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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

 

 

¨	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2013

or

 

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission File Number 001-35468

 

 

CafePress Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware		94-3342816
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)

6901 Riverport Drive, Louisville, KY 40258

(502)-995-2258

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

 

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 or the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer		¨		Accelerated filer		¨
Non-accelerated filer		x  (Do not check if a smaller reporting company)		Smaller reporting company		¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

The number of shares outstanding of the registrant’s common stock as of November 8, 2013 was 17,169,623 shares.

 

 

 

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Table of Contents

CAFEPRESS INC.

TABLE OF CONTENTS

 

				Page No.
PART I.		FINANCIAL INFORMATION			3
Item 1.		Condensed Consolidated Financial Statements (unaudited):			3
		Condensed Consolidated Balance Sheets as of September 30, 2013 and December 31, 2012			3
		Condensed Consolidated Statements of Operations for the three and nine months ended September  30, 2013 and 2012			4
		Condensed Consolidated Statements of Cash Flows for the nine months ended September  30, 2013 and 2012			5
		Notes to Condensed Consolidated Financial Statements			6
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			14
Item 3.		Quantitative and Qualitative Disclosures About Market Risk			21
Item 4.		Controls and Procedures			22
PART II.		OTHER INFORMATION			22
Item 1.		Legal Proceedings			22
Item 1A.		Risk Factors			23
Item 5.		Other Information			39
Item 6.		Exhibits			40
Signatures					42
Exhibit index					43

 

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PART I. FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements

CAFEPRESS INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except par value amounts)

 

		September 30,				December 31,
		2013				2012
		(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents		$	19,750			$	31,198
Short-term investments			1,740				9,403
Accounts receivable			4,844				10,390
Inventory			8,028				9,765
Deferred tax assets			2,794				2,794
Deferred costs			2,795				3,756
Prepaid expenses and other current assets			7,647				4,844
Total current assets			47,598				72,150
Property and equipment, net			21,120				19,892
Goodwill			39,448				40,231
Intangible assets, net			16,145				19,979
Deferred tax assets			5,971				4,417
Other assets			1,213				863
TOTAL ASSETS		$	131,495			$	157,532
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Accounts payable		$	8,950			$	15,088
Partner commissions payable			5,428				7,451
Accrued royalties payable			4,689				6,724
Accrued liabilities			14,367				17,761
Income tax payable			—				765
Deferred revenue			5,453				9,099
Short-term borrowings			—				894
Capital lease obligation, current			569				531
Total current liabilities			39,456				58,313
Capital lease obligation, non-current			2,190				2,282
Other long-term liabilities			2,346				3,628
TOTAL LIABILITIES			43,992				64,223
Commitments and Contingencies
Stockholders’ Equity:
Preferred Stock, $0.0001 par value: 10,000 shares authorized as of September 30, 2013 and December 31, 2012; none issued and outstanding			—				—
Common stock, $0.0001 par value - 500,000 shares authorized and 17,162 and 17,114 shares issued and outstanding as of September 30, 2013 and December 31, 2012, respectively			2				2
Additional paid-in capital			96,902				93,890
Accumulated deficit			(9,401	)			(583	)
TOTAL STOCKHOLDERS’ EQUITY			87,503				93,309
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY		$	131,495			$	157,532

See the accompanying notes to the condensed consolidated financial statements.

 

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CAFEPRESS INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2013				2012				2013				2012
		(Unaudited)								(Unaudited)
Net revenues		$	50,443			$	43,558			$	155,353			$	130,537
Cost of net revenues			30,622				25,541				95,602				76,015
Gross profit			19,821				18,017				59,751				54,522
Operating expenses:
Sales and marketing			14,233				12,401				42,789				34,338
Technology and development			5,094				3,661				15,415				9,810
General and administrative			4,297				4,003				13,185				12,181
Acquisition-related costs			546				1,134				324				2,508
Total operating expenses			24,170				21,199				71,713				58,837
Loss from operations			(4,349	)			(3,182	)			(11,962	)			(4,315	)
Interest income			11				18				37				58
Interest expense			(46	)			(46	)			(152	)			(146	)
Other (expense) income, net			(5	)			—				(1	)			—
Loss before income taxes			(4,389	)			(3,210	)			(12,078	)			(4,403	)
Benefit from income taxes			(1,271	)			(827	)			(3,260	)			(1,216	)
Net loss		$	(3,118	)		$	(2,383	)		$	(8,818	)		$	(3,187	)
Net loss per share of common stock:
Basic and diluted		$	(0.18	)		$	(0.14	)		$	(0.51	)		$	(0.22	)
Shares used in computing net loss per share of common stock:
Basic and diluted			17,153				17,095				17,134				14,319

See the accompanying notes to the condensed consolidated financial statements.

 

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CAFEPRESS INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

		Nine Months Ended September 30,
		2013				2012
		(Unaudited)
Cash Flows from Operating Activities:
Net loss		$	(8,818	)		$	(3,187	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization			6,651				4,449
Amortization of intangible assets			3,834				2,495
Gain on disposal of fixed assets			(160	)			(86	)
Stock-based compensation			2,958				3,062
Change in fair value of contingent consideration liability			(2,461	)			575
Deferred income taxes			(771	)			(1,135	)
Tax (short-fall) benefits from stock-based compensation			(70	)			35
Excess tax benefits from stock-based compensation			—				(142	)
Changes in operating assets and liabilities, net of effect of acquisitions:
Accounts receivable			5,546				(1,217	)
Inventory			1,737				(802	)
Prepaid expenses and other current assets			(2,012	)			(5,864	)
Other assets			(350	)			335
Accounts payable			(6,077	)			(3,896	)
Partner commissions payable			(2,023	)			—
Accrued royalties payables			(2,035	)			(1,849	)
Accrued and other liabilities			(683	)			818
Income taxes payable			(765	)			(1,539	)
Deferred revenue			(3,646	)			(379	)
Net cash used in operating activities			(9,145	)			(8,327	)
Cash Flows from Investing Activities:
Purchase of short-term investments			(1,491	)			(8,656	)
Proceeds from maturities of short-term investments			9,154				7,441
Purchase of property and equipment			(3,999	)			(5,140	)
Capitalization of software and website development costs			(3,136	)			(2,420	)
Proceeds from disposal of fixed assets			170				102
Decrease (increase) in restricted cash			170				(170	)
Acquisition of business, net of cash acquired			—				(7,071	)
Net cash provided by (used in) investing activities			868				(15,914	)
Cash Flows from Financing Activities:
Payments of short-term borrowings			(894	)			—
Principal payments on capital lease obligations			(398	)			(352	)
Proceeds from exercise of common stock options			60				287
Proceeds from sales of common stock in initial public offering, net			—				41,771
Borrowings under insurance financing			940				—
Payment under insurance financing			(428	)			—
Excess tax benefits from stock-based compensation			—				142
Payments of contingent consideration			(2,451	)			—
Net cash (used in) provided by financing activities			(3,171	)			41,848
Net (decrease) increase in cash and cash equivalents			(11,448	)			17,607
Cash and cash equivalents — Beginning of period			31,198				27,900
Cash and cash equivalents — End of period		$	19,750			$	45,507
Supplemental Disclosures of Cash Flow Information:
Cash paid for interest		$	135			$	145
Income taxes paid during the period			997				2,214
Noncash Investing and Financing Activities:
Accrued purchases of property and equipment		$	57			$	288
Property and equipment acquired under rent agreement			321				—
Property and equipment acquired under capital lease			344				—
Conversion of preferred stock to common stock			—				22,811
Common stock issued for acquisition			—				830

See the accompanying notes to the condensed consolidated financial statements.

 

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CAFEPRESS INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Business and Summary of Significant Accounting Policies

Business

CafePress Inc., or the Company, formerly CafePress.com, Inc., was incorporated under the laws of the State of California on October 18, 1999. On January 19, 2005, the Company was reincorporated under the laws of the State of Delaware. On June 7, 2011, the name of the Company was changed to CafePress Inc.

The Company serves its customers, including both consumers and content owners, through its portfolio of e-commerce websites and platform services providers, including its flagship website, CafePress.com. The Company’s consumer customers include millions of individuals, groups, businesses and organizations who leverage its 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. The Company’s business customers leverage its proprietary software and services platforms to bring e-commerce services to their own online environments. The Company’s content owner relationships include individual designers as well as artists and branded content and corporate and entertainment licensors who leverage its platform to reach a mass consumer base and monetize their content.

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 or through its technology deployed in other e-commerce environments. Content owners may also sell products through the retail marketplace found on the Company’s portfolio of e-commerce websites.

The Company manages substantially all aspects of doing business online, including e-commerce and hosted services, product manufacturing and sourcing, fulfillment, and customer service.

Our business is subject to seasonal fluctuations. In particular, we generate a significant portion of our revenues during the fourth quarter, primarily due to increased retail activity during the holiday seasons. During the fourth quarter, we typically see our largest increases in orders and customers. 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.

Initial Public Offering

On April 3, 2012, the Company’s registration statement on Form S-1 relating to an initial public offering, or IPO, of the Company’s common stock was declared effective by the Securities and Exchange Commission, or SEC. The IPO closed on April 3, 2012 at which time the Company sold 2,500,000 shares of common stock and received cash proceeds of $44.2 million from this transaction, net of underwriting discounts and commissions. Additionally, the Company incurred offering costs of approximately $4.6 million related to the IPO. An additional 2,000,000 shares of common stock were sold by existing stockholders from whom the Company did not receive any proceeds or incur any costs.

Concurrently, all outstanding shares of convertible preferred stock converted into 5,534,963 shares of common stock with the related carrying value of $22.8 million reclassified to common stock and additional paid-in capital.

Basis of Presentation

The accompanying unaudited condensed financial statements include the accounts of the Company and its wholly owned subsidiary. All intercompany transactions and balances have been eliminated.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles, or U.S. GAAP, and following the requirements of the SEC for interim reporting. As permitted under those rules, certain footnotes or other financial information that are normally required by U.S. GAAP can be condensed or omitted. These financial statements have been prepared on the same basis as the Company’s annual financial statements and, in the opinion of management, reflect all adjustments, consisting only of normal recurring adjustments, that are necessary for a fair statement of the Company’s financial information. The results of operations for the three and nine months ended September 30, 2013 are not necessarily indicative of the results to be expected for the year ending December 31, 2013 or for any other interim period or for any other future year. The balance sheet as of December 31, 2012 has been derived from audited financial statements at that date but does not include all of the information required by U.S. GAAP for complete financial statements.

 

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The accompanying condensed consolidated financial statements and related financial information should be read in conjunction with the audited financial statements and the related notes thereto for the year ended December 31, 2012 included in the Company’s Annual Report on Form 10-K as filed on March 18, 2013 with the SEC.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, the Company evaluates its estimates, including but not limited to those related to revenue recognition, provisions for doubtful accounts, credit card chargebacks, sales returns, inventory write-downs, stock-based compensation, fair value of the Company’s common stock, legal contingencies, depreciable lives, asset impairments, contingent consideration liabilities, accounting for business combinations, and income taxes including required valuation allowances. The Company bases its estimates on historical experience, projections for future performance and other assumptions that it believes to be reasonable under the circumstances. Actual results could differ materially from those estimates.

Revenue Recognition

The Company recognizes 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.

The Company evaluates 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 the Company is the primary obligor in a transaction, is subject to inventory and credit risk, has latitude in establishing prices and selecting suppliers, or has most of these indicators. When the Company is not the primary obligor and does not take inventory risk, revenues will be recorded at the net amount received by the Company 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. The Company periodically provides 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 used by customers, are treated as a reduction of revenues. The Company maintains an allowance for estimated future returns and credit card chargebacks based on current period revenues and historical experience.

The Company accounts 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 the Company considers it is the primary obligor in the transaction. The Company defers 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 the Company’s customers.

The Company runs internally managed promotions upon redemption of flash deals, 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.

The Company recognizes gift certificate breakage from flash deal promotions, its internally managed voucher promotions, and gift certificate sales as a component of revenues. The Company monitors historical breakage experience and when sufficient history of redemption exists, the Company records breakage revenue in proportion to actual gift certificate redemptions. When the Company concludes that insufficient history of redemption and breakage experience exists, breakage revenue is recognized upon expiration of the flash deal promotion or in the period the Company considers 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.

The Company recognized breakage revenue for flash deal promotions of $1.0 million and $1.6 million and the associated direct sales commission of $0.3 million and $0.6 million for the three months ended September 30, 2013 and 2012, respectively. This increased operating income by $0.7 million and $1.0 million for the three months ended September 30, 2013 and 2012, respectively. The Company recognized breakage revenue for flash deal promotions of $3.3 million and $3.7 million and the associated direct sales commission of $1.1 million and $1.3 million for the nine months ended September 30, 2013 and 2012, respectively. This increased operating income by $2.2 million and $2.4 million for the nine months ended September 30, 2013 and 2012, respectively.

The Company recognized breakage revenue of $0.0 million and $0.1 million 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 for the three months ended September 30, 2013 and 2012, respectively, and $0.2 million and $0.7 million for the nine months ended September 30, 2013 and 2012, respectively.

 

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Deferred revenues include funds received in advance of product fulfillment, deferred revenue for flash deal promotions and gift cards and amounts deferred until applicable revenue recognition criteria are met. Direct and incremental costs associated with deferred revenue are deferred, classified as deferred costs, and recognized in the period revenue is recognized.

Out-of-Period Adjustment

During the third quarter of 2013, the Company recorded an adjustment to its deferred tax assets and goodwill to correct an error related to the EZ Prints acquisition. In the initial valuation recorded in the fourth quarter of 2012, the deferred tax asset was understated. The adjustment increased long term deferred tax assets by $0.8 million and decreased goodwill by the corresponding amount. The Company has concluded that the impact of this adjustment is immaterial to the current and previously issued consolidated financial statements.

2. Balance Sheet Items

Property and equipment, net are comprised of the following (in thousands):

 

		September 30,				December 31,
		2013				2012
Building		$	3,782			$	3,782
Office furniture and computer equipment			13,863				13,697
Computer software			2,602				2,370
Internal use software and website development			13,685				9,336
Production equipment			21,099				21,598
Leasehold improvements			4,710				2,950
Total property and equipment			59,741				53,733
Less: accumulated depreciation and amortization			(38,621	)			(33,841	)
Property and equipment, net		$	21,120			$	19,892

Accrued liabilities consist of the following (in thousands):

 

		September 30,				December 31,
		2013				2012
Acquisition-related costs		$	3,831			$	1,094
Contingent consideration, short-term portion			2,906				5,896
Payroll and employee related expense			2,677				3,672
Other accrued liabilities			2,125				2,361
Production costs			1,389				1,586
Professional services			469				1,427
Royalties-minimum guarantee			342				94
Unclaimed royalty payments			281				281
Accrued advertising			180				897
Allowance for sales returns and chargebacks			167				453
Accrued liabilities		$	14,367			$	17,761

 

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The following table presents the changes in the allowance for sales returns and chargebacks (in thousands):

 

		Three Months  Ended September 30,								Nine Months Ended September 30,
		2013				2012				2013				2012
Balance, beginning of period		$	173			$	334			$	453			$	455
Add: provision			1,194				908				3,393				2,776
Less: deductions and other Adjustments			(1,200	)			(892	)			(3,679	)			(2,881	)
Balance, end of period		$	167			$	350			$	167			$	350

Intangible assets are composed of the following (in thousands):

 

						September 30, 2013												December 31, 2012
						Gross								Net				Gross								Net
		Amortization				carrying				Accumulated				carrying				carrying				Accumulated				carrying
		period				amount				amortization				amount				amount				amortization				amount
Developed technology			4.0 years			$	12,447			$	(4,579	)		$	7,868			$	12,447			$	(2,265	)		$	10,182
Business relationships			5.5 years				7,817				(3,460	)			4,357				7,817				(2,513	)			5,304
Other intangible assets			6.4 years				6,979				(3,059	)			3,920				6,979				(2,486	)			4,493
Total						$	27,243			$	(11,098	)		$	16,145			$	27,243			$	(7,264	)		$	19,979

3. Fair Value of Financial Instruments

The Company records its financial assets and liabilities at fair value. The accounting guidance for fair value provides a framework for measuring fair value, clarifies the definition of fair value, and expands disclosures regarding fair value measurements. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability, an exit price, in an orderly transaction between market participants at the reporting date. The accounting guidance establishes a three-tiered hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value:

Level 1 – Quoted prices in active markets for identical assets or liabilities.

