How to Issue Phony Financial Reports and Mislead Investors – Overstock.com and Patrick M. Byrne Style

In three previous blog posts, I detailed how Overstock.com (NASDAQ: OSTK) violated Generally Accepted Accounting Principles (GAAP) and SEC disclosure rules by improperly deferring the recognition of an accounting error to create a cookie jar reserve to inflate future profits. On October 24, 2008, Overstock.com revealed that it underbilled fulfillment partners in periods prior to Q3 2008 because of customer refund and credit errors. The company improperly chose to recognize future recoveries from underbilling its fulfillment partners on a cash basis (non-GAAP) rather than restating previously issued financial reports to correct the material accounting error (GAAP). Note: Details of my previous blog posts here, here, and here).

More recently, I provided Overstock.com with a series of questions to answer about its accounting errors during its Q2 2009 earnings call (Details here). Rather than answer each of my questions, CEO Patrick Byrne went on a ranting diatribe as described by investigative journalist Gary Weiss in his blog (Details here).

The reason for avoiding any meaningful discussion of Overstock.com’s questionable financial disclosures is clear. Overstock.com and Patrick Byrne are desperately trying to avoid restating the company’s financial reports due to accounting errors for the third time in three years.

I will come back to this point later in this blog post. However, first let’s examine Overstock.com’s consistent pattern of financial reporting irregularities and lies by management to investors.

Overstock.com’s history is littered with a consistent pattern of false and misleading financial disclosures and lies by management about the company’s financial performance and compliance with securities laws

Since, its inception in 1999, Overstock.com is has yet to produce a financial report that has not at least initially violated GAAP and SEC disclosure rules. In fact, certain financial reports from 2003 to 2005 were restated twice to correct accounting errors.

From December 2000 to March 2002, Patrick Byrne lied about Overstock.com’s financial performance in a series of interviews on national television and in various publications prior to the company’s initial public offering in March 2002. Patrick Byrne deceptively used pro forma non-GAAP “gross value merchandise value sales” (instead of the lower GAAP commission revenue) to hype the company’s top-line performance in order to falsely claim that Overstock.com was profitable, when it never was profitable (Details here).

In April 2004, Patrick Byrne appeared on the Kudlow and Cramer show on CNBC and commented about GAAP and a non-GAAP pro forma measure called "Earnings before interest, depreciation, and amortization" or 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 October 2004, Patrick Byrne bragged, "We don't resort to any pro forma accounting tricks to make the numbers look better." In January 2006, Patrick Byrne made the following comment 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)...."

Over the next few years, it became clear that Overstock.com never issued a financial report for any quarterly reporting period that initially conformed to GAAP or SEC disclosure rules, despite Byrne's April 2004 claim that he was "all about GAAP." Overstock.com even resorted to reporting a non-compliant EBITDA that violated SEC rules. As I will demonstrate below, Overstock.com did not comply with both GAAP and allowable non-GAAP financial measures (such as EBITDA) under SEC rules. In other words, investors are cautioned to be skeptical of any disclosure coming from Overstock.com and its management team led by corporate miscreant Patrick Byrne.

In February 2006, Overstock.com restated financial reports dating from 2002 to 2005 due to inventory accounting errors. Only 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. However, Overstock.com's later restatement of financial reports announced in October 2008 wiped out previous positive adjustments to income from correcting its inventory accounting error by a factor of three.

In Q4 2006, Overstock.com took advantage of record losses and inflated inventory reserves. Former company President Jason C. Lindsey told investors that, "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."

However, Overstock.com later disclosed that inventory reserves had actually increased in both relative and absolute amounts. If Overstock.com had actually sold "all the slow-moving inventory as claimed by Lindsey, there is no way that inventory reserves can increase in both absolute and relative terms. The company overstated its inventory reserves to create a cookie jar reserve so it could increase profits in fiscal year 2007 (Details here).

