ITEM 1. Business
Introduction
Geeknet, Inc. ("Geeknet") has two wholly-owned subsidiaries, ThinkGeek, Inc. (“ThinkGeek”) and ThinkGeek Solutions, Inc. ("ThinkGeek Solutions"). Geeknet, along with its subsidiaries, ("we" or the “Company”), operates a business aimed at the global geek community, which includes technology enthusiasts, pop-culture aficionados, and anyone who turns their interests into passions and feels a connection to other enthusiastic fans. Since 1999, ThinkGeek has become the place for innovative and imaginative products that appeal to the geek in everyone, which are provided through the ThinkGeek.com website (the "ThinkGeek website") and to the Company's wholesale channel customers. In August 2014, Geeknet, through its newly formed wholly-owned subsidiary, ThinkGeek Solutions, completed the acquisition of substantially all of the assets and certain liabilities of Treehouse Brand Stores, LLC ("Treehouse"). Since 2009, Treehouse has distributed video game-themed merchandise for the gaming community through its web-stores (the "ThinkGeek Solutions web-stores") and has engaged its fans with unique and exclusive products.
We are subject to the informational requirements of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Therefore, we file periodic reports, proxy statements and other information with the Securities and Exchange Commission (the “SEC”). Such reports, proxy statements and other information may be obtained by visiting the Public Reference Room of the SEC at 100 F Street, NE, Washington, DC 20549 or by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet site (http://sec.gov) that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC.
You can access other information at our Investor Relations website at investors.geek.net. The content of this website is not intended to be incorporated by reference into this report or any other report we file with the SEC. We make available, free of charge on our website, copies of our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to these reports as soon as reasonably practicable after filing such material electronically or otherwise furnishing it to the SEC.
Business Overview
Geeknet was incorporated in California in January 1995 and reincorporated in Delaware in December 1999. From the date of its incorporation through October 2001, the Company sold Linux-based hardware systems and services under the name VA Linux Systems, Inc. In December 2001, the Company changed its name to VA Software Corporation to reflect its decision to pursue media, e-commerce, software and online images businesses. In May 2007, the Company changed its name to SourceForge, Inc., and in November 2009, the Company changed its name to Geeknet to project a more accurate reflection of its business. On September 17, 2012, Geeknet sold its Media business to Dice Holdings, Inc. On August 1, 2014, Geeknet, through ThinkGeek Solutions, acquired substantially all of the assets and certain liabilities of Treehouse. The acquisition enabled Geeknet to establish official web-stores under exclusive licenses while expanding the Company's platform to increase its customer base.
Today, Geeknet sells collectibles, apparel, gadgets, electronics, toys and other retail products for technology enthusiasts and general consumers through the ThinkGeek website and certain exclusive products to the Company's wholesale channel customers. Some ThinkGeek products are custom made and developed by the Company's in-house product development team ("GeekLabs"). Revenue is generated by offering a broad range of unique products that are often not available in traditional brick-and-mortar stores and by introducing new products to the ThinkGeek
audience and fans on a regular basis. The Company has several wholesale arrangements with brick-and-mortar retailers located throughout the United States and internationally allowing the Company to reach a broader consumer audience and expand its brand awareness. Through ThinkGeek Solutions, the Company now distributes a wide variety of video game-themed merchandise through ThinkGeek Solutions web-stores built for the gaming community.
The Company has two reportable segments. The "Website" segment sells geek-themed retail products and video game-themed merchandise through the ThinkGeek website and through the ThinkGeek Solutions web-stores. The "Wholesale" segment sells primarily exclusive GeekLabs products to brick-and-mortar retailers. Prior to September 17, 2012, the Company had two reportable segments: e-Commerce and Media. The Media segment was discontinued in 2012 when it was sold to Dice Holdings, Inc.
Consumers can access information directly through our ThinkGeek website or contact our customer care representatives and experts by e-mail at orders@thinkgeek.com or by telephone at 1-888-GEEKSTUFF. The Company utilizes third-party fulfillment and warehouse providers to receive purchased inventory, fulfill customers’ orders, and process returns.
Sales and Marketing
Our marketing strategy is focused on acquiring new customers efficiently and building brand loyalty with existing customers to encourage repeat purchases. We market to prospective and current customers through all core online marketing channels: email, paid search, affiliate marketing, online display advertising, and social media. We also exhibit at relevant trade shows such as PAX (Penny Arcade Expo) East and PAX Prime, San Diego ComicCon, and Star Wars Celebration.
We design our marketing programs to tell stories about relevant products for different subsets of our audience. In addition, we employ a dynamic promotional strategy, testing a diverse range of special offers and sales designed to maximize profitable incremental sales using tried-and-true direct marketing techniques. These offers are programmed around specific themes, including product launches and holidays. In addition to promotions, we continue to offer our Geek Points loyalty program. Through this free program, customers earn 10 points for every dollar they spend on most purchases, which they can redeem for a selection of products.
Our authentic relationship with customers and fans enables us to foster thriving social media communities on Facebook, Twitter, Pinterest, Google+, YouTube, Instagram, Wanelo, and Vine. On our ThinkGeek website, we regularly perform testing of navigation, design, and promotional elements in order to improve the experience and increase conversion for desktop, tablet, and mobile customers. We use analytics and market research to understand customer behavior and identify opportunities to expand our audience.
In addition to our core business of selling products through our ThinkGeek website, we also sell products through our wholesale channel. During 2014, our wholesale channel continued to deliver substantial growth. Our wholesale clients buy our exclusive products to sell in their brick-and-mortar stores across the United States and internationally. Our clients are well-known reputable retailers that have a strong presence in malls and in stand-alone stores. Our notable clients include Barnes and Noble, f.y.e., GameStop, Hot Topic, Kohl's, Kroger, Meijer, Target, Toys "R" Us, and Walmart.
Our international wholesale channel grew significantly in 2014. We have partnered with distributors in Australia, the Netherlands, Germany, and the United Kingdom, and we believe selling to widely known popular retailers is an opportunity to expand our brand recognition and grow our wholesale business.
Technology and Design
GeekLabs
ThinkGeek continues to expand its exclusive product offerings with new items created and developed internally by our GeekLabs team. With hundreds of products across dozens of different product categories, GeekLabs continues to expand the ThinkGeek product offerings with unique high-margin items.
Some of the new best sellers this season included our Star Wars R2-D2 measuring cups and Back to the Future Flux Capacitor USB car charger. Another popular item was the Supernova Light Cube LED Bluetooth Speaker,
which offers ultra-bright unique lighting effects and hi-fi sounds wrapped up in a crystal cube, and our Mega Man buster gun replica resonated well with fans of the retro 8-bit Mega Man video game.
Star Wars continued to be a top first-party license for GeekLabs products. Because of this success, we signed a new expanded Star Wars license with over 50 different product categories covering both classic Star Wars and the new Star Wars: The Force Awakens movie scheduled for release in December 2015.
ThinkGeek continues to expand its investment in GeekLabs. This includes hiring specialists for our GeekLabs group, expanding our partnerships with Asian-based factories and increasing our compliance and safety testing team.
Website Engineering and Technology
We have implemented a broad array of services and systems for customer service, product searching, customer communication, order processing and order fulfillment. These services and systems use a combination of our own proprietary technologies and commercially available, licensed technologies. We focus our internal development efforts on creating and enhancing the specialized, proprietary software to improve our customer experience and ease of use and to increase the functionality of our ThinkGeek website. We also invest in cyber security to protect our customers, maintain secure transactions, and minimize business interruptions.
Our core online merchandise catalog, customer interaction, order processing, and back-end systems are a combination of proprietary ThinkGeek software and the enterprise resource planning (ERP) system. The systems are designed to provide connectivity to our distribution center, and include an inventory tracking system, a real-time order tracking system, an executive information system and an inventory replenishment system. Our Internet servers use secure sockets layer (SSL) technology to help conduct secure communications and transactions.
During the past year, we have improved the browsing functionality of our ThinkGeek website by performing a complete redesign of the site, creating a cleaner page structure. We have functionality that identifies products that may interest customers based on the history of products visited, purchased or added to a wish list. We utilize targeted customer emails that notify customers if a product is in stock, if a new product is available for sale, or to remind customers of a product they recently viewed at times with a special promotion or offer. This encourages our customers to revisit the ThinkGeek website and potentially purchase that product. We continue to streamline our online shopping cart making it easier to use and consistent with industry practices. In 2014, we expanded our mobile commerce feature set, enhancing the layout and account features available on our smartphone optimized site. We continuously test website layout and functionality changes to ensure optimal page configurations.
Product Safety
Since 2012, we have operated part of our product safety and quality assurance function internally. We have certified personnel, who are highly qualified in conducting safety and quality assurance testing. We believe this dedicated in-house function enables us to improve the quality of our products, minimize defective products, react in a timely manner and continue to exceed industry standards.
Competition
The market for retail products similar to those offered by ThinkGeek is highly competitive, and we compete in different consumer verticals. Our competition includes apparel companies such as Threadless and Zazzle, gadget providers such as Brookstone, and sources for unusual gifts such as Etsy, Fab, Jinx, UncommonGoods, and Vat19. Large online marketplaces such as Amazon.com and eBay also provide competitive pressure by selling many of the products that are not manufactured exclusively for ThinkGeek.
More recently, some online retailers have developed sites targeted to the computer enthusiast and video gaming markets. We believe that there are a number of competitive factors in our market, including company credibility, product selection and availability, price, website features, functionality and performance, ease of purchasing, customer service and reliability and speed of order shipment. ThinkGeek Solutions has allowed us to expand our video game merchandise offerings and increase our competitive advantage in the vertical.
Many of our competitors in the e-commerce industry have substantial competitive advantages, including greater resources that can be devoted to the development, promotion and sale of their online products, more established sales channels, enhanced software and website development experience, and broader name recognition. To be competitive,
we must respond promptly and effectively to changes in consumer preferences, technological change, evolving standards and our competitors’ innovations by continuing to enhance our services and products. Any pricing pressures or loss of customers resulting from our failure to compete effectively would reduce our revenue and margin.
Intellectual Property Rights
We protect our intellectual property through a combination of copyright, trademark, patent and trade secret laws, employee and third-party nondisclosure agreements, and other methods of protection. Geeknet, ThinkGeek and their associated logos are some of our trademarks that we use in the United States and in other countries. We have 4 U.S. patents and 15 registered trademarks.
Seasonality
Our business is highly seasonal, reflecting the general pattern associated with the retail industry of peak sales and earnings during the holiday shopping season. As a result, we generated a substantial portion of our revenue in the fourth quarter, which began on October 1, and ended on December 31. As is typical in the retail industry, we generally experience lower revenue during the other quarters. Therefore, our revenue in a particular quarter is not necessarily indicative of future revenue for a subsequent quarter or the full year.
Employees
Our employees are not represented by any collective bargaining organization. We have never experienced a work stoppage, and we believe that our relations with our employees are good. As of December 31, 2014, our employee base totaled 120, including 28 in operations, 27 in sales and marketing, 42 in technology and design and 23 in finance and administration.
Item 1A.
Item 1A. Risk Factors
CURRENT AND PROSPECTIVE INVESTORS IN GEEKNET SECURITIES SHOULD CAREFULLY CONSIDER THE RISKS DESCRIBED BELOW BEFORE MAKING AN INVESTMENT DECISION. THESE RISKS HIGHLIGHT POTENTIAL EVENTS, TRENDS, OR OTHER CIRCUMSTANCES THAT COULD ADVERSELY AFFECT OUR BUSINESS, FINANCIAL CONDITION, RESULTS OF OPERATIONS, AND CONSEQUENTLY THE MARKET VALUE OF OUR COMMON STOCK. THE RISKS DESCRIBED BELOW ARE NOT AN EXHAUSTIVE LIST OF ALL OF THE RISKS WE FACE. ADDITIONAL RISKS OF WHICH WE ARE NOT PRESENTLY AWARE OR THAT WE CURRENTLY BELIEVE ARE IMMATERIAL MAY ALSO IMPAIR OUR BUSINESS OPERATIONS. OUR BUSINESS COULD BE HARMED BY ANY OF THESE RISKS. ALL FORWARD-LOOKING STATEMENTS MADE BY US ARE QUALIFIED BY THE RISKS DESCRIBED BELOW.
Risks Related To Our Business
If the Company fails to launch new and innovative products, the demand for our products may be limited and our revenue will be adversely affected.
In order to attract customers, we must continually release new and innovative products, including signature products internally developed by GeekLabs. In addition to the direct revenue we derive from product sales, the release of new and innovative products attracts media coverage and drives customers to our business. The successful development, sourcing, manufacturing and merchandising of products is subject to numerous risks and uncertainties, including certain factors specific to our business over which we have limited or no control.
There can be no assurance that our new products will appeal to customers or that demand for these products will be sufficient to generate revenue consistent with our estimates. In addition, there can be no assurance that new products will be developed in a timely or cost-effective manner, or that we will be able to procure appropriate quantities of such products. Furthermore, if we are unable to deliver new and innovative products that allow us to increase demand, we may not be able to generate sufficient revenue to grow our business. See also additional risks related to competition set forth elsewhere in these Risk Factors.
Our business is highly seasonal. In addition, we are exposed to significant inventory risks as a result of seasonality, new product launches, rapid changes in product cycles and changes in consumer tastes.
Our business is highly seasonal, with a disproportionate amount of our sales occurring in the fourth quarter which begins on October 1 and ends on December 31. To be successful, we must accurately predict our customers' tastes and demands to avoid purchasing too much or not enough inventory. If we purchase too much inventory, we may be required to discount those products or write-off products we are unable to sell, reducing our gross margins. If we do not purchase enough inventory, we may fail to meet customer demand and lose potential orders, which could adversely affect our financial results.
In addition, when we launch a new product, it is difficult to accurately forecast customer demand. Certain products, especially custom-manufactured products or products purchased from outside the United States may require significant lead-time, payment or partial payment prior to shipment, and are often not returnable. We carry a broad selection of products and significant inventory levels of certain products and we may be unable to sell products in sufficient quantities or during the relevant selling seasons. Failure to properly assess our inventory needs could adversely affect our financial results.
