Overstock.com's New 10-K Report Reveals Management Deceptions, Major Internal Control Problems, and Zero Quality Earnings
|Patrick Byrne is suffering a hangover|
If Overstock.com would have properly followed GAAP in Q4 2008, the company (1) would have reported a net loss instead of a net profit, (2) would have reported sixteen consecutive losses instead of 15 consecutive losses, and (3) it would have failed to meet mean analysts’ consensus expectation for earnings per share (anyone of three materiality yardsticks under SEC Staff Accounting Bulletin No. 99 that would have triggered a restatement of prior year’s effected financial reports).
As I will describe below, both Overstock.com CEO Patrick M. Byrne and company President Jonathan E. Johnson made false statements about the possible impact of certain questionable accounting practices on the company's previously issued financial reports in a deliberate effort to avoid restating the company's financial reports to comply with GAAP.
Afterwards, I will detail a disturbing stupid financial reporting error and provide a brief analysis of the smoke and mirrors that helped Overstock.com report its first annual profit.
Brief Background - Overstock.com's Illegal "Cookie Jar" Reserves
In October 2008, Overstock.com restated its financial reports from Q1 2003 to Q3 2008 to correct certain customer refund and credit errors. It was the second time in two years that Overstock.com had to restate its financial reports to comply with GAAP.
In February 2009, I correctly reported in my blog that the October 2008 restatement did not include corrections arising from underbilled offsetting costs and reimbursements that were already earned from its fulfillment partners during those same corresponding periods, less a reasonable estimate of uncollectable amounts.
Overstock.com should have gone back and corrected or restated its financial reports to reflect income already earned from offsetting costs and reimbursements due from its fulfillment partners, less a reasonable estimate for uncollectable amounts (See SFAS No. 154 and SFAS No. 5 paragraph 1, 2, 8 and 23).
Instead, Overstock.com improperly deferred income that it earned but underbilled its fulfillment partners during prior reporting periods (Q3 2008 and before) to by moving such income to future reporting periods (Q4 2008, Q1 2009, Q2 2009, and Q3 2009). In other words, Overstock.com took income that should have been reported in prior reporting periods (Q3 2008 and before) and moved it to future reporting periods (Q4 2008 and later) to materially overstate its financial performance in those later reporting periods.
In effect, Overstock.com violated GAAP by creating an illegal cookie jar reserve to materially inflate future earnings or reduce future losses from Q4 2008 to Q3 2009.
Overstock.com ridiculously claimed that the collection of the entire amount of its underbillings (every single penny) “was not assured” and instead falsely claimed that a "gain contingency" existed rather than make a reasonable estimate of uncollectable amounts as required under SFAS No. 5. Therefore, Overstock.com improperly recognized income from underbilled fulfillment partners as amounts due to the company were collected on a non-GAAP cash basis, rather when they were earned under accrual accounting or GAAP. (More details can be found in my Open Letter to the Securities and Exchange Commission here).
Overstock.com's Stubborn Refusal to Comply with GAAP
Starting in February 2009, I notified both Overstock.com and the SEC about the company's illegal "cookie jar" reserve and its phony "gain contingency." Based on information available at the time, I initially calculated that Overstock.com improperly reported a Q4 2008 net profit of $1.014 million, instead of a properly reported net loss of $800k. As a result of violating GAAP, Patrick Byrne was able to boast that the company reported its first quarterly profit after fifteen consecutive quarterly losses.
Patrick Byrne responded to my blog by claiming that:
Antar's ramblings are gibberish. Show them to any accountant and they will confirm. He has no clue what he is talking about.Instead of properly restating its financial reports to correct its intentional breach of GAAP and other SEC disclosure rules, Overstock.com continued to issue phony financial reports in Q1, Q2, and Q3 2009 while publicly vilifying me.
In September 17, 2009, the SEC Enforcement Division took a very rare step and re-opened a previously closed probe of financial reporting irregularities at Overstock.com. A few weeks later, the SEC Division of Corporation Finance started a parallel probe of the company's financial reporting irregularities.
