PFSweb Inc (PFSW) 2005 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to your Third Quarter 2005 eCOST.com Earnings Conference Call. [Operator Instructions] I would now like to turn the presentation to your host for today's call, Mr. Brent Hirokawa, VP and Controller. Please proceed, sir.

Good afternoon and welcome to the eCOST Third Quarter 2005 Earnings Call. With me on the call today is Adam Shaffer, 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. In particular, among the forward-looking matters we will be discussing today are the following - first, two new initiatives we are implementing to reduce our costs, including our intention to increase our use of certain alternative freight services to UPS Ground and our efforts to establish an operational base in the Philippines. Second, details on certain other initiatives we are implementing as part of our growth strategy for achieving profitability. Third, a non-binding letter of intent we entered into today, that contemplates our merger with PSS Web, and finally, our expectation to continue the trend of reducing losses in the fourth quarter and achieve overall profitability in 2006.

These forward-looking statements are not guarantees of future performance and involve risks, uncertainties, and assumptions that are difficult to predict. In particular, with respect to the proposed merger with PFS Web, we note that the LOI we entered into today is non-binding and there can be no assurance we will ever enter into a definitive merger agreement with PFS Web. Also, with respect to our expectation to achieve profitability in 2006, 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 factors that could cause actual results to differ from our expectations can be found in our third quarter earnings release, dated today, as well as the Risk Factors and MDNA section in our most recent SEC filings. With that covered, I'll turn the call over to Adam.

Thanks, Brent. Thank you all for joining us today for our Third Quarter 2005 Earnings Call. I'd like to begin today's call first by providing an overview of our business for the third quarter, and then I'd like to provide you with more information on the other announcement from today, our letter of intent to merger with PFS Web, where each share of eCOST will be exchanged for one share of PFS Web.

We are pleased with the progress that we have made in the third quarter. We've implemented and have been executing on initiatives which have helped us to significantly reduce our losses from the second quarter. We've been able to increase both our gross margin as a percent of sales and our average order value, which translates to higher gross margin dollars per order compared to the prior quarter. We have also been able to maintain a positive spread between our average gross margin dollars per order and our costs to acquire a new customer. In addition, our balance sheet at the end of the quarter included no debt, over $6.2 million in cash, and reduced inventory levels compared to prior quarter end. We also maintain a $15 million revolving asset-based credit facility that we have no borrowings against.

The third quarter is our first complete quarter as a stand-alone company, as we've completed our separation from PC Mall, our former parent, on April 11th of this year.

Looking at the details of the quarter, our net sales in the third quarter were $38.2 million, a decrease of $2.9 million or 7%, from $41 million in the second quarter of 2005. The decrease was due mainly to the company's focus on profitability over growth. Pre-tax losses for the third quarter, excluding a one-time severance charge, were $2.2 million compared to $2.9 million in the second quarter. The reduced losses in the quarter were mainly due to improved gross margin percent, reduced advertising expenditures, and lower operating costs compared to the second quarter.

In the third quarter, consumer net sales represented 51% of our total sales, down from 58% of the total net sales last quarter, as business sales grew 24% compared to the third quarter of 2004. For the third quarter 2005, business sales represents 49% of total sales for the company. This increase in business sales has been driven by a team that is smaller and more efficient compared to last year. In the third quarter of 2005, we have 21 account relationship managers, compared to 25 account relationship managers in the third quarter of 2004.

Advertising -- we have spent less on advertising this quarter compared to Q2, as we began building new data-driven online advertising analyses with the help of our newly retained outside advertising technology firms. As we mentioned last call, our conversion rates have declined, as we focused our advertising campaigns in historically efficient channels. Although the average advertising cost per click remained about the same as prior periods, corresponding conversion rates were lower than historic results.

