| BLUE NILE INC Item 1A Risk Factors You should carefully consider the risks described below and elsewhere in this report, which could materially and adversely affect our business, results of operations or financial condition |
| In those cases, the trading price of our common stock could decline and you may lose all or part of your investment |
| Our limited operating history makes it difficult for us to accurately forecast net sales and appropriately plan our expenses |
| We were incorporated in March 1999 and have a limited operating history |
| As a result, it is difficult to accurately forecast our net sales and plan our operating expenses |
| We base our current and future expense levels on our operating forecasts and estimates of future net sales |
| Net sales and operating results are difficult to forecast because they generally depend on the volume and timing of the orders we receive, which are uncertain |
| Some of our expenses are fixed, and, as a result, we may be unable to adjust our spending in a timely manner to compensate for any unexpected shortfall in net sales |
| We also make certain assumptions when forecasting the amount of expense we expect related to our stock-based compensation, which are partly based on historical results |
| If actual results differ from our estimates, our net income in a given quarter may be lower than expected |
| 7 _________________________________________________________________ [58]Table of Contents We expect our quarterly financial results to fluctuate, which may lead to volatility in our stock price |
| We expect our net sales and operating results to vary significantly from quarter to quarter due to a number of factors, including changes in: • demand for our products; • the costs to acquire diamonds and precious metals; • our ability to attract visitors to our websites and convert those visitors into customers; • our ability to retain existing customers or encourage repeat purchases; • our ability to manage our product mix and inventory; • wholesale diamond prices; • consumer tastes and preferences for diamonds and fine jewelry; • our ability to manage our operations; • advertising and other marketing costs; • our, or our competitors’, pricing and marketing strategies; • general economic conditions; • conditions or trends in the diamond and fine jewelry industry; • conditions or trends in the Internet and e-commerce industry; and • costs of expanding or enhancing our technology or websites |
| As a result of the variability of these and other factors, our operating results in future quarters may be below the expectations of public market analysts and investors |
| In this event, the price of our common stock may decline |
| As a result of seasonal fluctuations in our net sales, our quarterly results may fluctuate and could be below expectations |
| We have experienced and expect to continue to experience seasonal fluctuations in our net sales |
| In particular, a disproportionate amount of our net sales has been realized during the fourth quarter as a result of the December holiday season, and we expect this seasonality to continue in the future |
| Approximately 36prca, 38prca and 38prca of our net sales in 2005, 2004 and 2003, respectively, were generated during the fourth quarter |
| In anticipation of increased sales activity during the fourth quarter, we may incur significant additional expenses, including higher inventory of jewelry and additional staffing in our fulfillment and customer support operations |
| If we were to experience lower than expected net sales during any future fourth quarter, it would have a disproportionately large impact on our operating results and financial condition for that year |
| We also experience considerable fluctuations in net sales in periods preceding other annual occasions such as Valentine’s Day and Mother’s Day |
| In the future, our seasonal sales patterns may become more pronounced, may strain our personnel and fulfillment activities and may cause a shortfall in net sales as compared to expenses in a given period, which would substantially harm our business and results of operations |
| Our failure to acquire quality diamonds and fine jewelry at commercially reasonable prices would result in higher costs and lower net sales and damage our competitive position |
| If we are unable to acquire quality diamonds and fine jewelry at commercially reasonable prices, our costs may exceed our forecasts, our gross margins and operating results may suffer and our competitive position could be damaged |
| The success of our business model depends, in part, on our ability to offer quality product to customers at prices that are below those of traditional jewelry retailers |
| A majority of the world’s supply of rough diamonds is controlled by a small number of diamond mining firms |
| As a 8 _________________________________________________________________ [59]Table of Contents result, any decisions made to restrict the supply of rough diamonds by these firms to our suppliers could substantially impair our ability to acquire diamonds at commercially reasonable prices, if at all |
| We do not currently have any direct supply relationship with these firms nor do we expect to enter into any such relationship in the foreseeable future |
| Our ability to acquire diamonds and fine jewelry is also substantially dependent on our relationships with various suppliers |
| Approximately 25prca, 25prca and 36prca of our payments to our diamond and fine jewelry suppliers in 2005, 2004 and 2003, respectively, were made to our top three suppliers |
| Our inability to maintain and expand these and other future diamond and fine jewelry supply relationships on commercially reasonable terms or the inability of our current and future suppliers to maintain arrangements for the supply of products sold to us on commercially reasonable terms would substantially harm our business and results of operations |
| Suppliers and manufacturers of diamonds as well as retailers of diamonds and diamond jewelry are vertically integrated and we expect they will continue to vertically integrate their operations either by developing retail channels for the products they manufacture or acquiring sources of supply, including, without limitation, diamond mining operations for the products that they sell |
