Overstock.com, Inc.
Q2 2013 Earnings Call Transcript

Published: 18 Jul 2013

[Operator:]

Good morning. My name is Stephanie, and I will be your conference operator today. At this time, I would like to welcome everyone to the Overstock.com Second Quarter 2013 Earnings 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. I would now like to introduce today's presenter Mr. Jonathan Johnson of Overstock.com. Please go ahead, sir.

[Jonathan Johnson:]

Thank you, Stephanie. Good morning everyone. We welcome our investors and other interested parties to our second quarter 2013 earnings conference call. Joining me on the call today are Dr. Patrick Byrne, Chairman and CEO; David Nielsen, Co-President; and Robert Hughes, Senior Vice President of Finance and Risk Management. To begin, let me remind you, that the following discussions and our responses to your questions reflect management's views as of today, July 18, 2013, and may include forward-looking statements. Actual results may differ materially. Additional information about factors that could potentially impact our financial results is included in the press release filed this morning and in the Form 10-K we filed on February 21 of this year and the Form 10-Q that we filed on April 25 of this year. During this call, we will discuss certain non-GAAP financial measures. The slides accompanying this webcast and our filings with the SEC each posted on our Investor Relations website contain additional disclosures regarding these measures including reconciliation of these measures to the most comparable GAAP measures. Please review the Safe Harbor statement on slide two and with that preliminary business out of the way, I will turn the call over to Rob to highlight some of the financial results.

[Robert Hughes:]

Thank you, Jonathan. Please turn to slide number 3 of the presentation. Q2 total net revenue was $293.2 million, a 22% increase from last year. Q2 gross margin improved 170 basis points from last year to 19.7%, and gross profit dollars increased by 34% to $57.8 million. Q2 contribution was $38.6 million, a 30% increase from last year, and contribution margin improved 80 basis points to 13.2%. Q2 technology and G&A expenses combined increased by 16% to $34.5 million. Net income for Q2 increased by 687% to $3.7 million or $0.15 per diluted share. Patrick, with that, let me turn the call over to you for the balance of the presentation.

[Patrick Byrne:]

Thank you, Mr. Hughes, thank you gentlemen. Slide 4, quarterly revenue growth, our sixth – 1, 2, 3, 4, about six straight quarter of acceleration. Although as we have frequently said, we don’t look at this number as much as we do as for gauging our growth as much as we look at contribution dollar growth. So now we think 22% is very healthy the industry we think of – the numbers are the industry’s growing at 15%-ish, if you really break that up, Amazon is growing somewhat faster than that and most of the pure plays that we are aware that we track, their growth is quite a bit below that. So, anyway, we are doing well above the mean and especially well above the median. Slide 5, next quarterly gross profit growth, essentially the same story. Slide 6, couple of things to note, our margins at 19.7% are higher than, I think it ever been and we even given that though the share that we are spending on marketing has gone up 100 basis points. Still that leaves the contribution margin at 13.2%. I have frequently said 12.5%; maybe 13% is I think the sweet spot for us. So I do think there is, as we keep finding efficiencies, in fact there is more we can get back to customers in terms of lower prices. So we have the flywheel spinning in the right direction, because it’s spinning one way and letting us generate these margins, contribution margins and so, now we can give some of that back and that makes it easier to get it spinning faster. Quarterly contribution, slide 7, $38.6 million, 30% growth from the same quarter last year. So that’s great. That’s the number we look at. We manage the business around that. We think we’ve got, we think in terms of our corporate expenses and our contributions margin and we do everything to optimize contribution margin and it’s growing 30% and it’s lovely. We actually think we have a business now that even at industry growth rates like 15%. This is up for contribution margin; we can manage all the expenses around the business to deliver a nicely accelerating bottom-line. It’s got a – if we just get – if we just see contribution margin spinning about 15%, we will be able to manage everything else, I think to have a really nice earnings stream. Slide 8. Operating expenses. One thing I would note here that and you have to look at this on a twelve month basis. Don’t worry about the rolling as the year goes on because it always builds in Q1 and Q2 and comes down of course in Q3 and Q4. So, there is not much too that, but I would note that at the start of this period, Q2 2011, look at the share that the G&A had of the total bar and now look at how it looks this quarter. What’s going on is we are expanding our operating expenses, but we are expanding them and in tax and G&A. We are really getting the resources now that we can invest – tech and marketing, thank you. We are really doing the things now that making investments and we’ve always had more ideas than we could possibly put into factors. But now the difference is smaller way of great resources our tech, our developers have never worked so well with the business as it’s all working now just like a dream. And we are getting to, we are able to knock off a lot of projects and that add – that results in the numbers you see. So, again, the share is shifting away from G&A and into tech and marketing. Slide 9, quarterly net income. The sixth straight quarter of GAAP net income, $3.7 million. I like this slide, slide 10. Our trailing 12 months cash flow from operations is almost $62 million and free cash flow is $46 million. So we have a great little cash machine here. Slide 11, GAAP trailing 12 months inventory turns on a GAAP basis, 43% is great, it’s $6.2 million on a core – on a direct only basis. However, I should point out that that does include the returns from the partners, right, which is about – which is a non-negligible portion of our inventory is actually returns that coming from the partner program and that weighs down this whole – it’s not just the returns from the direct sales. But it’s also returns from the partner program make up 90% of all of it and so that creates a downdraft on the direct inventory turns. Still, I have always thought we should be able to get that somewhat higher and we are still working on it. Slide 12, trailing 12 months GMROI, almost it’s a 1000%. Slide 13, unique customers, I’ll note that there is a slight increase from Q2 of last year to Q2 of this year in unique customers. Now…

