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DWRE > SEC Filings for DWRE > Form 10-Q on 9-Nov-2012All Recent SEC Filings

Show all filings for DEMANDWARE INC

Form 10-Q for DEMANDWARE INC


9-Nov-2012

Quarterly Report


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

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements are any statements that look to future events and consist of, among other things, statements regarding our business strategies; anticipated future operating results and operating expenses; our ability to attract new customers to enter into subscriptions for our solution; our ability to service those customers effectively and induce them to renew and upgrade their deployments of our solution; our ability to expand our sales organization to address effectively the new industries, geographies and types of organizations we intend to target; our ability to accurately forecast revenue and appropriately plan our expenses; market acceptance of enhanced solutions; alternate ways of addressing e-commerce needs or new technologies generally by us and our competitors; continued acceptance of software-as-a-service, or SaaS, as an effective method for delivering e-commerce solutions and other applications; the attraction and retention of qualified employees and key personnel; our ability to protect and defend our intellectual property; costs associated with defending intellectual property infringement and other claims; events in the markets for our solution and alternatives to our solution, as well as in the United States and global markets generally; future regulatory, judicial and legislative changes in our industry; and changes in the competitive environment in our industry and the markets in which we operate. In addition, forward-looking statements consist of statements involving trend analyses and statements including such words as "may," "believe," "could," "anticipate," "would," "might," "plan," "expect," and similar expressions or the negative of such terms or other comparable terminology, although not all forward-looking statements contain these words. These forward-looking statements speak only as of the date of this Form 10-Q and are subject to business and economic risks. These statements are not guarantees of future performance and involve certain risks, uncertainties, and assumptions that are difficult to predict, and you should not place undue reliance on our forward-looking statements. Our actual results could differ materially from those set forth in the forward-looking statements as a result of the factors set forth in this Item 2, in Part II, Item 1A, "Risk Factors," elsewhere in this Form 10-Q and in our other reports filed with the Securities and Exchange Commission, or SEC. We expressly disclaim any obligation to update the forward-looking statements to reflect events or circumstances that arise after the date hereof.

Overview

We are a leading provider of SaaS e-commerce solutions that enable companies to easily design, implement and manage their own customized e-commerce sites, including websites, mobile applications and other digital storefronts. Our customers use our highly scalable and integrated Demandware Commerce platform to create a seamless brand experience for consumers across all digital touch points worldwide.

We sell subscriptions to our on-demand software and related services through a direct sales force and indirect channels. Our customers consist of retailers and branded consumer product manufacturers that operate principally in the following vertical markets: apparel, general merchandise, health & beauty, home & garden, sporting goods and other vertical categories.

We derive most of our revenue from subscriptions to our on-demand platform and related services. Subscription fees are based on a variable revenue share pricing model, whereby our customers pay us a percentage of their total gross revenue that is processed on our platform. As part of their subscription fee, our customers commit to a minimum level of gross revenue to be processed on our platform, from which a minimum monthly, quarterly or annual, non-refundable subscription fee is derived. If a customer processes more gross revenue than its committed minimum level, then the customer is required to pay us additional fees, called overage fees, which are calculated as a percentage of the incremental revenue generated above the committed revenue. While we typically record overage fees each quarter, a significant portion is recorded in the fourth quarter. No refunds or credits are given if a customer processes less gross revenue than the contracted level. Customer contracts are generally non-cancellable for a minimum period that is typically three years and ranges from one year to seven years.

Subscription revenue is driven primarily by the number of customers we have, the number of e-commerce sites they operate on our platform, the contracted minimum value of our subscription agreements and the gross revenue generated from our customers in excess of their committed minimum levels. To date, revenue generated by our customers' traditional web e-commerce sites has been the primary driver of our subscription revenue. However, we believe that our multi-channel capabilities, including mobile, social and other web channels, have been and will continue to be important factors in our new customers' purchasing decisions.

