Overstock.com 3Q 2005 Conference Call Transcript

Oct.29.05 | About: Overstock.com, Inc. (OSTK)

Q3 2005 Overstock Com Inc Earnings Conference Call

28 Oct 2005 11:00 (NYSE:ET)

Corporate Participants

David Chidester - Overstock.com - SVP, Finance

Patrick Byrne - Overstock.com - President

Conference Call Participants

Craig Bibb - WR Hambrecht + Co. - Analyst

Douglas Anmuth - Lehman Brothers - Analyst

Scott Devitt - Legg Mason - Analyst

Colin Sebastian - Thomas Weisel Partners - Analyst

Aaron Kessler - Piper Jaffray - Analyst

Paul Keung - CIBC - Analyst

Justin Post - Merrill Lynch - Analyst

Rebecca Kujiwa - - Analyst

Derek Brown - - Analyst

Aruva Shaw - - Analyst

Don Best - Manchester (ph) - Analyst

Jim Krueger - - Analyst

Operator

I would like to welcome everyone to Overstock.com's thirdquarter 2005 financial results conference call. At this time, all lines are in a listen-only mode. Later, we will announce the opportunity for questions, and instructions will be given at that time. A Web-based slide presentation will be used during this call, and is available for your download or viewing over the Internet on the company website, www.shareholder.com/overstock. If you're listening via the telephone and want to see the presentation via the Internet, please ensure that you select the no audio, slides only option. If you select the regular webcast, you will experience up to a 25 second delay. (OPERATOR INSTRUCTIONS). This call is being recorded, and will be available for replay beginning today at 3:00 PM Eastern time through 11:59 PM Eastern time Friday, November 4th. The replay can be accessed by dialing 888-203-1112 or 719-457-0820 and entering the access code of 441-6025. At this time, I would like to turn the call over to Mr. David Chidester, Overstock.com's Senior Vice President of Finance. Mr. Chidester, you may begin, sir.

David Chidester, Overstock.com - SVP, Finance

Good morning, and welcome to Overstock.com's third-quarter 2005 conference call. Participating with me on the call today is Dr. Patrick Byrne, President of Overstock.com.

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, October 28, 2005 only. As you listen to the call, I encourage you to have our press release in front of you, since our financial results, detailed commentary and the President's letter to shareholders 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 purpose of the Safe Harbor provisions under the Private Securities Litigation Reform within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities 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.

With all that said, I will now review our financial results for this past quarter. Please note that all comparisons will be against our results from the third quarter of 2004, unless otherwise stated.

Total revenue in the quarter was 169 million, up 64%. Gross margins were essentially flat sequentially at 14.6%. A slight decrease in margins from inefficiencies in operations was offset by 50 a basis point increase in margins from the addition of Ski West to our travel business. Gross profit dollars increased 80% to 24.7 million.

Operating expenses grew 115% to 36 million. That was driven by a 91% increase in sales and marketing, a 250% increase in technology costs and a 96% increase in G&A. Our travel business, now including Ski West, added an additional 1.6 million of operating expenses this quarter, and we also incurred 700,000 of amortization expense related to the allocation of the Ski West purchase price to intangible assets, and this will be a quarterly charge going forward.

Our operating loss was 11.2 million or 6.6% of sales versus a 2.9% loss last year. Our net loss was 14.2 million or $0.75 per share, compared to a $3 million loss or $0.16 per share loss last year. And one important thing to note about our net loss -- we incurred a $2.1 million non-operating expense from the mark-to-market adjustment of our foreign bonds. And the coupon on these bonds is tied to the movement in Asian currencies against the US dollar. Because it's structured as a bond, there is no downside risk at maturity. They will mature at par and we will receive 100% of our cash back. However, derivative accounting requires that we run the change in the value of the derivative through the income statement each quarter. We have recorded cumulatively 2.4 million of nonoperating expense to date. The bonds will mature in the next 10 to 12 months. If we hold them to maturity as we plan, the expense will reverse itself and we will record a non-operating gain of 2.4 million, equal to any losses we have incurred to date.

We ended the quarter with 77 million in cash and marketable securities and 97 million of working capital. We also ended the quarter with 95 million in inventory, in preparation for Q4 sales. Operating cash flows were -12 million for the quarter and -20 million on a trailing 12-month basis. Free cash flows were -24 million and -60 million for the same periods. However, we do expect to generate positive operating cash flow for the full year 2005. Depreciation and amortization was 5 million for the quarter and 9.5 million year to date. Total capital expenditures increased by 12 million to 52 million year to date and we'll end the year with 55 to 60 million of total capital expenditures.

Two more points of interest -- the average invoice remained at $97, flat from last quarter, and BMV was 10% of total gross bookings, up 50 basis points over last year.

With that, I will turn the call over to Patrick.

Patrick Byrne, Overstock.com - President

Thank you, David. Well, as I said in my letter, gomen nasai. It's a Japanese expression that means more than I'm sorry in English. It means I'm sorry and I know I failed in a duty; I failed in a mission or an obligation. I lost $14 million of our money, and I'm sorry about that. Gomen nasai.

Let's see. We have a Safe Harbor; I don't have to read this again. It repeats basically what Dave Chidester said. Slide three -- this is a graph of this quarter. And whether you want to know about conversion or customer retention or repeat rates or marketing efficiency or sales growth versus previous year, it's incredible, but they basically all looked just like this, remarkably. The quarter got off to quite a nice start. So I've left off scale and label, because I'm just letting this stand as a symbol for just about everything that folks would want to know about.

This happens to be sales, sales by week. And the ordinate is a little bit truncated, more than I would have liked. But anyway, this stands for what happened this quarter. We got off to a nice start, and then things started deteriorating.

On slide four, you can see this. I am speaking slowly because I understand there is this 20-second lag. On slide 4, point A, you see where -- that's about where we cut over to a new system. And then there's the area shaded baby-mess yellow or green -- that's basically the next five or six weeks in the quarter. I think you can draw a line, a straight line between A and B, and that's really what I think the underlying secular results were in sales and all these other things you care about. Dollar shipping started on July 15th, and it was supposed to run to August 15th. Now, what we did once we realized we had a problem was we extended it through September 1st. In that green-shaded area, the last spike is basically the last day of dollar shipping, and then you see that it very -- the end of August, it was. And then it very quickly deteriorated to what its natural level was.

And then B is where products started being posted on our site. As I said in my letter, the real problem was, once we realize that some of these processes were not working as expected, we had to focus on everything that was facing the customer. And everything that's facing the customer means processing orders quickly, getting ship confirms loaded right, processing returns, giving credits on credit cards; everything like that had to take priority. And some background processes related to financial, related to posting new products, things like that, updating the site, all were secondary. And we didn't really expect it to take this long, to take that five weeks to get fixed, but it did.

I'd say, just going forward, you can see how on the right side of slide four, we did come out pretty robustly, once we got the products back up on the site. It seems to me that a 20% -- we sold through about 20% of our products in that time. And it seems to me that that's -- you can almost say that sales gradually decayed 20% or maybe even more, because many of them were our best-selling products that we sold through. And even when we got replenishment, if we could, we could not load them up again on the site.

Well, not much more needs to be said about that, other than I ended up holding up as much as they did, even given dollar shipping for half the quarter. I would have thought that they would have declined more. How I really think of this is effectively we lost about 30 or $35 million of sales, although how that showed up to -- some of that we made up by dollar shipping. But we really lost the gross profit, then, on 30 or $35 million of sales while this was going on.

Next slide. Oh, one more thing on that -- on the right side of slide four, that -- you see, we did end the quarter fairly robustly, and things have continued rather nicely since then. Slide five -- this is just a graph I show every time, 169 million, 64% year-over-year growth.