[Robert Hughes:]

Patrick, one thing I would say is, we are always making efforts to grow our customer base in our unique customers, at the same time, we are looking to call those customers that are not our best customers. So, I think looking at this kind of longer term trend is important in just focusing on year-over-year quarterly growth can be one of the few reasons.

[Patrick Byrne:]

Well, it’s pretty superficial, because we got to look at what their spending, what kind of customers, those customers, we don’t want. We just want to send them to other sites. So you can’t weigh too much of unique customers. If you go to slide 14, here we have new customers and CPA. Now, note that we have gone from a $20 CPA to a $26 CPA, keep that in mind. We did slightly more new customers this year, in the quarter than last year. Look at slide 15. In the same period, these customers have gone spending $138 to spending $157 with us, a 21% increase. So you can’t just look at the number of customers. We are getting more and more good customers. Slide 16. I should keep that $20 and $26 number in line. So gross profit per transaction has gone up, just in up for a little bit more to cover our increase in CPA and that’s again just a way of saying, we are getting better customers. We are getting better and better customers. We are getting the customers we want. They are little more expensive to get, but they are more profitable for us. Corporate employees, 11% increase, a 22% increase on top-line and we think that now that’s probably a good ratio by the way. Just overall, our corporate expenses increasing eating up about half of the increase in the contribution dollar increase is I think a good long-term goal for us.

[Robert Hughes:]

I would note, Patrick that the bulk of those net increase in corporate employees are IT developers. So I think that shows what we’ve always thought that if we had more developers, it would significantly help the business.

[Patrick Byrne:]

Right, and we have a wonderful new COO, Bhargav Shah, well he is not new anymore. He is nine months I guess, but he has plans and he is acting on the plans in ways to really flush out our development team and build more cycles both with here in Utah and with some satellite offshore development. So, we won’t be so development constrained as we have been through our old history. So that’s the end of the slides. Do you have any questions and comments?

[Robert Hughes:]

There are some questions. I will note that your impressive Bhargav’s work as you are giving him credit of nine months of work and several months he has been here. (Multiple Speakers) But I felt productive in field. So that’s good. We do have three questions that have been sent in ahead of time that I’d like to ask. First what’s the impact of tablets and mobile phones on e-commerce in general and Overstock specifically? Patrick, I know you spoke to this recently in a Lord Magazine.

