Liquidity Services Inc (LQDT) 2009 Q2 法說會逐字稿

Good day ladies and gentlemen and welcome to the Second Quarter 2009 Liquidity Services Inc. Earnings Conference Call. My name is Josh and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question and answer session towards the end of this conference. (OPERATOR INSTRUCTIONS) I'd now like to turn the presentation over to our host for today's call, Director of Investor Relations, Julie Davis. You may proceed ma'am.

Thank you Josh. Good afternoon and welcome to Liquidity Services Inc.'s earnings release conference call for fiscal second quarter 2009 and the three months ending March 31st, 2009. 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 conference 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'd 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 plans. 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 speak 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 a substitute for or superior to GAAP results.

A reconciliation of all non-GAAP measures included in this conference call to the nearest GAAP measure can be found in 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. The supplemental operating data includes GMV and should not be considered a substitute for or superior to GAAP results.

At this time, I'd like to turn the presentation over to our CEO, Bill Angrick.

Thank you and good afternoon. Welcome to our Q2 earnings call. I'll begin this session by reviewing our Q2 financial performance and then outline our progress against the major initiatives we established for the current fiscal year. Then I will turn it over to Jim Rallo for more details on the quarter and on our business outlook for the year.

In summary, LSI is navigating the current economic downturn quite well and we are in a very strong position to accelerate our growth during the balance of fiscal year 2009. Despite continued tough economic conditions, Q2 GMV was $91.2 million, up 3% over last year's results and above our guidance range. Q2 adjusted EBITDA was down 4% from last year and above our guidance range. Q2 adjusted EPS was $0.09 and at the high end of our guidance range.

It is worth noting that adjusted EBITDA and EPS for Q2 were sharply up from Q1 driven by improved margins in our commercial business and the rollout of our new surplus contract with the DOD, which had its first significant month of operations in March. These efficiencies contributed to LSI generating $5.7 million of operating cash flow during Q2.

Let's take a look at the Q2 results of each of our major businesses. GMV in our DOD Surplus business was down 8% from the prior year during Q2 as our new surplus contract contributed materially to only the last month of the quarter. As we ramp this business under the new contract, we expect to resume year-over-year growth with improved margins.

GMV in our DOD Scrap business was down 13% sequentially and 48% from the prior year due to a decrease in scrap metal prices caused by the economic recession. However, volumes have remained steady and prices have stabilized recently. Any improvement in the macro economy will likely have a positive impact on this part of our business.

GMV in our US Commercial business grew approximately 22% over the prior year period and 29% sequentially as a result of increased penetration of existing customers, who are seeking more value in the reverse supply chain during these difficult economic times. I'll comment on the progress our team is making in the areas of operations and business development within our Commercial business in a movement.

GMV in our GovDeals business grew approximately 22% over the prior year period and 24% sequentially as we added 162 new municipal government agency sellers during the quarter. We are very pleased with the progress of our GovDeals business in addressing the $2 billion municipal government surplus market. Our brand awareness continues to grow and municipal government agencies are increasingly using our marketplace to improve transparency around the sales process as well as to recover more value from surplus assets to address budgetary deficits.

Finally, our buyer marketplace continues to deliver strong results for our sellers as we ended the quarter with over 1.1 million registered buyers, which is up approximately 24% over the prior year period, including the addition of a record 65,000 new registered buyers during Q2. Transaction volume was up approximately 32% over the prior year period driven by a record number of 557,000 auction participants, illustrating that our marketplace is increasingly attractive to buyers in a down economy.

Next, I would like to recap the key initiatives we outlined for fiscal 2009 to position LSI for long-term growth. Our first initiative is the successful launch of our new DOD surplus contract. The rollout of our new surplus contract is on track and we expect to be fully ramped up during the new contract-- under the new contract during the June quarter. Our team has done a fine job addressing the DOD storage and inventory assurance requirements as we begin to bring surplus property to market under the new program. We are also exploring numerous initiatives to improve the lotting and merchandising of this property, to enhance recovery rates over time, which will expand margins in this business.

Our second initiative for fiscal '09 is to improve operations and service levels in our commercial business. Specifically, we've focused on improving our operational throughput, overall quality, and customer service. Our team continues to make terrific progress in these areas. Inventory turnover during Q2 was an average of 38 days, down from 64 days in the December quarter, representing a 41% improvement in 3 months.

Consequently, we have created the capacity to further scale our commercial business and our distribution centers. We estimate that we could increase the GMV flowing through our commercial distribution network by threefold with marginal additional fixed costs. We have improved our account management processes and recorded consecutive record months of closed auctions during the March quarter. We have improved our level of customer service, resulting in a steady decline in the percentage of disputed transactions, resulting in a high conversion rate and greater buyer customer retention.