Level 2 – Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

The Company’s financial instruments, including cash and cash equivalents, short-term investments, accounts receivable, accounts payable and accrued liabilities have carrying amounts which approximate fair value due to the short-term maturity of these instruments.

The following table represents the Company’s fair value hierarchy for its financial assets and liabilities (in thousands):

 

		September 30, 2013
		Fair Value				Level I				Level II				Level III
Cash and cash equivalents:
Money market funds		$	6,582			$	6,582			$	—			$	—
Total financial assets		$	6,582			$	6,582			$	—			$	—
Liabilities:
Acquisition related contingent consideration		$	3,970			$	—			$	—			$	3,970
Total financial liabilities		$	3,970			$	—			$	—			$	3,970

 

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		December 31, 2012
		Fair Value				Level I				Level II				Level III
Cash and cash equivalents:
Money market funds		$	14,594			$	14,594			$	—			$	—
Total financial assets		$	14,594			$	14,594			$	—			$	—
Liabilities:
Acquisition related contingent consideration		$	8,882			$	—			$	—			$	8,882
Total financial liabilities		$	8,882			$	—			$	—			$	8,882

In 2012 and 2011, the Company acquired businesses which the Company accounted for under the purchase method of accounting. The terms of the agreements relating to the acquisitions provide for contingent consideration up to $19.8 million that is accounted for as part of the purchase consideration. The estimated fair value of the performance-based contingent consideration was $4.0 million and $8.9 million as of September 30, 2013 and December 31, 2012, respectively. This contingent liability has been reflected as a current liability of $2.9 million and a non-current liability of $1.1 million as of September 30, 2013. The Company determined the estimated fair value of the liability for the contingent consideration based on a probability-weighted discounted cash flow analysis. In each period, the Company reassesses its current estimates of performance relative to the stated targets and adjusts the liability to the estimated fair value. Contingent consideration (benefit)/expense is recorded for any change in the estimated fair value of the recognized amount of the liability for contingent consideration. Any further changes to these estimates and assumptions could significantly impact the estimated fair values recorded for this liability resulting in significant charges to our Condensed Consolidated Statements of Operations.

The change in the contingent consideration liability, which is a Level 3 liability measured at fair value on a recurring basis, is summarized as follows during the three and nine months ended September 30, 2013 (in thousands):

 

		Three Months Ended				Nine Months Ended
		September 30, 2013				September 30, 2013
Fair value — beginning of period		$	4,093			$	8,882
Payment of contingent consideration during the period			—				(2,451	)
Change in fair value			(123	)			(2,461	)
Fair value — end of period		$	3,970			$	3,970

The Company determines the fair value of the liability for contingent consideration based on a probability-weighted discounted cash flow analysis. In each period, the Company reassesses its current estimates of performance relative to the stated targets and adjusts the liability to fair value.

During the quarter ended June 30, 2013, although EZ Prints and our corporate client relationships continued to contribute to our overall revenue growth, we did not see the incremental impact from new business opportunities that we expected when we completed our last probability-weighted cash flow analysis. In addition, in August 2013, we entered into an amendment to the October 2012 merger agreement with EZ Prints, pursuant to which the earn-out provision was revised such that the former stockholders of EZ Prints have contingent rights to receive a maximum earn-out consideration of up to $1.0 million based on achievement of revised performance targets of the acquired business for the period commencing September 1, 2013 and ending August 31, 2014. We also entered into an amended earn-out bonus agreement with an officer revising his contingent right to receive up to $1.0 million down to $0.1 million. The Company believes that the long-term value of the EZ Prints business is still intact, and continues to utilize the acquired EZ Prints technology in many facets of the combined business. However, as a result of the amendment to the merger agreement and revenue performance through the quarter ended June 30, 2013, we adjusted both our probability weightings and earn-out consideration targets, resulting in a reduction of $2.6 million to the fair value of the contingent consideration liability.

The total change in fair value of the contingent consideration liability during the nine months ended September 30, 2013 includes the impact of this adjustment, together with accretion on contingent consideration liabilities associated with our other acquisitions.

 

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The change in fair value of contingent consideration classified within Level 3 of the fair value hierarchy is recorded within acquisition-related costs in the consolidated statement of operations.

4. Line of Credit

As of December 2012, the Company had a line of credit consisting of a Term Facility with a maximum credit availability of $2.0 million, a Revolving Facility with a maximum credit availability of $3.5 million, limited by a borrowing base consisting of eligible accounts receivable, and $0.5 million non-formula borrowing tranche. There were no draws against the Term Facility as of December 31, 2012. The balance on the Revolving Facility as of December 31, 2012 was $0.9 million. In February 2013, the Company repaid the outstanding balance and terminated the line of credit agreement.

In March 2013, the Company entered into a credit agreement, which provides for a revolving credit facility of $5.0 million to fund acquisitions, share repurchases and other general corporate needs, is available through March 2015 and bears interest at either the London Inter Bank Offer Rate +1.75% or the bank’s prime rate + .75%. This credit agreement requires the Company to comply with various financial covenants, all of which the Company was in compliance with at September 30, 2013, and is secured on all assets of the Company. There were no draws against the facility as of September 30, 2013.

5. Stock-Based Compensation

The fair value of the Company’s stock-based payment awards was estimated on the grant date using the Black-Scholes option-pricing model. The expected term of options granted is calculated using the simplified method. The risk-free rate is based on the rates in effect at the time of grant for zero coupon U.S. Treasury notes with maturities approximately equal to each grant’s expected life. The expected volatility is based upon the volatility of a group of publicly traded industry peer companies. A dividend yield of zero is applied since the Company has not historically paid dividends and has no intention to pay dividends in the near future.

The following table summarizes stock option activity related to shares of common stock (in thousands, except the weighted average exercise price):

 

		Number of Stock Options Outstanding				Weighted- Average Exercise Price				Weighted- Average Remaining Contractual Life (Years)				Aggregate intrinsic value
Outstanding — December 31, 2012			3,483			$	12.22				4.95			$	955
Granted			380				6.33
Exercised			(35	)			1.68
Forfeited			(822	)			13.35
Outstanding — September 30, 2013			3,006				11.29				4.70				1,017
Vested and expected to vest — September 30, 2013			1,956				11.17				4.10				929
Vested — September 30, 2013			1,538				11.51				3.56				880

The fair value of the option awards was calculated using the Black-Scholes option valuation model with the following assumptions:

 

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2013				2012				2013				2012
Expected term (in years)			4.5				4.6				4.5				4.7
Risk-free interest rate			1.2	%			0.6	%			0.9	%			0.8	%
Expected volatility			53	%			60	%			56	%			60	%
Expected dividend rate			0.0	%			0.0	%			0.0	%			0.0	%

 

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Restricted Stock Unit Activity

The Company may grant restricted stock units, or RSUs, to its employees, consultants or outside directors under the provisions of the 2012 Stock Incentive Plan. The cost of RSUs is determined using the fair value of the Company’s common stock on the date of grant. Compensation cost is amortized on a straight-line basis over the requisite service period.

Restricted stock award and restricted stock unit activity for the nine months ended September 30, 2013 is summarized as follows (unit numbers in thousands):

 

		Number of Units Outstanding				Weighted Average Grant Date Fair Value Per Unit
Awarded and unvested at December 31, 2012			—			$	—
Granted			92				6.12
Vested			(13	)			6.56
Awarded and unvested at September 30, 2013			79			$	6.09

Stock-Based Compensation Expense

Cost of net revenues and operating expenses include stock-based compensation as follows (in thousands):

 

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2013				2012				2013				2012
Cost of net revenues		$	48			$	60			$	168			$	174
Sales and marketing			122				115				342				423
Technology and development			58				53				178				170
General and administrative			737				761				2,270				2,295
Total stock-based compensation expense		$	965			$	989			$	2,958			$	3,062

Capitalizable stock-based compensation relating to software development was not significant for any period presented.

6. Net Income (Loss) per Share of Common Stock

Basic net loss per share is computed by dividing the net loss attributable to common shares for the period by the weighted average number of common shares outstanding during the period.

Diluted net loss per share attributed to common shares is computed by dividing the net loss attributable to common shares for the period by the weighted average number of common and potential common shares outstanding during the period, if the effect of each class of potential common shares is dilutive. Potential common shares include restricted stock units and incremental shares of common stock issuable upon the exercise of stock options.

 

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The following table sets forth the computation of the Company’s basic and diluted net loss per share of common stock (in thousands, except for per share amounts):

 

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2013				2012				2013				2012
Net loss		$	(3,118	)		$	(2,383	)		$	(8,818	)		$	(3,187	)
Shares used in computing net loss per share of common stock, basic and diluted			17,153				17,095				17,134				14,319
Net loss per share of common stock, basic and diluted		$	(0.18	)		$	(0.14	)		$	(0.51	)		$	(0.22	)

7. Pro forma results of acquisition of Logo’d Softwear, Inc.

In April 2012, the Company acquired substantially all of the assets of Logo’d Softwear, Inc., an e-commerce provider of personalized apparel and merchandise for groups and organizations.

The following table presents unaudited pro forma results of operations for the three and nine months ended September 30, 2012 as if the aforementioned acquisition of Logo’d Softwear, Inc. had occurred as of January 1, 2012. The Company prepared the pro forma financial information for the combined entities for comparative purposes only, and it is not indicative of what actual results would have been if the acquisition had taken place at January 1, 2012, or of future results.

 

		Three Months Ended September 30, 2012				Nine Months Ended September 30, 2012
Revenues		$	43,558			$	133,294
Net loss		$	(2,383	)		$	(2,900	)
Net loss per share:
Basic and diluted		$	(0.14	)		$	(0.20	)

8. Segment Information

Operating segments are defined as components of an enterprise that engage in business activities for which separate financial information is available and evaluated by the chief operating decision maker in deciding how to allocate resources and assessing performance. The Company’s chief operating decision maker is its chief executive officer. The chief executive officer reviews financial information presented on a consolidated basis, for purposes of allocating resources and evaluating financial performance. The Company has one business activity and there are no segment managers who are held accountable for operations, or plans for levels or components below the consolidated unit level. Accordingly, the Company operates as a single reportable segment.

The Company’s revenues by geographic region, based on the location to where the product was shipped, are summarized as follows (in thousands):

 

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2013				2012				2013				2012
United States		$	45,086			$	39,143			$	140,001			$	116,762
International			5,357				4,415				15,352				13,775
Total		$	50,443			$	43,558			$	155,353			$	130,537

All of the Company’s long-lived assets are located in the United States.

 

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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. This Report on Form 10-Q 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 revenue, including statements about our expectations as to the variability of our growth rates from period to period; customer acquisition costs as a predictor of future growth; anticipated trends and challenges in our business and the markets in which we operate; the effect of a change in market interest rates, foreign currency exchange rate fluctuations, or inflation; expectations regarding the impact and contribution from EZ Prints, including the long term value of the EZ Prints business, and the potential impact of the revised earn-out provision; our anticipated cash needs and our estimates regarding our capital requirements and our needs for additional financing and the potential dilutive effect thereof; our anticipated growth strategies; 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 regulatory environment; our legal proceedings and related risks and impact and timing of costs related thereto; 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; our expectations regarding competition; use of proceeds; 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.

Overview

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 accents, 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.

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 to seasonality, our revenues and operating results may fluctuate due to a variety of factors, including consumer spending trends, our ability to maintain or increase website traffic to our ecommerce sites, including our ability to provide accurate search results and recommendations, our ability to deliver long-tail content to our ecommerce partners, fluctuations in the revenue contribution as between our various ecommerce properties, the gain, loss or success of significant strategic relationships and partner programs, changes in the product roadmap in connection with these relationships and programs, changes in the timing or delays in the launch of partner programs, as well as those other factors discussed under “Risk Factors”.

We monitor several key operating metrics including:

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2013				2012				2013				2012
Key operating metrics:
Total number of orders			1,315,414				830,819				4,221,583				2,558,278
Average order size		$	38			$	54			$	36			$	51
Average order size (excluding EZ Prints)		$	53			$	54			$	53			$	51

 

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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. Because we recognize revenues upon delivery, 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. The decrease in our average order size in 2013 was due to our acquisition of EZ Prints, Inc., or EZ Prints, which has a smaller average order size resulting from fulfillment pricing for some of its partners, and a relatively high volume of photo-related gift items priced at less than $10.

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 clothing and accessories, art and posters, stickers, home decor, and stationery, 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.

We recognize revenues associated with an order when the products have been delivered and all other 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 a permanent or a temporary 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. Certain sales transactions under our Create & Buy program and the Business-to-Business, or B2B 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 a majority of 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, affiliate channels and our social media programs. 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.

Benefit from income taxes

The company performs quarterly assessments to determine if additional valuation allowances on our deferred tax assets are necessary. Assessing the need for, or sufficiency of, a valuation allowance requires management to evaluate all available evidence, both positive and negative, including the recent trend of earnings before income taxes, adjusted for permanent items. Positive evidence necessary to overcome any negative evidence includes whether future taxable income in sufficient amounts and character within the carryback and carryforward periods is available under the tax law. When negative evidence exists, more positive evidence than negative evidence will be necessary.

We have generated a cumulative loss before income taxes as adjusted for permanent items for the twelve quarters ended September 30, 2013 (“cumulative loss position”). A cumulative loss position is considered significant negative evidence in assessing the realizability of a deferred tax asset. We considered this compared to the positive evidence supporting the realizability of our deferred tax assets. Such evidence includes having generated (1) taxable income in each of the last six tax years; (2) pre-tax income in nine of the last eleven years through our fiscal year ended December 31, 2012; and (3) cumulative pre-tax income as adjusted for permanent items over the last three years, exclusive of an unusual loss that created a future deductible amount. When weighting the evidence of our cumulative loss position, we considered the expenses incurred during the twelve months ended September 30, 2013 associated with the consolidation of our manufacturing facilities, which we do not expect to recur in the future. We also considered our experience of previously conducting a manufacturing facilities relocation which resulted in a pre-tax loss during the period, but was followed by a return to earnings before income taxes in the following year. We noted that we are forecasting taxable income and pre-tax earnings upon the completion of our current manufacturing consolidation activities. Based on the level of positive evidence, we have concluded that it is more likely than not that our deferred tax assets will be realized.

There is no guarantee that the tax benefits associated with our deferred tax assets will be fully realized. We will continue to assess the evidence and if the amount of negative evidence increases, we may conclude a valuation allowance is necessary. The amount of the deferred tax asset considered realizable, however, could be significantly reduced as early as next quarter if future estimates of taxable income are significantly lower than currently forecasted due to decreases in market conditions or our operating results. Any recording of a valuation allowance would be recorded as a tax expense which would decrease net income for the period.

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 18, 2013 with the SEC.

 

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Results of Operations

The following table presents the components of our statement of operations as a percentage of net revenues:

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2013				2012				2013				2012
Net revenues			100	%			100	%			100	%			100	%
Cost of net revenues			61				59				62				58
Gross profit			39				41				38				42
Operating expenses:
Sales and marketing			28				28				28				26
Technology and development			10				8				10				8
General and administrative			9				9				8				9
Acquisition-related costs			1				3				—				2
Total operating expenses			48				49				46				45
Loss from operations			(9	)			(7	)			(8	)			(3	)
Interest income			—				—				—				—
Interest expense			—				—				—				—
Other (expense) income			—				—				—				—
Loss before income taxes			(9	)			(7	)			(8	)			(3	)
Benefit from income taxes			(3	)			(2	)			(2	)			(1	)
Net loss			(6	)%			(5	)%			(6	)%			(2	)%
Effective tax rate			29.0	%			25.8	%			27.0	%			27.6	%

Comparison of the Three Month Periods Ended September 30, 2013 and 2012

 

		Three Months Ended September 30,								$ Change				% Change
		2013				2012
(in thousands, except for percentages)
Net revenues		$	50,443			$	43,558			$	6,885				16	%
Cost of net revenues			30,622				25,541				5,081				20
Gross profit			19,821				18,017				1,804				10
Operating expenses:
Sales and marketing			14,233				12,401				1,832				15
Technology and development			5,094				3,661				1,433				39
General and administrative			4,297				4,003				294				7
Acquisition-related costs			546				1,134				(588	)			(52	)
Total operating expenses			24,170				21,199				2,971				14
Loss from operations			(4,349	)			(3,182	)			(1,167	)			37
Interest income			11				18				(7	)			(39	)
Interest expense			(46	)			(46	)			—				—
Other (expense) income, net			(5	)			—				(5	)			—
Loss before income taxes			(4,389	)			(3,210	)			(1,179	)			37
Benefit from income taxes			(1,271	)			(827	)			(444	)			54
Net loss		$	(3,118	)		$	(2,383	)		$	(735	)			31	%

Net revenues

Net revenues increased $6.9 million, or 16%, in the three months ended September 30, 2013 compared to the same period in 2012. The increase in net revenues is primarily due to an increase in orders, which was attributable to the acquisition of EZ Prints that increased our presence in corporate partnerships, as well as an increase in our art category, and to a lesser extent, growth in international revenue. Our revenue growth rates have historically varied from period to period and we expect this trend to continue.

 

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Cost of net revenues

Cost of net revenues increased $5.1 million, or 20%, in the three months ended September 30, 2013 compared to the same period in 2012. As a percentage of net revenues, cost of net revenues was 61% in the three months ended September 30, 2013 and 59% in the same period in 2012. One time plant consolidation costs, the impact of the B2B portion of the EZ Prints legacy business, and changes in product mix increased cost of net revenues by 3.1 percentage points as a percentage of net revenues. These increases were partially offset by a 1.0 percentage point as a percentage of net revenues decline in royalty payments due to an increase in sales of products with lower royalty rates.

Sales and marketing

Sales and marketing expenses increased $1.8 million, or 15%, in the three months ended September 30, 2013 compared to the same period in 2012. Sales and marketing expenses were 28% of net revenues in the three months ended September 30, 2013 and in the same period in 2012. The increase in absolute dollars was primarily due to higher variable expenses, including increases of $1.2 million in customer acquisition expense due to increased online acquisition activities, such as keyword searches, online advertising and expansion of marketing efforts into new channels such as social media. In addition, personnel costs increased $0.5 million due to our acquisition of EZ Prints.

Technology and development

Technology and development expenses increased $1.4 million, or 39%, in the three months ended September 30, 2013 compared to the same period in 2012. Technology and development expenses were 10% of net revenues in the three months ended September 30, 2013 compared to 8% in the same period in 2012. The increase consists of $0.5 million related primarily to depreciation and the hosting services and costs to support our websites, as well as increases in personnel-related expenses of $0.4 million, and amortization expense of intangible assets increased $0.5 million. The acquisition of EZ Prints accounted for $1.2 million of these increases.

General and administrative

General and administrative expenses increased by $0.3 million, or 7%, in the three months ended September 30, 2013 compared to the same period in 2012. General and administrative expenses were 9% of net revenues in the three months ended September 30, 2013 and in the same period in 2012. The slight increase in absolute dollars is due to an increase in legal and professional fees, and to a lesser extent, personnel-related costs primarily related to additional employees and contractors due to our acquisition of EZ Prints.

Acquisition-related costs

Acquisition-related costs were $0.5 million and $1.1 million in the three months ended September 30, 2013, and September 30, 2012, respectively. The decrease of $0.6 million consists primarily of a $0.3 million decrease in contingent consideration liability related to our acquisition of L & S Retail Ventures Inc. and a $0.2 million decrease in legal fees related to acquisitions.

Benefit from income taxes

The benefit from income taxes was $1.3 million and $0.8 million in the three months ended September 30, 2013 and September 30, 2012, respectively. Our effective tax rate was 29.0% and 25.8% in the three months ended September 30, 2013 and September 30, 2012, respectively. The effective tax rate was higher in 2013 primarily due to the impact of a lower estimated domestic production tax deduction and a discrete charge of $0.2 million related to the expiration of unexercised stock options.

Comparison of the Nine Month Periods Ended September 30, 2013 and 2012

 

		Nine Months Ended September 30,								$ Change				% Change
		2013				2012
(in thousands, except for percentages)
Net revenues		$	155,353			$	130,537			$	24,816				19	%
Cost of net revenues			95,602				76,015				19,587				26
Gross profit			59,751				54,522				5,229				10
Operating expenses:
Sales and marketing			42,789				34,338				8,451				25
Technology and development			15,415				9,810				5,605				57
General and administrative			13,185				12,181				1,004				8
Acquisition-related costs			324				2,508				(2,184	)			(87	)
Total operating expenses			71,713				58,837				12,876				22
Loss from operations			(11,962	)			(4,315	)			(7,647	)			177
Interest income			37				58				(21	)			(36	)
Interest expense			(152	)			(146	)			(6	)			4
Other (expense) income, net			(1	)			—				(1	)			—
Loss before for income taxes			(12,078	)			(4,403	)			(7,675	)			174
Benefit from income taxes			(3,260	)			(1,216	)			(2,044	)			168
Net loss		$	(8,818	)		$	(3,187	)		$	(5,631	)			177	%

 

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Net revenues

Net revenues increased $24.8 million, or 19%, in the nine months ended September 30, 2013 compared to the same period in 2012. The increase in net revenues is due to an increase in orders attributable primarily to acquisitions, which increased our presence in corporate partnerships and clubs, groups, and organizations, and, to a lesser extent, to increased revenue from art products and expansion in mobile and social media programs.

Cost of net revenues

Cost of net revenues increased $19.6 million, or 26%, in the nine months ended September 30, 2013 compared to the same period in 2012. As a percentage of net revenues, cost of net revenues was 62% in the nine months ended September 30, 2013 compared to 58% in the same period in 2012. Within cost of net revenues, content royalty expense decreased by 1.3 percentage points as a percentage of net revenues due to an increase in sales of products with lower royalty rates while materials, shipping, labor and fixed overhead costs collectively increased as a percentage of net revenues by 4.6 percentage points due to changes in the product mix and pricing to attract new customers, plant consolidation expenses, as well as the impact of the B2B portion of the EZ Prints business, which has lower gross margins.

Sales and marketing

Sales and marketing expenses increased $8.5 million, or 25%, in the nine months ended September 30, 2013 compared to the same period in 2012. Sales and marketing expenses were 28% of net revenues in the nine months ended September 30, 2013 compared to 26% in the same period in 2012. The increase in sales and marketing expenses was primarily due to higher variable expenses, including increases of $5.3 million in customer acquisition costs primarily due to increased online customer acquisition activities, expansion of marketing efforts into new channels such as social media, as well as costs related to flash deal promotions. Due to our recent acquisitions, payroll and related costs increased $2.2 million and amortization of intangible assets increased by $0.3 million as compared to the same period in 2012.

Technology and development

Technology and development expenses increased $5.6 million, or 57%, in the nine months ended September 30, 2013 compared to the same period in 2012. Technology and development expenses were 10% of net revenues in the nine months ended September 30, 2013 compared to 8% in the same period in 2012. The increase in expense consists of $2.4 million related primarily to the hosting services and depreciation and costs to support our websites due to the growth in our business, increases in personnel-related expenses of $1.5 million, and amortization expense of intangible assets increased by$1.7 million. The acquisitions of EZ Prints and Logo’d Software, Inc. accounted for $3.8 million of these increases.

General and administrative

General and administrative expenses increased $1.0 million, or 8%, in the nine months ended September 30, 2013 compared to the same period in 2012. General and administrative expenses were 8% of net revenues in the nine months ended September 30, 2013 and 9% in the same period in 2012. The increase in absolute dollars is primarily due to an increase in personnel-related costs related to recent acquisitions and higher professional fees for legal and other services associated with becoming a public company.

Acquisition-related costs

Acquisition-related costs were $0.3 million and $2.5 million in the nine months ended September 30, 2013 and September 30, 2012, respectively. The decrease consists primarily of a $3.0 million decrease in contingent consideration liability, primarily related to EZ Prints and a $0.3 million decrease in legal fees related to acquisitions, offset by a $1.1 million increase in performance based compensation accruals primarily related to our acquisition of Canvas on Demand, LLC.

Benefit from income taxes

The benefit from income taxes was $3.3 million and $1.2 million in the nine months ended September 30, 2013 and September 30, 2012, respectively. Our effective tax rate was 27.0% and 27.6% in the nine months ended September 30, 2013 and September 30, 2012, respectively. The effective tax rate was lower in 2013 primarily due to the impact of a discrete charge of $1.0 million related to the expiration of unexercised stock options, offset by a lower estimated domestic production tax deduction.

Quarterly trends

Our business is subject to seasonal fluctuations. In particular, we typically generate a significant portion of our revenues during the fourth quarter, primarily due to increased retail activity during the holiday seasons. During the fourth quarter, we typically see our largest increases in orders and customers. 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.

 

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Liquidity and Capital Resources

As of September 30, 2013, we had cash, cash equivalents, and short term investments totaling $21.5 million. In connection with our initial public offering, or IPO, that closed on April 3, 2012 we received cash proceeds of $41.8 million, net of underwriters’ discounts and commissions and expenses paid by the company. Prior to the IPO, we have funded our operations primarily with cash flows from operations and, to a lesser extent, issuances of convertible preferred stock and debt financing, including capital leases. In March 2013, we entered into a credit agreement, which provides for a revolving credit facility of $5.0 million, which is available through March 2015. No amounts have been drawn on this facility.

We expect cash and cash equivalents, short term investments, availability of our credit facility and cash flow from operations, which is significantly weighted to our fourth quarter, will be sufficient to fund our operating cash needs for the next 12 months. Our future capital requirements may vary materially from those currently planned and will depend on many factors, including, among other things, market acceptance of our products, our growth, and our operating results. If we require additional capital resources to grow our business or to acquire complementary technologies and businesses at any time in the future, we may seek to sell additional equity or raise funds through debt financing or other sources. The sale of additional equity could result in additional dilution to our stockholders. If we raise additional funds by obtaining loans from third parties, the terms of those financing arrangements may include negative covenants or other restrictions on our business that could impair our operating flexibility, and would also require us to incur interest expense. We can provide no assurance that additional financing will be available at all or, if available, that we would be able to obtain financing on terms favorable to us.

The following table summarizes our cash flows for the periods indicated:

 

		Nine Months Ended September 30,
		2013				2012
(in thousands)
Net cash used in operating activities		$	(9,145	)		$	(8,327	)
Net cash provided by (used in) investing activities		$	868			$	(15,914	)
Net cash (used in) provided by financing activities			(3,171	)		$	41,848

Cash flows from operating activities

Our primary source of cash from operating activities is cash collections from our customers. The substantial majority of our net revenues are generated from credit card transactions and credit card accounts receivable and are typically settled within one and five business days. Our primary uses of cash for operating activities are for settlement of accounts payable to vendors and personnel-related expenditures. Our quarterly cash flows from operations are impacted by the seasonality of our business. We generate a significant portion of our cash flow from operations in the fourth quarter and cash flows in the first nine months have historically been negative due to the timing of settlements of accounts payable and accrued liabilities related to our fourth quarter holiday business. We expect that cash provided by operating activities may fluctuate in future periods due to a number of factors, including volatility in our operating results, seasonality, accounts receivable collections performance, inventory and supply chain management, and the timing and amount of personnel-related payments.

In the nine months ended September 30, 2013, net cash used in operations was $9.1 million, primarily due to normal seasonal working capital uses of cash of $10.3 million. Our net income, as adjusted for non-cash items such as depreciation, amortization, stock compensation, and adjustments to the fair value of our contingent consideration liabilities, provided cash of $1.2 million during the period.

In the nine months ended September 30, 2012, net cash used in operations was $8.3 million, primarily due to the use of cash of $14.4 million for the net change in operating assets and liabilities, partially offset by non-cash items of $6.9 million for depreciation and amortization, including amortization of intangible assets, and $3.1 million for stock-based compensation.

We experience a seasonal decrease in accounts payable and accrued royalties payable in the first nine months of the calendar year. This seasonal decrease typically occurs in the first quarter when we settle our accounts payable related to higher levels of inventory purchased in the preceding fourth quarter. In addition, accrued royalties and partner payable balances decline as payments associated with partner and shopkeeper activity during the preceding fourth quarter are made.

Cash flows from investing activities

In the nine months ended September 30, 2013, net cash provided by investing activities was $0.9 million, consisting primarily of net cash received from the maturity of short-term investments of $7.7 million, partially offset by $4.0 million for capital expenditures related to the purchase of property and equipment and $3.1 million of capitalized software and website development costs.

In the nine months ended September 30, 2012, net cash used in investing activities was $15.9 million, consisting primarily of net cash paid for the acquisition of Logo’d Softwear of $7.1 million, $5.1 million for capital expenditures related to the purchase of property and equipment and $2.4 million of capitalized software and website development costs, and net cash used to purchase short-term investments of $1.2 million.

Cash flows from financing activities

In the nine months ended September 30, 2013, net cash used in financing activities was $3.2 million, primarily due to payments of short-term borrowings and capital lease obligations of $1.7 million and payments of contingent consideration of $2.5 million, offset by finance borrowings of $1.0 million.

 

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In the nine months ended September 30, 2012, net cash provided by financing activities was $41.8 million, primarily due to the net proceeds received for our IPO, which closed on April 3, 2012.

Non-GAAP Financial Measures

Regulation G, conditions for use of Non-Generally Accepted Accounting Principles, or Non-GAAP, financial measures, and other SEC regulations define and prescribe the conditions for use of certain Non-GAAP financial information. We closely monitor Adjusted EBITDA which meets the definition of a Non-GAAP financial measure. We define Adjusted EBITDA as net income (loss) less interest and other income (expense), provision for (benefit from) income taxes, depreciation and amortization, amortization of intangible assets, acquisition-related costs, stock-based compensation and impairment charges.

We use Adjusted EBITDA as a key performance measure because we believe it facilitates operating performance comparisons from period to period by excluding potential differences caused by variations in capital structures (affecting net interest expense), tax positions (such as the impact on periods of changes in effective tax rates or fluctuations in permanent differences or discrete quarterly items), the impact of depreciation and amortization, amortization of intangible assets, acquisition-related costs, stock-based compensation and impairment charges. Because Adjusted EBITDA facilitates internal comparisons of our historical operating performance on a more consistent basis, we also use Adjusted EBITDA for business planning purposes and to incentivize and compensate our management personnel.

Our use of Adjusted EBITDA has limitations as an analytical tool, and you should not consider this measure in isolation or as a substitute for analysis of our results as reported under GAAP as the excluded items may have significant effects on our operating results and financial condition. When evaluating our performance, you should consider Adjusted EBITDA alongside other financial performance measures, including various cash flow metrics, net loss and our other GAAP results.

The following table presents a reconciliation of Adjusted EBITDA to net income, the most comparable GAAP measure, for each of the periods indicated:

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2013				2012				2013				2012
Net income		$	(3,118	)		$	(2,383	)		$	(8,818	)		$	(3,187	)
Non-GAAP adjustments:
Interest and other (income) expense			40				28				116				88
Benefit from income taxes			(1,271	)			(827	)			(3,260	)			(1,216	)
Depreciation and amortization			2,251				1,546				6,651				4,449
Amortization of intangible assets			1,201				864				3,834				2,495
Acquisition-related costs			546				1,134				324				2,508
Stock-based compensation			965				989				2,958				3,062
Adjusted EBITDA		$	614			$	1,351			$	1,805			$	8,199

Related Party Transactions

None.

Off-Balance Sheet Arrangements

We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. In addition, we do not have any undisclosed borrowings or debt and we have not entered into any synthetic leases. We are, therefore, not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to market risks in the ordinary course of our business. These risks primarily include risk related to interest rate, foreign currency exchange rate sensitivities and inflation.

 

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Interest rate sensitivity

We have cash and cash equivalents and short-term investments of $21.5 million and $40.6 million as of September 30, 2013 and December 31, 2012, respectively. These amounts were held primarily in cash deposits, money market funds and certificates of deposit. Our primary exposure to market risk is interest income sensitivity, which is affected by changes in the general level of the interest rates in the United States. Due to the short-term nature of these instruments, a change in market interest rates would not be expected to have a material impact on our financial condition or our results of operations.

Foreign currency exchange rate sensitivity

Our sales to international customers are denominated in multiple currencies, including the United States dollar, the British Pound, the Euro, the Canadian dollar and the Australian dollar. As the substantial majority of our sales are charged to credit cards, accounts receivables are generally settled in short time duration and accordingly, we have limited exposure to foreign currency exchange rates on our accounts receivable. To date, our operating costs have been denominated almost exclusively in United States dollars. As a result of our limited exposure to foreign currency exchange rates, we do not currently enter into foreign currency hedging transactions. If our international operations increase, our exposure to foreign currency exchange rate fluctuations may increase.

Inflation Risk

We do not believe that inflation has had a material effect on our business, financial condition or results of operations. If our costs were to become subject to significant inflationary pressures, we may not be able to fully offset such higher costs through price increases. Our inability or failure to do so could harm our business, financial condition and results of operations.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

We maintain “disclosure controls and procedures” as such term is defined in Rule 13a-15(e) under the Exchange Act, that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Our disclosure controls and procedures have been designed to meet reasonable assurance standards. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

Based on our management’s evaluation, with the participation of our Chief Executive Officer (our principal executive officer) and our Chief Financial Officer (our principal financial officer), as of the end of the period covered by this Report on Form 10-Q, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective at the reasonable assurance level.

Changes in Internal Control over Financial Reporting

There were no changes in internal control over financial reporting (as such term is defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

On July 10, 2013, a complaint captioned Desmarais v. CafePress Inc., et al. CIV-522744 was filed in the Superior Court of California, County of San Mateo naming as defendants the Company, certain of our directors, our chief executive officer, our chief financial officer and certain underwriters of our IPO. The lawsuit purports to be a class action on behalf of purchasers of shares issued in the IPO and generally alleges that the registration statement for the IPO contained materially false or misleading statements. The complaint purports to assert claims under the Securities Act of 1933, as amended, and seeks unspecified damages and other relief. On July 14, 2013 a similar compliant captioned Jinnah v. CafePress Inc., et al. CIV-522976 was filed in the same court. We are, at this time, unable to assess whether any loss or adverse effect on our financial condition is probable or remote or to estimate the range of potential loss, if any. We believe these suits to be without merit and will defend ourselves vigorously.

We may be subject to lawsuits, claims and proceedings incident to the ordinary course of business, particularly with respect to content that appears on our website. Any claims against us, whether meritorious or not, could be time consuming, result in costly litigation, require significant amounts of legal resources, management time and result in the diversion of significant operational resources. The results of these lawsuits, claims and proceedings cannot be predicted with certainty. We are not currently a party to any other litigation matters that, individually or in the aggregate, are expected to have a material adverse effect on our business, financial condition or results of operations.

 

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ITEM 1A. RISK FACTORS

This Report contains forward-looking statements that 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 risk factors set forth below, and this Report should be read in conjunction with such risk factors. The risks and uncertainties described in this Report are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently believe are immaterial may also affect our business. If any of these known or unknown risks or uncertainties actually occurs and have material adverse effects on our business, financial condition and results of operations could be seriously harmed.

Risks related to our business

Our results of operations are subject to quarterly fluctuations due to a number of factors that could adversely affect our business and the trading price of our common stock.

Our revenues and operating results may fluctuate from period to period and are likely to continue to fluctuate due to a variety of factors, many of which are beyond our control. Factors relating to our business that may contribute to these fluctuations include the following factors, as well as other factors described elsewhere in this prospectus:

 

•

spikes in our sales from major social or political events or developments resulting in a short term demand for products with related content;

 

•

seasonality of our revenues, including shifts in the timing of holiday selling seasons;

 

•

macroeconomic cycles and consumer spending;

 

•

demand for our user-designed products and services;

 

•

market acceptance and competitiveness of our products and services;

 

•

the gain, loss or success of significant strategic relationships and partner programs;

 

•

changes in the product roadmap in connection with strategic relationships and partner programs;

 

•

changes in the timing or delays in the launch of partner programs;

 

•

our ability to develop, introduce and market new products and services on a timely basis;

 

•

the timing and terms of any acquisition, performance on earn out provisions and integration activities post acquisition;

 

•

fluctuations in sales and marketing costs, including website traffic acquisition costs;

 

•

our ability to maintain or increase website traffic to our e-commerce properties;

 

•

our ability to provide accurate search results and recommendations and to deliver long-tail content to our ecommerce partners;

 

•

fluctuations in the sources of our revenue as between our various e-commerce properties;

 

•

the development of, or changes to, new technologies and platforms for Internet use, such as mobile, and evolving marketing methods such as social media, flash promotions and any changes in website traffic acquisition algorithms, policies or practices supporting such development;

 

•

new entrants that might occur to the market for customized goods in our distribution or marketing channels;

 

•

fluctuations in the cost of raw materials;

 

•

variations in the mix of products and services we sell;

 

•

new product and service announcements and introductions by us or our competitors;

 

•

difficulties encountered in the integration of newly-acquired businesses;

 

•

acquisition-related risks and associated expenses, and difficulty in estimating impact and costs related thereto;

 

•

litigation and associated risks and expenses, including extraordinary expenses related to litigation and settlement costs, and difficulty in estimating the impact and timing thereof;

 

•

the growth rate of the e-commerce industry; and

 

•

potential impact of sales tax initiatives on e-commerce sales demand.

As a result of these factors, among others, the results of any prior quarterly or annual periods should not be relied upon as indications of our future revenues or operating performance. In particular, due to the seasonality of our business, 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.

We may not sustain profitability or avoid net losses in the future. Although we have experienced consistent revenue growth in recent periods, these growth rates may not be sustainable and may slow or decrease in the future. In addition, our ability to be profitable depends on our ability to control our costs and operating expenses, which have increased and we expect to further increase as we expand our business and incur additional expense associated with being a public company. We have incurred in the past, and expect to continue to incur in future periods, stock-based compensation expense, which will reduce our net income and may result in future losses. If we fail to increase revenues at the rate we anticipate or if our costs and operating expenses increase without a commensurate increase in our revenues, our business, financial condition and results of operations will be negatively affected.

 

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We perform an analysis of our goodwill balances to test for impairment on an annual basis or whenever events occur that may indicate impairment possibly exists. 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. Goodwill is deemed to be impaired if the carrying amount of the reporting unit exceeds the estimated fair value. The impairment of a long-lived intangible asset other than goodwill is only deemed to have occurred if the sum of the forecasted undiscounted future cash flows related to the asset is less than the carrying value of the intangible asset we are testing for impairment. As of September 30, 2013, we had goodwill of $39.4 million and intangible assets of $16.1 million. Goodwill and intangible asset impairment analysis and measurement is a process that requires significant judgment. Further and sustained decline in our stock price and resulting market capitalization, further delays in expected new business opportunities associated with EZ Prints and our CafePress Services partnerships, unforeseen losses of any significant existing EZ Prints partners, or significant changes to our profitability resulting from the risk factors mentioned above or throughout this section, could result in impairment of a material amount of our $39.4 million goodwill balance or our $16.1 million intangible asset balance in the future. We cannot be certain that a future downturn in our business, the slower than expected growth of new business opportunities associated with EZ Prints or our CafePress Services partnerships, changes in market conditions or a longer-term decline in the quoted market price of our stock will not result in an impairment of goodwill or intangible assets and the recognition of resulting expenses in future periods, which could adversely affect our results of operations for those periods.

Due to the foregoing factors, our operating results in one or more future quarters may fall below the expectations of securities analysts and investors. In this event, the trading price of our common stock may be materially and adversely affected.

The seasonality of our business increases strain on our operations and if we are unable to scale sufficiently to support our operations during periods of peak demand, our business could suffer.

A significant portion of our net revenues and operating cash flows have historically been realized during the period from November through December each year, primarily due to increased retail activity during the holiday seasons. Any disruption in our ability to process, produce and fulfill customer orders in the fourth quarter could have a negative effect on our quarterly and annual operating results. As described in our Managements Discussion & Analysis herein, in anticipation of increased fourth quarter sales activity, we typically incur significant incremental expenses prior to and during peak selling seasons, particularly October through December, including the costs associated with hiring a substantial number of temporary employees to supplement our existing workforce. If we are unable to hire enough qualified employees to support our production or customer service operations or if there is a disruption in the labor we hire from our third-party providers, our business, financial condition and results of operations could be adversely affected. In addition, if too many customers access our websites within a short period of time due to increased holiday demand or other periods of peak demand, we may experience system delays or interruptions that make our websites unavailable or prevent us from efficiently fulfilling orders, which may reduce the volume of goods we sell and the attractiveness of our products and services. This in turn could harm our business, operating results and reputation. Because we continue to expect a significant portion of our net revenues and operating cash flows to be realized in the fourth quarter, the fourth quarter factors more significantly into our outlook for the fiscal year. Any disruption in our business operations or other factors that could lead to a material shortfall compared to our expectations for the fourth quarter could result in a material shortfall compared to our expectations for the full year. This could have a disproportionate effect on our operating results and cause our stock price to decline.

Our business depends heavily on the market recognition and reputation of our services, and our subsidiary’s services, and any harm to our brands or failure to maintain and enhance our brand recognition may materially harm our business, financial condition and results of operations.

We believe that maintaining and enhancing the recognition and reputation of the level of services associated with our brands are critical to our success and ability to compete. Many factors, some of which are beyond our control, are important to maintaining and enhancing our services and may negatively impact our reputation if not properly managed, such as:

 

•

our ability to maintain a convenient and reliable user experience as consumer preferences evolve and as we expand into new product categories and new business lines;

 

•

our ability to increase brand awareness among existing and potential distribution channels, corporate partners and consumers through various means of marketing and promotional activities;

 

•

our ability to retain and expand our network of buyers and sellers;

 

•

the efficiency, reliability and service quality of our products and services;

 

•

our ability to protect personally identifiable information and credit card data;

 

•

our ability to effectively control the product and service quality of content as we continue to develop the services provided by our retail websites, which we refer to collectively as the marketplace; and

 

•

any negative media publicity about user-generated content, perceived weaknesses in data privacy or security practices or product quality problems of our service or other e-commerce websites.

If we are unable to maintain our reputation, further enhance our brand recognition and increase positive awareness of our websites, our results of operations may suffer.

 

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We depend heavily on the continued success of our core business of selling user-designed products online, and any event that adversely affects our sales of user-designed products could harm our business and results of operations.

A significant proportion of our revenue has been derived from the online sale of user-designed products through our marketplace and through distribution channels derived from our marketplace. We expect that the sales of user-generated design products will continue to comprise a majority of revenue on our CafePress.com business. While we intend to continue to expand our product and service offerings, including the expansion of our Create & Buy service offerings, expansion of licensed content for creation of products, and expansion of our corporate client e-commerce services, revenues from these services may not increase to a level that would reduce our dependence on revenues from our marketplace. In addition, users who design products may choose not to use our e- commerce platform to create and sell their designs, and choose other platforms, thereby reducing the number of designs available through our websites and affecting future growth of our marketplace revenue. Customers who purchase user-designed products on our websites may also purchase other fulfillment and partner products through our e-commerce services as well, which aid the growth of our services. If competitive services increase and/or we cannot successfully attract or retain users to design and sell products through our e-commerce platform or if we are unable to attract and retain our customers for user-designed and other products, our operating results may suffer. If we are unable to sustain the growth of our core business or otherwise grow the core business through the additional e-commerce services noted, our business and our operating results could be harmed.

Intense competitive pricing pressures, particularly with respect to pricing and shipping, may harm our business and results of operations.

Demand for our products and services are extremely sensitive to price at all time, but especially in times of recession, slow economic growth and consumer uncertainty and conservatism. Many external factors, including our production and personnel costs, the cost of raw materials, particularly the price of cotton, consumer sentiment and our competitors’ pricing and marketing strategies, can significantly impact our pricing strategies. If we fail to meet consumers’ price expectations, we could lose customers and/or fail to attract new customers, which would harm our business and results of operations.

Changes in our pricing strategies across channels have had, and may continue to have, a significant impact on our revenues and net income. We frequently make changes to our pricing structure in order to remain competitive but that may result in lower profit margins. Most of our products are also offered by our competitors. If in the future, due to competitor activities or other marketing strategies, we significantly reduce our prices on our products without a corresponding increase in volume or decrease in cost of goods sold, it would negatively impact our revenues and could adversely affect our gross margins and overall profitability.

We generate a portion of our revenues from the fees we collect from shipping our products. We frequently offer discounted or free shipping, with minimum purchase requirements during promotional periods, to attract and retain customers. We also frequently offer coupons, promotional marketing giveaways and free or discounted products and services as a method to attract and retain customers, and such instances are generally unable to recoup shipping costs in such programs. In the future, if we continue to increase these coupon practices and discounted shipping offers to attract and retain customers and/or in response to actions taken by our competitors, our results of operations may be harmed.

We face intense competition and if we do not compete successfully against existing and new competitors, we may lose market share and customers.

The market for customized products and services is large, fragmented and intensely competitive and we expect competition to continue to increase in the future. We face competition from a wide range of companies, including the following:

 

•

small traditional offline printing businesses;

 

•

e-commerce companies, including large online retailers such as Amazon.com, Inc., Walmart.com and eBay Inc. (who also may be our distribution partners);

 

•

physical and catalog retailers of personalized merchandise such as American Stationery, Red Envelope and Things Remembered;

 

•

online providers of customized products such as Red Bubble, CustomInk, LLC, Spreadshirt, Inc., Threadless.com or Zazzle Inc. and online providers of unique goods like Etsy, Inc. or Uncommon Goods;

 

•

online providers allowing users to customize goods in specific vertical markets, such as Vistaprint N.V. for small businesses and Shutterfly, Inc. or SmugMug, for photographic products, or Minted, Smilebox or Blurb for specific stationery and book products, and Art.com for wall art products.

We may also indirectly compete with Internet portals and shopping search engines that are involved in e- commerce or sell products or services either directly or in collaboration with other retailers. If more companies move into the customized products space, we will face further direct and intense competition. Furthermore, to the extent that other companies are able to replicate our processes or advances in print-on-demand technologies reduce any technological or other early mover leads we may have, our business, prospects, financial condition and results of operations could be harmed.

Some of our current and potential competitors have significantly greater financial, marketing and other resources than us, including significant brand recognition, sales volume and customer bases. In addition, other online retailers may be acquired by, receive investment from or enter into strategic relationships with well-established and well-financed companies or investors which would help enhance their competitive positions.

Some of our competitors may be able to secure goods and raw materials from suppliers on more favorable terms, devote greater resources to marketing activities and promotional campaigns, adopt more aggressive pricing policies and devote substantially more resources to website and system development than us. Increased competition may reduce our operating margins, market share and brand recognition, or force us to incur losses. We may not be able to compete successfully against current and future competitors. Competitive pressures may harm our business, prospects, financial condition and results of operations.

 

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Our business model focuses on user-generated content and as a result, controversial political and social expressions appear on our site with which current or potential customers or business partners may not wish to be associated.

We have built our business by providing consumers an outlet for self-expression through customized goods that they can share with their friends, their communities and the world. Our service is often used for the expression of political and cause-related issues that may generate strong feelings on many sides of a given issue, including in other customers and potentially with the business partners who supply us with content or inventory and to those who choose to invest in our company. As a result, our websites frequently attract the attention of media outlets that may not understand the user-generated nature of our business model and attribute sentiments expressed by our users to our company. Additionally, because our service provides a platform for the expression of controversial ideas and humor, our site could be the target of negative social media or petition campaigns, computer attacks or boycotts by well-organized special interest groups or filtered by foreign countries, which may adversely impact our growth and operations. For example, our websites are currently blocked in China. Our distribution and channel partners may likewise become uncomfortable with aspects of our user-generated content business model in light of their own content usage policies and may cut back or refuse to display our products or otherwise limit our merchandising opportunities thus impacting our results of operations. We believe we must maintain a balance between the encouragement of self- expression in our users that creates a content-rich experience, the needs and concerns of our business partners and our mutual desire to protect our brands and our companies. If we fail to maintain this balance and lose partners, customers, or potential customers due to judgments made about the content on our websites, or conversely if we alienate corporate partners or businesses who wish to employ our customization services for their content or products without fear of negative reflection on their brand images, we risk damage to our brands and reputation and ultimately our business and results of operations.

If we are unable to attract customers or increase traffic to our websites in a cost-effective manner or at all, our business and results of operations could be harmed.

Our success depends on our ability to attract customers our websites. We rely on a variety of methods to draw visitors to our websites and promote our products and services, such as search engine marketing, email, affiliate networks, social media outlets and flash deal promotions through group-buying websites. We pay providers of online services, search engines and other websites and e-commerce businesses to provide content; marketing links, advertising banners and other links that direct customers to our websites. If these providers modify or terminate their relationship with us or increase the price they charge us or if our competitors offer them greater fees for traffic, our expenses could rise and traffic to our websites could decrease, resulting in harm to our operations.

We also devote substantial resources to optimizing our websites to increase the likelihood of our products and services appearing in unpaid search engine results; however there can be no assurance that these efforts will be successful. If our products and services receive low placement or do not appear within the listings of search engine results in response to relevant search queries, this could result in fewer customers clicking through to our websites, requiring us to resort to other more costly resources to replace this traffic. If we are unable to maintain or increase traffic to our websites, including through accurate search results and recommendations, or our products or services receive low placement or do not appear due to changes in search engine algorithms, our business and operating results could suffer.

We also promote our products and special offers through emails targeted to potential customers and our site members. However, if our customers deem such emails and other promotions to be intrusive, we could be forced to discontinue or significantly curtail our email marketing activities.

In addition, we engage in flash promotions through group buying websites, such as through Groupon, Amazon Local and LivingSocial. Such promotions involve significantly discounted product offers to customers with the goal of driving traffic to our websites for repeat purchases. Due to the low profit margin associated with the deep discounts offered to purchasers of such offers and the widespread availability of similar group buy offers by other e-commerce competitors, the flash promotions we choose to implement may not accomplish our long term goal of customer acquisition in a cost-effective manner.

Lastly, we have terminated a number of affiliate marketing partners in states that have imposed sales tax nexus for such marketing activities, and to the extent we determine it prudent to continue to do so, we may be unable to achieve our strategic goals in those channels. If we are unable to develop or maintain an effective and cost efficient means of reaching content providers and consumers, the costs of attracting customers using these methods significantly increase, or we are unable to develop new cost-effective means to obtain customers, then our ability to attract new and repeat customers would be harmed, traffic to our websites would be reduced and our business and results of operations would be harmed.

Our strategy with respect to content acquisition may adversely affect our financial condition and future financial results.

We obtain content for our websites and our products from multiple sources, including our user designers, for whom we may pay fees on any subsequent sales of products created with such content. We also increasingly rely on entertainment, publishing and corporate content provider sources to generate content for our products and services. Due to designer relationship issues, including compensation provided by us compared to that provided by our competitors, users may decrease or cease providing content to our websites in the future. We face challenges in managing the payment infrastructure and taxation implications of these transactions and expect to continue to do so in the future as competitive pressures or new regulatory or other issues arise.

In connection with obtaining entertainment and other media content, we sometimes enter into multi-year, royalty- based licenses with content owners and production organizations for film and television and other media distributors. To date, we have been able to obtain those licenses without paying significant advance royalty payments but there is no guarantee that these licensors will renew their license agreements on the same or reasonable terms. Furthermore, we plan on increasing the level of committed content licensing in our efforts to grow our service and customer base both in the United States and globally. Finally, our competitors may be successful in obtaining exclusive licenses for content we

 

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wish to obtain for our site, making such content unavailable to us now or in the future. We may also, as we have in the past, enter into agreements with content providers that contain exclusivity provisions that may restrict our ability to sell certain products or in certain geographies or to partner with certain content providers. In order to compete effectively for these licenses, we could be forced to pay higher royalties or agree to significant advance payments. Our results of operations could be adversely affected as a result of these content licensing payment commitments in the event that sales or revenue growth do not meet our expectations. In addition, our flexibility in planning for, or reacting to, changes in our business and the market segments in which we operate could be limited.

In connection with the selection and popularity of specific content, we employ licensing and business development professionals and Internet traffic analysts who evaluate popular culture trends and potential properties to support the content on our site and drive traffic to it. To the extent they are unsuccessful in identifying or obtaining content sources that will be popular with consumers and that will generate sales of our products, our results could materially be harmed. To the extent the content we do choose to obtain proves unpopular or unsuccessful and we have agreed to contractual minimums, we may not achieve the planned return on royalty advances and may incur losses or impairment charges.

If any of the above circumstances increase the cost of obtaining content, our margins may suffer. We must continue to ensure that our content is sufficiently diversified and desirable to meet the needs of the markets we target. We believe that failure to secure content could result in lower sales and customer retention and materially reduce margins.

If we are unable to market and sell products and services beyond our existing target markets and develop new products and services to attract new customers and new strategic partnerships and business relationships, our results of operations may suffer.

We believe we will need to address additional markets and sales channels, attract new business partners, content providers and consumers to further grow our business. To access new sales channels, we must build and maintain new processes in which to feed our product catalogues to corporate distribution partners. To access new markets and consumers, we expect that we will need to develop, market and sell new products and services. We also intend to continue the geographic expansion of our marketing efforts and customer service operations and the introduction of localized language websites in different countries. There is no guarantee we will be successful in this expansion. We continually seek to offer our array of e-commerce customization and products and services to new customers in existing channels and to expand the reach of our distribution channel partnerships. If we are unsuccessful in expanding the scope of those relationships, we may not grow our operations and businesses as fast as we would like.

In addition, we intend to develop new strategic relationships to expand our marketing and sales channels, such as co-branded or strategic partner- branded websites, retail in-store offerings, content feeds to distribution partners and deployable customization builders on third-party websites. Any failure to develop new products and services, or a lack of adoption of the new products and services we do develop to expand our business beyond our existing target markets or address additional market opportunities could harm our business, financial condition and results of operations.

If we are unable to manage our growth or execute our strategies effectively, our business and prospects may be materially and adversely affected.

We have experienced a period of rapid growth and expansion that has placed, and continues to place, significant strain on our management and resources. To accommodate our growth, we anticipate that we will need to implement a variety of new and upgraded operational and financial systems, procedures and controls, including the improvement of our accounting, legal and other internal management and control systems. We also have expanded our production and logistics centers and distribution network to accommodate more customer orders and provide better coverage of our target markets. The recent expansion of our production and logistics centers and distribution network may put pressure on our managerial, financial, operational and other resources. If we are unable to effectively manage our expanded logistics operations and control increasing costs, our growth potential, results of operations and business could suffer. Additionally, we will need to continue to expand, recruit, train, manage and motivate our workforce and manage our relationships with existing and new business partners, suppliers, third-party service providers and content providers. Our strategies also include broadening our product and service offerings, which will require us to work with different groups of suppliers and address the needs of different kinds of consumers. We may incur significant costs in trying to expand our offerings into these new areas or fail to successfully execute the roll-out of these new offerings. All of these endeavors involve risks and require substantial management effort and significant additional expenditures. We cannot assure you that we will be able to manage our growth or execute our strategies effectively, and any failure to do so may have a material adverse effect on our business and prospects.

We have pursued and may continue to pursue acquisition opportunities as part of our growth strategy and may not realize the anticipated benefits of any such acquisitions, which in turn could harm our business and operating results.

As part of our growth strategy, we intend to evaluate and pursue selected acquisition and expansion opportunities. For example, we acquired Imagekind, Inc. in 2008, Canvas On Demand, LLC in 2010, L&S Retail Ventures, Inc. in October 2011, Logo’d Softwear, Inc. in April 2012 and EZ Prints in October 2012. We may be unable to successfully integrate the businesses we acquire or to realize the anticipated benefits of our acquisitions. These acquisitions and any future acquisitions and the successful integration of assets and businesses into our own as well as the retention of personnel require significant attention from our management and could result in a diversion of resources from our existing business, which in turn could have an adverse effect on our business operations. There can be no assurance that we will be successful in these efforts. Acquired assets or businesses may not achieve the anticipated benefits we expect due to a number of factors including: unanticipated costs or liabilities associated with the acquisition, incurrence of acquisition-related costs, harm to our relationships with existing customers as a result of the acquisition, harm to our brands and reputation, the potential loss of key employees, use of resources that are needed in other parts of our business, and use of substantial portions of our available cash to consummate the acquisition. In addition, our ability to impose appropriate internal controls, including accurate forecasting, accounting integration of inventory, costs and reporting, to successfully manage these

 

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businesses will require significant investments of resources and management time. Finally, acquisitions could result in the use of substantial amounts of cash, earn-outs, potentially dilutive issuances of equity securities, the occurrence of significant goodwill impairment charges, amortization expenses for other intangible assets and exposure to potential unknown liabilities of the acquired business. For example, in connection with our acquisition of Canvas On Demand, we agreed to pay up to $9.0 million in earn-out payments to the former owners of Canvas On Demand. The earnout period concluded on September 30, 2013 and $8.6 million of the potential $9.0 million amount was earned and paid.

On December 31, 2102, we entered into a settlement agreement with the principal former stockholder of L&S Ventures, Inc. resolving in full any and all future earn out payments and modifying the terms of the remaining stockholder. We may enter into other modifications of certain acquisition terms over time which could result in cash payments, potentially dilutive issuances, goodwill impairment charges and other potential unknown liabilities.

In addition to possible stockholders’ approval, we may also have to obtain approvals and licenses from the relevant government authorities for acquisitions and comply with any applicable laws and regulations, which could result in increased costs and delay. Finally, over time we may need to modify earn out structures to accommodate changes in the business and such modifications may impact accounting treatments of acquisitions and otherwise trigger issues that could impact our results of operations. A failure to manage the earn-out provisions of these and other newly-acquired businesses could harm our financial condition and cause results of operations to be diminished.

Given the relatively short history of some of our service offerings, it may be difficult to evaluate our business and prospects.

In the last three years, we have substantially expanded the service offerings on our websites to include other services such as our Create & Buy services. For example, in 2010, we acquired Canvas On Demand, LLC, or Canvas On Demand, which provides an online service for creating personalized canvases from photographs, in 2011 we acquired L&S Retail Ventures, Inc., an online provider of invitation and stationery products, and in April 2012 we acquired Logo’d Softwear, Inc., an e-commerce provider of personalized apparel and merchandise for groups and organizations. In October 2012, we acquired EZ Prints which provides a deployable e-commerce platform for product customization. We cannot assure you that these services, or any other new services we may introduce or acquire, will be integrated or achieve market acceptance either at a level sufficient to justify our investment or at all.

 

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The integration of technology, infrastructure, personnel, policies and procedures of newly acquired business represents significant challenges to management. Further the challenges of forecasting and managing newly acquired business is formidable and we have a limited history of operating these new services, which makes predicting our future results of operations more difficult than it otherwise would be. Therefore, our past results of operations should not be taken as indicative of our future performance. Our ability to achieve satisfactory financial results from these new services is unproven.

If we fail to successfully identify and respond to constantly changing consumer preferences, adopt new technologies or adapt our websites and systems to customer requirements or emerging industry standards, our business, prospects and financial results may be materially and adversely affected.

The e-commerce and retail industries as well as the content-provider industry are subject to ever changing trends and consumer preferences. Consequently, we must anticipate emerging consumer trends for customized retail merchandise that will appeal to existing and potential consumers both with base products and licensed and user-generated content. If our consumers cannot find their desired products on or service through our websites, they may stop visiting our websites, visit less often or stop purchasing products on our websites or seek out our competitors’ services. If we do not anticipate, identify and respond effectively to consumer preferences and changes in consumer trends at an early stage, we may not be able to generate the desired level of sales. Likewise, we must anticipate and capitalize on trends in user-generated content and popular culture that will continue to drive consumer interest in our websites.

Internet business models and the online content distribution generally are characterized by rapid technological evolution, changes in user requirements and preferences, frequent introductions of new products and services embodying new technologies and the emergence of new industry standards and practices. To remain competitive, we must continue to enhance and improve the responsiveness, functionality and features of our websites and systems. Our success will depend, in part, on our ability to identify, develop, acquire or license leading technologies useful in our business, enhance our existing services, develop new services and technologies that address the increasingly sophisticated and varied needs of our existing and prospective business partners and consumers, and respond to technological advances and emerging industry standards and practices on a cost- effective and timely basis. The development of our websites and other proprietary technology entails significant technical and business risks. We may be unable to use new technologies or systems to effectively adapt our websites, proprietary technologies and transaction-processing systems to customer requirements or emerging industry standards. If we are unable to adapt in a cost- effective and timely manner in response to changing market conditions or customer requirements, whether for technical, legal, financial or other reasons, our business, prospects, financial condition and results of operations would be materially adversely affected.

Because our sales and revenues rely on consumer spending of discretionary income, continued uncertain economic conditions in the United States and world economies may materially and adversely affect our financial results.

As the majority of our revenues are generated from sales through our consumer e-commerce websites, our sales are driven by discretionary consumer spending habits and preferences. Historically, consumer purchasing declines during economic downturns and periods of uncertainty regarding future economic prospects or when disposable income or consumer lending is lower. While not always directly related to actual consumer behavior, macro-economic conditions like global currency and debt concerns, stock market volatility, levels of unemployment, increased fuel or commodity prices and transportation costs, and conditions in the commercial consumer lending and housing markets among other factors fuel uncertainty over future macro-economic conditions and prospects of a prolonged recessionary spending climate. Further deterioration of economic conditions in the near term or long term, or the perception that such deterioration might occur, could reduce demand for our products. As a result our revenues could decline and our results could be materially and adversely affected by such trends. Our ability to anticipate, identify and respond quickly to consumer spending pressures and prevailing economic conditions will be challenged if such economic uncertainties continue for prolonged periods or during peak periods for our sales that historically have occurred in our fiscal fourth quarter.

The proper functioning of our websites is essential to our business and any failure to maintain the satisfactory performance, security and integrity of our websites will materially and adversely affect our business, reputation, financial condition and results of operations.

The satisfactory performance, reliability and availability of our websites, our sophisticated marketing activities, our transaction- processing systems and our network infrastructure are critical to our success. Our revenues depend on the number of visitors who shop on our websites and the volume of orders we fulfill. Any system delays, interruptions or disruptions to our servers caused by telecommunications failures, computer viruses, physical break-ins, domain attacks, hacking or other attempts to harm our systems or servers that result in the unavailability or slowdown of our websites, loss of data or reduced order fulfillment performance would reduce the volume of products sold and the attractiveness of product offerings on our websites. We may also experience interruptions caused by reasons beyond our control. For example, in the fourth quarter of 2006, our servers experienced a denial of service attack, which disrupted access to our websites for several days during the holiday buying season. These unexpected interruptions may occur in the future, and future occurrences could damage our reputation and harm our revenues and results of operations.

We use internally developed systems for all aspects of transaction processing, including order management, content review and purchasing and inventory management. We rely on third-party providers for debit card and credit card processing services, other payment services and shipping. We periodically upgrade and expand our systems, and in the future, we intend to further upgrade and expand our systems and to integrate newly developed or purchased software with our existing systems to support increased transaction

 

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volume. Any inability to add additional software and hardware or to develop and upgrade our existing technology, transaction-processing systems or network infrastructure to accommodate increased traffic on our websites or increased sales volume through our transaction-processing systems may cause unanticipated system disruptions, slower response time, degradation in levels of customer service and impaired quality and speed of order fulfillment, which would cause our business, reputation, financial condition and results of operations to suffer.

If our production and fulfillment operations are interrupted for any significant period of time or either facility where our computer and communications hardware is located fails, our business and results of operations would be substantially harmed.

Our success depends on our ability to successfully receive, produce and fulfill orders and to promptly and securely deliver our products to our customers, which in turn depends in part on the efficient and uninterrupted operation of our computer and communications systems. A significant portion of our production, inventory management, packaging, labeling and shipping processes are performed in a single production and fulfillment center located in Louisville, Kentucky and such single location reliance presents risks. In addition, substantially all of the computer hardware necessary to operate our principal websites is located at third-party hosting facilities in Las Vegas, Nevada and in Louisville, Kentucky. These facilities are susceptible to damage or interruption from human error, fire, flood, ice storms, power loss, insufficient power availability, telecommunications failure, terrorist attacks, acts of war, break-ins, earthquakes and similar events. Louisville, Kentucky, our principal production site, is particularly susceptible to flooding and extreme weather patterns. We are also consolidating production there as we integrate acquired businesses heightening risks of single site production. The integration process itself also poses infrastructure challenges in moving equipment and resources, which may lead to increased costs in the short term due to redundancies needed, all of which may impact our results of operations. We also maintain offices and operations in Northern California, an area where the risk of an earthquake is significant due to the proximity of major earthquake fault lines. Any catastrophic loss to any of these facilities would likely disrupt our operations, delay production, shipments and revenues and result in significant expenses to repair or replace the facility. Our business interruption insurance may be insufficient to compensate us for losses that may occur, particularly from interruption due to an earthquake, which is not covered under our current policy. Any interruptions in our production, fulfillment center or systems operations, particularly if for any significant period of time, could damage our reputation and brands and substantially harm our business and results of operations.

Shipment of merchandise sold in our marketplaces could be delayed or disrupted by factors beyond our control and we could lose buyers and sellers as a result.

We rely upon third-party carriers such as United Parcel Service, Inc., or UPS, in the United States for timely delivery of our merchandise shipments. As a result, we are subject to carrier disruptions and increased costs due to factors that are beyond our control, including labor difficulties, inclement weather, terrorist activity and increased fuel costs. While we do have relationships with other carriers, we do not have a long-term agreement with any other third-party carriers, and we cannot be sure that our relationship with UPS will continue on terms favorable to us, if at all. If our relationship with UPS is terminated or impaired or if UPS is unable to deliver merchandise for us, we would be required to use alternative carriers for the shipment of products to our buyers. We may be unable to engage alternative carriers on a timely basis or on terms favorable to us, if at all. Potential adverse consequences include:

 

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reduced visibility of integrated order status and package tracking;

 

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delays in merchandise receipt and delivery;

 

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increased cost of shipment; and

 

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reduced shipment quality, which may result in damaged merchandise.

Any failure to receive merchandise at our distribution centers or deliver products to our buyers in a timely and accurate manner could lead to client dissatisfaction and cause us to lose sellers and buyers.

Many of our suppliers are located in regions that are subject to weather instability, earthquakes and other natural disasters.

The facilities of our third-party suppliers are subject to risk of catastrophic loss due to fire, flood or other natural or man-made disasters. For example, the majority of our suppliers are located in the United States and China in areas with above-average catastrophic weather instability and seismic activity and which are subject to typhoons, tsunamis and other storms. Additionally, since a significant portion of our revenues are attributed to cotton apparel and because we do not currently engage in any cotton or other commodity-related hedging activities, we are particularly susceptible to issues affecting the cotton growing and production industry. Any catastrophic loss to any of these facilities or disruptions in the production of cotton would likely disrupt our operations, delay production, shipments and revenues and result in significant expenses to repair or replace the facility or to purchase critical inventory for creation of our products.

If we become subject to liability for content that we print and distribute through our service, our results of operations would be adversely affected.

As a service provider that prints content provided by others, we face allegations related to, and potential liability for, negligence, copyright or trademark infringement or other claims that we display and the goods created from user-generated uploads to our service. We also may face allegations related to, and potential liability for, content uploaded from our users in connection with claims of defamation, racism, hate speech, obscenity or pornography that may be embodied in user expression. As globally available websites, we also receive inquiries about content that may be illegal or insensitive to cultural norms not only in the United States but worldwide, and those sensitivities may differ widely. For example, content related to glorification of the current North Korean regime, while offensive to many, is not illegal in the United States. In South Korea, distribution of such speech is considered illegal and we therefore are subject to geographic-specific blocks on content on our websites.

 

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Despite our status as an e-commerce service provider and not a publisher, we are exposed to risks associated with varying defamation laws in other jurisdictions in foreign countries, for example, including heightened risk of secondary liability on defamation suits in the United Kingdom and increased statutory penalties available for alleged trademark infringement in Germany. Further, we maintain relationships with law enforcement agencies to manage issues related to child pornography or other illegal uses of our service and must monitor our services for such impermissible, unauthorized and illegal activities. We also may be subject to subpoenas or other law enforcement or regulatory requests for information about our users or our website’s services and the handling of such information requests may expose us to risk of suit from our users if not correctly and consistently managed in light of applicable law and consumer expectations of data privacy and judicial action or regulatory enforcement is not processed with appropriate alacrity.

Despite our status as service provider and not a publisher, we also face allegations of infringement and potential liability for negligence, copyright, patent or trademark infringement or other claims based on the nature and content of materials that we distribute. In addition, a number of our entertainment, publishing and corporate content providers impose limitations and conditions on our use of their licensed content, and our failure to implement and abide by these terms could result in our loss of these licenses, damages to our reputation and potential liability for breach of contract and copyright or trademark infringement. We also may face potential liability for content uploaded from our users in connection with our community- related content or political commentary.

We maintain strict content usage policies that are frequently evaluated and updated and we maintain processes that review uploaded content for compliance with our terms of service and various policies. We also require users uploading content to attest that they have all necessary rights to upload content to our service and further require such users to indemnify us in the event that claims are made against us relating to such content. We maintain a content review process that includes evaluation and take-down of uploaded content on our site that fails to meet our policies and compliance with all safe harbors under relevant laws. Nevertheless, we receive significant volumes of cease and desist demands on a regular basis with respect to claims of intellectual property infringement and violation of the rights of third parties, such as rights of privacy and publicity, and expect this may grow with the volume of content made available through our service. We maintain an active dispute resolution process for intellectual property rights claimants so that allegations of infringement can be resolved expeditiously. Notwithstanding our efforts to monitor and manage content and promptly resolve all issues, these measures may not be effective in removing violative content nor sufficient to shield us from potential liability, including situations where users do not have the financial ability to fully indemnify us against material liabilities.

Failure to protect confidential or personally identifiable information of our customers and our network against security breaches or failure to comply with privacy and security laws and regulations could damage our reputation and brands and substantially harm our business and results of operations.

A significant challenge to e-commerce and communications is the secure transmission of confidential information over public networks. Our failure to prevent security breaches could damage our reputation and brands and substantially harm our business and results of operations.

Currently, most of our product orders and payments for products we offer are made through our websites. A majority of our sales are billed to our customers’ credit card accounts directly, orders are shipped to a customer’s address, and customers log on using their email address. In addition, some online payments for our products are settled through third-party online payment services. In such transactions, maintaining complete security for the transmission of confidential information on our websites, such as customers’ credit card numbers and expiration dates, personal information and billing addresses, is essential to maintain consumer confidence. We have limited influence over the security measures of third-party online payment service providers. In addition, we hold certain private information about our customers, such as their names, addresses, phone numbers and browsing and purchasing records.

We rely on encryption and authentication technology licensed from third parties to effect the secure transmission of certain confidential information, including credit card numbers and personally identifiable customer information. Advances in computer capabilities, 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. In addition, any party who is able to illicitly obtain a user’s password could potentially access the user’s transaction data or personal information. We may not be able to prevent third parties, such as hackers or criminal organizations, from stealing information provided by our customers to us through our websites. In addition, our third-party merchants and delivery service providers may violate their confidentiality obligations and disclose information about our customers. Any compromise of our security could damage our reputation and brands 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.

Significant capital and other resources may be required to protect against security breaches or to alleviate problems caused by such breaches. While we maintain insurance coverage at levels we deem reasonable to manage liabilities relating to potential cyber security risks, such coverage may be inadequate to cover all losses with respect to an actual breach. The methods used by hackers and others engaged in online criminal activity are increasingly sophisticated and constantly evolving. Even if we are successful in adapting to and preventing new security breaches, any perception by the public that e-commerce and other online transactions, or the privacy of user information, are becoming increasingly unsafe or vulnerable to attack could inhibit the growth of e-commerce and other online services generally, which in turn may reduce the number of orders we receive. Any failure, or perception of failure, to protect the confidential information of our customers or our network could damage our reputation and harm our business.

 

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We maintain industry standard privacy policies and practices with respect to the personally identifiable information of our users that we maintain. Any failure or perceived failure by us to comply with our privacy policies or privacy-related obligations to customers, sellers or other third parties may result in Federal or state governmental enforcement actions, litigation, or negative public statements against us by consumer advocacy groups or others and could cause our customers to lose trust in us, which could have an adverse effect on our reputation and business.

We accept payment by a variety of methods and a substantial majority of our net revenues is derived from credit card sales. This in turn exposes us to increased risks of dependence on third-party payment processing service providers as well as risks associated with higher transaction fees, compliance matters and fraud.

We accept payments for our products and services on our websites by a variety of methods, including credit card, debit card and other payment services. As we offer new payment options to our customers, we may be subject to additional fees, additional regulations, compliance requirements and fraud. To date, the substantial majority of our net revenues have been derived from credit card sales. As a result, we believe our business is vulnerable to any disruption in our customer payment processing capabilities and third-party processor disruptions. In most geographic regions, we rely on three or four third-party companies to provide payment processing services, including the processing of credit cards, debit cards and other payment services. If any of these companies became unwilling or unable to provide these services to us, then we would need to find and engage replacement providers. We may not be able to do so on terms that are acceptable to us or at all, or to process the payments ourselves, which could be costly and time consuming, either of which scenarios could disrupt our business. Additionally, as we typically experience increased activity from November through December each year due to increased retail activity during the holiday season, any disruption in our ability to process customer payments in the fourth quarter could have a significant and disproportionate negative impact on our business.

For certain payment methods, including credit and debit cards, we pay interchange and other fees, which may increase over time and raise our operating costs and lower our profit margins or require that we charge our customers more for our products. We are also subject to payment card association and similar operating rules and requirements, which could change or be reinterpreted to make it difficult or impossible for us to comply. If we fail to comply with these rules and requirements, we may be subject to fines and higher transaction fees and lose our ability to accept credit and debit card payments from our customers or facilitate other types of online payments, and our business and operating results could be materially adversely affected.

If we fail to manage our relationships with our suppliers, our business and prospects may suffer.

To address customer demand for a wider range of customizable products, we intend to continue to expand our merchandise selection. This in turn increases our reliance on suppliers of such merchandise. Additionally, our business and reputation depend in large part on our ability to process and ship orders quickly, including during unanticipated or seasonal periods of increased demand. As a result, we believe the successful management of our supplier relationships is a key aspect of our business and our ability to compete. We source our blank products from domestic and foreign manufacturers and distributors. Maintaining good relationships with suppliers that compete with each other can be difficult. For example, suppliers of similar products may compete for more prominent placement on our websites. Our current suppliers may not continue to sell merchandise to us on terms acceptable to us, and we may be unable to establish new or extend current supplier relationships to ensure a steady supply of blank inventory in a timely and cost-efficient manner. If we are unable to develop and maintain good relationships with suppliers, it may inhibit our ability to offer products demanded by our customers or to offer them in sufficient quantities and at prices acceptable to them. In addition, if our suppliers cease to provide us with favorable pricing or payment terms or return policies, our working capital requirements may increase and our operations may be materially and adversely affected. In addition, we subcontract certain activities to third- party vendors. Any deterioration in our supplier or subcontractor relationships, or a failure to resolve disputes with, or complaints from, our suppliers in a timely manner, could materially and adversely affect our business, prospects and results of operations.

We may suffer losses if we are unable to efficiently manage our inventory risks.

We must anticipate the popularity of products and purchase blank inventory and secure sufficient supplies before customizing and selling them to our customers. Across all of our businesses, including the newly-acquired businesses, we must manage differing demand and inventory controls to accurately forecast and protect against risks. If we fail to adequately predict demand and experience an unexpected peak in production, our production times will suffer, which may result in damage to our reputation and business. For example, if we do not have an adequate supply of ink due to periods of unexpected peak demand, our ability to print and deliver products may be delayed. Conversely, any over purchase of ink or other supplies exposes us to risks of obsolete or excess inventory. Under some of our current supply agreements, we enjoy flexible policies for returning the unsold items to our suppliers. In order to secure more favorable business terms, we have entered into and plan to continue to enter into purchase arrangements with our suppliers with more restrictive return policies or with commitments to purchase larger quantities of inventory or supplies. For example, some of our contracts with suppliers contain restrictions on our ability to return products, such as caps on the amount of products that can be returned, and we may lose preferential pricing terms for such products if we exceed these caps, which could materially affect our profit margins. If we are unable to correctly predict demand for the products that we are committed to purchase, we will be responsible for covering the cost of the products that we are unable to sell, and our financial condition and results of operations may suffer.

 

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We largely depend on overseas suppliers for blank inventory and if we do not appropriately manage the risks related to product safety and quality, we may face regulatory actions or recalls and our operating results will be harmed.

Like most retailers, manufacturers in China are the source of much of the blank inventory we utilize in the creation of customized products for sale on our websites, whether sourced from vendors directly by our supply managers or purchased through our business or fulfillment partners. Regulatory oversight of manufacturing in China is not subject to the same standards of product safety or supply chain scrutiny as may be expected in the United States. One or more of our vendors might not adhere to U.S. quality or legal standards, and we might not identify the deficiency before merchandise ships to our customers. As an example, The Transparency in Supply Chains Act of 2010 in California also requires us to audit our vendors with respect to risks of human trafficking and slavery and mitigate these risks in our operations. Any failure to disclose issues or other non-compliance could subject us to action by the California Attorney General or other regulatory authorities. Our distribution partners likewise maintain global sourcing policies with which we must comply in order to maintain business relationships. Such policies require us to monitor our supply chain and there is no guarantee we will be able to do so consistently and successfully over time and secure a price that is not otherwise damaging to our business. In addition, our vendors may have difficulty adjusting to our changing demands and growing business. Our vendors’ failure to manufacture or import quality merchandise in a timely and effective manner could damage our reputation and brands, and could lead to an increase in customer litigation against us and an increase in our routine litigation costs. We rely on indemnities from suppliers and manufacturers with respect to the goods we customize and that protection may or may not be enough to shield us from liability for quality deficiencies. Further, any merchandise that we receive, even if it meets our quality standards, could become subject to a later recall, which could damage our reputation, our brands and our customers’ brands and harm our business. While we have never been subject to a product recall, there can be no guarantee that we will not face one in the future and the costs associated with such a recall may be substantial. Recently enacted legislation has given the United States Consumer Product Safety Commission increased regulatory and enforcement power, particularly with regard to children’s safety, among other areas. As a result, companies like ours may be subject to more product recalls and incur higher recall-related expenses. Any recalls or other safety issues could harm our business and operating results.

Increased product returns and quality re-dos and the failure to accurately predict product returns could substantially harm our business and results of operations.

We generally offer our customers an unconditional 30-day return policy which allows our customers to return most products for a full refund if they are not satisfied for any reason. We make allowances for product re-dos and chargebacks in our financial statements based on historical return rates and current economic conditions. Actual merchandise returns are difficult to predict and may differ from our allowances. Issues with quality occur with rate of adoption of newly implemented base products and we must account for such implementation processes in our operations planning and forecasting. Any significant increase in merchandise returns or chargebacks above our allowances would substantially harm our business and results of operations.

Our business would be adversely affected by the departure of existing members of our senior management team and other key personnel.

Our success depends, in large part, on the continued contributions of our senior management team, in particular, the services of Bob Marino, our Chief Executive Officer, and Monica N. Johnson, our Chief Financial Officer, as well as other key personnel. In addition, we have not entered into long-term employment agreements or non- compete agreements with some members of our senior management team. Our employees can terminate their employment with us at any time. The loss of any member of our senior management team or key personnel could harm our ability to implement our business strategy and respond to the rapidly changing market conditions in which we operate.

If we are unable to attract, train, integrate and retain qualified personnel with relevant industry and operational expertise, we may be unable to effectively execute our business plan or maintain or, in the future, expand our operations, which in turn would harm our business.

Our operations depend heavily on skilled personnel trained in our proprietary printing and production techniques and personnel knowledgeable about the online retail industry. Our future success depends, to a significant extent, on our ability to attract, train, integrate and retain qualified personnel with relevant experience and skill sets. Recruiting and retaining capable personnel, particularly those with expertise in the retail, e- commerce and printing industries, is vital to our success. In recent years, a substantial amount of our growth in personnel has been due to newly- acquired businesses. In our newly-acquired businesses we must strive to integrate and retain employees of these businesses into or own and maintain motivation to drive future growth and revenue in the acquired properties. There is substantial competition for qualified personnel and we cannot assure you that we will be able to attract or retain our personnel. If we are unable to attract and retain qualified personnel for each of our e-commerce sites operations, our business may suffer.

Our failure to protect our intellectual property rights may undermine our competitive position, and litigation to protect our intellectual property rights or defend against third-party allegations of infringement may be costly.

Protection of our proprietary technology is critical to our business. Failure to protect and monitor the use of our existing intellectual property rights could result in the loss of valuable technologies and prevent us from maintaining a leading market position. We rely primarily on patents, trademarks, trade secrets, copyrights and other contractual restrictions to protect our intellectual property. As of September 30, 2013 , we had six issued patents and seven patents pending in the United States, which relate to our unique e-commerce services, our proprietary printing and decorating services and an online platform for designing and generating framed products. We may have, on occasion, disclosed inventions prior to making the relevant filings, which may make our patent applications and any resulting issued patents vulnerable to validity challenges. Our pending patent applications may not result in issued patents, or if patents are issued to us, such patents may not provide meaningful protection against competitors or against competitive technologies.

 

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We also rely upon certain unpatented proprietary manufacturing expertise and modeling methods and designs, licensed third-party technologies, continuing technological innovation and other trade secrets to develop and maintain our competitive position. While we enter into confidentiality and invention assignment agreements with our employees and third parties to protect our intellectual property, certain confidentiality and invention assignment agreements may be limited in duration or deemed by a court to be unenforceable. Moreover, these confidentiality and invention assignment agreements could be breached, potentially in a way that we could not immediately detect, and thus may not provide meaningful protection for our trade secrets or proprietary manufacturing expertise. Adequate remedies may not be available in the event of unauthorized use or disclosure of our trade secrets and manufacturing expertise. In addition, others may obtain knowledge of our trade secrets through independent development or legal means. The failure of our patents or confidentiality agreements to protect our processes, equipment, technology, trade secrets and proprietary manufacturing expertise, methods of system design, other methods and materials could have a material adverse effect on our business. In addition, effective patent, trademark, copyright and trade secret protection may be unavailable or limited in some foreign countries. In some countries where we operate we have not applied for patent, trademark or copyright protection.

Third parties may infringe or misappropriate our proprietary technologies or other intellectual property rights, which could harm our business, financial condition or operating results. Policing unauthorized use of proprietary technology can be difficult and expensive and potentially subjects our intellectual property rights to validity and enforceability challenges. Also, litigation may be necessary to enforce our intellectual property rights, protect our trade secrets or determine the validity and scope of the proprietary rights of others. We cannot assure you that the outcome of such potential litigation will be in our favor. Such litigation may be costly and may divert management attention and other resources away from our business. An adverse determination in any such litigation will impair our intellectual property rights and may harm our business, prospects and reputation.

We may face infringement or misappropriation claims by third parties, which, if determined adversely to us, could cause us to pay significant damage awards or prohibit us from conducting our business.

Our success depends largely on our ability to use and develop our technology and know-how without infringing or misappropriating the intellectual property rights of third parties. The validity and scope of claims relating to business process patents involve complex scientific, legal and factual questions and analysis and, therefore, may be highly uncertain. We have been and may continue to be subject to litigation involving claims of patent infringement or violation of intellectual property rights of third parties, including allegations of patent infringement asserted by patent holding companies or other adverse patent owners who have no relevant product revenues and against whom our own patents may therefore provide little or no deterrence. For example, in January 2013, Express Card Systems LLC filed suit against us and in a separate suit, against partner Target Corporation, for which we have an indemnification obligation for the licensed platform. CafePress settled both suits in May 2013 on behalf of itself, EZ Prints, its wholly-owned subsidiary, and its partner Target Corporation. While we may believe such suits to be meritless, the defense and prosecution of intellectual property suits, patent opposition proceedings and related legal and administrative proceedings can be both costly and time consuming and may significantly divert the efforts and resources of our technical and management personnel. If in the future any such suits are filed, their defense will likewise contribute to costs and diverting of resources of our management personnel. If a material, adverse determination is made in the future in any such litigation or proceedings to which we may become a party could subject us to significant liability to third parties, require us to seek licenses from third parties, which may not be available on reasonable terms, or at all, pay ongoing royalties, or subject us to injunctions prohibiting the use of our technologies. Protracted litigation could also result in our customers or potential customers deferring or limiting their purchase or use of our website services until resolution of such litigation.

We are involved in legal proceedings that may result in adverse outcomes.

In addition to the potential infringement claims otherwise described above, we may be involved in claims, suits, government investigations, and regulatory proceedings arising in the course of our business, including actions with respect privacy, data protection, law enforcement, taxes, labor and employment claims as well as stockholder derivative actions, class actions lawsuits and other matters. For example, we were recently named, among other defendants, in purported class action lawsuits on behalf of purchasers of shares issued in our IPO and thereafter.

Regardless of the outcome, such legal proceedings can have an adverse impact on us because of the legal defense costs, diversion of our Board of Directors, management and other personnel’s time and resources, and other factors and expenses. In addition, it is possible that resolution of one or more such proceedings could result in liability, penalties or sanctions, as well as judgments, penalties, consent decrees or orders preventing us from offering certain features in our product offerings or services, requiring changes in our business practices or revenue models, or introducing doubts in the minds of customers, business partners or investors as to the future materiality or validity of such claims that could adversely affect our business, operating results, and financial condition.

We are subject to, or will soon be subject to, additional regulatory compliance requirements, including Section 404 of the Sarbanes-Oxley Act of 2002, as a result of becoming a public company and our management has limited experience managing a public company.

We have limited experience as a public company and will incur significant legal, accounting and other expenses, particularly after we cease to be an “emerging growth company” that we did not incur as a private company. The individuals who constitute our management team have limited experience managing a publicly traded company, and limited experience complying with the increasingly complex and changing laws pertaining to public companies. Our management team and other personnel will need to

 

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devote a substantial amount of time to compliance initiatives and we may not successfully or efficiently manage our transition into a public company. In addition, the Sarbanes-Oxley Act and the Dodd-Frank Act of 2010, as well as rules subsequently implemented by the SEC and the Nasdaq Stock Market, or Nasdaq, impose a number of requirements on public companies, including requiring changes in corporate governance practices. The Sarbanes-Oxley Act requires, among other things, that we assess the effectiveness of our internal control over financial reporting annually and disclosure controls and procedures quarterly. While the JOBS Act will provide us with more time to achieve full compliance, the regulations surrounding Section 404 of the Sarbanes-Oxley Act will require us to incur substantial accounting expense and expend significant management time on compliance-related issues. Moreover, these rules and regulations will increase our legal, accounting and financial compliance costs and will make some corporate activities more time-consuming and costly than private company compliance. These rules and regulations could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors, our board committees or as executive officers and make securing directors’ and officers’ liability insurance more expensive.

If we are unable to successfully improve internal controls, our ability to report our financial results on a timely and accurate basis may be adversely affected.

We have implemented and continue to adopt and implement measures to improve our internal controls. We are likewise in the process of developing procedures for our newly-acquired companies as well. If the procedures we have adopted and implemented are insufficient, we may fail to meet our future reporting obligations, our financial statements may contain material misstatements and our operating results may be harmed. In the past we have experienced deficiencies in internal controls, and while the amounts of revenue involved were not material and we believe we have remediated the deficiency, there can be no assurance that similar or other significant deficiencies or material weaknesses in our financial reporting will not occur in the future. Any failure to maintain or implement required new or improved controls, or difficulties we encounter in their implementation, could result in significant deficiencies or material weaknesses, cause us to fail to meet our future reporting obligations or cause our financial statements to contain material misstatements. Internal control deficiencies could also result in a restatement of our financial statements in the future or cause investors to lose confidence in our reported financial information, leading to a decline in our stock price.

If we fail to detect weaknesses or errors in our internal controls, the trading price of our common stock may be adversely impacted as well as our ability to attract new and continued investors.

Since we are an “emerging growth company,” as defined by the JOBS Act of 2012 and for as long as we maintain such status, we are not required at this time to include an attestation report of our registered public accounting firm regarding internal control over financial reporting. The absence of such report could impair our ability to detect weaknesses or errors in our financial reporting. If we fail to maintain effective and appropriate internal controls over financial reporting processes or modify them as necessary to maintain such controls, investors could lose confidence in the accuracy and completeness of our financial reports. If the reliability of our internal control over financial reporting is in question, the price of our common stock may decline or be otherwise adversely affected. Such doubts about the efficacy of internal controls could also impair our ability to attract new investors and may adversely affect our ability to continue our growth and meet our forecasts.

Risks related to our industry

Uncertainties regarding the growth and sustained profitability of business-to-consumer e-commerce could adversely affect our revenues and business prospects and the trading price of our common stock.

The long term viability and prospects of e-commerce remain relatively uncertain. Our future operating results will depend on numerous factors, including:

 

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the growth of personal computer, Internet and broadband usage and penetration, and the rate of any such growth;

 

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the trust and confidence level of consumers in online shopping, as well as changes in consumer demographics and consumers’ tastes and preferences;

 

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concerns about buying customized and personalized products without face-to-face interaction with sales personnel;

 

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our ability to provide high-quality customization capabilities;

 

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the selection, price and popularity of products that we and our competitors offer on websites;

 

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whether alternative retail channels or business models that better address the needs of consumers emerge;

 

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the impact of new technology platforms for Internet access, like mobile, and methods of marketing, such as social media;

 

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the development of fulfillment, payment and other ancillary services associated with online purchases; and

 

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general economic conditions, particularly economic conditions affecting discretionary consumer spending.

A decline in the popularity of shopping on the Internet in general, interest in customized goods as a retail trend or any failure by us to adapt our websites and improve the online shopping experience of our customers in response to consumer requirements and tastes, will harm our revenues and business prospects.

 

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As a provider of customized consumer products, our growth and profitability depends, among other things, on the level of consumer confidence and spending in the United States and globally.

Our results of operations are sensitive to changes in overall economic and political conditions that impact consumer spending both in the United States and globally. The retail industry, in particular, is very sensitive to broad economic changes, and retail purchases tend to decline during recessionary periods. A substantial portion of our revenues are derived from retail sales in the United States, where sales are dependent on the availability of discretionary income. Additionally, as a provider of customized consumer products that represent discretionary purchases by consumers, we believe we are particularly vulnerable to fluctuations and trends in consumer confidence and spending as consumers are less likely to purchase customized goods during periods of economic uncertainty. Many factors outside of our control, including interest rates, volatility of the world’s stock markets, inflation and deflation, tax rates and other government policies and unemployment rates can adversely affect consumer confidence and spending. The domestic and international political environments, including military conflicts and political turmoil or social instability, may also adversely affect consumer confidence and reduce spending, which could in turn materially and adversely affect our growth and profitability.

Our international sales and operations subject us to additional risks that may materially and adversely affect our business and operating results.

We plan to continue to target customers in countries outside the United States. We maintain websites localized to the markets in the United Kingdom, Australia, Canada, Germany, Spain and France. Additionally, we utilize contract manufacturing operations through partners in the Czech Republic and Australia. In connection with our international presence we are subject to a variety of risks including:

 

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the need to develop new production, supplier and customer relationships;

 

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difficulties in enforcing contracts, collecting accounts receivables and longer payment cycles;

 

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regulatory, political or contractual limitations on our ability to operate and sell in certain foreign markets, including trade barriers such as export requirements, tariffs, taxes and other restrictions and expenses as well as tax nexus issues for royalties paid to non-U.S. content providers;

 

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varying and more extensive data privacy and security laws and regulations in other countries;

 

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challenges of international delivery and customs requirements;

 

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varying product safety requirements and content restrictions in other countries;

 

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difficulties of language translations, increased travel, infrastructure and legal compliance and enforcement costs associated with international operations;

 

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currency translation and transaction risk, which may negatively affect our revenues, cost of net revenues and gross margins, and could result in exchange losses;

 

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difficulty with managing widespread international operations and fulfillment partnerships;

 

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reduced protection for intellectual property rights in some countries;

 

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the need to defend against intellectual property infringement claims against us in unfamiliar foreign legal regimes and to comply with unfamiliar foreign regulatory schemes and laws;

 

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lower per capita Internet usage and lack of appropriate infrastructure to support widespread Internet usage as well as broadband connections on which our content-rich services depend;

 

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heightened exposure to political instability, war and terrorism; and

 

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changes in the general economic and political conditions.

As we continue to expand our business globally, our success will depend on our ability to anticipate and effectively manage these and other risks associated with our international presence. Our failure to manage any of these risks successfully could harm our international reputation and reduce our international sales, adversely affecting our business, operating results and financial condition.

If use of the Internet, particularly with respect to e-commerce, decreases or stays flat, our business and results of operations will be harmed.

Our future revenues 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 for several reasons including the following:

 

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actual or perceived lack of security of information or privacy protection;

 

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attacks on or attempts to hijack our domain or website traffic or similar damage to our domains or servers;

 

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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

 

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excessive governmental regulation and new taxation measures.

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 contextually rich websites that require the transmission of substantial secure data, is also significantly dependent upon the availability and adoption of broadband Internet access and other high speed Internet connectivity technologies.

 

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If we do not properly account for our unredeemed gift certificates, gift cards, merchandise credits and flash deal promotions through group- buying websites, our operating results will be harmed.

We account for unredeemed gift cards, gift certificates, and flash deal promotions through group-buying websites and merchandise credits based on historical redemption data. In the event that our historical redemption patterns change in the future, our estimates for redemption would change, which would affect our financial position or operating results. Further, in the event that a state or states were to require that the unredeemed amounts be escheated to such state or states, our business and operating results would be harmed.

As mentioned above, we also participate in flash deal promotions through group-buying websites such as Groupon. Due to the emerging development of this business model, the terms and conditions of these programs continue to evolve and the taxation, legal and other potential regulatory implications of these sales activities have yet to be fully settled. Based on the terms of the agreements that we have entered into to date, and based on our judgmental evaluation of the criteria in the authoritative accounting guidance, we have concluded that we are the primary obligor in these transactions and have recorded revenues on a gross basis and the fees retained by the group-buying website as sales and marketing expense. We will continue to evaluate changes in the terms and conditions of these programs, or changes in accounting guidance in determining our accounting for these programs. There can be no guarantee that the legal, accounting and customer service approaches we have taken to these programs will be appropriate in the future. Changes in the terms and conditions of these programs or our evaluation of our performance obligations and associated tax, escheatment and other obligations associated with these programs could have a material adverse effect on our business, operating results or financial position or otherwise harm our business.

Taxation risks could subject us to liability for past sales and cause our future sales to decrease.

United States Supreme Court precedents currently restrict the imposition of obligations to collect state and local sales and use taxes with respect to sales made over the Internet. However, in recent years, a number of states have attempted or are considering adoption of initiatives that limit or supersede the Supreme Court’s position regarding sales and use taxes on Internet sales or with respect to affiliate marketing programs we employ to generate sales on our websites. If these initiatives are successful, we could be required to collect sales taxes in additional states or change our business practices and we may be exposed to retroactive liability on sales. In addition, Congress is considering a bill introduced in July 2011 called the Main Street Fairness Act, which would authorize states to use the Streamlined Sales and Use Tax Agreement to require remote retailers to collect and remit sales taxes in those states. Other bills were introduced thereafter, including The Marketplace Equity Act and The Marketplace Fairness Act, which covered similar subject matters. The bill did not pass in the election year cycle of 2012, but attempts to implement the bill are expected to be successful in 2013 as soon as the second fiscal quarter of 2013. The imposition of a Federal tax scheme or the imposition by individual state and local governments of taxes upon Internet commerce or affiliate programs could create administrative burdens for us in the future that may pose operational challenges. We currently collect sales tax in states in which we believe we have established sales tax nexus based on our operations and physical presence and in compliance with existing law. We have elected to discontinue affiliate marketing programs residing in states that have enacted affiliate sales tax nexus statutes. Under some of our agreements, another company is the seller of record, but we are nevertheless obligated to collect sales tax on transactions. We may enter into additional agreements requiring similar tax collection obligations. We expect the complexity of the application of various taxation schemes to continue to pose challenges to our business as it grows.

We also pay royalties to our designers where they upload content and license to us for the creation of online storefronts operated by us. We believe it is our content owners’ obligation to pay taxes on their royalty income. In the U.S., we issue appropriate tax forms disclaiming the withholding on taxes on such royalty income to them. U.S. law remains unsettled on taxation of sales made in the U.S. for which we may owe royalty payments to licensors who reside outside the U.S. While we have had no taxing authority inquiries on such on the application position withholding taxes there is no guarantee that such procedures will be appropriate to disclaim taxable nexus in every state and foreign country in the future and we continually review such positions on a regular basis for recent developments.

We comply with tax liability obligations, including value added tax and provincial sales tax, in foreign jurisdictions as applicable but additional foreign countries may seek to impose sales or other tax collection obligations on us and as our international sales grow and we expand localized language sites our exposure to liability likewise grows.

A successful assertion of taxable nexus with respect to any of our sales, affiliate marketing or user royalty payment activity by one or more states or foreign countries that we should collect sales or other taxes on the sale of merchandise could result in substantial tax liabilities for past sales, decrease our ability to compete with traditional retailers or competitors, negatively impact our financial position or otherwise harm our business.

Risks related to ownership of our common stock

Our stock price has been volatile, may continue to be volatile and may decline regardless of financial performance.

The market price for our common stock has fluctuated and may continue to fluctuate in response to a number of factors, including:

 

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actual or anticipated fluctuations, including seasonal variations, in our financial condition and operating results;

 

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changes in the economic performance or market valuations of other e-commerce companies or companies perceived by investors to be comparable to us;

 

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•

loss of a significant amount of existing business;

 

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actual or anticipated changes in our growth rate relative to our competitors;

 

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actual or anticipated fluctuations in our competitors’ operating results or changes in their growth rates;

 

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issuance of new or updated research or reports by securities analysts, including the publication of unfavorable reports or change in recommendation or downgrading of our common stock;

 

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lack of coverage of us by industry or securities analysts;

 

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our announcement of actual results for a fiscal period that are higher or lower than projected results or our announcement of revenues or earnings guidance that is higher or lower than expected;

 

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regulatory developments in our target markets affecting us, our customers or our competitors;

 

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fluctuations in the supply and prices of materials used in our products, such as cotton;

 

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share price and volume fluctuations attributable to inconsistent trading volume levels of our shares;

 

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commencement of, our involvement in, litigation;

 

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terrorist attacks or natural disasters or other such events impacting countries where we or our customers have operations; and

 

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general economic and market conditions.

For example, from March 29, 2012 through September 30, 2013, our stock price has fluctuated from a high of $22.69 to a low of $4.91 on November 9, 2012. As of September 30, 2013, our stock price closed at $6.11.

Furthermore, the stock markets have experienced extreme price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many companies. These fluctuations often have been unrelated or disproportionate to the operating performance of those companies. These broad market and industry fluctuations, as well as general economic, political and market conditions such as recessions, interest rate changes or international currency fluctuations, may cause the market price of shares of our common stock to decline. As an e- commerce company, we believe our stock price may be particularly susceptible to volatility as the stock prices of technology and e-commerce companies have often been subject to wide fluctuations.

In the past, companies that have experienced volatility in the market price of their stock have been subject to securities class action litigation. We are currently, and in the future may be, the target of this type of litigation. Securities litigation against us could result in substantial costs and divert our management’s attention from other business concerns, which could seriously harm our business.

We have been named as a defendant in a purported securities class action lawsuit, which could cause us to incur substantial costs and divert management’s attention and financial and other resources.

In the past, securities class action litigation has often been brought against a company following periods of volatility in the market price of its securities. Companies such as ours in the high technology industry are particularly vulnerable to this kind of litigation due to the high volatility of their stock prices. On July 10, 2013, we were named, among other defendants, in a purported class action on behalf of purchasers of shares issued in our IPO that generally alleges that the registration statement for our IPO contained materially false or misleading statements. On July 14, 2013, a second, similar complaint was filed. These and any future lawsuits to which we may become a party will likely be expensive and time consuming to investigate, defend and resolve, and will divert our management’s attention and financial and other resources. Any litigation to which we are a party may result in an onerous or unfavorable judgment that may not be reversed upon appeal or in payments of substantial monetary damages or fines, or we may decide to settle lawsuits on similarly unfavorable terms, which could adversely affect our business, financial conditions, or results of operations.

We are an “emerging growth company,” and we intend to comply with reduced public company reporting requirements applicable to emerging growth companies, which could make our common stock less attractive to investors.

We are an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act enacted in April 2012, and, for as long as we continue to be an “emerging growth company,” we may choose to take advantage of exemptions from various reporting requirements afforded to “emerging growth companies,” including, but not limited to, exemptions from compliance with the auditor attestation requirements of Section 404 of the Sarbanes- Oxley Act of 2002, or the Sarbanes Oxley Act, exemptions from certain of the disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved. We could be an “emerging growth company” for up to five years following the date of our IPO, although, if the market value of our common stock that is held by non-affiliates exceeds $700 million or our revenues exceed $1 billion as of any June 30 before the end of that five-year period, we would cease to be an “emerging growth company” as of the following December 31. We cannot predict if investors will find our common stock less attractive because we choose to rely on these exemptions. If some investors find our common stock less attractive as a result of any choices to reduce future disclosure, there may be a less active trading market for our common stock and our stock price may be more volatile.

 

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We will not be required to comply with certain provisions of the Sarbanes-Oxley Act for as long as we remain an “emerging growth company.”

As long as we remain an “emerging growth company” we will not be required to comply with certain of the SEC rules that implement Section 404 of the Sarbanes-Oxley Act, and require us to provide an auditor attestation on the effectiveness of our internal control over financial reporting. Though we will be required to disclose changes made in our internal control procedures on a quarterly basis, we will not be required to make our first annual assessment of our internal control over financial reporting pursuant to Section 404 until the end of our 2013 financial reporting year.

Our independent registered public accounting firm is not required to formally attest to the effectiveness of our internal control over financial reporting until the later of the year following our first annual report required to be filed with the SEC, or the date we are no longer an “emerging growth company.” At such time, our independent registered public accounting firm may issue a report that is adverse in the event it is not satisfied with the level at which our controls are documented, designed or operating.

Anti-takeover provisions in our amended and restated certificate of incorporation and amended and restated bylaws, and Delaware law, contain provisions that could discourage a takeover.

In addition to the effect that the concentration of ownership by our officers, directors and significant stockholders may have as noted above, our amended and restated certificate of incorporation and our amended and restated bylaws contain provisions that may enable our management to resist a change of control. These provisions may discourage, delay or prevent a change in our ownership or a change in our management. In addition, these provisions could limit the price that investors would be willing to pay in the future for shares of our common stock. Such provisions as set forth in our amended and restated certificate of incorporation or amended and restated bylaws include:

 

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our board of directors is authorized, without prior stockholder approval, to create and issue preferred stock, commonly referred to as “blank check” preferred stock, with rights senior to those of common stock;

 

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advance notice is required of stockholders to nominate candidates to serve on our board of directors or to propose matters that can be acted upon at stockholder meetings;

 

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stockholder action by written consent is prohibited;

 

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special meetings of the stockholders will be permitted to be called only by a majority of our board of directors, the chairman of our board of directors or our chief executive officer;

 

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stockholders will not be permitted to cumulate their votes for the election of directors;

 

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newly created directorships resulting from an increase in the authorized number of directors or vacancies on our board of directors will be filled only by majority vote of the remaining directors, even though less than a quorum is then in office, or by a sole remaining director;

 

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our board of directors is expressly authorized to modify, alter or repeal our amended and restated bylaws; and

 

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stockholders will be permitted to amend our amended and restated bylaws only upon receiving at least two- thirds of the votes entitled to be cast by holders of all outstanding shares then entitled to vote generally in the election of directors, voting together as a single class.

We are also subject to the provisions of Section 203 of the Delaware General Corporation Law, which may prohibit certain business combinations with stockholders owning 15% or more of our outstanding voting stock. These and other provisions in our amended and restated certificate of incorporation, our amended and restated bylaws and Delaware law could make it more difficult for stockholders or potential acquirers to obtain control of our board of directors or initiate actions that are opposed by our then-current board of directors, including delaying or impeding a merger, tender offer or proxy contest involving us. Any delay or prevention of a change of control transaction or changes in our board of directors could cause the market price of our common stock to decline.

ITEM 5. OTHER INFORMATION

In October 2012, we acquired EZ Prints, pursuant to an Agreement and Plan of Merger, or Merger Agreement, as a result of which EZ Prints became our wholly-owned subsidiary. The Merger Agreement originally provided for earn-out consideration whereby the former stockholder of EZ Prints had contingent rights to receive up to $10.0 million based on achievement of certain performance targets for the acquired business over the twelve months following the closing of the merger. In addition, $4.5 million of the initial merger consideration was placed into an escrow account to settle certain claims for indemnification for breaches or inaccuracies in EZ Prints’ representations and warranties, covenants and agreements and other indemnifiable claims. Mr. Wes Herman, the previous Chief Executive Officer of EZ Prints, also entered into an employment agreement and earn-out bonus agreement with CafePress. These agreements provided Mr. Herman a contingent right to receive up to $1.0 million at the date that was twelve months after the closing of the merger based on the achievement of the same performance targets for the acquired business as the earn-out consideration metrics.

In August 2013, we entered into an amendment to the Merger Agreement, or the Amendment, pursuant to which the earn-out provision was revised such that the former stockholders of EZ Prints have contingent rights to receive a maximum earn-out consideration of up to $1.0 million based on achievement of revised performance targets of the acquired business for the period commencing September 1, 2013 and ending August 31, 2014. In connection with the Amendment, we agreed to an early release of the amounts held in the escrow account as well as certain other matters. We also entered into an amended earn-out bonus agreement with Wes Herman revising his contingent right to receive up to $1.0 million down to $0.1 million.

The above description of the Amendment is qualified in its entirety by reference to the full text of the Amendment, which was filed as Exhibit 2.1, to our quarterly report on Form 10-Q for the three months ended June 30, 2013 and incorporated herein by reference.

 

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ITEM 6. EXHIBITS

(A) Exhibits:

 

Exhibit
number		Description
2.1(1)		Amendment No. 1 to Agreement and Plan of Merger dated August 12, 2013, by and among the Registrant, EZ Prints, Inc. and Fortis Advisors LLC as Stockholder Representative.
3(i)(2)		Amended and Restated Certificate of Incorporation of the Company.
3(ii)(3)		Amended and Restated Bylaws of the Company.
10.1		Amended and Restated Bonus Agreement with Wes Herman
10.2		Amended and Restated Employment Agreement with Wes Herman
31.1		Certificate of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350).
31.2		Certificate of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350).
32.1(4)		Certificate of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350).
32.2(4)		Certificate of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350).
101.INS(5)		XBRL Instance Document.
101.SCH(5)		XBRL Schema Document.
101.CAL(5)		XBRL Calculation Linkbase Document.
101.DEF(5)		XBRL Taxonomy Definition Linkbase Document.
101.LAB(5)		XBRL Label Linkbase Document.
101.PRE(5)		XBRL Presentation Linkbase Document.

 

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(1)	Previously filed as Exhibit 2.1 to the Registrant’s Quarterly Report on Form 10-Q (File No. 001-35468), filed with the Securities and Exchange Commission on August 12, 2013, and incorporated by reference herein.

(2)	Previously filed as Exhibit 3(i) to the Registrant’s Quarterly Report on Form 10-Q (File No. 001-35468), filed with the Securities and Exchange Commission on May 15, 2012, and incorporated by reference herein.

(3)	Previously filed as Exhibit 3(ii) to the Registrant’s Quarterly Report on Form 10-Q (File No. 001-35468), filed with the Securities and Exchange Commission on May 15, 2012, and incorporated by reference herein.

(4)

The material contained in Exhibit 32.1 and Exhibit 32.2 is not deemed “filed” with the SEC and is not to be incorporated by reference into any filing of the Company under the Securities Act of 1933 or the Securities Exchange Act of 1934, whether made before or after the date hereof and irrespective of any general incorporation language contained in such filing, except to the extent that the registrant specifically incorporates it by reference.

(5)	In accordance with Rule 406T of Regulation S-T, the information furnished in these exhibits will not be deemed “filed” for purpose of Section 18 of the Exchange Act. Such exhibits will not be deemed to be incorporated by reference into any filing under the Securities Act or Exchange Act.

 

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SIGNATURES

Pursuant to the requirement of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

Date: November 13, 2013				CAFEPRESS INC.
				By:		/s/ Bob Marino
						Bob Marino Chief Executive Officer
						(Principal Executive Officer) and Director
				By:		/s/ Monica N. Johnson
						Monica N. Johnson Chief Financial Officer
						(Principal Financial and Accounting Officer)

 

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EXHIBIT INDEX

 

Exhibit
number		Description
2.1(1)		Amendment No. 1 to Agreement and Plan of Merger dated August 12, 2013, by and among the Registrant, EZ Prints, Inc. and Fortis Advisors LLC as Stockholder Representative.
3(i)(2)		Amended and Restated Certificate of Incorporation of the Company.
3(ii)(3)		Amended and Restated Bylaws of the Company.
10.1		Amended and Restated Bonus Agreement with Wes Herman
10.2		Amended and Restated Employment Agreement with Wes Herman
31.1		Certificate of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350).
31.2		Certificate of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350).
32.1(4)		Certificate of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350).
32.2(4)		Certificate of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350).
101.INS(5)		XBRL Instance Document.
101.SCH(5)		XBRL Schema Document.
101.CAL(5)		XBRL Calculation Linkbase Document.
101.DEF(5)		XBRL Taxonomy Definition Linkbase Document.
101.LAB(5)		XBRL Label Linkbase Document.
101.PRE(5)		XBRL Presentation Linkbase Document.

 

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(1)	Previously filed as Exhibit 2.1 to the Registrant’s Quarterly Report on Form 10-Q (File No. 001-35468), filed with the Securities and Exchange Commission on August 12, 2013, and incorporated by reference herein.

(2)	Previously filed as Exhibit 3(i) to the Registrant’s Quarterly Report on Form 10-Q (File No. 001-35468), filed with the Securities and Exchange Commission on May 15, 2012, and incorporated by reference herein.

(3)	Previously filed as Exhibit 3(ii) to the Registrant’s Quarterly Report on Form 10-Q (File No. 001-35468), filed with the Securities and Exchange Commission on May 15, 2012, and incorporated by reference herein.

(4)

The material contained in Exhibit 32.1 and Exhibit 32.2 is not deemed “filed” with the SEC and is not to be incorporated by reference into any filing of the Company under the Securities Act of 1933 or the Securities Exchange Act of 1934, whether made before or after the date hereof and irrespective of any general incorporation language contained in such filing, except to the extent that the registrant specifically incorporates it by reference.

(5)	In accordance with Rule 406T of Regulation S-T, the information furnished in these exhibits will not be deemed “filed” for purpose of Section 18 of the Exchange Act. Such exhibits will not be deemed to be incorporated by reference into any filing under the Securities Act or Exchange Act.

 

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