| **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**                      |

 

** **

**(MarkOne)**

 
| **x**                                                | ** ** | **ANNUAL  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**     |
|------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|
|                                                 |       |                                                                                                     |
| **For the fiscal year ended December 31, 2007** |
|                                                 |       |                                                                                                     |
| **or**                                               |
|                                                 |       |                                                                                                     |
| **o**                                                | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |

 

** **

**For the transition periodfrom                  to**

** **

**Commissionfile Number  000-51257**

** **

**BIDZ.com, Inc.**

(Exact name ofregistrant as specified in its charter)

 

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

 

 

Registrant’s telephonenumber, including area code      **(310) 280-7373**

 

Securities registeredpursuant 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**                      |
|                              |       |                                           |

 

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

 

**CommonStock, $.001 par value**

(Title of class)

 

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act.
|   | o  YES | x  NO |
|--------|------------------|-----------------|

 

 

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 or Section 15(d) ofthe Act.
|   | o  YES | x  NO |
|--------|------------------|-----------------|

 

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.
|   | x  YES | o  NO |
|--------|------------------|-----------------|

 

 

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K(§ 229.405 of this chapter) is not contained herein, and will not becontained, to the best of registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of this Form 10-Kor any amendment to this Form 10-K   o

 

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, a non-acceleratedfiler, or a smaller reporting company. See definitions of  “large accelerated filer,” “accelerated filer,”and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Checkone):

 
| 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 stock held by non-affiliatesof the registrant based upon the price of the common stock as of December 31,2007 was approximately $118.2 million. For purposes hereof, directors,executive officers and 10% or greater shareholders have been deemedaffiliates.  This determination of affiliate status is not necessarily aconclusive determination for others purposes.

 

The number of sharesoutstanding of the registrant’s common stock was 24,556,354 as of February 29,2008.

 

DOCUMENTSINCORPORATED 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 2008 Annual Meeting of Stockholders,which will be filed with the Securities and Exchange Commission within120 days of December 31, 2007.

 

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**BIDZ.COM,INC.**

 

**ANNUAL REPORT ON FORM 10-KFOR THE FISCAL YEAR ENDED DECEMBER 31, 2007**

 

Table of Contents

 
| ** **                                                                                                                 | **Page** |
|----------------------------------------------------------------------------------------------------------------------------|----------|
|                                                                                                                       |     |
| PART I                                                                                                                | 1        |
| Item 1. Business                                                                                                           | 1        |
| Item 1A. Risk Factors                                                                                                      | 12       |
| Item 1B.Unresolved Staff Comments                                                                                          | 23       |
| Item 2. Properties                                                                                                         | 23       |
| Item 3. Legal Proceedings                                                                                                  | 23       |
| Item 4. Submission of Matter to a Vote of Securities  Holders                                                              | 24       |
|                                                                                                                       |     |
| PART II                                                                                                               | 24       |
| Item 5. Market for Registrant’s Common Equity, Related  Stockholder Matters and Issuer Purchases of Equity Securities | 24       |
| Item  6. Selected Financial data                                                                                           | 26       |
| Item 7. Management’s Discussion and Analysis of  Financial Condition and Results of Operations                        | 27       |
| Item 7A. Quantitative and Qualitative Disclosures  about Market Risk                                                       | 35       |
| Item 8. Financial Statements and Supplementary Data                                                                        | 35       |
| Item 9. Changes in and Disagreements With Accounting  on Accounting and Financial Disclosure                               | 35       |
| Item 9A. Controls and Procedures                                                                                           | 35       |
| Item  9B. Other Information                                                                                                | 36       |
|                                                                                                                       |     |
| PART III                                                                                                              | 36       |
| Item 10. Directors and Executive Officers of the  Registrant                                                               | 37       |
| Item 11. Executive Compensation                                                                                            | 37       |
| Item 12. Security Ownership of Certain Beneficial  Owners and Management and Related Stockholder Matters                   | 37       |
| Item 13. Certain Relationships and Related  Transactions                                                                   | 37       |
| Item 14. Principal Accounting Fees and Services                                                                            | 37       |
|                                                                                                                       |     |
| PART IV                                                                                                               | 37       |
| Item 15. Exhibits and Financial Statement Schedules                                                                        | 37       |

 

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**Part I**

 

**Item1.**           Business

** **

**Overview**

 

We are a leading onlineretailer of jewelry, featuring a live auction format. We have established ourretail brand in the online marketplace by offering high-quality merchandise, aunique user-friendly shopping experience, and the opportunity for buyers toachieve significant cost savings versus traditional retail channels. A key toour success has been our ability to efficiently and effectively source 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. The majority ofour auctions are short-term, often lasting less than one hour, providingimmediate gratification to our customers and encouraging frequent visits andactive viewing of our website. Our product inventory includes gold, platinum,and silver jewelry set with diamonds, rubies, emeralds, sapphires, and otherprecious and semi-precious stones; and watches. In addition to our ownproducts, we have several independent merchants that sell art, collectibles andgift items. We offer to sell products through our website at *www.bidz.com.*

 

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

 

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

 

·                  a $1 minimum bid format,

 

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

 

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

 

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

 

We purchase jewelryinventory directly from manufacturers and liquidators. We also closely monitorour sales trends to assess consumer demand for certain jewelry styles andcategories and purchase such non-closeout inventory directly frommanufacturers. We have eliminated various inefficiencies and mark-upsassociated with traditional intermediaries in the jewelry market. Our sourcingmodel provides a critical alternative liquidation channel for manufacturers,for which disposal of closeout inventory represents a significant challenge. Wehave the flexibility to purchase a variety of lot sizes, and our centralizedwarehouse and fulfillment center enables our suppliers to ship their products toa single location, easing the burden on their infrastructures. We havedeveloped a database of product descriptions and pictures that enables us torapidly post inventory for sale. In addition, we closely monitor sales andgross margin trends of our products on a daily basis, allowing us to selectcarefully additional products for purchase and adjust supplier pricing asnecessary.

 

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**History**

 

We commenced operationsin early 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.

 

**IndustryOverview**

 

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

 

The Internet’sdevelopment into a significant global medium for communication, content, andcommerce has led to substantial growth in online shopping and has providedonline retailers with new opportunities to eliminate intermediaries from thetraditional retail supply chain. Internet usage and online commerce continue togrow worldwide. The growth can be attributed to factors such as an increasedawareness of the convenience of online shopping, an expanded range of productsavailable online, improvements in security and electronic payment technology,and increased access to broadband Internet connections facilitating onlineshopping.

 

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.

 

**TheJewelry Market**

 

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

 

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

 

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

 

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

 

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

 

 

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

 

**Our ValueProposition**

 

*Valueto Buyers*

 

Through online auctionson our website, we believe that we offer value to a broad range of customers byproviding the following:

 

***Bargain prices.     ***The price of all our products is dictated by the buyer alone based onthat buyer’s valuation of the product. Therefore, many items offered on ourwebsite are sold at a substantial discount to the prices in traditional retailchannels, such as at jewelry stores located in shopping malls. Our $1 minimumbid policy allows the savvy or lucky consumer the potential to purchase anyproduct being auctioned for only $1, offering even greater value to theconsumer. Regardless of the closing price, once an auction is closed, the finalbidder will receive the product.

 

***Entertaining auction format.***    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 product selection.***    We offer a broad selection ofjewelry, including rings, necklaces, earrings, bracelets, jewelry sets, andwatches. Our selection includes gold and silver jewelry, as well as jewelrywith precious and semi-precious stones.

 

***Product quality assurance.***    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 2007.

 

***Prompt fulfillment and responsive customer service.***    We maintain ininventory all the products we offer on our website, enabling us to ensureprompt order fulfillment and delivery to our customers. Our customer servicerepresentatives are available seven days a week, via live-help and e-mail, andare trained to provide assistance and answer a broad range of questionsregarding payment, delivery, and other matters.

 

***Positive shopping experience.***    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.

 

*Valueto Suppliers*

 

Jewelry manufacturerscontinually look for a cost-effective, efficient way to sell their regular andcloseout inventory. Our ability to purchase jewelry in various quantitiesprovides a critical one-stop inventory clearance alternative for manufacturersand an efficient sales channel for liquidators that purchase closeout inventoryfrom manufacturers.

 

***Single source for product disposition.***    Unlike manymulti-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 product

 

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quantity and deliveryschedule requirements. Products not delivered on time or in exact amounts arereturned. We have the flexibility to tailor our purchasing to a supplier’sneeds with regard to quantity, variety, and timing.

 

***Resolution of channel 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.

 

***Profitable alternative for suppliers.***    We eliminate thevarious inefficiencies and mark-ups associated with traditional intermediaries,and our high volume of sales from a single location provides us with favorableinventory turnover and lower inventory carrying and handling costs versustraditional jewelry retailers. Manufacturers can also sell excess products tous rather than expend the labor and cost of melting and reworking their goldproducts.

 

**GrowthStrategy**

 

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

 

***Expanding our customer 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 sourcing relationships***by expanding the number of suppliers fromwhich we opportunistically purchase regular and closeout inventory, therebyassuring consistent availability of a wide variety of designs and styles ofjewelry, and purchasing for cash from suppliers that do not extend credit termsand to obtain better supplier pricing;

 

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

 

***Opening an online jewelry retail store***in 2008 by allowing fixed price items tobe sold that will complement our core auction format; and

 

***Focusing on new international markets***by expanding into and creating a strongpresence in a number of English-speaking countries, including the UnitedKingdom, Canada, Australia, Ireland, and New Zealand, and introducing foreignlanguage versions of our website in 2008 for certain international markets.

 

**Marketing**

 

Our marketing strategy isdesigned to generate consumer traffic by increasing awareness of our websiteand recognition of our brand, building a loyal buyer base, and maximizingrepeat purchases. Our website has experienced substantial growth in users andbuyers, as evidenced through data compiled by us through the measurement toolson our website.

 

Our marketing andadvertising efforts consist primarily of the following initiatives:

 

***Search marketing:    ***We purchase search engine advertisingprimarily at an auction based price, which is paid each time a potentialcustomer clicks on one of our advertisements. We currently maintain advertisingrelationships with, among others, Google (US, Australia, Canada, EuropeanUnion, South East Asia, Mid East and South America), Yahoo (US, and Australia),MSN for search engine advertising.

 

***Online banner marketing:***    We utilize banner advertisementsfrom the largest banner advertising channels. We focus on contextual andbehavioral advertisements that appear on websites related to jewelry, fashion,shopping and women’s lifestyle. The Company maintains portal advertisingrelationships with Yahoo, MSN, Casale Media, 

 

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

 

***Affiliate programs:***    We attract customers byparticipating in affiliate programs. Our affiliate programs offer other websiteoperators an opportunity to earn commissions by providing their visitors accessto our website. We use Link Share for our U.S. and U.K. programs and CommissionJunction for our European affiliate programs. We also work with several otherAffiliate Networks including Azoogle, Hydra Media and Neverblue Media. In sodoing, we intend to extend the reach of our website and draw customers from avariety of other websites. By participating in our affiliate programs, websitepublishers earn volume-based commissions by directing customers to our website.

 

**SourcingStrategy**

 

We purchase closeoutinventory directly from manufacturers and liquidators. We also closely monitorour sales trends to assess consumer demand for certain jewelry styles andcategories and purchase regular jewelry inventory directly from manufacturers.We have eliminated various inefficiencies and mark-ups associated with traditionalintermediaries in the jewelry market. Our sourcing model provides a criticalalternative liquidation channel for manufacturers, for which disposal ofcloseout inventory represents a significant challenge. We have the flexibilityto purchase a variety of lot sizes, and our centralized warehouse andfulfillment center enables our suppliers to ship their products to a singlelocation, easing the burden on their infrastructure. We have developed adatabase of product descriptions and pictures that enables us rapidly to postinventory for sale. In addition, we closely monitor sales and gross margintrends of our products on a daily basis, allowing us to select carefullyadditional products for purchase and adjust supplier pricing as necessary.

 

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

 

We do not have any formalor binding supply agreements with any of our suppliers, manufacturers,distributors, or other suppliers. We purchase and carry inventory in all of theproducts we offer for sale to ensure availability and expedited delivery.Currently, we acquire inventories from our suppliers on a cash and revolvingcredit basis with payment typically due within 60 to 90 days. In an effortto achieve cost efficiencies and a more diverse supplier base, we have startedto acquire substantially more products on a cash basis. This strategy willallow for more flexibility to increase our product 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, fromtime to time, loose diamonds and semi-previous stones and deliver them tomanufacturers to produce into finished jewelry inventory. This source ofinventory allows us to reduce our product costs.

 

**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 company-owned merchandise start at$1, losses are incurred on approximately 15% to 25% of the items sold on anannual basis. The risks associated with a $1 minimum bid auction are mitigatedby profits generated from items sold at a gain, which resulted in an overall29.1% gross profit margin in 2007.

 

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We post more expensiveitems with 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.

 

**TechnologyOperations**

 

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

 

Our system architectureis built on industry-standard platforms that are designed to provide continuousservice 24 hours a day, 365 days per year. Our website servers arelocated at a third-party co-location facility operated by Savvis Inc. in ElSegundo, CA. Savvis provides redundant internet connectivity, physicalsecurity, climate control, redundant power delivered through a 100% uptimeguarantee. The back-office processing system is housed in our headquarters inCulver City and communicates with Savvis over four independent T1 lines. Thesesystems include both Oracle and Microsoft SQL database engines operating in amulti-processing Microsoft Windows environment designed to accommodate largevolumes of online traffic and are configured for high fault tolerance withredundancy and load balancing. Our Internet servers utilize VeriSign Inc.digital certificates to provide secure website communications for sales andpayment transactions.

 

In the fourth quarter weimplemented a major system upgrade that has moved our primary auction system toSavvis Inc. This upgrade included a complete re-write of our core auctionplatform. The auction platform is now running as a J2EE (Java 2 EnterpriseEdition) application utilizing Oracle 11g for robust transaction management.Included in the upgrade, we have also deployed the following solutions at theSavvis data center:

 

·                  anEnterprise SAN (Storage Area Network) Solution from Hitachi

 

·                  anEnterprise Network solution from Cisco Systems including Firewall, LoadBalancer, Secure VPN, Gigabit switching and IDS (Intrusion Detection System)

 

·                  Standardizedx64 Sun Fire Servers

 

We are currently planningto develop a second co-location in a different region to provide greater loadbalancing and disaster recovery. We utilize the firewall protection and theservices of TrustWave, which provides regular scanning of our systems forsecurity vulnerabilities and PCI compliance.

 

At December 31,2007, we had a technology and development staff of 23. We have structured thetechnology and development into two distinct departments: software developmentand production support. We anticipate that we will continue to devotesignificant resources to product development and product management in thefuture as we add new features and functionality.

 

**CustomerService and Fulfillment Operations**

 

An important element ofour sales strategy is to provide a high level of customer service support inorder to establish long-term relationships with our customers and encouragerepeat visits and purchases. Our customer service support staff providesdetailed payment, billing, and delivery guidance and is trained to answer abroad array of questions regarding auctions and payments conducted on ourwebsite. Our informed and helpful staff, together with the informative andeducational aspects of our website, promote customer confidence in purchasedecisions.

 

At December 31,2007, we had a customer service and billing staff of 31. We utilize automatedonline live-help, e-mail and phone systems to route traffic to our customerservice and billing support representatives to provide personalized assistance.The customer service center operates between the hours of 8:00 a.m. and5:00 p.m., Pacific time, seven days a week for telephone support and24 hours a day for online live-help and e-mail support. We outsourcesubstantially all of our online live-help and e-mail support.

 

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Customers may utilize thefollowing payment methods: credit card, money orders, and checks. We also offerour customers the opportunity to make payments using PayPal and Bill-Me-Laterservices. We require payment to be received by us prior to shipping themerchandise.

 

We maintain a fraudprevention department to detect suspect payments. Our internal system flagssuspect payments when the billing address or other pertinent information doesnot match cardholder information. Our fraud prevention department then requeststhat the customer provide additional information to verify identity beforeshipment is released.

 

We provide our customerswith a five-day grace period to pay for products won through auctions. Ifpayment is not received by the fifth day, the purchase order lapses and theproduct is cycled back into inventory. If a customer purchases additional itemsduring the five-day period, we offer the customer the opportunity to save onshipping by aggregating all purchased items into one shipment at a cost of only$3 per additional item for up to 30 items. If payment is not made within thefive-day period, the product is offered for auction again and thus the sameitem may be auctioned more than once.

 

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

 

We have a 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 as describedare subject to a 15% restocking fee. Our facility has security controls andrestricted access and has been designed for the prompt receipt, storage, andshipment of our products. In addition, we have security guards on duty24 hours a day, seven days a week to patrol the premises. Security iscomplemented by video and alarm surveillance.

 

**Seasonality**

 

Historically, sales inthe jewelry industry are seasonal and have been higher in the fourth quarter asa result of higher consumer spending during the December holiday shoppingseason. Approximately 33.9%, 28.5% and 33.8% of our net revenue in 2005, 2006and 2007, respectively, was generated during the fourth quarter. As we continueto grow, we expect to experience more pronounced seasonal fluctuations in ournet revenue and anticipate a disproportionate amount of our revenue will be inthe fourth quarter.

 

**Competition**

 

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

 

·              price,

 

·              productquality and selection,

 

·              vendorreliability,

 

·              shoppingconvenience,

 

·              customerservice, and

 

·              brandrecognition.

 

We currently compete witha variety of online auction jewelry sellers, such as eBay and uBid; onlineliquidation companies, such as Overstock; and online jewelry retailers, such asBlue Nile. We also compete with traditional offline jewelry retail chains, suchas Zales, Finlay Fine Jewelry, and Reed’s Jewelers, as well as with departmentand discount and other stores that sell jewelry at wholesale prices, such asWal-Mart, Target, J. C. Penney, and Costco, as well as with QVC and Home 

 

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Shopping Network. Wecompete primarily on the basis of our prices, the selection of merchandise, andour website functionality and ease-of-use. The negative factors relating to ourcompetitive position relate primarily to the relative size and name recognitionof our competitors.

 

As the online regularjewelry and liquidation market grows, we believe that companies involved inonline retail, as well as traditional retailers and liquidation brokers, willincrease their efforts to develop services that compete with our onlineservices. We also face potential competition from online companies not yetfocused on the liquidation market and from retail companies not yet operatingonline.

 

Many of our competitorshave greater brand recognition, longer operating histories, larger customerbases, and significantly greater financial, marketing, and other resources thanwe do. Smaller competitors may enter into strategic or commercial relationshipswith larger, more established and well-financed companies. Some of ourcompetitors could enter into exclusive distribution arrangements with oursuppliers and deny us access to their products, devote greater resources tomarketing and promotional campaigns, and devote substantially more resources totheir website and systems development than we do. New technologies and thecontinued enhancement of existing technologies also may increase competitivepressures on us.

 

**IntellectualProperty**

 

We regard our domainnames and similar intellectual property as critical to our success. However, wedo not hold any patents or registrations on such intellectual property. We relyon a combination of laws and contractual restrictions with our employees,customers, suppliers, affiliates, and others to establish and protect ourproprietary rights. Despite these precautions, it may be possible for a thirdparty to copy or otherwise obtain and use our intellectual property withoutauthorization. In addition, others may independently develop substantiallysimilar intellectual property. Although we are pursuing the registration of ourkey trademarks and patents in the United States, some of our trade names arenot eligible to receive trademark protection. In addition, effective trademarkand patent protection may not be available or may not be sought by us in everycountry in which our products are made available online.

 

From time to time, we maybe subject to legal proceedings and claims in the ordinary course of ourbusiness, including claims of alleged infringement of the trademarks and otherintellectual property rights of third parties. In addition, litigation may benecessary in the future to enforce our intellectual property rights, to protectour trade secrets, or to determine the validity and scope of our intellectualproprietary rights and those of others. Any such litigation, regardless ofoutcome or merit, could result in substantial costs and diversion of managementand technical resources, any of which could materially harm our business.

 

**GovernmentRegulation**

 

We are subject to federaland state consumer protection laws, including laws protecting the privacy ofconsumer non-public information and regulations prohibiting unfair anddeceptive trade practices. In particular, under federal and state financialprivacy laws and regulations, we must provide notice to consumers of ourpolicies on sharing non-public information with third parties, must provideadvance notice of any changes to our policies and, with limited exceptions,must give consumers the right to prevent sharing of their non-public personalinformation with unaffiliated third parties. Furthermore, the growth and demandfor online commerce could result in more stringent consumer protection lawsthat impose additional compliance burdens on online retailers. These consumerprotection laws could result in substantial compliance costs and couldinterfere with the conduct of our business.

 

Moreover, there iscurrently great uncertainty in many states whether or how existing lawsgoverning issues such as property ownership, sales and other taxes, and libeland personal privacy apply to the Internet and commercial online retailers.These issues may take years to resolve. For example, tax authorities in anumber of states, as well as a Congressional advisory commission, are currentlyreviewing the appropriate tax treatment of companies engaged in onlinecommerce, and new state tax regulations may subject us to additional statesales and income taxes. New legislation or regulation, the application of lawsand regulations from jurisdictions whose laws do not currently apply to ourbusiness, or the application of existing laws and regulations to the Internetand commercial online services could result in significant additional taxes onour business. These taxes could have an adverse effect on our results ofoperations. Furthermore, there is a possibility that we may be subject to significantfines or other payments for any past failures to comply with theserequirements.

 

Numerous states andforeign jurisdictions, including California, where our headquarters is located,have regulations regarding how auctions may be conducted and the liability ofauctioneers in conducting such auctions. No final legal determination has 

 

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been made whether theCalifornia regulations apply to businesses such as the business we conduct, andlittle precedent exists in this area. Several states and some foreignjurisdictions have attempted, and may attempt in the future, to impose suchregulations upon companies similar to us and their customers, which could harmour business. Regulatory and licensure claims could result in costly litigationor could require us to change our manner of doing business in ways thatincrease our costs or reduce our revenue or force us to prohibit listings ofcertain items for some locations. We could also be subject to fines or otherpenalties. Any of these outcomes could harm our business.

 

California applies the burden of security risks tothose owning and operating computer systems and networks, under a mandatorydisclosure law (SB 1386).  Companiesholding computerized personal information of California residents are requiredto take steps either to encrypt this personal information or adopt, as part ofan information security policy, notice and disclosure procedures for anycomputer security breaches, whether or not the breach occurs in California. Ifwe were found to be noncompliant we would be subject to civil suits, includingclass actions, for damages and injunctive remedies in California courts.

 

**Employees**

 

At December 31,2007, we had 235 full-time and 5 part-time employees. 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 otheremployment-related benefits, we are responsible for such payments and forcomplying with state and federal employment regulations, as well as allpersonnel management policies and procedures that are maintained byAdministaff. We pay Administaff a fee based on the aggregate salaries paid toour employees for these services.

 

**DelawareReincorporation**

 

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 discussiondescribes the Delaware Certificate of Incorporation and the Bylaws that wereadopted and is intended to be a summary and does not describe all provisions ofour certificate of incorporation or bylaws or Delaware law that may beapplicable to us. For a more thorough understanding of the terms of our capitalstock, you should refer to our certificate of incorporation and bylaws, whichhave been filed as exhibits to this report.

