On Bidz.com's Questionable and Inconsistent Inventory Disclosures

In previous blog posts, I raised questions about Bidz.com’s (NASDAQ: BIDZ) compliance with GAAP in valuing inventories and the company’s history of inconsistent inventory disclosures. In Bidz.com’s latest 10-Q report for Q2 2008, the company has changed its inventory disclosures yet again. See the comparison of Bidz.com's Q2 2008 and Q1 2008 inventory disclosures below:

Bidz.com Q2 2008 10-Q:

Inventories

Inventories consist mainly of merchandise purchased for resale and are stated at the lower of first-in, first-out (FIFO) cost or market.

Inventory Reserve

The unique nature of our business model where customers set the prices they are willing to pay may result in items selling below our cost, and we provide reserves against our inventory based on the difference between the average selling price and the cost of inventory if the average selling price is lower than the cost of inventory. We also provide reserves for obsolescence and slow moving inventory.

Note: Bold print and italics added by me.

Now, compare Bidz.com’s Q2 2008 inventory disclosure to the company’s inventory disclosure in its Q1 2008 10-Q report:

Inventories

Inventories consist mainly of merchandise purchased for resale and are stated at the lower of first-in, first-out (FIFO) cost or market.

Inventory Reserve

The unique nature of our business model where customers set the prices they are willing to pay may result in items selling below our cost, and we provide reserves against our inventory equal to the difference between the average selling price and the cost of inventory if the average selling price is lower than the cost of inventory held for one year or less. We provide reserves for obsolescence and slow moving inventory at 100% of the cost of inventory held for more than one year.

Note: Bold print and italics added by me.

In Q2 2008, Bidz.com reported inventory reserves “based on the difference between the average selling price and the cost of inventory if the average selling price is lower than the cost of inventory.” In comparison, during Q1 2008 and certain prior periods, Bidz.com reported inventory reserves “equal to the difference between the average selling price and the cost of inventory if the average selling price is lower than the cost of inventory held for one year or less.” In addition, in Q2 2008 unlike Q1 2008 and certain prior periods, apparently Bidz.com did not write down the entire cost of inventory “held for more than one year.”

Why did Bidz.com change its inventory disclosures?

Subtle changes in company disclosures are no accident, since management, attorneys, and external auditors usually carefully review such disclosures.

For example, in Q1 2008 and certain prior quarters, Bidz.com wrote down the value of its inventory held less than one year “equal to the difference between the average selling price and the cost of inventory if the average selling price is lower than the cost of inventory.” However, as I described in a previous blog post, such inventory disclosures did not seem to comply with GAAP. Average selling price is not the same as net realizable value, since "average selling price" does not deduct the cost of completion and cost of disposal of inventory.

Therefore, in Q1 2008 and certain prior periods, Bidz.com possibly overstated the value of certain inventory held less than one year by the amount of the cost of completion and disposal of such inventory. In addition, according to Accounting Research Bulletin No. 43, BIDZ.com can only use net realizable value to report inventory at the lower of cost or market, if the current replacement cost of inventory is greater than its net realizable value.

As I detailed above, in Q2 2008 Bidz.com changed its calculation of inventory reserves to “reserves against our inventory based on the difference between the average selling price and the cost of inventory if the average selling price is lower than the cost of inventory.” By using the language “based on” rather than “equal to” the average selling price, in Q2 2008 unlike Q1 2008 and certain prior periods, Bidz.com now apparently further reduces its inventory value to take into account the costs of completion and disposal when it writes down such inventory to market. However, as detailed above, the company cannot arbitrarily use net realizable value to write down the costs of its inventory to market.

Inventory held more than one year

In Q1 2008 and certain prior periods, BIDZ.com disclosed that “We provide reserves for obsolescence and slow moving inventory at 100% of the cost of inventory held for more than one year.” In Q2 2008, the company did not provide any specific disclosure relating to inventory held more than one year. Instead, in Q2 2008 unlike Q1 2008, Bidz.com apparently provided reserves against its entire inventory “based on the difference between the average selling price and the cost of inventory if the average selling price is lower than the cost of inventory.”

Bidz.com’s Q1 2008 and certain prior period inventory disclosures for inventory held for over a year did not appear to comply with GAAP. According to Accounting Research Bulletin No. 43, the lowest amount that inventory can be valued at is net realizable value (estimated selling price less cost of completion and disposal) minus normal profit margins. Therefore, BIDZ.com's method of valuing inventory over a year old seemed arbitrarily based on the age of such inventory, rather than the application of GAAP. Unless such inventory cannot be sold under any circumstances, BIDZ.com cannot "record reserves of 100% of the cost of inventory held more than one year." Therefore, in this specific case, such inventory held for more than a year was possibly understated.

Since Bidz.com apparently no longer writes down the full value of inventory held for more than a year, we need to ask how the company reversed its previous full write downs of such inventory. Did the company sell out all inventory held for more than a year of did they readjust their reserves to a number “based on” the average selling price?

In Q2 2008, inventory total inventory reserves decreased to $509,000 in Q2 2008 from $919,000 in Q1 2008 or about a 45% decrease. In Q2 2008, Inventory reserves as a percentage of gross inventories decreased to 0.9% from 2.6% or about a 65% decrease in relative inventory reserves.

Other developments

A new Barron’s article (subscription required) written by Bill Alpert, details the shady pasts including criminal records of certain partners and associates of Biz.com CEO David Zinberg. Rachael Granby from Seeking Alpha provides further commentary on the Barron's article.

Disclosure: No position in BIDZ.

Comments

[chris_dress:]

Sam:

You criminal you...who is paying you?

2008 Sep 02 09:12 AM

[porch:]

Sam,

Unbelievable, you just happen to write another article after Rachel wrote one? This attack on BIDZ is so transparent, and you will be back in jail where you obviously belong. Didn't learn your lesson the first time huh? You know there is an investigation surrounding BIDZ stock manipulation and the coincidence of these articles? Don't drop the soap.

2008 Sep 02 09:19 AM

[Alma Templeton:]

Sam still hasn't answered my questions from March debunking his reading of GAAP. This article is also predicated upon that erroneous reading.

He also hasn't responded to queries about why he gave Barry Minkow 300k to commission a report on USANA, a company that many of the same people attacking Bidz were shorting at the same time.

Sam hasn't even practiced accounting since the 80's, when he ripped people off using primitive techniques. Back when he was doing accounting, people made journal entries on paper and balanced the books using a calculator. Sam investigating fraud is like a mainframe programmer giving someone Java advice, or a lawyer from the 1700's trying to draft a document about internet piracy.

Quite honestly, I'm surprised that the people who seek to attack Bidz.com didn't bother to come up with the dollars to pay off a more credible "expert." Sam is, to put it simply, a dinosaur. He's a has been who has been exposed ages ago attempting to get over on the reader with one last fraud.

I hope that Magic Consulting also covers his legal fees.

2008 Sep 02 10:04 AM

[Scott Evans:]

Alma, it's not surprising he won't answer your question.

2008 Sep 02 02:44 PM

[brow007:]

no position??
how about naked short positions??

2008 Sep 09 03:54 PM

[KEW1155:]

He makes a valid point about inventory manipulation - not to say that it is here or not, but that is one way to get it done.

that said, the inventory did go up in the 2nd Q although the gross margin on sales did not - generally if inventory is artifically increased you would get a higher margin.

Best to keep your awareness high.

2008 Oct 28 08:12 PM