LIQUIDITY SERVICES INC quarterly report, Q3 FY2011

Business context and reporting period

Liquidity Services, Inc. operates online marketplaces for surplus, salvage and scrap assets. This unaudited Form 10-Q covers the fiscal third quarter and nine months ended June 30, 2011; comparisons are with the corresponding 2010 periods.

For the quarter, GMV was $148.1 million, up 35.9%, and the company completed approximately 115,000 transactions. Registered buyers reached approximately 1.567 million, up 19.2% year over year.

Financial performance and position

Quarterly net loss included a $16.6 million Geneva goodwill impairment. The quarter also included a $4.6 million income tax benefit, primarily associated with the planned UK closure. Nine-month net income was down from $9.5 million in 2010; the financial statements report $5.4 million of income, despite a contradictory MD&A sentence calling it a loss.

At June 30, cash and cash equivalents were $93.5 million and short-term investments were $10.9 million. Current assets were $139.6 million versus current liabilities of $50.8 million. The company had no borrowings under its $30 million credit facility; $25.5 million remained available after letters of credit and a contractual reserve. It reported compliance with facility covenants. Total liabilities were $57.6 million.

Nine-month investing cash flow was $9.2 million, including net sales of short-term investments, $9.0 million of acquisition payments and $4.4 million of capital expenditures. Financing cash flow was $12.0 million, including option-exercise proceeds and $3.5 million of share repurchases.

Material changes versus the prior comparable period

• Quarterly revenue grew 18.3%, while GMV rose 35.9%; management attributed growth to commercial marketplace programs, DoD scrap sales, state and local government activity, and acquisitions.
• Quarterly operating results shifted from $7.0 million of operating income to a $5.6 million loss, principally because of the Geneva impairment. Excluding acquisition costs and impairment, adjusted EBITDA increased to $15.1 million from $10.6 million.
• Nine-month operating income fell to $7.3 million from $19.1 million, and net income declined to $5.4 million from $9.5 million. Acquisition costs and goodwill impairment totaled $21.6 million for the nine months, including the Geneva impairment and a $4.7 million increase in the Network International earn-out estimate.
• Operating cash flow increased to $28.5 million from $24.4 million. Cash and cash equivalents rose to $93.5 million from $43.4 million at September 30, 2010.

Outlook, risks, contingencies and unusual items

• The company initiated closure of its UK operations after sustained losses and low adoption of online inventory sourcing. It expected substantial completion by fiscal year-end 2011, anticipated a remaining-quarter loss of approximately $2–$3 million, and expected UK results to be presented as discontinued operations in its 2011 Form 10-K.
• Management estimated a fiscal 2011 effective tax rate of approximately 26%, down from the prior estimate of 50%, mainly due to the expected UK-closure tax benefit; it estimated a longer-term rate of approximately 44%.
• The June 1, 2011 Truckcenter.com acquisition had approximately $16.0 million of consideration, including $9.0 million paid upfront and a $7.0 million estimated earn-out. The Network International earn-out liability was estimated at $5.0 million. Earn-out fair values depend on management projections and could differ materially from eventual payments.
• Management expected fiscal 2011 capital expenditures of $4.5–$5.0 million and believed available cash, investments and operating resources would cover anticipated needs for at least 12 months.
• The DoD Surplus Contract base term expires in February 2012, with two one-year renewal options exercisable by the agency; the Scrap Contract base term expires in June 2012, with three one-year renewal options. The contracts are significant sources of marketplace revenue.
• A subsidiary litigation matter seeks $2.8 million; the company’s subsidiaries stated they believe they have meritorious defenses and may recover costs from the DLA. The company reported no other pending or threatened claims it believed would have a material adverse effect.
• Management cited forward-looking uncertainties, including marketplace growth, buyer and seller activity, contract renewals, acquisition performance, and the possibility of additional financing needs. The filing reported no material off-balance-sheet arrangements.

Most important facts for investors to verify

• Confirm the $16.6 million Geneva goodwill impairment, the planned UK shutdown timeline and expected remaining-period losses.
• Reconcile the MD&A statement describing a nine-month “loss” with the financial statements’ $5.4 million of net income.
• Track DoD contract renewal decisions and performance, particularly given their contribution to revenue and the 2012 base-term expirations.
• Assess the actual results and final earn-out payments for Network International and Truckcenter.com against the reported $12.0 million combined estimated liability.
• Compare cash generation, capital spending and acquisition-related obligations with management’s liquidity expectations.