We are highly dependent upon a single third-party fulfillment and warehouse provider and its systems. Any decrease in the quality of service offered by our fulfillment and warehouse provider will adversely affect our reputation and the growth of our business. If we fail to realize anticipated operating efficiencies at our third-party fulfillment and warehouse provider, our operating results will be adversely affected.
Our ability to receive inbound inventory and ship completed orders efficiently and in a timely manner to our customers is substantially dependent on not only a single third-party fulfillment and warehouse provider ("3PL") but also the 3PL's systems. We ship products to customers worldwide predominantly using the services of our 3PL.
If our 3PL fails to meet our distribution and fulfillment needs, our relationship with and reputation among our customers will suffer and this will adversely affect our revenue. Additionally, if our 3PL is unable to meet our distribution and fulfillment needs, particularly during the holiday season, or our contract with our 3PL is terminated, we may be required to secure a second-source or replacement fulfillment and warehouse provider. If we fail to secure, or are unable to secure, a fulfillment and warehouse provider on comparable terms, our reputation and our financial results could be adversely affected.
If we do not continually enhance our website and mobile platform and order processing systems or respond to rapid technological changes, we could lose customers and our net revenues could decline.
If we are unable to continually upgrade our website and our mobile platform in a timely manner to accommodate higher volumes of traffic, our website performance could suffer and we may lose customers. In addition, if we are unable to expand the computer systems that we use to process and ship customer orders and process customer payments, we may not be able to fulfill any potential growth in customer orders from the website successfully. As a result, we could lose customers and our net revenues could decline. Further, to remain competitive, we must continue to enhance and improve the functionality and features of our website. The Internet and the online commerce industry are subject to rapid technological change. If competitors introduce new features and website enhancements, or if new industry standards and practices emerge, our existing website and systems may become obsolete or unattractive. Developing and enhancing our website and other systems entails significant technical and business risks. We may use new technologies ineffectively or we may fail to adapt our website, our transaction processing systems and our computer network to meet customer requirements or emerging industry standards. If we are unsuccessful in upgrading our systems to accommodate higher traffic or developing or implementing new technologies that enable us to meet evolving industry standards and remain competitive, our operating results could be adversely affected.
If we do not successfully and cost-effectively implement one or more of these intended upgrades or modified processes or if we do not achieve desired efficiencies or cost savings as a result of these changes or if attempts to enhance our website are unsuccessful or are not appealing to our customers, our business and operating results could be adversely affected.
Unplanned system interruptions and capacity constraints could harm our revenue and reputation.
Our business is dependent on the uninterrupted and highly-available operation of our website. We experience periodic service interruptions with our website. Service interruptions may be caused by a variety of factors, including
capacity constraints, software design flaws and bugs, and third party denial of service attacks. If we fail to provide customers with such access to our website at the speed and performance at which they require even during the high traffic peak seasons, our sales and business reputation could be adversely affected.
Our systems and operations remain vulnerable to damage or interruption from fire, power loss, telecommunications failure and similar events. If we do not invest further in our infrastructure or if our website experiences frequent or lengthy service interruptions, our business and reputation could be adversely affected.
Our business could be adversely affected by data loss or other security breaches.
The nature of our business involves the use of our proprietary information as well as the storage and transmission of customers' personally identifiable and proprietary information, and security breaches could expose us to a risk of loss of this information, litigation, enforcement actions and damage of our reputation. While we take measures to protect personally identifiable information from unauthorized access or disclosure, it is possible that our security controls over personally identifiable information may not prevent improper access or disclosure. Our security measures may be breached due to the actions of outside parties, employee error, malfeasance, or otherwise. Because the techniques used to obtain unauthorized access, disable or degrade service, or sabotage systems change frequently and often are not recognized until launched against a target, we may be unable to anticipate these techniques or to implement adequate preventative measures. As a result, an unauthorized party may be able to disrupt our operations or obtain access to our data or our customers' personally identifiable information or proprietary data. Due to the nature of sophisticated cyber-attacks, there is a risk that such attack may remain undetected for a period of time.
A cyber-attack, such as a denial of service attack, that renders our site inoperable could result in adverse consequences, including significant loss of revenues. Any security breach may also cause us to expend significant resources to restore system functionality and incur costs to deploy additional personnel, protection technologies and third party consultants to defend against a future security breach. We outsource the operation of our network connectivity and work actively to maintain up-to-date security and defense measures. If any of our outsourcing providers does not perform adequately, we may be exposed to greater risk of a cyber-attack.
Furthermore, concerns about our practices with regard to the collection, use, disclosure, or security of personal information, or other privacy related matters, even if unfounded, could damage our reputation and operating results. While we strive to comply with all applicable data protection laws and regulations, as well as our own posted privacy policies, any failure or perceived failure to comply may result in proceedings or actions against us by government entities or others, or could cause us to lose customers, which could potentially have an adverse effect on our business. We periodically review our security and privacy practices and we are continuing to implement and update policies and practices as a result of these reviews. We may not adequately identify risks and the policies and practices we implement may not be effective.
We are reliant on foreign sources of production for certain products.
In order to offer cost-effective and innovative products, we rely on manufacturers located outside of the United States, most of which are located in China, to supply us with sufficient quantities of these products based on our forecasts and to deliver these products in a timely manner.
Our arrangements with these manufacturers are generally limited to purchase orders tied to specific lots of goods. We are subject to the risks of relying on products manufactured outside of the United States, including political unrest, trade restrictions, customs and import/export regulations, local business practice and geo-political issues, such as political and social unrest and economic instability. Additionally, significant reliance on foreign sources of production increases the risks relating to compliance with domestic or international labor standards, customs and import/export laws and regulations, compliance with domestic or international manufacturing and product safety standards, currency fluctuations, restrictions on the transfer of funds, work stoppages or slowdowns and other labor issues, economic uncertainties including inflation and government regulations, availability and costs of raw materials, potentially adverse tax consequences and other uncertainties.
China has experienced rapid social, political and economic changes and further changes may adversely affect our ability to procure our products from Chinese suppliers. Our ability to obtain goods on a cost effective basis is also subject to our ability to maintain relationships with our suppliers and our ability to negotiate and maintain supply arrangements on favorable terms. The Chinese Yuan (“CNY”) exchange rate to the U.S. Dollar (“USD”) has not historically been volatile. In the event that the CNY/USD exchange rate changes substantially, our suppliers could
attempt to renegotiate our purchase orders with them, which could increase our costs. In addition, because our purchases are usually on a case by case basis, we are subject to the risk of unexpected changes in pricing or supply from these suppliers. We may also be unable to develop beneficial relationships with new vendors in the future.
We may be subject to product liability claims if people or property is harmed by the products we sell, which could be costly to defend and subject us to significant damage claims.
Some of the products we offer for sale may expose us to product liability or product safety claims relating to personal injury, death or property damage caused by such products and may require us to take actions such as product recalls, which could involve significant expense incurred by the Company. Although we maintain liability insurance, we cannot be certain that our coverage will be adequate for liabilities actually incurred or that insurance will continue to be available to us on economically reasonable terms, or at all. The successful assertion of an uninsured product liability or other claim against us could cause us to incur significant expenses to pay such a claim and could adversely affect our financial results. Even a successfully defended product liability claim could cause us to incur significant expenses to defend and could adversely affect our financial results. In addition, some of our vendor agreements with our suppliers do not indemnify us from product liability and even if some agreements provide for indemnification, it may not be possible or practical to avail ourselves of the benefits of the protection.
We may also be subject to involuntary product recalls or may voluntarily conduct a product recall. While costs associated with product recalls have generally not been material to our business, the costs associated with future product recalls individually or in the aggregate in any given fiscal year, could be significant. In addition, any product recall, regardless of direct costs of the recall, may harm consumer perceptions of our products and have a negative impact on our future revenues and results of operations.
As a seller of consumer products, we are subject to various statutory, regulatory, and legal developments that may have a material adverse impact on our business.
As an Internet retailer of consumer products, we are subject to significant federal, state, and local laws of the United States, as well as of the European Union and other international markets. We are taking steps we believe are necessary to comply with these laws and regulations, but there can be no assurance that we will be in compliance.
The impact of complying with new or changing statutes and regulations could impose increased costs on our business and affect how we operate or execute our strategies. Similarly, increased penalties for non-compliance could subject us to greater expense in the event any of our products were found to not comply with such regulations, and could have a negative impact on our future results of operations.
Increased focus on sales and use tax could subject us to liability for past sales and cause our future sales to decrease.
We currently collect sales taxes for merchandise shipped to Colorado, Ohio, Virginia, and Washington, but we do not collect sales or other taxes on shipments of our goods into the remaining states in the United States or internationally. The relocation of our fulfillment center or customer service centers or any future expansion of them, along with other aspects of our business, may result in additional sales and other tax obligations. We do not collect consumption tax (including value added tax, goods and services tax, and provincial sales tax) as applicable on goods and services sold that are delivered outside of the United States as our terms of sale provide that the customer is responsible for such expenses. One or more states or foreign countries may seek to impose sales or other tax collection obligations on out-of-jurisdiction e-commerce companies. A successful assertion by one or more states or foreign countries that we should collect sales or other taxes on the sale of merchandise or services could result in substantial tax liabilities for past sales, decrease our ability to compete with traditional retailers, and otherwise harm our business.
Currently, U.S. Supreme Court decisions restrict the imposition of obligations to collect state and local sales and use taxes with respect to sales made over the Internet. However, a number of states and the U.S. Congress continue to consider initiatives that could limit or supersede the Supreme Court's position regarding sales and use taxes on Internet sales, and some states have adopted laws that attempt to impose obligations on out-of-state retailers to collect taxes on their behalf. If any of these initiatives are successful, we could be required to collect sales and use taxes in additional states. The imposition by state and local governments of various taxes upon Internet commerce could create administrative burdens for us, put us at a competitive disadvantage if they do not impose similar obligations on all of our online competitors, and could result in a decrease of our future sales.
Failure to effectively manage and integrate acquisitions could have a negative impact on our business.
Part of our growth strategy is to evaluate and pursue selected acquisition and expansion opportunities. The Company completed an acquisition this year, and may look to acquire additional companies in the future. This acquisition and any future acquisitions and the successful integration of assets and businesses into our own as well as the retention of personnel require significant attention from our management and could result in a diversion of resources from our existing business, which in turn could negatively impact our business operations. We may encounter challenges in achieving appropriate internal control over financial reporting and challenges of transitioning legacy information technology systems in connection with the integration of an acquired company. We may be unable to successfully integrate the business we acquire, including their personnel, financial systems, distribution, operations and general operating procedures and therefore may not be able to realize the anticipated return on invested capital. If we fail to integrate acquired companies successfully, our business, reputation and operating results could suffer materially. Likewise, our failure to integrate and manage acquired companies successfully may lead to impairment of the associated goodwill and intangible asset balances.
Competition in the e-commerce retail industry is intense. Our failure to compete successfully could adversely affect our revenue and financial results.
Our business is rapidly evolving and operates in an intensely competitive industry. We have many competitors, including other e-commerce businesses as well as traditional brick-and-mortar retailers. Increases in shipping costs or the taxation of Internet commerce may make our products less competitive when compared with traditional brick- and-mortar retailers. Additionally, our current and future competitors may have greater resources, more customers and greater brand recognition than we do. These competitors may secure better terms from vendors and adopt more competitive pricing for their products. They may also devote more resources to their technology infrastructure, product development, order fulfillment, distribution facilities and marketing and advertising campaigns. In addition, as we expand into new markets and broaden our product offering, our competition may intensify as our current and future competitors enter into similar markets and offer similar products. Local competitors in these new markets may have substantial competitive advantages because of greater focus on and knowledge of local customers and their preferences and greater brand recognition. Further, if we fail to maintain a customer loyalty program that is competitive in our industry, we may not attract or retain customers, and our sales may suffer.
Increased competition is likely to result in price reductions, reduced gross margins and loss of market share, any of which could adversely affect our net revenues and results of operations. We expect competition to intensify in the future because current and new competitors can enter our market with little difficulty and can launch new websites at a relatively low cost.
We are vulnerable to claims that our website and software infringe third-party intellectual property rights. Any resulting claims against us could be costly to defend or subject us to significant damages.
We expect that our website will increasingly be subject to infringement claims as the number of competitors in our industry segment grows and the functionality of web properties in different Internet industry segments overlap. The scope of United States patent protection for software is not well-defined and will evolve as the United States Patent and Trademark Office grants additional patents. Because patent applications in the United States are not publicly disclosed until the patent is issued, applications may have been filed that would relate to our products. We may also receive patent infringement claims as companies increasingly seek to patent their software. Our developers may unknowingly infringe on third-party patent rights. We cannot prevent current or future patent holders or other owners of intellectual property from suing us and others seeking monetary damages or an injunction against our web offerings. We may seek licenses from such parties, but they could refuse to grant us a license or demand commercially unreasonable terms. We might not have sufficient resources to pay for the licenses. Such infringement claims could also cause us to incur substantial liabilities and to suspend or permanently cease the use of critical technologies or processes or the production or sale of major products. In either event, our operating results could be adversely affected. In recent years, companies have also been subject to patent infringement claims from non-practicing entities, or "patent trolls." In addition, employees hired from competitors might utilize proprietary and trade secret information from their former employers without our knowledge, even though our employment agreements and policies clearly prohibit such practices.
Any litigation regarding our intellectual property, with or without merit, could be costly and time consuming to defend, divert the attention of our management and key personnel from our business operations and cause interruption to our website. Claims of intellectual property infringement may require us to enter into royalty and licensing agreements
that may not be available on acceptable terms. In addition, parties making claims against us may be able to obtain injunctive or other equitable relief that could effectively block our ability to offer our products in the United States and abroad and could result in an award of substantial damages against us. Defense of any lawsuit or failure to obtain any required license could delay release of our products and increase our costs. If a successful claim is made against us and we fail to develop or license a substitute technology, our business, results of operations, financial condition or cash flows could be immediately and materially adversely affected.
Our Company’s success is dependent on the design and execution of appropriate business strategies.
