Friday, December 21, 2007

Warning to White Collar Criminals: Plan Ahead

If you are a white-collar criminal, plan on eventually being caught. It's just a matter of time. The Federal Prison Camp Tour website does an outstanding job of helping you plan ahead for your eventual future abode in the can.

The Federal Prison Camp Tour web site warns:

For any prospective federal camper...This material is not necessarily something you want to see, but certainly something you need to see.

This web site is recommended reading for lying CEO's like Patrick Byrne (Overstock.com), Richard Altomare (Universal Express), and a corrupt Utah Attorney General named Mark Shurtleff. Other criminal wannabees are recommended to plan ahead too.

Kindest regards,

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

Fortune Magazine Article: Takes one to know one

Recommended holiday season reading:

Fortune Magazine Special Report: Investors Guide 2008

Takes one to know one - Felonious former Crazy Eddie CFO Sam Antar turns fraudbuster. By Peter Carbonara

The magazine is on the newstands now.

Respectfully,

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

Thursday, December 13, 2007

Open Letter to Utah Attorney General Mark Shurtleff Re: Your lies on behalf of campaign contributor Overstock.com

To Utah Attorney General Mark Shurtleff:

I respectfully urge you to come clean about your efforts to smear me on behalf of your campaign contributor Overstock.com and its CEO Patrick Byrne.

The Securities and Exchange Commission is conducting a formal investigation of Overstock.com. Patrick Byrne is the admitted target of the SEC probe in contrast to his previous denials. By colluding with a public company and campaign contributor under investigation by the Securities and Exchange Commission to issue a press release containing lies and distortions about me, you have become a facilitator of the company and possibly involved yourself in the commission of a securities fraud.

I urge you to promptly issue a full and complete categorical retraction of your false and misleading open letter to Overstock.com and issue a full public apology to me. In addition, Overstock.com and its CEO Patrick Byrne are asked to completely and fully rescind the company's false and misleading press release containing Utah Attorney General Mark Shurtleff's lies and distortions in his open letter about me and issue a full public apology to me, too.

For additional information, please read the following blog posts:

Utah Attorney General Mark Shurtleff Panders to Campaign Contributor Overstock.com & CEO Patrick Byrne and Defames Critic

Utah Attorney General Mark Shurtleff Caught Lying on Behalf of Overstock.com and Patrick Byrne

Please note that other documentary evidence including taped phone conversations with persons in your office has been delivered to investigators from the Securities and Exchange Commission.

Respectfully,

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

Cc: Patrick Byrne (CEO of Overstock.com), Joseph J. Tabacco Jr. and Clay Corbus (Overstock.com Audit Committee members), and Kenneth Israel (Securities and Exchange Commission)

Update (08/18/08): Please read my blog post entitled, "Overstock.com (NASDAQ: OSTK) CEO Patrick Byrne Pays Utah Attorney General Mark Shurtleff to Defame a Blogger." Just a few days prior to Utah Attorney General Mark Shurtleff's defamation of me in his "open letter" and Overstock.com's subsequent press release, Shurtleff received a $5,000 so-called campaign contribution from Overstock.com. In addition, new details of phone conversations with Deputy Attorney General Richard Hamp and Chief Deputy Attorney General Kirk Torgensen verify that Utah Attorney General Mark Shurtleff lied on behalf of Overstock.com to defame me.

Monday, December 03, 2007

Overstock.com and CEO Patrick Byrne: Improper use of EBITDA results in Regulation G Violation

In my previous blog post entitled, "Overstock.com and CEO Patrick Byrne: Regulation G Violations," I focused on the company's possible violation of Regulation G when it presented a certain non-GAAP financial measure known as "Operating loss before restructuring" in its recent second and third quarter 10-Qs and "Adjusted EBITDA" in the second quarter 10-Q for fiscal year 2007.

In this blog post, I examine Overstock.com's (NASDAQ: OSTK) presentation of another non-GAAP financial measure, known as "earnings before interest, taxes, depreciation, and amortization" or EBITDA. Based on my analysis below, it appears that Overstock.com violated Regulation G by reconciling its non-GAAP financial measure, EBITDA, to "Operating loss" rather than "Net loss," contrary to the SEC's guidance on Regulation G. The result of Overstock.com reconciling EBITDA to "Operating loss" rather than "Net loss," contrary to the SEC's guidance on Regulation G, caused Overstock.com to overstate EBITDA by the at least the amount of "Loss from discontinued operations" for certain accounting periods presented in the second and third quarter 10-Qs for fiscal year 2007. In addition, certain stock-based compensation measures and "treasury stock issued to employees for compensation" were removed from Overstock.com's EBITDA calculation causing added overstatements of EBITDA for certain accounting periods presented in the second and third quarter 10-Qs for fiscal year 2007.

A serious question can be asked: Was Overstock trying to overstate its purported turnaround by violating Regulation G?

Regulation G

In accordance with Section 401 (b) of the Sarbanes-Oxley Act of 2002, the Securities and Exchange has established regulations defining the proper and improper use of non-GAAP financial disclosures by public companies.

Regulation G: EBITDA is a non-GAAP financial measure

In particular, Regulation G defines the EBITDA as a non-GAAP financial measure:

Another example would be EBITDA, which could be calculated using elements derived from GAAP financial presentations but, in any event, is not presented in accordance with GAAP.

Note: Bold print and italics added by me.

The “E” in EBITDA Refers to Earnings, and Earnings = Net Income

The Securities and Exchange Commission has provided specific guidance regarding the computation of EBITDA under Regulation G. According to the SEC’s "Frequently Asked Questions Regarding the Use of Non-GAAP Financial Measures" prepared by Staff Members in the Division of Corporation Finance, the following guidance is provided:

Question 14: Section I of the adopting release describes EBIT as "earnings before interest and taxes" and EBITDA as "earnings before interest, taxes, depreciation and amortization." What GAAP measure is intended by the term "earnings"? May measures other than those intended by the description in the release be characterized as "EBIT" or "EBITDA"? Does the exception for EBIT and EBITDA from the prohibition in Item 10(e)(1)(ii)(A) of Regulation S-K apply to these other measures?

Answer 14: "Earnings" is intended to mean net income as presented in the statement of operations under GAAP. Measures that are calculated differently than those described as EBIT and EBITDA in the adopting release should not be characterized as "EBIT" or "EBIDTA." Instead, the titles of these measures should clearly identify the earnings measure being used and all adjustments. These measures are not exempt from the prohibition in Item 10(e)(1)(ii)(A) of Regulation S-K.

Therefore, the intended meaning of “earnings” for EBITDA under Regulation G is “net income as presented in the statement of operations under GAAP.” That is, Overstock should have based its computation of EBITDA on net income, adding back only interest, depreciation, and amortization (there were no taxes to add back). In direct violation of this requirement, however, Overstock.com instead based its computation of EBITDA on “operating loss” rather than “net income” as the starting point. This had the effect of materially overstating EBITDA for the second and third quarters of 2007, as well as the six months ended June 30, 2007 and the nine months ended September 30, 2007. Later, I will show you just how material the misstatement was. Hint: It’s much, much larger than the standard benchmark used by auditors and regulators to establish whether an item is “material.”

Reconciliation requirement

In addition to violating Regulation G’s definition of EBITDA, Overstock.com also violated the SEC’s reconciliation requirement with respect to EBITDA. According to Regulation G, a company must reconcile its non-GAAP financial measure with the "most directly comparable financial measure or measures calculated and presented in accordance with GAAP." Read below:

Regulation G contains a general disclosure requirement and a specific requirement of a reconciliation of the non-GAAP financial measure to the most directly comparable GAAP financial measure.

Note: Bold print and italics added by me.

The SEC goes on to state that:

Whenever a company that is subject to Regulation G, or a person acting on its behalf, publicly discloses any material information that includes a non-GAAP financial measure, Regulation G requires the registrant to provide the following information as part of the disclosure or release of the non-GAAP financial measure:

  • a presentation of the most directly comparable financial measure calculated and presented in accordance with GAAP; and
  • a reconciliation (by schedule or other clearly understandable method), which shall be quantitative for historic measures and quantitative, to the extent available without unreasonable efforts, for prospective measures, of the differences between the non-GAAP financial measure presented and the most directly comparable financial measure or measures calculated and presented in accordance with GAAP.

