Bed Bath & Beyond - Earnings Call - Q3 2017

Transcript

Operator (participant)

Good day, ladies and gentlemen, and welcome to the Overstock.com Q3 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. If anyone should require operator assistance during today's conference, please press star then zero on your touch-tone telephone. As a reminder, this conference is being recorded. I would now like to turn the conference over to Robert Hughes, Chief Financial Officer. Sir, you may begin.

Robert Hughes (CFO)

Thank you. Good afternoon and welcome to our earnings call. Joining me today are Dr. Patrick Byrne, Founder and CEO, Saum Noursalehi, President of our retail business, and Seth Moore, Senior Vice President. Let me remind you that the following discussion and our responses to your questions reflect management's views as of today, November 8th, 2017, 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 afternoon and in Form 10-Q we also filed today. Please review the Safe Harbor Statement on Slide 2. During this call, we'll 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 reconciliations of these measures to the most comparable GAAP measures.

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

Patrick Byrne (Founder and CEO)

Thank you, Rob. Thank you for that glorious introduction. Patrick Byrne here. So happy to be speaking to everybody. Today is going to be a different. It's going to be an unusual call in several respects. For one thing, there is a non-negligible possibility that this is our last earnings call together, as you will come to understand. Secondly, there's far more people on this call: 743, about 850 on, as far as we know now. I suspect this has something to do. I know Marc Cohodes, my new friend, Marc Cohodes, talked about us in the Grant's Conference. We've been deluged with emails, and we've been informed that there are going to be hundreds of people who are really new to this story on today. So that's another reason it's going to be different.

But it's because we're going to be providing maybe a different angle on. We're providing an explanation of the overall structure of our business that will help people. I used to be an equity analyst, and I've structured today's call to be extremely fulsome, lots of information, and to help newcomers to this story sort of think about how to value a disparate collection of assets. So here's the short version in a few slides. Here's our GAAP operating income. As far as I'm concerned, of our retail business, 1%, been 1% for years, had to dip in 2011. Even before that, we were operating 0.5% down or something. That's about as rare as a leprechaun to see that. I'm happy that Amazon has got to the 1% range. There's Wayfair losing 5%, 10%, 12% a year.

People, I think, haven't often remarked on this fact of how rare this is. On the next slide, you see the capital that we have raised compared to our competitors. That's what it looks like. We have raised $200-odd million in capital, and by the same calculation which Rob can explain, we're up against people who have raised so much more than we have, have had so much more capital burn through it. I think our losses to date after 18 years are $160 million. I'm embarrassed about that. I can look back and see where there were $80 million-$100 million of mistakes. I also look at we're up against folks who spill that before their morning coffee. Yet, on this rather de minimis amount of capital compared to everyone else, we've built this $2 billion business with this earnings history.

I don't think that we've often gotten the, that's been noted as much as it might have been. It's a result of really one thing, and that is technology. And if I'm talking about technology, I'm sitting here next to Saum Noursalehi, who's really been responsible for what's happened here. The explanation is this: when we started off, we were proud of saying we're not a tech company. We're a lemonade stand with a computer in it, is what I used to say. That's because we couldn't really afford anything more. And that worked for six or seven years. We had this nice little niche in being a jobber, an online jobber, and doing jobbing and closeouts and bankruptcies and such. That only took us so far. Up until or through that period, we really did do a lot of integration of third parties.

But what happened about 11 years ago, we started building our own technology internally in area after area and refining it until it got better than any commercially available product, and then cutting away. And we've really done that across our whole site. And that is why we've been able to go so far on so little capital. Lest you think that I'm just flattering myself here and Saum, let me give you some examples. These are the kind of technology awards we've won over and over: Best of the Web, Fastest Retail Site on the Web. Our apps for Android and Apple iOS have for five years been winning almost, well, quite consistently. Sometimes first, sometimes second. First in one year iOS, second on Android, or vice versa. But our retail app is the best there is out there over and over.

Our recommendation engines, all these things that we used to integrate and have third parties provide, we got, starting really 11 years ago, thanks to the man on my right, the ability to do better internally and build this technology. Saum, why don't you talk a bit about this?

Saum Noursalehi (President of Retail Business)

Sure, Patrick. Thank you. Yeah, I really see our core competency as technology and product development. And as Patrick mentioned, we test against the best out there, the best third parties, and consistently we win on things like search recommendations or our marketing technology. So I really think we're the best in the industry in those technologies. But we're always open to test new third parties, and we try them. And when we notice that we're training the third party on how to build their product, that's usually a good indicator of taking that in-house.

Patrick Byrne (Founder and CEO)

I would also say Saum has been a fantastic partner in that we shared this vision of how to make the company should be a team of teams. Saum is very familiar from Agile development with that approach. He not only remade our whole technology department that way, has made our whole management structure agile. Going on. Again, this isn't just us saying it. McKinsey ran a study, some, it's about four years ago, looking at a very scientific study. It was actually about all this stuff about usability, lots of measurements and such. They came out saying Amazon had the best website in the industry for ease of use, intelligence, and all that kind of stuff all mixed into one. We were second. What I've learned is, I'll continue a little bit. Besides just the straight technology, our customer care. We've won all kinds of awards.

For years, the National Retail Federation surveyed 10,000 households and said, "Who blows you away with customer service?" We're always first, second, third, or fourth. Us, Zappos, L.L.Bean, or Amazon. I'm very proud that we were named as America's one of the top 100 most trustworthy companies a few years ago. Just an award we won last night, have not even announced in our own company, is we've been named Loyalty360, which is a prestigious customer service association, the number one in excellence in customer care, operational excellence. So we've had. I mean, our guys, I feel like they've never really gotten the attention. We know how a lot of folks on Wall Street haven't been following us for 10 years and have missed how they have built this incredible technology company. Very lean. These are numbers of the revenue per data scientist.

You can do the same comparison with all of our competitors. We are so lean and efficient. Very high-end developers, very high-end technologists. I made a mistake early in the company's history of sort of trying to save money. What we learned over time is you're just better off. I think Bill Gates said, "One great developer is worth a thousand good ones." We took that approach. We have a smaller number of very high-end developers. That leads me back to this slide. This is what we have: a business that, on a dollop of capital compared to everybody else - and most of the people, you see how much capital they raised, and they blew through all of it. Most of those names there are many of those names. They blew through everything and are gone.

In our case, we raised smaller than any of these names, and we're still in business. I'm sorry that we lost $160 million of your money building this $2 billion business, but I actually feel really - I look back. Before we move on to now looking at the future, I just say I want to look back over these - what is it? - 15 years we've been public now, and I'm quite proud of that record. This is really quite telling to anybody who's got some financial sophistication. I think this should be a business school case. The guys with this tiny amount of capital came out head-to-head, and we have fought Amazon for 18 years to a standstill. They're the only other guys that I know of who even got to profitability, and everyone else had 3x, 4x, 5x, 10x, 20x, 100x as much capital.

So with that said, I attribute that, I wanted to say, to the value approach we take that I learned, value approach to investing, and also the, and we bring to running this company. We own the whole thing, and we're not goosing anything, but really, technology. Technology has been the big secret. However, it is time to face facts, and the facts are, just from a strategic point of view, we are up against people, and it's always going to be like this, well, I thought by now we'd be making 4%-5% net income, operating income, and the truth is you can't. I mean, we get to 1%, and we can hold it there, but we have faced off this endless stream of competitors who come in, and they blow hundreds and hundreds of millions of dollars. We lost $160 million, we burned $160 million in capital in our history.

Wayfair burned half that last three months. We just have to face the fact that we've had this, well, I think Stalin said that sometimes quantity is its own kind of quality. We can have the smartest machine learning, the smartest AI, the smartest scientists. When we're up against people who are spending four or five times what we're spending in online marketing, running seven times as many commercials, there's one thing that Wayfair is bidding on now that we've been paying $0.07 for. They've bid up to $2. It's just folks, and there's just going to be other people behind them. And I don't see how you can build a better, that we can get to a 4%-5% operating margin business when there's just going to be one after another of these folks get going and no reason to think it's going to stop.

So with that said, before I go on, should I, let me take a breath. Saum, do you want to add anything to that?

Saum Noursalehi (President of Retail Business)

No.

Patrick Byrne (Founder and CEO)

Seth? Seth, you've got something smart to say. You always do.

Seth Moore (SVP)

Yeah. So we think there's a lot of promise in the business. But like Patrick said, as we continue to see pressure in the digital marketing space, not from a single competitor but from multiple VC-backed competitors, everything in digital marketing is an auction. And so as that pushes the auction prices up, there's an inevitable contraction until our competitors run out of runway. And if VCs keep stepping in with new startups behind that, it just keeps compressing even as old competitors flame out, which several on that list of competitors have flamed out, and their history is well known.

