Monday, May 12, 2008

Overstock.com and Patrick Byrne: Anatomy of a Stock Market Manipulation Scheme (Part 3)

More pumping and new false statements and disclosures uncovered

My criminal cousin Crazy Eddie Antar once told me that “people live on hope and their hopes and dreams must be fed by through our spin and lies.” Apparently, Overstock.com (NASDAQ: OSTK) CEO Patrick Byrne has adopted my cousin’s despicable mantra as he continues his unabated manipulative schemes to hype his company’s financial prospects, in a deliberate effort to artificially drive up the market value of its common stock.

As detailed in previous blog posts (here, here, and here), Patrick Byrne’s vindictive self-described campaign to “knee the shorts in the groin….for fun and amusement” is an affront to the integrity of our financial markets and raises serious issues of securities law violations for both Byrne and Overstock.com, both of whom are under investigation by the Enforcement Division of the Securities and Exchange Commission. In addition, new information contained in correspondence between the SEC Division of Corporation Finance and Overstock.com, resulting from its review of the company's financial disclosures, show new deceptions by company management and material misstatements of certain previous financial reports and disclosures.

Patrick Byrne's latest pump

Last Thursday, May 8, according to an article in Reuters:

Now he envisions an end to the red ink this year and hopes the online retailer will realize a net profit of $10 million in 2008.

"If we have a good year, I think we can make 1 percent (profit margin)," he said, estimating total sales of $1 billion. "That's different from saying I'm promising to make $10 million this year. But it's definitely possible."

Later, the article goes on the say:

The Utah-based CEO said he expected Overstock to lose 2 cents per dollar in sales in the first three quarters of 2008, but hoped to make it up in the fourth quarter to realize a profit for the year, and then continue profitably in 2009. "It is very realistic. I think we can," he added.

Note: Bold print and italics added by me.

The following day, Overstock.com’s common shares climbed 49 cents to close at $19.34.

In the first quarter of fiscal year 2008, Overstock.com reported a net loss of $3.9 million on revenues of $200.7 million. Now Patrick Byrne wants investors to believe that after two more quarters of losing "2 cents per dollar in sales," that Overstock.com can make up all of the losses of its first three quarters and make an additional $10 million in profits for the full year on $1 billion in revenues. Part of the problem is that Overstock.com's track record has a historically inverse relationship with Patrick Byrne's hype about the company's future performance.

Patrick Byrne’s hype versus Overstock.com’s financial performance: a historically inverse relationship

As detailed in a previous blog post, in the two years prior to Overstock.com's initial public offering in May 2002, Patrick Byrne made a series of statements to several press organizations claiming that Overstock.com was profitable when it was never profitable and hyped the company's future financial prospects with outrageous predictions of future revenue growth and massive profits. Below are some examples.

Way back in June 2000, Patrick Byrne told the Wall Street Transcript that Overstock.com would reach $1 billion in revenues and make a "ton of money" by 2003:

The Wall Street Transcript question:

Can you give us some idea of how you expect the company to grow over the next few years?

Patrick Byrne's response:

Sure. Two years ago [1999] we did $2 million and last year [2000] we did $36 million. We expect to do at least $120 million this year [2001], and the B2B business may allow us to blow that away then the $400 million range next year [2002], and want to be closing in on $1 billion by the year after [2003]. Most interestingly, I think we can achieve that with little or no added capital.

The Wall Street Transcript question:

Perhaps you can give us some idea of the character of the company and what needs to be done with it.

Patrick Byrne's response:

....I can't say it strongly enough: all we think about is, how do we buy better while getting more revenue and running with tighter expenses so we make more money.

Later on, the Wall Street Transcript had asked Patrick Byrne:

Where would you like to see the company in the year 2004? If you were looking around then, what would you like to see?

Patrick Byrne's response:

I would want to see us well over $400 million and as profitable as hell. Making a ton of money. I want to see that next year [2002].

Note: Bold print and italics added by me. Bracketed information added by me for clarity.

Finally, Patrick Byrne concluded the interview with the Wall Street Transcript by claiming that:

We simply focus on just earning a ton of money on a small amount of invested capital. 'Earning' money, GAAP profits, not just flipping stock to some bigger fool. We're totally focused on execution, running a tight ship, and being as profitable as hell.

Note: Bold print and italics added by me.

