PFSweb Inc (PFSW) 2005 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the eCOST.com second quarter 2005 earnings conference call. My name is Michelle, 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 today's presentation. (OPERATOR INSTRUCTIONS). As a reminder, today's conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today's call, Ms. Liz Murray, Executive Vice President and Chief Financial Officer. Please proceed, ma'am.

Thank you. Good afternoon, and welcome to the eCOST earnings call. With me on the call today is Adam Shaffer, our Chairman and CEO. Before I turn the call over to Adam, let me begin by reading the Safe Harbor provisions.

To help you interpret our growth opportunities and financial outlook, during the conference call today we will be making forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. As you know, our financial results are subject to numerous risks and uncertainties, and it is possible that actual results may vary from the predictions we make today.

Additional information regarding those factors that could cause such differences can be found in our second quarter earnings release dated today, as well as the risk factors and MD&A sections in our most recent SEC filing. Adam?

Thanks, Liz, and thank you all for joining us today for our second quarter 2005 earnings call. This second quarter has been another transition quarter for us as we completed our separation from PC Mall, our former parent, on April 11, and established ourselves as an independent publicly traded Company.

The quarter was not without its challenges, and we continue to suffer from teething problems, especially in the fulfillment center operations and merchandising. This has affected our financial results, including our gross margins, and unfortunately masked some of the improvements we did make during the quarter, including reduced return rates, improved warehouse operations, improvements in products margin and pricing strategy.

Disappointing though these operational issues were, the good news is we better understand our problem areas, and have made progress in fixing many of them and have seen encouragingly positive trends in June.

As with all transitions, the process was challenging and the business growth and gross margin temporarily suffered as a consequence. Despite some of these issues, we did achieved several positives.

Some of the highlights in the quarter include a 50% growth of the customer base in Q2 2005 compared to Q2 2004, now with over 1.3 million customers served; a continuing positive spread of gross margin to customer acquisition cost; the addition of several new category stores, including the software download store; a flower store, which is co-branded with FTD; and the framed art store. These are all great margin-enhancing opportunities for us, as these are private-label or co-branded affiliate relationships.

We also experienced growth in the Platinum Club membership to now over 4000 members, and the addition of Hewlett-Packard HP and Apple authorizations.

Looking at the details of the quarter, our sales growth in the second quarter was affected by some seasonality, as expected. And the growth year-over-year of 6% was slower than we had enjoyed in recent periods.

While we are still more completely evaluating all the aspects and play here, our consumer sales suffered more predominantly than those sales to our small-business customers. We were focused on profitability during the quarter, and turned away some of the business sales actively that was less profitable, which impacted the growth of the business sales area.

Consumer sales made up 58% of the quarter's total sales, and were down from the last quarter, which was approximately 60%.

One of the contributing reasons for our sales slowdown was advertising. We spend less on advertising this quarter compared to Q1. And what we did spend was less efficient. Although we focused our advertising spending in historically efficient channels, the quarterly results showed a less efficient conversion of consumer traffic to revenue in these channels. Although the average advertising cost per click remained about the same as prior periods, corresponding conversion rates were lower than historical levels.

To help us better understand these results, we recently retained an outside advertising firm to help us better analyze and interpret our daily advertising results on a much more granular level, resulting in better optimized advertising placement and product selection. We believe these additional resources will help us beyond our prior capabilities.

This SKU-level optimization should translate to more efficient advertising spend, hopefully resulting in higher conversion rates in the future.

In addition, this service provider will help us better map our product data feeds to our online advertising partners, which should enhance our product offers to include more refurbished and closeout products, which have historically been a challenge to advertise through many of our comparison shopping sites.

Due to the difficulty of matching new products with refurbished products, we had been at a disadvantage. For example, many refurbished products have different manufacturing part numbers that differ from the original part number. Better mapping should help display these refurbished products alongside when searching for the current side model, therefore showing a more competitive price for the same specification.

Cost to acquire -- looking at some of the metrics, our cost of acquisition this quarter was $19.51, which is higher than prior quarters, but still provides a positive spread between average gross margin per order and new customer acquisition cost. Therefore, on average, our first customer sale is a profitable sale on a variable basis.

The average order value also increased to $352 this quarter, up from $302 in the first quarter, largely due to the increased proportion of business sales and computer sales.

Distribution -- on the distribution side, we established our warehouse operations in Memphis, Tennessee, and began operating out of this facility in early April. Not unexpectedly, with the new facility and new people, there were start up challenges within the operation that caused several setbacks, as we became more familiar with the warehouse management system being utilized along with the process control fundamental to distribution centers.

