overstock.com is overstocked

8/3/2019 Overstock.com is Overstocked

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Overstock.comisoverstocke

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DL | davianletter.com

Tuesday,December27,2

Overstock.com is overstocked

Background

TounderstandtherecenteventsinOSTKnewsandfilingsitisessentialtounderstand

afewthingsabouttheirpriorsituation.InNovember2004,theycompleted an

offeringof$120.0millionof3.75%ConvertibleSeniorNotesdue2011 .Theyused

thesetofundoperationsandgrowthebusinessandallbut24.5milliondollarshad

beenrepaidasofQ22011.

AnotherimportantfactisthattheyenteredintoaMasterLeaseAgreementwithUS

BankinSeptember2010.USBankinknownforthisparticulartypeoffinancial

transaction,whereUSBankwillbuy,inthiscaseITequipment,fromOSTK,andthenimmediatelyleaseitbacktothemovera4yearperiodwitha$1payoffattheend.

(9.21.20108KPg.2)Thishappenedintheamountof14.6milliondollarsin2010.

Thesemasterleaseagreementsinmanycasesarebeneficialtobothpartiesasthe

companycanhavelesscashtiedupinfixedassetswhilegrowing,andthebankgets

interestplustaxadvantagesfromdepreciation.

Ofnote,therewasalsoafinancingagreementtakenoutwithUSBankin2009that

wasamendedin2011,tobedetailedbelow.

In Focus:

Background

TheBeginning

CurrentCrises

ShelfOffering

CurrentCash30MatUSBank


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TheBeginning

Asthepreviouslyissuednoteswerecomingdueandthecashtoredeemthemwasnotavailable,anewFinancing

AgreementwithUSBankwasagreedto,whichallowedthemtofund$17milliondollarsofthe24.5remainingonthe

notes,andtheremainingwaspaidfromcashonhand.Onthesurfacethisseemsbenign,butinthedetailsbelowtwo

criticalthingstakeplace.One,thedefaultsandtriggeringeventsoftheFinancingandMasterLeaseagreementsaretied

together,andOSTKisnowrequiredtokeep$30millionincashormarketablesecuritiesonhandatUSBankatalltimes

inordertohaveaccesstothiscredit.

OnSeptember21,2011,Overstock.com,Inc.(theCompany)completeditspreviously-announcedredemptionofthe

Companys3.75%ConvertibleSeniorNotesdueDecember1,2011(theNotes)bydepositingthefullamountofthe

redemptionpricefortheoutstandingNoteswiththepayingagentfortheNotes.TheCompanyfundedtheredemptionof

theNoteswithacombinationofcashonhandanda$17milliondrawunderitsFinancingAgreement withU.S.Bank

NationalAssociation.AmountsdueundertheFinancingAgreementaredueonDecember31,2012.TheFinancingAgreement

containsstandarddefaultprovisions.Inaddition,theCompany'sfailuretokeepatleast$20millionondepositincertain

accountswithU.S.Bankwouldconstitutea"triggeringevent"undertheFinancingAgreement.Asdescribedinthe

Company'spriorreports,theCompanyisalsoapartytoaMasterLeaseAgreementandaFinancialCovenantsRider

andrelateddocuments(collectively,the"MasterLeaseAgreement")withU.S.BancorpEquipmentFinance,Inc.Technology

FinanceGroup("Lessor"),anaffiliateofU.S.BankNationalAssociation,whichrequirestheCompanytomaintaina

minimumliquidity(definedascashplusmarketablesecurities)of$30millionintheaggregate(whichamountincludes

anyminimumliquidityrequiredundertheFinancingAgreement)atalltimesondepositwithU.S.BankNational

AssociationuntilallamountsowedundertheMasterLeaseAgreementarepaidinfull.TheMasterLeaseAgreement

providesthattheCompanyispermittedtowithdrawthefundsondepositwithU.S.BankNationalAssociationatthe

Company'sdiscretion,althoughitsfailuretomaintainaminimumliquidityof$30millionwouldbeanEventofDefault

undertheMasterLeaseAgreement.AnEventofDefaultundertheMasterLeaseAgreementwouldcauseanEventof

DefaultundertheFinancingAgreement.-9.21.20118KPg.2(moredetailsinQ32011p.15-16)

Originallyin2009USBankhada$20millionrevolvinglineopentoOSTKthatwassecuredwith$10millionincash&$10millioninotherassets,butinordertogetenoughcashouttopayofftheremainingnotesUSBankagreedtoamendthe

agreementin2011toallowOSTKtofullydrawthe$20millionlinewithonly$3millionofcashsecuringthisnote,and

therestofthenote/revolvinglineisbeingsecuredbyOSTKsotherassets.