We derive our services revenue from the implementation of our customers' e-commerce sites, which includes the integration of complementary technologies and adaptation to back-end systems and/or business processes and the configuration and deployment of the site. We also provide training services for individuals who are part of the implementation, maintenance and optimization teams of our customers. In general, it takes from four to six months to implement a new customer e-commerce site on our platform. Incremental e-commerce sites for a customer, including for additional brands or geographies, can be implemented in less than one month either by us, our partners, or the customers themselves.


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Deferred revenue primarily consists of the unearned portion of billed services fees and fees for our on-demand software. As we invoice nearly all our customers on a monthly or quarterly basis, our deferred revenue balance does not serve as a reliable indicator of our future subscription revenue.

We believe the large and growing market for SaaS e-commerce solutions will provide us with significant growth opportunities. As e-commerce transactions continue to account for a greater proportion of all retail sales, we believe that retailers and branded consumer product manufacturers will continue to enhance the performance and functionality of their e-commerce sites, increase their number of e-commerce sites and expand their online presence to encompass multiple digital channels. Just as companies have increasingly chosen SaaS solutions as an attractive alternative to costly and inflexible on-premise solutions for their enterprise-wide applications, we believe that retailers and branded consumer product manufacturers will increasingly adopt SaaS solutions for their e-commerce needs.

We are focused on growing our business by pursuing the significant market opportunity for SaaS e-commerce solutions. We plan to grow our revenue by adding new customers and helping our existing customers increase their revenue processed on our platform by taking full advantage of the functionality of Demandware Commerce, by increasing the number of e-commerce sites deployed by them and by extending their online presence across multiple channels, including mobile phones, social networks, call centers and in-store kiosks. We also plan to expand our customer base to include industry sectors, customer segments and geographic regions beyond those which we currently serve, including small- and medium-size businesses.

Initial Public Offering

In March 2012, we closed our initial public offering, or IPO, of 6,325,000 shares of common stock, including 825,000 shares sold pursuant to the underwriters' option to purchase additional shares, at an offering price of $16.00 per share. All outstanding shares of our redeemable convertible preferred stock converted to 18,028,763 shares of common stock at the closing of the IPO. Our common stock is traded on the New York Stock Exchange. We received proceeds from the IPO of $94.1 million, net of underwriting discounts and commissions but before offering expenses of $3.3 million. Offering expenses at December 31, 2011 of $1.7 million were recorded in other non-current assets. These offering expenses, and additional expenses incurred from January 2012 through the completion of the IPO of approximately $1.6 million, have been recorded as additional paid-in capital.

Key Metrics

We regularly review a number of metrics to evaluate growth trends, measure our performance, formulate financial projections and make strategic decisions. We discuss revenue, gross margin, and the components of operating income and margin below under "Basis of Presentation," and we discuss other key metrics below.

Number of Customers

We believe that our ability to expand our customer base is an indicator of our market penetration and growth of our business as we continue to invest in our direct sales force, our indirect sales channels and marketing initiatives. We define our number of customers at the end of a quarter as the number of customers generating subscription revenue through the end of the period who have a committed minimum level of gross revenue to be processed on our platform, from which a minimum monthly, quarterly or annual, non-refundable subscription fee is derived. As of September 30, 2012 and 2011, we had 137 and 91 customers, respectively.

Number of Customer E-commerce Sites

Since our customers generally operate more than one e-commerce site across various geographies and brands and pay us fees based on the total gross revenue they process on our platform, we believe the total number of customer e-commerce sites using our solutions in a given quarter is an indicator of the growth of our business. As of September 30, 2012 and 2011, our customers were operating 517 and 321 e-commerce sites on our platform, respectively.

Critical Accounting Policies and Estimates

Our financial statements are prepared in accordance with accounting principles generally accepted in the United States. The preparation of our financial statements and related disclosures requires us to make estimates, assumptions and judgments that affect the reported amount of assets, liabilities, revenue, costs and expenses and related disclosures. We believe that the estimates, assumptions and judgments involved in the accounting policies described in the notes to the condensed consolidated financial statements appearing elsewhere in this Quarterly Report on Form 10-Q and in our prospectus filed with the SEC on March 15, 2012 have the greatest potential impact on our financial statements and, therefore, we consider these to be our critical accounting policies.

