Overstock.com Inc (OSTK) 2009 Q3 法說會逐字稿

Good afternoon. My name is Sade and I will be your conference operator today. At this time I would like to welcome everyone to the Q3 2009 Overstock.com conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question and answer session. (Operator instructions) Thank you. Mr. Johnson, I hand the call to you.

Thank you for that welcome and introduction. And I say good afternoon and welcome to everybody on our third quarter 2009 conference call. Joining me on today's call are Dr. Patrick Byrne, Overstock's Chairman and CEO; and Steve Chesnut, Overstock's Vice President of Finance.

Let me start by getting some legal details out of the way. The following discussion and our responses to your questions reflect management's views as of today, November 3, 2009, 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 2008 annual report on form 10-KA

I encourage you to have today's press release in front of you as you listen to today's call because our financial results are detailed and detailed commentary and Patrick's letter are included in that press release, and will correspond to much of today's discussion. During the call we'll discuss certain non-GAAP financial, measures. Our press release, the slides accompanying this webcast and our filings with the SEC, each of which are posted on our investor relations website, contain additional disclosures regarding these non-GAAP financial measures including reconciliations of these measures to the most comparable GAAP measures.

Lastly, we expect to file our Form 10-Q for Q3 2009 by next Monday, and I encourage all of you to read it as well for additional information on our financial results. With that preliminary stuff out of the way, let me turn the call over to Steve to review some of the financial results.

We are going to go ahead and review the Q3 financials, as Jonathan mentioned. The details of this quarter are in today's press release, so I'm just going to summarize a few of the financial highlights for you. And as I go through and make these comparisons and remarks, we are going to be contrasting that back against the third quarter of 2008.

So let me go ahead and start through revenue. Revenue for the quarter was $195.1 million, which is up 4% from last year. If you remember, in Q2 we showed a negative 7% revenue decline, and so it's nice now in Q3 to be seeing a positive revenue growth which is really now, after three quarters of negative revenue growth, it's nice to see a positive quarter.

Gross profit expanded to $37.7 million, a 17% increase, and gross margin was 19.3%. This is a 210 basis point improvement over last year. And when you look at it, the improvement was largely driven because of supply chain process improvements, offset by lower prices on many items. Now let's take a look at operating income.

Operating income was a near $154,000 loss compared to a loss of $4.3 million last year. At the net loss level for the quarter, we showed $787,000 net loss. Now, as a percent of sales, this is 0.4%. On a year-to-date basis, our loss is just $2.5 million. Again, this is 0.4% as a percent of revenue.

The other interesting thing to note is that this an $11.2 million improvement over last year.

Now let's turn to the balance sheet real quick. Total cash and cash equivalents was $79.1 million at the end of Q3. Working capital was $34.1 million. This is an $865,000 improvement from the end of Q2. And as I look at this and as we are entering the fourth quarter, I'm feeling pretty comfortable with where cash and working capital is for the business. So with those brief financial remarks, I'll turn the call over to Patrick.

Thank you, Stephen, nice summary. I'm going to start, as always, with the slides, and tell you when to advance them. We've read the Safe Harbor. The highlights are pretty much what you -- I'm not going to go through these again other than just to point out the operating cash flow, that $19.7 million adjusted EBITDA and I mentioned before how we feel about EBITDA. I'm not a big fan of EBITDA because -- as a valuation metric. But it was interesting in that period, where things got a little tight for us. It was an interesting number to give to the world because, as people were trying to figure out what our cash generating ability was, that was a good place to start.

We are trailing $22.7 million operating cash flow over the last 12 months and $13 million free cash flow. Especially -- let me go back to the contribution dollar growth. I've mentioned a number of times over the past couple of years that, in our view, that's what we measure ourselves on in terms of growth. That's really what we are looking at internally as the thing that we care the most about growing. And so I'll move to slide four.

Quarterly revenue growth -- I thought we had all the issues in marketing fixed early last year. I think we averaged 27% for the first half of last year. We got caught in the downdraft, and it definitely compressed our growth rate. We have fought our way back to positive, as Steve pointed out. It is nice because it's nice to be back in positive growth. But we didn't do that through reckless marketing spend. Our marketing dollars just keep getting 15%-20% more efficient, year after year, if you look at our years as a whole, you see that in our -- so we didn't get there by panicking and goosing anything too much. But we are, I think, pretty disciplined now in how we are spending our marketing dollars and finding ways to get more revenue dollars with less -- and especially gross profit dollars with less spend.

Next slide, quarterly gross profit growth. Again, this is nice we had that big spike in late '07, but that was really because of how end of '06 turned out. So it was easy to grow off that. So this is growing 17%, but slide six tells the real story. Again, this is what we're looking at, is growing the contribution dollars, which are what we call [NECTR], which is the gross profit minus the marketing spend. And there's a lot of reasons for that. I won't recite them again here, but I'm happy to talk about our reasons for that in Q&A, if anyone desires.

