GEEKNET, INC - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations

(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis should be read in conjunction with "Selected Consolidated Financial Data" and our 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 Part I - Item 1 - "Special Note Regarding Forward-Looking Statements." Overview We sell technology-themed retail products for technology enthusiasts and general consumers through our ThinkGeek.com website and to our wholesale channel customers. We offer a broad range of unique products in a single web property that are not available in traditional brick-and-mortar stores. We introduce a range of new products to our audience on a regular basis and sell our own innovative GeekLabs products developed in-house. We have several wholesale partnerships with brick and mortar retailers that allow us to reach a new consumer audience and expand our unique brand. We have recently established and strengthened existing partnerships with certain retail store chains that have hundreds of locations throughout the United States and Canada.

Prior to September 17, 2012, we had two operating segments: e-Commerce and Media. e-Commerce sells technology-themed retail products for technology enthusiasts and general consumers through our ThinkGeek.com website and to our wholesale channel customers. Our Media segment provided web properties that served as platforms for the creation, review and distribution of online peer produced content, using our Media websites, SourceForge, Slashdot, and Freecode.

On May 11, 2012, we announced that our Board of Directors was exploring strategic alternatives with respect to our Media business, including the SourceForge, Slashdot and Freecode websites. We, along with our advisers, evaluated a range of options to maximize shareholder value, including, but not limited to, selling the Media business. We received bids from various organizations interested in purchasing the Media business and reviewed each one carefully with our advisers.

On September 17, 2012 (the "Closing Date"), we entered into an Asset Purchase Agreement (the "Purchase Agreement") with Dice Holdings, Inc. ("Dice") and two of Dice's subsidiaries, Dice Career Solutions, Inc. and eFinancialCareers Limited (collectively, the "Buyers") pursuant to which the Buyers purchased our Media business, including the SourceForge, Slashdot and Freecode websites (the "Purchased Business") and assumed certain related liabilities.

Our Board of Directors and management believe that selling the Media business will allow us to focus our business strategy on growing and improving our e-Commerce business and our ThinkGeek sourced and custom developed products. We believe the proceeds generated from the sale of the Media business and management's ability to solely focus on our core e-Commerce business will result in a positive impact to our future business strategy.

In accordance with the terms of the Purchase Agreement, the Buyers paid us $20.0 million in cash, of which $3.0 million was deposited by the Buyers into an escrow account for a period of twelve months after the Closing Date in order to secure our indemnification obligations to the Buyers for breaches of our representations, warranties, covenants and other obligations under the Purchase Agreement.

The Purchase Agreement contains customary representations, warranties and covenants. Subject to certain exceptions and limitations, each party has agreed to indemnify the other for breaches of representations, warranties and covenants and other specified matters. The Purchase Agreement generally limits the Company's liability for breaches of representations and warranties made in the Purchase Agreement to an aggregate of $10.0 million. The Purchase Agreement also contains covenants requiring us not to solicit or hire certain employees of the Buyers or 18-------------------------------------------------------------------------------- Table of Contents compete with the Purchased Business for a period of three years. We have also agreed with Dice to provide certain transition services to one another through December 31, 2013.

ThinkGeek's 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, and to increase traffic to our site and customer conversion. We attract traffic to our site by using a variety of traditional online and direct retail marketing channels including paid search and e-mail to our customers and followers. We continue to use the capabilities of the internet, including social networking sites such as Facebook, Twitter and YouTube, to increase brand awareness and to communicate with our customers.

Our ThinkGeek 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 ThinkGeek revenue has occurred in the fourth quarter ending December 31. As is typical in the retail industry, we generally experience lower monthly revenue during the first nine months of the year.

Each year we initiate programs and promotions to attract additional customers and increase sales from our existing customer base. This year we enhanced our Geek Points program by making the program more flexible for our customers and in the first half of 2013 we will be modifying this program. We ran special programs to discount certain products and product lines and we offered free shipping and discounted shipping days. We regularly send direct marketing e-mails to our customers and we increase the number of e-mails and promotions during the fourth quarter in preparation for the holiday season. We also utilize Facebook, Twitter and YouTube to generate interest in our new product launches.

We expect to continue to expand and diversify our sales and marketing programs next year.

During the first quarter of 2013, we restructured certain areas of the business and hired three new members of the senior leadership team. These changes will impact our operations beginning in the first quarter of 2013. We look forward to the knowledge, creativity, experience and passion these talented individuals will bring to the business.

