Liquidity Services Inc (LQDT) 2007 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q3 2007 Liquidity Services Inc. Earnings Conference Call. My name is Grace Ann and I will be your coordinator for today.

(OPERATOR INSTRUCTIONS) I would now like turn the presentation over to your host for today's conference, Ms. Julie Davis, Director of Investor Relations. Please proceed.

Thank you. Good afternoon and welcome to Liquidity Services Inc. Earnings Release Conference Call for the fiscal quarter for the three months ending June 30, 2007. During this call, we will refer to Liquidity Services Inc. as LSI. Presenting today are Bill Angrick, our Chairman and Chief Executive Officer, and Jim Rallo, our Treasurer and Chief Financial Officer.

This call is also being broadcast through the internet and is available through the Investor Relations section of the Liquidity Services Inc. website.

Before we begin, I would like to remind you that matters discussed on this call contain forward-looking statements that involve risks and uncertainties concerning LSI's expected financial performance as well as LSI's strategic and operational plan. These forward-looking statements involve a number of risks and uncertainties that could cause actual results to differ materially from those anticipated by these forward-looking statements. These risks and uncertainties include a variety of factors, some of which are beyond our control.

These forward-looking statements date as of today, and you should not rely on them as representing our views in the future and we undertake no obligation to update these statements after this call. Please refer to our SEC filings as well as our current earnings release posted a few minutes ago on our website for a more detailed description of the risk factors that may affect our results. Copies of these documents may be obtained from the SEC or by visiting the Investor Relations section of our website.

To supplement the company's consolidated financial statements presented in accordance with GAAP, we use certain non-GAAP measures. These non-GAAP measures include EBITDA, adjusted EBITDA, adjusted net income and adjusted EPS. We believe these non-GAAP measures provide useful information to both management and investors. These measures, however, should not be considered substitute for or superior to GAAP results. Our reconciliation of all non-GAAP measures included in this conference call to the nearest GAAP measure can be found on the financial tables included in the press release.

We also use certain supplemental operating data as a measure of certain components of operating performance, which we also believe is useful for management and investors. This supplemental operating data includes GMV and should not be considered a substitute for or superior to GAAP results.

At this time, I would like to turn the presentation over to our CEO, Bill Angrick

Thank you. Good afternoon. As detailed in our press release, Q3 was another strong quarter for LSI, thanks to the efforts of our dedicated employees, our focus on customer value and our shared passion for continuous improvement in our business.

During the quarter, overall GMV grew 34% year-over-year. Adjusted EBITDA grew 46% year over year and adjusted net income increased 34% year-over-year.

LSI's strategic goal is to develop the most efficient online marketplace and value added services to enable global enterprise customers to transact wholesale, surplus and salvage goods. Our performance during the quarter reflected solid execution of our business strategy as we achieved record GMV of $62.3 million. In addition, we reported sequential growth in all of our major business segments, including commercial DoD scrap and DoD surplus.

Our commercial business grew approximately 126% over the prior year period driven by strong contributions in our consumer electronics, office equipment and apparel categories. It's important to remember that the commercial business is a relatively new business for LSI. We have grown this business segment from an annualized GMV of approximately $51 million in Q3 fiscal '06 to an annualized GMV of approximately $116 million in Q3 fiscal '07. We have done this by experimenting with a variety of programs within companies and across the supply chain in order to gain valuable insights that support our investments to drive sustainable competitive advantages.

We're quite frank in noting that not all pilot programs with commercial customers will continue, as the parties may not agree to terms that are acceptable from a business or financial point of view. As noted in our earnings press release, our near term guidance reflect the anticipated loss of GMV in Q4 associated with the pilot program conducted in Q3. Business development activity, however, within our commercial business remains strong.

We continue to test and develop capabilities to meet the long-term needs of our clients and to support a much larger commercial business. Specifically, we are exploring more opportunities to serve manufacturers as a compliment to our existing portfolio of primarily retail clients. Our overall growth with clients within the retail sector has resulted in more seasonality in our business, which is also reflected in our Q4 guidance.

Our buyer marketplace continues to deliver strong results for our sellers as we averaged over five auction participants per completed transaction during Q3 and now enjoy over 1.1 million auction participants in our online marketplaces on a trailing 12 months basis. Our scrap business with the DoD, which grew approximately 54% over the prior year period, also contributed to strong growth in GMV and Adjusted EBITDA during the quarter.

The scrap business has exceeded our expectations as we continue to provide an efficient e-commerce marketplace for buyers to identify and purchase scrap metal.

