Bidz.com: Inventory and Cash Flow Concerns 35 comments
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Bidz.com, Inc. (BIDZ) has recently been scrutinized for its low free cash flow that is responsible for negative net cash balances. In addition, Bidz.com’s inventory levels and appraisal methods have been questioned by publications such as the Los Angeles Times.
The inventory issue is particularly important according to the Joseph T. Wells (Founder of the Association of Certified Fraud Examiners). In an article published by the Journal of Accountancy, Mr. Wells wrote that “inventory overstatements made up the majority of asset valuation frauds”. He went on to state:
Dishonest organizations usually use a combination of several methods to commit inventory fraud: fictitious inventory, manipulation of inventory counts, non-recording of purchases and fraudulent inventory capitalization. All these elaborate schemes have the same goal of illegally boosting inventory values.
Inventory Risks at Bidz.com
The Journal of Accountancy report provided 10 questions used to evaluate the probability of inventory fraud. According to Mr. Wells, “the more “yes” answers, the higher the risk for inventory fraud”. The following analysis applies these tools to Bidz.com’s inventory:
- Is the company attempting to obtain financing secured by inventory? Yes
In July 2006, we entered into a revolving credit line agreement with LaSalle Bank (Bank of America), to provide working capital financing secured by inventories and tangible assets.
Source: Bidz.com Form 10-K Filed on March 12, 2008 with Securities and Exchange Commission
- Is inventory a significant balance sheet item? Yes
Over the past three years, Bidz.com’s inventory has comprised between 78.3% and 89.7% of its total assets. This compares to 13.0% and 10.6% in 2007 for competitors Blue Nile, Inc. and Overstock.com, Inc. respectively.
Source: Form 10-Ks Filed with Securities and Exchange Commission
- Has the percentage of inventory to total assets increased over time? Yes
Bidz.com’s inventory has significantly increased as a percentage of total assets from 64.3% in 2001 to 89.0% in 2006. See table below (click to enlarge images):
Source: Bidz.com Forms Filed with Securities and Exchange Commission
- Has the ratio of cost of sales to total sales decreased over time? Yes
The Company’s ratio of cost of sales to total sales has decreased over time, as illustrated below:
Source: Bidz.com Forms Filed with Securities and Exchange Commission
- Have shipping costs fallen compared with total inventory? Information not available in Securities and Exchange Commission filings.
- Has inventory turnover slowed over time? Yes
Bidz.com’s inventory turnover has significantly decreased from 8.5x in 2003 to 3.3x in 2007 (as shown below). In addition, the Company’s turnover is substantially below its most direct competitors of 15.3x and 31.2x in 2007 for Blue Nile, Inc. and Overstock.com, Inc. respectively.
Source: Bidz.com Forms Filed with Securities and Exchange Commission
- Have there been significant adjusting entries that have increased the inventory balance? Information not available in Securities and Exchange Commission filings.
- After the close of an accounting period, have material reversing entries been made to the inventory account? Yes
In 2007, Bidz.com’s inventory reserve increased 133.2% over the previous year’s balance.
Source: Bidz.com Form 10-K Filed on March 12, 2008 with Securities and Exchange Commission
- Is the company a manufacturer, or does it have a complex system to determine the value of inventory? Yes
Bidz.com’s valuation methods for its jewelry have been criticized by numerous groups. The Los Angeles Times had this to say about their “appraisals”:
Bidz.com often offers buyers an "appraisal" of their item for a $33 charge. The reports are invariably produced by Woodland Hills-based American International Gemologists, which acknowledged to The Times that it does not physically inspect every item for which it provides an appraisal.
That raised a red flag for Jeanine Woodling, director of education at the nonprofit International Society of Appraisers. For a solid appraisal, "It's important for them to actually be able to see the piece," Woodling said.
- Is the company involved in technology or another volatile or rapidly changing industry? Yes
Consumer tastes and preferences for jewelry products can change rapidly, thereby exposing us to significant inventory risks.
Source: Bidz.com Form 10-K Filed on March 12, 2008 with Securities and Exchange Commission
Results: It appears that the answer would be “Yes” for 8 out of 10 questions and inconclusive for the remaining two. According to Mr. Wells’ work, this would indicate a higher risk of inventory fraud.
Bidz.com Cash Flow Concerns
Partially as a result of its inventory issues, Bidz.com’s operations do not generate cash. The Company’s net cash position is negative and substantially lower than its competitors as illustrated below:
Source: Forms Filed with Securities and Exchange Commission
In addition, the Company’s cash flow from operations and free cash flow are becoming increasingly negative.
Source: Forms Filed with Securities and Exchange Commission
Investment Considerations
Taking the inventory and cash flow concerns into account, investors should be cautious.
Disclosure: Author has a short position in BIDZ
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This article has 35 comments:
See secinfo.com/d12TC3.z66...
