Sunday, October 26, 2008

New Accounting Errors Make Overstock.com’s Financial Reports Not Reliable While SEC Regulation G Violations Continue

The saga of Overstock.com (NASDAQ: OSTK) led by CEO Patrick Byrne is a clear example of why so many investors have lost faith in the integrity of financial information disseminated by public companies. Overstock.com is a perennial money losing company selling investors hope for the future as its unprincipled management team continually disseminates an almost endless stream of false, misleading, deceptive, and erroneous disclosures.

Overstock.com’s latest Q3 2008 earnings release disclosed new accounting errors that render its previous financial reports as not reliable. The company disclosed that it is restating all financial reports from 2003 to 2008 due to material “errors related to the accounting of customer refunds and credits.” Therefore, Overstock.com reported that all financial reports dating back to 2003 “should no longer be relied upon.”

A History of Accounting Errors

Earlier this year, the Securities and Exchange Commission Division of Corporation Finance uncovered revenue accounting errors by Overstock.com dating back to the company's inception. In Overstock.com's responses to SEC inquiries, the company claimed that its revenue accounting error was not material. The company was clearly attempting to avoid a restatement of prior affected financial reports arising from intentional revenue accounting errors uncovered by the SEC. Instead, the company wanted to report its revenue accounting error as a one-time adjustment cumulative adjustment in its Q4 2007 financial report, apparently to hide the impact of such errors on previous affected individual financial reports.

I carefully examined Overstock.com's materiality analysis that was submitted to the SEC for its revenue accounting errors and found the company's analysis to be seriously flawed and misleading. At that time, I called on Overstock.com to restate its financial reports since my analysis found that the company's revenue accounting errors were material, contrary to Overstock.com's claims that they were not material.

Now, with newly disclosed accounting errors relating to customer refunds and credits, Overstock.com restated all financial statements back to 2003. In addition, Overstock.com reversed the previous one-time cumulative adjustment in Q4 2007 to correct its revenue recognition errors. By restating its financial statements, Overstock.com recorded such revenue accounting error corrections in their appropriate periods, as I called for in my blog.

Several years ago, Overstock.com restated financial reports dating from 2002 to 2005 due to inventory accounting errors. Because of Overstock.com's inventory build up at that time, the timing of Overstock.com's inventory accounting error disclosure enabled Patrick Byrne to boast that the company's numbers were too conservative. Overstock.com's restatement of financial reports wipes out previous positive adjustments to income from correcting its inventory accounting error.
After Overstock.com's latest string of revenue accounting errors and customer refund and credit accounting errors, the sum total of all accounting errors have added $10.3 million to cumulative losses of $255 million reported since the company's inception. In addition, the latest accounting error completely wiped out shareholder's equity to a negative $3.681 million. The company left open the possibility of additional adjustments to correct its accounting errors. What a mess!

So much for Patrick Byrne's phony claims that:

I wish to set a gold standard in communicating with candor your firm's results. In our public SEC filings we chose principles at the conservative edge of GAAP….  (Emphasis added.)

Tracy Coenen, an acclaimed forensic accountant and author observed in her blog:

Since 2000, Overstock.com has never had a profitable year. The only two quarters which ended up in the black [Q2 2002 and Q4 2004] are suspect…  (Emphasis added.)

She added:

Some of the financial statements that are being restated have already been restated by Overstock.com once, making the new financial statements “re-restated.” Leave to Ringmaster Byrne and his three ring circus. (Emphasis added.)

It is now clear that Overstock.com’s financial reports have never conformed to GAAP and are inaccurate despite previous assurances by Patrick Byrne that “I’m all about GAAP” and Sarbanes-Oxley certifications by Byrne and other senior officers attesting that accuracy of the company’s financial reports.

It should come as no surprise that Overstock.com's financial reporting cannot be relied on with a habitually lying CEO like Patrick Byrne. In an October 2007 blog post, I provided details dating back to 2000, how Patrick Byrne used deceptively used non-GAAP revenues to hype Overstock.com's top-line performance, while at the same time he claimed that Overstock.com was GAAP profitable, even though the company was not profitable at all.

Audit Committee, Auditors, and Management Asleep at the Wheel

It is also apparent that Overstock.com’s Audit Committee, PriceWaterhouseCoopers, its external auditors, and management are asleep at the wheel. On May 13, 2008, during the annual meeting of Overstock.com shareholders, Audit Committee Chairperson Allison H. Abraham praised the work of PricewaterhouseCoopers LLP:

The Audit Committee has had substantial opportunity to evaluate the work of PricewaterhouseCoopers and has found it to be consistent and of high quality.  (Emphasis added.)

Allison H. Abraham's evaluation of PricewaterhouseCoopers LLP is utter nonsense. The PricewaterhouseCoopers audit team has struck out as it missed three material accounting errors spanning at least 8 years.

We have to wonder if CFO David Chidester is asleep at the wheel, too. Overstock.com blamed its latest accounting errors on a 2005 major system upgrade and disclosed, “After the implementation, in the instance of some customer refunds, this reduction wasn’t happening, and we didn’t catch it.” The company claims that it took three years after the major system upgrade to catch the latest accounting error. If that is really the case, I suggest that David Chidester purchase a copy of “Accounting for Dummies” and study it well.

Insider Sales Ahead of Latest News of New Accounting Errors

Meanwhile, on May 22, 2008, David Chidester sold 2,766 shares of common stock at an average price of about $27.80 per share and pocketed about $77,000 in gross proceeds. After Overstock.com's latest accounting error was announced on Friday, the stock closed at $9.03 per share. Recent stock sales this year by CFO David Chidester may be subject to the clawback provisions under Sarbanes-Oxley Section 304.

