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

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Form 10-Q for INNERWORKINGS INC


10-May-2013

Quarterly Report


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

Overview

We are a leading provider of global print management and promotional solutions to corporate clients across a wide range of industries. 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 and database of information 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. Since 2002, we have expanded from a regional focus to a national and now global focus.

Our proprietary software applications and database 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 print jobs. As a result, we have 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 our print jobs with suppliers that are optimally suited to meet the client's needs at a highly competitive price.

Through our network of more than 10,000 global suppliers, we offer a full range of print, fulfillment and logistics services that allow 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 and data, 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.

We generate revenue by procuring and purchasing printed products from our suppliers and selling those products to our clients. We procure printed products for clients across a wide range of industries, such as retail, financial services, hospitality, non-profits, healthcare, food and beverage, broadcasting and cable, education, transportation and utilities. Our clients fall into two categories, enterprise and middle market. We enter into arrangements with our enterprise clients to provide some, or substantially all, of their printed products, typically on a recurring basis. We provide printed products to our middle market clients on an order-by-order basis.

We were formed in 2001, commenced operations in 2002 and converted from a limited liability company to a Delaware corporation in January 2006. Our corporate headquarters are located in Chicago, Illinois. As of March 31, 2013, we had approximately 1,400 employees and independent contractors in more than 30 countries. We organize our operations into two segments based on geographic regions: North America and International. The North America segment includes operations in the United States and Canada, and the International segment includes operations in the United Kingdom, continental Europe, the Middle East, Latin America and Asia. In the three months ended March 31, 2013, we generated global revenue from third parties of $164.4 million in the North America segment and $39.9 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 $188.5 million and $204.3 million during the three months ended March 31, 2012 and 2013, respectively. Total revenue increased 8.4% from the prior year of which 7% was from organic growth. Our revenue is generated from two different types of clients: enterprise and middle market. Enterprise clients usually order printed products in higher dollar amounts and volume than our middle market clients. 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 clients. We enter into contracts with our enterprise clients to provide some or a specific portion of their printed products on a recurring basis. Our contracts with enterprise clients are generally three to five years, subject to termination by either party upon prior notice ranging from 90 days to twelve months.

Several of our enterprise clients have outsourced substantially all of their recurring print needs to us. We provide printed products to our middle market clients on an order-by-order basis. During the three months ended March 31, 2013, enterprise clients accounted for 79% of our revenue, while middle market clients accounted for 21% 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 clients, is dependent on prices 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 clients because the gross profit margins established in our contracts with large enterprise clients are generally lower than the gross profit margins typically realized in our middle market business. Although our enterprise revenue generates lower gross profit margins, our enterprise business tends to be as profitable as our middle market business on an operating profit basis because the commission expense associated with enterprise clients 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 clients, is based on a fixed gross margin established by contract or, in the case of middle market clients, is determined at the discretion of the account executive or production manager within predetermined parameters. Our gross margins on our enterprise clients are typically lower than our gross margins on our middle market clients. As a result, our cost of goods sold as a percentage of revenue for our enterprise clients is typically higher than those for our middle market clients. Our gross profit for the three months ended March 31, 2012 and 2013 was $41.4 million and $46.0 million, or 22.0% and 22.5% of revenue, respectively.

Operating Expenses

Our selling, general and administrative expenses consist of commissions paid to our account executives, compensation costs for our management team and production managers as well as compensation costs for our finance and support employees, public company expenses, and corporate systems, legal and accounting, facilities and travel and entertainment expenses. Selling, general and administrative expenses as a percentage of revenue were 17.5% and 20.4% for the three months ended March 31, 2012 and 2013, respectively.

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 $8.7 million as of March 31, 2013 from $8.3 million as of December 31, 2012.

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 execute with 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.