[Patrick Byrne:]

Right, just last week I guess there was a Lord Magazine article which had this, we have about twice the rate. Our traffic is now 35% coming from mobile devices and our percentage of sales is I think 18% or 19%, which is about what we understand – well, it’s twice what we understand to be industry average. We were very early, we were ridiculously early, 10 years ago, we had some mobile devices, but it was way before they caught on in the states about five year and later, we had pretty much left them lapse and then we – then the iPhone came and the iPad and everything. And so we were, I’d say maybe a little bit slow to catch that wave. But we’ve put a lot into our mobile teams. We’ve put a lot into our devices. We are releasing a new android app at the end of what, July or August?

[Robert Hughes:]

August.

[Patrick Byrne:]

August, so we are continually developing here and we have a nice base that, well I could say it’s about two x what the industry average. As far as, what can I tell you about those people, the mobile people, first of all we didn’t think that people are going to shop the mobile. We thought they were going to shop and not buy, go to your PC to buy, that turns out just not to be true. However, the cell users, smartphone users have a lower average order size than typical customers. On the other hand, tablets have a higher average order size, significantly higher, which suggest that maybe there is a socioeconomic thing. Everybody now has a smartphone or essentially free, but tablets are still costly. So somebody can afford a tablet they are probably more affluent shopper. That difference will probably dry up over the years as tablets become essentially free too.

[Robert Hughes:]

Great, next question. Please comment on the international rollout.

[Patrick Byrne:]

International rollout, we will have something by the end of this quarter. I would call it a beta, but those maybe beginners, maybe an alpha, but there is something rolling out this quarter. A proof-of-concept for how we intend to go around the world. Dave, do you want to add to that?

[David Nielsen:]

Nothing to add to that. We are anxious to get there. We see a lot of opportunities in future of international.

[Patrick Byrne:]

Yes.

[Robert Hughes:]

And then the third question that’s been sent in, what vendors businesses have selling through Overstock’s marketplace compared to other marketplaces or their own websites?

[Patrick Byrne:]

Too numerous to mention, but I am happy you ask. First of all, less technical burden, just integrating with us has got very efficient and much easier than building their own website. In addition, we get great analytics, we are giving now analytics to our partners, and I am not talking Google Analytics about site, we are talking about really profound analytics that no typical small partner would have access to the kind of SaaS and data system that we do in terms of projecting in returns of. But we give them much more analytics than just concerning inventory management. We are giving them all kinds of analytics that lets them understand is their copy good, are their photo is good, things like that versus other people, and their products in the same category. So, it’s really a clever profound set of analytics we give beyond what we believe anyone else gives. In addition, going with us, we handle your customer service, we handle your returns and your also getting the benefit of our marketing department which has probably got the best paid listing algorithms in the business. It’s a great team and we do good SCO and so forth. And so you are getting access rather having to build yourself to all that marketing. And lastly, now that we are integrating with some other sites by a supplier who is putting us – coming into our system not only gets their products on our site but they show up in the marketplaces of other sites. Some that we can name now, some that we can’t. So, with that, I’ll turn it over to Dave to expand on that answer.

[David Nielsen:]

Yeah, I would also add in there Patrick. We also pay the fastest. So important for a vendor to note that you are getting your money back quicker than anyone.

[Patrick Byrne:]

Much faster than say, Amazon. This – how long is Amazon taking time?

[David Nielsen:]

I believe, I couldn’t give you an exact date, I know we are about 18 days and that’s significantly faster than the competition that we measure.

[Robert Hughes:]

Good. Okay, thank you Patrick. Stephanie, if you could open the line up for questions, we are ready for them.

[Operator:]

(Operator Instructions) Your first question comes from the line of Nat Schindler of BOA Merrill Lynch.

[Patrick Byrne:]

Hi, Nat.

