Liquidity Services Inc (LQDT) 2010 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Third Quarter 2010 Liquidity Services, Incorporated, Earnings conference call. My name is Dominique and I will be your operator for today. At this time, all participants are in listen-only mode. Later we will conduct a question-and-answer session. (Operator Instructions). As a reminder, this call is being recorded for replay purposes.

I would now like to hand the call over to Liquidity Services, Incorporated.

Hello and welcome to our Q3 fiscal 2010 financial results conference call. Joining us today are Bill Angrick, our Chairman and Chief Executive Officer, and Jim Rallo, our Chief Financial Officer and Treasurer. We will be available for questions after our prepared remarks.

The following discussion or responses to your questions reflects management views as of today, August 3, 2010, only, and will include forward-looking statements. Actual results may differ materially. Additional information about factors that could potentially impact our financial results is included in today's press release and our filings with the SEC, including our most recent annual report on Form 10-K. As you listen to today's call, we encourage you to have our press release in front of you, which includes our financial results, as well as metrics and commentary on the quarter.

During this call, we will discuss certain non-GAAP financial measures. In our press release and in our filings with the SEC, each of which is posted on our web site, you will find additional disclosures regarding these non-GAAP measures, including reconciliations of these measures with comparable GAAP measures.

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 gross merchandise volumes and should not be considered a substitute for or superior to GAAP results.

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

Good afternoon, and welcome to our Q3 earnings call. I'll begin the session by reviewing our Q3 financial performance and then provide context on our strategy and where we stand in our Company's overall development. Finally I will turn it over to Jim for more details on the quarter and on our outlook for the rest of the year.

Q3 was a very productive quarter for LSI as we exceeded our guidance range while continuing to make important investments for the future. Q3 GMV was up 20% year over year to a record $109 million, driven by strong performance across our online marketplaces. Adjusted EBITDA of $10.6 million, also a record, was up 18% year over year, and adjusted EPS, which excludes non-cash comp expenses and one-time acquisition and tax items, was $0.18.

As more commercial and government sellers and buying customers have discovered the efficiency of our online marketplaces, this has helped generate strong financial results for our shareholders. Let me briefly revisit our strategy and where we stand in our Company's development.

Overall we see numerous opportunities to further grow and improve our business. Our commercial business posted solid growth in Q3 and continues to make progress retaining and growing the number of Fortune 1000 clients selling on our platform. Within our commercial business, GMV from our large enterprise clients was up over 20% year over year in Q3 despite the fact that we have faced the headwind of a sluggish overall retail environment, which has resulted in very lean inventories and in-store discounting programs by several of our core enterprise clients. As these economic headwinds taper off, we would expect improved growth of core commercial accounts and our overall commercial business.

We are pleased with the overall progress of our new business development pipeline in our commercial business as we continue to focus on gaining market share. For example, in recent months, several new programs have launched on our Liquidation.com marketplace with the following user handles -- RetailWest -- this consists of general merchandise, clothing, and consumer electronics returns for a $2 billion West Coast regional retail grocery chain; ClassicAttire -- this consists of overstock apparel items for a $410 million manufacturer of branded clothing and accessories; SuperiorSports -- this consists of returned clothing, accessories, equipment, and hard goods for a $4 billion national sporting goods retailer; DIYCentral -- this consists of returns and selected overstock inventory, including hardware, fixtures, hand tools, and faucets for a $66 billion national home improvement retailer.

Additionally, we completed successful pilots with several new enterprise clients during Q3, but full implementation of these programs were delayed due to client issues. Of importance, we are observing new attitudes within Fortune 1000 clients to seek change within the reverse supply chain driven by a desire for improved transparency and more effective compliance with respect to brand and channel conflicts. In addition, LSI has successfully demonstrated how our marketplace supports our clients' environmental sustainability initiatives by connecting buyers with goods that have been previously discarded as waste. Results have been nothing short of remarkable as we've turned a client cost center into a source of positive financial recovery. This change in attitude is manifesting in more client request for proposals being issued in some cases for more than $50 million of annual GMV potential.

The results in our UK commercial business have not been satisfactory to date and we have taken several recent actions to improve our position. First, we installed a new leadership team, in some cases with veterans of our US commercial business, that we believe will be more effective in executing our business plan. Second, during Q3, we integrated the UK business operations with our US technology platform for both the online B2B marketplace and related inventory management system. We believe this will result in improved velocity within our UK operations and provide a seamless solution to our global clients. Third, we re-launched our UK B2B marketplace with a new brand, UK-liquidation.com, that delivers buyers a superior user experience. We expect the use of a single global B2B brand will increase the effectiveness of our marketing and merchandising programs.