| To the extent such vertical integration efforts are successful, some of the fragmentation in the existing diamond supply chain could be eliminated and our ability to obtain an adequate supply of diamonds and fine jewelry from multiple sources could be limited and our competitors may be able to obtain diamonds at lower prices |
| Our failure to meet customer expectations with respect to price would adversely affect our business and results of operations |
| Changes in our pricing strategies have had and may continue to have a significant impact on our net sales, gross margins and net income |
| In the past, we have instituted retail price reductions as part of our strategy to stimulate growth in net sales and optimize gross profit |
| We may institute similar price reductions in the future |
| Such price reductions may not result in an increase in net sales or in the optimization of gross profits |
| In addition, many external factors, including the costs to acquire diamonds and precious metals and our competitors’ pricing and marketing strategies, can significantly impact our pricing strategies |
| If we fail to meet customer expectations with respect to price in any given period, our business and results of operations would suffer |
| Purchasers of diamonds and fine jewelry may not choose to shop online, which would prevent us from increasing net sales |
| The online market for diamonds and fine jewelry is significantly less developed than the online market for books, music, toys and other consumer products |
| If this market does not gain widespread acceptance, our business may suffer |
| Our success will depend, in part, on our ability to attract consumers who have historically purchased diamonds and fine jewelry through traditional retailers |
| Furthermore, we may have to incur significantly higher and more sustained advertising and promotional expenditures or price our products more competitively than we currently anticipate in order to attract additional online consumers to our websites and convert them into purchasing customers |
| Specific factors that could prevent consumers from purchasing diamonds and fine jewelry from us include: • concerns about buying luxury products such as diamonds and fine jewelry without a physical storefront, face-to-face interaction with sales personnel and the ability to physically handle and examine products; • delivery time 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 or shipments of incorrect or damaged products; and • inconvenience associated with returning or exchanging purchased items |
| 9 _________________________________________________________________ [60]Table of Contents We may not succeed in continuing to establish the Blue Nile brand, which would prevent us from acquiring customers and increasing our net sales |
| A significant component of our business strategy is the continued establishment and promotion of the Blue Nile brand |
| Due to the competitive nature of the online market for diamonds and fine jewelry, if we do not continue to establish our brand and branded products, we may fail to build the critical mass of customers required to substantially increase our net sales |
| Promoting and positioning our brand will depend largely on the success of our marketing and merchandising efforts and our ability to provide a consistent, high quality customer experience |
| To promote our brand and branded products, we have incurred and will continue to incur substantial expense related to advertising and other marketing efforts |
| A critical component of our brand promotion strategy is establishing a relationship of trust with our customers, which we believe can be achieved by providing a high quality customer experience |
| In order to provide a high quality customer experience, we have invested and will continue to invest substantial amounts of resources in our website development and functionality, fulfillment operations and customer service operations |
| Our ability to provide a high quality customer experience is also dependent, in large part, on external factors over which we may have little or no control, including, without limitation, the reliability and performance of our suppliers, third-party jewelry assemblers, third-party carriers and networking vendors |
| During our peak seasons, we rely on temporary employees to supplement our full-time customer service and fulfillment employees |
| Temporary employees may not have the same level of commitment to our customers as our full-time employees |
| If our customers are dissatisfied with the quality of the products or the customer service they receive, or if we are unable to deliver products to our customers in a timely manner or at all, our customers may stop purchasing products from us |
| We also rely on third parties for information, including product characteristics and availability that we present to consumers on our websites, which may, on occasion, be inaccurate |
| Our failure to provide our customers with high quality customer experiences for any reason could substantially harm our reputation and adversely impact our efforts to develop Blue Nile as a trusted brand |
| The failure of our brand promotion activities could adversely affect our ability to attract new customers and maintain customer relationships, and, as a result, substantially harm our business and results of operations |
| We face significant competition and may be unsuccessful in competing against current and future competitors |
| The retail jewelry industry is intensely competitive, and we expect competition in the sale of diamonds and fine jewelry to increase and intensify in the future |
| Increased competition may result in price pressure, reduced gross margins and loss of market share, any of which could substantially harm our business and results of operations |
| Current and potential competitors include: • independent jewelry stores; • retail jewelry store chains, such as Tiffany & Co |
| com; • department stores, chain stores and mass retailers, such as Nordstrom and Neiman Marcus; • online auction sites, such as eBay; • catalog and television shopping retailers, such as Home Shopping Network and QVC; and • discount superstores and wholesale clubs, such as Costco Wholesale and Wal-Mart |