This had an adverse effect on our sales during the quarter, and resulted in poor customer service, increased returns, and lost customers, which will take some time to rebuild.

This issue also affected our costs in the month, and resulted in lower gross margin. Before April, we've relied on our former parent who acted as our outsource fulfillment provider, and charged us on the basis of $4 per order. We undertook a lease with a warehouse space, believing that we could improve upon that variable cost.

Clearly, we are operating well below capacity with the issues facing us in the quarter. Our costs are considerably higher on a per-order basis.

During the quarter, executive management spent considerable time working through the issues, and we are pleased to say that many of the warehouse issues have been resolved, and we have seen significant improvements in June. These signs are encouraging, and we believe that we can improve upon previous cost levels.

Improvements -- despite some of the teething problems highlighted, we did make improvements in the quarter again with June positive indicators. We eliminated our free shipment program, and reevaluated some of our pricing strategies, all of which delivered positive gains to gross profits in the quarter, unfortunately offset by the losses in the warehouse.

As I already mentioned, we are also working with an outside firm to better optimize our pricing to both maximize sales and gross margin. At the end of the quarter, we started to see a reduction in returns as announced (technical difficulty) taken in the warehouse. In addition, we developed new private-label affiliate partnerships, and have been able to increase use of virtual warehouse dropship partners and secure new relationships with top tier vendors.

Merchandising -- we were pleased of the vendor transition from PC Mall and retain all of the key relationships with the major suppliers, and have supplemented these relationships with additional top tier manufacturers.

We are delighted to be chosen by Apple as one of the only full line online retailers. In fact, I believe that there are only two to receive this medallion authorizing, in this case, eCOST to sell the full line of Apple products. This is a major coup as we see this as an incremental opportunity to grow our business in the creative professional market and also with their popular consumer line of products.

HP also has been secured as a key vendor relationship, and we have the authority to buy directly from them, including new, refurbished and closeout products.

In addition, eCOST.com is now authorized to sell products from top tier manufacturers such as AMD, Hitachi, TEFF (ph), LEICA cameras, Pioneer, and Yamaha, with several others now in process. The addition of these top tier brands working with eCOST further validates the importance of eCOST's opportunity as a key destination site for consumers. And our ability to represent such important product lines in the online channel is a key asset.

As we expand our business going forward and develop our brand, we will be well positioned to enhance these relationships, which will allow us to offer differentiated product offerings to our customers and procure at preferential terms.

Purchasing and procurement -- during the quarter, we focused on profitability. We streamlined some of the product offerings within some of our categories. We have also been purchasing products direct from manufacturers and other distribution sources, including virtual warehouse partners. We are spending time to increase our virtual warehouse and dropship partners as we evolve to a more focused approach on what we stock in our warehouse, thereby pushing more of the less predictable products through our virtual warehouse dropship partners.

In the quarter, approximately 18% of the revenue was shipped by virtual warehouse partners, up from approximately 10% a year ago. By doing this, we are able to better streamline the purchasing process while making more products available, increasing customer choice and service levels. At the same time, it allows us to focus on the unique closeout, refurb, and also hot new-to-market items that we stock in our Memphis, Tennessee facility.

We are also developing more private-label affiliate programs to introduce new product and services to our customer base with no inventory risk, along with a robust assortment of offerings such as our new framed art store and software download store.

Customers -- computers, along with electronics and digital imaging, continue to be efficient product categories to acquire new customers, which we then leverage across other product categories. We feel that technology buyers tend to be Internet-savvy, higher income individuals who spend more time online and purchase products online in many categories.

Recent industry research reports also show that online consumer electronic buyers spend nearly twice as much as average online buyers, and purchase within 2.5 times as many product categories as an average online buyer. Our ability to acquire technology customers and leverage them across all our product offerings is an efficient formula as we launch new categories. We feel this affect further differentiates us from our competitors.

Growth strategy -- our growth strategy remains consistent with our initial plans, but we are clearly more heavily focused on achieving profitability in the near term, and then expanding our business beyond that. We will achieve this by focusing on these six key areas.

One, continuing to execute much more effectively in the warehouse; two, refining our pricing strategy to maximize gross margins; three, leverage our existing customer base across all our product and service categories; four, continue to profitably grow and develop our (ph) business sales, utilizing our account relationship team; five, more effective advertising; six, continued negotiation with vendors and suppliers to reduce costs and enhance margins and offerings.

We have faced some challenges these past two quarters, and feel we are making substantial progress in re-establishing the business after the transition. While this has caused us some operational growing pains, we are delighted that the trends commencing in June are much more positive.