Our Company’s success is dependent on our ability to identify, develop and execute appropriate corporate strategies. Our current strategy includes transformational change to many areas of our business, including expanding product development, improving customer website experience and customer service, re-targeting our marketing, controlling costs and improving gross margin. Achieving the goals we have set in a timely manner will be challenging, and it is possible that our strategies may prove to be ineffective and that we may need to make substantial changes to them in future periods. It is also possible that we will be unsuccessful in executing our strategies, that the strategies we will implement expose us to additional risks or that strategies that have been successful in the past will fail to produce the desired results. Our results could be materially adversely affected if we fail to design and execute appropriate strategies. The market value of our common stock could be materially adversely affected if investors are uncertain about the appropriateness of our strategies or our ability to execute them.
Risks Related To Our Financial Results
We have a history of losses and may incur net losses in the foreseeable future. If we are unable to attain consistent profitability, the market price of our common stock and our ability to raise capital and continue operations may be materially and adversely affected.
We have an accumulated deficit of $751.7 million as of December 31, 2014. We may continue to incur net losses in the future. If we are unable to attain profitability on a sustained basis, the market price of our common stock and our ability to raise capital and continue operations may be materially and adversely affected.
Our ability to use net operating loss carryforwards to offset future taxable income for U.S. federal income tax purposes is subject to limitation and may be limited further.
In general, under Section 382 of the Internal Revenue Code of 1986, as amended (the “Code”), a corporation that undergoes an “ownership change” is subject to limitations on its ability to utilize its net operating losses (“NOLs”), to offset future taxable income. In general, an ownership change occurs if the aggregate stock ownership of certain stockholders increases by more than 50 percentage points over such stockholders' lowest percentage ownership during the testing period (generally three years). We determined that such an ownership change occurred as of November 2008. This ownership change resulted in limitations on the utilization of tax attributes, including net operating loss carryforwards and tax credits.
The occurrence of an additional ownership change could limit the ability to utilize NOLs that are not currently subject to limitation, and could further limit the ability to utilize NOLs that are currently subject to limitation. The amount of the annual limitation generally is equal to the value of the stock of the corporation immediately prior to the ownership change multiplied by the adjusted federal tax-exempt rate, set by the Internal Revenue Service. Limitations imposed on the ability to use NOLs to offset future taxable income could cause U.S. federal income taxes to be paid earlier than otherwise would be paid if such limitations were not in effect and could cause such NOLs to expire unused, in each case reducing or eliminating the benefit of such NOLs. Similar rules and limitations may apply for state income tax purposes.
Certain factors specific to our business over which we have limited or no control may nonetheless adversely impact our total revenue and financial results.
The primary factors over which we have limited or no control that may adversely impact our total revenue and financial results include the following:
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specific economic conditions relating to our business
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adoption of new government laws and regulations
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the spending habits of our customers
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the performance of our suppliers
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execution by our third party fulfillment centers
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our ability to retain key personnel.
If our revenue and operating results fall below our expectations, the expectations of securities analysts or the expectations of investors, the trading price of our common stock will likely be materially and adversely affected. You should not rely on the results of our business in any past periods as an indication of our future financial performance.
If we are unable to maintain or acquire licenses to include intellectual property owned by others in our products, revenues and operating results could suffer.
A material portion of our revenue is derived from sales of products related to popular online or video games, films and television shows. We rely on our ability to acquire rights related to popular online or video games, films and television shows and pay royalties to branded content owners for the use of their content on these products. Competition for these licenses can be intense, and we may not be able to acquire or renew desirable licenses at reasonable rates or at all. In addition, while part of our business strategy involves predicting future trends, we may be unsuccessful in predicting which video games, films, television shows or other pop culture phenomena will be popular in the future and target our license-acquisition activities accordingly. Our failure to maintain our existing licenses or acquire successful new licenses at reasonable rates could significantly impact our content sales or interrupt our supply chain and require use to modify our products or business plans and could adversely impact our results of operations.
Our wholesale business is heavily dependent on sales to several large retailers.
Our wholesale business continued to grow during 2014, primarily as a result of sales to several large retailers. These large retailers could reduce their purchasing levels or cease buying products from us at any time for any reason. They could also bring to market products that compete with our successful products. In addition, our wholesale customers have a variety of suppliers to choose from and therefore can make substantial demands on us, including demands on product pricing and returns. We have not experienced a material level of product returns to date, but the risk exists. If we lose a significant wholesale customer or if sales of our products to a significant wholesale customer materially decrease, it could have an adverse effect on our business and financial results.
Increased shipping costs and labor stoppages may adversely affect sales of our products.
Many of our products are imported from overseas and delivered to customers from our fulfillment center located in Ohio. We have established relationships with reputable common carriers for the inbound and outbound delivery of these products. If these carriers were to increase the prices they charge to ship our goods, and we pass these increases on to our customers, our customers might choose to buy comparable products locally to avoid shipping charges. In addition, these carriers may experience labor stoppages or other issues such as those being experienced in the West Coast ports, which could impact our ability to deliver products on a timely basis to our customers and adversely affect customer relationships.
Changes to financial accounting standards may affect our results of operations.
We prepare our financial statements to conform to accounting principles generally accepted in the United States of America. These accounting principles are subject to interpretation by the Financial Accounting Standards Board, the Securities and Exchange Commission, and various bodies formed to interpret and create appropriate accounting standards. A change in an accounting policy can have a significant effect on our reported results and may even affect our reporting of transactions completed before a change is announced. Changes to those rules or the questioning of current practices may adversely affect our reported financial results.
Other Risks Related To Our Overall Business
We are exposed to risks associated with worldwide economic slowdowns and related uncertainties.
We are subject to macroeconomic fluctuations in the U.S. economy and elsewhere. Concerns about consumer and investor confidence, volatile corporate profits and reduced capital spending, international conflicts, terrorist and military activity, civil unrest and/or pandemic illness could cause a slowdown in sales revenue in the United States and abroad. Purchases of our products are discretionary. If the economic climate deteriorates, customers or potential customers could delay, reduce or suspend their purchases of our products. There could be a number of follow-on effects from the recent financial crisis on our business, including insolvency of key suppliers resulting in product delays; customer insolvencies; counterparty failures; and increased expense or inability to obtain future financing. If weak macroeconomic conditions persist or worsen, our results of operations could be adversely affected.
We depend on third parties to provide a number of products and services, subjecting us to significant operational risks.
We currently depend on a number of third-party providers, and this reliance subjects us to significant operational risks, any of which could impair our ability to deliver products to our customers should they occur. These risks include:
•
reduced management and control of our data, including the risk of unauthorized disclosure of customer and/or other protected information
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reduced control over delivery schedule and quality assurance
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misappropriation of our intellectual property
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failures by the third parties on whom we rely to comply with all domestic and foreign laws relating to our business
We may encounter difficulties in the implementation or operation of our new enterprise resource planning system.
We implemented a new enterprise resource planning (ERP) system for our Company. We expect that the ERP system will enable us to improve our productivity, stream line processes, make our operations more cost efficient and obtain website, inventory and other financial data timely and accurately. The implementation of the new ERP system has required, and will continue to require, the involvement of significant financial and human resources. The effective and efficient operation of our business is dependent on our ERP system as we rely heavily on this system to manage all aspects of our business, including forecasting, purchasing, supply chain management, financial management and safeguarding critical and sensitive information. Any disruptions, delays or deficiencies in the design and implementation of the new ERP system or its inability to meet the continuously evolving needs of our business could disrupt our business and adversely affect the Company's business and our financial results.
If we lose key personnel or fail to integrate replacement personnel successfully, our ability to manage our business could be impaired.
Our future success depends, in part, on our ability to attract and retain certain key personnel, including management, technical, sales, and other critical personnel. The competition for attracting and retaining key employees is intense. In the Internet and high technology industries, qualified candidates often consider equity awards in compensation arrangements and fluctuations in our stock price may make it difficult to recruit, retain, and motivate employees. The loss of any key employee could result in significant disruptions to our operations, including adversely affecting the timeliness of product releases, the successful implementation and completion of company initiatives, and the results of our operations. In addition, the integration of replacement personnel could be time consuming, may cause additional disruptions to our operations, and may be unsuccessful.
Our stock price has been volatile historically and may continue to be volatile.
The trading price of our common stock has been and may continue to be subject to wide fluctuations. During the year ended December 31, 2014, the closing sale prices of our common stock on the NASDAQ Global Market ranged from $7.71 to $19.18 per share and the closing sale price on December 31, 2014, the last trading day of the
year, was $8.28 per share. Our stock price may fluctuate in response to a number of events and factors, such as quarterly variations in operating results, announcements of technological innovations or new products by us or our competitors, changes in financial estimates and recommendations by securities analysts, the operating and stock price performance of other companies that investors may deem comparable to us, and news reports relating to trends in our markets or general economic conditions.
In addition, the stock market in general and the market prices for Internet-related companies in particular have experienced volatility that often has been unrelated to the operating performance of such companies. These broad market and industry fluctuations may adversely affect the price of our stock, regardless of our operating performance. Additionally, volatility or a lack of positive performance in our stock price may adversely affect our ability to retain key employees, all of whom have been granted stock options.
Sales of our common stock by a significant stockholder may cause the price of our common stock to decrease.
Several of our stockholders own significant portions of our common stock. If these stockholders were to sell substantial amounts of their holdings of our common stock, then the market price of our common stock could be negatively impacted. The effect of such sales, or of significant portions of our stock being offered or made available for sale, could result in strong downward pressure on our stock price. Investors should be aware that they could experience significant short-term volatility in our stock if such stockholders decide to sell a substantial amount of their holdings of our common stock at once or within a short period of time.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
Our principal locations are as follows:
We believe that our existing properties are in good condition and are adequate and suitable for the conduct of our business.
Item 3.
Item 3. Legal Proceedings
In the normal course of business, we experience routine claims and legal proceedings. The disclosure under the caption “Legal Proceedings” in Part II Item 8. Note 5. Commitments and Contingencies is incorporated by reference into this Item 3.
Item 4.
Item 4. Mine Safety Disclosure
Not applicable.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock is traded on the NASDAQ Global Market under the symbol GKNT. As of February 13, 2015, there were 280 holders of record of our common stock. We have not declared any cash dividends since our inception and do not expect to pay any dividends in the foreseeable future. The high and low closing sales prices, as reported by NASDAQ, of our common stock are as follows:
The foregoing reflects interdealer prices without retail markup, markdown, or commissions and may not necessarily reflect actual transactions.
Issuer Purchases of Equity Securities
The following table sets forth information regarding the Company's purchases of its common stock during the three months ended December 31, 2014.
(1) All shares were repurchased to satisfy minimum tax withholding obligations from vestings of restricted stock units.
Stock Performance Graph
Set forth below is a line graph comparing the percentage change in the cumulative return to the stockholders of our common stock with the cumulative return of the NASDAQ Stock Market (U.S.) Index, the S&P 600 SmallCap Internet Retail Index and the RDG Internet Composite (“RDG”) Index for the period commencing December 31, 2009 and ending on December 31, 2014. Returns for the indices are weighted based on market capitalization at the beginning of each measurement point.
Item 6.
Item 6. Selected Financial Data
You should read the selected consolidated financial data set forth below in conjunction with Part II Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with “Selected Consolidated Financial Data” and our consolidated financial statements and the related notes included elsewhere in this Form 10-K. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in the forward-looking statements as a result of certain factors including the risks discussed in “Item 1A. Risk Factors” and elsewhere in this Form 10-K. See “Caution Concerning Forward-Looking Statements.”
Overview
We sell collectibles, apparel, gadgets, electronics, toys and other retail products for technology enthusiasts and general consumers through our ThinkGeek website and certain exclusive products to our wholesale customers. Since 1999, ThinkGeek has been creating a world where everyone can embrace their inner geek, express their passions and connect with one another. In August 2014, Geeknet, through its newly formed wholly-owned subsidiary, ThinkGeek Solutions, completed the acquisition of substantially all of the assets and certain liabilities of Treehouse. Since 2009, Treehouse has distributed video game-themed merchandise for the gaming community and has engaged their fans with unique and exclusive products. We offer a broad range of unique products through our ThinkGeek website that are typically not available in traditional brick-and-mortar stores. We introduce a range of new products to our audience on a regular basis. Some ThinkGeek products are custom made and developed by GeekLabs, our in-house product development team. We have several wholesale arrangements with brick-and-mortar retailers located throughout the U.S. and internationally, allowing us to reach a broader consumer audience and expand our brand awareness. Through ThinkGeek Solutions, we now distribute a wide variety of video game-themed merchandise through the ThinkGeek Solutions web-stores built for the gaming community.
Our business is highly seasonal, reflecting the general pattern associated with the retail industry of peak sales and earnings during the calendar year-end holiday shopping season. In the past several years, a substantial portion of our revenue has occurred in the fourth quarter, which begins on October 1 and ends on December 31. As is typical in the retail industry, we generally experience lower monthly revenue during the first nine months of the year.
Our business strategy is to increase revenue by expanding the range of new and innovative products we sell, including our exclusive GeekLabs products, to manage gross margin dollars at the product level, to increase traffic to our ThinkGeek website and customer conversion, and to efficiently deliver goods to our customers.
Our marketing strategy is focused on acquiring new customers efficiently and building brand loyalty with existing customers to encourage repeat purchases. We market to prospective and current customers through all core online marketing channels: email, paid search, affiliate marketing, online display advertising, and social media. Our promotional strategy is focused on providing a range of special offers and sales designed to maximize profitable incremental sales using tried-and-true direct marketing techniques. These offers are programmed around specific themes, including product launches and holidays. We also utilize social networking platforms such as Facebook, Twitter, Pinterest, Google+, YouTube, Instagram, Wanelo, and Vine to communicate with customers, increase brand awareness and generate interest in our new product launches.
The Company has two reportable segments. The "Website" segment sells geek-themed retail products and video game-themed merchandise through the ThinkGeek website and through the ThinkGeek Solutions web-stores. The "Wholesale" segment sells primarily exclusive GeekLabs products to brick-and-mortar retailers. Prior to September 17, 2012, the Company had two reportable segments: e-Commerce and Media. The Media segment was discontinued in 2012 when it was sold to Dice Holdings, Inc.