To help us better understand these results, we recently retained several outside advertising technology firms to enable us to better analyze and interpret our daily advertising results on a much more granular level, resulting in better optimized advertising placement and more cost-efficient product selection. As each of our advertising partners is differ in terms of typical consumer profile, we can now employ partner-specific SKU optimization tactics to hone our existing and new advertising campaigns. These optimizations are founded on our historic success with certain products and product categories for each advertising partner, including both search engines and shopping comparison sites.

Tailored to our partners unique shopping profiles and purchasing behaviors, this SKU-level optimization should translate to more efficient advertising spend and beneficially impact our online advertising conversion rates, compared to our prior capabilities. In addition, these technology firms 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 the comparison shopping sites, due to the difficulty in mapping often unique products that have limited sourced availability.

For example many refurbished products have different manufacturer part numbers that differ from the original part number. Improved product mapping should help display these refurbished products while searching for the current models, therefore showing a more competitive price for the same specification. As many of our price comparison partners have unique methodologies and data format specification for product data feeds, our new technology partners also provide cost-efficient, ongoing management of these requirements. It is still early days with these efforts, but the initial results have been encouraging. The ability to be able to show more closeout and refurbished products on the comparison sites and search engines, we feel, should translate to higher conversion rates and increased sales.

Cost to acquire -- looking at some of the metrics, our cost of acquisition this quarter was $23.06, which is higher than prior quarters, but still provides a positive spread between the average gross margin dollars per order and the average cost to acquire a new customer. The average order value also increased to $389 this quarter, up from $352 in the second quarter, largely due to the increased proportion of business sales. As the gross margin percentage has increased sequentially, along with the average order value, the average gross margin dollars per order has sequentially increased by 18% in the third quarter, to $27.81 per average order.

Distribution -- on the distribution side, we continue to focus on reducing costs and strengthening operations in our Memphis facility. We've been pleased with management's continued streamlining of many of the variable elements of the operation while increasing our speed and accuracy. As we are not running at optimum cost efficiency with our distribution center, due mainly to our fixed costs and current shipment run rates, the warehouse costs to negatively impact our gross margin. Before April, we relied on our former parent, who acted as our outsourced fulfillment partner and charged us on the basis of $4 per order. We undertook a lease for the warehouse space, believing that we could improve upon that cost. Clearly, we are operating well below capacity in the quarter and our costs were considerably higher on a per-order basis, and we continue to believe that we can improve upon previous cost levels. We also continue to explore alternative ways of reducing our fixed costs, including subleasing a portion of our unused space.

Improvements -- we continue to make improvements to our business in the quarter. We have increased our sequential gross margin by 45 basis points, to 7.15% in the third quarter, compared to 6.7% in the second and first quarter. We have employed more sophisticated pricing strategies which we feel should enable us to better manage and enhance our gross margins and maximize sales. We continue to reduce our return rates as a result of better warehouse management and processes and a more focused approach internally. We have become much more granular with regard to our advertising analysis and we have also been able to reduce our personnel costs as we have continued to streamline our team.

Some of the other major highlights of the quarter include the significant reduction of operating loss in Q3 compared to Q2, increased gross margin percent, to 7.15%, up sequentially from 6.7%, a 42% growth of the customer base in Q3, 2005, compared to Q3, 2004, to over 1.3 million customers served, an increase in average order value and gross margin dollars per order, a continuing positive spread of gross margin to customer acquisition costs, continued reduction in return rates, the addition of several new category stores, including DirecTV, and pet supplies, and our new, enhanced jewelry stores. These are all great, margin-enhancing opportunities for us, as these are private or co-branded affiliate relationships.

The launch of our new Platinum Club 30-day trial membership, which converts to an annual membership after the trial period, has been successful. The Platinum Club, including the 30-day member trial, which started not long ago, has increased our membership base to over 6,500 members.

Purchasing and procurement -- during the quarter, as we focused on profitability, we continued to streamline some of the product offerings within some of our categories. We have also been purchasing products from direct manufacturers and other distribution sources, including virtual warehouse partners. We are spending time to increase our virtual warehouse and drop ship 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 a virtual warehouse drop ship partners. In the quarter, approximately 18% of revenue was shipped by virtual warehouse partners, up from 12% 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 facility.

