10-K 1 d10k.txt FORM 10-K FOR YEAR ENDED 03/31/2001 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED MARCH 31, 2001 COMMISSION FILE NUMBER 000-27357 ASHFORD.COM, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 76-0617905 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 3800 BUFFALO SPEEDWAY, SUITE 400 HOUSTON, TEXAS 77098 (Address of principal executive offices) ----------------- (713) 369-1300 (Registrant's telephone number, including area code) SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: COMMON STOCK, $.001 PAR VALUE Indicate by check mark whether the Registrant (1) has filed all reports required 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: Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K 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. [ ] The aggregate market value of voting stock held by non-affiliates of the registrant as of May 31, 2001 was $7,623,806. The number of shares of common stock outstanding as of May 31, 2001 was 55,833,437. DOCUMENTS INCORPORATED BY REFERENCE Certain sections of the Registrant's definitive proxy statement filed in connection with its annual meeting of stockholders to be held on August 27, 2001 are incorporated by reference into Part III of this Form 10-K where indicated. Certain exhibits and appendices filed with the Registration Statement on Form S-1 (File No. 333-82759), as amended, are incorporated by reference into Part IV of this Form 10-K where indicated. ASHFORD.COM, INC. TABLE OF CONTENTS PART I Item 1. Business................................................... 3 Item 2. Properties................................................. 23 Item 3. Legal Proceedings.......................................... 23 Item 4. Submission of Matters to a Vote of Security Holders........ 23 Item 4a. Executive Officers of the Registrant....................... 23 PART II Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters........................................ 25 Item 6. Selected Consolidated Financial Data....................... 25 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.................................. 26 Item 7A. Quantitative and Qualitative Disclosure about Market Risk....................................................... 33 Item 8. Financial Statements and Supplementary Data................ 33 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure........................ 33 PART III Item 10. Directors and Executive Officers of the Registrant......... 33 Item 11. Executive Compensation..................................... 33 Item 12. Security Ownership of Certain Beneficial Owner and Management................................................. 33 Item 13. Certain Relationships and Related Transactions............. 33 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K................................................... 33 2 PART I ITEM 1. BUSINESS The discussion in this Report contains forward-looking statements within the meaning of Section 21E of the Securities and Exchange Act of 1934, including statements regarding our expectations, beliefs, hopes, intentions or strategies regarding the future. These forward-looking statements involve risks and uncertainties. We are under no duty to update any of the forward-looking statements after the date of this filing on Form 10-K to conform these statements to actual results. Our actual results could differ materially from those discussed herein. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in "Risk Factors That May Affect Future Results" as well as those discussed in this section and elsewhere in this Report, and the risks discussed in the "Risk Factors" section included in our Registration Statement on Form S-1 as declared effective by the Securities and Exchange Commission on September 22, 1999 (Reg. No. 333-82759). COMPANY OVERVIEW We are a Web-based retailer focused on luxury and premium products, including new and vintage watches, clocks, diamonds, jewelry, leather goods, writing instruments, fragrances, and sunglasses, altogether offering more than 12,000 styles of products from over 300 leading luxury brands. During the past two years we have rapidly expanded our primary product focus from offering only new watches to offering 11 different product categories. Our strategy has been to add complementary products to create a portfolio that combines items purchased frequently, such as leather and sunglasses, with higher priced items purchased less frequently, such as watches and diamonds. In March 2000, we launched our corporate gift business which offers an additional 800 luxury products in new categories such as crystal, silver and pewter that are targeted to the corporate market. By combining our expertise in luxury products and our commitment to excellent customer service with the benefits of Internet retailing, we are able to deliver a unique shopping experience to our retail and corporate consumers. We believe that our current luxury and premium product offerings are well suited for online commerce given our brand recognition, generally high average sales prices and relatively low average distribution and shipping costs. Our Web site features detailed product information, helpful and useful shopping services and innovative merchandising through easy-to-navigate Web pages. We offer customers the convenience and flexibility of shopping 24 hours a day, seven days a week, from their homes, offices or other locations. In addition, with the exception of diamonds, we carry almost all of the products we sell in inventory, which enables us to ship most products to our customers within 24 hours. Our customer service representatives are available through phone and e-mail and are trained to answer a broad array of questions regarding product styles, features and technical specifications, as well as provide product recommendations. This informative and high-quality shopping experience provides luxury brand owners a Web-based retail channel consistent with the luxury character and premium quality of their products. INDUSTRY OVERVIEW GROWTH OF THE INTERNET AND ONLINE COMMERCE Internet usage and online commerce continue to grow worldwide. International Data Corporation, or IDC, estimates that there were 142 million Web users worldwide at the end of 1998. IDC anticipates that number will grow to approximately 502 million users by the end of 2003. IDC also estimates that revenue generated worldwide from online commerce will exceed $1.3 trillion by 2003, although growth rates for online commerce for luxury and premium products and the growth rate for our business may differ significantly from the growth of online commerce generally. These projected growth rates can be attributed to many factors, including: . a large and growing installed base of personal computers and other Internet- connected devices in the workplace and home; . advances in performance and speed of personal computers and modems; . improvements in network security, infrastructure and bandwidth; 3 . easier and cheaper access to the Internet; and . the rapidly expanding availability of online content and commerce sites. The growth in online commerce can also be attributed to a number of advantages the Internet provides to online retailers. Online retailers can display a larger number of products at a lower cost than traditional store-based or catalog retailers. In addition, online retailers can rapidly adjust their selections, editorial content and pricing, providing significant merchandising flexibility. Online retailers also benefit from the minimal cost to publish on the Web, the ability to reach a large group of customers from a central location, and the potential for low-cost customer interaction. Unlike traditional retail channels, online retailers do not have the cost of managing and maintaining a retail store infrastructure or the significant printing and mailing costs of catalogs. Online retailers can also easily obtain demographic and behavioral data about customers, increasing opportunities for direct marketing and personalized services. The benefits of online retailing should be viewed in the context of the inherent challenges of online retailing, such as the expenses of establishing and maintaining a Web site, reliance on newly developed Internet technology, coordinating new distribution channels, and the difficulty of converting a Web site visitor to a purchaser given limitations such as a customer's inability to physically inspect, try on or use a product. TRADITIONAL LUXURY GOODS MARKET The luxury goods market includes a broad selection of product categories. Based on data from Global Industry Analysts, or GIA, and DataMonitor, leading independent market research companies, and our own internal research, we estimate the worldwide market for luxury and premium lifestyle products to be greater than $130 billion. This market includes fine watches and other luxury and premium product categories, such as sunglasses, fragrances, leather goods, ties and scarves, jewelry and corporate gifts. We believe that our current luxury and premium product categories represent a significant online commerce opportunity. Traditional Retail Channels for Luxury and Premium Products. We believe that the traditional retailers for luxury and premium products in the United States today can be grouped as follows: . high-end department stores and jewelry stores that often strive to provide a high level of customer service and a knowledgeable sales staff, but typically offer a limited selection of mid-range to high-end products; . national department stores that tend to carry broad selections of low-end to mid-range products from brands that are complementary to the stores' other offerings, but typically offer limited product-specific customer service; . specialty and single-brand stores, which are retail locations that carry a broad selection of specific product categories, but are limited to the geographic region in which the few physical stores are located; and . boutiques, which are small stores, often located in malls that generally carry a selection of the latest trends in lower-priced fashion products and accessories. Challenges in Traditional Luxury Goods Retailing. We believe that traditional store-based retailers face a number of challenges in providing a satisfactory shopping experience for buyers of luxury and premium products. . Selection is limited because physical retail space constrains the number of styles and the amount of product inventory that may be carried by any one store. In addition, the significant carrying costs of physical inventory in multiple store locations require traditional store-based retailers to focus their product selection on the most popular products that produce the highest inventory turns, further limiting consumer selection. . Traditional store-based retailers have a high cost structure. Most of the leading luxury and premium product retailers are located either in the most exclusive and expensive shopping locales or in high-cost retail outlets or malls, both of which must be in close proximity to the target buyers. This is because their sales are dependent on serving customers who are willing to physically visit their stores. 4 . Traditional retailers sell luxury products often at a significantly higher price than wholesale to cover high operating costs. As a result, consumers ultimately pay for the high cost structure of the retail store. . The needs of luxury goods customers are changing. Increasingly, luxury goods brands are appealing to a broader, time-constrained customer base that is not willing or able to spend the time necessary to shop in traditional store- based retail locations. . In many cases, customers are served by employees with limited knowledge regarding the features of the products they sell, whether due to high employee turnover, limited training or other factors. . Traditional store-based retailers can only serve those customers who have convenient access to their stores. These store-based retailers must open new stores to serve additional geographic areas, resulting in significant investments in inventory, physical space, leasehold improvements and the hiring and training of store personnel. We believe that these challenges facing traditional store-based retailers limit their ability to offer an extensive selection of luxury and premium products, broad geographic coverage and convenient access, and staff that is sufficiently knowledgeable to assist with significant customer decisions typically involving purchases of several hundred dollars. As a result, we believe customers often do not find shopping for luxury and premium products to be a convenient or enjoyable experience. THE ASHFORD.COM SOLUTION Our online store is designed to provide consumers with a convenient and enjoyable shopping experience in a Web-based retail environment. We provide an extensive selection, detailed product information that enables consumers to make informed decisions, competitive pricing compared to traditional retail channels, a commitment to the highest level of customer service and the convenience of online shopping. The key components of the Ashford.com experience include: Extensive Product Selection. We offer a broad selection of luxury and premium products that would be economically and physically difficult to offer in a traditional store, together with the unique environment of the Internet that enables us to dynamically adjust our product mix and merchandising strategy. Our online store offers over 12,000 styles of products from over 300 leading luxury brands across 11 product categories. Additionally, some of the brands we offer lack a U.S. distribution network, making them hard to find in traditional retail outlets. We believe that our extensive selection increases the likelihood that the consumer will find the product they would like to purchase. Compelling Content and Detailed Product Information. Our Web site includes significant content and detailed product information to provide our customers with a convenient and enjoyable shopping experience. Our Web site displays detailed product descriptions and product photos. For certain brands, we have dedicated pages to communicating specific brand histories and key messages. We also employ specialists with product expertise, such as master watchmakers and a certified gemologist, who are available to address detailed customer questions by phone or e-mail. Our goal is to provide our customers with the product information they need to make educated and highly satisfactory purchase decisions. Competitive Prices and Compelling Value. We offer our customers products at competitive prices and, combined with our high-quality shopping experience, provide compelling value. Commitment to Excellent Customer Service. Luxury and premium goods consumers expect the highest level of personalized customer service, which we are committed to providing. Our customer service representatives are available through phone and e-mail and are trained to answer a broad array of questions regarding product styles, features and technical specifications, as well as provide product recommendations. Before shipping, we inspect each product, and in the case of watches, set the time and date for the customer. In addition, we offer gift-wrapping and same-day shipping on orders placed before 4:00 p.m. CST (2:00 p.m. CST for items in the diamonds and bridal department) and standard overnight shipping in the United States. We also offer a 30-day return policy on all products to ensure customer satisfaction. We also offer our watch customers a certification of authenticity, repair and battery replacement services and an Ashford.com warranty for the length of the manufacturer's warranty plus an additional two years. 5 Personalized Shopping Experience. We provide a convenient and enjoyable shopping experience that addresses the dynamic needs of the luxury goods customer. These services are designed to help consumers search through our product offerings and make informed selections. Our services include: . Search Capability. Our site offers search capabilities making it easy for customers to find products on the site. Search criteria include brand, price, keyword, size, features and other criteria. . Real-Time Customer Interaction. Using real-time, online customer interaction software, our customer service representatives are able to answer specific questions about our products and services. This feature allows customers shopping from home with just one phone line to communicate in real-time with a customer service representative without losing their Internet connection and leaving our online store. . In-Stock Notification. With the exception of diamonds, we carry almost all of our products in inventory. For items in stock, we clearly indicate to the customer on our Web site that we can ship the product generally within 24 hours. For an item not currently in stock, we indicate on our Web site that the customer can expect a longer delivery time. . Gifts and Wish List. We provide a variety of gift suggestions and feature product suggestions for particular holidays. We also provide a wish list service that customers can use to provide friends and relatives with gift ideas by e-mail. Customers buying gifts can choose among a variety of gift- wrap styles at the time of order. . Shopping Hours. Our online store provides consumers the opportunity to shop from their homes, offices or other locations 24 hours a day, seven days a week. Geographic Coverage. By selling online, we are able to sell products throughout the U.S. and worldwide where the products might not otherwise be available. In addition, consumers are able to go to one location and find an extensive selection as opposed to visiting several stores with limited product offerings. BUSINESS STRATEGY Our objective is to be one of the leading online retailers of luxury and premium products. Key elements of our strategy include: Focus on the Premium Retail Watch Market. We have become what we believe to be one of the leading sellers of watches on the Internet by providing thousands of styles of new and vintage watches from premium brands at competitive prices. We intend to capitalize on our online market position in watches to become the primary destination for consumers to purchase premium watches. Our objective is to grow our market position and expand our customer base through superior execution and strong relationships with luxury and premium brand owners. Extend Leadership Position in Fine Watches to Other Product Categories. We believe that there are excellent online market opportunities for a variety of luxury and premium products, including leather goods, sunglasses, fragrances, ties and scarves, diamonds and jewelry. Over the past two years we have enhanced our product offerings by expanding into these luxury and premium product categories, which has enabled us to leverage our customer base, brand name, merchandising expertise and distribution capabilities. We believe that offering a broad selection of luxury goods will enable us to increase sales per customer visit, encourage repeat purchases and expand our customer base. Leverage Leadership Position in Luxury and Premium Products to the Corporate Gifts Market. We believe that there are excellent online opportunities targeted to the business market for corporate gifts. We believe that the combination of our extensive selection, hands-on customer service and the efficiencies of the Internet allow us to offer corporate accounts a more convenient, customized and value added service. Our objective is to grow our market position in the corporate gift category by adding a regionalized sales force to provide personalized service and access to premium brands more conveniently via the Internet. Build Ashford.com Experience and Brand. We intend to establish a brand identity that will support the creation of an Internet luxury community and provide luxury brand owners a powerful new distribution 6 channel consistent with their luxury identities. We will focus our brand campaign on convenience, value, selection, trust and service. We intend to create an environment where our shoppers are confident that they have found a smarter, easier and more compelling way to buy luxury goods. We believe this approach will support an ongoing relationship with and sales to our target customers who are more likely to purchase our products. Expand Relationships with Leading Luxury Brands. Our intent is to be the Internet retailer of choice for luxury and premium brands. Direct relationships enable us to purchase products more efficiently. We believe that our merchandising history and well-established relationships with brand owners enable us to provide our customers with compelling product offerings, while giving us access to additional sources of merchandise. Pursue Ways to Increase Our Sales. We intend to pursue new opportunities to increase our sales by: . continuing to take steps to add new customers and to promote repeat purchases; . pursuing international market opportunities; . establishing advantageous relationships with distributors and brand owners; and . acquiring complementary businesses, products and technologies. Expand Our Operational and Systems Infrastructure. We plan to continue to devote resources to growing our systems and operational infrastructure to handle increased volume, enhance our service offerings and take advantage of the unique characteristics of online luxury goods retailing. We have developed technologies and implemented systems to support secure and reliable online retailing. We are committed to growing capacity rapidly in order to sustain high levels of customer service. THE ASHFORD.COM ONLINE RETAIL STORE We have designed our online retail store to be the primary place for consumers to purchase luxury and premium products online. We believe our Web site provides a secure, reliable and enjoyable shopping experience in an attractive, easy-to-use online store. The user interface is simple and generally consistent throughout the site. The interface also has powerful search features that allow customers to search products by brand, price, keyword, size, features and other criteria. A consumer on our site can browse the different departments of our store, conduct targeted searches, view recommended products, verify product availability, visit our gifts department and participate in promotions. Unlike a traditional retail store, consumers can shop in the comfort and convenience of their homes or offices. OUR STORE DEPARTMENTS We have categorized products into different departments, including but not limited to new watches, vintage watches, diamonds and bridal, jewelry, writing accessories, sunglasses, fragrances, and leather goods and handbags. Within each department, products can be viewed by brand, or sorted by price, keyword, size, features and other criteria. The following is a summary of our most significant departments. New Watches. Since inception, we have focused on becoming the leading retailer of fine watches on the Internet. Here we offer over 7,500 styles from over 50 brands, providing outstanding selection for the customer. Our prices in this department generally range from $75 to over $30,000. To date, our average purchase price in this department has been approximately $500 per watch. Vintage Watches. This department offers our collection of fine, vintage watches in various price ranges. Vintage watches are generally high-quality brand, previously owned watches. These watches often attract collectors or watch enthusiasts in search of a specific model. Unlike many other sellers of vintage watches, we offer a broad selection combined with outstanding service, including maintenance, cleaning, a certification of authenticity and extended warranties. Diamonds and Bridal. The diamonds and bridal department offers an extensive collection of bridal jewelry and certified loose diamonds. We carry a broad selection of diamonds of various cuts, sizes and quality with prices generally ranging from $99 to over $400,000. We offer customers a unique 7 diamond purchasing experience through our "Build Your Ring" functionality that enables customers to build and purchase custom rings interactively. Jewelry. The jewelry department offers a broad selection of jewelry from semi-precious stones to sterling silver with prices generally from $75 to over $10,000 from leading jewelry manufacturers as well as our exclusive Ashford Collection(TM). Writing Accessories. The writing accessories department offers fine pens, pencils and stationery from leading brands, with prices generally ranging from $20 to over $2,000. The collection includes over 700 styles from over 35 leading brands. Sunglasses. This department offers our growing collection of sunglasses, with prices generally ranging from $50 to over $350. The collection includes over 500 styles from 35 brands. Fragrances. The fragrance department offers a broad selection of over 200 fragrances. Our prices in this department generally range from $30 to $75. Leather Goods and Handbags. This department offers over 500 styles of leather goods products from 25 brands. Our prices in this department generally range from $25 to $1,200. In March 2000, we launched our corporate gift business offering an additional 800 luxury products in new categories such as crystal, silver and pewter that are targeted for the corporate market. We believe that the corporate gift market complements our retail offerings because it is less seasonal and offers the opportunity for higher margins. In addition to offering thematically organized corporate gifts, Ashford.com offers custom engraving, etching and embossing to our corporate customers. MERCHANDISING We believe that the breadth and depth of our product selection, together with the flexibility of our online store and our range of helpful and useful shopping services, enable us to pursue a unique merchandising strategy. Unlike store-based retail formats, our online store provides us with significant flexibility with regard to the organization and presentation of our product selection. To encourage purchases, we feature various promotions on a rotating basis throughout the store and continually update our online recommendations. We also actively create and maintain pages that are designed to highlight certain products and brands. The following are examples of some of our specific merchandising strategies. Featured Products. We frequently give a product prominent placement on the site, describe its key features and potentially highlight it as our Collector's Choice. Products that receive this merchandising focus generally receive a boost in sales. Product Bundling. To promote purchases of higher value items, we combine products from our large selection to offer bundling promotions. Special Promotions. We offer certain products on promotion and provide special pricing. The technological advantages of online retailing, compared to traditional store-based retailing, allow us to adjust our promotions rapidly to promote targeted sales. We employ a dedicated team of buyers and merchandisers that continually monitor the consistency and quality of our merchandising efforts. This team, combined with our technology, is able to pursue a merchandising strategy in which we dynamically change our product offerings to enhance the consumer's shopping experience. MARKETING & PROMOTION We have designed our marketing and promotion strategy to build the Ashford.com brand, increase customer traffic, promote the sales of new products, maximize repeat purchases and build strong customer loyalty. Our marketing and promotional activities primarily target a customer demographic that is more likely to buy our luxury and premium products. These activities include both offline and online advertising. In the last fiscal year, we spent approximately $11.9 million on advertising, of which approximately 50% was spent online. 