| In addition to these competitors, we may face competition from suppliers of our products that decide to sell directly to consumers, either through physical retail outlets or through an online store |
| Many of our current and potential competitors have advantages over us, including longer operating histories, greater brand recognition, existing customer and supplier relationships, and significantly greater financial, marketing and other resources |
| In addition, traditional store-based retailers offer consumers the 10 _________________________________________________________________ [61]Table of Contents ability to physically handle and examine products in a manner that is not possible over the Internet as well as a more convenient means of returning and exchanging purchased products |
| Some of our competitors seeking to establish an online presence may be able to devote substantially more resources to website systems development and exert more leverage over the supply chain for diamonds and fine jewelry than we can |
| In addition, larger, more established and better capitalized entities may acquire, invest or partner with traditional and online competitors as use of the Internet and other online services increases |
| Our online competitors can duplicate many of the products, services and content we offer, which could harm our business and results of operations |
| In order to increase net sales and to sustain or increase profitability, we must attract customers in a cost-effective manner |
| Our success depends on our ability to attract customers in a cost-effective manner |
| We have relationships with providers of online services, search engines, directories and other websites and e-commerce businesses to provide content, advertising banners and other links that direct customers to our websites |
| We rely on these relationships as significant sources of traffic to our websites |
| Our agreements with these providers generally have terms of one year or less |
| If we are unable to develop or maintain these relationships on acceptable terms, our ability to attract new customers would be harmed |
| In addition, many of the parties with which we have online-advertising arrangements could provide advertising services to other online or traditional retailers, including retailers with whom we compete |
| As competition for online advertising has increased, the cost for these services has also increased |
| A significant increase in the cost of the marketing vehicles upon which we rely could adversely impact our ability to attract customers in a cost-effective manner |
| We rely exclusively on the sale of diamonds and fine jewelry for our net sales, and demand for these products could decline |
| Luxury products, such as diamonds and fine jewelry, are discretionary purchases for consumers |
| The volume and dollar value of such purchases may significantly decrease during economic downturns |
| The success of our business depends in part on many macroeconomic factors, including employment levels, salary levels, tax rates and credit availability, all of which affect consumer spending and disposable income |
| Any reduction in consumer spending or disposable income may affect us more significantly than companies in other industries |
| Our net sales and results of operations are highly dependent on the demand for diamonds and diamond jewelry, particularly engagement rings |
| Should prevailing consumer tastes for diamonds decline or customs with respect to engagement shift away from the presentation of diamond jewelry, demand for our products would decline and our business and results of operations would be substantially harmed |
| The significant cost of diamonds results in large part from their scarcity |
| From time to time, attempts have been made to develop and market synthetic stones and gems to compete in the market for diamonds and diamond jewelry |
| We expect such efforts to continue in the future |
| If any such efforts are successful in creating widespread demand for alternative diamond products, demand and price levels for our products would decline and our business and results of operations would be substantially harmed |
| In recent years, increasing attention has been focused on “conflict” diamonds, which are diamonds extracted from war-torn regions in Africa and sold by rebel forces to fund insurrection |
| Diamonds are, in some cases, also believed to be used to fund terrorist activities in some regions |
| Although we believe that the suppliers from whom we purchase our diamonds seek to exclude such diamonds from their inventories, we cannot independently determine whether any diamond we offer was extracted from these regions |
| Current efforts to increase consumer awareness of this issue and encourage legislative response could adversely affect consumer demand for diamonds |
| Consumer confidence is dependent, in part, on the certification of our diamonds by independent laboratories |
| A decrease in the quality of the certifications provided by these laboratories could adversely 11 _________________________________________________________________ [62]Table of Contents impact demand for our products |
| Additionally, a decline in consumer confidence in the credibility of independent diamond grading certifications could adversely impact demand for our diamond products |
| Our jewelry offerings must reflect the tastes and preferences of a wide range of consumers whose preferences may change regularly |
| Our strategy has been to offer primarily what we consider to be classic styles of fine jewelry, but there can be no assurance that these styles will continue to be popular with consumers in the future |
| If the styles we offer become less popular with consumers and we are not able to adjust our inventory in a timely manner, our net sales may decline or fail to meet expected levels |
| We rely on our suppliers, third-party carriers and third-party jewelers as part of our fulfillment process, and these third parties may fail to adequately serve our customers |
| In general, we rely on our suppliers to promptly ship us diamonds ordered by our customers |
| Any failure by our suppliers to sell and ship such products to us in a timely manner will have an adverse effect on our ability to fulfill customer orders and harm our business and results of operations |