We also continue to develop additional affiliate programs to introduce new product and service categories to our customer base, with no inventory risk, along with a robust assortment of offerings, such as our new DirecTV program and our new pet supply store. We also continue to further integrate high-margin extended service offering throughout our site, in efforts to attach more extended service agreements with computers and other consumer electronics, including LCD and plasma TVs.

Our 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 than expanding-- and then expanding our business beyond that. We will achieve this by continuing to execute much more effectively in the warehouse, refining our pricing strategy to maximize gross margins, leveraging our existing customer base across all our product and service categories and offerings, continue to profitably grow and develop our business sales, utilizing our account relationship team, continue to add new product categories and services which carry higher gross margins than our original category of computer hardware and software, attract new customers cost-effectively by re-appraising and better fine-tuning our advertising efforts, the continued negotiation with vendors and suppliers to reduce costs and enhance our margins, and greater utilization of virtual warehouse drop ship partners.

New incentives -- we still have much work to do and continue to focus on gross margin improvement and cost savings initiatives, as we focus on achieving profitability. Two new and promising initiatives that are currently in process include what I call ``project increased freight margin.'' We are working diligently on implementing a lower-cost freight method in our system, to be able to take advantage of lower-cost freight alternatives, compared to UPS Ground, that leverage the United States Post Office for the final mile. Services such as DHL At Home and FedEx Smart Post should be in place before the end of the fourth quarter, giving us the availability to further decrease costs on our ground shipments to customers.

Project Philly -- we have started establishing operational functionality offshore, in the Philippines, in order to access high-quality and low-cost personnel to further enhance our overall service levels while reducing costs over time. We expect to begin realizing cost savings in late Q1, 2006, with increased benefits throughout the year.

Our intention to merge with PFS Web -- we have faced some challenges during the first three quarters of this year and we feel we've made and continue to make good progress in re-establishing the business. We also remain optimistic about our business, including our new cost-savings initiatives outlined here today. However, the fixed costs of our business versus our current volume still remains. The need to reduced these costs and/or grow into these costs, while we continue to build an even stronger platform for profitable growth, makes the potential opportunity to merge with PFS Web very strategic for us. We are very excited by our planned merger with PFS Web, a global leader in logistics and fulfillment services. PFS Web's advanced distribution and fulfillment and IT capabilities offer eCOST a solid platform to significantly improve our web commerce platform and increase the overall customer experience. We believe that the combination of our core strengths will further enhance our financial position and offer suppliers additional distribution and back-end capabilities. We believe PFS Web's presence-- I'm sorry, PFS Web presents a compelling opportunity to further enhance its operations and future performance.

Through our proposed merger, we hope to align the core strengths of both companies, enabling eCOST to increase its direct sales and customer satisfaction by leveraging PFS Web's operational infrastructure and technology expertise. The combined revenue of the two companies for the trailing 12 months, ended September 30th, 2005, totals $528 million.

While we are excited by the strong growth opportunities inherent in this proposed merger, there is still much work to be done by both companies, including due diligence, the negotiation and execution of a definitive agreement, board of directors and stockholder approval, and other customary conditions. While we remain excited about the potential opportunity of combining with PFS Web, we stay very focused on our ongoing improvements to the company. We have been seeing positive signs in a number of areas and we'll continue to focus on achieving profitability. We believe we will continue to reduce the level of losses sequentially in the fourth quarter of 2005. With these continuing improvements, we expect to achieve operating profitability and positive net income for 2006 overall. As we realize earnings improvements, we will reinvest for sales growth.

Now I'd like to turn the call over to Brent, who will provide the financial results in more detail for the third quarter. Brent?