Finally, we have made progress in cross-selling our UK capabilities with our US client base, many of whom have needs in the European Union or which require products in the US to be exported internationally under a zero defect process. Specifically we have recently launched new programs in the UK with several of our large US-based Fortune 500 clients that will expand our UK business over time.

Next our government business is healthy and growing at sustainable levels. We have been experiencing a favorable product mix in our DoD surplus business, which is likely to continue for an extended period of time as the DoD undertakes a major overhaul of its rolling stock fleet and other asset categories to address mission requirements. Moreover, our team continues to leverage our data to drive merchandising decisions that improve recovery rates for the items we sell. We have also experienced improvements in volume and price in our DoD scrap business, which we believe is sustainable with the exception of selected outlier sales such as the large Inconel sale conducted in Q3.

Improved volumes in our scrap business are in part a result of new value-added services we have brought to the DoD for automatic data processing and technology assets, which were previously destroyed due to privacy and security concerns. We have partnered with the DoD to develop new electronic recycling and sales programs that successfully address their issues and in turn we have created new revenue streams for our DoD partner and LSI.

Our GovDeals marketplace continues to gain recognition as the best-in-class marketplace serving the surplus needs of state and local government agencies. We have continued to expand our presence nationally and gain market share. Recent new contract awards include the State of Iowa, the State of Missouri Department of Transportation, and Knox County, Tennessee, which is a cooperative agreement that extends our services to all other agencies in the State of Tennessee.

Additionally, we continue to increase adoption of our online financial settlement services, which adds value to both the seller and buyer by increasing the convenience and speed for settling GovDeals transactions. Our GovDeals business has an approximately 5% share of a $2 billion-plus market opportunity, which is served principally today by local auctioneers, so we believe there is significant room for future growth in this part of our business.

Finally, we continue to diversify and grow LSI's business by selectively acquiring complementary businesses. We are pleased that during Q3 we successfully closed the acquisition of Network International, an online marketplace that extends our reach to a portfolio of over 22 Fortune 500 corporate clients and which is led by a talented management team.

The sale of idle, used, and surplus capital assets today represents approximately 50% of our current GMV and is a business that we know well and expect to continue to grow for numerous reasons. First, fundamentally the Internet presents a more efficient and effective model for commercial sellers of capital assets than physical onsite auctions. Second, LSI brings core competencies to this market, including an established base of nearly a 0.5 million registered buyers with a specific interest in purchasing used capital assets such as heavy equipment, rolling stock, machine tools, and scrap metal, and product domain expertise from selling these items for retail and government clients for the past ten years. Finally, our solution addresses this large, fragmented market at the early stages of online adoption where LSI can be a force to drive real value creation for buyers and sellers. We have begun the integration of Network International into our commercial asset recovery division and we intend to build on our leadership position in the retail and government markets to create the leading online marketplace for capital assets.

In closing, we have the leading technology solution in the large, fragmented reverse supply chain market that is still in the early stages of adopting online solutions. We continue to expand our market share through innovation and customer focus, which has created an increasing network effect among buyers and sellers for both consumer goods and capital assets.

Finally, we have the financial strength and managerial depth to invest in future growth to create long-term value for our customers and stockholders. While we are very proud of our past accomplishments, the future is even brighter for LSI. Our entire team of over 700 associates look forward to working together to expand our business while maintaining the highest standards of integrity, service, and quality.

Now let me turn it over to Jim for a more detailed review of our financial results and outlook.

Thanks Bill. As we indicated at the beginning of the year, we expected to resume growth in fiscal year 2010. We are pleased that the more commercial and government sellers and buyers are choosing to participate in our online marketplaces. Our record quarterly results and increased guidance ranges reflect both market share gains and our continued focus on enhancing service levels and operating efficiencies across our entire business. Our strategy of bringing innovative technology to the reverse supply chain market and our efficient business model has translated into strong results for stockholders.

Trailing 12-month EBITDA has improved to $36.3 million and trailing 12-month operating cash flow has improved to $29 million.