The increased level of trust with our buyers reinforces the virtuous cycle of attracting more demand and supply to our marketplace. In fact, the number of transactions in our commercial business was up 50% over last year and the number of auction participants in our commercial business was up 28% over last year during Q2.

Our third initiative is to make our marketplaces more flexible and easier to use for sellers and buyers. We currently have several technology projects underway that will make it easier for sellers to list and sell goods through our platform from their own retail store and/or warehouse location. We are also advancing several projects to make our online marketplace more convenient for buyers to find and purchase goods, both in the US and UK. We've recently improved the quality of information that buyers receive during the auction process. And based on buyer feedback, we have expanded the variety of lot sizes and product categories on our marketplace, which has resulted in record buyer participation during Q2.

Our fourth initiative is to expand and further segment our seller and buyer base to increase their participation. With over two million annual auction participants and growing, we are the largest and most transparent marketplace for surplus goods. And thus, have a tremendous opportunity to further expand our base of sellers. As we ramp up our business development efforts, we are seeing increased interest in our service in all segments of the supply chain, including retailers, manufacturers, and reverse logistics service providers. While growth in Q2 was primarily a result of doing more volume with existing sellers, we expect to expand the number of middle market and Fortune 500 sellers during the second half of fiscal '09 based on the progress our business development team is making.

This is a great time for LSI to be in the market telling our story, as large organizations are intensely pursuing cost reductions, efficiencies as well as improved transparency. We believe they are more receptive to LSI's solutions.

With respect to buyers, we have added new product categories like gaming systems, household appliances, jewelry, and non-perishable foods to our marketplace. The greater breadth and depth of product we have available reinforces buyer participation and in turn, seller participation as they can access greater liquidity and efficient market pricing for a variety of goods. This combination of strong buyer demand and increased supply will continue to fuel LSI's growth.

Now I'll turn it over to Jim for more details on the quarter and our business outlook.

Thanks Bill. The amount of gross merchandise volume or GMV increased $3 million or 3.4% to $91.2 million for the 3 months ended March 31, 2009, from $88.2 million for the 3 months ended March 31, 2008, primarily due to; one, our commercial business which grew 21.7% and generated 41.3% of our revenue and 42.3% of our GMV for the 3 months ended March 31, 2009, as compared to 32.1% and 35.9% respectively for the 3 months ended March 31, 2008; two, our GovDeals business, which also grew 21.7% and generated 2.4% of our revenue and 21.2% of our GMV for the 3 months ended March 31, 2009, as compared to 1.8% and 18% respectively for the 3 months ended March 31, 2008; and three, the acquisition of Geneva completed on May 1st, 2008, which generated 5.4% of our revenue and 3.6% of our GMV for the 3 months ended March 31, 2009.

Revenue decreased $3.1 million or 5% to $59.7 million for the 3 months ended March 31, 2009, from $62.8 million for the 3 months ended March 31, 2008. This is primarily due to a 48.2% decrease in our scrap business, which utilizes the profit-sharing model as a result of decreasing commodity prices. This business generated 15.9% of our revenue and 10.4% of our GMV for the 3 months ended March 31, 2009, as compared to 29.1% and 20.7% respectively for the 3 months ended March 31, 2008.

GMV and revenue continued to diversify due to the continued growth in our US Commercial and GovDeals businesses and the addition of our international commercial business. As a result, the percentage of GMV and revenue derived from our DOD contracts during the 3 months ended March 31, 2009, decreased to 31.6% and 48.2% respectively compared to 44.6% and 62.6% respectively in the prior-year period.

Cost of goods sold, excluding amortization, increased $6.5 million or 40.5% to $22.7 million for the 3 months ended March 31, 2009, from $16.2 million for the 3 months ended March 31, 2008. As a percentage of revenue, cost of goods sold, excluding amortization, increased to 38% from 25.7%. These increases are primarily due to; one, the acquisition of Geneva, which was completed on May 1, 2008 and utilizes the purchase model, which is a higher cost of goods sold than the profit-sharing model; two, the decrease in our scrap business revenue which utilizes the profit-sharing model; and three, the new surplus contract, which began significant sales during March 2009 and also utilizes the purchase model.

Profit-sharing distributions decreased $10.8 million or 47.9% to $11.8 million for the 3 months ended March 31, 2009, from $22.6 million for the 3 months ended March 31, 2008. As a percentage of revenue, profit-sharing distributions decreased to 19.8% from 36%. These decreases are primarily due to a 48.2% decrease in our scrap business.

