Overstock.com Delays Filing 10-K, Reports Even More GAAP Violations, While Patrick Byrne Hides

CEO Patrick M. Byrne intoxicated

Yesterday, Overstock.com (NASDAQ: OSTK) filed a Notification of Late Filing (Form 12b-25) for its 2009 annual 10-K report at around 4:23 PM (Eastern) or about 37 minutes before the drop-dead deadline when the 10-K report was due to be filed.

The Notification of Late Filing identifies new previously undisclosed material violations of Generally Accepted Accounting Principles (GAAP) and other Securities and Exchange Commission disclosure rules. The company needs more time to determine the accounting impact of certain material GAAP violations first acknowledged by the company on January 29 and new GAAP violations reported by the company in its "Notification of Late Filing."

Apparently, KPMG who was hired as Overstock.com's new auditors after they fired Grant Thornton, has finally learned what I've known for a very long time: The deeper you dig into Overstock.com's financial reporting, the more black holes (GAAP and SEC disclosure violations) you will find.

Newest Found GAAP Violations

As I discussed above, Overstock.com's Notification of Late Filing includes both previously disclosed and newly discovered GAAP violations. Those new GAAP violations were highlighted by me in the text below in bold and italic print:

As announced on January 29, 2010, Overstock.com, Inc. (the “Company”) is restating its previously issued financial statements for the fiscal year ended December 31, 2008 (including the interim periods within that fiscal year), and the quarterly periods ended March 31, 2009, June 30, 2009 and September 30, 2009 to correct errors related to:

Operational errors and the accounting for amounts that the Company pays its drop ship fulfillment partners and an amount due from a vendor that went undiscovered for a period of time. Specifically, these errors related to (1) amounts the Company paid to partners or deducted from partner payments related to return processing services and product costs and (2) amounts the Company paid to a freight vendor based on incorrect invoices from the vendor.  Once discovered the Company applied “gain contingency” accounting for the recovery of such amounts, which was an inappropriate accounting treatment.

The accounting for certain of the Company’s share-based compensation plans. Specifically, the Company incorrectly amortized the expense related to restricted stock units based on the actual three year vesting schedule rather than a three year straight line amortization schedule and applied an outdated forfeiture rate in calculating share-base compensation expense under the plans.

Identification of amounts related to customer refunds and credits not properly included in the Company’s monthly reconciliation of customer refunds and credits to third party statements to determine the completeness and accuracy of returns expense.

The accounting for certain external audit fees on a ratable basis, instead of as incurred.

The recognition of co-branded credit card bounty revenue and promotion expense on an immediate recognition basis, instead of over time.

The late recognition of a reduction in the restructuring accrual for a new sublease and the recognition of interest expense related to the accretion of the restructuring accrual.

Other miscellaneous corrections and reclassifications, none of which were material either individually or in the aggregate.

Overstock.com nonchalantly lumped in its latest GAAP violations with other GAAP violations previously disclosed by the company on January 29, rather than separately disclosing them. Those newly identified GAAP violations add to a long laundry list of other violations some of which are discussed in more detail below. Because I have exposed various financial reporting violations by Overstock.com, Patrick Byrne ridiculously considers me to be an "anti-Overstock.com" blogger.

SEC Regulation G Violations

In various blog posts during 2007 and 2008, I exposed how Overstock.com violated SEC Regulation G by using an improper EBITDA calculation to materially overstate its financial performance from Q2 2007 to Q2 2008. When I confronted management about its EBITDA violations, Patrick Byrne, Jonathan Johnson, and David Chidester lied about the company's compliance with SEC Regulation G during quarterly conference calls and Byrne vilified me for even raising the issue.

In Q3 2008, Overstock.com finally corrected its improper EBITDA calculation by calling it "adjusted EBITDA" when it restated financial reports and amended its filings with the SEC to correct certain GAAP violations involving customer refund and credit errors described below. However, the company improperly failed to disclose in its amended SEC filings that the reason for changing its EBITDA calculation was because of violations of Regulation G (Details from my blog here and from Lee Webb's Stockwatch article here).

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.

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).

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." Overstock.com CEO Patrick Byrne responded 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 CEO Patrick Byrne continued to respond by orchestrating a massive corporate sponsored retaliation campaign against me and other critics who agreed with my findings. In addition, Patrick Byrne, company President Jonathan Johnson, former CFO David Chidester, and others blatantly lied to and misled shareholders during various conference calls and vilified me in an attempt to cover up their financial reporting manipulation schemes.

In March 2009, Overstock.com fired PricewaterhouseCoopers as its auditors and hired Grant Thornton to replace them.

In September 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.

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. 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 about the overpayment, Grant Thornton told Overstock.com that it must restate its prior financial reports to correct that error to comply with GAAP.

On November 13, 2009, Overstock.com fired and vilified Grant Thornton, rather than restate its financial reports and later filed an "unreviewed" Q3 2009 10-Q that finally disclosed the overpayment to the fulfillment partner. In this case too, Overstock.com improperly claimed that a "gain contingency" existed as justification for not restating its financial reports to correct the overpayment error.

On December 28, 2009, KPMG replaced Grant Thornton as Overstock.com's auditors.

My Vindication

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 (More details here.)

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. As I detailed above, KPMG has  found even more material GAAP violations as nonchalantly disclosed in its "Notification of Late Filing."

