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Overstock.com, Inc. (NASDAQ:OSTK)

Q2 2012 Earnings Call

July 19, 2012 11:30 am ET

Executives

Jonathan Johnson - President & Corporate Secretary

Patrick Byrne - Chairman & CEO

Steve Chesnut - SVP, Finance & Risk Management

Analysts

Justin Ruiss - Sidoti

Nathaniel Schindler - Bank of America

Chris Donnelly - Pacific Roth Capital

Operator

Good morning. My name is Jodie, and I will be your conference operator today. At this time, I would like to welcome everyone to the Overstock.com second quarter 2012 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session. (Operator Instructions) Thank you.

I would now like to turn the conference over to Jonathan Johnson, President of Overstock.com. Please go ahead sir.

Jonathan Johnson

Thank you, Jodie. Good morning and welcome to our second quarter 2012 earnings conference call. Joining me today are Dr. Patrick Byrne, the company's Chairman and CEO and Steve Chesnut, the company's Senior Vice President of Finance and Risk Management.

To begin, let me remind you that the following discussion and our responses to your questions reflect management’s views as of today, July 19, 2012 and may include forward-looking statements. Actual results may differ materially. Additional information about factors that could potentially impact our financial results is included in the press release filed this morning and the Form 10-K that we filed on March 2, 2012.

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

And with that preliminary piece out of the way let me turn the call over to Steve to highlight some of the financial results.

Steve Chesnut

Thank you, Jonathan. Please turn to slide three and let me start with the last bullet point. Net income for the quarter was a positive $470,000 or that was $0.02 per share. This is $8.3 million improvement over last year and it was due to a combination of revenue growth, contribution of margin expansion and lower operating expenses. On the topline, total revenue was $239.5 million, a 2% increase from last year.

Gross margin improved a 110 basis points from Q2 of last year, while contribution increased by 14% to $29.7 million due to a 9% increase in gross profit and a 1% decrease in sales and marketing expense. Combined technology and G&A expense has decreased by $3.9 million due primarily to a reduction in compensation and legal costs.

While we don’t provide it on this slide that we ended the quarter with $60 million in cash and cash equivalents, working capital at the end of Q2 was a negative $7.6 million while working capital at December 31, 2011 was negative $14.1 million, so a nice improvement.

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

Patrick Byrne

Thank you, Steve. Good morning everybody. Well that was a long time to hold our breath, but I do feel that things we’ve been telling over the last quarter to that we’re turning things around and getting the fly wheels spinning back in the correct direction have come through.

Slide four I am going to be quick like moving through these slides. Quarterly revenue growth slide four, you see we have broken the slide and up a little bit, not satisfactory. The markets growing 12% to 14% in general we say. As I mentioned many times, we think of our growth on as we look at contribution to our growth is what we manage everything there. However, it’s still nice to get our head above water on GAAP record growth, and I think that not everything goes as planned you will that spinning up fairly quickly.

Slide five, gross profit growth, same basic story, on slide its only better it’s up to 9%. Slide six, I’ve said in the past 12%, 12.5% on our contribution, is seems to be in a sweet spot for us. Remember, we calculate this differently than some business -- well, we calculate margins different than some online businesses, but at the end of the day, it all comes out in the wash when you look at the contribution dollars. And we think we’re right in the sweet spot there. We have opportunities to increase that. We actually are attending to pass them on more to our consumers than we are trying to make them stick to our [rates].

Slide seven, this is what I like seeing contribution back up at 14% growth rate, which is the general industry growth rate. So I am very pleased with this. This is what we managed all of our -- everything above this line really gets managed and optimize this line and I also believe you will see this accelerate nicely. Everything stays on course.

Slide eight, operating expenses. I think this is a new slide in this format. And it’s useful to look at this at the blue and green segments together. Red is marketing, but the blue and green gives you our tech and G&A and you can see we have, thanks to great management and my colleagues, manage that, kept that –well gotten that, tightened up a notch and but we feel very good, we are a not skimpy anywhere in fact I think we have a better innovative cycle that we’ve never had before. So this is good management led especially by Mr. Chesnut, who is hawkish on our expenses.

Slide nine, quarterly net income; back in the black, $0.5 million. Q2 for us, that’s not that, that’s still nowhere near acceptable, but we’re glad to have the right sign back there.

Slide 10, cash flows, Steve may address those a little bit more, but again positive we like that.

Slide 11, GAAP inventory turns seems to be hovering just under 40 it’s hard for us to break and a significant thing you should know about our core returns, I mean our core turns.

Do you want to explain that effect Steve of the partner returns and how that all weighs in here.

Steve Chesnut

Since we take back 100% of the returns for including fulfillment partner that gets weighted into these GAAP terms which creates a little bit of a drag on our overall return rate. And just because I know just to put on that I don’t think we should actually take a 100% there is couple of partners who have something, some other arrangement but we should take back almost a 100% of our return or partner returns and make that core inventory, so that does effect and drag down a bit our core inventory returns.

Slide 12, (inaudible) trailing 12 months [190%] and that is acceptable. On slide 13, net promoters score this generally stays in the 50s and 60s and the 50s most, 60s once. Slide 14, still adding new customers were up to 28 million people have bought from us and about a million and half bought in the quarter.

