More Questions on BIDZ.com's Inventory Disclosures

In two previous items on my blog (here and here), I examined BIDZ.com’s (NASDAQ:BIDZ) inventory disclosures and raised questions about the company’s compliance with GAAP in valuing inventories. In this blog post, I will examine some of BIDZ.com’s historical inventory disclosures. From fiscal year 2005 to 2007, it seems that while BIDZ.com’s piled on massive amounts of inventory and inventory turnover decreased (in other words merchandise stayed in BIDZ.com’s stockrooms for longer periods of time) the company switched to a less conservative method to value its inventory at the lower of cost or market. Both of the methods used by BIDZ.com to value its inventory at the lower of cost or market don't seem to be in compliance with GAAP and may violate Securities and Exchange Commission Staff Accounting Bulletin No. 99 which prohibits even immaterial departures from GAAP.

BIDZ.com’s Fiscal Year 2005 10-K inventory disclosures

In BIDZ.com’s 10-K for fiscal year 2005, the company made the following disclosure about the company’s inventory:

Inventories: Inventories consist of merchandise purchased for resale and are stated at the lower of first-in, first-out cost (FIFO) or market. We record reserves against our inventory for estimated obsolescence or damage equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. We record reserves of 50% of the value of inventory held for more than six months and 100% of the value of inventory held for more than one year. If actual market conditions are less favorable than those projected by us, specific reserves or additional inventory write-downs may be required.

Note: Bold print and italics added by me.

Like other inventory disclosures that I have examined in my previous blog items, BIDZ.com’s inventory disclosure for its fiscal year 2005 10-K does not seem to be compliance with GAAP. As detailed above, BIDZ.com recorded “reserves of 50% of the value of inventory held for more than six months and 100% of the value of inventory held for more than one year.” It does not appear that BIDZ.com in the company's 2005 10-K used any of the three allowable measures under GAAP to value its inventory at the lower of cost or market: current replacement cost, net realizable value, or net realizable value less normal profit margins.

Why did all inventory held for six months suddenly lose half its value in a single day (from day 182 to 183)? Why did all inventory held by the company beyond one year suddenly lose its entire value in a single day (from day 365 to 366)? Does BIDZ.com really claim that a blanket reduction in value of 50% for all inventory held more than six months represents either current replacement cost, net realizable value, or net realizable value less normal profit margin? Unless inventory held more than one year is worthless crap and can in effect be tossed away in the garbage, the lowest allowable measure for determining market under GAAP is net realizable value less normal profit margins.

Inventory at the lower of cost or market under GAAP

BIDZ.com’s automatic reduction of inventory values by a fixed percentage of its original cost based on the number of days such inventory is held seems contrary to the requirements of Accounting Research Bulletin (ARB) No. 43 for valuing inventory at the lower of cost or market as detailed below. As I described in a previous blog post:

According to Accounting Research Bulletin (ARB) No. 43, inventory must be valued at the lower of cost or market value. Market means the current replacement cost of inventory. If the current replacement cost of inventory is greater than its net realizable value (estimated selling price less cost of completion and disposal), net realizable value is considered market. If the current replacement cost of inventory is less than its net realizable value minus normal profit margins, than net realizable value minus normal profit margins is considered market. Therefore, the upper limit of market is net realizable value and the lower limit of market is net realizable value minus normal profit margins. Lower of cost or market may be applied to each individual inventory item, the total of each major category of inventory, or the aggregate total of inventory.

In the fiscal year 2005 10-K disclosure above, BIDZ.com’s automatic reduction of the value of inventory held more than six months to 50% of its original cost basis and automatic reduction of the value of inventory held for more than one year to zero does not appear to be any one of the three appropriate measures of market (current replacement cost, net realizable value, or net realizable value less normal profit margins) as defined by ARB No. 43.

Next, let’s examine a certain BIDZ.com inventory disclosure in a Form S-1 Registration Statement issued after the 2005 K-1

On June 29, 2006, BIDZ.com filed an amendment to its Form S-1 Registration Statement and included the following disclosure about inventory levels and inventory turnover:

We attempt to reduce inventory obsolescence by managing the product offerings available for auction at any given time. However, as our inventory balances increase and inventory turnover decreases, we anticipate that our reserves for inventory obsolescence may increase.

Note: Bold print and italics added by me.

In BIDZ.com's S-1 Registration Statement disclosure above, the company warned investors that as the company’s “inventory balances increase and inventory turnover decreases,” future reserves against inventory may increase. However, as detailed below, BIDZ.com later changed its method of valuing inventory at the lower of cost or market to a less conservative method that resulted in the company recognizing less inventory reserves and higher gross profit margins in future accounting periods. In addition, both the prior method and new method of valuing inventory at the lower of cost or market used by BIDZ.com do not seem to be in compliance with GAAP.