Comparison of three months ended March 31, 2012 and 2013

Revenue



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



                              Three Months Ended March 31,
                  2012         % of Total        2013         % of Total
                                 (dollars in thousands)
North America   $ 158,015             83.8 %   $ 164,370             80.4 %
International      30,531             16.2        39,946             19.6

Revenue         $ 188,546            100.0 %   $ 204,316            100.0 %

North America

North America revenue increased by $6.4 million, or 4.0%, from $158.0 million during the three months ended March 31, 2012 to $164.4 million during the three months ended March 31, 2013. This increase in revenue is driven primarily by organic new enterprise and middle market account growth.

International

International revenue increased by $9.4 million, or 30.8%, from $30.5 million during the three months ended March 31, 2012 to $39.9 million during the three months ended March 31, 2013. This increase is primarily due to revenues contributed from prior year acquisitions, as well as organic growth in Latin America, which includes expansion in to Brazil.

Cost of goods sold

Our cost of goods sold increased by $11.2 million, or 7.6%, from $147.2 million during the three months ended March 31, 2012 to $158.3 million during the three months ended March 31, 2013. The increase is a result of the revenue growth during the three months ended March 31, 2013. Our cost of goods sold as a percentage of revenue was 78.0% and 77.5% during the three months ended March 31, 2012 and 2013, respectively.

Gross Profit

Our gross profit as a percentage of revenue, which we refer to as gross margin, was 22.0% and 22.5% during the three months ended March 31, 2012 and 2013, respectively. This increase is primarily due to improved gross margin in Latin America driven by process improvements.

Selling, general and administrative expenses

Selling, general and administrative expenses increased by $8.7 million, or 26.2%, from $33.1 million during the three months ended March 31, 2012 to $41.7 million during the three months ended March 31, 2013. As a percentage of revenue, selling, general and administrative expenses increased from 17.5% for the three months ended March 31, 2012 to 20.4% for the three months ended March 31, 2013. 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. The increase in selling, general and administrative expenses as a percent of revenue is due to actual revenues being less than expected.

Depreciation and amortization

Depreciation and amortization expense increased by $0.1 million, or 0.9%, from $2.4 million during the three months ended March 31, 2012 and to $2.5 million during the three months ended March 31, 2013.

Income from operations

Income from operations decreased by $4.1 million, or 69.5%, from $5.9 million during the three months ended March 31, 2012 to $1.8 million during the three months ended March 31, 2013. As a percentage of revenue, income from operations was 3.1% and 0.9% during the three months ended March 31, 2012 and 2013, respectively. This decrease is primarily attributable to the increase in selling, general and administrative expenses discussed above.

Other expense

Other expense increased by $0.7 million from $0.3 million for the three months ended March 31, 2012 to $0.9 million during the three months ended March 31, 2013. The decrease is primarily attributable to a decrease in the gain on sale of shares of Echo of $0.2 million and an increase in foreign currency losses of $0.6 million, offset by a decrease in interest expense of $0.2 million.

Income tax expense

Income tax expense decreased by $1.9 million, or 101.5%, from $1.9 million during the three months ended March 31, 2012 to a tax benefit of less than $0.1 million during the three months ended March 31, 2013. Our effective tax rate was 34.2% and (3.2)% for the three month periods ended March 31, 2012 and 2013, respectively.

The decrease in the effective tax rate was primarily due to the 2012 R&D tax credit which was recognized in the first quarter of 2013. On January 2, 2013, the President signed the American Taxpayer Relief Act of 2012. The legislation retroactively extended the R&D tax credit for two years, from January 1, 2012 through December 31, 2013. Our effective tax rate for the three months ended March 31, 2013 reflected the 2012 R&D tax credit of $0.3 million. Excluding the impact of this discrete event, the effective tax rate for the three months ended March 31, 2013 was 32.4% which decreased from the prior year due to international expansion into countries with lower statutory tax rates, as well as the 2013 R&D tax credit.

