Overstock.com fails to cobble together a Q1 profit 2009-04-24 20:25 ET - Street Wire
by Lee M. Webb
Overstock.com Inc., an on-line discount retailer headed by naked short selling conspiracist Patrick M. Byrne, has posted a first-quarter loss and is back to its money-losing trend after recording a controversial $1-million profit for the fourth quarter of 2008. The company released its first-quarter results and hosted a rather brief and lacklustre conference call on April 22.
In a short message to shareholders accompanying the first-quarter results released ahead of the 3 p.m. conference call, Mr. Byrne remarked that the current economic environment remains tough. He noted that the company's year-over-year revenues dropped 8 per cent.
"However, our continued focus on aspects of the business below the revenue line is paying off," Mr. Byrne wrote. "Gross margin was 20.1 per cent in the quarter and, even adjusting for some non-recurring items, it was 19.1 per cent, still an all-time high for us.
"Similarly, contribution percentage was higher than ever due to better margins and a controlled marketing spend.
"We are making prudent long-term investments in the business in talent and capital expenditures, throttled by internally generated cash flows, thus ensuring we do not get out in front of our headlights."
Any first-quarter throttling was not enough to squeeze out even a modest profit, however. The numbers
For the three months ending March 31, Overstock.com reported revenues of $187.4-million, down 8 per cent or $15.4-million from the $202.8-million in revenues for the same period last year.
The company's gross profit came in at $37.7-million, a $3.7-million year-over-year increase from the $34-million reported for the first-quarter of 2008. Sales and marketing expenses dropped $1.5-million to $13.5-million, but general, administrative and technology expenses climbed $3.1-million to $27.2-million for the quarter.
Overstock.com rang up a first-quarter loss of $2.1-million or nine cents per share, bumping its accumulated deficit to $267-million. As will be discussed in more detail below, the first-quarter loss would have been considerably higher if not for what might be characterized as some "found money."
At the end of the quarter, Overstock.com had $78.6-million in cash and cash equivalents. The company had a working capital surplus of $33.7-million as of March 31.
Found money
As noted above and reported in a previous Stockwatch article, Overstock.com managed to turn a controversial fourth-quarter profit last year after discovering that it had underbilled its fulfillment partners to the tune of $1.8-million earlier in the year. Rather than backing that amount out into the appropriate periods, Overstock.com reported it as one-time gain and reduced the cost of goods sold for the quarter by $1.8-million. That bit of accounting turned what would have been an $800,000 fourth-quarter loss into a $1-million profit.
As it turns out, Overstock.com managed to find some more money that it used to reduce the cost of goods sold for the first quarter of 2009, too.
"In Q1 2009, we reduced total cost of goods sold by $1.9-million for recoveries from partners who were underbilled in 2008 for certain fees and charges that they were contractually obligated to pay and a refund due of overbillings by a freight carrier for charges from Q4 2008," the company disclosed.
"We just keep squeezing the tube of toothpaste thinner and thinner and finding new stuff to come out," Mr. Byrne remarked during the conference call after chief financial officer Steve Chesnut said that the underbilling and overbilling had been found "as part of good corporate diligence and governance."
In addition, Overstock.com managed to record a $1.9-million gain, reported as part of "other income," by extinguishing $4.9-million worth of its senior convertible notes, which it bought back at rather hefty discount.
If not for the fortuitous 2008 underbilling recoveries, fourth-quarter overbillings refund and the paper gain from extinguishing some of its debt, Overstock.com would have tallied a first-quarter loss of $5.9-million or approximately 26 cents per share.
So, while Overstock.com did not manage to conjure up a first-quarter profit by using the same accounting abracadabra employed in the fourth quarter, it did succeed in trimming its net loss to $2.1-million.
Presto, bonus!
After Mr. Chesnut ran through a scripted review of Overstock.com's first-quarter numbers, Mr. Byrne offered his spin on the results, waxing doolally over his some of his favourite metrics including non-GAAP measures such as "net promoter score," a measure of customer satisfaction and "contribution," which is gross profit minus sales and marketing expense.
