Is Overstock.com in a Death Spiral?

Last Friday, Overstock.com (NASDAQ: OSTK) reported a fourth quarter net loss of $3.4 million compared to net income of $14.9 million in the previous year’s fourth quarter. Its revenues declined 10% to $314.1 million compared to $348.9 million in the previous year's fourth quarter. Details of the fourth quarter financial results were so bad, that Overstock.com did not present a full income statement for that quarter in its press release. Instead it only provided key metrics of its fourth quarter numbers and presented a full year income statement. For the entire year, Overstock.com reported a net loss of $19.4 million compared to net income of $13.9 million in the previous year. Its 2011 revenues decreased 3% to $1.054 billion compared to $1.090 billion in the previous year.

As of December 31, 2011, the company reported a net working capital deficit (current assets less current liabilities) of $14.1 million. Overstock.com's negative net working capital balance indicates that it’s having problems paying its bills as it entered into its traditionally weakest quarter of the year (the first quarter of 2012). Overstock.com common stock closed at $6.11 per share, down $0.77 per share as investors reacted to the company’s horrible earnings report.

Overstock.com inserted new language in its 2011 10-K report warning investors that, “We may not be able to achieve profitability on a quarterly or annual basis in the future.” In addition, the company warned that its poor financial performance could disrupt its relationships with suppliers concerned about getting paid.

Overstock.com will have to raise substantial amounts of new cash to pay its bills and avoid possible insolvency. The company's direct and indirect costs of raising new funds could be so onerous that the company and its current shareholders could be left in even worse financial straits. It's known as a "death spiral."

If the company raises equity, the amount of new funding required by it to stay afloat could significantly dilute the value of its existing common shares and send its stock price spiraling down even further. If Overstock.com tries to raise cash in the form of debt its interest rates could be much higher because of its deteriorating financial condition and the looming possibility of bankruptcy. Higher interest costs would increase future losses.

Overstock.com faces an ongoing investigation by the Securities and Exchange Commission after it was discovered that the company violated various accounting rules to inflate earnings in past years. District Attorney’s from seven California Counties are suing Overstock.com for alleged consumer fraud and are seeking over $15 million of restitution, fines, penalties, and cost reimbursements from the company. Last May, the Judge in that case had to compel Overstock.com to turn over information to the California District Attorneys after they complained to the court that it was illegally withholding subpoenaed documents. On December 28, 2011, The Huffington Post reported that a study found, “The site with the dubious honor of proffering the worst customer service in 2011 was Overstock.com, those ubiquitous merchants of discounted furniture, clothes and home furnishing.”

Suppliers concerned about getting paid

In its 2011 10-K report, Overstock.com warned investors that its suppliers may require it to prepay for its purchases and might suspend doing further business with the company due to its poor financial performance:

Financial performance concerns may cause fulfillment partners or other suppliers to limit or suspend doing business with us, or require prepayments.

We rely upon our fulfillment partners and other suppliers for the product offerings sold on our website and other products and services we use to run our business. Our ability to retain or attract new fulfillment partners and other suppliers may depend in part on our financial performance. Poor financial performance may create concern about our creditworthiness, which could result in suppliers choosing to limit or suspend doing business with us or require us to prepay for our purchases, which could harm our business, prospects, financial condition and results of operations. [Emphasis added.]

Overstock.com's inventory decreased $9.121 million to $22.993 million as of December 31, 2011 compared to $32.114 million in the previous year. Its accounts payable increased $3.021 to $70.332 million from $67.311 million in the previous year. When a company owes out more money to its suppliers despite a drop in inventory, it indicates that the company delayed payments to its suppliers. Overstock.com was able to temporarily spruce up its reported cash flows from operations and free cash flows by $12.142 million because it's taking a longer amount of time to pay its suppliers ($9.121 million from reduction of inventory plus $3.021 million increase in accounts payable). However, the window dressing of cash flow numbers is only temporary since it will have to pay those vendors during the first quarter of 2012. (Note: There is a $77,000 discrepancy between the increase in accounts payable on the balance sheet and the increase in accounts payable in the statement of cash flows.)

Is Overstock.com in a death spiral?

Patrick Byrne

Overstock.com could require approximately $50 million to cover its $14.1 million working capital deficit and provide a cushion to keep it afloat. As of February 10, 2012, there were 23.387 million shares of outstanding common stock. Since the company is expected to continue losing money in the next few quarters, it may have to raise all its funds in the form of equity instead of debt. With new equity instead of debt, the company won't have to pay potentially onerous interest costs and risk higher losses.

On Friday, Overstock.com common stock closed at $6.11 per share, down $0.77 per share. Based on Friday’s stock price, $50 million of new common equity would require Overstock.com to issue at least 8.183 million new common shares ($50 million new equity divided by $6.11 per share) which could dilute existing shareholders by 35% (23.387 million outstanding shares divided by 8.183 million new shares). A potential 35% dilution of existing shareholders stakes could send the stock spiraling below $5 per share and force Overstock.com to issue even more shares.

Many institutions will not own stock that is trading under $5 per share. If certain institutions sell their stock or other institutions cannot buy the stock due to that limitation, Overstock.com shares could spiral down even further. Most stocks cannot be margined under $5 per share and other investors may choose to avoid buying its shares if they cannot borrow against it.

Canadian fund manager Francis Chou takes a bath on Overstock.com investments

Francis Chou

One person who has taken a bath while trying to support Overstock.com's stock price is Canadian fund manager Francis Chou. From January 1, 2011 to January 6, 2012, Chou's funds purchased 1,041,029 Overstock.com thinly traded common shares as it dropped from $16.48 per share on December 31, 2010 to $6.99 per share on January 6, 2012. Chou's funds paid an average price of $10.63 per share.

At Overstock.com's closing stock price of $6.11 per share last Friday, Chou's funds are down $4.54 per share (26%) on its recent investments in common stock. To date, Chou's funds have invested approximately $57 million in the company’s common stock and own approximately 14% of all its outstanding common shares. Chou's total investment is losing over $35 million (over 60%).

