10-K 1 a07-5984_110k.htm 10-K

 

 

 

UNITED STATES

OMB APPROVAL

 

SECURITIES AND EXCHANGE
COMMISSION

OMB Number: 3235-0063
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Washington, D.C. 20549

 

FORM 10-K

 

(Mark One)

x

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

For the fiscal year ended December 31, 2006

 

 

 

 

 

or

 

 

 

o

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                  to                  

Commission file Number  000-51257

BIDZ.com, Inc.

(Exact name of registrant as specified in its charter)

Delaware

 

95-4728109

State or other jurisdiction of
incorporation or organization

 

(I.R.S. Employer
Identification No.)

 

 

 

3562 Eastham Drive, Culver City, California

 

90232

(Address of principal executive offices)

 

(Zip Code)

 

Registrant’s telephone number, including area code      (310) 280-7373

Securities registered pursuant to Section 12(b) of the Act:  None

Title of each class

 

Name of each exchange on which registered

 

 

 

 

 

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $.001 par value

(Title of class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

o  YES

x  NO

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

o  YES

x  NO

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

x  YES

o  NO

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements

incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K

o  

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act (Check one):

Large accelerated filer  o

Accelerated filer   o

Non-accelerated filer  x

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).

o  YES

x  NO

 

The aggregate market value of the voting stock held by non-affiliates of the registrant based upon the price at which the common stock was last sold was approximately $63,173,000. For purposes hereof, directors, executive officers and 10% or greater shareholders have been deemed affiliates.  This determination of affiliate status is not necessarily a conclusive determination for others purposes.

The number of shares outstanding of the registrant’s common stock was 23.252,654 as of March 12, 2007.

DOCUMENTS INCORPORATED BY REFERENCE

Information required by Part III (Items 10, 11, 12, 13 and 14) is incorporated by reference to portions of our definitive proxy statement for our 2007 Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission within 120 days of December 31, 2006.

 




BIDZ.COM, INC.

ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 2006

Table of Contents

 

Page

 

 

 

 

 

 

PART I

 

1

Item 1. Business

 

1

Item 1A. Risk Factors

 

13

Item 1B.Unresolved Staff Comments

 

25

Item 2. Properties

 

25

Items 3. Legal Proceedings

 

25

Item 4. Submission of Matter to a Vote of Securities Holders

 

25

 

 

 

PART II

 

26

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

26

Item 6. Selected Financial data

 

29

Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

30

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

 

40

Item 8. Financial Statements and Supplementary Data

 

40

Item 9. Changes in and Disagreements With Accounting on Accounting and Financial Disclosure

 

40

Item 9A. Controls and Procedures

 

40

Item 9B. Other Information

 

40

 

 

 

PART III

 

41

Item 10. Directors and Executive Officers of the Registrant

 

41

Item 11. Executive Compensation

 

41

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

41

Item 13. Certain Relationships and Related Transactions

 

41

Item 14. Principal Accounting Fees and Services

 

41

 

 

 

PART IV

 

41

Item 15. Exhibits and Financial Statement Schedules

 

41

 

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Part I

Item 1.           Business

Overview

We are a leading online retailer of jewelry, featuring a live auction format. We have established our retail brand in the online marketplace by offering high-quality merchandise, a unique user-friendly shopping experience, and the opportunity for buyers to achieve significant cost savings versus traditional retail channels. A key to our success has been our ability to efficiently and effectively source jewelry merchandise and rapidly respond to changing consumer demands for certain jewelry. We offer our products through a continuous live format, featuring “no reserve” auctions, a $1 minimum opening bid, and a unique 15-second auction extension period that allows our auctions to continue until all bids are received. The majority of our auctions are short-term, often lasting less than one hour, providing immediate gratification to our customers and encouraging frequent visits and active viewing of our website. Our product inventory includes gold, platinum, and silver jewelry set with diamonds, rubies, emeralds, sapphires, and other precious and semi-precious stones; and watches. We offer to sell products through our website at www.bidz.com.

We sell to consumers looking for reliable bargains on jewelry. Because we purchase and retain all of our jewelry inventory onsite, we can provide our customers with timely service and delivery of their purchases. In addition, each item is inspected by one of our trained product specialists prior to its placement on our website, which assures our customers of the quality of their purchases of our products. We provide a trustworthy and secure buying environment with a 15-day return policy on all merchandise. We believe that some of our customers are resellers intending to sell our goods in secondary markets, such as on eBay, at local auctions, and through other retail channels. These resellers have the opportunity to purchase products at lower prices than they would receive from manufacturers or other distributors. Our auctions are conducted 24 hours a day, seven days a week. We also offer daily telephone customer support for payments, 24-hour live-help and e-mail customer support.

The following aspects of our innovative auction model differentiate us from other auction websites:

·                  a $1 minimum bid format with no reserve,

·                  interactive auctions with 15-second time extensions for all auctions each time a bid is received within 15 seconds of termination of the auction, and

·                  short-term auctions, often lasting less than one hour, providing our customers immediate gratification to encourage frequent visits and active viewing of our website.

There is no charge to a potential buyer for registering on our website or placing bids. Buyers have access to a broad selection of items without expensive additional markups or commissions to intermediaries. Our website offers detailed product information, including photographs of our merchandise. Our website also provides a dynamic display of auto-refreshing screens, enabling our customers to follow our in-progress auctions in real-time. Successful bidders are automatically notified when an auction is completed. To assist users further, we offer customer support via phone, live-help and e-mail seven days a week. We provide a mechanism for our customers to provide comments and feedback on their bidding and purchasing experience.

We purchase jewelry inventory directly from manufacturers and liquidators. We also closely monitor our sales trends to assess consumer demand for certain jewelry styles and categories and purchase such non-closeout inventory directly from manufacturers. We have eliminated various inefficiencies and mark-ups associated with traditional intermediaries in the jewelry market. Our sourcing model provides a critical alternative liquidation channel for manufacturers, for which disposal of closeout inventory represents a significant challenge. We have the flexibility to purchase a variety of lot sizes, and our centralized warehouse and fulfillment center enables our suppliers to ship their products to a single location, easing the burden on their infrastructures. We have developed a database of product descriptions and pictures that enables us rapidly to post inventory for sale. In addition, we

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closely monitor sales and gross margin trends of our products on a daily basis, allowing us to select carefully additional products for purchase and adjust supplier pricing as necessary.

We also maintain a Certified Merchant Program, which allows independent online merchants to sell on our auction website a variety of goods, such as art and collectibles. Items sold through our Certified Merchant program represented less than 1% of our net revenue in 2006.

History

We commenced operations in early 1998 by offering a limited selection of merchandise for sale on eBay’s website through our predecessor, Asset Lenders of America, a group of 11 collateral lending stores. In the fall of 1998, we formed Bidz.com, Inc., acquired Asset Lenders of America, and purchased the domain name www.bidz.com . In February 1999, we launched the www.bidz.com website and began offering closeout jewelry through our auction format. In November 1999, we merged Asset Lenders of America into our company.

Industry Overview

Growth of Online Commerce and the Online Auction Market

The Internet’s development into a significant global medium for communication, content, and commerce has led to substantial growth in online shopping and has provided online retailers with new opportunities to eliminate intermediaries from the traditional retail supply chain. Internet usage and online commerce continue to grow worldwide. The growth can be attributed to factors such as an increased awareness of the convenience of online shopping, an expanded range of products available online, improvements in security and electronic payment technology, and increased access to broadband Internet connections facilitating online shopping.

Online auction sites have created a robust global marketplace, which overcomes the inefficiencies associated with traditional auction purchasing while offering the benefits of online commerce. Companies such as eBay spearheaded the creation of a centralized online auction market, offering buyers a significantly broader selection of goods to purchase. Today, online auction sites offer significant convenience, allowing trading at all hours and providing continually updated product offerings. By leveraging the interactive nature of the Internet, our website also enables customers to experience the excitement of live auctions, including the competitive bidding process.

The Jewelry Market

Jewelry is designed and manufactured by a large number of manufacturers, generally with small operations. Jewelry manufacturers sell to a variety of wholesalers, distributors, and retailers. Jewelry in turn is sold to consumers through a variety of jewelry stores. The U.S. jewelry retail market consists primarily of small, independent stores, regional operators, and a limited number of national retail chains, such as Tiffany & Co., Zales, and Kay Jewelers. Multi-line department and discount stores and others also sell jewelry, such as Wal-Mart, Target, J. C. Penney, and Costco, as well as enterprises such as QVC and Home Shopping Network. Despite the presence of major jewelry retail chains, a majority of the jewelry retail business remains fragmented.

Manufacturers traditionally hold inventory to buffer against uncertain demand within their normal, offline sales channels. Manufacturers’ primary distribution channels consist of regular sales to major established retailers at wholesale prices and sales to wholesalers that service smaller retail chains. In recent years, several dynamics have shifted inventory risk from retailers to manufacturers, including the following:

dominant retailers insisting on just-in-time deliveries from manufacturers;

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dominant retailers often demanding to cancel orders mid-production and returning unsold merchandise;

rapid changes in style, color, or models, turning inventory into closeout merchandise;

incorrect estimates of consumer demand leading to overproduction; and

changes in a retailer’s financial situation or strategy resulting in cancelled orders.

Disposal of closeout jewelry represents a significant challenge for many manufacturers and liquidators. Manufacturers often use multiple channels, such as catalogs, resellers, liquidators, and small retailers, to sell their closeout jewelry inventory as a result of the wide variety in lot size of their products. Multiple channels create additional logistical burdens and reduce the control of manufacturers over distribution.

Manufacturers are often required to adhere to delivery and quantity specifications. If a manufacturer does not meet required delivery schedules or specifications, or products are unsold, the products may be returned to the manufacturer. In both cases, manufacturers rarely meet their costs on their closeout products. Manufacturers often opt to melt down the jewelry into its component parts and reconstruct jewelry pieces with current season styles. The melt-down process is difficult, requires skilled labor, and results in a very low return on manufacturing costs.

Our Value Proposition

Value to Buyers

Through online auctions on our website, we believe that we offer value to a broad range of customers by providing the following:

Bargain prices.     The price of all our products is dictated by the buyer alone based on that buyer’s valuation of the product. Therefore, many items offered on our website are sold at a substantial discount to the prices in traditional retail channels, such as at jewelry stores located in shopping malls. Our $1 minimum bid policy allows the savvy or lucky consumer the potential to purchase any product being auctioned for only $1, offering even greater value to the consumer. Regardless of the closing price, once an auction is closed, the final bidder will receive the product. We also offer an auto-bidding option under which customers may pre-bid for a product.

Entertaining auction format.     We offer our customers the excitement of winning an item that may not be available in the future. We offer short-term, live auctions, many lasting less than one hour, providing our customers an alternative to the traditional, longer auction format. We believe the shorter time frame of our auctions encourages repeat visits and active viewing of our website.

Broad product selection.     We offer a broad selection of jewelry, including rings, necklaces, earrings, bracelets, jewelry sets, and watches. Our selection includes gold and silver jewelry, as well as jewelry with precious and semi-precious stones. We also sell individual and sets of gemstones.

Product quality assurance.     We provide detailed and accurate descriptions of each product. Our trained product specialists inspect our jewelry, utilizing the Gemological Institute of America Diamond and Colored Stone Grading System prior to posting on our website for auction. We guarantee the quality of our products through our 15-day return policy on all of our merchandise with a money-back guarantee if the product is not as described on our website. Items that are returned that are identical to their description are subject to a restocking fee, which is 15% of the original purchase price. Shipping fees are non-refundable. Our commitment to quality and product description accuracy is demonstrated by consistently low return rates on our items, which were approximately 3% of all items sold in 2006.

Prompt fulfillment and responsive customer service.     We maintain in inventory all the products we offer on our website, enabling us to ensure prompt order fulfillment and delivery to our customers. Our customer service

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representatives are available seven days a week, via live-help and e-mail, and are trained to provide assistance and answer a broad range of questions regarding payment, delivery, and other matters.

Positive shopping experience.     Our easy-to-navigate website provides our customers with clear and detailed information about our products, including multiple photographs of many items. Customers can bid on our products 24 hours a day, seven days a week. Buyers are provided a five-day payment grace period on all products purchased.

Value to Suppliers

Jewelry manufacturers continually look for a cost-effective, efficient way to sell their regular and closeout inventory. Our ability to purchase jewelry in various quantities provides a critical one-stop inventory clearance alternative for manufacturers and an efficient sales channel for liquidators that purchase closeout inventory from manufacturers.

Single source for product disposition:     Unlike many multi-store retail chains that often require large lot purchases to stock appropriate levels of inventory at their multiple locations, we have the flexibility to buy and sell both small and large jewelry lots in a highly efficient manner. As a single source for the sale of regular and closeout jewelry products, we provide suppliers with greater control of distribution by reducing the need to spread products across multiple channels. In addition, manufacturers and liquidators are often required to adhere to stringent product quantity and delivery schedule requirements. Products not delivered on time or in exact amounts are returned. We have the flexibility to tailor our purchasing to a supplier’s needs with regard to quantity, variety, and timing.

Resolution of channel conflict:     Manufacturers seek to avoid liquidating their products through traditional retail channels in which their discounted products may be sold alongside their full-price products. Such side-by-side selling can result in weaker pricing and decreased brand strength, which is known as channel conflict or sales channel pollution. As a result, many manufacturers turn to liquidation wholesalers and discount retailers. These liquidation channels, however, provide manufacturers limited control over distribution and are unreliable and expensive to manage. Because we offer an alternate online distribution channel that focuses on the sale of jewelry, our suppliers are able to sell their discounted jewelry independently of their full-priced products. We believe this enables our suppliers to avoid customer confusion and potential loss of sales of their full-priced jewelry products.

Profitable alternative for suppliers:     We eliminate the various inefficiencies and mark-ups associated with traditional intermediaries, and our high volume of sales from a single location provides us with favorable inventory turnover and lower inventory carrying and handling costs versus traditional jewelry retailers.

Growth Strategy

Our objective is to become the leading online jewelry retailer. We intend to achieve this objective through the following strategies:

Expanding our customer base by maintaining and expanding our relationships with third-party search engines, Internet portals, and websites and by increasing our online advertising expenditures within these channels;

Enhancing sourcing relationships by expanding the number of suppliers from which we opportunistically purchase regular and closeout inventory, thereby assuring consistent availability of a wide variety of designs and styles of jewelry, and purchasing for cash from suppliers that do not extend credit terms and to obtain better supplier pricing;

Increasing the breadth and depth of our product offerings by increasing available inventory within specific jewelry categories, allowing us to make more jewelry categories available and enabling us to list more auction items on a daily basis; and

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Focusing on new international markets by expanding into and creating a strong presence in a number of English-speaking countries, including the United Kingdom, Canada, Australia, Ireland, and New Zealand, and introducing foreign language versions of our website for certain international markets.

Marketing

Our marketing strategy is designed to generate consumer traffic by increasing awareness of our website and recognition of our brand, building a loyal buyer base, and maximizing repeat purchases. Our website has experienced substantial growth in users and buyers, as evidenced through data compiled by us through the measurement tools on our website.

Our marketing and advertising efforts consist primarily of the following initiatives:

Search marketing:     We purchase search engine advertising primarily at an auction based price, which is paid each time a potential customer clicks on one of our advertisements. We currently maintain advertising relationships with, among others, Google (US, UK, Australia, Canada, European Union, South East Asia, Mid East and South America), Yahoo Overture (US, UK and Australia), Looksmart USA and MIVA for search engine advertising.

Online banner marketing:     We utilize banner advertisements and product data feeds from the largest banner advertising channels. We focus on contextual and behavioral advertisements that appear on websites related to jewelry, fashion, shopping and women’s lifestyle. The Company maintains portal advertising relationships with Yahoo, MSN, Casale Media, Advertising.com, ValueClick Media, Tribal Fusion and others. The fee structure for our purchase of banner advertisements is based on a set price for an action (such as clicks or new buyers), or on a cost per thousand basis, for which we pay a set fee per thousand banner advertisements that appear on the selected websites.

