Overstock.com, Inc. (NASDAQ:OSTK )

Q3 2015 Earnings Conference Call

Robert Hughes — SVP, Finance and Risk Management

Patrick Byrne — CEO

Dave Nielsen — Co-President

Scott Tilghman — BB&T Capital Markets

Good day ladies and gentlemen, and welcome to the Overstock.com Inc. Fourth Quarter 2014 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder today’s program is being recorded.

I would now like to introduce to your host for today’s program Stormy Simon, President, Overstock.com. Please go ahead.

Thanks, Jonathan. Good morning and welcome to our fourth quarter and full year 2014 earnings conference call. Joining me today are Dr. Patrick M. Byrne, our Founder and CEO; and Robert Hughes, Senior Vice President of Finance & Risk Management.

I’ll turn the call over to Rob to highlight our financial results.

Robert Hughes

Thank you, Stormy. Before I cover the financial highlights, let me remind you that the following discussion and our responses to your questions reflect managements’ views as of today, January 29, 2015 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, in the Form 10-K that we filed on February 27, 2014, Form 10-Qs that we filed on April 29th, July 29th, and October 28, 2014.

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 non-GAAP measures, including reconciliation to these measures to the most comparable GAAP measures. Please review the Safe Harbor statement on slide two and turning to slide three.

Q4 2014 total net revenue was $470.4 million, an 18% increase from last year. Q4 2014 gross profit dollars increased 19% to $85.4 million and gross margin was 18.2%. Q4 2014 contribution was $48.3 million a 19% increase from last year. Q4 2014 technology and G&A expenses combined increased 19% to $46.6 million. Pre-tax income for Q4 was $2.3 million and net income was $1.3 million. Operating cash flow for 2014 was $80.8 million compared to $83.6 million for 2013.

Patrick with that let me turn the call over to you.

Patrick Byrne

Thank you Robert, thank you Stormy. After here, I am actually feel — I feel better about the better about the business obviously the market has its own thinking. I feel better about the business than I have in long time. The — of course what the stickiest on January when did we get this judgment Mark? 16th of January we had a little surprise, ultimately cost us $5.5 million in the quarter, but turning that aside, we feel — turning to slide four we feel we have the business, we are growing significantly faster than market again, 18% we’re out of those doldrums.

Slide five, our gross profit growth is back heading the right direction 19% and I think I’ve indicated the market people sit report different numbers for how fast e-commerce is growing, Amazon is growing 20 plus in North America, but other I think that the — I think the high single-digit is probably if you take Amazon out that’s about where things are high single-digits. So I always think 15% or above is pretty good, so I’m happy that our gross profit growth is back to 19%.

Slide six, quarterly contribution growth 19%, again so I feel I look at these graphs and the thing I look at I care about a lot is contribution growth, which we call nectar here we talked about contribution, if we can have that growing we can manage expenses around contribution. And I think we have a very good internally where we’ve had a very good history being able to manage expenses to what we say internally they’re going to be.

Now what has been variable, more variable than it should be is the growth the top-line growth and the contribution growth, but with contribution growing double-digits we can sort the manage the whole business around that and what we’re. So slide seven, again it drops to 10.3% it always drops in Q4 there is a mix shift in Q4 and there is a mix shift in a lot of electronics and low margin stuff get sold.

Still not happy, I do think that our contribution margin should be higher I’ve said 12.0% is I think really the sweet spot. And when we get above 12.0% I think that it tends to stole out on us.

Slide eight, just want to compare this with so Overstock’s contribution margin for Q4 shows up is 10.3% on slide eight. Just want to compare with a couple of people. There is Amazon, now Amazon we have two lines representing them the black and the blue. And it can’t really because they don’t breakout their numbers in a Wayfair that would lead you know for sure when you take out their service business. Their contribution margin is somewhere between 11.3% and negative 14%. Not sure Wayfair for example their contribution margin is 0.5% in the last reported quarter, which if that’s where it stays it kind of doesn’t matter how much scale it get. So we think that, why we think that’s worth noting.