8 Online Advertising. We have agreements with significant Internet destinations under which our advertisement banner will appear on the screen each time one of over several hundred watches or fashion accessory-related words is entered as a search term by a user. We also have month-to-month banner advertising agreements with a broad range of online sites, including major online portals. These agreements typically provide for minimum impressions and we renew these agreements on a month-to-month basis depending on results. We also advertise our site in conjunction with other major online portals, Internet service providers and luxury and premium market-related Web sites to build our brand and increase our reach on the Internet. In addition, we have an affiliate program and other initiatives aimed at increasing traffic and supporting our brand development. Under our affiliate program, we pay our registered affiliates referral fees for sales generated via their links to our Web site. Online Direct Marketing. As our customer base grows, we continue to collect significant data about our customers' buying preferences and habits in an effort to increase repeat purchases. We intend to maximize the value of this information by delivering meaningful information and special offers to our customers via e-mail and other means. In addition, we publish a weekly, online newsletter delivered by e-mail to subscribers in which we highlight important developments and special promotions. Offline Advertising. We have used offline advertising to promote both our brand and specific merchandising opportunities. Our offline advertising has primarily consisted of television advertisements and print advertisements in magazines and newspapers. During fiscal 2001, we shifted our primary marketing focus from traditional print and broadcast media to Internet and online media. We believe Internet and online media provides a more efficient and economical means of attracting new customers. Other Promotional Activities. During April 2000, we gave away the Ashford Diamond(TM), a 15-carat, colorless, internally flawless, pear-shaped diamond worth an estimated $1.5 million as part of the Ashford.com Million Dollar Diamond Giveaway contest. The promotion ran for several months during the year and as part of the promotion we made donations to designated charities. FULFILLMENT OPERATIONS We obtain our products from brands and a diverse network of distributors, brokers and retailers. We have ongoing efforts to continue to expand the number of direct relationships with brand owners in all our product categories. For brands where we do not have direct relationships, we buy products from a network of distributors, brokers and retailers. With the exception of diamonds, we carry inventory on almost all of the products available for sale on our site. We store our products and conduct our fulfillment operations in our headquarters facility located in Houston, Texas. When we receive an order, we immediately begin the packaging and shipping operation. Most orders are shipped on the date of order entry. Our inventory management system tracks the quantities of all stock keeping units, which enables us to display information about the availability of the products on our Web site. We offer overnight shipping on all orders and next-day delivery on orders placed before 4:00 p.m. CST (2:00 p.m. CST for items in the diamonds and bridal department) along with a variety of other convenient delivery options. We have developed relationships with both United Parcel Service and Federal Express to maximize our overall service level to all 50 states. The ability to provide overnight delivery is an important ongoing service for our customers. CUSTOMER SERVICE We believe that our ability to establish and maintain long-term relationships with our customers, earn their trust and encourage repeat visits and purchases, largely depends on the strength of our customer support and fulfillment operations and staff. We are committed to providing the high level of personalized customer service that luxury and premium goods consumers expect. We have a high-quality customer service staff with a broad range of experience and knowledge enabling us to quickly respond to customer phone calls and e- mails. We provide extensive training to our customer service representatives, including on-site training from manufacturers, to allow our representatives to answer a broad array of questions regarding product styles, features and technical specifications, as well as provide product recommendations. 9 Our customer service representatives are available through phone and e-mail 24 hours a day, 7 days a week. Before shipment, we inspect each product, and in the case of watches, adjust the date and set the time for the customer. With the exception of diamonds, we ship almost all of our products on the date of order entry. Once shipment is made, we immediately send e-mail confirmation to the customer. We offer a 30-day return policy on all products. We also offer our watch customers a certification of authenticity, repair and battery replacement services and an extended warranty. OPERATIONS AND TECHNOLOGY We have implemented a broad array of site management, search, customer interaction and distribution services and systems that we use to process customer orders and payments. These services and systems use a combination of our own and commercially available, licensed technologies. These applications also manage the process of accepting, authorizing and charging customer credit card orders with an address verification and approval system. We focus our internal development efforts on creating, implementing and enhancing specialized software that we use to: . accept and validate customer orders; . enable customer service representatives to engage in real-time, online interaction with multiple customers simultaneously; . organize, place and manage orders with vendors; . receive product and assign it to customer orders; and . manage shipment of products to customers based on various ordering criteria. Our systems are based on industry-standard architectures and have been designed to reduce downtime in the event of outages or catastrophic occurrences. Our Web site is available 24 hours a day, 7 days a week. Our system hardware is hosted at a third-party facility in Houston, Texas, which provides redundant communications lines and emergency power backup. We have implemented load balancing systems and redundant servers to provide fault tolerant service. The market in which we compete is characterized by rapidly changing technology, evolving industry standards, frequent new service and product announcements and enhancements, and changing customer demands. Accordingly, our future success will depend on our ability to: . adapt to rapidly changing technologies; . adapt our services to evolving industry standards; and . continually improve the performance, features and reliability of our service in response to competitive service and product offerings and evolving demands of the marketplace. Our failure to adapt to market changes could harm our business. In addition, the widespread adoption of new Internet, networking or telecommunications technologies or other technological changes could require substantial expenditures by us to modify or adapt our services or infrastructure. This could have a material adverse effect on our business, results of operations and financial condition. GOVERNMENT REGULATION We are not currently subject to direct federal, state or local regulation other than regulations applicable to businesses generally and directly applicable to online commerce, as well as the secondhand watch statutes enacted in several states, as discussed below. However, as Internet use gains popularity, it is possible that a number of laws and regulations may be adopted with respect to the Internet. These laws may cover issues such as user privacy, freedom of expression, pricing, content and quality of products and services, taxation, advertising, intellectual property rights and information security. Furthermore, the growth of online commerce may prompt calls for more stringent consumer protection laws. Several states have proposed legislation to limit the uses of personal user information gathered online or require online services to establish privacy policies. The Federal Trade Commission has also initiated action against at least one online service regarding the manner in which personal information is collected from users and 10 provided to third parties. We do not currently provide personal information regarding our users to third parties. However, the adoption of additional consumer protection laws could create uncertainty in Web usage and reduce the demand for our products and services. We are not certain how our business may be affected by the application of existing laws governing issues such as property ownership, copyrights, encryption and other intellectual property issues, taxation, libel, obscenity and export or import matters. The vast majority of these laws were adopted prior to the advent of the Internet. As a result, they do not contemplate or address the unique issues of the Internet and related technologies. Changes in laws that are intended to address these issues could create uncertainty in the Internet market place. This uncertainty could reduce demand for our services or our cost of doing business may increase as a result of litigation costs or increased service delivery costs. In addition, because our services are available over the Internet in multiple states and foreign countries, other jurisdictions may claim that we are required to qualify to do business in that state or foreign country. Our failure to qualify in a jurisdiction where we are required to do so could subject us to taxes and penalties. It could also hamper our ability to enforce contracts in these jurisdictions. The application of laws or regulations from jurisdictions whose laws do not currently apply to our business could have a material adverse effect on our business, results of operations and financial condition. Several states have laws regulating the sale of secondhand watches. For example, California, New York and Texas prohibit anyone from representing as "new" any watch that has had its serial number removed. Pursuant to these laws, a watch with a serial number removed must clearly be labeled as "secondhand" even if it has never been worn. We have implemented procedures whereby all of our buyers explicitly communicate to suppliers that we will only buy a watch if its serial number has not been removed. In addition, we inspect each watch we sell that is manufactured with a serial number to ensure it has a serial number prior to shipment. If a court were to find, however, that we have violated these statutes, we could be subject to civil or criminal penalties. COMPETITION The online commerce market is new, rapidly evolving and intensely competitive. Since the introduction of online commerce, the number of online commerce Web sites competing for customer attention has increased rapidly. We expect future competition to intensify given the relative ease with which new Web sites can be developed. We currently or potentially will compete with a variety of competitors, including the following: . traditional retailers of luxury and premium products, which may compete with both an online and offline presence, including high-end department stores such as Saks Fifth Avenue and Neiman Marcus, jewelers such as Zales and national department stores such as Macy's; . manufacturers of our products that decide to sell directly to end-customers, either through physical retail outlets or through an online store; . other online retailers of luxury and premium products, including online service providers that feature shopping services; and . catalog retailers of luxury and premium products. We believe that the following are the principal competitive factors in our market: . brand recognition; . selection; . convenience; . order delivery performance; . customer service; 11 . site features and content; and . price. Many of our current and potential traditional store-based and online competitors, particularly the traditional store-based retailers and the brand owners of products we sell, have longer operating histories, larger customer or user bases, greater brand recognition and significantly greater financial, marketing and other resources than we do. Many of these current and potential competitors can devote substantially more resources to Web site and systems development than we can. In addition, larger, well-established and well-financed entities may acquire, invest in or form joint ventures with online competitors. Our competitors may be able to secure products from vendors on more favorable terms, fulfill customer orders more efficiently and adopt more aggressive pricing or inventory availability policies than we can. Traditional store-based retailers also enable customers to see and feel products in a manner that is not possible over the Internet. Given our limited operating history, many of our competitors have significantly greater experience selling luxury and premium products. For example, established catalog retailers may have greater experience than we do in marketing and selling goods with in-person customer interaction. Our online competitors are particularly able to use the Internet as a marketing medium to reach significant numbers of potential customers. Finally, new technologies and the expansion of existing technologies, such as price comparison programs that select specific titles from a variety of Web sites and may direct customers to other online retailers, may increase competition. INTELLECTUAL PROPERTY We rely on various intellectual property laws and contractual restrictions to protect our proprietary rights in products and services. These include confidentiality, invention assignment and nondisclosure agreements with our employees, contractors, vendors and strategic partners. Despite these precautions, it may be possible for a third party to copy or otherwise obtain and use our intellectual property without our authorization. In addition, we pursue the registration of our trademarks and service marks in the U.S. and internationally. However, effective intellectual property protection may not be available in every country in which our services are made available online. We rely on technologies that we license from third parties. These licenses may not continue to be available to us on commercially reasonable terms in the future. As a result, we may be required to obtain substitute technology of lower quality or at greater cost, which could materially adversely affect our business, results of operations and financial condition. As of the date of this filing, we have not been notified that our technologies infringe the proprietary rights of third parties. However, there can be no assurance that third parties will not claim infringement by us with respect to our current or future technologies. We expect that participants in our markets will be increasingly subject to infringement claims as the number of services and competitors in our industry segment grows. Any infringement claim, with or without merit, could be time-consuming, result in costly litigation, cause service upgrade delays or require us to enter into royalty or licensing agreements. These royalty or licensing agreements might not be available on terms acceptable to us or at all. As a result, any claim of infringement against us could have a material adverse effect upon our business. EMPLOYEES As of May 31, 2001, we had 234 full-time and part-time employees. We also employ independent contractors to perform duties in various departments. None of our employees is represented by a labor union. We have not had any work stoppages and consider our employee relations to be good. We believe that our success is dependent on our ability to attract and retain qualified personnel in numerous areas. RISK FACTORS THAT MAY AFFECT FUTURE RESULTS The following risk factors and other information included in this Report should be carefully considered. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our 12 business operations. If any of the following risks actually occur, our business, financial condition and operating results could be materially adversely affected. RISKS RELATED TO OUR BUSINESS Our Limited Operating History Makes Future Forecasting Difficult. Because Most of our Expenses Are Fixed Based on Planned Operating Results, Failure to Accurately Forecast Revenue Could Cause Net Losses in a Given Quarter to be Greater than Expected. We were incorporated in March 1998 and began selling products on our Web site in April 1998. Accordingly, we have an extremely limited operating history upon which to base an evaluation of our business and prospects. Our business and prospects must be considered in light of the risks, expenses and difficulties frequently encountered by companies in their early stage of development, particularly companies in new and rapidly evolving markets such as online commerce. As a result of our limited operating history, it is difficult to accurately forecast our net sales and we have limited meaningful historical financial data upon which to base planned operating expenses. We base our current and future expense levels on our operating plans and estimates of future net sales, and our expenses are to a large extent fixed. Sales and operating results are difficult to forecast because they generally depend on the volume and timing of the orders we receive, which is uncertain. As a result, we may be unable to adjust our spending in a timely manner to compensate for any unexpected revenue shortfall. This inability could cause our net losses in a given quarter to be greater than expected. We Anticipate Future Losses and Negative Cash Flow, which May Limit or Delay Our Ability to Become Profitable. Since our formation, we have made significant expenditures on our technology, Web site development, advertising, hiring of personnel and startup costs. As a result, we have incurred losses since our inception and expect to experience negative cash flow during future periods. We expect to incur additional costs and expenses related to: . brand development, marketing and other promotional activities; . the continued maintenance and development of our Web site, the systems and staff that process customer orders and payments, and our computer network; . the expansion of our product offerings and Web site content; and . development of relationships with strategic business partners. Our ability to become profitable depends on our ability to generate and sustain substantially higher net sales while maintaining reasonable expense levels, both of which are uncertain. If we do achieve profitability, we cannot be certain that we would be able to sustain or increase profitability on a quarterly or annual basis in the future. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." We May Be Unable to Meet Our Future Capital Requirements. If our current cash and cash that may be generated from future operations are insufficient to satisfy our liquidity requirements, we may seek to sell additional equity or debt securities or to obtain additional credit facilities from lenders. We cannot be certain that financing will be available to us on favorable terms when required, or at all. If we raise funds through the issuance of equity, equity-related or debt securities, the securities may have rights, preferences or privileges senior to those of the rights of our common stock and our stockholders may experience dilution. We require substantial working capital to fund our business. Since our inception, we have experienced negative cash flow from operations and expect to experience negative cash flow from operations in the future. We have sufficient funds for our anticipated needs for working capital and capital expenditures through at least the next 12 months. After that, we may need to raise additional funds. Our Operating Results are Volatile and Difficult to Predict. If We Fail to Meet the Expectations of Public Market Analysts and Investors, the Market Price of Our Common Stock May Decline Significantly. 13 Our quarterly operating results have fluctuated in the past, and we expect both our quarterly and annual operating results to fluctuate significantly in the future. Because our operating results are volatile and difficult to predict, we believe that quarter-to-quarter comparisons of our operating results are not a good indication of our future performance. In some future quarter our operating results may fall below the expectations of securities analysts and investors. In this event, the trading price of our common stock may decline significantly. The following are material factors that may harm our business or cause our operating results to fluctuate: . our inability to obtain new customers at reasonable cost, retain existing customers or encourage repeat purchases; . seasonality; . our inability to manage inventory levels or control inventory theft; . our inability to manage our fulfillment operations; . our inability to adequately maintain, upgrade and develop our Web site, the systems that we use to process customer orders and payments or our computer network; . the ability of our competitors to offer new or enhanced Web sites, services or products; . our inability to obtain product lines from our suppliers; . the availability and pricing of merchandise from vendors; and . increases in the cost of online or offline advertising. A number of factors will cause our gross margins to fluctuate in future periods, including the mix of corporate sales to traditional retail sales, the mix of products we sell, inventory management, marketing and supply decisions, inbound and outbound shipping and handling costs, the level of product returns and the level of discount pricing and promotional coupon usage. Any change in one or more of these factors could reduce our gross margins in future periods. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Our Stock May be Delisted from the Nasdaq National Market. On April 9, 2001, we received a notice from Nasdaq that our common stock had failed to maintain a minimum bid price of one dollar over the preceding 30 consecutive trading days as required for continued listing on the Nasdaq National Market. The notice stated that if at any time prior to July 9, 2001, the closing bid price of our common stock does not sustain at one dollar or more for at least 10 consecutive trading days, our common stock could be delisted from the exchange. If our common stock price fails to sustain the minimum closing bid price for the requisite number of days, the Nasdaq staff will issue a determination that the common stock will be delisted. Thereafter, and prior to any actual delisting, we will have an opportunity to request a hearing. At such hearing, we will have the ability to present a plan demonstrating that we can come into compliance with the continued listing requirements. A common course of action for companies attempting to maintain their listing by ensuring a bid price in excess of one dollar is the institution of a reverse stock split. A reverse stock spilt could negatively impact the value of our common stock by allowing additional downward pressure on the stock price as its relative value becomes greater following the reverse split. That is to say, the stock, at its new, higher price, has farther to fall and therefore more room for investors to short or otherwise trade the value of the stock downward. Similarly, a delisting may negatively impact the value of the stock, as stocks trading on the over-the-counter market are typically less liquid and trade with larger variations between the bid and ask price. From the date of the letter through June 26, 2001, our stock has not traded above one dollar for 10 consecutive days. We Expect to Experience Seasonal Fluctuations in Our Net Sales, which Will Cause Our Quarterly Results to Fluctuate and Could Cause Our Annual Results to be Below Expectations. We expect to experience significant seasonal fluctuations in our net sales that will cause quarterly fluctuations in our operating results. In particular, we realized approximately 40%, 50% and 40% of our net 14 sales for fiscal 2001, 2000 and 1999, respectively, during the fourth calendar quarter, primarily due to gift purchases made during the holiday season. We expect this trend to continue in the future. Due to our limited operating history, it is difficult to predict the seasonal pattern of our sales and the impact of seasonality on our business and financial results. In the future, our seasonal sales patterns may become more pronounced, may strain our personnel and warehousing and order shipment activities and may cause a shortfall in net sales as compared to expenses in a given period. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." If We Are Unable to Purchase or Continue to Purchase Products Directly from the Brand Owners, Our Net Sales Could Decrease. A significant portion of our units sold is purchased directly from the brand owners. We are negotiating with some of the remaining brand owners to purchase those brands directly, in all product categories. We believe that purchasing directly from the brand owners will provide us with a more predictable supply of products, as well as a lower cost of goods. As a result, we believe that part of our success is contingent on attaining or maintaining our ability to buy directly from the brand owners. If we lose or do not improve our ability to buy directly from the brand owners, our net sales or margins may decrease. Our Ability to Meet Consumer Demand is in Part Dependent upon the Availability of Products Purchased Indirectly from Sources Other than the Brand Owners. If We Are Unable to Obtain Popular Products Through Indirect Sources, Our Net Sales Will Decline. We purchase brands indirectly from distributors and other third parties that we do not purchase directly from the brand owners. The availability of products purchased indirectly depends on many factors, including consumer demand, manufacturer production and fashion trends. Since there are no guarantees that we will be able to obtain a sufficient supply of products indirectly from third-party distributors and other suppliers, customer demand may, at times, exceed our supply of those products. If this occurs we could lose customers and our net sales would decline. In addition, the luxury goods brand owners could establish procedures to limit or control our ability to purchase products indirectly and several brand owners in the U.S. have distinctive legal rights rendering them the only legal importer of their respective brands into the U.S. In the event we acquire such products indirectly from distributors and other third parties who may not have complied with applicable customs laws and regulations, such goods can be subject to seizure from our inventory by U.S. Customs, and the importer may have a civil action for damages against us. As it is often difficult to ascertain the original circumstances of importation of certain goods offered to us by our distributors and other third parties, this could impact our ability to obtain sufficient quantities of popular luxury goods, such as watches, and cause customer dissatisfaction. If We Are Unable to Obtain Sufficient Quantities of Popular Luxury and Premium Products, Our Net Sales Could Decrease. If we are not able to offer our customers a sufficient supply and selection of products in a timely manner, we could lose customers and our net sales could be below expectations. Our success depends on our ability to purchase products in sufficient quantities at competitive prices, particularly for the holiday shopping season. As is common in the industry, we generally do not have long- term or exclusive arrangements with brand owners, distributors or brokers that guarantee the availability of products for resale. In the luxury goods market, a product or fashion style periodically becomes intensely popular. From time to time, we may have trouble obtaining sufficient product allocations of particularly popular brands. In addition, we believe that some of our suppliers may establish their own online retailing efforts, which may impact our ability to get sufficient product allocations from suppliers. In several cases, the brands that we wish to carry have delayed establishing a relationship with us until they have their own Web site up and running. In other cases, the brand owners distribute only a small amount of product and rely partially on the scarcity of that product to provide a merchandising mystique. It is unlikely that we will obtain products for our Web site from brands who follow the scarcity mystique, and there is no assurance that we will actually obtain relationships within all sectors that we have planned to offer. Therefore, we do not have a predictable or guaranteed supply of products. 15 Because We Carry Almost All of the Products We Sell in Inventory, if We are Unable to Accurately Predict and Plan for Changes in Consumer Demand Our Net Sales and Gross Margins May Decrease. At March 31, 2001, we held approximately $24.1 million of products in inventory. The rapidly changing trends in consumer tastes in the market for luxury and premium products subject us to significant inventory risks. It is critical to our success that we accurately predict these trends and do not overstock unpopular products. The demand for specific products can change between the time the products are ordered and the date of receipt. We are particularly exposed to this risk because we derive a majority of our net sales in the fourth calendar quarter of each year. Our failure to sufficiently stock popular products in advance of the fourth calendar quarter would harm our operating results for the entire fiscal year. In the event that one or more products do not achieve widespread consumer acceptance, we may be required to take significant inventory markdowns, which could reduce our net sales and gross margins. This risk may be greatest in the first calendar quarter of each year, after we have significantly increased inventory levels for the holiday season. We believe that this risk will increase as we begin to offer additional luxury items due to our lack of experience in purchasing these items. In addition, to the extent that demand for our products increases over time, we may be forced to increase inventory levels. Any increase would subject us to additional inventory risks. If We Experience Significant Inventory Theft, Our Gross Profit Margin Would Decrease. Although immaterial to date, in the past we have experienced theft of merchandise shipments in route from our facility to our customers. In the future, we expect that we may also experience theft of merchandise while it is being held in our fulfillment facility. We have worked with our shipping carriers and have taken steps aimed at preventing theft. If these steps are inadequate or if security measures fail at our fulfillment facility, we could incur significant inventory theft, which could cause gross profit margins and results of operations to decrease significantly. Sales of Luxury Goods Are Particularly Susceptible to General Economic Downturns. If General Economic Conditions Deteriorate, Our Sales Could Suffer. Purchases of luxury products are typically discretionary for consumers and may be particularly affected by negative trends in the general economy. The success of our operations depends to a significant extent on a number of factors relating to discretionary consumer spending and affecting disposable consumer income, such as employment, wages and salaries, business conditions, interest rates, exchange rates, availability of credit and taxation. In addition, because the purchase of luxury products is relatively discretionary, any reduction in disposable income in general may affect us more significantly than companies in other industries. To Manage Our Growth and Expansion, We Need to Improve and Implement Financial and Managerial Controls and Improve Our Reporting Systems and Procedures. If We Are Unable to Do So Successfully, We May Not Be Able to Manage Growth Effectively and Our Operating Results Would Be Harmed. Our rapid growth in personnel and operations has placed, and will continue to place, a significant strain on our management, information systems and resources. In order to manage this growth effectively, we need to continue to improve our financial and managerial controls and reporting systems and procedures. Any inability of our management to integrate additional companies, employees, customer databases, merchandise lines, categories of merchandise, technology advances, fulfillment systems, and customer service into operations and to eliminate unnecessary duplication may have a materially adverse effect on our business, financial condition and results of operations. If We Are Unable to Successfully Expand Our Accounting and Financial Reporting Systems, Our Stock Price Could Decline. We continue to expand our financial and management information systems to accommodate new data. If we fail to successfully implement and integrate our new financial reporting and management information systems with our existing systems or if we are not able to expand these systems to accommodate our growth, we may not have adequate, accurate or timely financial information. Our failure to have adequate, accurate or timely financial information would hinder our ability to manage our business and operating results. If we continue to grow rapidly, we will face additional challenges in upgrading and maintaining our financial and reporting systems. 16 We May Not Be Able to Compete Successfully Against Current and Future Competitors. We expect competition in the online sale of luxury and premium products to intensify in the future. Increased competition is likely to result in price pressure, reduced gross margins and loss of market share, any of which could seriously harm our net sales and operating results. In addition, the luxury goods industry is intensely competitive. We currently or potentially compete with a variety of other companies, including: . traditional retailers of luxury and premium products; . brand owners of the products we sell; . other online retailers of luxury and premium products; and . catalog retailers. Many of our competitors have advantages over us including longer operating histories, greater brand recognition and significantly greater financial, sales and marketing and other resources. In addition, traditional store-based retailers offer customers benefits that are not obtainable over the Internet, such as enabling customers to physically inspect a product before purchase and not incurring costs associated with maintaining a Web site. If We Are Unable to Build Awareness of the Ashford.com Brand, We May Not Be Able to Compete Effectively Against Competitors with Greater Name Recognition and Our Sales Could Be Adversely Affected. If we are unable to economically achieve or maintain a leading position in online commerce or to promote and maintain our brand, our business, results of operations and financial condition could suffer. We believe that the importance of brand recognition will increase as more companies engage in commerce over the Internet. Development and awareness of our brand will depend largely on our success in increasing our customer base. If the leading brand owners do not perceive us as an effective marketing and sales channel for their merchandise, or consumers do not perceive us as offering a desirable way to purchase merchandise, we may be unsuccessful in promoting and maintaining our brand. If We Enter New Business Categories That Do Not Achieve Market Acceptance, Our Brand and Reputation Could Be Damaged and We Could Fail to Attract New Customers. If we launch or acquire a new department or product category that is not favorably received by consumers, our brand or reputation could be damaged. This damage could impair our ability to attract new customers, which could cause our net sales to fall below expectations. An expansion of our business to include other luxury goods will require significant additional expenses, and strain our management, financial and operational resources. This type of expansion would also subject us to increased inventory risk. We may choose to expand our operations by developing other new departments or product categories, promoting new or complementary products, expanding the breadth and depth of products and services offered or expanding our market presence through relationships with third parties. In addition, we may pursue the acquisition of other new or complementary businesses, products or technologies. If Our Strategy to Sell Products Outside of the United States is Not Successful, Our Increases in Operating Expenses May Not Be Offset by Increased Sales. If we are not able to successfully market, sell and distribute our products in foreign markets or if certain risks and uncertainties of doing business in foreign markets prove insurmountable then these factors could have a material adverse effect on our future global operations, and consequently, on our operating margins. We do not currently have any overseas fulfillment or distribution facility or arrangement or any Web site content localized for foreign markets, and we cannot be certain that we will be able to establish a global presence. In addition, there are certain risks inherent in doing business on a global level, including: . regulatory requirements; . export restrictions; 17 . tariffs and other trade barriers; . difficulties in staffing and managing foreign operations; . difficulties in protecting intellectual property rights; . longer payment cycles; . problems in collecting accounts receivable; . political instability; . fluctuations in currency exchange rates; and . potentially adverse tax consequences. If We Experience Problems with Our Third-Party Shipping Services, We Could Lose Customers. We rely upon third-party carriers, primarily Federal Express and UPS, for product shipments, including shipments to and from our warehouse. We are therefore subject to the risks, including employee strikes and inclement weather, associated with these carriers' ability to provide delivery services to meet our shipping needs. In addition, failure to deliver products to our customers in a timely manner would damage our reputation and brand. Our Operating Results Depend on Our Internally Developed Web Site, Network Infrastructure and Transaction-Processing Systems. If We Do Not Successfully Maintain Our Web Site and the Systems That Process Customer Orders, We Could Lose Customers and Net Sales Could be Reduced. The satisfactory performance, reliability and availability of our Web site, transaction-processing systems and network infrastructure are critical to our operating results, as well as to our ability to attract and retain customers and maintain adequate customer service levels. Any system interruptions that result in the unavailability of our Web site or reduced performance of the transaction systems would reduce the volume of sales and the attractiveness of our service offerings. This would seriously harm our business, operating results and financial condition. We use internally developed systems for our Web site and substantially all aspects of transaction processing, including customer profiling and order verifications. We have experienced periodic systems interruptions due to server failure, which we believe will continue to occur from time to time. If the volume of traffic on our Web site or the number of purchases made by customers increases by more than two times our current holiday sales levels, we will need to further expand and upgrade our technology, transaction processing systems and network infrastructure. We have experienced and expect to continue to experience temporary capacity constraints due to sharply increased traffic during sales or other promotions, which cause unanticipated system disruptions, slower response times, degradation in levels of customer service, impaired quality and delays in reporting accurate financial information. If we fail to maintain our Web site or toll-free call center in order to accommodate increased traffic, we may lose customers, which would reduce our net sales. Furthermore, if we fail to maintain the computer systems that we use to process and ship customer orders and process payments, we may not be able to successfully fulfill customer orders. As a result, we could lose customers and our net sales could be reduced. In addition, our failure to maintain or upgrade our Web site or these computer systems without system downtime would further reduce our net sales. We may experience difficulty in improving and maintaining our systems if our employees or contractors that develop or maintain our computer systems become unavailable to us. We have experienced periodic systems interruptions, which we believe will continue to occur, while enhancing and expanding these computer systems. Our Facilities and Systems are Vulnerable to Natural Disasters and Other Unexpected Problems. The Occurrence of a Natural Disaster or Other Unexpected Problem Could Damage Our Reputation and Brand and Reduce Our Net Sales. The occurrence of a natural disaster or unanticipated problems at our leased or offsite hosting facilities that house substantially all of our computer and communications hardware systems could cause 18 interruptions or delays in our business, destroy data or render us unable to accept and fulfill customer orders. Any of these interruptions or delays at these facilities would reduce our net sales. In addition, our systems and operations are vulnerable to damage or interruption from fire, flood, power loss, telecommunications failure, break-ins, earthquake and similar events. We have not established specific procedures for handling damage or interruptions caused by these events and our business interruption insurance may not adequately compensate us for losses that may occur. In addition, the failure by the third-party facility to provide the data communications capacity required by us, as a result of human error, natural disaster or other operational disruptions, could interrupt our service. The occurrence of any or all of these events could damage our reputation and brand and impair our business. Our Net Sales Could Decrease if Our Online Security Measures Fail. Our relationships with our customers may be adversely affected if the security measures that we use to protect their personal information, such as credit card numbers, are ineffective. If, as a result, we lose many customers, our net sales could decrease. We rely on security and authentication technology that we license from third parties. With this technology, we perform real-time credit card authorization and verification with our bank. We cannot predict whether events or developments will result in a compromise or breach of the technology we use to protect a customer's personal information. Furthermore, our servers may be vulnerable to computer viruses, physical or electronic break-ins and similar disruptions. We may need to expend significant additional capital and other resources to protect against a security breach or to alleviate problems caused by any breaches. We cannot assure that we can prevent all security breaches. Our Net Sales and Gross Margins Would Decrease If We Experience Significant Credit Card Fraud. A failure to adequately control fraudulent credit card transactions would reduce our net sales and our gross margins because we do not carry insurance against this risk. We have developed procedures to help us to detect the fraudulent use of credit card information. Under current credit card practices, we are liable for fraudulent credit card transactions because we do not obtain a cardholder's signature. If We Do Not Respond to Rapid Technological Changes, Our Services Could Become Obsolete and We Could Lose Customers. If we face material delays in introducing new services, products and enhancements, our customers may forego the use of our services and use those of our competitors. To remain competitive, we must continue to enhance and improve the functionality and features of our online store. The Internet and the online commerce industry are rapidly changing. If competitors introduce new products and services, or if new industry standards and practices emerge, our existing Web site and proprietary technology and systems may become obsolete. To develop our Web site and technology entails significant technical and business risks. We may use new technologies ineffectively or we may fail to adapt our technology to meet customer requirements or emerging industry standards. Intellectual Property Claims Against Us Can Be Costly and Could Impair Our Business. Other parties may assert infringement or unfair competition claims against us. We cannot predict whether they will do so, or whether any future assertions or prosecutions will harm our business. If we are forced to defend against any infringement claims, whether they are with or without merit or are determined in our favor, then we may face costly litigation, diversion of technical and management personnel, or product shipment delays. Further, the outcome of a dispute may be that we would need to develop non-infringing technology or enter into royalty or licensing agreements. Royalty or licensing agreements, if required, may be unavailable on terms acceptable to us, or at all. If the Protection of Our Trademarks and Proprietary Rights is Inadequate, Our Brand and Reputation Could Be Impaired and We Could Lose Customers. The steps we take to protect our proprietary rights may be inadequate. We regard our copyrights, service marks, trademarks, trade dress, trade secrets and similar intellectual property as critical to our success. We rely on trademark and copyright law, trade secret protection and confidentiality or license agreements with our employees, customers, partners and others to protect our proprietary rights. We currently have applications for registration in the United States Patent and Trademark Office, as well as various foreign trademark offices, of several of the company's trademarks. In some instances, these applications span a variety of goods and services. Effective trademark, service mark, copyright and trade 19 secret protection may not be available in every country in which we will sell our products and services online. Furthermore, the relationship between regulations governing domain names and laws protecting trademarks and similar proprietary rights is unclear. Therefore, we may be unable to prevent third parties from acquiring domain names that are similar to, infringe upon or otherwise decrease the value of our trademarks and other proprietary rights. The Loss of the Services of One or More of Our Key Personnel, or Our Failure to Attract, Assimilate and Retain Other Highly Qualified Personnel in the Future, Could Disrupt Our Operations and Result in Loss of Net Sales. Our future performance will depend on the continued services of our management and key personnel and the ability to attract additional management and key personnel. The loss of the services of one or more of our key personnel could seriously interrupt our business. We depend on the continued services and performance of our senior management and other key personnel. Our future success also depends upon the continued service of our executive officers and other key sales, marketing and support personnel. Our relationships with officers and key employees are at will and none of our officers or key employees is bound by an employment agreement for any specific term. We currently have key person life insurance policies covering Kenneth E. Kurtzman and James H. Whitcomb, Jr. While the proceeds of these policies might assist us in recruiting executive officers, the proceeds would not address the potential disruption to our business of recruiting and integrating new senior management. We May Not Achieve Expected Benefits of Any Investments or Acquisitions That We Complete. As we identify appropriate opportunities, we intend to continue to make acquisitions of or investments in complementary companies, products or technologies. We may not correctly identify or realize the anticipated benefits of any acquisition or investment. For example, we may not be able to successfully assimilate the additional personnel, operations, acquired technology and products into our business. Acquisitions may further strain our existing financial and managerial controls and reporting systems and procedures. In addition, key personnel of acquired companies may decide not to work for us. These difficulties could disrupt our ongoing business, distract our management and employees or increase our expenses. Further, any physical expansion in facilities due to an acquisition may result in disruptions that seriously impair our business. We are not experienced in managing facilities or operations in geographically distant areas. Finally, in connection with any future acquisitions, we may incur debt or issue equity securities as part or all of the consideration for the acquired company's assets or capital stock. We may be unable to obtain sufficient additional financing on favorable terms, or at all. Equity issuances could be dilutive to our existing stockholders or us. Executive Officers, Directors and Entities Affiliated with Them Have Substantial Control over Ashford.com which Could Delay or Prevent a Change in Our Corporate Control Favored by Our Other Stockholders. Executive officers, directors and entities affiliated with them, if acting together, would be able to significantly influence all matters requiring approval by our stockholders, including the election of directors and the approval of mergers or other business combination transactions. It May Be Difficult for a Third Party to Acquire Us Even if Doing So Would Be Beneficial to Our Stockholders. Provisions of our certificate of incorporation, our by-laws and Delaware law could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders. In particular, our certificate of incorporation provides for a board of directors that is divided into three classes which may issue preferred stock without any stockholder action. Our certificate of incorporation also does not allow stockholders to act by written consent or for cumulative voting in the election of directors. Only one class of directors is up for reelection at each annual meeting. In addition, Section 203 of the Delaware General Corporation Law places restrictions on business combinations with interested stockholders. RISKS RELATED TO OUR INDUSTRY We Depend on Increasing Use of the Internet and on the Growth of Online Commerce. Our future revenues substantially depend upon the increased acceptance and use of the Internet and other online services as a medium of commerce. Rapid growth in the use of the Internet, the Web and 20 online services is a recent phenomenon. As a result, acceptance and use may not continue to develop at historical rates and a sufficiently broad base of customers may not adopt, and/or continue to use, the Internet and other online services as a medium of commerce. Demand and market acceptance for recently introduced services and products over the Internet are subject to a high level of uncertainty and there exist few proven services and products. In addition, the Internet may not be accepted as a viable long-term commercial marketplace for a number of reasons, including potentially inadequate development of the necessary network infrastructure or delayed development of enabling technologies and performance improvements. If the Internet continues to experience significant expansion in the number of users, frequency of use or bandwidth requirements, the infrastructure for the Internet may be unable to support the demands placed upon it. In addition, the Internet could lose its viability as a commercial medium due to delays in the development or adoption of new standards and protocols required to handle increased levels of Internet activity, or due to increased governmental regulation. Changes in, or insufficient availability of, telecommunications services to support the Internet also could result in slower response times and adversely affect usage of the Internet generally. Our business, financial condition and results of operations would be seriously harmed if: . use of the Internet, the Web and other online services does not continue to increase or increases more slowly than expected; . the infrastructure for the Internet, the Web and other online services does not effectively support expansion that may occur; . the Internet, the Web and other online services do not become a viable commercial marketplace; or . traffic to our Web site decreases or fails to