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DWRE > SEC Filings for DWRE > Form 10-Q on 10-May-2013All Recent SEC Filings

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Form 10-Q for DEMANDWARE INC


10-May-2013

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 digital 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 digital 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 also 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 cloud-based digital commerce solutions for retailers and branded manufacturers. Our digital commerce platform, Demandware Commerce, enables customers to establish and execute complex digital commerce strategies that include global expansion, multi-brand rollouts and omni-channel operations. We enable companies to easily design, implement and manage their own customized digital commerce sites, including websites, mobile applications and other digital storefronts. Through our highly scalable and open Demandware Commerce platform, our customers create seamless brand experiences to reach their consumers across all digital touch points globally.

We sell subscriptions to our on-demand software and related services through both a direct sales force and indirect channels. Our current customers consist of retailers and branded consumer product manufacturers that operate principally in the following vertical markets: apparel and footwear, general merchandise, health & beauty, home & garden, toys and 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 generally based on a revenue share pricing model, in which 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 term that is generally three years and range up to seven years.

Subscription revenue is driven primarily by the number of customers we have, the number of digital 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 omni-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' digital 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 approximately six months to implement a new customer site on our platform. Incremental sites for a customer, including for additional brands or geographies, can be implemented in less than one month.


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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 of 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 cloud-based digital commerce solutions will provide us with significant growth opportunities. As digital 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 digital commerce sites, increase their number of sites and expand their online presence to encompass multiple digital channels such as in-store digital solutions. Just as companies have increasingly chosen cloud-based 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 cloud-based solutions for their digital commerce needs.

We are focused on growing our business by pursuing the significant market opportunity for cloud-based digital 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 sites deployed by them and by extending their online presence across multiple channels, including mobile applications, social networks, call centers and in-store applications. We also plan to expand our customer base to include industry sectors, customer segments and geographic regions beyond those which we currently serve.

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 then 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 $3.1 million.

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 under "Basis of Presentation and Significant Accounting Policies," included in Note 1 of Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q, 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 particular quarter as the number of customers generating subscription revenue during the period, and 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 March 31, 2013, we had 156 customers.

Number of Customer Sites

Since our customers generally operate more than one digital 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 sites using our solutions in a given quarter is an indicator of the growth of our business. As of March 31, 2013, our customers were operating 630 sites on our platform.

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 Annual Report on Form 10-K filed with the SEC on March 8, 2013 have the greatest potential impact on our financial statements and, therefore, we consider these to be our critical accounting policies.


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As of March 31, 2013, there have been no material changes to our critical accounting policies since December 31, 2012.

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
                                                     March 31,
                                                2013           2012
                Results of Operations:
                Revenue:
                Subscription                  $  18,905      $ 13,613
                Services                          1,609         2,477

                Total revenue                    20,514        16,090
                Cost of revenue:
                Subscription                      3,964         2,866
                Services                          2,518         2,553

                Total cost of revenue             6,482         5,419

                Gross profit                     14,032        10,671
                Operating expenses:
                Sales and marketing              11,376         6,338
                Research and development          4,740         3,471
                General and administrative        5,233         2,705

                Total operating expenses         21,349        12,514

                Loss from operations             (7,317 )      (1,843 )
                Other (expense) income, net        (436 )        (274 )

                Loss before income taxes         (7,753 )      (2,117 )
                Income tax expense                  219           126

                Net loss                      $  (7,972 )    $ (2,243 )

Revenue and Metrics

Revenue



                                      Three Months Ended
                                           March 31,                    Change
                                      2013           2012           $            %
                                                 (dollars in thousands)
      Subscription revenue          $  18,905      $ 13,613      $ 5,292         38.9 %
      Percentage of total revenue        92.2 %        84.6 %
      Services revenue              $   1,609      $  2,477      $  (868 )      (35.0 )%
      Percentage of total revenue         7.8 %        15.4 %

Subscription revenue. Subscription revenue for the three months ended March 31, 2013 increased by $5.3 million, or 38.9%, compared to the three months ended March 31, 2012. The increase was driven primarily by an increase of $3.5 million in revenue from new customers. We had 156 customers and 630 sites operating on our platform at March 31, 2013, an increase from 110 customers and 402 sites operating on our platform at March 31, 2012. In addition, revenue from existing customers net of revenue declines from customer terminations grew $1.8 million in the 2013 period. Revenue realized from overage fees increased from $3.6 million to $5.8 million, and represented 26.1% and 30.6% of subscription revenue, for the three months ended March 31, 2012 and 2013, respectively.