Slide nine, technology and G&A expense, quarter-to-quarter this isn’t super meaningful, but you see that it is you see really what the effect is of these two massive lawsuit judgments in this Q4 and Q4 of 2013 have but with the red bar as you can see really where our G&A, our recurring G&A is. Hopefully we don’t have is kind of a big surprise judgments against us going forward, but so I think that we have our G&A we certainly have our G&A under control and what we’re doing is we’re building out technology, what’s happening more and more is I know that at some point I talked about what we have as the business that we can grow the net is the contribution and then have half of those dollars fall in the bottom-line of somewhere about a year ago I also said its we’re having so many opportunities to innovate it’s just I think that we have kind of the luxury unlike some of our competitors. We have to build out these internal systems and are losing a ton of money as they do it, that we’re able to keep our nose above the horizon. We’re able to keep gaining some altitude and yeah we could as you’ll see in a minute we could show back on innovation still out a lot $20 million more of profit, but and follow that rule saying as contribution grows we’ll have half falls the bottom line, but I’ve as I’ve announced I think about a year ago I don’t think that’s the right long-term strategy for us right now

So there is slide nine, slide 10 quarterly income of course is kind a throwing off by this tax NOL that we got last Q4 so it doesn’t mean much. So it is disappointing that Q4 came out where it did on net income especially after this where given this $5.5 million cost associated with the lawsuit.

On slide 11, operating free cash flow, we have a nice healthy business certainly we’re spinning up a lot of cash and there was a day some years ago where people worried about survival, we have a very strong cash flow, and this is the $40 million of free cash flow is after not just a lot of internal investments in the business that we could turn off if we decided not to do certain expansion, but there is another $17 million taken out of this past year that goes towards building the new headquarters and that we’ve paid cash for land and all kinds of things. So we have a nice business that’s spinning up plenty of cash.

Slide 12, again 42 turns on a GAAP basis 4.4 which I still think is too low, we should have a new team over analytics and sourcing analytics and I’d love to see this get over 6, or even 7 or 8 on a GAAP basis, but in internal basis.

Slide 13, 960%, 958% GMROI. Slide 14, unique customers and cost per customer, you see a slight increase in both the cost per customer up to $15 and in the unique customers for the Q4 versus Q4. New customers slide 15, another modest increase 9% increase. Customer orders slide 16, customer orders and average order size sort of healthy increase in average order size again up another $10 from Q4 last year and of course this always drops during Q4.

Slide 17 gross profit per transaction also up about the same amount. So now with slide 18, let us turn to so I actually thought if the — I don’t want to be in the except for business, but except for this big surprise on January 16th, I actually thought the quarter had worked out we had a slow start to the year but we came bouncing back nicely in Q4. The operations of the business are humming and I was quite happy with them. This was quite a disappointment this news on January 16th, but sort to look at the fundamentals of the business I thought as the year came out got off to a slow start we had some trouble, we said we would adjust on the fly and over Q3 and Q4 we did and now our operations delivered a nice result in Q4 so we had that at piece of surprise down in Texas.

Now with that said Rob why don’t you go over 2014?

Robert Hughes

Okay. Our 2014 total net revenue was $1.5 billion a 15% increase in last year, 2014 gross profit dollars increased 13% to $279.1 million, the gross margin was 18.6%, 2014 contribution was $169.6 million a 9% increase from last year. 2014 tech and G&A expenses combined increased 13% to $158 million and pre-tax income was $13.2 million and net income was $8.8 million.

Patrick Byrne

And same operating cash flow. Okay slide 19, so annual revenue, 15% increase drove at the bottom end of what I think of is good for us. But happy that got back there. Slide 16 annual gross profit growth 13% again got off to a slow start here and we came charging back 19% in Q4, but for the year it was 13%. Same story on contribution growth 9% for the year is parts I think about where the industry is growing overall, but we should really be able to get definitely have this in double-digits. And I think that 15% or north of 15% is what I would think a 15% is acceptable and 20% is good. 9% for the year is unacceptable; the star will let you down.

Slide 22, gross margin, contribution margins it did come down from last year again that’s really the first half of this year was we — but we’ve come back over and I think 12.0% is the place we wanted to be operating, is just a place we want to be operating.

Slide 23, this starts getting more meaningful and I think you can see a little bit clear here than you could on the quarterly, which is going to have a lot of quarter-to-quarter noise, as the red line indicate our G&A as a percentage of revenue is coming down nicely 5.2% to 4.8% is one year is fine. Our tech moving up to 5.8%, that’s moving in that direction that we wanted to we’re really evolving into being a tech company.

We see some tremendous opportunities, what we really see is there is a place that all the big guys are driving, eBay, Google, Amazon, us, there’s a business model that we’re all driving towards in a sense it’s the same those are the same business model it’s the same set of functions that our business models are attempting to solve in a different way, but we’re all, I think we’re evolving towards the same place and we have this list of business functions that have to be accomplished and we’ve broken the innovation bottleneck in this company in my view in the last two years.

We’ve gotten really good at building out quickly, agilely designing systems and build them better than we ever have in our history and I’m taking advantage of that, I’m thinking millions in the same. And it shows up here but I just want to point out that it’s tech spending is going up and the G&A is going down, which is what I like seeing happen.

