Our websites collectively showcase more than 25,000 independently certified diamonds, a wide range of precious and semi-precious jewelry and over 2,000 watch styles from brands such as Tag Heuer, Omega and Movado. In addition, we offer an assortment of luxury goods, such as fragrances and sunglasses, from brands such as Prada, Gucci and Fendi. We sell diamonds and fine jewelry at competitive prices and brand name goods at discounts to suggested retail prices.
We provide our customers with informative websites that are convenient and easy-to-navigate. Our websites feature informational resources such as a “Learning Center” and a “Glossary of Watch Terms” that provide detailed product information. These efforts are supplemented with a call center staffed by trained personnel who provide product support as well as information on payment options and shipping alternatives. We feature diamonds that are graded and certified by the Gemological Institute of America (GIA), the world’s preeminent diamond grading organization. We offer GIA certificates online for customers to review before a purchase decision is made. Customers can shop 24 hours a day, seven days a week on our websites and can use interactive search functions to find desired products quickly. Diamonds, watches and fine jewelry may be returned up to 30 days (and all other products we sell may be returned up to 15 days) from ship date for exchange or a full refund of the purchase price (exclusive of shipping and handling costs) provided the item is unworn, has not been sized or altered and is returned with all
original packaging, security tags and documentation. We also provide an in-house service center for our watches and fine jewelry.
We operate the following three websites:
| • | www.diamond.com features independently certified diamonds, fine jewelry and brand name watches, and accounted for approximately 45% and 39% of our net sales during the years ended December 31, 2005 and 2004, respectively. | |
| • | www.ashford.com features brand name luxury products, including watches, fine jewelry, designer handbags and accessories, home accents, fragrances, sunglasses and fine writing instruments, and accounted for approximately 32% and 39% of our net sales during the years ended December 31, 2005 and 2004, respectively. | |
| • | www.worldofwatches.com features a large selection of brand name watches, and accounted for approximately 23% and 22% of our net sales during the years ended December 31, 2005 and 2004, respectively. |
Our Websites
Our websites offer the convenience and flexibility of being able to shop for brand name watches and luxury goods, diamonds and fine jewelry 24 hours a day, seven days a week. Our websites provide a secure, informative and enjoyable shopping experience in an easy-to-use online format. Each website has an interactive search capability that allows our customers to search for products by different criteria, obtain product information and recommendations and participate in promotions and discounts.
www.diamond.com
www.diamond.com is an online retailer of independently certified diamonds, precious and semi-precious jewelry and brand name watches. Although engagement diamonds and settings have historically been the website’s primary focus, www.diamond.com provides jewelry for all occasions. We promote customer education regarding key aspects of buying diamonds through a “Learning Center” and other user-friendly interactive areas. On www.diamond.com, customers can search for independently certified diamonds using criteria such as carat, clarity, color and cut, and can use the “Design Your Ring” feature to customize their purchase. Our “Engagement Ring Showcase” illustrates some of our diamonds in a variety of our most popular mountings and settings. During the years ended December 31, 2005 and 2004, net sales of products offered on www.diamond.com comprised approximately 45% and 39%, respectively, of our total net sales.
www.ashford.com
www.ashford.com provides a comprehensive online selection of brand name luxury goods, including watches, jewelry, designer handbags and accessories, home accents, fragrances, sunglasses and fine writing instruments. We are transitioning out of offering brand name handbags and anticipate that by the end of the second quarter 2006, we will no longer offer brand name handbags. Our Ashford ® branded watches are available exclusively on www.ashford.com . These watches are consistent in style and quality with our other brand name watches we sell, but at lower prices. Our Ashford branded watches are assembled in Switzerland with Swiss movements and are delivered to customers in attractive packaging emphasizing the Ashford brand. During the years ended December 31, 2005 and 2004, net sales of products offered on www.ashford.com comprised approximately 32% and 39% respectively, of our total net sales.
www.worldofwatches.com
www.worldofwatches.com sells designer brand name watches such as Tag Heuer, Omega and Movado. This website provides detailed product information regarding automatic and quartz movements, water and scratch resistance, shock proofing, strap and case materials, warranties and maintenance. During the years
ended December 31, 2005 and 2004, net sales of products offered on www.worldofwatches.com comprised approximately 23% and 22%, respectively, of our total net sales.
Supplier Relationships
Diamonds and Fine Jewelry
In March 2004, we entered into a supply agreement with SDG Marketing, Inc., an affiliate of The Steinmetz Diamond Group. The Steinmetz Diamond Group, an international diamond dealer includes several companies that purchase diamonds directly from DeBeers Group. Beny Steinmetz, Daniel Steinmetz and Nir Livnat, all beneficial holders of our common stock are the beneficiaries of several trusts and foundations which own several of the companies which comprise The Steinmetz Diamond Group, including, SDG Marketing, Inc. Under the Supply Agreement, SDG Marketing became obligated to provide us with replenishable inventory of independently certified diamonds with a value equal to $4.0 million, $5.0 million, and $6.0 million for each of the years ending November 30, 2004, 2005, and 2006, respectively. In addition, under the Supply Agreement, we granted SDG Marketing the right of first refusal to provide us with jewelry based on our projected purchase needs. For the year ended December 31, 2005, 18% of the diamonds we sold were supplied by SDG Marketing, Inc. The remainder of the diamonds sold during 2005 were supplied from various third party diamond suppliers and were not held in our inventory until the diamonds were ordered by a customer.
Due to the decreasing percentage of our diamond sales being derived from diamonds supplied by SDG, and the comparably greater risks of holding and carrying inventory, during the first quarter of 2006, we commenced discussions to wind down our supply agreement with SDG Marketing with the objective of reducing the risks and costs of holding inventory. In March 2006, we entered into a Termination Agreement with SDG Marketing, Inc. whereby the Supply Agreement was terminated. In connection with the Termination Agreement, we (i) returned to SDG Marketing approximately $3.7 million of diamond inventory to satisfy a $3.7 million payable to SDG Marketing; and (ii) delivered to SDG Marketing approximately $700,000 of diamond inventory as payment in kind to satisfy a $700,000 payable to SDG Marketing.
The termination of our Supply Agreement with SDG Marketing converts our sourcing strategy from a mix of an inventory and online model to a completely virtual, online model of offering diamonds from third party diamond suppliers, including SDG Marketing, without actually holding the inventory until the diamonds are ordered by our customers. It also allows us to offer a broad selection of diamonds without incurring the costs and risks of holding them in our inventory while still enabling us to bypass multiple layers of intermediaries traditionally associated with diamond sourcing. As a result of the termination of the Supply Agreement, we have less than $50,000 of diamond inventory on hand as of March 30, 2006 and now exclusively source diamonds from various third party suppliers who will generally ship the diamonds to us in one or two days. We then deliver the products to our customers through our normal fulfillment process.
We currently acquire our fine jewelry directly from manufacturers on a worldwide basis. We identify manufacturers with high value products by capitalizing on our management’s extensive experience in jewelry retailing. We purchased approximately $1.9 million of jewelry from The Steinmetz Diamond Group in 2005 from its jewelry manufacturing facility in India which became fully operational in December 2004. These jewelry purchases from Steinmetz represented approximately 38%of the aggregate dollar value of all of our 2005 jewelry purchases.
