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SPSC > SEC Filings for SPSC > Form 10-Q on 30-Oct-2013All Recent SEC Filings

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Form 10-Q for SPS COMMERCE INC


30-Oct-2013

Quarterly Report


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

Overview

We are a leading provider of on-demand supply chain management solutions, providing prewired, proven integrations and comprehensive retail performance analytics to thousands of customers worldwide. We provide our solutions through the SPS Commerce platform, a cloud-based software suite that improves the way suppliers, retailers, distributors and other customers manage and fulfill orders. We deliver our solutions to our customers over the Internet using a Software-as-a-Service model and derive the majority of our revenues from thousands of monthly recurring subscriptions from businesses that utilize our solutions.

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

Key Financial Terms and Metrics

We have several key financial terms and metrics, including annualized average recurring revenues per recurring revenue customer, which we also refer to as wallet share. During the nine months ended September 30, 2013, there were no changes in the definitions of our key financial terms and metrics, which are discussed in more detail under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in our Annual Report on Form 10-K for the year ended December 31, 2012 as filed with the Securities and Exchange Commission on March 6, 2013.

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

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

Critical Accounting Policies and Estimates

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

We believe that of our significant accounting policies, the following accounting policies involve a greater degree of judgment, complexity and effect on materiality. A critical accounting policy is one that is both material to the presentation of our financial statements and requires us to make difficult, subjective or complex judgments for uncertain matters that could have a material effect on our financial condition and results of operations. Accordingly,


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we believe that our policies for revenue recognition, the allowance for doubtful accounts, income taxes, stock-based compensation and the valuation of goodwill and intangible assets are the most critical to aid in fully understanding and evaluating our financial condition and results of operations.

During the nine months ended September 30, 2013, there were no changes in our critical accounting policies or estimates.

See Note A to our consolidated financial statements included in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the year ended December 31, 2012, as filed with the Securities and Exchange Commission on March 6, 2013, for additional information regarding our critical accounting policies, as well as a description of our other significant accounting policies.


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Results of Operations

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



                                                 Three Months Ended September 30,
                                              2013                          2012                          Change
                                                 % of revenue                  % of revenue          $             %
Revenues                              $ 27,008        100.0 %    $ 20,267              100.0 %    $  6,741          33.3 %
Cost of revenues                         8,249         30.5         5,945               29.3         2,304          38.8

Gross profit                            18,759         69.5        14,322               70.7         4,437          31.0

Operating expenses
Sales and marketing                     10,291         38.1         7,840               38.7         2,451          31.3
Research and development                 2,806         10.4         2,088               10.3           718          34.4
General and administrative               4,284         15.9         3,726               18.4           558          15.0
Amortization of intangible assets        1,007          3.7           530                2.6           477          90.0

Total operating expenses                18,388         68.1        14,184               70.0         4,204          29.6

Income from operations                     371          1.4           138                0.7           233         168.8
Other income (expense)
Interest expense                            -            -            (27 )             (0.1 )          27        (100.0 )
Interest income                             31          0.1             6                 -             25         416.7
Other income (expense)                      37          0.1           (67 )             (0.3 )         104             *

Total other income (expense), net           68          0.3           (88 )             (0.4 )         156             *

Income before income taxes                 439          1.6            50                0.2           389         778.0
Income tax (expense) benefit              (169 )       (0.6 )         124                0.6          (293 )           *

Net income                            $    270          1.0      $    174                0.9            96          55.2


                                                 Nine Months Ended September 30,
                                              2013                          2012                          Change
                                                 % of revenue                  % of revenue          $             %
Revenues                              $ 76,418        100.0 %    $ 54,622              100.0 %    $ 21,796          39.9 %
Cost of revenues                        23,258         30.4        15,236               27.9         8,022          52.7

Gross profit                            53,160         69.6        39,386               72.1        13,774          35.0

Operating expenses
Sales and marketing                     29,163         38.2        21,259               38.9         7,904          37.2
Research and development                 7,966         10.4         5,650               10.3         2,316          41.0
General and administrative              12,542         16.4        10,079               18.5         2,463          24.4
Amortization of intangible assets        2,441          3.2         1,050                1.9         1,391         132.5

Total operating expenses                52,112         68.2        38,038               69.6        14,074          37.0

Income from operations                   1,048          1.4         1,348                2.5          (300 )       (22.3 )
Other income (expense)
Interest expense                            -            -            (27 )               -             27        (100.0 )
Interest income                             76          0.1            34                0.1            42         123.5
Other expense                              (95 )       (0.1 )        (170 )             (0.3 )          75         (44.1 )

Total other expense, net                   (19 )         -           (163 )             (0.3 )         144         (88.3 )

Income before income taxes               1,029          1.3         1,185                2.2          (156 )       (13.2 )
Income tax expense                        (272 )       (0.4 )        (329 )             (0.6 )          57         (17.3 )

Net income                            $    757          1.0      $    856                1.6           (99 )       (11.6 )

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

* Percentage is not meaningful.