Slide 24, annual net income $8.8 million again that’s after $5.5 million of cost related to this lawsuit, I should be more or could be more, do I see this do I see myself worrying about growing this steadily or is that more vital than staying profitable while I’ll put it this way I think we’ve had now 12 quarters of GAAP profitability, last I checked I’m not sure if there’s another peer play out there probably be traded I can’t think of any well I don’t have them all in detail like I used to, but I know Amazon isn’t and I know anyway we’ve had 12 straight quarters of every quarter being GAAP profitable. So we’ve really got things we’re running at tight shift, tighter than it’s ever run and we’ve got some things dialed in so it really comes out to strategic decision.

I’d love to see this net income moving up, but two business if it’s a choice between that and there’s really this [indiscernible] waiting to be occupied nobody’s gotten all their functions get done nobody’s gotten none of the big players have gotten there yet, now channel advisors is another one I shouldn’t left out in a sense we’re all driving towards the same business and to me I’m in a real rush to get all those modules done and integrated and working and it’s important to do that, more important to me to do that than to see this number growing 15% a year.

Corporate employees, so this is tech and G&A you see increase in that and we’re actually kind of busting at the scenes we’ll be in our new place in a year and half and it will be just right. Key automations, page 26, well, Bitcoin, Pets, Farmers Market, Insurance, Supply Chain and SOFS, Private Label Credit Card and Medici you should know that on a fully, these cost does this year about $11.5 million direct and on a fully burden basis you might think of that as $23 million. $23 million that of expense that we could choose not to do and to stick with what we have, but then we just we’ve chosen to do these other things. So this set of innovations has — but this would have taken us a lot longer five years ago, we’ve got so we can dream of projects like this, research them and spit them out quite quickly. And the constellation of projects I think are going to make a little bit more sense to people a year from now than they do necessarily right now.

So with that said, we can go to questions, I see there are a number of questions had been mailed in. Shall I start hitting these questions and then we’ll go to Q&A on the phone. Okay, Lancer Vicky, how do you assess Overstock’s historical record on creating value for its shareholders?

I see it much to applaud, revenue growth et cetera you keep subscribing to [indiscernible] turn the markets a weighing machine, what are we going to do in the next 10 years different than the last decade?

I believe Overstock is a great company in many ways, but the stock price is essentially the same as it was eight years ago. This lack of value creation can’t be ignored. I chose this my answer is my job is in the stock price, my job is the company. We built a profitable $1.5 billion pure play e-commerce company that’s been profitable every quarter from last 12 quarters. I’m not sure how many more companies like us that are out there. What the market — how you folks value that is kind of how you folks value that. That’s not my job and I think Ben Graham was right then and I think he’s right now and I think I’m not going to change anything in order to move the stock price we’re just going to keep focus on building the value.

And I see these other companies smaller than us growing about the same size as us and losing a fortune and being told their worth five times us and I’m not going to try to copy them in any way to get any of that, I do have to point out, we know for a fact so if this is going back eight years we know that for a fact that in these eight years our stock was manipulated by some powerful players we have a lawsuit about that, a lawsuit it concerns Merrill Lynch and Goldman Sachs, but it also concerns a couple of guys Hays and Aaron Steen that has been doing very big fines, I see our lawyer here is starting to scream at us, but now that lawsuit got to through the system it’s — with intact against Merrill Lynch, Goldman Sachs is added for now on a jurisdictional issue, but it’s all been kicked up to the California Supreme Court and we’ll know in another couple of months I think whether they are going to examine the case or not. But we know that for at least some of this period our stock was heavily manipulated.

And we don’t have data towards more recent years there are some reason to think that those days aren’t over and they’ve just moved into new areas in order to accomplish the same thing, which is another reason I say look at the end of the stock price is the stock price what we focus on here is building value in the business I think we’ve built about $1.5 billion company growing 19% and making money consistently and with really huge opportunities and we have finally cash assisted like the last two years, three years.

It is really, technology is no longer the pain of my existence, technologies are friend, and we’ve really gotten agile and can do all kinds of things that led us these opportunities that were real struggle five, six years ago. So I actually feel my instincts are generally different than the markets, sometimes when the markets been real happy I’ve been down and sometimes vice-versa. So but again my — we create value for our shareholders by building a better and better business with better and bigger business with the stronger brand and staying profitable and integrating these new channels and bringing these new innovations online that storm is behind and driving.

And that’s how we build value really if I even I could lie to you and say well we’re going to do something different in order to drive us backwards, I wouldn’t even know what and that thing is going to be X I have no idea what X would be, I’d be lying to. But I’d truly I’d be lying to you have even said it because I’m not going to do anything in an attempt to drive our stock price.

