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GKNT > SEC Filings for GKNT > Form 10-Q on 8-Nov-2012All Recent SEC Filings

Show all filings for GEEKNET, INC

Form 10-Q for GEEKNET, INC


8-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Special Note Regarding Forward-Looking Statements This Quarterly Report on Form 10-Q contains forward-looking statements that involve risks and uncertainties. Words such as "may," "could," "anticipate," "potential," "intend," "expect," "believe," "in our view," and variations of such words and similar expressions, are intended to identify such forward-looking statements, which include, but are not limited to, statements regarding our expectations and beliefs regarding future revenue growth; sources of revenue; gross margins; financial performance and results of operations; management's strategy, plans and objectives for future operations; employee relations and our ability to attract and retain highly qualified personnel; our intent to continue to invest in establishing our brand identity; competition, competitors and our ability to compete; liquidity and capital resources; the outcome of any litigation to which we are a party; our accounting policies; and sufficiency of our cash resources and investments to meet our operating and working capital requirements. Actual results may differ materially from those expressed or implied in such forward-looking statements due to various factors, including those set forth in the Risk Factors contained in Part II., Item 1A Risk Factors, included elsewhere in this Form 10-Q. We undertake no obligation to update the forward-looking statements to reflect events or circumstances occurring after the date of this Quarterly Report on Form 10-Q.

Critical Accounting Estimates
There have been no significant changes to our critical accounting estimates during the nine months ended September 30, 2012 as compared to what was previously disclosed in Management's Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2011.

Overview

Prior to September 17, 2012, we had two operating segments: e-Commerce and Media. e-Commerce sells technology-themed retail products for technology enthusiasts and others through our ThinkGeek website and our wholesale channel. Our Media segment provided web properties that served as platforms for the creation, review and distribution of online peer produced content, using our Media websites, SourceForge, Slashdot, and Freecode.

On May 11, 2012, we announced that our Board of Directors was exploring strategic alternatives with respect to our Media business, including the SourceForge, Slashdot and Freecode websites. We, along with our advisers, evaluated a range of options to maximize shareholder value, including, but not limited to, selling the Media business. We received bids from various organizations interested in purchasing the Media business and reviewed each one carefully with our advisers.

On September 17, 2012 (the "Closing Date"), we entered into an Asset Purchase Agreement (the "Purchase Agreement") with Dice Holdings, Inc. ("Dice") and two of Dice's subsidiaries, Dice Career Solutions, Inc. and eFinancialCareers Limited (collectively, the "Buyers") pursuant to which the Buyers purchased our Media business, including the SourceForge, Slashdot and Freecode websites (the "Purchased Business") and assumed certain related liabilities.

Our Board of Directors and management believe that selling the Media business will allow us to focus on our business strategies to grow and improve our e-Commerce business and our ThinkGeek sourced and custom developed products by our product development team ("GeekLabs"). We believe the proceeds generated from the sale of the Media business and management's ability to solely focus on our core e-Commerce business will result in a positive impact to our future business strategy.

In accordance with the terms of the Purchase Agreement, the Buyers paid us $20.0 million in cash, of which $3.0 million was deposited by the Buyers into an escrow account for a period of twelve months after the Closing Date in order to secure our indemnification obligations to the Buyers for breaches of our representations, warranties, covenants and other obligations under the Purchase Agreement.

The Purchase Agreement contains customary representations, warranties and covenants. Subject to certain exceptions and limitations, each party has agreed to indemnify the other for breaches of representations, warranties


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and covenants and other specified matters. The Purchase Agreement generally limits the Company's liability for breaches of representations and warranties made in the Purchase Agreement to an aggregate of $10.0 million. The Purchase Agreement also contains covenants requiring us not to solicit or hire certain employees of the Buyers or compete with the Purchased Business for a period of three years. We have also agreed with Dice to provide certain transition services to one another following the Closing Date for a period of up to six months.