We also continue to make important investments in Q3 to support our future growth. On June 15, 2010, we acquired the stock of Network International for approximately $10.3 million. The acquisition price includes an up-front cash payment of $7.5 million and an earn-out payment. Under the terms of the agreement, the earn-out is based on EBITDA earned by Network International during each of the three six-month periods after the closing date of the acquisition through December 31, 2011. Our estimate of the fair value of the earn-out as of June 30, 2010, is $2.8 million out of a possible total earn-out of $7.5 million. We incurred $500,000 of acquisition costs, which were expensed as incurred during the quarter.

The operating results of Network International have been included in the consolidated financial statements from the date of acquisition, which were not material for the period ended June 30, 2010. Network International is a leading online marketplace for the sale of idle, surplus, and used equipment in the oil and gas, petrochemical, and power generation industries. Network International conducts sales of clients' assets on a consignment basis using its online marketplace, www.networkinternational.com, an extensive global buyer base, and product domain expertise. Network International will operate as part of our Commercial Asset Recovery Division.

The acquisition strengthens our business by adding 22 Fortune 500 corporations and eight of the world's largest multinationals across the energy supply chain as new clients, along with a critical mass of buyers and relationships to further expand our commercial capital asset business. This acquisition will allow Network International's clients to increase their financial recovery and improve cycle times for a broader range of assets by accessing our menu of value-added services in the leveraging our base of over 400,000 registered buyers of capital assets ranging from heavy machinery to rolling stock and scrap metal.

Investments in our online financial settlement software and reporting tools continued to drive an improved customer experience in our GovDeals.com marketplace for state and local governments. Adoption of our online financial settlement services has continued to increase due to the time savings and convenience experienced by buyers and sellers. As a result, average fees for our GovDeals marketplace as a percentage of gross merchandise volume or GMV has increased by 13.8% to 9.1% in Q3 from 8% in the prior-year period.

Next I will comment on our Q3 financial results. Total GMV increased to a record $109 million, up 20.3% year over year.

GMV in our scrap business increased $18.9 million, up 37.5% year over year as a result of increasing commodity prices and a mix shift to higher-value metals. GMV in our surplus business increased to a record $22.8 million, up 28.2% year over year as a result of increasing property flow from the DoD and a higher mix of high-value capital assets such as rolling stock. GMV in our GovDeal business increased to $24.4 million, up 16.7% year over year as we continued to add new clients, thus further penetrating the $2 billion state and local government market.

GMV in our US commercial business increased to $40.2 million, up 16.1% year over year, as a result of launching several new programs for large retailers as we continued to drive adoption of our technology platform in the reverse supply chain market.

Total revenue increased to $72.7 million, up 25.3% year over year, primarily due to one, the increases in our scrap and surplus businesses previously discussed, and a 21.9% increase in our US commercial business, which had a higher mix of clients utilizing the purchase model.

Technology and operations expenses increased by 5% to $12 million year over year, primarily due to increases in staff wages, including stock-based compensation associated with the hiring of 23 additional personnel to support the growth discussed above. As a percentage of revenue, these expenses decreased to 16.5% from 19.7%.

Sales and marketing expenses increased by 18.7% to $5.2 million year over year, primarily due to increases in staff wages, including stock-based compensation associated with the hiring of 23 additional personnel to support the growth discussed above. As a percentage of revenue, these expenses decreased to 7.2% from 7.6%.

General and administrative expenses were consistent at $6.2 million year over year. As a percentage of revenue, these expenses decreased to 8.4% from 10.6%.

The company continues to demonstrate strong cash flow generation and growth. Although we experienced a greater mix of purchase business year over year, we continue to achieve strong inventory turnover within our commercial business and our overall working capital continues to be a source of cash. During Q3, LSI generated $8.5 million of operating cash flow, up 19.8% year over year. And over the last 12 months, LSI has generated $29 million of operating cash flow.

Adjusted earnings before interest, taxes, depreciation, and amortization or adjusted EBITDA grew 17.9% year over year to a record $10.6 million. Our investments in improving service levels and operating efficiencies have enabled us to expand our margins during the fiscal year. Adjusted EBITDA margin was 14.5% in the quarter, 12.7% excluding our annual scrap business bonus, which was $1.3 million earned in the quarter, based on revenues and 9.7%, 8.5% excluding the bonus, based on GMV. These efficiency gains have driven strong results for shareholders as we have generated $36.3 million of adjusted EBITDA over the last 12 months.