Todd — Grand Master Capital, can Pat and the team explain the year, but however Glen that’s respectfully and thank you for a good question I can understand that’s a fair question. I wouldn’t know how to do anything differently than we are. Todd Amiens, Grand Master Capital, can you explain the year-over-year increase in both accounts payable and accrued liabilities how much is seasonality, how much of the expenditures were fixed assets? $41 million is for internal software and website? Rob why don’t you take that?

Robert Hughes

Okay, so yeah the increase in accounts payable and accrued liabilities and cash is that they always reach their peak at year-end due to holiday sales. And then if you look at them year-over-year that increases due largely to the increased sales growth that we had in this Q4. On the expenditures for fixed assets, let me comment on that the internally used software and website development is about $14 million. As Patrick mentioned earlier, I think we had about $17 million for a new corporate headquarters including the purchase of land and the other 10 is related primarily to our IT infrastructure and that includes things like expanding our data warehouse, upgrades to our ERP hardware and upgrades to our IT data storage systems.

Patrick Byrne

Thank you. Vincent Hunes [ph] asked will the company be spinning out Medici is separately publicly traded company? And why doesn’t the board have a stock repurchase authorization in place even if it’s not immediately used?

I thought that we typically did always run with one in place. I’d have to check the minutes if we actually still have one authorized, but any case the truth is if it was authorized it was so many years ago we’d have to reauthorize it. But I think that’s a good idea, we’ll be having a Board Meeting next week and I’m sure this will be a subject of discussion. There are some other questions that they okay, the plans for Medici as a separately publicly traded company.

Haven’t thought that, I mean I’ve considered that I’ve considered going to be a tax free spin off of stock in Medici that’s day ever comes, don’t really know. I do see the logic of once this thing incubated fitting it out, I’m sorry are we getting new question coming in. Very good, once this is ready to leave drydock, what should the ownership structure be should it be — should we be dividending out shares in it? I don’t know yet right now we’re focusing on designing and building this destroyer. I will say that I think that we’re making faster progress on this than we had anticipated and I’m expecting that I expect that before we speak again we will have some significant news, significant well we will have a development here before we speak again on that. So that show real progress, I think that we’ve come further than on the goal of Medici than we’re further along than the world understands we’re further along than we thought was possible back in October as we were getting it organized.

So I see other say just a moment please. Okay, what are Overstock’s plans for the shelf offering we filed in Q4? No plans whatsoever and I certainly don’t want to issue stock here, we don’t want the capital we got tons of cash, we’re generating lots of cash. I don’t I just my pop may rest in peace it was always his mantra, he always kept the shelf offering on the shelf or you don’t wait till the day you need it. So you don’t want to be in the position of wanting to do an offering and then filing the shelf. You want to have the shelf there and then and so if the day ever comes and what if these good four years mark or five years.

Robert Hughes

I think, I believe there are three, is it more?

Patrick Byrne

And so I think we just we filed in Q4 wasn’t just a renewal or an extension of what was already there. Yeah we have no plans to issue stock at this price. Is Overstock selling in China now? If so will China be material contribution to sales 2015? We’re not really selling anything in China other than what being ordered and shipped there. We are opening a warehouse in Q2 in China the last steps of the integration are being accomplished now will be open in Q2 and we will be selling into China from the warehouse in China in Q2.

And so that is am I correct in thinking that’s all of the questions that have actually come our way? Hi regarding your key innovations do you think there will be a distraction from your main business. Hi, no I don’t that — I don’t at all, and if not why not please explain how these seemingly disjointed innovations create synergies, which of them have the most promise and why? Thank you.

Fair set of question, they certainly don’t act as a distraction Stormy and I, Stormy has become President this is working beautifully, the business model as you know it as you see it from the outside is what Stormy is running now. And is a beautiful operators, Stormy is a beautiful operator of these different programs that is taking through finding ways definitely finding ways to improve the way the different departments run and or manage and so forth. I am down here in different part of the building basically with several dozen developers and business people and we’re developing these different projects. And some of them let me just give you and no it’s — they are not a distraction, it’s really quite isolate it’s a set of projects we can turn off anytime we want the total expense is about 15% of the total expenses in the rest of the business.

So basically we have an innovations budget that’s around 15% of what is sort of inline expense budget is setting aside marketing. So lot of these things so for example Bitcoin, Bitcoin cost us directly, we figure about 400 grand to get integrate and live with all the people we had on it such. We might allocate another 400 grand to that and $800,000 it was a bit of disappointment, incidentally Bitcoin I thought we will do at least $6 million or $7 million this year. And after the first month of sales, that seem possible I thought at least four would come domestically four or five and then there will be a few, couple of few international and the truth is nothing international showed up and almost no international sales and the domestic sales came in at $3 million.