We currently use the following key metrics to measure our e-Commerce business: Year Ended December 31, 2012 2011 2010 Daily unique visitors (in thousands) (1) 89,330 73,076 53,111 Number of orders received (in thousands) (2) 2,010 1,640 1,239 Conversion rate 2.25 % 2.24 % 2.33 % Average order value received (3) $ 61.10 $ 61.51 $ 63.74 Number of orders shipped (in thousands) (4) 2,011 1,707 1,303 Average order value shipped (5) $ 59.13 $ 58.04 $ 58.59 (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 website to help us determine the effectiveness of our online marketing efforts.

(2) The number of orders received represents all orders placed on the ThinkGeek website during each period shown and does not necessarily correlate to revenue recognized during the period. For example, some orders placed on the ThinkGeek website at the end of a reporting period are recognized as revenue in the subsequent reporting period because delivery had not yet occurred.

(3) Average order value received or shipped is calculated by the total sales for orders received or shipped divided by the number of orders received or shipped. Average order value can vary depending on, but not limited to, seasonality, promotions, the number of volume sales in a given period, the competitive environment and economic conditions.

(4) The number of orders shipped represents all orders associated with the amount of revenue recognized for ThinkGeek for the period presented.

(5) Wholesale channel sales contributed to the total average order value shipped. Excluding wholesale channel sales, average order value shipped for ThinkGeek website orders was $56 and $55 for the years ended December 31, 2012 and 2011. Wholesale channel sales were insignificant compared to total sales during 2010 and therefore did not have a meaningful impact on average order value shipped for the year ended December 31, 2010.

19-------------------------------------------------------------------------------- Table of Contents Critical Accounting Policies 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 normally 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, areas that are particularly significant include revenue recognition, inventories, the assessment of impairment of long-lived assets, stock-based compensation and discontinued operations.

Basis of Presentation The results of our Media business, which was sold on September 17, 2012, are classified as discontinued operations for the years ended December 31, 2012, 2011 and 2010 in the Company's Consolidated Statement of Operations. The results include Media business revenues, cost of sales and operating and non operating expenses, excluding general corporate costs. Also included as discontinued operations for the year ended December 31, 2010 are the results from the sale of the Company's Geek.com business. 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.

The assets and liabilities related to the Media business are included in their respective sections on the December 31, 2011 Consolidated Balance Sheet as they did not meet the criteria for classification as assets held for sale at that date.

During the fourth quarter of 2012, we reviewed our accounting treatment for accruing liabilities for our Geek Points loyalty program. We performed an analysis on the costs incurred for redeeming the Geek Points using historical data and determined that the liabilities were understated at the end of each of the reporting periods presented. Although the impact of the adjustments is immaterial, we adjusted our consolidated financial statements for all prior periods presented.

Net Revenue Net revenue is derived from the online sale of consumer goods and through our wholesale channel. Net revenues are presented net of sales tax. We recognize revenue from consumer goods when persuasive evidence of an arrangement exists, delivery has occurred, the sale price is fixed or determinable, and collectibility is reasonably assured. 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 historical experiences of shipping transit times for domestic and international orders using different carriers. On average, shipping transit times are approximately one to six business days. As of December 31, 2012 and December 31, 2011, $1.3 million and $0.9 million, respectively, was recognized as deferred revenue for orders placed at the end of the reporting period, but not yet delivered.

We also engage in the sale of gift certificates. When a gift certificate is sold, revenue is deferred until the certificate is redeemed and the products are delivered. Deferred revenue at December 31, 2012 and December 31, 2011 relating to gift certificates was $1.0 million and $0.7 million, respectively.

We reserve an amount for estimated returns at the end of each reporting period.

We generally give customers a 90-day right to return products. These estimates are based on historical trends of amounts returned per revenue for a period.

Reserves for returns at December 31, 2012 and December 31, 2011 were $0.5 million and $0.7 million, respectively, and are recorded as accrued liabilities and other in the consolidated balance sheets.

We voluntarily ceased selling a product in July 2012 because of safety concerns.

We are offering our customers who have purchased this product, the opportunity to return the product in exchange for a ThinkGeek 20-------------------------------------------------------------------------------- Table of Contents credit. As of December 31, 2012, we issued an insignificant amount of credits.

We believe the reserves for returns at December 31, 2012 to be adequate.