Patrick Byrne in Hiding

I recently sent CEO Patrick Byrne and audit committee member Joseph J. Tabacco the following emails below requesting a full apology from the company and the removal of defamatory remarks from Overstock.com's website and its related party Deep Capture LLC website:

From: Sam E. Antar
Sent: Monday, March 08, 2010 11:02 PM
To: Patrick Byrne
Subject: Overstock.com Restatement
Importance: High

Hi Patrick:

Will you finally admit that I was correct when I reported in my blog that Overstock.com violated GAAP by using a phony gain contingency in light of the company’s recently announced restatement?

You owe me a public apology.

Regards,

Sam

I received no reponse from Patrick Byrne.

A day later, I tried to get a response from him again. This time I cc'd Audit Committee member Joseph J. Tabacco Jr, certain persons from the SEC, and certain journalists. At least Tabacco and the others sent me "read receipts" acknowledging that they received and read my email. However, Byrne failed to respond to me and stayed in hiding.

From: Sam E. Antar
Sent: Tuesday, March 09, 2010 2:12 PM
To: Patrick Byrne
Cc: Joseph J. Tabacco Jr. (Overstock.com Audit Committee), persons from SEC, and certain journalists
Subject: FW: Overstock.com Restatement
Importance: High

Having not received a response from last night’s email (see below), I am asking for a response to the following question I asked you in that email:

Will you finally admit that I was correct when I reported in my blog that Overstock.com violated GAAP by using a phony gain contingency in light of the company’s recently announced restatement?

 In addition, I have the following questions:

Will you finally admit that I was correct when I reported in my blog that Overstock.com used an improper EBITDA from Q2 2007 to Q2 2008 in violation of SEC Regulation G to materially inflate its financial performance, in light of its later amended disclosures?

Will you publicly admit that I was right about Overstock.com’s violations of GAAP and other SEC disclosure rules (such as Regulation G)?

Will you publicly admit that you were wrong when you claimed that the company was complying with GAAP and other SEC disclosure rules, while at the same time you were publicly defaming me and other critics?

Will the company admit that I notified audit committee member Joseph J. Tabacco about Overstock.com’s GAAP and SEC disclosure violations (such as Regulation G) and continued to issue improper financial reports until it was forced to make corrections in its financial reporting?

As the CEO of Overstock.com you owe me a public apology.

Respectfully,

Sam E. Antar

The next day, I sent an email directly to Joseph J. Tabacco Jr. and cc'd Patrick Byrne, certain persons from the SEC, and certain journalists. While Tabacco sent me a "read receipt" acknowledging my email, he failed to respond to me. Byrne continued to duck the issues, too.

From: Sam E. Antar
Sent: Saturday, March 13, 2010 3:25 PM
To: Joseph J. Tabacco Jr. (Overstock.com Audit Committee)
Cc: Patrick Byrne, persons from the Securities and Exchange Commission, and certain journalists
Subject: Overstock.com Financial Reporting Violations
Importance: High

To Joseph J. Tabacco (Overstock.com Audit Committee Member):

On Overstock.com’s website, there is a page labeled “Naked Short Selling” and on that page is a link labeled “November 2008 – Utah Attorney General Mark Shurtleff comments on anti-Overstock.com blogger Sam Antar.” Here is the link: http://www.overstock.com/naked-short-selling.html.

First off, I have never been involved any illegal naked short selling.

Second, how can Overstock.com label me as an “anti-Overstock.com blogger” when?:

I correctly reported in my blog that Overstock.com used an improper EBITDA from Q2 2007 to Q2 2008 in violation of SEC Regulation G to materially inflate its financial performance, in light of its later amended disclosures.

I correctly reported in my blog that Overstock.com violated GAAP by using a phony gain contingency in light of the company’s recently announced restatement.

The company has the nerve to falsely imply that I am naked short selling Overstock.com and am an “anti-Overstock.com blogger” even though I correctly exposed financial reporting violations by the company as cited above.

Simply said, Overstock.com, its audit committee, its management, and its auditors were wrong and I was right about SEC disclosure violations such as Regulation G and the company’s GAAP violation that led to its recently announced restatement.

I did the job that Overstock.com and its auditors were unable and unwilling to do as evidenced by its delayed response in correcting financial reporting violations that were reported in my blog and its vicious campaign to smear me and other critics rather than immediately correct its financial reporting violations.

Third, please note Utah Attorney General Mark Shurtleff received $5,000 in cash from Overstock.com a few days prior to writing his defamatory letter about me. Both Chief Deputy Attorney General Kirk Torgensen and Deputy Attorney General Richard Hamp acknowledged that Shurtleff’s claims about me were false in various tape recorded conversations cited in my blog.

For additional information, read my blog post entitled, “Overstock.com (NASDAQ: OSTK) CEO Patrick Byrne Pays Utah Attorney General Mark Shurtleff to Defame a Blogger.” Link here: http://whitecollarfraud.blogspot.com/2008/08/overstockcom-nasdaq-ostk-ceo-patrick.html,

Therefore, I respectfully request a full public apology from Overstock.com and that the company remove all false and defamatory references to me in its web site and its Deep Capture web site immediately.

Respectfully,

Sam E. Antar

I have no doubt that Overstock.com's management and audit committee will continue their violate fiduciary duties to shareholders while vilifying any critic who uncovers any financial reporting irregularities and other misconduct by the company.