Overstock.com CEO Patrick Byrne had better timing than Francis Chou. Back on May 20 to May 24, 2010, Byrne's 100% controlled High Plains Investments LLC dumped 140,000 common shares at an average price of $22.11 per share and collected over $3 million in proceeds.

Is Overstock.com CEO Patrick Byrne on his way out?

In the 2010 10-K report, Overstock.com stated that:

Our performance is substantially dependent on the continued services and on the performance of our senior management and other key personnel, including Patrick M. Byrne, our Chief Executive Officer. [Emphasis added.]

While, in the 2011 10-K report, Overstock.com stated that:

Our performance is substantially dependent on the continued services and on the performance of our senior management and other key personnel.

The 2011 10-K report omitted Byrne’s name. It could be a subtle hint that he could be on his way out. His leadership has been a liability to the company.

Lies to investors and accounting shenanigans

On December 11, 2001, Overstock.com CEO Patrick Byrne appeared on Fox News claimed, “We're profitable.” Brenda Buttner asked, "Your real honest-to-goodness profit, not pro forma?" Patrick Byrne responded, "None of that stuff." On March 1, 2002, Business 2.0 Magazine reporter Owen Thomas asked, "Are you profitable? Patrick Byrne responded, "Yes, that's real GAAP profit, not Amazon-bullshit-accounting profit."

On March 5, 2002, Overstock.com filed an S-1 registration statement in connection with its planned initial public offering. It contradicted Byrne’s claim to Fox News that his company was anywhere near “profitable.” At that time, the company lost money in each and every quarter since its inception. It lost $13.8 million in 2001 and lost $2.997 million in the quarter ended December 31, 2001. In February 2003, Overstock.com filed its 2002 10-K report. It contradicted Byrne claim to Business 2.0 that Overstock.com was profitable. Overstock.com reported a loss of $9.725 million in the quarter ended March 31, 2002.

When Patrick Byrne could no longer lie about Overstock.com’s profitability, he resorted to breaking accounting rules to create fictitious earnings.

Over the last several years, this blog has detailed various illegal accounting shenanigans used by Overstock.com to materially overstate its financial performance. From Q2 2007 to Q2 2008, the company used improper EBITDA calculations to materially inflate its pro forma earnings in violation of S.E.C. Regulation G. For example, in the quarter ended June 30, 2008 Overstock.com reported a positive $1.117 million EBITDA using an improper calculation instead of a negative $0.430 million EBITDA had it complied with Regulation G. From Q4 2008 to Q3 2009, the company violated Generally Accepted Accounting Principles (GAAP) and materially inflated its reported earnings. For example, in the quarter ended December 31, 2008, the company improperly reported a $1.014 million profit by violating GAAP instead of a $0.705 million loss.

In both cases I alerted the company by providing detailed information about its accounting irregularities. However, its CEO Patrick Byrne chose to retaliate against me rather than immediately correct its financial reports. For example, during various conference calls with investors he personally attacked me while claiming that his company was complaint with accounting rules. My accounting analysis was eventually proven correct by Overstock.com's later revisions of financial reports.

In September 2009, the Securities and Exchange Commission started an investigation of the company after I complained to the regulator. In March 2010, Overstock.com was forced to restate its financial reports to correct various GAAP violations initially identified in this blog. The S.E.C. investigation of Overstock.com is ongoing. In its recent 2011 10-K report, Overstock.com disclosed that, "...unfavorable resolution of this matter could materially affect our business, prospects, financial condition and results of operations."

In February 2011, Overstock.com was penalized by Google for cheating on its search engine optimization code to boost its search ranking and increase revenues. Overstock.com blamed Google for contributing to its drop in 2011 revenues. However, if the company did not cheat on its search engine optimization, it would have reported lower revenues in previous years and its revenues would not have dropped in the current year.

On December 6, 2011, a California Judge dismissed Overstock.com's long running litigation against Goldman Sachs (NYSE: GS). In its 2011 10-K report, Overstock.com disclosed that Goldman Sachs could, "...seek reimbursement from us of their allowable court costs."

Loan defaults, failure to make timely disclosures, and poor excuses

On December 27, 2011, Overstock.com paid U.S. Bank $20.329 million (including a $1.428 million prepayment penalty) to terminate a Master Lease Agreement (Sale-leaseback transaction) to avoid a default based on its dismal fourth quarter financial results. On January 6, 2012, Overstock.com filed an amended 8-K report informing investors of its decision to hold shareholder advisory votes on executive compensation every three years. The company failed to disclose that its amended 8-K report was filed late. Overstock.com’s failure to file a timely amended 8-K report caused its December 9, 2011 Form S-3 registration statement seeking badly needed capital to be rendered invalid. Its failure to file a timely 8-K report caused it to default on a $20 million credit facility from U.S. Bank.

However, the company did not notify investors of the loan default. Under S.E.C. rules, an “event of default” is required to be disclosed within four business days (8-K General Instructions and Item 2.04). Overstock.com improperly delayed disclosure of its failure to file timely reports with the S.E.C. and its loan default until February 17, 2012, a day after it resolved its default issues with U.S. Bank. The bank granted the company a waiver of default “effective as of September 30, 2011”, the same day that the amended 8-K report was supposed to be filed.

I asked Overstock.com to explain why it didn’t disclose that its amended 8-K report was filed late, why it delayed disclosing the credit facility default to investors for several weeks, what steps it was taking to handle its invalid S-3 registration statement.

Jonathan Johnson

During the Friday March 2, 2012 conference call with investors, company President Jonathan Johnson responded that it was not necessary to disclose that the January 6, 2012 amended 8-K filing was filed late because it was “obviously late.” However, company disclosures about the frequency of shareholder advisory votes are frequently filed using amended 8-K reports, so the fact that an amended 8-K report was filed does not imply that it was filed late. Nothing contained in the amended 8-K report made it “obvious” that it was filed late.

Jonathan Johnson also claimed that Overstock.com delayed informing investors of the default in its $20 million credit facility with U.S. Bank because:

…we determined it was not material, U.S. Bank agreed and quickly provided a waiver when we requested in that.