We sell technology-themed retail products for technology enthusiasts and others through our ThinkGeek website and our wholesale channel. We offer a broad range of unique products in a single web property that are not available in traditional brick-and-mortar stores. We introduce a range of new products to our audience on a regular basis and sell our own innovative GeekLabs products developed in-house. We have several wholesale partnerships with brick and mortar retailers that allow us to reach a new consumer audience and expand our unique brand. We have recently established and strengthened partnerships with certain retail store chains that have hundreds of locations throughout the United States and Canada.

ThinkGeek's business strategy is to increase revenue by expanding the range of new and innovative products we sell, including our exclusive GeekLabs products, and by increasing traffic to our site and customer conversion. We attract traffic to our sites by using a variety of traditional online and direct retail marketing channels including paid search and e-mail to our customers and followers. We continue to use the capabilities of the internet, including social networking sites such as Facebook, Twitter and YouTube, to increase brand awareness and to communicate with our customers.

Our ThinkGeek business is highly seasonal, reflecting the general pattern associated with the retail industry of peak sales and earnings during the calendar year-end holiday shopping season. In the past several years, a substantial portion of ThinkGeek revenue has occurred in the fourth quarter ending December 31. As is typical in the retail industry, we generally experience lower monthly revenue during the first nine months of the year.

Each year we initiate programs and promotions to attract additional customers and increase sales to our existing customer base. This year we enhanced our Geek Points program by making the program more flexible for our customers and we expect to continue to implement improvements next year. We regularly send direct marketing e-mails to our customers and we increase the number of e-mails and promotions during the fourth quarter in preparation for the holiday season. We also utilize Facebook, Twitter and YouTube to generate interest in our new product launches.

We currently use the following key metrics to measure our e-Commerce business:

                                      Three Months Ended September 30,           Nine Months Ended September 30,
                                          2012                  2011                2012                   2011
Unique visitors (in thousands) (1)        19,599                  16,176            56,686                   46,076
Number of orders received (in
thousands) (2)                               284                     234               887                      748
Conversion rate                             1.45 %                  1.45 %            1.56 %                   1.62 %
Average order value received (3)   $          65           $          64     $          62           $           62

Number of orders shipped (in
thousands) (4)                               279                     241               892                      779
Average order value shipped  (3)
(5)                                $          62           $          61     $          59           $           57

(1) Unique visitors is the total of unique visitors for the ThinkGeek website during the periods presented. This data is accumulated daily and can include the same unique visitor on different days. We track unique visitors and the volume of traffic to our website to help us determine the effectiveness of our online marketing efforts.

(2) The number of orders received represents all orders placed on the ThinkGeek website during each period shown and does not necessarily correlate to revenue recognized during the period. For example, some orders placed on the ThinkGeek website at the end of a reporting period are recognized as revenue in the subsequent reporting period because delivery had not yet occurred.

(3) Average order value received or shipped is calculated by the total sales for orders received or shipped divided by the number of orders received or shipped. Average order value can vary depending on, but not limited to, seasonality, promotions, the number of volume sales in a given period, the competitive environment and economic conditions.

(4) The number of orders shipped represents all orders associated with the amount of revenue recognized for ThinkGeek for the period presented.

(5) Wholesale channel sales contributed to the total average order value shipped. Excluding wholesale channel sales, average order value


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shipped for ThinkGeek website orders was $57 and $58 for the three months ended September 30, 2012 and 2011 and $55 and $54 for the nine months ended September 30, 2012 and 2011.

Critical Accounting Policies

Accounting policies, methods and estimates are an integral part of the condensed consolidated financial statements prepared by management and are based upon management's current judgments. Those judgments are normally based on knowledge and experience with regard to past and current events and assumptions about future events. Certain accounting policies, methods and estimates are particularly sensitive because of their significance to the financial statements and because of the possibility that future events affecting them may differ from management's current judgments. While there are a number of accounting policies, methods and estimates affecting our financial statements, areas that are particularly significant include revenue recognition, inventories, the assessment of impairment of goodwill and long-lived assets, stock-based compensation and contingencies and litigation.