At least KPMG has uncovered some previously undisclosed material GAAP and SEC disclosure violations by the company. However, it's only the tip of the iceberg. All I can say for now, is that newly discovered documentation of misconduct and financial reporting irregularities by Overstock.com is in the right hands.

At this time, I will provide no closure for Patrick Byrne or KPMG about what I already know and what the company has knowingly failed to disclose to its auditors and investors. They'll have to keep guessing while Patrick Byrne remains under the delusion that he can run and hide from accountability for his actions.

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 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.

Patrick Byrne To Tough It Out With SEC Over GAAP Violations

Apparently, Overstock.com (NASDAQ: OSTK) is going to stubbornly tough it out and force the Securities and Exchange Commission to take enforcement action to make its financial reports comply with Generally Accepted Accounting Principles (GAAP). The SEC re-opened its investigation of Overstock.com in response to a series of investigative reports by this blog documenting continuing GAAP violations by the company and other false and misleading representations to investors by its management team, led by CEO Patrick M. Byrne.

Flawed financial reports incorporated in new registration statement

Earlier today, Overstock.com filed a registration statement in connection with its 2005 Equity Incentive Plan. CEO Patrick M. Byrne, CFO Steven J. Chesnut, audit committee members Allison H. Abraham, Clay Corbus, and Joseph J. Tabacco Jr. all signed off on Overstock.com's SEC filing. In addition, PricewaterhouseCoopers (PWC), Overstock.com's former auditors, consented to the company using flawed financial reports in its SEC filing. See below:

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM 

We hereby consent to the incorporation by reference in this Registration Statement on Form S-8 of our report dated February 23, 2009 relating to the financial statements, financial statement schedule and the effectiveness of internal control over financial reporting, which appears in Overstock.com, Inc.’s Annual Report on Form 10-K/A for the year ended December 31, 2008.

/s/ PricewaterhouseCoopers LLP

PricewaterhouseCoopers LLP
Salt Lake City, UT
October 26, 2009

As I will detail below, Overstock.com's 2008 Annual Report on Form 10K/A contained material accounting errors and GAAP violations that were overlooked by PWC during the course of its audit. Therefore, internal controls of financial reporting was ineffective. Worst yet, PWC has given similar consents to Overstock.com in the past, only to have such financial reports later restated due to GAAP violations.

Summary of latest GAAP violations exposed in this blog

In October 2008, Overstock.com disclosed new customer credit and refund accounting errors and restated all financial reports from Q1 2003 to Q2 2008 to reflect an additional $8.2 million of claimed accumulated losses in prior reporting periods. It was the second time in two years that Overstock.com restated its financial reports due a violation of GAAP. PWC had erroneously given clean audit opinions on the company's financial reports before each restatement correcting GAAP violations for such reports.

Those customer refund and credit errors also caused Overstock.com to underbill earned income due from its fulfillment partners for offsetting costs and reimbursements. Overstock.com restated its prior financial reports to correct its customer refund and credit errors. However, the company failed to make offsetting corrections and properly accrue underbilled income earned from its fulfillment partners in those same affected prior reporting periods, as required by GAAP.

Instead, Overstock.com improperly recognized income from its underbilled fulfillment partners using a non-GAAP cash basis as amounts were collected future accounting periods: Q4 2008 $1.8 million, Q1 2009 estimated at $1.4 million, and Q2 2009 $87k. For additional details see SFAS No. 154 and SFAS No. 5 paragraph 1, 2, 8, 22, and 23.

In effect, Overstock.com improperly created a "cookie jar reserve" to inflate earnings in future reporting periods. For example, the company should have reported a Q4 2008 loss, but instead reported a profit for that quarter by violating GAAP. That improperly reported net profit enabled Overstock.com to report its first quarterly profit after a string of 15 consecutive quarterly losses and beat mean analysts’ consensus expectations for earnings per share (See: SEC Staff Accounting Bulletin No. 99 about Materiality).

Overstock.com's phony "gain contingency" excuse

After my early blog posts (here and here) detailing Overstock.com's above GAAP violation, the company later claimed that when it initially discovered the accounting error, it immediately determined that a “gain contingency” existed on underbilled amounts due from fulfillment partners because "recovery of such amounts was not assured." See below:

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.]

However, in my report to the SEC, I showed that no gain contingency existed because:

(1) The company already earned amounts due from underbilling its fulfillment partners in prior reporting periods,
(2) Its fulfillment partners were already contractually liable to pay all underbilled amounts from prior reporting periods, and
(3) The collection of large sums of such underbilled amounts due from its fulfillment partners was reasonably assured.

Both Overstock.com and PWC had to know that the collection of significant amounts due from underbilling of its fulfillment partners was assured, contrary to its disclosure that "the recovery of such amounts was not assured, and that consequently the potential recoveries constituted a gain contingency."

Overstock.com floats the cash that it receives from customers and is later required to pay fulfillment partners in up to 30 days. The company has the right to offset various errors against future remittances to its fulfillment partners. The company can withhold a larger portion of the monthly remittances from such fulfillment partners (up to a few months, if necessary) to recover underbilling errors.