Inventories Inventories consist solely of finished goods that are valued at the lower of cost, using the weighted average cost method, or market. We review inventories each quarter and, when required, reduce estimated excess and obsolete inventories to their net realizable values.

Long-Lived Assets We continually evaluate whether events and circumstances have occurred that indicate the remaining estimated useful life of long-lived assets may warrant revision or that the remaining balance of long-lived assets may not be recoverable. When factors indicate that long-lived assets should be evaluated for possible impairment, we use an estimate of the related undiscounted future cash flows over the remaining life of the long-lived assets in measuring whether they are recoverable. If the carrying value of the asset exceeds the estimated undiscounted future cash flows, a loss is recorded as the excess of the asset's carrying value over fair value. Long-lived assets and certain identifiable intangible assets to be disposed of are reported at the lower of carrying amount or fair value less costs to sell.

Geek Points Loyalty Program 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 trends, adjusted for known modifications to the program that will occur in the future. The cost of the redemptions is included in cost of revenues on the Company's consolidated statements of operations.

Stock-Based Compensation We measure compensation cost for stock awards at grant date fair value and recognize 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 our 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.

We estimate the forfeiture rate based on historical trends of our stock-based awards that cancel.

Income Taxes The Company has recognized a deferred tax asset associated with previously reported net operating losses, which can result in a future tax benefit. 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 sanctioned by Internal Revenue Code Section 382 on the use of net operating loss carryforwards.

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.

Contingencies and Litigation 21-------------------------------------------------------------------------------- Table of Contents We are subject to proceedings, lawsuits and other claims. We assess the likelihood of any adverse judgments or outcomes to these matters as well as ranges of probable losses. A determination of the amount of any loss contingency required is assessed and recorded, if probable, after careful analysis of each individual matter. The required loss contingencies may change in the future as the facts and circumstances of each matter change.

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.

Year Ended December 31, 2012 2011 2010 Consolidated Statements of Operations Data: Net revenue 100.0 % 100.0 % 100.0 % Cost of revenue 82.3 84.4 82.6 Gross margin 17.7 % 15.6 % 17.4 % Operating expenses: Sales and marketing 7.7 8.8 9.1 Technology and design 3.3 1.9 2.0 General and administrative 8.4 9.6 11.9 Total operating expenses 19.4 % 20.3 % 23.0 % Loss from operations (1.7 ) (4.7 ) (5.6 ) Gain on sale of non-marketable securities 3.4 - - Interest and other income (expense), net (0.1 ) - 0.1 Income (loss) from continuing operations before income taxes 1.6 (4.7 ) (5.5 ) Income tax provision (benefit) - (1.1 ) 0.1 Net income (loss) from continuing operations 1.5 % (3.5 )% (5.6 )% Income from discontinued operations, net of tax 10.2 % 2.0 % (0.8 )% Net income (loss) 11.7 % (1.5 )% (6.4 )% Net Revenue Net revenue is derived from the sale of consumer goods at retail on our ThinkGeek website and from our wholesale channel, and includes shipping, net of returns and allowances. These consumer goods are typically electronics, gadgets, apparel, edibles, geek-themed and other specialty or unique items. Our customers are primarily technology enthusiasts and general consumers. We sell and ship our products domestically and internationally.

Year Ended December 31, Year Ended December 31, 2012 2011 % Change 2011 2010 % Change ($ in thousands) Net revenue $ 118,913 $ 99,057 20 % $ 99,057 $ 76,335 30 % We experienced significant growth in net revenue during the years ended December 31, 2012 and December 31, 2011 as compared to their respective prior year periods. This is primarily due to an increase in the number of orders placed through our ThinkGeek website and an increase in revenue through our wholesale channel.

Our orders have grown year over year primarily due to heightened consumer awareness of our web site as a result of more advertising, diversified product offerings and the increase and variety of promotions offered to our customers.

During 2012, we introduced a number of new products that included unique products developed in our GeekLabs. Our internally developed Minecraft Foam Pickaxe and Minecraft Foam Sword were best sellers throughout 22-------------------------------------------------------------------------------- Table of Contents the year. Also our GeekLabs product, Star Trek Pizza Cutter, continues to be a popular item. Other best selling GeekLabs products include Portal themed products, LED Iron Man shirt and Star Wars family car decals. Other popular products this year were the Bag of Holding Messenger bag, DIY guitar pick punch, Star Wars lightsaber, bathrobe products and Doctor Who-themed products. During 2011, new products such as the i-CADE ,the Joystick-IT, the Han Solo Carbonite Chocolate Bar, the Portal Plush Turret and items inspired by the popular TV show DEXTER were introduced. We are licensed to sell our unique GeekLabs products that have themes such as StarWars, StarTrek or Minecraft through the relationships we have with Lucas Films, CBS and Mojang, respectively.