Thanks, Adam. Net sales for the third quarter of 2005 were $38.2 million compared to $41 million in the prior quarter and $43.4 million in the comparable quarter of the prior year. The $2.9 million or 7% decrease in quarterly sequential sales was due to the increase focus on margin improvement over growth and partially due to seasonality. Average order value increased by 10%, while the number of orders fulfilled in the third quarter compared to the prior quarter decreased from $123,000 to $102,000, or 17%, due to the retrenchment of advertising efforts as Adam discussed earlier.

Comparing the third quarter of this year against the third quarter of last year, sales decreased by $5.2 million, or 12%, reflecting a 27% decrease in the number of orders, partially offset by a 22% increase in the average order value. The decrease in net sales is again due to the increased focus on margin improvement over growth, lower ad spend, and lower conversion rates in the consumer area. The company added 57,000 new customers during the third quarter of 2005, expanding our customer base to over 1.3 million, representing an increase of 42% over the customer base to the comparable quarter end of the prior year and an increase of 4% over the prior quarter-end.

Looking at sales mix, our consumer sales for the third quarter of 2005 comprised 51% of net sales compared to 58% in the prior quarter and 65% in the comparable quarter of the prior year. Consumer sales in the third quarter decreased by $5 million sequentially and by $9 million on the prior year comparable quarter. Business sales, which comprised the other 49% of net sales, increased by $1 million, or 8% sequentially, and by $4 million, or 24% on the comparable year prior quarter.

The increased proportion of business sales resulted in an increase in average order value to $389 compared to $352 per order in the prior quarter and $320 per order in the prior year comparable quarter.

Net loss for the third quarter 2005 was $2.3 million, or a loss of $0.13 per share, compared to a net loss of $9.4 million, or $0.54 per share in the prior quarter, and a net loss of $900,000, or $0.06 per share in the prior year's comparable quarter. The net loss for the current quarter includes a one-time severance charge of $147,000 related to a former executive. In addition, you may recall that during the prior quarter, we took a $6.5 million non-cash tax provision related to providing a valuation allowance against the net operating losses included in our deferred tax assets. On a pre-tax basis, and excluding the one-time effect of the severance charge, the net loss in the current quarter would be approximately $750,000 lower than the pre-tax net loss in the prior quarter. The reduced level of loss is primarily due to improvements in our gross margin percentage, and reductions in selling, general, and administrative expense.

Gross profit for the third quarter of 2005 was $2.7 million, which is line with the gross profit in the prior quarter and $1.4 million lower than the $4.1 million gross profit reflected in the prior year comparable quarter. Gross profit margin as a percentage of sales grew to 7.1% this quarter, as compared to 6.7% in the prior quarter and 9.5% in the comparable third quarter of last year.

The company's gross profit percentage varies from period to period, depending on product mix, pricing strategies, key vendor support programs, and other factors. The increase in gross margin percentage in the third quarter of 2005 is due to implementing and executing various margin enhancing initiatives such a streamlining our warehouse operations through better velocity management practices, processing returns more effectively, and increasing the recoupment on freight.

The decrease in gross margin percentage as compared to the comparable quarter of the prior year is primarily due to fixed costs related to running our own distribution center and partly a function of a higher proportion of sales to business customers, which typically carry lower gross margins and higher AOV than consumer sales.

Costs related to operating our warehouse and fulfilling customer orders are classified within cost of goods sold and affect our gross margin percentage.

Selling, general, and administrative expenses for the third quarter, 2005, were $5.1 million, or 13% of sales, as compared to $5.7 million, or 14% of sales, in the prior quarter, and $5.5 million, or 13% of sales in the comparable quarter of the prior year. Excluding a one-time severance charge taken during the third quarter of this year, SG&A expense was lower sequentially by approximately $750,000, due to lower personnel costs resulting from targeted reductions in the workforce and lower advertising spend.

Advertising expense this quarter was $1.3 million, or 3.4% of net sales, as compared to $1.5 million or 3% of net sales in the prior quarter.