However, U.S. Bank did not “quickly” provide a waiver. The late amended 8-K report was filed on January 6, 2012. U.S. Bank did not grant a waiver of default stemming from the late filing until several weeks later on February 16, 2012. Until Overstock.com resolved its regulatory issues and U.S. Bank granted the waiver of default, the bank could have accelerated payment on the $17 million due under the credit facility.

The issue of materiality is determined when the loan default occurred, not weeks later when it was later resolved. It's possible that Overstock.com did not know about the default for several weeks after the late amended 8-K report was filed and U.S. Bank quickly granted the company a waiver of default after it was informed of the breach of loan covenants. However, any delay in notifying U.S. Bank of the default would indicate that Overstock.com has issues monitoring its compliance with loan covenants (a possible material weakness in internal controls).

Coincidently, a few hours after the Friday conference call, Overstock.com filed an 8-K report to inform investors that it provided the wrong phone number for them to listen to the audio replay of the call. I guess that Overstock.com thinks that a wrong telephone number is more important to disclose to investors than a default on a $20 million credit facility. In big or small matters, this company can't seem to do anything right.

Since Overstock.com's inception over a decade ago, the company has accumulated over $260 million in losses and restated its financial reports three times to correct violations of Generally Accepted Accounting Principles (GAAP). The company revised its financial reports numerous times to correct violations of S.E.C. disclosure rules. Despite Overstock.com's repeated violations of accounting and S.E.C rules and retaliation against its critics, the S.E.C. granted it a waiver and allowed it to be eligible to use a Form S-3 registration to raise new capital. If Overstock.com crashes and burns, the S.E.C. may explain to angry investors why it waived its rules to permit the company to issue more common stock and raise new capital.

Written by:

Sam E. Antar

Recent Interviews

March 5, 2011: Forbes - When Sam Antar Speaks, People Listen...and Speak Their Mind by Walter Pavlo

March 5, 2012: Trusted Professional - Reformed ‘Crazy Eddie’ fraudster reveals tricks of the trade by Chris Gaetano

March 3, 2012: Wall Street Journal - Psychos on Wall Street, by Al Lewis (Print Story and Video)

Other Overstock.com Coverage

March 5, 2012: William K. Wolfrum Chronicles - Rush Limbaugh and Overstock.com’s Patrick Byrne: Misogynists getting their due

Disclosure

I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped my cousin Eddie Antar and other members of his family mastermind one of the largest securities frauds uncovered during the 1980's. I committed my crimes in cold-blood for fun and profit, and simply because I could. If it weren't for the heroic efforts of the FBI, SEC, Postal Inspector's Office, US Attorney's Office, and class action plaintiff's lawyers who investigated, prosecuted, and sued me, I would still be the criminal CFO of Crazy Eddie today.

There is a saying, "It takes one to know one." Today, I work very closely with the FBI, IRS, SEC, Justice Department, and other federal and state law enforcement agencies in training them to identify and catch white-collar criminals. Often, I refer cases to them as an independent whistleblower. I teach white-collar crime classes for various government entities, professional organizations, businesses, and colleges and universities. I do not seek or want forgiveness for my vicious crimes from my victims. My past sins are unforgivable.

I do not own any Overstock.com securities long or short.

Overstock.com Was Ineligible to File a Registration Statement Last December

Yesterday, I described how Overstock.com (NASDAQ: OSTK) defaulted on its loan covenants with U.S. Bank because of its failure to a file timely report with the Securities and Exchange Commission. In addition, I detailed how the company improperly delayed disclosure of the loan default until it could obtain a waiver from the bank. Now it appears that Overstock.com’s failure to file a timely report with the S.E.C. made it ineligible to file its Form S-3 registration statement on December 9, 2011 where it is seeking to raise additional funds to keep the company afloat. In addition, Overstock.com's continuing failure to comply with S,E.C. rules could indicate that is has a material weakness in internal controls. The company seems to be incapable of complying with S.E.C. rules even as it faces a continuing investigation by the regulator into previous financial shenanigans.

Background

On March 21, 2011, Overstock.com filed a proxy statement and asked its shareholders to vote at the annual meeting on how frequently the company should seek an “advisory vote” on the compensation of its executive officers. Shareholders were given a choice on whether the advisory vote should be held every year, two years, three years, or to abstain from voting. The vote was “not binding.” The Board of Directors could ultimately decide, "...to hold an advisory vote on executive compensation more or less frequently, as applicable, than the option approved by our stockholders." After the Board finally reaches its decision, the company is required to file an amended 8-K report. At the annual meeting on May 4, 2011, shareholders approved an “advisory vote” every three years.

On Friday, January 6, 2012, Overstock.com filed an amended 8-K report and disclosed that its Board reached a final decision about the frequency of advisory votes on its executive’s compensation:

Consistent with the stockholders’ advisory vote on this matter, Overstock intends to hold future stockholder advisory votes on executive compensation once every three years until the next required vote on the frequency of stockholder votes on executive compensation.

It turned out that the amended 8-K report filed on January 6, 2012 was filed late. It should have been filed on September 30, 2011. Since the company failed to file timely reports with the S.E.C., it defaulted on its loan covenants with U.S. Bank. The company failed to disclose that its amended 8-K report was filed late and it failed to notify investors about the loan default. Under S.E.C. rules, an “event of default” is required to be disclosed within four business days (8-K General Instructions and Item 2.04). Instead, Overstock.com improperly delayed disclosure of its failure to file timely reports with the S.E.C. and its loan default until February 17, 2012, a day after it resolved its default issues with U.S. Bank. The bank granted the company a waiver of default “effective as of September 30, 2011”, the same day that the amended 8-K report was supposed to be filed.

Ineligible to file a Form S-3 Registration Statement

Overstock.com’s late filing of the amended 8-K report made it ineligible to file its Form S-3 Registration Statement on December 9, 2011. Overstock.com held its annual meeting on May 4, 2011. Overstock.com filed its amended 8-K report on January 6, 2012. Under Item 5.07 (d) of S.E.C. rules for filing an 8-K report, a company’s decision on the frequency of its advisory vote involving executive compensation must be disclosed:

(d) No later than one hundred fifty calendar days after the end of the annual or other meeting of shareholders at which shareholders voted on the frequency of shareholder votes on the compensation of executives....

