Sunday, November 30, 2008

New York Democratic Party Leadership Takes Money from Same-Sex Marriage Supporters and Won't Deliver on Promises

Many politicians from both sides of the aisle emulate the same character traits as criminals. Criminals consider your humanity as a weakness to be exploited in the execution of their crimes. First, criminals try to raise your comfort level by bonding with you to gain your trust. After gaining your trust, criminals take your money based on false promises of hope. As the criminal CFO of Crazy Eddie, I sold many gullible investors on the hope of a prosperous future by using phony financial reports to raise their comfort level and trust.

Apparently, the same holds true with the New York Democratic Party leadership. They exploited the aspirations of gay rights supporters by selling them the hope of promptly moving to legalize same-sex marriage in return for campaign contributions to get party members elected. Now they are telling those same voters that swift action on same-sex marriage legislation may make them unelectable in the future.

According to a New York Times article by Jeremy W. Peters:
After a pledge from New York Democratic leaders that their party would legalize same-sex marriage if they won control of the State Senate this year, money from gay rights supporters poured in from across the country, helping cinch a Democratic victory.
But now, party leaders have sent strong signals that they may not take up the issue during the 2009 legislative session. Some of them suggest it may be wise to wait until 2011 before considering it, in hopes that Democrats can pick up more Senate seats and Gov. David A. Paterson, a strong backer of gay rights, would then be safely into a second term.
The New York Democratic leadership collected millions of dollars from the gay community with false promises of prompt action on legalizing same-sex marriage and now they will not deliver on their promises. According to the New York Times article:
Daniel J. O’Donnell, an assemblyman from the Upper West Side who led the push for the bill in the Assembly.
Mr. O’Donnell added that expectations are high in the gay community that New York will be able to deliver the movement’s next victory. “The leadership of the Senate and others in our community collected a lot of money from a lot of people with the promise — spoken and unspoken — that if the Democrats won the Senate, they would take a vote,” he said.
Mr. O’Donnell plans to introduce a bill relatively early in the 2009 session, setting up a possible confrontation with the Senate.
However, Daniel J. O'Donnell's plan to introduce a bill faces a certain clash with the Democratic Party leadership who, as detailed above, "have sent strong signals that they may not take up the issue during the 2009 legislative session."

According to the New York Times article, some party leaders may even want to wait until 2011 when, Governor David A. Paterson "would then be safely into a second term." Unfortunately, when the New York Democrats raised campaign contributions for same-sex marriage supporters, they failed to disclose that action to legalize same-sex marriage would be contingent on Governor David A. Paterson getting re-elected in 2011.

In effect, the Democratic Party leadership is now saying to same-sex marriage supporters, “Wait a few year years. We need to get Governor David A. Paterson re-elected, before we try to legalize same-sex marriage.”

Apparently, the gay community is a victim of political expedience. The Democrats believe that quick action on same-sex marriage may penalize them in future elections. Liz Krueger, a Democrat who represents the Upper East Side, was quoted by the New York Times as saying:
We want to get there, but we want to get there the right way or else we risk setting ourselves back another decade.
Senator Thomas K. Duane, a leading advocate on gay and lesbian issues, was quoted by the New York Times as saying:
“I can’t even imagine before the budget’s done that we would do anything,” Mr. Duane said. The Legislature is required to pass its budget before the state’s fiscal year begins on April 1.
But even once the budget is passed, Mr. Duane said, other factors will have to be weighed, like whether the timing is too politically risky for the governor.
“We definitely want David Paterson to run for re-election and to win,” he said. “There’ll be a discussion. And we’ll have a point of view about time frame; he’ll have a point of view on time frame.”
People with knowledge of Governor Paterson’s position on gay marriage said the governor is wary of making a big push for the bill as the Senate leadership remains in flux.
So now we have the New York Democratic Party leadership attempting to con both supporters of same-sex marriage and opponents of same-sex marriage. They sold hope of "prompt action" to legalize same-sex marriage to proponents of same-sex marriage. Now, it seems that they are holding out the possibility of delay (code word - the hope of no action) to opponents of same-sex marriage. The party leadership wants to con opponents of same-sex marriage that holding back on prompt action to legalize same-sex marriage makes them electable for another term, by selling them on the hope of maybe never taking action.

To the supporters of same-sex marriage the New York Democratic Party leadership said in effect, “Give us your money, elect us, and we will move to quickly legalize same-sex marriage.”

To opponents of same-sex marriage they say in effect, “Elect us and ignore our rhetoric supporting same-sex marriage. We value your votes and even maybe your future money, too. So we won’t vote for it anytime soon. You still have a chance to change our minds on this issue.”

In New York, the Governor David A. Paterson is a Democrat, and the Democratic Party controls both the State Senate and Assembly. They are concerned that some Democrats may not vote in favor of a same-sex marriage law.

I say, "Baloney." This is about honoring a campaign promise to take "prompt action" on legalizing same-sex marriage in return for campaign contributions. The New York Democratic leadership should not make promises to voters that they will not keep.

I am not debating the merits of legalizing same-sex marriage. My point is that politicians often pander to the aspirations of trusting constituencies to get elected, only to make excuses to them after collecting their campaign money. Like many politicians, I preyed on the hopes and aspirations of gullible investors.

Let's bring the issue of legalized same-sex marriage to a vote in the 2009 legislative session for the sake of both constituencies – supporters and opponents of same-sex marriage.
Pandering rhetoric is cheap for politicians supporting each side of the issue. Politicians should show courage and vote on same-sex marriage, despite the political consequences and make good on their promises to voters.

To the Democratic leadership, I remind you of a quote from the movie "Mr. Smith Goes to Washington" by Senator Jefferson Smith, played by James Stewart:
I guess this is just another lost cause, Mr. Paine. All you people don't know about lost causes. Mr. Paine does. He said once they were the only causes worth fighting for. And he fought for them once, for the only reason any man ever fights for them; because of just one plain simple rule: 'Love thy neighbor.'... And you know that you fight for the lost causes harder than for any other. Yes, you even die for them.
Whichever side loses a vote in the current legislative session can live to fight another day by bringing it to a vote again, after the next election. That's what democracy is all about.

Written by:

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

Other posts of interest from my White Collar Fraud blog:

Advice to President-Elect Barack Obama about Combating White Collar Crime From a Convicted Felon

Why White Collar Criminals Do Not Fear Today's FBI

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

Overstock.com (NASDAQ: OSTK) CEO Patrick Byrne Pays Utah Attorney General Mark Shurtleff to Defame a Blogger

Disclosure: I am a registered Democrat (in New York convicted felons have the right to vote), but I have voted for both Democrats and Republicans from the right to the left of the political spectrum.