 

**CommonStock**

 

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

 

**PreferredStock**

 

Our certificate ofincorporation authorizes our Board of Directors, without any vote or action bythe holders of our common stock, to issue preferred stock from time to time inone or more series. Our Board of Directors is authorized to determine thenumber of shares and to fix the designations, powers, preferences, and the relative,participating, optional, or other rights of any series of preferred stock.Issuances of preferred stock would be subject to the applicable rules ofNasdaq or other organizations on which our securities are then quoted orlisted. Depending upon the terms of preferred stock established by our Board ofDirectors, any or all series of preferred stock could have preference over thecommon stock with respect to 

 

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dividends and otherdistributions and upon our liquidation. If any shares of preferred stock areissued with voting powers, the voting power of the outstanding common stockwould be diluted. No shares of preferred stock are presently outstanding, andwe have no present intention to issue any shares of preferred stock.

 

**Anti-TakeoverEffects of Provisions of the Certificate of Incorporation and Bylaws**

 

*General*

 

Our Delaware certificateof incorporation, our bylaws, and the DGCL contain certain provisions thatcould delay or make more difficult an acquisition of control of our company notapproved by our Board of Directors, whether by means of a tender offer, openmarket purchases, a proxy contest, or otherwise. These provisions have beenimplemented to enable us, particularly but not exclusively in the initial yearsof our existence as a publicly owned company, to develop our business in amanner that will foster our long-term growth without disruption caused by thethreat of a takeover not deemed by our Board of Directors to be in thebest interests of our company and our stockholders. These provisions could havethe effect of discouraging third parties from making proposals involving anacquisition or change of control of our company even if such a proposal, ifmade, might be considered desirable by a majority of our stockholders. Theseprovisions may also have the effect of making it more difficult for thirdparties to cause the replacement of our Board of Directors or our currentmanagement without the concurrence of our Board of Directors.

 

There is set forth belowa description of the provisions contained in our Delaware certificate ofincorporation and bylaws and the DGCL that could impede or delay an acquisitionof control of our company that our Board of Directors has not approved. Thisdescription is intended as a summary only and is qualified in its entirety byreference to our certificate of incorporation and bylaws, which are included asexhibits to this report, as well as the DGCL.

 

*Authorizedbut Unissued Preferred Stock*

 

Our certificate of incorporationauthorizes our Board of Directors to issue one or more series of preferredstock and to determine, with respect to any series of preferred stock, theterms and rights of such series without any further vote or action by ourstockholders. The existence of authorized but unissued shares of preferredstock may enable our Board of Directors to render more difficult or discouragean attempt to obtain control of our company by means of a proxy contest, tenderoffer, or other extraordinary transaction. Any issuance of preferred stock withvoting and conversion rights may adversely affect the voting power of theholders of common stock, including the loss of voting control to others. Theexistence of authorized but unissued shares of preferred stock will also enableour Board of Directors, without stockholder approval, to adopt a “poison pill”takeover defense mechanism. We have no present plans to issue any shares ofpreferred stock.

 

*Numberof Directors; Removal; Filling Vacancies*

 

Our certificate of incorporationand bylaws provides that the number of directors shall be fixed only byresolution of our Board of Directors from time to time. Our certificate ofincorporation provides that directors may be removed by stockholders for causeby the affirmative vote of a majority of the shares entitled to vote. Delawarelaw provides that vacancies on the Board of Directors may be filled only by amajority vote of the remaining directors or by the sole remaining director.

 

*ClassifiedBoard*

 

Our certificate of incorporationprovides for our board to be divided into three classes, as nearly equal innumber as possible, serving staggered terms. Approximately one-third of ourboard will be elected each year. See “Management—Board of Directors.” 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.

 

*StockholderAction*

 

Our certificate ofincorporation provides that stockholder action may be taken only at an annualor special meeting of stockholders. This provision prohibits stockholder actionby written consent in lieu of a meeting. Our certificate of 

 

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

 

The provisions of ourcertificate of incorporation and bylaws prohibiting stockholder action bywritten consent may have the effect of delaying consideration of a stockholderproposal until the next annual meeting unless a special meeting is called asprovided above. These provisions would also prevent the holders of a majorityof the voting power of our stock from unilaterally using the written consentprocedure to take stockholder action. Moreover, a stockholder could not forcestockholder consideration of a proposal over the opposition of the Board ofDirectors by calling a special meeting of stockholders prior to the time ourchairman or a majority of the whole board believes such consideration to beappropriate.

 

*AdvanceNotice for Stockholder Proposals and Director Nominations*

 

Our bylaws establish anadvance notice procedure for stockholder proposals to be brought before anyannual or special meeting of stockholders and for nominations by stockholdersof candidates for election as directors at an annual meeting or a special meetingat which directors are to be elected. Subject to any other applicablerequirements, including, without limitation, Rule 14a-8 under the ExchangeAct, only such business may be conducted at a meeting of stockholders as hasbeen brought before the meeting by, or at the direction of, our Board ofDirectors, or by a stockholder who has given our Secretary timely writtennotice, in proper form, of the stockholder’s intention to bring that businessbefore the meeting. The presiding officer at such meeting has the authority tomake such determinations. Only persons who are nominated by, or at thedirection 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.

 

*Amendmentsto Bylaws*

 

Our certificate ofincorporation provides that only our Board of Directors or the holders of amajority of the shares entitled to vote at an annual or special meeting ofstockholders have the power to amend or repeal our bylaws.

 

*Amendmentsto Certificate of Incorporation*

 

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

 

*DelawareStatutory Provisions*

 

Anti-Takeover Provisionof Delaware Law. Under Section 203 of the DGCL, no Delaware corporationshall engage in a “business combination” with an “interested stockholder” for aperiod of three years following the date that the stockholder became aninterested stockholder. “Business combination” includes a merger,consolidation, asset sale, or other transaction resulting in financial benefitto the interested stockholder. “Interested stockholder” is a person who,together with affiliates and associates, owns, or within three years, did own15% or more of the corporation’s voting stock. This prohibition does not applyif:

 

·                                          prior to the time that the stockholderbecame an interested stockholder, the board of directors of the corporationapproved either the business combination or the transaction resulting in thestockholder’s becoming an interested stockholder,

 

·                                          upon consummation of the transactionresulting in the stockholder’s becoming an interested stockholder, thestockholder owns at least 85% of the outstanding voting stock of thecorporation, excluding voting stock owned by directors who are also officersand certain employee stock plans, or

 

·                                          at or subsequent to the time that thestockholder became an interested stockholder, the business combination isapproved by the board and authorized at an annual or special meeting ofstockholders, and not by written consent, by the affirmative vote of at leasttwo-thirds of the outstanding voting stock that the interested stockholder doesnot own.

 

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

 

**Limitationof Liability and Indemnification of Officers and Directors**

 

Our certificate ofincorporation limits the liability of our directors to the fullest extentpermitted by the DGCL. In addition, our certificate of incorporation and bylawsprovide that we will indemnify our directors and officers to the fullest extentpermitted by law.

 

**Indemnificationfor Securities Act Liabilities**

 

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

 

**TransferAgent and Registrar**

 

Thetransfer agent and registrar for our common stock is American Stock Transfer &Trust Company. The transfer agent’s address is 6201 15th Avenue,Brooklyn, New York 11219 and its telephone number is (718) 921-8124.

 

**ITEM 1A.  Risk Factors**

 

*Webelieve the risks and uncertainties described below are the most significant weface. The occurrence of any of the following risks could harm our business. Inthat case, the value of our common stock could decline, and you may lose partor all of your investment. Additional risks and uncertainties not presentlyknown to us or that we currently deem immaterial may also impair ouroperations.*

 

***We have established a public market for our common stock on the NASDAQCapital Market; our stock is subject to short selling and trading in our commonstock may be volatile.***

 

Since November 2007,we have been included by Nasdaq on the Regulation SHO Threshold Security List,which may be indicative of a significant amount of naked shorting in our commonstock.  As defined in Rule 203(c)(6) ofRegulation SHO, a “threshold security” is any equity security of any issuerthat is registered under Section 12 of the Exchange Act, or that isrequired to file reports under Section 15(d) of the Exchange Act(commonly referred to as reporting securities), where, for five consecutivesettlement days: (i) there are aggregate fails to deliver at a registeredclearing agency of 10,000 shares or more per security; the level of fails isequal to at least one-half of one percent of the issuer’s total sharesoutstanding; and the security is included on a list published by aself-regulatory organization (SRO).   Asecurity ceases to be a threshold security if it does not exceed the specifiedlevel of fails for five consecutive settlement days. Short selling and possiblemarket price manipulation of our common stock has a negative effect on thetrading price of our common stock and may cause trading in our common stock tobe volatile.

 

***The trading price in our common stock may be volatile and you may loseall or part of your investment.***

 

Themarket price of our common stock has been subject to significant fluctuationsand these fluctuations could continue. Some factors that could affect themarket price of our common stock are as follows:

 

·                  actual or anticipated changes in ouroperating results,

·                  changes in research analystsrecommendations or estimates of financial performance,

·                  changes in market valuation of similarcompanies, economic  and general marketconditions,

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

·                  our issuance of additional shares ofcommon stock or other securities, and

·                  intellectual property or litigationdevelopments.

 

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Tradingin our common stock may experience significant price and volume fluctuationsand adversely affect the trading price of our common stock. Following periodsof volatility in the market price of a public company’s securities, securitiesclass action litigation has often been instituted against that company. Suchlitigation could result in substantial cost and a diversion of management’sattention and resources.

 

***We must continue to generate a high volume of visitortraffic to our website and convert those visitors into buyers.***

 

Our net revenue dependsto a significant extent on the number of customers who visit our website topurchase merchandise and the dollar amount of their purchases. Generatingincreased traffic to our website and converting that traffic into buyersrequires us to achieve effective results from our marketing campaigns; offer awide variety of products that our customers can purchase at favorable prices; maintaina user-friendly shopping experience; ensure the satisfactory availability,performance, and reliability of our website, network infrastructure, andtransaction processing systems; and provide high-quality customer service. Ourbusiness will be harmed if we are unable to increase our customer base and thedollar volume of the orders customers place with us.

 

***Weare subject to “prank” bidding by persons who are not required to provide theiridentification.***

 

Presently, we do notrequire new users to our site to provide their identification uponregistration.  Consequently, from time totime we are subject to “prank” bidders who may win auctions but do not intendto purchase our merchandise.  Althoughthe Company reauctions merchandise not purchased by such bidders, a largenumber of failed auctions in which winning bidders do not complete theirpurchases could adversely affect our results of operations.

 

***We may face increasing costs to acquire new customers.***

 

The acquisition of newcustomers is a key factor in increasing demand for our jewelry products andincreasing our revenue. We currently attract new customers by driving trafficto our website using a marketing and advertising strategy that includestargeted keyword searches, online banner advertising, targeted e-mailadvertising, and participation in affiliate programs. We do not maintainlong-term contracts or arrangements with any companies, including any searchengines, Internet portals, or other websites, and we may not successfully enterinto additional relationships or maintain existing ones. In addition, trafficto our website could decline if our online marketing programs become lesseffective or the traffic decreases to the search engines, Internet portals, andwebsites with which we advertise. Our business could be materially andadversely affected if any substantial number of companies on which we advertiseexperience financial or operational difficulties or experience other corporatedevelopments that adversely affect their performance. A failure to maintain orexpand existing online advertising relationships or to establish additionalonline advertising relationships that generate a significant amount of trafficfrom other websites could result in decreased sales or limit the growth of our business.

 

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

 

We believe thatcontinuing to increase the popularity of our website will be critical toexpanding our business. Promoting and positioning our website will dependlargely on the success of our marketing efforts and our ability to provide avariety and sufficient quantity of high-quality products at attractive pricesin a convenient manner. Promoting our website will require us to increase ourmarketing budget and otherwise increase our financial commitment to creatingand maintaining brand loyalty among users. Brand promotion activities may notyield increased revenue, and even if they do, any increased revenue may not offsetthe expenses we incur in building our website popularity and our brand. If wedo attract new users to our website, they may not conduct transactions on afrequent basis or in sufficient dollar amounts. If we fail to promote andmaintain our website or incur substantial expenses in an unsuccessful attemptto promote and maintain our brand, our business would be harmed.

 

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

 

In 2006 and 2007, 20.8%and 22.3%, respectively, of our net revenue was generated by shipments tocustomers outside of the United States. We plan, over time, to expand our reachinto international markets. We do not, however, currently have any overseasfulfillment, distribution, or server facilities or any website contentlocalized for foreign markets. We cannot be certain that we will be able toexpand our global presence. In addition, there are certain risks associatedwith doing business 

 

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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 complaints or negative publicity about our customerservice could adversely affect our reputation and, as a result, our businesscould suffer.***

 

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

 

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

 

We have a limitedoperating history. As a result, it is difficult to forecast accurately oursales or operating expenses. We base our estimated expense levels on ouroperating forecasts and estimates of future sales. Sales and results ofoperations are difficult to forecast because they generally depend on thenumber, dollar volume, and timing of the orders we receive, which areuncertain. Some of our expenses are fixed, making it difficult to adjust ourspending in a timely manner to take into account any unexpected shortfall insales. 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.

 

***Quarterlyfinancial results may not be consistent and impact our stock price.***

 

There are numerousinfluences on our quarterly financial results that extend beyond the normalseasonal trends. Fluctuations that are under our control include: our abilityto influence the timing and quantity of items we place for auction; our decisionto acquire merchandise at favorable prices; our expenditures on marketing andour ability to attract customer visits to our website. Fluctuations that arenot under our control that may directly impact our quarterly financial resultsinclude: changes in market price for precious metals and gems; changes inconsumers’ discretionary income and demand for our products; and changes infashion trends.

 

***Wemay be at risk to accurately report financial results or detect fraud if wefail to maintain an effective system of internal controls.***

 

As directed by Section 404 of the Sarbanes-OxleyAct of 2002, the Securities and Exchange Commission adopted rules requiringpublic companies to include a report that contains an assessment by managementon the company’s internal control over financial reporting in their annualreports on Form 10-K. In addition, the independent registered publicaccounting firm auditing the company’s financial statements must attest to andreport on our assessment of the effectiveness of the internal controls overfinancial reporting. While we are consistently working on improvements andconducting rigorous reviews of our internal controls over financial reporting,our independent auditors may interpret Section 404 requirements and applyrelated rules and regulations differently. If our independent auditors arenot satisfied with our internal control over financial reporting or with thelevel at which it is documented, operated or reviewed, they may decline toattest to management’s assessment or issue a qualified report. Additionally, ifwe are not able to meet all the requirements of Section 404 in a timelymanner or with adequate compliance, we might be subject to sanctions orinvestigation by regulatory authorities, such as the Securities and ExchangeCommission.

 

Future changes in ouraccounting, financial reporting, and regulatory environment may create newareas of risk exposure. Failure to modify our existing control environmentaccordingly may impair our controls over financial reporting and cause ourinvestors to lose confidence in the reliability of our financial reporting,which may adversely affect our stock price.

 

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

 

The success of ourbusiness depends, in part, on our ability to offer our customers a wide varietyof jewelry that they can 

 

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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.

 

In addition, we have aconcentration of inventory purchases from a small number of suppliers. Our toptwo suppliers accounted for approximately 42.1%, 31.1% and 24.0 % of our totalpurchases in 2005, 2006, and 2007, respectively. In 2007, we purchased 12.1% ofour merchandise from R-7 and 11.9% from LA Jewelers, Inc.

 

***We have given substantial deposits of inventory to ourmanufacturing vendors to produce finished jewelry products.***

 

We maybe at risk of loss for the diamonds, precious and semi-precious gems that wehave given to our manufacturing vendors to produce into finished jewelryproducts. If the businesses of the vendors fail, the diamond inventory is lostor stolen, the vendors do not have adequate insurance coverage or if thevendors fail to produce and deliver finished jewelry products, we would incursubstantial losses that would have a material impact on our net income andfinancial position.

 

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

 

The market for onlineauctions is rapidly evolving and intensely competitive. We expect competitionto intensify further in the future. Barriers to entry are relatively low, andcurrent and new competitors can launch new websites at relatively low costusing commercially available software.

 

We currently compete witha number of other companies, and other competitors may appear in the future.Our competitors currently include various online auction services and retailersthat offer jewelry, including eBay, Blue Nile, Overstock, and uBid. We alsoencounter competition from national jewelry retail chains, such as Zales, KayJewelers, and Finlay Fine Jewelry, and mass retailers and other enterprisesthat sell jewelry, such as Wal-Mart, Target, J. C. Penney, Costco, QVC, andHome Shopping Network. Many of our competitors have greater brand recognition,longer operating histories, larger customer bases, and significantly greaterfinancial, marketing, and other resources than we do. Smaller competitors mayenter into strategic or commercial relationships with larger, more established,and well-financed companies. Other competitors may enter into exclusivedistribution agreements with our suppliers that deny us access to suppliers’products. Competitors may also devote greater resources to marketing andpromotional campaigns and to website and systems technology than we do. We maynot be able to compete successfully against current and future competitors oraddress increased competitive pressures. Furthermore, attempts have been madein the past to develop and market synthetic stones and gems to compete in themarket for gemstones and gemstone jewelry. We expect such efforts to continuein the future. If any such efforts are successful in creating widespread demandfor synthetic or alternative gemstone products, demand and price levels for ourproducts could decline and our business and results of operations would besubstantially harmed.

 

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

 

Luxury products, such asjewelry, are discretionary purchases for consumers. The volume and dollaramount of such purchases may be affected by adverse trends in the generaleconomy and consumer perceptions of those trends, and purchases maysignificantly decrease during economic downturns. The success of our businessdepends in part on macroeconomic factors, such as employment levels, salarylevels, tax rates, and credit availability, all of which affect disposableincome and consumer spending. Any reduction in disposable income or consumerspending may affect us more significantly than companies in other industries.

 

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

 

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

 

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

 

If our sales increase, wewill be required to increase our inventory proportionately. Consumer tastes andpreferences for jewelry products can change rapidly, thereby exposing us tosignificant inventory risks. Currently, because the products we sell alsoconsist of closeout merchandise from manufacturers, distributors, and othersuppliers, we have less control over the specific items that we offer for salethan we would if we primarily ordered goods for manufacture for us. Inaddition, it is important that we are able to purchase jewelry that we perceiveto be in demand. The demand for specific products can change between the timewe order items and when we sell them. As a result, we may be required to takesignificant inventory markdowns, which could reduce our gross margin, if we donot accurately predict these trends or if we overstock unpopular merchandise.

 

***We may be subject to a tax liability for past sales and ourfuture sales may decrease if we are required to collect sales and use taxes onthe products we sell.***

 

In accordance withcurrent industry practice and our interpretation of current law, we do notcurrently collect sales or other taxes with respect to shipments of goods intostates other than California. However, one or more states or foreign countriesmay seek to impose sales or other tax obligations on us in the future. Asuccessful assertion by one or more states or foreign countries that we shouldbe collecting sales or other taxes on the sale of our products could result insubstantial tax liabilities for past and future sales, discourage customersfrom purchasing products from us, decrease our ability to compete withtraditional retailers, and otherwise substantially harm our business, financialcondition, and results of operations.

 

***We rely on suppliers and third-party carriers as part of ourfulfillment process, and these third parties may fail to meet shippingschedules or requirements****.*

 

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

 

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

 

The jewelry industry isaffected by fluctuations in the prices of precious metals and precious andsemi-precious stones. The availability and prices of gold, silver, platinum,and other precious metals and precious and semi-precious stones may beinfluenced by such factors as cartels, political instability in exportingcountries, changes in global demand, and inflation. Shortages of thesematerials or an increase in their prices could reduce the quantity of productswe have available for sale and our ability to sell our products for more thanour cost, causing reduced sales or lower margins compared to our historical andexpected sales and margins.

 

***The satisfactory availability, performance, and reliabilityof our website, network infrastructure, and transaction processing systems arecritical to our ability to attract, retain, and service customers.***

 

Any problems with theavailability, performance, or reliability of our website, networkinfrastructure, or transaction processing systems could result in decreasedcustomer traffic, reduced orders, reduced order fulfillment performance, andlower net revenue as well as negative publicity and damage to our reputation.In order to remain competitive, we must continually seek to improve and expandthe functionality and features of our website, network infrastructure,transaction processing systems, and delivery and shipping functions to accommodateany substantial increase in the volume of traffic to and orders from ourwebsite. We may not be successful in these efforts, and we may not be able toproject accurately the rate or timing of increases, if any, in the use of orsales 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.

 

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***Our business operations could be disrupted due to the lackof documentation of our internally developed software application systems anddependence on key system developers to maintain the system.***

 

Our business depends inpart on continuous and uninterrupted online availability to our customers. Ourinternally developed software application systems are not fully documented andthis makes it more difficult to locate and trouble shoot problems that mayoccur in our systems. Any delays in resolving system problems will result inlonger disruptions to the service available to our customers and/or prevent ouremployees from performing their functions efficiently. The internally developedAuction platform, Billing, Shipping, and Inventory Control systems are notfully documented. We are dependent on institutional knowledge of our key systemdevelopers to provide ongoing support and functional enhancements. If we wereto lose the services of these key systems support personnel, operations maysuffer from system down time that would take longer than desirable to correctand return to normal operations.

 

***Our business and results of operations would be harmed inthe event of any failure of our auction and bidding systems hardware, which islocated at a single third-party co-location facility, or any failure of ourfulfillment and administrative hardware.***

 

Our business depends inpart on the efficient and uninterrupted operation of our computer andcommunications hardware. The servers and other hardware necessary to operateour website, including our auction and bidding systems, are located at a singlethird-party co-location facility in El Segundo, CA. We rely on that facility toprovide Internet access with the speed, capacity, and reliability we require.Our servers and other hardware that run our transaction processing, orderfulfillment, and office administration tasks are located at our headquarters.Our servers and other hardware are vulnerable to damage or interruption fromhuman error, fire, flood, power loss, telecommunications failure, terroristattacks, acts of war, break-ins, earthquakes, and similar events. We do notcurrently have redundant systems in multiple locations or a formal disasterrecovery plan, and our business interruption insurance may be insufficient tocompensate us for any losses that may occur. In addition, our servers arevulnerable to computer viruses, physical or electronic break-ins, and similardisruptions, which could lead to interruptions, delays, loss of critical data,the inability to accept and fulfill customer orders, or the unauthorizeddisclosure of confidential customer data. System disruptions or failures wouldalso create a large number of customer questions and complaints that need to beaddressed by our customer service support personnel. The occurrence of any ofthe foregoing risks could substantially harm our business and results ofoperations. Our systems are vulnerable to damage or interruption fromearthquakes, floods, fires, power loss, telecommunication failures, terroristattacks, computer viruses, computer denial-of-service attacks, and similarevents.

 

***We may not be able to increase our capacity or respond torapid technological changes in a timely manner or without serviceinterruptions, which may harm our business.***

 

We may not be able toaccommodate any substantial growth in traffic or user demand on our website,network infrastructure, and transaction processing systems in a timely manneror without substantial costs. If we are unable to upgrade our existingtechnology, network infrastructure, and transaction processing systems toaccommodate any increased sales volume, our potential customers may bedissatisfied and may purchase merchandise from our competitors. We may alsofail to provide enough capacity in our customer service and sales supportfunctions to provide a high level of customer service. A failure to implementnew systems and increase customer service capacity effectively could adverselyaffect our sales. Enhancement of our website, network infrastructure, andtransaction processing systems will require us to spend a significantly higheramount than we have in the past. Moreover, to date, our spending in these areasas a percentage of revenue has been lower than industry averages. We haveincreased sigficantly in 2007 our system expenditures to accommodate theseneeds.