Note: Bold print and italics added by me.

What is the most directly comparable financial measure calculated and presented in accordance with GAAP?

The SEC did not mandate or define "the most directly comparable financial measure." However, the SEC provides certain guidance depending on whether or not the non-GAAP financial measure is intended to be considered a performance measure or a liquidity measure. According to Regulation G:

We do intend that the definition of non-GAAP financial measure capture all measures that have the effect of depicting either:

  • a measure of performance that is different from that presented in the financial statements, such as income or loss before taxes or net income or loss, as calculated in accordance with GAAP; or
  • a measure of liquidity that is different from cash flow or cash flow from operations computed in accordance with GAAP.

Note: Bold print and italics added by me.

Therefore, a non-GAAP performance measure must be reconciled to items such as "income or loss before taxes or net income or loss" or a measure of liquidity such as “cash flow from operations.”

Further, the SEC guidance states that, if the non-GAAP EBIT or EBITDA financial measure is a performance measure, the registrant should make the following reconciliation:

Question 15: If EBIT or EBITDA is presented as a performance measure, to which GAAP financial measure should it be reconciled?

Answer 15: Because EBIT and EBITDA exclude recurring charges, companies should consider the answer to Question 8 if they intend to use EBIT or EBITDA as a performance measure. If a company is able to justify such use, EBIT or EBITDA should be reconciled to net income as presented in the statement of operations under GAAP. Operating income would not be considered the most directly comparable GAAP financial measure because EBIT and EBITDA make adjustments for items that are not included in operating income.

Note: Bold print and italics added by me.

Alternatively, if the non-GAAP measure is intended to be a liquidity measure, the SEC provides the following guidance:

Question 12: Are the requirements in Item 10(e)(1)(i) of Regulation S-K for the prominent presentation of, and reconciliation to, the most directly comparable GAAP financial measure or measures intended to change the staff's historical practice of requiring the prominent presentation of amounts for the three major categories of the statement of cash flows when a non-GAAP liquidity measure is presented?

Answer 12: No. The requirements in Item 10(e)(1)(i) are consistent with the staff's historical practice. The three major categories of the statement of cash flows should be presented when a non-GAAP liquidity measure is presented.

Note: Bold print and italics added by me.

Therefore a non-GAAP liquidity measure should be reconciled to, "The three major categories of the statement of cash flows should be presented when a non-GAAP liquidity measure is presented."

As I show below, Overstock.com did not reconcile EBITDA to any of the allowable GAAP numbers. Instead, Overstock.com reconciled EBITDA to "Operating Loss."

Was it a Performance Measure or a Liquidity Measure?

Based on Overstock.com’s disclosures in the second quarter fiscal 2007 10-Q, it appears as though management intends to use EBITDA as a liquidity measure. Specifically, Overstock.com disclosed:

However, we expect to spend less than $5 million in new capital expenditures during 2007, and therefore we use EBITDA as a reasonable measure of actual cash used or cash generated by the operations of the business.

Note: Bold print and italics added by me.

Similarly, in the third quarter fiscal 2007 10-Q, Overstock.com disclosed:

However, we expect to spend less than $5 million in new capital expenditures during 2007, and therefore we use EBITDA as a reasonable measure of actual cash used or cash generated by the operations of the business.

Note: Bold print and italics added by me.

If Overstock.com was in fact using EBITDA as a liquidity measure, the company should have reconciled it to any of, "the three major categories of the statement of cash flows should be presented when a non-GAAP liquidity measure is presented," rather than “Operating loss."

Why didn’t Overstock make the required reconciliation? Was it ignorance of the standard? Or was it trying to hide the fact that, in the case of Overstock.com, EBITDA is not a “reasonable measure of actual cash used or generated by the operations of the business”?

Overstock.com’s second quarter fiscal year 2007 10-Q EBITDA disclosure

As discussed above, Overstock.com, contrary to the SEC’s guidance, computed EBITDA starting with “operating loss” rather than “net income.” As we will see in a moment, this had the effect of materially overstating EBITDA. Below, is Overstock.com’s full second quarter fiscal year 2007 EBITDA 10-Q disclosure:

Commentary—EBITDA (non-GAAP). EBITDA for the second quarter of 2007 was $(4.2 million), an improvement from $(7.5 million) in Q2 2006. For the first six months of the year, EBITDA was $(12.4 million), $1.6 million better than the $(14.0 million) in the previous year. We believe that discussing EBITDA at this stage of our business is useful to us and investors, because our current capital expenditures are significantly lower than our depreciation levels. During 2005 and 2006, we made significant investments in our systems and overall infrastructure, and as a result will have approximately $30 million of related depreciation expense in 2007. However, we expect to spend less than $5 million in new capital expenditures during 2007, and therefore we use EBITDA as a reasonable measure of actual cash used or cash generated by the operations of the business.

Although EBITDA was negative $4.2 million in the second quarter, EBITDA excluding restructuring costs (“adjusted EBITDA”, a non-GAAP measure) was a positive $2.0 million in the second quarter, and $(146,000) year-to-date. We believe that discussing adjusted EBITDA also provides useful information to us and investors, as we use this measure as a representation of cash used or cash generated from the operations of the business if we had not originally incurred these costs. For further details on EBITDA and adjusted EBITDA, see the reconciliation of these non-GAAP measures to GAAP operating loss as follows (in thousands):

Item

Three months ended June 30, 2006

Three Months ended June 30, 2007

Six months ended June 30, 2006

Six months ended June 30, 2007

Operating loss

$ (15,550)

$ (13,519)

$ (29,742)

$ (31,239)

Add:
Depreciation and amortization

$ 6,876

$ 7,974

$ 13,026

$15,745

Stock-based compensation

$ 1,088

$ 1,137

$ 2,046

$ 2,210

Stock-based compensation to consultants for service

$ (9)

$ 135

$ 34

$ 140

Treasury stock issued to employees for compensation

$ 105

$ 113

$ 612

$ 715

EBITDA

$ (7,490)

$ (4,160)

$ (14,024)

$ (12,429)

Add: Restructuring

-

$ 6,194

-

$ 12,283

Adjusted EBITDA

$ (7,490)

$ 2,034

$ (14,024)

$ (146)

Note: Bold print and italics added by me.

Overstock.com’s difference between “Operating loss” and "Net loss" for accounting periods presented in second quarter fiscal year 2007 10-Q

An excerpt from Overstock.com’s “Consolidated Statement of Operations” which highlights the company's differences between “Operating loss” and “Net loss” is below (in thousands):

Item

Three months ended June 30, 2006

Three Months ended June 30, 2007

Six months ended June 30, 2006

Six months ended June 30, 2007

Operating loss

$ (15,550)

$ (13,519)

$ (29,742)

$ (31,239)

Interest income

$ 2,215

$ 1,078

$ 2,530

$ 2,068

Interest expense

$ (1,275)

$ (1,027)

$ (2,542)

$ (2,056)

Other income, net

$ (1)

-

$ (1)

-

Loss from continuing operations

$ (14,611)

$ (13,468)

$ (29.742)

$ (31,227)

Loss from discontinued operations

$ (1,128)

$ (300)

$ (1,907)

$ (3,924)

Net loss

$ (15,739)

$ (13,768)

$ (31,649)

$ (35,151)

Since Overstock.com based its non-GAAP EBITDA financial measure on “Operating Loss” rather than “Net loss,” the company’s EBITDA was overstated by at least the amount of “Loss from discontinued operations” for each accounting period. That amount was:

  • Second quarter fiscal year 2006: $1.128 million
  • Second quarter fiscal year 2007: $0.3 million
  • Six months ended June 30, 2006: $1.907 million
  • Six months ended June 30, 2006: $3.924 million

Other Overstock.com EBITDA overstatements for accounting periods presented in second quarter fiscal year 2007 10-Q

In addition, Overstock.com improperly removed from EBITDA the following expenses for each accounting period presented in the second quarter 10-Q:

