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SPSC > SEC Filings for SPSC > Form 10-Q on 7-Nov-2012All Recent SEC Filings

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Form 10-Q for SPS COMMERCE INC


7-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Overview

We are a leading provider of on-demand supply chain management solutions and the Retail Universe community, providing integration, collaboration, connectivity, visibility and data analytics to thousands of trading partners worldwide. We provide our solutions through SPSCommerce.net, a hosted software suite that improves the way suppliers, retailers, distributors and other trading partners manage and fulfill orders. We deliver our solutions to our customers over the Internet using a Software-as-a-Service model.

We plan to grow our business by further penetrating the supply chain management market, increasing revenues from our customers as their businesses grow, expanding our distribution channels, expanding our international presence and developing new solutions and applications. We also intend to selectively pursue acquisitions that will add customers, allow us to expand into new regions or industries or allow us to offer new functionalities.

On August 6, 2012, we entered into an asset purchase agreement with Edifice Information Management Systems, Inc. ("Edifice"), a privately-held information services company specializing in the collection, analysis and distribution of point-of-sale data used by retailers and suppliers to improve their supply chain efficiencies. We completed the asset purchase on August 7, 2012. Under the asset purchase agreement, we purchased and acquired substantially all of the assets of Edifice for $26.3 million in cash and 347,852 shares of our common stock. We also assumed certain liabilities of Edifice. This acquisition allows us to expand our point-of-sale analytic offerings, expand our base of recurring revenue customers and add suppliers to our network. See Note B to our condensed consolidated financial statements included in this Quarterly Report on Form 10-Q for additional information regarding the acquisition of Edifice.

On September 11, 2012, we completed a public stock offering where we issued and sold 1,840,000 shares of common stock, including 240,000 shares sold pursuant to the exercise in full of the underwriters' over-allotment option, at a price to the public of $33.50 per share. We received net proceeds of approximately $57.8 million from this offering after payment of approximately $3.8 million of underwriting discounts and commissions and legal, accounting and other fees incurred in connection with the offering. See Note F to our condensed consolidated financial statements included in this Quarterly Report on Form 10-Q for additional information regarding our common stock.

Key Financial Terms and Metrics

We have several key financial terms and metrics, including annualized average recurring revenues per recurring revenue customer. During the nine months ended September 30, 2012, there were no changes in the definitions of our key financial terms and metrics, which are discussed in more detail under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in our Annual Report on Form 10-K for the year ended December 31, 2011 as filed with the Securities and Exchange Commission on March 9, 2012.

To supplement our financial statements, we also provide investors with Adjusted EBITDA and non-GAAP income per share, both of which are non-GAAP financial measures. We believe that these non-GAAP measures provide useful information to management and investors regarding certain financial and business trends relating to our financial condition and results of operations. Our management uses these non-GAAP measures to compare the company's performance to that of prior periods for trend analyses and planning purposes. Adjusted EBITDA is also used for purposes of determining executive and senior management incentive compensation. These measures are also presented to our board of directors.

These non-GAAP measures should not be considered a substitute for, or superior to, financial measures calculated in accordance with generally accepted accounting principles in the United States of America ("GAAP"). These non-GAAP financial measures exclude significant expenses and income that are required by GAAP to be recorded in our financial statements and are subject to inherent limitations. Investors should review the reconciliations of non-GAAP financial measures to the comparable GAAP financial measures that are included in this "Management's Discussion and Analysis of Financial Condition and Results of Operations."


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Critical Accounting Policies and Estimates

This discussion of our financial condition and results of operations is based upon our financial statements, which are prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues, costs and expenses and related disclosures. We base our estimates of the carrying value of certain assets and liabilities on historical experience and on various other assumptions that we believe to be reasonable. On an ongoing basis, we evaluate our estimates and assumptions. Our actual results may differ from these estimates under different assumptions or conditions.