Finally, as we previously anticipated, our DoD surplus GMV grew sequentially for the first time in five quarters. Based on improved property flows, we expect that sequential growth in our DoD surplus business will continue.

We are very proud of our strong results to date and remain focused on building our business for the long term. With this perspective, we have identified a number of near term priorities and investment initiatives that will maximize our long-term growth and competitive advantages in the marketplace.

First, we intend to expand our scope of services to increase our level of integration with sellers. Second, we intend to further segment the buyer marketplace and develop the appropriate offerings to expand the demand side of our business. Third, we intend to continue to add talent and depth in our commercial business to support the needs of our buyers and sellers.

At this time, I will turn over our presentation to Jim Rallo, our CFO and Treasurer.

Thanks Bill.

The company continues to experience strong top line growth. As the amount of Gross Merchandise Volume, or GMV, transacted to our marketplaces increased $15.6 million, or 33.5%, $62.3 million for the three months ended June 30, 2007, from $46.7 million for the three months ended June 30, 2006. We believe this increase is attributable to our investment in our sales and marketing organization, the acquisition of STR on October 16, 2006, as well as increased market acceptance by corporate sellers and professional buyers of our online marketplaces as an efficient channel to auction and purchase wholesale surplus and salvage assets which resulted in 126.3% growth in our commercial marketplace over the same period last year. In addition, our scrap contract, which generated 29.2% of our revenue and 24.6% of our GMV for the three months ended June 30, 2007, grew 54.2% from the three months ended June 30, 2006.

The growth of our commercial and scrap businesses was partially offset by a 27.2% decrease in our surplus business from the three months ended June 30, 2006, compared to the three months ended June 30, 2007. Revenue increased $13.8 million or 35.5% to $52.5 million for the three months ended June 30, 2007, from $38.7 million for the three months ended June 30, 2006. This increase is primarily due to the items driving GMV growth.

[Columbus sole] amortizationing increased $10 million or 290.5% to $13.4 million for the three months ended June 30, 2007 from $3.4 million for the three months ended June 30, 2006. As a percentage of revenue, cost of goods sold excluding amortization increased to 25.6% for the three months ended June 30, 2007, from 8.9% in the three months ended June 30, 2006. This increase is primarily due to an increase in merchandise we purchased for our own account and the acquisition of STR.

Profit sharing distributions decreased $3.1 million or 15.2% to $17.4 million for the three months ended June 30, 2007, to $20.5 million for the three months ended June 30, 2006. As a percentage of revenue, profit sharing distributions decreased to 33.2% for the three months ended June 30, 2007, from 53% for the three months ended June 30, 2006. This decrease is a result of faster growth in our commercial business where most of our stores have adopted our [consignment model] as well as a decreasing the amount of profits we are required to pay the Department of Defense under our surplus contract which was modified on September 12, 2006.

Technology and operations expenses increased $2.8 million or 52.7% to $8.1 million for the three months ended June 30, 2007, from $5.3 million for the three month ended June 30, 2006. As a percentage of revenue, these expenses increased 15.5% for the three months ended June 30, 2007, from 13.7% for the three months ended June 30, 2006. This increase is primarily due to the addition of 107 technology and operations personnel, the majority of which were needed to support the increased volume of transactions and merchandise discussed above for our commercial business, where we added four distribution centers over the last 12 months and an additional 49 operating personnel which were needed to support our inventory assurance program under the surplus contract in conjunction with the contract modification on September 12, 2006.

We are also experiencing less than optimal utilization of our distribution center network. We have invested over the last 12 months to support continued growth in our commercial business. Sales and marketing expenses increased $1.2 million or 47.5% to $3.6 million for the three months ended June 30, 2007, from $2.4 million for the three months ended June 30, 2006. As a percentage of revenue, these expenses increased to 6.8% for the three months ended June 30, 2007, from 6.2% for the three months ended June 30, 2006. This increase is primarily due to our hiring of 23 additional sales and marketing personnel and $300,000 of increased expenditures on marketing and promotional activities, the majority of which was needed to support the growth of our commercial business.

General administrative expenses increased $1.4 million or 40.7% to $4.7 million for the three months ended June 30, 2007, from $3.3 million from the three months ended June 30, 2006. As a percentage of revenue, these expenses increased to 9% for the three months ended June 30, 2007, from 8.6% for the three months ended June 30, 2006. The increase is primarily due to one, cost of $900,000 related to additional accounting, legal and insurance compliance and other expenses needed to support our growth and the requirements of being a public company. Two, expenses of $300,000 related to the adoption of Statement 123R, and three, cost of $100,000 for travel-related expenses associated with business development efforts.

