Table of Contents

 

 

 
| **UNITED  STATES**                      | OMB  APPROVAL                                                                                                    |
|-----------------------------------------|------------------------------------------------------------------------------------------------------------------|
| **SECURITIES  AND EXCHANGE COMMISSION** | OMB  Number: 3235-0063  Expires: April 30, 2009  Estimated average burden hours per response: 2,196.00 |
| **Washington, D.C. 20549**              |
| ** **                              |
| **FORM 10-K**                      |

 

**(Mark One)**

 

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

 

**For thefiscal year ended December 31, 2008**

 

**or**

 

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

 

** **

**For thetransition periodfrom                  to                  **

 

**Commission file Number  000-51257**

 

**BIDZ.com, Inc.**

(Exact name of registrant as specified in its charter)

 

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

 

 

Registrant’stelephone number, including area code  **(310)280-7373**

 

Securitiesregistered pursuant to Section 12(b) of the Act:

 

| **Title of each class**           | ** ** | **Name of each exchange on which registered** |
|-----------------------------------|------------|-----------------------------------------------|
| **Common Stock, $.001 par value** | ** ** | **NASDAQ Capital Market**                     |

 

 

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

 

(Title of class)

 

Indicateby check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405of the Securities Act.
|   | o  YES | x  NO |
|--------|------------------|-----------------|

 

 

Indicateby check mark if the registrant is not required to file reports pursuant to Section 13or Section 15(d) of the Act.
|   | o  YES | x  NO |
|--------|------------------|-----------------|

 

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.
|   | x  YES | o  NO |
|--------|------------------|-----------------|

 

 

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K (§ 229.405 of this chapter) is not contained herein, andwill not be contained, to the best of registrant’s knowledge, in definitiveproxy or information statements incorporated by reference in Part III ofthis Form 10-K or any amendment to this Form 10-K   o

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer, or a smaller reporting company. Seedefinitions of “large accelerated filer,” “accelerated filer,” and “smallerreporting company” in Rule 12b-2 of the Exchange Act (Check one):

 

| Large accelerated filer  o          | Accelerated filer   x        |
|-----------------------------------------------|----------------------------------------|
| Non-accelerated filer  o            | Smaller reporting company  o |
| (Do not check if a smaller reporting company) |                                   |
|                                          |                                   |

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

 

 

The aggregate market value of the voting stockheld by non-affiliates of the registrant based upon the price of the commonstock as of June 30, 2008 was approximately $110.3 million. For purposeshereof, directors, executive officers and 10% or greater shareholders have beendeemed affiliates.  This determination of affiliate status is notnecessarily a conclusive determination for others purposes.

 

Thenumber of shares outstanding of the registrant’s common stock was 22,917,918 asof February 23, 2009.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Information required by Part III(Items 10, 11, 12, 13 and 14) is incorporated by reference to portions ofour definitive proxy statement for our 2009 Annual Meeting of Stockholders,which will be filed with the Securities and Exchange Commission within120 days of December 31, 2008.

 

 

 

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**BIDZ.COM, INC.**

** **

**ANNUAL REPORT ON FORM 10-KFOR THE FISCAL YEAR ENDED DECEMBER 31, 2008**

 

Table of Contents

 
| ** **                                                                                                                  | **Page** |
|-----------------------------------------------------------------------------------------------------------------------------|----------|
|                                                                                                                        |     |
| PART I                                                                                                                 | 2        |
| Item 1. Business                                                                                                            | 2        |
| Item 1A. Risk Factors                                                                                                       | 12       |
| Item  1B.Unresolved Staff Comments                                                                                          | 22       |
| Item 2. Properties                                                                                                          | 22       |
| Item 3. Legal Proceedings                                                                                                   | 22       |
| Item 4.  Submission of Matter to a Vote of Securities Holders                                                               | 23       |
|                                                                                                                        |     |
| PART II                                                                                                                | 23       |
| Item 5. Market  for Registrant’s Common Equity, Related Stockholder Matters and Issuer  Purchases of Equity Securities | 23       |
| Item 6.  Selected Financial data                                                                                            | 25       |
| Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of  Operations                        | 26       |
| Item 7A.  Quantitative and Qualitative Disclosures about Market Risk                                                        | 33       |
| Item 8.  Financial Statements and Supplementary Data                                                                        | 33       |
| Item 9.  Changes in and Disagreements With Accounting on Accounting and Financial  Disclosure                               | 33       |
| Item 9A.  Controls and Procedures                                                                                           | 33       |
| Item 9B. Other Information                                                                                                  | 34       |
|                                                                                                                        |     |
| PART III                                                                                                               | 34       |
| Item 10.  Directors and Executive Officers of the Registrant                                                                | 34       |
| Item 11.  Executive Compensation                                                                                            | 34       |
| Item 12.  Security Ownership of Certain Beneficial Owners and Management and Related  Stockholder Matters                   | 34       |
| Item 13.  Certain Relationships and Related Transactions                                                                    | 34       |
| Item 14.  Principal Accounting Fees and Services                                                                            | 34       |
|                                                                                                                        |     |
| PART IV                                                                                                                | 34       |
| Item 15.  Exhibits and Financial Statement Schedules                                                                        | 34       |

 

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**Part I**

 

**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 ability toefficiently and cost effectively source closeout and regular jewelrymerchandise, and rapidly respond to changing consumer demands for certainjewelry. We offer our products through a continuous live format, featuring a $1minimum opening bid, and a unique 15-second auction extension period thatallows our auctions to continue until all bids are received. On select auctionswe maintain a reserve price that must be met before a sale will be consummated.In 2009, we plan to offer auctions with a minimum opening bid that is higherthan $1. The majority of our auctions are short-term, often lasting less thanone hour, providing immediate gratification to our customers and encouragingfrequent visits and active viewing of our website.

 

In addition to our auction site we have a fixed pricing format thatoffers similar items of merchandise as those listed for auction.  This online store provides us access todifferent types of consumers, and we plan to offer customers the ability todesign their own jewelry including diamond earrings and rings in the nearfuture.

 

Our product inventory includes gold, platinum, and silver jewelry setwith diamonds, rubies, emeralds, sapphires, and other precious andsemi-precious stones; watches and accessories. We believe we are the secondlargest online retailer of jewelry based on revenue and the largest onlinejewelry auction site based on web traffic.

 

In line with our growth plans, we completed a major upgrade of ourauction platform at the end of 2007. The new auction LiveBid system supports abroad range of leading browser software including Microsoft Internet Explorer,FireFox and Safari. The new system touts high availability, faster end-userresponse time and greater scalability among the key features delivered in thisrelease. We have leveraged this new software solution to launch additional sitefeatures and our new online retail store. We launched the Spanish version ofour website in May 2008, the Arabic version in October 2008 and theGerman version in December 2008.

 

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

 

·                  $1minimum bid format,

 

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

 

·                  shortterm auctions, often lasting less than one hour, providing our customersimmediate gratification to encourage frequent visits and active viewing of ourwebsite.

 

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, live-help and e-mailseven days a week. We provide a mechanism for our customers to provide commentsand feedback on their bidding and purchasing experience.

 

We purchase jewelry 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 infrastructures. We have developed a database of product descriptions andpictures that enables us to rapidly 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.

 

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**History**

 

We commenced operations inearly 1998 by offering a limited selection of merchandise for sale on eBay’swebsite through our predecessor, Asset Lenders of America, a group of 11collateral lending stores. In the fall of 1998, we formed Bidz.com, Inc.as a California corporation, acquired Asset Lenders of America, and purchasedthe domain name *www.bidz.com*. InFebruary 1999, we launched the *www.bidz.com*website and began offering closeout jewelry through our auctionformat. In November 1999, we merged Asset Lenders of America into ourCompany. In June 2006, the Company reincorporated in the state ofDelaware.

 

**Industry Overview**

 

**Growth of Online Commerce and the Online Auction Market**

 

The Internet’s developmentinto a significant global medium for communication, content, and commerce hasled to substantial growth in online shopping and has provided online retailerswith new opportunities to eliminate intermediaries from the traditional retailsupply chain. Internet usage and online commerce continue to grow worldwide.The growth can be attributed to factors such as an increased awareness of theconvenience of online shopping, an expanded range of products available online,improvements in security and electronic payment technology, and increasedaccess to broadband Internet connections facilitating online shopping.

 

Online auction sites havecreated a robust global marketplace, which overcomes the inefficienciesassociated with traditional auction purchasing while offering the benefits ofonline commerce. Companies such as eBay spearheaded the creation of acentralized online auction market, offering buyers a significantly broaderselection of goods to purchase. Today, online auction sites offer significantconvenience, allowing trading at all hours and providing continually updatedproduct offerings. By leveraging the interactive nature of the Internet, ourwebsite also enables customers to experience the excitement of live auctions,including the competitive bidding process.

 

**The Jewelry Market**

 

Jewelry is designed and manufactured by a large number 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 operators, and alimited number of national retail chains, such as Tiffany & Co.,Zales, and Kay Jewelers. Multi-line department and discount stores and othersalso sell jewelry, such as Wal-Mart, Target, J. C. Penney, and Costco, as wellas enterprises such as QVC and Home Shopping Network. Despite the presence ofmajor jewelry retail chains, a majority of the jewelry retail business remainsfragmented.

 

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:

 

·              dominantretailers insisting on just-in-time deliveries from manufacturers,

 

·              dominantretailers often demanding to cancel orders mid-production and returning unsoldmerchandise,

 

·              rapidchanges in style, color, or models, turning inventory into closeoutmerchandise,

 

·              incorrectestimates of consumer demand leading to overproduction, and

 

·              changesin a retailer’s financial situation or strategy 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.

 

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**Our Value Proposition**

 

*Value to Buyers*

 

Through online auctions and the fixed price online store on ourwebsite, we believe that we offer value to a broad range of customers by providingthe following:

 

***Bargain prices.    ***The price of all our products is dictated bythe buyer alone based on that buyer’s valuation of the product. Therefore, manyitems offered on our website are sold at a substantial discount to the pricesin traditional retail channels, such as at jewelry stores located in shoppingmalls. Our $1 minimum bid policy allows the savvy or lucky consumer thepotential to purchase any product being auctioned for only $1, offering evengreater value to the consumer. Regardless of the closing price, once an auctionis closed for those auctions without a reserve price, the final bidder willreceive the product.

 

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

 

***Broad productselection.***    We offer abroad selection of jewelry, including rings, necklaces, earrings, bracelets,jewelry sets, and watches. Our selection includes gold and silver jewelry, aswell as jewelry with precious and semi-precious stones.

 

***Product qualityassurance.***    We providedetailed and accurate descriptions of each product. Our trained productspecialists inspect our jewelry, utilizing the Gemological Institute of AmericaDiamond and Colored Stone Grading System prior to posting on our website forauction. We guarantee the quality of our products through our 15-day returnpolicy on all of our merchandise with a money-back guarantee if the product isnot as described on our website. Items that are returned that are identical totheir description are subject to a restocking fee, which is 15% of the originalpurchase price and shipping fees are non-refundable. Our commitment to qualityand product description accuracy is demonstrated by consistently low returnrates on our items, which were approximately 3% of all items sold in 2008.

 

***Prompt fulfillmentand responsive customer service.***    Wemaintain in inventory all the products we offer on our website, enabling us toensure prompt order fulfillment and delivery to our customers. Our customerservice representatives are available seven days a week, via telephone,live-help and e-mail, and are trained to provide assistance and answer a broadrange of questions regarding payment, delivery, and other matters.

 

***Positive shoppingexperience.***    Oureasy-to-navigate website provides our customers with clear and detailedinformation about our products, including multiple photographs of many items.Customers can bid on our products 24 hours a day, seven days a week. Buyers areprovided a five-day payment grace period on all products purchased.

 

*Value to Suppliers*

 

Jewelry manufacturers continually look for a cost-effective, efficientway to sell their regular and closeout inventory. Our ability to purchasejewelry in various quantities provides a critical one-stop inventory clearancealternative for manufacturers and an efficient sales channel for liquidatorsthat purchase closeout inventory from manufacturers.

 

***Single source forproduct disposition.***    Unlikemany multi-store retail chains that often require large lot purchases to stockappropriate levels of inventory at their multiple locations, we have theflexibility to buy and sell both small and large jewelry lots in a highlyefficient manner. As a single source for the sale of regular and closeoutjewelry products, we provide suppliers with greater control of distribution byreducing the need to spread products across multiple channels. In addition,manufacturers and liquidators are often required to adhere to stringent productquantity and delivery schedule requirements. Products not delivered on time orin exact amounts are returned. We have the flexibility to tailor our purchasingto a supplier’s needs with regard to quantity, variety, and timing.

 

***Resolution ofchannel conflict.***    Manufacturersseek to avoid liquidating their products through traditional retail channels inwhich their discounted products may be sold alongside their full-priceproducts. Such side-by-side selling can result in weaker pricing and decreasedbrand strength, which is known as channel conflict or sales channel pollution.As a result, many manufacturers turn to liquidation wholesalers and discountretailers. These liquidation channels, however, provide manufacturers limitedcontrol over distribution and are unreliable and expensive to manage. Becausewe offer an alternate online distribution channel that focuses on the auctionsale of jewelry, our suppliers are able to sell their discounted jewelryindependently of their full-priced products. We believe this enables oursuppliers to avoid customer confusion and potential loss of sales of theirfull-priced jewelry products.

 

***Profitablealternative for suppliers.***    Weeliminate the various inefficiencies and mark-ups associated with traditionalintermediaries, and our high volume of sales from a single location provides uswith favorable inventory turnover and lower inventory carrying and handlingcosts versus traditional jewelry retailers. Manufacturers can also sell excessproducts to us rather than expend the labor and cost of melting and reworkingtheir gold, platinum or silver products.

 

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** **

**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 maintaining and expanding ourrelationships with third-party search engines, Internet portals, and websitesand by increasing our online advertising expenditures within these channels;

 

***Enhancing sourcingrelationships***by expanding the number of suppliersfrom which we opportunistically purchase regular and closeout inventory,thereby assuring consistent availability of a wide variety of designs andstyles of jewelry, and purchasing for cash from suppliers that do not extendcredit terms and to obtain better supplier pricing;

 

***Increasing thebreadth and depth of our product offerings***byincreasing available inventory within specific jewelry categories, allowing usto make more jewelry categories available and enabling us to list more auctionitems on a daily basis;

 

***Continuing to buildmarket share for our online jewelry retail store Buyz.com***byallowing fixed price items to be sold that will complement our core auctionformat; and

 

***Focusing on newinternational markets***by expanding into andcreating a strong presence in a number of English-speaking countries, includingthe United Kingdom, Canada, Australia, Ireland, and New Zealand, along with thenewly introduced foreign language versions of our website: Spanish, Arabic andGerman.

 

**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.

 

Our marketing and advertising efforts consist primarily of thefollowing initiatives:

 

***Searchmarketing:    ***We purchasesearch engine advertising primarily at an auction based price, which is paideach time a potential customer clicks on one of our advertisements. Wecurrently maintain advertising relationships with, among others, Google (US,Australia, Canada, European Union, South East Asia, Mid East and SouthAmerica), Yahoo (US, and Australia), MSN for search engine advertising.

 

***Online bannermarketing:***    We utilizebanner advertisements from the largest banner advertising channels. We focus oncontextual and behavioral advertisements that appear on websites related tojewelry, fashion, shopping and women’s lifestyle. The Company maintains portaladvertising relationships with Yahoo, MSN, Casale Media, Advertising.com,ValueClick Media, AOL and others. The fee structure for our purchase ofbanner advertisements is based on a set price for an action (such as clicks ornew buyers), or on a cost per thousand basis, for which we pay a set fee perthousand banner advertisements that appear on the selected websites.

 

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

 

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

 

**Sourcing Strategy**

 

We purchase closeout inventory directly from manufacturers,site-holders and liquidators. We also closely monitor our sales trends toassess consumer demand for certain jewelry styles and categories and purchaseregular jewelry inventory directly from manufacturers. We have eliminatedvarious inefficiencies and mark-ups associated with traditional intermediariesin the jewelry market. Our sourcing model provides a critical alternativeliquidation channel for manufacturers, for which disposal of closeout inventoryrepresents a 

 

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significant challenge. We have the flexibility to purchase a variety oflot sizes, 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 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 do not have any formal or binding supply agreements with any of oursuppliers, manufacturers, distributors, or other suppliers. We purchase andcarry inventory in the majority of the products we offer for sale to ensureavailability and expedited delivery. In an effort to achieve a more diversesupplier base, we have started to acquire substantially more high-end brandname products. Currently, we acquire inventories from our suppliers on a cashand revolving credit basis with payment typically due within 60 to90 days. This strategy will allow for more flexibility to increase ourproduct selection, reduce our product costs, and enlarge our supplyrelationships by allowing us to purchase from vendors that do not extend creditto their customers.

 

We also purchase, from time to time, loose diamonds and semi-preciousstones and deliver them to manufacturers to produce into finished jewelryinventory. This source of inventory allows us to reduce our product costs.

 

On a selective and limited basis, we take consignment inventory fromour vendors to sell on our website. Since we only make payment for theinventory when payment is made by our customers this arrangement is beneficialto our cash flow. Sales of such merchandise remain small as our main focus ison closeout inventory.

 

**MerchandisingStrategy**

 

We seek to maintainprofitability while providing variety and value to our customers by carefullyselecting the types of products we post on our website at any given time, theduration of the auction for each item, and the frequency with which we re-postcomparable items after sales. We actively monitor our auctions and sales sothat we are able to adjust continually the makeup and quantity of goods on ourwebsite at any given time. Since bids on all merchandise start at $1, lossesare incurred on approximately 15% to 25% of the items sold on an annual basis.The risks associated with a $1 minimum bid auction are mitigated by profitsgenerated from items sold at a gain, which resulted in an overall 28.3% grossprofit margin in 2008.

 

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

 

**Technology Operations**

 

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

 

Our system architecture is built on industry-standard platforms thatare designed to provide continuous service 24 hours a day, 365 daysper year. Our website and back-office servers are located at a third-partyco-location facility operated by Savvis Inc. in El Segundo, CA. Savvis providesredundant internet connectivity, physical security, climate control, redundantpower delivered through a 100% uptime guarantee. The back-office processingsystem is housed in our headquarters in Culver City, and communicates withSavvis over four independent T1 lines. Our systems include both Oracle andMicrosoft SQL database engines operating in a multi-processing MicrosoftWindows environment designed to accommodate large volumes of online traffic andare configured for high fault tolerance with redundancy and load balancing. OurInternet servers utilize VeriSign Inc. digital certificates to providesecure website communications for sales and payment transactions.

 

In the third quarter we implemented a major system upgrade that hasmoved our primary back-office processing systems to Savvis Inc. This movefollowed the migration of our primary auction platform to Savvis in the fourthquarter of 2007.

 

We are continuing to plan and are currently implementing a standard ERPsolution, Microsoft Dynamics AX that will integrate financial functions along withcompany operations including: Inventory and Warehouse Management (WHMS), OrderProcessing (OMS), and Customer Relationship Management (CRM) along withreporting and analytics functions.

 

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We are currently planning to develop a second co-location in adifferent geographic region to provide greater load balancing and disasterrecovery. We utilize the firewall protection and the services of TrustWave,which provides regular scanning of our systems for security vulnerabilities andPCI compliance.

 

At December 31, 2008, we had a technology and development staff of20. We have structured the technology and development functions into twodistinct departments: software development and production support. Weanticipate that we will continue to devote significant resources to productdevelopment and product management in the future as we add new features andfunctionality.

 

**Customer Service and Fulfillment Operations**

 

An important element of our sales strategy is to provide a high levelof customer service support in order to establish long-term relationships withour customers and encourage repeat visits and purchases. Our customer servicesupport staff provides detailed payment, billing, and delivery guidance and istrained to answer a broad array of questions regarding auctions and paymentsconducted on our website. Our informed and helpful staff together with theinformative and educational aspects of our website, promote customer confidencein purchase decisions.

 

At December 31, 2008, we had a customer service and billing staffof 24. We utilize automated online live-help, e-mail and phone systems to routetraffic to our customer service and billing support representatives to providepersonalized assistance. The customer service center operates between the hoursof 8:00 a.m. and 5:00 p.m., Pacific time, seven days a week fortelephone support and 24 hours a day for online live-help and e-mailsupport. We outsource substantially all of our online live-help and e-mailsupport.

 

Customers may utilize the following payment methods: credit card, moneyorders, and checks. We also offer our customers the opportunity to make paymentsusing PayPal and Bill-Me-Later services. We require payment to be received byus prior to shipping the merchandise.

 

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

 

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. If payment is not made within the five-day period, theproduct is offered for auction again and thus the same item may be auctionedmore than once.

 

Our goal is to fulfill purchase orders on a timely, secure, andaccurate basis. We inspect and track each product at all stages of thereceiving and order fulfillment process. Following payment, the merchandise isprocessed for shipment. Customer orders are typically delivered within sevenbusiness days, depending on the shipping method. Most purchases are deliveredwith signature or delivery confirmation. We ship all products via nationallyrecognized carriers, such as Federal Express and the U. S. Postal Service.

 

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 as described are subject to a 15% restocking fee.Our facility has security controls with restricted access and has been designedfor the prompt receipt, storage, and shipment of our products. In addition, wehave security guards on duty 24 hours a day, seven days a week to patrolthe premises. Security is complemented by video and alarm surveillance.

 

**Seasonality**

 

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 shoppingseason. Approximately 28.5%, 33.8% and 16.9% of our net revenue was generatedduring the fourth quarter of 2006, 2007 and 2008, respectively. The fourthquarter of 2008 was an exception as we encountered a significant slowdown insales resulting from the 2008 financial and economic crisis. As we continue togrow, we expect to experience more pronounced seasonal fluctuations in our netrevenue and anticipate a disproportionate amount of our revenue will be in thefourth quarter.

 

**Competition**

 

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

 

·              price,

 

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·              productquality and selection,

 

·              vendorreliability,

 

·              shoppingconvenience,

 

·              customerservice, and

 

·              brandrecognition.

 

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 Blue Nile. We also compete with traditionaloffline jewelry retail chains, such as Zales, Finlay Fine Jewelry, and Reed’sJewelers, as well as with department and discount and other stores that selljewelry at wholesale prices, such as Wal-Mart, Target, J. C. Penney, andCostco, as well as with QVC and Home Shopping Network. We compete primarily onthe basis of our prices, the selection of merchandise, and our websitefunctionality and ease-of-use. The negative factors relating to our competitiveposition relate primarily to the relative size and name recognition of ourcompetitors.

 

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

 

Many of our competitors have greater brand recognition, longer operatinghistories, larger customer bases, and significantly greater financial,marketing, and other resources than we do. Smaller competitors may enter intostrategic or commercial relationships with larger, more established andwell-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 existingtechnologies also may increase competitive pressures on us.

 

**IntellectualProperty**

 

We regard our domain namesand similar intellectual property as critical to our success. As of January 2009,we hold registered trademarks for “Bidz.com” and the Bidz.com Logo. Wecurrently do not hold any patents pertaining to intellectual propertysurrounding the technology and business processes utilized by Bidz.com. We havehowever filed patent applications with the US patent office for 5 inventions. We also rely on a combination of laws andcontractual restrictions with our employees, customers, suppliers, affiliates,and others to establish and protect our proprietary rights. Despite theseprecautions, it may be possible for a third party to copy or otherwise obtainand use our intellectual property without authorization. In addition, othersmay independently develop substantially similar intellectual property. Althoughwe are pursuing the registration of our additional trademarks and patents inthe United States, some of our trade names are not eligible to receivetrademark protection. In addition, effective trademark and patent protectionmay not be available or may not be sought by us in every country in which ourproducts are made available online.

 

From time to time, we may besubject to legal proceedings and claims in the ordinary course of our business,including claims of alleged infringement of the trademarks and other intellectualproperty rights of third parties. In addition, litigation may be necessary inthe future to enforce our intellectual property rights, to protect our tradesecrets, or to determine the validity and scope of our intellectual proprietaryrights and those of others. Any such litigation, regardless of outcome ormerit, could result in substantial costs and diversion of management andtechnical resources, any of which could materially 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 their non-publicpersonal information with unaffiliated third parties. Furthermore, the growthand demand for online commerce could result in more stringent consumerprotection laws that impose additional compliance burdens on online retailers.These consumer protection laws could result in substantial compliance costs andcould 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 

 

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subject us to additional state sales and income taxes. New legislationor regulation, the application of laws and regulations from jurisdictions whoselaws do not currently apply to our business, or the application of existinglaws and regulations to the Internet and commercial online services couldresult in significant additional taxes on our business. These taxes could havean adverse effect on our results of operations. Furthermore, there is apossibility that we may be subject to significant fines or other payments forany past failures to comply with these 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.