Overstock.com did not have to reach an agreement with its fulfillment partners on underbilled amounts as it claimed, since its supplier agreement already allowed for such offsets (Source: Overstock.com correspondence to SEC Division of Corporation Finance). In addition, the greatest amount of the underbillings would certainly be attributable to its higher volume fulfillment partners who sold the most merchandise and are likely to be long time and current company suppliers.

Therefore, Overstock.com's ability to recoup a substantial share of previous underbillings to fulfillment partners could have been reasonably estimated, as required by Statement of Financial Accounting Principles No. 5. In many ways, Overstock.com's recovery of underbilled amounts due from its fulfillment partners was far more certain than recouping money in ordinary credit card disputes from its average customers.

In the eighteen months prior to disclosing its accounting error, the gross potential amount the company underbilled its fulfillment partners was about $4.7 million (See my calculations here). Over $3 million of such amounts due from underbilling its fulfillment partners was actually recovered within weeks and months after the company initially discovered the underbilling errors.

Overstock.com and PWC should have also considered subsequent corrected billings to and collections from fulfillment partners after the cutoff date of each financial report and before it filed its respective Q3 2008 10-Q and full year 2008 10-K reports with the SEC.

In other words, if new information, known as "subsequent events" is received after the cut-off date of a financial report but before the filing of such report which affects either assets or income in that financial report, a company must adjust its financial report to reflect that new information. (See: SAS No. 1 Paragraph 1, 2, 3, and 7 and Letter from SEC Chief Accountant entitled "Audit Risk").

Therefore, no gain contingency existed since underbilled amounts due from fulfillment partners was already earned, the fulfillment partners were already contractually required to pay such underbilled amounts, and a substantial amount due to the company from underbilling fulfillment partners was reasonably assured, contrary to company disclosures.

In any case, Securities and Exchange Commission’s interpretation of accounting rules is that “GAAP do not allow for the deferral of accounting adjustments arising from a change in estimate or the correction of error.” (Source: Cease and Desist order issued “In the matter of Carl M. Apel”). Overstock.com cannot defer income from underbilling its fulfillment partners to future accounting periods.

New Evidence of a botched audit by PWC and Overstock.com's failure to take into account subsequent events

In its Q3 2008 10-Q report, fiscal year 2008 10-K/A report, and Q1 2009 10-Q report, Overstock.com made no subsequent events disclosure. However, in Q2 2009 10-Q report, the company finally made such a disclosure (Footnote 15, page 22):

Management evaluated activity of Overstock.com through July 31, 2009 (the issue date of the Unaudited Consolidated Financial Statements) and concluded that no subsequent events have occurred that would require recognition in the Unaudited Consolidated Financial Statements or disclosure in the Notes to the Unaudited Consolidated Financial Statements. [Emphasis added.]

Why was the subsequent events disclosure omitted from prior financial reports? As I detailed above, Overstock.com failed to consider subsequent corrected billings to and collections from its fulfillment partners. Overstock.com's 2008 10-K/A financial report was audited by PricewaterhouseCoopers and the 2009 10-K financial report will be audited by Grant Thornton.

Note: A reader has alerted me that Overstock.com’s subsequent events disclosure in Q2 2009 is new required disclosure under SFAS 165. In any case, Overstock.com was required to take into account those subsequent events (corrected billings to and collections from its fulfillment partners) and the company was required to make subsequent events adjustments and disclosures under existing accounting guidance and SEC rules at the time financial reports were issued for Q3 2008, Q4 2008, and Q1 2009. In addition, as I detailed above, no gain contingency existed for underbilled amounts due from fulfillment partners as claimed by the company. Therefore, PWC still botched the 2008 audit.

Grant Thornton

Grant Thornton, will face a dilemma. Overstock.com’s GAAP violations in 2008 caused material errors in 2009 financial reports that Grant Thornton must audit. Will Grant Thornton will go out on a limb and risk issuing a clean audit opinion without Overstock.com restating financial reports to correct its GAAP violations?

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

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

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

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

...the CEO (principal executive officer) and Senior Vice President, Finance (principal financial officer) each concluded that the control deficiency previously described constituted a material weakness in the Company’s system of internal control over financial reporting as of September 30, 2008.

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

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

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

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

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

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

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

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

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

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

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

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

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

Yours ever,

Patrick

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

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

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

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

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

To be continued....

Written by,

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

Disclosure: Not short or long Overstock.com.

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.

The SEC stands by while Overstock.com continues to violate Regulation G and overstates EBITDA in latest report

Before we begin let's review some of Overstock.com's history of false and misleading disclosures

Overstock.com (NASDAQ: OSTK) CEO Patrick Byrne likes to call himself a “humble servant” to his company's shareholders and a “market reform advocate” to the investing public, while he and his company have a documented long history of false and misleading disclosures and utterly despicable behavior such as stalking and smearing critics with its in-house black ops team. As previously detailed in this blog, from December 2000 to March 2002, Patrick Byrne had lied about Overstock.com being profitable when the company was never profitable at that time.

