The Smoking Gun? Gairsoppa Contract Facts via UK FOI
Since our original report on Odyssey Marine Exploration (NASDAQ:OMEX) was published at http://www.omextruth.com on Oct 31, we have been contacted by multiple salvage industry experts. Every one of these industry veterans have uniformly been adamant that they see a very different picture of OMEX than what Odyssey presents to shareholders. We now have public documents that confirm some of the alarming information brought to our attention by industry expert whistleblowers.
Through a Freedom of Information Request with the UK Government, we have obtained the actual salvage contract that OMEX has for the SS Gairsoppa recovery with the UK Department for Transport. This contract appears to contradict Odyssey's repeated public statements that they are reimbursed for all search and salvage expenses.
The central issue is which expenses are allowable in the determination of "net salvage value", an industry term representing the value of the salvage net of excluded processing and selling expenses. Specifically, there is a large difference (roughly analogous to the difference between gross profits and net profits of a business) between net salvage value being determined net of total expenses, or net of only certain expenses.
According to contract provided by the UK Government, the list of reimbursable expenses is very specific and limited to "expenses of realisation*, storage, handling, freight, assay costs and insurance up to the point of sale." This is NOT the same as the much broader "search, recovery, and processing expenses" that Odyssey represents to investors. Based on our discussion with salvage industry experts, we believe the actual allowable expenses (reimbursed before the 80/20 split of the net salved value) is a small fraction of what OMEX has claimed it is entitled to; search and recovery expenses are the most significant and are borne directly by the salvage firm. Based on feedback from industry experts, we estimate the value of these limited excluded expenses at approximately $3-5mm, dramatically lower than Odyssey's claimed $27mm of reimbursable expenses.
If true, this would imply materially lower profit margins for the Gairsoppa project than OMEX has claimed. Given the total silver salvaged from the Gairsoppa is estimated at $75mm, which nears OMEX's cumulative revenue since the year 2000 of $108mm, we believe this is a highly material issue.
CONDITIONS OF CONTRACT FOR SALVAGE OF CARGO (NO CURE NO PAY):
5. CALCULATION OF NET SALVED VALUE AND MANNER OF REALISATION
5.1 The parties hereto shall agree as to the time, place and manner of realisation of all salved Cargo so as to maximise the proceeds of such realisation. The agreed reasonable and verifiable expenses of the custody of and dealing with the disposal of the salved Cargo, including the expenses of realisation, storage, handling, freight, assay costs and insurance up to the point of sale, shall be deductible from the proceeds of sale in calculating the Net Salved Value on which the Contractor's remuneration shall be based. Should the parties not be able to agree on time, place and manner of realisation then the matter is to be referred to Arbitrators, appointed in accordance with Condition 27, for a decision.
6.1 All operations by the Contractor connected with this Contract shall be conducted entirely at the Contractor's own risk and on "No Cure No Pay" terms and all risks, charges and expenses up to and including expenses connected to the sale of recovered Cargo shall be borne entirely by the Contractor in accordance with the terms of this Contract.
This language in the contract appears to directly contradict OMEX's repeated public statements as well as SEC filings:
OMEX's most recent 10-Q filed Nov 12, 2013 (emphasis ours):
Operating and recovery expenses incurred in connection with the Gairsoppa contract consist of vessel-related expenses (ships' crew, provisions, port fees and charter expenses), fuel, specialized equipment and administrative expenses. These expenses are charged to the Consolidated Statements of Income as incurred and subsequently reimbursed per our contract and recorded as a benefit (credit to expense) in the period we are assured of recoupment.
We invite readers to read the entire contract language in the links below - we cannot find language of this type appearing anywhere in any of the actual contracts.
And OMEX's most recent 10-K filed March 12, 2013 (emphasis ours):
"Any monetary proceeds from the salvage will first be applied to reimbursement of Odyssey's search, recovery and processing expenses. Any remaining monetary proceeds will next be divided with Odyssey retaining 80% of the net salved value, and 20% retained by the UKG"
Full FOI Request Documents - dated Dec 4, 2013:
Where is OMEX's Auditor?