Slide seven -- I think we have said publicly, or our most recent comment about this, about contribution margin is to expect it to be within 12% to 15%. I'm comfortable with that. I think 13%, maybe in some quarters even 14%, might be the right number. Maybe 13% is the correct number, not -- so I'll just stick with our previous guidance. Maybe you can take it, instead of saying 12% to 15%, 12% to 14% for now is where we expect this to settle.

Slide eight, quarterly adjusted EBITDA. That's adjusted EBITDA. It's a non-GAAP measure. It excludes stock-based compensation. It looks like we only have one more quarter of a heavy negative to show on this. In fact, the truth is I'm going to eventually stop, as I've mentioned before and again and again, I really don't like EBITDA as a measure of much, certainly when you're talking about valuation, which going forward would be the more appropriate target of using EBITDA because it looks like that's a situation where things got a little tight looks well behind us for now. I'm not anticipating a return. So the meaningfulness of this number disappeared as that becomes lessening and as there are no more negative numbers, is how I guess I should put it. As there aren't any more negative numbers, this isn't so meaningful to me as a positive number because people tend to use that for valuation, and I don't think EBITDA means very much for valuation.

Slide nine, trailing 12 month cash flow from operations, again $23 million at this point. That feels nice. We have a nice little cash machine here. And slide 10, GAAP annualized inventory turns -- I think we got that to about 40 on a GAAP basis. It, of course, drops as we end the third quarter because we pack our warehouse, and our inventory goes up substantially, and so that drops. But our inventory management has gotten really, really good, I think. And of course, a better number to measure our internal inventory management is the non-GAAP number, the red line, which is at 5.9. And, again, that drop is -- that's got to drop as we build inventories for the fourth quarter, and then it's got to squeeze up, or squirt up, as we finish the fourth quarter.

Okay, slide 11 -- GMROI, all the same comments.

And slide 12 -- very proud of this. Should mention that we changed the technology with which we measure this, our customer satisfaction. Again, for those new to this story, this is a measure that Fred Reichheld promoted in his book, The Ultimate Question. We think it's a very good measure. On this measure the average American company scores an 8% on their overall net promoter score. On that measure, we score well, 66% this quarter. It bounces around in the high 60s, low 70s.

We also measure NPS of those who contact customer service, so those that you would think would have some unhappiness. They just get better and better. Our customer care department just love-bombs them. We've managed to -- Stormy has managed to squeeze those costs down nicely, and Brian Popelka. The costs are being managed beautifully, and yet the customer satisfaction, even for people who call customer service, is just phenomenal. It's far above what, according to Reichheld, anyway, the average American company experiences overall. And when you talk about our overall, it's up there with the all-stars, the Apple and so on and so forth. And we are very proud that in the National Retail Federation American Express poll we became, a few years ago, the number four customer service-ranked company in America and the number four again and then, now, number two, second only to L.L. Bean. So I think we have a phenomenal customer satisfaction, starting with customer service, but that actually goes through the whole supply chain. And it's a measure of things that go on through the whole supply chain.

Okay, slide 13 are just the highlights. Revenue growth has gone back into the black. Contribution dollars are growing 26%. Adjusted EBITDA, it's -- we're almost out of even trailing any negatives over a two-year basis, at which point you will see me discontinue that. And I'm mentioning that now just so somebody doesn't read any nefarious motive into that.

Gross margin has stabilized. We do keep finding ways to squeeze costs out of the supply chain, and Steve Chesnut and Steve Tryon on are heading that effort. It's been very successful so far. If I told you how many hundreds of basis points we still think we can squeeze out, I'm sure Jonathan would wrap my knuckles. But you don't see them all because, as we squeeze costs out, there's a great deal of passing on to the consumer.

So recently I had cause to look at some statements of mine from four or five years ago. I think our gross margins had dropped to 13, and we were saying that we could add 200 to 300 basis points. In fact, we've added 600 or 700 basis points. And in fact, what we did was we squeezed far more than that out of the supply chain, but we just keep passing that on to the consumer and dropping prices. And as we squeeze hundreds of basis points more out of the supply chain, we should be able to just keep dropping our prices.

We want to be able to take them to a place that nobody else can follow.

Okay, well, that's the end of my 13 slides. I will say we are prepared for a rip-roaring Christmas. If we do have one, I don't want there to be any tears and people be surprised. I think we are going to have a great Q4, on both the top line and the bottom line. So I'll stop there. Jonathan or Steve, do you have anything else you would like to add?

No, I think that's it. I'd love to turn it over to questions.

Okay. Are you suggesting I overstayed my welcome? Go ahead and turn it over to questions.

Absolutely not, Patrick. We always like your commentary.