Overstock.com’s unprincipled management team intentionally violated GAAP in reporting revenues from at least fiscal year 2000 until the SEC Division of Corporation Finance recently forced the company to report revenues in compliance with GAAP. To make matters worse, the company misled the SEC Division of Corporation Finance about the materiality of its revenue accounting errors and therefore violated Statement of Accounting Standards No. 154 by not restating prior period financial statements to correct its revenue accounting errors. In fact, Overstock.com has had only two profitable quarters (Q4 2002 and Q4 2004) in its entire history. At least one of those quarters earnings were materially overstated as a result of Overstock.com's intentional revenue accounting errors that were uncovered by the SEC. To make matters even far worse, as detailed many times in this blog dating back to November 2007, when it comes to non-GAAP disclosures, Overstock.com has continually violated SEC Regulation G and overstated EBITDA in its financial reports filed with the SEC from Q2 2007 forward.

Apparently, Patrick Byrne and his management team feel that they can make their own accounting and SEC disclosure rules on the fly - GAAP and SEC disclosure requirements be damned. In the mean time, the SEC sits by idly while Overstock.com distorts its financial performance to investors.
Overstock.com’s continued material violations of SEC Regulation G governing non-GAAP disclosures such as EBITDA causes it to turn a negative EBITDA to a positive EBITDA
It is incomprehensible that the SEC has so far failed to take any action against Overstock.com for violations of Regulation G, despite being continually informed by this blogger, its recently terminated investigation of the company, and also taking actions against other similarly non-compliant companies to force them to correct such violations.

In Overstock.com’s latest Q2 2008 earnings report, the company improperly reported EBITDA of $1.117 million in violation of SEC Regulation G. Overstock.com’s reported non-compliant EBITDA was overstated by $1.545 million as a result of the company improperly removing from its EBITDA calculations the effects of certain stock-based compensation expenses and improperly reconciling EBITDA to operating loss rather than net loss, in violation of SEC Regulation G. Therefore, had Overstock.com properly reported EBITDA in compliance with SEC Regulation G, the company would have reported a negative EBITDA of $428,000 instead of its non-compliant positive EBITDA of $1.117 million.

The sheer size of Overstock.com’s overstatement of EBITDA is clearly a material accounting error as defined by SEC Staff Accounting Bulletin No. 99. Overstock.com’s overstatement of EBITDA in violation of SEC Regulation G flips a properly calculated negative EBITDA of $428,000 into an improperly reported positive EBITDA of $1.117 million. According the SAB No. 99, one of the main considerations in determining if an accounting error is material is, “whether the misstatement changes a loss into income or vice versa.” Here with Overstock.com, we have a clearly material violation of SEC Regulation G in the company's Form 8-K filed with the Securities and Exchange Commission. See the charts below (Click on image to enlarge):

SEC Regulation G defines EBITDA specifically as "earnings before interest, taxes, depreciation, and amortization" but Overstock.com makes up its own EBITDA and violates SEC rules

During the Q2 2008 earnings call, the following exchange took place between CEO Patrick Byrne and CFO David K. Chidester:

Patrick Byrne: Great. Slide number 10. EBITDA and this excludes stock based compensation. Do you want to mention that Dave? Do you want to – ?

David Chidester: Just – there is different ways people calculate EBITDA I think. We just want to make sure it’s clear that our calculation of EBITDA does [ph] include stock based compensation.

Patrick Byrne: Is that the convention?

David Chidester: (inaudible) It’s completely the convention in our industry and I think because it’s a new – it only came about a couple of years ago, everybody pretty much excludes it when they talk about EBITDA and talk about cash earnings.

What David Chidester said is that he thinks Overstock.com can compute EBITDA by eliminating stock-based compensation expenses from its computation and as a result of such a false claim by him, the company reported a materially overstated EBITDA in violation of SEC Regulation G. He further claims that removing stock-based compensation from EBITDA is "completely the convention in our industry." David Chidester's claims about Overstock.com's EBITDA disclosures are flat out false and as the CFO of a public company, he cannot claim ignorance to SEC Regulation G. That "everyone else is doing it" excuse was previously used by both David Chidester and Patrick Byrne as justification for the company's intentional revenue accounting errors uncovered by the SEC. However, SEC Staff Accounting Bulletin No. 99 specifically states that "Authoritative literature takes precedence over industry practice...."

In this case, Overstock.com improperly removed stock-based compensation expenses to flip a properly calculated negative EBITDA in compliance with Regulation G into an improperly reported positive EBITDA. In fact, for public companies the SEC provides specific rules for calculating EBITDA under SEC Regulation G. Overstock.com clearly cannot exclude stock-based compensation expenses from EBITDA.

According to the SEC Division of Corporation Finance Regulation G guidance provided by 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) 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.” Net income, not operating income as used by Overstock.com, is the starting point towards computing EBITDA and stock-based compensation expenses cannot be excluded from EBITDA according to SEC Regulation G.

David Chidester’s above comments about Overstock.com's EBITDA disclosures are flat out false! On May 13, David K. Chidester, Senior Vice President – Finance sold 2,766 shares at an average price of about $27.83 per share of and pocketed gross proceeds totaling about $77,000. After Overstock.com’s Q1 2008 earnings call, the company’s stock price plunged 41.12% or $11.31 to close at just $16.31 per share. As David Chidester cashes out, Overstock.com shareholders are bearing the losses.

The SEC has taken action against other non-compliant companies violating Regulation G but has utterly failed to take action against Overstock.com for similar violations

In a previous blog post, I detailed how CGG Veritas, like Overstock.com, improperly removed stock-based compensation expense from its reported EBITDA in violation of SEC Regulation G. The SEC Division of Corporation Finance informed CGG Veritas that:

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.]