The number of unique visitors increased 22% during the year ended December 31, 2012, as compared to the year ended December 31, 2011 and the number of unique visitors increased 38% during the year ended December 31, 2011 , as compared to the year ended December 31, 2010. The higher volume of visitors is primarily due to our efforts to increase consumer awareness of our ThinkGeek website through media coverage and advertising.

Wholesale revenue to retailers and brick and mortar stores increased $1.5 million during the year ended December 31, 2012, as compared to the year ended December 31, 2011. These stores include chain stores with a strong presence in malls across the country and in Canada and free standing retail stores. Some of our current wholesale clients are f.y.e., HMV, Books-A-Million and Urban Outfitters. We also partnered with Old Navy for a custom version of the Electronic Rock Guitar shirt during the 2011 holiday season. The ThinkGeek sales team continues to strengthen relationships with our existing wholesale clients and acquire new clients who have particular interest in ThinkGeek products.

ThinkGeek products are sold in the U.S. and internationally. Approximately 86%, 86% and 82% of sales were made to customers in the US in 2012, 2011 and 2010 respectively. We have been focusing on increasing ThinkGeek awareness in other countries and increasing our ability to ship to other countries.

We continue to diversify our product offerings by introducing new products, including our innovative GeekLabs products and expanding licensing partnerships.

We also are working to continually improve our ThinkGeek website. We have developed enhancements that include improved product search capabilities, easier navigation in the website, and a smoother check-out process. In 2011, we developed our mobile site allowing our customers to access our website from numerous new channels such as tablets and smart phones.

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.

Year Ended December 31, Year Ended December 31, 2012 2011 % Change 2011 2010 % Change ($ in thousands) Cost of revenue $ 97,848 $ 83,602 17 % $ 83,602 $ 63,036 33 % Gross margin $ 21,065 $ 15,455 36 % $ 15,455 $ 13,299 16 % Gross margin % 18 % 16 % 16 % 17 % Cost of revenues increased $14.2 million during the year ended December 31, 2012, as compared to the year ended December 31, 2011 primarily due to an increase in product costs of $13.1 million and packaging and fulfillment costs of $2.4 million, partially offset by a lower expense of $0.9 million related to a reduction of our Geek Points liability and a lower expense of $0.3 million due to a rebate received from a vendor . The aforementioned increases were due to the increase in revenues and number of orders. Royalties increased due to a higher volume of sales of our licensed product lines. Our Geek Points liability decreased due to management's decision to modify the Geek Points loyalty program in the first half of 2013.

Cost of revenues increased $20.6 million during the year ended December 31, 2011, as compared to year ended December 31, 2010 primarily due to an increase in product costs of $13.4 million, shipping costs of $3.6 million, fulfillment and packing costs of $1.9 million, and merchandising and customer support costs of $1.0 million. These increases were due to the increase in revenues and number of orders. Fulfillment costs were also higher due to the start-up costs related to moving to a new fulfillment center. The increase in merchandising and customer support costs was also due to increased personnel required to support our broader product offering.

23-------------------------------------------------------------------------------- Table of Contents Gross margin as a percentage of revenues increased by two percentage points due to a decrease in seventeen full-time equivalents ("FTEs"). During the first quarter of 2012, we began outsourcing our customer service department, which reduced FTEs. We also redirected certain of our workforce from merchandising, included as cost of revenue, to developing our own innovative products in our GeekLabs, included in technology and design. Also contributing to better margins is our efforts to reduce shipping costs due to renegotiations with our largest shipping supplier.

Gross margin percentage for the year ended December 31, 2011 decreased from the year ended December 31, 2010 due to higher customer discounts as well as increased inbound shipping costs, fulfillment costs and merchandising and customer support costs. The higher customer discounts were primarily due to decisions to discontinue certain products in the second and third quarters of 2011 to prepare for the peak holiday season and apparel promotions during the holiday season.

We are continually analyzing gross margins by the 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 product, materials and in-bound shipping costs.

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.

