Overstock Still Underwhelms

Overstock.com (OSTK - commentary - Cramer's Take) reported another dismal quarter on July 28, and I maintain a cautious stance on the stock despite continued share-price erosion and high levels of short interest.

Investors should continue to avoid shares, which were recently trading below $17, as commentary in its recently filed 10-Q quarterly report confirms things will get worse before they get better.

Overstock's 10-Q, filed Friday, states that the company expects its recent surge in technology spending to continue through the end of 2006. Overstock also noted in the filing that a slowing in top-line growth, coupled with rising legal fees and payroll-related expenses, will drive general and administrative costs as a percentage of revenue higher in 2006 vs. 2005. This is not a productive path to profitability, though some have pointed out that the leverage in the company's business model makes profitability inevitable.

It was hard to see any evidence of that leverage in Overstock's second-quarter results. The company reported second-quarter revenue of $160 million and a net loss per share of 78 cents. This represented anemic 6% year-over-year revenue growth and marked a sixfold decrease in EPS. Revenue fell 11% sequentially from the first quarter, a decline that was 2 percentage points worse than the same period a year earlier. Operating income dropped slightly from first-quarter levels, which was roughly in line with the sequential change in operating income from the year-ago period.

Overstock has made it clear in recent earnings conference calls and analyst presentations that it has abandoned its "grow at any price" strategy to focus on profitability. In order to intentionally slow revenue growth through an even greater decline in operating expenses, the company has set out to cut its advertising budget. In 2005, for instance, ad spending represented 7.9% of total revenue vs. 9.6% in 2004. The company cut its advertising spending to $12.2 million in the second quarter of 2006 from $14.5 million in the year-ago period, or 7.6% of sales vs. 9.6% last year.

There is little evidence in the second-quarter numbers that the company's strategy of paring spending and focusing on profitability is working, save the part about slowing top-line growth. Overstock's net loss hit $15.8 million in the second quarter vs. a $2.6 million loss in the year-ago period. Part of the decline in income stems from reduced interest earnings and the inclusion of stock-based compensation; on an operating basis, the company's loss fell to $15.6 million in the second quarter of 2006 from $6.1 million in the second quarter of 2005.

Spending on technology and general and administrative initiatives grew at a much-quicker clip than revenue in the quarter.

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William Gabrielski is a research analyst at TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Gabrielski welcomes your feedback; click here to send him an email.

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