Adjusted net income was $4 million and adjusted diluted earnings per share was $0.15 for the quarter based on approximately 27.4 million diluted weighted average shares outstanding.

Adjusted net income and adjusted diluted earnings per share for the quarter were adversely affected by a sharp increase in our effective income tax rate of approximately 46% to 57% for the quarter. We estimate that they fiscal year 2010 effective tax rate will be approximately 50%, which is an increase from the estimated 46% utilized during the first two quarters of the year, resulting in an effective tax rate for the quarter of approximately 57% from the cumulative adjustment. The estimated 4% increase in the effective rate is a result of higher losses incurred year to date than were expected in our foreign operations, which are not deductible against our US taxable income. Excluding this tax adjustment, adjusted diluted earnings per share for the quarter would've been $0.18, which was significantly above our guidance range for the quarter of $0.11 to $0.15 and the $0.16 from the third quarter of the prior year.

We estimate that our future effective income tax rate will be approximately 46%, which is comprised of one, approximately 35% for federal taxes; two, approximately 8% for state taxes, which combined approximates our cash tax rate of 43%; and three, approximately 3% for booking tax differences, including stock-based compensation expenses primarily related to employee stock options, which are currently expensed in our financial statements, but are not deductible for tax purposes until they are exercised.

We continue to have a strong balance sheet. At June 30, 2010, we had $69.2 million of cash or approximately $2.53 per share in cash, current assets of $98.4 million, and total assets of $154.9 million. The company continues to be debt-free.

Capital expenditures during the quarter were $800,000. We expect capital expenditures to be $4 million to $4.5 million for the fiscal year ended September 30, 2010.

Management is providing the following guidance for the next quarter and fiscal year 2010. Our guidance reflects the expected results of the recent Network International acquisition completed on June 15.

We expect GMV for fiscal year 2010 to range from $408 million to $418 million, which is an increase from our prior guidance range of $360 million to $400 million. We expect GMV for the fiscal fourth quarter of 2010 to range from $100 million to $110 million.

We expect adjusted EBITDA for fiscal year 2010 to range from $35 million to $37 million, which is an increase from our prior guidance range of $31 million to $35 million. We expect adjusted EBITDA for the fiscal fourth quarter of 2010 to range from $6 million to $8 million.

We estimate adjusted earnings per diluted share for fiscal year 2010 to range from $0.55 to $0.59. For the fiscal fourth quarter of 2010, we estimate adjusted earnings per diluted share to range from $0.08 to $0.12.

This guidance reflects one, the expected increase in the effective tax rate for fiscal year 2010 to approximately 50% from 46%, and two, the recent impact of our stock repurchase program under which we repurchased 293,181 shares for approximately $4 million during the prior quarter. However, it does not assume that we will continue to repurchase shares with the approximately $3.2 million yet to be expended under the program.

Our guidance adjusts EBITDA and diluted EPS for the effects of stock-based compensation, which we estimate to be approximately $1.9 million to $2.2 million for the fourth quarter. We expect our trend of increasing stock-based compensation costs to moderate in fiscal year 2010 -- oh, I'm sorry, 2011.

Bill and I will now answer any questions.

(Operator Instructions). Your first question comes from the line of Colin Sebastian of Lazard. Please proceed.

Great. Thanks very much. And good quarter, guys. I guess first on the commercial side, it looks like volumes there strengthened over the course of the quarter. And so is that momentum we should expect to carry through over the remainder of the calendar year? That's, of course, excluding the impact of Network International. And then on the government side, you know, if you could also address how visible the pipeline is there for growth?

Thanks and I have one follow-up.

Sure. With regard to the corporate business on the commercial pipeline, we had seen in years past some seasonality. The August time -- July/August time frame is a little bit of a lull. Some of our clients sort of take the breather before the last push during the holiday season. I think this year we're seeing more stable sequential GMV. And that's a result of new business wins that are continuing to roll into the fourth quarter. And as I said in the opening remarks, we've done a very nice job of expanding the pipeline, of doing a number of pilots that have been around, exporting products that don't have any business being in the United States due to brand and channel complex issues. And that's where we are seeing some strategic value in the UK presence that we have.

We're also doing a good job presenting our solution around environmental sustainability initiatives, both with large retailers and manufacturers, as well as the government side. We've created new markets for products that have been historically destroyed and it's dead-weight loss to the economy, to potential small business buyers. Certainly it's in compliance with environmental and green initiatives. So that's been another big selling point for us that's helped us make progress on the pipeline.

