near at all like we used to spend. You will see this number continue to drop and there will be big decreases in ’07 and then again in ’08 if we spend what we think we are going to spend, which is a lot less.

Patrick M. Byrne

It is basically single-digit millions per year. Is that fair?

Jason C. Lindsey

Sure.

Patrick M. Byrne

Okay. I mean, that could change of course, but how we have budgeted things now and we are not even sure how we use that much.

Slid 15. Slide 15 is just the highlights, the highlight reel. It is the gross margins bounce back as we -- actually, these are all all-time highs. Our gross margins bounced to 16%; our contribution margin is over 10% on a nectar basis, on Jason’s basis it is 8.9%; inventory turns are over 30 are a GAAP basis; GMROI on a GAAP basis is 121% for the quarter.

These are sustainable or even possibly something we can improve on.

Jason C. Lindsey

These are all -- I think these are all the indicators of why we were so excited about the operation and we really thought the business could be better than it has ever been, and I think it is.

I view, as we said there, we had two really -- well, we had thousands of things to do but I kind of divide them into two really big jobs. Job one was we had to clean up and job two is we have to redecorate. These all I think show that the job of cleaning up is largely done. Some of these numbers can get better and if we sell, if our mix changes some might get slightly worse but I think in general these numbers are all going to get better, and they are as good as they have ever been, so I am quite encouraged.

Now the job comes of redecorating, and redecorating means things like doing things to enhance the website so the customer experience and what they are going to see I think is going to get noticeably better over the year. Things like our SKU count, our SKU count will increase dramatically between now and the Christmas season, I think probably several times over, and they are all -- I think we can do all that without increasing our inventory levels and hurting our turns much because it is all going to be through our partner business.

So I am quite encouraged with where we came from and what we have accomplished, and we just have to do the next job now, which is to redecorate.

Patrick M. Byrne

Before we go to questions, I am going to throw something else in. I would like to shout out to the vendors who have supported us. I know in years past, for four years I have talked about Oracle and Teradata. There are some others I want to mention who are really in some cases more of that redecorating than the clean-up, but they are doing very good work for us.

Visual Science is a website analytics company we have been with for years. They have been here in D.C. It is a great, very, very high-end solution. They do a lot of selling to the government, I think. I think it is some ex-government scientists, so I have nothing but great things to say about Visual Science.

But we did go in parallel and then bring -- well, we brought live Omniture and have cut over to them as our main analytics source. Omniture is a company that is about 20 miles from us, and they -- their technology, they have upgraded in the last four or five months. They have issued a new release that is very powerful and it is very user friendly, but in addition it has a system called Genesis, which I will get back to in a second.

We have had, we have brought live Mercado. I will not mention who used to be on but our search engine is now Mercado. It is fantastic. They have been the best -- I have to say, the implementation of Mercado, which we cut over to in mid-March, has been one of the smoothest -- well, maybe the smoothest corporate implementation we have ever done. Great company to work with and a very powerful merchandising system that they have that was attractive.

We also have companies doing -- Aggregate Knowledge does our product recommendations on our product pages, and sometimes in our e-mails and such. Choice Stream is powering our gift center and moving on into other areas of our site. That does personalization as opposed to recommendations. And then Kefta. Kefta is San Francisco based company that does a lot of -- I don’t know if you would call it content management. It is maybe a higher order. Some people confuse it with the recommendations or something but it is really a different product.

But one of the things that is working so well to tie all these together is Omniture. Omniture has this Genesis system that becomes the platform that everybody can integrate to, so it has been a -- it has been a very good partner for us to have.

Given how much time they have spent, we have kind of become the test bed for these different companies working with each other. I wanted to call out to them.

Operator, may we go to questions?

Question-and-Answer Session

Operator

(Operator Instructions)

Your first question will come from the line of Aaron Kessler of Piper Jaffray.

Aaron Kessler - Piper Jaffray

Good quarter, good to see the improvement on the margin side. A couple of questions for you; first, it looks like you are starting to really get expenses under control. When should we look for you to start to look to reaccelerate revenues, and as you look to reaccelerate revenues, how do you maintain that kind of 7% or below marketing level? I believe you tried to reaccelerate revenues last year and it did not work out as you had planned. How should we think about it this time? Have you got any analytics in place? I have one follow-up. Thank you.

Patrick M. Byrne

I would not look for it this quarter. As I said, I think that we missed something big in what is going on in the Internet and we missed a way to market and I am kicking myself, because we used to pioneer the new ways and then other people catch up. We missed a way. Some other people we see have figured it out. They are ahead of us. Not a whole lot of people and we are really focused on getting that done. Most of the things will be done this quarter and next quarter, so I would not expect any big reacceleration. And then, we are only going to reaccelerate dramatically if those work.

