Overstock.com: 'The 10-Ks They Are A-Changing'

| About: Overstock.com, Inc. (OSTK)

In my last article I pointed out how an examination of Overstock.com's (NASDAQ:OSTK) 10-K for 2011, when compared with the 10-K for 2010, showed an inexplicable loss of 200 employees.

Well, as the great Al Jolson used to say, "You ain't seen nuthin' yet." Or as Bob Dylan would have put it: "The 10-Ks they are a-changing."

A loyal reader and Overstock-watcher has sent me a detailed analysis of how the 2011 10-K differed from the 2010 10-K. With that person's kind permission, I have taken the liberty of passing it on to you, in its entirety, below.

The deletions and additions go in roughly the order in which they are situated in the 10-K. Have fun!

New disclosure:

These forward-looking statements speak only as of the date of this report and, except as required by law, we undertake no obligation to update forward-looking statements to reflect events or circumstances occurring after the date of this report.

Generally, we require verification of receipt of payment, or authorization from credit card or other payment vendors whose services we offer to our customers (such as PayPal and BillMeLater), before we ship products to consumers or business purchasers. From time to time we grant credit to our business purchasers with normal credit terms (typically 30 days). For sales in our fulfillment partner business, we generally receive payments from our customers before our payments to our suppliers are due.

44 Prior to July 2011, we operated an online auction service as part of our Website. In July 2011, we removed our Marketplace tab for auctions from our Website and no longer provide auction services. The financial results and related assets of the online auction service were not significant to our business. Our Marketplace tab allowed sellers to list items for sale, buyers to bid on items of interest, and users to browse through listed items online. We recorded only our listing fees and commissions for items sold as revenue. From time to time, we also sold items returned from our shopping business through our auction service, and for these sales, we recorded the revenue on a gross basis. Revenue from the auctions is included in the fulfillment partner segment.

Prior to June 2011, we operated an online site for listing real estate for sale as part of our Website. In June 2011, we removed our online site for listing real estate for sale from our Website and no longer provide these real estate listing services. The financial results and related assets of the online site for listing real estate for sale were not significant to our business. The real-estate listing service allowed customers to search active listings across the country. Revenue from the real estate business is included in the fulfillment partner segment on a net basis.

Prior to June 2011, we operated Eziba.com, a private sale website featuring home décor products, jewelry, apparel and accessories from many leading brands. In June 2011, we turned off the Eziba.com website; however, we continue to sell the type of products that were listed on Eziba.com through our websites, O.co and Overstock.com.

Revenue from our other businesses is less than 1% of total net revenues.

* website organization and load speed;

Additionally our efforts to protect our trade secrets may not succeed.


73 Mr. Geoffrey R. Atkinson currently serves as our Senior Vice President, Analytics, Analytics Marketing & Merchandising. Since joining us in 2005, Mr. Atkinson has worked primarily on marketing and customer retention. Mr. Atkinson has previously served as Senior Vice President of Marketing and Vice President of Tactical Marketing. Before joining Overstock.com, Mr. Atkinson worked in marketing and branding at Smith Sport Optics, a manufacturer of sunglasses and goggles for sports and leisure, in Sun Valley, Idaho. Mr. Atkinson holds a Bachelor of Arts Degree in Sociology from Dartmouth College.

A new disclosure:

We may not be able to achieve profitability on a quarterly or annual basis in the future.

Another deletion:

The last year we incurred a net loss was for the year ended December 31, 2008 in which the amount was a net loss of $11.0 million.

Another deletion:

expand warehouse and office space;

More new disclosures:

We depend on our fulfillment partners to provide a large portion of the product selection we offer and on vendors for the products we purchase and offer in our direct business. Cyber-attacks affecting any of our most significant suppliers or affecting a significant number of our suppliers could have adverse effects on our business, prospects, financial condition and results of operations. The adverse effects could include our inability to source product or fulfill orders or the compromise of our customers' confidential data.