From Q2 2007 to Q2 2008, Overstock.com violated SEC Regulation G by reporting a non-compliant “Earnings before interest, taxes, depreciation and amortization” or EBITDA to materially overstate its financial performance.

As I detailed above, Patrick Byrne had previously claimed that "I don’t believe in EBITDA. If somebody talks EBITDA, put your hand on your wallet; they’re a crook." He said that “EBITDA is the stupidest thing I ever heard emanate from Wall Street." Therefore, Patrick Byrne is "stupid" and a "crook" by his own definition, since Overstock.com used a non-compliant EBITDA to materially overstate its financial performance in violation of SEC Regulation G.

Despite Byrne's prior statements, Overstock.com improperly reconciled its non-compliant EBITDA to operating income rather than net income and improperly excluded stock-based compensation costs from its non-compliant EBITDA measure. When pressed by me to discuss Overstock.com's non-compliant EBITDA disclosures, CEO Patrick Byrne, company President Jonathan E. Johnson, former CFO David Chidester, now demoted by the company, lied to investors in a conference call about Overstock.com’s compliance with SEC Regulation G (Details here).

Lee Webb from Stockwatch chronicled my year long battle with Overstock.com to successfully force the company to comply with SEC Regulation G for certain non-GAAP financial disclosures and my ongoing battle to force the company to comply with GAAP and SEC rules in reporting certain accounting errors (Details here).

In January 2008, former company President Jason C. Lindsey backdated his resignation (Details here).

In January 2008, the Securities and Exchange Commission discovered that Overstock.com's revenue accounting failed to comply with GAAP and SEC disclosure rules, from the company's inception (Details here). This blog detailed how the company improperly provided the SEC with a flawed and misleading materiality analysis to convince regulators that its revenue accounting error was not material to avoid restating its financial reports (Details here).

Instead of restating prior financial reports to correct its material revenue accounting error, Overstock.com improperly used a one-time cumulative adjustment in its Q4 2007 financial report to hide the material impact of such errors on prior reporting periods. In Q4 2007, Overstock.com’s one-time cumulative adjustment reduced revenues by $13.7 million and increased net losses by $2.1 million resulting from the one-time cumulative adjustment to correct its revenue accounting errors.

In April 2008, Company President Jonathan E. Johnson lied to Wired.com about Overstock.com’s GAAP compliance in reporting revenues. In a financial report, Overstock.com compared Q1 2008 GAAP revenues to non-GAAP Q1 2007 revenues. At that time Overstock.com failed to restate Q1 2007 revenues to correct material revenue accounting errors uncovered by the SEC (Details here). Shortly afterwards, Johnson sold almost $1 million in stock (Details here). The next month, now demoted CFO David Chidester cashed out about $77,000 from selling his Overstock.com shares. Several months later, Overstock.com had to restate Q1 2007 revenues.

On October 24, 2008, Overstock.com disclosed new customer refund and credit errors and it company warned investors that all previous financial reports issued from 2003 to Q2 2008 “should no longer be relied upon.” This time, Overstock.com restated 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 also restated all financial statements to correct those errors, as I previously recommended.

The company reported that the combined amount of revenue accounting errors (previously uncovered by the SEC) and newly disclosed customer refund and credit accounting errors resulted in a cumulative reduction in previously reported revenues of $12.9 million and an increase in previously reported accumulated losses of $10.3 million.

Since Overstock.com had previously reported an increase in accumulated losses from its revenue accounting error of $2.1 million (see above), its new customer refund and credit errors resulted in an additional $8.2 million in accumulated losses in prior reporting periods.

It was the second time in three years that Overstock.com had to restate its financial reports and the company filed amended reports with the SEC. In addition, Overstock.com corrected its non-compliant EBITDA measure (as described above) in those amended financial reports. However, the explanatory note to those amended financial reports filed with the SEC, Overstock.com only made reference to corrections of its revenue accounting errors customer refund and credit errors, but made no reference to correcting its non-compliant EBITDA to comply with SEC Regulation G.