Year Ended December 31, Year Ended December 31, 2012 2011 % Change 2011 2010 % Change ($ in thousands) Sales and marketing $ 9,184 $ 8,681 6 % $ 8,681 $ 6,910 26 % Percentage of total net revenue 8 % 9 % 9 % 9 % Sales and marketing expenses increased $0.5 million for the year ended December 31, 2012 as compared to the year ended December 31, 2011 primarily due to an increase of $0.7 million in personnel and related overhead expenses because of an average of five additional full-time equivalents in our marketing workforce as compared to prior year and severance costs of $0.1 million. Also contributing to the increase is $0.1 million in marketing services and public relations costs used to increase brand awareness and traffic to our website. This increase was partially offset by a decrease of $0.4 million in marketing expenses primarily due our decision to discontinue printing large catalogs.

Sales and marketing expense increased $1.8 million for the year ended December 31, 2011 as compared to the year ended December 31, 2010 primarily due to increases in marketing expenses of $0.7 million, credit card fees of $0.5 million and direct labor expenses of $0.5 million. The increase in discretionary marketing expenses was primarily due to an increase of $0.4 million in paid affiliate fees and $0.2 million increase in promotional materials. The increase in credit card fees was due to an increase in our revenue.

Technology and Design Expenses During the fourth quarter of 2012, we changed the name of our Research and Development department to Technology and Design. We believe that the name Technology and Design conforms to similar naming conventions used in our industry for similar activities. 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. We expense all of our technology and design costs as they are incurred.

24-------------------------------------------------------------------------------- Table of Contents Year Ended December 31, Year Ended December 31, 2012 2011 % Change 2011 2010 % Change ($ in thousands) Technology and design $ 3,968 $ 1,857 114 % $ 1,857 $ 1,514 23 % Percentage of total net revenue 3 % 2 % 2 % 2 % Technology and design expense increased $2.1 million for the year ended December 31, 2012 as compared to the year ended December 31, 2011 primarily due to our increased focus on testing and developing our own GeekLabs innovative products.

We redirected certain of our workforce and hired new employees for our internal development center, GeekLabs, which resulted in an increase of $1.2 million in personnel and related overhead expenses. Also contributing to the increase are $0.2 million in fees related to developing prototypes of GeekLabs custom products and $0.4 million rent expense for equipment used in our new data recovery site built this year.

Technology and design expense increased $0.3 million for the year ended December 31, 2011 as compared to the year ended December 31, 2010 primarily due to an increase in labor costs.

General and Administrative Expenses General and administrative expenses consist of personnel and related expenses for finance and accounting, human resources, legal and safety and quality assurance, professional fees for accounting and legal services as well as insurance and other public company related costs.

During the second half of 2012, we transitioned our product safety and quality assurance function in-house. Prior to the transition we were using various third-party vendors to perform these services. We have invested in certified personnel, who are highly qualified in conducting safety and quality assurance testing. We also began the process of building a testing laboratory. We believe our investment will enable us to improve the quality of our products, minimize defective products, and continue to exceed industry standards.

Year Ended December 31, Year Ended December 31, 2012 2011 % Change 2011 2010 % Change ($ in thousands) General and administrative $ 10,001 $ 9,501 5 % $ 9,501 $ 9,093 4 % Percentage of total net revenue 8 % 10 % 10 % 12 % General and administrative expenses increased $0.5 million for the year ended December 31, 2012 as compared to the year ended December 31, 2011 primarily due to an increase in professional services fees of $0.4 million, an increase in business consulting services of $0.3 million and an increase of $0.2 million in stock-based compensation. These increases were partially offset by nonrecurring severance costs of $0.6 million that occurred in the prior year period primarily related to the resignation of our ThinkGeek Chief Executive Officer.

General and administrative expenses as a percentage of total net revenue improved by two percentage points in year ended December 31, 2012 as compared to the same prior year period primarily due to the significant investments in our ThinkGeek business and in our leadership that occurred in the prior year period as well as efficiencies gained from the move of our headquarters.

General and administrative expenses increased by $0.4 million for the year ended December 31, 2011 as compared to the year ended December 31, 2010 . This change was driven by investments in infrastructure to support growth including stock based compensation for key executives $1.4 million and $0.1 million of public relations costs, partially offset by a decrease in facilities costs of $0.7 million and a decrease in severance costs of $0.4 million.

