Open Letter to the Securities and Exchange Commission: Investigate Troubling Issues at Amedisys Missed by Wall Street Journal

To Securities and Exchange Commission Chairperson Mary Schapiro:

On June 30, 2010, Amedisys (NASDAQ: AMED) announced that it "received notice of a formal investigation from the Securities and Exchange Commission (SEC) pertaining to the company, and received a subpoena for documents relating to the matters under review by the Senate Finance Committee." The SEC investigation follows an April 2010 Wall Street Journal report questioning Amedisys’s Medicare reimbursement patterns and raising serious questions about possible abuse by the company of Medicare’s reimbursement system. In mid-June 2010, several class action lawsuits were filed against Amedisys alleging securities fraud, based on the Wall Street Journal report.

In my analysis below, I will provide additional troubling data and issues missed in the Wall Street Journal report and not cited in the various class action lawsuits for the SEC to consider in its investigation.

Background

The analysis is based entirely on information derived from Amedisys's public disclosures in various reports filed with the SEC. Those reports provide certain statistical information about Medicare episodic, non-Medicare episodic, and non-Medicare/non-episodic home health care visits, admissions, and recertifications for each reporting period.

Amedisys further categorizes that data by base/start-up entities and acquired entities for each reporting report. Amedisys defines Base/Start-up agencies as agencies that were originally opened by the company and acquired entities owned by the company for at least a year.

Therefore, the analysis below is based almost entirelry on Amedisys’s statistical data for base/start-up agencies to provide a consistent apple-to apples comparison of the data.

Note: Download entire work sheet here (formatted for legal sized paper).

What explains the sudden increase in the growth of in base/startup Medicare episodic visits per admission?

Prior to Q2 2007, Amedisys reported fairly typical (i.e., moderate) growth in visits per Medicare episode. For example, during 2006, the number of visits per Medicare admission for base/start-up agencies increased to 29.4 visits per admission from 28 visits per admission in 2005, or a 2.2% increase over the previous comparable period. See the chart below:

Similarly, in Q1 2007, base/start-up Medicare episodic visits per admission declined to 29.1 visits per admission compared to 29.4 visits per admission in Q1 2006 or a 1.2 decrease from the previous year comparable period. See the chart below:

Starting in Q2 2007, however, the amount of base/start-up Medicare episodic visits grew much faster than admissions. By Q3 2009, base/start-up agencies reported an increase to 36.5 visits per admission, an all time-high for the company. See the chart below:

Why did the number of visits per Medicare admission at base/start-up agencies suddenly begin increasing at such dramatic rates starting in Q2 2007?

Why did recertifications skyrocket in 2007?

Looking more closely at data provided in company filings, it appears that the increase in visits per admission was driven mostly by an increase in recertifications and recertifications per admission. Recertifications occur when a provider receives permission from Medicare, based on a doctor’s request, to provide another “episode” of care.

Note: Comparable was data not available for base/start-up Medicare episodes. Therefore, the chart above includes combined amounts for base/start-up and acquired entity Medicare episodes.

According to Amedisys, the number of Medicare recertifications grew 51.07% from the first half of 2007 to the first half of 2008. Yet admissions increased just 42.72% in that same period. What could cause such a discrepancy?

Why visits per Medicare admission suddenly begin declining in Q4 2009?

In Q4 2009, base/start-up Medicare episodic visits per admission suddenly began to decline, falling to 35.2 visits per admission compared to 36.5 visits per admission in Q3 2009, It was the first Q4 v Q3 sequential decline in base/start-up Medicare episodic visits per admission since 2006. See the chart below:

And in Q1 2010, base/startup Medicare episodic visits per admission declined to 33.7 visits per admission compared 35.2 visits per admission in the preceding Q4 2009 period and 34.4 visits per admission during the comparable Q1 2009 period. Thus, Amedisys reported its first decline in comparable prior year base/start-up Medicare episodic visits per admission since Q1 2007. See the chart below:

What explains this sudden trend reversal and does it have anything to do with the onset of scrutiny by journalists (such as the Wall Street Journal) or analysts (such as Citron Research)?

