Overstock.com, Inc.
Q3 2013 Earnings Call Transcript

Published: 17 Oct 2013

[Operator:]

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

[Jonathan Johnson:]

Thank you, Kate. Good morning and welcome to our third quarter 2013 earnings conference call. Joining me today are Dr. Patrick Byrne, Chairman and CEO; David Nielsen, Co-President; Stormy Simon, Co-President and Robert Hughes, Senior Vice President of Finance and Risk Management. To begin with, let me remind you, that the following discussions and our responses to your questions reflect management's views as of today, October 17, 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 that we filed on February 21 of this year and the Form 10-Q that we filed on April 25 of this year and the Form 10-Q that we filed on July 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 those non-GAAP measures including reconciliations of these measures to the most comparable GAAP measures. Please review the Safe Harbor statement on Slide 2. Now, I would like to 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. Q3 total net revenue was $301.4 million, an 18% increase from last year. Q3 gross profit dollars increased by 27% to $59.2 million and gross margin improved 140 basis points from last year to 19.6%. Q3 contribution was $36.7 million, a 16% increase from last year, and contribution margin was 12.2%. Q3 technology and G&A expenses combined increased by 11% to $33.2 million. Net income for Q3 increased by 31% to $3.5 million or $0.14 per diluted share. Patrick, with that, let me turn the call over to you for the balance of the presentation.

[Patrick Byrne:]

Thank you, Rob, Thank you Jonathan. Slide 4, quarterly revenue growth, you do see that it’s ticked down a little bit, where our goal as we’ve said several times that keeping above industry which we think of is 12% to 15%. So, next – but that what is the eighth, ninth quarter, 1, 2,3,4,5, sixth quarter of positive revenues growth. So we’ve seen them put those past behind us. Slide 5, gross profit growth 27%, super. Slide, 6, you’ll notice that our contribution margin at 12.2% is pretty close to what we said – we’ve said in previous calls that 12.5% is really the right place for us to be and in fact I was getting a little worried when I saw this is ticking over 13% that’s too much. So we are giving more back to the customers in lower prices. Margins this quarter at 19.6%. I think, or an all time – well, an all-time high with the previous quarter. We have spent more and more things. Some of that was caused by the Hummingbird change you read about with Google. In July that affected us and so we got back on some other paid marketing channels. We doubled down on for sometime in order to offset that and they were a little bit more expensive. Anyway, the Hummingbird issue has been resolved for us. It has been, I think since August, we are – it’s actually, not only have we come back to where we were. We are actually, the last I saw – the last number that I saw, we are actually doing a little bit better than we were before Hummingbird. So Hummingbird has been good for us. But anyway, this – the Q3 did cause us to increase some other pay channels that we would not – have not been anticipating. So that creates the 19.6% – 7.5% gives you the 12.2%. Next slide, Slide 7. Quarterly contribution growth growing at 16% is still above our target of 12% to 15% and as I again said many times, what we think of as growth here the number that we think of this growth is this contribution dollar. That’s what we managed the company around and I actually have thought – long thought that Wall Street might give more consideration to looking at companies at ratios of market cap to contribution. It’s an interesting measure for a technology company, for an internet company. Anyway 16% and it’s still above the 12% to 15% of what we think where the industry is, but only margin was so and we are looking – working hard to turn that around and make it accelerate again. Next slide. Quarterly operating expenses, Slide 8. There is – if you look the tech in the G&A, our last year this quarter they were $30 million, this year, they were about $32 million, $33 million, out of graph. There was an extraordinary expense; I am going to turn it to Jonathan.

[Jonathan Johnson:]

So, lead to the last two quarters, the second and the third quarter, but particularly the third quarter, we have been spending more than usual on legal to defend the suit in California brought by eight different county district attorneys. That case went to trial. We had a two week trial in September. The bench trial, the judgment rule for quite some time, but for the last six months and in particular last three months, our legal expenses then inordinately high.

[Patrick Byrne:]

Can you stretch any number range that how big it has been?

[Jonathan Johnson:]

In the third quarter, it was roughly, for that case, $4 million.

[Patrick Byrne:]

And the previous quarter it was not a whole heck of lot less.