So bit of a disappointment and all of that worth $400,000 in other ways. These things are not these other they’re not as disjointed and as you may imagine. So for example put adoption, put adoptions — so first just in terms of the big picture management time, Stormy has got all the operations of Overstock as you know it totally under its own managed beautifully. I have got Dave down here in the incubator and we’re building out all kinds of things some of them don’t work, some of them work beautifully, some of them have added very significantly to the bottom-line and the top-line in the last year. We’re not going to tell you which is which and some of things you see us do that you might have wonder like pet adoption how is that going make us any money. Well the truth is pet adoptions was very easy to do, it cost us about $400,000 worth of peoples time to do.

It let us get better at some technologies we’ve gotten very good at search at internal search and to test this I mean go search is a horrible experience in most sites in my view. Come in our site and search your stuff now and I mean it can be better, but I think it’s so much better than it was and I think it’s actually searching our site versus a lot of our competitors, you’ll see how much easier it is to filter and find what you’re looking for.

So we apply that to integrating in all to all these pet shelters. It may look like well so first all of that gave us some practice in expanding our knowledge of search. And we had to sort of get better at this technology. And that’s good for us that’s a good exercise in addition and then process of developing the thing for [ET adoption we had to develop a module that says okay, I want to adopt the pet I am in this zip code, I want to look within 50 miles. Well there is a really kind of all share a motive for adopting that for building that module. There is other usage we can put that module of code to just in our main inline business.

So it has real what economist would call externality to do some of this innovation. What it really, what it to some degree what they are our vehicles for us to develops things that we really need to develop to make our inline, our normal business better anyway. So it has externalities they not that expensive and the ones that our expensive so some of these have contributed many tens and millions of dollars in sales this year, some of these innovations and when I think of them all together, well obviously I don’t want to disclose which have done so well, but we think that these, that having this sort of greenhouse that’s taking up an additional 15 so in other words we could cut our expense structure by that 15% anytime we want by stopping doing these things, but we’re doing them both because they some of them bring these things we are doing them because they some of them bring — have externalities that by accomplishing them we are actually getting code and functionality that our businesses expansion in our main business needs and also some of them intrinsically just really do great value. So I will stop there, so that’s last question okay, any other questions have come in or shall we go to…?

Jonathan, moderator of the call, please open the floor for questions.

Question-and-Answer Session

Certainly. [Operator Instructions] And our first question comes from the line of Scott Tilghman from B. Riley. Your question please.

Scott Tilghman

Thanks, I have a few questions for you. First off, with the discussion around the various module and getting those up and running it seem like you’ve largely made the decision to invest rather than acquire some of those capabilities and I am wondering that’s going to be the case going forward or if you see any potential tuck-in opportunities?

Patrick Byrne

I really don’t, we do have people come to us with companies and either they are priced at far beyond what we could we build the technology for ourselves or even it might look reasonable that we could buy them by the time you get we had something recently to come to us in Europe, a small company that might have been a vehicle for us to move into the European market. By the time you get, our experience has been we’ve liquidated 19.com within the U.S. in our history and some we bought and some we just bought the inventory and the truth is, you are not buying anyway not a big fan of acquiring any of these companies and I’ve always been against the philosophy oh not invented here we can do it better ourselves I’ve always been the guy against that, before I’ve reluctant I have reluctantly approach the point where I think we’ve gotten so good at designing and building software that works perfectly for us I don’t really see buying other technology companies. Now we do buy, we bought the inventory of bids last quarter and there was another we’ve really revised where we started off the game of doing after big bankruptcies and there is others on the horizon right now, and other nice one on the horizon right now. And actually I should mention the bids inventory kind of hurt our inventory and turns numbers because it was a ton of jewelry have we disclosed what we paid for.

Stormy Simon

No I don’t, we got a good deal.

Patrick Byrne

We got a good deal. I mean — and it’s weighing down our balance sheet now hopefully we should be able to get through it by as we go to Valentine’s Day where a lot of it but anyway so other than buying inventories I really think it’s unlikely you will see us buy a company unless something really came to us unassigned it’s such a distraction trying to integrate these other companies.

Scott Tilghman

That’s helpful. Second, I wanted to touch on the streaming announcement, obviously everyone was involved there, but one of the key expenses is content I am wondering if you found a way to perhaps not take one as much cost in trying to ramp up that capability?

Patrick Byrne

Definitely, we think we have a way of getting the slice probably by the middle of this year without big upfront capital cost with hardly any other than some integration, see what happened is here there are a number of companies that have built good systems, very good systems in some cases good platform, they build it and now they realized they don’t have any way of getting traffic and it’s so expensive to get the traffic our traffic is now 25 million to 40 million unique visitors a months per internet retailer 30 million average month in 2014 we’ve got the traffic.