Amount of base/start-up Medicare episodic visits per admission is much higher than non-Medicare episodic visits per admission, despite similar reimbursement rates and procedures

In reviewing Amedisys’s filings, I was also struck by the gap between visits per Medicare admission and visits per admission for other payors. Visits per admission are greatest for base/start-up Medicare episodic, second greatest for non-Medicare episodic, and smallest for non-Medicare non-episodic.

For example, during 2009, I calculated that there were 35.3 Medicare episodic visits per admission compared to 29.6 non-Medicare episodic visits per admission and 22.7 non-Medicare non-episodic visits per admission.

In 2009, Medicare episodic visits per admission were 19.2% higher than non-Medicare episodic visits per admission and in 2008 Medicare episodic visits per admission were 24.5% higher than non-Medicare episodic visits per admission. See the chart below:
 

 
One might argue that differences in reimbursement procedures explains the above gap. Yet, according to Amedisys, non-Medicare episodic visits are reimbursed in a “similar manner” to Medicare episodic visits. See disclosure from the company’s 2009 10-K report below:

Payments from Medicaid and private insurance carriers are based on episodic-based rates or per visit rates (non-episodic based) depending upon the terms and conditions established with such payors. Episodic-based rates paid by our non-Medicare payors are paid in a similar manner and subject to the same adjustments as discussed …for Medicare; however, these rates can vary based upon negotiated terms.

If both base/start-up Medicare episodic and non-Medicare episodic visits are reimbursed “in a similar manner” why do Medicare episodic visits per admission far exceed non-Medicare episodic visits per admission?

Ratio of base/start-up Medicare episodic recertifications to admissions is much higher than non-Medicare episodic recertifications to admissions despite similar reimbursement rates

Likewise, the ratio of recertifications to admissions is greatest for base/start-up Medicare episodic treatment, second greatest for non-Medicare episodic treatment, and smallest for non-Medicare non-episodic treatment. See the chart below:

I also find it interesting that, during 2008, the ratio of recertifications to admissions for Medicare cases handled by base/start-up agencies was over 100%. See the chart below:

Then, during 2009, the ratio of recertifications to admissions fell dramatically, particularly after Q1. For the full year (2009) it was 93.7% versus 100.3% the year prior (2008). See the chart below:

What explains the substantial decline in recertifications to admissions, particularly after Q3 2009? And did it have anything to do with increased scrutiny of the company’s published financial disclosures?

Sudden resignation of two high level executives coincides with the recent declines in visits and recertifications per Medicare admission. Is it purely coincidental?

On September 3, 2009, Amedisys President and COO Larry Graham and Alice Ann Schwartz, its chief information officer, suddenly resigned from the company. Amedisys provided no reason for their resignations and simply said that the two execs “are leaving the company to pursue other interests.”

In my experience, sudden, unexpected executive departures are often a sign of problems beneath the surface. And while it could be entirely coincidental, the trends at Amedisys appear to be consistent with my experience.

After the sudden resignation of Graham and Schwartz, the ratio of Medicare episodic recertifications to admissions dramatically dropped from 96.3% in Q3 2009 to 89.3% in Q4 2009 and to just 81.7% in Q1 2010. The number of visits per Medicare admission also began to decline, as I described earlier.

In the months before Graham's sudden departure from Amedisys, he unloaded over $2.6 million of stock. Was it shrewd timing in anticipation of a run to the exits before the fire bell sounded? In my world, I don't believe in coincidences.

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 in cold-blood for fun and profit, and 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.

There is a saying, "It takes one to know one." Today, I work very closely with the FBI, IRS, SEC, Justice Department, and other federal and state law enforcement agencies in training them to identify and catch white-collar criminals.

Recently, I exposed financial reporting violations by Overstock.com (NASDAQ: OSTK) as an independent whistleblower. The Securities and Exchange Commission is now investigating Overstock.com and its CEO Patrick Byrne for securities law violations (Details here, here, and here).

In addition, the SEC is now investigating possible GAAP violations by Bidz.com (NASDAQ: BIDZ) after I alerted them about the company's inventory accounting practices.

I do not own Overstock.com, Bidz.com, or Amedisys securities long or short. My investigation of  those companies is a freebie to securities regulators to get me into heaven, though I doubt that I will ever get there. In any case, no good deed ever goes unpunished by the SEC. That's life.