As we said on our last quarter's call, our sales growth rate was less this quarter than in Q1. As we continue to focus on profitability, we remain optimistic about the business. We expect margins and profitability to improve based on the areas I just outlined.

At this stage, we are more focused on profitability and less focused on sales growth. Therefore, we will withdraw our previous 2005 sales guidance. As we better establish our model and deliver operating profitability and positive net (technical difficulty) 2006, we will reinvest for sales growth.

Now I would like to turn the call back over to Liz, who will provide the financial results for the quarter.

Thanks, Adam. Sales for the second quarter 2005 were 41 million compared to 38.8 million in the prior year comparable quarter, representing an increase of 2.2 million, or 6%. Sales decreased sequentially by approximately 14 million, partially due to seasonality, but also as a result of the issues Adam has already addressed.

The sales increase over last year was driven in combination by a 5% increase in the number of orders and 6% growth in the number of customers over the second quarter 2004.

Looking at the sales mix, consumer sales for the second quarter 2005 comprised 58% of our total net sales, compared to 63% in the prior quarter and 60% in the second quarter 2004. Consumer sales were down sequentially, but slightly up on the prior year comparable quarter.

Business sales in the second quarter, which make up the balance of 42%, grew approximately 13% over prior year but were also lower sequentially, largely due to the focus on profitable growth.

The increased proportion of business sales resulted in an increase in average order volume to 352 compared to $302 in the prior quarter and $341 in the prior year comparable quarter. The sequential increase in AOV is approximately 17%, and reflects the increased sales of computer equipment, which now makes up about 70% of the Company's sales.

Net loss for the second quarter was 9.4 million, equivalent to a loss of $0.54 per share. The net loss in the quarter reflects a 6.5 million non-cash tax provision relating to a valuation allowance against the net operating losses included in the Company's deferred tax assets.

Under FAS 109, given the losses recently incurred and the inherent uncertainty in the forecast, the visibility into the utilization of those NOLs is less certain. Consequently, we have established a provision against the NOLs, and we will continue to evaluate this asset on an ongoing basis.

Pre-tax losses for the second quarter were 2.9 million, slightly higher than the first quarter's loss of 2.8 million. This compares to an essentially breakeven second quarter of 2004.

Year-over-year, the cost structure has increased due to higher advertising expenses and increased costs associated with establishing and running an independent stand-alone Company, including our own fulfillment center and various others staff functions.

Gross profit for the second quarter of 2005 was 2.7 million, compared to 3.7 million in the prior quarter and in the prior year comparable quarter. Gross profit margin as a percent of sales was 6.7% in the second quarter, in line with the prior quarter, and compares with 9.7% in the second quarter 2004. The Company's gross profit percentage will likely vary from quarter to quarter, depending on the product mix, pricing strategies, key vendor support programs and other factors.

The lack of margin expansion this quarter is almost exclusively due to the initial cost additional cost of running our own distribution center and the transitional issues we faced in managing the fulfillment operation. Cost of fulfillment runs through cost of goods sold, and with the inefficiencies and learning curve we experienced this quarter, the margin forfeiture was approximately 1%. Margins otherwise improved in the quarter on a few key fronts, including freight and pricing.

SG&A expenses for the second quarter 2005 were 5.7 million, equivalent to 13.9% as a percentage of sales, compared to 6.6 million and 12% of sales in Q1 2005. Expenses were lower sequentially by nearly 1 million due to lower advertising expenses, lower personnel and outside service costs.

Compared to the second quarter 2004, SG&A expenses increased approximately 1.8 million due to the higher advertising expenses and increased personnel costs of operating the Company on a stand-alone basis, along with the additional costs of a public Company. This includes staffing, all the primary functions such as procurement, marketing, finance, and additional costs such as legal, insurance, and fees related to public Company requirements.

Advertising expense this quarter was 3.6% of sales, in line with the prior quarter, and compares to an advertising expense in the second quarter 2004 equal to 3% of sales.

At the end of the second quarter, the Company had cash and cash equivalents and short-term investments of approximately 6.3 million, compared to 11 million at the end of March 2005.

During the quarter, the Company commenced its startup procurement program, having established relationships with most of the major vendors. At the end of June, we had approximately 10.7 million of total inventory, which comprised 9.3 million net of reserves of inventory held for resale and 1.4 million related to deferred revenues. We added approximately 800,000 in capital expenditures in the second quarter associated with the warehouse buildout completion.

We have no debt, and have a borrowing facility in place of up to 15 million. The amount of funds available under this line is based on inventory levels and receivables balances.