E-mail campaigns:     We utilize an electronic direct marketing program to encourage prospect activation, customer referrals, customer retention, repeat purchases and customer acquisition. This program includes permission-based e-mail marketing to visitors who indicate a desire to continue to receive product recommendations and promotional discounts. We purchase e-mail direct marketing for a set fee per thousand e-mails sent or for each new lead from websites and marketing agencies that meet our policies against spamming. We also purchase on a cost per action basis such as clicks, new registration users and new buyers.

Affiliate programs:     We attract customers by participating in affiliate programs. Our affiliate programs offer other website operators an opportunity to earn commissions by providing their visitors access to our website. We use Link Share for our U.S. and U.K. programs and Commission Junction for our European affiliate programs. We also work with several other Affiliate Networks including Azoogle, Hydra Media and CPA Empire. In so doing, we intend to extend the reach of our website and draw customers from a variety of other websites. By participating in our affiliate programs, website publishers earn volume-based commissions by directing customers to our website.

Sourcing Strategy

We purchase closeout inventory directly from manufacturers and liquidators. We also closely monitor our sales trends to assess consumer demand for certain jewelry styles and categories and purchase regular jewelry inventory directly from manufacturers. We have eliminated various inefficiencies and mark-ups associated with traditional intermediaries in the jewelry market. Our sourcing model provides a critical alternative liquidation channel for

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manufacturers, for which disposal of closeout inventory represents a significant challenge. We have the flexibility to purchase a variety of lot sizes, and our centralized warehouse and fulfillment center enables our suppliers to ship their products to a single location, easing the burden on their infrastructure. We have developed a database of product descriptions and pictures that enables us rapidly to post inventory for sale. In addition, we closely monitor sales and gross margin trends of our products on a daily basis, allowing us to select carefully additional products for purchase and adjust supplier pricing as necessary.

We identify manufacturers and liquidators with high-value products by capitalizing on our extensive experience in the jewelry industry. Our jewelry sourcing model capitalizes on our close industry relationships to avoid several layers of supply chain intermediaries and the mark-ups associated with additional intermediaries. We closely monitor the historical sales trends of our products on a daily basis.

We do not have any supply arrangements with our suppliers to purchase jewelry on favorable terms and conditions. We do not have any formal or binding supply agreements with any of our suppliers, manufacturers, distributors, or other suppliers. We purchase and carry in inventory all of the products we offer for sale to ensure availability and expedited delivery. Currently, we acquire inventories from our suppliers on a revolving credit basis, with payment typically due within 60 days. In an effort to achieve cost efficiencies and a more diverse supplier base, we have started to acquire substantially more products on a cash basis. This strategy will allow for more flexibility with respect to product selection, reduce our product costs, and enlarge our supply relationships by allowing us to purchase from vendors that do not extend credit to their customers.

In 2006, we started purchasing loose diamonds and semi-previous stones and delivering them to manufacturers to produce into finished jewelry inventory. This allows us to reduce our product costs and this source of inventory is expected to grow in future periods.

Merchandising Strategy

We seek to maintain profitability while providing variety and value to our customers by carefully selecting the types of products we post on our website at any given time, the duration of the auction for each item, and the frequency with which we repost comparable items after sales. We actively monitor our auctions and sales so that we are able to adjust continually the makeup and quantity of goods on our website at any given time. Since bids on all company-owned merchandise start at $1, losses are incurred on approximately 15% to 25% of the items sold on an annual basis. The risks associated with a $1 minimum bid auction are mitigated by profits generated from items sold at a gain, which resulted in an overall 23.7% gross profit margin in 2006.

We post more expensive items with longer auction durations, typically running for two to three days, allowing customers to peruse the piece and make thoughtful decisions. Less expensive items are selected for shorter auctions, typically running for an hour or less, creating more excitement for the product and providing the customer with more immediate gratification. Items purchased in bulk are slotted for posting sequentially so that all items simultaneously posted on our website are unique.

Certified Merchant Program

We created the Certified Merchant Program to provide our customers the opportunity to purchase products beyond just those in our inventory.  Online auctions offer merchants the ability to minimize their risk of price erosion on unsold products.  This opportunity has created great interest in our Certified Merchant Program.  We ensure that the same value and reliability we provide to our customers is also provided by our Certified Merchants through a comprehensive application process and continued monitoring of Certified Merchants participating in the program.

All prospective program participants must complete an on-line application and is required to provide a list of references and a copies of both a business and a reseller license. Additionally, each applicant must submit a valid credit card to be kept on file at our offices. We review each application and contact references for each applicant.  We also conduct background checks of each applicant through Dunn & Bradstreet or the Better Business Bureau.

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If selected to participate in the Certified Merchant Program, the Certified Merchant must agree to comply with our rules, policies and regulations.  All Certified Merchant products listed on our website must be in stock and available for immediate shipment. All Certified Merchants must offer a 15-day money back guarantee on all products listed on our website. We manage and monitor compliance of our Certified Merchants through customer complaints and verify all complaints immediately.  We have a “No Tolerance” rule for unethical activities, or any activities that violate the consumers’ trust.  At our discretion, if any Certified Merchant engages in activity unacceptable to us, such Certified Merchant’s products will be immediately removed from our website and the Certified Merchant will no longer be permitted to participate in our program.

If a customer bids on and wins a product on our website listed by a Certified Merchant, the customer will purchase the product not through our website but by making the payment directly to the Certified Merchant. The Certified Merchant is expected to ship the purchased product to the customer within 7 days of receipt of the payment.

As of December 31, 2006, we have approximately 40 Certified Merchants. We maintain only the larger Certified Merchants and discontinued business with smaller merchants.  From April 2006, most Certified Merchants are allowed to sell without a fee to us. This is intended to attract good Certified Merchants and provide a greater variety of products on our website. We intend to expand our Certified Merchant Program by creating relationships with leading established retailers of electronics, hard to find collectibles, and other products.

Technology Operations

Both our website user interface and back-office transaction processing systems are internally developed. This proprietary system maintains records for our registered users, sales invoicing and cash receipts, auction transactions, inventory control, and historical transaction data. Our system handles all aspects of the auction process, including notifying users via e-mail of auction status.

Our system architecture is built on industry-standard platforms that are designed to provide continuous service 24 hours a day, 365 days per year. Our website servers are located at a third-party co-location facility operated by Alchemy Communications in downtown Los Angeles. Alchemy provides redundant web-facing communications lines and emergency power backup. The back-office processing system is housed in our headquarters in Culver City and communicates with Alchemy over three independent T1 lines. These systems include both PostgreSQL and Microsoft SQL database engines operating in a multi-processing Linux environment designed to accommodate large volumes of online traffic and are configured for high fault tolerance with redundancy and load balancing. Our Internet servers utilize VeriSign Inc. digital certificates to provide secure website communications for sales and payment transactions.

We are currently planning to scale up our auction system infrastructure to enable systems operations to perform at greater capacity and develop a second co-location in a different region to provide greater load balancing and disaster recovery. We utilize the firewall protection and the services of TrustWave, which provides regular scanning of our systems for security vulnerabilities.

At December 31, 2006, we had a technology and development staff of 17. We have structured the technology and development into two distinct departments: software development and production support. We anticipate that we will continue to devote significant resources to product development and product management in the future as we add new features and functionality.

Customer Service and Fulfillment Operations

An important element of our sales strategy is to provide a high level of customer service support in order to establish long-term relationships with our customers and encourage repeat visits and purchases. Our customer service support staff provides detailed payment, billing, and delivery guidance and is trained to answer a broad array of questions regarding auctions and payments conducted on our website. Our informed and helpful staff, together with the informative and educational aspects of our website, promotes customer confidence in purchase decisions.

At December 31, 2006, we had a customer service and billing staff of 21. We utilize automated online live-help, e-mail and phone systems to route traffic to our customer service and billing support representatives to provide

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personalized assistance. The customer service center operates between the hours of 8:00 a.m. and 5:00 p.m., Pacific time, seven days a week for telephone support and 24 hours a day for online live-help and e-mail support. We outsource substantially all of our online live-help and e-mail support.

Customers may utilize the following payment methods: credit card, money orders, and checks. We also offer our customers the opportunity to make payments using PayPal and Bill-Me-Later services. We require payment to be received by us prior to shipping the merchandise.

We maintain a fraud prevention department to detect suspect payments. Our internal system flags suspect payments when the billing address or other pertinent information does not match cardholder information. Our fraud department then requests that the customer provide additional information to verify identity before shipment is made.

We provide our customers with a five-day grace period to pay for products won through auctions. If payment is not received by the fifth day, the purchase order lapses and the product is cycled back into inventory. If a customer purchases additional items during the five-day period, we offer the customer the opportunity to save on shipping by aggregating all purchased items into one shipment at a cost of only $3 per additional item for up to 30 items. We also offer free worldwide shipping on selected auction items.

Our goal is to fulfill purchase orders on a timely, secure, and accurate basis. Following payment, the merchandise is packaged for shipment. We inspect and track each product at all stages of the receiving and order fulfillment process. Customer orders are typically delivered within seven business days, depending on the shipping method. Most purchases are delivered with signature or delivery confirmation. We ship all products via nationally recognized carriers, such as Federal Express and the U. S. Postal Service. All of our shipments are fully insured.

We have a 15-day return policy on all of our merchandise with a money-back guarantee if the product is not as described on our website. Items that are returned that are as described are subject to a 15% restocking fee. Our facility has security controls and restricted access and has been designed for the prompt receipt, storage, and shipment of our products. In addition, we have security guards on duty 24 hours a day, seven days a week to patrol the premises.

Seasonality

Historically, sales in the jewelry industry are seasonal and have been higher in the fourth quarter as a result of higher consumer spending during the December holiday shopping season. Approximately 29.3%, 33.9% and 28.5% of our net revenue in 2004, 2005 and 2006, respectively, was generated during the fourth quarter. As we continue to grow, we expect to experience more pronounced seasonal fluctuations in our net revenue and anticipate a disproportionate amount of our revenue will be in the fourth quarter.

Competition

The online jewelry auction market is new, rapidly evolving, and intensely competitive with relatively low barriers to entry, as new competitors can launch websites at relatively low cost. We believe that competition in the online jewelry market is based predominantly on the following:

price,

product quality and selection,

vendor reliability,

shopping convenience,

customer service, and

brand recognition.

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We currently compete with a variety of online auction jewelry sellers, such as eBay and uBid; online liquidation companies, such as Overstock; and online jewelry retailers, such as Blue Nile. We also compete with traditional offline jewelry retail chains, such as Zales, Finlay Fine Jewelry, and Reed’s Jewelers, as well as with department and discount and other stores that sell jewelry at wholesale prices, such as Wal-Mart, Target, J. C. Penney, and Costco, as well as with QVC and Home Shopping Network. We compete primarily on the basis of our prices, the selection of merchandise, and our website functionality and ease-of-use. The negative factors relating to our competitive position relate primarily to the relative size and name recognition of our competitors.

As the online regular jewelry and liquidation market grows, we believe that companies involved in online retail, as well as traditional retailers and liquidation brokers, will increase their efforts to develop services that compete with our online services. We also face potential competition from online companies not yet focused on the liquidation market and from retail companies not yet operating online.

Many of our competitors have greater brand recognition, longer operating histories, larger customer bases, and significantly greater financial, marketing, and other resources than we do. Smaller competitors may enter into strategic or commercial relationships with larger, more established and well-financed companies. Some of our competitors could enter into exclusive distribution arrangements with our suppliers and deny us access to their products, devote greater resources to marketing and promotional campaigns, and devote substantially more resources to their website and systems development than we do. New technologies and the continued enhancement of existing technologies also may increase competitive pressures on us.

Intellectual Property

We regard our domain names and similar intellectual property as critical to our success. However, we do not hold any patents or registrations on such intellectual property. We rely on a combination of laws and contractual restrictions with our employees, customers, suppliers, affiliates, and others to establish and protect our proprietary rights. Despite these precautions, it may be possible for a third party to copy or otherwise obtain and use our intellectual property without authorization. In addition, others may independently develop substantially similar intellectual property. Although we are pursuing the registration of our key trademarks and patents in the United States, some of our trade names are not eligible to receive trademark protection. In addition, effective trademark and patent protection may not be available or may not be sought by us in every country in which our products are made available online.

From time to time, we may be subject to legal proceedings and claims in the ordinary course of our business, including claims of alleged infringement of the trademarks and other intellectual property rights of third parties. In addition, litigation may be necessary in the future to enforce our intellectual property rights, to protect our trade secrets, or to determine the validity and scope of our intellectual proprietary rights and those of others. Any such litigation, regardless of outcome or merit, could result in substantial costs and diversion of management and technical resources, any of which could materially harm our business.

Government Regulation

We are subject to federal and state consumer protection laws, including laws protecting the privacy of consumer non-public information and regulations prohibiting unfair and deceptive trade practices. In particular, under federal and state financial privacy laws and regulations, we must provide notice to consumers of our policies on sharing non-public information with third parties, must provide advance notice of any changes to our policies and, with limited exceptions, must give consumers the right to prevent sharing of their non-public personal information with unaffiliated third parties. Furthermore, the growth and demand for online commerce could result in more stringent consumer protection laws that impose additional compliance burdens on online retailers. These consumer protection laws could result in substantial compliance costs and could interfere with the conduct of our business.

Moreover, there is currently great uncertainty in many states whether or how existing laws governing issues such as property ownership, sales and other taxes, and libel and personal privacy apply to the Internet and commercial online retailers. These issues may take years to resolve. For example, tax authorities in a number of states, as well as a Congressional advisory commission, are currently reviewing the appropriate tax treatment of companies engaged in online commerce, and new state tax regulations may subject us to additional state sales and income taxes. New legislation or regulation, the application of laws and regulations from jurisdictions whose laws do not currently

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apply to our business, or the application of existing laws and regulations to the Internet and commercial online services could result in significant additional taxes on our business. These taxes could have an adverse effect on our results of operations. Furthermore, there is a possibility that we may be subject to significant fines or other payments for any past failures to comply with these requirements.

Numerous states and foreign jurisdictions, including California, where our headquarters is located, have regulations regarding how auctions may be conducted and the liability of auctioneers in conducting such auctions. No final legal determination has been made whether the California regulations apply to businesses such as the business we conduct, and little precedent exists in this area. Several states and some foreign jurisdictions have attempted, and may attempt in the future, to impose such regulations upon companies similar to us and their customers, which could harm our business. Regulatory and licensure claims could result in costly litigation or could require us to change our manner of doing business in ways that increase our costs or reduce our revenue or force us to prohibit listings of certain items for some locations. We could also be subject to fines or other penalties. Any of these outcomes could harm our business.

Employees

At December 31, 2006, we had 198 full-time employees. We may utilize part-time employees, temporary employees, and independent contractors to respond to fluctuations in our business. None of our employees is covered by a collective bargaining agreement with us, and we consider our relations with our employees to be good.

We have an agreement with Administaff, a professional employer organization, to manage all payroll processing, workers’ compensation, health insurance, and other employment-related benefits for our employees. Although Administaff processes our payroll and pays our workers’ compensation, health insurance and other employment-related benefits, we are responsible for such payments and for complying with state and federal employment regulations, as well as all personnel management policies and procedures that are maintained by Administaff. We pay Administaff a fee based on the aggregate salaries paid to our employees for these services.

Delaware Reincorporation

On June 22, 2006 the Company reincorporated in the state of Delaware. In connection with our reincorporation in Delaware, we are authorized to issue 100,000,000 shares of common stock, $0.001 par value, and 4,000,000 shares of undesignated preferred stock, $0.001 par value.

The following discussion describes the Delaware Certificate of Incorporation and the Bylaws that was adopted and is intended to be a summary and does not describe all provisions of our certificate of incorporation or bylaws or Delaware law that may be applicable to us. For a more thorough understanding of the terms of our capital stock, you should refer to our certificate of incorporation and bylaws, which have been filed as exhibits to this report.