As of September 30, 2012, there have been no material changes to our critical accounting policies since December 31, 2011. During the nine month period ended September 30, 2012, we invested certain of the proceeds from our initial public offering in available-for-sale marketable securities. Our accounting policy with respect to marketable securities is described below.


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Cash Equivalents and Short-Term Investments-The Company considers all highly liquid investments maturing within 90 days from the date of purchase to be the equivalent of cash for the purpose of balance sheet and statement of cash flows presentation. As of September 30, 2012, $62.6 million of the Company's cash equivalents were invested in money market funds, and $2.9 million in marketable debt securities.

Short-term investments in marketable securities are classified as available-for-sale and mature within twelve months from the date of purchase. The Company's investments in marketable securities are recorded at fair value, with any unrealized gains and losses, net of taxes, reported as a component of stockholders' equity until realized or until a determination is made that an other-than-temporary decline in market value has occurred. When the Company determines that an other-than-temporary decline has occurred for debt securities that the Company does not then intend to sell, the Company recognizes the credit loss component of an other-than-temporary impairment in other income (expense) and the remaining portion in other comprehensive income. The credit loss component is identified as the amount of the present value of cash flows not expected to be received over the remaining term of the security, based on cash flow projections. In determining whether an other-than-temporary impairment exists, the Company considers: (i) the length of time and the extent to which the fair value has been less than cost; (ii) the financial condition and near-term prospects of the issuer of the securities; and (iii) the Company's intent and ability to retain the security for a period of time sufficient to allow for any anticipated recovery in fair value. The cost of marketable securities sold is determined based on the specific identification method and any realized gains or losses on the sale of investments are reflected as a component of interest income or expense. As of September 30, 2012, $37.0 million of the Company's short-term investments were marketable debt securities. The unrealized gains on our short-term investments were not significant for the nine months ended September 30, 2012.

Recent Accounting Pronouncements

Under the Jumpstart Our Business Startups Act, or JOBS Act, which was signed into law in April 2012, we meet the definition of an emerging growth company. We have irrevocably elected to opt out of the extended transition period for complying with new or revised accounting standards pursuant to Section 107(b) of the JOBS Act. See "Risk Factors-We are an "emerging growth company" and may elect to comply with reduced public company reporting requirements applicable to emerging growth companies, which could make our common stock less attractive to investors."

Results of Operations

The following table sets forth our results of operations for each of the periods
indicated as dollars (in thousands). The period-to-period comparison of
financial results is not necessarily indicative of future results.



                                     Three Months  Ended           Nine Months  Ended
                                        September 30,                 September 30,
                                      2012           2011          2012           2011
     Results of Operations:
     Revenue:
     Subscription                  $   16,250      $ 11,220      $  45,061      $ 30,902
     Services                           2,456         2,255          8,095         7,029

     Total revenue                     18,706        13,475         53,156        37,931
     Cost of revenue:
     Subscription                       3,501         2,473          9,407         6,842
     Services                           2,990         2,958          8,598         7,655

     Total cost of revenue              6,491         5,431         18,005        14,497

     Gross profit                      12,215         8,044         35,151        23,434
     Operating expenses:
     Sales and marketing                8,496         5,082         24,402        14,385
     Research and development           3,935         2,934         11,490         8,345
     General and administrative         3,350         1,526          9,751         4,498

     Total operating expenses          15,781         9,542         45,643        27,228

     Loss from operations              (3,566 )      (1,498 )      (10,492 )      (3,794 )
     Other income (expense), net          134          (468 )         (621 )         (13 )

     Loss before income taxes          (3,432 )      (1,966 )      (11,113 )      (3,807 )
     Income tax expense                    39           125            235           180

     Net loss                      $   (3,471 )    $ (2,091 )    $ (11,348 )    $ (3,987 )