I do not seek or want forgiveness for my vicious crimes from my victims. I plan on frying in hell with other white-collar criminals for a very long time.

Open Letter to the Securities and Exchange Commission Part 9: Overstock.com's Excuses Simply Don't Add Up

To SEC Chairperson Mary Schapiro:

In August 2009, I wrote my first Open Letter to the Securities and Exchange Commission detailing how Overstock.com deliberately violated Generally Accepted Accounting Principles (GAAP) in recognizing income for recoveries from underbilled fulfillment partners by improperly claiming that a “gain contingency” existed under accounting rules. The SEC Division of Corporation Finance agreed with my reports and Overstock.com was eventually forced to restate its 2008 and 2009 financial reports to correct those GAAP violations.

CEO Patrick Byrne after drinking it up

The Division of Corporation Finance reviewers did a superb job in carefully examining Overstock.com's financial disclosures. The SEC reviewers rejected each and every excuse put forth by Overstock.com in its desperate effort to avoid restating its financial reports for the third time in three years.

However, the SEC may not be aware that Overstock.com apparently lied about a certain key issue involving the timing of its decision to disclose that a purported "gain contingency" existed for potential recoveries from underbilled fulfillment partners. In addition, Overstock.com's other responses to SEC reviewers provide further evidence of deliberate attempt by the company to violate GAAP and establish an illegal "cookie jar" reserve to materially inflate future earnings (Q4 2008 to Q3 2009).

Since the Enforcement Division is investigating Overstock.com, they should take note of my analysis below.

Brief Background

On October 24, 2008, Overstock.com reported that it discovered customer refund and credit errors. On November 7, 2008, Overstock.com filed its Q3 2008 10-Q report and restated all prior affected financial reports from 2003 to Q2 2008 to correct such errors. Those customer refund and credit errors resulted in an additional $8.2 million of accumulated losses in prior reporting periods.

However, the customer refund and credit errors also caused Overstock.com to underbill its fulfillment partners for offsetting costs and reimbursements. While Overstock.com restated prior financial reports to correct its customer refund and credit errors, the company did not make offsetting corrections resulting from underbilling its fulfillment partners for certain reimbursements as required by GAAP.

In other words, Overstock.com should have gone back and corrected or restated its financial reports to reflect income already earned from offsetting costs and reimbursements and owed to the company from its fulfillment partners, less a reasonable estimate for uncollectable amounts. Instead, Overstock.com improperly recognized income from such underbillings as amounts due to the company was recovered on a non-GAAP cash basis in future accounting periods: Q4 2008, Q1, 2009, and Q2 2009. (See SFAS No. 154 and SFAS No 5 paragraph 1, 2, 8 and 23).

Therefore, Overstock.com overstated its customer refund and credit accounting error since the company failed to accrue offsetting fees and charges due from its fulfillment partners as income in the appropriate accounting periods, less a reasonable reserve for unrecoverable amounts. By deferring recognition of income until underbilled amounts were recovered, the company effectively created a "cookie jar" reserve to increase future earnings.

For example, Overstock.com improperly reported a Q4 2008 net profit of $1.014 million instead of a properly reported Q4 2008 net loss of $705k as a result of its improper recognition of income from recoveries of underbilled amounts owed by its fulfillment partners.

Overstock.com claimed that a "gain contingency" existed

On February 24, 2009 Overstock.com filed its 2008 10-K report and for the first time the company claimed that a "gain contingency" existed for any potential recoveries from its fulfillment partners:

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.]

Therefore, Overstock.com claimed that it could recognize income as it recovered underbilled amounts from its fulfillment partners in future reporting periods, rather than restate its financial reports to reflect when such underbilled amounts were actually earned by the company during previous accounting periods.

On January 29, 2010, Overstock.com finally admitted that its claimed gain contingency was "inappropriate" under accounting rules, as I correctly reported in my blog:

Once discovered, the Company applied “gain contingency” accounting for the recovery of such amounts, which it has now determined was an inappropriate accounting treatment.