Aaron Kessler - Piper Jaffray

Great, and then a couple of other questions; where do you expect gross margins to go in the direct side over the next few quarters? Also, what was the Omniture platform able to do that Visual Sciences could not do? Thank you.

Patrick M. Byrne

Jason, what do you want to say about core margins?

Jason C. Lindsey

I am pleased with where they are at. Hopefully they can continue to sneak up but I do not anticipate anything, any huge stair steps from here.

Patrick M. Byrne

I would not anticipate stair steps. I think that they float up but I think --

Jason C. Lindsey

I hope they float up as well. I hope that they do. I think that they can.

Patrick M. Byrne

Comparing Visual Science with Omniture is a little like comparing old girlfriends or something. It is just not -- it is something -- I can actually only say nice things about them both, which is probably a good rule.

Aaron Kessler - Piper Jaffray

Was Genesis one of the big differences though in terms of the platform that integrated all the marketing?

Patrick M. Byrne

Well, let me give you -- Genesis is one of the big differences. I can tell you quickly, Visual Science, the take on them always was that their technology had surged ahead of Omniture and I would have to say that a couple of years ago, that is why we switched to Visual Science. They really did have very advanced technology.

Omniture introduced something in the fall that they would say catches up and surpasses Visual Science. At the very least, it dramatically closes the gap. One of the other differences is Visual Science is so advanced but you kind of need a -- you would need almost a Masters degree in visual science to operate it. It is very advanced stuff.

Omniture, whether it has caught up or not I know some would dispute, but you can get people in a few hours on Omniture. If you have 30, 40 people in the company using Omniture and figuring things out. It is harder to do that with Visual Science, whether or not there technology is a bit better.

And then -- I cannot comment professionally on -- they would say that they still have the lead. Omniture says that they have closed the gap and even passed it. But the Genesis platform was, the Genesis plus the fact that Omniture is so close to us and they really smothered us with attention, but the Genesis platform I think is the beginning of something pretty powerful.

Jason C. Lindsey

Just one more point on the core margins and to give some color on to why I am cautious. You have two things going on. One is we are getting out of fixed warehouse space and you will see some of that effect in this quarter and then some in the third quarter, so everything else being equal, you would see them float up.

However, another dynamic that is going on is as we liquidated all of our slow-moving inventory and things that did not meet our metrics last year, we really sold everything and got our inventory extremely fresh.

Now, one thing that we didn’t sell was kind of all of our spring garden patio type of stuff. The reason we didn’t is we spent a lot of time looking at it and trying to determine if it was best to just get rid of all that stuff at Christmas or would it be cheaper to kind of locker stock it and hold on to it until the spring and then sell it then. After having done several tests, there is just not much you can sell as far as garden and lawn patio in this country in December.

So what we ended up doing was holding it, and so we do still have several million dollars worth of stuff that we call our excess inventory from last year that we didn’t liquidate that we are going to be liquidating now and even into the beginning of the third quarter. Although we reserved against that and do feel like we have an adequate reserve and that we will be forced to -- and we will release that reserve some as we sell that stuff. I am just not sure exactly the clearing price of all that.

So you put those two factors together and I think it should float up but I would not be surprised if it does not come up much for another quarter or two.

Patrick M. Byrne

Did you mention what it was, Jason? If you did, I missed it.

Jason C. Lindsey

Just garden and patio, outdoor spring type inventory.

Patrick M. Byrne

Furniture, and we are giving great deals on that garden and patio -- we call it wicker, but it is really wrought-iron, is it wrought-iron, Jason?

Jason C. Lindsey

Yes, wrought-iron with pads and stuff that are over the top of the wrought-iron, lounge chairs and things like that.

Patrick M. Byrne

If you want to both help us out and get yourselves a great deal, come in. We have millions of dollars of that stuff and --

Jason C. Lindsey

We are selling for less than we bought it for in China, so it really is a good deal.

Patrick M. Byrne

Jason was -- he dumped everything at Christmas. It’s kind of funny. Years ago when I ran merchandising, I would say by the time you liquidate something, you are better off just cutting the price and dumping it through the website. Anyway, now that Jason is running merchandising, I think he came to the same conclusion and at Christmas, that is what happened to our margins. We just realized instead of trucking the stuff off to a liquidator, we just cut the prices and moved it out and got the new customers.

But the one set of things he didn’t do was the millions of dollars of that furniture, wrought-iron furniture, you can’t sell it at Christmas. But we do have -- a big chunk of our inventory is still that and when that disappears over the next two months, three months, that is a significant chunk of our inventory and Jason has taken a very healthy reserve against all of that inventory. But anybody who wants a great deal on some patio furniture, we are the place to go. You are helping us and yourself.