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Revenue and Metrics

Revenue



                                      Three Months Ended                                   Nine Months Ended
                                         September 30,                 Change                September 30,                 Change
                                      2012           2011           $          %           2012          2011           $           %
                                                                           (dollars in thousands)
Subscription revenue                $  16,250      $ 11,220      $ 5,030       44.8 %    $ 45,061      $ 30,902      $ 14,159       45.8 %
Percentage of total revenue              86.9 %        83.3 %                                84.8 %        81.5 %
Services revenue                    $   2,456      $  2,255      $   201        8.9 %    $  8,095      $  7,029      $  1,066       15.2 %
Percentage of total revenue              13.1 %        16.7 %                                15.2 %        18.5 %

Subscription revenue. Subscription revenue for the three months ended September 30, 2012 increased by $5.0 million, or 44.8%, compared to the three months ended September 30, 2011. The increase was driven primarily by an increase of $4.0 million in revenue from new customers and an increase of $1.0 million in revenue from existing customers net of revenue declines from customer terminations. These increases were generated through both organic site growth and the launch of additional e-commerce sites in the 2012 period. We had 137 customers and 517 e-commerce sites operating on our platform at September 30, 2012, an increase from 91 customers and 321 e-commerce sites operating on our platform at September 30, 2011. Revenue realized from overage fees increased from $3.3 million to $4.4 million, and represented 29.3% and 27.3% of subscription revenue, for the three months ended September 30, 2011 and 2012, respectively.

Subscription revenue for the nine months ended September 30, 2012 increased by $14.2 million, or 45.8%, compared to the nine months ended September 30, 2011. The increase was driven primarily by an increase of $10.8 million in revenue from new customers and an increase of $3.4 million in revenue from existing customers net of revenue declines from customer terminations. These increases were generated through both organic site growth and the launch of additional e-commerce sites in the 2012 period. Revenue realized from overage fees increased from $8.8 million to $12.1 million, and represented 28.3% and 26.9% of subscription revenue, for the nine months ended September 30, 2011 and 2012, respectively.

Services revenue. Services revenue for the three months ended September 30, 2012 increased by $0.2 million, or 8.9%, compared to the three months ended September 30, 2011. The increase was primarily driven by a $0.1 million increase in implementation service revenues as the number of customers live on our platform continued to grow during the quarter. Additionally, we recognized $0.1 million in the quarter from our LINK partner membership program. We did not offer any such fee-based membership program in 2011.

Services revenue for the nine months ended September 30, 2012 increased by $1.1 million, or 15.2%, compared to the nine months ended September 30, 2011. The increase was primarily driven by $0.5 million more in services performed after our customers launched their sites on our platform compared to the 2011 period. We recognize billings received for our implementation and training service engagements that are sold with the subscription prior to the customers use of our e-commerce platform ratably over the estimated life of our customer base, which ranges between three and six years for revenue recognized in the 2012 period. Additionally, fees received from sponsors of and participants attending our global customer conference increased $0.2 million during the same period of 2012 over 2011. Additionally, we recognized $0.3 million in the nine months ended September 30, 2012 from our LINK partner membership program. No such fee-based membership program existed in 2011.

In October 2012, neckermann.de GmbH ("Neckermann") commenced formal insolvency proceedings and, in connection therewith, we terminated Neckermann's subscription agreement with us. For the third quarter ended September 30, 2012, Neckermann accounted for approximately 9% of our revenue. We collected in full all revenue from Neckermann recognized in the third quarter ended September 30, 2012, and will recognize revenue from Neckermann on a cash basis of accounting going forward. See "Risk Factors-We depend on a limited number of customers, one of which recently filed for bankruptcy, for a substantial portion of our revenue."


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Cost of Revenue



                                       Three Months Ended                                    Nine Months Ended
                                          September 30,                  Change                September 30,                  Change
                                       2012           2011            $          %           2012          2011            $          %
                                                                            (dollars in thousands)
Cost of subscription revenue         $   3,501       $ 2,473       $ 1,028       41.6 %    $  9,407       $ 6,842       $ 2,565       37.5 %
Percentage of subscription revenue        21.5 %        22.0 %                                 20.9 %        22.1 %
Gross margin                              78.5 %        78.0 %                                 79.1 %        77.9 %
Cost of services revenue             $   2,990       $ 2,958       $    32        1.1 %    $  8,598       $ 7,655       $   943       12.3 %
Percentage of services revenue           121.7 %       131.2 %                                106.2 %       108.9 %
Gross margin                             (21.7 )%      (31.2 )%                                (6.2 )%       (8.9 )%

