| Commitments and Contingencies | 12. Commitments and Contingencies
Leases
Lease agreements are accounted for as either operating or capital
leases depending on certain defined criteria. The Company leases
certain of its facilities and equipment under noncancelable capital
and operating leases with various expiration dates through 2027.
Certain of the operating lease agreements contain rent holidays and
rent escalation provisions. Rent holidays and rent escalation
provisions are considered in determining straight-line rent expense
to be recorded over the lease term. The lease term begins on the
date of initial possession of the lease property for purposes of
recognizing rent expense on a straight-line basis over the term of
the lease.
In 2005, the Company entered into a capital lease agreement for a
production facility in Louisville, Kentucky consisting of 126,352
square feet. The lease was amended in May 2007 to lease an
additional 20,000 square feet. The capital lease has an interest
rate of 6.5% and expires in 2017.
Pursuant to an amendment to the lease in August of 2012, the
Company added 184,813 square feet. On August 1, 2014, the
Company further amended its primary facility lease (“Facility
Lease Amendment”) to extend the term related only to the
184,813 square feet of leased production and office space from
July 31, 2014 to July 31, 2021. In connection with the
Facility Lease Amendment, the Company also entered into an option
to terminate the lease in its entirety on or after July 31,
2018. In the case of such early lease termination, the Company
would be required to pay a termination fee dependent upon the
effective date of an early lease termination, as follows:
(i) For a termination effective as of
July 31, 2018: $1,512,679
(ii) For a termination effective as of
July 31, 2019: $934,814
(iii) For a termination effective as of
July 31, 2020: $429,736.
Under the terms of the Facility Lease Amendment, the Company is
further required to maintain a Letter of Credit naming the Landlord
as the beneficiary for the maximum amount of the termination fee
for which the Company may be liable under the terms of the Facility
Lease Amendment. See Note 5, Line of Credit.
In October 2007, the Company entered into an operating lease for
office space in San Mateo, California. In December 2012, the
Company amended the lease agreement. The amended lease term ends in
March 2018. The lease includes an option for early termination
effective January 31, 2016. On June 12, 2015, the Company
exercised the early termination option and, accordingly, paid a
termination fee of $0.3 million. See Note 11,
Restructuring
In connection with the acquisition of EZ Prints, the Company
entered into an operating lease agreement for a production facility
in Atlanta, Georgia that expires in March 2016.
Future minimum lease payments under noncancelable operating and
capital leases as of June 30, 2015 are as follows:
Years Ended December 31, Capital Operating
Remaining six months of 2015 $ 304 $ 999
2016 607 876
2017 355 701
2018
— 415
Total minimum lease payments 1,266 $ 2,991
Less amount representing interest (85 )
Present value of capital lease obligations 1,181
Less current portion (547 )
Long-term portion of capital lease obligations $ 634
The future minimum operating lease commitments assume that the
Company exercises its option for early termination under its
current primary facility lease agreement, and does not include an
early termination fee of approximately $1.5 million in 2017.
