buyers volume, page-8

re: an issue of trust Adultshop with its pants down

September 12, 2002
TUESDAY'S explanation by the directors of Adultshop.com as to why their bullish profit forecasts went so spectacularly wrong was an unsatisfying experience.

So much so, that it's arguable the market in the stock is uninformed and that the Australian Stock Exchange should have maintained a suspension on trading until it was provided with satisfactory answers.

Instead, the ASX reinstated trading, and in the past two days more than 40 million shares changed hands, with the share price gaining 3c to 14c after sales of up to 15.5c.

It's believed that the ASX market surveillance division is examining heavy selling of the company's shares in the face of the bullish forecasts by the company. It's also suggested that the ASX is considering a reference to the corporate regulator, the Australian Securities and Investments Commission.

Market talk persists that there has been heavy "shorting" and "covering" going on in the Adultshop market (selling shares which are not owned and supplying them by buying at a lower price), which, on the face of it, would have been an extremely risky practice given the extraordinary growth picture that the company was forecasting.

Adultshop, which peddles erotica online, reported revenue of $37.8 million and a maiden profit of $272,000 for the December 2001 half year, and on May 13 forecast revenue of $80.8 million and profit of $5.36 million for the June half year, escalating to revenue of $106.5 million and profit of $11.6 million for the December half year.

The company also said it had $6.6 million cash at December 2001 and forecast that it would increase to $17.4 million by June 2002 and $30.35 million by December 2002.

On July 25, the company reported that cash flow for the June quarter was $6.336 million and that the cash balance was $17.49 million, marginally exceeding the forecast. Chief executive Malcolm Day said that performance reinforced the positive outlook for 2002-03.

The company's share price was then 36c, but it dropped under heavy selling pressure. On August 7, the ASX queried the company when the share price hit 23.5c, but the directors said they were not aware of any information which would explain the recent trading.

On September 2, the company sought a trading halt pending an announcement. The following day it obtained a suspension of quotation pending the release of its profit results for 2001-02 and "an announcement with respect to its previously projected results for the December half year".

On September 5, the company reported a profit of $5.63 million for the year to June, slightly ahead of the forecast, but revised downward its forecast for the December half year. Instead of an $11.6 million profit and cash reserves of $30.35 million, the directors now expect a loss for the half year and cash reserves of $10 million to $12 million – $18 million to $20 million less than forecast!

That suggests a loss of $5 million to $7 million for the half year, which would mean a turnaround of more than $17 million in the expected profitability. The directors said that trading losses were expected to be contained in the September quarter, and the company would trade profitably in the December quarter. EBITDA for the half year was expected to be in the range of $1 million to $2 million, compared with the forecast of $20.12 million.

Adultshop admitted to a problem with its credit billing which had resulted in a reduction in membership and consequent loss of revenue.

The ASX reinstated trading but also fired off a string of questions to Adultshop which demonstrated that it was not satisfied with the quality of the information provided by the company.

Essentially, the ASX wanted to know what was the basis for Adultshop's heroic earnings forecasts, and it wanted more information on the nature and extent of the problems referred to by the company.

Adultshop responded that it didn't know it needed to revise its forecasts until September 2. In late August, the company outsourced its credit billing functions which had resulted in an unforeseen 60 per cent fall in membership – from more than 300,000 to 115,000 – caused largely by the rejection of members in the credit card validation process.

Yet Adultshop maintained there was no need to restate revenue and earnings for 2001-02 and no problem with the June 30 receivables of $10.02 million. In fact, 90 per cent had been recovered since balance date, and the the remainder was expected to be received. It also defended the May forecasts, saying they were made on the conservative basis of likely trading patterns, taking into account historical sales, profits and cash flow.

Adultshop also said that many members who had been rejected in the validation process had been "happy, satisfied and financial customers". If that meant they paid for services rendered, then why did Adultshop accept their invalidation?

Many of the rejections occurred because of inconsistencies in the data fields used for the validation process, which suggests that the information supplied by some members was suspect . . . but two-thirds of the members?

Adultshop is saying there were no problems with payments and that its cash resources grew by $11 million in 2001-02 but are expected to fall by $5 million to $7 million in the current half.

Adultshop's response doesn't add up and the ASX should require a full explanation from the company