Net Revenue

Net revenue is derived from the online sale of consumer goods and from product sales through our wholesale channel. We recognize revenue from consumer goods or product sales when persuasive evidence of an arrangement exists, delivery has occurred, the sale price is fixed or determinable, and collectibility is reasonably assured. Revenue is deferred for orders shipped but not delivered before the end of the period. The amount recorded as deferred revenue is estimated because of our high volume of transactions and the use of multiple shipping carriers. These estimates are used to determine what orders that shipped at the end of the reporting period, were delivered and should be recognized as revenue. When calculating these estimates, we consider historical experiences of shipping transit times for domestic and international orders using different carriers. On average, shipping transit times are approximately one to six business days. As of September 30, 2012 and December 31, 2011, $0.7 million and $0.9 million, respectively, was recognized as deferred revenue for orders placed at the end of the reporting period, but not yet delivered.

We also engage in the sale of gift certificates. When a gift certificate is sold, revenue is deferred until the certificate is redeemed and the products are delivered. Deferred revenue at September 30, 2012 and December 31, 2011 relating to gift certificates was $0.7 million at each period.

We reserve an amount for estimated returns at the end of each reporting period. We generally give customers a 90-day right to return products. These estimates are based on historical trends of amounts returned per revenue for a period. Reserves for returns at September 30, 2012 and December 31, 2011 were $0.2 million and $0.7 million, respectively. This decrease was due to the seasonality effect from holiday sales occurring at year end.

We voluntarily ceased selling a product in July 2012 because of safety concerns. We are offering our customers who have purchased this product, the opportunity to return the product in exchange for a ThinkGeek credit. We believe the reserves for returns at September 30, 2012 to be adequate. We will adjust our reserves for returns as deemed appropriate based on future product returns. Inventories

Inventories consist solely of finished goods that are valued at the lower of cost, using the weighted average cost method, or market. We review inventories each quarter and, when required, reduce estimated excess and obsolete inventories to their net realizable values.

Long-Lived Assets

We continually evaluate whether events and circumstances have occurred that indicate the remaining estimated useful life of long-lived assets may warrant revision or that the remaining balance of long-lived assets may not be recoverable. When factors indicate that long-lived assets should be evaluated for possible impairment, we use an estimate of the related undiscounted future cash flows over the remaining life of the long-lived assets in measuring whether they are recoverable. If the carrying value of the asset exceeds the estimated undiscounted future cash flows, a loss is recorded as the excess of the asset's carrying value over fair value. Long-lived assets and certain identifiable intangible assets to be disposed of are reported at the lower of carrying amount or fair value less costs to sell.


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Stock-Based Compensation

We measure compensation cost for stock awards at grant date fair value and recognize the expense net of estimated forfeitures for shares expected to vest over the service period of the award.

Calculating compensation expense for stock options requires the input of subjective assumptions, including the expected term of the stock option grant, stock price volatility, interest rates and the forfeiture rate. The fair value of the option grants are calculated on the date of grant using the Black-Scholes option pricing model. The expected life is based on historical settlement patterns. Expected volatility is based on the historical implied volatility of our stock. The interest rate for periods within the contractual life of the award is based on the U.S. Treasury yield curve in effect at the time of grant. We estimate the forfeiture rate based on historical trends of our stock-based awards that cancel.

Discontinued Operations

Due to the sale of the Company's Media business on September 17, 2012, the results of the Media business are classified as discontinued operations for the three and nine months ended September 30, 2012 and 2011. The results include Media business revenues, cost of sales and operating and non operating expenses, excluding previously allocated general corporate costs.

Results of Operations and Discontinued Operations

The following table sets forth our operating results for the periods indicated
as a percentage of net revenue, represented by selected items from the
consolidated statements of operations. This table should be read in conjunction
with the condensed consolidated financial statements and the accompanying notes
included in this Form 10-Q.

