Is Overstock.com Trying to Cook The Books, Again?

I hoped that Overstock.com (NASDAQ: OSTK) had finally learned the error of its ways. Now it seems that the company has again resorted to accounting shenanigans to inflate its reported income.

Background

From Q2 2007 to Q2 2008, Overstock.com used an improper EBITDA calculation to materially overstate its pro-forma income in violation of Securities and Exchange Commission Regulation G. From Q4 2008 to Q3 2009, the company violated Generally Accepted Accounting Principles (GAAP) and materially overstated its reported earnings. I endured malicious personal attacks, cyber-stalking, pretexting, and threats to my personal safety from Overstock.com’s gun-toting CEO Patrick Byrne and his paid thugs in retaliation for exposing its illegal accounting practices. In each case, I complained to the Securities and Exchange Commission. Eventually Overstock.com was forced to stop using those illegal accounting practices. It seems that Overstock.com is up to its old tricks again.

Executive summary

In the three month period (third quarter) ended September 30, 2013, Overstock.com claimed that its pretax income was $3.624 million compared to $2.824 million in the same quarter of 2012, an $800,000 increase over the previous year. However, the validity of the increase in pretax income is questionable.

In 2013, Overstock.com quietly changed the useful life of certain fixed assets. The company did not inform investors in its 2013 financial reports that the useful life of its computer software and computer hardware costs was higher in 2013 than it was in 2012, leaving the impression that their useful lives were the same in both years. It simply changed the useful life numbers without providing an explanation. Since it was able to spread depreciation and amortization expenses over a longer period of time, it was able to report a lower depreciation and amortization expense in each quarter and inflate its reported profits.

Furthermore, there is a $700,000 numerical discrepancy in the amount reported for capitalized internal use-software and website development costs in the third quarter. There is another $400,000 numerical discrepancy in the amount reported for amortization expense associated with internal use-software and website development in the third quarter.

Moreover, in the third quarter of 2013, Overstock.com reduced its accrual for loss contingencies by $300,000 from the previous quarter despite a growing number of serious lawsuits against the company. If the company reversed its previous estimate of loss contingencies, it added $300,000 to its third quarter pretax income.

At the very least it appears that a substantial part of the $800,000 increase in pretax income would have disappeared if Overstock.com had not changed the useful life of certain fixed assets. It's possible that Overstock.com could have reported a decline in pretax income. The third quarter numbers don't add up. The numbers cannot be trusted. These accounting irregularities could be a red flag for a material weakness in internal controls over financial reporting.

Depreciation and amortization accounting

Fixed assets are required to be depreciated or amortized over their “estimated” useful lives. For example, a company purchases computer software for $10,000. It amortizes computer software over its 2 year useful life. Initially, the computer software is reported on the balance sheet as fixed asset. No expense is initially recognized on the income statement. Over the next two years, the company recognizes $5,000 per year of amortization expense in its income statement ($10,000 cost divided by 2 year useful life).

If a company lengthens the useful life of a fixed asset, it spreads out depreciation and amortization expense over a longer period of time. Therefore, it can report higher profits by recognizing a lower depreciation and amortization expense in each period. For example, if a company changes its policy to amortize computer software over 4 years instead of 2 years, it can reduce its amortization expense from $5,000 per year to $2,500 per year ($10,000 cost divided by 4 year useful life). Therefore, the company can increase its profits by $2,500 per year in the first 2 years it owns the software by extending the useful life from 2 years to 4 years.

As the amount of fixed assets increase on the balance sheet, the amount reported for depreciation and amortization expense should grow too. However, after analyzing Overstock.com's numbers, I discovered that its fixed assets increased year-over-year, while its depreciation and amortization expense decreased year-over-year. The numbers grew in opposite directions. That occurs when a company is either reporting an erroneous amount of depreciation and amortization expense or when it lengthens the useful life of its fixed assets.

Overstock.com buries changes in the useful life of fixed assets

To find out how Overstock.com changed the useful life of its fixed assets, you have to compare different S.E.C. flings over two years because the company did not fess up and tell investors about the change. Buried under 72 pages of disclosures and another 9 page of footnotes in Overstock.com's 2012 10-K report, we finally learn that the useful life of computer software was 2 to 3 years and the useful life of computer hardware was 3 years in 2012. See below (highlights added):

Overstock.com 2012 10-K report

However, Overstock.com's 10-Q reports issued for each quarter of 2013 show a different useful life for computer software and computer hardware than was reported in 2012. Buried on page 9 of the first two quarter 10-Q reports and page 10 of the third quarter 10-Q report, Overstock.com revealed that the useful life of computer software was 2 to 4 years. However, the useful life of computer software was 2 to 3 years in 2012. In those same 2013 10-Q reports, the useful life of computer hardware was 3 to 4 years. However, the useful life of computer equipment was only 3 years in 2012. (Source: Q1 10-Q, Q2 10-Q, and Q3 10-Q reports)

In each of those 2013 10-Q reports, Overstock.com disclosed:

Fixed assets

Fixed assets, which include assets such as technology infrastructure, internal-use software, website development, furniture and fixtures and leasehold improvements, are recorded at cost and depreciated using the straight-line method over the estimated useful lives of the related assets or the term of the related capital lease, whichever is shorter, as follows:

Note: Yellow highlights were added for emphasis

Overstock.com's fixed asset disclosure leaves the impression that the useful life of its computer software and computer hardware was the same in both 2013 and 2012. The company did not inform investors that the useful life of computer software and computer hardware was higher in 2013 than it was in 2012. It simply changed the numbers without explanation. It did not provide a year-to-year comparison of the useful life of its fixed assets in its 2013 financial reports.

Third quarter 2013: Higher level of fixed assets but lower depreciation and amortization expense

In the three month period (third quarter) ended September 30, 2013, Overstock.com claimed that its pretax income was $3.624 million compared to $2.824 million in the same quarter of 2012. Pretax income increased by $800,000 over the previous year. However, the validity of the increase in pretax income is questionable.

In the three month period ended September 30, 2013 (third quarter) depreciation and amortization expense was $3.307 million compared to $3.839 million in the same three month period of the previous year. Depreciation and amortization expense decreased by $532,000 year-over-year.

At the end of the third quarter of 2013, Overstock.com reported fixed assets of $26.892 million on its balance sheet compared to $23.034 million at the end of the same quarter of the previous year. The amount of fixed assets on its balance sheet was $3.858 million higher in 2013 than it was in 2012. Depreciation and amortization expense was $532,000 lower despite a $3.858 million higher amount of fixed assets.

Third quarter 2013: Numbers don't add up

The amount of internal-use software and website development costs that the company claimed it capitalized for the entire nine month period (first three quarters) ended September 30, 2013 is $700,000 lower than the totals it claimed that it capitalized in each of the three quarters of the year. In the previous quarter ended June 30, 2013, the six month total equaled the total reported for the first and second quarters. Therefore, the $700,000 discrepancy appears to impact its third quarter 2013 numbers.

Moreover, amortization expense for internal-use software and website development costs that the company claimed it reported for the entire nine month period (first three quarters) ended September 30, 2013 is $400,000 higher than the totals it claimed it amortized in each of the three quarters of the year. In the previous quarter ended June 30, 2013, the six month total equaled the total reported for the first and second quarters. Therefore, the $400,000 discrepancy appears to impact its third quarter 2013 numbers.

According to the third quarter ended September 30, 2013 10-Q report:

During the three months ended September 30, 2013 and 2012, we capitalized $3.3 million and $3.0 million, respectively, of costs associated with internal-use software and website development, both developed internally and acquired externally. Amortization of costs associated with internal-use software and website development was $1.8 million and $2.0 million for those respective periods. During the nine months ended September 30, 2013 and 2012, we capitalized $8.1 million and $6.8 million, respectively, of such costs and had amortization of $5.9 million and $6.3 million for those respective periods. [Emphasis added.]

