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INWK > SEC Filings for INWK > Form 10-Q on 8-Nov-2012All Recent SEC Filings

Show all filings for INNERWORKINGS INC

Form 10-Q for INNERWORKINGS INC


8-Nov-2012

Quarterly Report


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

Overview

We are a leading global marketing supply chain company. With proprietary technology, an extensive supplier network and deep domain expertise, the Company procures, manages and delivers printed materials and promotional products as part of a comprehensive outsourced enterprise solution. Our technology is designed to capitalize on excess manufacturing capacity and other inefficiencies in the traditional print supply chain to obtain favorable pricing and to deliver high-quality products and services for our clients.

Our proprietary software applications and database, PPM4, create a fully-integrated solution that stores, analyzes and tracks the production capabilities of our supplier network, as well as quote and price data for each bid we receive and print job we execute. As a result, we believe PPM4 contains one of the largest independent repositories of equipment profiles and price data for print suppliers in the United States. We leverage our technology to match each print job with the supplier that is optimally suited to meet the client's needs at a highly competitive price. Our procurement managers use PPM4 to manage the print procurement process from end-to-end.

Through our supplier network of approximately 9,000 suppliers, we offer a full range of print, fulfillment and logistics services that allows us to procure printed products on virtually any substrate. The breadth of our product offerings and services and the depth of our supplier network enable us to fulfill all of the print procurement needs of our clients. By leveraging our technology platform, our clients are able to reduce overhead costs, redeploy internal resources and obtain favorable pricing and service terms. In addition, our ability to track individual transactions and provide customized reports detailing print procurement activity on an enterprise-wide basis provides our clients with greater visibility and control of their print expenditures.

Since 2002, we have expanded from a regional focus to a national and then international focus with the acquisitions of CPRO, a leading provider of print solutions in Latin America, and Productions Graphics, a leading print management firm with a particular strength in continental Europe, in 2011. We operate in 44 different countries. Our operations are organized into two segments based on geographic regions: United States and International. The United States segment includes operations in the United States, and the International segment includes operations in the United Kingdom, continental Europe and Latin America. In the nine months ended September 30, 2012, we generated revenues of $481.5 million in the United States segment and $108.2 million in the International segment. We believe the opportunity exists to expand our business into new geographic markets. Our objective is to continue to increase our sales in the major print markets in the United States and internationally. We intend to hire or acquire more account executives within close proximity to these large markets.

Revenue

We generate revenue through the sale of printed products to our clients. Our revenue was $458.6 million and $589.7 million during the nine months ended September 30, 2011 and 2012, respectively. Total revenue increased 28.6% from the prior year of which 20% was from organic growth. Our revenue is generated from two different types of clients: enterprise and middle market/transactional. Enterprise jobs usually involve higher dollar amounts and volume than our middle market/transactional jobs. We categorize a client as an enterprise client if we have a contract with the client for the provision of printing services on a recurring basis; if the client has signed an open-ended purchase order or a series of related purchase orders; or if the client has enrolled in our e-stores program, which enables the client to make online purchases of printing services on a recurring basis. We categorize all other clients as middle market/transactional clients, with a significant part of growth in this area coming from a growth initiative to sell print over the phone, or Inside Sales. We enter into contracts with our enterprise clients to provide some or a specific portion of their printed products on a recurring basis.

Several of our enterprise clients have outsourced substantially all of their recurring print needs to us. We provide printed products to our middle market/transactional clients on an order-by-order basis. During the nine months ended September 30, 2012, enterprise clients accounted for 75% of our revenue, while middle market/transactional clients accounted for 25% of our revenue.

Our revenue consists of the prices paid by our clients for printed products. These prices, in turn, reflect the amounts charged to us by our suppliers plus our gross profit. Our gross profit margin, in the case of some of our enterprise clients, is fixed by contract or, in the case of middle market/transactional clients, is negotiated on a job-by-job basis. Once either type of client accepts our pricing terms, the selling price is established and we procure the product for our own account in order to re-sell it to the client. We take full title and risk of loss for the product upon shipment. The finished product is typically shipped directly from our supplier to a destination specified by our client. Upon shipment, our supplier invoices us for its production costs and we invoice our client.