A September 25, 2009, Salt Lake Tribune article quoted Patrick Byrne's reaction to the SEC investigation instigated by my blog reports detailing GAAP and SEC disclosure violations:
"Gary Weiss and Sam Antar are goniffs," Byrne declared, using a yiddish term that he says means "a con man, a hustler and a scoundrel."In October 2009, the SEC Division of Corporation Finance discovered that Overstock.com overpaid a fulfillment partner $785,000 during 2008. The company recovered that overpayment in Q1 2009 and improperly reported the overpayment recovery as income in that same quarter, rather than properly restate its 2008 financial reports to correct that error.
If the SEC is listening to them, their next step is to let Bernie Madoff write their indictment of me." Byrne was referring to the mastermind, now in prison, of a multibillion-dollar fraud whose case helped show how laissez faire Wall Street regulators had become.
Overstock.com improperly concealed the recovery of the overpayment by including that amount in recoveries from underbilled fulfillment partners in Q1 2009 instead of separately disclosing the overpayment recovery in its financial reports.
Grant Thornton claimed that it did not know about the 2008 overpayment and Q1 2009 recovery from the fulfillment partner until October 2009. After learning details about the overpayment, Grant Thornton told Overstock.com that it must restate its prior financial reports to correct that error and other underbilling errors previously indentified in this blog to comply with GAAP.
On November 13, 2009, Overstock.com fired and publicly vilified Grant Thornton, rather than restate its financial reports as its auditors and this blog had recommended.
On November 16, 2009 filed an "unreviewed" Q3 2009 10-Q that finally disclosed the overpayment to the fulfillment partner. However, Overstock.com still improperly claimed that a "gain contingency" existed as justification for not restating its financial reports to correct its previously reported underbilling errors and newly disclosed overpayment errors.
On November 18, 2009, during a conference call Patrick Byrne tried to justify Overstock.com's improper accounting of recoveries from underbilled fulfillment partners, overpaid fulfillment partners, and other overpaid vendors that were reported as income on a non-GAAP cash basis. He falsely claimed that even if Overstock.com changed its accounting for underbilling and overpayment recoveries, it would not change any previously reported profit into a loss or any previously reported loss into a profit:
In fact, we as I understand it, this doesn't change any positive quarter to a negative quarter or any negative quarter to a positive quarter.In a November 25, 2009 Salt Lake Tribune article, Jonathan Johnson was quoted as saying:
A day later, I posted in my blog new calculations of the impact of Overstock.com's GAAP violations on Q4 2008 to counter both Byrne's and Johnson's false statements to the Salt Lake Tribune, based on revised disclosures in the company's Q3 2009 "unreviewed" 10-Q report. This time I reported that Overstock.com improperly reported net profit of $1.014 million should have been properly reported as a $485k net loss.
None of these changes that they [Grant Thornton] are talking about, or that people at the SEC are now asking about, make any of our quarters go from negative to positive or from positive to negative.
On December 28, 2009, KPMG replaced Grant Thornton as Overstock.com's auditors.
On January 29, 2010 Overstock.com finally ate crow and admitted that its accounting for recoveries from both underbilled and overpaid fulfillment partners was "inappropriate" and that no gain contingency existed, as I previously reported in my blog.
The company reported that its financial reports from Q1 2008 to Q3 2009 "should no longer be relied upon" and that it will restate its financial reports to correct its GAAP violations. In addition, Overstock.com disclosed another GAAP violation due to its improper amortization of expenses for share-based compensation plans.
Simply said, I was right and Overstock.com was wrong. I was able to identify material GAAP and SEC disclosure violations that Overstock.com's management, its audit committee, and its former auditors at PricewaterhouseCoopers were unable and unwilling to identify and correct.
Late Filing of 2009 10-K Report
On March 16, 2010, Overstock.com announced that it could not file its 2009 10-K report by that day's deadline. The company required a two week extension to complete its financial reports.