We currently use the following key metrics to measure our sales derived from our ThinkGeek website:
(1)
Unique visitors is the total of unique visitors for the ThinkGeek website during the periods presented. This data is accumulated daily and can include the same unique visitor on different days. We track unique visitors and the volume of traffic to our ThinkGeek website to help us determine the effectiveness of our marketing efforts. This metric is herein referred to as "daily unique visitors." Daily unique visitors as presented excludes the impact from ThinkGeek Solutions in order to show comparable period over period results. Since the date of acquisition, the ThinkGeek Solutions web-stores had 14.7 million daily unique visitors.
(2)
The number of orders shipped represents all ThinkGeek website orders associated with the amount of revenue recognized for the periods presented. The number of orders shipped excludes the impact from ThinkGeek Solutions in order to show comparable period over period results. Since the date of acquisition, ThinkGeek Solutions has contributed approximately 82 thousand shipped orders.
(3)
Average order value shipped is calculated by the total Website sales for orders shipped divided by the number of Website orders. Average order value shipped can vary depending on, but not limited to, seasonality, promotions, the competitive environment and economic conditions. Average order value shipped as presented excludes the impact from ThinkGeek Solutions. Including ThinkGeek Solutions, the average order value shipped was not impacted.
In addition to our Website sales, we also had sales through our wholesale channel of $29.1 million, $22.4 million, and $7.0 million for the years ended December 31, 2014, 2013, and 2012, respectively. These wholesale revenues primarily consisted of sales of certain unique licensed ThinkGeek products.
Critical Accounting Estimates
Accounting policies, methods and estimates are an integral part of the consolidated financial statements prepared by management and are based upon management’s current judgments. Those judgments are based on knowledge and experience with regard to past and current events and assumptions about future events. Certain accounting policies, methods and estimates are particularly sensitive because of their significance to the financial statements and because of the possibility that future events affecting them may differ from management’s current judgments. While there are a number of accounting policies, methods and estimates affecting our financial statements, we believe the following critical accounting estimates reflect the more significant estimates and assumptions used in the preparation of our consolidated financial statements. The following descriptions of critical accounting estimates should be read in conjunction with our consolidated financial statements and related notes.
Revenue Recognition
We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sale price is fixed or determinable, and collectibility is reasonably assured. Net revenue for the Website segment is derived from the online sale of consumer goods. Website net revenue includes shipping revenue and is presented net of returns and allowances, discounts and sales taxes. Net revenue for the Wholesale segment is derived primarily from the sale of certain exclusive products through our wholesale channel. Wholesale net revenue is presented net of discounts and allowances.
Website revenue is deferred for orders shipped but not delivered before the end of the period. The amount recorded as deferred revenue is estimated because of our high volume of transactions and the use of multiple shipping carriers. These estimates are used to determine what orders that shipped at the end of the reporting period were delivered and should be recognized as revenue. When calculating these estimates, we consider our historical experience of shipping transit times for domestic and international orders. On average, shipping transit times are approximately one to eight business days. As of December 31, 2014 and December 31, 2013, $1.2 million and $1.6 million, respectively, were recognized as deferred revenue for orders shipped at the end of the reporting period but not yet delivered to the customer.
We reserve an amount for estimated returns on Website orders at the end of each reporting period. We provide ThinkGeek website customers a 90-day right to return purchased products. These estimates are based on historical patterns and recent trends of customer returns. Reserves for returns at December 31, 2014 and December 31, 2013 were $0.8 million and $0.5 million, respectively.
Inventory Valuation
Inventories consist primarily of finished goods that are valued at the lower of cost, using the weighted-average cost method, or market. We value our inventory at the lower of cost or market based on analyzing current retail prices as well as the age of our inventory. If demand for our products deteriorates, then additional write-downs may be required.
Geek Points Accruals
We maintain a customer loyalty program by issuing Geek Points to participating customers for certain purchases of products. Customers can redeem their Geek Points toward future purchases in accordance with program rules and promotions. Geek Points expire three years from the date they are earned. The Company accrues the cost of anticipated redemptions using an estimated redemption rate calculated based on historical experiences and recent trends. The estimated cost of the redemptions for the Geek Points earned is included in Cost of revenue on the Company's Consolidated Statements of Operations.
Business Combinations
Business combinations are accounted for using the purchase method of accounting. The purchase price of an acquisition is allocated to the assets acquired, including intangible assets and liabilities assumed, based on their respective fair values at the acquisition date. Significant estimates and assumptions are required to value assets acquired and liabilities assumed at the acquisition date, including contingent consideration. Liabilities related to contingent consideration are remeasured at fair value in each subsequent reporting period. These estimates are inherently uncertain and subject to refinement and typically include the calculation of an appropriate discount rate and projection of cash flows associated with each acquired asset or assumed liability. As a result, during the measurement period, which may be up to one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed with corresponding adjustments to goodwill. Upon the conclusion of the measurement period or final determination of the values of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded in the Consolidated Statements of Operations.
Goodwill
We evaluate goodwill for impairment annually as of December 31, and when an event occurs or circumstances change that indicates that the carrying amount may not be recoverable. The Company performs the annual goodwill impairment assessment first by using a qualitative approach to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If the results of the qualitative assessment conclude that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, additional quantitative impairment testing is performed. The quantitative assessment of goodwill impairment is tested at the reporting unit level by comparing the carrying amount of the reporting unit's net assets, including goodwill, to the fair value of the reporting unit. If the carrying amount of the reporting unit exceeds its fair value, a second step is performed to measure the amount of the impairment loss, if any. The fair value of the reporting units are estimated using market and discounted cash flow approaches. The discounted cash flow approach uses expected future operating results. The market approach uses comparable company information to determine revenue and earnings multiples to value our reporting units. The preparation of the goodwill impairment analysis requires us to make significant estimates and assumptions with respect to the determination of fair values of tangible and intangible assets. These estimates and assumptions, which include future values, are often subjective and may differ significantly from period to period based on changes in the overall economic environment, changes in our business and changes in our strategy or our internal forecasts.
Results of Operations and Discontinued Operations
The following table sets forth our operating results for the periods indicated as a percentage of net revenue, represented by selected items from the Consolidated Statements of Operations. This table should be read in conjunction with the consolidated financial statements and the accompanying notes included in this Form 10-K.
Net Revenue
Net revenue is derived from the online sale of consumer goods through our Website segment, and through our Wholesale segment. Website net revenue includes shipping revenue and is presented net of returns and allowances, discounts, and sales taxes. Wholesale net revenue is presented net of discounts and allowances. We sell and ship our products domestically and internationally.
Net revenue increased $2.4 million during the year ended December 31, 2014 as compared to the prior period. Our Wholesale segment continued to deliver strong growth, resulting in an increase in revenue which more than offset the decline in our Website revenue. Net revenue had increased $19.3 million during the year ended December 31, 2013 as compared to 2012, primarily due to an increase in revenue through our Wholesale segment and an increase in Website revenue driven by higher daily unique visitors and average order value shipped.
During 2014, we introduced a number of new products that included unique theme-based products developed in our GeekLabs. Our best selling products during 2014 were licensed products that related to Minecraft, Doctor Who, Star Wars and Star Trek. Some of our popular licensed products this year were the R2-D2 USB Car Charger, the Minecraft Creeper backpack, the R2-D2 Measuring Cups, and the Flux Capacitor USB Car Charger. We are authorized to sell our unique GeekLabs products with licensed themes such as StarWars, StarTrek or Minecraft through the relationships we have with Disney, CBS and Mojang, respectively.
Website
Website revenue declined $4.3 million for the year ended December 31, 2014 as compared to the prior year period. This decrease was driven by a decline in the number of daily unique visitors as well as a decline in the average order value for shipped orders. Excluding the impact from the Treehouse acquisition, the number of daily unique
visitors decreased from 91.2 million at December 31, 2013 to 85.4 million at December 31, 2014. This decrease is primarily due to a decline in e-mail open rates as well as a decline in social media traffic. In addition, the average order value for shipped orders from the Website segment experienced a decline from $57 as of December 31, 2013 to $56 as of December 31, 2014.
Website revenue had increased $4.0 million during the year ended December 31, 2013 as compared to 2012. Daily unique visitors had increased from 89.3 million to 91.2 million and average order value for shipped orders from the Website segment had improved from $56 to $57 during the year ended December 31, 2013 as compared to 2012.
Website revenues for international orders were $24.1 million, $24.2 million, and $22.3 million for the years ended December 31, 2014, 2013, and 2012, respectively.
Wholesale
Wholesale revenue increased $6.7 million and $15.4 million during the years ended December 31, 2014 and December 31, 2013, as compared to their respective prior periods. We continue to strengthen our relationships with existing clients and acquire new clients who have particular interest in certain unique licensed ThinkGeek products. We have wholesale agreements with several large retailers in the toy, gaming and pop culture markets that have many brick-and-mortar locations throughout the United States and internationally. Some of our current wholesale clients include Barnes and Noble, f.y.e., GameStop, Hot Topic, Kohl's, Kroger, Meijer, Target, Toys "R" Us, and Walmart.
Wholesale revenue for international orders were $5.8 million, $2.6 million, and $1.6 million for the years ended December 31, 2014, 2013, and 2012, respectively.
Cost of Revenue / Gross Margin
Cost of revenue consists of product, shipping and fulfillment costs and personnel and related overhead expenses associated with the operations and merchandising functions.
Gross margin as a percentage of revenues for the year ended December 31, 2014 decreased by approximately two percentage points from the year ended December 31, 2013. This decrease was driven primarily by higher product costs, an increase in promotions, higher royalty fees, as well as higher fulfillment costs attributable to issues experienced at our third-party fulfillment center. Gross margin as a percentage of revenues for the year ended December 31, 2013 had increased by approximately two percentage points from the year ended December 31, 2012. This increase was primarily attributable to higher sales of our unique Geeklabs products which generally have higher gross margins and improved margins from our Wholesale segment, despite higher royalty fees as a percentage of revenues.
We are continually analyzing gross margins by product and category levels to ensure that product mix and product costs are in line with our gross margin expectations. We work to manage gross margins through negotiations with our vendors to reduce costs related to our products, materials, fulfillment and shipping.
Website
Gross margin as a percentage of revenue for Website decreased by approximately four percentage points when comparing the year ended December 31, 2014 to the prior year period. This decrease is primarily due to higher product costs and higher royalties fees as percentages of revenue. Gross margin as a percentage of revenue for Website remained constant at approximately 17% when comparing the year ended December 31, 2013 to December 31, 2012.
Website cost of revenues increased $1.0 million during the year ended December 31, 2014, as compared to the year ended December 31, 2013 primarily due to an increase in fulfillment costs of $0.7 million, and an increase in royalty fees of approximately $0.4 million. Fulfillment costs increased and revenue was negatively impacted during the holiday season due to delivery issues experienced at our third-party fulfillment center and related customer service issues.
Website cost of revenues increased $3.7 million during the year ended December 31, 2013, as compared to the year ended December 31, 2012 primarily due to an increase in shipping costs of $3.1 million and an increase in royalty fees of $1.5 million. These costs were partially offset by a decrease in product costs of $0.5 million and cost savings of approximately $0.5 million in our customer service department. Shipping costs increased as a result of higher sales in 2013, and offering free upgraded shipping to our customers during the holiday season.
Wholesale
Gross margin as a percentage of revenue for Wholesale increased by approximately one percentage point when comparing the year ended December 31, 2014 to December 31, 2013. This increase is primarily due to lower royalty fees as a percentage of revenue, partially offset by higher product costs as a percentage of revenue. Gross margin as a percentage of revenue for Wholesale had increased by approximately seven percentage points when comparing the year ended December 31, 2013 to December 31, 2012. This increase was primarily due to lower product costs as a percentage of revenue, partially offset by higher royalty fees and higher packaging and fulfillment costs as percentages of revenue. Wholesale product costs were lower as a percentage of revenue because we primarily sold GeekLabs products through our Wholesale segment which generally have higher product margins.
Wholesale cost of revenues increased $4.3 million during the year ended December 31, 2014, as compared to the year ended December 31, 2013. Higher sales volume drove an increase in product costs of $3.1 million, an increase in royalty fees of $0.7 million, and an increase in packaging and fulfillment costs of $0.5 million.
Wholesale cost of revenues increased $9.6 million during the year ended December 31, 2013, as compared to the year ended December 31, 2012 primarily due to an increase in product costs of $4.4 million, an increase in royalty fees of $3.5 million, and an increase in packaging and fulfillment costs of $1.2 million. Product and packaging and fulfillment costs increased as a result of higher sales to our wholesale clients in 2013 compared to 2012. Royalty payments to our third-party licensors increased primarily as a result of higher sales of licensed products through our Wholesale segment.
Operating Expenses
Sales and Marketing Expenses
Sales and marketing expenses consist primarily of personnel and related overhead expenses, including sales commissions, marketing and sales support functions, as well as costs associated with advertising and promotional activities.
Sales and marketing expenses increased $3.8 million for the year ended December 31, 2014 as compared to the year ended December 31, 2013 primarily due to an increase in marketing expenses related to brand marketing of $1.7 million, costs related to external wholesale commissions of $1.2 million, paid search fees of $0.3 million and affiliate partnership expenses of $0.2 million. During 2014, the Company launched a new brand and redesigned the ThinkGeek website. We are continuing to implement new programs and to build on existing programs to increase brand awareness and attract more visitors to our ThinkGeek website and ThinkGeek Solutions web-stores.
Sales and marketing expenses increased $2.7 million for the year ended December 31, 2013 as compared to the year ended December 31, 2012 primarily due to an increase of $2.5 million in marketing expenses related to market research, affiliate partnerships, paid search and online display advertising. Sales and marketing expenses were also higher due to an increase of $0.3 million in electronic payment services and credit card fees, and an increase of $0.3 million in accrued bonus and commission expense. These expenses were partially offset by a savings of $0.4 million in printed catalogs. The marketing related expenses increase was due to implementing new programs and building on existing marketing programs to attract more attention and visitors to our ThinkGeek website. We had also retained consultants to assist us in researching marketing matters such as revising certain terms and conditions of our Geek Points program and a market study of our current and potential customers. Electronic payment services and credit card fees increased due to a higher volume of transactions. The savings in printed catalogs was due to the discontinuance of printed catalogs in the second half of 2012.