Technology and operations expenses increased $1.4 million or 13.4% to $11.7 million for the 3 months ended March 31, 2009, from $10.3 million for the 3 months ended March 31, 2008. As a percentage of revenue, these expenses increased to 19.6% from 16.4%. These increases are primarily due to; one, the decrease of 48.2% in revenue from our scrap business while incurring similar operational costs as pounds of scrap sold during the 2 periods were not materially different; two, the rollout of operations associated with our new surplus contract; three, expenses of $900,000 associated with our commercial business needed to support its 21.7% growth; and four, expenses of $400,000 associated with Geneva, which was acquired on May 1st, 2008.

Sales and marketing expenses increased $600,000 or 14.2% to $4.5 million for the 3 months ended March 31, 2009, from $3.9 million for the 3 months ended March 31, 2008. As a percentage of revenue, these expenses increased to 7.5% from 6.2%. These increases are primarily due to our hiring of 29 additional sales and marketing personnel.

General and administrative expenses decreased $200,000 or 2.7% to $5.1 million for the 3 months ended March 31, 2009, from $5.3 million for the 3 months ended March 31, 2008, primarily due to a decrease in executive bonuses, which are tied to the profitability and growth of the Company. As a percentage of revenue, these expenses increased to 8.6% from 8.4% primarily due to the 5% decrease in revenue.

The Company had strong cash flow generation and growth during the quarter. LSI generated $5.7 million of operating cash flow during the 3 months ended March 31, 2009, an increase of $1.9 million or 47.6% over the $3.8 million of operating cash flow during the 3 months ended March 31, 2008.

Adjusted earnings before interest, taxes, depreciation, and amortization or adjusted EBITDA decreased $200,000 or 4.3% to $5.5 million for the 3 months ended March 31, 2009, from $5.7 million for the 3 months ended March 31, 2008.

Adjusted net income decreased $800,000 and 24.2% to $2.5 million for the 3 months ended March 31, 2009, from $3.3 million for the 3 months ended March 31, 2008.

Adjusted diluted earnings per share decreased $0.03 or 25% to $0.09 for the 3 months ended March 31, 2009, based on approximately 27.8 million diluted weighted average shares outstanding from $0.12 for the 3 months ended March 31, 2008, based on approximately 28.3 million diluted weighted average shares outstanding.

I'll now discuss the Company's other key operating metrics as I've already touched on GMV, which management believes allows us to monitor the success of our marketing programs as well as our [lotting] and merchandising strategy. During the last 12 months, we also benefited from our ability to more effectively market assets to potential buyers. Our marketing efforts resulted in a 24.5% increase in registered buyers to approximately 1,111,000 at March 31, 2009, from approximately 892,000 on March 31, 2008.

Auction participants increased to 557,000 for the 3 months ended March 31, 2009, representing an increase of 93,000 or 20.2% over the 463,000 auction participants for the 3 months ended March 31, 2008.

Completed transactions increased 29,000 or 31.6% to approximately 120,000 for the 3 months ended March 31, 2009, from approximately 91,000 for the 3 months ended March 31, 2008.

The Company continues to have a strong balance sheet. On March 31, 2009, LSI had $54 million of cash, current assets of $79.4 million and total assets of $124.4 million. The Company continues to be debt free with current liabilities of $27.9 million and long-term liabilities of $2.9 million for total liabilities of $30.8 million at March 31, 2009. Stockholders' equity totaled $93.6 million at March 31, 2009.

Capital expenditures during the 3 months ended March 31, 2009, were $1.1 million. We expect capital expenditures to be $3 million to $3.5 million for fiscal year ended September 30, 2009.

The management team is providing the following guidance for the next quarter and fiscal year 2009. The following forward-looking statements take into account that we are in a period of economic uncertainty and unprecedented market volatility, which makes it difficult for us to forecast business trends resulting in a wider than usual guidance range. In the short term, we believe changes in consumer spending patterns may impact the overall supply of goods in the reverse supply chain and the volume and value of those goods sold in our commercial marketplace. In the longer term, we expect our business to benefit from the following trends; one, as consumers trade down and seek greater value, we anticipate stronger buyer demand for the surplus merchandise sold on our marketplace; two, as corporations and public sector agencies focus on reducing costs, improving transparency, and working capital flows by outsourcing in reverse supply chain activities, we expect our seller base to increase; and three, as corporations and public sector agencies increasingly prefer service providers with a proven track record and demonstrated financial strength, we expect our competitive position to strengthen.