Services revenue. Services revenue for the three months ended March 31, 2013 decreased by $0.9 million, or (35.0%), compared to the three months ended March 31, 2012. We recognize service revenue performed after our customers have launched on our platform as such services are delivered, and we performed $0.4 million less of these services compared to the 2012 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 digital commerce platform ratably over the estimated life of our customer base, which was three to six years for revenue recognized in the 2012 period, and just over six years for revenue recognized in the current period. Revenue from service


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engagements sold with the subscription declined $0.6 million compared to the three months ended March 31, 2012, with $0.4 million of the decrease due to the change in estimated expected customer life that was assessed at December 31, 2012, and $0.5 million of the decrease due to our realizing the remaining portion of the deferred services revenue balance in the fourth quarter of 2012 from one large customer, as a result of the bankruptcy filing by that customer, and the cessation of that relationship. This $0.9 million decrease in revenue from service engagements sold with the subscription was offset by an increase in revenues from more customers and sites operating on our platform during the three months ended March 31, 2013 compared to the three months ended March 31, 2012.

Cost of Revenue



                                          Three Months Ended
                                               March 31,                    Change
                                          2013           2012            $           %
                                                     (dollars in thousands)
   Cost of subscription revenue         $   3,964       $ 2,866       $ 1,098        38.3 %
   Percentage of subscription revenue        21.0 %        21.1 %
   Gross margin                              79.0 %        78.9 %
   Cost of services revenue             $   2,518       $ 2,553       $   (35 )      (1.4 )%
   Percentage of services revenue           156.5 %       103.1 %
   Gross margin                             (56.5 )%       (3.1 )%

Cost of subscription revenue. Cost of subscription revenue for the three months ended March 31, 2013 increased by $1.1 million, or 38.3%, compared to the three months ended March 31, 2012. The increase was primarily attributable to $0.3 million of increased depreciation and maintenance expenses associated with equipment for our data centers and $0.5 million of increased hosting and bandwidth expenses due to an expansion of our capacity to accommodate the growth during the 2013 period. In addition, we increased our headcount in our support and technical operations team by 9 employees, or 33.3% in the 2013 period. As a result, our personnel and related expenses, such as salaries, bonuses, payroll taxes, recruiting fees and stock compensation, increased $0.2 million in the 2013 period.

Cost of services revenue. Cost of services revenue for the three months ended March 31, 2013 decreased by $35,000, or (1.4%), compared to the three months ended March 31, 2012. The decrease was primarily attributable to $0.4 million of increased stock compensation expense, offset by $0.4 million of decreased outside consulting expenses resulting from a decreased use of third-party contractors to assist our direct services implementation teams. While we experienced an increase in the number of customers in the implementation phase during the three months ended March 31, 2013, because more of our implementations were lead by third party integrators, the number of implementations performed directly and solely by our client service team decreased by 89% when compared to the three months ended March 31, 2012. Our increased use of third party integration partners to service our customer implementations has allowed us to enable more customers to launch sites on our platform while minimizing the additional headcount required by us to perform the implementation which has enabled us to control our internal costs.

Operating Expenses

Sales and Marketing



                                        Three Months Ended
                                             March 31,                   Change
                                         2013          2012           $          %
                                                  (dollars in thousands)

Sales and marketing $ 11,376 $ 6,338 $ 5,038 79.5 % Percentage of total revenue 55.5 % 39.4 %

Sales and Marketing. Sales and marketing expenses for the three months ended March 31, 2013 increased by $5.0 million, or 79.5%, compared to the three months ended March 31, 2012. The increase was attributable to the continued expansion of our sales force to address increased opportunities in new and existing markets. Total headcount within sales and marketing increased from 97 at March 31, 2012 to 131 at March 31, 2013, an increase of 35.1%. We added employees within our direct sales, retail practice and marketing organizations in both North America and Europe, which contributed to $2.6 million of increased personnel and related expenses, of which $1.0 million was related to stock compensation expense. In addition, commissions and sales bonuses increased by $1.0 million, or 75.1%, in the 2013 period as a result of an increase in the committed annual contract value for new customers acquired during the 2013 period. Additionally, marketing program expenses increased $0.9 million in the 2013 period as we increased the level of spending to enhance our global brand. Finally, we incurred $0.2 million of increased travel and entertainment expenses and $0.3 million of increased costs such as rent, information technology, or IT, costs and depreciation and amortization expenses incurred as a result of our growth.