Technology and Design Expenses
Technology and design expenses consist of personnel and related overhead expenses for GeekLabs and developers that design and create new products to sell on our ThinkGeek website. It also includes personnel and related overhead and technology expenses for our engineering group that work to continually improve website design, functionality and capacity, as well as costs related to our enterprise resource planning (ERP) system. A majority of our technology and design costs are expensed as they are incurred. A portion of the costs incurred to develop internal-use software that meet certain criteria are capitalized as property and equipment in the accompanying Consolidated Balance Sheets.
Technology and design expenses increased $2.5 million for the year ended December 31, 2014 as compared to the year ended December 31, 2013. This is primarily due to higher costs of approximately $1.8 million related to implementation and on-going costs related to our ERP system and an increase of $0.5 million in personnel and related overhead expenses. Implementation costs include consultant fees related to ongoing support and custom modifications to the web-based application.
Technology and design expenses increased $2.1 million for the year ended December 31, 2013 as compared to the year ended December 31, 2012. This was primarily due to an increase of $0.9 million in personnel and related overhead expenses, an increase of $0.8 million in database costs, and an increase of approximately $0.3 million in equipment and facility related costs. We had hired specialists in custom manufacturing for our GeekLabs group, and we had hired specialists to support the infrastructure and functionality of the Company's ThinkGeek website and reporting systems for our engineering group.
General and Administrative Expenses
General and administrative expenses consist of salaries and related expenses for finance and accounting, human resources and legal personnel, professional fees for accounting and legal services as well as insurance and other public company related costs.
General and administrative expenses decreased $1.3 million for the year ended December 31, 2014 as compared to the year ended December 31, 2013 primarily due to a decrease of $1.0 million in stock based compensation related to the departure of certain members of senior management in the prior year period, as well as a decrease of approximately $0.3 million in accounting related services.
General and administrative expenses decreased $0.7 million for the year ended December 31, 2013 as compared to the year ended December 31, 2012 primarily due to a decrease of $0.9 million in stock based compensation and a decrease of $0.3 million in salaries and accrued bonus expenses, partially offset by an increase of $0.4 million in recruiting fees. Stock based compensation was lower due to the departure of key senior management during 2013. Recruiting fees were higher due to new executive hires.
Acquisition-Related Costs
Acquisition-related costs include any changes in the estimated fair value of performance-based contingent consideration payments which were initially recorded in connection with our acquisition of Treehouse, and third-party fees incurred in connection with our acquisition activity. For the year ended December 31, 2014, acquisition-related costs were approximately $0.3 million.
In each period, we revise our accrual for earn-out payments based on our current estimates of performance relative to the stated target. The accrual could be adjusted if the achievement of goals results in an amount paid that is different from our accrual estimate.
Income Taxes
In prior years, we performed a study addressing the recoverability of our net operating loss carryforwards. The results of the study indicated that there was a change of control as defined by Section 382 of the Internal Revenue Code in 2008. As a result of the change in control, utilization of approximately $16.4 million of the net operating losses are subject to an annual limitation. Consistent with historical practice, we continue to fully reduce the net operating loss carryforwards and all other deferred tax assets by a valuation allowance. This is due to our conclusion that it is more likely than not that we would not recover the deferred tax assets. The amount of federal net operating losses available to offset taxable income in 2015 and beyond as of December 31, 2014 is $29.2 million. Additionally, the Company does not have a history of taxable income, therefore we have not recorded a benefit on the loss for the year ended December 31, 2014.
Discontinued Operations, Net of Tax
Due to the sale of our Media business on September 17, 2012, the results of the Media business are classified as (Loss) income from discontinued operations for the years ended December 31, 2013 and 2012. The results include Media business revenues, cost of sales and operating and non-operating expenses, excluding previously allocated general corporate costs.
On September 17, 2012, the Company entered into a purchase agreement with Dice Holdings, Inc. ("Dice") and two of Dice's subsidiaries, (collectively, the "Buyers") pursuant to which the Buyers purchased the Company's Media business segment, including the SourceForge, Slashdot and Freecode websites and assumed certain related liabilities. In accordance with the terms of the purchase agreement, the Buyers paid the Company $20.0 million in cash. The $13.7 million gain on the sale of the Media business segment for the year ended December 31, 2012 is the selling price of $20.0 million less the carrying value of certain assets and liabilities assumed by the Buyers, offset by transaction costs of $1.1 million.
The income tax benefit for the year ended December 31, 2013 represents federal and state tax receivables as a result of overpayments. The tax provision recorded on discontinued operations for the year ended December 31, 2012 represents the tax based upon the with and without method. The 2012 tax provision is significantly lower than the statutory rate as a result of net operating losses recognized with a full valuation allowance.
Liquidity and Capital Resources
Operating Activities
Net cash provided by operating activities was $4.0 million for the year ended December 31, 2014 as compared to net cash used in operating activities of $6.0 million for the year ended December 31, 2013. When compared to the prior year, the change in the net cash provided by operating activities was primarily driven by changes in the timing of receipts in accounts receivable from our wholesale customers, as well as the timing of purchases of our inventory. These increases to net cash provided by operating activities more than offset our higher net loss from operations, as adjusted for non-cash items.
Net cash used in operating activities increased $4.1 million during the year ended December 31, 2013 as compared to the year ended December 31, 2012. This was primarily due to a higher use of cash to fund changes in operating assets and liabilities of approximately $4.4 million, driven primarily by an increase in accounts receivable from our wholesale customers. This increase was partially offset by the change in our loss from operations, as adjusted for non-cash items of approximately $0.3 million.
Investing Activities
Cash used in investing activities for the year ended December 31, 2014 was $1.8 million, consisting primarily of $1.4 million for the acquisition of Treehouse, $0.2 million for internal-use software development costs as part of the ERP implementation, and approximately $0.2 million in other property and equipment investments.
Cash provided by investing activities for the year ended December 31, 2013 of $2.8 million included $3.0 million in proceeds, previously held in escrow, from the sale of the Media business.
Cash provided by investing activities for year ended December 31, 2012 of $21.8 million included proceeds of $17.0 million for the sale of the Company's Media business and proceeds of $6.0 million for the sale of the Company's series C-1 preferred stock investment in CollabNet, Inc., partially offset by $1.1 million in transaction costs and $0.1 million in investments in property and equipment.
Financing Activities
Cash used in financing activities for the year ended December 31, 2014 included approximately $0.3 million for the settlement of a contingent short-term liability related to the acquisition of Treehouse that was due to the seller based on the terms in the asset purchase agreement and approximately $0.4 million for the repurchase of our common stock to satisfy the employees' minimum tax withholding obligations that arose from the vesting of restricted stock units, partially offset by cash provided by the issuance of common stock from stock option exercises.
Cash used in financing activities for the year ended December 31, 2013 of $1.0 million included $0.8 million for the repurchase of 53,884 common stock in conjunction with the modified Dutch tender offer, $0.5 million for the repurchase of our common stock to satisfy tax withholding obligations that arose from the vesting of restricted stock, partially offset by $0.3 million cash provided by the issuance of common stock from stock option exercises.
Cash used in financing activities for the year ended December 31, 2012 of $0.8 million included $1.2 million for the repurchase of our common stock to satisfy tax withholding obligations that arose from the vesting of restricted stock, partially offset by $0.4 million cash provided by the issuance of common stock from stock option exercises.
Cash Flows From Discontinued Operations
Cash flows from discontinued operations includes operating and investing activities that have been reported separately in the Consolidated Statements of Cash Flows. The absence of cash flows from discontinued operations in our ongoing operations is not expected to materially impact our future cash flow or liquidity due to the relatively modest amounts historically contributed by the discontinued operations.
Liquidity
Our liquidity and capital requirements depend on numerous factors, including our investment in inventory to support our business, the timing of the collection of our accounts receivables from our wholesale customers, market acceptance of our products, the resources we devote to developing, marketing, selling and supporting our products and website, the timing and expense associated with expanding our distribution channels, potential acquisitions and other factors.
On December 12, 2011, we entered into a secured credit agreement with Wells Fargo Bank, N.A. ("Wells Fargo"), that provided us with a $5 million revolving line of credit including a $2 million sub-facility for the issuance of standby letters of credit. If utilized, the applicable interest rate for the credit facility would be 2.5% above one or three month LIBOR. We renewed the revolving credit facility during the fourth quarter of 2014, and the facility now expires October 15, 2015. To date, we have not drawn down on our line of credit and have no plans to do so at this time. As part of our agreement we must keep a minimum of $5 million in bank accounts at Wells Fargo at all times. This credit line is collateralized by substantially all of the assets of the Company. As of December 31, 2014, the borrowing capacity of our line of credit was reduced by a letter of credit outstanding with one of our vendors for less than $0.1 million.
We expect to devote capital resources to continue:
•
developing unique, exclusive GeekLabs products;
•
investing in engineering and infrastructure that will provide us with opportunities and capabilities to support future growth;
•
improving website and mobile user experience and functionality;
•
investing to expand our business platform;
•
investing in marketing programs to expand our brand awareness;
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investing and improving product safety and quality assurance testing;
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investing in human resources and leadership;
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investing in capital projects that support our distribution and related support systems;
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optimizing supplier and manufacturer relationships; and
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investing in other general corporate activities.
Stock Repurchase Program
On June 17, 2013, the Company announced the commencement of a modified Dutch tender offer to repurchase up to 400,000 shares of its common stock at a price of not less than $12.00 nor greater than $14.00 per share. The Company's Board of Directors determined it was in the best interest of its stockholders to repurchase shares at that time given its cash position and stock price and the likelihood that the Company's common stock may be removed from the Russell 2000 Index. The Company was subsequently removed from the Russell 2000 Index on June 28, 2013. The tender offer expired on July 15, 2013. Pursuant to the terms of the tender offer, the Company purchased 53,884 shares at $14.00 per share for a total cost of $0.8 million, excluding fees and expenses related to the tender offer. These shares represented approximately 0.81% of the shares outstanding as of July 15, 2013.
Contractual Obligations
The contractual obligations presented in the table below represent our estimates of future payments under fixed contractual obligations and other commitments. Changes in our business needs, cancellation provisions and other factors may result in actual payments differing from the estimates. We cannot provide certainty regarding the timing and amounts of payments. The following table summarizes our contractual obligations and commitments as of December 31, 2014 (in thousands):
(1) Includes future payments for the Company's facilities under non-cancelable operating leases that expire at various dates through 2019.
(2) Includes a one-time termination fee that we would be required to pay to our third-party fulfillment and warehouse provider if we were to cancel our contract with them and also includes committed licensing payments and other service agreements.
Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The updated guidance will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The new standard is effective for the Company on January 1, 2017. Early application is not permitted. The standard permits the use of either the retrospective or cumulative effect transition method. The Company is evaluating the effect that the guidance will have on its consolidated financial statements and related disclosures. The Company has not yet selected a transition method nor has it determined the effect of the standard on its ongoing financial reporting.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We operate primarily in the United States, and the majority of our sales are denominated in U.S. dollars. Accordingly, we do not have any material exposure to foreign currency rate fluctuations.
We do not currently hold any derivative instruments and do not engage in hedging activities.
Item 8.
Item 8. Financial Statements and Supplementary Data
All other schedules are omitted because they are not applicable, not required, or because the required information is included in the consolidated financial statements or notes thereto.
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Geeknet, Inc.:
We have audited the accompanying consolidated balance sheets of Geeknet, Inc. and subsidiaries (the Company) as of December 31, 2014 and 2013, and the related consolidated statements of operations, comprehensive (loss) income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2014. In connection with our audits of the consolidated financial statements, we also have audited financial statement schedule II. These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Geeknet, Inc. and subsidiaries as of December 31, 2014 and 2013, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2014, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 23, 2015 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting. On August 1, 2014, Geeknet, Inc. acquired substantially all of the assets and certain liabilities of Treehouse Brand Stores, LLC (“Treehouse”), and management excluded from its assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2014, Treehouse’s internal control over financial reporting associated with total assets of approximately $3.6 million and total revenues of approximately $5.4 million included in the consolidated financial statements of Geeknet, Inc. and subsidiaries as of and for the year ended December 31, 2014. Our audit of internal control over financial reporting of the Company also excluded an evaluation of the internal control over financial reporting of Treehouse.
/s/ KPMG LLP
McLean, Virginia
February 23, 2015
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Geeknet, Inc.:
We have audited Geeknet, Inc.’s and subsidiaries (the Company) internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Geeknet, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Item 9A(b), Management’s Report of Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control - Integrated Framework (1992) issued by COSO.
On August 1, 2014, Geeknet, Inc. acquired substantially all of the assets and certain liabilities of Treehouse Brand Stores, LLC (“Treehouse”), and management excluded from its assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2014, Treehouse’s internal control over financial reporting
associated with total assets of approximately $3.6 million and total revenues of approximately $5.4 million included in the consolidated financial statements of Geeknet, Inc. and subsidiaries as of and for the year ended December 31, 2014. Our audit of internal control over financial reporting of the Company also excluded an evaluation of the internal control over financial reporting of Treehouse.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Geeknet, Inc. and subsidiaries as of December 31, 2014 and 2013, and the related consolidated statements of operations, comprehensive (loss) income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2014, and our report dated February 23, 2015 expressed an unqualified opinion on those consolidated financial statements.
/s/ KPMG LLP
McLean, Virginia
February 23, 2015
GEEKNET, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except par value)
The accompanying notes are an integral part of these consolidated financial statements.
GEEKNET, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
The accompanying notes are an integral part of these consolidated financial statements.
GEEKNET, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME
(In thousands)
The accompanying notes are an integral part of these consolidated financial statements.
GEEKNET, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(In thousands)
The accompanying notes are an integral part of these consolidated financial statements.
GEEKNET, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
The accompanying notes are an integral part of these consolidated financial statements.