The following forward-looking statements also reflect the following trends and assumptions for the next quarter and fiscal year 2009. One, reduced commodity prices, which will continue to result in decreases in GMV and profit realized in our scrap business compared to fiscal year 2008. Two, lower average sales prices realized in our commercial, state and local government marketplaces compared to fiscal year 2008. Three, new business rules under our new DOD surplus contract, which will remove selected items from the product pool we have historically handled and sold, resulting in lower GMV in our surplus business. Four, upfront costs associated with launching our new DOD surplus contract including the hiring of new staff and the opening of two new warehouses totaling 665,000 square feet in Columbus, Ohio, and Oklahoma City, Oklahoma. Five, our expectation that we will achieve full implementation of our new surplus contract in the third quarter of fiscal 2009. Six, the continued sale throughout fiscal year 2009 of property issued prior to December 18th, 2008, under our original surplus contract. Seven, improved operations and service levels in our commercial business, which we expect will continue to improve margins during the last two quarters of fiscal year 2009. And eight, an increase in our expected effective income tax rate from 43% in fiscal year 2008 to 46% for fiscal year 2009 as a result of non-deductible stock-based compensation costs increasing in proportion to our US-based taxable income.

Our results may also be materially affected by changes in business trends and our operating environment and by other factors such as investments in 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 23% up to 25%. Payments under this incentive feature are based on the amount of scrap we sell for the DOD to small businesses during the proceeding 12 months as of June 30th of each year. We are eligible to receive this incentive in each year of the term of the scrap contract and have assumed for purposes of providing guidance regarding our projected financial results for the next quarter and fiscal 2009 that we will again receive this incentive payment.

We expect GMV for fiscal year 2009 to range from $355 million to $370 million, which is unchanged from our previous estimate. We expect GMV for the fiscal third quarter of 2009 to range from $94 million to $98 million.

We expect adjusted EBITDA for fiscal year 2009 to range from $25.5-- I'm sorry, $22.5 million to $26.5 million, which is unchanged from our previous estimate. We expect adjusted EBITDA for the fiscal third quarter of 2009 to range from $8.7 million to $9.4 million.

We estimate adjusted earnings per diluted share for fiscal year 2009 to range from $0.45 to $0.47, which is unchanged from our previous estimate. For the fiscal third quarter of 2009, we estimate adjusted earnings per diluted share to be $0.16 to $0.17. This guidance reflects the recent impact of our stock repurchase program under which we repurchased 707,462 shares for approximately $3.9 million during the prior quarter. However, it does not assume that we will continue to repurchase shares with the approximately $6.1 million yet to be expended under the program.

Our guidance adjust EBITDA and diluted EPS for the effects of FAS 123(R), which we estimate to be approximately $1.6 million to $1.7 million per quarter for the remaining 2 quarters of fiscal year 2009.

I will now turn the discussion back over to Bill for closing comments.

Thanks Jim. In summary, as we noted at the beginning of the current fiscal year, we do expect to build a stronger business as a result of the actions we have taken in support of our strategic initiatives for fiscal year 2009. Our team is executing well and we have a more diversified, higher margin, overall business.

We have favorable cash flow dynamics with negative working capital requirements and excellent returns on invested capital. We have built the leading e-commerce marketplace with the largest buyer base, addressing the $100 billion reverse supply chain market opportunity. And we have the financial strength and operating discipline to invest in future growth to create long-term value for our stockholders. The bottom line is that we have a very strong competitive position that we continue to expect to strengthen during the balance of fiscal year 2009.

That concludes our remarks and we're pleased to take questions from those on the call.

Thank you very much sir. (OPERATOR INSTRUCTIONS) And our first question comes from the line of Shawn Milne from Janney Montgomery Scott. Shawn, you may proceed.

Hey, good afternoon. It's Shawn Milne from Janney Montgomery. A couple questions and thanks for taking my questions. And I apologize in advance for the background noise. But Bill good solid commercial growth this quarter. Can you talk about the linearity in the quarter? Did you see better growth in March? It sounded like it was and our data would suggest that it did. And in terms of the pipeline of new partners, when can we start to see that come on to the platform and potentially accelerate growth? And then Jim, if you could address the margin potential in terms of increased operating efficiencies in your commercial business? You know what kind of magnitude are we potentially looking at here? Thank you very much.

Sure, I'll take the first part of the question. With regard to the commercial business, we've seen consecutive months, really dating back to November of improving auction volume, buyer participation, recovery rates, and therefore GMV. Now it is true March is a seasonally longer month than others yet the recurring ramp that we're seeing across the buyer and seller side is very encouraging for commercial.

As we noted one quarter ago, we have invested in expanding the size of our business development team. We brought two new directors on in early March. So we expect to get traction and some of the prospects in that pipeline during the second half of the year. By way of example, we're looking at expanding into new product verticals such as personal care and accessories, non-perishable food, appliances, certain branded apparel items, a variety of gaming systems and consoles. So there's a wide range of Fortune 500 retail and manufacturing prospects in that funnel. And I do believe we're going to see the benefit of that.