Since the S.E.C rules cite “calendar days” rather than business days, it was required to file an amended 8-K report by Friday, September 30, 2011, 149 "calendar days" after the annual meeting of shareholders. U.S. Bank waived the default stemming from the late filing “effective as of September 30, 2011.” Therefore, the company did not comply with S.E.C. rules under Item 5.07 due to its late filing of the amended 8-K report.

On December 9, 2011, Overstock.com filed a Form S-3 shelf registration statement with the Securities and Exchange Commission that would allow it to sell up to $200 million of its debt securities, common stock, warrants and other securities. On December 20, 2011, the S.E.C. gave Overstock.com a "Notice of Effectiveness" on its Form S-3 registration statement. On December 22, 2011, Overstock.com filed its prospectus with the S.E.C. When Overstock.com made those filings pursuant to its Form S-3 Registration Statement it was not current on all its filings as required by S.E.C. rules. Its amended 8-K report filed on January 6, 2012, should have been filed on September 30, 2011 to comply with S.E.C. rules under Item 5.07.

Under S.E.C. rules, a company that does not comply with Item 5.07 on an 8-K report loses its eligibility to file a Form S-3 registration statement. According to an article written in the New York Law Journal written by Guy P. Lander:

Companies must disclose their decisions as to how often they will hold say-on-pay votes going forward either in the Form 8-K disclosing their annual meeting voting results or in an amendment to that Form 8-K. If companies choose the amendment to the Form 8-K, it must be filed led no later than 150 calendar days following their annual meetings and at least 60 calendar days before their deadlines for submission of shareholder proposals. Missing the filing deadline for this Item 5.07 of Form 8-K will cause issuers to lose their eligibility to file Form S-3 registration statements (absent a subsequent waiver from the SEC Staff). [Emphasis added.]

Overstock.com was not eligible to file its Form 3 Registration Statement because there is no safe harbor resulting from a failure to comply with Item 5.07 on Form 8-K. According to S.E.C. rules:

Item 5.07 is not among the list of items subject to the safe harbor from liability in Rules 13a-11 [17 CFR 240.13a-11] and 15d-11[17 CFR 240.15d-11] under the Exchange Act. In addition, companies that fail to file a timely report required by Item 5.07 will lose their eligibility to file Form S-3 registration statements. [Page 49, Footnote 168].

Does Overstock.com have a material weakness in internal controls?

Overstock.com's failure to file a timely amended 8-K report could be indicative of a material weakness in internal controls. For example, the S.E.C. Division of Corporation Finance asked China Lithium Technologies (CLTT:OTC BB) to explain why certain problems, including a "Failure to file timely a current report on Form 8-K pursuant to Item 5.07...", was not indicative of a weakness in disclosure controls and procedures. The company responded by saying, "...our amended 2010 Form 10-K will include an acknowledgement of the material weaknesses in our disclosure controls and procedures." (See pages 8 and 9.).

Overstock.com should file an amended 10-Q report for the quarter ended September 30, 2011. On the very first page of the 10-Q report the company inaccurately asserted that it filed all required reports.

Ongoing S.E.C. investigation into fabricated earnings

Patrick Byrne

Over the last several years, this blog has detailed various illegal accounting shenanigans used by Overstock.com to materially overstate its financial performance. From Q2 2007 to Q2 2008, the company used improper EBITDA calculations to materially inflate its pro forma earnings in violation of S.E.C. Regulation G. For example, in the quarter ended June 30, 2008 Overstock.com reported a positive $1.117 million EBITDA using an improper calculation instead of a negative $0.430 million EBITDA had it complied with Regulation G. From Q4 2008 to Q3 2009, the company violated Generally Accepted Accounting Principles (GAAP) and materially inflated its reported earnings. For example, in the quarter ended December 31, 2008, the company improperly reported a $1.014 million profit by violating GAAP instead of a $0.705 million loss. In both cases I alerted the company by providing detailed information about its accounting irregularities. However, its CEO Patrick Byrne chose to vilify me rather than immediately correct its financial reports.

My accounting analysis was proven correct by Overstock.com's later revisions of financial reports. In September 2009, the Securities and Exchange Commission started an investigation of the company after I complained to the regulator. In March 2010, Overstock.com was forced to restate its financial reports to correct various GAAP violations initially identified in this blog. The S.E.C. investigation of Overstock.com is ongoing.

California District Attorneys allege consumer fraud

Overstock.com is being sued by District Attorneys from seven California District Attorneys who are alleging consumer fraud. They are seeking at least $15 million of restitution, fines, penalties, and cost reimbursements from the company for allegedly defrauding consumers. The Judge in that case had to compel an uncooperative Overstock.com to turn over information to the California District Attorneys.

Written by:

Sam E. Antar

Disclosure

I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped my cousin Eddie Antar and other members of his family mastermind one of the largest securities frauds uncovered during the 1980's. I committed my crimes in cold-blood for fun and profit, and simply because I could. If it weren't for the heroic efforts of the FBI, SEC, Postal Inspector's Office, US Attorney's Office, and class action plaintiff's lawyers who investigated, prosecuted, and sued me, I would still be the criminal CFO of Crazy Eddie today.

There is a saying, "It takes one to know one." Today, I work very closely with the FBI, IRS, SEC, Justice Department, and other federal and state law enforcement agencies in training them to identify and catch white-collar criminals. Often, I refer cases to them as an independent whistleblower. I teach white-collar crime classes for various government entities, professional organizations, businesses, and colleges and universities. I do not seek or want forgiveness for my vicious crimes from my victims. My past sins are unforgivable.

I do not own any Overstock.com securities long or short.

How Overstock.com Violated S.E.C Rules on Timely Disclosures and Delayed Reporting a Default on Bank Loan

Last Friday after the stock market closed, Overstock.com (NASDAQ: OSTK) filed an 8-K report and disclosed that it defaulted on its loan covenants with U.S. Bank. The loan default resulted from Overstock.com's failure to file timely reports with the Securities and Exchange Commission. The bank granted the company a waiver of default. However, a close examination of the company’s various S.E.C. filings reveals that Overstock.com committed another securities law violation. The company improperly delayed the disclosure of the loan default to investors for several more weeks until it could resolve the default issue with the bank. Even in the face of an ongoing S.E.C. investigation into previous financial shenanigans, Overstock.com continues to flout securities law right under the nose of regulators.