  • Stock-based compensation
  • Stock-based compensation to consultants for service, and
  • Treasury stock issued to employees for compensation

See the chart below (in thousands):

Item

Three months ended June 30, 2006

Three Months ended June 30, 2007

Six months ended June 30, 2006

Six months ended June 30, 2007

Stock-based compensation

$ 1,088

$ 1,137

$ 2,046

$ 2,210

Stock-based compensation to consultants for service

$ (9)

$ 135

$ 34

$ 140

Treasury stock issued to employees for compensation

$ 105

$ 113

$ 612

$ 715

EBITDA overstatement

$1,184

$ 1,385

$ 2,692

$ 3,065

Total EBITDA Overstatements by Overstock.com for accounting periods presented in second quarter fiscal year 2007 10-Q

The chart below illustrates the materiality of Overstock.com's EBITDA overstatements for each accounting period presented in the second quarter fiscal year 2007 10-Q (thousands):

Item

Three months ended June 30, 2006

Three Months ended June 30, 2007

Six months ended June 30, 2006

Six months ended June 30, 2007

EBITDA, as reported

$ (7,490)

$ (4,160)

$ (14,024)

$ (12,429)

Add (subtract):
Loss from discontinued operations

$ (1,128)

$ (300)

$ (1,907)

$ (3,924)

Stock-based compensation

$ (1,088)

$ (1,137)

$ (2,046)

$ (2,210)

Stock-based compensation to consultants for service

$ 9

$ (135)

$ (34)

$ (140)

Treasury stock issued to employees for compensation

$ (105)

$ (113)

$ (612)

$ (715)

EBITDA, recomputed

$ (9,802)

$ (5,845)

$ (18,623)

$ (19,418)

Percentage Overstatement

30.87%

40.50%

32.79%

56.23%

This means that Overstock.com’s EBITDA figure was overstated by a material amount in each and every one of the comparable periods presented in the second quarter 2007 10-Q.

To add insult to injury, Overstock.com also failed to reconcile EBITDA to any of the allowable liquidity measures. Was it because cash from operations was horribly in the red during the six month periods ending June 30, 2006 and June 30, 2007? Cash used in operating activities in those periods was an astounding (-$79.006 million) and (-$43.301 million), respectively.

Overstock.com’s third quarter fiscal year 2007 10-Q EBITDA disclosure

As discussed above, Overstock.com, contrary to the SEC’s guidance, based its EBITDA computation on “operating loss” rather than “net income.” That again led to a material overstatement of EBITDA in the third quarter. Below, is Overstock.com’s third quarter fiscal year 2007 EBITDA 10-Q disclosure:

Non-GAAP Financial Measure

Regulation G, Conditions for Use of Non-GAAP Financial Measures, and other SEC regulations regulate the disclosure of certain non-GAAP financial information. Our measure of “EBITDA” is a non-GAAP financial measure. EBITDA, which we reconcile to “Operating loss” in our income statement, is earnings before interest, taxes, depreciation, amortization and stock-based compensation. EBITDA is used in addition to and in conjunction with results presented in accordance with GAAP and should not be relied upon to the exclusion of GAAP financial measures. EBITDA reflects an additional way of viewing our results that, when viewed with our GAAP results, provides a more complete understanding of factors and trends affecting our results. You should review our financial statements and publicly-filed reports in their entirety and not rely on any single financial measure. Our discussion below (i) explains why management believes that presentation of EBITDA provides useful information to investors regarding our financial condition and results of operations, (ii) to the extent material, discloses the additional purposes, if any, for which management uses this non-GAAP measure, and (iii) provides a reconciliation of this measure to our operating losses.

Note: Bold print and italics added by me.

Note: As discussed in my previous blog item, the obligatory reference to Regulation G was absent from previous filings submitted to the Securities and Exchange Commission. Why didn't Overstock.com make this Regulation G disclosure earlier? Was Overstock.com attempting to play a game of catch up in its third quarter 10-Q? Why did the company finally consider Regulation G in its third quarter 10-Q. Apparently, Overstock.com did not even comply with Regulation G, anyway.

Whatever the motive, the company went on to falsely state that EBITDA is also a “reasonable measure of actual cash used or generated by the operations of the business.” The disclosure continues:

Commentary—EBITDA (non-GAAP). EBITDA for the third quarter of 2007 was $4.1 million, an improvement from $(14.4 million) in Q3 2006. For the first nine months of the year, EBITDA was $(8.3 million), $20.0 million better than the $(28.3 million) in the previous year. We believe that, because our current capital expenditures are significantly lower than our depreciation levels, discussing EBITDA at this stage of our business is useful to us and investors. During 2005 and 2006, we made significant investments in our systems and overall infrastructure, and as a result will have approximately $30 million of related depreciation expense in 2007. However, we expect to spend less than $5 million in new capital expenditures during 2007, and therefore we use EBITDA as a reasonable measure of actual cash used or cash generated by the operations of the business.

But, as I noted in my last blog entry, EBITDA was a lousy measure of “actual cash used or generated by the operations of the business” during the third quarter. Third quarter cash from operating activities was negative $2.456 million, as it has been in the vast majority of quarters since inception.

The remainder of Overstock.com’s misleading EBITDA disclosure, from the MD&A section, is copied below:

For further details on EBITDA, see the reconciliation of this non-GAAP measure to our GAAP operating loss as follows (in thousands):

Item

Three months ended September 30, 2006

Three Months ended September 30, 2007

Nine months ended September 30, 2006

Nine months ended September 30, 2007

Operating loss

$ (23,152)

$ (4.874)

$ (52,881)

$ (36,113)

Add:
Depreciation and amortization

$ 7,776

$ 7,080

$ 20,802

$22,825

Stock-based compensation

$ 1,042

$ 1,176

$ 3,088

$ 3,386

Stock-based compensation to consultants for service

$ (3)

$ 140

$ 31

$ 280

Stock-based compensation relating to performance shares

-

$ 350

-

$ 350

Treasury stock issued to employees for compensation

$ 67

$ 213

$ 679

$ 928

EBITDA

$ (14,270)

$ 4,085

$ (28,281)

$ (8,344)

Note: Bold print and italics added by me.

Overstock.com’s difference between “Operating loss” and "Net loss" for accounting periods presented in the third quarter fiscal year 2007 10-Q

An excerpt from Overstock.com’s “Consolidated Statement of Operations” which highlights the company's differences between “Operating loss” and “Net loss” is below:

Item

Three months ended September 30, 2006

Three Months ended September 30, 2007

Nine months ended September 30, 2006

Nine months ended September 30, 2007

Operating loss

$ (23,152)

$ (4,874)

$ (52,881)

$ (36,113)

Interest income

$ 459

$ 1,291

$ 2,989

$ 3,359

Interest expense

$ (1,096)

$ (1,029)

$ (3,638)

$ (3,085)

Other income, net

$ (6)

$ (92)

$ (7)

$ (92)

Loss from continuing operations

$ (23,795)

$ (4,704)

$ (53,537)

$ (35,931)

Loss from discontinued operations

$ (708)

-

$ (2,615)

$ (3,924)

Net loss

$ (24,503)

$ (4,704)

$ (56,152)

$ (39,855)

Since Overstock.com based its non-GAAP EBITDA financial measure on “Operating Loss” rather than “Net loss,” the company’s EBITDA was overstated by at least the amount of “Loss from discontinued operations” for each accounting period, which was already amply discussed, that amount was:

  • Third quarter fiscal year 2006: $0.708 million
  • Nine months ended September 30, 2006: $2.615 million
  • Nine months ended September 30, 2007: $3.924 million

Other Overstock.com EBITDA overstatements for accounting periods presented in third quarter fiscal year 2007 10-Q

In addition, Overstock.com improperly removed from EBITDA the following expenses for each accounting period presented in the third quarter 10-Q:

  • Stock-based compensation
  • Stock-based compensation to consultants for service,
  • Stock-based compensation relating to performance shares, and
  • Treasury stock issued to employees for compensation

See the chart below (in thousands):

Item

Three months ended September 30, 2006

Three Months ended September 30, 2007

Nine months ended September 30, 2006

Nine months ended September 30, 2007

Stock-based compensation

$ 1,042

$ 1,176

$ 3,088

$ 3,386

Stock-based compensation to consultants for service

$ (3)