Looking forward to the third quarter and 2005, we are continuing to focus on profitability, and believe that the positive trends experienced in June will result in improved profitability going forward. The warehouse is running much more efficiently and effectively. And although we are not operating at scale, we are seeing improvements in gross margins based on the results thus far.

We are, however, cautious about top line growth, and believe the recovery to pre-spin (ph) levels will take some time. Consequently, with our focus on profitability, and based on improvements already evidenced in June, we will continue to make sequential improvements to reduce the quarterly losses from the first and second quarter levels, and are estimated losses in the each of the remaining 2005 quarters, but at reduced levels.

With these ongoing improvements, we expect to achieve operating profitability and positive net income for 2006 overall. And we will reinvest for sales growth as we reach our milestone improvements.

This concludes management's prepared remarks. And I will now turn the call back to Michelle for questions.

(OPERATOR INSTRUCTIONS) Tony Frist (ph), American Wealth Management.

It is a bit unnerving. I hope I am not the only one asking a question. Alan, I have I guess a question for you. I am interested in the Company because it is a low-cost producer -- it seems to be a low-cost provider. And it seems to be a market that is expanding. However, how do you feel you're set up to weather the rest of the year? And I was actually hopeful that you guys were further along to getting to profitability. It doesn't seem you are a long way off. I would like to possibly ask if Liz could explain that write-off -- the $6 million write-off that occurred this quarter -- a little bit more thoroughly?

(multiple speakers) I am happy to address that question now. The GAAP rules under FAS 109 require you to look at the utilization of net operating losses, which we have built up since inception of in excess of $12 million, and make a pretty conservative view about the utilization of those losses. And given that we have incurred losses this quarter, last quarter, and those are facts, the forecast and the outlook has less certainty relative to factual and actual reports. And so on balance, we concluded that it would be more appropriate to reserve against that deferred tax asset. And so we took this non-tax charge of 6.5 million, which was the balance at the end of June. And we provided that in our income statement. And that's the 6.5 million that flowed through in the quarter.

Okay, so that's a charge you took. It's a non-cash charge -- it is not like FASH (ph) 150 or 142 or anything like that? I don't know why I am having a hard time understanding it, but -- it was against your NOL?

It was, yes.

And it reduced your NOL?

It in effect negates the net operating loss. The NOLs don't go away, and all we have done is taken a provision against those NOLs, a conservative view of the NOLs, and said we are going to take a reserve, and we will reevaluate that as the quarters go on the terms of profitability, et cetera. And in the light of profitability, we will reverse that valuation provision and report the full value of the NOLs on the balance sheet under deferred tax assets.

Okay, it is not related to any impairment due to product we can't sell or anything like that?

No, not at all. (multiple speakers) Not at all. It --

Okay, that is what I was a little confused about.

I apologize. It's really an accounting standard that evaluates the tax asset in the context of timing and likelihood of use, et cetera. And so it is predominantly accounting issues. The value, as I say, has not gone away. And we are just taking a provision against that in our balance sheet at this time.

I see. Let me just modify my question, if I might, and point the second half to Alan and make it a little different. Do we have an investment bank, or anyone from Wall Street that is retained to advise us on growth in some of these issues and possibly raise money?

You know, right now, we don't have -- right now, we are evaluating all opportunities and all issues. But nothing concrete yet that we can talk about.

Okay, I might -- I did try to call Alan a couple times but couldn't get through. I might even try again later this week and see if I can figure out how to get you on the line, because I might have a bank I would like to introduce you to. But anyway, if there's not a --

That would be nice. It would be nice if you would like to do that; fine.

Okay, well, thank you, and best of luck, guys. And it is interesting. I think the market is expanding, so I think it is the right place to be.

Yes, we remain encouraged about the business opportunity.

Yes, I think it is out there. So best of luck, and I guess we will see you or (multiple speakers) hear you on the next call.

Richard Fetyko, Merriman Curhan.

If you can just elaborate a little more on some of the individual issues that you said impacted your gross margins. It sounds like there are a number of them. But if you could go one by one and tell us which ones have been taken care of, and as of now, which ones are still outstanding or need improvements? And which ones had the most impact on your gross margins, I suppose -- give us a little more idea of which are the areas that impacted your gross margins, where you are making progress, and so forth?

Well, Richard, you know that we have our fulfillment operations hitting (ph) up in our gross margin. And so that area really affected us in a big way. But the good news is it has been getting better throughout the quarter. It just was a slower start than we would have liked. It was not as efficiently run, as we were getting up to speed on all the processes and systems. We reconfigured what we're doing down there with the people. We made some improvements with the team in general.