Overstock.com inflates losses from an accounting error to create a cookie jar reserve to increase income in future accounting periods

As I will detail below, Overstock.com’s additional accumulated losses of $8.2 million in prior reporting periods from its customer refund and credit errors were improperly overstated by at least $3.0 million dollars to create a cookie jar reserve to inflate future earnings. In its restatement of prior period financial reports, Overstock.com failed to include accruals of income for amounts due to the company from underbilling its fulfillment partners for offsetting costs and reimbursements, less a reasonable estimate of uncollectible amounts, as required by GAAP.

Instead, Overstock.com improperly recognized over $3 million of such underbilling recoveries over three future quarters (Q4 2008, Q1 2009 and Q2 2009) as income on a cash basis. As a result, Overstock.com improperly deferred recognition of an accounting error over future periods and materially inflated income during those periods. In effect, Overstock.com wrongfully corrected an accounting error over two or more periods by using a cookie jar reserve.

The SEC does not permit the correction of an accounting error “prospectively, over two of more periods”

In a “cease and desist order” issued “In the matter of Carl M. Apel,” the Securities and Exchange Commission took the following position:

The correction of error, including erroneous estimates related to loss contingencies, should be disclosed in the period in which the error is discovered. The correction is accounted for and reported as a prior period adjustment, that is, by restating the financial statements of the affected prior periods. See FAS 16, Prior Period Adjustments (June 1977) [as partially superseded by FAS 109, Accounting For Income Taxes (February 1992) ¶288(n)]; APB 20, ¶¶13, 36 and 37; and APB 9, Reporting the Results of Operations (December 1966) ¶¶18 and 26. 

As these provisions make clear, GAAP do not allow for the deferral of accounting adjustments arising from a change in estimate or the correction of error. If a change in estimate affects one period only, the change may not be accounted for over two or more periods in order to diminish the effect of the change on income, or for any other purpose. Correction of error may not be accounted for prospectively, or over two or more periods, in order to diminish the effect of the correction on any one period. [Emphasis added.]

As the SEC makes clear, “GAAP do not allow for the deferral of accounting adjustments arising from a change in estimate or the correction of error” and “Correction of error may not be accounted for prospectively, or over two or more periods, in order to diminish the effect of the correction on any one period.” However, Overstock.com prospectively corrected its accounting errors from underbilling fulfillment partners over three periods and violated GAAP and SEC rules.

After my original blog post exposed Overstock.com’s latest financial reporting violations, the company is desperately trying to avoid a third restatement of its financial reports due to the improper deferral of income from recovering offsetting cost reimbursements and fees against its customer refund and credit errors from its fulfillment partners.

Q4 2008: Overstock.com’s improper accounting of customer refund and credit errors

On January 30, 2009, Overstock.com reported a net profit of $1 million profit and $.04 earnings per share for Q4 2008, after 15 consecutive quarterly losses and it beat mean analysts’ consensus expectations of negative $0.04 earnings per share. CEO Patrick Byrne gloated to investors, "After a tough three years, returning to GAAP profitability is a relief."

However, Overstock.com's press release failed to disclose that its $1 million reported profit resulted from a one-time gain of $1.8 million relating to payments received from fulfillment partners for amounts previously underbilled them. Later, during the earnings call, CFO Steve Chesnut finally admitted to investors that:

Gross profit dollars were $43.6 million, a 6% decrease. This included a one-time gain of $1.8 million relating to payments from partners who were under-billed earlier in the year. [Emphasis added.]

As I detailed above, Overstock.com already disclosed in an October 24, 2008 press release that it failed to bill its fulfillment partners for offsetting cost reimbursements and fees resulting from its customer refund and credit errors. The company claimed to have already corrected those errors by restating all financial reports issued prior to Q3 2008 and it increased accumulated losses by $10.3 million.