In three month period ended September 30, 2013, Overstock.com claimed that it capitalized $3.3 million of costs associated with internal-use software and website development. In the nine month period ended September 30, 2013, the company claimed that it capitalized $8.1 million of such costs.

In the three month period ended September 30, 2013, Overstock.com claimed that its amortized $1.8 million of internal-use software and website development costs. In the nine month period ended September 30, 2013, the company claimed that it amortized $5.9 million of such costs.

In the second quarter ended June 30, 2013 10-Q report, Overstock.com claimed that:

During the six months ended June 30, 2013 and 2012, we capitalized $5.5 million and $3.9 million, respectively, of such costs and had amortization of $3.7 million and $4.3 million for those respective periods. [Emphasis added.]

Let's do some basic math.

During the six month period ended June 30, 2013, Overstock.com capitalized $5.5 million of costs associated with internal-use software and website development. In the three month period ended September 30, 2013 it claimed that it capitalized an additional $3.3 million of such software costs. Therefore, Overstock.com should have reported a nine month total of $8.8 million. However, it reported a nine month total of $8.1 million, leaving a $700,000 discrepancy in its third quarter numbers.

During the six month period ended June 30, 2013, Overstock.com amortized $3.7 million of costs associated with internal-use software and website development. In the three month period ended September 30, 2013 it claimed that it amortized an additional $1.8 million of such software costs. Therefore, Overstock.com should have reported a nine month total of $5.5 million. However, it reported a nine month total of $5.9 million, leaving a $400,000 discrepancy in its third quarter numbers.

Third quarter 2013: Reduction in amounts accrued for loss contingencies

In the three month period (third quarter) ended September 30, 2013, Overstock.com reduced its accrual for loss contingencies by $300,000 from the previous quarter despite a growing number of serious lawsuits against the company. If the company reversed its previous estimate of loss contingencies, it added $300,000 to its third quarter pretax income.

In the third quarter ended September 30, 2013 10-Q report, Overstock.com disclosed:

We establish liabilities when a particular contingency is probable and estimable. At September 30, 2013, we have accrued $2.6 million in light of these probable and estimable liabilities. It is reasonably possible that the actual losses may exceed our accrued liabilities. We have other contingencies which are reasonably possible; however, the reasonably possible exposure to losses cannot currently be estimated. [Emphasis added.]

In the second quarter ended June 30, 2013 10-Q report, Overtock.com reported:

We establish liabilities when a particular contingency is probable and estimable. As of June 30, 2013, we have accrued $2.9 million in light of these probable and estimable liabilities. It is reasonably possible that the actual losses may exceed our accrued liabilities. We have other contingencies which are reasonably possible; however, the reasonably possible exposure to losses cannot currently be estimated. [Emphasis added.]

A loss contingency reserve can be reduced two ways. Either the company paid out money it previously accrued (no effect on income) or it changed its estimate of contingent liabilities (reversed prior accruals of loss contingency expense). Such a change in estimate would increase its pretax income. Was Overstock.com trying to further tweak its third quarter numbers?

Conclusion

Given Overstock.com's prior history of accounting violations and its past malicious retaliatory actions against journalists, independent whistleblowers like me, and other critics, investors should be skeptical of its accounting and financial disclosures.

Written by,

Sam E. Antar

Disclosure

I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped my cousin 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 heroic 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 want or seek forgiveness for my vicious crimes from my victims. My past sins are unforgivable.

There is a saying, "It takes one to know one." I've provided professional work for the FBI, IRS, SEC, Justice Department, and other federal and state law enforcement agencies in training them to identify fraud and catch white-collar criminals. Often, I refer cases to them as an independent whistleblower. In addition, I teach white-collar crime classes for various government entities, professional organizations, businesses, and colleges and universities. Recently, I've helped the AICPA Fraud Task Force develop better methods for detecting fraud.

I do not own any Overstock.com securities long or short.

Nature's Sunshine Products, Willbros Group, Cal Dive International, and BSQUARE Violate S.E.C. Rules on Calculating EBITDA

Nature’s Sunshine Products (NASDAQ: NATR), Willbros Group (NYSE: WG), Cal Dive International (NYSE: DVR), and BSQUARE (NASDAQ: BSQR) have recently issued earnings reports which include a calculation of EBITDA (earnings before interest, taxes, depreciation, and amortization) that apparently does not comply with Securities and Exchange Commission interpretations for Regulation G governing such non-GAAP financial measures. In each case, their erroneous EBITDA calculations have enabled them to significantly distort their financial performance by erroneously reporting a positive EBITDA, when they should have reported a negative EBITDA in the latest quarter.

How EBITDA is supposed to be calculated under Regulation G

According to the S.E.C. Compliance & Disclosure Interpretations, EBITDA is defined under Regulation G as net income (not operating income) before net interest, taxes, depreciation, and amortization. See below:

Question 103.01

Question: Exchange Act Release No. 47226 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 described 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: "Earnings" means net income as presented in the statement of operations under GAAP. Measures that are calculated differently than those described as EBIT and EBITDA in Exchange Act Release No. 47226 should not be characterized as "EBIT" or "EBITDA" and their titles should be distinguished from "EBIT" or "EBITDA," such as "Adjusted EBITDA." These measures are not exempt from the prohibition in Item 10(e)(1)(ii)(A) of Regulation S-K, with the exception of measures addressed in Question 102.09. [Jan. 11, 2010]

Question 103.02

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

Answer: If a company presents EBIT or EBITDA as a performance measure, such measures 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. [Jan. 11, 2010]

The proper way for a public company to compute EBITDA under Regulation G is by starting the calculation with net income (not operating income) and only adding back net interest, taxes, depreciation and amortization. A public company cannot add back other items such as stock-based compensation costs, impairments of fixed assets, or anything else to compute EBITDA. Such errors can materially overstate EBITDA and lead to potential regulatory sanctions. Any different calculation cannot be called EBITDA, but it can be called "Adjusted EBITDA" or some other appropriate name.

Examples of erroneous EBITDA calculations uncovered by the Securities and Exchange Commission

Reviews of public company financial reports by the S.E.C Division of Corporation Finance highlight how EBITDA is required to be computed under Regulation G.

In September 2007, the Division of Corporation Finance told CGG Veritas that its EBITDA calculation erroneously included an adjustment for stock-based compensation:

The acronym EBITDA refers specifically to earnings 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.

In March 2010, the Division of Corporation Finance told Crown Crafts that its EBITDA calculation erroneously included an adjustment for asset impairment charges:

We note that your calculation of EBITDA in the press release furnished as an exhibit includes an adjustment for goodwill impairment charges. As such, the non-GAAP measure should not be characterized as EBITDA. When you include an adjustment that is not included in the definition of EBITDA as set forth in Item 10(e) of Regulation S-K, please revise the title of the non-GAAP measure to clearly identify the earnings measure being used and all adjustments. Refer to question 103.01 of the Division’s Compliance & Disclosure Interpretations on the use of non-GAAP measures available on our website http://sec.gov/divisions/corpfin/guidance/nongaapinterp.htm.

In March 2010, the SEC Division of Corporation Finance told General Finance Corporation that its EBITDA calculation improperly included an adjustment for foreign currency gains and losses:

We note that the measure you call EBITDA does not appear consistent with the definition of EBITDA since it excludes foreign currency exchange (gain) loss and other. Please revise the title of this non-GAAP measure in future filings to accurately reflect the items being excluded. For further guidance see Question 103.01 of our Compliance and Disclosure Interpretation on Non-GAAP Financial Measures, available on our website at www.sec.gov/divisions/corpfin/guidance/nongaapinterp.htm.

Below, I will detail how Nature's Sunshine, Willbros Group, Cal Div, and BSQUARE all used improper adjustments to EBITDA which enabled them to report a positive EBITDA instead of a properly calculated negative EBITDA.