 

We also intend tointroduce additional or enhanced features and services to retain currentcustomers and attract new customers to our website. We may experiencedifficulties that could delay or prevent us from introducing new features andservices. If we introduce a feature or a service that is not favorably received,our current customers may not use our website as frequently and we may not besuccessful in attracting new customers. These new features or services also maycontain errors that are discovered only after their introduction, and we mayneed to modify significantly the design of these features or services tocorrect errors.

 

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

 

A significant barrier toonline commerce and communications is the secure transmission of confidentialinformation over public networks. Third parties may have the technology orexpertise to breach the security of customer transaction data. Our 

 

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security measures may notprevent security breaches that could result in substantial harm to our businessand results of operations and damage to our reputation. Currently, a majorityof our sales are billed to our customers’ credit card accounts directly. Undercurrent credit card practices, we are liable for fraudulent credit cardtransactions because we do not obtain cardholder signatures. We rely onencryption and authentication technology licensed from third parties to effectsecure transmission of confidential information, including credit card numbers.We do not currently carry insurance against this risk. Advances in computercapabilities, new discoveries in the field of cryptography, or other developmentsmay result in a compromise or breach of the technology we use to protectcustomer transaction data. In addition, anyone who is able to circumvent oursecurity measures could misappropriate proprietary information or causeinterruptions in our operations. Any such compromise of our security coulddamage our reputation and brand and expose us to a risk of loss or litigationand possible liability, which would substantially harm our business and resultsof operations.

 

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

 

Our network securitymeasures to prevent third parties from penetrating our network and improperlyaccessing our customers’ personal information or credit card information maynot be successful. Although we have not experienced any theft of our customers’credit card information to date, as new discoveries in the field ofcryptography and advances in computer capabilities occur, our security measuresmay not effectively prevent others from obtaining improper access to ourcustomer information. In addition, third parties may target our customersdirectly 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 grow our business will be impaired by delays,interruptions, or failures of the Internet.***

 

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

 

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

 

Our success depends onthe widespread acceptance and use of the Internet as an effective medium forcommerce by consumers. The acceptance and use of the Internet may not continueto expand as expected, and a sufficient broad base of consumers necessary forits continued growth may not adopt the Internet as a medium for commerce.Consumers who historically have used traditional means of commerce may haveconcerns about privacy, the inability to physically inspect merchandise beforebuying, delivery time, product damage during shipment, and the costs andinconvenience involved in returning purchased items, which may inhibit theircrossover to e-commerce. In order to expand our user base, we must appeal toand acquire consumers who historically have used traditional means of commerceto purchase goods. If these new customers execute fewer or lower dollar amountsof orders than our historical users, and we are unable to gain efficiencies inour operating costs, including the cost of acquiring new customers, ourbusiness and profits could be adversely affected.

 

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

 

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

 

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

 

Our inventory is storedat our warehouse/office facility in Culver City, California. Consequently, ourmerchandise supply is vulnerable to fire, flood, earthquakes, and similarevents that may impact our facility. Any damage to or loss of all or asignificant portion of our inventory could cause significant delays in shipmentof goods to our customers, resulting in negative publicity about and diminishedcustomer confidence in our website. In addition, we may experience theft of ourproducts while they are being held in inventory or during the course of theirshipment to our customers by third-party carriers. We have implemented securitymeasures to prevent such theft and maintain insurance to cover losses resultingfrom theft. Nevertheless, we could incur significant losses from theft, whichwould substantially harm our business and results of operations, if oursecurity measures fail, losses exceed our insurance coverage, or we are notable to maintain insurance at a reasonable cost.

 

***Increases in credit card processing fees could increase ourcosts.***

 

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

 

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

 

Since our formation, wehave funded our operations through the sale of equity securities and cashgenerated from operations. The working capital characteristics of our businesshave allowed us to collect cash from sales to customers within several businessdays of the related sale, while we typically have extended payment terms withour suppliers. We do not, however, have any formal or binding supply agreementswith any of our suppliers, manufacturers, distributors, or other suppliers orany other formal agreements with them on payment terms. Accordingly, there is arisk that we may default on our obligations if we are unable to generatesufficient cash through sales in a timely manner or through our creditfacility.

 

***Seasonal fluctuations in our net revenue could cause ourquarterly results to fluctuate and cause our results of operations to be belowexpectations.***

 

Historically, sales inthe jewelry industry are seasonal and have been higher in the fourth quarter ofthe calendar year as a result of higher consumer spending during the December holidayseason. Approximately 33.9%, 28.5% and 33.8% of our net revenue in 2005, 2006and 2007, respectively, was generated during the fourth quarter. As we continueto grow, we expect to experience more pronounced seasonal fluctuations in ournet revenue and anticipate a disproportionate amount of our revenue will occurin the fourth quarter. In anticipation of any increased sales activity duringthe fourth quarter, we may incur significant additional expenses, includinghigher sales and marketing costs and additional staffing in our fulfillment andcustomer support operations. If we were to experience lower than expected salesduring any future fourth quarter, it would have a disproportionately largeimpact on our results of operations for that year. In the future, our seasonalsales patterns may become more pronounced, may strain our personnel andfulfillment activities, and may cause a shortfall in sales compared withexpenses in a given period, which would substantially harm our business andresults of operations.

 

***Sales growth in prior periods may not be indicative of ourfuture growth.***

 

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

 

***We have grown quickly, and our business will suffer if wefail to manage our growth.***

 

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

 

***Descriptions of our jewelry items are not guarantees and mayconfuse, mislead, or disappoint our customers.***

 

In an effort to provideaccurate descriptions of jewelry posted on our website, we provide appraisalsummaries from third-party gemological laboratories for some of our jewelryitems. All other jewelry and watch descriptions are provided by our 

 

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full-time GemologicalInstitute of America, or GIA, trained gemologists and several experiencedproduct specialists. Nevertheless, there is a subjective component involvedwith respect to assessing the clarity, color, and carat characteristics ofdiamonds and other gemstones. In addition, mistakes or omissions of importantinformation in our descriptions may occur. Even if our descriptions areaccurate, buying a product online may lead to disappointment resulting inreturned merchandise. For example, a customer may determine that a piece doesnot have the expected look, feel, and overall appearance of the merchandisethat the buyer envisioned from the website photograph.

 

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

 

***Wemay unknowingly be involved in “conflict” diamond purchases that result in anegative public relationship impact.***

 

There has been anincrease in attention to “conflict” diamonds originating out of war-tornregions of Africa. The proceeds from the sale of “conflict” diamonds have beenused to fund the ongoing aggression and terrorist activates throughout theworld. We make every effort to evaluate our vendor sources to ensure they arenot a dealer in “conflict” diamonds. In addition we have implemented ananti-money laundering program to guard against both illicit purchase and salesactivities. If these risks were to occur, we may face a negative publicreaction to our brand name resulting in loss of sales.

 

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

 

Our Internet domain nameis critical to our success. Under current domain name registration practices,no other entity can obtain an identical domain name, but can obtain a similarname or the identical name with a different suffix, such as “.net” or “.org,”or with a different country designation, such as “jp” for Japan. We have notregistered our domain name with different suffixes nor have we registered ourname in any other jurisdiction. As a result, third parties may use domain namesthat are similar to our domain name, which may result in confusion to potentialcustomers and lost sales. We are aware that other businesses have registeredthe name “bidz” with other suffixes and in other countries.

 

***Wemay be subject to assertions by third parties for infringement on theirintellectual property rights.***

 

Third parties may in thefuture assert that we have infringed on their intellectual property rights aswe self-develop our auction platform, sales transaction system, and inventorycontrol system.  We have a largerexposure of being accused of intellectual property rights infringements than ifwe had purchased our technology off the shelf. We also may be at risk forselling items that infringe on other third party trade dress rights, copyright,or patent rights that may cause the offended party to bring action against us.In either event of alleged infringement, we would face substantial litigationcost to defend ourselves and utilization of our management and personnelresources.

 

***Wemay be unable to protect or enforce our own intellectual property rightsadequately, and we may become subject to intellectual property litigation.***

 

We regard the protectionof our trademarks, copyrights, domain name, trade dress, and trade secrets ascritical to our success. We rely on a combination of common law as well astrademark, copyright, trade dress, and trade secret laws to protect ourintellectual property rights. We also have entered into confidentiality andinvention assignment agreements with our employees and relevant contractors andnondisclosure agreements with relevant parties with whom we conduct business inorder to limit access to and disclosure of our proprietary information. Thesecontractual arrangements and other steps we have taken to protect ourintellectual property may not prevent misappropriation of our intellectualproperty or deter independent development of similar intellectual property byothers. We also are pursuing the registration of our domain name, trademarks,and service marks in the United States and internationally. Effectivetrademark, copyright, patent, trade dress, trade secret, and domain name protectionis very expensive to maintain and may require litigation. We must protect ourtrademarks, copyrights, patents, and domain names in an increasing number ofjurisdictions, a process that is expensive and may not be successful in everylocation.

 

Third parties may fromtime to time claim that we have infringed their intellectual property relatingto our business model or auction systems. We expect that participants in ourmarket increasingly will be subject to infringement claims as the number ofservices and competitors in our industry segment grows. Any claim like this,whether meritorious or not, could be time-

 

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consuming, result incostly litigation, cause service upgrade delays, or require us to enter intoroyalty or license agreements. These royalty or license agreements may not beavailable on acceptable terms or at all. As a result, any such claim could harmour business.

 

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

 

We anticipate that wewill become increasingly subject to international intellectual property risks,including differing intellectual property laws, which may be insufficient toprotect our intellectual property, unique local laws, and lack of applicablelaw or clear precedent.

 

***Various legal rules and regulations related to privacyand the collection, dissemination, and security of personal information mayadversely affect our marketing efforts.***

 

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

 

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

 

Numerous states andforeign jurisdictions, including California, where our headquarters arelocated, have regulations regarding how auctions may be conducted and theliability of auctioneers in conducting such auctions. No final legaldetermination has been made whether the California regulations apply to ourbusiness, and little precedent exists in this area. Several states and someforeign jurisdictions have attempted, and may attempt in the future, to imposeregulations that could affect us or our users, which could harm our business.

 

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

 

Several states haveproposed, and California, Minnesota, Utah, and Vermont have recently passed,legislation that would limit the uses of personal user information gatheredonline or offline. Many states already have such laws and continually considerstrengthening them, especially against online services. However, the FairCredit Reporting Act, or FCRA, a federal statute enacted in 1970 to protectconsumer privacy, includes a provision preempting conflicting state laws on thesharing of information between corporate affiliates. The preemptive provisionsof FCRA were permanently extended in 2002, thereby ensuring that we are notsubject to the laws of each individual state with respect to matters within thescope of FCRA, but remain subject to the other provisions of FCRA.

 

The Federal TradeCommission also has settled several proceedings against companies regarding themanner in which personal information is collected from users and provided tothird parties. Specific statutes intended to protect user privacy have beenpassed in many foreign jurisdictions. Compliance with these laws, given thetight integration of our systems across different countries and the need tomove data to facilitate transactions among our users, such as payment companiesand shipping companies, is both necessary and difficult. Failure to complycould subject us to lawsuits, fines, criminal penalties, statutory damages,adverse publicity, and other losses that could harm our business. Changes toexisting laws or the passage of new laws intended to address these issues coulddirectly affect the way we do business or could create uncertainty on the useof the Internet. This could reduce demand for our products, increase the costof our doing business, expose us to litigation costs, increase our service ordelivery costs, or otherwise harm our business.

 

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***New and existing regulations could harm our business.***

 

We are subject to thesame foreign and domestic laws as other companies conducting both online andoffline business. There are still relatively few laws specifically directedtowards online business. However, due to the increasing popularity and use ofthe Internet 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 was 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 ourproducts are available over the Internet in multiple states and because we sellmerchandise to consumers residing in multiple states, we could be required toqualify to do business as a foreign corporation in each state in which ourproducts are available. Our failure to qualify as a foreign corporation in ajurisdiction in which we are required to do so could subject us to penalties.Any new legislation or regulation, or the application of laws or regulationsfrom jurisdictions whose laws do not currently apply to our business could havea material adverse affect on our business.

 

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

 

Our performance dependssubstantially upon David Zinberg, our Chairman of the Board, President, andChief Executive Officer, who has extensive experience with the purchase andsale of jewelry. We rely on Mr. Zinberg to make critical operationaldecisions on a daily basis, such as product offerings and purchases, and tomake key strategic plans. We have an employment agreement with Mr. Zinbergextending through 2009. The loss of the services of Mr. Zinberg wouldadversely affect our business and operations.

 

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

 

Fromour inception until mid-2003, we raised over $20.5 million in gross equity capitalby selling shares of our common stock to approximately 830 investors at pricesranging from $4.00 to $6.00 per share with a weighted average share price of$4.50. We also issued shares of common stock to about 30 persons in exchangefor services and other non-cash consideration valued in excess of $5.5 millionand issued 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 “general solicitation”of securities. In addition, these employees received compensation for sellingour common stock and were required to be licensed as broker-dealers with theSecurities and Exchange Commission, or SEC, and various state authorities, butthey were not so licensed. In such situations, a number of remedies may beavailable to regulatory authorities and the investors who purchased commonstock in those offerings, including a right of rescission, civil penalties, arestraining order or injunction, and a court order to pay restitution andcosts.

 

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

 

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

 

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***The concentration of our capital stock ownership with ourfounder and executive officers and directors and their affiliates will limityour ability to influence corporate matters.***

 

Our founder, executiveofficers, and directors together own approximately 33.3% of our common stock asof December 31, 2007. Marina Zinberg, our Vice President, who is thesister of David Zinberg, our Chairman, President and Chief Executive Officer,owns an additional 31.3% of our common stock. As a result, these individuals will have significant influence over ourmanagement and affairs and over all matters requiring stockholder approval,including the election of directors and the approval of significant corporatetransactions, such as a merger or a sale of our company or its assets, for theforeseeable future. This concentrated control will limit the ability of otherstockholders to influence corporate matters. Because of this, we may takeactions that some of our stockholders do not view as beneficial. As a result,the market price of our common stock could be adversely affected becausestockholders may not view favorably the concentration of control in the handsof management.

 

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

 

On June 22, 2006, wereincorporated in Delaware, and the Delaware certificate of incorporation andthe Delaware General Corporation Law, or DGCL, contain provisions that may havethe effect of making more difficult or delaying attempts by others to obtaincontrol of our company, even when these attempts may be in the best interestsof our stockholders. The Delaware certificate of incorporation also authorizesour Board of Directors, without stockholder approval, to issue one or moreseries of 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 combination transactionswith “interested stockholders.” The Delaware certificate of incorporationdivides our Board of Directors into three classes, with one class to stand forelection each year for a three-year term after the initial election. Theclassification of directors tends to discourage a third party from initiating aproxy solicitation or otherwise attempting to obtain control of our company andmay maintain the incumbency of our Board of Directors, as this structuregenerally increases the difficulty of, or may delay, replacing a majority ofdirectors. The Delaware bylaws authorize our Board of Directors to fillvacancies or newly created directorships. A majority of the directors then inoffice may elect a successor to fill any vacancies or newly created directorships.

 

**ITEM 1B.  Unresolved Staff Comments**

 

Not applicable.

 

**Item2.**           Properties.

** **

We lease a 50,000 squarefoot facility in Culver City, California, which serves as our corporateheadquarters and houses our sales, marketing, research and development,customer service, fulfillment, and warehouse operations. Our lease expires in October 2009.We expect that our current facility will satisfy our needs through 2009. In August 2007,we leased a separate 12,000 square-foot warehouse in Culver City, Californiaand this lease expires in August 2012.

 

**Item3.**           LegalProceedings

** **

*Cartier v. Bidz.com*

 

We area defendant in a lawsuit filed by Cartier, and Cartier International, B.V., inthe United States District Court Southern District of New York in April 2006.The lawsuit alleges that Cartier has proprietary rights, including trade dress,patents, trademarks, copyrights and others, in watch designs known as a Tank,Tank Francaise, Tank Americaine, Panthere and Pasha De Cartier Grille, and TankDevan, and further alleges that we have infringed upon those rights by sellingwatches bearing copies of one or more of the watch designs. We intend to defendthe lawsuit vigorously. We do not believe the outcome of the case will have amaterially adverse effect on our financial position. The court has yet to set atrial date.

 

We are not currently aparty to any material legal proceedings.

 

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

** **

On June 6, 2007, theCompany  held its annual meeting of shareholders, at which time thefollowing directors were elected to serve a three year term expiring in2010:  David Zinberg, and Peter Hanelt. The number of votes cast for eachof the directors was 1,765,825, the number of votes against was 0 and thenumber of abstentions and broker non-votes was 97,758. The term forLawrence Y. Kong and Man Jit Singh, will be expiring at the annual meeting ofstockholders in 2008.

 

Effective May 7,2007, the Board was expanded to five (5) members with one (1) additionaldirector, Garry Itkin, appointed to the Board. As previously reported, Mr. Itkin,who served as a director of the Company since July 2003, resigned as adirector on December 18, 2006, citing his inability to devote sufficienttime to his duties as a director.  Mr. Itkin is now able to devotethe time necessary to participate fully as a director of the Company andresumed his position as Director.

 

**Part II**

 

**Item5.**           Marketfor Registrant’s Common Equity, Related Stockholder Matters and IssuerPurchases of Equity Securities

** **

Ourcommon stock is quoted on The NASDAQ Stock Market LLC under the symbol “BIDZ.”The following table sets forth the high, low and closing market prices of ourcommon stock during each of the four calendar quarters for 2007:

 

| **For the quarter ended:** | ** ** | **High** | ** ** | **Low** | ** ** | **Close** | ** ** |
|----------------------------|------------|----------|------------|---------|------------|-----------|------------|
|                       |       |     |       |    |       |      |       |
| March 31, 2007        |       | $        | —     |    | $          | —    |       | $ | — |   |
| June 30, 2007         |       | 10.70    |       | 4.90    |       | 8.10      |       |
| September 30, 2007    |       | 13.94    |       | 6.82    |       | 13.46     |       |
| December 31, 2007     |       | 22.50    |       | 8.20    |       | 8.97      |       |
|                            |            |          |            |         |            |           |            |  |  |  |

 

As of December 31,2007, there were 24,556,354 shares of common stock outstanding.

 

Wehave established a public market for our common stock on the NASDAQ CapitalMarket. We have registered for offer and sale the shares of common stock thatare reserved for issuance pursuant to stock options covered by our stock optionplans. Shares covered by such registration statements upon the exercise ofstock options or warrants generally will be eligible for sale in the publicmarket, except that affiliates will continue to be subject to volumelimitations and other requirements of Rule 144. As of December 31,2007, the number of shares of our common stock that is subject to outstandingoptions to purchase common stock is 8,131,300.

 

Sharesheld by management and affiliates of our company are subject to the resalelimitations of Rule 144. In general, under Rule 144 as currently ineffect, any person, or persons whose shares are aggregated for purposes of Rule 144,who beneficially owns restricted securities with respect to which at least sixmonths has elapsed since the later of the date the shares were acquired fromus, or from an affiliate of ours, is entitled to sell within any three-monthperiod a number of shares that does not exceed the greater of 1% of the thenoutstanding shares of our common stock and the average weekly trading volume incommon stock during the four calendar weeks preceding such sale. Sales under Rule 144also are subject to certain manner-of-sale provisions and notice requirementsand to the availability of current public information about us.

 

**Dividends**

 

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

 

24

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**EquityCompensation 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                                          |       | 1,115,000                                  |       | $                                 | 6.00       |                                  | —     |   |
| 2002 Special  Stock Option Plan                                 |       | 395,000                                    |       | $                                 | 4.50       |                                  | —     |   |
|                                                            |       |                                       |       |                              |       |                                  |       |
| **Equity  compensation plans not approved by security holders** | ** ** | ** **                                 | ** ** | ** **                        | ** ** | ** **                            | ** ** |
| 2001 Stock  Option Plan                                         |       | 571,300                                    |       | $                                 | 6.00       |                                  | —     |   |
| Non-statutory  Stock Option (2)                                 |       | 6,050,000                                  |       | $                                 | 6.00       |                                  | —     |   |
|                                                            |       |                                       |       |                              |       |                                  |       |
| **Total**                                                       |       | 8,131,300                                  |       | $                                 | 6.20       |                                  | —     |   |

----

(1)                                The total number of shares of commonstock to be issued upon exercise of all outstanding stock options is 8,131,300as of December 31, 2007.

 

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

 

**Recent Sales of UnregisteredSecurities**

 

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

 

In 2007, we issued 10,000and 8,750 shares of our common stock to each of our outside directors, PeterHanelt and Man Jit Singh, respectively, as payment of independent directorfees. We also issued 40,000, 35,000 and 35,000 restricted share awards of ourcommon stock, with 25% vesting at the end of each year over a four year period,under the 2006 Award Plan to each of our outside directors, Peter Hanelt, ManJit Singh and Garry Itkin, respectively, as payment of independent directorfees. We issued stock options to purchase an aggregate of 1,000,000 shares inour common stock at an exercise price of $8.23 per share to 4 of our employees underour 2006 Award Plan for services rendered to the our company. We also issued16,000 restricted share awards of our common stock, with 25% vesting at the endof each year over a four year period, under the 2006 Award Plan to 5 employeesfor services rendered to our company.

 

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

 

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

 

25

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**Issuer Purchases of EquitySecurities**

 

The following tablecontains information about repurchases of our common stock during the fourthquarter of 2007:

 
| ** **                              | ** ** | ** **    | ** ** | ** **  | ** ** | **Total Number of** | ** ** | **Maximum**                    | ** ** |
|-----------------------------------------|------------|---------------|------------|-------------|------------|-------------------------------|------------|--------------------------------|------------|
| ** **                              | ** ** | ** **    | ** ** | ** **  | ** ** | **Shares**                    | ** ** | **Number**                     | ** ** |
| ** **                              | ** ** | **Total**     | ** ** | **Average** | ** ** | **Purchased as**         | ** ** | **of Shares that**   | ** ** |
| ** **                              | ** ** | **Number**    | ** ** | **Price**   | ** ** | **Part of a**       | ** ** | **may**                        | ** ** |
| ** **                              | ** ** | **of**        | ** ** | **Paid**    | ** ** | **Publicly**                  | ** ** | **yet be Purchased** | ** ** |
| ** **                              | ** ** | **Shares**    | ** ** | **per**     | ** ** | **Announced**                 | ** ** | **Under the**             | ** ** |
| **2007**                                | ** ** | **Purchased** | ** ** | **Share**   | ** ** | **Program**                   | ** ** | **Program (1)**                | ** ** |
| October 1 — October 31   |       | —        |       | —      |       | —                        |       | —                         |       |
| November 1 — November 30 |       | —        |       | —      |       | —                        |       | —                         |       |
| December 1 — December 31 |       | 100,000       |       | $           | 8.86       |                          | 100,000    |                           | 464,000    |   |
| Total                                   |       | 100,000       |       | $           | 8.86       |                          | 100,000    |                           | 464,000    |   |

----

(1)                                  In June 2007, we authorized thestock buyback program for up to $5.0 million of our outstanding common stock tobe repurchased through the open market at prices deemed appropriate bymanagement.  As of December 31,2007, we have $4.1 million of authorization remaining under this program andthe maximum number of shares that may yet be repurchased is based on theaverage price paid per share of $8.86.