GEEKNET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Overview
Geeknet, Inc. ("Geeknet") through its wholly-owned subsidiary, ThinkGeek, Inc. (“ThinkGeek”), sells collectibles, apparel, gadgets, electronics, toys and other retail products for technology enthusiasts and general consumers through its ThinkGeek.com website (the "ThinkGeek website") and certain exclusive products to the Company's wholesale customers. Since 1999, ThinkGeek has been creating a world where everyone can embrace their inner geek, express their passions and connect with one another. In August 2014, Geeknet, through its newly formed wholly-owned subsidiary ThinkGeek Solutions, Inc. ("ThinkGeek Solutions" and together with Geeknet and ThinkGeek, the "Company"), completed the acquisition of substantially all of the assets and certain liabilities of Treehouse Brand Stores, LLC ("Treehouse"). Since 2009, Treehouse has distributed video game-themed merchandise for the gaming community through web-stores (the "ThinkGeek Solutions web-stores") and has engaged its fans with unique and exclusive products. This acquisition aligns with the Company's strategic priorities and will allow it to expand its platform to increase its customer base. ThinkGeek Solutions remains managed by Treehouse's former leadership team and is headquartered in Denver, Colorado.
ThinkGeek offers a broad range of unique products through its ThinkGeek website that are often not available in traditional brick-and-mortar stores. The Company introduces a range of new products to ThinkGeek's audience on a regular basis. Some ThinkGeek products are custom made and developed by the Company's in-house product development team ("GeekLabs"). The Company has several wholesale arrangements with brick-and-mortar retailers located throughout the United States and internationally, allowing the Company to reach a broader consumer audience and expand its brand awareness. ThinkGeek Solutions distributes a wide variety of video game-themed merchandise to its customer base through the ThinkGeek Solutions web-stores built for the gaming community.
The Company has two reportable segments. The "Website" segment sells geek-themed retail products and video game-themed merchandise through the ThinkGeek website and through the ThinkGeek Solutions web-stores. The "Wholesale" segment sells primarily exclusive GeekLabs products to brick-and-mortar retailers.
2. Summary of Significant Accounting Policies
Basis of Presentation
The Company has prepared the accompanying consolidated financial statements in accordance with accounting principles generally accepted in the United States of America ("GAAP"). The results of the Company's Media business, which was sold on September 17, 2012, are classified as discontinued operations for the years ended December 31, 2013 and 2012 in the Company's Consolidated Statements of Operations. The cash flows from the Media business' operating and investing activities are shown separately in cash flows from discontinued operations, with the exception of proceeds from the sale of the Media business and related transaction costs. See Note 10. Discontinued Operations for additional information.
Use of Estimates in Preparation of Consolidated Financial Statements
The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of such financial statements, as well as the reported amounts of revenue and expenses during the periods indicated. Estimates include, but are not limited to, orders in transit at the end of the reporting period, provision for returns, inventory valuation, Geek Point accruals, stock-based compensation, the fair values of certain assets acquired and liabilities assumed in a business combination, and income taxes. Actual results could differ from those estimates.
Recently Adopted Accounting Pronouncements
In July 2013, the Financial Accounting Standards Board issued Accounting Standards Update No. 2013-11, Income Taxes, to amend previous guidance for income taxes and requires that an unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, with certain exceptions. This
standard is effective for fiscal years beginning on or after December 15, 2013 and subsequent interim periods. The standard shall be applied prospectively to all unrecognized tax benefits that exist at the effective date. The adoption of this standard, which became effective January 1, 2014, did not have an impact on the Company's results of operations or its financial position.
Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The updated guidance will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The new standard is effective for the Company on January 1, 2017. Early application is not permitted. The standard permits the use of either the retrospective or cumulative effect transition method. The Company is evaluating the effect that the guidance will have on its consolidated financial statements and related disclosures. The Company has not yet selected a transition method nor has it determined the effect of the standard on its ongoing financial reporting.
Principles of Consolidation
These consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.
Segment and Geographic Information
Operating segments are identified as components of an enterprise about which separate discrete financial information is available for evaluation by the chief operating decision-maker, or decision-making group, in making decisions about how to allocate resources and assess performance. The Company’s chief decision-making group is the Chief Executive Officer and the Chief Financial Officer. The Company has three operating segments: Website, Wholesale, and ThinkGeek Solutions, and two reportable segments: Website and Wholesale. The ThinkGeek Solutions operating segment has been aggregated into the Website reportable segment. The Website segment sells geek-themed retail products and video game-themed merchandise through the ThinkGeek website and through the ThinkGeek Solutions web-stores. The Wholesale segment sells primarily exclusive GeekLabs products to brick-and-mortar retailers.
Business Combinations
Business combinations are accounted for using the purchase method of accounting. The purchase price of an acquisition is allocated to the assets acquired, including intangible assets and liabilities assumed, based on their respective fair values at the acquisition date. Significant estimates and assumptions are required to value assets acquired and liabilities assumed at the acquisition date, including contingent consideration. Liabilities related to contingent consideration are remeasured at fair value in each subsequent reporting period. These estimates are inherently uncertain and subject to refinement and typically include the calculation of an appropriate discount rate and projection of cash flows associated with each acquired asset or assumed liability. As a result, during the measurement period, which may be up to one year from the acquisition date, the Company may record adjustments to the assets acquired and liabilities assumed with corresponding adjustments to goodwill. Upon the conclusion of the measurement period or final determination of the values of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded in the Consolidated Statements of Operations.
Goodwill and Other Intangible Assets
Identifiable intangible assets were recorded based on their estimated fair values in connection with the acquisition of Treehouse. The identifiable intangible assets are amortized on a straight-line basis over their respective useful lives ranging from three to five years. Amortization expense for identifiable intangible assets was $0.1 million for the year ended December 31, 2014. Identifiable intangible assets with finite lives are reviewed for impairment when events and circumstances indicate that the carrying value may not be recoverable. The changes in the carrying amount of the intangible assets for the year ended December 31, 2014 are as follows (in thousands):
Estimated amounts that will be amortized related to purchased intangibles are as follows as of December 31, 2014 (in thousands):
Goodwill was recorded as the excess of the purchase price over the net assets acquired. Goodwill was assigned to the Company's reporting units, which are its operating segments. As of December 31, 2014, the goodwill was assigned to the ThinkGeek Solutions operating segment, which is aggregated into the Website reportable segment. As of December 31, 2014, approximately $1.1 million of goodwill is expected to be deductible for tax purposes. The changes in the carrying amount of goodwill for the year ended December 31, 2014 is as follows (in thousands):
The Company evaluates goodwill for impairment annually as of December 31, and when an event occurs or circumstances change that indicates that the carrying amount may not be recoverable. The Company performs the annual goodwill impairment assessment first by using a qualitative approach to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If the results of the qualitative assessment conclude that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, additional quantitative impairment testing is performed. The quantitative assessment of goodwill impairment is tested at the reporting unit level by comparing the carrying amount of the reporting unit's net assets, including goodwill, to the fair value of the reporting unit. If the carrying amount of the reporting unit exceeds its fair value, a second step is performed to measure the amount of the impairment loss, if any. The preparation of the goodwill impairment analysis requires the Company to make significant estimates and assumptions with respect to the determination of fair values of tangible and intangible assets. These estimates and assumptions, which include future values, are often subjective and may differ significantly from period to period based on changes in the overall economic environment, changes in its business and changes in its strategy or its internal forecasts. The Company performed its annual goodwill impairment assessment as of December 31, 2014 using the qualitative approach, and determined that it was not more likely than not that the goodwill was impaired.
Cash and Cash Equivalents
The Company considers all highly-liquid investments with an original maturity of three months or less to be cash equivalents. Cash and cash equivalents consist principally of cash deposited in money market and checking accounts and other highly-liquid short term investments.
Credit Line
On December 12, 2011, the Company entered into a secured credit agreement with Wells Fargo Bank, N.A. ("Wells Fargo"), that provided it with a $5 million revolving line of credit including a $2 million sub-facility for the issuance of standby letters of credit. If utilized, the applicable interest rate for the credit facility would be 2.5% above one or three month LIBOR. The revolving credit facility was renewed during the fourth quarter of 2014, and now expires October 15, 2015. To date, the Company has not drawn down on our line of credit and has no plans to do so at this time. As part of the agreement, the Company must keep a minimum of $5 million in bank accounts at Wells Fargo Bank at all times. This credit line is collateralized by substantially all of the assets of the Company. As of December 31, 2014, the borrowing capacity of the line of credit was reduced by a letter of credit outstanding with one of the Company's vendors for less than $0.1 million.
Fair Value Measurements
The Company records its financial assets and liabilities at fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability, an exit price, in an orderly transaction between market participants at the reporting date. The accounting guidance establishes a three-tiered hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value:
Level 1 - Quoted prices in active markets for identical assets or liabilities.
Level 2 - Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
The following table summarizes the Company's financial assets and liabilities that are measured at fair value on a recurring basis and are categorized using the fair value hierarchy (in thousands):
On August 1, 2014, the Company completed the acquisition of Treehouse, which the Company accounted for under the purchase method of accounting. The terms of the asset purchase agreement relating to the acquisition provides for contingent consideration up to $2.0 million in cash earn-out payments based on the achievement of certain specified performance metrics through 2015. The estimated fair value of the performance-based contingent consideration was $1.1 million at December 31, 2014. This contingent liability has been reflected as a current liability of approximately $0.2 million and a non-current liability of approximately $0.9 million. The Company determined the estimated fair value of the liability for the contingent consideration based on a probability-weighted discounted cash flow analysis. In each period, the Company will reassess its current estimates of performance relative to the stated targets and will adjust the liability to the estimated fair value through earnings.
The change in the contingent consideration liability is summarized as follows for the year ended December 31 , 2014 (in thousands):
Trade Accounts Receivable
Trade accounts receivable are primarily amounts related to customer receivables and are not interest bearing. The Company will record an allowance for doubtful accounts to reserve for potentially uncollectible trade receivables. The Company also reviews its trade receivables by aging category to identify specific customers with known disputes or collectibility issues. The Company exercises judgment when determining the adequacy of these reserves and evaluates historical bad debt trends, general economic conditions in the United States and internationally, and changes in customer financial conditions.
Inventories
Inventories consist primarily of finished goods that are valued at the lower of cost, using the weighted average cost method, or market. The Company values its inventory at the lower of cost or market based on analyzing current retail prices as well as the age of its inventory. If demand for the Company's products deteriorates, then additional write-downs may be required.
Minimum Royalty and Content License Commitments
Royalty-based obligations are either paid in advance and capitalized as prepaid royalties or accrued as incurred and subsequently paid. Royalty-based obligations paid in advance are generally non-refundable. Royalty-based obligations are expensed to cost of revenues at the contractual royalty rate for the relevant product sales on a per transaction basis. Contracts with some licensors include minimum guaranteed royalty payments, which are payable regardless of the ultimate volume of sales. Prepaid royalties were $0.8 million and $0.1 million for the years ended December 31, 2014 and 2013, respectively. Royalty-based obligations were $4.0 million at December 31, 2014 and 2013, respectively. Accrued royalty obligations are classified as accrued and other liabilities in the Consolidated Balance Sheets.
Property and Equipment
Property and equipment are stated at cost and are depreciated using the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized over the lesser of the estimated useful lives or the corresponding lease term.
Net Revenue
The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sale price is fixed or determinable, and collectibility is reasonably assured. Net revenue for the Website segment is derived from the online sale of consumer goods. Website net revenue includes shipping revenue and is presented net of returns and allowances, discounts and sales taxes. Net revenue for the Wholesale segment is derived primarily from the sale of certain exclusive products through the wholesale channel. Wholesale net revenue is presented net of discounts and allowances.
Website revenue is deferred for orders shipped but not delivered before the end of the period. The amount recorded as deferred revenue is estimated because of the Company's high volume of transactions and the use of multiple shipping carriers. Estimates are used to determine which orders that shipped at the end of the reporting period were delivered and should be recognized as revenue. When calculating these estimates, the Company considers its historical experience of shipping transit times for domestic and international orders using different carriers. On average, shipping transit times are approximately one to eight business days. As of December 31, 2014 and December 31,
2013, $1.2 million and $1.6 million, respectively, was recognized as deferred revenue for orders shipped by the end of the reporting period but not yet delivered to the customer.
The Company also engages in the sale of gift certificates. When a gift certificate is sold, Website revenue is deferred until the certificate is redeemed and the products are delivered. Deferred revenue at December 31, 2014 and December 31, 2013 relating to gift certificates was $1.6 million and $1.2 million, respectively. In addition, subsequent to the acquisition of Treehouse, the Company now records deferred revenue when it receives payments in advance of the delivery of products. Deferred revenue at December 31, 2014 relating to payments received in advance of the delivery of products was $0.5 million.
The Company reserves an amount for estimated returns on Website orders at the end of each reporting period. The Company provides ThinkGeek website customers a 90-day right to return purchased products. These estimates are based on historical patterns and recent trends of customer returns. Reserves for returns at December 31, 2014 and December 31, 2013 were $0.8 million and $0.5 million respectively, and are recorded as accrued and other liabilities in the Consolidated Balance Sheets.
Geek Points Loyalty Program
The Company maintains a customer loyalty program by issuing Geek Points to participating customers for certain purchases of products. Customers can redeem their Geek Points toward future purchases in accordance with program rules and promotions. Geek Points expire three years from the date they are earned. The Company accrues the cost of anticipated redemptions using an estimated redemption rate calculated based on historical experiences and trends. The estimated cost of the redemptions for the Geek Points earned is included in Cost of revenue on the Company's Consolidated Statements of Operations.
Income Taxes
The Company has recognized a deferred tax asset associated with previously reported net operating losses, which can be used to offset future taxable income. A valuation allowance is recognized if it is more likely than not that some portion or all of the deferred tax asset will not be realized. The Company has recognized a valuation allowance for the full amount of the deferred tax asset as there is insufficient evidence to support that it is more likely than not that the assets will be realized. The Company reviews its valuation allowance at each reporting period, using, but not limited to, forecasted financial information to determine if the deferred tax assets could more likely than not be realized and after considering the impact of limits on the use of net operating loss carryforwards in accordance with Internal Revenue Code Section 382. The Company performs Section 382 studies on an as needed basis to analyze if there was a change in control of ownership as defined by Section 382 of the Internal Revenue Code that could limit the amount of net operating loss carryforwards available to offset future federal taxable income.