Nature’s Sunshine

In the quarter ended September 30, 2011, Nature’s Sunshine erroneously included share-based compensation expense, contract termination costs, and foreign exchange gains or losses in its EBITDA calculation. In the quarter ended September 30, 2010, it erroneously included loss from discontinued operations, share-based compensation expense, and foreign exchange gains or losses in its EBITDA calculation. See the yellow highlighted items below from its 8-K filing. (Click on image to enlarge):

Note: According to the company's 8-K report, “Other income (expense), net is primarily comprised of foreign exchange gains (losses), interest income, and interest expense.” As I detailed above, foreign currency gains or losses cannot be properly included in an EBITDA calculation.

Nation’s Sunshine should have reported a negative EBITDA in both the three months ended September 30, 2011 and 2010, rather than a positive EBITDA in each period. It erroneously claimed that its EBITDA had doubled to positive $11.505 million in its latest quarter compared to a positive $5.074 in the prior year’s comparable quarter.

Based on my calculations, it should have reported a negative EBITDA of $2.887 million in the quarter ended September 30, 2011 compared to a negative EBITDA of $2.5 million in the previous year's comparable quarter. In other words, its financial performance, as measured by EBITDA, seems like it got worse in 2011 compared to 2010, not better. See my calculations below. (Click on image to enlarge):

Note: The company did not specify the amount of foreign exchange gains or losses for the respective three month periods ended September 30, 2011 and 2010. I was able to calculate that amount by subtracting the totals for the respective six month periods ended June 30, 2011 and 2010 from the totals for the respective nine month periods ended September 30, 2011 and 2010. (See the Statement of Cash Flows in the June 30, 2011 10-Q and September 30, 2011 10-Q reports).

Willbros Group, Inc.

In both the quarters ended September 30, 2011 and 2010, Willbros erroneously started its EBITDA calculation with net income (loss) from continuing operations, rather than net income (loss). In addition, the company erroneously included goodwill impairment costs in its EBITDA calculation. See yellow highlighted items below from 8-K filing. (Click on image to enlarge):

Willbros should have reported a negative EBITDA of $113.640 million instead of a positive EBITDA of $32.186 million for the quarter ended September 30, 2011. In addition, it should have reported a positive EBITDA of $64.035 million instead of a positive EBITDA of $78.745 million for the quarter ended September 30, 2010. Its financial performance, as measured by a correct EBITDA calculation, got worse in latest quarter compared to the previous year. See my calculations below. (Click on image to enlarge):

Cal Drive International

In the quarter ended September 30, 2011, Cal Dive erroneously included non-cash stock compensation expense and non-cash fixed assets impairment charges in its EBITDA calculation. In the quarter ended September 30, 2010, Cal Dive erroneously included non-cash stock compensation expense, non-cash goodwill impairment charge, and non-cash fixed assets impairment charges in its EBITDA calculation. See the yellow highlighted items below from its 8-K filing. (Click on image to enlarge):

Cal Div should have reported a negative EBITDA of $20.839 million instead of a positive EBITDA of $18.363 million for the quarter ended September 30, 2011. In addition, it should have reported a negative EBITDA of $267.078 million instead of a positive EBITDA of $50.330 million for the quarter ended September 30, 2010. See my calculations below. (Click on image to enlarge):

BSQUARE Corp

In the quarters ended September 30, 2011 and 2010, BSQUARE erroneously included stock-based compensation expense in its EBITDA calculation. See the yellow highlighted items below from its 8-K filing. (Click on image to enlarge):

In addition, BSQUARE disclosed that "Other income or expense consists of interest income on our cash, cash equivalents and investments, gains and/or losses recognized on our investments, as well as gains or losses on foreign exchange transactions." Investment gains or losses and foreign exchange gains or losses cannot be included in an EBITDA calculation. However, the company did not specify such amounts in its recent S.E.C. filings, though they seem to be minimal given the total amounts reported for other income (expense) in each quarter, detailed above.

If we assume no other erroneous items were used in its EBITDA calculation, the company should have reported a negative EBITDA of $0.281 million instead of a positive EBITDA of $0.297 million for the quarter ended September 30, 2011. Further, it should have reported a positive EBITDA of $1.210 million instead of a positive EBITDA $1.486 million in the previous year's comparable quarter.

Other companies identified by this blog using erroneous EBITDA calculations

In the past, this blog has identified eight other companies who used improper EBITDA calculations. Seven of them promptly corrected their EBITDA calculations after this blog reported them. The other company, Overstock.com, now known as O.co, led by Patrick Byrne defiantly refused to correct its improper EBITDA calculations for almost two years. Finally, under pressure, it complied with Regulation G. After this blog uncovered violations of Generally Accepted Accounting Principles (GAAP) which helped Overstock.com fabricate profits, the S.E.C. Enforcement Division opened an investigation of the company for violations of various securities laws. That investigation is ongoing.

Closing comment

The management and audit committees of Nature's Sunshine, Willbros Group, Cal Dive International, and BSQUARE need to study SEC rules governing the calculation of non-GAAP measures such as EBITDA and follow them in future filings. I will continue tracking future financial reports to see if they miscalculate EBITDA and violate Regulation G again.

Written by,

Sam E. Antar

Disclosure

I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped my cousin 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 heroic 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. Often, I refer cases to them as an independent whistleblower. Further, I teach white-collar crime classes for various government entities, professional organizations, businesses, and colleges and universities.

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. My past sins are unforgivable.

I do not own any securities of any of the public companies referred to in this blog post, long or short.

Were Groupon’s and Overstock’s Management and Auditors Stupid or Did They Condone Improper Accounting Practices?

Back on August 24, 2011, accounting professors J. Edward Ketz and Anthony H. Catanach Jr., reported in their blog that Groupon (planned ticker symbol: GRPN) violated Generally Accepted Accounting Principles (GAAP) in reporting its revenues and recommended that it restate its financial reports to correct its error. They sent a complaint to the Securities and Exchange Commission Whistleblower Office. Last week, Groupon restated its financial reports to comply with revenue accounting rules as called for by Ketz and Catanach. The company revised its reported 2009 revenues from $30.5 million to $14.5 million and its 2010 revenues from $713.4 million to $312.9 million – no small potatoes!

Why did Groupon’s CFO and its auditors at Ernst and Young (the third largest accounting firm in the world) miss revenue accounting violations? Ketz and Catanach did not have access to company management or its books and records. They found GAAP violations from merely reading financial reports filed with the S.E.C. in anticipation of the company’s initial public offering. They compared the company’s revenue accounting disclosures with applicable accounting rules and found material misstatements in violation of GAAP. Were Groupon’s management and its auditors stupid? Shouldn’t they know revenue accounting rules? In a blog post this evening, noted forensic accountant and author Tracy Coenen suggests that Groupon used higher and improper revenue numbers to mask troubling trends in its business model.

Over the last several years, my blog exposed a pattern of accounting shenanigans which helped Overstock.com (NASDAQ: OSTK) (also known as O.co) materially overstate its reported earnings. From Q2 2007 to Q2 2008, the company used improper EBITDA calculations to materially inflate its financial performance in violation of S.E.C. Regulation G. For example, in Q2 2008 Overstock.com reported a positive $1.117 million EBITDA using its improper calculation instead of a negative $0.430 million EBITDA had it complied with Regulation G. From Q4 2008 to Q3 2009, Overstock.com violated Generally Accepted Accounting Principles (GAAP) and materially inflated its reported earnings. For example, in Q4 2008, Overstock.com improperly reported a $1.014 million net profit instead of a $0.705 million net loss if it has followed GAAP.

In both cases, I provided the company with detailed information about its accounting irregularities, but its CEO Patrick Byrne chose to vilify me and continue violating accounting rules. In both cases, my analysis of Overstock.com's accounting violations was ultimately proven correct by its later revisions of financial reports. The S.E.C. is currently investigating Overstock.com for securities law violations.