                                         Three Months Ended September 30,       Nine Months Ended September 30,
                                             2012                 2011              2012                 2011
Consolidated Statements of Operations
Data:
Net revenue                                  100.0  %              100.0  %         100.0  %              100.0  %
Cost of revenue                               86.9                  91.3             86.8                  91.1
Gross margin                                  13.1  %                8.7  %          13.2  %                8.9  %
Operating expenses:
Sales and marketing                            9.9                  10.3              9.7                  10.5
Research and development                       6.5                   3.4              5.3                   3.0
General and administrative                    15.3                  18.0             14.5                  16.1
Total operating expenses                      31.7  %               31.7  %          29.5  %               29.6  %
Loss from operations                         (18.6 )               (23.0 )          (16.3 )               (20.7 )
Gain on Sale of non-marketable
securities                                       -                     -              7.6                     -
Interest and other income (expense),
net                                           (0.1 )                   -             (0.1 )                   -
Loss from continuing operations before
income taxes                                 (18.7 )               (23.0 )           (8.8 )               (20.7 )
Income tax benefit                            (7.1 )                (1.8 )           (3.3 )                (1.7 )
Net loss from continuing operations          (11.6 )%              (21.2 )%          (5.5 )%              (19.0 )%
Income from discontinued operations,
net of tax                                    60.0  %                2.9  %          20.4  %                2.7  %
Net income (loss)                             48.5  %              (18.3 )%          14.9  %              (16.3 )%

Net Revenue

Net revenue is derived from the sale of consumer goods at retail on our ThinkGeek website and from our wholesale channel, and includes shipping, net of returns and allowances. These consumer goods are typically electronics, toys, gadgets, apparel, edibles, geek-themed and other specialty or unique items. Our customers are primarily technology enthusiasts and general consumers. We sell and ship our products domestically and internationally.


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Three Months Ended Nine Months Ended
September 30, September 30,
2012 2011 % Change 2012 2011 % Change
($ in thousands)
Net revenue $ 17,260 $ 14,693 17 % $ 52,574 $ 44,217 19 %

Net revenue increased $2.6 million and $8.4 million during the three and nine months ended September 30, 2012 as compared to the same prior year periods primarily due to an increase in the number of orders placed through our ThinkGeek website and an increase in revenue through our wholesale channel as compared to the prior year period.
The number of unique visitors increased 21% and 23% during the three and nine month periods ended September 30, 2012, respectively, as compared to the same prior year periods. The higher volume of visitors is primarily due to our efforts to increase consumer awareness of our ThinkGeek website through advertising and media coverage.
Wholesale revenue to retailers and brick and mortar stores increased $0.7 million and $1.6 million during the three and nine month periods ended September 30, 2012, respectively, as compared to the same prior year periods ended September 30, 2011. These increases are the result of the ThinkGeek sales team strengthening relationships with our existing wholesale clients and acquiring new clients who have particular interest in ThinkGeek products. We continue to diversify our product offerings by introducing new products, including our innovative GeekLabs products and expanding licensing partnerships.
Thinkgeek products are sold in the U.S. and internationally. The majority of Thinkgeek sales are in the U.S. and were 77% and 79% of total sales for each of the three months ended September 30, 2012 and September 30, 2011, respectively, and 80% and 82% of total sales for each of the nine months ended September 30, 2012 and September 30, 2011, respectively. International sales continue to grow and were 23% and 21% of total net sales for each of the three months ended September 30, 2012 and September 30, 2011, respectively, and 20% and 18% for each of the nine months ended September 30, 2012 and 2011, respectively. We have been focused on increasing Thinkgeek awareness in other countries and increasing our ability to ship to other countries which have resulted in the increase in sales internationally.
Cost of Revenue / Gross Margin

Cost of revenue consists of product, shipping and fulfillment costs and personnel and related overhead expenses associated with the operations and merchandising functions.