The company continues to have strong cash flow. Adjusted earnings before interest, taxes, depreciation and amortization, or adjusted EBITDA, increased $1.8 million or 46.3% to $5.8 million for the three months ended June 30, 2007, from $4 million for the three months ended June 30, 2006. The three months ended June 30, 2007, represented the company's continued achievement of better than 30% bottom line growth. Adjusted net income increased $900,000 or 33.8% to $3.4 million for the three months ended June 30, 2007, from $2.5 million for the three months ended June 30, 2006. Adjusted diluted earnings per share increased $0.03 or 33.3% to $0.12 for the three months ended June 30, 2007, based on $28.3 million in diluted weighted average shares outstanding from $0.09 in $28.3 million in diluted weighted average shares outstanding for the three months ended June 30, 2006.

I will now discuss the company's other key operating metrics. I have already touched on GNP which management believes allows us to monitor the success of our marketing program as well as our [lotting] and merchandising strategies. During the last 12 months, we also benefited from our ability to more effectively market assets to potential buyers as we gained transaction experience and industry knowledge in the vertical product segments auctioned throughout our marketplaces.

Our marketing efforts resulted in approximately 32.6% increase in registered buyers to approximately 649,000 at June 30, 2007, from approximately 489,000 in June 30, 2006. Auction participants which consist of registered buyers who have bid in an auction during the period and are counted more than once that they have bid in more than one auction, increased to 287,000 for the three months ended June 30, 2007, representing an increase of 26,000 or approximately 10.2% over the 261,000 auction participants in the three months ended June 30, 2006.

Completed transactions increased 6.8% to approximately 54,000 for the three months ended June 30, 2007, from approximately 50,000 for the three months ended June 30, 2006. In addition, the Company has seen a significant increase in average transaction value to $1,156 for the three months ended June 30, 2007, from $925 for the three months ended June 30, 2006. This 25% increase is being driven by our buyers who are looking for larger merchandise lots, especially in our scrap business.

The Company continues to have a strong balance sheet. As of June 30, 2007, LSI had $56.1 million of cash, current assets of $77.9 million and total assets of $100.4 million. The company continues to be debt free, current liabilities of $21.1 million and long-term liabilities of $1.5 million for total liabilities of $22.6 million as of June 30, 2007. Stockholders equity totaled $77.8 million at June 30, 2007.

The management team is providing the following guidance for the next quarter and fiscal year 2007. The following forward-looking statements are based on current business trends and our current operating environment, including one, the re-engineering of certain business and inventory processes in our surplus business with the Department of Defense, which has resulted in a slowdown of property received by the DoD. Two, our expectations that there will be a modest increase in the flow of good received by the DoD over the next quarter, three, that we believe we have yet to realize the full potential of recent significant investments and new distribution centers, personnel and value added services necessary to support a much larger commercial business in the future, which has resulted in less than our target profitability. Four, our expectation that we will experience a seasonal slowdown in supplies from several of our historical commercial sellers during the next quarter, five, our expectation that we will not continue to sell certain products during the next quarter upon the completion of a pilot program because we were not able to come to satisfactory terms with the client, and six, the acquisition of STR Inc., which closed on October 16, 2006. Our results may be materially affected by changes in business trends and our operating environment, as well as by other factors, including investments we expect to make in our infrastructure and value added services to support new business in both commercial and public sector markets.

Our scrap contract with the DoD includes an incentive feature, which can increase the amount of profit sharing distribution we receive from 20% to 22%. Payments under this incentive feature are based on the amount of scrap we sold for the DoD to small businesses during the preceding 12 months as of June 30 of each year. We earned $1 million under this incentive feature for the 12 months ended June 30, 2007, and we recorded this amount in the quarter ended June 30, 2007. We are eligible to receive this incentive in each year of the term of the scrap contract. In addition, there are incentive features in our surplus contract that allow us to earn up to an additional 5.5% of the profit sharing distribution above our new base rate of 25%, which began December 1, 2006.

For the purposes of providing guidance regarding our projected financial results for Fiscal Year 2007, we have assumed that we will not receive any of the surplus contract incentive payments, as the period we would be eligible to record such incentive may not occur until Fiscal Year 2008.