$ 140

$ 31

$ 280

Stock-based compensation relating to performance shares

-

$ 350

-

$ 350

Treasury stock issued to employees for compensation

$ 67

$ 213

$ 679

$ 928

EBITDA Overstatement

$ 1,106

$ 1,879

$ 3,798

$ 4,944

Total EBITDA Overstatements by Overstock.com for accounting periods presented in third quarter fiscal year 2007 10-Q

The chart below illustrates the materiality of Overstock.com's EBITDA overstatements for each accounting period presented in the third quarter fiscal year 2007 10-Q (thousands):

Item

Three months ended September 30, 2006

Three Months ended September 30, 2007

Nine months ended September 30, 2006

Nine months ended September 30, 2007

EBITDA, as reported

$ (14,270)

$ 4,085

$ (28,281)

$ (8,344)

Add (subtract):
Loss from discontinued operations

$ (708)

-

$ (2,615)

$ (3,924)

Stock-based compensation

$ (1,042)

$ (1,176)

$ (3,088)

$ (3,386)

Stock-based compensation to consultants for service

$ 3

$ (140)

$ (31)

$ (280)

Stock-based compensation relating to performance shares

-

$ (350)

-

$ (350)

Treasury stock issued to employees for compensation

$ (67)

$ (213)

$ (679)

$ (928)

EBITDA, recomputed

$ (16,084)

$ 2,206

$ (34,694)

$ (17,212)

Percentage Overstatement

12.71%

85.18%

22.68%

106.28%

This means that Overstock.com’s EBITDA figure was overstated by a material amount in both the nine months ended September 30, 2006 and September 30, 2007, as presented in the third quarter 2007 10Q.

To add insult to injury, Overstock.com again failed to reconcile EBITDA to any of the allowable liquidity measures. And again, I have to ask, was it because cash from operations was so horribly in the red during the nine month periods ending September 30, 2006 (-$78.242 million) and September 30, 2007 (-$45.757 million)? Does Overstock.com management really expect us to believe that their EBITDA metric, as presented or as corrected, was really a “reasonable measure of actual cash used or cash generated by the operations of the business”? How stupid do they think we are?

Is Overstock.com Using Non-GAAP Measures to Hype a Bogus Turnaround?

On March 7, 2006, in an interview with ZDNet News, Patrick Byrne said:

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.

Note: Bold print and italics added by me.

Overstock.com never came close to achieving the "billion-dollar mark" in annual sales as hyped by Byrne and the company has resorted to making up its own "phony accounting standard" governing the use of EBITDA, in apparent violation of SEC Regulation G, to overstate its financial performance.

Using non-GAAP financial measures to hype Overstock.com's performance is nothing new for double taking CEO, Patrick Byrne. He continues to use non-GAAP financial measurements as it suits him, depending on his agenda at the time. In a previous blog item, I detailed how Byrne interchangeably used both GAAP and non-GAAP sales figures prior to Overstock.com’s IPO. The trouble was, during that period he used these two sales measures interchangeably without ever telling the user which measure he was using, leading one to conclude that Overstock’s sales were much higher than they really were at the time.

In another blog item, I detailed how Patrick Byrne used non-GAAP financial measures, the reduction of inventory reserves, and the reversal of previously booked restructuring expenses to hype up Overstock.com financial performance for the second quarter of fiscal year 2007. Without, the use of what Patrick Byrne has defined as a "phony accounting standard--pro forma," Overstock.com's hyped up turn around would have all but disappeared. In addition, I detailed how the reduction in inventory reserves in the second quarter of fiscal year 2007, wiped away Overstock.com's entire improvement in operating income.

Playing a game of catch up on disclosures is nothing new for Overstock.com and its double talking CEO, Patrick Byrne, too. For example, on May 9, 2006, the Securities and Exchange Commission launched a formal investigation of Overstock.com. On May 17, 2006, Patrick Byrne received a personal subpoena from the SEC. However, Overstock.com delayed its disclosure of Patrick Byrne's subpoena for almost an entire year, belatedly disclosing Byrne's SEC subpoena in the company's first quarter fiscal year 2007 10-Q that was released on May 9, 2007.

On May 10, 2007, while attempting to deflect from the news of Overstock.com's belated disclosure of his personal SEC subpoena, Patrick Byrne offered more double talk and suggested that Overstock.com and he was not the target of a Securities and Exchange Commission investigation.

Here is the punch-line: as a matter of law I must tread carefully here, but I can say that the heart of the investigation is not, I would suggest, Overstock-centric, but rather, concerns itself with a strange set of relationships among ..... Well, let me just say that the irony here is just delicious.

Note: Bold print and italics added by me.

On May 12, 2007, in a post (message number 7271) on InvestorVillage, using his Hannibal alias, Patrick Byrne continued his double talk and claimed that:

The funny part is how it still has not dawnede on the miscreants that a fair bit of the material being requested by the SEC concerns THEM, not me or Overstock.

Note: Bold print and italics added by me.

However, on August 10, 2007, Byrne finally admitted that he is in fact, "the target of their [SEC] investigation," in contrast to his previous denials. Note: Bracketed information added by me for clarity.

Again, it appears that its just business as usual at Overstock.com, where the primary business activity is over-hyping its results. The tone at the top of this perennially money losing and capital hungry company has been set by a lying CEO who talks out of three sides of his mouth.

Patrick Byrne once said, "...I think 'EBITDA' is the stupidest thing I ever heard emanate from Wall Street (no small feat)...." Now, Overstock.com and Patrick Byrne conveniently misuse EBITDA in an apparent violation of Regulation G to mislead investors.

To be continued....

Written by,

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

For additional information about Overstock.com's misleading financial disclosures, please read the blog posts below:

08/22/07: Did Overstock.com CEO Patrick Byrne cook the company's numbers and mislead investors? (Part 2)

08/24/07: Did Overstock.com CEO Patrick Byrne cook the company's numbers and mislead investors? (Part 3)

Thursday, November 29, 2007

Utah Attorney General Mark Shurtleff Caught Lying on Behalf of Overstock.com and Patrick Byrne

In a previous item on my blog dated November 19, 2007 and entitled, "Utah Attorney General Mark Shurtleff Panders to Campaign Contributor Overstock.com & CEO Patrick Byrne and Defames Critic," I responded to Utah Attorney General Mark Shurtleff's deliberate efforts to defame me on behalf of campaign contributor Overstock.com (NASDAQ: OSTK) and its CEO Patrick Byrne. Utah Attorney General Mark Shurtleff has ignored my requests to categorically retract his letter and issue a public apology.

Enclosed is a taped conversation between Deputy Attorney General Richard Hamp and I that categorically refutes the deliberate lies of Utah Attorney General Mark Shurtleff. Listen to it for yourself. The other person in the tape that he refers to as "Kirk" is Kirk Torgensen, the Chief Deputy Utah Attorney General.

Utah Attorney General Mark Shurtleff colluded with a public company (Overstock.com) that is a campaign contributor and it's CEO Patrick Byrne, both of whom are under investigation by the SEC, to disparage, defame, and discredit me.

The above taped conversation has been delivered to the Securities and Exchange Commission. Other taped conversations will be delivered to the Securities and Exchange Commission and posted on this blog in the near future. Both New York and Utah are "one party" consent states and as such, the recording of my phone conversations was legally permissible.

Written by,

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

Update (12/13/07): Please read my blog post entitled, "Open Letter to Utah Attorney General Mark Shurtleff Re: Your lies on behalf of campaign contributor Overstock.com."

Update (08/18/08): Please read my blog post entitled, "Overstock.com (NASDAQ: OSTK) CEO Patrick Byrne Pays Utah Attorney General Mark Shurtleff to Defame a Blogger." Just a few days prior to Utah Attorney General Mark Shurtleff's defamation of me in his "open letter" and Overstock.com's subsequent press release, Shurtleff received a $5,000 so-called campaign contribution from Overstock.com. In addition, new details of phone conversations with Deputy Attorney General Richard Hamp and Chief Deputy Attorney General Kirk Torgensen verify that Utah Attorney General Mark Shurtleff lied on behalf of Overstock.com to defame me.

