| ** ** | **UNITED STATES**                       | OMB APPROVAL  OMB Number:  3235-0063                                      |
|------------|-----------------------------------------|--------------------------------------------------------------------------------|
| ** ** | **SECURITIES AND EXCHANGE  COMMISSION** |
|       | **Washington,  D.C. 20549**             | Expires:         January 31, 2008 |
|       |                                    | Estimated average  burden                                                      |
|       | **FORM 10-K**                      | hours per  response . .2,196.00                                                |

 

**(Mark One)**

 
| **ý**                                                                                                                                                                                                                                                    | ** ** | **ANNUAL  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**    |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                                          |       |                                                                                                    |   |   |
| **For the fiscal year ended December 31,  2005**                                                                                                                                                                                                         |
| ** **                                                                                                                                                                                                                                                    |
| **or**                                                                                                                                                                                                                                                        |
|                                                                                                                                                                                                                                                          |       |                                                                                                    |   |   |
| **o**                                                                                                                                                                                                                                                         | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
| ** **                                                                                                                                                                                                                                                    | ** ** | ** **                                                                                              |
| **For the  transition period from                  to                  ** |
| ** **                                                                                                                                                                                                                                                    |
| **Commission  file Number    000-51257**                                                                                                                                                                                                  |

 

**BIDZ.com, Inc.**

(Exact name ofregistrant as specified in its charter)

 

| **California**                                                 | ** ** | **95-4728109**                         |
|----------------------------------------------------------------|------------|----------------------------------------|
| State or  other jurisdictin of   incorporation or organization |       | (I.R.S.  Employer  Identification No.) |
|                                                           |       |                                   |
| **3562  Eastham Drive, Culver City, California**               | ** ** | **90232**                              |
| (Address of  principal executive offices)                      |       | (Zip Code)                             |

 

Registrant’s telephone number, including areacode     **(310) 280-7373**

 

Securities registered pursuant to Section 12(b) of theAct:  **None**

 
| **Title of each class** | ** ** | **Name of each exchange on which  registered** |
|-------------------------|------------|------------------------------------------------|
|                    |       |                                           |
|                    |       |                                           |

 

Securities registered pursuantto Section 12(g) of the Act:

 

**CommonStock, no par value**

(Title of class)

 

(Title of class)

 

Indicate by check mark if the registrant is awell-known seasoned issuer, as defined in Rule 405 of the Securities Act.
|   |   | o  YES | ý  NO |
|--------|--------|------------------|----------------------|

 

Indicate by check mark if the registrant isnot required to file reports pursuant to Section 13 or Section 15(d) ofthe Act.
|   |   | o  YES | ý  NO |
|--------|--------|------------------|----------------------|

 

Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or 15 (d) ofthe Securities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.
|   |   | ý  YES | o  NO |
|--------|--------|-----------------------|-----------------|

 

Indicate by check mark if disclosure ofdelinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 ofthis chapter) is not contained herein, and will not be contained, to the bestof registrant’s knowledge, in definitive proxy or information statements 
| incorporated by reference in Part III  of this Form 10-K or any amendment to this Form 10-K | o |
|------------------------------------------------------------------------------------------------------------|---|

 

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

 
| Large accelerated filer  o | Accelerated filer   o | Non-accelerated filer  ý |
|--------------------------------------|---------------------------------|-----------------------------------------|

 
| Indicate by check mark whether the  registrant is a shell company (as defined in Rule 12b-2 of the Act). | o  YES | ý  NO |
|---------------------------------------------------------------------------------------------------------------|------------------|----------------------|

 

The aggregate market value of the votingstock held by non-affiliates of the registrant based upon the price at whichthe common stock was last sold was approximately $66,912,000. For purposeshereof, directors, executive officers and 10% or greater shareholders have beendeemed affiliates.  This determination ofaffiliate status is not necessarily a conclusive determination for otherspurposes.

 

The number of shares outstanding of theregistrant's common stock was 23,312,500 as of March 29, 2006.

 

DOCUMENTS INCORPORATED BYREFERENCE

None.

 

 

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| Table of Contents                                                                                                          |   |
|----------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                       |   |
| PART I                                                                                                                |   |
| Item 1.  Business.                                                                                                         |   |
| Item  1A. Risk Factors                                                                                                     |   |
| Item 1B.Unresolved Staff Comments                                                                                          |   |
| Item 2. Properties                                                                                                         |   |
| Items 3. Legal Proceedings                                                                                                 |   |
| Item 4. Submission of Matter to a Vote of  Securities Holders                                                              |   |
|                                                                                                                       |   |
| PART II                                                                                                               |   |
| Item 5. Market for Registrant’s Common  Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |   |
| Item 6. Selected Financial data                                                                                            |   |
| Item 7: Management's Discussion and and  Analysis of Financial Condition and Results of Operations                         |   |
| Item 7A. Quantitative and Qualitative  Disclosures about Market Risk                                                       |   |
| Item 8. Financial Statements and  Supplementary Data                                                                       |   |
| Item 9. Changes in and Disagreements With  Accounting on Accounting and Financial Disclosure                               |   |
| Item 9A. Controls and Procedures                                                                                           |   |
| Item 9B. Other Information                                                                                                 |   |
|                                                                                                                       |   |
| PART III                                                                                                              |   |
| Item 10. Directors and Executive Officers  of the Registrant                                                               |   |
| Item 11. Executive Compensation                                                                                            |   |
| Item 12. Security Ownership of Certain  Beneficial Owners and Management and Related Stockholder Matters                   |   |
| Item 13. Certain Relationships and Related  Transactions                                                                   |   |
| Item 14. Principal Accounting Fees and  Services                                                                           |   |
| Item 15. Exhibits and Financial Statement  Schedules                                                                       |   |

 

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**ITEM1. Business**

 

**Overview**

 

We are a leading online retailer of jewelry, featuring a live auctionformat. We have established our retail brand in the online marketplace byoffering high-quality merchandise, a unique user-friendly shopping experience,and the opportunity for buyers to achieve significant cost savings versustraditional retail channels. A key to our success has been our abilityefficiently and effectively to source closeout merchandise and rapidly respondto changing consumer demands for certain jewelry. We offer our products througha continuous live format, featuring “no reserve” auctions, a $1 minimum openingbid, and a unique 30-second auction extension period that allows our auctionsto continue until all bids are received. The majority of our auctions areshort-term, often lasting less than one hour, providing immediate gratificationto our customers and encouraging frequent visits and active viewing of ourwebsite. Our product inventory includes gold, platinum, and silver jewelry setwith diamonds, rubies, emeralds, sapphires, and other precious andsemi-precious stones; and watches. Through our website at *www.bidz.com*, we averaged daily sales of approximately7,000 items with an average order size of $112 during 2005.

 

We sell to consumers looking for reliable bargains on jewelry. Becausewe purchase and retain all of our jewelry inventory onsite, we can provide ourcustomers with timely service and delivery of their purchases. In addition,each item is inspected by one of our trained product specialists prior to itsplacement on our website, which assures our customers of the quality of theirpurchases of our products. We provide a trustworthy and secure buyingenvironment with a 15-day return policy on all merchandise. We believe thatsome of our customers are resellers intending to sell our goods in secondarymarkets, such as on eBay, at local auctions, and through other retail channels.These resellers have the opportunity to purchase products at lower prices thanthey would receive from manufacturers or other distributors. Our auctions areconducted 24 hours a day, seven days a week. We also offer daily telephonecustomer support and 24-hour e-mail customer support.

 

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

 

•                  a $1 minimum bid format with no reserve,

 

•                  interactive auctions with 30-second time extensionsfor all auctions each time a bid is received within 30 seconds of terminationof the auction, and

 

•                  short-term auctions, often lasting less than onehour, providing our customers immediate gratification to encourage frequentvisits and active viewing of our website.

 

There is no charge to a potential buyer for registering on our websiteor placing bids. Buyers have access to a broad selection of items withoutexpensive additional markups or commissions to intermediaries. Our websiteoffers detailed product information, including photographs of our merchandise.Our website also provides a dynamic display of auto-refreshing screens,enabling our customers to follow our in-progress auctions in real-time.Successful bidders are automatically notified when an auction is completed. Toassist users further, we offer customer support via phone and e-mail seven daysa week. We provide a mechanism for our customers to provide comments andfeedback on their bidding and purchasing experience.

 

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Our sales currently focus on closeout jewelry. Because jewelry to beliquidated is frequently melted down into its component parts rather than sold,we are able to acquire closeout jewelry at very low prices, often just abovethe cost of the melted down product. We have eliminated the variousinefficiencies of the closeout jewelry market by

 

•                  removing several layers of intermediaries from thesupply chain, and

 

•                  aggregating merchandise often only available ininconsistent quantities.

 

In addition to our primary focus on jewelry, we currently offer alimited amount of art and collectibles. We also maintain a Certified MerchantProgram, which allows independent online merchants to sell on our auctionwebsite a variety of goods, such as art and collectibles. Items sold throughour Certified Merchant program represented less than 1% of our net revenue in2005. We anticipate this percentage will decrease further in the future.

 

**History**

 

We commenced operations in early 1998 by offering a limited selectionof merchandise for sale on eBay’s website through our predecessor, AssetLenders of America, a group of 11 collateral lending stores. In the fall of1998, we formed Bidz.com, Inc., acquired Asset Lenders of America, andpurchased the domain name *www.bidz.com*.In February 1999, we launched the *www.bidz.com*website and began offering closeout jewelry through our auction format. In November 1999,we merged Asset Lenders of America into our company.  On March 17, 2006, we filed a registrationstatement on Form S-1 (File No. 333-132545) (“Registration Statement”) with theU.S. Securities and Exchange Commission to register our planned initial publicoffering of common stock ("IPO").

 

**Industry Overview**

 

*Growth of Online Commerce andthe Online Auction Market*

 

The Internet’s development into a significant global medium forcommunication, content, and commerce has led to substantial growth in onlineshopping and has provided online retailers with new opportunities to eliminateintermediaries from the traditional retail supply chain. Internet usage andonline commerce continue to grow worldwide. According to Forrester, U.S. onlineretail sales are expected to grow from $172.4 billion in 2005 to$328.6 billion by 2010, a 13.8% CAGR. This projected increase can beattributed to factors such as an increased awareness of the convenience ofonline shopping, an expanded range of products available online, improvementsin security and electronic payment technology, and increased access tobroadband Internet connections facilitating online shopping. Within thiscategory, Forrester indicates that online auction sales are projected to growfrom $27.7 billion in 2005 to $65.2 billion in 2010, an 18.7% CAGR,representing approximately one-fifth of all online sales in 2010.

 

Online auction sites have created a robust global marketplace, whichovercomes the inefficiencies associated with traditional auction purchasingwhile offering the benefits of online commerce. Companies such as eBayspearheaded the creation of a centralized online auction market, offeringbuyers a significantly broader selection of goods to purchase. Today, onlineauction sites offer significant convenience, allowing trading at all hours andproviding continually updated product offerings. By leveraging the interactivenature of the Internet, our website also enables customers to experience theexcitement of live auctions, including the competitive bidding process.

 

*The Jewelry Market*

 

Jewelry is designed and manufactured by a large number ofmanufacturers, generally with small operations. Jewelry manufacturers sell to avariety of wholesalers, distributors, and retailers. Jewelry in turn is sold toconsumers through a variety of jewelry stores. The U.S. jewelry retail marketconsists primarily of small, independent stores, regional

 

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operators, and a limited number of national retail chains, such asTiffany & Co., Zales, and Kay Jewelers. Multi-line department anddiscount stores and others also sell jewelry, such as Wal-Mart, Target, J. C.Penney, and Costco, as well as enterprises such as QVC and Home ShoppingNetwork. Despite the presence of major jewelry retail chains, a majority of thejewelry retail business remains fragmented. According to the U.S. Census Bureaustatistics, 96.0% of all retail jewelry firms operate as a single store.

 

In addition, according to the U.S. Department of Commerce, the U.S.jewelry market was estimated to be $57.2 billion in 2004 and has beengrowing at 5.5% CAGR over the last 20 years. According to Forrester, onlinesales of jewelry/luxury goods are expected to grow from $3.2 billion in2005 to $6.1 billion in 2010, a 13.8% CAGR. According to National Jeweler,jewelry and watches represented one of the fastest-growing categories on theInternet with consumers spending 27.0% more on jewelry and watches online in2005 compared with 2004.

 

Manufacturers traditionally hold inventory to buffer against uncertaindemand within their normal, offline sales channels. Manufacturers’ primarydistribution channels consist of regular sales to major established retailersat wholesale prices and sales to wholesalers that service smaller retailchains. In recent years, several dynamics have shifted inventory risk fromretailers to manufacturers, including the following:

 

•                  dominant retailers insisting on just-in-timedeliveries from manufacturers;

 

•                  dominant retailers often demanding to cancel ordersmid-production and returning unsold merchandise;

 

•                  rapid changes in style, color, or models, turninginventory into closeout merchandise;

 

•                  incorrect estimates of consumer demand leading tooverproduction; and

 

•                  changes in a retailer’s financial situation orstrategy resulting in cancelled orders.

 

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

 

Manufacturers are often required to adhere to delivery and quantityspecifications. If a manufacturer does not meet required delivery schedules orspecifications, or products are unsold, the products may be returned to themanufacturer. In both cases, manufacturers rarely meet their costs on theircloseout products. Manufacturers often opt to melt down the jewelry into itscomponent parts and reconstruct jewelry pieces with current season styles. Themelt-down process is difficult, requires skilled labor, and results in a verylow return on manufacturing costs.

 

**Our Value Proposition**

 

*Value to Buyers*

 

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

 

***Truebargain prices.*** The price of all our products is dictated by the buyer alone based onthat buyer’s valuation of the product. Therefore, many items offered on ourwebsite are sold at a substantial discount to the prices in

 

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traditional retail channels, such as at jewelry stores located inshopping malls. Our $1 minimum bid policy allows the savvy or lucky consumerthe potential to purchase any product being auctioned for only $1, offeringeven greater value to the consumer. Regardless of the closing price, once anauction is closed, the final bidder will receive the product. We also offer anauto-bidding option under which customers may pre-bid for a product.

 

***Entertainingauction format.*** We offer our customers the excitement of winning an item that may not beavailable in the future. We offer unique, short-term, live auctions to ourcustomers, providing a quicker, more exciting alternative to the traditional,longer auction format. The shorter time frame of our auctions, many lastingless than one hour, provide our customers immediate gratification and encouragerepeated visits and active viewing of our website.

 

***Broadproduct selection.*** We offer a broad selection of jewelry, including rings, necklaces,earrings, bracelets, jewelry sets, and watches. Our selection includes gold andsilver jewelry, as well as jewelry with precious and semi-precious stones. Wealso sell individual and sets of gemstones.

 

***Productquality assurance.*** We provide detailed and accurate descriptions of each product. Ourtrained product specialists inspect our jewelry, utilizing the GemologicalInstitute of America Diamond and Colored Stone Grading System prior to postingon our website for auction. We guarantee the quality of our products throughour 15-day return policy. Our commitment to quality and product descriptionaccuracy is demonstrated by consistently low return rates on our items, whichwere approximately 3% of all items sold in 2005.

 

***Promptfulfillment and responsive customer service.***  We maintain in inventory all the products weoffer on our website, enabling us to ensure prompt order fulfillment anddelivery to our customers. Our customer service representatives are availableseven days a week, via phone or e-mail, and are trained to provide assistanceand answer a broad range of questions regarding payment, delivery, and othermatters.

 

***Positiveshopping experience.***  Our easy-to-navigate website provides ourcustomers with clear and detailed information about our products, includingmultiple photographs of many items. Customers can bid on our products 24 hoursa day, seven days a week. Buyers are provided a five-day payment grace periodon all products purchased.

 

*Value to Suppliers*

 

Jewelry manufacturers continually look for a cost-effective, efficientway to sell their closeout inventory. Our ability to purchase jewelry invarious quantities provides a critical one-stop inventory clearance alternativefor manufacturers and an efficient sales channel for liquidators that purchasecloseout inventory from manufacturers.

 

***Singlesource for product disposition.***  Unlike many multi-store retail chains thatoften require large lot purchases to stock appropriate levels of inventory attheir multiple locations, we have the flexibility to buy and sell both smalland large jewelry lots in a highly efficient manner. As a single source for theliquidation of closeout jewelry products, we provide suppliers with greatercontrol of distribution by reducing the need to spread products across multiplechannels. In addition, manufacturers and liquidators are often required toadhere to stringent product quantity and delivery schedule requirements.Products not delivered on time or in exact amounts are returned. We have theflexibility to tailor our purchasing to a supplier’s needs with regard toquantity, variety, and timing.

 

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***Resolutionof channel conflict.***  Manufacturers seek to avoid liquidating theirproducts through traditional retail channels in which their discounted productsmay be sold alongside their full-price products. Such side-by-side selling canresult in weaker pricing and decreased brand strength, which is known aschannel conflict or sales channel pollution. As a result, many manufacturersturn to liquidation wholesalers and discount retailers. These liquidationchannels, however, provide manufacturers limited control over distribution andare unreliable and expensive to manage. Because we offer an alternate onlinedistribution channel that focuses on the sale of jewelry, our suppliers areable to sell their closeout jewelry independently of their full-pricedproducts. We believe this enables our suppliers to avoid customer confusion andpotential loss of sales of or distressed sales prices to liquidators orcloseout retailers for their full-priced jewelry products.

 

***Moreprofitable alternative for suppliers.***  We eliminate the various inefficiencies andmark-ups associated with traditional intermediaries, and our high volume ofsales from a single location provides us with favorable inventory turnover andlower inventory carrying and handling costs versus traditional jewelryretailers. The efficiencies of our sales channel enable us to provide oursuppliers with favorable product margins versus sales through traditionalcloseout alternatives.

 

**Growth Strategy**

 

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

 

•                  ***Expanding ourcustomer base*** by maintainingand expanding our relationships with third-party search engines, Internetportals, and websites and by increasing our online advertising expenditureswithin these channels;

 

•                  ***Enhancingsourcing relationships*** byexpanding the number of suppliers from which we opportunistically purchasecloseout inventory, thereby assuring consistent availability of a wide varietyof designs and styles of jewelry, and utilizing a portion of the net proceedsof our planned IPO for cash purchases to secure suppliers that do not extendcredit terms and to obtain better supplier pricing;

 

•                  ***Increasing thebreadth and depth of our product offerings*** by increasing available inventory within specificjewelry categories, allowing us to make more jewelry categories available andenabling us to list more auction items on a daily basis; and

 

•                  ***Focusing on newinternational markets*** byexpanding into and creating a strong presence in a number of English-speakingcountries, including the United Kingdom, Canada, Australia, Ireland, and NewZealand, and introducing foreign language versions of our website for certaininternational markets.

 

**Marketing**

 

Our marketing strategy is designed to generate consumer traffic byincreasing awareness of our website and recognition of our brand, building aloyal buyer base, and maximizing repeat purchases. Our website has experiencedsubstantial growth in users and buyers, as evidenced through data compiled byus through the measurement tools on our website, expanding to approximately2.2 million registered users at the end of 2005 and 200,000 buyers in2005.

 

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Our marketing and advertising efforts consist primarily of thefollowing initiatives:

 

•                  *Website searches: *Wepurchase search engine advertising primarily at a pre-negotiated price, whichis paid each time a potential customer clicks on one of our advertisements. Wecurrently maintain advertising relationships with, among others, Google (US,UK, Australia, Canada, European Union, South East Asia, Mid East, and SouthAmerica), Yahoo! Overture (US, UK, and Australia), Ask USA, Looksmart USA, andMIVA for search engine advertising.

 

•                  *Contextual marketing:*  We utilizebanner advertisements and product data feeds on third-party websites with hightraffic volumes. We focus on contextual advertisements that appear on websitesrelated to jewelry, fashion, shopping, and women’s lifestyle. We maintainportal advertising relationships with Yahoo! (US, UK, and Australia), Ask USA,24/7 Real Media, MSN, WhenU, Claria, Hotbar, BlueLithium, and others. The feestructure for our purchase of banner and contextual advertisements is basedeither on a set price for each click on our advertisement or on a cost perthousand basis, for which we pay a set fee per thousand contextual or banneradvertisements that appear on the selected websites.

 

•                  *E-mail campaigns:*  We utilizean electronic direct marketing program to encourage prospect activation, customerreferrals, customer retention, and repeat purchases. This program includespermission-based e-mail marketing to visitors who indicate a desire to continueto receive product recommendations and promotional discounts. We purchasee-mail direct marketing for a set fee per thousand e-mails sent or for each newlead.

 

•                  *Affiliate programs:*  We attractcustomers by participating in affiliate programs. Our affiliate programs offerother website operators an opportunity to earn commissions by providing theirvisitors access to our website. In March 2005, we outsourced our U.S.affiliate programs to Link Share. In August 2005, we engaged CommissionJunction and Checkmystats to handle our European and Australian affiliateprograms. In so doing, we intend to extend the reach of our website and drawcustomers from a variety of other websites. By participating in our affiliateprograms, website publishers earn volume-based commissions by directingcustomers to our website.

 

**Sourcing Strategy**

 

We purchase closeout inventory directly from manufacturers andliquidators. We also closely monitor our sales trends to assess consumer demandfor certain jewelry styles and categories and purchase such non-closeoutinventory directly from manufacturers. We have eliminated variousinefficiencies and mark-ups associated with traditional intermediaries in thejewelry market. Our sourcing model provides a critical alternative liquidationchannel for manufacturers, for which disposal of closeout inventory representsa significant challenge. We have the flexibility to purchase a variety of lotsizes, and our centralized warehouse and fulfillment center enables oursuppliers to ship their products to a single location, easing the burden ontheir infrastructure. We have developed a database of product descriptions andpictures that enables us rapidly to post inventory for sale. In addition, weclosely monitor sales and gross margin trends of our products on a daily basis,allowing us to select carefully additional products for purchase and adjustsupplier pricing as necessary.

 

We currently purchase products from approximately 160 suppliers. Ourtop five suppliers accounted for 52.2%, 61.3%, and 52.6% of our total purchasesin 2003, 2004, and 2005, respectively. In 2005, we purchased 37.1% of ourmerchandise from LA Jewelers, Inc. We purchased a total of 15.5% of ourmerchandise from Quintessence Jewelry Corp., Dialuck Corp., A.T.P., RayaltyJewelry Inc. in 2005.

 

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We identify manufacturers and liquidators with high-value products bycapitalizing on our extensive experience in the jewelry industry. Our jewelrysourcing model capitalizes on our close industry relationships to avoid severallayers of supply chain intermediaries and the mark-ups associated withadditional intermediaries. We closely monitor the historical sales trends ofour products on a daily basis.

 

We purchase much of our inventory at or just above the manufacturer’smanufacturing costs. During 2005, the cost for many of the products wepurchased ranged between $10 and $300 per item. We have informal arrangementswith our suppliers to purchase closeout jewelry on favorable terms andconditions. Our arrangements, however, do not include any supply or priceobligations, and we do not have long-term supply agreements with any of oursuppliers. We purchase and carry in inventory all of the products we offer forsale to ensure availability and expedited delivery. Currently, we acquire allinventories from our suppliers on a revolving credit basis, with paymenttypically due within 60 days. In an effort to achieve cost efficienciesand a more diverse supplier base, we intend to acquire substantially moreproducts on a cash basis. This strategy will allow for more flexibility withrespect to product selection, reduce our product costs, and enlarge our supplyrelationships by allowing us to purchase from vendors that do not extend creditto their customers.

 

**Merchandising Strategy**

 

We seek to maintain profitability while providing variety and value toour customers by carefully selecting the types of products we post on ourwebsite at any given time, the duration of the auction for each item, and thefrequency with which we repost comparable items after sales. We activelymonitor our auctions and sales so that we are able to adjust continually themakeup and quantity of goods on our website at any given time. Since bids onall company-owned merchandise start at $1, losses are incurred on 15% to 25% ofthe items sold on an annual basis. The risks associated with a $1 minimum bidauction are mitigated by profits generated from items sold at a gain, whichresulted in an overall 21.3% gross profit margin in 2005.

 

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

 

**Technology and Operations**

 

Both our website user interface and back-office transaction processingsystems are internally developed. This proprietary system maintains records forapproximately 2.2 million registered users, sales invoicing and cashreceipts, auction transactions, inventory control, and historical transactiondata. Our system handles all aspects of the auction process, includingnotifying users via e-mail of auction status. During the month of February 2006,we averaged 1.8 million page views per day.

 

Our system architecture is built on industry-standard platforms thatare designed to provide continuous service 24 hours a day, 365 daysper year. Our website servers are located at a third-party co-location facilityoperated by Alchemy Communications in downtown Los Angeles. Alchemy providesredundant web-facing communications lines and emergency power backup. Theback-office processing system is housed in our headquarters in Culver City andcommunicates with Alchemy over two independent T1 lines. These systems includeboth PostgreSQL and Microsoft SQL database engines operating in a multi-processingLinux environment designed to accommodate large volumes of online

 

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traffic and are configured for high fault tolerance with redundancy andload balancing. Our Internet servers utilize VeriSign Inc. digitalcertificates to provide secure communications for sales and paymenttransactions.

 

During the last quarter of 2005, our Internet auction systems operatedat just over 60% of capacity. We are currently planning to scale up ourinfrastructure to enable systems operations to perform at 30% of capacity anddevelop a second co-location in a different region to provide greater loadbalancing and disaster security. We utilize the firewall protection and theservices of TrustWave, which provides regular scanning of our systems forsecurity vulnerabilities.

 

As of December 31, 2005, we had a technology and development staffof 15. We have structured the technology and development into three distinctdepartments: research and development, quality assurance, and productionsupport. We anticipate that we will continue to devote significant resources toproduct development in the future as we add new features and functionality.

 

**Customer Service and Fulfillment Operations**

 

An important element of our sales strategy is to provide a high levelof customer service and sales support in order to establish long-termrelationships with our customers and encourage repeat visits and purchases. Oursales support staff provides detailed payment, billing, and delivery guidanceand is trained to answer a broad array of questions regarding auctionsconducted on our website. Our informed and helpful staff, together with theinformative and educational aspects of our website, promotes customerconfidence in purchase decisions.

 

As of December 31, 2005, we had a customer service and billingstaff of approximately 23. We utilize automated e-mail and phone systems toroute traffic to our customer service and billing support representatives toprovide personalized assistance. The customer service center operates betweenthe hours of 8:00 a.m. and 5:00 p.m., Pacific time, for telephonesupport and 24 hours a day for e-mail support. We outsource a portion ofour e-mail support.

 

Customers may utilize the following payment methods: credit card, moneyorders, and checks. We also offer our customers the opportunity to use PayPaland Bill-Me-Later to make payments. We require payment to be received by usprior to shipping the merchandise.

 

We maintain a fraud prevention department to detect suspect payments.Our internal system flags suspect payments when the shipping address, name, orother pertinent information does not match cardholder information. Our frauddepartment then requests that the customer provide additional information to verifyidentity before shipment is made.

 

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

 

Our goal is to fulfill purchase orders on a timely, secure, andaccurate basis. Following payment, the merchandise is packaged for shipment. Weinspect and track each product at all stages of the receiving and orderfulfillment process. Customer orders are typically delivered within sevenbusiness days, depending on the shipping method and the extent of any productcustomization required. Most purchases are delivered with signature or deliveryconfirmation. We ship all products via nationally recognized carriers, such asFederal Express and the U. S. Postal Service. All of our shipments of productsare fully insured by Federal Express or self-insured by us.

 

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We have a 15-day return policy on all of our merchandise with amoney-back guarantee if the product is not as described on our website. Itemsthat are returned that are identical to their description are subject to a 15%restocking fee.

 

Our facility has security controls and restricted access and has beendesigned for the prompt receipt, storage, and shipment of our products. Inaddition, we have security guards on duty 24 hours a day, seven days aweek to patrol the premises.

 

**Seasonality**

 

Historically, sales in the jewelry industry are seasonal and have beenhigher in the fourth quarter as a result of higher consumer spending during theDecember holiday season. Approximately 26.0%, 29.3%, and 33.9% of our netrevenue in 2003, 2004, and 2005, respectively, was generated during the fourthquarter. As we continue to grow, we expect to experience more pronouncedseasonal fluctuations in our net revenue and anticipate a disproportionateamount of our revenue will be in the fourth quarter.

 

**Competition**

 

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

 

•                  price,

 

•                  product quality and selection,

 

•                  vendor reliability,

 

•                  shopping convenience,

 

•                  customer service, and

 

•                  brand recognition.

 

We currently compete with a variety of online auction jewelry sellers,such as eBay and uBid; online liquidation companies, such as Overstock; andonline jewelry retailers, such as Odimo and Blue Nile. We also compete withtraditional offline jewelry retail chains, such as Zales, Finlay Fine Jewelry,and Reed’s Jewelers, as well as with department and discount and other storesthat sell jewelry at wholesale prices, such as Wal-Mart, Target, J. C. Penney,and Costco, as well as with QVC and Home Shopping Network.

 

As the online liquidation market grows, we believe that companiesinvolved in online retail, as well as traditional retailers and liquidationbrokers, will increase their efforts to develop services that compete with ouronline services. We also face potential competition from online companies notyet focused on the liquidation market and from retail companies not yetoperating online.

 

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Many of our competitors have greater brand recognition, longeroperating histories, larger customer bases, and significantly greaterfinancial, marketing, and other resources than we do. Smaller competitors mayenter into strategic or commercial relationships with larger, more establishedand well-financed companies. Some of our competitors could enter into exclusivedistribution arrangements with our suppliers and deny us access to theirproducts, devote greater resources to marketing and promotional campaigns, anddevote substantially more resources to their website and systems developmentthan we do. New technologies and the continued enhancement of existing technologiesalso may increase competitive pressures on us.

 

**Intellectual Property**

 

We regard our domain names and similar intellectual property ascritical to our success. We rely on a combination of laws and contractualrestrictions with our employees, customers, suppliers, affiliates, and othersto establish and protect our proprietary rights. Despite these precautions, itmay be possible for a third party to copy or otherwise obtain and use ourintellectual property without authorization. In addition, others mayindependently develop substantially similar intellectual property. Although weare pursuing the registration of our key trademarks and patents in the UnitedStates, some of our trade names are not eligible to receive trademarkprotection. In addition, effective trademark and patent protection may not beavailable or may not be sought by us in every country in which our products aremade available online.