So some of these there is two companies in particular that build very good platforms that we can do deals where they are powering this tab and getting us into the business and that’s the direction we are going to take and it will take essentially no I mean, no upfront capital it will take some time for some development teams to work and do integrations, but no we’re not going to go out and spend millions acquiring capital. There’s really two different platforms there is AVOD and SVOD, AVOD audio visual on demand that’s something like iTunes.

That we can get live without any capital and then if we do start offering subscription, which is more like Netflix we would probably start with a very narrow range a few hundred titles in for your subscription, but through analytics we can figure out what are the few hundred titles that most of our customers would like to see this month. So start up probably with a very narrow band in the SVOD and then gradually picking it, which is I think how the other guys have done the same thing. But anyway this you should not expect a large any large expense associated with getting these new platforms live. And it won’t be just movies, movies, games, music, books all of it.

Scott Tilghman

Thanks the other area I want to focus on is marketing and a few different parts to the question, one being just an update on your philosophy in balancing promotion with gross profit dollars, do you think you can get the contribution margins back to that 12% level in 2015 and related this was called out in your release, are their structural changes in marketing that we should think about just from a cost standpoint going forward or were some of those elevated expenses unique to fourth quarter?

Patrick Byrne

Well, good question, why don’t I start and then Stormy who is now running marketing wants to join in, or I’ll just take it. There is a structural shift our Club O is doing very well and since I’ve disclosed the numbers in the past, I’ll disclose now Club O is now at 20% of our sales and it’s growing very rapidly. I am a big fan of Club O versus coupons we’ve spent a ton of money every year on coupon and I think that is large S to the customers and I’d much rather focus the large S not to customers who are just out there waiting for a coupon, but those who’ve actually made a commitment to us and the commitment is they’ve joined Club O. So what I really and this is a big opportunity is really dramatically winning ourselves off the coupons but shutting all of that those funds into large asset benefit towards our Club O members.

Hard to do that in the past because the Club O pipeline wasn’t thick enough, we actually spent about $30 million a year on coupon and that part of the slight difference between the way we count revenue and the way GAAP does, but we’re spending $30 million on coupons I’d love to see that they were never giving a coupon to the non-Club O world, but we’re pouring it into the Club O world.

So I think that may have a significant effect on the efficiency of our marketing as we make that shift itself. And Stormy is personally running marketing actually a wonderful fellow took it over two years ago a technologist and got the technology really enhanced and now Stormy has been in there directly herself and I know that she think there’s lots of opportunities and improvement in market. Do you want to say anything about that Stormy or? Stormy holds her cards close to her chest.

Stormy Simon

I do, well I’d say I’m extremely proud of the results of what we spent in marketing now I won’t, but I will say that the longer I spend there the more I realize how steep the competitive environment is and while all these other firms are out raising all these money this money and being able to spend so much on the marketing dollars and then being rewarded for it. We’re spending it with what we make, so while it may seem like a high percentage it’s actually to keep us relevant and competitive. And everybody knows out there that the e-commerce market 15 years ago was very different than it is today.

And so in order to continue to innovate with what consumers want, which is sites like interest and consent, which we’re answering with the video on demand, but there is a lot of things that go into marketing and it’s really including engagement and consumer tools that make them chose your site of the destination and in that sense we’re going to continue to invest because we have to continue to be relevant. And that’s just where it land.

Patrick Byrne

I would add in the early days of the company I thought we had a real edge in marketing and there were just big gaping arbitrages that you Wall Street guys were salivated over in the marketplace for online advertising, it was ridiculous, nobody was measuring themselves correctly and it was just break the gaping holes, you can buy things that had a 100 times that were mispriced by a 100 fold no kidding, there were things that were mispriced in both direction by a 100 fold. It isn’t like that now everybody is smart enough, they don’t have these great big holes and I think that we did lose our edge for a number of years, I did and the early days we felt like we were 40 IQ points smarter than the industry in the sense of and that’s why we were growing a 100% over and over year-after-year because no one else had figured this stuff well, the basics have all been figured out, so our mission and so the beta, I don’t think we are dumber than the industry but we sort of restate about where the industry was.

In the last two years well I’ll put this way now I feel better about our marketing department either than I ever felt or that I have felt in about 12 years. I feel better that the people in it management structure who is on top of what, I mean we really for the first time, I am feeling very relieved with storming over this, the executive she has in place, I feel really good about the marketing department and there is big opportunities, one of the big ones to me and that’s just an example. We spent $30 million on coupon. I’d love that to be $30 million of largest to our Club O members and now that Club O is growing so quickly is because and we’re not going to do any sudden gear shift because when you shift gears bad things happen, it spin out so it’s going to be a transition but so that something dramatically affect our economics but we don’t know what it is. Other than our Club O is growing triple digits rates and we have some other plans for expanding it dramatically. So, I will stop there.