WhywouldUSBankallowthis?Goodquestionright?Letsdropdowntopage18ontheQ32010toanswerthat

question.

WeretiredalloftheSeniorNotesthatremainedoutstandingonSeptember21,2011for$24.5millionincash,resultingina

lossof$26,000onearlyextinguishmentofdebt,netof$26,000ofassociatedunamortizeddiscount.Weretired$34.6

millionoftheSeniorNotesduringtheninemonthsendedSeptember30,2011,for$34.6millionincash,resultinginaloss

of$54,000onearlyextinguishmentofdebt,netof$77,000ofassociatedunamortizeddiscount.Ofthe$34.6millioninSeniorNotesretiredduringtheninemonthsendedSeptember30,2011,$10.1millionwereheldbyChouAssociates

ManagementInc.(Chou)oranaffiliateofChouand$21.7millionwereheldbyFairfaxFinancialHoldingsLimited

(Fairfax)oranaffiliateofFairfax.ChouandFairfaxarebeneficialownersofmorethan5%ofourcommonstock.We

retired$16.1millionoftheSeniorNotesduringthethreemonthsendedSeptember30,2010for$15.8millionincash,

resultinginagainof$141,000onearlyextinguishmentofdebt,netof$92,000ofassociatedunamortizeddiscount.We

retired$25.4millionoftheSeniorNotesduringtheninemonthsendedSeptember30,2010for$24.9millionincash,

resultinginagainof$346,000onearlyextinguishmentofdebt,netof$158,000ofassociatedunamortizeddiscount.


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AsofSeptember30,2011andDecember31,2010,zeroand$34.5millionoftheSeniorNotes,netofdebtdiscount

remainedoutstanding,respectively.

SoUSBankletOSTKdraw$17millionundertheirrevolvinglinetoprotectUSBankslienpositionagainstOSTKs

maturingSeniorDebt.Makessenseright?ThebankhadalreadyagreedtofundOSTK,andtheyweresittingina

secondarylienposition,tobecometheprimarylienholdertheyneedtopayoffthecurrentprimarylienholder.Mynext

questionishowdidOSTKfundtheother$7.4million.MaybetheyhadenoughearningsinQ3toreplenishthe$7.2

millionpayout,butOSTKreporteda ($7.8million)netlossforthequarter,andhada($4.5million)decreaseincurrent

assets,alongwitha$2.2milliondollarincreaseintotalliabilities,whileatthesametimemoving$17millionoftheir

maturingSeniorConvertibleNotesfromacurrentliabilitytoalongtermliabilitywiththefundsdrawnoffoftheir

revolvingcreditlinewithUSBank.Keepinmindthe$17millionrevolvinglinematuresinDecemberof2012,andwhile

thisisnotanuncommonbankingpractice,toprotectinterestrateriskandallowthebanktorevaluetheunderlying

collateral.OSTKmustalsobeincompliancewiththeMasterLeaseAgreement,intheamountof$20.3million.Notonly

doesthismeanOSTKowesUSBankagrandtotalof$37.3million,butasIwillquotebelow,managementbelievesthey

willnotbeincompliancecomeyearend.

WhiletheMasterLeaseAgreement,andthemodifiedFinancingAgreementmayhavetemporallyhelpedsomecashflowissues,it

alsohascostOSTKoninterestrate,andtherighttodepreciatetheequipmentfortaxbenefits,makingUSBankseffectiveratemore

appealing(toabank)sincetheyhavenotonlybeenabletoraiseOSTKsinterestrate,butnowUSBankcanoffsettheirearnings

expensewiththedepreciationexpenseoftheequipmentonceownedbyOSTK.

CurrentCrises

ThefirstandforemostproblemforOSTKisthefactthattheyadmitasofQ3thattheyarecurrentlynotmeetingthe

FixedChargeCoverageratio,andiftheycannotcometoanagreementwithUSBanktheywillbeindefaultonboththe

MasterLeaseAgreementandtheFinancingAgreement.ThisissueneedstoberesolvedbyDecember31,2011,orelsetheywillbeindefaultandhavenoaccesstocredit.