Common Stock

The holders of common stock are entitled to one vote per share on all matters to be voted upon by stockholders. There will be no cumulative voting. Subject to preferences that may be applicable to any outstanding preferred stock, holders of common stock are entitled to receive ratably such dividends as may be declared by our Board of Directors out of funds legally available for that purpose. In the event of the liquidation, dissolution, or winding up of our company, the holders of common stock are entitled to share ratably in all assets remaining after payment of liabilities and the liquidation preferences of any outstanding preferred stock. The common stock has no preemptive or conversion rights, other subscription rights, or redemption or sinking fund provisions.

Preferred Stock

Our certificate of incorporation authorizes our Board of Directors, without any vote or action by the holders of our common stock, to issue preferred stock from time to time in one or more series. Our Board of Directors are

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authorized to determine the number of shares and to fix the designations, powers, preferences, and the relative, participating, optional, or other rights of any series of preferred stock. Issuances of preferred stock would be subject to the applicable rules of Nasdaq or other organizations on which our securities are then quoted or listed. Depending upon the terms of preferred stock established by our Board of Directors, any or all series of preferred stock could have preference over the common stock with respect to dividends and other distributions and upon our liquidation. If any shares of preferred stock are issued with voting powers, the voting power of the outstanding common stock would be diluted. No shares of preferred stock are presently outstanding, and we have no present intention to issue any shares of preferred stock.

Anti-Takeover Effects of Provisions of the Certificate of Incorporation and Bylaws

General

Our Delaware certificate of incorporation, our bylaws, and the DGCL contain certain provisions that could delay or make more difficult an acquisition of control of our company not approved by our Board of Directors, whether by means of a tender offer, open market purchases, a proxy contest, or otherwise. These provisions have been implemented to enable us, particularly but not exclusively in the initial years of our existence as a publicly owned company, to develop our business in a manner that will foster our long-term growth without disruption caused by the threat of a takeover not deemed by our Board of Directors to be in the best interests of our company and our stockholders. These provisions could have the effect of discouraging third parties from making proposals involving an acquisition or change of control of our company even if such a proposal, if made, might be considered desirable by a majority of our stockholders. These provisions may also have the effect of making it more difficult for third parties to cause the replacement of our Board of Directors or our current management without the concurrence of our Board of Directors.

There is set forth below a description of the provisions contained in our Delaware certificate of incorporation and bylaws and the DGCL that could impede or delay an acquisition of control of our company that our Board of Directors has not approved. This description is intended as a summary only and is qualified in its entirety by reference to our certificate of incorporation and bylaws, which are included as exhibits to this report, as well as the DGCL.

Authorized but Unissued Preferred Stock

Our certificate of incorporation authorizes our Board of Directors to issue one or more series of preferred stock and to determine, with respect to any series of preferred stock, the terms and rights of such series without any further vote or action by our stockholders. The existence of authorized but unissued shares of preferred stock may enable our Board of Directors to render more difficult or discourage an attempt to obtain control of our company by means of a proxy contest, tender offer, or other extraordinary transaction. Any issuance of preferred stock with voting and conversion rights may adversely affect the voting power of the holders of common stock, including the loss of voting control to others. The existence of authorized but unissued shares of preferred stock will also enable our Board of Directors, without stockholder approval, to adopt a “poison pill” takeover defense mechanism. We have no present plans to issue any shares of preferred stock.

Number of Directors; Removal; Filling Vacancies

Our certificate of incorporation and bylaws provides that the number of directors shall be fixed only by resolution of our Board of Directors from time to time. Our certificate of incorporation provides that directors may be removed by stockholders for cause by the affirmative vote of a majority of the shares entitled to vote. Delaware law provides that vacancies on the Board of Directors may be filled only by a majority vote of the remaining directors or by the sole remaining director.

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Classified Board

Our certificate of incorporation provides for our board to be divided into three classes, as nearly equal in number as possible, serving staggered terms. Approximately one-third of our board will be elected each year. See “Management—Board of Directors.” The provision for a classified board could prevent a party who acquires control of a majority of our outstanding common stock from obtaining control of the board until our second annual stockholders meeting following the date the acquirer obtains the controlling share interest. The classified board provision could have the effect of discouraging a potential acquirer from making a tender offer or otherwise attempting to obtain control of us and could increase the likelihood that incumbent directors will retain their positions.

Stockholder Action

Our certificate of incorporation provides that stockholder action may be taken only at an annual or special meeting of stockholders. This provision prohibits stockholder action by written consent in lieu of a meeting. Our certificate of incorporation and bylaws further provide that special meetings of stockholders may be called only by our Chairman of the Board of Directors, Chief Executive Officer, President, or Secretary, and shall be called by any such person at the request in writing of a majority of the Board of Directors. Stockholders are not permitted to call a special meeting or to require our Board of Directors to call a special meeting of stockholders.

The provisions of our certificate of incorporation and bylaws prohibiting stockholder action by written consent may have the effect of delaying consideration of a stockholder proposal until the next annual meeting unless a special meeting is called as provided above. These provisions would also prevent the holders of a majority of the voting power of our stock from unilaterally using the written consent procedure to take stockholder action. Moreover, a stockholder could not force stockholder consideration of a proposal over the opposition of the Board of Directors by calling a special meeting of stockholders prior to the time our chairman or a majority of the whole board believes such consideration to be appropriate.

Advance Notice for Stockholder Proposals and Director Nominations

Our bylaws establish an advance notice procedure for stockholder proposals to be brought before any annual or special meeting of stockholders and for nominations by stockholders of candidates for election as directors at an annual meeting or a special meeting at which directors are to be elected. Subject to any other applicable requirements, including, without limitation, Rule 14a-8 under the Exchange Act, only such business may be conducted at a meeting of stockholders as has been brought before the meeting by, or at the direction of, our Board of Directors, or by a stockholder who has given our Secretary timely written notice, in proper form, of the stockholder’s intention to bring that business before the meeting. The presiding officer at such meeting has the authority to make such determinations. Only persons who are nominated by, or at the direction of, our Board of Directors, or who are nominated by a stockholder that has given timely written notice, in proper form, to our Secretary prior to a meeting at which directors are to be elected, are eligible for election as directors.

Amendments to Bylaws

Our certificate of incorporation provides that only our Board of Directors or the holders of a majority of the shares entitled to vote at an annual or special meeting of stockholders have the power to amend or repeal our bylaws.

Amendments to Certificate of Incorporation

Any proposal to amend, alter, change, or repeal any provision of our certificate of incorporation requires approval by the affirmative vote of a majority of the voting power of all of the shares of our capital stock entitled to vote on such matters.

Delaware Statutory Provisions

Anti-Takeover Provision of Delaware Law. Under Section 203 of the DGCL, no Delaware corporation shall engage in a “business combination” with an “interested stockholder” for a period of three years following the date that the

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stockholder became an interested stockholder. “Business combination” includes a merger, consolidation, asset sale, or other transaction resulting in financial benefit to the interested stockholder. “Interested stockholder” is a person who, together with affiliates and associates, owns, or within three years, did own 15% or more of the corporation’s voting stock. This prohibition does to apply if:

prior to the time that the stockholder became an interested stockholder, the board of directors of the corporation approved either the business combination or the transaction resulting in the stockholder’s becoming an interested stockholder,

upon consummation of the transaction resulting in the stockholder’s becoming an interested stockholder, the stockholder owns at least 85% of the outstanding voting stock of the corporation, excluding voting stock owned by directors who are also officers and certain employee stock plans, or

at or subsequent to the time that the stockholder became an interested stockholder, the business combination is approved by the board and authorized at an annual or special meeting of stockholders, and not by written consent, by the affirmative vote of at least two-thirds of the outstanding voting stock that the interested stockholder does not own.

A Delaware corporation may elect not to be governed by these restrictions. We have not made such election. Although David Zinberg and Marina Zinberg each own more than 15% of our stock, they are not subject to the restrictions of Section 203.

Limitation of Liability and Indemnification of Officers and Directors

Our certificate of incorporation limits the liability of our directors to the fullest extent permitted by the DGCL. In addition, our certificate of incorporation and bylaws provide that we will indemnify our directors and officers to the fullest extent permitted by law. We have entered into indemnity agreements with our current directors and executive officers and expect to enter into a similar agreement with any new directors or executive officers.

Indemnification for Securities Act Liabilities

Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted for directors, officers, or controlling persons pursuant to the provisions described in the preceding paragraph, we have been informed that in the opinion of the SEC such indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable.

Transfer Agent and Registrar

The transfer agent and registrar for our common stock is Continental Stock Transfer & Trust Company. The transfer agent’s address is 17 Battery Place, New York, New York 10004 and its telephone number is (212) 509-4000.

ITEM 1A.  Risk Factors

We believe the risks and uncertainties described below are the most significant we face. The occurrence of any of the following risks could harm our business. In that case, the value of our common stock could decline, and you may lose part or all of your investment. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also impair our operations.

We must continue to generate a high volume of visitor traffic to our website and convert those visitors into buyers

Our net revenue depends to a significant extent on the number of customers who visit our website to purchase merchandise and the dollar amount of their purchases. Generating increased traffic to our website and converting that traffic into buyers requires us to achieve effective results from our marketing campaigns; offer a wide variety of

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products that our customers can purchase at favorable prices; maintain a user-friendly shopping experience; ensure the satisfactory availability, performance, and reliability of our website, network infrastructure, and transaction processing systems; and provide high-quality customer service. Our business will be harmed if we are unable to increase our customer base and the dollar volume of the orders customers place with us.

We do not have a guaranteed supply of jewelry products, and we have a heavy concentration of inventory purchases from our top two suppliers.

The success of our business depends, in part, on our ability to offer our customers a wide variety of jewelry that they can purchase at prices that are substantially below those of traditional jewelry retailers. We do not have any formal or binding supply agreements with any of our manufacturers, distributors, or other suppliers for our supply of jewelry products. As a result, we do not have a guaranteed supply of jewelry products at favorable prices. Our inability to maintain and expand our jewelry supply relationships or the inability of our suppliers to continue to supply us with jewelry products at favorable prices would substantially harm our business and results of operations.

In addition, we have a heavy concentration of inventory purchases from a small number of suppliers. Our top two suppliers accounted for approximately 48.1%, 42.1% and 31.1% of our total purchases in 2004, 2005, and 2006, respectively. In 2006, we purchased 26.4% of our merchandise from LA Jewelers, Inc., a jewelry manufacturer and liquidator. We purchased a 4.7% of our merchandise from Dialuck Corp. in 2006.

The satisfactory availability, performance, and reliability of our website, network infrastructure, and transaction processing systems are critical to our ability to attract, retain, and service customers.

Any problems with the availability, performance, or reliability of our website, network infrastructure, or transaction processing systems could result in decreased customer traffic, reduced orders, reduced order fulfillment performance, and lower net revenue as well as negative publicity and damage to our reputation. In order to remain competitive, we must continually seek to improve and expand the functionality and features of our website, network infrastructure, transaction processing systems, and delivery and shipping functions to accommodate any substantial increase in the volume of traffic to and orders from our website. We may not be successful in these efforts, and we may not be able to project accurately the rate or timing of increases, if any, in the use of or sales from our website, or timely expand or upgrade our website, infrastructure, or systems to accommodate any such increases. Additionally, we may not be able to remedy any such availability, performance, or reliability problems in a timely manner, or at all, because we depend in part on third parties for such availability, performance, and reliability.

Our business and results of operations could be harmed due to the lack of a comprehensive test bed for quality assurance and software application implementation

Our business depends in part on the efficient and uninterrupted operation of our electronic data processing systems. We do not employ a comprehensive test bed that would ensure high quality assurance when implementing changes to our internally developed application systems. Any problems with implementing software upgrades without going through a proper test environment could impact our business by decreasing customer traffic, reducing selling prices, reducing order fulfillment, or lowering net revenue and gross margins, all of which could produce negative publicity and damage our reputation. We plan to build a full featured test environment that will support all changes to our production applications. We are in the process of evaluating and implementing a test and staging environment for validating all changes to our production environment.

Our business operations could be disrupted due to the lack documentation of our internally developed software application systems and dependence on key system developers to maintain the system

Our business depends in part on continuous and uninterrupted online availability to our customers. Our internally developed software application systems are not fully documented and this makes it more difficult to locate and trouble shoot problems that may occur in our systems. Any delays in resolving system problems will result in longer disruptions to the service available to our customers and/or prevent our employees from performing their functions

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efficiently. The internally developed Auction platform, Billing, Shipping, and Inventory Control systems are not fully documented. We are dependent on institutional knowledge of our key system developers to provide ongoing support and functional enhancements. If we were to lose the services of these key systems support personnel, operations may suffer from system down time that would take longer than desirable to correct and return to normal operations.

We may face increasing costs to acquire new customers.

The acquisition of new customers is a key factor in increasing demand for our jewelry products and increasing our revenue. We currently attract new customers by driving traffic to our website using a marketing and advertising strategy that includes targeted keyword searches, online banner advertising, targeted e-mail advertising, and participation in affiliate programs. We do not maintain long-term contracts or arrangements with any companies, including any search engines, Internet portals, or other websites, and we may not successfully enter into additional relationships or maintain existing ones. Recently, we have experienced significantly higher rates for keyword search advertising. We expect that we may have to pay increasing fees to maintain, expand, or enter into new relationships with third-party search engines, Internet portals, and websites. In addition, traffic to our website could decline if our online marketing programs become less effective or the traffic decreases to the search engines, Internet portals, and websites with which we advertise. Our business could be materially and adversely affected if any substantial number of companies on which we advertise experience financial or operational difficulties or experience other corporate developments that adversely affect their performance. A failure to maintain or expand existing online advertising relationships or to establish additional online advertising relationships that generate a significant amount of traffic from other websites could result in decreased sales or limit the growth of our business.

Competition from online auctioneers and other online companies with greater brand recognition may adversely affect our sales.

The market for online auctions is rapidly evolving and intensely competitive. We expect competition to intensify further in the future. Barriers to entry are relatively low, and current and new competitors can launch new websites at relatively low cost using commercially available software.

We currently compete with a number of other companies, and other competitors may appear in the future. Our competitors currently include various online auction services and retailers that offer jewelry, including eBay, Blue Nile, Overstock, and uBid. We also encounter competition from national jewelry retail chains, such as Zales, Kay Jewelers, and Finlay Fine Jewelry, and mass retailers and other enterprises that sell jewelry, such as Wal-Mart, Target, J. C. Penney, Costco, QVC, and Home Shopping Network. Many of our competitors have greater brand recognition, longer operating histories, larger customer bases, and significantly greater financial, marketing, and other resources than we do. Smaller competitors may enter into strategic or commercial relationships with larger, more established, and well-financed companies. Other competitors may enter into exclusive distribution agreements with our suppliers that deny us access to suppliers’ products. Competitors may also devote greater resources to marketing and promotional campaigns and to website and systems technology than we do. We may not be able to compete successfully against current and future competitors or address increased competitive pressures. Furthermore, attempts have been made in the past to develop and market synthetic stones and gems to compete in the market for gemstones and gemstone jewelry. We expect such efforts to continue in the future. If any such efforts are successful in creating widespread demand for synthetic or alternative gemstone products, demand and price levels for our products could decline and our business and results of operations would be substantially harmed.

We rely heavily on the sale of jewelry for our net revenue, and demand for these products could decline.

Luxury products, such as jewelry, are discretionary purchases for consumers. The volume and dollar amount of such purchases may be affected by adverse trends in the general economy and consumer perceptions of those trends, and purchases may significantly decrease during economic downturns. The success of our business depends in part on

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macroeconomic factors, such as employment levels, salary levels, tax rates, and credit availability, all of which affect disposable income and consumer spending. Any reduction in disposable income or consumer spending may affect us more significantly than companies in other industries.