On December 6, 2000, Overstock.com issued a press release entitled, "Overstock.com Becomes First Internet Retailer; Achieves Break-Even Using Only $27 Million in Capital," and Byrne claimed:

We're proud to say that we used up only $27 million in capital before we became profitable, while other top e-tailers have burned through hundreds of millions and even billions of dollars in capital, and have not yet figured out a way to make a profit.

Note: Bold print and italics added by me.

However, Overstock.com has never had a profitable year in its entire history and its reported revenues have never come close to the $1 billion mark hyped by Byrne. By fiscal year 2005, Overstock.com's reported revenues topped out at $799.3 million while it lost $25.1 million. The company had accumulated losses of $96.8 million from its inception in 1997 to 2005.

In March 2006, Patrick Byrne claimed that Overstock.com:

...should cross the billion-dollar mark.... This year, with a little luck, we should be an EBITDA-profitable year, so I'm kind of comfortable with that.

Note: Bold print and italics added by me.

However, in fiscal year 2006, Overstock.com's reported revenues declined to $788.2 million compared to its peak $799.3 million of reported revenues in the previous year, far below the “billion-dollar mark” hyped by Byrne. Worst yet, Overstock.com reported EBITDA of minus $55.7 million, a far cry from being "EBITDA-profitable," and massive record net losses of $101.8 million. In fiscal year 2007, Overstock.com's reported revenues continued to decline to $760.2 million compared to $799.3 million in the previous fiscal year. In fiscal year 2006, the company reported massive net losses of $45 million and accumulated losses of $243.7 million since its inception in 1997.

More hype and lies uncovered from Overstock.com’s recent Q1 2008 earnings call

It is simply amazing, how many new lies that Patrick Byrne and his management team make up. Every time I try to find the answer to a simple question, I find even more inconsistencies and newer lies. As detailed in a previous blog post, during the first quarter of fiscal year 2008, Overstock.com reported a 27% leap in revenues to $200.7 million compared to $157.9 million in the previous year's first quarter as Patrick Byrne claimed that the company had “returned to above industry-level revenue growth this quarter.”

However, Overstock.com failed to disclose in its earnings release that it compared Q1 2008 GAAP reported revenues to Q1 2007 non-GAAP reported revenues. In addition, Overstock.com failed to disclose in its Q1 2008 earnings release that the company’s hyped up resumption of “industry level growth” was aided by an inordinately low revenue base resulting from a decline in Q1 2007 revenues compared to Q1 2006. Also, Overstock.com did not disclose that Q1 2008 benefited from the early occurrence of Easter holiday sales and an extra shopping day due to the leap year, a benefit not present in the two previous comparable fiscal year quarters.

A few months earlier, in January 2008, Overstock.com had disclosed that the Securities and Exchange Commission Division of Corporation Finance found the company’s revenue accounting practices were not in compliance with GAAP and with its own disclosures dating back to at least fiscal year 2000. Rather than comply with Statement of Financial Accounting Standards No. 154 and restate prior year financial reports to correct previous errors in revenue accounting, Overstock.com chose to make a one-time cumulative adjustment in Q4 2007 which rendered many of its previous financial reports and disclosures incomparable. Worst yet, during the Q1 2008 earnings conference call that followed, Patrick Byrne and David Chidester made up new lies about the comparability of Overstock.com's financial reports and the impact of the SEC imposed revenue recognition change to GAAP on Overstock.com’s reported revenue growth.

According to correspondence between the SEC Division of Corporation Finance and Overstock.com, written before the Q1 2008 earnings call and just released last Friday, the company's base line Q1 2007 GAAP revenues were actually $4.8 million higher at $162.7 million. Therefore, Overstock.com's reported Q1 2008 revenue growth compared to Q1 2007 should have been 23% and not 27% as reported. However, during Overstock.com’s recent Q1 earnings call, Patrick Byrne and David Chidester tried to play down the effect of the SEC imposed change on Overstock.com’s revenue accounting to GAAP. In contrast to Overstock.com’s earlier correspondence to the SEC weeks earlier, during the Q1 2008 earnings call, Byrne and Chidester claimed that Overstock.com’s reported revenue growth in Q1 2008 compared to Q1 2007 had benefited by just $900,000 from the SEC imposed change in revenue reporting to GAAP and that Overstock.com's growth in revenues was a "true 27%" (See below):

David Chidester:

...net effect of the revenue deferral just discussed at the end of Q1 was incremental the revenue by 900,000....

