INVESTMENTS and FINANCE: Web of Homestore Filings

Corporate Focus
by Anthony Palazzo

Even for an Internet company, Homestore.com Inc.'s (Nasdaq: HOMS) Securities and Exchange Commission filings are difficult to understand, with their extensive footnotes and complex side deals with partners like Budget Group Inc. and AOL Online, a unit of AOL Time Warner Inc.

So last week's announcement that the filings were not only indecipherable but flat out wrong, actually clarified a few things, while raising new questions about which shoe might drop next.

The Westlake Village-based Web site said a preliminary investigation into accounting practices by the audit committee of Homestore's board found that it overstated on-line advertising revenues by between $54 million and $95 million in the first nine months of 2001. In other words, out of a total of $119 million in advertising revenue Homestore has reported through Sept. 30, 2001, as much as 80 percent isn't legit.

The looming restatement comes as little surprise.

Among Homestore practices that have drawn past ire are the use of stock to pay operating expenses, such as marketing costs, and the use of so-called "roundtrip" accounting. In these transactions, Homestore exchanges goods and services with a partner, and then records them as revenue and expense items based on values assigned.

"If I give you $10 million, then you turn around and send the $10 million right back to me and I book it, that $10 million went out of my left pocket and right back into my right pocket," said Lynn E. Turner, the former SEC accounting chief who is now a professor at Colorado State University.

Barter agreements

Homestore's audit committee has identified a number of purportedly revenue-producing transactions that should have been treated as barter, because the purchase of advertising on Homestore's site was tied to purchases of goods and services by Homestore.

Homestore said it might discover other material misstatements in 2001 and in 2000.

Homestore's stock hasn't traded since the inquiry was announced on Dec. 21 two weeks after its chief financial officer, Joseph Shew, resigned unexpectedly. The company is "working closely" with both Nasdaq and the SEC, said company spokesman Gary Gerdemann.

Indeed, the revelations might only have just begun. "I wish I had two weeks to go through these (filings)," Turner said.

Homestore's fate may hinge on the resolution of deals with two of its marketing partners, Budget and AOL. In each of the deals, signed in the first half of 2001, Homestore issued stock to its partner and guaranteed that the price would remain at certain levels all above $60 a share at future dates beginning in March 2002. If the stock fell below these levels, Homestore would have to make up the difference, in stock, in cash or by buying it back at the high price.

The two deals put Homestore on the hook for up to $65 million in the Budget agreement and $90 million with AOL, whose put options start to kick in next year. With $206 million in cash, equivalents and restricted cash at Sept. 30, and its stock price quickly imploding (it fell below $10 on Sept. 20 and never recovered), Homestore began looking for ways out of the agreements.

Claims against AOL

In November, the company filed an arbitration request with the American Arbitration Association, claiming that AOL didn't deliver to Homestore the amount of traffic promised in their five-year marketing and distribution agreement. (Homestore spokesman Gerdemann said the arbitration procedure hasn't yet started.)

Homestore also renegotiated its deal with Budget, settling the stock-price guarantee which was to begin in March by issuing 4.8 million additional shares, then valued at $24.2 million. The only problem: On Nov. 1, two days after the new deal was announced, Homestore issued third quarter results that cut in half the value of the shares it had just issued. And now, it turns out, even those results can't be relied upon.

In early November, Budget began selling some of its Homestore stock, said Sarah Lewensohn, director of investor relations for Budget, based in Lisle, Ill. But with trading suspended, Budget is stuck with however many shares it couldn't unload prior to announcement of the accounting inquiry. Knowing then what it knows now, would Budget have accepted all those Homestore shares? "It's not a question we would answer," Lewensohn said.

Will Budget, like many other shareholders, take legal action?

"As a shareholder we are monitoring it closely but we do not have any further comment at this time," Lewensohn said.



Financial Editor Anthony Palazzo can be reached at 323-549-5225, ext. 224 or at tpalazzo@labusinessjournal.com.

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