Current Overstock.com President Jonathan Johnson may have a 10b-5 issue after lying to Wired.com. He claimed that Overstock.com was using GAAP numbers in Q1 2007 when the company actually used non-GAAP numbers due to its revenue accounting error. In a blog post, I detailed how Overstock.com's Q1 2008 earnings release failed to disclose that the company compared Q1 2008 revenues and other related items reported on a GAAP basis to Q1 2007 revenues and other related items that were reported on a non-GAAP basis.

At the time it was clear from Overstock.com's SEC filings that Q1 2007's numbers were not reported on a GAAP basis. Overstock.com made a one-time cumulative adjustment in Q4 2007 to correct its revenue accounting errors, rather than restate previous financial reports. Therefore, Q1 2007's numbers could not have been reported in compliance with GAAP.

According to a Wired.com article by Betsy Schiffman:

In its earnings release, Overstock.com failed to disclose that it compared first-quarter 2008 revenues reported on a GAAP basis to first-quarter 2007 revenues that were reported on a non-GAAP basis," Antar wrote on his White Collar Fraud blog.
For those who don't speak accountantese, "non-GAAP" basically refers to non-standard accounting practices, and the difference between GAAP and non-GAAP numbers is often substantial.
"Sam is just wrong," says Jonathan Johnson, senior vice president of legal at Overstock. "They're both GAAP numbers . . . I can't read his blog because it's so full of lies."  (Emphasis added.)

The liar is Jonathan Johnson, since Overstock.com's Q1 2007 numbers, as detailed above, were not reported in compliance with GAAP due to the company's revenue accounting errors and its failure to restate previous financial reports.

What was Jonathan Johnson thinking when he outright lied to Wired.com reporter Betsy Schiffman? A couple of days later, Jonathan Johnson unloaded 55,922 shares of Overstock.com common shares at an average price per share of $17.11 per share and pocketed gross proceeds totaling about $957,000 (Source: Form 4 here and here). That's almost double Friday's closing price per share of $9.03.

Worst yet, with Overstock.com's latest disclosure of customer refund and credit accounting errors, now both Q1 2008 and Q1 2007 reports used non-GAAP numbers, rather than just Q1 2007's report.

Posting and emailing questions to Patrick Byrne a day before the earnings call

While Overstock.com cannot seem to report GAAP numbers, the company also has trouble reporting compliant non-GAAP numbers, such as EBITDA, too. Since November 2007, this blog (all related posts here) has detailed how Overstock.com’s EBITDA disclosures are materially overstated due to the company’s non-compliance with SEC Regulation G governing such disclosures.

A day before the Q3 2008 earnings call, I posted a series of questions on this blog about Overstock.com’s violations of SEC Regulation G governing its EBITDA disclosures and other false and misleading disclosures by management. During the earnings call, CEO Patrick Byrne, President Jonathan Johnson, and CFO David Chidester denied that Overstock.com’s reported EBITDA violated Regulation G with new false statements and distortions.

Their false claims about Overstock.com’s Regulation G compliance went unchallenged by spineless Wall Street analysts attending the earnings call. In addition, the cowards at Overstock.com did not permit me to ask any questions during the call despite my requests.

Overstock.com’s Violation of Securities and Exchange Commission Regulation G governing Non-GAAP Disclosures Such as EBITDA

Since Q2 2007, Overstock.com has embraced EBITDA as an important measure of the company’s performance, despite previous statements by Patrick Byrne critical of companies that use EBITDA. More importantly, Overstock.com’s EBITDA disclosures are materially overstated due to the company’s non-compliance with SEC Regulation G governing such disclosures.

Overstock.com reconciles its reported EBITDA to operating loss, rather than net loss and improperly eliminates stock-based compensation costs from its EBITDA calculation. In previous quarters, Overstock.com’s reported EBITDA has been materially overstated by the amount of any losses from discontinued operations (not part of operating losses) and stock-based compensation costs.

During the earnings call, Patrick Byrne and Jonathan Johnson responded to me about Overstock.com’s EBITDA disclosures with outright untruths and I was not permitted to challenge their false statements:

Patrick Byrne:
The claim that EBITDA is not compliant with SEC definition, nonsense. Our EBITDA reconciles to GAAP. The SEC says you have to reconcile EBITDA to GAAP. We follow, I believe, the general industry practice and the A in EBITDA, amortization of stock-based compensation, our EBITDA excludes it. Moreover we reconcile everything to GAAP. Sam Antar the Crook has pointed out as a couple of people have received comment letters. They were people who had not reconciled to GAAP. In any case, we’ve gone through this over and over with our lawyers. They’re saying you’re doing this right. Jonathan, do you want to add anything?
Jonathan Johnson:
No. Our EBITDA reconciles to GAAP. End of story.  (Emphasis added.)

Sorry Jonathan, it is not the end of the story. Now here are the facts.

Patrick Byrne and Jonathan Johnson want you to believe just because the company’s reported EBITDA calculation “reconciles to GAAP,” it is not in violation of SEC Regulation G. That assertion is simply untrue. The SEC Regulation G requires that non-GAAP measures such as EBITDA be reconciled “the most directly comparable GAAP financial measure” and not any GAAP measure that management wants to reconcile it to.

Specifically, in the case of EBITDA, the SEC has defined the “the most directly comparable GAAP financial measure” as net income or loss and not operating income or loss, as used by Overstock.com.

According to the SEC guidance:

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.  (Emphasis added.)

Overstock.com cannot reconcile EBITDA to operating income or loss (a GAAP financial measure) and it must reconcile EBITDA to net income or loss (the most directly comparable GAAP financial measure).

In addition, Patrick Byrne claimed that:

Antar the Crook has pointed out as a couple of people have received comment letters they were people who had not reconciled to GAAP.  (Emphasis added.)

