Overstock Q4 Earnings: "Sloppy", Says Scott Devitt (OSTK)

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

Stifel Nicolaus Internet analyst Scott Devitt on Overstock's earnings (announced last night after close):

Reports 4Q05 Results, Maintain Hold

• We are maintaining our Hold rating on Overstock shares. We continue to believe in the long-term opportunity for Overstock.com. As with any business that has not reached scale and sustained profits, we believe an investment in Overstock carries a significant amount of risk.
• The company did not include fourth quarter income statement or detail, but rather gave full-year 2005 information. This was due to a change in the way the company accounts for inbound freight. The company is working with its auditors as to how to present the 4Q05 numbers given that it is the quarter in which the change is occurring.
• Overstock's reported full year 2005 revenue of $803.8 million up 63% year/year and a loss per share of $1.29. 4Q05 revenue was $318 million, up 44% year/year, and a loss per share of $0.21. We were expecting 4Q revenue of $332.4 and a loss per share of $0.08 in the quarter.
• Gross margins for the quarter were 15.0%, below our 15.5% expectation. We expect gross margins to continue to expand and rise above 16% by 2007.
• We are lowering our 2006 estimate of revenue from $1.2 billion to $1 billion and lowering our cash EPS estimate from a loss of $0.71 to a loss of $1.05. We are lowering our 2007 EPS estimate to a loss of $0.49.

Our Thoughts

Today, Overstock.com trades for 3.5x 2006 gross profit, compared to TJMaxx at 2.8x and Amazon at 10x. Amazon and Overstock are not comparable businesses at the moment and we would argue, even at scale, Amazon's model is preferable given the differences in inventory risk in the respective core businesses. Overstock takes real risk with its inventory and Amazon, for the most part, does not. However, a comparison to Amazon does not even maintain relevance at present. Overstock is fighting to attain a level in which its business can become self-funding. The transition from the "grow at any cost" mentality to a more disciplined approach to growth can be and is turning out to be sloppy.

That said, Overstock today trades at a 25% premium to TJMaxx on a multiple of gross profit which we believe to be a fair multiple differential given the differences in the stages of maturity. We believe Overstock has both execution risk and liquidity risk; however, if the company makes it through this transition we think the shares would prove to be undervalued.

Given the way discount rates account for the two aforementioned risks, we believe the shares to be fairly valued at current levels. We continue to monitor cash ($112 million), inventory ($92 million w/ a 5% reserve), and cash flow ($-6 million from ops and $-44 million in capex in 2005) against revenue growth (24% in 2006), gross profit margin (15.6% in 2006), and sales and marketing (8% in 2006). As with any business that has not reached scale and sustained profits, an investment in Overstock carries a significant amount of risk, in our view.

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