[Jonathan Johnson:]

That’s correct.

[Patrick Byrne:]

So there is this – there is a $6 million or $7 million charge flung through in the last couple of quarters that there was some charge in the same period last year. It was causing something but nothing like that. So it has taken us probably $6 million or $7 million to get ready for trial and try it. Right, what you are anticipating this quarter for costs?

[Jonathan Johnson:]

In that case, having all the way but it will come down significantly, I would think it would be maybe a quarter of those costs for the fourth quarter.

[Patrick Byrne:]

Okay. Next slide. Slide 9, net income, even given that headwind, net income down from $2.7 million to $3.5 million, roughly acceptable, but again, I look at that. I think while there is a $4 million extraordinary charge buried in there that, but you know all the facts. And when the trial is over and the bench – the judge has made a decision, we will be able so probably in a quarter or two, we’ll be able to talk about this more openly and why we chose the path we chose in five minutes like we did. So, $3.5 million on the net income, Joe gave out that. Slide 10 $55 million of operating cash flow and $39 million of free cash flow over the last trailing 12 months, that’s a fine business. Next slide, GAAP inventory turns at 42%. Again on our – internally, we are running just under 6, that’s on our own purchasing and such which doesn’t sound to – always have we think we should be able to do much better, but as our – you also have to remember that our inventory, we had a mix shift and the products we are selling now are products that conventional retail is more likely to get three turns where they are 2.5 turns with. So that as we have shifted into more and more home goods that is pressing the core inventory turns, but the overall inventory turns of 42% are acceptable and on the next slide, Slide 12, we see our GMROI at 994%. The day that breaks 1000% we’ll really celebrate. Unique customers up slightly, Slide 13, up slightly. 14, CPA and again new customers up slightly – I am sorry, the last slide was total customers. Here is new customers, up slightly, cost per customer has gone way up, but as you’ll know the value of our customers are going way up. We’ve gone in the last two years from about a $110, $120 to $170 average order size. Our repeat rates are starting to pick up a little bit. So these are more valuable customers than we’ve ever had and they are worth paying, more worth. Slide 15. Customer orders and average order size. Slide 15. $170 and we had a $2 million placed, again slightly up from last year. So the real – the growth in the revenue is really coming from the growth in the size of the order in this case 16%. Slide 16. Gross profit per transaction is up 24%. So these transactions are more valuable. The customers are more valuable to us. Slide 17. Increase in corporate employees. Most of this is in technology and we don’t mind that. I think that we’ve in fact; I’ve always regretted how tight we had to run the technology team. Now we are – we have a filled out team, we have the team that we want to go to play the game. We have a wonderful technology team, a flat spot in it, that I can – aware of and so we don’t – so this growth from $730 million to $836 million we’ve normally seen excessive to me. But now what’s really happening is, corporate is fixed and the G&A is relatively fixed and we are growing our technical horsepower and it’s overdue and we expect big things from it and I am so thrilled. We’ve gone from having ideas and being able to execute only on a small number of them to we can now come up with ideas and bring them live within a couple months and we are building some massive projects that you’ll be hearing about in the quarters ahead. Now, questions?

[Robert Hughes:]

So, Patrick, before we open the lines, we do get two sets of questions that have come in from Investor Relations site. The first is, how is our marketing campaign with new plan working and in particular any comments on the supermarkets.

[Patrick Byrne:]

Series of question. Working with higher along and I’ll turn this over to Stormy Simon.

[Stormy Simon:]

Well, I would say it’s the high, but I wouldn’t take that literally. That supermarket is a great collaboration between Overstock and its new team. The marketing campaign is going well. We are reaching an audience that believe we previously haven’t spoken to or it’s been a long time. One of the reasons there is, reasons behind the magnet, so one of those reasons is new path 30 million visitors on in are friends on Facebook, huge Twitter following. He is in a market that we aren’t and we are actually seeing visitors from his influencers and it’s been going well. I would call it a success. We learned a lot from it and you can see more – you’ll look forward to more campaigns like it.

[Jonathan Johnson:]

Okay, alright, next question?

[Robert Hughes:]

Second question was, we would like Overstock’s analysis on the senate passed marketplace fairness act.