Brand Name Watches and Other Luxury Goods
Parallel Market. We acquire the majority of our brand name watches and luxury goods through the parallel market, an alternative distribution channel outside the control of brand owners. This market, which is sometimes referred to as the grey market, can develop as a result of brand owners’ attempts to build and control brand image by authorizing a difference in the price or supply of a product either between countries or different regions within the United States. To enhance distribution of products, we believe
many brand owners do not implement procedures to limit the ability of third parties to purchase and sell goods in the parallel market. As a result, the parallel market comprises numerous suppliers from across the world for many brands and products. We believe that our parallel market purchases and subsequent sales to consumers are in compliance with existing legal and regulatory requirements.
Our access to the parallel markets enables us to acquire genuine, current season merchandise instead of closeout merchandise like some of our competitors. Through the parallel market, we are able to purchase this merchandise at prices lower than could be purchased through a brand owner’s authorized distribution channels. Because we are not constrained by the pricing guidelines that authorized retailers must follow, we offer products below suggested retail prices while maintaining attractive margins.
During the years ended December 31, 2005 and 2004, 70% and 77%, respectively, of the aggregate dollar value of our brand name watches and luxury goods were purchased from suppliers in the parallel market and the remainder was purchased directly from brand owners and authorized distributors. Our suppliers in the parallel market are located in the United States, Canada, Europe and the Far East and are typically wholesalers who acquire products either directly or indirectly from brand owners or their authorized distributors. We have long standing relationships and experience with our parallel market suppliers developed through several years of watches and luxury goods retailing. We have met many of our suppliers at trade shows and referrals from other suppliers over the past ten years and our buying team has maintained these relationships. We use a variety of suppliers and do not source a material amount of the aggregate dollar volume of our purchases from any individual supplier. Our buying team seeks to continuously build and strengthen our supplier relationships by maintaining brand sensitivity and increasing our supplier sales volume. In selecting inventory on the parallel markets, our buying team identifies the type and style of products it wishes to acquire based on past sales history and trends in the market. Our suppliers on the parallel market are chosen based on their ability to provide the necessary quantities of the desired product as well as their terms and pricing for that product. After our buying team chooses the supplier, we submit a written purchase order for the merchandise. After delivery and inspection of the purchased products, we pay for the products in accordance with the terms of the purchase order. In certain circumstances we are required to pay all or a portion of the purchase price for goods prior to inspection.
Our Policies and Procedures. Since we source most of our watches and luxury products from the parallel market, we attempt to minimize our risk of purchasing stolen or counterfeit goods by following strict product sourcing policies and procedures. Our product sourcing and quality control policies and procedures for watches and other luxury goods include (i) purchasing products only from suppliers with whom we have a pre-existing relationship or to whom we have been referred; (ii) performing background checks on new suppliers and their officers through recognized search firms and other vendors; and (iii) performing in-house product inspection upon receipt of products. By purchasing products only from suppliers with whom we have a pre-existing relationship and have never had a material dispute, we believe we minimize our exposure to stolen goods. Our background checks enable us to obtain publicly available information on suppliers and their principals including information related to (1) the suppliers’ litigation history and court records, (2) the other entities for which the supplier’s principals have served as officers and directors and (3) liens on the supplier’s property. In addition to performing background checks on new suppliers, we solicit information on the reliability of new suppliers from our existing suppliers and other vendors.
Our in-house product inspection procedures include reviewing source documentation evidencing the purchase of the merchandise in bona fide transactions from brand owners, authorized distributors of brand owners or retailers for all of our products other than watches, ensuring that the merchandise and the packaging bear the brand name, logo or criteria of authenticity of the manufacturer as applicable by examining the look and placement of factory markings and emblems inspecting the workmanship of materials and fabrics to ensure it is consistent with the product’s reputation and that materials are without blemish or flaw, and determining whether the merchandise is damaged or has been tampered with.
In addition, by purchasing each type and style of luxury good and watch on the parallel market in significant quantities, we minimize the risk of purchasing stolen goods. Theft of these types of products
rarely occurs in such larger quantities and, when it does, information on such theft typically is quickly disseminated among purchasers of such goods on the parallel markets. Other than purchasing products in significant quantities and purchasing products only from suppliers with whom we have a pre-existing relationship or to whom we have been referred, we do not undertake additional inventory acquisition procedures to ensure that the watches we purchase on the parallel market are not stolen.
Marketing
Our marketing strategy is designed to generate consumer traffic by increasing awareness of our websites. We seek to acquire customers efficiently, build upon our customer base and increase repeat purchases. Given our limited resources and significantly increased marketing costs, all three of our websites experienced a decrease in number of visitors from 2004 to 2005, as evidenced through data compiled by us through third party software, information received from our portal partners and measurement tools on our websites.
The profile of our customer base on each of our websites is different. www.diamond.com appeals to the diamond and fine jewelry consumer and has a higher concentration of customers who are men over the age of 30. www.ashford.com appeals to the luxury goods consumer and has a higher concentration of customers who are women over the age of 35. www.worldofwatches.com appeals to a younger customer base.
Our marketing and advertising efforts consist primarily of the following initiatives:
Portal and Targeted Website Advertising. We utilize banner advertisements and purchase selected keywords on search engines and product data feeds on websites with high traffic volumes. We currently maintain portal and advertising relationships with, among others, MSN, Google and Yahoo/ Overture. Search engines, portals and other advertisers are compensated by us on a fixed fee (cost is based on the provision of a specific set of marketing activities) or a pay-for-performance basis (costs are strictly tied to some measure, typically sales). We have an agreement with Amazon.com to offer our products on Amazon.com’s marketplace expiring in September 2007. Under this agreement Amazon.com receives a percentage of the revenue generated from the sale of our products on its marketplace. This percentage is within the range of commissions generally paid by merchants who offer products on Amazon.com’s marketplace. Amazon processes orders and we are responsible for fulfillment, customer service and merchandising. Approximately 90% of our marketing expenses are for online advertising. Over the last twelve months, our online advertising costs, including banner advertisements and selected key words on search engines, has increased significantly and this significant increase in online advertising costs has adversely affected our business.
Affiliate Program. We attract customers by participating in affiliate programs such as BeFree that extend the reach of our websites and draw customers from a variety of other websites. By joining our affiliate program, website publishers earn volume-based commissions by directing customers to our websites. Currently, we have over 5,000 affiliate websites enrolled that actively promote our websites. Affiliates are generally compensated on a pay-for-performance basis.
Direct Marketing. We utilize an electronic direct marketing program to encourage repeat purchases, customer retention, prospect activation and referral business. This program increased substantially in the latter part of 2004 and in 2005 due to expanded functionality and a wider range of personalized offers. We utilize permission-based e-mail marketing to visitors who indicate a desire to continue to receive product recommendations and promotional discounts. We also utilize referral incentives, financing options, wish lists, birthday/anniversary event marketing and other similar programs.
Customer Service and Sales Support
An important element of our sales strategy is to provide a high level of customer service and sales support. Our highly trained sales support staff provides detailed product information and guidance, which,
together with the informative and educational aspects of our websites, promote customer confidence in their purchase decisions.
We have a customer service and sales support center staffed by, depending on the time of year, approximately 30 to 100 representatives. This center utilizes automated email and phone systems to route traffic to our customer service and sales support representatives to provide personalized assistance. This center operates seven days a week during extended business hours. Each customer service representative completes a four to six-week training program that covers best practices to provide real time assistance in purchasing brand name watches, luxury goods, diamonds and fine jewelry as well as payment alternatives and shipping services. Our customer service representatives are also trained to track and document customer inquiries and feedback, allowing us to improve the overall quality of our products and service. We contact customers to measure customer satisfaction, and periodically utilize third parties to monitor the performance of our customer service and sales support representatives.