Our net revenue and results of operations depend in part on the demand for jewelry. Consumers’ tastes are subject to frequent, significant, and sometimes unpredictable changes. Should prevailing consumer tastes for jewelry change or the demand for jewelry decrease, the sale of our products could decline and our business and results of operations would suffer.

Furthermore, our ability to increase our net revenue and enhance our profitability may depend on our ability to expand our product offerings beyond our current offerings. If we offer new products that are not accepted by customers, our brand and reputation could be adversely affected, our sales may fall short of expectations, and we may incur substantial expenses that are not offset by increased sales.

Because we carry all of our jewelry products in inventory, our net revenue and gross margin may decrease if we are unable to predict and plan for changes in consumer demand.

We had $31.2 million in inventory and $3.1 million in prepaid inventory as of December 31, 2006. If our sales increase, we will be required to increase our inventory proportionately. Consumer tastes and preferences for jewelry products can change rapidly, thereby exposing us to significant inventory risks. Currently, because the products we sell also consist of closeout merchandise from manufacturers, distributors, and other suppliers, we have less control over the specific items that we offer for sale than we would if we primarily ordered goods for manufacture for us. In addition, it is important that we are able to purchase jewelry that we perceive to be in demand. The demand for specific products can change between the time we order items and when we sell them. As a result, we may be required to take significant inventory markdowns, which could reduce our gross margin, if we do not accurately predict these trends or if we overstock unpopular merchandise.

We rely on suppliers and third-party carriers as part of our fulfillment process, and these third parties may fail to meet shipping schedules or requirements.

We rely on suppliers to deliver our orders promptly, which we then carry in inventory to ensure availability and expedited delivery to our customers. We also rely on third-party carriers to ship our products to our customers. As a result, we are subject to various risks, including employee strikes and inclement weather, associated with the ability of third-party carriers to provide delivery services to meet our shipping needs and those of our suppliers. The failure of our suppliers and third-party carriers to deliver products to us or our customers in a timely manner or otherwise to serve us or our customers adequately would damage our reputation and brand and substantially harm our business and results of operations.

Increases in the cost of precious metals and precious and semi-precious stones would increase the cost of our jewelry products.

The jewelry industry is affected by fluctuations in the prices of precious metals and precious and semi-precious stones. The availability and prices of gold, silver, platinum, and other precious metals and precious and semi-precious stones may be influenced by such factors as cartels, political instability in exporting countries, changes in global demand, and inflation. Shortages of these materials or an increase in their prices could reduce the quantity of products we have available for sale and our ability to sell our products for more than our cost, causing reduced sales or lower margins.

Our business and results of operations would be harmed in the event of any failure of our auction and bidding systems hardware, which is located at a single third-party co-location facility, or any failure of our fulfillment and administrative hardware.

Our business depends in part on the efficient and uninterrupted operation of our computer and communications hardware. The servers and other hardware necessary to operate our website, including our auction and bidding systems, are located at a single third-party co-location facility in downtown Los Angeles. We rely on that facility to

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provide Internet access with the speed, capacity, and reliability we require. Our servers and other hardware that run our transaction processing, order fulfillment, and office administration tasks are located at our headquarters. Our servers and other hardware are vulnerable to damage or interruption from human error, fire, flood, power loss, telecommunications failure, terrorist attacks, acts of war, break-ins, earthquakes, and similar events. We do not currently have redundant systems in multiple locations or a formal disaster recovery plan, and our business interruption insurance may be insufficient to compensate us for any losses that may occur. In addition, our servers are vulnerable to computer viruses, physical or electronic break-ins, and similar disruptions, which could lead to interruptions, delays, loss of critical data, the inability to accept and fulfill customer orders, or the unauthorized disclosure of confidential customer data. System disruptions or failures would also create a large number of customer questions and complaints that need to be addressed by our customer service support personnel. The occurrence of any of the foregoing risks could substantially harm our business and results of operations. Our systems are vulnerable to damage or interruption from earthquakes, floods, fires, power loss, telecommunication failures, terrorist attacks, computer viruses, computer denial-of-service attacks, and similar events.

We may not be able to increase our capacity or respond to rapid technological changes in a timely manner or without service interruptions, which may harm our business.

We may not be able to accommodate any substantial growth in traffic or user demand on our website, network infrastructure, and transaction processing systems in a timely manner or without substantial costs. If we are unable to upgrade our existing technology, network infrastructure, and transaction processing systems to accommodate any increased sales volume, our potential customers may be dissatisfied and may purchase merchandise from our competitors. We may also fail to provide enough capacity in our customer service and sales support functions to provide a high level of customer service. A failure to implement new systems and increase customer service capacity effectively could adversely affect our sales. Enhancement of our website, network infrastructure, and transaction processing systems will require us to spend a significantly higher amount than we have in the past. Moreover, to date our spending in these areas as a percentage of revenue has been lower than industry averages. We anticipate increasing our system expenditures to accommodate these needs in the future.

We also intend to introduce additional or enhanced features and services to retain current customers and attract new customers to our website. We may experience difficulties that could delay or prevent us from introducing new features and services. If we introduce a feature or a service that is not favorably received, our current customers may not use our website as frequently and we may not be successful in attracting new customers. These new features or services also may contain errors that are discovered only after their introduction, and we may need to modify significantly the design of these features or services to correct errors.

Our growth will depend on our ability to increase the popularity of our website, and we may not be able to do so effectively.

We believe that continuing to increase the popularity of our website will be critical to expanding our business. Promoting and positioning our website will depend largely on the success of our marketing efforts and our ability to provide a variety and sufficient quantity of high-quality products at attractive prices in a convenient manner. Promoting our website will require us to increase our marketing budget and otherwise increase our financial commitment to creating and maintaining brand loyalty among users. Brand promotion activities may not yield increased revenue, and even if they do, any increased revenue may not offset the expenses we incur in building our website popularity and our brand. If we do attract new users to our website, they may not conduct transactions on a frequent basis or in sufficient dollar amounts. If we fail to promote and maintain our website or incur substantial expenses in an unsuccessful attempt to promote and maintain our brand, our business would be harmed.

We anticipate expanding our international sales activities, causing our business to become increasingly susceptible to numerous risks that could affect our profitability.

In 2005 and 2006, 19.2% and 20.8%, respectively, of our net revenue was generated by shipments to customers outside of the United States. We plan, over time, to expand our reach into international markets. We do not, however, currently have any overseas fulfillment, distribution, or server facilities or any website content localized for foreign markets. We cannot be certain that we will be able to expand our global presence. In addition, there are

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certain risks associated with doing business on an international basis, including regulatory requirements, legal uncertainty regarding liability, tariffs, and other trade barriers, longer payment cycles, and potentially adverse tax consequences, any of which could adversely affect our business. Although our foreign sales historically have been denominated in U.S. dollars, we also may be subject to increased risks relating to foreign currency exchange rate fluctuations to the extent we decide to denominate our sales in foreign currencies.

Our ability to grow our business will be impaired by delays, interruptions, or failures of the Internet.

Our success depends on the continued growth and maintenance of the Internet. The Internet has experienced, and is likely to continue to experience, significant growth in the numbers of users and amount of traffic. If Internet usage continues to grow as anticipated, the infrastructure may not be able to support the level of usage and its performance and reliability may decline. If outages or delays on the Internet increase, overall Internet usage could grow more slowly or decline. In addition, the performance of the Internet may be harmed by increased number of users or bandwidth requirements or by viruses, worms, and similar issues. The Internet has experienced a variety of outages and other delays as a result of damage to portions of its infrastructure, and it could face outages and delays in the future. These outages and delays could reduce the level of Internet usage.

We depend on the continued growth and acceptance of online commerce, and our business will be substantially impaired if the growth of online commerce slows or does not grow as expected.

The business of buying and selling goods over the Internet is relatively new and dynamic. Our success depends on the widespread acceptance and use of the Internet as an effective medium for commerce by consumers. The acceptance and use of the Internet may not continue to expand as expected, and a sufficient broad base of consumers necessary for its continued growth may not adopt the Internet as a medium for commerce. Consumers who historically have used traditional means of commerce may have concerns about privacy, the inability to physically inspect merchandise before buying, delivery time, product damage during shipment, and the costs and inconvenience involved in returning purchased items, which may inhibit their crossover to e-commerce. In order to expand our user base, we must appeal to and acquire consumers who historically have used traditional means of commerce to purchase goods. If these new customers execute fewer or lower dollar amounts of orders than our historical users, and we are unable to gain efficiencies in our operating costs, including the cost of acquiring new customers, our business and profits could be adversely affected.

Our failure to protect confidential information of our customers and our network against security breaches could damage our reputation and substantially harm our business and results of operations .

A significant barrier to online commerce and communications is the secure transmission of confidential information over public networks. Third parties may have the technology or expertise to breach the security of customer transaction data. Our security measures may not prevent security breaches that could result in substantial harm to our business and results of operations and damage to our reputation. Currently, a majority of our sales are billed to our customers’ credit card accounts directly. Under current credit card practices, we are liable for fraudulent credit card transactions because we do not obtain cardholder signatures. We rely on encryption and authentication technology licensed from third parties to effect secure transmission of confidential information, including credit card numbers. We do not currently carry insurance against this risk. Advances in computer capabilities, new discoveries in the field of cryptography, or other developments may result in a compromise or breach of the technology we use to protect customer transaction data. In addition, anyone who is able to circumvent our security measures could misappropriate proprietary information or cause interruptions in our operations. Any such compromise of our security could damage our reputation and brand and expose us to a risk of loss or litigation and possible liability, which would substantially harm our business and results of operations.

We are vulnerable to fraudulent activities on our website, including unauthorized use of customer information and identity theft by third parties .

Our network security measures to prevent third parties from penetrating our network and improperly accessing our customers’ personal information or credit card information may not be successful. Although we have not experienced any theft of our customers’ credit card information to date, as new discoveries in the field of

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cryptography and advances in computer capabilities occur, our security measures may not effectively prevent others from obtaining improper access to our customer information. In addition, third parties may target our customers directly with fraudulent identity theft schemes designed to appear as legitimate e-mails from us. In March 2006, one such third party attempted to solicit customer information through a tactic, commonly known as “phishing,” whereby an e-mail purporting to be from us solicited customer information from recipients of the e-mail. Any such security breach or fraud perpetrated on our customers could expose us to increased costs and could harm our business and results of operations.

Increased product returns and the failure to predict product returns could substantially harm our business and results of operations .

As we expand our business and product offerings, rates of product return may increase. Any significant increase in product returns above our return assumptions and allowances could substantially harm our business and results of operations.

Our inventory is vulnerable to damage or loss caused by fire, flood, earthquakes, and similar events, and we face the risk of theft of our products from inventory or during shipment.

All our inventory is stored at our warehouse/office facility in Culver City, California. Consequently, our merchandise supply is vulnerable to fire, flood, earthquakes, and similar events that may impact our facility. Any damage to or loss of all or a significant portion of our inventory could cause significant delays in shipment of goods to our customers, resulting in negative publicity about and diminished customer confidence in our website. In addition, we may experience theft of our products while they are being held in inventory or during the course of their shipment to our customers by third-party carriers. We have implemented security measures to prevent such theft and maintain insurance to cover losses resulting from theft. Nevertheless, we could incur significant losses from theft, which would substantially harm our business and results of operations, if our security measures fail, losses exceed our insurance coverage, or we are not able to maintain insurance at a reasonable cost.

Customer complaints or negative publicity about our customer service could adversely affect our reputation and, as a result, our business could suffer.

Customer complaints or negative publicity about our customer service could severely diminish consumer confidence in and the use of our website. Effective customer service requires significant personnel expense, and this expense, if not managed properly, could significantly impact our profitability. The failure to manage or train our customer service representatives properly could compromise our ability to handle customer inquiries and complaints effectively. If we do not handle customer inquiries and complaints effectively, we may lose customer confidence. As a result, our revenue could suffer and our operating margin may decrease.

Increases in credit card processing fees could increase our costs.

Visa, MasterCard, American Express, and Discover Card could increase the interchange fees that they charge for transactions using their cards. Increases in interchange fees may result in increased operating costs and reduced profit margin.

Our limited operating history makes it difficult for us to forecast accurately net revenue and appropriately plan our expenses.

We have a limited operating history. As a result, it is difficult to forecast accurately our sales or operating expenses. We base our estimated expense levels on our operating forecasts and estimates of future sales. Sales and results of operations are difficult to forecast because they generally depend on the number, dollar volume, and timing of the orders we receive, which are uncertain. Some of our expenses are fixed, making it difficult to adjust our spending in a timely manner to take into account any unexpected shortfall in sales. We may also be unable to adjust spending in a timely manner to compensate for any unexpected sales shortfall, which could cause our net income in a given quarter to be lower than expected.

19




We incurred losses from operations prior to fiscal 2004 and have accumulated a significant deficit.

Prior to fiscal year 2004 we experienced significant operating losses. At December 31, 2006, we had an accumulated deficit of $21.6 million. We cannot be certain that the improvements in our operations resulting since 2004 will continue in the future. See “Management’s discussion and analysis of financial condition and results of operations—Liquidity and Capital Resources.”

We may default on our obligations, if we are unable to generate sufficient cash through sales in a timely manner.

Since our formation, we have funded our operations through the sale of equity securities and cash generated from operations. The working capital characteristics of our business have allowed us to collect cash from sales to customers within several business days of the related sale, while we typically have extended payment terms with our suppliers. We do not, however, have any formal or binding supply agreements with any of our suppliers, manufacturers, distributors, or other suppliers or any other formal agreements with them on payment terms. Accordingly, there is a risk that we may default on our obligations if we are unable to generate sufficient cash through sales in a timely manner or through our credit facility.

Seasonal fluctuations in our net revenue could cause our quarterly results to fluctuate and cause our results of operations to be below expectations .

Historically, sales in the jewelry industry are seasonal and have been higher in the fourth quarter of the calendar year as a result of higher consumer spending during the December holiday season. Approximately 29.3%, 33.9% and 28.5% of our net revenue in 2004, 2005 and 2006, respectively, was generated during the fourth quarter. As we continue to grow, we expect to experience more pronounced seasonal fluctuations in our net revenue and anticipate a disproportionate amount of our revenue will occur in the fourth quarter. In anticipation of any increased sales activity during the fourth quarter, we may incur significant additional expenses, including higher sales and marketing costs and additional staffing in our fulfillment and customer support operations. If we were to experience lower than expected sales during any future fourth quarter, it would have a disproportionately large impact on our results of operations for that year. In the future, our seasonal sales patterns may become more pronounced, may strain our personnel and fulfillment activities, and may cause a shortfall in sales compared with expenses in a given period, which would substantially harm our business and results of operations.

Sales growth in prior periods may not be indicative of our future growth.

Our sales have fluctuated significantly in the past, in part, as a result of varying amounts of funds we have spent on advertising and inventory levels and may fluctuate significantly in the future because of increasing advertising and inventory costs. These factors may prevent the meaningful use of period-to-period comparisons of financial results. For these and other reasons, investors should not rely on past sales growth rates as a prediction of our future sales growth.

We have grown quickly, and our business will suffer if we fail to manage our growth .

We have expanded our operations at a rapid pace. This expansion has placed a significant strain on our management, operations, and financial resources. We anticipate adding personnel in the future, including managerial, technical, and operations personnel. In order to manage any further growth of our operations, we also will be required to improve existing and implement new transaction-processing, operational and financial systems, procedures, and controls. If we are unable to manage growth effectively, our business and results of operations will be harmed.

Descriptions of our jewelry items are not guarantees and may confuse, mislead, or disappoint our customers .

In an effort to provide accurate descriptions of jewelry posted on our website, we provide appraisal summaries from third-party gemological laboratories for some of our jewelry items. All other jewelry and watch descriptions are provided by our full-time Gemological Institute of America, or GIA, trained gemologists and several experienced product specialists. Nevertheless, there is a subjective component involved with respect to assessing the clarity,

20




color, and carat characteristics of diamonds and other gemstones. In addition, mistakes or omissions of important information in our descriptions may occur. Even if our descriptions are accurate, buying a product online may lead to disappointment resulting in returned merchandise. For example, a customer may determine that a piece does not have the expected look, feel, and overall appearance of the merchandise that the buyer envisioned from the website photograph.