Next slide -- I said at the beginning of the year that I would cap margins at 15%, excluding effects of travel and auctions and things like that. Well, they are not really having that much of an effect yet. And it has stayed at 15%. The first thing I would say is I'm ready to take this 15% cap off, given our expense structure. I want to take it off without changing our value proposition to the consumer, and we can do that through, again, the savings in logistics and customer service and better buying.

I think that for most of our history, our improvements have come in terms of buildup, buildup, buildup and then belch, a belch-through. I expected this year to be different. I expected this year to be more stair-step, sort of a 20 or 30 basis point improvement each quarter. It hasn't happened, obviously, looking at what is in front of you. But I do think that we have a buildup that's ready to break loose, and I would be surprised if you do not see substantially higher margin for this quarter and Q1.

The savings we can talk about, rather than just drone on here - - if people want to go into it in the Q&A, I will -- but it has to do with logistics and customer service that our new systems do make possible.

The next slide is gross profit per transaction, nothing out of the ordinary; it's basically stayed flat with the previous quarter.

Slide eight -- this is our CPA and marketing efficiency. I'll tell you, I look more at the marketing efficiency, which is how much we're spending on marketing as a percentage of revenue. You see that has basically hovered around the 10% level this year. I think that is too high. I view it as it's the difference between using muscle and using brains. Having to spend 10% of revenue to keep up this growth is muscle. We want to maintain this growth or higher growth on brains, and I'll get to what I mean by that, but not just with heavy dollar spend. And I think the right number here is probably 8.5% for next year.

Slide nine, G&A expense, non-tech -- you see that's going up; it went up from 7.5 to 10 million this quarter. As David said, 1 million 1 of that is we have moved from a tiny building that we were all sitting in each other's laps to, this July, about three times the space. And it was a lot of space. We have to let the building -- or 60, maybe 70% fill up the building, but it should last us for a long, long time.

The other piece is the Ski West acquisition of $25 million. The auditors have come through and said 10 million of that is goodwill, but the other 15 million is the assets of the business that we want you to depreciate roughly over five years. There will be a $3 million amortization per year for the next five years, and that comes to 750,000 per quarter.

Slide ten, technology expense -- what you see here is the big stair-step. I talked last quarter or two about what we call around here O-Town (ph), the ability to be a large mainstream competitive player on the Internet, maybe not quite the size of Amazon in North America, but on the same order of magnitude. We've been laying the curbs and the gutters for it, and that's showing up here. It's actually not overwhelmingly, in terms of -- showing up in terms of headcount. What is happening is that depreciation, I think you'll see, at least 22 to $25 million of depreciation next year from -- David, what is it going to end this year?

David Chidester, Overstock.com - SVP, Finance

It will end this year about 14 million.

Patrick Byrne, Overstock.com – President

Yes, and a lot of that is kicking in in the third and in the fourth quarter.

A few things on the customer base, slide 11 -- 76% more customers have bought from us than had at this point last year. More interesting in the next few slides, where the unique customers who purchased in the quarter that supported that 50% growth -- and I think, David, the GMS growth was quite a bit higher than 64, was it not?

David Chidester, Overstock.com - SVP, Finance

The GMS growth was actually slower than that.

Patrick Byrne, Overstock.com – President

Okay, I had that backwards. So 50% year-over-year growth supporting the 64% GAAP revenue growth. I think that we ought to start publishing. Our problem with GMS at this point is comparables are difficult, because in the past, we didn't have auctions and travel. I think we ought to use a number like GMV, gross merchandise value, or something, that eBay does, and just combine everything together. But we'll see if the auditors let us talk that way.

David Chidester, Overstock.com - SVP, Finance

Yes, we actually split the three numbers out in our earnings release, in the tables, for everybody so you can see the three different GMS numbers. But we don't report them all together; you are right.

Patrick Byrne, Overstock.com – President

Believe it or not, the auditors have -- more power to them, but they have an opinion on that. I think that we ought to come up with some unified number that captures it all. New customers, I guess, 37% year-over-year growth, again. So we are getting more -- and 52% more orders supporting that 64% growth. So we are getting more out of our customers and out of each order.

Slide 15, auctions -- you see, on the one hand, auction -- the gross merchandise value has basically held flat at 7.3 million. The listings fell. That was by design. Holly went through and cleaned out a bunch of unproductive listings and sellers that were cluttering things up, and she cut online marketing expense, and things held their own. As far as the future goes, this seems to have stabilized. We have now ended our first year with auctions; it lost $5 million. The loss did decline a bit in the third quarter, and it's looking better in the fourth quarter. My goal is for '06 to have this be at breakeven. I would consider that a nice accomplishment and just a free option for the future. And the CPA for auctions is slowly getting -- they are getting more efficient, and they have some other ideas about that that will come into play in the first quarter.

Okay, I've been wanting to talk for a year about what I'm going to show you for the next few slides. I feel when people come through that there seem to be two camps of people -- those who share the vision that we have here and understand what we're trying to build, and those who want to talk more about, well, other things. And I feel almost -- not duplicitous, but I feel less than forthcoming because I keep trying to talk in the language of one group to the other group, and it doesn't go over. So I would feel better if, to calibrate everybody, I could put everybody -- I can throw out there a very clear explanation of what we're trying to do. It may matter to some people, it may not matter to some people. But it's a little difficult to talk to the two different camps in the two different vocabularies.

This is Overstock as a percentage of e-commerce, US ecommerce, since we went public. We went public on Q1 2002 numbers. You'll notice that each fourth quarter, it spikes. So we've gone from 0.2% to 0.9% in Q3, and you see that each Q4 is when it tends to spike. Now, it's no secret that I'm chasing the guys at Amazon. This is a picture of Amazon's revenue, in North America versus -- as a multiple of Overstock's revenue -- again, since we went public. This is a little bit -- that's all on a GAAP basis, but because we had an accounting change, I've made slide 19, with the green line that's inserted here to make it an apples-to-apples comparison. So we started off with them about 31 times our size; now they are about 6 times our size. Why that is important is shown in the next slide.

I think, if we have a good Q4, by the end of this Q4, we should only see them being about 4 times our size. Now, that's Amazon North America, and we don't have an international business. This is the vision that has excited us because, if we get too -- that starts being, in my mind, when we are a quarter the size of them in North America, which I think can happen this quarter -- I think, if we have a good quarter, that should happen this quarter, plus or minus, I hope minus -- we start being a meaningful competitor to Amazon at that point. That also puts us in the place to do -- if you were to ask me at the beginning of the year -- now that I don't think it will happen, I'm going to come out and say what I was really thinking at the beginning of the year. These numbers are our Q4 numbers over the last several years and the growth rates implied, and this was an ambitious perspective. But my goal at the beginning of the year was to get us to a $400 million fourth quarter, which would have been 81% growth over Q4 of '04; that's where it switches from blue to red. So this is just looking at the past several Q4's and where we could be in the next several.

So my goal was a $400 million fourth quarter; that's what everybody here was trying to do. That would have been 81% growth, and then if we could maintain 80% growth for two more years, it got us to 1.3 billion. Now, why did I pick that as a number? Because 1.3 billion is what Amazon did last year in Q4 in North America. So I sort of set that as a goal, 80%. I know it's a high growth rate, and I know that it starts getting harder to grow as you get bigger. But, given the growth rates that we had achieved over the last several years, this did not look outlandish to me. Again, those are just Q4's. Well, that was an extremely ambitious perspective, I acknowledge. Here's a more modest perspective. I think that the world has us -- I should mention I don't spend -- just for my own sanity, I don't spend a lot of time reading analysts' reports. I know there are some very good analysts who get us -- Scott Devitt and Doug and guys at Hambrecht and Piper, of course, get us. And I'm sure other people do. But I don't spend a lot of time -- I generally can't even tell you what our numbers are; I've got my internal goals, but not -- but this is one case where I look at -- I understand that the world thinks we're going to do about $350 million this fourth quarter. And that seems like a reasonable number to me. And then the goal is 69% growth for two more years, and that puts us at a $1 billion fourth quarter two years from now.