Sunday, November 23, 2008

Overstock.com: Rule 10b-5 Exposure from Disclosure Violations

In this blog post, I will detail how certain members of Overstock.com's (NASDAQ: OSTK) unprincipled management team conned investors into believing that the company's non-compliant EBITDA disclosures were in compliance with Securities and Exchange Commission Regulation G, governing non-GAAP disclosures. I believe that Overstock.com's non-compliant EBITDA disclosures that materially overstated the company's financial performance, together with other false and misleading representations by management, expose them to possible violations of anti-fraud Rule 10b-5.

In my last blog post, I detailed how Overstock.com finally amended its financial reports to comply with SEC Regulation G, almost a year after it was notified by me of its violations. This blog was first in exposing how Overstock.com used a non-compliant EBITDA measure to overstate its financial performance from Q2 2007 to Q2 2008.

Other bloggers, such as forensic accountant Tracy Coenen, NY Times columnist Floyd Norris, and investigative reporter Gary Weiss also reported about Overstock.com's non-compliant EBITDA measures, too. However, the company stubbornly refused to correct its non-compliant EBITDA measures and continued to materially overstate its financial performance. Instead, CEO Patrick Byrne retaliated with a malicious smear campaign directed at his critics in an effort to discredit them.

Even as Overstock.com finally attempted to correct its non-compliant EBITDA disclosures in its latest Q3 2008 10-Q report and other amended reports recently filed with the SEC, the company continued to violate certain other disclosure requirements under Regulation G by failing to fully disclose its change from using a non-compliant EBITDA measure to a compliant renamed "Adjusted EBITDA" measure.

It should come as no surprise that Overstock.com is unable or rather unwilling to provide accurate financial disclosures and comply with securities laws. Throughout Overstock.com's entire history, there has been a continuous pattern of untrue, false, deceitful, inconsistent, and contradictory disclosures made by the company and certain members of its management team led by CEO Patrick Byrne.

Overstock.com Has a History of False and Misleading Financial Disclosures

In a previous blog post, I provided details dating back to 2000, how Patrick Byrne deceptively used non-GAAP revenues to hype Overstock.com's top-line performance, while at the same time claiming that Overstock.com was GAAP profitable, even though the company was not profitable at all.

In February 2006, Overstock.com disclosed inventory accounting errors and restated financial reports from 2002 to Q3 2005.

In January 2008, the Securities and Exchange Commission discovered that Overstock.com's revenue accounting failed to comply with Generally Accepted Accounting Principles (GAAP), since the company's inception. The company provided the SEC with a flawed and misleading materiality analysis to convince them that its revenue accounting error was not material. The company wanted to avoid a restatement of prior affected financial reports arising from intentional revenue accounting errors uncovered by the SEC. Instead, the company used a one-time cumulative adjustment in its Q4 2007 financial report, apparently to hide the material impact of such errors on previous affected individual financial reports. This blog detailed how Overstock.com's materiality analysis was seriously flawed and misleading and called on Overstock.com to restate its financial reports. Despite emails to Overstock.com, the company stubbornly refused to restate its financial reports.

On October 24, 2008, Overstock.com's Q3 2008 press release disclosed new customer refund and credit errors and the company warned investors that all previous financial reports issued from 2003 to Q2 2008 “should no longer be relied upon.” This time, Overstock.com said it would restate all financial reports dating back to 2003. In addition, Overstock.com reversed its one-time cumulative adjustment in Q4 2007 used to correct its revenue accounting errors and instead restated all financial statements to correct those errors, too, as I previously recommended.

However, Overstock.com continued to violate Regulation G and report a non-compliant EBITDA measure in its Q3 2008 press release. During the Q3 2008 earnings call that followed, Overstock.com CEO Patrick Byrne and President Jonathan E. Johnson responded to questions in my blog, posted the day earlier, about the company's non-compliance with Regulation G. Byrne and Johnson made untrue material statements and omitted material facts at they attempted to con investors into believing that its EBITDA disclosures complied with Regulation G. Afterwards, I again called on Overstock.com to change its non-compliant EBITDA measures to comply with Regulation G.

Finally, on November 10, 2008, Overstock.com amended its financial reports from Q2 2007 to Q3 2008 to comply with SEC Regulation G. However, Overstock.com still violated Regulation G by failing to fully disclose its change from using a non-compliant EBITDA measure to a compliant renamed "Adjusted EBITDA" measure.

In addition, Overstock.com warned investors in its 10-Q report that the company may be subject to future regulatory action from the Securities and Exchange Commission and litigation from shareholders seeking damages:

As a result of these errors, we may become subject to litigation and regulatory action. Although we would vigorously defend against any such actions, there can be no assurance that we would prevail. An award of damages in such suit or a regulatory penalty imposed as a result of regulatory action could be substantial and harm our business. The financial costs and the dedication of the time of management to defend such actions could also harm us financially and disrupt our business. [Emphasis added.]

Below, I will describe why Overstock.com and certain members of management may be "subject to litigation and regulatory action," including Rule 10b-5 violations, due to their willful failure to comply with SEC disclosure requirements.

Overstock.com and its Management Cannot Claim Ignorance of Disclosure Violations
Starting in November 2007, I notified Overstock.com of its Regulation G violations and material overstatements of its financial performance from using a non-compliant EBITDA in emails Cc’d to the SEC. Read receipts for those emails were acknowledged by both Overstock.com and the SEC. However, Overstock.com stubbornly continued to report a non-compliant EBITDA disclosure until November 10, 2008, when released its latest Q3 2008 10-Q report.

During the same period that Overstock.com used a non-compliant EBITDA to materially overstate its financial performance, company President Jonathan E. Johnson and CFO David Chidester unloaded stock at huge profits. During certain earnings calls, Patrick Byrne, Jonathan Johnson, and David Chidester made outright false and deceptive statements to investors in order to mislead them into believing that the company's reported EBITDA did not violate Regulation G. Their actions show a clear intent to "deceive, manipulate, or defraud investors" and should satisfy scienter requirements for a Rule 10b-5 violation.

Overstock.com Violated SEC Regulation G governing Non-GAAP Disclosures Such as EBITDA

In financial reports issued from Q2 2007 to its recent Q3 2008 press release, Overstock.com improperly reconciled its non-compliant EBITDA to operating loss, rather than net loss (the most directly comparable GAAP measure required under Regulation G guidance), and improperly removed stock-based compensation costs from its non-compliant EBITDA disclosure. As a result of Overstock.com's violations of Regulation G, the company materially overstated its non-compliant EBITDA in financial reports from Q2 2007 to Q2 2008, including comparable non-compliant EBITDA numbers for each period.

Since Overstock.com improperly reconciled its non-compliant EBITDA to operating loss, rather than net loss, EBITDA was materially overstated by the amount of non-operating items such as losses from discontinued operations in certain periods. In addition, since Overstock.com improperly removed stock-based compensation from its non-compliant EBITDA during each period, the company materially overstated EBITDA by such amounts. Therefore, Overstock.com's non-compliant EBITDA disclosure was "materially deficient" under Regulation G.