[Patrick Byrne:]

Well, I think the political economy of it is this is an Astroturf movement funded by Wal-Mart and Target, because they are at a disadvantage because they have stores everywhere. So they have to collect tax everywhere. So they’ve created this Astroturf movement and lastly and then I am going to turn it over to Jonathan, but lastly, Amazon. This is really a story of big box retailers versus the internet and big box retailers are 87% of retail, of brick and mortar retail and they want this, because even if they have websites, they have to charge tax, because they have their big box stores in every state. So they have to collect tax in every state. Amazon has become a big box retailer, not in terms of having stores but in terms of its supply chain. Its big boxes are warehouse, they’ve always taken the position that their warehouse in Texas, they don’t own, they just own a 100% of the stock of some subsidiary corporation called Amazon Texas Warehouse or something, a very aggressive tax position that amazingly to me taxes through and let them get away with four years. The ground is dissolving under their feet on that argument though. And so now, I think that they’ve taken the position that given that, as that argument dissolves, they have become a big box retailer in every state, because of their 40 warehouses, somehow they have to charge – or soon they are going to have to collect tax in every state, because of that and hence because of that they’ve switched sides and they’ve joined the other big boxes, Wal-Mart, Target, Home Depot and getting behind this Astroturf movement. And it’s really just to eliminate the advantage that the pure players like we have – like us have had by keeping our operations in one state. Jonathan?

[Jonathan Johnson:]

Yeah, I agree with everything Patrick said. I do think that the senate passed marketplace fairness act will not be passed in the House and so. While we are prepared if necessary to comply with it, I think, members of the House realize that it would be a huge drag on both e-commerce and small brick and mortar stores that do some business over the internet because to comply with the marketplace fairness act is enormous. We are ready to comply if need to be, but small brick and mortars and small retailers, frankly would just have to get off of the internet, the cost of compliance is so big. The house judiciary committee Chairman, Bob Goodlatte put out a set of principles for what he would like to see in any house passed bill, those principles are good, they are fair. If Congress passes a law that was built on those principles, that something Overstock could support quickly. So, Kate, with that, let’s open it to questions from the calling lines.

[Operator:]

(Operator Instructions) And our first question comes from the Nat Schindler with Bank of America Merrill Lynch. Your line is open.

[Patrick Byrne:]

Hello, Nat.

[Nat Schindler:]

Hello. Just a few questions and as usual probably go a little back and forth here if possible. But, one question on going a little deeper into the Hummingbird change. This has been talked about in the SCO community, but it’s unlike Panda that happened a while back, people don’t really understand it. Could you – it seems the most ambiguous change Google has made, no one can tell me exactly what has changed. Could you go into some detail on what did change and why did it get worse and then get better?

[Patrick Byrne:]

Well, the change basically favors local results and pushes down pure play results. That’s the essence of the change. However, it started off with a fairly abrupt transition, but then the Google algorithm which you are of course more closely guarded than the Coca-Cola recipe. They have all kind of stabilizing factors in them and functions like the Mexicans and other functions all these strange functions that will take a sharp preservation and over time bring it, dampen it. So, the short preservation in this case was at the beginning of July, when they clicked this on, it changed results for everybody, for us, for Amazon. And it basically is not and it’s basically some more waiting of local results start floating to the top, but then based on how people click in such, the system. I mean, I am reading – I don’t know anything that you don’t know, it is I am reading the press. But having read about Google and their algorithms over the years, it doesn’t surprise me that there was a sharp affected first, but then the system responds to how are people clicking, how are people clicking through and buying in different places. And then, things floated back to it in position. And in fact, we came off – as far as we can tell, we came off a little bit better than we went into it. So that’s really all I know that it was an initial sum on the scale and favored local results but then based on consumer activity, it has shifted partly back at least for us.

[Nat Schindler:]

Okay, and then, on the shifted back, are you seeing they have shifted mostly in August or July or is this October?

[Patrick Byrne:]

August, September.

[Nat Schindler:]

August, sorry – August, September. I am trying to reconcile that with ComScore data on unique users at your site. That seem to continue to go decelerate fairly dramatically through the quarter having the worst in September is their data at all which is directionally accurate?