Monday, November 26, 2007

Overstock.com and CEO Patrick Byrne: Securities and Exchange Commission Regulation G Violations

A careful analysis of Securities and Exchange Commission Regulation G, guidance provided by the SEC on Regulation G, and Overstock.com's financial disclosures raises a serious question as to whether or not Overstock.com misused certain non-GAAP measures in violation of certain provisions of Regulation G. As detailed, in a previous blog post, entitled "Did Overstock.com CEO Patrick Byrne cook the company's numbers and mislead investors? (Part 4)," Overstock.com (NASDAQ: OSTK) added a new disclosure in its third quarter fiscal year 2007 10-Q that was absent from its third quarter 8-K, second quarter 10-Q, and second quarter 8-K about Regulation G. The disclosure relates to the applicability of Regulation G.

In accordance with Section 401 (b) of the Sarbanes-Oxley Act of 2002, the Securities and Exchange Commission established Regulation G which governs the use of non-GAAP financial disclosures by public companies. Months later, staff members in the Division of Corporation Finance provided guidance for implementing Regulation G in a document entitled, "Frequently Asked Questions Regarding the Use of Non-GAAP Financial Measures."

Regulation G Defines Non-GAAP Measures

In particular, Regulation G defines the following as a non-GAAP measure:

An example of a non-GAAP financial measure would be a measure of operating income that excludes one or more expense or revenue items that are identified as "non-recurring." Another example would be EBITDA, which could be calculated using elements derived from GAAP financial presentations but, in any event, is not presented in accordance with GAAP.

Note: Bold print and italics added by me.

Based on the above definition, Overstock.com has used three non-GAAP financial measures in its latest quarterly filings with the Securities and Exchange Commission:

  • Operating loss before restructuring (second quarter 8-K and 10-Q and third quarter 10-Q)
  • Earnings before depreciation, interest, taxes, depreciation, and amortization (second quarter 8-K and 10-Q and third quarter 8-K and 10-Q) or EBITDA
  • Adjusted EBITDA or EBITDA before restructuring costs (second quarter 8-K and 10-Q)

Possible Regulation G Violations by Overstock.com

Regulation G made amendments to Item 10 of Regulation S-K and Item 10 of Regulation S-B to provide additional guidance to registrants that include non-GAAP financial measures in Commission filings. Now, according to Item 10 of Regulation S-K and Item 10 of Regulation S-B:

The prohibition on adjusting a non-GAAP performance measure to eliminate or smooth items identified as non-recurring, infrequent or unusual, when the nature of the charge or gain is such that it is reasonably likely to recur will make clear that such an adjustment is prohibited only when (1) the nature of the charge or gain is such that it is reasonably likely to recur within two years, or (2) there was a similar charge or gain within the prior two years....

Note: Bold print and italics added by me.

Additionally, according to the SEC’s "Frequently Asked Questions Regarding the Use of Non-GAAP Financial Measures" the following practices are prohibited:

Item 10(e) of Regulation S-K prohibits adjusting a non-GAAP financial performance measure to eliminate or smooth items identified as non-recurring, infrequent or unusual, when the nature of the charge or gain is such that it is reasonably likely to recur within two years or there was a similar charge or gain within the prior two years.

Note: Bold print and italics added by me.

Thus, Regulation G provides two tests to determine if an item can be labeled non-recurring, infrequent or unusual:

(1) the nature of the charge or gain is such that it is reasonably likely to recur within two years, or
(2) there was a similar charge or gain within the prior two years

Did Overstock.com identify its restructuring costs as "non-recurring, infrequent, or unusual" in its third quarter fiscal year 2007 financial disclosures?

As described above, in its recent third quarter fiscal year 2007 10-Q, Overstock.com had presented a non-GAAP financial measure, known as "operating loss before restructuring." In the same 10-Q, Overstock.com management appears to be implying that the company's restructuring costs are non-recurring, infrequent or unusual items. I demonstrate this fact later.

Patrick Byrne's comments during Overstock.com's third quarter earnings conference call also clearly indicate that the company intends to portray its restructuring costs as non-recurring, infrequent, or unusual in nature. This fact is also demonstrated later.

For now, what is important to realize is that Overstock.com's restructuring costs did not meet the criteria established under Regulation G for use in a non-GAAP financial measure, since there were similar restructuring costs "within the prior two years" and because management expected similar costs to occur in the future.

Disclosures in the Third Quarter 10-Q

Overstock.com's disclosure about "restructuring" expense in the "Notes to Unaudited Consolidated Financial Statements" section of its third quarter 10-Q, clearly attempts to portray the company’s restructuring costs as "non-recurring, infrequent, or unusual," and unlikely to recur in the future. That disclosure is as follows:

Restructuring Expense

During the fourth quarter of 2006, the Company commenced implementation of a facilities consolidation and restructuring program designed to reduce the overall expense structure in an effort to improve future operating performance. The facilities consolidation and restructuring program was substantially completed by the end of the second quarter of 2007. There were no restructuring expenses during the third quarter of 2007.

Note: Bold print and italics added by me.

Certain wording in “Management’s Discussion and Analysis” (or the “MD&A” section) also clearly indicates that the company’s use of the non-GAAP measure “operating loss before restructuring” is intended to reflect management’s assertion that Overstock.com’s restructuring costs are "non-recurring, infrequent, or unusual" in nature.

Commentary—Operating loss. Our operating loss for the third quarter was $4.9 million, down 79% from $23.2 million in 2006. Over the first nine months of the year, our operating loss was $36.1 million, down 32% from $52.9 million over the same period last year. The 2007 operating loss includes $12.3 million of restructuring costs ($6.1 million in Q1 and $6.2 million in Q2). Before restructuring costs, the operating loss was $23.8 million for the nine months ended September 30, 2007, a $29.1 million year-over-year improvement. Restructuring costs primarily represent our efforts to reduce our overall expense structure through the consolidation of our corporate office, data centers and warehouse facilities. Therefore, we believe that discussing our operating loss before restructuring costs (a non-GAAP measure) provides useful information to us and investors because it is a representation of the expense structure of the company if we had not originally incurred these costs. We use this measure to monitor our progress in reducing our overall expense structure, including the comparison of operating results in the current year to similar periods in the previous year. See the following table for operating loss before restructuring costs (in thousands):

Item

Three months ended September 30, 2006

Three months ended September 30, 2007

Nine months ended September 30, 2006

Nine months ended September 30, 2007

Operating loss

$ (23,152)

$ (4,874)

$ (52,881)

$ (36,113)

Add back: restructuring

-

-

-

12,283

Operating loss before restructuring

$ (23,152)

$ (4,874)

$ (52,881)

$ (23,830)

Thus, in what appears to be a direct violation of Regulation G, the company has implied that its restructuring charges are somehow nonrecurring in nature. Overstock.com has lost money in every year of its existence, the company has reported losses from discontinued operations in the last three fiscal years, it has reported restructuring charges in the last two years, and is likely to incur additional restructuring charges in future years.

Obligatory Reference to Regulation G

As if to somehow validate its incredulous classification of restructuring costs, Overstock.com also added an obligatory reference to Regulation G in the third quarter 2007 10-Q. The new disclosure, copied below, also appears in the MD&A section of the filing:

Non-GAAP Financial Measure

Regulation G, Conditions for Use of Non-GAAP Financial Measures, and other SEC regulations regulate the disclosure of certain non-GAAP financial information. Our measure of “EBITDA” is a non-GAAP financial measure. EBITDA, which we reconcile to “Operating loss” in our income statement, is earnings before interest, taxes, depreciation, amortization and stock-based compensation. EBITDA is used in addition to and in conjunction with results presented in accordance with GAAP and should not be relied upon to the exclusion of GAAP financial measures. EBITDA reflects an additional way of viewing our results that, when viewed with our GAAP results, provides a more complete understanding of factors and trends affecting our results. You should review our financial statements and publicly-filed reports in their entirety and not rely on any single financial measure. Our discussion below (i) explains why management believes that presentation of EBITDA provides useful information to investors regarding our financial condition and results of operations, (ii) to the extent material, discloses the additional purposes, if any, for which management uses this non-GAAP measure, and (iii) provides a reconciliation of this measure to our operating losses.