Later on, Patrick Byrne

No. I would not say there is any significant -- this is a true 27%, it wasn't that that 13 million flopped into this quarter and its not apple-to-apples or something like that. The difference from the accounting change is negligible. It wasn't about Easter, it wasn't different things, this is real change.

David Chidester

Yeah, and again I would just clarify that the Q1'07 revenue and Q1'08 revenue are comparable, because again the only effect that Q1 of '07 had no deferral or reversal. Q1'08 had a deferral and a reversal that netted to only a $900,000 difference. So, the two are completely comparable.

Note: Bold print and italics added by me.

In contrast to management's false statements above, Friday's release of correspondence between the SEC Division of Corporation Finance and Overstock.com, clearly shows that the company's change in revenue reporting to GAAP reduced Overstock.com's reported revenue growth by $4.8 million and not $900,000 or about five times higher than the amount claimed by management. In addition, according to Overstock.com’s correspondence with the SEC, Q1 2006 GAAP revenues were $5.2 million higher than previously reported at $183.3 million. The company’s GAAP revenue had declined 11.2% in Q1 2007 compared to Q1 2006. thus over a two year period Overstock.com’s Q1 2008 GAAP revenues grew only a mere 10% or just about 5% a year, hardly what Overstock.com claims to be “industry level growth.”

Are Patrick Byrne’s latest claims about Overstock.com's financial prospects really achievable?

The short answer is most probably no. Despite the false statements and disclosures detailed above, during the Q1 2008 earnings call, Patrick Byrne claimed that Overstock.com’s revenue growth is sustainable:

Yeah, I can say as far as growth goes, I don't believe this is a blip. I don't want to get anybody's hopes up.

Before, we can determine if Overstock.com can achieve $1 billion in revenues and $10 million in profits for fiscal year 2008, we require last year’s revenues as a starting point. Should we use Overstock.com’s previously reported non-GAAP revenues for 2007 or do we use the company’s GAAP compliant revenues as disclosed to the SEC? During the earnings call, Byrne was apparently using Overstock.com’s non-GAAP reported revenues as a baseline to project Overstock.com’s future growth. Instead, I will use Overstock.com’s newly disclosed GAAP compliant revenue figures as a baseline for an “apples to apples” approach to determine if Overstock.com can actually achieve $1 billion in revenues and $10 million in profits for 2008 (See below).

• Q2 2007: GAAP revenues $147.651 million disclosed in correspondence to the SEC versus previously reported non-GAAP revenues $148.967 million in Overstock.com's not restated financial statements

• Q3 2007: GAAP revenues $162.265 million disclosed in correspondence to the SEC versus previously reported non-GAAP revenues $161.930 million in Overstock.com's not restated financial statements

• Q4 2007: GAAP revenues $304.851 million disclosed in correspondence to the SEC before adding the cumulative adjustment to revenues resulting from the SEC imposed revenue recognition change to GAAP

Therefore, based on Overstock.com's GAAP revenues, the company's revenue growth for the remaining three quarters of fiscal year 2008 would have to accelerate from 23% in Q1 2008 to 30% for the remainder of the year. See the chart below:

Selected Financial Information

Q1

Q2

Q3

Q4

Totals

2008 Revenues - Reported Q1 and estimated Q2 to Q4 (in $ 000's)

200,745

191,946

210,945

396,364

1,000,000

2007 Revenues - From correspondence with SEC (in $ 000's)

162,749

147,651

162,265

304,851

777,516

Growth

23.3%

30%

30%

30%

28.6%

However, as detailed above, Q1 2008 revenue growth compared to Q1 2007 was aided by the inordinately low revenue base resulting from a decline in Q1 2007 revenues compared to Q1 2006. In addition, Q1 2008 revenues were helped by an additional shopping day due to the leap year and the early occurrence of Easter, not present in the two previous fiscal quarters. Q2 2008 revenues will also be aided by the inordinately low sales volume base resulting from a decline in Q1 2007 revenues compared to Q2 2006. However, Overstock.com faces tougher revenue comparisons in Q3 2008 and Q4 2008. Unlike Q1 and Q2 2007, Overstock.com's Q3 and Q4 2007 revenues actually increased in comparison with previous year periods. (See the table below):