[Patrick Byrne:]

Yes, the – well, I am not familiar with their data although that’s a great service. Yes, I would say what I understand is, that the retail world in general had a soft September. That’s what we are hearing. I don’t know if you’ve heard something else, but there has been a slowdown on September.

[Nat Schindler:]

Okay and then going on, on that same tangent, somewhat of a competitor reported last night and they discussed – they were a little certain in fact about the Q4, particularly due to the shutdown and just the macro economy that you just mentioned that retail in general has a softer September. Is that’s something you are seeing as well or is it something that you consider a risk going forward?

[Patrick Byrne:]

Actually, not. In fact, we are – I think that we may be in for tough times as a country, but we learned in the early days the best times for us or rather really good times or really bad times it’s the mediocre times that we – that our advantages are not so eminent. But if there is a slowdown or coming, we have great liquidation capabilities. We are starting to do more liquidation deals and bankruptcy deals. I don’t know if we can say the name of the – of any of them?

[Stormy Simon:]

I don’t know either.

[Patrick Byrne:]

Okay, anyway we are getting and we’ve rebuilt the team that handles bankruptcy liquidation. We are getting a lot of calls, lot of calls from people, names you would know, not necessarily who are bankrupt but who really want to liquidate. So we are getting those calls in a way we haven’t in a decade probably. And we now have the team to put it together. So we think that we are actually, I used to think that we were very counter cyclical and thinking our early days, there were some strong evidence of that. So, I am not too afraid of, there is a slowdown, there is other people who are going to be hurting long before and those people really – there is one channel that is – what they all need is one channel to move their stuff without polluting their sales channel and we provide that solution. So we actually think that, in the case of an abrupt slowdown, we’ll be doing better than our competitors.

[Nat Schindler:]

Okay, great and then switching gears slightly going off on your Club O, so we’ve heard similar, it sounds like that’s been a real driver of your increase of average order size, we’ve heard very similar things about Amazon’s Prime. How big is Club O relative to your customer base which seems relatively stable at this point. So what percentage is Club O and how is that trending?

[Patrick Byrne:]

I can tell you that, just on a sales basis, Club O is double-digit percentage of our business and growing multiples of our overall growth. So I’ll leave it at. I think it’s the best loyalty program, obviously I think that. But it’s – there is other – I’ve seen other articles and such that are mentioning it has the most generous loyalty program on the net. It’s 20 bucks, you get free shipping, 5% back on everything, 25% back on some products, don’t we have did a TV and with a 40% or more Jonathan?

[Stormy Simon:]

Yes.

[Jonathan Johnson:]

40% back on television.

[Patrick Byrne:]

It’s very good, it’s very good for certain vendors and brands. So they can keep some price integrity and yet subsidize that. It’s very attractive to some of our suppliers to do things that way, it also enhances the value of being a Club O member. Of course we introduced and I think we’ve tinkered around this quarter with Amazon, we have introduced Amazon pricing minus 15% – I guess minus 10% or 15% on some goods and that was expensive for us. I heard it was much more expensive for them, but what we’ve after tinkering with a couple permutations, we decided to go with Amazon pricing on books, but 15% rewards. So we are 5% on everything, 15% on books and some products at the 25% and through this occasionally up to 40%. And people are going for it. People are really liking Club O. Dave?

[David Nielsen:]

Could I connect just a couple of dots on the liquidation piece of this? As Patrick just mentioned, we are ramping that up and building up that team and not surprising I am sure to that. There is a lot of brands out there that they have excess inventory because of some of the slowdown and they want to move it through a channel that isn’t seen, isn’t scraped, isn’t looked at on any Google search or any other search for that matter and becoming a Club O member gives us the ability to sell those products at a discount that they would – you’d never find them if you search it in Google. It’s through a closed community through Club O and that’s …

[Patrick Byrne:]

And that’s the discount you mean, price minus the reward?

[David Nielsen:]

Minus the rewards.

[Patrick Byrne:]

Yes.

[David Nielsen:]

So those rewards you get back as Patrick mentioned in the 25% to 40%-ish and sometimes 50%. So it’s a significant savings to you and that’s feeding some of this growth in Club O.