| Our suppliers, in turn, rely on third-party carriers to ship diamonds to us, and in some cases, directly to our customers |
| We also rely on third-party carriers for product shipments to our customers |
| We and our suppliers are therefore subject to the risks, including employee strikes and inclement weather, associated with such carriers’ abilities to provide delivery services to meet our and our suppliers’ shipping needs |
| Our suppliers’, third-party carriers’ or third-party jewelers’ failure to deliver products to us or our customers in a timely manner or to otherwise adequately serve our customers would damage our reputation and brand and substantially harm our business and results of operations |
| If our fulfillment operations are interrupted for any significant period of time, our business and results of operations would be substantially harmed |
| Our success depends on our ability to successfully receive and fulfill orders and to promptly and securely deliver our products to our customers |
| Most of our inventory management, jewelry assembly, packaging, labeling and product return processes are performed in a single fulfillment center |
| This facility is susceptible to damage or interruption from human error, fire, flood, power loss, telecommunications failure, terrorist attacks, acts of war, break-ins, earthquake and similar events |
| We do not presently have a formal disaster recovery plan and our business interruption insurance may be insufficient to compensate us for losses that may occur in the event operations at our fulfillment center are interrupted |
| We have expanded and may further expand our existing fulfillment center or transfer our fulfillment operations to a larger fulfillment center in the future |
| Any interruptions in our fulfillment center operations for any significant period of time, including interruptions resulting from the expansion of our existing facility or the transfer of operations to a new facility, could damage our reputation and brand and substantially harm our business and results of operations |
| We face the risk of theft of our products from inventory or during shipment |
| We may experience theft of our products while they are being held in our fulfillment center or during the course of shipment to our customers by third-party shipping carriers |
| We have taken steps to prevent such theft and maintain insurance to cover losses resulting from theft |
| However, if security measures fail, losses exceed our insurance coverage or we are not able to maintain insurance at a reasonable cost, we could incur significant losses from theft, which would substantially harm our business and results of operations |
| Our failure to protect confidential information of our customers and our network against security breaches could damage our reputation and brand 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 |
| Our failure to prevent these security breaches could damage 12 _________________________________________________________________ [63]Table of Contents our reputation and brand and substantially harm our business and results of operations |
| Currently, a majority of our sales are billed to our customers’ credit card accounts directly |
| We rely on encryption and authentication technology licensed from third parties to effect secure transmission of confidential information, including credit card numbers |
| Advances in computer capabilities, human errors, new discoveries in the field of cryptography or other developments may result in a compromise or breach of the technology used by us to protect customer transaction data |
| 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, anyone who is able to circumvent our security measures could misappropriate proprietary information or cause interruptions in our operations |
| We may need to expend significant resources to protect against security breaches or to address problems caused by breaches |
| Our failure to effectively manage the growth in our operations may prevent us from successfully expanding our business |
| We have experienced, and in the future may experience, rapid growth in operations, which has placed, and could continue to place, a significant strain on our operations, services, internal controls and other managerial, operational and financial resources |
| To effectively manage future expansion, we will need to maintain our operational and financial systems and managerial controls and procedures, which include the following processes: • transaction-processing and fulfillment; • inventory management; • customer support; • management of multiple supplier relationships; • operational, financial and managerial controls; • reporting procedures; • recruitment, training, supervision, retention and management of our employees; and • technology operations |
| If we are unable to manage future expansion, our ability to provide a high quality customer experience could be harmed, which would damage our reputation and brand and substantially harm our business and results of operations |
| The success of our business may depend on our ability to successfully expand our product offerings |
| Our ability to significantly increase our net sales and maintain and increase our profitability may depend on our ability to successfully expand our product lines beyond our current offerings |
| If we offer a new product category that is not accepted by consumers, the Blue Nile 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 |
| Expansion of our product lines may also strain our management and operational resources |
| If we are unable to accurately manage our inventory of fine jewelry, our reputation and results of operations could suffer |
| Except for loose diamonds, substantially all of the fine jewelry we sell is from our physical inventory |
| Changes in consumer tastes for these products subject us to significant inventory risks |
| If we under-stock one or more of our products, we may not be able to obtain additional units in a timely manner on terms favorable to us, if at all, which would damage our reputation and substantially harm our business and results of operations |
| In addition, if demand for our products increases over time, we may be forced to 13 _________________________________________________________________ [64]Table of Contents increase inventory levels |