Additionally, in response to customer requests and as a courtesy to resellers, we provide “Compare” and/or “Close Now” prices for jewelry items listed on our website. Compare and Close Now prices are not meant to reflect fair market values or manufacturer suggested retail prices, and in fact, may be higher than prices found in local retail stores. As a consequence, perceived misrepresentations in item descriptions by disappointed buyers may occur, resulting in negative publicity about and diminished customer confidence in our website.

We may not be able to maintain our domain name uniqueness.

Our Internet domain name is critical to our success. Under current domain name registration practices, no other entity can obtain an identical domain name, but can obtain a similar name or the identical name with a different suffix, such as “.net” or “.org,” or with a different country designation, such as “jp” for Japan. We have not registered our domain name with different suffixes nor have we registered our name in any other jurisdiction. As a result, third parties may use domain names that are similar to our domain name, which may result in confusion to potential customers and lost sales. We are aware that other businesses have registered the name “bidz” with other suffixes and in other countries.

We may be unable to protect or enforce our own intellectual property rights adequately, and we may become subject to intellectual property litigation .

We regard the protection of our trademarks, copyrights, domain name, trade dress, and trade secrets as critical to our success. We rely on a combination of common law as well as trademark, copyright, trade dress, and trade secret laws to protect our intellectual property rights. We also have entered into confidentiality and invention assignment agreements with our employees and relevant contractors and nondisclosure agreements with relevant parties with whom we conduct business in order to limit access to and disclosure of our proprietary information. These contractual arrangements and other steps we have taken to protect our intellectual property may not prevent misappropriation of our intellectual property or deter independent development of similar intellectual property by others. We also are pursuing the registration of our domain name, trademarks, and service marks in the United States and internationally. Effective trademark, copyright, patent, trade dress, trade secret, and domain name protection is very expensive to maintain and may require litigation. We must protect our trademarks, copyrights, patents, and domain names in an increasing number of jurisdictions, a process that is expensive and may not be successful in every location.

Third parties may from time to time claim that we have infringed their intellectual property relating to our business model or auction systems. We expect that participants in our market increasingly will be subject to infringement claims as the number of services and competitors in our industry segment grows. Any claim like this, whether meritorious or not, could be time-consuming, result in costly litigation, cause service upgrade delays, or require us to enter into royalty or license agreements. These royalty or license agreements may not be available on acceptable terms or at all. As a result, any such claim could harm our business.

We may be unable to enforce protection of our intellectual property rights under the laws of other countries.

We anticipate that we will become increasingly subject to international intellectual property risks, including differing intellectual property laws, which may be insufficient to protect our intellectual property, unique local laws, and lack of applicable law or clear precedent.

21




Various legal rules and regulations related to privacy and the collection, dissemination, and security of personal information may adversely affect our marketing efforts.

We are subject to increasing regulation at the federal, state, and international levels relating to privacy and the use of personal user information designed to protect the privacy of personally identifiable information as well as to protect against its misuse. These laws include the Federal Trade Commission Act, the CAN-SPAM Act of 2003, the Children’s Online Privacy Protection Act, the Fair Credit Reporting Act, the Homeland Security Act, and related regulations. Several states have proposed legislation that would limit the use of personal information gathered online or require online services to establish privacy policies. Moreover, proposed legislation in the United States and existing laws in foreign countries require companies to establish procedures to notify users of privacy and security policies, obtain consent from users for collection and use of personal information, and/or provide users with the ability to access, correct, and delete personal information stored by companies. These regulations and other laws, rules, and regulations enacted in the future may adversely affect our ability to collect, disseminate, or share demographic and personal information about users and our ability to e-mail or telephone users, which could be costly and adversely affect our marketing efforts .

We may be subject to a tax liability for past sales and our future sales may decrease if we are required to collect sales and use taxes on the products we sell .

In accordance with current industry practice and our interpretation of current law, we do not currently collect sales or other taxes with respect to shipments of goods into states other than California. However, one or more states or foreign countries may seek to impose sales or other tax obligations on us in the future. A successful assertion by one or more states or foreign countries that we should be collecting sales or other taxes on the sale of our products could result in substantial tax liabilities for past and future sales, discourage customers from purchasing products from us, decrease our ability to compete with traditional retailers, and otherwise substantially harm our business, financial condition, and results of operations.

We may be subject to regulations governing the conduct and liability of auctioneers, which could affect the way in which we conduct our business or otherwise increase our cost of doing business.

Numerous states and foreign jurisdictions, including California, where our headquarters is located, have regulations regarding how auctions may be conducted and the liability of auctioneers in conducting such auctions. No final legal determination has been made whether the California regulations apply to our business, and little precedent exists in this area. Several states and some foreign jurisdictions have attempted, and may attempt in the future, to impose regulations that could affect us or our users, which could harm our business.

We are subject to regulations relating to consumer privacy, which could increase the cost of our doing business, expose us to litigation costs, increase our service or delivery costs, and otherwise harm our business.

Several states have proposed, and California, Minnesota, Utah, and Vermont have recently passed, legislation that would limit the uses of personal user information gathered online or offline. Many states already have such laws and continually consider strengthening them, especially against online services. However, the Fair Credit Reporting Act, or FCRA, a federal statute enacted in 1970 to protect consumer privacy, includes a provision preempting conflicting state laws on the sharing of information between corporate affiliates. The preemptive provisions of FCRA were permanently extended in 2002, thereby ensuring that we are not subject to the laws of each individual state with respect to matters within the scope of FCRA, but remain subject to the other provisions of FCRA.

The Federal Trade Commission also has settled several proceedings against companies regarding the manner in which personal information is collected from users and provided to third parties. Specific statutes intended to protect user privacy have been passed in many foreign jurisdictions. Compliance with these laws, given the tight integration of our systems across different countries and the need to move data to facilitate transactions among our users, such as payment companies and shipping companies, is both necessary and difficult. Failure to comply could subject us to lawsuits, fines, criminal penalties, statutory damages, adverse publicity, and other losses that could harm our business. Changes to existing laws or the passage of new laws intended to address these issues could directly affect the way we do business or could create uncertainty on the use of the Internet. This could reduce demand for our

22




products, increase the cost of our doing business, expose us to litigation costs, increase our service or delivery costs, or otherwise harm our business.

New and existing regulations could harm our business .

We are subject to the same foreign and domestic laws as other companies conducting both online and offline business. There are still relatively few laws specifically directed towards online business. However, due to the increasing popularity and use of the Internet and online services, many laws relating to the Internet are being debated at all levels of government around the world, and it is possible that such laws and regulations will be adopted. These laws and regulations could cover issues such as user privacy, freedom of expression, pricing, fraud, content and quality of products and services, taxation, advertising, intellectual property rights, and information security. Applicability to the Internet of existing laws governing issues, such as property ownership, copyrights and other intellectual property issues, taxation, libel and defamation, obscenity, and personal privacy is uncertain. The vast majority of these laws was adopted prior to the advent of the Internet and related technologies and, as a result, do not contemplate or address the unique issues of the Internet and related technologies. Those laws that do reference the Internet, such as the U.S. Digital Millennium Copyright Act and the European Union’s Directive on Distance Selling and Electronic Commerce, have only recently begun to be interpreted by the courts and implemented by the European Union member states, so their applicability and scope remain uncertain. As our activities and the types of goods listed on our website expand, regulatory agencies may claim that we or our users are subject to licensure in their jurisdiction, either with respect to our business in general, or in order to allow the sale of certain items, such as real estate, event tickets, boats, and automobiles.

In addition, because our products are available over the Internet in multiple states and because we sell merchandise to consumers residing in multiple states, we could be required to qualify to do business as a foreign corporation in each state in which our products are available. Our failure to qualify as a foreign corporation in a jurisdiction in which we are required to do so could subject us to penalties. Any new legislation or regulation, or the application of laws or regulations from jurisdictions whose laws do not currently apply to our business could have a material adverse affect on our business.

We depend to a very significant extent on David Zinberg, our Chairman of the Board, President, and Chief Executive Officer.

Our performance depends substantially upon David Zinberg, our Chairman of the Board, President, and Chief Executive Officer, who has extensive experience with the purchase and sale of jewelry. We rely on Mr. Zinberg to make critical operational decisions on a daily basis, such as product offerings and purchases, and to make key strategic plans. We have an employment agreement with Mr. Zinberg extending through 2009. The loss of the services of Mr. Zinberg would adversely affect our business and operations.

Holders of common stock issued by us in prior offerings are entitled to rescind their purchases.

From our inception until mid-2003, we raised over $20.5 million in gross equity capital by selling shares of our common stock to approximately 830 investors at prices ranging from $4.00 to $6.00 per share with a weighted average share price of $4.50. We also issued shares of common stock to about 30 persons in exchange for services and other non-cash consideration valued in excess of $5.5 million and issued options to purchase common stock to approximately 250 individuals at a weighted average exercise price of $4.45. After conducting these sales of our securities, we determined that these sales were not exempt from the registration requirements under the Securities Act of 1933 and similar provisions of laws of the states in which our stockholders reside, because certain of our employees who solicited investors engaged in “general solicitation” of securities. In addition, these employees received compensation for selling our common stock and were required to be licensed as broker-dealers with the Securities and Exchange Commission, or SEC, and various state authorities, but they were not so licensed. In such situations, a number of remedies may be available to regulatory authorities and the investors who purchased common stock in those offerings, including a right of rescission, civil penalties, a restraining order or injunction, and a court order to pay restitution and costs.

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If we were ordered to rescind all purchases of our common stock by stockholders not affiliated with us, we could be required to make an aggregate payment to the holders of these shares of up to approximately $20.5 million, in addition to statutory interest of $11.3 million, as of December 31, 2006. We may also be liable for the $5.5 million of services rendered and property exchanged in consideration for the issuance of common stock, in addition to interest of approximately $2.9 million through December 31, 2006. In addition, we may be liable for the $1.3 million that we will offer to non-management optionees as the optionees did not receive information regarding our potential liability for these violations of federal and state securities laws. In addition, regulators could impose monetary fines or other sanctions as provided under these laws.

Federal securities laws do not provide that a rescission offer will terminate a purchaser’s right to rescind a sale of stock that was not registered as required or was not otherwise exempt from such registration requirements. If any or all of the offerees reject a rescission offer, we may continue to be liable under federal and state securities laws for up to an amount equal to the value of all options and common stock granted or issued since the date of issuance plus any statutory interest we may be required to pay.

We do not intend to pay dividends on our common stock, and, consequently, your only opportunity to achieve a return on your investment is if the price of our common stock appreciates.

We have never declared or paid any cash dividends on our common stock and do not intend to pay dividends on our common stock for the foreseeable future. We intend to invest any future earnings to fund our business. Therefore, stockholders likely will not receive any dividends on our common stock for the foreseeable future. Investors cannot be certain that they will receive a positive return on their investment when they sell their shares or that they will not lose the entire amount of their investment.

The concentration of our capital stock ownership with our founder and executive officers and directors and their affiliates will limit your ability to influence corporate matters.

Our founder, executive officers, and directors together own approximately 35.2% of our common stock as of December 31, 2006. Marina Zinberg, our Vice President, who is the sister of David Zinberg, our Chairman, President and Chief Executive Officer, owns an additional 33.2% of our common stock.  As a result, these individuals will have significant influence over our management and affairs and over all matters requiring stockholder approval, including the election of directors and the approval of significant corporate transactions, such as a merger or a sale of our company or its assets, for the foreseeable future. This concentrated control will limit the ability of other stockholders to influence corporate matters. Because of this, we may take actions that some of our stockholders do not view as beneficial. As a result, the market price of our common stock could be adversely affected because stockholders may not view favorably the concentration of control in the hands of management.

Our charter documents and Delaware law could make it more difficult for a third party to acquire us, and discourage a takeover .

On June 22, 2006, we reincorporated in Delaware, and the Delaware certificate of incorporation and the Delaware General Corporation Law, or DGCL, contain provisions that may have the effect of making more difficult or delaying attempts by others to obtain control of our company, even when these attempts may be in the best interests of our stockholders. The Delaware certificate of incorporation also authorizes our Board of Directors, without stockholder approval, to issue one or more series of preferred stock, which could have voting and conversion rights that adversely affect or dilute the voting power of the holders of common stock. Delaware law also imposes conditions on certain business combination transactions with “interested stockholders.” The Delaware certificate of incorporation divides our Board of Directors into three classes, with one class to stand for election each year for a three-year term after the initial election. The classification of directors tends to discourage a third party from initiating a proxy solicitation or otherwise attempting to obtain control of our company and may maintain the incumbency of our Board of Directors, as this structure generally increases the difficulty of, or may delay, replacing a majority of directors. The Delaware bylaws authorize our Board of Directors to fill vacancies or newly created directorships. A majority of the directors then in office may elect a successor to fill any vacancies or newly created directorships.

24




ITEM 1B.  Unresolved Staff Comments

Not applicable.

Item 2.           Properties.

We lease a 50,000 square foot facility in Culver City, California, which serves as our corporate headquarters and houses our sales, marketing, research and development, customer service, fulfillment, and warehouse operations. Our lease expires in October 2009. We expect that our current facility will satisfy our needs through 2009.

Item 3.           Legal Proceedings

On November 27, 2006, two of our shareholders filed a lawsuit against us and David Zinberg, our Chief Executive Officer, alleging fraud, rescission breach of fiduciary duties and damages in connection with plaintiffs’ purchase of our common stock.  The aggregate purchase price for the plaintiffs shares was $60,000.  From time to time, we may be involved in litigation relating to claims rising out of our ordinary course of business. We are not currently a party to any material legal proceedings.

Item 4.           Submission of Matters to a Vote of Security Holders

On December 15, 2005, the Company  held its annual meeting of shareholders, at which time the following directors were elected:  David Zinberg, Lawrence Kong and Garry Itkin.  The number of votes cast for each of the directors was 15,155,000, the number of votes against was 0 and the number of abstentions and broker non-votes was 0.   Effective March 15, 2006, the Board was expanded to five (5) members and two (2) additional directors, Peter Hanelt and Man Jit Singh, were appointed to the Board. On December 18, 2006, Garry Itkin resigned as a director.

25




Part II

Item 5.                                   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

There is no established public trading market for any of the Company’s securities.  As of December 31, 2006, the number of shares of our common stock that is subject to outstanding options or warrants to purchase common stock is 8,353,000.  As of December 31, 2006, there were 23,233,904 shares of common stock outstanding.

Holders

As of December 31, 2006, there were 1,128 holders of record of our common stock. As of December 31, 2006, we had 79 holders of stock options exercisable for shares of our common stock.

Dividends

We have never declared or paid any dividends on our common stock and do not anticipate that we will pay any dividends to holders of our common stock in the foreseeable future. Instead, we currently plan to retain any earnings to finance the growth of our business. Payments of any cash dividends in the future will be within the discretion of our Board of Directors and will depend on our financial condition, results of operations, and capital requirements as well as other factors deemed relevant by our Board of Directors.

Equity Compensation Plan Information

 

 

 

 

 

 

Number of securities

 

 

 

 

 

 

 

remaining available for

 

 

 

Number of securities

 

 

 

future issuance under

 

 

 

to be issued upon

 

Weighted-average

 

equity compensation

 

 

 

exercise of

 

exercise price of

 

plans (excluding

 

 

 

outstanding options,

 

outstanding options,

 

securities reflected in

 

Plan category

 

warrants and rights (1)

 

warrants and rights

 

column (a))

 

Equity compensation plans approved by security holders

 

 

 

 

 

 

 

2006 Stock Award Plan

 

115,000

 

$6.00

 

885,000

 

2002 Special Stock Option Plan

 

1,456,500

 

$3.96

 

43,500

 

 

 

 

 

 

 

 

 

Equity compensation plans not approved by security holders

 

 

 

 

 

 

 

2001 Stock Option Plan

 

731,500

 

$6.00

 

168,500

 

Non-statutory Stock Option (2)

 

6,050,000

 

$6.00

 

 

 

 

 

 

 

 

 

 

Total

 

8,353,000

 

$5.64

 

1,097,000

 

 

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(1)                                The total number of shares of common stock to be issued upon exercise of all outstanding stock options, warrants and rights is 8,353,000 as of December 31, 2006.