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. CGG Veritas responded to the SEC that, "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' ….”

As detailed above, Overstock.com, just like CGG Veritas, improperly removed the effects of stock-based compensation expenses from its non-compliant EBITDA disclosures in violation of Regulation G. Yet the SEC has continued to fail to take action against Overstock.com to correct such non-compliant EBITDA disclosures despite being directly informed by this blogger.

In that same blog post, I detailed how CKX Inc, like Overstock.com, improperly reconciled its non-compliant EBITDA to operating income or loss rather than net income. The SEC notified CKX Inc.:

Reference is made to your presentation of the non-GAAP financial measure, EBITDA, in the table of your historical and pro forma financial information for the year ended December 31, 2004. 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 Inc. that its non-compliant EBITDA must be computed by revising their "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." Any other calculation cannot be called EBITDA. However, Overstock.com, just like CKX Inc., improperly reconciled its non-compliant EBITDA to operating income or loss rather than net income or loss and the SEC has utterly failed to take action against Overstock.com to correct its non-compliant EBITDA disclosures despite being notified by this blogger.
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 or loss before depreciation and amortization and the company was able to remove losses from discontinued operations from its non-GAAP financial measure.

What is the appropriate term for Overstock.com’s non-compliant EBITDA financial measure?

Overstock.com, like CKX, improperly used operating income or loss as the starting point to compute its non-compliant EBITDA calculation. In addition, Overstock.com, like CGG Veritas, improperly removed stock-based compensation expenses from its non-compliant EBITDA calculation. Perhaps Overstock.com's non-compliant EBITDA should be renamed OIBDAS or operating income or loss before depreciation, amortization, and stock-based compensation expense. Note: Overstock.com does not have income tax expenses due to its losses. However, this blogger has directly notified Overstock.com Audit Committee member Joseph J. Tabacco Jr. of the company's non-compliant EBITDA disclosures and the company has failed, just like the SEC, to address its EBITDA reporting errors.

What’s going on at the SEC?

I am beginning to believe that our present SEC is not of the same caliber that I feared as the criminal CFO of Crazy Eddie in the 1980s. They are overwhelmed and under-resourced. Instead, they using their highly taxed resources to chase delusional conspiracy theories such as those blaming short sellers on problems related to the subprime crises effecting Fannie Mae and Freddie Mac. I suggest that you read Joe Nocera's blog post entitled, "First, Let's Kill All Short-Sellers." Perhaps that explains why companies like Overstock.com can thumb their noses at SEC rules while the SEC drops investigations of such companies.

As detailed above, Overstock.com's stock price on Friday 41.12% or $11.31 to close at just $16.31 per share after the company's misleading earnings release. Eric Savitz, in the Barron's Tech Trader Daily blog noted:

Stifel Nicolaus analyst Scott Devitt this morning cut his rating on Overstock.com (OSTK) to Sell from Hold. He notes that the company, which reported Q2 financial results this morning, trades for 21×2009 EBITA, “the highest multiple in the sector.”
Devitt says the company has had two consecutive quarters of mid-20% growth, but that it has had “fairly easy comps,” and that growth could drop into the low-to-mid teens by 2009. [Emphasis added.] 

However, Gary Weiss noted in his blog that:

Sam [Antar] has specifically warned that Overstock was distorting the "growth" numbers reported to the public. He set forth his case in exhaustive detail. But analysts and the clowns at the SEC -- who just gave Overstock's accounting a clean bill of health -- paid no attention. [Emphasis added.]

Acclaimed forensic accountant, author, and blogger Tracy Coenen asked:

I keep wondering why Pricewaterhouse Coopers doesn’t catch this material error in calculating a figure that is heavily touted in reports to investors. Rumor has it that they review the quarterly reports, but this makes me wonder. [Emphasis added.]

The tragedy of American capitalism is that most investors rely on incompetent or at the very least lazy and spineless Wall Street analysts for research and inadequately trained but similarly spineless auditors to make sure financial reports are free of material errors. This tragedy is further compounded by an overwhelmed and under-resourced SEC chasing delusional conspiracy theories touted by company managements who are unwilling to take responsibility for their misdeeds.

To be continued….

Written by:

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

Disclosure: Not long or short Overstock.com, CGG Veritas, and CKX. Inc.

Overstock.com Continues to Violate SEC Regulation G and Materially Overstate EBITDA in Q1 2008

If the Securities and Exchange Commission Division of Corporation Finance had examined Overstock.com’s (NASDAQ: OSTK) non-GAAP financial disclosures such as EBITDA, they would have found violations of SEC Regulation G governing non-GAAP financial measures that caused EBITDA to be materially overstated in the company’s second, third, and fourth quarter fiscal year 2007 financial reports. Instead, they focused only on Overstock.com’s revenue accounting practices up to fiscal year 2007 and discovered that the company had intentionally violated GAAP in reporting revenue as far back as fiscal 2000. In Overstock.com’s Q1 2008 earnings release and 10-Q report the company continued to improperly remove from its EBITDA calculation, certain stock-based expenses in violation of Regulation G. As a result, Overstock.com’s reported Q1 2008 EBITDA of $3.524 million was materially overstated by $1.339 million or about 61%.