Patrick Byrne (Founder and CEO)

Yep. Many of them. Okay. So that's kind of the strategic overview and look at the past. Now let's look at the future. What we are doing, people are writing me saying, "What the heck are you guys even making?" Oh, I see we're up to 1,000 people on the line. This is quite, I'm used to about four. Not 400, four. Okay. This is what we are doing. We are building a tech stack for civilization between Overstock and Medici. And let me show you what that Medici is, of course, our venture capital arm focusing on blockchain. Let me show you what I mean. And I'm going to, since this is such a smorgasbord of assets, I'm hoping that if you bear with me for this 20-25 minutes, it will save you hours of trying to understand what we have inside OSDK.

First, so a tech stack for civilization begins, I think, with money. You need money. You need capital and a capital market, identity and voting, and commerce. Everything we are building fits in this structure. So for example, on money, there's a slight lag. Okay. Blockchain meets money. We have a wonderful investment in a Barbados company called Bitt. Bitt is the leading company in the idea of digitizing fiat currency for central banks, creating digital wallets for citizens, for people, essentially a frictionless payment system, including remittances, which incidentally are a $500 billion industry globally. Remittances alone on which the VIG is about 15%. So $75 billion is being taken out of the world's poor. And if a guy's driving a cab in Brooklyn and sending their income home to Azerbaijan, 15% of what they send is taken out in friction costs. We can essentially eliminate that. Financial inclusion.

This is a huge issue. For 30 years, economists have been talking about the problem of the unbanked, banking the unbanked. 85% of the world doesn't have a bank account. It isn't even tied into the modern world as we know it. That can all be accomplished without actually them having to go and build the banking, copying the West and building the banking systems we built through these digital wallets on your cell phone. We own 11% but with options up to 35% of Bitt. This is a, it's based in Barbados, and it is earliest possible soft launch. I've learned to think in those terms. If everything goes right, you will see in December a, we will do a soft launch. It's dependent, of course, on a central bank letting us digitize their currency, having us digitize their currency. We're in discussions with a number of them.

If it all goes as well as it can go, you could see this happen in mid-December. Soft launch of the world's first digital currency. The opportunities for this, the global ramifications for the poor, for financial inclusion, for changing economies are just mind-boggling. Next, blockchain in blockchain meets money. We have some other investments. Ripio, which is another digital wallet, payments, credit lending. It's based in Latin America. It's live. They have a product in the market. Medici under Jonathan Johnson, who runs Medici, has made this investment 2.25%. There's also Spera, which we are very excited about. Spera is a payments and invoicing system run by a fellow who has built successful payments and invoice payments companies. Very interesting fellow. He's building this on the blockchain. This may have a real kind of crossroads position emerge between a couple worlds. Seems to be quite far along.

We own 18%. And then PeerNova. PeerNova is out in Silicon Valley. It's a banking compliance, basically back office system for banks. We own 12%. We did take a big write-down here. They are in discussions with someone that a contract that would buy them, say, 18 months or two years of—I mean, they're well in discussions with one of the big banks in New York. Don't know if they're going to get the deal or not. It's actually a great product. I've actually been surprised. PeerNova, I would say two or three years ago, was technically maybe the best we could find. I'm surprised they have not gotten more traction. Okay. Next, we move to capital. Blockchain meets capital formation is the next area that I wanted to have us have strategic investments. We do have an investment in Factom.

It's now doing mortgage loan compliance and digital asset verification. We own just 2.5%. I will alert you that there may be another investment coming here, but I won't say anything more about it. Capital markets. Now this, of course, capital markets is tZERO. And I know a lot of people are on because they've heard about us because of tZERO. Blockchain meets capital markets. The advantage of it is instant trade clearance and settlement. We have an SEC-compliant exchange for ICOs. I believe it's the only one in the world, the only exchange in the world, or an ATS that is technically, technologically blockchain and SEC-compliant. And who would have thought my old nemeses at the SEC would be so cooperative? I have to say I kind of want to take back a lot of things. I was talking about a different SEC 10 years ago.

The SEC has actually been very far-sighted and professional. And we have the only—they let us get this through the only SEC-compliant venue in the world where you can trade blockchain. We have these things called Digital Locate Receipts. I'll be talking about at length. Our ownership is 81% in tZERO. Medici's ownership is 81%. And Overstock owns 100% of Medici. So here I'm just going to—oh, Symbiont as well. Symbiont is a company we have. It's smart contracts for digital securities. It's another blockchain meets capital markets company. They have a deal going in Delaware where they're digitizing corporate ownership. Basically, I think the two leading companies in blockchain meets capital markets are tZERO and Symbiont. I think those are the two companies to watch. We own 81% of one and only 1% of the other.

Run by Mark Smith and Caitlin Long, who's quite a philosopher of this stuff. You see her name more and more in the press. She knows what's going on in this space. Next, Digital Locate Receipt platform. I'm going to talk about this at length. I glossed through it in the last conference call and explained roughly what we were doing. But it has over the 13 weeks since then, the monster has gone from twitching his fingers and twitching his toes to standing up and walking. As of five days ago, I would say walking. As of today, actually really moving, really running. Wait till you see the numbers. As of today. Here I have to just, without harking back to any old bad memories for anyone, as people know, we were in this horrible fight with Wall Street some years ago.

It was really classy. I want to thank this guy, Marc Cohodes. He spoke at Grant's conference sometime a month or two ago in front of thousands of people. He said a lot of really nice things about us. And given what enemies we once were, that showed a lot of class. I should point out our lawsuits discovered this guy, Marc, had done nothing wrong. He inherited a problem. A guy named David Rocker had been running the hedge fund. David Rocker started a fight. And when he was gone, Marc inherited. And he was actually quite professional with me. I look back. We probably should have shaken hands four years earlier and settled and gotten out. But he got in touch with us, me. And we've actually developed a distant friendship through the years.

And he came to start seeing us this summer, I think, because he was short Wayfair and started looking at our numbers and figuring out how efficient our retail business is and realizing we don't get credit for it. But all that said, thank you very much, Marc, for the kind words you said about us. Now, as a function, what that fight was about with his boss and stuff 10, 12 years ago doesn't matter. I do want to mention one thing I've never disclosed publicly. I brushed off a bunch of bad things that were said about me. Things were started to get said about a guy named Gordon Macklin, a 79-year-old man on our board of directors. What the world didn't know is Macklin had lived down the street from me when I was 13.

He used to drive me to school, and we were friends. I took like four or five bad reports about me. When the reports came out, when I started Overstock, out of respect to this old man, I'm invited on the board. When people started slagging him is when I got in that fight with Rocker. Then that all turned into this big thing. The point of all this, for you who are trying to understand the value of our company today, is in the process of all those fights, we got a piece of paper. We learned something. I'm going to show you a piece of paper that cost you, the shareholders, $20 million to see. That's how much it cost for us to get this piece of paper. This comes. Sometimes it's slow, I'm told. Okay. This is. I can legally show this.

This came out of that lawsuit. This is from Goldman Sachs. How much of Goldman Sachs' prime brokerage actually comes from this thing called securities lending? The answer turns out to be 75% of American prime brokerage revenue. Not 75%. I thought it was 5% or 10%. But it turns out it's 75%, which is why when I started getting in a fight with David Rocker about this thing called naked short selling, the whole world fell on me. It's because it turns out I was talking about 75% of the revenue of Goldman Sachs. So this is why it's so profitable. And let me point out this is the revenue, not the profits, because the profits of the securities lending desk are relatively, I mean, the expenses are relatively tiny. So I suspect it may be 100% of the profits at Goldman Sachs. This is what's going on.

This is securities lending, how it's supposed to work. A pension fund has some stock that custodian with a prime broker. The prime broker finds a short seller who will pay $20 for a locate, gives them the locate, takes the $20. That's how it's supposed to work. But how it really works is things like this. There's very little to keep the prime broker when he sees that there's a short seller willing to pay $20 for that locate. Nothing to keep him from telling other prime brokers, oh, I mean, other short sellers, oh, I'll give you a locate too. I'll give you a locate too. And we have all kinds of data.

I mean, it all turned out this was all - we have all kinds of data that even when the government, the SEC, we have a - where they went in and tried to do audits on this stuff in like 2007 and 2008, they were telling Goldman, "We do these audits." Well, they were telling the industry, "We do these audits on your locate trails, and you're supposed to record who's stock you're lending." Your guys are running things like Mickey Mouse and Daffy Duck and stuff. And that's why they overlent much more stock than they had, which is why a couple other things happened.

One is one of the reasons, and this has been sort of forgotten from history if this slide comes up, that when Alan Greenspan, when the world was collapsing in October 2008 and Greenspan came out of retirement and talked to Congress, he identified it partially as a settlement crisis, well, that settlement crisis came about because of that overlocating and the sloppiness, just the slop in that whole locate system. In addition, it has led to, I believe, the pension crisis. There's a recent actuarial report that what the pensions have been doing is assuming a 7.5% return on actuarial assumption, and they've been earning a 4.5% for years. And that difference of 3% is what's bankrupting them, well, a group of pension funds have just sued the prime brokerage industry over collusion in the securities lending market.