increase as expected or if we spend more than we expect to attract visitors to our Web site. If We Are Unable to Acquire the Necessary Web Domain Names, Our Brand and Reputation Could Be Damaged and We Could Lose Customers. We may be unable to acquire or maintain Web domain names relating to our brand in the United States and other countries in which we may conduct business. As a result, we may be unable to prevent third parties from acquiring and using domain names relating to our brand, which could damage our brand and reputation and take customers away from our Web site. We currently hold, among others, the "Ashford.com," "newwatch.com," "sunglasses.com," "TimeZone.com," "Paris1925.com," "Jasmin.com" and "Ashfordcorporategifts.com" domain names and may seek to acquire additional domain names. Governmental agencies and their designees generally regulate the acquisition and maintenance of domain names. The regulation of domain names in the United States and in foreign countries is subject to change in the near future. The changes in the United States are expected to include a transition from the current system to a system that is controlled by a non-profit corporation and the creation of additional top-level domains. Governing bodies may establish additional top-level domains, appoint additional domain name registrars or modify the requirements for holding domain names. We May Need to Change the Manner in Which We Conduct Our Business if Government Regulation Increases. The adoption or modification of laws or regulations relating to the Internet could adversely affect the manner in which we currently conduct our business. In addition, the growth and development of the market for online commerce may lead to more stringent consumer protection laws, both in the United States and abroad, that may impose additional burdens on us. Laws and regulations directly applicable to communications or commerce over the Internet are becoming more prevalent. The United States Congress recently enacted Internet laws regarding children's privacy, copyrights, taxation and the transmission of sexually explicit material. The European Union recently enacted its own privacy regulations. Laws regulating the Internet, however, remain largely unsettled, even in areas where there has been some legislative action. It may take years to determine whether and how existing laws such as those governing intellectual property, privacy, libel, and taxation apply to the Internet. In order to comply with new or existing laws regulating online commerce, we may need to modify the manner in which we do business, which may result in additional expenses. For instance, we may need to spend time and money revising the process by which we fulfill customer orders to ensure that each shipment complies with applicable laws. 21 We may need to hire additional personnel to monitor our compliance with applicable laws. We may also need to modify our software to further protect our customers' personal information. We May Be Subject to Liability for the Internet Content That We Publish. As a publisher of online content, we face potential liability for defamation, negligence, copyright, patent or trademark infringement, or other claims based on the nature and content of materials that we publish or distribute. If we face liability, then our reputation and our business may suffer. In the past, plaintiffs have brought these types of claims and sometimes successfully litigated them against online companies. In addition, we could be exposed to liability with respect to the unauthorized duplication of content or unauthorized use of other parties' proprietary technology. Although we carry general liability insurance, our insurance currently does not cover claims of these types. We cannot be certain that we will be able to obtain insurance to cover the claims on reasonable terms or that it will be adequate to indemnify us for all liability that may be imposed on us. Any imposition of liability that is not covered by our insurance or is in excess of insurance coverage could decrease our gross profit. Our Net Sales Could Decrease if We Become Subject to Sales or Other Taxes. If one or more states or any foreign country successfully asserts that we should collect sales or other taxes on the sale of our products, our net sales and results of operations could be harmed. One or more local, state or foreign jurisdictions may seek to impose sales tax collection obligations on us. In addition, any new operation could subject our shipments in other states to state sales taxes under current or future laws. If we become obligated to collect sales taxes, we will need to update our system that processes customer orders to calculate the appropriate sales tax for each customer order and to remit the collected sales taxes to the appropriate authorities. These upgrades will increase our operating expenses. In addition, our customers may be discouraged from purchasing products from us because they have to pay sales tax, causing our net sales to decrease. As a result, we may need to lower prices to retain these customers. RISKS RELATED TO SECURITIES MARKETS Our Common Stock Price Is Volatile, Which Could Result In Substantial Losses for Individual Stockholders. The trading price of our common stock fluctuates significantly. For example, since our initial public offering through March 31, 2001, the reported sale price of our common stock on the Nasdaq National Market was as high as $24.88 and as low as $0.30. Trading prices of our common stock may fluctuate in response to a number of events and factors, such as: . actual or anticipated variations in our quarterly operating results; . announcements of technological innovations or new products or services by us or our competitors; . changes in financial estimates by securities analysts; . conditions or trends in the Internet and/or online commerce industries; . changes in the economic performance and/or market valuations of other Internet, online commerce or retail companies; . announcements by us or our competitors of significant acquisitions, strategic partnerships, joint ventures or capital commitments; . additions or departures of key personnel; . release of transfer restrictions on our outstanding shares of common stock or sales of additional shares of common stock; and . potential litigation. In addition, the stock market has from time to time experienced extreme price and volume fluctuations. These broad market fluctuations may adversely affect the market price of our common stock. 22 ITEM 2. PROPERTIES Our corporate offices and fulfillment operations are located in Houston, Texas, where we lease approximately 76,000 square feet under a lease that provides for aggregate annual lease payments through the term of the lease expiring in April 2003. ITEM 3. LEGAL PROCEEDINGS We are, and from time to time, may be involved in litigation relating to claims arising out of our ordinary course of business. We believe that there are no claims or actions pending or threatened against us, the ultimate disposition of which would materially adversely affect us. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS We held a special meeting of our shareholders on April 25, 2001 to vote on the merger and the merger agreement between Ashford.com, Inc. and Guild.com, Inc. The proposal to approve the adoption of the merger and the merger agreement was approved by the vote set forth below: FOR AGAINST ABSTAIN ------------------ --------------------- --------------------- 27,424,700 52,094 10,237 ITEM 4a. EXECUTIVE OFFICERS OF THE REGISTRANT The following tables set forth specific information regarding our executive officers and directors as of March 31, 2001
Name Age Position(s) ---- --- ----------- J. Robert Shaw 35 Chairman of the Board Kenneth E. Kurtzman 38 Chief Executive Officer and Director James H. Whitcomb, Jr. 35 President, Chief Information Officer and Director William J. Hensler 53 Chief Operating Officer David F. Gow 38 Chief Financial Officer Ryan J. Maierson 29 Vice President, General Counsel and Secretary Kevin R. Harvey 36 Director Colombe M. Nicholas 56 Director Robert Cohn 51 Director Scott Hockler 39 Director
J. ROBERT SHAW is one of our co-founders and has served as the Chairman of the Board since April 1998. In 1989, Mr. Shaw founded Synergy Development Corp., an information-technology consulting firm that provided equipment and services to online commerce companies, and was President and Chief Executive Officer since its inception. In 1999, Synergy Development Corp. reorganized as Emerging Inc., an online commerce consulting firm. Mr. Shaw was President, Chief Executive Officer and Director of Emerging Inc. since its inception. Emerging Inc. ceased operations in April 2001. From 1985 to 1989, Mr. Shaw served as Vice President of Sales and Finance for StyleWare, Inc., a software company that was subsequently sold to Claris Corporation. Mr. Shaw received a Bachelor of Business Administration in Economics cum laude from the University of St. Thomas. KENNETH E. KURTZMAN joined us in May 1999 as our Chief Executive Officer and a Director. Mr. Kurtzman resigned as our Chief Executive Officer in April 2001 and as a Director in June 2001. From August 1995 to April 1999, Mr. Kurtzman served as Vice President and General Manager of several divisions of Compaq Computer Corporation, including the Small and Medium Business Division and Compaq.com. From September 1989 to August 1995, Mr. Kurtzman worked for McKinsey & Co., an international consulting firm, where most recently he served as a Principal working in the computing, telecommunications, systems integration, banking and energy industries. Mr. Kurtzman received a Bachelor of Arts degree in Economics magna cum laude from Rice University, an undergraduate degree in 23 economics from Cambridge University and a Masters in Business Administration degree from the Graduate School of Business at Stanford University. JAMES H. WHITCOMB, JR. is one of our co-founders and oversees all aspects of technology. He has served as our President and as a Director since March 1998. From our inception to May 1999, he served as Chief Executive Officer and from May 1999 to February 2000 he served as our Chief Operating Officer. From February 1990 to March 1998, Mr. Whitcomb served as Chief Technology Officer at Synergy Development Corp, an information-technology consulting firm, and served as a director since its inception. In 1999, Synergy Development Corp. reorganized as Emerging Inc., where Mr. Whitcomb continued as a director. Emerging, Inc. ceased operations in April 2001. Mr. Whitcomb earned a bachelor's degree in accounting from the University of Texas at Austin. WILLIAM J. HENSLER joined us in February 2000 as our Chief Operating Officer. Mr. Hensler oversees all logistical operations, including distribution, customer service and quality assurance. Prior to joining us, Mr. Hensler worked for Compaq Computer Corporation, where he held positions such as Vice President of the Small and Medium Business Division and Vice President of Quality for the PC Products Group. Prior to joining Compaq, Mr. Hensler directed Coopers & Lybrand's Total Quality Center of Excellence, where he was responsible for business development and the creation of the Total Quality intellectual property. Mr. Hensler has also published numerous articles on management and customer satisfaction. Mr. Hensler received a Bachelor of Science degree from the University of Illinois. DAVID F. GOW served as our Chief Financial Officer from March 1999 to April 2001, when he was promoted to Chief Executive Officer. From January 1996 to February 1999, Mr. Gow was the Director of Strategic Planning at Compaq Computer Corporation. From August 1993 to January 1996, Mr. Gow worked as a consultant with McKinsey & Co., serving the technology, energy, banking and retail industries. Mr. Gow received a Bachelor of Arts in Economics from Williams College and a Masters degree from the Kennedy School of Government at Harvard University. RYAN J. MAIERSON served as our Vice President, General Counsel and Secretary to the Board of Directors from January 2001 to June 2001. He was responsible for overseeing all aspects of our legal affairs. Prior to becoming general counsel, Mr. Maierson served for one year as our assistant general counsel and director of business development. He began his legal career as a law clerk to the Supreme Court of Texas and then practiced at the Houston-based law firm of Bracewell & Patterson, LLP. Mr. Maierson received his undergraduate degree in economics, magna cum laude, from the Wharton School of the University of Pennsylvania in 1992 and his law degree, with honors, from The University of Texas School of Law in 1996, where he was elected to the Order of the Coif national honorary society. KEVIN R. HARVEY has served on our board of directors since December 1998. Mr. Harvey has been a Managing Member of the general partner of Benchmark Capital, a venture capital firm, since January 1995. From July 1993 to January 1995, he served as General Manager for Lotus Development Corporation. In August 1990, Mr. Harvey founded Approach Software Corporation, a software company, where he served as the President and Chief Executive Officer until July 1993 when Approach was sold to Lotus Development Corporation. Prior to founding Approach, Mr. Harvey founded StyleWare Inc. Mr. Harvey is also a director of Broadbase Software, a developer and provider of customer relationship applications, Critical Path, Inc., an e-mail hosting services company, Red Hat Software, a developer and provider of open source software and services and a director of several privately held companies. Mr. Harvey received a B.S.E.E. degree from Rice University. COLOMBE M. NICHOLAS has served on our board of directors since August 1999. Ms. Nicholas served as President and Chief Executive Officer for Anne Klein Group, a women's fashion apparel company, from August 1996 to July 1999, when the company was sold to Kasper, ASL. From December 1993 to July 1996, Ms. Nicholas served as President and Chief Executive Officer of Orr Felt Company, a family-owned business that provides felt for paper manufacturing. From April 1991 to November 1993, she was the President and Chief Operating Officer of Giorgio Armani Fashion Corporation, the largest licensee of Armani Spa, Italy. From May 1980 to January 1989, Ms. Nicholas served as President and Chief Executive Officer of Christian Dior New York, a designer fashion company. Ms. Nicholas received a Bachelor of Arts Degree in languages from the University of Dayton and a J.D. from the University of Cincinnati College of Law. ROBERT COHN has served on our board of directors since May 2000. From September 1997 until his retirement in May 1999, Mr. Cohn served as Executive Vice President of Lucent Technologies, Inc. 24 From June 1982 until September 1997, Mr. Cohn served as founder, Chief Executive Officer and Chairman of the Board of Octel Communications, a provider of voice messaging systems. Mr. Cohn presently serves as a director of Chapters Online Inc., a Canadian internet portal company, and Saba Software, Inc., an enterprise software company. Mr. Cohn holds a B.S. from the University of Florida and an M.B.A. from Stanford University. SCOTT HOCKLER was appointed to our board of directors during February 2001. Mr. Hockler resigned from the Company and his board position during June 2001. PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS MARKET INFORMATION On September 24, 1999, our common stock began trading on the Nasdaq National Market under the symbol "ASFD." Prior to that date, there was no public market for our common stock. The following table sets forth the high and low closing sale prices for the common stock for the period indicated, as reported by the Nasdaq National Market. Common Stock Price ---------------------------- High Low ----------- ----------- Year ended March 31, 2000: Second Quarter (from September 22, 1999) $13.00 $9.22 Third Quarter 24.88 9.44 Fourth Quarter 13.13 4.72 Year ended March 31, 2001: $ 5.88 $2.50 First Quarter 4.06 2.56 Second Quarter 3.13 0.30 Third Quarter 1.19 0.38 Fourth Quarter HOLDERS As of May 31, 2001, there were 208 stockholders of record of the common stock, although there are a larger number of beneficial owners. DIVIDENDS We have never declared or paid cash dividends on our common stock. We currently intend to retain all future earnings to finance future growth and, therefore, do not anticipate paying any cash dividends in the foreseeable future. RECENT SALES OF UNREGISTERED SECURITIES In February 2001, we issued 1,991,000 shares of our common stock in exchange for the outstanding capital stock of E.S.T., Inc. ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA The following selected consolidated financial and operating data should be read in conjunction with the consolidated financial statements and notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations," which are included elsewhere in this Report. See Note 2 of Notes to Consolidated Financial Statements also included elsewhere in this Report for an explanation of the determination of the number of shares and share equivalents used in computing the pro forma per share amounts shown below. The pro forma share amounts reflect the conversion of outstanding preferred stock into common stock. The selected consolidated financial data reflect that prior to March 31, 1998, we had no operations or activities. The following selected consolidated financial data was derived from our audited consolidated 25 financial statements appearing elsewhere in this Report. We were incorporated in March 1998, and did not commence operations or activities until April 1998.
Period from Year Ended Year Ended Inception March 31, March 31, through March 31, ---------------------------------------------------------------- 2001 2000 1999 -------- -------- ------- (in thousands, except per share amounts) STATEMENT OF OPERATIONS DATA: Net sales $ 67,195 $ 39,931 $ 5,938 Cost of sales 56,348 33,487 5,110 --------- -------- ------- Gross profit (1) 10,847 6,444 828 Operating expenses: Marketing and sales (includes non-cash amortization of $79,735, $27,525 and $0, respectively) 105,895 60,806 1,013 General and administrative (includes non-cash amortization of $2,633, $3,003 and $0, respectively) (2) 27,929 17,093 1,019 Restructuring charge 662 - - Impairment loss 1,094 - - Depreciation and amortization 13,460 3,277 67 --------- -------- ------- Total operating expenses 149,040 81,176 2,099 --------- -------- ------- Loss from operations (138,193) (74,732) (1,271) Interest income 1,644 2,677 13 Interest expense (132) (7) (6) --------- -------- ------- Net loss $(136,681) $(72,062) $(1,264) ========= ======== ======= Net loss per share, basic and diluted $(2.99) $(2.65) $(0.12) ========= ======== ======= Pro forma net loss per share, basic and diluted (3) $(2.99) $(2.05) $(0.10) ========= ======== ======= Shares used to compute net loss per share: Basic and diluted 45,725 27,197 10,397 Pro forma basic and diluted (3) 45,725 35,071 13,264 March 31, March 31, March 31, 2001 2000 1999 --------- --------- --------- (in thousands) BALANCE SHEET DATA: Cash and cash equivalents $ 7,095 $ 46,474 $ 893 Working capital 23,861 148,898 2,555 Total assets 56,266 177,608 5,108 Total stockholders' equity 43,268 171,270 2,808
(1) Includes the reclassification of certain promotional costs from marketing and sales to cost of sales related to the adoption of the Emerging Issues Task Force Issue No. 00-14, "Accounting for Certain Sales Incentives." All periods presented have been reclassified for consistent presentation. Also includes a charge of approximately $1.8 million during the year ended March 31, 2001, relating to inventory valuation reserves. See Note 2 of Notes to Consolidated Financial Statements included elsewhere in this Report. (2) Includes non-recurring charges of approximately $400,000 during the year ended March 31, 2001, relating to the pending settlement of litigation. See Note 12 of Notes to Consolidated Financial Statements included elsewhere in this Report. (3) See Note 2 of Notes to Consolidated Financial Statements included elsewhere in this Report for an explanation of the determination of the number of shares and share equivalents used in computing pro forma per share amounts. 26 ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The discussion in this Report contains forward-looking statements (as such term is defined in Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934) that involve risks and uncertainties. Our actual results could differ materially from those discussed herein. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in "Risk Factors That May Affect Future Results" as well as those discussed in this section and elsewhere in this Report, and the risks discussed in the "Risk Factors" section included in our Registration Statement on Form S-1 as declared effective by the Securities and Exchange Commission on September 22, 1999 (Reg. No. 333-82759). OVERVIEW We were incorporated on March 6, 1998 and commenced operations and began offering products for sale on our Web site in April 1998. We initially focused exclusively on the sale of new and vintage watches. Since inception, we have focused on broadening our product offerings, establishing relationships with luxury and premium brand owners, generating sales momentum and expanding our operational and customer service capabilities. We have grown rapidly since launching our site in April 1998 and have experienced significant increases in our net sales and corresponding cost of sales since inception. We currently offer more than 12,000 styles of products from over 300 leading luxury brands. We are currently focusing our efforts on continuing to increase net sales while maintaining or decreasing current expense levels. We plan to continue the growth of our corporate gift business, which generally generates higher margin sales and is less seasonal in nature than our traditional retail sales, and our newer, higher margin product categories, such as our Ashford Collection jewelry. As part of a larger effort to improve overall operating efficiencies and lower total operating costs as a percentage of sales, we have specifically reduced our traditional print and media marketing activities and broadened our focus on Internet and online media, which we believe to be a more efficient and economical means of attracting new customers. Other specific initiatives designed to improve financial performance and liquidity management include reducing the scope of product offerings, decreasing our investment in inventory and eliminating certain operating costs, including personnel costs. As stated above, we plan to continue the growth of our corporate gift business which was introduced in March 2000. Our corporate gift business offers over 800 luxury products such as crystal, silver and pewter that appeal to the corporate market. These products usually generate higher margin sales and are less seasonal in nature than our traditional retail sales. Also, many corporate gift products are finished with custom engraving, etching or embossing which further increases our margin. The market for luxury and premium products is highly seasonal, with a disproportionate amount of net sales occurring during the fourth calendar quarter. Therefore, we increase our purchases of inventory during and in advance of that quarter. Although less significant, seasonal sales periods occur in February due to Valentine's Day and in May and June due to graduation gift giving, Mother's Day and Father's Day. We expect that these trends will continue in future periods. Our gross margin will fluctuate in future periods based on factors such as: . product sales mix; . the mix of direct and indirect sources of inventory; . pricing strategy; . promotional activities; . inventory management; and . inbound and outbound shipping costs. We have incurred net losses since inception and expect to generate negative cash flows during future periods. Our ability to become profitable depends on our ability to generate and sustain substantially higher net sales while maintaining reasonable expense levels, both of which are uncertain. If we do achieve profitability, we cannot be certain that we would be able to sustain or increase profitability on a quarterly or annual basis in the future. 