[Nat Schindler:]

And then, what’s the accounting for Club O? So, when you pay the 20 bucks per year – that goes in, I would assume goes into revenues and then on the discount, does it come out of as well as the free shipping. Is that counter revenue or is that in sales and marketing?

[Robert Hughes:]

Well, it’s counter revenue if those points are earned.

[Nat Schindler:]

Okay, as a point, okay. Great, and sorry, I think I cut you off Jonathan?

[Jonathan Johnson:]

No, I was going to add, we haven’t made a first about this yet, because it’s still in beta, but we have introduced a feature. One deal at a time, you are familiar with – sites?

[Nat Schindler:]

Yes.

[Jonathan Johnson:]

We now have ODAT we just brought live a week ago ODAT we have products within different stores. It’s not yet being displayed, another week or so it will be being displayed as I want, but we are starting to have really killer ODAT deals. Stormy?

[Stormy Simon:]

Yes, we are.

[Jonathan Johnson:]

Dave, do you want to add?

[David Nielsen:]

These pages, as we have launched some of these deals, we are finding some of the higher – it’s some of the higher conversion lots on our home page. So it’s performing. We’ve got more work to do, as you mentioned Patrick, more durations we’ll have many more deals coming here quickly. But, it speaks to the innovation. We’ve been able to turn that out fairly quickly.

[Patrick Byrne:]

Anything else Nat?

[Nat Schindler:]

Well, just – there has been speculation that Prime is – Prime customers are 10x the revenue of a non-Prime customer at Amazon. Something on that order. How could I compare – for you – versus – sorry Club O versus other prime customers, or versus other Overstock customers?

[Patrick Byrne:]

It’s many, many multiples, more valuable for a customer at Club O, but other than that, we are not releasing any numbers. But it’s a much more profitable customer.

[Jonathan Johnson:]

I guess, Nat, just like people are to speculate about what Amazon is, they have to speculate about our Club O.

[Patrick Byrne:]

And Hummingbird, they have to speculate about Hummingbird in the same way.

[Jonathan Johnson:]

Anything else Nat?

[Nat Schindler:]

No, I think that’s great. Thank you.

[Jonathan Johnson:]

Thank you. Thanks for calling in. Kate?

[Operator:]

(Operator Instructions) Our next question comes from the line of Ari Cole [ph] with Cole Capital. Your line is open.

[Unidentified Analyst:]

Good afternoon gentlemen. Again, thank you for doing this…

[Patrick Byrne:]

Hi Ari.

[Unidentified Analyst:]

Hello, thank you for doing this call. Two unrelated questions. You’ve been doing dynamic personalization on your website which has helped you to increase your average ticket the past number of quarters. Can you just explain what you are doing on that front, maybe they would allow you to improve your conversion rate, where you are really are offering what the customers are looking for based on their purchases to another big data information you have?

[Patrick Byrne:]

We are using – so, we have built our own recommendation system. We still have a nice relationship with rich relevance and which we see as best of breed in terms of third parties in that field. But we’ve also built our own systems and we like our own systems. And that has something, so that has something to do with driving the average order size, but not, it’s been a mix shift, although the mix shift is arguably caused by getting people better recommendations that they like. But beyond that I am not quite sure but just to your question.

[Unidentified Analyst:]

Okay.

[Patrick Byrne:]

Jonathan?

[Unidentified Analyst:]

Let me change the track then, in terms of your customer repeat rate, I’ve always been surprised that your customer repeat purchase rate over, I guess, 12 months, is not higher. The question is what potentially needs to be done in addition to Club O that will allow you to have a much, much, much larger repeat rate. And what I mean is, we are talking 80% versus, 50% or 30% of customers coming back, because otherwise it seems that many of the customers are purely being driven by price and if they don’t see the right price, they may buy somewhere else.

[Patrick Byrne:]

Well, good question. We do see it is a great area for improvement, although we are slightly up over last year in that regard recently. I mean, we look at it very closely. We do have something going against that. When you are buying books, your shopping, when you are coming and buying a $500 sofa or a $1000 bed, that customer just by their nature isn’t coming once a month and buying a new bed. So it’s the nature of our customers that they will be less – they will be – have a lower repeat rate, but we do see it as an area for improvement.