What they're suing is to recover that 3% out of which they have been deprived. Well, we have a, I mean, I think this could become the first trillion-dollar lawsuit in American history. It's a class action suit. I think you'll see. And by the way, I had nothing to do with this suit. As soon as it was filed, I found out that people were trying to, private detectives were figuring out if I was behind this. I'll save you guys the money. No, I had nothing to do with this suit. However, I do now believe that there'll be other pension funds joining us. So at the heart of all this is that issue I was talking about. And it all goes to the securities lending desk, which is also responsible for 75% of the revenue. So the answer to that has, tZERO has the answer to this.

And in tZERO's system, the role of those six prime brokers is significantly reduced. We have this system where we have a SEC-compliant venue that can trade blockchain. We run. We're taking the stock, running an overnight auction, generating a locate, but it's not even a locate. It's better than a locate. It's a pre-borrow. We call it a DLR, Digital Locate Receipt. We believe that because we're taking an opaque over-the-counter market onto an exchange, you'll see price discovery work much better. So let's say the short seller is going to get it for, pay $10 instead of $20. That $10 goes in, and $8 goes to the pension fund, and we keep two. Doing God's work. And what we're basically doing is we have found a pipe. We've found through this crazy lawsuit that you shareholders indulged all these years.

We found the pipe that was really the pipe of 75% of the revenue of Goldman Sachs' prime brokerage in the United States, and what we have invented is a thing that can basically replumb this piping and have it go back to the pension funds, thereby lessening the pension fund crisis, and we make a couple shekels in the process. Since I spoke with you last, this is really moving, and I mean in the last five days, is finally you could basically say the wheels are off the ground in the last five days. On the supply side, starting five days ago and now as of today on a fixed basis, we have $80 billion-$120 billion of lendable securities. We do the math.

The math on what we think we can make off lending these securities while providing fair service to both sides as opposed to the current system is, I hate to tell you how much, but we'll see. Time will tell. We have another, somebody just offered us another $6 billion in hard-to-borrow, specifically hard-to-borrows, and so on and so forth. We have 2,000 traders as of last Wednesday. Actually, the integration was only signed off on yesterday. You have 2,000 traders, active traders on systems that can use it. Another 3,000 come on within another week. Really, what's more important is that we have. I mean, who knows how much they're going to actually, how much demand they can absorb. We are in the process of rollout with 12 brokers. Some of these brokers may have 1,000 clients, say three admins.

And so what these brokers are doing today, and I mean today, literally November 8th, they're saying, "Okay, we've got 1,000 people. I'll let 50 of you use this. Let's see how it goes. Next week or two weeks, if it works, we'll go to 200 people." So we have these kinds of rollouts. Today is kind of a big magic day for this platform. It's the first time we're really considering it. I mean, it's not loaded up with $800 million or $3 billion. It's got, well, each day for the last five days, $80 billion-$120 billion of securities to lend, including lots of hard-to-borrow, thousands of tickers, lots of hard-to-borrow, billions of hard-to-borrows in there. So for further information, just visit these addresses. So if it isn't, I have to take a moment. I just have to take a moment.

There's a certain irony here of anyone who has followed this story of me, of all people, coming back with this. But we basically have found, well, as I say, the pipe. I mean, I almost can't say this without laughing. The pipe that is 75% of Goldman Sachs' prime brokerage revenue. We have a better solution. It's based in the blockchain. No SEC audits and finding Daffy Duck and Mickey Mouse. Everything's one-to-one, rigid, blockchain, immutable, secure, transparent to regulators. It's such a brilliant. I mean, it's such an invention. And the idea that we have this. Basically, in short, I'm telling you, we have an invention. We're going after 75% of Goldman's revenue. We're going after directly after. And the market has learned all about this. They really have. We are hearing from so many clients of prime brokers. I love this. I was just in New York.

You can't believe the people who are reaching out to me. I'm thinking of these prime brokers. I'm reminded of who was it? Oscar Wilde said of George Bernard Shaw that Shaw doesn't have any enemies, but he's intensely disliked by his friends. Well, these prime brokers may not have any enemies because everyone's afraid of them. And we already know that they're trying to do something about this. We're already hearing that they're threatening people about who want to use the system. They don't have any enemies, but they're intensely disliked by their clients. And now that we have $100 billion on the supply side, who knows if this gets off the ground or if the whole industry collapses into our laps like a thunderclap? I don't know. But you now know everything I know. So now you really do.

I mean, that's information current as of a few hours ago, the last update. So this is really just in the last five days, really sort of on the track. Okay. Next, the other thing that they have at tZERO that's so powerful, that is getting a lot of attention this quarter, is a venue for trading ICOs. And it comes about from this. Around the last time I spoke to you, the SEC came out with a ruling regarding the DAO. And it basically moved the line in the understanding of what's a security and what isn't. Although one could also say a lot of people had been issuing ICOs, kind of dancing around the edges of things. Anyway, they clarified in this July 25th decision.

And because of that report, anything that is a security, any token that is a security has to trade on an SEC-compliant register or exchange that can trade this stuff. Well, like I say, when it comes to having an SEC-compliant ATS geared to trade blockchain, there's precisely one of those in the world, as far as I know. And we own it. I'm not gloating. It's the humor of this, after all these years, it just seems too funny to me, too funny to believe. But here we are. So the solution is an approved ATS, trade blockchain instruments, as I say, is SEC-compliant. Just because it gets a little confusing for newcomers to this field to explain, to understand what's going on, think of the taxonomy as in our world, people who are working in blockchain are thinking of things this way.

There's fiat currency, stuff that some government makes up by fiat, like a dollar. There's cryptocurrencies such as Bitcoin and Ethereum. Then there are these tokens, these ICOs that have been getting issued like mad this year. And there are utility tokens and security tokens. Everything I was just talking about are security tokens. They have to trade on a, again, SEC-compliant venue that handles blockchain. But there's a whole universe of these other utility tokens that have been issued that are not going to be considered securities. I think that going forward, the blend is going to go from probably 90%-10% to 10%-90%. It's probably been 90%-10% utility versus security, or maybe even more extreme. And it's going to go the other way now or in the other direction.

Those utility tokens, those that have been issued and that are still issued, still could use an exchange to trade on. And we can use our ATS to do that. I mean, technically, technologically, it can do it. Here's the problem. And this is an example of how you'll notice there are some things sliding here and there, dates and stuff. This is a very active, I mean, this space is developing very quickly. And here's an example. We don't have regulatory clarity. Can we take our SEC-compliant ATS, trade securities on it, blockchain securities on it, and also trade these other utility tokens? One could say, "Why not?" But the SEC might say, "Hey, don't bring that unregulated garbage onto a regulated exchange." For that reason, we're probably taking the safe strategy of, and we'd love regulatory clarity from the SEC on this. Oddly enough, we don't have it.

And it might take a year or something to get that. Well, we can create a mirror of our ATS that will trade those utility tokens, and it will be distinct from all the other ones in the world. Why? Because we're in negotiations with a nation-state who are saying, "Put it in our country, and we will embrace it, and we will say now there's a government looking out for this and making sure it's honest and stuff." So it's not no Malcolm X kind of thing. And it's a legitimate, it's a great country. It's a country with a very respectable legal system and such. And they have made that offer. And there's another offer. There's another conversation that has started, or another contact has been made for exactly the same thing today.

So we can take this technology we have and not only trade the security tokens in an SEC-overseen ATS in the United States, but we can put the technology in the hands of another nation, and they will have the only utility token exchange in the world that is being regulated by a government and overseen by a government. So now the thing is, each of these projects are only like one or two months or a couple of months' work, but they're, and in particular, security tokens, I think you'll see us. We're aiming for January, having listings and such. But each of these. We have so many things going on, each of which look like one or two months, but collectively, they don't look like one or two months. Would you say, "Saum?" Saum has to do so. Okay. Okay. Identity and voting. Blockchain meets identity and voting.

We have investments in IdentityMind, digital identity and compliance, risk management, and we own 5%. I think that was just recently named one of the hottest 50 companies in Silicon Valley or something. We also have SettleMint. I'm especially proud of SettleMint. We made an angel investment. It does secure and auditable voting, document authentication. It also started its ICO this September for Internet of Things, a really interesting idea, what they've built there. Very classy guys from Belgium and Canada. We own 33%. And this is one of the leading companies in Europe on blockchain. They have some—okay. So moving on. That's Medici Ventures. Jonathan Johnson runs this. Steve Hopkins, he's president. Steve Hopkins, general counsel.

They've had this for a year and have done a marvelous job of taking what may have started off with me dashing around the world and throwing term papers and checks at a few different young entrepreneurs and saying, "We should build this and that," to they've turned this into a real enterprise and very well managed. And they're bringing not only a lot of value from Medici Ventures to these portfolio companies, but we've had a couple of symposia here at Peace Coliseum in Utah. And the benefit people are getting. Ambassadors come from each of these companies. And the benefit they're getting by sort of all getting to know each other and such is validating the model. We thought we could really bring something to this space. We set out three years ago. We've been hearing people gripe about it for three years.

I'm very happy that the world has kind of caught up with this idea that blockchain is here to stay, so now we go to the top layer, commerce. Of course, that is Overstock.com. At this point, may I borrow a bottle of water, please? Thanks. Overstock.com. Before we go on, do you want to say anything, Seth or Saum?

