Thursday, March 15, 2007

Talk is Cheap, Unless You’re a Shareholder


On July 1, 2005, we acquired all the outstanding capital stock of Ski West, Inc. (“Ski West”), an on-line travel company whose proprietary technology provides easy consumer access to a large, fragmented, hard-to-find inventory of lodging, vacation, cruise and transportation bargains…. We paid an aggregate of $25.1 million (including $111,000 of capitalized acquisition related costs) for Ski West, and we may be subject to additional earn-out payment…

As part of this program to reduce our expense structure and sell non-core businesses, we decided during the fourth quarter of 2006 to sell the Company’s travel subsidiary (“OTravel”)…. As a result, OTravel’s operations have been classified as a discontinued operation and therefore are not included in the results of continuing operations.

—Overstock.com 2006 10K


Well that was fast.

Seems Our Man in Salt Lake City, a self-described “value investor” and Warren Buffett disciple, decided to hit the bid on Ski West, a business he’d bought a mere 18 months before the decision to sell.

And to sell at a discount to his cost basis, no less.

Just a year ago, Our Man in Salt Lake City was talking up the operating trends at that operation, as follows:

Ski West did okay. The business we bought made money through the second half of the year. We, on top of that, we already had started development of a travel business that we sort of integrated -- we spent six months integrating into Ski West and writing off, we wrote off all the development costs of code and different things we have done, we wrote to zero.

So travel as a whole showed a loss for the second half of the year but the business we bought made money, made a nice little chunk of money. And then on top of that, we have gotten everything we think fixed and together in travel, so even in January, the whole business made money not just the business we bought but now everything worked together is making money. It made a nice little sum in January.


The only problem with that statement, which occurred on the February 7, 2006 conference call, is that Our Man in Salt Lake had hinted at far greater things on an earlier call, from August 2005.

Specifically:


SkiWest. I'll give you some numbers on SkiWest and let me walk through the numbers and then I'll give you sort of the footnote at the end. Last year Ski West revenue was $30 million. And that means from April 1 until March 31 was $30 million. And then for this year they plan to do at least $60 million. Last year on 30 million of revenue they made a $1 million. This year, meaning from April 2005 to March of 2006, they figure that they would be able to do 2 million, 2.5 million of income operating profit.

A few footnotes on that. If a company is growing that fast, and its April to March number is 60 million, then its July number will be higher. It will be 70 million, 75 million. In addition, they're growing now at faster than 100% pace. So it's possible to be talking about maybe 80 to 90 million in the July to June period, July of this year to June of next year period, 80 to 90 million. In which case, it looks more like something that could make 3.5, 4, something like that.

It looks like Ski West came nothing close to “something like that,” at least according to the following disclosure in the latest 10K.

The loss from discontinued operations for OTravel was $6.9 million for the year ended December 31, 2006, including a goodwill impairment charge of $4.5 million.

The lesson?

Talk is cheap—although it can be very expensive for shareholders.



Jeff Matthews
I Am Not Making This Up


© 2007 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.

5 comments:

pondering said...

Actions speak volumes. Jeff you’re holding a magnifying glass to a fallen leaf on a sunny day with this one.

QuestionMark and the Mysterians said...

Probably better than holding a magnifying glass to an ant on a sunny day, which is probably what the twisted bad Dr. did when he was little.

How long before the board members and/or the SEC gives Patty a few whacks for his message board shenanigans? Or having people on the OSTK payroll who's job it is to spy on message board posters?

Sam E. Antar said...

Jeff:

Enclosed are questions I would ask Patrick Byrne aka Hannibal (CEO of Overstock.com) relating the 10 – K and other disclosures by Overstock.com:

I quote the following disclosures in Overstock.com’s 10 - K filed with the SEC for the fiscal year ended 12/31/06:

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

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

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

Can you quantify within a reasonable range the “significant improvement" in specifically "direct sales" that you believe can be achieved?

Are such beliefs about future gross margins based on previous gross margins achieved in the fourth quarter for "direct sales" of merchandise that was unrelated to the “aggressive” discounting?

I quote the following disclosures in Overstock.com’s 10 – K for the fiscal year ended 12/31/06 & 10 –Q for the quarter ended 09/30/06:

10 – Q for quarter ended 09/30/06:
The reserve for returns was … $1.8 million as of … September 30, 2006….

10 – K for fiscal year ended 12/30/06:
The reserve for returns was … $3.6 million as of December 31, 2006….