Why was I was able to find accounting irregularities at Overstock.com missed by PricewaterhouseCoopers and Grant Thornton (the second and sixth largest accounting firms in the world)?  PricewaterhouseCoopers was Overstock.com's auditors from 1999 to 2008 and Grant Thornton was its auditors from Q1 to Q3 2009. Just like Professors Ketz and Catanach, I found accounting violations by merely reading Overstock.com's financial reports and comparing its financial disclosures to applicable accounting rules. I am not an accounting professor and I lost my CPA license because I am a convicted felon. Is a convicted felon and former CPA smarter than the company and two of the six largest public accounting firms?

Back in my Crazy Eddie days, in many cases I had to deceive my auditors at KPMG (then known as Peat Marwick Main) to manipulate earnings and defraud investors. In October 2000, Joseph T. Wells asked the following question about Crazy Eddie's auditors in the Journal of Accountancy:

Were the auditors stupid? No, just too trusting. After all, no one wants to think the client is a crook. But it happens all too often. That’s why the profession requires auditors to be skeptical.

I personally don’t believe that the managements of both Groupon and Overstock.com tricked their auditors into using improper accounting rules to misstate their respective company's financial performance. Further, I don’t believe that the managements and auditors of Groupon and Overstock.com were so stupid that they did not understand accounting rules. I believe that the managements of both companies simply chose to avoid following applicable accounting rules and their auditors condoned those practices. Seriously, can they be so stupid? If so, their audits are nothing but window dressing.

Public accounting firms are supposed to be gatekeepers and protect the integrity of financial reporting. However, financial reports have apparently become promotional materials to help inflate stock prices, rather than provide investors with a proper picture of a company’s financial performance. In too many cases, public accounting firms have become advocates of management at the expense of investors, creditors, and other users of financial information. Some investors don’t seem to care as long as they can profit from higher stock prices caused by improper accounting practices that are condoned management and so-called independent auditors.

Our government doesn’t seem to care, too. President Barack Obama wants cut red tape and make it easier for small companies to go public without going through a rigorous review process by the Securities and Exchange Commission. Front runner for the Republican Party presidential nomination Mitt Romney wants to repeal corporate governance and accounting reforms under the Sarbanes-Oxley Act altogether. Meanwhile, congressional Republicans have already succeeded in cutting funding for the Securities and Exchange Commission despite increased responsibilities under the Dodd-Frank Act.

Have you ever wondered why committing securities fraud is so easy and is going to get even easier in the future?

Written by:

Sam E. Antar

Recommended reading

TheStreet.com - Bucket List of Apologies -- SEC Edition by Gary Weiss

TheStreet.com - Obama Signals Green Light for Stock Fraud by Gary Weiss

Footnoted.com - The Footnoted Jobs Program... by Michelle Leder

Business Insider - "The Feds Are Drinking The Same Kool-Aid As Crazy Eddie's Former Auditors" by Sam E. Antar

Dag Blog -"Crazy Eddie" Fraudster Sam Antar To Return To Crime - Thanks to Darrell Issa & Anti-Regulation Republicans by William K. Wolfrum

Disclosure

I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped my cousin 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 heroic 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. Often, I refer cases to them as an independent whistleblower. In addition, I teach about white-collar crime for government entities, professional organizations, businesses, and colleges and universities.

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. My past sins are unforgivable.

I do not have any position in Groupon or Overstock.com securities.

Why the SEC should not be duped by Overstock’s excuses to avoid sanctions

After almost two years of investigation by the Securities and Exchange Commission, Overstock.com (NASDAQ: OSTK), also known as O.co, faces a possible enforcement action and sanctions arising from certain accounting violations reported in this blog. The company cannot deny that it violated various accounting rules. My accounting analysis was proven correct by its later revisions of financial reports. To avoid an enforcement action and possible sanctions, the company has no choice but to attempt to persuade the SEC that it acted in good faith and its misstatements of financial reports were unintentional. That excuse is simply untrue in light of the company’s actions.

Over the last several years, I've reported on a pattern of accounting shenanigans which helped Overstock.com materially overstate its earnings. From Q2 2007 to Q2 2008, the company used improper EBITDA calculations to materially inflate its financial performance in violation of SEC Regulation G. From Q4 2008 to Q3 2009, it violated Generally Accepted Accounting Principles (GAAP) and materially inflated its reported earnings. In both cases, I provided the company with detailed information about its accounting irregularities, but its management chose to vilify me rather than immediately correct its financial reports. Even after Overstock.com revised its financial reporting, it still continued to smear me in retaliation for exposing accounting irregularities.

If the company and its auditors want to claim they acted in good faith, it follows that this convicted felon and former CPA has more knowledge about SEC reporting rules and GAAP than any of them. I guess that I must be an accounting genius. I was able to find accounting irregularities missed by PricewaterhouseCoopers and Grant Thornton (the third and sixth largest accounting firms in the world) who unlike me, had access to the company’s books and records. PricewaterhouseCoopers was Overstock.com's auditors from 1999 to 2008 and Grant Thornton was its auditors from Q1 to Q3 2009.

Further, the Sarbanes-Oxley Act of 2002 eliminates the excuse that a company relied on the erroneous advice of its auditors. It clearly places the primary responsibility for poor internal controls and improper financial reporting on management.

Overstock.com has so far restated its financial reports three times due to GAAP violations. Every single financial report from 1999 to Q3 2009 had to be revised from one to three times due to GAAP violations. Every single internal control certification signed by the CEO and CFO of the company during that period turned out to be false. Every single audit by PricewaterhouseCoopers from 1999 to 2008 and review by Grant Thornton in 2009 turned out to be flawed.

The Sarbanes-Oxley Act is a law to be enforced. Companies and their auditors who violate that Act must be held accountable by the SEC. Compliance is not a performance goal where violations are shrugged off by the SEC and where companies and their auditors who violate that Act are asked to do better next time. It's the law! The integrity of financial information is the main pillar underlying our capitalist economic system. It is not supposed to be the cat and mouse game that seems to be going on today between the SEC on one side and public companies and their auditors the other side.

Early lies about profitability

Patrick Byrne

On December 11, 2001, Patrick Byrne appeared on Fox News claimed, “We're profitable.” On March 5, 2002, Overstock.com filed an S-1 report in connection with its planned initial public offering. It contradicted Byrne’s claim that his company was anywhere near “profitable.” In future years, Byrne’s deceptive behavior continued as Overstock.com resorted to violating accounting rules to materially overstate its financial performance and even report profits when it was actually losing money.

Overstock.com violated SEC Regulation G governing non-GAAP pro forma numbers

In April 2004, Patrick Byrne appeared on the CNBC and said “I don’t believe in EBITDA. If somebody talks EBITDA, put your hand on your wallet; they’re a crook.” In 2007, Overstock.com changed its tune and starting using EBITDA in its financial reports. In February 2008, the company even said, “A multiple of EBITDA is currently the most standard measure of valuation in the industry.” With that admitted knowledge, the company used an improper EBITDA calculation to materially overstate its financial performance from Q2 2007 to Q2 2008.

On December 3, 2007, I detailed how Overstock.com improperly started its EBITDA calculation with operating income or loss (rather than net income or loss) and improperly added back stock-compensation costs. Under Regulation G, EBITDA can only be computed by starting from net income or net loss and adding back net interest (interest expense minus interest income), taxes, depreciation, and amortization. On May 28, 2008, I detailed how the SEC Division of Corporation Finance reviewed similar improper EBITDA calculations by two other public companies and made them comply with Regulation G. During this period, I sent multiple emails with links to my blog posts alerting the SEC and Overstock.com about the improper EBITDA calculations. However, the company defiantly continued to use an improper EBITDA calculation and materially overstated its financial performance. (See the chart below. Click on image to enlarge.)

In Q2 2008 (period ended 06/30/08), Overstock.com reported a positive $1.117 million EBITDA using its improper calculation instead of a negative $0.430 million EBITDA had it complied with Regulation G.