| If one or more of our products does not achieve widespread consumer acceptance, we may be required to take significant inventory markdowns, or may not be able to sell the product at all, which would substantially harm our results of operations |
| If the single facility where substantially all of our computer and communications hardware is located fails, our business, results of operations and financial condition would be harmed |
| Our ability to successfully receive and fulfill orders and to provide high quality customer service depends in part on the efficient and uninterrupted operation of our computer and communications systems |
| Substantially all of the computer hardware necessary to operate our websites is located at a single leased facility |
| Our systems and operations are vulnerable to damage or interruption from human error, fire, flood, power loss, telecommunications failure, terrorist attacks, acts of war, break-ins, earthquake and similar events |
| We do not presently have redundant systems in multiple locations or a formal disaster recovery plan, and our business interruption insurance may be insufficient to compensate us for 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 |
| The occurrence of any of the foregoing risks could substantially harm our business and results of operations |
| Repurchases of Our Common Stock May Not Prove to be the Best Use of Our Cash Resources In 2005, our board of directors authorized the repurchase of up to dlra30 million of Blue Nile, Inc |
| common stock during the subsequent 12 months |
| We repurchased approximately dlra17dtta4 million of Blue Nile, Inc |
| common stock in 2005 |
| In February 2006, our board of directors authorized the repurchase of up to dlra100 million of Blue Nile, Inc |
| common stock during the subsequent 24 months |
| Our 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 |
| We have incurred significant operating losses in the past and may not be able to sustain profitability in the future |
| We experienced significant operating losses in each quarter from our inception in 1999 through the second quarter of 2002 |
| As a result, our business has a limited record of profitability and may not continue to be profitable or increase profitability |
| If we are unable to acquire diamonds and fine jewelry at commercially reasonable prices, if net sales decline or if our expenses otherwise exceed our expectations, we may not be able to sustain or increase profitability on a quarterly or annual basis |
| We rely on the services of our key personnel, any of whom would be difficult to replace |
| We rely upon the continued service and performance of key technical, fulfillment and senior management personnel |
| If we lose any of these personnel, our business could suffer |
| Competition for qualified personnel in our industry is intense |
| We believe that our future success will depend on our continued ability to attract, hire and retain key employees, including Mark Vadon, our Chief Executive Officer, on whom we rely for management of our company, development of our business strategy and management of our strategic relationships |
| Vadon, we do not have “key person” life insurance policies covering any of our employees |
| Failure to adequately protect our intellectual property could substantially harm our business and results of operations |
| We rely on a combination of patent, trademark, trade secret and copyright law and contractual restrictions to protect our intellectual property |
| These afford only limited protection |
| Despite our efforts to protect our proprietary rights, unauthorized parties have attempted and may in the future attempt to copy aspects of our website features and functionality or to obtain and use information that we consider as proprietary, such as the technology used to operate our websites, our content and our trademarks |
| We have 14 _________________________________________________________________ [65]Table of Contents registered “Blue Nile,” “bluenile |
| com,” the BN logo and the Blue Nile BN stylized logo as trademarks in the United States and in certain other countries |
| Our competitors have, and other competitors may, adopt service names similar to ours, thereby impeding our ability to build brand identity and possibly leading to customer confusion |
| In addition, there could be potential trade name or trademark infringement claims brought by owners of other registered trademarks or trademarks that incorporate variations of the term Blue Nile or our other trademarks |
| Any claims or customer confusion related to our trademarks could damage our reputation and brand and substantially harm our business and results of operations |
| com, bluenile |
| ca Internet domain names and various other related domain names |
| Domain names generally are regulated by Internet regulatory bodies |
| If we lose the ability to use a domain name in a particular country, we would be forced to either incur significant additional expenses to market our products within that country, including the development of a new brand and the creation of new promotional materials and packaging, or elect not to sell products in that country |
| Either result could substantially harm our business and results of operations |
| The regulation of domain names in the United States and in foreign countries is subject to change |
| Regulatory bodies could establish additional top-level domains, appoint additional domain name registrars or modify the requirements for holding domain names |
| As a result, we may not be able to acquire or maintain the domain names that utilize the name Blue Nile in all of the countries in which we currently or intend to conduct business |
| Litigation or proceedings before the US Patent and Trademark Office or similar international regulatory agencies may be necessary in the future to enforce our intellectual property rights, to protect our trade secrets and domain names and to determine the validity and scope of the proprietary rights of others |
| Any litigation or adverse priority proceeding could result in substantial costs and diversion of resources and could substantially harm our business and results of operations |
| We sell and intend to increasingly sell our products internationally, and the laws of many countries do not protect our proprietary rights to as great an extent as do the laws of the United States |