And I think I would add that one of the reasons we've had such a focus on operational productivity and efficiency is we want to create the capacity, given what we observed in our business development pipeline. When you look at the inventory turnover numbers, you know I've been around a lot of traditional distribution businesses. To improve as rapidly as we've improved in the span of three months, in terms of throughput and velocity, is a real testament to the team but also I think our acknowledgment that we have some neat opportunities on the business development side and need to have that capacity.

So we're well positioned to execute during the last half of the year. And that's part of the margin story that you saw in the March quarter. And I think that will continue.

Shawn, the last part of your question on the margins. I mean as we had predicted in the beginning of the year, we expect significant margin improvement in the back half of the year. That's really being driven by two components of the business. One is the commercial business which has seen improving margins throughout the year. We do anticipate that to continue. As Bill mentioned in his comments, we've seen significant operating efficiencies gained particularly in the last quarter alone, where we went from 64 days of inventory turns in the commercial business down to 38 days in a single quarter. Now, we're not anticipating those kind of gains throughout the rest of the year, but again we do expect to get further operating efficiencies out of the commercial business. In addition, we'll have a margin pickup as we'll finally get significant contribution out of the new surplus contract, which again from my comments earlier on the call, you know we really just rolled out in the month of March for our first full month of operations.

So we're looking at margins really in the back half of the year on a GMV basis that are somewhere between 9% and 10% EBITDA to GMV. And on a GAAP revenue basis, adjusted EBITDA to GAAP revenue, you're talking somewhere between 14% and 15% probably for the back half of the year, which would get you on a full year basis to margins that are in line with last year, maybe slightly above last year's margins. And then we expect to have to continue I guess well of those improvements into 2010. So we would continue to expect margins that I would say are the-- on a GMV basis and kind of the higher single digits, lower double digits. And on a GAAP revenue basis, kind of low teens, maybe 12.5% to 14%, something like that Shawn.

Okay, thank you very much.

And our next question comes from the line of Sri Anantha from Oppenheimer. Sri, you may proceed.

Yes, thank you. Bill, I know in your prepared remarks you mentioned about stabilization in scrap pricing. Have you guys seen that in your transactions today? That's the first question. Second one, I know in the prior calls you talked about the ASPs declining in your commercial business even though volumes have been pretty strong. Are we still seeing those ASP declines or are you beginning to-- or are you beginning to see stabilization in the ASP declines? Thank you.

Thank you for the question. With regard to our scrap business, well as you know, all of our results have been not withstanding a significant year-over-year decline in scrap, roughly 50% year-over-year declines. Yet, in the last 60 days or so, we have seen stabilization Sri of scrap pricing. In fact, in some categories like copper and brass, you've even seen a little bit of an uptick.

It's been noted in a number of statements this week around the world that you're seeing some ramp in production in places like China, stimulating the flow of material and construction activity and all of that trickles back into the scrap marketplace. I would remind listeners that our guidance for fiscal 2009 does not include a recovery of the scrap marketplace. But we call it as we see it every quarter. And we see stabilization, which is welcome and certainly any improvement would create additional contribution margin, which falls mostly to the bottom line for the business.

With regard to the commercial and I'll add public sector arena, we have as well seen stabilization of pricing. I think what affected pricing was the dramatic overhang of supply in the November/December timeframe in retail supply chain. As a result, most retailers adopted an aggressive in-store discounting posture to flush through that inventory. And that overhang of supply affected the secondary marketplace as well.

I think heading into the June quarter, a lot of those issues have been addressed by retailers. You know the queue of Chapter 7 situation seems to be lightening up as well. When you have companies like Circuit City declare bankruptcy and several billion dollars of product, in certain categories like consumer electronics coming into the marketplace that can affect pricing.

The culture and mindset however of our team has been to be very proactive in managing changes in street retail prices. And I would amplify that our contracts and relationships typically stipulate that any profit sharing or other pricing reflects current retail street pricing so that we are not penalizing the short term for any broad changes in pricing.

Buyer demand has resulted in increasing buyer participation in our commercial business, which has the effect of driving higher recovery rates. So we've seen that February over January, March over February. So as that continues that bodes well for the second half of the year.

Yes, thanks Bill. And Jim, one just quick question. I know you guys have taken a number of restructuring initiatives. Are we seeing the benefits of all those initiatives? And is 2Q a good baseline going forward? Thanks.

Yes, Sri. Actually I think we're starting to see the benefit of those initiatives. And in fact, we'll continue to see the benefit for Q3 and Q4. And so that I would not run rate your margin assumptions for Q2 as I think that we'll gain operating efficiencies as I discussed earlier, answering Shawn's question. And I think Q3 and Q4 will be much stronger.