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Three and Nine Months Ended September 30, 2013 compared to Three and Nine Months Ended September 30, 2012

Revenues. Revenues for the three months ended September 30, 2013 increased $6.7 million, or 33%, to $27.0 million from $20.3 million for the same period in 2012. Our fiscal quarter ended September 30, 2013 represented our 51st consecutive quarter of increased revenues. Revenues for the nine months ended September 30, 2013 increased $21.8 million, or 40%, to $76.4 million from $54.6 million for the same period in 2012.

The increase in revenues for both the three and nine month periods resulted from two primary factors: the increase in recurring revenue customers and the increase in annualized average recurring revenues per recurring revenue customer, which we also refer to as wallet share.

The number of recurring revenue customers increased 9% to 19,387 at September 30, 2013 from 17,723 at September 30, 2012.

Annualized average recurring revenues per recurring revenue customer increased 22% to $5,018 for the three months ended September 30, 2013 from $4,101 for the same period in 2012. This increase in wallet share was primarily attributable to increased fees resulting from increased usage of our solutions by our recurring revenue customers and growth in larger customers, including those acquired from Edifice in 2012.

Recurring revenues from recurring revenue customers accounted for 89% of our total revenues for each of the three and nine months ended September 30, 2013, compared to 88% and 87% for each of the same periods in 2012. We anticipate that the number of recurring revenue customers and the recurring revenues per recurring revenue customer will continue to increase as we increase the number of solutions we offer and increase the penetration of those solutions across our customer base.

Cost of Revenues. Cost of revenues for the three months ended September 30, 2013 increased $2.3 million, or 39%, to $8.2 million from $5.9 million for the same period in 2012. Cost of revenues for the nine months ended September 30, 2013 increased $8.0 million, or 53%, to $23.3 million from $15.2 million for the same period in 2012. The increase in cost of revenues for both the three and nine month periods in 2013 was primarily due to increased headcount in 2013 which resulted in higher personnel costs. Also contributing to the increase were higher expenses for depreciation, occupancy and network services in 2013 as compared to 2012. As a percentage of revenues, cost of revenues was approximately 30% for each of the three and nine months ended September 30, 2013, compared to 29% and 28% for each of the same periods in 2012. Going forward, we anticipate that cost of revenues will increase in absolute dollars as we continue to expand our business.

Sales and Marketing Expenses. Sales and marketing expenses for the three months ended September 30, 2013 increased $2.5 million, or 31%, to $10.3 million from $7.8 million for the same period in 2012. Sales and marketing expenses for the nine months ended September 30, 2013 increased $7.9 million, or 37%, to $29.2 million from $21.3 million for the same period in 2012. The increase in sales and marketing expenses for both the three and nine month periods in 2013 was primarily due to increased headcount in 2013, which resulted in higher personnel costs, as well as increased commissions earned by sales personnel from new business. We also had increased expenses for depreciation, stock-based compensation and occupancy in 2013 as compared to 2012. As a percentage of revenues, sales and marketing expenses were 38% for each of the three and nine months ended September 30, 2013 compared to 39% for each of the comparable periods in 2012. As we expand our business, we will continue to add resources to our sales and marketing efforts over time, and we expect that these expenses will continue to increase in absolute dollars.


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Research and Development Expenses. Research and development expenses for the three months ended September 30, 2013 increased $718,000, or 34%, to $2.8 million from $2.1 million for the same period in 2012. Research and development expenses for the nine months ended September 30, 2013 increased $2.3 million, or 41%, to $8.0 million from $5.7 million for the same period in 2012. The increase in research and development expenses for both the three and nine month periods in 2013 was primarily due to increased headcount in 2013, which resulted in higher personnel costs, as well as increased depreciation and software subscription expense in 2013 as compared to 2012. As a percentage of revenues, research and development expenses were 10% for each of the three and nine months ended September 30, 2013 and 2012. As we enhance and expand our solutions and applications, we expect that research and development expenses will continue to increase in absolute dollars.