The Company provides for uncertain tax positions and the related interest and penalties based upon management's assessment of whether a tax benefit is more likely than not to be sustained upon examination by taxing authorities.
Stock-Based Compensation
The Company measures compensation cost for stock awards at grant date fair value and recognizes the expense net of estimated forfeitures for shares expected to vest over the service period of the award.
Calculating compensation expense for stock options requires the input of subjective assumptions, including the expected term of the stock option grant, stock price volatility, interest rates and the forfeiture rate. The fair value of the option grants are calculated on the date of grant using the Black-Scholes option pricing model. The expected life is based on historical settlement patterns. Expected volatility is based on the historical implied volatility of the Company's stock. The interest rate for periods within the contractual life of the award is based on the U.S. Treasury yield curve in effect at the time of grant. The Company estimates the forfeiture rate based on historical trends of the stock-based awards that cancel.
Computation of Per Share Amounts
Basic earnings per common share is computed using the weighted-average number of common shares outstanding during the period. Diluted earnings per common share is computed using the weighted-average number
of common and dilutive common equivalent shares outstanding during the period. Common equivalent shares are anti-dilutive when their conversion would reduce the loss per share. For the years ended December 31, 2014 and 2013, respectively, the Company excluded all stock options and restricted stock awards from the calculation of diluted net loss per common share because all such securities were anti-dilutive.
Employee stock options, nonvested shares, and similar equity instruments granted by the Company are treated as potential common shares outstanding in computing diluted earnings per share. Diluted shares outstanding include the dilutive effect of in-the-money options, calculated based on the average share price for each period using the treasury stock method. Under the treasury stock method, the amount the employee must pay for exercising stock options, the amount of compensation cost for future service that the Company has not yet recognized, and the amount of tax benefits that would be recorded in additional paid-in capital when the award becomes deductible are assumed to be used to repurchase shares.
Foreign Currency Translation and Comprehensive Income (Loss)
Prior to the sale of the Media business on September 17, 2012, the Company had a wholly-owned subsidiary in the United Kingdom, of which the functional currency was the local currency. Balance sheet accounts were translated into U.S. dollars at exchange rates prevailing at balance sheet dates. Revenue and expenses were translated into U.S. dollars at average rates for the period and are included in discontinued operations for the year ended December 31, 2012. The Company also has a wholly-owned subsidiary in Belgium of which there has been no activity in the periods presented in the Company's consolidated financial statements. Adjustments resulting from translation were recorded in other comprehensive income as a component of stockholders' equity. Comprehensive income (loss) is comprised of net income (loss) and foreign currency translation gains or losses.
Supplier Concentration
While no supplier concentration exists in the Company’s business, certain suppliers that the Company's GeekLabs uses to manufacture its unique products are located outside of the United States, most of which are located in China. Additionally, ThinkGeek's ability to receive inbound inventory and ship completed orders to its customers is substantially dependent on a single third-party fulfillment and warehouse provider.
Concentrations of Credit Risk and Significant Customers
The Company’s investments are held with two reputable financial institutions; both institutions are headquartered in the United States. The Company’s investment policy limits the amount of risk exposure. The Company has cash in financial institutions that is insured by the Federal Deposit Insurance Corporation ("FDIC") up to $0.25 million per institution. At December 31, 2014 and December 31, 2013, the Company had cash and cash equivalents in excess of the FDIC limits.
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of trade receivables in our Wholesale segment due from a limited number of large retailers. The Company provides credit, in the normal course of business, to a number of companies and performs ongoing credit evaluations of its customers. The credit risk in the Company’s trade receivables is substantially mitigated by its credit evaluation process and reasonably short collection terms. The Company maintains reserves for potential credit losses, if any, and such losses have been within management’s expectations.
For the years ended December 31, 2014, December 31, 2013 and December 31, 2012, respectively, no one customer represented 10% or greater of net revenue.
3. Business Combination
On August 1, 2014, the Company completed its acquisition of substantially all of the assets and certain liabilities of Treehouse. Treehouse was formed in 2009 and distributes a wide variety of video game-themed merchandise to its customer base through internet stores built for the gaming community. The acquisition enables the Company to establish official web-stores under exclusive licenses to increase the Company's customer base. Under the terms of the asset purchase agreement, the Company agreed to pay $1.5 million in cash, less Treehouse's cash and deferred wages at the date of acquisition, with additional earn-out payments of up to $2.0 million based on the achievement of certain specified performance metrics through 2015. The Company determined the fair value of the liability for the contingent consideration based on a probability-weighted discounted cash flow analysis. The fair value measurement
is based on significant inputs not observable in the market and represents a Level 3 measurement as defined in the fair value hierarchy. In each period, the Company will reassess its current estimates of performance relative to the targets and adjust the liability to fair value through earnings.
The acquisition was accounted for using the purchase method of accounting. Accordingly, the results of Treehouse have been included in the accompanying consolidated financial statements from the date of acquisition, and are included in the Website segment. Treehouse contributed net revenues of approximately $5.4 million and a net loss of approximately $0.2 million for the period from its acquisition date to December 31, 2014. In addition, approximately $0.3 million of acquisition-related costs were incurred during the year ended December 31, 2014. The purchase price has been allocated to the assets acquired and liabilities assumed based upon the respective estimates of fair value as of the date of the acquisition, using assumptions that the Company's management believes are reasonable based on the information currently available. The excess of the purchase price over the estimated amounts of net assets was recorded as goodwill. The allocation of the purchase price to the estimated fair value of the assets acquired and liabilities assumed at the acquisition date is as follows (in thousands):
The following table summarizes the identifiable intangible assets acquired and their respective estimated lives ($ in thousands):
The following unaudited pro forma consolidated financial information reflects the results of operations of the Company as if the acquisition had been completed as of January 1, 2013, after giving effect to certain pro forma accounting adjustments. The pro forma adjustments were recorded principally for the purpose of eliminating intercompany transactions between the Company and Treehouse, adjusting for depreciation and amortization expense based on the fair values of the assets acquired, and adjusting for stock based compensation expense related to a senior management award. These pro forma results are not necessarily indicative of what the Company's operating results would have been had the acquisition actually taken place at the beginning of the period.
4. Balance Sheet Components
Prepaid expenses and other current assets
Prepaid expenses and other current assets consist of the following (in thousands):
Property and equipment
Property and equipment consist of the following (in thousands):
Depreciation and amortization expense for property and equipment was $1.3 million, $1.3 million and $1.4 million for the years ended December 31, 2014, 2013 and 2012, respectively. Included in Software for the year ended December 31, 2014 is approximately $0.2 million of capitalized costs associated with internal-use software developed as part of implementing a new enterprise resource planning (ERP) system.
Accrued and other liabilities
Accrued and other liabilities consisted of the following (in thousands):
(1)Accrued Geek Points represents the cost of anticipated future redemptions for awards earned as of the end of the respective periods.
Other long-term liabilities
Other long-term liabilities consist of the following (in thousands):
(1)Long-term contingent consideration represents the fair value of the potential earn-out payments related to the acquisition of Treehouse based on the terms of the asset purchase agreement.
5. Commitments and Contingencies
Legal Proceedings
The Company is involved from time to time, in claims, proceedings and litigation arising in the normal course of business. The Company reviews all claims and accrues a liability for those matters where it believes that the likelihood that a loss will occur is probable and the amount of loss is reasonably estimable.
On June 10, 2013, the Company was served with a complaint filed by UbiComm LLC in U.S. District Court, for the District of Delaware, alleging infringement of U.S. Patent Number 5,603,054 ("Patent '054"). On September 3, 2013, the Company filed a Motion to Dismiss the Complaint, which was granted on November 15, 2013. On the same day, Ubicomm appealed the dismissal to the U.S. Court of Appeals for the Federal Circuit (the "Appeals Court"). Subsequently, the parties agreed to stay the matter pending the U.S. Supreme Court decision in Alice Corp v. CLS Bank which related to Patent '054. Following the Supreme Court's CLS Bank decision on June 19, 2014, Ubicomm decided to withdraw the appeal. The parties entered into a Joint Motion to Dismiss the appeal on July 23, 2014, and the Appeals Court granted the motion to dismiss on July 31, 2014.
Purchase Obligations
The following table summarizes the Company's contractual obligations and other commitments as of December 31, 2014 (in thousands):
(1) Includes future payments for the Company's facilities under non-cancelable operating leases that expire at various dates through 2019.
(2) Includes a one-time termination fee that the Company would be required to pay to its third-party fulfillment and warehouse provider if the Company were to cancel the contract. This amount also includes committed licensing payments and other service agreements.
Rent Expense
Rent expense from continuing operations for the years ended December 31, 2014, December 31, 2013 and December 31, 2012 was approximately $0.4 million, $0.5 million and $0.4 million, respectively.
6. Employee Benefit Plans
Retirement Savings Plan
The Company maintains an employee savings and retirement plan which is qualified under Section 401(k) of the Internal Revenue Code and is available to substantially all full-time employees of the Company. The plan provides for tax deferred salary deductions and after-tax employee contributions. Contributions include employee salary deferral contributions and beginning in 2012, matching employer contributions. Employer matching contributions were $0.2 million for the years ended December 31, 2014 and 2013, respectively, and $0.4 million for the year ended December 31, 2012.
Employee Stock Purchase Plan
In May 2012, the Company's Board of Directors and shareholders approved an Employee Stock Purchase Program (“ESPP”) to provide an opportunity for all employees to purchase the Company's common stock through accumulated payroll deductions. The Company's ESPP authorizes up to 100,000 shares to be granted. The per share price of the Company's common stock purchased pursuant to the ESPP is 95% of the fair market value of the common stock on the last day of the offering period. The ESPP has two six month offering periods beginning September 1 and March 1. The number of shares issued under our ESPP was 2,333 shares as of December 31, 2014.
7. Common Stock and Stock Compensation
Stock Repurchase Program
On June 17, 2013, the Company announced the commencement of a modified Dutch tender offer to repurchase up to 400,000 shares of its common stock at a price of not less than $12.00 nor greater than $14.00 per share. The Company's Board of Directors determined it was in the best interest of its stockholders to repurchase shares at that time given its cash position and stock price and the likelihood that the Company's common stock may be removed from the Russell 2000 Index. The Company was subsequently removed from the Russell 2000 Index on June 28, 2013. The tender offer expired on July 15, 2013. Pursuant to the terms of the tender offer, the Company purchased 53,884 shares at $14.00 per share for a total cost of $0.8 million, excluding fees and expenses related to the tender offer. These shares represented approximately 0.81% of the shares outstanding as of July 15, 2013.
Equity Incentive Plans
In December 2007, the Company's stockholders approved the 2007 Equity Incentive Plan (“2007 Plan”). The 2007 Plan replaced the Company's 1998 Stock Plan (the “1998 Plan”) and the 1999 Director Option Plan (the “Directors' Plan”), collectively referred to as the “Equity Plans.” The Equity Plans will continue to govern awards previously granted under each respective plan. There were initially 525,000 shares of common stock reserved for issuance under the 2007 Plan, subject to increase for stock options or awards previously issued under the Equity Plans which expire, cancel or are forfeited. In May 2011, the Company's stockholders approved the addition of 200,000 shares of common stock available for issuance under the 2007 Plan. At December 31, 2014, a total of 118,455 shares of common stock were available for issuance under the 2007 Plan.
In May 2012 at the Annual Meeting of Stockholders, the stockholders approved an amendment to the 2007 Plan. The 2007 Plan was amended to change the way restricted stock unit grants reduce the number of shares available for issuance under the 2007 Plan. Prior to the amendment, for each grant or forfeiture of a restricted stock unit, the number of shares available for issuance under the 2007 Plan decreased or increased by two. The amendment changed this 2:1 ratio to a 1:1 ratio.
Options granted under the 2007 Plan must be issued at a price equal to at least the fair market value of the Company’s common stock on the date of grant. All vested stock options under the 2007 Plan may be exercised at the earlier of within 10 years of the date of grant or within 90 days of termination of employment, or such other time as may be provided in the stock option agreement, and vest as determined by the Board of Directors, typically over a three year period. The Company’s policy is to issue new shares upon exercise of options or vesting of Restricted Stock Units ("RSUs") under the 2007 Plan.
Stock Options
The following table summarizes option activities from December 31, 2013 through December 31, 2014:
The total intrinsic value of options exercised was insignificant for the years ended December 31, 2014 and 2013, respectively, and $0.1 million for the year ended December 31, 2012. The Company issues new shares upon the exercise of options. The weighted-average grant date fair value was $4.05, $6.11 and $7.42 for the years ended December 31, 2014, 2013 and 2012, respectively. The total cash received from stock option exercises was insignificant for the year ended December 31, 2014, and $0.3 million and $0.4 million for the years ended December 31, 2013 and 2012, respectively. No tax benefit was realized from exercised options for the years ended December 31, 2014, 2013 and 2012, respectively.
The fair value of the option grants has been calculated on the date of grant using the Black-Scholes option pricing model. The expected life was based on historical settlement patterns. Expected volatility was based on historical implied volatility in the Company’s stock. The interest rate for periods within the contractual life of the award is based on the U.S. Treasury yield curve in effect at the time of grant. The following table summarizes the weighted-average assumptions for stock options granted:
Restricted Stock
RSUs granted to employees typically vest over a three year period. RSUs granted to non-employee directors typically vest on the same day of the grant and represent compensation for serving on the Company's Board of Directors. The following table summarizes restricted stock activities from December 31, 2013 through December 31, 2014:
Stock-Based Compensation Expense
The following table summarizes stock-based compensation expense as recorded in the Consolidated Statements of Operations (in thousands):
The stock-based compensation expense for the year ended December 31, 2014, is net of insignificant amounts capitalized to internal-use software.