Slide 15, new customers and CPA. CPA is up a little bit but this is acceptable. And we have a great addition to our marketing team Tim Dilworth came in few months ago from Coldwater creek and Stormy is focused on building some things we haven’t even been talking about probably. So Tim has taken this and is doing a really fine job.

Slide 16 is all numbers you can just calculate yourself that are reported financials but we kind of save some time, slide the average order size is I think about its higher than its ever been, as nasty that is, we are seeing a mixed shift and what people are coming to us for. Okay.

Slide 17, gross profit per transaction, this is nice and this is also partially a reflection of that mixed shift as well as improvements in our supply chain. We keep on finding basis points to squeeze out of our supply chain. Its really, it's the cornucopia, just keeps on giving. We still see more [players] as we can save basis points out.

Slide 18 corporate employees, we are down about a 100, not about we are down 170 people at corporate from this time last year, 19% decrease yet with a 14% increase in contribution dollars. Good management, to all my colleagues, Jonathan, Steve, Kevin and all my colleagues here. Let's go Jonathan or Steve, do you have anything.

Jonathan Johnson

There are two questions that have been submitted before the call, Patrick I mean oppose this deal, one is from a shareholder, (inaudible) who’s got three questions regarding technology and if I can I will just read all three. Overstock leverage its investment in technology by providing that technology license to other companies' websites would Overstock have a competitive advantage given that its technology is live, tough and robust because it include fulfillment services and then lastly would there be any incremental costs Overstock if you would make its technology available partners who pay transactions and transactions?

Patrick Byrne

Good questions, the answers are yes, yes and no. Yes, we could leverage our investment in technology by providing this to other companies’ websites and I think we would have a competitive advantage. It is getting really good and we've worked always with a comparatively tiny, tiny tech department compared to our big competitors and even our mid-sized competitors.

It’s small but effective and they have overtime developed technology that because we are a consumer, for years we've been a consumer of other third party technology. We have a pretty good idea of where they are and we now see that the stuff we have grown in house is really good and competitive, in some cases better than the best of the third party technology we can find on the market. So we could leverage that.

We would have a competitive advantage and there would be negligible incremental cost to doing so. So this is a direction our, our business conceivably to go, we would from a subsidiary and probably have to find the right, what we would have to find the right people to run that. We've had so many different things on our plates that it was not high on our list but these questions are questions that we ask ourselves frequently, should we be commercializing some of our technology. And so I would say the door is open to that but we don't have any immediate plans, do you want to add anything guys.

Jonathan Johnson

I agree with what you said.

Steve Chesnut

It's well said.

Jonathan Johnson

Okay, last question we have submitted earlier is from Glen (inaudible). Patrick he asked what is the status of the potential stock buyback you discussed in March?

Patrick Byrne

The status is we have not had one approved by the board, we will be having a board meeting next week, I suspect this will be a subject to be discussed, you probably know where my heart is Glen but I will always differ to the my colleagues. We did not get pushy about that in this last quarter because just in field would be prudent but now the things are at the point I think we ought to be seriously considering a modest stock buybacks direct of course where the market stays, where the market moves. You have Steve, do you have anything to add?

Steve Chesnut

I think this is a good board discussion for next week.

Patrick Byrne

Right and I am sure that there will be positive opinions at the Board level on that. Jonathan, that’s more to add.

Jonathan Johnson

Yeah I agree and if we choose to do it, we will certainly in compliance with the SEC people know what we have decided to do so. Those are all the questions we’ve had submitted ahead of time. Jodie can you please prompt the listeners to see if there are any other questions?

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Justin Ruiss from Sidoti

Justin Ruiss - Sidoti

I just have a few questions I know expenses you got it up down a lot, does that have anything to do with legal expenses or is it just typically coming down on your average wear and tear?

Steve Chesnut

Some of it is headcount as we showed we are down 19% at corporate but some of it is legal.

Jonathan Johnson

Given that our suit against Merrill Lynch and Goldman Sachs is no longer, it's in appeal stage and now to get ready for trial stage, that’s significantly less. I think legal expenses year-over-year were down $1.6 million and then compensation was down $2.8 million year-over-year. So that gives you a sense of some of the (inaudible).

Patrick Byrne

So 60% is the comp and 40% yield.

Justin Ruiss - Sidoti

So I guess, just looking at that then, I am looking at the margins, they way they are now and they way they’ve improved, are we looking at like a sustainable margin at this point, maybe just for the year and you know going out further?

Patrick Byrne

There is always this, in the fourth quarter as there is a shift to books and electronics that usually compresses it some, but in general as a general response, I would say this is in any means unusual or spite. This is a new norm.

Steve Chesnut

Yeah, I think we are real comfortable where we have the pricing model right now. And so I would anticipate that margins, gross margin will maintain pretty consistent with what we've seen in the second quarter with the understanding. Fourth quarter, there is a mix shift that will drive margins down.

Patrick Byrne

But that happens every year.