(2)                                Includes a non-statutory stock option to purchase 6,000,000 shares at an exercise price of $6.00 per share granted to David Zinberg, our President and Chief Executive Officer.

Recent Sales of Unregistered Securities

During the past three years we have sold the following securities that were not registered under the Securities Act of 1933.  The share issuances were undertaken in reliance on the exemption from registration under the Securities Act of 1933 (the “Act”) set forth in Section 4(2) of the Act or Rule 701 under the Act.

In 2006, we issued 10,000 shares of our common stock to each of our outside directors, Peter Hanelt and Man Jit Singh, as payment of independent director fees.  We also issued 15,000 and 1,404 shares of common to an employee and independent consultant, respectively, for services rendered. The shares of common stock were issued at a price of $6.00 per share. We issued stock options to purchase an aggregate of 235,000 shares of our common stock at an exercise price of $6.00 per share to three of our employees under our 2006 Incentive Stock Plan for services rendered to our company.

In 2005, we issued stock options to purchase an aggregate of 678,500 shares and 25,000 shares of our common stock at an exercise price of $6.00 per share to, respectively, 44 of our employees under our 2001 Stock Option Plan and one non-employee in exchange for services rendered to our company.

In 2004, we issued stock options to purchase an aggregate of 137,000 shares and 25,000 shares of our common stock at an exercise price of $6.00 per share to, respectively, 48 of our employees under our 2001 Stock Option Plan and one non-employee, and issued to our Chief Executive Officer, David Zinberg, non-plan options to purchase 6,000,000 shares of our common stock at an exercise price of $6.00 per share.  In 2004, we also issued an aggregate of 28,544 shares of our common stock to six individuals in exchange for asset purchases, services, and other non-cash consideration at a weighted average price of $5.00 per share.

Issuer Purchases of Equity Securities

The following table contains information about repurchases of our common stock during the fourth quarter of 2006: 

 

 

 

 

 

 

Total Number of

 

Maximum

 

 

 

 

 

 

 

Shares

 

Number

 

 

 

Total

 

Average

 

Purchased as

 

of Shares that

 

 

 

Number

 

Price

 

Part of a

 

may

 

 

 

of

 

Paid

 

Publicly

 

yet be Purchased

 

 

 

Shares

 

per

 

Announced

 

Under the

 

2006

 

Purchased

 

Share

 

Program

 

Program

 

October 1 – October 31

 

 

 

 

 

November 1 – November 30

 

 

 

 

 

 

 

December 1 – December 31

 

15,000

 

$

6.00

 

 

 

Total

 

15,000

 

$

6.00

 

 

 

 

Pursuant to a Stock Vesting Agreement between the Company and Lawrence Kong, our Chief Executive Officer, 250,000 shares of common stock previously issued to Mr. Kong and subject to vesting provisions vested on June 30, 2006.  Although the Agreement did not allow the Company to withhold any portion of such common stock in order to reimburse us for our income tax withholding obligations associated with the stock vesting, in September 2006, Mr. Kong voluntarily surrendered 115,000 shares of common stock to us to reimburse us for satisfying our tax withholding obligations.  In recognition of the loss to Mr. Kong of the opportunity to derive the benefit of any appreciation of such shares, we issued to Mr. Kong non-qualified stock options for an equal number of shares with an exercise price equal to the fair market value of those shares on the date of grant.

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Postponed Initial Public Offering and Rescission Offer

On March 17, 2006, we filed a registration statement in connection with a planned initial public offering of our common stock.  We planned to conduct a rescission offer following the initial public offering in order to address sales of certain of our securities made in violation of certain provisions of federal and state securities laws.  See, “Risk Factors — Holders of common stock issued by us in prior offerings are entitled to rescind their purchases.” In June, 2006, our underwriters informed us that they were unable to complete the offering, primarily because we did not obtain a sufficient number of 180-day “lock-up” agreements from our existing stockholders.  Our underwriters have advised us that they are unable to take our company public in the foreseeable future, unless we obtain a sufficient number of these lock-up agreements.  Accordingly, we postponed our plans to conduct the initial public offering and the rescission offer, and requested for withdrawal of the registration statement that was filed.

If we do not have the financial resources for a rescission offer, any assertion by our stockholders of their legal claims against us could have a material and adverse effect on our liquidity, our financial position, results of operations, and cash flows. Moreover, even if we are successful in obtaining the financing necessary to conduct a rescission offer and make such offer to our stockholders, if, prior to the rescission offer, any stockholders who acquired their common stock in our offerings sell their common stock for less than the price at which they purchased their shares, they will be entitled to recover from us damages equal to the difference between their investment amount plus interest from the date of issuance and the value or price of the security at the time of its sale. Because these stockholders will no longer own our common stock, we will not be able to extinguish these damage claims by offering to rescind the stockholder’s purchase of our common stock.

The probability that stockholders would assert a claim against us and the extent of the our liability, if any, are contingent on a number of factors, including a stockholder’s desire to rescind his or her purchase based on the price of our rescission offer and the key purchase price of the tender for shares, applicable legal precedent, and statutes of limitation. As of the date of this filing, two of our shareholders have filed actions seeking a rescission of their investment in our common stock, which was in the aggregate $60,000, and unspecified damages.  Based on current facts known to management at this time, management does not believe that assertion of any such claims by the Company’s shareholders in a material amount is probable. Accordingly, no accruals for either potential amounts payable or reserves have been made at this time.

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Item 6.            Selected Financial Data

The selected financial data presented below has been derived from our financial statements. The statement of operations data for each of the fiscal years ended December 31, 2004, 2005, and 2006 and the balance sheet data at December 31, 2005 and 2006 are derived from our audited financial statements that are included in this report. The statement of operations data for the years ended December 31, 2002 and 2003 and the balance sheet data at December 31, 2002, 2003 and 2004 are derived from audited financial statements that are not included in this report. The historical results presented below are not necessarily indicative of the results to be expected in any future period.

You should read this information together with “Management’s discussion and analysis of financial condition and results of operations” and our financial statements and the related notes included elsewhere in this report.

 

 

Years Ended December 31,

 

(in thousands, except per share data)

 

2002

 

2003

 

2004

 

2005

 

2006

 

 

 

 

 

 

 

 

 

 

 

 

 

Statement of Operations Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Revenue

 

34,778

 

47,665

 

65,324

 

90,579

 

131,823

 

Cost of Revenue

 

32,315

 

42,188

 

53,072

 

71,257

 

100,633

 

Gross Profit

 

2,463

 

5,477

 

12,252

 

19,322

 

31,190

 

Operating Expenses:

 

 

 

 

 

 

 

 

 

 

 

General & Administrative

 

10,336

 

9,259

 

8,800

 

10,938

 

13,853

 

Sales & Marketing

 

1,071

 

1,960

 

2,542

 

5,078

 

10,300

 

Rescission and Public Offering Costs

 

 

 

 

442

 

1,287

 

Depreciation & Amortization

 

91

 

61

 

139

 

157

 

273

 

Total Operating Expenses

 

11,498

 

11,280

 

11,481

 

16,615

 

25,713

 

Profit (Loss) from Operations

 

(9,035

)

(5,803

)

771

 

2,707

 

5,477

 

Interest income (expense), net

 

(65

)

(27

)

 

22

 

32

 

Income taxes

 

 

 

 

(82

)

(120

)

Net Profit (Loss)

 

(9,100

)

(5,830

)

771

 

2,647

 

5,389

 

Net Profit (Loss) common share:

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted

 

(0.35

)

(0.21

)

0.03

 

0.11

 

0.23

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance Sheet Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash & Cash Equivalents

 

 

10

 

5

 

7

 

359

 

Working Capital (Deficit)

 

(1,441

)

(3,148

)

(2,164

)

1,009

 

5,974

 

Total Assets

 

9,836

 

7,270

 

12,490

 

17,746

 

38,542

 

Post-dated check financing

 

5,135

 

4,198

 

6,503

 

5,315

 

 

Total Liabilities

 

10,765

 

9,355

 

13,570

 

15,963

 

31,815

 

Total stockholders’ equity (deficit)

 

(929

)

(2,085

)

(1,080

)

1,783

 

6,727

 

 

29




Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

You should read the following discussion and analysis in conjunction with our financial statements and related notes. This discussion contains forward-looking statements that involve risks, uncertainties, and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of a variety of factors, including those set forth under “Risk factors” and elsewhere in this prospectus.

Overview

We are a leading online retailer of jewelry, featuring a live auction format. We have established our retail brand in the online marketplace by offering high-quality merchandise, a unique user-friendly shopping experience, and the opportunity for buyers to achieve significant cost savings versus traditional retail channels. A key to our success has been our ability to efficiently and cost effectively source jewelry merchandise and rapidly respond to changing consumer demands for certain jewelry. We offer our products through a continuous live format, featuring “no reserve” auctions, a $1 minimum opening bid, and a unique 15-second auction extension period that allows our auctions to continue until all bids are received. The majority of our auctions are short-term, often lasting less than one hour, providing immediate gratification to our customers and encouraging frequent visits and active viewing of our website. Our product inventory includes gold, platinum, and silver jewelry set with diamonds, rubies, emeralds, sapphires, and other precious and semi-precious stones; and watches.

We sell to consumers looking for reliable bargains on jewelry. Because we purchase and retain all of our jewelry inventory onsite, we can provide our customers with timely service and delivery of their purchases. In addition, each item is inspected by one of our trained product specialists prior to its placement on our website, which assures our customers of the quality of their purchases of our products. We provide a trustworthy and secure buying environment with a 15-day return policy on all merchandise. We believe that some of our customers are resellers intending to sell our goods in secondary markets, such as on eBay, at local auctions, and through other retail channels. These resellers have the opportunity to purchase products at lower prices than they would receive from manufacturers or other distributors. Our auctions are conducted 24 hours a day, seven days a week. We also offer daily telephone customer support, 24-hour online live-help and e-mail customer support.

Critical Accounting Policies

The preparation of our financial statements requires us to make certain estimates and judgments that affect amounts reported and disclosed in our financial statements and related notes. We base our estimates on historical experience and on other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates. The following are the critical accounting policies that we believe require significant estimation and judgment.

Revenue Recognition

We derive our revenue from five sources: merchandise sales, shipping revenue, auction transaction fee revenue, commission revenue and advertising revenue. In accordance with SAB 104, we recognize revenue from all five sources when the following revenue recognition criteria are met: (1) persuasive evidence of an arrangement exists; (2) the product has been shipped or the service has been rendered and the customer assumes the risk of loss; (3) the selling price is fixed or determinable; and (4) collection of the resulting receivable is reasonably assured.

We recognize merchandise sales upon shipments made to consumers that are fulfilled from our warehouse. We generally require online payment by credit card or other electronic payment methods at the point of sale. We record amounts received or billed prior to shipment of goods to customers as deferred revenue. We reduce gross sales by returns and charge backs from customers.

30




We report shipping and handling fees and costs in accordance with Emerging Issues Task Force (“EITF”) issue No. 00-10, “Accounting for Shipping and Handling Fees and Costs.” As such, in the Statement of Operations all amounts billed to customers by us related to shipping and handling are included in “Net revenue” and our shipping and handling costs are included in “Cost of revenue.”

We include auction transaction fee revenue in net revenue. The auction transaction fee is a 3% fee charged to all customers on all payments for merchandise sales.

We derive commissions revenue from sales of Certified Merchant merchandise that is owned by third parties and recognize that revenue when services have been rendered. For commission revenue, we recognize as revenue only the commission portion of the price our customers pay for the purchased products because we are acting as an agent in such transactions. Commissions are also reduced by the impact of refunds made to customers when the Certified Merchant does not meet its obligations to the customers.

We recognize advertising revenue, which consists primarily of pop-unders, when the services are rendered and the advertising revenue is known and collectible.

Return and Allowance Reserve

We estimate potential future product returns and chargebacks related to current period revenue. We analyze historical returns, and changes in customer demand and acceptance of our products when evaluating the adequacy of the sales returns reserve and other allowances in any accounting period. If actual returns are greater than our estimates, we will record additional returns and allowances in addition to our estimates, which will result in lower net revenue recorded during that period.  Reserves for returns and chargebacks are included in accrued liabilities.

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 average selling price. In addition, for the year ended December 31, 2006 we record 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 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.

Prepaid Inventory

We record payments made to our suppliers for merchandise purchases we have yet to receive. These payments are recorded as prepaid inventory until they are in our physical possession and satisfactorily examined; we then categorize them as inventory.

Deferred Income Tax Allowance

We recognize deferred tax assets and liabilities for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Realization of the deferred tax asset depends on generating sufficient taxable income in future years. We reduce deferred tax assets by a valuation allowance when we believe it is more likely than not that some portion or all of the deferred tax assets will not be realized.

Stock-Based Compensation

Prior to January 1, 2006, we measured compensation expense to employees for our stock option incentive plans under the recognition and measurement provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. Utilizing the intrinsic value method prescribed by APB No.

31




25, we did not record compensation expense when stock options were granted to eligible participants as long as the exercise price was not less than the fair market value of the stock when the option was granted.

We recorded stock-based compensation representing the difference between the option exercise price and the deemed fair value of our common stock on the grant date for financial reporting purposes. We determined the deemed fair value of our common stock based upon the most recent third-party sale of our common stock known to us. Had different assumptions or criteria been used to determine the deemed fair value of our common stock, different amounts of stock-based compensation could have been reported.

In accordance with Statement of Financial Accounting Standards (‘‘SFAS’’) No. 123, ‘‘Accounting for Stock-Based Compensation,’’ and SFAS No. 148, ‘‘Accounting for Stock-Based Compensation-Transition and Disclosure,’’ which amended SFAS No. 123, we disclosed pro forma net income and net income per share as if the fair value based method had been applied in measuring compensation expense. The disclosure provisions of SFAS No. 148 were effective for financial statements for interim periods beginning after December 15, 2002. We adopted the disclosure requirements in the first quarter of 2003. This information is contained in Note 1 to our financial statements. The fair values of options and shares issued pursuant to our option plan at each grant date were estimated using the Black-Scholes option pricing model. Because there has been no public market for our common stock, we used the minimum value method in determining the expected volatility of our common stock was zero. The transition provisions did not have an impact on our financial position or results of operations as we did not elect to adopt the fair value-based method of accounting for stock-based employee compensation under SFAS No. 123.

On January 1, 2006, we adopted SFAS No. 123 (revised 2004), ‘‘Share-Based Payment’’ (‘‘SFAS 123R’’) requiring that share-based payment transactions be recognized in the financial statements based on the fair value of the equity or liability instrument issued. For the year ended December 31, 2006, we used the Black-Scholes option pricing model to estimate the value of our options in implementing SFAS 123R and the calculated method to determine expected volatility, rather than the minimum value method, which we previously used to determine expected volatility. Under SFAS 123R stock-based compensation expense recognized during the period is based on the value of the portion of stock-based payment awards that is ultimately expected to vest. Accordingly, stock-based compensation expense recognized in the statements of income will be reduced for forfeitures for the year ended December 31, 2006. SFAS 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. In the pro forma information required under SFAS 148 for the period prior to 2006, we did not account for forfeitures, as all options granted were fully vested at the date of grant and were not subject to any service period conditions. We expensed stock-based compensation on the date of grant, as all options granted prior to January 1, 2006, vested immediately. In the future, we anticipate that stock-based compensation will include vesting provisions and therefore stock-based compensation expense in the future will be reduced for forfeitures.