ITEM 2. MANAGEMENT’S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
You should read the following discussion in conjunction with our
condensed consolidated financial statements (unaudited) and related
notes included elsewhere in this report. Except for the historical
financial information contained herein, this quarterly report on
Form 10-Q contains certain forward-looking statements within the
meaning of Section 27A of the Private Securities Litigation
Reform Act of 1995, as amended and Section 21E of the
Securities Exchange Act of 1934, as amended and are subject to the
safe harbor created by the Securities Litigation Reform Act of
1995. 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 recent divestitures and potential
impacts and anticipated benefits and consequences thereof and our
ongoing obligations under the terms of the related agreements; our
plans for future services and enhancements of existing services;
the benefits of our services, technology and manufacturing
processes; our expectations regarding our expenses and revenue,
including statements about our expectations as to the variability
of our revenues and growth rates from period to period and our
valuation allowances; our expectations regarding the effect of
seasonality and cyclicality on our business; critical accounting
policies; customer acquisition costs as a driver of future growth;
statements regarding continuing customer desire for custom
products; the impairment of goodwill; anticipated trends and
challenges in our business and the markets in which we operate;
status of our strategic evaluations process and our intent to
continue with an ongoing general evaluation of our business
overall, including plans to divest our EZ Prints business and our
expectations regarding the amount of proceeds in relation to the
net asset value of the business unit; the effect of any potential
strategic alternatives, if and to the extent implemented; the
payment of any contingent consideration from our divestiture
transactions: our belief that the strategic steps we have taken
will provide us with resources required to focus on improving our
core business, enhance stockholder value and strengthen our balance
sheet; quarterly trends; our liquidity position and cash flows;
anticipated cash needs and our capital requirements and our needs
for additional financing and the potential impact; our ability to
recognize and remedy issues with internal controls and accounting
treatment thereof; the expected results of any remediation plans;
benefits of non-GAAP financial results; our investment plans; our
anticipated growth strategies; our expectations with respect to raw
materials and suppliers; the impact of production issues and
delayed orders; our expectations regarding the volatility of cash
provided by operating activities and the causes thereof; our
ability to retain and attract customers and drive traffic to our
websites; our expectations regarding the shift to mobile site
access and the projected impact of such shift on our business; our
regulatory environment; our legal proceedings and related risks and
impact and timing of costs related thereto; the effect of recent
changes in executive leadership and in other roles in our
management team; our expectations with regard to how changes in
market interest rates would affect us; our exposure to foreign
currency exchange rate fluctuations; the impact of inflationary
pressures; intellectual property; competition; sources of new
revenue; and expectations regarding our share repurchase program.
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.
Recent Strategic Transactions
Art business asset sale
On March 1, 2015, we completed the sale of our Arts business
pursuant to an asset purchase agreement with Circle Graphics, Inc.
(“Circle Graphics”), dated as of February 11,
2015, whereby we received $28.5 million in proceeds, net of
expenses, $2.4 million of which is in escrow for our
indemnification obligations pursuant to an escrow agreement between
us, Circle Graphics and the escrow agent.
In connection with the Art business asset purchase agreement, we
also entered into a transition services agreement and a commercial
agreement with Circle Graphics. The transition services
agreement with Circle Graphics provides certain corporate support
services that our Art business has historically received from us,
is effective as of the closing date, and certain services can be
provided for up to one year after close. The commercial agreement
permits us to continue to sell Art products on our
websites. If the fulfillment price provided by Circle Graphics
is consistent with market prices, the Art products we sell on our
websites must be exclusively fulfilled by Circle Graphics, provided
that Circle Graphics meets certain pricing criteria. The
initial term of the commercial agreement is for a period of three
years following the closing date.
Groups business asset sale
On March 6, 2015, we completed the sale of our Groups
business, which engages in providing personalized apparel and
merchandise for groups and organizations through our e-commerce
websites (“Groups”), pursuant to an asset purchase
agreement with Logo Sportswear Inc. (“Logo Sportswear”)
whereby we received $9.2 million in proceeds, net of expenses, $1.0
million of which is in escrow for our indemnification obligations
pursuant to an escrow agreement between us, Logo Sportswear and the
escrow agent.
In connection with the Groups business asset purchase agreement, we
also entered into a transition services agreement and a referral
agreement with Logo Sportswear. The transition services
agreement with Logo Sportswear provides certain corporate support
services that our Groups business has historically received from
us, is effective as of the closing date, and certain services can
be provided for up to one year after close. Under the referral
agreement we will continue to promote Logo Sportswear product types
on our websites and redirect potential customers from our websites
to a Logo Sportswear website. The initial term of the referral
agreement is for a period of two years following the closing
date.
