Bidz 10-Q 2010
Washington, D.C. 20549
For the quarterly period ended September 30, 2010
For the transition period to
Commission file number 000-51257
(Exact name of Registrant as specified in its charter)
3562 Eastham Drive
(Address, including zip code, of principal executive office)
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer, non-accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act). (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes x No
Number of shares outstanding of Registrants common stock, $0.001 par value, as of October 31, 2010: 19,554,991
This quarterly report includes forward looking statements. All statements other than statements of historical facts contained in this report, including statements regarding our future financial position, business strategy and plans and objectives of management for future operations, are forward looking statements. The words believe, may, will, estimate, continue, anticipate, intend, expect and similar expressions, as they relate to us, are intended to identify forward looking statements. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs. These forward looking statements are subject to a number of risks, uncertainties and assumptions discussed throughout this filing.
ITEM 1. FINANCIAL STATEMENTS
(in thousands, except share and per share data)
(in thousands, except share and per share data)
1. Basis of Presentation and Nature of Business Operations
Basis of Presentation
The accompanying condensed balance sheet as of December 31, 2009, as revised for prior period corrections described in Note 11, which has been derived from audited financial statements, and the unaudited financial statements included herein have been prepared in accordance with the instructions to Form 10-Q and do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. These financial statements and related notes should be read in conjunction with the Companys audited financial statements for the fiscal year ended December 31, 2009 filed in the Annual Report on Form 10-K by the Company on March 9, 2010 with the Securities and Exchange Commission. In the opinion of management, these financial statements reflect all adjustments, which are of a normal recurring nature and adjustments to prior periods as described in Note 11, which are necessary to present fairly the financial position of Bidz.com, Inc. as of September 30, 2010 and the results of operations for the three month and nine month periods ended September 30, 2009 and 2010 and the cash flows for the nine month periods ended September 30, 2009 and 2010. The results of operations for the three months and nine months ended September 30, 2010 are not necessarily indicative of the results which may be expected for the entire fiscal year.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. We have made estimates for sales returns and allowance reserve, inventory reserve, inventory vendor marketing contribution reserves, deferred tax assets and liabilities, and accrued expenses.
Nature of Business Operations
Bidz.com, Inc. was founded in November of 1998 as a California corporation with its principal location of business in Los Angeles, California. In June 2006, we reincorporated in Delaware, and with our principal location of business in Los Angeles. We operate websites located at www.bidz.com and www.buyz.com for the purpose of selling merchandise, utilizing our unique sales auction and fixed price platforms, and www.modnique.com for online retailing of designer products, entertainment tickets, travel, and other consumer goods.
We sell our products throughout the United States and our international customer base includes Europe, Middle East, and Asia. Revenue generated from the United States accounted for approximately 62.2% and 56.7% of net revenue for the three months ended September 30, 2009 and 2010, respectively, and 66.2% and 58.9% for the nine months ended September 30, 2009 and 2010, respectively.
On October 1, 2010, our independent registered public accounting firm, Stonefield Josephson, Inc. (Stonefield), notified us that Stonefield had combined its practice with Marcum LLP and began practicing as Marcum LLP. Accordingly, effective October 1, 2010, Stonefield effectively resigned as our independent registered public accounting firm and Marcum LLP became our independent registered public accounting firm. This change in our independent registered public accounting firm was approved by the Audit Committee of our Board of Directors.
In September 2010, we executed a definitive written licensing agreement with NCR Corporation. In June 2010, we had reached an oral agreement in principal with NCR Corporation to enter into an ecommerce patent license agreement.
In July 2010, in a privately negotiated transaction, but part of our share repurchase program, we repurchased 2,180,952 shares for $2.3 million from Marina Zinberg with the approval of the Special Committee composed of independent members of our Board of Directors. The shares have subsequently been retired.
In July 2010, we announced that the Superior Court of California, County of Los Angeles, dismissed Bahram Akhavan v. Bidz.com, Inc. et al., the State Court shareholder derivative cases filed against the Companys Board of Directors.
Recent Accounting Pronouncements
In February 2010, the FASB issued an update on Subsequent Events related to Amendments to Certain Recognition and Disclosure Requirements. SEC filers are required to evaluate subsequent events through the date the financial statements are issued, and they are no longer required to disclose the date through which subsequent events have been evaluated. This update is effective upon issuance. Implementation of this standard did not have a material impact on our financial position and results of operations.
2. Earnings (loss) per Common Share
The basic earnings (loss) per common share is calculated by dividing net income (loss) available to common stockholders less preferred dividends by the weighted average number of common shares outstanding. Diluted earnings (loss) per common share is computed similarly to basic earnings (loss) per common share, except that the denominator is increased to include the number of additional common shares that would have been outstanding if potential common shares had been issued and if the additional common shares were not anti-dilutive.
The dilutive effect of outstanding stock options is reflected in diluted earnings (loss) per share by application of the treasury stock method including the impact of pro forma deferred tax benefits for the three month and nine month periods ending September 30, 2009 and 2010. The following table sets forth the computation of basic and diluted net income (loss) per share (unaudited).
(in thousands, except share and per share data)
There was no dilutive effect from outstanding stock options for the three month and nine month periods ended September 30, 2009 and 2010 as all the stock options outstanding at period end were out of the money and are anti-dilutive.
Inventories consist of the following (in thousands) as of:
4. Revolving Credit Line
In July 2006, we entered into a revolving credit line agreement with LaSalle Bank, wholly owned by Bank of America, to provide working capital financing secured by inventories and tangible assets. The agreement allowed for us to initially draw on a line of credit
up to $10 million. During the three month period ended March 31, 2008 we increased the limit to $25 million. The revolving credit line agreement was set to expire in July of 2010. We terminated the revolving credit line on April 2, 2010.
5. Stock Based Compensation
We recognize in our financial statements the cost resulting from all share-based compensation transactions to employees, including grants of stock options and award of restricted stock based on their fair values. We have used the Black-Scholes model to estimate the fair value of options. Our assessment of the estimated compensation charges will be affected by our stock price as well as assumptions regarding a number of subjective variables and the related tax impact. These variables include, but are not limited to, our stock price volatility, forfeiture rates and employee stock option exercise behaviors (or expected term).
We are also required to calculate the additional paid in capital pool (APIC Pool) available to absorb tax deficiencies recognized subsequent to adoption, as if we had adopted the statement at its effective date of January 1, 1995. We calculate our APIC pool using the long form method, which requires that we track each award grant on an employee-by-employee basis and grant-by-grant basis to determine if there is a tax benefit or tax deficiency for such award. We then compare the fair value expense to the tax deduction received for each grant and aggregate the benefits and deficiencies to establish and maintain the APIC Pool. We group the excess tax benefits from both employee and nonemployee awards into a single APIC pool. During the three months ended September 30, 2009 and 2010, we recognized no income tax expense for APIC shortfalls, and for the nine months ended September 30, 2009 and 2010, we recognized $72,000 and $218,000, respectively.
The restricted stock awards are expensed pro rata over the vesting period based upon the fair value of the awards at the time of grant. Stock-based compensation from restricted stock awards totaled $252,000 and $254,000 for the three months ended September 30, 2009 and 2010, respectively and $587,000 and $747,000 for the nine months ended September 30, 2009 and 2010, respectively. The unamortized stock-based expense for restricted stock awards was $1.9 million at September 30, 2010.
A summary of all restricted stock activity during the nine months ended September 30, 2010 is as follows (unaudited):
We adopted our 2001 Stock Option 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 2006 Plan provides for the granting of awards in the form of incentive stock options, nonqualified stock options, stock appreciation rights, shares of restricted common stock, bonus stock in lieu of obligations, or other stock-based awards to employees, directors, and independent contractors who provide valuable services to our company. The vesting requirements, performance thresholds and other terms and conditions of options granted under the Plans will be determined by our Compensation Committee and Board of Directors.
The following is a summary of stock option activity as of September 30, 2010, and changes during the nine months ended September 30, 2010 (unaudited).
The following table summarizes information about stock options outstanding and exercisable at September 30, 2010 (unaudited).
Stock-based compensation expense from stock options for the three months ended September 30, 2009 and 2010 amounted to $30,000 and $2,000, respectively, and for the nine months ended September 30, 2009 and 2010 amounted to $90,000 and $24,000, respectively. The unamortized stock-based compensation expense from stock options is $3,000 as of September 30, 2010. 154,000 shares of stock options were granted in the nine months ended September 30, 2010 when it was determined that the purchase of stock by employees with a nonrecourse loan from us is effectively the same as granting a stock option (as described in Note 11).
Net revenue by geographic area is presented based upon the country of destination. No foreign country represented 10% or more of net revenue for three month and nine month periods ended September 30, 2009 and 2010. Net revenue by geographic area was as follows (unaudited):
(in thousands, except percentage data)
Purchases from two vendors, including a related party discussed in Note 8, amounted to $7.8 million and $3.0 million representing 37.1% and 21.3% of the total purchases during the three months ended September 30, 2009 and 2010, respectively, and $17.2 million and $11.1 million representing 28.0% and 23.2% of the total purchases during the nine months ended September 30, 2009 and 2010, respectively. Outstanding accounts payable to the two vendors totaled $2.9 million and $3.0 million at December 31, 2009 and September 30, 2010, respectively. Loss of either of these vendors is not expected to have a significant negative impact on the financial position, results of operations and cash flows of the Company.
During the three months ended September 30, 2009 and 2010, we purchased approximately 9.3% and 12.8%, respectively, of our merchandise from LA Jewelers, Inc., where one of its managers is a stockholder who beneficially owns approximately 7.3% of our outstanding common stock as of September 30, 2010. During the nine months ended September 30, 2009 and 2010, we purchased approximately 7.6% and 12.7%, respectively of our merchandise from LA Jewelers, Inc. The accounts payable balances due to LA Jewelers Inc. were $1.5 million and $2.6 million at December 31, 2009 and September 30, 2010, respectively.
LA Jewelers Inc. participates in our inventory co-op marketing program. For the three months ended September 30, 2009 and 2010, we earned approximately $265,000 and $242,000, respectively from LA Jewelers Inc. relating to co-op marketing contributions and $326,000 was unamortized as of September 30, 2010. For the nine months ended September 30, 2009 and 2010, we earned approximately $480,000 and $672,000, respectively. The amounts of co-op marketing contributions due from LA Jewelers Inc. were $178,000 and $389,000 as of December 31, 2009 and September 30, 2010, respectively.
In May, 2007 we entered into an understanding with LA Jewelers Inc. whereby they will guarantee that we will earn a certain minimum gross profit margin on their merchandise. This agreement provides that in the event of a gross profit margin shortfall we will be compensated for the difference between our actual gross profit margin and the guaranteed minimum gross profit margin. For the three months ended September 30, 2009 and 2010, we recognized $20,000 and $4,000, respectively, under this agreement, and for the nine months ended September 30, 2009 and 2010, we recognized $192,000 and $102,000, respectively. As of December 31, 2009 and September 30, 2010, we have $4,000 outstanding under this gross profit margin guarantee.