U.S.BankhasthecontractualrighttodemandpaymentofallamountsoutstandingundertheFinancingAgreementand

MasterLeaseAgreementifwefailtocomplywithcertainloancovenants.AtSeptember30,2011ourTotalFixedCharge

Coverageannualizedratiowasinexcessoftherequired1.20:1.00.However,basedontheresultsforthefirstthree

quartersof2011,itislikelythatwewillbeoutofcompliancewiththeTotalFixedChargeCoverageratioatDecember31,

2011unlesscurrenttrendsimprovesubstantially.WehaveheldinitialandcollegialdiscussionswithU.S.Bankregardingthi

potentialnon-compliance.-Q3201110QPg.17

TotalFixedChargeCoverageisdefinedastheCompanysEBITDAR(whichisdefinedtomeanearningsbeforeinterestexpense,taxexpense,depreciationexpense,amortizationexpenseandrent[definedaspaymentsforrealpropertyleases

andotheroperatingleases])minustheaggregateamountoffederal,state,localand/orforeignincometaxesaccruedminu

declareddividendsminus50%ofdepreciationexpensedividedbytheCompanys(rentalexpenseplusinterestexpenseplus

requiredprincipalpaymentsincludingcapitalizedleasesonatrailingbasis).

Consequently,ourfailuretokeepatleast$30millionondepositincertainaccountswithU.S.Bank wouldconstitutea

triggeringeventundertheFinancingAgreement.Ifatriggeringeventoccurs,wewouldbecomesubjecttofinancial

covenants(i)limitingourcapitalexpendituresto$20millionannually,and(ii)requiringustomaintainaFinancing

Agreementdefinedfixedchargescoverageratioofatleast1.10to1.00 asoftheendofanyfiscalquarterfortheperiodof


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thepriorfourquarters.Theoccurrenceofatriggeringeventcouldalsoresultinadecreaseintheamountavailabletous

underthenoncash-collateralizedportionofthefacility,asavailabilitywouldthendepend,inpart,ontheBorrowingBase

(asdefinedintheFinancingAgreement).AtSeptember30,2011,wehad$30.0millionincompensatingcashbalancesheld

atU.S.Bank.-Q3201110QPg.16

.

whichrequiresustomaintainaminimumliquidity(definedascashplusmarketablesecurities )of$30millioninthe

aggregate(whichamountincludesanyminimumliquidityrequiredundertheFinancingAgreement)atalltimesondeposit

withU.S.BankNationalAssociationuntilallamountsowedundertheMasterLeaseAgreementarepaidinfull.

ShelfOffering

Whenfacedwiththisscenario,theyseemtohaveabackupplaninplacewiththeirshelfofferingtoissueupto$200

Millionofnewshares(52.54%dilution)tousetopayoffUSBankintheeventofdefaultortoatleastuseasastick

duringnegotiations.Intheeventofitsusethemarketpriceofitsstockwillcraterappropriately.

MoreShelfinfo:http://sec.gov/Archives/edgar/data/1130713/000104746911010016/0001047469-11-010016-

index.htm

CurrentCash30MatUSBank


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Nowthereisarealproblem,theycantpaythisyearsliabilitiesorevenclose.Theycanhoweverberescuedoutofthis

shortagebyanamazingQ4,andthatseemstobewhattheyrelyonmostyearstofundtheirliabilities.Theyareinneed

ofanamazingQ4,sincetheyseemtobeoutofoptionstogetanyadditionaldebtfunding(excludingtheshelf).

Q4Outlook

InordertogetanearlypreviewofwhatQ4mightbelike,letslookatsomebasicdatafromGoogleInsightwhichdoes

analysisonsearchrates,andAlexawhichusesanoptintrackingsystemforusers.

Keywords:overstock.comando.co(Red)

Keywordoverstock


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Alexa:

2011Q4seemstobehavingaboutthesameamountofhitsas2007and2009,whichwerenotgoodholidayseasonsfor

OSTK,andarewhatledthemintotheholeinthefirstplace.Thekeyherethencomesdowntoconversionratios;hits

dontmatterunlesstheyareabletomakethesale.


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Q32011Pg.31

RevenueforthequarterendedSeptember30,2011decreasedby$5.7million,ordown2%comparedtoquarterending

September30,2010.Whilevisitstoourwebsitewereupslightlyyearoveryear,conversionrateswerelower,resultingin

fewerorders.Newcustomergrowthfellapproximately8%forthequarterendedSeptember30,2011comparedtolast

year.

Ok,solowervisitsandlowerconversionsequalbadquarterforsales.Whenthatbadquarteristheoneyoucountonin

ordertonotgobankrupt,thereisaproblemcomingsoon.

Soistheeconomyjustbad,arepeoplenotshoppingonline?Wherehasthetrafficgone?

Letslookatamazon.com:


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Conclusion

Thereareafewdifferentscenariosthatcanplayoutatthispoint,puttingprobabilitiesonthemisdifficultandwewill

notapproachthathere.

1) USBankdoesnotletOSTKrenegotiatethedefaultduetocoverageratio.a. OSTKdeployssharesfromshelfontoopenmarket,dilutingtheircommonstockb. OSTKgoesintoCh.11c. OSTKfindsanotherlenderinahurrytorefinancewith(unlikelyin4days).