During various conference calls, management made false comments in defense of its accounting policies and attacked me. On July 18, 2008, during the Q2 2008 earnings call, former CFO David Chidester falsely claimed that the company was justified in adding back stock compensation costs to compute EBITDA. He said “It’s completely the convention in our industry….” On October 24, 2008, during the Q3 2008 earnings call, Patrick Byrne falsely asserted that “The claim that EBITDA is not compliant with SEC definition, nonsense.” Byrne went on to call me, “Sam Antar the Crook.

Vindication

On November 7, 2008 Overstock.com filed its Q3 2008 10-Q and disclosed that it discovered errors in its accounting for customer refunds and credits. The company restated financial reports from Q1 2007 to Q2 2008 to correct those errors. In addition, it finally complied with SEC Regulation G and stopped calling its non-GAAP financial measure (operating income plus stock compensation) EBITDA. It warned investors that it was an “adjusted EBITDA” calculation.

On July 26 and September 12, 2010, I reported how seven other public companies used improper EBITDA calculations and violated SEC Regulation G. Unlike Overstock.com, those companies corrected their improper EBITDA calculations in their very next financial report and did not attack me for pointing it out.

Overstock.com violated GAAP


In February 4, 2009, I detailed how Overstock.com violated GAAP and materially overstated its earnings in Q4 2008. In that quarter, Overstock.com improperly reported a net profit instead of a net loss due to its GAAP violation. It was the company’s first reported net profit after 15 consecutive quarterly losses. I immediately notified the SEC and Overstock.com about its GAAP violations and urged the company to restate its financial reports to correct its illegal accounting practices. However, Overstock.com continued to violate GAAP and materially overstate its earnings from Q1 to Q3 2009.

Back in October 2008, Overstock.com discovered errors in accounting for customer refunds and credits. The company restated its financial reports from Q1 2007 to Q2 3008 and reduced its retained earnings by 8.2 million to correct those errors due to its overstatement of income during those periods. It also underbilled its fulfillment partners certain offsetting fees and reimbursements due the company arising from those errors. However, Overstock.com’s restatement of financial reports did not properly reflect adjustments for income that it already earned from those offsetting costs and reimbursements during those periods.

Public companies are required to use accrual basis accounting. Income is recognized in the period it is earned and not when it is later billed or when amounts are subsequently collected. Instead, the company recorded income as payments were received from its fulfillment partners on a non-GAAP cash basis in future accounting periods (Q4 2008 to Q3 2009). In other words, Overstock.com took income that should have been reported in prior reporting periods (Q2 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. The company effectively created a "cookie jar" reserve to inflate future earnings.

On February 6, 2009, Patrick Byrne responded to my initial accounting analysis with his usual vindictive attack on the InvestorVillage message board. He claimed that “Antar's ramblings are gibberish. Show them to any accountant and they will confirm. He has no clue what he is talking about.”

On February 23, 2009, Overstock.com filed its 2008 10-K report and claimed that a "gain contingency" existed to justify its accounting practices. It said that, “When the underbilling was originally discovered, we determined that the recovery of such amounts was not assured, and that consequently the potential recoveries constituted a gain contingency.”

Judd Bagley

In April 2009, Patrick Byrne sent his paid hack Judd Bagley to spread false information my divorce, attempted to blackmail me into settling that case, and even tried to contact my ex-spouse in an attempt to intimidate me. At about the same time, Judd Bagley created a Facebook profile under the name of Larry Bergman and proceeded to con people into friending him. The company’s pretexting operation targeted me, journalists, bloggers, our families, and even minor children, too. Eventually, Facebook booted Bagley for violating its rules.

On July 22, 2009, during the Q2 2009 earnings call, Patrick Byrne called me “Sam Antar the Crook” because I dared to question his company’s claim that a "gain contingency" existed.

On August 5, 2009, I published a letter to the SEC that cited various accounting rules and pointed out that “No gain contingency existed.” Overstock.com had made the ridiculous assumption that all potential recoveries of underbilled fees and reimbursements owed to it from fulfillment partners (every single penny) were “not assured”. In addition, I noted that the company did not mention the existence of a “gain contingency” when it originally disclosed the underbilling error in its Q3 2008 10-Q report filed in November 2008. It waited until it filed its annual 2008 10-K report in February 2009 to claim that a gain contingency existed.

Further, I pointed out how Overstock.com used that same phony gain contingency rationale to further inflate its reported earnings in Q1 and Q2 2009. During 2009, the company found overbillings from vendors that occurred in 2008. When it corrected the 2008 overbillings from vendors in 2009, it inflated its reported income. It should have adjusted its 2008 financial reports to correct those errors.

SEC investigates

On September 17, 2009, the SEC Enforcement Division started investigating Overstock.com. On September 23, 2009, a Salt Lake Tribune article reported Patrick Byrne’s angry reaction with anti-Semitic overtones:

"Gary Weiss and Sam Antar are goniffs," Byrne declared, using a yiddish term that he says means "a con man, a hustler and a scoundrel." If the SEC is listening to them, their next step is to let Bernie Madoff write their indictment of me. 

Best-selling author and investigative reporter Gary Weiss had exposed Patrick Byrne’s dirty trick tactics against critics. Both Gary Weiss and I are Jewish.

In October 2009, Aaron Edelstein from Crain’s New York Business asked Patrick Byrne about my reporting of accounting irregularities. Byrne responded saying “He’s a criminal who works for short-sellers. He throws mud day after day. No matter what he says, he finds some spurious thing to jump up and down about.”

On October 1, 2009, the SEC Division of Corporation Finance started reviewing Overstock.com’s financial reports. It discovered that the company 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.  Grant Thornton, who replaced PricewaterhouseCoopers as Overstock.com’s auditors in 2009, claimed that it did not know about the 2008 overpayment and the Q1 2009 recovery from the fulfillment partner until October 2009. The SEC wanted Overstock.com to restate its financial reports to correct that error and other GAAP violations previously identified in my blog. Grant Thornton agreed.

The SEC reviewers also wanted to know why Overstock.com failed to report the existence of a gain contingency when it originally disclosed the underbilling error in its Q3 2008 10-Q report filed on November 7, 2008. The company waited until it filed its 2008 10-K report on February 23, 2009 to claim that a gain contingency existed. Overstock.com told them that as of November 2008 "...it would have been inappropriate to disclose a gain contingency." However, the 10-K report claimed that it determined that a gain contingency existed "When the underbilling was originally discovered...." back on October 24, 2008. If Overstock.com's 10-K disclosure was true, the company's explanation to the SEC could not be true. Likewise, if Overstock.com's explanation to the SEC was true, the company's 2008 10-K disclosure can't be true. Nevertheless, the SEC determined that no gain contingency existed, as I did my August letter.

On November 13, 2009, Overstock.com fired Grant Thornton rather than restate its financial reports. Three days later, Overstock.com defiantly issued an “unreviewed” Q3 2008 10-Q report without correcting its GAAP violations.

Jonathan Johnson

On November 18, 2009, Patrick Byrne falsely claimed that even if the company restated its financial reports, no previously reported profit would turn into a loss. Byrne said, “In fact, we as I understand it, this doesn't change any positive quarter to a negative quarter or any negative quarter to a positive quarter.

On November 24, 2009, the Salt Lake Tribune reported that Company President Jonathan Johnson said, “None of these changes that they [Grant Thornton] are talking about, or that people at the SEC are now asking about, make any of our quarters go from negative to positive or from positive to negative.”

Vindication

On December 29, 2009, Overstock.com hired KPMG to replace Grant Thornton. On January 29, 2010, Overstock.com warned investors that its financial reports “…. should no longer be relied upon.” On March 31, 2010, Overstock.com filed its 2009 10-K report and finally restated its financial reports to correct GAAP violations, as I recommended back in February 2009. The company also admitted that the "gain contingency…was an inappropriate accounting treatment.” (See the chart below detailing restatements. Click on image to enlarge.)

As it turns out, every comment made by Patrick Byrne and Jonathan Johnson were false. The company actually lost money in Q4 2008 rather than make a profit as previously claimed.