Again, Patrick Byrne’s claim is untrue. According to the first SEC comment letter cited by me, CKX Inc., like Overstock.com improperly reconciled EBITDA to “income or loss from operations” a GAAP measure. However, both Overstock.com and CKX should have reconciled EBITDA to net income or loss which is “the most directly comparable GAAP financial measure” as required by SEC Regulation G.

The SEC told CKX in its comment letter:

…please revise your calculation of EBITDA such that it is computed as net income (loss) (rather than income or loss from continuing operations) before interest expense, income tax expense (benefit), depreciation and amortization. Alternatively, if you believe your current presentation of your non-GAAP measure is appropriate, but has been characterized inappropriately as EBITDA, revise your presentation….  (Emphasis added.)

CKX responded to the SEC comment letter:

The Registrant has revised its presentation in the Summary Historical and Pro Forma Financial Data to include operating income before depreciation and amortization ("OIBDA"). All references to EBITDA have been removed. The Registrant has revised its disclosures to reconcile OIBDA to operating income which is the most directly comparable financial measure calculated and presented in accordance with GAAP. (Emphasis added.)

Therefore, CKX renamed its non-compliant EBITDA disclosure as “OIBDA” or “operating income before depreciation and amortization” and the company was able to reconcile OIBDA to operating income “which is the most directly comparable measure” under SEC Regulation G.

In the second SEC comment letter cited by me, CGG Veritas, like Overstock.com, improperly eliminated stock-based compensation expenses from its non-complaint reported EBITDA. Patrick Byrne would like investors to believe that stock-based compensation costs are properly excluded from EBITDA as an amortization expense. However, as cited the comment letter to CGG Veritas, the SEC does not agree with Overstock.com's claim that stock-based compensation costs are properly excludable from EBITDA.

The SEC told CGG Veritas:

The acronym EBITDA refers specifically to earning before interest, tax, depreciation and amortization. However, your measure also adjusts earnings for stock option expense. We will not object to your using such a measure as a liquidity measure but request that you rename it to avoid investor confusion.  (Emphasis added.)

CGG Veritas replied to the SEC:
In response to the Staff’s comment, we will in future filings refer to the non-GAAP measure in question as “EBITDAS”, which we will define as “earnings before interest, tax, depreciation, amortization and share-based compensation cost…  (Emphasis added.)

Therefore, it is clear that Overstock.com, like CGG Veritas, cannot eliminate stock-based compensation costs from EBITDA under Regulation G.

Based on the two SEC comment letters above, I have suggested that Overstock.com simply re-name its non-compliant EBITDA disclosure as OIBITDAS or operating income before interest, taxes, depreciation, amortization, and stock-based compensation. However, Overstock.com stubbornly refuses to comply with SEC Regulation G and it materially overstates EBITDA.

Another excuse offered by Patrick Byrne during the Q3 2008 earnings call and David Chidester during the previous Q2 2008 earnings call is that Overstock.com is following “industry practice” by eliminating stock-based compensation costs from EBITDA. However, following the accounting practices of some other non-compliant companies who have not faced SEC action is no excuse for violating SEC Regulation G.

According to SEC Staff Accounting Bulletin No.99:

Some have argued to the staff that registrants should be permitted to follow an industry accounting practice even though that practice is inconsistent with authoritative accounting literature… The staff disagrees with this argument. Authoritative literature takes precedence over industry practice that is contrary to GAAP. (Emphasis added.)

Therefore, Patrick Byrne and David Chidester’s “industry practice” excuse is dead wrong. Accounting practice does not take precedence over authoritative literature such as SEC Regulation G.

Another issue that was raised by me, but ignored by Overstock.com management, is the company’s inconsistent EBITDA disclosures. In my questions to Patrick Byrne, I wrote:

In certain accounting periods, Overstock.com has eliminated part of its restructuring costs from EBITDA while in other accounting periods such restructuring costs are included in its EBITDA calculations. For example, Overstock.com’s Q2 2007 10-Q and Q3 2007 10-Q does not eliminate restructuring charges from both is reported quarterly and year-to-date reported EBITDA. I note that during fiscal year 2007, all of restructuring charges totaling $12.283 million occurred in Q1 and Q2 2007 and no other quarters. In contrast, in Overstock.com’s fiscal year 2007 10-K , the company's year-to-date EBITDA eliminates $2.169 million of the $12.283 restructuring charges that were included in previously reported year-to-date EBITDA calculations in Q2 2007 and Q3 2007.

Patrick Byrne simply could not find an available lie to respond to my question, “Why did Overstock.com use inconsistent calculations for computing its reported EBITDA?”

Overstock.com’s recent embrace of EBITDA as a crucial financial measure despite Patrick Byrne’s previous criticisms of EBITDA

In my previous blog post, I cited three statements by Patrick Byrne that were critical of EBITDA and asked in general, in light of such statements why is Overstock.com using EBITDA now?

On April 23, 2004, Patrick Byrne appeared on the Kudlow and Cramer show on CNBC and commented about EBITDA:

Well, first of all, I’m all about GAAP. I have been so critical of the companies that do–I don’t believe in one-time charges; I don’t believe in EBITDA. If somebody talks EBITDA, put your hand on your wallet; they’re a crook. (Emphasis added.)

In January 2006, Patrick Byrne made the following comments about EBITDA to Tom Mullaney from Business Week in an email:

…I think “EBITDA” is the stupidest thing I ever heard emanate from Wall Street (no small feat), I … don’t begin to know how to answer. I suppose I could go and recast all my numbers into EBITDA (or for that matter, “pro forma”) but I think I’ll do something more valuable with my time, like alphabetize my CD’s by, “Name of drummer.”  (Emphasis added.)