[Unidentified Analyst:]

Thank you. Best of luck.

[Patrick Byrne:]

Thank you.

[Jonathan Johnson:]

Thanks, Ari.

[Operator:]

Our next question comes from the line of – with B. Riley. Your line is open.

[Scott Tilghman:]

Good morning.

[Patrick Byrne:]

Hey.

[Scott Tilghman:]

I wanted to touch on two strategy questions, first, in the offline world you have the TJX companies getting more active on the e-commerce front again, which they haven’t been doing. Wondering how you are going to be addressing that over the next few quarters or what you’ll be watching? And then second, heading into the holidays, last year, we saw a great push with mobile across the ecosystem that seems to be accelerating again this year. Just wondering what you have in place to capture those customers?

[Patrick Byrne:]

Okay, on competing with the stores, I’ll acknowledge that the stores do have a wonderful advantage. Their cost of marketing, their website, their marginal cost is essentially zero. They can just put on the receipts of everyone who goes into the T.J. Max. Go to T.J. Max.com. So they have zero marginal cost other than if they do online advertising. So that’s a wonderful advantage for them. On the other hand, their distribution systems are not a conventional retail store – they been a liquidator. It’s not really set up in the way, I mean, if you got to build some parallel systems to get the kind of efficiencies we do. So we are not too afraid of them. We think we’ve got a good brand, but I do know that they have an advantage because of their foot traffic to their stores. And I am sorry, what was the second one?

[Scott Tilghman:]

Mobile push.

[Patrick Byrne:]

We are, we really said this publicly in the past, our mobile is about two x the percent that it is for the industry in general, both in terms of the share of our traffic that is mobile and the share of our business that is mobile. So we have some wonderful mobile solutions. We introduced more this quarter and we plan on staying ahead of the curve on mobile. In fact, we were one so far ahead of the curve. We have mobile solutions in 2003 and 2004 the problem was nobody had smartphones and we sort of let it half fade and then smartphones came out in 2008, that’s 2007, 2008 and we were behind the curve. But we have caught up. We got great mobile solutions and we think we just introduced a nice feature this week and so we think mobile is an area where it’s growing significantly faster than the general business and it’s shifting to mobile – if consumers shift to mobile that’s all good for us.

[Scott Tilghman:]

Let me just follow-up and this sort of ties into the prior caller’s question. Do you find that your mobile users are among your most active? Your club users or are you finding any sort of cherry picking with their activity? Do you have any way to quantify that?

[Patrick Byrne:]

I am going to turn that over to Stormy. Dave, do you want to answer that?

[Dave Nielsen:]

Sure, we see our mobile users as tablets are getting more and more popular, obviously people are sitting on the sofa and they are browsing. But it’s a successful business for us, even the tablet business, mobile business for us is doing very well. So, we continue to stay focused on it. We know that’s where the future is headed and we continue to develop to that.

[Patrick Byrne:]

Jonathan?

[Jonathan Johnson:]

Scott, we do notice differences in how smartphones, tablets, PCs interact with us and so we work to market each of them slightly differently.

[Patrick Byrne:]

I’ll throw in something that I said publicly on fast business. So there is nothing new here. But there is a quite an interest gap between tablet users and phone users. Phones have essentially gone to free and so, you get one type of customer shopping from their phone, whereas tablets are still hundreds of dollars, people have them are more affluent and you get a different type of shopping behavior.

[Scott Tilghman:]

Makes sense. Thank you.

[Patrick Byrne:]

Thank you.

[Jonathan Johnson:]

Thanks, Scott.

[Operator:]

I am not showing any further questions at this time. I would like to turn the call back over to the presenters for closing comments.

[Jonathan Johnson:]

Okay, thank you. We appreciate all that have called in. We appreciate our shareholders for entrusting us with their capital. We will get back to what we think will be and always it’s our busiest quarter. So, thanks everybody.

[Patrick Byrne:]

Thank you.

[Stormy Simon:]

Thanks.

[David Nielsen:]

Thank you.

[Operator:]

Thank you. That concludes today’s conference call. And you may now disconnect. Everyone have a wonderful day.