BIDZ.com’s inventory disclosure for the second quarter of fiscal year 2006

According to BIDZ.com’s second quarter fiscal year 2006 10-Q, the company changed its method of valuing inventory at the lower of cost or market to a less conservative method which resulted in lower inventory reserves and higher gross margins as inventory levels piled up and inventory turnover was significantly decreasing:

Inventory Reserve

We record reserves against our inventory for lower of cost or market equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. Beginning from the three months ended June 30, 2006 we will only record reserves of 100% of the value of inventory held for more than one year and will no longer record reserves for 50% of the value of inventory held for between six months and one year. If the previous method of estimating reserves had been used, the inventory reserves would have been higher by $138,000.

Note: Bold print and italics added by me.

As detailed above, beginning in the second quarter of fiscal year 2006, BIDZ.com “will only record reserves of 100% of the value of inventory held for more than one year and will no longer record reserves for 50% of the value of inventory held for between six months and one year.” Previously BIDZ.com recorded “reserves of 50% of the value of inventory held for more than six months” and up to one year. The company continued to write-down the value of all inventory held more than one year to zero value. According to BIDZ.com’s 10-Q disclosure above, the company claimed that its change of method in valuing inventory at the lower of cost or market resulted in an immediate reduction of inventory reserves and an increase in gross profits of $138,000.

How did BIDZ.com determine estimated market value for inventory held less than one year beginning in the second quarter of fiscal year 2006? For a clue, we need to examine the company’s 10-K inventory disclosure for fiscal year 2006:

Inventories:

Inventories consist mainly of merchandise purchased for resale and are stated at the lower of first-in, first-out cost (FIFO) or market. We record reserves against our inventory for lower of cost or market equal to the difference between the cost of inventory and the average selling price. In addition, for the year ended December 31, 2006 we recorded reserves for obsolete and slow moving inventory of 100% of the value of inventory held for more than one year. For the year ended December 31, 2005, we recorded reserves of 50% of the value of inventory held for more than six months and 100% of the value of inventory held for more than one year. If actual market conditions are less favorable than those projected by us, specific reserves or additional inventory write-downs may be taken.

Note: Bold print and italics added by me.

According to BIDZ.com’s fiscal year 2006 K-1, above, the company recorded reserves against its inventory “for lower of cost or market equal to the difference between the cost of inventory and the average selling price.” If BIDZ.com used such a measure to determine report market in the second, third, and fourth quarter of fiscal year 2006, the company’s reported inventory does not seem to be in compliance with GAAP.

As I pointed out in my previous blog items examining BIDZ.com’s inventory disclosures, “average selling price” is not net realizable value (estimated selling price less costs of completion and disposal). Net realizable value can only be used as market value for inventory if it is less than the estimated replacement cost of such inventory and net realizable value is less than the cost basis of such inventory, too.

If we assume that BIDZ.com’s average selling price used by the company to value inventory at the lower of cost or market is less than its estimated replacement cost, than BIDZ.com is understating its inventory reserves and overstating its gross profits by not deducting the estimated costs of completion and disposal from its inventory values. If the current replacement cost of BIDZ.com’s inventory was less than its net realizable value but higher than its net realizable value less normal profit margins, than inventory reserves would be understated and gross profits would be overstated by an even greater amount: the difference between the average selling price used by BIDZ.com to value inventory at the lower of cost or market and its lower current replacement cost. Furthermore, if the current replacement cost of BIDZ.com's inventory is less than its net realizable value less normal profit margins than the company's inventory reserves would have been understated and gross profits overstated by a still higher amount: the difference between the average selling price used by BIDZ.com and the even lower net realizable value less normal profit margins. Therefore, neither BIDZ.com’s fiscal year 2005 10-K inventory disclosures, second quarter fiscal year 2006 10-Q inventory disclosures, nor its fiscal year 2006 10-K inventory disclosures appear to be in compliance with GAAP.

At a minimum, in the second quarter of fiscal year 2006, BIDZ.com chose a less conservative method to value its inventories at the lower of cost or market as inventory levels piled up and inventory turnover dramatically decreased. As detailed above, according to BIDZ.com’s inventory disclosure in its second quarter fiscal year 2006 10-Q, “If the previous method of estimating reserves had been used, the inventory reserves would have been higher by $138,000.” The key question is how much higher would inventory reserves have increased and gross profits decreased in the following quarters and fiscal years as BIDZ.com’s inventory levels substantially increased and inventory turns dramatically decreased, if the company had not changed its method of valuing inventories?