 

**Item 6.    Selected Financial Data**

 

The selected financialdata presented below has been derived from our financial statements. Thestatement of operations data for each of the fiscal years ended December 31,2005, 2006, and 2007 and the balance sheet data at December 31, 2006 and2007 are derived from our audited financial statements that are included inthis report. The statement of operations data for the years ended December 31,2003 and 2004 and the balance sheet data at December 31, 2003, 2004 and2005 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)** | ** ** | **2003**                                    | ** ** | **2004** | ** ** | **2005** | ** ** | **2006** | ** ** | **2007** | ** ** |
| ** **                                                         | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Statement of Operations Data:**                                  | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|                                                               |       |                                        |       |   |   |   |   |   |   |   |   |
| Net Revenue                                                        |       | 47,665                                      |       | 65,324 |   | 90,579 |   | 131,823 |   | 187,131 |   |
| Cost of Revenue                                                    |       | 42,188                                      |       | 53,072 |   | 71,257 |   | 100,633 |   | 132,683 |   |
| Gross Profit                                                       |       | 5,477                                       |       | 12,252 |   | 19,322 |   | 31,190 |   | 54,448 |   |
| Operating Expenses:                                                |       |                                        |       |   |   |   |   |   |   |   |   |
| General &  Administrative                                 |       | 9,259                                       |       | 8,800 |   | 10,938 |   | 13,853 |   | 20,458 |   |
| Sales &  Marketing                                        |       | 1,960                                       |       | 2,542 |   | 5,078 |   | 10,300 |   | 12,578 |   |
| Rescission and  Public Offering Costs                              |       | —                                      |       | — |   | 442 |   | 1,287 |   | — |   |
| Depreciation &  Amortization                              |       | 61                                          |       | 139 |   | 157 |   | 273 |   | 498 |   |
| Total Operating Expenses                                           |       | 11,280                                      |       | 11,481 |   | 16,615 |   | 25,713 |   | 33,534 |   |
| Profit (Loss) from Operations                                      |       | (5,803                                      | )          | 771 |   | 2,707 |   | 5,477 |   | 20,914 |   |
| Interest income (expense), net                                     |       | (27                                         | )          | — |   | 22 |   | 32 |   | (250 | ) |
| Income taxes                                                       |       | —                                      |       | — |   | (82 | ) | (120 | ) | (2,538 | ) |
| Net Profit (Loss)                                                  |       | (5,830                                      | )          | 771 |   | 2,647 |   | 5,389 |   | 18,126 |   |
| Net Profit (Loss) common share:                                    |       |                                        |       |   |   |   |   |   |   |   |   |
| Basic                                                              |       | (0.21                                       | )          | 0.03 |   | 0.11 |   | 0.23 |   | 0.77 |   |
| Diluted                                                            |       | (0.21                                       | )          | 0.03 |   | 0.11 |   | 0.23 |   | 0.69 |   |
|                                                               |       |                                        |       |   |   |   |   |   |   |   |   |
| **Balance Sheet Data:**                                            | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                         | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash & Cash Equivalents                                   |       | 10                                          |       | 5 |   | 7 |   | 359 |   | 4,808 |   |
| Working Capital (deficit)                                          |       | (3,148                                      | )          | (2,164 | ) | 1,009 |   | 5,974 |   | 31,080 |   |
| Total Assets                                                       |       | 7,270                                       |       | 12,490 |   | 17,746 |   | 38,542 |   | 72,401 |   |
| Revolving Credit Line                                              |       | —                                      |       | — |   | — |   | 3,941 |   | 5,924 |   |
| Total Liabilities                                                  |       | 9,355                                       |       | 13,570 |   | 15,963 |   | 31,815 |   | 39,733 |   |
| Total Stockholders’ Equity (deficit)                          |       | (2,085                                      | )          | (1,080 | ) | 1,783 |   | 6,727 |   | 32,668 |   |

 

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

 

*The following discussion should be read in conjunction withthe financial statements and related notes which appear elsewhere in this form.This discussion contains forward-looking statements. Our actual results coulddiffer materially from those anticipated in these forward-looking statements asa result of various factors, including various risks and uncertaintiesdiscussed below and throughout this report.*

 

**Overview**

 

We area leading online retailer of jewelry, featuring a live auction format. We haveestablished our retail brand in the online marketplace by offering high-qualitymerchandise, a unique user-friendly shopping experience, and the opportunityfor buyers to achieve significant cost savings versus traditional retailchannels. A key to our success has been our ability to efficiently and costeffectively source closeout and regular jewelry merchandise, and rapidlyrespond to changing consumer demands for certain jewelry. We offer our productsthrough a continuous live format, featuring a $1 minimum opening bid, and aunique 15-second auction extension period that allows our auctions to continueuntil all bids are received. The majority of our auctions are short-term, oftenlasting less than one hour, providing immediate gratification to our customersand encouraging frequent visits and active viewing of our website. Our productinventory includes gold, platinum, and silver jewelry set with diamonds,rubies, emeralds, sapphires, and other precious and semi-precious stones; andwatches. We believe we are the second largest online retailer of jewelry basedon revenue and the largest online jewelry auction site based on web traffic.

 

We sell to consumerslooking for reliable bargains on jewelry. Because we purchase and retain all ofour jewelry inventory onsite, we can provide our customers with timely serviceand delivery of their purchases. In addition, each item is inspected by one of ourtrained product specialists prior to its placement on our website, whichassures our customers of the quality of their purchases of our products. Weoperate in a highly competitive market with low barriers to entry. By sellingour own merchandise, we provide a buying environment in which we minimizefraudulent activity and questionable product quality frequently associated withpurchase transactions from third-party sellers. We also provide a 15-day returnpolicy on all merchandise. We believe that many of our customers resellmerchandise that they purchase from our auctions on eBay, at local auctions,and through other retail channels. Our auctions are conducted 24 hours aday, seven days a week. We also offer daily telephone customer support, 24-houronline live-help and e-mail customer support.

 

Historically, sales inthe jewelry industry are seasonal and have been higher in the fourth quarter ofthe calendar year as a result of higher consumer spending during the December holidayseason. Approximately 33.9%, 28.5% and 33.8% of our net revenue in 2005, 2006and 2007, respectively, was generated during the fourth quarter. As we continueto grow, we expect to experience more pronounced seasonal fluctuations in ournet revenue and anticipate a disproportionate amount of our revenue will occurin the fourth quarter.

 

In line with our growthplans, we have completed a major upgrade of our auction platform at the end of2007. The new auction LiveBid system supports a broad range of leading browsersoftware including Microsoft Internet Explorer, FireFox and Safari. The newsystem touts high availability, faster end-user response time and greaterscalability among the key features delivered in this release. We plan onleveraging this new software solution to launch major additional site features,the new online retail store and foreign language versions of our website.

 

**CriticalAccounting Policies**

 

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

 

*RevenueRecognition*

 

Wederive our revenue from four sources: merchandise sales, shipping revenue,auction transaction fee revenue and other revenue. In accordance with SAB 104,we recognize revenue from all four sources when the following revenuerecognition criteria are met: (1) persuasive evidence of an arrangementexists; (2) the product has been shipped or the service has been renderedand the customer takes ownership and assumes the risk of loss; (3) theselling price is fixed or determinable; and 

 

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(4) collectionof the resulting receivable is reasonably assured.

 

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.

 

Wepresent sales tax liability on a net basis in accordance with Emerging IssuesTask Force (“EITF”) Issue No. 06-03.  Sales are not grossed up withthe attendant taxes and deducted as a separate line item. The EITF becomeseffective for interim and annual reporting periods beginning after December 15,2006.

 

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

 

Weinclude auction transaction fee revenue in net revenue. The 3% auctiontransaction fee is applied to all merchandise sales, including shipping andhandling, but not to sales tax.

 

Otherrevenue includes commissions and advertising revenue. We derive commissionrevenue from sales of Certified Merchant merchandise that is owned by thirdparties and recognize that revenue when services have been rendered. Forcommission revenue, we recognize as revenue only the commission portion of theprice our customers pay for the purchased products because we are acting as anagent in such transactions. Commissions are also reduced by the impact ofreturns and other discounts redeemed to obtain such sales. We recognizeadvertising revenue from allowing other companies to advertise on our web sitewhen the services are rendered and the advertising revenue is known andcollectible.

 

*Returnand Allowance Reserve*

 

We estimate potentialfuture product returns and chargebacks related to current period revenue. Weanalyze historical returns, and changes in customer demand and acceptance ofour products when evaluating the adequacy of the sales returns reserve andother allowances in any accounting period. If actual returns are greater thanour estimates, we will record additional returns and allowances in addition toour estimates, which will result in lower net revenue recorded during thatperiod.  Reserves for returns andchargebacks are included in accrued liabilities.

 

*InventoryReserve*

 

# We record reservesagainst our inventory equal to the difference between the cost of inventory andthe average selling price that is lower than cost for inventory that is heldfor less than one year. We also record reserves of 100% of the cost ofinventory held for more than one year. Inventory reserve is $461,000 and $1.1million at December 31, 2006 and 2007, respectively. If actual marketconditions are less favorable than those projected by us, specific reserves oradditional inventory write-downs may be required.

#  

*Inventory Co-op Marketing Contributions*

 

# In third quarter 2007, westarted to bill and collect from our inventory vendors co-op marketingcontributions as an incentive for us to market and sell the inventory for saleon the Bidz website. In accordance with EITF 02-16:  Accounting by aCustomer (including a Reseller) for Certain Consideration Received from aVendor, the co-op marketing contributions that cannot be identifiedspecifically to benefit the vendors are a reduction in cost of sales and willresult in an increase in gross profit. We cannot specifically identify thebenefits to each vendor, consequently, co-op marketing contributions arecharged against inventory as a reduction of costs and amortized as a reductionof cost of sales over an estimated inventory turnover period of approximately 110days. For the years ended December 31, 2006 and 2007, we have earned $0and $4.8 million of co-op marketing contributions, respectively, with $0 and$4.2 million, respectively, remaining unamortized as an offset to inventory at December 31,2006 and 2007. Receivable from vendors for co-op marketing contributions isincluded in other current assets and amounted to $0 and $2.9 million at December 31,2006 and 2007, respectively.

 

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*DeferredTax Benefit*

 

We recognized deferredtax benefit of $2.2 million as of December 31, 2007 (and more fullydescribed in Note 11 in our audited financial statements). Deferred tax benefitis included in other current assets (as described in Note 3 in our auditedfinancial statements).

 

*Stock-BasedCompensation*

 

Prior to January 1,2006, we measured compensation expense to employees for our stock optionincentive plans under the recognition and measurement provisions of AccountingPrinciples Board Opinion No. 25, *Accountingfor Stock Issued to Employees,*and related interpretations.Utilizing the intrinsic value method prescribed by APB No. 25, we did notrecord compensation expense when stock options were granted to eligibleparticipants as long as the exercise price was not less than the fair marketvalue of the stock when the option was granted.

 

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

 

In accordance withStatement of Financial Accounting Standards (‘‘SFAS’’) No. 123, ‘‘Accountingfor Stock-Based Compensation,’’ and SFAS No. 148, ‘‘Accounting for Stock-BasedCompensation-Transition and Disclosure,’’ which amended SFAS No. 123, wedisclosed pro forma net income and net income per share as if the fair valuebased method had been applied in measuring compensation expense. The disclosureprovisions of SFAS No. 148 were effective for financial statements forinterim periods beginning after December 15, 2002. We adopted thedisclosure requirements in the first quarter of 2003. This information iscontained in Note 1 to our financial statements. The fair values of options andshares issued pursuant to our option plan at each grant date were estimatedusing the Black-Scholes option pricing model. Because there has been no publicmarket for our common stock, we used the minimum value method in determining theexpected volatility of our common stock was zero. The transition provisions didnot have an impact on our financial position or results of operations as we didnot elect to adopt the fair value-based method of accounting for stock-basedemployee compensation under SFAS No. 123.

 

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. For the years ended December 31, 2006 and 2007, we usedthe Black-Scholes option pricing model to estimate the value of our options inimplementing SFAS 123R and the calculated method to determine expectedvolatility, rather than the minimum value method, which we previously used 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 forfeitures for the years ended December 31, 2006 and 2007.SFAS 123R requires forfeitures to be estimated at the time of grant and revised,if necessary, in subsequent periods if actual forfeitures differ from thoseestimates. In the pro forma information required under SFAS 148 for the periodprior to 2006, we did not account for forfeitures, as all options granted werefully vested at the date of grant and were not subject to any service periodconditions. We expensed stock-based compensation on the date of grant, as alloptions granted prior to January 1, 2006, vested immediately. In thefuture, we anticipate that stock-based compensation will include vestingprovisions and therefore stock-based compensation expense in the future will bereduced for forfeitures.

 

We adopted SFAS 123Rusing the modified prospective method which requires the application of theaccounting standard as of January 1, 2006. Under this transition method,we are required to recognize compensation cost beginning January 1, 2006for the portion of outstanding awards for which the requisite service has beenrendered, based on the grant-date fair value of those awards calculated underSFAS 123 for our pro forma disclosures. In accordance with the modifiedprospective method, the financial statements for prior periods have not beenrestated to reflect, and do not include, the impact of SFAS 123R.

 

We also adopted FASB StaffPosition No. FAS 123(R)-3, **Transition Election Related to Accounting for the TaxEffects of Share-Based Payment Awards** (“FSP 123(R)-3”).Under FSP 123(R)-3, the Company elected to use the short-cut method to 

 

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calculate the historicalpool of windfall tax benefits. The Company elected to use the tax law orderingapproach for purposes of determining whether an excess of tax benefit has beenrealized.

 

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

 

The following tablepresents our historical results of operations for the periods indicated as apercentage of net revenue.

 

| ** **                            | ** ** | **Years Ended December 31,** | ** ** |
|---------------------------------------|------------|---------------------------------------------|------------|
| ** **                            | ** ** | **2005**                                    | ** ** | **2006** | ** ** | **2007** | ** ** |
|                                  |       |                                        |       |   |   |   |   |
| Net Revenue                           |       | 100.0                                       | %          | 100.0 | % | 100.0 | % |
| Gross Profit                          |       | 21.3                                        |       | 23.7 |   | 29.1 |   |
| Operating Expenses:                   |       |                                        |       |   |   |   |   |
| General &  Administrative    |       | 12.1                                        |       | 10.5 |   | 10.9 |   |
| Sales &  Marketing           |       | 5.6                                         |       | 7.8 |   | 6.7 |   |
| Rescission and  Public Offering Costs |       | 0.4                                         |       | 1.0 |   | — |   |
| Depreciation &  Amortization |       | 0.2                                         |       | 0.2 |   | 0.3 |   |
| Total Operating Expenses              |       | 18.3                                        |       | 19.5 |   | 17.9 |   |
| Profit from Operations                |       | 3.0                                         |       | 4.2 |   | 11.2 |   |
| Interest income (expense), net        |       | 0.0                                         |       | 0.0 |   | (0.1 | ) |
| Income taxes                          |       | (0.1                                        | )          | (0.1 | ) | (1.4 | ) |
| Net Profit                            |       | 2.9                                         | %          | 4.1 | % | 9.7 | % |

 

*NetRevenue*

 

Substantially all of ournet revenue consists of jewelry sold via the Internet, net of returns. We alsogenerate net revenue from shipping and handling, auction transaction feerevenue, and other revenue.

 

The following tablepresents our sources of revenue for the periods indicated as a percentage ofnet revenue.

 

| ** **                    | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------|------------|--------------------------------------------|------------|
| ** **                    | ** ** | **2005**                                   | ** ** | **2006** | ** ** | **2007** | ** ** |
|                          |       |                                       |       |   |   |   |   |
| Net Revenue                   |       |                                       |       |   |   |   |   |
| Merchandise  sales            |       | 88.6                                       | %          | 85.3 | % | 84.6 | % |
| Shipping &  handling |       | 10.4                                       |       | 11.5 |   | 12.1 |   |
| Transaction fee               |       | 0.7                                        |       | 3.1 |   | 3.1 |   |
| Other revenue                 |       | 0.3                                        |       | 0.1 |   | 0.2 |   |
|                          |       |                                       |       |   |   |   |   |
| Total Net Sales               |       | 100.0                                      | %          | 100.0 | % | 100.0 | % |

 

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

 

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

 
| ** **                                            | ** ** | **Years ended December 31,** | ** ** |
|-------------------------------------------------------|------------|---------------------------------------------|------------|
| **(in thousands, except percentages)** | ** ** | **2005**                                    | ** ** | **2006** | ** ** | **2007** | ** ** |
| ** **                                            | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Geographic area**                              | ** ** | **Amount**                                  | ** ** | **Percent** | ** ** | **Amount** | ** ** | **Percent** | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| United States                                         |       | $                                           | 73,199     |   | 80.8 | % | $ | 104,338 |   | 79.2 | % | $ | 145,412 |   | 77.7 | % |
| International                                         |       | 17,380                                      |       | 19.2 |   | 27,485 |   | 20.8 |   | 41,719 |   | 22.3 |   |
| Total                                                 |       | $                                           | 90,579     |   | 100.0 | % | $ | 131,823 |   | 100.0 | % | $ | 187,131 |   | 100.0 | % |

 

*GrossProfit*

 

Our gross profit consistsof net revenue less the cost of sales. Our cost of sales consists of the costof merchandise sold to 

 

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customers, amortizedco-op marketing contributions from vendors, inbound and outbound shippingcosts, packaging and shipping supplies, insurance on shipments, product repairand service costs, and credit card and other transaction fees associated withpayments.

 

*General and Administrative Expenses*

 

Our general and administrative expenses consistprimarily of payroll and related benefit costs for our employees. Theseexpenses also include fulfillment, customer service, technology, professionalfees, other general corporate expenses, and stock-based compensation,consisting substantially of stock option grants and stock grants to employeesand directors.

 

*Salesand 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.

 

*Rescissionand Public Offering Costs*

 

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

 

**Resultsof Operations**

 

**Comparisonof Year Ended December 31, 2007 with Year Ended December 31, 2006**

 

*NetRevenue*

 

Netrevenue increased 42.0% to $187.1 million in 2007 from $131.8 millionin 2006. This increase in net revenue was due primarily to the growth in demandfor our jewelry products and the increase in average order value. The growth indemand was primarily the result of the number of new buyers we attracted during2007. We have also implemented three initiatives in 2007 that generated moredemand from our customers. In certain circumstances, including satisfaction ofour gross profit criteria and availability of multiple quantities of items, weallow customers who did not have the winning bid to purchase items at theirlast bid price, we allow customers to purchase multiple quantities of items andwe allow customers viewing the item to purchase the item at the winning bidprice.

 

*GrossProfit*

 

Gross profit increased 74.6%to $54.4 million in 2007 from $31.2 million in 2006. Gross profit asa percentage of net revenue increased to 29.1% in 2007 from 23.7% in 2006. Theincrease in gross profit as a percentage of net revenue resulted primarily frommore effective purchasing, increased margin on shipping and handling charges,and co-op marketing contributions from vendors commencing in July 2007.Gross profit margins benefited from the amortized co-op marketing contributionsthat reduced our cost of sales by $4.8 million or 2.6% of net revenue.

 

*Generaland Administrative Expenses*

 

General andadministrative expenses increased 47.7% to $20.5 million in 2007 from$13.9 million in 2006. The increase in general and administrative expenseswas due mainly to increases in payroll and payroll related expenses, SOXcompliance costs, outsourcing and other administrative expenses. We increasedour personnel from 198 at year end, 2006 to 240 at year end, 2007. General andadministrative expenses as a percentage of net revenue was 10.9% in 2007compared to 10.5% in 2006.

 

*Salesand Marketing Expenses*

 

Sales and marketingexpenses increased 22.1% to $12.6 million in 2007 from $10.3 millionin 2006. This increase resulted primarily from increased marketing campaigns toattract new buyers. Our efforts to control the sales and marketing expenses 

 

31

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and improve theeffectiveness of our marketing campaigns have been successful in lowering thecosts relative to the higher growth in net revenue. Consequently, sales andmarketing expenses as a percentage of net revenue decreased to 6.7% in 2007from 7.8% in 2006. We expect our sales and marketing expenses to continue toincrease in absolute dollars, as we intend to continue increasing our online marketingcampaigns in order to attract new customers.

 

**Comparisonof Year Ended December 31, 2006 with Year Ended December 31, 2005**

 

*NetRevenue*

 

Net revenue increased45.5% to $131.8 million in 2006 from $90.6 million in 2005. Thisincrease in net revenue was due to the increase in the number of orders and theaverage selling price per order. The increase in the number of orders wasprimarily the result of the number of new buyers we attracted during 2006. Theincrease in average selling price was due mainly to the purchase of higherpriced inventory.

 

*GrossProfit*

 

Gross profit increased61.4% to $31.2 million in 2006 from $19.3 million in 2005. Grossprofit as a percentage of net revenue increased to 23.7% in 2006 from 21.3% in2005. The increase in gross profit as a percentage of net revenue resultedprimarily from more effective purchasing, implementation of a 3% auctiontransaction fee in November 2005, partially offset by a small decrease inmargin on shipping and handling charges.

 

*Generaland Administrative Expenses*

 

General andadministrative expenses increased 26.7% to $13.9 million in 2006 from$10.9 million in 2005. The increase in general and administrative expenses in2006 was due primarily to a $1.5 million increase in payroll and payrollrelated expenses and a $701,000 increase in outsourcing expenses. We increasedour personnel from 176 at year end, 2005 to 198 at year end, 2006. Ouroutsourcing expenses increased in 2006 in the areas of customer service, photoediting, auction uploading and IT support. General and administrative expensesas a percentage of net revenue decreased to 10.5% in 2006 from 12.1% in 2005 aswe continue to leverage on our operational infrastructure.

 

*Salesand Marketing Expenses*

 

Sales and marketingexpenses increased 103% to $10.3 million in 2006 from $5.1 million in2005. This increase resulted primarily from increased marketing campaigns andcost of online advertising to attract new buyers. Sales and marketing expensesas a percentage of net revenue increased to 7.8% in 2006 from 5.6% in 2005. 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. We do not expect our sales and marketing expensesas a percentage of revenue to increase.

 

*Rescissionand Public Offering Costs*

 

These costs consistprimarily of regulatory filing fees, accountant fees, legal fees and printingexpenses incurred in the planned initial public offering, which amounted to$442,000 and $1.3 million for the years ended December 31, 2005 and2006, respectively. Costs incurred in 2005 relate primarily to rescissionrelated costs of the planned initial public offering whereas costs incurred in2006 relate to the registration statement of the planned initial publicoffering. The capitalized costs of the rescission and initial public offeringwere expensed when the Company determined it was unable to complete theoffering and subsequently requested withdrawal of the registration statement.

 

**QuarterlyOperations Data**

 

The following tables setforth quarterly statements of operations data for the eight quarters ended December 31,2007, including amounts expressed as a percentage of net revenue. Thisquarterly information is unaudited, but has been prepared on the same basis asthe annual financial statements and, in our opinion, reflects all adjustmentsnecessary for a fair representation of the information for the periodspresented. This quarterly statement of operations data should be read inconjunction with our audited financial statements and the related notesincluded elsewhere in this prospectus. Results of operations for any quarterare not necessarily indicative of results for any future period.

 

32

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Historically, sales inthe jewelry industry are seasonal and have been higher in the fourth quarter asa result of higher consumer spending during the December holiday season.Approximately 33.9%, 28.5%, and 33.8% of our net revenue in 2005, 2006, and2007, respectively, was generated during the fourth quarter. As we continue togrow, we expect to experience more pronounced seasonal fluctuations in our netrevenue and anticipate a disproportionate amount of our revenue in the fourthquarter in the future.

 
| ** **                                                                 | ** ** | **Quarters ended** | ** ** |
|----------------------------------------------------------------------------|------------|-------------------------|------------|
| **(in thousands,**                                                         | ** ** | **March 31,**      | ** ** | **June 30,** | ** ** | **Sept. 30,** | ** ** | **Dec. 31,** | ** ** | **March 31,** | ** ** | **June 30,** | ** ** | **Sept. 30,** | ** ** | **Dec. 31,** | ** ** |
| **except per share data)**                                       | ** ** | **2006**                | ** ** | **2006** | ** ** | **2006** | ** ** | **2006** | ** ** | **2007** | ** ** | **2007** | ** ** | **2007** | ** ** | **2007** | ** ** |
| ** **                                                                 | ** ** | **(unaudited)**         | ** ** |
| ** **                                                                 | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net revenue                                                                |       | $                       | 34,694     |   | $ | 32,434 |   | $ | 27,061 |   | $ | 37,634 |   | $ | 44,724 |   | $ | 39,123 |   | $ | 40,051 |   | $ | 63,233 |   |
| Gross profit                                                               |       | 9,178                   |       | 7,689 |   | 6,662 |   | 7,661 |   | 11,128 |   | 10,874 |   | 12,695 |   | 19,751 |   |
| General and administrative                                                 |       | 3,352                   |       | 3,443 |   | 3,052 |   | 4,007 |   | 4,843 |   | 4,985 |   | 4,945 |   | 5,684 |   |
| Sales and  marketing                                                       |       | 2,407                   |       | 2,838 |   | 2,531 |   | 2,523 |   | 2,600 |   | 2,019 |   | 2,406 |   | 5,552 |   |
| Rescission and  public offering costs                                      |       | —                  |       | 1,231 |   | — |   | 56 |   | — |   | — |   | — |   | — |   |
| Depreciation and  amortization                                             |       | 54                      |       | 67 |   | 74 |   | 78 |   | 74 |   | 113 |   | 160 |   | 152 |   |
| Income from  operations                                                    |       | 3,365                   |       | 110 |   | 1,005 |   | 997 |   | 3,611 |   | 3,757 |   | 5,184 |   | 8,363 |   |
| Net income                                                                 |       | $                       | 3,292      |   | $ | 147 |   | $ | 997 |   | $ | 953 |   | $ | 3,435 |   | $ | 2,915 |   | $ | 3,563 |   | $ | 8,213 |   |
| Net income per  share available to common stockholders — Basic   |       | $                       | 0.14       |   | $ | 0.01 |   | $ | 0.04 |   | $ | 0.04 |   | $ | 0.15 |   | $ | 0.13 |   | $ | 0.15 |   | $ | 0.34 |   |
| Net income per  share available to common stockholders — Diluted |       | $                       | 0.14       |   | $ | 0.01 |   | $ | 0.04 |   | $ | 0.04 |   | $ | 0.14 |   | $ | 0.12 |   | $ | 0.14 |   | $ | 0.29 |   |
| Weighted average  number of shares outstanding — Basic           |       | 23,312                  |       | 23,312 |   | 23,311 |   | 23,270 |   | 23,246 |   | 23,272 |   | 23,593 |   | 24,150 |   |
| Weighted average  number of shares outstanding — Diluted         |       | 23,827                  |       | 23,822 |   | 23,801 |   | 23,750 |   | 23,725 |   | 24,147 |   | 26,324 |   | 28,507 |   |
|                                                                       |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| ** **                                                                 | ** ** | **March 31,**      | ** ** | **June 30,** | ** ** | **Sept. 30,** | ** ** | **Dec. 31,** | ** ** | **March 31,** | ** ** | **June 30,** | ** ** | **Sept. 30,** | ** ** | **Dec. 31,** | ** ** |
| ** **                                                                 | ** ** | **2006**                | ** ** | **2006** | ** ** | **2006** | ** ** | **2006** | ** ** | **2007** | ** ** | **2007** | ** ** | **2007** | ** ** | **2007** | ** ** |
| ** **                                                                 | ** ** | **(unaudited)**         | ** ** |
| ** **                                                                 | ** ** | ** **              | ** ** | ** ** |
| Net revenue                                                                |       | 100.0                   | %          | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 |   |
| Gross profit                                                               |       | 26.5                    |       | 23.7 |   | 24.6 |   | 20.4 |   | 24.9 |   | 27.8 |   | 31.7 |   | 31.2 |   |
| General and  administrative                                                |       | 9.7                     |       | 10.6 |   | 11.2 |   | 10.6 |   | 10.8 |   | 12.7 |   | 12.3 |   | 9.0 |   |
| Sales and  marketing                                                       |       | 6.9                     |       | 8.8 |   | 9.4 |   | 6.7 |   | 5.8 |   | 5.2 |   | 6.0 |   | 8.8 |   |
| Rescission and  public offering costs                                      |       | —                  |       | 3.8 |   | — |   | 0.1 |   | — |   | — |   | — |   | — |   |
| Depreciation and  amortization                                             |       | 0.2                     |       | 0.2 |   | 0.3 |   | 0.2 |   | 0.2 |   | 0.3 |   | 0.4 |   | 0.2 |   |
| Operating income                                                           |       | 9.7                     |       | 0.3 |   | 3.7 |   | 2.6 |   | 8.1 |   | 9.6 |   | 12.9 |   | 13.2 |   |
| Net income                                                                 |       | 9.5                     | %          | 0.4 | % | 3.7 | % | 2.5 | % | 7.7 | % | 7.5 | % | 8.9 | % | 13.0 |   |

 

 

33

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Additional operatingmetrics:

 
| ** **                              | ** ** | **March 31,** | ** ** | **June 30,** | ** ** | **Sept. 30,** | ** ** | **Dec. 31,** | ** ** | **March 31,** | ** ** | **June 30,** | ** ** | **Sept. 30,** | ** ** | **Dec. 31,** | ** ** |
|-----------------------------------------|------------|--------------------|------------|-------------------|------------|--------------------|------------|-------------------|------------|--------------------|------------|-------------------|------------|--------------------|------------|-------------------|------------|
| ** **                              | ** ** | **2006**           | ** ** | **2006**          | ** ** | **2006**           | ** ** | **2006**          | ** ** | **2007**           | ** ** | **2007**          | ** ** | **2007**           | ** ** | **2007**          | ** ** |
| ** **                              | ** ** | **(unaudited)**    | ** ** |
| ** **                              | ** ** | ** **         | ** ** | ** **        | ** ** | ** **         | ** ** | ** **        | ** ** | ** **         | ** ** | ** **        | ** ** | ** **         | ** ** | ** **        | ** ** |
| Average selling price per order (gross) |       | $                  | 142        |              | $          | 133                |       | $                 | 124        |               | $          | 123               |       | $                  | 154        |              | $          | 171 |   | $ | 173 |   | $ | 169 |   |
| Average orders per day                  |       | 2,901              |       | 2,832             |       | 2,587              |       | 3,757             |       | 3,317              |       | 2,678             |       | 2,699              |       | 4,443             |       |
| Average items sold per day              |       | 7,173              |       | 7,730             |       | 7,293              |       | 9,685             |       | 9,482              |       | 8,678             |       | 8,814              |       | 12,709            |       |
| Acquisition cost per new buyer ($)      |       | 38                 |       | 49                |       | 51                 |       | 36                |       | 45                 |       | 38                |       | 43                 |       | 51                |       |
| Number of new buyers                    |       | 63,618             |       | 57,520            |       | 49,412             |       | 70,419            |       | 58,056             |       | 53,637            |       | 55,423             |       | 109,833           |       |
|                                         |            |                    |            |                   |            |                    |            |                   |            |                    |            |                   |            |                    |            |                   |            |  |  |  |  |  |  |  |  |

 

**Liquidityand Capital Resources**

 

Since inception, we havefunded our operations through the sale of equity securities and cash generatedfrom operations. The significant components of our working capital areinventory, other current assets, and liquid assets such as cash and accountsreceivable, reduced by accounts payable, accrued expenses, and deferredrevenue. Our business model contains beneficial working capitalcharacteristics: while we collect cash from sales to customers within severalbusiness days of the related sale, we typically have extended payment termswith our suppliers.

 

As of December 31,2007, we had a working capital surplus of $31.1 million and have no long-termdebt obligations. Net cash used for operating activities was $3.2 million in2007 compared with $2.4 million in 2006. Net cash is affected primarily bychanges in net income and loss, inventories, other current assets, revolvingcredit line, accounts payable, accrued expenses, and deferred revenue. Werecorded net income of  $2.6 millionin 2005, $5.4 million in 2006 and $18.1 million in 2007. The improvementin profitability resulted primarily from the improved gross profit margins of21.3%, 23.7%, and 29.1% in 2005, 2006, and 2007 respectively. Inventories, andaccounts payable generally increase in line with sales growth and changes inour inventory strategy. Our inventory strategy is influenced by our ability to secureinventory that we believe will improve sales and our gross margins.

 

The increase in cash usedfor operating activities in 2007 compared with 2006 was $779,000. Net incomewas $18.1 million in 2007 compared with $5.4 million in 2006. Inventoriesincreased by $23.0 million in 2007 compared with an increase of$18.5 million in 2006. Other current assets increased by $5.9 million in2007 compared to an increase of $1.0 million in 2006. Accounts payableincreased by $4.4 million in 2007 compared to an increase of $14.7 million in2006. The increase in inventories and corresponding increases in financing andaccounts payable is attributable to our ability to purchase and hold inventorythat we believe will improve sales and our gross margins. Accrued expensesincreased by $2.6 million in 2007 compared to an increase of $178,000 in 2006.Deferred revenue decreased by $1.0 million in 2007 compared to an increase of$2.4 million in 2006.

 

Net cash used forinvesting activities was $197,000, $367,000, and $1.4 million in 2005, 2006 and2007, respectively, and was primarily related to capital expenditures for ouroffice equipment and technology system infrastructure, including hardware andsoftware.

 

Net cash provided byfinancing activities was $9.0 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 common stock of $886,000. Net cash used forfinancing activities was $3.2 million in 2006, primarily related to proceedsfrom the revolving line of credit of $3.9 million net against $690,000 for theretirement of common stock and $90,000 for the purchase of treasury stock.There were no financing activities in 2005.

 

InJuly 2006, we entered into a revolving credit line agreement with LaSalleBank (Bank of America) to provide working capital financing secured byinventories and tangible assets. As of December 31, 2007, we have a limit of$15 million under the loan agreement. 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, 2007, there was anoutstanding balance of $5.9 million under the revolving credit line andremaining availability of $7.6 million after deducting reserve of $1.5 millionfor minimum required excess availability, which is a reserve of the $15 millioncredit line that we cannot utilize. There is an unused fee of 0.15% on theunused portion of the revolving credit line.

 

34

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We believe that cash andcash equivalents currently on hand, cash flows from operations and availabilityof the $15 million revolving line of credit will be sufficient to continue ouroperations and to pursue our growth strategy for the foreseeable future. Ourfuture capital requirements will depend on many factors, including the rate ofour revenue growth; the timing and extent of spending to enhance our website,network infrastructure and transaction processing systems; the extent of our advertisingand marketing programs; the levels of the inventory we carry; acquisition andrelocation to a new corporate office; and other factors relating to ourbusiness. Enhancement of our website, network infrastructure, and transactionprocessing systems will require us to spend significantly more than we have inthe past. Moreover, to date our spending in these areas has been lower thanindustry averages. We anticipate increasing our system expenditures toaccommodate these needs in the future. We may require additional financingin the future in order to execute our operating plan. We cannot predict whetherthis additional financing will be in the form of equity, debt, or acombination of debt or equity.

 

**LeaseObligations**

 

The following tablepresents our contractual obligations at December 31, 2007, over the nextfive years and thereafter (in thousands):

 

| ** **                       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **       | ** ** |
|----------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------------|------------|
| ** **                       | ** ** | **Total**  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **After 5** | ** ** |
| **Payments by Period** | ** ** | **Amount** | ** ** | **2008**   | ** ** | **2009**   | ** ** | **2010**   | ** ** | **2011**   | ** ** | **2012**   | ** ** | **Years**        | ** ** |
| Property lease                   |       | $          | 2,576      |       | $          | 1,128      |       | $          | 987        |       | $          | 173        |       | $                | 173        |   | $ | 115 |   | $ | — |   |
|                                  |            |            |            |            |            |            |            |            |            |            |            |            |            |                  |            |  |  |  |  |  |  |  |

 

As more fully describedin Note 8 to the audited financial statements, we are obligated for the leaseof our office and warehouse space.

 

**Impactof Inflation**

 

The effect of inflationand changing prices on our operations was not significant during the periodspresented.

 

**Item7A.**  Quantitativeand Qualitative Disclosure About Market Risk

** **

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

 

**Item8.**           FinancialStatements and Supplementary Data

** **

See Item 15(a)

 

**Item9.**           Changesin and Disagreements With Accountants on Accounting and Financial Disclosure

** **

None.

 

**Item9A.**  Controlsand Procedures

** **

***Evaluation of Disclosure Controls and Procedures***

 

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

 

35

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***Report of Management on Internal Control over FinancialReporting***

 

Management is responsiblefor establishing and maintaining adequate internal control over financialreporting, as defined in Rule 13a-15(f) of the 1934 Act. Our internalcontrol over financial reporting is designed to provide reasonable assuranceregarding the reliability of financial reporting and the preparation offinancial 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 reasonableassurance that our transactions are recorded as necessary to permit preparationof financial 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 assessed the effectiveness of our internal controlover financial reporting as of December 31, 2007, using the criteria setforth by the Committee of Sponsoring Organizations of the Treadway Commission(COSO) in Internal Control — Integrated Framework. Based on thisassessment, management has concluded that our internal control over financialreporting was effective as of December 31, 2007. There has been no changein 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, 2007 that has materially affected, oris reasonably likely to materially affect, our internal control over financialreporting.

 

Stonefield Josephson, Inc., an independent registered publicaccounting firm, has issued an attestation report on management’s assessment ofinternal control over financial reporting, a copy of which is included in thisannual report on Form 10-K.

 

***Changes in Internal Control Over Financial Reporting***

 

There were no changes inour internal control over financial reporting during the quarter ended December 31,2007, that our certifying officers concluded materially affected, or arereasonably likely to materially affect, our internal control over financialreporting.

 

***Limitations on Controls***

 

Management does notexpect that our disclosure controls and procedures or our internal control overfinancial reporting will prevent or detect all error and fraud. Any controlsystem, no matter how well designed and operated, is based upon certainassumptions and can provide only reasonable, not absolute, assurance that itsobjectives will be met. Further, no evaluation of controls can provide absoluteassurance that misstatements due to error or fraud will not occur or that allcontrol issues and instances of fraud, if any, within the Company have beendetected. Also, projections of any evaluation of effectiveness to futureperiods are subject to the risk that controls may become inadequate because ofchanges in conditions, or that the degree of compliance with the policies orprocedures may deteriorate.

 

**Item 9B.         OtherInformation**

 

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 2008 annual meeting of shareholders, whichwe expect to file before 120 days after December 31, 2007. Weincorporate that information in this annual report by reference to our 2008proxy statement.

 

36

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**Item 10.****   ****Directors, Executive Officers and Corporate Governance.**

 

Information required by this item is incorporated byreference from the definitive proxy statement required to be filed pursuant toRegulation 14A for the 2008 Annual Meeting of our stockholders.

 

We have adopted a code of conduct that applies to ourChief Executive Officer, Chief Financial Officer, and to all of our otherofficers, directors, employees and agents. The code of conduct is available atthe Corporate Governance section of the Investor Relations link on our websiteat *www.bidz.com*. We intend to disclosefuture amendments to, or waivers from, certain provisions of our code of ethicson the above website.

 

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

 

Information required by this item is incorporated byreference from the definitive proxy statement required to be filed pursuant toRegulation 14A for the 2008 Annual Meeting of our stockholders.

 

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

 

Information required by this item is incorporated byreference from the definitive proxy statement required to be filed pursuant toRegulation 14A for the 2008 Annual Meeting of our stockholders.

 

**Item 13.****   ****Certain Relationships and Related Transactions, and DirectorIndependence.**

 

Information required by this item is incorporated byreference from the definitive proxy statement required to be filed pursuant toRegulation 14A for the 2008 Annual Meeting of our stockholders.

 

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

 

Information required by these items is incorporated byreference from the definitive proxy statement required to be filed pursuant toRegulation 14A for the 2008 Annual Meeting of our stockholders.

 

**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                                                       |       |   |
|                                                       | Balance Sheets as of December 31, 2006 and 2007                                                           |       |   |
|                                                       | Statements of Operations for the Years ended  December 31, 2005, 2006, and 2007                           |       |   |
|                                                       | Statements of Changes in Stockholders’ Equity for the  Years ended December 31, 2005, 2006, and 2007 |
|                                                       | Statements of Cash Flows for the Years ended  December 31, 2005, 2006, and 2007                           |       |   |
|                                                       | Notes  to Financial Statements                                                                                 |       |   |
|                                                       |                                                                                                           |       |   |
| **(b)**                                                    | **Financial Statement Schedule**                                                                               | ** ** | ** ** |
|                                                            |                                                                                                                |            |  |  |

 

37

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**Report Of Stonefield Josephson, Inc. IndependentRegistered Public Accounting Firm**

 

To The Board of Directorsand Stockholders of Bidz.com, Inc.:

 

We have audited theaccompanying balance sheets of Bidz.com, Inc. (the “Company”) as of December 31,2007 and 2006, and the related statements of operations, stockholders’ equity, and cash flows for each of the years inthe three-year period ended December 31, 2007. Our audits also included the financial statement schedule listed inthe index at Item 15. These financial statements and the schedule are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these financial statements based on our audits.

 

Weconducted our audits in accordance with the standards of the Public CompanyAccountingOversight Board (United States). Those standards require that we plan andperform the audit to obtain reasonable assurance about whether the financialstatements are free of material misstatement. An audit includes examining, on atest basis, evidence supporting the amounts and disclosures in the financial statements.An audit also includes assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation. We believethat our audits provide a reasonable basis for our opinion.

 

Inour opinion, thefinancial statements referred to above present fairly, in all material respects, the financial position of Bidz.com, Inc.as of December 31, 2007 and 2006, and the results of its operations and its cash flows for the years thenended, in conformity with accounting principles generally accepted inthe United States. 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.

 

Wealso have audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the Company’s internal control overfinancial reporting as of December 31, 2007, based on criteria establishedin Internal Control—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO) and our report dated March 10,2008 expressed an unqualified opinion.

 

/s/  Stonefield Josephson, Inc.

 

Irvine, California

March 10, 2008

 

38

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**Report ofIndependent Registered Public Accounting Firm**

 

Tothe Board of Directors and Stockholders of Bidz.com, Inc.:

 

Wehave audited management’s assessment, included in the accompanying “Management’sReport on Internal Control over Financial Reporting”, that Bidz.com, Inc.maintained effective internal control over financial reporting as of December 31,2007, based on criteria established in Internal Control— Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission(COSO). Bidz.com, Inc.’s management is responsible for maintainingeffective internal control over financial reporting and for its assessment ofthe effectiveness of internal control over financial reporting. Ourresponsibility is to express an opinion on management’s assessment and anopinion on the effectiveness of the company’s internal control over financialreporting based on our audit.

 

Weconducted our audit in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform the audit to obtain reasonable assurance about whethereffective internal control over financial reporting was maintained in allmaterial respects. Our audit included obtaining an understanding of internalcontrol over financial reporting, assessing the risk that a material weaknessexists, evaluating management’s assessment, testing and evaluating the designand operating effectiveness of internal control based on the assessed risk, andperforming such other procedures as we considered necessary in the circumstances.We believe that our audit provides a reasonable basis for our opinion.

 

Acompany’s internal control over financial reporting is a process designed toprovide reasonable assurance regarding the reliability of financial reportingand the preparation of financial statements for external purposes in accordancewith generally accepted accounting principles. A company’s internal controlover financial reporting includes those policies and procedures that (1) pertainto the maintenance 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.

 

Becauseof its inherent limitations, internal control over financial reporting may notprevent or detect misstatements. 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.

 

Inour opinion, management’s assessment that Bidz.com, Inc. maintainedeffective internal control over financial reporting as of December 31,2007, is fairly stated, in all material respects, based on criteria establishedin Internal Control—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO). Also, in our opinion, Bidz.com, Inc.maintained, in all material respects, effective internal control over financialreporting as of December 31, 2007, based on criteria established inInternal Control—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO).

 

Wealso have audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the balance sheet and the relatedstatements of operations, stockholders’ equity and cash flows of Bidz.com, Inc.as of December 31, 2007 and our report dated March 10, 2008 expressedan unqualified opinion thereon.

 

/s/  StonefieldJosephson, Inc.

 

Irvine,California

March 10,2008

 

39

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**Bidz.com, Inc.**

 

**BalanceSheets**

 

*(In thousands, except share data)*

 
| ** **                                                                                                                                                                            | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                            | ** ** | **2006**              | ** ** | **2007** | ** ** |
|                                                                                                                                                                                  |       |                  |       |   |   |
| **Assets**                                                                                                                                                                            | ** ** | ** **            | ** ** | ** ** | ** ** |
| Current assets:                                                                                                                                                                       |       |                  |       |   |   |
| Cash                                                                                                                                                                                  |       | $                     | 359        |   | $ | 4,808 |   |
| Accounts  receivable                                                                                                                                                                  |       | 1,930                 |       | 2,275 |   |
| Inventories, net  of reserves of $461 and $1,075 at December 31, 2006 and  December 31, 2007, respectively                                                                  |       | 34,308                |       | 56,686 |   |
| Other current  assets                                                                                                                                                                 |       | 1,192                 |       | 7,044 |   |
| Total current  assets                                                                                                                                                                 |       | 37,789                |       | 70,813 |   |
| Property and equipment, net                                                                                                                                                           |       | 478                   |       | 1,323 |   |
| Intangible asset                                                                                                                                                                      |       | 150                   |       | 161 |   |
| Deposits                                                                                                                                                                              |       | 125                   |       | 104 |   |
| Total assets                                                                                                                                                                          |       | $                     | 38,542     |   | $ | 72,401 |   |
| ** **                                                                                                                                                                            | ** ** | ** **            | ** ** | ** ** | ** ** |
| **Liabilities and Stockholders’ Equity**                                                                                                                                         | ** ** | ** **            | ** ** | ** ** | ** ** |
| Current liabilities:                                                                                                                                                                  |       |                  |       |   |   |
| Revolving credit  line                                                                                                                                                                |       | $                     | 3,941      |   | $ | 5,924 |   |
| Accounts payable  (includes related party amounts of $4,331 and $5,050 at December 31,  2006 and December 31, 2007, respectively)                                           |       | 21,987                |       | 26,400 |   |
| Accrued expenses                                                                                                                                                                      |       | 1,952                 |       | 4,509 |   |
| Deferred revenue                                                                                                                                                                      |       | 3,935                 |       | 2,900 |   |
| Total current  liabilities                                                                                                                                                            |       | 31,815                |       | 39,733 |   |
|                                                                                                                                                                                  |       |                  |       |   |   |
| Commitments and contingencies                                                                                                                                                         |       |                  |       |   |   |
|                                                                                                                                                                                  |       |                  |       |   |   |
| Stockholders’ equity:                                                                                                                                                            |       |                  |       |   |   |
| Preferred stock:  par value $0.001; authorized 4,000,000 shares; none issued and outstanding at  December 31, 2006 and December 31, 2007, respectively                      |       | —                |       | — |   |
| Common stock:  par value $0.001; authorized 100,000,000 shares; issued and outstanding  23,233,904 and 24,556,354 at December 31, 2006 and December 31,  2007, respectively |       | 23                    |       | 25 |   |
| Additional paid  in capital                                                                                                                                                           |       | 28,352                |       | 36,961 |   |
| Shares held in  treasury, at cost; 15,000 and 100,000 shares at December 31, 2006 and  December 31, 2007, respectively                                                      |       | (90                   | )          | (886 | ) |
| Accumulated deficit                                                                                                                                                                   |       | (21,558               | )          | (3,432 | ) |
| Total  stockholders equity                                                                                                                                                            |       | 6,727                 |       | 32,668 |   |
| ** **                                                                                                                                                                            |       | $                     | 38,542     |   | $ | 72,401 |   |

 

40

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**Bidz.com, Inc.**

 

**Statementsof Operations**

 

*(Inthousands, except share and per share data)*

 
| ** **                                                       | ** ** | **Years Ended December 31,** | ** ** |
|------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                       | ** ** | **2005**                          | ** ** | **2006** | ** ** | **2007** | ** ** |
|                                                             |       |                              |       |   |   |   |   |
| Net revenue:                                                     |       |                              |       |   |   |   |   |
| Merchandise  sales                                               | ** ** | $                                 | 90,309     |   | $ | 131,687 |   | $ | 186,830 | ** ** |
| Other revenue                                                    |       | 270                               |       | 136 |   | 301 |   |
|                                                             |       | 90,579                            |       | 131,823 |   | 187,131 |   |
| Cost of revenue                                                  |       | 71,257                            |       | 100,633 |   | 132,683 |   |
| Gross Profit                                                     |       | 19,322                            |       | 31,190 |   | 54,448 |   |
| Operating expenses:                                              |       |                              |       |   |   |   |   |
| General and  administrative                                      |       | 10,938                            |       | 13,853 |   | 20,458 |   |
| Sales and  marketing                                             |       | 5,078                             |       | 10,300 |   | 12,578 |   |
| Rescission and  public offering costs                            |       | 442                               |       | 1,287 |   | — |   |
| Depreciation and  amortization                                   |       | 157                               |       | 273 |   | 498 |   |
| Total operating expenses                                         |       | 16,615                            |       | 25,713 |   | 33,534 |   |
| Income from operations                                           |       | 2,707                             |       | 5,477 |   | 20,914 |   |
| Other income - interest income                                   |       | 22                                |       | 80 |   | 41 |   |
| Other expense - interest (expense)                               |       | —                            |       | (48 | ) | (291 | ) |
| Income before income tax expense                                 |       | 2,729                             |       | 5,509 |   | 20,664 |   |
| Income tax expense                                               |       | 82                                |       | 120 |   | 2,538 |   |
| Net income                                                       | ** ** | $                                 | 2,647      |   | $ | 5,389 |   | $ | 18,126 | ** ** |
|                                                             |       |                              |       |   |   |   |   |
| Net income per share available to common  shareholders - basic   | ** ** | $                                 | 0.11       |   | $ | 0.23 |   | $ | 0.77 | ** ** |
| Net income per share available to common  shareholders - diluted | ** ** | $                                 | 0.11       |   | $ | 0.23 |   | $ | 0.69 | ** ** |
| Weighted average number of shares outstanding -  basic           |       | 24,337,159                        |       | 23,302,026 |   | 23,567,995 |   |
| Weighted average number of shares outstanding -  diluted         |       | 24,858,535                        |       | 23,791,368 |   | 26,266,008 |   |

 

41

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**Bidz.com, Inc.**

 

**Statements of Changes in Stockholders’ Equity**

 

*(In thousands)*

 
| ** **                                                                     | ** ** | ** **        | ** ** | **Class B**  | ** ** | **Additional** | ** ** | ** **   | ** ** | **Deferred**    | ** ** | ** **      | ** ** | **Total**              | ** ** |
|--------------------------------------------------------------------------------|------------|-------------------|------------|-------------------|------------|----------------|------------|--------------|------------|-----------------|------------|-----------------|------------|------------------------|------------|
| ** **                                                                     | ** ** | **Common  Stock** | ** ** | **Common  Stock** | ** ** | **paid in**    | ** ** | **Treasury** | ** ** | **Stock-based** | ** ** | **Accumulated** | ** ** | **Stockholders’** | ** ** |
| ** **                                                                     | ** ** | **Shares**        | ** ** | **Amount**        | ** ** | **Shares**     | ** ** | **Amount**   | ** ** | **capital**     | ** ** | **shares**      | ** ** | **Compensation**       | ** ** | **Deficit** | ** ** | **Equity** | ** ** |
|                                                                           |       |              |       |              |       |           |       |         |       |            |       |            |       |                   |       |   |   |   |   |
| Balance at  December 31, 2004                                             |       | 11,922            |       | $                 | 28,388     |           | 15,535     |         | $          | 426             |       | $               | —     |                   | $          | — |   | $ | (300 | ) | $ | (29,594 | ) | $ | (1,080 | ) |
| Conversion of  class B common stock to  common stock                      |       | 15,535            |       | 426               |       | (15,535        | )          | (426         | )          | —          |       | —          |       | —                 |       | — |   | — |   |
| Cancellation of  common stock                                                  |       | (4,145            | )          | —            |       |           |       |         |       |            |       |            |       |                   |       |   |   |   |   |
| Fair value of  options granted to non-employee consultants                     |       | —            |       | 16                |       | —         |       | —       |       | —          |       | —          |       | —                 |       | — |   | 16 |   |
| Amortization of  deferred stock-based compensation                             |       | —            |       | —            |       | —         |       | —       |       | —          |       | —          |       | 200                    |       | — |   | 200 |   |
| Net income                                                                     |       | —            |       | —            |       | —         |       | —       |       | —          |       | —          |       | —                 |       | 2,647 |   | 2,647 |   |
| Balance at  December 31, 2005                                             |       | 23,312            |       | $                 | 28,830     |           | —     |         | $          | —          |       | $               | —     |                   | $          | — |   | $ | (100 | ) | $ | (26,947 | ) | $ | 1,783 |   |
| Reincorporation  from California (no par value) to Delaware ($0.001 par value) |       | —            |       | (28,807           | )          | —         |       | —       |       | 28,807          |       | —          |       | —                 |       | — |   | — |   |
| Issuance of  common stock for service                                          |       | 37                |       | —            |       | —         |       | —       |       | 219             |       | —          |       | —                 |       | — |   | 219 |   |
| Fair value of  options granted to  employee                               |       | —            |       | —            |       | —         |       | —       |       | 16              |       | —          |       | —                 |       | — |   | 16 |   |
| Retirements of  common stock                                                   |       | (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 |   |
| 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 employee                                     |       | —            |       | —            |       | —         |       | —       |       | 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       | ) | $ | — |   | $ | (3,432 | ) | 32,668 |   |

 

42

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**Bidz.com, Inc.**

 

**Statements of Cash Flows**

 

*(In thousands)*

 
| ** **                                                                             | ** ** | **Years Ended December 31,** | ** ** |
|----------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                             | ** ** | **2005**                          | ** ** | **2006** | ** ** | **2007** | ** ** |
|                                                                                   |       |                              |       |   |   |   |   |
| **Cash flows provided by (used for) operating  activities:**                           | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income                                                                             |       | $                                 | 2,647      |   | $ | 5,389 |   | $ | 18,126 |   |
|                                                                                   |       |                              |       |   |   |   |   |
| **Adjustments  to reconcile net income to net cash provided by operating activities:** | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Depreciation and  amortization                                                         |       | 157                               |       | 273 |   | 498 |   |
| Change in  inventory reserve                                                           |       | 22                                |       | 130 |   | 614 |   |
| Amortization of  deferred stock-based compensation                                     |       | 200                               |       | 100 |   | — |   |
| Stock-based  compensation                                                              |       | 16                                |       | 235 |   | 774 |   |
| **Changes  in assets and liabilities:**                                                | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| **(Increase)  decrease in assets:**                                                    | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Accounts  receivable                                                                   |       | (325                              | )          | (1,044 | ) | (345 | ) |
| Inventories                                                                            |       | (5,210                            | )          | (18,517 | ) | (22,992 | ) |
| Other current  assets                                                                  |       | (51                               | )          | (1,034 | ) | (5,852 | ) |
| Deposits                                                                               |       | 350                               |       | 115 |   | 21 |   |
| **Increase  (decrease) in liabilities:**                                               | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Post-dated check  financing                                                            |       | (1,188                            | )          | (5,315 | ) | — |   |
| Accounts payable                                                                       |       | 2,394                             |       | 14,690 |   | 4,413 |   |
| Accrued expenses                                                                       |       | 669                               |       | 178 |   | 2,557 |   |
| Deferred revenue                                                                       |       | 518                               |       | 2,358 |   | (1,035 | ) |
| Net cash  provided by (used for) operating activities                                  |       | 199                               |       | (2,442 | ) | (3,221 | ) |
|                                                                                   |       |                              |       |   |   |   |   |
| **Cash flows (used for) investing activities:**                                        | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Capital  expenditures                                                                  |       | (197                              | )          | (367 | ) | (1,354 | ) |
| **Cash flows provided by (used for) financing  activities:**                           | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revolving credit  line                                                                 |       | —                            |       | 3,941 |   | 1,983 |   |
| Retirement of  common stock                                                            |       | —                            |       | (690 | ) | — |   |
| Repurchase of  common stock                                                            |       | —                            |       | (90 | ) | (886 | ) |
| Proceeds from  exercise of stock options                                               |       | —                            |       | — |   | 4,772 |   |
| Tax benefit from  exercise of stock options                                            |       | —                            |       | — |   | 3,155 |   |
| Net cash  provided by (used for) financing activities                                  |       | —                            |       | 3,161 |   | 9,024 |   |
| ** **                                                                             | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Net increase in cash**                                                               |       | 2                                 |       | 352 |   | 4,449 |   |
| **Cash, beginning of period**                                                          |       | 5                                 |       | 7 |   | 359 |   |
| **Cash, end of period**                                                                |       | $                                 | 7          |   | $ | 359 |   | $ | 4,808 |   |
|                                                                                   |       |                              |       |   |   |   |   |
| **Supplemental disclosure of cash flow  information:**                                 | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest paid                                                                          |       | $                                 | —     |   | $ | 48 |   | $ | 291 |   |
| Income taxes  paid                                                                     |       | $                                 | 91         |   | $ | 323 |   | $ | 502 |   |
|                                                                                   |       |                              |       |   |   |   |   |
| **Supplemental disclosure of non-cash investing  and financing activities:**           | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Retirement of  property and equipment                                                  |       | $                                 | 57         |   | $ | 17 |   | $ | 293 |   |

 

43

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**Bidz.com, Inc.**

 

**Notes to financial statements**

 

**(inthousands, except share and per share amounts)**

 

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

 

*Businessand Organization:*

 

We were formed in November 1998as a California corporation and in June 2006, we were re-incorporated as aDelaware corporation with our principal location of business in Los Angeles,California. We operate a website located at *www.bidz.com*for the purpose of selling merchandise, utilizing our unique onlinesales auction platform.

 

We sell our productsthroughout the United States and in international markets, concentrated mainlyin English speaking countries such as Canada, Australia and the United Kingdom.Revenue generated from the United States accounted for approximately 80.8%,79.2%, and 77.7% of net revenue for the years ended December 31, 2005,2006, and 2007, respectively.

 

*Recent Developments:*

 

We filed a registration statement on Form S-8 with the Securities and ExchangeCommission on June 29, 2007, in connection with the registration under theSecurities Act of 1933, as amended, of 3,400,000 shares of the Company’s commonstock, par value $0.001 per share, issuable pursuant to the Company’s 2001Stock Option Plan, 2002 Special Stock Option Plan and 2006 Stock Award Plan.

 

On May 1,2007 our common stock began trading under the symbol BIDZ on the OTC BulletinBoard and on June 6, 2007 we began trading on the NASDAQ Capital Market.

 

*Useof Estimates:*

 

Preparing financialstatements in conformity with accounting principles generally accepted in theUnited States requires us to make estimates and assumptions that affect thereported amounts of assets and liabilities. These estimates include certainreserves for inventories, returns and allowances, valuation allowance for deferredtaxes, disclosure of contingent assets and liabilities at the date of thefinancial statements, and the reported amounts of revenue and expenses duringthe reporting periods. Actual results could differ from those estimates.

 

*FairValue of Financial Instruments:*

 

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

 

*Cashand Cash Equivalents:*

 

For purposes of thestatements of cash flows, cash equivalents include all highly liquid debtinstruments with original maturities of three months or less that do not secureany corporate obligation. We had no cash equivalents at December 31, 2006or 2007.

 

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

 

*AccountsReceivable:*

 

Accounts receivableconsist mainly of amounts due from customer credit card and other electronicpayments billed but not yet received at period end. We had no allowance fordoubtful accounts at December 31, 2006 or 2007.

 

44

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*Returnand Allowance Reserve:*

 

We estimate potentialfuture product returns and chargebacks related to current period revenue. We analyze historical returns andchanges in customer demand and acceptance of our products when evaluating theadequacy of the sales returns reserve and other allowances in any accountingperiod. If actual returns 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 liabilities.

 

*Concentrationof Credit Risk:*

 

Financial instrumentsthat potentially subject us to significant concentrations of credit riskconsist primarily of cash and receivables. We derive our accounts receivableprimarily from revenue earned from customers located in the United States. Wemaintain an allowance for doubtful accounts based upon the expectedcollectability of accounts receivable. We record an allowance if one isnecessary. No customer accounted for more than 10% of revenue or receivablesduring 2005, 2006, or 2007.

 

We had a concentration ontwo merchandise suppliers during 2005, 2006, and 2007, as more fully describedin Note 13.

 

*Inventories:*

 

Inventories consistmainly of merchandise purchased for resale and are stated at the lower offirst-in, first-out cost (FIFO) or market. We record reserves against our inventory equal to the differencebetween the cost of inventory and the average selling price that is lower thancost of inventory that is held for less than one year. In addition, for theyears ended December 31, 2006 and 2007 we recorded reserves for obsoleteand slow moving inventory of 100% of the value of inventory held for more thanone year. If actual market conditions are less favorable than those projectedby us, specific reserves or additional inventory write-downs may be taken.

 

We recorded ininventories loose diamonds and semi-previous stones that we purchased anddelivered to manufacturers to produce into finished jewelry inventory toresell.

 

Werecord payments made to our suppliers for purchases we have yet to receive asprepaid inventory until they are in our possession and satisfactorily examined.Prepaid inventory included in inventories is $3.1 million and $94,000 at December 31,2006 and 2007, respectively.

 

*Propertyand Equipment:*

 

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

 

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

 

*IntangibleAsset:*

 

Our intangible assetconsists of the cost to acquire our domain names, which was $150,000 and$161,000 as of December 31, 2006 and 2007, respectively. Our domain nameshave indefinite lives and therefore are not subject to amortization. We performan annual evaluation for impairment on the intangible asset. No impairmentexisted at December 31, 2006 or 2007.

 

*Long-LivedAssets:*

 

In accordance withStatement of Financial Accounting Standards (“SFAS”) No. 144, “Accountingfor the Impairment or Disposal of Long-Lived Assets,” long-lived assets to beheld and used are analyzed for impairment whenever events or changes incircumstances indicate that the carrying amount of the assets may not berecoverable. SFAS No. 144 applies to assets subject to amortization. Wereview property, equipment, and other long-lived assets subject to amortizationfor 

 

45

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impairment wheneverevents or changes in circumstances indicate that the carrying amount of theassets may not be recoverable. We measure recoverability by comparing theassets’ carrying amount with future undiscounted net cash flows the assets areexpected to generate.

 

If such assets areconsidered to be impaired, we measure the impairment to be recognized by theamount by which the carrying amount of the assets exceeds the projecteddiscounted future cash flows arising from the assets or their fair values,whichever is more determinable.

 

*RevenueRecognition:*

 

We derive our revenuefrom four sources: merchandise sales, shipping charges, auction transactionfees, and other revenue. In accordance with SAB 104, we recognize revenue fromall 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 assumes the risk of loss; (3) theselling price is fixed or determinable; and (4) collection of theresulting receivable is reasonably assured.

 

We recognize merchandisesales upon shipments made to individual consumers and businesses that arefulfilled from our warehouse. We generally require online payment by creditcard or other electronic payment methods at the point of sale. We recordamounts received or billed prior to shipment of goods to customers as deferredrevenue. We reduce gross sales by returns, charge backs from customers, andother discounts redeemed to obtain such sales.

 

Wepresent sales tax liability on a net basis in accordance with Emerging IssuesTask Force (“EITF”) Issue No. 06-03.  Sales are not grossed up withthe attendant taxes and deducted as a separate line item. The EITF becomeseffective for interim and annual reporting periods beginning after December 15,2006.

 

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

 

Weinclude auction transaction fee revenue in net revenue. The 3% auctiontransaction fee is applied to all merchandise sales, including shipping andhandling, but not to sales tax.

 

Otherrevenue includes commissions and advertising revenue. We derive commissionrevenue from sales of Certified Merchant merchandise that is owned by thirdparties and recognize that revenue when services have been rendered. Forcommission revenue, we recognize as revenue only the commission portion of theprice our customers pay for the purchased products because we are acting as anagent in such transactions. Commissions are also reduced by the impact ofreturns and other discounts redeemed to obtain such sales. We recognizeadvertising revenue from allowing other companies to advertise on our web sitewhen the services are rendered and the advertising revenue is known andcollectible.

 

Outbound shipping chargesto customers are included in merchandise sales and amounted to$9.4 million, $15.1 million, and $22.6 million in 2005, 2006, and 2007,respectively.

 

*Costof Revenue:*

 

Cost of revenue includesproduct costs, inbound and outbound shipping charges, packaging and shippingsupplies, insurance on shipments, product repair and service costs, and creditcard and other electronic payment fees, and is recorded in the same period inwhich related revenue have been recorded.

 

Outbound shipping costson merchandise sales totaled $5.0 million, $6.9 million, and $9.7million in 2005, 2006, and 2007, respectively.

 

*DeferredRevenue:*

 

Deferred revenueliability is recorded for sales transactions where the products had not yetbeen shipped.

 

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*IncomeTax Expense:*

 

We account for incometaxes using an asset and liability approach, which requires the recognition oftaxes payable or refundable for the current year and deferred tax assets andliabilities for the future tax consequences of events that have been recognizedin our financial statements or tax returns. The measurement of current anddeferred tax assets and liabilities is based on provisions of enacted tax laws;the effects of future changes in tax laws or rates are not anticipated. Ifnecessary, the measurement of deferred tax assets is reduced by the amount ofany tax benefits that are not expected to be realized based on availableevidence.

 

*Stock-BasedCompensation:*

 

Prior to January 1,2006, we measured compensation expense to employees for our stock optionincentive plans under the recognition and measurement provisions of AccountingPrinciples Board Opinion No. 25, *Accountingfor Stock Issued to Employees,*and related interpretations.Utilizing the intrinsic value method prescribed by APB No. 25, we did notrecord compensation expense when stock options were granted to eligibleparticipants as long as the exercise price was not less than the fair marketvalue of the stock when the option was granted.

 

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

 

In accordance withStatement of Financial Accounting Standards (‘‘SFAS’’) No. 123, ‘‘Accountingfor Stock-Based Compensation,’’ and SFAS No. 148, ‘‘Accounting forStock-Based Compensation-Transition and Disclosure,’’ which amended SFAS No. 123,we disclosed pro forma net income and net income per share as if the fair valuebased method had been applied in measuring compensation expense. The disclosureprovisions of SFAS No. 148 were effective for financial statements forinterim periods beginning after December 15, 2002. We adopted thedisclosure requirements in the first quarter of 2003. The fair values ofoptions and shares issued pursuant to our option plan at each grant date wereestimated using the Black-Scholes option pricing model. Because there has beenno public market for our common stock, we used the minimum value method indetermining 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-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. For the years ended December 31, 2006 and 2007, we usedthe Black-Scholes option pricing model to estimate the value of our options inimplementing SFAS 123R and the calculated method to determine expectedvolatility, rather than the minimum value method, which we previously used 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, which is none or 0% for the years ended December 31,2006 and 2007. SFAS 123R requires forfeitures to be estimated at the time ofgrant and revised, if necessary, in subsequent periods if actual forfeituresdiffer from those estimates. In the pro forma information required under SFAS148 for the period prior to 2006, we did not account for forfeitures, as alloptions granted were fully vested at the date of grant and were not subject toany service period conditions. We expensed stock-based compensation on the dateof grant, as all options granted prior to January 1, 2006, vested immediately.Stock-based compensation subsequent to January 1, 2006 will includevesting provisions and therefore stock-based compensation expense is reducedfor estimated forfeitures.

 

We adopted SFAS 123Rusing the modified prospective method which requires the application of theaccounting standard as of January 1, 2006. Under this transition method,we are required to recognize compensation cost beginning January 1, 2006for the portion of outstanding awards for which the requisite service has beenrendered, based on the grant-date fair value of those awards calculated underSFAS 123 for our pro forma disclosures. In accordance with the modifiedprospective method, the financial statements for prior periods have not beenrestated to reflect, and do not include, the impact of SFAS 123R.

 

The pro forma informationfor the years ended December 31, 2005 required under SFAS No. 123 wasas follows (in thousands, except per share amounts):

 

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The following tableillustrates the effect on net income and income per share if we had applied thefair value recognition provisions of FASB Statement No. 123, “Accountingfor Stock-Based Compensation,” to stock-based employee compensation (inthousands, except per share data).