I -- as I also mentioned in the opening statements, we're seeing lots of large RFPs being brought to the public marketplace or which are in planning stages to be brought to the marketplace, so these are larger-size opportunities. We think we've been a -- an influence on that behavior in the marketplace.

And on the government side, state and local governments are clearly addressing maybe a little bit later than the private sector budget deficits. And so they've got to cut back on services or raise taxes. We step into the void and provide service and convenience and more value all aligned with dealing with the fiscal -- the deficit environment that we live in today, so GovDeals is a wonderful solution for these selling agencies. Buyers are increasingly interested in buying in the used capital equipment and vehicle markets and we're seeing a lot of opportunities there. So the volume of clients has grown. The transaction volume that we experienced in our June quarter was a record for our GovDeals business, really a number of new high watermarks in the GovDeals business in the June quarter, so we like the progress we're making there.

Yes, I think, Colin, the one thing I would also add is on the DoD business, we have seen a higher flow of goods, which right now looks like will continue into the near term. These goods have been higher-value capital assets such as rolling stock. The DoD right now is currently going through a -- what I'll call a replenishment period of taking out the older trucks and other types of vehicles and putting in new, more modern vehicles, so we're getting the benefit of that. And that schedule has really moved out for the next two years at this point.

Okay, great. That's helpful. And then I guess as a follow-up on the commercial side, I wonder if you could talk a little bit more about the margin profile there specifically. And given the acquisition, what are your expectations for that segment on the profitability side going forward? You've -- you're obviously adding quite a few big name brands and retailers as well and how does that impact your profitability? And can you kind of spell out maybe what portion of the commercial business is driven by say the top 10 or 15 sellers?

Thank you.

Sure. I think we're increasingly diversified in terms of our client portfolio on the commercial business. As we have continued to expand the number of larger retailers working with us, that's reduced the size of any individual program. Also it's meant that it's becoming incrementally easier to add a significant new client to the program. We were just having a conversation the other day with a prospect, a national well-known retailer that quite interested in what we're doing and wanted to know that we -- they wouldn't represent a disproportionate share of our business. And they weren't even in the top five. So we like the profile diversification that we're getting.

The economic substance of the business is to drive more gross profit dollars to the bottom line. So we're not so much concerned with the contribution or take rate percentages as much as we are in terms of the dollars contributed to the bottom line. And as we look at different categories, there are different margin profiles. Consumer electronics, which is a -- an attractive space we've been involved with, you're going to have more competition for those assets and maybe lower take rates in those categories, yet we're driving similar contribution to the bottom line because we have larger GMV-per-unit-handled dynamics in that business.

In terms of the mix between capital assets and the acquisition, the capital assets business is a pure consignment business, so the take rates as a percentage of GMV are going to be lower. At one end of the continuum in our overall business, you have a GovDeals model where your take rate could be as low as 7.5% in a pure self-serve model. You get a little bit more as you implement financial settlement services as an add-on service, and then Network International operates in the low double digits in terms of take rate. And that's partly due to some additional value-added services. So that will shift the blended margins just as a function of mix.

Okay, that's helpful. Thanks very much.

Your next question comes from the line of Shawn Milne of Janney Capital Markets. Please proceed.

Thank you and thanks for taking my questions and, again, congratulations on a nice quarter.

Jim, I just wanted to follow up on something you just touched upon. You did talk about getting -- it sounds like you've got better visibility on the surplus side. Did -- were you indicating that you believe that visibility is a couple of years out? And is this something to do with perhaps some of the conflicts winding down in Iraq and some assets coming back? Or do you just have a better visibility on their internal plan on some older assets?

And then, Bill, just on the commercial side, I know you won't want to give guidance today, but given that you're adding some retailers and you're talking about the ability to bring on more retailers more easily, do you think you're getting to the point now where you see more of a secular sort of 10%, 15% kind of growth? Or do you still feel like we're going to bump around a little bit with the economy?

And then just a housekeeping, Jim, and then I'll stop there, just what was the growth in commercial GMV if you take out the slight impact from the acquisition?

Thank you.