Okay, let's go to questions. Do we have any?

(Operator instructions) Brent Rystrom, Feltl and Company.

Any thoughts that you want to offer us on the book pricing war with Wal-Mart, Barnes & Noble, Borders?

Well, I just saw a good analysis come out from somebody. I just saw it this afternoon -- that really hit the nail on the head in terms of what you could expect us to cost Amazon versus what you could -- the benefit, and make some assumptions about how much they lose a book on -- Sarah Palin's new book and things like that. I'm not sure the assumptions were dead on.

But anyway, it was -- I think Wal-Mart does this for different reasons than Amazon. I think Wal-Mart does it just sort of to general -- the way they use toys in their store, to generate excitement and pull people in, whereas it's more, of course, bread and butter to Amazon's business.

I don't know. Do you have any comments or any smart thoughts (multiple speakers) --?

-- are you seeing it show up on your side of the media side of the business as far as an impact, so far? Has it been benign or has it been hurting you at all?

Well, it's in such a narrow range of titles. Yes, of course, it's hurting us in that range of titles. But we do price below Amazon on books, movies, music, games, everything, essentially across the board. We have about 1 million titles. There's about 120,000 titles that matter at any given time, and they've picked out 10 right in the belly of the bell curve and said they're just going to lose $5, let's say, on each one of those. And we are not following them there; that's not our plan. But it's okay; we still beat them on 99.999% of the SKUs in that area.

I'd just commented on that, Brent. You know, BMVG is for the third quarter was about 3% of our revenue, which was up a little bit from Q2 but down from 4% last year. It's a pretty small part of our business, so as Wal-Mart and Amazon and others duke it out there, it doesn't really have that big an effect unless.

Virtually meaningless, in other words, or virtually not impactful. Looking at the model, the margins on the fulfillment business looked really, really decent. The margins on direct look a little bit light of what I was looking for. Any thoughts on that?

Well, we are looking at, on the direct business, we are measuring it -- got to look at both margin and turn, on an annualized basis. And we think it's approaching -- we think it's gotten to be a good business. Yes, the margins are a little bit lighter, it's where we still think we can squeeze lots of percentage -- well, percentage points out of our cost structure and keep it reducing.

But that's a -- I'm very comfortable where the core business is going. In fact, I think we've gotten -- although we stay agnostic on, do we want to grow versus partner and so forth. Our information has gotten so good that I think it makes sense for -- I really do expect it to grow substantially. It's actually growing nicely right now. I'll say that much about the fourth quarter. It's -- the core business, we know what to buy better than we've ever known before. And I really do expect to see that, the core business, to have significant growth next year.

Jonathan, do you want to jump on, say anything to follow that up?

Patrick, this is Steve. Let me just comment. So, if we look back at kind of third quarter last year, we were roughly just mid-10's on direct gross margin. We've, because of supply chain efficiency, better buy, better demand management, we've pushed that up to just north of 12. So that just speaks loudly to what you have just said, where we've got people focused on supply chain, we are thinking about demand, we are doing better buys. That's starting to translate into improved gross profit rate.

In terms of capacity, let me add to that, just in terms of capacity, it's now, given that we've taken down the whole of a much bigger warehouse in Salt Lake, there is a good 75 basis points that are going to unused capacity at this point. Isn't that about the right -- unused, other than in the fourth quarter, it will largely be used. So you can think of it being a 75 basis point handicap on that margin that, as we grow the direct business, that's where some tens of basis points can fall out.

Jonathan, I cut you off. What were you going to add?

I was going to say, I agree. We do have a little bit of a headwind given the extra warehouse capacity. But we think there's more money to squeeze out of that process. We also think we're getting pretty good at -- we're pretty good at the pick, pack and ship game. And we've begun to approach folks to offer a consignment model so we can make use of our warehouse space and our skill is pick, pack and shippers. So that's the nascent project, but I think it's a place that we have some potential.

Absolutely, and we are actually starting to -- we've ribbed that up, or we've got that going even more slowly and carefully than other projects in the past. But we have developed a nice software package so we can do that, get the accounting right, etc. And we are really looking for our first few big vendors who want to reduce their own warehousing costs and have some excess inventory to liquidate and just want to send it to us.

So I think the consignment model ultimately should be a right good business for us. By the way, I want to give a citation to the report I referred to was the one that came out today from J.P. Morgan is the one about the Amazon/Wal-Mart book pricing war.

The cash build in the quarter was a pleasant surprise. Any highlight on what drove that? It was several million higher than I would have expected. And then implications for cash at the end of the fourth quarter?

Steve, why don't you start off?

I think that the key driver was the fundamental P&L itself. When you've got the top line growing and you are managing expenses and you are managing the marketing spend, you start to see that cash flow start to come out. And then the key measure that we watch is where working capital is going. Sometimes you get a little bit of swings between cash on hand and payables. So, when we saw the uptick also on working capital, that spoke loudly that this thing had nice cash flow coming through the quarter.