Our guidance adjusts EBITDA and Diluted EPS for the effects of the adoption of FAS 123R, which we estimate to be approximately $525,000 to $575,000 for the fourth quarter of fiscal year 2007. We expect GMV for fiscal year 2007 to range from $232 million to $234 million. We expect GMV for Q4 '07 to range from $57 million to $59 million.

We expect Adjusted EBITDA for fiscal year 2007 to range from $18.8 million to $19 million. We expect Adjusted EBITDA for Q4 '07 to range from $4.2 million to $4.4 million. We estimate Adjusted Earnings Per Diluted Share for fiscal year 2007 to be $0.40. In Q4 '07, we estimate Adjusted Earnings Per Diluted Share to be $0.09.

We plan to provide specific guidance for fiscal year 2008 during our next earnings announcement, which will be subsequent to the conclusion of our fiscal year end September 30, 2007. We expect GMV and Adjusted EBITDA will increase approximately 25% and 30%, respectively, for fiscal year 2008.

I will now turn our discussion back over to Bill.

Thank you, Jim.

In closing, LSI is executing in line with our stated objectives through operational and financial discipline. We are very excited about the future. And, we are well positioned to deliver long term growth for our stakeholders as we continue to build on our many strengths, including our large and growing buyer base that offers large lot liquidity for as-is merchandise and the reverse supply chain, our growing transaction database that enables us to effectively merchandise and price goods in the reverse supply chain marketplace, our scaleable technology platform that provides transparency and reach for buyers and sellers and our strong operating cash flows and balance sheet that provide us financial flexibility to invest for future growth, both organically and via acquisitions.

We thank you for your time and attention today, and look forward to answering your questions at this time.

(OPERATOR INSTRUCTIONS)

Your first question comes from the line of Jordan Rohan of RBC Capital Markets.

Hey, guys. I guess the question I have, as I understand your guidance reflects that there is some pilot program goods that are not in next quarter's GMV outlook but were in 3Q numbers. How big was that pilot program? How much of a percentage of the 3Q GMV was it? And, going forward, approximately how much of your GMV flow through is due to these test programs, which may or not be sustainable? I need some sort of guidance on how much stuff we can count on every time as opposed to stuff that might go away. Thanks.

Jordan, thanks for the question. I think, first to give you some context around our business, we don't talk specifically about programs. Programs, pilot programs in particular, are parts of relationships in which for individual clients we may explore multiple avenues to grow the business, including by product category, lot size, level of value added services, such as refurbished product versus as-is product.

These are all important actions that help us understand the needs of a client in growing our business. So, you would generally observe in a commercial marketplace you don't have long term contractual exclusivity as you might see in public sector relationships like we do with the DoD. I think it would be a mistake to assume that the cessation of any individual pilot program is a broader indication of that individual relationship with the seller, because, in most cases, we have multiple programs with individual sellers.

I don't think we have any disclosure as it relates to what specific GMV guidance we give around the notion of things that we are testing, because that is inherently a part of our business. I think our over-arching goal continues to be to test and refine and grow our business, and we have been successful in doing that as I noted in the size of our overall business today, which over the last four quarters, has grown from the range of $51 million to $116 million of GMV. So, we think the direction that we are headed in in this approach is very positive and we will continue to do that.

Jordan, I would add to that that the overall amount of that program was not material and that we don't really have any material specific programs or sellers on the commercial marketplace. However, unplugging a program or replugging one in is an operational delay, which is affecting us in the fourth quarter. You will note from our 2008 objectives that as far as supply to sell in the marketplace, we are not changing our viewpoint on that at all. There is certainly supply available.

Can you give me some understanding of where the goods that were in the pilot program are now being sold or liquidated? What kind of decision did that particular retailer make?

Well, I think one broad comment about the large corporate clients and managers within those companies it comes as no surprise that how they might view economics of a program can differ across company quite widely. I mean, based on the level of cost that they integrated to the sale of excess inventory or returned merchandise and when we look at the economics of our business, they encompass not only the value of the goods but the costs associated with transportation, storage, for the manifesting and moving inventories and performing other value added services such as fraud prevention, which essentially involves a provision of a labeling services so those items are not returned to the store. And, so some clients factor in all those costs and that is the way we look at things.

