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PRSS > SEC Filings for PRSS > Form 10-K on 18-Mar-2013All Recent SEC Filings

Show all filings for CAFEPRESS INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-K for CAFEPRESS INC.


18-Mar-2013

Annual Report


ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

You should read the following discussion in conjunction with our consolidated financial statements and related notes included elsewhere in this report. This report, including the following Management's Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements that involve risks and uncertainties. In some cases, you can identify forward-looking statements by terms such as "may," "might," "will," "objective," "intend," "should," "could," "can," "would," "expect," "believe," "estimate," "predict," "potential," "plan," or the negative of these terms, and similar expressions intended to identify forward-looking statements. These statements reflect our current views with respect to future events and are based on assumptions and subject to risks and uncertainties. Given these uncertainties, you should not place undue reliance on these forward-looking statements These forward-looking statements, include, but are not limited to, statements about our plans for future services and enhancements of existing services; our expectations regarding our expenses and revenues; our anticipated cash needs and our estimates regarding our capital requirements and our needs for additional financing; our anticipated growth strategies; our ability to successfully integrate acquired businesses; our intention to expand our service offerings; our ability to retain and attract customers; our ability to retain and control the costs of suppliers; our ability to increase content licenses; our regulatory environment; our legal proceedings; intellectual property; our expectations regarding competition; and sources of new revenue. These statements involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from any future results, performances or achievements expressed or implied by the forward-looking statements. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected. These risks and uncertainties include, but are not limited to, the risks set forth throughout this report, including under Item 1A, "Risk Factors." These forward-looking statements speak only as of the date hereof. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.

We believe we are a leading e-commerce platform enabling customers worldwide to create, buy and sell a wide variety of customized and personalized products. We serve our customers, including both consumers and content owners, through our portfolio of e-commerce websites, including our flagship website, CafePress.com. Our consumers include millions of individuals, groups, businesses and organizations who leverage our innovative and proprietary print-on-demand services to express interests, beliefs, and affiliations by customizing a wide variety of products. These products include clothing and accessories, art and posters, stickers, home decor, and stationery. Our content owners include individual designers as well as artists and branded content licensors who leverage our platform to reach a mass consumer base and monetize their content. We believe we are a leading e-commerce platform for customization of consumer products based on our more than a decade of experience of providing high-quality customized products in single unit and small quantity orders on a when-ordered basis. We have developed a strong brand with a growing community that, as of December 31, 2012, had more than 19 million members and more than three million shops, and we shipped over 4 million orders in 2012 from a catalog of over 400 million unique products, as measured by the number of different combinations of designs and types of merchandise.

We define members as visitors to our website who register with us and provide their email address. Members often become customers through purchases on our websites, content owners by opening a shop or purchasing through our Create & Buy function, or both. Content owners include individuals or groups who upload or design images for their own purchase or for sale to others, or corporate clients who provide content to support the sale of branded merchandise. These products can be sold through storefronts hosted by CafePress, which we refer to as shops. Content owners may also sell products through the retail marketplace found on our portfolio of e-commerce websites.

An important driver for our growth is customer acquisition, primarily through online marketing efforts including paid and natural search, email, affiliate and an array of other channels, as well as the acquisition efforts of our


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content owners. We are investing aggressively in customer acquisition and as a result, our sales and marketing expenses are our largest operating expense. Increases in our content library of user-generated and branded content also drive our growth. The expansion of product categories, as well as branded products, contributed to increases in our sales volume as consumers continue to desire custom products, individualized to their unique interests and affiliations. To further expand our customer base outside the United States, we maintain localized websites in Australia, Canada, Germany, France, Spain and the United Kingdom.

The majority of our net revenues is generated from sales of customized products through our e-commerce websites and associated charges. In addition, we generate revenues from fulfillment services, including print and production services provided to third parties. Consumers purchase customized products directly from our website or through storefronts hosted by CafePress. Customized products include user-designed products as well as products designed by our content owners. We pay royalties to content owners for the use of their content on our products and royalty payments are included in cost of net revenues.

A key differentiator of our business model is our ability to profitably produce customized merchandise in small quantities on a when-ordered basis. We generally process and ship orders within three business days after a customer places an order and in many instances can process and ship an order within 24 hours from when the order is placed. We have invested substantial time and resources in establishing our production and fulfillment operations in Louisville, Kentucky and Raleigh, North Carolina. We combine our state-of-the-art print-on- demand infrastructure and technology with variable staffing and efficient distribution to deliver small production run orders profitably at scale.

Seasonal and cyclical influences impact our business volume. A significant portion of our sales are realized in conjunction with traditional retail holidays, with the largest sales volume in the fourth quarter of each calendar year. Our unique offering of custom gifts for the holidays combined with consumers' continued shift to online purchasing drive this trend. As a result of this seasonality, our revenues in the first quarter of each year are generally substantially lower than our revenues in the fourth quarter of the preceding year, and we expect this to continue for the foreseeable future. In addition, political merchandise typically represents one of our largest content categories, which may create a cyclical impact on our volume during key election periods.