We have a 30-day return policy on all of our brand name watches, diamonds and fine jewelry, and a 15-day return policy on all other merchandise. Most of the brand name watches that we offer do not include serial numbers, which invalidates the manufacturer’s warranty. To address potential consumer concerns, we offer our own warranty, which in many cases is of a longer duration than the manufacturer’s warranty. We also provide our watch customers with repair and battery replacement services. For our diamond customers, we provide independent certifications primarily from the Gemological Institute of America. On our websites, we display all our warranties, guarantees and policies relating to security, shipping, refunds, exchanges and special orders.
Fulfillment Operations
Our goal is to fulfill orders timely, securely and accurately. When an order is received and accepted, the merchandise is sent to assembly for packaging. In the case of selected jewelry orders, our on-site personnel perform setting and sizing. We inspect and track each product at all stages of the receiving and order fulfillment process. Customer orders are typically delivered within one to three business days, depending on the shipping method and the extent of customization required.
We ship nearly all products via nationally recognized carriers. All shipments of products for which the cost of goods shipped is over $150 are shipped at no cost to the customer and are fully insured by a third party in case of loss or theft. We assume the risk of loss or theft on shipments of products for which the cost of goods shipped is less than $100.
Our fulfillment center in Sunrise, Florida has security controls and restricted access and has been designed for the prompt receipt, storage and shipment of our products.
Technology and Systems
We have established site management, customer interaction and distribution services and systems to process customer orders and payments. These services and systems use a combination of proprietary and commercially available licensed technologies. These applications are used to:
| • | accept and validate customer orders; | |
| • | enable customer service representatives to engage in real-time, online interaction with multiple customers simultaneously; | |
| • | organize, place and manage orders with suppliers; | |
| • | receive product and assign it to customer orders; | |
| • | manage product shipments to customers based on various ordering criteria; and | |
| • | manage inventory for stock replenishment. |
Our systems are based on industry-standard architectures and have been designed to reduce downtime in the event of outages or catastrophic occurrences. We have implemented load balancing systems for the day to day operations and redundant servers to provide fault tolerant service. Our system hardware is located at our facility in Sunrise, Florida, which has redundant communications lines and emergency power backup. We also have redundant systems at a location in Boca Raton, Florida.
Seasonality
Our business has been highly seasonal, with peak sales occurring in late November and December during the holiday shopping season. The fourth quarter accounted for 35.9%, 41.2% and 43.8% of our net sales in 2005, 2004 and 2003, respectively. In anticipation of increased sales activity during the fourth quarter, we incur significant additional expenses, including customer support and jewelry assembly costs. In addition, we make merchandising and inventory decisions for the holiday season well in advance. We have also experienced relatively higher net sales in February and May relating to Valentine’s Day and Mother’s Day. Due to the seasonality of our sales, our quarterly results will fluctuate, perhaps significantly.
Competition
We face competition from both traditional and online retailers of diamonds, jewelry and luxury goods with greater brand recognition and resources, which may adversely affect our business. We currently or potentially will compete with a variety of competitors, including the following:
| • | independent and chain stores that sell jewelry, watches or other luxury goods, such as Tiffany & Co., Zales and Signet PLC’s Kay Jewelers; | |
| • | other online retailers that sell brand name watches and luxury goods, diamonds and fine jewelry, such as Amazon.com and Blue Nile; | |
| • | department stores; | |
| • | boutiques and websites operated by brand owners; | |
| • | mass retailers that sell jewelry, watches and other luxury goods; | |
| • | catalog and television shopping retailers; and | |
| • | online auction houses and closeout retailers. |
We believe that the following are the principal competitive factors in our market:
| • | product selection and availability; | |
| • | price; | |
| • | convenience; | |
| • | website recognition; | |
| • | site features and content; | |
| • | functionality and ease of use; | |
| • | order delivery performance; and | |
| • | customer service. |
The primary bases on which we compete with online and traditional retailers in the market for brand name watches and luxury products, diamonds and fine jewelry are price, merchandise selection and customer service. We believe we offer current season luxury products, brand name watches and diamonds at prices that are competitive with or lower than many of our online competitors. In addition, we offer a broader product selection of current season luxury products, diamonds and watches than many of our online competitors. We believe we currently offer luxury products and watches at more attractive prices
than many of our traditional store-based competitors. Also, due to extensive training of our customer service personnel, we believe we offer more responsive and informed customer service than many of our online and traditional store-based competitors. However, many of our current and potential competitors, particularly the traditional store-based retailers and the brand owners of products we sell, have longer operating histories, larger customer or user bases, greater brand recognition and significantly greater financial, marketing and other resources than we do. Many of these current and potential competitors can devote substantially more resources to website and systems development than we can. In addition, larger, well-established and well-financed entities may acquire, invest in or form joint ventures with online competitors.
Our competitors may be able to secure products from vendors on more favorable terms, fulfill customer orders more efficiently and adopt more aggressive pricing than we can. Traditional store-based retailers also enable customers to see and feel products in a manner that is not possible over the Internet. Given our limited operating history, many of our competitors have significantly greater experience selling luxury products. Advances in technologies, such as price comparison programs that select specific items from a variety of websites may increase competition by directing customers to other online retailers.
Intellectual Property
We rely on various intellectual property laws and contractual restrictions to protect our proprietary rights in products and services. The contractual restrictions include confidentiality and nondisclosure agreements with our employees, contractors, vendors and strategic partners. Despite these precautions, it may be possible for a third party to copy or otherwise obtain and use our intellectual property without our authorization. In addition, we pursue the registration of our trademarks and service marks in the U.S. and internationally. However, effective intellectual property protection may not be available in every country in which our products and services are made available online. We have registered the following domain names: www.diamond.com, www.ashford.com, www.worldofwatches.com, www.odimo.com, and www.diamonddepot.com. We have registered trademarks for WorldofWatches.com, diamonddepot.com, 1-888-Watches and 1-888-Diamond. Our website designs, features and images are subject to federal copyright protection. We are also developing proprietary product lines that are and will be protected by federal trademark and copyright protection.
There can be no assurance that the steps we take to protect our proprietary rights will be adequate or that third parties will not infringe or misappropriate our proprietary rights. Any such infringement or misappropriation, should it occur, could have a material adverse effect on our business, result of operations and financial condition. Furthermore, there can be no assurance that our business activities will not infringe upon the proprietary rights of others, or that other parties will not assert infringement claims against us. For example, in August 2005, we settled for a nominal amount an action against us by Gucci America, Inc. seeking an injunction and unspecified damages alleging that we sold counterfeit goods. We expect that participants in our markets will be increasingly subject to infringement claims as the number of services and competitors in our industry segment grows. Any infringement claim, with or without merit, could be time-consuming, result in costly litigation, cause service upgrade delays or require us to enter into royalty or licensing agreements. These royalty or licensing agreements might not be available on terms acceptable to us or at all. As a result, any claim of infringement against us could have a material adverse effect upon our business.
Government Regulation
Internet and E-Commerce
We are not currently subject to direct federal, state or local regulation other than regulations applicable to businesses generally and directly applicable to online commerce, as well as the secondhand watch statutes enacted in several states, as discussed below. However, as Internet use increases, it is possible that a number of laws and regulations may be adopted with respect to the Internet. These laws may cover issues such as user privacy, freedom of expression, pricing, content and quality of products and
services, taxation, advertising, intellectual property rights and information security. Furthermore, the growth of online commerce may prompt calls for more stringent consumer protection laws. Several states have proposed legislation to limit the uses of personal user information gathered online or require online services to establish privacy policies. The Federal Trade Commission has also initiated action against at least one online service regarding the manner in which personal information is collected from users and provided to third parties. We do not currently provide personal information regarding our users to third parties. However, the adoption of additional consumer protection laws could create uncertainty in web usage and reduce the demand for our products and services.