During the three months ended September 30, 2009 and 2010, we recorded $641,000 and $944,000, respectively, and during the nine months ended September 30, 2009 and 2010, we recorded $1.3 million and $3.5 million, respectively, in wholesale merchandise sales to a customer that is owned by Daniella Zinberg, the daughter of our Chief Executive Officer, David Zinberg. There was no accounts receivable due from this customer as of December 31, 2009 and September 30, 2010.
9. Income Tax
We recognize the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. For tax positions meeting the more-likely-than-not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement with the relevant tax authority.
During the nine months ended September 30, 2010, the Company recorded prior period adjustments of $424,000 to beginning retained earnings and $390,000 to additional paid-in capital for changes to tax positions related to prior periods. Prior period income tax liabilities were adjusted for $814,000, and include applicable interest and penalties of $48,000 and $109,000, respectively. The prior period adjustment is not material to previously issued financial statements (as described in Note 11).
We are subject to income taxes in the U.S. federal jurisdiction and California. Tax regulations within each jurisdiction are subject to the interpretation of the related tax laws and regulations and require significant judgment to apply. With few exceptions, we are no longer subject to U.S. federal examinations by tax authorities for the years before 2008 after the conclusion of examinations by the Internal Revenue Service for the 2004, 2005, 2006, and 2007 tax years. As part of the 2007 tax examination, we have submitted revised calculations related to the prior period adjustments (as described in Note 11) and other uncertain tax positions. We may be selected for examination by the Internal Revenue Service for the 2008 and 2009 tax years.
We are subject to various legal proceedings and claims that arise in the ordinary course of business. Although the Company believes it has defenses to the allegations and intends to pursue them vigorously, management does not currently have sufficient information to assess the validity of the claims or the amount of potential damages. Company management currently believes, however, that resolution of such legal matters will not have a material adverse impact on the Companys financial position, results of operations or cash flows.
11. Revision of Prior Period Amounts
It was determined during the preparation of the first quarter of 2010 interim financial statements that the purchase of stock by employees with a nonrecourse loan from us is effectively the same as granting new stock options. We had granted one year loans to employees in November 2007 to purchase 154,000 shares when they exercised their stock options. These loans were extended for 15 months in November 2008, and then another year in February 2010. Stock option expenses related to the loan extensions are calculated to be $66,000, $680,000 and $(60,000) for years 2007, 2008 and 2009, respectively after considering the tax effect and related penalties and interest.
Management has evaluated the effect of the prior period expenses and determined that they were immaterial to each of the reporting periods affected and, therefore, amendment of previously filed reports was not required. However, if the adjustments to correct the cumulative errors had been recorded in the first quarter of 2010, we believe the impact would have been significant to the first quarter and would impact comparisons to prior periods. In accordance with guidelines issued in SEC Staff Accounting Bulletin, we have recorded adjustments in the current years beginning retained earnings account to correct these immaterial prior period errors. We have also revised in the current Form 10-Q filing, and plan to revise in future filings of our Form 10-Q and 10-K, the previously reported quarterly financial statements for 2009 in our Form 10-Q and annual financial statements for 2009 and 2008 in our Form 10-K for these immaterial amounts, and certain amounts from prior years have been reclassified to conform to the current years presentation.
The following table sets forth the cumulative effect on retained earnings of the error in stock option expenses in prior periods (unaudited):
The following table sets forth the revised prior period balances reported in our comparative financial statements (unaudited):
The following discussion should be read in conjunction with the financial statements and related notes which appear elsewhere in this form. This discussion contains forward-looking statements. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including various risks and uncertainties discussed below and throughout this report.
We are a leading online retailer of jewelry, featuring a live auction format on Bidz.com. We have established our retail brand in the online marketplace by offering high-quality merchandise, a unique user-friendly shopping experience, and the opportunity for buyers to achieve significant cost savings versus traditional retail channels. A key to our success has been our ability to efficiently and cost effectively source closeout jewelry, watches, accessories and brand name merchandise, and rapidly respond to changing consumer demands for our merchandise. We offer our products through a continuous live format, featuring a $1 minimum opening bid, and a unique 15-second auction extension period that allows our auctions to continue until all bids are received. On select auctions we maintain a reserve price that must be met before a sale will be consummated. In 2009, we began offering auctions with a minimum opening bid that is higher than $1. The majority of our auctions are short-term, often closing within one day, providing immediate gratification to our customers and encouraging frequent visits and active viewing of our website.
Our product inventory includes gold, platinum, and silver jewelry set with diamonds, rubies, emeralds, sapphires, and other precious and semi-precious stones; watches, accessories and brand name merchandise. We believe we are one of the larger online retailers of jewelry based on revenue and the largest online jewelry auction site based on web traffic.
In addition to our auction site we have retail sites that offer similar items of merchandise as those listed for auction, as well as other designer products and consumer goods. Buyz.com, our fixed price site for jewelry, provides us access to different types of consumers. We plan to offer customers the ability to design their own jewelry including diamond earrings and rings in the near future. Modnique.com, our online retail site for designer products and consumer goods, provides a private sale concept that only sells to invited members. We plan to negotiate favorable deals with designers and manufacturers, including purchasing inventory from recognizable brand names at deep discounts to attract customers that are fashion minded as well as cost conscious. Inventory is often sold that is held by our suppliers using a just in time ordering and/or drop ship model.
In line with our growth plans, we previously completed a major upgrade of our auction platform at the end of 2007. The new auction system supports a broad range of leading browser software including Microsoft Internet Explorer, FireFox and Safari. The new system includes high availability, faster end-user response time and greater scalability among the key features delivered in this release. We have leveraged this new software solution to launch additional site features and our new online retail store, Buyz.com. We launched the Spanish and Arabic versions of our website in 2008.
In 2009, we completed and deployed an implementation of Dynamics AX, a robust ERP solution from Microsoft. Dynamics AX replaced our proprietary in-house business management software in the areas of inventory management, order management, customer management, logistics, purchasing, warehouse management and fulfillment.
We sell to consumers looking for reliable bargains on jewelry, watches, accessories and brand name merchandise. Because we purchase and retain most of our inventory onsite, we can provide our customers with timely service and delivery of their purchases. In addition, each item is inspected by one of our trained product specialists prior to its placement on our website, which assures our customers of the quality of their purchases of our products. We operate in a highly competitive market with low barriers to entry. By selling mainly our own merchandise, we provide a buying environment in which we minimize fraudulent activity and questionable product quality frequently associated with purchase transactions from third-party sellers. We also provide a 15-day return policy on all merchandise. We believe that many of our customers resell merchandise that they purchase from our auctions on eBay, at local auctions, and through other retail channels. Our auctions and fixed price sales are conducted 24 hours a day, seven days a week. We also offer 24-hour telephone customer support and online live-help as well e-mail customer support.
Critical Accounting Policies
The preparation of our financial statements requires us to make certain estimates and judgments that affect amounts reported and disclosed in our financial statements and related notes. We base our estimates on historical experience and on other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates. The following are the critical accounting policies that we believe require significant estimation and judgment.
We derive our revenue from four sources: merchandise sales, which include wholesale merchandise sales, shipping revenue, transaction fees revenue and other revenue. We recognize revenue from all four sources when the following revenue recognition criteria are met: (1) persuasive evidence of an arrangement exists; (2) the product has been shipped or the service has been rendered and the customer takes ownership and assumes the risk of loss; (3) the selling price is fixed or determinable; and (4) collection of the resulting receivable is reasonably assured.
For online sales through our websites, we recognize merchandise sales upon shipments made to consumers that are fulfilled from our warehouse. We require payment before we ship and the payment is generally made online by credit card or other electronic payment methods. We record amounts received or billed prior to shipment of goods to customers as deferred revenue. We reduce gross sales by returns and charge-backs from customers. For wholesale merchandise sales, we recognize sales when the merchandise is delivered to the customer and credit terms may be offered to such customers.
We provide layaway sales to our retail customers which are payable in monthly installments. The amounts paid and yet to be shipped are recorded as deferred revenue.
In the Statements of Income (Operations) all amounts billed to customers by us related to shipping and handling are included in Net revenue and our shipping costs are included in Cost of revenue.
We include transaction fees revenue in net revenue. The 3% auction transaction fees are applied to merchandise sales on the bidz.com site, including shipping and handling but not to wholesale merchandise sales. The fees do not apply to sales on buyz.com and modnique.com.
We present sales tax liability on a net basis. Sales taxes are excluded from revenue and included as a liability.
Other revenue consists primarily of commissions we derive from hosting sales of Certified Merchant merchandise that is owned by third parties and we recognize only the commission portion of the price our customers pay for the purchased products because we are acting as an agent in such transactions.
Cost of Revenue
Cost of revenue includes product costs, inbound and outbound shipping charges, packaging and shipping supplies, insurance on shipments, product repair and service costs, and credit card and other electronic payment fees, and is recorded in the same period in which related revenue has been recorded. The cost of revenue is reduced by amortized co-op marketing contributions from our vendors and referral credits given to customers through our refer a friend program.
Outbound shipping costs on merchandise sales totaled $1.4 million and $1.3 million in the three months ended September 30, 2009 and 2010, respectively, and $4.6 million and $4.1 million in the nine months ended September 30, 2009 and 2010, respectively.
Returns and Allowances Reserve
We estimate potential future product returns and charge-backs related to current period revenue. We analyze historical returns, and changes in customer demand and acceptance of our products when evaluating the adequacy of the sales returns reserve and other allowances in any accounting period. If actual returns are greater than our estimates, we will record additional returns and allowances in addition to our estimates, which will result in lower net revenue recorded during that period. Reserves for returns and charge-backs are included in accrued expenses.
Inventories consist mainly of merchandise purchased for resale and are stated at the lower of first-in, first-out (FIFO) cost or market.
The unique nature of our business model where customers set the prices they are willing to pay may result in items selling below our cost. We provide reserves against our inventory based on the estimated difference between the average selling price and the cost of inventory. We also provide reserves for obsolescence and slow moving inventory.
Inventory Co-op Marketing Contributions
We bill and collect from our inventory vendors co-op marketing contributions as an incentive for us to market and sell their merchandise on the Bidz website. We account for the co-op marketing contributions that cannot be identified specifically to benefit the vendors as a reduction in the cost of inventory purchased and cost of sales. We cannot specifically identify the benefits to each vendor, and consequently, co-op marketing contributions are charged against inventory as a reduction of costs and amortized as a reduction of cost of sales. For the three months ended September 30, 2009 and 2010, we have recognized $1.6 million and $1.6 million of co-op marketing contributions, respectively, and for the nine months ended September 30, 2009 and 2010, we have recognized $5.8 million and $5.3 million, respectively. Approximately $3.3 million remain unamortized and is included as an offset to inventory at September 30, 2010. Receivable from vendors for co-op marketing contributions, less allowance for doubtful accounts, if any, is included in other receivables and amounted to $1.7 million at September 30, 2010.