Back in February 2009, Byrne said “Antar's ramblings are gibberish. Show them to any accountant and they will confirm. He has no clue what he is talking about.” The "gibberish" was Overstock.com's illegal accounting practices and Byrne's ramblings in defense of his company's accounting shenanigans. I knew exactly what I was talking about.

Continued retaliation

In November 2010, District Attorneys from seven California counties filed a lawsuit alleging consumer fraud by Overstock.com. On April 12, 2011, I reported how the DAs complained to the court that Overstock.com was withholding personal contact information of former employees with possible knowledge of wrongdoing. That day, a Bloomberg reporter asked Patrick Byrne about the issue and he went on a disgusting rampage in his Deep Capture website:

The sounds of squealing could be heard over the low hum of the air recirculation machinery in the drab, windowless federal interview room.  “Please!” Sam Antar wimpered. “Let me write one more smear. Let me feel like I’m a player, one last time!”

The federal agent spoke sharply: “Silence!”  She turned to look at her colleagues with bemusement.  “Jesus, what is it with these finance gerbils? I haven’t seen someone break this pitifully since that bookkeeper in Reno. ” She set aside her Nutcracker Flail, took a long pull on her Gaulioses, and said, “OK, let’s give Sam the night off. We’ll get him cleaned up for the judge in the morning.”

With that, Sam Antar, still restrained in straightjacket, was hauled back to the Shower Room, where he spent the night toe-writing in excrement on the linoleum.

Which would be altogether unremarkable, were it not for the fact that within hours, a Bloomberg reporter named Clyde Eltzrothis called, asking me to comment on it.

Patrick Byrne went on to accuse the California District Attorneys of not acting in good faith:

It is not our job to host DA’s on a no-limits fishing trip, especially when they have not acted in good faith in the past.

On May 18, 2011, Judge Robert B. Freeman granted the California District Attorney’s motion to compel Overstock.com to turn over the contact information of certain former employees. He rejected Byrne's argument.

Good faith?

Responsible companies that act in "good faith" fix their accounting errors and move on. They don't retaliate against whistleblowers who point out misstatements in financial reports. Patrick Byrne doesn't seem to be upset that Overstock.com violated accounting rules and had to restate its financial reports. Apparently, he's upset because his company's accounting irregularities were exposed. Byrne's disgusting prison fantasy involving me demonstrates his obsession to get back at me for pointing out his company's shenanigans. Byrne and his crew will make up anything and resort to any smear tactic in their attempts to punish me for uncovering their wrongdoing. But the fact remains that I uncovered violations of accounting rules which helped Overstock.com overstate its financial performance and the company made revisions in its financial reporting to correct those violations.

Final comments

Last year, the Dodd-Frank Act was signed into law and the SEC issued final regulations about whistleblower protections. On May 25, 2011, SEC Chairman Mary Schapiro said in a speech that, “… the final rules make clear that the statute’s whistleblower protections apply to anyone who provides us information, even if that information relates to a possible securities law violation, and regardless of whether it leads to a successful enforcement action.”

Here, the SEC has a whistleblower that correctly identified accounting violations which caused a public company to restate its financial reports. The SEC has clear evidence of blatant retaliation by the issuer against that whistleblower. The freedom to criticize accounting practices without fear of reprisal from public companies is essential to our democracy and the integrity of our capital markets. It’s time for the SEC to put its money where its mouth is. The ball is in their court!

Written by,

Sam E. Antar

Disclosure

I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped my cousin 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 heroic 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. Often, I refer cases to them as an independent whistleblower. In addition, I teach about white-collar crime for government entities, professional organizations, businesses, and colleges and universities.

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. My past sins are unforgivable.

I do not own any Overstock.com securities long or short.

Green Mountain Coffee Roasters: Do they know how to count the beans?

Updated at 5:35 PM and 12:42 AM (5/5), please see bottom of post for additional issues

Does anyone at Green Mountain Coffee Roasters (NASDAQ: GMCR) know math or accounting? Seriously, does anyone in their accounting department know how to count the beans?

On September 28, 2010, Green Mountain Coffee disclosed that the SEC started an informal inquiry into its accounting practices eight days earlier. On that same day, the company reported an accounting error involving its K-Cup margin percentages. On November 19, 2010, Green Mountain Coffee disclosed four new accounting errors. On that date, the company said it would restate its financial reports issued from 2007 to the quarter ended 2010 to correct its errors.

Before the restatement of accounting errors, Green Mountain Coffee issued a 10-Q report for the quarter ended December 26, 2009 and disclosed the following financial results for Timothy’s:

For the thirteen-weeks ended December 26, 2009, Timothy’s contributed approximately $7,141,000 in revenue and $902,000 of income before taxes.

After the restatement of financial reports, Green Mountain Coffee issued a 10-Q report for the quarter ended December 25, 2010 and disclosed the following revised financial results for Timothy’s in 2009:

For the thirteen weeks ended December 26, 2009, the Timothy’s acquisition resulted in an additional $4.1 million of revenue and $0.0 million of income before income taxes.
[Emphasis added.]

Yesterday, Green Mountain Coffee issued its 10-Q report for the quarter ended March 26, 2011 and reported the following financial results for Timothy's from the previous fiscal year:

For the thirteen weeks ended March 27, 2010, the Timothy’s operations contributed an additional $13.0 million of revenue and $3.8 million of income before taxes. [Emphasis added.]

Maybe they need a calculator?

Therefore, for the twenty six weeks ended March 27, 2010, Timothy's operations should have contributed an additional $3.8 million of income before taxes ($0.0 million of income before income taxes for thirteen weeks ended December 26, 2009 plus $3.8 million of income before taxes for the thirteen weeks ended March 27, 2010). Right?

In that same 10-Q report for the quarter ended March 26, 2011, Green Mountain Coffee reported the following financial results for Timothy's for the previous twenty-six weeks ended March 27, 2010:

...Timothy’s operations contributed in an additional $17.2 million of revenue and $2.8 million of income before income taxes. [Emphasis added.]

Green Mountain Coffee's numbers for Timothy's don't add up. Timothy's Income for before taxes for the twenty-six weeks ended March 27, 2010 should be $3.8 million, not $2.8 million if you add up the numbers for each thirteen-week period. Did Green Mountain Coffee make a mathematical error or did the company find a new error in the quarter ended December 26, 2009 that was not found in its previous restatement of financial reports?

Green Mountain Coffee revises its reconciliation of its GAAP net income and non-GAAP net income to comply with Regulation G

At least Green Mountain Coffee corrected its presentation of net income to non-GAAP net income to comply with SEC Regulation G, as I recommended in a February 13, 2011 blog post.

In its 10-Q report for the quarter ended December 25, 2010, Green Mountain presented the following reconciliation of its GAAP net income and non-GAAP net income:

In my February 2011 blog post, I pointed out that:

According to Regulation G, Green Mountain's non-GAAP net income is required to be reconciled to its most directly comparable GAAP measure, which in this case is GAAP net income. Accordingly, Green Mountain showed how its non-GAAP net income did not include acquisition-related expenses, SEC inquiry expenses, and amortization of identifiable intangibles. However, according to SEC Regulation G Compliance & Disclosure Interpretations, Green Mountain cannot provide side-by-side reconciliations of GAAP and non-GAAP numbers in such a way that it presents a full non-GAAP income statement. See below:

Question 102.10

Question: Is it appropriate to present a full non-GAAP income statement for purposes of reconciling non-GAAP measures to the most directly comparable GAAP measures?

Answer: Generally, no. Presenting a full non-GAAP income statement may attach undue prominence to the non-GAAP information. [Jan. 11, 2010].

In addition, I alerted the SEC about Green Mountain Coffee's violation of Regulation G.

In its 10-Q report for the quarter ended March 26, 2011, Green Mountain Coffee revised its reconciliation of GAAP net income and non-GAAP net income and no longer presented a full non-GAAP income statement. See below:

I've just started reviewing Green Mountain Coffee's latest 10-Q report and found even more troubling disclosures which I hope to detail soon.