According to Regulation G, a "materially deficient" non-GAAP disclosure, such as Overstock.com's reported non-compliant EBITDA disclosure, can give rise to Rule 10b-5 violations:


Disclosure pursuant to Regulation G that is materially deficient may, in addition to violating Regulation G, give rise to a violation of Section 10(b) or Rule 10b-5 thereunder if all the elements for such a violation are present. In this regard, we reminded companies in December 2001 that, under certain circumstances, non-GAAP financial measures could mislead investors if they obscure the company's GAAP results. We continue to be of the view that some disclosures of non-GAAP financial measures could give rise to actions under Rule 10b-5.
Section 3(b) of the Sarbanes-Oxley Act provides that a violation of that Act or the Commission's rules thereunder shall be treated for all purposes as a violation of the Exchange Act. Therefore, if an issuer, or any person acting on its behalf, fails to comply with Regulation G, the issuer and/or the person acting on its behalf could be subject to a Commission enforcement action alleging violations of Regulation G. Additionally, if the facts and circumstances warrant, we could bring an action under both Regulation G and Rule 10b-5. [Emphasis added.]

One specific issue cited by the SEC that could give rise to a Rule 10b-5 violation is that "under certain circumstances, non-GAAP financial measures could mislead investors if they obscure the company's GAAP results." One way that a non-GAAP measure can "obscure the company's GAAP results" is for a company to report a GAAP net loss while using a non-compliant EBITDA measure to produce positive financial performance.

In Q2 2008, Overstock.com originally reported a net loss of $6.463 million before its later disclosed adjustments due to accounting errors. In that same quarter, Overstock.com originally reported a non-compliant EBITDA of positive $1.117 million. If Overstock.com had reported EBITDA in compliance with Regulation G, EBITDA should have been reported at negative $430K, before adjustments due to accounting errors. Therefore, Overstock.com's non-compliant EBITDA measure in Q2 2008 clearly does "obscure the company's GAAP results."

Worse yet, later accounting errors disclosed by Overstock.com caused a further overstatement of EBITDA in the amount of $896K. Therefore, a compliant EBITDA, after adjusting for accounting errors, should have been reported at negative $1.326 million, rather than positive $1.117 million, as originally claimed by Overstock.com.

See the charts below (Click on image to enlarge):


Securities and Exchange Commission Rule 10b-5

Before we continue, let's review Securities and Exchange Commission Rule 10b-5:

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,
a. To employ any device, scheme, or artifice to defraud,
b. To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
c. To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person,
in connection with the purchase or sale of any security. [Emphasis added.]

Rule 10b-5 is the bedrock upon which federal securities law is built. According to Rule 10b-5, it is the presentation of "untrue statement of a material fact" or the omission of a "material fact" that gives rise to a securities fraud.

Since Overstock.com's non-compliant EBITDA measure violated Regulation G and materially overstated the company's financial performance, there is an "untrue statement of a material fact" in violation of Rule 10b-5. In addition, Overstock.com's willful failure to disclose that its non-compliant EBITDA violated Regulation G, qualifies as "unlawful...to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading," under Rule 10b-5.

How Rule 10b-5 Applies to Regulation G Violations

SEC Regulation G states, "... if the facts and circumstances warrant, we could bring an action under both Regulation G and Rule 10b-5." According to the "General disclosure requirement" under SEC Regulation G:

Regulation G includes the general disclosure requirement that a registrant, or a person acting on its behalf, shall not make public a non-GAAP financial measure that, taken together with the information accompanying that measure, contains an untrue statement of a material fact or omits to state a material fact necessary in order to make the presentation of the non-GAAP financial measure, in light of the circumstances under which it is presented, not misleading (23). [Emphasis added.]

The language of Regulation G's general disclosure requirement above, is almost the same language in Rule 10b-5. Both Regulation G and Rule 10b-5 prohibit "an untrue statement of a material fact" or the omission of a "material fact" that causes a financial disclosure to be "misleading."

Despite prior notice by me of Overstock.com violation's of Regulation G, certain members of management continued to make "untrue" statements of "material facts" and omitted other material facts in an attempt to deceive investors into believing that the company was in compliance with Regulation G. Those actions expose them to potential rule 10b-5 violations.

Untrue Statement of a Material Fact and Omission of a Material Fact during the Q2 2008 Earnings Call and Q2 2008 Financial Reports

During the Q2 2008 earnings call, both CEO Patrick Byrne and CFO David Chidester made "untrue" statements of a "material fact" and omitted other material facts in an effort to mislead investors about Overstock.com's failure to comply with SEC Regulation G and overstate the company's financial performance. See below:


Patrick Byrne: Great. Slide number 10. EBITDA and this excludes stock based compensation. Do you want to mention that Dave? Do you want to – ?
David Chidester: Just – there is different ways people calculate EBITDA I think. We just want to make sure it’s clear that our calculation of EBITDA does include stock based compensation.
Patrick Byrne: Is that the convention?
David Chidester: It’s completely the convention in our industry and I think because it’s a new – it only came about a couple of years ago, everybody pretty much excludes it when they talk about EBITDA and talk about cash earnings. [Emphasis added.]

What both Patrick Byrne and David Chidester failed to tell investors was that Overstock.com improperly reconciled its non-compliant EBITDA to operating losses, rather than net losses (the most directly comparable GAAP measure required under Regulation G guidance). In addition, Chidester falsely claimed that stock-based compensation costs can be properly excluded from EBITDA. Under Regulation G guidance, any such non-GAAP measure cannot be called EBITDA. In other words, EBITDA is strictly net income or loss (not operating income or loss), before interest, taxes, depreciation, and amortization (nothing else can be excluded from EBITDA).

David Chidester tried to explain that:

There is different ways people calculate EBITDA I think… It’s completely the convention in our industry and I think because it’s a new – it only came about a couple of years ago, everybody pretty much excludes it when they talk about EBITDA and talk about cash earnings.

David Chidester cannot claim that following the accounting practices of other non-compliant companies validated Overstock.com’s non-compliant EBITDA disclosures. Contrary to David Chidester’s comment above, SEC Regulation G was issued more than “a couple of years ago” and became effective on March 28, 2003. Worse yet, SEC Staff Accounting Bulletin No. 99 issued way back in August 1999, expressly states that “Authoritative literature takes precedence over industry practice.” In this case, authoritative literature (Regulation G) already existed and took precedence over the so-called "industry practice" of non-compliant companies.

During the same Q2 2008 earnings call, Patrick Byrne described Overstock.com’s EBITDA performance as follows:

Well, okay. Well, EBITDA fourth consecutive quarter of positive EBITDA. Again, I am not a huge fan of this number but it is meaningful in some circumstances and it does describe something for us.
Slide 11, trailing twelve month EBITDA is now at $9.6 million. I think that has a – that’s the valley of death and we seem to be climbing out the far side.

Contrary to Patrick Byrne’s false claims above, Overstock.com did not achieve its “fourth consecutive quarter of positive EBITDA" and was not climbing out the far side" of the "valley of death."