Gain (loss) on foreign currency exchange
A significant portion of our purchases are international purchases which exposes us to fluctuations in foreign currency exchange rates relative to the U.S. dollar. Our financial results are reported in U.S. dollars. As a result, transactions conducted in foreign currencies must be translated into U.S. dollars for reporting purposes based upon the applicable foreign currency exchange rates, which may result in realized and unrealized gains or losses from exchange rate fluctuations. We record a gain or loss on foreign currency exchange between the time we receive the inventory and when we make foreign currency payments to our international suppliers. Transactions occurring during the period are translated at rates in effect at the time of the transaction, and adjustments are made at each period end to re-measure unsettled assets and liabilities denominated in foreign currencies at the period-end exchange rates.
Description of Our Revenue, Costs, and Expenses
The following table presents our historical results of operations for the periods indicated as a percentage of net revenue.
Substantially all of our net revenue consists of jewelry, accessories, and consumer products sold via the Internet, net of returns. We also generate net revenue from wholesale merchandise sales that are not online, shipping and handling, auction transaction fees and other revenue.
The following table presents our sources of revenue for the periods indicated as a percentage of net revenue.
Our gross profit consists of net revenue less the cost of revenue. Our cost of revenue consists of the cost of merchandise sold to customers net of amortized co-op marketing contributions from vendors, inbound and outbound shipping costs, packaging and shipping supplies, insurance on shipments, product repair and service costs, and credit card and other transaction fees associated with payments.
General and Administrative Expenses
Our general and administrative expenses consist primarily of payroll and related benefit costs for our employees. These expenses also include fulfillment, customer service, technology, professional fees, other general corporate expenses, and stock-based compensation, consisting substantially of restricted stock awards to employees and directors.
Sales and Marketing Expenses
Our marketing expenses consist primarily of costs associated with paid website search marketing, online banner marketing, e-mail campaigns, affiliate programs and optimization services. These marketing programs, which are designed to drive buyers to our website, are the most important factors in increasing demand for our jewelry products and increasing net revenue.
Comparison of Three Months Ended September 30, 2010 to Three Months Ended September 30, 2009 (Note 11)
Net loss in the three months ended September 30, 2010 was $(614,000), or $(0.03) per basic and diluted share compared to a net loss in the three months ended September 30, 2009 of $(58,000), or $(0.00) per basic and diluted share. Net loss increased by $556,000 in the three months ended September 30, 2010 compared to the three months ended September 30, 2009 primarily due to decreases in revenue and gross profit margin.
Net revenue decreased 12.0% to $21.8 million in the three months ended September 30, 2010 from $24.8 million in the three months ended September 30, 2009. Wholesale merchandise sales were $1.1 million in the three months ended September 30, 2010 compared to $917,000 in the three months ended September 30, 2009.
The continuing economic weakness affected our revenue in the third quarter of 2010 compared to the third quarter of 2009. There was an overall decrease in online demand for our jewelry and other merchandise as discretionary spending by consumers remain weak. If the economy and consumer discretionary spending continue to be weak it will cause a negative effect on our revenue and profitability.
Gross profit decreased 21.8% to $5.6 million in the three months ended September 30, 2010 from $7.2 million in the three months ended September 30, 2009. The decrease in gross profit resulted from the decrease in sales volume which declined by 12.0% for the three months ended September 30, 2010 compared to the prior year period and the decrease in gross profit margin to 25.7% in the three months ended September 30, 2010 from 28.9% in the prior year period. Gross profit margin in the three months ended September 30, 2010 was affected by weaker demand for our jewelry and other merchandise and lower gross profit margin from our wholesale merchandise sales.
General and Administrative Expenses
General and administrative expense increased 4.1% to $5.0 million in the three months ended September 30, 2010 from $4.8 million in three months ended September 30, 2009. The increase in general and administrative expenses was due to expenses to operate modnique.com. General and administrative expense as a percentage of net revenue increased to 22.8% in the three months ended September 30, 2010 from 19.3% in the three months ended September 30, 2009 as a result of higher general and administrative expense and deleveraging from lower revenue.
Sales & Marketing Expenses
Sales and marketing expense decreased 33.8% to $1.5 million in the three months ended September 30, 2010 from $2.2 million in the three months ended September 30, 2009. Sales and marketing expense as a percentage of net revenue decreased to 6.8% in the three months ended September 30, 2010 from 9.0% in the three months ended September 30, 2009. Sales and marketing expense was reduced to control our operating expenses and also as a result of lower revenue.
Income Tax Expense
We recorded an income tax benefit of $421,000 in the three months ended September 30, 2010 compared to an income tax benefit of $7,000 in the three months ended September 30, 2009, with effective tax rates of 40.7% and 10.8%, respectively. The tax benefit in the three months ended September 30, 2009 was affected by the tax effect of stock based compensation.
Comparison of Nine Months Ended September 30, 2010 to Nine Months Ended September 30, 2009 (Note 11)
Net loss in the nine months ended September 30, 2010 was $1.4 million, or $(0.06) per basic and diluted share compared to a net income in the nine months ended September 30, 2009 of $2.1 million or $0.09 per basic and diluted share, respectively. Net income decreased by $3.5 million in the nine months ended September 30, 2010 compared to the prior year period primarily due to decreases in revenue and gross profit margin.
Net revenue decreased 8.7% to $75.7 million in the nine months ended September 30, 2010 from $82.9 million in the nine months ended September 30, 2009. Merchandise wholesale sales were $4.7 million in the nine months ended September 30, 2010 compared to $1.6 million in the nine months ended September 30, 2009.
The continuing economic weakness affected our revenue in the nine month period ended September, 2010 compared to the nine month period ended September 30, 2009. There was an overall decrease in online demand for our jewelry and other merchandise as discretionary spending by consumers remain weak. If the economy and consumer discretionary spending continue to be weak it will cause a negative effect on our revenue.
Gross profit decreased 25.8% to $19.0 million in the nine months ended September 30, 2010 from $25.6 million in the nine months ended September 30, 2009. The decrease in gross profit resulted from the decrease in sales revenue which declined by 8.7% for the nine months ended September 30, 2010 compared to the prior year period and the decrease in gross profit margin to 25.0% in the nine months ended September 30, 2010 from 30.9% in the prior year period. Gross profit margin in the nine months ended September 30, 2010 was affected by our free shipping promotion in the first half of 2010 and weaker demand for our jewelry and other merchandise.
General and Administrative Expenses
General and administrative expenses increased by 11.6% to $15.8 million in the nine months ended September 30, 2010 from $14.2 million in the nine months ended September 30, 2009. The increase in general and administrative expenses was due to expenses to operate modnique.com and higher overall administrative expenses. General and administrative expenses as a percentage of net revenue increased to 20.9% in the nine months ended September 30, 2010 from 17.1% in the nine months ended September 30, 2009 as a result of higher general and administrative expense and deleveraging from lower revenue.
Sales and Marketing Expenses
Sales and marketing expenses decreased 35.2 % to $4.5 million in the nine months ended September 30, 2010 from $7.0 million in the nine months ended September 30, 2009. Sales and marketing expenses as a percentage of net revenue decreased to 5.9% in the nine months ended September 30, 2010 from 8.4% in the nine months ended September 30, 2009. Sales and marketing expense was reduced to control our operating expenses and also as a result of lower revenue.
Income Tax Expense
We recorded an income tax benefit of $576,000 in the nine months ended September 30, 2010 compared to an income tax expense of $1.7 million in the nine months ended September 30, 2009 and the effective tax rates were 29.5% and 44.3%, respectively. Income tax benefit in the nine months ended September 30, 2010 was adversely affected and lower than expected when we recorded a reversal in
deferred tax benefit from restricted stock awards that vested in the period at a market value that was substantially lower than the grant date fair market value, since we had no APIC pool to offset this shortfall.
Additional Quarterly Data
Modnique.com and wholesale merchandise sales and data are excluded in computing additional quarterly data.
Liquidity and Capital Resources
The significant components of our working capital are inventory and liquid assets such as cash and accounts receivable, reduced by a revolving credit line, accounts payable, accrued expenses and deferred revenue. Our business model contains beneficial working capital characteristics: while we collect cash from sales to customers within several business days of the related online payment, we typically have extended payment terms with our suppliers.
As of September 30, 2010, we had a working capital surplus of $26.6 million and no long-term debt obligations. Net cash provided by operating activities was $10.0 million in the nine months ended September 30, 2010 compared to net cash used of $380,000 in the nine months ended September 30, 2009. Cash in the nine months ended September 30, 2010 was primarily affected by changes in our net loss, inventories, other current assets and deferred revenue and in the nine months ended September 30, 2009 was primarily affected by changes in our net income, inventories and accounts payable. Our inventories and accounts payable generally increase or decrease in line with changes in our inventory strategy. Our inventory strategy is influenced by our ability to secure inventory that we believe will improve sales and/or our gross profit margin.
We recorded net loss of $1.4 million in the nine months ended September 30, 2010 compared to a net income of $2.1 million in the nine months ended September 30, 2009. In the nine months ended September 30, 2010, inventories decreased by $8.8 million, other current assets decreased by $2.4 million and deferred revenue increased by $1.3 million, which resulted in a net increase in our cash position. In the nine months ended September 30, 2009, inventories increased by $6.0 million and accounts payable decreased by $4.0 million.
Net cash used in investing activities was $102,000 in the nine months ended September 30, 2010 compared to $404,000 in the nine months ended September 30, 2009. The expenditures related mainly to acquisition of office and computer equipment, and software.
In the nine months ended September 30, 2010, net cash of $5.6 million was used in financing activities when $2.9 million was used to repay our revolving credit line, $164,000 was used to retire common stock from net vesting of restricted shares to pay for payroll taxes, and $2.5 million was used to repurchase shares of our common stock. In the nine months ended September 30, 2009, net cash of $2.5 million was used in financing activities when $5.0 million was used to repurchase shares of our common stock and $2.5 million in proceeds came from the utilization of our revolving credit line.
We believe that cash currently on hand and cash flows from operations will be sufficient to continue our operations and to pursue our growth strategy for the foreseeable future. Our future capital requirements will depend on many factors, including the rate of our revenue growth; the extent of our advertising and marketing programs; the levels of the inventory we carry; and other factors relating to our business. Enhancement of our website, network infrastructure, and transaction processing systems may require us to spend significantly more than we have in the past. Moreover, to date our spending in these areas has been lower than industry averages. We may require additional financing in the future in order to execute our operating plan and we may not be able to obtain such financing. We cannot predict whether this additional financing will be in the form of equity, debt, or a combination of debt and equity.
The following table presents our contractual obligations at September 30, 2010, over the next five years and thereafter (in thousands):
We are obligated for the lease of our office and warehouse space. We leased a 50,000 square-foot office and warehouse and a separate 12,000 square-foot warehouse space in Culver City, California. The leases expire in June 2012 and August 2012, respectively. In November 2009, we leased a 26,000 square-foot office and warehouse space in Marina Del Rey, California. The lease expires in October 2012.
In September 2010, we executed a definitive ecommerce patent license agreement with NCR Corporation that commits us to six annual payments of $105,000 ending in September 2015.
Certain amounts from prior years have been reclassified to conform to the current years presentation.
Market risk represents the risk of loss arising from adverse changes in market rates and foreign exchange rates. We do not believe that a change in market interest rates would have a material effect on our results of operations or financial condition. Although we derive a portion of our sales outside of the United States, all of our sales are denominated in U.S. dollars. We have limited exposure to financial market risks related to changes in interest rates and foreign currency exchange rates.
Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. Disclosure controls and procedures are the controls and other procedures that we designed to ensure that we record, process, summarize and report in a timely manner the information we must disclose in reports that we file with or submit to the Securities and Exchange Commission. Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that, as of the date of their evaluation, our disclosure controls and procedures were not effective because of the material weaknesses in our internal control over financial reporting discussed below. Notwithstanding the material weaknesses described below, management has concluded that our financial statements for the periods covered by and included in this report are fairly stated in all material respects in accordance with generally accepted accounting principles in the United States for the periods presented herein.
Report of Management on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) of the 1934 Act. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States. Internal control over financial reporting include those policies and procedures that (1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect our transactions and dispositions of our assets; (2) provide reasonable assurance that our transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles in the United States, and that our receipts and expenditures are being made only in accordance with appropriate authorizations; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements.
We assessed the effectiveness of our internal control over financial reporting as of September 30, 2010, using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control Integrated Framework. During the third quarter of 2010, we continue to have certain control deficiencies that represent material weaknesses identified during the fourth quarter 2009 as a result, primarily, of the conversion from our internally developed proprietary legacy operating system to a Microsoft Dynamics AX ERP system. The control deficiencies existing at September 30, 2010 related to: maintaining an effective control environment over Information Technology (IT) specifically in user security configurations, and security evaluations for the Microsoft AX ERP system. As a result of the foregoing, management concluded that our internal control over financial reporting as of September 30, 2010 has a material weakness in user security configurations.
To ensure that our financial statements were fairly stated in accordance with generally accepted accounting principles in the United States, we expanded procedures to be performed in order to prepare the financial statements as of September 30, 2010. These procedures included additional analyses and review of the inventory processes and related balances to fairly state inventory and the associated cost of goods sold in the three month and nine month periods ended September 30, 2010. Additionally, we performed multiple levels of review within the financial statement close process.
Changes in Internal Control over Financial Reporting
Other than as described below, there were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) during the three month period ended September 30, 2010, that our certifying officers concluded could materially affect our internal control over financial reporting.
To address the material weaknesses described above, management has implemented a remediation program, which has been approved by our Audit Committee. We implemented the remediation program in the fourth quarter of 2009 through September 30, 2010, and anticipate that we will continue implementation of the program in the 4th quarter of 2010. We completed the following changes in internal control activities in the three months ended September 30, 2010 to remediate previously identified internal control weaknesses:
Management has developed a risk analysis and assessment to address the lack of a Company-wide risk assessment program related to the conversion process of our operating system to the Microsoft AX ERP system.
Management has completed remediation of its design and monitoring of change controls over our ERP and accounting systems.
Management has completed implementation of a timely termination process for user access to Microsoft AX ERP system for former employees.
Management has strengthened its control over proper review of new vendor set-up and changes to existing vendors.
Remediation of existing internal control weaknesses:
Management is in the process of remediation to ensure that we maintain an effective control environment over Information Technology (IT) specifically in user security configurations, and security evaluations for the Microsoft AX ERP system. Management is implementing a vigorous user access review, including a conflicts remediation process, to address user security configurations, security evaluations deficiencies, and managing user access security controls for all financial systems, particularly focusing on the AX ERP system. Controls are being re-designed to ensure that access to certain financial applications are adequately restricted to only employees requiring access to complete their job functions. Exceptions to these access requirements are in remediation.
Limitations on Controls
Management does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent or detect all error and fraud. Any control system, no matter how well designed and operated, is based upon certain assumptions and can provide only reasonable, not absolute, assurance that its objectives will be met. Further, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In June 2010, the State Derivative Action of Bahram Akhavan vs Bidz.com, Inc., et al was dismissed. On February 26, 2010, the Superior Court of California granted the Companys Motion to Dismiss the State Derivative Action with leave to amend. In response, on April 9, 2010, Mr. Akhavan, the plaintiff in the State Derivative Action, made a demand to inspect certain books and records of the Company, which the Company rejected on the grounds, among other reasons, that the request lacked a proper purpose under Delaware law. On May 5, 2010, Mr. Akhavan filed an action in the Delaware Court of Chancery to compel the Company to permit inspection of the requested documents. In June 2010, after the Company filed a Motion to Dismiss the Delaware action, Mr. Akhavan withdrew both the State Court Derivative Action, as well as the Delaware action, resulting in the dismissal of both cases.
In April 2010, the Federal Trade Commission (FTC) decided not to recommend enforcement action against us. In May 2009, the Company received a Civil Investigative Demand for information from the FTC relating to email marketing practices. We have been cooperating fully with the FTC regarding this matter, and on April 2, 2010, we received notice that the FTC has decided not to recommend enforcement action against us.
In February 2010, Marla Tidenberg vs Bidz.com, Inc., et al was dismissed. On or about September 29, 2008, the Company, David Zinberg and Marina Zinberg were named as defendants in a complaint filed in the United States District Court for the Central District of California (Marla Tidenberg v. Bidz.com, Inc., et al., cv08 05553 (PSG)). On March 19, 2009, Tidenberg filed a Third Amended Complaint, which names only the Company as a defendant. The lawsuit alleges, among other things, that we engaged in unfair business practices by misrepresenting the value of our merchandise and by false bidding. The complaint purports to represent a class of persons who purchased any merchandise from us. On January 7, 2010 the Court denied Marla Tidenbergs Motion for Class Certification. On February 26, 2010, Marla Tidenberg accepted our offer to pay her Twenty Thousand Dollars in exchange for a dismissal of her case with prejudice.
Cases pending Motions to Dismiss:
In July, 2009, the Company and certain of its officers and its Board of Directors were named as defendants in a shareholder derivative lawsuit filed in the United States District Court for the Central District of California (Farris Hassan v. Bidz.com, Inc., et al., cv09-04984 (CBM) (C.D. Cal. (filed July 10, 2009) (the Federal Derivative Action)). The Federal Derivative Action alleges violations of law, including breaches of fiduciary duties, waste of corporate assets, unjust enrichment and violations of California Corporations Code. An amended complaint also includes allegations relating to the Companys co-op marketing contributions and minimum gross profit guarantees.
On April 27, 2010, the United States District Court granted the Companys Motion to Dismiss the Federal Derivative Action with leave to amend. The plaintiff filed an amended complaint, and the Company filed another Motion to Dismiss on July 12, 2010. The Court took the Motion under submission, and we are awaiting the Courts decision. We believe that the lawsuit is meritless, and, if our Motion to Dismiss is denied, we intend to defend the case vigorously.
In May and June, 2009, the Company and certain of its officers were named as defendants in three parallel class action complaints filed in the United States District Court for the Central District of California (Ramon Gomez v. Bidz.com, Inc., et al., cv09-3216 (CBM) (C.D. Cal.; filed on May 7, 2009); James Mitchell v. Bidz.com, Inc., et al., cv09-03671 (CBM) (C.D. Cal.; filed on May 22, 2009); Mark Walczyk v. Bidz.com, Inc., et al., cv09-0397 (CBM) (C.D. Cal.; filed on June 3, 2009)). On July 30, 2009, the Court consolidated the cases. The consolidated complaint charges violations of Section 10(b) and Section 20(a) of the Securities Exchange Act of 1934 and alleges that the Company failed to disclose unethical and fraudulent business practices, that it did not have controls in place to prevent shill bidding, that it uses unreliable or false appraisal prices on its merchandise, and that it failed to correctly account for and disclose in detail its co-op marketing contributions and minimum gross profit guarantees.
On May 25, 2010, in a 30-page opinion, the Honorable Consuelo B. Marshall of the United States District Court granted the Companys Motion to Dismiss the securities fraud complaint with leave to amend. On June 22, 2010, the plaintiff filed its amended complaint. On July 30, 2010, the Company filed a Motion to Dismiss the amended complaint and on September 8, 2010, the Plaintiff filed another amended complaint. On September 27, 2010 the Company filed another Motion to Dismiss the amended complaint, which was heard by the Court on November 1, 2010. The Court took our Motion under submission, and we are awaiting the Courts ruling. We believe that the lawsuit is meritless and, if the Court denies our Motion to Dismiss, we intend to defend the cases vigorously.
Other Cases and matters pending:
On or about June 25, 2009, the Company was named as a defendant in a patent infringement lawsuit filed in the United States District Court for the Eastern District of Texas, Tyler Division (Soverain Software LLC v. J.C. Penney Corporation, Inc., Amway Corp., Avon Products, Inc., Bidz.com, Inc., Etronics, Inc. HSN, Inc., HSN Improvements, LLC, Cornerstone Brands, Inc., Ballard Designs, Inc., Garnet Hill, Inc., Smith & Noble, LLC, The Territory Ahead, Inc., QVC, Inc., Shutterfly, Inc., Victorias Secret Stores Brand Management, Inc., Victorias Secret Direct Brand Management, LLC, VistaPrint, Ltd., and VistaPrint USA, Inc. cv6:09-CV-274). The Complaint alleges that defendants ecommerce sites infringe one or more patents held by the plaintiff. The Plaintiff seeks a judgment that its patents are not invalid and enforceable, a preliminary and permanent injunction against infringement of the patents, damages (including treble damages) and attorney fees. We believe that the lawsuit is meritless and intend to defend the case vigorously.
On February 10, 2009, the Securities and Exchange Commission (SEC) issued a subpoena to produce documents relating to the Companys inventory reserve policies, as well as other matters. We have been cooperating fully with the SEC regarding this matter, our management and certain employees have complied with subpoenas for testimony, and we do not believe that the investigation will adversely affect management, our results of operations, cash flows or our financial position. On October 27, 2009, the SEC issued a subpoena to produce documents relating to the Companys co-op marketing contributions and minimum gross profit guarantees.
We are, from time to time, a party to disputes arising from normal business activities, including various employee-related matters. In the opinion of our management, resolution of these matters, individually or collectively, will not have a material adverse effect upon our financial condition or future cash flows and operating results.
Our business, financial condition, results of operations, cash flows, and prospects, and the prevailing market price and performance of our common stock, may be adversely affected by a number of factors, including the matters discussed below. Certain statements and information set forth in this Quarterly Report on Form 10-Q, as well as other written or oral statements made from time to time by us or by our authorized officers on our behalf, constitute forward-looking statements within the meaning of the Federal Private Securities Litigation Reform Act of 1995. Words such as anticipates, believes, estimates, expects, intends, may, plans, seeks, projects, will, would, and similar expressions are intended to identify such forward-looking statements. We intend for our forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and we set forth this statement in order to comply with such safe harbor provisions. You should note that our forward-looking statements speak only as of the date of this Quarterly Report on Form 10-Q or when made and we undertake no duty or obligation to update or revise our forward-looking statements, whether as a result of new information, future events, or otherwise. Although we believe that the expectations, plans, intentions, and projections reflected in our forward-looking statements are reasonable, such statements are subject to known and unknown risks, uncertainties, and other factors that may cause our actual results, performance, or achievements to be materially different from any future results, performance, or achievements expressed or implied by the forward-looking statements. The risks, uncertainties, and other factors that our stockholders and prospective investors should consider include, but are not limited to, the following:
Adverse domestic and global economic conditions or the perception of said conditions may have adverse effects on our growth and operating results
The continued success of our business depends on the willingness of our customers to spend in a discretionary manner. While we do offer lower priced merchandise and may consequently fare better than those who exclusively offer more expensive merchandise, jewelry is essentially perceived as a luxury good. If the economy continues to be weak it will cause people to feel less comfortable purchasing discretionary goods and would cause a negative effect on our operating results. Our annual and quarterly operating results may vary significantly in the future based on economic factors over which we have little or no control. Because we have little or no control over these factors and/or their magnitude, our operating results are difficult to predict. Any substantial adverse change in the economic factors could negatively affect our business and results of operations.