[Nat Schindler:]

Hi guys. It’s a solid quarter there. Just a couple questions. I know that you said that you are looking towards getting the customers you want not just any customers. But I am trying to understand the growth in your average order size, approximately 30% in the last two years, while orders themselves are virtually unchanged. Is it different product categories have you shifted more towards the higher end such as house ware I guess I know you are heavily in house wares or is there a change in pricing strategy? Is the market just less promotion heavy? What’s allowing you to raise, functionally get the 30% higher prices on the order?

[Patrick Byrne:]

Category shifts, Rob, what can we disclose that’s already out there. So you have in front.

[Robert Hughes:]

Yes, we noted in the press release Nat, and in the 10-K a shift in the more home and garden products and away from – lesser percentage from things like BMMG and apparel.

[Nat Schindler:]

Okay. I had to you is, roughly 60% home and garden already, is that going even further that direction?

[Robert Hughes:]

Well, I am not sure if we are sharing that, but our home and garden category is doing quite well. But there are other categories in the high end jewelry brings up average order size for example. But the home and garden is shifting, I can say, I’ll say it’s beyond that number you throw out but we don’t want to give the exact number.

[Nat Schindler:]

Okay, and are these higher categories obviously – these different categories are higher average order size, are they just a necessarily higher markup categories? So that allows you to get the higher gross profit per order or is it – keeps your gross margins up or is there is just less price competition in these categories?

[Patrick Byrne:]

Yeah, Nat anything you sell without a plug and especially items in the home categories, a lot of that is private label and in general, private label products can command a higher margin. But I’ll go back to our pricing. We are scraping 0.5 million products every week if it’s not the lowest price or equal to the lowest, it’s not on our website. So we haven’t changed any of our pricing models, since we are not allowing margins to creep up because of anything like that. We have a very rigorous pricing policy.

[Nat Schindler:]

Okay, it makes sense. And then also just going on to that, as you go more private label, you’ve kind of stepped away more and more from your original brand and your original kind of race on – you are no longer really an overstock company. You are selling just products that can’t be perfectly priced compared to something else because they are not branded and it’s hard to say that your discount anymore. Is that a fair characterization?

[Patrick Byrne:]

No way.

[Jonathan Johnson:]

Nat, this is Jonathan. I think not. We still have a good business and what I will call liquidation or close out that fits the original Overstock model. It’s certainly not as much or as large as it was when we first started, but we are a discounter. As Dave mentioned, we have a low price on the Internet. So, to assume, it’s just because we are selling branded products and just because we are selling replenishable products and we are not discounters, is just a faulty assumption. We are very price sensitive and still working to bring the best value at the best price to our customers.

[Patrick Byrne:]

And in fact, we are and also you got to remember that by switching the partner business, some of that partner business is straight liquidation and to get partners who are liquidators, so in the sense we – it’s the same business model we started with only that more of a virtual organization. In addition, well, actually Dave wanted to add something. Go ahead David.

[David Nielsen:]

Well I think, we are both right on the same path in terms of some additional fizzle that you are going to see in the coming months on our website with some features of some major close outs. We have got an initiative going that we are excited about. We’ll probably see more in the fourth quarter than in the third, but back to some of our roots, just a campaign, a marketing campaign merchandizing campaign that we got going that’s going to be real exciting.

[Patrick Byrne:]

Yeah, that’s going back in that direction dealing of straight liquidation. And we have a team put together in the last few months that they are now working to build or rebuild that what we started with. I guess there would be one more point. We do intense price comparison of our products and I think we now are making over sharing. But we now compare ourselves with ten people. We are about to start comparing ourselves to 60 people. And we find that hundreds of thousands match at a day and our prices are the lowest. All kind of, a large percentage of our products, you can find on our sites and the last is on. And you may correct me Dave, but we were on average 9% below Amazon. But we sold our products than they sold our product, I am not talking peanut deals I am just talking about sofa sets and chairs and blenders. We are on average 9% lower than they are. And we have best price guarantee. We pretty much don’t want a product on our site if it isn’t the best price. So we think, we are an extreme discount site. We think that we provide discounts that nobody else can provide on the net. So, we may be getting there differently in the bankruptcy auctions that we started with, but we still think that we are an extreme discounter. Sorry.