We look at the total supply chain cost of tracking and selling reverse supply chain merchandise, which is how we delivered an end-to-end solution and a strong value proposition over time. And, clients that don't factor in all those costs may not elect to use an end-to-end solution, and may take a segment of product and sell it to a B to C type of liquidation company. And, over the last five or six years, we have seen from time to time, on a small scale, a business to consumer type of liquidation, player typically a smaller type company with a very narrow focus for a period of time, have an avenue to certain products. I think the challenge there, and we have seen this again and again, is that that model is not a sustainable long-term model, and therefore, not a sustainable value proposition for the client. In many cases, clients have tried that and this is going back to 2000, 2001, 2002, have ultimately come back to our marketplace.

All right. Thank you very much.

Your next question comes from the line of Shawn Milne of Oppenheimer.

Thank you, and good afternoon. I just want to kind of go back to the topic of the guidance in the fourth quarter. Certainly, if you look back to the fourth quarter last year, we saw some seasonality in your commercial business. I believe it declined just a little bit sequentially so, that seems to be a seasonal issue. We can see it certainly around the July 4 week. Jim, can you break-- can you give us a little bit more sense for the guidance in the fourth quarter looking at 58 at the midpoint. Historically, you have not guided your scrap business either as strong as you just put up in the current quarter. Any more granularity around that would be helpful.

And, Bill, the last question was talking about pilots in the commercial business. As you look for-- you give broad strokes for 25% plus volume growth next year. You want to take a stab at what you think the commercial business could grow by? There is certainly some argument in the marketplace that losing one retailer or one partner is sending this business over a cliff. If you can give us a sense of what you are thinking for '08. Thanks.

Shawn, let me start with the three questions you had for me. The first one, a good observation on scrap. We had a record blow out quarter on scrap last quarter. Some great things happened, especially towards the end. I think the continuous flow of scrap material from the DoD has said to us that there is really a new normalized level of that business, a higher level than we would expect, or have expected in the past. That being said, we do see the normal [asset] as not being $15.3 million we hit this quarter. It is going to be less than that by a couple of million dollars, but certainly, what we thought before was more like $11 million to $12 million normalized run rate.

So, we feel good about a higher level there. So, we do expect to see some drop off in scrap. The rest of the drop off from the $62 million, Shawn, I would kind of say most of that was seasonality, or a significant percentage of it. And, then the rest would be related to the pilot program which we're unplugging. And, then we will fill that program with another seller starting towards the end of the quarter or Q1 '08.

And, let me follow up in the second part of your question, Shawn. Just to put into context from where we have come. In the June '06 quarter, the commercial business did roughly $12.5 million of GMV. We just came out of a quarter where I think we did over 120% year-over-year growth, so our incremental growth over the last year has been more than the entire business a year ago. And, I think the size and stature of the companies that we are working with and the strategic nature of how they want to think about using LSI's marketplace and value added services just is, in terms of size and potential financial contribution, significant.

So, whether we have a few instances where we have a cessation of a pilot program, that is a small commentary on the overall goal and opportunity. I think we have, as I mentioned, a number of important relationships that we are building on and we see that there is a great need for our services, not only in the retail big box and department store channels, but also among the vendor base that supply those channels. And, we have probably a greater proportion today of our GMV flowing through the retail business which is accentuating the seasonality.

I think over time that will diversify process supply chain as we become more involved with manufacturers. But, we have a very healthy growth opportunity in the commercial business. I would expect it to grow, significantly better than our secular guidance of 25% top line growth. And, indeed, that is what our forward guidance anticipates.

Okay. Thank you.

Your next question comes from the line of Paul Keung of CIBC World Markets.

Hi, Bill. Hi Jim. Okay, I want to ask about the question about the pilot program, just [for the conclusion] one more time. I guess, from my notes, this is the first time you have had it where that [take the pilot program] and put them on hold or called discontinued. But, when you look through your portfolio, you mentioned you have 10% to 15% penetration of your targeted large seller accounts. When you look through that portfolio after that one discontinuation, would you say the remainder of them, if not most of them, continue to grow their business organically with you year-over-year, well above the 25% pace?

Yes, yes. And let me just remind everyone that the decision to move forward with any particular client or with any particular program or pilot essentially boils down to economic terms. At the end of the day, LSI is focused on ensuring that we receive value for value delivered in terms of our total solution. Our total solution involves the merchandising and transportation and sale of goods, and in some cases, management of the compliance aspects of selling goods to protect brands and channels.

I have to say in the history of business, it is not unusual that two parties may not agree on the economic terms of a relationship. And, we have tended to have a philosophy of not growing our top line at all cost, or at any cost, meaning taking on business that would be break even or unprofitable business for us. And, why that is is because there's ample avenues for growth on the supply side. Yes, there is. When you are dealing with larger clients, it is more complex logistics, and so, really, there are more timing issues around.