Our business has been and may continue to be significantly impacted by adverse worldwide economic conditions and the current uncertainty in the outlook for the global economy makes it more likely that our actual results will differ materially from expectations.
Global financial markets have been experiencing extreme disruptions in recent years, including severely diminished liquidity and credit availability, declines in consumer confidence, declines in economic growth, increases in unemployment rates, and uncertainty about economic stability. There can be no assurance that there will not be further deterioration in financial markets and confidence in economic conditions. These economic uncertainties affect businesses such as ours in a number of ways, making it difficult to accurately forecast and plan our future business activities. The current tightening of credit in financial markets may lead consumers to postpone spending, which may cause our customers to reduce purchases of jewelry. Demand for jewelry is a function of the health of the economies in the United States and around the world. Since the US economy and other economies around the world still face uncertain growth, the demand for jewelry has been and may continue to be adversely affected and therefore, demand for our jewelry products and our operating results have been and may continue to be adversely affected as well. We cannot predict the timing, strength or duration of any economic disruption or subsequent economic growth, worldwide, in the United States, in our industry, or in the jewelry market. These and other economic factors have had and may continue to have a material adverse effect on demand for our jewelry products and on our financial condition and operating results.
Our future operating results are highly dependent upon how well we manage our business to respond to the weak economic condition.
Our annual and quarterly operating results may fluctuate based on how well we manage our business to respond to the weak economic condition. Some of these factors include the following:
· our ability to manage our sales and marketing efforts;
· our ability to structure our organization to achieve our operating objectives and to meet the needs of our customers; and
· our ability to manage our expenses and inventories.
If we fail to manage our business effectively, our results of operations could be adversely affected.
Growth of our business may depend on our ability to successfully introduce and expand new product offerings, including Modnique.
Our ability to significantly increase our net sales and maintain and increase our profitability may depend on our ability to successfully introduce and expand new product lines beyond our current offerings. In February 2010, we launched modnique.com, a division that will be focused on online retailing of designer products, entertainment tickets, travel, and other consumer goods through a private sale concept that only sells to invited members. If we offer new product categories in Modnique that are not accepted by consumers, the Bidz.com brand and reputation could be adversely affected, our net sales may fall short of expectations and we may incur substantial expenses that are not offset by increased net sales. Introduction and expansion of new product lines may also strain our management and operational resources.
Our business may be impacted by our ability to obtain debt financing for our operations and the unavailability of funding could adversely affect our business.
As a result of current economic uncertainties, including with respect to global capital and credit markets and overall economic growth, we may find it more difficult or expensive to secure additional capital or credit to pursue actions we would consider beneficial to us or our shareholders. We have terminated, on April 2, 2010, a revolving line of credit with Bank of America (formerly LaSalle Bank). If we are unable to obtain alternative financing from another lender or lenders in the future, on terms that are acceptable to us, our business, ability to continue operations and financial condition could be adversely impacted.
The trading price in our common stock may be volatile and you may lose all or part of your investment.
The market price of our common stock has been subject to significant fluctuations and these fluctuations could continue. Some factors that could affect the market price of our common stock are as follows:
· actual or anticipated changes in our operating results,
· our stock is subject to short selling and may cause trading in our common stock to be volatile,
· our stock is subject to margin calls and may cause trading in our common stock to be volatile,
· changes in research analysts recommendations or estimates of financial performance,
· changes in market valuation of similar companies, economic and general market conditions,
· announcements of significant contracts, company developments, commercial relationships, banking credit facilities, capital commitments, acquisitions or joint ventures,
· issuance of additional shares of common stock or other securities, and
· intellectual property or litigation developments.
Trading in our common stock may experience significant price and volume fluctuations and adversely affect the trading price of our common stock. Following periods of volatility in the market price of a public companys securities, securities class action litigation has often been instituted against that company. Such litigation could result in substantial cost and a diversion of managements attention and resources. See Item 1, Legal Proceedings, above.
Repurchases of our common stock may not prove to be the best use of our cash resources.
We have and plan to continue to repurchase shares of our common stock. Since the inception of our share repurchase program in June 2007, through September 30, 2010, we have repurchased 5.6 million shares for a total of approximately $21.0 million. Our board of directors authorized the repurchase of up to $33.5 million of our common stock and a total of $12.5 million remains available for repurchases. These repurchases and any repurchases we may make in the future may not prove to be at optimal prices and our use of cash for the stock repurchase program may not prove to be the best use of our cash resources and may adversely impact our future liquidity.
We have been and may continue to become the target of securities class action suits and derivative suits which could result in substantial costs and divert management attention and resources.
Securities class action suits and derivative suits are often brought against companies following periods of volatility in the market price of their securities, such as we experienced at the end of 2007. Defending against these suits, even if meritless, can result in substantial costs to us and could divert the attention of our management. See Item 1, Legal Proceedings, above.
We may be at risk to accurately report financial results or detect fraud if we fail to maintain an effective system of internal controls.
As directed by Section 404 of the Sarbanes-Oxley Act of 2002, the Securities and Exchange Commission adopted rules requiring public companies to include a report that contains an assessment by management on the companys internal control over financial reporting in their quarterly reports on Form 10-Q. In addition, the independent registered public accounting firm auditing the companys financial statements must attest to and report on our assessment of the effectiveness of the internal controls over financial reporting. While we are consistently working on improvements and conducting rigorous reviews of our internal controls over financial reporting, our independent auditors may interpret Section 404 requirements and apply related rules and regulations differently. If our independent auditors are not satisfied with our internal control over financial reporting or with the level at which it is documented, operated or reviewed, they may decline to attest to managements assessment or issue a qualified report. Additionally, if we are not able to meet all the requirements of Section 404 in a timely manner or with adequate compliance, we might be subject to sanctions or investigation by regulatory authorities, such as the Securities and Exchange Commission.
In conducting its assessment, our management concluded that there were material weaknesses, as defined in the Public Company Accounting Oversight Boards Auditing Standard No. 5, in our disclosure controls and internal control over financial reporting as of September 30, 2010. We have implemented certain controls to remediate some of the material weaknesses, and are in the process of implementing additional controls, to remediate the remaining material weaknesses. Management believes these material weaknesses were not fully remediated as of September 30, 2010 and through the date of this report. See discussion included in Item 4 Controls and Procedures above for additional information regarding our disclosure controls and internal control over financial reporting.
We cannot assure you that significant deficiencies or material weaknesses in our disclosure controls and internal control over financial reporting will not be identified in the future or that the identified material weaknesses will be remediated by the end of 2010. Also, future changes in our accounting, financial reporting, and regulatory environment may create new areas of risk exposure. Failure to modify our existing control environment accordingly may impair our controls over financial reporting and cause our investors to lose confidence in the reliability of our financial reporting, which may adversely affect our stock price.
Internal controls over IT could continue to adversely affect our system of internal controls
On October 2, 2009, we migrated from our proprietary enterprise operating system to an ERP system running on a customized Microsoft Dynamics AX. We have encountered unexpected deficiencies in implementing the new system, including control deficiencies that resulted in material weaknesses in our system of internal controls. These deficiencies had a material adverse effect on our operations, results of operations and system of internal controls in the fourth quarter of 2009. The new system will require that we design and adopt new internal controls, and any failure by us to implement and test those new controls in a timely manner would continue to result in material weaknesses in our system of internal controls.
Our branded inventory may be vulnerable to complaints or claims of infringement on intellectual property rights
We purchase branded merchandise from third party vendors and are relying on their licensing agreements with the brand owners. In the event that a third party vendor misrepresents its licensing rights, we are vulnerable to complaints or claims of infringement on intellectual property rights and could be subject to legal proceedings and/or barred from selling the affected merchandise. If the third party vendor does not have the ability to take financial responsibility over the infringement our results of operations could be adversely affected.
We will devote necessary resources to respond promptly and thoroughly to the SEC investigation.
On February 10, 2009 and October 27, 2009, the Securities and Exchange Commission (SEC) issued subpoenas to us to produce documents relating to the Companys inventory reserve policies, vendor marketing contributions, as well as other matters. We intend to cooperate fully with the SECs formal investigation, and our management will devote the resources required to respond promptly and thoroughly to any request by the SEC for any additional information or documents. Although the investigation is ongoing and it is difficult to predict the time required by senior management to respond to it, we do not presently anticipate that the investigation will adversely affect management, our results of operations or our financial position. Until the investigation is concluded, however, it is difficult to assess its impact on us.
We must continue to generate a high volume of visitor traffic to our website and convert those visitors into buyers.
Our net revenue depends to a significant extent on the number of customers who visit our website to purchase merchandise and the dollar amount of their purchases. Generating increased traffic to our website and converting that traffic into buyers requires us to achieve effective results from our marketing campaigns; offer a wide variety of products that our customers can purchase at favorable prices; maintain a user-friendly shopping experience; ensure the satisfactory availability, performance, and reliability of our website, network infrastructure, and transaction processing systems; and provide high-quality customer service. Our business will be harmed if we are unable to increase our customer base and the dollar volume of the orders customers place with us.
We are subject to prank bidding by persons who are not required to provide their identification.
Presently, we do not require new users to our site to provide their identification upon registration. Consequently, from time to time we are subject to prank bidders who may win auctions but do not intend to purchase our merchandise. Although the Company re-auctions merchandise not purchased by such bidders, a large number of failed auctions in which winning bidders do not complete their purchases could adversely affect our results of operations.
We may face increasing costs to acquire new customers.
The acquisition of new customers is a key factor in increasing demand for our jewelry products and increasing our revenue. We currently attract new customers by driving traffic to our website using a marketing and advertising strategy that includes targeted keyword searches, online banner advertising, targeted e-mail advertising, and participation in affiliate programs. We do not maintain long-term contracts or arrangements with any companies, including any search engines, Internet portals, or other websites, and we may not successfully enter into additional relationships or maintain existing ones. In addition, traffic to our website could decline if our online marketing programs become less effective or the traffic decreases to the search engines, Internet portals, and websites with which we advertise. Our business could be materially and adversely affected if any substantial number of companies on which we advertise experience financial or operational difficulties or experience other corporate developments that adversely affect their performance. A failure to maintain or expand existing online advertising relationships or to establish additional online advertising relationships that generate a significant amount of traffic from other websites could result in decreased sales or limit the growth of our business.
Our growth will depend on our ability to increase the popularity of our website, and we may not be able to do so effectively.