Gain on Sale of Non-Marketable Securities 25-------------------------------------------------------------------------------- Table of Contents Year Ended December 31, Year Ended December 31, 2012 2011 % Change 2011 2010 % Change ($ in thousands) Gain on sale of non-marketable securities $ 4,021 $ - nm $ - $ - nm nm= not meaningful As of December 31, 2011, we owned approximately 9% of the outstanding capital stock of CollabNet, Inc. ("CollabNet"), which consist of shares of CollabNet's Series C-1 preferred stock. This investment was accounted for under the cost method as we held less than 20% of the voting stock of CollabNet and did not otherwise exercise significant influence over CollabNet.

On April 5, 2012, we sold our Series C-1 preferred stock investment in CollabNet, Inc. to a third party for $6.0 million. The carrying value of the investment at the time of the sale was $2.0 million and as such, a gain of $4.0 million was recognized during 2012. The carrying value of the investment was zero and $2.0 million at December 31, 2012 and December 31, 2011.

Interest and Other Income (Expense), Net Year Ended December 31, Year Ended December 31, 2012 2011 % Change 2011 2010 % Change ($ in thousands) Interest income $ 4 $ - nm $ - $ 63 (100 )% Other than temporary impairment - (8 ) (100 )% (8 ) (6 ) 33 % Other income (expense), net $ (126 ) 8 (1,675 )% 8 - nm Interest and other income (expense), net $ (122 ) $ - nm $ - $ 57 (100 )% nm= not meaningful Interest and other income (expense), net during the year ended December 31, 2012 primarily consisted of the write off of certain receivables, foreign currency gains and losses, penalties and credit facility fees, partially offset by other income.

Interest income decreased in the year ended December 31, 2011 as compared to the year ended December 31, 2010 as a result our decision to invest in short-term treasuries, which generally have lower yields. Other income (expense) decreased in the December 31, 2011 as compared to the year ended December 31, 2010, primarily due to realized losses on investments.

Income Taxes Year Ended December 31, 2012 2011 2010 ($ in thousands) Income tax provision (benefit) $ 6 $ (1,137 ) $ 98 The income tax benefit recognized in 2011 is offset by a tax provision in discontinued operations as there was a loss in continuing operations and income in discontinued operations in that same year. There was not a similar benefit in 2012 and 2010 as there was income or loss in both continuing and discontinuing operations in those years.

26-------------------------------------------------------------------------------- Table of Contents We have recently completed 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 ("IRC") in 2008. As a result of the change of control, certain net operating losses previously included in our deferred tax disclosures will not be available to offset future taxable income as the IRC limits the annual utilization of these carryforwards. Consistent with what we have done historically, 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 was more-likely-than-not that we would not recover the deferred tax assets because of management's uncertainties about our ability to generate taxable income in the future.

Our previously reported net operating loss carryforwards of $280.6 million as of December 31, 2011 will be limited to $49.9 million, of which $13.0 million will be utilized to offset taxable income in 2012. Also reducing the net operating loss carryforwards was $1.4 million of recognized built in losses. The amount of net operating losses available to offset taxable income in 2013 and beyond as of December 31, 2012 is $35.5 million.

This change in control also limits the amount of net operating loss carry-forwards available to offset future California taxable income. As of December 31, 2011, our previously reported net operating loss carryforwards of $76.2 million will be limited to $38.9 million, of which $2.0 million will be utilized to offset taxable income in 2012 with $36.9 million available to offset California taxable income in 2013 and beyond. The net operating losses not expected to be utilized in 2012 expire between 2013 and 2031.

Discontinued Operations, Net of Tax Year Ended December 31, 2012 2011 2010 ($ in thousands) (Loss) income from discontinued operations $ (1,509 ) $ 2,986 $ (805 ) Gain on sale of discontinued operations 13,712 $ - (55 ) Income tax provision (benefit) from discontinued operations 101 1,054 (265 ) Income (loss) from discontinued operations, net of tax $ 12,102 $ 1,932 $ (595 ) Due to the sale of our Media business on September 17, 2012, the results of the Media business are classified as (Loss) income on discontinued operations for the years ended December 31, 2012, 2011 and 2010. The results include Media business revenues, cost of sales and operating and non operating expenses, excluding general corporate costs and including tax effects.

On September 17, 2012, we entered into a Purchase Agreement with Dice pursuant to which the Buyers purchased our Media business, including the SourceForge, Slashdot and Freecode websites and assumed certain related liabilities. In accordance with the terms of the Purchase Agreement, the Buyers paid Geeknet $20.0 million in cash of which $3.0 million was deposited by the Buyers into an escrow account. 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 gain on disposal assumes a full recovery of the $3.0 million held in escrow.