In March 2006, Patrick Byrne told Greg Sandoval from c/net news.com:

[Amazon] made up a phony accounting standard--pro forma….

Later, Byrne added:

When it reached EBITDA (earnings before interest, tax, depreciation and amortization) breakeven, Wall Street wanted to declare it a national holiday. I've never used pro forma in my life. (Emphasis added.)

In effect, Patrick Byrne’s previous statements criticizing EBITDA and saying, “If somebody talks EBITDA, put your hand on your wallet; they’re a crook” defines his recent actions touting EBITDA as crooked. He has called EBITDA "the stupidest thing I ever heard emanate from Wall Street (no small feat)" and a "phony accounting standard--pro forma…." Now he uses a non-compliant EBITDA, as he pleases, to hype Overstock.com's financial performance.

During the Q3 2008 earnings call, Patrick Byrne responded:

Sam Antar the Crook, as I like to call him and he likes to identify himself, I think he has to as a felon. Sam Antar the Crook has sent us pages and pages of public questions. I'm going to boil it down. He says that in the past I've said that EBITDA is garbage and anyone who uses it is crooks and now we use EBITDA. Well, that's true.

So far, so good. Now, here is where the doubletalk begins. A deeply disturbed Patrick Byrne went on his long winded rant:

In the past, I've also said that the reason I don't like EBITDA as a measure is, (a) intellectually because you don't end up counting the spend that you spend on capital equipment either when you spend it or when you depreciate it.
Well that's not right. And secondly, what I really object to is valuing businesses off EBITDA. That's what Wall Street does and I just object to that because eventually you've got to think of the expense of that item either as you spend it or as you depreciate it.
There are two times, as I've said a dozen times, I'm sure or more, that EBITDA is interesting. One is when you're in a low cash situation, it gets very interesting. Also just when you're in a situation of not having to do much CapEx, and our CapEx dropped significantly below our actual GAAP depreciation.
We are like the proverbial boa constrictor digesting a baby hippo and we ate the baby hippo about three year goes ago actually right now and it's moved its way through the boa constrictor.

In others words, Patrick Byrne is in effect saying that, “I don't like EBITDA as a measure” but I will use EBITDA as it pleases me. However, the bedrock of our accounting system is the consistent application and disclosures of financial measures like EBITDA. A financial measure, such as EBITDA, is not meant to be turned on or off like a faucet as management pleases. Investors require comparable financial information and not measures that pop in and out of financial reports as they please management’s agenda.

Patrick Byrne and Overstock.com's justification for using EBITDA are contradicted by the company's Q3 2008 financial performance

In any case, Patrick Byrne shot himself in the foot when he tried to justify using EBITDA, despite his previous comments criticizing it, by claiming that "it gets very interesting.... when you're in a situation of not having to do much CapEx, and our CapEx dropped significantly below our actual GAAP depreciation." In addition, Overstock.com's Q3 2008 financial report claims:

We believe that, because our current capital expenditures are lower than our depreciation levels, discussing EBITDA at this stage of our business is useful to us and investors because it approximates cash used or cash generated by the operations of the business.  (Emphasis added.)

Those claims are contradicted by Overstock.com's financial performance. Actually, during Q3 2008, capital expenditures were much higher than the previous year's comparable quarter and capital expenditures were higher than GAAP depreciation, in contrast to Byrne's comments and Overstock.com's disclosures.

During Q3 2008, expenditures for property and equipment ("CapEx") totaled $8.8 million compared to $316K during Q3 2007 or about 27 times higher, in contrast to Byrne's comment claiming that EBITDA is "interesting" when capital expenditures are dropping.

In addition, during Q3 2008, Overstock.com's capital expenditures of $8.8 million exceeded depreciation and amortization expenses of $5.6 million by $3.2 million or 57%. This disclosure contradicts both Byrne's and the company's disclosure that using EBITDA is justified when capital expenditures are lower than depreciation expenses.

Not a single Wall Street analyst attending the earnings call, challenged Byrne's doubletalk.
Perhaps the most amusing comment during the earnings call was echoed by both Patrick Byrne and Jonathan Johnson. Both Byrne and Johnson said, “Our EBITDA reconciles to GAAP.” However, as is evident by Overstock.com’s history of financial misstatements, the company’s previous financial reports never complied with GAAP!

There were other amusing moments, too. Former company President Jason C. Lindsey made a futile attempt at addressing his previous misstatements about junk inventory levels that were pointed out by this blog. However, you will need to wait for part 2 or 3 of this series of blog posts for further details.

To be continued....

Written by,

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

Disclosure: Not long or short Overstock.com

Friday, October 24, 2008

Message to Overstock.com Management about Q3 Earnings Call

To Patrick Byrne, Jonathan E. Johnson III, David Chidester, and Jason C. Lindsey:

I listened in to Overstock.com's (NASDAQ: OSTK) Q3 2008 earnings call.

There is a lesson that I learned as the criminal CFO of Crazy Eddie:
"The cover up is worse than the crime."
It is inappropriate for you to lie to, deceive, and mislead investors about your financial reporting. I call it criminal.

You can run but you cannot hide your charades from this convicted felon.
Stay tuned for my next blog post for further details.

Kindest regards,

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

Update:

During the Q3 2008 earnings call, Overstock.com's management attempted to address issues raised in my previous blog post with new false and misleading statements. A detailed response to Overstock.com is posted here.

Disclosure: Not long or short Overstock.com.

Thursday, October 23, 2008

My Questions for Overstock.com CEO Patrick Byrne Regarding Upcoming Earnings Call for Q3 2008

During the Q2 2008 earnings call, Patrick Byrne asked if I had any “questions” even though he knew that I was not on the call. Therefore, I am taking Patrick Byrne up on his invitation to ask questions for Overstock.com’s (NASDAQ: OSTK) upcoming Q3 2008 earnings call tomorrow on Friday, October 24.