Again, why is that important? Well, Amazon by then will have grown to, I'm sure, 1.6 billion, 1.7 billion, maybe better, more power to them. But at least that puts us -- at that point, it puts us on the same -- it puts us in the ring with them. We've been punching above our weight for a long time. This would put us rightfully in the ring with them. And I don't think that's a crazy ambition. It's not something we can do henceforth, using marketing muscle. We've got to use more brains to get there, but that's the perspective on what it is we're trying to do here. And if we can do that on an operating cash flow positive basis, then I think that's a worthwhile goal.

Now, that may seem outlandish, but I'm really saying the 350 million I wouldn't say is in the bag for this year; it's going to take a good quarter. But that's not outlandish. And so we are in that quarter already, so I'm really saying 69%. Can we keep that up for two years?

Well, why is that important? Here's just a graph showing the tall bars are Amazon's G&A and tech expense over the fourth quarters for the last several years versus ours; we are a tiny fraction of theirs. Our margins are about the same, as I said. We are falling a little bit behind, on an apples-to-apples basis. But if we had a -- we would have to spend more marketing to get there than them. But if we can show up on the same order of magnitude as they are, and have all the other expenses other than marketing be this tiny fraction, then we should have a very valuable business. If folks want to get inside my head, that's the ambition that we have.

To get there, we need to get -- it's really two things -- conversion, which comes down to personal vision, this Propeller, Project Propeller, site design and brand equity; and then, the second is gross margins. I think that the $55 million that we have put into things this year -- our systems, more or less -- $50 million of that are systems that support this first and second goal.

But again, I'll end on the note that I know I botched the end of this. I've set a goal for this year of growing 60 to 100% and being breakeven, plus or minus 1%, in net income. It's now gotten $14 million harder to do that than it was a few months ago, but we've pulled rabbits out of our hat before, and I think that we are searching for the rabbit now.

So with that, operator, I'll stop and let's go to questions.

Questions and Answers

Operator

(OPERATOR INSTRUCTIONS). Craig Bibb, WR Hambrecht + Co.

Patrick Byrne, Overstock.com – President

I meant to include you, if I didn't, on the list of analysts who I know get what we're trying to do.

Craig Bibb, WR Hambrecht + Co. – Analyst

Well, thank you. During the quarter, you are having IT travails; your conversion is down. And so, I would think you would back off your marketing spending at that point, until you got your hands around things. It looks like you accelerated, so why would that be?

Patrick Byrne, Overstock.com – President

What do you mean, we accelerated? We accelerated our spend?

Craig Bibb, WR Hambrecht + Co. – Analyst

Your marketing spend came in higher as a percentage of revs, and it came in much higher on an absolute basis. I would think you would be backing off marketing, if your conversion is down.

Patrick Byrne, Overstock.com – President

Well, we did, for a period of several weeks, forego deals that came our way. Most of the deals -- the vast majority of what we spend is still online and, say, 75% or so. And they are typically not deals that -- the large parts of that online spending are not things that we can change week to week. But where we had a chance to, we did pull back.

Craig Bibb, WR Hambrecht + Co. – Analyst

And then, can you show progress on this line in Q4?

Patrick Byrne, Overstock.com – President

I think we can, yes. I wouldn't expect it to go up. I would expect it to come down a little bit. But I think the 10% -- if it ends this year at 10%, that's probably going to be right. And I acknowledge that's a point or two higher than I would have liked.

Craig Bibb, WR Hambrecht + Co. – Analyst

And then, looking at the graph you had for sales -- and then I'll let someone else take a question. But it looked like if I extended the graph upward, that October sales would still be running below where you were in July, before you turned down, if that's fair?

Patrick Byrne, Overstock.com – President

No. No, our October sales are definitely running above July.

Craig Bibb, WR Hambrecht + Co. – Analyst

And conversion is back to normal?

Patrick Byrne, Overstock.com – President

Conversion is back to normal. Conversion is back to normal, but still, to me, that's our biggest opportunity. Our conversion is 2.5 to 3%. Our competitors are much higher. Now, our competitors like Amazon are 10%, and our book category converts at around 10%. If you weighted our average, it might not be that dramatically worse, but it's still worse. JCPenney and other guys do 12 to 15%. I view the conversion as the biggest thing we can do to get growth now. When I say, let's get there with brains rather than muscle, that's what I'm talking about.

Craig Bibb, WR Hambrecht + Co. – Analyst

Are the IT projects all finished, so that you can get there?

Patrick Byrne, Overstock.com – President

They are not all finished. Even the ERP system is itself not finished. The last, what we think of, issues that put the patient in the critical part of the hospital, the last one is done. But there's still some intensive care ones and some normal ones. Propeller is -- Propeller is very promising. I guess, now that (technical difficulty) I understand more about what (technical difficulty) salvation can do of about 35 to 40% lift. Now, at the risk of just walking people through some sixth-grade math, if something is growing 60% and you give it 25% lift, it takes you to 100% lift. It's not -- so if you have something that is 100, and it's growing 60% (ph) (technical difficulty) brings it back to 200, which is 100% lift. So what I hear all over the industry as the numbers, 35 to 40% is what the scientists say. We have gotten Propeller, in short bursts -- well, we've gotten Propeller to run 12 to 21% lift. And even in short bursts -- we've had short bursts over 50%. It's unstable, and even when we had, say, 21% for four or five days, some of that was caused by -- a strange phenomenon that happens when we run Propeller on part of our traffic is we start occasionally getting people placing $100,000 orders. And that never happens without Propeller, so I don't what the reason is. The problem is it decays. We haven't -- and it's really a huge math problem, I guess. But the mathematical model that has been built decays quicker than it should if you were just selling, I guess, apparel or CDs or something. And that's the problem we are wrestling with. Unfortunately, wrestling with it requires some very fine, finely-tuned A/B testing. And that has been -- we really finished, in a sense, the guts of Propeller a year ago. But this year, it's just taken all this time to keep -- actually, a lot of it has been building both the architecture and the site that could use the input from Propeller but then, also, building the very refined testing that can let you tune in Propeller. So you now know everything I do about Propeller, but I'm very encouraged by it.

Craig Bibb, WR Hambrecht + Co. – Analyst

It sounds like, if I cut through that, though, if you are still testing, Propeller is not going to have an impact on the Q4; it's more of a '06?

Patrick Byrne, Overstock.com – President

No, it's live now. It's live now. It's live only on parts of the site. It has been live for about a week. No, it has actually been live on and off for three weeks. It should have an effect on Q4. It should help us get to that 350 million or above.

Operator

Douglas Anmuth, Lehman Brothers.

Douglas Anmuth, Lehman Brothers – Analyst

Two questions for you. You had IT issues, obviously, in 3Q and then warehouse issues two years ago, during the fourth quarter. So, as we head into this holiday season, are you comfortable with how the Company is positioned in both IT and warehouse, if you look to get a much bigger order number during the quarter?

Then, secondly, in terms of the macroenvironment, you said October sales are above July. Are you seeing anything in terms of macro headwinds here? And what are you seeing from the perspective of other retailers who may be discounting more and earlier during the quarter, and how do you think that will affect you?

Patrick Byrne, Overstock.com – President

On IT and logistics, I'm very comfortable with logistics. I won't be comfortable with IT until we have gone through a season. Two years ago, we did have a real problem with logistics. When the wave hit, the dock almost splintered. This year, I'm very comfortable. We've got Steve Tryon who is now running it. He's gotten some terrific help, and I'm very comfortable there.