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Research and Development



                                        Three Months Ended
                                             March 31,                   Change
                                        2013           2012           $          %
                                                  (dollars in thousands)

Research and development $ 4,740 $ 3,471 $ 1,269 36.6 % Percentage of total revenue 23.1 % 21.6 %

Research and Development. Research and development expenses for the three months ended March 31, 2013 increased by $1.3 million, or 36.6%, compared to the three months ended March 31, 2012. The increase was attributable to investments made to enhance and improve the functionality of our digital commerce platform. We increased our engineering headcount by 19 employees, or 32.8%, in the 2013 period, which contributed to increased personnel and related expenses of $1.6 million, of which $0.9 million related to stock compensation expense. Additionally, we incurred increased expenses of allocated overhead costs such as rent, IT costs, and depreciation and amortization, of $0.2 million, relating to overall increased expenses to support our continued growth. As a direct result of our strong hiring efforts, we decreased contractor costs $0.5 million in the 2013 period.

General and Administrative



                                        Three Months Ended
                                             March 31,                   Change
                                        2013           2012           $          %
                                                  (dollars in thousands)

General and administrative $ 5,233 $ 2,705 $ 2,528 93.5 % Percentage of total revenue 25.5 % 16.8 %

General and Administrative. General and administrative expenses for the three months ended March 31, 2013 increased $2.5 million, or 93.5%, compared to the three months ended March 31, 2012. The increase was driven primarily by increased employee-related costs and professional fees to support our growing business. We incurred increased personnel and related costs of $1.9 million, of which $1.3 million related to stock compensation expense, and increased professional fees of $0.2 million for accounting, audit, and tax services incurred to support the expansion and growth of our business. Additionally, our insurance expense increased $0.1 million over the prior period, as a direct result of our transition from a private company to a public company. Finally, we incurred $0.3 million of increased costs, such as rent, IT costs and depreciation expenses as a result of our growth as well as increased miscellaneous state taxes of $0.1 million as a result of expanding into new states in the U.S.

Other (Expense) Income



                                      Three Months Ended
                                           March 31,                    Change
                                      2013            2012          $            %
                                                 (dollars in thousands)

Other (expense) income $ (436 ) $ (274 ) $ (162 ) (59.1 )% Percentage of total revenue (2.1 )% (1.7 %)

Other (Expense) Income. Other (expense) income for the three months ended March 31, 2013 increased $0.2 million, or (59.1%), compared to the three months ended March 31, 2012. The increase was attributable to $0.4 million in foreign exchange losses related to fluctuations in the British pound sterling and Euro in relation to the U.S. Dollar in the 2013 period compared to foreign exchange gains of $0.2 million in the 2012 period. During the 2012 period, we incurred $0.4 million in other expense due to the increase in the fair value of our warrant which was no longer outstanding in the 2013 period.


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Liquidity and Capital Resources

To date, we have financed our operations primarily through the sale of equity securities, including net cash proceeds from our IPO in March 2012, in which we raised approximately $94.1 million from our IPO, net of underwriting discounts and commissions but before offering expenses of $3.1 million.

Our cash, cash equivalents and marketable securities totaled $107.1 million at March 31, 2013.

At March 31, 2013, our principal sources of liquidity were $56.3 million of cash and cash equivalents.

Borrowing availability for eligible equipment purchases under the Loan and Security Agreement, dated July 18, 2008, between us and Silicon Valley Bank, as amended, which we refer to as the 2008 Loan Agreement, expired in March 2013. We are currently evaluating an extension or amendment to the 2008 Loan Agreement. To the extent that we do not extend or amend our 2008 Loan Agreement, or replace it with a new facility that allows us to borrow for eligible equipment purchases, we will need to fund these equipment purchases through our existing cash and cash equivalents. The 2008 Loan Agreement is secured by substantially all of our assets, except our intellectual property. The 2008 Loan Agreement also contains various covenants that limit, among other things, indebtedness, investments, liens, transactions and certain mergers and sales of assets. In addition, the loan contains financial covenants that impose a minimum adjusted quick ratio (as defined in the 2008 Loan Agreement) and minimum quarterly revenue targets. We were in compliance with all such covenants at March 31, 2013.

Based on our current level of operations and anticipated growth, we believe our future cash flows from operating activities, existing cash and cash equivalents will provide adequate funds for our ongoing operations for at least the next twelve months. Our future capital requirements will depend on many factors, including our rate of revenue, billings growth and collections, the level of our sales and marketing efforts, the timing and extent of spending to support product development efforts and expansion into new territories, the timing of general and administrative expenses as we grow our administrative infrastructure, the continuing market acceptance of our solution, and potential acquisitions of complementary businesses, services or technologies. To the extent that existing cash and cash from operations are not sufficient to fund our future activities, we may need to raise additional funds. If we make acquisitions of complementary businesses, services or technologies, we could be required to seek additional equity financing or utilize our cash resources.

Depending on certain growth opportunities, we may choose to accelerate investments in sales and marketing, research and development, which may require the use of proceeds from our initial public offering for such additional expansion and expenditures.

The following table sets forth a summary of our cash flows for the periods indicated (in thousands):

. . .

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