So on the supply chain of the DoD, it's not insignificant when the DoD makes a decision to upgrade any of its key asset categories. And their decisions to enhance the vehicles on the ground, both domestic and overseas, is a huge change-out and therefore for a variety of reasons we're getting volume from end-of-life trucks and demilitarized equipment. And those are long lead-time programs and so they stretch into multiple years. And based on that, Shawn, a couple of years out would be typical when there's a weapon systems upgrade or a change-out of capital equipment. So that's providing a very firm sort of product mix improvement that we expect would continue.

In terms of the military pulling out of theater, we don't have any specific guidance to give you on that. In some instances, they will leave things behind. In other instances, they'll transition those to European outposts. But in other instances, reserve units have come back with that equipment and that has come through our marketplace. So we wouldn't want to give you any additional guidance on that until we see how this sort of plays out in the coming three, six months.

In terms of the growth in the commercial business, on the one hand, we have seen improved urgency around competing business that has been managed in the traditional either in-house way or jobbers and liquidators. We were speaking to a Fortune 500 warehouse club that we do not do business with today that is currently selling products through 60 liquidators at localized levels and interestingly enough saw our presentation at one of our growth stock conferences and said hey, this is a real opportunity for us. We'd like to sit down with you. And so we're doing a pilot.

So I think there's just that increased awareness that there's a better way to do it, that LSI has such a head start in terms of the buyer base and being compliant, being able to deal with complex needs of large sellers that we're getting a good at-bat with these opportunities. So that will improve growth over time.

The mid-teens growth is achievable. The headwinds that I spoke of in my prepared remarks refer to the fact that you still have a sluggish consumer who is being very frugal and in some cases that has limited same-store sales with some of our longer-standing client programs. And retailers can get a little nervous about hitting same-store sales numbers and so they choose to be a little extreme in discounting and will products through their stores and discount programs that in a more normalized economic environment they would just take off the shelves and replace with full-margin goods.

I don't think that's sustainable. And when that behavior shifts to more normal activity, then we'll have even better growth in the mid teens because we're certainly not getting the benefit of that today. And so those are the things that we see around the business that's affecting sort of the secular growth.

Jim, just housekeeping on the -- can you strip out the Network International GMV from that number you talked about?

Sure. Network contributed a couple million dollars of GMV for the quarter, Shawn.

Okay. And just lastly housekeeping, the -- on the earnings, did you strip out the integration costs of -- in the adjusted EBITDA or not?

We did not strip out integration costs, absolutely not. We did strip out the $524,000 that are a single line item on the income statement, which are acquisition-related costs, so one time in nature.

Deal costs.

Deal costs, yes. Not integration costs, Shawn. The -- yes, those will be ongoing for the next six months or so. And we will not strip them out.

Okay, thank you very much.

Your next question comes from the line of Gary Prestopino of Barrington Research. Please proceed.

Hi. Just real quickly on the Network International clients, are there any existing clients that you're dealing with them now?

No, there was no overlap in their client portfolio and ours prior to the acquisition.

So you're going to probably rapidly try and cross-sell?

We have already begun to engage the -- their blue chip clients with various ideas. And, for example, when we talked about what we're doing with the DoD to handle the wide range of IT assets from business equipment, laptops, PDAs, we know that when you look at the large industrial and commercial clients out there, that's a huge opportunity. So IT assets are positioned as one example of cross-selling services.

Okay. And then you mentioned several pilots were delayed, implementation has been delayed. And you -- I think you mentioned [some just having] to do with the economy. Is that kind of the main reason still?

No. I think every large corporation is going to have its own set of issues or priorities. And as we move through time, various issues are going to crop up. In some cases, it's just a client rolling out a new forward supply chain warehouse distribution center, but -- or in other cases having to manage a store renovation program. But the point is that we've had success in demonstrating our value proposition. The client is very interested in moving forward. But delays are occurring unrelated to LSI's performance. And so when that happens, we just pass that along.

Well, in terms of pilots in the past on the commercial side, if you've had a pilot, how many of -- have the majority of those, a good percentage, say 90%-plus, come in and become contracted as a commercial client?

A significant -- oh, go ahead.

Oh, go ahead, I'm sorry.

Yes, a significant majority of pilots result in longer-term relationships.

So can you possibly quantify just what the potential GMV of these pilots is right now?