Selected data from BIDZ.com's financial statements

See the chart below:

Fiscal Year	2005	2006	2007
Cost of good sold (in thousands)	$71,257	$100,633	$132,683
Ending inventory, net of reserves (in thousands)	$15,921	$34,308	$56,686
Inventory turnover based on average inventory amount	5.35	4.00	2.92
Average days of inventory outstanding based on average inventory and cost of goods sold	68.26	91.09	125.16
Inventory reserves (in thousands)	$331	$461	$1,071
Inventory reserves as a percentage of gross inventory	2.04%	1.33%	1.85%

The average number of days that inventory remained in BIDZ.com’s stockrooms increased by about 23 days from 68.26 days at the end of 2005 (before the company’s change of method in estimating the market value of its inventory) to 91.09 days at the end of 2006 (after the company’s change of method in estimating the market value of its inventory) or about a 33% increase in the time it took the company to sell its inventory. However, the inventory reserves as a percentage of gross inventory dropped from 2.04% at the end of 2005 to 1.33% at the end of 2006 or a 34.8% reduction in relative inventory reserves. As detailed above, when BIDZ.com changed its method of valuing inventory at the lower of cost or market in the second quarter of fiscal year 2006, the company immediately recognized a $138,000 reduction in reserves and increase in gross profits. As BIDZ.com held on to its inventory about 33% longer at the end of 2006 compared to 2005, it is probable that inventory reserves would have been significantly higher had the company not changed its method of valuing inventory to a less conservative method in the second quarter of fiscal year 2006.

At the end of fiscal year 2007, the average number of days that inventory remained in BIDZ.com’s stockrooms was 125.16 days compared to 91.09 days at the end of fiscal year 2006 and 68.26 days at the end of fiscal year 2005. Therefore, at the end of fiscal year 2007 BIDZ.com held on to inventory almost twice as long as compared to fiscal year 2005 (125.16 days in 2007 versus only 68.26 days in 2005). However, at the end of fiscal year 2007 inventory reserves as a percentage of gross inventories was 1.85% compared to fiscal year 2005 at 2.04%. Therefore, while the average amount of time inventory remained in BIDZ.com’s stockrooms almost doubled from 68.26 days in 2005 to 125.16 days in 2007, the relative amount of inventory reserves declined by about 10% from 2.04% of gross inventory in 2005 to 1.85% of gross inventory in 2007.

As the number of average days (125.16 days) that inventory remained in BIDZ.com’s stockrooms in fiscal year 2007 got closer to more than six months (183 days), it is probable that a relatively larger portion of such inventory was held for more than six months compared to fiscal year 2005 when the average was only 68.26 days. Therefore, if BIDZ.com had continued to automatically write-down inventory held more than six months to 50% of its original cost basis, rather than use an amount “equal to the difference between the cost of inventory and the average selling price,” it is probable that the company’s inventory reserves would have been much higher at the end of fiscal year 2007. In any case, BIDZ.com's apparent use of “average selling price” rather than net realizable value for determining market resulted in lower reported inventory reserves and higher gross margins, too.

To be continued....

Disclosure: No postion

Comments

[Numbersman]

Go blow your smoke some place else. Your points were previously refuted and yet to still continue to beat this "inventory" dead horse. You love to use terms like, "don't seem to be" and "may violate". Either they do or they don't or they are or aren't. I'm sick and tired of your innuendos. Move on!!!

[no news]

This guy stated on another post that he guided through life by a Sith Lord.. Can anyone take anything this guy says seriously....

Who would write they are guided though life by a Sith Lord? Star Wars is NOT REAL.... YOU can not communicate with Sith Lords....

No one believes people who claim the Sith Lord inspires them to research a company named BIDZ...

You can deny you have been telling people the Sith Lord guides you.

That is amazing.... Hey man.... Good luck in life... oh wait, did you use that Sith Lord comment when you were convicted?

[no news]

BIDZ is literally a gold mine.... Everyone has a chance to buy this stock at a great price.... I don't mind posting this.... because after earnings... I will follow this up with the current stock price and you will see..... Instead of listening to a guy who claims the Sith Lord guides him.... Invest in a good company now and send this guy back Star Wars...

[no news]

Here is where he states the Sith Lord inspires him.... what a joke...
messages.finance.yahoo...

[drmalaka]

Another group of pro BIDZ commenters. Do you guys get paid to troll sites and write good things about the company? How about you guys post your own articles on why the company is so great.

I don't know how to read this news, it seems to state the same point over and over, so a three paragraph article seems to turn into a really long one.

What I do know is that when analyzing a company I certainly do not like to see accounting shenanigans and changes like they are making. I also don't like to see a company with that kind of inventory build up.

Good luck to you long plays, it looks like you may need a lot of it, especially as the retailers keep getting killed by the economy.

[no news]

BIDZ is not a retailer.... Value shoppers will go to bidz... Inventory goes up because they are buying closeout at basement pricing...

I'm glad you liked the article that was inspired by a Sith Lord....