We believe that continuing to increase the popularity of our website will be critical to expanding our business. Promoting and positioning our website will depend largely on the success of our marketing efforts and our ability to provide a variety and sufficient quantity of high-quality products at attractive prices in a convenient manner. Promoting our website will require us to increase our marketing budget and otherwise increase our financial commitment to creating and maintaining brand loyalty among users. Brand promotion activities may not yield increased revenue, and even if they do, any increased revenue may not offset the expenses we incur in building our website popularity and our brand. If we do attract new users to our website, they may not conduct transactions on a frequent basis or in sufficient dollar amounts. If we fail to promote and maintain our website or incur substantial expenses in an unsuccessful attempt to promote and maintain our brand, our business would be harmed.
We anticipate expanding our international sales activities, causing our business to become increasingly susceptible to numerous risks that could affect our profitability.
In the three months period ended September 30, 2009 and 2010, 37.8% and 43.3%, respectively, and in the nine month periods ended September 30, 2009 and 2010, 33.8% and 41.1%, respectively, of our net revenue was generated by shipments to customers outside of the United States. We plan, over time, to expand our reach into international markets. We do not, however, currently have any overseas fulfillment, distribution, or server facilities. We cannot be certain that we will be able to expand our global presence. In addition, there are certain risks associated with doing business on an international basis, including regulatory requirements, legal uncertainty regarding liability, tariffs, and other trade barriers, longer payment cycles, and potentially adverse tax consequences, any of which could adversely affect our business. Although our foreign sales historically have been denominated in U.S. dollars, we also may be subject to increased risks relating to foreign currency exchange rate fluctuations to the extent we decide to denominate our sales in foreign currencies.
Customer complaints or negative publicity about our customer service could adversely affect our reputation and, as a result, our business could suffer.
Customer complaints or negative publicity about our customer service could severely diminish consumer confidence and the use of our website. Effective customer service requires significant personnel expense, and this expense, if not managed properly, could significantly impact our profitability. The failure to manage or train our customer service representatives properly could compromise our ability to handle customer inquiries and complaints effectively. If we do not handle customer inquiries and complaints effectively, we may lose customer confidence. As a result, our revenue could suffer and our operating margin may decrease.
Quarterly financial results may not be consistent and impact our stock price.
There are numerous influences on our quarterly financial results that extend beyond the normal seasonal trends. Fluctuations that are under our control include: our ability to influence the timing and quantity of items we place for auction; our decision to acquire merchandise at favorable prices; our expenditures on marketing and our ability to attract customer visits to our website. Fluctuations that are not under our control that may directly impact our quarterly financial results include: changes in market price for precious metals and gems; changes in consumers discretionary income and demand for our products; and changes in fashion trends.
We do not have a guaranteed supply of jewelry products, and we have a concentration of inventory purchases from our top two suppliers.
The success of our business depends, in part, on our ability to offer our customers a wide variety of jewelry that they can purchase at prices that are substantially below those of traditional jewelry retailers. We do not have any formal or binding supply agreements with any of our manufacturers, distributors, or other suppliers for our supply of jewelry products. As a result, we do not have a guaranteed supply of jewelry products at favorable prices. Our inability to maintain and expand our jewelry supply relationships or the inability of our suppliers to continue to supply us with jewelry products at favorable prices would substantially harm our business and results of operations.
In addition, we have a concentration of inventory purchases from a small number of suppliers. Our top vendors based on the amount of purchases vary from quarter to quarter. The top two suppliers accounted for approximately 37.1% and 21.3% of our total purchases in the three month period ended September 30, 2009 and 2010, respectively and in the nine month period ended September 30, 2009 and 2010, 28.0% and 23.2%, respectively, were purchased from our top two suppliers.
We may give substantial deposits of inventory to our manufacturing vendors to produce finished jewelry products.
We may be at risk of loss for the diamonds, precious and semi-precious gems that we have given to our manufacturing vendors to produce into finished jewelry products. If the businesses of the vendors fail, the diamond inventory is lost or stolen, the vendors do not have adequate insurance coverage or if the vendors fail to produce and deliver finished jewelry products, we would incur substantial losses that would have a material impact on our net income and financial position.
Competition from online auctioneers and other online companies with greater brand recognition may adversely affect our sales.
The market for online auctions is rapidly evolving and intensely competitive. We expect competition to intensify further in the future. Barriers to entry are relatively low, and current and new competitors can launch new websites at relatively low cost using commercially available software.
We currently compete with a number of other companies, and other competitors may appear in the future. Our competitors currently include various online auction services and retailers, including eBay, Blue Nile and Overstock. We also encounter competition from national jewelry retail chains, such as Zales, Kay Jewelers, and Finlay Fine Jewelry, and mass retailers and other enterprises, such as Wal-Mart, Target, J. C. Penney, Costco, QVC, and Home Shopping Network. Many of our competitors have greater brand recognition, longer operating histories, larger customer bases, and significantly greater financial, marketing, and other resources than we do. Smaller competitors may enter into strategic or commercial relationships with larger, more established, and better financed companies. Other competitors may enter into exclusive distribution agreements with our suppliers that deny us access to suppliers products. Competitors may also devote greater resources to marketing and promotional campaigns and to website and systems technology than we do. We may not be able to compete successfully against current and future competitors or address increased competitive pressures. Furthermore, attempts have been made in the past to develop and market synthetic stones and gems to compete in the market for gemstones and gemstone jewelry. We expect such efforts to continue in the future. If any such efforts are successful in creating widespread demand for synthetic or alternative gemstone products, demand and price levels for our products could decline and our business and results of operations would be substantially harmed.
We rely heavily on the sale of jewelry for our net revenue, and demand for these products could decline.
Luxury products, such as jewelry, are discretionary purchases for consumers. The volume and dollar amount of such purchases may be affected by adverse trends in the general economy and consumer perceptions of those trends, and purchases may significantly decrease during economic downturns. The success of our business depends in part on macroeconomic factors, such as employment levels, salary levels, tax rates, and credit availability, all of which affect disposable income and consumer spending. Any reduction in disposable income or consumer spending may affect us more significantly than companies in other industries.
Our net revenue and results of operations depend in part on the demand for jewelry. Consumers tastes are subject to frequent, significant, and sometimes unpredictable changes. Should prevailing consumer tastes for jewelry change or the demand for jewelry decrease, the sale of our products could decline and our business and results of operations would suffer.
Furthermore, our ability to increase our net revenue and enhance our profitability may depend on our ability to expand our product offerings beyond our current offerings. If we offer new products that are not accepted by customers, our brand and reputation could be adversely affected, our sales may fall short of expectations, and we may incur substantial expenses that are not offset by increased sales.
Because we carry our jewelry products in inventory, our net revenue and gross margin may decrease if we are unable to predict and plan for changes in consumer demand.
If our sales increase, we will be required to increase our inventory proportionately. Consumer tastes and preferences for jewelry products can change rapidly, thereby exposing us to significant inventory risks. Currently, because the products we sell also consist of closeout merchandise from manufacturers, distributors, and other suppliers, we have less control over the specific items that we offer for sale than we would if we primarily ordered goods manufactured for us. In addition, it is important that we are able to purchase jewelry that we perceive to be in demand. The demand for specific products can change between the time we order items and when we sell them. As a result, we may be required to take significant inventory markdowns, which could reduce our gross margin, if we do not accurately predict these trends or if we overstock unpopular merchandise.
We may be subject to a tax liability for past sales and our future sales may decrease if we are required to collect sales and use taxes on the products we sell.
In accordance with current industry practice and our interpretation of current law, we do not currently collect sales or other taxes with respect to shipments of goods into states other than California, New York, Rhode Island and North Carolina. However, additional states or foreign countries may seek to impose sales or other tax obligations on us in the future. A successful assertion by one or more states or foreign countries that we should be collecting sales or other taxes on the sale of our products could result in substantial tax liabilities for past and future sales, discourage customers from purchasing products from us, decrease our ability to compete with traditional retailers, and otherwise substantially harm our business, financial condition, and results of operations.
We rely on suppliers and third-party carriers as part of our fulfillment process, and these third parties may fail to meet shipping schedules or requirements.
We rely on suppliers to deliver our orders promptly, which we then carry in inventory to ensure availability and expedited delivery to our customers. We also rely on third-party carriers to ship our products to our customers. As a result, we are subject to various risks, including employee strikes and inclement weather, associated with the ability of third-party carriers to provide delivery services to meet our shipping needs and those of our suppliers. The failure of our suppliers and third-party carriers to deliver products to us or our customers in a timely manner or otherwise to serve us or our customers adequately would damage our reputation and brand and substantially harm our business and results of operations.
Increases in the cost of precious metals and precious and semi-precious stones would increase the cost of our jewelry products.
The jewelry industry is affected by fluctuations in the prices of precious metals and precious and semi-precious stones. The availability and prices of gold, silver, platinum, and other precious metals and precious and semi-precious stones may be influenced by such factors as cartels, political instability in exporting countries, changes in global demand, and inflation. Shortages of these materials or an increase in their prices could reduce the quantity of products we have available for sale and our ability to sell our products for more than our cost, causing reduced sales or lower margins compared to our historical and expected sales and margins.
The satisfactory availability, performance, and reliability of our website, network infrastructure, and transaction processing systems are critical to our ability to attract, retain, and service customers.
Any problems with the availability, performance, or reliability of our website, network infrastructure, or transaction processing systems could result in decreased customer traffic, reduced orders, reduced order fulfillment performance, and lower net revenue as well as negative publicity and damage to our reputation. In order to remain competitive, we must continually seek to improve and expand the functionality and features of our website, network infrastructure, transaction processing systems, and delivery and shipping functions to accommodate any substantial increase in the volume of traffic to and orders from our website. We may not be successful in these efforts, and we may not be able to project accurately the rate or timing of increases, if any, in the use of or sales from our website, or timely expand or upgrade our website, infrastructure, or systems to accommodate any such increases. Additionally, we may not be able to remedy any such availability, performance, or reliability problems in a timely manner, or at all, because we depend in part on third parties for such availability, performance, and reliability. Our website and back-office servers are located at a third-party co-location facility operated by Savvis Inc. in El Segundo, CA which is vulnerable to fire, earthquakes, and similar events.
Our business and results of operations would be harmed in the event of any failure of our auction and bidding systems hardware, which is located at a single third-party co-location facility, or any failure of our fulfillment and administrative hardware.
Our business depends in part on the efficient and uninterrupted operation of our computer and communications hardware. The servers and other hardware necessary to operate our website, including our auction and bidding systems, are located at a single third-party co-location facility in El Segundo, CA. We rely on that facility to provide Internet access with the speed, capacity, and reliability we require. Our servers and other hardware that run our transaction processing, order fulfillment, and office administration tasks are located at our headquarters. Our servers and other hardware are vulnerable to damage or interruption from human error, fire, flood, power loss, telecommunications failure, terrorist attacks, acts of war, break-ins, earthquakes, and similar events. We do not currently have redundant systems in multiple locations or a formal disaster recovery plan, and our business interruption insurance may be insufficient to compensate us for any losses that may occur. In addition, our servers are vulnerable to computer viruses, physical or electronic break-ins, and similar disruptions, which could lead to interruptions, delays, loss of critical data, the inability to accept and fulfill customer orders, or the unauthorized disclosure of confidential customer data. System disruptions or failures would also create a large number of customer questions and complaints that need to be addressed by our customer service support personnel. The occurrence of any of the foregoing risks could substantially harm our business and results of operations. Our systems are vulnerable to damage or interruption from earthquakes, floods, fires, power loss, telecommunication failures, terrorist attacks, computer viruses, computer denial-of-service attacks, and similar events.