Selected Financial Information

Q1

Q2

Q3

Q4

Totals

2007 Revenues - From Overstock.com correspondence with the SEC (in $ 000's)

162,749

147,651

162,265

304,851

777,516

2006 Revenues - From Overstock.com correspondence with the SEC (in $ 000's)

183,251

159,809

156,024

289,515

788,598

Growth

-11.1%

-7.6%

4.0%

5.3%

-1.4%

Considering all the factors detailed above, it will be extremely difficult for Overstock.com to grow its revenues at 30% for the remainder of the year in order to achieve $1 billion in total revenues. Even if Overstock.com's revenues reach $1 billion for fiscal year 2008, it is difficult to see how the company can achieve $10 million in net profits as hyped by Byrne. Assuming that Patrick Byrne is right and Overstock.com's revenues reach $1 billion and its loses "2 cents per dollar in sales" for the first three quarters, the company would have to report substantially high record profits in its final quarter or $21.97 million to make up for losses in the first three quarters. (See the table below):

Selected Financial Information

Q1

Q2

Q3

Q4

Total

2008 Revenues - Reported Q1 and estimated Q2 to Q4 (in $ 000's)

200,745

191,946

210,945

396,364

1,000,000

2008 Net Profits or (Losses) - Reported Q1 and estimated Q2 to Q4) (in $000's)

(3,909)

(3,839)

(4,219)

21,967

10,000

Percentage of Net Profits or (Losses) to Revenues

(1.9%)

(2.0%)

(2.0%)

5.5%

1.0%

The last time Overstock.com reported any quarterly profits was in Q4 2004, about 4 years ago. In that quarter, Overstock.com reported profits of $2.695 million on previously reported non-GAAP revenues of $221.3 million. However, according to correspondence between the SEC Division of Corporation Finance and Overstock.com, those profits were materially overstated by at least 10% and possibly as high as 19% due in large part to over-reporting of revenue by $2.16 million in Q4 2004. While Overstock.com previously reported a $4.73 million net loss for the entire 2004 fiscal year, the company's correspondence with the SEC shows that that company's losses should have been $923 higher or losses were materially understated by 19%.

In order for Overstock.com's performance to match Patrick Byrne's latest hype, Overstock.com's Q4 2008 profits would have to exceed its highest of only one of two quarterly profits ever reported by the company by almost a factor of ten.

In Overstock.com's previous Q4 2007, the company reported operating expenses of $53.178 million on GAAP revenues of $304.951 million (Note: GAAP revenues as per Overstock.com correspondence with SEC). Let's assume for the sake of argument that Overstock.com, in the highly unlikely event, can keep its total dollar level operating expenses in Q4 2008 at the same level as Q4 2007, while the company's GAAP revenue rises by $91.513 million or 30% more than the previous comparable period.

Selected Financial Information

Q4 2008

Percentage

Q4 2008 Projected Revenues - 30% increase over previous fiscal year period (in $ 000's)

396,364

100.00%

Less: Q4 2008 Cost of Goods Sold (in $ 000's)

321,219

81.04%

Q4 2008 Gross Margins (in $ 000's)

75,145

18.96%

Q4 2008 Operating Expenses - Same level as previous fiscal year period (in $000's)

53,178

13.42%

Projected Operating Income (in $ 000's)

21,967

5.54%

Note: For simplicity we will ignore non-operating income and expenses such as interest income and interest expense.

Under the assumptions detailed above, Overstock.com would require about 18.96% gross margins in Q4 2008 to match Patrick Byrne's latest hype. In Q4 2007, gross margins were only 16.38% based on Overstock.com's SEC imposed revenue accounting change to GAAP. Therefore, Overstock.com would have to increase Q4 2008 GAAP revenues by 30% compared to Q4 2007, keep its Q4 2008 operating expenses at exactly the same Q4 2007 level in absolute dollars, and increase gross margins by 2.58%, to make a full year $10 million net profit on revenues of $1 billion after losing "2 cents per dollar in sales" in its first three quarters. Not much of a chance (no surprise).

To be continued....

Written by:

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

Note: Please read Gary Weiss and Tracy Coenen's blogs for up to date coverage of Overstock.com.

Disclosure: No position in Overstock.com securities long or short

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