If Overstock.com had reported EBITDA in compliance with Regulation G in Q2 2008, the company would have reported a negative EBITDA compared to a positive EBITDA in the previous quarter. Therefore, EBITDA would have dropped in Q2 2008 compared to the previous quarter. If we also take into account adjustments for subsequent accounting errors, Overstock.com would have reported a negative EBITDA in two of those four quarters (Q4 2007 and Q2 2008).

In Q2 2008, Overstock.com’s properly computed EBITDA, before subsequent accounting errors, should have been reported as $-430K and not positive $1.117 million, as originally reported. If we include later disclosed accounting error adjustments, Overstock.com should have reported a $-1.326 million EBITDA.

Overstock.com's “trailing twelve month EBITDA, before subsequent accounting errors, should have been reported at $5.145 million and not "$9.6 million" as hyped by Byrne. If we include later disclosed accounting error adjustments, Overstock.com should have reported a meager $1.229 million EBITDA. In other words, Overstock.com overstated EBITDA over seven-fold!

See the charts below (click on image to enlarge):


Statement of a Material Fact and Omissions of Material Facts during the Q2 2008 Earnings Call and Q3 2008 Press Release

During Overstock.com’s Q3 2008 earnings call, both CEO Patrick Byrne and company President Jonathan E. Johnson III, made outright materially false and misleading statements in defending the company’s non-compliant EBITDA disclosures, in response to questions raised in my blog the day before the call. The company did not permit me to participate in the call and rebut the untrue statements below:


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.]

Patrick Byrne misled investors by claiming that, “Our EBITDA reconciles to GAAP.” A non-GAAP measure, such as EBITDA, is required to be reconciled with the most “directly comparable GAAP measure” under Regulation G, and not just any GAAP measure that management feels like using.

As described above, Overstock.com improperly reconciled its non-compliant EBITDA measure to operating loss, rather than net loss, which is the most directly comparable GAAP measure under Regulation G. In addition, Byrne’s claim that following “general industry practice” somehow validated Overstock.com’s non-compliant EBITDA disclosure was utter nonsense, too. SAB No. 99 clearly requires a company to follow authoritative literature (Regulation G) over industry practice.

Patrick Byrne had claimed that, “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.” Patrick Byrne’s claim is untrue.

As I described in a previous blog post, the SEC required CKX Inc. and CGG Veritas to change their non-compliant EBITDA measures to conform to Regulation G. CKX Inc., like Overstock.com, reconciled its non-compliant EBITDA measure to operating income or loss (a GAAP number) but not to net income or loss which is the most directly comparable GAAP financial measure” as required by SEC Regulation G. CGG Veritas, like Overstock.com, improperly eliminated stock-based compensation expenses from its non-complaint reported EBITDA.

Patrick Byrne wanted investors to believe that stock-based compensation costs are properly excluded from EBITDA as an amortization expense. However, as cited in the SEC comment letter to CGG Veritas, the SEC did not agree with Overstock.com's claim that stock-based compensation costs are properly excludable from EBITDA.

Patrick Byrne claimed that "In any case, we’ve gone through this over and over with our lawyers." However, just two weeks later on November 11, Overstock.com issued its Q3 2008 10-Q report and changed its non-compliant EBITDA disclosures to comply with Regulation G. Therefore, the findings of this blog that Overstock.com used a non-compliant EBITDA in violation of Regulation G were vindicated by Overstock.com's revised disclosures in its Q3 2008 10-Q and other amended financial reports.

Still, Overstock.com violated Regulation G again, since the company did not fully disclose its change from a non-compliant EBITDA measure to a compliant "Adjusted EBITDA" measure.

Inconsistent EBITDA Calculations without Explanation Give Rise to Further Violations

Overstock.com simply renamed its non-compliant EBITDA disclosure to "Adjusted EBITDA" as it finally sought to correct Regulation G violations on its Q3 2008 10-Q report. The company now reconciled "Adjusted EBITDA" to net loss (the most directly comparable GAAP measure required under Regulation G), rather than operating loss, as it did in the past. By renaming its non-compliant EBITDA disclosure as “Adjusted EBITDA,” the Overstock.com can now properly eliminate stock-based compensation costs and losses from discontinued operations from “Adjusted EBITDA.”

However, the company ran afoul of Regulation G again and possibly Rule 10b-5, since it deliberately failed to make a material disclosure about changing its non-compliant EBITDA to a compliant "Adjusted EBITDA." Footnote number 23 of Regulation G, addresses the requirement of the consistent application of non-GAAP financial measures, such as EBITDA:

... registrants should consider whether a change in the method of calculating or presenting a non-GAAP financial measure from one period to another, without a complete description of the change in that methodology, complies with the requirement of Regulation G that a registrant, or a person acting on its behalf, shall not make public a non-GAAP financial measure that, taken together with the information accompanying that measure, contains an untrue statement of a material fact or omits to state a material fact necessary in order to make the presentation of the non-GAAP financial measure, in light of the circumstances under which it is presented, not misleading. [Emphasis added.]

Therefore, a company cannot change its “method of calculating or presenting a non-GAAP financial measure from one period to another, without a complete description of the change in that methodology.” If a company fails to make such a disclosure, it violates Regulation G and possibly Rule 10b-5. Overstock.com simply amended its previous financial reports to rename its non-compliant EBITDA disclosure to "Adjusted EBITDA" without any "description of the change" in that non-GAAP financial measure.

In addition, during other periods Overstock.com used inconsistent calculations to compute its non-compliant EBITDA disclosures and failed to disclose "a complete description of the change" in "methodology" used to calculate EBITDA. 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.

Other False and Misleading Disclosures Relating to Overstock.com's Use of EBITDA

In Overstock.com's Q3 2008 press release, the company made materially false and misleading disclosures in describing why it used EBITDA in its financial reports:

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.

However, in its "current" period Q3 2008, Overstock.com's capital expenditures were higher than depreciation expenses, contrary to the company's disclosure above. 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%. In Overstock.com's Q3 2008 10-Q report issued about two weeks later, the company changed its misleading disclosure.

EBITDA is Used as a Measure of Valuation by Investors

In a letter (page 18) to the SEC, Overstock.com acknowledged:

A multiple of EBITDA is currently the most standard measure of valuation in the industry.

Various analyst reports issued by Scott W. Devitt from Stifel Nicholas, Shawn C. Milne from Oppenheimer, and Justin Post from Merrill Lynch have valued Overstock.com in terms of multiples of EBITDA. Therefore, a material overstatement of reported EBITDA by Overstock.com results in a materially significant over-valuation of the company and causes investors to buy stock and allows insiders to sell stock at overvalued prices.

Insiders Unload Shares as Overstock.com Reports Materially Overstated EBITDA

During the same period that Overstock.com used a non-compliant EBITDA and materially overstated its financial performance, both company President Jonathan Johnson and CFO David Chidester sold stock at substantial profits. In April 2008, Jonathan Johnson unloaded 55,922 shares at an average price of $17.11 per share (Source: Form 4 here and here). In May 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. Last Friday, Overstock.com closed at just $6.80 per share.