 

From time to time, we may be subject to legal proceedings and claims inthe ordinary course of our business, including claims of alleged infringementof the trademarks and other intellectual property rights of third parties. Inaddition, litigation may be necessary in the future to enforce our intellectualproperty rights, to protect our trade secrets, or to determine the validity andscope of our intellectual proprietary rights and those of others. Any suchlitigation, regardless of outcome or merit, could result in substantial costsand diversion of management and technical resources, any of which couldmaterially harm our business.

 

**Government Regulation**

 

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

 

Moreover, there is currently great uncertainty in many states whetheror how existing laws governing issues such as property ownership, sales andother taxes, and libel and personal privacy apply to the Internet andcommercial online retailers. These issues may take years to resolve. Forexample, tax authorities in a number of states, as well as a Congressionaladvisory commission, are currently reviewing the appropriate tax treatment ofcompanies engaged in online commerce, and new state tax regulations may subjectus to additional state sales and income taxes. New legislation or regulation,the application of laws and regulations from jurisdictions whose laws do notcurrently apply to our business, or the application of existing laws andregulations to the Internet and commercial online services could result in significantadditional taxes on our business. These taxes could have an adverse effect onour results of

 

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operations. Furthermore, there is a possibility that we may be subjectto significant fines or other payments for any past failures to comply withthese requirements.

 

Numerous states and foreign jurisdictions, including California, whereour headquarters is located, have regulations regarding how auctions may beconducted and the liability of auctioneers in conducting such auctions. Nofinal legal determination has been made whether the California regulationsapply to businesses such as the business we conduct, and little precedentexists in this area. Several states and some foreign jurisdictions have attempted,and may attempt in the future, to impose such regulations upon companiessimilar to us and their customers, which could harm our business. Regulatoryand licensure claims could result in costly litigation or could require us tochange our manner of doing business in ways that increase our costs or reduceour revenue or force us to prohibit listings of certain items for somelocations. We could also be subject to fines or other penalties. Any of theseoutcomes could harm our business.

 

**Employees**

 

As of December 31, 2005, we had approximately 162 full-timeemployees and eight part-time employees. We utilize part-time employees,temporary employees, and independent contractors to respond to fluctuations inour business. None of our employees is covered by a collective bargainingagreement with us, and we consider our relations with our employees to be good.

 

We have an agreement with Administaff, a professional employerorganization, to manage all payroll processing, workers’ compensation, healthinsurance, and other employment-related benefits for our employees. Administaffis a co-employer of our employees along with us. Although Administaff processesour payroll and pays our workers’ compensation, health insurance and otheremployment-related benefits, we are ultimately responsible for such paymentsand are responsible for complying with state and federal employmentregulations. We pay Administaff a fee based on the aggregate salaries paid toour employees for these services.

 

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** **

**DELAWARE REINCORPORATION**

 

Our stockholders have approved a reincorporation to Delaware andadoption of a new charter, which we anticipate will become effectiveconcurrently with our planned IPO.

 

In connection with our planned IPO and reincorporation in Delaware, wewill be authorized to issue 100,000,000 shares of common stock, $.001 parvalue, and 4,000,000 shares of undesignated preferred stock, $.001 par value.The following discussion describes the Delaware Certificate of Incorporationand the Bylaws that we intend to adopt in connection with our plannedreincorporation and is intended to be a summary and does not describe allprovisions of our certificate of incorporation or bylaws or Delaware law thatmay be applicable to us. For a more thorough understanding of the terms of ourcapital stock, you should refer to our certificate of incorporation and bylaws,which are included as exhibits to the Registration Statement.

 

 

**Common Stock**

 

The holders of common stock will be entitled to one vote per share onall matters to be voted upon by stockholders. There will be no cumulativevoting. Subject to preferences that may be applicable to any outstandingpreferred stock, holders of common stock will be entitled to receive ratablysuch dividends as may be declared by our Board of Directors out of fundslegally available for that purpose. In the event of the liquidation,dissolution, or winding up of our company, the holders of common stock will beentitled to share ratably in all assets remaining after payment of liabilitiesand the liquidation preferences of any outstanding preferred stock. The commonstock has no preemptive or conversion rights, other subscription rights, orredemption or sinking fund provisions.

 

**Preferred Stock**

 

Our certificate of incorporation will authorize our Board of Directors,without any vote or action by the holders of our common stock, to issuepreferred stock from time to time in one or more series. Our Board of Directorswill be authorized to determine the number of shares and to fix thedesignations, powers, preferences, and the relative, participating, optional,or other rights of any series of preferred stock. Issuances of preferred stockwould be subject to the applicable rules of Nasdaq or other organizationson which our securities are then quoted or listed. Depending upon the terms ofpreferred stock established by our Board of Directors, any or all series ofpreferred stock could have preference over the common stock with respect todividends and other distributions and upon our liquidation. If any shares ofpreferred stock are issued with voting powers, the voting power of theoutstanding common stock would be diluted. No shares of preferred stock arepresently outstanding, and we have no present intention to issue any shares ofpreferred stock.

 

**Anti-Takeover Effects of Provisions of theCertificate of Incorporation and Bylaws**

 

*General*

 

Our proposed Delaware certificate of incorporation, our bylaws, and theDGCL contain certain provisions that could delay or make more difficult anacquisition of control of our company not approved by our Board of Directors,whether by means of a tender offer, open market purchases, a proxy contest, orotherwise. These provisions have been implemented to enable us, particularlybut not exclusively in the initial years of our existence as a publicly ownedcompany, to develop our business in a manner that will foster our long-termgrowth without disruption caused by the threat of a takeover not

 

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deemed by our Board of Directors to be in the best interests of ourcompany and our stockholders. These provisions could have the effect ofdiscouraging third parties from making proposals involving an acquisition orchange of control of our company even if such a proposal, if made, might beconsidered desirable by a majority of our stockholders. These provisions mayalso have the effect of making it more difficult for third parties to cause thereplacement of our Board of Directors or our current management without theconcurrence of our Board of Directors.

 

There is set forth below a description of the provisions contained inour proposed Delaware certificate of incorporation and bylaws and the DGCL thatcould impede or delay an acquisition of control of our company that our Boardof Directors has not approved. This description is intended as a summary onlyand is qualified in its entirety by reference to our certificate ofincorporation and bylaws, which are included as exhibits to the registrationstatement of which this prospectus forms a part, as well as the DGCL.

 

*Authorized but UnissuedPreferred Stock*

 

Our certificate of incorporation will authorize our Board of Directorsto issue one or more series of preferred stock and to determine, with respectto any series of preferred stock, the terms and rights of such series withoutany further vote or action by our stockholders. The existence of authorized butunissued shares of preferred stock may enable our Board of Directors to rendermore difficult or discourage an attempt to obtain control of our company bymeans of a proxy contest, tender offer, or other extraordinary transaction. Anyissuance of preferred stock with voting and conversion rights may adverselyaffect the voting power of the holders of common stock, including the loss ofvoting control to others. The existence of authorized but unissued shares ofpreferred stock will also enable our Board of Directors, without stockholderapproval, to adopt a “poison pill” takeover defense mechanism. We have nopresent plans to issue any shares of preferred stock.

 

*Number of Directors; Removal;Filling Vacancies*

 

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

 

*Classified Board*

 

Our certificate of incorporation will provide for our board to bedivided into three classes, as nearly equal in number as possible, servingstaggered terms. Approximately one-third of our board will be elected eachyear. See “Management—Board of Directors.” The provision for a classified boardcould prevent a party who acquires control of a majority of our outstandingcommon stock from obtaining control of the board until our second annualstockholders meeting following the date the acquirer obtains the controllingshare interest. The classified board provision could have the effect ofdiscouraging a potential acquirer from making a tender offer or otherwiseattempting to obtain control of us and could increase the likelihood thatincumbent directors will retain their positions.

 

*Stockholder Action*

 

Our certificate of incorporation will provide that stockholder action maybe taken only at an annual or special meeting of stockholders. This provisionprohibits stockholder action by written consent in lieu of a meeting. Ourcertificate of incorporation and bylaws will further provide that specialmeetings of stockholders may be called only by our Chairman of

 

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the Board of Directors, Chief Executive Officer, President, orSecretary, and shall be called by any such person at the request in writing ofa majority of the Board of Directors. Stockholders are not permitted to call aspecial meeting or to require our Board of Directors to call a special meetingof stockholders.

 

The provisions of our certificate of incorporation and bylawsprohibiting stockholder action by written consent may have the effect ofdelaying consideration of a stockholder proposal until the next annual meetingunless a special meeting is called as provided above. These provisions wouldalso prevent the holders of a majority of the voting power of our stock fromunilaterally using the written consent procedure to take stockholder action.Moreover, a stockholder could not force stockholder consideration of a proposalover the opposition of the Board of Directors by calling a special meeting ofstockholders prior to the time our chairman or a majority of the whole boardbelieves such consideration to be appropriate.

 

*Advance Notice for StockholderProposals and Director Nominations*

 

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

 

*Amendments to Bylaws*

 

Our certificate of incorporation will provide that only our Board ofDirectors or the holders of a majority of the shares entitled to vote at anannual or special meeting of stockholders have the power to amend or repeal ourbylaws.

 

*Amendments to Certificate ofIncorporation*

 

Any proposal to amend, alter, change, or repeal any provision of ourcertificate of incorporation will require approval by the affirmative vote of amajority of the voting power of all of the shares of our capital stock entitledto vote on such matters.

 

*Delaware Statutory Provisions*

 

Anti-Takeover Provision of Delaware Law. Under Section 203 of theDGCL, no Delaware corporation shall engage in a “business combination” with an “interestedstockholder” for a period of three years following the date that thestockholder became an interested stockholder. “Business combination” includes amerger, consolidation, asset sale, or other transaction resulting in financialbenefit to the interested stockholder. “Interested stockholder” is a personwho,

 

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together with affiliates and associates, owns, or within three years,did own 15% or more of the corporation’s voting stock. This prohibition does toapply if:

 

•                  prior to the time that the stockholder became aninterested stockholder, the board of directors of the corporation approvedeither the business combination or the transaction resulting in the stockholder’sbecoming an interested stockholder,

 

•                  upon consummation of the transaction resulting inthe stockholder’s becoming an interested stockholder, the stockholder owns atleast 85% of the outstanding voting stock of the corporation, excluding votingstock owned by directors who are also officers and certain employee stockplans, or

 

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

 

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

 

**Limitation of Liability and Indemnificationof Officers and Directors**

 

Our certificate of incorporation will limit the liability of ourdirectors to the fullest extent permitted by the DGCL. In addition, ourcertificate of incorporation and bylaws will provide that we will indemnify ourdirectors and officers to the fullest extent permitted by law. In connectionwith our planned IPO, we intend to enter into indemnity agreements with ourcurrent directors and executive officers and expect to enter into a similaragreement with any new directors or executive officers.

 

**Indemnification for Securities ActLiabilities**

 

Insofar as indemnification for liabilities arising under the SecuritiesAct of 1933 may be permitted for directors, officers, or controlling personspursuant to the provisions described in the preceding paragraph, we have beeninformed that in the opinion of the SEC such indemnification is against publicpolicy as expressed in the Securities Act and is therefore unenforceable.

 

**Transfer Agent and Registrar**

 

The transfer agent and registrar for our common stock is Registrar andTransfer Company. The transfer agent’s address is 10 Commerce Drive, Cranford,New Jersey 07016 and its telephone number is (908) 497-2300.

 

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**ITEM 1A. Risk Factors**

 

*We believe the risks and uncertaintiesdescribed below are the most significant we face. The occurrence of any of thefollowing risks could harm our business. In that case, the trading price of ourcommon stock could decline, and you may lose part or all of your investment.Additional risks and uncertainties not presently known to us or that wecurrently deem immaterial may also impair our operations.*

 

***We must continue to generate ahigh volume of visitor traffic to our website and convert those visitors intobuyers.***

 

Our net revenue depends to a significant extent on the number ofcustomers who visit our website to purchase merchandise and the dollar amountof their purchases. Generating increased traffic to our website and convertingthat traffic into buyers requires us to achieve effective results from ourmarketing campaigns; offer a wide variety of products that our customers canpurchase at favorable prices; maintain a user-friendly shopping experience;ensure the satisfactory availability, performance, and reliability of ourwebsite, network infrastructure, and transaction processing systems; andprovide high-quality customer service. Our business will be harmed if we areunable to increase our customer base and the dollar volume of the orderscustomers place with us.

 

***We do not have a guaranteedsupply of jewelry products, and we have a heavy concentration of inventorypurchases from our top five suppliers.***

 

The success of our business depends, in part, on our ability to offerour customers a wide variety of jewelry that they can purchase at prices thatare substantially below those of traditional jewelry retailers. We haveinformal arrangements with manufacturers, distributors, and others for oursupply of jewelry products on favorable terms and conditions, but thesearrangements do not include any supply or price obligations on their part. As aresult, we do not have a guaranteed supply of jewelry products at favorableprices. Our inability to maintain and expand our jewelry supply relationshipsor the inability of our suppliers to continue to supply us with jewelryproducts at favorable prices would substantially harm our business and resultsof operations.

 

In addition, we have a heavy concentration of inventory purchases froma small number of suppliers. Our top five suppliers accounted for approximately52.2%, 61.3%, and 52.6% of our total purchases in 2003, 2004, and 2005,respectively. In 2005, we purchased 37.1% of our merchandise from LA Jewelers, Inc.,a jewelry manufacturer and liquidator. We purchased a total of 15.5% of ourmerchandise from Quintessence Jewelry Corp., Dialuck Corp., A.T.P., and RayaltyJewelry Inc. in 2005.

 

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

 

Any problems with the availability, performance, or reliability of ourwebsite, network infrastructure, or transaction processing systems could resultin decreased customer traffic, reduced orders, reduced order fulfillmentperformance, and lower net revenue as well as negative publicity and damage toour reputation. In order to remain competitive, we must continually seek toimprove and expand the functionality and features of our website, networkinfrastructure, transaction processing systems, and delivery and shipping functionsto accommodate any substantial increase in the volume of traffic to and ordersfrom our website. We may not be successful in these efforts, and we may not beable to

 

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project accurately the rate or timing of increases, if any, in the useof or sales from our website, or timely expand or upgrade our website,infrastructure, or systems to accommodate any such increases. Additionally, wemay not be able to remedy any such availability, performance, or reliabilityproblems in a timely manner, or at all, because we depend in part on thirdparties for such availability, performance, and reliability.

 

***We may face increasing costs toacquire new customers.***

 

The acquisition of new customers is a key factor in increasing demandfor our jewelry products and increasing our revenue. We currently attract newcustomers by driving traffic to our website using a marketing and advertisingstrategy that includes targeted keyword searches, portal and websiteadvertising, participation in affiliate programs, and direct advertising. We donot maintain long-term contracts or arrangements with any companies, includingany search engines, Internet portals, or other websites, and we may notsuccessfully enter into additional relationships or maintain existing ones.Recently, we have experienced significantly higher rates for keyword searchadvertising. We expect that we will have to pay increasing fees to maintain,expand, or enter into new relationships with third-party search engines,Internet portals, and websites. In addition, traffic to our website coulddecline if our online marketing programs become less effective or the trafficdecreases to the search engines, Internet portals, and websites with which weadvertise. Our business could be materially and adversely affected if anysubstantial number of companies on which we advertise experience financial oroperational difficulties or experience other corporate developments thatadversely affect their performance. A failure to maintain or expand existingonline advertising relationships or to establish additional online advertisingrelationships that generate a significant amount of traffic from other websitescould result in decreased sales or limit the growth of our business.

 

***Competition from onlineauctioneers and other online companies with greater brand recognition mayadversely affect our*sales.**

 

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

 

We currently compete with a number of other companies, and othercompetitors may appear in the future. Our competitors currently include variousonline auction services and retailers that offer jewelry, including eBay,Odimo, Blue Nile, Overstock, and uBid. We also encounter competition fromnational jewelry retail chains, such as Zales, Kay Jewelers, and Finlay FineJewelry, and mass retailers and other enterprises that sell jewelry, such asWal-Mart, Target, J. C. Penney, Costco, QVC, and Home Shopping Network. Many ofour competitors have greater brand recognition, longer operating histories,larger customer bases, and significantly greater financial, marketing, andother resources than we do. Smaller competitors may enter into strategic orcommercial relationships with larger, more established, and well-financedcompanies. Other competitors may enter into exclusive distribution agreementswith our suppliers that deny us access to suppliers’ products. Competitors mayalso devote greater resources to marketing and promotional campaigns and towebsite and systems technology than we do. We may not be able to competesuccessfully against current and future competitors or address increasedcompetitive pressures.

 

Furthermore, attempts have been made in the past to develop and marketsynthetic stones and gems to compete in the market for gemstones and gemstonejewelry. We expect such efforts to continue in the future. If any such effortsare successful in creating widespread demand for synthetic or alternativegemstone products, demand and price levels for our products could decline andour business and results of operations would be substantially harmed.

 

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

 

Luxury products, such as jewelry, are discretionary purchases forconsumers. The volume and dollar amount of such purchases may be affected byadverse trends in the general economy and consumer perceptions of those trends,and purchases may significantly decrease during economic downturns. The successof our business depends in part on macroeconomic factors, such as employmentlevels, salary levels, tax rates, and credit availability, all of which affectdisposable income and consumer spending. Any reduction in disposable income orconsumer spending may affect us more significantly than companies in otherindustries.

 

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

 

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

 

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

 

We had $15.9 million in inventory as of December 31, 2005. Ifour sales increase, we will be required to increase our inventoryproportionately. Consumer tastes and preferences for jewelry products canchange rapidly, thereby exposing us to significant inventory risks. Currently,because the products we sell typically consist of closeout merchandise frommanufacturers, distributors, and other suppliers, we have less control over thespecific items that we offer for sale than we would if we primarily orderedgoods for manufacture for us. In addition, it is important that we are able topurchase jewelry that we perceive to be in demand. The demand for specificproducts can change between the time we order items and when we sell them. As aresult, we may be required to take significant inventory markdowns, which couldreduce our gross margin, if we do not accurately predict these trends or if weoverstock unpopular merchandise.

 

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

 

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

 

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

 

The jewelry industry is affected by fluctuations in the prices ofprecious metals and precious and semi-precious stones. The availability andprices of gold, silver, platinum, and other precious metals and precious andsemi-precious stones

 

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may be influenced by such factors as cartels, political instability inexporting countries, changes in global demand, and inflation. Shortages ofthese materials or an increase in their prices could reduce the quantity ofproducts we have available for sale and our ability to sell our products formore than our cost, causing reduced sales or lower margins.

 

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

 

Our business depends in part on the efficient and uninterruptedoperation of our computer and communications hardware. The servers and otherhardware necessary to operate our website, including our auction and biddingsystems, are located at a single third-party co-location facility in downtown Los Angeles. We rely on that facility toprovide Internet access with the speed, capacity, and reliability we require.Our servers and other hardware that run our transaction processing, orderfulfillment, and office administration tasks are located at our headquarters.Our servers and other hardware are vulnerable to damage or interruption fromhuman error, fire, flood, power loss, telecommunications failure, terrorist attacks,acts of war, break-ins, earthquakes, and similar events. We do not currentlyhave redundant systems in multiple locations or a formal disaster recoveryplan, and our business interruption insurance may be insufficient to compensateus for any losses that may occur. In addition, our servers are vulnerable tocomputer viruses, physical or electronic break-ins, and similar disruptions,which could lead to interruptions, delays, loss of critical data, the inabilityto accept and fulfill customer orders, or the unauthorized disclosure ofconfidential customer data. System disruptions or failures would also create alarge number of customer questions and complaints that need to be addressed byour customer service support personnel. The occurrence of any of the foregoingrisks could substantially harm our business and results of operations.

 

Although our systems have been designed around industry-standardarchitectures to reduce downtime in the event of outages or catastrophicoccurrences, they remain vulnerable to damage or interruption from earthquakes,floods, fires, power loss, telecommunication failures, terrorist attacks,computer viruses, computer denial-of-service attacks, and similar events.

 

***We may not be able to increaseour capacity or respond to rapid technological changes in a timely manner orwithout service interruptions, which may harm our business.***

 

We may not be able to accommodate any substantial growth in traffic oruser demand on our website, network infrastructure, and transaction processingsystems in a timely manner or without substantial costs. If we are unable toupgrade our existing technology, network infrastructure, and transactionprocessing systems to accommodate any increased sales volume, our potentialcustomers may be dissatisfied and may purchase merchandise from ourcompetitors. We may also fail to provide enough capacity in our customerservice and sales support functions to provide a high level of customerservice. A failure to implement new systems and increase customer servicecapacity effectively could adversely affect our sales. Enhancement of ourwebsite, network infrastructure, and transaction processing systems willrequire us to spend a significantly higher amount than we have in the past.Moreover, to date our spending in these areas as a percentage of revenue hasbeen lower than industry averages. We anticipate increasing our systemexpenditures to accommodate these needs in the future.

 

We also intend to introduce additional or enhanced features andservices to retain current customers and attract new customers to our website.We may experience difficulties that could delay or prevent us from introducingnew features and services. If we introduce a feature or a service that is notfavorably received, our current customers may not use our website as frequentlyand we may not be successful in attracting new customers. These new features orservices

 

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also may contain errors that are discovered only after their introduction,and we may need to modify significantly the design of these features orservices to correct errors.

 

***Our growth will depend on ourability to increase the popularity of our website.***

 

We believe that continuing to increase the popularity of our website willbe critical to expanding our business. Promoting and positioning our websitewill depend largely on the success of our marketing efforts and our ability toprovide a variety and sufficient quantity of high-quality products atattractive prices in a convenient manner. Promoting our website will require usto increase our marketing budget and otherwise increase our financialcommitment to creating and maintaining brand loyalty among users. Brandpromotion activities may not yield increased revenue, and even if they do, anyincreased revenue may not offset the expenses we incur in building our websitepopularity and our brand. If we do attract new users to our website, they maynot conduct transactions on a frequent basis or in sufficient dollar amounts. Ifwe fail to promote and maintain our website or incur substantial expenses in anunsuccessful attempt to promote and maintain our brand, our business would beharmed.

 

***We anticipate expanding ourinternational sales activities, causing our business to become increasinglysusceptible to numerous risks that could affect our profitability.***

 

In 2005, 19.2% of our net revenue was generated by customers whoresided outside of the United States. We plan, over time, to expand our reachinto international markets. We do not, however, currently have any overseasfulfillment, distribution, or server facilities or any website contentlocalized for foreign markets. We cannot be certain that we will be able toexpand our global presence. In addition, there are certain risks associatedwith doing business on an international basis, including regulatoryrequirements, legal uncertainty regarding liability, tariffs, and other tradebarriers, longer payment cycles, and potentially adverse tax consequences, anyof which could adversely affect our business. We also may be subject toincreased risks relating to foreign currency exchange rate fluctuations.

 

***Our ability to grow ourbusiness will be impaired by delays, interruptions, or failures of theInternet.***

 

Our success depends on the continued growth and maintenance of theInternet. The Internet has experienced, and is likely to continue toexperience, significant growth in the numbers of users and amount of traffic.If Internet usage continues to grow as anticipated, the infrastructure may notbe able to support the level of usage and its performance and reliability maydecline. If outages or delays on the Internet increase, overall Internet usagecould grow more slowly or decline. In addition, the performance of the Internetmay be harmed by increased number of users or bandwidth requirements or byviruses, worms, and similar issues. The Internet has experienced a variety ofoutages and other delays as a result of damage to portions of itsinfrastructure, and it could face outages and delays in the future. Theseoutages and delays could reduce the level of Internet usage.

 

***We depend on the continuedgrowth and acceptance of online commerce.***

 

The business of buying and selling goods over the Internet isrelatively new and dynamic. Our success depends on the widespread acceptanceand use of the Internet as an effective medium for commerce by consumers. Theacceptance and use of the Internet may not continue to expand as expected, anda sufficient broad base of consumers necessary for its continued growth may notadopt the Internet as a medium for commerce.

 

Consumers who historically have used traditional means of commerce mayhave concerns about privacy, the inability to physically inspect merchandisebefore buying, delivery time, product damage during shipment, and the costs andinconvenience involved in returning purchased items, which may inhibit theircrossover to e-commerce. In order to

 

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expand our user base, we must appeal to and acquire consumers whohistorically have used traditional means of commerce to purchase goods. Ifthese new customers execute fewer or lower dollar amounts of orders than ourhistorical users, and we are unable to gain efficiencies in our operating costs,including the cost of acquiring new customers, our business and profits couldbe adversely affected.

 

***Our failure to protectconfidential information of our customers and our network against securitybreaches could damage our reputation and substantially harm our business andresults of operations.***

 

A significant barrier to online commerce and communications is thesecure transmission of confidential information over public networks. Thirdparties may have the technology or expertise to breach the security of customertransaction data. Our security measures may not prevent security breaches thatcould result in substantial harm to our business and results of operations anddamage to our reputation. Currently, a majority of our sales are billed to ourcustomers’ credit card accounts directly. Under current credit card practices,we are liable for fraudulent credit card transactions because we do not obtaincardholder signatures. We rely on encryption and authentication technologylicensed from third parties to effect secure transmission of confidentialinformation, including credit card numbers. We do not currently carry insuranceagainst this risk. Advances in computer capabilities, new discoveries in thefield of cryptography, or other developments may result in a compromise orbreach of the technology we use to protect customer transaction data. Inaddition, anyone who is able to circumvent our security measures couldmisappropriate proprietary information or cause interruptions in ouroperations. Any such compromise of our security could damage our reputation andbrand and expose us to a risk of loss or litigation and possible liability,which would substantially harm our business and results of operations.

 

***Increased product returns andthe failure to predict product returns could substantially harm our businessand results of operations.***

 

Historically, we have experienced a very low rate of product returns.These rates of return may increase in the future, however, as we expand ourbusiness and product offerings. Any significant increase in product returnsabove our return assumptions and allowances could substantially harm ourbusiness and results of operations.

 

***Our inventory is vulnerable todamage or loss caused by fire, flood, earthquakes, and similar events, and weface the risk of theft of our products from inventory or during shipment.***

 

All of our inventory is stored at our warehouse/office facility inCulver City, California. Consequently, our merchandise supply is vulnerable tofire, flood, earthquakes, and similar events that may impact our facility. Anydamage to or loss of all or a significant portion of our inventory could causesignificant delays in shipment of goods to our customers, resulting in negativepublicity about and diminished customer confidence in our website. In addition,we may experience theft of our products while they are being held in inventoryor during the course of their shipment to our customers by third-partycarriers. We have implemented security measures to prevent such theft andmaintain insurance to cover losses resulting from theft. Nevertheless, we couldincur significant losses from theft, which would substantially harm ourbusiness and results of operations, if our security measures fail, lossesexceed our insurance coverage, or we are not able to maintain insurance at areasonable cost.

 

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

 

Customer complaints or negative publicity about our customer servicecould severely diminish consumer confidence in and the use of our website.Effective customer service requires significant personnel expense, and thisexpense, if not

 

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managed properly, could significantly impact our profitability. Thefailure to manage or train our customer service representatives properly couldcompromise our ability to handle customer inquiries and complaints effectively.If we do not handle customer inquiries and complaints effectively, we may losecustomer confidence. As a result, our revenue could suffer and our operatingmargin may decrease.

 

***Increases in credit cardprocessing fees could increase our costs.***

 

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

 

***Our limited operating historymakes it difficult for us to forecast accurately net revenue and appropriatelyplan our expenses.***

 

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

 

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

 

Historically, sales in the jewelry industry are seasonal and have beenhigher in the fourth quarter of the calendar year as a result of higherconsumer spending during the December holiday season. Approximately 26.0%,29.3%, and 33.9% of our net revenue in 2003, 2004, and 2005, respectively, wasgenerated during the fourth quarter. As we continue to grow, we expect toexperience more pronounced seasonal fluctuations in our net revenue andanticipate a disproportionate amount of our revenue will occur in the fourthquarter. In anticipation of any increased sales activity during the fourthquarter, we may incur significant additional expenses, including higher salesand marketing costs and additional staffing in our fulfillment and customersupport operations. If we were to experience lower than expected sales during anyfuture fourth quarter, it would have a disproportionately large impact on ourresults of operations for that year. In the future, our seasonal sales patternsmay become more pronounced, may strain our personnel and fulfillmentactivities, and may cause a shortfall in sales compared with expenses in agiven period, which would substantially harm our business and results ofoperations.

 

***Sales growth in prior periodsmay not be indicative of our future growth.***

 

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

 

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***We have grown quickly, and our business willsuffer if we fail to manage our growth.***

 

We have expanded our operations at a rapid pace. This expansion hasplaced a significant strain on our management, operations, and financialresources. We anticipate adding key personnel in the future, includingmanagerial, technical, and operations personnel. In order to manage any furthergrowth of our operations, we also will be required to improve existing andimplement new transaction-processing, operational and financial systems,procedures, and controls. If we are unable to manage growth effectively, ourbusiness and results of operations will be harmed.

 

***Descriptions of our jewelry items are notguarantees and may confuse, mislead, or disappoint our customers.***

 

In an effort to provide accurate descriptions of jewelry posted on ourwebsite, we provide appraisal summaries from third-party gemologicallaboratories for some of our jewelry items. All other jewelry and watchdescriptions are provided by our full-time Gemological Institute of America, orGIA, trained gemologists and several experienced product specialists. Althoughwe attempt to provide a complete and accurate description of each jewelry itemwe offer, there is a subjective component involved with respect to assessingthe clarity, color, and carat characteristics of diamonds and other gemstones.In addition, mistakes or omissions of important information in our descriptionsmay occur. Even if our descriptions are accurate, buying a product online maylead to disappointment resulting in returned merchandise. For example, acustomer may determine that a piece does not have the expected look, feel, andoverall appearance of the merchandise that the buyer envisioned from thewebsite photograph.