Overstock.com's conflicting explanation to the Division of Corporation Finance

Overstock.com did not disclose that a "gain contingency" existed for potential recoveries from underbilled fulfillment partners in its Q3 2008 10-Q report (when the company restated its financial reports to correct customer refund and credit errors). The company waited until it filed its subsequent 2008 10-K report to finally claim that a gain contingency existed.

On October 1, 2009, SEC Division of Corporation Finance reviewers wanted to know why Overstock.com did not report the purported gain contingency in its Q3 2008 10-Q report:

Also, tell us why your September 30, 2008 Form 10-Q did not disclose a gain contingency. Refer to paragraph 17.b of SFAS No. 5.

On October 20, 2009, Overstock.com responded as follows:

At the time we filed our September 30, 2008 [Q3 2008] Quarterly Report on Form 10-Q, we had just completed our analysis of the under billing problem and had not yet commenced substantive discussions with our partners with respect to our potential recoveries of the under billed amounts. We believe that it would have been inappropriate to disclose a gain contingency.  SFAS No. 5, paragraph 17(b) or ASC 450-30-50 states that, “adequate disclosure shall be made of contingencies that might result in gains, but care shall be exercised to avoid misleading implications as to the likelihood of realization.”  Given the situation described above and the uncertainties of the recoveries, we determined that it would have been inappropriate under SFAS No. 5 to disclose a gain contingency at this early stage of the process. [Emphasis added.]

Overstock.com had filed its Q3 2008 10-Q report on November 7, 2008. The company claimed to the SEC reviewers that as of that date "...it would have been inappropriate to disclose a gain contingency."

However, Overstock.com's annual 2008 10-K report made a conflicting claim that a reportable gain contingency had already existed as of November 7, 2008:

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. [Emphasis added.]

The underbilling was "originally discovered" months before Overstock.com filed its Q3 2008 10-Q report on November 7, 2008. The company's subsequently filed 2008 10-K report claimed that "When the underbilling was originally discovered, we determined that...the potential recoveries constituted a gain contingency."

Therefore, Overstock.com's 2008 10-K report claimed that a reportable "gain contingency" existed as of November 7, 2008. However, the company contradicted itself and claimed to the SEC reviewers that reportable reportable "gain contingency" did not exist on November 7, 2008.

If Overstock.com's 10-K disclosure is true, the company's explanation to the SEC Division of Corporation Finance can't be true. Likewise, if Overstock.com's explanation to the SEC Division of Corporation Finance is true, the company's 2008 10-K disclosure can't be true.

What I believe happened

I believe that when Overstock.com filed its Q3 2008 10-Q report in November 2008, the company had not yet thought of using a gain contingency as justification for its improper accounting of recoveries from underbilled fulfillment partners.

In my August 5, 2009 Open Letter to the Securities and Exchange Commission, I reported that Overstock.com "apparently played a game of catch up" and concocted the "gain contingency" excuse in its 2008 10-K report  to "rebut" previous "criticism in my blog" of Overstock.com's improper accounting for recoveries from fulfillment partners

SEC reviewers rejected Overstock.com's "gain contingency" claim

In its 2008 10-K report, 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.

Overstock.com told SEC reviewers that:

During the first two weeks of November, we began to contact partners to notify them of the under billing issue and to begin our negotiations with each one regarding the possibility of recovering certain of the under billing amounts. We provided to each partner a detail of the net under billing transactions so that they could review and respond to us regarding any questions or concerns. In our original correspondence, we offered to forgive all 2007 under billing amounts if they would negotiate with us for the under billing amounts related to 2008. We also offered to deduct these amounts from our remittances to partners from our future sales of their products on our website. For the few larger fulfillment partners with net under billings greater than $20,000 during 2008, we set up conference calls with our SVP of Finance and SVP of Merchandising to contact each fulfillment partner directly to discuss the issues, answer any questions and negotiate.

The SEC reviewers rejected that excuse:

We also noted approximately half of your total 2008 under billings were comprised of 28 partners with balances in excess of $20,000. We assume you had historical revenue data from these partners which would have afforded you the ability to determine how long it would have taken to recover these under billings or assess the realization of the amounts owed to you, assuming you closely track sales data for your largest partners. We calculated you recovered approximately 67% of the 2008 under billings in the fourth quarter of 2008, and by the end of the first quarter of 2009 you collected approximately 84% of the under billings related to 2008. Notwithstanding the above comments, it appears the collection of under billings was reasonably assured as of December 31, 2008. [Emphasis added.]