Since public companies have up to four business days to file an 8-K report, they often choose to disclose negative news on a Friday, after the stock market closes and especially before a three-day holiday weekend, in hopes that most investors won't notice it. Overstock.com could have filed its 8-K report as early as Thursday February 16 or on Tuesday or Wednesday of the following week. Clearly, the company was hoping to bury news of its loan default and securities law violations.

Background

On March 21, 2011, Overstock.com filed a proxy statement and its shareholders were asked to vote at the annual meeting on how frequently the company should seek an “advisory vote” on the compensation of its executive officers. Shareholders were given a choice on whether the advisory vote should be held every year, two years, or three years. However, the vote was “not binding.” The Board of Directors could ultimately decide, "...to hold an advisory vote on executive compensation more or less frequently, as applicable, than the option approved by our stockholders." After the Board finally reaches its decision, the company is required to file an amended 8-K report within four business days.

At the annual meeting on May 4, 2011, shareholders approved an “advisory vote” every three years. The next day, it filed an 8-K report which disclosed the amount of votes in favor of the nonbinding proposal. Apparently, the management of Overstock.com could not add or subtract. On May 24, 2011, the company filed an amended 8-K report to fix the amount of votes casted, though it did not change the outcome of the vote.

Misleading 8-K report filed with the Securities and Exchange Commission

On Friday, January 6, 2012, Overstock.com filed another amended 8-K report and disclosed that its Board made a final decision about the frequency of advisory votes on its executive’s compensation:

Consistent with the stockholders’ advisory vote on this matter, Overstock intends to hold future stockholder advisory votes on executive compensation once every three years until the next required vote on the frequency of stockholder votes on executive compensation.

It turns out that the amended 8-K report filed on January 6, 2012 was filed late. It should have been filed on September 30, 2011. By failing to file that amended 8-K report on time, Overstock.com defaulted on its loan agreement with U.S. Bank. The company misled investors by failing to disclose that the amended 8-K report should have been filed earlier. In addition, the company improperly omitted information about the loan default which resulted from its failure to file a timely report with the S.E.C. Instead, Overstock.com continued to deceive investors by delaying disclosure of its loan default until February 17, 2012, a day after it resolved its default issues with U.S. Bank.

On Friday, February 17, 2012, Overstock.com finally disclosed that it failed to file a timely 8-K report with the S.E.C. and informed investors that it defaulted on its loan with U.S. Bank. The lender granted the company a waiver of default:

….the Amendment grants a waiver of any default under the Financing Agreement resulting from the Company’s filing on January 6, 2012 of an amendment to its Form 8-K originally filed on May 5, 2011 to report that the Company would follow its own recommendation, as approved by the Company’s stockholders in an advisory vote on May 4, 2011, regarding the timing of future advisory votes of the Company’s stockholders regarding the Company’s executive compensation. The waiver is effective as of or immediately prior to the due date of the amendment to the Form 8-K. [Emphasis added.]

According to the amended loan document:

Pursuant to Section 12.1(d) of the Financing Agreement, an Event of Default shall occur if, among other things, Borrower fails to timely file with the Securities and Exchange Commission periodic and current reports that are in material compliance with the requirements of the Exchange Act. Borrower has informed Bank that Borrower failed to timely file a required amendment to Borrower’s Form 8-K regarding Borrower’s annual meeting of stockholders held on May 4, 2011 (such failure being referred to herein as the “Existing Default”). Borrower has requested that Bank waive the Existing Default, and subject to the full satisfaction of the conditions precedent set forth in Section 4.1 below, Bank hereby so waives the Existing Default, effective as of September 30, 2011. Except as expressly provided in the foregoing provisions of this Article II and as expressly provided in Article III below, all provisions of the Financing Agreement remain in full force and effect and the foregoing waiver will not apply to any other or subsequent failure to comply with the Section identified above or any other provision of the Financing Agreement. [Emphasis added.]

As I detailed above, Overstock.com's amended 8-K report filed on January 6, 2012 should have been filed on September 30, 2011. Therefore, U.S. Bank waived the “Existing Default” stemming from the company’s failure to file a timely amended 8-K report, “effective as of September 30, 2011.” The company misled investors by failing to disclose that the amended 8-K report was filed late. Furthermore, the amended 8-K report improperly omitted information that Overstock.com defaulted on its loan because it failed to file a timely report with the S.E.C. Under S.E.C. rules, an “event of default” is required to be disclosed within four business days (8-K General Instructions and Item 2.04). Therefore, the company improperly delayed disclosure of the loan default for several more weeks. On February 16, 2012, the company obtained a waiver from the bank. A day later it finally disclosed the loan default.

Weak financial position

Patrick Byrne, CEO

In the first nine months of 2011, Overstock.com reported a $16 million loss compared to only a $1.1 million loss during the previous year's nine month period. The company revealed it was "likely" that it would not comply with certain key terms of a Master Lease Agreement (sale-leaseback transaction) with U.S. Bank at December 31, 2011 (the end of the fourth quarter), unless "current trends improve substantially." Apparently, Overstock.com's soon to be reported fourth quarter numbers continued their downward trend. In late December 2011, Overstock.com was unable to restructure its Master Lease Agreement with U.S. Bank. It paid $20.329 million to U.S. Bank which included a $1.428 million prepayment penalty to avoid default and depleted the company of much needed working capital.

Overstock.com owes U.S. Bank $17 million under its current loan agreement and that amount is due on December 31, 2012. Therefore, the amount due U.S. Bank will be classified as a current liability on Overstock.com’s first quarter 2012 balance sheet and reduce its net working capital by another $17 million. The company had only $18.4 million in working capital as of September 30, 2011. It could report negative working capital on March 31, 2012 if current trends continue.