 

California appliesthe burden of security risks to those owning and operating computer systems andnetworks, under a mandatory disclosure law (SB 1386).  Companies holding computerized personalinformation of California residents are required to take steps either to encryptthis personal information or adopt, as part of an information security policy,notice and disclosure procedures for any computer security breaches, whether ornot the breach occurs in California. If we were found to be noncompliant wewould be subject to civil suits, including class actions, for damages andinjunctive remedies in California courts.

 

**Employees**

 

At December 31, 2008,we had 164 full-time and 1 part-time employee. We may utilize part-timeemployees, temporary employees, and independent contractors to respond tofluctuations in our business. None of our employees are covered by a collectivebargaining agreement with us, and we consider our relations with our employeesto be good.

 

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

 

**Delaware Reincorporation**

 

On June 22, 2006 theCompany reincorporated in the state of Delaware. In connection with ourreincorporation in Delaware, we are authorized to issue 100,000,000 shares ofcommon stock, $0.001 par value, and 4,000,000 shares of undesignated preferredstock, $0.001 par value.

 

The following discussion describes the Delaware Certificate ofIncorporation and the Bylaws that were adopted and is intended to be a summaryand does not describe all provisions of our certificate of incorporation orbylaws or Delaware law that may be applicable to us. For a more thoroughunderstanding of the terms of our capital stock, you should refer to ourcertificate of incorporation and bylaws, which have been filed as exhibits tothis report.

 

**Common Stock**

 

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

 

**Preferred Stock**

 

Our certificate of incorporation authorizes our Board of Directors,without any vote or action by the holders of our common stock, to issuepreferred stock from time to time in one or more series. Our Board of Directorsis authorized to determine the number of shares and to fix the designations,powers, preferences, and the relative, participating, optional, or other rightsof any series of preferred stock. Issuances of preferred stock would be subjectto the applicable rules of Nasdaq or other organizations on which oursecurities are then quoted or listed. Depending upon the terms of preferredstock established by our Board of Directors, any or all series of 

 

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preferred stock could have preference over the common stock withrespect to dividends and other distributions and upon our liquidation. If anyshares of preferred stock are issued with voting powers, the voting power ofthe outstanding 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 Delaware certificate of incorporation, our bylaws, and the DGCLcontain 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 deemed byour Board of Directors to be in the best interests of our company and ourstockholders. These provisions could have the effect of discouraging thirdparties from making proposals involving an acquisition or change of control ofour company even if such a proposal, if made, might be considered desirable bya majority of our stockholders. These provisions may also have the effect ofmaking it more difficult for third parties to cause the replacement of ourBoard of Directors or our current management without the concurrence of ourBoard of Directors.

 

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

 

*Authorized but Unissued Preferred Stock*

 

Our certificate of incorporation authorizes our Board of Directors toissue one or more series of preferred stock and to determine, with respect toany series of preferred stock, the terms and rights of such series without anyfurther 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; FillingVacancies*

 

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

 

*Classified Board*

 

Our certificate of incorporation provides for our board to be dividedinto three classes, as nearly equal in number as possible, serving staggeredterms. Approximately one-third of our board will be elected each year. Theprovision for a classified board could prevent a party who acquires control ofa majority of our outstanding common stock from obtaining control of the boarduntil our second annual stockholders meeting following the date the acquirerobtains the controlling share interest. The classified board provision couldhave the effect of discouraging a potential acquirer from making a tender offeror otherwise attempting to obtain control of us and could increase thelikelihood that incumbent directors will retain their positions.

 

*Stockholder Action*

 

Our certificate of incorporation provides 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 further provide that special meetingsof stockholders may be called only by our Chairman of the Board of Directors,Chief Executive Officer, President, or Secretary, and shall be called by anysuch person at the request in writing of a majority of the Board of Directors.Stockholders are not permitted to call a special meeting or to require ourBoard of Directors to call a special meeting of 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. 

 

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These provisions would also prevent the holders of a majority of thevoting power of our stock from unilaterally using the written consent procedureto take stockholder action. Moreover, a stockholder could not force stockholderconsideration of a proposal over the opposition of the Board of Directors bycalling a special meeting of stockholders prior to the time our chairman or amajority of the whole board believes such consideration to be appropriate.

 

*Advance Notice for Stockholder Proposals andDirector Nominations*

 

Our bylaws 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, are eligible for election asdirectors.

 

*Amendments to Bylaws*

 

Our certificate of incorporation provides 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 of Incorporation*

 

Any proposal to amend, alter, change, or repeal any provision of ourcertificate of incorporation requires 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“interested stockholder” for a period of three years following the date thatthe stockholder became an interested stockholder. “Business combination” includesa merger, consolidation, asset sale, or other transaction resulting infinancial benefit to the interested stockholder. “Interested stockholder” is aperson who, together with affiliates and associates, owns, or within threeyears, did own 15% or more of the corporation’s voting stock. This prohibitiondoes not apply if:

 

·                                          priorto the time that the stockholder became an interested stockholder, the board ofdirectors of the corporation approved either the business combination or thetransaction resulting in the stockholder’s becoming an interested stockholder,

 

·                                          uponconsummation of the transaction resulting in the stockholder’s becoming aninterested stockholder, the stockholder owns at least 85% of the outstandingvoting stock of the corporation, excluding voting stock owned by directors whoare also officers and certain employee stock plans, or

 

·                                          ator subsequent to the time that the stockholder became an interestedstockholder, the business combination is approved by the board and authorizedat an annual or special meeting of stockholders, and not by written consent, bythe affirmative vote of at least two-thirds of the outstanding voting stockthat 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 limits the liability of our directorsto the fullest extent permitted by the DGCL. In addition, our certificate ofincorporation and bylaws provide that we will indemnify our directors andofficers to the fullest extent permitted by law.

 

**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.

 

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**Transfer Agent and Registrar**

 

The transfer agent and registrar for our commonstock is American Stock Transfer & Trust Company. The transfer agent’saddress is 6201 15th Avenue, Brooklyn, New York 11219 and itstelephone number is (718) 921-8124.

 

**ITEM 1A.  Risk Factors**

 

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

 

***The trading price in our commonstock may be volatile and you may lose all or part of your investment.***

 

The market price of our common stock has beensubject to significant fluctuations and these fluctuations could continue. Somefactors that could affect the market price of our common stock are as follows:

 

·                  actualor anticipated changes in our operating results,

·                  ourstock is subject to short selling and may cause trading in our common stock tobe volatile,

·                  changesin research analysts recommendations or estimates of financial performance,

·                  changesin market valuation of similar companies, economic and general marketconditions,

·                  announcementsof significant contracts, company developments, commercial relationships,banking credit facilities, capital commitments, acquisitions or joint ventures,

·                  issuanceof additional shares of common stock or other securities, and

·                  intellectualproperty or litigation developments.

 

Trading in our common stock may experiencesignificant price and volume fluctuations and adversely affect the tradingprice of our common stock. Following periods of volatility in the market priceof a public company’s securities, securities class action litigation has oftenbeen instituted against that company. Such litigation could result insubstantial cost and a diversion of management’s attention and resources.

 

***The adverse domestic and global economicconditions or the perception of said conditions may have adverse effects on ourgrowth and operating results.***

 

The continued success of ourbusiness depends on the willingness of our customers to spend in adiscretionary manner.  While we do offer lower priced merchandise and mayconsequently fare better than those who exclusively offer more expensivemerchandise, jewelry is essentially perceived as a luxury good. If the economycontinues to decline it will cause people to feel less comfortable purchasingdiscretionary goods and would cause a negative effect on our operating results.Our annual and quarterly operating results may vary significantly in the futurebased on economic factors over which we have little or no control. Because wehave little or no control over these factors and/or their magnitude, ouroperating results are difficult to predict. Any substantial adverse change inthe economic factors could negatively affect our business and results ofoperations.

 

***Our business has been and may continue to besignificantly impacted by the decline in worldwide economic conditions, and thecurrent uncertainty in the outlook for the global economy makes it more likelythat our actual results will differ materially from expectations .***

 

Global financial markets have been experiencing extreme disruptions inrecent months, including severely diminished liquidity and credit availability,declines in consumer confidence, declines in economic growth, increases inunemployment rates, and uncertainty about economic stability. There can be noassurance that there will not be further deterioration in financial markets andconfidence in economic conditions.  Theseeconomic uncertainties affect businesses such as ours in a number of ways,making it difficult to accurately forecast and plan our future businessactivities. The current tightening of credit in financial markets may leadconsumers to postpone spending, which may cause our customers to reducepurchases of jewelry. Demand for jewelry is a function of the health of theeconomies in the United States and around the world. Since the US economy andother economies around the world are in a recession, the demand for jewelry hasbeen and may continue to be adversely affected and therefore, demand for ourjewelry products and our operating results have been and may continue to beadversely affected as well. We cannot predict the timing, strength or durationof any economic disruption or subsequent economic recovery, worldwide, in theUnited States, in our industry, or in the jewelry market. These and othereconomic factors have had and may continue to have a material adverse effect ondemand for our jewelry products and on our financial condition and operatingresults.

 

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***Our future operating results are highly dependentupon how well******we manage our business to respond to the economic recession.***

 

Our annual andquarterly operating results may fluctuate based on how well we manage ourbusiness to respond to the economic recession. Some of these factors includethe following:

 

·          ourability to manage our sales and marketing efforts;

·          ourability to structure our organization to achieve our operating objectives andto meet the needs of our customers; and

·          ourability to manage expenses and inventory levels.

 

If we fail tomanage our business effectively, our results of operations could be adverselyaffected.

 

***We will devote necessaryresources to respond promptly and thoroughly to the SEC investigation.***

** **

On February 10, 2009, theSecurities and Exchange Commission (“SEC”) issued a subpoena to us to producedocuments relating to the Company’s inventory reserve policies, as well asother matters. We intend to cooperate fully with the SEC’s formalinvestigation, and our management will devote the resources required to respondpromptly and thoroughly to any request by the SEC for any additionalinformation or documents. Although the investigation is in its preliminarystages, and it is therefore difficult to predict the time required by seniormanagement to respond to it, we do not presently anticipate that theinvestigation will adversely affect management, our results of operations orour financial position. Until the investigation is concluded, however, it isdifficult to assess its impact on us.

 

***We must continue togenerate a high volume of visitor traffic to our website and convert thosevisitors into buyers.***

 

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 are unableto increase our customer base and the dollar volume of the orders customersplace with us.

 

***We are subject to “prank” bidding by personswho are not required to provide their identification.***

 

Presently, we do not require new users to our site to provide theiridentification upon registration. Consequently, from time to time we aresubject to “prank” bidders who may win auctions but do not intend to purchaseour merchandise.  Although the Companyre-auctions merchandise not purchased by such bidders, a large number of failedauctions in which winning bidders do not complete their purchases couldadversely affect our results of operations.

 

***We may faceincreasing costs to acquire 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, online banner advertising,targeted e-mail advertising, and participation in affiliate programs. We do notmaintain long-term contracts or arrangements with any companies, including anysearch engines, Internet portals, or other websites, and we may notsuccessfully enter into additional relationships or maintain existing ones. Inaddition, traffic to our website could decline if our online marketing programsbecome less effective or the traffic decreases to the search engines, Internetportals, and websites with which we advertise. Our business could be materiallyand adversely affected if any substantial number of companies on which weadvertise experience financial or operational difficulties or experience othercorporate developments that adversely affect their performance. A failure tomaintain or expand existing online advertising relationships or to establishadditional online advertising relationships that generate a significant amountof traffic from other websites could result in decreased sales or limit thegrowth of our business.

 

***Our growth willdepend on our ability to increase the popularity of our website, and we may notbe able to do so effectively.***

 

We believe that continuing to increase the popularity of our websitewill be critical to expanding our business. Promoting and positioning ourwebsite will depend largely on the success of our marketing efforts and ourability to provide a variety and sufficient quantity of high-quality productsat attractive prices in a convenient manner. Promoting our website will requireus to 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.If we fail to promote and maintain our website or incur substantial expenses inan unsuccessful attempt to promote and maintain our brand, our business wouldbe harmed.

 

***We anticipateexpanding our international sales activities, causing our business to becomeincreasingly susceptible to numerous risks that could affect our profitability.***

 

In 2007 and 2008, 22.3% and 23.9%, respectively, of our net revenue wasgenerated by shipments to customers outside of the United States. We plan, overtime, to expand our reach into international markets. We do not, however,currently have any overseas fulfillment, distribution, or server facilities. Wecannot be certain that we will be able to expand our global presence. Inaddition, there 

 

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

 

***Customer complaintsor negative publicity about our customer service could adversely affect ourreputation and, as a result, our business could suffer.***

 

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

 

***Our limitedoperating history makes it difficult for us to forecast accurately net revenueand appropriately plan 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.

 

***Quarterly financial results may not beconsistent and impact our stock price.***

 

There are numerous influences on our quarterly financial results thatextend beyond the normal seasonal trends. Fluctuations that are under ourcontrol include: our ability to influence the timing and quantity of items weplace for auction; our decision to acquire merchandise at favorable prices; ourexpenditures on marketing and our ability to attract customer visits to ourwebsite. Fluctuations that are not under our control that may directly impactour quarterly financial results include: changes in market price for preciousmetals and gems; changes in consumers’ discretionary income and demand for ourproducts; and changes in fashion trends.

 

***We may be at risk to accurately reportfinancial results or detect fraud if we fail to maintain an effective system ofinternal controls.***

 

As directed bySection 404 of the Sarbanes-Oxley Act of 2002, the Securities and ExchangeCommission adopted rules requiring public companies to include a reportthat contains an assessment by management on the company’s internal controlover financial reporting in their annual reports on Form 10-K. Inaddition, the independent registered public accounting firm auditing thecompany’s financial statements must attest to and report on our assessment ofthe effectiveness of the internal controls over financial reporting. While weare consistently working on improvements and conducting rigorous reviews of ourinternal controls over financial reporting, our independent auditors mayinterpret Section 404 requirements and apply related rules andregulations differently. If our independent auditors are not satisfied with ourinternal control over financial reporting or with the level at which it isdocumented, operated or reviewed, they may decline to attest to management’sassessment or issue a qualified report. Additionally, if we are not able tomeet all the requirements of Section 404 in a timely manner or withadequate compliance, we might be subject to sanctions or investigation byregulatory authorities, such as the Securities and Exchange Commission.

 

Future changes in our accounting, financial reporting, and regulatoryenvironment may create new areas of risk exposure. Failure to modify ourexisting control environment accordingly may impair our controls over financialreporting and cause our investors to lose confidence in the reliability of ourfinancial reporting, which may adversely affect our stock price.

 

***We do not have aguaranteed supply of jewelry products, and we have a concentration of inventorypurchases from our top two 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 do not haveany formal or binding supply agreements with any of our manufacturers,distributors, or other suppliers for our supply of jewelry products. 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.

 

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In addition, we have a concentration of inventory purchases from asmall number of suppliers. Our top two suppliers accounted for approximately31.1%, 24.0% and 14.6% of our total purchases in 2006, 2007, and 2008,respectively.

 

***We may givesubstantial deposits of inventory to our manufacturing vendors to producefinished jewelry products.***

 

We may be at risk of loss for the diamonds,precious and semi-precious gems that we have given to our manufacturing vendorsto produce into finished jewelry products. If the businesses of the vendorsfail, the diamond inventory is lost or stolen, the vendors do not have adequateinsurance coverage or if the vendors fail to produce and deliver finishedjewelry products, we would incur substantial losses that would have a materialimpact on our net income and financial position.

 

***Competition fromonline auctioneers and other online companies with greater brand recognitionmay adversely 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 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, BlueNile, Overstock, and uBid. We also encounter competition from national jewelryretail chains, such as Zales, Kay Jewelers, and Finlay Fine Jewelry, and massretailers and other enterprises that sell jewelry, such as Wal-Mart, Target, J.C. Penney, Costco, QVC, and Home Shopping Network. Many of our competitors havegreater brand recognition, longer operating histories, larger customer bases,and significantly greater financial, marketing, and other resources than we do.Smaller competitors may enter into strategic or commercial relationships withlarger, more established, and well-financed companies. Other competitors mayenter into exclusive distribution agreements with our suppliers that deny usaccess to suppliers’ products. Competitors may also devote greater resources tomarketing and promotional campaigns and to website and systems technology thanwe do. We may not be able to compete successfully against current and futurecompetitors or address increased competitive pressures. Furthermore, attemptshave been made in the past to develop and market synthetic stones and gems tocompete in the market for gemstones and gemstone jewelry. We expect suchefforts to continue in the future. If any such efforts are successful increating widespread demand for synthetic or alternative gemstone products,demand and price levels for our products could decline and our business andresults of operations would be substantially harmed.

 

***We rely heavily onthe sale of jewelry for our net revenue, and demand for these products coulddecline.***

 

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 allof our jewelry products in inventory, our net revenue and gross margin maydecrease if we are unable to predict and plan for changes in consumer demand.***

 

If our 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 also 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 manufactured 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.

 

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***We may be subject to a tax liability for pastsales and our future sales may decrease if we are required to collect sales anduse taxes 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 and New York. However,additional states or foreign countries may seek to impose sales or other taxobligations on us in the future. A successful assertion by one or more statesor foreign countries that we should be collecting sales or other taxes on thesale of our products could result in substantial tax liabilities for past andfuture sales, discourage customers from purchasing products from us, decreaseour ability to compete with traditional retailers, and otherwise substantiallyharm our business, financial condition, and results of operations.

 

***We rely on suppliersand third-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 ofour suppliers. 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 thecost of precious metals and precious and semi-precious stones would increasethe cost of 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 may be influenced by such factors as cartels, politicalinstability in exporting countries, changes in global demand, and inflation.Shortages of these materials or an increase in their prices could reduce thequantity of products we have available for sale and our ability to sell our productsfor more than our cost, causing reduced sales or lower margins compared to ourhistorical and expected sales and margins.

 

***The satisfactoryavailability, performance, and reliability of our website, networkinfrastructure, and transaction processing systems are critical to our abilityto 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 shippingfunctions to accommodate any substantial increase in the volume of traffic toand orders from our website. We may not be successful in these efforts, and we maynot be able to project accurately the rate or timing of increases, if any, inthe use of 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.

 

***Our business andresults of operations would be harmed in the event of any failure of ourauction and bidding systems hardware, which is located at a single third-partyco-location facility, or any failure of our fulfillment and administrativehardware.***

 

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 ElSegundo, CA. We rely on that facility to provide Internet access with thespeed, capacity, and reliability we require. Our servers and other hardwarethat run our transaction processing, order fulfillment, and officeadministration tasks are located at our headquarters. Our servers and otherhardware are vulnerable to damage or interruption from human error, fire,flood, power loss, telecommunications failure, terrorist attacks, acts of war,break-ins, earthquakes, and similar events. We do not currently have redundantsystems in multiple locations or a formal disaster recovery plan, and ourbusiness interruption insurance may be insufficient to compensate us for anylosses that may occur. In addition, our servers are vulnerable to computerviruses, physical or electronic break-ins, and similar disruptions, which couldlead to interruptions, delays, loss of critical data, the inability to acceptand fulfill customer orders, or the unauthorized disclosure of confidentialcustomer data. System disruptions or failures would also create a large numberof customer questions and complaints that need to be addressed by our customerservice support personnel. The occurrence of any of the foregoing risks couldsubstantially harm our business and results of operations. Our systems arevulnerable to damage or interruption from earthquakes, floods, fires, powerloss, telecommunication failures, terrorist attacks, computer viruses, 

 

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computer denial-of-service attacks, and similar events.

 

***Our failure toprotect confidential information of our customers and our network againstsecurity breaches could damage our reputation and substantially harm ourbusiness and results 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.

 

***We are vulnerable tofraudulent activities on our website, including unauthorized use of customerinformation and identity theft by third parties****.*

 

Our network security measures to prevent third parties from penetratingour network and improperly accessing our customers’ personal information orcredit card information may not be successful. Although we have not experiencedany theft of our customers’ credit card information to date, as new discoveriesin the field of cryptography and advances in computer capabilities occur, oursecurity measures may not effectively prevent others from obtaining improperaccess to our customer information. In addition, third parties may target ourcustomers directly with fraudulent identity theft schemes designed to appear aslegitimate e-mails from us. In March 2006, one such third party attemptedto solicit customer information through a tactic, commonly known as “phishing,”whereby an e-mail purporting to be from us solicited customer information fromrecipients of the e-mail. Any such security breach or fraud perpetrated on ourcustomers could expose us to increased costs and could harm our business andresults of operations.

 

***Our ability to growour business 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. These outagesand delays could reduce the level of Internet usage.

 

***We depend on thecontinued growth and acceptance of online commerce, and our business will besubstantially impaired if the growth of online commerce slows or does not growas expected.***

 

Our success depends on the widespread acceptance and use of theInternet as an effective medium for commerce by consumers. The acceptance anduse of the Internet may not continue to expand as expected, and a sufficientbroad base of consumers necessary for its continued growth may not adopt theInternet as a medium for commerce. Consumers who historically have usedtraditional means of commerce may have concerns about privacy, the inability tophysically inspect merchandise before buying, delivery time, product damage duringshipment, and the costs and inconvenience involved in returning purchaseditems, which may inhibit their crossover to e-commerce. In order to expand ouruser base, we must appeal to and acquire consumers who historically have usedtraditional means of commerce to purchase goods. If these new customers executefewer or lower dollar amounts of orders than our historical users, and we areunable to gain efficiencies in our operating costs, including the cost ofacquiring new customers, our business and profits could be adversely affected.

 

***Increased productreturns and the failure to predict product returns could substantially harm ourbusiness and results of operations.***

 

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

 

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

 

Our inventory is stored at our warehouse/office facility in CulverCity, California. Consequently, our merchandise supply is vulnerable to fire,flood, earthquakes, and similar events that may impact our facility. Any damageto 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 inventory orduring the course of their shipment to our customers by third-party carriers.We have implemented security measures to prevent such theft and maintaininsurance to cover losses resulting from theft. Nevertheless, we could incursignificant losses from theft, which would substantially harm our business andresults of operations, if our security measures fail, losses exceed ourinsurance coverage, or we are not able to maintain insurance at a reasonablecost.

 

***Increases in creditcard processing 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.

 

***We may default onour obligations, if we are unable to generate sufficient cash through sales ina timely manner.***

 

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

 

***Seasonalfluctuations in our net revenue could cause our quarterly results to fluctuateand cause our results 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 28.5%,33.8% and 16.9% of our net revenue was generated during the fourth quarter of2006, 2007 and 2008, respectively. The fourth quarter of 2008 was anexception as we encountered a significant slowdown in sales resulting from the2008 financial and economic crisis. 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 duringany future fourth quarter, it would have a disproportionately large impact onour results of operations for that year. In the future, our seasonal salespatterns may 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 inprior periods may 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 useof period-to-period comparisons of financial results. For these and other reasons,investors should not rely on past sales growth rates as a prediction of ourfuture sales growth.

 

***We had grownquickly, and our business will suffer if we fail to manage our future growth.***

 

We had expanded our operations at a rapid pace prior to the 2008financial and economic crisis. This expansion had placed a significant strainon our management, operations, and financial resources. When the economyrecovers, we anticipate adding personnel in the future, including managerial,technical, and operations personnel. In order to manage the future growth ofour operations, we also will be required to improve existing and implement newtransaction-processing, operational and financial systems, procedures, andcontrols. If we are unable to manage growth effectively, our business andresults of operations will be harmed.

 

In conjunction with the expiration of our property lease in CulverCity, California in October, 2009, we have begun seeking alternative realestate options that may require us to relocate our operations. In managing thistransition, our operations could be interrupted and 

 

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we could experience increased employee turnover, or both.

 

***Descriptions of ourjewelry items are not guarantees and may confuse, mislead, or disappoint ourcustomers.***

 

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. Nevertheless,there is a subjective component involved with respect to assessing the clarity,color, and carat characteristics of diamonds and other gemstones. In addition,mistakes or omissions of important information in our descriptions may occur.Even if our descriptions are accurate, buying a product online may lead todisappointment resulting in returned merchandise. For example, a customer maydetermine that a piece does not have the expected look, feel, and overallappearance of the merchandise that the buyer envisioned from the websitephotograph.