We believe that of our significant accounting policies, the following accounting policies involve a greater degree of judgment, complexity and effect on materiality. A critical accounting policy is one that is both material to the presentation of our financial statements and requires us to make difficult, subjective or complex judgments for uncertain matters that could have a material effect on our financial condition and results of operations. Accordingly, we believe that our policies for revenue recognition, the allowance for doubtful accounts, income taxes, stock-based compensation and the valuation of goodwill and intangible assets are the most critical to aid in fully understanding and evaluating our financial condition and results of operations.

During the nine months ended September 30, 2012, there were no significant changes in our critical accounting policies or estimates.

See Note A to our financial statements included in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the year ended December 31, 2011, as filed with the Securities and Exchange Commission on March 9, 2012, for additional information regarding our critical accounting policies, as well as a description of our other significant accounting policies.


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Results of Operations

The following table presents our results of operations for the periods indicated
(dollars in thousands):



                                                   Three Months Ended September 30,
                                                2012                             2011                         Change
                                                   % of revenue                     % of revenue          $             %
Revenues                             $ 20,267              100.0 %    $ 15,529              100.0 %    $  4,738         30.5 %
Cost of revenues                        5,945               29.3         4,076               26.2         1,869         45.9

Gross profit                           14,322               70.7        11,453               73.8         2,869         25.1

Operating expenses
Sales and marketing                     7,840               38.7         6,404               41.2         1,436         22.4
Research and development                2,088               10.3         1,605               10.3           483         30.1
General and administrative              3,726               18.4         2,914               18.8           812         27.9
Amortization of intangible assets         530                2.6           260                1.7           270        103.8

Total operating expenses               14,184               70.0        11,183               72.0         3,001         26.8

Income from operations                    138                0.7           270                1.7          (132 )      (48.9 )

Other income (expense)
Interest expense                          (27 )             (0.1 )          -                  -            (27 )          *
Interest income                             6                 -             16                0.1           (10 )      (62.5 )
Other expense                             (67 )             (0.3 )         (28 )             (0.2 )         (39 )      139.3

Total other expense, net                  (88 )             (0.4 )         (12 )             (0.1 )         (76 )          *

Income before income taxes                 50                0.2           258                1.7          (208 )      (80.6 )

Income tax benefit (expense)              124                0.6           (81 )             (0.5 )         205            *

Net income                           $    174                0.9      $    177                1.1            (3 )       (1.7 )


                                                   Nine Months Ended September 30,
                                                2012                             2011                         Change
                                                   % of revenue                     % of revenue          $             %
Revenues                             $ 54,622              100.0 %    $ 42,115              100.0 %    $ 12,507        29.7  %
Cost of revenues                       15,236               27.9        11,147               26.5         4,089         36.7

Gross profit                           39,386               72.1        30,968               73.5         8,418         27.2

Operating expenses
Sales and marketing                    21,259               38.9        17,382               41.3         3,877         22.3
Research and development                5,650               10.3         4,259               10.1         1,391         32.7
General and administrative             10,079               18.5         8,208               19.5         1,871         22.8
Amortization of intangible assets       1,050                1.9           383                0.9           667        174.2

Total operating expenses               38,038               69.6        30,232               71.8         7,806         25.8

Income from operations                  1,348                2.5           736                1.7           612         83.2
Other income (expense)
Interest expense                          (27 )               -             -                  -            (27 )          *
Interest income                            34                0.1            74                0.2           (40 )      (54.1 )
Other expense                            (170 )             (0.3 )         (62 )             (0.1 )        (108 )      174.2

Total other income (expense), net        (163 )             (0.3 )          12                 -           (175 )          *

Income before income taxes              1,185                2.2           748                1.8           437         58.4

Income tax expense                       (329 )             (0.6 )        (188 )             (0.4 )        (141 )       75.0

Net income                           $    856                1.6      $    560                1.3           296         52.9

Due to rounding, totals may not equal the sum of the line items in the table above.

* Percentage is not meaningful.