However, Overstock.com nonchalantly disclosed even more GAAP violations "in its notification of late filing" that were previously undisclosed by the company. Overstock.com falsely claimed that those errors were previously disclosed by the company on January 29, when the company announced that it was restating its financial reports to comply with GAAP as described above.
On March 31, 2010 Overstock.com filed its 2009 10-K report and Q4 2009 financial report. Overstock.com's financial disclosures revealed that company improperly reported a Q4 2008 net profit of $1.014 million instead of a properly reported Q4 2008 net loss of $705k (See page F-53).
Excluding relatively minor adjustments relating to new GAAP violations reported by Overstock.com, I was right again and Patrick Byrne and Jonathan Johnson were entirely wrong again. I calculated that Overstock.com would report a loss in Q4 2008 if the company properly followed GAAP. In contrast, both Byrne and Johnson falsely stated that none of those questionable accounting practices turned a loss into a reported profit.
Byrne and Johnson, as the principal officers of Overstock.com had the means to make the same calculations I did. They both knew that any accounting error that turns a properly reported loss into an improperly reported profit is grounds for an automatic restatement of financial reports to correct such errors. Instead, they lied to investors in a deliberate attempt to hide the material financial impact of the company's GAAP violations to avoid restating the company's financial reports to correct those violations.
As I have said many times before, each and every initial financial report for every reporting period issued by Overstock.com from its inception in 1999 to Q3 2009 turned out to violate GAAP or some other SEC disclosure rules. Likewise, every single audit report from 1999 to 2008 was wrong and every single Sarbanes-Oxley internal control certification signed by management turned out to be false. The company's audit committee is as useless as Crazy Eddie's audit committee was, back in the day. So far, Overstock.com has restated its financial reports three times to correct GAAP violations.
Screwed up Internal Controls Cost Millions
KPMG issued "an adverse opinion "on the effectiveness of the Company's internal control over financial reporting."
Even though Overstock.com seems to have corrected certain GAAP violations, the company revealed that during 2009 it continued to underbill its fulfillment partners approximately $1.2 million but will "to not seek recovery of these amounts from our fulfillment partners."
Previously, Overstock.com disclosed that it underbilled its fulfillment partners $2.8 million in 2007 and $2.7 million in 2008. The company claims that it recovered none of the underbilling originating in 2007 and $2.3 million of the underbilling originating in 2008.
Therefore, from 2007 to 2009 literally $4.4 million of earned income walked out the door - 2007: $2.8 million, 2008: $400k, and 2009: $1.2 million.
New Financial Disclosure Errors Uncovered by Gary Weiss
Investors still cannot be comfortable with the credibility of Overstock.com's financial reporting.
For example, investigative reporter, bestselling author, and blogger Gary Weiss just browsed through Overstock.com's 2009 10-K report and uncovered yet another unsettling financial reporting error by Overstock.com. See below:
...the Marin County District Attorney and four other DAs in northern California want the company to fork over $8.5 million to settle consumer ripoffs by Overstock. The company disagrees and is fighting it, so .... No, wait a moment, make that read "$7.5 million." It uses the smaller number on page F-37 and the bigger number on page 33.
Really. Here it is. Page 33:
In January 2010 attorneys for the Company received correspondence from the Office of the District Attorney of County of Santa Clara in which the respective offices of the various district attorneys have made a collective proposal to resolve the dispute by the Company's payment of $8,500,000 in penalties and reimbursement.Page F-37:
The Company received correspondence from the Office of the District Attorney of the County of Monterey in which the respective offices of the various district attorneys have made a collective proposal to resolve the dispute by the Company's payment of $7,500,000 in penalties and reimbursement.
Hey what's a million here or there when your numbers are already fabricated, right? Anyway, I'm sure glad they asked for that delay to get their numbers straight.Apparently, Overstock.com's management, its audit committee, and its auditors are simply incapable of simply proof reading its financial reports.