We adopted SFAS 123R using the modified prospective method which requires the application of the accounting standard as of January 1, 2006. Under this transition method, we are required to recognize compensation cost beginning January 1, 2006 for the portion of outstanding awards for which the requisite service has been rendered, based on the grant-date fair value of those awards calculated under SFAS 123 for our pro forma disclosures. As of December 31, 2006, stock options to purchase 115,000 shares were not fully vested. For the year ended December 31, 2006,  we issued stock options to purchase 235,000 shares of which 120,000 stock options were forfeited . The adoption of SFAS 123R resulted in a stock-based compensation expense of $16,000 for the year ended December 31, 2006. In accordance with the modified prospective method, the financial statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123R.

We also adopted FASB Staff Position No. FAS 123(R)-3, Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards (“FSP 123(R)-3”). Under FSP 123(R)-3, the Company elected to use the short-cut method to calculate the historical pool of windfall tax benefits. The Company elected to use the tax law ordering approach for purposes of determining whether an excess of tax benefit has been realized.

32




Description of Our Revenue, Costs, and Expenses

The following table presents our historical results of operations for the periods indicated as a percentage of net revenue.

 

Years Ended December 31,

 

 

 

2004

 

2005

 

2006

 

 

 

 

 

 

 

 

 

Net Revenue

 

100.0

%

100.0

%

100.0

%

Gross Profit

 

18.8

 

21.3

 

23.7

 

Operating Expenses:

 

 

 

 

 

 

 

General & Administrative

 

13.5

 

12.1

 

10.5

 

Sales & Marketing

 

3.9

 

5.6

 

7.8

 

Rescission and Public Offering Costs

 

0.0

 

0.4

 

1.0

 

Depreciation & Amortization

 

0.2

 

0.2

 

0.2

 

Total Operating Expenses

 

17.6

 

18.3

 

19.5

 

Profit from Operations

 

1.2

 

3.0

 

4.2

 

Interest income (expense), net

 

0.0

 

0.0

 

0.0

 

Income taxes

 

0.0

 

(0.1

)

(0.1

)

Net Profit

 

1.2

%

2.9

%

4.1

%

 

Net Revenue

Substantially all of our net revenue consists of jewelry sold via the Internet, net of returns. We also generate net revenue from shipping and handling, auction transaction fee revenue, commissions from Certified Merchants, and advertising revenue.

The following table presents our sources of revenue for the periods indicated as a percentage of net revenue.

 

Year Ended December 31,

 

 

 

2004

 

2005

 

2006

 

 

 

 

 

 

 

 

 

Net Revenue

 

 

 

 

 

 

 

Merchandise sales

 

89.5

%

88.6

%

85.3

%

Shipping & Handling

 

9.6

 

10.4

 

11.5

 

Transaction Fee

 

0.0

 

0.7

 

3.1

 

Commissions

 

0.8

 

0.3

 

0.1

 

Advertising

 

0.1

 

0.0

 

0.0

 

Total Net Sales

 

100.0

%

100.0

%

100.0

%

 

33




In November 2005, we implemented a 3% transaction fee on all sales.

Net revenue by geographic area is presented based upon the country of destination. No foreign country accounted for 10% or more of net revenue for any of the fiscal years presented. Net revenue by geographic area for the periods indicated was as follows:

 

 

Years ended December 31,

 

(in thousands, except percentages)

 

2004

 

2005

 

2006

 

 

 

 

 

Geographic area

 

Amount

 

Percent

 

Amount

 

Percent

 

Amount

 

Percent

 

United States

 

$

53,986

 

82.6

%

$

73,199

 

80.8

%

$

104,338

 

79.2

%

International

 

11,338

 

17.4

 

17,380

 

19.2

 

27,485

 

20.8

 

Total

 

$

65,324

 

100.0

%

$

90,579

 

100.0

%

$

131,823

 

100.0

%

 

Gross Profit

Our gross profit consists of net revenue less the cost of sales. Our cost of sales consists of the cost of merchandise sold to customers, inbound and outbound shipping costs, packaging and shipping supplies, insurance on shipments, product repair and service costs and credit card and other transaction fees associated with payments.

General and Administrative Expenses

Our general and administrative expenses consist primarily of payroll and related benefit costs for our employees. These expenses also include fulfillment, customer service, technology, professional fees, other general corporate expenses, and stock-based compensation, consisting substantially of stock option grants and stock grants to employees and consultants.

Sales and Marketing Expenses

Our marketing expenses consist primarily of costs associated with paid website search marketing, online banner marketing, e-mail campaigns, affiliate programs and optimization services. These marketing programs, which are designed to drive buyers to our website, are the most important factor in increasing demand for our jewelry products and increasing net revenue.

Rescission and Public Offering Costs

These costs consist primarily of regulatory filing fees, accountant fees, legal fees and printing expenses incurred in the planned initial public offering.

Results of Operations

Comparison of Year Ended December 31, 2006 with Year Ended December 31, 2005

Net Revenue

Net revenue increased 45.5% to $131.8 million in 2006 from $90.6 million in 2005. This increase in net revenue was due to the increase in the number of orders and the average selling price per order. The increase in the number of orders was primarily the result of the number of new buyers we attracted during 2006. The increase in average selling price was due mainly to the purchase of higher priced inventory.

34




Gross Profit

Gross profit increased 61.4% to $31.2 million in 2006 from $19.3 million in 2005. Gross profit as a percentage of net revenue increased to 23.7% in 2006 from 21.3% in 2005. The increase in gross profit as a percentage of net revenue resulted primarily from more effective purchasing, implementation of a 3% auction transaction fee in November 2005, partially offset by a small decrease in margin on shipping and handling charges.

General and Administrative Expenses

General and administrative expenses increased 26.7% to $13.9 million in 2006 from $10.9 million in 2005. The increase in general and administrative expenses in 2006 was due primarily to a $1.5 million increase in payroll and payroll related expenses and a $701,000 increase in outsourcing expenses. We increased our personnel from 176 at year end 2005 to 198 at year end 2006. Our outsourcing expenses increased in 2006 in the areas of customer service, photo editing, auction uploading and IT support. General and administrative expenses as a percentage of net revenue decreased to 10.5% in 2006 from 12.1% in 2005 as we continue to leverage on our operational infrastructure.

 Sales and Marketing Expenses

Sales and marketing expenses increased 103% to $10.3 million in 2006 from $5.1 million in 2005. This increase resulted primarily from increased marketing campaigns and cost of online advertising to attract new buyers. Sales and marketing expenses as a percentage of net revenue increased to 7.8% in 2006 from 5.6% in 2005. We expect our sales and marketing expenses to continue to increase in absolute dollars, as we intend to continue increasing our online marketing campaigns in order to attract new customers. We do not expect our sales and marketing expenses as a percentage of revenue to increase.

Rescission and Public Offering Costs

These costs consist primarily of regulatory filing fees, accountant fees, legal fees and printing expenses incurred in the planned initial public offering, which amounted to $442,000 and $1.3 million for the years ended December 31, 2005 and 2006, respectively. Costs incurred in 2005 relate primarily to rescission related costs of the planned initial public offering whereas costs incurred in 2006 relate to the registration statement of the planned initial public offering. The capitalized costs of the rescission and initial public offering were expensed when the Company determined it was unable to complete the offering and subsequently requested withdrawal of the registration statement.

Comparison of Year Ended December 31, 2005 with Year Ended December 31, 2004

Net Revenue

Net revenue increased 38.7% to $90.6 million in 2005 from $65.3 million in 2004. This increase in net revenue was due to the increase in the number of orders, partially offset by a decrease in the average selling price per order. The increase in the number of orders was primarily the result of the number of new buyers we attracted during 2005.

Gross Profit

Gross profit increased 57.7% to $19.3 million in 2005 from $12.3 million in 2004. Gross profit as a percentage of net revenue increased to 21.3% in 2005 from 18.8% in 2004. The increase in gross profit as a percentage of net revenue resulted primarily from more effective purchasing, implementation of a 3% auction transaction fee in November 2005, and increased margin on shipping and handling charges.

General and Administrative Expenses

General and administrative expenses increased 24.3% to $10.9 million in 2005 from $8.8 million in 2004. The increase in general and administrative expenses in 2005 was due primarily to a $1.5 million increase in payroll and

35




payroll related expenses, which included increasing the number of personnel on our technology development staff. General and administrative expenses as a percentage of net revenue decreased to 12.1% in 2005 from 13.5% in 2004. We intend to continue to enhance our technology and information systems and expect these expenses to increase in absolute dollars in future periods.

Sales and Marketing Expenses

Sales and marketing expenses increased 99.8% to $5.1 million in 2005 from $2.5 million in 2004. This increase resulted primarily from an increased marketing campaign and cost of online advertising to attract new buyers. Sales and marketing expenses as a percentage of net revenue increased to 5.6% in 2005 from 3.9% in 2004. We expect our sales and marketing expenses to continue to increase in absolute dollars, as we intend to continue increasing our online marketing campaign in order to attract new customers.

Rescission and Public Offering Costs

In 2005, we expensed $442,000, primarily consisting of legal fees in order to resolve issues related to the unregistered sales of our common stock prior to effecting an initial public offering.

Quarterly Operations Data

The following tables set forth quarterly statements of operations data for the eight quarters ended December 31, 2006, including amounts expressed as a percentage of net revenue. This quarterly information is unaudited, but has been prepared on the same basis as the annual financial statements and, in our opinion, reflects all adjustments necessary for a fair representation of the information for the periods presented. This quarterly statement of operations data should be read in conjunction with our audited financial statements and the related notes included elsewhere in this prospectus. Results of operations for any quarter are not necessarily indicative of results for any future period.

36




Historically, sales in the jewelry industry are seasonal and have been higher in the fourth quarter as a result of higher consumer spending during the December holiday season. Approximately 29.3%, 33.9%, and 28.5% of our net revenue in 2004, 2005, and 2006, respectively, was generated during the fourth quarter. As we continue to grow, we expect to experience more pronounced seasonal fluctuations in our net revenue and anticipate a disproportionate amount of our revenue in the fourth quarter in the future. Gross profit in the fourth quarter of 2006 declined when we offered free shipping promotions to our buyers.  We stopped this promotion after January 2007.

 

 

Quarters ended

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(in thousands,

 

March 31,

 

June 30,

 

Sept. 30,

 

Dec. 31,

 

March 31,

 

June 30,

 

Sept. 30,

 

Dec. 31,

 

except per share data)

 

2005

 

2005

 

2005

 

2005

 

2006

 

2006

 

2006

 

2006

 

 

 

(unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net revenue

 

$

20,720

 

$

18,053

 

$

21,098

 

$

30,708

 

$

34,694

 

$

32,434

 

$

27,061

 

$

37,634

 

Gross profit

 

3,745

 

3,624

 

4,338

 

7,615

 

9,178

 

7,689

 

6,662

 

7,661

 

General and administrative

 

2,589

 

2,502

 

2,430

 

3,417

 

3,352

 

3,443

 

3,052

 

4,007

 

Sales and marketing

 

875

 

714

 

1,163

 

2,326

 

2,407

 

2,838

 

2,531

 

2,523

 

Rescission and public offering costs

 

 

 

442

 

 

 

1,231

 

 

56

 

Depreciation and amortization

 

38

 

38

 

40

 

41

 

54

 

67

 

74

 

78

 

Income from operations

 

243

 

370

 

263

 

1,831

 

3,365

 

110

 

1,005

 

997

 

Net income

 

$

243

 

$

370

 

$

244

 

$

1,790

 

$

3,292

 

$

147

 

$

997

 

$

953

 

Net income per share available to common stockholders – Basic

 

$

0.01

 

$

0.02

 

$

0.01

 

$

0.08

 

$

0.14

 

$

0.01

 

$

0.04

 

$

0.04

 

Net income per share available to common stockholders – Diluted

 

$

0.01

 

$

0.02

 

$

0.01

 

$

0.07

 

$

0.14

 

$

0.01

 

$

0.04

 

$

0.04

 

Weighted average number of shares outstanding – Basic

 

27,411

 

23,312

 

23,312

 

23,312

 

23,312

 

23,312

 

23,311

 

23,270

 

Weighted average number of shares outstanding – Diluted

 

27,941

 

23,835

 

23,880

 

23,829

 

23,827

 

23,822

 

23,801

 

23,750

 

 

 

 

March 31,
2005

 

June 30,
2005

 

Sept. 30,
2005

 

Dec. 31,
2005

 

March 31,
2006

 

June 30,
2006

 

Sept. 30,
2006

 

Dec. 31,
2006

 

 

 

(unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net revenue

 

100.0

%

100.0

%

100.0

%

100.0

%

100.0

%

100.0

%

100.0

%

100.0

%

Gross profit

 

18.1

 

20.1

 

20.6

 

24.8

 

26.5

 

23.7

 

24.6

 

20.4

 

General and administrative

 

12.5

 

13.9

 

11.5

 

11.1

 

9.7

 

10.6

 

11.2

 

10.6

 

Sales and marketing

 

4.2

 

4.0

 

5.5

 

7.6

 

6.9

 

8.8

 

9.4

 

6.7

 

Rescission and public offering costs

 

 

 

2.1

 

 

 

3.8

 

 

0.1

 

Depreciation and amortization

 

0.2

 

0.2

 

0.2

 

0.1

 

0.2

 

0.2

 

0.3

 

0.2

 

Operating income

 

1.2

 

2.0

 

1.2

 

6.0

 

9.7

 

0.3

 

3.7

 

2.6

 

Net income

 

1.2

%

2.0

%

1.2

%

5.8

%

9.5

%

0.4

%

3.7

%

2.5

%

 

37




Additional operating metrics:

 

 

March 31,

 

June 30,

 

Sept. 30,

 

Dec. 31,

 

March 31,

 

June 30,

 

Sept. 30,

 

Dec. 31,

 

 

 

2005

 

2005

 

2005

 

2005

 

2006

 

2006

 

2006

 

2006

 

 

 

(unaudited)

 

 

 

 

 

Average selling price per order (gross)

 

$

106

 

$

106

 

$

108

 

$

124

 

$

142

 

$

133

 

$

124

 

$

123

 

Average orders per day

 

2,285

 

2,381

 

2,381

 

2,953

 

2,901

 

2,832

 

2,587

 

3,757

 

Average items sold per day

 

7,923

 

6,699

 

6,669

 

6,901

 

7,173

 

7,730

 

7,293

 

9,685

 

Acquisition cost per new buyer

 

34

 

30

 

27

 

34

 

38

 

49

 

51

 

36

 

Number of new buyers

 

25,688

 

23,651

 

42,875

 

68,381

 

63,618

 

57,520

 

49,412

 

70,419

 

 

Liquidity and Capital Resources

Since inception, we have funded our operations through the sale of equity securities and cash generated from operations. The significant components of our working capital are inventory and liquid assets such as cash and accounts receivable, reduced by post-dated check financing, revolving credit line, accounts payable, and deferred revenue. Our business model contains beneficial working capital characteristics: while we collect cash from sales to customers within several business days of the related sale, we typically have extended payment terms with our suppliers.

As of December 31, 2006, we had a working capital surplus of $6.0 million and have no long-term debt obligations. The “post-dated check financing” reflected on our balance sheet as of December 31, 2005 results from post-dated checks outstanding. It is customary for our vendors to accept checks post-dated by 60 days as extended payment for purchase of merchandise. Our post-dated check financing procedures have changed in the year 2006. In prior years we have recorded post-dated checks to vendors as though the checks had cleared our bank and therefore reduced outstanding accounts payable. We now employ “positive pay” procedures with our financial institution, which preclude post-dated checks from clearing prior to the check date. Therefore, post-dated checks to vendors remain in accounts payable and will not be deducted from accounts payable until the date of the check. At year end December 31, 2006 all post-dated checks provided to vendors are subject to “positive pay.” As of December 31, 2006, we have $0 post-dated check financing and accounts payable of $22.0 million. This compares with $5.3 million of post-dated check financing and outstanding accounts payable of $7.3 million at December 31, 2005. In 2005, accounts payable have increased proportionately as post-dated check financing has decreased.