In April 2012, we acquired substantially all of the assets of Logo'd Softwear, Inc., an e-commerce provider of personalized apparel and merchandise for groups and organizations, in exchange for $7.5 million in cash, 45,060 shares of CafePress common stock valued at $0.8 million, and cash contingent consideration of up to $8.6 million to be determined based on certain operating metrics. In addition, the principal stockholder was granted 235,242 stock options to purchase shares of CafePress common stock with vesting based on the achievement of certain performance milestones. The contingent right to future earn-out payments will expire on March 31, 2016. We may be unable to successfully integrate this business or realize the anticipated benefits of the acquisition.

In October 2012, we entered into a Merger Agreement with EZ Prints. At the effective time of the merger, all outstanding shares of capital stock of EZ Prints held by the EZ Prints stockholders were converted into the right to receive an initial closing payment in the aggregate amount of $30.0 million in cash, subject to customary adjustments and other transaction expenses. The Merger Agreement also provides for earn-out consideration whereby the EZ Prints stockholders have contingent rights to receive up to $10.0 million based on achievement of certain performance targets for the acquired business over the 12 months following the closing of the Merger. To the extent that such performance targets are achieved, the first $2.7 million will be paid in either CafePress common stock or cash, at the election of the receiving EZ Prints Stockholders, which election was made prior to the closing of the Merger with 6% of EZP stockholders electing stock and 94% electing cash. Any remainder of the $10.0 million, if earned, above $2.7 million would be paid out solely in cash. The Merger Agreement provides that the value of each share of common stock to be issued as part of the earn-out consideration will be $9.24. Accordingly, if the performance targets are achieved in full, CafePress will issue approximately 876 shares of CafePress common stock with an aggregate value of $8,100 (based on the value of $9.24 per share) to


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three former stockholders of EZ Prints, and the remaining earn-out consideration will be paid in cash. We may be unable to successfully integrate this business or realize the anticipated benefits of the acquisition.

We monitor several key operating metrics including:

                             Mar. 31,        June 30,        Sept. 30,                              Mar. 31,        June 30,        Sept. 30,
Three months ended             2011            2011             2011           Dec. 31, 2011          2012            2012             2012           Dec. 31, 2012
Key operating metrics:
(excluding EZ Prints)
Total customers                557,309         629,170          600,013             1,138,425         700,019         737,148          679,310             1,245,338
Total number of orders         665,088         742,529          736,562             1,401,126         839,020         888,439          830,819             1,600,952
Average order size           $      50       $      50       $       50       $            49       $      48       $      52       $       54       $            50

Total customers

Total customers represent the number of transacting customers in a given period based on shipment date. We track the total number of customers by unique member number or email address. As a result, an individual who creates multiple accounts using different email addresses will be counted as multiple unique customers. The total number of customers represents those that are unique to the period specified. Therefore, the total number of unique customers for individual quarters within a year will not necessarily equal the total number of unique customers for the entire year.

We monitor total customers as a key indicator of demand. We seek to expand our customer base through our marketing efforts, expansion of product merchandise, user-generated and licensed content, and acquisitions and through increasing opportunities for customers to create and buy customized and personalized products. We believe the number of customers, both new and repeat, is a key indicator of the growth of our current business.

Total number of orders

Total number of orders represents the number of individual transactions that are shipped during the period. We monitor the total number of orders as a leading indicator of revenue trends. We generally process and ship orders within three business days after a customer places an order. During periods of peak demand, such as the fourth quarter, we optimize our fulfillment operations and resource allocations on a daily basis to maintain process efficiency and high levels of customer satisfaction.

Average order size

Average order size is calculated as billings for a given period based on shipment date divided by the total number of associated orders in the same period. Due to timing of meeting revenue recognition criteria, billings may not be recognized as revenues until the following period. We closely monitor the average order size as it relates to changes in order volume, product pricing and product mix.

Basis of presentation

Net revenues

We generate revenues from online transactions through our portfolio of e-commerce websites. We sell a wide range of customized products such as t-shirts, hats, canvas art prints, banners, stickers and mugs, as well as products containing content supplied by the content owner and offered through our e-commerce websites or, in some cases, through feeds from independent third party websites.


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We recognize revenues associated with an order when all revenue recognition criteria have been met. Revenues are recorded at the gross amount when we are the primary obligor in a transaction, are subject to inventory and credit risk, have latitude in establishing prices and selecting suppliers, or have most of these indicators. For transactions where we act as principal and record revenues on a gross basis, applicable royalty payments to our content owners are recorded in cost of net revenues.