On IT, I go down every day, and I say just tell me when the wave hits that things are not going to have a problem. And more and more in the last three, four weeks, people are now, for the first time, saying they are comfortable. We are comfortable; we've gotten so we can process 10,000 orders an hour. And we have some benchmarks that are set with a lot of conservativism about what we need to be able to process. And we are now -- we are sort of 99.8% of orders flow through promptly and everything, without any intervention. But, Dave Chidester, you may have a better feel for that. Do you have a comment?

David Chidester, Overstock.com - SVP, Finance

No, I would say you are exactly right. It's something that we are going to watch real closely, obviously. It's our first year into the new architecture, so it's something we are taking very seriously. But I think we are feeling better and better every day.

Patrick Byrne, Overstock.com – President

I've checked that every day, and people tell me -- people are now breathing easy and are not staying late nights and things like that. We over-spec'd it. The system, when it's all completely burned in, is far more capable and powerful than what we got off. So I'm comfortable, but we are on it. We're looking at the CPU processing and running and if it’s, let's say, over 15 or 20%, we get worried -- things like that. And I'm sorry, what was your other question?

Douglas Anmuth, Lehman Brothers – Analyst

I was just curious if you're seeing anything thus far in terms of macro headwinds, and what you expect the discounting environment to be like in the fourth quarter?

Patrick Byrne, Overstock.com – President

Well, every time I talk about macro -- I said once in early April that hey, the last couple days of March were soft. And people come out and say, oh, Byrne is blaming the first quarter on the last couple of days. And that was the Pope thing (ph). And so I don't like to talk too much about the macroenvironment.

Put it this way -- I have not at all been surprised that -- I think that retail is quite sluggish, and what I am hearing is things are sluggish. I've been hearing this both brick and mortar and online. There's reports that show what happened in September was Internet usage was up, but shopping in the first couple weeks of September -- shopping dropped rather dramatically. I forget if the number was 6 or 8%, although people were spending, I think, 6 or 8% more time online than they had been a couple weeks earlier. So people are going online, but they are doing other -- they were doing other things than shopping.

What I hear, especially in electronics, is that there is overstock, that there's some very interesting new products being introduced. And of course, as electronics have a curve, and they reach a certain point on the curve, and then they suddenly lose 50% of their value in 90 days. That's, I think, going to happen this Christmas season. There's a couple of big electronic products like the new Microsoft system. So my sense of things is that in electronics, in particular, people are going to see heavy discounting.

Douglas Anmuth, Lehman Brothers – Analyst

And do you view that as positive or negative for you guys? I mean, negative from the standpoint that competitors and the traditional retailers would be discounting more, but you could have much greater access to inventory, potentially, if things were overstocked?

Patrick Byrne, Overstock.com – President

I think both those statements are true. And if we are smart, it works in our favor, and if we are not smart we get stuck with mistakes. I could say that this year, for the first time -- I mean, I know for the last couple of years we have gone into the quarter with a bunch Franck Muller's or some other experimental thing. We don't, this quarter. We are deep as heck in inventory, and more time went in this year to plotting what that -- doing a lot of analysis and figuring out what do we really want to get deep in and not run out of, and they have gone out and they have bought it. So we are deep, but it's all inventory that we want. There's no safe load of Franck Muller's in the warehouse. We have never been in such a good position with good inventory going into the Christmas season.

Operator

Scott Devitt, Legg Mason.

Scott Devitt, Legg Mason – Analyst

A couple of questions. First, around the inventory that you just mentioned, I think on the last call, you guys said something like 65 to 70 million peak inventory, and you are at 95. So I'm wondering if you are higher than you expected, due to what happened in the third quarter, or if there is some opportunity that arose leading into the fourth quarter that caused you to build higher than you thought. And then, second, I think Dave mentioned that you still thought you could be operating cash flow positive for the full year. So I'm assuming that means something north of 62 million in OCF this quarter? And then I had one follow-up.

Patrick Byrne, Overstock.com – President

On the 65 to 70, did we say that would be the peak or that's where we would end Q3?

Scott Devitt, Legg Mason – Analyst

That was the end, and I think it possibly could have been slightly higher than that after the September 30th number.

Patrick Byrne, Overstock.com – President

A couple of things have happened. In previous years, a lot of our buying for the Christmas season got done in October and even right up -- usually, there's not much in early November, and then people start panicking around mid-November and we are taking stuff in December 1st that we sell.

This year is different. People started calling us over the summer. And I certainly don't think it's going up from here, but I'd say that that bulge, the zenith probably moved from what is normally November 5th -- probably that moved back - - I know exactly what our inventory is as of this morning. What did we show us ending, David?

David Chidester, Overstock.com - SVP, Finance

95 million.

Patrick Byrne, Overstock.com - President

It's not going up from there. And so part of it was something going on out in the world, that people -- we were getting calls, and we were buying in August and September for the holiday season, rather than the last-minute stuff.

Does that answer that first question?

Scott Devitt, Legg Mason – Analyst

Yes, and then the operating cash flow and then one other.

Patrick Byrne, Overstock.com – President

Well, operating cash flow, I still think probably positive 25 million is about right for the year. Dave, do you have a different --?

David Chidester, Overstock.com - SVP, Finance

Yes, it will be positive. We'll drop, assuming inventory drops 15 to 20 million by the end of the year, and we generate a whole bunch of December sales through our fulfillment partners that add up in payables. So, yes, we should see, like you say, Scott, 60 to 70 million of positive operating cash flow we anticipate in Q4.

Scott Devitt, Legg Mason – Analyst

And then, just separately, but related to the inventory build, you have mentioned in the past that you expense your inbound freight, which I think is a little bit different from other online retailers, and your direct gross margin was 11% this quarter. So that was down, I think, 220 basis points sequentially. Could you possibly just break down the decline in the direct gross number as to, maybe, the inbound piece, outbound shipping and anything else that may have happened there?

Patrick Byrne, Overstock.com – President

Sure. I know a huge piece of it is inbound. All that expense associated with trucking in the $95 million of inventory was expensed in the third quarter. I actually don't like that, and I think that going into the new year, I might ask to -- I think it understates three quarters of margin and then overstates margin in the fourth quarter. So I may talk to Dave about changing that.

But, Dave, of the 220 basis points, what would you attribute to the --?

David Chidester, Overstock.com - SVP, Finance

The majority of that is inbound freight. We had made mention to it in Q2. It was actually a couple hundred basis points higher, just as a percent of the direct business, than it was in Q2. I mean, inventory increased 35 million from quarter to quarter. So it was primarily inbound freight is the difference between this quarter and last.

Patrick Byrne, Overstock.com - President

How many total basis points do you think were involved? I know it on a core basis, but can you say overall, Dave?

David Chidester, Overstock.com - SVP, Finance

Probably, on the overall business, 2.5 basis points.

Patrick Byrne, Overstock.com – President

No, 250 basis points.

David Chidester, Overstock.com - SVP, Finance

Yes, 2.5 points, 250 basis points.

Patrick Byrne, Overstock.com - President

And that's basically -- we have very little inbound freight at this point, so you get that big swing in the other direction. So I think you can probably see why I think that might be something that we want to start treating differently.

David Chidester, Overstock.com - SVP, Finance

Yes, and one of the reasons we are optimistic about margins in Q4, is that we know that's going to come down significantly.

Patrick Byrne, Overstock.com - President

We put 400 basis points in margins last year, and I still think this year, for year on year, we've put 300 in so far this year, and I think that we'll finish the year at least -- last year was 13.3, and I would expect to finish this year at least 15.3 for the year.

Operator

Colin Sebastian, Thomas Weisel Partners.

Colin Sebastian, Thomas Weisel Partners - Analyst

A couple of quick questions. I was wondering if you could give us a sense of the split you're planning on advertising between TV and online for Q4 and into next year?

Patrick Byrne, Overstock.com - President

Well, Q4, it's -- I've said in the past that it's about 25% offline -- TV, radio and print. And we won't be departing much from that. We won't be departing much. We don't have any distinct new number. I know that it's been slightly different, but it's within 5 percentage points, plus or minus, there.