Net income

Net income decreased by $2.8 million, or 75.7%, from $3.7 million during the three months ended March 31, 2012 to $0.9 million during the three months ended March 31, 2013. Net income as a percentage of revenue was 2.0% and 0.4% during the three months ended March 31, 2012 and 2013, respectively. This decrease is primarily attributable to the increase in selling, general and administrative expenses discussed above.

Liquidity and Capital Resources

At March 31, 2013, we had $10.6 million of cash and cash equivalents.

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 provided by operating activities for the three months ended March 31, 2013 was $4.6 million and consisted of net income of $0.9 million and $3.8 million of non-cash items, offset by $0.1 million used by working capital and other activities. The most significant impact on working capital and other activities consisted of an increase in accounts payable of $4.8 million and an increase in inventories of $2.0 million, offset by a decrease in accrued expenses and other liabilities of $4.1 million and an increase in prepaid expenses and other assets of $3.1 million.

Cash used in operating activities for the three months ended March 31, 2012 was $7.5 million and consisted of net income of $3.7 million, $0.4 million of non-cash items and $11.6 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 $22.8 million and an increase in prepaid expenses and other of $10.3 million offset by an increase in accounts payable of $16.0 million.

Investing Activities. Cash used in investing activities in the three months ended March 31, 2013 of $9.1 million was attributable to capital expenditures of $2.9 million and payments for current year acquisitions, net of cash acquired, of $6.3 million.

Cash used in investing activities in the three months ended March 31, 2012 of $3.2 million was attributable to payments made in connection with acquisitions of $1.6 million and capital expenditures of $1.9 million, offset by proceeds from the sale of Echo shares and other investments of $0.3 million.

Financing Activities. Cash used in financing activities in the three months ended March 31, 2013 of $1.9 million was primarily attributable to payments of contingent consideration of $9.1 million, offset by net borrowings under the revolving credit facility of $5.5 million, proceeds from the exercise of stock options of $0.8 million and excess tax benefits over compensation cost on exercised stock awards of $1.0 million.

Cash provided by financing activities in the three months ended March 31, 2012 of $12.9 million was primarily attributable to the $11.4 million of borrowings under the revolving credit facility and $4.2 million of excess tax benefits over compensation cost on exercised stock awards offset by $3.2 million of payments of contingent consideration.

We will continue to utilize cash, in part, to fund acquisitions of or make strategic investments in complementary businesses and to expand our sales force. Although we can provide no assurances, we believe that our available cash and cash equivalents and the $78.8 million available under our revolving credit facility will be sufficient to meet our working capital and operating expenditure requirements for the foreseeable future. Thereafter, we may find it necessary to obtain additional equity or debt financing.

We earn a significant amount of our operating income outside the United States, which is deemed to be permanently reinvested in foreign jurisdictions. We do not currently foresee a need to repatriate funds; however, should we require more capital in the United States than is generated by our operations locally or through debt or equity issuances, we could elect to repatriate funds held in foreign jurisdictions. If foreign earnings were to be remitted to the United States, foreign tax credits would be available to reduce any U.S. tax due upon repatriation. Included in our cash and cash equivalents are amounts held by foreign subsidiaries. We had $7.2 million and $6.0 million of foreign cash and cash equivalents as of December 31, 2012 and March 31, 2013, respectively, which are generally denominated in the local currency where the funds are held.

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 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, 2012, under the caption "Contractual Obligations."

Critical Accounting Policies and Estimates

As of March 31, 2013, there were no material changes to our critical accounting policies and estimates disclosed in our Annual Report on Form 10-K for the year ended December 31, 2012.

Recent Accounting Pronouncements

In February 2012, the FASB issued ASU 2013-02 which requires an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required under GAAP to be reclassified in its entirety to net income. For other amounts that are not required under GAAP to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other disclosures required under GAAP that provide additional detail about those amounts. These requirements are effective for public companies for reporting periods beginning after December 15, 2012. We have adopted ASU 2013-02 in the current quarter and included the required disclosures in Note 5 in the Notes to Condensed Consolidated Financial Statements.

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, 2012.

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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