Auditors are the watchdogs of financial reporting, especially for public companies. First-class auditors, who are independent of management, are critical to assuring a robust audit process, one designed to detect corner cutting as well as outright fraud. Any deficiencies in the independence and skill of the audit team create an opportunity for a wide range of evils, as demonstrated by the spectacular incompetence of Friehling & Horowitz, the auditors for Bernard Madoff's finances. When we ponder the relationship between Ferlita, Walsh, Gonzalez & Rodriguez, P.A. (the "Ferlita Firm") and OMEX's senior management, we see disturbing parallels:
- This auditor is unusually small and appears unsophisticated for a company of Odyssey's size and complexity of corporate structure, especially in light of Odyssey's multiple offshore entities. The Ferlita Firm's only other public company clients are small, one (NASDAQ:VIFL) has a capitalization of approximately $15mm and revenue of less than $4mm/year and the other (OTCQB:PCYN) trades for approximately $0.12 per share with a nominal market capitalization.
- The Ferlita Firm has only a few partners, so there is a high likelihood that the same individuals perform the audit each year, fostering personal ties to management.
- The Ferlita Firm has been Odyssey's auditor since inception, from what we can ascertain. These long-term ties between the same individuals are generally prohibited under Sarbanes-Oxley, although the Ferlita Firm apparently qualifies for exemption from partner rotation requirements based on its small size. We ask, is this prudent?
- The same firm was also auditor to Seahawk Deep Ocean Technology, Inc. (OTCPK:SHWK: $0.0012), run by Odyssey's senior managers, Stemm and Morris. The ties thus go back twenty years.
The most recent 2012 PCAOB report on the Ferlita Firm found multiple deficiencies, including a deficiency related to perhaps the largest single issue affecting OMEX's value - the fair value measurement of financial instruments. Here is a link to the PCAOB report.
The PCAOB reported that it appeared to the inspection team that the Ferlita Firm, at the time it issued its audit report, had not obtained sufficient competent support for its opinion on material items in the issuer's financial statements. Those deficiencies were:
"(1) the failure to perform sufficient audit procedures related to a deferred income tax asset valuation allowance; and
(2) the failure to perform sufficient audit procedures related to fair value measurements of financial instruments." (emphasis added)
The PCAOB report in 2009 found similar problems. This makes the recent deficiencies all the more disturbing. Why hasn't the Ferlita Firm cleaned up its act? Portions of both PCAOB reports are not available to the public. We urge the Audit Committee to obtain the complete reports to assess further the quality of the Firm's work, and to provide this information to the public.
No prudent director should reasonably rely on the Ferlita firm in light of these red flags. We believe that because of these deficiencies and the apparent discrepancy between OMEX's SEC filed financial statements and the contract we have obtained via FOI, the Audit Committee must immediately obtain a new auditor for OMEX.
Shareholders Deserve Answers
Thanks to the Freedom of Information Act, we now know Odyssey is being investigated by the UK Government related to the HMS Victory.
Likewise, the company has failed to address our publicly expressed concerns about the four German WWII government (that no longer exists) blockade runner ships we believe are the ships Odyssey is claiming it will pursue as commodity salvage projects. We believe an attempt to salvage these ships in nearly 6,000m of water will encounter legal challenges as to the true ownership, which we outlined in our previous report published November 15, 2013.
These issues underscore the continued need for complete and accurate auditing of the fair value of the undersea mining financial instruments. We know that Odyssey has failed to release information about the value of this supposed "world-class" Oceanica asset and has only made vague promises of grandeur.
Shareholders deserve more than more vague promises. We believe shareholders should not rely on statements made about the supposed "fair value" of the Neptune or Oceanica assets until Odyssey submits all of its records to a competent, nationally recognized auditor for review.
* "expense of realisation" appears to be a UK accounting term meaning the cost of converting an asset to cash (e.g. auction fees)
Disclosure: I am short OMEX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.