In December 9, 2011, Overstock.com filed a shelf registration statement with the Securities and Exchange Commission that would allow it to sell up to $200 million of its debt securities, common stock, warrants and other securities. It appears likely that Overstock.com will need to raise capital in the first quarter of 2012 to stay afloat. Such an offering will likely significantly dilute the value of existing common shares. (See "Overstock.com continued...." by the Davian Letter").

On December 14, 2011, the Overstock.com unloaded millions of dollars of excess inventory in a public auction and generated a mere $150,000 in cash, just pennies on the dollar. On January 30, 2012, held another public auction of excess merchandise, but the company did not disclose how much merchandise was sold.

Francis Chou takes a bath after CEO Patrick Byrne dumps shares

Francis Chou, F

Mutual funds managed by Canada-based investment manager Francis Chou have taken a bath on their investment in Overstock.com common shares. Chou’s funds have invested approximately $57 million in the company’s common stock and own approximately 14% of all its outstanding common shares. That investment is losing $34.9 million (down 61%) based on Friday’s closing stock price of $6.77 per share.

Overstock.com CEO Patrick Byrne is not as unfortunate as Francis Chou. Back on May 20 to May 24, 2010, Byrne's 100% controlled High Plains Investments LLC dumped 140,000 company shares at an average price of $22.11 per share and collected over $3 million in proceeds.

Ongoing S.E.C. investigation into fabricated earnings

Over the last several years, this blog has detailed various illegal accounting shenanigans used by Overstock.com to materially overstate its financial performance. From Q2 2007 to Q2 2008, the company used improper EBITDA calculations to materially inflate its pro forma earnings in violation of S.E.C. Regulation G. For example, in the quarter ended June 30, 2008 Overstock.com reported a positive $1.117 million EBITDA using an improper calculation instead of a negative $0.430 million EBITDA had it complied with Regulation G. From Q4 2008 to Q3 2009, the company violated Generally Accepted Accounting Principles (GAAP) and materially inflated its reported earnings. For example, in the quarter ended December 31, 2008, the company improperly reported a $1.014 million profit by violating GAAP instead of a $0.705 million loss. In both cases I alerted the company by providing detailed information about its accounting irregularities. However, its CEO Patrick Byrne chose to vilify me rather than immediately correct its financial reports.

My accounting analysis was proven correct by Overstock.com's later revisions of financial reports. In September 2009, the Securities and Exchange Commission started an investigation of the company after I complained to the regulator. In March 2010, Overstock.com was forced to restate its financial reports to correct various GAAP violations initially identified in this blog. The S.E.C. investigation of Overstock.com is ongoing.

California District Attorneys allege consumer fraud

Overstock.com is being sued by District Attorneys from seven California District Attorneys who are alleging consumer fraud. They are seeking at least $15 million of restitution, fines, penalties, and cost reimbursements from the company for allegedly defrauding consumers. The Judge in that case had to compel an uncooperative Overstock.com to turn over information to the California District Attorneys.

Written by:

Sam E. Antar

Update

Overstock - Another Default? by The Davian Letter

Recommended Reading

TheStreet.com: Facebook's Biggest Surprise -- No Funny Numbers by Gary Weiss

JOSB and the conflicting inventory accounting disclosures by The Davian Letter

Disclosure

I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped my cousin Eddie Antar and other members of his family mastermind one of the largest securities frauds uncovered during the 1980's. I committed my crimes in cold-blood for fun and profit, and simply because I could. If it weren't for the heroic efforts of the FBI, SEC, Postal Inspector's Office, US Attorney's Office, and class action plaintiff's lawyers who investigated, prosecuted, and sued me, I would still be the criminal CFO of Crazy Eddie today.

There is a saying, "It takes one to know one." Today, I work very closely with the FBI, IRS, SEC, Justice Department, and other federal and state law enforcement agencies in training them to identify and catch white-collar criminals. Often, I refer cases to them as an independent whistleblower. I teach white-collar crime classes for various government entities, professional organizations, businesses, and colleges and universities.

I do not seek or want forgiveness for my vicious crimes from my victims. I plan on frying in hell with other white-collar criminals for a very long time. My past sins are unforgivable.

I do not own any Overstock.com securities long or short and have no position in any of Francis Chou's funds.

Overstock.com (O.co): Insolvency Looming?

Updated at bottom of blog post to include analyst downgrade

Overstock.com (NASDAQ:OSTK), also known as O.co, faces possible insolvency if current earnings trends continue and it cannot restructure two loans with U.S. Bank, its biggest creditor by March 31, 2012 at the latest. In an apparent effort to mask its weakening net working capital position, it played a shell game to window dress its balance sheet at the end of the third quarter (September 30, 2011). Overstock.com owed U.S. Bank $20.329 million under the “Master Lease Agreement” (sale-leaseback) and another $17 million under a “Financing Agreement” (line of credit). Therefore, the company owes U.S. Bank $37.329 million under two loan agreements.

Last week Overstock.com surprised investors by reporting a third quarter $7.8 million net loss (diluted earnings per share of negative $0.33) compared to a net loss of $3.4 million (diluted earnings per share of negative $0.15) in the previous year’s third quarter. Its net loss was $0.10 per share higher than was projected by Wall Street analysts. So far, Overstock.com has lost $16 million in the first nine months of the year compared to only a $1.1 million dollar loss during the previous year's nine month period.

"Likely" breach of debt covenant buried in footnotes

As I described in my last blog post, the company buried news of an impending default in its Master Lease Agreement (sale leaseback) with U.S. Bank on page 43 of its footnotes in its third quarter 10-Q report. The Master Lease Agreement with U.S. Bank requires Overstock.com "…to maintain a minimum Total Fixed Charge Coverage annualized ratio of at least 1.20:1.00, based on operating results, measured at the end of each fiscal quarter." The company revealed that, "… based on the results for the first three quarters of 2011, it is likely that we will be out of compliance with the Total Fixed Charge Coverage ratio at December 31, 2011 unless current trends improve substantially. We have held initial and collegial discussions with U.S. Bank regarding this potential non-compliance."

The 10-Q report gives a peek into Overstock.com’s "current trends" and since it was filed 27 days into the 92 day fourth quarter. According to the company’s own analysis, the projected fourth quarter numbers don’t look good “unless current trends improve substantially” in the next few weeks.