Our revenue from enterprise clients tends to generate lower gross profit margins than our revenue from middle market/transactional clients because the gross profit margins established in our contracts with large enterprise clients are generally lower than the gross profit margins we typically realize in our middle market/transactional business. Although our enterprise revenue generates lower gross profit margins, our enterprise business tends to be as profitable as our middle market/transactional business on an operating profit basis because the commission expense associated with enterprise jobs is generally lower.

Cost of Goods Sold and Gross Profit

Our cost of goods sold consists primarily of the price at which we purchase products from our suppliers. Our selling price, including our gross profit, in the case of some of our enterprise jobs, is based on a fixed gross margin established by contract or, in the case of middle market/transactional jobs, is determined at the discretion of the account executive or procurement manager within predetermined parameters. Our gross margins on our enterprise jobs are typically lower than our gross margins on our middle market/transactional jobs. As a result, our cost of goods sold as a percentage of revenue for our enterprise jobs is typically higher than it is for our middle market/transactional jobs. Our gross profit for the nine months ended September 30, 2011 and 2012 was $106.8 million and $136.1 million, or 23.3% and 23.1% of revenue, respectively.

Operating Expenses and Income from Operations

Our selling, general and administrative expenses consist of commissions paid to our account executives, compensation costs for our management team and procurement managers as well as compensation costs for our finance and support employees, public company expenses, corporate systems, legal and accounting, facilities and travel and entertainment expenses. Selling, general and administrative expenses as a percentage of revenue were 18.2% for each of the nine months ended September 30, 2011 and 2012.

We accrue for commissions when we recognize the related revenue. Some of our account executives receive a monthly draw to provide them with a more consistent income stream. The cash paid to our account executives in advance of commissions earned is reflected as a prepaid expense on our balance sheet. As our account executives earn commissions, a portion of their commission payment is withheld and offset against their prepaid commission balance, if any. Our prepaid commission balance, net of accrued earned commissions not yet paid, increased to $7.0 million as of September 30, 2012 from $3.6 million as of December 31, 2011.

We agree to provide our clients with printed products that conform to the industry standard of a "commercially reasonable quality," and our suppliers in turn agree to provide us with products of the same quality. In addition, the quotes we provide our clients include customary industry terms and conditions that limit the amount of our liability for product defects. Product defects have not had a material adverse effect on our results of operations.

Our income from operations for the nine months ended September 30, 2012 increased 37% from $15.1 million to $20.7 million.

Comparison of three months ended September 30, 2011 and 2012

Revenue



Our revenue by segment for each of the years presented was as follows:



                            Three months ended September 30,
                  2011         % of Total        2012         % of Total
                                 (dollars in thousands)
United States   $ 135,635             85.9 %   $ 162,746             81.5 %
International      22,184             14.1        37,023             18.5

Revenue         $ 157,819            100.0 %   $ 199,769            100.0 %

United States

United States revenue increased by $27.1 million, or 20.0%, from $135.6 million during the three months ended September 30, 2011 to $162.7 million during the three months ended September 30, 2012. This increase in revenue is driven primarily by organic new enterprise and middle market/transactional account growth.

International

International revenue increased by $14.8 million, or 66.9%, from $22.2 million during the three months ended September 30, 2011 to $37.0 million during the three months ended September 30, 2012. This increase is due to our expansion into continental Europe through the acquisition of Productions Graphics during the fourth quarter of 2011 and organic growth in Latin America.

Cost of goods sold

Our cost of goods sold increased by $32.2 million, or 26.6%, from $120.7 million during the three months ended September 30, 2011 to $152.9 million during the three months ended September 30, 2012. The increase is a result of the revenue growth during the three months ended September 30, 2012. Our cost of goods sold as a percentage of revenue was 76.5% during the three months ended September 30, 2011 and September 30, 2012.

Gross Profit

Our gross profit as a percentage of revenue, which we refer to as gross margin, was 23.5% during the three months ended September 30, 2011 and September 30, 2012.