Questions:
Can you describe the factors involved in the relative and absolute increase in “reserve for returns” from 09/30/06 to 12/31/06?

I quote the following disclosures in Overstock.com’s reports filed with the SEC:

10-Q Quarter Ended 09/30/06:

"As of September 30, 2006, our inventory balance was $68.8 million, net of allowance for obsolescence or damaged inventory of $4.5 million."

10-K Fiscal Year Ended 12/31/06:

"As of December 31, 2006, our inventory balance was $20.3 million, net of allowance for obsolescence or damaged inventory of $6.6 million."

Questions:
Can you describe why the allowance for “obsolescence or damaged inventory” rose as a percentage of total inventories from 09/30/06 to 12/31/06?

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

Respectfully,

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

PS:

Jeff, I read conference call transcripts frequently and there is too little follow through by financial analysts to representations made by management.

As a criminal, I took advantage of the relative lack of critical questions.

jmf said...

thanks from germany

i have listen to one call from ooverstock.

not march madness

madness from january-december

Sam E. Antar said...

Jeff,

More questions for Patrick Byrne:

To Patrick Byrne AKA Hannibal (CEO of Overstock.com)

The third quarter fiscal year 10-q contains the following disclosure:

“We write down our inventory for estimated obsolescence or damage equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required. Once established, the original cost of the inventory less the related inventory reserve represents the new cost basis of such products. Reversal of these reserves is recognized only when the related inventory has been sold or scrapped. As of September 30, 2006, our inventory balance was $68.8 million, net of allowance for obsolescence or damaged inventory of $4.5 million. At December 31, 2005, our inventory balance was $93.3 million, net of reserve for obsolescence or damaged inventory of $5.2 million.”

In addition, the 3rd quarter 10-q for fiscal year 2006 contained the following disclosure:

Direct Gross Margins—Gross profits for our direct business decreased 40% from $9.3 million for the quarter ended September 30, 2005 to $5.5 million recorded during the same period in 2006. Gross profits as a percentage of direct revenue were 13.6% and 9.8% for the quarters ended September 30, 2005 and 2006, respectively. For the nine months ended September 30, 2005 and 2006, gross profits for our direct business were $27.4 million and $21.8 million, a decrease of 20%. The lower gross margins experienced by the direct business are primarily the result of lowering prices to our customers in an effort to reduce inventory levels, and we expect continued markdowns to have a similar effect on gross margins through the fourth quarter.

Link here to Overstock.com 3rd quarter fiscal year 2006 filing with the SEC:

http://sec.gov/Archives/edgar/data/1130713/000110465906073420/a06-21698_110q.htm

During the 4th quarter Overstock.com had negative gross margins of about $3 million on its direct sales of about $98 million. In the previous quarter Overstock.com had positive gross margins of about $5 million on direct sales of about $56 million. At the end of the third quarter or beginning of the 4th quarter Overstock.com has about $68 million of total inventory on hand.

Link here to the Overstock.com 8-k relating to the 4th quarter of fiscal year 2006 filed with the SEC:

http://sec.gov/Archives/edgar/data/1130713/000110465907007027/a07-3084_2ex99d1.htm

Jason C. Lindsey said during the 4th quarter conference call:

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

Link:
http://internet.seekingalpha.com/article/26114


Questions:
Based on the proper application of valuing inventory at the “lower of cost or market” principal and other principles under Generally Accepted Accounting Principles (GAAP) do you believe the inventory amounts reported on the 3rd quarter balance sheet and previous quarters were materially correct and /or properly reported in accordance with GAAP?

In hindsight based on your experience in the 4th quarter 2006, do you believe that inventories were properly valued at the end of the third quarter?

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

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

Byrne:

I don't know. We have a plan this year that we should cross the billion-dollar mark. Put it this way: Amazon, at our stage, was losing $1.2 million a year in operations. It made up a phony accounting standard--pro forma. And when it reached pro forma breakeven, Wall Street set off fireworks.
When it reached EBITDA (earnings before interest, tax, depreciation and amortization) breakeven, Wall Street wanted to declare it a national holiday. I've never used pro forma in my life. We've had some GAAP (generally accepted accounting principles) profitable quarters, plenty of operating profit and EBITDA profitable quarters. This year, with a little luck, we should be an EBITDA-profitable year, so I'm kind of comfortable with that.

Link here:
http://news.com.com/CEO+on+the+hot+seat+-+page+2/2008-1030_3-6046300-2.html?tag=st.num

My question:

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

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

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

Respectfully,

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