Okay, next question.

Operator

Your next question will come from the line of Doug Anmuth of Lehman Brothers.

Doug Anmuth - Lehman Brothers

This is actually Brian on the line for Doug. I have two quick questions; first, what sorts of things are you doing to grow the partner business that makes you believe the SKU count can dramatically increase?

Secondly, are you seeing any meaningful acceleration in any categories on the site I guess beyond BMBG? Has there been any notable change in the mix? Thanks.

Patrick M. Byrne

I’ll just take -- I am going to open the first one to you, Jason, on partner. We do have somebody that we have done nice business with, vCommerce. They also -- they are a partner/integrator in Phoenix and they also handle targets. Jason, do you want to -- I know it is public because, what we are also doing. Would you expand?

Jason C. Lindsey

Yes, we have an agreement with Channel Advisors, who represent another large universe of partners who sell via the web and we are in the process of integrating with them. We think by actually a month from now, this time next month we should be live. We have many partners who are integrated within but not vCommerce, so it will just open up a new universe of partners for us.

Where we have started is we spent a lot of time over the last couple of months identifying places on our shelves where we are just kind of empty and identifying places where people come, search but we do not have a very good selection, if no selection at all.

The first big wave of partners that we will be signing on through Channel Advisors and where we are spending all of our focus is just that, to fill out categories where we do not have any selection or have very poor selection. So we are really trying to stock the shelves. You will see a dramatic improvement in our product selection and accordingly, our SKU count.

Patrick M. Byrne

I’m sorry, Brian, what was the second part of your question?

Doug Anmuth - Lehman Brothers

Just are there any categories on the site beyond the media categories where you are seeing a pick-up? Was it furniture, was it electronics -- just any color on that would be helpful.

Patrick M. Byrne

We are seeing things change and there has probably been more volatility among the departments than we have ever seen before as a reflection of these new ways we are measuring and realizing that some products were not really very good to be doing in terms of return on capital, and then some areas were great, we could put more capital into them.

But we are not -- I do not think we want to say which departments are doing better than others. Jason, would you --

Jason C. Lindsey

That’s fair.

Patrick M. Byrne

There is more change going on than we have ever seen before.

Jason C. Lindsey

I do think you can say basically all of our departments are going to have a much bigger selection over the coming months.

Patrick M. Byrne

Yes. Channel Advisors, for those who do not know, is a company that started off hooking up power sellers on eBay. They did $1.6 billion in gross merchandise value last year. I think they have about 1,000 partners or maybe 1,500 partners, so that means they are doing an average of $1 million to $1.6 million a year on eBay, and also they do Amazon, they integrated with Amazon as well. That set of people will be exposed to us.

We actually had planned on -- I gave a talk at their conference a few weeks ago and we hoped to be live in April, and it looks like we are just pushing off a few weeks into May.

Anything else, Brian?

Doug Anmuth - Lehman Brothers

That’s it. Thank you.

Patrick M. Byrne

Thank you. Go ahead, next question.

Operator

Your next question will come from the line of Justin Post of Merrill Lynch.

Justin Post - Merrill Lynch

Thank you. Patrick, could you talk a little bit about traffic to the site? You did see total sales down a bit year over year. What are the core traffic metrics you are watching?

Secondly, obviously the partner revenues are driving or having fulfillment partner revenues are up. Can you talk about the revenue per partner or any metrics on number of partners that you have added over the last six months or so?

Patrick M. Byrne

Traffic, I know that everybody is looking at traffic and the thing to probably look at is hit wise. Hit wise, we have always found when we study it is very -- is the most accurate on traffic. Actually, Nielsen is good too. But we are not really -- we have gotten out of being, of getting -- we have gotten out of the game of being really uptight about how big our traffic numbers are.

We look at things on a revenue per visitor basis. What we have realized is and the reason we are able to cut marketing expenses -- what did we cut it as a percentage?

Jason C. Lindsey

From 11% to 7%, or something like that.

Patrick M. Byrne

So almost 40% and sales came down 11%, it is because we are cutting the inefficient marketing. What has happened is the vast majority of our marketing has always been online. That game has really gotten bit up. We just decided to stop chasing it. As we went through and got very granular about what was succeeding and what was not, we just started hacking and we kept -- we did shrink 11% but with spending 40% or so less on -- it wasn’t 40% but it was -- anyway, we are, we still overspent some in January, I’ll say, but it really took until the middle of February to really get the bolts tightened down there.