Coming to the end of his spiel, Mr. Byrne, participating "on a cell phone from overseas," opened the call up for questions, turning first to e-mail questions.
"Sam, my friend Sam Antar, the felon, never lets me down," Mr. Byrne remarked, evidently unable to forego an opportunity to take a swipe at Mr. Antar. "He sent some questions."
As previously reported by Stockwatch, Mr. Antar was the chief financial officer and a principal architect of the Crazy Eddie Inc. securities fraud that imploded in the 1980s. He copped a plea and received a light sentence of six months of house arrest, community service and probation after co-operating with prosecutors. Over the past couple of years, he has been a relentless critic of Overstock.com.
"I'm not sitting at a table with all the paperwork in front of me, but Sam's list of questions included a question on James Joyce," Mr. Byrne said.
In fact, Mr. Antar's list included eight questions about Mr. Joyce, a former Overstock.com director and consultant who resigned on April 1. Overstock.com announced his departure in a rather gushing news release that neglected to mention the fact that the company had agreed to pay Mr. Joyce $1.25-million in connection with the termination a consulting agreement with his firm, Icent LLC.
Among other things, Mr. Antar asked for a detailed description of the services Mr. Joyce's Icent provided to Overstock.com.
"What factors justified the huge $1.2-million contract termination fee which is approximately 3.5 times annual fees paid to Icent LLC?" Mr. Antar continued.
"Is it Overstock.com's view that its agreement with Icent LLC and any amendments thereof are considered a 'material definitive agreement' under SEC rules?" he queried. "Please explain in detail Overstock.com's position of that point.
"Does Overstock.com intend to disclose as an exhibit in a future filing to the SEC copies of any agreements made with Icent LLC?
"Please describe any contract termination provision in any agreement with Icent LLC.
"Assuming that the original contract with Icent LLC had a contract termination provision, was it ever amended?
"Did the original contract with Icent LLC call for a contract termination payment of $1.2 million? If not, was it agreed to at a later time?
"Did James V. Joyce or Icent LLC render any services that relate to Deep Capture LLC or antisocialmedia.net?"
With that list of questions distilled by Mr. Byrne's recollection to "a question on James Joyce," Overstock.com's leader served up an answer in which the previously reported contract termination payment was transformed into a bonus payment.
"We paid him a $1.25-million bonus because he did great work," Mr. Byrne said. "I think he's responsible for -- we've leaned out our supply chain beautifully.
"He did great work and we paid him a nice, big, fat bonus at the end of the engagement with him."
Mr. Byrne then asked Overstock.com president Jonathan Johnson whether he had anything to add.
"Yes, let me comment on that. Jim (Mr. Joyce) came, joined us with his consulting company in 2006 when we were tangled up," Mr. Johnson said. "And Jim helped us untangle a lot of knots over the years and really helped us lean out several processes and improve as a company.
"And as time wound up, we looked at the value he added and the bonus we gave him I think was well earned and it was nice to have Jim here.
"It was nice to have him help untangle some knots and we're better for having him with us."
Interestingly, the word "bonus" does not appear anywhere in connection with Mr. Joyce or Icent in Overstock.com's SEC filings and, moreover, the company's senior executives waived any bonus entitlements for 2008.
Mr. Byrne chimed in with a final comment regarding the knotty subject of Mr. Joyce.
"Right," Mr. Byrne said. "Jim is basically an old teacher of mine that shows up every once in a while in my life and helps me untangle things."
Mr. Antar had submitted a number of other questions relating to Mr. Byrne's involvement, if any, in a vicious "retaliatory smear campaign" against his critics and other matters, but those questions evidently escaped the recollection of Overstock.com's chief executive officer. Stockwatch will provide some of the context and examine those questions in a future article.
Having dispensed with Mr. Antar, Mr. Byrne turned to telephone questions. As it turned out, only two analysts had any questions.
Schindler's list
Bank of America-Merrill Lynch analyst Nat Schindler was up first with a series of questions that took up much of the rest of unusually short conference call.