Before, asking each of my questions below, I provide the context of my questions. I look forward to an articulate and detailed separate response to each of my questions and will publish Byrne’s answers on my blog.

Let’s see if Patrick Byrne, who calls himself a transparent CEO, has the guts to answer each and every question.

Using Earnings before interest, taxes, and depreciation (EBITDA) in Overstock.com’s financial reports

On April 23, 2004, Patrick Byrne appeared on the Kudlow and Cramer show on CNBC and commented about EBITDA:

Well, first of all, I’m all about GAAP. I have been so critical of the companies that do–I don’t believe in one-time charges; I don’t believe in EBITDA. If somebody talks EBITDA, put your hand on your wallet; they’re a crook. [Emphasis added.]

In January 2006, Patrick Byrne made the following comments about EBITDA to Tom Mullaney from Business Week in an email:

I think “EBITDA” is the stupidest thing I ever heard emanate from Wall Street (no small feat), I … don’t begin to know how to answer. I suppose I could go and recast all my numbers into EBITDA (or for that matter, “pro forma”) but I think I’ll do something more valuable with my time, like alphabetize my CD’s by, “Name of drummer.” 

In March 2006, Patrick Byrne told Greg Sandoval from c/net news.com:


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.
When it reached EBITDA (earnings before interest, tax, depreciation and amortization) breakeven, Wall Street wanted to declare it a national holiday. I've never used pro forma in my life. We've had some GAAP (generally accepted accounting principles) profitable quarters, plenty of operating profit and EBITDA profitable quarters. This year, with a little luck, we should be an EBITDA-profitable year, so I'm kind of comfortable with that. [Emphasis added.]

Despite Patrick Byrne’s comments above, since Q2 2007, Overstock.com has been reporting what it claims is EBITDA in reports filed with the SEC and unlike Overstock.com, Amazon does not report EBITDA in reports filed with the SEC.

Questions for Patrick Byrne

Based on your comments above, do you believe that you are “crook” for using EBITDA in Overstock.com’s financial reports and do you believe that investors should “put their hand on” their wallets and not consider investing in your company?

If you believe that “EBITDA” is the “stupidest thing” you “ever heard emanate from Wall Street” and a “phony accounting standard—pro forma” why does Overstock.com use EBITDA in its financial reports?

Did you flip flop your views on EBITDA when it was advantageous to use it in Overstock.com's reports filed the SEC?

Are Overstock.com’s EBITDA disclosures in compliance with SEC Regulation G?

Securities and Exchange Commission Regulation G governs the use of EBITDA and other non-GAAP financial measures. According to the SEC Division of Corporation Finance Regulation G guidance provided in their "Frequently Asked Questions Regarding the Use of Non-GAAP Financial Measures" EBITDA refers specifically to “earning before interest, taxes, depreciation and amortization." See below:

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. [Emphasis added.]

Therefore, the intended meaning of “earnings” for EBITDA under Regulation G is “net income as presented in the statement of operations under GAAP.” EBITDA can only be computed as earnings (meaning net income or loss and not operating income or loss) before interest, taxes, depreciation, and amortization and the SEC requires that “measures that are calculated differently than those described as…EBITDA in the adopting release [Regulation G] should not be characterized as EBITDA.”

However, Overstock.com defines its reported EBITDA as follows:

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. [Emphasis added.]

Therefore, Overstock.com improperly reconciled its reported EBITDA to operating loss instead of net loss and the company also improperly eliminates “stock-based compensation” from its EBITDA computation. Let’s examine, the SEC’s actions, regarding two other companies who reported EBITDA that was not complaint with Regulation G, before I ask Patrick Byrne additional questions about Overstock.com's EBITDA calculations.

CKX Inc. improperly reconciled EBITDA to “income from operations”

Like Overstock.com, CKX reconciled EBITDA to “income or loss from operations” and similarly they both had losses from discontinued operations. As a result of using operating income or loss from operations, rather than net income or loss, as the starting point towards computing EBITDA, both CKX and Overstock.com overstated EBITDA by at least the amount of losses from discontinued operations. The SEC notified CKX:


We note that you define EBITDA as income or loss from continuing operations before interest expense, income tax expense (benefit), depreciation and amortization, and consider it to be an important supplemental measure of your operating performance which is used by management to evaluate the performance of the Company. However, it appears your definition of EBITDA does not comply with the guidance set forth in Question 14 of the “Frequently Asked Questions Regarding the Use of Non-GAAP Financial Measures.” Question 14 states that the term “earnings” is intended to mean net income as presented in the statement of operations under GAAP and further, measures that are calculated differently than those described as EBIT or EBITDA should not be characterized as “EBIT” or “EBITDA.” In this regard, please revise your calculation of EBITDA such that it is computed as net income (loss) (rather than income or loss from continuing operations) before interest expense, income tax expense (benefit), depreciation and amortization. Alternatively, if you believe your current presentation of your non-GAAP measure is appropriate, but has been characterized inappropriately as EBITDA, revise your presentation and supplementally tell us in detail how it complies with FR-65. [Emphasis added.]

The SEC told CKX to revise their EBITDA calculation from “income or loss from continuing operations before interest expense, income tax expense (benefit), depreciation and amortization” to “net income (loss) (rather than income or loss from continuing operations) before interest expense, income tax expense (benefit), depreciation and amortization."

CKX responded to the SEC:

The Registrant has revised its presentation in the Summary Historical and Pro Forma Financial Data to include operating income before depreciation and amortization ("OIBDA"). All references to EBITDA have been removed. The Registrant has revised its disclosures to reconcile OIBDA to operating income which is the most directly comparable financial measure calculated and presented in accordance with GAAP. [Emphasis added.]