As of December 31, 2014, total compensation cost not yet recognized and the weighted-average remaining term is as follows ($ in thousands):
8. Computation of Per Share Amounts
The following table presents the calculation of basic and diluted earnings per share (in thousands, except per share data):
The following potential common shares have been excluded from the calculation of diluted earnings per share for all periods presented because they are anti-dilutive (in thousands):
9. Income Taxes
The Company provides for income taxes using an asset and liability approach, where deferred income taxes are provided based upon enacted tax laws and rates applicable to periods in which the taxes become payable. The Company is subject to taxation in the U.S. and various states and foreign jurisdictions. With few exceptions, as of December 31, 2014, the Company is no longer subject to U.S. federal, state, local, or foreign examinations by tax authorities for years before 2010.
(Loss) income from continuing operations before income taxes consists of the following components (in thousands):
During the years ended December 31, 2014 and 2013, the Company did not pay income taxes. During the year ended December 31, 2012, the Company paid income taxes of $0.1 million.
The components of the income tax provision from continuing operations, by classification, included in the accompanying Consolidated Statements of Operations is as follows (in thousands):
As part of the acquisition of Treehouse, the Company acquired indefinite lived intangible assets which will be amortized for income tax purposes and result in a net operating loss that has a finite carryforward period. The amortization also results in a deferred tax liability that will not reverse until some indefinite future period when the asset is either sold or written down due to impairment. As such, this deferred tax liability is not netted against the Company's deferred tax assets when determining the amount of valuation allowance that should be recorded.
Deferred tax assets and liabilities consist of the following (in thousands):
Consistent with historical practice, the Company continues to fully reduce the federal and state net operating loss carryforwards and all other deferred tax assets by a valuation allowance. This is due to the conclusion that it is more likely than not that the Company would not recover the deferred tax assets because of uncertainties about the Company's ability to generate taxable income in the future.
The amount of federal net operating losses available to offset taxable income in 2015 and beyond as of December 31, 2014 is $29.2 million. Of this amount, utilization of approximately $16.4 million of the net operating losses are subject to an annual limitation due to a change in control as defined by Section 382 of the Internal Revenue Code that occurred in 2008. Additionally, approximately $1.2 million of the net operating loss carryforwards have not been recognized as they related to benefits associated with stock option exercises that have not reduced current taxes payable.
The federal net operating losses expire between 2023 and 2034. The Company's state net operating losses begin to expire in 2017. The net operating loss carryforwards stated above are reflective of various federal and state tax limitations. As of December 31, 2014 and December 31, 2013, the Company has federal research and development credit carryforwards of $1.5 million and $1.1 million, respectively, which expire between 2028 and 2034. These credits are presented net of the related unrecognized tax benefit.
Reconciliation of the federal statutory income tax rate to the Company’s effective income tax rate on (loss) income from continuing operations is as follows:
A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in thousands):
The Company classifies interest expense and penalties related to unrecognized tax benefits and interest income on tax overpayments as components of its income tax expense. No interest or penalties were recognized during the years ended December 31, 2014, 2013 and 2012, respectively. The Company does not expect its unrecognized tax benefits to change significantly over the next 12 months. There are no unrecognized tax benefits that would affect the actual tax rate at December 31, 2014, as a full valuation is recorded on the deferred tax assets.
10. Discontinued Operations
Media Business
On September 17, 2012, Geeknet, Inc. entered into a purchase agreement with Dice Holding's Inc. ("Dice") and two of Dice’s subsidiaries, (collectively, the “Buyers”) pursuant to which the Buyers purchased the Company’s Media business segment, including the SourceForge, Slashdot and Freecode websites and assumed certain related liabilities.
In accordance with the terms of the purchase agreement, the Buyers paid $20.0 million in cash to the Company. The purchase agreement contained customary representations, warranties and covenants, and the indemnification thereof. The purchase agreement generally limited the Company's liability for breaches of representations and warranties made in the purchase agreement to an aggregate of $10.0 million. The Company's representations and warranties made under the purchase agreement generally expired on September 17, 2013, although certain representations, warranties and covenants survive pursuant to the terms of the purchase agreement.
The following shows revenues, gross profit and (loss) income from discontinued operations, net of tax from discontinued operations:
Gross profit and (loss) income from discontinued operations do not include allocated corporate costs that were previously allocated to the Company's Media segment. The $13.7 million gain on the sale of the Media business is the selling price of $20.0 million less the carrying value of certain assets and liabilities assumed by the Buyers, offset by transaction costs of $1.1 million. The carrying value of the total assets and total liabilities included in the purchased business were $8.3 million and $3.1 million, respectively.
The income tax benefit for the year ended December 31, 2013 represents federal and state tax receivables as a result of overpayments. The tax provision recorded on discontinued operations for the year ended December 31, 2012 represents the tax based upon the with and without method. The 2012 tax provision is significantly lower than the statutory rate as a result of net operating losses recognized with a full valuation allowance.
11. Segment and Geographic Information
The Company has three operating segments: Website, Wholesale, and ThinkGeek Solutions. The ThinkGeek Solutions operating segment has been aggregated into the Website reportable segment. The Website segment sells geek-themed retail products and video game-themed merchandise to technology enthusiasts and general consumers through the ThinkGeek website and through the ThinkGeek Solutions web-stores. The Wholesale segment has higher gross margins, as it primarily sells exclusive higher margin GeekLabs products to brick-and-mortar retailers. Prior to the sale of the Company's Media business on September 17, 2012, the Company had two operating segments that offered different products and services, e-Commerce and Media. The Media segment was discontinued in 2012 when it was sold.
The accounting policies of the reportable segments are consistent with those described in the summary of significant accounting policies. The majority of costs are specifically identifiable to each segment. However, where costs are not specifically identifiable, they are allocated based on the ratio of segment product costs to total product costs. The Company's chief decision-making group is the Chief Executive Officer and the Chief Financial Officer. The Company's accounts receivables are primarily related to the Wholesale segment. Other than inventory, the Company's assets and liabilities are not allocated or reviewed by the chief decision-making group on a segment basis. Beginning in the first quarter of 2014, the Company began identifying inventory that was dedicated exclusively to the Wholesale segment which was approximately $1.5 million as of December 31, 2014.
The Company's products are sold in the United States and internationally. Net revenues derived from international orders were $29.9 million, $26.8 million, and $23.9 million for the years ended December 31, 2014, 2013, and 2012, respectively.
12. Quarterly Financial Information
Quarterly Consolidated Financial Data
(Unaudited, in thousands, except per share amounts)
The Company’s quarters end on March 31, June 30, September 30 and December 31 of each calendar year. You should read the following tables presenting our quarterly results of operations in conjunction with the consolidated financial statements and related notes included in Item 8 of this Form 10-K. We have prepared the unaudited information on the same basis as our audited consolidated financial statements.
The Company's sales are highly seasonal, reflecting the general pattern associated with the retail industry of peak sales and earnings during the holiday shopping season. As a result, a substantial portion of the 2014 and 2013 revenue occurred in the fourth quarter, which began on October 1 and ended on December 31. As is typical in the retail industry, the Company generally experiences lower revenue during the other quarters. Therefore, the revenue in a particular quarter is not necessarily indicative of future revenue for a subsequent quarter or a full year.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
The Company's management, including the Company's Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934), as amended, as of December 31, 2014. Disclosure controls are controls and procedures designed to provide reasonable assurance that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods prescribed by SEC rules and regulations, and that such information was accumulated and communicated to our management to allow timely decisions regarding required disclosure.
Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of December 31, 2014 our disclosure controls and procedures were effective in providing reasonable assurance that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934 was recorded, processed, summarized and reported within the time periods prescribed by SEC rules and regulations, and that such information was accumulated and communicated to our management to allow timely decisions regarding required disclosure.
A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system's objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.
(b) Management's Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting and for the assessment of the effectiveness of internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended. In connection with the preparation of the Company's annual financial statements, management has undertaken an assessment of the effectiveness of the Company's internal control over financial reporting as of December 31, 2014 based on criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO"). Based on our assessment we believe that our internal control over financial reporting is effective as of December 31, 2014, based on those criteria. On August 1, 2014, the Company acquired substantially all of the assets and certain liabilities of Treehouse Brand Stores, LLC ("Treehouse"), and management excluded from its assessment of the effectiveness of the Company's internal control over financial reporting as of December 31, 2014, Treehouse's internal control over financial reporting associated with total assets of approximately $3.6 million and total revenues of approximately $5.4 million included in the consolidated financial statements of the Company as of and for the year ended December 31, 2014.
Our independent registered public accounting firm, KPMG LLP, has issued an audit report on the effectiveness of our internal controls over financial reporting as of December 31, 2014, which is included in this Form 10-K.
(c) Changes in Internal Control over Financial Reporting and Remediation
As a result of management’s evaluation of our internal control over financial reporting, we believe that our internal control over financial reporting was effective as of December 31, 2014. Management had previously identified and disclosed a material weakness in internal control over financial reporting relating to ineffective process level controls
impacting the existence and accuracy of accrued liabilities and cost of revenue, as well as ineffective monitoring and management oversight over the process level controls related to the inventory purchase order accrual.
To remediate this material weakness, we implemented changes in our internal control over financial reporting in accordance with our remediation plan. During 2014, we undertook the implementation of our integrated ERP system in two phases to improve our internal controls:
•
Phase One included the implementation of the core general ledger, accounts payable and fixed asset modules. This provided us with improved visibility into transactions including our accounts payable and receivable; improved sales order approval processes to generate wholesale billing; and direct linkage to our budgeting application to improve our periodic budget to actual analyses.
•
Phase Two included the implementation of inventory control and warehouse management. This improved our ability to accurately account for on-hand and in-transit inventory. This enabled us to capture our inventory activity from the creation of vendor purchase orders to the receipt of products into inventory to the shipment of products to wholesale and retail customers. In conjunction with Phase Two of the implementation, the accrual for goods received but not yet invoiced was automated so that it is recorded when inventory is received and relieved when invoices are paid.
The new processes and related controls added as a result of the two phases of our ERP implementation have been fully operational since August 1, 2014. We believe that these changes have strengthened our internal control over financial reporting and coupled with their operation over a sufficient period of time subsequent to full implementation on August 1, 2014 have remediated the material weakness we previously identified.
Item 9B.
Item 9B. Other Information
Annual Meeting of Stockholders
The annual meeting of stockholders for 2015 is scheduled to be held on May 6, 2015. Under our bylaws as currently in effect, notices of stockholder proposals must be received no earlier than 120 days and no later than 90 days prior to the first anniversary the date of the 2014 annual meeting in order to be timely. Accordingly, notices of stockholder proposals with respect to the 2015 annual meeting of stockholders must have been received no earlier than January 7, 2015, and no later than February 6, 2015, in order to be timely.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
The information called for by this item is incorporated by reference to the sections entitled “Certain Beneficial Owners,” “Security Ownership of Directors and Executive Officers” and “Information About The Directors, Nominees And Executive Officers” in the Company’s 2015 Proxy Statement, which will be delivered to stockholders in connection with the Company’s annual stockholders’ meeting to be held on May 6, 2015.
Code of Ethics
In addition to the Company’s Code of Business Conduct and Ethics that is applicable to all employees and directors, the Company has adopted a Code of Ethics for Principal Executive and Senior Financial Officers. The Company has posted the text of its Code of Ethics for Principal Executive and Senior Financial Officers on its Internet website at: investors.geek.net/governance.cfm
We will post on this section of our website any amendment to our Code of Ethics for Principal Executive and Senior Financial Officers that are required to be disclosed by the rules of the SEC or The NASDAQ Stock Market.
Item 11.
Item 11. Executive Compensation
The information called for by this item is incorporated by reference to the section entitled “Compensation of Directors and Executive Officers” in the Company’s 2015 Proxy Statement, which will be delivered to stockholders in connection with the Company’s annual stockholders’ meeting to be held on May 6, 2015.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Equity Compensation Plans
The information called for by this item is incorporated by reference to the sections entitled “Certain Beneficial Owners” and “Security Ownership of Directors and Executive Officers” in the Company’s 2015 Proxy Statement, which will be delivered to stockholders in connection with the Company’s annual stockholders’ meeting to be held on May 6, 2015.
The following table summarizes our equity compensation plans as of December 31, 2014, all of which have been approved by our stockholders:
______________________
(1)
All options outstanding are under the Company’s 2007 Equity Incentive Plan.
(2)
Does not include 110,764 restricted stock units outstanding under the Company's 2007 Equity Plan.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information called for by this item is incorporated by reference to the section entitled “Certain Relationships and Related Transactions” in the Company’s 2015 Proxy Statement, which will be delivered to stockholders in connection with the Company’s annual stockholders’ meeting to be held on May 6, 2015.
Item 14.
Item 14. Principal Accounting Fees and Services
The information called for by this item is incorporated by reference to the section entitled “Principal Accountant Fees and Services” in the Company’s 2015 Proxy Statement, which will be delivered to stockholders in connection with the Company’s annual stockholders’ meeting to be held on May 6, 2015.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedule
(a)
The following documents are filed as part of this report:
All Financial Statements:
See the Consolidated Financial Statements and notes thereto in Item 8 above.
Schedule II - Valuation and Qualifying Accounts are filed as part of this Form 10-K.
Exhibits:
See the Exhibit Index.
(b)
Exhibits: We have filed, or incorporated into this Report by reference, the exhibits listed on the accompanying Exhibit Index immediately following the signature page to this Form 10-K.
(c)
Financial Statement Schedules: See Item 15(a) above.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
GEEKNET, INC.
By:
/s/ Kathryn K. McCarthy
Kathryn K. McCarthy
President, Chief Executive Officer
By:
/s/ Julie Pangelinan
Julie Pangelinan
Executive Vice President, Chief Financial Officer
Date: February 23, 2015
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below hereby constitutes and appoints Kathryn K. McCarthy and Julie Pangelinan, and each of them, his true and lawful attorneys-in-fact, each with full power of substitution, for him and all capacities, to sign any amendments to this report on Form 10-K and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission and does hereby ratify and confirm all that each of said attorneys-in-fact or their substitute or substitutes may do or cause to be done by virtue hereof.
Pursuant to the requirement of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
GEEKNET, INC.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
(In thousands)
_______________________
‡ Denotes a management contract or compensatory plan or arrangement.