General and Administrative Expenses. General and administrative expenses for the three months ended September 30, 2013 increased $558,000, or 15%, to $4.3 million from $3.7 million for the same period in 2012. General and administrative expenses for the nine months ended September 30, 2013 increased $2.5 million, or 24%, to $12.5 million from $10.1 million for the same period in 2012. The increase in general and administrative expenses for both the three and nine month periods in 2013 was primarily due to increased headcount in 2013, which resulted in higher personnel costs, as well as increased stock-based compensation, depreciation and software maintenance and subscription expenses. As a percentage of revenues, general and administrative expenses were 16% for each of the three and nine months ended September 30, 2013 compared to approximately 18% for each of the same periods in 2012. Going forward, we expect that general and administrative expenses will continue to increase in absolute dollars as we expand our business.

Amortization of Intangible Assets. Amortization expense was $1.0 million and $2.4 million for the three and nine months ended September 30, 2013, compared to $530,000 and $1.1 million for the same periods in 2012. The increase in amortization expense in 2013 from 2012 was the result of the August 2012 acquisition of Edifice, as well as the additional $290,000 of expense resulting from the impairment of a certain non-competition agreement.

Income Tax (Expense) Benefit. We recorded income tax expense of $169,000 and $272,000 for the three and nine months ended September 30, 2013. We recorded an income tax benefit of $124,000 and income tax expense of $329,000 for the three and nine months ended September 30, 2012. We record our interim provision for income taxes based on our estimated annual effective tax rate for the year. Differences between our effective tax rate and statutory tax rates are primarily due to the impact of meals and entertainment expense, employee stock purchase plan expense and the federal R&D credit. Our provisions for income taxes included current foreign and state income tax expense, as well as deferred tax expense.

The decrease in income tax expense for the nine months ended September 30, 2013, compared to the nine months ended September 30, 2012, was primarily due to a discrete tax benefit of $117,000 in 2013 for the retroactive benefit of the 2012 federal R&D credit. The American Taxpayer Relief Act of 2012 was enacted on January 2, 2013 and extended the federal R&D credit from January 1, 2012 through December 31, 2013.

Adjusted EBITDA. Adjusted EBITDA, which is a non-GAAP measure of financial performance, consists of net income plus depreciation and amortization, interest expense, interest income, income tax expense, non-cash, stock-based compensation expense and other adjustments as necessary for a fair presentation. For third quarter 2013, other adjustments included the impact of a use tax refund related to items previously expensed. We use Adjusted EBITDA as a measure of operating performance because it assists us in comparing performance on a consistent basis, as it removes from our operating results the impact of our capital structure. We believe Adjusted EBITDA is useful to an investor in evaluating our operating performance because it is widely used to measure a company's operating performance without regard to items such as depreciation and amortization, which can vary depending upon accounting methods and the book value of assets, and to present a meaningful measure of corporate performance exclusive of our capital structure and the method by which assets were acquired.


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

                                                    Three Months Ended             Nine Months Ended
                                                      September 30,                  September 30,
                                                   2013            2012           2013           2012
Net income                                       $     270        $   174       $     757       $   856
Depreciation and amortization of property and
equipment                                            1,233            873           3,586         2,117
Amortization of intangible assets                    1,007            530           2,441         1,050
Interest expense                                        -              27              -             27
Interest income                                        (31 )           (6 )           (76 )         (34 )
Income tax expense (benefit)                           169           (124 )           272           329
Other                                                 (105 )           -             (105 )          -

EBITDA                                               2,543          1,474           6,875         4,345
Stock-based compensation expense                     1,085            715           3,120         2,042

Adjusted EBITDA                                  $   3,628        $ 2,189       $   9,995       $ 6,387

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

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

                                                       Three Months Ended            Nine Months Ended
                                                         September 30,                 September 30,
                                                       2013           2012          2013           2012
Net income                                          $      270      $    174      $     757      $    856
Stock-based compensation expense                         1,085           715          3,120         2,042
Amortization of intangible assets                        1,007           530          2,441         1,050

Non-GAAP income                                     $    2,362      $  1,419      $   6,318      $  3,948