 

| ** **                                                                                                                               | ** ** | **2005** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| Net income, as  reported                                                                                                                 |       | $        | 2,647      |   |
| Add: Stock-based  employee compensation expense under APB 25, intrinsic value method, net of  related tax effects                        |       | —   |       |
| Deduct: Total  stock-based employee compensation expense determined under SFAS 123, fair  value based method, net of relaxed tax effects |       | (785     | )          |
| Pro forma net  income                                                                                                                    |       | $        | 1,862      |   |
|                                                                                                                                     |       |     |       |
| Net Income per  share                                                                                                                    |       |     |       |
| Basic — as  reported                                                                                                           |       | $        | 0.11       |   |
| Basic — pro  forma                                                                                                             |       | $        | 0.07       |   |
| Diluted —  as reported                                                                                                         |       | $        | 0.11       |   |
| Diluted —  pro forma                                                                                                           |       | $        | 0.07       |   |

 

The fair value for these optionsunder SFAS 123, fair value based method, was estimated on the date ofgrant using a Black-Scholes option pricing model with the assumptions discussedin Note 9.

 

Disclosures for the yearsended December 31, 2006 and 2007 are not presented as the amounts arerecognized in the financial statements in accordance with SFAS 123R, asdiscussed above.

 

*InternalUse Software:*

 

Pursuant to SOP 98-1, weexpense all costs incurred for the development of internal use software thatrelate to the planning and post-implementation phases of the development andcertain maintenance and enhancement costs. We capitalize and amortize directcosts incurred in the application development phase over the software’sestimated useful life of three years. The capitalized software costs of$250,000 was incurred from 2002 to 2004, and have been amortized since placedin use. At December 31, 2006 and 2007, the net unamortized balanceincluded in Property and Equipment is $80,000 and $0, respectively. Thecapitalized software costs of $250,000 was 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.

 

*Basicand Diluted Income Per Share:*

 

In accordance with SFAS No. 128,“Earnings Per Share,” we compute the basic income per common share by dividingnet income 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, 2005, 2006, and 2007, we had 8,342,000 shares, 8,353,000 shares, and 8,131,300 shares, respectively,of common stock equivalents upon the exercise of the employee and non-employeestock options. These common stock equivalents consisted of 7,715,000 employeestock options and 627,000 non-employee stock options as of December 31,2005; 7,726,000 employee stock options and 627,000 non-employee stock optionsas of December 31, 2006; and 8,079,300 employee stock options and 52,000non-employee stock options as of December 31, 2007. As of December 31,2005, dilutive common stock equivalents totaled 521,376, consisting of 305,251employee stock options and 216,125 non-employee stock options. 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.

 

The dilutive effect ofoutstanding stock options is reflected in diluted earnings per share byapplication of the treasury stock method for the years ended December 31,2005, 2006 and 2007. The following table sets forth the computation of basicand diluted net income per share (in thousands, except share and per sharedata):

 

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| ** **                                           | ** ** | **2005**   | ** ** | **2006**   | ** ** | **2007**   | ** ** |
|------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| Basic and diluted net income per share:              |       |       |       |       |       |       |       |
| Numerator:                                           |       |       |       |       |       |       |       |
| Net income                                           |       | $          | 2,647      |       | $          | 5,389      |       | $ | 18,126 |   |
| Denominator:                                         |       |       |       |       |       |       |       |
| Weighted average  shares of common stock outstanding |       | 24,337,159 |       | 23,302,026 |       | 23,567,995 |       |
| Effect of  dilutive securities                       |       | 521,376    |       | 489,342    |       | 2,698,013  |       |
| Denominator for  diluted calculation                 |       | 24,858,535 |       | 23,791,368 |       | 26,266,008 |       |
| Net income per share, basic                          |       | $          | 0.11       |       | $          | 0.23       |       | $ | 0.77 |   |
| Net income per share, diluted                        |       | $          | 0.11       |       | $          | 0.23       |       | $ | 0.69 |   |

 

*AdvertisingExpense:*

 

We recognize advertisingexpenses in accordance with SOP 93-7, “Reporting on Advertising Costs.” Assuch, we expense the costs of producing advertisements at the time productionoccurs and we expense the cost of communicating advertisements in the periodduring which the advertising space or airtime is used. We recognize Internetadvertising expenses based on the terms of the individual agreements, which aregenerally (1) during the period customers are acquired; (2) based onthe number of clicks generated during a given period over the term of thecontract; or (3) based on the number of e-mails sent during an e-maildistribution campaign. Advertising expenses totaled $5.1 million,$10.3 million, and $12.6 million during the years ended December 31,2005, 2006, and 2007, respectively.

 

*Reclassification:*

 

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

 

*Rescissionand Public Offering Costs:*

 

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

 

*NewAccounting Pronouncements:*

 

In February 2007,the FASB issued Statement No. 159 (“FAS 159”) which expanded FAS No. 157,“*Fair Value Measurements*,” whichdefines fair value, establishes guidelines for measuring fair value and expandsdisclosures regarding fair value measurements. FAS 159 does not require any newfair value measurements but rather eliminates inconsistencies in guidance foundin various prior accounting pronouncements. FAS 159 is effective for fiscalyears beginning after November 15, 2007. The adoption of FAS 159 does nothave a material impact on our financial statements.

 

In September 2006,the FASB issued Statement SFAS No. 157 (“FAS 157”), “ *Fair Value Measurements*,” which definesfair value, establishes guidelines for measuring fair value and expandsdisclosures regarding fair value measurements. FAS 157 does not require any newfair value measurements but rather eliminates inconsistencies in guidance foundin various prior accounting pronouncements. SFAS 157 is effective for fiscalyears beginning after November 15, 2007.

 

In July 2006,the FASB issued Interpretation No. 48, “*Accountingfor Uncertainty in Income Taxes, an interpretation of FAS*109”**(“FIN 48”) which clarifies the accountingfor uncertainty in income taxes recognized in accordance with FAS 109, “*Accounting for Income Taxes.”*FIN 48 is acomprehensive model for how a company should recognize, measure, present, anddisclose in its financial statements uncertain tax positions that the companyhas taken or expects to take on a tax return. If an income tax position exceedsa more likely than not (greater than 50%) probability of success upon taxaudit, the company will recognize an income tax benefit or expense in itsfinancial statements. Additionally, companies are required to accrue 

 

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interestand related penalties, if applicable, on all tax exposures consistent withjurisdictional tax laws. This interpretation is effective as of January 1,2007.  The adoption of this statement does not have a material impact onour financial statements.

 

Wepresent sales tax liability on a net basis in accordance with Emerging IssuesTask Force (“EITF”) Issue No. 06-03.  Sales are not grossed up withthe attendant taxes and deducted as a separate line item. The EITF becomeseffective for interim and annual reporting periods beginning after December 15,2006.

 

**(2)       Inventories:**

 

Inventories consist ofthe following at December 31, 2006 and 2007 (in thousands):

 

| ** **                              | ** ** | **2006** | ** ** | **2007** | ** ** |
|-----------------------------------------|------------|----------|------------|----------|------------|
|                                    |       |     |       |     |       |
| Fine jewelry, watches and other         |       | $        | 29,511     |     | $          | 53,054 |   |
| Loose diamonds and semi-precious stones |       | 2,133    |       | 4,392    |       |
| Prepaid inventory                       |       | 3,125    |       | 94       |       |
| Inventory with manufacturing vendors    |       | —   |       | 221      |       |
| Product inventories                     |       | 34,769   |       | 57,761   |       |
| Less: Inventory reserve                 |       | (461     | )          | (1,075   | )          |
|                                    |       | $        | 34,308     |     | $          | 56,686 |   |

 

As of December 31,2006 and 2007, all inventories have been pledged as collateral for ourrevolving credit line with LaSalle Bank (Bank of America).

 

**(3)       OtherCurrent Assets:**

 

Other current assetsconsist of the following at December 31, 2006 and 2007 (in thousands):

 

| ** **                               | ** ** | **2006** | ** ** | **2007** | ** ** |
|------------------------------------------|------------|----------|------------|----------|------------|
|                                     |       |     |       |     |       |
| Co-op marketing contributions receivable |       | $        | —     |     | $          | 2,873 |   |
| Deferred tax benefit                     |       | —   |       | 2,250    |       |
| Employee advances                        |       | —   |       | 1,086    |       |
| Prepayments and other current assets     |       | 1,192    |       | 835      |       |
|                                     |       | $        | 1,192      |     | $          | 7,044 |   |

 

**(4)       Propertyand Equipment:**

 

Property and equipmentconsists of the following at December 31, 2006 and 2007 (in thousands):

 

| ** **                                      | ** ** | **2006** | ** ** | **2007** | ** ** |
|-------------------------------------------------|------------|----------|------------|----------|------------|
|                                            |       |     |       |     |       |
| Computer hardware and software                  |       | $        | 581        |     | $          | 1,608 |   |
| Furniture and equipment                         |       | 262      |       | 507      |       |
| Internal developed software                     |       | 250      |       | —   |       |
| Automobile                                      |       | —   |       | 27       |       |
|                                            |       | 1,093    |       | 2,142    |       |
| Less: accumulated depreciation and amortization |       | 615      |       | 820      |       |
|                                            |       | $        | 478        |     | $          | 1,322 |   |

 

Depreciation andamortization expense of property and equipment totaled $157,000, $273,000 and$498,000 for the years ended December 31, 2005, 2006, and 2007,respectively.

 

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As of December 31,2006 and 2007, all property and equipment have been pledged as collateral forour revolving credit line with LaSalle Bank (Bank of America).

 

**(5)     RevolvingCredit Line:**

 

InJuly 2006, we entered into a revolving credit line agreement with LaSalleBank (Bank of America), to provide working capital financing secured byinventories and tangible assets. The agreement allowed for us to initially drawon a line of credit up to $10.0 million, with a provision to increase the limitup to $15.0 million with the future consent of the bank’s loan committee.During the first quarter of 2007 we successfully increased the limit to $15.0million. All cash receipts from our revenues are restricted to being depositedinto a LaSalle Bank account, to be applied to current reported cashdisbursements requirements, under a positive pay system, and then to the creditline outstanding balance. The revolving credit line agreement expires in July of2010. As of December 31,2007, there was an outstanding balance of $5.9 million under the revolvingcredit line and remaining availability of $7.6 million after deducting areserve of $1.5 million for minimum required excess availability which is areserve of the $15.0 million credit line that we cannot utilize. The interestrate on the revolving credit line outstanding as of December 31, 2007 is7.25% per annum. There is an unused fee of 0.25% on the unused portion of therevolving credit line.

 

Day-to-daydrawdowns on our credit line are subject to the prevailing prime rate. Theinterest is calculated on the average outstanding balance and compound monthly.As of December 31, 2007 our effective interest rate was 7.25%.  We have the option to extended term advances,for 30, 60, or 90 days that are subject to LIBOR rates. The rates will be acertain percentage above the LIBOR rates and will vary with the maturity termand amount borrowed. Interest is calculated over the stated term at an annualrate. As of December 31, 2007 we had no advances under LIBOR.

 

Under the terms andconditions of the revolving credit line agreement, the Company is subject tocertain restrictive covenants including the following restrictive financialcovenants:

 

Minimum TTM EBITDA:Actual Trailing Twelve Month (TTM) EBITDA compliance is measured on a monthlybasis, and shall not vary negatively from the Dollar amount for planned LTMEBITDA, set forth in an agreed upon schedule, for the applicable period, and issubject to resetting in Lender’s discretion based upon a business plan forsubsequent periods acceptable to Lender.

 

Capital Expenditures:Borrower shall not make capital expenditures in excess of an agreed upon amountfor each fiscal year covered by the loan agreement. All capital expenditurelimits are subject to resetting on an annual basis at the Lender’s discretionbased upon a business plan for subsequent periods acceptable to the Lender.

 

Minimum ExcessAvailability: We are to maintain an Excess Availability of $1.5 million with aMaximum Revolver Amount of $15.0 million. This covenant is subject to resettingat the Lender’s discretion based upon a business plan for subsequent periodsacceptable to Lender.

 

**(6)       AccountsPayable:**

 

During the years ending December 31,2006 and 2007 we employ “positive pay” procedures with our financialinstitution by transmitting check disbursement information to the financialinstitution to allow for our review and approval of exception transaction priorto them being posted to our account.

 

**(7)       AccruedExpenses:**

 

Accrued expenses consistof the following at December 31, 2006 and 2007 (in thousands):

 

| ** **                              | ** ** | **2006** | ** ** | **2007** | ** ** |
|-----------------------------------------|------------|----------|------------|----------|------------|
| Merchandise purchases                   |       | $        | 115        |     | $          | — |   |
| Accrued payroll and other related costs |       | 920      |       | 1,451    |       |
| Accrued net sales returns               |       | 164      |       | 346      |       |
| Other accrued expenses                  |       | 610      |       | 2,367    |       |
| Accrued marketing expenses              |       | 143      |       | 345      |       |
|                                    |       | $        | 1,952      |     | $          | 4,509 |   |

 

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**(8)           Commitments:**

 

The following tablepresents our contractual obligations at December 31, 2007, over the nextfive years and thereafter (in thousands):

 

| ** **                       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **       | ** ** |
|----------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------------|------------|
| ** **                       | ** ** | **Total**  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **After 5** | ** ** |
| **Payments by Period** | ** ** | **Amount** | ** ** | **2008**   | ** ** | **2009**   | ** ** | **2010**   | ** ** | **2011**   | ** ** | **2012**   | ** ** | **Years**        | ** ** |
| Property lease                   |       | $          | 2,576      |       | $          | 1,128      |       | $          | 987        |       | $          | 173        |       | $                | 173        |   | $ | 115 |   | $ | — |   |
|                                  |            |            |            |            |            |            |            |            |            |            |            |            |            |                  |            |  |  |  |  |  |  |  |

 

We lease a 50,000square-foot office and warehouse and a separate 12,000 square-foot warehousespace in Culver City, California. The leases expires in October 2009 and August 2012,respectively. We are obligated to pay real estate taxes, insurance, andmaintenance expenses. We expect that, in the normal course of business, the leasewill be renewed or replaced by leases on other properties upon termination.Thus, we anticipate that future minimum lease commitments will likely be morethan the amounts shown for 2007. Rental expenses for operating leases totaled$885,000, $908,000, and $995,000 for the years ended December 31, 2005,2006, and 2007, respectively.

 

**(9)           Stockholders’ Equity:**

 

*DelawareReincorporation*

 

OnJune 22, 2006 the Company reincorporated in the state of Delaware. Inconnection with our reincorporation in Delaware, we are authorized to issue100,000,000 shares of common stock, $0.001 par value, and 4,000,000 shares ofundesignated preferred stock, $0.001 par value.

 

*PreferredStock*

 

Our certificate ofincorporation authorizes our Board of Directors, without any vote or action bythe holders of our common stock, to issue preferred stock from time to time inone or more series. Our Board of Directors will be authorized to determine thenumber of shares and to fix the designations, powers, preferences, and therelative, participating, optional, or other rights of any series of preferredstock. Depending upon the terms of preferred stock established by our Board ofDirectors, any or all series of preferred stock could have preference over thecommon stock with respect to dividends and other distributions and upon ourliquidation. If any shares of preferred stock are issued with voting powers,the voting power of the outstanding common stock would be diluted. No shares ofpreferred stock are presently outstanding, and we have no present intention toissue any shares of preferred stock.

 

*CommonStock*

 

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

 

No dividends have beendeclared or paid on our common stock through December 31, 2007.

 

In 2007, common stockshares totaling 1,192,700 were issued from the exercise of stock options and15,000 shares held in treasury were retired. Common stock shares totaling18,750 were issued to independent board members. Restricted common stock awardstotaling 110,000 shares were issued to independent board members, and 16,000shares were issued to employees. Restricted common stock awards outstanding andyet to be vested totaled 126,000 shares as of December 31, 2007.

 

In 2006, common stockshares totaling 20,000 were issued to independent board members. 15,000 shareswere issued to an employee, and 1,404 shares were issued to a non-employee forservices rendered. We repurchased and retired 115,000 shares from the ChiefFinancial Officer and we repurchased 15,000 shares from an employee that isheld in Treasury.

 

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In 2005, David Zinbergsurrendered 4,144,689 shares of common stock for cancellation. Also in2005, David Zinberg and Marina Zinberg converted all their Class B commonstock to common stock and after the abovementioned cancellation they own3,542,343 and 7,707,657 shares of common stock respectively.

 

*DeferredStock-Based Compensation*

 

In connection withcertain stock grants to two employees during the year ended December 31,2001, we recognized $2.0 million in deferred stock-based compensation forthe deemed fair value of common stock at the date of the grant. We include suchamounts as a reduction of stockholders’ equity (deficit). We amortize suchamounts over the vesting period of five years in accordance with FASB InterpretationNo. 28, “Accounting for Stock Appreciation Rights and Other Variable StockOption or Award Plans.”

 

Amortization expensestotaled $200,000, $100,000, and $0 during the years ended December 31,2005, 2006, and 2007, respectively. As of December 31, 2007, all existingdeferred stock-based compensation grants were fully vested and all associatedcosts had been fully amortized.

 

To meet the statutoryobligation for the applicable income and other employment taxes, 115,000 commonshares were surrendered back to us in 2006 and a net-share settlement waseffected. Based on a fair market value of $6.00 per share on the vesting dateas determined based on a combination of factors that include recent sharetransactions between shareholders and an independent valuation of the Company,the employee’s tax obligations to the taxing authorities were approximately$690,000. The net-share settlement had the effect of share repurchases by us asit reduced and retired the number of shares outstanding and did not representan expense to the Company. The employee received no cash proceeds andtaxes were paid directly to the taxing authorities.

 

**(10)         Stock Option Plans:**

 

We adopted our 2001 StockOption Plan, our 2002 Special Stock Option Plan and our 2006 Award Plan (collectively,the “Plans”), in January 2001, January 2002, and March 2006,respectively. The Plans provide for the granting of awards in the form ofincentive stock options, nonqualified stock options, stock appreciation rights,shares of restricted common stock, bonus stock in lieu of obligations, or otherstock-based awards to employees, directors, and independent contractors whoprovide valuable services to our company.  The vesting requirements,performance thresholds and other terms and conditions of options granted underthe Plans will be determined by our Compensation Committee and Board ofDirectors. Outstanding options all vest immediately prior to 2006 and have 25%vesting at the end of each year over four years for options granted in 2006 and2007. Options generally have an expiration period of five years and new commonstock shares are issued upon the exercise of stock options. At December 31,2007, no shares were available for future grants under the Plans.

 

The following is asummary of stock option activity as of December 31, 2007, and changesduring the year ended December, 2007:

 

| ** **                            | ** ** | ** ** | ** ** | ** **    | ** ** | **Weighted**     | ** ** | ** **                | ** ** |
|---------------------------------------|------------|------------|------------|---------------|------------|------------------|------------|---------------------------|------------|
| ** **                            | ** ** | ** ** | ** ** | ** **    | ** ** | **Average**      | ** ** | ** **                | ** ** |
| ** **                            | ** ** | ** ** | ** ** | **Weighted-** | ** ** | **Remaining**    | ** ** | **Aggregate**             | ** ** |
| ** **                            | ** ** | ** ** | ** ** | **Average**   | ** ** | **Life of** | ** ** | **Instrinsic**            | ** ** |
| ** **                            | ** ** | ** ** | ** ** | **Exercise**  | ** ** | **Contract**     | ** ** | **Value as of** | ** ** |
| **Options**                           | ** ** | **Shares** | ** ** | **Price**     | ** ** | **(Years)**      | ** ** | **12/31/07**              | ** ** |
| Oustanding at January 1, 2007    |       | 8,353,000  |       | $             | 5.64       |             |       |                      |       |   |
| Granted                               |       | 1,000,000  |       | 8.23          |       |             |       |                      |       |
| Exercised                             |       | (1,192,700 | )          | 4.00          |       |             |       |                      |       |
| Forfeited                             |       | —     |       | —        |       |             |       |                      |       |
| Expired                               |       | (29,000    | )          | 6.00          |       |             |       |                      |       |
| Outstanding at December 31, 2007 |       | 8,131,300  |       | $             | 6.20       |             | 3.33       |                      | $          | 22,983,000 |   |
| Exercisable at December 31, 2007 |       | 7,045,050  |       | $             | 5.92       |             | 3.16       |                      | $          | 21,516,000 |   |

 

During the year ended December 31,2007, we issued 1,000,000 stock options to purchase shares in our common stock.During 2007, 1,192,700 stock options were exercised and the recognized taxbenefit related thereto is $3.2 million. The total fair value of optionsexercised during 2007 was $9.5 million. As of December 31, 2007, stockoptions to purchase 1,086,250 shares were not fully vested. Stock-basedcompensation cost from stock options for the year ended December 31, 2007,was $488,000. We recognize compensation expense on a straight-line basis overthe requisite service period for each stock option grant. The stock optionswere granted at prices equal to the fair market value of our common stock onthe date of grant and 

 

53

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have a four year vestingperiod with 25% vesting on each subsequent anniversary of the grant date. Thestock options expire 5 years from the grant date.

 

The following is asummary of stock option activity for the years ended December 31, 2005,2006, and 2007:

 
| ** **                       | ** ** | **2005**   | ** ** | **2006**     | ** ** | **2007**   | ** ** |
|----------------------------------|------------|------------|------------|--------------|------------|------------|------------|
| ** **                       | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                       | ** ** | ** ** | ** ** | **Average**  | ** ** | ** ** | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                       | ** ** | ** ** | ** ** | **Exercise** | ** ** | ** ** | ** ** | **Exercise** | ** ** | ** ** | ** ** | **Exercise** | ** ** |
| ** **                       | ** ** | **Shares** | ** ** | **Price**    | ** ** | **Shares** | ** ** | **Price** | ** ** | **Shares** | ** ** | **Price** | ** ** |
| Outstanding at beginning of year |       | 7,728,500  |       | $            | 5.59       |       | 8,342,000  |   | $ | 5.63 |   | 8,353,000 |   | $ | 5.64 |   |
| Granted                          |       | 703,000    |       | 6.00         |       | 235,000    |       | 6.00 |   | 1,000,000 |   | 8.23 |   |
| Exercised                        |       | —     |       | —       |       | —     |       | — |   | 1,192,700 | ) | 4.00 |   |
| Canceled / forfeited             |       | (90,000    | )          | 4.83         |       | (224,000   | )          | 5.45 |   | (29,000 | ) | 6.00 |   |
| Outstanding at year-end          |       | 8,342,000  |       | $            | 5.63       |       | 8,353,000  |   | $ | 5.64 |   | 8,131,300 |   | $ | 6.20 |   |
| Options exercisable at year-end  |       | 8,342,000  |       | $            | 5.63       |       | 8,238,000  |   | $ | 5.64 |   | 7,045,050 |   | $ | 5.92 |   |

 

The weighted-averagegrant date fair value of options granted during 2005, 2006, and 2007 was $1.14,$2.40, and $2.59 per share, respectively.

 

The following tablesummarizes information about stock options outstanding and exercisable at December 31,2007:

 

| ** **                    | ** **     | ** **      | ** **      | ** **    | ** ** | **Options Outstanding and Exercisable** | ** **     |
|-------------------------------|----------------|-----------------|-----------------|---------------|------------|--------------------------------------------------------|----------------|
| ** **                    | ** **     | ** **      | ** **      | ** **    | ** ** | **as of December 31, 2007**        | ** **     |
| ** **                    | ** **     | ** **      | ** **      | ** **    | ** ** | ** **                                             | ** **     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                    | ** **     | ** **      | ** **      | ** **    | ** ** | **Options Outstanding**                           | ** **     | **Options Exercisable** | ** ** |
| ** **                    | ** **     | ** **      | ** **      | ** **    | ** ** | **Weighted**                                           | ** **     | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                    | ** **     | ** **      | ** **      | **Number**    | ** ** | **Average**                                            | ** **     | **Average** | ** ** | **Number** | ** ** | **Average** | ** ** |
| **Range of  Exercise Prices** | ** **     | **Outstanding** | ** **      | **Remaining** | ** ** | **Exercise**                                           | ** **     | **Exercisable** | ** ** | **Exercise** | ** ** |
| ** **                    | **12/31/2007** | ** **      | **Contractual** | ** **    | **Price**  | ** **                                             | **12/31/2007** | ** ** | **Price** | ** ** |
| $                             | 4.01           |            | $               | 5.00          |       | 395,000                                                |           | 0.93 |   | $ | 4.50 |   | 395,000 |   | $ | 4.50 |   |
| $                             | 5.01           |            | $               | 6.00          |       | 6,736,300                                              |           | 3.32 |   | $ | 6.00 |   | 6,650,050 |   | $ | 6.00 |   |
| $                             | 6.01           |            | $               | 7.00          |       | 490,000                                                |           | 4.18 |   | $ | 6.50 |   | — |   | — |   |
| $                             | 9.01           |            | $               | 10.00         |       | 510,000                                                |           | 4.45 |   | $ | 9.90 |   | — |   | — |   |
| $                             | 4.01           |            | $               | 10.00         |       | 8,131,300                                              |           | 3.33 |   | $ | 6.20 |   | 7,045,050 |   | $ | 5.92 |   |

 

*StockOption Compensation*

 

In connection withcertain stock option grants to employees, consisting of 678,500, 235,000, and1,000,000 options during the years ended December 31, 2005, and 2006, and2007, respectively, we recognized approximately $0, $16,000, and $488,000,respectively, of employee stock-option compensation. The unamortizedstock-based compensation expense as of December 31, 2006 and 2007 is $260,000and $2.4 million, respectively.

 

Options granted in 2006and 2007 were valued in accordance with SFAS 123R. The fair value of theseoptions was calculated using a Black-Scholes option pricing model using thefollowing assumptions: (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 limited tradinghistory at the time of grant in 2007, and in accordance with SFAS 123R, we usedthe calculated method to determine volatility. Prior to June 15, 2007, wehad estimated the expected life to be equal to the option period and and from June 15,2007, we had estimated the expected life to be equal to the vesting period.

 

54

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Options granted in 2005were valued for the excess of deemed fair value of shares of common stocksubject to such options over the exercise price of these options at the grantdate in accordance with APB Opinion No. 25, “Accounting for Stock Issuedto Employees.”.

 

During the year ended December 31,2005, we granted 25,000 options to a consultant and non-employee. We recordedstock option compensation expense of $16,000 related to the grant in 2005. Thefair value for the options was measured on the grant date. At December 31,2005, the fair value of these options was calculated using a Black-Scholesoption pricing model using the following assumptions: (1) risk-freeinterest rates of 4.0%, (2) an expected life of three years, (3) expectedvolatility of 0.01%, and (4) a dividend yield of 0%. Because there was nopublic market for our common stock, we used the minimum value method todetermine volatility.

 

*RestrictedShares*

 

We began issuingrestricted stock awards in 2007, pursuant to the 2006 Award Plan. Therestricted stock awards were issued as time-based awards, which vest typicallywith 25% vesting at the end of each year over four years, or earlier if thereis an acceleration event. The retricted stock awards are expensed pro rata overthe vesting period based upon the market value of the awards at the time ofgrant. Stock-based compensation from the issuance of common stock and restrictedstock awards totaled $286,000 for the year ended December 31, 2007 andrestricted common stock awards outstanding and yet to be vested totaled 126,000shares as of December 31, 2007. No restricted shares were vested during2007 and the total fair vaue of shares vested was $0. The unamortizedstock-based expense for restricted stock awards was $1.1 million as of December 31,  2007.

 

A summary of allrestricted stock activity during the years ended December 31, 2006 and2007 follows:

 

| Restricted shares outstanding, January 1, 2006    |   | —  |   |
|--------------------------------------------------------|--------|---------|--------|
| Shares granted                                         |   | —  |   |
| Shares vested                                          |   | —  |   |
| Shares forfeited                                       |   | —  |   |
|                                                   |   |    |   |
| Restricted shares outstanding, December 31,  2006 |   | —  |   |
| Shares granted                                         |   | 126,000 |   |
| Shares vested                                          |   | —  |   |
| Shares forfeited                                       |   | —  |   |
|                                                   |   |    |   |
| Restricted shares outstanding, December 31,  2007 |   | 126,000 |   |

 

**(11)         Income Tax Expense:**

 

Income tax expenseamounted to $120,000 and $2.5 million for the years ended December 31,2006 and 2007 (an effective rate of 2.2% for 2006 and 12.3% for 2007). Areconciliation of the provision (benefit) for income tax expense with amountsdetermined by applying the statutory U.S. federal income tax rate to incomebefore income tax expense is as follows (in thousands):

 

| ** **                                                              | ** ** | **2005** | ** ** | **2006** | ** ** | **2007** | ** ** |
|-------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Computed tax benefit at federal statutory rate of  34%                  |       | $        | 928        |     | $          | 1,873    |       | $ | 7,026 |   |
| State taxes, net federal tax benefits                                   |       | 162      |       | 364      |       | 347      |       |
| Meals and entertainment                                                 |       | 22       |       | 26       |       | 15       |       |
| Limitation on executive compensation—section 162 (m)               |       | —   |       | 387      |       | —   |       |
| Change in valuation allowance, net of adjustment of  net operating loss |       | (1,078   | )          | (2,535   | )          | (4,850   | )          |
| Minimum tax credit                                                      |       | —   |       | 108      |       | —   |       |
| Excess benefit of vested stock                                          |       | —   |       | (170     | )          | —   |       |
| Other                                                                   |       | 48       |       | 67       |       | —   |       |
| Total income tax provision                                              |       | $        | 82         |     | $          | 120      |       | $ | 2,538 |   |

 

55

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Deferred tax assets andliabilities are recognized for future tax consequences between the carryingamounts of assets and liabilities and their respective tax bases using enactedtax rates in effect for the year in which the differences are expected to reverse.Significant deferred tax assets and liabilities consist of the following (inthousands):

 

| ** **                       | ** ** | **2006**   | ** ** | **2007**   | ** ** |
|----------------------------------|------------|------------|------------|------------|------------|
| **Deferred Tax Assets:**         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net operating loss carryforwards |       | 4,499      |       | —     |       |
| Employee stock options           |       | 912        |       | 304        |       |
| Inventory costs                  |       | 197        |       | 1,309      |       |
| Minimum tax credit carryforwards |       | 233        |       | 28         |       |
| Accrued expenses                 |       | 79         |       | 157        |       |
| Other reserves and allowances    |       | 70         |       | 258        |       |
| Excess benefit of vested stock   |       | 199        |       | —     |       |
| Deferred revenue                 |       | —     |       | 351        |       |
| State taxes                      |       | —     |       | 18         |       |
| Other (fixed assets)             |       | 35         |       | 96         |       |
| Total Deferred  Tax Assets       |       | 6,224      |       | 2,521      |       |
|                             |       |       |       |       |       |
| Deferred Tax Liability:          |       |       |       |       |       |
| State taxes                      |       | (324       | )          |       |       |
| Inventory costs                  |       |       |       | (271       | )          |
| Total Deferred  Tax Liabilities  |       |       |       | (271       | )          |
|                             |       |       |       |       |       |
| Valuation Allowance              |       | (5,900     | )          | —     |       |
| Net Deferred Tax Assets          |       | —     |       | 2,250      |       |

 

As a result of our 2007operating results, we utilized all Federal and California tax net operatingloss carryforwards of approximately $10.7 million and $9.8 million,respectively. We removed the valuation allowance from our net deferred taxassets. It is likely the tax benefits will be realized in the future.

 

Thetax benefits from the expense in 2007 for share based compensation awards thatwill result in future tax deduction are included in deferred tax assets. Theactual tax deduction exceeds the compensation cost recognized by the companyfor financial reporting purposes. The excess tax benefits increased the company’sadditional paid in capital by $3.2 million for the year ended December 31,2007, as required by FAS 123R.

 

We adopted the provisionsof FASB Interpretation 48, *Accounting for Uncertaintyin Income Taxes*, on January 1, 2007. Previously, we hadaccounted for tax contingencies in accordance with Statement of FinancialAccounting Standards 5, *Accounting forContingencies*. As required by Interpretation 48, which clarifiesStatement 109, *Accounting for Income Taxes*, werecognize the financial statement benefit of a tax position only afterdetermining that the relevant tax authority would more likely than not sustainthe position following an audit. For tax positions meeting the more-likely-than-not**threshold, the amount recognized in the financialstatements is the largest benefit that has a greater than 50 percent likelihoodof being realized upon ultimate settlement with the relevant tax authority. Atthe adoption date, we applied Interpretation 48 to all tax positions for whichthe statute of limitations remained open. Our analysis of the implementation ofInterpretation 48 reveals that there is no material effect on our financialstatements.

 

We are subject to incometaxes in the U.S. federal jurisdiction and California. Tax regulations withineach jurisdiction are subject to the interpretation of the related tax laws andregulations and require significant judgment to apply. With few exceptions, weare no longer subject to U.S. federal and California examinations by taxauthorities for the years before 2003.

 

We are under examinationby the Internal Revenue Service for the 2004, 2005 and 2006 tax years. Theexamination was  concluded as of December 31,2007 and final settlement is expected to be approximately $35,000, includinginterest and penalties.

 

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**(12)         Segment Information:**

 

Net revenue by geographicarea is presented based upon the country of destination. No foreign countryaccounted for 10% or more of net revenue for any of the fiscal years presented.Net revenue by geographic area was as follows for the years ended December 31,2005, 2006 and 2007 (in thousands):

 

| ** **    | ** ** | **2005** | ** ** | **2006** | ** ** | **2007** | ** ** |
|---------------|------------|----------|------------|----------|------------|----------|------------|
| United States |       | $        | 73,199     |     | $          | 104,338  |       | $ | 145,412 |   |
| International |       | 17,380   |       | 27,485   |       | 41,719   |       |
| Total         |       | $        | 90,579     |     | $          | 131,872  |       | $ | 187,131 |   |

 

Long-lived assets includeproperty and equipment and intangible assets that resided in the United Statesduring the years ended December 31, 2005, 2006, and 2007.

 

**(13)         Concentrations:**

 

Purchases of merchandisefrom one of our top two vendors, which is a related party (see Note 15),constituted 37.1%, 26.4%, and 11.9% of total merchandise purchased by us in theyears ending December 31, 2005, 2006, and 2007, respectively. Purchases ofmerchandise from our top two vendors amounted to $27.8 million,$34.4 million, and $40.4 million representing 42.1%, 31.1%, and 24.0%,respectively, of the total purchases during the years ended December 31,2005, 2006, and 2007, respectively.

 

Outstanding accountspayable to our top two vendors totaled $4.5 million and $6.2 million as ofDecember 31, 2006 and 2007, respectively. Loss of either of these vendorswill not have a negative impact on our operations.

 

**(14)         Contingencies:**

 

We are subject to variouslegal proceedings and claims that arise in the ordinary course ofbusiness.  Although the Company believes it has defenses to theallegations and intends to pursue them vigorously, currently, management doesnot currently have sufficient information to assess the validity of the claimsor the amount of potential damages.  Company management currentlybelieves, however, that resolution of such legal matters will not have amaterial adverse impact on the Company’s financial position, results ofoperations or cash flows.

 

*PriorSales of Securities*

 

From our inception, in1999, and in 2000, 2001, 2002, and mid-2003, we raised $20.5 million ingross equity capital offerings by selling our common stock in the followingapproximate amounts for each year:

 

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

 

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

 

We also issued toapproximately 30 persons or entities shares of common stock in exchange forservices and other non-cash consideration valued in excess of $5.5 millionin the following approximate amounts for each year:

 

57

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

 

We also issued toapproximately 248 employees or other service providers options to purchasecommon stock in the following amounts for each year:

 

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

 

Some of these optionshave been exercised and all options issued in 2002 have been exercised.

 

These offers and sales ofthe common stock and options to purchase common stock were not registered underthe federal and state securities laws, but were issued in reliance uponexemptions from such registration under Section 4(2) of theSecurities Act and Rule 506 of Regulation D promulgated thereunder.Similarly, in employing persons who were not licensed as broker-dealers, werelied on certain exemptions from the broker-dealer licensing requirements ofthe Exchange Act and of state securities laws.

 

After conducting theseoffers and sales of common stock and granting these options to purchase commonstock, we determined that the offers and sales did not comply with theexemptions from registration under the Securities Act and similar provisions oflaws in each state in which our stockholders reside, because certain of ouremployees who solicited investors engaged in a “general solicitation” ofsecurities. In addition, these employees were required to be licensed asbroker-dealers with the SEC and various states, but they were not so licensed.We also determined that because investors did not receive information regardingour potential liability for these violations of federal and state securitieslaws, the common stock was issued to persons who failed to receive adequateinformation under federal and state securities laws. In such situations anumber of remedies may be available to regulatory authorities and the investorswho purchased common stock in those offerings, including, without limitation, aright of rescission, civil penalties, seizure of our assets, a restrainingorder or injunction, and a court order to pay restitution and costs.

 

After voluntarilyreporting these violations to the SEC, the SEC staff advised us that it wouldnot undertake an investigation in the matter. However, we have not approachedstate securities commissioners in the states in which our investors reside.Consequently, there is substantial uncertainty concerning what action the stateregulators may take against us and what effect any such action will have on ourbusiness.

 

The probability thatstockholders would assert a claim against us and the extent of the ourliability, if any, are contingent on a number of factors, including astockholder’s desire to rescind his or her purchase based on the price of ourrescission offer and the key purchase price of the tender for shares,applicable legal precedent, and statutes of limitation. Based on current factsknown to management at this time, management does not believe that assertion ofany such claims by the Company’s shareholders in a material amount is probable.Accordingly, no accruals for either potential amounts payable or reserves havebeen made at this time.

 

*Cartierv. Bidz.com*

 

We are a defendant in alawsuit filed by Cartier, and Cartier International, B.V., in the United StatesDistrict Court Southern District of New York in April 2006. The lawsuitalleges that Cartier has proprietary rights, including trade dress, patents,trademarks, copyrights and others, in watch designs known as a Tank, TankFrancaise, Tank Americaine, Panthere and Pasha De Cartier Grille, and TankDevan, and further alleges that we have infringed upon those rights by sellingwatches bearing copies of one or more of the watch designs. We intend to defendthe lawsuit vigorously. We do not believe the outcome of the case will have amaterially adverse effect on our financial position.  The court has yet to set a trial date.

 

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**(15)         Related Party Transactions:**

 

We purchasedapproximately 37.1%, 26.4%, and 11.9% of our merchandise in 2005, 2006, and2007, respectively, from LA Jewelers, where one of its managers is astockholder that beneficially owns 1,228,000 shares of our common stock as of December 31,2006 (see Note 13). LA Jewelers participates in our inventory co-opmarketing program. For the year ended December 31, 2007 we earned $522,000from LA Jewelers relating to co-op marketing contributions and $379,000 wasunamortized as of December 30, 2007.

 

In May, 2007 we enteredinto an understanding with LA Jewelers whereby they will guarantee that we willearn a certain minimum gross profit margin on their merchandise. This agreementprovides that in the event of a gross profit margin shortfall we will becompensated for the difference between our actual gross profit margin and theguaranteed minimum gross profit margin. For the year ended December 31,2007, $427,000 was recognized under this agreement and as of December 31,2007, $129,000 was outstanding and accrued under this gross profit marginguarantee.

 

Marina Zinberg, who is aVice President and owns 31.3% of our outstanding shares, is the sister of DavidZinberg, our President and Chief Executive Officer. During 2007 we paid Ms. Zinberga salary of $100,000. Ms. Zinberg, was formerly our corporate secretaryand treasurer, reports to David Zinberg.

 

 **(16)        Subsequent Events:**

 

Bank of America hasapproved an increased in our revolving credit line to $25 million in February 2008.

 

TheBoard of Directors, in February 2008, has authorized an increase in thestock buyback program through the open market to $20 million from $5 million of its outstanding common stock. Thestock buyback will be at prices deemed appropriate by management over a 24month period. As of February 2008, we have repurchased 38,270 shares in January 2008for $291,000 and 100,000 shares in December 2007 for $886,000

 

Wehave been informed that the beneficial ownership of our common stock by themanager of LA Jewelers, who previously held 1,228,000 shares of our commonstock, has fallen below 5% (see Note 13). Accordingly, we will not report our transactions with LA Jewelers as arelated party in future filings until such time as the manager’s beneficialownership, or ownership in a group, exceeds 5%.

 

**(b)           Financial Statement Schedules:**

 

**Schedule II —Valuation and Qualifying Accounts**

 

**(in thousands)**

 
| ** **                                           | ** ** | **Balance at the**

**Beginning of**

**the Year** | ** ** | **Charged to Revenue, Cost, or Expenses** | ** ** | ** ** | ** ** | **Balance at the End of the Year** | ** ** |
|------------------------------------------------------|------------|--------------------------------------------------------------|------------|-----------------------------------------------------|------------|------------|------------|--------------------------------------------------------|------------|
| ** **                                           | ** ** | ** **                                                   | ** ** | ** **                                          | ** ** | ** ** |
| ** **                                           | ** ** | ** **                                                   | ** ** | ** **                                          | ** ** | ** ** |
| ** **                                           | ** ** | ** **                                                   | ** ** | ** **                                          | ** ** | ** ** |
| **Description**                                      | ** ** | ** **                                                   | ** ** | **Deductions**                                      | ** ** | ** ** |
| **Reserve deducted from asset to which it applies:** | ** ** | ** **                                                   | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** **                                             | ** ** |
| Year ended December 31, 2006                    |       |                                                         |       |                                                |       |       |       |                                                   |       |
| Reserve for  inventory                               |       | $                                                            | 331        |                                                | $          | 259        |       | $                                                      | (129       | ) | $ | 461 |   |
| Reserve for  sales returns                           |       | 123                                                          |       | 300                                                 |       | (259       | )          | 164                                                    |       |
| Reserve for  chargebacks                             |       | 30                                                           |       | —                                              |       | (5         | )          | 25                                                     |       |
|                                                 |       |                                                         |       |                                                |       |       |       |                                                   |       |
| Year ended December 31, 2007                    |       |                                                         |       |                                                |       |       |       |                                                   |       |
| Reserve for  inventory                               |       | $                                                            | 461        |                                                | $          | 675        |       | $                                                      | (61        | ) | $ | 1,075 |   |
| Reserve for  sales returns                           |       | 164                                                          |       | 970                                                 |       | (788       | )          | 346                                                    |       |
| Reserve for  chargebacks                             |       | 25                                                           |       | 75                                                  |       | —     |       | 100                                                    |       |

 

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**(c)           Exhibits**

 

Thefollowing exhibits are incorporated by reference 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 (16)                                             |

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(1)                  Incorporated by reference toExhibit 2.1 of Registrant’s Form S-1 (File No. 333-132545).

(2)                  Incorporated by reference toExhibit 3.1 of Registrant’s Form S-1 (File No. 333-132545).

(3)                  Incorporated by reference toExhibit 3.2 of Registrant’s Form S-1 (File No. 333-132545).

(4)                  Incorporated by reference toExhibit 10.1 of Registrant’s Form 10 (File No. 000-51257).

(5)                  Incorporated by reference toExhibit 10.2 of Registrant’s Form 10 (File No. 000-51257).

(6)                  Incorporated by reference toExhibit 10.3 of Registrant’s Form S-1 (File No. 333-132545).

(7)                  Incorporated by reference toExhibit 10.4 of Registrant’s Form S-1 (File No. 333-132545).

(8)                  Incorporated by reference toExhibit 10.3 of Registrant’s Form 10 (File No. 000-51257).

(9)                  Incorporated by reference toExhibit 10.5 of Registrant’s Form S-1 (File No. 333-132545).

(10)            Incorporated by reference toExhibit 10.6 of Registrant’s Form S-1 (File No. 333-132545).

(11)            Incorporated by reference toExhibit 10.7 of Registrant’s Form S-1 (File No. 333-132545).

(12)            Incorporated by reference toExhibit 10.4 of Registrant’s Form 10 (File No. 000-51257).

(13)            Incorporated by reference toExhibit 10.5 of Registrant’s Form 10 (File No. 000-51257).

(14)            Incorporated by reference toExhibit 10.9 of Registrant’s Form S-1 (File No. 333-132545).

(15)            Incorporated by reference toExhibit 10.10 of Registrant’s Form 10 (File No. 000-51257)

(16)            Incorporated by reference toExhibit 10.11 of Registrant’s Form 10 (File No. 000-51257)

(17)            Incorporated by reference toExhibit 10.12 of Registrant’s Form 10 (File No. 000-51257)

(18)            The certification attachedas Exhibit 32 that accompanies this Annual Report on Form 10-K is notdeemed filed with the Securities and Exchange Commission and is not to beincorporated by reference into any filing of Bidz.com, Inc. under the SecuritiesAct of 1933 or the Securities Exchange Act of 1934, whether made before orafter the date of this Annual Report on Form 10-K, irrespective of anygeneral incorporation language contained in such filing.

 

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**SIGNATURES**

 

Pursuant to therequirements of Section 13 or Section 15(d) of the SecuritiesAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.

 
|                       | BIDZ.COM, INC. |
|----------------------------|---------------------|
|                       |                |   |
|                       |                |   |
|                       | By:                 | /s/ DAVID ZINBERG |
|                       |                |   |
|                       |                | **David  Zinberg** |
|                       |                | **President  and Chief Executive Officer** |
|                       |                |   |
| Dated: March 10, 2008 |                |   |

 

Pursuant to therequirements of the Securities Exchange Act of 1934, this report has beensigned below by the following persons on behalf of the registrant and in thecapacities and on the dates indicated.

 
| **Signature**        | ** ** | **Title**                            | ** ** | **Date**            |
|----------------------|------------|--------------------------------------|------------|---------------------|
|                 |       |                                 |       |                |
| /s/ DAVID ZINBERG    |       | Chairman of the Board, President and |       | March 10, 2008 |
| David Zinberg        |       | Chief Executive Officer (Principal   |       |                |
|                 |       | Executive Officer)                   |       |                |
|                 |       |                                 |       |                |
| /s/ LAWRENCE Y. KONG |       | Chief Financial Officer and          |       | March 10, 2008 |
| Lawrence Y. Kong     |       | Director (Principal Financial and    |       |                |
|                 |       | Accounting Officer)                  |       |                |
|                 |       |                                 |       |                |
| /s/ PETER G. HANELT  |       | Director                             |       | March 10, 2008 |
| Peter G. Hanelt      |       |                                 |       |                |
|                 |       |                                 |       |                |
| /s/ MAN JIT SINGH    |       | Director                             |       | March 10, 2008 |
| Man Jit Singh        |       |                                 |       |                |
|                 |       |                                 |       |                |
| /s/ GARRY ITKIN      |       | Director                             |       | March 10, 2008 |
| Garry Itkin          |       |                                 |       |                |

 

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