27 We have a limited operating history upon which to base an evaluation of our business and prospects. As a result of our limited operating history, it is difficult to accurately forecast our net sales and we have limited meaningful historical financial data upon which to base projected operating expenses. We base our current and future expense levels on our operating plans and estimates of future net sales, and our expenses are fixed to a large extent. Sales and operating results are difficult to forecast because they generally depend on the volume and timing of the orders we receive. As a result, we may be unable to adjust our spending in a timely manner to compensate for any unexpected revenue shortfall. This inability could cause our net losses in a given quarter to be greater than expected and could significantly limit or delay our ability to generate net profits in any future period. The SEC is conducting an investigation concerning our accounting and disclosures relating to certain marketing activities during fiscal years 2000 and 2001. We have been cooperating with the SEC, and we will continue to do so. Our audit committee also has completed an internal review of certain matters related to the SEC review. We do not believe that any of the accounting issues raised by the SEC will have a material effect on our financial statements. RESULTS OF OPERATIONS FISCAL 2001 COMPARED WITH FISCAL 2000 NET SALES Net sales consist of product sales and are net of product returns, coupons and promotional discounts. Net sales increased from $39.9 million for fiscal 2000 to $67.2 million for fiscal 2001. The growth in net sales is primarily related to an increase in units sold due to the growth of our customer base and the growth of our corporate gift business, including a business acquisition. The growth in the rate of repeat purchases from existing customers and the introduction of new product lines during the latter part of fiscal 2000 also contributed to our net sales growth. Net sales were adversely affected during the latter part of fiscal 2001 by a general decline in retail spending and reduced marketing and sales efforts. COST OF SALES Cost of sales consists primarily of the cost of products sold, free product and service incentives delivered to customers at the time of sale, inbound and outbound shipping costs and warranty and inventory obsolescence costs. Cost of sales increased as net sales increased. Gross profit increased from $6.4 million for fiscal 2000 to $10.8 million for fiscal 2001. The increase in gross profit is due to several factors. The primary factor is the continued growth of our corporate gift business, including a recent acquisition, which has generated higher-margin sales to date than our traditional retail sales. In addition, we have reduced the amount of free product and service incentives offered to customers at the time of purchase. See also "Recent Accounting Pronouncements." Finally, we continue to see a favorable shift in the mix of products sold from lower-margin products to higher-margin products due to the addition and continued expansion of new product categories. Gross margin was adversely affected by an inventory obsolescence charge of approximately $1.8 million recorded during the fourth quarter of fiscal 2001 as a result of our focus on reducing inventory levels. We anticipate continued gross margin improvements in future periods as we continue to grow our corporate gift business and our newer higher-margin product categories such as home and lifestyle products and our Ashford Collection jewelry. We also expect gross margin improvements in future periods as a result of our efforts to reduce certain expenses such as outbound shipping costs which now are paid by the customer on most orders. OPERATING EXPENSES Marketing and Sales. Marketing and sales expenses consist primarily of advertising costs, credit card fees, fulfillment activities and related employee salary and benefit expenses and amortization of related deferred compensation. Fulfillment activities include receiving of goods, picking of goods for shipment and packaging of goods for shipment. Fulfillment costs, including the cost of operating and staffing distribution centers, are included in marketing and sales. Marketing and sales expenses increased from approximately $60.8 million for fiscal 2000 to $105.9 million for fiscal 2001. The increase in marketing and sales is attributable to an increase in non-cash amortization from $27.5 million for fiscal 2000 to $79.7 million for fiscal 2001 primarily relating to a marketing contract entered into with another online retailer during the latter part of fiscal 2000 that expired in fiscal 2001. Excluding non-cash amortization, the decrease in marketing and sales is primarily attributable to a reduction in traditional print and media marketing activities. During fiscal 2001, we shifted our primary marketing focus from traditional print and broadcast media to Internet and online media. We believe Internet and online media provides a more efficient and economical means of attracting new customers. Our advertising and promotional expenditures are generally intended to build brand awareness, generate site traffic and increase overall sales. We expect our marketing and sales expense to continue to decline as a percentage of sales in 28 future periods as we continue our focus of becoming more efficient and economical at acquiring customers. See also "Recent Accounting Pronouncements." General and Administrative. General and administrative expenses include executive, finance and administrative employee salaries and benefits, amortization of related deferred compensation, professional fees, Web site maintenance, office lease expenses and other general corporate expenses. General and administrative expenses increased from $17.1 million for fiscal 2000 to $27.9 million for fiscal 2001. Our general and administrative expenses have increased primarily as a result of costs associated with increased headcount, property and franchise taxes and legal costs related to our overall growth and expanded activities. In the future, we expect our general and administrative expenses to decrease as a result of our restructuring activities during January 2001 and May 2001. Depreciation and Amortization. Depreciation and amortization expense includes depreciation related to property and equipment and amortization related to intangible assets. Depreciation and amortization expense increased from $3.3 million for fiscal 2000 to $13.5 million for fiscal 2001. The increase is primarily due to depreciation and amortization expense related to Internet domain and other intangible asset purchases as well as Web site development costs and technology equipment purchases beginning in the latter half of fiscal 1999 and continuing through the latter part of fiscal 2001. Interest Income. Interest income consists of earnings on cash and cash equivalents. Interest income decreased from $2.7 million for fiscal 2000 to $1.6 million for fiscal 2001. The decrease is due to lower cash balances during the current year. See also "Liquidity and Capital Resources." Interest Expense. Interest expense consists of interest costs on borrowings. The increase in interest expense for fiscal 2001 is due to borrowings on our revolving credit facility entered into during September 2000. FISCAL 2000 COMPARED WITH FISCAL 1999 NET SALES Net sales consist of product sales and are net of product returns, coupons and promotional discounts. Net sales increased from $5.9 million for fiscal 1999 to $39.9 million for fiscal 2000. The growth in net sales reflects a significant increase in units sold principally due to the growth in our customer base and repeat purchases from our existing customers, in addition to the introduction of new product lines during fiscal 2000. The increase in site traffic and awareness results primarily from advertising expenditures and additional product offerings and availability that were financed through our convertible preferred and common stock offerings. COST OF SALES Cost of sales consists primarily of the cost of products sold, free product and service incentives delivered to customers at the time of sale, inbound and outbound shipping costs and warranty and inventory obsolescence costs. Cost of sales increased as net sales increased. Gross profit increased from $828,000 for fiscal 1999 to $6.4 million for fiscal 2000. Gross margin increased from 14% during fiscal 1999 to 16% during fiscal 2000. The increase in gross margin is principally due to the addition of new product categories, the mix of products sold and abnormally low margins during the prior year resulting from start-up activities. OPERATING EXPENSES Marketing and Sales. Marketing and sales expenses consist primarily of advertising costs, credit card fees, fulfillment activities and related employee salary and benefit expenses and amortization of related deferred compensation. Fulfillment activities include receiving of goods, picking of goods for shipment and packaging of goods for shipment. Fulfillment costs, including the cost of operating and staffing distribution centers, are included in marketing and sales. Marketing and sales expenses increased from approximately $1.0 million for fiscal 1999 to $60.8 million for fiscal 2000. The increase in marketing and sales is partially attributable to an increase in non-cash amortization from $0 for fiscal 1999 to $27.5 million for fiscal 2000 primarily relating to a marketing contract entered into with another online retailer during the latter part of fiscal 2000 which expired in fiscal 2001. The remaining increase during fiscal 2000 is primarily due to increased advertising and promotional expenditures, amortization of deferred compensation, and increased payroll and related costs associated with fulfilling customer demand. Our 29 advertising and promotional expenditures are intended to build brand awareness, generate site traffic and increase overall sales. General and Administrative. General and administrative expenses include executive, finance and administrative employee salaries and benefits, amortization of related deferred compensation, professional fees, Web site maintenance, office lease expenses and other general corporate expenses. General and administrative expenses increased to $17.1 million for fiscal 2000 compared to $1.0 million for fiscal 1999. The increase in general and administrative expenses was primarily a result of expenses associated with increased headcount, new office space and professional fees related to our growth and expanded activities. Depreciation and Amortization. Depreciation and amortization expense includes depreciation related to property and equipment as well as amortization related to purchased intangibles and other assets. Depreciation and amortization expense was $3.3 million for fiscal 2000 compared to $67,000 in fiscal 1999. The increase relates to Internet domain names and other intangible assets purchased during fiscal 2000 and technology and other equipment purchased in the latter half of fiscal 1999 and continuing through fiscal 2000. Internet domain names and related intangible assets purchased in connection with business acquisitions are amortized over their estimated useful lives, which is deemed to be two years. Interest Income. Interest income consists of earnings on cash and cash equivalents. The increase during fiscal 2000 relates to interest earned on cash balances resulting from our Series B and Series C convertible preferred stock offerings in April 1999 and July 1999, respectively, and interest earned on cash balances resulting from our initial public offering in late September 1999. Interest income was $2.7 million during fiscal 2000 compared to $13,000 during fiscal 1999. LIQUIDITY AND CAPITAL RESOURCES General. We have financed our operations primarily through private sales of convertible preferred stock, an initial public offering and the private sale of our common stock. The proceeds from these offerings have been used primarily to fund our operations, including inventory purchases, marketing and advertising campaigns, employee salaries and equipment purchases. Operating Activities. Net cash used in operating activities decreased from $68.7 million for fiscal 2000 to $32.5 million for fiscal 2001. Our net operating cash outflow for fiscal 2000 was primarily a result of prepaid marketing agreements, inventory purchases and, to a lesser extent, operating losses, exclusive of depreciation and amortization. Our operating cash outflow during fiscal 2001 was primarily a result of operating losses, exclusive of depreciation and amortization and impairment loss. The decrease in net cash used in operating activities during fiscal 2001 compared to fiscal 2000 primarily relates to a lower level of inventory purchases and prepaid advertising during the current year. We anticipate our net cash used in operating activities to continue to decline in future periods in connection with our efforts to improve overall operating efficiencies, lower total operating costs as a percentage of sales and improve inventory management practices and procedures, exclusive of any non-cash charges taken in future periods in connection with these efforts. Investing Activities. Net cash used in investing activities totaled $11.5 million for fiscal 2001 compared to $14.8 million for fiscal 2000. Net cash used in investing activities during fiscal 2001 consisted of $6.8 million related to property and equipment purchases primarily associated with technology and Web site enhancements, $3.3 million of Internet domain and other intangible asset purchases and a $1.4 million increase in restricted cash pledged as collateral against potential credit card chargebacks. The increase in restricted cash is consistent with our increased sales levels. Net cash used in investing activities during fiscal 2000 consisted of approximately $6.9 million related to the purchase of computer and office equipment and Web site enhancements as well as leasehold improvements associated with leased office and warehouse facilities and $7.9 million of Internet domain and other intangible asset purchases. Financing Activities. Net cash provided by financing activities totaled $4.7 million during fiscal 2001. Financing activities during fiscal 2001 primarily related to net proceeds from our revolving credit facility. Net cash provided by financing activities during fiscal 2000 totaled $129.1 million. The majority of the cash related to net proceeds from our initial public offering in September 1999. Commitments. As of March 31, 2001, our principal commitments consisted of obligations outstanding under non-cancelable operating leases. We have no material commitments for capital expenditures. 30 Credit Facility. During September 2000, we executed a three-year revolving credit facility with Congress Financial Corporation, a unit of First Union National Bank. The credit facility is to be used for working capital needs and is secured by our assets. Availability under the credit facility is determined pursuant to a borrowing base related to our assets, as defined in the agreement, and was $6.9 million at March 31, 2001. Approximately $4.7 million was outstanding under the revolving credit facility as of March 31, 2001. Amounts outstanding under the credit facility bear interest at the prime rate or LIBOR plus 250 basis points, as elected by us. In addition to the amount outstanding at March 31, 2001, $250,000 was reserved against the issuance of a standby letter of credit. Financial Condition. We believe that current cash balances and borrowing capacity will be sufficient to meet anticipated cash needs for at least the next 12 months. However, any projections of future cash needs and cash flows are subject to substantial uncertainty. If current cash and cash that may be generated from future operations are insufficient to satisfy our liquidity requirements, we may seek to sell additional equity or debt securities or to obtain additional credit facilities from lenders. There can be no assurance that financing will be available in amounts or on terms acceptable to us, if at all. Our ability to raise cash through the sale of additional equity or convertible debt securities may be affected by market conditions and other factors, and if available could result in additional dilution to our stockholders. In addition, we will, from time to time, consider the acquisition of or investment in complementary businesses, products, services and technologies, which might impact our liquidity requirements or cause us to issue additional equity or debt securities. Restructuring. During May 2001, management initiated a review of our lines of business, cost structure and general activities. The objective of this review was to identify opportunities for improved financial performance and liquidity management in light of economic conditions and market forces. Specific initiatives resulting from this review include reducing the scope of product offerings, decreasing our investment in inventory and eliminating certain operating costs, including personnel costs. In February 2001, the Company entered into a merger agreement with an online watch retailer. During June 2001, as a result of certain business difficulties that arose in the relationship between the Company and the former principles of the online watch retailer and to resolve litigation between them, the parties began negotiating a dissolution of that relationship. The online watch retailer tentatively agreed to a settlement whereby the online watch retailer and certain of it's management will receive aggregate consideration of approximately $800,000, consisting of $200,000 of inventory, $100,000 of severance pay and 1.5 million shares of our common stock to settle all potential future claims and obligations. We expect to record a charge of approximately $2.4 million during the quarter ending June 2001 in connection with this settlement. During January 2001, we entered into a merger agreement with an online art dealer. Final closing of the merger occurred in May 2001. In connection with the closing of the transaction, the stockholders of the online art dealer received approximately 7.1 million shares of our common stock. In addition, all of the acquired company's outstanding warrants and stock options were converted to outstanding warrants and options to acquire approximately 1.6 million shares of our common stock. The aggregate purchase price was approximately $4.3 million, consisting of $3.3 million of our common stock, $700,000 of options and warrants to purchase shares of our common stock and $300,000 of business combination costs. The principle assets received include $7.3 million of cash, an Internet domain name and related trademarks and other tangible and intangible assets related to Internet retail operations. The total value of net tangible assets acquired exceeded the $4.3 million purchase price. The acquisition will be accounted for using the purchase method of accounting. In connection with the May 2001 review, management concluded that the operating cost structure of the online art retailer was inconsistent with the level of sales activity and our revised objectives. In June 2001, the prior management of the online art retailer made a proposal to our management and Board of Directors, which we have agreed to accept, to assume the prospective operations of the online art retailer as a separately capitalized entity. Pursuant to this agreement, we will retain the cash from the acquisition, and we will contribute assets of approximately $500,000, including $400,000 of cash, an Internet domain name and related trademarks and other intangible assets in return for 5% ownership interest in the new entity. In addition, we will enter into a revenue sharing agreement with the new entity whereby we will offer the new entity's product on our Web site in return for 50% of the gross profit from sales generated by the Company's Web site. We will not assume any future operating costs or obligations. Further, substantially all employees previously employed by the online art retailer will become employees of the new entity or will be terminated. 31 In connection with the May 2001 review, during June 2001, we sold two Internet domain names and related trademarks related to a product information Internet site in exchange for $400,000 cash. We expect to record a loss on sale of approximately $500,000 during the quarter ending June 2001. In connection with the May 2001 review, we entered into severance agreements with 41 employees. We expect to record a charge of $80,000 during the quarter ending June 2001 related to these headcount reductions. RECENT ACCOUNTING PRONOUNCEMENTS The FASB issued an Exposure Draft, Business Combinations and Intangible Assets, containing tentative decisions about requiring the use of a nonamortization approach to account for purchased goodwill. Under the nonamortization approach, goodwill would be tested for impairment, rather than being amortized to earnings. Under the Exposure Draft, the Company's purchased intangibles would continue to be amortized consistent with its current policy. Upon adoption of the principles in this Exposure Draft, the Company would record any goodwill as income or expense. In March 2000, the Financial Accounting Standards Board (FASB) issued Financial Interpretation (FIN) No. 44, Accounting for Certain Transactions Involving Stock Compensation." FIN 44 clarifies the application of Accounting Principles Board (APB) Opinion No. 25 for certain issues, such as the definition of an employee for purposes of applying APB Opinion No. 25, the criteria for determining whether a plan qualifies as a noncompensatory plan, the accounting consequence of various modifications to the terms of a previously fixed stock option or award and the accounting for an exchange of stock compensation awards in a business combination. Adoption of FIN 44 did not change our existing accounting policies or disclosures. In May 2000, EITF issued EITF 00-14 "Accounting for Certain Sales Incentives," which provides guidance on the accounting for certain sales incentives offered by companies to their customers such as discounts, coupons, rebates and products or services. EITF 00-14 addresses the recognition, measurement and income statement classification for sales incentives offered voluntarily by a vendor without charge to customers that can be used in, or that are exercisable by a customer as a result of a single exchange transaction. The accompanying financial statements include the reclassification of free product and service incentives delivered to customers at the time of sale, from marketing and sales expense to cost of sales, related to the adoption of EITF 00-14. All periods presented have been reclassified for consistent presentation. In July 2000, the EITF reached a consensus on EITF 00-10, "Accounting for Shipping and Handling Fees and Costs." This consensus requires that all amounts billed to a customer in a sale transaction related to shipping and handling, if any, represent revenue and should be classified as revenue. We have historically classified shipping charges to customers as revenue. In September 2000, the EITF concluded that the classification of shipping and handling costs should be disclosed pursuant to Accounting Principles Board (APB) Opinion No. 22, "Disclosure of Accounting Policies." If shipping and handling costs are significant and are not included in cost of sales, companies should disclose both the amount of such costs and which line item on the income statement includes that amount. Shipping and handling costs cannot be netted against sales. We classify inbound and outbound shipping costs as costs of sales. We generally do not impose separate handling charges on customers. However, during fiscal 2001, we began charging for shipping costs. We began charging for packaging costs during fiscal 2002. Costs attributable to receiving, inspecting and warehousing inventories and picking, packaging and preparing customers' orders for shipment are classified as marketing and sales expense and totaled $3.8 million, $1.9 million and $65,000 during the years ended March 31, 2001 and 2000 and the period from Inception through March 31, 1999, respectively. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We have assessed our vulnerability to certain market risks, including interest rate risk associated with financial instruments included in cash, cash equivalents and short-term investments. Due to the short-term nature of these investments and our investment policies and procedures, we have determined that the risk associated with interest rate fluctuations related to these financial instruments does not pose a material risk to us. 32 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA See Exhibit (a) (1) ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not Applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information regarding directors is incorporated by reference from the section entitled "Proposal No. 1 - Election of Directors" of our definitive Proxy Statement to be filed pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended, for the registrant's Annual Meeting of Stockholders to be held on August 27, 2001. The Proxy Statement is anticipated to be filed within 120 days after the end of the registrant's fiscal year ended March 31, 2001. For information regarding executive officers of the Company, see the information appearing under the caption "Executive Officers of the Registrant" in Part I, Item 4a of this Report on Form 10-K. ITEM 11. EXECUTIVE COMPENSATION Information regarding executive compensation is incorporated by reference from the section entitled "Executive Compensation and Related Information" of the Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information regarding security ownership of certain beneficial owners and management is incorporated by reference from the section entitled "Stock Ownership of Certain Beneficial Owners and Management" of the Proxy Statement. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information regarding certain relationships and related transactions is incorporated by reference from the section entitled "Certain Relationships and Related Transactions" of the Proxy Statement. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (A) (1) Financial Statements: Page Report of Independent Public Accountants F-1 Consolidated Balance Sheets F-2 Consolidated Statements of Operations F-3 Consolidated Statements of Stockholders' Equity F-4 Consolidated Statements of Cash Flows F-5 Notes to Consolidated Financial Statements F-6 33 (A) (2) Exhibits
Exhibit Number Description ---------- ----------- 2.1** Option Agreement dated August 17, 1999 by and between the Company and Power Reserve, Inc. and Richard E. Paige 2.2** Asset Acquisition Agreement dated October 26, 1999 by and between the Company and Power Reserve, Inc. 2.3** Asset Acquisition Agreement dated October 26, 1999 by and between the Company and Richard E. Paige 2.4*** Agreement and Plan of Reorganization dated as of January 14, 2000 by and among the Company, Ashford-Jasmin Fragrance Company and Jasmin.com Corporation 2.5****** Merger Agreement by and among the Company, Ashford-Watchnetwork Company, and EST, Inc. 2.6 Agreement and Plan of Reorganization dated January 3, 2001 by and among the Company, Guild.com, Inc., and Ashford-Guild Art Corporation 3.1* Amended and Restated Certificate of Incorporation of the Company 3.2* By-laws of the Company 4.1* Amended and Restated Investors' Rights Agreement, dated July 9, 1999, among the Company and the investors and founders named therein 4.2* Specimen Certificate of the Company's common stock 4.3 Reference is made to Exhibits 3.1 and 3.2 10.1* Form of Indemnification Agreement entered into between the Company and its directors and officers 10.2* 1998 Stock Incentive Plan 10.3* 1999 Equity Incentive Plan 10.4* 1999 Employee Stock Purchase Plan 10.5* Office Lease dated July, 1999 between the Company and Crescent Real Estate Funding III, L.P. 10.6* Employment Agreement dated May 10, 1999 between the Company and Kenneth E. Kurtzman 10.7* Employment Agreement dated November 28, 1998 between the Company and James H. Whitcomb, Jr. 10.8* Advertising Agreement dated July 30, 1999 between the Company and America Online, Inc. 10.9* Credit Agreement dated August 9, 1999 between the Company and Chase Bank of Texas, National Association 10.10**** Stock Purchase Agreement dated as of November 29, 1999 by and among the Company, Amazon.com, Inc. and Amazon.com Advertising Services NV, Inc. 10.11***** Loan and Security Agreement by and among Congress Financial Corporation (Southwest) as Lender and Ashford.com, Inc., Ashford Buying Company, Ashford Corporate Gifts, Inc., and Ashford-Jasmin Fragrance Company 21.1 Subsidiaries of the Registrant 23.1 Consent of Independent Public Accountants * Incorporated by reference to the Company's Registration Statement on Form S-1 (File No. 333-82759). ** Incorporated by reference to the Company's Current Report on Form 8-K/A filed on November 12, 1999. *** Incorporated by reference to the Company's Current Report on Form 8-K/A filed on February 1, 1999. **** Incorporated by reference to the Company's Current Report on Form 8-K filed on December 15, 1999. ***** Incorporated by reference to the Company's Current Report on Form 8-K filed on October 3, 2000. ****** Incorporated by reference to the Company's Current Report on Form 8-K filed on March 21, 2001.
(B) Reports on Form 8-K: On March 21, 2001, we filed a Form 8-K under Item 2 announcing the execution of a merger agreement with E.S.T., Inc. (dba The Watch Network). On April 19, 2001, we filed a Form 8-K under Item 5 announcing the receipt of a letter from The Nasdaq Stock Market advising that our common stock had failed to maintain a minimum bid price of $1.00 over the last 30 consecutive trading days preceding April 10, 2001 as required by The Nasdaq National Marketplace Rule 4450(a)5. We will be provided 90 calendar days, or until July 9, 2001 to regain compliance by maintaining a bid price of at least $1.00 for a minimum of ten consecutive trading days. On April 27, 2001 we filed a Form 8-K under Item 5 announcing that David Gow had been named Chief Executive Officer to replace Kenny Kurtzman, who was named Vice Chairman of the Board of Directors. Mr. Gow was also appointed to our Board of Directors. 34 On May 9, we filed a Form 8-K under Item 2 announcing the closing of a merger agreement with Guild.com, Inc. 35 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Date: June 29, 2001 ASHFORD.COM, INC. By: /s/ David F. Gow -------------------------- David F. Gow Chief Executive Officer Pursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the 29th day of June: SIGNATURE TITLE --------- ----- /s/ DAVID F. GOW Chief Executive Officer, Director --------------------------------- David F. Gow /s/ JAMES H. WHITCOMB, JR. President, Chief Information Officer, --------------------------------- Director James H. Whitcomb, Jr. /s/ BRIAN E. BERGERON Chief Financial Officer --------------------------------- Brian E. Bergeron /s/ J. ROBERT SHAW Chairman of the Board --------------------------------- J. Robert Shaw /s/ KEVIN R. HARVEY Director --------------------------------- Kevin R. Harvey /s/ COLOMBE M. NICHOLAS Director --------------------------------- Colombe M. Nicholas /s/ ROBERT COHN Director --------------------------------- Robert Cohn /s/ J. TERRY MANNING Director --------------------------------- J. Terry Manning /s/ GORDON MAYER Director --------------------------------- Gordon Mayer 36 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Board of Directors of Ashford.com, Inc.: We have audited the accompanying consolidated balance sheets of Ashford.com, Inc. and subsidiaries (the Company), a Delaware corporation, as of March 31, 2001 and 2000, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the two years in the period ended March 31, 2001 and the period from inception (March 6, 1998) through March 31, 1999. 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 auditing standards generally accepted in the 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. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Ashford.com, Inc. and subsidiaries as of March 31, 2001 and 2000, and the results of their operations and their cash flows for each of the two years in the period ended March 31, 2001 and the period from inception (March 6, 1998) through March 31, 1999, in conformity with accounting principles generally accepted in the United States. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company has suffered significant losses from operations since its inception, losses are expected to continue through fiscal 2002 and its financial resources are limited. These matters raise substantial doubt about its ability to continue as a going concern. Management's plans in regards to these matters are also described in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. Houston, Texas June 13, 2001 ASHFORD.COM, INC. CONSOLIDATED BALANCE SHEETS (In thousands, except share amounts)
March 31, March 31, 2001 2000 --------- --------- ASSETS Current assets: Cash and cash equivalents $ 7,095 $ 46,474 Restricted cash 1,500 120 Accounts receivable, net of allowance for doubtful accounts of $231 and $25, respectively 2,559 4,527 Merchandise inventory 24,066 24,205 Prepaid and other 1,535 79,793 --------- -------- Total current assets 36,755 155,119 Property and equipment, net of accumulated depreciation of $5,894 and $1,159, respectively 8,441 7,837 Purchased intangibles, net of accumulated amortization of $10,483 and $2,141, respectively 10,162 11,365 Other assets 908 3,287 --------- -------- Total assets $ 56,266 $177,608 ========= ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable and accrued liabilities $ 8,189 $ 6,221 Revolving credit facility 4,705 - Other long-term liabilities 104 117 Commitments and contingencies Stockholders' equity: Preferred stock, $.001 par value, 10,000,000 shares authorized, no shares issued and outstanding at March 31, 2001 and 2000 - - Common stock, $.001 par value, 100,000,000 shares authorized, 48,691,917 and 44,956,224 shares issued at March 31, 2001 and 2000, respectively 49 45 Treasury stock, at cost, 770,893 and no shares outstanding at March 31, 2001 and 2000, respectively - - Additional paid-in capital 259,365 260,563 Subscriptions receivable (1,156) (780) Deferred compensation (4,983) (15,232) Accumulated deficit (210,007) (73,326) --------- -------- Total stockholders' equity 43,268 171,270 --------- -------- Total liabilities and stockholders' equity $ 56,266 $177,608 ========= ========
The accompanying notes are an integral part of these financial statements. ASHFORD.COM, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except share amounts)
Period from Inception (March 6, 1998) Year Ended Year Ended through March 31, March 31, 2001 March 31, 2000 1999 -------------- -------------- ----------------- Net sales $ 67,195 $ 39,931 $ 5,938 Cost of sales 56,348 33,487 5,110 --------- -------- ------- Gross profit 10,847 6,444 828 Operating expenses: Marketing and sales (includes non-cash amortization of $79,735, $27,525 and $0, respectively) 105,895 60,806 1,013 General and administrative (includes non-cash amortization of $2,633, $3,003 and $0, respectively) 27,929 17,093 1,019 Restructuring charge 662 - - Impairment loss 1,094 - - Depreciation and amortization 13,460 3,277 67 --------- -------- ------- Total operating expenses 149,040 81,176 2,099 --------- -------- ------- Loss from operations (138,193) (74,732) (1,271) Interest income 1,644 2,677 13 Interest expense (132) (7) (6) --------- -------- ------- Net loss $(136,681) $(72,062) $(1,264) ========= ======== ======= Net loss per share, basic and diluted $ (2.99) $ (2.65) $ (0.12) ========= ======== ======= Shares used to compute net loss per share Basic and diluted 45,725 27,197 10,397
The accompanying notes are an integral part of these financial statements. ASHFORD.COM, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (In thousands)
Preferred Stock Common Stock Treasury Stock ---------------------------------------------- Additional Total Par Par Paid-In Subscription Deferred Accumulated Stockholders' Shares Value Shares Value Shares Cost Capital Receivable Compensation Deficit Equity ------------------------------------------------------------------------------------------------------------ Balance at Inception, March 6, 1998 - $ - - $ - $ - $ - $ - $ - $ - $ - $ - Issuance of common stock for cash upon formation on March 6, 1998 - - 6,313 6 - - (5) - - - 1 Issuance of common stock for services in April 1998 - - 4,375 4 - - 50 - - - 54 Issuance of Series A preferred stock in exchange for cash and conversion of note payable on December 4, 1998 9,500 9 - - - - 3,991 - - - 4,000 Deferred compensation related to grants of options to purchase common stock - - - - - - 431 - (431) - - Amortization of deferred compensation - - - - - - - - 17 - 17 Net loss - - - - - - - - - (1,264) (1,264) ------- --- ------ --- --- ---- ------- ------- -------- --------- --------- Balance at March 31, 1999 9,500 9 10,688 10 - - 4,467 - (414) (1,264) 2,806 Deferred compensation related to grants of options to purchase common stock - - - - - - 19,123 - (19,123) - - Issuance of Series B preferred stock in exchange for cash and conversion of note payable on April 17, 1999 7,149 7 - - - - 30,083 - - - 30,090 Officer exercise of options to purchase common stock pursuant to note receivable - - 1,852 2 - - 778 (780) - - - Issuance of Series C preferred stock in exchange for cash on July 8, 1999 1,425 2 - - - - 16,302 - - - 16,304 Conversion of preferred stock into common stock in connection with initial public offering on September 22, 1999 (18,074) (18) 18,074 18 - - - - - - - Issuance of common stock in exchange for cash in connection with initial public offering on September 22, 1999, net of offering expenses of $1.9 million - - 6,250 6 - - 73,642 - - - 73,648 Issuance of warrants in connection with execution of distribution and marketing agreements - - - - - - 4,182 - - - 4,182
Issuance of common stock in connection with Internet domain and other intangible asset purchases - - 685 1 - - 7,374 - - - 7,375 Issuance of common stock for cash and marketing agreement - - 7,407 8 - - 104,612 - - - 104,620 Amortization of deferred compensation - - - - - - - - 4,305 - 4,305 Net loss - - - - - - - - - (72,062) (72,062) ------- --- ------ --- --- ---- ------- ------- -------- --------- --------- Balance at March 31, 2000 - - 44,956 45 - - 260,563 (780) (15,232) (73,326) 171,270 Director exercise of options to purchase common stock pursuant to note receivable - - 143 - - - 376 (376) - - - Issuance of warrants in connection with execution of distribution and marketing agreements - - - - - - 118 - - - 118 Issuance of warrants in connection with purchases of fixed assets - - - - - - 914 - - - 914 Issuance of common stock in connection with internet domain and other intangible asset purchases - - 3,004 3 - - 4,238 - - - 4,241 Issuance of common stock in connection with employee stock purchase plan - - 79 - - - 191 - - - 191 Exercise of common stock options - - 510 1 - - 161 - - - 162 Common stock reacquired for cash - - - - 771 - - - - - - Recapture of deferred compensation, net - - - - - - (7,196) - 7,196 - - Amortization of deferred compensation - - - - - - - - 3,053 - 3,053 Net loss - - - - - - - - - (136,681) (136,681) ------- --- ------ --- --- ---- ------- ------- -------- --------- --------- Balance at March 31, 2001 - $ - 48,692 $49 771 $ - $259,365 $(1,156) $ (4,983) $(210,007) $ 43,268 ======= === ====== === === ==== ======== ======= ======== ========= =========
The accompanying notes are an integral part of these financial statements. ASHFORD.COM, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
Period from Inception (March 6, 1998) Year Ended Year Ended through March 31, March 31, March 31, 2001 2000 1999 ---------- ---------- ---------- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $(136,681) $(72,062) $(1,264) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 95,828 33,805 67 Impairment loss 1,094 - - Compensation expense related to issuance of common stock - - 52 Changes in assets and liabilities, net of effects of acquisitions: Accounts receivable 1,968 (4,391) (136) Merchandise inventory 762 (20,635) (3,273) Prepaid and other 1,780 (8,911) (453) Other assets (354) (201) - Accounts payable and accrued liabilities 3,054 3,733 1,300 --------- -------- ------- Net cash used in operating activities (32,549) (68,662) (3,707) --------- -------- ------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment (6,859) (6,853) (302) Internet domain and other intangible asset purchases (3,306) (7,936) - Restricted cash (1,380) (20) (100) --------- -------- ------- Net cash used in investing activities (11,545) (14,809) (402) --------- -------- ------- CASH FLOWS FROM FINANCING ACTIVITIES: Net proceeds from initial public offering - 73,648 - Proceeds from issuance of common stock 353 10,000 2 Issuance of Series A preferred stock - - 3,245 Issuance of Series B preferred stock - 29,100 - Issuance of Series C preferred stock - 16,304 - Debt issuance costs (343) - - Proceeds from revolving credit facility 4,705 - - Proceeds from notes payable - - 1,755 --------- -------- ------- Net cash provided by financing activities 4,715 129,052 5,002 --------- -------- ------- Net (decrease) increase in cash and cash equivalents (39,379) 45,581 893 CASH AND CASH EQUIVALENTS: Beginning of period 46,474 893 - --------- -------- ------- End of period $ 7,095 $ 46,474 $ 893 ========= ======== =======
The accompanying notes are an integral part of these financial statements. ASHFORD.COM, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) (In thousands)
Period from Inception (March 6, 1998) Year Ended Year Ended through March 31, March 31, March 31, 2001 2000 1999 ---------- ---------- ---------- SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES: Issuance of preferred stock upon conversion of note payable, including accrued interest $ - $ - $ 755 Issuance of common stock in connection with marketing agreement - 94,620 - Issuance of common stock in connection with Internet domain 4,241 7,375 - and other intangible asset purchases Issuance of warrants in connection with purchases of fixed assets 914 - - Issuance of warrants in connection with execution of distribution and marketing agreements 118 4,182 -
The accompanying notes are an integral part of these financial statements. ASHFORD.COM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2001 1. OPERATIONS AND ORGANIZATION OF BUSINESS BACKGROUND Ashford.com, Inc. (the Company), formerly NewWatch Company, is a Delaware corporation which was incorporated on March 6, 1998 (Inception), and commenced operations in April 1998. The Company is engaged in the distribution of luxury and premium products including new and vintage watches, diamonds, jewelry, fragrances, leather accessories, sunglasses and writing instruments, primarily through online retail sales and corporate sales. The Company has suffered significant losses from operations since its inception. Management is implementing a strategy to significantly reduce costs and improve operating efficiencies (see Note 4). Management believes that the Company's current cash balances, including those obtained from the merger with an online art retailer, and borrowing capacity will be sufficient to meet anticipated needs for at least the next 12 months, assuming it executes according to its restructured operating plans. However, any projections of future cash needs and cash flows are subject to substantial uncertainty. Accordingly, there is substantial doubt as to the Company's ability to continue as a going concern. If current cash and cash that may be generated from future operations are insufficient to satisfy the Company's liquidity requirements, management may seek to sell additional equity or debt securities or to obtain additional credit facilities from lenders. There can be no assurance that financing will be available in amounts or on the terms acceptable to the Company, if at all. The Company's ability to raise cash through the sales of additional equity or convertible debt securities may be difficult depending on market conditions and other factors, and if available could result in additional dilution to the Company's stockholders. In addition, management will, from time to time, consider the acquisition of or investment in complementary businesses, products, services and technologies, which might impact the Company's liquidity requirements or cause the Company to issue additional equity or debt securities. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany balances have been eliminated. ESTIMATES The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires the Company's management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. REVENUE RECOGNITION Revenue is generally recognized on sales of merchandise held for sale when the product is sold and shipped, net of coupons, discounts and estimated returns. Amounts billed for shipping are included in revenue. CASH AND CASH EQUIVALENTS Cash and cash equivalents consist of cash on hand and short-term, highly liquid investments with original maturities of three months or less. ASHFORD.COM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) RESTRICTED CASH Restricted cash in the amounts of $1.5 million and $120,000 at March 31, 2001 and 2000, respectively, were pledged as collateral against potential credit card chargebacks. The increase in restricted cash is consistent with the Company's increased sales levels. CONCENTRATION OF CREDIT RISK Financial instruments that potentially subject the Company to a concentration of credit risk consist of cash, cash equivalents, restricted cash and accounts receivable. Cash, cash equivalents and restricted cash are deposited with high credit, quality financial institutions. Concentration of credit risk with respect to accounts receivable are limited due to the Company's large number of customers and their dispersion substantially throughout the United States. A substantial portion of the Company's net sales is derived from customer credit cards. As a result, the related accounts receivable from these sales are collected within a few days of processing the credit card transactions. Credit is also extended to a select group of customers based upon an evaluation of the customer's financial condition and collateral is generally not required. The Company maintains an allowance for doubtful accounts receivable based upon expected collectibility. Credit losses have not been significant to date. During the years ended March 31, 2001 and 2000 and for the period from Inception through March 31, 1999, no single customer accounted for more than 10% of net revenues. FAIR VALUE OF FINANCIAL INSTRUMENTS The Company's financial instruments, including cash, cash equivalents, restricted cash, accounts receivable and accounts payable are carried at cost, which approximates their fair value because of the short-term nature of these instruments. MERCHANDISE INVENTORY Inventory consists of merchandise held for sale, and is stated at the lower of cost or market. The Company uses the average cost method of determining the cost of its inventory and evaluates the market value of its inventory quarterly based on known market prices available directly from manufacturers and key suppliers. Inventory balances are reviewed monthly for slow moving inventories. Based on changes in business conditions and expected future cash flows, the Company recorded cost of sales of approximately $1.8 million during the fourth fiscal quarter of 2001 relating to inventory valuation charges. PURCHASED INTANGIBLES Purchased intangibles include Internet domain names, related trademarks and other identifiable intangible assets purchased by the Company and are presented net of related accumulated amortization. As a result of rapid technological and industry changes occurring in the Internet industry, purchased intangibles are amortized over estimated useful lives of two years. IMPAIRMENT OF LONG-LIVED ASSETS The Company evaluates the recoverability of long-lived assets in accordance with Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of." SFAS 121 requires recognition of impairment of long-lived assets in the event the net book value of such assets exceeds the future estimated undiscounted cash flows attributable to such assets. The carrying value of intangible assets and other long-lived assets is reviewed on a regular basis ASHFORD.COM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) for the existence of facts or circumstances, both internally and externally, that may suggest impairment. See discussion of impairment of long-lived assets in Note 3. FULFILLMENT COSTS Included in marketing and sales expense are fulfillment costs, which consist of the cost of operating and staffing warehousing and distribution centers. Such costs include those attributable to receiving, inspecting and warehousing inventories and picking, packaging and preparing customers' orders for shipment. ADVERTISING COSTS The Company recognizes advertising expenses in accordance with the American Institute of Certified Public Accountants' Statement of Position (SOP) 93-7, "Reporting on Advertising Costs." As such, the Company expenses the cost of communicating advertising in the period in which the advertising takes place. Internet advertising expenses are recognized based on the terms of the individual agreements, but generally on a straight-line basis over the term of the contract. No direct-response advertising has been incurred. During the years ended March 31, 2001 and 2000 and for the period from Inception through March 31, 1999, the Company incurred advertising expense of approximately $11.9 million, $23.7 million, and $694,000, respectively. TECHNOLOGY, CONTENT AND WEB SITE DEVELOPMENT COSTS Technology and content costs consist principally of payroll and related expenses for development, systems and telecommunications operations personnel and consultants. Technology and content costs are generally expensed as incurred, except for certain costs relating to Web site development the development of internal-use software. Costs incurred in connection with developing or obtaining software for internal use are capitalized in accordance with SOP 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." Costs associated with developing the Company's Web site are accounted for in accordance with Emerging Issues Task Force (EITF) Issue No. 00-2, "Accounting for Web Site Development Costs," which requires certain Web site development costs to be capitalized. Capitalized Web site development costs at March 31, 2001 and 2000, primarily relate to external direct costs incurred in developing and obtaining software utilized on the Company's Web site. START-UP COSTS In accordance with SOP 98-5, the Company has expensed all start-up costs, including organization costs, as incurred. WARRANTY The Company guarantees its watches to be genuine, in new condition and free from defects for a period of at least two years. If the Company is an authorized agent or service center for the manufacturer, it will extend the original manufacturer's warranty for a period of two years. The Company estimates future warranty costs not covered by the original manufacturer's warranty. Warranty expense is accrued at the date revenue is recognized on the sale of merchandise held for sale. The Company has not incurred significant warranty claims to date. As discussed in Note 12, the Company recorded a $400,000 expense to settle a lawsuit related to watches it sold. ASHFORD.COM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) INCOME TAXES The Company is a C Corporation for U.S. federal income tax purposes and uses the liability method in accounting for income taxes. Under this method, deferred taxes are recorded based upon differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted rates and laws that will be in effect when the differences are expected to reverse. A valuation allowance has been established where necessary to reduce deferred tax assets to the amount more likely than not expected to be realized in future tax returns. COMPREHENSIVE INCOME The Company has adopted the provisions of SFAS 130, "Reporting Comprehensive Income." SFAS 130 establishes standards for reporting comprehensive income and its components in financial statements. Comprehensive income, as defined, includes all changes in equity (net assets) during a period from nonowner sources. To date, the Company has not engaged in transactions that are required to be reported in comprehensive income. SEGMENT INFORMATION The Company complies with SFAS 131, "Disclosures about Segments of an Enterprise and Related Information." The Company identifies its operating segments based on business activities and management responsibility. The Company operates in a single business segment: the retail sale of luxury products in the United States. STOCK-BASED COMPENSATION SFAS 123, "Accounting for Stock-Based Compensation", establishes a fair value- based method of accounting for stock-based compensation plans. SFAS 123 allows the Company to adopt one of two methods for accounting for stock options. The Company has elected the method that requires disclosure only of stock-based compensation. Because of this election, the Company accounts for its employee stock-based compensation plans under Accounting Principles Board (APB) Opinion No. 25 and the related interpretations. Accordingly, deferred compensation is recorded for stock-based compensation grants based on the excess of the estimated fair value of the common stock on the measurement date over the exercise price. The deferred compensation is amortized over the vesting period of each unit of stock-based compensation grant. If the exercise price of the stock-based compensation grants is equal to the estimated fair value of the Company's stock on the date of grant, no compensation expense is recorded. NET LOSS PER SHARE Net loss per share is computed using the weighted average number of shares of common stock outstanding. Shares associated with stock options, warrants, convertible preferred stock and contingently issuable common stock are not included because they are antidilutive. PRO FORMA NET LOSS PER SHARE (UNAUDITED) Pro forma net loss per share is computed using the weighted average number of common shares outstanding, including the pro forma effects of the automatic conversion of outstanding preferred stock into shares of the Company's common stock effective upon the closing of the Company's initial public offering as if such conversion occurred on the dates of original issuance (See Note 9). The following table sets forth the computation of basic and dilutive, and pro forma basic and dilutive, net loss per share (in thousands, except per share amounts): ASHFORD.COM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Period from Inception Year Ended Year Ended through March 31, March 31, March 31, 2001 2000 1999 ---------- ---------- --------- Numerator- Net loss $(136,681) $(72,062) $(1,264) ========= ======== ======= Denominator- Weighted average common shares 45,725 27,197 10,397 ========= ======== ======= Denominator for basic and diluted calculation 45,725 27,197 10,397 Weighted average effect of pro forma securities- Series A preferred stock --- 4,503 2,867 Series B preferred stock --- 3,075 --- Series C preferred stock --- 296 --- --------- -------- ------- Denominator for pro forma basic and diluted calculation 45,725 35,071 13,264 ========= ======== ======= Net loss per share- Basic and diluted $ (2.99) $ (2.65) $ (0.12) ========= ======== ======= Pro forma basic and diluted $ (2.99) $ (2.05) $ (0.10) ========= ======== =======
RECLASSIFICATION OF PRIOR PERIOD BALANCES Certain prior period balances have been reclassified for consistent presentation. RECENT ACCOUNTING PRONOUNCEMENTS The FASB issued an Exposure Draft, Business Combinations and Intangible Assets, containing tentative decisions about requiring the use of a nonamortization approach to account for purchased goodwill. Under the nonamortization approach, goodwill would be tested for impairment, rather than being amortized to earnings. Under the Exposure Draft, the Company's purchased intangibles would continue to be amortized consistent with its current policy. Upon adoption of the principles in this Exposure Draft, the Company would record any goodwill as income or expense. In March 2000, the FASB issued Financial Interpretation (FIN) No. 44, Accounting for Certain Transactions Involving Stock Compensation." FIN 44 clarifies the application of APB 25 for certain issues, such as the definition of an employee for purposes of applying APB 25, the criteria for determining whether a plan qualifies as a noncompensatory plan, the accounting consequence of various modifications to the terms of a previously fixed stock option or award and the accounting for an exchange of stock compensation awards in a business combination. Adoption of FIN 44 did not change the Company's existing accounting policies or disclosures. In May 2000, the EITF issued EITF 00-14 "Accounting for Certain Sales Incentives," which provides guidance on the accounting for certain sales incentives offered by companies to their customers such as discounts, coupons, rebates and products or services. EITF 00-14 addresses the recognition, measurement and income statement classification for sales incentives offered voluntarily by a vendor without charge to customers that can be used in, or that are exercisable by a customer as a result of a single exchange transaction. The accompanying financial statements include the reclassification of free product and service incentives delivered to customers at the time of sale, from marketing and sales expense to cost of sales, related to the adoption of EITF 00-14. All periods presented have been reclassified for consistent presentation. ASHFORD.COM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) In July 2000, the EITF reached a consensus on EITF 00-10, "Accounting for Shipping and Handling Fees and Costs." This consensus requires that all amounts billed to a customer in a sale transaction related to shipping and handling, if any, represent revenue and should be classified as revenue. The Company historically has classified shipping charges to customers as revenue. In September 2000, the EITF concluded that the classification of shipping and handling costs should be disclosed pursuant to Accounting Principles Board (APB) Opinion No. 22, "Disclosure of Accounting Policies." If shipping and handling costs are significant and are not included in cost of sales, companies should disclose both the amount of such costs and which line item on the income statement includes that amount. Shipping and handling costs cannot be netted against sales. The Company classifies inbound and outbound shipping costs as costs of sales. The Company generally does not impose separate handling charges on customers. However, during fiscal year 2001, the Company began charging for shipping costs. The Company began charging for packaging costs during fiscal 2002. Costs attributable to receiving, inspecting and warehousing inventories and picking, packaging and preparing customers' orders for shipment are classified as marketing and sales expense and totaled $3.8 million, $1.9 million and $65,000 during the years ended March 31, 2001 and 2000 and the period from Inception through March 31, 1999, respectively. 3. IMPAIRMENT OF LONG-LIVED ASSETS During the fourth quarter ended March 31, 2001, the Company determined that the carrying value of certain assets exceeded its net realizable value. In accordance with SFAS 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of," the Company recorded an impairment loss of $1.1 million during the fourth quarter ended March 31, 2001. In connection with management's plan to reduce costs and improve operating efficiencies, the Company discontinued the use of several third party software contracts and wrote down fixed assets of approximately $0.6 million. The Company also decided not to further pursue the utilization of certain marketing and distribution arrangements and wrote down intangible assets associated with these arrangements of approximately $0.5 million. 4. RESTRUCTURING AND RELATED CHARGES During the fourth quarter ended March 31, 2001, in connection with management's plan to reduce costs and improve operating efficiencies, the Company recorded restructuring charges of approximately $0.7 million, consisting of approximately $0.5 million for headcount reductions and approximately $0.2 million for contract cancellations. Headcount reductions consisted of approximately 40 employees, or about 17% of the Company's workforce, across all areas of the Company. Total cash outlays associated with the restructuring were $0.6 million. The remaining $0.1 million of restructuring costs is expected to be paid through December 31, 2001. The restructuring accrual consists of the following:
Severance and Contract Benefits Cancellations Total --------------------------------------------------------- Provision for fiscal year 2001 $502 $160 $662 Amount paid in fiscal year 2001 472 80 552 ---- ---- ---- Balance at March 31, 2001 $ 30 $ 80 $110 ==== ==== ====
During May 2001, the Company initiated a review of its lines of business, cost structure and general activities. The objective of this review was to identify opportunities for improved financial performance and liquidity management. Specific initiatives resulting from this review include reducing the scope of product offerings, ASHFORD.COM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) decreasing the Company's investment in inventory and eliminating certain operating costs, including costs associated with personnel. In connection with this review, the Company expects to record charges during the quarter ending June 2001 attributed to the following matters. REDUCTION OF PERSONNEL In connection with the May 2001 review, the Company entered into severance agreements with 41 employees. The Company expects to record a charge of $80,000 during the quarter ending June 2001 in connection with these headcount reductions. DISPOSITION OF ONLINE WATCH RETAILER In February 2001, the Company entered into a merger agreement with an online watch retailer. In connection with the agreement, the Company paid an aggregate purchase price of $2.3 million representing the assumption of liabilities and direct acquisition costs of approximately $650,000, and 1,991,000 shares of the Company's common stock. The agreement further provided that the Company issue up to an additional 5,500,000 shares of its common stock to the online retailer upon resolution of certain authorized dealer relationship contingencies and in connection with the online retailer meeting certain gross profit targets as set forth in the agreement. Further, certain key members of the online watch retailer's management entered into separate employment agreements with the Company which provide for employment for eighteen months following the merger and representation on the board of directors of the Company. Principal assets acquired include inventory, supplier relationships and intellectual property. During June 2001, as a result of certain business difficulties that arose in the relationship between the Company and the former principles of the online watch retailer and to resolve litigation between them, the parties began negotiating a dissolution of that relationship. The online watch retailer tentatively agreed to a settlement whereby the online watch retailer and certain of it's management will receive aggregate consideration of approximately $0.8 million representing $0.2 million of inventory, $0.1 million of severance pay and 1,500,000 shares of the Company's common stock to settle all potential future claims and obligations. The Company expects to record a charge of approximately $2.4 million in connection with this settlement. OUTSOURCING OF ONLINE ART OPERATIONS In May 2001, the Company closed a merger agreement with an online art retailer. In connection with the agreement, the Company issued approximately 7.1 million shares of the Company's common stock and options and warrants to purchase approximately 1.6 million shares of the Company's common stock, in exchange for all of the fully diluted shares of the online art retailer's capital stock. The purchase price was approximately $4.3 million, consisting of $3.3 million of the Company's common stock, $0.7 million of options and warrants to purchase shares of the Company's common stock and $0.3 million of business combination costs. The principle assets received include $7.3 million of cash, an Internet domain name and related trademarks and other tangible and intangible assets related to Internet retail operations. The total value of net tangible assets acquired exceeded the $4.3 million purchase price. In connection with the May 2001 review, the Company concluded that the operating cost structure of the online art retailer was inconsistent with the level of sales activity and overall Company objectives. In June 2001, the prior management of the online art retailer made a proposal to the Company, which the Company has agreed to accept, to assume the prospective operations of the online art retailer as a separately capitalized entity. Pursuant to this agreement, the Company will contribute assets of approximately $0.5 million, including $0.4 million of cash, an Internet domain name and related trademarks and other intangible assets in return for 5% ownership interest in the new entity. In addition, the Company and the new entity will enter into a revenue sharing agreement whereby the Company will offer the new entity's product on its Web site in return for half of the gross profit from sales generated by the Company's Web site. The Company will not ASHFORD.COM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) assume any future operating costs or obligations. Further, substantially all Company employees previously employed by the online art retailer will become employees of the new entity or will be terminated. ASHFORD.COM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) SALE OF ASSET In connection with the May 2001 review, during June 2001, the Company sold two Internet domain names and related trademarks related to a product information Internet site in exchange for $0.4 million cash. The Company expects to record a loss on sale of approximately $0.5 million during the quarter ending June 2001. 5. OTHER SIGNIFICANT ACQUISITIONS In August 1999, the Company entered into an option agreement to purchase two Internet domain names and related trademarks (the "Purchased Assets") from a product information Internet site (the "Option Agreement"). In connection with the Option Agreement, the Company paid $300,000 in cash upon execution of the Option Agreement for the exclusive right to acquire the Purchased Assets. In October 1999, the Company exercised its option to acquire the Purchased Assets. The Company paid an aggregate purchase price of $4.3 million representing $940,000 of cash (including the aforementioned payment in connection with the Option Agreement) and 332,500 shares of the Company's common stock. In September 1999, the Company entered into an asset purchase agreement to purchase an Internet domain name and related trademarks from a luxury goods retailer. In connection with this agreement, the Company paid $1.6 million in cash upon execution for the domain name, related trademarks and non-competition covenants. The asset purchase agreement further provided that the Company pay an additional $20,000 of cash consideration for each authorized dealer relationship successfully transitioned to the Company by the luxury goods retailer, not to exceed $160,000, all of which was paid as of March 31, 2000. In January 2000, the Company entered into a merger agreement with an online fragrance retailer. In connection with the agreement, the Company paid an aggregate purchase price of $7.5 million representing $3.7 of cash, including the assumption of certain liabilities, and 330,354 shares of the Company's common stock. The principal assets received include an Internet domain name and related trademarks, inventory and other tangible and intangible assets related to Internet retail operations. The agreement further provided that the Company issue up to an additional 736,514 shares of its common stock to the Internet retailer upon the resolution of certain authorized dealer relationship contingencies as set forth in the agreement. In August 2000, the Company issued 658,998 shares of its common stock in connection with the resolution of the authorized dealer relationship contingencies. The fair market value of the shares issued totaled approximately $1.8 million. This acquisition was accounted for using the purchase method of accounting. The purchase price was allocated in accordance with APB 16, "Business Combinations," as follows (in thousands): Property and equipment $ 780 Intangible assets 7,962 Net working capital items 613 -------- Total purchase price $ 9,355 ======== Property and equipment relate primarily to computer equipment and software costs. Intangible assets resulting from the acquisition relate to an Internet domain name, related trademarks, customer lists and direct brand relationships and is being amortized using the straight-line method over an expected useful life of 2 years. The following unaudited pro forma data is presented to show pro forma revenues, net loss and basic and diluted net loss per share as if the acquisition of the online fragrance retailer had occurred as of the Company's Inception. ASHFORD.COM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Period from Inception Year Ended through March 31, March 31, 2000 1999 ---------- ----------- Revenues $ 40,177 $ 5,952 ========== =========== Net loss $ (77,603) $ (1,372) ========== =========== Basic and diluted net loss per share $ (2.82) $ (0.12) ========== =========== In October 2000, the Company entered into an asset purchase agreement with a retailer principally engaged in the business of selling customized gifts to clients in the investment banking industry. The agreement provided for an aggregate purchase price of approximately $3.3 million representing $1.9 million of cash paid at closing, 392,037 shares of the Company's common stock and an additional $600,000 to be paid in cash over the following twelve months. Principal assets acquired include a customer base, supplier relationships and intellectual property. 6. PROPERTY AND EQUIPMENT Property and equipment is stated at cost. Depreciation is computed based on the straight-line method over the estimated useful lives of the respective assets. Repair and maintenance costs are charged to expense as incurred. Property and equipment consists of the following (in thousands):
Estimated March 31, March 31, Useful Life 2001 2000 --------------------- --------------- --------------- Software and Web site development costs 2 years $ 8,200 $ 4,290 Computer and office equipment 3 to 5 years 4,653 3,978 Machinery and equipment 5 years 331 134 Leasehold improvements 3 to 5 years 1,151 594 ------- -------- 14,335 8,996 Less- Accumulated depreciation (5,894) (1,159) ------- -------- Property and equipment, net $ 8,441 $ 7,837 ======= ========
Depreciation expense totaled approximately $5.3 million, $1.1 million and $49,000 during the years ended March 31, 2001 and 2000 and the period from Inception through March 31, 1999, respectively. 7. NOTE PAYABLE In March 1999, the Company received $1.0 million cash from a stockholder in exchange for a note payable bearing interest at an annual rate of 6%. The note payable had a maturity date of June 1999. The note payable was converted into preferred stock in April 1999 (see Note 9). In management's opinion, the terms of this note and its subsequent conversion were at arms length. 8. REVOLVING CREDIT FACILITY During September 2000, the Company executed a three-year revolving credit facility with a maximum available credit of $25 million with Congress Financial Corporation, a unit of First Union National Bank. The credit facility is to be used for working capital needs and is secured by the Company's assets. Availability under the credit facility is determined pursuant to a borrowing base as defined in the agreement, and was $6.9 million on March 31, 2001. Amounts outstanding under the credit facility bear interest at the prime rate or LIBOR plus 250 basis points (8.50% at March 31, 2001), as elected by the Company. Approximately $4.7 million was outstanding under the revolving credit facility as of March 31, 2001. In addition to the amount outstanding at March 31, 2001, $250,000 was reserved against the issuance of a standby letter of credit. ASHFORD.COM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 9. STOCKHOLDERS' EQUITY PREFERRED STOCK In December 1998, the Company entered into a stock purchase agreement with an investor whereby the Company issued 9,500,000 shares of Series A convertible preferred stock in exchange for approximately $3,245,000 in cash and conversion of a $755,000 note payable, including accrued interest. In April 1999, the Company increased the number of authorized shares of its convertible preferred stock to 17,100,000 with a par value of $.001 per share. In addition, 7,600,000 shares of the Company's preferred stock was designated as Series B preferred stock. Also in April 1999, the Company entered into a stock purchase agreement with five investors whereby 7,148,750 shares of the Company's Series B convertible preferred stock was issued in exchange for approximately $29.1 million in cash and conversion of a $1.0 million note payable, including accrued interest. In July 1999, the Company increased the number of authorized shares of its convertible preferred stock to 19,166,250 shares with a par value of $.001 per share. In addition, 2,066,250 shares of the Company's convertible preferred stock was designated as Series C convertible preferred stock. Also in July 1999, the Company entered into a stock purchase agreement with six investors whereby 1,425,679 shares of the Company's Series C convertible preferred stock were issued in exchange for approximately $16.3 million in cash. On September 22, 1999, the Company completed its initial public offering of 6,250,000 shares of its common stock. Net proceeds before expenses to the Company were approximately $73.6 million. As of the closing date of the offering, all of the Series A, Series B and Series C convertible preferred stock was converted into an aggregate of 18,074,429 shares of common stock. Concurrent with the initial public offering, the Board of Directors were authorized, without further action by the stockholders, to issue up to 10,000,000 shares of preferred stock in one or more series and to designate the rights, preferences, privileges and restrictions of each preferred stock series. WARRANTS In connection with a number of distribution and marketing agreements entered into with luxury brand owners and representatives during fiscal 2000, the Company has issued 494,930 warrants which are fully vested and may be exercised for 494,930 shares of common stock. The warrants are exercisable through January 2002 at a weighted average exercise price of $8.91 per share. The agreements are for periods up to twenty-four months and provide the Company with certain exclusive online distributor rights, allow the Company to utilize certain trademarks and images in connection with its marketing and advertising activities and require the Company to fund certain marketing and advertising activities. The Company has recorded the estimated fair value of the warrants on the date of grant as deferred marketing expense which is being amortized over the terms of the related agreements. During the fourth quarter ended March 31, 2001, the Company decided not to further pursue the utilization of certain of its marketing and distribution agreements recording an impairment charge of $0.5 million. See Note 3 for discussion of related impairment losses. Deferred marketing expense totaled $0.2 million and $2.4 million at March 31, 2001 and 2000, respectively, and is included in other assets in the accompanying consolidated balance sheet. In July 2000, the Company issued a warrant to a company to purchase 100,000 shares of common stock at $2.81 in exchange for software maintenance services rendered by the company. 