Colin Sebastian, Thomas Weisel Partners - Analyst

And then, your comment regarding the breakeven operating profit -- I was just wondering if you could perhaps describe what some of those rabbits might be that you could pull out of the hat?

Patrick Byrne, Overstock.com - President

Well, was gotten some -- Propeller is one of them. Propeller is -- and what we are doing is we are freeing up resources off ERP. We've sort of formed a S.W.A.T. team to just focus on the things that can make a difference this fourth quarter. And there are some really -- I mean, if I tell you some of the things we've learned -- one thing that has happened is we've gotten a very nice -- we now have two different systems that we use for site analytics, and that's systems that track the clicking behavior through the site. And this is where you do different testing, you change your color, you put up a 2.95 shipping banner, things like that. And we have found, just in the last two weeks, something that makes me want to stick a fork in my head. It's giving us a very measurable lift, and it's something we could have been doing for five years. That's an example. It's actually just a certain banner we've started putting up around our site, and it changes lift. It changes revenue per visitor significantly -- well, not significantly but measurably.

I think that there's dozens of things like that. We are redesigning our checkout. We've got the assistance of a company called Optimos to do that; they are doing a whole bunch of testing for us. Propeller is the big one. Propeller -- right now, it's running a minicart as you check out, and it's powering different pieces of the site. But we are finally -- I've been banging (ph) for several years that we have to -- I don't think our site has been beautifully designed in the past. I think it's been designed by guys, for guys; it's not designed for female customers. It's not designed even very well for guys. There's a lot of experimentation and new mockups going on and being tested now. And since we have over 1 million people a day, we can get very incredible data quickly. And what we find is you change the look and feel, and you use colors to organize data and information, and it has immediate effects. We've only had the real system that could measure that since late September. And that was just another one of these projects, and I'm thrilled with what's coming out of it already. It's really going to take, I think, 6 to 12 months to squeeze all the juice out of that lemon. But we are looking for things that -- some big wins that we could have in this quarter, because I do think that -- I do want to hit that $350 million mark.

Colin Sebastian, Thomas Weisel Partners - Analyst

And then, lastly, are you seeing any lift or change in customer behavior from the Holiday O program?

Patrick Byrne, Overstock.com - President

I'm familiar with the Club O. On the Holiday O, I don't know the data offhand. Dave, do you have that at your fingertips?

David Chidester, Overstock.com - SVP, Finance

It's early, but similar to Club O, people who are joining -- and you really need to get through a Christmas to measure what their behavior was before and after they joined. But we've had quite a large response of people joining. It will be hard to know until Christmas is over on how it actually plays out.

Patrick Byrne, Overstock.com - President

I can say that Club O -- we now have plenty of data where you take somebody who was a customer for a full year without being a Club O member and then joined the Club O and then was a customer for a full year -- and we've got many, many thousands or tens of thousands who now fit that description. And I would say that it has exceeded even my wildest expectations, in terms of how it affects behavior, once you get people to join. And I have pretty wild expectations. It's not 100% improvement in their value as a customer, but it's not a whole heck of a long way off from that.

Colin Sebastian, Thomas Weisel Partners - Analyst

And just one last one. On the balance sheet, I noticed you drew down a little bit on the credit line. If you would just clarify the reasoning behind that?

David Chidester, Overstock.com - SVP, Finance

That's just, once again, for working capital. Because we have money tied up in the foreign bonds, we have a 30 million line of credit in place that we can draw down on. It's just -- this is the cash nadir for the year right now as we build inventory.

Patrick Byrne, Overstock.com - President

Really, the cash starts flooding back in on or around November 4th, is where we start getting swamped. And also, something to understand -- I know Dave mentioned this, but sort of went over it lightly. Those two bonds that we have, one -- it's $50 million in cash. One matures next September, one next November. If I had it to do it again, I would probably have them both in September, because we don't need cash in November. That's just something you should know when thinking about our cash needs.

Operator

Aaron Kessler, Piper Jaffray.

Aaron Kessler, Piper Jaffray - Analyst

A couple questions for you. First, can you give us an insight into the travel revenues in the quarter, as well as the gross margins? I believe you did break out the gross bookings for travel.

Patrick Byrne, Overstock.com - President

The gross bookings were just short of 10 million. And I'll let Dave -- I know that your GAAP revenue, Dave, is quite a bit less than that. What do you call it?

David Chidester, Overstock.com - SVP, Finance

Actual net revenue came in about 1.3 million.

Patrick Byrne, Overstock.com - President

That's a pretty good measure of what the gross margin -- that's pretty close to 100% gross margin revenue.

Aaron Kessler, Piper Jaffray - Analyst

And then, as we think about the G&A and tech costs going into next year, can you give us a sense for where those are going to be, either as a percent of revenues or maybe on an absolute basis?

Patrick Byrne, Overstock.com - President

Sure, I can give you one and one. I think that, if you model this at 8.5% of revenue gets spent on marketing and our G&A is $95 million plus or minus 5, you have a good basic model for the Company. You have got to figure out how much top line you think we are going to do and what our -- if we added 400 basis points in margin last year and, I think, 200 this year is a good assumption, you might figure that we -- I think that, and I can even walk you through where I think the margin improvements are. I think that there's another number like that to spit out. And so really, all we have to do is figure out, if we spent 8.5% on marketing, what does the top line look like? I can almost give you those two other numbers -- 95 million in G&A, including tech, and 8.5% on marketing.

Aaron Kessler, Piper Jaffray - Analyst

(Indiscernible) follow-up question, clarification. On the second page in the press release, you said 196.4 million in gross bookings, and I believe on the income statement table it said about 180 million (multiple speakers) bookings.

David Chidester, Overstock.com - SVP, Finance

I'll clarify that for you. The 180 is the shopping business. The 196 includes auctions and travel. So the breakdown that you see at the bottom of the table is the correct breakdown of all gross bookings. So that number is wrong; that number should say 179.5 million.

Operator

Paul Keung, CIBC.

Paul Keung, CIBC - Analyst

My questions relate to the cost side of the equation. I think, as you know, Patrick, since April, we've been talking about the spending on infrastructure marketing. We were afraid you would probably end up spending more than you think to meet the targets that you put at the start of the year. So if you break that down, on the sales efficiency side, you mentioned that in some areas you've been efficient, using your brains, as you say; in other areas, you are not, using muscle. So what do you expect to reduce the spending in the fourth quarter, and '06 on the marketing?

And then, to follow that corollary, if you were to -- you're spending more on free shipping this quarter. So why not just go straight to $1 shipping? And does that work for your model, from an economic perspective, going forward?

Patrick Byrne, Overstock.com - President

Well, on the brains versus muscle, I didn't mean to claim that we had been using any brains this year. We have been trying to get in position to use our brains. We have been firing up our brains. But this year, it's still been muscle. I think, especially in online, we figure out how to spend online dollars. But we haven't been using our brains, and it shows up in not seeing a lift in conversion. Other things have happened that have suppressed -- we actually do have a listing conversion, but by segment. One thing that has happened is this year, we've gotten very big in keywords, and keywords convert quite marginally, so the weighted average has -- that retards the weighted average.

I mean, going forward, that if we can -- that 10% should drop to 8 or 8.5%, if we can just get conversion to move up 20%, which I think we should be able to do with things. Or not even conversion, revenue per visitor gets moved up 20%, which could happen either by increasing conversion or increasing the average order size, which Propeller personalization should do both of those as well as site design.

So I don't mean to say we have been using our brains in how you spend a dollar online. But where the real money is is to get those other -- to get much better in those two areas.

Paul Keung, CIBC - Analyst

But Patrick, we are a month into the quarter. So I'm just trying to figure is there any way -- you are not really cutting spending, so obviously (ph) you're going to keep this thing to where it is. What do you think the sales will be there because the conversion rates are improving and should improve? Is that the point of that comment?

