Supporters of Patrick Byrne and Overstock.com (NASDAQ:OSTK) can’t seem to get over the fact that the company has never turned a profit and that it is being investigated by the SEC (despite false assertions in the most recent conference call that the SEC has resolved “all the issues” and has sprinkled holy water on the company) and that there are numerous “unusual” disclosures and elements in the financial statements.
I thought it would be fun to take a trip down memory lane regarding all these unusual, irregular, questionable, problematic, abnormal, odd items and see if a pattern emerges.
While under the watchful eye of the Sith Lord, I have generated quite a few blog posts regarding Patrick Bryne and Overstock.com. Isn’t it amazing how one, solitary public company can have situation after situation that indicates something is wrong with the financial data and disclosures?
Jason C. Lindsey of Overstock.com: “I am pleased with the quarter. I think we made a big improvement….”
Reality: Revenue for the quarter was down 11%, operating losses were $3.5 million more than last year, net losses were $5.5 million more than last year. Not much of an “improvement” if these metrics are all down.
10-K: “We ended 2006 with $20 million of inventory, significantly lower than the $93 million we had at the end of 2005. From this lower inventory level, we expect to turn our inventory much more efficiently. We have entered 2007 with more attractive, higher margin inventory, and as a result, we expect our gross margins in 2007 to increase significantly over 2006 levels.”
Reality: The reserve numbers sure don’t indicate that there is anything more attractive about the inventory. In both straight dollars and as a percentage of inventory, there’s more junk on the balance sheet at December 31, 2006. At 12/31/05, Overstock reported $98.5 million of inventory, with a reserve of $5.2 million. The reserve was 5.3% of the total inventory. At 12/31/06, Overstock reported $26.9 million of inventory, with a reserve of $6.6 million. The reserve was 24.5% of the total inventory.
May 9, 2006 8-K: “On May 9, 2006 the Company issued a press release regarding its receipt of a subpoena from the Securities and Exchange Commission, Salt Lake City District Office. The subpoena requests a broad range of documents, including, among other documents, all documents relating to the Company’s accounting policies, the Company’s targets, projections or estimates related to financial performance, the Company’s recent restatement of its financial statements, the filing of its 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 the Company’s proxy statement in April 2006, communications with certain shareholders, and communications regarding short selling, naked short selling, purchases and sales of Company stock, obtaining paper certificates, and stock loan or borrow of Company shares.”
Reality: Subpoena received and disclosed on the same day.
March 31, 2007 10-Q: “On May 17, 2006, Patrick Byrne also received a subpoena from the Securities and Exchange Commission, Salt Lake City District Office.”
Reality: Overstock.com waited nearly a year to disclose this subpoena.
David Chidester of Overstock.com: “… Total revenue for the quarter was down 6% to $149 million. This was an improvement in growth from the first quarter when sales were down 11%… Our total operating loss is $13.5 million, including $6.2 million of restructuring charges….”
Patrick Byrne: “I never thought I would say I feel good about a quarter with a GAAP loss of $13.8 million. But Jason, David and I feel great about this quarter. It is not just because of the $13.8 million.”
Reality: Only in the Overstock.com world is losing money an improvement. I guess losing less millions than the many millions you lost the year before is technically an improvement. But if you looked at year-to-date numbers (not just the quarter), you would have seen that losses for the year actually grew from ($29.7 million)in 2006 to ($31.2 million)i in 2007.
8-K: “During Q2 we generated $14.9 million positive operating cash flow and $2.0 million positive EBITDA, excluding restructuring costs (”EBITDA excluding restructuring costs” is a non-GAAP number: see the reconciliation to operating income in the “Key financial and operating metrics” section below).”
Reality by Patrick Byrne himself: “One of the first lessons I was taught was to watch out for companies with “one-time” charges, for rarely, if ever, did they turn out to be truly, “one-time.” Subsequent experience confirmed this. Of course, the world had not really discovered “restructuring charges,” let alone the mantra of “pro forma accounting” that the Internet would later spawn (”EBE: Earnings Before Expenses,” as one wag put it). I was similarly discouraged from calculating EBITDA (”That cash either counts the day it went out the door when you bought that ice machine, or as it depreciated, and GAAP depreciation turns out to be a pretty good approximation of how equipment really depreciates,” I was told).”
Patrick Byrne: In an April 2007 conference call, Patrick Byrne said that Overstock had a “game plan” in the first quarter of 2006 regarding inventory. He said they they knew in that first quarter of 2006 that “things were going to get really ugly and the company was going to have to take medicine” related to inventory on-hand.
Reality: In early 2006, investors were not told about this inventory problem. Instead, Patrick Byrne made the rounds and hyped the 2006 projections. Despite his statements that the company would hit the billion dollar mark in sales and have an EBITDA profitable year, Overstock.com didn’t come close.
Inventory Reserves: Inventory reserves went up dramatically at the close of the fourth quarter of 2006, right after an equity offering on December 15, 2006.