The gain and results from discontinued operations for the year ended December 31, 2012 are subject to adjustments based upon final allocation of revenues and expenses to us and the Buyers. Final settlement of transition services will occur during 2013. The tax provision (benefit) recorded on discontinued operations for the years ended December 31, 2012, 2011 and 2010 represents the tax based upon the with and without. The 2012 tax provision is significantly lower than the statutory rate as a result of net operating losses with a full valuation allowance. The tax provision for 2011 is offset by a tax benefit in continuing operations. The 2010 tax benefit represents use of available tax credits.

Liquidity and Capital Resources 27-------------------------------------------------------------------------------- Table of Contents Year Ended December 31, ($ in thousands) 2012 2011 2010 Net cash (used in) provided by: Continuing operations Operating activities $ (1,883 ) $ 1,070 $ (3,083 ) Investing activities 21,787 (827 ) 7,214 Financing activities (849 ) 658 1,805 Discontinued operations 1,329 676 454Net increase in cash and cash equivalents $ 20,384 $ 1,577 $ 6,390 Our principal sources of cash as of December 31, 2012 were our existing cash and cash equivalents of $57.3 million, which included proceeds of $17.0 million from the sale of our Media business and $6.0 million from the sale of our investment in CollabNet.

Operating Activities Net cash used in operating activities increased $3.0 million during the year ended December 31, 2012 as compared to the year ended December 31, 2011 primarily due to a decrease in changes in assets and liabilities of $4.7 million, offset by improved profitability from continuing operations of $1.2 million, excluding the $4.0 million gain on sale of non-marketable securities and an increase in stock-based compensation of $0.5 million. The changes in assets and liabilities was primarily due to an increase in cash used to purchase inventory of $12.1 million, an increase of prepaid expenses of $2.3 million, other assets and liabilities of $2.9 million, partially offset by an increase in accounts payable of $12.6 million. Inventory purchases are higher to support ThinkGeek growth, improve our in-stock levels and meet anticipated demands in the first quarter of 2013 for our website and wholesale channel sales. Typically during the first quarter of each year, we receive minimal amounts of inventory due to industry practices in other countries where our suppliers are located.

Net cash provided by operating activities increased $4.2 million during the year ended December 31, 2011 as compared to the year ended December 31, 2010, as a result of a improved profitability of $0.8 million, an increase in stock-based compensation of $1.6 million, and an increase in depreciation and amortization expense of $0.7 million, partially offset by a decrease in changes in assets and liabilities of $1.2 million.

Investing Activities Cash provided by investing activities for the 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 in transaction costs and $0.1 million in investments in property and equipment.

Cash used in investing activities for year ended December 31, 2011 of $0.8 million was primarily due to the expansion of our distribution equipment at our contract-fulfillment and warehouse provider and purchases of property and equipment related to computer and equipment and leasehold improvements for relocating our corporate headquarters from Mountain View, California to Fairfax, Virginia. This was partially offset by cash received from the sale of intangible assets that had occurred in the prior year.

Cash provided by investing activities for the year ended December 31, 2010 of $7.2 million was primarily due to the sale of $10.2 million of auction rate securities to UBS AG ("UBS") and a $1.0 million reduction in restricted cash resulting from the conclusion of our former corporate headquarter lease in Fremont, California, partially offset by $4.0 million for the purchase of property and equipment, primarily payments for distribution equipment installed at our third-party contract-fulfillment and warehouse provider.

Financing Activities 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.

28-------------------------------------------------------------------------------- Table of Contents Cash provided by financing activities for the year ended December 31, 2011 of $0.7 million included $1.0 million in cash provided by the issuance of common stock from stock option exercises, partially offset by $0.4 million of repurchases of our common stock.

Cash provided by financing activities for the year ended December 31, 2010 of $1.8 million included $2.0 million in cash provided by the issuance of common stock from stock option exercises, partially offset by $0.2 million of repurchases of our common stock.