 

Additionally, in response to customer requests and as a courtesy toresellers, we provide “Compare,” and/or “Retail” prices for jewelry itemslisted on our website. Compare prices are not meant to reflect fair marketvalues or manufacturer suggested retail prices, and in fact, may be higher thanprices found in local retail stores. As a consequence, perceivedmisrepresentations in item descriptions by disappointed buyers may occur,resulting in negative publicity about and diminished customer confidence in ourwebsite.

 

***We may unknowingly be involved in “conflict”diamond purchases that result in a negative public relationship impact.***

 

There has been an increase in attention to “conflict” diamondsoriginating out of war-torn regions of Africa. The proceeds from the sale of “conflict”diamonds have been used to fund ongoing aggression and terrorist activitiesthroughout the world. We make every effort to evaluate our vendor sources toensure they are not a dealer in “conflict” diamonds. In addition we haveimplemented an anti-money laundering program to guard against both illicitpurchase and sales activities. If these risks were to occur, we may face anegative public reaction to our brand name resulting in loss of sales.

 

***We may not be ableto maintain our domain name 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 subject to assertions by thirdparties for infringement on their intellectual property rights.***

 

Third parties may in the future assert that we have infringed on theirintellectual property rights as we self-develop our auction platform, salestransaction system, and inventory control system.  We have a larger exposure to being accused ofintellectual property rights infringements than if we had purchased ourtechnology off the shelf. We also may be at risk for selling items thatinfringe on other third party trade dress rights, copyright, or patent rightsthat may cause the offended party to bring an action against us. In eitherevent of alleged infringement, we would face substantial litigation cost todefend ourselves and utilization of our management and personnel resources.

 

***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, domain name,trade dress, and trade secrets as critical to our success. We rely on acombination of common law as well as trademark, copyright, trade dress, andtrade secret laws to protect our intellectual property rights. We also haveentered into confidentiality and invention assignment agreements with ouremployees and relevant contractors and nondisclosure agreements with relevantparties with whom we conduct business in order to limit access to anddisclosure of our proprietary information. These contractual arrangements andother steps we have taken to protect our intellectual property may not preventmisappropriation of our intellectual property or deter independent developmentof similar intellectual property by others. We also are pursuing the registrationof our domain name, trademarks, and service marks in the United States andinternationally. Effective trademark, copyright, patent, trade dress, tradesecret, and domain name protection is very expensive to maintain and mayrequire litigation. We must protect our trademarks, copyrights, patents, anddomain names in an increasing number of jurisdictions, a process that isexpensive and may not be successful in every location.

 

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Third parties may from time totime claim that we have infringed their intellectual property relating to ourbusiness model or auction systems. We expect that participants in our marketincreasingly will be subject to infringement claims as the number of servicesand competitors in our industry segment grows. Any claim like this, whethermeritorious or not, could be time-consuming, result in costly litigation, causeservice upgrade delays, or require us to enter into royalty or licenseagreements. These royalty or license agreements may not be available onacceptable terms or at all. As a result, any such claim could harm ourbusiness.

 

***We may be unable toenforce protection of our intellectual property rights under the laws of othercountries.***

 

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 andregulations related to privacy and the collection, dissemination, and securityof personal information 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 that wouldlimit 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 toregulations governing the conduct and liability of auctioneers, which couldaffect the way in which we conduct our business or otherwise increase our costof doing business.***

 

Numerous states and foreign jurisdictions, including California, whereour headquarters are 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 our business, and little precedent exists in this area. Several statesand some foreign jurisdictions have attempted, and may attempt in the future,to impose regulations that could affect us or our users, which could harm ourbusiness.

 

***We are subject toregulations relating to consumer privacy, which could increase the cost of ourdoing business, expose us to litigation costs, increase our service or deliverycosts, and otherwise harm our business.***

 

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 online services.However, the Fair Credit Reporting Act, or FCRA, a federal statute enacted in1970 to protect consumer privacy, includes a provision preempting conflictingstate laws on the sharing of information between corporate affiliates. Thepreemptive provisions of FCRA were permanently extended in 2002, therebyensuring that we are not subject to the laws of each individual state withrespect to matters within the scope of FCRA, but remain subject to the otherprovisions 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 acrossdifferent countries and the need to move data to facilitate transactions amongour users, such as payment companies and shipping companies, is both necessaryand difficult. 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.

 

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

 

We are subject to the same foreignand domestic laws as other companies conducting both online and offlinebusiness. There are still relatively few laws specifically directed towardsonline business. However, due to the increasing popularity and use of theInternet and online services, many laws relating to the Internet are beingdebated at all levels of government around the world, and it is possible thatsuch laws and regulations will be adopted. These laws and regulations couldcover issues such as user privacy, freedom of expression, pricing, fraud,content and quality of products and services, taxation, advertising,intellectual property rights, and information security. Applicability to theInternet of existing laws governing issues, such as property ownership,copyrights and other intellectual property issues, taxation, libel anddefamation, obscenity, and personal privacy is uncertain. The vast majority ofthese laws were adopted prior to the advent of the Internet and relatedtechnologies and, as a result, do not contemplate or address the unique issuesof the Internet and related technologies. Those laws that do reference theInternet, such as the U.S. Digital Millennium Copyright Act and the EuropeanUnion’s Directive on Distance Selling and Electronic Commerce, have onlyrecently begun to be interpreted by the courts and implemented by the EuropeanUnion member states, so their applicability and scope remain uncertain. As ouractivities and the types of goods listed on our website expand, regulatoryagencies may claim that we or our users are subject to licensure in theirjurisdiction, either with respect to our business in general, or in order toallow the sale of certain items, such as real estate, event tickets, boats, andautomobiles.

 

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 to qualifyas a foreign corporation in a jurisdiction in which we are required to do socould 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 verysignificant extent on David Zinberg, our Chairman of the Board and ChiefExecutive Officer.***

 

Our performance depends substantially upon David Zinberg, our Chairmanof the Board and Chief Executive Officer, who has extensive experience with thepurchase and sale of jewelry. We rely on Mr. Zinberg to make criticaloperational decisions on a daily basis, such as product offerings andpurchases, and to make key strategic plans. We have an employment agreementwith Mr. Zinberg extending through 2009. The loss of the services of Mr. Zinbergwould adversely affect our business and operations.

 

***Holders of commonstock issued by us in prior offerings may be entitled to rescind their purchases.***

 

From our inception until mid-2003, we raisedover $20.5 million in gross equity capital by selling shares of our commonstock to approximately 830 investors at prices ranging from $4.00 to $6.00 pershare with a weighted average share price of $4.50. We also issued shares ofcommon stock to about 30 persons in exchange for services and other non-cashconsideration valued in excess of $5.5 million and issued approximately 250stock option grants to purchase common stock at a weighted average exerciseprice of $4.45. After conducting these sales of our securities, we determinedthat these sales were not exempt from the registration requirements under theSecurities Act of 1933 and similar provisions of laws of the states in whichour stockholders reside, because certain of our employees who solicitedinvestors engaged in a “general solicitation” of securities. In addition, theseemployees received compensation for selling our common stock and were requiredto be licensed as broker-dealers with the Securities and Exchange Commission,or SEC, and various state authorities, but they were not so licensed. In suchsituations, a number of remedies may be available to regulatory authorities andthe investors who purchased common stock in those offerings, including a rightof rescission, civil penalties, a restraining order or injunction, and a courtorder to pay restitution and costs. We believe, however, that as to any optionsby investors at this time or in the future, applicable statutes of limitationswill mitigate our exposure to any civil remedies.

 

***We do not intend topay dividends on our common stock, and, consequently, your only opportunity toachieve a return on your investment is if the price of our common stockappreciates.***

 

We havenever declared or paid any cash dividends on our common stock and do not intendto pay dividends on our common stock for the foreseeable future. We intend toinvest any future earnings to fund our business. Therefore, stockholders likelywill not receive any dividends on our common stock for the foreseeable future.Investors cannot be certain that they will receive a positive return on theirinvestment when they sell their shares or that they will not lose the entireamount of their investment.

 

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***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, executiveofficers, and directors together own approximately 34.9% of our common stock asof December 31, 2008. Marina Zinberg, our Vice President, who is thesister of David Zinberg, our Chairman and Chief Executive Officer, owns anadditional 32.0% of our common stock.  Asa result, these individuals will have significant influence over our managementand affairs and over all matters requiring stockholder approval, including theelection of directors and the approval of significant corporate transactions,such as a merger or a sale of our company or its assets, for the foreseeablefuture. This concentrated control will limit the ability of other stockholdersto influence corporate matters. Because of this, we may take actions that someof our stockholders do not view as beneficial. As a result, the market price ofour common stock could be adversely affected because stockholders may not viewfavorably the concentration of control in the hands of management.

 

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

 

On June 22, 2006, we reincorporated inDelaware, and the 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 ourstockholders. The Delaware certificate of incorporation also authorizes ourBoard of Directors, without stockholder approval, to issue one or more seriesof preferred stock, which could have voting and conversion rights thatadversely affect or dilute the voting power of the holders of common stock.Delaware law also imposes conditions on certain business combinationtransactions with “interested stockholders.” The Delaware certificate ofincorporation divides our Board of Directors into three classes, with one classto stand for election each year for a three-year term after the initialelection. The classification of directors tends to discourage a third partyfrom initiating a proxy solicitation or otherwise attempting to obtain controlof our company and may maintain the incumbency of our Board of Directors, as thisstructure generally increases the difficulty of, or may delay, replacing amajority of directors. The Delaware bylaws authorize our Board of Directors tofill vacancies or newly created directorships. A majority of the directors thenin office may elect a successor to fill any vacancies or newly createddirectorships.

 

**ITEM 1B.  Unresolved StaffComments**

 

Notapplicable.

 

**Item2.**           Properties.

** **

Welease a 50,000 square foot facility in Culver City, California, which serves asour corporate headquarters and houses our sales, marketing, research anddevelopment, customer service, fulfillment, and warehouse operations. Our leaseexpires in October 2009 and we will either extend the lease or relocate toanother suitable location. In August 2007, we leased a separate 12,000square-foot warehouse in Culver City, California and this lease expires in August 2012.

 

**Item3.**           LegalProceedings

** **

On February 10, 2009, the Securities andExchange Commission (“SEC”) issued a subpoena to produce documents relating tothe Company’s inventory reserve policies, as well as other matters. We intendto fully cooperate with the SEC regarding this matter.

 

On or about January 15, 2009, Landmark Technology, LLC (“Landmark”)filed a First Amended Complaint in the civil action titled Landmark Technology,LLC v. Zale Corp, et al. in the U.S. District Court for the Eastern District ofTexas. The First Amended Complaint added the Company as a defendant and allegedthat the Company infringed and is infringing certain patents of Landmark directly,contributorily and by inducement. The First Amended Complaint seeks atemporary, preliminary and permanent injunction against infringement of theLandmark patents, damages (including a reasonable royalty and lost profits),enhanced or exemplary damages, a finding that the alleged infringement is “willful,”attorneys fees, costs and other relief.

 

On or about September 29, 2008, we were served with a lawsuitfiled in the U.S. District Court for the Central District of California byMarla Tidenberg against Bidz.com, Mr. Zinberg and Marina Zinberg. Thelawsuit purports to represent a class and alleges, among other things, that weengaged in unfair business practices by misrepresenting the value of ourmerchandise and by “false” bidding. The complaint purports to represent aclass of persons who purchased any merchandise from us. We believe thatthe lawsuit is meritless and intend to defend the case vigorously.

 

On or about April 12, 2006, a lawsuit was filed in the U.S.District Court for the Southern District of New York by Cartier, a division ofRichemont North America, and Cartier International B.V. against Bidz.com, Inc.,David Zinberg and others. The lawsuit alleges that Cartier has proprietaryrights, including trade dress, patents, trademarks, copyrights and others, inwatch designs known as a 

 

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Tank, Tank Francaise, Tank Americaine, Panthere and Pasha De CartierGrille, and Tank Devan, and further alleges that we have infringed upon thoserights by selling watches bearing copies of one or more of the watch designs.The Company and Mr. Zinberg entered into a settlement agreement withCartier in August 2008. A Consent Judgment was entered in the civilaction.

 

We are, from time to time, a party todisputes arising from normal business activities, including variousemployee-related matters. In the opinion of our management, resolution of thesematters, individually or collectively, will not have a material adverse effectupon our financial condition or future operating results.

 

**Item4.**           Submissionof Matters to a Vote of Security Holders

** **

In June 25, 2008, we held our AnnualMeeting of Shareholders.  We solicitedproxies for the Annual Meeting pursuant to Regulation 14A under the SecuritiesExchange Act of 1934, as amended.  Therewas no solicitation in opposition to the two nominees of the Board of Directorslisted in our Proxy Statement, dated June 5, 2008, and both nominees wereelected.

 

The following matters were acted upon by ourshareholders at the Annual Meeting, at which approximately 12,715,726 shares ofcommon stock, or 53.1% of the shares of common stock outstanding and entitledto vote at the Annual Meeting, were present in person or by proxies:

 

1.             Electionof Directors,   The Board of Directorsnominated two persons for election as Class II directors, each to holdoffice for three-year terms.  Eachnominee was an incumbent director, no other person was nominated, and eachnominee was elected.  The votes cast for,or withheld or abstained with respect to, each nominee were as follows:  Man Jit Singh—12,590,783 for, 124,943withheld, and Lawrence Y. Kong—12,567,580 for, 148,146 withheld.

 

2.             Proposalto Approve Amendment to 2006 Stock Award Plan. The Board of Directors submitted a resolution that the shareholdersapprove an amendment to our 2006 Stock Award Plan to increase by 500,000 sharesof common stock, from 1,000,000 to 1,500,000 shares, the total number of sharesof common stock reserved and available in connection with awards under the 2006Plan.  There were 12,142,763 sharesvoting in favor of, 540,564 shares voting against, the resolution.  The holders of 32,399 shares abstained, andthere were no “broker non-votes.”  Theresolution, having received the affirmative vote of the holders of a majorityof the shares of common stock outstanding and entitled to vote at the AnnualMeeting, was adopted.

 

3.             Ratificationof Appointment of Independent Auditor. The Board of Directors submitted a resolution that the shareholdersratify the action of the Audit Committee in selecting and appointing the firmof Stonefield Josephson, Inc. as the Company’s independent registeredpublic accounting firm for the year ending December 31, 2008.  There were 12,677,921 shares voting in favorof, 13,180 shares voting against the resolution.  The holders of 24,625 shares abstained, andthere were no “broker non-votes.”  Theresolution, having received the affirmative vote of the holders of a majorityof the shares of common stock outstanding and entitled to vote at the AnnualMeeting, was adopted.

 

**Part II**

 

**Item5.**           Market forRegistrant’s Common Equity, Related Stockholder Matters and Issuer Purchases ofEquity Securities

** **

Our common stock is quoted on The NASDAQ StockMarket LLC under the symbol “BIDZ.” The following table sets forth the high,low and closing market prices of our common stock during each of the fourcalendar quarters for 2008:

 
| **For the quarter ended:** | ** ** | **High** | ** ** | **Low** | ** ** | **Close** | ** ** |
|-------------------------------------------|------------|----------|------------|---------|------------|-----------|------------|
|                                      |       |     |       |    |       |      |       |
| March 31, 2008                       |       | $        | 11.55      |    | $          | 7.09      |       | $ | 8.40 |   |
| June 30, 2008                        |       | $        | 13.95      |    | $          | 7.91      |       | $ | 8.71 |   |
| September 30, 2008                   |       | $        | 11.98      |    | $          | 7.50      |       | $ | 8.66 |   |
| December 31, 2008                    |       | $        | 9.00       |    | $          | 2.00      |       | $ | 4.60 |   |

 

As of December 31, 2008, there were 22,917,918 shares of commonstock outstanding.

 

We have established a public market for our commonstock on the NASDAQ Capital Market since June 2007. We have registered foroffer and sale the shares of common stock that are reserved for issuancepursuant to stock options covered by our stock option plans. Shares covered bysuch registration statements upon the exercise of stock options or warrantsgenerally will be eligible for sale in the public market, except thataffiliates will continue to be subject to volume limitations and otherrequirements of Rule 144. As of December 31, 2008, the number ofshares of our common stock that is subject to outstanding options to purchasecommon stock is 6,864,500.

 

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Shares held by management and affiliates of ourcompany are subject to the resale limitations of Rule 144. In general,under Rule 144 as currently in effect, any person, or persons whose sharesare aggregated for purposes of Rule 144, who beneficially owns restrictedsecurities with respect to which at least six months has elapsed since thelater of the date the shares were acquired from us, or from an affiliate ofours, is entitled to sell within any three-month period a number of shares thatdoes not exceed the greater of 1% of the then outstanding shares of our commonstock 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.

 

**Dividends**

 

We have never declared or paid any dividends on our common stock and donot anticipate that we will pay any dividends to holders of our common stock inthe foreseeable future. Instead, we currently plan to retain any earnings tofinance the growth of our business. Payments of any cash dividends in thefuture will be within the discretion of our Board of Directors and will dependon our financial condition, results of operations, and capital requirements aswell as other factors deemed relevant by our Board of Directors.

 

**Equity Compensation Plan Information**

 
| ** **                                                      | ** ** | ** **                                 | ** ** | ** **                        | ** ** | **Number of securities**    | ** ** |
|-----------------------------------------------------------------|------------|--------------------------------------------|------------|-----------------------------------|------------|---------------------------------------|------------|
| ** **                                                      | ** ** | ** **                                 | ** ** | ** **                        | ** ** | **remaining available for** | ** ** |
| ** **                                                      | ** ** | **Number of securities**         | ** ** | ** **                        | ** ** | **future issuance under**   | ** ** |
| ** **                                                      | ** ** | **to be issued upon**       | ** ** | **Weighted-average**              | ** ** | **equity compensation**          | ** ** |
| ** **                                                      | ** ** | **exercise of**                       | ** ** | **exercise price of**   | ** ** | **plans (excluding**             | ** ** |
| ** **                                                      | ** ** | **outstanding options,**              | ** ** | **outstanding options,**     | ** ** | **securities reflected in** | ** ** |
| **Plan category**                                          | ** ** | **warrants and rights (1)** | ** ** | **warrants and rights** | ** ** | **column (a))**                  | ** ** |
| **Equity compensation plans approved by  security holders**     | ** ** | ** **                                 | ** ** | ** **                        | ** ** | ** **                            | ** ** |
| 2006 Stock award plan                                           |       | 290,500                                    |       | $                                 | 7.89       |                                  | 1,302,990  |   |
| 2002 Special stock option plan                                  |       | —                                     |       | $                                 | —     |                                  | —     |   |
|                                                            |       |                                       |       |                              |       |                                  |       |
| **Equity compensation plans not approved by  security holders** | ** ** | ** **                                 | ** ** | ** **                        | ** ** | ** **                            | ** ** |
| 2001 Stock option plan                                          |       | 549,000                                    |       | $                                 | 6.00       |                                  | —     |   |
| Non-statutory stock option (2)                                  |       | 6,025,000                                  |       | $                                 | 6.00       |                                  | —     |   |
|                                                            |       |                                       |       |                              |       |                                  |       |
| **Total**                                                       |       | 6,864,500                                  |       | $                                 | 6.20       |                                  | —     |   |

 

----

(1)                                The total number ofshares of common stock to be issued upon exercise of all outstanding stockoptions is 6,864,500 as of December 31, 2008.

 

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

 

**Recent Sales of Unregistered Securities**

 

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

 

In 2008, we issued 24,800 restricted share awards of our common stock,with 25% vesting at the end of each year over a four year period, under the2006 Award Plan to 13 employees for services rendered to our company. No stockoptions were granted in 2008.

 

In 2007, we issued 10,000 and 8,750 shares of our common stock to eachof our outside directors, Peter Hanelt and Man Jit Singh, respectively, aspayment of independent director fees. We also issued 40,000, 35,000 and 35,000restricted share awards of our common stock, with 25% vesting at the end ofeach year over a four year period, under the 2006 Award Plan to each of ouroutside directors, Peter Hanelt, Man Jit Singh and Garry Itkin, respectively,as payment of independent director fees. We issued stock options to purchase anaggregate of 1,000,000 shares in our common stock at an exercise price of $8.23per share to 4 of our employees under our 2006 Award Plan for services renderedto the our company. We also issued 16,000 restricted share awards of our commonstock, with 25% vesting at the end of each year over a four year period, underthe 2006 Award Plan to 5 employees for services rendered to our company.

 

In 2006, we issued 10,000 shares of our common stock to each of ouroutside directors, Peter Hanelt and Man Jit Singh, as payment of independentdirector fees.  We also issued 15,000 and1,404 shares of common to an employee and independent consultant, 

 

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respectively, for services rendered. The shares of common stock wereissued at a price of $6.00 per share. We issued stock options to purchase anaggregate of 235,000 shares of our common stock at an exercise price of $6.00per share to three of our employees under our 2006 Award Plan for servicesrendered to our company.

 

**Issuer Purchases of Equity Securities**

 

The following table contains information about repurchases of ourcommon stock during the fourth quarter of 2008:

 
| ** **                              | ** ** | ** **    | ** ** | ** **  | ** ** | **Total number of** | ** ** | **Maximum**                    | ** ** |
|-----------------------------------------|------------|---------------|------------|-------------|------------|-------------------------------|------------|--------------------------------|------------|
| ** **                              | ** ** | ** **    | ** ** | ** **  | ** ** | **shares**                    | ** ** | **dollar value**          | ** ** |
| ** **                              | ** ** | **Total**     | ** ** | **Average** | ** ** | **purchased as**         | ** ** | **of shares that**   | ** ** |
| ** **                              | ** ** | **number**    | ** ** | **price**   | ** ** | **part of a**       | ** ** | **may**                        | ** ** |
| ** **                              | ** ** | **of**        | ** ** | **paid**    | ** ** | **publicly**                  | ** ** | **yet be purchased** | ** ** |
| ** **                              | ** ** | **shares**    | ** ** | **per**     | ** ** | **announced**                 | ** ** | **under the**             | ** ** |
| **2008**                                | ** ** | **purchased** | ** ** | **share**   | ** ** | **program**                   | ** ** | **program (1)**           | ** ** |
| October 1 — October 31   |       | —        |       | —      |       | 1,377,534                     |       | $                              | 7,963,000  |   |
| November 1 — November 30 |       | 450,386       |       | $           | 2.82       |                          | 1,827,915  |                           | $          | 6,691,000 |   |
| December 1 — December 31 |       | 25,953        |       | $           | 3.93       |                          | 1,853,868  |                           | $          | 6,590,000 |   |
| Total                                   |       | 476,339       |       | $           | 7.23       |                          | 1,853,868  |                           | $          | 6,590,000 |   |

 

----

(1)           In June 2007,we authorized the stock buyback program for up to $5 million of our outstandingcommon stock to be repurchased through the open market at prices deemedappropriate by management.  In February 2008, we authorized anincrease in the stock buyback program to $20 million from $5 million. In February 2009,we authorized an increase in the stock buyback program to $33.5 million from$20.0 million. As of February 23, 2009 we have repurchased a total ofapproximately 1.9 million shares for a total of approximately $13.5 million.About $20.0 million remain available under the buyback program to repurchaseshares in the open market. The stock buyback will be at prices deemedappropriate by management over a 24 month period.