Therefore, CKX renamed its non-compliant EBITDA disclosure as OIBDA or operating income before depreciation and amortization and the company was able to reconcile OIBDA to operating income. Therefore, CKX was able to remove losses from discontinued operations from its non-GAAP financial measure. Overstock.com Audit Committee member Joseph J. Tabacco Jr, was alerted by me via email (return receipt received) that Overstock.com, like CKX, improperly reconciled its reported EBITDA to operating income or loss rather than net income or loss.

Questions for Patrick Byrne

Why does Overstock.com continue to improperly reconcile its reported EBITDA to operating loss rather than net loss?

Why not rename Overstock.com’s non-compliant EBITDA disclosure to a more appropriate name to comply with Regulation G?

CGG Veritas, improperly eliminated “stock-based” compensation from its reported EBITDA computation

Another company, CGG Veritas, like Overstock.com, improperly eliminated “stock-based” compensation from its reported EBITDA computation and as a result overstated its reported EBITDA by the amount of stock-based compensation. The SEC notified CGG Veritas:


The acronym EBITDA refers specifically to earning before interest, tax, depreciation and amortization. However, your measure also adjusts earnings for stock option expense. We will not object to your using such a measure as a liquidity measure but request that you rename it to avoid investor confusion. [Emphasis added.]

CGG Veritas responded to the SEC:

In response to the Staff’s comment, we will in future filings refer to the non-GAAP measure in question as “EBITDAS”, which we will define as “earnings before interest, tax, depreciation, amortization and share-based compensation cost”, and will reconcile to net cash provided by operating activities as presented on the Company’s consolidated statements of cash flows. [Emphasis added.]

As a result of the SEC’s review, CGG Veritas changed its non-compliant EBITDA measure to EBITDAS or earnings before interest, taxes, depreciation, amortization, and stock-based compensation.

Overstock.com Audit Committee member Joseph J. Tabacco Jr, was alerted by me via email (return receipt received) that Overstock.com, like CGG Veritas, improperly removed stock-based compensation from its reported EBITDA calculation.

Questions for Patrick Byrne

Why does Overstock.com continue to improperly remove stock-based compensation from its reported EBITDA?

Why not rename Overstock.com’s non-compliant EBITDA disclosure to a more appropriate name to comply with Regulation G?

Based on the SEC actions regarding both CKX Inc. and CGG Veritas under SEC Regulation G, why not rename Overstock.com’s improperly reported EBITDA to OIBITAS or operating income or loss before interest, taxes, depreciation, and stock-compensation expense to comply with SEC Regulation G?

Improperly reported EBITDA calculation by Overstock.com results in overstatement of EBITDA in violation of SEC Regulation G

Since Overstock.com improperly reconciles EBITDA to operating loss rather than net loss, the company’s reported EBITDA is overstated by the amount of loss from discontinued operations in certain accounting periods. In addition, since Overstock.com improperly eliminates stock-based compensation costs from EBITDA, the company’s reported EBITDA is overstated by such amounts.

In Overstock.com’s “CEO Owner’s Guide” Patrick Byrne made the following comments:

I wish to set a gold standard in communicating with candor your firm's results. In our public SEC filings we chose principles at the conservative edge of GAAP…. [Emphasis added.]

Question for Patrick Byrne

Do you believe that reconciling EBITDA to operating loss and eliminating stock-based compensation from EBITDA, both of which overstated Overstock.com reported EBITDA in violation of SEC Regulation G, is consistent with your “gold standard” and choosing “principles at the conservative edge of GAAP” as enumerated above?

Inconsistent EBITDA disclosures by Overstock.com

In certain accounting periods, Overstock.com has eliminated part of its restructuring costs from EBITDA while in other accounting periods such restructuring costs are included in its EBITDA calculations. For example, Overstock.com’s Q2 2007 10-Q and Q3 2007 10-Q does not eliminate restructuring charges from both is reported quarterly and year-to-date reported EBITDA. I note that during fiscal year 2007, all of restructuring charges totaling $12.283 million occurred in Q1 and Q2 2007 and no other quarters. In contrast, in Overstock.com’s fiscal year 2007 10-K , the company's year-to-date EBITDA eliminates $2.169 million of the $12.283 restructuring charges that were included in previously reported year-to-date EBITDA calculations in Q2 2007 and Q3 2007.

Question for Patrick Byrne

Why did Overstock.com use inconsistent calculations for computing its reported EBITDA?

Patrick Byrne claims a "gold standard in communicating with candor" Overstock.com's results

As I detailed above, Patrick Byrne claims to “wish to set a gold standard in communicating with candor” Overstock.com results. As detailed above, in March 2006, he told Greg Sandoval from c/net news.com:

We have a plan this year that we should cross the billion-dollar mark…. This year, with a little luck, we should be an EBITDA-profitable year, so I'm kind of comfortable with that.

Both revenues and reported EBITDA fell way off the mark touted by Byrne. In fiscal year 2006, Overstock.com did not “cross the billion-dollar mark” in revenues and instead reported revenue of only $788.15 million. In addition, Overstock.com did not have “an EBITDA-profitable year” and instead improperly reported a non-compliant EBITDA of negative $55.718 million which understated Overstock.com's negative EBITDA or rather overstated the company's EBITDA performance. About a year later, on April 25, 2007, during the Q1 2007 earnings conference call, Patrick Byrne made the following startling admission in contrast to his comments to Greg Sandoval, a year earlier:


We had our game plan. Really, we had our game plan as of Q1 last year [2006] of what was going to have to happen.
We knew things were going to get really ugly and the company was going to have take medicine but that we could come out of it a far better company, and that medicine was going to be in the form of some expenses, it was going to be in the form of dumping a bunch of inventory as we figured out really how to take our inventory management to the next level -- all kinds of things. We knew it was going to get ugly. Maybe not as ugly as it got but we thought we would come out in the first quarter smelling like a rose operationally and this is exactly what we -- what I at least thought was going to happen in the first quarter. [Emphasis added.]