 

Additionally, in response to customer requests and as a courtesy toresellers, we provide “Compare” and/or “Close Now” prices for jewelry itemslisted on our website. While Compare and Close Now prices are comparable withthose values found on many competitor Internet auction sites, such as Yahoo!Auctions and eBay, they are not meant to reflect fair market values ormanufacturer suggested retail prices, and in fact, may be higher than pricesfound in local retail stores. As a consequence, perceived misrepresentations initem descriptions by disappointed buyers may occur, resulting in negativepublicity about and diminished customer confidence in our website.

 

***We may not be able to maintain our domainname uniqueness.***

 

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

 

***We may be unable to protect or enforce ourown intellectual property rights adequately, and we may become subject tointellectual property litigation.***

 

We regard the protection of our trademarks, copyrights, patents, domainname, trade dress, and trade secrets as critical to our success. We rely on acombination of trademark, copyright, patent, trade dress, and trade secret lawsto protect our intellectual property rights. We also have entered intoconfidentiality and invention assignment agreements with our employees andcontractors and nondisclosure agreements with parties with whom we conductbusiness in order to limit access to and disclosure of our proprietaryinformation. These contractual arrangements and other steps we have taken toprotect our intellectual property may not prevent misappropriation of ourintellectual property or deter independent development of similar intellectualproperty by others. We also are pursuing the registration of our domain name,

 

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trademarks, and service marksin the United States and internationally. Effective trademark, copyright,patent, trade dress, trade secret, and domain name protection is very expensiveto maintain and may require litigation. We must protect our trademarks,copyrights, patents, and domain names in an increasing number of jurisdictions,a process that is expensive and may not be successful in every location.

 

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

 

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

 

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

 

***Various legal rules and regulationsrelated to privacy and the collection, dissemination and security of personalinformation may adversely affect our marketing efforts.***

 

We are subject to increasing regulation at the federal, state, andinternational levels relating to privacy and the use of personal userinformation designed to protect the privacy of personally identifiableinformation as well as to protect against its misuse. These laws include theFederal Trade Commission Act, the CAN-SPAM Act of 2003, the Children’s OnlinePrivacy Protection Act, the Fair Credit Reporting Act, the Homeland SecurityAct, and related regulations. Several states have proposed legislation thatwould limit the use of personal information gathered online or require onlineservices to establish privacy policies. Moreover, proposed legislation in theUnited States and existing laws in foreign countries require companies toestablish procedures to notify users of privacy and security policies, obtainconsent from users for collection and use of personal information, and/orprovide users with the ability to access, correct, and delete personalinformation stored by companies. These regulations and other laws, rules, andregulations enacted in the future may adversely affect our ability to collect,disseminate, or share demographic and personal information about users and ourability to e-mail or telephone users, which could be costly and adverselyaffect our marketing efforts**.**

 

***We may be subject to liability for past salesand our future sales may decrease if we are required to collect sales and usetaxes on the products we sell.***

 

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

 

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***We may be subject to regulations governingthe conduct and liability of auctioneers.***

 

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

 

***We are subject to regulations relating toconsumer privacy.***

 

Several states have proposed, and California, Minnesota, Utah, andVermont have recently passed, legislation that would limit the uses of personaluser information gathered online or offline. Many states already have such lawsand continually consider strengthening them, especially against onlineservices. However, the Fair Credit Reporting Act, or FCRA, a federal statuteenacted in 1970 to protect consumer privacy, includes a provision preemptingconflicting state laws on the sharing of information between corporateaffiliates. The preemptive provisions of FCRA were permanently extended in2002, thereby ensuring that we are not subject to the laws of each individualstate with respect to matters within the scope of FCRA, but remain subject tothe other provisions of FCRA.

 

The Federal Trade Commission also has settled several proceedingsagainst companies regarding the manner in which personal information iscollected from users and provided to third parties. Specific statutes intendedto protect user privacy have been passed in many foreign jurisdictions.Compliance with these laws, given the tight integration of our systems across differentcountries and the need to move data to facilitate transactions among our users,such as payment companies and shipping companies, is both necessary anddifficult. Failure to comply could subject us to lawsuits, fines, criminalpenalties, statutory damages, adverse publicity, and other losses that couldharm our business. Changes to existing laws or the passage of new laws intendedto address these issues could directly affect the way we do business or couldcreate uncertainty on the use of the Internet. This could reduce demand for ourproducts, increase the cost of our doing business, expose us to litigationcosts, increase our service or delivery costs, or otherwise harm our business.

 

***New and existing regulations could harm ourbusiness.***

 

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

 

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In addition, because our products are available over the Internet inmultiple states and because we sell merchandise to consumers residing inmultiple states, we could be required to qualify to do business as a foreigncorporation in each state in which our products are available. Our failure toqualify as a foreign corporation in a jurisdiction in which we are required todo so could subject us to penalties. Any new legislation or regulation, or theapplication of laws or regulations from jurisdictions whose laws do notcurrently apply to our business could have a material adverse affect on ourbusiness.

 

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

 

Our performance depends substantially upon David Zinberg, our Chairmanof the Board, President, and Chief Executive Officer, who has extensiveexperience with the purchase and sale of jewelry, art, and collectibles throughnon-traditional channels, including through liquidation. We rely on Mr. Zinbergto make critical operational decisions on a daily basis, such as productofferings and purchases, and to make key strategic plans. We do not currentlyhave key-man life insurance on any of our executive officers. We have anemployment agreement with Mr. Zinberg extending through 2007. The loss ofthe services of Mr. Zinberg would adversely affect our business andoperations.

 

***Holders of common stock issued by us in priorofferings are entitled to rescind their purchases.***

 

From our inception until mid-2003, we raised over $20.5 million ingross equity capital by selling shares of our common stock to approximately 830investors at prices ranging from $4.00 to $6.00 per share with a weightedaverage share price of $4.50. We also issued shares of common stock to about 30persons in exchange for services and other non-cash consideration valued inexcess of $5.5 million and issued options to purchase common stock toapproximately 250 individuals at a weighted average share price of $4.45. Toassist us in selling our common stock, we compensated individuals who were notlicensed as broker-dealers under the Securities Exchange Act of 1934, or understate securities laws. After conducting these sales of our securities, wedetermined that these sales were not exempt from the registration requirementsunder the Securities Act of 1933 and similar provisions of laws of the statesin which our stockholders reside. In addition, our employees who receivedcompensation for selling our common stock were required to be licensed asbroker-dealers with the Securities and Exchange Commission, or SEC, and variousstate authorities, but they were not so licensed. In such situations, a numberof remedies may be available to regulatory authorities and the investors whopurchased common stock in those offerings, including a right of rescission,civil penalties, a restraining order or injunction, and a court order to payrestitution and costs.

 

In order to address the contingent liabilities, we plan to make arescission offer to our stockholders who are or were residents of Alabama,Arkansas, Alaska, Arizona, California, Colorado, Connecticut, Florida, Georgia,Hawaii, Iowa, Idaho, Illinois, Indiana, Kansas, Kentucky, Louisiana, Massachusetts,Maryland, Maine, Michigan, Minnesota, Missouri, Mississippi, Montana, NorthCarolina, North Dakota, Nebraska, New Hampshire, New Jersey, New Mexico,Nevada, New York, Ohio, Oregon, Pennsylvania, South Carolina, South Dakota,Tennessee, Texas, Utah, Virginia, Washington, Washington, DC, West Virginia,Wisconsin and Wyoming. If our rescission offer is accepted by all offerees, wecould be required to make an aggregate payment to the holders of these sharesof up to approximately $20.5 million, in addition to statutory interest of$11.6 million, as of December 31, 2005. To the extent thatstockholders accept our rescission offer and we cannot fund such purchases withother resources, we may utilize a portion of the net proceeds of our plannedIPO. In addition, regulators could impose monetary fines or other sanctions asprovided under these laws.

 

Federal securities laws do not provide that a rescission offer willterminate a purchaser’s right to rescind a sale of stock that was notregistered as required or was not otherwise exempt from such registrationrequirements. If any or all of the offerees reject the rescission offer, we maycontinue to be liable under federal and state securities laws for up to an

 

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amount equal to the value of all options and common stock granted orissued since the date of issuance plus any statutory interest we may berequired to pay. See “Management’s Discussion and Analysis of Financial Conditionand Results of Operations—Rescission offer.”

 

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

 

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

 

***The concentration of our capital stockownership with our founder and executive officers and directors and theiraffiliates will limit your ability to influence corporate matters.***

 

Our founder, executive officers, and directors together ownapproximately 37.6% of our common stock. As a result, they have significant influenceover our management and affairs and over all matters requiring stockholderapproval, including the election of directors and the approval of significantcorporate transactions, such as a merger or a sale of our company or itsassets, for the foreseeable future. This concentrated control will limit theability of other stockholders to influence corporate matters. Because of this,we may take actions that some of our stockholders do not view as beneficial. Asa result, the market price of our common stock could be adversely affectedbecause stockholders may not view favorably the concentration of control in thehands of management.

 

***Sale of substantial number of shares that areeligible for sale could adversely affect the price of our common stock.***

 

The market price of our common stock could decline as a result of salesof a large number of shares of our common stock in the market or a perceptionthat such sales may occur. As of December 31, 2005, we had 23,312,500 shares ofcommon stock outstanding. Except for any shares that are held by ouraffiliates, as that term is defined in Rule 144 under the Securities Actof 1933, which generally includes our directors, officers, and certainprincipal stockholders, substantially all of the shares outstanding will befreely tradable without restriction or further registration under the securitieslaws. Shares held by affiliates of our company are subject to the resalelimitations of Rule 144 described below.

 

In general, under Rule 144 as currently in effect, any person, orpersons whose shares are aggregated for purposes of Rule 144, whobeneficially owns restricted securities with respect to which at least one yearhas elapsed since the later of the date the shares were acquired from us, orfrom an affiliate of ours, is entitled to sell within any three-month period anumber of shares that does not exceed the greater of 1% of the then outstandingshares of our common stock

 

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and the average weekly trading volume in common stock during the fourcalendar weeks preceding such sale. Sales under Rule 144 also are subjectto certain manner-of-sale provisions and notice requirements and to theavailability of current public information about us.

 

As of December 31, 2005, we had outstanding options to purchase8,342,000 shares of common stock. We plan to register for offer and sale theshares of common stock that are reserved for issuance pursuant to options.Shares covered by such registration statements upon the exercise of stockoptions or warrants generally will be eligible for sale in the public market,except that affiliates will continue to be subject to volume limitations andother requirements of Rule 144. The issuance or sale of such shares coulddepress the market price of our common stock.

 

***The market price for our common stock may bevolatile, and you may not be able to sell our stock at a favorable price or atall.***

 

Presently, there is no public market for our common stock. An activepublic market for our common stock may not develop or be sustained after ourplanned IPO. Many factors could cause the market price of our common stock torise and fall, including the following:

 

•                  actual or anticipated fluctuations in our operatingresults;

 

•                  the level and quality of any research analystcoverage for our common stock;

 

•                  the financial guidance we may provide to the public,any changes in such guidance, or our failure to meet such guidance;

 

•                  changes in financial estimates by industry orsecurities analysts or our failure to meet such estimates;

 

•                  various market factors or perceived market factors,including rumors, whether or not correct, involving us, our customers, oursuppliers, or our competitors;

 

•                  fluctuations in the supply and costs acquiring thejewelry we sell;

 

•                  the costs incurred in shipping our products to ourcustomers;

 

•                  the gain or loss of significant suppliers;

 

•                  introductions of new products or new pricingpolicies by us or by our competitors;

 

•                  recruitment or departure of key personnel;

 

•                  changes in market valuations or earnings of ourcompetitors;

 

•                  developments with respect to intellectual propertyrights;

 

•                  market conditions and trends in the online commerceindustry and the economy as a whole; and

 

•                  acquisitions or strategic alliances by us or by ourcompetitors.

 

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In addition, stocks of Internet-related and online commerce companieshave experienced significant price and volume fluctuations that often have beenunrelated or disproportionate to these companies’ operating performance. Publicannouncements by us or other such companies concerning, among other things,their performance, accounting practices, or legal problems could cause themarket price of our common stock to decline regardless of our actual operatingperformance.

 

***Our charter documents and Delaware law couldmake it more difficult for a third party to acquire us, and discourage atakeover.***

 

We plan to reincorporate in Delaware. Our planned Delaware certificate of incorporation and the DelawareGeneral Corporation Law, or DGCL, contain provisions that may have the effectof making more difficult or delaying attempts by others to obtain control ofour company, even when these attempts may be in the best interests of our stockholders.Our certificate of incorporation also authorizes our Board of Directors,without stockholder approval, to issue one or more series of preferred stock,which could have voting and conversion rights that adversely affect or dilutethe voting power of the holders of common stock. Delaware law also imposesconditions on certain business combination transactions with “interestedstockholders.” Our certificate of incorporation divides our Board of Directorsinto three classes, with one class to stand for election each year for athree-year term after the initial election. The classification of directorstends to discourage a third party from initiating a proxy solicitation orotherwise attempting to obtain control of our company and may maintain the incumbencyof our Board of Directors, as this structure generally increases the difficultyof, or may delay, replacing a majority of directors. Our bylaws authorize ourBoard of Directors to fill vacancies or newly created directorships. A majorityof the directors then in office may elect a successor to fill any vacancies ornewly created directorships.

 

***Failure to achieve and maintain effectiveinternal controls in accordance with Section 404 of the Sarbanes-Oxley Actof 2002 could have a material adverse effect on our business and stock price.***

 

Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002,beginning with our Annual Report on Form 10-K for the fiscal year ending December 31,2007 we will be required to furnish a report on our internal control overfinancial reporting. In order to achieve compliance with Section 404 ofSarbanes-Oxley within the prescribed period, we will need to engage in aprocess to document and evaluate our internal control over financial reporting,which will be both costly and challenging. There is a risk that neither we norour independent auditors will be able to conclude at December 31, 2007that our internal controls over financial reporting are effective as requiredby Section 404 of Sarbanes-Oxley.

 

In addition, during the course of our testing, we may identifydeficiencies that we may not be able to remediate in time to meet the deadlineimposed by Sarbanes-Oxley for compliance with the requirements of Section 404.Furthermore, if we fail to achieve and maintain the adequacy of our internalcontrols, as such standards are modified, supplemented, or amended from time totime, we may not be able to ensure that we can conclude on an ongoing basisthat we have effective internal controls over financial reporting in accordancewith Section 404 of Sarbanes-Oxley. Effective internal controls,particularly those related to revenue recognition, are necessary for us toproduce reliable financial reports and are important to helping preventfinancial fraud. If we cannot provide reliable financial reports or preventfraud, our business and results of operations could be harmed, investors couldlose confidence in our reported financial information, and the trading price ofour stock could drop significantly.

 

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**ITEM 1B. Unresolved Staff Comments**

 

Not applicable.

 

**ITEM2.  Properties**

 

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

 

**ITEM3.  Legal Proceedings**

 

From time to time, we may be involved in litigation relating to claimsrising out of our ordinary course of business. We are not currently a party toany material legal proceedings.

 

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

 

On December 15, 2005, the Company  held its annual meeting of shareholders, atwhich time the following directors were elected:  David Zinberg, Lawrence Kong and Garry Itkin.  The number of votes cast for each of thedirectors was 15,155,000, the number of votes against was 0 and the number ofabsentions and broker non-votes was 0.  Effective March 15, 2006, the Board was expanded to five (5) membersand two (2) additional directors, Peter Hanelt and Man Jit Singh, wereappointed to the Board.

 

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**Part II**

 

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

 

There is no established public trading marketfor any of the Company’s securities.  As of December 31, 2005, thenumber of shares of our common stock that is subject to outstanding options orwarrants to purchase common stock is 8,342,000.  As of December 31,2005, there were 23,312,500 shares of common stock outstanding.

 

**Holders**

 

As of December 31, 2005, there were1,132 holders of record of our common stock and no holders of record of our Class Bcommon stock.  As of December 31, 2005, we had 97 holders of stockoptions exercisable for shares of our common stock.

 

**Dividends**

 

We have never declared or paid cash dividendson our common stock.  We anticipate that in the future we will retain anyearnings for the development and operation of our business.  Accordingly,we do not anticipate declaring or paying any cash dividends in the foreseeablefuture.  Please also review Item 11 “Description of Registrant’sSecurities to be Registered” herein.

 

**Equity Compensation Plan Information**

 
| **Plan category**                                          | ** ** | **Number of securities  to be issued upon  exercise of  outstanding options,  warrants and rights (1)** | ** ** | **Weighted-average  exercise price of  outstanding options,  warrants and rights** | ** ** | **Number of securities  remaining available for  future issuance under  equity compensation  plans (excluding  securities reflected in  column (a))** | ** ** |
|-----------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| **Equity compensation plans approved by  security holders**     |       |                                                                                                                                                      |       |                                                                                                        |       |                                                                                                                                                                                                         |       |
| 2002 Special Stock Option Plan                                  |       | 1,500,000                                                                                                                                                 |       | $                                                                                                           | 3.96       |                                                                                                                                                                                                         | 0          |   |
|                                                            |       |                                                                                                                                                      |       |                                                                                                        |       |                                                                                                                                                                                                         |       |
| **Equity compensation plans not approved by  security holders** |       |                                                                                                                                                      |       |                                                                                                        |       |                                                                                                                                                                                                         |       |
| 2001 Stock Option Plan                                          |       | 792,000                                                                                                                                                   |       | $                                                                                                           | 6.00       |                                                                                                                                                                                                         | 108,000    |   |
| **Total**                                                       |       |                                                                                                                                                      |       |                                                                                                        |       |                                                                                                                                                                                                         |       |

 

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(1)  The total number of shares of common stockto be issued upon exercise of all outstanding stock options, warrants andrights is 8,342,000.

 

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**ITEM 6. Selected Financial Data**

 

The selected consolidatedfinancial data presented below has been derived from our consolidated financialstatements. The statement of operations data for each of the fiscal years endedDecember 31, 2003, 2004, and 2005 and the balance sheet data at December 31,2004 and 2005 are derived from our audited financial statements that areincluded in this report. The statement of operations data for the years ended December 31,2002 and the balance sheet data at December 31, 2002 and 2003 are derivedfrom audited financial statements that are not included in this report. Thestatement of operations data for the year ended December 31, 2001 and thebalance sheet data at December 31, 2001 are derived from our unauditedfinancial statements that are not included in this report. The historicalresults presented below are not necessarily indicative of the results to beexpected in any future period.

 

You should read thisinformation together with “Management’s discussion and analysis of financialcondition and results of operations” and our financial statements and therelated notes included elsewhere in this report.

 
| **(in thousands, except share and per** | ** ** | **Years ended December 31,** | ** ** |
|------------------------------------------------------------------|------------|---------------------------------------------|------------|
| **share data)**                                             | ** ** | **2001**                                    | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                                                       | ** ** | **(unaudited)**                             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Statement of Operations Data:**                                |       |                                        |       |   |   |   |   |   |   |   |   |
| Net revenue                                                      |       | $                                           | 7,423      |   | $ | 34,778 |   | $ | 47,665 |   | $ | 65,324 |   | $ | 90,579 |   |
| Cost of revenue                                                  |       | 6,210                                       |       | 32,315 |   | 42,188 |   | 53,072 |   | 71,257 |   |
| Gross profit                                                     |       | 1,213                                       |       | 2,463 |   | 5,477 |   | 12,252 |   | 19,322 |   |
| Operating expenses:                                              |       |                                        |       |   |   |   |   |   |   |   |   |
| General and administrative                                       |       | 3,512                                       |       | 10,336 |   | 9,259 |   | 8,800 |   | 10,938 |   |
| Sales and marketing                                              |       | 1,244                                       |       | 1,071 |   | 1,960 |   | 2,542 |   | 5,078 |   |
| Rescission and pre-IPO costs                                     |       | —                                      |       | — |   | — |   | — |   | 442 |   |
| Depreciation and amortization                                    |       | 571                                         |       | 91 |   | 61 |   | 139 |   | 157 |   |
| Total operating expenses                                         |       | 5,327                                       |       | 11,498 |   | 11,280 |   | 11,481 |   | 16,615 |   |
| Income (loss) from operations                                    |       | (4,114                                      | )          | (9,035 | ) | (5,803 | ) | 771 |   | 2,707 |   |
| Interest income (expense), net                                   |       | —                                      |       | (65 | ) | (27 | ) | — |   | 22 |   |
| Income tax expense                                               |       | —                                      |       | — |   | — |   | — |   | 82 |   |
| Net income (loss)                                                |       | $                                           | (4,114     | ) | $ | (9,100 | ) | $ | (5,830 | ) | $ | 771 |   | $ | 2,647 |   |
| Net income (loss) per common share:                              |       |                                        |       |   |   |   |   |   |   |   |   |
| Basic                                                            |       | $                                           | (0.17      | ) | $ | (0.35 | ) | $ | (0.21 | ) | $ | 0.03 |   | $ | 0.11 |   |
| Diluted                                                          |       | $                                           | (0.17      | ) | $ | (0.35 | ) | $ | (0.21 | ) | $ | 0.03 |   | $ | 0.11 |   |
| Weighted average number of shares  outstanding—diluted      |       | 24,099,241                                  |       | 25,924,016 |   | 27,283,233 |   | 28,014,361 |   | 24,858,535 |   |

 
| ** **                                | ** ** | **At December 31,** | ** ** |
|-------------------------------------------|------------|-------------------------------|------------|
| ** **                                | ** ** | **2001**                      | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** |
| **Balance Sheet Data:**                   |       |                          |       |   |   |   |   |   |   |   |   |
| Cash and cash equivalents                 |       | $                             | —     |   | $ | — |   | $ | 10 |   | $ | 5 |   | $ | 7 |   |
| Working capital (deficit)                 |       | (479                          | )          | (1,441 | ) | (3,148 | ) | (2,164 | ) | 1,009 |   |
| Total assets                              |       | 1,132                         |       | 9,836 |   | 7,270 |   | 12,490 |   | 17,746 |   |
| Bank overdraft                            |       | 463                           |       | 5,135 |   | 4,198 |   | 6,503 |   | 5,315 |   |
| Total liabilities                         |       | 1,521                         |       | 10,765 |   | 9,355 |   | 13,570 |   | 15,963 |   |
| Total stockholders’ equity (deficit) |       | (389                          | )          | (929 | ) | (2,085 | ) | (1,080 | ) | 1,783 |   |
|                                           |            |                               |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**ITEM 7.  Management's Discussionand Analysis of Financial Condition and Results of Operations**

 

**Management'sdiscussion and analysis of financial condition and results of operations**

** **

You should read the followingdiscussion and analysis in conjunction with our financial statements andrelated notes. This discussion contains forward-looking statements that involverisks, uncertainties, and assumptions. Our actual results may differ materiallyfrom those anticipated in these forward-looking statements as a result of avariety of factors, including those set forth under "Risk factors"and elsewhere in this prospectus.

 

**Overview**

 

We are a leading onlineretailer of jewelry, featuring a live auction format. We have established ourretail brand in the online marketplace by offering high-quality merchandise, aunique user-friendly shopping experience, and the opportunity for buyers toachieve significant cost savings versus traditional retail channels. A key toour success has been our ability efficiently and effectively to source closeoutmerchandise and rapidly respond to changing consumer demands for certainjewelry. We offer our products through a continuous live format, featuring"no reserve" auctions, a $1 minimum opening bid, and a unique30-second auction extension period that allows our auctions to continue untilall bids are received. The majority of our auctions are short-term, oftenlasting less than one hour, providing immediate gratification to our customersand encouraging frequent visits and active viewing of our website. Our productinventory includes gold, platinum, and silver jewelry set with diamonds,rubies, emeralds, sapphires, and other precious and semi-precious stones; andwatches. Through our website at www.bidz.com, we averaged daily sales ofapproximately 7,000 items with an average order size of $112 during 2005.

 

We sell to consumers lookingfor reliable bargains on jewelry. Because we purchase and retain all of ourjewelry inventory onsite, we can provide our customers with timely service anddelivery of their purchases. In addition, each item is inspected by one of ourtrained product specialists prior to its placement on our website, whichassures our customers of the quality of their purchases of our products. Weprovide a trustworthy and secure buying environment with a 15-day return policyon all merchandise. We believe that some of our customers are resellersintending to sell our goods in secondary markets, such as on eBay, at localauctions, and through other retail channels. These resellers have theopportunity to purchase products at lower prices than they would receive frommanufacturers or other distributors. Our auctions are conducted 24 hours aday, seven days a week. We also offer daily telephone customer support and24-hour e-mail customer support.

 

**CriticalAccounting Policies**

 

The preparation of ourfinancial statements requires us to make certain estimates and judgments thataffect amounts reported and disclosed in our financial statements and relatednotes. We base our estimates on historical experience and on other assumptionsthat we believe to be reasonable under the circumstances. Actual results maydiffer from these estimates. The following are the critical accounting policiesthat we believe require significant estimation and judgment.

 

*RevenueRecognition*

 

We derive our revenue from fivesources: merchandise sales, commission revenue, advertising revenue, shippingrevenue, and auction transaction fee revenue. In accordance with SAB 104, werecognize revenue from all five sources

 

 

36

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when the following revenuerecognition criteria are met: (1) persuasive evidence of an arrangementexists; (2) the product has been shipped or the service has been renderedand the customer takes ownership and assumes the risk of loss; (3) theselling price is fixed or determinable; and (4) collection of theresulting receivable is reasonably assured.

 

We recognize merchandise salesupon shipments made to consumers that are fulfilled from our warehouse. Wegenerally require online payment by credit card or other electronic paymentmethods at the point of sale. We record amounts received or billed prior toshipment of goods to customers as deferred revenue. We reduce gross sales byreturns, chargebacks from customers, and other discounts redeemed to obtainsuch sales.

 

We report shipping and handlingfees and costs in accordance with Emerging Issues Task Force ("EITF")issue No. 00-10, "Accounting for Shipping and Handling Fees andCosts." As such, in the Statement of Operations all amounts billed tocustomers by us related to shipping and handling are included in "Netrevenue" and our shipping and handling costs are included in "Cost ofrevenue."

 

We derive commissions revenuefrom sales of Certified Merchant merchandise that is owned by third parties andrecognize that revenue when services have been rendered. For commissionrevenue, we recognize as revenue only the commission portion of the price ourcustomers pay for the purchased products because we are acting as an agent insuch transactions. Commissions are also reduced by the impact of returns andother discounts redeemed to obtain such sales.

 

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

 

We include auction transactionfee revenue in net revenue. The auction transaction fee is a 3% fee charged toall customers on all payments.

 

*InventoryReserve*

 

We record reserves against ourinventory for estimated obsolescence or damage equal to the difference betweenthe cost of inventory and the estimated market value based upon assumptionsabout future demand and market conditions. We record reserves of 50% of thevalue of inventory held for more than six months and 100% of the value ofinventory held for more than one year. If actual market conditions are lessfavorable than those projected by us, specific reserves or additional inventorywrite-downs may be required.

 

*Return andAllowance Reserve*

 

We estimate potential futureproduct returns related to current period revenue. We analyze historicalreturns, current economic trends, and changes in customer demand and acceptanceof our products when evaluating the adequacy of the sales returns reserve andother allowances in any accounting period. If actual returns are greater thanour estimates, we will record additional returns and allowances in addition toour estimates, which will result in lower net revenue recorded during thatperiod.

 

*DeferredIncome Tax Allowance*

 

We recognize deferred taxassets and liabilities for the future tax consequences attributable todifferences between the financial statement carrying amounts of existing assetsand liabilities and their respective tax bases. Realization of the deferred taxasset depends on generating sufficient taxable income in future years. Wereduce deferred tax assets by a

 

 

37

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valuation allowance when webelieve it is more likely than not that some portion or all of the deferred taxassets will not be realized.

 

*Stock-BasedCompensation*

 

We account for our employeecompensation plans under the recognition and measurement provisions ofAccounting Principles Board Opinion No. 25, Accounting for Stock Issued toEmployees, and related interpretations. We expense stock-based compensation onthe date of grant since all options vest immediately.

 

In 2006, we will be adoptingthe FASB issued SFAS No.123 (revised 2004), "Share-based Payment"Statement (123R) requiring that share-based payment transactions be recognizedin the financial statements based on the fair value of the equity or liabilityinstrument issued.

 

We have recorded stock-basedcompensation representing the difference between the option exercise price andthe deemed fair value of our common stock on the grant date for financialreporting purposes. We determined the deemed fair value of our common stockbased upon the most recent private placement share price at the time of theoption grant. Had different assumptions or criteria been used to determine thedeemed fair value of our common stock, different amounts of stock-basedcompensation could have been reported.

 

Pro forma information regardingnet income (loss) attributable to common stockholders and net income (loss) pershare attributable to common stockholders is required in order to show our netincome (loss) as if we had accounted for employee stock options under the fairvalue method of SFAS No. 123, as amended by SFAS No. 148. Thisinformation is contained in Note 1 to our financial statements. The fairvalues of options and shares issued pursuant to our option plan at each grantdate were estimated using the Black-Scholes option pricing model.