                           Three Months Ended                       Nine Months Ended September 30,
                             September 30,                                       2012
                           2012          2011         % Change          2012               2011          % Change
($ in thousands)
Cost of revenue        $   15,004     $  13,414           12 %     $    45,656         $    40,263           13 %
Gross margin           $    2,256     $   1,279           76 %     $     6,918         $     3,954           75 %
Gross margin %                 13 %           9 %                           13 %                 9 %

Cost of revenues increased $1.6 million during the three months ended September 30, 2012 as compared to the three months ended September 30, 2011 primarily due to higher sales. Also, contributing to the increase is a $0.2 million reserve to inventory for a product that we sell on our ThinkGeek website. The Consumer Product Safety Commission filed an administrative complaint against the maker of this product because of safety concerns, particularly to children. As other retailers have done, we voluntarily suspended the sales of this product in late July 2012. We do not anticipate this to have a material impact on net revenues.

Cost of revenues increased $5.4 million during the nine months ended September 30, 2012 as compared to the nine months ended September 30, 2011 primarily due to higher sales and the $0.2 million reserve to inventory for a certain product as described above.


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Gross margin as a percentage of revenues for the three and nine months ended September 30, 2012 increased by four percentage points due to our efforts in reducing fulfillment and outbound shipping costs and improvements in inventory management. We also continued to create efficiencies in inventory management throughout the past year which led to fewer discontinued inventory discounts and reduced write downs of obsolete inventory.

Also contributing to the increase in gross margins is a decrease in seventeen full-time equivalents ("FTEs"). During the first quarter of 2012, we began outsourcing our ThinkGeek customer service department, which reduced FTEs. We also redirected certain of our workforce from merchandising, included as cost of revenue, to developing our own innovative products in our GeekLabs, included in research and development.

Operating Expenses

Sales and Marketing Expenses

Sales and marketing expenses consist primarily of personnel and related overhead
expenses, including sales commissions, marketing and sales support functions, as
well as costs associated with advertising and promotional activities.
                          Three Months Ended                            Nine Months Ended
                             September 30,                                September 30,
                          2012            2011        % Change         2012            2011         % Change
($ in thousands)
Sales and marketing  $     1,714      $    1,507          14 %     $     5,089     $    4,649           9 %
Percentage of total
net revenue                   10 %            10 %                          10 %           11 %

Sales and marketing expenses increased $0.2 million for the three months ended September 30, 2012 as compared to the three months ended September 30, 2011 primarily due to an increase of $0.3 million in personnel and related overhead expenses due to certain individuals that were transferred to the sales and marketing department during the third quarter of 2012 and severance costs of $0.1 million. This increase was partially offset by a decrease of $0.2 million in marketing expenses primarily due our decision to discontinue printing large catalogs.

Sales and marketing expenses increased $0.4 million for the nine months ended September 30, 2012 as compared to the nine months ended September 30, 2011 primarily due to an increase of $0.8 million in personnel and related overhead expenses because of an average of five additional FTE in our marketing workforce as compared to the same prior year period, partially offset by a decrease in marketing expenses of $0.3 million and $0.2 million of cost savings in credit card fees. Marketing expenses are lower primarily due to our decision to discontinue printing large catalogs. Our credit card fees are lower because during the fourth quarter of 2011 we reduced our fees by changing our credit card processing vendor.

Sales and marketing as a percentage of sales decreased one percentage point during the nine months ended September 30, 2012 as compared to the same period in the prior year period primarily due to a decrease in credit card fees.

Research and Development Expenses

Research and development expenses consist primarily of personnel and related
overhead expenses for GeekLabs and product developers for ThinkGeek.  We expense
all of our research and development costs as they are incurred.
                             Three Months Ended                          Nine Months Ended
                               September 30,                               September 30,
                            2012             2011       % Change        2012            2011       % Change
($ in thousands)
Research and
development            $     1,117       $      497        125 %    $     2,792     $    1,324        111 %
Percentage of total
net revenue                      6 %              3 %                         5 %            3 %


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Research and development expense increased $0.6 million for the three months ended September 30, 2012 as compared to the three months ended September 30, 2011 primarily due to our increased focus on testing and developing our own GeekLabs innovative products. We redirected certain of our workforce and hired new employees for our internal development center, GeekLabs, which resulted in an increase of $0.4 million in personnel and related overhead expenses. Also contributing to the increase are $0.1 million in fees related to developing . . .

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