EZ Prints, Inc. divestiture plan
In the second quarter of 2015, we committed to a plan to divest our
EZ Prints business, which provides a suite of enterprise class
deployable software products and services to provide private label
e-commerce customization services. We reviewed the carrying value
of the EZ Prints assets as compared to the fair value of such
assets as measured by the offers received. Accordingly, as
prescribed by ASC 360, Impairment or Disposal of Long-Lived
Assets
InvitationBox.com business asset sale
On November 5, 2014, we entered into an asset purchase
agreement with Phoenix Online LLC, a related party which
subsequently separated from CafePress, which sold certain assets
and liabilities of our InvitationBox.com business for a nominal
amount of cash and quarterly revenue share payments equal to: a) 5%
of the gross revenue generated by the InvitationBox.com business
for a period of five years; b) 3% of the gross revenue generated by
the InvitationBox.com business for a period of five years as
consideration for our guaranty of a certain assumed lease for up to
$900,000; and c) 2% of the gross revenue generated by the
InvitationBox.com business for a period of five years as
consideration for certain transition services to be provided by us.
If and when such corporate guaranty is released or the underlying
lease is terminated, and/or the transition services end then the
additional cash revenue payments will cease.
The Art and Groups transactions closed in the first quarter of
2015. The Art and Groups businesses together represented
approximately 34% of our total revenue in 2014. We believe these
strategic steps will provide us the resources required to focus on
improving our core business, further enhance stockholder value and
strengthen our balance sheet.
Prior year consolidated statements of operations have been recast
to reflect the sale of our Invitation box.com business assets in
2014, the sale of our Art and Groups business assets in the first
quarter of 2015, and the classification of the EZ Prints business
as held for sale within discontinued operations. Results of
discontinued operations are excluded from Management’s
Discussion and Analysis of Financial Condition and Results of
Operations for all periods presented, unless otherwise
noted. See Note 4, Discontinued Operations
As previously disclosed, our Board of Directors authorized the
review of various strategic alternatives to streamline our
operations, unlock stockholder value and strengthen our balance
sheet, and retained Raymond James & Associates as our
exclusive independent financial advisor to assist the Board of
Directors in this review. Recent announcements of the closed
divestitures of our Art, Groups and Invitation Box.com businesses
are the successful result of our formal strategic evaluations
process, which is now substantially completed; although we
currently intend to divest our EZ Prints business and continue with
an ongoing general evaluation of our business overall.
Our Business
We are a leading e-commerce platform provider enabling consumer and
business partner customers worldwide to shop, create and sell a
wide variety of customized and personalized products through our
flagship website, CafePress.com, as well as providing a robust
platform of technology products and service offerings to allow
corporate customers to leverage our online services for their own
consumer customers with little up-front investment and no
inventory.
Our facility in Louisville, Kentucky has innovative technology and
manufacturing processes that enable us to provide high-quality
customized products that are individually built to order. Our
proprietary processes enable us to produce a broad range of
merchandise efficiently, cost effectively and quickly.
The majority of our net revenues are generated from sales of
customized products through our e-commerce websites, associated
partner websites or through storefronts hosted by CafePress. In
addition, we generate revenues from fulfillment services, including
print and production services provided to third parties. Customized
products include user-designed products as well as products
designed by our content owners.
An important revenue driver is customer acquisition, primarily
through online marketing efforts including paid and natural search,
email, social, affiliate and an array of other channels, as well as
the acquisition efforts of our content owners. As a result, our
sales and marketing expenses are our largest operating expense.
Our consumers and content owner customers are increasingly
accessing e-commerce sites from their mobile devices. This shift to
mobile site access presents challenges for us as we cope with
shifting traffic patterns, and we have experienced lower conversion
rates from traffic from mobile devices. We expect that this shift
to mobile site access will continue for the foreseeable future.
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 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 each of the first three quarters of
the 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.
We monitor several key operating metrics including (from continuing
operations):
Three Months Ended Six Months Ended
2015 2014 2015 2014
Key operating metrics:
Total number of orders 608,956 734,775 1,225,894 1,383,791
Average order size $ 36 $ 39 $ 36 $ 40
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.
For the three and six month periods ended June 30, 2015, the
decrease in orders is primarily the result of a decline in business
volumes within our CafePress.com marketplace and in our
international domains. These decreases more than offset a business
volume increase within our CafePress Services partner channels.