As it turned out, Overstock.com improperly failed to include in its restatement of previously issued financial reports an accrual of amounts due the company from underbilling its fulfillment partners for offsetting costs and reimbursements, less a reasonable estimate of uncollectible amounts.

After the earnings call, I wrote blog post explaining that if Overstock.com properly followed accounting rules, it would have reported an $800,000 loss instead of a $1 million profit, it would have reported sixteen consecutive losses instead of 15 consecutive losses, and 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).

Patrick Byrne responded to me on a stock market chat board

On February 6, 2009, Patrick M. Byrne responded to my blog post and tried to rationalize Overstock.com’s treatment of the “one-time gain” in an unsigned post, using an alias, on an internet stock market chat board. Byrne’s chat board post was later removed and re-posted with his name attached to it, after I complained to the SEC. Here is what Patrick Byrne told readers on the chat board:

Antar's ramblings are gibberish. Show them to any accountant and they will confirm. He has no clue what he is talking about.

For example: when one discovers that one underpaid some suppliers $1 million and overpaid others $1 million. For those whom one underpaid, one immediately recognizes a $1 million liability, and cleans it up by paying. For those one overpaid, one does not immediately book an asset of a $1 million receivable: instead, one books that as the monies flow in. Simple conservatism demands this (If we went to book the asset the moment we found it, how much should we book? The whole $1 million? An estimate of the portion of it we think we'll be able to collect?) The result is asymmetric treatment. Yet Antar is screaming his head off about this, while never once addressing this simple principle. Of course, if we had booked the found asset the moment we found it, he would have screamed his head off about that. Behind everything this guy writes, there is a gross obfuscation like this. His purpose is just to get as much noise out there as he can. [Emphasis added.]

Actually, Patrick Byrne confirmed that I was correct in saying that Overstock.com improperly used cash basis accounting (non-GAAP) rather than accrual basis accounting (GAAP) to correct its accounting error. In a follow up blog post, I criticized Byrne’s response noting that:

… Overstock.com recognized the "one-time of $1.8 million" using cash-basis accounting when it "received payments from partners who were under-billed earlier in the year" instead of accrual basis accounting, which requires income to be recognized when earned. A public company is not permitted to correct any accounting error using cash-basis accounting.

Patrick Byrne claimed that “…one books that as the monies flow in. Simple conservatism demands this…”

However, the SEC’s position is that you cannot abuse “conservatism” to “understate net assets and profits” or by overstating a loss from an accounting error to create a cookie jar reserve to increase income in future reporting periods. However, that's exactly what Overstock.com did.

SEC Chief Accountant’s position on abusing “conservatism”

In 1999, the SEC’s Chief Accountant concerned about “earnings management” by companies warned issuers against using “conservatism” to deliberately understate “net assets and profits” or, in effect, overstate losses. See below:

The SEC staff also has noted that some believe that conservatism is a characteristic that should be discussed. However, in SFAC 2 the FASB noted:

“Since a preference that possible errors in measurement be in the direction of understatement rather than overstatement of net income and net assets introduces a bias into financial reporting, conservatism tends to conflict with significant qualitative factors such as representational faithfulness, neutrality, and comparability (including consistency)...Conservatism in financial reporting should no longer connote deliberate, consistent understatement of net assets and profits...The Board emphasizes that any attempt to understate results consistently is likely to raise questions about the reliability and integrity of the information about those results and will probably be self-defeating in the long run.”

Accordingly, the consistent understating of results (i.e., conservatism) or overly optimistic estimates of realization (i.e., lack of conservatism or aggressiveness) are inconsistent with the characteristics of quality financial reporting needed for transparent reporting in today’s markets. As some have noted, an analogy can be made to the game of golf. One desires to hit the ball down the middle of the fairway to get the best result and longest drive. While staying in the fairway is acceptable, the quality of the drive is determined by how close to the middle one gets. The staff believes that it is important for financial management and auditors to communicate with the audit committee whether, and where, the ball is on the fairway. [Emphasis added.]