I'm not a paid pumper, I am a loyal customer of BIDZ and I can buy great products and I don't have to pay retail prices. The profits are real and the company is real.... A bunch of haters are trying to ruin this company and I don't care to read about it. I will defend good USA companies... Not hate of them to make a buck...

And I can't stand around and let others be guided by a man claiming he gets inspired by a Star Wars evil character called a Sith Lord..

It's just silly and we can't allow this anymore....

[Frustone]

Which would you rather have…..a warehouse storing US Dollars or a warehouse storing precious metals at "lower of cost or market"?
With precious metal prices where they are, BIDZ’ inventory sounds like a non-depreciating “no brainer” asset to me; a reservoir of potential cash liquidity or standby company “life preserver”.
I originally invested in Bidz knowing that it's inventory could be a "wild card", an asset, not a liability. When the company decided to expand warehousing capabilities and capacity (increase inventory) I supported it completely.
To answer my own question…..right now, I would rather have a warehouse storing precious metals at "lower of cost or market".

[foolishboy]

We, the stockholders of BIDZ, have been through all of these assault by innuendo blogs. After a "well intentioned" article appears, such as this one written by Sam Amar, the only affect is to drive the stock down. Because of the sensational earnings and the way this company is run, the stock has always corrected itself and tried to head higher in value. This is inspite of the fact that up until mid-March, there were 4,300,000 shorts, either real or naked, which were a driving force in trying to stop and reverse any upward movement the stock was trying to take. Within the last week and a half, the storts, either naked or real, have decreased to around 3,200,000. Within the last week, you can see the begining of a possible short squeeze, and the stock, on a low volume has bee bouncing off of $9.00 a share. In spite of Sam Amar's recent article. Instead of coming to the table and stating a fact, that such and such is wrong and here is why it is wrong, Mr. Amar attackes by innuendo, hint or suggestion, he attempts to make a case against BIDZ. In his opening remarks, he states that IT SEEMS, while BIDZ wa piling on inventory, and then he suggests that the methods used by BIDZ to value inventory, MAY VIOLATE........ and the he states IT DOES NOT APPEAR, that in 2005 BIDZ used any allowable means under GAAP to value its inventory. My question about all of this is to question the motiviation of Mr. Amar to submit such a POS for publication in financial circles. There is not one shred of solid evidence to show any improper conduct on the part of BIDZ. Through these repeat type of aricles subitted by Mr. Amar, he is developing a history of malice against this company. My question goes to Mr. Amar. Why are you so inclined to drive this company into oblivion? Is Mr. Amar a shill for certain hedge funds or investment groups, or firms that hold a portion of the 3,000,000 shorts that are just waiting for this stock to plummet? What are you getting for this hatchet job Mr. Amar???????????

[jimmy46]

great blog,
the inventory numbers don't lie

[LBC]

Sam, you should make sure that your check from the short sellers clears before you write your next post. They are getting squeezed and will screw you over like the criminals they are when you no longer serve their purposes. But you should know all about criminal behavior by now...

[BigCoxy]

Sam, I would like to see your response to foolishboy? I guess in all the other answers given when lawsuits are brought up you always say, "bring them on". Well, we know why, it is because you never actually make a statement as a fact in any of your articles. If you are so sure of yourself lets see some real facts from you other than the "It appears" and "It seems" nonsense. I think you don't make statements as facts because you know you would be hung out to dry.

Kindest Regards,
BigCoxy (never been convicted and trying to do the right thing since the mid 70s)

[no news]

He can't say too much.... He said it all when he said he was inspired to investigate bidz accounting from "the sith lord"... What kind of person believes in Sith Lords, let alone communicates with them...

How can someone ever publish his works...

[BigCoxy]

Looks like the shorts are beginning to be squeezed. That said, it was a nice try to get Sam "The convicted criminal mastermind felon inspired by the sith lord and is proud of his criminal past and turning on his own family" Antar to attempt a final smear piece. A piece that was cleverly rahashing the same garbage in order to manipulate the price so they can illegally line their own pockets.

Correction, criminal masterminds don't get caught.
Kindest Regards,
BigCoxy (Seeing through the BS that is price manipulation since May 4, 1993)

[SIMONEV]

Net Income 8,213 3,563 2,915 3,435
Operative CF (3.2) (2.4) 0.2 0.2

This company is buying much more than they will sell...
This could happen once or twice... not every year since its birth...

[BigCoxy]

The growth in inventory is feeding buyz.com, also their sales is growing so your statement that they are buying more than they can sell is hogwash. That said, I'm sure there will be more blogs issued that state "It seems" or "It appears" to attempt to illegally manipulate the share price. I wouldn't expect anything less from those that look to destroy others through lies and innuendos to further themselves.

[SIMONEV]

If "The growth in inventory is feeding buyz.com" then earnings should reflect in cash flows.
Why operative cash flows are negative? Where is going the cash coming from earnings?
Please help me understanding this company just answering these questions.