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 and through our partner’s
websites.
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 and
business partners to provide fulfillment services under which we
are not the primary obligor. These arrangements constituted a
smaller component of our business. We consider ourselves as 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, labor, royalties and fixed
overhead costs related to our manufacturing facilities, as well as
outbound shipping and handling costs. The cost of materials may
vary based on revenues as well as the price we are able to
negotiate. Shipping fluctuates with volume as well as the method of
shipping 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 are comprised of fees we pay to our
content owners for the use of their content on our products. Such
fees vary based primarily on sales channel and volume. Certain
sales transactions under our Create & Buy program do not
incur royalties. 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.
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 the majority 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 and social websites, display
advertising and affiliate channels. We believe this expense is a
key lever that we can use within our business as we adjust volumes
to our target return on investment. We expect to continue to invest
in sales and marketing expense in the foreseeable future to fund
new customer acquisition, increase focus on driving repeat customer
purchases, and build our brand.
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.
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 operations related to our
content usage and fraudulent review personnel.
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.
As of December 31, 2014 we had fulfilled our obligations
related to our previous acquisitions and therefore maintained no
accrual for performance-based contingent consideration
payments.
Critical accounting policies and estimates
The discussion and analysis of our financial condition and results
of operations are based upon our unaudited condensed consolidated
financial statements, which have been prepared in accordance with
accounting principles generally accepted in the United States. The
preparation of these financial statements requires us to make
estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses. On an on-going basis, we
evaluate our critical accounting policies and estimates. We base
our estimates on historical experience and on various other
assumptions that we believe to be reasonable under the
circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities that
are not readily apparent from other sources. Actual results may
differ from these estimates under different assumptions or
conditions. Our critical accounting policies and estimates are
discussed in our Annual Report on Form 10-K filed on March 31,
2015 with the SEC. We update our critical accounting policies and
estimates in our periodic reports on Form 10-Q when they are
modified or expected to be modified.
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, as of
July 1 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.
We determine our reporting units for goodwill impairment testing by
identifying those components at, or one level below, our operating
segments that (1) constitute a business, (2) have
discrete financial information available, and (3) are
regularly reviewed by segment management.
As of the date of our goodwill impairment tests, we determined we
had one operating segment.
In performing our quantitative impairment tests, we determine the
fair value of our reporting unit 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 the fair value of our overall business based
on our current market capitalization, market comparables, or other
objective evidence of fair value. Based on our annual impairment
analyses performed as of July 1, 2014, which resulted in
excess fair value over carrying value of 22%, we concluded that
step two of the goodwill impairment test was not required and
therefore no impairment was recorded.
During fiscal year 2014, our market value dropped to below its book
value, we had management changes, and we had changes to certain
strategic objectives and operations. We considered these items to
be triggering events which resulted in additional goodwill
impairment tests carried out at September 30, 2014 and
December 31, 2014. As a result, we updated our quantitative
impairment test using a combination of the income and market
approaches. Based on our updated impairment analyses performed as
of September 30, 2014 and as of December 31, 2014, which
considered cash flows from continuing operations, excluding the
sale of its InvitationBox.com, Art, and Groups business assets,
there was excess fair value over carrying value of 20% and 27%,
respectively. Accordingly, we concluded that step two of the
goodwill impairment tests were not required at either of these
dates and no impairment was recorded.
In the first quarter of 2015, we closed the sale of our Art and
Groups business assets and in the second quarter of 2015 classified
our EZ Prints business as “Assets Held for Sale” and
“Liabilities Held for Sale” in accordance with ASC
205-20-55, Presentation of Financial Statements and ASC 360,
Property, Plant, and Equipment. We considered these items to be
triggering events, and accordingly, performed goodwill impairment
tests as of March 31, 2015 and June 30, 2015. These tests
resulted in estimated excess fair value over carrying value of 3%
and 6%, respectively. Accordingly, we concluded that step two of
the goodwill impairment tests were not required at either these
dates and no impairment was recorded.