After Patrick Byrne’s chat board remarks confirming improper cash basis accounting, Overstock.com concocted a new excuse to justify Patrick Byrne’s stock market chat board ramblings.

How Overstock.com tried to justify using non-GAAP cash basis accounting to improperly defer correcting an accounting error in Q4 2008, Q1 2009, and Q2 2009

On February 23, 2009, Overstock.com filed its fiscal year 2008 10-K with the SEC and that report included Q4 2008’s quarterly numbers. The company tried to justify using cash basis accounting to correct its accounting error by saying that “When the underbilling was originally discovered, we determined that the recovery of such amounts was not assured, and that consequently the potential recoveries constituted a gain contingency.” See below:

In addition, during Q4 2008, we reduced Cost of Goods Sold by $1.8 million for billing recoveries from partners who were underbilled earlier in the year for certain fees and charges that they were contractually obligated to pay. When the underbilling was originally discovered, we determined that the recovery of such amounts was not assured, and that consequently the potential recoveries constituted a gain contingency. Accordingly, we determined that the appropriate accounting treatment for the potential recoveries was to record their benefit only when such amounts became realizable (i.e., an agreement had been reached with the partner and the partner had the wherewithal to pay). [Emphasis added.]

In Q1 2009, Overstock.com continued to claim that it could recognize income from recovering previous underbillings of its fulfillment partners on a cash basis due to a "gain contingency." In addition, the company disclosed yet another accounting error originating in Q4 2008 resulting from overbillings by a freight carrier. Overstock.com improperly recognized that accounting error as income in Q2 2009, rather than restate its Q4 2008 financial report as required by GAAP:

In Q1 2009, we reduced total cost of goods sold by $1.9 million for recoveries from partners who were underbilled in 2008 for certain fees and charges that they were contractually obligated to pay and a refund due of overbillings by a freight carrier for charges from Q4 2008.

During the earnings call that followed Overstock.com’s Q1 2009 press release, Patrick Byrne gave a fuzzy quantification of the “overbilling by a freight carrier for charges from Q4 2008. He said:

…we did get the benefit of a shipping billing benefit of some several hundred thousand dollars and so forth.

In Q2 2009, Overstock.com collected another $87,000 from fulfillment partners. During the earnings call, Patrick Byrne reiterated Overstock.com's claim that a "gain contingency" existed for underbilled amounts due from fulfillment partners:

First question is when the under-billing was originally discovered, we determined that the recovery of such amounts was not assured and consequently the potential recovery constituted a gain contingency.

That's correct, as we unraveled in the fourth quarter last year, and so Sam then asks a whole bunch of questions about this.

But the short answer is we unraveled this in the fourth quarter. It all came about simultaneously with the facts leading to the restatement. And when you discover that you owe people money, or that you're not owed money that you thought you were owed, you announce that immediately when you discover that you think you've under-billed other people, that's called a contingent gain, and you don't get to book the entire thing as an asset immediately, because you got to go and collect it. [Emphasis added.]

According to claims in Overstock.com’s financial disclosures to the SEC and Byrne’s comments during the Q2 2009 earnings call, the decision to consider future recoveries from underbilling fulfillment partners as a "gain contingency" was made at the time the underbilling error was discovered. If that is really true, the date such discovery had to have been much earlier than October 20, 2008, the date that the Board of Directors approved the company's restatement of previously issued financial reports to correct customer refund and credit errors (Source: 8-K report page 5).

However, auditing and SEC rules require that a company take into account material events affecting the measurement or realization of assets in a financial report up to the date that either the final 10-Q report or 10-K report is filed with the commission (See: SAS No. 1 Paragraph 1, 2, 3, and 7 and Letter from SEC Chief Accountant entitled "Audit Risk"). In other words, if new information is received after the cut-off date that affects either assets or income in a financial report, a company must adjust its financial report to reflect that new information.