| Assertions by third parties of infringement by us of their intellectual property rights could result in significant costs and substantially harm our business and results of operations |
| Third parties have, and may in the future, assert that we have infringed their technology or other intellectual property rights |
| We cannot predict whether any such assertions or claims arising from such assertions will substantially harm our business and results of operations |
| If we are forced to defend against any infringement claims, whether they are with or without merit or are determined in our favor, we may face costly litigation, diversion of technical and management personnel or product shipment delays |
| Furthermore, the outcome of a dispute may be that we would need to develop non-infringing technology or enter into royalty or licensing agreements |
| Royalty or licensing agreements, if required, may be unavailable on terms acceptable to us, or at all |
| Increased product returns and the failure to accurately predict product returns could substantially harm our business and results of operations |
| We offer our customers an unconditional 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 differ from our allowances |
| Any significant increase in merchandise returns above our allowances would substantially harm our business and results of operations |
| Interruptions to our systems that impair customer access to our websites would damage our reputation and brand and substantially harm our business and results of operations |
| The satisfactory performance, reliability and availability of our websites, transaction processing systems and network infrastructure are critical to our reputation and our ability to attract and retain customers and to maintain adequate customer service levels |
| Any future systems interruptions or downtime 15 _________________________________________________________________ [66]Table of Contents or technical difficulties that result in the unavailability of our websites or reduced order fulfillment performance could result in negative publicity, damage our reputation and brand and cause our business and results of operations to suffer |
| We may be susceptible to such disruptions in the future |
| We may also experience temporary system interruptions for a variety of other reasons in the future, including power failures, software or human errors or an overwhelming number of visitors trying to reach our websites during periods of strong seasonal demand or promotions |
| Because we are dependent in part on third parties for the implementation and maintenance of certain aspects of our systems and because some of the causes of system interruptions may be outside of our control, we may not be able to remedy such interruptions in a timely manner, or at all |
| We may be unsuccessful in further expanding our operations internationally |
| To date, we have made limited international sales, but we have recently expanded our product offerings and marketing and sales efforts in the United Kingdom and Canada and anticipate continuing to expand our international sales and operations in the future either by expanding local versions of our website for foreign markets or through acquisitions or alliances with third parties |
| Any international expansion plans we choose to undertake will require management attention and resources and may be unsuccessful |
| We have minimal experience in selling our products in international markets and in conforming to the local cultures, standards or policies necessary to successfully compete in those markets |
| We do not currently have any overseas fulfillment or distribution or server facilities, and outside of the United Kingdom and Canada, we have very limited web content localized for foreign markets and we cannot be certain that we will be able to expand our global presence if we choose to further expand internationally |
| In addition, we may have to compete with retailers that have more experience with local markets |
| Our ability to expand and succeed internationally may also be limited by the demand for our products and the adoption of electronic commerce in these markets |
| Different privacy, censorship and liability standards and regulations and different intellectual property laws in foreign countries may prohibit expansion into such markets or cause our business and results of operations to suffer |
| Our current and future international operations may also fail to succeed due to other risks inherent in foreign operations, including: • the need to develop new supplier and jeweler relationships; • international regulatory requirements and tariffs; • difficulties in staffing and managing foreign operations; • longer payment cycles from credit card companies; • greater difficulty in accounts receivable collection; • our reliance on third-party carriers for product shipments to our customers; • risk of theft of our products during shipment; • potential adverse tax consequences; • foreign currency exchange risk; • lack of infrastructure to adequately conduct electronic commerce transactions or fulfillment operations; • price controls or other restrictions on foreign currency; • difficulties in obtaining export and import licenses; • increased payment risk and greater difficulty addressing credit card fraud; • consumer and data protection laws; 16 _________________________________________________________________ [67]Table of Contents • lower levels of adoption or use of the Internet; and • geopolitical events, including war and terrorism |
| Our failure to successfully expand our international operations may cause our business and results of operations to suffer |
| Our failure to rapidly respond to technological change could result in our services or systems becoming obsolete and substantially harm our business and results of operations |
| As the Internet and online commerce industries evolve, we may be required to license emerging technologies useful in our business, enhance our existing services, develop new services and technologies that address the increasingly sophisticated and varied needs of our prospective customers and respond to technological advances and emerging industry standards and practices on a cost-effective and timely basis |