In addition to the warehouse, which I see, because I have been spending a lot of time with them trying to get that to a more optimized level -- another area is freight, which affects gross margins. And probably at the beginning of the quarter, we still had our free freight policy in place. And over the last couple of months, we have been evolving away from that -- in testing, and now evolving away from the free freight, which really helped benefit gross margins. If you look at our site right now, the price promotion for UPS Ground is $1.99. And once you get past a certain weight, it actually goes up considerably. So that should absolutely help, because that was a loss area.

Also, another area that affects gross margin is -- and this is -- the downside was returns. Because of the warehouse, we saw a lot more returns than we normally would have seen. And during the end of the quarter, that return metric has gotten better and better as we have really been focusing on what the issues there with regard to returns have been. It is some mis-shipment issues and things like that. So that is all getting better. So I think there are a bunch of areas within the warehouse that caused some of this gross margin thing.

And then with the inexperienced (technical difficulty) I don't want to say completely inexperienced. We have some pretty good guys down there. But we did reconfigure the management team a bit to try and drive as much efficiency out of the people that are down there. So every day, we are seeing better and better metrics coming out of that group.

So on the fulfillment side, when you talk about warehouse issues, are these issues that -- taking and putting together an order takes too long? Is it slowing you down -- it's just fulfilling the orders, which is taking too long, and the orders are getting canceled? Or is it just taking too long and the costs are high, taking --

Richard, it is all of that. You start with a bunch of -- a few senior-type people, but the rest of a lot of new folks. And in a new footprint -- although the footprint is very similar to PC Mall, there are still the intricacies of running in your own place.

So yes, it is -- how many orders an hour do they get out the door? How many orders do they not make out by the end of the day and hold over and get customers frustrated that they are not getting their products the next day if they ordered it FedEx? And it kind of becomes a major customer service issue.

Also, some of the newer folks potentially, even with all the systems that we have in place to protect it, some mis-ships happen. Even the way the package some of the product, I realized, created some mis-shipments or missing piece shipments that we have been dealing with.

So I have been down to Memphis several times working with this team. And it's not rocket science. It is just really execution and spending the time with them to make sure that their processes and their management are intact and kind of in sync. So I am kind of bullish on where we are going with that place. It's unfortunate that it has just given us a little bit of the hiccup in the first few (technical difficulty)

So how much did you spend or would you attribute to fulfillment in terms of cost of goods sold, or what kind of impact did it have on gross margins? If you were to eliminate all these issues, what kind of lift in gross margins could you realize?

That was about probably close to 1%, may be a little better right there. (multiple speakers)

Okay, so that would get us to about 7.7%, which still runs about 200 basis points lower than last year. Do you think that you can get to that 9 to 10% range over time, and what would it take to get to that?

What you are not seeing in that number is that part of that gross margin equation has to do with the freight that we are charging. You have two areas of freight. You have freight that --what the customers pay us for the freight that we ship to them. And that is getting better and better as the weeks go on, because we have been changing our freight or shipment policy, our promotion. So the gaps (ph) to what we were losing there that was affecting our gross margin is getting better and better. And that is worth a decent amount.

Also, we are looking -- and we have been spending time with the vendors, the distribution vendors to try and get alternative ship methods for some of the lighter goods that we sell, which should also help on the gross margin side. (multiple speakers)

And the margin in the quarter, Richard, reflects -- two pretty poor months. And the reason that we are reasonably optimistic on the outlook is that we have seen the margin in June having washed in result in many of these issues, and we have seen the pickup in June. So unfortunately, we have two poorer months and a stronger month in June, which really bodes well for us going forward. And at least 1% was the fulfillment area. But the other improvements that we made, including pricing and freight, really began to affect the June month. And so you have got kind of one month out of three that looks strong, and the margin overall is detracted by the two poorer months.

What is really interesting right now is that we are spending a lot of time on the pricing strategy analysis. But you know, we sell so many SKUs. And so now we have a much more automatic (technical difficulty) and again, I hate to use the word "granular," but granular way of understanding how to increase gross margins, because in many cases, we might be leaving money on the table. So we are evaluating all of that on a regular basis now. And that is quite important to increasing gross margins.

And how are the gross margins trending in July?

Very similar to June.

Okay.

(OPERATOR INSTRUCTIONS) Ladies and gentlemen, this does conclude the question-and-answer portion of today's conference call. I would like to turn the presentation back over to Mr. Shaffer for closing remarks.

Just thank you very much for participating and supporting the Company. And we look forward to working hard and growing our business and driving this business to profitability. And we look forward to meeting with you again next call. Thank you all.

Ladies and gentlemen, thanks for your participation in today's conference call. This does conclude your presentation, and you may now disconnect. Good day.