Updated concerns

One issue that I am curious about is Green Mountain Coffee's costs related to the SEC inquiry and defending class-action lawsuits against the company. In the quarter ended December 26, 2010, it spent $5.989 million (pre-tax) in legal fees and other expenses and in the latest quarter ended March 26, 2011, it spent only $0.405 million (pre-tax). Under accrual basis accounting, expenses are recognized when incurred, not when paid. Below are my questions:

Question 1: Did Green Mountain Coffee pay sizable retainers to lawyers, accountants, and other experts in the quarter ended December 26, 2010 and expense the full amount in that quarter, rather than record them as a prepaid expense (asset) and expense those costs, as incurred, against income in future accounting periods?

Question 2: Did Green Mountain Coffee offset those costs with possible reimbursements from its D & O insurance carriers (assuming it has coverage)?

Question 3: If Green Mountain has insurance coverage, but did not accrue any possible insurance reimbursements, why didn't it disclose a gain contingency?

Written by:

Sam E. Antar

Disclosure

I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped my cousin 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 heroic 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. Often, I refer cases to them as an independent whistleblower. I teach about white-collar crime for professional organizations, businesses, and colleges and universities.

Recently, I exposed GAAP violations by Overstock.com which caused the company to restate its financial reports for the third time in three years. The SEC is now investigating Overstock.com and its CEO Patrick Byrne for securities law violations (Details here, here, and here).

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.

I do not own any Green Mountain Coffee Roasters or Overstock.com securities long or short. My investigations of these companies are a freebie for securities regulators to get me into heaven, though I doubt I will ever get there. My past sins are unforgivable.

Green Mountain Coffee Roasters: Murky Financial Disclosures

Updated

Just about every time, I examine financial reports issued by Green Mountain Coffee Roasters (NASDAQ: GMCR), I find new troubling accounting practices and financial disclosures. For example, in my last blog post I questioned whether the company correctly considered a certain accounting error as an "immaterial accounting error" when it was originally reported to investors. In this blog post, I will examine Green Mountain's segment reporting and non-GAAP financial presentations and raise questions whether they properly comply applicable accounting and SEC disclosure rules. In addition, I will discuss other new reporting errors disclosed by Green Mountain in its latest 10-Q report.

Last Saturday, fellow Seeking Alpha contributor Jason Merriam noted in his article that, "The accounting practices at Green Mountain Coffee Roasters (GMCR) are not baffling...they are downright ludicrous." I think Green Mountain's financial disclosures are both baffling and ludicrous.


Background

On September 20, 2010, the SEC notified Green Mountain Coffee Roasters that it was conducting an informal inquiry. It requested information concerning “revenue recognition practices and the Company’s relationship with one of its fulfillment vendors.” Eight days later, on September 28, 2010, Green Mountain surprised investors by disclosing news of the SEC inquiry in an 8-K filing.

In that 8-K report, Green Mountain also disclosed that it discovered an "immaterial accounting error" involving its K-Cup margin percentages which resulted in a $7.6 million cumulative overstatement of pre-tax income in financial reports issued from 2007 to June 26, 2010. Since Green Mountain determined that its K-Cup margin error was immaterial under accounting rules, it disclosed that it was going to correct that error by making a one-time cumulative adjustment to earnings in the latest quarter.

On November 19, 2010, Green Mountain disclosed three new overstatements totaling $3.2 million pre-tax income and one new understatement of $0.7 million in pre-tax income. These errors plus the K-Cup margin error resulted in a total overstatement of $10.1 million in pre-tax income. This time, the company said it would restate its financial reports issued from 2007 to 2010 to correct its errors.

In my last blog post, I questioned whether Green Mountain correctly determined that its K-Cup margin error was an "immaterial accounting error" when it was initially disclosed on September 28, 2010. Under SEC Staff Accounting Bulletin No. 99, an individual accounting error that overstates profits and causes a company to beat analysts' consensus earnings expectations for any reporting period should be considered a material accounting error.

My analysis showed that the K-Cup margin error caused Green Mountain to overstate profits and beat analysts' consensus earnings expectations in the quarter ended March 27, 2010. Therefore, Green Mountain should have considered its K-Cup margin error as a material accounting error on September 28, 2010 and it should have immediately disclosed to investors that it was going to restate its financial reports from 2007 to 2010 to correct that error. Instead, Green Mountain waited until November 19, 2010 to inform investors that it was going to restate its financial reports.

Below, I will examine certain other financial disclosures by Green Mountain and raise questions whether the company properly complied with GAAP and other applicable SEC disclosure rules.


Restating segment numbers without disclosing it

I compared Green Mountain’s segment reporting in its Q1, Q2, and Q3 2010 10-Q reports with the previously year’s corresponding 10-Q reports and found certain inconsistencies in amounts reported for income before taxes, total assets, and depreciation and amortization. For example, in its Q3 2009 10-Q report, Green Mountain originally reported the following selected segment information for the 39 weeks ended June 27, 2009:

In its Q3 2010 10-Q report, Green Mountain reported different segment numbers for the same period ending June 27, 2009:

In its Q3 2009 10-Q, Green Mountain reported that “Income before taxes” for the Keurig segment was $29.725 million for the “Thirty-nine weeks ended June 27, 2009.” However, in the Q3 2010 10-Q, Green Mountain reported that “Income before taxes” for the Keurig segment was $26.116 million for the same “Thirty-nine weeks ended  June 27, 2009” or $3.609 million less income than previously reported.  Apparently, Green Mountain revised its earnings for its Keurig segment by shifting $3.609 depreciation and amortization expense from Corporate and reallocated it to its Keurig segment.

SCBU and Keurig segment total assets

In the Q3 2009 10-Q, Green Mountain reported “total assets” of $412.413 million for its SCBU segment, $112.857 million for its Keurig segment, and $99.565 million for Corporate  as of June 27, 2009. However, in its Q3 2010 10-Q, Green Mountain reported “total assets” of $236.181 million for its SCBU segment, $240.859 million for its Keurig segment, and $14.936 million for Corporate as of June 27, 2009.

Changes in computing profits and assets for segments

In its Q3 2009 10-Q, Green Mountain disclosed that:

Corporate expenses also include interest expense, amortization of identifiable intangibles related to the acquisition of Keurig, as well as certain corporate legal expenses and compensation of the board of directors. All of the Company’s goodwill for the Keurig business unit and intangible assets related to the Keurig business unit are included in Corporate assets. [Emphasis added.]

However, in its Q3 2010 10-Q Green Mountain disclosed that:

Corporate expenses also include interest expense, certain corporate legal and acquisition-related expenses and compensation of the board of directors. In addition, fiscal 2009 corporate expenses are offset by $17,000,000 of proceeds received from a litigation settlement with Kraft. Corporate assets include cash and short-term investments.

Goodwill and intangibles related to the Frontier Natural Products Co-op, Tully’s, Timothy’s and Diedrich acquisitions are included in the SCBU reporting unit of the Company. Goodwill and intangibles related to Green Mountain Coffee Roasters, Inc.’s acquisition of Keurig are included in the Keurig reporting unit of the Company. [Emphasis added]

According to Green Mountain's Q3 2009 10-Q report, its "Corporate expenses" included “amortization of identifiable intangibles related to the acquisition of Keurig.” According to Green Mountain's Q3 2010 10-Q report, those same expenses were apparently “included in the Keurig reporting unit of the Company” instead of being considered as "Corporate expenses." In 2009, Green Mountain considered goodwill and intangible assets related to the Keurig as part of "Corporate assets." In 2010, those same goodwill and intangible assets were no longer "Corporate assets" but were included in the Keurig segment's balance sheet.