Saum Noursalehi (President of Retail Business)

On retail? Well, let's go to the slide, and then we can kind of.

Patrick Byrne (Founder and CEO)

Okay. The overall results, the $1.1 million retail net income is nice. We missed by $786,000 on the bottom line. That doesn't mean much together. Let's go to retail results only. What's going on here is our gross margin is getting significantly better, but the contribution dollars, which is to say gross profit minus marketing costs, is getting worse, and that's because this digital landscape has just been distorted beyond belief.

I mean, we have to take it as a given now. I can't just complain about it. We have to take it as a given that this may be permanent. But there are people who just don't mind losing $200 million a year in exactly the same business. It's kind of hard to run a lemonade stand when there's a guy next to you with his own lemonade stand, and he loses $200 million a year and doesn't seem to care. So I'll move forward. But I'm sorry.

Saum Noursalehi (President of Retail Business)

Oh, I was just going to comment. Yeah, revenue and contribution is down, but nice to see gross margins getting better. And primarily, that's attributed to improvements to our supply chain operations, which are getting really tight, as well as really smart algorithms in our pricing that are really starting to pay off. And so the technology behind that really helping, as well as a shift in our mix in our category to more profitable areas.

Seth Moore (SVP)

The really remarkable thing is that in most companies, when you see a stair step in gross margin like we've had the last couple of quarters, there's usually a bunch of price increases behind it. And the beautiful thing about this is that we have actually decreased prices over the same period of time, even while increasing our gross margins because we've generated such a surplus out of our supply chain.

Patrick Byrne (Founder and CEO)

Yeah. It's amazing. There's a metaphor they use in Japanese manufacturing where you've got a reservoir and you're draining the water out. And after a while, some rocks emerge out of the water as you drain it. And you stop the draining, and you go and you blow up the rocks.

And then you drain some more water. There's no bottom to it. Well, these guys have institutionalized this process where every year they're scraping dozens of basis points out here and there and in returns logistics and now inbound logistics. Although we do think we think we've had a sort of conceptual breakthrough this quarter, Seth and team and Carol and Vidya. And we do see ways where we could drop another 100 basis points, oh, more than 100 basis points out. Anyway, it's a continuous process. You never drain it to the bottom. You just drain it till you find another rock you can study and figure out how to blow up. Club O. I'm so glad I'm finally seeing this. Paid memberships up 30%, and it's accelerating. Our Club O was written up in Consumer Reports or somebody. Who was it?

It was like the most. Seth or Saum, do you remember that?

Saum Noursalehi (President of Retail Business)

I don't remember who it was, but yeah. It's one of the top three loyalty programs out there.

Patrick Byrne (Founder and CEO)

Yeah. It was us, Amazon Prime, and I forget who the third was. So these are the three worth joining. And it's finally catching on, and we've finally figured out how to market it. I should mention that these improvements. So I'm going to be showing you some improvements and then the big problem. It's a case of, well, these improvements are being driven by the kinds of things I was just talking about in supply chain, but also a lot of machine learning, AI, big data kind of work. And we're really attracting people from the coast, people with PhDs and machine learning kind of folks. I mean, well, like I was talking about our technologists earlier.

Anyway, Club O is doing fabulously. We think in 2018, we're going to introduce a new level for more money that has a very interesting set of benefits for joining and different. Go ahead, Saum.

Saum Noursalehi (President of Retail Business)

Oh, I would just add, yeah. So we're going to introduce a new tier. But the reason this is so powerful, it's a lot like what I hear about Prime, which is the lifetime value of customers that join this program significantly increased. And so the more we can get that to grow, the more it's going to pay off long-term.

Seth Moore (SVP)

And the really remarkable thing is that in the home goods industry, there's sort of two types of really valuable customers. There's the decorations, those people who decorate for fun. And then there's the on a mission customers, people who just moved or had a baby or had their in-laws moved in.

They have to wipe out their furnishings and start over. Club O catches them at the start of that cycle. And once they're in, they keep boomeranging back to spend the rewards. But as they do, they accrue more rewards. And so we end up capturing the entire wallet cycle on these customers. That's just immensely valuable. And so this hook and this rise is letting us capture more of the wallet share of those most valuable of home customers.

Patrick Byrne (Founder and CEO)

And it's taken, I would say, five years, probably a few years longer than it should have, but to both know how to promote this, but really fine-tune the offering and fine-tune. We give 5% back on every product, but that's really just a minimum. There's some we're giving 20% or 25%. We have found this is a wonderful way to clear inventory.

I mean, it just took some fine-tuning and data scientists and such to study it. But really, this category is strong. And as you'll be seeing, it's now over 25% of our revenue. So okay, moving on. Last quarter, Saum, I remember you brought up that email was challenged because we were in a migration. Yeah.

Saum Noursalehi (President of Retail Business)

That's right. We were in a big platform migration, as I brought up a quarter ago. This channel has really rebounded. We're starting to spin out campaigns faster than we ever have. And we're building a lot of personalization. I think over the next quarter or two, you'll really see payoffs. But it's already doubled in growth, and it's nice to see.

Patrick Byrne (Founder and CEO)

Yeah. And again, this has been. There's been all these different approaches to doing digital marketing.

And if it's, I don't know, recommendations was collaborative filtering, and then there was this Bayesian holy grail and this and that. There's been all these different statistical modeling approaches. But machine learning, and I'd say there's probably been, say, five generations of approaches in the 18 years. And some of them, we were the first people in the new approach. I think that I brought kind of Wall Street arbitrage techniques to digital marketing when people were just not even, it was amazing the spreads that used to exist 15 years ago. But we've gone through different iterations, and some we caught the wave and a couple of waves we missed. The new wave is machine learning. The newer wave, it's here, say, a few years. Seth, why don't you take it for a minute and explain why our machine learning has become so powerful?

Seth Moore (SVP)

Yeah. So one of the beauties of machine learning is that it lets you move on and understand, well, it lets you act on faint data signals that are so complicated that humans can't understand them. And so much of what happens in retail lives in that world of too many interaction effects to be understood. And that's the beauty of neural networks, is that you don't actually have to understand the causal variables. Now, a lot of companies will never get there because they don't reach the trust level to say, "Let the machine make a decision." We all say, so many of the companies out there, especially in the brick-and-mortar world, say, "Give my buyer a report and then let my buyer make a decision." And if that human layer sits in between those faint data signals that can't be understood by humans, never get acted on.

And so the fact that we've been digital from the ground up and the machines make the decisions in the company means we're culturally able to leverage machine learning in a way other companies are too distrustful to do.

Patrick Byrne (Founder and CEO)

And I have to mention, we are—so when I talk, I'm regularly in Silicon Valley with some of the biggest firms, whose names you can imagine out there. And they work with all kinds of e-commerce companies like ours. And they've gone from telling me, "I think there may have been a point where we slipped so we were only in the top 15th or 20th companies in terms of our sophistication some years ago." I'm comfortable now we're in the top three.

And I regularly get told, "Hey, look, there's you guys doing this and there's Amazon." And sometimes we're now being told, "Amazon hasn't even gotten to this thing yet that you're doing." We have these, and it's not just Silicon Valley. It's kind of a small community. And we know we hear what people are working on. I feel that good about our technology. Another example of that is all that same stuff applies for all the other large channels, paid digital marketing channels. Mutatis mutandis, all those same things go. We have gotten past, it used to be we were competing with the sophistication of our models. We're now competing with the sophistication of our machine intelligence, our machine learning, and AI.

In fact, it's been disruptive within the company, but it's great because it's freeing up really, really smart people and analytics that we are then shifting to be what we are finding is this great model. These super quantitative people end up often being the people who can run channels. It isn't knowing necessarily a whole lot about the purses or something. I'm just saying that and not talking about an individual, but it's someone who can just look at data.

For years, in the early days, I used to say, "My dream someday would be that decisions were not getting made about what got put in an email by lobbying, but just by some person who didn't even understand English and couldn't understand any lobbying." And any question like, "What should go in the upper left-hand corner of an email?" would be something you could look up in some table. Well, we have finally found that person. And it's an artificial person. And he doesn't speak English. It's a neural network. And that's exactly what we dreamed of so many years ago. Saum?

Saum Noursalehi (President of Retail Business)

Yeah. I'll just comment. So 32% year-over-year growth in these digital channels. And we also spoke, Patrick, about our big investments in marketing tech, our in-house marketing tech. And that's really starting to pay off. So you can see that in these results.

And I'd also add that we're often featured with a lot of the top partners that we work with, with Google, for example, on showcase ads, PLAs for our campaign structure, Facebook for the tests we do with incrementality. So we're really cutting edge on the digital side.

Patrick Byrne (Founder and CEO)

Really, our marketing tech, that's what I'm saying. When I get so much feedback from the field, not about me, I don't know what end of this plugs into a toaster, but about our engineers that other engineers work with and the things that the frontiers that we are actually breaking through, I really am comfortable saying I know we're in the top three in the industry in terms of the sophistication of our marketing tech. And again, that all shows up. That's why we have a company that has raised a fraction of what everyone else raises in our field.