Curiously, the same disclosure was absent from previous filings submitted to the Securities and Exchange Commission. Why didn't Overstock.com make this Regulation G disclosure earlier? Was Overstock.com attempting to play a game of catch up? I’ll get back to this in a minute.

Whatever the motive, the company went on to falsely state that EBITDA is also a “reasonable measure of actual cash used or generated by the operations of the business.” The disclosure continues:

Commentary—EBITDA (non-GAAP). EBITDA for the third quarter of 2007 was $4.1 million, an improvement from $(14.4 million) in Q3 2006. For the first nine months of the year, EBITDA was $(8.3 million), $20.0 million better than the $(28.3 million) in the previous year. We believe that, because our current capital expenditures are significantly lower than our depreciation levels, discussing EBITDA at this stage of our business is useful to us and investors. During 2005 and 2006, we made significant investments in our systems and overall infrastructure, and as a result will have approximately $30 million of related depreciation expense in 2007. However, we expect to spend less than $5 million in new capital expenditures during 2007, and therefore we use EBITDA as a reasonable measure of actual cash used or cash generated by the operations of the business.

But, EBITDA was a lousy measure of “actual cash used or generated by the operations of the business” during the third quarter. Third quarter cash from operating activities was negative, as it has been in the vast majority of quarters since inception.

The remainder of Overstock.com’s misleading EBITDA disclosure, from the MD&A section, is copied below:

For further details on EBITDA, see the reconciliation of this non-GAAP measure to our GAAP operating loss as follows (in thousands):

Item

Three months ended September 30, 2006

Three Months ended September 30, 2007

Nine months ended September 30, 2006

Nine months ended September 30, 2007

Operating loss

$ (23,152)

$ (4.874)

$ (52,881)

$ (36,113)

Add:
Depreciation and amortization

$ 7,776

$ 7,080

$ 20,802

$22,825

Stock-based compensation

$ 1,042

$ 1,176

$ 3,088

$ 3,386

Stock-based compensation to consultants for service

$ (3)

$ 140

$ 31

$ 280

Stock-based compensation relating to performance shares

-

$ 350

-

$ 350

Treasury stock issued to employees for compensation

$ 67

$ 213

$ 679

$ 928

EBITDA

$ (14,270)

$ 4,085

$ (28,281)

$ (8,344)

Note: Bold print and italics added by me.

More Pro Forma Hype (and Potential Violations) from the Conference Call

During Overstock.com’s third quarter earnings conference call, CEO Patrick Byrne also clearly asserted that the company’s restructuring costs were non-recurring, infrequent or unusual items when he called them “one-time charges.” The exact quote is copied here:

We returned to positive EBITDA and there was one-time charges in the past -- restructuring charges really did turn out to be restructuring charges. And we have positive trailing 12 months cash flow and I think that only goes up substantially from here.

Note: Bold print and italics added by me.

In case there is any question about Byrne’s intent, he repeats the same assertion at a later point in the call. This time the CEO claimed that the company’s restructuring charges were “not going to happen again next year.” Byrne’s comment in its entirety follows:

Remember, by the way, that there’s, in comparison with this year, there is $16 million, $17 million of what we called restructuring this year and it really is restructuring in the sense of it is not going to happen again next year.

Note: Bold print and italics added by me.

Regardless of the CEO’s explanation, the above assertions fly in the face of Regulation G. The reason is that Overstock.com actually fails both of the SEC’s tests used to determine whether or not a non-GAAP measure is allowable.

Are Overstock.com’s restructuring charges reasonably likely to recur within two years?

While Patrick Byrne had claimed that Overstock.com’s restructuring charges were “one-time charges” and that such costs are “not going to happen again next year,” he simultaneously revealed the possibility of future restructuring charges, rather than the reasonable likelihood of such costs in future quarters. Just a few brief moments later, during the very same call, Mr. Byrne states that:

There is only one possible thing that could -- well, you never know what’s possible, but the only thing that we would consider is if we can move, if we can find a tenant for our building and we can move over into our warehouse, we could save $4 million or $5 million a year. But if we did that, there would probably be some CapEx and restructuring.

Note: Bold print and italics added by me.

I guess we can chalk this one up to Mr. Byrne’s ability to talk out of both sides of his mouth. The point is, this statement clearly points to a failure of the first of the SEC’s two tests.

Did Overstock.com report restructuring costs “within the prior two years…” in its financial reports?

If only one of the SEC’s tests is failed, then the non-GAAP measure in question is not allowed. But, for good measure, Overstock.com also failed the second test. During at least the prior two years, Overstock.com reported restructuring charges.

During the prior two years, Overstock.com reported restructuring charges:

  • Q4 2006: $5.674 million
  • Q1 2007: $6.089 million
  • Q2 2007: $6.194 million

The inescapable conclusion is that Overstock.com could not use the non-GAAP financial measure, “operating loss before restructuring” in its third quarter 10-Q. Moreover, it appears that the company used this measure to smooth or overstate the profits reported in its third quarter 10-Q—in an apparent violation of Regulation G.

Patrick Byrne’s recent statements (above) about Overstock.com’s restructuring charges, contradict earlier statements by him about the use of restructuring costs as non-recurring items

Now consider whether it is possible to speak out of three sides of one’s mouth. About two years earlier, in the second quarter 2005 Form 8-K containing the company’s earnings announcement, Patrick Byrne chided other companies for their propensity to report one-time charges which “usually turn out not to be one-time any” and their focus on non-GAAP measures.

I worked at First Manhattan in the early 1990's. One of the first lessons I was taught was to watch out for companies with "one-time" charges, for rarely, if ever, did they turn out to be truly, "one-time." Subsequent experience confirmed this. Of course, the world had not really discovered "restructuring charges," let alone the mantra of "pro forma accounting" that the Internet would later spawn ("EBE: Earnings Before Expenses," as one wag put it). I was similarly discouraged from calculating EBITDA ("That cash either counts the day it went out the door when you bought that ice machine, or as it depreciated, and GAAP depreciation turns out to be a pretty good approximation of how equipment really depreciates," I was told).

The common failure of these variations is, it seems to me, this: they start by showing a way to look at a financial statement excluding certain events, but lead people to pretend that those events are not real. "EBITDA" might be a useful step in projecting the future cash needs of a business, but it misleads people into thinking that "depreciation" is not a real expense. Similarly, "restructuring" and "one-time" charges may in fact be only one-time charges, but that does not make them "not real" (and they usually turn out not to be "one-time" anyway).

Note: Bold print, italics, and underlines added by me.

Now how on earth can this prior assertion be reconciled with Patrick Byrne’s current shenanigans? It appears that Patrick Byrne uses non-GAAP financial measurements as it suits him, depending on his agenda at the time. This looks remarkably like the situation that I wrote about previously, in which Mr. Byrne interchangeably used both GAAP and non-GAAP sales figures prior to Overstock.com’s IPO. The trouble was, during that period he used these two sales measures interchangeably without ever telling the user which measure he was using, leading one to conclude that Overstock’s sales were much higher than they really were at the time.

Did Overstock.com Determine it Violated Regulation G During the Second Quarter?

Another curious change in the third quarter 2007 10-Q (below) is that Overstock.com did not disclose the non-GAAP financial measure known as "Adjusted EBITDA," which it had presented in the second quarter. Overstock.com’s version of “adjusted EBITDA” conveniently eliminates restructuring costs, making second quarter 2007 EBITDA appear miraculously positive for the quarter. But the presentation of adjusted-EBITDA also flies in the face of Regulation G. Therefore I also have to ask: Did Overstock.com subsequently realize it had made a mistake when it used "Adjusted EBITDA" in its second quarter 8-K and 10-Q? I wonder what will happen in the fourth quarter after its auditors review Regulation G more carefully?