 

**Item 6.    SelectedFinancial Data**

 

Theselected financial data presented below has been derived from our financialstatements. The statement of operations data for each of the fiscal years endedDecember 31, 2006, 2007, and 2008 and the balance sheet data at December 31,2007 and 2008 are derived from our audited financial statements that areincluded in this report. The statement of operations data for the years ended December 31,2004 and 2005 and the balance sheet data at December 31, 2004, 2005 and2006 are derived from audited financial statements that are not included inthis report. The historical results presented below are not necessarilyindicative of the results to be expected in any future period. You should readthis information together with “Management’s discussion and analysis offinancial condition and results of operations” and our financial statements andthe related notes included elsewhere in this report.

 
| ** **                                                         | ** ** | **Years ended December 31,** | ** ** |
|--------------------------------------------------------------------|------------|---------------------------------------------|------------|
| **(in thousands, except per share data)** | ** ** | **2004**                                    | ** ** | **2005** | ** ** | **2006** | ** ** | **2007** | ** ** | **2008** | ** ** |
| ** **                                                         | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Statement of income data:**                                      | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|                                                               |       |                                        |       |   |   |   |   |   |   |   |   |
| Net revenue                                                        |       | $                                           | 65,324     |   | $ | 90,579 |   | $ | 131,823 |   | $ | 187,131 |   | $ | 207,410 |   |
| Cost of revenue                                                    |       | 53,072                                      |       | 71,257 |   | 100,633 |   | 132,683 |   | 148,688 |   |
| Gross profit                                                       |       | 12,252                                      |       | 19,322 |   | 31,190 |   | 54,448 |   | 58,722 |   |
| Operating expenses:                                                |       |                                        |       |   |   |   |   |   |   |   |   |
| General & administrative                                  |       | 8,800                                       |       | 10,938 |   | 13,853 |   | 20,458 |   | 21,209 |   |
| Sales & marketing                                         |       | 2,542                                       |       | 5,078 |   | 10,300 |   | 12,578 |   | 12,681 |   |
| Public offering costs                                              |       | —                                      |       | 442 |   | 1,287 |   | — |   | — |   |
| Depreciation & amortization                               |       | 139                                         |       | 157 |   | 273 |   | 498 |   | 690 |   |
| Total operating expenses                                           |       | 11,481                                      |       | 16,615 |   | 25,713 |   | 33,534 |   | 34,580 |   |
| Income from operations                                             |       | 771                                         |       | 2,707 |   | 5,477 |   | 20,914 |   | 24,142 |   |
| Interest income (expense), net                                     |       | —                                      |       | 22 |   | 32 |   | (250 | ) | (142 | ) |
| Income taxes                                                       |       | —                                      |       | (82 | ) | (120 | ) | (2,538 | ) | (9,597 | ) |
| Net income                                                         |       | $                                           | 771        |   | $ | 2,647 |   | $ | 5,389 |   | $ | 18,126 |   | $ | 14,403 |   |
| Net income common share:                                           |       |                                        |       |   |   |   |   |   |   |   |   |
| Basic                                                              |       | $                                           | 0.03       |   | $ | 0.11 |   | $ | 0.23 |   | $ | 0.77 |   | $ | 0.61 |   |
| Diluted                                                            |       | $                                           | 0.03       |   | $ | 0.11 |   | $ | 0.23 |   | $ | 0.69 |   | $ | 0.57 |   |

 

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| **Balance sheet data:**                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash & cash equivalents          |       | $          | 5          |       | $          | 7          |       | $          | 359        |       | $          | 4,808 |   | $ | 4,456 |   |
| Working capital (deficit)                 |       | (2,164     | )          | 1,009      |       | 5,974      |       | 29,865     |       | 32,785     |       |
| Total assets                              |       | 12,490     |       | 17,746     |       | 38,542     |       | 70,965     |       | 48,405     |       |
| Revolving credit line                     |       | —     |       | —     |       | 3,941      |       | 5,924      |       | —     |       |
| Total liabilities                         |       | 13,570     |       | 15,963     |       | 31,815     |       | 39,383     |       | 13,599     |       |
| Total stockholders’ equity (deficit) |       | $          | (1,080     | )          | $          | 1,783      |       | $          | 6,727      |       | $          | 31,582 |   | $ | 34,806 |   |

 

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

 

*The following discussion should beread in conjunction with the financial statements and related notes whichappear elsewhere in this form. This discussion contains forward-lookingstatements. Our actual results could differ materially from those anticipatedin these forward-looking statements as a result of various factors, includingvarious risks and uncertainties discussed below and throughout this report.*

 

**Overview**

 

We are a leading online retailer of jewelry,featuring a live auction format. We have established our retail brand in theonline marketplace by offering high-quality merchandise, a unique user-friendlyshopping experience, and the opportunity for buyers to achieve significant costsavings versus traditional retail channels. A key to our success has been ourability to efficiently and cost effectively source closeout and regular jewelrymerchandise, and rapidly respond to changing consumer demands for certainjewelry. We offer our products through a continuous live format, featuring a $1minimum opening bid, and a unique 15-second auction extension period thatallows our auctions to continue until all bids are received. On select auctionswe maintain a reserve price that must be met before a sale will be consummated.In 2009, we will offer auctions with a minimum opening bid that is higher than$1. The majority of our auctions are short-term, often lasting less than onehour, providing immediate gratification to our customers and encouragingfrequent visits and active viewing of our website.

 

In addition to our auction site we have afixed pricing format that offers similar items of merchandise as those listedfor auction.  This online store providesus access to different types of consumers and we plan to offer customers theability to design their own jewelry including diamond earrings and rings in thenear future.

 

Our product inventory includes gold,platinum, and silver jewelry set with diamonds, rubies, emeralds, sapphires,and other precious and semi-precious stones; watches and acessories. We believewe are the second largest online retailer of jewelry based on revenue and thelargest online jewelry auction site based on web traffic.

 

We sell to consumers looking for reliablebargains on jewelry. Because we purchase and retain all of our jewelryinventory onsite, we can provide our customers with timely service and deliveryof their purchases. In addition, each item is inspected by one of our trainedproduct specialists prior to its placement on our website, which assures ourcustomers of the quality of their purchases of our products. We operate in ahighly competitive market with low barriers to entry. By selling our ownmerchandise, we provide a buying environment in which we minimize fraudulentactivity and questionable product quality frequently associated with purchasetransactions from third-party sellers. We also provide a 15-day return policyon all merchandise. We believe that many of our customers resell merchandisethat they purchase from our auctions on eBay, at local auctions, and throughother retail channels. Our auctions and fixed price sales are conducted24 hours a day, seven days a week. We also offer daily telephone customersupport, 24-hour online live-help and e-mail customer support.

 

In line with our growth plans, we completed a major upgrade of ourauction platform at the end of 2007. The new auction LiveBid system supports abroad range of leading browser software including Microsoft Internet Explorer,FireFox and Safari. The new system touts high availability, faster end-userresponse time and greater scalability among the key features delivered in thisrelease. We have leveraged this new software solution to launch additional sitefeatures and the new online retail store. We launched the Spanish version ofour website in the second quarter of 2008, the Arabic version in October 2008and the German version in December 2008.

 

**Critical Accounting Policies**

 

Thepreparation of our financial statements requires us to make certain estimatesand judgments that affect amounts reported and disclosed in our financialstatements and related notes. We base our estimates on historical experienceand on other assumptions that we believe to be reasonable under thecircumstances. Actual results may differ from these estimates. The followingare the critical accounting policies that we believe require significantestimation and judgment.

 

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*Revenue Recognition*

 

We derive our revenue from four sources: merchandisesales, which include wholesale merchandise sales, shipping revenue, transactionfee revenue and other revenue. In accordance with SAB 104, we recognize revenuefrom all four sources when the following revenue recognition criteria are met: (1) persuasiveevidence of an arrangement exists; (2) the product has been shipped or theservice has been rendered and the customer takes ownership and assumes the riskof loss; (3) the selling price is fixed or determinable; and (4) collectionof the resulting receivable is reasonably assured.

 

For online sales through our website, werecognize merchandise sales upon shipments made to consumers that are fulfilledfrom our warehouse. We require payment before we ship and the payment isgenerally made online by credit card or other electronic payment methods. Werecord amounts received or billed prior to shipment of goods to customers asdeferred revenue. We reduce gross sales by returns and chargebacks fromcustomers. For wholesale merchandise sales, we recognize sales when themerchandise is delivered to the customer and credit terms may be offered tosuch customers.

 

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

 

We include transaction fee revenue in net revenue.The 3% auction transaction fee is applied to all merchandise sales, includingshipping and handling but not to wholesale merchandise sales.

 

We present sales tax liability on a net basis inaccordance with Emerging Issues Task Force (“EITF”) Issue No. 06-03. Sales are not grossed up with the attendant taxes and deducted as a separateline item. The EITF became effective for interim and annual reporting periodsbeginning after December 15, 2006.

 

Other revenue consists primarily ofcommissions we derive from hosting sales of Certified Merchant merchandise thatis owned by third parties and we recognize only the commission portion of theprice our customers pay for the purchased products because we are acting as anagent in such transactions.

 

*Cost of Revenue*

 

Cost of revenue includes product costs, inbound and outbound shippingcharges, packaging and shipping supplies, insurance on shipments, productrepair and service costs, and credit card and other electronic payment fees,and is recorded in the same period in which related revenue has been recorded.The cost of revenue is reduced by amortized co-op marketing contributions fromour vendors.

 

*Return and Allowance Reserve*

 

Weestimate potential future product returns and chargebacks related to currentperiod revenue. We analyze historical returns, and changes in customer demandand acceptance of our products when evaluating the adequacy of the salesreturns reserve and other allowances in any accounting period. If actualreturns are greater than our estimates, we will record additional returns andallowances in addition to our estimates, which will result in lower net revenuerecorded during that period.  Reservesfor returns and chargebacks are included in accrued expenses.

 

*Inventories*

 

Inventories consist mainly of merchandisepurchased for resale and are stated at the lower of first-in, first-out (FIFO)cost or market.

 

*Inventory Reserve*

 

The unique nature of our business model where customers set the pricesthey are willing to pay may result in items selling below our cost, and weprovide reserves against our inventory based on the difference between theaverage selling price and the cost of inventory if the average selling price islower than the cost of inventory. We also provide reserves for obsolescence andslow moving inventory.

 

*Inventory Co-op MarketingContributions*

 

# In the third quarter of2007, we started to bill and collect from our inventory vendors co-op marketingcontributions as an incentive for us to market and sell their merchandise onthe Bidz website. In accordance with EITF 02-16:  Accounting by a Customer(including a Reseller) for Certain Consideration Received from a Vendor, theco-op marketing contributions that cannot be identified specifically to benefitthe vendors are a reduction in cost of sales and will result in an increase ingross profit. We cannot specifically identify the benefits to each vendor,consequently, co-op marketing contributions are charged against inventory as areduction of costs and amortized as a reduction of cost of sales. For the yearsended December 31, 2007 and 2008, we have earned $4.8 million and $11.1million of co-op marketing contributions, respectively, with $4.2 and $4.3million, respectively, remaining unamortized and is an offset to inventory at December 31,2007 and 2008. Receivable from vendors for co-op marketing contributions, lessallowance for 

 

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# doubtful accounts, isincluded in other current assets and amounted to $2.9 million and $934,000 at December 31,2007 and 2008, respectively.

#  

*Deferred Tax Benefit*

 

We recognized total current and long term deferred tax benefits of $2.3million and $2.0 million as of December 31, 2007 and 2008, respectively,(and more fully described in Note 11 in our audited financial statements).

 

*Stock-Based Compensation*

 

On January 1,2006, we adopted SFAS No. 123 (revised 2004), ‘‘Share-Based Payment’’ (‘‘SFAS123R’’) requiring that share-based payment transactions be recognized in thefinancial statements based on the fair value of the equity or liabilityinstrument issued. We use the Black-Scholes option pricing model to estimatethe value of our options in implementing SFAS 123R and the calculated method todetermine expected volatility. Under SFAS 123R stock-based compensation expenserecognized during the period is based on the value of the portion ofstock-based payment awards that is ultimately expected to vest. Accordingly,stock-based compensation expense recognized in the statements of income will bereduced for estimated forfeitures. SFAS 123R requires forfeitures to beestimated at the time of grant and revised, if necessary, in subsequent periodsif actual forfeitures differ from those estimates.

 

**Description of Our Revenue, Costs, and Expenses**

 

Thefollowing table presents our historical results of operations for the periodsindicated as a percentage of net revenue.

 
| ** **                           | ** ** | **Years ended December 31,** | ** ** |
|--------------------------------------|------------|---------------------------------------------|------------|
| ** **                           | ** ** | **2006**                                    | ** ** | **2007** | ** ** | **2008** | ** ** |
|                                 |       |                                        |       |   |   |   |   |
| Net revenue                          |       | 100.0                                       | %          | 100.0 | % | 100.0 | % |
| Gross profit                         |       | 23.7                                        |       | 29.1 |   | 28.3 |   |
| Operating expenses:                  |       |                                        |       |   |   |   |   |
| General & administrative    |       | 10.5                                        |       | 10.9 |   | 10.3 |   |
| Sales & marketing           |       | 7.8                                         |       | 6.7 |   | 6.1 |   |
| Public offering costs                |       | 1.0                                         |       | — |   | — |   |
| Depreciation & amortization |       | 0.2                                         |       | 0.3 |   | 0.3 |   |
| Total operating expenses             |       | 19.5                                        |       | 17.9 |   | 16.7 |   |
| Income from operations               |       | 4.2                                         |       | 11.2 |   | 11.6 |   |
| Interest income (expense), net       |       | 0.0                                         |       | (0.1 | ) | (0.1 | ) |
| Income taxes                         |       | (0.1                                        | )          | (1.4 | ) | (4.6 | ) |
| Net income                           |       | 4.1                                         | %          | 9.7 | % | 6.9 | % |

 

*Net Revenue*

 

Substantiallyall of our net revenue consists of jewelry sold via the Internet, net ofreturns. We also generate net revenue from wholesale merchandise sales that isnot online, shipping and handling, transaction fee revenue, and other revenue.

 

Thefollowing table presents our sources of revenue for the periods indicated as apercentage of net revenue.

 
| ** **                   | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------|------------|--------------------------------------------|------------|
| ** **                   | ** ** | **2006**                                   | ** ** | **2007** | ** ** | **2008** | ** ** |
|                         |       |                                       |       |   |   |   |   |
| Net Revenue                  |       |                                       |       |   |   |   |   |
| Merchandise sales            |       | 85.3                                       | %          | 84.6 | % | 71.9 | % |
| Wholesale merchandise sales  |       | —                                     |       | — |   | 14.4 |   |
| Shipping & handling |       | 11.5                                       |       | 12.1 |   | 10.8 |   |
| Transaction fee              |       | 3.1                                        |       | 3.1 |   | 2.7 |   |
| Other revenue                |       | 0.1                                        |       | 0.2 |   | 0.2 |   |
| Total Net Revenue            |       | 100.0                                      | %          | 100.0 | % | 100.0 | % |

 

Asdescribed in note 12 to our audited financial statements, net revenue bygeographic area is presented based upon the country of destination. No foreigncountry accounted for 10% or more of net revenue for any of the fiscal yearspresented. Net revenue by geographic area for the periods indicated was asfollows:

 

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| ** **                                            | ** ** | **Years ended December 31,** | ** ** |
|-------------------------------------------------------|------------|---------------------------------------------|------------|
| **(in thousands, except percentages)** | ** ** | **2006**                                    | ** ** | **2007** | ** ** | **2008** | ** ** |
| **Geographic area**                              | ** ** | **Amount**                                  | ** ** | **Percent** | ** ** | **Amount** | ** ** | **Percent** | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| United States                                         |       | $                                           | 104,338    |   | 79.2 | % | $ | 145,412 |   | 77.7 | % | $ | 157,747 |   | 76.1 | % |
| International                                         |       | 27,485                                      |       | 20.8 |   | 41,719 |   | 22.3 |   | 49,663 |   | 23.9 |   |
| Total                                                 |       | $                                           | 131,823    |   | 100.0 | % | $ | 187,131 |   | 100.0 | % | $ | 207,410 |   | 100.0 | % |

 

*Gross Profit*

 

Our gross profit consistsof net revenue less the cost of revenue. Our cost of revenue consists of thecost of merchandise sold to customers, amortized co-op marketing contributionsfrom vendors, inbound and outbound shipping costs, packaging and shippingsupplies, insurance on shipments, product repair and service costs, and creditcard and other transaction fees associated with payments.

 

*General and Administrative Expenses*

 

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

 

*Sales and Marketing Expenses*

 

Our marketing expenses consist primarily of costsassociated with paid website search marketing, online banner marketing, e-mailcampaigns, affiliate programs and optimization services. These marketingprograms, which are designed to drive buyers to our website, are the mostimportant factor in increasing demand for our jewelry products and increasingnet revenue.

 

*Public Offering Costs*

 

These costs consist primarily of regulatory filingfees, accountant fees, legal fees and printing expenses incurred in the plannedinitial public offering.

 

**Results of Operations**

 

**Comparison of Year Ended December 31,2008 with Year Ended December 31, 2007**

 

*Net Revenue*

 

Netrevenue increased 10.8% to $207.4 million in 2008 from $187.1 millionin 2007. This increase in net revenue was due primarily to the growth in ourwholesale sales of $29.9 million offset by a decline in our online sales of$9.6 million. In 2008, we started selling consignment inventory on a selectiveand limited basis and recorded revenue of $635,000 from sales of inventory thatwere on consignment from vendors. Based on the terms of the consignmentagreements, we record as revenue sales of the consignment inventory.

 

Thefinancial and economic crisis of 2008 resulted in a major slowdown in ourrevenue from the fourth quarter of 2008. For the year ended December 31,2008, there was an overall decrease in online demand for our jewelry asconsumers reduced their discretionary spending. If the economy continuesto decline it will cause a decline in demand and have a negative effect on ourrevenue.

 

*Gross Profit*

 

Gross profit increased 7.9% to $58.7 million in 2008 from$54.4 million in 2007. Gross profit as a percentage of net revenuedecreased to 28.3% in 2008 from 29.1% in 2007. The decrease in gross profitpercentage resulted primarily from lower gross margins from wholesale revenueoffset by higher gross margins from online revenue. Co-op marketingcontributions from vendors contributed more to gross margins in 2008 due to afull year of contribution compared to 2007 when it was only implemented in thethird quarter of 2007. The total gross profit dollars increased despite thedrop in the gross profit percentage due to the increase in revenue.

 

*General and Administrative Expenses*

 

General and administrative expenses increased 3.7% to$21.2 million in 2008 from $20.5 million in 2007. We managed to holdthe general and administrative expenses relatively flat for the year aftermaking significant cost reductions in the fourth quarter of 2008. We reducedour personnel from 240 at year end 2007 to 165 at year end 2008 with most ofthe reduction occurring in the fourth quarter of 2008. General andadministrative expenses as a percentage of net revenue declined to 10.3% in2008 compared to 10.9% in 2007.

 

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An impairment charge of $256,000 was recorded in 2008 on advances madeto employees to purchase shares of our common stock when the value of ourcommon stock held as collateral for the advances fell below the amount of theadvances. The 154,000 shares of the common stock held as collateral were valuedbased on the closing price at the end of the year ended December 31, 2008.

 

*Sales and Marketing Expenses*

 

Sales and marketing expenses increased 0.8% to $12.7 million in2008 from $12.6 million in 2007. We reduced significantly the sales andmarketing expenses in the fourth quarter of 2008 in line with the significantlyslowing online revenue. Sales and marketing expenses as a percentage of netrevenue decreased to 6.1% in 2008 from 6.7% in 2007.

 

**Comparison of Year Ended December 31,2007 with Year Ended December 31, 2006**

 

*Net Revenue*

 

Net revenue increased 42.0% to $187.1 millionin 2007 from $131.8 million in 2006. This increase in net revenue was dueprimarily to the growth in demand for our jewelry products and the increase inaverage order value. The growth in demand was primarily the result of thenumber of new buyers we attracted during 2007. We have also implemented threeinitiatives in 2007 that generated more demand from our customers. In certaincircumstances, including satisfaction of our gross profit criteria andavailability of multiple quantities of items, we allow customers who did not havethe winning bid to purchase items at their last bid price, we allow customersto purchase multiple quantities of items and we allow customers viewing theitem to purchase the item at the winning bid price.

 

*Gross Profit*

 

Gross profit increased 74.6% to $54.4 million in 2007 from$31.2 million in 2006. Gross profit as a percentage of net revenueincreased to 29.1% in 2007 from 23.7% in 2006. The increase in gross profit asa percentage of net revenue resulted primarily from more effective purchases,increased margin on shipping and handling charges, and co-op marketingcontributions from vendors commencing in July 2007. Gross profit marginsbenefited from the amortized co-op marketing contributions that reduced ourcost of sales by $4.8 million or 2.6% of net revenue.

 

*General and Administrative Expenses*

 

General and administrative expenses increased 47.7% to$20.5 million in 2007 from $13.9 million in 2006. The increase ingeneral and administrative expenses was due mainly to increases in payroll andpayroll related expenses, SOX compliance costs, outsourcing and otheradministrative expenses. We increased our personnel from 198 at year end, 2006to 240 at year end, 2007. General and administrative expenses as a percentageof net revenue was 10.9% in 2007 compared to 10.5% in 2006.

 

*Sales and Marketing Expenses*

 

Sales and marketing expenses increased 22.1% to $12.6 million in2007 from $10.3 million in 2006. This increase resulted primarily fromincreased marketing campaigns to attract new buyers. Our efforts to control thesales and marketing expenses and improve the effectiveness of our marketingcampaigns have been successful in lowering the costs relative to the highergrowth in net revenue. Consequently, sales and marketing expenses as apercentage of net revenue decreased to 6.7% in 2007 from 7.8% in 2006. Weexpect our sales and marketing expenses to continue to increase in absolutedollars, as we intend to continue increasing our online marketing campaigns inorder to attract new customers.

 

* PublicOffering Costs*

 

These costs consist primarily of regulatory filing fees, accountantfees, legal fees and printing expenses incurred in the planned initial publicoffering, which amounted to $0 and $1.3 million for the years ended December 31,2007 and 2006, respectively. Costs incurred in 2006 relate to the registrationstatement of the planned initial public offering. The capitalized costs of theplanned initial public offering were expensed when the Company determined itwas unable to complete the offering and subsequently requested withdrawal ofthe registration statement.

 

**Quarterly Operations Data**

 

Thefollowing tables set forth quarterly statements of operations data for theeight quarters ended December 31, 2008, including amounts expressed as apercentage of net revenue. This quarterly information is unaudited, but hasbeen prepared on the same basis as the annual financial statements and, in ouropinion, reflects all adjustments necessary for a fair representation of theinformation for the periods presented. This quarterly statement of operationsdata should be read in conjunction with our audited financial statements andthe related notes included elsewhere in this prospectus. Results of operationsfor any quarter are not necessarily indicative of results for any futureperiod.