New laws or regulations may be enacted with respect to the Internet or existing laws may be applied or interpreted to apply to the Internet, which may decrease the use of the Internet or our websites or increase our costs of doing business. As use of the Internet continues to evolve, we expect that there will be an increasing number of laws and regulations pertaining to the Internet in the United States and throughout the world. Because our services are available over the Internet in multiple states and foreign countries, other jurisdictions may claim that we are required to qualify to do business in that state or foreign country. We are qualified to do business only in Florida. Our failure to qualify in a jurisdiction where we are required to do so could subject us to taxes and penalties. It could also hamper our ability to enforce contracts in these jurisdictions. The application of laws or regulations from jurisdictions whose laws do not currently apply to our business could have a material adverse effect on our business, results of operations and financial condition.
Anti-Money Laundering Program
Under the USA Patriot Act and other federal regulations, dealers in precious metals, stones and jewels are required to establish a compliance program which includes policies and procedures to detect and report suspicious transactions to the U.S. government, as well as ensure compliance with the USA Patriot Act. Dealers must also implement employee training programs, designate a special compliance officer and conduct independent audits of the effectiveness of the compliance program. To meet these requirements, we have developed and implemented a written anti-money laundering program reasonably designed to prevent Odimo from being used to facilitate money laundering or the financing of terrorist activities, designated Amerisa Kornblum, our Chief Financial Officer as our designated compliance officer, established an ongoing training program and implemented an independent testing program to ensure compliance with the regulations.
Decoded Watches
We acquire most of the brand name watches we sell in the parallel market. As a result, many of the brand name watches we sell have had their serial numbers removed (“decoded”). We have reviewed the laws of each of the 50 states, and have identified 41 states (in which net sales of decoded watches was approximately $4.6 million and $4.5 million during the years ended December 31, 2005 and 2004, respectively) that have criminal statutes that prohibit the sale or possession of certain products that have been decoded. Among these 41 states, only California, Georgia and South Dakota have statutes that specifically refer to decoded watches. Certain state statutes have exceptions for goods that are not stolen or if there is no intent to defraud, deceive or misrepresent. However, other states have statutes that do not contain these exceptions. We are not aware of any case in any jurisdiction that has convicted anyone under these statutes for the sale of decoded watches that were not stolen.
Based on our review of such statutes in these 41 states, we have determined that it is unlikely that our sales of decoded watches violate the laws in these states. This determination is subject to uncertainty because there are few reported decisions of courts interpreting these statutes, none of which involve the sale of watches. We believe, however, that the intended purpose of all of these statutes is to prevent the sale of stolen merchandise. If a court were to determine that our sale of decoded watches violates a state law, we could be subject to claims for damages, fines or other criminal penalties and be unable to continue to sell decoded watches in that state.
We have developed and implemented policies and procedures to minimize the risk of acquiring stolen merchandise. To ensure that the luxury goods and watches we purchase on the parallel markets are not stolen, we only purchase products from suppliers with whom we have a pre-existing relationship or to whom we have been referred. We purchase decoded watches from either authorized distributors or their customers, and in each case these suppliers are permitted to sell watches to retailers, including Odimo. Serial numbers are removed from the watchcase of the decoded watches we sell but not from the watch movements. However, because we acquire most of our watches through the parallel market, there is a greater risk that we may inadvertently acquire stolen merchandise than would be the case if we acquired merchandise through brand owners’ authorized distribution channels. If we acquire and resell decoded watches that were stolen, there would be a greater risk of our sales violating these state laws.
In addition to the statutes described above, seventeen states (in which net sales of decoded watches was approximately $3.6 million and $4.5 million during the years ended December 31, 2005 and 2004, respectively) have statutes that regulate the sale of decoded watches. These laws categorize decoded watches as “grey market” goods or “secondhand” watches and impose specific disclosure requirements. For example, laws in California and New York prohibit anyone from offering “grey market” goods without affixing to the product a label or tag disclosing, among other things, that the item is “secondhand” and is not covered by the manufacturer’s express written warranty, even though the item has never been used. We have implemented procedures, such as affixing a tag disclosing that the item is “secondhand”, and designed our websites to contain the requisite disclosure (i.e. no manufacturer’s warranty) to comply with the laws in these states that regulate the sale of decoded watches. However, if a court were to determine that we failed to comply with such laws in a particular state, we could be subject to claims for damages, fines or other penalties or prohibited from selling decoded watches in that state.
Employees
As of March 10, 2006, we had 113 full-time employees. Of these employees, 28 were in fulfillment operations, 13 were in technology and development, 12 were in marketing, 7 were in merchandising, 35 were in customer service and 18 were general or administrative employees. We utilize part-time and temporary employees to respond to fluctuating seasonal demand around peak holiday periods. Our employees are not covered by a collective bargaining agreement and we consider our relations with our employees to be good.
Available Information
We make available free of charge on or through our Internet website our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission. Our corporate Internet address is www.odimo.com . The information found on our website is not part of this or any other report filed with or furnished to the SEC. All of our filings with the SEC may be obtained at the SEC’s Public Reference Room. The SEC maintains an Internet site that contains reports, proxy and other information statements and other information regarding issuers that file electronically with the SEC at www.sec.gov.
Item 1A. Risk Factors
Some of the statements in this report and in particular, statements found in Management’s Discussion and Analysis of Financial Condition and Results of Operations, that are not historical in nature may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are often identified by the words “will,” “should,” “anticipate,” “believe,” “expect,” “intend,” “estimate,” “hope,” or similar expressions. These statements reflect management’s current views with respect to future events and are subject to risks and uncertainties. There are important factors that could cause actual results to differ materially from those in forward-looking statements, many of which are beyond our control. These factors, risks and uncertainties include, but are not limited to, the factors described below.
Our actual results, performance or achievement could differ materially from those expressed in, or implied by, these forward-looking statements, and accordingly, we can give no assurances that any of the events anticipated by the forward-looking statements will transpire or occur, or if any of them do so, what impact they will have on our results of operations or financial condition. In view of these uncertainties, investors are cautioned not to place undue reliance on these forward-looking statements. We expressly disclaim any obligation to publicly revise any forward-looking statements that have been made to reflect the occurrence of events after the date hereof.
You should carefully consider the risks and uncertainties described below, together with all other information included in this report, including the consolidated financial statements and the related notes herein, as well as in our other public filings, before making any investment decision regarding our stock. If any of the following risks actually occurs, our business, financial condition, results of operations and future prospects would likely be materially and adversely affected. In that event, the market price of our stock could decline and you could lose all or part of your investment.
Risks Related to Our Business and Industry
There is substantial doubt about our ability to continue as a going concern due to our cash requirements which means that we may not be able to continue operations unless we obtain additional funding.
Our independent registered public accounting firm’s report on our financial statements for the fiscal year ended December 31, 2005 includes an explanatory paragraph regarding our ability to continue as a going concern. Note 2 to the financial statements states that our ability to continue operations, meet our operational goals and pursue our long-term strategy is dependent upon our raising additional capital, which raises substantial doubt about our ability to continue as a going concern. Further, the registered public accounting firm’s report states that the financial statements do not include any adjustments that might result from the outcome of this uncertainty.
We have incurred operating losses since our inception and anticipate incurring operating losses at least through 2006. We need additional capital to meet our future cash requirements and execute our business strategy.