Selling, general and administrative expenses

Selling, general and administrative expenses increased by $7.9 million, or 27.6%, from $28.7 million during the three months ended September 30, 2011 to $36.6 million during the three months ended September 30, 2012. As a percentage of revenue, selling, general and administrative expenses increased from 18.2% for the three months ended September 30, 2011 to 18.3% for the three months ended September 30, 2012. The increase in selling, general and administrative expenses is primarily due to incremental sales commission and cost of procurement staff to secure new enterprise accounts.

Depreciation and amortization

Depreciation and amortization expense increased by $0.2 million, or 8.1%, from $2.5 million during the three months ended September 30, 2011 to $2.7 million during the three months ended September 30, 2012. The increase in amortization expense is a result of the amortization of the intangible assets acquired in connection with our acquisitions.

Income from operations

Income from operations increased by $1.7 million, or 28.1%, from $5.9 million during the three months ended September 30, 2011 to $7.6 million during the three months ended September 30, 2012. As a percentage of revenue, income from operations was 3.8% during each of the three months ended September 30, 2011 and September 30, 2012.

Other income and expense

Other income decreased by $0.6 million from income of $0.4 million for the three months ended September 30, 2011 to expense of $0.2 million during the three months ended September 30, 2012. The decrease is primarily attributable to a decrease in the gain on sale of shares of Echo.

Income tax expense

Income tax expense increased by $0.3 million, or 10.3%, from $2.2 million during the three months ended September 30, 2011 to $2.5 million during the three months ended September 30, 2012. Our effective tax rate was 35.0% and 33.1% for the three month periods ended September 30, 2011 and 2012, respectively. The decrease in the effective tax rate is due to our international expansion in to countries with lower statutory tax rates, partially offset by the United States research and development tax credit which expired at the end of 2011 and has not been renewed for 2012.

Net income

Net income increased by $0.8 million, or 20.3%, from $4.1 million during the three months ended September 30, 2011 to $5.0 million during the three months ended September 30, 2012. Net income as a percentage of revenue was 2.6% and 2.5% during the three months ended September 30, 2011 and 2012, respectively.

Comparison of nine months ended September 30, 2011 and 2012

Revenue



Our revenue by segment for each of the years presented was as follows:



                             Nine months ended September 30,
                  2011         % of Total        2012         % of Total
                                 (dollars in thousands)
United States   $ 395,816             86.3 %   $ 481,492             81.6 %
International      62,796             13.7       108,221             18.4

Revenue         $ 458,612            100.0 %   $ 589,713            100.0 %

United States

United States revenue increased by $85.7 million, or 21.6%, from $395.8 million during the nine months ended September 30, 2011 to $481.5 million during the nine months ended September 30, 2012. This increase in revenue is driven primarily by organic new enterprise and middle market/transactional account growth.

International

International revenue increased by $45.4 million, or 72.3%, from $62.8 million during the nine months ended September 30, 2011 to $108.2 million during the nine months ended September 30, 2012. This increase is due to our expansion into Latin America and continental Europe through the acquisitions of CPRO and Productions Graphics, respectively, during 2011.

Cost of goods sold

Our cost of goods sold increased by $101.7 million, or 28.9%, from $351.8 million during the nine months ended September 30, 2011 to $453.6 million during the nine months ended September 30, 2012. The increase is a result of the revenue growth during the nine months ended September 30, 2012. Our cost of goods sold as a percentage of revenue increased from 76.7% during the nine months ended September 30, 2011 to 76.9% during the nine months ended September 30, 2012.

Gross Profit

Our gross profit as a percentage of revenue, which we refer to as gross margin, decreased from 23.3% during the nine months ended September 30, 2011 to 23.1% during the nine months ended September 30, 2012. The decrease is primarily the result of a higher concentration of our business coming from enterprise clients, which generate lower gross margins, and the addition of the South American operations during the first quarter of 2011, which have lower gross margins than the United States operations. Additionally, due to the planned timing of various projects and services, Productions Graphics, which was acquired in the fourth quarter of 2011, regularly experiences relatively low margins in the first half of each fiscal year with increasing margins in the second half.