 

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Historically,sales in the jewelry industry are seasonal and have been higher in the fourthquarter as a result of higher consumer spending during the December holidayseason. Approximately 28.5%, 33.8%, and 16.9% of our net revenue in 2006, 2007,and 2008, respectively, was generated during the fourth quarter. The fourthquarter of 2008 was an exception as we encountered a significant slowdown insales resulting from the 2008 financial and economic crisis. 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.

 
| ** **                                                                 | ** ** | **Quarters ended** | ** ** |
|----------------------------------------------------------------------------|------------|-------------------------|------------|
| **(in thousands,**                                                    | ** ** | **March 31,**      | ** ** | **June 30,** | ** ** | **Sept. 30,** | ** ** | **Dec. 31,** | ** ** | **March 31,** | ** ** | **June 30,** | ** ** | **Sept. 30,** | ** ** | **Dec. 31,** | ** ** |
| **except per share data)**                                  | ** ** | **2007**                | ** ** | **2007** | ** ** | **2007** | ** ** | **2007** | ** ** | **2008** | ** ** | **2008** | ** ** | **2008** | ** ** | **2008** | ** ** |
| ** **                                                                 | ** ** | **(unaudited)**         | ** ** |
| ** **                                                                 | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net revenue                                                                |       | $                       | 44,724     |   | $ | 39,123 |   | $ | 40,051 |   | $ | 63,233 |   | $ | 61,929 |   | $ | 54,986 |   | $ | 55,356 |   | $ | 35,139 |   |
| Gross profit                                                               |       | 11,128                  |       | 10,874 |   | 12,695 |   | 19,751 |   | 18,036 |   | 15,318 |   | 13,294 |   | 12,075 |   |
| General and administrative                                                 |       | 4,843                   |       | 4,985 |   | 4,945 |   | 5,684 |   | 5,907 |   | 5,680 |   | 5,267 |   | 4,355 |   |
| Sales and marketing                                                        |       | 2,600                   |       | 2,019 |   | 2,406 |   | 5,552 |   | 4,199 |   | 3,131 |   | 2,314 |   | 3,037 |   |
| Depreciation and amortization                                              |       | 74                      |       | 113 |   | 160 |   | 152 |   | 162 |   | 172 |   | 172 |   | 185 |   |
| Income from operations                                                     |       | 3,611                   |       | 3,757 |   | 5,184 |   | 8,363 |   | 7,768 |   | 6,335 |   | 5,541 |   | 4,498 |   |
| Net income                                                                 |       | $                       | 3,435      |   | $ | 2,915 |   | $ | 3,563 |   | $ | 8,213 |   | $ | 4,605 |   | $ | 3,615 |   | $ | 3,259 |   | $ | 2,924 |   |
| Net income per share available to common  stockholders — Basic   |       | $                       | 0.15       |   | $ | 0.13 |   | $ | 0.15 |   | $ | 0.34 |   | $ | 0.19 |   | $ | 0.15 |   | $ | 0.14 |   | $ | 0.13 |   |
| Net income per share available to common  stockholders — Diluted |       | $                       | 0.14       |   | $ | 0.12 |   | $ | 0.14 |   | $ | 0.29 |   | $ | 0.18 |   | $ | 0.14 |   | $ | 0.13 |   | $ | 0.13 |   |
| Weighted average number of shares  outstanding — Basic           |       | 23,246                  |       | 23,272 |   | 23,593 |   | 24,150 |   | 24,538 |   | 23,828 |   | 23,523 |   | 23,312 |   |
| Weighted average number of shares  outstanding — Diluted         |       | 23,725                  |       | 24,147 |   | 26,324 |   | 28,507 |   | 25,829 |   | 25,739 |   | 25,213 |   | 23,313 |   |
|                                                                       |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| ** **                                                                 | ** ** | **March 31,**      | ** ** | **June 30,** | ** ** | **Sept. 30,** | ** ** | **Dec. 31,** | ** ** | **March 31,** | ** ** | **June 30,** | ** ** | **Sept. 30,** | ** ** | **Dec. 31,** | ** ** |
| ** **                                                                 | ** ** | **2007**                | ** ** | **2007** | ** ** | **2007** | ** ** | **2007** | ** ** | **2008** | ** ** | **2008** | ** ** | **2008** | ** ** | **2008** | ** ** |
| ** **                                                                 | ** ** | **(unaudited)**         | ** ** |
| Net revenue                                                                |       | 100.0                   | %          | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 |   |
| Gross profit                                                               |       | 24.9                    |       | 27.8 |   | 31.7 |   | 31.2 |   | 29.1 |   | 27.9 |   | 24.0 |   | 34.4 |   |
| General and administrative                                                 |       | 10.8                    |       | 12.7 |   | 12.3 |   | 9.0 |   | 9.5 |   | 10.3 |   | 9.5 |   | 12.4 |   |
| Sales and marketing                                                        |       | 5.8                     |       | 5.2 |   | 6.0 |   | 8.8 |   | 6.8 |   | 5.7 |   | 4.2 |   | 8.7 |   |
| Depreciation and amortization                                              |       | 0.2                     |       | 0.3 |   | 0.4 |   | 0.2 |   | 0.3 |   | 0.3 |   | 0.3 |   | 0.5 |   |
| Operating income                                                           |       | 8.1                     |       | 9.6 |   | 12.9 |   | 13.2 |   | 12.5 |   | 11.6 |   | 10.0 |   | 12.8 |   |
| Net income                                                                 |       | 7.7                     | %          | 7.5 | % | 8.9 | % | 13.0 | % | 7.4 | % | 6.6 | % | 5.8 | % | 8.3 | % |
|                                                                       |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Additional operating metrics:                                              |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                       |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| ** **                                                                 | ** ** | **March 31,**      | ** ** | **June 30,** | ** ** | **Sept. 30,** | ** ** | **Dec. 31,** | ** ** | **March 31,** | ** ** | **June 30,** | ** ** | **Sept. 30,** | ** ** | **Dec. 31,** | ** ** |
| ** **                                                                 | ** ** | **2007**                | ** ** | **2007** | ** ** | **2007** | ** ** | **2007** | ** ** | **2008** | ** ** | **2008** | ** ** | **2008** | ** ** | **2008** | ** ** |
| ** **                                                                 | ** ** | **(unaudited)**         | ** ** |
| Average selling price per order (gross)                                    |       | $                       | 154        |   | $ | 171 |   | $ | 173 |   | $ | 169 |   | $ | 182 |   | $ | 183 |   | $ | 175 |   | $ | 169 |   |
| Average orders per day                                                     |       | 3,317                   |       | 2,678 |   | 2,699 |   | 4,443 |   | 3,734 |   | 3,023 |   | 2,453 |   | 2,462 |   |
| Average items sold per day                                                 |       | 9,482                   |       | 8,678 |   | 8,814 |   | 12,709 |   | 12,186 |   | 10,082 |   | 8,431 |   | 8,287 |   |
| Acquisition cost per new buyer                                             |       | $                       | 45         |   | $ | 38 |   | $ | 43 |   | $ | 51 |   | $ | 50 |   | $ | 48 |   | $ | 43 |   | $ | 51 |   |
| Number of new buyers                                                       |       | 58,056                  |       | 53,637 |   | 55,423 |   | 109,833 |   | 83,179 |   | 64,882 |   | 54,072 |   | 59,485 |   |
|                                                                            |            |                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Liquidity and Capital Resources**

 

The significant components of our workingcapital are inventory and liquid assets such as cash and accounts receivable,reduced by revolving credit line, accounts payable, accrued expenses anddeferred revenue. Our business model contains beneficial working 

 

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capital characteristics: while we collectcash from sales to customers within several business days of the related onlinepayment, we typically have extended payment terms with our suppliers.

 

As of December 31, 2008, we had a working capital surplus of $32.8million and have no long-term debt obligations. Net cash provided by operatingactivities was $18.6 million in 2008 compared with net cash used for operatingactivities of $2.0 million in 2007. Net cash is affected primarily by changesin net income, inventories, accounts receivable, other receivable, accountspayable, accrued expenses, and deferred revenue. We recorded net income of$5.4 million in 2006, $18.1 million in 2007 and $14.4 million in2008. Inventories, and accounts payable generally increase or decrease in linewith sales trend and changes in our inventory strategy. Our inventory strategyis influenced by our ability to secure inventory that we believe will improvesales and our gross margins.

 

The increase in cash provided by operating activities in 2008 comparedwith cash used for operating activities in 2007 was $20.6 million. Net incomewas $14.4 million in 2008 compared with $18.1 million in 2007. Inventoriesdecreased by $19.3 million in 2008 compared with an increase of$23.0 million in 2007. Accounts receivable decreased by $1.6 million in2008 compared to an increase of $216,000 in 2007. Other receivable decreased by$2.0 million in 2008 compared to an increase of $3.0 million in 2007. Accountspayable decreased by $16.4 million in 2008 compared to an increase of $4.4million in 2007. The decrease in inventories and corresponding decrease inaccounts payable in 2008 is attributable to the declining business and economicoutlook. Accrued expenses decreased by $1.4 million in 2008 compared to an increaseof $2.6 million in 2007. Deferred revenue decreased by $2.0 million in 2008compared to a decrease of $1.0 million in 2007.

 

Net cash used for investing activities were 367,000, $1.4 million, and$1.0 million in 2006, 2007 and 2008, respectively, and was primarily related tocapital expenditures for our office equipment and technology systeminfrastructure, including hardware and software.

 

Netcash used for financing activities was $18.0 million in 2008; $5.9 million wasused to pay down the revolving credit facility, $2.5 million was used to retireshares from the net exercise of stock options, and $12.5 million was used torepurchase treasury shares net against proceeds of $2.1 million from theexercise of stock options and $716,000 from the tax benefit from exercise ofstock options.  Net cash provided byfinancing activities was $7.8 million in 2007; financing was provided byproceeds from the revolving credit line of $2.0 million, exercise of stockoptions of $4.8 million, and tax benefit from exercise of stock options of $3.2million net against repurchase of treasury shares of $886,000. Net cash usedfor financing activities was $3.2 million in 2006, related to proceeds from therevolving line of credit of $3.9 million net against $690,000 for the retirementof common stock from net vesting of restricted stocks and $90,000 for thepurchase of treasury stock.

 

In July 2006, we entered into arevolving credit line agreement with LaSalle Bank (Bank of America) to provideworking capital financing secured by inventories and tangible assets. As of December 31,2008, we have a limit of $25 million under the loan agreement. All cashreceipts from our revenues are restricted to being deposited into a Bank ofAmerica account, to be applied to current reported cash disbursementsrequirements, under a positive pay system, and then to the credit lineoutstanding balance. The revolving credit line agreement expires in July of2010. As of December 31, 2008, there was no outstandingbalance under the revolving credit line. The interest rate is at prime andthere is an unused fee of 0.15% on the unused portion of the revolving creditline.

 

We believe that cash and cash equivalentscurrently on hand, cash flows from operations and the availability of a $25million revolving line of credit will be sufficient to continue our operationsand to pursue our growth strategy for the foreseeable future. Our futurecapital requirements will depend on many factors, including the rate of ourrevenue growth; the timing and extent of spending to enhance our website,network infrastructure, and transaction processing systems; the extent of ouradvertising and marketing programs; the levels of the inventory we carry;acquisition and relocation to a new corporate office; and other factorsrelating to our business. Enhancement of our website, network infrastructure,and transaction processing systems will require us to spend significantly morethan we have in the past. Moreover, to date our spending in these areas hasbeen lower than industry averages. We anticipate increasing our systemexpenditures to accommodate these needs in the future. We may requireadditional financing in the future in order to execute our operating plan andwe may not be able to obtain such financing. We cannot predict whether thisadditional financing will be in the form of equity, debt, or a combinationof debt and equity.

 

**Lease Obligations**

 

Thefollowing table presents our contractual obligations at December 31, 2008,over the next five years and thereafter (in thousands):

 
| **Payments by period** | ** ** | **Total  amount** | ** ** | **Less than  1 year** | ** ** | **1 to 3  years** | ** ** | **3 to 5  years** | ** ** | **After 5  years** | ** ** |
|----------------------------------|------------|-------------------|------------|---------------------------------|------------|-----------------------------|------------|-----------------------------|------------|-------------------------|------------|
| ** **                       | ** ** | ** **        | ** ** | ** **                      | ** ** | ** **                  | ** ** | ** **                  | ** ** | ** **              | ** ** |
| Property lease                   |       | $                 | 1,448      |                            | $          | 987                         |       | $                           | 346        |                    | $          | 115 |   | $ | — |   |
| Equipment lease                  |       | 207               |       | 56                              |       | 104                         |       | 47                          |       | —                  |       |
|                             |       | $                 | 1,655      |                            | $          | 1,043                       |       | $                           | 450        |                    | $          | 162 |   | $ | — |   |

 

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Asmore fully described in Note 8 to the audited financial statements, we areobligated for the lease of our office and warehouse space, and operating leasesfor copy machines.

 

**Impact of Inflation**

 

The effect of inflation and changing prices on our operations was notsignificant during the periods presented.

 

**Item7A.**  Quantitative and Qualitative Disclosureabout Market Risk

** **

Marketrisk represents the risk of loss arising from adverse changes in market ratesand foreign exchange rates. We do not believe that a change in market interestrates would have a material effect on our results of operations or financialcondition. Although we derive a portion of our sales outside of the UnitedStates, all of our sales are denominated in U.S. dollars. We have limitedexposure to financial market risks, including changes in interest rates andforeign currency exchange rates.

 

**Item8.**           FinancialStatements and Supplementary Data

** **

See Item 15(a)

 

**Item9.**           Changes inand Disagreements with Accountants on Accounting and Financial Disclosure

** **

None.

 

**Item9A.**  Controls and Procedures

** **

***Evaluation of Disclosure Controlsand Procedures***

 

Underthe supervision and with the participation of our management, including ourChief Executive Officer and Chief Financial Officer, we evaluated theeffectiveness of the design and operation of our disclosure controls andprocedures (as defined in Rules 13a-15(e) and 15d-15(e) underthe Securities Exchange Act of 1934) as of the end of the period covered bythis report.  Disclosure controls and procedures are the controls andother procedures that we designed to ensure that we record, process, summarizeand report in a timely manner the information we must disclose in reports thatwe file with or submit to the Securities and Exchange Commission.  Basedon this evaluation, our Chief Executive Officer and our Chief Financial Officerconcluded that, as of the date of their evaluation, our disclosure controls andprocedures were effective.  There were no significant changes made in ourinternal controls or in other factors that could significantly affect internalcontrols subsequent to the date of their evaluation.

 

***Report of Managementon Internal Control over Financial Reporting***

 

Managementis responsible for establishing and maintaining adequate internal control overfinancial reporting, as defined in Rule 13a-15(f) of the 1934 Act.Our internal control over financial reporting is designed to provide reasonableassurance regarding the reliability of financial reporting and the preparationof financial statements for external purposes in accordance with generallyaccepted accounting principles. Internal control over financial reportinginclude those policies and procedures that (1) pertain to the maintenanceof records that in reasonable detail accurately and fairly reflect ourtransactions and dispositions of our assets; (2) provide reasonable assurancethat our transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, and that our receipts and expenditures are being made only inaccordance with appropriate authorizations; and (3) provide reasonableassurance regarding prevention or timely detection of unauthorized acquisition,use or disposition of our assets that could have a material effect on ourfinancial statements.

 

We assessedthe effectiveness of our internal control over financial reporting as of December 31,2008, using the criteria set forth by the Committee of Sponsoring Organizationsof the Treadway Commission (COSO) in Internal Control — IntegratedFramework. Based on this assessment, management has concluded that our internalcontrol over financial reporting was effective as of December 31, 2008.

 

Stonefield Josephson, Inc., an independent registered public accountingfirm, has issued an attestation report on management’s assessment of internalcontrol over financial reporting, a copy of which is included in this annualreport on Form 10-K.

 

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***Changes in InternalControl over Financial Reporting***

 

There has beenno change in our internal controls over financial reporting (as defined in Rule 13a-15(f) underthe Securities Exchange Act of 1934) that occurred during the fourth quarter ofour fiscal year ended December 31, 2008 that our certifying officersconcluded materially affected, or is reasonably likely to materially affect,our internal control over financial reporting.

 

***Limitations on Controls***

 

Management does not expect that our disclosure controls and proceduresor our internal control over financial reporting will prevent or detect allerror and fraud. Any control system, no matter how well designed and operated,is based upon certain assumptions and can provide only reasonable, notabsolute, assurance that its objectives will be met. Further, no evaluation ofcontrols can provide absolute assurance that misstatements due to error orfraud will not occur or that all control issues and instances of fraud, if any,within the Company have been detected. Also, projections of any evaluation ofeffectiveness to future periods are subject to the risk that controls maybecome inadequate because of changes in conditions, or that the degree ofcompliance with the policies or procedures may deteriorate.

 

**Item 9B.         Other Information**

 

None.

 

**Part III**

 

We have omitted the information required in Part IIIof this annual report because we intend to include that information in ourdefinitive proxy statement for our 2009 annual meeting of shareholders, whichwe expect to file before 120 days after December 31, 2008. Weincorporate that information in this annual report by reference to our 2009proxy statement.

 

**Item 10.****    Directors, Executive Officersand Corporate Governance.**

 

Information required by this item isincorporated by reference from the definitive proxy statement required to befiled pursuant to Regulation 14A for the 2009 Annual Meeting of ourstockholders.

 

We have adopted a code of conduct thatapplies to our Chief Executive Officer, Chief Financial Officer, and to all ofour other officers, directors, employees and agents. The code of conduct isavailable at the Corporate Governance section of the Investor Relations link onour website at *www.bidz.com*. We intend todisclose future amendments to, or waivers from, certain provisions of our codeof ethics on the above website.

 

**Item 11.****    Executive Compensation.**

 

Information required by this item isincorporated by reference from the definitive proxy statement required to befiled pursuant to Regulation 14A for the 2009 Annual Meeting of ourstockholders.

 

**Item 12.****    Security Ownership of CertainBeneficial Owners and Management and Related Stockholder Matters.**

 

Information required by this item isincorporated by reference from the definitive proxy statement required to be filedpursuant to Regulation 14A for the 2009 Annual Meeting of ourstockholders.

 

**Item 13.****    Certain Relationships andRelated Transactions, and Director Independence.**

 

Information required by this item isincorporated by reference from the definitive proxy statement required to befiled pursuant to Regulation 14A for the 2009 Annual Meeting of ourstockholders.

 

**Item 14.****    Principal Accountant Fees andServices.**

 

Information required by this item isincorporated by reference from the definitive proxy statement required to befiled pursuant to Regulation 14A for the 2009 Annual Meeting of ourstockholders.

 

**Part IV**

 

**Item 15. Exhibits andFinancial Statement Schedules**

 
|       | The following documents are filed as part of this report: |
|------------|-----------------------------------------------------------|
|       |                                                      |   |   |
| ** ** | **(a)**                                                   | ** ** | **Financial Statements** |
|       |                                                      |   |   |
|       |                                                      |   | Report of Independent Registered Public Accounting Firm |

 

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|       |    |       | Balance Sheets as of December 31, 2007 and 2008                                                           |
|------------|---------|------------|----------------------------------------------------------------------------------------------------------------|
|       |    |       | Statements of Income for the Years ended December 31, 2006,  2007, and 2008                               |
|       |    |       | Statements of Changes in Stockholders’ Equity for the Years ended  December 31, 2006, 2007, and 2008 |
|       |    |       | Statements of Cash Flows for the Years ended December 31, 2006,  2007, and 2008                           |
|       |    |       | Notes to Financial Statements                                                                                  |
|       |    |       |                                                                                                           |
| ** ** | **(b)** | ** ** | **Financial Statement Schedule**                                                                               |

 

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**Report ofIndependent Registered Public Accounting Firm**

 

To The Board of Directors and Stockholders of Bidz.com, Inc.:

 

We have audited the accompanying balance sheets of Bidz.com, Inc.(the “Company”) as of December 31, 2007 and 2008, and the relatedstatements of income, stockholders’ equity, and cash flows for each of theyears in the three-year period ended December 31, 2008. Our audits alsoincluded the financial statement schedule listed in the index at Item 15. Thesefinancial statements and the schedule are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these financialstatements based on our 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 audit to obtain reasonable assurance about whetherthe financial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well asevaluating the overall financial statement presentation. We believe that ouraudits 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, 2007 and 2008, and the results of its operations andits cash flows for each of the years in the three-year period ended December31, 2008, in conformity with accounting principles generally accepted in theUnited States of America. Also in our opinion, the related financial statementschedule, when considered in relation to the basic financial statements takenas a whole, presents fairly in all material respects the information set forththerein.

 

We also have audited, in accordance with the standards of the PublicCompany Accounting Oversight Board (United States), the Company’s internalcontrol over financial reporting as of December 31, 2008, based oncriteria established in Internal Control—Integrated Framework issued by theCommittee of Sponsoring Organizations of the Treadway Commission (COSO) and ourreport dated February 23, 2009 expressed an unqualified opinion.

 

/s/  Stonefield Josephson, Inc.

 

Los Angeles, California

February 23, 2009

 

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**REPORT OF INDEPENDENT REGISTEREDPUBLIC ACCOUNTING FIRM**

 

To the Board ofDirectors and Stockholders of Bidz.com, Inc.

 

We have audited Bidz.com, Inc.’sinternal control over financial reporting as of December 31, 2008, based on criteria established in *Internal Control—Integrated Framework* issued by theCommittee of Sponsoring Organizations of the Treadway Commission (COSO). Bidz.com, Inc.’smanagement is responsible for maintaining effective internal control overfinancial reporting and for its assessment of the effectiveness of internalcontrol over financial reporting included in the accompanying “Report ofManagement on Internal Control over Financial Reporting.” Our responsibility isto express an opinion on the company’s internal control over financialreporting based on our audit.

 

We conducted our auditin accordance with the standards of the Public Company Accounting OversightBoard (United States). Those standards require that we plan and perform theaudit to obtain reasonable assurance about whether effective internal controlover financial reporting was maintained in all material respects. Our audit ofinternal control over financial reporting included obtaining an understandingof internal control over financial reporting, assessing the risk that amaterial weakness exists, and testing and evaluating the design and operatingeffectiveness of internal control based on the assessed risk. Our audit alsoincluded performing such other procedures as we considered necessary in thecircumstances. We believe that our audit provides a reasonable basis for ouropinion.

 

A company’s internalcontrol over financial reporting is a process designed to provide reasonableassurance regarding the reliability of financial reporting and the preparationof financial statements for external purposes in accordance with generallyaccepted accounting principles. A company’s internal control over financialreporting includes those policies and procedures that (1) pertain to themaintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the company; (2) providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and that receipts and expenditures of the company arebeing made only in accordance with authorizations of management and directorsof the company; and (3) provide reasonable assurance regarding preventionor timely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

 

Because of its inherentlimitations, internal control over financial reporting may not prevent ordetect misstatements. Also, projections of any evaluation of effectiveness tofuture periods are subject to the risk that controls may become inadequatebecause of changes in conditions, or that the degree of compliance with thepolicies or procedures may deteriorate.

 

In our opinion, Bidz.com, Inc.maintained, in all material respects, effective internal control over financialreporting as of December 31, 2008,based on criteria established in *InternalControl—Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO).

 

We have also audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the balance sheets as of December 31, 2007 and 2008 andthe related statements of income, stockholders’ equity, and cash flows for eachof the years in the three-year period ended December 31, 2008, of Bidz.com, Inc.,and our report dated February 23, 2009 expressed an unqualified opinion.

 

 
| /s/  Stonefield Josephson, Inc. |   |
|--------------------------------------|--------|
| Los  Angeles, California             |   |
| February 23,  2009              |   |

 

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**Bidz.com, Inc.**

** **

**Balance Sheets**

 

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

** **
| ** **                                                                                                                                                                           | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                           | ** ** | **2007**              | ** ** | **2008** | ** ** |
|                                                                                                                                                                                 |       |                  |       |   |   |
| **Assets**                                                                                                                                                                           |       |                  |       |   |   |
| Current assets:                                                                                                                                                                      |       |                  |       |   |   |
| Cash                                                                                                                                                                                 |       | $                     | 4,808      |   | $ | 4,456 |   |
| Accounts receivable                                                                                                                                                                  |       | 2,146                 |       | 591 |   |
| Inventories, net of reserves of $1,075 and  $820 at December 31, 2007 and December 31, 2008, respectively                                                                  |       | 56,686                |       | 37,657 |   |
| Other receivable (includes related party  amounts of $673 and $102 at December 31, 2007 and December 31,  2008, respectively)                                              |       | 3,002                 |       | 1,041 |   |
| Current deferred tax assets                                                                                                                                                          |       | 2,121                 |       | 1,950 |   |
| Other current assets                                                                                                                                                                 |       | 485                   |       | 689 |   |
| Total current assets                                                                                                                                                                 |       | 69,248                |       | 46,384 |   |
| Long term deferred tax asset                                                                                                                                                         |       | 129                   |       | 84 |   |
| Property and equipment, net                                                                                                                                                          |       | 1,323                 |       | 1,672 |   |
| Intangible asset                                                                                                                                                                     |       | 161                   |       | 161 |   |
| Deposits                                                                                                                                                                             |       | 104                   |       | 104 |   |
| Total assets                                                                                                                                                                         |       | $                     | 70,965     |   | $ | 48,405 |   |
|                                                                                                                                                                                 |       |                  |       |   |   |
| **Liabilities and Stockholders’ Equity**                                                                                                                                        |       |                  |       |   |   |
| Current liabilities:                                                                                                                                                                 |       |                  |       |   |   |
| Revolving credit line                                                                                                                                                                |       | $                     | 5,924      |   | $ | — |   |
| Accounts payable (includes related party  amounts of $5,050 and $1,364 at December 31, 2007 and December 31,  2008, respectively)                                          |       | 26,050                |       | 9,636 |   |
| Accrued expenses                                                                                                                                                                     |       | 4,509                 |       | 3,091 |   |
| Deferred revenue                                                                                                                                                                     |       | 2,900                 |       | 872 |   |
| Total current liabilities                                                                                                                                                            |       | 39,383                |       | 13,599 |   |
|                                                                                                                                                                                 |       |                  |       |   |   |
| Commitments and contingencies (Note 14)                                                                                                                                              |       |                  |       |   |   |
|                                                                                                                                                                                 |       |                  |       |   |   |
| Stockholders’ equity:                                                                                                                                                           |       |                  |       |   |   |
| Preferred stock: par value $0.001;  authorized 4,000,000 shares; none issued and outstanding at December 31,  2007 and December 31, 2008, respectively                     |       | —                |       | — |   |
| Common stock: par value $0.001; authorized  100,000,000 shares; issued and outstanding 24,556,354 and 22,917,918 at  December 31, 2007 and December 31, 2008, respectively |       | 25                    |       | 23 |   |
| Additional paid in capital                                                                                                                                                           |       | 36,961                |       | 24,520 |   |
| Shares held in treasury, at cost; 100,000  and 0 shares at December 31, 2007 and December 31, 2008, respectively                                                           |       | (886                  | )          | — |   |
| Employees share purchase receivable                                                                                                                                                  |       | (1,086                | )          | (708 | ) |
| Accumulated earnings (deficit)                                                                                                                                                       |       | (3,432                | )          | 10,971 |   |
| Total stockholders’ equity                                                                                                                                                      |       | 31,582                |       | 34,806 |   |
|                                                                                                                                                                                 |       | $                     | 70,965     |   | $ | 48,405 |   |

 

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**Bidz.com, Inc.**

 

**Statements of Income**

 

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

 
| ** **                                                       | ** ** | **Years Ended December 31,** | ** ** |
|------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                       | ** ** | **2006**                                    | ** ** | **2007** | ** ** | **2008** | ** ** |
|                                                             |       |                                        |       |   |   |   |   |
| Net revenue:                                                     |       |                                        |       |   |   |   |   |
| Merchandise sales                                                | ** ** | **$**                                       | 131,687    |   | **$** | 186,830 |   | **$** | 177,089 |   |
| Wholesale merchandise sales                                      |       | —                                      |       | — |   | 29,886 |   |
| Other revenue                                                    |       | 136                                         |       | 301 |   | 435 |   |
|                                                             |       | 131,823                                     |       | 187,131 |   | 207,410 |   |
| Cost of revenue                                                  |       | 100,633                                     |       | 132,683 |   | 148,688 |   |
| Gross Profit                                                     |       | 31,190                                      |       | 54,448 |   | 58,722 |   |
| Operating expenses:                                              |       |                                        |       |   |   |   |   |
| General and administrative                                       |       | 13,853                                      |       | 20,458 |   | 21,209 |   |
| Sales and marketing                                              |       | 10,300                                      |       | 12,578 |   | 12,681 |   |
| Public offering costs                                            |       | 1,287                                       |       | — |   | — |   |
| Depreciation and amortization                                    |       | 273                                         |       | 498 |   | 690 |   |
| Total operating expenses                                         |       | 25,713                                      |       | 33,534 |   | 34,580 |   |
| Income from operations                                           |       | 5,477                                       |       | 20,914 |   | 24,142 |   |
| Other income - interest income                                   |       | 80                                          |       | 41 |   | 40 |   |
| Other expense - interest (expense)                               |       | (48                                         | )          | (291 | ) | (182 | ) |
| Income before income tax expense                                 |       | 5,509                                       |       | 20,664 |   | 24,000 |   |
| Income tax expense                                               |       | 120                                         |       | 2,538 |   | 9,597 |   |
| Net income                                                       | ** ** | **$**                                       | 5,389      |   | **$** | 18,126 |   | **$** | 14,403 |   |
|                                                             |       |                                        |       |   |   |   |   |
| Net income per share available to common  shareholders - basic   | ** ** | **$**                                       | 0.23       |   | **$** | 0.77 |   | **$** | 0.61 |   |
| Net income per share available to common  shareholders - diluted | ** ** | **$**                                       | 0.23       |   | **$** | 0.69 |   | **$** | 0.57 |   |
| Weighted average number of shares  outstanding - basic           |       | 23,302,026                                  |       | 23,567,995 |   | 23,798,338 |   |
| Weighted average number of shares  outstanding - diluted         |       | 23,791,368                                  |       | 26,266,008 |   | 25,069,509 |   |

 

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**Bidz.com, Inc.**

 

**Statements of Changes in Stockholders’ Equity**

 

*(in thousands)*

* *
| ** **                                                                     | ** ** | ** **            | ** ** | ** **       | ** ** | ** **     | ** ** | ** **   | ** ** | **Employees**   | ** ** | ** **       | ** ** | ** **             | ** ** | ** ** | ** ** |
|--------------------------------------------------------------------------------|------------|-----------------------|------------|------------------|------------|----------------|------------|--------------|------------|-----------------|------------|------------------|------------|------------------------|------------|------------|------------|
| ** **                                                                     | ** ** | ** **            | ** ** | ** **       | ** ** | **Additional** | ** ** | ** **   | ** ** | **share**       | ** ** | **Deferred**     | ** ** | **Accumulated**        | ** ** | **Total**  | ** ** |
| ** **                                                                     | ** ** | **Common stock** | ** ** | **paid in** | ** ** | **Treasury**   | ** ** | **purchase** | ** ** | **stock-based** | ** ** | **earnings**     | ** ** | **stockholders’** | ** ** |
| ** **                                                                     | ** ** | **Shares**            | ** ** | **Amount**       | ** ** | **capital**    | ** ** | **shares**   | ** ** | **receivable**  | ** ** | **compensation** | ** ** | **(deficit)**          | ** ** | **equity** | ** ** |
| Balance at December 31, 2005                                              |       | 23,312                |       | $                | 28,830     |           | $          | —       |       | $               | —     |             | $          | —                 |       | $          | (100       | ) | $ | (26,947 | ) | $ | 1,783 |   |
| Reincorporation from California (no par  value) to Delaware ($0.001 par value) |       | —                |       | (28,807          | )          | 28,807         |       | —       |       | —          |       | —           |       | —                 |       | —     |       |
| Issuance of common stock for service                                           |       | 37                    |       | —           |       | 219            |       | —       |       | —          |       | —           |       | —                 |       | 219        |       |
| Fair value of options granted to employees                                     |       | —                |       | —           |       | 16             |       | —       |       | —          |       | —           |       | —                 |       | 16         |       |
| Retirements of common stock from net  vesting of restricted stocks             |       | (115                  | )          | —           |       | (690           | )          | —       |       | —          |       | —           |       | —                 |       | (690       | )          |
| Purchase of treasury stock                                                     |       | —                |       | —           |       | —         |       | (90          | )          | —          |       | —           |       | —                 |       | (90        | )          |
| Amortization of deferred stock-based compensation                              |       | —                |       | —           |       | —         |       | —       |       | —          |       | 100              |       | —                 |       | 100        |       |
| Net income                                                                     |       | —                |       | —           |       | —         |       | —       |       | —          |       | —           |       | 5,389                  |       | 5,389      |       |
| Balance at December 31, 2006                                              |       | 23,234                |       | $                | 23         |           | $          | 28,352       |       | $               | (90        | )                | $          | —                 |       | $          | —     |   | $ | (21,558 | ) | $ | 6,727 |   |
| Issuance of common stock to directors                                          |       | 19                    |       | —           |       | 113            |       | —       |       | —          |       | —           |       | —                 |       | 113        |       |
| Employees share purchase receivable                                            |       | —                |       | —           |       | —         |       | —       |       | (1,086          | )          | —           |       | —                 |       | (1,086     | )          |
| Issuance of common stock from exercise of  stock options                       |       | 1,192                 |       | 2                |       | 4,770          |       | —       |       | —          |       | —           |       | —                 |       | 4,772      |       |
| Tax benefit from exercise of options                                           |       | —                |       | —           |       | 3,155          |       | —       |       | —          |       | —           |       | —                 |       | 3,155      |       |
| Fair value of options granted to employees                                     |       | —                |       | —           |       | 488            |       | —       |       | —          |       | —           |       | —                 |       | 488        |       |
| Grant of restricted stock awards to  employees and directors                   |       | 126                   |       | —           |       | 173            |       | —       |       | —          |       | —           |       | —                 |       | 173        |       |
| Retirements of common stock                                                    |       | (15                   | )          | —           |       | (90            | )          | 90           |       | —          |       | —           |       | —                 |       | —     |       |
| Purchase of treasury stock                                                     |       | —                |       | —           |       | —         |       | (886         | )          | —          |       | —           |       | —                 |       | (886       | )          |
| Net income                                                                     |       |                  |       |             |       |           |       |         |       |            |       |             |       | 18,126                 |       | 18,126     |       |
| Balance at December 31, 2007                                              |       | 24,556                |       | $                | 25         |           | $          | 36,961       |       | $               | (886       | )                | $          | (1,086                 | )          | $          | —     |   | $ | (3,432 | ) | $ | 31,582 |   |
| Issuance of common stock for service                                           |       | 1                     |       | —           |       | 5              |       | —       |       | —          |       | —           |       | —                 |       | 5          |       |
| Employees share purchase receivable                                            |       | —                |       | —           |       | —         |       | —       |       | 122             |       | —           |       | —                 |       | 122        |       |
| Impairment in employees share purchase  receivable                             |       | —                |       | —           |       | —         |       | —       |       | 256             |       | —           |       | —                 |       | 256        |       |
| Retirements of common stock from net vesting  of restricted stocks             |       | —                |       | —           |       | (10            | )          | —       |       | —          |       | —           |       | —                 |       | (10        | )          |
| Issuance of common stock from exercise of  stock options                       |       | 442                   |       | —           |       | 2,095          |       | —       |       | —          |       | —           |       | —                 |       | 2,095      |       |
| Retirement of common stock from net  exercise of stock options                 |       | (250                  | )          | —           |       | (2,480         | )          | —       |       | —          |       | —           |       | —                 |       | (2,480     | )          |
| Tax benefit from exercise of options                                           |       | —                |       | —           |       | 716            |       | —       |       | —          |       | —           |       | —                 |       | 716        |       |
| Fair value of stock options granted to  employees                              |       | —                |       | —           |       | 283            |       | —       |       | —          |       | —           |       | —                 |       | 283        |       |
| Grant of restricted stock awards to  employees and directors                   |       | 25                    |       | —           |       | 358            |       | —       |       | —          |       | —           |       | —                 |       | 358        |       |
| Cancellation of restricted stock awards to  employee                           |       | (2                    | )          | —           |       | —         |       | —       |       | —          |       | —           |       | —                 |       | —     |       |
| Retirements of common stock                                                    |       | (1,854                | )          | (2               | )          | (13,408        | )          | 13,410       |       | —          |       | —           |       | —                 |       | —     |       |
| Purchase of treasury stock                                                     |       | —                |       | —           |       | —         |       | (12,524      | )          | —          |       | —           |       | —                 |       | (12,524    | )          |
| Net income                                                                     |       | —                |       | —           |       | —         |       | —       |       |            |       | —           |       | 14,403                 |       | 14,403     |       |
| Balance at December 31, 2008                                              |       | 22,918                |       | $                | 23         |           | $          | 24,520       |       | $               | —     |             | $          | (708                   | )          | $          | —     |   | $ | 10,971 |   | $ | 34,806 |   |

 

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** **

**Bidz.com, Inc.**

 

**Statements of Cash Flows**

 

*(in thousands)*

 
| ** **                                                                             | ** ** | **Years Ended December 31,** | ** ** |
|----------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                             | ** ** | **2006**                                    | ** ** | **2007** | ** ** | **2008** | ** ** |
|                                                                                   |       |                                        |       |   |   |   |   |
| **Cash flows provided by (used for) operating  activities:**                           |       |                                        |       |   |   |   |   |
| Net income                                                                             |       | $                                           | 5,389      |   | $ | 18,126 |   | $ | 14,403 |   |
|                                                                                   |       |                                        |       |   |   |   |   |
| **Adjustments to reconcile net income to net  cash provided by operating activities:** | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Depreciation and amortization                                                          |       | 273                                         |       | 498 |   | 686 |   |
| Loss on disposal of fixed asset                                                        |       | —                                      |       | — |   | 4 |   |
| Change in inventory reserve                                                            |       | 130                                         |       | 614 |   | (255 | ) |
| Impairment in employees share purchase  receivable                                     |       | —                                      |       | — |   | 256 |   |
| Amortization of deferred stock-based  compensation                                     |       | 100                                         |       | — |   | — |   |
| Stock-based compensation                                                               |       | 235                                         |       | 774 |   | 641 |   |
| **Changes in assets and liabilities:**                                                 | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| **(Increase) decrease in assets:**                                                     | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Accounts receivable                                                                    |       | (1,044                                      | )          | (216 | ) | 1,555 |   |
| Inventories                                                                            |       | (18,517                                     | )          | (22,992 | ) | 19,284 |   |
| Other receivable                                                                       |       | —                                      |       | (3,002 | ) | 1,961 |   |
| Current deferred tax assets                                                            |       | —                                      |       | (2,121 | ) | 171 |   |
| Other current assets                                                                   |       | (1,034                                      | )          | 357 |   | (204 | ) |
| Deposits                                                                               |       | 115                                         |       | 21 |   | — |   |
| **Increase (decrease) in liabilities:**                                                | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Post-dated check financing                                                             |       | (5,315                                      | )          | — |   | — |   |
| Accounts payable                                                                       |       | 14,690                                      |       | 4,413 |   | (16,414 | ) |
| Accrued expenses                                                                       |       | 178                                         |       | 2,557 |   | (1,418 | ) |
| Deferred revenue                                                                       |       | 2,358                                       |       | (1,035 | ) | (2,028 | ) |
| Net cash provided by (used for) operating  activities                                  |       | (2,442                                      | )          | (2,006 | ) | 18,642 |   |
|                                                                                   |       |                                        |       |   |   |   |   |
| **Cash flows provided by (used for) investing  activities:**                           |       |                                        |       |   |   |   |   |
| Capital expenditures                                                                   |       | (367                                        | )          | (1,354 | ) | (1,058 | ) |
| Proceeds from sale of fixed asset                                                      |       | —                                      |       | — |   | 19 |   |
| Net cash used for investing activities                                                 |       | (367                                        | )          | (1,354 | ) | (1,039 | ) |
| **Cash flows provided by (used for) financing  activities:**                           |       |                                        |       |   |   |   |   |
| Revolving credit line                                                                  |       | 3,941                                       |       | 1,983 |   | (5,924 | ) |
| Long term deferred tax assets                                                          |       | —                                      |       | (129 | ) | 45 |   |
| Issuance of common stock                                                               |       | —                                      |       | — |   | 5 |   |
| Employees share purchase receivable                                                    |       |                                        |       | (1,086 | ) | 122 |   |
| Retirements of common stock from net  vesting of restricted stocks                     |       | (690                                        | )          | — |   | (10 | ) |
| Proceeds from exercise of stock options                                                |       | —                                      |       | 4,772 |   | 2,095 |   |
| Retirements of common stock from net  exercise of stock options                        |       | —                                      |       | — |   | (2,480 | ) |
| Tax benefit from exercise of stock options                                             |       | —                                      |       | 3,155 |   | 716 |   |
| Purchase of treasury stock                                                             |       | (90                                         | )          | (886 | ) | (12,524 | ) |
| Net cash provided by (used for) financing  activities                                  |       | 3,161                                       |       | 7,809 |   | (17,955 | ) |
|                                                                                   |       |                                        |       |   |   |   |   |
| **Net increase (decrease) in cash**                                                    |       | 352                                         |       | 4,449 |   | (352 | ) |
| **Cash, beginning of period**                                                          |       | 7                                           |       | 359 |   | 4,808 |   |
| **Cash, end of period**                                                                |       | $                                           | 359        |   | $ | 4,808 |   | $ | 4,456 |   |
|                                                                                   |       |                                        |       |   |   |   |   |
| **Supplemental disclosure of cash flow  information:**                                 |       |                                        |       |   |   |   |   |
| Interest paid                                                                          |       | $                                           | 48         |   | $ | 291 |   | $ | 182 |   |
| Income taxes paid                                                                      |       | $                                           | 323        |   | $ | 502 |   | $ | 9,874 |   |
| **Supplemental disclosure of non-cash  investing and financing activities:**           |       |                                        |       |   |   |   |   |
| Retirement of property and equipment                                                   |       | $                                           | 17         |   | $ | 293 |   | $ | 9 |   |
| Retirement of treasury shares                                                          |       | $                                           | —     |   | $ | 90 |   | $ | 13,410 |   |

 

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**Bidz.com, Inc.**

 

**Notes to financialstatements**

 

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

 

**(1)     Summary ofSignificant Accounting Policies:**

 

*Business and Organization:*

 

We were formed in November 1998 as a California corporation and inJune 2006, we were re-incorporated as a Delaware corporation with ourprincipal location of business in Los Angeles, California. We operate a websitelocated at *www.bidz.com*for thepurpose of selling merchandise, utilizing our unique online sales auctionplatform and a fixed price online store at *www.buyz.com*.

 

We sell our products throughout the United States and in internationalmarkets, concentrated mainly in English speaking countries such as Canada,Australia and the United Kingdom. Revenue generated from the United Statesaccounted for approximately 79.2%, 77.7%, and 76.1% of net revenue for theyears ended December 31, 2006, 2007, and 2008, respectively.

 

*Reclassification*

 

Certain amounts from prior years have beenreclassified to conform to the current year’s presentation.

 

*RecentDevelopments:*

 

On February 10, 2009, the Securities andExchange Commission (“SEC”) issued a subpoena to produce documents relating tothe Company’s inventory reserve policies, as well as other matters. We intendto fully cooperate with the SEC regarding this matter.

 

In February 2009, weauthorized an increase in the stock buyback program to $33.5 million from $20.0million. As of February 23, 2009 we have repurchased a total ofapproximately 1.9 million shares for a total of approximately $13.5 million.About $20.0 million remain available under the buyback program to repurchaseshares in the open market.

 

*Use of Estimates:*

 

Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenue and expensesduring the reporting period. Actual results could differ from thoseestimates. We have made estimates for return and allowance reserve, inventory reserve,vendor co-op marketing contributions, deferred tax assets, accrued expenses,stock price volatility, stock option forfeiture rate, and expected stock optionterm.

 

*Fair Value of Financial Instruments:*

 

The carrying amount of our cash, accounts receivable, other currentassets, accounts payable, deferred revenue and accrued expenses approximatestheir estimated fair values as a result of the short-term maturities of thosefinancial instruments.

 

*Cash and Cash Equivalents:*

 

For purposes of the statements of cash flows, cash equivalents includeall highly liquid debt instruments with original maturities of three months orless that do not secure any corporate obligation. We had no cash equivalents atDecember 31, 2007 or 2008.

 

Our credit card processor maintains a security interest insubstantially all our bank accounts.

 

*Accounts Receivable:*

 

Accounts receivable consist mainly of amounts due from customer creditcard and other electronic payments billed but not yet received at period end.We had no allowance for doubtful accounts at December 31, 2007 or 2008.

 

*Return and Allowance Reserve:*

 

We estimate potential future product returns and chargebacks related tocurrent period revenue. We analyze historical returns and changes in customerdemand and acceptance of our products when evaluating the adequacy of the salesreturns reserve and other allowances in any accounting period. If actualreturns and chargebacks are greater than our estimates, we will recordadditional returns and allowances in addition to our estimates, which willresult in lower net revenue recorded during that period. Reserves for returnsand charge backs are included in accrued expenses.

 

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*Concentration of Credit Risk:*

 

Financial instruments that potentially subject us to significantconcentrations of credit risk consist primarily of cash and receivables. Thecurrent banking crisis may put cash deposits with our banks at risk and theFDIC deposit insurance will not be sufficient to cover any potential lossarising from a bank failure. We derive our accounts receivable primarily fromrevenue earned from customers located in the United States. We maintain anallowance for doubtful accounts based upon the expected collectability ofaccounts receivable. We record an allowance if one is necessary. No customeraccounted for more than 10% of revenue or receivables during 2006, 2007, or2008.

 

We had a concentration on two merchandise suppliers during 2006, 2007,and 2008, as more fully described in Note 13.

 

*Inventories:*

 

Inventories consist mainly of merchandise purchased for resale and arestated at the lower of first-in, first-out cost (FIFO) or market. We record ininventories loose diamonds and semi-precious stones that we purchased anddelivered to manufacturers to produce into finished jewelry inventory toresell.

 

We record payments made to our suppliers forpurchases we have yet to receive as prepaid inventory until they are in ourpossession and satisfactorily examined. Prepaid inventory included ininventories is $94,000 and $36,000 at December 31, 2007 and 2008,respectively.

 

*Inventory Reserve*

 

The unique nature of our business model where customers set the pricesthey are willing to pay may result in items selling below our cost, and weprovide reserves against our inventory based on the difference between theaverage selling price and the cost of inventory if the average selling price islower than the cost of inventory. We also provide reserves for obsolescence andslow moving inventory.

 

*Inventory Co-op MarketingContributions*

 

# In the third quarter of2007, we started to bill and collect from our inventory vendors co-op marketingcontributions as an incentive for us to market and sell their merchandise onthe Bidz website. In accordance with EITF 02-16:  Accounting by a Customer(including a Reseller) for Certain Consideration Received from a Vendor, theco-op marketing contributions that cannot be identified specifically to benefitthe vendors are a reduction in cost of sales and will result in an increase ingross profit. We cannot specifically identify the benefits to each vendor;consequently, co-op marketing contributions are charged against inventory as areduction of costs and amortized as a reduction of cost of sales. For the yearsended December 31, 2007 and 2008, we have earned $4.8 million and $11.1million of co-op marketing contributions, respectively, with $4.2 and $4.3 million,respectively, remaining unamortized and is an offset to inventory at December 31,2007 and 2008. Receivable from vendors for co-op marketing contributions, lessallowance for doubtful accounts, is included in other current assets andamounted to $2.9 million and $934,000 at December 31, 2007 and 2008,respectively.

#  

*Property and Equipment:*

 

Property and equipment are recorded at cost and depreciated using thestraight-line method over the estimated useful lives of the related assets asfollows:

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

 

*Intangible Asset:*

 

Our intangible asset consists of the cost to acquire our domain names,which was $161,000 as of December 31, 2007 and 2008. Our domain names haveindefinite lives and therefore are not subject to amortization. We perform anannual evaluation for impairment on the intangible asset. No impairment existedat December 31, 2007 or 2008 and no loss or impairment was recognizedduring 2006, 2007 and 2008.

 

*Long-Lived Assets:*

 

In accordance with Statement of Financial Accounting Standards (“SFAS”)No. 144, “Accounting for the Impairment or Disposal of 

 

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Long-Lived Assets,” long-lived assets to be held and used are analyzedfor impairment whenever events or changes in circumstances indicate that thecarrying amount of the assets may not be recoverable. SFAS No. 144 appliesto assets subject to amortization. We review property, equipment, and otherlong-lived assets subject to amortization for impairment whenever events orchanges 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.

 

If such assets are considered to be impaired, we measure the impairmentto be recognized by the amount by which the carrying amount of the assetsexceeds the projected discounted future cash flows arising from the assets ortheir fair values, whichever is more determinable.

 

*Revenue Recognition:*

 

We derive our revenue from four sources: merchandise sales, whichinclude wholesale merchandise sales, shipping revenue, transaction fee revenue,and other revenue. In accordance with SAB 104, we recognize revenue from allfour sources when the following revenue recognition criteria are met: (1) persuasiveevidence of an arrangement exists; (2) the product has been shipped or theservice has been rendered and the customer assumes the risk of loss; (3) theselling price is fixed or determinable; and (4) collection of theresulting receivable is reasonably assured.

 

For online sales through our website, werecognize merchandise sales upon shipments made to individual consumers andbusinesses that are fulfilled from our warehouse. We require payment before weship and the payment is generally made online by credit card or otherelectronic payment methods. We record amounts received or billed prior toshipment of goods to customers as deferred revenue. We reduce gross sales byreturns, charge backs from customers, and other discounts redeemed to obtainsuch sales. For wholesale merchandise sales, we recognize sales when themerchandise is delivered to the customer and credit terms may be offered tosuch customers.

 

We report shipping and handling fees and costs in accordance withEmerging Issues Task Force (“EITF”) issue No. 00-10, “Accounting forShipping and Handling Fees and Costs.” As such, in the Statement of Income allamounts billed to customers by us related to shipping and handling are includedin “Net revenue” and our shipping costs are included in “Cost of revenue.”

 

We include transaction fee revenue in net revenue.The 3% transaction fee is applied to all merchandise sales, including shippingand handling, but not to wholesale merchandise sales.

 

Other revenue includes primarily commissions andadvertising revenue. We derive commission revenue from sales of CertifiedMerchant merchandise that is owned by third parties and recognize that revenuewhen services have been rendered. For commission revenue, we recognize asrevenue only the commission portion of the price our customers pay for thepurchased products because we are acting as an agent in such transactions. Werecognize advertising revenue from allowing other companies to advertise on ourweb site when the services are rendered and the advertising revenue is knownand collectible.

 

We present sales tax liability on a net basis inaccordance with Emerging Issues Task Force (“EITF”) Issue No. 06-03.

 

Outbound shipping revenue from customers are included in merchandisesales and amounted to $15.1 million, $22.6 million, and $22.3 million in2006, 2007, and 2008, respectively.

 

*Cost of Revenue:*

 

Cost of revenue includes product costs, inbound and outbound shippingcharges, packaging and shipping supplies, insurance on shipments, productrepair and service costs, and credit card and other electronic payment fees,and is recorded in the same period in which related revenue has been recorded.The cost of revenue is reduced by amortized co-op marketing contributions fromour vendors.

 

Outbound shipping costs on merchandise sales totaled $6.9 million,$9.7 million, and $10.0 million in 2006, 2007, and 2008, respectively.

 

*Deferred Revenue:*

 

Deferred revenue liability is recorded for sales transactions where theproducts had not yet been shipped.

 

*Income Tax Expense:*

 

We account for income taxes using an asset and liability approach,which requires the recognition of taxes payable or refundable for the currentyear and deferred tax assets and liabilities for the future tax consequences ofevents that have been recognized in our financial statements or tax returns.The measurement of current and deferred tax assets and liabilities is based onprovisions of enacted 

 

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tax laws; the effects of future changes in tax laws or rates are notanticipated. If necessary, the measurement of deferred tax assets is reduced bythe amount of any tax benefits that are not expected to be realized based onavailable evidence.

 

*Stock-Based Compensation:*

 

Prior to January 1, 2006, we measured compensation expense toemployees for our stock option incentive plans under the recognition andmeasurement provisions of Accounting Principles Board Opinion No. 25, *Accounting for Stock Issued to Employees,*andrelated interpretations. Utilizing the intrinsic value method prescribed by APBNo. 25, we did not record compensation expense when stock options weregranted to eligible participants as long as the exercise price was not lessthan the fair market value of the stock when the option was granted.

 

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

 

In accordance with Statement of Financial Accounting Standards (‘‘SFAS’’)No. 123, ‘‘Accounting for Stock-Based Compensation,’’ and SFAS No. 148,‘‘Accounting for Stock-Based Compensation-Transition and Disclosure,’’ whichamended SFAS No. 123, we disclosed pro forma net income and net income pershare as if the fair value based method had been applied in measuringcompensation expense. The disclosure provisions of SFAS No. 148 wereeffective for financial statements for interim periods beginning after December 15,2002. We adopted the disclosure requirements in the first quarter of 2003. Thefair values of options and shares issued pursuant to our option plan at eachgrant date were estimated using the Black-Scholes option pricing model. Becausethere has been no public market for our common stock, we used the minimum valuemethod in determining the expected volatility of our common stock was zero. Thetransition provisions did not have an impact on our financial position orresults of operations as we did not elect to adopt the fair value-based methodof accounting for stock-based employee compensation under SFAS No. 123.

 

On January 1, 2006, we adopted SFAS No. 123 (revised 2004), ‘‘Share-BasedPayment’’ (‘‘SFAS 123R’’) requiring that share-based payment transactions berecognized in the financial statements based on the fair value of the equity orliability instrument issued. For the years ended December 31, 2006 and2007, we used the Black-Scholes option pricing model to estimate the value ofour options in implementing SFAS 123R and the calculated method to determineexpected volatility, rather than the minimum value method, which we previouslyused to determine expected volatility. No options were granted for the yearended December 31, 2008.

 

Under SFAS 123R stock-based compensation expense recognized during theperiod is based on the value of the portion of stock-based payment awards thatis ultimately expected to vest. Accordingly, stock-based compensation expenserecognized in the statements of income will be reduced for estimatedforfeitures, which is 0% for the years ended December 31, 2006 and 2007.SFAS 123R requires forfeitures to be estimated at the time of grant andrevised, if necessary, in subsequent periods if actual forfeitures differ fromthose estimates. In the pro forma information required under SFAS 148 for theperiod prior to 2006, we did not account for forfeitures, as all optionsgranted were fully vested at the date of grant and were not subject to anyservice period conditions. We expensed stock-based compensation on the date ofgrant, as all options granted prior to January 1, 2006, vestedimmediately. Stock-based compensation subsequent to January 1, 2006includes vesting provisions and therefore stock-based compensation expense isreduced for estimated forfeitures.

 

We adopted SFAS 123R using the modified prospective method whichrequires the application of the accounting standard as of January 1, 2006.Under this transition method, we are required to recognize compensation costbeginning January 1, 2006 for the portion of outstanding awards for whichthe requisite service has been rendered, based on the grant-date fair value ofthose awards calculated under SFAS 123 for our pro forma disclosures. Inaccordance with the modified prospective method, the financial statements forprior periods have not been restated to reflect, and do not include, the impactof SFAS 123R.

 

*Internal Use Software:*

 

Pursuant to SOP 98-1, we expense all costs incurred for the developmentof internal use software that relate to the planning and post-implementationphases of the development and certain maintenance and enhancement costs. Wecapitalize and amortize direct costs incurred in the application developmentphase over the software’s estimated useful life of three years. The capitalizedsoftware costs of $250,000 was incurred from 2002 to 2004, and have beenamortized since placed in use. At December 31, 2007 and 2008, the netunamortized balance included in Property and Equipment is $0. The capitalizedsoftware costs of $250,000 were retired in the year ended December 31,2007 when it was determined that the software was no longer in use. We expenseresearch and development costs and other computer software maintenance costsrelated to software development as incurred.

 

*Basic and Diluted Income per Share:*

 

In accordance with SFAS No. 128, “Earnings Per Share,” we computethe basic income per common share by dividing net income 

 

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available to common stockholders by the weighted average number ofcommon shares outstanding. We compute diluted income per common share similarlyto basic income per common share, except that we increase the denominator toinclude the number of additional common shares that would have been outstandingif the potential common shares had been issued and if the additional commonshares were dilutive. At December 31, 2006, 2007, and 2008, we had8,353,000 shares, 8,131,300 shares, and 6,864,500 shares, respectively, ofcommon stock equivalents upon the exercise of the employee and non-employeestock options. These common stock equivalents consisted of 7,726,000 employeestock options and 627,000 non-employee stock options as of December 31,2006; and 8,079,300 employee stock options and 52,000 non-employee stockoptions as of December 31, 2007; and 6,839,500 employee stock options and25,000 non-employee stock options as of December 31, 2008. As of December 31,2006, dilutive common stock equivalents totaled 489,342 consisting of 291,716employee stock options and 197,626 non-employee stock options. As of December 31,2007, dilutive common stock equivalents totaled 2,698,013 consisting of2,682,069 employee stock options and 15,944 non-employee stock options. As of December 31,2008, dilutive common stock equivalents totaled 1,271,171 consisting of1,265,568 employee stock options and 5,602 consisting of non-employee stockoptions.

 

The dilutive effect of outstanding stock options is reflected indiluted earnings per share by application of the treasury stock method for theyears ended December 31, 2006, 2007 and 2007. The following table setsforth the computation of basic and diluted net income per share (in thousands,except share and per share data):

 
| ** **                                           | ** ** | **2006**   | ** ** | **2007**   | ** ** | **2008**   | ** ** |
|------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| Basic and diluted net income per share:              |       |       |       |       |       |       |       |
| Numerator:                                           |       |       |       |       |       |       |       |
| Net income                                           |       | $          | 5,389      |       | $          | 18,126     |       | $ | 14,403 |   |
| Denominator:                                         |       |       |       |       |       |       |       |
| Weighted average shares of common stock  outstanding |       | 23,302,026 |       | 23,567,995 |       | 23,798,338 |       |
| Effect of dilutive securities                        |       | 489,342    |       | 2,698,013  |       | 1,271,171  |       |
| Denominator for diluted calculation                  |       | 23,791,368 |       | 26,266,008 |       | 25,069,509 |       |
| Net income per share, basic                          |       | $          | 0.23       |       | $          | 0.77       |       | $ | 0.61 |   |
| Net income per share, diluted                        |       | $          | 0.23       |       | $          | 0.69       |       | $ | 0.57 |   |

 

*Advertising Expense:*

 

We recognize advertising expenses in accordance with SOP 93-7, “Reportingon Advertising Costs.” As such, we expense the costs of producingadvertisements at the time production occurs and we expense the cost ofcommunicating advertisements in the period during which the advertising spaceor airtime is used. We recognize Internet advertising expenses based on theterms of the individual agreements, which are generally (1) during theperiod customers are acquired; (2) based on the number of clicks generatedduring a given period over the term of the contract; or (3) based on thenumber of e-mails sent during an e-mail distribution campaign. Advertisingexpenses totaled $10.3 million, $12.6 million, and $12.7 millionduring the years ended December 31, 2006, 2007, and 2008, respectively.

 

*Public Offering Costs:*

 

These costs consist primarily of regulatoryfiling fees, accountant fees, legal fees and printing expenses incurred in theplanned initial public offering, which amounted to $1.3 million for the yearended December 31, 2006. The costs incurred in 2006 relate to theregistration statement of the planned initial public offering. The capitalizedcosts of the rescission and initial public offering were expensed when theCompany determined it was unable to complete the offering and subsequentlyrequested withdrawal of the registration statement.

 

*New Accounting Pronouncements:*

 

In February 2007, the FASB issued Statement No. 159(“FAS 159”) which expanded FAS No. 157, “*FairValue Measurements*,” which defines fair value, establishesguidelines for measuring fair value and expands disclosures regarding fairvalue measurements. FAS 159 does not require any new fair value measurementsbut rather eliminates inconsistencies in guidance found in various prioraccounting pronouncements. FAS 159 is effective for fiscal years beginningafter November 15, 2007. The adoption of FAS 157 and FAS 159 did not havea material impact on our financial statements.

 

In September 2006, the FASB issued StatementSFAS No. 157 (“FAS 157”), “*FairValue Measurements*,” which defines fair value, establishesguidelines for measuring fair value and expands disclosures regarding fairvalue measurements. FAS 157 does not require any new fair value measurementsbut rather eliminates inconsistencies in guidance found in various prioraccounting pronouncements. SFAS 157 is effective for fiscal years beginningafter November 15, 2007.

 

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**(2)     Inventories:**

 

Inventories consist of the following at December 31, 2007 and 2008(in thousands):

 
| ** **                              | ** ** | **2007** | ** ** | **2008** | ** ** |
|-----------------------------------------|------------|----------|------------|----------|------------|
|                                    |       |     |       |     |       |
| Fine jewelry, watches and other         |       | $        | 53,054     |     | $          | 37,485 |   |
| Loose diamonds and semi-precious stones |       | 4,392    |       | 570      |       |
| Prepaid inventory                       |       | 94       |       | 36       |       |
| Inventory with manufacturing vendors    |       | 221      |       | 386      |       |
| Product inventories                     |       | 57,761   |       | 38,477   |       |
| Less: inventory reserve                 |       | (1,075   | )          | (820     | )          |
|                                    |       | $        | 56,686     |     | $          | 37,657 |   |

 

As of December 31, 2007 and 2008, all inventories have beenpledged as collateral for our revolving credit line with LaSalle Bank (Bank ofAmerica).

 

**(3)     OtherCurrent Assets:**

 

Other current assets consist of the following at December 31, 2007and 2008 (in thousands):

 
| ** **           | ** ** | **2007** | ** ** | **2008** | ** ** |
|----------------------|------------|----------|------------|----------|------------|
|                 |       |     |       |     |       |
| Prepaid expense      |       | $        | 355        |     | $          | 328 |   |
| Prepaid income tax   |       | —   |       | 282      |       |
| Other current assets |       | 130      |       | 79       |       |
|                 |       | $        | 485        |     | $          | 689 |   |

 

**(4)     Property andEquipment:**

 

Property and equipment consists of the following at December 31,2007 and 2008 (in thousands):

 
| ** **                                       | ** ** | **2007** | ** ** | **2008** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|
|                                             |       |     |       |     |       |
| Computer hardware and software                   |       | $        | 1,608      |     | $          | 2,626 |   |
| Furniture and equipment                          |       | 508      |       | 517      |       |
| Automobile                                       |       | 27       |       | 30       |       |
|                                             |       | 2,143    |       | 3,173    |       |
| Less: accumulated depreciation and  amortization |       | 820      |       | 1,501    |       |
|                                             |       | $        | 1,323      |     | $          | 1,672 |   |

 

Depreciation and amortization expense of property and equipment totaled$273,000, $498,000 and $690,000 for the years ended December 31, 2006,2007, and 2008, respectively.

 

As of December 31, 2007 and 2008, all property and equipment havebeen pledged as collateral for our revolving credit line with LaSalle Bank(Bank of America).

 

**(5)     RevolvingCredit Line:**

 

In July 2006, we entered into arevolving credit line agreement with LaSalle Bank (Bank of America), to provideworking capital financing secured by inventories and tangible assets. Theagreement allowed for us to initially draw on a line of credit up to $10.0million, with a provision to increase the limit up to $15.0 million with thefuture consent of the bank’s loan committee. During the first quarter of 2007we increased the limit to $15.0 million and during the first quarter of 2008 wefurther increased the limit to $25.0 million.

 

All cash receipts from our revenues arerestricted to being deposited into a LaSalle Bank account, to be applied tocurrent reported cash disbursements requirements, under a positive pay system,and then to the credit line outstanding balance. The revolving credit lineagreement expires in July of 2010. As of December 31,2008, there was no outstanding balance under the revolving credit line. Thereis an unused fee of 0.25% on the unused portion of the revolving credit line.

 

Day-to-day drawdown on the credit line issubject to the prevailing prime rate. The interest is calculated on the averageoutstanding 

 

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balance and compound monthly. As of December 31,2008 our effective interest rate was 3.25%. We have the option to extended term advances, for 30, 60, or 90 daysthat are subject to LIBOR rates. The rates will be a certain percentage abovethe LIBOR rates and will vary with the maturity term and amount borrowed.Interest is calculated over the stated term at an annual rate. As of December 31,2008 we have no advances under LIBOR.

 

Under the terms and conditions of the revolving credit line agreement,the Company is subject to certain restrictive covenants including the followingrestrictive financial covenants:

 

Minimum TTM EBITDA: Actual Trailing Twelve Month (TTM) EBITDAcompliance is measured on a monthly basis, and shall not vary negatively fromthe Dollar amount for planned LTM EBITDA, set forth in an agreed upon schedule,for the applicable period, and is subject to resetting in Lender’s discretionbased upon a business plan for subsequent periods acceptable to Lender.

 

Capital Expenditures: Borrower shall not make capital expenditures inexcess of an agreed upon amount for each fiscal year covered by the loanagreement. All capital expenditure limits are subject to resetting on an annualbasis at the Lender’s discretion based upon a business plan for subsequentperiods acceptable to the Lender.

 

Minimum Excess Availability: We are to maintain an Excess Availabilityof $2.5 million with a Maximum Revolver Amount of $25.0 million. This covenantis subject to resetting at the Lender’s discretion based upon a business planfor subsequent periods acceptable to Lender.

 

**(6)     AccountsPayable:**

 

During the years ending December 31, 2007 and 2008 we employ “positivepay” procedures with our financial institution by transmitting check disbursementinformation to the financial institution to allow for our review and approvalof exception transaction prior to them being posted to our account.

 

**(7)     AccruedExpenses:**

 

Accrued expenses consist of the following at December 31, 2007 and2008 (in thousands):

 
| ** **                              | ** ** | **2007** | ** ** | **2008** | ** ** |
|-----------------------------------------|------------|----------|------------|----------|------------|
| Income tax payable                      |       | 921      |       | —   |       |
| Accrued payroll and other related costs |       | 1,451    |       | 878      |       |
| Accrued net sales returns               |       | 346      |       | 171      |       |
| Other accrued expenses                  |       | 1,446    |       | 1,309    |       |
| Accrued marketing expenses              |       | 345      |       | 733      |       |
|                                    |       | $        | 4,509      |     | $          | 3,091 |   |
|                                         |            |          |            |          |            |  |  |

 

 **(8)     Commitments:**

 

The following table presents our contractual obligations at December 31,2008, over the next five years and thereafter (in thousands):

 
| **Payments by period** | ** ** | **Total  amount** | ** ** | **Less than  1 year** | ** ** | **1 to 3  years** | ** ** | **3 to 5  years** | ** ** | **After 5  years** | ** ** |
|----------------------------------|------------|-------------------|------------|---------------------------------|------------|-----------------------------|------------|-----------------------------|------------|-------------------------|------------|
|                             |       |              |       |                            |       |                        |       |                        |       |                    |       |
| Property  lease                  |       | $                 | 1,448      |                            | $          | 987                         |       | $                           | 346        |                    | $          | 115 |   | $ | — |   |
| Equipment  lease                 |       | 207               |       | 56                              |       | 104                         |       | 47                          |       | —                  |       |
|                             |       | $                 | 1,655      |                            | $          | 1,043                       |       | $                           | 450        |                    | $          | 162 |   | $ | — |   |

 

We lease a 50,000 square-foot office and warehouse and a separate12,000 square-foot warehouse space in Culver City, California. The leasesexpire in October 2009 and August 2012, respectively. We areobligated to pay real estate taxes, insurance, and maintenance expenses. Weexpect 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 2007. Rental expenses for operating leases totaled $908,000,$995,000, and $1.2 million for the years ended December 31, 2006, 2007,and 2008, respectively.

 

We have commitment for operating leases of copy machines used in ouroffice.

 

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**(9)     Stockholders’Equity:**

 

*Delaware Reincorporation*

 

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

 

*Preferred Stock*

 

Our certificate of incorporation authorizes 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. 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.

 

*Common Stock*

 

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

 

No dividends have been declared or paid on our common stock through December 31,2008.

 

In 2008, common stock shares totaling 442,500 shares were issued fromthe exercise of stock options and 249,623 shares were retired in the netexercise of options to pay for the exercise price and payroll taxes. 1,853,873shares held in treasury from our stock repurchase program were retired. 1,250shares were issued as obligations for service. Restricted common stock awardstotaling 24,800 shares were issued to employees. 2,000 shares of restrictedcommon stock were retired on termination of employment of an employee and 1,490shares were retired from net vesting of restricted common stock to pay forpayroll taxes. Restricted common stock awards outstanding and yet to be vestedtotaled 117,800 shares as of December 31, 2008.

 

In 2007, common stock shares totaling 1,192,700 were issued from theexercise of stock options and 15,000 shares held in treasury were retired.Common stock shares totaling 18,750 were issued to independent board members.Restricted common stock awards totaling 110,000 shares were issued toindependent board members, and 16,000 shares were issued to employees.Restricted common stock awards outstanding and yet to be vested totaled 126,000shares as of December 31, 2007.

 

In 2006, common stock shares totaling 20,000 were issued to independentboard members. 15,000 shares were issued to an employee, and 1,404 shares wereissued to a non-employee for services rendered. We repurchased and retired115,000 shares from the Chief Financial Officer and we repurchased 15,000shares from an employee that is held in Treasury.

 

*Deferred Stock-Based Compensation*

 

In connection with certain stock grants to two employees during theyear ended December 31, 2001, we recognized $2.0 million in deferredstock-based compensation for the deemed fair value of common stock at the dateof the grant. We include such amounts as a reduction of stockholders’ equity(deficit). We amortize such amounts over the vesting period of five years inaccordance with FASB Interpretation No. 28, “Accounting for StockAppreciation Rights and Other Variable Stock Option or Award Plans.”

 

Amortization expenses totaled $100,000, $0, and $0 during the yearsended December 31, 2006, 2007, and 2008, respectively. As of December 31,2008, all existing deferred stock-based compensation grants were fully vestedand all associated costs had been fully amortized.

 

To meet the statutory obligation for the applicable income and otheremployment taxes, 115,000 common shares were surrendered back to us in 2006 anda net-share settlement was effected. Based on a fair market value of $6.00 pershare on the vesting date as determined based on a combination of factors thatinclude recent share transactions between shareholders and an independentvaluation of the Company, the employee’s tax obligations to the taxingauthorities were approximately $690,000. The net-share

 

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** **

settlement had the effect of share repurchases by us as it reduced andretired the number of shares outstanding and did not represent an expense tothe Company. The employee received no cash proceeds and taxes were paiddirectly to the taxing authorities.

 

**(10)         StockCompensation Plans:**

 

We adopted our 2001 Stock Option Plan, our 2002 Special Stock OptionPlan and our 2006 Award Plan (collectively, the “Plans”), in January 2001,January 2002, and March 2006, respectively. The Plans provide for thegranting of awards in the form of incentive stock options, nonqualified stockoptions, stock appreciation rights, shares of restricted common stock, bonusstock in lieu of obligations, or other stock-based awards to employees,directors, and independent contractors who provide valuable services to ourcompany.  The vesting requirements, performance thresholds and other termsand conditions of options granted under the Plans will be determined by ourCompensation Committee and Board of Directors. Outstanding options all vestimmediately prior to 2006 and have 25% vesting at the end of each year overfour years for options granted in 2006 and 2007. No options were granted in 2008.Options generally have an expiration period of five years and new common stockshares are issued upon the exercise of stock options. At December 31,2008, 1,302,990 shares were available for future grants under the Plans.

 

The following is a summary of stock option activity for the year ended December 31,2008:

 
| **Options**                           | ** ** | **Shares** | ** ** | **Weighted-   average  exercise  price** | ** ** | **Weighted  average  remaining  life of  contract  (years)** | ** ** | **Aggregate  intrinsic  value as of  12/31/08** | ** ** |
|---------------------------------------|------------|------------|------------|-----------------------------------------------|------------|-------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| Outstanding at January 1, 2008   |       | 8,131,300  |       | $                                             | 6.20       |                                                              |       |                                                      |       |   |
| Granted                               |       | —     |       | —                                        |       |                                                              |       |                                                      |       |
| Exercised                             |       | (442,500   | )          | 4.74                                          |       |                                                              |       |                                                      |       |
| Cancelled                             |       | (807,500   | )          | 8.07                                          |       |                                                              |       |                                                      |       |
| Expired                               |       | (16,800    | )          | 4.50                                          |       |                                                              |       |                                                      |       |
| Outstanding at December 31, 2008 |       | 6,864,500  |       | $                                             | 6.08       |                                                              | 2.36       |                                                      | $          | — |   |
| Exercisable at December 31, 2008 |       | 6,864,500  |       | $                                             | 6.08       |                                                              | 2.36       |                                                      | $          | — |   |

 

During the year ended December 31, 2007 and 2008, stock options topurchase shares in our common stock were issued. New shares in our common stockare issued when stock options are exercised. During 2007, 1,192,700 stockoptions were exercised and the recognized tax benefit related thereto is $3.2million. The total fair value of options exercised during 2007 was $9.5million. During 2008, 442,500 stock options were exercised and the recognizedtax benefit related thereto is $818,000. The total fair value of optionsexercised during 2008 was $2.3 million. In 2008, 375,000 of the stock optionsexercised were “net exercised” and 249,623 shares were surrendered back to usand retired in payment for the exercise price and payroll taxes.

 

In 2008, employees voluntarily cancelled 807,500 unvested options topurchase shares as the options were substantially “out of the money” and 16,800options expired “out of the money.” As of December 31, 2008, all 6,864,500stock options to purchase shares were fully vested.

 

The following is a summary of stock option activity for the years endedDecember 31, 2006, 2007, and 2008:

 
| ** **                       | ** ** | **2006**   | ** ** | **2007**                               | ** ** | **2008**   | ** ** |
|----------------------------------|------------|------------|------------|----------------------------------------|------------|------------|------------|
| ** **                       | ** ** | **Shares** | ** ** | **Weighted  average  exercise  price** | ** ** | **Shares** | ** ** | **Weighted  average  exercise  price** | ** ** | **Shares** | ** ** | **Weighted  average  exercise  price** | ** ** |
| Outstanding at beginning of year |       | 8,342,000  |       | $                                      | 5.63       |       | 8,353,000  |   | $ | 5.64 |   | 8,131,300 |   | $ | 6.20 |   |
| Granted                          |       | 235,000    |       | 6.00                                   |       | 1.000,000  |       | 8.23 |   | — |   | — |   |
| Exercised                        |       | —     |       | —                                 |       | 1,192,700  | )          | 4.00 |   | (442,500 | ) | 4.74 |   |
| Canceled / forfeited             |       | (224,000   | )          | 5.45                                   |       | (29,000    | )          | 6.00 |   | (824,300 | ) | 8.00 |   |
| Outstanding at year-end          |       | 8,353,000  |       | $                                      | 5.64       |       | 8,131,300  |   | $ | 6.20 |   | 6,864,500 |   | $ | 6.08 |   |
| Options exercisable at year-end  |       | 8,238,000  |       | $                                      | 5.64       |       | 7,045,050  |   | $ | 5.92 |   | 6,864,500 |   | $ | 6.08 |   |

 

The weighted-average grant date fair values of options granted during2006, and 2007 were $2.40, and $2.59 per share, respectively, and no optionswere granted in 2008.