[Nat Schindler:]

Well, it makes sense. And a final question. I have noticed on your site something I haven’t seen before and I am just wondering whether or not this is new or if I was just oblivious. But you are doing a lot more warranty protection or it looks like more a highlighted warranty protection on purchases? Is that been, is that new?

[Patrick Byrne:]

No, that’s not new. Now we’ve been providing warranty protection for years and years. We have…

[Nat Schindler:]

The sale – the sold warranties.

[Patrick Byrne:]

Yes, we have sold warranties and provided the option for warranties for several years.

[Nat Schindler:]

Okay. I just – I’ve never seen it, maybe it’s the positioning or something like that has been highlighted to me more. But, hey, thank you very much.

[Jonathan Johnson:]

Thank you, Nat.

[Patrick Byrne:]

Thank you.

[Operator:]

(Operator Instructions) Your next question comes from the line of (Inaudible) with LS Capital.

[Unidentified Analyst:]

Hi guys, how are you?

[Patrick Byrne:]

Hey, how are you?

[Unidentified Analyst:]

Just a quick question on your tech, you guys I think referred to your R&D tax, it’s toward the capitalized software which has gone up about 40%. I appreciate you guys wanting to spend and kind of keeping up with technology. Is that something that we should continue to see going forward? I mean, is there, should we expect capitalized software to continue to grow about that rate?

[Patrick Byrne:]

What we are thinking here…

[Unidentified Analyst:]

I am just trying to – you guys are talking about a contribution margin from operating income and it’s kind of – if you were to exit expense, the dollar that you’ve put in the cash flow statement, I am just trying to get an apples-to-apples, it obviously has improved the contribution margin from an OpEx level. On a cash flow basis, it just kind of moves from P&L to cash flow. I am just trying to figure out kind of where you guys are looking going forward, it’s gone up than should you continue to be spending there, I am just not sure what the R&D requirements are and such like that?

[Patrick Byrne:]

I can say, first my – we wanted to expense everything we can expect. I would never want to capitalize like Rob our CFO for us have to follow the GAAP rules. So he makes the capitalization decisions. Rob, do you first of all have any reason, then you tell us why the share has gone down a little bit of what we are capitalizing?

[Robert Hughes:]

Recently the percentage of what we have capitalized gone down, but it varies based on a couple of things. So, we do have to look at the nature of the projects people are working on and whether they meet the capitalization rules or not. Then when a project goes into production capitalization stop, so from quarter-to-quarter depending on what they are working on versus maintenance activities or design activities it’s going to fluctuate a bit. But it has more recently people have worked on some maintenance activities and projects have gone live than a little lower.

[Patrick Byrne:]

And sort of more than, thank you Rob. And then, just to your point, you can expect to see tech spending go off.

[Unidentified Analyst:]

Okay.

[Patrick Byrne:]

Because we think, we have so many more ideas, actually it isn’t the case their R&D sort of becomes minimal for this. We see so many things we can do. I’ll put it this way, a lot of ours in the past, we made a lot of deals with excellent third-party vendors who powered different aspects of our business and what we have learned to do. So just to give you an example is search, the internal search, you come to Overstock and you search for red shoes, we’ve had over the years three I guess different vendors for that for the box that does the internal search. We got rid of the last one a few years ago and we had different very large companies that they are competing for us to try to get to accept their boxes and we tested them but we built our own and we did not built something that we show testing better than anything else available in the marketplace. So and that lets to save both millions of dollars from the point of you’ve not having to pay an outside vendor and it gives a list and conversion. So, we are doing things like that and so we are hiring developers, but there is such a big payoff for having ample – it’s not just developers, tech talent and general and scientist. So there is just a terrific payoff and I think that we want to expand this as quickly as we can without getting interjection.