If Overstock.com's explanation of a gain contingency is to be believed, the company improperly determined that a gain contingency existed when it first discovered underbilling its fulfillment partners, instead of spending any time trying to determine the recoverability of such underbilled amounts.

Overstock.com should have waited at least until November 7, 2008 (or 38 days into the fourth quarter) when it filed its Q3 2008 10-Q report before making a final determination as to the collectibility of underbilled amounts due from fulfillment partners as of the end of Q3 2008.

In fact, the company could have waited an additional seven days to determine the collectibility of underbilled amounts due from fulfillment partners and still filed its 10-Q report on time. If management truly wanted to make a reasonable estimate as to the collectibility of underbilled amounts due from fulfillment partners, Overstock.com could have properly filed a late 10-Q report by explaining the circumstances. It didn't. Apparently, management deliberately tried to avoid restating its financial reports for a third time in three years.

In any case, no gain contingency existed at all and Overstock.com collected $1.8 million in underbilled amounts from its fulfillment partners during Q4 2008. Since Overstock.com filed its Q3 2008 10-Q report 38 days into the fourth quarter, management had to know that large amounts due from underbilling its fulfillment partners were in fact collectible.

Therefore, Overstock.com cannot claim that "we determined that the recovery of such amounts was not assured, and that consequently the potential recoveries constituted a gain contingency". In fact, the recovery of large amounts of previously underbilled amounts was "assured" since the company quickly recovered $1.8 million in Q4 2008.

Why Overstock.com’s claimed “gain contingency” is a false representation to investors
Overstock.com had already earned those "fees and charges" in prior periods from fulfillment partners. It simply underbilled them. Those fulfillment partners were already "contractually obligated to pay" such underbilled amounts. In addition, there was no question that Overstock.com was owed money from its fulfillment partners and that the recovery of substantial amounts was assured. Therefore, no gain contingency existed under accounting rules.

If there was any question as to the recovery of any amounts owed the company, management is required to make a reasonable estimate of uncollectible amounts (loss contingency) and book an appropriate reserve against amounts due from fulfillment partners. By immediately considering underbilled amounts due from fulfillment partners as a gain contingency, the company failed to make a reasonable estimate of such uncollectible amounts and violated accounting rules or GAAP (See SFAS No. 5 paragraph 1, 2, 8, 22, and 23).

Statement of Financial Accounting Standards No. 154 requires Overstock.com to restate affected prior period financial reports to reflect when the underbilled cost reimbursements and fees were actually earned by the company (accrual basis or GAAP). Statement of Financial Accounting Standards No.5 requires Overstock.com to offset such accrued income in each restated financial period with a reasonable estimate of uncollectible underbilled amounts.

Therefore, Overstock.com overstated its customer refund and credit accounting error by failing restate its prior affected financial reports and accrue underbilled amounts due from its fulfillment partners as income in the appropriate accounting periods, less a reasonable reserve for unrecoverable amounts. By improperly deferring recognition of income until underbilled amounts were collected, the company used non-GAAP cash basis accounting to effectively create a "cookie jar" reserve to increase future earnings.

In addition, Overstock.com improperly failed to disclose any potential “gain contingency” in its Q3 2008 10-Q report, when it disclosed that it underbilled its fulfillment partners (See SFAS No. 5 Paragraph 17b). Was management's claimed "gain contingency" a backdated made up attempt to cover up the company's improper treatment of an accounting error? The "gain contingency" disclosure only appeared in Overstock.com's fiscal year 2008 10-K after I criticized its improper treatment of the underbilling error in my blog.

The only way that Overstock.com could recognize income from underbilling its fulfillment partners in future accounting periods is if there was a “significant uncertainty as to collection” of all underbilled amounts (See SFAS No. 5 paragraph 23). As it turns out, a large portion of the underbilled amounts to fulfillment partners was easily recoverable within a very brief period of time. Therefore, no “significant uncertainty as to collection” existed.