In previous blog posts (here, here, and here), I detailed Overstock.com’s SEC Regulation G violations and resulting overstatements of EBITDA in its second, third, and fourth quarter fiscal year 2007 financial reports. In this blog post, I will analyze the SEC Division of Corporation Finance’s review of noncompliant EBITDA calculations for two another companies: CGG Veritas (NYSE: CGV) and CKX Inc. (NASDAQ: CKXE). Afterwards, I will compare their similar noncompliant EBITDA disclosures to Overstock.com’s noncompliant EBITDA disclosures.

Before we begin, please note that Audit Committee member Joseph J. Tabacco Jr. was notified via email, Cc’d to the SEC, several times last year about Overstock.com’s SEC Regulation G violations and he acknowledged reading such emails by returning read receipts to me. Therefore, Overstock.com cannot claim ignorance as an excuse for violating SEC Regulation G and materially overstating EBITDA. In addition, in Overstock.com's response to certain inquiries from the SEC Division of Corporation Finance noted the importance of EBITDA in helping investors evaluate the company’s financial performance by disclosing, “A multiple of EBITDA is currently the most standard measure of valuation in the industry.”

Why did Overstock.com continue to violate SEC Regulation G and as a result overstate EBITDA in Q1 2008? As detailed in previous blog items (here, here, here, and here), on Friday, April 18, 2008, Overstock.com issued a blatantly misleading surprise earnings release intentionally timed with the expiration of options to manipulate the market (i.e., as a "short squeeze"). Apparently, Overstock.com’s callous disregard of SEC Regulation G and resulting overstatement of EBITDA is yet another act by the company in furtherance of CEO Patrick Byrne’s manipulative and vindictive self-described campaign to “knee the shorts in the groin….for fun and amusement.”

Patrick Byrne once said, "...I think 'EBITDA' is the stupidest thing I ever heard emanate from Wall Street (no small feat)...." Now, in contrast to Patrick Byrne's previous comments about EBITDA, Overstock.com misuses EBITDA in violation of SEC Regulation G to materially overstate the company's financial performance. Patrick Byrne's so-called "gold standard" in communicating "with candor" Overstock.com's financial performance to investors is nothing more than a ruse or a wall of false integrity built to fool gullible investors and Wall Street analysts into trusting the representations of the company's unprincipled management team.

Worst yet, two key company officers have dumped stock as the price Overstock.com’s shares have continued to rise after its materially misleading Q1 2008 earnings release. On April 23 and 24, 2008 Jonathan E. Johnson, Senior Vice President – Corporate Affairs and Legal unloaded 55,922 shares of Overstock.com common shares and pocketed gross proceeds totaling about $957,000 after lying to Wired.com magazine about the comparability of the company’s revenues in its Q1 2008 earnings report. In that recent earnings release, Overstock.com compared Q1 2008 GAAP revenues to Q1 2007 non-GAAP revenues without making an appropriate disclosure. Johnson claimed to Wired.com that Q1 2007 revenues were reported in compliance with GAAP when in fact they were not restated to conform to GAAP. On May 13, David K. Chidester, Senior Vice President – Finance sold 2,766 shares and pocketed gross proceeds totaling about $77,000.

The SEC Division of Corporation Finance has required CGG Veritas to properly report EBITDA in compliance with SEC Regulation G

Let’s examine the SEC Division of Corporation Finance’s review of EBITDA disclosures by CGG Veritas, and afterwards compare that company’s noncompliant EBITDA disclosures with Overstock.com’s noncompliant EBITDA disclosures. CGG Veritas, like Overstock.com, had improperly removed certain stock-based compensation expenses from EBITDA causing its EBITDA computation to be overstated. The SEC notified CGG Veritas that its EBITDA calculation in the company's fiscal year 2006 annual report was not in compliance with SEC Regulation G guidance:

Form 20-F for the year ended December 31, 2006 Operating and Financial Review and Prospects, page 37 EBITDA, page 55

1. With regard to your disclosure of a non-GAAP measure labeled EBITDA:

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.

Your disclosure states that you provide this non-GAAP measure because investors use it to determine your operating cash flow and historical ability to meet debt service and capital expenditure requirements. As a measure of liquidity, therefore, your measure should be compared to the most directly comparable liquidity measure, which we believe would be net cash provided by operating activities as presented on your consolidated statements of cash flows.

Please comply in future filings. Refer to the requirements of Regulation S-K, Item 10(c). [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.]

Therefore, the SEC instructed CGG Veritas that EBITDA can only mean earnings (meaning net income or loss) before interest, taxes, depreciation, and amortization. No other items can be removed from earnings to compute EBITDA. If a company such as CGG Veritas and Overstock.com wants to remove stock-based compensation expense from its EBITDA calculation, such a non-GAAP measure cannot be called EBITDA.

The SEC Division of Corporation Finance was referring to Regulation G guidance provided by their "Frequently Asked Questions Regarding the Use of Non-GAAP Financial Measures" when they informed CGG Veritas that "EBITDA refers specifically to earning before interest, tax, depreciation and amortization." According to the SEC's Regulation G guidance:

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) 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 should not be characterized as EBITDA.” That is, both CGG Veritas and Overstock should compute EBITDA starting from net income or loss and adding back only interest, taxes, depreciation, and amortization (there were no taxes for Overstock.com to add back).

