Q: Will this thing ever be profitable?
A: It already is.
That's the funny thing about Motley Fool Rule Breakers selection Overstock.com (Nasdaq: OSTK). The online closeout retailer -- and the subject of last week's Dueling Fools -- has posted operating losses on an annual basis since its inception, yet the business is effectively profitable, with sustainable GAAP profits not too far away. If Overstock were to show zero percent sales growth over the next four quarters, the company would still show an operating profit.
Overstock.com is profitable at zero growth
The key variable here is marketing expense. We know that, in general, increased marketing spending drives higher sales -- at the expense of short-term profit. If you think of the expense as an investment, the company's lack of an annual profit is easier to put into perspective.
Here's a simple illustration: Over the past three years, Overstock has shown annual gross merchandise sales (GMS) growth of 138%, 82%, and 83%, respectively (excluding contributions from travel and auction businesses). Revenues have grown a similar 83% over the past four quarters to $641.3 million. Over the last four quarters, marketing expense came in at 9.5% of revenues; in four quarters before that, marketing expense was only 7% of revenues. CEO Patrick Byrne said last quarter that the company can sustain its current growth rate (72% revenue growth last quarter) with marketing expenses between 8% and 9%. That said, I think it is safe to assume that the company can easily weather a worst-case scenario of zero growth by reducing its marketing expense to 7.5% of revenues.
Overstock.com at zero growth (in millions)
|
12 Months Ended:
|
Q2 2002
|
Q2 2003
|
Q2 2004
|
Q2
2005
|
Q2 2006*
|
|
Gross Merch.
Sales
|
$88.1
|
$209.6
|
$381.2
|
$699.3**
|
$699.3**
|
|
GMS
Growth
|
|
138%
|
82%
|
83%
|
0%
|
|
Revs.
|
N/C
|
N/C
|
$350.8
|
$641.3
|
$641.3
|
|
Gross
Profits
|
$8.2
|
$23.1
|
$34.4
|
$94.4
|
$94.4
|
|
Sales and Mktng.
|
$5.2
|
$12.6
|
$24.7
|
$60.9
|
$48.1
|
|
G&A
|
$10.1
|
$13.7
|
$20.8
|
$28.0
|
$28.0
|
|
Total
Opr. Expns.
|
$19.0
|
$28.0
|
$46.1
|
$104.5
|
$91.7
|
|
Opr.
Profit
|
-$10.7
|
-$4.8
|
-$11.7
|
-$10.1
|
$2.7
|
|
Opr. Margin
|
N/C
|
N/C
|
-3.3%
|
-2.3%
|
0.4%
|
*Zero growth, marketing expense at 7.5% of revenues
**GMS excludes Travel and Auction contributions
N/C: Not comparable due to revenue accounting change
From the table, you can see that if Overstock were to maintain revenues of $641.3 million over the next four quarters while reducing marketing expense to 7.5% of revenues -- and of course keeping G&A expense constant -- the company would save $12.8 million. That's enough to turn the company's operating loss of $10.1 million over the past four quarters into a $2.7 million operating profit.
I'm sure that John Reeves, the bear in last week's Overstock duel, is probably saying "And if the Easter Bunny had wings, he would fly."
However, the point here is that Overstock could begin showing an annual operating profit today without even having to project growth as I did in the duel last week. Among other things, we also know that GMS has grown 694% to $699.3 million (excluding contributions from the travel and auction business) over the past three years, and gross profit has climbed tenfold, while G&A expenses have less than tripled.
With that in mind, the company's nominal operating losses -- averaging less than $10 million per year over the past four years -- are a lot easier to put into perspective as "investments." Since we can probably expect the company to show better than zero growth -- even with marketing expense as low as 7.5% of revenues -- it is also easier to see that sustained profitability is not too far away.
Profitable company, profitable stock?
I realize that some of the Rule Breakers newsletter's biggest gainers are companies that have never shown a profit, including Vertex Pharmaceuticals (Nasdaq: VRTX), Universal Display (Nasdaq: PANL), and CV Therapeutics (Nasdaq: CVTX) -- up 71%, 43%, and 35% to date, respectively. But profitable companies are significantly less risky, and are hardly unrewarding -- high-flier eBay (Nasdaq: EBAY) was profitable at its IPO, and Amazon.com (Nasdaq: AMZN) has seen its stock rise considerably since the company became substantially profitable at the end of 2001. (Both are Motley Fool Stock Advisor picks.)
Overstock CEO Patrick Byrne bought $2.2 million in stock last month and his father -- former GEICO and White Mountains (NYSE: WTM) chief Jack Byrne -- bought $8 million in stock last week. Knowing that, I'd venture to say that Overstock looks pretty interesting at this point. It's probably worth sifting through some of the controversialissues surrounding the company and its stock.
Stock up on further Foolishness:
Whether you're backing Byrne or supporting the supposed "Sith Lord," join the debate on our Overstock.com discussion board.
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Fool contributor Jeff Hwang owns shares of Overstock.com and eBay. The Fool has a disclosure policy.
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