Our failure to protect confidential information of our customers and our network against security breaches could damage our reputation and substantially harm our business and results of operations.
A significant barrier to online commerce and communications is the secure transmission of confidential information over public networks. Third parties may have the technology or expertise to breach the security of customer transaction data. Our security measures may not prevent security breaches that could result in substantial harm to our business and results of operations and damage to our reputation. Currently, a majority of our sales are billed to our customers credit card accounts directly. Under current credit card practices, we are liable for fraudulent credit card transactions because we do not obtain cardholder signatures. We rely on encryption and authentication technology licensed from third parties to effect secure transmission of confidential information, including credit card numbers. We do not currently carry insurance against this risk. Advances in computer capabilities, new discoveries in the field of cryptography, or other developments may result in a compromise or breach of the technology we use to protect customer transaction data. In addition, anyone who is able to circumvent our security measures could misappropriate proprietary information or cause interruptions in our operations. Any such compromise of our security could damage our reputation and brand and expose us to a risk of loss or litigation and possible liability, which would substantially harm our business and results of operations.
In addition, the Payment Card Industry (PCI) imposes strict customer credit card data security standards that require us to provide quarterly self assessments to ensure that credit card information of our customers are protected. Failure to meet the PCI data security standards could result in substantial fines and/or loss of the right to collect credit card payments. The loss of credit card activity would materially impact operations.
We are vulnerable to fraudulent activities on our website, including unauthorized use of customer information and identity theft by third parties.
Our network security measures to prevent third parties from penetrating our network and improperly accessing our customers personal information or credit card information may not be successful. Although we have not experienced any theft of our customers credit card information to date, as new discoveries in the field of cryptography and advances in computer capabilities occur, our security measures may not effectively prevent others from obtaining improper access to our customer information. In addition, third
parties may target our customers directly with fraudulent identity theft schemes designed to appear as legitimate e-mails from us. In March 2006, one such third party attempted to solicit customer information through a tactic, commonly known as phishing, whereby an e-mail purporting to be from us solicited customer information from recipients of the e-mail. Any such security breach or fraud perpetrated on our customers could expose us to increased costs and could harm our business and results of operations.
Our ability to grow our business will be impaired by delays, interruptions, or failures of the Internet.
Our success depends on the continued growth and maintenance of the Internet. The Internet has experienced, and is likely to continue to experience, significant growth in the numbers of users and amount of traffic. If Internet usage continues to grow as anticipated, the infrastructure may not be able to support the level of usage and its performance and reliability may decline. If outages or delays on the Internet increase, overall Internet usage could grow more slowly or decline. In addition, the performance of the Internet may be harmed by increased number of users or bandwidth requirements or by viruses, worms, and similar issues. The Internet has experienced a variety of outages and other delays as a result of damage to portions of its infrastructure, and it could face outages and delays in the future. These outages and delays could reduce the level of Internet usage.
We depend on the continued growth and acceptance of online commerce, and our business will be substantially impaired if the growth of online commerce slows or does not grow as expected.
Our success depends on the widespread acceptance and use of the Internet as an effective medium for commerce by consumers. The acceptance and use of the Internet may not continue to expand as expected, and a sufficient broad base of consumers necessary for its continued growth may not adopt the Internet as a medium for commerce. Consumers who historically have used traditional means of commerce may have concerns about privacy, the inability to physically inspect merchandise before buying, delivery time, product damage during shipment, and the costs and inconvenience involved in returning purchased items, which may inhibit their crossover to e-commerce. In order to expand our user base, we must appeal to and acquire consumers who historically have used traditional means of commerce to purchase goods. If these new customers execute fewer or lower dollar amounts of orders than our historical users, and we are unable to gain efficiencies in our operating costs, including the cost of acquiring new customers, our business and profits could be adversely affected.
Increased product returns and the failure to predict product returns could substantially harm our business and results of operations.
As we expand our business and product offerings, rates of product return may increase. Any significant increase in product returns above our return assumptions and allowances could substantially harm our business and results of operations.
Our inventory is vulnerable to damage or loss caused by fire, flood, earthquakes, and similar events, and we face the risk of theft of our products from inventory or during shipment.
Our inventory is stored at our warehouse/office facility in Culver City, California and at our warehouse in Marina Del Rey, California. Consequently, our merchandise supply is vulnerable to fire, flood, earthquakes, and similar events that may impact our facility. Any damage to or loss of all or a significant portion of our inventory could cause significant delays in shipment of goods to our customers, resulting in negative publicity about and diminished customer confidence in our website. In addition, we may experience theft of our products while they are being held in inventory or during the course of their shipment to our customers by third-party carriers. We have implemented security measures to prevent such theft and maintain insurance to cover losses resulting from theft. Nevertheless, we could incur significant losses from theft, which would substantially harm our business and results of operations, if our security measures fail, losses exceed our insurance coverage, or we are not able to maintain insurance at a reasonable cost.
Increases in credit card processing fees could increase our costs.
Our merchant bank processor, Visa, MasterCard, American Express, Discover Card, PayPal and Bill-Me-Later could increase the processing and interchange fees that they charge for transactions using their cards or service. Increases in processing and interchange fees may result in increased operating costs and reduced profit margin.
We may default on our obligations, if we are unable to generate sufficient cash through sales in a timely manner.
Since our formation, we have funded our operations through the sale of equity securities and cash generated from operations. The working capital characteristics of our business have allowed us to collect cash from sales to customers within several business days of the related sale, while we typically have extended payment terms with our suppliers. We do not, however, have any formal or binding supply agreements with any of our suppliers, manufacturers, distributors, or other suppliers or any other formal agreements with them on payment terms. Accordingly, there is a risk that we may default on our obligations if we are unable to generate sufficient cash through sales in a timely manner or through our credit facility.
Seasonal fluctuations in our net revenue could cause our quarterly results to fluctuate and cause our results of operations to be below expectations.
Historically, sales in the jewelry industry are seasonal and have been higher in the fourth quarter of the calendar year as a result of higher consumer spending during the December holiday season. Approximately 33.8%, 16.9% and 24.9% of our net revenue was generated during the fourth quarter of 2007, 2008 and 2009, respectively. The fourth quarter of 2008 and 2009 were exceptions. In the fourth quarter of 2008 we encountered a significant slowdown in sales resulting from the 2008 financial and economic crisis. The fourth quarter of 2009 was further affected by the migration of our proprietary enterprise operating system to an ERP system running on a customized Microsoft Dynamics AX as unexpected deficiencies in implementing the new system had a material adverse effect on our results operations. As we continue to recover and grow, we expect to experience more pronounced seasonal fluctuations in our net revenue and anticipate a disproportionate amount of our revenue will occur in the fourth quarter. In anticipation of any increased sales activity during the fourth quarter, we may incur significant additional expenses, including higher sales and marketing costs and additional staffing in our fulfillment and customer support operations. If we were to experience lower than expected sales during any future fourth quarter, it would have a disproportionately large impact on our results of operations for that year. In the future, our seasonal sales patterns may become more pronounced, may strain our personnel and fulfillment activities, and may cause a shortfall in sales compared with expenses in a given period, which would substantially harm our business and results of operations.
Sales growth in prior periods may not be indicative of our future growth.
Our sales have fluctuated significantly in the past, in part, as a result of varying amounts of funds we have spent on advertising and inventory levels and may fluctuate significantly in the future because of varying advertising and inventory costs. These factors may prevent the meaningful use of period-to-period comparisons of financial results. For these and other reasons, investors should not rely on past sales growth rates as a prediction of our future sales growth.
We had grown quickly, and our business will suffer if we fail to manage our future growth.
We had expanded our operations at a rapid pace prior to the 2008 financial and economic crisis. This expansion had placed a significant strain on our management, operations, and financial resources. When the economy and our business recover, we anticipate adding personnel in the future, including managerial, technical, and operations personnel. In order to manage the future growth of our operations, we also will be required to improve existing and implement new transaction-processing, operational and financial systems, procedures, and controls. If we are unable to manage growth effectively, our business and results of operations will be harmed.
Descriptions of our jewelry items are not guarantees and may confuse, mislead, or disappoint our customers.
In an effort to provide accurate descriptions of jewelry posted on our website, we provide appraisal summaries from third-party gemological laboratories for some of our jewelry items. All other jewelry and watch descriptions are provided by our full-time Gemological Institute of America, or GIA, trained gemologists and other experienced product specialists. Nevertheless, there is a subjective component involved with respect to assessing the clarity, color, and carat characteristics of diamonds and other gemstones. In addition, mistakes or omissions of important information in our descriptions may occur. Even if our descriptions are accurate, buying a product online may lead to disappointment resulting in returned merchandise. For example, a customer may determine that a piece does not have the expected look, feel, and overall appearance of the merchandise that the buyer envisioned from the website photograph.
Additionally, in response to customer requests and as a courtesy to resellers, we provide Compare, and/or Retail prices for jewelry items listed on our website. Compare prices are not meant to reflect fair market values or manufacturer suggested retail prices, and in fact, may be higher than prices found in local retail stores. As a consequence, perceived misrepresentations in item descriptions by disappointed buyers may occur, resulting in negative publicity about and diminished customer confidence in our website.
We may unknowingly be involved in conflict diamond purchases that result in a negative public relationship impact.
There has been an increase in attention to conflict diamonds originating out of war-torn regions of Africa. The proceeds from the sale of conflict diamonds have been used to fund ongoing aggression and terrorist activities throughout the world. We make every effort to evaluate our vendor sources to ensure they are not a dealer in conflict diamonds. In addition we have implemented an anti-money laundering program to guard against both illicit purchase and sales activities. If these risks were to occur, we may face a negative public reaction to our brand name resulting in loss of sales.
We may not be able to maintain our domain name uniqueness.
Our Internet domain name is critical to our success. Under current domain name registration practices, no other entity can obtain an identical domain name, but can obtain a similar name or the identical name with a different suffix, such as .net or .org, or with a different country designation, such as jp for Japan. We have not registered our domain name with different suffixes nor have we registered our name in any other jurisdiction. As a result, third parties may use domain names that are similar to our domain name, which may result in confusion to potential customers and lost sales. We are aware that other businesses have registered the name bidz with other suffixes and in other countries.
We may be subject to assertions by third parties for infringement on their intellectual property rights.
Third parties may in the future assert that we have infringed on their intellectual property rights as we self-develop our auction platform, sales transaction system, and inventory control system. We have a larger exposure to being accused of intellectual property rights infringements than if we had purchased our technology off the shelf. We also may be at risk for selling items that infringe on other third party trade dress rights, copyright, or patent rights that may cause the offended party to bring an action against us. In either event of alleged infringement, we would face substantial litigation cost to defend ourselves and utilization of our management and personnel resources.