We have entered into arrangements with certain customers to provide fulfillment services under which we are not the primary obligor. These arrangements have historically constituted a smaller component of our business. We consider that we are acting as an agent in such transactions. The net fees received on such transactions are recorded as revenues.

Cost of net revenues

Cost of net revenues includes materials, shipping, labor, royalties and fixed overhead costs related to our manufacturing facilities. The cost of materials may vary based on revenues as well as the price we are able to negotiate when purchasing cotton or other such commodities. Shipping fluctuates with volume as well as the method of shipping chosen by the consumer and fuel surcharges. Labor varies primarily by volume and product mix, and to a lesser extent, based on whether the employee is an hourly or a salary employee. We rely on temporary employees to augment our permanent staff particularly during periods of peak demand. Our royalty expenses comprise fees we pay to our content owners for the use of their content on our products. Certain sales transactions under our Create & Buy program do not incur royalties. For other product sales, royalties vary with volume as well as whether the transaction occurred in a shop or the marketplace. Royalty-based obligations are expensed to cost of net revenues at the contractual rate for the relevant product sales.

Operating expenses

Operating expenses consist of sales and marketing, technology and development, general and administrative expenses and acquisition-related costs. Personnel-related expenses comprise a significant component of our operating expenses and consist of wages and related benefits, bonuses and stock-based compensation.

Sales and marketing

Sales and marketing expenses consist primarily of customer acquisition costs, personnel costs and costs related to customer support, order processing and other marketing activities. Customer acquisition, customer support and order processing expenses are variable and historically have represented more than half of our overall sales and marketing expenses.

Our customer acquisition costs consist of various online media programs, such as paid search engine marketing, email, flash deal promotions through group-buying websites, display advertising and affiliate channels. We believe this expense is a key lever that we can use to drive growth and volume within our business as we adjust volumes to our target return on investment. We expect sales and marketing expense to increase in absolute dollars in the foreseeable future as we continue to invest in new customer acquisition.

Technology and development

Technology and development expenses consist of costs incurred for engineering, network operations, and information technology, including personnel expenses, as well as the costs incurred to operate our websites. Technology and development costs are expensed as incurred, except for certain costs related to the development of internal use software and website development, which are capitalized and amortized over the estimated useful lives ranging from two to three years. We expect technology and development expenses will increase in absolute dollars as we continue to expand our network operations and personnel to support our anticipated future growth.


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General and administrative

General and administrative expenses consist of personnel, professional services and facilities costs related to our executive, finance, human resources and legal functions. Professional services consist primarily of outside legal and accounting services. General and administrative expenses also include headcount and related costs for our fraudulent review organization as well as our content usage review organization. We expect general and administrative expenses to increase in absolute dollars due to the anticipated growth of our business and infrastructure and the costs associated with being a public company, such as costs associated with SEC reporting and compliance, including compliance with the Sarbanes-Oxley Act of 2002, insurance, investor relations fees and similar expenses.

Acquisition-related costs

Acquisition-related costs include performance-based compensation payments, any changes in the estimated fair value of performance-based contingent consideration payments which were initially recorded in connection with our acquisitions and third-party fees incurred in connection with our acquisition activity.

In each period, we revise our accrual for earn-out payments based on our current estimates of performance relative to the stated targets and, where applicable, additional service provided. The accrual could be adjusted if the achievement of goals results in an amount paid that is different from our accrual estimate.

Critical accounting policies and estimates

Our financial statements are prepared in accordance with generally accepted accounting principles in the United States. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, operating expenses and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. In many instances, we could have reasonably used different accounting estimates, and in other instances changes in the accounting estimates are reasonably likely to occur from period-to-period. Accordingly, actual results could differ significantly from the estimates made by our management. To the extent that there are material differences between these estimates and actual results, our future financial statement presentation, financial condition, results of operations and cash flows will be affected. We believe that the accounting policies discussed below are critical to understanding our historical and future performance, as these policies relate to the more significant areas involving management's judgments and estimates.

Revenue recognition

We recognize revenues from product sales, net of estimated returns based on historical experience, when the following revenue recognition criteria are met:
(1) persuasive evidence of an arrangement exists; (2) delivery has occurred or the service has been provided; (3) the selling price or fee revenue earned is fixed or determinable; and (4) collection of the resulting receivable is reasonably assured.

We evaluate whether it is appropriate to record the gross amount of product sales and related costs as product revenues or the net amount earned as fulfillment revenues. Revenues are recorded at the gross amount when we are the primary obligor in a transaction, are subject to inventory and credit risk, have latitude in establishing prices and selecting suppliers, or have most of these indicators. When we are not the primary obligor and do not take inventory risk, revenues will be recorded at the net amount received by us as fulfillment revenues.

