Are Bidz.com's Stock Buy Backs a Wise Move?

Why are Bidz.com (NASDAQ: BIDZ) insiders selling shares as the company is buying back shares, especially when management has claimed that the company’s shares are undervalued? Legendary investor Warren Buffett, CEO of Berkshire Hathaway (NYSE: BRKA), was once said:

Now, repurchases are all the rage, but are all too often made for an unstated and, in our view, ignoble reason: to pump or support the stock price... We will not repurchase shares unless we believe Berkshire stock is selling well below intrinsic value, conservatively calculated." [Emphasis added.]

Does Bidz.com’s share repurchase program really build “intrinsic value” or is it a short-term ploy “to pump or support the stock price” as insiders sell their shares?

During the Q2 2008 earnings call, CFO Lawrence Kong claimed:

As of July 31, 2008, we had repurchased a total of approximately 1,024,000 shares in the open market for a total of $8.8 million at an average price of $8.58 per share. We continue to repurchase in the open market under the stock repurchase program and still have approximately $11.2 million for additional share repurchases under our current program. The stock repurchase program reflects our continued confidence in the market opportunity and strategy and what [inaudible] appears to be at the undervaluation of our stock at current levels. We believe our stock to be a strong investment opportunity and a good use of our cash resources. [Emphasis added.]

Lawrence Kong claimed that, “We believe our stock to be a strong investment opportunity…..” Yet, most recently on September 3, 2008, Lawrence Kong sold 53,801 shares and pocketed gross proceeds of $239,764 or about $8.98 per share. Kong and other Bidz.com insiders have unloaded about 480,000 shares so far this year, pocketing gross proceeds in excess of $5.2 million, while the company has been repurchasing its stock (Source: SEC Form 4 Reports).

In some instances, Bidz.com has paid more money per share to buy back its shares, than the price per share received by insiders who sold their shares. For, example, in May and June 2008, Bidz.com repurchased 54,000 shares and paid $501,714 or about $9.29 per share. By comparison, Lawrence Kong recently sold 53,801 shares at an average price of $8.98 per share.

In certain other instances, other insiders have also sold their shares for less money per share than the company, at times, paid to buy back shares on the open market. For example, in February 2008, CEO David Zinberg sold 5,000 shares at $7.50 per share for gross proceeds of $37,500. That same month, Marina Zinberg (Vice President and sister of David Zinberg) sold 15,000 shares at $7.49 per share and received gross proceeds of $112,350. In March 2008, Bidz.com repurchased 433,827 shares at an average price per share of $8.11.

Does Bidz.com management personally hold the same views on the value of company stock as officially espoused by the company?

Examining Share repurchases for the six months ended June 30, 2008

While Lawrence Kong has claimed that Bidz.com’s share repurchase program is a “good use of our cash resources,” during the six-months ended June 30, 2008, the company utilized significant financial resources to repurchase shares of common stock. That resulted in very low cash balances at the end of Q2 2008 and the company had to draw on its line of credit to make certain inventory purchases.

During the first six months of fiscal year 2008, BIDZ.com repurchased 823,297 shares, paying $6.965 million or an average price of $8.46 per share (Source: Q1 2008 10-Q report and Q2 2008 10-Q report). During that same period, reported net income was $8.22 million and net cash provided by operating activities was $3.342 million. Therefore, the company’s expenditures for share repurchases amounted to 85% of reported net income and more than twice the amount of net cash provided by operating activities. At the end of the second quarter, the Bidz.com cash balance dropped $5.975 million to a mere $618,000 from $6.593 million in the previous quarter.

As of June 30, 2008, Bidz.com’s reported net working capital of $31.877 million. However, the company’s working capital comprised almost entirely of inventory totaling $54.732 million, which took on average about 120 days to sell during the six-month period. In a previous blog post, I raised serious questions about Bidz.com’s compliance with GAAP in valuing inventory.

In addition, by June 2008, the company spent a cumulative total of $7.85 million to repurchase 923,297 shares since the beginning of its stock repurchase program in 2007. The stock repurchase program reduced available net working capital by about 20%. With relatively low cash balances totaling $618,000 and most of its working capital tied up in low turnover inventory, Bidz.com had to utilize its line to credit to make certain inventory purchases. As of June 30, 2008, Bidz.com owed $5.6 million under its line of credit.

During the Q2 2008 earnings call, CFO Lawrence Kong claimed:

Our positive cash flow and revolving line of credit provide us with strong liquidity to continue to successfully grow the business. [Emphasis added.]

However, as detailed above, about twice the amount of net cash provided by operating activities was utilized to buy back stock during the first six-months of the fiscal year. During the six-month period ended June 30, 2008, Bidz.com expended $6.965 million or $3.623 million in excess of cash flows of $3.342 million to repurchase its common stock. The end result was a low cash balance of $618,000 and and line of credit balance of $5.6 million. In effect, Bidz.com's share repurchases are being financed in part with short term credit. It is a risky move to use a revolving line of credit to fund stock repurchases and the same time use it to provide funds to operate a business.