Mr. Schindler opened with a question regarding Overstock.com's partner revenue and cost of goods sold, which benefited from the $1.9-million adjustment mentioned above.
"I wanted to know where you think that market will settle out, especially after all these one-time gains go away," Mr. Schindler said.
"Great question," Mr. Byrne began. "I think about that a lot. Obviously, it differs by category and in electronics, people have quite a different view. It depends really on what their margins are.
"We have a roster of benefits that we think people get from being our partner instead
of Amazon's and we hear from people who give us both a try.
"Now, of course there's a self selection issue there but we certainly hear from a lot of people who give us both a try as to why they like -- what they get from our program that they don't get from Amazon.
"So we have a roster of other benefits to give them for the money.
"But all that said, I do not want to create a pricing umbrella and we do think that there are improvements we can make there and that will benefit everybody. Us and our partners.
"So I wouldn't expect to be seeing that expand. If anything, I would expect to see -- I've been wrong before, but I would expect to see that shaving down -- being shaved down but growth coming back instead that more than makes up for it."
With all that said, Mr. Schindler returned to the $1.9-million one-time gain, asking whether all of that had gone into the partner cost of goods sold (COGS) line.
Prompted by Mr. Byrne, chief financial officer Mr. Chesnut offered a response.
"No, it clearly was in the COGS line but it was not all towards the partners because part of that, UPS or part of the freight billing piece would have been spread across partner and core business," Mr. Chesnut said.
"Yes, you might -- you might think slightly over half had something to do with partners themselves," Mr. Byrne added.
Mr. Schindler then wanted to know whether Overstock.com could maintain a partner margin of 20 per cent.
"No, because I actually think you're going to see us get bigger in electronics over the course of this year and that's at a much lower margin, so the blend is going to come down," Mr. Byrne remarked before turning to Mr. Chesnut.
"I think we'll continue, as we grow the partner business, we'll see a mix shift that will probably give some dilution around that," Mr. Chesnut said.
"I think to Patrick's point, I think we'll continue to look for ways to shave our expense structure that we can then ultimately try and drive prices lower," Mr. Chesnut later added.
Mr. Schindler went on to pose some questions about excess inventory in the traditional retail sector because of the economic downturn and how that is playing out in relation to Overstock.com.
Mr. Byrne said that there was still a very competitive pricing environment, but he thought that it was "starting to clear itself out."
"For example, I'm still hearing from the buyers that the fantastic -- I mean, we're just getting in some -- a few months ago it was across the board but now it's getting more niche by niche," Mr. Byrne said rather disjointedly. "There are people in certain parts of the retail industry who are calling us who never -- especially with high end I'd say -- I don't want to give anything away but just high end brands that had never been open to selling to us before, are calling and willing to sell."
Mr. Byrne went on to say that the company was trying to explore a consignment model, a different kind of deal than Overstock.com has structured in the past.
"But it's not as easy talking to manufacturers into giving that a try as I had hoped," Mr. Byrne acknowledged.
Noting that Mr. Byrne had said during the fourth-quarter and year-end conference call held on Jan. 30 that Overstock.com's revenue was down approximately 3 per cent during January yet the results for the first-quarter were down by 8 per cent, Mr. Schindler wanted to know where the downturn occurred.
While Mr. Byrne had been the one who served up that estimate during the previous conference call, Mr. Johnson jumped in to offer a response to the question.
"Let me comment on that one, Patrick, if I may," Mr. Johnson interjected. "When we were talking on the Q4 call, we were looking at internal numbers, non-GAAP numbers and when the month closed and we closed our books on GAAP basis, it was closer to eight and we've been pretty flat for the quarter."
With that, Mr. Schindler gave way to Morningstar analyst Larry Witt.
Witt's end
Mr. Witt opened with a question about the company's contribution margin.
"You mentioned that the current number around 12 per cent or 13 per cent is a reasonable number to think about for our models," Mr. Witt said. "But I think in the past you had mentioned that your internal goal is closer to 15 per cent. Has something fundamentally changed?"
Mr. Byrne stumbled about a bit with his answer.