We got to profitability and were able to defend it for seven years against this craziness going on. Now we get to this, a case of, "Other than that, Mrs. Lincoln, how did you like the play?" Here's, in one picture, what's going wrong. SEO since May has been a real problem for us. The graph on your left is Google organic rankings. We are the red line. Amazon is the yellow. Walmart's the blue, and Target is the gray. So we've always, I thought, been very strong on, and we pay a lot of attention to Google and what they say they want sites to do. And then we do what they say is they want people basically. They favor sites that have good information and all kinds of stuff. So we did that. It's been very strong.

This is the first time in years we've had a cycle like this that we've not. It's plateaued now. But in a nutshell, even though everything else, all these other systems are just running as I've dreamed of for years, we have this problem, and it's especially perplexing because Google is about site experience. And on your right is a, and their algorithms are supposed to favor. And I'm not alleging at all anything like Google's doing anything inappropriate. I'm explaining why this is a conundrum to us. It has been a conundrum since May. Our site experience per, say, Bizrate or all these other things that measure it is better than our whole field in the home furnishing category. We're better than them. So you would think that the Google algorithm, if anything, would favor us. But something happened in May. Now, they believe nothing happened in May.

It's been quite an interesting. We've all been kind of puzzled. Well, I'll stop there now. Saum, Seth, you're the masters.

Saum Noursalehi (President of Retail Business)

Yeah. I would just add, so yeah, Bizrate did this survey comparing us to the top 17 home furnishing competitors, and you could see we rank better than them. But you also saw that in the earlier slide that Patrick showed, which was on the McKinsey slide that also reaffirms our ease of use of our website. But our strategy is to just continue to focus on building the best user experience in our space, and we think that's going to be reflected in the Google rankings. Seth?

Seth Moore (SVP)

Yeah. And I would add to that, part of the reason when we discuss the decline in contribution percentage, it's a double whammy of the two variables we just talked about.

It's actually a story of both the health of the paid channels, which have a positive contribution rate but a lower one, and of the decline in SEO, which is a virtually free channel and has very, very high contribution rates. And so that shift in mix is what's accountable for the change in contribution margin. But masked within that is the fact that we have a very healthy paid digital business that's growing nicely and offsetting in terms of revenue much of the loss in this one free channel.

Patrick Byrne (Founder and CEO)

Yes. So I would say that, Seth, just summarize it perfectly. Here, let's say, oh, sorry. We do have, you should know that since May, we've done about probably two years of normal projects of SEO and have without really, well, you never know what would have happened if we hadn't responded, but we've done about 60 projects.

Now we are working on the mother of all projects. We're working on, go ahead, Saum.

Saum Noursalehi (President of Retail Business)

Oh, I was going to say, and my SEO really, and if you've been reading how Google's algorithms work, what that really means is customer experience and the experience on the site. So it's been all focused on the page speed, our mobile experience, and how to optimize conversions.

Patrick Byrne (Founder and CEO)

Yeah. What's that? Google has this new technology called AMP, Accelerated Mobile Pages. I believe we're the first to have implemented it. Check it out.

Saum Noursalehi (President of Retail Business)

It's a widely, I think across the board, we've launched it, and we were featured by them.

Patrick Byrne (Founder and CEO)

Check out our mobile, how the speed on our, it's kind of weird because the pages load in about a quarter of a second, and it just seems kind of strange.

Anyway, so we've had this great relationship with Google, and this is not about cheating Google spiders or something. This is about having the best customer experience. They want faster pages. They want better pictures. Their AI can now read whether a picture is good or not. And so you have to have better and better pictures. And so it drives good behavior out of websites like ours. But this one has been a real conundrum. We've done 60 projects in five months. We are now working on the mother of all projects. It deals with site experience. Unfortunately, it's not going to be able to roll until about December 15th to 30th or somewhere in the last couple of weeks of the year. So anyway, that's other than that, Mrs. Lincoln, how did you like the play? I've never been so proud of all these other departments.

It's like we have finally reached this nirvana state that I dreamed of over a decade ago in terms of our marketing technology, our sophistication, our mathematicians, and so forth. Wayfair comparison, I just have to point out, even with that, even with that one terrible slide I just showed you, we're significantly, our customer acquisition cost is far below theirs. And that's a function of how brilliant all our other marketing technology is, frankly, how brilliant these guys are sitting next to me.

Saum Noursalehi (President of Retail Business)

Yeah. And the reason even but that is important is, as you know, Google organic search is a free channel. So it's free acquisition. Yeah.

Patrick Byrne (Founder and CEO)

Okay. Moving on. There's. I see four likely outcomes. Most pessimistic to optimistic. Pessimistic. Oops, sorry. Pessimistic is absent SEO improvement, we would get profitable growth anyway in May once we lap this stuff just because everything else is so strong.

That's not very optimistic, but that's sort of what I take as a base case. Next, the mother of all site experiences occurs cusp December, January. Next, this Club O, now that it is over 25% of our sales and moving like this, and I think it's actually going to accelerate. I'm really looking for 80% growth out of these guys by—that can in itself just make an enormous difference. Let that run for another few months, and it doesn't matter if SEO comes back. This has replaced it. If we can keep this accelerating and running at 50% or growth or something. Next, we have a new—I have to give credit.

There's an entirely new paradigm of an approach to this stuff that JP Knab, our SVP of marketing, and Nariman Noursalehi, younger and wiser brother of Saum here, but another fantastic—maybe the single smartest guy in the company, if it's not Seth. They had a brilliant idea. Can't—I've always been honest, always been honest with the public about warts and all, bad things going on, good things going on. This idea, which will be live, I believe, in January, involves another large company and a partnership that no one has thought of this paradigm of a partnership before. Nobody. And it's somebody who can bring us a tremendous amount of business. And it's a partnership that works well for both of us and that should work well for both of us. Well, it's been Seth and Saum without giving away.

Saum Noursalehi (President of Retail Business)

This is a teaser. I would just say it's a massive source of new customer acquisition.

Patrick Byrne (Founder and CEO)

Yeah. A massive source of new customer acquisitions. I'm.

Saum Noursalehi (President of Retail Business)

We'll leave it at that.

Patrick Byrne (Founder and CEO)

Okay. Okay. Moving on. And we're nearing the end. I should have warned you folks upfront. We expected that it might actually be as much as an hour of. I expected maybe an hour of getting through all these slides. But I want to give a good comprehensive view to everybody of what you have in your business. We're almost at the end. We have a tab that's up in beta. It's Overstock Cars. It's, of course, quite small. 32,000 visitors a month versus people with 14 million and 26 million. We aren't pushing it yet. Hartsig's bringing no attention to it. It's only got 1.4 million cars. Everyone else has three million or four million.

We will have in Q1 and maybe even before the end of the year, we'll have this three million or four million cars too. So it's much smaller now on traffic and inventory, but it's a really new take on a car site, and it's a monetization model, and I think it's a much better monetization model where people are getting not just new and used cars, but their online financing, their warrants, and their warranties, their financial side of the car equation through us. I think we're essentially the only site that does that. Autotrader does online financing but doesn't do warranties. We're the only guys offering warranties. Once we get this right, we're still tinkering with the experience and the search experience and such, which this thing only got up six weeks ago, I think.

But once we get this right, this is a real little gem either to keep within our business or maybe even combine with someone else. Seth?

Seth Moore (SVP)

No, absolutely. There's a lot of interest in it because it's an unorthodox method of monetizing cars traffic. And so rather than trying to extract a pound of flesh out of dealers, it's trying to work together with them. Yeah.

Patrick Byrne (Founder and CEO)

So okay. Now to the last substantive slide. Here we are. I'll show you this one more time and say it's time given what the strategic picture this tells me is we've struggled to defend a 1% operating margin against people who just come in with a tiny amount of capital versus guys who just come in and just throw cash at us with their ability and willingness to take losses.

That we have to look honestly at the strategic situation and say, "I just don't want to do that forever." If Wayfair, if somebody turns off the oxygen hose for them and they don't get new capital, and let's imagine they did go under if that happened, like some of these other folks in our rearview mirror, there's going to be someone lined up a week later. There's going to be a year later doing the same thing. I feel like we're not as we are going to be able, even if we had. Well, just as we are, we're not. I don't want to run a 1% margin business forever. So for that reason, we have a number of options. There are, in boardrooms across America, we know people talking about their Amazon strategy and freaking out about the disruption Amazon brings. Some of those are brick-and-mortar companies.

And Seth has been doing work and analyzing the kinds of synergies that are available between us and large brick-and-mortar companies. Without naming names, could you describe what you're finding in general?

Seth Moore (SVP)

Yeah. There's a number of places throughout our supply chain where there's huge potential within alignment with brick-and-mortars. Hundreds of basis points of gross margin to be unlocked in line with what we've already been achieving, but they can put it on hypergrowth in terms of shaving those basis points out. And with that expansion in gross margin and in sort of supply chain surplus comes greater growth, greater ability to win digital marketing auctions, and more fuel to drive the business.

Patrick Byrne (Founder and CEO)

Yeah. And the synergy goes both ways. So for example, if we were combined with a large chain, these large chains have similar logistical footprints.

They typically have a dozen or so mega distribution centers, each of which are feeding a couple dozen distribution centers, each of which are feeding 10 to 15 stores. If we were integrated with such a company, we could overnight, I mean, you would have a system that was competitive with Amazon, fulfillment by Amazon, or even nicer than fulfillment by Amazon in several ways. We built this thing, Saum, and Stormy actually built some years ago, SOS, this thing we called SOS. It is a software logistics system for an agile network supply chain. We've only had it hooked up to our three distribution centers, but it could be hooked up to thousands. And it was actually built to be hooked up to as many as we wanted. You don't need thousands. You need a dozen.

So just by, for example, if we were part of a large brick-and-mortar chain, that itself looks like $200 million-$250 million of various logistics costs fall right to the bottom line. Seth was looking at a large brick-and-mortar website the other day, and it's quite slow. We have the fastest, over-and-over, we win this award as the fastest internet retailing website. We know how much it improves sales to be that fast. If we were to make their website as fast as ours, it's going to mean a billion-dollar increase for them. And on and on and on. There are so many synergies in that direction that they bring us in both directions, that they bring us and we bring them. There are other kinds of possible companies with lots of traffic but don't have the right monetization model.

Basically, if you look at our monetization per visitor, whether you're looking at gross profit or what we call nectar, contribution margin, compare that to anybody else. It's so much higher, and that's a function of basically, that's the simple measure of the intelligence of the site. That's the rubber meets the road measure. How many dollars of economic value or pennies are you squeezing out of each visitor? And the more granular you're getting, the more in your analysis, the better you can do. So there's opportunities like that. There's other kinds of companies that aren't even ones people are thinking about. There's that see themselves getting disrupted by Amazon. And what we're hearing is for all these kinds of companies, large club. I'm dying about thinking of the possibilities of us with a large club membership kind of company.

If they have 10 million people and a million in their club and a million started shopping with us, that alone would double us, which I think I just gave away enough variables that you can solve the equation of how much of exactly what Club O does for us. So the possibilities are overwhelming, and this summer it's become apparent. I think a lot of people have had the same idea at the same time. But a different direction we could go. And I'm being very honest with you, folks. I don't know which of these directions I am going to go. I'm used to a lot of Monday morning quarterback. I'd love to hear from people who want to tell me what they really think is the right solution. Here's a different alternative. Recapitalize with a large partner who wants to think really big.

We hear that there are some folks over in Asia who want to write some billion-dollar checks. They're looking for someone who will think really big, and they're looking, and there's a number. There's a new fund with, I won't even tell you how many tens of billions it has. And my understanding, and some of them have been here, is, be frank, that they're looking for somebody to whom they will write a $1 billion or multi-billion-dollar check who can think really big, like take on Amazon big. We've shown the world what we can do with burning $160 million of your capital. There's a piece to me that would love to show the world what I could do with a billion, what we could do with a $1 billion. That's a lively possibility. And we could also capitalize up from Medici.

I think Medici. We didn't even talk about today, the ICO. The terms of it have been put in this press release. This is such a moving target. Now we've learned today the fork that we just postponed everything for. The fork. I don't know if you folks know this. The fork just got canceled today. Did you hear this?

Saum Noursalehi (President of Retail Business)

No.

Patrick Byrne (Founder and CEO)

Yeah. So we just postponed everything, and now the fork's been canceled today or so. There's between regulators and things like that. It's kind of a flake. It's kind of hard to say exactly what you'll be doing in two weeks. But anyway, Medici is. We think has phenomenal, frankly, just ridiculous value. It will be possible at some point to monetize up from assets like tZERO.

So with all that said, it's time. I've been hinting at this for 18 months and more or less told you a month ago. It's time to tell you, or I mean, a quarter ago, we've engaged Guggenheim Partners, a wonderful fellow there, and Andy Taussig. Ken Langone introduced me to Andy, and Ken's used them for a couple of decades. I've grown greatly fond of Andy, and they've been officially engaged and on this project. And that's that. So we need some help both thinking through these alternatives and executing on them, on our decision. So with that as a fulsome explanation for the 936 people who, gosh, we've never had a call with that kind of attendance. It's time to go to questions, and we're going to stay and take. I know we've already gone over an hour and 10 minutes.

Let's go to, but I'll stay on until we get through all the questions we have, really.

Seth Moore (SVP)

All right. The first question: Will the ICO of tZERO dilute ownership of the company, or will the coins just be used to transact on the exchange?

Patrick Byrne (Founder and CEO)

The coins as the terms that are described in the press release that went out, they will be security tokens. Think of them as utility tokens, but these are going to have a novel feature: utility tokens that have a cut of the top-line revenue of tZERO. So that is what makes them a security. So they'll be utility tokens, but they'll actually have an interest in the revenue, not the profit, but the revenue of tZERO. All right.

Seth Moore (SVP)

Any thoughts of having tZERO partner with an existing exchange, Nasdaq, etc.?

Patrick Byrne (Founder and CEO)

That's one strategy. Love to. There's also exchanges. Yes, we could partner with an existing exchange. I'd love to. We're ready to do that. Tell them to call collect. All right.

Seth Moore (SVP)

How much of a lead does tZERO have to the likes of Goldman or R3?

Patrick Byrne (Founder and CEO)

Well, frankly, R3 has already distanced themselves. They've gone from being a blockchain company to being a "blockchain-inspired" company. So I even heard more recently, like a couple of days ago, that they've even distanced themselves from that. So I don't worry about them. Goldman is a black box. Goldman is behind, but they want to catch up. They don't want to lose what they have. I can tell you a funny story. If you go on YouTube, you can see—you look for my name and the word Amsterdam, and you'll see a speech I gave three or four years ago at the keynote of the world's first global conference on Bitcoin.

And I got up and I talked philosophy for an hour. But I also talked about applications of blockchain. I said, "The main event of Bitcoin isn't Bitcoin, folks. It's this thing called blockchain. And we're going to be able to do this and that and the other thing." Goldman Sachs was there. I remember I met the fellow. And that was, say, 9:00 A.M. in Holland. And at 4:55 P.M. on the East Coast of the United States that day, they filed like four patents for the things I had been talking about up on stage. So they must have just telephoned it back and had some lawyers work on it. Anyway, Goldman is, but so we don't see them. I mean, it's a black box.

We don't see them in the—they're out in the industry trying to learn, but they haven't yet really revealed anything of what they have to the marketplace. So that's what I have to say about them. And I feel like once—even if they do this time, it'll be a fair fight. This time, it'll be a fair fight. Remember, there's an old Irish—what do they call it? Irish Alzheimer's. It's when you forget everything but your grudges.

Seth Moore (SVP)

All right. Will Overstock.com apply blockchain technology to its delivery logistics network?

Patrick Byrne (Founder and CEO)

That's something—great question. Where are you on that? Say that. Yes. Will it apply one of the opportunities that we lose?

And for example, one of the things that, say, looking at those options, one of the options is splitting off that top layer, the commerce layer, selling just that to the brick and mortar and creating lots and lots of capital to pursue all the blockchain stuff. You give up one possible synergy. Overstock is a wonderful testbed for developing blockchain supply chain technologies. And there are a couple of companies in that field we're talking about investing in. And I would love to invest in them and have them, if we don't just do it internally, invest in them but be a platform for them, as we've been for so many other companies, frankly. It would make you sick if you knew how many companies we've been a platform for, and then they go on and get sold for a billion dollars. Anyway, but now we know better.

We'd like a piece of them. But I'd love to have the Overstock logistics. I mean, it would be such extraordinary value to be able to scale up a, if someone were building a blockchain supply chain and logistics company, to be able to do it on our platform.

Seth Moore (SVP)

How many dollars has Medici deployed into blockchain investments?

Patrick Byrne (Founder and CEO)

Rob, why don't you take that?

Robert Hughes (CFO)

I'm going to have to defer to our 10-Q largely on that. So I think you'll find the nine companies that Medici's invested in described there in our 10-Q, starting with the largest, of course, was tZERO, which was around $28 million, as I recall.

Patrick Byrne (Founder and CEO)

And $10 million is cash, stock, right? No, it was $28 million. Okay.

Robert Hughes (CFO)

A combination of stock and cash, nearly $30 million in total. The others are much smaller, but they vary from as little as several hundred thousand dollars to $5 million or $6 million.

Patrick Byrne (Founder and CEO)

But we've also had to sustain losses, fund the losses, capitalize the losses. I would say we're probably getting. I'm sorry, I've not looked at it of late. But if I said $50 million-ish, would you feel that sounded about right, Rob?

Robert Hughes (CFO)

Yes.

Patrick Byrne (Founder and CEO)

To include the losses? Sorry, I don't have the exact number. The 10-Q will. Go ahead.

Seth Moore (SVP)

Will the tZERO ICO be used for any of Medici's expenses, or are they solely used by tZERO?

Patrick Byrne (Founder and CEO)

The tZERO. Great question. Oh, I should also. Somebody asked what % of Medici do we own. We own 100% of Medici. Will the tZERO proceeds be used for Medici's expenses? Well, no, the tZERO proceeds, I anticipate keeping the bulk or all of them within tZERO.

We do have—there's a note from tZERO to Medici. For how many millions, Rob?

Robert Hughes (CFO)

There's two notes. One from the original acquisition and then one for their operating costs

Which is $46 million or so probably in total there?

Patrick Byrne (Founder and CEO)

Oh. Well, by the way, if that's $46 million in total, then the total capital committed has to be closer to $60 million-ish in everything we've invested in then $50 million.

Seth Moore (SVP)

Oh, yeah. Correct. Sorry. On top of tZERO with the other one. Yeah.

Patrick Byrne (Founder and CEO)

So we've invested about $60 million of capital when you include the losses we have absorbed as we've spun some things up. And do you feel that's answered, or?

Seth Moore (SVP)

Yeah.

Patrick Byrne (Founder and CEO)

Okay. All right. Can we expect—Oh, no. Actually, I want to mention that. So we do have that note. We could conceivably dividend—I mean, dividend up enough to pay off the note.

I wouldn't anticipate dividending anything more than that. It is nice. We own 81%. Actually, it wouldn't be a dividend if we just paid off the note. It would just be paying off the note, and because we own 81%, we actually can pay dividends from tZERO to Medici without paying taxes, intercompany tax exclusion. However, my guess is that 81% is going to drop beneath 80% as a function of the ICO we go through, assuming that they get their security ICO, so we'll drop beneath 81%. Anyway, but no, we do not anticipate the capital that comes into tZERO is there, in my view, to build tZERO, which means there's actually a couple of nice acquisitions we have our eyes on and to build out the ecosystem.

I know I said there was an unfortunate article, frankly, where I thought that I was speaking under embargo to a journalist, and I was having a social conversation at the end of an interview about something else, and there was some confusion between us. No slagging on him. There was some confusion between us, and he understood the embargoed part, the B part, the B, the thing he could write a story on, so a bunch of that stuff got out that was, to me, a social conversation. Hey, I said we might raise $200 million-$500 million. I don't think the upper end of that is likely now, especially because the ICO market is starting to get a little potty, and we don't need anything like that. We don't need anything like that to accomplish all of our dreams in tZERO.

I'd say someday, when it's a nice established company, you could see us moving capital out of it. But you have to, I think it more is, or it's at least as equally likely that the way we draw capital out of tZERO, so to speak, is not to have it pay us dividends. Although I would like that note paid off someday. But not to have us pay dividends. But as it gets bigger and is more established, we just start selling off 1% or 2% here or there. We'll sell. There'll be other investors who will want some. And we'll start selling small parts of our stakes. I think I'm also learning that the market doesn't want to see Patrick Byrne own 81% of this, which is okay by me. Okay by me.

There'll be other investors come along that let us take our interest down to 50 or below even. In that process, that's how we draw capital out of tZERO rather than direct payments, with the exception of, yeah, of course, I'd like the loan paid back when it's comfortable for them to do so.

Seth Moore (SVP)

Can we expect to see more cash flow from the OSTK parent next year, presumably with less expenses related to Medici and tZERO?

Patrick Byrne (Founder and CEO)

Yes, you will certainly see. Yeah, you will certainly not see the cash drain that Medici and tZERO have been this year. You may see a cash come back the other direction. You may. Yeah, I would expect our just straightforward operating results to be better next year. I mean, I'm so Jonesed on it.

For those reasons, I showed you a few slides back of sort of the four possible outcomes. Although that's setting aside the possibility of, if we do something strategic, then this whole cash flow picture gets much different.

Saum Noursalehi (President of Retail Business)

Yeah. And in addition to that, we've been in this position before with Google organic search several times. We always dig out of it, and we're going to figure it out again. It might take another quarter or so, but we'll get out of it.

Patrick Byrne (Founder and CEO)

And like we say, the mother of all of the site improvements that I think will make the Google spiders, Google bots happy is coming to the end of the year.

Saum Noursalehi (President of Retail Business)

Yep.

Seth Moore (SVP)

This person is asking, "I think OSTK e-commerce is being unfairly valued by the market due to low EBITDA and cash flows. Can we expect to see that improve in the future?" So very similar question.

Patrick Byrne (Founder and CEO)

Similar question, similar answer, same answer. It's kind of, yeah. Yeah.

Seth Moore (SVP)

Great. Will the majority of ICO proceeds be held in cryptocurrencies or converted into fiat U.S. dollars?

Patrick Byrne (Founder and CEO)

Well, I suppose I will defer to our CFO who will have an opinion on that. Or Anthony, would you like to?

Robert Hughes (CFO)

I thought I read Patrick that under the terms of the offering that it was all going to come in in U.S. dollars. But I'm not deeply involved in that.

Patrick Byrne (Founder and CEO)

I believe that's not the case. I believe that you can pay in U.S. dollars or Bitcoin or Ethereum. That's what it was at one stage. Look, I'd have to visit the terms again.

Literally, folks, we're doing so much deal-making right now on so many different fronts that just the amount of lawyering we can put in in a week, that's the pipe. That's the constraint. We've got lawyers staying up all night, night after night, working on different things. So various aspects of what you saw today in our release were determined 11 minutes before we got on, we sent the release out or finalized, I should say.

Seth Moore (SVP)

A couple of retail questions. What is the time for additional international expansions, and what are the plans there?

Patrick Byrne (Founder and CEO)

Excited about international. A guy named Ali Hussain is running this, Vice President. It's growing about 40%. I think it's 32% year-to-date and 40% now.

We're about to hit Wayfair right where we know where they've been talking all about Europe and stuff, but they are actually their big success has been in Canada. We are very close. Well, you guys, is it days or weeks before we're hitting? There's a sort of a big.

Seth Moore (SVP)

We're making several big enhancements to our experience into Canada. Canada is already growing very nicely, sort of north of 50% year-to-date. With these changes, we expect that to accelerate.

Patrick Byrne (Founder and CEO)

We have a large digital marketing campaign about to snap out all over Canada using all the sophistication we've brought to what we have in the U.S. We actually know Walmart and Wayfair is always talking about what they're doing in Europe, but it's a big misdirection. Canada is where their big source is.

Seth Moore (SVP)

Two questions about mobile. Comments on mobile conversions and, more specifically, how has your new AR functionality improved your results?

Saum Noursalehi (President of Retail Business)

I can take that, Patrick. Pleasure. So we've invested heavily in mobile the last year, particularly on the experience and page speed. And we've tied into the same recommendation engines the desktop site uses. But we're seeing massive conversion lifts year-over-year in mobile. Desktop conversion is up as well, but mobile is on another level.

Patrick Byrne (Founder and CEO)

Yeah. Saum is so modest here. And here's a good way you can check some of what you've heard tonight. If you have an iPhone, go, you don't even have to need the new iPhone. Just download the system, the update your system so you're on System 11. If you're on 11, you can download our Overstock Retail App, and you can see our augmented reality and check it against the other guys.

It's a really good illustration of how good our tech is. It's unbelievable. It's just been live a couple of weeks. It's the first one, again, on Apple iPhone to use this. I don't know. I forget the first involved in this, all the first. But here I've been bragging about our technology in this company and bragging about Saum and Seth and what they do. Here's a quick way you can check right now at your desk. Pull out an iPhone, update the system, and get on our retail app and start using our augmented reality. It makes everything else in the market look kludgy and cartoonish. Saum, why don't you?

Saum Noursalehi (President of Retail Business)

Yeah. On AR, yeah, we're investing a lot there. We think we have the best experience out there. In particular, the models that we have, the 3D models that we use, we have really strict quality checks. And so we think the experience and the lighting that you see, the textures that you see, are on another level. And AR, in general, I see as a game changer, particularly in the home furnishing space, where you really need to see these bulkier items in your home and the dimensions and how they fit with the styles in your home.

Patrick Byrne (Founder and CEO)

So for those who thought that much of my verbiage tonight was a bunch of self-congratulatory nonsense, just check it out. Just download our app and see what we've gone live with. It's like no one else in the market yet has. I mean, there is another, the other guy has introduced something. Just compare the two. 3D cartoons versus. Okay. Go ahead.

Seth Moore (SVP)

So there was another question. Has the new iPhone had a positive impact on results? I can take that.

Usually, model to model, we don't see material changes. There was a material stair step when sort of the larger format of phones came out. It just made the mobile world more shoppable. But model to model, we don't see big differences. Last quarter, tZERO generated modest revenue from its short selling effort. And how did 3Q operating performance compare against 2Q? And how should we think about it going forward?

Patrick Byrne (Founder and CEO)

How you're thinking about it going forward is it's gotten somewhat better. Yeah. It had a tougher start to the year. The reduction in everybody I see is down 27% or something in trading revenues, these big banks. Well, SpeedRoute has that at the core of its business. But that's really a non-event. It's come back. It's profitable. It's in the black. The SpeedRoute business. But really, the main event is this thing. They've got ColdFusion.

These guys have invented ColdFusion. If you want to talk about how it's—I think that you're going to see their revenues and value explode. I'll tell you the truth. I wouldn't sell tZERO today for $2 billion for what I think—well, I know what they have. I know what they have and what they're on the edge of.

Seth Moore (SVP)

All right.

Patrick Byrne (Founder and CEO)

I'm not sure I would sell it for $10 billion. I think we've got—we're going after 75% of Goldman Sachs' revenue. And no one likes them.

Seth Moore (SVP)

So when considering Medici's other investments besides tZERO, I presume, which ones have the most potential to generate future shareholder value?

Patrick Byrne (Founder and CEO)

Besides tZERO, I'd say—well, I would say Bitt.com And Bitt.com blockchain meets central banking. I mean, this thing has a global application.

I think the first to market with the kind of wallet we're bringing to market. I just saw a—I mean, it's all in testing. It's all done. It's all being tested for another four weeks. It's really slick. It's really better than anything I've seen in the market. That's a potential enormous business. We're working on another investment. But basically, I'll say this. I'm working on something else that's bigger than anything else. It's bigger than tZERO. It's bigger than Overstock retail. I'm working on the idea of my lifetime. I was actually hoping to be able to announce it today. And the fellow I want to announce it with is sitting in the next room. But we had too much. But I'm hoping in a week or two, you'll hear an announcement that is sort of a—I mean, it'll have global significance.

Seth Moore (SVP)

All right. Here's another one that just came through. Can you provide any detail on how many accredited investors have been verified prior to the ICO or on interest from pre-committed capital?

Patrick Byrne (Founder and CEO)

Well, we haven't even opened it up to any of that yet. That's what we are. We were supposed to be announcing today, finalizing the terms for a November 15th ICO. As I've explained in the letter, and I'm sorry I didn't have another slide or two for my deck to explain, there's a whole bunch of things going on. One of it being this whole question of the fork, and the fork just got canceled the afternoon. The fork, the forks. Everything's been about this fork. And so there's all this uncertainty among the big ICO investors.

For that reason and the reason that we got in the middle of a lot of other negotiations on a lot of other fronts, including this stuff, if you look at our press release today, you'll notice that we just hold warrants on 15% of the company today from two investors who look very high quality. You can read—who are very high quality. I'm really looking forward to working with both of them. And you can read about it yourself in the press release. So go ahead.

Seth Moore (SVP)

So there is actually a question specifically on that front. It says, "The warrants to Passport and Soros. They seem fairly cheap given the potential for positive news with the tZERO ICO." What's the thought behind why now and why those two investors?

Patrick Byrne (Founder and CEO)

First of all, the pricing is Black-Scholes. If you make an assumption on our volatility of 25%, which seems appropriate if you set aside their recent craziness. But they bring enormous value. I've gotten to know the fellow John Burbank at Passport. And we haven't had any connections to the world of Silicon Valley or the world of New York. I'm looking forward to having them. We don't have any benchmark behind us, any Kleiner Perkins, anything like that. It's going to be nice working with Passport. And the Quantum Fund, besides, of course, they bring a lot. They bring access not only to large pools of capital. We don't need that. But access. There's a whole shift going on. And I don't know how much has sort of filtered out to the world. But the capital market, as you know it, is facing an extinction event.

It's all going to shift to ICOs. It's so much more efficient, and this is a chance for these folks to have a pole position, to have part of a company with a pole position in this space. The good that Soros can do in his financial circles for tZERO is just, to me, pricing this at Black-Scholes felt, and normally I hate Black-Scholes. I think Black-Scholes works and holds maybe over a few hours, if maybe over two or three months, but I don't believe in it for the long term. Life has fat tails, as that old Roger Lowenstein book described. It doesn't work, but anyway, to me, this is getting them and having, I mean, Soros is now, well, I'm not going to speak for them. The press release speaks for itself, but people see the possibility of tZERO.

Having people in the financial circles opening up and embracing it and saying, "We've got nine of these investments to worry about." I love having a connection with firms like that who will take it and lead it to greatness. Excellent.

Seth Moore (SVP)

There's a couple of questions around guidance. We don't usually offer guidance from quarterly.

Patrick Byrne (Founder and CEO)

Guidance at this point, we don't. There's a lot happening right now. There's a lot happening in the next eight weeks, four weeks. I can't tell you what's going to happen tomorrow.

Seth Moore (SVP)

So after the ICO, how much equity will Overstock own in tZERO? And what will be the financial interest to OSTK's shareholders? And will there be a way to monetize that interest?

Patrick Byrne (Founder and CEO)

Ownership will be. Well, after the ICO, I suspect it wi%ll drop from 81% to 60% or 70%, something like that. Depends on pricing and such.

But to have 60% of a company, I think, is worth $5 billion is fine by me. And there's different ways to monetize that without depleting it of capital. I think primarily it's going to be the market's going, my understanding is the market's going to want us to see us get down sort of to 50% or less. And the process of going from 80%-50%, we'll be able to monetize at different stages.

Seth Moore (SVP)

Let's see. That's another guidance question. Is it best to buy OSTK or to buy into the ICO itself? And how does the token's appreciation become part of Overstock's profits?

Patrick Byrne (Founder and CEO)

I can't tell you what's best to buy into. I'm not recommending or buy into anything related to us. I'm just laying, I'm laying our cards on the table.

I used to do this, and it would sometimes hurt me because people would find we could say five great things, but the one bad thing they'd raise a stink about. But we're laying all our cards on the table because I don't want there to be any tears. No matter what happens in the months ahead, whatever strategic events happen in whichever direction that I've kind of sketched out, I don't want anyone to say, "Oh, if I'd known that that might be what you do, then I'd-" I've laid my cards on the table. There's only one card I'm holding. There's one decision-making thing that I'm holding back that would affect my decision. But you folks know now, kind of at a comprehensive level, kind of know everything we know about these different possibilities.

So whatever happens and whatever we do, no one has a right to have any tears.

Seth Moore (SVP)

Another one. Do you think the warrants will complicate strategic alternatives being considered at all?

Patrick Byrne (Founder and CEO)

No, I don't. It brings so much value. And there's other aspects to this I can't disclose now. I think it brings a heck of a lot of value. But we did consider that possibility. On the other hand, what does it mean to the world, to our value, that George Soros has just bought options on 10%? And obviously, I doubt it has much to do with the fact that we sell shoes online. People can sort of guess with that what Quantum—well, who knows. But basically, tZERO has gotten us a lot of attention. tZERO, by the way, is run by a wonderful fellow, Joe Cammarata. I've got to congratulate.

Real vision, real fintech entrepreneur all his life. And I think this is going to be his big home run. And he was the one who brought Passport and the Quantum Fund and pointed out the advantages and the doors that open for tZERO in terms of getting integrated and accepted and defended. And the guidance and such is it's going to be super valuable.

Seth Moore (SVP)

Can you remind us of the timeline for the tZERO ICO and the goalpost management aspect?

Patrick Byrne (Founder and CEO)

Well, things are so turbulent. We'd love to get a little bit of guidance from the SEC on some aspects of what we want to design. But we don't want that to be a gating item. There's also the question of this report, which we just learned got canceled. But what we're saying is now November 30th. I forget whatever the words were in the press release.

Trust me, some lawyers carefully scrubbed that. So that is our level of expectation. But what we're thinking of is subject to what do they say in there? Security and regulation and this and that.

Seth Moore (SVP)

California mileage may vary.

Patrick Byrne (Founder and CEO)

Where the sun rises. But we're expecting November 30th to be going forward.

Seth Moore (SVP)

Can you share some color on tZERO token's revenue sharing feature? What percentage of the revenue is shared with token holders?

Patrick Byrne (Founder and CEO)

Well, it depends on how many coins we sell and for how much. But we may do something like the coins may be set up so they are getting 10% of the revenue of tZERO. That's the number we're roughly using now. I don't know if we're using that because we really plan that. But we're using 10% that we'd sell off 10% of the revenue stream.

And it will be - and the owners of the tokens will use them to pay fees on the tZERO exchange. And the more tokens you own, we believe there will be a significant bonus. You own X amount of tokens, then as you spend tokens, you're getting a bonus of 30%, 50%, something like that. Hang on a second. Oh, well, the conference that I said at the top of the call that this conceivably there was a non-negligible chance this was the last conference call. Depending on what happens with those strategic alternatives, it's conceivable that we're not having another conference call. Or if it were, it wouldn't be a - it would be a different kind of conference call. So you guys now know everything I know. We have a company standup I have to get out to. Happy holidays, everybody.

Thank you for being, well, I hope you've, it's been fun working for you in one way or another. I suspect there'll be more calls in the future. But thanks for listening to this long explanation of where we are. I hope that you forgive that it was so long because we know a lot of you were trying to, and haven't looked at us in 10 years if ever and are trying to figure out what the heck is going on. Looks like a lot of confusion from the emails I get about all these different assets. I hope we've tried to construct this call to integrate it all into a picture of how it fits together. Thank you very much. Good day.

Saum Noursalehi (President of Retail Business)

Thank you.

Operator (participant)

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect. Everyone, have a great day.