Patrick Byrne, Overstock.com - President

Well, the fourth quarter, the conversion rates soar, anyway. I'm talking more to secular level. Yes, over the next six weeks, conversion rates basically go to 5%, 6%, something like that (ph).

Paul Keung, CIBC - Analyst

Right. And then on the free shipping? Does it work at $1 shipping, just to do it year-round? Does it work for you, or you are just not there yet in terms of costs and scale?

Patrick Byrne, Overstock.com - President

Well, one way, if we do get 2 or 3% more, if the logistics in customer service -- let me back up a second. We are now spending about 2.3% of revenue on customer service. Where we should be is about 0.5%, maybe 1%. So just by getting customer service, getting some better systems and automation -- I think where other people are, are below 1%, say, 0.8%. There's over 1.5% we should be able to gain there. And on logistics, there's some huge savings we can do in shipping, now that we have an ERP system and we can be much smarter about how we give warehouses orders. And you can do a lot of intelligent things, build intelligence into your system and save a lot. So I don't think it's out of the question to expect to get another 200 or 300 basis points. What do we do with that? Well, I think that more and more, I'm leaning towards keeping it and not cutting to $1 shipping. I was one of the bigger fans of $1 shipping, and $1 shipping does seem to pay for itself. I don't know, there's pros and cons. Dave, do you want to make the con? I'm sure you are on the con side of $1 shipping. Why don't you make the con side?

David Chidester, Overstock.com - SVP, Finance

Well, the con side is that if hits gross margins. And in the face of the expense structure rising, the focus is trying to increase margins. And it does hide a little bit how efficient is your marketing, because you are shooting your marketing some steroids that they are not getting charged for. So that's kind of the con side of $1 shipping.

Patrick Byrne, Overstock.com - President

On the other hand, you do get higher sales, and the higher sales, even at the lower gross margin, make up about 75% of what you give up in margin by the $1 shipping. On the other hand, back on the con side, it seems to shift sales just up a bit. If you tell people we're going to have $1 shipping for this week, you get a lot of revenue this week. But people seem to just shift their spending from next week back to this week. So you put all that together, and we've grown -- what we've really realized is, we must be doing something wrong, because we normally have 2.95 shipping. And yet, when we have $1 shipping, people come in and buy beds and bookcases and all this stuff. Well, the saving of $1.95 stimulating that behavior tells me we are not messaging well enough that our shipping is only 2.95. And so you see more of those banners.

So I think that that's probably the direction we're going to go, is more towards showing people that a 2.95 everyday flat rate is a great deal, rather than just shooting marketing some steroids with $1 shipping. I think it's kind of a lazy way, for now.

But on the other hand, it's not out of the question that, if we really get a lot of savings in our supply chain, you could see us pass some of that on to the consumer. And switching to $1 shipping might be a good way to do that.

Paul Keung, CIBC - Analyst

Just one more small question, if I may. On the gross margins, how much of that decline -- and I know you expect it to be better -- is a function of merchandise mix versus just shipping and the pricing stuff, to the extent --? The reason why I ask that -- I'm concerned that you're saying you're trying to drive your gross margin. Is there going to be a shift in merchandising that can also reduce sort of your sales targets?

Patrick Byrne, Overstock.com - President

No. Our merchandising margin is holding its own or improving. It's certainly not deteriorating. Our merchandising margin is right where our goal was for it to be. In some weeks it's even, I think, too high. So that drop to 11% on the core stuff that we buy is not a function of -- the mix is not against us. It's a function more of the supply chain and factors like the inbound shipping suddenly going up.

Okay, it's an hour. Shall we limit this to another 15 minutes, David?

David Chidester, Overstock.com - SVP, Finance

It's up to you.

Patrick Byrne, Overstock.com - President

Let me see. We have a whole list of people. We're not going to be able to get through everybody. Why don't we go -- okay, well, we've got five more people, I see. So go ahead to Justin Post.

Justin Post, Merrill Lynch - Analyst

You like to compare your model a lot to Amazon's. And I'm just wondering; your marketing is higher than theirs. And you've mentioned earlier conversion is lower. When you go to Amazon, you really kind of know what you're going to get, and the inventory really is sustainable. Can you talk about how you're going to convince people that they can come to Overstock and find what they need, as opposed to just come on a special promotion basis?

Patrick Byrne, Overstock.com - President

Well, it is a different model. It is a different model, and I forget what Amazon -- in North America, what percentage of their revenue is still book, music, video? Do you know? Is it 60, 70, still?

Justin Post, Merrill Lynch - Analyst

Yes, it's well over 50.

Patrick Byrne, Overstock.com - President

So, that's a challenge for us, because we are not going to have -- we can, first of all, have a much better BMVG department. Right now, you can't -- it's hard to find descriptions of books and CDs and stuff; that's one of the things we are working on this month. But it is going to be hard. We are never going to get the furniture department to convert like Amazon's books do.

On the other hand, there are good apparel sites like JCPenney, who do very well on conversion. So our shtick is not that we have everything, but that we have something good in each place you want to look. We're getting there on apparel. The short answer is we'll never get Amazon conversions, but if we go from 2.5% conversion to 3.5% conversion, that's 40% less. And it seems to me that that's a much cheaper way to get 40% growth than trying to buy $400 million new revenue through marketing deals. So that's really where our focus is going to be.

Justin Post, Merrill Lynch - Analyst

And then, two quick follow-ups. Partners, plus or minus any in the quarter -- did you lose or gain any? And second question -- I think T.J. Maxx shut down their operations. Do you think that's a positive, or does it indicate that it's a tougher business, your business model?

Patrick Byrne, Overstock.com - President

On partners, I'm not aware of losing any big ones. And Dave, I'll cut to you in a second. I've been impressed -- other times when we've had problems -- and the same time last year, we switched to a different software package to manage our partners. And we had problems, and there was a lot of teeth, toes and fingernails about what was going on. And they beat us up, and they were right to. I mean, we are providing them a service, and we stopped providing it very well. That was a year ago.

This time, I loved -- I mean, they get it. We are all part of the same team, and the partners that I talked to showed a lot of forbearance and understanding. I'm not aware of losing any big ones, and most of our partners are up -- the whole company is up, I think, 79% or something year to date. So most of our partners are quite happy with that. Dave, do you know of any big partners --?

David Chidester, Overstock.com - SVP, Finance

No. I think we've built a very loyal partner group. And right ahead of Christmas, they are just excited for Christmas.

Patrick Byrne, Overstock.com - President

We've busted a gut, and they know it. They really did put up with a lot. For five weeks, we couldn't load their products. And some of these guys are small guys who went out and brought inventory, and I felt terrible, because they are sitting on this cash that we couldn't -- but we did -- we had people working nights and weekends, once the system could take it, to get their products up. I think they understand that. They view themselves almost, from what I can tell, as part of Overstock. And our own buyers were mad at the IT department, too. And that may have been an attitude that was shared by the partners, but it's not really an us/them situation. And I'm sorry, I've lost -- I didn't make a note on your second point. Oh, T.J. Maxx?

Justin Post, Merrill Lynch - Analyst

T.J. Maxx.

Patrick Byrne, Overstock.com - President

Well, I'm surprised. A few years ago, somebody told me that T.J. Maxx had tried cataloguing back in the early '90s, and they had gotten killed. And they got killed on the returns cost. Now, I may be -- I was talking to somebody in the logistics field who knew their business well, and said that they had gotten out of it because the returns killed them, and they just decided never to get into it again. So then, the message was you don't have to worry about them coming in, Byrne. Well, they did come in, but they came in -- and it's a monkey business (ph). They got out of it. I think that's definitely good for us. I think that we are getting -- it's going to take a while for folks on the outside to see this, but we have become -- you know, apparel was nothing two years ago. It's going to do over $100 million this year. On 7th Avenue, New York, we have become a player, and people respect us -- not, obviously, the same stature as T.J. Maxx. But we are on everybody's radar. And I think it's good for us that they pulled out of this, because those people want -- they see the new economy coming to them, finally. They see this coming, and they want a place in it. And I think that we are evolving into -- I just know, even yesterday, I was dealing with some folks who were telling me this, that the name that we have now gotten, especially in the apparel industry.