Shares used to compute non-GAAP income per share
Basic                                                   15,223        13,042         15,064        12,500
Diluted                                                 15,986        13,894         15,781        13,373
Non-GAAP income per share
Basic                                               $     0.16      $   0.11      $    0.42      $   0.32
Diluted                                             $     0.15      $   0.10      $    0.40      $   0.30


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Liquidity and Capital Resources

At September 30, 2013, our principal sources of liquidity were cash and cash equivalents of $80.8 million and accounts receivable, net of allowance for doubtful accounts, of $11.1 million. Our working capital at September 30, 2013 was $86.0 million compared to $77.0 million at December 31, 2012. The increase in working capital from December 31, 2012 to September 30, 2013 resulted from the following:

$14.8 million increase in cash and cash equivalents, due primarily to the $16.1 million of cash provided by operations and the $3.7 million of cash received from the exercise of stock options and proceeds from our employee stock purchase plan, reduced by the $5.0 million of cash used for capital expenditures;

$208,000 increase in net accounts receivable, as new accounts slightly exceeded collections of outstanding balances for the nine months ended September 30, 2013;

$1.4 million increase in deferred costs, current, for expenses related to increased implementation resources and commission payments for new business;

$2.6 million decrease in prepaid expenses and other current assets, primarily related to the Edifice acquisition in 2012;

$172,000 decrease in accounts payable, primarily due to timing of payments;

$2.4 million increase in accrued compensation and benefits, due primarily to increased headcount and payroll timing;

$1.6 million increase in accrued expenses and other current liabilities due primarily to the future payments required under a software licensing agreement; and

$953,000 increase in deferred revenue, current, due to new business for the nine months ended September 30, 2013.

Net Cash Flows from Operating Activities

Net cash provided by operating activities was $16.1 million for the nine months ended September 30, 2013 compared to $8.3 million for the same period in 2012. The slight decrease in net income, the changes in non-cash expenses, including increased depreciation, amortization and stock-based compensation, and the changes in our working capital accounts, including those discussed above, resulted in the overall increase in net cash provided by operations.

Net Cash Flows from Investing Activities

Net cash used in investing activities was $5.0 million for the nine months ended September 30, 2013, all for capital expenditures. Net cash used in investing activities was $29.1 million for the nine months ended September 30, 2012, with $26.3 million used for the acquisition of Edifice and $2.8 million used for capital expenditures. Our capital expenditures are for supporting our business growth and existing customer base, as well as for our internal use such as equipment for our employees.

Net Cash Flows from Financing Activities

Net cash provided by financing activities was $3.7 million for the nine months ended September 30, 2013, all related to the exercise of stock options and proceeds from our employee stock purchase plan. Net cash provided by financing activities was $58.6 million for the nine months ended September 30, 2012, and primarily represented $57.8 million of net proceeds from our public offering of common stock in September 2012 and $1.1 million proceeds from the exercise of stock options.


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Credit Facility

We have a revolving credit agreement with JPMorgan Chase Bank, N.A. that will mature on September 30, 2016. The revolving credit agreement provides for a $20 million revolving credit facility that we may draw upon from time to time, subject to certain terms and conditions. There were no borrowings outstanding at September 30, 2013 and we were in compliance with all covenants under the revolving credit agreement as of that date.

Adequacy of Capital Resources

Our future capital requirements may vary significantly from those now planned and will depend on many factors, including the costs to develop and implement new solutions and applications, the sales and marketing resources needed to further penetrate our market and gain acceptance of new solutions and applications we develop, the expansion of our operations in the United States and internationally, the response of competitors to our solutions and applications and our use of capital for acquisitions, if any. Historically, we have experienced increases in our expenditures consistent with the growth in our operations and personnel, and we anticipate that our expenditures will continue to increase as we grow our business.

We believe our cash and cash equivalents and our cash flows from operations will be sufficient to meet our working capital and capital expenditure requirements for at least the next twelve months.

Inflation and changing prices did not have a material effect on our business during the nine months ended September 30, 2013. We do not expect that inflation or changing prices will materially affect our business in the foreseeable future.

Our results of operations and cash flows are not materially affected by fluctuations in foreign currency exchange rates.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements, investments in special purpose entities or undisclosed borrowings or debt. Additionally, we are not a party to any derivative contracts or synthetic leases.

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