If our relationships with these third parties are terminated or impaired or if these third parties are unable to deliver products for us, whether as a result of labor shortage, slow down or stoppage, deteriorating financial or business condition, terrorist attacks, cyber-attacks, internet or other infrastructure or communications impairment, natural disasters, or for any other reason, we would be required to use alternative carriers for the shipment of products to our customers. (Just the part about cyber attacks and communications disruptions is new)

infrastructure or communications impairment or other events that could interrupt the normal operation of the credit card processors, could have a material adverse effect on our business, prospects, financial condition and results of operations.
Events affecting our credit card processors, including cyber-attacks, internet or other

A new disclosure:

Financial performance concerns may cause fulfillment partners or other suppliers to limit or suspend doing business with us, or require prepayments.

We rely upon our fulfillment partners and other suppliers for the product offerings sold on our website and other products and services we use to run our business. Our ability to retain or attract new fulfillment partners and other suppliers may depend in part on our financial performance. Poor financial performance may create concern about our creditworthiness, which could result in suppliers choosing to limit or suspend doing business with us or require us to prepay for our purchases, which could harm our business, prospects, financial condition and results of operations.

A deletion:

Our performance is substantially dependent on the continued services and on the performance of our senior management and other key personnel. (Last year the sentence read, "Including our CEO Patrick Bryne," whereas this year it does not)

An addition:

We may be ordered to pay allowable court costs which could be substantial. (This sentence was added to the end of the paragraph on the Goldman Sachs litigation.)

Here's a gem:

During the three months ended December 31, 2009, we had a change in estimate for our sales returns allowance that reduced the allowance by approximately $3.0 million from the prior quarter-end balance and $3.2 million from the prior year-end balance that was recorded in accordance with ASC 250 "Accounting Changes and Error Corrections" on a prospective basis. The change in estimate for our sales returns allowance had the following impact on our financial results for the three and twelve months ended December 31, 2009 (amounts in thousands, except per share data):

The reasons for the change in estimate in the fourth quarter of 2009 were as follows. We made improvements to our information systems during 2008 and 2009 that enabled enhanced reporting and analysis of our returns data used in the estimation process. In early 2009, we implemented initiatives to reduce overall return rates in several of our product categories. In September 2009, we entered into a new master supplier agreement with our fulfillment partners that provided financial incentives for suppliers to reduce returns. These initiatives resulted in a sustained decrease in our product return trends resulting in the change in estimate of sales returns allowance during the three months ended December 31, 2009.

Although we believe that our estimates, assumptions, and judgments are reasonable, actual results have historically differed from our estimates. Based on our actual returns experience through December 31, 2011, had our estimated returns equaled our actual returns, our net loss would have decreased approximately $1.5 million for the year ended December 31, 2007, our net loss would have increased approximately $725,000 for the year ended December 31, 2008, and our net income would have decreased approximately $805,000 for the year ended December 31, 2009. Based on the improvements and initiatives discussed above, we believe that our estimates, assumptions and judgments have improved and our actual product returns have not differed materially from our estimates at December 31, 2010 and during 2011.

More new disclosures:

Our $20 million credit facility with U.S. Bank is scheduled to terminate on December 31, 2012. Although we have $20 million on deposit with U.S. Bank, and may repay and terminate the facility, we may attempt to renegotiate the facility or replace it. There can be no assurance we will be able to do so. In December 2011, we paid $20.1 million to terminate our obligations under our Master Lease Agreement, resulting in a significant decrease in cash on hand at December 31, 2011 (see "Borrowings" below).

The stated termination date of the Financing Agreement is December 31, 2012. The maximum amount potentially available under the Financing Agreement is $20 million, limited to $3 million for cash-collateralized letters of credit and other financial accommodations, and $17 million for advances supported by our non-cash collateral. As permitted by the Financing Agreement, during the year ended December 31, 2011, we used the entire $17 million available for advances supported by our non-cash collateral to fund the redemption of our then-outstanding Senior Convertible Notes due December 1, 2011.

Advances under the Financing Agreement bear interest at one-month LIBOR plus 2.5%. The interest rate for borrowings under the Financing Agreement was 2.75% at December 31, 2011. We have also entered into an interest rate cap agreement with U.S. Bank with an effective date of October 1, 2011 limiting our exposure for one-month LIBOR at 0.5% for the term of the Financing Agreement.