We're due-- I do want to point out to everyone that remember in Q3, our next quarter that is, we do receive a scrap incentive. So that does kind of skew things a little bit, meaning that the profit-sharing distribution will be lower. Our estimate for that this year is I'll say approximately $1 million. But stripping that out, you're still going to see margin improvements from Q3 over Q2.

And I think the other thing is maybe restructuring is not a perfect adjective. We had front loaded a lot of investment to prepare for the new DOD surplus contract, people, 665,000 square feet of warehouse space. So we had an overhang of capacity, carried through the first part of this year that we're finally getting some leverage on. So that's also driving additional margin.

Thanks Bill. Thanks Jim.

And our next question comes from the line of Colin Sebastian from Lazard. Colin, you may proceed.

Okay, thanks and good afternoon. I guess first let me follow up on the earlier questions on the commercial segment, which if I'm doing the math correctly accounted for about 46% of GMV and I think is the highest level it's been for a couple of years. So my question is what portion of this growth would be attributable from the weaker holiday retail? And given the leaner inventory and production levels that you talked about now, sort of in the middle of this year, do you have any concern that the supply of commercial goods on the marketplace might taper off? And then secondly, if you could provide a little more color on the purchase model in the commercial segment, which stepped up a bit in the quarter? Is this related to a particular partner? And more generally, what is the profile of partners who are typically taking advantage of this model?

So thank you for the question Colin. I'll address the first part of it and then pass it on to Jim regarding purchase model.

So, on the commercial business there are at least three things that are helping drive GMV in our model. First, we're an auction model. So we're all about driving the maximum amount of competition to each and every auction. And the buyer base that we have continues to grow. We have more customers. We have more auction participants for each completed transaction, which has a very positive impact on both our sellers' experience in terms of financial recovery and also on our economic model because independent of prevailing trends, you know the more people bidding for that item, we're going to get a higher average sale price and result. And as I mentioned in my first response to Shawn Milne, we've seen continued record growth in the buyer participation as we've moved through the quarter. So that bodes well for us in terms of seller satisfaction, in terms of getting the maximum economic return out of our merchandising and auction activities.

With regard to supply-- well yes the US economy shrunk in the last quarter. So we're down 6% in GDP. Well fewer goods going through the marketplace. But this is a $100 billion marketplace. We process just under $40 million during the quarter, $160 million annualized. So we're a very small percent of retail supply chain. And therefore, this macro trend will not limit us as we build out our client base. And we're building out the client base on the seller side with enterprise customers; Fortune 500 retailers who retail finish goods in brick and mortar stores, whether it be warehouse clubs, big box retail store chains or department store chains.

And across the economy, people are focused on how do I get lean and drive efficiency in my core business? And how do I find ways to be partnering with best of breed players for things that they don't view as core? Which reverse supply chain is, it's non-core to these clients' businesses. So we're benefiting from that. And the word-of-mouth credibility, the fact that we're processing more and more volume each and every day reduces the risk for these large players to align their companies with our company.

The other piece of seller growth is the middle market, the small midsize businesses that have the need to be in the market selling, recovering working capital to grow. And that's an area of growth. And a lot of the technology and issues we have are making it easier for those mid-market sellers to use our platform, upload their products and manifest easier. And they're getting the same benefit of this buyer base that the large sellers are. So we expect that middle market to grow.

And this compounds. You know there are about 300 companies that are what I'd call Fortune 500 size companies that can move significant volumes, $30 million, $40 million, $50 million of GMV each. And that's who we're targeting. And systematically we're presenting our offering and driving progress.

So that in our mind is a huge opportunity that we intend to take advantage of and probably the best possible window of opportunity, which is this slow growth economy, which elevates the role of reverse supply chain up the list of strategic priorities for decision makers in the companies that we're prospecting.

Now I think the last part of your question was related to purchase model.

Yes, so a couple quick things there Colin. One, the commercial business accounted for just over 42% of the total business on the GMV basis. That actually is the strongest quarter we've had. So you are correct. It is obviously the major component of the Company right now. That's no surprise given the growth rates that it continues to have. We will expect that obviously to expand further over the next several quarters.

On the purchase model, the purchase model was up slightly this quarter. Purchase model was about 42% of the commercial business last quarter. It is 48% of the commercial business this quarter. So a 6% change.

I mean as you know we don't necessarily control that. I would tell you that really it was just the mix of goods. In particular, we had one of our larger consignment sellers that did have a slight pause this quarter in product moving to us. And obviously we had good growth this quarter in the commercial business. We have plenty of product to move. But it just so happened that we moved a little bit more purchase model product than consignment. Again I would expect that mix to be somewhere around where it is the last two quarters as we continue throughout the year.