That is where I would say if this is a game of getting the car ran off the road and it’s back on the road and driving again, certainly the two tires of the supply chain side are back on the road. They are fine. The third tire of marketing expense and cutting bad marketing expense, that is back on the road.

The fourth one of finding a cheap way of getting momentum back, it is not quite there yet.

Jason C. Lindsey

Regarding your question of partner revenues, I actually think the amount of partner products on site over the last six months has probably gone down, although I have not looked at the -- I think it has gone down, and the reason it has gone down is because all the metrics that we put in place for our core products this last summer about velocity, meaning if it is on the site, it’s got to move and it’s got to sell, and we really institutionalized a bunch of procedures about our pricing and making sure products are always moving, we basically did that for ourselves this summer. And then this fall, we implemented a version of that for our partners. In other words, things that our partners put on our site have to move over a certain amount of time and they have to move at a certain rate or we take them down.

So we have actually gone through a pretty serious process of culling products and partners, so the SKUs they put on the site and the amount of people we deal with has come down as we have culled products and partners that are not selling and are not providing adequate customer service to our customers.

So again, the two-step process was one, you have to clean house. I think we have done that. Now we have to redecorate and that is why we are focusing so much on areas where we do not have a good product selection and so it is really just now, over probably the middle of March where we really started an effort to okay, let’s put a whole bunch of new stuff on the site in areas where we do not have selection. So to date, the increases have been getting the clutter out of the way and getting products that people want has kind of spurred the increase.

I think going forward, the increase will be a whole bunch of selection that we just did not have before.

Justin Post - Merrill Lynch

Okay, and a quick follow-up; so if revenues were down 11% and revenues per visitor were up, is it fair to say that visitors were maybe down more than 11%?

Patrick M. Byrne

Yes.

Justin Post - Merrill Lynch

Thank you.

Operator

Your next question will come from the line of Scott Devitt of Stifel Nicolaus.

Jason C. Lindsey

Scott, who won the bet?

Scott Devitt - Stifel Nicolaus

I’m going with Jason, and I am recommending Gorat’s on Patrick’s bill. But that’s my opinion.

The first question is on Google Checkout, which you have not integrated yet, is that coming? I understood it was possible that it would be a 1Q integration.

Patrick M. Byrne

The answer is yes, it is coming and it is coming this year, but it will not be 1Q. It will be probably 3Q.

Scott Devitt - Stifel Nicolaus

Secondly, you talked a lot about the first quarter and metrics did dramatically improve as you cleaned out the direct inventory in the fourth quarter. You also shied away from just longer term guidance or projections about the business. But now that it is becoming fairly predictable, excluding possibly the capacity to grow revenue, can you just talk to the operating expenses line items below gross margin, sales and marketing, tech and development and G&A as a percentage of revenue to run the business? You have significantly reduced the CapEx spend. Do you think that is sustainable long-term as well?

Patrick M. Byrne

I will let Jason answer this question, other than to say on the technology, it is absolutely sustainable. We went from spending 1.5% of revenue on technology to spending about 8%. It is coming back down, and neither of those were the right number. The right number was about half-way between the two, and it --

So yes, CapEx is quite sustainable at a low level. Jason, why don’t you address the --

Jason C. Lindsey

Well, regarding guidance, this is kind of a slippery slope and our official stance has always been we do not offer guidance, so my comment I guess first is I don’t want to go into the line items in the model and tell you what I think and don’t think about the different line items.

I can say, just like I said last quarter, Dave told me 10 minutes before the call that the consensus estimate was somewhere around $60 million, and I said on the call I was quite comfortable with that. I was comfortable with that. I am comfortable with it. I am still comfortable with it. In fact, I am more comfortable with it now than I was before, but I still think it is a good number.

We just have focused so much on cleaning house as opposed to redecorating. Now that we start to shift to redecorating, I do think that we will have, we will start to see improvements in sales at some point in the future. But we just don’t know what sales are going to do, and because of that I just don’t think that I would change the estimates at all. Additionally, you have restructuring charges. We had some significant ones and other than corporate, we do think they are largely behind us but we just do not know what is going to happen at corporate.

So you kind of put all that in a bag and given the changes that have happened, I am still comfortable with $60 million. I think it is as good a guess as any, and I think that is probably a pretty good guess. I think $60 million is probably about right for the year.

Patrick M. Byrne

I think you actually said last time, Jason, didn’t you say minus 20, minus 20, minus 20, 0?