Recent stock sales this year by CFO David Chidester are subject to the clawback provisions under Sarbanes-Oxley Section 304. David Chidester's false and misleading comments during the Q2 2008 earnings call described above, certainly qualify as "misconduct" under Sarbanes-Oxley 304. It is unfortunate that Section 304 only applies to CEOs and CFOs and not necessarily to Jonathan Johnson, as President of the company.

The SEC and shareholders seeking damages will have to sue the company, its board of directors, and management to recover damages and seek to enjoin the company and its officers from making up new lies to investors and stop further securities law violations. Overstock.com's D & O carrier may have substantial future claims to contend with.

To be continued....

Written by:

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

Disclosure: Not long or short Overstock.com

Sunday, November 16, 2008

Advice to President-Elect Barack Obama about Combating White Collar Crime From a Convicted Felon

To President-Elect Barack Obama:

While our capital markets require reform, no amount of regulation or oversight can be effective unless those persons charged with carrying it out, have the proper amount experience, knowledge, competence, and professional skepticism to successfully perform their respective jobs and responsibilities. As the cold-blooded and heartless criminal CFO of Crazy Eddie, I had no fear of oversight from outside or independent board members and our external auditors. I took advantage of their lack of requisite skills, knowledge, and experience to effectively carry out my crimes. If you want to see capitalism succeed as an engine for our future economic prosperity, I respectfully ask you to first consider the issue of competence, before looking at the issue of regulation and oversight.

Window Dressing Boards of Directors

We need better standards of qualification for public company board members. Too often, company boards are packed with people with great resumes but such persons have no specialized experience and training to effectively carry out their functions or boards are packed with cronies of company management. Instead, we must require that board members have the proper amount of specialized education, background, and experience necessary to perform their duties effectively. We do not need well meaning, intelligent people, serving in positions they are not well suited for, since in many cases they make ineffective Board members. The time for “window dressing” must end.

Today, too many board members are appointed for “window dressing” purposes, rather than their specific competence to carry out their duties. Michelle Leder’s blog, Footnoted.org once noted:

So where do former members of the House and Senate, not to mention Governors and former Cabinet members go when they exit from the political stage? Many of them wind up filling seats on boards of directors.

For example, your new Chief of Staff Rahm Emanuel was appointed by President Bill Clinton to serve on Freddie Mac’s (NYSE: FRE) board of directors, after serving in Clinton's administration. I am assuming that Mr. Emanuel took the job and served on Freddie Mac's board from 2000 to 2001 with the best of intentions. However, like many other well meaning but gullible board members, he found himself in the wrong place at the wrong time, in the hands of an unscrupulous management team.

According to the SEC complaint filed against Freddie Mac:

…Freddie Mac misreported its net income in 2000, 2001 and 2002 by 30.5 percent, 23.9 percent and 42.9 percent, respectively. Furthermore, Freddie Mac’s senior management exerted consistent pressure to have the company report smooth and dependable earnings growth in order to present investors with the image of a company that would continue to generate predictable and growing earnings.
“As has been seen in so many cases, Freddie Mac’s departure from proper accounting practices was the result of a corporate culture that sought stable earnings growth at any cost,” said Linda Chatman Thomsen, the SEC’s Director of Enforcement. “Investors do not benefit when good corporate governance takes a back seat to a single-minded drive to achieve earnings targets.”

Rahm Emanuel was not named in the SEC’s complaint against Freddie Mac. However, in a statement before the Senate Committee on Banking, Housing, and Urban Affairs, Acting Director of the Office of Federal Housing Enterprise Oversight, James B. Lockhart III noted:

For the most part, the same long-tenured shareholder-elected Directors oversaw the same CEO, COO, and General Counsel of Freddie Mac from 1990 to 2003. The non-executive Directors allowed the past performance of those officers to color their oversight. Directors should have asked more questions, pressed harder for resolution of issues, and not automatically accepted the rationale of management for the length of time needed to address identified weaknesses and problems. The oversight exercised by the Board might have been more vigorous if there had been a regular turnover of shareholder-elected Directors or if Directors had not expected to continue to serve on the Board until the mandatory retirement age. Conversely, the terms of the presidentially appointed Directors are far too short, averaging just over 14 months, for them to play a meaningful role on the Board. The position is an anachronism that should be repealed so shareholders can elect all Directors. The Board of Directors was apprised of control weaknesses, the efforts of management to shift income into future periods and other issues that led to the restatement, but did not recognize red flags, failed to make reasonable inquiries of management, or otherwise failed in its duty to follow up on matters brought to its attention. [Emphasis added.]

The problem is that intelligent and well meaning board of directors are often duped by unscrupulous company management teams who take advantage of their lack of requisite skills and professional cynicism.

Prospective qualified board members must know how to make effective inquiries and spot "red flags." They must know how to ask questions, who to direct their questions to, and how to handle false and misleading answers by management with effective follow up questions. Such skills only come adequately qualified board members who have proper training, education, and experience before joining company boards.

Lack of Truly Independent and Properly Qualified Audit Committee Members

So-called independent audit committee members of boards or directors are less independent and less competent than the external auditors, who they oversee. Too many audit committee members have no formal educational background in accounting and auditing or specialized training in fraud detection. 

Many so-called “independent” board members own stock and receive stock options in their respective companies, while independent external auditors cannot own stock or receive stock-based compensation from their audit clients. Owning company stock and receiving stock-based compensation, provides a disincentive to effective independent audit committee oversight of financial reporting and can adversely affect an audit committee member’s professional skepticism. Therefore, audit committee members cannot be considered truly "independent" if they own company stock or receive stock-based compensation. I suggest that our securities laws be amended to require truly independent and adequately qualified audit committees.

Lack of Properly Trained Auditors

External auditors receive too little or no training in forensic accounting, fraud detection, or criminology. Most Certified Public Accountants never take a single college level course devoted exclusively to issues of white collar crime or internal controls and many important subjects covered in the CPA licensing exam are learned after graduation in a cram CPA exam review course.

College level accounting education needs to be reformed to teach future CPAs the necessary tools to do battle in audits against corporate crooks who take advantage of their lack of skills. We should mandate that a larger proportion of continuing professional education, required by CPAs to maintain their licenses, be devoted to issues of white collar crime and fraud detection.

Not Enough Law Enforcement Resources Devoted to White Collar Crime

While I never feared Crazy Eddie’s board of directors and auditors, I did fear the Securities and Exchange Commission and the Federal Bureau of Investigation. However, I doubt that many criminals have such fear for the SEC and FBI today.

Both the SEC and FBI are under-resourced and overwhelmed and as a result, they are unable to successfully investigate too many complicated white collar crime cases, unless such cases are handed to them on a silver platter by others. The most experienced SEC and FBI personnel are leaving government work for better paying private sector jobs. Therefore, if you really want criminals to think twice before executing their crimes, I suggest that you beef up our nation's investigative and law enforcement resources.