Michael Stewart is the VP of Operations at Builders Fixed Income Fund Inc. From their disclosures:
"Short Sales. The Fund may engage in short sales against the box, which involve
selling a security that the Fund owns, or a security equivalent in kind or
amount to the security sold short that the Fund has the right to obtain, for
delivery at a specified date in the future. The Fund may enter into a short sale
to hedge against anticipated declines in the market price of ProLoan
mortgage-backed securities or to reduce portfolio volatility. If the value of a
security sold short increases prior to the scheduled delivery date, the Fund
loses the opportunity to participate in the gain. If the price declines during
this period, the Fund will realize a short-term capital gain. Although the
Fund's gain is limited by the price at which it sold the security short, its
potential loss is unlimited. The Fund will segregate cash or liquid securities
in the amount of its short position, and the segregated assets will be marked to
market daily. "
“Is the company attempting to obtain financing secured by inventory?”
This is often used as collateral and effectively proves nothing against the company. Additionally, as indicated in their conference call, BOA thus routinely sends auditors to physically check their inventory. No accounting fraud can magically make inventory magically exist. If one were to apply this criterion to all businesses, they would think that everyone was fraudulent. At this point in the market, it is extremely hard to get a loan. Yet, Bidz did. This is a testament to the solid nature of their business.
This one is funny. Note that the author uses an outdated figure and ignores the fact that their inventory has actually gone down as a percentage of assets from 89.0% to 78.3% from 2006 to 2007. In reality, for a growing business, this is not an abnormal quantity of inventory. The author shows his face on this by intentionally cherry picking the facts that he uses.
See above. One again note the author's cherry picking of facts.
This is an odd one to use to claim fraud given that it’s also the hallmark of a successful business and the goal of any business. This is effectively trying to use the growth and success of their business as innuendo. It’s completely ridiculous.
As Bidz have grown, they have become more able to purchase inventory. As a result of this, they have opted to purchase more. They are clearly able to sell whatever they purchase. Bidz is probably more easily compares to say Zales than Blue Nile as Blue Nile takes a lot of inventory on consignment. Zales turnover averages around 2.5 or 2.6, a number that Bidz has always been above. Additionally, they had cash of roughly 60 million, debt of roughly 165 million and negative cash of around 125-130 mil.. Maybe we should start to short Zales as they’re clearly fraud using the authors ridiculous criteria.
In 2007, Bidz.com’s inventory reserve increased 133.2% over the previous year’s balance."
This is a daft attempt by known shorter Stewart if I’ve ever seen anyone. This was not the result of a reversing entry. They have more inventory now. Consequently, by applying the same logic to a higher quantity of inventory, they have a larger reserve. To claim that this involves a reversing entry, is both erroneous and slanderous. If Steward has to use a lie as bald faced as this, it’s clear that he doesn’t have much for ammunition.
This one is just dumb. Hedge fund honcho Stewart claims that the LA Times, quoting Citron, trashing their appraisals means that their inventory valuations are wrong. I could dispute the erroneous allegations about their inventory appraisals, but that’s for another time and another day. In reality, their inventory valuations have nothing to do with the appraisals. The inventory is valued at lower of FIFO cost or market. So, this has nothing to do with the appraisals as they are based on the actual worth of the item, not the lower of cost or market.
Consumer tastes and preferences for jewelry products can change rapidly, thereby exposing us to significant inventory risks.”
That’s a standard disclosure that any consumer company has to make some form of. In reality, the jewelry business is more constant than most. That statement was meant to refer to tech businesses and things along those lines. Anyone can take anything and twist the words. A good person does it well. Stewart, the VP of Operations at Builder’s Fixed Income Fund, is not good at this. His assertions do not even remotely stand up under the light of day. He is nothing but a huckster and a charlatan attempting to make a quick buck by bending the truth to the point of outright lies.
I think this really says it all. The fact that he's entirely full of it and can't even come up with a cogent argument to support his short position is just gravy.
drmalaka, you said bidz sucks, how? from all the negative articles, they did say clear and couldn't prove it. they just tried to blur people's eyes. if bidz sucks, why it can keep growing every quarter and SEC didn't do any investigation? or maybe SEC did, but counldn't find any problem in bidz.
I'm going to short this one tomorrow. thx
Truth be told I do worry though about any listed asset which is small enough to fit in someone's pocket.....
If any of you understood how the concept of how markets work you would not care. Since you all love the company I would assume you are long term investors. Short term moves in the stock should not matter to you, in the long run the stock will go to its true value.
The shorts are creating a buying opportunity for you. If they are so wrong then there will be a short squeeze very soon and you will have been idiots yelling at the shorts and not thanking them for the cheap stock price.
I have read a lot about the company and all the negative stuff was more convinving. Then you add in the incredibly weakening economy which will probably hit this company hard.
Everyone has a right to their opinion, don't lambast the author and think you can do anything to help the stock, let the markets do that.
Good luck being long this one.