| We may not be able to successfully implement new technologies or adapt our websites, proprietary technologies and transaction-processing systems to customer requirements or emerging industry standards |
| Our failure to do so would substantially harm our business and results of operations |
| Our results of operations may be affected by the timing, effectiveness and costs of any upgrades or changes to our systems and infrastructure |
| If use of the Internet, particularly with respect to online commerce, does not continue to increase as rapidly as we anticipate, our business will be harmed |
| Our future net sales and profits are substantially dependent upon the continued growth in the use of the Internet as an effective medium of business and communication by our target customers |
| Internet use may not continue to develop at historical rates and consumers may not continue to use the Internet and other online services as a medium for commerce |
| Highly publicized failures by some online retailers to meet consumer demands could result in consumer reluctance to adopt the Internet as a means for commerce, and thereby damage our reputation and brand and substantially harm our business and results of operations |
| In addition, the Internet may not be accepted as a viable long-term commercial marketplace for a number of reasons, including: • actual or perceived lack of security of information or privacy protection; • possible disruptions, computer viruses, spyware, phishing, attacks or other damage to the Internet servers, service providers, network carriers and Internet companies or to users’ computers; and • excessive governmental regulation |
| Our success will depend, in large part, upon third parties maintaining the Internet infrastructure to provide a reliable network backbone with the speed, data capacity, security and hardware necessary for reliable Internet access and services |
| Our business, which relies on a contextually rich website that requires the transmission of substantial data, is also significantly dependent upon the availability and adoption of broadband Internet access and other high speed Internet connectivity technologies |
| We rely on our relationship with a third-party consumer credit company to offer financing for the purchase of our products |
| The purchase of the diamond and fine jewelry products we sell is a substantial expense for many of our customers |
| We currently rely on our relationship with a single financial institution to provide financing to our customers |
| If we are unable to maintain this or other similar arrangements, we may not be able to offer financing alternatives to our customers, which may reduce demand for our products and substantially harm our business and results of operations |
| 17 _________________________________________________________________ [68]Table of Contents We may undertake acquisitions to expand our business, which may pose risks to our business and dilute the ownership of our existing stockholders |
| A key component of our business strategy includes strengthening our competitive position and refining the customer experience on our websites through internal development |
| However, from time to time, we may selectively pursue acquisitions of businesses, technologies or services |
| Integrating any newly acquired businesses, technologies or services may be expensive and time-consuming |
| To finance any acquisitions, it may be necessary for us to raise additional funds through public or private financings |
| Additional funds may not be available on terms that are favorable to us, and, in the case of equity financings, would result in dilution to our stockholders |
| If we do complete any acquisitions, we may be unable to operate such acquired businesses profitably or otherwise implement our strategy successfully |
| If we are unable to integrate any newly acquired entities or technologies effectively, our business and results of operations could suffer |
| The time and expense associated with finding suitable and compatible businesses, technologies or services could also disrupt our ongoing business and divert our management’s attention |
| Future acquisitions by us could also result in large and immediate write-offs or assumptions of debt and contingent liabilities, any of which could substantially harm our business and results of operations |
| We have no current plans, agreements or commitments with respect to any such acquisitions |
| Our net sales may be negatively affected if we are required to charge taxes on purchases |
| We do not collect or have imposed upon us sales or other taxes related to the products we sell, except for certain corporate level taxes, sales taxes with respect to purchases by customers located in the State of Washington, and certain taxes required to be collected on sales to customers outside of the United States of America |
| 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 sales, discourage customers from purchasing products from us, decrease our ability to compete with traditional retailers or otherwise substantially harm our business and results of operations |
| Currently, decisions of the US Supreme Court restrict the imposition of obligations to collect state and local sales and use taxes with respect to sales made over the Internet |
| However, implementation of the restrictions imposed by these Supreme Court decisions is subject to interpretation by state and local taxing authorities |
| While we believe that these Supreme Court decisions currently restrict state and local taxing authorities outside the State of Washington from requiring us to collect sales and use taxes from purchasers located within their jurisdictions, taxing authorities outside the State of Washington could disagree with our interpretation of these decisions |
| Moreover, a number of states, as well as the US Congress, have been considering various initiatives that could limit or supersede the Supreme Court’s position regarding sales and use taxes on Internet sales |
| If any state or local taxing jurisdiction were to disagree with our interpretation of the Supreme Court’s current position regarding state and local taxation of Internet sales, or if any of these initiatives were to address the Supreme Court’s constitutional concerns and result in a reversal of its current position, we could be required to collect sales and use taxes from purchasers located in states other than Washington |
