IT Value

Botched ERP Hookup Spurs Restatement

Overstock.com says it "failed to hook up some of the accounting wiring" and will revise more than five years of results.
Stephen TaubOctober 24, 2008

Overstock.com says it will restate its financial results for a five-and-a-half-year period because of problems in implementing an Oracle enterprise resource planning program.

The controversial Internet retailer, which has aggressively sparred with short sellers and other hedge funds in the past few years, says the revisions to its 2003–2007 results probably will reduce revenue by $12.9 million and increase cumulative net loss by $10.3 million.

“The short version is: when we upgraded our system, we didn’t hook up some of the accounting wiring; however, we thought we had manual fixes in place,” said Patrick Byrne, chairman and CEO, in a letter to shareholders. “We’ve since found that these manual fixes missed a few of the unhooked wires. It also turned out there were errors cutting both ways which partially obscured the problem because we relied on reasonability testing to verify certain balances rather than a ground-up reconciliation.”

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In a separate letter to shareholders, senior finance vice president David Chidester took responsibility for the company’s financial reporting. “I am extremely disappointed that we have a restatement and I owe you an explanation of what happened,” he said.

Chidester said he is confident the company has identified and fixed the problem. He explained that as part of a major system upgrade in 2005 that included its accounting system, one change was that instead of recording refunds to customers in batches, it now recorded them transaction by transaction. “When we issue a customer refund, the refund reduces the amount of cash we receive from our credit card processors and, as a result, our financial system should reduce our accounts receivable balance,” he said. “After the implementation, in the instance of some customer refunds, this reduction wasn’t happening, and we didn’t catch it.”

Chidester said the company uses internal “reason codes” to track the reasons it gives customer refunds. Trouble was, under the new system not all reason codes were automatically recorded. Some customer refunds required manual entry in the financial system.

“We set up automatic and manual processes so that these would be recorded,” Chidester elaborated. “Unfortunately, we missed some of the manual customer refunds, and as a result, we did not record all that were occurring.” Over time, this error built up and, on a cumulative basis, eventually became material, he conceded.

Separately, the finance executive said that on a much smaller scale, the company found that the system did not reverse out shipping revenue for cancelled orders as it should have, and these $2.95 charges also added up over time.

Chidester also pointed out that these errors were partially masked by an offsetting error that made overall cost of returns appear reasonable. In the past two years, Overstock underbilled its fulfillment partners for some returns-related costs and fees, he said.

“In other words, we weren’t recording some customer refunds and we weren’t recouping some costs from partners on some returns,” he added. “The combined result was that our returns costs looked reasonable. We have corrected the under billing problem and are initiating a process to collect a portion of the amounts owed, which we will record as we receive them.”

Chidester also assured that the company has reexamined its procedures for testing and verifying its balance sheet. He said he has put into place processes to record all refunds in the financial system, and as a further check, it is reconciling refunds and the related balance-sheet accounts to the credit card and bank statements rather than relying on a reasonableness test. To ensure that it records refunds in the proper period, the company also adjusted its reserve for returns in each period based on actual return experience.

This is not Overstock’s first restatement. In February 2006, it announced it would restate its financials for the four years ended 2005 to correct an error related to accounting for freight costs. Overstock disclosed at the time that the misstatements stemmed from its practice of expensing the cost of delivering freight to its warehouses immediately, rather than capitalizing these costs as a component of inventory and expensing them as the inventory is sold.

In August 2005, Overstock filed a lawsuit against hedge fund and noted short seller Rocker Partners, since renamed Copper River Partners, and several affiliated entities: David Rocker (who ran Rocker at the time), Marc Cohodes (who currently runs Copper River), and others, alleging they conspired to denigrate Overstock’s business for personal profit.

In February 2006, Byrne accused Rocker Partners and research firm Gradient Analytics of engaging in a conspiracy to drive down the company’s share price.

In November 2007, Copper River went on the offensive, filing a lawsuit against Overstock, Byrne, and a number of directors alleging they made false statements and projections to boost the company’s stock price. The hedge fund also asserted that the company launched a “deceptive and malicious campaign to silence” its critics, including members of the press and research firms.

Last week Overstock announced it had settled all claims against Gradient Analytics and its principals and officers. Overstock provided a statement from Gradient that said: “Having reviewed all SEC filings, relevant accounting literature, and all other information available to it, Gradient now believes that, to the best of its knowledge, Overstock’s stated accounting policies did in fact conform with Generally Accepted Accounting Principles (GAAP) and regrets any prior statements to the contrary.”

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