During Q4 2008, Overstock.com collected a total of “$1.8 million relating to payments from partners who were underbilled earlier in the year.” Overstock.com filed its Q3 2008 10-Q report 38 days into that quarter and clearly should have known by that time that significant amounts owed by fulfillment partners from underbilling them in the past was actually collectible and that no gain contingency existed as to such amounts.

On February 23, 2009, Overstock.com filed its annual audited 10-K report with the SEC. By that time, Overstock.com clearly knew that $1.8 million in underbilled amounts due from fulfillment partners was collected by December 31, 2008. In addition, Overstock.com collected over $1.5 million in underbilled amounts during Q1 2009. Since Overstock.com issued its 10-K report 54 days into Q1 2009, the auditors should have known that no gain contingency existed for underbilled amounts due from fulfillment partners. Overstock.com "dismissed" PricewaterhouseCoopers as its auditors and replaced them with Grant Thornton, shortly thereafter.

To summarize the material financial distortions caused by Overstock.com’s improper deferral of income from an accounting error, see the chart below (Click on image to enlarge):

Taking advantage of convertible debt holders and other one-time items aid Overstock.com's financial performance.

In November 2004, Overstock.com raised new cash through the issuance of convertible debt securities. Since that offering, Overstock.com restated its financial reports from 2003 to 2004 two times. In other words, Overstock.com's convertible debt holders relied on financial reports that violated GAAP and SEC disclosure rules.

In Q1 2009, and Q2 2009, Overstock.com reported gains of $1.926 million and $0.884 million respectively from buying back such debt at a discount to its face value, thereby taking advantage of those investors who relied on financial reports that violated GAAP and SEC rules.

In Q1 and Q2 2009, Overstock.com benefited from the reimbursement of legal fees due to an insurance settlement in the amount of $0.6 million each quarter.

In Q1 2009, Overstock.com made a one-time exit payment departing director James. V. Joyce.

In Q2 2009, Overstock.com benefited from one-time adjustments relating to a change of estimate involving past accrued restructuring charges totaling $0.218 million. See the chart below (Click on image to enlarge):

As the above chart demonstrates, Overstock.com only reported profits in Q4 2008 and Q2 2009 due to GAAP violations, buying back debt issued under false pretenses at a profit, and other one-time benefits. Overstock.com has never reported a profitable year during its entire existence and has accumulated losses of over $266 million. The company has a negative net worth of $4 million.

To be continued.....

Written by:

Sam E. Antar

Disclosure:

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 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.

Overstock.com Director James V. Joyce Bolts, Receives Huge Questionable Exit Payment

After yesterday's stock market closed, Overstock.com (NASDAQ: OSTK) announced the resignation of James V. Joyce from its Board of Directors. However, Overstock.com's press release made no reference to a $1,250,000 payment for the termination of consulting services to Icent LLC, a management consulting company headed by Mr. Joyce. Overstock.com left investors the mundane task of finding out about the $1,250,000 termination payment by disclosing it in a separate SEC filing. See below:

Overstock.com press release:

SALT LAKE CITY, April 1 /PRNewswire-FirstCall/ -- Overstock.com, Inc. (Nasdaq: OSTK) today announced that James V. Joyce has resigned from the Board of Directors of Overstock.com. Chairman and CEO Patrick Byrne said, "James' consulting engagement has been concluded with his customary extraordinary results. James' advice has been of tremendous value to me, the board, and the company for years, but especially over the last two years of getting the company back on the rails. I am deeply in his debt." Mr. Joyce had been a director since January 2008. [Emphasis added.]

Separate Overstock.com 8-K report filed with the SEC:

On April 1, 2009 Mr. James V. Joyce resigned from his position as a member of the Board of Directors of Overstock.com, Inc. (the “Company”). Mr. Joyce’s resignation is not the result of a disagreement with the Company on any matter relating to the Company’s operations, policies or practices. Mr. Joyce and the Company are concurrently ending the Company’s consulting arrangement with Icent LLC, which is a management consulting company of which Mr. Joyce is the chief executive officer, and through which Mr. Joyce has provided consulting services to the Company. In connection with the termination of the consulting arrangement, the Company has agreed to pay $1,250,000 to Mr. Joyce. [Emphasis added.]