Window dressing its balance sheet

At the end of its third quarter, the Overstock.com had $18.4 million of net working capital (current assets minus current liabilities). However, the company would have reported a mere $1.4 million of net working capital had it not played a shell game and window dressed its balance sheet during the third quarter. Apparently, the company wanted to avoid reporting dangerously low net working capital going into the fourth quarter, while at the same time it is trying to renegotiate terms of its Master Lease Agreement (sale leaseback) with U.S. Bank.

On September 21, 2011, Overstock.com borrowed $17 million under its Financing Agreement (line of credit) with U.S. Bank and used $7.5 million of internal cash to redeem $24.5 million of convertible debt before its December 1, 2011 due date (10-Q report page 16 and 33). It could have waited until the fourth quarter to redeem its convertible debt when it was due. Further, the convertible debt was unsecured debt, while the amount it borrowed from U.S. Bank is secured debt.

The convertible debt was classified on the company's balance sheet as a current liability at the end of its second quarter. The $17 million that it borrowed under its Financing Agreement (line of credit) is a long term debt (noncurrent liability) because payment is due on December 31, 2012 (10-Q report page 42). The company used secured long term debt (noncurrent liability) to replace an unsecured current liability in the quarter before its payment was due.

Had Overstock.com not borrowed that $17 million from U.S. Bank to redeem its convertible debentures before the end of the third quarter (September 30, 2011), it would have ended the quarter with a mere $1.4 million in working capital (current assets less current liabilities). In any case, its balance sheet window dressing is temporary, since the $17 million it borrowed will become a current liability by the end of the first quarter of 2012 (March 31, 2012) which is traditionally a weak quarter for the company.

Liquidity issues

CEO Patrick Byrne

At the end of the third quarter (September 30, 2011), Overstock.com owed U.S. Bank $20.329 million under its Master Lease Agreement (sale leaseback). As I detailed above, the company revealed that if current trends don’t "substantially improve" it "likely" won't be in compliance with certain minimum financial benchmarks required under the agreement. According to the Master Lease Agreement, an "Event of Default" includes the "...failure of Lessee to perform any term, covenant or condition of the Lease...." In such a case, if the company cannot restructure its Master Lease Agreement with U.S. Bank, the lender can require the company to immediately pay "…the entire amount of rent and other sums…."

$14.485 million of the $20.329 million Overstock.com owed U.S. Bank under its Master Lease Agreement (sale leaseback) was classified as long term debt (noncurrent liability) as of the end of the third quarter (September 30, 2011). As I detailed above, Overstock.com had only $18.4 million of net working capital at the end of the third quarter. By window dressing its balance sheet, the company made it appear that it had adequate net working capital to pay all amounts due under that agreement in the event of a potential default. Even if we set aside the window dressing issue, the company barely had enough net working capital to pay all amounts due under the Master Lease Agreement in the event of a potential default.

The company is required to have $30 million in compensating balances deposited at U.S. Bank against its Master Lease Agreement (sale leaseback) and Financing Agreement (line of credit). Excluding those $30 million compensating cash balances, the company had only $95.8 million of current assets available to cover $101.6 million of current liabilities as of the end of its third quarter. (Note: The $101.6 million current liabilities amount excludes $5.8 million of current liabilities under the Master Lease Agreement).

In other words, Overstock.com could have a difficult time paying debts as they come due if continues to maintain $30 million in compensating cash balances at U.S. Bank. Further, the $17 million it borrowed under the Financing Agreement becomes classified at a current liability in the first quarter of 2012 which will reduce net working capital by the same amount.

Overstock.com may have to reduce its $30 million of compensating balances on deposit with U.S. Bank. However, if the company does not maintain its compensating balances with U.S. Bank it would default on both loan agreements totaling $37.3 million. Therefore, Overstock.com also may have to renegotiate its Financing Agreement (line of credit) with U.S. Bank.

Other issues

Overstock.com also has to contend with an ongoing investigation by the Securities and Exchange Commission into securities law violations after this blog exposed it fabricating its earnings. So far, every single financial report issued from its inception to Q3 2009 had to be restated up to three times due to violations of Generally Accepted Accounting Principles.

The company is being sued by District Attorneys from seven California District Attorneys who are alleging consumer fraud. They are seeking at least $15 million of restitution, fines, penalties, and cost reimbursements from the company for allegedly defrauding consumers. The Judge in that case had to compel an uncooperative Overstock.com to turn over information to the California District Attorneys.

Earlier in the year, Google penalized Overstock.com for improperly gaming its search algorithm to boost its search rankings.

Two weeks ago, Overstock.com CEO Patrick Byrne, Deep Capture LLC, and Mark Mitchell, a writer for Deep Capture, were sued in a Canadian court for defamation. Deep Capture LLC is an affiliate of Overstock.com and its website was used to promote Byrne's delusional conspiracy theories and libel company critics. The judge ordered the Deep Capture website shut down.

Written by,

Sam E. Antar

Update

Two days after the above post post was published, TheStreet Wire "downgraded" Overstock.com "from hold to sell" based on the following issues:

The company, on the basis of change in net income from the same quarter one year ago, has significantly underperformed when compared to that of the S&P 500 and the Internet & Catalog Retail industry. The net income has significantly decreased by 131.9% when compared to the same quarter one year ago, falling from -$3.36 million to -$7.79 million.

The debt-to-equity ratio is very high at 2.34 and currently higher than the industry average, implying that there is very poor management of debt levels within the company. Along with the unfavorable debt-to-equity ratio, OSTK maintains a poor quick ratio of 0.84, which illustrates the inability to avoid short-term cash problems.

Return on equity has greatly decreased when compared to its ROE from the same quarter one year prior. This is a signal of major weakness within the corporation. Compared to other companies in the Internet & Catalog Retail industry and the overall market, OVERSTOCK.COM INC's return on equity significantly trails that of both the industry average and the S&P 500.

The gross profit margin for OVERSTOCK.COM INC is rather low; currently it is at 16.10%. It has decreased from the same quarter the previous year. Along with this, the net profit margin of -3.20% trails that of the industry average.

Net operating cash flow has decreased to $7.24 million or 11.92% when compared to the same quarter last year. Despite a decrease in cash flow of 11.92%, OVERSTOCK.COM INC is in line with the industry average cash flow growth rate of -15.64%.

Recommended Reading

Overstock.com Nears Default While Utah Media Sleeps, by Gary Weiss

Green Mountain Coffee: Accounting Irregularities and Other Concerns, by Tracy Coenen

How to Commit Short Sale Fraud ...And Get Away With It, by Monique Byrher

Advance Praise for Ayn Rand Nation, by Gary Weiss

Disclosure

I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped my cousin Eddie Antar and other members of his family mastermind one of the largest securities frauds uncovered during the 1980's. I committed my crimes in cold-blood for fun and profit, and simply because I could.

If it weren't for the heroic efforts of the FBI, SEC, Postal Inspector's Office, US Attorney's Office, and class action plaintiff's lawyers who investigated, prosecuted, and sued me, I would still be the criminal CFO of Crazy Eddie today.

There is a saying, "It takes one to know one." Today, I work very closely with the FBI, IRS, SEC, Justice Department, and other federal and state law enforcement agencies in training them to identify and catch white-collar criminals. Often, I refer cases to them as an independent whistleblower. I teach white-collar crime classes for various government entities, professional organizations, businesses, and colleges and universities.

I do not seek or want forgiveness for my vicious crimes from my victims. I plan on frying in hell with other white-collar criminals for a very long time. My past sins are unforgivable.

I do not own any Overstock.com securities long or short.

Overstock's "Likely" Breach of Debt Covenants

Yesterday, Overstock.com (NASDAQ: OSTK), also known as O.co, issued a press release and surprised investors by reporting a third quarter $7.8 million net loss (diluted earnings per share of negative $0.33) compared to a net loss of $3.4 million (diluted earnings per share of negative $0.15) in the previous year’s third quarter. Its net loss was $0.10 per share higher than was projected by Wall Street analysts. Third quarter revenues declined 2% to $239.7 million, compared to $245.4 million in the previous year's third quarter.

Overstock also filed a separate 10-Q report with the Securities and Exchange Commission and buried even worse news deep inside the footnotes on page 43. The company revealed "it is likely" that it won't comply with certain key terms of  its Master Lease Agreement (sale-leaseback transaction) with U.S. Bank at December 31, 2011 (the end of its fourth quarter), unless "current trends improve substantially." The 10-Q report was filed 27 days into its 92 day fourth quarter. The company owes U.S. Bank $20.329 million under the Master Lease Agreement.

Overstock.com has two loan agreements with U.S. Bank, a Financing Agreement (line of credit) and a Master Lease agreement (sale-leaseback transaction). The Master Lease Agreement requires the company to maintain certain minimum financial benchmarks. See below:

The Master Lease Agreement requires us to maintain a minimum Total Fixed Charge Coverage annualized ratio of at least 1.20:1.00, based on operating results, measured at the end of each fiscal quarter. “Total Fixed Charge Coverage” is defined as our EBITDAR (which is defined to mean earnings before interest expense, tax expense or benefit, depreciation expense, amortization expense and rent (defined as payments for real property leases and other operating leases)) less the aggregate amount of federal, state, local and/or foreign income taxes accrued less declared dividends less 50% of depreciation expense divided by our (rental expense plus interest expense plus required principal payments including capitalized leases, excluding principal payments made for retirements of Senior Notes, on a trailing twelve-month basis). The “annualized ratio” shall be based on a four-quarter, rolling average of the current fiscal quarter and the immediately preceeding three fiscal quarters. [Emphasis added].

The company disclosed that "it is likely" that it won't be able to maintain the minimum financial benchmarks required under the Master Lease Agreement. See below:

U.S. Bank has the contractual right to demand payment of all amounts outstanding under the Financing Agreement and Master Lease Agreement if we fail to comply with certain loan covenants. At September 30, 2011 our Total Fixed Charge Coverage annualized ratio was in excess of the required 1.20:1.00. However, based on the results for the first three quarters of 2011, it is likely that we will be out of compliance with the Total Fixed Charge Coverage ratio at December 31, 2011 unless current trends improve substantially. We have held initial and collegial discussions with U.S. Bank regarding this potential non-compliance. [Emphasis added].

Whether or not Overstock.com will be able to modify the terms of its Master Lease Agreement, it is clearly worried about the current trend of its fourth quarter numbers, even though that quarter is supposed to be its best quarter.

Overstock.com also has to contend with an ongoing investigation by the Securities and Exchange Commission into securities law violations after this blog exposed it fabricating its earnings.

The company is being sued by District Attorneys from seven California District Attorneys who are alleging consumer fraud. The Judge in that case had to compel an uncooperative Overstock.com to turn over information to the California District Attorneys.

Last week, Overstock.com CEO Patrick Byrne, Deep Capture LLC, and Mark Mitchell, a writer for Deep Capture, were sued in a Canadian court for defamation. Deep Capture LLC is an affiliate of Overstock.com and its website was used to promote Byrne's delusional conspiracy theories and libel company critics. The judge ordered the Deep Capture website shut down.

Written by,

Sam E. Antar

Disclosure

I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped my cousin Eddie Antar and other members of his family mastermind one of the largest securities frauds uncovered during the 1980's. I committed my crimes in cold-blood for fun and profit, and simply because I could.

If it weren't for the heroic efforts of the FBI, SEC, Postal Inspector's Office, US Attorney's Office, and class action plaintiff's lawyers who investigated, prosecuted, and sued me, I would still be the criminal CFO of Crazy Eddie today.

There is a saying, "It takes one to know one." Today, I work very closely with the FBI, IRS, SEC, Justice Department, and other federal and state law enforcement agencies in training them to identify and catch white-collar criminals. Often, I refer cases to them as an independent whistleblower. I teach white-collar crime classes for various government entities, professional organizations, businesses, and colleges and universities.

I do not seek or want forgiveness for my vicious crimes from my victims. I plan on frying in hell with other white-collar criminals for a very long time. My past sins are unforgivable.

I do not own any Overstock.com securities long or short.