Scott Tilghman

I just want to clarify though, when the commentary around the sponsored search and display ad spending that was in the release. Are you shifting dollars and therefore it’s costing you a little bit more and should we expect that to go forward? Or is that somewhat unique to the holiday period?

Stormy Simon

Well I think that going back to, it gets more and more expensive due to the number of playing there. So.

Patrick Byrne

Getting up.

Stormy Simon

Yeah. Certainly by the competitors

Scott Tilghman

Stormy Simon

Or folks buying your terms that base just gets more and more expensive.

Patrick Byrne

However it is possible to if we can still get smarter there, you can get smarter in terms of understanding the long-term not just looking the gross profit made off transaction when you buy some term but what kind of customer do you get. And then can you fiddle with their re-engagement rates things like that so, that’s what I mean when I say getting smarter. Some of these areas I think we are probably as good as the game but some we have places to improve.

I am not showing any further questions in the queue at this time. [Operator instruction]. And it looks like we have a follow-up from Scott Tilghman from B. Riley. Your question please.

Scott Tilghman

I am back.

Unidentified Company Representative

Hi, Scott.

Stormy Simon

Hi, Scott.

Scott Tilghman

Two quick questions. One, on gross margins we have seen pretty nice improvement over the last two years but the one exception has really been in the fourth quarter period recognizing the mix is a portion of that I am still wondering why there isn’t a little bit more improvement given the overall trends that we’ve seen through the past two fiscal years?

Unidentified Company Representative

Well for the Q4 itself let me, Rob do you want to answer that? Let me pull that slide up. Yeah, I would say that, I would have expected this to be a little bit stronger in Q4 more than improvement versus last year that just tenths of a percent. Stormy or Robert do you want to address that.

Robert Hughes

Well I think we got more of the benefit in earlier periods from the shift to home from our other categories and that has played out nicely but we don’t proportionally get as much from those businesses and some of our other businesses are going well but they aren’t as higher margins and they grew nicely in the first quarter as well.

Scott Tilghman

Okay, now I was just looking at the first three quarters if we look at 2012 overall up 70 to 80 basis points whereas Q4 is only up about 30 so that’s why I’m wondering what the mix or what’s causing that delta whether it’s simply the mix around the holidays or if there were some other components in there.

The other thing I wanted to ask and this is more of a philosophical question with the plan change in eBay’s structure you are going to have a more streamline business that is fairly well capitalized, if they wanted to make an acquisition and this is probably for you Patrick more than anyone else, is that something that you would be open to or do you feel like you have a lot of opportunity ahead of you that you would not want to accept any offers?

Patrick Byrne

I am not interested in anything like this price I think there is tremendous opportunity on any sort of ratio you compare us to the market we sell at a huge discount.

Scott Tilghman

Absolutely.

Patrick Byrne

And anything where we open to hearing to people but I wouldn’t if somebody came in and say we’ll talk about making an offer up 30 from today’s prices and something I’d say save yourself. I think that we’re multiples of where we’re currently trading but and we do occasionally get, there are people besides, there are various players besides one you mentioned to make sort of informal contacts it’s kind of hard to judge them because it’s sort of hey you should know this guy and he wants to give you call and such. So it’s not out of the question but if I mean if I thought that we had played out I’d be the first to say let’s maximize this in a sale if somebody — I do sometimes think not from a CEO point of view but from the gods of economics, I can see this makes perfect sense for certain companies out there strategically. It would make perfect sense for them to acquire and I don’t want to say names because I don’t want to give any ideas but just from sort of a — put my advisors as looking at how the gods of economics I think, this would be a perfect opportunity for strategically for several companies that out there in the discourse but it’s not something we push it all and I’ll just leave at that.

Scott Tilghman

Fair enough. One question I had overlooked and I promise this is the last one. Just wanted to get your sense of the promotional environment obviously you have a newly public competitor this was their first holiday season following their IPO number of other retailers have made various comments around the promotional activities some saying the same as last year some saying better some worst just wanted to get your read on how things looked pre-Christmas and how things are shaping up here in the early part of the year?

Patrick Byrne

I’ll let Stormy hit that first what do you want to say about the competitive environment in Q4.

Stormy Simon

It was tough. I mean everybody was racing to the bottom on price and yeah the competitors on our radar and we’re watching them and I think, we differentiated ourselves in this commerce space a few ways and there are some places where we’re playing with our supplier and fulfillment services I would have loved to have started that a few years ago, we’re investing heavily and I actually Patrick at earlier said there were things we would turn off I would not turn off that initiative, I would keep that going I think we’re going to be better at than anybody else, I know our prices are better.