Net Cash Provided By Discontinued Operations Cash flow 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 the e-Commerce business, market acceptance of our online products, the resources we devote to developing, marketing, selling and supporting our online 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., or 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. The revolving credit facility has the option of an applicable interest rate of 2.5% above one or three month LIBOR. We renewed the revolving credit facility during the fourth quarter of 2012, and the facility now expires October 15, 2013. 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 dollars in Wells Fargo Bank at all times. This credit line is collateralized by substantially all of the assets of the Company. As of December 31, 2011, we were in default of certain covenants for which we received a waiver from Wells Fargo Bank. As of December 31, 2012, we were not in default of these covenants. As of December 31, 2012, 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.

On September 17, 2012 we entered into an Asset Purchase Agreement with Dice pursuant to which the Buyers purchased our Media business, including the SourceForge, Slashdot and Freecode websites and assumed certain related liabilities. In accordance with the terms of the Purchase Agreement, the Buyers paid us $20.0 million in cash, of which $3.0 million was deposited by the Buyers into an escrow account for a period of twelve months after the Closing Date in order to secure our indemnification obligations to the Buyers for breaches of our representations, warranties, covenants and other obligations under the Purchase Agreement.

The Purchase Agreement contains customary representations, warranties and covenants. Subject to certain exceptions and limitations, each party has agreed to indemnify the other for breaches of representations, warranties and covenants and other specified matters. The Purchase Agreement generally limits the Company's liability for breaches of representations and warranties made in the Purchase Agreement to an aggregate of $10.0 million. The Purchase Agreement also contains covenants requiring us not to solicit or hire certain employees of the Buyers or compete with the Purchased Business for a period of three years. We have also agreed with Dice to provide certain transition services to one another through December 31, 2013.

We expect to devote capital resources to continue: • investing in capital projects that support our distribution and related support systems, and infrastructure, •investing and improving product safety and quality assurance testing, •enhancing and diversifying sales and marketing programs, •improving our technology and functionality, •developing trendy unique exclusive GeekLabs products, •optimizing supplier and manufacturer relationships, and •investing in other general corporate activities.

29-------------------------------------------------------------------------------- Table of Contents We do not believe that the absence of cash flows from our Media business will significantly impact our cash balances as the majority of cash generated is derived from our e-Commerce sales. We believe that our existing cash balances will be sufficient to meet near term liquidity needs.

Stock Repurchase Program In February 2011, we announced an "odd lot" share repurchase program under which our Board of Directors approved the repurchase of up to $1 million of our common stock Under this program, the Company repurchased 4,868 shares of common stock at a weighted average price of $26.01 per share for aggregate purchase price of approximately $127,000. There was no "odd lot" share repurchase program during 2012.

Contractual Obligations The contractual obligations presented in the table below represent our estimates of future payments under fixed contractual obligations, purchase orders (primarily for inventory) and 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, 2012 (in thousands): Payments due by period Total Less than 1 year 1-3 years Thereafter Operating Lease Obligations (1) $ 622 $ 367 $ 255 $ - Purchase Obligations (2) 917 774 143 - Total Obligations $ 1,539 $ 1,141 $ 398 $ - (1) Includes future payments for the Company's facilities under non-cancelable operating leases that expire at various dates through 2014.

(2) Includes a one-time termination fee of approximately $0.4 million 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.

Financial Risk Management We currently face limited exposure to adverse movements in foreign currency exchange rates and we do not engage in hedging activity. We do not anticipate significant currency gains or losses in the near term. These exposures may change over time as business practices evolve and could have a material adverse impact on our financial results.

Recent Accounting Pronouncements In June 2011, the FASB issued authoritative guidance that amends previous guidance for the presentation of comprehensive income. It eliminates the option to present other comprehensive income in the statement of changes in equity.

Under this revised guidance, an entity has the option to present the components of net income and other comprehensive income in either a single continuous statement of comprehensive income or in two separate but consecutive financial statements. The revised guidance also required entities to present reclassification adjustments out of accumulated other comprehensive income by component in both the statement in which net income is presented and the statement in which other comprehensive income is presented. In December 2011, the FASB issued guidance which indefinitely defers the guidance related to the presentation of reclassification adjustments. We adopted this standard on January 1, 2012. The adoption of this standard only impacts the presentation of our consolidated financial statements.

In May 2011, the FASB issued authoritative guidance that amends previous guidance for fair value measurement and disclosure requirements. The revised guidance changes certain fair value measurement principles, clarifies the application of existing fair value measurements and expands the disclosure requirements, particularly for 30-------------------------------------------------------------------------------- Table of Contents Level 3 fair value measurements. We adopted this standard on January 1, 2012.

The adoption of this standard did not have an impact on our consolidated financial statements.

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