We have incurred operating losses since our inception in 1998 and anticipate incurring operating losses at least through 2006. As of December 31, 2005, our accumulated deficit was $92.4 million, including a net loss of approximately $23.5 million and $12.5 million for the years ended December 31, 2005 and 2004, respectively. Our ability to become profitable depends on our ability to generate and sustain substantially higher net sales that exceed historical levels while maintaining reasonable expense levels. Since our inception, we have incurred significant operating expenses and capital expenditures for technology, website development, advertising, personnel and other operating costs. During the next 12 months, we expect to incur approximately $10 million of costs and capital expenditures related to:
| • | marketing, advertising and other promotional activities; | |
| • | the expansion of our fulfillment operations, which includes supply procurement, inventory management, order receipt, packaging and shipment; and | |
| • | the continued development of our websites and our computer network. |
We currently need additional capital to meet our future cash requirements and execute our business strategy. If we don’t raise funds on acceptable terms or complete an alternative transaction, we may not be able to continue our operations. Financing may not be available on acceptable terms, or at all. Additional financing, if available, may be dilutive to the holders of our common stock and involve significant cash payment obligations and covenants and/or financial ratios that restrict our ability to operate our business.
Even if we do achieve profitability, we cannot be certain that we would be able to sustain or increase profitability on a quarterly or annual basis in the future or that we will meet our capital requirements. If we are unable to achieve or sustain profitability, or meet our capital requirements, we will continue to need
additional capital, and may continue to be dependent upon debt or equity financing for funds to meet our cash requirements, and our stock price could suffer.
In order to decrease our losses, we must attract customers in a cost-effective manner.
Our success depends upon our attracting customers in a cost-effective manner. We rely on relationships with, among others, online service providers, search engines, directories and other websites to direct traffic to our websites. The costs for these relationships has substantially increased over the last 12 months and the continued increase in such costs will lead us to not attract customers in a cost-effective manner which, in turn, will adversely impact our business.
Because we do not have a predictable or guaranteed supply of merchandise, we may lose customers and sales if we are unable to meet our customers’ demand for particular products.
We do not have any written agreements or formal arrangements to acquire merchandise. As a result, we do not have a predictable or guaranteed supply of merchandise. The availability of these products depends on many factors, including consumer demand, brand owner pricing and distribution practices, manufacturer production and fashion trends. If we are unable to acquire a sufficient supply and selection of products in a timely manner at competitive prices, we may lose customers and our sales could decline.
We acquire most of the brand name watches and luxury goods we sell through the parallel market, or grey market as it is also called, which increases the risk that we may inadvertently sell counterfeit or stolen goods or merchandise which is physically materially different from merchandise acquired from channels authorized by the brand owners, which could expose us to liability for intellectual property infringement claims and damage our reputation.
Approximately 35% and 44% of our net sales (70% and 77% of our net sales excluding diamonds and fine jewelry) during the years ended December 31, 2005 and 2004, respectively, were generated from sales of merchandise that we did not acquire directly from the brand owners or their authorized distributors. These alternative distribution channels are commonly referred to as the “parallel market” or the “grey market.” Merchandise purchased from these alternative distribution channels includes authentic trademarked and copyrighted products that are intended for sale in foreign countries. In addition to our own compliance and quality testing procedures, we rely on assurances from our suppliers as to the authenticity of these products to ensure that products we receive are genuine. Our purchase of merchandise in the parallel market increases the risk that we will mistakenly purchase and sell counterfeit goods, stolen goods or merchandise which is physically materially different from merchandise acquired from channels authorized by the brand owners. We may have difficulty demonstrating that the merchandise we sell is authentic because many of the distributors and other intermediaries from whom we purchase merchandise may be unwilling to disclose their suppliers. If we sell goods that are counterfeit, stolen or are determined to be physically materially different, we may be subject to significant liability for infringement of trademarks, incur legal defense costs and suffer damage to our reputation and decreased sales.
We have received in the past, and anticipate that we will receive in the future, communications from brand owners alleging that certain items sold through our websites infringe on such brand owners’ trademarks, patents, copyrights and other intellectual property rights. We may be subject to lawsuits by brand owners and their authorized distributors based on allegations that we sell physically materially different merchandise, counterfeit goods or stolen goods. For example, in August 2005, we settled for a nominal amount an action filed against us in U.S. District Court, Southern District of Florida, by Gucci America Inc. seeking an injunction and unspecified damages alleging that we sold counterfeit goods. Claims by brand owners, with or without merit, could be time consuming, result in costly litigation, generate bad publicity for us, or subject us to large claims for damages.
If brand owners take action to limit or prevent us from acquiring their products in the parallel market, we may not be able to find alternative sources of supply for such products at satisfactory prices or at all, which would result in reduced sales.
Some brand owners such as Rolex and Raymond Weil have implemented, and are likely to continue to implement, procedures to limit the ability of third parties, including Odimo, to purchase products through the parallel market by designating an exclusive legal importer of their brands into the United States. In the event we acquire such products from distributors and other intermediaries who may not have complied with applicable laws and regulations, such goods may be subject to seizure from our inventory by the U.S. Customs Service, and the brand owner may have a civil action for damages against us. Such limitations or controls could affect our ability to obtain products at satisfactory prices, or at all. When we are aware of these policies we do not sell such brand names. However, we do not contact brand owners to determine whether such restrictions exist prior to purchasing these goods from our suppliers. If more brand owners adopt such a policy, the number of products we are able to sell will decrease. Brand owners may also decide to more closely monitor their distribution chain, to prevent their authorized distributors from selling goods in the parallel markets.
Courts could find that we have tortiously interfered with contractual arrangements between a brand owner and its authorized wholesalers and retailers where those contractual arrangements restrict authorized wholesalers and retailers from selling to entities, such as Odimo, that will resell the products. In addition, United States copyright law may prohibit importation of genuine goods without the brand owner’s permission when the goods are packaged together with goods that are protected by a United States copyright such as the nonmechanical design features of watches, artistic features of home accessories and the package design of fragrances we sell.
If it is determined that our sales of decoded watches violate state laws, we would be subject to claims for damages, fines or other penalties or be unable to sell decoded watches in such states.
Many of the brand name watches we sell have had their serial numbers removed (“decoded”). We have reviewed the laws of each of the 50 states, and have identified 41 states that have statutes that prohibit the sale or possession of certain products that have been decoded. Among the 41 states, only California, Georgia and South Dakota have statutes that specifically refer to decoded watches. In 11 states (in which our net sales of decoded watches were approximately $910,000 and $1.2 million during the years ended December 31, 2005 and 2004, respectively), the statutes contain exceptions for products that have not been stolen or if there was no intent to defraud, deceive or misrepresent. However, in 30 states (in which our aggregate net sales of decoded watches were approximately $3.5 million and $4.6 million during the years ended December 31, 2005 and 2004, respectively), including California, Georgia and South Dakota, the statutes do not contain these exceptions. As a result, there is uncertainty as to whether these laws apply to sales of decoded watches if the goods are not stolen or if there is no intent to defraud, deceive or misrepresent. In addition, if we inadvertently purchase stolen watches, we may be unable to rely on these exceptions. We do not engage in the same in-house compliance and quality testing procedures for watches as we do for our other merchandise. The only procedures we follow to ensure that the watches we purchase are not stolen are that we purchase in significant quantities and we purchase watches only from suppliers with whom we have a pre-existing relationship or to whom we have been referred. Accordingly, we face increased risk that the watches we buy may be stolen or counterfeit because we do not have access to source documentation for our watches. If a court were to determine that our sales of decoded watches violate the laws of any state, we would be subject to claims for damages, and fines or other penalties, and we would be unable to continue to sell decoded watches in that state. We derived approximately $5.0 million and $6.3 million of net sales from decoded watches during the years ended December 31, 2005 and 2004, respectively, which represented approximately 26% and 30% of our net sales of watches and approximately 10% and 12% of our total net sales during the years ended December 31, 2005 and 2004, respectively.