The Second Quarter Faux Pas

In its second quarter 2007 8-K (filing its earnings press release) and 10-Q, Overstock.com presented two non-GAAP financial measures, known as "operating loss before restructuring" and "Adjusted EBITDA" that eliminated the effect of restructuring charges. The financial disclosures in its second quarter 10-Q also portrayed the company’s restructuring costs as "infrequent or unusual" items. Comments made by Patrick Byrne and Jason C. Lindsey during the second quarter earnings conference call further assert that Overstock.com's restructuring costs were "infrequent or unusual" items. However, Overstock.com's second quarter restructuring costs did meet not the criteria established under Regulation G for use in a non-GAAP financial measure, since (1) there were similar restructuring costs "within the prior two years" and (2) management readily admitted that there are likely to be more restructuring costs in upcoming quarters.

Apparent Violation of Regulation G in Second Quarter “Notes”

Disclosures in the "Notes to Unaudited Consolidated Financial Statements" section of its second quarter 10-Q, make the claim that the company’s "facilities consolidation and restructuring program should be substantially completed during calendar year 2007.” (Also, in the third quarter 10-Q, Overstock.com claimed that its "restructuring program was substantially completed by the end of the second quarter.”) But these disclosures run afoul of Regulation G because there were similar restructuring costs "within the prior two years." In other words, Overstock.com failed the SEC’s first test.

The above violation also makes the remainder of Overstock.com’s disclosures pertaining to EBITDA and adjusted-EBITDA materially misleading. The remaining disclosures are copied below:

Commentary—Operating loss. Our operating loss for the second quarter was $13.5 million, down from $15.6 million in 2006. Over the first six months of the year, our operating loss was $31.2 million, up from $29.7 million over the same period last year. However, the 2007 operating loss includes $12.3 million of restructuring costs ($6.1 million in Q1 and $6.2 million in Q2). Before restructuring costs, the operating loss was $19.0 million over the first half of this year, a $10.7 million year-over-year improvement. Restructuring costs primarily represent our efforts to reduce our overall expense structure through the consolidation of our corporate office, data centers and warehouse facilities. Therefore, we believe that discussing our operating loss before restructuring costs (a non-GAAP measure) provides useful information to us and investors because it is a representation of the expense structure of the company if we had not originally incurred these costs. We use this measure to monitor our progress in reducing our overall expense structure, including the comparison of operating results in the current year to similar periods in the previous year. See the following table for operating loss before restructuring costs (in thousands):

Item

Three months ended June 30, 2006

Three months ended June 30, 2007

Six months ended June 30, 2006

Six months ended June 30, 2007

Operating loss

$ (15,550)

$ (13,519)

$ (29,742)

$ (31,239)

Add back: restructuring

-

$ 6,194

-

12,283

Operating loss before restructuring

$ (15,550)

$ (7,325)

$ (29,742)

$ (18,956)

Commentary—EBITDA (non-GAAP). EBITDA for the second quarter of 2007 was $(4.2 million), an improvement from $(7.5 million) in Q2 2006. For the first six months of the year, EBITDA was $(12.4 million), $1.6 million better than the $(14.0 million) in the previous year. We believe that discussing EBITDA at this stage of our business is useful to us and investors, because our current capital expenditures are significantly lower than our depreciation levels. During 2005 and 2006, we made significant investments in our systems and overall infrastructure, and as a result will have approximately $30 million of related depreciation expense in 2007. However, we expect to spend less than $5 million in new capital expenditures during 2007, and therefore we use EBITDA as a reasonable measure of actual cash used or cash generated by the operations of the business.

Although EBITDA was negative $4.2 million in the second quarter, EBITDA excluding restructuring costs (“adjusted EBITDA”, a non-GAAP measure) was a positive $2.0 million in the second quarter, and $(146,000) year-to-date. We believe that discussing adjusted EBITDA also provides useful information to us and investors, as we use this measure as a representation of cash used or cash generated from the operations of the business if we had not originally incurred these costs. For further details on EBITDA and adjusted EBITDA, see the reconciliation of these non-GAAP measures to GAAP operating loss as follows (in thousands):

Item

Three months ended June 30, 2006

Three Months ended June 30, 2007

Six months ended June 30, 2006

Six months ended June 30, 2007

Operating loss

$ (15,550)

$ (13,519)

$ (29,742)

$ (31,239)

Add:
Depreciation and amortization

$ 6,876

$ 7,974

$ 13,026

$15,745

Stock-based compensation

$ 1,088

$ 1,137

$ 2,046

$ 2,210

Stock-based compensation to consultants for service

$ (9)

$ 135

$ 34

$ 140

Treasury stock issued to employees for compensation

$ 105

$ 113

$ 612

$ 715

EBITDA

$ (7,490)

$ (4,160)

$ (14,024)

$ (12,429)

Add: Restructuring

-

$ 6,194

-

$ 12,283

Adjusted EBITDA

$ (7,490)

$ 2,034

$ (14,024)

$ (146)

Conference Call Disclosures Also Point to Violations of Regulation G

Not to be outdone, Overstock.com also succeeds in failing the SEC’s second test during the second quarter conference call. During the second quarter 2007 earnings conference call, Patrick Byrne claimed:

I don’t see any other major restructuring charges to come.”

However, Jason C. Lindsey then contradicted Patrick Byrne's claim by stating that,

“There might be one or two other things coming but I don’t think there’s any really big things.”

Note: Bold print and italics added by me.

So again Overstock.com fails both of the SEC’s tests with regard to the exclusion of costs from non-GAAP measures. At least this time Patrick Byrne wasn’t speaking out of both sides of his mouth, he needed a little help from Jason Lindsey.

Is There Any Way that Overstock’s Disclosure was Consistent with Regulation G?

For the sake of argument, there is one remaining claim Overstock.com could attempt to make to support its non-GAAP presentations. Unfortunately, this one doesn’t work out well either. But, for the sake of argument, let’s assume that Overstock.com might attempt to argue that they were actually eliminating recurring charges in the third quarter presentation of “operating loss before restructuring charges” and the second quarter presentation of “adjusted EBITDA”. (This assumption contradicts other statements made by management in its SEC filings and conference calls. But, let’s ignore the inconsistencies for a minute.)

The Securities and Exchange Commission’s “Frequently Asked Questions Regarding the Use of Non-GAAP Financial Measures” also addresses when it is acceptable to eliminate recurring items from a non-GAAP measure. The SEC addresses the issue by first posing the following question:

Question 8: Item 10(e) of Regulation S-K prohibits adjusting a non-GAAP financial performance measure to eliminate or smooth items identified as non-recurring, infrequent or unusual, when the nature of the charge or gain is such that it is reasonably likely to recur within two years or there was a similar charge or gain within the prior two years. Is it appropriate to eliminate or smooth an item that is identified as "recurring"?

Note: Bold print and italics added by me.

The SEC’s guidance is provided in the answer that follows:

Answer 8: Companies should never use a non-GAAP financial measure in an attempt to smooth earnings. Further, while there is no per se prohibition against removing a recurring item, companies must meet the burden of demonstrating the usefulness of any measure that excludes recurring items, especially if the non-GAAP financial measure is used to evaluate performance.

It is permissible and may well be necessary to identify, discuss, and analyze material restructuring charges and other items, whether they are recurring or non-recurring, in Management's Discussion and Analysis of Financial Condition and Results of Operations. Depending on the nature and materiality of the charge or other item, it will likely be necessary to discuss the nature of such charges or other items, their recurring or non-recurring nature, their significance to an investor in evaluating the company's financial condition and/or results of operations and whether they relate to material known trends, events or uncertainties that must be disclosed.

Whether an item may, or indeed must, be discussed in MD&A is a different question from whether it may be eliminated or adjusted in connection with a non-GAAP financial measure. Whether a non-GAAP financial measure that eliminates a recurring item or items from the most directly comparable GAAP financial measure is acceptable depends on all of the facts and circumstances. Such measures more likely would be permissible if management reasonably believes it is probable that the financial impact of the item will disappear or become immaterial within a near-term finite period. In addition, inclusion of such a measure may be misleading absent the following disclosure:

  • the manner in which management uses the non-GAAP measure to conduct or evaluate its business;
  • the economic substance behind management's decision to use such a measure;
  • the material limitations associated with use of the non-GAAP financial measure as compared to the use of the most directly comparable GAAP financial measure;
  • the manner in which management compensates for these limitations when using the non-GAAP financial measure; and
  • the substantive reasons why management believes the non-GAAP financial measure provides useful information to investors.