Okay. I'll try to be briefer, so we can -- next is Rebecca Kujiwa (ph).

Rebecca Kujawa, - Analyst

Two quick questions -- or actually, just really one. Your inventory has almost tripled year over year. And actually, you've talked a little bit about what that build is and how you have been buying earlier. One, your inventory, your distribution center, must be stuffed to the gills. Will you have to change your planning at all for next year, as far as capacity goes, assuming that you expect the same/similar build earlier in the year (ph) than you were expecting before?

Patrick Byrne, Overstock.com - President

Great question. It is stuffed to the gills, and we've actually rented a little warehouse down the street for $20,000 for bulk storage. But actually, one of the great virtues of this new Oracle ERP system I am pleased with -- and by the way, I know, when I'm talking about Oracle, it should be absolutely clear they are not the ones who tripped up. In fact, they and IBM saved our bacon. And so, by me talking about this ERP problem, I hope people don't hold it against Oracle. It was completely our fault. It was completely my fault. I made the decision that I shouldn't have.

But one of the virtues of it is we can have a lot of intelligence. So, for example -- now, I don't think we have to keep this secret anymore; we used to keep this secret because other people hadn't figured it out. You have to divide products into ship alone's or ship together's. And you normally don't want to split ship together's, because you don't want them to come from two separate warehouses. Well, it turns out that a very high percentage of the time that somebody orders one of our core ship together's, it comes from -- it ends up shipping alone from a warehouse, just because either they order nothing else or they order something else that's a core ship alone, or they order a partner product, and say over three quarters of the time.

What that means is that we can start -- under our old system, we were not able to split inventory. We had to keep all of one SKU in one warehouse. Now, with the new system, we can split it between warehouses, so we can put -- if we get 1,000 of something, we can put 500 of them or 400 of them in Salt Lake and 600 of them in our Indiana facility, which means that we will be able to not only get it to the customer faster but, if we are shipping to New York, you are saving 30% or something on the freight. There's actually the partner we have, OHL, who runs our Indiana facility, actually has 90 facilities around the country. We are not going to split inventory among 90 places, but you might see us start splitting it into three or four big places. And that can -- probably no more than three, actually. That can create real savings on logistics. It also gives you more capacity.

I have basically had -- one thing has worked out better this year then planned, and one thing worse. I thought that next year, we were going to have to do some sort of dramatic warehouse overhaul, either completely redoing this warehouse here or going out to some million square foot facility in Salt Lake, or something like that. It now looks to us like, using the brains side of the equation, we can get through next year and the year after without any big, significant redesign of the logistics system.

On the other hand, I thought our computers were going to last us this year and maybe next year, maybe not, and our computer system would be strong enough. And actually, when we looked at it this year, we realized, no, we had to replace it. So one system got replaced a year earlier, and one system is going to last a year longer.

Rebecca Kujawa, - Analyst

If I take from your explanation, if you do want to do another site, either Indiana -- either an expansion of Indiana or add an additional site, you will likely look at OHL, or at least a thirdparty logistics manager?

Patrick Byrne, Overstock.com - President

I think so. In fact, we've already -- we are moving into a bigger facility in OHL in the first quarter.

Next, I see Derek Brown.

Derek Brown, - Analyst

Two questions. The first is in terms of your sort of '06 Q4 timeline or projection, hypothetical, that you laid out --

Patrick Byrne, Overstock.com - President

Ambition.

Derek Brown, - Analyst

Ambition. The question is, why would you feel confident that year-over-year growth could accelerate next year, given that that isn't something that has happened for maybe the last two or three or four years?

And then, somewhat related to that is sales and marketing, as a percentage of revenue, you talked about it perhaps dropping to the 8.5 level next year. And that's a pretty meaningful decline, which would clearly reverse the trend that we've seen over the last few quarters. And it seemed like a lot of that is hinged on Propeller. And until Propeller fully launches and you sort of get the type of feedback you want from it, why would you feel confident that those types of hypotheticals could be achieved?

And one really short follow-up is what would your expected CapEx levels be for 2006?

Patrick Byrne, Overstock.com - President

I'll take the first one. First of all, my degree of confidence on meeting my ambitions, even the less grand ambitions -- I'm not saying I'm confident we can meet them. I think it's a slightly scaled-back ambition; it's still a good ambition. How I think of it now is that we can probably get -- I think that the reason we are able to grow so much, so much more cheaply than other people, is -- and just for comparison, and I know people hate to use comparisons, but Amazon at our size was losing 1 billion 1 a year, an operating loss of 400 million. I think that -- corny as it sounds, I think that the reason we grow like this is we are just that much a better deal. We're just getting better and better at all kinds of things. But I don't think that that takes you past about 50%. The market is growing 15 to maybe 25% in the fourth quarter. I think that we can grow 50% reasonably, just because we are good, but it takes people -- there is a limit on how much people are going to change their habits in a given year.

But if we can grow 50% -- so if you take 100 and you grow it 50%, there is 150. If we can get even a 20% lift from the combination of site design and personalization, Propeller -- well, that 20% on 150 is 30; it brings you to 180. It takes you back to 80% growth. So that's kind of the way I look at it. And I meant to mention, we are -- I think I did mention -- we are seeing definite results from Propeller, I mean double-digit lift. And I don't think it's out of the question we get -- nobody here does think it's out of the question that we can get to conceivably the 35 or 40% lift that other people experience that seems to be, when you go to these conferences, what people say is the upper end on what you get. My guess is our business model doesn't allow for that. Our business model means maybe it is capped at half of that. Maybe just 20% is the most we're really going to get on a stable basis. But we are already seeing, like I say, spurts of four or five days at a time, we get a 21% lift, and then it decays. What we're trying to do is figure out how to stop it from decaying. As far as CapEx, it's obviously greatly reduced from this year. Dave Chidester, do you want to --?

David Chidester, Overstock.com - SVP, Finance

Yes, I think greatly reduced, but we're in the middle of planning for '06. I think we'll have a much better number next quarter, but it will be considerably less than it was this year.

Patrick Byrne, Overstock.com - President

Why don't -- let me go back to that first point. That's all just for color. Then there's site design, and site design -- when the book is written, and I explain what we found out in the last two or three weeks, you're just going to want to stick another fork in my head. The site design issues -- I can't believe how, when you can really refine your measurement, how you can find little things that make 5% differences. So I think you put all that together and you say, if we can get even 20% out of combined Propeller and site design, that kicks us back up into sort of a 70 or 80% growth rate.

But we may not; I mean, our history has been five or six years that may look like smooth growth. But it's really been we figure something out, and it pops us 30%. And then we work a few months, we figure something out, and it pops us 20 or 30%. Those things that are able to be figured out are getting fewer and farther between. I think that there's really -- the last two big ones are personalization and site design. Then there is conceivably one other, third one; I won't tell you the project name, because everyone will laugh at it and give me -- bring it up to me. But there's one third one. But then, the things that we can figure out that have made us grow so much faster than other people will most -- will, I think, be used up. And then you'll see us regress towards what's an industry rate. Yes, we have two more people who have been waiting -- three more people. Dan Thorne (ph), Aruva Shaw (ph) and Jim Krueger (ph). Okay, Ms. Shaw or Mr. Shaw?

Aruva Shaw, - Analyst

Actually, all my questions have been answered.

Patrick Byrne, Overstock.com - President

How about Dan Thorne from Manchester (ph)?