Jason C. Lindsey

Well, I think Scott asked a question about how this business looks like in the long-term, what is it that you are shooting for. What we are shooting for around here are margins of somewhere around 20% and you spend 5% on marketing, 5% on G&A, 5% on tech, and that leaves 5% for operating profits. We talk a lot about that every executive meeting as we look at our financials and how they are going and what marching orders we are shooting for. That’s exactly what we are shooting for.

I still believe that someday that’s, plus or minus a percent or two on any of those lines, that’s pretty close to -- that’s what we’re trying to achieve, so --

Patrick M. Byrne

But I think you also said in terms of earnings, four quarters -- I remember you saying what you just said and I thought, correct me if I’m wrong, that you sort of said you thought 60 would break out minus $20 million, minus $20 million, minus $20 million, $0, and we did it and the first quarter was minus 21. Do I not recall that accurately?

Jason C. Lindsey

I’m not sure I said that but I think if you, with a really broad brush because again, there is a lot of people that make up the average, I think something like that is kind of how they get to the $60 million.

Patrick M. Byrne

Okay, and the big restructuring charges are -- I think essentially all the restructuring charges are behind us except for if we move corporate. That would be another big restructuring charge.

Jason C. Lindsey

If we do it, it would be, yes.

Patrick M. Byrne

But we are not -- we’re 50-50 or something now, whether it is actually going to happen. We would like to, but that is also what makes it hard for us to get too specific this year on guidance, but Jason’s long-term model of 20, 5-5-5 and operating profit of 5 is what we are shooting for.

Scott Devitt - Stifel Nicolaus

And then just one final question; you are focusing a lot more on the commission or partner revenue in inventories, $16 million now. Do you think the inventory levels will grow from here throughout the year? What are your thoughts on that, maybe in terms of a percentage of direct costs over time, the inventory line?

Jason C. Lindsey

I think they will probably go up some, but again you do have two things going on there. One, we have some inventory that is kind of left over that was spring inventory that we are trying to liquidate now, and you are going to replace that with better inventory, so those two dynamics are going against each other, although the $16 million number is a net number against the reserve against that inventory, so I do think it will come up. We are retailer so we are going to build inventories in the third quarter and then sell it in the fourth.

I think in general to sustain this level of -- if our sales for our core stuff did not go up, this is a very good level of inventory and I think it would stay quite stable. Our hope obviously is that in the future our sales go up, both core and partner, at some point and when they do, I think the inventory levels to support it will go up. I do not think there is much more operational efficiency as far as days on hand or inventory turns from where we are at.

In fact, the inventory turn slide in the grass is not overstated -- it’s a fact. It’s just math, but it has a tailwind of a huge liquidation and so naturally, that number should come down.

But 10 to 12 inventory turns in a year on a real basis, on a GAAP basis it is because of our partner business is going to show 25 or 30, I think is good and I do not think it needs to get a lot better than that. I think our inventory levels around where we are at with these type of sales levels is probably about right.

But I do think sales will go up and we will build inventory for the fourth quarter, so they will go up for that reason as well.

Patrick M. Byrne

I guess we have time for one more question, if one there be. Is there one?

Operator

Sir, due to time constraints, that will conclude the question-and-answer session. I would like to turn the call over Jason and Patrick for closing comments.

Jason C. Lindsey

I am pleased with the quarter. I think we made a big improvement. I am pleased with the margins, the inventory efficiency, our contribution margins. I think it was a very big step in the right direction and I hope that we can maintain it and keep making more steps in this direction. I am pleased with what we did this quarter.

Patrick M. Byrne

I will echo that. We saw about a year ago that we had to run a gauntlet but on the far side, we saw daylight and I’m looking at the graphs on slide 15, these are all operational improvements. I am thrilled with them. I think that this is what we aimed for a year ago but I am not sure that either Jason or I believed we could actually get to this point but we are excited about these operating improvements.

We look forward to talking to you next quarter.

Jason C. Lindsey

Thank you.

Patrick M. Byrne

Bye-bye.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the presentation and you may now disconnect. Have a wonderful day.

TRANSCRIPT SPONSOR

Wall Street Horizon Logo

Do you get frustrated during earnings season?

Have you had trades go south because of bad earnings dates?

We know what it's like. We’ve been there. We’re Wall Street Horizon and we work with some of the largest firms on Wall Street.

Founded by former Fidelity Investments executives, we understand the power of trading on good information and the pain and suffering of trading otherwise. We obsess about earnings and economic events calendars so you don’t have to. Accurate. On time. Guaranteed.

Let us help.

Get Smart

Get Wall Street Horizon.

View our Free 30-day trial for investment professionals

To sponsor a Seeking Alpha transcript click here.

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 Q1 2007 Earnings Call Transcript

Check out Seeking Alpha’s new Earnings Center »

This Transcript
All Transcripts