Questions for Patrick Byrne

Since both your interview with Greg Sandoval and your “game plan” quoted above occurred during the same quarter (Q1 2006), why did you wait almost an entire year to disclose that you knew that things were going to get "really ugly" and the company was going to have to "take medicine"?

Do you believe that waiting almost an entire year to disclose your “game plan” is consistent with your “wish to set a gold standard in communicating with candor” Overstock.com results?

Questionable disclosures about inventories

On December 15, 2006, Overstock.com sold 2.734 million shares of stock and received a cash infusion of about $40 million. At that time, investors were not informed by Patrick Byrne that he already knew that things were going to get "really ugly" and the company was going to have to "take medicine." What followed was "really ugly" in the form of declining revenues, negative gross margins on direct sales, massive increases in inventory reserves, and huge record losses in Overstock.com's final quarter of fiscal year 2006.

On February 5, 2007, Overstock.com disclosed that Q4 2006 revenues declined to $297.47 million from $317.98 million or a 6.5% reduction. During the final quarter, company lost a record $40.7 million and reported negative gross margins on direct sales. During the Q4 2006 earnings conference call, but before Overstock.com had released its 10-K report that included inventory reserve disclosures, Jason C. Lindsey explained Overstock.com’s negative gross margins and lower inventory levels as follows:


We took all that to heart in the fourth quarter and although the fourth quarter results are very bad, and I admit they are very bad, they were bad on purpose. In other words, we used the fourth quarter to get rid of all the slow-moving inventory. I am quite pleased with the inventory balances we have now....I am pleased that the fourth quarter is now over. We have sold it. Our inventory turns are much higher. Our margins are much higher and it really does feel like we have made a lot of progress there. [Emphasis added.]

The key words are “I admit they are very bad, they were bad on purpose… we used the fourth quarter to get rid of all the slow moving inventory.... We have sold it.”

Just a few short weeks later, Overstock.com released its 10-K for fiscal year 2006. In that filing, the company reported its highest ever level of inventory reserves, making it quite clear that the slow moving inventory had not been moved (contrary to Lindsey’s earlier assertion).

Gross inventory levels (before reserves) started the year at about $98.5 million and dropped to about $26.9 million by the end of the year, about a $71.6 million drop in inventory.

But, the bad inventory wasn’t gone. This is clear because inventory reserves rose from about $5.2 million at the beginning of the year to about $6.6 million at the end of the year. On a relative basis, inventory reserves went up a staggering 361% from about 5.3% of gross inventory at the beginning of the year to 24.5% of inventory at the end of the year.

Overstock.com cannot have two opposing versions of the truth exist simultaneously. If the company's inventory reserves were accurately stated at the end of the fiscal year at $6.6 million, than no progress was made in reducing the level of junk inventory. If Overstock.com made progress in reducing junk inventory, how can the company report such huge reserves at the end of the fourth quarter?

As detailed above, during the earnings conference call for the next quarter (first quarter fiscal year 2007) Patrick Byrne made the startling admission of Overstock.com’s previously undisclosed “game plan...of what was going to have to happen" during fiscal year 2006. He "knew things were going to get really ugly." Patrick Byrne's comment reinforced Jason C. Lindsey’s comment that the fourth quarter of fiscal year 2006 was “very bad…bad on purpose.”

Questions for Patrick Byrne

Why did Jason C. Lindsey say “we used the fourth quarter to get rid of all the slow-moving inventory” and "we have sold it" when in fact, afterwards, it was disclosed that inventory reserves increased in both total dollars and relative amounts to gross inventories?

Was Jason Lindsey misinformed, trying to mislead investors, or outright lying?

Did Overstock.com defer recognition of adequate inventory reserves until after Q3 2006 by making a "catch up" adjustment to inventory reserves in Q4 2006?

Why did Overstock.com wait until months after it sold 2.734 million shares of stock and received a cash infusion of about $40 million to disclose that management already knew that things were going to get "really ugly" and the company was going to have to "take medicine"?

If we take Jason C. Lindsey at his word that Overstock.com “used the fourth quarter to get rid of all the slow-moving inventory” and that the company really “sold it,” were inventory reserves deliberately inflated in Q4 2006 to help increase earnings or reduce losses in future accounting periods by reversing such reserves?

Additional Comments

Since Patrick Byrne invited me to ask questions for Overstock.com’s earnings call I look forward to his detailed responses to each individual question. As I said, I will post his responses on my blog.

The ball is now in Patrick Byrne’s court. Let’s see if Patrick Byrne has the guts to answer my questions.

To be continued….

Written by,

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

Disclosure: Not long or short Overstock.com

Update: A day after this blog post, Overstock.com announced new accounting errors and as a result, the company is restating all financial reports dating back to 2003. During the Q3 2008 earnings call, management attempted to address issues raised in this blog post with new false and misleading statements. After listening to management's latest round of lies and distortions, I posted a message to Overstock.com's management here. A detailed response to Overstock.com is posted here.