Ceasing a certain flow of goods and picking up an alternative set of goods to smooth that transition, but this is a normal part of dealing with larger companies and I think our longer-term guidance is in tact and it is driven by a variety of strong organic growth opportunities with our existing accounts.

Okay. And, I just want to clarify one more time to make sure it is out there. And, your outlook does not include the surplus incentives, any new pilot programs or not even any new customers to your platform. Correct?

Well, first, I think as Jim noted, in the press release as comments, there is no incentives in there. And, as far as the base business growing, it is continuing to do more with existing clients.

Great, okay. And then, another quick question on the STR acquisition. How that acquisition is trending versus the original expectations of $18 million in GMV run rate and given the trend of that, could we see similar types of acquisitions like STR over the balance of the calendar year '07or into '08?

Well, STR has delivered the value that we anticipated and really, we don't think of the business as the discreet sort of standalone business. At this stage of the integration, which will be a year in October, we have cross-pollinated buyers and sellers. There's more that we'd like to do technologically in enhancing the buyer experience of the traditional, and in many cases, larger buyers that STR served relative to the Liquidation Outcome marketplace, but it's been a very value added part of our portfolio and, indeed, on the acquisition front, we would look to a variety of ideas that incorporate traditional liquidators, auction marketplaces, essentially, anything that is complimentary to our base of buyers and sellers.

We'd also have a dimension of screening around capabilities that we think are important to further integrating with our large sellers that involve merchandising and selling assets in the reverse supply chain. I think the company has been very disciplined about acquisitions. This is not a roll up play of any kind. So, we have not done a series of acquisitions on our first four, five, six quarters as a public company, but absolutely we would expect to have acquisitions involving our growth story over time.

I would add, as we said last quarter the integration with STR has gone as we've scheduled and operationally that is running ahead of plan. So, when you talk about the numbers, you mentioned earlier that we originally got into, we are running ahead of that.

Okay, great. Thank you.

Your next question comes from the line of Chris Penny of FBR.

Thank you. A quick question on the pilot program again. How long was that in place for, and how long had you been in discussions with the client as to kind final terms?

Well, I would say you typically looking at programs that would last anywhere from three to nine months. And, you have an ongoing review of the essential terms of the relationship and those encompass multiple aspects, the price of the goods in addition to the underlying services that support moving the goods, storing the goods, preparing them for sale, and that all adds up to what we view as the total cost of managing the supply chain in these areas. We always price the service and consider the incremental cost and benefit of each of those aspects of the program.

Bill, I guess the broader question is, and concerns investors are going to have is, if you look at the revenue of your commercial as a percentage of that GMV. It was-- had started in the low 20's, went to 30-- or mid 20's, went to 30 and the last couple of quarters has kind of come back a little bit. But, along with that and then the pricing impact to this customer, how do we get comfort that this is just-- this pilot program and cancel this customer is just a matter of doing business and really shouldn't be a concern to people, but it's going to keep happening if prices are too high or something like that. How do we get comfortable that this is just a-- that this may only happen one or two times and not start to give a trend where other customers start to push back on pricing?

Well, look, I think it is not-- we have had situations on a recurring basis where the size and flow of goods may expand and contract within the individual customer. This is normal. We have larger clients and we have larger programs because we aspire to be the leading marketplace for the Fortune 500 retail supply chain. And, that means that individual programs on a base of 25 to 30 clients, you may have a more meaningful impact from time to time, but it is clearly the case that we have never had the fact of a single set of products coming in and out of our marketplace limiting our growth. And, I just think you have to look at the last four to six quarters for the proof of that. And, we expect those basic customer value drivers to be the drivers for our business well into the future.

I think what we are pleased by is that, the incremental value of any of the clients we are working with is significantly larger than it was in the June '06 quarter, which is why we set our targets on the types of clients and the types of services we have brought into our marketplace. So, I think our track record demonstrates that we are able to sustain a much larger business. And, during that period, we have had times where clients may not have the same regularity of product or may step back. Sometimes, it is purely on an economic basis, sometimes it is purely on an organizational basis. People come and go from these companies that have no bearing on-- you know, the programs are working on, it is just part of life working with Fortune 500 companies.

Okay. Last question. In the past, you have talked about the STR acquisition. There were some practices or-- that they were doing that you were thinking about extending into the regular liquidity platform. I think a lot of that was going to direct sell through without really going on the site. Is that-- how is that going? Is that something that you are seeing some acceleration in or is that still just kind of in the testing phase?