So when you take a step back and look at our growth strategy, we're going after Fortune 1000 clients. And I would say in a subset of those clients, the largest retailers and manufacturers who supply them, so that Fortune 100 retailer base on an aggregate basis, you're talking about over $1 billion of GMV potential. And therefore we're looking at opportunities anywhere from at the low end $5 million to $10 million of GMV, at the high end $50 million to $60 million of GMV per client. So those are all stair-step kind of growth opportunities for us and we expect to be able to deliver a commercial business of $1 billion-plus GMV, which means that we've got a significant opportunity in terms of these various discussions and pilots. So I think that's consistent with our growth outlook from the time that we came to the public markets. And we're methodically demonstrating our services. We understand that individual companies have unique needs, so we will be adaptable in terms of our pricing model, in terms of whether they want a full-service logistic solution versus a sell-and-place solution. In some cases, clients need additional services like export control. They want the products to leave the United States and we'll handle that. In some cases, they're asking us to de-label the products and sell in the US. So those range of menu of services we review with each client and deliver. So we're excited about it and we believe with each successive quarter we're closer to being an outstanding solution.

Okay. And then in terms of last year you signed up what, about 23 new retailers? And, I mean, it's a safe assumption to say you're probably not penetrated nearly what you could be with these retailers. Is that a safe assumption to make?

Yes.

Okay. And let's look at the retailers that you've had for say the last 12 to 18 months, the new accounts. As they've come on and you've proven that you can liquidate their goods, get them a good return, what -- has there been a step function in terms of the amount of GMV that they've given you every quarter? Has it been increasing every quarter?

Yes.

Okay. All right. So, okay. And can you kind of ballpark where that's been or where it's gone?

So you look at our business and there are crosscurrents in the business. It -- one point made earlier was within retailers today, you've got strategies and tactics being used to deal with reduced volume coming in from their traditional consumer, so the consumer is not as robust, consumer shopping is not as robust as prior years in a normalized economy, so some of the volume that might otherwise hit our marketplace is not going to the marketplace. So we are with existing accounts seeing some sluggishness in that unit volume going through reverse supply chain. We think that'll correct at some point in the next four quarters as people improve their participation in the consumer marketplace. With new clients, we have had very strong contribution from new clients in the last year. That's helped more than offset the sluggishness of longer-standing corporate accounts. Again, the size range of a new client engagement could be anywhere from $5 million to up to $50 million. And those are the type -- types of organizations that we've targeted and we'll continue to target.

Okay, thank you.

(Operator Instructions). Your next question comes from the line of Jason Helfstein of Oppenheimer & Company.

Hey, thanks. Two questions. I apologize if you already asked them or addressed them.

So the -- did the -- your initiatives to work on the international business add any cost this year that will mitigate in 2011? And then what impact did the fee percentage for the US commercial business this quarter?

Thanks.

So on the international business, we had at the inception of 2010 established an objective to have that business achieve profitability. We have not achieved profitability. We have addressed that through significant integration efforts, including a leadership change made within the last five months that we believe sets it on a course to become more strategic and integrated with the solution we're selling to the Fortune 1000 client base. In a number of cases, our US clients are now using our capabilities in the UK, which is precisely why we developed that business. So there has been a drag on the business this year from the UK business. And we believe as we roll into 2011 that turns into a contributor. So we -- we're pretty focused on that and we'll give you updates as we proceed through each of our quarterly results.

In terms of the second question, was your question what is the take rate --

So --

-- as a percent of GMV?

Or, no, so if you look at the commercial business, if my math is right, the fee as a percent of the revenue is 21%. And I think that's down from the last few quarters where it was like 24% and 26%. I'm just wondering what was the dynamic there.

Okay.

Sure. Hey, Jason, it's Jim.

So what happened is you had a couple million dollars of fees in there for Network International. As we talked about earlier, the take rate for that business, there was no distribution centers. It's a very what we call asset-light model. We sell everything in-place on a consignment basis. So that take rate is only about 12.5%. So when you mix that in, that's dropped it down just a couple points for this period. I would expect that to go down again. What you're looking at is -- I'm assuming you're looking specifically at the consignment GMV versus the consignment revenue recorded, correct?

Correct.

Right. And, yes, if you strip that out, actually it was about the same. It's been about the same for the last several quarters. So that's -- that's what's thrown it off. I would expect that number to go down actually more significantly next quarter because we'll have a full quarter of Network International in our numbers. Just as a reminder for everyone, Network International is about $45 million to $50 million a year in annual GMV, again, at a take rate of approximately 12.5%.

Thank you.