At December 31, 2011, we had $20.0 million in compensating cash balances held at U.S. Bank. If we draw on the $20.0 million compensating cash balance, it will constitute a triggering event and result in additional and more restrictive covenants.

During 2011, we were out of compliance with two covenants and obtained waivers from U.S. Bank for these covenant violations.

The $25.7 million of net cash provided by operating activities during the year ended December 31, 2011 was primarily due to a decrease in inventory of $9.1 million from an effort to maintain lower inventory levels and a shift in sales mix, particularly in clothing and shoes, from a direct inventory-based model to a fulfillment partner-based model to reduce seasonal inventory risks, an increases in accrued liabilities of $7.0 million primarily related to marketing and legal expenses, an increase in deferred revenue of $4.0 million primarily due to continued growth of our Club O loyalty program and an increase in accounts payable of $2.9 million.

Recommendation Algorithm Development Costs

During 2011, we announced two contests offering cash prizes of up to $1.3 million for each contest period to the researcher or research team who can design and develop a recommendation algorithm which provides a minimum of 1% increase in sales as compared to our existing algorithm. The contest periods end March 31, 2012 and September 30, 2012 and the cash prizes, if any, would be awarded at those times.

Our foreign brand domain name may cause confusion in foreign markets.

In July, 2010, we undertook an effort to associate our brand globally with the domain address: www.O.co. We did this in part because in many foreign markets the word "Overstock" lacked a good foreign cognate. Following a period of testing for the O.co brand and domain address, we returned to the Overstock.com name as our primary brand domestically because domestic consumer acceptance did not occur as quickly as we had hoped. While we have returned domestically to the Overstock.com brand and principal domain address, there is no assurance that the use of Overstock.com or O.co will gain acceptance or have success in foreign markets.

We cannot provide assurance that our technology can prevent breaches of the systems that we use to protect customer data.

Prior to October 2010, we were asked for information in the form of records connected to this matter, all of which we provided. The SEC has interviewed several witnesses. However we do not know the present status of the investigation. We have not heard formally from the SEC on this matter after October 2010, and we know of no person interviewed since that time related to this matter.

The platforms of the listing services are accessible to subscribers who have the ability to feature their cars listings for sale and supply the descriptions of the vehicles, including the general condition of the vehicle and other important information. We have no ability to know whether the information sellers provide is correct. While our site terms and conditions of usage prohibit unlawful acts, we cannot rule out the possibility that users of our car listing site will engage in unlawful transactions, or fail to comply with all laws and regulations applicable to them and their transactions. We may be subject to allegations of civil or criminal liability for any unlawful activities conducted by such users.

We are aware that other companies operating online car listing service have periodically received complaints from users alleging improprieties in connection with listings and occasionally these complaints may result in regulatory action. With any online listing service there is the possibility that sellers may attempt to employ "bait and switch" techniques, attracting consumers with advertisements of low cost, good condition vehicles in hopes of switching buyer interest to another less favorable vehicle once a potential purchaser responds. Additionally, sellers may attempt to sell vehicles without accurate descriptions of the condition of the vehicles. We have occasionally received complaints of this nature regarding our car listing service. In response to serious or repeat complaints concerning a car dealer, we may take action to prohibit such persons from listing inventory, but we do not have the ability to require users of our services to fulfill their obligations to make accurate disclosures or comply with consumer laws prohibiting "bait and switch" or other prohibited seller tactics. We are aware that other companies providing similar services periodically are threatened or by or subject to legal actions against the listing service for damages because of user conduct. We may encounter similar legal actions in connection with our cars listing service, which may harm our business or reputation among consumers.

Our insurance coverage and indemnity rights may not adequately protect us against loss.

and hardware suppliers for losses we might incur as a result of the use of the technology products they supply, we are not indemnified by all our suppliers, nor can we be certain that our indemnification rights are enforceable or adequate to cover actual losses we may incur as a result of the sale or use of products our indemnitors provide to us. Actual losses for which we are not insured or indemnified, or which exceed our insurance coverage or the capacity of our indemnitors, could harm our business, prospects, financial condition and results of operations.