Cost of subscription revenue. Cost of subscription revenue for the three months ended September 30, 2012 increased by $1.0 million, or 41.6%, compared to the three months ended September 30, 2011. The increase was primarily attributable to $0.3 million of increased depreciation, maintenance, and equipment and software support expenses associated with equipment for our data centers and $0.6 million of increased hosting and bandwidth expenses due to an expansion of our capacity to accommodate the growth during the 2012 period. In addition, we increased our headcount in our support and technical operations team by 40.9% in the 2012 period, growing from 22 employees at September 30, 2011 to 31 employees at September 30, 2012. As a result, our personnel and related expenses, such as salaries, bonuses, payroll taxes, recruiting fees and stock compensation, increased by $0.2 million in the 2012 period.

Cost of subscription revenue for the nine months ended September 30, 2012 increased by $2.6 million, or 37.5%, compared to the nine months ended September 30, 2011. The increase was primarily attributable to $0.8 million of increased depreciation, maintenance, and equipment and software support expenses associated with equipment for our data centers and $1.3 million of increased hosting and bandwidth expenses due to an expansion of our capacity to accommodate the growth during the 2012 period. In addition, we increased our headcount in our support and technical operations team by 40.9% in the 2012 period, growing from 22 employees at September 30, 2011 to 31 employees at September 30, 2012. As a result, our personnel and related expenses, such as salaries, bonuses, payroll taxes, recruiting fees and stock compensation, increased by $0.8 million in the 2012 period. These expense increases were partially offset by a $0.4 million decrease in a third party license arrangement which we terminated in 2011.

Cost of services revenue. Cost of services revenue for the three months ended September 30, 2012 increased by $32,000, or 1.1%, compared to the three months ended September 30, 2011. The increase was primarily attributable to $0.5 million of increased personnel and related expenses due to increased client services headcount, offset by $0.5 million of decreased outside consulting expenses resulting from a decreased use of third-party contractors to assist our direct services implementation teams. The increase in services headcount from 36 in the 2011 period to 44 in the 2012 period resulted from our expansion into new geographical regions as well as an increase in the number of customer implementations conducted in the 2012 period versus the 2011 period. While we had more customers in the implementation phase during the three months ended September 30, 2012 than in the comparable period in 2011, we also had a higher percentage of customers utilizing our partners for their implementations of e-commerce sites. Approximately 14% of current period implementations were performed directly by our client service team as opposed to through a partner, compared to 27% during the three months ended September 30, 2011. Our increased use of partners to service our customer implementations has allowed us to enable more customers to launch sites on our platform while controlling our internal costs.

Cost of services revenue for the nine months ended September 30, 2012 increased by $0.9 million, or 12.3%, compared to the nine months ended September 30, 2011. The increase was primarily attributable to $1.4 million of increased personnel and related expenses due to increased client services headcount due to our expansion into new geographical regions and the increased number of customer implementations conducted in the 2012 period versus the 2011 period, and $0.1 million of increased allocated overhead costs such as rent, information technology, or IT, costs, and depreciation and amortization expenses incurred as a result of our growth. This is offset by $0.7 million of decreased outside consulting expenses resulting from a decreased use of third-party contractors to assist our direct services implementation teams. During the nine months ended September 30, 2012, we experienced an approximate 22% increase in the average headcount when compared to the nine months ended September 30, 2011. While we experienced an increase in the number of customers in the implementation phase during the nine months ended September 30, 2012 when compared to the prior period, approximately 22% of the current period implementations were performed directly by our client service team as opposed to through a partner, compared to 33% during the nine months ended September 30, 2011. Our increased use of partners to service our customer implementations has allowed us to enable more customers to launch sites on our platform while controlling our internal costs.


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Operating Expenses

Sales and Marketing

Three Months Ended Nine Months Ended
September 30, Change September 30, Change
2012 2011 $ % 2012 2011 $ %
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