Similar considerations may apply under Item 12 of Form 8-K.

Note: Bold print and italics added by me.

The question is, do any of Overstock.com’s non-GAAP measures, operating loss before restructuring” (second and third quarters), EBITDA (second and third quarter) or “adjusted EBITDA” (second quarter) qualify as allowable measures under SEC guidance? (Hint: The answer contains two letters.)

According to the above SEC guidance, if Overstock.com had considered its restructuring charges to be recurring charges and not "infrequent or unusual" items when presenting the non-GAAP financial measure known as “operating loses before restructuring,” the company would be required to make certain additional disclosures (see above) to avoid having such a non-GAAP financial measure considered as a “misleading” disclosure. In particular, Overstock.com was required to disclose, “the material limitations associated with use of the non-GAAP financial measure as compared to the use of the most directly comparable GAAP financial measure.”

Overstock.com does make such a disclosure (see above) relating to EBITDA in its third quarter fiscal year 2007 10-Q. However, Overstock.com's EBITDA disclosure in the company's third quarter 10-Q does not eliminate restructuring charges unlike its other non-GAAP financial measures: Operating loss before restructuring (second and third quarter 10-Q) and Adjusted EBITDA (second quarter 10-Q). Overstock.com failed to disclose, “the material limitations associated with use of the non-GAAP financial measure as compared to the use of the most directly comparable GAAP financial measure” relating to both "Operating loss before restructuring" and "Adjusted EBITDA."

Overstock.com cannot have it two ways. Either Overstock.com considered its restructuring costs as "non-recurring, infrequent or unusual" item and it violated Regulation G for use in a non-GAAP financial measure that eliminates nonrecurring items, or if such restructuring costs were considered as recurring, then the company violated Regulation G by failing to disclose the limations of such measures. (Of course it is clear by management’s other assertions that Overstock.com is claiming that its restructuring charges are nonrecurring—Regulation G be damned.)

“Merely labeling an item as non-recurring does not make it so”

Now consider the absurd. What if Overstock.com thought it was acceptable to label a regularly occurring item as non-recurring? To hammer the point home, the SEC even goes so far as to specifically prohibit this kind of tomfoolery. This is no joke. The SEC's “FAQs” to Regulation G also provides the following question and answer guidance:

Question 9: Is it permissible to use non-GAAP financial measures that eliminate recurring restructuring charges or other recurring items if those charges or items are not labeled as non-recurring?

The SEC’s guidance:

Answer 9: For many years, staff practice has been to object to the use of non-GAAP financial measures that eliminate the effect of recurring items by describing them as non-recurring. Management should consider the substantive nature of the item when determining whether to classify it as recurring or non-recurring. Merely labeling an item as non-recurring does not make it so.

Whether a company can present a non-GAAP financial measure that eliminates recurring restructuring charges will depend on all the facts and circumstances. However, if there is a past pattern of restructuring charges, no articulated demonstration that such charges will not continue and no other unusual reason that a company can substantiate to identify the special nature of the restructuring charges, it would be difficult for a company to meet the burden of disclosing why such a non-GAAP financial measure is useful to investors. In such circumstances, Item 10(e) of Regulation S-K would not permit the use of the non-GAAP financial measure. Similar considerations may apply under Item 12 of Form 8-K.

Note: Bold print and italics added by me.

As detailed above, in both Overstock.com’s 10-Q and in management’s comments during the second and third quarter earnings conference calls, the company asserts that its restructuring costs are non-recurring items—despite actually failing both of the SEC’s tests for determining whether an item is nonrecurring. So, maybe Overstock.com thought this was an acceptable practice? Well, SEC guidance related to Regulation G even appears to explicitly preclude this sort of doublespeak. To quote the SEC, “merely labeling an item as non-recurring does not make it so.”

Driving the Final Nail in the Coffin

How can such “recurring restructuring charges,” under the SEC’s guidance (above), be considered “unusual” of a “special nature” for a company like Overstock.com that has lost money in every year of its existence and has a such a long history of failed business ventures? For a company like Overstock.com, can any restructuring charge ever be considered nonrecurring, unusual, or infrequent in nature?

Overstock’s risk factors certainly make it clear that the pattern of losses may be expected to continue.

We have a history of significant losses. If we do not achieve profitability, our financial condition and our stock price could suffer.

We have a history of losses and we may continue to incur operating and net losses for the foreseeable future. We incurred net losses of $4.7 million and $39.9 million for the three and nine months ended September 30, 2007. As of September 30, 2007, our accumulated deficit was $238.5 million. We will need to generate significant revenues to achieve profitability, and we may not be able to do so. Even if we do achieve profitability, we may not be able to sustain or increase profitability on a quarterly or annual basis in the future. If our revenues grow more slowly than we anticipate, or if our operating expenses exceed our expectations, our financial results would be harmed.

Note: Bold print and italics added by me.

The company has continuously engaged in highly speculative and money losing ventures that continue to this day. Overstock.com has gone through frequent and continuous changes in its operating structure which has led to consistent charges for restructuring and discontinued operations. Such speculative ventures have included OverstockB2B, collaborative filtering, m-commerce, Travel, Auctions, and Design Your Own Jewelry. All of these speculative ventures have produced losses and consumed significant amounts of shareholder capital.

To make matters worse, the highly speculative business ventures continue to this day. For example, Overstock Cars apparently hasn’t resulted in any profits. Overstock.com’s Community Site Business has not produced any profits, either. In fact, many parts of Overstock.com’s Community Site business are still in beta. Overstock.com’s Community Site Business has recently been added to the company’s list of risk factors in its recent third quarter fiscal year 2007 10-Q. Regarding possible risks from its Community Site Business, Ovestock.com discloses:

Our entry into this business will require us to devote substantial financial, technical, managerial and other resources to this site. It is uncertain whether the business will benefit financially from the Community site. The Community site will also expose us to additional risks, including legal and regulatory risks, including, but not limited to, legal actions for possible intellectual property infringement, and claims for libel. Additionally, our entry into the Community site service will require us to compete with established businesses having substantially greater experience

Note: Bold print and italics added by me.

In addition, Overstock.com’s risk factors section in both second and third quarter 10-Qs, lists many other risks that may possibly lead future restructuring charges.

In fact, the opening paragraph of Overstock.com's "risk factors" disclosure in the third quarter 10-Q contains added cautionary language, absent in the company's previous 10-Q:

Please consider the following risk factors carefully. If any one of the following risks were to occur, our business, financial condition, operating results and cash flows could be materially adversely affected. In addition, these are not the only risks we face.

Note: Bold print, italics, and underlines added by me.

However, in its second quarter fiscal year 2007 10-Q, Overstock.com's opening "risk factors" paragraph stated:

These forward-looking statements are subject to risks and uncertainties that could cause actual results and events to differ materially. 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.

Note: Bold print and italics added by me.

The contrast in risk factor disclosures, detailed above, is curious considering that Overstock.com in its third quarter fiscal year 10-Q disclosed that its restructuring program "was substantially completed by the end of the second quarter of 2007," while its second quarter 10-Q the company claimed that "restructuring program should be substantially completed during calendar year 2007." Why did Overstock.com include the added cautionary language in its "risk factors" disclosure? Was Overstock.com playing another game of catch up?

Whether Overstock.com’s restructuring charges are considered as recurring or non-recurring by the company, it is difficult to see how the company’s disclosures are in compliance with Regulation G or SEC guidance concerning Regulation G. The company apparently fails to meet the SEC criteria under any conceivable scenario.

So it appears that, the more things change, the more they stay the same. Overstock.com continues to use pro forma metrics to suit its own agenda, SEC regulations be damned. Even the CEO’s own prior assertions are set aside in the hope of reporting some modicum of profit, real or imagined.

To be continued....

Written by:

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

Added note:

No response yet from Utah Attorney General Mark Shurtleff about his efforts to defame me on behalf of campaign contributor Overstock.com and its CEO Patrick Byrne.