Net cash provided by operating activities was $1.5 million in 2006 compared with $199,000 in 2005. Net cash is affected primarily by changes in net income and loss, inventories, post-dated check financing, revolving credit line,  accounts payable and deferred revenue. We recorded net income of  $771,000 in 2004, $2.6 million in 2005 and $5.4 million in 2006. The improvement in profitability resulted primarily from the improved gross profit margins of 18.8%, 21.3%, 23.7% in 2004, 2005, and 2006, respectively. The implementation of the 3% transaction fee on merchandise sales also contributed to gross profit margins improvement in 2006. Inventories, and accounts payable generally increase in line with sales growth and changes in our inventory strategy. Our inventory strategy is influenced by our ability to secure inventory that we believe will improve sales and our gross margins. In 2006, we also started purchasing loose diamonds and semi-precious stones and delivering them to manufacturers to produce into finished jewelry inventory.

The increase in cash provided by operating activities in 2006 compared with 2005 was $1.3 million. Net income was $5.4 million in 2006 compared with $2.6 million in 2005. Inventories increased by $15.4 million in 2006 compared with an increase of $5.2 million in 2005. Prepaid inventory increased by $3.1 million in 2006 compared to none in 2005. Post-dated check financing decreased by $5.3 million in 2006 compared with a decrease of $1.2 million in

38




2005. We utilized the revolving credit line in the amount of $3.9 million in 2006 and we had no revolving line of credit in 2005. Accounts payable increased by $14.7 million in 2006 compared with an increase by $2.4 million in 2005. The increase in inventories and corresponding increases in financing and accounts payable is attributable to our ability to purchase and hold inventory that we believe will improve sales and our gross margins. Deferred revenue increased by $2.4 million in 2006 compared to an increase of $518,000 in 2005. The increase in deferred revenue resulted from ceasing operations at the end of the year to conduct annual physical inventory, the extended year-end weekend holidays and higher daily sales volume that have to be deferred.

Net cash used for investing activities was $35,000, $197,000, and $367,000 in 2004, 2005, 2006, respectively, and was primarily related to capital expenditures for our office equipment and technology system infrastructure, including software.

Net cash used for financing activities was $780,000 in 2006. There were no financing activities in 2005. Net cash used for financing activities was $138,000 in 2004. The financing activities were primarily related to net cash used for the retirement of common stock and purchase of treasury stock.

In July 2006, we entered into a revolving credit line agreement with LaSalle Bank, ABN AMRO, to provide working capital financing secured by inventories and tangible assets. The loan agreement allows for us to initially draw on a line of credit up to $10 million, with a provision to increase the limit up to $15 million with the future consent of the bank’s loan committee. All cash receipts from our revenues are restricted to being deposited into a LaSalle Bank account, to be applied to current reported cash disbursements requirements, under a positive pay system, and then to the credit line outstanding balance. The revolving credit line agreement expires in July of 2010. As of December 31, 2006, there was an outstanding balance of $3.9 million under the revolving credit line and remaining availability of $5.1 million after deducting reserve of $1.0 million for minimum required excess availability, which is a reserve of the $10 million credit line that we cannot utilize. There is an unused fee of 0.15% or the unused portion of the revolving credit line.

In December 2006, we received a notice of default under the loan agreement for violating two covenants. We failed to meet the trailing twelve month EBITDA covenant, due in part to the expensing of rescission and public offering costs of $1.3 million in 2006, and exceeded the $225,000 capital expenditure covenant with actual expenditures of $367,000 in 2006. In February 2007, the lender waived the default and amended the covenants.

We believe that cash and cash equivalents currently on hand, cash flows from operations and the availability of our revolving line of credit will be sufficient to continue our operations and to pursue our growth strategy for the foreseeable future. Our future capital requirements will depend on many factors, including the rate of our revenue growth; the timing and extent of spending to enhance our website, network infrastructure, and transaction processing systems; the extent of our advertising and marketing programs; the levels of the inventory we carry; and other factors relating to our business. Enhancement of our website, network infrastructure, and transaction processing systems will require us to spend significantly more than we have in the past. Moreover, to date our spending in these areas has been lower than industry averages. We anticipate increasing our system expenditures to accommodate these needs in the future. We may require additional financing in the future in order to execute our operating plan. We cannot predict whether this additional financing will be in the form of equity, debt, or a combination of debt or equity. We may not be able to obtain any necessary additional funds on a timely basis, on acceptable terms, or at all.

Aggregate Contractual Obligations

The following table presents our contractual obligations as of March 31, 2006, over the next five years and thereafter.

(in thousands)

 

Payments by Period

 

 

 

Total

 

Less Than

 

1-3

 

4-5

 

After 5

 

Contractual Obligations

 

Amount

 

1 Year

 

Years

 

Years

 

Years

 

Property lease

 

$

2,701

 

$

931

 

$

1,770

 

$

 

$

 

 

39




We lease a 50,000 square foot facility in Culver City, California, which serves as our corporate headquarters and houses our sales, marketing, research and development, customer service, fulfillment, and warehouse operations. Our lease expires in October 2009. We expect that our current facility will satisfy our needs through 2009.

Impact of Inflation

The effect of inflation and changing prices on our operations was not significant during the periods presented.

Item 7A.  Quantitative and Qualitative Disclosure About Market Risk

Market risk represents the risk of loss arising from adverse changes in market rates and foreign exchange rates. We do not believe that a change in market interest rates would have a material effect on our results of operations or financial condition. Although we derive a portion of our sales outside of the United States, all of our sales are denominated in U.S. dollars. We have limited exposure to financial market risks, including changes in interest rates and foreign currency exchange rates.

Item 8.           Financial Statements and Supplementary Data

See Item 15(a)

Item 9.           Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

None.

Item 9A.  Controls and Procedures

Evaluation of Disclosure Controls and Procedures .

Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report.  Disclosure controls and procedures are the controls and other procedures that we designed to ensure that we record, process, summarize and report in a timely manner the information we must disclose in reports that we file with or submit to the Securities and Exchange Commission.  Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that, as of the date of their evaluation, our disclosure controls and procedures were effective.  There were no significant changes made in our internal controls or in other factors that could significantly affect internal controls subsequent to the date of their evaluation.

Item 9B.         Other Information

None.

40




Part III

We have omitted the information required in Part III of this annual report because we intend to include that information in our definitive proxy statement for our 2007 annual meeting of shareholders, which we expect to file before 120 days after December 31, 2006. We incorporate that information in this annual report by reference to our 2007 proxy statement.

Item 10.    Directors, Executive Officers and Corporate Governance.

Information required by this item is incorporated by reference from the definitive proxy statement required to be filed pursuant to Regulation 14A for the 2007 Annual Meeting of our stockholders.

We have adopted a code of conduct that applies to our Chief Executive Officer, Chief Financial Officer, and to all of our other officers, directors, employees and agents. The code of conduct is available at the Corporate Governance section of the Investor Relations page on our website at www.bidz.com. We intend to disclose future amendments to, or waivers from, certain provisions of our code of ethics on the above website.

Item 11.    Executive Compensation.

Information required by this item is incorporated by reference from the definitive proxy statement required to be filed pursuant to Regulation 14A for the 2007 Annual Meeting of our stockholders.

Item 12.    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

Information required by this item is incorporated by reference from the definitive proxy statement required to be filed pursuant to Regulation 14A for the 2007 Annual Meeting of our stockholders.

Item 13.    Certain Relationships and Related Transactions, and Director Independence.

Information required by this item is incorporated by reference from the definitive proxy statement required to be filed pursuant to Regulation 14A for the 2007 Annual Meeting of our stockholders.

Item 14.    Principal Accountant Fees and Services.

Information required by these items is incorporated by reference from the definitive proxy statement required to be filed pursuant to Regulation 14A for the 2007 Annual Meeting of our stockholders.

Part IV

Item 15. Exhibits and Financial Statement Schedules

The following documents are filed as part of this report:

 

 

 

(a)

Financial Statements

 

 

 

 

 

Report of Independent Registered Public Accounting Firm

 

 

Balance Sheets as of December 31, 2005 and 2006

 

 

Statements of Operations for the Years ended December 31, 2004, 2005, and 2006

 

 

Statements of Changes in Stockholders’ Equity (Deficit) for the Years ended December 31, 2004, 2005, and 2006

 

 

Statements of Cash Flows for the Years ended December 31, 2004, 2005, and 2006

 

 

Notes to Financial Statements

 

 

 

41




Report of Independent Registered Public Accounting Firm

Board of Directors and Stockholders
BIDZ.com, Inc.

We have audited the accompanying balance sheets of BIDZ.com, Inc. as of December 31, 2006 and 2005, and the related statements of income, changes in stockholders’ equity (deficit), and cash flows for each of the three years in the period ended December 31, 2006.  These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  We were not engaged to perform an audit of the Company’s internal control over financial reporting.  Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting.  Accordingly, we express no such opinion.  An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of BIDZ.com, Inc. as of December 31, 2006 and 2005, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2006 in conformity with accounting principles generally accepted in the United States of America.

/s/ Stonefield Josephson, Inc.

 

 

 

Irvine, California

March 6, 2007

 

42




Bidz.com, Inc.

 

Balance sheets

 

(in thousands, except share data)

 

 

December 31,

 

 

 

2005

 

2006

 

 

 

 

 

 

 

Assets

 

 

 

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash

 

$

7

 

$

359

 

Accounts receivable

 

886

 

1,930

 

Inventories, net of reserves of $331and $461 at December 31, 2005 and December 31, 2006 respectively

 

15,921

 

31,183

 

Prepaid inventory

 

 

3,125

 

Other current assets

 

158

 

1,192

 

Total current assets

 

16,972

 

37,789

 

Property and equipment, net

 

384

 

478

 

Intangible asset

 

150

 

150

 

Deposits

 

240

 

125

 

Total assets

 

$

17,746

 

$

38,542

 

 

 

 

 

 

 

Liabilities and Stockholders’ Equity (Deficit)

 

 

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Post-dated check financing (includes related party amounts of $2,184 and $0 at December 31, 2005 and December 31, 2006 respectively)

 

$

5,315

 

$

 

Revolving credit line

 

 

3,941

 

Accounts payable (includes related party amounts of $2,712 and $4,331 at December 31, 2005 and December 31, 2006 respectively)

 

7,297

 

21,987

 

Accrued expenses

 

1,774

 

1,952

 

Deferred revenue

 

1,577

 

3,935

 

Total current liabilities

 

15,963

 

31,815

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Preferred stock: no par value; authorized 4,000,000 shares; none issued and outstanding at December 31, 2005 and par value $0.001; authorized 4,000,000 shares: none issued and outstanding at December 31, 2006

 

 

 

Common stock: no par value; authorized 50,000,000 shares; issued and outstanding 23,312,500 at December 31, 2005 and par value $0.001; authorized 100,000,000 shares; issued and outstanding 23,233,904 at December 31, 2006

 

28,830

 

23

 

Additional paid in capital

 

 

28,352

 

Shares held in treasury, at cost, 15,000 shares at December 31, 2006

 

 

(90

)

Deferred stock-based compensation

 

(100

)

 

Accumulated deficit

 

(26,947

)

(21,558

)

Total stockholders equity

 

1,783

 

6,727

 

 

 

$

17,746

 

$

38,542

 

 

43




Bidz.com, Inc.

Statements of operations

(in thousands, except share and per share data)

 

 

Years Ended December 31,

 

 

 

2004

 

2005

 

2006

 

 

 

 

 

 

 

 

 

Net revenue:

 

 

 

 

 

 

 

Merchandise sales

 

$

64,738

 

$

90,309

 

$

131,687

 

Commissions

 

549

 

264

 

134

 

Advertising

 

37

 

6

 

2

 

 

 

 

 

 

 

 

 

Total net revenue

 

65,324

 

90,579

 

131,823

 

 

 

 

 

 

 

 

 

Cost of revenue

 

53,072

 

71,257

 

100,633

 

 

 

 

 

 

 

 

 

Gross Profit

 

12,252

 

19,322

 

31,190

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

General and administrative

 

8,800

 

10,938

 

13,853

 

Sales and marketing

 

2,542

 

5,078

 

10,300

 

Rescission and public offering costs

 

 

442

 

1,287

 

Depreciation and amortization

 

139

 

157

 

273

 

 

 

 

 

 

 

 

 

Total operating expenses

 

11,481

 

16,615

 

25,713

 

 

 

 

 

 

 

 

 

Income from operations

 

771

 

2,707

 

5,477

 

 

 

 

 

 

 

 

 

Other income - interest income

 

 

22

 

80

 

 

 

 

 

 

 

 

 

Other expense - interest (expense)

 

 

 

(48

)

 

 

 

 

 

 

 

 

Income before income tax expense

 

771

 

2,729

 

5,509

 

 

 

 

 

 

 

 

 

Income tax expense

 

 

82

 

120

 

 

 

 

 

 

 

 

 

Net income

 

$

771

 

$

2,647

 

$

5,389

 

 

 

 

 

 

 

 

 

Net income per share available to common shareholders - basic

 

$

0.03

 

$

0.11

 

$

0.23

 

 

 

 

 

 

 

 

 

Net income per share available to common shareholders - diluted

 

$

0.03

 

$

0.11

 

$

0.23

 

 

 

 

 

 

 

 

 

Weighted average number of shares outstanding - basic

 

27,466,302

 

24,337,159

 

23,302,036

 

 

 

 

 

 

 

 

 

Weighted average number of shares outstanding - diluted

 

28,014,361

 

24,858,535

 

23,791,368

 

 

44




Bidz.com, Inc.

 

Statements of changes in stockholders’ equity (deficit)

 

(in thousands)

 

 

 

 

 

 

Class B

 

Additional

 

 

 

Deferred

 

 

 

Total

 

 

 

Common Stock

 

Common Stock

 

paid in

 

Treasury

 

Stock-based

 

Accumulated

 

Stockholders

 

 

 

Shares

 

Amount

 

Shares

 

Amount

 

capital

 

shares

 

Compensation

 

Deficit

 

Deficit

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2003

 

11,940

 

$

28,354

 

15,535

 

$

426

 

$

 

$

 

$

(500

)

$

(30,365

)

$

(2,085

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Issuance of common stock for asset purchases

 

25

 

125

 

 

 

 

 

 

 

125

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Issuance of common stock in lieu of refund for merchandise return

 

3

 

15

 

 

 

 

 

 

 

15

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Issuance of common stock for service

 

1

 

5

 

 

 

 

 

 

 

5

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair value of options granted to non-employee consultants

 

 

27

 

 

 

 

 

 

 

27

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Retirements of common stock

 

(47

)

(138

)

 

 

 

 

 

 

(138

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amortization of deferred stock-based compensation

 

 

 

 

 

 

 

200

 

 

200

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

 

 

 

771

 

771

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2004

 

11,922

 

$

28,388

 

15,535

 

$

426

 

$

 

$

 

$

(300

)

$

(29,594

)

$

(1,080

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Conversion of class B common stock to common stock

 

15,535

 

426

 

(15,535

)

(426

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cancellation of common stock

 

(4,145

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair value of options granted to non-employee consultants

 

 

16

 

 

 

 

 

 

 

16

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amortization of deferred stock-based compensation

 

 

 

 

 

 

 

200

 

 

200

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

 

 

 

2,647

 

2,647

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2005

 

23,312

 

$

28,830

 

 

$

 

$

 

$

 

$

(100

)

$

(26,947

)

$

1,783

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Reincorporation from California (no par value) to Delaware ($0.001 par value)

 

 

(28,807

)

 

 

28,807

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Issuance of common stock for service

 

37

 

 

 

 

219

 

 

 

 

219

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair value of options granted to employee

 

 

 

 

 

16

 

 

 

 

16