Selling, general and administrative expenses

Selling, general and administrative expenses increased by $23.9 million, or 28.7%, from $83.4 million during the nine months ended September 30, 2011 to $107.3 million during the nine months ended September 30, 2012. As a percentage of revenue, selling, general and administrative expenses were 18.2% for the nine months ended September 30, 2011 and September 30, 2012.

Depreciation and amortization

Depreciation and amortization expense increased by $0.7 million, or 9.3%, from $7.4 million during the nine months ended September 30, 2011 to $8.1 during the nine months ended September 30, 2012. The increase in amortization expense is a result of the amortization of the intangible assets acquired in connection with our acquisitions.

Income from operations

Income from operations increased by $5.7 million, or 37.7%, from $15.1 million during the nine months ended September 30, 2011 to $20.7 million during the nine months ended September 30, 2012. As a percentage of revenue, income from operations increased from 3.3% during the nine months ended September 30, 2011 to 3.5% during the nine months ended September 30, 2012. The increase in income from operations as a percentage of revenue is primarily a result of the preference claim charge which was incurred in the second quarter of 2011.

Other income and expense

Other income decreased by $2.2 million from income of $1.3 million for the nine months ended September 30, 2011 to expense of $0.9 million during the nine months ended September 30, 2012. The decrease is primarily attributable to a decrease in the gain on sale of shares of Echo.

Income tax expense

Income tax expense increased by $1.0 million, or 16.5%, from $5.7 million during the nine months ended September 30, 2011 to $6.7 million during the nine months ended September 30, 2012. Our effective tax rate was 35.0% and 33.7% for the nine month periods ended September 30, 2011 and 2012, respectively. The decrease in the effective tax rate is due to our international expansion in to countries with lower statutory tax rates, partially offset by the United States research and development tax credit which expired at the end of 2011 and has not been renewed for 2012.

Net income

Net income increased by $2.5 million, or 23.6%, from $10.6 million during the nine months ended September 30, 2011 to $13.1 million during the nine months ended September 30, 2012. Net income as a percentage of revenue was 2.3% and 2.2% during the nine months ended September 30, 2011 and 2012, respectively.

Liquidity and Capital Resources

At September 30, 2012, we had $9.2 million of cash and cash equivalents and $0.4 million in available-for-sale securities.

Operating Activities. Cash used in operating activities primarily consists of net income adjusted for certain non-cash items, including depreciation and amortization, and the effect of changes in working capital and other activities. Cash used in operating activities for the nine months ended September 30, 2012 was $13.1 million and consisted of net income of $13.1 million, and $14.0 million of non-cash items, offset by $8.4 million of excess tax benefits on exercises of stock awards and $31.9 million used by working capital and other activities. The most significant impact on working capital and other activities consisted of an increase in accounts receivable and unbilled revenue of $29.9 million and an increase in prepaid expenses and other of $26.2 million offset by a decrease in accounts payable of $18.6 million.

Cash provided by operating activities for the nine months ended September 30, 2011 was $17.0 million and consisted of net income of $10.6 million and non-cash items of $7.4 million, offset by $1.0 million used by working capital and other activities. The most significant impact on working capital and other activities consisted of an increase in accounts receivable and unbilled revenue of $16.9 million and prepaid expenses and other of $13.7 million, offset by an increase in accounts payable of $26.4 million.

Investing Activities. Cash used in investing activities in the nine months ended September 30, 2012 of $10.8 million was primarily attributable to capital expenditures of $7.5 million, payments to sellers for acquisitions closed prior to 2009 of $3.0 million and payments for current year acquisitions of $0.9 million, offset by proceeds from the sale of Echo shares and other investments of $0.6 million.

Cash used in investing activities in the nine months ended September 30, 2011 of $19.2 million was attributable to capital expenditures of $5.7 million, payments made in connection with acquisitions of $10.3 million and payments to sellers for acquisitions closed prior to 2009 of $6.2 million, offset by the proceeds on sale of Echo shares of $3.0 million.

