At the end of fiscal year 2008, business was merrily humming along at Liquidity Services (NASDAQ:LQDT), an online marketplace for wholesale surplus and salvage assets such as consumer electronics, apparel, and technology hardware. As other companies were crumbling everywhere, Liquidity Services' business was booming. It was simply unfazed by the current market malaise, with no signs of letting up.

That's partly a testament to the power of network effects, a force that has helped Liquidity as well as large caps such as UPS (NYSE:UPS), CME Group (NASDAQ:CME), and Visa (NYSE:V).

Total revenues were up 33% in 2008, with sales in the company's own marketplaces up 54%. The company nearly reached one million registered buyers, up 46% in just a year. And among the proverbial cherries on top, adjusted diluted earnings per share were up 19%.

What happened?
From where, then, did the asteroid that hit Liquidity's fiscal first quarter come? Revenues of $55.6 million and adjusted diluted earnings per share of $0.03 missed both the company's guidance and Wall Street's expectations by a wide margin, and were both down year over year.

But the real bombshell of the quarter -- which the company's press release didn't highlight -- was that the company lost $8.7 million in operating cash during the quarter, compared to a gain of $7.5 million in the previous year. That's an astounding $16.2 million year-over-year swing in cash flow from operations. I think it's fair to say that the enterprise value/free cash flow calculus that used to make Liquidity enticingly attractive has been dramatically undermined.

According to the company, the culprit responsible for this fiasco of a quarter was a 45% decline in Liquidity's scrap business due to declines in commodity prices -- which the company really couldn't have avoided -- along with aggressive in-store discounting during the holiday season. The discounting kept goods off the secondary marketplace, which is Liquidity's bread and butter.

Despite expecting a significant decrease in merchandise volume flowing through its marketplace, the company nonetheless maintained its 2009 earnings guidance of $0.45 to $0.47 per share, based on several operational improvements and contract changes that it says should help the bottom line. Color me very skeptical. Wall Street probably won't believe them either.

What's next?
Stepping back, however, it appears that Liquidity's disappointing quarter was simply the product of a vicious economy and nothing more. The more relevant question for investors is whether the company's business model and competitive advantage still remain intact, enabling it to flourish despite this temporary setback.

My answer to that is an emphatic yes. Even in a bad quarter, merchandise volumes still rose 21% year over year, registered buyers gained 44%, transaction volumes jumped 71%, and auction participants were up 53%. Liquidity's market remains very relevant.

Nonetheless, I wouldn't blame investors for taking this stock to the woodshed. After this quarter, it has a lot more to prove.

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Devon Rackle does not own shares in any of the companies listed in this article. UPS is a Motley Fool Income Investor recommendation. Try any of our Foolish newsletters, free for 30 days. The Fool has a disclosure policy.