Although we maintain liability and other types of insurance, including but not limited to, property, workers compensation, general liability, product liability, and security and privacy breach insurance, we cannot be certain that the types, coverage, or the amounts of coverage we maintain will be adequate for losses actually incurred, or that the insurance will continue to be available to us on economically reasonable terms. Similarly, although we are indemnified by most of our suppliers and vendors for product liability for products they supply us, and we have indemnification agreements with software

Third parties have demonstrated that they can breach the security of customer transaction data of large sophisticated internet retailers, government organizations and others.

We are subject to cyber security risks and may incur increasing costs in an effort to minimize those risks and to respond to cyber incidents.

Our business is entirely dependent on the secure operation of our website and systems as well as the operation of the internet generally. Our business involves the storage and transmission of users' proprietary information, and security breaches could expose us to a risk of loss or misuse of this information, litigation, and potential liability. A number of large internet companies have disclosed security breaches, some of which have involved intentional attacks. We may not have the resources or technical sophistication to anticipate or prevent rapidly evolving types of cyber-attacks. Attacks may be targeted at us, our customers, or both. If an actual or perceived breach of our security occurs, customer and/or supplier perception of the effectiveness of our security measures could be harmed and we could lose customers, suppliers or both. Actual or anticipated attacks and risks may cause us to incur increasing costs, including costs to deploy additional personnel and protection technologies, train employees, and engage third party experts and consultants.

A person who is able to circumvent our security measures could misappropriate our or our users' proprietary information, cause interruption in our operations, damage our computers or those of our users, or otherwise damage our reputation and business. Any compromise of our security could result in a violation of applicable privacy and other laws, significant legal and financial exposure, damage to our reputation, and a loss of confidence in our security measures, which could harm our business.

Most of our customers use credit cards to pay for their purchases. We rely on encryption and authentication technology licensed from third parties to provide the security and authentication to effectively secure transmission of confidential information, including customer payment card numbers. We cannot provide assurance that our technology can prevent breaches of the systems that we use to protect customer data. Data breaches can also occur as a result of non-technical issues.

Under payment card rules and our contracts with our card processors, if there is a breach of payment card information that we store, we could be liable to the payment card issuing banks for their cost of issuing new cards and related expenses. In addition, if we fail to follow payment card industry security standards, even if there is no compromise of customer information, we could incur significant fines or lose our ability to give customers the option of using payment cards to fund their payments or pay their fees. If we were unable to accept payment cards, our business would be seriously damaged.

Our servers are also vulnerable to computer viruses, physical or electronic break-ins, and similar disruptions, including "denial-of-service" type attacks. We may need to expend significant resources to protect against security breaches or to address problems caused by breaches. Security breaches, including any breach by us or by persons with whom we have commercial relationships that result in the unauthorized release of our users' personal information, could damage our reputation and expose

The Ohio Department of Taxation issued additional estimated assessments of estimated tax, interest and penalties totaling $97,768 as of December 31, 2011.We believe the assessment to be wrong and are contesting the assessment.

The States of Colorado, Oklahoma and South Dakota have enacted laws requiring remote vendors to notify resident purchasers in those states of their obligation to pay a use tax on their purchases.

In instances where customers receive free Club O reward dollars not associated with any purchases, we account for these transactions as sales incentives such as coupons and record a reduction of revenue at the time the reward dollars are redeemed.

We record Club O reward dollars earned from purchases as deferred revenue at the time they are earned and we recognize it as revenue upon redemption. (The "earned from purchases" part is new.)

In instances where customers receive free Club O reward dollars not associated with any purchases, we account for these transactions as sales incentives such as coupons and record a reduction of revenue at the time the reward dollars are redeemed.

On March 15, 2011, the Appellate Division of the New York State Court of Appeals denied our motion for leave to appeal to the New York State Court of Appeals. We have determined not to pursue at the trial court level our claims that the law is unconstitutional as applied. We are proceeding with an appeal to the New York State Court of Appeals of the Appellate Division's ruling on our claim that the statute is unconstitutional on its face.

A hearing on these matters was held November 18, 2011. No administrative ruling has been issued following the hearing. (<== Re the Ohio sales tax obligation)

* * *

That's the end of the comparison made by the aforementioned long-time Overstock-watcher. As I've said before: Overstock is the gift that keeps on giving, unless you happen to own the stock.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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