Your next question comes from the line of Heath Terry of FBR Capital Markets. Please proceed.

Great, thanks. Yes, I was wondering if you could give us a sense as you start to see a broader mix of product from your commercial relationships, particularly the consumer electronics that you talked about, is there a sense that at some point you broaden out -- want to broaden out the distribution channel as well to try and reach a broader base of demand beyond just what you're seeing on Liquidation.com with potentially a consumer portal or partnering with some of the other more consumer-focused e-commerce sites that are out there to create demand for the inventory that's being created -- or being generated by these partnerships.

Yes, we have viewed ourself as having a unique perspective and view of where do these individual products and lot sizes belong in terms of channel to maximize recovery for the client. So indeed we have sat down with many of our large clients to give some perspective on what's the marginal cost relative to the marginal benefit of routing products through a multichannel strategy. And within that -- within those channels, LSI would play an enabling role.

Either we have a proprietary channel that we're routing their product through or we have data that suggests there is a complementary channel that the client has access to. It might be a client-branded channel and they outsource the fulfillment of the transaction to LSI and rely on our data and merchandising advice and counsel to bring those products to market. It could be a third party consumer channel, which is appropriate for the product either by condition or SKU.

And in our own business, we have today some domain expertise with respect to channeling items in single units to consumers. Recall that in our UK business, we have experience in selling single units via in-house and third party channels. And we also acquired a business, Dyscern.com, which is a consumer-facing marketplace. Those consumer channels today are an insignificant part of the overall volume, but it's very strategic and valuable for us to be able to provide the client the full perspective.

And we're very open to creating new channels or leveraging client channels to achieve their results. In either case, they're leveraging our domain expertise and our business logic to understand what's the marginal benefit versus the marginal cost. And we would -- we'd be willing to take that to any conclusion that the client would deem valuable.

And has that gotten to the extent that you -- that there's some kind of time frame you cold put on when we might see some of those incremental channels?

No, I think it would be surprising if we didn't have some increasing exposure to either client-branded or LSI-branded consumer marketplaces in the next year.

Great. Thank you very much.

You have a follow-up question from the line of Shawn Milne of Janney Capital Markets.

Thank you. And I apologize if I missed it in your prepared remarks, but -- or when you talked about -- a little bit about guidance. But, Jim, if you look at the fourth quarter guidance in terms of GMV, unless Network has a lot of seasonality to it, it looks like you're guiding the core business at ex-Network pretty soft, which doesn't, you know, seem to jive with the good outlook in surplus flow, higher commodity prices, and, again, decent commercial growth. Can you talk about that?

And then, Bill, strategically, just going back to the last question, do you view Amazon's acquisition of Woot as a competitive threat or an opportunity?

Thanks.

Sure. Relative to other flat sale marketplaces, Woot's been around for a long time. We have not competed with Woot for store returns and seasonal goods. I think typically -- traditionally Woot has focused on brand new items, a lot of which have been in the consumer electronics channel and have created price points that are in some cases very low average sale price points to create enthusiasm within their community. So looking at the history of Woot and the history of our business development, we've not competed with them. They are an outlet for new overstock goods. And to the extent that that was a strategic priority for us, I would think we'd be more likely to overlap with them. That new overstock product has not been a focus. It's not our market opportunity. So I don't expect there to be a lot of overlap with Woot.

As it relates to guidance, I'll turn it over to Jim.

So, Shawn, most of the decrease is due to seasonality, so as Bill indicated in his remarks, we do have a high level of confidence right now in the flow of product on the DoD side of the business. That being said, that product flow historically slows down in July and August, particularly in the month of August, basically just due to staffing issues, meaning there's a lot of vacation on the administrative side of the Department of Defense, which slows down our property flow. So we're anticipating that. We're also anticipating as we saw a little bit last year a decline in the state and local government business basically for the same reason. The folks that are involved in selling those assets through our GovDeals marketplace tend to take vacations in the later July or August time period.

(Overtalking).

And so, again, we do anticipate as you indicated softness compared to this quarter in several of the businesses, but not unexpected based on prior-year seasonality.

Great, thank you.

(Operator Instructions). Ladies and gentlemen, this concludes our question-and-answer session. I would now like to turn the call back to Liquidity Services, Incorporated for closing comments.

Okay, thank you very much for joining our earnings call. We appreciate your time. Jim will be available after the call to take your questions.

Thank you very much. Have a good evening.

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