Product sales and shipping revenues are recognized net of promotional discounts, rebates, and return allowances. Revenues from product sales and services rendered are recorded net of sales and consumption taxes. We periodically provide incentive offers to customers to encourage purchases. Such offers include current discount offers, such as percentage discounts off current purchases, and other similar offers. Current discount offers, when


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used by customers, are treated as a reduction of revenues. We maintain an allowance for estimated future returns and credit card chargebacks based on current period revenues and historical experience.

We account for flash deal promotions through group-buying websites as gift certificates. Deferred revenue is recorded at the time of the promotion based on the gross fee payable by the end customer as we are the primary obligor in the transaction. We defer the costs for the direct and incremental sales commission retained by group-buying websites and records the associated expense as a component of sales and marketing expense at the time revenue is recognized. Revenue is recognized on redemption of the offer and delivery of the product to our customers.

We run internally managed promotions upon redemption of flash promotions, in which customers can purchase a voucher redeemable for a specified product at a promotional price. This program is accounted for as gift certificates. Deferred revenue is recorded at the time the voucher is purchased and revenue is recognized on redemption and delivery of the product to the customers.

We recognize gift certificate breakage from flash promotions, its internally managed voucher promotions, and gift certificate sales as a component of revenues. We monitor historical breakage experience and when sufficient history of redemption exists, we record breakage revenue in proportion to actual gift certificate redemptions. When we conclude that insufficient history of redemption and breakage experience exists, breakage revenue is recognized upon expiration of the flash deal promotion or in the period we consider the obligation for future performance related to such breakage to be remote. Changes in customers' behavior could impact the amounts that are ultimately redeemed and could affect the breakage recognized as a component of revenues.

We recognized breakage revenue for flash promotions of $5.6 million, $2.6 million and $0.4 million and the associated direct sales commission of $1.9 million, $1.1 million and $0.2 million for the years ended December 31, 2012, 2011 and 2010, respectively. This increased operating income by $3.7 million, $1.5 million and $0.2 million for the years ended December 31, 2012, 2011 and 2010, respectively.

We recognized breakage revenue, and thus increased operating income by the same amount as there are no associated deferred costs for its internally managed voucher promotions and gift certificate programs of $0.7 million and $0.1 million for the years ended December 31, 2012 and 2011, respectively. Voucher promotions or gift certificate programs in the year ended December 31, 2010 were not significant.

Internal use software and website development costs

We incur costs associated with website development and for software developed or obtained for internal use. We expense all costs that relate to the planning associated with website development and for the post- implementation phases of development as product development expense. Costs incurred in the development phase are capitalized and amortized over the product's estimated useful life of two to three years. Costs associated with repair or maintenance are expensed as incurred.

Goodwill and intangible assets

Goodwill represents the excess of the purchase price over the fair value of assets acquired and liabilities assumed related to a business combination. Goodwill is presumed to have an indefinite life and is not subject to amortization. We conduct a quantitative test for the impairment of goodwill at least annually, during the third quarter of each year, and also whenever events or changes in circumstances indicate that the carrying value of the goodwill may not be fully recoverable. The quantitative impairment test is a two-step process. The first step is a comparison of the fair value of the reporting unit with its carrying amount, including goodwill. If this step indicates impairment, then the loss is measured as the excess of recorded goodwill over its implied fair value, or the excess of the fair value of the reporting unit over the fair value of all identified assets and liabilities.


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As of the date of our annual goodwill impairment tests in 2012 and 2011, we had two reporting units: Art and CafePress Consumer. We determine our reporting units for goodwill impairment testing by identifying those components at, or one level below, our reporting segments that (1) constitute a business, (2) have discrete financial information available, and (3) are regularly reviewed by segment management. In performing our quantitative impairment tests, we determine the fair value of our reporting units through a combination of the income and market approaches. Under the income approach, we estimate fair value based on a discounted cash flow model using a discount rate determined by our management to be commensurate with the risk inherent in our current business model. Under the market approach, we estimate fair value of our overall business based on our current market capitalization. Based on our annual impairment analyses performed in the third quarter of 2012 and 2011, neither of our reporting units were at risk of failing step one of the quantitative goodwill impairment assessment and therefore no impairment was recorded.

Subsequent to our annual impairment analysis in the third quarter of 2012, we exceeded the cash flow forecasts in the income approach for both of our reporting units. Our stock price declined during the second half of 2012; however, it has subsequently recovered since the announcement of our actual 2012 fiscal year financial performance. Accordingly, we considered the decline in our stock price as of December 31, 2012 to be temporary in nature and not an indicator requiring an event-driven impairment assessment.

During the fourth quarter of 2012, our acquisition of EZ Prints and the combination of that business with our legacy CafePress B2B group resulted in three reporting units as of December 31, 2012: Art, CafePress Consumer, and CafePress Services. Our goodwill balance in each reporting unit as of December 31, 2012 was $6.8 million, $10.4 million, and $23.0 million, . . .

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