 

**Descriptionof Our Revenue, Costs, and Expenses**

 

The following table presentsour historical results of operations for the periods indicated as a percentageof net revenue. 

 
| ** **                      | ** ** | **Years ended December 31,** | ** ** |
|---------------------------------|------------|-----------------------------------|------------|
| ** **                      | ** ** | **2003**                          | ** ** | **2004** | ** ** | **2005** | ** ** |
|                            |       |                              |       |   |   |   |   |
| Net revenue                     |       | 100.0                             | %          | 100.0 | % | 100.0 | % |
| Gross profit                    |       | 11.5                              |       | 18.8 |   | 21.3 |   |
| Operating  expenses:            |       |                              |       |   |   |   |   |
| General and administrative      |       | 19.4                              |       | 13.5 |   | 12.1 |   |
| Sales and marketing             |       | 4.1                               |       | 3.9 |   | 5.6 |   |
| Rescission and pre-IPO costs    |       | —                            |       | — |   | 0.4 |   |
| Depreciation and amortization   |       | 0.1                               |       | 0.2 |   | 0.2 |   |
| Total  operating expenses       |       | 23.6                              |       | 17.6 |   | 18.3 |   |
| Income  (loss) from operations  |       | (12.1                             | )          | 1.2 |   | 3.0 |   |
| Interest  income (expense), net |       | (0.1                              | )          | — |   | 0.0 |   |
| Income tax  expense             |       | —                            |       | — |   | 0.1 |   |
| Net income  (loss)              |       | (12.2                             | )%         | 1.2 | % | 2.9 | % |

 

 

38

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*Net Revenue*

 

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

 

The following table presentsour sources of revenue for the periods indicated as a percentage of netrevenue.

 
| ** **            | ** ** | **Years ended  December 31,** | ** ** |
|-----------------------|------------|-------------------------------|------------|
| ** **            | ** ** | **2003**                      | ** ** | **2004** | ** ** | **2005** | ** ** |
| Net revenue           |       |                          |       |   |   |   |   |
| Merchandise sales     |       | 82.5                          | %          | 89.5 | % | 88.6 | % |
| Shipping and handling |       | 15.9                          |       | 9.6 |   | 10.4 |   |
| Transaction fees      |       | 0.0                           |       | 0.0 |   | 0.7 |   |
| Commissions           |       | 1.1                           |       | 0.8 |   | 0.3 |   |
| Advertising           |       | 0.5                           |       | 0.1 |   | 0.0 |   |
|                  |       |                          |       |   |   |   |   |
| Total net  revenue    |       | 100.0                         | %          | 100.0 | % | 100.0 | % |

 

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

 

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

 
| ** **          | ** ** | **Years ended December 31,**            | ** ** |
|---------------------|------------|-----------------------------------------|------------|
| ** **          | ** ** | **2003**                                | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **          | ** ** | **(in thousands, except  percentages)** | ** ** |
| **Geographic area** | ** ** | **Amount**                              | ** ** | **Percent** | ** ** | **Amount** | ** ** | **Percent** | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| United  States      |       | $                                       | 41,382     |   | 86.8 | % | $ | 53,986 |   | 82.6 | % | $ | 73,199 |   | 80.8 | % |
| International       |       | 6,283                                   |       | 13.2 |   | 11,338 |   | 17.4 |   | 17,380 |   | 19.2 |   |
| Total               |       | $                                       | 47,665     |   | 100.0 | % | $ | 65,324 |   | 100.0 | % | $ | 90,579 |   | 100.0 | % |

 

*GrossProfit*

 

Our gross profit consists ofnet revenue less the cost of sales. Our cost of sales consists of the cost ofmerchandise sold to customers, inbound and outbound shipping costs, shippingsupplies, insurance on shipments, and credit card and other transaction feesassociated with payments.

 

*General andAdministrative Expenses*

 

Our general and administrativeexpenses consist primarily of payroll and related benefit costs for ouremployees. These expenses also include fulfillment, customer service,technology, professional fees, other general corporate expenses, and

 

 

39

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stock-based compensation,consisting substantially of stock option grants and stock grants to employeesand consultants. We anticipate that our compensation expense under SFASNo. 123 will increase.

 

*Sales andMarketing Expenses*

 

Our marketing expenses consistprimarily of costs associated with paid website searches, contextual marketing,e-mail campaigns, and affiliate programs. These marketing programs, which aredesigned to drive buyers to our website, are the most important factor inincreasing demand for our jewelry products and increasing net revenue. We willuse a significant portion of the proceeds of this offering to support theseefforts during the next 12 to 18 months. We expect our sales and marketingexpenses will grow at a faster rate than our revenue growth, as we expectincreasing demand for online marketing will increase the cost of such onlinemarketing.

 

**Results ofOperations**

 

**Comparisonof Year Ended December 31, 2005 with Year Ended December 31, 2004**

 

*Net Revenue*

 

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

 

*GrossProfit*

 

Gross profit increased 57.7% to$19.3 million in 2005 from $12.3 million in 2004. Gross profit as apercentage of net revenue increased to 21.3% in 2005 from 18.8% in 2004. Theincrease in gross profit as a percentage of net revenue resulted primarily frommore effective purchasing, implementation of a 3% auction transaction fee inNovember 2005, and increased margin on shipping and handling charges. Weexpect the 3% auction transaction fee will have a significant impact on thegross margin in 2006.

 

*General andAdministrative Expenses*

 

General and administrativeexpenses increased 24.3% to $10.9 million in 2005 from $8.8 millionin 2004. The increase in general and administrative expenses in 2005 was dueprimarily to a $1.5 million increase in payroll and payroll relatedexpenses, which included increasing the number of personnel on our technologydevelopment staff. General and administrative expenses as a percentage of netrevenue decreased to 12.1% in 2005 from 13.5% in 2004. We intend to continue toenhance our technology and information systems and expect these expenses toincrease in absolute dollars in future periods.

 

*Sales andMarketing Expenses*

 

Sales and marketing expensesincreased 99.8% to $5.1 million in 2005 from $2.5 million in 2004.This increase resulted primarily from an increased marketing campaign and costof online advertising to attract new buyers. Sales and marketing expenses as apercentage of net revenue increased to 5.6% in 2005 from 3.9% in 2004. Weexpect our sales and marketing expenses to continue to increase in absolutedollars, as we intend to continue increasing our online marketing campaign inorder to attract new customers.

 

 

40

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*Rescissionand Pre-IPO Costs*

 

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

 

**Comparisonof Year Ended December 31, 2004 with Year Ended December 31, 2003**

 

*Net Revenue*

 

Net revenue increased 37.0% to$65.3 million in 2004 from $47.7 million in 2003. This increase innet revenue was due primarily to an increase in the number of orders, partiallyoffset by a decrease in the average selling price per order. The increase inthe number of orders was primarily the result of the number of new buyers weattracted during 2004.

 

*GrossProfit*

 

Gross profit increased 123.7%to $12.3 million in 2004 from $5.5 million in 2003. The increase ingross profit in 2004 resulted primarily from increases in sales volume. Grossprofit as a percentage of net revenue increased to 18.8% in 2004 from 11.5% in2003. The increase in gross profit as a percentage of net revenue resultedprimarily from an increase in gross margin from merchandise sales, partiallyoffset by a decrease in gross margin from shipping and handling.

 

*General andAdministrative Expenses*

 

General and administrativeexpenses decreased 5.0% to $8.8 million in 2004 from $9.3 million in2003. The decrease was primarily due to lower stock-based compensationexpenses, which decreased $1.5 million to $232,000 in 2004 from$1.7 million in 2003, primarily as a result of a reduction in stock optionsissued and amortization of deferred stock compensation. This decrease waspartially offset by a $379,000 increase in payroll and payroll related expensesand a $485,000 increase in accounting and legal fees.

 

*Sales andMarketing Expenses*

 

Sales and marketing expensesincreased 29.7% to $2.5 million in 2004 from $2.0 million in 2003.The increase in sales and marketing expenses was caused by our increasedmarketing campaign to attract new buyers.

 

**QuarterlyOperations Data**

 

The following tables set forthquarterly statements of operations data for the eight quarters endedDecember 31, 2005, including amounts expressed as a percentage of netrevenue. This quarterly information is unaudited, but has been prepared on thesame basis as the annual financial statements and, in our opinion, reflects alladjustments necessary for a fair representation of the information for theperiods presented. This quarterly statement of operations data should be readin conjunction with our audited financial statements and the related notesincluded elsewhere in this prospectus. Results of operations for any quarterare not necessarily indicative of results for any future period.

 

Historically, sales in thejewelry industry are seasonal and have been higher in the fourth quarter as aresult of higher consumer spending during the December holiday season.Approximately 26.0%, 29.3%, and 33.9% of our net revenue in 2003, 2004, and2005, respectively, was generated during the fourth quarter. As we continue togrow, we expect to experience more pronounced seasonal fluctuations in our netrevenue and anticipate a disproportionate amount of our revenue in the fourthquarter in the future.

 

 

41

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| ** **                                                                 | ** ** | **Quarters ended**                        | ** ** |
|----------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                 | ** ** | **March 31,  2004**                       | ** ** | **June 30,  2004** | ** ** | **Sept. 30,  2004** | ** ** | **Dec. 31,  2004** | ** ** | **March 31,  2005** | ** ** | **June 30,  2005** | ** ** | **Sept. 30,  2005** | ** ** | **Dec. 31,  2005** | ** ** |
| ** **                                                                 | ** ** | **(in thousands, except per share data)** | ** ** |
| ** **                                                                 | ** ** | **(unaudited)**                           | ** ** |
|                                                                       |       |                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net revenue                                                                |       | $                                         | 14,898     |   | $ | 15,936 |   | $ | 15,341 |   | $ | 19,149 |   | $ | 20,720 |   | $ | 18,053 |   | $ | 21,098 |   | $ | 30,708 |   |
| Gross profit                                                               |       | 2,984                                     |       | 2,714 |   | 3,113 |   | 3,441 |   | 3,745 |   | 3,624 |   | 4,338 |   | 7,615 |   |
| General and administrative                                                 |       | 1,940                                     |       | 2,050 |   | 2,214 |   | 2,596 |   | 2,589 |   | 2,502 |   | 2,430 |   | 3,417 |   |
| Sales and marketing                                                        |       | 497                                       |       | 605 |   | 645 |   | 795 |   | 875 |   | 714 |   | 1,163 |   | 2,326 |   |
| Rescission and pre-IPO costs                                               |       | —                                    |       | — |   | — |   | — |   | — |   | — |   | 442 |   | — |   |
| Depreciation and amortization                                              |       | 29                                        |       | 36 |   | 36 |   | 38 |   | 38 |   | 38 |   | 40 |   | 41 |   |
| Income from operations                                                     |       | 518                                       |       | 23 |   | 218 |   | 12 |   | 243 |   | 370 |   | 263 |   | 1,831 |   |
| Net income                                                                 |       | $                                         | 518        |   | $ | 23 |   | $ | 218 |   | $ | 12 |   | $ | 243 |   | $ | 370 |   | $ | 244 |   | $ | 1,790 |   |
| Net income per share available to common  stockholders – basic   |       | $                                         | 0.02       |   | $ | 0.00 |   | $ | 0.01 |   | $ | 0.00 |   | $ | 0.01 |   | $ | 0.02 |   | $ | 0.01 |   | $ | 0.08 |   |
| Net income per share available to common  stockholders – diluted |       | $                                         | 0.02       |   | $ | 0.00 |   | $ | 0.01 |   | $ | 0.00 |   | $ | 0.01 |   | $ | 0.02 |   | $ | 0.01 |   | $ | 0.07 |   |
| Weighted average number of shares  outstanding – basic           |       | 27,479                                    |       | 27,472 |   | 27,457 |   | 27,466 |   | 27,411 |   | 23,312 |   | 23,312 |   | 23,312 |   |
| Weighted average number of shares  outstanding – diluted         |       | 28,041                                    |       | 28,023 |   | 28,003 |   | 28,002 |   | 27,941 |   | 23,835 |   | 23,880 |   | 23,829 |   |

 
| ** **                    | ** ** | **March 31, 2004** | ** ** | **June 30, 2004** | ** ** | **Sept. 30, 2004** | ** ** | **Dec. 31, 2004** | ** ** | **March 31, 2005** | ** ** | **June 30, 2005** | ** ** | **Sept. 30, 2005** | ** ** | **Dec. 31, 2005** | ** ** |
|-------------------------------|------------|-------------------------|------------|------------------------|------------|-------------------------|------------|------------------------|------------|-------------------------|------------|------------------------|------------|-------------------------|------------|------------------------|------------|
| ** **                    | ** ** | **(unaudited)**         | ** ** |
| Net revenue                   |       | 100.0                   | %          | 100.0                  | %          | 100.0                   | %          | 100.0                  | %          | 100.0                   | %          | 100.0                  | %          | 100.0                   | %          | 100.0                  | %          |
| Gross profit                  |       | 20.0                    |       | 17.0                   |       | 20.3                    |       | 18.0                   |       | 18.1                    |       | 20.1                   |       | 20.6                    |       | 24.8                   |       |
| General and administrative    |       | 13.0                    |       | 12.9                   |       | 14.4                    |       | 13.6                   |       | 12.5                    |       | 13.9                   |       | 11.5                    |       | 11.1                   |       |
| Sales and marketing           |       | 3.3                     |       | 3.8                    |       | 4.2                     |       | 4.2                    |       | 4.2                     |       | 4.0                    |       | 5.5                     |       | 7.6                    |       |
| Rescission and pre-IPO costs  |       | —                  |       | —                 |       | —                  |       | —                 |       | —                  |       | —                 |       | 2.1                     |       | —                 |       |
| Depreciation and amortization |       | 0.2                     |       | 0.2                    |       | 0.2                     |       | 0.2                    |       | 0.2                     |       | 0.2                    |       | 0.2                     |       | 0.1                    |       |
| Operating income              |       | 3.5                     |       | 0.1                    |       | 1.4                     |       | 0.1                    |       | 1.2                     |       | 2.0                    |       | 1.2                     |       | 6.0                    |       |
| Net income                    |       | 3.5                     |       | 0.1                    |       | 1.4                     |       | 0.1                    |       | 1.2                     |       | 2.0                    |       | 1.2                     |       | 5.8                    |       |

 

Additional operating metrics: 

 
| ** **                              | ** ** | **March 31,  2004** | ** ** | **June 30,  2004** | ** ** | **Sept. 30,  2004** | ** ** | **Dec. 31,  2004** | ** ** | **March 31,  2005** | ** ** | **June 30,  2005** | ** ** | **Sept. 30,  2005** | ** ** | **Dec. 31,  2005** | ** ** |
|-----------------------------------------|------------|---------------------|------------|--------------------|------------|---------------------|------------|--------------------|------------|---------------------|------------|--------------------|------------|---------------------|------------|--------------------|------------|
| ** **                              | ** ** | **(unaudited)**     | ** ** |
| Average selling price per order (gross) |       | $                   | 130        |               | $          | 138                 |       | $                  | 128        |                | $          | 110                |       | $                   | 106        |               | $          | 106 |   | $ | 108 |   | $ | 124 |   |
| Acquisition cost per new buyer          |       | 29                  |       | 31                 |       | 35                  |       | 31                 |       | 34                  |       | 30                 |       | 27                  |       | 34                 |       |
| Average transactions per day            |       | 4,119               |       | 4,513              |       | 4,422               |       | 6,651              |       | 7,923               |       | 6,699              |       | 6,669               |       | 6,901              |       |
| Number of new buyers                    |       | 17,001              |       | 19,373             |       | 18,392              |       | 25,612             |       | 25,688              |       | 23,651             |       | 42,875              |       | 68,381             |       |
|                                         |            |                     |            |                    |            |                     |            |                    |            |                     |            |                    |            |                     |            |                    |            |  |  |  |  |  |  |  |  |

 

 

42

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**Liquidityand Capital Resources**

 

Since our formation, we havefunded our operations through the sale of equity securities and cash generatedfrom operations. The significant components of our working capital areinventory and liquid assets, such as cash and accounts receivable, reduced byaccounts payable and accrued expenses. The working capital characteristics ofour business allow us to collect cash from sales to customers within severalbusiness days of the related sale, while we typically have extended paymentterms with our suppliers.

 

As of December 31, 2005,we had net working capital of $1.0 million and had no short- or long-termdebt obligations. The working capital characteristics of our business haveallowed us to grow rapidly even with a working capital deficit from 2001 untilOctober 2005. As of December 31, 2005, we had net cash of $7,000taking into account our bank overdraft of $5.3 million. Net cash providedby operating activities was $1.4 million in 2005 compared with net cashused for operating activities of $2.1 million in 2004. Net cash isaffected primarily by changes in net income and loss, inventories, and accountspayable. We recorded net income of $771,000 in 2004 and $2.6 million in2005 and a net loss of $5.8 million in 2003. The improvement inprofitability resulted primarily from the improved gross profit margins of11.5%, 18.8%, and 21.3% in 2003, 2004, and 2005, respectively. Inventories andaccounts payable generally increase in line with sales growth and changes inour inventory strategy. The level of inventory fluctuates whether we are ableto secure attractive inventory.

 

The increase in cash providedby operating activities in 2005 compared with 2004 was $3.5 million,primarily due to an increase in net income. Net income was $2.6 million in2005 compared with $771,000 in 2004. Inventories increased by $5.2 millionin 2005 compared with an increase of $4.9 million in 2004. Accountspayable increased by $2.4 million in 2005 compared with an increase of$2.5 million in 2004. Accrued expenses increased by $669,000 in 2005compared with a decrease of $731,000 in 2004.

 

The "bank overdraft"reflected on our balance sheets results from post-dated checks outstanding. Itis customary for our vendors to accept checks post-dated by 60 days asextended payment for purchases of merchandise. We do not maintain a bankoverdraft facility, as the post-dated checks are not presented for payment untilthe date printed on the check. We did not encounter any unanticipated cashdraws by issuing post-dated checks in 2003, 2004, or 2005.

 

Net cash used for investingactivities was $232,000, $35,000, and $197,000 in 2003, 2004, 2005,respectively, and was primarily related to capital expenditures for our officeequipment and technology system infrastructure, including software.

 

Net cash of $1.2 millionwas used for financing activities in 2005, and net cash provided by financingactivities was $2.2 million and $2.0 million in 2004 and 2003,respectively. The financing activities were primarily related to changes inbank overdraft and net proceeds from issuance of common stock. Net cash of$1.2 million and $937,000 was used to reduce bank overdraft in 2005 and2003, respectively. Net cash provided by bank overdraft was $2.3 millionin 2004. Net cash proceeds from issuance of common stock were$3.0 million, $0, and $0 in 2003, 2004, and 2005, respectively.

 

 

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**AggregateContractual Obligations**

 

The following table presentsour contractual obligations as of December 31, 2005, over the next fiveyears and thereafter. 

 
| ** **                  | ** ** | ** **         | ** ** | **Payments by Period** | ** ** |
|-----------------------------|------------|--------------------|------------|------------------------|------------|
| **Contractual Obligations** | ** ** | **Total  Amount**  | ** ** | **Less Than  1 Year**  | ** ** | **1-3  Years** | ** ** | **4-5  Years** | ** ** | **After 5  Years** | ** ** |
| ** **                  | ** ** | **(in thousands)** | ** ** |
| Property  lease             |       | $                  | 3,306      |                   | $          | 847 |   | $ | 1,769 |   | $ | 690 |   | $ | — |   |
|                             |            |                    |            |                        |            |  |  |  |  |  |  |  |  |  |  |  |

 

We believe that cash and cashequivalents currently on hand, cash flows from operations, and the net proceedsof our planned IPO will be sufficient to continue our operations for theforeseeable future. Our future capital requirements will depend on manyfactors, including the rate of our revenue growth; the timing and extent ofspending to enhance our website, network infrastructure, and transaction processingsystems; the extent of our advertising and marketing programs; the levels ofthe inventory we carry; and other factors relating to our business. Enhancementof our website, network infrastructure, and transaction processing systems willrequire us to spend significantly more than we have in the past. Moreover, todate our spending in these areas has been lower than industry averages. Weanticipate increasing our system expenditures to accommodate these needs in thefuture. We may require additional financing in the future in order to executeour operating plan. We cannot predict whether this additional financing will bein the form of equity, debt, or a combination of debt or equity. We may not beable to obtain any necessary additional funds on a timely basis, on acceptableterms, or at all.

 

**Quantitativeand Qualitative Disclosure about Market Risk**

 

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

 

 

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**Rescission offer**

 

From our inception, in 1999, and in 2000,2001, 2002, and mid-2003, we raised over $20.5 million in gross equitycapital offering by selling our common stock in the following approximateamounts for each year:

 

| **Year** | ** ** | **Number of Shares** | ** ** | **Weighted Ave. Price per Share** | ** ** |
|----------|------------|----------------------|------------|-----------------------------------|------------|
| 1999     |       | 978,070              |       | $                                 | 4.00       |   |
| 2000     |       | 1,198,191            |       | $                                 | 4.00       |   |
| 2001     |       | 580,621              |       | $                                 | 4.47       |   |
| 2002     |       | 1,051,924            |       | $                                 | 5.00       |   |
| 2003     |       | 753,262              |       | $                                 | 5.26       |   |

 

We sold these shares to approximately 830investors. The persons associated with us who solicited these investors werenot licensed as broker-dealers in any state or with the SEC.

 

We also issued to approximately 30 persons orentities shares of common stock in exchange for services and other non-cashconsideration valued in excess of $5.5 million in the followingapproximate amounts for each year: 

 

| **Year** | ** ** | **Number of Shares** | ** ** | **Weighted Ave. Price per Share** | ** ** |
|----------|------------|----------------------|------------|-----------------------------------|------------|
| 1999     |       | 57,500               |       | $                                 | 4.00       |   |
| 2000     |       | 100,000              |       | $                                 | 4.00       |   |
| 2001     |       | 585,700              |       | $                                 | 4.09       |   |
| 2002     |       | 445,774              |       | $                                 | 5.00       |   |
| 2003     |       | 18,673               |       | $                                 | 5.60       |   |
| 2004     |       | 28,544               |       | $                                 | 4.95       |   |

 

We also issued to approximately 248 employeesor other service providers options to purchase common stock in the followingamounts: 

 

| **Year** | ** ** | **Number of Options** | ** ** | **Exercise Price** | ** ** |
|----------|------------|-----------------------|------------|--------------------|------------|
| 2002     |       | 1,332,000             |       | $                  | 3.75       |   |
| 2003     |       | 485,500               |       | $                  | 4.50       |   |
| 2004     |       | 6,162,000             |       | $                  | 6.00       |   |

 

None of these options have been exercised.

 

These offers and sales of the common stockand options to purchase common stock were not registered under the federal andstate securities laws, but were issued in reliance upon exemptions from suchregistration under Section 4(2) of the Securities Act and Rule 506 ofRegulation D promulgated thereunder. Similarly, in employing persons whowere not licensed as broker-dealers, we relied on certain exemptions from thebroker-dealer licensing requirements of the Exchange Act and of statesecurities laws.

 

 

45

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After conducting these offers and sales ofcommon stock and granting these options to purchase common stock, we determinedthat the offers and sales did not comply with the exemptions from registrationunder the Securities Act and similar provisions of laws in each state in whichour stockholders reside, because certain of our employees who solicitedinvestors engaged in a "general solicitation" of securities. Inaddition, these employees were required to be licensed as broker-dealers withthe SEC and various states, but they were not so licensed. We also determinedthat because investors did not receive information regarding our potentialliability for these violations of federal and state securities laws, the commonstock was issued to persons who failed to receive adequate information underfederal and state securities laws. In such situations a number of remedies maybe available to regulatory authorities and the investors who purchased commonstock in those offerings, including, without limitation, a right of rescission,civil penalties, seizure of our assets, a restraining order or injunction, anda court order to pay restitution and costs. As a result, the investors in thoseofferings and other holders of our common stock are entitled to return theirshares to us and assert a legal claim to receive back from us the full pricethey paid, plus interest. In the event that a rescission by all of ourstockholders were to occur, we would be liable for the $20.5 million wereceived in exchange for our common stock, in addition to interest ofapproximately $9.3 million through December 31, 2005. We may also beliable for the $5.5 million of services rendered and property exchanged inconsideration for the issuance of common stock, in addition to interest ofapproximately $2.3 million through December 31, 2005.

 

Accordingly, we are subject to potentialliabilities, including penalties and fines, under the Securities Act, theExchange Act, the regulations thereunder, and applicable state securities laws.Both federal and state securities laws also provide remedies to investors forsuch violations, which remedies include rescission, or a right to recover theinvestment plus interest from the date of issuance of the security, and, if theinvestor no longer owns the security, damages equal to the difference betweenthe investment amount plus interest from the date of issuance and the value orprice of the security at the time of its sale.

 

In order to address these contingentliabilities, we intend to make a rescission offer to persons who are or wereresidents of Alabama, Arkansas, Alaska, Arizona, California, Colorado,Connecticut, Florida, Georgia, Hawaii, Iowa, Idaho, Illinois, Indiana, Kansas,Kentucky, Louisiana, Massachusetts, Maryland, Maine, Michigan, Minnesota, Missouri,Mississippi, Montana, North Carolina, North Dakota, Nebraska, New Hampshire,New Jersey, New Mexico, Nevada, New York, Ohio, Oregon, Pennsylvania, SouthCarolina, South Dakota, Tennessee, Texas, Utah, Virginia, Washington,Washington, DC, West Virginia, Wisconsin, and Wyoming. If our rescission offeris accepted by all offerees, we could be required to make an aggregate paymentto the holders of these shares of up to approximately $37.6 million, whichincludes statutory interest.

 

Our anticipated rescission offer will coveroutstanding shares of common stock and outstanding options to purchase sharesof common stock issued in connection with the securities offerings describedabove. We intend to make the rescission offer to the holders of these shares andoptions as soon as practicable after the completion of our planned IPO of ourcommon stock. The rescission offer will be kept open for at least 20 businessdays and will be registered under the Securities Act.

 

We will offer to rescind prior purchases ofour common stock for an amount equal to the price paid for the shares plusinterest, calculated from the date of purchase through the date on which therescission offer expires, at the applicable statutory interest rate per year.With respect to outstanding options to purchase our common stock that aresubject to the rescission offer, we will offer to rescind the entire optiongrant, regardless of whether the option is vested, in exchange for an amountequal to 20% of the aggregate exercise price for the entire option, plusinterest, calculated from the date of grant of the option through the date onwhich the rescission offer expires, at the applicable statutory interest rateper year.

 

 

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Our making this rescission offer may notterminate a purchaser's right to rescind a sale of securities that was notregistered or qualified under the Securities Act or applicable state securitieslaws and was not otherwise exempt from registration or qualification. Accordingly,should the rescission offer be rejected by any or all offerees, we may continueto be contingently liable under the Securities Act and applicable statesecurities laws for the purchase price of these shares as well as for the valueof the options we granted up to an aggregate amount of approximately$37.6 million, which includes statutory interest. In addition, it ispossible that an optionholder could argue that offering to rescind the issuanceof outstanding options for an amount equal to 20% of the aggregate exerciseprice, plus interest, does not represent an adequate remedy for the issuance ofthe option in violation of applicable securities laws. If a court were toimpose a greater remedy, our exposure as a result of the rescission offer couldbe higher. In addition, if it is determined that we offered securities withoutproperly registering them under federal or state law, or securing an exemptionfrom registration, regulators could impose monetary fines or other sanctions asprovided under these laws.

 

We do not expect that we will be able to fundany costs related to our rescission offer from our current cash balance, and,accordingly, will rely on the proceeds of our planned IPO to fund any paymentsmade pursuant to any stockholders or optionholders who accept the rescissionoffer. We believe, however, that it is not probable that the rescission will beaccepted by our stockholders or optionholders. This belief is based on thepurchase price of shares of common stock and the exercise price of the optionsgranted in the offerings described above compared with the anticipated initialpublic offering price.

 

**ITEM 7A. Quantitative and Qualitative Disclosure about Market Risk**

 

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

 

 

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**Item 8. Financial Statements and Supplementary Data**

 

See Item 15(a)

 

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

 

None

 

**Item 9A. Controls and Procedures**

 

***Evaluation ofDisclosure Controls and Procedures***.

 

Under the supervision and with theparticipation of our management, including our Chief Executive Officer andChief Financial Officer, we evaluated the effectiveness of the design andoperation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934) as of the end of theperiod covered by this report.  Disclosure controls and procedures are thecontrols and other procedures that we designed to ensure that we record,process, summarize and report in a timely manner the information we mustdisclose in reports that we file with or submit to the Securities and ExchangeCommission.  Based on this evaluation, our Chief Executive Officer and ourChief Financial Officer concluded that, as of the date of their evaluation, ourdisclosure controls and procedures were effective.  There were nosignificant changes made in our internal controls or in other factors thatcould significantly affect internal controls subsequent to the date of theirevaluation.

 

**Item 9B. Other Information**

 

None

 

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**Part III**

 

**ITEM 10. Directors and Executive Officers of the Registrant**

 

The following table sets forthcertain information regarding our directors, executive officers, and keyemployees.

 
| **Name**                  | ** ** | **Age** | ** ** | **Position**                                                  |
|---------------------------|------------|---------|------------|---------------------------------------------------------------|
| David Zinberg             |       | 48      |       | Chairman of the Board, President, and Chief Executive Officer |
| Lawrence Y. Kong          |       | 45      |       | Chief Financial Officer, Secretary, Treasurer, and Director   |
| Claudia Y. Liu            |       | 46      |       | Vice President of Operations                                  |
| Peter G. Hanelt (1)(2)(3) |       | 60      |       | Director                                                      |
| Garry Y. Itkin (1)(2)(3)  |       | 45      |       | Director                                                      |
| Man Jit Singh (1)(2)(3)   |       | 49      |       | Director                                                      |
| Larry E. Russell          |       | 54      |       | Chief Technology Officer                                      |
| Anatoli Lau               |       | 35      |       | Vice President of Development                                 |
| Yuri Mordovskoi, Ph.D.    |       | 44      |       | Vice President of Technology                                  |

 

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(1)Member of our Governance and Nominating Committee.

 

(2)Member of our Audit Committee.

 

(3)Member of our Compensation Committee.

 

**David Zinberg**,founder of our company, has served as the Chairman of the Board of Directors,President, and Chief Executive Officer of our company since our inception in November 1998.Mr. Zinberg served as our Secretary from our inception until March 2001.From 1988 to 1997, Mr. Zinberg served as the Chief Executive Officer ofAsset Lenders of America (our predecessor, formerly known as Union Pawn), acollateral lending and bail bond company. Mr. Zinberg is the brother ofMarina Zinberg, a Vice President of our company.

 

**Lawrence Y. Kong** hasserved as our Chief Financial Officer since January 2001, our Secretaryand Treasurer since March 2006, and a director since July 2003. Mr. Kongearned a Bachelor of Science in Accounting (*summacum laude*) from the University of South Alabama in June 1982and a Masters of Business Administration in Finance from the University ofChicago in June 1984. Mr. Kong passed the Certified Public Accountantexamination (State of Illinois) in 1983 and is a member of the AmericanInstitute of Certified Public Accountants. Mr. Kong is the husband of Ms. Liu.

 

**Claudia Y. Liu** hasserved as our Vice President of Operations since November 2002. From October 2001to November 2002, Ms. Liu served as our Billing Manager. From January 1998to May 2001, Ms. Liu served as a director and general manager ofCybertowers Pte Ltd., a public company on the Kuala Lumpur Stock Exchangein Malaysia that specialized in satellite tracking systems. Ms. Liu is thewife of Mr. Kong.