SG&A expenses in the third quarter of the prior year included a $1.3 million non-cash stock-based compensation charge related to IPO. Excluding non-cash stock-based compensation charges and severance, SG&A expenses were approximately $600,000 higher compared to the comparable quarter of the prior year. This year-over-year increase is primarily due increased personnel and other incremental costs related to operating the company on a stand-alone basis and other public company costs.

In terms of our balance sheet and liquidity, at the end of the third quarter, the company had cash and cash equivalents of $6.3 million, which was approximately the same balance as at the end of June. During the course of the third quarter, the company actively managed inventory levels down from $10.7 million to $6.7 million, which helped maintain our cash position.

We also have an asset-based line of credit in place for up to $15 million, which we have not borrowed against to date. Our borrowing capacity under this line is a function of inventory levels and receivable balances. The credit facility contains standard terms and conditions customarily found in similar facilities offered to similarly situated borrowers, and has its sole financial covenant a minimum tangible net worth requirement, which we are in compliance with.

Now looking forward to the fourth quarter of 2005, we are continuing to focus on achieving profitability and believe that the early positive indications from many of the operating initiatives implemented and executed upon during the last two quarters will enable the company to continue the trend of reducing the level of losses sequentially. The warehouse is running more effectively, and although we are not operating at scale, we are seeing improvements in gross margins, based on the results so far. With these continuing improvements, we plan to continue to reduce the losses in the fourth quarter of 2005 compared to the third quarter, with the company achieving profitability for 2006 overall.

This concludes management's prepared remarks, and I will now turn the call back to Michelle for Q&A.

[Operator Instructions] Richard Fetyko, Merriman and Company.

Like to see the progress in the gross margin, and I'm just wondering if you expect that progress in the fourth quarter and '06, what type of levels you think you can return to, or need to, to get to profitability and what other-- you know, and so if you could prioritize some of the cost initiatives, in which areas do you feel like there's more-- the most opportunity to reduce costs and improve margins overall? And then finally, on the PFS Web merger, I'm wondering also, you know, which areas of your operations you feel like have the most cost synergies with that merger, and if there any sales synergies?

Yeah, OK, so on the gross margin levels, you know, our plan is to continue to increase our gross margin as a percent. I don't want to be too specific, but the areas we're working on are several. One is on the product gross margin, we mentioned, we're maximizing, with the new technology that we have, the ability to understand if we're leaving any money on the table, so with 200,000 SKUs floating out there on several different shopping comparison sites, we're able to get real-time analysis now to find out if we're too low in some cases, and able to enhance our gross margin. It also tells us if we're too high in some areas, where we can go back to our vendors and say, ``Hey, what's going on? We should be able to get better prices.'' It's an indicator that maybe we missed a pricing move that we can enhance our gross margin that way.

The other area that we're focused on heavily is on the freight side. Both as recoupment back from the customer, but also, as I mentioned, this DHL At Home, you know, we've been trying to get that going for a while. It's really been that it's there, it's been there, it's just that we have not be able to implement that through our system, and we're feeling pretty good that this quarter, it'll be out and running. And that-- if you consider that over 70% of our products go UPS Ground, and UPS Ground to residents are quite expensive, using this DHL At Home or FedEx at Home really can significantly reduce the cost of packages, and that'll help there.

Also, as long as we keep on trying to- now we have that fixed issue with the warehouse, but as long as we're able to continue to optimize our costs in the warehouse on a variable basis, that'll also help our gross margins. So we're focused on every line of that gross margin, including freight, including product, you know, and also, you know, the good news is, we've been able to reduce our return rates and continue to reduce our return rates, which also impact our gross margin, ultimately. So you know, the bummer of it all is that that our fulfillment lives up in gross margin, where a lot of our competitors might not have it that way, but the fact of the matter is, it's there, and you know, I think sometimes it's a bit misleading. You know, the gross margins are probably better if you looked at it, compared to others.

Sure. And lastly, on the PFS Web merger, just maybe if you could identify areas of cost synergies that-- I assume that's [inaudible] a reason, as opposed to sales synergies?