Okay thanks. And then just lastly on the GovDeals side, which performed very well in the quarter, was there anything specific or one time in nature about that segment in the quarter or is this the pace of growth we should expect from the segment over the next couple of quarters? It sounds like you had some-- a good number of adds, new partner adds.

With regard to the municipal government agency market opportunity, this is a market of 60,000 cities, towns as well as the 50 states. It's a very interesting and very fragmented market. And I think one of the virtues of the GovDeals business is there is no customer concentration of any material level. So we're simply executing strategy of expanding one, the volume of goods and participation of our existing sellers. And we've continued to invest in our outreach to support existing sellers. We brought on a new vice president of client services in that organization just within the last 30 days.

So it's an interesting time for public sector agencies. Receipts are down. Costs are well ahead of revenue. And so they're looking for creative ways to fill budgetary deficits. And GovDeals has an outstanding value proposition to bring to the table. And these agencies are embracing it. And so that's helping drive activity Colin.

Second, that brand name and frankly the word-of-mouth referral within the municipal government arena is very strong. So the brand and the value add that we're bringing with other clients is helping us bring new clients on board. And that's helping us fuel growth.

So to grow that business 20% to 25% year over year consistently has been the track record we believe will continue to be the track record. And it's another way that the company has multiple engines for growth as we move to the second half of the year.

Yes Colin. Also as a reminder, the fiscal third quarter, which is coming up here, is the seasonally high quarter for GovDeals. That is typically when there is a lot activity within the municipal sector there. And so there's a lot of assets being sold. So we don't, as you mentioned earlier, was there something one-time in nature, we don't expect that. We do expect sequentially a growth quarter for the Company.

Thank you very much.

And our next question comes from the line of Stephen Ju from RBC Capital Markets. Stephen, you may proceed.

Afternoon guys. Circling back on the GovDeals side of things again, it looks like the implied takeaway for that segment is about 7.5%, which seems to lag the other parts of the Company. Any chance to take this up over the course of time? And also any change in the competitive landscape? Recall last quarter you guys were talking about how some of your competitors were falling by the way side or running into some difficulties. And as you walk in and pitch your services to new clients, are you indeed seeing less competition? And are you starting to see some of the clients come back to you guys because those competitors are now gone? Thanks.

Thanks for the question Steve. With regard to GovDeals, well GovDeals, its inception to date has styled itself as a seller, self-service model. So once a client is enrolled and signed up and executes a contract, that seller's able to list its own assets and collect its own money and leverage the GovDeals marketplace and buyer base and auction model. There are some other value-added services it provides such as a reutilization tool if assets would be offered to other government users before going to the marketplace.

So 7.5% is appropriate for the level of-- the base offering. And yet what we've seen is a number of these agencies who are facing staff reductions or cost reductions as a result of the budgetary deficit they face, are looking for us to step in and provide more services.

And one of the things that we observed as an opportunity and we are pursuing is to provide financial settlement services to those municipal government clients such that LSI/GovDeals handles the payment by providing online payment tools. We collect a buyer premium in return for providing those services, which would have a material impact on our overall take rate. And that program has been launched. It has been well received. It's steadily gaining increasing acceptance. And so over time and I don't have a date certain but over time we do expect that to possibly influence the take rate, but also create a stronger value proposition for buyers.

Buyers want the convenience of paying online. If they can pay online, they can remit funds more expediently to the seller. The seller can get their money, get their funds more rapidly. They can in fact fund their agency needs. So this is a win-win for all parties by introducing this financial settlement services, which we do provide on the commercial side and with our federal government clients. So that's what I would say about GovDeals.

With regards to the competitive landscape, I think this is a huge opportunity. I mean if we were to draw up on the board some dream scenarios, the fact that you'd have a down-- an economic downturn where sellers actually do want to have transparency around the vendors and suppliers and partners they're working with, plays to our strength. The fact that we have strong capitalization, the fact that we have a very high sort of corporate value around integrity, transparency, reliability, plays to our strength. And I think that point has really been amplified as we've gone through this very uncertain period over the last six to nine months.

I would also say that companies are more open minded to changing their business practices to look for the next frontier of cost savings or innovation to free up working capital, shrink the size of their warehouse or store footprint and be leaner. And so effectively we're kind of a lean supply chain solution by introducing this e-commerce platform and our value-added services alongside retail store operations, distribution center operations, even online retailers. So we are benefiting from that.