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Three & Nine Months Ended September 30, 2012 compared to Three & Nine Months Ended September 30, 2011

Revenues. Revenues for the three months ended September 30, 2012 increased $4.8 million, or 31%, to $20.3 million from $15.5 million for the same period in 2011. Our fiscal quarter ended September 30, 2012 represented our 47th consecutive quarter of increased revenues. Revenues for the nine months ended September 30, 2012 increased $12.5 million, or 30%, to $54.6 million from $42.1 million for the same period in 2011.

The increase in revenues resulted from two primary factors: the increase in recurring revenue customers and the increase in annualized average recurring revenues per recurring revenue customer.

The number of recurring revenue customers increased 11% to 17,723 at September 30, 2012 from 15,896 at September 30, 2011.

Annualized average recurring revenues per recurring revenue customer increased 21% to $4,101 for the three months ended September 30, 2012 from $3,376 for the same period in 2011. This increase was primarily attributable to increased fees resulting from increased usage of our solutions by our recurring revenue customers and growth in larger customers, including those acquired from Edifice.

Recurring revenues from recurring revenue customers accounted for 88% and 87% of our total revenues for the three and nine months ended September 30, 2012, respectively, compared to 85% and 84% for each of the same periods in 2011. We anticipate that the number of recurring revenue customers and the recurring revenues per recurring revenue customer will continue to increase as we increase the number of solutions we offer and increase the penetration of those solutions across our customer base.

Cost of Revenues. Cost of revenues for the three months ended September 30, 2012 increased $1.8 million, or 46%, to $5.9 million from $4.1 million for the same period in 2011. Cost of revenues for the nine months ended September 30, 2012 increased $4.1 million, or 37%, to $15.2 million from $11.1 million for the same period in 2011. The increase in cost of revenues was attributable to increased costs for personnel and depreciation for both the three and nine month periods in 2012. In addition, increased costs for network services and stock-based compensation contributed to the increase in cost of revenues for the nine month period in 2012. As a percentage of revenues, cost of revenues was 29% and 28% for the three and nine months ended September 30, 2012, compared to 26% and 27% for the same periods in 2011. Going forward, we anticipate that cost of revenues will continue to increase in absolute dollars as we build our business.

Sales and Marketing Expenses. Sales and marketing expenses for the three months ended September 30, 2012 increased $1.4 million, or 22%, to $7.8 million from $6.4 million for the same period in 2011. Sales and marketing expenses for the nine months ended September 30, 2012 increased $3.9 million, or 22%, to $21.3 million from $17.4 million for the same period in 2011. The increase in sales and marketing expenses for both the three and nine month periods in 2012 was primarily due to increased personnel costs and higher commissions earned by sales personnel from new business, as well as increased stock-based compensation and marketing costs. As a percentage of revenues, sales and marketing expenses were 39% for each of the three and nine months ended September 30, 2012, compared to 41% for the same periods in 2011, respectively. As we build our business, we will continue to add resources to our sales and marketing efforts over time, and we expect that these expenses will continue to increase in absolute dollars.

Research and Development Expenses. Research and development expenses for the three months ended September 30, 2012 increased $483,000, or 30%, to $2.1 million from $1.6 million for the same period in 2011. Research and development expenses for the nine months ended September 30, 2012 increased $1.4 million, or 33%, to $5.7 million from $4.3 million for the same period in 2011. The increase in research and development expenses for both the three and nine month periods in 2012 was primarily due to increased personnel costs and depreciation expense. As a percentage of revenues, research and development expenses were 10% for all periods presented. As we enhance and expand our solutions and applications, we expect that research and development expenses will continue to increase in absolute dollars.