The application of the goodwill impairment test requires judgment,
including the identification of reporting units, assigning assets
and liabilities to reporting units, assigning goodwill to reporting
units, and determining the fair value of each reporting unit.
Significant judgment, and the use of significant estimates and
assumptions, is required to estimate the fair value of reporting
units, including estimating future cash flows, future market
conditions, and determining the appropriate discount rates, growth
rates, and operating margins, among others.
Our discounted cash flow analyses factor in assumptions on revenue
and expense growth rates. These estimates are based upon our
historical experience and projections of future activity, factoring
in customer demand, and a cost structure necessary to achieve the
related revenues. Additionally, these discounted cash flow analyses
factor in expected amounts of working capital and weighted average
cost of capital. We believe its assumptions are reasonable,
however, the fair value of the reporting unit is close to its
carrying amount, including goodwill, and is sensitive to changes in
assumptions.
There can be no assurance that its estimates and assumptions made
for purposes of its goodwill impairment testing, at the annual date
and the interim testing date, will prove to be accurate predictions
of the future. A sustained decline in our stock price and resulting
market capitalization, delays in expected new business
opportunities, unforeseen losses or failure to achieve planned
profitability improvements in the future and changes in other
estimates and assumptions as noted above could result in a
significant goodwill impairment charge. In addition, a change in
reporting units from any further reorganization, could materially
affect the determination of reporting units or fair value for each
reporting unit, which could trigger impairment in the future. It is
not possible at this time to determine if any such future
impairment charge would result.
Further, should some or all of our strategic alternatives fail to
come to fruition, our assigned fair value could be impacted and
result in the fair value of our reporting unit dropping below its
book value. We will continue to review our results against
forecasts and assess our assumptions to ensure they continue to be
appropriate.
We evaluate our finite-lived assets for impairment whenever events
or changes in circumstances indicate that the carrying amount of
the asset is impaired or the estimated useful lives are no longer
appropriate. Intangible assets resulting from the acquisition of
entities accounted for using the purchase method of accounting are
estimated by management based on the fair value of assets received.
Our intangible assets have an economic useful life and/or expire
after a specified period of time and thus are classified as
finite-lived intangible assets on our balance sheets. Amortization
of finite-lived intangible assets is computed using the
straight-line method over the estimated economic life of the assets
which range from three years to eight years. If indicators of
impairment exist and the undiscounted projected cash flows
associated with such assets are less than the carrying amount of
the asset, an impairment loss is recorded to write the asset down
to their estimated fair values. Fair value is estimated based on
discounted future cash flows. Factors that could result in an
impairment review include, but are not limited to, significant
underperformance relative to projected future operating results,
significant negative industry or economic trends and changes in the
planned use of assets. During the third and fourth quarters of
2014, we considered the impact of our annual and interim goodwill
impairment tests, as well as the change in management and in
certain strategic objectives and operations, on the recoverability
of our long-lived assets. We concluded that there was no impairment
of our long-lived intangible assets as of December 31,
2014.
In the second quarter of 2015, we committed to a plan to divest our
EZ Prints business, which provides a suite of enterprise class
deployable software products and services to provide private label
e-commerce customization services. We reviewed the carrying value
of the EZ Prints assets as compared to the fair value of such
assets as measured by the offers received. Accordingly, as
prescribed by ASC 360, Impairment or Disposal of Long-Lived
Assets
In connection with the sale of InvitationBox.com assets in 2014,
and the sale of the Art and Groups businesses in the first quarter
of 2015, we eliminated $18.5 million of goodwill.
Results of Operations
The following table presents the components of our statement of
operations as a percentage of net revenues:
Three Months Ended June 30,
Six Months Ended June 30,
2015 2014 2015 2014
Net revenues 100 % 100 % 100 % 100 %
Cost of net revenues 59 64 61 63
Gross profit 41 36 39 37
Operating expenses:
Sales and marketing 19 26 21 2 |