In addition to the statutes described above, seventeen states (in which net sales of decoded watches was approximately $3.6 million and $4.5 million during the years ended December 31, 2005 and 2004,
respectively) have statutes that regulate the sale of decoded watches. These laws categorize decoded watches as “grey market” goods or “secondhand” watches and impose specific disclosure requirements. For example, laws in California and New York prohibit anyone from offering “grey market” goods without affixing to the product a label or tag disclosing, among other things, that the item is “secondhand” and is not covered by the manufacturer’s express written warranty, even though the item has never been used. We have recently implemented procedures, such as affixing a tag disclosing that the item is “secondhand”, and designed our websites to contain the requisite disclosure (i.e. no manufacturer’s warranty) to comply with the laws in these states that regulate the sale of decoded watches. However, if a court were to determine that we failed to comply with such laws in a particular state, we could be subject to claims for damages, fines or other penalties or prohibited from selling decoded watches in that state.
If we fail to identify and rapidly respond to fashion trends, we may be forced to absorb excess inventory or lower the sales prices for our goods.
The fashion industry is subject to rapidly changing trends and shifting consumer demand. Accordingly, our success depends on the priority that our target customers place on fashion and our ability to anticipate, identify and capitalize upon emerging fashion trends. Our failure to anticipate, identify or react appropriately to changes in styles or trends could lead to, among other things, excess inventories and markdowns, as well as decreased appeal of our merchandise.
Our net sales and operating results are volatile and difficult to predict, which may adversely affect the trading price of our common stock.
Our net sales and operating results have historically fluctuated significantly from quarter to quarter and we expect they will continue to fluctuate significantly in the future. Because our net sales and operating results are volatile and difficult to predict, we believe that quarterly comparisons of our net sales and results of operations are not necessarily meaningful and you should not rely on the results of one quarter as an indication of our future performance.
Competition from traditional and online retail companies with greater brand recognition and resources may adversely affect our sales.
The retail industry is intensely competitive, and we expect competition in the sale of brand name watches and luxury goods, diamonds and fine jewelry to increase in the future. Increased competition may result in decreased net sales, lower margins, loss of market share or increased marketing expenditures, any of which could substantially harm our business, financial condition and results of operations. Our competitors include:
| • | independent and chain stores that sell jewelry, watches or other luxury products, such as Tiffany & Co., Zales and Signet PLC’s Kay Jewelers; | |
| • | other online retailers that sell diamonds, fine jewelry, brand name watches and/or luxury products, such as Amazon.com and Blue Nile; | |
| • | department stores; | |
| • | boutiques and websites operated by brand owners; | |
| • | mass retailers and warehouse clubs that sell jewelry, watches or other luxury products; | |
| • | catalog and television shopping retailers; and | |
| • | online auction houses and closeout retailers. |
Competition in the e-commerce market may intensify, because the Internet lowers the barriers to entry and facilitates comparison-shopping. In addition, manufacturers and brand owners may create their own websites to sell their own merchandise. Many of our current and potential competitors have greater brand recognition, longer operating histories, more extensive customer bases, broader product and service
offerings and greater resources for marketing, research and product development, strategic acquisitions, alliances and joint ventures than we do. As a result, these competitors may be able to secure merchandise from suppliers on more favorable terms, and may be able to adopt more aggressive pricing policies.
If our advertising relationships with Internet portals and other websites fail to create consumer awareness of our websites and product offerings, our sales may suffer.
Substantially all of our sales come from customers who link to our websites from websites operated by other online retailers or Internet portals with whom we advertise. Establishing and maintaining relationships with leading Internet portals and other online retailers through our affiliate program is competitive and expensive. During the years ended December 31, 2005 and 2004, we spent $7.6 million and $6.6 million, respectively, on online advertising, affiliate programs and public relations. We do not maintain long-term contracts or arrangements with Internet portals, and we may not successfully enter into additional relationships or renew existing ones beyond their current terms. We expect that we will have to pay increasing fees to maintain, expand or enter into new relationships of this type. In addition, traffic to our websites could decline if our Internet portal and online marketing programs become less effective or if the traffic to the website of an Internet portal on which we advertise decreases. Our business could be materially adversely affected if any of our online advertisers experience financial or operational difficulties or if they experience other corporate developments that adversely affect their performance. A failure to maintain, expand or enter into Internet portal 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.
If online advertising rates continue to rise, we may purchase less advertising and our sales could decrease.
Approximately 90% of our marketing expenses are for online advertising. Over the last 12 months, online advertising rates, including banner advertisements and selected key words on search engines, have significantly increased and our business has been adversely affected. Online advertising costs accounted for 14.7% and 12.7% of our net sales for the years ended December 31, 2005 and 2004, respectively. If the costs of online advertising continue to rise, our ability to purchase online advertising may be limited, which in turn could have an adverse effect on our sales.
Because we carry almost all of our brand name watches, jewelry and luxury goods in inventory, if we are unable to accurately predict and plan for changes in consumer demand, our net sales and gross margins may decrease.
We held approximately $6.1 million and $8.8 million of brand name watches, fine jewelry and luxury goods in inventory as of December 31, 2005 and 2004, respectively. If our sales levels increase, we will increase our inventory proportionately. Consumer tastes and preferences for luxury products can change rapidly, thus exposing us to significant inventory risks. The demand for specific products can change between the time the products are ordered and the date of receipt. We do not have return privileges with respect to all of our inventory (other than diamonds). As a result, if we do not accurately predict these trends or if we overstock unpopular products, we may be required to take significant inventory markdowns, which could reduce our net sales and gross margins. We are particularly exposed to this risk in the first quarter of each year because we derive a disproportionately large amount of our annual net sales in the fourth quarter, and maintain significantly increased inventory levels for the holiday selling season.
Our operating results are subject to seasonal fluctuations, and adverse results in our fourth quarter will have a disproportionate impact on our results of operations for the year.
We have experienced, and expect to continue to experience, seasonal fluctuations in our net sales, with a disproportionate amount of our net sales realized during the fourth quarter ending December 31, as a result of the holiday buying season. Over 35.9%, 41.2% and 43.8% of our net sales in the years ended December 31, 2005, 2004 and 2003, respectively, were generated during the fourth quarter. If we were to
experience lower than expected net sales during any fourth quarter, it would have a disproportionately large impact on our operating results and financial condition for that year. Also, in anticipation of increased sales activity during the fourth quarter, we increase our inventories and staffing in our fulfillment and customer support operations and incur other additional expenses, which may have a negative effect on our cash flow.
We are dependent on Alan Lipton, our Chief Executive Officer and President, and other members of our management team. The loss of any of them could harm our business.
Our performance is substantially dependent upon the services and performance of our senior management team: Alan Lipton, our Chief Executive Officer and President, Jeffrey Kornblum, our Chief Operating Officer, Amerisa Kornblum, our Chief Financial Officer, Secretary and Treasurer, and George Grous, our Chief Technology Officer. We have employment agreements with each of these four key employees, with terms through July 2007. All members of our management team may terminate their employment with us at any time. The loss of the services of any of our senior management team or certain of our key employees for any reason could adversely affect our operations or otherwise have a material adverse effect on our business.
We may not be able to increase capacity or respond to rapid technological changes in a timely manner or without service interruptions, which may cause customer dissatisfaction.