General and Administrative Expenses. General and administrative expenses for the three months ended September 30, 2012 increased $812,000, or 28%, to $3.7 million from $2.9 million for the same period in 2011. General and administrative expenses for the nine months ended September 30, 2012 increased $1.9 million, or 23%,


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to $10.1 million from $8.2 million for the same period in 2011. The increase in general and administrative expenses for both the three and nine month periods in 2012 was primarily due to increased personnel costs, as well as increased stock-based compensation, accounting, legal and depreciation expenses. In addition, higher credit card processing fees contributed to the increase in general and administrative expense for the nine month period in 2012. As a percentage of revenues, general and administrative expenses were approximately 18% for each of the three and nine months ended September 30, 2012 compared to approximately 19% for each of the same periods in 2011. Going forward, we expect that general and administrative expenses will continue to increase in absolute dollars as we build our business.

Amortization of Intangible Assets. Amortization expense was $530,000 and $1.1 million for the three and nine months ended September 30, 2012, compared to $260,000 and $383,000 for each of the same periods in 2011. The increase in amortization expense in 2012 from 2011 was the result of the May 2011 acquisition of Direct EDI being included for all of 2012 as well as the August 2012 acquisition of Edifice.

Other Income (Expense). Interest expense was $27,000 for the three and nine months ended September 30, 2012, resulting from borrowings under our line of credit for the Edifice acquisition. There was no interest expense for the comparable periods in 2011. Interest income for the three and nine months ended September 30, 2012 was $6,000 and $34,000, respectively, compared to $16,000 and $74,000 for the same periods in 2011. Other expense for the three and nine months ended September 30, 2012 was $67,000 and $170,000, respectively, and $28,000 and $62,000 for the same periods in 2011. The increase in other expense was due primarily to higher franchise taxes in 2012.

Income Tax Benefit (Expense). We recorded an income tax benefit of $124,000 for the three months ended September 30, 2012 and income tax expense of $329,000 for the nine months ended September 30, 2012. Income tax expense was $81,000 and $188,000 for the three and nine months ended September 30, 2011, respectively. We record our interim provision for income taxes based on our estimated annual effective tax rate for the year. Our provisions for income taxes included current federal alternative minimum tax expense, current foreign and state income tax expense, and deferred tax expense. The decrease in income tax expense for the three months ended September 30, 2012, compared to the three months ended September 30, 2011, is primarily related to discrete net favorable tax items of $175,000, consisting of an increase in the state deferred tax rate related to the Edifice acquisition and provision to return adjustments for the year 2011. The increase in income tax expense for nine months ended September 30, 2012, compared to the nine months ended September 30, 2011, was primarily related to deferred tax expense incurred in 2012 subsequent to the reversal of substantially all of the valuation allowance on our deferred tax assets in the fourth quarter of 2011.

Adjusted EBITDA. Adjusted EBITDA, which is a non-GAAP measure of financial performance, consists of net income plus depreciation and amortization, interest expense, interest income, income tax expense (benefit) and non-cash, stock-based compensation expense. We use Adjusted EBITDA as a measure of operating performance because it assists us in comparing performance on a consistent basis, as it removes from our operating results the impact of our capital structure. We believe Adjusted EBITDA is useful to an investor in evaluating our operating performance because it is widely used to measure a company's operating performance without regard to items such as depreciation and amortization, which can vary depending upon accounting methods and the book value of assets, and to present a meaningful measure of corporate performance exclusive of our capital structure and the method by which assets were acquired.


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The following table provides a reconciliation of net income to Adjusted EBITDA (in thousands):

                                                    Three Months Ended             Nine Months Ended
                                                      September 30,                  September 30,
                                                   2012            2011           2012           2011
Net income                                       $     174        $   177       $     856       $   560
Depreciation and amortization of property and
equipment                                              873            541           2,117         1,436
Amortization of intangible assets                      530            260           1,050           383
Interest expense                                        27             -               27            -
Interest income                                         (6 )          (16 )           (34 )         (74 )
Income tax (benefit) expense                          (124 )           81             329           188

EBITDA                                               1,474          1,043           4,345         2,493
Stock-based compensation expense                       715            487           2,042         1,286

Adjusted EBITDA                                  $   2,189        $ 1,530       $   6,387       $ 3,779

Non-GAAP Income Per Share. Non-GAAP income per share, which is also a non-GAAP measure of financial performance, consists of net income plus non-cash, stock-based compensation expense and amortization expense related to intangible assets divided by the weighted average number of shares of common stock outstanding during each period. We believe non-GAAP income per share is useful to an investor because it is widely used to measure a company's operating performance.

The following table provides a reconciliation of net income to non-GAAP income per share (in thousands, except per share amounts):

                                                       Three Months Ended            Nine Months Ended
                                                         September 30,                 September 30,
                                                       2012           2011          2012           2011
Net income                                          $      174      $    177      $     856      $    560
Stock-based compensation expense                           715           487          2,042         1,286
Amortization of intangible assets                          530           260          1,050           383

Non-GAAP income                                     $    1,419      $    924      $   3,948      $  2,229

Shares used to compute non-GAAP income per share
Basic                                                   13,042        11,970         12,500        11,918
Diluted                                                 13,894        12,735         13,373        12,685

Non-GAAP income per share
Basic                                               $     0.11      $   0.08      $    0.32      $   0.19
Diluted                                             $     0.10      $   0.07      $    0.30      $   0.18


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Liquidity and Capital Resources

At September 30, 2012, our principal sources of liquidity were cash and cash equivalents of $69.7 million and accounts receivable, net of allowance for doubtful accounts, of $10.1 million. Our working capital at September 30, 2012 was $74.0 million compared to $36.8 million at December 31, 2011. The increase in working capital from December 31, 2011 to September 30, 2012 resulted primarily from the following:

$37.7 million increase in cash and cash equivalents, due primarily to cash received from our public offering of common stock in September 2012, cash provided by operations and cash received from the exercise of stock options, all reduced by cash used for the Edifice acquisition and capital expenditures;

$2.2 million increase in net accounts receivable, due to new business for the nine months ended September 30, 2012, as well as accounts acquired from Edifice;

$1.2 million increase in deferred costs, current, for expenses related to increased implementation resources and commission payments for new business;

$633,000 increase in prepaid expenses and other current assets, primarily related to the Edifice acquisition;

$1.3 million increase in accounts payable, primarily due to timing of payments;

$1.5 million increase in accrued compensation and benefits, due primarily to increased headcount and payroll timing;

$179,000 increase in accrued expenses and other current liabilities, primarily due to an increase in accruals for professional services; and

$1.4 million increase in deferred revenue, current, due to new business for the nine months ended September 30, 2012.

Net Cash Flows from Operating Activities

Net cash provided by operating activities was $8.3 million for the nine months ended September 30, 2012 compared to $3.5 million for the same period in 2011. The increase in net income and the changes in non-cash expenses, including increased depreciation, amortization and stock-based compensation, and the changes in our working capital accounts discussed above, resulted in the overall increase in net cash provided by operations.

Net Cash Flows from Investing Activities

Net cash used in investing activities was $29.1 million for the nine months ended September 30, 2012, with $26.3 million used for the acquisition of Edifice and $2.8 million used for capital expenditures. Net cash used in investing activities was $12.6 million for the nine months ended September 30, 2011, and represented $10.9 million for the acquisition of Direct EDI and $1.7 million for capital expenditures. Our capital expenditures are for supporting our business growth and existing customer base, as well as for our internal use such as equipment for our employees.

Net Cash Flows from Financing Activities

Net cash provided by financing activities was $58.6 million for the nine months ended September 30, 2012, and primarily represented $57.8 million of net proceeds from our public offering of common stock in September 2012 and $1.1 million proceeds from the exercise of stock options. Net cash provided by financing activities was $108,000 for the nine months ended September 30, 2011, representing proceeds from the exercise of stock options substantially offset by repayments of capital lease obligations and payment of offering costs related to the issuance of common stock.


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Credit Facility

On September 30, 2011, we entered into a revolving credit agreement with JPMorgan Chase Bank, N.A. The revolving credit agreement provides for a . . .

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