 

The following table summarizes information about stock optionsoutstanding and exercisable at December 31, 2008:

 

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| ** **                    | ** ** | ** **                          | ** ** | ** **                                   | ** ** | ** **                                                                                          | ** ** | ** **                          | ** ** | ** **                             | ** ** | ** ** | ** ** |
|-------------------------------|------------|-------------------------------------|------------|----------------------------------------------|------------|-----------------------------------------------------------------------------------------------------|------------|-------------------------------------|------------|----------------------------------------|------------|------------|------------|
| ** **                    | ** ** | ** **                          | ** ** | ** **                                   | ** ** | **Options outstanding and exercisable  as of December 31, 2008** | ** ** |
| ** **                    | ** ** | ** **                          | ** ** | ** **                                   | ** ** | **Options outstanding**                                                                        | ** ** | **Options exercisable**        | ** ** |
| **Range of  exercise prices** | ** ** | **Number  outstanding  12/31/2008** | ** ** | **Weighted  average  remaining contractual** | ** ** | **Weighted  average  exercise  price**                                                              | ** ** | **Number  exercisable  12/31/2008** | ** ** | **Weighted  average  exercise  price** | ** ** |
| ** **                    | ** ** | ** **                          | ** ** | ** **                                   | ** ** | ** **                                                                                          | ** ** | ** **                          | ** ** | ** **                             | ** ** | ** ** | ** ** |
| $                             | 5.01       |                                | $          | 6.00                                         |       | 6,631,500                                                                                           |       | 2.33                                |       | $                                      | 6.00       |       | 6,631,500  |   | $ | 6.00 |   |
| $                             | 6.01       |                                | $          | 7.00                                         |       | 105,500                                                                                             |       | 3.18                                |       | $                                      | 6.50       |       | 105,500    |   | $ | 6.50 |   |
| $                             | 9.01       |                                | $          | 10.00                                        |       | 127,500                                                                                             |       | 3.45                                |       | $                                      | 9.90       |       | 127,500    |   | $ | 9.90 |   |
| $                             | 5.01       |                                | $          | 10.00                                        |       | 6,864,500                                                                                           |       | 2.36                                |       | $                                      | 6.08       |       | 6,864,500  |   | $ | 6.08 |   |

 

*Stock Option Compensation*

 

During the years ended December 31, 2006, and 2007, and 2008,respectively, we recognized approximately $16,000, $488,000, and $283,000respectively, of employee stock-option compensation. We recognize compensationexpense on a straight-line basis over the requisite service period for eachstock option grant. The unamortized stock-option compensation expense as of December 31,2007 and 2008 is $2.4 million and $0, respectively. The cancellation of allunvested options in 2008 resulted in no unamortized expense as of December 31,2008.

 

Options granted in 2006 and 2007 were valued in accordance with SFAS123R and no options were granted in 2008. The fair value of these options wascalculated using a Black-Scholes option pricing model using the followingassumptions: (1) risk-free interest rates of 4.3% to 5.0%, (2) anexpected life of four to five years, (3) expected volatility of 31% to37%, (4) expected forfeitures of 0%, and (5) a dividend yield of 0%.Because there was no public market for our common stock in 2006 and limitedtrading history at the time of grant in 2007, and in accordance with SFAS 123R,we used the calculated method to determine volatility. Prior to June 15,2007, we had estimated the expected life to be equal to the option period andfrom June 15, 2007 we had estimated the expected life to be equal to thevesting period.

 

*Restricted Stock Awards*

 

We began issuing restricted stock awards in 2007, pursuant to the 2006Award Plan. The restricted stock awards were issued as time-based awards,which vest typically with 25% vesting at the end of each year over four yearsor earlier if there is an acceleration event. The restricted stock awards areexpensed pro rata over the vesting period based upon the market value of theawards at the time of grant. Stock-based compensation from the issuance ofcommon stock and restricted stock awards totaled $286,000 and $358,000 for theyears ended December 31, 2007 and 2008, respectively. The unamortizedstock-based expense for restricted stock awards was $1.1 million and $967,000as of December 31, 2007 and 2008, respectively.

 

The total fair value of 31,000 restricted shares that vested in 2008was $220,000, and no restricted shares were vested during 2007. Restrictedcommon stock awards outstanding and yet to be vested totaled 126,000 shares and117,800 as of December 31, 2007 and 2008, respectively.

 

A summary of all restricted stock activity during the years ended December 31,2007 and 2008 follows:

 
| Restricted shares outstanding,  January 1, 2007   |   | —  |   |
|--------------------------------------------------------|--------|---------|--------|
| Shares granted                                         |   | 126,000 |   |
| Shares vested                                          |   | —  |   |
| Shares forfeited                                       |   | —  |   |
|                                                   |   |    |   |
| Restricted shares outstanding,  December 31, 2007 |   | 126,000 |   |
| Shares granted                                         |   | 24,800  |   |
| Shares vested                                          |   | (31,000 | )      |
| Shares forfeited                                       |   | (2,000  | )      |
|                                                   |   |    |   |
| Restricted shares outstanding,  December 31, 2008 |   | 117,800 |   |

 

The weighted-average grant date fair values of restricted stock awardsduring 2007, and 2008 were $10.41, and $8.61 per share, respectively.

 

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**(11)         IncomeTax Expense:**

 

Income tax expense amounted to $2.5 million and $9.6 million for theyears ended December 31, 2007 and 2008 (an effective rate of 12.3% for 2007and 40.0% for 2008). A reconciliation of the provision (benefit) for income taxexpense with amounts determined by applying the statutory U.S. federal incometax rate to income before income tax expense is as follows (in thousands):

 
| ** **                                                              | ** ** | **2006** | ** ** | **2007** | ** ** | **2008** | ** ** |
|-------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Computed tax benefit at federal statutory  rate of 35%                  |       | $        | 1,873      |     | $          | 7,026    |       | $ | 8,400 |   |
| State taxes, net federal tax benefits                                   |       | 364      |       | 347      |       | 1,380    |       |
| Meals and entertainment                                                 |       | 26       |       | 15       |       | 5        |       |
| Limitation on executive  compensation—section 162 (m)              |       | 387      |       | —   |       | —   |       |
| Change in valuation allowance, net of  adjustment of net operating loss |       | (2,535   | )          | (4,850   | )          | —   |       |
| Minimum tax credit                                                      |       | 108      |       | —   |       | —   |       |
| Excess benefit of vested stock                                          |       | (170     | )          | —   |       | —   |       |
| Other                                                                   |       | 67       |       | —   |       | (188     | )          |
| Total income tax provision                                              |       | $        | 120        |     | $          | 2,538    |       | $ | 9,597 |   |

 

The income tax expense for 2008consists of the following (in thousands):

 
| ** ** | ** ** | **Federal** | ** ** | **State** | ** ** | **Total** | ** ** |
|------------|------------|-------------|------------|-----------|------------|-----------|------------|
| Current    |       | $           | 7,758      |      | $          | 2,017     |       | $ | 9,775 |   |
| Deferred   |       | (259        | )          | 81        |       | (178      | )          |
| Total      |       | $           | 7,499      |      | $          | 2,098     |       | $ | 9,597 |   |

 

The difference in annual effective tax rates arises from the netoperating loss carryforwards available to offset the taxable income for the2007 tax year. All net operating losses were utilized and are not available tooffset the federal and California taxable income for the year ended December 31,2008.

 

Deferred tax assets and liabilities are recognized for future taxconsequences between the carrying amounts of assets and liabilities and theirrespective tax bases using enacted tax rates in effect for the year in whichthe differences are expected to reverse. Significant deferred tax assets andliabilities consist of the following (in thousands):

 
| ** **                            | ** ** | **2007**   | ** ** | **2008**   | ** ** |
|---------------------------------------|------------|------------|------------|------------|------------|
| **Deferred tax assets:**              | ** ** | ** ** | ** ** | ** ** | ** ** |
|                                  |       |       |       |       |       |
| **Current deferred tax assets:**      |       |       |       |       |       |
| Inventory costs                       |       | $          | 1,309      |       | $          | 868 |   |
| Minimum tax credit carryforwards      |       | 28         |       | —     |       |
| Accrued expenses                      |       | 157        |       | 80         |       |
| Other reserves and allowances         |       | 258        |       | 159        |       |
| Deferred revenue                      |       | 351        |       | 240        |       |
| State taxes                           |       | 18         |       | 603        |       |
| Total current deferred tax assets     |       | 2,121      |       | 1,950      |       |
| **Current deferred tax liability:**   |       | —     |       | —     |       |
| **Net current deferred tax asset**    |       | $          | 2,121      |       | $          | 1,950 |   |
|                                  |       |       |       |       |       |
| **Long term deferred tax assets:**    |       |       |       |       |       |
| Employee stock options                |       | $          | 304        |       | $          | 244 |   |
| Other (fixed assets)                  |       | 96         |       | 3          |       |
| Total long term deferred tax assets   |       | 400        |       | 247        |       |
| **Long term deferred tax liability:** |       |       |       |       |       |
| Inventory costs                       |       | (271       | )          | (163       | )          |
| ** **                            |       |       |       |       |       |
| **Net long term deferred tax asset**  |       | $          | 129        |       | $          | 84 |   |

 

Thetax benefits from the expense in 2007 and 2008 for share based compensationawards that will result in future tax deduction are included in deferred taxassets. The actual tax deduction exceeds the compensation cost recognized bythe company for financial reporting purposes. The excess tax benefits increasedthe company’s additional paid in capital by $3.2 million and $716,000 for theyears ended December 31, 2007 and 2008, respectively, as required by FAS123R.

 

We adopted the provisions of FASB Interpretation 48, *Accounting for Uncertainty in Income Taxes*, on January 1,2007. Previously, we had accounted for tax contingencies in accordance withStatement of Financial Accounting Standards 5, *Accountingfor*

 

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*Contingencies*. Asrequired by Interpretation 48, which clarifies Statement 109, *Accounting for Income Taxes*, we recognize the financialstatement benefit of a tax position only after determining that the relevanttax authority would more likely than not sustain the position following anaudit. For tax positions meeting the more-likely-than-not**threshold,the amount recognized in the financial statements is the largest benefit thathas a greater than 50 percent likelihood of being realized upon ultimatesettlement with the relevant tax authority. At the adoption date, we applied Interpretation48 to all tax positions for which the statute of limitations remained open. Ouranalysis of the implementation of Interpretation 48 reveals that there is nomaterial effect on our financial statements.

 

There are no unrecognized tax benefits that, if recognized, wouldimpact the effective tax rate. We do not anticipate any significant change inour positions in the next twelve months.

 

The Company recognizes accrued interest and penalties related tounrecognized tax benefits in income tax expense. During the year ended December 31,2008, no interest or penalties were recognized in the income statement orbalance sheet by the Company.

 

We are subject to income taxes in the U.S. federal jurisdiction andCalifornia. Tax regulations within each jurisdiction are subject to theinterpretation of the related tax laws and regulations and require significantjudgment to apply. With few exceptions, we are no longer subject to U.S.federal and California examinations by tax authorities for the years before 2007.

 

We were under examination by the Internal Revenue Service for the 2004,2005 and 2006 tax years. The examination was concluded as of December 31,2007 and final settlement was accrued and made in the amount of $35,000,including interest and penalties.

 

 **(12)        Segment Information:**

 

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 as followsfor the years ended December 31, 2006, 2007 and 2008 (in thousands):

 
| ** **    | ** ** | **2006** | ** ** | **2007** | ** ** | **2008** | ** ** |
|---------------|------------|----------|------------|----------|------------|----------|------------|
| United States |       | $        | 104,338    |     | $          | 145,412  |       | $ | 157,747 |   |
| International |       | 27,485   |       | 41,719   |       | 49,663   |       |
| Total         |       | $        | 131,823    |     | $          | 187,131  |       | $ | 207,410 |   |

 

Long-lived assets include property and equipment and intangible assetsthat resided in the United States during the years ended December 31,2006, 2007, and 2008.

 

**(13)         Concentrations:**

 

Purchase of merchandise from one of our top two vendors which is arelated party (see Note 15), constituted 26.4%, 11.9%, and 9.9% of totalmerchandise purchased by us in the years ending December 31, 2006, 2007,and 2008, respectively. Purchases of merchandise from our top two vendorsamounted to $34.4 million, $40.4 million, and $18.3 million representing31.1%, 24.0%, and 14.6%, respectively, of the total purchases during the yearsended December 31, 2006, 2007, and 2008, respectively.

 

Outstanding accounts payable to our top two vendors totaled$6.2 million and $1.3 million as of December 31, 2007 and 2008,respectively. Loss of either of these vendors will not have a negative impacton our operations.

 

**(14)         Contingencies:**

 

We are subject to various legal proceedings and claims that arise inthe ordinary course of business.  Although the Company believes it hasdefenses to the allegations and intends to pursue them vigorously, currently,management does not currently have sufficient information to assess thevalidity of the claims or the amount of potential damages.  Companymanagement currently believes, however, that resolution of such legal matterswill not have a material adverse impact on the Company’s financial position,results of operations or cash flows.

 

In September 2008, we were served withan alleged class action lawsuit alleging, among other things, that the companyengaged in unfair business practices by misrepresenting the value of itsmerchandise and by “false” bidding. The complaint purports to represent a classof persons who purchased any merchandise from the company. The company believesthat the lawsuit is meritless and intends to file a motion to dismissforthwith.

 

*Prior Sales of Securities*

 

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

 

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issued shares of common stock to about 30 persons in exchange forservices and other non-cash consideration valued in excess of $5.5 million andissued approximately 250 stock option grants to purchase common stock at aweighted average exercise price of $4.45. After conducting these sales of oursecurities, we determined that these sales were not exempt from theregistration requirements under the Securities Act of 1933 and similarprovisions of laws of the states in which our stockholders reside, becausecertain of our employees who solicited investors engaged in a “generalsolicitation” of securities. In addition, these employees received compensationfor selling our common stock and were required to be licensed as broker-dealerswith the Securities and Exchange Commission, or SEC, and various stateauthorities, but they were not so licensed. In such situations, a number ofremedies 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. After voluntarily reporting these violations to the SEC,the SEC staff advised us that it would not undertake an investigation in thematter.

 

The probability that stockholders wouldassert a claim against us and the extent of the our liability, if any, arecontingent on a number of factors, including a stockholder’s desire to rescind,applicable legal precedent, and statutes of limitation. We believe, however,that as to any options by investors at this time or in the future, applicablestatutes of limitations will mitigate our exposure to any civil remedies. Basedon current facts known to management at this time, management does not believethat assertion of any such claims by the Company’s shareholders in a materialamount is probable. Accordingly, no accruals for either potential amountspayable or reserves have been made at this time.

 

* ***(15)        RelatedParty Transactions:**

 

We purchased approximately 26.4%, 11.9%, and 9.9% of our merchandise in2006, 2007, and 2008, respectively, from LA Jewelers, where one of its managersis a stockholder who beneficially owns approximately 5.1% of our outstandingcommon stock as of December 31, 2008 (see Note 13). The accountspayable balances due to LA Jewelers were $5.1 million and $1.4 million as of December 31,2007 and 2008, respectively. All business with LA Jewelers is conducted at arm’slength and the purchase price, terms and conditions that have been negotiatedare competitive with the market and other suppliers.

 

LA Jewelers participates in our inventory co-op marketing program. Forthe years ended December 31, 2007 and 2008, we earned $522,000 and $1.2million, respectively, from LA Jewelers relating to co-op marketingcontributions and $361,000 was unamortized as of December 31, 2008. Theamounts of co-op marketing contributions due from LA Jewelers were $544,000 and$22,000 as of December 31, 2007 and 2008, respectively.

 

In May, 2007 we entered into an understanding with LA Jewelers wherebythey will guarantee that we will earn a certain minimum gross profit margin ontheir merchandise. This agreement provides that in the event of a gross profitmargin shortfall we will be compensated for the difference between our actualgross profit margin and the guaranteed minimum gross profit margin. For theyears ended December 31, 2007 and 2008, we recognized $427,000 and$588,000, respectively, under this agreement. As of December 31, 2007 and2008, we have $129,000 and $80,000, respectively, outstanding under this grossprofit margin guarantee.

 

Marina Zinberg, who is a Vice President and owns 32.0% of ouroutstanding shares, is the sister of and reports to David Zinberg, our ChiefExecutive Officer. During 2008 we paid Ms. Zinberg a salary of $100,000. Ms. Zinbergwas previously our corporate secretary and treasurer.

 

**(16)         SubsequentEvents:**

 

See Recent Developments in Note 1.

 

**(b)           FinancialStatement Schedules:**

 

**Schedule II — Valuation and QualifyingAccounts**

 

**(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, 2007                                        |       |                                                           |       |                                                   |       |           |       |                                                     |       |
| Reserve for inventory                                                                   |       | $                                                              | 461        |                                                   | $          | 675            |       | $                                                        | (61        | ) | $ | 1,075 |   |
| Reserve for sales returns                                                               |       | 164                                                            |       | 970                                                    |       | (788           | )          | 346                                                      |       |
| Reserve for charge-backs                                                                |       | 25                                                             |       | 75                                                     |       | —         |       | 100                                                      |       |
|                                                                                    |       |                                                           |       |                                                   |       |           |       |                                                     |       |
| Year ended December 31, 2008                                                       |       |                                                           |       |                                                   |       |           |       |                                                     |       |
| Reserve for inventory                                                                   |       | $                                                              | 1,075      |                                                   | $          | —         |       | $                                                        | (255       | ) | $ | 820 |   |
| Reserve for sales returns                                                               |       | 346                                                            |       | (727                                                   | )          | 552            |       | 171                                                      |       |
| Reserve for charge-backs                                                                |       | 100                                                            |       | —                                                 |       | (46            | )          | 54                                                       |       |

 

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**(c)           Exhibits**

 

The following exhibits are incorporated byreference or filed herewith

 
| **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 (3)                                                                                                                                                       |
| 10.1                |       | 2001 Stock Option Plan(4)                                                                                                                                                          |
| 10.2                |       | 2002 Stock Option Plan(5)                                                                                                                                                          |
| 10.3                |       | 2006 Stock Award Plan (6)                                                                                                                                                          |
| 10.4                |       | Employment Agreement, dated as of June 6, 2006, between  Bidz.com, Inc. and David Zinberg (7)                                                                            |
| 10.4.1              |       | Employment Agreement, dated as of November 1, 2002, between  Bidz.com, Inc. and David Zinberg (8)                                                                   |
| 10.5                |       | Employment Agreement, dated as of June 6, 2006, between Bidz.com, Inc.  and Lawrence Y. Kong (9)                                                                    |
| 10.6                |       | Stock Vesting Agreement, dated as of June 30, 2001, between  Bidz.com, Inc. and Lawrence Y. Kong (10)                                                                    |
| 10.7                |       | Form of Indemnification Agreement between Bidz.com, Inc.  and each officer and director (11)                                                                             |
| 10.7.1              |       | Indemnification Agreement, dated as of November 1, 2002, between  Bidz.com, Inc. and David Zinberg (12)                                                             |
| 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(13)                                   |
| 10.9                |       | Client Service Agreement dated January 2, 2006 between  Bidz.com, Inc. and Administaff Companies II, L.P. (14)                                                           |
| 10.10               |       | Loan and Security Agreement by Bidz.com, Inc. and LaSalle Retail  Finance, dated July 12, 2006 (15)                                                                      |
| 10.11               |       | Employment Agreement, dated as of March 1, 2007 between  Bidz.com, Inc. and Leon Kuperman (16)                                                                           |
| 10.12               |       | Employment Agreement, dated as of February 21, 2007 between  Bidz.com, Inc. and Claudia Liu (17)                                                                         |
| 31.1                |       | Certification of the Chief Executive Officer pursuant to  Section 302 of the Sarbanes-Oxley Act.                                                                              |
| 31.2                |       | Certification of the Chief Financial Officer pursuant to  Section 302 of the Sarbanes-Oxley Act.                                                                              |
| 32                  |       | Certification of the Chief Executive Officer and Chief Financial  Officer pursuant to Section 906 of the Sarbanes-Oxley Act                                                   |

 

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| (1)  |   | Incorporated by reference to  Exhibit 2.1 of Registrant’s Form S-1 (File No. 333-132545).                                                                                                                                                                                                                                                                                                                                                                                    |
|------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2)  |   | Incorporated by reference to  Exhibit 3.1 of Registrant’s Form S-1 (File No. 333-132545).                                                                                                                                                                                                                                                                                                                                                                                    |
| (3)  |   | Incorporated by reference to  Exhibit 3.2 of Registrant’s Form S-1 (File No. 333-132545).                                                                                                                                                                                                                                                                                                                                                                                    |
| (4)  |   | Incorporated by reference to  Exhibit 10.1 of Registrant’s Form 10 (File No. 000-51257).                                                                                                                                                                                                                                                                                                                                                                                     |
| (5)  |   | Incorporated by reference to  Exhibit 10.2 of Registrant’s Form 10 (File No. 000-51257).                                                                                                                                                                                                                                                                                                                                                                                     |
| (6)  |   | Incorporated by reference to  Exhibit 10.3 of Registrant’s Form S-1 (File No. 333-132545).                                                                                                                                                                                                                                                                                                                                                                                   |
| (7)  |   | Incorporated by reference to  Exhibit 10.4 of Registrant’s Form S-1 (File No. 333-132545).                                                                                                                                                                                                                                                                                                                                                                                   |
| (8)  |   | Incorporated by reference to  Exhibit 10.3 of Registrant’s Form 10 (File No. 000-51257).                                                                                                                                                                                                                                                                                                                                                                                     |
| (9)  |   | Incorporated by reference to Exhibit 10.5  of Registrant’s Form S-1 (File No. 333-132545).                                                                                                                                                                                                                                                                                                                                                                                   |
| (10) |   | Incorporated by reference to  Exhibit 10.6 of Registrant’s Form S-1 (File No. 333-132545).                                                                                                                                                                                                                                                                                                                                                                                   |
| (11) |   | Incorporated by reference to  Exhibit 10.7 of Registrant’s Form S-1 (File No. 333-132545).                                                                                                                                                                                                                                                                                                                                                                                   |
| (12) |   | Incorporated by reference to  Exhibit 10.4 of Registrant’s Form 10 (File No. 000-51257).                                                                                                                                                                                                                                                                                                                                                                                     |
| (13) |   | Incorporated by reference to  Exhibit 10.5 of Registrant’s Form 10 (File No. 000-51257).                                                                                                                                                                                                                                                                                                                                                                                     |
| (14) |   | Incorporated by reference to  Exhibit 10.9 of Registrant’s Form S-1 (File No. 333-132545).                                                                                                                                                                                                                                                                                                                                                                                   |
| (15) |   | Incorporated by reference to  Exhibit 10.10 of Registrant’s Form 10 (File No. 000-51257)                                                                                                                                                                                                                                                                                                                                                                                     |
| (16) |   | Incorporated by reference to  Exhibit 10.11 of Registrant’s Form 10 (File No. 000-51257)                                                                                                                                                                                                                                                                                                                                                                                     |
| (17) |   | Incorporated by reference to Exhibit 10.12  of Registrant’s Form 10 (File No. 000-51257)                                                                                                                                                                                                                                                                                                                                                                                     |
| (18) |   | The certification attached as  Exhibit 32 that accompanies this Annual Report on Form 10-K is not  deemed filed with the Securities and Exchange Commission and is not to be  incorporated by reference into any filing of Bidz.com, Inc. under the  Securities Act of 1933 or the Securities Exchange Act of 1934, whether made  before or after the date of this Annual Report on Form 10-K,  irrespective of any general incorporation language contained in such filing. |

 

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Tableof Contents

 

**SIGNATURES**

 

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

 
|                          | BIDZ.COM, INC. |
|-------------------------------|---------------------|
|                          |                |
|                          |                |
|                          | By:                 | /s/ DAVID ZINBERG |
|                          |                |   |
| ** **                    | ** **          | **David Zinberg** |
| ** **                    | ** **          | **Chief Executive Officer** |
|                          |                |   |
| Dated: February 23, 2009 |                |   |

 

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 and          |       | February 23, 2009 |
| David Zinberg        |       | Chief Executive Officer (Principal |       |                   |
|                 |       | Executive Officer)                 |       |                   |
|                 |       |                               |       |                   |
| /s/ LAWRENCE Y. KONG |       | Chief Financial Officer and        |       | February 23, 2009 |
| Lawrence Y. Kong     |       | Director (Principal Financial and  |       |                   |
|                 |       | Accounting Officer)                |       |                   |
|                 |       |                               |       |                   |
| /s/ PETER G. HANELT  |       | Director                           |       | February 23, 2009 |
| Peter G. Hanelt      |       |                               |       |                   |
|                 |       |                               |       |                   |
| /s/ MAN JIT SINGH    |       | Director                           |       | February 23, 2009 |
| Man Jit Singh        |       |                               |       |                   |
|                 |       |                               |       |                   |
| /s/ GARRY ITKIN      |       | Director                           |       | February 23, 2009 |
| Garry Itkin          |       |                               |       |                   |

 

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