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Yesterday, Overstock.com (NASDAQ:OSTK) disclosed that it was forced to pay off its existing obligations under a Master Lease Agreement with US Bank to avoid an anticipated default under its covenants on December 31, 2011. So far, Overstock.com has lost $16 million in the first nine months of the year compared to only a $1.1 million loss during the previous year's nine month period. The termination of the Master Lease Agreement by Overstock.com to avoid a pending default appears to confirm that it will report dismal fourth quarter 2011 numbers.

According to the 8-K report filed with the Securities and Exchange Commission after the market closed on December 28, 2011:

On December 27, 2011 Overstock.com, Inc. (the “Company”) and U.S. Bancorp Equipment Finance, Inc. - Technology Finance Group (“Lessor”), agreed to terminate a Master Lease Agreement, dated September 17, 2010 (“Master Lease Agreement”) and all related schedules. The Company paid approximately $20.1 million to Lessor in connection with the amendment and agreement to terminate the Master Lease Agreement, including approximately $1.2 million in prepayment premiums. The aggregate amount the Company paid to amend the Master Lease Agreement and terminate the schedules associated with the Master Lease Agreement was less than the amount the Company would have been required to pay over the scheduled life of the Master Lease Agreement and all related schedules. By this transaction, the Master Lease Agreement was first amended to eliminate all financial covenants, effective immediately. Lessor also committed to convey to the Company all of the equipment and other assets covered by the Master Lease Agreement for no additional consideration.

The Company amended the Master Lease Agreement in order to eliminate the total fixed charge coverage ratio covenant under the Master Lease Agreement. As disclosed in the Company’s Form 10-Q for the quarter ended September 30, 2011, based on the Company’s results for the first three quarters of 2011, management considered it likely at that time that the Company would be out of compliance with the Master Lease Agreement’s total fixed charge coverage ratio covenant at December 31, 2011. In order to avoid a covenant violation, the Company amended the Master Lease Agreement to eliminate the financial covenants.

Lessor is an affiliate of U.S. Bank National Association (the “Bank”). The Company has a $20 million cash-secured credit facility with the Bank. The Bank or its affiliates have also provided other commercial services to the Company from time to time. (Emphasis added.)

Overstock.com tried to spin its termination of the Master Lease Agreement as positive news by claiming that the amount paid to US Bank was “was less than the amount the company would have been required to pay over the scheduled life of the Master Lease Agreement and all related schedules." However, the company apparently agreed to pay the full obligation of $18.9 million that was due under the Master Lease Agreement as of December 31, 2011 plus applicable taxes and a stiff $1.2 million prepayment penalty. It was unable to restructure its Master Lease Agreement and obtain less stringent terms from US Bank.

As of September 30, 2011, OSTK owed US Bank $20.329 million under the Master Lease Agreement. $1.428 million of that amount was payable during the quarter ending December 31, 2011. (See Quarter Ended September 30, 2011 10-Q report page 17). Therefore, Overstock.com would have owed US Bank $18.901 million as of December 31, 2011 ($20.329 million less $1.428 million). The prepayment penalty amounts to approximately 6% of Overstock.com's obligation to US Bank under the Master Lease Agreement as of December 31, 2011. That prepayment penalty will be reflected as a charge to its otherwise expected dismal fourth quarter financial results. Furthermore, the company will have to take additional depreciation charges in future periods since it will take title to the equipment and other assets covered under the Master Lease Agreement.

Liquidity Problems

As of September 30, 2011, Overstock.com reported that it had only $18.4 million in working capital. However, the company would have reported a mere $1.4 million of net working capital (current assets minus current liabilities) had it not played a shell game and window dressed its balance sheet during the third quarter.

On September 21, 2011, Overstock.com borrowed $17 million under a separate Financing Agreement (line of credit) with US 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). The convertible debt was classified on the company's balance sheet as a current liability. 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).

Had Overstock.com not borrowed that $17 million from US 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.

As of December 31, 2011, $12.959 million of Overstock.com's $18.901 million obligation under the Master Lease Agreement would have been classified as a long term liability. Since the company paid $20.1 million, including a $1.2 million prepayment penalty to terminate the agreement, its working capital was apparently depleted by another $7.1 million ($20.1 million less $12.959 million).

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 do some sort of equity related offering in the first quarter of 2012 to stay afloat and avoid further liquidity problems. Such an offering will likely significantly dilute the value of existing common shares. (See Davian Letter "Overstock.com is Overstocked.")

On December 14, 2011, the company unloaded millions of dollars of excess inventory in a public auction and generated a mere $150,000 in cash, just pennies on the dollar.

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 allegedly fabricating its earnings numbers. So far, every single financial report issued from its inception in 1999 to the third quarter of 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 (NASDAQ:GOOG) penalized Overstock.com because it improperly gamed its search algorithm to boost its search rankings.

In October 2011, Overstock.com CEO Patrick Byrne, his hedge fund High Plains Investments LLC, 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.

Latest Developments

Back in January 2011, Overstock.com changed its name to O.co and directed its customers to use the O.co domain. As late as September 30, 2011, Patrick Byrne claimed in a press release that, "Our customers associate 'O' with Overstock.com, which made the transition to O.co seamless."

However, in the third quarter ended September 30, 2011, Overstock.com reported a $7.8 million loss compared to a $3.4 million loss in the previous year's quarter. Revenues during that quarter had declined by 2% to $239.7 million from $245.4 million in the previous year. The company revealed that, "We also believe that our current efforts to rebrand ourselves from Overstock.com to O.co may have contributed to the decline in revenue." (See 10-Q page 33). Apparently, Overstock.com's transition to O.co was not as "seamless" as previously claimed by Byrne at the end of that same quarter. During a conference call with analysts, Patrick Byrne now admitted that customers found the transition was "confusing."

On November 14, 2011, Ad Age reported that the company's president, Jonathan Johnson, also backpedaled on remarks made by Byrne at the end of its third quarter:

The online retailer's president, Jonathan Johnson, said it is stepping back from the O.co name "for now," though not abandoning it outright ..."

Confused? So were customers. Mr. Johnson said customers responded well to the O.co advertising, but after watching the spots, "a good portion" of those who sought out the website went to O.com, instead of O.co. (O.com is one of the off-the-market single letter domain names still held by ICANN.)

"We were going too fast and people were confused, which told us we didn't do a good job," Mr. Johnson said.

Marketing Magazine put Overstock.com's rebranding efforts at the top of its list of 2011 marketing blunders.

Worst Customer Service In 2011

Just yesterday, the Huffington Post reported that, “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.”

Byrne Sold Shares Before Decline

Yesterday, Overstock.com common stock closed at $7.77 per share. Back on May 20 to May 24, 2010, Patrick 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. Despite Byrne's optimistic forecasts, the company surprised investors and failed to meet analysts' consensus earnings expectations in the quarter ended June 30, 2010. Since the time Byrne has sold his stock, Overstock.com’s shares have dropped about 65% in market value and its market capitalization has dropped approximately $330 million.

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

Source: Overstock.com Facing Dismal Fourth Quarter Numbers?