Well, we mentioned one initiative really is further segmenting the buyer base, understanding the needs of the individual buyer base. And, it is true that if someone is managing a chain of 50 retail brick and mortar stores, they have different needs than someone who is buying merchandise and reselling it on their own online storefront. And so, I think as a natural part of segmenting and growing the buyer base, you want to bring the services that those individual buyer segments require and I think STR came out of an environment where it was able to spend more time with the client up front, because they were spending more money on individual transactions and that's the way it should be.

I think this is a segment of the buyer marketplace that has been slower to move online, but I think is willing to fulfill more of their transactions using an online marketplace concept. And, it is the same concept that we had in targeting and reaching all the traditional brokers and buyers and jobbers of scrap metal and before that, the brokers and buyers and offline players in the military surplus business. So, this is an evolution that has been repeated at least twice in the evolution of LSI and I think we will provide all of the efficiency of automating the transaction process with the relationship of serving your larger buyers.

Okay. Thank you.

Your next question comes from the line of David Lin of William Blair.

Good afternoon, guys. Can you talk about your new GM of the commercial side of the business? I know he's only been there for a few months but in his due diligence process, can you talk about any specific initiatives that he plans on implementing or any changes that he plans on making that would maybe reaccelerate the commercial side of business?

Well, let me say that the business that Tom Schmidt was involved in when he came onboard at LSI was and is a very attractive growth business. And I think our core areas of focus we outlined in our initial remarks. I think we continue to build on our strengths and we intend to further leverage our marketplace and our value added services with Fortune 500 sellers in the retail supply chain. I think, if anything, the rigor of having a divisional general manager, which we had not had before in the history of LSI, brings more focus on new operational process mapping and execution, which is customary as you are building the infrastructure to grow much larger business. I think the relationship pipeline that we have developed and that we are heavily involved with on the commercial side is just moving the needle on the order of magnitude.

It is one thing to deal with small and middle market companies that may only ever sell a million dollars a year versus working with large clients that might sell 10, 20, 50, 100 million dollars of goods a year. And so, it is a much more strategic upfront selling process and a much more comprehensive delivery of the service. So, those are very high return areas for Tom and the asset recovery business that he is stepping into. Those are the areas that we will continue to invest in, as we mentioned, segmenting the buyer base, providing the services to those segments the way they want to be served and adding talent and depth across the entire business as we grow and evolve.

Okay, thanks. And, Jim, as a follow up, did you discuss why technology and operations was down sequentially? Did you talk about that?

I did not. I don't think the technology and operations expenses were not down on a significant basis sequentially, David. I did not think it was material. I would say that on any given quarter, we can have some fluctuations in that line but for the most part, we are running what I would say is a normalized level at this point.

Okay, thanks guys.

Your next question comes from the line of Steve Weinstein of Pacific Crest.

Great. Thank you. Just a follow up question on the pilot program. First, just so we can understand how it is going to float through the P&L. Was this a program where you were reporting the revenue on a gross or a net basis? And then, second, it sounds like you had anticipated that this program would continue through this September quarter and now it's not, so I'm wondering was this a contract that they could just get out of whenever they wanted to? Was there a trigger you needed to hit? And, how does that relate to us having confidence in these other pilot programs, which it sounds like you have a number in the works.

Well, let me just comment on the nature of our business, and the nature of a marketplace. I think the marketplace ultimately is a spot marketplace. You know, folks that we have developed relationships and business with have no long-term contractual exclusivity to Liquidity Services, unlike in the public sector arena where there is no termination for convenience clauses.

That said, the scale of the types of programs that we're working on involve an investment on both sides to organize the flow of goods, organize the level of compliance management, fraud prevention, organize the use of either client distribution centers or our distribution center hubs which gives us a lot of visibility around the business and higher switching costs from these sellers.

And, when it comes to an individual case, I have to say we would certainly point out that it is rare in our history that we would not continue programs, but if the economic terms are not prudent, we would quickly make the call not to continue a program. And, I think that's just a philosophy and approach that we have in growing the business and having an emphasis on profitable growth and realizing that there is no binding constraint on the supplies out of our marketplace.

And so, when you get into the economics, again, you have to factor in not just the price at which you sell the goods, but your total costs of serving the client or a program, which incorporate costs around physically transporting the goods, storing the goods, manipulating the merchandise. That can include refurbishing goods to labeling goods and all of those are a cost of doing business that we factor into each and every situation with larger clients and for the most part, we have preserved and compounded our growth profitably and we expect to do that in the future.