Our capital markets depend on the integrity of financial information that is supposed to be insured by external auditors, audit committees, and consistently effective law enforcement. Inadequately trained independent external auditors, the first line of defense for insuring the integrity of financial reporting, are supervised by even less competent and less independent audit committees. On top of that, our regulators and law enforcement agencies lack the required resources to effectively prosecute many crimes enabled by the lack of effective audits and company oversight by boards of directors. Therefore, we face a perfect storm for disaster, as the cancer of white collar crime destroys our economic fabric and inflicts a collective harm on our great society.

If you want capitalism to succeed as an engine of prosperity for our great nation, I ask you to heed my my advice based on my experience as a cold blooded convicted felon.

Respectfully:

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

PS: While Rahm Emanuel may not have been an effective board member of Freddie Mac, he can provide valuable insight to you about the perils of lack of effective oversight by boards of directors. After all, the wisest people are those that learn from past mistakes. In addition, I will continue to provide you with more unsolicited advice from time-to-time. You can learn a lot from a convicted felon who scammed the system and took advantage of gullible human beings in ways your advisors never dreamed of. Disclosure: Registered Democrat (convicted felons can vote in New York State but don't get to serve on juries - which I don't mind) and I vote both Democrat and Republican depending on the best candidate for the job. In addition, I have no position in Freddie Mac securities.

Monday, November 10, 2008

Overstock.com's New Disclosures Today Show Company Financial Reports Were a "Joke"

Overstock.com’s (NASDAQ: OSTK) new amended financial reports filed today, vindicates findings, first exposed in this blog, that the company violated Securities and Exchange Commission Regulation G governing non-GAAP disclosures, such as EBITDA and materially overstated its non-compliant EBITDA in financial reports dating back to Q2 2007. Even worse, Overstock.com disclosed in its 10-Q for Q3 2008, released today, that its restatement of financial reports dating back to 2003, due to accounting errors relating to revenues, customer refunds, and customer credits, may subject the company to future regulatory action from the Securities and Exchange Commission and litigation from shareholders seeking damages:

On October 24, 2008, we disclosed certain accounting errors and announced our intent to restate certain of our financial statements and other information to correct these errors (see Note 3 to the consolidated financial statements contained in Part I, Item 1 “Financial Statements (Unaudited) (Restated)”). As a result of these errors, we may become subject to litigation and regulatory action. Although we would vigorously defend against any such actions, there can be no assurance that we would prevail. An award of damages in such suit or a regulatory penalty imposed as a result of regulatory action could be substantial and harm our business. The financial costs and the dedication of the time of management to defend such actions could also harm us financially and disrupt our business. (Emphasis added.)

As I detailed in a previous blog post, on October 24, 2008, Overstock.com surprised investors and reported that it was restating all financial reports dating back to 2003, due to a newly disclosed accounting error relating to customer refunds and credits. The company disclosed that all previous financial reports issued from 2003 to Q2 2008 “should no longer be relied upon.”
In Overstock.com's latest 10-Q report released today, the company revealed:

...the CEO (principal executive officer) and Senior Vice President, Finance (principal financial officer) each concluded that the control deficiency previously described constituted a material weakness in the Company’s system of internal control over financial reporting as of September 30, 2008.
...management, including our CEO (principal executive officer) and Senior Vice President, Finance (principal financial officer), has revised its earlier assessment and has now concluded that our disclosure controls and procedures were not effective as of December 31, 2007 or during the interim periods ending September 30, 2008 in reaching a reasonable level of assurance that information required to be in our reports filed or submitted under the Exchange Act was properly recorded, processed, summarized, and reported within the time periods specified in the Commission’s rules and forms.  (Emphasis added.)

Therefore, Overstock.com disclosed that it did not maintain a straight set of books due to a "material weakness" in internal controls.

The latest customer refund and credit accounting errors follow a string of material accounting errors that have plagued Overstock.com throughout its history. Earlier this year, the Securities and Exchange Commission discovered that Overstock.com intentionally did not report revenues in compliance with GAAP, since its inception. In February 2006, the company disclosed inventory accounting errors for fiscal years 2002 to 2005.

According to a Fortune magazine article way back in February 2000:

Overstock.com came to Byrne's attention last spring when its founder approached High Plains for capital. "The financials were a joke," says High Plains CFO John Pettway.  (Emphasis added.)

However, Overstock.com's financial reports remained a "joke," as evidenced by its string of material accounting errors and willful non-compliance with SEC Regulation G in reporting a non-compliant EBITDA.

Starting in November 2007, this blog was the first to expose Overstock.com’s willful violations of SEC Regulation G governing non-GAAP disclosures, such as EBITDA. As a result of Overstock.com's violations of Regulation G, the company materially overstated its non-compliant EBITDA in financial reports from Q2 2007 to Q2 2008, including comparable non-compliant EBITDA numbers for each period. Overstock.com reconciled its non-compliant EBITDA to operating loss, rather than net loss (the most directly comparable GAAP measure required under SEC Regulation G), and improperly removed stock-based compensation costs from its non-compliant reported EBITDA.

Beginning in November 2007 to just last week, I informed Overstock.com Audit Committee member Joseph J. Tabacco Jr, via several emails, Cc'd to the SEC, about the company's non-compliant EBITDA disclosures, but management led by CEO Patrick Byrne, stubbornly refused to change its non-compliant EBITDA disclosures, until today. When Overstock.com originally disclosed that it was restating its financial reports dating back to 2003 in its October 24 press release and subsequent Q3 2008 earnings call, my blog noted that the company continued to report a non-compliant EBITDA in its Q3 2008 earnings report. During the Q3 2008 earnings call, both CEO Patrick Byrne and company President Jonathan Johnson, responding to questions posted in my blog a day earlier, flat out denied that Overstock.com violated Regulation G. Patrick Byrne told investors:

The claim that EBITDA is not compliant with SEC definition is nonsense.  (Emphasis added.)

In my next blog post, I detailed how Overstock.com's recently announced accounting errors for customers refunds and credits caused further material overstatements of the company's non-compliant EBITDA disclosures.

Shortly afterwards, I emailed Overstock.com's Board of Directors, CEO Patrick Byrne, and Audit Committee member Joseph J. Tabacco Jr. to alert them about the company's continuing non-compliance with Regulation G in reporting EBITDA.

Overstock.com CEO Patrick Byrne responded with callous indifference, writing me:

I usually have my secretary handle these kinds of letters. Would you like her email?
Yours ever,
Patrick

However, cooler heads at the company, likely led by Audit Committee member Joseph J. Tabacco Jr., prevailed over Patrick Byrne and Jonathan Johnson. Now, in Overstock.com's latest 10-Q for Q3 2008 released today, the company renamed its non-compliant EBITDA disclosure to “Adjusted EBITDA” and it reconciles "Adjusted EBITDA" to net loss, rather than operating loss, the most directly comparable GAAP measure required under Regulation G. By renaming its non-compliant EBITDA disclosure as “Adjusted EBITDA,” the company can now properly eliminate stock-based compensation costs and losses from discontinued operations from “Adjusted EBITDA.”