According to the SEC's calculations, Overstock.com "...recovered approximately 67% of the 2008 under billings in the fourth quarter of 2008" or within a mere six weeks. Therefore, the SEC felt that "collection of under billings was reasonably assured as of December 31, 2008" and the company could not claim that a "gain contingency" existed in its 10-K report.

A question for Overstock.com

As I detailed above, Overstock.com filed its Q3 2008 10-Q on November 7. The 10-Q report was not due until November 15. Overstock.com claimed that:

During the first two weeks of November, we began to contact partners to notify them of the under billing issue and to begin our negotiations with each one regarding the possibility of recovering certain of the under billing amounts.

Why didn't the company simply file a "Notification of Late Filing" with the SEC and get even more time to properly complete its Q3 2008 10-Q report?

That would have been the conservative thing to do.

My conclusion

Apparently, Overstock.com did not want to restate its financial reports and needed any excuse to use recoveries from underbilled fulfillment partners to materially inflate future earnings starting in Q4 2008. That's why Overstock.com told one story to investors in its 2008 10-K report and later told a different story to SEC reviewers. In other words, Overstock.com wanted to create an illegal "cookie jar" reserve to overstate future earnings.

Written by:

Sam E. Antar

Note: See important disclosure under list of previous open letters to the SEC.

Blog Reaction:

June 29, 2010: Going Concern - Were PwC and Grant Thornton Ignoring Overstock.com’s Accounting Issues? by Caleb Newquist

Recommended reading about my recent issues with the SEC over a certain subpoena:

Featured in Portfolio.com

June 22, 2010: Portfolio.com - SEC Crazy Talk by Gary Weiss

June 22, 2010: Columbia Journalism Review: The SEC Is After Two Dow Jones Journalists' Emails by Ryan Chittum

June 23, 2010: Business Insider - SEC Has Launched Investigation Of InterOil (IOC) Skeptics And Wants Their Emails To The Media by Henry Blodget

June 23, 2010: Reuters - When the SEC subpoenas journalists’ sources by Felix Salmon

June 28, 2010: The Reporters Committee for Freedom of the Press - SEC subpoenas target whistleblowers' e-mail to reporters by Ellen Biltz

My previous open letters to the SEC (please note that each letter is based on Overstock.com's deliberately vague, incoherent, and inconsistent, and often contradictory disclosures at the time each one was issued):

08/05/09: Open Letter to the Securities and Exchange Commission: Stop Overstock.com GAAP Violations Now!

11/22/09: Open Letter to the Securities and Exchange Commission Part 2: New Information on Overstock.com's GAAP and SEC Disclosure Violations

11/23/09: Open Letter to the Securities and Exchange Commission Part 3: Overstock.com Lied About Grant Thornton and Concealed Error

11/26/09: Open Letter to the Securities and Exchange Commission Part 4: Patrick Byrne Ignores Real Issues As He Vilifies Grant Thornton

12/14/09: Open Letter to the Securities and Exchange Commission Part 5: Issuer Retaliation Complaint Against Overstock.com

01/03/10: Open Letter to the Securities and Exchange Commission Part 6: Conflicting Disclosures by Overstock.com Reveal Improper Audit Opinion Shopping

02/02/10: Open Letter to the Securities and Exchange Commission Part 7: Why Overstock.com and David Chidester Parted Ways

04/05/10: Open Letter to the Securities and Exchange Commission Part 8: Bring Enforcement Action Against Overstock.com for False and Misleading Disclosures

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 in cold-blood for fun and profit, and 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.

There is a saying, "It takes one to know one." Today, I work very closely with the FBI, IRS, SEC, Justice Department, and other federal and state law enforcement agencies in training them to identify and catch white-collar criminals.

Recently, I exposed financial reporting violations by Overstock.com (NASDAQ: OSTK) as an independent whistleblower. The Securities and Exchange Commission is now investigating Overstock.com and its CEO Patrick Byrne for securities law violations (Details here, here, and here).

In addition, the SEC is now investigating possible GAAP violations by Bidz.com (NASDAQ: BIDZ) after I alerted them about the company's inventory accounting practices.