Justin Ruiss - Sidoti

That’s a seasonal thing. And then, lastly, just the one thing I am looking at is how do you feel, are you comfortable with the inventory levels that you are at now or is that anything that’s bothering you?

Patrick Byrne

It's being too much, too little do you mean?

Justin Ruiss - Sidoti

In any direction, it's where you are comfortable with inventory? Are you looking to scale back, are you looking to increase?

Steve Chesnut

I think, we feel real comfortable where the inventory levels are right now and actually I think we feel pretty where our in stock levels are right now. We are valuating some of the clothing apparel footwear business determining if we can move that from core to partner, but that's the question that we are debating right now.

Patrick Byrne

Steve has done a wonderful job. Steve and Dave Nelson have done a wonderful job on working on inventory management and in stock percentages and they have driven it up nicely and in fact we're doing better.

Operator

Your next question comes from the line of Nathaniel Schindler from Bank of America.

Nathaniel Schindler - Bank of America

Hi guys, just a little question on the 19% drop in the employee base. Where were those cuts taken and do you foresee any additional types or attrition or like not necessarily of your true cuts, but do you see this is an appropriate level going forward from which you will slowly grow or is this going to be, are we are going to see a continued downward trend on that line?

Patrick Byrne

No, I don’t see any further cuts and I would say here or slight, we are still – it will be slow growth on the technology side and among technologists, we are always looking for good technologist. Some of this is driven by the systems we have developed are letting us automate some parts of the business that were done by hand for years and so part of it is just a reflection of the systems that they have developed and you might see a slow growth in technologists, but certainly there is not any move to eliminate any more job. Jonathan?

Jonathan Johnson

And to answer the first part of your question over the past years, we've managed expenses. Each department has contributed to that effort and so I wouldn't say there's any one group, that's been particularly hard to hit by some of the employee downsizing, so it's across the board.

Nathaniel Schindler - Bank of America

Just a little bit more on that. There's pretty significant about 500,000 drops just quarter-over-quarter in your technology line, yet no discernable move in the depreciation, so I am figuring that's mostly people right.

Patrick Byrne

Yeah we've had some attrition in the technology line.

Jonathan Johnson

And we've had attrition and as Patrick said, that's a group of employees that we were trying to hire them back and grow that group.

Patrick Byrne

Now we would take a 100 tomorrow, a hundred great, we tend to hire only at the senior range and developers, so they are pretty hard to come by, but we will take a hundred tomorrow, it's really the cap is recruiting and getting people to relocate.

Operator

Your next question comes from the line of Chris Donnelly from Pacific Roth Capital.

Chris Donnelly - Pacific Roth Capital

My question that I have is, it relates to your thoughts on cash flow generation in the second half of the year and I know you guys don't give guidance, but maybe if you can directionally talk to us about your thoughts on free cash flow this year versus last year and if we can get any incremental improvement in that metric as well as where do you think we shake out the year in terms of cash balances.

Patrick Byrne

Yeah, so as we think about the year, obviously relative to where we were last year at this time, we have seen I think on a year-to-date basis through Q2. Net income has improved and that is –

Steve Chesnut

Like minus seven to plus 8.3 million.

Patrick Byrne

Yeah so we have seen, I mean obviously the improvement on that net income side, we think we will continue going into the back half of the year. Capital spending will be slightly less than last year, so as you think about it from a free cash flow standpoint, we will see improvements obviously in the P&L side and that will be slightly less than last year’s capital spending. That’s probably the best way to think about it.

Chris Donnelly - Pacific Roth Capital

So let’s just say last year you generated about 16 million in free cash flow, is it a reasonable expectation that free cash flow this year generation would be better than last year?

Patrick Byrne

Yeah Chris we don’t, I mean obviously you have got all the numbers. You can go ahead and calculate what you think free cash flow is going to be, but I think our general statement is we have seen the improvement in the P&L. We anticipate that we will continue to see strong P&L performance in the back half and then capital spending will be slightly less than last year.

Steve Chesnut

I think we're going to crush it, but that's just me and my natural optimism. These guys are of course conservative as they should be, but I feel really good about where we are and what’s happening and I think we are going to do far better.

Chris Donnelly - Pacific Roth Capital

Yeah. I mean I love the improvements in the business. My only sort of concern is that free cash flow through the six months of this year is worse than last year. I know there are seasonal factors so on and so forth, but we have had improved net income, yet it hasn’t translated into free cash flow, so that’s why I asked.

Patrick Byrne

Yeah I think last year, also if you look at kind of last year, where we were. We get a lot of work around inventory and trying to get the inventory brought down and in line. So there was a lot of movement in that free cash flow that was driven because of working capital and it was specifically around inventory. Where this year, you see the improvements, the working capital is pretty stable and the improvements driven on the P&L side and a little bit on the capital spending side.

Operator

There are no further questions at this time. I’ll now turn the conference over to Jonathan Johnson.

Jonathan Johnson

Jodie, thank you. We thank our investors, the analysts that call in and others that are interested. We’re going to get back to work and look forward to talking to you again at the end of Q3. Bye, bye.

Operator

Thank you. That concludes today’s Overstock.com second quarter 2012 earnings conference call. You may now disconnect.

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