Reality: Executives admit the company knew very early in 2006 that they had impaired inventory. They waited until after the equity offering to book the expenses related to writing down that inventory.
July 28, 2006 earnings call: “So far, [inventory] has sold okay. We are getting rid of it and it does not look like we have – obviously, we are more than adequately reserved, I think, for all of it, but just as far as having sold the last of it, so that there is no more drag on margins, we definitely want to have that happen by the end of the year.”
Reality: On November 6, 2006, the story changes and Overstock.com executives disclose that there really are problems with inventory and “… that is why the margins are going to hurt.” If margins are “going to hurt,” then what management is saying is that they were not adequately reserved, as they had represented a little more than three months earlier.
Reconciliation of EBITDA: Despite Patrick Byrne’s earlier dislike of non-GAAP financial measures, Overstock.com has used EBITDA in its financial disclosures. The company reconciles EBITDA to the company’s operating loss which offers a certain picture of Overstock’s finances.
Reality: The correct reconciliation of EBITDA uses net loss, rather than operating loss. SEC rules do not permit a company to use a common financial measure in a way that is uncommon. That is… professionals recognize EBITDA as a certain calculation and Overstock is not permitted to calculate the measure in a different way, even if they disclose their calculation. Why? Because this is misleading. In this particular case, EBITDA in at least the 2nd and 3rd quarters of 2007 was higher under Overstock’s incorrect methodology than it would have been under the correct, commonly recognized methodology.
8-K: “On April 25, 2006 the Compensation Committee of the Board of Directors of Overstock.com, Inc. (the “Company”) approved additional grants under the Company’s Performance Share Plan, including grants of 25,000 performance shares to each of Patrick Byrne, who, effective April 25, 2006, was appointed Chairman and Chief Executive Officer, and to Jason Lindsey, who, effective April 25, 2006, was appointed President and Chief Operating Officer of the Company.”
Reality: Overstock.com was apparently giving Byrne this award despite the horrible job he did of running the company. On January 2, 2008, Patrick Byrne admits to having screwed up the company prior to Linsdey’s appointment on April 25, 2006. He said: “Jason co-founded the company and helped build it before retiring the first time. When I screwed it up a couple years ago he came out of retirement and has played a decisive role getting it back on track,’” said Overstock chairman and chief executive officer Patrick Byrne.”
8-K: “On December 31, 2007, Mr. Jason C. Lindsey resigned, effective immediately.”
Reality: Financing documents dated January 1, 2008 show Jason Lindsey still as an employee. A declaration made by Lindsey in the Gradient lawsuit states that he was an employee “…from April 2006 until January 2, 2008.” I don’t really care if Lindsey resigned on December 31, January 1, or January 2. But shouldn’t Overstock get its story straight? When your dates don’t match, it creates suspicion, and one begins to wonder what the company is hiding.
December 31, 2007 earnings release: “EBITDA” is presented as ($3,963,000), and is calculated using operating income.
Reality: The SEC prohibits Overstock.com from calling this phony calculation “EBTIDA,” saying “Earnings” is intended to mean net income as presented in the statement of operations under GAAP. Measures that are calculated differently than those described as EBIT and EBITDA in the adopting release should not be characterized as “EBIT” or “EBIDTA.”
Properly calculated EBITDA for the year puts overstock at ($15,119,000). This, of course, is a material difference from what Overstock reported.
First quarter 2008 earnings release: Total revenue was reported at $200.7 million versus $157.9 million for the same period in 2007, which was a 27% increase.
Reality: The 2008 revenue is calculated in accordance with GAAP. The 2007 revenue is a non-GAAP number. The two cannot and should not be compared as they are not both calculated on the same basis. Jonathan Johnson, senior vice president of legal at Overstock then lied to Wired.com and said both figures were GAAP.
Second quarter 2008 earnings call: Overstock executive David Chidester said with reard to the SEC “…we’ve got all the issues resolved,” making it seem as if the SEC is done investigating Overstock.com. Patrick Byrne said, “So, is it fair to say that all these other issues that the knuckleheads keep on raising as issues, the SEC examiners, looked at and sprinkled holy water on?”
Reality: The SEC’s Enforcement Division is still actively investigating Overstock.com and Patrick Byrne.Their investigation is not concluded, and they haven’t finished investigating the company’s accounting or possible violations of securities laws. The statements by executives in regard to this matter are misleading and false. Statements by executives that that the SEC’s closure of a matter implies that there are no violations of securities laws at a company are prohibited.
I’ve yet to see one of Overstock.com’s supporters come up with anything substantive that refutes the above realities. There’s plenty of mudslinging and name calling, but no actual facts used to prove a point.
So I ask you… count up all these unusual and suspect disclosures and figures, and ask yourself… is there some sort of grand conspiracy against Overstock.com, led by some mythical Sith Lord dreamed up by Patrick Byrne?
Or is Overstock simply a horrible company, with an even more horrible CEO, and a group of executives who have been painstakingly trying to fudge their numbers and disclosures in an effort to mislead investors and prop up the stock price of a company that has been and is still a miserable failure?