I do not own Overstock.com or Bidz.com securities long or short. My exposure of confirmed financial reporting violations by Overstock.com and possible financial reporting violations by Bidz.com was a freebie to securities regulators to get me into heaven, though I doubt that I will ever get there.

I do not seek or want forgiveness for my vicious crimes from my victims. I plan on frying in hell with other white-collar criminals for a very long time.

Open Letter to the Securities and Exchange Commission: Stop Overstock.com GAAP Violations Now!

To Mary Schapiro (Chairperson of the Securities and Exchange Commission):

The Securities and Exchange Commission must take immediate action to require Overstock.com (NASDAQ: OSTK) to properly restate all financial reports affected by its accounting errors and stop the company from issuing any more financial reports that violate Generally Accepted Accounting Principles (GAAP). Enough is enough.

In February 2009, I notified both the SEC and Overstock.com about how the company violated GAAP by improperly deferring the recognition of an accounting error to create a cookie jar reserve to inflate future profits. However, nothing was done to stop this illegal practice and Overstock.com's latest Q2 2009 press release and 10-Q report filed with the SEC violated GAAP, too.

In this blog post, I will provide the SEC with a bullet proof case to take enforcement action against Overstock.com.

Background

On October 24, 2008, Overstock.com disclosed that it discovered customer refund and credit errors and restated all prior affected financial reports from 2003 to Q2 2008 to correct such errors. Those customer refund and credit errors resulted in an additional $8.2 million of accumulated losses in prior reporting periods.

The customer refund and credit errors also caused Overstock.com to underbill its fulfillment partners for offsetting costs and reimbursements. While Overstock.com restated prior financial reports to correct its customer refund and credit errors, it failed to make such corrections resulting from underbilling its fulfillment partners as required by GAAP (See SFAS No. 154).

In addition, Overstock.com failed to make a reasonable estimate of uncollectable underbilled amounts due from its fulfillment partners as required by GAAP (See: SFAS No. 5 paragraph 1, 2, 8, 22, and 23). Instead, the company improperly recognized income from such underbillings as they were recovered on a non-GAAP cash basis in future accounting periods (Q4 2008, Q1, 2009, and Q2 2009).

In effect, Overstock.com overstated accumulated losses of $8.2 million in prior periods from its customer refund and credit errors by failing to accrue offsetting costs and reimbursements due from its fulfillment partners, less estimated uncollectable amounts. It turns out that over $3 million of underbilled amounts to fulfillment partners was actually recovered within several months. Those amounts were improperly recognized as income in future reporting periods after the error was discovered (Q4 2008, Q1 2009, and Q2 2009). In other words, Overstock.com improperly created a cookie jar reserve to inflate financial results in future reporting periods. See the chart below (click on image to enlarge):

Notes to chart: In Q1 2009, Overstock.com disclosed yet another accounting error because a freight carrier overbilled the company "several hundred thousand dollars" in Q4 2008," according to remarks made by CEO Patrick M. Byrne during the Q1 2009 earnings call. For purposes of my analysis, I'll assume that the amount overbilled by the freight carrier is $500,000. That overbilling error from the freight carrier partially offset Overstock.com’s improper recognition of income from its underbilling error to its fulfillment partners in Q4 2009.

If Overstock.com would have properly followed GAAP in Q4 2008, the company (1) would have reported a net loss instead of a net profit, (2) would have reported sixteen consecutive losses instead of 15 consecutive losses, and (3) it would have failed to meet mean analysts’ consensus expectation for earnings per share (anyone of three materiality yardsticks under SEC Staff Accounting Bulletin No. 99 that would have triggered a restatement of prior year’s effected financial reports).

Why Overstock.com’s deferral of income from its underbilling errors to fulfillment partners is dead wrong under GAAP and SEC rules

Under Statement of Financial Accounting Standards No. 154, Overstock.com is required to restate each affected prior period financial report to reflect when the underbilled cost reimbursements and fees due from fulfillment partners were actually earned by the company (accrual basis or GAAP).

Statement of Financial Accounting Standards No.5 requires Overstock.com to offset such accrued income in each restated financial period with a reasonable estimate of uncollectable underbilled amounts.