2) USBankrenegotiates,andextractsmorecontrolorassetsfromOSTK,buttheycontinueoperatingasis.a. Q4isgoodenough,andtheybuysometime,andthemarketignores.b. Q4isbad,theydonothavecash,andhavetocomebeggingtoUSBank,whoIcantimaginewouldput

evenmoreonthelineatthispoint,sowhoknowstheoutcome,butitwouldbebad.Possiblyusethe

shelfofferingagainhere,dilutingmassively.

c. Q4isgreat,theyaremadewholefortheyearandstockrallies.

TheoutcomeslooktomainlyresultinalowersharepriceeitherimmediatelyinJanuary,orafterQ4reporting,or

wheneverthesharesintheshelfarereleased.TheonlyscenariothatwouldresultinahighersharepricewouldbeifUS

Bankrenegotiatestheirdefault(temporary),ortheyhaveanamazingQ4.

OtherConcernswithOSTK

CEOisinalegalmessinCanada,whichwillnotlikelyresultinanyadverseeffectstothestockprice,butdoesshowcharacterconcerns.

TheyareplayingagameofhotpotatowiththeirITassetsandtheMasterLeaseagreements. TheirITinfrastructureisveryfarbehindcompetitors,andunabletowithstandanymajorproblems,andis

extremelygeographicallyconcentrated.Hereisinfofrom10K2010:

If the facility where substantially all of our computer and communications hardware is located fails, our

business, prospects, financial condition and results of operations could be harmed.

If the facility where substantially all of our computer and communications hardware is located fails, or we

suffer an interruption of services through the facility for any reason, our business, prospects, financial condition and

results of operations could be harmed.

Our success, and in particular, our ability to successfully receive and fulfill orders and provide high-quality

customer service, largely depends on the efficient and uninterrupted operation of our computer and communications

systems. Substantially all of our computer and communications hardware is located at a single co-location facility in

Salt Lake City, Utah, with a partially redundant back-up system located less than six miles from the co-location

facility. In the event of an earthquake or major local disaster, or any other man-made or natural cause of interruption

of service, both our primary and back-up sites could be adversely affected. Although we have designed our back-up

system in an effort to minimize service interruptions in the event of a failure of our main facility, our systems and

operations are vulnerable to damage or interruption from fire, flood, power loss, telecommunications failure,

terrorist attacks, acts of war, break-ins, earthquake and similar events. In the event of a failure of our primary

facility, the failover to our back-up facility would take at least several hours, during which time our Website would

be completely shut down. Our back-up facility is designed to support sales at a level slightly above our average daily

sales, but is not adequate to support sales at a high level. The back-up facility may not process effectively during

time of higher traffic to our Website and may process transactions more slowly and may not support all of the


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functionality of our primary site. These limitations could have an adverse effect on our conversion rate and sales.

Our disaster recovery plan may be inadequate, and we do not carry business interruption insurance sufficient to

compensate us for losses that could occur. Despite the implementation of network security measures, our servers are

vulnerable to computer viruses, physical or electronic break-ins and similar disruptions, the occurrence of any of

which could lead to interruptions, delays, loss of critical data or the inability to accept and fulfill customer orders.

The occurrence of any of the foregoing risks could harm our business, prospects, financial condition and results of

operations.

TheSharepricehasbeenunabletosustainanymovesbelow$7.75;therehasbeenanobviousbidderunderneathsupportingit,soletsseewhothatis.

http://www.secform4.com/filings/1130713/000114420411071089.htm

Mr.Chouisa>10%ownerofOSTK,andalsoowned$10MillionoftherecentlyredeemedConvertibleNotes

thatthisdebtwastakenouttopayoff.

DISCLAIMER

TheinformationcontainedhereinreflectstheviewsofTheDavianLetterLLCanditsaffiliates(collectively"TDL")asof

thedateofpublication.Theseviewsaresubjecttochangewithoutnoticeatanytimesubsequenttothedateof

issue.TDLhasaneconomicinterestinthepricemovementofthesecuritiesdiscussedinthisresearchnote,butTDL's

economicinterestissubjecttochangewithoutnotice.Allinformationprovidedinthisresearchnoteisfor

informationalpurposesonlyandshouldnotbedeemedasinvestmentadviceorarecommendationtopurchaseor

sellanyspecificsecurity.Whiletheinformationpresentedhereinisbelievedtobereliable,norepresentationorwarrantyismadeconcerningtheaccuracyofanydatapresented.Inaddition,therecanbenoguaranteethatany

projection,forecastoropinioninthisresearchnotewillberealized.Alltradenames,trademarks,servicemarks,and

logoshereinarethepropertyoftheirrespectiveownerswhoretainallproprietaryrightsovertheiruse.

overstock.com is overstocked

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