| The imposition by state and local governments of various taxes upon Internet commerce could create administrative burdens for us and could decrease our future net sales |
| Government regulation of the Internet and e-commerce is evolving and unfavorable changes could substantially harm our business and results of operations |
| We are not currently subject to direct federal, state or local regulation other than regulations applicable to businesses generally or directly applicable to retailing and online commerce |
| However, as the Internet becomes increasingly popular, it is possible that laws and regulations may be adopted with respect to the Internet, which may impede the growth of the Internet or other online services |
| These regulations and laws may cover issues such as taxation, advertising, intellectual property rights, freedom of expression, pricing, restrictions on imports and exports, customs, tariffs, information security, privacy, data protection, content, distribution, electronic contracts and other communications, the provision of online payment 18 _________________________________________________________________ [69]Table of Contents services, broadband residential Internet access and the characteristics and quality of products and services |
| Several states have proposed legislation to limit the uses of personal user information gathered online or require online companies to establish privacy policies |
| The Federal Trade Commission has also initiated action against at least one online company regarding the manner in which personal information is collected from users and provided to third parties |
| The adoption of additional privacy or consumer protection laws could create uncertainty in Internet usage and reduce the demand for our products and services |
| We are not certain how our business may be affected by the application of existing laws governing issues such as property ownership, copyrights, personal property, encryption and other intellectual property issues, taxation, libel, obscenity, qualification to do business and export or import matters |
| The vast majority of these laws were adopted prior to the advent of the Internet |
| As a result, they do not contemplate or address the unique issues of the Internet and related technologies |
| Changes in laws intended to address these issues could create uncertainty for those conducting online commerce |
| This uncertainty could reduce demand for our products and services or increase the cost of doing business as a result of litigation costs or increased fulfillment costs and may substantially harm our business and results of operations |
| Our failure to address risks associated with payment methods, credit card fraud and other consumer fraud could damage our reputation and brand and may cause our business and results of operations to suffer |
| Under current credit card practices, we are liable for fraudulent credit card transactions because we do not obtain a cardholder’s signature |
| We do not currently carry insurance against this risk |
| To date, we have experienced minimal losses from credit card fraud, but we face the risk of significant losses from this type of fraud as our net sales increase and as we expand internationally |
| Our failure to adequately control fraudulent credit card transactions could damage our reputation and brand and substantially harm our business and results of operations |
| Additionally, for certain payment transactions, including credit and debit cards, we pay interchange and other fees, which may increase over time and raise our operating costs and lower our operating margins |
| Changes in accounting standards and/or our accounting policy relating to stock-based compensation may negatively affect our reported results of operations |
| Prior to January 2, 2006, we accounted for stock-based employee compensation arrangements in accordance with the provisions of Accounting Principles Board Opinion (“APB”) Nodtta 25, “Accounting for Stock Issued to Employees” (“APB 25”), and related interpretations |
| Under APB 25, compensation expense was recognized for the difference between the fair value of our stock on the date of grant and the exercise price |
| Had compensation cost for the Company’s stock options been determined based on the fair value of the options at the date of grant under SFAS 123, our net income for periods prior to January 2, 2006 would have been as set forth in Note 1 to our consolidated financial statements included elsewhere in this report |
| The Company has adopted the provisions of SFAS Nodtta 123R, “Share-Based Payment” (“SFAS 123R”), commencing with the first quarter of 2006 using the modified prospective transition method |
| We are using the Black-Scholes option pricing model to value options granted |
| The adoption of this statement will result in significant stock-based compensation expense as we will be required to expense the fair value of options granted |
| Actual future expense may vary significantly from our estimates based on the amount and timing of options granted, the assumptions used in valuing these options and other factors |
| We may need to implement additional finance and accounting systems, procedures and controls as we grow our business and organization and to satisfy new reporting requirements |
| As a public reporting company, we are required to comply with the Sarbanes-Oxley Act of 2002 and the related rules and regulations of the SEC, including expanded disclosures and accelerated reporting 19 _________________________________________________________________ [70]Table of Contents requirements and more complex accounting rules |
| Compliance with Section 404 of the Sarbanes-Oxley Act of 2002 and other requirements may increase our costs and require additional management time and resources |
| We may need to continue to implement additional finance and accounting systems, procedures and controls to satisfy new reporting requirements |
| If our internal controls over financial reporting are determined to be ineffective, investors could lose confidence in the reliability of our internal control over financial reporting, which could adversely affect our stock price |