A key element of our strategy is to generate a high volume of traffic on our websites. Our servers and communication systems operate at between 20% and 90% of capacity, depending on the time of year and current promotions and advertising levels. Over the past year, we have experienced server and communication interruptions for periods of routine maintenance and systems upgrades. As traffic on our websites grows, we may not be able to accommodate all of the growth in user demand on our websites and in our customer service center. If we are unable to upgrade our existing technology or network infrastructure and the systems used to process customers’ orders and payments to accommodate increased sales volume, our potential customers may be dissatisfied and may purchase merchandise from our competitors. We may also fail to provide enough capacity in our customer service center to answer phones or provide adequate customer service. A failure to implement new systems and increase customer service center capacity effectively or within a reasonable period of time could adversely affect our sales.
We also intend to introduce additional or enhanced features and services to retain current customers and attract new customers to our websites. If we introduce a feature or a service that is not favorably received, our current customers may not use our websites as frequently and we may not be successful in attracting new customers. We may also experience difficulties that could delay or prevent us from introducing new services and features. These new services or features may contain errors that are discovered only after they are introduced and we may need to significantly modify the design of these services or features to correct these errors. If customers encounter difficulty with or do not accept new services or features, they may decide to purchase instead from one of our competitors, decreasing our sales.
Our costs have increased because we are a public company.
As a public company, we have incurred and will continue to incur significant legal, accounting and other expenses that we did not incur as a private company. In 2005, these expenses were approximately $1.5 million. We expect these expenses to be between $1.0 million and $2.0 million annually. We will incur costs associated with our public company reporting requirements. We also anticipate that we will incur costs associated with recently adopted corporate governance requirements, including requirements under the Sarbanes-Oxley Act of 2002, as well as new rules implemented by the SEC and Nasdaq National Market. We expect these rules and regulations to increase our legal and financial compliance costs and to make some activities more time-consuming and costly.
In addition, we will have to hire additional personnel to assist us in complying with these requirements. If we are unable to attract and retain such personnel, we may have difficulty satisfying the
periodic reporting and disclosure obligations of public companies. We also expect these new rules and regulations may make it more difficult and more expensive for us to obtain director and officer liability insurance and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. As a result, it may be more difficult for us to attract and retain qualified individuals to serve on our board of directors or as executive officers. If we fail to comply with the requirements applicable to public companies, we may incur fines or penalties, and may be subject to enforcement action by the SEC or delisting from the Nasdaq National Market.
All of our operations are located at our Sunrise, Florida facility, and disruptions at this facility could prevent us from receiving orders or fulfilling orders for our customers in a timely manner.
Our operations are located at a leased facility in Sunrise, Florida. Our ability to fulfill customer orders through our Sunrise facility in a timely manner, or at all, could be affected by a number of factors, including any disruption of our computer or communications systems, an employee strike or other labor stoppage, a disruption in the transportation infrastructure or hurricanes or other natural disasters. If we are unable to fulfill our customers’ orders through the Sunrise facility, we may not be able to quickly secure a replacement distribution facility on terms acceptable to us or at all. Our computer and communications systems are particularly vulnerable to power loss, telecommunications failure, general Internet failure or failures of Internet service providers, human error, computer viruses and physical or electronic break-ins. Any of these events could lead to system damage or interruptions, delays and loss of critical data, and make our websites or customer service center inaccessible to our customers or prevent us from efficiently fulfilling orders. For example, in October 2005, our computer and communication systems were impaired for 7 days as a result of Hurricane Wilma. Frequent or long service delays or interruptions in our service or disruptions during a peak holiday season will reduce our net sales and profits, and damage our reputation. Future net sales and profits will be harmed if our customers believe that our system is unreliable.
The availability and price of diamonds are significantly influenced by a small number of diamond mining firms as well as the political situation in diamond-producing countries. A decrease in the availability or an increase in the price of diamonds may make it difficult for us to procure enough diamonds at competitive prices to supply our customers.
The supply and price of rough (uncut and unpolished) diamonds in the principal world markets have been and continue to be significantly influenced by a small number of diamond mining firms. As a result, any decisions made to restrict the supply of rough diamonds by these diamond mining firms to our suppliers could substantially impair our ability to acquire diamonds at reasonable prices. We do not currently have any direct supply relationships with these diamond mining firms, nor do we expect to pursue such a relationship. The availability and price of diamonds to our suppliers may fluctuate depending on the political situation in diamond-producing countries. Sustained interruption in the supply of rough diamonds, an overabundance of supply or a substantial change in the relationship between the major mining firms and our suppliers could adversely affect us. Our recent experience suggests that the price of rough diamonds is increasing. A failure to secure diamonds at reasonable commercial prices and in sufficient quantities would lower our revenues and adversely impact our results of operations. In addition, increases in the price of diamonds may adversely affect consumer demand, which could cause a decline in our net sales.
Increases in the cost of precious metals and precious and semi-precious stones would increase the cost of our jewelry products, which could result in reduced margins or increased prices and reduced sales of such products.
The jewelry industry in general is affected by fluctuations in the prices of precious metals and precious and semi-precious stones. The availability and prices of gold, silver and 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 a rise in their price could result in reduced margins or increased prices causing reduced sales of such products.
Increased product returns and the failure to accurately predict product returns could reduce our gross margins and result in excess inventory.
We offer our customers a 15- or 30-day return policy that allows our customers to return most products if they are not satisfied for any reason. We make allowances for product returns in our financial statements based on historical return rates. Actual merchandise returns are difficult to predict and may significantly exceed our allowances. Any significant increase in merchandise returns above our allowances would reduce our gross margins and could result in excess inventory or inventory write-downs. Once a product is purchased from the parallel market and has been inspected and accepted by us, we cannot return the product to our supplier.
If we attain specified levels of financial performance, we are obligated to make earn-out payments to one of our stockholders.
If and to the extent that our net income before income taxes, interest income and expense, depreciation expense, amortization expense, and other non-cash expenses (as defined in the agreement with GSI Commerce, Inc.) is positive during the 2006 and 2007 fiscal years, we will be obligated to make a payment to GSI Commerce, Inc., the entity from which we purchased the www.ashford.com domain name in December 2002, equal to 10% of such amount for such year, up to a maximum aggregate amount of $2.0 million. This payment is tied to income derived from our entire business, not just from our www.ashford.com website.
Other online retailers may use domain names that are similar to ours. If customers associate these websites with us, our brands may be harmed and we may lose sales.
Our Internet domain names are an important aspect of our business. Under current domain name registration practices, no one else can obtain an identical domain name, but they 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. For example, we do not own the domain name “www.diamonds.com” or “www.diamonds-usa.com.” As a result, third parties may use domain names that are similar to ours, which may result in confusion of potential customers, impairment of the value of our brands and lost sales.
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 our future earnings, if any, to fund our growth. Therefore, you likely will not receive any dividends from us on our common stock for the foreseeable future.
Legal claims against us could be costly and result in substantial liabilities or the loss of significant rights.
We are currently a party to a proceeding with an uncertain outcome, which could result in significant judgments against us. In January 2006, we were served with a complaint which was a consolidation of two previously served complaints. The complaint names the Company, Alan Lipton, and Amerisa Kornblum as defendants and is pending in the Circuit Court of the 17th Judicial Circuit in and for Broward County, Florida on behalf of a purported class of purchasers of our common stock in or traceable to our initial public offering. The complaint generally alleges that we and the other defendants violated Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 due to allegedly false and misleading statements in public disclosures in connection with our initial public offering regarding the impact to our operations of advertising expenses. We believe that the lawsuits are without merit and intend to vigorously defend
ourselves. We and the individual defendants have filed a motion to dismiss to the complaint which has not yet been heard. We are currently unable to predict the outcome of the actions or the length of time it will take to resolve the actions.