 

**Peter G. Hanelt** hasserved as a director of our company since March 2006. Mr. Hanelt hasbeen a self-employed business consultant since November 2003. Mr. Haneltserved as Chief Restructuring Officer and Chief Operating Officer of the GoodGuys, a regional consumer electronics retailer, from December 2001 throughJuly 2003 and as a consultant from July 2003 through October 2003.From October 1998 to June 2001, Mr. Hanelt served as ChiefExecutive Officer and a director of Natural Wonders, Inc., a nationalspecialty retailer of nature and science merchandise. Mr. Hanelt alsoserves on the boards of Silicon Image, a publicly traded manufacturer ofsemiconductors; Shoe Pavillion, Inc., a publicly

 

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traded retailer; Patelco Credit Union, a not for profit company; andInterHealth Nutraceuticals, Inc. and Trader Vic’s Restaurants, bothprivate companies.

 

**Garry Y. Itkin** hasserved as a director of our company since July 2003. Mr. Itkin hasserved as the Chief Executive Officer of AFB Trading One, Inc., aprivately held distillery, since September 1999. Mr. Itkin served asour acting Chief Financial Officer from February 1999 until 2000. From November 1987to May 1999, Mr. Itkin served as Managing Partner of Jeff Ratner &Associates, Inc., a public accounting and consulting firm in BeverlyHills, California. Mr. Itkin received his MBA degree from Pepperdine Universityin 1986. In 2005, Mr. Itkin received his JD degree from the RussianFederation North West Academy of Governmental Service.

 

**Man Jit Singh** hasserved as a director of our company since March 2006. Since July 2003,Mr. Singh served as a Principal of Diogenes, Inc., a private equityfirm, and from April 2001 to May 2003, served as Chief ExecutiveOfficer of Compete, Inc., a predictive analytics firm. Mr. Singhserved as Chief Executive Officer of several companies specializing inmanagement recruitment and temporary staffing, including, from December 1997until June 2000, Futurestep Inc. (Founder and Chief ExecutiveOfficer), which is Korn Ferry International’s online subsidiary for middlemanagement recruitment. Prior to Futurestep, from July 1994 to July 1996,Mr. Singh served on the management committee of BET Plc, a $3 billionservice conglomerate focused on outsourcing non-core activities of itscustomers. Mr. Singh has also held senior positions at various managementconsulting firms, including Sibson & Co (Partner & Co-leaderof Strategy), The Cast Group AG (Chief Executive Officer), and Cresap(Principal responsible for West Coast practice).

 

**Larry E. Russell** hasserved as our Chief Technology Officer since February 2006. Prior to thattime, Mr. Russell served as our Chief Internal Control Officer from April 2005.From July 1998 to April 2005, Mr. Russell served as anAccounting and Information Systems Consultant at AccounTec. From 1995 to 1998, Mr. Russellserved as the Controller, Cost Accountant, and Chief Information Officer atGruber Systems, a manufacturer of molds and production equipment. From May 1991to August 1995, Mr. Russell served as a manager in Technology Supportand Network Administration at Ernst & Young, LLP. Mr. Russell isa Certified Public Accountant and holds a Certified Information TechnologyProfessional designation by the AICPA.

 

**Anatoli Lau** hasserved as our Vice President of Development since February 2006. From March 2001until he joined our company in October 2003, Mr. Lau served as aSenior Software Developer for ABS Consulting Group, a technology consultingcompany. From December 1999 to April 2001, Mr. Lau served as asoftware engineer for Globinet E-Commerce Technologies, designing web sites anddeveloping Internet shopping programs and programs for access through theInternet to SQL servers with ASP and CGI technology.

 

**Yuri Mordovskoi, Ph.D.,**has served as our Vice President of Technology since March 2005. From March 2003until February 2005, Mr. Mordovskoi served as President and Founderof Technolect, Inc., a software development company for e-commercesolutions. Mr. Mordovskoi served as a software development consultant forvarious companies, including our company, from September 2001 until February 2003.From August 1997 to September 2001, Mr. Mordovskoi served asChief Technical Officer of Language Force, Inc. Mr. Mordovskoireceived his degree in Mathematics and Software Engineering from the SovietMilitary Space Academy and his Ph.D. in Artificial Intelligence from theScientific Research Institute in Moscow.

 

We consider Messrs. Zinberg, Kong, and Ms. Liu as ourexecutive officers; we consider Messrs. Hanelt, Itkin, and Singh asindependent directors; and Messrs. Lau, Mordovskoi, and Russell as keyemployees.

 

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**Board of Directors**

 

*Classification*

 

Our certificate of incorporation provides that the authorized number ofdirectors may be changed only by resolution of the Board of Directors, and ourauthorized number of directors is five. Upon completion of the reincorporation,our certificate of incorporation will provide that our Board of Directors willbe divided into three classes serving three-year staggered terms. As a result,only one class of directors will be elected at each annual meeting of ourstockholders, with the other classes continuing for the remainder of theirrespective three-year terms. Messrs. Zinberg and Hanelt have beendesignated as Class I directors, whose terms will expire at the 2006annual meeting of stockholders. Messrs. Kong and Singh have beendesignated as Class II directors, whose terms will expire at the 2007annual meeting of stockholders. Mr. Itkin has been designated as a Class IIIdirector, whose term will expire at the 2008 annual meeting of stockholders.This classification of the Board of Directors may delay or prevent a change incontrol of our company or our management.

 

*Board Committees*

 

Our Board of Directors has established three standing committees: anAudit Committee, a Compensation Committee, and a Governance and NominatingCommittee. Messrs. Hanelt, Itkin, and Singh each serve on all threecommittees.

 

Mr. Hanelt is chairman of the Audit Committee. Our Board ofDirectors has determined that each member of our Audit Committee satisfies theindependence and financial literacy requirements of the Nasdaq National Market.Our Board of Directors has also determined that Mr. Hanelt is an AuditCommittee “financial expert” as defined under the SEC rules implementing Section 407of the Sarbanes-Oxley Act and satisfies the financial sophisticationrequirements of the Nasdaq National Market. Our Board of Directors has approvedan Audit Committee charter that meets the applicable standards of the SEC andthe Nasdaq National Market. The primary purpose of the Audit Committee is toselect the independent registered public accounting firm to conduct theindependent audit of the financial statements of our company; review the annualfinancial statements, any significant accounting issues, and the scope of theaudit with the independent registered public accounting firm; and discuss withsuch firm any other audit related matters that may arise during the year.

 

Mr. Singh is chairman of the Compensation Committee. TheCompensation Committee reviews and acts on matters relating to compensationlevels and benefit plans for our key executives. Each member of theCompensation Committee meets the independence requirements of the NasdaqNational Market applicable to Compensation Committee members, and is a “non-employeedirector” as defined in Rule 16b-3 promulgated under the SecuritiesExchange Act of 1934, as amended, or the Exchange Act, and an “outside director”as that term is defined in Section 162(m) of the Internal Revenue Code of1986, as amended. The purpose of our Compensation Committee is to discharge theresponsibilities of our Board of Directors to oversee our compensationpolicies, plans, and programs and to review and determine the compensation tobe paid to our executive officers. Our Board of Directors has approved aCompensation Committee charter that meets the applicable standards of the SECand the Nasdaq National Market.

 

Mr. Itkin is chairman of the Governance and Nominating Committee.All members of the Governance and Nominating Committee meet the independencerequirements of the Nasdaq National Market applicable to nominating committeemembers. Our Board of Directors has approved a Governance and NominatingCommittee charter that meets the applicable standards of the SEC and the NasdaqNational Market. The purpose of the Governance and Nominating Committee is toassist our Board of Directors in fulfilling its responsibility to nominate andapprove qualified new members to our Board of Directors in accordance with ourcertificate of incorporation and bylaws; to develop and

 

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recommend to our Board of Directors a set of corporate governanceprinciples; and to oversee the selection and review of committees of our Boardof Directors.

 

Prior to the establishment of the Audit, Compensation, and Governanceand Nominating Committees in February 2006, these functions were performedby our Board of Directors.

 

**Compensation Committee Interlocks and InsiderParticipation**

 

Our Compensation Committee currently consists of Messrs. Itkin,Hanelt, and Singh. Mr. Itkin served as the Chief Financial Officer of ourcompany and our predecessor from 1995 until 2000. None of the other members ofour Compensation Committee has, at any time, served as an officer or employeeof our company. None of our executive officers currently serves, or in the pastyear has served, as a member of the board of directors or compensationcommittee of any entity that has one or more executive officers serving on ourBoard of Directors or Compensation Committee.

 

**Director Compensation**

 

We grant annually to each non-employee director options to purchase10,000 shares of our common stock. In addition, non-employee directors willreceive additional options for committee service per year over the standardnon-employee director compensation: options to purchase an additional 5,000shares of common stock to the Chairman of the Audit Committee, and options topurchase an additional 2,500 shares of common stock to each member of our AuditCommittee (other than the Chairman), Compensation Committee and CorporateGovernance and Nominating Committee. We will also reimburse each non-employeedirector for travel and related expenses incurred in connection with attendanceat board and committee meetings and provide $24,000 per member in cashconsideration annually for serving on our Board of Directors and an additional$1,000 per member per meeting and an additional $7,500 annually to the Chairmanof the Audit Committee. Each non-employee director will also receive an initialgrant of options to purchase 20,000 shares of common stock in connection with ourplanned IPO. Employees who also serve as directors will receive no additionalcompensation for their services as a director.

 

***Section 16(a) Beneficial OwnershipReporting Compliance***

 

On April 22, 2005, we filed a Form 10registration statement under the Securities Exchange Act of 1934 (“Exchange Act”)to register our class of common stock. The Form 10 registration statement became effective by operation oflaw 60 days following the filing of the Form 10.  On the effective date, our officers,directors and beneficial owners of more than ten percent of our common stockwere required to file beneficial ownership reports on Forms 3, 4 and 5, buthave only recently done so.  Accordingly,known failures to file the required forms include those of Messrs. Zinberg,Kong and Itkin, and Ms. Zinberg.

 

**ITEM 11. Executive Compensation**

 

**Summary of Cash and Other Compensation**

 

The following table sets forth, for the periods indicated, the totalcompensation for services in all capacities to us received by our ChiefExecutive Officer and two other executive officers whose aggregate compensationexceeded $100,000 during the fiscal year ended December 31, 2005.

 

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**Summary Compensation Table**

 
| ** **                                         | ** ** | ** **                  | ** ** | ** **          | ** ** | ** **         | ** ** | **Long-Term**           | ** ** |
|----------------------------------------------------|------------|-----------------------------|------------|---------------------|------------|--------------------|------------|-------------------------|------------|
| ** **                                         | ** ** | ** **                  | ** ** | ** **          | ** ** | ** **         | ** ** | **Compensation**        | ** ** |
| ** **                                         | ** ** | ** **                  | ** ** | ** **          | ** ** | ** **         | ** ** | **Awards**              | ** ** |
| ** **                                         | ** ** | ** **                  | ** ** | ** **          | ** ** | ** **         | ** ** | **Securities**          | ** ** |
| **Name and Principal**                             | ** ** | **Annual Compensation (1)** | ** ** | **Underlying**      | ** ** |
| **Position**                                       | ** ** | **Year**                    | ** ** | **Salary ($)** | ** ** | **Bonus ($)** | ** ** | **Options (#)(2)** | ** ** |
|                                               |       |                        |       |                |       |               |       |                    |       |
| David Zinberg                                      |       | 2005                        |       | $                   | 240,000    |               | $          | 200,000                 |       | 230,000 |   |
| President and Chief Executive Officer              |       | 2004                        |       | 240,000             |       | 280,000            |       | 6,000,000               |       |
|                                               |       | 2003                        |       | 240,000             |       | 200,000            |       | —                  |       |
|                                               |       |                        |       |                |       |               |       |                    |       |
| Lawrence Y. Kong                                   |       | 2005                        |       | 200,000             |       | 100,000            |       | 100,000                 |       |
| Chief Financial Officer, Secretary, and  Treasurer |       | 2004                        |       | 120,000             |       | 80,000             |       | —                  |       |
|                                               |       | 2003                        |       | 120,000             |       | 80,000             |       | 250,000                 |       |
|                                               |       |                        |       |                |       |               |       |                    |       |
| Claudia Y. Liu                                     |       | 2005                        |       | 100,000             |       | 1,000              |       | 25,000                  |       |
| Vice President of Operations                       |       | 2004                        |       | 73,750              |       | —             |       | —                  |       |
|                                               |       | 2003                        |       | 49,667              |       | —             |       | 100,000                 |       |
|                                                    |            |                             |            |                     |            |                    |            |                         |            |  |  |

 

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(1)The officers also received certain perquisites, the value of which did notexceed 10% of the annual salary and bonus.

 

(2)The options were granted at a per share exercise price equal to the fair marketvalue of our common stock on the date of grant, as determined by ourBoard of Directors. All of these options were vested and exercisableimmediately upon grant.

 

**Option Grants**

 

The following table sets forth certain information with respect tostock options granted to the officers listed during the fiscal year ended December 31,2005.

 

**Option Grants in Last Fiscal Year**

 
| ** **       | ** ** | **Individual Grants**                                   | ** ** | ** **                                                                                    | ** ** | ** **                                   | ** ** |
|------------------|------------|--------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| **Name**         | ** ** | **Number of  Securities  Underlying  Options  Granted** | ** ** | **Percent of  Total Options  Granted to  Employees in  Fiscal Year** | ** ** | **Exercise  Price Per  Share (1)** | ** ** | **Expiration  Date (2)** | ** ** | **Potential Realizable Value At  Assumed Annual Rates of  Stock Price Appreciation  for Option Term (3)** | ** ** |
| **5%**           | ** ** | **10%**                                                      |
| David Zinberg    |       | 230,000                                                      |       | 33.9                                                                                          | %          | $                                            | 6.00       |   | 11/28/10 |   | $ | 381,269 |   | $ | 842,504 |   |
| Lawrence Y. Kong |       | 100,000                                                      |       | 14.7                                                                                          |       | 6.00                                         |       | 11/28/10 |   | 165,769 |   | 366,306 |   |
| Claudia Y. Liu   |       | 25,000                                                       |       | 3.7                                                                                           |       | 6.00                                         |       | 11/28/10 |   | 41,442 |   | 91,577 |   |
|                  |            |                                                              |            |                                                                                               |            |                                              |            |  |  |  |  |  |  |  |  |  |

 

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(1)The exercise prices of all stock options granted were at prices believed by ourBoard of Directors to be equal to the fair market value of our common stock onthe date of grant.

 

(2)All options were vested and exercisable immediately upon grant.

 

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(3)Potential gains are net of the exercise price, but before taxes associated withthe exercise. Amounts represent hypothetical gains that could be achieved forthe respective options if exercised at the end of the option term. There ispresently no public trading market for our common stock. Accordingly, thecalculated hypothetical realizable values are based on a $6.00 per share price,which represents the last price at which our common stock was sold. The assumed5% and 10% rates of stock price appreciation are provided in accordance withthe rules of the SEC and do not represent our estimate or projection ofthe future price of our common stock. Actual gains, if any, on stock optionexercises will depend upon the future market prices of our common stock.

 

**Option Values and Holdings**

 

The following table describes, for each of the listed officers, theexercisable and unexercisable options held by them as of December 31,2005. The “Value of Unexercised In-the-Money Options at Fiscal Year-End” shownin the table represents an amount equal to the difference between $6.00 pershare and the option exercise price multiplied by the number of unexercisedin-the-money options. None of the officers listed exercised any options duringfiscal 2005.

 

**Aggregated Option Exercises and Year-EndValues**

 
| ** **       | ** ** | **Number of Securities  Underlying Unexercised  Options at Fiscal Year-End** | ** ** | **Value of Unexercised  In-The-Money Options  at Fiscal Year-End** | ** ** |
|------------------|------------|------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------|------------|
| **Name**         | ** ** | **Exercisable**                                                                                            | ** ** | **Unexercisable**                                                                           | ** ** | **Exercisable** | ** ** | **Unexercisable** | ** ** |
| David Zinberg    |       | 6,230,000                                                                                                  |       | —                                                                                      |       | $ | — |   | $ | — |   |
| Lawrence Y. Kong |       | 350,000                                                                                                    |       | —                                                                                      |       | — |   | — |   |
| Claudia Y. Liu   |       | 200,000                                                                                                    |       | —                                                                                      |       | — |   | — |   |
|                  |            |                                                                                                            |            |                                                                                             |            |  |  |  |  |  |  |

 

**Employment Agreements with Executive Officers**

 

On November 1, 2002, we entered into an employment agreement withDavid Zinberg, our President and Chief Executive Officer. The agreementprovides for an initial term of five years beginning November 1, 2002 andending on October 31, 2007, with automatic annual extensions unlessterminated by us or Mr. Zinberg upon 60 days prior written noticefrom the anniversary of the commencement date. The agreement also provides foran annual base salary of $240,000, discretionary bonuses, and stock options topurchase our common stock.

 

The agreement provides that Mr. Zinberg’s employment may beterminated by (i) mutual written consent of the parties, (ii) Mr. Zinbergin his sole discretion for a material breach by us of the agreement, (iii) usfor “cause,” or (iv) upon the death or complete physical or mentaldisability of Mr. Zinberg. In the event of termination of Mr. Zinberg’semployment by us for cause, we will pay Mr. Zinberg any remaining basesalary through the effective date of the termination plus any benefits underother bonus or stock plans or programs in which he has a vested interest at thedate of termination, and all unvested stock options held by Mr. Zinbergwill automatically vest. In the event we terminate Mr. Zinberg’semployment for reasons other than those set forth above, he will be entitled toa lump sum payment equal to the sum of his entire remaining annual base salaryand any accrued but unpaid bonus through the end of the term of the agreement,all vested stock options held by him at such time will immediately vest, and noseverance will be deemed to have occurred under any of our then-existing stockoption plans or agreements.

 

There are no employment agreements with any of our other executiveofficers.

 

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**Equity Compensation Plan Information**

 

*2001 Stock Option Plan*

 

During January 2001, our Board of Directors adopted the Bidz.com, Inc.Stock Option Plan, or the 2001 Plan. The 2001 Plan provides for the grant ofincentive and nonqualified stock options to acquire our common stock todirectors, executive officers, employees, consultants, and others providingvaluable services to our company. The purpose of the 2001 Plan is to strengthenthe mutuality of interests of those persons and our stockholders by providingsuch individuals with a proprietary interest in pursuing our long-term growthand financial success. We believe that the 2001 Plan represents an important factorin attracting, retaining, and rewarding qualified personnel.

 

Awards or portions of awards that terminate, expire, or are otherwiseforfeited will again be available for further awards under the 2001 Plan. Wehave reserved for issuance 900,000 of shares of common stock pursuant to the2001 Plan. As of December 31, 2005, options to purchase 792,000 shares ofcommon stock were outstanding, no shares of common stock have been issued uponexercise, and there were 108,000 shares of common stock remaining available forgrant. No further grants will be made under the 2001 Plan.

 

The power to administer the 2001 Plan rests with a committee appointedby our Board of Directors consisting of members of our Compensation Committeeany other members as determined by our Board of Directors. The committee hasthe power to determine the timing and recipients of awards, the form and amountof each award, and the terms and conditions for the grant or exercise. Thecommittee may delegate its authority under the 2001 Plan to persons other thanmembers of the committee other than executive officers. The exercise price pershare of common stock underlying options granted under the 2001 Plan may not beless than 110% of the fair market value of the common stock if the option holderis a holder of 10% or more of our common stock, and 100% of the fair marketvalue of the common stock in the case of any other employee. Except for optionsgranted to our executive officers, directors, and consultants, options mustbecome exerciseable at a rate of no less than 20% per year over five years fromthe date the options are granted.

 

In the event of any change in the capitalization of our company, by wayof stock split, reverse stock split, stock dividend, combination,recapitalization, or reclassification, the committee may make appropriateadjustments for the aggregate number of shares of common stock issuable underthe 2001 Plan, and appropriate provision for the protection of the outstandingoptions.

 

The 2001 Plan will remain in effect until January 2011, or willterminate earlier if all shares subject to it are distributed, or until allawards have expired or lapsed, or until otherwise terminated by our Board ofDirectors. Our Board of Directors may not, however, without the approval of a majorityof our stockholders, amend provisions of the 2001 Plan regarding (i) theclass of individuals entitled to receive incentive stock options; (ii) thenumber of shares of our common stock that may be issued under the 2001 Plan(except for adjustments made upon a change in our capitalization); (iii) certainmodifications in the 2001 Plan relating to our executive officers. The 2001Plan is not intended to be the exclusive means by which we may issue options toacquire our common stock. To the extent permitted by applicable law and Nasdaqrequirements, we may issue options other than pursuant to the 2001 Plan with orwithout stockholder approval.

 

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*2002 Special Stock Option Plan*

 

During December 2002, our Board of Directors adopted the Bidz.com, Inc.2002 Special Stock Option Plan, or the 2002 Plan. The 2002 Plan provides forthe grant of options to acquire our common stock to directors, executiveofficers, employees, consultants, and others providing valuable services to ourcompany. The purpose of the 2002 Plan is to strengthen the mutuality ofinterests of those persons and our stockholders by providing such individualswith a proprietary interest in pursuing our long-term growth and financialsuccess. We believe that the 2002 Plan represents an important factor inattracting, retaining, and rewarding qualified personnel.

 

Awards or portions of awards that terminate, expire, or are otherwiseforfeited will again be available for further awards under the 2002 Plan. Wehave reserved for issuance 1,500,000 shares of common stock pursuant to the2002 Plan. As of December 31, 2005, options to purchase 1,500,000 sharesof common stock were outstanding, and there were no shares of common stockissued upon exercise of outstanding options or remaining available for grant.

 

The power to administer the 2002 Plan rests with a committee appointedby our Board of Directors consisting of members of our Compensation Committeeand any other members as determined by our Board of Directors. The committeehas the power to determine the timing and recipients of awards, the form andamount of each award, and the terms and conditions for the grant or exercise.The committee may delegate its authority under the 2002 Plan to persons otherthan members of the committee other than executive officers. The exercise priceper share of common stock underlying options granted under the 2002 Plan, thevesting requirements, and the other terms of options granted under the 2002Plan will be determined by the committee in its sole discretion, subject toapproval by our Board of Directors.

 

In the event of any change in the capitalization of our company, by wayof stock split, reverse stock split, stock dividend, combination,recapitalization, or reclassification, the committee may make appropriateadjustments for the aggregate number of shares of common stock issuable underthe 2002 Plan, and appropriate provision for the protection of the outstandingoptions.

 

The 2002 Plan will remain in effect until December 2012, or willterminate earlier if all shares subject to it are distributed, or until allawards have expired or lapsed, or until otherwise terminated by our Board ofDirectors. The 2002 Plan is not intended to be the exclusive means by which wemay issue options to acquire our common stock. To the extent permitted byapplicable law, we may issue options other than pursuant to the 2002 Plan withor without stockholder approval.

 

*2006 Stock Award Plan*

 

During March 2006, our Board of Directorsadopted, and our stockholders approved, our 2006 Stock Award Plan, or 2006Plan.

 

*Backgroundand Purpose*

 

The terms of the plan provide for grants ofstock options, stock appreciation rights, restricted stock, deferred stock,bonus stock, dividend equivalents, other stock related awards and performanceawards that may be settled in cash, stock, or other property. The purpose ofthe 2006 Plan is to assist us in attracting, motivating, retaining, andrewarding high-quality executives and other employees, officers, directors, andconsultants by enabling such persons to acquire or increase a proprietaryinterest in our company in order to strengthen the mutuality of interestsbetween such persons

 

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and our stockholders, and providing suchpersons with annual and long-term performance incentives to expend theirmaximum efforts in the creation of stockholder value.

 

*GeneralTerms of the 2006 Plan; Shares Available for Issuance*

 

The 2006 Plan provides for the granting ofawards in the form of incentive stock options, nonqualified stock options,stock appreciation rights, shares of restricted common stock, bonus stock inlieu of obligations, or other stock-based awards to employees, directors, andindependent contractors who provide valuable services to our company. The totalnumber of shares of our common stock that may be subject to awards under the2006 Plan is equal to 1,000,000 shares, plus (i) the number of shares withrespect to which awards previously granted under the 2001 Plan and the 2002Plan that terminate without the issuance of the shares or where the shares areforfeited or repurchased; (ii) any shares available for grant in the sharereserve of the 2001 Plan as of the date the 2006 Plan is approved by thestockholders; (iii) with respect to awards granted under the plans, thenumber of shares which are not issued as a result of the award being settledfor cash or otherwise not issued in connection with the exercise or payment ofthe award; and (iv) the number of shares that are surrendered or withheldin payment of the exercise price of any award or any tax withholdingrequirements in connection with any award granted under the existing plans. Ifany award previously granted under the 2006 Plan is forfeited, terminated,canceled, surrendered, does not vest, or expires without having been exercisedin full, stock not issued under such award will again be available for grantfor purposes of the 2006 Plan. If any change is made in the stock subject to the2006 Plan, or subject to any award granted under the 2006 Plan (throughconsolidation, spin-off, recapitalization, stock dividend, split-up,combination of shares, exchange of shares, or otherwise), the 2006 Planprovides that appropriate adjustments will be made as to the aggregate numberand type of shares available for awards, the maximum number and type of sharesthat may be subject to awards to any individual, the number and type of sharescovered by each outstanding award, the exercise price, grant price or purchaseprice relating to any award, and any other aspect of any award that the Boardof Directors or Compensation Committee determines appropriate.

 

The 2006 Plan provides that it is notintended to be the exclusive means by which we may issue options to acquire ourcommon stock or any other type of award. To the extent permitted by applicablelaw and the rules and regulations of the Nasdaq National Market, we may issueother options, warrants, or awards other than pursuant to the 2006 Plan withoutstockholder approval.

 

*Limitationson Awards*

 

In the event that a dividend or otherdistribution (whether in cash, shares of our common stock, or other property),recapitalization, forward or reverse split, reorganization, merger,consolidation, spin-off, combination, repurchase, share exchange, or othersimilar corporate transaction or event affects our common stock so that anadjustment is appropriate in order to prevent dilution or enlargement of therights of participants, the plan administrator is authorized to substitute,exchange, or adjust any or all of (1) the number and kind of shares thatmay be delivered under the plan, (2) the per person limitations describedin the preceding paragraph, and (3) all outstanding awards, includingadjustments to exercise prices of options and other affected terms of awards.The plan administrator is authorized to adjust performance conditions and otherterms of awards in response to these kinds of events or in response to changesin applicable laws, regulations, or accounting principles.

* *

*Eligibility*

 

The persons eligible to receive awards underthe plan consist of directors, officers, employees, and independent contractorsof our company and those of our affiliates. However, incentive stock optionsmay be granted under the plan

 

 

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only to our employees, including officers,and those of our affiliates. An employee on leave of absence may be consideredas still in our employ or in the employ of an affiliate for purposes ofeligibility under the plan.

 

*Administration*

 

Our Board of Directors administers the plan,unless the Board delegates administration to a committee. Our Board hasdelegated administration of the plan to the Compensation Committee. Together,our Board of Directors and the Compensation Committee are referred to as theplan administrator. The Compensation Committee members must be"non-employee directors" as defined by Rule 16b-3 of theSecurities Exchange Act, "outside directors" for purposes ofSection 162(m), and independent as defined by Nasdaq or any other nationalsecurities exchange on which any of our securities may be listed for trading inthe future. Subject to the terms of the plan, the plan administrator isauthorized to select eligible persons to receive awards, determine the type andnumber of awards to be granted and the number of shares of our common stock towhich awards will relate, specify times at which awards will be exercisable ormay be settled (including performance conditions that may be required as acondition thereof), set other terms and conditions of awards, prescribe formsof award agreements, interpret and specify rules and regulations relating tothe plan, and make all other determinations that may be necessary or advisable forthe administration of the plan.

 

*StockOptions and Stock Appreciation Rights*

 

The plan administrator is authorized to grantstock options, including both incentive stock options, which we refer to asISOs, and nonqualified stock options. In addition, the plan administrator isauthorized to grant stock appreciation rights, which entitle the participant toreceive the appreciation in our common stock between the grant date and theexercise date of a stock appreciation right. The plan administrator determinesthe exercise price per share subject to an option and the grant price of astock appreciation right. However, the per share exercise price of an ISO andthe per share grant price of a stock appreciation right must not be less thanthe fair market value of a share of our common stock on the grant date and theper share exercise price of an ISO must not be less than 100% of the fairmarket value of a share of our common stock on the grant date. The planadministrator generally will fix the maximum term of each option or stockappreciation right, the times at which each stock option or stock appreciationright will be exercisable, and provisions requiring forfeiture of unexercisedstock options or stock appreciation rights on or following termination of employmentor service, except that no stock option or stock appreciation right may have aterm exceeding 10 years. Stock options may be exercised by payment of theexercise price in cash, shares that have been held for at least six months (orthat the plan administrator otherwise determines will not cause us a financialaccounting charge), and outstanding awards or other property having a fairmarket value equal to the exercise price, as the plan administrator maydetermine from time to time. The plan administrator determines methods ofexercise and settlement and other terms of the stock appreciation rights. Stockappreciation rights under the plan may include "limited stock appreciationrights" exercisable for a stated period of time after we experience achange in control or upon the occurrence of some other event specified by theplan administrator, as discussed below.

 

*Restrictedand Deferred Stock*

 

The plan administrator is authorized to grantrestricted stock and deferred stock. Restricted stock is a grant of shares ofour common stock, which may not be sold or disposed of and which may beforfeited in the event of certain terminations of employment or service, priorto the end of a restricted period specified by the plan administrator. Aparticipant granted restricted stock generally has all of the rights of one ofour stockholders, unless otherwise determined by the plan administrator. Anaward of deferred stock confers upon a participant the right to receive sharesof our common stock at the end of a specified deferral period, and may besubject to possible forfeiture of the award in the event of certainterminations of employment prior to the end of a specified restricted period.Prior to settlement, an

 

 

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award of deferred stock carries no voting ordividend rights or other rights associated with share ownership, althoughdividend equivalents may be granted, as discussed below.