For Q4 going back to the competitor as I think what makes this different is we are not a marketplace we drive value with each of our products and then we complement that with promotional sales and pricing. The big competitor I think you may be talking about welfare and home they don’t offer everything we do we have a fanatic customer base about the products that we offer huge growth in various categories.

Promotionally, we have to stay competitive and whether that site sales or coupons we are going to do everything we can do to keep our market share and engage our consumers deeper than we have in the previous years.Q1, I think we’re doing a pretty good job at doing that.

Patrick Byrne

I’ll ask that something what is there I think probably more momentum in our areas than we should have less than before we responded. But thanks to Stormy in our supplier area. And it’s a big pond and we were happy with the suppliers they came into the pond and they were getting other suppliers too tough, we’ve really in the last year or year and a half. Stormy has taken a very aggressive attitude towards that world of that pond to potential supplier and we think that we’re actually shifting; we think we’re making great progress versus Wayfair and shifting. We have a lot of loyalty in that world and we think we’re actually to be honest both Amazon and Wayfair suppliers they have different reasons, Amazon has its own reasons to have ticked off in suppliers, but we think we’re making really good headway and have at least stopped if it’s about of the bold we stopped the outbreak place there and we think we’ve been rolling them back some in terms of their suppliers and our — Stormy just came from a show they’re having to really squeeze their suppliers they know that they are not they’ve got to start showing Wall Street something and their new strategy has just become go and bully their suppliers and so we’re getting a lot of people coming to us.

Stormy Simon

But I would say just five of them as competitors Overstock stated true to not becoming a marketplace where we still stand behind every product everything that sold here is done with a partnership with our suppliers. And I think consumers appreciate that they know who they’re going to calls or something go wrong with their order. And while we keep an eye on our competitors, we can’t be afraid to take them on and with that being said I’m not I’m aware but we’re going to stand strong.

Patrick Byrne

Yeah we could take out very we probably were not as aggressive as we should have been in several years ago and letting them get to the tow hole and even this world of suppliers. So we have taken a very aggressive posture now in that world of home suppliers and things are going quite nicely.

Stormy Simon

Yeah and they just raised the ton of money and we’re going to, I mean profitable.

Patrick Byrne

Yeah we have a constraint we’re being profitable last I saw they lost $50 million or $60 million halfway through the year. And I think my understanding is that they’re putting the word out that Wall Street isn’t going to tolerate that for much longer and they’ve got to turn and announced or taking to hire their suppliers and that’s what their suppliers are saying to us as they become in our world.

Scott Tilghman

Great thanks for the color and the time.

Stormy Simon

Thank you. This does conclude the question-and-answer session for today’s program. I’d like to hand the program back for any further remarks.

I have nothing further

Patrick Byrne

You have nothing further?

Nothing further.

Patrick Byrne

I have actually it’s funny and I think I’ve told people that stands a story from Seinfeld where remember there is one episode where he decides to do what’s backwards whatever he thinks because I actually feel competitively solid where we are. We’ve got I have got so thrilled that we’re able to be innovating like we are now and then Stormy is running the company and making some of the changes internally and that she’s made and so forth. I think we’ve really got our reduction our own.

It is a chance, strategic change for us that we’ve got during the last year of realizing rather than working about taking pretax operating income $18 million to $20 million to $22 million to $24 million until we move until we’ve run out of these innovations we want to do we think that there is still an opportunity to build something that no one is there yet, no one is really hasn’t has everything we’re thinking of. And we think that when it all connects up and it should be obvious this year our strategy should become obvious I think sometime over the course of this year more obvious than it is now. I think that I’m actually quite excited that I feel like we’re really moving the ball in a way that sometimes as I say we were fumbling or having trouble making first down and I feel that we’re really moving the ball.

Yeah I would agree and there is a first question from Glenn and I appreciate those owning stocks for eight years and agreed I’m not sure why we’re not being seeing for the value that we are absolutely creating but to Patrick’s point we have to run the business and that’s our commitment. Hopefully, the stock price should follow when you look at other people in the same space that’s following them and they’re not doing what we’re doing.

Patrick Byrne

Yeah if I mean we can go lose $100 million a year or two and we’re growing 60%, 70%.

Meaning guys we really do mind.

Patrick Byrne

We can go and lose $100 million and add a $1 billion or more sales but that’s not how we want to do thing.

Unidentified Company Representative

No. We appreciate your time, support and investment.

Patrick Byrne

Thank you folks.

Thank you ladies and gentlemen for your participation in today’s conference. This does conclude the program. You may now disconnect. Good day.

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