The re-allocation of goodwill and intangible assets seems to be the reason behind Green Mountain’s revision of its reported income before taxes for the thirty-nine weeks ended June 27, 2009 for its Keurig segment from $26.116 million in its Q3 2009 10-Q report to $29.725 million for the same period in its Q3 2010 10-Q report. In addition, the re-allocation of goodwill and intangible assets seems to explain why Keurig’s total assets as of June 27, 2009 was revised upward from $112.857 million in its Q3 2009 10-Q report to $240.859 million in its Q3 2010 10-Q report for the same June 27, 2009 date.

Green Mountain’s murky financial disclosures do not seem to explain why the company made downward revisions of its total assets for its SCBU segment as of June 27, 2009 from $412.413 million in its Q3 2009 10-Q report to $236.181 million in its Q3 2010 10-Q report.

Did Green Mountain comply with segment reporting rules under GAAP?

According to Statement of Financial Reporting Standards No. 131 (SFAS No. 131):

31. An enterprise shall provide an explanation of the measurements of segment profit or loss and segment assets for each reportable segment. At a minimum, an enterprise shall disclose the following…. d. The nature of any changes from prior periods in the measurement methods used to determine reported segment profit or loss and the effect, if any, of those changes on the measure of segment profit or loss.

However, Green Mountain made no reference to any change in its "measurement methods" used to determine profit and losses for its segments from 2009 to 2010. The company did not disclose that it revised 2009 earnings for its Keurig segment. As detailed above, Green Mountain revised its income before taxes for the thirty-nine weeks ended June 27, 2009 for its Keurig segment from $26.116 million in its Q3 2009 10-Q report to $29.725 million for the same period in its Q3 2010 10-Q report. According to SFAS No. 131, Green Mountain Coffee should have disclosed that it changed its computations for reporting profits for its Keurig segment. The company effectively restated its segment numbers without telling anyone.

Compensation issues

In its latest proxy statement Green Mountain disclosed that:

Our incentive compensation plans are typically based on corporate and business unit performance, measured by a range of objective and subjective criteria, and not solely on individual performance.

I was unable to determine from Green Mountain's financial disclosures if it made any compensation adjustments resulting from it revising profits for its Keurig segment for the thirty-nine weeks ended June 27, 2009.

Green Mountain’s Non-GAAP Disclosures

Over the last couple of years, I’ve identified many instances of public companies violating of Securities and Exchange Commission (SEC) Regulation G governing non-GAAP financial measures. In each case, those companies corrected their financial reports to properly comply with Regulation G after I notified them about their violations.  As I will detail below, Green Mountain needs to revise its presentation of non-GAAP net income to comply with SEC Regulation G.

For example, in its Q1 2011 10-Q report the Green Mountain presented the following reconciliation of its GAAP net income and non-GAAP net income:

According to Regulation G, Green Mountain's non-GAAP net income is required to be reconciled to its most directly comparable GAAP measure, which in this case is GAAP net income. Accordingly, Green Mountain showed how its non-GAAP net income did not include acquisition-related expenses, SEC inquiry expenses, and amortization of identifiable intangibles. However, according to SEC Regulation G Compliance & Disclosure Interpretations, Green Mountain cannot provide side-by-side reconciliations of GAAP and non-GAAP numbers in such a way that it presents a full non-GAAP income statement. See below:

Question 102.10

Question: Is it appropriate to present a full non-GAAP income statement for purposes of reconciling non-GAAP measures to the most directly comparable GAAP measures?

Answer: Generally, no. Presenting a full non-GAAP income statement may attach undue prominence to the non-GAAP information. [Jan. 11, 2010].

For example, NightHawk Radiology Holdings, Inc. made a similar reconciliation of GAAP and non-GAAP numbers and provided a full non-GAAP income statement in its 8-K report dated filed on February 17, 2010. See below:

On April 2, 2010, the SEC Division of Corporation Finance reviewed NightHawk Radiology Holdings 8-K report:

1. We note that you have presented an alternative income statement which excludes certain items recorded in your GAAP-basis Statements of Operations. This represents a full non-GAAP income statement which does not appear to be consistent with Regulation G. Please confirm in future Exchange Act filings you will remove such presentation or tell us why you believe it is appropriate. For additional guidance, refer to Question 102.10 of the Compliance & Disclosure Interpretations regarding Non-GAAP Financial Measures.

On April 14, 2010, NightHawk Radiology Holdings responded to the SEC Division of Corporation Finance:

The Company confirms that it will remove from future filings the presentation referred to above in this Comment 1 and replace it with a reconciliation table that is consistent with the guidance provided in the Answer to Question 102.10 of the Compliance & Disclosure Interpretations regarding Non-GAAP Financial Measures.

On May 6, 2010, NighHawk Radiology Holdings issued its 10-Q report and made a proper reconciliation of its non-GAAP adjusted net income to GAAP net income in compliance with Regulation G:

This time, NighHawk Radiology Holdings reconciled its non-GAAP adjusted net income to GAAP net income without providing a full non-GAAP income statement. Green Mountain should do the same.

Continuing financial reporting problems

In its Q1 2011 10-Q report, Green Mountain disclosed that it made errors in its previously audited fiscal year-end consolidated statement of cash flows:

Revision to Fiscal 2010 Year-End Consolidated Statement of Cash Flows

In preparing the consolidated financial statements for the thirteen weeks ended December 25, 2010, management identified that certain amounts previously disclosed within the Consolidated Statement of Cash Flows for the fiscal year ended September 25, 2010 required reclassification. These misstatements had no effect on the Company’s cash and cash equivalents. Specifically, the supplemental disclosure of fixed asset purchases included in accounts payable and not disbursed was overstated by approximately $8.2 million. This resulted in an $8.2 million understatement on the capital expenditures for fixed assets line and net cash used for investing activities category for fiscal 2010 and a corresponding understatement of the change in accounts payable line and an overstatement of net cash used in operating activities. The Company will make this immaterial correction when the 2010 financial statements are next issued.

The company reported continuing material weaknesses in internal controls over financial reporting for its latest quarter:

Under the supervision of and with the participation of management, including the Company’s Chief Executive Officer and Chief Financial Officer, the Company conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended, as of December 25, 2010. Based on that evaluation and the material weaknesses referenced above, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were not effective as of December 25, 2010. [Emphasis added].

Closing comment

In its Q1 2011 10-Q report, Green Mountain disclosed that it was spent about $6 million on "legal and accounting expenses related to the SEC inquiry, the Company’s internal investigation and pending litigation" or approximately $46,000 per week during the quarter. According to Green Mountain's latest proxy statement, the combined annual base salaries for fiscal 2010 of its top five executive officers are just $2.01 million. In other words, in a single quarter Green Mountain spent three times the annual base salaries of its five top executive officers on legal and accounting issues arising from its restatements of financial reports.

The company's Audit Committee and Board of Directors recommended that "shareholders ratify the Audit Committee’s appointment of PricewaterhouseCoopers LLP" as its auditors. From 2007 to Q3 2010, every single financial report issued by Green Mountain which was audited or reviewed by PricewaterhouseCoopers needed to be restated due to material accounting errors. To date, no member of Green Mountain's board, none of its executive officers and certainly not its auditors have been held accountable for any errors in financial reporting.

Written by:

Sam E. Antar

Recommended reading:

February 11, 2011: Dag Blog -"Crazy Eddie" Fraudster Sam Antar To Return To Crime - Thanks to Darrell Issa & Anti-Regulation Republicans by William K. Wolfrum

Disclosure

I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped my cousin 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 heroic 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. Often, I refer cases to them. I teach about white-collar crime for professional organizations, businesses, and colleges and universities.

Recently, I exposed GAAP violations by Overstock.com which caused the company to restate its financial reports for the third time in three years. The SEC is now investigating Overstock.com and its CEO Patrick Byrne for securities law violations (Details here, here, and here).

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.

I do not own any Green Mountain Coffee Roasters or Overstock.com securities long or short. My investigations of these companies are a freebie for securities regulators to get me into heaven, though I doubt I will ever get there. My past sins are unforgivable.