Don Best, Manchester (ph) - Analyst

This is Don Best (ph) for Dan; he had to step out. First, do you expect your current level of spending on IT and G&A to remain at the current level in the next quarter, or will there be a big drop?

Patrick Byrne, Overstock.com - President

Well, a lot of it is becoming depreciation, so it's not going to drop. Dave -- I think 21 million, is that still your number for this quarter?

David Chidester, Overstock.com - SVP, Finance

Yes. I think, overall, G&A and tech -- we had talked at the beginning of the year about it being 60 million plus or minus 3 million. And I think for the year, we are going to end up at the high end of that range, which means we're going to see -- by the end of the year, we should have all of the spend that we've put in this year will be depreciating, so it will be a much more -- the Q4 number will go up again from Q3, but it will be much more similar to the number that we will see going forward. But yes, we do have one more stair-step in the next quarter.

Don Best, Manchester (ph) - Analyst

My second question is, we burned some cash this latest quarter, because we were building up inventory for the Christmas season. You've also been buying stock. I'm a little concerned about us buying more stock than we can actually afford, given our declining cash balance, your requirement for the foreign bonds. What is your plan on stock purchases, and do you feel that's a risk to your business strategy by continuing to buy stock?

Patrick Byrne, Overstock.com - President

I think we're in the same boat there. I think we're in the same boat. We are in a place where, in seven more days, cash stops being an issue. It starts flooding through the door, and it's just not going to be an issue. Where we see it as conceivably being an issue is if we're trying to build inventory next year, in August, and the bond does not mature until -- half the bond matures in September, and half of it in November. Do we get into a cash squeeze?

But there's small things that can be done to -- you know, we will be able to get around that. But I see your point. I don't want to go out and use a chunk of cash that is presently on the books to go and buy -- I mean, I would love to go and buy more stock. But I'm also reaching the point where, although I would insist that my father and I count as separate persons, from an SEC sense, people might argue that we're the same person, and we are reaching the point that I think we're about 1.3 million shares, I'm told, from being over 50%, which we don't want to do. So there's not much more stock we can buy in, anyway, without tripping that. And Jim Krueger? And I think this is the last one.

Jim Krueger, - Analyst

Patrick, can you please talk about the improvements to the Board that you have announced in the next few days?

Patrick Byrne, Overstock.com - President

Yes, dramatic improvements. Jason Lindsey (ph) is sitting right here with me. Well, first of all, there's my father. My father was the Chairman for the first three or four years of the Company. He stepped down because of some Sarbanes-Oxley stuff, and then he slowly came back and was Vice Chairman. I've been asking him to be Chairman for almost a year. I think I announced three or six months ago that you would see this before the end of the year, didn't I? I put that in the press release, and people wondered why I put it in. Well, I put it in partially to pressure him into taking it. He has been retired, and he's been sort of coming out of retirement to take care of some other things in his business life. But we have a great working relationship. We bang heads a little bit, but we've worked together on and off, on different projects, for 20 years. He's been a great Board member. And I did try to give people warning.

I was afraid people were going to say that it's a sign of destabilization; that's why I gave people warning, but also to try to present them with a bit of a fait accompli. And he took it. He has flunked retirement for the fourth time, and he's going to be Chairman. And I strongly believe that the Chairman and the CEO position should be split. In my mind, I work for 10,000 strangers, most of whom I never going to meet. And I can't meet them each quarter, but what I can do is meet a group of five people that represent them. And I think it's a mistake for someone to be the CEO and to be the Chairman, because he is straddling two hearts in one breast. Ray Groves is a former managing partner of Ernst & Young -- Ernst & Whinney, then Ernst & Young. I worked with him in the mid '90s on a number of acquisitions, and sat on a couple of boards with him, and in fact, he made me the money that was the origin of Overstock. We did about four deals together, and two of them worked out just spectacularly. And we had a great relationship. We haven't done anything for five or six years together, but literally, the funding from Overstock, when I think of it, when we were still private -- my piece of it all came from deals that I did with Ray. We were in a printing company and a fixed base operator company and a mulch company that we just sold. He has a tremendous business mind as well as, of course, a great financial mind. I think he's going to sit on the audit committee, but Gordon is going to stay chairing the audit committee. And then Jason Lindsey is -- Jason is my best friend out here in Utah, my best buddy. He's a CPA, MBA, real entrepreneur himself, made a lot of money before we ever met. We really started -- Overstock was our first real project together. He, I'd say, built the Company at least as much or more than I did, is super well-respected around here. I've always told people, if I get hit by the proverbial bus or somebody drives over me on purpose, to call Jason; he's very well-respected within the Company.

He retired a couple of years ago. I actually wrote something about this on Motley Fool a few weeks ago. He had a health issue with his family. Well, he was the CFO, and I was the President. He became President, and about three weeks later, he had a health situation with his family which I won't go into here. And he came to me, and it was a serious health issue, and he told me that I could say this, because there's been so much scuttlebutt about this crap. He had a real health problem in his family, and it was unfortunately, I don't know, just weeks or a couple months after becoming President. So he stepped down, and of course some people said, well, the CFO/President is stepping down after being President for two months. What does that mean? Well, it meant that he had a serious health problem in his family. We said that. And he's back. He's actually sort of kept a toe in the water with us for the last couple of years, and he knows everything going on in the business. He's much more conservative than I am. I think he'd like to see us throttle back to 20% growth and start spitting out 40 or $50 million. And I'm not sure he's wrong about that, but -- so it's a very healthy relationship of equals. He will be on the Board, and he's a great, great financial guy, too. Anything else, Mr. Krueger?

Jim Krueger, - Analyst

No. Thank you very much.

Patrick Byrne, Overstock.com - President

Well, 10:26, hour and a half. I see a lot of folks have stayed on; that's always nice. Again, gomen nasai. I guess I'll add one more thing. Jason just passed me a note. I'll tell you what I think. I guess I'm doing two things. I've just reminding newcomers of the story. I'm doing things differently in two ways. One is, I don't understand this. There are guys who say, Byrne is always making excuses. I'm not. I'm saying, hey, I stepped in it, and I made a mistake. And I've said that -- we've been public about 13 quarters, I think, and in four or five of them, I've come out and said, I made a mistake. This went badly, and here's what went wrong. Here's my mistakes. And when I do, people say, oh, Byrne is making all these excuses. I don't know what they are listening to. These are my mistakes. I made these mistakes. They want to bayonet the wounded or something. But all I can say is what I can do with the last quarter is learn from it, making no excuses. I take full responsibility, and it wasn't the fault of my CIO and it wasn't the fall of any of my colleagues here. It was purely my fault. Gomen nasai.

The other is, it seems to me the normal game is played with -- people throw out numbers with a lot of windage in then, trying to be 95% sure they are going to beat them. I warn you that all the numbers I throw out, I'm really putting out the kind of numbers I talk with the executives about, without windage in them. I think it's 50/50 whether we go over them or under them. People always love to -- I think that I'm more open about what's going on in this company than any CEO in America. I give folks pretty much the letters and operational reports I give the Board of Directors. I know I work for shareholders.

That means, though, that if I say here's these ten things we are working on, and these three things went great and these four things are mediocre and these three things went badly, it's very easy for people to jump on the things that went badly and say, oh, more blown missions. Well, if folks want just corporate pap, I can write corporate pap. I'm really trying to let people know the details of what's going on. You decide for yourself, but there's not windage in my numbers. When I tell you that we are shooting for 350, it's not, hey, we've got a secret plan, I know we are going to make 380, or any of those games. I'm telling it to you straight.

I appreciate your forbearance, and to all my owners, I apologize for losing $14 million of our money this quarter.

We'll see if we can get it back next time. Bye-bye.

Operator

Thank you, and this does conclude today's conference. We do appreciate your participation. You may now disconnect.

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