We may be unable to protect or enforce our own intellectual property rights adequately, and we may become subject to intellectual property litigation.
We regard the protection of our trademarks, copyrights, domain name, trade dress, and trade secrets as critical to our success. We rely on a combination of common law as well as trademark, copyright, trade dress, and trade secret laws to protect our intellectual property rights. We also have entered into confidentiality and invention assignment agreements with our employees and relevant contractors and nondisclosure agreements with relevant parties with whom we conduct business in order to limit access to and disclosure of our proprietary information. These contractual arrangements and other steps we have taken to protect our intellectual property may not prevent misappropriation of our intellectual property or deter independent development of similar intellectual property by others Effective trademark, copyright, patent, trade dress, trade secret, and domain name protection is very expensive to maintain and may require litigation.
Third parties may from time to time claim that we have infringed their intellectual property relating to our business model or auction systems. We expect that participants in our market increasingly will be subject to infringement claims as the number of services and competitors in our industry segment grows. Any claim like this, whether meritorious or not, could be time-consuming, result in costly litigation, cause service upgrade delays, or require us to enter into royalty or license agreements. These royalty or license agreements may not be available on acceptable terms or at all. As a result, any such claim could harm our business.
We may be unable to enforce protection of our intellectual property rights under the laws of other countries.
We anticipate that we will become increasingly subject to international intellectual property risks, including differing intellectual property laws, which may be insufficient to protect our intellectual property, unique local laws, and lack of applicable law or clear precedent.
Various legal rules and regulations related to privacy and the collection, dissemination, and security of personal information may adversely affect our marketing efforts.
We are subject to increasing regulation at the federal, state, and international levels relating to privacy and the use of personal user information designed to protect the privacy of personally identifiable information as well as to protect against its misuse. These laws include the Federal Trade Commission Act, the CAN-SPAM Act of 2003, the Childrens Online Privacy Protection Act, the Fair Credit Reporting Act, the Homeland Security Act, and related regulations. In May 2009, we received a Civil Investigation Demand for Information from the Federal Trade Commissioner (FTC) relating to email marketing practices. We have been cooperating fully with the FTC regarding this matter, and in a notice dated April 2, 2010, FTC has decided not to recommend enforcement action against us. Several states have proposed legislation that would limit the use of personal information gathered online or require online services to establish privacy policies. Moreover, proposed legislation in the United States and existing laws in foreign countries require companies to establish procedures to notify users of privacy and security policies, obtain consent from users for collection and use of personal information, and/or provide users with the ability to access, correct, and delete personal information stored by companies. These regulations and other laws, rules, and regulations enacted in the future may adversely affect our ability to collect, disseminate, or share demographic and personal information about users and our ability to e-mail or telephone users, which could be costly and adversely affect our marketing efforts.
We may be subject to regulations governing the conduct and liability of auctioneers, which could affect the way in which we conduct our business or otherwise increase our cost of doing business.
Numerous states and foreign jurisdictions, including California, where our headquarters are located, have regulations regarding how auctions may be conducted and the liability of auctioneers in conducting such auctions. No final legal determination has been made whether the California regulations apply to our business, and little precedent exists in this area. Several states and some foreign jurisdictions have attempted, and may attempt in the future, to impose regulations that could affect us or our users, which could harm our business.
We are subject to regulations relating to consumer privacy, which could increase the cost of our doing business, expose us to litigation costs, increase our service or delivery costs, and otherwise harm our business.
Several states have proposed, and several states such as California, Minnesota, Utah, and Vermont have recently passed, legislation that would limit the uses of personal user information gathered online or offline. Many states already have such laws and continually consider strengthening them, especially against online services. However, the Fair Credit Reporting Act, or FCRA, a federal statute enacted in 1970 to protect consumer privacy, includes a provision preempting conflicting state laws on the sharing of information between corporate affiliates. The preemptive provisions of FCRA were permanently extended in 2002, thereby ensuring that we are not subject to the laws of each individual state with respect to matters within the scope of FCRA, but remain subject to the other provisions of FCRA.
The Federal Trade Commission also has settled several proceedings against companies regarding the manner in which personal information is collected from users and provided to third parties. As noted above, we are cooperating with the FTC in an investigation relating to email marketing. See Item 1, Legal Proceedings. Specific statutes intended to protect user privacy have been passed in many foreign jurisdictions. Compliance with these laws, given the tight integration of our systems across different countries and the need to move data to facilitate transactions among our users, such as payment companies and shipping companies, is both necessary and difficult. Failure to comply could subject us to lawsuits, fines, criminal penalties, statutory damages, adverse publicity, and other losses that could harm our business. Changes to existing laws or the passage of new laws intended to address these issues could directly affect the way we do business or could create uncertainty on the use of the Internet. This could reduce demand for our products, increase the cost of our doing business, expose us to litigation costs, increase our service or delivery costs, or otherwise harm our business.
New and existing regulations could harm our business.
We are subject to the same foreign and domestic laws as other companies conducting both online and offline business. There are still relatively few laws specifically directed towards online business. However, due to the increasing popularity and use of the Internet and online services, many laws relating to the Internet are being debated at all levels of government around the world, and it is possible that such laws and regulations will be adopted. These laws and regulations could cover issues such as user privacy, freedom of expression, pricing, fraud, content and quality of products and services, taxation, advertising, intellectual property rights, and information security. Applicability to the Internet of existing laws governing issues, such as property ownership, copyrights and other intellectual property issues, taxation, libel and defamation, obscenity, and personal privacy is uncertain. The vast majority of these laws was adopted prior to the advent of the Internet and related technologies and, as a result, do not contemplate or address the unique issues of the Internet and related technologies. Those laws that do reference the Internet, such as the U.S. Digital Millennium Copyright Act and the European Unions Directive on Distance Selling and Electronic Commerce, have only recently begun to be interpreted by the courts and implemented by the European Union member states, so their applicability and scope remain uncertain. As our activities and the types of goods listed on our website expand, regulatory agencies may claim that we or our users are subject to licensure in their jurisdiction, either with respect to our business in general, or in order to allow the sale of certain items, such as real estate, event tickets, boats, and automobiles.
In addition, because our products are available over the Internet in multiple states and because we sell merchandise to consumers residing in multiple states, we could be required to qualify to do business as a foreign corporation in each state in which our products are available. Our failure to qualify as a foreign corporation in a jurisdiction in which we are required to do so could subject us to penalties. Any new legislation or regulation, or the application of laws or regulations from jurisdictions whose laws do not currently apply to our business could have a material adverse affect on our business.
We depend to a very significant extent on David Zinberg, our Chief Executive Officer.
Our performance depends substantially upon David Zinberg, our Chief Executive Officer, who has extensive experience with the purchase and sale of jewelry. We rely on Mr. Zinberg to make critical operational decisions on a daily basis, such as product offerings
and purchases, and to make key strategic plans. We have an employment agreement with Mr. Zinberg extending through July 2011 and renewable annually. The loss of the services of Mr. Zinberg would adversely affect our business and operations.
Holders of common stock issued by us in prior offerings may be entitled to rescind their purchases.
From our inception until mid-2003, we raised over $20.5 million in gross equity capital by selling shares of our common stock to approximately 830 investors at prices ranging from $4.00 to $6.00 per share with a weighted average share price of $4.50. We also issued shares of common stock to about 30 persons in exchange for services and other non-cash consideration valued in excess of $5.5 million and issued approximately 250 stock option grants to purchase common stock at a weighted average exercise price of $4.45. After conducting these sales of our securities, we determined that these sales were not exempt from the registration requirements under the Securities Act of 1933 and similar provisions of laws of the states in which our stockholders reside, because certain of our employees who solicited investors engaged in a general solicitation of securities. In addition, these employees received compensation for selling our common stock and were required to be licensed as broker-dealers with the Securities and Exchange Commission, or SEC, and various state authorities, but they were not so licensed. In such situations, a number of remedies may be available to regulatory authorities and the investors who purchased common stock in those offerings, including a right of rescission, civil penalties, a restraining order or injunction, and a court order to pay restitution and costs. We believe, however, that as to any options by investors at this time or in the future, applicable statutes of limitations will mitigate our exposure to any civil remedies.
We do not intend to pay dividends on our common stock, and, consequently, your only opportunity to achieve a return on your investment is if the price of our common stock appreciates.
We have never declared or paid any cash dividends on our common stock and do not intend to pay dividends on our common stock for the foreseeable future. We intend to invest any future earnings to fund our business. Therefore, stockholders likely will not receive any dividends on our common stock for the foreseeable future. Investors cannot be certain that they will receive a positive return on their investment when they sell their shares or that they will not lose the entire amount of their investment.
The concentration of our capital stock ownership with our founder and executive officers and directors and their affiliates will limit your ability to influence corporate matters.
As of September 30, 2010, our founder, executive officers, and directors together owned approximately 40.6% of our common stock, and Marina Zinberg, who is the sister of David Zinberg, our Chairman and Chief Executive Officer, owned an additional 20.9% of our common stock. As a result, these individuals will have significant influence over our management and affairs and over all matters requiring stockholder approval, including the election of directors and the approval of significant corporate transactions, such as a merger or a sale of our company or its assets, for the foreseeable future. This concentrated control will limit the ability of other stockholders to influence corporate matters. Because of this, we may take actions that some of our stockholders do not view as beneficial. As a result, the market price of our common stock could be adversely affected because stockholders may not view favorably the concentration of control in the hands of management.
Our charter documents and Delaware law could make it more difficult for a third party to acquire us, and discourage a takeover.
On June 22, 2006, we reincorporated in Delaware, and the Delaware certificate of incorporation and the Delaware General Corporation Law, or DGCL, contain provisions that may have the effect of making more difficult or delaying attempts by others to obtain control of our company, even when these attempts may be in the best interests of our stockholders. The Delaware certificate of incorporation also authorizes our Board of Directors, without stockholder approval, to issue one or more series of preferred stock, which could have voting and conversion rights that adversely affect or dilute the voting power of the holders of common stock. Delaware law also imposes conditions on certain business combination transactions with interested stockholders. The Delaware certificate of incorporation divides our Board of Directors into three classes, with one class to stand for election each year for a three-year term after the initial election. The classification of directors tends to discourage a third party from initiating a proxy solicitation or otherwise attempting to obtain control of our company and may maintain the incumbency of our Board of Directors, as this structure generally increases the difficulty of, or may delay, replacing a majority of directors. The Delaware bylaws authorize our Board of Directors to fill vacancies or newly created directorships. A majority of the directors then in office may elect a successor to fill any vacancies or newly created directorships.
No stock awards or stock options were granted during the three months ended September 30, 2010.
Issuer Purchases of Equity Securities
The following table contains information about purchases of our common stock during the three months ended September 30, 2010:
(1) In June 2007, we authorized the stock buyback program for up to $5 million of our outstanding common stock to be repurchased through the open market at prices deemed appropriate by management. In February 2008, we authorized an increase in the stock buyback program to $20 million from $5 million. In February 2009, we authorized an increase in the stock buyback program to $33.5 million. The stock buyback will be at prices deemed appropriate by management over a 24 month period.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized.