S-1/A 1 d187703ds1a.htm AMENDMENT NO. 8 TO REGISTRATION STATEMENT ON FORM S-1 Amendment No. 8 to Registration Statement on Form S-1
Table of Contents

As filed with the Securities and Exchange Commission on March 6, 2012

Registration No. 333-174829

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Amendment No. 8

to

FORM S-1

REGISTRATION STATEMENT

Under

The Securities Act Of 1933

 

 

CafePress Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   5900   94-3342816

(State or other jurisdiction of

incorporation or organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification No.)

1850 Gateway Drive, Suite 300

San Mateo, California 94404

(650) 655-3000

(Address and telephone number of registrant’s principal executive offices)

 

 

Bob Marino

Chief Executive Officer

6901 A Riverport Drive

Louisville, Kentucky 40258

(502) 995-2258

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

 

Copies to:

 

Jorge del Calvo, Esq.

Davina K. Kaile, Esq.

Stanley F. Pierson, Esq.

Pillsbury Winthrop Shaw Pittman LLP

2475 Hanover Street

Palo Alto, CA 94304

(650) 233-4500

(650) 233-4545 facsimile

 

Kirsten Mellor, Esq.

General Counsel

CafePress Inc.

1850 Gateway Drive,

Suite 300

San Mateo, CA 94404

(650) 655-3000

 

Bruce K. Dallas, Esq.

Martin A. Wellington, Esq.

Davis Polk & Wardwell LLP

1600 El Camino Real

Menlo Park, CA 94025

(650) 752-2000

(650) 752-2111 facsimile

 

 

Approximate date of commencement of proposed sale to the public:

As soon as practicable after this Registration Statement becomes effective.

 

 

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  ¨

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

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. (Check one):

 

¨ Large accelerated filer   ¨ Accelerated filer   x Non-accelerated filer   ¨ Smaller reporting  company

(Do not check if a smaller reporting company)

 

 

 

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.

 

 

 


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The information in this preliminary prospectus is not complete and may be changed. Neither we nor the selling stockholders may sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell these securities and is not soliciting an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

Subject to completion, dated March 6, 2012

Prospectus

            shares

 

LOGO

Common stock

We are offering         shares of our common stock and the selling stockholders identified in this prospectus are offering         shares of our common stock. We will not receive any proceeds from the sale of shares of our common stock by the selling stockholders. This is our initial public offering and no public market currently exists for our common stock. We expect the initial public offering price to be between $        and $        per share.

We have applied to list our common stock on The NASDAQ Global Market under the symbol “CPRS.”

 

      Per share        Total  

 

 

Initial public offering price

   $                                  $                            

Underwriting discounts and commissions

   $           $     

Proceeds to CafePress Inc., before expenses

   $           $     

Proceeds to selling stockholders, before expenses

   $           $     

 

 

We and the selling stockholders have granted the underwriters an option for a period of 30 days to purchase up to an additional         shares of our common stock solely to cover overallotments.

Investing in our common stock involves a high degree of risk. Please read “Risk factors” beginning on page 11.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

Delivery of the shares is expected to be made on or about                     , 2012.

 

J.P. Morgan      Jefferies

Cowen and Company

 

Janney Montgomery Scott    ThinkEquity LLC

                    , 2012


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LOGO


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LOGO


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LOGO

I refuse to quit

EAT SLEEP BIKE

I Walk for my mom MS awareness

Support free expression

Learn to Be Zen

fun facts

at a glance

2007 2008 2009 2010

150,000,000

100,000,000

200,000,000

250,000,000

350,000,000

300,000,000

products created

Over 150,000 new images uploaded on average

per week*

our members

2007 2008 2009 2010

4,000,000

6,000,000

8,000,000

10,000,000

12,000,000

We define members as visitors to our websites

who register with us and provide their email

address.

of customers

total number

2007 2008 2009 2010

4,000,000

6,000,000

8,000,000

10,000,000

12,000,000

We track the total number of customers by

unique member number or email address. As

a result, an individual who creates multiple

accounts using different email addresses

will be counted as multiple unique customers.

Over 315 million unique products

6 million products shipped in 2010

* from January 1, 2011 through June 30, 2011

Over 2 million orders shipped in 2010


Table of Contents

Table of contents

 

     Page  

Prospectus summary

     1   

Risk factors

     11   

Special note regarding forward-looking statements

     34   

Use of proceeds

     36   

Dividend policy

     36   

Capitalization

     37   

Dilution

     39   

Selected consolidated financial data

     42   

Management’s discussion and analysis of financial condition and results of operations

     45   

Business

     73   

Management

     90   

Executive compensation

     99   

Related party transactions

     121   

Principal and selling stockholders

     123   

Description of capital stock

     126   

Shares eligible for future sale

     130   

Material United States federal income tax considerations to non-U.S. holders

     133   

Underwriting

     137   

Legal matters

     143   

Experts

     143   

Where you can find additional information

     143   

Index to consolidated financial statements

     F-1   

 

 

Neither we, nor the selling stockholders, nor the underwriters have authorized anyone to provide any information or to make any representations other than those contained in this prospectus or in any free writing prospectuses we have prepared. We take no responsibility for, and can provide no assurance as to the reliability of, any other information that others may give you. We and the selling stockholders are offering to sell, and seeking offers to buy, shares of our common stock only in jurisdictions where offers and sales are permitted. The information in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or any sale of shares of our common stock. Our business, financial condition, results of operations and prospects may have changed since that date.

Until                     , 2012 (25 days after the commencement of this offering), all dealers that buy, sell or trade shares of our common stock, whether or not participating in this offering, may be required to deliver a prospectus. This delivery requirement is in addition to the obligation of dealers to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions.

For investors outside the United States: Neither we, nor the selling stockholders, nor the underwriters have done anything that would permit this offering or possession or distribution of this prospectus in any jurisdiction where action for that purpose is required, other than in the United States. Persons outside the United States who come into possession of this prospectus must inform themselves about, and observe any restrictions relating to, the offering of the shares of common stock and the distribution of this prospectus outside of the United States.


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Prospectus summary

This summary highlights information about CafePress Inc. and the offering contained elsewhere in this prospectus and is qualified in its entirety by the more detailed information and consolidated financial statements included elsewhere in this prospectus. You should carefully read the entire prospectus before making an investment decision, including the information presented under the headings “Risk factors” and “Management’s discussion and analysis of financial condition and results of operations” and the consolidated financial statements and related notes included elsewhere in this prospectus. In this prospectus, except as otherwise indicated or as the context may otherwise require, all references to “CafePress”, “CafePress.com”, “we”, “us” and “our” refer to CafePress Inc.

Company 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 personal and shared 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 share and monetize their content. We believe we are a leading e-commerce platform for customization of consumer products based on our more than a decade of experience of providing high-quality customized products in single unit and small quantity orders on a when-ordered basis. We have developed a strong brand with a growing community that, as of December 31, 2011, had more than 15 million members and more than three million shops, and we shipped over 7.8 million products in 2011 from a catalog of over 320 million unique products, as measured by the number of different combinations of designs and types of merchandise.

Our mission is to offer an unrivaled platform that is the world’s premier source for self-expression through product customization and personalization. We benefit from the network effect created when millions of customers are attracted to our catalog of content and are often inspired to contribute and share their own content. By enabling communities to share their interests, beliefs and affiliations through customized and personalized merchandise, we believe we drive social commerce.

Our expansive content catalog covers topics our customers are deeply passionate about, as well as relevant current events. As a result, we believe our catalog serves as a cultural barometer reflecting the latest topics, ideas, trends, moods and opinions. For the year ended December 31, 2011, we had nearly 130,000 new images uploaded to our retail e-commerce websites on average per week.

We have built a state-of-the-art facility in Louisville, Kentucky with innovative technology and manufacturing processes that enable us to provide high-quality customized products that are individually built to order at mass scale. Our proprietary, vertically integrated processes enable us to produce a broad range of merchandise efficiently, and cost effectively and quickly. We have an art print production facility in Portland, Oregon and as a result of our acquisition of Canvas On Demand LLC, we also have a custom canvas production facility in Raleigh, North Carolina. Our recent acquisition of substantially all of the assets of L&S Retail Ventures, Inc., including the e-commerce website InvitationBox.com, adds further print production facilities in North Carolina. We also recently entered into an agreement to acquire substantially all of the assets of Logo’d Softwear, Inc., which, if and when consummated, will add further print production facilities in Connecticut. We may not be able to close this acquisition as planned or at all, and may be unable to successfully integrate this business or realize the anticipated benefits of the acquisition.

 

 

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The majority of our net revenues is generated from sales of customized products through our e-commerce websites and associated charges. In addition, we generate revenues from fulfillment services, including print and production services provided to third parties. Fulfillment revenues were less than 2% and 1% of net revenues during the years ended December 31, 2010 and 2011, respectively.

Consumers purchase customized products directly from our website or through storefronts hosted by CafePress. Customized products include user-designed products as well as products designed by our content owners. We pay royalties to content owners for the use of their content on our products and royalty payments are included in cost of net revenues.

In 2010, we generated net revenues of $127.9 million. In 2011, net revenues were $175.5 million, an increase of 37% from 2010.

For information on how we define and tabulate our number of members and customers, see “—Overview” and “—Key operating metrics” in “Management’s discussion and analysis of financial condition and results of operations.”

Industry overview

Customization of consumer products is undergoing an enormous transformation which is being driven by the following trends:

 

 

Consumer demand for long tail selection and customization.    Consumers increasingly expect a broader selection of both design choices and content to create or customize products. We refer to the array of choices beyond what is typically in high demand or widely available as “long tail” selection.

 

 

E-commerce.    Online shopping and e-commerce have become mainstream. According to Forrester, United States online retail sales were expected to be $197 billion in 2011.(1) According to eMarketer, in 2011, approximately 179 million consumers ages 14 and older in the United States were expected to research products online and 83% of them were expected to make an online purchase. With the rise of e-commerce, the user experience has improved with easy-to-use interfaces, broad selection, enhanced search, rich media and streamlined payment options.

 

 

Internet tools and do-it-yourself empowerment.    Historically, consumers have needed help from third-party vendors to customize apparel and other products, but with the widespread availability of easy-to-use digital tools, today people can design products themselves. The ability to use do-it-yourself design tools reduces the need to visit a local artisan, further disrupting the traditional way products have been customized.

 

 

Advances in mass customization technologies.    Historically, customizing products often required either large production runs with complex and expensive set-ups or allowed for only minimal customization through basic engraving or monogramming. With recent innovations in digital printing technology, the ability to digitally print in a cost effective, flexible volume and high-quality manner on a variety of mass market products has only recently emerged.

Market opportunity

Our services address multiple large adjacent markets which include, but are not limited to:

 

 

Screen printing and garment printing.    According to Freedonia, the U.S. screen printing and garment printing market is expected to grow from $7.2 billion in 2009 to $8.1 billion in 2014.

 

(1)    Source: “U.S. Online Retail Forecast, 2010-2015”, Forrester Research, Inc., February 28, 2011

 

 

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Creative photo merchandise.    IDC estimates that the market for creative photo merchandise will grow from $2.8 billion in 2010 to $6.6 billion in 2014. Creative photo merchandise encompasses all products that are customized with photos including, but not limited to, cards, calendars, posters, photobooks and scrapbook pages, wall art and home décor.

 

 

Promotional products.    According to Promotional Products Association International, the promotional products industry grew 5.9% to $16.6 billion in 2010, up from $15.6 billion in 2009. This includes $2.7 billion in online sales of promotional products in 2010, up 11.1% from $2.4 billion in 2009.

 

 

Customization services for product manufacturers.     From tablet cases to water bottles and beyond, our product diversity suggests a large opportunity encompassing ever-expanding retail merchandise categories. Based on 2009 U.S. Census Bureau data, we estimate the U.S. market for customizable retail goods is approximately $1.0 trillion.

We believe traditional printing models are not optimized to satisfy individual consumers and smaller constituencies due to long lead times, costly set-up, limited printing capabilities and minimum quantities needed to achieve efficiency.

Our strengths

We believe our business model provides us with the following competitive advantages:

 

 

Viral network effect.    We enjoy a network effect that attracts new users to our various services. We attract new customers when new sales channels are launched and when new designs are added to our content catalog, where they are socially shared and made discoverable online. These new customers then often add their own new designs to our content catalog.

 

 

Trusted premium brands.    We believe we have built strong relationships with our customers who are passionate about the products they create. In addition to our flagship brand, CafePress.com, we operate a portfolio of vertically targeted brands that individually target specific consumers, products and use cases, and collectively expand the reach of the CafePress platform.

 

 

Broad product assortment.    We offer a wide variety of products across many different categories as diverse as t-shirts, hats, canvas art prints, banners, stickers, iPhone and iPad cases, mugs, water bottles, GPS units, cards and calendars. We believe this product assortment makes us a more compelling one-stop solution for our customers.

 

 

Innovative and efficient operations.    Our workflow automation enables us to schedule and produce items and efficiently merge them into a single shipment. We generally process and ship orders within three business days after a customer places an order and in many instances can ship orders within 24 hours after an order is placed. Transforming blank materials into finished goods in real-time minimizes inventory and capital requirements.

 

 

Long tail marketing expertise.     We believe our experience in data and analytics allows us to make effective marketing decisions across a continuously updated product catalog with sparse data.

 

 

Comprehensive online offering.    We believe our tools satisfy our users’ diverse needs, including finding the perfect unique gift, creating customized items or selling custom creations to their own communities or for profit through our online marketplace.

The CafePress platform

We have developed services and production capabilities that allow us to offer users the ability to find, make, buy and sell a wide variety of expressive customized products. Our platform consists of front-end design and

 

 

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sales channels and a back-end services platform. Our front-end design and sales channels include our branded e-commerce websites, CafePress.com, CanvasOnDemand.com, Imagekind.com, GreatBigCanvas.com and InvitationBox.com, as well as resellers and co-brands which include content owners, branded product manufacturers, other retailers and retail brands and distributors and resellers. Our back-end services platform includes user-generated content, licensed fan content, design tools, our turn-key online shops platform and fulfillment and manufacturing capabilities.

Our strategy

Our goal is to be the world’s customization platform. Key elements of our strategy to achieve this goal include the following:

 

 

Expand customer base.    We intend to expand our customer base and continue to promote our portfolio of e-commerce websites through existing marketing channels, which include word of mouth referrals from existing customers, trade publications, catalogs, online advertising, search engine marketing and social media.

 

 

Expand content partners.    We intend to expand our licensed content partners to increase the range of content accessible on our site and attract new users.

 

 

Expand product partners.    We believe we can partner with branded product manufacturers to help them offer customized designs on their products.

 

 

Expand product and service offerings.    We intend to continue to innovate to enable us to expand our products and services.

 

 

Increase sales to existing customers.    We seek to increase both our average order size and the lifetime value we receive from a customer by increasing retention rates, up-selling and cross-selling efforts and continuing to improve and streamline our design and ordering processes.

 

 

Offer customization through additional brands.    We intend to leverage our platform by developing new brands and seeking co-branding opportunities to provide rich customer experiences along a range of industries.

 

 

Seek acquisition and international expansion opportunities.    We intend to develop additional business opportunities through selected acquisition and international expansion, targeting customers in key geographies where Internet usage and e-commerce are widespread and targeting key verticals where we can leverage our technology and catalog of content. We currently have localized websites for the United States, Australia, Canada, Germany and the United Kingdom.

Risks and challenges

Investing in our common stock involves substantial risks, including, but not limited to, the following:

 

 

Fluctuations in our operating results.    Our revenues and operating results may fluctuate from period to period, which could cause our stock price to decline. Factors that may contribute to these fluctuations include major social or political events or developments resulting in a short term demand for products, macroeconomic cycles and consumer spending and demand for our user-designed products and services.

 

 

Seasonality of our business.    The seasonality of our business places increased strain on our operations. A significant portion of our net revenues and operating cash flows have historically been realized during the period from November through December each year. Any disruption in, or failure to scale, our business

 

 

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operations during this period or any other period of peak demand could have a disproportionate effect on our operating results and our stock price could decline.

 

 

User-generated content.    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. In addition, as a service provider that prints and distributes user-generated content, we face allegations related to, and potential liability for, negligence, copyright or trademark infringement or other claims based on the nature and content of materials that we print or distribute. If we lose or alienate current or potential customers or business partners due to the content on our websites, or become subject to liability, we risk damage to our brands, reputation and our business and results of operations.

 

 

Proper functioning of our websites, systems and infrastructure.    The satisfactory performance, reliability and availability of our websites, our marketing activities, our transaction-processing systems and our network infrastructure are critical to our success. Any failure to maintain the satisfactory performance, security and integrity of our websites, system or infrastructure could materially and adversely affect our business, reputation, financial condition and results of operations.

 

 

Production and fulfillment operations.    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. If our production and fulfillment operations are interrupted for any significant period of time, it could damage our brands and reputation and substantially harm our business and results of operations.

Corporate information

CafePress Inc., a Delaware corporation, was incorporated as CafePress.com, Inc. in California on October 15, 1999, and reincorporated in Delaware on January 19, 2005. Our corporate headquarters are located at 1850 Gateway Drive, Suite 300, San Mateo, California 94404 and our telephone number is (650) 655-3000. We maintain numerous e-commerce websites including those found at www.cafepress.com, www.canvasondemand.com, www.imagekind.com and www.invitationbox.com. The information contained in or connected to our websites is not a part of, and is not incorporated into, this prospectus and should not be relied on in determining whether to make an investment decision.

In March 2012, we entered into an agreement to acquire substantially all of the assets of Logo’d Softwear, Inc., an e-commerce provider of personalized apparel and merchandise for groups and organizations. The asset purchase agreement provides for a total initial purchase price of $8.3 million, consisting of $7.5 million in cash and $0.8 million in shares of CafePress common stock priced as of the closing date, as well as contingent rights for the principal stockholder to receive up to $8.6 million in future performance-based cash consideration. In addition, in connection with, and upon closing of, the acquisition, the principal stockholder will receive CafePress stock options to purchase shares of our common stock with an aggregate value of up to $2.1 million, with vesting based on the achievement of certain performance milestones. The contingent right to future earn-out payments will expire either March 31, 2016, or June 30, 2016, depending on the closing date of the acquisition. The acquisition is anticipated to close during the second quarter of 2012, subject to obtaining the requisite approvals and other customary closing conditions. We may not be able to close this acquisition as planned or at all, and may be unable to successfully integrate this business or realize the anticipated benefits of the acquisition.

CAFEPRESS, CANVAS ON DEMAND, IMAGEKIND and INVITATIONBOX are among the trademarks or service marks owned by CafePress. Other trademarks, service marks and trade names appearing in this prospectus are the property of their respective owners.

 

 

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The offering

 

Common stock offered by CafePress Inc.

         shares

 

Common stock offered by the selling stockholders

         shares

 

Overallotment option

We and the selling stockholders have granted a 30-day option to the underwriters to purchase up to an aggregate of          additional shares to cover overallotments, if any.

 

Common stock to be outstanding immediately after this offering

         shares (         shares if the underwriters exercise their overallotment option in full)

 

Use of proceeds

We intend to use the net proceeds from this offering for general corporate purposes, including working capital and capital expenditures. In addition, we may use a portion of the net proceeds to acquire or invest in complementary businesses, products or technologies, including in connection with our proposed acquisition of substantially all of the assets of Logo’d Software, Inc. We do not currently have any understandings or agreements relating to any significant acquisitions or investments other than for Logo’d Softwear, Inc. See “Use of proceeds.”

 

NASDAQ Global Market symbol

CPRS

The number of shares of common stock to be outstanding immediately after this offering is based on 14,478,700 shares outstanding as of December 31, 2011 and excludes:

 

 

2,558,609 shares of common stock issuable upon the exercise of options outstanding as of December 31, 2011, at a weighted average exercise price of $11.31 per share;

 

 

400,000 shares of common stock reserved for future issuance under our 2012 Stock Incentive Plan, as well as up to 285,087 shares originally reserved for issuance under our 2004 Stock Plan and 1999 Stock Plan but which may become available for awards under our 2012 Stock Incentive Plan as described below, which plan will become effective in connection with this offering and contains provisions that will automatically increase its share reserve each year, as more fully described in “Executive compensation—Employee benefit plans”;

 

 

250,000 shares of common stock reserved for future issuance under our Employee Stock Purchase Plan, which shares will become available for purchase when determined by our compensation committee, and contains provisions that will automatically increase its share reserve each year following its effective date, as more fully described in “Executive compensation—Employee benefit plans”;

 

 

shares of our common stock proposed to be issued in connection with, and in the event of the closing of, our proposed acquisition of substantially all of the assets of Logo’d Softwear, Inc., with an aggregate value of $0.8 million based on the fair market value per share of our common stock on the closing date (approximately          shares based on an assumed initial public offering price of $         per share, the mid-point of the range set forth on the cover page of this prospectus); and

 

 

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shares of our common stock subject to options with an aggregate value of up to $2.1 million, measured using a Black-Scholes option pricing model based on the fair market value per share of our common stock on the closing date, which may be granted in connection with our proposed acquisition of substantially all of the assets of Logo’d Softwear, Inc.

Unless otherwise stated, all information in this prospectus assumes:

 

 

the conversion of all of our outstanding shares of preferred stock into an aggregate of 5,534,963 shares of common stock effective upon the completion of this offering, assuming a one-to-one conversion ratio of our outstanding shares of preferred stock as of December 31, 2011 into common stock;

 

 

no exercise of options outstanding as of December 31, 2011;

 

 

the filing of our amended and restated certificate of incorporation immediately prior to the completion of this offering;

 

 

no exercise of the overallotment option granted to the underwriters; and

 

 

a 1-for-2 reverse stock split of our outstanding capital stock effected on September 15, 2011.

As of December 31, 2011, no shares remained available for future issuance under our 1999 Stock Plan and 82,837 shares remained available for future issuance under our 2004 Stock Plan. In February 2012, our board of directors and stockholders approved an increase of 600,000 shares to be reserved for issuance under our 2004 Stock Plan and our board of directors approved the grant of options to purchase 408,500 shares of our common stock pursuant to our 2004 Stock Plan. Upon the completion of this offering, no shares of our common stock will remain available for future issuance under our 1999 Stock Plan or our 2004 Stock Plan. Upon the completion of this offering, shares originally reserved for issuance under our 1999 Stock Plan or our 2004 Stock Plan, but which are not issued or subject to outstanding grants on the effective date of our 2012 Stock Incentive Plan, shares subject to outstanding options under our 1999 Stock Plan and our 2004 Stock Plan on the effective date of our 2012 Stock Incentive Plan that are subsequently forfeited or terminated for any reason before being exercised, and shares subject to vesting restrictions under our 1999 Stock Plan and our 2004 Stock Plan on the effective date of our 2012 Stock Incentive Plan that are subsequently forfeited, will become available for awards under our 2012 Stock Incentive Plan.

 

 

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Summary consolidated financial data

The information set forth below should be read together with “Capitalization”, “Selected consolidated financial data”, “Management’s discussion and analysis of financial condition and results of operations” and our consolidated financial statements and related notes included elsewhere in this prospectus. The summary consolidated statements of operations data for the years ended December 31, 2009, 2010 and 2011 and the consolidated balance sheet data as of December 31, 2011 have been derived from our audited consolidated financial statements included elsewhere in this prospectus. Historical results are not necessarily indicative of the results to be expected in the future.

 

      Year ended December 31,  
(in thousands, except per share data)    2009     2010     2011  

 

 

Consolidated statements of operations data:

  

Net revenues

   $ 103,493      $ 127,930      $ 175,482   

Cost of net revenues(1)

     57,688        72,447        100,191   
  

 

 

 

Gross profit

     45,805        55,483        75,291   

Operating expenses:

      

Sales and marketing(1)

     17,711        26,484        40,809   

Technology and development(1)

     13,152        14,305        12,768   

General and administrative(1)

     9,322        9,593        13,573   

Acquisition-related costs

            794        2,696   
  

 

 

 

Total operating expenses

     40,185        51,176        69,846   
  

 

 

 

Income from operations

     5,620        4,307        5,445   

Interest income

     220        116        56   

Interest expense

     (253     (215     (194

Other income (expense), net

     (3     239          
  

 

 

 

Income before income taxes

     5,584        4,447        5,307   

Provision for income taxes

     2,255        1,724        1,701   
  

 

 

 

Net income

   $ 3,329      $ 2,723      $ 3,606   
  

 

 

 

Net income per share of common stock(2):

      

Basic

   $ 0.15      $ 0.11      $ 0.17   
  

 

 

 

Diluted

   $ 0.15      $ 0.10      $ 0.16   
  

 

 

 

Shares used in computing net income per share of common stock(2):

      

Basic

     8,065        8,308        8,798   
  

 

 

 

Diluted

     8,668        8,860        9,403   
  

 

 

 

Pro forma net income per share of common stock(2):

      

Basic (unaudited)

       $ 0.25   
      

 

 

 

Diluted (unaudited)

       $ 0.24   
      

 

 

 

Shares used in computing pro forma net income per share of common stock(2):

      

Basic (unaudited)

         14,333   
      

 

 

 

Diluted (unaudited)

         14,938   

 

 

 

 

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      Year ended December 31,  
(in thousands, except key operating metrics)    2009      2010      2011  

 

 
     (unaudited)  

Other financial and non-GAAP financial data:

     

Adjusted EBITDA(3)

   $ 14,136       $ 14,550       $ 18,740   

Capital expenditures

     3,283         5,836         5,373   

Key operating metrics:

        

Total customers(4)

     1,736,787         2,077,587         2,681,605   

Total number of orders(5)

     2,157,835         2,655,264         3,545,305   

Average order size(6)

   $ 48       $ 48       $ 50   

 

 

The table below presents a summary of our consolidated balance sheet data as of December 31, 2011:

 

 

on an actual basis;

 

 

on a pro forma basis to give effect to: (a) the issuance of 5,534,963 shares of common stock issuable upon the conversion of all of our outstanding shares of preferred stock upon completion of this offering and (b) the filing of our amended and restated certificate of incorporation upon the completion of this offering; and

 

 

on a pro forma as adjusted basis to give effect to: (a) the pro forma conversion described above and (b) the sale of          shares of common stock in this offering at an assumed initial public offering price of $         per share, the mid-point of the range set forth on the cover page of this prospectus, after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us.

 

December 31, 2011

(in thousands)

  

Actual

     Pro forma      Pro forma
as adjusted
 

 

 
     (unaudited)  

Consolidated balance sheet data:

  

Cash and cash equivalents(1)

   $ 27,900       $ 27,900       $                

Short-term investments

     8,437         8,437      

Working capital

     17,973         17,973      

Total assets

     88,982         88,982      

Total indebtedness

     3,174         3,174      

Convertible preferred stock

     22,811              

Total stockholders’ equity

     25,620         48,431      

 

 
(1)   The table presented above excludes the potential impact of the proposed acquisition of substantially all of the assets of Logo’d Softwear, Inc. pursuant to an asset purchase agreement entered into in early March 2012. The asset purchase agreement provides for a total initial purchase price of $8.3 million, consisting of $7.5 million in cash and $0.8 million in shares of CafePress common stock priced as of the closing date, as well as contingent rights for the principal stockholder to receive up to $8.6 million in future performance-based cash consideration. In addition, in connection with, and upon closing of, the acquisition, the principal stockholder will receive CafePress stock options to purchase shares of our common stock with an aggregate value of up to $2.1 million, with vesting based on the achievement of certain performance milestones.

A $1.00 increase (decrease) in the assumed initial public offering price of $         per share, the mid-point of the range set forth on the cover of this prospectus, would increase (decrease), on a pro forma as adjusted basis, each of cash and cash equivalents, working capital, total assets and total stockholders’ equity by approximately $         million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us. The pro forma as adjusted information discussed above is illustrative only and will be adjusted based on the actual public offering price and other terms of this offering determined at pricing.

 

 

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(1)   Amounts include stock-based compensation expense as follows:

 

      Year ended December 31,  
     2009      2010      2011  

 

 

Cost of net revenues

   $ 160       $ 152       $ 164   
Sales and marketing    359      472      520  

Technology and development

     618         569         267   

General and administrative

     1,004         981         1,427   
  

 

 

 

Total stock-based compensation expense

   $ 2,141       $ 2,174       $ 2,378   

 

 

 

(2)   Please see notes 2 and 9 to our audited consolidated financial statements for an explanation of the calculations of our basic and diluted net income per share of common stock and unaudited pro forma net income per share of common stock.

 

(3)   Adjusted EBITDA is a non-GAAP financial measure that our management uses to assess our operating performance and it is a factor in the evaluation of the performance of our management in determining compensation. We define Adjusted EBITDA as net income less interest and other income (expense), provision for 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 income 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:

 

      Year ended December 31,  
(in thousands)    2009      2010     2011  

 

 
    

(unaudited)

 

Net income

   $ 3,329       $ 2,723      $ 3,606   

Non-GAAP adjustments:

       

Interest and other (income) expense

     36         (140     138   

Provision for income taxes

     2,255         1,724        1,701   

Depreciation and amortization

     6,013         6,364        5,836   

Amortization of intangible assets

     362         911        2,385   

Acquisition-related costs

             794        2,696   

Stock-based compensation

     2,141         2,174        2,378   
  

 

 

 

Adjusted EBITDA

   $ 14,136       $ 14,550      $ 18,740   

 

 

 

(4)   Total customers represents the number of transacting customers in a given period.

 

(5)   Total number of orders represents the number of individual transactions that are shipped during the period.

 

(6)   Average order size is calculated as billings for a given period 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.

 

 

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Risk factors

Investing in our common stock involves a high degree of risk. You should carefully consider the risks and uncertainties described below before making a decision to buy our common stock. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also impair our business operations. If any of the following risks actually occurs, our business, financial condition, results of operations or growth prospects could be harmed. In that case, the trading price of our common stock could decline and you might lose all or part of your investment in our common stock. In assessing these risks, you should also refer to the other information set forth in this prospectus, including our consolidated financial statements and the related notes.

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 or loss of significant strategic relationships;

 

 

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

 

 

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

 

 

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; and

 

 

the growth rate of the e-commerce industry.

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 revenue growth in recent periods, these growth rates may not be sustainable and may decrease in the future. In addition, our ability to be profitable depends on our ability to control our costs and operating expenses, which we expect will increase as we expand our business and incur additional expense associated with being a public

 

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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.

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 places increased 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. 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 and 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 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 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;

 

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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 as the marketplace; and

 

 

any negative media publicity about user-generated content or product quality problems of our 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.

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.

Since inception, most of our revenues have been derived from the online sale of user-designed products through our marketplace. We expect that sales of user-designed products will continue to grow and comprise a majority of our revenues in the future. While we intend to continue to expand our product and service offerings, including the expansion of our Create & Buy services, revenues from these services may not increase to a level that would reduce our dependence on revenues from our marketplace. In addition, customers who purchase user-designed products on our websites may also purchase other products through our e-commerce services. If we cannot successfully attract or retain our customers for user-designed products, our operating results may suffer.

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, our site could be the target of 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. 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 desire to protect our brands and company. If we fail to maintain this balance and lose 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 products, we risk damage to our brands and reputation and ultimately our business and results of operations.

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

Our success depends on our ability to attract customers in a cost-effective manner. We rely on a variety of methods to draw visitors to our websites and promote our products and services, such as search engine

 

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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. 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. 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 shall have to continue to do so, we may be unable to achieve our strategic goals. 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 royalties on 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 content, we sometimes enter into multi-year, royalty-based licenses with production studios 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 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

 

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properties to support the content on our site. 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 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, our results of operations may suffer.

We believe we will need to address additional markets and attract new business partners, content providers and consumers to further grow our business. 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. 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 and retail in-store offerings. Any failure to develop new products and services, 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 intend to expand our production and logistics centers and distribution network to accommodate more customer orders and provide better coverage of our target markets although we do not have any specific plans or commitments at this time. We cannot assure you that we will be able to lease suitable facilities at commercially acceptable terms. In addition, the expansion of our production and logistics centers and distribution network will put pressure on our managerial, financial, operational and other resources. If we are unable to secure new facilities or 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 will 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.

 

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

In recent years, we have gradually 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 and in 2011, we acquired L&S Retail Ventures, Inc., an online provider of invitation and stationery products. We cannot assure you that this service, 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.

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. If our consumers cannot find their desired products on our websites, they may stop visiting our websites, visit less often or stop purchasing products on our websites or seek out our competitors’ websites. 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.

The Internet and the online content and retail industries 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 recessionary conditions in the United States and world economies may materially and adversely affect our financial results.

As the majority of our revenues is 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,

 

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macro-economic conditions like stock market volatility, high 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 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.

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

Demand for our products and services is sensitive to price, especially in times of recession, slow economic growth and consumer 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 our consumers’ price expectations, we could lose customers, which would harm our business and results of operations.

Changes in our pricing strategies 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. In addition, we occasionally offer free or discounted products and services to attract and retain customers. In the future, if we increase these offers to respond 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 increase in the future. We face competition from a wide range of companies, including the following:

 

 

traditional offline printing businesses;

 

 

e-commerce companies, including large online retailers such as Amazon.com, Inc. and eBay Inc.;

 

 

physical and catalog retailers of personalized merchandise;

 

 

online providers of unique goods such as Etsy, Inc., as well as various other private companies offering customized products such as CustomInk, LLC, Spreadshirt, Inc., Threadless.com or Zazzle Inc.; and

 

 

online providers allowing users to customize goods in specific vertical markets, such as Vistaprint N.V. for small businesses and Shutterfly, Inc. for photographic products.

 

 

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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 more direct and intense competition. Furthermore, to the extent that other companies are able to replicate our processes or that 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.

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 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.

 

 

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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 substantially all of the computer hardware necessary to operate our websites is located at one third-party hosting facility in Las Vegas, Nevada. 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 is particularly susceptible to flooding and extreme weather patterns. We 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. 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:

 

 

reduced visibility of order status and package tracking;

 

 

delays in merchandise receipt and delivery;

 

 

increased cost of shipment; and

 

 

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

 

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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, we face allegations related to, and potential liability for, negligence, copyright or trademark infringement or other claims based on the nature and content of materials that we display and the goods created from user-generated uploads to our service. We also may face allegations related to, or 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. We are also exposed to risks associated with varying defamation laws in other jurisdictions in foreign countries, including heightened risk of secondary liability on defamation suits in the United Kingdom, despite our status as an e-commerce service provider and not a publisher. Further, we maintain relationships with law enforcement agencies to manage issues related to child pornography or other illegal uses of our service.

As a distributor of content, we also face potential liability for negligence, copyright, patent or trademark infringement or other claims based on the nature and content of materials that we distribute. 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. We maintain a content review process that includes evaluation and take-down of uploaded content on our site that fails to meet our policies. Nevertheless, we receive significant volumes of cease and desist demands on a regular basis with respect to claims of intellectual property infringement and infringement 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. Notwithstanding our efforts, these measures may not be effective in removing violative content nor sufficient to shield us from potential liability.

Our agreements with our content providers likewise contain indemnification clauses acknowledging that the user uploading content owns copyrights and trademarks in the work, is authorized to do so and to create products through our service. However, many of our content providers may lack the financial ability to fully indemnify us against any material liabilities or we may choose not to pursue such indemnification claims if we think that doing so may deter others from offering non-violative content on our services.

We maintain an intellectual property rights policy and dispute process, and we strive to promptly respond to all claims of infringement and to expeditiously remove infringing content from our websites where we believe valid claims may exist, as well as to comply with any applicable legal or contractual requirements. These processes

 

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require significant legal and operational resources and, given the volume of uploaded images to our websites, are challenging to implement. If our processes prove ineffective or we are unable to effectively scale these processes with the growth of our business, we may face significant liability and our business may suffer. Litigation to defend these claims could be costly and the expenses and damages arising from any liability could harm our results of operations. There can be no assurance that we are adequately insured or indemnified to cover claims of these types or liability that may be imposed on us.

Failure to protect confidential 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 confidential information, including credit card numbers. 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. 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.

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.

 

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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 and compliance matters.

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. To date, the substantial majority of our net revenues has been derived from credit card sales. As a result, we believe our business is vulnerable to any disruption in our customer payment processing capabilities. In most geographic regions, we rely on one or two 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 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. If we fail to adequately predict demand and experience

 

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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.

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 risk 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 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 our quality or legal standards, and we might not identify the deficiency before merchandise ships to our customers. New legislation in California called the Transparency in Supply Chains Act of 2010 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.

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 our business partners with respect to the branded 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 and 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. 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 brands’ images.

Increased product returns 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 returns 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. Any significant increase in merchandise returns or chargebacks above our allowances would substantially harm our business and results of operations.

 

 

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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 upon little or no notice. 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. In addition, we recently added several members to our senior management team. Integrating them into our management team could prove disruptive to our daily operations, require a disproportionate amount of resources and management attention and prove unsuccessful.

If we are unable to attract, train 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 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. 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, our business may suffer.

We may 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 and Canvas On Demand, LLC in 2010 and in October 2011, we acquired L&S Retail Ventures, Inc. Additionally, in March 2012, we entered into an agreement to acquire substantially all of the assets of Logo’d Softwear, Inc., an e-commerce provider of personalized apparel and merchandise for groups and organizations. Although we currently expect to close this acquisition during the second quarter of 2012, we may not be able to close this acquisition as planned or at all. Additionally, we may be unable to successfully integrate this business or to realize the anticipated benefits of the acquisition. Future acquisitions and the successful integration of new assets and businesses into our own would 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, 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 make up to $9.0 million in earn-out payments to the former owners of Canvas On Demand. In addition to possible stockholders’ approval, we may also have to obtain

 

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approvals and licenses from the relevant government authorities for the acquisitions and to comply with any applicable laws and regulations, which could result in increased costs and delay.

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 December 31, 2011, we had three issued patents, 10 patents pending in the United States and one pending in foreign jurisdictions, 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.

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,

 

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may be highly uncertain. We may 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. 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. An adverse determination 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 will 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 never operated as a public company and will incur significant legal, accounting and other expenses 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 devote a substantial amount of time to new compliance initiatives and we may not successfully or efficiently manage our transition into a public company. We expect that requirements to comply with rules and regulations such as the Sarbanes-Oxley Act of 2002 will increase our legal and financial compliance costs and make some activities more time-consuming and costly. We will need to hire a number of additional employees with public accounting and disclosure experience in order to meet our ongoing obligations as a public company. For example, Section 404 of the Sarbanes-Oxley Act of 2002 requires that our management report on, and may require that our independent registered public accounting firm attest to, the effectiveness of our internal control over financial reporting in our annual report on Form 10-K for the year ending December 31, 2013, to be filed in 2014. Section 404 compliance may divert internal resources and will take a significant amount of time and effort to complete. We may not be able to successfully complete the procedures and certification and attestation requirements of Section 404 by the time we will be required to do so. If we fail to do so, or if in the future our Chief Executive Officer, Chief Financial Officer, General Counsel or independent registered public accounting firm determines that our internal control over financial reporting is not effective as defined under Section 404, we could be subject to sanctions or investigations by The NASDAQ Global Market, or NASDAQ, the Securities and Exchange Commission, or the SEC, or other regulatory authorities. Furthermore, investor perceptions of our company may suffer and this could cause a decline in the market price of our common stock. Irrespective of compliance with Section 404, any failure of our internal controls could have a material adverse effect on our stated results of operations and harm our reputation. If we are unable to implement these changes effectively or efficiently, it could harm our operations, financial reporting or financial results and could result in an adverse opinion on internal controls from our independent auditors.

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 are in the process of adopting and implementing several measures to improve our internal controls. 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

 

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harmed. We cannot assure you that significant deficiencies or material weaknesses in our internal control over financial reporting will not be identified 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. Any such failure could also adversely affect the results of the periodic management evaluations and annual auditor attestation report regarding the effectiveness of our internal control over financial reporting that are, or may be, required under Section 404 of the Sarbanes-Oxley Act of 2002, and which will first be required in our Annual Report on Form 10-K for the year ending December 31, 2013, to be filed in 2014. 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.

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:

 

 

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

 

 

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

 

 

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

 

 

our ability to provide high-quality customization capabilities;

 

 

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

 

 

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

 

 

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

 

 

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.

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

 

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economic uncertainty. For example, in 2009, our net revenues declined by $16.9 million and increased by $24.4 million in 2010. We believe that our lower net revenues in 2009 relative to 2010 was due to several factors, including, in part, to fluctuations in consumer confidence and spending during these periods which, in turn, were impacted by, among other things, the economic recession and subsequent recovery or consumers’ perception of a recovery. 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 United Kingdom, Australia and Canada and have recently launched our first localized language website in Germany. Additionally, we have operations in the Czech Republic. In connection with our international presence we are subject to a variety of risks including:

 

 

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

 

 

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

 

 

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;

 

 

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

 

 

challenges of international delivery and customs requirements;

 

 

varying product safety requirements and content restrictions in other countries;

 

 

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

 

 

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

 

 

difficulty with staffing and managing widespread international operations;

 

 

reduced protection for intellectual property rights in some countries;

 

 

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;

 

 

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;

 

 

heightened exposure to political instability, war and terrorism; and

 

 

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.

 

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If use of the Internet, particularly with respect to e-commerce, does not continue to increase as we anticipate, 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. Failures by some online retailers to meet consumer demands could result in consumer reluctance to adopt the Internet as a means for commerce, and thereby damage our reputation and brands and substantially harm our business and results of operations.

In addition, the Internet may not be accepted as a viable long-term commercial marketplace for a number of reasons, including:

 

 

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

 

 

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

 

 

possible disruptions, computer viruses, spyware, phishing, attacks or other damage to the Internet servers, service providers, network carriers and Internet companies or to users’ computers; and

 

 

excessive governmental regulation and taxation.

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.

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, 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.

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 accounting, 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.

 

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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 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 U.S. Judiciary Committee held hearings on Internet sales taxation proposals in November 2011, and certain legislation was referred to the Senate Finance Committee, but the Committee has not yet reported to Congress. 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 and we issue appropriate tax forms disclaiming the withholding on taxes on such royalty income to them but there is no guarantee that such procedures will be appropriate to disclaim taxable nexus in every state and foreign country in the future.

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 this offering and our common stock

Our share price may be volatile and you may be unable to sell your shares at or above the offering price.

Prior to this offering, there has not been a public market for our common stock. We cannot predict the extent to which an active trading market will develop on the NASDAQ Global Market or how liquid that market might become. The initial public offering price for our shares will be determined by negotiations between us and representatives of the underwriters and may not be indicative of prices that will prevail in the trading market. There is no guarantee that shares of our common stock will appreciate in value or even maintain the price at which our stockholders have purchased their shares. The market price of shares of our common stock could be

 

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subject to wide fluctuations in response to many risk factors listed in this prospectus and others beyond our control, including:

 

 

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

 

 

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

 

 

loss of a significant amount of existing business;

 

 

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

 

 

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

 

 

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;

 

 

lack of coverage of us by industry or securities analysts;

 

 

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;

 

 

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

 

 

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

 

 

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

 

 

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

 

 

general economic and market conditions.

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. If the market price of shares of our common stock after this offering does not exceed the initial public offering price, you may not realize any return on your investment in us and may lose some or all of your investment. In the past, companies that have experienced volatility in the market price of their stock have been subject to securities class action litigation. We may be the target of this type of litigation in the future. 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.

Substantial future sales of our common stock in the public market could cause our stock price to fall.

Additional sales of our common stock in the public market after this offering, or the perception that these sales could occur, could cause the market price of our common stock to decline. Upon the completion of this offering, we will have         shares of common stock outstanding. All shares sold in this offering will be freely transferable without restriction or additional registration under the Securities Act of 1933, or the Securities Act, except for

 

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any shares held by our affiliates as defined in Rule 144 under the Securities Act. The remaining         shares of common stock outstanding after this offering will be eligible for sale at various times beginning 180 days after the date of this prospectus upon the expiration of lock-up agreements as described below and subject to vesting requirements and the requirements of Rule 144 or Rule 701.

Our directors, executive officers and holders of substantially all of our outstanding common stock (on a fully-diluted basis as of December 31, 2011 without giving effect to this offering) have agreed with limited exceptions that they will not sell any shares of common stock owned by them without the prior written consent of J.P. Morgan Securities LLC and Jefferies & Company, Inc., on behalf of the underwriters, for a period of 180 days from the date of this prospectus. However, subject to certain exceptions, in the event that either:

 

 

during the last 17 days of the 180-day restricted period, we issue an earnings release or material news or a material event relating to us occurs, or

 

 

prior to the expiration of the 180-day restricted period, we announce that we will release earnings results during the 16-day period beginning on the last day of the 180-day restricted period,

then in either case the expiration of the 180-day restricted period will be extended until the expiration of the 18-day period beginning on the date of the issuance of an earnings release or the occurrence of the material news or event, as applicable, unless J.P. Morgan Securities LLC and Jefferies & Company, Inc. waive, in writing, such an extension. At any time and without public notice, J.P. Morgan Securities LLC and Jefferies & Company, Inc. may in their sole discretion release some or all of the securities from these lock-up agreements prior to the expiration of the lock-up period. As resale restrictions end, the market price of our common stock could decline if the holders of those shares sell them or are perceived by the market as intending to sell them. In addition, after this offering, the holders of 5,418,474 shares of common stock, which includes the shares issued upon conversion of our preferred stock upon the completion of this offering, without taking into account any shares sold in this offering by the selling stockholders, will be entitled to contractual rights by which they may require us to register those shares under the Securities Act. All of these shares are subject to a lock-up period for 180 days. Registration of these shares under the Securities Act would result in these shares becoming freely tradable without restriction under the Securities Act immediately upon the effectiveness of the registration statement. We also intend to file a registration statement on Form S-8 under the Securities Act to register approximately 3.7 million shares under our 1999 Stock Plan, 2004 Stock Plan and 2012 Stock Incentive Plan, as well as 250,000 shares reserved for issuance under our Employee Stock Purchase Plan. For more information, see “Shares eligible for future sale.”

Our insiders who are significant stockholders may control the election of our board of directors and may have interests that conflict with those of other stockholders.

Our directors, executive officers and holders of 5% of more of our capital stock, together with their affiliates, beneficially owned, in the aggregate, 70% of our outstanding capital stock as of December 31, 2011, and will beneficially own, in the aggregate, more than     % of our outstanding capital stock immediately after this offering. As a result, acting together, this group has the ability to exercise significant control over most matters requiring our stockholders’ approval, including the election and removal of directors and significant corporate transactions. This concentration of ownership could have the effect of delaying or preventing a change in control or otherwise discouraging a potential acquirer from attempting to obtain control of us, which in turn could have a material adverse effect on our stock price and may prevent attempts by our stockholders to replace or remove our board of directors or management.

 

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As a new investor, you will experience immediate and substantial dilution.

Purchasers in this offering will immediately experience substantial dilution in the net tangible book value of their shares. Because our common stock has in the past been sold at prices substantially lower than the initial public offering price that you will pay, you will suffer immediate dilution of $        per share in net tangible book value, based on an assumed initial offering price of $        per share of common stock, the mid-point of the range set forth on the cover page of this prospectus. As of December 31, 2011, we also had outstanding stock options to purchase approximately 2,558,609 shares of our common stock with exercise prices that are below the assumed initial public offering price of the common stock. To the extent that these options are exercised, purchasers in this offering will experience further dilution.

Management may apply the net proceeds from this offering to uses that do not increase our market value or improve our operating results.

We intend to use the net proceeds from this offering for general corporate purposes, including as yet undetermined amounts related to working capital and capital expenditures. However, our management will have considerable discretion in applying the net proceeds and you will not have the opportunity, as part of your investment decision, to assess whether we are using the net proceeds appropriately. Until the net proceeds we receive are used, they may be placed in investments that do not produce income or that lose value. We may use the net proceeds for purposes that do not result in any increase in our results of operations, which could cause the price of our common stock to decline.

 

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Special note regarding forward-looking statements

This prospectus contains forward-looking statements that involve risks and uncertainties. The forward-looking statements are contained principally in the sections entitled “Prospectus summary”, “Risk factors”, “Management’s discussion and analysis of financial condition and results of operations” and “Business.” 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. Forward-looking statements include, but are not limited to, statements regarding:

 

 

our mission is to offer an unrivaled platform that is the world’s premier source for self-expression through product customization and personalization and our goal to be the world’s customization platform;

 

 

trends and challenges in our business and the market for customization of consumer products, including trends in consumer demand for customization and e-commerce;

 

 

our market opportunity and market data;

 

 

our expectations regarding the seasonality and cyclicality of our business;

 

 

the effectiveness of our content usage policies;

 

 

our competitive position and our expectation regarding key competitive factors;

 

 

our ability to expand our production and fulfillment capabilities in a timely and cost-effective manner;

 

 

our intellectual property and our investment in sales and marketing and technology and development;

 

 

our expectations regarding fluctuations in our operating results;

 

 

our expectations regarding our expenses and revenues, including net revenues, and the uses of the proceeds of this offering;

 

 

our anticipated cash needs and our estimates regarding our capital requirements and our needs for additional financing;

 

 

our anticipated growth strategies;

 

 

the anticipated timing, costs and benefits of our pending acquisition;

 

 

our ability to retain and attract customers and the anticipated benefits of our sales and marketing and customer acquisition efforts; and

 

 

the regulatory environment in which we do business.

These statements involve known and unknown risks, uncertainties and other factors that 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. We discuss many of these risks in this prospectus in greater detail under the heading “Risk factors.” Also, these forward-looking statements represent our estimates and assumptions only as of the date of this prospectus. Unless required by law, we do not intend to update any of these forward-looking statements to reflect circumstances or events that occur after the statement is made.

 

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You should read this prospectus and the documents that we reference in this prospectus and have filed as exhibits to the registration statement, of which this prospectus is a part, completely and with the understanding that our actual future results may be materially different from what we expect. We qualify all of our forward-looking statements by these cautionary statements.

The market data and certain other statistical information used throughout this prospectus are based on independent industry publications, governmental publications, reports by market research firms or other independent sources. Some data are also based on our good faith estimates.

 

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Use of proceeds

We estimate that we will receive net proceeds from this offering of approximately $        million, based on an assumed initial public offering price of $        per share, the mid-point of the range set forth on the cover of this prospectus, after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us. A $1.00 increase (decrease) in the assumed initial public offering price would increase (decrease) the net proceeds to us from this offering by approximately $        million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us. We will not receive any proceeds from the sale of shares by any selling stockholder.

The principal purposes for this offering are to increase our working capital, create a public market for our common stock and facilitate our access to the public capital markets.

We currently intend to use our proceeds from this offering for general corporate purposes, including working capital and capital expenditures. The amount and timing of these expenditures will vary depending on a number of factors, including competitive and technological developments and the rate of growth, if any, of our business. In addition, we may use a portion of the net proceeds to acquire or invest in complementary businesses, products or technologies, including in connection with our proposed acquisition of substantially all of the assets of Logo’d Softwear, Inc.; however, we do not currently have any understandings or agreements relating to any significant acquisitions or investments other than for Logo’d Softwear, Inc.

As of the date of this prospectus, we have not determined all of the anticipated uses for the proceeds of this offering or the amounts that we will actually spend on the uses set forth above. The amount and timing of actual expenditures may vary significantly depending upon a number of factors, including the amount of cash generated from our operations, competitive and technological developments and the rate of growth, if any, of our business. Accordingly, our management will have significant flexibility in applying the net proceeds of this offering. Pending use of the net proceeds as described above, we intend to invest the net proceeds of this offering in short-term, interest-bearing, investment-grade securities.

Dividend policy

We have never declared or paid any cash dividends on shares of our capital stock. We currently expect to retain all of our earnings, if any, to finance the expansion and development of our business, and we do not currently intend to pay any cash dividends on our capital stock in the foreseeable future. Our board of directors will determine whether to declare any future dividends, if any, in its discretion subject to applicable laws. Any such determination will depend on our financial condition, results of operations, capital requirements, general business conditions and any other factors our board of directors may deem relevant.

 

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Capitalization

The following table describes our capitalization as of December 31, 2011:

 

 

on an actual basis;

 

 

on a pro forma basis to give effect to the issuance of 5,534,963 shares of common stock issuable upon the conversion of all of our outstanding shares of preferred stock upon completion of this offering and the filing of our amended and restated certificate of incorporation upon the completion of this offering; and

 

 

on a pro forma as adjusted basis to give effect to (a) the pro forma matters described above and (b) to the sale of         shares of common stock in this offering at an assumed initial public offering price of $        per share, the mid-point of the range set forth on the cover page of this prospectus, after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us.

You should read this table together with “Management’s discussion and analysis of financial condition and results of operations” and our consolidated financial statements and the related notes appearing elsewhere in this prospectus.

 

December 31, 2011

(in thousands, except share and per share data)

  

Actual

    Pro forma     Pro forma
as adjusted

 

     (unaudited)

Convertible preferred stock, $0.0001 par value per share; 12,344,521 shares authorized; 5,534,963 shares issued and outstanding, actual; no shares authorized, issued or outstanding, pro forma and pro forma as adjusted

   $ 22,811      $     

Stockholders’ equity:

      

Preferred stock, $0.0001 par value per share; no shares authorized, issued or outstanding actual; 10,000,000 shares authorized, no shares issued or outstanding, pro forma and pro forma as adjusted

      

Common stock, $0.0001 par value per share; 34,815,000 shares authorized; 8,943,737 shares issued and outstanding, actual; 500,000,000 shares authorized, 14,478,700 shares issued and outstanding, pro forma; and         shares issued and outstanding, pro forma as adjusted

     1        1     

Additional paid-in capital

     26,120        48,931     

Accumulated deficit

     (501     (501  
  

 

 

Total stockholders’ equity

     25,620        48,431     
  

 

 

Total capitalization

   $ 48,431      $ 48,431     

 

The actual, pro forma and pro forma as adjusted information set forth in the table:

 

 

excludes 2,558,609 shares of common stock issuable upon the exercise of options outstanding as of December 31, 2011, at a weighted average exercise price of $11.31 per share;

 

 

excludes 400,000 shares of common stock reserved for future issuance under our 2012 Stock Incentive Plan, as well as up to 285,087 shares originally reserved for issuance under our 2004 Stock Plan and 1999 Stock Plan but which may become available for awards under our 2012 Stock Incentive Plan as described below, which plan will become effective in connection with this offering and contains provisions that will automatically increase its share reserve each year, as more fully described in “Executive Compensation—Employee Benefit Plans”;

 

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excludes 250,000 shares of common stock reserved for future issuance under our Employee Stock Purchase Plan, which shares will become available for purchase when determined by our compensation committee, and contains provisions that will automatically increase its share reserve each year following its effective date, as more fully described in “Executive Compensation—Employee benefit plans”;

 

 

shares of our common stock proposed to be issued in connection with, and in the event of the closing of, our proposed acquisition of substantially all of the assets of Logo’d Softwear, Inc., with an aggregate value of $0.8 million based on the fair market value per share of our common stock on the closing date (approximately                     shares based on an assumed initial public offering price of $         per share, the mid-point of the range set forth on the cover page of this prospectus);

 

 

shares of our common stock subject to options with an aggregate value of up to $2.1 million, measured using a Black-Scholes option pricing model based on the fair market value per share of our common stock on the closing date, which may be granted in connection with our proposed acquisition of substantially all of the assets of Logo’d Softwear, Inc.; and

 

 

assumes no exercise of the overallotment option granted to the underwriters.

As of December 31, 2011, no shares remained available for future issuance under our 1999 Stock Plan and 82,837 shares remained available for issuance under our 2004 Stock Plan. In February 2012, our board of directors and stockholders approved an increase of 600,000 shares to be reserved for issuance under our 2004 Stock Plan and our board of directors approved the grant of options to purchase 408,500 shares of our common stock pursuant to our 2004 Stock Plan. Upon the completion of this offering, no shares of our common stock will remain available for future issuance under our 1999 Stock Plan or our 2004 Stock Plan. Upon completion of this offering, shares originally reserved for issuance under our 1999 Stock Plan or our 2004 Stock Plan but which are not issued or subject to outstanding grants on the effective date of our 2012 Stock Incentive Plan, shares subject to outstanding options under our 1999 Stock Plan and our 2004 Stock Plan on the effective date of our 2012 Stock Incentive Plan that are subsequently forfeited or terminated for any reason before being exercised, and shares subject to vesting restrictions under our 1999 Stock Plan and our 2004 Stock Plan on the effective date of our 2012 Stock Incentive Plan that are subsequently forfeited, will become available for awards under our 2012 Stock Incentive Plan upon the completion of this offering.

A $1.00 increase (decrease) in the assumed initial public offering price of $        per share, the mid-point of the range set forth on the cover of this prospectus, would increase (decrease) the pro forma as adjusted amount of each of cash and cash equivalents, additional paid-in capital, total stockholder’s equity and total capitalization by $        million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us.

 

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Dilution

Our net tangible book value as of December 31, 2011 was $        , or $         per share of common stock, assuming no conversion of our outstanding shares of preferred stock. Our pro forma net tangible book value as of December 31, 2011 was $        , or $        per share of common stock, assuming the conversion of all of our outstanding shares of preferred stock into common stock upon the completion of this offering. The per share impact of the conversion of all of our outstanding shares of preferred stock into common stock in calculating our pro forma net tangible book value per share as of December 31, 2011 was an increase of $        . Pro forma net tangible book value per share represents the amount of our total tangible assets less total liabilities, divided by the pro forma number of shares of common stock outstanding, assuming the issuance of 5,534,963 shares of common stock upon the conversion of all of our outstanding shares of Series A preferred stock, Series B preferred stock and Series I preferred stock. Net tangible book value dilution per share represents the difference between the amount per share paid by purchasers of shares of common stock in this offering and the net tangible book value per share of common stock immediately after completion of this offering on a pro forma as adjusted basis. After giving effect to the sale of the shares of common stock by us at an assumed initial public offering price of $        per share, which is the mid-point of the price range set forth on the cover of this prospectus, and the application of our estimated net proceeds from the offering, and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us, our pro forma as adjusted net tangible book value as of December 31, 2011 would have been $        , or $        per share of common stock. This represents an immediate increase in pro forma as adjusted net tangible book value of $        per share of common stock to existing common stockholders and an immediate dilution of $        per share to new investors purchasing shares of common stock in this offering.

The following table illustrates this per share dilution:

 

    

Assumed initial public offering price

      $                

Pro forma net tangible book value as of December 31, 2011

   $                   

Increase attributable to new investors

     
  

 

 

    

Pro forma as adjusted net tangible book value

     
     

 

 

 

Net tangible book value dilution to new investors

      $     

 

 

The table presented above excludes the potential impact of the proposed acquisition of substantially all of the assets of Logo’d Softwear, Inc. pursuant to an asset purchase agreement entered into in early March 2012. The asset purchase agreement provides for a total initial purchase price of $8.3 million, consisting of $7.5 million in cash and $0.8 million in shares of CafePress common stock priced as of the closing date, as well as contingent rights for the principal stockholder to receive up to $8.6 million in future performance-based cash consideration. In addition, in connection with, and upon closing of, the acquisition, the principal stockholder will receive CafePress stock options to purchase shares of our common stock with an aggregate value of up to $2.1 million, with vesting based on the achievement of certain performance milestones.

A $1.00 increase (decrease) in the assumed initial public offering price of $        , the mid-point of the range set forth on the cover of the prospectus, would increase (decrease) our pro forma as adjusted net tangible book value per share by $        , assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us.

If the underwriters exercise their overallotment option in full, the pro forma as adjusted net tangible book value per share of our common stock after giving effect to this offering would be approximately $        per share, and the dilution in pro forma as adjusted net tangible book value per share to investors in this offering would be approximately $        per share of common stock.

 

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The following table summarizes as of December 31, 2011, on the pro forma as adjusted basis described above, the number of shares of common stock purchased from us, the total consideration paid and the average price per share paid by existing and new investors purchasing shares of common stock in this offering, before deducting the estimated underwriting discounts and commissions and estimated offering expenses.

 

      Shares purchased      Total consideration      Average price
per share
 
     Number      Percent      Amount      Percent     

 

 

Existing stockholders

     14,478,700         %       $ 30,891,322         %       $ 2.13   

New stockholders

              
  

 

 

 

Total

        100.0%       $           100.0%       $     

 

 

A $1.00 increase (decrease) in the assumed initial public offering price of $        , the mid-point of the range set forth on the cover of the prospectus, would increase (decrease) the total consideration paid by new investors by $        , assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us.

Sales by selling stockholders in this offering will reduce the number of shares of common stock held by existing stockholders to         or approximately     % of the total number of shares of common stock outstanding after this offering and will increase the number of shares of common stock held by new investors by         to approximately     % of the total number of shares of common stock outstanding after this offering.

The table above:

 

 

excludes 2,558,609 shares of common stock issuable upon the exercise of options outstanding as of December 31, 2011, at a weighted average exercise price of $11.31 per share;

 

 

excludes 400,000 shares of common stock reserved for future issuance under our 2012 Stock Incentive Plan, as well as up to 285,087 shares originally reserved for issuance under our 2004 Stock Plan but which may become available for awards under our 2012 Stock Incentive Plan as described below, which plan will become effective in connection with this offering and contains provisions that will automatically increase its share reserve each year, as more fully described in “Executive compensation—Employee benefit plans”;

 

 

excludes 250,000 shares of common stock reserved for future issuance under our Employee Stock Purchase Plan, which shares will become available for purchase when determined by our compensation committee and contains provisions that will automatically increase its share reserve each year following its effective date, as more fully described in “Executive Compensation—Employee benefit plans”;

 

 

shares of our common stock proposed to be issued in connection with, and in the event of the closing of, our proposed acquisition of substantially all of the assets of Logo’d Softwear, Inc., with an aggregate value of $0.8 million based on the fair market value per share of our common stock on the closing date (approximately                 shares based on an assumed initial public offering price of $         per share, the mid-point of the range set forth on the cover page of this prospectus);

 

 

shares of our common stock subject to options with an aggregate value of up to $2.1 million, measured using a Black-Scholes option pricing model based on the fair market value per share of our common stock on the closing date, which may be granted in connection with our proposed acquisition of substantially all of the assets of Logo’d Softwear, Inc.;

 

 

assumes no exercise of the overallotment option granted to the underwriters; and

 

 

excludes amounts paid by us in connection with the repurchase, forfeiture or cancellation of shares of our common stock.

 

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As of December 31, 2011, no shares remained available for future issuance under our 1999 Stock Plan and 82,837 shares remained available for future issuance under our 2004 Stock Plan. In February 2012, our board of directors and stockholders approved an increase of 600,000 shares to be reserved for issuance under our 2004 Stock Plan and our board of directors approved the grant of options to purchase 408,500 shares of our common stock pursuant to our 2004 Stock Plan. Upon the completion of this offering, no shares of our common stock will remain available for future issuance under our 1999 Stock Plan or our 2004 Stock Plan. Upon the completion of this offering, shares originally reserved for issuance under our 1999 Stock Plan or our 2004 Stock Plan but which are not issued or subject to outstanding grants on the effective date of our 2012 Stock Incentive Plan, shares subject to outstanding options under our 1999 Stock Plan and our 2004 Stock Plan on the effective date of our 2012 Stock Incentive Plan that are subsequently forfeited or terminated for any reason before being exercised, and shares subject to vesting restrictions under our 1999 Stock Plan and our 2004 Stock Plan on the effective date of our 2012 Stock Incentive Plan that are subsequently forfeited, will become available for awards under our 2012 Stock Incentive Plan upon the completion of this offering.

To the extent that any outstanding options are exercised, there will be further dilution to new investors.

 

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Selected consolidated financial data

The selected consolidated statement of operations data for the years ended December 31, 2009, 2010 and 2011 and the consolidated balance sheet data as of December 31, 2010 and 2011 are derived from our audited consolidated financial statements included elsewhere in this prospectus. The selected consolidated statement of operations data for the years ended December 31, 2007 and 2008 and the consolidated balance sheet data as of December 31, 2007, 2008 and 2009 are derived from our audited consolidated financial statements not included in this prospectus. Our historical results are not necessarily indicative of the results that may be expected in the future. You should read the following selected historical financial data below together with “Management’s discussion and analysis of financial condition and results of operations” and our consolidated financial statements, related notes and other financial information included elsewhere in this prospectus.

 

      Year ended December 31,  
(in thousands, except per share data)    2007     2008     2009     2010     2011  

 

 

Consolidated statements of operations data:

          

Net revenues

   $ 96,844      $ 120,407      $ 103,493      $ 127,930      $ 175,482   

Cost of net revenues(1)

     59,764        74,403        57,688        72,447        100,191   
  

 

 

 

Gross profit

     37,080        46,004        45,805        55,483        75,291   

Operating expenses:

          

Sales and marketing(1)

     16,344        20,447        17,711        26,484        40,809   

Technology and development(1)

     8,174        12,590        13,152        14,305        12,768   

General and administrative(1)

     6,563        10,883        9,322        9,593        13,573   

Acquisition-related costs

                          794        2,696   

Impairment charges

            3,746                        
  

 

 

 

Total operating expenses

     31,081        47,666        40,185        51,176        69,846   
  

 

 

 

Income (loss) from operations

     5,999        (1,662     5,620        4,307        5,445   

Interest income

     750        527        220        116        56   

Interest expense

     (467     (302     (253     (215     (194

Other income (expense), net

     (33     2        (3     239          
  

 

 

 

Income (loss) before income taxes

     6,249        (1,435     5,584        4,447        5,307   

Provision for income taxes

     1,661        808        2,255        1,724        1,701   
  

 

 

 

Net income (loss)

   $ 4,588      $ (2,243   $ 3,329      $ 2,723      $ 3,606   
  

 

 

 

Net income (loss) per share of common stock(2):

          

Basic

   $ 0.26      $ (0.29   $ 0.15      $ 0.11      $ 0.17   
  

 

 

 

Diluted

   $ 0.24      $ (0.29   $ 0.15      $ 0.10      $ 0.16   
  

 

 

 

Shares used in computing net income (loss) per share of common stock(2):

          

Basic

     7,334        7,673        8,065        8,308        8,798   
  

 

 

 

Diluted

     8,356        7,673        8,668        8,860        9,403   
  

 

 

 

Pro forma net income per share of common stock(2):

          

Basic (unaudited)

           $ 0.25   
          

 

 

 

Diluted (unaudited)

           $ 0.24   
          

 

 

 

Shares used in computing pro forma net income per share of common stock(2):

          

Basic (unaudited)

             14,333   
          

 

 

 

Diluted (unaudited)

             14,938   

 

 

 

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0,000,000 0,000,000 0,000,000 0,000,000 0,000,000
      Year ended December 31,  
(in thousands, except key operating metrics)    2007      2008      2009      2010      2011  

 

 
    

(unaudited)

 
Other financial and non-GAAP financial data:               

Adjusted EBITDA(3)

   $ 11,133       $ 9,715       $ 14,136       $ 14,550       $ 18,740   

Capital expenditures

     6,426         7,393         3,283         5,836         5,373   

Key operating metrics:

              

Total customers(4)

     1,737,658         2,053,122         1,736,787         2,077,587         2,681,605   

Total number of orders(5)

     2,188,811         2,582,176         2,157,835         2,655,264         3,545,305   

Average order size(6)

   $ 45       $ 47       $ 48       $ 48       $ 50   

 

 

 

0,000,000 0,000,000 0,000,000 0,000,000 0,000,000
      As of December 31,  
(in thousands)    2007      2008      2009      2010      2011  

 

 

Consolidated balance sheet data:

              

Cash and cash equivalents

   $ 4,102       $ 8,809       $ 13,255       $ 19,276       $ 27,900   

Short-term investments

     13,980         9,998         12,974         10,033         8,437   

Working capital

     4,791         7,993         15,502         15,873         17,973   

Total assets

     38,329         46,798         52,388         72,056         88,982   

Total indebtedness

     5,641         3,670         3,326         3,020         3,174   

Convertible preferred stock

     20,318         22,811         22,811         22,811         22,811   

Total stockholder’s equity (deficit)

     (4,821      1,840         7,709         17,419         25,620   

 

 

 

(1)   Amounts include stock-based compensation expense as follows:

 

0,000,000 0,000,000 0,000,000 0,000,000 0,000,000
      Year ended December 31,  
(in thousands)    2007      2008      2009      2010      2011  

 

 
               

Cost of net revenues

   $ 82       $ 174       $ 160       $ 152       $ 164   

Sales and marketing

     265         377         359         472         520   

Technology and development

     242         501         618         569         267   

General and administrative

     591         881         1,004         981         1,427   
  

 

 

 

Total stock-based compensation expense

   $ 1,180       $ 1,933       $ 2,141       $ 2,174       $ 2,378   

 

 

 

(2)   Please see notes 2 and 9 to our audited consolidated financial statements for an explanation of the calculations of our basic and diluted net income per share of common stock and unaudited pro forma net income per share of common stock.

 

(3)   Adjusted EBITDA is a non-GAAP financial measure that our management uses to assess our operating performance and it is a factor in the evaluation of the performance of our management in determining compensation. We define Adjusted EBITDA as net income less interest and other income (expense), provision for 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 income and our other GAAP results.

 

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

 

0,000,000 0,000,000 0,000,000 0,000,000 0,000,000
      Year ended December 31,  
(in thousands)    2007     2008     2009      2010     2011  

 

 

Net income (loss)

   $ 4,588      $ (2,243   $ 3,329       $ 2,723      $ 3,606   

Non-GAAP adjustments:

           

Interest and other (income) expense

     (250     (227     36         (140     138   

Provision for income taxes

     1,661        808        2,255         1,724        1,701   

Depreciation and amortization

     3,954        5,387        6,013         6,364        5,836   

Amortization of intangible assets

            311        362         911        2,385   

Acquisition-related costs

                           794        2,696   

Stock-based compensation

     1,180        1,933        2,141         2,174        2,378   

Impairment and restructuring charges

            3,746                         
  

 

 

 

Adjusted EBITDA

   $ 11,133      $ 9,715      $ 14,136       $ 14,550      $ 18,740   

 

 

 

(4)   Total customers represents the number of transacting customers in a given period.

 

(5)   Total number of orders represents the number of individual transactions that are shipped during the period.

 

(6)   Average order size is calculated as billings for a given period 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.

 

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Management’s discussion and analysis of financial condition and results of operations

The following management’s discussion and analysis of financial condition and results of operations should be read together with our consolidated financial statements and related notes included elsewhere in this prospectus. This discussion contains forward-looking statements, which involve risk and uncertainties. Our actual results could differ materially from those anticipated in the forward looking statements as a result of certain factors, including but not limited to those discussed in “Risk factors” and elsewhere in this prospectus. See “Risk factors” and “Special note regarding forward-looking statements” at the beginning of this prospectus.

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. We have developed a strong brand with a growing community that, as of December 31, 2011, had more than 15 million members and more than three million shops, and we shipped over 7.8 million products in 2011 from a catalog of over 320 million unique products, as measured by the number of different combinations of designs and types of merchandise.

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

CafePress was founded in 1999, initially providing an e-commerce platform for individuals to offer their unique content on products with no upfront investment. We became profitable within two years after proving out the economics of small volume print-on-demand manufacturing with direct-to-consumer custom product pricing. As our content catalog grew, and we reached a critical mass of buyers and sellers, we added our retail marketplace in 2004.

In 2005, we raised venture capital to finance expansion of our production and fulfillment capabilities in response to increasing demand. We chose Louisville, Kentucky as the site for our flagship manufacturing plant to take advantage of logistical efficiencies, and this facility was completed in 2006. Building on increasing awareness of our brand, along with sales of politically oriented merchandise in connection with the U.S. general election, our net revenues increased to $120.4 million in 2008.

In 2009, our net revenues declined to $103.5 million as a result of macro-economic conditions in our primary markets that reduced discretionary spending by our customers coupled with the absence of election year sales.

 

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In mid-2009, we adopted a royalty and pricing structure which pays differentiated royalties for sales transactions through the content owners’ shops as compared to the royalties paid on sales through our marketplace. These changes positively impacted our gross margin, resulting in a 46% increase in Adjusted EBITDA in 2009, despite the 14% decline in net revenues.

In 2010, we aggressively focused on order and customer growth. This included increasing sales and marketing expenses to drive brand awareness and customer acquisition, as well as the acquisition of Canvas On Demand, LLC in September 2010. As a result of these investments, our net revenues grew by 24% in 2010 compared to 2009. We have continued this strategy into 2011, and as a result, our net revenues grew by 37% in 2011 from 2010. In October 2011, we acquired substantially all of the assets of L&S Retail Ventures, Inc. to expand our online customized stationery offerings. Further, in March 2012, we entered into an agreement to acquire substantially all of the assets of Logo’d Softwear, Inc., to expand our offerings in personalized apparel and merchandise for groups and organizations. The acquisition is anticipated to close during the second quarter of 2012, subject to obtaining the requisite approvals and other customary closing conditions. We may not be able to close this acquisition as planned or at all, and may be unable to successfully integrate this business or realize the anticipated benefits of the acquisition. We believe the market for print on demand customized and personalized products is at an early stage and we plan to continue to invest in sales and marketing programs, including customer acquisition. Accordingly, for the foreseeable future, we expect our customer acquisition costs to increase in absolute dollars to support the overall growth of our business and revenues.

An important driver for our growth is customer acquisition, primarily through online marketing efforts including paid and natural search, email, affiliate and an array of other channels, as well as the acquisition efforts of our content owners. We are investing aggressively in customer acquisition and as a result, our sales and marketing expenses are our largest operating expense. Increases in our content library of user-generated and branded content also drive our growth. The expansion of product categories, as well as branded products, contributed to increases in our sales volume as consumers continue to desire custom products, individualized to their unique interests and affiliations. To further expand our customer base outside the United States, we maintain localized websites in Australia, Canada, Germany and the United Kingdom.

The majority of our net revenues is generated from sales of customized products through our e-commerce websites and associated charges. In addition, we generate revenues from fulfillment services, including print and production services provided to third parties. Fulfillment revenues were less than 2% and 1% of net revenues during the years ended December 31, 2010 and 2011, respectively. Consumers purchase customized products directly from our website or through storefronts hosted by CafePress. Customized products include user-designed products as well as products designed by our content owners. We pay royalties to content owners for the use of their content on our products and royalty payments are included in cost of net revenues.

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

Seasonal and cyclical influences impact our business volume. A significant portion of our sales are realized in conjunction with traditional retail holidays, with the largest sales volume in the fourth quarter of each calendar year. Our unique offering of custom gifts for the holidays combined with consumers’ continued shift to online purchasing drive this trend. As a result of this seasonality, our revenues in the first quarter of each year are

 

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generally substantially lower than our revenues in the fourth quarter of the preceding year, and we expect this to continue for the foreseeable future. In addition, political merchandise represents one of our largest content categories, creating a cyclical impact on our volume during key election periods.

Although our principal growth has been organic, we have also grown through acquisitions. In July 2008, we acquired Imagekind, Inc., an online art marketplace, for cash and stock consideration valued at $8.4 million. In September 2010, we acquired Canvas On Demand, an online service for creating personalized canvases from photographs, for cash and stock consideration valued at $10.1 million. We also agreed to make up to $9.0 million in earn-out payments to the former owners of Canvas On Demand, contingent upon the achievement of performance targets in each 12-month period from October 1 through September 30 through 2013, and, subject to certain exceptions, the continued employment of the two former owners. We record these earn-out payments as acquisition-related costs in our consolidated statements of operations.

In October 2011, we acquired substantially all of the assets of L&S Retail Ventures, Inc., an online customized stationery company located in Cary, North Carolina. In connection with the acquisition, there was an initial cash purchase price of $4.5 million, and contingent rights for the two principal stockholders to receive up to $8.0 million in future performance-based consideration, including CafePress stock options valued at up to $1.0 million based on the fair value of our common stock as determined at the first board of directors meeting following the acquisition date, with annual vesting in equal installments over a four-year period beginning January 1, 2012, and subject to continued employment and the achievement of certain performance targets. The contingent right to future earn-out payments will expire on December 31, 2015.

In March 2012, we entered into an agreement to acquire substantially all of the assets of Logo’d Softwear, Inc., an e-commerce provider of personalized apparel and merchandise for groups and organizations. The asset purchase agreement provides for a total initial purchase price of $8.3 million, consisting of $7.5 million in cash and $0.8 million in shares of CafePress common stock priced as of the closing date, as well as contingent rights for the principal stockholder to receive up to $8.6 million in future performance-based cash consideration. In addition, in connection with, and upon closing of, the acquisition, the principal stockholder will receive CafePress stock options to purchase shares of our common stock with an aggregate value of up to $2.1 million, with vesting based on the achievement of certain performance milestones. The contingent right to future earn-out payments will expire either March 31, 2016, or June 30, 2016, depending on the closing date of the acquisition. The acquisition is anticipated to close during the second quarter of 2012, subject to obtaining the requisite approvals and other customary closing conditions. We may not be able to close this acquisition as planned or at all, and may be unable to successfully integrate this business or realize the anticipated benefits of the acquisition.

Key operating metrics

 

Three months ended    Mar. 31,
2010
     June 30,
2010
     Sept. 30,
2010
     Dec. 31,
2010
     Mar. 31,
2011
     June 30,
2011
     Sept. 30,
2011
     Dec. 31,
2011
 

 

 

Key operating metrics:

                       

Total customers

     412,820         466,224         465,498         899,614         557,309         629,170         600,013         1,138,425   

Total number of orders

     471,058         546,441         537,153         1,100,612         665,088         742,529         736,562         1,401,126   

Average order size

   $ 46       $ 47       $ 47       $ 50       $ 50       $ 50       $ 50       $ 49   

 

 

Total customers

Total customers represents the number of transacting customers in a given period based on shipment date. We track the total number of customers by unique member number or email address. As a result, an individual who creates multiple accounts using different email addresses will be counted as multiple unique customers. The total number of customers

 

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represents those that are unique to the period specified. Therefore, the total number of unique customers for individual quarters within a year will not necessarily equal the total number of unique customers for the entire year.

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

Total number of orders

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

Average order size

Average order size is calculated as billings for a given period based on shipment date divided by the total number of associated orders in the same period. 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.

Basis of presentation

Net revenues

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

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

 

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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 comprise fees we pay to our content owners for the use of their content on our products. Certain sales transactions under our Create & Buy program do not incur royalties. For other product sales, royalties vary with volume as well as whether the transaction occurred in a shop or the marketplace. Royalty-based obligations are expensed to cost of net revenues at the contractual rate for the relevant product sales.

Operating expenses

Operating expenses consist of sales and marketing, technology and development, and general and administrative expenses. In addition, we have incurred costs related to acquisition compensation and impairment of goodwill and other intangible assets. Personnel-related expenses comprise a significant component of our operating expenses and consist of wages and related benefits, bonuses and stock-based compensation.

Sales and marketing

Sales and marketing expenses consist primarily of customer acquisition costs, personnel costs and costs related to customer support, order processing and other marketing activities. Customer acquisition, customer support and order processing expenses are variable and historically have represented more than half of our overall sales and marketing expenses. In 2011, these expense categories accounted for 74% of our total sales and marketing expense.

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

Technology and development

Technology and development expenses consist of costs incurred for engineering, network operations, and information technology, including personnel expenses, as well as the costs incurred to operate our websites. Technology and development costs are expensed as incurred, except for certain costs related to the development of internal use software and website development, which are capitalized and amortized over the estimated useful lives ranging from two to three years. While technology and development expenses have decreased in recent periods, 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.

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. After this offering, 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 becoming 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.

 

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Acquisition-related costs

Acquisition-related costs includes costs related to earn-out payments in connection with our acquisitions of Canvas On Demand and L&S Retail Ventures, Inc. Earn-out payments of up to $9.0 million in connection with our acquisition of Canvas on Demand are payable in installments through 2014. The amounts payable are contingent upon achievement of performance targets and are subject to maximum amounts of $2.1 million, $2.6 million and $4.3 million in each of the 12-month periods ending September 30, 2011, 2012 and 2013, respectively, and, subject to certain exceptions, the continued employment of the two former owners. The performance targets for the 12-month period ending September 30, 2011 were met and we accordingly paid an aggregate amount of $2.1 million to the two former owners of Canvas on Demand on October 30, 2011 pursuant to the terms of the agreement. In addition, if maximum amounts are not earned in each 12-month period ending September 30, 2012 or 2013 but additional specific performance targets are met in 2013, then final earn-out payments may be payable in 2014, with the total additional amounts payable across the remaining three years not to exceed $6.9 million.

Acquisition-related costs will also include performance-based compensation payments, as well as any changes in the estimated fair value of performance-based contingent consideration payments which were initially recorded in connection with our acquisition of substantially all of the assets of L&S Retail Ventures, Inc.

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

Critical accounting policies

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

Revenue recognition

We recognize revenues from product sales, net of rebates and promotional discounts, and net of estimated returns and chargebacks 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 revenues earned are fixed or determinable; and (4) collection of the resulting receivable is reasonably assured.

Revenues related to merchandise sales are recognized upon delivery to our customers. We evaluate whether it is appropriate for us to record the gross amount of product sales and related costs as product revenues or the net amount earned as fulfillment revenues. When we are the primary obligor in a transaction, are subject to inventory risk, have latitude in establishing prices and selecting suppliers, or have several but not all of these

 

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indicators, revenues are recorded gross. 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. For certain transactions, we have concluded we are not the primary obligor and we record the net amount received by us as fulfillment revenues. Fulfillment revenues during the years ended December 31, 2009, 2010 and 2011 were less than 2%, 2% and 1% of net revenues, respectively.

Product sales and shipping revenues are recognized net of estimated returns, rebates, promotional discounts, and allowances for credit card chargebacks, including chargebacks processed through group-buying websites. We periodically provide incentive offers to customers to encourage purchases. Such offers include current discount offers, such as percentage discounts off current purchases, and other similar offers. Current discount offers, when used by customers, are treated as a reduction of revenues. We maintain an allowance for estimated future returns and credit card chargebacks based on current period revenues and historical experience. During the years ended December 31, 2009, 2010 and 2011, returns and credit card chargebacks were 2% of net revenues for each of these periods, and have been within management’s expectations.

We account for flash deal promotions through group-buying websites as gift certificates. We record deferred revenues at the time of the promotion based on the gross fee payable by the end customer, as we are the primary obligor in the transaction. We defer costs for the direct and incremental sales commission retained by the group-buying websites and record the associated expense as a component of sales and marketing expense at the time revenue is recognized. Revenues and costs are recognized on redemption of the offer and delivery of the product to our customers. We recognize gift certificate breakage from gift certificate sales and flash deal promotions as a component of net revenues. We monitor historical breakage experience and when sufficient history of redemption exists, we record breakage revenue in proportion to actual gift certificate redemptions. When we conclude that insufficient history of redemption and breakage experience exists, we recognize breakage revenue upon expiration of a flash deal promotion or in the period we consider the obligation for future performance related to such breakage to be remote. We recognized breakage revenue of $0.4 million and $2.7 million and the associated direct sales commission of $0.2 million and $1.1 million for the years ended December 31, 2010 and 2011, respectively. This increased operating income by $0.2 million and $1.6 million for the years ended December 31, 2010 and 2011, respectively. Changes in customers’ behavior could impact the amounts that are ultimately redeemed and could affect the breakage recognized as a component of net revenues.

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

Internal use software and website development costs

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

Goodwill and intangible assets

Goodwill represents the excess of the purchase price over the fair value of assets acquired and liabilities assumed related to a business combination. Goodwill is presumed to have an indefinite life and is not subject to

 

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amortization. We conduct a test for the impairment of goodwill at least annually, which we conduct in the third quarter of each year, and also whenever events or changes in circumstances indicate that the carrying value of the goodwill may not be fully recoverable. The impairment test is a two-step process. The first step is a comparison of the fair value of the reporting unit with its carrying amount, including goodwill. If this step indicates impairment, then the loss is measured as the excess of recorded goodwill over its implied fair value, or the excess of the fair value of the reporting unit over the fair value of all identified assets and liabilities.

We determined that we have two reporting units for all periods presented. We have fully integrated the Imagekind and Canvas On Demand businesses into the art reporting unit and all of our goodwill is recorded in the art reporting unit. Accordingly, our goodwill is evaluated for impairment at the art reporting unit level. Based on the annual impairment analyses performed in the third quarter of 2010 and 2011, the fair value of our art reporting unit substantially exceeded its carrying value. As such, we concluded that the art reporting unit neither failed nor was at risk of failing step one of the goodwill impairment test.

The application of the goodwill impairment test requires judgment, including the identification of reporting units, assignment of assets and liabilities to reporting units, assignment of goodwill to reporting units, and determination of the fair value of each reporting unit. Significant judgments required to estimate the fair value of reporting units include estimating future cash flows, and determining the appropriate discount and growth rates and other assumptions and evaluation of market comparable multiples. Changes in these estimates and assumptions could materially affect the determination of fair value for each reporting unit which could trigger impairment. We determined we had two reporting units for all periods presented. In 2009, 2010 and 2011, we determined there was no indication of impairment.

We evaluate our finite-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset is impaired or the estimated useful lives are no longer appropriate. Intangible assets resulting from the acquisition of entities accounted for using the purchase method of accounting are estimated by management based on the fair value of assets received. Our intangible assets have an economic useful life and/or expire after a specified period of time and thus are classified as finite-lived intangible assets on our balance sheets. Amortization of finite-lived intangible assets is computed using the straight-line method over the estimated economic life of the assets which range from three years to eight years. If indicators of impairment exist and the undiscounted projected cash flows associated with such assets are less than the carrying amount of the asset, an impairment loss is recorded to write the asset down to their estimated fair values. Fair value is estimated based on discounted future cash flows. Factors that could result in an impairment review include, but are not limited to, significant underperformance relative to projected future operating results, significant negative industry or economic trends and changes in the planned use of assets.

Income taxes

We use the liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized by applying the statutory tax rates in effect in the years in which the differences between the financial reporting and tax filings basis of existing assets and liabilities are expected to reverse. We have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance against our deferred tax assets. We believe that the net deferred tax assets shown on our balance sheet are more likely than not to be realized in the future. In the event that actual results differ from those estimates in future periods, we may need to record an increase to our valuation allowance, which will negatively impact deferred tax assets and the results of operations in the period the change is made.

 

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Stock-based compensation

We recognize compensation costs related to stock options granted to employees based on the estimated fair value of the awards on the date of grant, net of estimated forfeitures. We estimate the grant date fair value, and the resulting stock-based compensation expense, using the Black-Scholes option-pricing model. The grant date fair value of the stock-based awards is generally recognized on a straight-line basis over the requisite service period, which is generally the vesting period of the respective awards.

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

 

      Year ended December 31,  
     2009      2010      2011  

 

 

Expected term (in years)

     4.6            4.6            4.6      

Risk-free interest rate

     2.1%         1.8%         1.5%   

Expected volatility

     62%         59%         58%   

Expected dividend rate

     0%         0%         0%   

 

 

The Black-Scholes model requires the use of highly subjective and complex assumptions which determine the fair value of stock-based awards, including the option’s expected term and the price volatility of the underlying stock. These assumptions include:

 

 

Expected term.    The expected term represents the period that our stock-based awards are expected to be outstanding and was primarily determined using the simplified method in accordance with guidance provided by the SEC. For option grants considered to be “plain vanilla”, the simplified method calculates the expected term as the average of the time-to-vesting and the contractual life of the awards. For awards not considered “plain vanilla”, the expected term is based on the historical option exercise behavior of our employees and posting-vesting cancellations.

 

 

Risk-free interest rate.    The risk-free interest rate is based on the U.S. Treasury yield in effect at the time of grant for zero coupon U.S. Treasury notes with maturities approximately equal to each award’s expected term.

 

 

Expected volatility.    The expected volatility is derived from historical volatilities of several unrelated public companies within the online retail industries that are deemed to be comparable to our business because we have no trading history. When making the selections of our industry peer companies to be used in the volatility calculation, we considered the size, operational and economic similarities to our principle business operations. We have utilized historical volatility as the basis for the volatility input into the Black-Scholes option pricing model for the purpose of determining the fair value of stock options. We used the historical volatility of a peer group of companies as: (a) we have no reason to believe that our future volatility over the expected term will differ from the historical volatilities of our peer companies, (b) the computation of historical volatility uses a simple average calculation, (c) a sequential period of historical data at least equal to the expected term of the option was used and (d) a reasonably sufficient number of price observations was used.

 

 

Expected dividend.    The expected dividend was assumed to be zero as we have never paid dividends and have no current plans to do so.

In addition to assumptions used in the Black-Scholes option-pricing model, we must also estimate a forfeiture rate to calculate the stock-based compensation for our awards. Our forfeiture rate is based on an analysis of our actual forfeitures. We will continue to evaluate the appropriateness of the forfeiture rate based on actual forfeiture experience, analysis of employee turnover and other factors. Quarterly changes in the estimated forfeiture rate can have a significant impact on our stock-based compensation expense as the cumulative effect

 

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of adjusting the rate is recognized in the period the forfeiture estimate is changed. If a revised forfeiture rate is higher than the previously estimated forfeiture rate, an adjustment is made that will result in a decrease to the stock-based compensation expense recognized in the financial statements. If a revised forfeiture rate is lower than the previously estimated forfeiture rate, an adjustment is made that will result in an increase to the stock-based compensation expense recognized in the financial statements.

We will continue to use judgment in evaluating the expected term, expected volatility and forfeiture rate related to our own stock-based compensation on a prospective basis. As we continue to accumulate additional data related to our common stock, we may have refinements to the estimates of our expected volatility, expected terms and forfeiture rates, which could materially impact our future stock-based compensation expense.

We are also required to estimate the fair value of the common stock underlying our stock-based awards when performing the fair value calculations with the Black-Scholes option-pricing model. The fair values of the common stock underlying our stock-based awards were estimated on each grant date by our board of directors, with input from management. We believe that our board of directors has the relevant experience and expertise to determine a fair value of our common stock on each respective grant date. Given the absence of a public trading market of our common stock, and in accordance with the American Institute of Certified Public Accountants Practice Guide, Valuation of Privately-Held-Company Equity Securities Issued as Compensation, our board of directors exercised reasonable judgment and considered numerous objective and subjective factors to determine the best estimate of the fair value of our common stock including:

 

 

independent contemporaneous valuations;

 

 

rights, preferences and privileges of our convertible preferred stock relative to those of our common stock;

 

 

actual operating and financial performance;

 

 

current business conditions and projections;

 

 

hiring of key personnel and the experience of our management;

 

 

secondary sales of shares of our capital stock in arm’s-length transactions;

 

 

likelihood of achieving a liquidity event, such as an initial public offering or a merger or acquisition of our company given prevailing market conditions and the nature and history of our business;

 

 

illiquidity of stock-based awards involving securities in a private company;

 

 

industry information such as market size and growth; and

 

 

the U.S. and global capital market conditions.

In valuing our common stock, our board of directors determined the equity value of our business using the income approach valuation method. The income approach estimates value based on the expectation of future cash flows that a company will generate, such as cash earnings, cost savings, tax deductions and the proceeds from disposition. These future cash flows are discounted to their present values using a discount rate derived from an analysis of the cost of capital of comparable publicly traded companies in our industry or similar lines of business as of each valuation date and is adjusted to reflect the risks inherent in our cash flows. The market approach was used as a reasonableness check, as it takes the fair value of a company by applying market multiples of comparable publicly traded companies in our industry or similar lines of business which are based on key metrics implied by the enterprise values or acquisition values of our comparable publicly traded companies. In utilizing the market approach as a reasonableness check, we determined that our concluded invested capital value from the income approach was reasonable.

 

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We also considered the appropriate adjustment to recognize the lack of marketability due to being a closely held entity. In concluding an appropriate marketability discount at each valuation date, we relied upon an analysis of certain restricted stock studies. We selected appropriate discounts based on these studies by comparing financial indications for our company relative to the benchmarks. Additionally, we made qualitative adjustments for factors such as potential transfer restrictions, distribution levels and holding period. Finally, our concluded marketability discounts were supported by put models provided for each valuation date. The primary factor resulting in changes in the marketability discount over time was the expected term to a liquidity event at each valuation date.

For the valuation dates from March 2010 through March 2011, we used the option pricing model to allocate value to the common stock. As there was a very wide range of possible future exit events, forecasting specific probabilities and potential values associated with any future events was considered highly speculative and imprecise. As such, we relied primarily upon the option pricing model, in order to allocate the total invested capital allocated to debt and the respective classes of equity. As of June 2011, we began to utilize the probability weighted expected return model because of the increased likelihood of an initial public offering.

We granted stock options with the following exercise prices since May 7, 2010:

 

Grant date    Number of
options
granted
    

Exercise
price

($)

    

Fair value
per share of
common stock

($)

 

 

 

May 7, 2010

     295,735         11.40         11.40   

August 6, 2010

     73,950         11.40         11.40   

November 5, 2010

     45,175         11.90         11.90   

February 10, 2011

     74,875         12.70         12.70   

May 4, 2011

     628,687         14.10         14.10   

August 4, 2011

     106,000         18.80         18.80   

November 2, 2011

     139,458         17.90         17.90   

February 9, 2012

     111,500         17.90         17.90   

February 23, 2012

     297,000         17.90         17.90   
   

The intrinsic value of all outstanding options as of December 31, 2011 was $        million based on the estimated fair value for our common stock of $        per share, the mid-point of the price range set forth on the cover of this prospectus.

No single event caused the valuation of our common stock to increase or decrease through November 2, 2011. Instead, a combination of the factors described below in each period led to the changes in the fair value of the underlying common stock.

Significant factors considered by our board of directors in determining the fair value of our common stock at these grant dates include:

May 2010

In May 2010, the U.S. economy and the financial stock markets were in recovery following a challenging sales environment in 2009, and consumer spending was slowly increasing. We experienced revenue growth, generating $21.9 million for the quarter ended March 31, 2010 compared to $21.1 million for the same quarter in 2009. As our business continued to grow, and developing multi-year forecasts became possible, we began estimating our enterprise value with a discounted cash flow approach. Under the discounted cash flow approach, we analyzed the forecast of our expected future financial performance, and discounted those to a present value using an

 

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appropriate discount rate which reflected our then current cost of capital. We applied a marketability discount to reflect the fact that our common stockholders were unable to liquidate their holdings at will, or possibly at all. An independent contemporaneous valuation of our common stock as of March 31, 2010 determined the fair value of our common stock to be $11.50 per share under the discounted cash flow approach. The discount rate applied to our cash flows was 15.0% and our enterprise value reflected a non-marketability discount of 20.0% based on a liquidity event expected to occur within two years. This value was weighted 75% in the valuation of our common stock. We also considered a sale of stock by stockholders who agreed to sell shares of our common stock at $11.00 per share to a third-party investor for approximately $1.2 million in February 2010. The transaction was negotiated by unrelated third parties and represents an arm’s length transaction of the common stock. Given the facts and circumstances surrounding the transactions, we assigned a 25% weight to the value indicator. The independent contemporaneous valuation took into consideration this transaction and concluded that the common stock value was $11.38 per share at March 31, 2010. There was no change in our financial forecasts between March 31, 2010 and May 7, 2010. Based on the contemporaneous valuation and the common stock sale transaction, on May 7, 2010, our board of directors granted stock options with an exercise price of $11.40 per share, which was equal to the fair value per share of our common stock as determined by our board of directors as of such date.

August 2010

Between May 2010 and August 2010, the U.S. economy and the financial stock markets continued their recovery. We experienced revenue growth, generating $25.7 million for the quarter ended June 30, 2010 compared to $21.5 million for the same quarter in 2009, and $21.9 million for the quarter ended March 31, 2010. In June 2010, an independent investor purchased an aggregate of 0.7 million shares of our common stock and Series A convertible preferred stock from existing stockholders. All shares were tendered for $11.40 per share and the transaction was completed on June 30, 2010. We did not have a full contemporaneous valuation of our common stock prepared as of June 30, 2010 but rather we reviewed the market to determine if there was any significant changes in market multiples that had occurred within our peer group that could affect our valuation. Our board of directors, with assistance from management, determined that the fair value of our common stock at June 30, 2010 was $11.40, based on the significance of the stock sales transaction with a sale price of $11.40 per share, that we met our second quarter financial plan and did not revise our financial forecast, and there was no material change in our peer group market multiples in the second quarter. On August 6, 2010, our board of directors granted stock options with an exercise price of $11.40 per share, which was equal to the fair value per share of our common stock as determined by our board of directors as of such date, as there was no material change in our business or in our industry between July 1 and August 6, 2010 that would alter the valuation as of June 30, 2010.

November 2010

Between August 2010 and November 2010, the U.S. economy and the financial stock markets continued their recovery. We experienced revenue growth, generating $25.4 million for the quarter ended September 30, 2010 compared to $20.1 million for the same quarter in 2009. An independent contemporaneous valuation of our common stock as of September 30, 2010 determined the fair value of our common stock to be $11.88 per share under the discounted cash flow approach. The discount rate applied to our cash flows was 16.0% and our enterprise value reflected a non-marketability discount of 17.5% based on a liquidity event expected to occur within 18 months. Based on the independent contemporaneous valuation and that there was no change in our financial forecast, on November 5, 2010, our board of directors granted stock options with an exercise price of $11.90 per share, which was equal to the fair value per share of our common stock as determined by our board of directors as of such date.

 

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February 2011

Between December 2010 and February 2011, the U.S. economy and the financial stock markets continued their recovery. We experienced revenue growth, generating $54.9 million for the quarter ended December 31, 2010 compared to the $40.7 million for the same quarter in 2009. An independent contemporaneous valuation of our common stock as of December 31, 2010 determined the fair value of our common stock to be $12.70 per share under the discounted cash flow approach. The discount rate applied to our cash flows was 16.0% and our enterprise value reflected a non-marketability discount of 17.5% based on a liquidity event expected to occur within 15 months. Based on the independent contemporaneous valuation and that there was no change in our financial forecast, on February 10, 2011, our board of directors granted stock options with an exercise price of $12.70 per share, which was equal to the fair value per share of our common stock as determined by our board of directors as of such date.

May 2011

Between February 2011 and May 2011, the U.S. economy and the financial stock markets continued their recovery. We experienced revenue growth, generating $32.0 million for the quarter ended March 31, 2011 compared to $21.9 million for the same quarter in 2010. An independent contemporaneous valuation of our common stock as of March 31, 2011 determined the fair value of our common stock to be $14.10 per share under the discounted cash flow approach. The discount rate applied to our cash flows was 16.0% and our enterprise value reflected a non-marketability discount of 10% based on a liquidity event expected to occur within six months. There was no change in financial forecasts, and based on the independent contemporaneous valuation, and consideration of our progress towards being ready for a liquidity event, on May 4, 2011, our board of directors granted stock options with an exercise price of $14.10 per share, which was equal to the fair value per share of our common stock as determined by our board of directors as of such date.

August 2011

Between May 2011 and August 2011, the U.S. economy and the financial stock markets were relatively flat. We experienced continued revenue growth, generating $37.3 million for the quarter ended June 30, 2011 compared to $25.7 million for the same quarter in 2010. An independent contemporaneous valuation of our common stock as of July 27, 2011 determined the fair value of our common stock to be $18.74 per share under the discounted cash flow approach. The discount rate applied to our cash flows was 15.5% and our enterprise value reflected a non-marketability discount of 7.5% based on a liquidity event expected to occur within two months. Due to the continued progress towards a liquidity event, we utilized the Probability-Weighted Expected Return (“PWERM”) approach to allocate value to our common stock. As a result of our continued revenue growth, we increased our forecasts for fiscal 2011 and maintained the same expected long-term growth rates. This increase in forecasts, together with utilization of the PWERM approach and a decrease in the non-marketability discount, was the primary reason for the increase in fair value of our common stock. Based on the independent contemporaneous valuation, and consideration of our progress toward being ready for a liquidity event, and no further change in our financial forecasts on August 4, 2011, our board of directors granted stock options with an exercise price of $18.80 per share, which was equal to the fair value per share of our common stock as determined by our board of directors as of such date.

November 2011

Between August 2011 and November 2011, the U.S. economy was relatively flat but the financial stock markets experienced increased volatility, and discount ranges for IPO valuations increased. We experienced continued revenue growth, generating $36.6 million for the quarter ended September 30, 2011 compared to $25.4 million

 

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for the same quarter in 2010. An independent contemporaneous valuation of our common stock as of October 28, 2011 determined the fair value of our common stock to be $17.89 per share under the discounted cash flow approach. The discount rate applied to our cash flows was 16.0% and our enterprise value reflected a non-marketability discount of 10.0% based on a liquidity event expected to occur within two months. Due to the continued progress towards a liquidity event, we utilized the PWERM approach to allocate value to our common stock. We maintained the same expected long-term growth rates. In addition, we included forecasted results related to our acquisition of substantially all of the assets of L&S Retail Ventures, Inc. However, as a result of the instability in the financial stock markets and increasing IPO discount ranges, we increased the discount rate applied to our cash flows, as well as our non-marketability discount. This increase in discount rate and the non-marketability discount, together with utilization of the PWERM approach, was the primary reason for the decrease in fair value of our common stock. Based on the independent contemporaneous valuation, and consideration of our progress toward being ready for a liquidity event, and no further change in our financial forecasts on November 2, 2011, our board of directors granted stock options with an exercise price of $17.90 per share, which was equal to the fair value per share of our common stock as determined by our board of directors as of such date.

February 2012

Between November 2011 and February 2012, the U.S. economy showed some signs of improvement, but the financial stock markets continued to experience significant levels of volatility. Although financial stock market conditions and volatility appear to have improved during January 2012, holiday results for e-commerce and retail companies, as well as their near-term outlooks, have been mixed, resulting in high volatility in this sector. We experienced continued revenue growth, generating $69.5 million for the quarter ended December 31, 2011 compared to $54.9 million for the same quarter in 2010. An independent contemporaneous valuation of our common stock as of January 31, 2012 determined the fair value of our common stock to be $17.88 per share under the discounted cash flow approach. The discount rate applied to our cash flows was 17.0% and our enterprise value reflected a non-marketability discount of 10.0% based on a liquidity event expected to occur within two months. Due to the continued progress towards a liquidity event, we utilized the PWERM approach to allocate value to our common stock. As a result of our continued revenue growth, we increased our forecasted revenues and EBITDA for fiscal 2012-2013, and maintained the same expected long-term growth rates. However, as a result of continued instability in the financial stock markets and volatility in our peer group, we increased the discount rate applied to our cash flows. This increase in forecasts and in our discount rate, together with utilization of the PWERM approach, resulted in no significant change to the fair value of our common stock. Based on the independent contemporaneous valuation, and consideration of our progress toward being ready for a liquidity event, and no further change in our financial forecasts, on February 9, 2012 and February 23, 2012, our board of directors granted stock options with an exercise price of $17.90 per share, which was equal to the fair value per share of our common stock as determined by our board of directors as of such dates.

Our stock-based compensation expense for awards granted is as follows:

 

      Year ended December 31,  
(in thousands)    2009      2010      2011  

 

 

Cost of net revenues

   $ 160       $ 152       $ 164   

Sales and marketing

     359         472         520   

Technology and development

     618         569         267   

General and administrative

     1,004         981         1,427   
  

 

 

 

Total stock-based compensation expense

   $ 2,141       $ 2,174       $ 2,378   

 

 

 

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As of December 31, 2011, we had $6.3 million of unrecognized stock-based compensation expense, net of estimated forfeitures, that is expected to be recognized over a weighted average period of 3.0 years. In future periods, our stock-based compensation expense is expected to increase as a result of our existing unrecognized stock-based compensation to be recognized as these awards vest and as we issue additional stock-based awards to attract and retain employees.

Results of operations

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

 

        Year ended December 31,  
       2009     2010     2011  

 

 

Net revenues

       100     100     100

Cost of net revenues

       56        57        57   
    

 

 

 

Gross profit

       44        43        43   
    

 

 

 

Operating expenses:

        

Sales and marketing

       17        21        23   

Technology and development

       13        11        7   

General and administrative

       9        7        8   

Acquisition-related costs

       0        1        2   
    

 

 

 

Total operating expenses

       39        40        40   
    

 

 

 

Income from operations

       5        3        3   

Interest income

       0        0        0   

Interest expense

       0        0        0   

Other income, net

       0        0        0   
    

 

 

 

Income before income taxes

       5        3        3   

Provision for income taxes

       2        1        1   
    

 

 

 

Net income

       3     2     2
    

 

 

 

Effective tax rate

       40.4     38.8     32.1

 

 

 

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Comparison of the years ended December 31, 2010 and December 31, 2011

The following table presents our statements of operations for the periods indicated:

 

(in thousands, except for percentages)    Year ended
December  31,
                
   2010      2011      $ Change     % Change  

 

 

Net revenues

   $ 127,930       $ 175,482       $ 47,552        37

Cost of net revenues

     72,447         100,191         27,744        38   
  

 

 

 

Gross profit

     55,483         75,291         19,808        36   
  

 

 

 

Operating expenses:

          

Sales and marketing

     26,484         40,809         14,325        54   

Technology and development

     14,305         12,768         (1,537     (11

General and administrative

     9,593         13,573         3,980        41   

Acquisition-related costs

     794         2,696         1,902        240   
  

 

 

 

Total operating expenses

     51,176         69,846         18,670        36   
  

 

 

 

Income from operations

     4,307         5,445         1,138        26   

Interest income

     116         56         (60     (52

Interest expense

     (215      (194      21        (10

Other (expense) income, net

     239                 (239     (100
  

 

 

 

Income before income taxes

     4,447         5,307         860        19   

Provision for income taxes

     1,724         1,701         (23     (1
  

 

 

 

Net income

   $ 2,723       $ 3,606       $ 883        32

 

 

Net revenues

Net revenues increased $47.6 million, or 37%, in 2011 compared to 2010. The increase in net revenues is primarily due to an increase in orders, which was attributable to new customer acquisitions and expansion of our merchandise catalog, particularly new art products, as well as growth in our international sales. Canvas On Demand and InvitationBox.com led our new product expansion and contributed $23.8 million of the total increase in net revenues. The remaining increase in net revenues was due to an increase in domestic sales for our other products of $19.1 million and an increase in international sales of $4.7 million. These increases were attributable to our increased focus on customer acquisition and international expansion, respectively. While the acquisition of Canvas On Demand significantly contributed to the increase in net revenues in 2011, and we expect it to continue to contribute to the growth of our art product revenues, our revenue growth rates have historically varied from period to period and we expect this trend to continue.

Cost of net revenues

Cost of net revenues increased $27.7 million, or 38%, in 2011 compared to 2010. As a percentage of net revenues, cost of net revenues was 57% in 2011, which is consistent with 2010. Within cost of net revenues, materials, shipping, labor and fixed overhead costs collectively increased as a percentage of net revenues by 1.8 percentage points due to changes in the product mix and increased promotional offerings designed to attract new customers. These increases were partially offset by a 1.3 percentage point decline in royalty payments due to an increase in sales of products with lower royalty rates.

 

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Sales and marketing

Sales and marketing expenses increased $14.3 million, or 54%, in 2011 compared to 2010. Sales and marketing expenses were 23% of net revenues in 2011 compared to 21% in 2010. The increase in sales and marketing expenses was primarily due to higher variable expenses, including increases of $11.2 million in customer acquisition costs, $0.7 million in order processing expenses and $0.7 million in customer service costs. In addition, payroll and related costs increased $1.2 million to support the growth in our net revenues and represented a full year of personnel costs related to our Canvas On Demand acquisition in September 2010. Customer acquisition costs increased primarily due to increased online acquisition activities, such as keyword searches, display marketing and email marketing, as well as costs related to flash deal promotions. We expect our customer acquisition costs on an annual basis to continue at similar rates, as a percentage of revenue, for the foreseeable future.

Technology and development

Technology and development expenses decreased $1.5 million, or 11%, in 2011 compared to 2010. Technology and development expenses were 7% of net revenues in 2011 compared to 11% in 2010. The decrease in absolute dollars is primarily due to a reduction in personnel- and contractor-related expenses of $1.4 million, increased capitalization of website development costs of $0.6 million, partially offset by an increase of $0.7 million in website services expense.

General and administrative

General and administrative expenses increased $4.0 million, or 41%, in 2011 compared to 2010. General and administrative expenses were 8% of net revenues in 2011 compared to 7% in 2010. The increase in absolute dollars is primarily due to an increase in personnel-related costs related to additional employees and contractors to support the growth in our business, and higher professional fees for legal and accounting services.

Acquisition-related costs

Acquisition-related costs were $2.7 million and $0.8 million in 2011 and 2010, respectively. This expense represents the accrual of performance-based contingent consideration payments related to our acquisitions of Canvas On Demand in September 2010 and L&S Retail Ventures, Inc. in October 2011.

Provision for income taxes

The provision for income tax was $1.7 million in both 2011 and 2010. Our effective tax rate was 32.1% and 38.8% in 2011 and 2010, respectively. The effective tax rate was lower in 2011 primarily due to the impact of a lower effective state tax rate and lower incentive stock option expense in 2011.

 

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Comparison of the years ended December 31, 2009 and 2010

The following table presents our statements of operations for the periods indicated:

 

      Year ended
December 31,
   

$ Change

    % Change  
(in thousands, except for percentages)    2009     2010      

 

 

Net revenues

   $ 103,493      $ 127,930      $ 24,437        24  % 

Cost of net revenues

     57,688        72,447        14,759        26   
  

 

 

 

Gross profit

     45,805        55,483        9,678        21   
  

 

 

 

Operating expenses:

        

Sales and marketing

     17,711        26,484        8,773        50   

Technology and development

     13,152        14,305        1,153        9   

General and administrative

     9,322        9,593        271        3   

Acquisition-related costs

            794        794        *   
  

 

 

 

Total operating expenses

     40,185        51,176        10,991        27   
  

 

 

 

Income from operations

     5,620        4,307        (1,313     (23

Interest income

     220        116        (104     (47

Interest expense

     (253     (215     38        15   

Other income (expense), net

     (3     239        242        *   
  

 

 

 

Income before income taxes

     5,584        4,447        (1,137     (20

Provision for income taxes

     2,255        1,724        (531     (24
  

 

 

 

Net income

   $ 3,329      $ 2,723      $ (606     (18 )% 

 

 

 

*   Not meaningful

Net revenues

Net revenues increased $24.4 million, or 24%, in 2010 compared to 2009. Net revenues increased due to an increase in the number of customers and overall orders. Revenues generated from Canvas On Demand accounted for $7.4 million of the total increase in net revenues. In addition, revenues from international sales accounted for $6.1 million of the increase. The remaining increase of $10.9 million was generated primarily from a 20% increase in customers.

Cost of net revenues

Cost of net revenues increased $14.8 million, or 26%, in 2010 compared to 2009. As a percentage of net revenues, cost of net revenues increased to 57% in 2010 from 56% in 2009. Within our cost of net revenues, materials, shipping, labor and fixed overhead costs all increased as a percentage of net revenues by 4.6 percentage points due to changes in the product mix and promotional offerings designed to attract new customers. These costs were partially offset by a 3.7 percentage point decline in royalty payments as a percentage of net revenues as compared to 2009 due to an increase in sales of products with lower royalty rates primarily as a result of the differentiated royalty pricing structure that we adopted during 2009.

Sales and marketing

Sales and marketing expenses increased $8.8 million, or 50%, in 2010 compared to 2009. As a percentage of net revenues, sales and marketing expenses increased to 21% in 2010 from 17% in 2009. The increase in sales

 

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and marketing expenses was primarily due to increases of $4.8 million in customer acquisition costs. Customer acquisition costs increased primarily due to increased online acquisition activities, such as keyword searches, display marketing and email marketing, as well as costs related to flash deal promotions. The remainder of the increase was the result of variable cost increases of $0.5 million in customer support costs and $0.4 million in order processing expenses. In addition, payroll and related costs increased $2.2 million to support the growth in our net revenues. General marketing expenses for public relations and events also increased by $0.3 million.

Technology and development

Technology and development expenses increased $1.2 million, or 9%, in 2010 compared to 2009. As a percentage of net revenues, technology and development decreased to 11% in 2010 from 13% in 2009. The increase in absolute dollars is primarily due to an increase of $0.6 million in third-party contractor services and a $0.4 million increase in depreciation and amortization.

General and administrative

General and administrative expenses increased $0.3 million, or 3%, in 2010 compared to 2009. As a percentage of net revenues, general and administrative decreased to 7% in 2010 from 9% in 2009. The increase in absolute dollars is primarily due to increases in personnel related costs of $0.2 million and a $0.3 million increase in facilities costs, partially offset by a decrease of $0.1 million in legal expenses.

Acquisition-related costs

Acquisition-related costs were $0.8 million in 2010 and represents the amount of the earn-out payment accrued for the acquisition of Canvas On Demand.

Other income (expense), net

Other income (expense), net was $0.2 million in 2010 and was comprised of non-operating income from the sale of a domain name, which we expect to be a non-recurring event.

Provision for income taxes

The provision for income tax was $1.7 million in 2010 compared to $2.3 million in 2009. Our effective tax rate was 38.8% in 2010 compared to 40.4% in 2009. This decrease in our effective tax rate is primarily due to the impact of higher tax credits in 2010 and lower incentive stock option expense.

 

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Quarterly results of operations

The following table sets forth our unaudited quarterly statement of operations data for each of the eight quarters in the period ended December 31, 2011. In management’s opinion, the data below has been prepared on the same basis as the audited financial statements included elsewhere in this prospectus, and reflects all necessary adjustments, consisting only of normal recurring adjustments, necessary for a fair statement of this data. The results of historical periods are not necessarily indicative of the results of operations for a full year or any future period.

 

22,000 22,000 22,000 22,000 22,000 22,000 22,000 22,000

Three months ended

(in thousands)

  Mar. 31,
2010
    June 30,
2010
    Sept. 30,
2010
   

Dec. 31,

2010

   

Mar. 31,

2011

   

June 30,

2011

   

Sept. 30,

2011

   

Dec. 31,

2011

 

 

   

 

 

 
    (unaudited)        

Net revenues

  $ 21,900      $ 25,710      $ 25,421      $ 54,899      $ 32,036      $ 37,335      $ 36,574      $ 69,537   

Cost of net revenues

    12,135        13,946        14,715        31,651        18,757        21,592        20,813        39,029   
 

 

 

 

Gross profit

    9,765        11,764        10,706        23,248        13,279        15,743        15,761        30,508   

Operating expenses:

               

Sales and marketing

    4,247        5,210        5,846        11,181        7,903        8,743        9,368        14,795   

Technology and development

    3,388        3,745        3,527        3,645        3,447        3,141        3,043        3,137   

General and administrative

    2,184        2,533        2,283        2,593        2,686        3,448        3,520        3,919   

Acquisition-related costs

                  28        766        511        579        670        936   
 

 

 

 

Total operating expenses

    9,819        11,488        11,684        18,185        14,547        15,911        16,601        22,787   
 

 

 

 

Income (loss) from operations

    (54     276        (978     5,063        (1,268     (168     (840     7,721   

Interest income

    34        35        28        19        17        16        12        11   

Interest expense

    (58     (54     (52     (51     (50     (47     (45     (52

Other income, net

                         239                               
 

 

 

 

Income (loss) before income taxes

    (78     257        (1,002     5,270        (1,301     (199     (873     7,680   

Provision for (benefit from) income taxes

    (38     77        (380     2,065        (470     (70     (339     2,580   
 

 

 

 

Net income (loss)

  $ (40   $ 180      $ (622   $ 3,205      $ (831   $ (129     (534   $ 5,100   
 

 

 

 

Other Financial and Non-GAAP Financial Data:

               

Adjusted EBITDA(1)

  $ 2,076      $ 2,509      $ 1,443      $ 8,522      $ 1,841      $ 2,961      $ 2,412      $ 11,526   

Capital expenditures

  $ 866      $ 1,470      $ 2,036      $ 1,464      $ 471      $ 1,154      $ 3,472      $ 276   

 

 

 

(1)   Adjusted EBITDA is a non-GAAP financial measure that our management uses to assess our operating performance and it is a factor in the evaluation of the performance of our management in determining compensation. 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 income (loss) and our other GAAP results.

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

 

22,000 22,000 22,000 22,000 22,000 22,000 22,000 22,000

Three months ended

(in thousands)

  Mar. 31,
2010
    June 30,
2010
    Sept. 30,
2010
    Dec. 31,
2010
    Mar. 31,
2011
   

June 30,

2011

    Sept. 30,
2011
    Dec. 31,
2011
 

 

 
    (unaudited)              

Net income (loss)

  $ (40   $ 180      $ (622   $ 3,205      $ (831   $ (129   $ (534   $ 5,100   

Non-GAAP adjustments:

               

Interest and other (income) expense

    24        19        24        (207     33        31        33        41   

Provision for (benefit from) income taxes

    (38     77        (380     2,065        (470     (70     (339     2,580   

Depreciation and amortization

    1,555        1,605        1,627        1,577        1,526        1,477        1,404        1,429   

Amortization of intangible assets

    77        78        215        541        542        542        536        765   

Acquisition-related costs

                  28        766        511        579        670        936   

Stock-based compensation

    498        550        551        575        530        531        642        675   
 

 

 

 

Adjusted EBITDA

  $ 2,076      $ 2,509      $ 1,443      $ 8,522      $ 1,841      $ 2,961      $ 2,412      $ 11,526   

 

 

 

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The following table presents the unaudited quarterly results of operations as a percentage of net revenues:

 

Three months ended

(in thousands)

 

Mar. 31,

2010

   

June 30,

2010

   

Sept. 30,

2010

   

Dec. 31,

2010

   

Mar. 31,

2011

   

June 30,

2011

   

Sept. 30,

2011

   

Dec. 31,

2011

 

 

 
    (unaudited)        

Net revenues

    100  %      100     100  %      100     100  %      100     100     100

Cost of net revenues

    55        54        58        58        59        58        57        56   
 

 

 

 

Gross margin

    45        46        42        42        41        42        43        44   

Operating expenses:

               

Sales and marketing

    19        20        23        20        25        23        26        21   

Technology and development

    15        15        14        7        11        8        8        5   

General and administrative

    10        10        9        5        8        9        10        6   

Acquisition-related costs

                  0        1        2        2        2        1   
 

 

 

 

Total operating expenses

    45        45        46        33        45        42        45        33   
 

 

 

 

Income (loss) from operations

    (0     1        (4     9        (4     (0     (2     11   

Interest income

    0        0        0        0        0        0        0        0   

Interest expense

    (0     (0     (0     (0     (0     (0     (0     (0

Other income (expense), net

    (0                   0                             0   
 

 

 

 

Income (loss) before income taxes

    (0     1        (4     10        (4     (1     (2     11   

Provision for (benefit from) income taxes

    (0     0        (1     4        (1     (0     (1     4   
 

 

 

 

Net income (loss)

    (0 )%      1     (2 )%      6     (3 )%      (0 )%      (1 )%      7

 

 

Quarterly trends

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. We also typically experience increases in revenues during shopping-related seasonal events, such as Mother’s Day, Father’s Day and other retail holidays.

Beginning with the third quarter of 2010, our gross margin declined due to changes in product mix and increased promotional discounts to attract new customers.

Within operating expenses, since a significant portion of sales and marketing is variable, our sales and marketing expenses fluctuate with volume. In 2010 and continuing into 2011, we increased our sales and marketing expenses to drive new customer acquisition.

In September 2010, we acquired Canvas On Demand, which resulted in acquisition-related costs from the fourth quarter of 2010, representing the amount of the earn-out payment accrued in connection with the acquisition, as well as increases in operating expenses directly related to the Canvas On Demand personnel and facilities in Raleigh, North Carolina. The increase in acquisition-related costs, combined with our increased sales and marketing expenses, resulted in a loss from operations for the first, second and third quarters of 2011. We currently expect customer acquisition costs to increase in absolute dollars and to fluctuate as a percentage of net revenues for the foreseeable future.

Liquidity and capital resources

Since inception, 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. Based on our

 

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current operating plan, and in the absence of this offering, we believe our existing cash, cash equivalents and short-term investments combined with cash generated from operations will be sufficient to meet our working capital and capital expenditure needs for at least the next 12 to 18 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.

Cash flows

The following summary of our cash flows for the periods indicated has been derived from our financial statements included elsewhere in this prospectus:

 

      Year ended December 31,  
(in thousands)    2009     2010    

2011

 

 

 

Net cash provided by operating activities

   $ 10,701      $ 13,553      $ 16,924   

Net cash used in investing activities

   $ (6,256   $ (7,932   $ (8,027

Net cash provided by (used in) financing activities

   $ 1      $ 400      $ (273

 

 

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 six 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 2011, net cash provided by operations was $16.9 million, primarily due to our net income of $3.6 million, adjusted for non-cash items of $8.2 million for depreciation and amortization, including amortization of intangible assets, and $2.4 million for stock-based compensation. In addition, the growth in our business resulted in net cash from the change in our operating assets and liabilities of $3.9 million as our accounts payable, deferred revenue and accrued liabilities increased more than our accounts receivable, inventory and other assets. As our net revenues are primarily settled through credit cards, and our accounts payable are settled based on contractual payment terms with our suppliers, growth in our business resulted in a greater increase in our operating liabilities than our operating assets.

In 2010, net cash provided by operations was $13.6 million, primarily due to our net income of $2.7 million, adjusted for non-cash items of $7.3 million for depreciation and amortization, including amortization of

 

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intangible assets, and $2.2 million for stock-based compensation. In addition, the growth in our business resulted in net cash from the change in our operating assets and liabilities of $2.3 million as our accounts payable, deferred revenue and accrued liabilities increased more than our accounts receivable, inventory and other current assets.

In 2009, net cash provided by operations was $10.7 million, primarily due to our net income of $3.3 million adjusted for non-cash items of $6.4 million for depreciation and amortization expense for property and equipment and intangible assets and $2.1 million for stock-based compensation expense.

Cash flows from investing activities

Our investing activities have consisted primarily of capital expenditures to purchase property and equipment related to both our manufacturing plants and technology data centers, as well as capitalization of software and website development costs. Investing cash flows include cash used in the acquisition of businesses in 2010 and 2011 and purchases of, and proceeds from, the sale of short-term investments.

In 2011, net cash used in investing activities was $8.0 million. Net cash used for the acquisition of substantially all of the assets of L&S Retail Ventures, Inc. was $4.5 million including $0.5 million of restricted cash held in escrow at December 31, 2011. In addition, we used $3.4 million for capital expenditures related to the purchase of property and equipment, and capitalized $1.9 million of software and website development costs, partially offset by net proceeds from the sale of short-term investments of $1.6 million.

In 2010, net cash used in investing activities was $8.0 million. Net cash used for the acquisition of Canvas on Demand was $5.4 million. In addition, we used $4.4 million for capital expenditures related to the purchase of property and equipment and capitalized $1.4 million of software and website development costs, partially offset by net proceeds from the sale of short-term investments of $2.9 million.

In 2009, net cash used in investing activities was $6.3 million, including capital expenditures of $2.0 million and $1.3 million in capitalization of software and website development costs, along with net purchases of short-term investments of $3.0 million.

Cash flows from financing activities

In 2011, net cash used in financing activities was $0.3 million, primarily due to payments of $2.2 million for costs related to the pending initial public offering and payments on our capital lease obligations of $0.4 million, partially offset by $1.9 million received from the exercise of stock options and the related excess tax benefits of $0.5 million.

In 2010, net cash provided by financing activities was $0.4 million, primarily due to $0.4 million received from the exercise of stock options, $0.4 million in excess tax benefits, offset by payments on our capital lease obligations of $0.4 million.

In 2009, net cash provided by financing activities consisted of $0.2 million of proceeds from the exercise of stock options and $0.2 million in excess tax benefits, which were offset by payments on our capital lease obligations of $0.3 million.

 

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Contractual obligations

The following summarizes our contractual obligations as of:

 

December 31, 2011    Payments due by period  
(in thousands)   

Less than
1 year

     1 to 3
years
     4 to 5
years
     More than
5 years
     Total  

 

 

Capital lease obligations

   $ 661       $ 1,322       $ 1,437       $ 373       $ 3,793   

Operating lease obligations

     2,289         1,027         374                 3,690   

Purchase obligations

     1,381                                 1,381   
  

 

 

 

Total

   $ 4,331       $ 2,349       $ 1,811       $ 373       $ 8,864   

 

 

Purchase obligations of $1.4 million at December 31, 2011 consist primarily of inventory and various service contracts.

In September 2010, we acquired Canvas On Demand. In connection with the acquisition, we agreed to make up to $9.0 million in earn-out payments to the former owners of Canvas On Demand, payable in installments through 2014 based on a 12-month period from October 1 through September 30. The amounts payable in each 12-month period are contingent upon achievement of performance targets and are subject to maximum amounts of $2.1 million, $2.6 million and $4.3 million in each of the 12-month periods ending September 30, 2011, 2012 and 2013, respectively. The performance targets are measured by a determination of compounded annual growth rate, or CAGR, on revenue attributed to specified business lines, as determined in accordance with GAAP consistently applied. The performance targets are as follows: (a) in the first earn-out period, the acquired business must achieve a CAGR of 25%, and a CAGR of 10% for the combined art businesses of CafePress and Canvas on Demand, and a net profit measurement of 9% on such combined business, (b) in the second earn-out period, the acquired business must achieve a CAGR of 20%, and a CAGR of 10% for the combined business, and a net profit measurement on the combined business of 9%, and (c) in the third earn-out period, the combined business must achieve a CAGR of 20%, and a net profit measurement on the combined business of 9%. Additionally, if the maximum amounts in each of the first earn-out period, the second earn-out period and the third earn-out period are not otherwise earned, alternative performance targets will be analyzed in order to achieve the performance target payments (but not in excess of the same respective maximum amounts for each period) as follows: (a) during the first earn-out period, if the Create & Buy business achieves in the first nine months of 2011 a CAGR of 25% and a net profit measurement of 9%, then the former owners collectively may earn an amount of up to $0.3 million toward the same maximum earn-out payment, and/or if new strategic business development and channel initiatives formed after April 1, 2011, or Channel Initiatives, in the period from April 1, 2011 through September 30, 2011 achieve a CAGR of 25% and a net profit measurement of 9%, then the former owners collectively may earn an amount of up to $0.2 million towards the same maximum earn-out payment, (b) during the second earn-out period, if the Create & Buy business achieves a CAGR of 25% and a net profit measurement of 9%, then the former owners collectively may earn an amount of up to $0.4 million toward the same maximum earn-out payment, and/or if Channel Initiatives achieve a CAGR of 25% and a net profit measurement of 9%, then the former owners collectively may earn an amount of up to $0.4 million toward the same maximum earn-out payment, and (c) during the third earn-out period, if the Create & Buy business achieves a CAGR of 25% and a net profit measurement of 9%, then the former owners collectively may earn an amount up to $0.9 million toward the same maximum earn-out payment, and/or if Channel Initiatives achieve a CAGR of 25% and a net profit measurement of 9%, then the former owners collectively may earn an amount of up to $0.9 million toward the same maximum earn-out payment. In addition, if maximum amounts are not earned in each of the 12-month periods ending September 30, 2011, 2012 or 2013, but additional specific performance targets are met in 2013, then final earn-out payments may be payable in 2014, with the total amounts paid across the four years not to exceed $9.0 million. If the first two

 

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earn-out payments are not all fully achieved, the performance target for that final earn-out opportunity shall be achieved if the combined business recognizes incremental revenue of $32.0 million more than the art business as operated by CafePress, and a net profit measurement on the combined business of 9% is likewise achieved by end of the third earn-out period. Earn-out payments are contingent on the continued employment of the two former owners, Tom Lottrechiano and Joe Schmidt, with exceptions related to termination by either party for defined reasons, and each of Messrs. Lottrechiano and Schmidt will also receive additional earn-out payments of $250,000 for their continued employment through March 1, 2012. Accordingly, earn-out payments are being recorded as acquisition-related costs and are accrued over the service period. In each period, we accrue for acquisition-related costs based on the service provided and our current estimates of performance relative to the stated targets. The accrual could be adjusted if the actual performance differs from our current estimates. Acquisition-related costs were $0.8 million and $2.7 million for the years ended December 31, 2010 and 2011, respectively. As of December 31, 2010, $0.7 million and $0.1 million were classified as accrued liabilities and other long-term liabilities, respectively. The performance targets for the 12-month period ending September 30, 2011 were met and we accordingly paid an aggregate amount of $2.1 million to the two former owners of Canvas on Demand on October 30, 2011 pursuant to the terms of the agreement. As of December 31, 2011, $1.2 million of aggregate acquisition-related costs was recorded as accrued liabilities.

In October 2011, we acquired substantially all of the assets of L&S Retail Ventures, Inc. The total purchase price of $7.3 million consisted of an initial cash purchase price of $4.5 million and $2.8 million in contingent consideration related to expected performance-based contingent consideration payments for which there is no requirement of continued employment with us by the sellers. In connection with the acquisition, the two principal stockholders have contingent rights to receive up to $8.0 million in future performance-based consideration, including: (a) aggregate performance-based contingent consideration payments of up to $5.0 million for the first three earn-out periods; (b) a performance-based compensation payment of up to $2.0 million, payable at the end of the fourth earn-out period; and (c) CafePress stock options valued at up to $1.0 million based on the fair value of our common stock as determined at the first board of directors meeting following the acquisition date, with annual vesting in equal installments over a four-year period beginning January 1, 2012, and subject to continued employment and the achievement of certain performance targets. The earn-out periods for the contingent cash payments commence on January 1 and end December 31 for each of 2012, 2013, 2014 and 2015. Thus the contingent right to future earn-out payments will expire on December 31, 2015.

Specifically, the two principal stockholders may receive up to $1.7 million in performance-based contingent consideration payments per year payable after the end of each of the first three earn-out periods based on specific revenue and operating income targets for such earn-out periods. The aggregate maximum performance-based contingent consideration payments for the first three years is $5.0 million. These performance-based contingent consideration payments are not subject to continued employment. Accordingly, the estimated fair value of the performance-based contingent consideration of $2.8 million as of the acquisition date was included as part of the purchase price allocation. We determined the fair value of the liability for the contingent consideration based on a probability-weighted discounted cash flow analysis. In each period, we reassess our current estimates of performance relative to the stated targets and adjust the liability to fair value. In addition to the aggregate maximum $5.0 million in performance-based contingent consideration payments, the agreement included performance-based compensation of up to $2.0 million in cash, payable after the end of the fourth earn-out period, based on specific revenues and operating income targets during such earn-out period. This payment is contingent on the continued employment of the two principal stockholders. Accordingly, this payment will be expensed as earned, and will be classified as acquisition-related costs.

With respect to the specific performance targets for the contingent cash payments, the acquired business must achieve: (a) a threshold CAGR of 24% on revenues in each of the four earn-out periods, and (b) a threshold

 

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operating income percentage of 18%, 19%, 20%, 20% in the first, second, third and fourth earn-out periods, respectively. If the acquired business does not achieve these operating income targets, but achieves (a) a threshold CAGR of 34%, and (b) a threshold operating income percentage of 13%, 14%, 15%, and 15% in the first, second, third and fourth earn-out periods, respectively, then the two principal stockholders will be eligible for a portion of the contingent cash payments that would have been earned at the higher operating income percentage thresholds.

With respect to the specific performance targets for the CafePress stock options, the acquired business must achieve (a) a threshold CAGR of 20% on revenues in each of the four earn-out periods, and (b) a threshold operating income percentage of 18%, 19%, 20% and 20% in the first, second, third and fourth earn-out periods, respectively, for such stock options to vest. If such operating income percentages are not achieved, the two principal stockholders may be eligible to earn a cash payout for a portion of the value of the stock options, provided that the business acquired achieves (a) a threshold CAGR of 43% on revenues in each of the four earn-out periods, and (b) a threshold operating income percentage of 13%, 14%, 15% and 15% in the first, second, third and fourth earn-out periods, respectively.

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.

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 and foreign currency exchange rate sensitivities.

Interest rate sensitivity

We have cash and cash equivalents and short-term investments of $29.3 million and $36.3 million as of December 31, 2010 and 2011, 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 a 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.

 

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Recent accounting pronouncements

Effective January 1, 2010, we adopted new authoritative guidance on fair value measurements and disclosures. The new guidance requires additional disclosures regarding fair value measurements, amends disclosures about postretirement benefit plan assets, and provides clarification regarding the level of disaggregation of fair value disclosures by investment class. This guidance is effective for interim and annual reporting periods beginning after December 15, 2009, except for certain Level 3 activity disclosure requirements that will be effective for reporting periods beginning after December 15, 2010. Accordingly, we adopted this new guidance beginning January 1, 2010, except for the additional Level 3 requirements, which we adopted on January 1, 2011. Level 3 assets and liabilities are those whose fair value inputs are unobservable and reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. The adoption of this guidance did not have a material impact on our financial statements.

In December 2010, new authoritative guidance was issued with respect to when to perform Step 2 of the goodwill impairment test for reporting units with zero or negative carrying amounts. According to the new guidance, entities must consider whether it is more likely than not that goodwill impairment exists by assessing if there are any adverse qualitative factors indicating impairment. The qualitative factors are consistent with the existing guidance. The new guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. The adoption of this guidance did not have a material impact on our consolidated financial statements.

In December 2010, the Financial Accounting Standards Board, or the FASB, issued Accounting Standards Update Disclosure of Supplementary Pro Forma Information for Business Combinations (Topic 805)Business Combinations, to improve consistency in how the pro forma disclosures are calculated. Additionally, the update enhances the disclosure requirements and requires description of the nature and amount of any material, nonrecurring pro forma adjustments directly attributable to a business combination. The new guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. The adoption of this guidance did not have a material impact on our consolidated financial statements.

In May 2011, the FASB amended its guidance, to converge fair value measurement and disclosure guidance in U.S. GAAP with International Financial Reporting Standards, or IFRS. IFRS is a comprehensive series of accounting standards published by the International Accounting Standards Board. The amendment changes the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. For many of the requirements, the FASB does not intend for the amendment to result in a change in the application of the requirements in the current authoritative guidance. The amendment becomes effective prospectively for our interim period ending March 31, 2012. Early application is not permitted. We do not expect the amendment to have a material impact on our financial position, results of operations or cash flows.

In June 2011, the FASB amended its guidance on the presentation of comprehensive income. Under the amended guidance, an entity has the option to present comprehensive income in either one or two consecutive financial statements. A single statement must present the components of net income and total net income, the components of other comprehensive income and total other comprehensive income, and a total for comprehensive income. In a two-statement approach, an entity must present the components of net income and total net income in the first statement. That statement must be immediately followed by a financial statement that presents the components of other comprehensive income, a total for other comprehensive income, and a total for comprehensive income. The option under current guidance that permits the presentation of other comprehensive income in the statement of changes in stockholders’ equity has been eliminated. The amendment becomes effective retrospectively for our interim period ending March 31, 2012. Early adoption is permitted. We are currently assessing the impact that this potential change would have on our financial position, results of operations or cash flows.

 

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In August 2011, the FASB amended its guidance for performance of goodwill impairment tests. The amendment provides an option to first assess qualitative factors to determine whether performing the current two-step impairment test is necessary. If an entity believes, as a result of its qualitative assessment, that it is more-likely-than-not that the fair value of a reporting unit is less than its carrying amount, the quantitative impairment test will be required; otherwise no further testing will be required. The amendment becomes effective for annual and interim goodwill impairment tests performed for our fiscal year ending December 31, 2012. Early adoption is permitted. We are currently assessing the impact that this potential change would have on our financial position, results of operations or cash flows.

 

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Business

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 personal and shared 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 share and monetize their content. We believe we are a leading e-commerce platform for customization of consumer products based on our more than a decade of experience of providing high-quality customized products in single unit and small quantity orders on a when-ordered basis. We have developed a strong brand with a growing community that, as of December 31, 2011, had more than 15 million members and more than three million shops, and we shipped over 7.8 million products in 2011 from a catalog of over 320 million unique products, as measured by the number of different combinations of designs and types of merchandise.

We operate a portfolio of branded websites, including CafePress.com, and enable resellers and co-branded websites to design and customize products that individually target specific consumers, products and use cases, or to provide their customers with product customization capabilities. We believe this collectively helps expand the reach of our platform. We benefit from the network effect created when millions of customers are attracted to our catalog of content and are often inspired to contribute and share their own content. By enabling communities to share their interests, beliefs and affiliations through customized and personalized merchandise, we believe we drive social commerce.

Our expansive content catalog covers topics our customers are deeply passionate about, as well as relevant current events. As a result, we believe our catalog serves as a cultural barometer reflecting the latest topics, ideas, trends, moods and opinions. For the year ended December 31, 2011, we had nearly 130,000 new images uploaded to our retail e-commerce websites on average per week. We have accumulated over 320 million unique products, allowing us to market and provide almost any expressive idea across an increasingly diverse product assortment.

We have built a state-of-the-art facility in Louisville, Kentucky with innovative technology and manufacturing processes that enable us to provide high-quality customized products that are individually built to order at mass scale. Our proprietary, vertically integrated processes enable us to produce a broad range of merchandise efficiently, cost effectively and quickly. We have an art print production facility in Portland, Oregon and as a result of our acquisition of Canvas On Demand, we also have a custom canvas production facility in Raleigh, North Carolina. Our recent acquisition of substantially all of the assets of L&S Retail Ventures, Inc. adds further print production facilities in North Carolina.

The majority of our net revenues is generated from sales of customized products through our e-commerce websites and associated charges. In addition, we generate revenues from fulfillment services, including print and production services provided to third parties. Fulfillment revenues were less than 2% and 1% of net revenues during the years ended December 31, 2010 and 2011, respectively. Consumers purchase customized products directly from our website or through storefronts hosted by CafePress. Customized products include user-designed products as well as products designed by our content owners. We pay royalties to content owners for the use of their content on our products and royalty payments are included in cost of net revenues.

In 2010, we generated net revenues of $127.9 million. In 2011, net revenues were $175.5 million, an increase of 37% from 2010.

 

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In March 2012, we entered into an agreement to acquire substantially all of the assets of Logo’d Softwear, Inc., an e-commerce provider of personalized apparel and merchandise for groups and organizations. The asset purchase agreement provides for a total initial purchase price of $8.3 million, consisting of $7.5 million in cash and $0.8 million in shares of CafePress common stock priced as of the closing date, as well as contingent rights for the principal stockholder to receive up to $8.6 million in future performance-based cash consideration. In addition, in connection with, and upon closing of, the acquisition, the principal stockholder will receive CafePress stock options to purchase shares of our common stock with an aggregate value of up to $2.1 million, with vesting based on the achievement of certain performance milestones. The contingent right to future earn-out payments will expire either March 31, 2016, or June 30, 2016, depending on the closing date of the acquisition. The acquisition is anticipated to close during the second quarter of 2012, subject to obtaining the requisite approvals and other customary closing conditions. We may not be able to close this acquisition as planned or at all, and may be unable to successfully integrate this business or realize the anticipated benefits of the acquisition.

Vision and mission

Our vision is to empower expression by making products extraordinary and personal. Our mission is to offer an unrivaled platform that is the world’s premier source for self-expression through product customization and personalization.

We believe that people possess an innate desire to express who they are, where they belong and what they love. Personalizing products is a common way to express what is most meaningful in our lives. We strive to build the best platform for truly mass-customized, one-of-a-kind personalization, and become the leading source for customized products, whether selling directly to consumers and businesses or helping other brands and product manufacturers make their products more expressive for their customers.

Industry overview

Customization of consumer products is undergoing an enormous transformation, driven by advances in Internet technology that enable consumers to shop for products in new ways and advances in manufacturing technology that enable high-quality printing on a broad range of merchandise that can be efficiently and cost effectively processed in small and single unit batches.

 

 

Consumer demand for long tail selection and customization.    Consumer tastes and interests are diverse. E-commerce companies such as Amazon.com and eBay are offering more items than ever before, creating growing expectations for a broader and expanding range of products and services. The Internet has further fueled demand for a broader selection of merchandise and has provided a forum for self-expression. Social media services such as Facebook and Twitter have given voice to consumers and enabled the sharing of ideas. Consumers increasingly expect a broader selection of both design choices and content to create or customize products. We refer to the array of choices beyond what is typically in high demand or widely available as “long tail” selection.

 

 

E-commerce.    Online shopping and e-commerce have become mainstream. According to Forrester, United States online retail sales were expected to be $197 billion in 2011.(1) According to eMarketer, in 2011, approximately 179 million consumers ages 14 and older in the United States were expected to research products online and 83% of them were expected to make an online purchase. Shopping has become a fundamentally different experience as search and discovery have improved and as the unit economics of fulfillment have made e-commerce channels a viable alternative to traditional retail. With the rise of e-commerce, the user experience has improved with easy-to-use interfaces, broad selection, enhanced search, rich media and streamlined payment options. Additionally, improved capabilities of inventory management

 

(1)    Source: “U.S. Online Retail Forecast, 2010-2015”, Forrester Research, Inc., February 28, 2011

 

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systems, logistics infrastructure and ground and air transportation have provided fast and affordable delivery of consumer products.

 

 

Internet tools and do-it-yourself empowerment.    Historically, consumers have needed help from third-party vendors to customize apparel and other products, but with the widespread availability of easy-to-use digital tools, today people can design products themselves. Customers are significantly less intimidated by designing online as evidenced by the widespread use of online photo slideshows and online product design software. The ability to use do-it-yourself design tools reduces the need to visit a local artisan, further disrupting the traditional way products have been customized.

 

 

Advances in mass customization technologies.    Historically, customizing products often required either large production runs with complex and expensive set-ups or allowed for only minimal customization through basic engraving or monogramming. Recent innovations in digital printing technology are driving the ability to digitally print in a high-quality manner on a variety of surfaces and on mass market products. In addition, manufacturing process and workflow innovation enables cost-effective and fast production of small and single unit batches at scale.

Market opportunity

Online tools, e-commerce and digital production technologies are disrupting the existing fragmented, offline product print and customization markets. Our services address multiple large adjacent markets which include, but are not limited to:

 

 

Screen printing and garment printing.    According to Freedonia, the U.S. screen printing and garment printing market is expected to grow from $7.2 billion in 2009 to $8.1 billion in 2014.

 

 

Creative photo merchandise.    IDC estimates that the market for creative photo merchandise will grow from $2.8 billion in 2010 to $6.6 billion in 2014. Creative photo merchandise encompasses all products that are customized with photos including, but not limited to, cards, calendars, posters, photobooks and scrapbook pages, wall art and home décor.

 

 

Promotional products.    According to Promotional Products Association International, the promotional products industry grew 5.9% to $16.6 billion in 2010, up from $15.6 billion in 2009. This includes $2.7 billion in online sales of promotional products in 2010, up 11.1% from $2.4 billion in 2009.

 

 

Customization services for product manufacturers.    Providing mass-customization services for retailers and product manufacturers is an emerging opportunity. From tablet cases to water bottles and beyond, our product diversity suggests a large opportunity encompassing ever-expanding retail merchandise categories. Based on 2009 U.S. Census Bureau data, we estimate the U.S. market for customizable retail goods is approximately $1.0 trillion.

We believe traditional printing models are not optimized to satisfy individual consumers and smaller constituencies due to long lead times, costly set-up, limited printing capabilities and minimum quantities needed to achieve efficiency. Moreover, the traditional businesses addressing these opportunities are fragmented and generally lack the tools and competencies to aggregate and serve consumers as they move online to make purchases.

 

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Our strengths

We believe we are well positioned in the market because we have more than a decade of experience meeting demand for customized single unit and small quantity orders that the traditional printing industry has generally not been able to serve efficiently and economically. We believe our business model provides us with the following competitive advantages:

 

 

Viral network effect.    We enjoy a network effect that attracts new users to our various services. We attract new customers when new sales channels are launched and when new designs are added to our content catalog, where they are socially shared and made discoverable online. These new customers then often add their own new designs to our content catalog. Over a decade in operation, our content library now contains millions of designs that are constantly replenished by our community of content owners. Launching new customizable products multiplies this effect as it makes many more unique combinations of design and product instantly available and entices new customers to join our community.

 

 

Trusted premium brands.    We have built strong relationships with our customers who are passionate about the products they create. We have more than a decade of experience of providing high-quality customized products in single unit and small quantity orders on a when-ordered basis and have invested heavily in developing technologies to deliver customized products with speed and quality. Based on this history and experience, we believe that we are recognized as pioneers in our industry and are trusted as a source of high-quality merchandise and consistent delivery, backed by strong service. In addition to our flagship brand, CafePress.com, we operate a portfolio of vertically targeted brands that individually target specific consumers, products and use cases, and collectively expand the reach of the CafePress platform.

 

 

Broad product assortment.    We offer a wide variety of products across many different categories as diverse as t-shirts, hats, canvas art prints, banners, stickers, iPhone and iPad cases, mugs, water bottles, GPS units, cards and calendars. We believe this product assortment makes us a more compelling one-stop solution for our customers.

 

 

Innovative and efficient operations.    We have developed manufacturing expertise and propriety processes for customizing different kinds of products. Although each process has different requirements and cycle times, our workflow automation enables us to schedule and produce items and efficiently merge them into a single shipment. We generally process and ship orders within three business days after a customer places an order and in many instances can ship orders within 24 hours after an order is placed. Transforming blank materials into finished goods in real-time minimizes inventory and capital requirements.

 

 

Long tail marketing expertise.    We believe our experience in data and analytics tools allows us to make effective real-time marketing decisions with sparse data and across a continuously updated product catalog. Specifically, our proprietary marketing systems and tools analyze data from thousands of search queries, customer purchases and new product additions across our websites each day and automatically make recommendations that allow us to develop and expand a variety of marketing initiatives. We believe our online marketing initiatives, particularly as they relate to complex search queries, enable us to acquire new customers cost-effectively due to the scale of the automation that we have achieved and lower acquisition cost associated with complex search terms relative to more generic keywords. In addition, we believe that potential customers who initiate complex searches are more likely to buy once they reach our websites.

 

 

Comprehensive online offering.    We believe our tools satisfy our users’ diverse needs, including finding the perfect unique gift, creating customized items or selling custom creations to their own communities or for profit through our online marketplace.

 

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The CafePress platform

We have developed services and production capabilities that allow us to offer users the ability to create, buy and sell a wide variety of expressive customized products. These services evolved into a platform currently consisting of the following components:

 

LOGO

Front-end design and sales channels

Our e-commerce websites and sales channels include:

 

 

CafePress.com.    CafePress.com is where consumers can find unique products that can also be customized and personalized. Users can choose from our catalog of over 320 million unique products or design their own.

 

LOGO

 

 

CanvasOnDemand.com.    CanvasOnDemand.com takes photographs and transforms them into canvas artwork.

LOGO

 

 

Imagekind.com.    Imagekind.com is where consumers can find artwork by independent artists that can be produced on posters, canvases and framed wall art.

LOGO

 

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GreatBigCanvas.com.    GreatBigCanvas.com is a premium provider of canvas wall art and panoramic canvas photographs.

LOGO

 

 

InvitationBox.com.    InvitationBox.com is a premium online provider of customizable stationery products, including invitations, announcements and other products and gifts.

 

LOGO

 

 

CafePress content owners.    Over three million content owners, including designers, artists, small businesses, groups, clubs and organizations, use our e-commerce platform to design their own products and sell them through their own hosted e-commerce “shop.” In addition to such individual content owners, large entertainment and publishing companies also license to us materials related to their products for creation of their own “shops”, online store experiences appearing embedded in their websites but hosted by us, or for sale directly by us in our marketplaces. Examples of the types of licensed properties that are made available as content for sale printed on our products include film properties such as The Hangover Part II and The Twilight Saga, with respect to which we may be provided with quotes, character names and images, from television properties such as American Idol®, Dexter®, The Big Bang Theory® and Grey’s Anatomy®, with respect to which we may be provided with quotes and images, and sometimes the right to sell replicas of apparel, costumes or products that have appeared on those shows, as well as entertainment publishing brands such as Snoopy® and Garfield®, with respect to which we may be provided with materials and images from their published properties.

 

 

Branded product manufacturers.    By supplying custom design tools and manufacturing services, we enable product manufacturers such as Sigg and TomTom® to offer customized designs on their products.

 

 

Other retailers.    We can enhance the online store experiences of other retailers and retail brands, such as Urban Outfitters, Inc. and philosophy brand cosmetics, by enabling them to offer their customers the ability to create customized products through our services appearing on the retailer’s website but hosted by us.

 

 

Distributed sales.    We supply distributors and resellers with short-run and quick-turn custom printed products.

Back-end services platform

Our back-end services form a platform consisting of the following components that can be used to create unique front-end buyer and seller experiences:

 

 

User-generated content.    Over 32 million designs have been uploaded through our platform to create over 320 million unique products available as of December 31, 2011, with an average of nearly 130,000 new image uploads added per week to our retail e-commerce websites in the year ended December 31, 2011. This constantly growing content library allows our users to find items that meet their exact, unique and expressive needs.

 

 

Licensed fan content.    We have developed relationships with major entertainment licensors that allow users to create designs using their logos and brands. This program extends our users ability to self express and

 

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interact with popular brands in ways previously not available and allows the brands to create viral social merchandising programs, which in turn enables them to engage with their fan base.

 

 

Design tools.    Our “what you see is what you get” design tools allow users to easily customize hundreds of items with their own images, text and other advanced features. Our tools are readily adaptable to new products.

 

 

Shops.    Content owners sell their own custom merchandise using our turn-key shops platform, which includes hosting, payment processing, marketing services, fulfillment and customer service.

 

 

Print/Production.    We offer users high-quality printing on over 600 product SKUs. We generally process and ship orders within three business days after a customer places an order and in many instances can ship orders within 24 hours after an order is placed. Our proprietary quality assurance systems help ensure that high-quality products are delivered to our users.

 

 

Fulfillment.    Our fulfillment processes aggregate thousands of orders every day, automating the workflow though our plants in an efficient, cost-effective manner, whether orders contain one product or many products and product types.

Our strategy

Our goal is to be the world’s customization platform. Key elements of our strategy to achieve this goal include the following:

 

 

Expand customer base.    We intend to expand our customer base and continue to promote our portfolio of e-commerce websites through existing marketing channels, which include word of mouth referrals from existing customers, trade publications, catalogs, online advertising, search engine marketing and social media. In addition, we have formed and intend to enter into new complementary strategic alliances with other large e-commerce companies to expand our online distribution presence, and also intend to continue to partner with large retail outlets.

 

 

Expand content partners.    We intend to expand our licensed content partners to increase the range of content accessible on our site and attract new users. For example, in 2010, we signed and implemented new agreements with licensors such as American Broadcasting Companies Inc. and ABC Studios, Warner Bros. and CBS Consumer Products Inc.

 

 

Expand product partners.    We believe we can partner with branded product manufacturers to help them offer customized designs on their products. For example, in 2010, we signed and launched agreements with manufacturers such as Trek and TomTom.

 

 

Expand product and service offerings.    We intend to continue to innovate to enable us to expand our products and services. In the past four quarters, we have expanded our merchandise selection to include products such as iPhone and iPad cases, canvas artwork and new apparel products such as pajamas. In addition we have launched new services, including the ability for sellers to create design templates, which extended buyer customization capabilities to our shops platform.

 

 

Increase sales to existing customers.    We seek to increase both our average order size and the lifetime value we receive from a customer by increasing retention rates, up-selling and cross-selling efforts and continuing to improve and streamline our design and ordering processes. We typically realize higher average order values from existing customers compared to first time customers.

 

 

Offer customization through additional brands.    We intend to leverage our platform by developing new brands and seeking co-branding opportunities to provide rich customer experiences along a range of industries.

 

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Seek acquisition and international expansion opportunities.    We intend to develop additional business opportunities through selected acquisition and international expansion, targeting customers in key geographies where Internet usage and e-commerce are widespread and targeting key verticals where we can leverage our technology and catalog of content. We currently have localized websites for the United States, Australia, Canada, Germany and the United Kingdom. Our acquisitions of Canvas On Demand and Imagekind have added talented artists and art to our content catalog, as well as enabling customers to find and create original works of art. Our recent acquisition of the e-commerce website InvitationBox.com greatly expands our online customized stationery offerings. We plan to continue to seek adjacent opportunities to expand our product offerings and customer base.

Risks related to our business

Our business is subject to various risks and uncertainties, including, but not limited to, the following:

 

 

Fluctuations in our operating results.    Our revenues and operating results may fluctuate from period to period, which could cause our stock price to decline. Factors that may contribute to these fluctuations include, but are not limited to, major social or political events or developments resulting in a short term demand for products with related content, macroeconomic cycles and consumer spending, demand for our user-designed products and services, fluctuations in sales and marketing costs, including website traffic acquisition costs, and fluctuations in the cost of raw materials.

 

 

Seasonality of our business.    The seasonality of our business places increased strain on our operations. 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, or failure to scale, our business operations during this period or any other period of peak demand could have a disproportionate effect on our operating results and our stock price could decline.

 

 

User-generated content.    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. In addition, as a service provider that prints and distributes user-generated content, we face allegations related to, and potential liability for, negligence, copyright or trademark infringement or other claims based on the nature and content of materials that we print or distribute. Additionally, because our service provides a platform for the expression of controversial ideas, our site could be the target of computer attacks or boycotts. If we lose or alienate current or potential customers or business partners due to the content on our websites, or become subject to liability, we risk damage to our brands, reputation and our business and results of operations.

 

 

Proper functioning of our websites, systems and infrastructure.    The satisfactory performance, reliability and availability of our websites, our marketing activities, our transaction-processing systems and our network infrastructure are critical to our success. Any failure to maintain the satisfactory performance, security and integrity of our websites, systems or infrastructure could materially and adversely affect our business, reputation, financial condition and results of operations.

 

 

Production and fulfillment operations.    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. If our production and fulfillment operations are interrupted for any significant period of time, it could damage our brands and reputation and substantially harm our business and results of operations.

For additional discussion of the risks applicable to our business, please see the discussion under the heading “Risk factors.”

 

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Our products and services

Our websites are designed to be fun, convenient and easy to use. They enable users to purchase a wide range of merchandise, customize products using our online design tools, create and manage shops and access our design, sales and support staff.

Merchandise assortment

Users visiting one of our e-commerce websites can currently select from over 600 SKUs of merchandise to customize. Our merchandise catalog currently includes:

 

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Online designers

Our portfolio of e-commerce websites are designed to make product customization simple and easy. Once a product has been selected, users can perform a wide range of design and editing functions including:

 

 

uploading their own designs and photos;

 

 

adding text;

 

 

adding stock art;

 

 

scaling and rotating images to ideally fit products;

 

 

repositioning product elements using conventional and intuitive drag-and-drop functionality;

 

 

changing fonts or font characteristics; and

 

 

changing color schemes.

Shops

Our shops platform allows users to sell and market their designed merchandise to their own communities. In addition to customizing the products that they sell, content owners may also customize the look and feel of shops through which they sell their products. We provide a variety of tools to help users market and manage their stores including basic search engine optimization, email list management and real-time sales reports.

Design, sales and customer service support

We are committed to providing a high level of customer service including phone, email and chat support. Our support centers also offer design support to help ensure that members customizing their own items receive quality finished products.

 

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Technology

 

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The technology required to deliver one-of-a-kind products with the speed and quality of ready-made inventory is substantial in both scope and complexity. We have invested heavily in developing significant proprietary technologies addressing each aspect of the CafePress experience including:

 

 

Design.    We have multiple product design tools based on user needs ranging from simple, fill-in-the-blank or upload-your-photo-here templates, to fully layered, rich editors mixing vector and raster artwork. We also offer design tools for a user to design a single product or to design over one hundred products at the same time. Our proprietary image rendering systems paint realistic virtualizations of actual products in real time. Users can design a product for sale or purchase.

 

 

Sell.    We offer comprehensive turn-key e-commerce services. Content owners can design and manage thousands of unique products in a shop, control their own marketing descriptions and set their own retail pricing. Many aspects of the shop can be customized, including the merchandising, navigation and look and feel. Content owners can also opt to list their products for sale on our marketplace to generate additional revenues. We pay royalties to content owners in accordance with their agreements with us.

 

 

Find.    It is typically extremely difficult to provide accurate search results and product recommendations across a vast, long tail product catalog where a majority of designs and products have little, if any, previous order history. We are constantly reinventing our sophisticated algorithms to make the best use of historical data to better predict conversion and drive our internal search, email and other marketing programs.

 

 

Buy.    Our platform allows customers to place orders and purchase products with a few simple clicks. Once a purchase has been placed, our fully integrated platform delivers not only the order but also all of the multivariate data necessary to create and fulfill the product on a timely basis.

 

 

Prepress.    Our content owners supply us with artwork which can be highly variable in content and consistency. We believe our pre-press technologies allow us to deliver consistent, high quality across multiple processes. Our prepress operations adjust colors to best match intended colors across multiple printing platforms, each with its own color gamut. Other prepress operations include scaling, masking, anti-aliasing and artifact removal.

 

 

Print /Production.    We often modify and augment printers and their drivers for them to work for our mass-customization operations. We believe these proprietary modifications enable us to deliver high quality products more efficiently. Our proprietary, vertically integrated processes enable us to produce a broad range of merchandise efficiently and cost effectively. We generally process and ship orders within three business days after a customer places an order and in many instances can ship orders within 24 hours after an order is placed.

 

 

Fulfillment.    We have invested significant resources to optimize order routing and management. Our fulfillment processes aggregate orders and route them to the most appropriate printing location based on

 

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item type and cost-efficiency, and guides and tracks products through assembly, packaging, sorting and shipment. Our proprietary quality assurance system allows for the efficient and accurate review of each individual product and its shipment.

We have designed our portfolio of e-commerce websites and manufacturing technologies to scale and accommodate future growth. We intend to continue to evaluate and potentially incorporate innovative technologies. Our technology and development expenses were $13.2 million in 2009, $14.3 million in 2010 and $12.8 million in 2011.

Sales and marketing

We employ a variety of methods to acquire consumers for our retail business beyond those who directly navigate to our websites. These programs include, but are not limited to:

 

 

Search engine marketing.    Our search engine marketing team employs sophisticated workflow processes to actively manage and bid on over 10 million keywords per day. This process is facilitated by a proprietary in-house search marketing platform developed over many years. This platform enables us to research and categorize thousands of new keywords per month, apply multivariate testing to find optimal advertising creative content and conduct optimized bidding in a scalable fashion. Our search advertising dollars are primarily used for purchases on Google and Bing.

 

 

Search engine optimization.    We use and continually innovate online marketing practices to generate the best results for consumers through search engine keyword searches. These practices, known as search engine optimization, may have many proprietary components but all are focused on maximizing the opportunity for consumers to find products on our site through keyword searches on sites like Google, Yahoo! and others. Among other activities, we strive to: ensure that millions of pages of our site are indexed and available for use by search engines, maintain a site structure that assists search engines in developing relevant search results for their users, and develop valuable and relevant content on our site that is useful to consumers searching for it and target popular search choices. Specifically and as an example, we have tens of millions of website pages indexed for Google and derive search traffic across tens of thousands of keywords daily. Finally, we also analyze trends in content and seasonality furthers develops search relevance for desirable products.

 

 

Affiliate and display marketing.    Our affiliate program currently supports thousands of affiliate publishers who drive traffic and sales to our site in exchange for pre-determined commissions. We employ multiple large affiliate networks to recruit new publishers and accept new publishers into our affiliate program on a daily basis. We also conduct large scale display advertising on several advertising exchanges. These advertisements are seen millions of times per month across the Internet and serve the purpose of driving sales as well as brand awareness.

 

 

Shopping channels.    Our shopping channel program allows us to distribute marketplace products across the Internet to most major shopping engines and marketplaces. Placement is usually provided on a revenue share or cost-per-click basis. We currently market millions of products in this manner both domestically, and internationally and we consider and form new marketing partnerships on an ongoing basis.

 

 

Email marketing.    We seek to attract and retain customers by targeted email marketing. Our members typically receive two types of sales marketing communications: lifecycle campaigns triggered by specific activities performed by the member, or promotional campaigns typically centered around a seasonal event or holiday such as Mother’s Day or Fourth of July. Our email platform allows advanced segmentations and targeting of our members across thousands of topics and interests.

 

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Social media.    We manage paid or organic programs across top social media sites including Facebook and Twitter. Our paid programs allow us to micro-target users based on their interests and demographics, matching them with content and product on our sites. Our organic programs encourage visitors to share content with their friends and networks through a variety of on-site and post-purchase programs, resulting in a growing amount of referred traffic and sales.

 

 

Other media.    We also use other vehicles for customer acquisition including trade publications, public relations, catalogs and flash deal promotions through group-buying websites.

Intellectual property

We rely primarily on a combination of patents, trade secrets, trademarks and copyrights, as well as employee and third-party confidentiality and invention agreements to safeguard our intellectual property. As of December 31, 2011, we had three issued patents, 10 patents pending in the United States and one pending in foreign jurisdictions, generally covering our unique e-commerce services or proprietary printing and decorating services and our online platform for designing and generating framed products. We continually assess appropriate occasions for seeking patent protection for those aspects of our technology, designs and methodologies and processes that we believe may ultimately provide significant competitive advantages. We regularly register copyrights covering our principal e-commerce websites.

As of December 31, 2011, we held 30 U.S. trademark registrations (some of which are registered in multiple classes), which include, among others, CAFEPRESS.COM, CAFEPRESS, the “cafe press” logo, CANVAS ON DEMAND, IMAGEKIND and INVITATIONBOX. We are in the process of registering additional trademarks supporting our business and we also claim common law trademark rights in numerous trademarks. We have registered our CAFEPRESS.COM and CAFEPRESS trademarks in numerous countries in Africa, Asia, Australia, Europe and North America.

We also rely upon certain unpatented proprietary manufacturing expertise, licensed third-party technologies, continuing technological innovation and other trade secrets to develop and maintain our competitive position. For certain of our proprietary know-how and processes, we rely on trade secret protection and confidentiality and invention agreements to safeguard our interests. We believe that many elements of our system, including technical processes, equipment and system designs, algorithms and procedures, which relate to our software controls, manufacturing process and methods of system design involve proprietary know-how, technology or data that are not covered by patents or patent applications. We have taken security measures to protect these elements. For example, all of our research and development personnel are required to enter into confidentiality and assignment of invention agreements with us. These agreements address intellectual property protection issues and require our employees to assign to us all of the inventions, designs and technologies they develop during the course of employment with us. We also require our customers and business partners to enter into non-disclosure agreements before we disclose any sensitive aspects of our technology, proprietary processes, sales data or business plans.

We are not subject to any material intellectual property claims alleging that we infringe, misappropriate or otherwise violate the intellectual property rights of others, nor have we asserted any material intellectual property infringement claims against third parties.

 

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Competition

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

 

 

traditional offline printing businesses;

 

 

e-commerce companies, including large online retailers such as Amazon.com and eBay;

 

 

physical and catalog retailers of personalized merchandise;

 

 

online providers of unique goods such as Etsy, as well as various other private companies offering customized products such as CustomInk, Spreadshirt, Threadless or Zazzle; and

 

 

online providers allowing users to customize goods in specific vertical markets, such as VistaPrint for small businesses and Shutterfly for photographic products.

We 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 begin selling customized products, we will face more direct and intense competition. Furthermore, to the extent that other companies are able to replicate our processes or that 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 may 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, and competitive pressures may harm our business, prospects, financial condition and results of operations.

We believe the principal competitive factors in our industry include:

 

 

favorable brand recognition and trust;

 

 

technological expertise;

 

 

quality, breadth and type of the products sold and services offered;

 

 

ability to source products efficiently and cost effectively;

 

 

ease of use and convenience;

 

 

ability to anticipate and quickly adapt to changing customer demands and customer service needs;

 

 

ability to recruit talent;

 

 

competitive pricing; and

 

 

effective marketing.

We believe that we compete favorably with respect to each of these factors.

 

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Government regulation

The legal environment of the Internet is evolving rapidly in the United States and elsewhere. The manner in which existing laws and regulations will be applied to the Internet in general, and how they will relate to our business in particular, are often unclear in many cases. For example, we often cannot be certain how existing laws will apply in the e-commerce and online context, including with respect to such topics as privacy, defamation, pricing, credit card fraud, advertising, taxation, sweepstakes, promotions, content regulation, quality of products and services and intellectual property ownership and infringement.

The nature of our user-generated content business model presents legal challenges to our business and operations. Our content usage policies and policies surrounding infringement of intellectual property rights or the rights of third parties, such as rights of privacy and publicity, play a key role in our business operations and the systems and practices that support them are particularly important to our business, operations and reputation. Both in the United States and internationally, we must monitor and comply with a host of legal concerns regarding the content-based nature of our business. As an e-commerce platform, the scope of liability for third-party content uploaded to our site for sale on printed products requires analysis of varying definitions of political speech, hate speech, defamation, pornography, profanity and obscenity, among other speech-related concerns. We likewise must monitor our e-commerce platform for potential and alleged intellectual property infringement and violation of rights of privacy and publicity that can vary widely between countries and regions, and, accordingly, we frequently must navigate the legal and regulatory schemes of numerous countries outside the United States. Our ability to employ processes to quickly remove infringing or offending content from our automated upload website is an important tool in protecting us from exposure for the potentially infringing activities of our users worldwide.

Numerous laws and regulatory schemes have been adopted at the national and state level in the United States, and in some cases internationally, have a direct impact on our business and operations. These laws include the following:

 

 

The Copyright Act of 1976 and all of the statutes and regulations associated with and enforced by the United States Patent and Trademark Office which protect the rights of third parties from infringement by users of our service. We maintain an automated service whereby users can upload any content they designate for use in creating customized products, but we likewise maintain content usage policies that prohibit intellectual property rights infringement or infringement of the rights of others, including rights of privacy and publicity. We maintain an active Intellectual Property Rights policy support operation which responds to take-down requests for third-party intellectual property that might appear on our sites despite policies forbidding the practice. As our business expands to other countries, we must respond to regional and country-specific intellectual property considerations, including take down and cease and desist notices in foreign languages and we must build infrastructure to support these processes.

 

 

The Digital Millennium Copyright Act, which provides relief for claims of circumvention of copyright protected technologies but includes a safe harbor intended to reduce the liability of online service providers for listing or linking to third-party websites that include materials that infringe copyrights or other rights of others.

 

 

The CAN-SPAM Act of 2003 and similar laws adopted by a number of states, which regulate unsolicited commercial e-mails, create criminal penalties for unmarked sexually-oriented material and e-mails containing fraudulent headers and control other abusive online marketing practices. Similarly, the guidelines of the Federal Trade Commission imposes responsibilities upon us for communications with respect to consumers and imposes fines and liability for failure to comply with rules with respective advertising or marketing practices they may deem misleading or deceptive. Similarly, the European Union, or the E.U., also maintains standards and regulations with respect to communications with consumers that we must comply with as we expand our marketing practices into those countries.

 

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Numerous product safety and environmental regulations that apply to the manufacture, sale and distribution of products and that apply to our products and services to varying degrees based on the individual types of products sold through our portfolio of e-commerce websites and the inks used in our decorating processes. These regulations include, without limitation, the Consumer Product Safety Act, The Fair Packaging and Labeling Act, the Federal Food, Drug and Cosmetic Act, California Proposition 65, the California Transparency in Supply Chains Act of 2010, as well as a number of other federal and state product safety and environmental regulatory schemes. Product safety regulations applicable to the E.U. in particular, where the majority of our international sales is currently shipped, are often more stringent than those in the United States and we therefore must evaluate and test applicable products to E.U. standards with respect to products intended for distribution in those markets.

 

 

The Credit Card Accountability Responsibility and Disclosure Act of 2009 (CARD Act) and other state laws and regulations that relate to credit card and gift certificate use fairness, including expiration dates and fees, as well as state laws surrounding escheat and abandonment of unclaimed property.

 

 

In the United States and internationally, we must evaluate tax liabilities from transactions on our portfolio of e-commerce websites and maintain finance infrastructure to support the collection and remittance of applicable sales taxes. In the United States, sales tax nexus issues with respect to Internet sales to consumers in states where we do not have a physical presence, which create potential nexus through affiliate program marketing activities and other nascent efforts to imply tax nexus on royalties payable on content licenses. This continues to be an area of great uncertainty and legal scrutiny both on a federal and state level, with over 27 states evaluating or imposing new legislation on various e-commerce activities or engaging in lawsuits with e-retailers. In Europe, we must comply with regulations with respect to customs, duties and V.A.T. as they apply to our business, sometimes on a country-by-country basis, which requires complex tracking and remittance processes.

 

 

The Communications Decency Act of 1996, which gives statutory protection to online service providers for claims against interactive computer services providers who distribute third-party content.

 

 

The Children’s Online Privacy Protection Act of 1998, which restricts the distribution of certain materials deemed harmful to children and imposes additional restrictions on the ability of online services to collect user information from minors. In addition, the Protection of Children From Sexual Predators Act of 1998 requires online service providers to report evidence of violations of federal child pornography laws under certain circumstances.

 

 

Data privacy and security with respect to the collection of personally identifiable consumer information continues to be a focus of worldwide legislation and compliance review. Examples include statutes adopted by the State of California that require online services to report certain breaches of the security of personal data, and to report to California customers when their personal data might be disclosed to direct marketers. In the E.U., where U.S. companies must meet certain privacy and security standards, the Data Protection Directive requires comprehensive information privacy and security protections for consumers with respect to certain information collected about them. Compliance levels include disclosures, consents, transfer restrictions, notice and access provisions for which we may in the future need to build further infrastructure to further support.

We expect and plan for new laws and regulations to be adopted over time that will be directly applicable to the Internet and to our activities. Any existing or new legislation applicable to our business could expose us to substantial liability, including significant expenses necessary to comply with such laws and regulations and potential penalties or fees for non-compliance, and could negatively impact the growth in the use of the Internet in general and our services in particular. We may also run the risk of retroactive application of new laws to our business practices that could result in liability or losses. As we continue to expand further into

 

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international territories, we expect the above-noted regulatory issues to also apply to such expansion as well as new issues to arise. Although we cannot presently anticipate all of the laws and regulations that might be applicable in new countries that we enter, we expect that legal issues applicable to our business in those countries will continue to arise as we assess and evaluate the scope of our operations in such countries.

We post on our website our privacy policies and practices concerning the use and disclosure of user data. Any failure by us to comply with our posted privacy policies, Federal Trade Commission requirements or other privacy-related laws and regulations could result in proceedings by governmental or regulatory bodies that could potentially harm our business, results of operations and financial condition. In this regard, there are a large number of legislative proposals before the United States Congress and various state legislative bodies regarding privacy issues related to our business. It is not possible to predict whether or when such legislation may be adopted, and certain proposals, if adopted, could harm our business through a decrease in user registrations and revenues. These decreases could be caused by, among other possible provisions, the required use of disclaimers or other requirements before users can utilize our services.

Due to the global nature of the Internet, it is possible that the governments of other states and foreign countries might attempt to change previous regulatory schemes or choose to regulate its transmissions or prosecute us for violations of their laws. We might unintentionally violate such laws, such laws may be modified and new laws may be enacted in the future. Any such developments could harm our business, operating results and financial condition. We may be subject to legal liability for our online services. The law relating to the

liability of providers of these online services for activities of their users is currently unsettled both within the

United States and abroad. Due to the unique nature of our content-rich automated upload service, claims are frequently alleged or asserted against us for trademark and copyright infringement and violation of rights of publicity to which we rapidly and expeditiously respond. We maintain content usage review systems that, through a combination of manual and automated blocks, monitor potentially infringing content of which we become aware. Nevertheless, claims may continue to be brought and threatened against us for negligence, copyright or trademark infringement, or other theories based on the nature and content of information, its origin and its distribution and there is no guarantee that we will be able to resolve any such claims quickly and without damage to us, our business model, our reputation or our operations.

Employees

As of December 31, 2011, we had 523 full-time employees, including 319 in production and operations, 69 in engineering, 97 in sales and marketing and 38 in general and administrative. None of our employees are represented by labor unions or covered by a collective bargaining agreement. We consider relations with our employees to be good and have never experienced a work stoppage.

 

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Facilities

As of December 31, 2011, our properties consist of the following locations:

 

Principal use    Location    Square footage      Lease expiration  

 

 
Corporate Headquarters    San Mateo, California      42,000         March 31, 2013   
Production Facilities    Louisville, Kentucky      146,000         July 31, 2017   
Production Facilities    Raleigh, North Carolina      55,000         December 31, 2015   
Production Facilities    Cary, North Carolina      6,292         April 30, 2012   
Production Facilities    Portland, Oregon      2,400         May 31, 2013   

 

 

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Production facilities in Louisville, Kentucky

We believe that current facilities are sufficient to meet our needs for the foreseeable future and should additional space be needed, such space can be leased on commercially reasonable terms to accommodate any future growth.

Legal proceedings

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. We are not currently a party to any legal proceedings outside the ordinary course of business. Nevertheless, litigation is inherently unpredictable. 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.

 

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Management

Executive officers and directors

The following table shows information about our executive officers and directors, and their ages as of December 31, 2011:

 

Name    Age      Position(s)

 

Bob Marino

     48       Chief Executive Officer and Director

Monica N. Johnson

     48       Chief Financial Officer

Tom Lotrecchiano

     51       Senior Vice President

Abdul Popal

     39       Senior Vice President of Business and Corporate Development

Joe Schmidt

     40       Senior Vice President

Fred E. Durham III

     40       Co-Founder, Strategic Research Director and Director

Brad W. Buss(1)(3)

     47       Director

Patrick J. Connolly(2)(3)

     65