And fourth-quarter?

I think it should -- I'm optimistic that it's going to spit out quite a bit of cash this fourth quarter. And you probably won't see our working capital dip down into the -- if things go as planned, you shouldn't see our working capital dip down into the 30s again -- well, again. But short of some balance sheet anything we do, not in the balance sheet or a buy-in or something like that. We are comfortable we've been operating within the low 30s, but it should get over 40, and then we'd like to keep it there.

Does that imply cash over 100 in the fourth quarter?

Steve?

Yes. Brent, you have to be real careful because it probably will be north of 100 is clear. But then we pay down payables pretty fast after that. That's why we watch working capital, because we get more of a consistent pattern of what's happening with the underlying business.

Thank you very much. Congratulations, guys.

(Operator instructions). You have no further questions at this time.

There's been a couple questions that have been e-mailed in I'd like to review and we can answer. One is -- short of an economic meltdown, do we foresee Overstock as being profitable for the entire year after Q4? And then the second one from this investor is -- is international growing faster than domestic?

My answer to those -- the first one is -- may I have permission, counselor to answer the first question?

You know I don't like too much guidance. But yes, you have permission to answer on this one.

The first one, the answer is yes. I do think that after the fourth quarter we should have a GAAP-profitable year. I'm hopeful of that without an economic meltdown and so forth.

International is growing, but its percentage growth is high. But of course, that's base because the denominator is small. It's not yet -- you are not seeing -- you're not seeing 1% of our sales, yet, be international. However, that could change. And it's really, I think, next -- I just came back from Europe and looking at opportunities to do things there. And it is a place where -- well, international in general is a place that we intend to focus in -- well, we are focusing now.

And it's spinning up. It's spinning up at a very high percentage rate, but it will be less than 1% of sales for this calendar year. Jonathan or Steve, do you want to add something to that?

I would agree. I see nice potential in international, but it's such a small percentage of the business now, it's not that meaningful. I will say I think we're being very careful in dipping our toe in the international water, to do it prudently and carefully and not to dive headfirst into something. And we feel like that's the right thing to do because with better control of the costs and the exposures and things. So I'm very pleased with where international is, how we are approaching it, and hopefully it's going to do well.

Two other questions have come in. One is -- how does management weigh benefits of driving faster operating margins versus benefits of the various lawsuits? And that is in conjunction with the question that says -- it looks like our legal expenses are limiting improvements in our gross margins. At what point will those legal expenses stop increasing?

Well, legal expenses did -- have increased and did weigh down on operating margin. We are scheduled to be going to court in the first case, in Marin in February. And Jonathan, why don't I let you answer both of those?

Okay. We are picking up more legal expenses. Some of them do relate to our two suits in California, our suit against Rocker Partners and then against Prime Brokers. We've also seen an increase in patent troll suits, which I think is to be expected as we maintain being a player in this field. We've taken an aggressive stance in fighting those.

I think we'll see legal expenses grow or be significant or kind of levels they are at in Q4 and maybe through the first half of the year as we go to trial. Trial is always an expensive endeavor. But we are at a point where that trial is so close it's definitely worth spending and getting to because we feel good about where we are and what the possible results are.

Steve Chesnut, do you have anything to add?

Yes. I think that other piece is that, sitting on the balance sheet right now, we've got a little over $800,000 of that settlement money, of $2.75 million, that will also be used to help offset some of these future expenditures around legal suits. So we've got a little bit of a hedge sitting there.

Jonathan, do you want to expand on that? Have you explained that to the public yet?

I think we put it in our disclosures, our filings. We did settle with our D&O insurer, and we have some that we earn out as we spend legal expenses. And so part of our expenses are offset by that insurance pool. Like Steve said, there's a little less than $1 million left in there. And we'll burn through that over the next several quarters.

But I will say, we put out a press release last week. One of our lawyers, [John O'Quinn], who was a lion of a man, unfortunately was killed in a car accident last week. A sad situation, but we are still plowing forward and are prepared to take both the cases he was helping us with to completion.

Yes. Condolences to O'Quinn. He was a great colleague for Overstock and, as Jonathan says, a lion of a man. He was a wonderful fellow.

Well, Patrick, I think that's all of the questions. Do you want to say anything in closing?

No. Just, I really to look forward to speaking with folks in January or February, when the next conference call is. I feel very good about this quarter, and I just feel very good about the quarter we are in. Things are going well. We've really positioned ourselves tightly, and we've stumbled occasionally before. But I think things are looking pretty good for us right now.

Okay. We'll put our shoulder back to the wheel and start working for our owners again.

It's nice working for smart owners.

This concludes today's conference call. You may now disconnect.