Are Bidz.com's share repurchases really a good long term use of shareholder resources at this time? I don't think so.

To be continued….

Written by,

Sam E. Antar (former Crazy Eddie CFO and a convicted felon)

Disclosure: Not long or short Bidz.com securities

To BIDZ.com CFO Lawrence Kong: Is BIDZ reporting inventory in compliance with GAAP?

To Lawrence Kong (BIDZ.com CFO):

Hopefully you read my previous blog item that raised a question if BIDZ.com (NASDAQ: BIDZ) is complying with GAAP in reporting inventory. I listened to BIDZ.com's presentation at Citibank’s Small & Mid-Cap Conference. You explained BIDZ.com’s inventory reserve disclosures as follows:

We record a reserve equal to difference between the lower of cost of inventory and the average selling price. This means that if the average selling price for an item is less than our cost we will record a reserve. We also reserve 100% against any inventory that is over one year old. And this is fairly standard practice. [Emphasis added.]

Sorry Lawrence, you cannot write down inventory to the "average selling price" under GAAP. You can use net realizable value (estimated selling price less costs of completion and disposal) to determine the lower of cost or market in valuing inventory, if net realizable value is lower than cost. BIDZ.com may use net realizable value (not average selling price) only when the current replacement cost of such inventory exceeds net realizable value. Did BIDZ.com even consider current replacement cost when valuing inventory at the lower of cost or market? Why did BIDZ.com use "average selling price" instead of net realizable value?

In addition, you cannot arbitrarily take a 100% reserve against inventory just because BIDZ.com held it for more than one year, too. Are you claiming that all inventory held over one year suddenly becomes completely worthless in the matter of a single day (from day 365 to day 366)?

You claim that BIDZ.com uses “fairly standard practice” in valuing inventory held for more than one year. Take a look at Securities and Exchange Commission Staff Accounting Bulletin No. 99:

GAAP Precedence Over Industry Practice

Some have argued to the staff that registrants should be permitted to follow an industry accounting practice even though that practice is inconsistent with authoritative accounting literature. This situation might occur if a practice is developed when there are few transactions and the accounting results are clearly inconsequential, and that practice never changes despite a subsequent growth in the number or materiality of such transactions. The staff disagrees with this argument. Authoritative literature takes precedence over industry practice that is contrary to GAAP. [Emphasis added.

So please don’t give me that "standard practice" nonsense. Public companies are required to follow GAAP – PERIOD.

By the way, I was reading BIDZ.com's SEC Form S-1 dated March 17, 2006 for the company's initial public offering. The prospectus contained the following inventory disclosure:

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. [Emphasis added.]

BIDZ.com’s inventory disclosure for financial statements contained in the S-1 report (above) seems arbitrary and not in compliance with GAAP, too. Did the value of inventory held over six months suddenly drop 50% in a single day? Did BIDZ.com compute the market value (as required under GAAP) for inventory held less than six months? Did BIDZ.com actually compute the current replacement cost and net realizable value of inventories disclosed the the above S-1 report? What factors and computations did BIDZ.com use in reporting a 50% drop in value for inventory held more than six months? The same questions apply to inventory held for more than one year, too.

In addition, you should know that intentional departures from GAAP, even if they are immaterial, are not permitted by SAB No.99. As I detailed in my previous blog item, SAB No. 99 states:

Facts: A registrant's management intentionally has made adjustments to various financial statement items in a manner inconsistent with GAAP. In each accounting period in which such actions were taken, none of the individual adjustments is by itself material, nor is the aggregate effect on the financial statements taken as a whole material for the period. The registrant's earnings "management" has been effected at the direction or acquiescence of management in the belief that any deviations from GAAP have been immaterial and that accordingly the accounting is permissible.

Question: In the staff's view, may a registrant make intentional immaterial misstatements in its financial statements?

Interpretive Response: No. In certain circumstances, intentional immaterial misstatements are unlawful. [Emphasis added.]

One more thing. During the conference you said that BIDZ.com had "a clean accounting opinion." Please don't hide behind your accounting firm. As a crook, I ran circles around my auditors. Therefore, you, your audit committee, and your auditors are respectfully requested to carefully review all of BIDZ.com's accounting disclosures from day one in light of the questions I have raised.

Kindest regards,

Sam E. Antar (I am not the Sith Lord but I am a criminal mastermind from the 1980s and a convicted felon)

PS: To the analysts attending investment conferences. Grow a pair of balls and ask smart questions. Softballing is a career hazard. You have been warned by a convicted stock swindler.