"Well, that's a good -- I know we've said at some point we've said 25, 5 and 5 was the model," he began. "I don't really know. I'm afraid - I have said 15 per cent before.
"I think that that 20 per cent margin may be too rich a pricing umbrella and we'd be better off with taking a lower margin and having lower marketing costs.
"I guess I would be more accurate to say the range of opinion within our executive team at this point is the right place for that to be is 12 per cent to 15 per cent and can't get any -- if we did a prediction market across the whole team, that would be the window that would come up.
"I tend to I think favor the lower end of that. I don't think we're ready to get there yet.
"We need to iron some more costs out of our system and then I think we can actually -- I think that we should be dropping the price, keep on squeezing the costs out of our system and dropping the price to drive growth and getting the contribution dollars flowing that way, and not have too much starch in the price, just in the interest of the long-term value of the brand.
"So I probably misspoke.
"When I said 12 per cent to 13 per cent that was my personal opinion.
"I think that the generally accepted range within our executive team at this point is 12 per cent to 15 per cent is the right number there."
Perhaps that rambling response satisfied Mr. Witt. In any event, he changed gears and turned to a question involving eBay Inc., a company that just posted first-quarter GAAP net income of $357.1-million or 28 cents per share on revenues of $2.02-billion. The company recently announced its intention to focus more on the liquidation and overstock market, which will put it more directly in competition with Overstock.com.
"Do you expect to see increased competition to get merchants on their (eBay's) platform?" Mr. Witt asked. "And how do you think that affects your business?"
"Well, eBay has a great business and any time I try to answer one of these competitive questions it always shows up like I'm saying nasty things," Mr. Byrne said. "I'm not saying nasty things. They obviously have a great business.
"But there are some real differences. And five or six years ago I think we went through this cycle once before. And they were saying the same thing and it really just didn't work out for them.
"And there's a couple reasons. One is the English auction is a lousy way to move large amounts of homogeneous goods.
"If you've got 1,000 Northface parkas and you put them up at auction at, the first one might clear at $50, and the next at $48 and then $46. You know, pretty soon they're going for $5 or $10 apiece, and you've got the problem of if you do three auctions a day, one closing every eight hours, it still takes you a year to get through them. So the English auction doesn't work for large amounts of homogeneous goods.
"So then they go, say, to fixed price. Well the problem with fixed price for them is -- it's been some years since I've done this calculation but when I used to do it, it's something like, literally it was something like 100 or 200 times the traffic of eBay per product. You've got to do it per product.
"And when you're talking about fixed price, it would be -- liquidation, it comes down to how many eyeballs do you get in front of a product before the price finds it true God's eye only market clearing price.
"Obviously, they have more traffic than we do. I think it's about six times the traffic or something but do they have 100 times still the products or something? So the traffic per product is still much lower than us so that's the bind that they're in.
"I think they could do it if they opened up an overstock store limited within eBay, if they opened up an area of eBay that was a store like ours. I don't know, there's probably ways they could go about it and maybe they have cracked that nut.
"But I guess my point is the route they're taking now is the same thing that six or seven years ago they were saying they were going to do. It didn't work. They did not take over this market like they thought they were.
"In particular, the areas that we play, I'd say there's a third dynamic which is if you're TAG Heur watches, are really going to start liquidating on eBay and what is your own distribution system going to do if you do that? Well, they're going to revolt. There's these different dynamics that make it.
"Although they're a great company and a powerhouse and everything, it's not as much a slam-dunk for them to do as you might think."
Shortly after that analysis of money-making eBay, the chief executive officer of money-losing Overstock.com closed out the first-quarter conference call.
Meanwhile, after languishing below $10 per share for quite some time, Overstock.com's stock price has enjoyed some recent buoyancy.
With approximately 272,000 shares changing hands in Nasdaq trading, Overstock.com gained 98 cents to close at $12.73 on April 24.
Comments regarding this article may be sent to lwebb@stockwatch.com.
(More information regarding Overstock.com Inc. is available in Stockwatch articles published on Feb. 20 and 27; March 6 and 18; and April 6, 2009.)
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