Journalists, bloggers, and others who dared to expose misdeeds by Overstock.com's unprincipled management team have faced a vicious retaliatory smear campaign orchestrated by CEO Patrick Byrne with the collusion of his paid shills: cyberstalker Judd Bagley, Mark Mitchell (former Columbia Journalism Review reporter who left CJR under mysterious circumstances), and message board trolls Dave Patch and Evren Karpak.

Journalists Gary Weiss, Herb Greenberg, Joe Nocera, Floyd Norris, Roddy Boyd, Carol Remond, Bethany McLean, Seth Jayson, bloggers Jeff Matthews, Zac Bissonnette and Tracy Coenen, and others have faced reprisals in the form of despicable smears and outright lies spewed by Byrne and his paid cronies.

In addition, independent research firm Gradient Analytics and short seller Copper River Management were subjected to meritless litigation from Overstock.com, on top of the smear campaign orchestrated by CEO Patrick Byrne. Gradient, whose early work first exposed deceptive financial reporting of revenues by Overstock.com, recently settled with the company, while the litigation against Copper River continues on. Overstock.com's latest disclosures about accounting errors and restatements of financial reports, puts its litigation prospects with Copper River in severe jeopardy.
Patrick Byrne even recruited the current Attorney General of the state of Utah Mark Shurtleff, with a $5,000 payment, to discredit me in an effort to get me to back off from covering Overstock.com in my blog. Byrne's collusion with Shurtleff was exposed in tape recorded conversations by me with members of Shurtleff's office.

I call on the Securities and Exchange Commission to start an enforcement action and the Justice Department to conduct a criminal investigation into the vicious retaliatory smear campaign orchestrated by CEO Patrick Byrne in an effort to prevent critics from exposing the false and misleading reports and disclosures by Overstock.com and its unprincipled management team.

To be continued....

Written by,

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

Disclosure: Not short or long Overstock.com.

Thursday, November 06, 2008

Lawsuit Alleges Shill Bidding on Bidz.com Web Site

On August 22, 2008, a class action lawsuit was filed against Bidz.com (NASDAQ: BIDZ) and certain members of its management, alleging that the "defendants have materially misrepresented the goods sold through the Bidz.com web site and are involved in a systematic program of shill bidding."
Although this lawsuit was filed last August, the company still has not yet disclosed it, in various press releases and 8-Ks filed with the Securities and Exchange Commission. The company will probably make the usual claim that the lawsuit is "meritless" and that they will put up a "vigorous defense," blah, blah, blah.

The lawsuit goes on to allege that:

David Zinberg, with the help of Marina Zinberg, built Bidz.com from a series of pawn shops into a major online retailer with hundreds of millions in annual revenue. The Company, however, is rife with corruption: it makes its money by misrepresenting the quality of its merchandise, and then, falsely bidding up these prices itself to trick buyers who would pay more than they would absent this fraud. These fraudulent acts are able to thrive in the corporate environment that the Zinbergs have created, one filled with related party transactions and suspicious accounting. [Emphasis added.]

Allegations of shill bidding on Bidz.com’s web site are not new. A consumer complaint website, Ripoffreport.com, and Citron Research, a Los Angeles website run by short seller Andrew Left, the LA Times, and others have detailed examples of suspected shill bidding on Bidz.com’s web site for over a year.


This blog has raised questions about Bidz.com’s compliance with GAAP in valuing inventories, the company’s history of inconsistent inventory disclosures, and more recent troubling changes in inventory disclosures. In addition, I have been critical of Bidz.com's share repurchase program and the simultaneous sales of stock by insiders, too.

Written by:

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

Disclosure: Not long or short Bidz.com.

Sunday, November 02, 2008

What Overstock.com Did Not Tell Investors About Latest Accounting Errors

Playing down the material impact of newly disclosed accounting errors

Overstock.com’s (NASDAQ: OSTK) recently announced restatements of prior financial reports dating back to 2003, caused greater material distortions of reported financial performance, than the company's management team has led investors to believe, in their comments made during the Q3 2008 earnings call.

As I detailed in my last blog post, Overstock.com surprised investors and reported that it is restating all financial reports dating back to 2003, due to a newly disclosed accounting error relating to customer refunds and credits. The company disclosed that all previous financial reports issued from 2003 to Q2 2008 “should no longer be relied upon.”

The latest customer refund and credit accounting errors follow a string of material accounting errors that have plagued Overstock.com throughout its history. Earlier this year, the Securities and Exchange Commission discovered that Overstock.com did not report revenues in compliance with GAAP, since its inception. In 2006, the company disclosed inventory accounting errors for fiscal years 2002 to 2005. Apparently, Overstock.com cannot maintain a straight set of books.

Overstock.com's accounting errors have resulted in $10 million of additional losses on top of $255 million reported to date by a company that never had a profitable year. Shareholders' equity was completely wiped out and is now at negative $3.6 million. Reported earnings for Overstock.com's only two profitable quarters (back in Q2 2002 and Q 2004) are highly suspect.

So far, Overstock.com has provided only limited disclosures about the full impact of its latest round of accounting errors. The company did not provide restated financial reports for each separate quarter from 2003 to 2007, though it did provide restated summary annual reports from 2003 to 2007. However, the company did provide restated financial reports for Q3 2007 (for comparison with Q3 2008, its latest quarter), Q1 2008, and Q2 2008. By just examining Q1 and Q2 2008's restated financial reports, we can see how Overstock.com's accounting errors caused significant material distortions in financial results for individual quarters.

The Devil is Always in the Details Left Out and Avoided by Overstock.com

During the Q3 2008 earnings call, CFO David Chidester played down the significance of Overstock.com’s recently disclosed accounting errors by emphasizing its impact on revenues over a 5-1/2 year period, rather than discussing its much greater distortion of reported earnings and EBITDA for individual quarters:

…the effect is going to be on a cumulative basis is a reduction of revenue of $12.9 million over that 5-1/2 year period [fiscal years 2003 to 2007 and the first six months of fiscal year 2008] and a reduction in net income of $10.3 million. Just for some frame of reference, you can see that adjustment to revenue represents less than 0.5% of our revenue over that time period, and all but $1.7 million of the adjustment to net income relates to previous to 2008. (Emphasis added.)

Apparently, David Chidester wants investors to consider Overstock.com's accounting errors in terms of the company's "less than 0.5%" overstatement of revenues over a 5-1/2 year period. He avoided leveling to investors how "$1.7 million of the adjustment" significantly overstated earnings and EBITDA in Q1 and Q2 2008, as I will describe below. Relatively small adjustments to a quarter's revenues have a much greater relative impact on reported quarterly net income or losses, earnings per share, EBITDA, and trends in earnings.

