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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.
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