Yeah, first of all, I mean, what's nice is, it's not a competitive business for us, it's very-- it's a wonderful marriage, if we can get there. You know, they provide lots of wonderful services with regard to world-class fulfillment systems, you know, they have wonderful rates with freight carriers, but I really don't want to get too deep into any synergies. We really need to-- we're not really prepared yet to talk through that, but you know, you can probably use your imagination with some of the things that they're probably strong at, that we would benefit from, but we're not prepared yet to talk about that. You know, we haven't gotten a definitive agreement. I think when we get close to that definitive agreement, there will be more fleshing out that we'd be able to explain to you, so if you can just be patient, we just wanted to be prudent by putting this out there today, because did sign that LOI.

Sure, thanks. And then on revenues, in the fourth quarter, which is seasonally the strongest quarter, I mean, should we expect a decent revenue growth, quarter over quarter, or is it the case where--

You're talking year-over-year or sequential?

Sequentially.

You know, it's-- the fourth quarter sequentially is seasonally a better quarter, so yeah. If you look historically, you know, I don't see any reason why historic sequential trends wouldn't apply.

OK, thanks.

[Operator Instructions] Edward Weller, ThinkEquity Partners.

Could you talk about how the number of SKUs that you're offering out of your own warehouse, in your own assortment, has changed year to year, like one would assume it's down. And the extent to which the number of SKUs being offered by third parties in what you call ``virtual warehouse'' has increased? And could you address why you want to bother owning your own inventory if you can offer extensive inventories owned by third parties?

Yeah, you know, and a lot of people have asked that, but I don't think they completely grasp that we're in the business of trying to corner the market and be more unique. If you want to just be the player that just sells what everybody else, then you can fend for yourself through these distribution partners, which are helpful, but we focus on these closeouts and refurbs, where we really do create unique opportunities, and also when a product is incredibly hot, let's call it an i-Pod Nano, you want to have that in stock, because it's like a golden nugget - you gotta have it or it will disappear from your virtual warehouse partner. But let's talk about just some numbers.

You know, I think we used the number of about 100,000 SKUs. It's probably close to 200,000 SKUs that we have floating out there right now. It you look at that, at any one given time, I bet you we have somewhere between 4,000 and 8,000 unique SKUs sitting in our warehouse. The rest are really virtual warehouse SKUs, where they're onesies, twosies, hard to predict, and let that be somebody else's problem, and they do a wonderful job to alleviate any purchasing risk and inventory risks. Also let's us be in stock on all that wonderful stuff. But really what we're trying to do is focus on the things that are hard to get and putting them in the warehouse. That's where we take the inventory risk, because we're the only players in town that have that stuff. And so that's kind of the beauty of our hybrid model.

Could you address how that 4,000 to 8,000 changes-- has changed from last year?

Right now, let's talk about revenue, because- that I've talked about today, and about a year ago, we were running about 10% to 12% of our revenue through VWs, and now we're close to the 18% to 20% range of revenue. Now that's substantial, and we are pushing more and more that way. Where we've slowed down is that we would like to have more virtual warehouse partners in place, it's just the ability to get these programs going, and I'm hoping that's another area-- I don't want to call it a ``synergy,'' but I think it's an area where I think a partner like PFS Web can help us accelerate in that area, because the more virtual warehouse partners we can get in place, the more opportunities we will have to not have to stock the product and utilize these folks. So right now, it takes us a bit of time to get a new virtual warehouse partner hooked up. I'm hoping to accelerate that with the help of others.

Thank you.

[Operator Instructions] Gentlemen, I'm currently showing we have no questions in the queue at this time.

OK. You know, so if there are no other questions, we'd like to say thank you, everybody, for participating. We're very excited about what's going on here. We have, you know, some parallel tracks that we're following, and we appreciate everybody's support, and we'll talk to you on the next call. Thank you very much for participating today.

[Operator Instructions]