On January 14, 2008, James Joyce replaced former company President Jason C. Lindsey on Overstock.com's Board of Directors after Lindsey resigned from both posts (President and Board Member) at the company. Jason Lindsey's resignation letter was dated December 31, 2007. However, in a separate sworn declaration filed in connection with a court proceeding, Lindsey said he resigned on January 2, 2008. In addition, a revolving line of credit note dated January 1, 2008 still listed Lindsey as a person "authorized to request advances" despite his claimed resignation as President of Overstock.com, a day earlier. Apparently, Lindsey's backdated his resignation.

Overstock.com's $1,250,000 contract termination payment to former Board member James Joyce is over five times the sum of $225,000 in consulting services "authorized to be paid to Mr. Joyce for services rendered to the Company during 2007." The company has not disclosed additional amounts in consulting services paid to Mr. Joyce in 2008 or 2009 to-date, aside from the termination fee.
See Overstock.com 8-K SEC filing dated January 14, 2008 below:

On January 14, 2008 the Board of Directors of Overstock.com, Inc. (the “Company”) appointed James V. Joyce to the Board of Directors. Mr. Joyce has served as a consultant to the Company since September 2005. The aggregate amount the Company has paid to Mr. Joyce since January 1, 2007 is $615,000 (including $225,000 authorized to be paid to Mr. Joyce for services rendered to the Company during 2007). The Company has previously granted Mr. Joyce options to acquire 40,000 shares of the Company’s common stock at a weighted average exercise price of $30.38 per share. In connection with the restricted stock unit grants described below, on January 14, 2008 the Company also granted Mr. Joyce restricted stock units to acquire 15,000 shares of the Company’s common stock under the Company’s 2005 Equity Incentive Plan and entered into or will enter into a Restricted Stock Unit Grant Notice and Restricted Stock Agreement with Mr. Joyce in substantially the form filed herewith as Exhibit 10.1. A copy of the press release issued by the Company on January 14, 2008 is attached hereto as Exhibit 99.1 and is incorporated by reference. [Emphasis added.]

A shrewd person posting on the Yahoo message board noted:

And another thing - why does a retailer that's been in business a decade need "management" consulting services (rhetorical question, I know the answer)? What aspect of "management" was Mr. Joyce consulting on? How many FTE's were consulting under Joyce's banner that would require a contractual payout of a whopping 1.25 million? How many man hours does that payout represent?

Let's see, the avg cost of a non top-tier name "management consultant" has gotta be billed at around $150/hr or so these days.

Sooooooo, that's a payoff of over 8,000 man hours.

Ok hec, let's say Joyce was worth every penny of $500/hr - that's a payout of 2,500 man hours. Under most standard per-diem consulting contracts, the contracting company only has to provide 2-weeks termination warning or forfeit 2 weeks of billings. Let's see...80 hours of billable hours at the fantastic rate of $500/hr = $40,000.

Ok longs - speak up - is THIS the kind of shareholder equity stewardship you are expecting from Patrick Byrne?

Stinky, stinky

Why has Overstock.com paid James Joyce such a huge sum to terminate his consulting agreement? Masquerading stock market reformer Patrick Byrne has claimed that he has "gold standard in communicating with candor” Overstock.com’s results. However, Overstock.com left out any mention of such a huge payment in its press release, leaving investors the mundane task of digging through SEC filings to obtain information about the contract termination payment.

Overstock.com CEO Patrick Byrne once said:

In our public SEC filings we chose principles at the conservative edge of GAAP….

However, Overstock.com violated GAAP in just about every financial report since inception (Details here, here, and here).

Written by:

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

Disclosure:

I have no position in Overstock.com securities, long or short.

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

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.

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.