However, in a direct violation of this requirement, CGG Veritas improperly used operating income rather than net income as the starting point in calculating its noncompliant EBITDA and furthermore improperly removed stock-based compensation from its noncompliant EBITDA calculation. Similarly, Overstock.com improperly used operating loss rather than net loss as the starting point in calculating its noncompliant EBITDA and furthermore improperly removed stock-based compensation from its noncompliant EBITDA calculation.

In the case of CGG Veritas, the company responded to the SEC by calculating EBITDA starting from net income rather than operating income and renaming their non-GAAP financial measure as EBITDAS or “earnings before interest, taxes, depreciation, amortization and share-based compensation cost.” In addition, since CGG Veritas considered its EBITDAS disclosure as a “measure of liquidity,” the company was required to reconcile it to net cash provided by operating activities as presented on the Company’s consolidated statements of cash flows.

Overstock.com continues to violate SEC Regulation G and overstate EBITDA

Meanwhile, Overstock.com continues to make two crucial errors in its EBITDA computations despite my email notifications to Audit Committee member Joseph J. Tabacco Jr. First, Overstock.com improperly reconciled EBITDA to operating loss rather than net loss, causing its EBITDA computation to be overstated by the amount of losses from discontinued operations. Second, Overstock.com improperly removed stock-based compensation expense from EBITDA causing its EBITDA computation to be overstated by the amount of stock-based compensation expense. See Overstock.com’s Q1 2007 and Q1 2008 EBITDA computations below from the company’s recent earnings release and 10-Q (Click on image to enlarge):

In Q1 2007, Overstock.com reported a $3.624 million loss from discontinued operations. However, since Overstock.com improperly reconciled EBITDA to operating loss rather than net loss, the company’s Q1 2007 EBITDA computation was materially overstated by at least the amount of its loss from discontinued operations or $3.624 million. In addition, Overstock.com improperly removed stock-based compensation expenses from EBITDA totaling $1.68 million in Q1 2007 and $1.339 million on Q1 2008 causing further material overstatements of EBITDA, too. Therefore, Overstock.com’s EBITDA was materially overstated in Q1 2007 by $5.304 million or 64.14% and in Q1 2008 by $1.339 million or 61.28%. See the charts below Click on images to enlarge):

Let’s examine the SEC Division of Corporation Finance’s actions regarding CKX Inc. and how that company complied with Regulation G in response to the SEC’s inquiry

Let’s examine the SEC Department of Corporation Finance’s review of CKX Inc.'s EBITDA calculations. 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. However, unlike Overstock.com, CKX Inc. did not improperly remove stock-based compensation expense from its noncompliant EBITDA calculations. The SEC notified CKX Inc.:

Reference is made to your presentation of the non-GAAP financial measure, EBITDA, in the table of your historical and pro forma financial information for the year ended December 31, 2004. 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.]

Once again, the SEC reiterates how EBITDA must be computed by telling CKX to revise their "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." Any other calculation cannot be called EBITDA.

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 noncompliant EBITDA disclosure as OIBDA or operating income before depreciation and amortization and the company was able to remove losses from discontinued operations from its non-GAAP financial measure.

What is the appropriate term for Overstock.com’s noncompliant EBITDA financial measure? Overstock.com, like CKX, improperly used operating loss as the starting point to compute its noncompliant EBITDA calculation. In addition, Overstock.com, like CGG Veritas improperly removed stock-based compensation expenses from its noncompliant EBITDA calculation. Perhaps Overstock.com's noncompliant EBITDA can be renamed OIBDAS or operating income or loss before depreciation, amortization, and stock-based compensation expense.

Reconciliation requirement

In addition to violating Regulation G’s definition of EBITDA, Overstock.com also violated the SEC’s reconciliation requirement with respect to EBITDA. As detailed above, the SEC required CGG Veritas to reconcile EBITDA to net cash provided by operating activities, since CGG Veritas considered its EBITDA measure as a liquidity measure. Apparently, Overstock.com, like CGG Veritas, considered its noncompliant EBITDA as a liquidity measure and the company should have reconciled EBITDA to net cash provided by operating activities, too. Specifically, Overstock.com disclosed in its Q1 2008 10-Q:

…we believe that EBITDA is an additional measure of actual cash used or cash generated by the operations of the business. [Emphasis added.]

According to Regulation G, a company must reconcile its non-GAAP financial measure with the "most directly comparable financial measure or measures calculated and presented in accordance with GAAP." The SEC provides certain guidance depending on whether or not the non-GAAP EBITDA financial measure is intended to be considered a performance measure or a liquidity measure. If the non-GAAP EBITDA financial measure is a performance measure, the registrant should make the following reconciliation:

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

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

Therefore, if EBITDA is used as a performance measure, it should be reconciled to net income or loss as presented in the statement of operations under GAAP. Alternatively, if the non-GAAP measure is intended to be a liquidity measure, the SEC provides the following guidance:

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

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

Therefore, according to SEC guidance, "The three major categories of the statement of cash flows should be presented when a non-GAAP liquidity measure is presented." Overstock.com did not reconcile its noncompliant EBITDA to any of the allowable GAAP numbers. Instead, Overstock.com reconciled its noncompliant EBITDA liquidity measure to “Operating Loss.”

To be continued....

Written by,

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

Disclosure: Not long or short Overstock.com, CGG Veritas, or CKX Inc.