Okay, and on the gross or net basis.

Steve, actually the program had components of both.

Okay.

So, it was a hybrid type of program that we had. And, so it will affect both lines.

Okay. All right, thanks.

Your next question comes from the line of Scott Devitt of Stifel Nicholas.

Thanks. On the commercial business, the ratio of consignment to purchase inventory has changed pretty materially even after you exclude the STR transaction and it has continued over the past two quarters. I was wondering if you could just walk us through the deals that you are signing, like clients are not accepting the consignment model as they have been historically, and then-- the reason I ask is because your cash flow statement this year looks just dramatically different than it did last year. Year to date, I think operating cash flow is actually negative for the year. Thanks.

Sure. Well first, let's understand that when we are going into a larger company and most cases, that company is accustomed to selling goods to a traditional liquidator and that behavioral aspect is something that we are not intending to change day one. And, therefore, we are very comfortable having outright purchase arrangements for profit sharing relationships that incorporate the relative cost of serving that client and then measuring those results over time.

So, I think the fact that we are disciplined about monitoring and managing programs and not running our business at all costs is important for owners of LSI to bear in mind that we have a wonderful data warehouse of how goods are priced in the reverse supply chain. And, we incorporate that data in supporting the individual pricing models and relationships to grow the business. And ultimately, the highest value on a total supply chain cost to that client we believe is derived from either a profit sharing model or a consignment model. But, the client has to go at their own pace, and we are very comfortable with that.

So, when you closed the STR deal, I believe you said that you anticipated the capacity to shift some of the gross purchase inventory from STR to net. And actually, what's happened is it seems like STR has stayed constant as a purchase business and actually, your core commercial businesses has shifted pretty significantly from consignment to purchase. So, it is similar to the first question, but do you anticipate that that trend will continue or, given your comment in terms of what you are saying about it being early in some of the agreements, do you anticipate that that ratio will shift back towards to consignment?

Well, let me just first say that in many cases, the substance of what you would deem a purchase relationship is a neutral working capital event in the timing of cash flow. And, that relates to, not only the historical STR business, but our overall business in the commercial segment, i.e., we have items where for an accounting or financial control reason, there would be an invoice generated to make the ledger entry. The goods are presented, competed and priced with a buyer. The funds are collected by LSI prior to having any remittance to the seller for the cost of those goods. So, from a timing perspective, they are not terribly constraining in terms of working capital. But, we manage our business, as we have said, for a long time on contribution margin. And, we manage our business to drive similar EBITDA contribution margins whether it is a consignment, a profit share or an outright purchase model. And, that has been our philosophy and we are not going to change our philosophy. Thanks.

You have a follow up question from the line of Shawn Milne of Oppenheimer.

Thanks. I wanted to go back. There was an earlier comment that maybe questioned your pricing model in the commercial business. I think if I heard you correctly, you were trying to indicate at least there were both sides of this potential of the pilot program may not have been happy with the results. As I understand the commercial business, there was certainly a pilot or a customer out there that we can follow that had much lower average selling prices per lot size. Given that your variable costs are driven on a per lot basis, to me that client did not seem to be as profitable from your standpoint. Is that an accurate comment? Is that something that weighed into your decision making?

Well, let me just reiterate what I said earlier, just give a tangible example. Clearly, all clients, all products are not equal relative to the value of the item and the incremental costs of processing the item for sale. An example, if I had a pallet of paper towels and I were to touch and manipulate and move that pallet, it's going to cost me about the same per pallet of paper towels as it would a pallet of DVD or high end consumer electronics. So, there is a marginal cost that is relatively fixed per certain level of value added services. And, so certainly, for lower value products, all things being equal, you are going to have lower contribution margins, and dare I say, negative contribution margins if it's not priced correctly.

Now, with all of our pilot programs, we factor those in. So, we have variable pricing, as we've said for a while, on the level of value added services that we provide. And so, the question might come in terms of negotiating the terms of a program relationship, what is the level of value added services that is appropriate or desired. And, what is the relative cost of handling that pallet of merchandise. And, the relative attractiveness of low value goods means that you are going to be able to afford only so much touching and handling of that merchandise. So, we would take that into account in any program and certainly for folks that desire a high level of value added services, we feel that there is an appropriate price list for those services and that is what we incorporate into our pricing models.

Okay.

Ladies and gentlemen, this concludes the presentation. Jim Rallo will take any follow up questions. His direct line is 202-558-6207.