Sunday, October 19, 2008

Why White Collar Criminals Do Not Fear Today's FBI

As the heartless cold blooded criminal CFO of Crazy Eddie, the Federal Bureau of Investigation was a respected adversary that filled my stomach with butterflies and caused me many sleepless nights as I feared their tenacity to successfully investigate my crimes. Unfortunately, the white collar criminals of today have much less to fear from the FBI. According to an article in the New York Times:
The Federal Bureau of Investigation is struggling to find enough agents and resources to investigate criminal wrongdoing tied to the country’s economic crisis, according to current and former bureau officials.
The bureau slashed its criminal investigative work force to expand its national security role after the Sept. 11 attacks, shifting more than 1,800 agents, or nearly one-third of all agents in criminal programs, to terrorism and intelligence duties. Current and former officials say the cutbacks have left the bureau seriously exposed in investigating areas like white-collar crime, which has taken on urgent importance in recent weeks because of the nation’s economic woes.
The pressure on the F.B.I. has recently increased with the disclosure of criminal investigations into some of the largest players in the financial collapse, including Fannie Mae and Freddie Mac. The F.B.I. is planning to double the number of agents working financial crimes by reassigning several hundred agents amid a mood of national alarm. But some people inside and out of the Justice Department wonder where the agents will come from and whether they will be enough.
Even if the FBI doubles the number of agents working financial crimes, it does not solve the main problem of effectively investigating white collar crime. White collar crime investigations are often complicated cases, take long periods of time, require enormous resources, and most importantly, experienced agents.

Top-notch, experienced FBI agents are leaving the Bureau for higher paying private industry jobs as soon as they qualify for retirement causing a brain drain within the FBI. As white collar crime is becoming increasingly complex, our government must revise employee retention policies to compete with the private sector.

The FBI lacks adequate legal, technological, and personnel resources to meet its responsibilities to investigate white collar crime. According to the New York Times article:
From 2001 to 2007, the F.B.I. sought an increase of more than 1,100 agents for criminal investigations apart from national security. Instead, it suffered a decrease of 132 agents, according to internal F.B.I. figures obtained by The New York Times. During these years, the bureau asked for an increase of $800 million, but received only $50 million more. In the 2007 budget cycle, the F.B.I. obtained money for a total of one new agent for criminal investigations.
Too often, complicated white collar crime investigations fall apart because the FBI lacks experienced agents with the patience, knowledge, and experience to put together a successful criminal investigation. According to the New York Times article:
In some instances, private investigative and accounting firms are now collecting evidence, taking witness statements and even testifying before grand juries, in effect preparing courtroom-ready prosecutions they can take to the F.B.I. or local authorities.
“Anytime you bring to the F.B.I. a case that is thoroughly investigated and reduce the amount of work for investigators, the likelihood is that they will take the case and present it for prosecution,” said Alton Sizemore, a former F.B.I. agent who is a fraud examiner for Forensic Strategic Solutions in Birmingham, Ala.
In other words, in order for the FBI to give serious consideration to many cases, they must be presented to them neatly gift wrapped on a silver platter.

The criminals of today are elated by an under-resourced and relatively inexperienced FBI. As a result, the cancer of white collar crime continues to destroy the integrity of our great capitalist economic system.

Written by:

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

Disclosure: My mug shot and finger prints are on file with the FBI.

Friday, October 10, 2008

A Crisis of Confidence: Some Small Steps We Can Take Now

The main pillar of our capitalist economic system is the integrity of financial information. When the markets loose faith in the integrity of financial information, the collective market capitalizations of all companies suffer. Today, we a suffering a loss of faith and confidence in the integrity of the financial information reported by public companies and the result has been a downward spiral in stock prices and a tightening of credit that threatens to destroy our economy.

There are some small steps we can do now to restore faith in our markets and get our economy back on track.

Continuity: We immediately need a new Treasury Secretary that both Democrats and Republicans can agree on now, to provide continuity no matter who wins the November election. That means that President George Bush, Democratic Party candidate Barack Obama, Republican Party candidate John McCain, Speaker of the U.S. House of Representatives Nancy Pelosi, and other leaders should stop their silly posturing and get together right now to select a mutually agreeable Treasury Secretary for the long haul to get us out of this mess.

Capital Formation: The government should declare a capital gains holiday for all new investments made during the next six months and held for at least three years. A capital gains holiday will result in a major infusion of badly needed capital and bolster our economy. It will reward risk taking during our uncertain times.

Bankruptcy Laws: Bankruptcy laws should be amended to allow financially responsible homeowners to regain their financial footing. Subject to certain guidelines, they should be permitted to make reduced payments on their mortgages and the amount of any reduction in payments can be added to their principal balances to be repaid over time.

I believe that the above steps will be better than the ill conceived $700 billion plus bail out plan offered. The current bail out plan should be scrapped. America requires a Sarbanes-Oxley II to enhance corporate financial disclosures, controls, and governance. For additional information about Sarbanes-Oxley, start here.

Blog Update

The Stupid Nation Blog adds:

Our allegedly "conservative" led government seems hell bent for leather to nationalize the U.S. economy, and in significant measure, dismantle capitalism (whether temporarily or permanently remains to be seen).

Later, the blog goes on to say:

We need calm, deliberate, thoughtful Congressional action consistent with capitalist principles to help right the markets. Throwing capitalism out with the rest of the bad debt trash is not the answer. The world is littered with failed socialist states, and the graveyards of Europe and Asia are chock full of the victims of socialism and it's hideous derivatives. Some deregulation may have played a part in this confluence of horrid events, but we maintain that it was big liberal government meddling in the mortgage market which is the epicenter of this calamity. Without disastrous Government intervention, the sub-prime market would never have been able to become the monster that swallowed the world.

I agree and the Stupid Nation Blog is recommended reading for every concerned voter looking for a well analyzed and informative view of events.

More to come in future blog posts.

To be continued....

Written by:

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

Disclosure: No preference in the election at this time. Just disgusted with the lack of leadership from both political parties and the pandering that is going on.