As companies try to rethink how they do things and in some cases we've displaced traditional salvage or liquidation companies because they don't have the financial strength. They don't have the financial transparency. They don't have the technology tools to bring a national solution. We've replaced some incumbents who've been involved with these companies for many years because they're just not providing that additional value-added innovative solution. And so that is playing to our strength. And I think over time, as I noted earlier, LSI is just going to be very much benefiting from the next year or two of this type of environment we're in.

Are you guys running anything beyond an eight-hour shift in any of your distribution centers for the commercial segment?

You know in some cases Stephen we are but it's very modest. The team that's managing that part of our business is very excited about the opportunity to increase throughput and capacity if we were to do things like add a weekend day or a double shift if needed. So I mean we're poised to take on significant volumes from the types of companies we're prospecting. And we intend to do that.

Is-- do you think your footprint right now in terms of distribution centers is appropriate or do you think-- do you foresee a need for more?

As I mentioned on the call, we believe we can manage a three-fold increase in the GMV flowing through our commercial distribution network. So we're well positioned without adding space to ramp our business.

Thank you.

And our next question comes from the line of Gary Prestopino from Barrington Research. Gary, you may proceed.

Thanks. Most of my questions have been answered. But how many sellers do you now have on GovDeals? And what's the potential market out there of sellers?

So roughly 2,000 sellers of a 60,000 municipal government agency target market.

So-- and then in terms of buyers, what are you doing to attract more buyers? And are you seeing a phenomenon where possibly because of sluggish economy, people are trying to do some things on their own with self employed business through your website?

Well absolutely. I think well before the current economic downturn, we've always been an incubator for small businesses and entrepreneurs who are looking to source goods from us. And to do that through a web browser without having to get into their truck and drive to local auction or drive to a seller's warehouse dock that saves them time. And it's very convenient. And a number of the activities we've discussed in terms of our operational excellence and improvement have made it even more convenient for these buyers to be sourcing goods in our web-based platform.

So people that have lost their jobs because of the economy coming out of a variety of industries are finding their way to our marketplace. And so that's helping drive the potential size of the addressable audience for these buyers.

And the material that we sell, the goods that we sell are all below wholesale cost. So many of our buyers purchase goods and resell them to consumers in online store fronts they manage or brick and mortar discount stores that they manage. Some export outside the United States. Some buy even salvage or scrap items for us for parts. And they reconstitute those parts as part of their value added depot repair other operations and resale.

So this is a very interesting and organic and we believe growth market that will continue to benefit from transparency, the amount of supply that we bring. You know we're bringing new categories of items that open up entire new channels of buyers. We've got now a wide range of jewelry items that are in the marketplace, of household appliance items, of gaming systems and consoles. We had things like iPods and GPS systems and home theater plasma TV systems through the holiday season.

And that's very interesting for buyers. In fact, the buyers are finding that they can build a truckload of goods after they've bought their first pallet. And in some cases at the other end of the continuum, you have average consumers who are looking for deals, who come on to our marketplace even though we don't target market to consumers who are saying you know that plasma TV is a great deal. And I'm willing to buy it. And so there's potentially tens of millions of bargain conscious shoppers who use the internet to find low value-- well priced-- high-value, low priced merchandise and liquidation.com for example has benefited from that. So we think Gary we will continue to prosper, notwithstanding the economic climate.

And then just one last question. In terms of your commercial business, which is mostly retail right, you know from I'm reading retailers are keeping their inventories very lean. And I'm just wondering as you look out six months, the next couple of quarters, how does that impact your business in terms of very lean inventories? Obviously it's going to-- might impact the supply, but does that lead to higher ASPs because there's less product out there or am I just totally off base?

So certainly if there's-- I mean in theory is that there's scarcity value. And we continue to grow our buyer base that drives higher pricing in an auction format. And in certain spot-- categories, we have seen that.

Yet, we benefit from a continuous flow of store returns. You know 6% or so of everything sold at retail is returned. So the fact in the United States is that return activity continues. The amount of returns for online retailers is probably double that of brick and mortar. That continues. There's an intractable challenge of having the right product, the right size in the hands of the consumer. And if they don't like it, they take it back. And we solve the burden and the friction and complexity around that returns process and the recovery of value for the retailer.

Increasingly, retailers who have their own network of suppliers are saying hey, maybe you can be the single point of service for all of us, not just the retailers but the manufacturers as well. So yes, the GDP has been off, but the absolute size of our market opportunity and the step function improvement in net recovery to the retailer and manufacturer of using our marketplace are such that we have a lot of growth ahead of us.

Thank you.

Ladies and gentlemen, that's all the time we have for today's call. Ms. Davis, you may proceed.

Thank you. Thanks to everyone for joining the call today. If there are additional questions, Jim Rallo and myself are available for those. Thanks so much.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a wonderful day.