The 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”).

In an earlier blog post, I criticized Overstock.com’s improper deferral of income from its underbillings to fulfillment partners for offsetting cost and reimbursements. Patrick Byrne responded on the stock market chat board and claimed that "conservatism" permitted his company to recognize recoveries from underbilled fulfillment partners as they were collected on a non-GAAP cash basis. See below:

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

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

Patrick Byrne’s remarks that “one books that as the monies flow in. Simple conservatism demands this….” runs counter to the SEC Chief Accountant's interpretation of GAAP in a letter to the American Institute of Certified Public Accountants:

Conservatism in financial reporting should no longer connote deliberate, consistent understatement of net assets and profits...The Board emphasizes that any attempt to understate results consistently is likely to raise questions about the reliability and integrity of the information about those results and will probably be self-defeating in the long run.”

Accordingly, the consistent understating of results (i.e., conservatism) or overly optimistic estimates of realization (i.e., lack of conservatism or aggressiveness) are inconsistent with the characteristics of quality financial reporting needed for transparent reporting in today’s markets.

In other words, conservatism cannot be used to understate profits or overstate losses. Overstock.com restated prior financial reports to correct its customer refund and credit error, but failed include in its restatement offsetting costs and reimbursements earned from its fulfillment partners. Therefore, Overstock.com violated GAAP by overstating losses from its accounting error.

Those underbilling errors were improperly recognized as income as amounts were recovered in future reporting periods. As I detailed above, Overstock.com cannot defer recognition of any accounting error (See SFAS No. 154 and cease and desist order issued “In the Matter of Apel”).

In later SEC filings, Overstock.com apparently played a game of catch up by making up yet another false excuse in an effort to rebut criticism in my blog of Byrne’s internet chat board remarks. The company falsely claimed that future recoveries of amounts underbilled to fulfillment partners was a “gain contingency” because the recovery of such underbilled amounts "was not assured" (Source: 2008 10-K, Q1 2009 10-Q, and Q2 2009 10-Q). 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, Overstock.com improperly failed to disclose any potential “gain contingency” in its prior Q3 2008 10-Q report, when it disclosed that it underbilled its fulfillment partners for offsetting costs and reimbursements (See: SFAS No. 5 Paragraph 17b).

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

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

The only way that Overstock.com could recognize income from underbilling its fulfillment partners in future accounting periods is if there was a “significant uncertainty as to collection” of all underbilled amounts (See SFAS No. 5 paragraph 23). As it turns out, a large portion of the underbilled amounts to fulfillment partners was easily recoverable within a very brief period of time: Q4 2008 $1.8 million, Q1 2009 $1.4 million, and Q2 2009 $78k. There was no “significant uncertainty as to collection” of all amounts underbilled fulfillment partners.

Why Overstock.com had to know that the recovery of significant underbilled amounts was assured

Overstock.com's management 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."

All you need to do is to follow the cash trail. When Overstock.com sells fulfillment partner inventory, customers promptly remit cash to the company. Afterwards, Overstock.com remits the portion cash proceeds due to its fulfillment partners for the inventory it sold to its customers.

According to Overstock.com’s “Supplier Agreement” with fulfillment vendors, the company (Source: Overstock.com correspondence to SEC Division of Corporation Finance):

Remit(s) semi-monthly payments within 2 business days of the 1st and 16th of each month for Product sold, subject to offsets. Payments shall be made net 30. [Emphasis added.]

Initially Overstock.com gets to float cash that it receives from customers and is later required to pay fulfillment partners in up to 30 days. In addition, Overstock.com retains the right to offset various errors against future remittances to its fulfillment partners. Therefore, if the fulfillment partners are still doing business with Overstock.com, all that the company has to do is to withhold a larger portion of the monthly remittances from such fulfillment partners (up to a few months, if necessary) to recover underbilling errors.

The greatest amount of the underbillings would certainly be attributable to its higher volume fulfillment partners who sold the most merchandise. Those high volume fulfillment partners are likely to be long time and current company suppliers of merchandise.