By the way, California made this demand back in January. Isn't it charming how Overstock didn't bother filing an 8-K saying that people who can put you in jail want $8.5 million/$7.5 million? As I've said before, Overstock's not big on niceties of the securities laws, particularly the ones concerning "fraud," "ethics" and "disclosure."
Here's another unsettling misleading disclosure error under the caption "Risk Factors: and I am not joking:
Public statements we or our chief executive officer, Patrick M. Byrne, have made or may make in the future may antagonize regulatory officials or others.
We and our chief executive officer, Patrick M. Byrne, have from time to time made public statements regarding our or his beliefs about matters of public interest, including statements regarding naked short selling. Some of those public statements have been critical of the Securities and Exchange Commission and other regulatory agencies. These public statements may have consequences for us, whether as a result of increased regulatory scrutiny or otherwise.
Smoke and Mirrors behind Overstock.com Reported 2009 Net Profit
Overstock.com reported a 2009 first time annual profit of $7.7 million. However, a careful study of the company's financial disclosures reveals that its profit is derived from one-time nonrecurring items or other non-operating items. See below:
Without the above items, Overstock.com's 2009 reported $7.7 million net profit disappears into a $3.1 million loss.
- Gain from extinguishment of debt (Consolidated Statement of Cash Flows): $2.8 million
- Gain from settlements of legal matters (Footnote 16: Commitments and Contingencies): $7.1 million
- Reduction of sales return allowances $4.3 million (Page F-16) which added $900k to profits
- Total: $10.8 million
Overstock.com's debt was issued in 2004 under false pretenses. Financial reports issued by Overstock.com prior to the issuance of such debt were restated twice by the company due to material GAAP violations. In other words, Overstock.com repurchased debt at a profit that was originally issued to investors on the basis of financial reports that violated GAAP.
The gains in settlements of legal matters merely reflect to a large extent Overstock.com's recoupment of costs previously incurred in litigation.
The significant reduction of sales return allowances is a change in estimate. In others words, previously reported sales return allowances by the company may have been overstated. A downward revision of such an estimate creates a temporary book profit.
New Loss Contingencies
In its 2009 10-K report, Overstock.com disclosed new loss contingencies that could put a big hole in its corporate pockets (Footnote 16: Commitments and Contingencies):
- District Attorneys of Marin and four other counties in Northern California to settle investigation into advertising practices: $8.5 million.
- Ohio taxes: $613k
- Total potential future losses: $9.13 million
With the SEC investigation of Overstock.com continuing, KPMG took a huge risk in certifying the company's 2009 financial reports. Apparently, KPMG needs a refresher course on Statement of Auditing Standards No. 99 that deals with management teams that lack integrity like the executives running Overstock.com. There are many black holes in Overstock.com's financial reporting that KPMG may not be aware of. Those black holes will be the subject of future blog posts.
On 10/26/10, I updated certain amounts relating to sales return allowances based on new clarified disclosures by Overstock.com resulting from an SEC Division of Corporation Finance inquiry.
Sam E. Antar
I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped Eddie Antar and other members of his family mastermind one of the largest securities frauds uncovered during the 1980's. I committed my crimes, simply because I could.
If it weren't for the efforts of the FBI, SEC, Postal Inspector's Office, US Attorney's Office, and class action plaintiff's lawyers who investigated, prosecuted, and sued me, I would still be the criminal CFO of Crazy Eddie today.
I do not own Overstock.com securities short or long. My research on Overstock.com and in particular its lying CEO Patrick Byrne is a freebie for securities regulators and the public in order to help me get into heaven, though I doubt that I will ever get there anyway. I will probably end up joining corporate miscreants such as Patrick Byrne in hell.
In any case, exposing corporate crooks is a lot of fun for a forcibly "retired" crook like me. Analyzing Overstock.com's financial reporting is a forensic accountant's wet dream and Patrick Byrne is about to become the SEC's new orgasm.