[Unidentified Analyst:]

Okay. And just really quickly, you guys hinted at sort of cleverly that you guys had some partnerships in the quarter with some vendors that you didn’t want to mention. Was that, are those partners that you didn’t have last year? I guess I am trying to, – not only that you guys have revenue growth from average order size, I was curious if that’s come at all from some of these partnerships whether it’s here or whoever these other players are?

[Patrick Byrne:]

All those kind of partnerships, those are not substantial yet. We don’t disclose that, but it has not reached the level being substantial.

[Unidentified Analyst:]

Okay. And then just following up on the last question, if you would, maybe to give us a little bit more detail. The warranty question, what percentage, I mean, has warranty is the percentage of sales increase? Maybe that’s a better way of just sort of asking the question rather than the other did? Has it been a meaningful, has it or not year-over-year as a percent?

[Patrick Byrne:]

No.

[Unidentified Analyst:]

No, perfect. Thanks guys.

[Patrick Byrne:]

Thank you.

[Operator:]

(Operator Instructions) Your next question is a follow-up from Nat Schindler with BOA Merrill Lynch.

[Nat Schindler:]

Yeah, hi, just want to jump on once again. Wondering, you said, there were customers you didn’t want. Why wouldn’t you want a customer?

[Patrick Byrne:]

They are more expensive than the gross profit contribution margin. We suppose somebody is a customer who is actually a jewelry store and orders 100 pieces a month and on day 29 sends back a 40 that didn’t sell. The cost of that out lay the benefit. So there are types of customers you can identify as being just not worth – where they cannot worth the name.

[Nat Schindler:]

Okay, and then eventually though, you are going to have to grow the business, grow the customer base, is that going to be, is next year going to be, is this going to be a customer growth story and no longer it’s much of an average order size growth story or is this going to – or do you think you’ll continue to be really an average order size growth for a while as you shift further and further towards home and garden?

[Patrick Byrne:]

I think we are not going to comment on that.

[Jonathan Johnson:]

And what I would say that, historically, we’ve seen our active third quarter customers be very productive in the fourth quarter. And so we do focus on marketing heavily in the third quarter looking for new customers.

[Patrick Byrne:]

That’s fair to say and those customers tend to be good customers that is in August, September, October and be the best actually. So, I really don’t want to go into – asking us to give a model and we don’t want to give a model. Your specific question, but we are not afraid of our ability to compete in getting new customers at an efficient price. Tell you something big we have been talking about, we probably should be talked about in the release is Club O. Club O is now a very significant part of our profitability. Its contribution margin is growing very quickly and I think I saw it written up a few months or two ago, some analysts pointed out we have the best loyalty program on the net and we really just begun to work it. We’ve got a good team in place it’s become a very profitable part of our business and we see it as key to moving forward to really expand the number of Club O customers. But they maybe all coming from our current customer base. It could be that our current customer base, we can just get 10% of them to shift to Club O. We – it becomes fantastically profitable for us, but it isn’t really about going out enquiring new customers and it’s more just getting our current customers to shift.

[Jonathan Johnson:]

New customers are great. Current customers shopping more often are great. It’s orders that we are really looking to.

[Patrick Byrne:]

And our Club O customers have a very high satisfaction and they become very profitable for us and they stay very happy to get great my club service and so you got to start factoring in Club O and I am not sure we are recently releasing any Club O information Nat. Well, Club O is the significant part of what’s going on?

[Nat Schindler:]

It makes sense. Thank you.

[Jonathan Johnson:]

You are welcome.

[Operator:]

(Operator Instructions)

[Patrick Byrne:]

Okay, I think we can wrap this up.

[Jonathan Johnson:]

Great Stephanie, thank you for hosting the call to our shareholders who have entrusted us with their capital. We thank you and we will…

[Patrick Byrne:]

We thank you especially.

[Jonathan Johnson:]

We thank you especially and we will get back to work in preparing to the third and fourth quarters. Thanks everybody.

[Operator:]

Thank you, sir. That concludes today’s conference call. You may now disconnect.