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

Overstock.com violated GAAP by immediately claiming that a "gain contingency" existed and not considering material subsequent events

The claim by the company that it immediately determined that a “gain contingency” existed improperly did not take into account subsequent material events as required by GAAP. Overstock.com is required to consider material events affecting the measurement or realization of assets in a financial report up to the date that either the final 10-Q report or 10-K report is filed with the commission (See: SAS No. 1 Paragraph 1, 2, 3, and 7 and Letter from SEC Chief Accountant entitled "Audit Risk"). In other words, if new information is received after the cut-off date that affects either assets or income in a financial report, a company must adjust its financial report to reflect that new information.

In any case, even if we take Overstock.com at its word that it determined that a “gain contingency” existed when the “underbilling was originally discovered” that date of discovery had to be sometime after August 4, 2008, the filing date of Q2 2008 10-Q, and before October 20, 2008, the date that Overstock.com approved restatement of financial reports due to customer refund and credit errors (Source: 8-K report page 5).

During Q4 2008, Overstock.com easily collected a total of “$1.8 million relating to payments from partners who were underbilled earlier in the year.” Overstock.com filed its Q3 2008 10-Q report 38 days into that quarter and clearly should have known by that time that significant amounts owed by fulfillment partners from underbilling them in the past was actually collectable and that no gain contingency existed as to such amounts. In addition, Overstock.com collected about $1.4 million in underbilled amounts during Q1 2009 and $87k in underbilled amounts during Q2 2009.
If Overstock.com's explanation of a gain contingency is to be believed, the company improperly determined that a gain contingency existed when it first discovered underbilling its fulfillment partners, instead of spending any time trying to determine the recoverability of such underbilled amounts as required by GAAP.

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

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

Substantial amounts of underbilled amounts to fulfillment partners were recovered

In the three quarters after Overstock.com’s underbillings to fulfillment partners was discovered, the company was able to recover approximately $3.3 million. Overstock.com sought to only recover such underbillings from the year prior to discovering that accounting error.

Originally, Overstock.com’s customer refund and credit errors added $8.2 million to accumulated losses reporting periods prior to Q3 2008. Of that $8.2 million dollar amount, $1.7 million of customer refund and credit errors occurred in Q1 and Q2 2008 (six months prior to discovery of the underbilling error).

Those customer refund and credit errors, along with certain other revenue accounting errors added $3.0 million in losses to fiscal year 2007 (7 to 18 months prior to discovery of the error). Therefore, the gross potential amount of customer refund and credit errors occurring in the eighteen months prior to its discovery is about $4.7 million (Source: Overstock.com 8-K report dated October 24, 2008).

Overstock.com collected about $3.3 million in offsetting costs and reimbursements from fulfillment partners who were underbilled because of those customer refund and credit errors. Overstock.com conservatively collected over 70% of underbilled amounts due from its fulfillment partners arising in the eighteen months prior to announcing its accounting error. The company only sought to collect such underbilled amounts for a period of only twelve months prior to the discovery of billing errors. Therefore, the percentage of recoveries was probably even much higher.

Those calculations aside, the recovery of over $3 million of underbilled amounts to fulfillment partners within a relatively short period of time shows that substantial amounts were easily recoverable and could have been estimated. The only question was how long it would take for Overstock.com to recover such underbilled amounts.

Request for prompt SEC action

For the reasons detailed above, the Securities and Exchange Commission has a duty to require Overstock.com to restate all financial reports to properly reflect when income was actually earned from offsetting costs and reimbursements underbilled to its fulfillment partners. Otherwise, investors will continue to rely on financial reports issued by Overstock.com that violate GAAP.

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.

Personal note to the Securities and Exchange Commission:

The Securities and Exchange Commission is cautioned not to take my freebies for granted any more, unless they want another Bernie Madoff embarrassment on their hands. All frauds ultimately implode and so will Overstock.com implode under the weight of its continued violations of GAAP and its management's lies to investors.

Special note to journalists:

Don't let the nutcase lying CEO of Overstock.com Patrick Byrne hide behind a wall of false integrity as a stock market reformer and let him draw attention away from his lies to investors and his company's financial reporting irregularities. Consider it a badge of honor if he smears you like he has done with other great journalists such as Bethany McLean, Joe Nocera, Gary Weiss, Roddy Boyd, and Herb Greenberg.