50,000 shares were immediately exercisable and the remaining 50,000 shares vest monthly through December 2001. These warrants expire on July 1, 2005. In March 2001, the Company issued a warrant to a company to purchase 75,000 shares of common stock at $0.66 in exchange for a marketing services agreement. 37,500 shares were ASHFORD.COM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) immediately exercisable and the remaining 37,500 shares vest on December 31, 2001. These warrants expire in March 2006. The Company has recorded the estimated fair value of the warrants on the date of grant as intangible assets which are being amortized over the terms of the related agreements. The unvested warrants are subject to variable accounting, with fair value re-measurements at the end of each quarterly reporting period. Intangible assets associated with these warrants totaled $0.1 million at March 31, 2001 and are included in other assets in the accompanying consolidated balance sheet. During fiscal year 2001, the Company issued warrants, which are fully vested, to a related party to purchase 258,706 shares of common stock at $0.01 in exchange for Web site development services rendered by the related party. 129,353 of the warrants expire in September 2005 and the remaining warrants expire in December 2005. The Company has recorded the fair value of the services rendered, which management believes are equivalent to those available and transacted with unrelated parties, as software and Web site development costs. Software and Web site development costs associated with these warrants totaled $0.7 million and are included in fixed assets in the accompanying consolidated balance sheet. No warrants were outstanding at March 31, 1999 and none have been exercised through March 31, 2001. RESTRICTED STOCK On December 4, 1998, the Company entered into an agreement with its founding and key management employees whereby the employees agreed to allow 5,957,099 shares of previously issued common stock to be subject to certain restrictions (Restricted Stock). The restrictions provide the Company with the right, but not the obligation, to repurchase any unvested shares of Restricted Stock upon termination of employment. Under this agreement, one holder's Restricted Stock, representing 1,895,849 shares, vests ratably over a 39-month service period. Of the other holders' Restricted Stock, 1,015,313 shares vested on March 6, 1999; the remaining shares vest ratably over a 36-month service period. Restrictions on 1,203,633, 1,598,305 and 1,268,929 shares lapsed into unrestricted common stock during fiscal 2001, 2000 and 1999, respectively. The Company repurchased 770,893 shares during fiscal 2001 which are recorded as treasury stock in the accompanying consolidated balance sheet. The Company paid par value for the shares. With the exception of the vesting period, holders of Restricted Stock retain all the rights of common stockholders including voting, dividend and liquidation rights. The remaining 1,115,339 shares subject to restrictions are included in outstanding common stock in the accompanying balance sheet at March 31, 2001. COMMON STOCK The holders of the common stock are entitled to receive dividends when and as declared by the board of directors. Upon the liquidation, dissolution or winding up of the Company, all of the remaining assets of the Company available for distribution after that required for holders of preferred stock shall be distributed among the holders of common stock pro rata based on the number of shares held by each. The common stock is not redeemable. The holders of outstanding common stock are entitled to elect two directors of the Company at each annual election of directors. In August 1999, the Company's board of directors declared a stock split of 4.75 shares for every 1 share of common stock or preferred stock then outstanding. The stock split became effective on September 21, 1999. Accordingly, the accompanying financial statements and footnotes have been restated to reflect the stock split, including an assumed increase in authorized shares of common stock and preferred stock. The par value of the shares of common stock to be issued in connection with the stock split was credited to common stock and a like amount charged to additional paid-in capital. The Company's board of directors is authorized to issue up to 100,000,000 shares of common stock with a par value of $.001 per share. ASHFORD.COM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) In December 1999, the Company sold 707,964 shares of its common stock to a leading online retailer for $10.0 million in cash. The Company also issued an additional 6,698,664 shares of its common stock to the online retailer in exchange for par value and advertising placements targeted at the online retailer's customer base with the intent of delivering new customers to the Company (the "Advertising Placements"). The fair market value of the shares issued in connection with the Advertising Placements totaled $94.6 million and were amortized over the one-year term of the agreement and is fully amortized as of March 31, 2001. As of March 31, 2000, the net amount related to this agreement included in prepaid and other current assets in the accompanying consolidated balance sheet totaled $71.0 million. EQUITY INCENTIVE COMPENSATION PLANS In April 1998, the Company adopted an incentive compensation plan (the 1998 Stock Incentive Plan) which provided the ability to grant incentive stock options, nonqualified stock options and restricted stock. The Company does not intend to grant any additional options or stock awards under this plan. In July 1999, the Company adopted an incentive compensation plan (the 1999 Stock Incentive Plan) which provides the ability to award incentive stock options, nonqualified stock options, restricted stock, stock units and stock appreciation rights. The aggregate number of awards under the 1999 Stock Incentive Plan shall not exceed 6,175,000 shares of common stock. The 1999 Stock Incentive Plan allows for annual increases of the lesser of 5% of the total number of shares of common stock then outstanding or 1,900,000 shares of common stock. In February 2000, the Company adopted an incentive compensation plan (the 2000 Non- Officer Stock Plan) which provides the ability to grant up to 2,490,000 incentive stock options to non-officer employees. The maximum number of options allowed to be granted under the 2000 Non-Officer Stock Plan was increased to 4,090,000 in May 2000. The 1999 Stock Incentive Plan and the 2000 Non-Officer Stock Plan are administered by the board of directors of the Company, which has the authority to determine the type, number, vesting requirements and other features and conditions of such awards. Generally, the Company grants stock options with exercise prices equal to the fair market value of the common stock on the date of grant. Options generally vest over a four-year period and expire ten years from the date of grant. The following table summarizes stock option activity under the plans:
Weighted Weighted Average Average Number of Exercise Grant Date Shares Price Fair Value ---------------------------------------------------------- Balance at Inception - - Options granted 1,258,750 $ 0.05 $ 0.16 Options forfeited (190) $ 0.05 --------------------------------------- Outstanding at March 31, 1999 1,258,560 $ 0.05 Options granted 7,269,976 $ 4.70 $ 4.02 Options exercised (1,852,500) $ 0.43 Options forfeited (252,644) $ 4.91 --------------------------------------- Outstanding at March 31, 2000 6,423,392 $ 5.01 Options granted 6,521,637 $ 1.41 $ 1.10 Options exercised (653,008) $ 0.82 Options forfeited (2,441,259) $ 4.39 --------------------------------------- Outstanding at March 31, 2001 9,850,762 $ 3.06 =======================================
ASHFORD.COM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The following table summarizes information regarding stock options outstanding and exercisable as of March 31, 2001:
Outstanding Options Vested and Exercisable ---------------------------------------------------------- --------------------------------------------- Weighted- Average Remaining Weighted- Weighted- Number of Contractual Average Number Average Exercise Price Shares Life Exercise Price of Shares Exercise Price ------------------------------------------------------------------------------ --------------------------------------------- $ 0.05 955,625 8 $ 0.05 542,466 $ 0.05 $ 0.30 - $ 0.43 3,550,675 10 0.32 813,903 0.33 $ 0.56 35,000 10 0.56 417 0.56 $ 0.88 - $ 1.00 173,000 10 0.95 5,987 0.95 $ 1.50 - $ 2.13 247,000 10 1.54 28,521 1.53 $ 2.44 - $ 3.57 2,360,841 9 2.60 567,793 2.63 $ 3.79 - $ 4.72 107,610 9 4.14 44,213 4.14 $ 5.88 - $ 8.75 1,126,892 9 7.40 376,220 7.59 $ 9.16 - $ 13.50 1,250,619 9 10.26 545,921 10.45 $ 14.19 - $ 14.94 43,500 9 14.90 14,051 14.90 --------------- -------------- Total 9,850,762 2,939,492
Under APB 25, no compensation expense is recognized when the exercise price of the Company's employee stock options equals the fair value of the underlying stock on the date of grant. Deferred compensation has been recorded for those situations where the exercise price of an option was lower than the deemed fair value of the underlying common stock. Prior to the Company's initial public offering, the fair value of the common stock on the date of grant was determined based upon valuations in relation to preferred stock financings and an independent appraisal. For the year ended March 31, 2000 and the period from Inception through March 31, 1999, the Company recorded aggregate deferred compensation of $19.1 million and $431,500, respectively, which is being amortized over the vesting period of the underlying options. No deferred compensation was recorded during the year ended March 31, 2001. For the years ended March 31, 2001 and 2000 and the period from Inception through March 31, 1999, total amortization of deferred compensation totaled $3.1 million, $4.3 million and $17,500, respectively. Had compensation expense been determined consistent with the provisions of SFAS 123, the Company's net loss for the years ended March 31, 2001 and 2000 and the period from Inception through March 31, 1999, would have been adjusted to the following pro forma amounts (in thousands, except per share data):
Period from Inception Year Ended Year Ended through March 31, March 31, March 31, 2001 2000 1999 ------------------ ------------------ ------------------- Net loss- As reported $ (136,681) $ (72,062) $ (1,264) Pro forma $ (137,660) $ (71,607) (1,255) Basic and diluted net loss per share- As reported $ (2.99) $ (2.65) $ (0.12) Pro forma $ (3.01) $ (2.63) $ (0.12)
ASHFORD.COM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Pro forma basic and diluted net loss per share- As reported $ (2.99) $ (2.05) $ (0.10) Pro forma $ (3.01) $ (2.04) $ (0.10)
Prior to the Company's initial public offering, the Company computed the fair value of options granted using the minimum value method. Significant weighted average assumptions used to estimate fair value of options granted prior to the Company's initial public offering include a risk-free interest rate of 5.6 percent, expected lives of 10 years and no expected dividends. Subsequent to the Company's initial public offering, the Company computed the fair value of options granted using the Black-Scholes option pricing model. Significant weighted average assumptions used to estimate fair value of options granted subsequent to the Company's initial public offering are as follows: Year Ended Year Ended March 31, March 31, 2001 2000 ----------------------------------------- Risk-free interest rate 5.9% 6.4% Expected volatility 123.8% 98.4% Expected life 3.3 years 3.3 years EMPLOYEE STOCK PURCHASE PLAN On July 9, 1999, the Company adopted a compensatory employee stock purchase plan, effective September 22, 1999, for up to 950,000 shares of common stock. During February 2001, the maximum number of shares to be issued under the plan was increased to 1,662,500. Participation is voluntary and substantially all full-time employees meeting limited eligibility requirements may participate. Contributions are made through payroll deductions and may not be less than 1% or more than 15% of the participant's base pay, as defined. The participant's option to purchase common stock is deemed to be granted on the first day and exercised on the last day of the fiscal quarter at a price which is the lower of 85% of the market price on the first or last day of the fiscal quarter. During the year ended March 31, 2001, 79,415 shares of common stock were issued under the plan. Through March 31, 2000, no shares of common stock had been issued under the plan. OFFICER AND DIRECTOR AND EMPLOYEE LOANS In May 1999, the Company entered into a $780,000 full-recourse promissory note bearing 5% interest with an officer, in connection with the exercise of options to purchase 1,852,500 shares of common stock. The shares of common stock purchased were pledged as collateral against the note. In April 2001, the officer resigned from the Company and the Company agreed to repurchase all of the shares of common stock from the officer at the price paid by the officer in exchange for payment in full on the loan, including all principal and related interest. In June 2000, the Company entered into a $375,888 full-recourse promissory note with one of its members of its board of directors in connection with the exercise of options to purchase 143,250 shares of common stock. The note bears interest at 6.71% per annum, is secured by a pledge of the shares acquired and is payable in full by April 2004. 10. INCOME TAXES A reconciliation of income tax expense computed at the U.S. statutory rate to the provision reported in the consolidated statements of operations is as follows: ASHFORD.COM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Period from Year Year Inception Ended Ended through March 31, March 31, March 31, 2001 20000 1999 ------------------ --------------- ---------------- Income tax at the statutory rate $ (46,472) $ (24,501) $ (496) Increase (decrease) resulting from: Increase in valuation allowance 45,578 23,650 495 Incentive stock options 842 533 - Non-deductible expenses 52 318 1 ------------------ --------------- ---------------- Total $ - $ - $ - ================== =============== ================
Deferred taxes result from the effect of transactions that are recognized in different periods for financial and tax reporting purposes. The primary components of the Company's deferred tax assets and liabilities are as follows (in thousands):
March 31, March 31, 2001 2000 ---------------- ---------------- Deferred tax assets- Net operating loss carryforward $ 61,492 $ 22,075 Amortization of intangibles 4,148 1,045 Non-qualified stock options 1,132 936 Inventory 1,341 - Property and equipment 821 - Accruals and reserves 722 162 Other 67 48 ----------- ----------- Total deferred tax assets 69,723 24,266 Deferred tax liabilities- Difference between book and tax basis of property and equipment - (121) ----------- ----------- Total deferred tax liabilities - (121) Less- Valuation allowance (69,723) (24,145) ----------- ----------- Deferred tax assets, net $ - $ - =========== ===========
Due to the uncertainty surrounding the realization of these assets, a valuation allowance has been provided to fully offset the deferred tax assets. As of March 31, 2001 and 2000, Ashford.com had net operating loss carryforwards of approximately $180.9 million and $64.9 million, respectively, which may be used to offset taxable income in future years. The net operating loss carryforward will begin to expire in fiscal year 2014. A change in control, as defined by federal income tax regulations, could significantly limit the Company's ability to utilize its carryforwards. 11. RELATED PARTY TRANSACTIONS Certain key members of the Company's management and the board of directors are stockholders of a company from which the Company purchases computer equipment, receives consulting services and rented certain office space at prices and terms that management believes are equivalent to those available to and ASHFORD.COM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) transacted with unrelated parties. During two years ended March 31, 2001 and 2000 and the period from Inception, through March 31, 1999, charges for consulting services and office rent, and payments for Web site development costs and computer equipment to this related party totaled $3.6 million, $2.5 million and $172,848, respectively. Payments made during fiscal year 2001 include $2.9 million of cash and 258,706 warrants to purchase the Company's common stock for $0.01. See Note 9. In December 1999, the Company entered into a marketing agreement with a minority interest stockholder for the delivery of new customers at a price and terms that management believes are equivalent to those available and transacted with unrelated parties. Total net payments of $0.5 million and $6.0 million were made during fiscal 2001 and 2000, respectively, pursuant to this agreement. 12. COMMITMENTS AND CONTINGENCIES LEASES Rent expense for the years ended March 31, 2001 and 2000 and for the period from Inception through March 31, 1999, was approximately $1.3 million, $853,000 and $47,000, respectively. Future minimum lease payments relating to noncancelable operating leases, primarily for office space and equipment, are as follows: For the year ending March 31- 2002 1,291 2003 1,208 2004 93 ------ $2,592 ====== 401(k) PLAN Effective February 1, 1999, the Company established a defined contribution 401(k) plan. Employees eligible to join the plan are those 21 years of age or older and have a minimum of 1,000 hours of service within a 12-month period after their date of hire. Eligible employees may enter the plan on the effective date and thereafter on any January 1 or July 1. The service requirement is waived for those employed on the effective date. The Company does not contribute to the plan. EMPLOYMENT AGREEMENTS The Company has entered into employment agreements with each of its employees. Either party may terminate such employment agreement at any time. The employment agreements provide for employees to receive the compensation and benefits offered to and accepted by them. The employment agreements also provide the Company with protection for its trade secrets, intellectual property rights and other confidential information. LITIGATION During the fourth quarter of fiscal 2001, the Company recorded a charge of approximately $400,000 relating to the pending settlement of a lawsuit filed against the Company and certain of its officers during 1999. The final settlement of this lawsuit is contingent upon court approval; however, management does not expect a material change in the settlement amount upon obtaining court approval. The SEC is conducting an investigation concerning our accounting and disclosures relating to certain marketing activities during fiscal years 2000 and 2001. We have been cooperating with the SEC, and we will continue to do so. Our audit committee also has completed an internal review of certain matters related to the SEC review. We do not believe that any of the accounting issues raised by the SEC will have a material effect on our financial statements. ASHFORD.COM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The Company is, and from time to time may be, a party to various other claims and legal proceedings generally incidental to its business. Although the ultimate disposition of these matters is not presently determinable, management does not believe that ultimate settlement of any or all of such matters will have a material adverse effect upon the Company's financial condition or results of operations. 13. QUARTERLY RESULTS (UNAUDITED) The following tables contain selected unaudited Consolidated Statement of Operations information for each quarter of fiscal year 2001 and fiscal year 2000. The Company believes that the following information reflects all normal recurring adjustments necessary for a fair presentation of the information for the periods presented. The operating results for any quarter are not necessarily indicative of results for any future period.
Year Ended March 31, 2001 ------------------------------------------------------------------------ Fourth Third Second First Quarter Quarter Quarter Quarter ------------- ------------- -------------- -------------- (in thousands, except per share data) Net sales $ 14,328 $ 27,750 $ 12,013 $ 13,105 Gross profit (1) 843 5,273 2,293 2,439 Net loss (17,001) (40,022) (40,556) (39,102) Net loss per share, basic and diluted $(0.37) $(0.87) $(0.89) $(0.87) Pro forma net loss per share, basic and diluted $(0.37) $(0.87) $(0.89) $(0.87) Shares used to compute net loss per share: Basic and diluted 46,456 45,758 45,598 45,099 Pro forma basic and diluted (2) 46,456 45,758 45,598 45,099
Year Ended March 31, 2000 ---------------------------------------------------------------------------- Fourth Third Second First Quarter Quarter Quarter Quarter -------------- -------------- --------------- --------------- (in thousands, except per share data) Net sales $ 11,804 $ 20,104 $ 4,400 $ 3,623 Gross profit (1) 2,174 3,427 225 620 Net income (loss) (41,292) (19,038) (8,553) (3,178) Net income (loss) per share, basic and diluted $(0.92) $(0.51) $(0.57) $(0.27) Pro forma net income (loss) per share, basic and diluted $(0.92) $(0.51) $(0.27) $(0.12) Shares used to compute net income (loss) per share: Basic and diluted 44,909 37,198 14,920 11,604 Pro forma basic and diluted (2) 44,909 37,198 31,117 26,995
(1) Includes the reclassification of certain promotional costs from marketing and sales to cost of sales related to the adoption of the Emerging Issues Task Force Issue No. 00-14, "Accounting for Certain Sales Incentives." All periods presented have been reclassified for consistent presentation. Also includes a charge of approximately $1.8 million during the fourth quarter of the year ended March 31, 2001, relating to inventory valuation reserves. See Note 2. (2) Includes shares associated with the conversion of preferred stock into common stock as if the conversion occurred on the dates of original issuance. See Note 2.