Risks Relating to Doing Business on the Internet
If we are required to collect sales and use taxes on the products we sell in jurisdictions outside of Florida, we may be subject to liability for past sales and our future sales may decrease.
In accordance with current industry practice and our interpretation of current law, we do not currently collect sales and use taxes or other taxes with respect to shipments of goods into states other than Florida. However, one or more states or foreign countries may seek to impose sales or other tax collection 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 or otherwise substantially harm our business, financial condition and results of operations.
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, the Children’s Online Privacy Protection Act, the Fair Credit Reporting Act and related regulations as well as other legal provisions. Several states have proposed legislation that would limit the use of personal information gathered online or require online services to establish privacy policies. These regulations and other laws, rules and regulations enacted in the future, may adversely affect our ability to collect and disseminate or share demographic and personal information from users and our ability to email or telephone users, which could be costly and adversely affect our marketing efforts.
Consumers may prefer to purchase brand name watches and luxury goods, diamonds and fine jewelry from traditional retailers, which would adversely affect our sales.
The online market for brand name watches and luxury goods, diamonds and fine jewelry is significantly less developed than the online market for books, music, toys and other consumer products. Our success will depend in part on our ability to attract consumers who have historically purchased brand name watches and luxury goods, diamonds and fine jewelry through traditional retailers. We may have difficulty attracting additional consumers to purchase products on our websites for a variety of reasons, including:
| • | concerns about buying expensive products without a physical storefront, face-to-face interaction with sales personnel and the ability to physically handle and examine products; | |
| • | concerns over counterfeit or substandard goods; | |
| • | delivery times associated with Internet orders; | |
| • | product offerings that do not reflect consumer tastes and preferences; | |
| • | pricing that does not meet consumer expectations; | |
| • | concerns about the security of online transactions and the privacy of personal information; | |
| • | delayed shipments, theft or shipments of incorrect or damaged products; and | |
| • | inconvenience associated with returning or exchanging purchased items. |
If the Internet infrastructure fails to grow or deteriorates, our ability to grow our business will be impaired.
Our success will depend on the continued growth and maintenance of the Internet infrastructure. This includes maintenance of a reliable network infrastructure with the necessary speed, data capacity and security for providing reliable Internet services. Viruses, worms and similar programs also harm the performance of the Internet. 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 as well as our ability to provide our solutions.
Risks Related to the Securities Markets and Ownership of Our Common Stock
Our stock price has been and may continue to be volatile.
The market price for our common stock has been and is likely to continue to be volatile. In addition, the market price of our common stock may fluctuate significantly in response to a number of factors, most of which we cannot control, including:
| • | actual or anticipated fluctuations in our results of operations; | |
| • | variance in our financial performance from the expectations of market analysts; | |
| • | developments with respect to intellectual property rights; | |
| • | announcements by us or our competitors of new product and service offerings, significant contracts, acquisitions or strategic relationships; | |
| • | our involvement in litigation; | |
| • | our sale of common stock or other securities in the future; | |
| • | market conditions in our industry; | |
| • | recruitment or departure of key personnel; | |
| • | changes in market valuation or earnings of our competitors; | |
| • | the trading volume of our common stock; | |
| • | changes in the estimation of the future size and growth rate of our markets; and | |
| • | general economic or market conditions and other factors, including factors unrelated to our operating performance or the operating performance of our competitors. |
Future sales of our common stock may cause our stock price to decline.
A small number of our current stockholders hold a substantial number of shares of our common stock. Shares held by our officers, directors and principal stockholders will be considered “restricted securities” within the meaning of Rule 144 under the Securities Act and, are eligible for resale subject to the volume, manner of sale, holding period and other limitations of Rule 144.
Sales of a substantial number of shares, or the expectation that such sale may occur, could significantly reduce the market price of our common stock. Moreover, the holders of a substantial number of our shares of common stock have rights to require us to file registration statements to permit the resale of their shares in the public market or to include their shares in registration statements that we may file for ourselves or other stockholders. We also have registered all common stock that we may issue under our stock incentive plan. Accordingly, these shares, when registered, can be freely sold in the public market upon issuance, subject to restrictions under the securities laws. If any of these stockholders cause a large number of securities to be sold in the public market, the sales could reduce the trading price of our common stock. These sales also could impede our ability to raise future capital.
Our common stock has been publicly traded for a short time and an active trading market may not be sustained.
Although we are currently listed for trading on the Nasdaq National Market, our stock has been thinly traded and an active trading market for our common stock may never be sustained. An inactive market may impair your ability to sell shares at the time you wish to sell them or at a price that you consider reasonable. Furthermore, an inactive market may impair our ability to raise capital by selling shares and may impair our ability to acquire other businesses, products and technologies by using our shares as consideration.
Anti-takeover provisions in our organizational documents and Delaware law may discourage or prevent a change in control, even if an acquisition would be beneficial to our stockholders, which could affect our stock price adversely and prevent attempts by our stockholders to replace or remove our current management.
Our restated certificate of incorporation and restated bylaws contain provisions that may delay or prevent a change in control, discourage bids at a premium over the market price of our common stock and adversely affect the market price of our common stock and the voting and other rights of the holders of our common stock. These provisions include:
| • | Our board of directors has the exclusive right to elect directors to fill a vacancy created by the expansion of the board of directors or the resignation, death or removal of a director, which prevents stockholders from being able to fill vacancies on our board of directors. | |
| • | Our stockholders may not act by written consent. As a result, a holder or holders controlling a majority of our capital stock would be able to take certain actions only at a stockholders’ meeting. | |
| • | No stockholder may call a special meeting of stockholders. This may make it more difficult for stockholders to take certain actions. | |
| • | Our stockholders may not remove a director without cause, and our certificate of incorporation provides for a classified board of directors with staggered, three-year terms. As a result, it could take up to three years for stockholders to replace the entire board. | |
| • | Our certificate of incorporation does not provide for cumulative voting in the election of directors. This limits the ability of minority stockholders to elect director candidates. | |
| • | Stockholders must provide advance notice to nominate individuals for election to the board of directors or to propose matters that can be acted upon at a stockholders’ meeting. These provisions may discourage or deter a potential acquirer from conducting a solicitation of proxies to elect the acquirer’s own slate of directors or otherwise attempting to obtain control of our company. | |
| • | Our board of directors may issue, without stockholder approval, shares of undesignated preferred stock. The ability to authorize undesignated preferred stock makes it possible for our board of directors to issue preferred stock with voting or other rights or preferences that could impede the success of any attempt to acquire us. |
As a Delaware corporation, we are also subject to certain Delaware anti-takeover provisions. Under Delaware law, a corporation may not engage in a business combination with any holder of 15% or more of its capital stock unless the holder has held the stock for three years or, among other things, the board of directors has approved the transaction. Our board of directors could rely on Delaware law to prevent or delay an acquisition of us.
If our officers, directors and principal stockholders choose to act together, they may be able to control our management and operations, acting in their best interests and not in the best interests of other stockholders.
Our officers, directors and holders of 5% or more of our outstanding common stock beneficially own the majority of our outstanding common stock. As a result, these stockholders, acting together, will be able to significantly influence all matters requiring approval by our stockholders, including the election of directors and the approval of mergers or other business combination transactions. The interests of this group of stockholders may not always coincide with our interests or the interests of other stockholders, and they may act in a manner that advances their best interests and not necessarily those of other stockholders. As a result of their actions or inactions our stock price may decline.
Item 1B. Unresolved Staff Comments
None.
