Wednesday, April 25, 2007

Questions the Securities and Exchange Commission may ask Patrick Byrne (CEO of Overstock.com) in its investigation of (not “on”) Overstock.com

As the Chief Financial Officer of Crazy Eddie, I pretended to be transparent our shareholders, Wall Street analysts, the press, our auditors, our independent directors, and the government investigators. As a criminal, I thought that I knew how to lie when I was seldom asked a good question. I have said that “white collar crime is a crime of deceit and white collar criminals are artful liars.”

One component of white collar crime is the use of deception. In my previous post on this blog, entitled “The Deceptions of Patrick Byrne (CEO of Overstock.com) and Judd Bagley (Director of Social Media at Overstock.com), I analyze various deceptions employed by Patrick Byrne and Judd Bagley in their efforts to distance the smear web site antisocialmedia.net from Overstock.com.

Another component of white collar crime is the use of smears and intimidation against any person that stands in the criminal’s way. My previous blog post “
Don’t Mess with Overstock.com CEO Patrick Byrne” describes some of the consequences of crossing paths with Patrick Byrne. An effective criminal uses tactics such as questioning the integrity of critics and smearing them in an attempt to deflect inquiry into their actions.

An effective criminal knows when they should not answer questions at all. For example, they can exercise their rights against self-incrimination afforded them under our Constitution. Prior to testifying, they can pretend to ignore important questions and hope that they are never confronted with such questions by government investigators.

The Securities and Exchange Commission is currently investigating Overstock.com to determine if there are any violations of securities law by Overstock.com management and others possibly working in concert with them. Soon we may be able to determine if any securities laws were broken by Overstock.com, its management, and others as the Securities and Exchange Commission investigation of Overstock.com continues.

Patrick Byrne wants to ignore questions

Patrick Byrne (CEO of Overstock.com) purports I am “inane” and that I should be “ignored.”

For example, in a post (message # 4463) on InvestorVillage.com, on February 2, 2007, Patrick Byrne wrote, under his alias Hannibal, he wrote:

I laughed so hard at your message that I had to go back and read enough of Ignored Sam's messages to see what he was saying. It seems that his whole shtick now is that no one will answer his questions so he must have a point (instead of, for example, reading it that he is inane).

Patrick Byrne purports to believe in transparency

I quote the following from an interview with of Patrick Byrne, published on redcoatpublishing.com entitled “The UN-CEO” in July 2004:

And Byrne’s quirky management style is not limited to his hiring practices. He has some unusual ideas about how companies should be run. For example, he believes in telling the truth about how the business is going. “I think that I owe the shareholders an honest explanation, once a quarter, of what’s happened—what’s gone well and what hasn’t gone well,” he said.

The Securities and Exchange Commission investigates Overstock.com

The Securities and Exchange Commission began investigating Overstock.com in May 2006. Overstock.com’s recent 10 – K for the fiscal year ended December 31, 2006 and other reports filed with the SEC contain the following representation:

On May 9, 2006 we received a notice of an investigation and subpoena from the Securities and Exchange Commission, Salt Lake City District Office. The subpoena requested a broad range of documents, including, among other documents, all documents relating to our accounting policies, our targets, projections or estimates related to financial performance, our recent restatement of its financial statements, the filing of our complaint against Gradient Analytics, Inc., the development and implementation of certain new technology systems and disclosures of progress and problems with those systems, communications with and regarding investment analysts, communications regarding shareholders who did not receive our proxy statement in April 2006, communications with certain shareholders, and communications regarding short selling, naked short selling, purchases and sales of our stock, obtaining paper certificates, and stock loan or borrow of our shares. We have responded to the subpoena.


Patrick Byrne discusses the Securities and Exchange investigation of Overstock.com

Shortly afterwards, in a news release dated May 9, 2006, Patrick Byrne said the following about the Securities and Exchange Commission’s investigation into Overstock.com:

Overstock.com Chairman and CEO Patrick Byrne said, “I may be the first CEO in history to celebrate receiving an SEC subpoena. Some of the requests suggest the whispering of the blackguards, but I remain unconcerned about their hokum. In truth, I am gratified to see that the SEC is looking into the issues about which I have been speaking: I believe our capital markets are broken in a deep way, our system of corporate voting and governance is a hoax, the savings of Americans are being drained through our financial system’s fissure of unsettled trades, and the system appears to be cracking around Overstock.com (of course, I could be proved wrong if they would force the settlement of, or even reveal the size of, all unsettled trades in OSTK, which I believe number from 7 to 30 million shares).

On the Overstock.com’s web site, he describes the SEC investigation as not being directed at Overstock.com:

Q: Was Overstock behind the SEC subpoenaing business journalists?

A: No.

Q: Has Overstock been subpoenaed?

A: Yes. We received a subpoena from the SEC on May 9, 2006. Prior to receiving the subpoena, we were already cooperating fully with various agencies, including the SEC.

Q: Is Overstock being investigated by the SEC or other agencies?

A: The SEC is conducting an investigation on Overstock.com (see previous question). We are not aware of other investigations by any other agencies.

Note: Italics added by me.

On December 27, 2005, prior to Overstock.com receiving its SEC subpoena, Patrick Byrne described the SEC investigation of Gradient Analytics (since dropped by the SEC). At that time, he was more direct in his language as it related to Gradient:

"Incidentally, during the interview, the Bloomberg reporter asked me about our lawsuit against Rocker and Gradient," said Byrne. "As part of my response, I mentioned the SEC's investigation of Gradient for a copy of the SEC letters which I had previously provided to Bloomberg. Curiously, at that moment, Bloomberg cut away from the interview without warning to a commercial and returned midstream to the interview only when I had finished discussing the SEC's investigation of Gradient."

Note: Italics added by me.

Patrick Byrne was able to write “…SEC's investigation of Gradient…” However, when describing the SEC investigation of Overstock.com, even after they dropped their investigation of Gradient Analytics, he continues to purport that it is an investigation “on Overstock.com” rather than of Overstock.com, on the company’s web site.

Patrick Byrne understands the use of the terminology “investigation of” versus “investigation on” as illustrated in the following representations he made about his WorldStock project on Overstock.com’s web site:

All producers sign a statement of principles concerning the manner in which the goods are produced, and we conduct our own investigation of such suppliers and their reputations.

Note: Italics added by me.

The Securities and Exchange Commission has dropped its investigation of Gradient Analytics but still investigates Overstock.com

On February 14, 2007, the Securities and Exchange Commission dropped its investigation of Gradient Analytics, while they continue their investigation into Overstock.com today.

Floyd Norris, the New York Times Financial Correspondent, wrote in a post on his blog “Notions on High and Low Finance” entitled “Overstock Foes Win One” (subscription required) the following commentary:

Now that we know the government won’t go after the people who said Overstock stock was overvalued, we can wait to see if it will go after Overstock itself.

After posting the 10 – K disclosure (see above) by Overstock.com about the SEC investigation on his blog, Norris continues:

That list includes just about everything Gradient complained about. Could this be a case where a company complains about a short seller and ends up facing S.E.C. charges itself? We’ll see.

The Securities and Exchange Commission may question Patrick Byrne

Patrick Byrne may eventually be questioned and be required to testify under oath by the Securities and Exchange Commission as they investigate Overstock.com. He may have testified already.

Therefore, I have some questions for Patrick Byrne about issues I believe that the Securities and Exchange Commission may be concerned about. Let’s hope he can answer these questions without deception, without deflection, truthfully, and unambiguously.

After all, Patrick Byrne, CEO of Overstock.com, has represented on Overstock.com's web site:

I wish to set a gold standard in communicating with candor your firm's results.

Questions for Patrick Byrne aka Hannibal (CEO of Overstock.com) relating to Overstock.com financial disclosures

Selected Financial Information from Overstock.com's Financial Reports (below):



In Thousands $

In Thousands $

Quarter Ended 09/30/06

Quarter Ended 12/31/06

Revenue:

Direct Revenue

56,564

98,158

Fulfillment Partner Revenue

100,321

195,871

Total Revenue

156,885

294,029

Cost of Goods Sold:

Direct

51,037

101,730

Fulfillment Partner

84,483

164,926

Total Cost of Goods Sold

135,520

266,656

Gross Profit

21,365

27,373

Gross Profit - Direct

5,527

(3,572)

Gross Profit - Fulfillment

15,838

30,945

Gross Profit Percentage - Direct

9.8%

-3.6%

Gross Profit Percentage - Fulfillment

15.8%

15.8%

Gross Product Inventory

73,282

26,859

Reserve for Obsolete and Damaged Inventory

(4,500)

(6,585)

Net Product Inventory

68,782

20,274

Gross Reduction of Inventory

48,508

Reduction of Inventory due to deconsolidated certain assets related to the variable interest entity

(5,986)

Change in Consolidated Net Inventories

42,522

Reserve for Obsolete and Damaged Inventory as a Percentage of Gross Inventory

6.1%

24.5%

Reserve for Sales Returns

1,800

3,600

Reserve for Sales Returns as a Percentage of Total Revenue

1.1%

1.2%

Total Revenue

156,885

294,029

Cost of Goods Sold:

Product Costs, Freight Costs, and other Cost of Goods Sold

123,187

248,025

Fulfillment Costs

12,333

18,631

Total Cost of Goods Sold

135,520

266,656

Product Costs, Freight Costs, and other Cost of Goods Sold as a Percentage of Total Revenue

78.5%

84.4%

Fulfillment Costs as a Percentage of Total Revenues

7.9%

6.3%

Total Cost of Goods Sold as a Percentage of Total Revenue

86.4%

90.7%

Gross Profit Margin

13.6%

9.3%



I quote Patrick Byrne’s remarks from Overstock.com’s 3rd quarter fiscal year 2006 earnings call transcript, relating to inventories and gross margins:

I think it should. I am going to put some meat on that, because we think that we can dramatically reduce inventory from here. But to move that amount of inventory, core inventory, we are giving great deals, better than -- well, we are giving great deals and clearing a whole bunch of stuff out, so we will end with extremely fresh inventory and a much smaller amount than you have ever seen us run with as a fraction of sales.

But to do that, to clean out every nook and cranny in the warehouse, is going to require clearance prices on it, so that is why the margins are going to hurt.

I quote the remarks of Jason C. Lindsey, Overstock.com’s Chief Operating Officer from the 4th quarter earnings call transcript, relating to inventories and gross margins:

All of the things we have talked about before as far as classifying all of our SKUs as either red and green and 80% of our -- excuse me, 20% of our inventory was doing 80% of our gross profits, or even more than that. We took all that to heart in the fourth quarter and although the fourth quarter results are very bad, and I admit they are very bad, they were bad on purpose. In other words, we used the fourth quarter to get rid of all the slow-moving inventory. I am quite pleased with the inventory balances we have now.

Note: Italics added by me.

I quote the following disclosure from Overstock.com’s 10 – K, for the fiscal year ended December 31, 2006, relating to gross margins:

Commentary—Gross Margins. We consciously and aggressively discounted older inventory during the fourth quarter, and as a result, our direct gross margins were negatively impacted. However, we did this to significantly clean and reduce our inventory in an effort to reduce the overall SKU (stock keeping unit) count on our website and to refine our product selection to categories that turn faster and have higher profitability. We believe that we can run our direct business with less inventory than we have had in the past, while filling in product selection using fulfillment partners, rather than acquiring the inventory directly. As a result of these efforts, we believe that we should see a significant improvement in direct and overall gross margins beginning in the first quarter of 2007. With reduced inventory levels, we now have excess warehouse capacity, and we are therefore making efforts to reduce warehouse space. We believe that we will see additional improvement to direct gross margins if and when we are able to successfully do this.

Questions
What were the gross margins specifically attributable to “direct revenue" that you “consciously and aggressively discounted” during the fourth quarter?

What were the gross margins specifically attributable to "direct revenue" unrelated to “consciously and aggressively” discounting of the “older inventory” referred to above?

Was Overstock.com’s belief about future improvements in gross margins for “direct revenue” based on gross margins achieved in the fourth quarter for such direct revenues that were unrelated to the “aggressive” discounting?

Can you disclose the effect on gross margins of “direct revenues” that was specifically attributed to Overstock.com’s reduction in inventory on its balance sheet from the 3rd quarter ended September 30, 2006 to the end of the last quarter of the fiscal year that ended of December 31, 2006?

Can you describe all the reasons why the allowance for “obsolescence or damaged inventory” rose significantly as a percentage of total inventories from September 30, 2006 to December 31, 2006?

What issues relating to inventory became apparent in the 4th quarter that was not apparent in the 3rd quarter?

Based on your statement in the 3rd quarter earnings transcript that I quoted above and the disclosures made in the recent 10 - Q and 10 – K, do you believe that Overstock.com took appropriate steps to properly value its inventory for the 3rd quarter ended September 30, 2006?

When you issued Overstock.com’s 10 – Q for the quarter ended September 30, 2006, did management properly determine the replacement cost or net realizable values of its inventory for that quarter in accordance with Generally Accepted Accounting Principles?

Was Overstock.com’s inventory amounts reported on its 10 – Q for the third quarter ended September 30, 2006, properly reported at the “lower of cost or market” under Generally Accepted Accounting Principles?

Do you believe that inventories for the 3rd quarter ended September 30, 2006 were reported in accordance with Generally Accepted Accounting Principles (GAAP)?

In hindsight, do you believe that the inventories reported on the balance sheet by Overstock.com in its financial statements for the third quarter ended September 30, 2006 were overstated?

Could the additional relative adjustments made to allowance for “obsolescence or damaged inventory” for the quarter ended December 31, 2006, been made for the quarter ended September 30, 2006?

Does Overstock.com use the most conservative accounting principles permitted to determine the valuation of inventory at the lower of cost or market?

Does Overstock.com have adequate internal controls in place to insure the proper recording of inventories and gross margins on its financial statements?

Did Overstock.com’s offering of 2,734,152 shares of common stock on December 15, 2006, have any influence on the company’s accounting for inventories and gross margins for the 3rd quarter ended September 30, 2006?

Can you describe in detail what effect the offering of common shares referred to above had on decisions relating to Overstock.com’s accounting for inventories and gross margins for the 3rd quarter ended September 30, 2006?

For example, assume that:

  • De-consolidation of variable interest annuity had no effect on gross margins
  • Almost all inventories on hand are for direct revenues
  • Gross margins on direct revenues unrelated to "aggressively discounting older inventory" is about 9.8% (same gross margin reported in 3rd quarter on direct revenues), net of fulfillment costs
  • Overstock.com’s normal gross margins on “direct revenues” is about 9.8% (based on 3rd quarter gross margins), net of fulfillment costs.
  • That the company during the 4th quarter maintained previous margins of about (9.8%, net of fulfillment costs) on “direct revenue” unrelated to “consciously and aggressively" discounting older inventory

Questions
Did Overstock.com lose about $7 million as a result of the company “consciously and aggressively” discounting older inventory “to significantly clean and reduce” its inventory?

If gross margins on “direct revenues” unrelated to efforts to “consciously and aggressively" discount older inventory was higher than 9.8%, would the company have lost even more money on the inventory it “consciously and aggressively discounted.”

If gross margins on “direct revenues” unrelated to efforts to “consciously and aggressively" discount older inventory was lower than 9.8%, would the company have lost less money on the older inventory it “consciously and aggressively discounted?”

However, in such a case that gross margins on “direct revenues” unrelated to efforts to “consciously and aggressively" discount older inventory was less than 9.8%, did Overstock.com make any disclosure as to a broader based decline in overall margins unrelated to “consciously and aggressively" discounting older inventory?”

Previous Disclosures
From an interview of you entitled “
Newsmaker: CEO in the Hot Seat” published by c/net news.com on March 6, 2006, I quote the following:

What are Overstock's problems right now, and when will the company be profitable?

Byrne:

I don't know. We have a plan this year that we should cross the billion-dollar mark. Put it this way: Amazon, at our stage, was losing $1.2 million a year in operations. It made up a phony accounting standard--pro forma. And when it reached pro forma breakeven, Wall Street set off fireworks.

When it reached EBITDA (earnings before interest, tax, depreciation and amortization) breakeven, Wall Street wanted to declare it a national holiday. I've never used pro forma in my life. We've had some GAAP (generally accepted accounting principles) profitable quarters, plenty of operating profit and EBITDA profitable quarters. This year, with a little luck, we should be an EBITDA-profitable year, so I'm kind of comfortable with that.


Questions
What were Overstock.com’s sales for the latest fiscal year?

Didn’t sales for the fiscal year ending December 31, 2006 end up at $798,150,000 as reported later on Overstock.com’s 10 – K for the fiscal year ended December 31, 2006?

Did Overstock.com achieve an “EBITDA-profitable year” for the latest fiscal year?

Isn’t it a fact that Overstock.com reported an “EBITDA loss” for the latest fiscal year?

Isn’t it true that Overstock.com lost about $101 million for the fiscal year ended December 31, 2006?

How would you compare your company’s application of accounting principles side by side with Amazon.com?

When you made the statement “We have a plan this year that we should cross the billion-dollar mark” were you attempting to hype Overstock.com in the eyes of the investment community?

Previous Disclosures
The Overstock.com
web site quotes you as follows:

In our filings we chose principles at the conservative edge of GAAP, but I will continue to present and discuss our results as I see them using the internal terms we have grown up with.

Question
Does the “conservative edge” you purported on Overstock.com’s web site, refer to accounting principles applied by the company relating to inventory valuations and disclosures in its financial statements?

Previous Disclosures
In the 3rd Quarter
earnings call transcript dated November 6, 2006, you stated:

Internally, I can tell you that we have always scaled this business for $1 billion, so that was our thought as to where we had to reach to at least make it a viable business, so this is distressing.

Later, during that same meeting, you said:

I think we started last year with fixed assets of $11 million, on which we were trying to do 800 to $1 billion.

Finally, later during that same meeting, you said:

Has slowing growth changed the economics of the business? Yes, it has. As we always, I am not even sure I have talked about this publicly, but we always thought of the $1 billion mark, charging to the $1 billion mark and that was the scale. Being stuck at the $800 million mark presents a problem.

However, in the 4th Quarter earnings call transcript dated February 5, 2007, you said:

First of all, the infrastructure, and the infrastructure is under control and is tuned and is beautiful, but we are not done. The expense structure is still -- we built the expense structure for a $2 billion company and we got stuck here. We have had to fix our expense structure and we are not finished with those fixes.

Questions
Can you explain the inconsistency of your representations as it relates to scaling the company?

Upcoming Overstock.com earnings conference call

Overstock.com has scheduled an earnings conference call at 11:00 AM (ET) on April 25, 2007. Perhaps a brave participant in the conference call will ask Patrick Byrne these questions?

Don’t count on such questions being asked.

Wall Street analysts are not known for asking tough questions. If they ask questions and push for unambiguous and truthful answers, they may not be able to participate in the next earnings conference call.

Maybe, Patrick Byrne or other members of Overstock.com management team attending the earnings conference call can answer them in a truthful, transparent, and unambiguous manner?

In an article entitled “Ignorance Isn’t Bliss for Execs on Trial” by Greg Farrell and Del Jones, USA TODAY published on March 15, 2005, Patrick Byrne was interviewed about playing dumb:

Chief executives who are mounting legal defenses should be wary of playing dumb, warns Patrick Byrne, CEO of Overstock.com. Such a posture could insult a jury, he says. Maybe that's their only choice, but "Ebbers would have been better to plea bargain to 15 years," rather than "tick jurors off ... with a provocative defense," Byrne says.

Well Patrick, here is an oppurtunity to be transparent and not play dumb.

I will post more questions for Patrick Byrne in a later post.

Written by,

Sam E. Antar (former Crazy Eddie CFO & convicted felon)

For additional information on Overstock.com:

Gary Weiss - Search Overstock.com

O-Smear


Update on Overstock.com first quarter for fiscal year 2007 conference call

The Fraudfiles Blog: Today's Earnings Call for Overstock.com by Tracy Coenen

Gary Weiss Blog - Is Overstock.com's Quarterly Delusion 'Materially Misleading'? by Gary Weiss

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