 

*DividendEquivalents*

 

The plan administrator is authorized to grantdividend equivalents conferring on participants the right to receive, currentlyor on a deferred basis, cash, shares of our common stock, other awards, orother property equal in value to dividends paid on a specific number of sharesof our common stock or other periodic payments. Dividend equivalents may begranted alone or in connection with another award, may be paid currently or ona deferred basis and, if deferred, may be deemed to have been reinvested inadditional shares of our common stock, awards, or otherwise as specified by theplan administrator.

 

*BonusStock and Awards in Lieu of Cash Obligations*

 

The plan administrator is authorized to grantshares of our common stock as a bonus free of restrictions for servicesperformed for us or to grant shares of our common stock or other awards in lieuof our obligations to pay cash under the plan or other plans or compensatoryarrangements, subject to such terms as the plan administrator may specify.

 

*OtherStock-Based Awards*

 

The plan administrator is authorized to grantawards under the plan that are denominated or payable in, valued by referenceto, or otherwise based on or related to shares of our common stock. Such awardsmight include convertible or exchangeable debt securities, other rightsconvertible or exchangeable into shares of our common stock, purchase rightsfor shares of our common stock, awards with value and payment contingent uponour performance or any other factors designated by the plan administrator, andawards valued by reference to the book value of shares of our common stock orthe value of securities of or the performance of specified subsidiaries orbusiness units. The plan administrator determines the terms and conditions ofsuch awards.

 

*PerformanceAwards*

 

The right of a participant to exercise orreceive a grant or settlement of an award, and the timing thereof, may besubject to such performance conditions, including subjective individual goals,as may be specified by the plan administrator. In addition, the plan authorizesspecific performance awards, which represent a conditional right to receivecash, shares of our common stock, or other awards upon achievement of certainpre-established performance goals and subjective individual goals during aspecified fiscal year. Performance awards granted to persons whom the planadministrator expects will, for the year in which a deduction arises, be"covered employees" (as defined below) will, if and to the extentintended by the plan administrator, be subject to provisions that shouldqualify such awards as "performance based" compensation not subjectto the limitation on tax deductibility by us under Section 162(m) of theInternal Revenue Code, or the Code. For purposes of Section 162(m), theterm "covered employee" means our Chief Executive Officer and ourfour most highly compensated officers as of the end of a taxable year asdisclosed in our filings with the SEC. If and to the extent required underSection 162(m), any power or authority relating to a performance awardintended to qualify under Section 162(m) is to be exercised by theCompensation Committee, it will not be exercised by our Board of Directors.

 

Subject to the requirements of the plan, theplan administrator will determine performance award terms, including therequired levels of performance with respect to specified business criteria, thecorresponding amounts payable upon achievement of such levels of performance,termination and forfeiture provisions, and the form of settlement. One or

 

 

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more of the following business criteria basedon our financial statements, or those of our affiliates, or those of ourbusiness units or affiliates (except with respect to the total stockholderreturn and earnings per share criteria), will be used by the plan administratorin establishing performance goals for such performance awards (including forawards designed to comply with the performance-based compensation exception toSection 162(m)): (i) total stockholder return, (ii) totalstockholder return compared to total return (on a comparable basis) of apublicly available index; (iii) net income; (iv) pretax earnings;(v) earnings before interest expense, taxes, depreciation, andamortization; (vi) pretax operating earnings after interest expense butbefore bonuses and extraordinary or special items; (vii) operating margin;(viii) earnings per share; (ix) return on equity; (x) return oncapital; (xi) return on investment; (xii) operating earnings;(xiii) cash flow from operations; and (xiv) ratio of debt tostockholders' equity. In granting performance awards, the plan administratormay establish unfunded award "pools," the amounts of which will bebased upon the achievement of a performance goal or goals based on one or moreof the business criteria described in the plan. During the first 90 daysof a performance period, the plan administrator will determine who willpotentially receive performance awards for that performance period, either outof the pool or otherwise.

 

After the end of each performance period, theplan administrator (which will be the Compensation Committee for awardsintended to qualify as performance-based for purposes of Section 162(m))will determine (a) the amount of any pools and the maximum amount ofpotential performance awards payable to each participant in the pools and(b) the amount of any other potential performance awards payable toparticipants in the plan. The plan administrator may, in its discretion,determine that the amount payable as a performance award will be reduced fromthe amount of any potential award.

 

*OtherTerms of Awards*

 

Awards may be settled in the form of cash,shares of our common stock, other awards, or other property in the discretionof the plan administrator. Awards under the plan are generally granted withouta requirement that the participant pay consideration in the form of cash orproperty for the grant (as distinguished from the exercise), except to theextent required by law. The plan administrator may require or permitparticipants to defer the settlement of all or part of an award in accordancewith such terms and conditions as the plan administrator may establish,including payment or crediting of interest or dividend equivalents on deferredamounts, and the crediting of earnings, gains, and losses based on deemedinvestment of deferred amounts in specified investment vehicles. The planadministrator is authorized to place cash, shares of our common stock, or otherproperty in trusts or make other arrangements to provide for payment of ourobligations under the plan. The plan administrator may condition any paymentrelating to an award on the withholding of taxes and may provide that a portionof any shares of our common stock or other property to be distributed will bewithheld (or previously acquired shares of our common stock or other propertybe surrendered by the participant) to satisfy withholding and other taxobligations. Awards granted under the plan generally may not be pledged orotherwise encumbered and are not transferable except by will or by the laws ofdescent and distribution or to a designated beneficiary upon the participant'sdeath, except that the plan administrator may, in its discretion, permittransfers of nonqualified stock options for estate planning or other purposessubject to any applicable restrictions under Rule 16b-3 under theSecurities Exchange Act of 1934.

 

The plan administrator may grant awards inexchange for other awards under the plan or under other of our compensationplans, or other rights to payment from us, and may grant awards in addition toor in tandem with such other awards or rights. In addition, the planadministrator may cancel awards granted under the plan in exchange for apayment of cash or other property. The terms of any exchange of or purchase ofan award will be determined by the plan administrator in its sole discretion.

 

 

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*Accelerationof Vesting; Change in Control*

 

The plan administrator may, in itsdiscretion, accelerate the vesting, exercisability, lapsing of restrictions, orexpiration of deferral of any award, including if we undergo a "change incontrol," as defined in the plan. In addition, the plan administrator mayprovide in an award agreement or employment agreement that the performancegoals relating to any performance-based award will be deemed to have been metupon the occurrence of any "change in control." The planadministrator may, in its discretion and without the consent of theparticipant, either (i) accelerate the vesting of all awards in full or asto some percentage of the award to a date prior to the effective date of the"change in control;" or (ii) provide for a cash payment inexchange for the termination of an award or any portion of an award where suchcash payment is equal to the fair market value of the shares that theparticipant would receive if the award were fully vested and exercised as ofsuch date, less any applicable exercise price. The plan administrator willdetermine whether each award is assumed, continued, substituted, or terminated.In connection with a "change in control," we may assign to theacquiring or successor company any repurchase rights associated with anyawards, and the plan administrator may provide that any repurchase rights held byus associated with such awards will lapse in whole or in part contingent uponthe "change in control."

 

In the event of a "corporatetransaction" (as defined in the plan), the acquiror may assume orsubstitute for each outstanding stock award. If the acquiror does not assume orsubstitute for an outstanding stock option, such stock option will terminateimmediately prior to the close of such corporate transaction to the extent theoption is not exercised.

 

*Amendmentand Termination*

* *

Our Board of Directors may amend, alter,suspend, discontinue, or terminate the plan or the plan administrator'sauthority to grant awards without further stockholder approval, exceptstockholder approval must be obtained for any amendment or alteration if suchapproval is required by law or regulation or under the rules of any stockexchange or quotation system on which shares of our common stock are thenlisted or quoted. Stockholder approval will not be deemed to be required underlaws or regulations, such as those relating to ISOs, that condition favorabletreatment of participants on such approval, although our Board of Directorsmay, in its discretion, seek stockholder approval in any circumstance in whichit deems such approval advisable. Unless earlier terminated by our Board ofDirectors, the plan will terminate on the earlier of (i) 10 yearsafter its adoption by our Board of Directors or (ii) such time as noshares of our common stock remain available for issuance under the plan and wehave no further rights or obligations with respect to outstanding awards underthe plan. Amendments to the plan or any award require the consent of theaffected participant if the amendment has a material adverse effect on theparticipant.

 

*FederalIncome Tax Consequences of Awards*

 

The information set forth below is a summaryonly and does not purport to be complete. In addition, the information is basedupon current federal income tax rules, and therefore is subject to change whenthose rules change. Moreover, because the tax consequences to any recipient maydepend on his particular situation, each recipient should consult therecipient's tax adviser regarding the federal, state, local, and other taxconsequences of the grant or exercise of an award or the disposition of stockacquired as a result of an award. The plan is not qualified under theprovisions of Section 401(a) of the Code and is not subject to any of theprovisions of the Employee Retirement Income Security Act of 1974.

 

 

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*NonqualifiedStock Options*

* *

Generally, there is no taxation upon thegrant of a nonqualified stock option. On exercise, an optionee will recognizeordinary income equal to the excess, if any, of the fair market value on thedate of exercise of the stock over the exercise price. If the optionee is ouremployee or an employee of an affiliate, that income will be subject towithholding tax. The optionee's tax basis in those shares will be equal totheir fair market value on the date of exercise of the option, and theoptionee's capital gain holding period for those shares will begin on thatdate.

 

Subject to the requirement of reasonableness,the provisions of Section 162(m), and the satisfaction of a tax reportingobligation, we will generally be entitled to a tax deduction equal to thetaxable ordinary income realized by the optionee.

 

*IncentiveStock Options*

* *

The plan provides for the grant of stockoptions that qualify as "incentive stock options," which we refer toas ISOs, as defined in Section 422 of the Code. Under the Code, anoptionee generally is not subject to ordinary income tax upon the grant orexercise of an ISO. In addition, if the optionee holds a share received onexercise of an ISO for at least two years from the date the option was grantedand at least one year from the date the option was exercised, which we refer toas the Required Holding Period, the difference, if any, between the amountrealized on a sale or other taxable disposition of that share and the holder'stax basis in that share will be long-term capital gain or loss.

 

If, however, an optionee disposes of a shareacquired on exercise of an ISO before the end of the Required Holding Period,which we refer to as a Disqualifying Disposition, the optionee generally willrecognize ordinary income in the year of the Disqualifying Disposition equal tothe excess, if any, of the fair market value of the share on the date the ISOwas exercised over the exercise price. However, if the sales proceeds are lessthan the fair market value of the share on the date of exercise of the option,the amount of ordinary income recognized by the optionee will not exceed thegain, if any, realized on the sale. If the amount realized on a DisqualifyingDisposition exceeds the fair market value of the share on the date of exerciseof the option, that excess will be short-term or long-term capital gain,depending on whether the holding period for the share exceeds one year.

 

For purposes of the alternative minimum tax,the amount by which the fair market value of a share of stock acquired onexercise of an ISO exceeds the exercise price of that option generally will bean adjustment included in the optionee's alternative minimum taxable income forthe year in which the option is exercised. If, however, there is aDisqualifying Disposition of the share in the year in which the option isexercised, there will be no adjustment for alternative minimum tax purposeswith respect to that share. If there is a Disqualifying Disposition in a lateryear, no income with respect to the Disqualifying Disposition will be includedin the optionee's alternative minimum taxable income for that year. Incomputing alternative minimum taxable income, the tax basis of a share acquiredon exercise of an ISO is increased by the amount of the adjustment taken intoaccount with respect to that share for alternative minimum tax purposes in theyear the option is exercised.

 

We are not allowed an income tax deductionwith respect to the grant or exercise of an ISO or the disposition of a shareacquired on exercise of an ISO after the Required Holding Period. However, ifthere is a Disqualifying Disposition of a share, we are allowed a deduction inan amount equal to the ordinary income includible in income by the optionee,provided that amount constitutes an ordinary and necessary business expense forus and is reasonable in amount, and either the employee includes that amount inincome or we timely satisfy our reporting requirements with respect to thatamount.

 

 

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*StockAwards*

* *

Generally, the recipient of a stock awardwill recognize ordinary compensation income at the time the stock is receivedequal to the excess, if any, of the fair market value of the stock receivedover any amount paid by the recipient in exchange for the stock. If, however,the stock is not vested when it is received (for example, if the employee isrequired to work for a period of time in order to have the right to sell thestock), the recipient generally will not recognize income until the stockbecomes vested, at which time the recipient will recognize ordinarycompensation income equal to the excess, if any, of the fair market value ofthe stock on the date it becomes vested over any amount paid by the recipientin exchange for the stock. A recipient may, however, file an election with theInternal Revenue Service, within 30 days of his or her receipt of thestock award, to recognize ordinary compensation income, as of the date therecipient receives the award, equal to the excess, if any, of the fair marketvalue of the stock on the date the award is granted over any amount paid by therecipient in exchange for the stock.

 

The recipient's basis for the determinationof gain or loss upon the subsequent disposition of shares acquired as stockawards will be the amount paid for such shares plus any ordinary incomerecognized either when the stock is received or when the stock becomes vested.

 

Subject to the requirement of reasonableness,the provisions of Section 162(m), and the satisfaction of a tax reportingobligation, we will generally be entitled to a tax deduction equal to thetaxable ordinary income realized by the recipient of the stock award.

 

*StockAppreciation Rights*

 

We may grant stock appreciation rightsseparate from any other award, which we refer to as stand-alone stockappreciation rights, or in tandem with options, which we refer to as tandemstock appreciation rights, under the plan.

 

With respect to stand-alone stockappreciation rights, if the recipient receives the appreciation inherent in thestock appreciation rights in cash, the cash will be taxable as ordinarycompensation income to the recipient at the time that the cash is received. Ifthe recipient receives the appreciation inherent in the stock appreciationrights in shares of stock, the recipient will recognize ordinary compensationincome equal to the excess of the fair market value of the stock on the day itis received over any amounts paid by the recipient for the stock.

 

With respect to tandem stock appreciationrights, if the recipient elects to surrender the underlying option in exchangefor cash or shares of stock equal to the appreciation inherent in theunderlying option, the tax consequences to the recipient will be the same asdiscussed above relating to the stand-alone stock appreciation rights. If therecipient elects to exercise the underlying option, the recipient will be taxedat the time of exercise as if he or she had exercised a nonqualified stockoption (discussed above).

 

Subject to the requirement of reasonableness,the provisions of Section 162(m), and the satisfaction of a tax reportingobligation, we will generally be entitled to a tax deduction equal to thetaxable ordinary income realized by the recipient of the stock appreciationright.

 

*DividendEquivalents*

* *

Generally, the recipient of a dividendequivalent award will recognize ordinary compensation income at the time thedividend equivalent award is received equal to the fair market value dividendequivalent award received. Subject to the requirement of reasonableness, theprovisions of Section 162(m), and the satisfaction of a tax reportingobligation, we

 

 

63

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will generally be entitled to a tax deductionequal to the taxable ordinary income realized by the recipient of the dividendequivalent.

 

Section 162 Limitations

 

Section 162(m) denies a deduction to anypublicly held corporation for compensation paid to certain "coveredemployees" in a taxable year to the extent that compensation to suchcovered employee exceeds $1 million. It is possible that compensationattributable to stock awards, when combined with all other types ofcompensation received by a covered employee from us, may cause this limitationto be exceeded in any particular year. For purposes of Section 162(m), theterm "covered employee" means our Chief Executive Officer and ourfour highest compensated officers as of the end of a taxable year as disclosedin our filings with the SEC.

 

Certain kinds of compensation, includingqualified "performance-based" compensation, are disregarded forpurposes of the Section 162(m) deduction limitation. In accordance withTreasury regulations issued under Section 162(m), compensationattributable to certain stock awards will qualify as performance-basedcompensation if the award is granted by a committee of the Board of Directorsconsisting solely of "outside directors" and the stock award isgranted (or exercisable) only upon the achievement (as certified in writing bythe committee) of an objective performance goal established in writing by thecommittee while the outcome is substantially uncertain, and the material termsof the plan under which the award is granted is approved by stockholders. Astock option or stock appreciation right may be considered"performance-based" compensation as described in the previoussentence or by meeting the following requirements: the incentive compensationplan contains a per-employee limitation on the number of shares for which stockoptions and stock appreciation rights may be granted during a specified period,the material terms of the plan are approved by the stockholders, and theexercise price of the option or right is no less than the fair market value ofthe stock on the date of grant.

 

The regulations under Section 162(m)require that the directors who serve as members of the committee must be"outside directors." The plan provides that directors serving on thecommittee must be "outside directors" within the meaning ofSection 162(m). This limitation would exclude from the committee directorswho are (i) our current employees or those of one of our affiliates,(ii) our former employees or those of one of our affiliates who receivecompensation for past services (other than benefits under a tax-qualifiedpension plan), (iii) our current and former officers or those of one ofour affiliates, (iv) directors currently receiving direct or indirectremuneration from us or one of our affiliates in any capacity other than as adirector, and (v) any other person who is not otherwise considered an"outside director" for purposes of Section 162(m). Thedefinition of an "outside director" under Section 162(m) isgenerally narrower than the definition of a "non-employee director"under Rule 16b-3 of the Exchange Act. 

 

 

64

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**ITEM 12. Security Ownership of Certain Beneficial Owners and Management andRelated Stockholder Matters**

 

The following table sets forth certain information regarding thebeneficial ownership of our common stock on March 15, 2006 by thefollowing:

 

•                  each of our directors and executive officers;

 

•                  all of our directors and executive officers as agroup; and

 

•                  each person known by us to own more than 5% of ourcommon stock.

 

Beneficial ownership is determined in accordance with the rules ofthe SEC. In computing the number of shares beneficially owned by a person andthe percentage ownership of that person, shares of common stock subject tooptions or warrants held by that person that are currently exercisable orexercisable within 60 days of December 31, 2005 are deemedoutstanding, but are not deemed outstanding for computing the percentageownership of any other person. Percentage of beneficial ownership is based upon23,312,500 shares of common stock outstanding as of March 15, 2006.

 

Except as otherwise indicated and subject to applicable communityproperty laws, each person named in the table has sole voting and investmentpower with respect to the shares set forth opposite such person’s name.

 
| **Name and Address of Beneficial Owner (1)** |   | **Number of  Shares  Beneficially  Owned** |   | **Percent  Beneficially  Owned** |   |
|----------------------------------------------------------------------------|--------|-------------------------------------------------|--------|----------------------------------|--------|
| **Directors and Executive Officers:**                                      |   |                                            |   |                             |   |
| David Zinberg                                                              |   | 9,772,343                                       | (2)    | 33.1                             | %      |
| Lawrence Y. Kong                                                           |   | 800,000                                         | (3)    | 3.4                              |   |
| Claudia Y. Liu                                                             |   | 800,000                                         | (4)    | 3.4                              |   |
| Peter G. Hanelt                                                            |   | —                                          | (5)    | —                           |   |
| Garry Y. Itkin                                                             |   | 680,000                                         | (6)    | 2.9                              |   |
| Man Jit Singh                                                              |   | —                                          | (5)    | —                           |   |
| Directors and executive officers as a group  (six persons)                 |   | 11,252,343                                      |   | 37.6                             |   |
|                                                                       |   |                                            |   |                             |   |
| **5% Stockholders:**                                                       |   |                                            |   |                             |   |
| Marina Zinberg                                                             |   | 7,707,657                                       | (7)    | 33.1                             |   |
| Saied Aframian                                                             |   | 1,200,000                                       | (8)    | 5.2                              |   |

 

----

(1)Except as otherwise indicated, each person may be reached at our company’saddress at Bidz.com, Inc., 3562 Eastham Drive, Culver City, California90232.

 

(2)Includes 6,230,000 shares issuable upon exercise of vested stock options.

 

(3)Includes 350,000 shares issuable upon exercise of vested stock options and200,000 shares issuable upon exercise of vested stock options held byClaudia Y. Liu, Mr. Kong’s spouse.

 

65

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(4)Includes 200,000 shares issuable upon exercise of vested stock options, 250,000shares held by Lawrence Y. Kong, Ms. Liu’s spouse, and 350,000 sharesissuable upon exercise of vested stock options held by Mr. Kong.

 

(5)Our Board of Directors intends to grant to each of Messrs. Hanelt andSingh options to purchase 20,000 shares of our common stock upon the effectivedate of this offering.

 

(6)Includes 20,000 shares issuable upon exercise of vested stock options.

 

(7)Marina Zinberg is the sister of David Zinberg.

 

(8)Includes 100,000 shares held by Saied Aframian’s wife. Mr. Aframian is anowner of LA Jewelers Inc., one of our principal suppliers. The address forMr. Aframian is c/o LA Jewelers Inc., 640 S. Hill St.Suite #354, Los Angeles, California 90014.

 

66

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**ITEM 13. Certain Relationships and Related Transactions**

 

**Relationship with LA Jewelers**

 

LA Jewelers, Inc. was one of the first suppliers to extend us aline of credit to purchase our inventory in 2001. LA Jewelers has extendedcredit to us of approximately $4.9 million as of December 31, 2005.In 2005 and 2004, LA Jewelers supplied approximately 37.1% and 33.8%,respectively, of the merchandise purchased by us. One of the owners of LAJewelers, Saied Aframian, beneficially owns 1,200,000 shares of our commonstock.

 

**Transactions with Mr. Zinberg**

 

During September 2005, Mr. Zinberg, our President and ChiefExecutive Officer, purchased an automobile from us for approximately $57,000,which represented the fair market value of the automobile.

 

During 2004, we advanced to Mr. Zinberg an aggregate ofapproximately $173,000, which has since been repaid. We do not have anyoutstanding loans to any of our directors or executive officers.

 

**Transactions with Mr. Mordovskoi**

 

Yuri Mordovskoi, our Vice President of Technology, is a majorstockholder in Technolect, Inc., a technology consulting firm. During theyear ended December 31, 2005, we paid to Technolect $150,000 inconsideration for technology consulting services provided to us by Technolect.We own 10% of the common stock of Technolect. As of December 31, 2005, wehave made no investments in Technolect.

 

Between 2002 and 2004, we paid Huntingford Investment Ltd. anaggregate of $250,000 in consideration for auction software developed by thatcompany. The $250,000 consideration was comprised of 25,000 shares of ourcommon stock valued at $5.00 per share and $125,000 cash. Mr. Mordovskoiserved as a consultant to Huntingford in connection with that project andultimately received from Huntingford 12,500 shares of our common stockissued to Huntingford.

 

We believe that these transactions were on terms no less favorable tous than could have been obtained from unrelated third parties.

 

**Family Relationships**

 

Claudia Y. Liu, our Vice President of Operations, is the wife ofLawrence Y. Kong, our Chief Financial Officer. During 2005, we paid Ms. Liua base salary of $100,000 and a bonus of $1,000. During 2005, we also grated toMs. Liu options to purchase 25,000 shares of our common stock at anexercise price of $6.00 per share, which was equal to the fair market value ofour common stock on the date of grant. Ms. Liu is not in a reportingposition to Mr. Kong, and compensation decisions relating to Ms. Liuare performed in the same manner as our other employees without input from Mr. Kong.

 

Marina Zinberg, who is a Vice President and beneficially owns 33.1% ofour outstanding shares of common stock, is the sister of David Zinberg, ourChairman of the Board, President, and Chief Executive Officer. During 2005, wepaid Marina Zinberg a salary of $78,000. Ms. Zinberg, who was formerly ourcorporate secretary and treasurer, reports to Mr. Zinberg. Compensationdecisions relating to Ms. Zinberg are performed in the same manner as ourother employees without input from Mr. Zinberg.

 

67

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**Item 14. Principal Accountant Fees and Services**

 

*Audit Fees*

 

The aggregate fees for professional servicesrendered by our auditors, Stonefield Josephson, Inc. for fiscal year endedDecember 31, 2005 was$225,884 for the audit of our annual financial statements contained in this Form 10-Kand for the review of our financial statements included in our Form 10-Qfor the period ended June 30, 2005 and September 30, 2005.  We were not required to file a Form 10-Qfor the period ended March 31, 2005, as we were at that time not subjectto the reporting requirements of the Exchange Act.

 

*Audit-Related Fees*

 

No fees were billed during the fiscal yearended December 31, 2005 for assurance and related services by StonefieldJosephson, Inc.

 

*Tax Fees*

 

The aggregate fees billed during the fiscal year ended December 31,2005 for tax compliance, tax advice and tax planning by Stonefield Josephson, Inc.were $11,020.

 

 

68

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**Item 15. Exhibits and Financial Statement Schedules**

 

(a) The following documents arefiled as part of this report:

 

**1. Financial Statements:**

 
| Report of Independent Registered Public Accounting Firm                                                       |   |
|---------------------------------------------------------------------------------------------------------------|--------|
| Balance  Sheets as of December 31, 2004 and 2005                                                         |   |
| Statements  of Operations for the Years ended December 31, 2003, 2004, and 2005                          |   |
| Statements of Stockholders’ Equity (Deficit) for the Years ended  December 31, 2003, 2004, and 2005 |   |
| Statements  of Cash Flows for the Years ended December 31, 2003, 2004, and 2005                          |   |
| Notes to Financial Statements                                                                                 |   |
| Schedule II – Valuation and Qualifying Accounts                                                |   |

 

F-1

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**Report of independent registered publicaccounting firm**

 

Board of Directors

Bidz.com, Inc.

Culver City, California

 

We have audited the accompanying balance sheets of Bidz.com, Inc.as of December 31, 2004 and 2005, and the related statements ofoperations, stockholders’ equity (deficit) and cash flows for each of the threeyears in the period ended December 31, 2005. Our audits also include thefinancial statement schedule listed at the index in Schedule II as ofand for the years ended December 31, 2004 and 2005. These financialstatements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements based onour audits.

 

We conducted our audits in accordance with the standards of the PublicCompany Accounting Oversight Board (United States). Those standards requirethat we plan and perform the audits to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement. An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. An audit also includes assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation. We believethat our audits provide a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above presentfairly, in all material respects, the financial position of Bidz.com, Inc.as of December 31, 2004 and 2005, and the results of its operations andits cash flows for each of the three years in the period ended December 31,2005, in conformity with accounting principles generally accepted in the UnitedStates. Also, in our opinion, the financial statement schedule whenconsidered in relation to the basic financial statements, taken as a whole,presents fairly, in all material respects, the information set forth therein asof and for the years ended December 31, 2004 and 2005.

 
| /s/ Stonefield Josephson, Inc. |   |
|-------------------------------------|--------|

 

CERTIFIED PUBLIC ACCOUNTANTS

 

Los Angeles, California

February 22, 2006

 

F-2

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**Bidz.com, Inc.**

 

**Balancesheets**

 
| ** **                                                                                                                                                               | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| **(****in thousands, except share and per share data)**                                                                               | ** ** | **2004**              | ** ** | **2005** | ** ** |
| ** **                                                                                                                                                               |       |                  |       |   |   |
| **Assets**                                                                                                                                                               |       |                  |       |   |   |
| Current assets:                                                                                                                                                          |       |                  |       |   |   |
| Cash                                                                                                                                                                     |       | $                     | 5          |   | $ | 7 |   |
| Accounts receivable                                                                                                                                                      |       | 561                   |       | 886 |   |
| Inventories, net of reserves of $309 and  $331 at December 31, 2004 and 2005, respectively                                                                          |       | 10,733                |       | 15,921 |   |
| Other current assets                                                                                                                                                     |       | 107                   |       | 158 |   |
| Total current assets                                                                                                                                                     |       | 11,406                |       | 16,972 |   |
| Property and equipment, net                                                                                                                                              |       | 344                   |       | 384 |   |
| Intangible asset                                                                                                                                                         |       | 150                   |       | 150 |   |
| Deposits                                                                                                                                                                 |       | 590                   |       | 240 |   |
| Total assets                                                                                                                                                             |       | $                     | 12,490     |   | $ | 17,746 |   |
| ** **                                                                                                                                                               |       |                  |       |   |   |
| **Liabilities  and stockholders’ equity (deficit)**                                                                                                                 |       |                  |       |   |   |
| Current liabilities:                                                                                                                                                     |       |                  |       |   |   |
| Bank overdraft (includes related party  amounts of $3,272 and $2,184 at December 31, 2004 and 2005,  respectively)                                                  |       | $                     | 6,503      |   | $ | 5,315 |   |
| Accounts payable (includes related party  amounts of $1,555 and $2,712 at December 31, 2004 and 2005,  respectively)                                                |       | 4,903                 |       | 7,297 |   |
| Accrued expenses                                                                                                                                                         |       | 1,105                 |       | 1,774 |   |
| Deferred revenue                                                                                                                                                         |       | 1,059                 |       | 1,577 |   |
| Total current liabilities                                                                                                                                                |       | 13,570                |       | 15,963 |   |
|                                                                                                                                                                     |       |                  |       |   |   |
| Commitments and contingencies                                                                                                                                            |       | —                |       | — |   |
|                                                                                                                                                                     |       |                  |       |   |   |
| Stockholders’ equity (deficit):                                                                                                                                     |       |                  |       |   |   |
| Common Stock; no par value; authorized  50,000,000 shares; issued and outstanding 11,922,500 and 23,312,500 shares at  December 31, 2004 and 2005, respectively     |       | 28,388                |       | 28,830 |   |
| Class B Common Stock; no par value;  authorized 25,000,000 shares; issued and outstanding 15,534,689 and 0 shares  at December 31, 2004 and 2005, respectively |       | 426                   |       | — |   |
| Deferred stock-based compensation                                                                                                                                        |       | (300                  | )          | (100 | ) |
| Accumulated deficit                                                                                                                                                      |       | (29,594               | )          | (26,947 | ) |
| Total stockholders’ equity (deficit)                                                                                                                                |       | (1,080                | )          | 1,783 |   |
|                                                                                                                                                                     |       |                  |       |   |   |
|                                                                                                                                                                     |       | $                     | 12,490     |   | $ | 17,746 |   |

 

F-3

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**Bidz.com, Inc.**

 

**Statementsof operations**

 
| ** **                                                                             | ** ** | **Years ended December 31,** | ** ** |
|----------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| **(in thousands, except share and per share data)** | ** ** | **2003**                                    | ** ** | **2004** | ** ** | **2005** | ** ** |
| Net revenue:                                                                           |       |                                        |       |   |   |   |   |
| Merchandise sales                                                                      |       | $                                           | 46,907     |   | $ | 64,738 |   | $ | 90,309 |   |
| Commissions                                                                            |       | 539                                         |       | 549 |   | 264 |   |
| Advertising                                                                            |       | 219                                         |       | 37 |   | 6 |   |
|                                                                                   |       | 47,665                                      |       | 65,324 |   | 90, 579 |   |
| Cost of revenue                                                                        |       | 42,188                                      |       | 53,072 |   | 71,257 |   |
| Gross profit                                                                           |       | 5,477                                       |       | 12,252 |   | 19,322 |   |
| Operating expenses:                                                                    |       |                                        |       |   |   |   |   |
| General and administrative                                                             |       | 9,259                                       |       | 8,800 |   | 10,938 |   |
| Sales and marketing                                                                    |       | 1,960                                       |       | 2,542 |   | 5,078 |   |
| Rescission and pre-IPO costs                                                           |       | —                                      |       | — |   | 442 |   |
| Depreciation and amortization                                                          |       | 61                                          |       | 139 |   | 157 |   |
| Total operating expenses                                                               |       | 11,280                                      |       | 11,481 |   | 16,615 |   |
| Income (loss) from operations                                                          |       | (5,803                                      | )          | 771 |   | 2,707 |   |
| Other income – interest income                                                    |       | —                                      |       | — |   | 22 |   |
| Other expense – interest (expense)                                                |       | (27                                         | )          | — |   | — |   |
| Income (loss) before income tax expense                                                |       | (5,830                                      | )          | 771 |   | 2,729 |   |
| Income tax expense                                                                     |       | —                                      |       | — |   | 82 |   |
| Net income (loss)                                                                      |       | $                                           | (5,830     | ) | $ | 771 |   | $ | 2,647 |   |
| Net income (loss) per share available to  common stockholders – basic        |       | $                                           | (0.21      | ) | $ | 0.03 |   | $ | 0.11 |   |
| Net income (loss) per share available to  common stockholders – diluted      |       | $                                           | (0.21      | ) | $ | 0.03 |   | $ | 0.11 |   |
| Weighted average number of shares  outstanding – basic                       |       | 27,283,233                                  |       | 27,466,302 |   | 24,337,159 |   |
| Weighted average number of shares outstanding –  diluted                     |       | 27,283,233                                  |       | 28,014,361 |   | 24,858,535 |   |

 

F-4

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**Bidz.com, Inc.**

 

**Statements of changes in stockholders’ equity(deficit)**

 
| ** **                                                         | ** ** | **Common Stock** | ** ** | **Class B  Common Stock** | ** ** | **Deferred  Stock-based** | ** ** | **Accumulated** | ** ** | **Total  Stockholders’** | ** ** |
|--------------------------------------------------------------------|------------|-----------------------|------------|-------------------------------------|------------|---------------------------|------------|-----------------|------------|-------------------------------|------------|
| **(in thousands)**                                            | ** ** | **Shares**            | ** ** | **Amount**                          | ** ** | **Shares**                | ** ** | **Amount**      | ** ** | **Compensation**              | ** ** | **Deficit** | ** ** | **Equity (Deficit)** | ** ** |
| Balance at  December 31, 2002                                 |       | 11,177                |       | $                                   | 24,578     |                      | 15,535     |            | $          | 426                           |       | $ | (1,400 | ) | $ | (24,535 | ) | $ | (931 | ) |
| Proceeds received  from sale of common stock                       |       | 753                   |       | 2,992                               |       | —                    |       | —          |       | —                        |       | — |   | 2,992 |   |
| Issuance of  common stock for service                              |       | 19                    |       | 105                                 |       | —                    |       | —          |       | —                        |       | — |   | 105 |   |
| Intrinsic value  of stock options granted to employees             |       | —                |       | 716                                 |       | —                    |       | —          |       | —                        |       | — |   | 716 |   |
| Fair value of  options granted to non-employee consultants         |       | —                |       | 4                                   |       | —                    |       | —          |       | —                        |       | — |   | 4 |   |
| Retirements of  common stock                                       |       | (9                    | )          | (41                                 | )          | —                    |       | —          |       | —                        |       | — |   | (41 | ) |
| Amortization of  deferred stock-based compensation                 |       | —                |       | —                              |       | —                    |       | —          |       | 900                           |       | — |   | 900 |   |
| Net loss                                                           |       | —                |       | —                              |       | —                    |       | —          |       | —                        |       | (5,830 | ) | (5,830 | ) |
| Balance at  December 31, 2003                                 |       | 11,940                |       | $                                   | 28,354     |                      | 15,535     |            | $          | 426                           |       | $ | (500 | ) | $ | (30,365 | ) | $ | (2,085 | ) |
| Issuance of  common stock for asset purchases                      |       | 25                    |       | 125                                 |       | —                    |       | —          |       | —                        |       | — |   | 125 |   |
| Issuance of  common stock in lieu of refund for merchandise return |       | 3                     |       | 15                                  |       | —                    |       | —          |       | —                        |       | — |   | 15 |   |
| Issuance of  common stock for service                              |       | 1                     |       | 5                                   |       | —                    |       | —          |       | —                        |       | — |   | 5 |   |
| Fair value of  options granted to non-employee consultants         |       | —                |       | 27                                  |       | —                    |       | —          |       | —                        |       | — |   | 27 |   |
| Retirements of  common stock                                       |       | (47                   | )          | (138                                | )          | —                    |       | —          |       | —                        |       | — |   | (138 | ) |
| Amortization of  deferred stock-based compensation                 |       | —                |       | —                              |       | —                    |       | —          |       | 200                           |       | — |   | 200 |   |
| Net income                                                         |       | —                |       | —                              |       | —                    |       | —          |       | —                        |       | 771 |   | 771 |   |
| Balance at  December 31, 2004                                 |       | 11,922                |       | $                                   | 28,388     |                      | 15,535     |            | $          | 426                           |       | $ | (300 | ) | $ | (29,594 | ) | $ | (1,080 | ) |
| Conversion of  Class B common stock to common stock           |       | 15,535                |       | 426                                 |       | (15,535                   | )          | (426            | )          | —                        |       | — |   | — |   |
| Cancellation of  common stock                                      |       | (4,145                | )          |                                |       |                      |       |            |       |                          |       |   |   |   |   |
| Fair value of  options granted to non-employee consultants         |       | —                |       | 16                                  |       | —                    |       | —          |       | —                        |       | — |   | 16 |   |
| Amortization of  deferred stock-based compensation                 |       | —                |       | —                              |       | —                    |       | —          |       | 200                           |       | — |   | 200 |   |
| Net income                                                         |       | —                |       | —                              |       | —                    |       | —          |       | —                        |       | 2,647 |   | 2,647 |   |
| Balance at  December 31, 2005                                 |       | 23,312                |       | $                                   | 28,830     |                      | 0          |            | $          | —                        |       | $ | (100 | ) | $ | (26,947 | ) | $ | 1,783 |   |

 

F-5

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**Bidz.com, Inc.**

 

**Statementsof cash flows**

 
| ** **                                                                                               | ** ** | **Years ended December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| **(in thousands)**                                                                                  | ** ** | **2003**                                    | ** ** | **2004** | ** ** | **2005** | ** ** |
| **Cash flows provided by (used for) operating  activities:**                                             |       |                                        |       |   |   |   |   |
| Net income (loss)                                                                                        |       | $                                           | (5,830     | ) | $ | 771 |   | $ | 2,647 |   |
| **Adjustments to reconcile net income (loss)  to net cash provided by (used for) operating activities:** |       |                                        |       |   |   |   |   |
| Depreciation and amortization                                                                            |       | 61                                          |       | 139 |   | 157 |   |
| Change in inventory reserve                                                                              |       | (164                                        | )          | (198 | ) | 22 |   |
| Amortization of deferred stock-based  compensation                                                       |       | 900                                         |       | 200 |   | 200 |   |
| Stock-based compensation                                                                                 |       | 825                                         |       | 32 |   | 16 |   |
| **Changes in assets and liabilities:**                                                                   | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| **(Increase) decrease in assets:**                                                                       |       |                                        |       |   |   |   |   |
| Accounts receivable                                                                                      |       | 214                                         |       | 7 |   | (325 | ) |
| Inventories                                                                                              |       | 3,122                                       |       | (4,944 | ) | (5,210 | ) |
| Other current assets                                                                                     |       | (35                                         | )          | (54 | ) | (51 | ) |
| Deposits                                                                                                 |       | (390                                        | )          | — |   | 350 |   |
| **Increase (decrease) in liabilities:**                                                                  |       |                                        |       |   |   |   |   |
| Accounts payable                                                                                         |       | 217                                         |       | 2,457 |   | 2,394 |   |
| Accrued expenses                                                                                         |       | 271                                         |       | (731 | ) | 669 |   |
| Deferred revenue                                                                                         |       | (963                                        | )          | 184 |   | 518 |   |
| Net cash provided by (used for) operating  activities                                                    |       | (1,772                                      | )          | (2,137 | ) | 1,387 |   |
| **Cash flows (used for) investing activities:**                                                          |       |                                        |       |   |   |   |   |
| Capital expenditures, net                                                                                |       | (232                                        | )          | (35 | ) | (197 | ) |
| **Cash flows provided by (used for) financing  activities:**                                             |       |                                        |       |   |   |   |   |
| Increase (decrease) in bank overdraft                                                                    |       | (937                                        | )          | 2,305 |   | (1,188 | ) |
| Proceeds from issuance of common stock, net                                                              |       | 2,992                                       |       | — |   | — |   |
| Payments for retirement of common stock                                                                  |       | (41                                         | )          | (138 | ) | — |   |
| Advance on short-term loan, shareholder                                                                  |       | —                                      |       | (173 | ) | — |   |
| Payments from short-term loan, shareholder                                                               |       | —                                      |       | 173 |   | — |   |
| Net cash provided (used for) by financing  activities                                                    |       | 2,014                                       |       | 2,167 |   | (1,188 | ) |
| **Net increase (decrease) in cash**                                                                      |       | 10                                          |       | (5 | ) | 2 |   |
| **Cash, beginning of year**                                                                              |       | —                                      |       | 10 |   | 5 |   |
| **Cash, end of year**                                                                                    |       | $                                           | 10         |   | $ | 5 |   | $ | 7 |   |
| **Supplemental disclosure of cash flow  information:**                                                   |       |                                        |       |   |   |   |   |
| Interest paid                                                                                            |       | $                                           | 27         |   | $ | — |   | $ | — |   |
| Income tax expense paid                                                                                  |       | $                                           | —     |   | $ | — |   | $ | 91 |   |
| **Supplemental disclosure of non-cash  investing and financing activities:**                             |       |                                        |       |   |   |   |   |
| Disposal of property and equipment                                                                       |       | $                                           | —     |   | $ | — |   | $ | 57 |   |
| Stock issued for asset purchased                                                                         |       | $                                           | —     |   | $ | 125 |   | $ | — |   |

 

F-6

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**Bidz.com, Inc.**

 

**Notes to financial statements**

**(in thousands, except share and per share amounts)**

 

**(1)           Summaryof Significant Accounting Policies:**

 

*Business and Organization:*

 

We were formed in November 1998as a California corporation with our principal location of business in LosAngeles, California. We operate a website located at *www.bidz.com* for the purpose of selling merchandise,utilizing our unique online sales auction platform.

 

We sell our products throughoutthe United States and have expanded the reach of our customer base to Europeand Asia in recent years. Revenue generated from the United States accountedfor approximately 87%, 83%, and 81% of net revenue for the years ended December 31,2003, 2004, and 2005, respectively.

 

As noted in our financial statementsand the related notes for the years ended December 31, 2002, 2003 and2004, the report of our independent registered public accounting firm statedthat our history of significant operating losses, working capital deficit, lackof additional financing, and negative cash flows from operations raisedsubstantial doubt about our ability to continue as a going concern.

 

During the year ended December 31,2005, we reported net income of $2.6 million and net cash provided byoperating activities of $1.4 million. This compares to net income of$771,000 and net cash used by operations of $2.1 million in the year endedDecember 31, 2004. As of December 31, 2005, we had current assets of$17.0 million and current liabilities of $16.0 million or workingcapital of $1.0 million. Available cash was $2.6 million beforepost-dated checks and was $7,000 net of post-dated checks. Our operations andcash flows have improved significantly since fiscal 2004.

 

*Use of Estimates:*

 

Preparing financial statementsin conformity with accounting principles generally accepted in the UnitedStates requires us to make estimates and assumptions that affect the reportedamounts of assets and liabilities. These estimates include certain reserves forinventories, valuation allowance for deferred taxes, disclosure of contingentassets and liabilities at the date of the financial statements, and thereported amounts of revenue and expenses during the reporting periods. Actualresults could differ from those estimates.

 

*Fair Value of Financial Instruments:*

 

The carrying amount of ourcash, accounts receivable, accounts payable, deferred revenue and accruedexpenses approximates their estimated fair values as a result of the short-termmaturities of those financial instruments.

 

*Cash and Cash Equivalents:*

 

For purposes of the statementsof cash flows, cash equivalents include all highly liquid debt instruments withoriginal maturities of three months or less that do not secure any corporateobligations. We had no cash equivalents at December 31, 2004 or 2005.

 

Our credit card processormaintains a security interest in substantially all our bank accounts.

 

F-7

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*Accounts Receivable:*

 

Accounts receivable consist ofamounts due from customers and from credit cards and other electronic paymentmethods billed but not yet received at period end. We had no allowance fordoubtful accounts at December 31, 2004 or 2005.

 

*Return and Allowance Reserve*

 

We estimate potential futureproduct returns related to current period revenue. We analyze historicalreturns, current economic trends, and changes in customer demand and acceptanceof our products when evaluating the adequacy of the sales returns reserve andother allowances in any accounting period. If actual returns are greater thanour estimates, we will record additional returns and allowances in addition toour estimates, which will result in lower net revenue recorded during thatperiod. All reserves for returns and chargebacks are included in accrued liabilities.

 

*Concentration of Credit Risk:*

 

Financial instruments thatpotentially subject us to significant concentrations of credit risk consistprimarily of cash and receivables. We derive our accounts receivable primarilyfrom revenue earned from customers located in the United States. We maintain anallowance for doubtful accounts based upon the expected collectibility ofaccounts receivable. We record an allowance if one is necessary. No customeraccounted for more than 10% of revenue or receivables during 2003, 2004, or2005.

 

We had a concentration ofreliance on two merchandise suppliers during 2003, 2004, and 2005. In addition,as more fully described in Note 11, we rely on 60-day payment terms frommost of our vendors to finance our working capital needs.

 

*Inventories:*

 

Inventories consist ofmerchandise purchased for resale and are stated at the lower of first-in,first-out cost (FIFO) or market. We record reserves against our inventory forestimated obsolescence or damage equal to the difference between the cost ofinventory and the estimated market value based upon assumptions about futuredemand and market conditions. We record reserves of 50% of the value ofinventory held for more than six months and 100% of the value of inventory heldfor more than one year. If actual market conditions are less favorable thanthose projected by us, specific reserves or additional inventory write-downsmay be required.

 

*Property and Equipment:*

 

Property and equipment arerecorded at cost and depreciated using the straight-line method over theestimated useful lives of the related assets as follows:

 

| ** **              | ** ** | **Years** | ** ** |
|-------------------------|------------|-----------|------------|
| Computer software       |       | 3         |       |
| Computer hardware       |       | 3         |       |
| Furniture and equipment |       | 5         |       |

 

F-8

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*Intangible Asset:*

 

Our intangible asset consistsof the cost to acquire our domain name, which was $150,000 as of December 31,2004 and 2005. Our domain name has an indefinite life and therefore is notsubject to amortization. We perform an annual evaluation for impairment on thisintangible asset. No impairment existed at December 31, 2004 or 2005.

 

*Long-Lived Assets:*

 

In accordance with Statement ofFinancial Accounting Standards (“SFAS”) No. 144, “Accounting for theImpairment or Disposal of Long-Lived Assets,” long-lived assets to be held andused are analyzed for impairment whenever events or changes in circumstancesindicate that the carrying amount of the assets may not be recoverable. SFAS No. 144applies to assets subject to amortization. We review property, equipment, andother long-lived assets subject to amortization for impairment whenever eventsor changes in circumstances indicate that the carrying amount of the assets maynot be recoverable. We measure recoverability by comparing the assets’ carryingamount with future undiscounted net cash flows the assets are expected togenerate. We base cash flow forecasts on trends of historical performance andour estimate of future performance, giving consideration to existing andanticipated competitive and economic conditions. If such assets are consideredto be impaired, we measure the impairment to be recognized by the amount bywhich the carrying amount of the assets exceeds the projected discounted futurecash flows arising from the assets or their fair values, whichever is moredeterminable.

 

*Revenue Recognition:*

 

We derive our revenue from fivesources: merchandise sales, commission revenue, advertising revenue, shippingrevenue, and auction transaction fee revenue. In accordance with SAB 104, werecognize revenue from all five sources when the following revenue recognitioncriteria are met: (1) persuasive evidence of an arrangement exists; (2) theproduct has been shipped or the service has been rendered and the customertakes ownership and assumes the risk of loss; (3) the selling price isfixed or determinable; and (4) collection of the resulting receivable isreasonably assured.

 

We recognize merchandise salesupon shipments made to individual consumers and businesses that are fulfilledfrom our warehouse. We generally require online payment by credit card or otherelectronic payment methods at the point of sale. We record amounts received orbilled prior to shipment of goods to customers as deferred revenue. We reducegross sales by returns, chargebacks from customers, and other discountsredeemed to obtain such sales.

 

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

 

We derive commission revenuefrom sales of Certified Merchant merchandise that is owned by third parties andrecognize that revenue when services have been rendered. For commissionrevenue, we recognize as revenue only the commission portion of the price ourcustomers pay for the purchased products because we are acting as an agent insuch transactions. Commissions are also reduced by the impact of returns andother discounts redeemed to obtain such sales.

 

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

 

F-9

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Outbound shipping charges tocustomers are included in merchandise sales and amounted to $7.6 million,$6.3 million and $9.4 million in 2003, 2004, and 2005, respectively.

 

Auction transaction fee revenueis included in merchandise sales and amounted to $0, $0, and $638,000 in 2003,2004, and 2005, respectively. On November 1, 2005 we began charging a 3%auction transaction fee on all merchandise sales.

 

*Cost of Revenue:*

 

Cost of revenue includesproduct costs, inbound and outbound shipping charges, packaging supplies,product repair costs, and credit card fees, and is recorded in the same periodin which related revenue have been recorded.

 

Outbound shipping costs onmerchandise sales totaled $3.6 million, $3.8 million, and$5.0 million in 2003, 2004, and 2005, respectively.

 

*Deferred Revenue:*

 

Deferred revenue representscash received and credit card receivables for products that have not yet beenshipped.

 

*Income Tax Expense:*

 

We recognize deferred taxassets and liabilities for the future tax consequences attributable todifferences between the financial statement carrying amounts of existing assetsand liabilities and their respective tax bases. We measure deferred tax assets,including tax loss and credit carryforwards and liabilities, using enacted taxrates expected to apply to taxable income in the years in which those temporarydifferences are expected to be recovered or settled. We recognize the effect ofa change in tax rates on deferred tax assets and liabilities in income in theperiod that includes the enactment date. Deferred income tax expense representsthe change during the period in the deferred tax assets and deferred taxliabilities. The components of the deferred tax assets and liabilities areindividually classified as current and non-current based on theircharacteristics. Realization of the deferred tax asset depends on generatingsufficient taxable income in future years. Deferred tax assets are reduced by avaluation allowance when we believe it is more likely than not that someportion or all of the deferred tax assets will not be realized.

 

*Stock-Based Compensation:*

 

We measure compensation expenseto employees for our stock option incentive plans using the intrinsic valuemethod prescribed by Accounting Principles Board Opinion No. 25 (“APB 25”),“Accounting for Stock Issued to Employees.” We provide pro forma disclosures ofnet loss as if the fair value based method prescribed by the Statement of FinancialAccounting Standards (“SFAS”) No. 123, “Accounting for Stock-BasedCompensation,” has been applied.

 

In December 2002, the FASBissued SFAS No. 148, “Accounting for Stock-Based Compensation-Transitionand Disclosure,” which amends, SFAS No. 123, “Accounting for Stock-BasedCompensation,” to provide alternative methods of transition for a voluntarychange to the fair value based method of accounting for stock-based employeecompensation. In addition, SFAS No. 148 expands the disclosurerequirements of SFAS No. 123 to require more prominent disclosures in bothannual and interim financial statements regarding the method of accounting forstock-based employee compensation and the effect of the method used on reportedresults.

 

F-10

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The transition provisions ofSFAS No. 148 are effective for fiscal years ended after December 15,2002. The transition provisions do not currently have an impact on ourfinancial position or results of operations as we have not elected to adopt thefair value-based method of accounting for stock-based employee compensationunder SFAS No. 123. The disclosure provisions of SFAS No. 148 areeffective for financial statements for interim periods beginning after December 15,2002. We adopted the disclosure requirements in the first quarter of 2003.

 

The following table illustratesthe effect on net loss and loss per share if we had applied the fair valuerecognition provisions of FASB Statement No. 123, “Accounting forStock-Based Compensation,” to stock-based employee compensation (in thousands,except per share data).

 
| ** **                                                                                                                               | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Net income (loss), as reported                                                                                                           |       | $        | (5,830     | )        | $          | 771      |       | $ | 2,647 |   |
| Add: Stock-based employee compensation  expense under APB 25, intrinsic value method, net of related tax effects                         |       | 716      |       | —   |       | —   |       |
| Deduct: Total stock-based employee  compensation expense determined under SFAS 123, fair value based method, net  of relaxed tax effects |       | (1,010   | )          | (8,789   | )          | (785     | )          |
| Pro forma net income (loss)                                                                                                              |       | $        | (6,124     | )        | $          | (8,018   | )          | $ | 1,862 |   |

 
| ** **                      | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** |
|---------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Net Income (loss) per share     |       |     |       |     |       |     |       |
| Basic – as reported   |       | $        | (0.21      | )        | $          | 0.03     |       | $ | 0.11 |   |
| Basic – pro forma     |       | $        | (0.22      | )        | $          | (0.29    | )          | $ | 0.07 |   |
| Diluted – as reported |       | $        | (0.21      | )        | $          | 0.03     |       | $ | 0.11 |   |
| Diluted – pro forma   |       | $        | (0.22      | )        | $          | (0.29    | )          | $ | 0.07 |   |

 

The fair value for theseoptions under SFAS 123, fair value based method, was estimated on the dateof grant using a Black-Scholes option pricing model with the assumptionsdiscussed in Note 8.

 

*Internal Use Software:*

 

Pursuant to SOP 98-1, weexpense all costs incurred for the development of internal use software thatrelate to the planning and post-implementation phases of the development andcertain maintenance and enhancement costs. We capitalize and amortize directcosts incurred in the application development phase over the software’sestimated useful life of three years. The capitalized software costs of$250,000 was incurred from 2002 to 2004, and have been amortized since placedin use. At December 31, 2004 and 2005, the net unamortized balanceincluded in Property and Equipment is $174,000 and $90,000, respectively. Weexpense research and development costs and other computer software maintenancecosts related to software development as incurred.

 

*Basic and Diluted Income (Loss) Per Share:*

 

In accordance with SFAS No. 128,“Earnings Per Share,” we compute the basic income (loss) per common share bydividing net income (loss) available to common stockholders by the weightedaverage number of common shares outstanding. We compute diluted loss per commonshare similarly to basic income (loss) per common share, except that weincrease the denominator to include the number of additional common shares thatwould have been outstanding

 

F-11

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if the potential common shareshad been issued and if the additional common shares were dilutive. At December 31,2003, 2004, and 2005, we had 1,655,000 shares, 7,728,500 shares, and 8,342,000shares, respectively, of common stock equivalents upon the exercise of theemployee options and non-employee stock options. These common stock equivalentsconsisted of 1,077,500 employee stock options and 577,000 non-employee stockoptions as of December 31, 2003; 7,126,500 employee stock options and602,000 non-employee stock options as of December 31, 2004; and 7,715,000employee stock options and 627,000 non-employee stock options as of December 31,2005. We excluded the stock equivalents from the computation of dilutedearnings per share as their effect was anti-dilutive for year ended December 31,2003. As of December 31, 2004, dilutive common stock equivalents totaled548,059, consisting of 331,934 employee stock options and 216,125 non-employeestock options. As of December 31, 2005, dilutive common stock equivalentstotaled 521,376, consisting of 305,251 employee stock options and 216,125non-employee stock options.

 

The dilutive effect ofoutstanding stock options is reflected in diluted earnings per share byapplication of the treasury stock method for the year ended December 31,2005. The following table sets forth the computation of basic and diluted netincome (loss) per share (in thousands, except share and per share data):

 
| ** **                                                                        | ** ** | **2003**   | ** ** | **2004**   | ** ** | **2005**   | ** ** |
|-----------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| Basic and diluted net income (loss) per share: |       |       |       |       |       |       |       |
| Numerator:                                                                        |       |       |       |       |       |       |       |
| Net income (loss)                                                                 |       | $          | (5,830     | )          | $          | 771        |       | $ | 2,647 |   |
| Denominator:                                                                      |       |       |       |       |       |       |       |
| Weighted average shares of common stock  outstanding                              |       | 27,283,233 |       | 27,466,302 |       | 24,337,159 |       |
| Effect of dilutive securities                                                     |       | —     |       | 548,059    |       | 521,376    |       |
|                                                                              |       |       |       |       |       |       |       |
| Denominator for diluted calculation                                               |       | 27,283,233 |       | 28,014,361 |       | 24,858,535 |       |
| Net income (loss) per share, basic                                                |       | $          | (0.21      | )          | $          | 0.03       |       | $ | 0.11 |   |
| Net income (loss) per share, diluted                                              |       | $          | (0.21      | )          | $          | 0.03       |       | $ | 0.11 |   |

 

*Advertising Expense:*

 

We recognize advertisingexpenses in accordance with SOP 93-7, “Reporting on Advertising Costs.” Assuch, we expense the costs of producing advertisements at the time productionoccurs and expense the cost of communicating advertisements in the periodduring which the advertising space or airtime is used. We recognize Internetadvertising expenses based on the terms of the individual agreements, which aregenerally (1) during the period customers are acquired; (2) based onthe number of clicks generated during a given period over the term of thecontract; or (3) based on the number of e-mails sent during an e-maildistribution campaign. Advertising expenses totaled $2.0 million,$2.5 million, and $5.1 million during the years ended December 31,2003, 2004, and 2005, respectively.

 

F-12

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*Reclassification:*

 

Certain amounts from prioryears have been reclassified to conform to the current year’s presentation.

 

*New Accounting Pronouncements:*

 

In December 2004, the FASBissued SFAS No. 123R (Revised 2004), “Share-Based Payment” (“SFAS 123R”).This statement addresses the accounting for share-based payment transactions inwhich a company receives employee services in exchange for the company’s equityinstruments or liabilities that are based on the fair value of the company’sequity securities or may be settled by the issuance of these securities.SFAS 123R eliminates the ability to account for share-based compensationusing APB 25 and generally requires that such transactions be accounted forusing a fair value method. The provisions of this statement are effective forfinancial statements issued in the first quarter reporting period commencingafter December 15, 2005. Therefore, we will adopt the provisions ofSFAS 123R in our first quarter of 2006. The stock-based compensation wewill recognize after the adoption of SFAS 123R will be affected by thenumber and type of stock-based awards granted in the future and the pricingmodel and related assumptions we decide to use in order to estimate the fairvalues of options.

 

We are currently evaluatingwhich pricing model we will use to estimate the value of our options and whichtransition method we will use to implement SFAS 123R. We have not yetdetermined the impact that the adoption of SFAS No. 123R will have on ourresults of operations.

 

In March 2005, the SECissued Staff Accounting Bulletin No. 107 (“SAB 107”), “Share BasedPayment,” which expresses the SEC’s views on the interaction between SFAS No. 123Rand certain SEC rules and regulations. We are currently assessing theguidance in SAB 107 as part of our evaluation of the adoption of SFAS No. 123R.

 

In June 2005, theFinancial Accounting Standards Board issued Statement of Financial AccountingStandards No. 154, “Accounting Changes and Error Corrections - areplacement of APB Opinion No. 20 and FASB Statement No. 3”(SFAS 154). This Statement replaces APB Opinion No. 20, “AccountingChanges,” and FASB Statement No. 3, “Reporting Accounting Changes inInterim Financial Statements,” and changes the requirement for accounting forand reporting a change in accounting principles. This Statement requiresretroactive application to financial statements of prior periods for changes inaccounting principles. This Statement is effective January 1, 2006. Thisstandard has no impact on our financial statements.

 

In June 2005, the EmergingIssues Task Force, or EITF, reached a consensus on Issue 05-6, *Determining the Amortization Period for LeaseholdImprovements*, which requires that leasehold improvements acquired ina business combination or purchased subsequent to the inception of a lease beamortized over the lesser of the useful life of the assets or a term thatincludes renewals that are reasonably assured at the date of the businesscombination or purchase. EITF 05-6 is effective for periods beginning after July 1,2005. We do not expect the provisions of this consensus to have a materialimpact on our financial position, results of operations, or cash flows.

 

F-13

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**(2)           Inventories:**

 

Inventories consist of thefollowing:

 
| **(in thousands):**         | ** ** | **2004** | ** ** | **2005** | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|
| Product inventories              |       | $        | 11,042     |     | $          | 16,252 |   |
| Less: allowance for obsolescence |       | (309     | )          | (331     | )          |
|                             |       | $        | 10,733     |     | $          | 15,921 |   |

 

**(3)           Propertyand Equipment:**

 

Property and equipment consistsof the following:

 
| **(in thousands):**                         | ** ** | **2004** | ** ** | **2005** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|
| Computer hardware and software                   |       | $        | 76         |     | $          | 231 |   |
| Furniture and equipment                          |       | 224      |       | 262      |       |
| Internal developed software                      |       | 250      |       | 250      |       |
|                                             |       | 550      |       | 743      |       |
| Less: accumulated depreciation and  amortization |       | 206      |       | 359      |       |
|                                             |       | $        | 344        |     | $          | 384 |   |

 

Depreciation and amortizationexpense of property and equipment totaled $61,000, $139,000, and $157,000 forthe years ended December 31, 2003, 2004, and 2005, respectively.

 

**(4)           AccountsPayable and Bank Overdraft:**

 

We issued a number ofpost-dated checks to our vendors for merchandise purchased. We had outstandingpost-dated checks in the amounts of $6.6 million and $7.9 million,which we reduced from the cash balance and accounts payable as of December 31,2004 and 2005, respectively.

 

F-14

----

 

**(5)           AccruedExpenses:**

 

Accrued expenses consist of thefollowing:

 
| **(in thousands):**                | ** ** | **2004** | ** ** | **2005** | ** ** |
|-----------------------------------------|------------|----------|------------|----------|------------|
| Merchandise purchases                   |       | $        | —     |     | $          | 489 |   |
| Accrued payroll and other related costs |       | 333      |       | 387      |       |
| Accrued net sales returns               |       | —   |       | 123      |       |
| Other accrued expenses                  |       | 572      |       | 415      |       |
| Accrued marketing expenses              |       | 200      |       | 360      |       |
|                                    |       | $        | 1,105      |     | $          | 1,774 |   |

 

**(6)           Commitments:**

 

The following table presentsour contractual obligations at December 31, 2005, over the next five yearsand thereafter.

 
| **(in thousands)  Payments by Period** | ** ** | **Total  Amount** | ** ** | **Less  Than  1 Year** | ** ** | **1-3  Years** | ** ** | **4-5  Years** | ** ** | **After 5  Years** | ** ** |
|-------------------------------------------------------|------------|-------------------|------------|-----------------------------|------------|----------------|------------|----------------|------------|-------------------------|------------|
| Property lease                                        |       | $                 | 3,306      |                        | $          | 847            |       | $              | 1,769      |                    | $          | 690 |   | $ | — |   |
|                                                       |            |                   |            |                             |            |                |            |                |            |                         |            |  |  |  |  |  |

 

We lease a 50,220 square-footoffice and warehouse space in Culver City, California. The lease expires in October 2009.We are obligated to pay real estate taxes, insurance, and maintenance expenses.We expect that, in the normal course of business, the lease will be renewed orreplaced by leases on other properties upon termination. Thus, we anticipatethat future minimum lease commitments will likely be more than the amountsshown for 2005. Rental expenses for operating leases totaled $624,000,$837,000, and $885,000 for the years ended December 31, 2003, 2004, and2005, respectively.

 

**(7)           Stockholders’Equity (Deficit):**

 

*Preferred Stock*

 

Our certificate ofincorporation authorizes our Board of Directors to designate and issue up to4,000,000 shares of preferred stock, no par value. The holders of preferredstock will have such rights, preferences, and privileges as may be determinedby our Board of Directors prior to the issuance of such shares. As of December 31,2004 and 2005, we had not designated or issued any shares of preferred stock.

 

*Common Stock*

 

At December 31, 2004 and2005, our authorized shares consisted of 50,000,000 shares of common stock and25,000,000 shares of Class B common stock. Both classes of common stockhave no par value. Each share of

 

F-15

----

 

common stock and Class Bcommon stock has the right to one vote. The holders of common stock areentitled to receive dividends out of legally available funds when, as, and ifdeclared by our Board of Directors. Receipt of dividends is subject to priorrights of holders of all classes of stock outstanding having priority rights asto dividends. The holders of Class B common stock holders are not entitledto receive any dividends. The holders of Class B common stock, at theiroption, have the right to convert their shares to common stock. In the eventthat we liquidate, dissolve, or wind up, the holders of Class B commonstock then outstanding will be entitled to share ratably in any distribution ofassets according to their pro rata percentage of the total number of shares ofcommon stock and Class B common stock outstanding on the date of thedistribution. No dividends have been declared or paid on our common stockthrough December 31, 2005. The holders of the Class B common stockconverted their shares to common stock during 2005.

 

We acquired assets by issuing25,000 shares of our common stock valued at $125,000 for the year ended December 31,2004. We recorded stock-based compensation expenses for 1,044 shares with avalue of $5,000 issued to consultants for the year ended December 31,2004. We issued 2,500 shares with a value of $15,000 as a refund of merchandisereturned by a customer during the year ended December 31, 2004.

 

We retired 46,770 shares of ourcommon stock for $138,000 during the year ended December 31, 2004. We didnot retire any shares in 2005. In 2005 and as discussed in Note 12, DavidZinberg surrendered 4,144,689 shares of common stock for cancellation.

 

In 2005, David Zinberg andMarina Zinberg converted all their Class B common stock to common stock andafter the abovementioned cancellation they own 3,542,343 and 7,707,657 sharesof common stock respectively.

 

*Deferred Stock-Based Compensation*

 

In connection with certainstock grants to two employees during the year ended December 31, 2001, werecognized $2.0 million in deferred stock-based compensation for thedeemed fair value of common stock at the date of the grant. We include suchamounts as a reduction of stockholders’ equity (deficit). We amortize suchamounts over the vesting period of five years in accordance with FASBInterpretation No. 28, “Accounting for Stock Appreciation Rights and OtherVariable Stock Option or Award Plans.” During the year ended December 31,2003, we entered into a termination agreement with one employee and all of theunvested portion of the employee’s stock became fully vested on the date of thetermination agreement. The amortization expense for 2003 included anunamortized amount of $500,000 related to acceleration of these unvested commonstock grants. Amortization expenses totaled $900,000, $200,000, and $200,000during the years ended December 31, 2003, 2004, and 2005, respectively.

 

F-16

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**(8)           StockOption Plans:**

 

We adopted our 2001 StockOption Plan and our 2002 Special Stock Option Plan (collectively, the “Plans”),in January 2001 and January 2002, respectively. Under the Plans, wemay issue incentive stock options to our employees and non-qualified stockoptions to consultants and non-employees. Options granted under the Plansgenerally expire at the end of five years and generally immediately vest.Additional shares may be granted under the Plans. During the year ended December 31,2005, we granted options to acquire 25,000 shares of common stock outside thePlans. At December 31, 2005, 108,000 shares were available for futuregrants under the Plans.

 

The following is a summary ofstock option activity.

 
| ** **                       | ** ** | **2003**   | ** ** | **2004**                               | ** ** | **2005**   | ** ** |
|----------------------------------|------------|------------|------------|----------------------------------------|------------|------------|------------|
| ** **                       | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| Outstanding at beginning of year |       | 1,332,000  |       | $                                      | 3.75       |       | 1,654,500  |   | $ | 3.95 |   | 7,728,500 |   | $ | 5.59 |   |
| Granted                          |       | 485,500    |       | 4.44                                   |       | 6,162,000  |       | 6.00 |   | 703,500 |   | 6.00 |   |
| Exercised                        |       | —     |       | —                                 |       | —     |       | — |   | — |   | — |   |
| Canceled / forfeited             |       | (163,000   | )          | 3.75                                   |       | (88,000    | )          | 3.96 |   | (90,000 | ) | 4.83 |   |
| Outstanding at year-end          |       | 1,654,500  |       | $                                      | 3.95       |       | 7,728,500  |   | $ | 5.59 |   | 8,342,000 |   | $ | 5.63 |   |
| Options exercisable at year-end  |       | 1,654,500  |       | $                                      | 3.95       |       | 7,728,500  |   | $ | 5.59 |   | 8,342,000 |   | $ | 5.63 |   |

 

The following table summarizesinformation about stock options outstanding and exercisable at December 31,2005.

 
| ** **                                  | ** ** | **Options Outstanding  and Exercisable at  December 31, 2005** | ** ** |
|---------------------------------------------|------------|-----------------------------------------------------------------------------------------|------------|
| **Range of Exercise Prices** | ** ** | **Shares**                                                                              | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average   Remaining   Life of   Contract** | ** ** |
| $ 3.01 – $4.00                    |       | 1,105,000                                                                               |       | $ |  3.75 |   | 1.96 |   |
| $ 4.01 – $5.00                    |       | 410,000                                                                                 |       | $ |  4.50 |   | 2.93 |   |
| $ 5.01 – $6.00                    |       | 6,827,000                                                                               |       | $ |  6.00 |   | 5.28 |   |
|                                        |       | 8,342,000                                                                               |       | $ |  5.63 |   | 4.73 |   |

 

The weighted-average grant datefair value of options granted during 2003, 2004, and 2005 was $1.77, $1.43, and$1.14 per share, respectively.

 

F-17

----

 

*Stock Option Compensation*

 

In connection with certainstock option grants to employees, consisting of 48,500, 6,137,000, and 678,500options during the years ended December 31, 2003, 2004, and 2005,respectively, we recognized approximately $716,000, $0, and $0, respectively,of stock-option compensation for the excess of deemed fair value of shares ofcommon stock subject to such options over the exercise price of these optionsat the grant date in accordance with APB Opinion No. 25, “Accounting forStock Issued to Employees.” The options granted in 2004, include a seven-yearoption granted outside of our Plans to Mr. Zinberg for the purchase of6,000,000 shares of common stock at an exercise price of $6.00 per share, whichrepresented the fair value of the stock on the date of the grant.

 

During the years ended December 31,2003, 2004, and 2005, we granted 2,000, 25,000, and 25,000 options,respectively, to consultants and non-employees. We recorded stock optioncompensation expenses of $4,000, $27,000, and $16,000 related to these grantsin 2003, 2004, and 2005, respectively. The fair value for these options wasmeasured on the grant date. At December 31, 2003, 2004, and 2005, the fairvalue of these options was calculated using a Black-Scholes option pricingmodel using the following assumptions: (1) risk-free interest rates of 3%to 4.5%, (2) an expected life of three to seven years, (3) expectedvolatility of 0.01%, and (4) a dividend yield of 0%. Because there was nopublic market for our common stock, the fair value of the underlying commonstock was estimated.

 

**(9)           IncomeTax Expense:**

 

Income tax expense amounted to$0 for each of the years ended December 31, 2003 and 2004 (an effectiverate of 0% for 2003 and 2004 and 3% for 2005) and $82,000 for the year ended December 31,2005. A reconciliation of the provision (benefit) for income tax expense withamounts determined by applying the statutory U.S. federal income tax rate toincome before income tax expense is as follows (in thousands):

 
| ** **                                                                                         | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Computed tax (benefit) at federal statutory  rate of 34%                                           |       | $        | (1,982     | )        | $          | 262      |       | $ | 928 |   |
| State taxes, net federal tax benefits                                                              |       | (204     | )          | 45       |       | 162      |       |
| Meals and entertainment                                                                            |       | 14       |       | 15       |       | 22       |       |
| Expiration of state net operating loss                                                             |       | —   |       | 47       |       | —   |       |
| Other                                                                                              |       | (20      | )          | 4        |       | 48       |       |
| Change in valuation allowance, net of  reduction of net operating loss and cancellation of options |       | 2,192    |       | (373     | )          | (1,078   | )          |
|                                                                                               |       | $        | —     |     | $          | —   |       | $ | 82 |   |

 

F-18

----

 

The components of our deferredtax assets and liabilities at December 31, 2004 and 2005 were as follows(in thousands):

 
| ** **                                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
|--------------------------------------------------------------|------------|----------|------------|----------|------------|
| Deferred tax assets – net operating loss  carryforwards |       | $        | 8,490      |     | $          | 6,017 |   |
| Employee stock options                                       |       | 1,085    |       | 930      |       |
| Inventory reserve                                            |       | 124      |       | 132      |       |
| Minimum tax credit carryforward                              |       | —   |       | 80       |       |
|                                                         |       |     |       |     |       |
| Total deferred tax assets                                    |       | $        | 9,699      |     | $          | 7,159 |   |
| Valuation allowance                                          |       | (9,699   | )          | (7,159   | )          |
|                                                         |       |     |       |     |       |
| Net deferred tax assets                                      |       | $        | —     |     | $          | — |   |

 

As a result of our history oflosses, a valuation allowance has been provided for the full amount of our netdeferred tax assets. It is uncertain when such benefits will be realized.

 

As of December 31, 2005,we had federal and state income tax loss carryforwards of approximately$14.8 million and $10.9 million, respectively, which may be used tooffset future taxable income. The carryforwards expire in years 2013 through2023.

 

**(10)         SegmentInformation:**

 

Net revenue by geographic area is presented based upon the country ofdestination. No foreign country accounted for 10% or more of net revenue forany of the fiscal years presented. Net revenue by geographic area was asfollows (in thousands):

 
| ** **    | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** |
|---------------|------------|----------|------------|----------|------------|----------|------------|
| United States |       | $        | 41,382     |     | $          | 53,986   |       | $ | 73,199 |   |
| International |       | 6,283    |       | 11,338   |       | 17,380   |       |
| Total         |       | $        | 47,665     |     | $          | 65,324   |       | $ | 90,579 |   |

 

Long-lived assets includeproperty and equipment and intangible assets that resided in the United Statesduring the years ended December 31, 2003, 2004, and 2005.

 

**(11)         Concentrations:**

 

Purchases of merchandise fromone of our top two vendors, which is a related party (see Note 13),constituted 21%, 34%, and 37% of total merchandise purchased by us in the yearsending December 31, 2003, 2004, and 2005, respectively. Purchases ofmerchandise from our top two vendors amounted to $12.1 million,$22.6 million, and

 

F-19

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$27.8 million,representing 38%, 48%, and 42%, respectively, of the total purchases during theyears ended December 31, 2003, 2004, and 2005, respectively.

 

Outstanding accounts payable toour top two vendors (net of amounts of post-dated checks) totaled$1.8 million and $3.2 million as of December 31, 2004 and 2005,respectively. These vendors also were holding post-dated checks amounting to$3.5 million and $2.5 million as of December 31, 2004 and 2005,respectively. Loss of any of these vendors may have a negative impact on ouroperations.

 

**(12)         Contingencies:**

 

We are subject to various legalproceedings and claims that arise in the ordinary course of business. Wecurrently do not believe that resolution of such legal matters will have amaterial adverse impact on our financial position, results of operations, orcash flows.

 

*Prior Sales of Securities*

 

From our inception, in 1999,and in 2000, 2001, 2002, and mid-2003, we raised $20.5 million in grossequity capital offerings by selling our common stock in the followingapproximate amounts for each year:

 
| **Year** | ** ** | **Number of Shares** | ** ** | **Weighted Ave. Price per Share** | ** ** |
|----------|------------|--------------------------------|------------|-------------------------------------------------------|------------|
| 1999     |       | 978,070                        |       | $                                                     | 4.00       |   |
| 2000     |       | 1,198,191                      |       | $                                                     | 4.00       |   |
| 2001     |       | 580,621                        |       | $                                                     | 4.47       |   |
| 2002     |       | 1,051,924                      |       | $                                                     | 5.00       |   |
| 2003     |       | 753,262                        |       | $                                                     | 5.26       |   |

 

We sold these shares toapproximately 830 investors. The persons associated with us who solicited theseinvestors were not licensed as broker-dealers in any state or with the SEC.

 

We also issued to approximately30 persons or entities shares of common stock in exchange for services andother non-cash consideration valued in excess of $5.5 million in thefollowing approximate amounts for each year:

 
| **Year** | ** ** | **Number of Shares** | ** ** | **Weighted Ave. Price per Share** | ** ** |
|----------|------------|--------------------------------|------------|-------------------------------------------------------|------------|
| 1999     |       | 57,500                         |       | $                                                     | 4.00       |   |
| 2000     |       | 100,000                        |       | $                                                     | 4.00       |   |
| 2001     |       | 585,700                        |       | $                                                     | 4.09       |   |
| 2002     |       | 445,774                        |       | $                                                     | 5.00       |   |
| 2003     |       | 18,673                         |       | $                                                     | 5.60       |   |
| 2004     |       | 28,544                         |       | $                                                     | 5.00       |   |

 

F-20

----

 

We also issued to approximately248 employees or other service providers options to purchase common stock inthe following amounts:

 
| **Year** | ** ** | **Number of Options** | ** ** | **Exercise Price** | ** ** |
|----------|------------|---------------------------------|------------|-------------------------|------------|
| 2002     |       | 1,332,000                       |       | $                       | 3.75       |   |
| 2003     |       | 485,500                         |       | $                       | 4.50       |   |
| 2004     |       | 6,162,000                       |       | $                       | 6.00       |   |

 

None of these options have beenexercised.

 

These offers and sales of thecommon stock and options to purchase common stock were not registered under thefederal and state securities laws, but were issued in reliance upon exemptionsfrom such registration under Section 4(2) of the Securities Act and Rule 506of Regulation D promulgated thereunder. Similarly, in employing personswho were not licensed as broker-dealers, we relied on certain exemptions fromthe broker-dealer licensing requirements of the Exchange Act and of statesecurities laws.

 

After conducting these offersand sales of common stock and granting these options to purchase common stock,we determined that the offers and sales did not comply with the exemptions fromregistration under the Securities Act and similar provisions of laws in eachstate in which our stockholders reside, because certain of our employees whosolicited investors engaged in a “general solicitation” of securities. Inaddition, these employees were required to be licensed as broker-dealers withthe SEC and various states, but they were not so licensed. We also determinedthat because investors did not receive information regarding our potential liabilityfor these violations of federal and state securities laws, the common stock wasissued to persons who failed to receive adequate information under federal andstate securities laws. In such situations a number of remedies may be availableto regulatory authorities and the investors who purchased common stock in thoseofferings, including, without limitation, a right of rescission, civilpenalties, seizure of our assets, a restraining order or injunction, and acourt order to pay restitution and costs. As a result, the investors in andother holders of our common stock are entitled to return their shares to us andassert a legal claim to receive back from us the full price they paid, plusinterest. In the event that a rescission by all of our stockholders were tooccur, we would be liable for the $20.5 million we received in exchangefor our common stock, in addition to interest of approximately$9.3 million through December 31, 2005. We may also be liable for the$5.5 million of services rendered and property exchanged in considerationfor the issuance of common stock, in addition to interest of approximately$2.3 million through December 31, 2005.

 

Accordingly, we are subject topotential liabilities, including penalties and fines, under the Securities Act,the Exchange Act, the regulations thereunder, and applicable state securitieslaws. Both federal and state securities laws also provide remedies to investorsfor such violations, which remedies include rescission, or a right to recoverthe investment plus interest from the date of issuance of the security, and, ifthe investor no longer owns the security, damages equal to the differencebetween the investment amount plus interest from the date of issuance and thevalue or price of the security at the time of its sale.

 

After voluntarily reportingthese violations to the SEC, the SEC staff advised us that it would notundertake an investigation in the matter. We intend to make a rescission offerto all of our investors. However, we have not approached state securitiescommissioners in the states in which our investors reside. Consequently, thereis substantial

 

F-21

----

 

uncertainty concerning whataction the state regulators may take against us and what effect any such actionwill have on our business and our ability to obtain additional financing.

 

If we do not have the financialresources for a rescission offer, any assertion by our stockholders of theirlegal claims against us could have a material and adverse effect on ourliquidity, our financial position, results of operations, and cash flows.Moreover, even if we are successful in offering rescission to our stockholders,if, prior to the rescission offer, any stockholders who acquired their commonstock in our offerings sell their common stock for less than the price at whichthey purchased their shares, they will be entitled to recover from us damagesequal to the difference between their investment amount plus interest from thedate of issuance and the value or price of the security at the time of itssale. Because these stockholders will no longer own our common stock, we willnot be able to extinguish these damage claims by offering to rescind thestockholder’s purchase of our common stock.

 

The probability thatstockholders would assert a claim against us and the extent of the ourliability, if any, are contingent on a number of factors, including astockholder’s desire to rescind his or her purchase based on the price of ourrecission offer and the key purchase price of the tender for shares, applicablelegal precedent, and statutes of limitation.

 

However, there could be futureclaims of which we are currently not aware. Based on the current facts known tous at this time, we do not believe that assertion of such claims by ourstockholders is probable. Accordingly, no accruals for either potential amountspayable or reserves have been made at this time. However, there can be noassurance that we will have the financial resources for us to conduct a rescissionoffer. An unfavorable outcome in any of these contingencies could have amaterial and adverse impact on our financial position, results of operations,and cash flows.

 

The accompanying financialstatements do not include any adjustments that might result from the outcomefor this uncertainty.

 

*Williams v. Bidz.com, Inc. and Mr. DavidZinberg*

 

We were a defendant in alawsuit brought by Victoria Williams, the mother and administrator of theEstate of Michael Henderson. Mr. Henderson was a principal stockholder,director, and officer of our company prior to his resignation on July 27,2000 as director and officer. The lawsuit was against us and David Zinberg, ourPresident and Chief Executive Officer, and sought, among other things, torescind a Severance Agreement entered between us and Mr. Henderson, torequire us to issue 11,250,000 shares of our common stock to Ms. Williams,and to voluntarily dissolve us. Under the Severance Agreement, Mr. Hendersonagreed that he would retain only 1,090,000 shares of our common stock and thatthe remaining 10,160,000 shares held by him would be reissued to Mr. Zinberg.

 

In March 2005, we and Mr. Zinbergreached a settlement in principle with Ms. Williams, pursuant to which Ms. Williamsreceived a total of 970,000 shares of common stock, which included 900,000shares of common stock originally issued to Mr. Henderson in 2000 underthe Severance Agreement, and 70,000 shares of Mr. Zinberg’s shareholdings.As part of the settlement, Mr. Zinberg also agreed to contribute 4,144,689shares to us for cancellation.

 

*Yossi Gatlin v. Bidz.com*

 

We are a defendant in a lawsuitbrought by Yossi Gatlin in October 2005 for an automobile purchased fromus in March 2002 for $28,000. Gatlin alleges that we did not provide priorregistration so that Gatlin was not able to register the vehicle. Gatlin isclaiming his payment of $28,000, the value of the automobile represented to be$350,000, and

 

F-22

----

 

loss of the use of theautomobile in the amount of $100,000. We have accrued a liability in the amountof $28,000 for this lawsuit.

 

**(13)         RelatedParty Transactions:**

 

We purchased approximately 21%,34%, and 37% of our merchandise in 2003, 2004, and 2005 from a stockholder thatowned 1,200,000 shares of our common stock as of December 31, 2005, asmore fully explained in Note 11.

 

David Zinberg, our Presidentand Chief Executive Officer, purchased an automobile from us for $57,000 in2005.

 

In 2004, we advanced to Mr. Zinberg,our President and Chief Executive Officer, an aggregate of $173,000, which wasrepaid as of December 31, 2004. We did not have any outstanding loans toany of our directors or executive officers as of December 31, 2005.

 

Our Vice-President ofTechnology is a major shareholder of Technolect, Inc. which providedtechnology consulting services to us in the amount of $150,000 for the yearended December 31, 2005. We own 10% of the common stock of Technolect, Inc.with a cost basis of $0 at December 31, 2005.

 

Marina Zinberg, who is a VicePresident and owns 33.1% of our outstanding shares, is the sister of DavidZinberg, our President and Chief Executive Officer. During 2005, we paid MarinaZinberg a salary of $78,000. Ms. Zinberg, who was formerly our corporatesecretary and treasurer, reports to David Zinberg. Compensation decisionsrelating to Ms. Zinberg are performed in the same manner as our otheremployees without input from David Zinberg.

 

**(14)         SubsequentEvents:**

 

On March 15, 2006, ourBoard of Directors authorized us to file a registration statement with theSEC for an initial public offering of our common stock. In connection with theoffering, we intend to reincorporate in Delaware concurrently with our listingon the Nasdaq National Market. If the offering is consummated under the termspresently anticipated, all of the shares of common stock outstanding as of theeffective date of the reincorporation will automatically convert into the samenumber of shares of common stock in the Delaware Corporation.

 

During March 2006, ourBoard of Directors adopted our 2006 Stock Award Plan, or 2006 Plan, which wassubsequently approved by our Board of Directors in March 2006.

 

F-23

----

 

**2. Financial Statement Schedules:**

 

**Schedule II - Valuation andQualifying Accounts**

 

**(in thousands)**

 
| **Description**                                       | ** ** | **Balance at the  Beginning of the  Year** | ** ** | **Charged to  Revenue,  Cost, or  Expenses** | ** ** | **Deductions** | ** ** | **Balance at the  End of the  Year** | ** ** |
|-------------------------------------------------------|------------|----------------------------------------------------------------|------------|--------------------------------------------------------|------------|----------------|------------|----------------------------------------------------------|------------|
| **Reserve deducted from asset to which it  applies:** |       |                                                           |       |                                                   |       |           |       |                                                     |       |
| Year ended December 31, 2004                     |       |                                                           |       |                                                   |       |           |       |                                                     |       |
| Reserve for inventory                                 |       | $                                                              | 507        |                                                   | $          | —         |       | $                                                        | (198       | ) | $ | 309 |   |
| Reserve for sales returns                             |       | —                                                         |       | —                                                 |       | —         |       | —                                                   |       |
| Reserve for chargebacks                               |       | —                                                         |       | —                                                 |       | —         |       | —                                                   |       |
| Year ended December 31, 2005                     |       |                                                           |       |                                                   |       |           |       |                                                     |       |
| Reserve for inventory                                 |       | $                                                              | 309        |                                                   | $          | 22             |       | $                                                        | —     |   | $ | 331 |   |
| Reserve for sales returns                             |       | —                                                         |       | 408                                                    |       | (285           | )          | 123                                                      |       |
| Reserve for chargebacks                               |       | —                                                         |       | —                                                 |       | —         |       | 30                                                       |       |

 

F-24

----

 

**3. Exhibits:**

 
| **Exhibit  Number** | ** ** | **Exhibits** |
|---------------------|------------|--------------|
|                |       |         |
| 2.1                 |       |         | Agreement and Plan of Merger, dated as of March 15, 2006, by and  between Bidz.com, Inc., a Delaware corporation, and Bidz.com, Inc.,  a California corporation (1) |
| 3.1                 |       |         | Certificate of Incorporation of the Registrant (2) |
| 3.2                 |       |         | Bylaws of the Registrant (2) |
| 4.1                 |       |         | Specimen of Common Stock Certificate (1) |
| 10.1                |       |         | 2001 Stock Option Plan (2) |
| 10.2                |       |         | 2002 Stock Option Plan (2) |
| 10.3                |       |         | 2006 Stock Award Plan (1) |
| 10.4                |       |         | Form of Employment Agreement, dated as  of           , between  Bidz.com, Inc. and David Zinberg (1) |
| 10.4                | (b)        |         | Employment Agreement, dated as of November 1, 2002, between  Bidz.com, Inc. and David Zinberg (2) |
| 10.5                |       |         | Form of Employment Agreement, dated as  of           , between  Bidz.com, Inc. and Lawrence Y. Kong (1) |
| 10.6                |       |         | Stock Vesting Agreement, dated as of June 30, 2001, between  Bidz.com, Inc. and Lawrence Y. Kong (1) |
| 10.7                | (a)        |         | Form of Indemnification Agreement between Bidz.com, Inc.  and each officer and director (1) |
| 10.7                | (b)        |         | Indemnification Agreement, dated as of November 1, 2002, between  Bidz.com, Inc. and David Zinberg (2) |
| 10.8                |       |         | Lease, between Bidz.com, Inc. and PAS Trust, dated as of  April 15, 2003, and Addendum No. 2, dated as of March 3, 2004  (2) |
| 23.1                |       |         | Consent of Stonefield Josephson, Inc. |
| 31.1                |       |         | Certification of Chief Executive Officer Required Under  Rule 13a-14(a) or Rule 15d-14(a) of the Securities  Exchange Act of 1934, as amended. |
| 31.2                |       |         | Certification of Principal Financial Officer Required Under  Rule 13a-14(a) or Rule 15d-14(a) of the Securities  Exchange Act of 1934, as amended. |
| 32                  |       |         | Certifications Required Under Rule 13a-14(b) or  Rule 15d-14(b) of the Securities Exchange Act of 1934, as amended,  and 18 U.S.C. Section 1350. |

 

----

(1)                                  Incorporated by reference to the Registrant’sRegistration Statement on Form S-1 (File No. 333-132545) as filedwith the Commission on or about March 17, 2006.

 

(2)                                  Incorporated by reference to the Registrant’sRegistration Statement on Form 10 (File No. 000-51257) as filed withthe Commission on or about April 22, 2005.

 

F-25

----

 

**SIGNATURES**

 

Pursuant to the requirements of Section 13 or Section 15(d) of theSecurities Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned, thereunto duly authorized.

 
|                  | BIDZ.COM, INC. |
|-----------------------|---------------------|
|                  |                |
|                  |                |
|                  | By:                 | /s/ DAVID ZINBERG |
|                  |                |   |
|                  |                | **David Zinberg** |
|                  |                | **President and Chief Executive Officer** |
|                  |                |   |
| Dated: March 29, 2006 |                |

 

Pursuant to the requirements of the Securities Exchange Act of 1934,this report has been signed below by the following persons on behalf of theregistrant and in the capacities and on the dates indicated.

 
| **Signature**         | ** ** | **Title**                                                                                      | ** ** | **Date**        |
|-----------------------|------------|------------------------------------------------------------------------------------------------|------------|-----------------|
|                  |       |                                                                                           |       |            |
| /s/ DAVID  ZINBERG    |       | Chairman of  the Board, President and  Chief Executive Officer (Principal   Executive Officer) |       | March 29,  2006 |
| David  Zinberg        |       |                                                                                           |       |
|                  |       |                                                                                           |       |            |
| /s/ LAWRENCE  Y. KONG |       | Chief  Financial Officer and  Director (Principal Financial and  Accounting Officer)           |       | March 29,  2006 |
| Lawrence Y.  Kong     |       |                                                                                           |       |
|                  |       |                                                                                           |       |            |
| /s/ GARRY Y.  ITKIN   |       | Director                                                                                       |       | March 29,  2006 |
| Garry Y.  Itkin       |       |                                                                                           |       |
|                  |       |                                                                                           |       |            |
| /s/ PETER G.  HANELT  |       | Director                                                                                       |       | March 29,  2006 |
| Peter G.  Hanelt      |       |                                                                                           |       |
|                  |       |                                                                                           |       |            |
| /s/ MAN JIT  SINGH    |       | Director                                                                                       |       | March 29,  2006 |
| Man Jit Singh         |       |                                                                                           |       |
|                  |       |                                                                                           |       |            |

 

 

F-26

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