Analysis of Impact of Customer Refund and Credit Accounting Errors on Q1 and Q2 2008

A careful analysis of Overstock.com’s preliminary adjustments for accounting errors in Q1 and Q2 2008 show a significant material overstatement of previously reported earnings and EBITDA. The company left out any analysis of the impact of accounting errors on reported EBITDA for each period, and therefore, I computed it myself. (Click on the image to enlarge it)



Analysis of Accounting Errors on Reported Earnings per Share (EPS)

Earnings per share in Q1 2008 and Q2 2008 were materially overstated by a significant 23.53% and 17.86% respectively, since Overstock.com’s losses in each period were wider than originally reported.

More important, an accounting misstatement that "hides a failure to meet analysts' consensus expectations for the enterprise," is a red flag that runs afoul of SEC Staff Accounting Bulletin No. 99, governing materiality. Wall Street analysts' mean consensus expectations for EPS was -$0.28 for Q2 2008 (Source: Yahoo Finance).

Originally, Overstock.com's reported EPS equaled analysts' mean consensus expectations of -$0.28 EPS in Q2 2008. However, with an accounting error adjustment of $0.05 in added losses per share, Overstock.com failed to meet analysts' mean consensus expectations for EPS in Q2 2008 by $0.05 per share.

Analysis of Customer Refund and Credit Accounting Errors on Reported EBITDA

In Q1 2008, Overstock.com’s reported EBITDA was materially overstated by a significant 29.37%. In Q2 2008, Overstock.com’s reported EBITDA was materially overstated by a whopping 414.75% and the company's reported EBITDA was reduced from $1.117 million to a paltry $217K!
Now consider Overstock.com's EBITDA overstatements in conjunction with the company's acknowledgement in a letter (page 18) to the SEC about the importance of EBITDA as a measure of valuing the company:

A multiple of EBITDA is currently the most standard measure of valuation in the industry.  (Emphasis added.)

Various analyst reports issued by Scott W. Devitt from Stifel Nicholas, Shawn C. Milne from Oppenheimer, and Justin Post from Merrill Lynch have valued Overstock.com in terms of multiples of EBITDA. Therefore, a material overstatement of reported EBITDA by Overstock.com results in a materially significant over-valuation of the company.

Perhaps that's why Overstock.com failed to disclose how its accounting errors materially overstated reported EBITDA. Worst yet, not a single Wall Street analyst attending the earnings call had the balls to ask management about how its accounting errors materially impacted their valuations based on EBITDA.

Overstock.com's Willful Non-compliance with SEC Regulation G and SEC Guidance Governing Non-GAAP Disclosures such as EBITDA Results in Even Greater Misstatements

In addition to Overstock.com's material overstatements of reported EBITDA from accounting errors, the company's financial reporting is further distorted by reporting a non-compliant EBITDA in violation of SEC Regulation G. Therefore, Overstock.com's restated EBITDA remains misstated, even after corrections for accounting errors.

As I detailed in my last blog post, Overstock.com improperly reconciles its non-compliant reported EBITDA to operating income or loss, rather than net income or loss (the most directly comparable GAAP measure required by Regulation G) and also improperly eliminates stock-based compensation costs from its reported EBITDA. Computations of Overstock.com's correct restated EBITDA in compliance with Regulation G are provided below (Click on the image to enlarge it):


In both Q1 and Q2 2008, Overstock.com’s non-compliant reported EBITDA, adjusting for both accounting errors and non-compliance with SEC Regulation G, was overstated by 154.4% and 219.7%, respectively. In addition, in Q2 2008, Overstock.com’s non-compliant reported EBITDA of positive $1.117 million flips to a negative EBITDA of $1.330 million, if EBITDA is reported in compliance with SEC Regulation G.

More important, Overstock.com's accounting errors and added misstatements from its willful non-compliance with SEC Regulation G is a red flag under SEC Staff Accounting Bulletin No. 99, governing materiality. The company's misstatement of Q2 2008 EBITDA "changes a loss to income and vice versa."

During the Q3 2008 earnings call, CEO Patrick Byrne bragged that Overstock.com reported its:

…third positive EBITDA in a row.

Byrne's comment is simply not true, since Overstock.com’ uses a non-compliant EBITDA in violation of Regulation G.

Since Overstock.com's Q2 2008 misstatement of EBITDA results in a non-compliant positive EBITDA, rather than a compliant negative EBITDA, it "masks a change in earnings or other trends," under SAB No. 99, because the company did not achieve positive EBITDA in three consecutive quarters.

In addition, Patrick Byrne's hyping a non-compliant reported EBITDA runs counter to his claimed principle of setting "a gold standard in communicating with candor" Overstock.com's results and choosing "principles at the conservative edge of GAAP…."

Overstock.com CEO Patrick Byrne's Flip Flops and Double-Talk about Why Overstock.com uses EBITDA

In April 2004, Patrick Byrne told CNBC, "I don’t believe in EBITDA. If somebody talks EBITDA, put your hand on your wallet; they’re a crook." In January 2006, Byrne told Business Week reporter Tom Mullaney that, "…I think “EBITDA” is the stupidest thing I ever heard emanate from Wall Street (no small feat)." Finally, in March 2006, he told Greg Sandoval from c/net news.com that EBITDA is a "phony accounting standard--pro forma."

During the Q3 2008 earnings call, Patrick Byrne's offered the following excuse for flip-flopping on EBITDA, despite his previous criticism of it, in response to questions raised by me in a previous blog post:

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. (Emphasis added.)

As described below, Byrne’s claims about why he is now using EBITDA are contradicted by Overstock.com's recent financial performance.

Patrick Byrne has bragged that Overstock.com is not in a "low cash situation" with about $70 million in cash balances at the end of the latest quarter.

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.
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.

The Silence of the Wall Street Analyst Lambs

Not a single Wall Street analyst attending the earnings call, challenged Byrne's double-talk and no one asked a single question about the impact of Overstock.com's misstatements on their previous valuation models using EBITDA. Do Nat Schindler from Merrill Lynch, Dom Lacava from Canaccord Adams, and Scott Devitt from Stifel Nicolaus & Company really care about Overstock.com's accounting errors or have they traded their skepticism in return for coveted access to earnings calls? The silence of these Wall Street lambs is really pathetic.

To make matters worse, Overstock.com refused to let me asks questions during the earnings call. What are they afraid of?

Investigative reporter and best selling author Gary Weiss observed in his blog:

...the analysts on the call (the much-feared Antar having been excluded), timidly let all this bullcrap fly, unchallenged.

This convicted felon has warned warned Overstock.com's unprincipled management team that its bullcrap will not go unnoticed by me. I'll have more to say about Overstock.com's Q3 2008 earnings call in part 3.

Written by:

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

Disclosure: Not long or short Overstock.com and more transparent about my criminal past than Patrick Byrne is about his history of lies to investors.