Financing Activities. Cash provided by financing activities in the nine months ended September 30, 2012 of $20.2 million was primarily attributable to the borrowings under the revolving credit facility of $14.0 million, excess tax benefits over compensation cost on exercised stock awards of $8.4 million and proceeds from the exercise of stock options of $4.0 million, offset by payments of contingent consideration of $6.1 million.

Cash provided by financing activities in the nine months ended September 30, 2011 of $6.7 million was primarily attributable to borrowings under the revolving credit facility of $5.8 million, excess tax benefits over compensation cost on exercised stock awards of $0.7 million and proceeds from exercise of stock options of $0.2 million.

Although we can provide no assurances, we believe that our available cash and cash equivalents, short-term investments and amounts available under our revolving credit facility will be sufficient to meet our working capital and operating expenditure requirements for the foreseeable future.

Off-Balance Sheet Obligations

We do not have any off-balance sheet arrangements.

Contractual Obligations

With the exception of the contingent consideration in connection with our business acquisitions discussed in Note 2 in the Notes to the Consolidated Financial Statements, there have been no material changes outside the normal course of business in the contractual obligations disclosed in Item 7 to our Annual Report on Form 10-K for the fiscal year ended December 31, 2011, under the caption "Contractual Obligations."

Critical Accounting Policies and Estimates

As of September 30, 2012, there were no material changes to our critical accounting policies and estimates disclosed in our Form 10-K for the year ended December 31, 2011.

Recent Accounting Pronouncements

In June 2011, the Financial Accounting Standards Board (FASB) amended its standard on the presentation of comprehensive income in financial statements to improve the comparability, consistency and transparency of financial reporting and to increase the prominence of items that are recorded in other comprehensive income. The new accounting standard requires entities to report components of comprehensive income in either (1) a continuous statement of comprehensive income or (2) two separate but consecutive statements. The provisions of this new standard are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. While the new standard changes the presentation of comprehensive income, there are no changes to components that are recognized in net income or other comprehensive income under current accounting guidance. For interim periods, the standard requires companies to present a total for comprehensive income in either a single continuous statement or two consecutive statements. We adopted this standard in the first quarter of 2012.

In September 2011, the FASB amended its standards related to goodwill impairment testing with the objective being to simplify the annual goodwill impairment process by allowing entities to use qualitative factors first before performing the traditional two-step goodwill impairment test. The two-step impairment test is now only required if an entity determines through this qualitative analysis that it is more likely than not that the fair value of the reporting unit is less than its carrying value. Adoption of the new standard was permitted for our fourth quarter 2011 impairment test, but we elected to perform the traditional two-step test until a further assessment could be made. We have not yet determined if this standard will be adopted in 2012. Because the measurement of a potential impairment has not changed, the standard will not have an impact on our consolidated results of operations, financial position or cash flows.

Forward-Looking Statements

This Quarterly Report on Form 10-Q, including Management's Discussion and Analysis of Financial Condition and Results of Operations, contains words such as "may," "will," "believe," "expect," "anticipate," "intend," "plan," "project," "estimate" and "objective" or the negative thereof or similar terminology concerning the Company's future financial performance, business strategy, plans, goals and objectives. These expressions are intended to identify forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include information concerning our possible or assumed future performance or results of operations and are not guarantees. While these statements are based on assumptions and judgments that management has made in light of industry experience as well as perceptions of historical trends, current conditions, expected future developments and other factors believed to be appropriate under the circumstances, they are subject to risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different. Some of the factors that would cause future results to differ from the recent results or those projected in forward-looking statements include, but are not limited to, the risk factors described in our Annual Report on Form 10-K for the year ended December 31, 2011.

Additional Information

We make our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, other reports and information filed with the SEC and amendments to those reports available, free of charge, through our Internet website (http://www.inwk.com) as soon as reasonably practical after we electronically file or furnish such materials to the SEC. All of our filings may be read or copied at the SEC's Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. Information on the operation of the Public Filing Room can be obtained by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet website (http://www.sec.gov) that contains reports, proxy and information statements and other information regarding issuers that file electronically.

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