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SPS COMMERCE INC - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis of our financial condition and results of operations should be read together with the section titled "Selected Financial Data" and our audited financial statements and related notes which are included elsewhere in this Annual Report on Form 10-K. Our actual results could differ materially from those anticipated in the forward-looking statements included in this discussion as a result of certain factors, including, but not limited to, those discussed in "Risk Factors" included elsewhere in this Annual Report on Form 10-K. Overview We are a leading provider of cloud-based 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 services suite that improves the way suppliers, retailers, distributors and other customers manage and fulfill orders. We 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, from time to time, 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. For 2013, 2012 and 2011, we generated revenues of $104.4 million, $77.1 million and $58.0 million, respectively. Our fiscal quarter ended December 31, 2013 represented our 52nd consecutive quarter of increased revenues. Recurring revenues from recurring revenue customers accounted for 89%, 88% and 85% of our total revenues for 2013, 2012 and 2011, respectively. Our revenues are not concentrated with any customer, as our largest customer represented 2% or less of total revenues in 2013, 2012 and 2011. Key Financial Terms and Metrics Sources of Revenues Trading Partner Integration. Our revenues primarily consist of monthly revenues from our customers for our Trading Partner Integration solution. This solution consists of a monthly subscription fee and a transaction-based fee. We also receive set-up fees for initial integration services we provide to our customers. Most of our customers have contracts with us that may be terminated by the customer by providing 30 days prior notice. Trading Partner Enablement. Our Trading Partner Enablement solution helps organizations, typically large retailers, to implement new integrations with trading partners. This solution ranges from Electronic Data Interchange testing and certification to more complex business workflow automation and results in a one-time payment to us. Trading Partner Intelligence. Our Trading Partner Intelligence solution consists of data analytics applications which allow our customers to improve their visibility across, and analysis of, their supply chains. Through interactive data analysis, our retailer customers improve their visibility into supplier performance and their understanding of product sell-through. Our revenues for this solution primarily consist of a monthly subscription fee. Other Trading Partner Solutions. The remainder of our revenues is derived from solutions that allow our customers to perform tasks such as barcode labeling or picking-and-packaging information tracking as well as purchases of miscellaneous supplies. These revenues are primarily transaction-based. 30-------------------------------------------------------------------------------- Table of Contents Cost of Revenues and Operating Expenses Overhead Allocation. We allocate overhead expenses such as rent, certain employee benefit costs, office supplies and depreciation of general office assets to cost of revenues and operating expenses categories based on headcount. Cost of Revenues. Cost of revenues consist primarily of personnel costs for our implementation teams, customer support personnel and application support personnel. Cost of revenues also includes our cost of network services, which is primarily data center costs for the locations where we keep the equipment that serves our customers, and connectivity costs that facilitate electronic data transmission between our customers and their trading partners. Sales and Marketing Expenses. Sales and marketing expenses consist primarily of personnel costs for our sales, marketing and product management teams, commissions earned by our sales personnel and marketing costs. In order to expand our business, we will continue to add resources to our sales and marketing efforts over time. Research and Development Expenses. Research and development expenses consist primarily of personnel costs for development and maintenance of existing solutions. Our research and development group is also responsible for enhancing existing solutions and applications as well as internal tools and developing new information maps that integrate our customers to their trading partners in compliance with those trading partners' requirements. General and Administrative Expenses. General and administrative expenses consist primarily of personnel costs for finance, human resources and internal information technology support, as well as legal, accounting and other fees, such as credit card processing fees. Other Metrics Recurring Revenue Customers. As of December 31, 2013, we had approximately 19,700 customers with contracts to pay us monthly fees, which we refer to as recurring revenue customers. We report recurring revenue customers at the end of a period. A small portion of our recurring revenue customers consists of separate units within a larger organization. We treat each of these units, which may include divisions, departments, affiliates and franchises, as distinct customers. Average Recurring Revenues Per Recurring Revenue Customer. We calculate average recurring revenues per recurring revenue customer, which we also refer to as wallet share, by dividing the recurring revenues from recurring revenue customers for the period by the average of the beginning and ending number of recurring revenue customers for the period. For interim periods, we annualize this number by multiplying the quotient calculated above by the quotient of 12 divided by the number of months in the period. We anticipate that average 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. Non-GAAP Financial Measures. 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 that of 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. These non-GAAP 31-------------------------------------------------------------------------------- Table of Contents financial measures exclude significant expenses and income that are required by GAAP to be recorded in the company's 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 The discussion of our financial condition and results of operations is based upon our financial statements, which are prepared in accordance with accounting principles generally accepted in the United States, or 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. On an ongoing basis, we evaluate our estimates and assumptions. 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. Our actual results may differ from these estimates under different assumptions or conditions. We believe that of our significant accounting policies, which are described in the notes to our financial statements, 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, these are the policies we believe are the most critical to aid in fully understanding and evaluating our financial condition and results of operations. Revenue Recognition We generate revenues by providing a number of solutions to our customers. These solutions include Trading Partner Integration, Trading Partner Enablement and Trading Partner Intelligence. All of our solutions are hosted applications that allow customers to meet their supply chain management requirements. Sales taxes are presented on a net basis within revenue. Revenues are recorded when all of the following criteria are met: (1) persuasive evidence of an arrangement exists, (2) delivery has occurred, (3) the fee is fixed or determinable, and (4) collectability is probable. If collection is not considered probable, revenues are recognized when the fees are collected. Fees related to our Trading Partner Integration, Trading Partner Enablement and Trading Partner Intelligence solutions consist of two revenue sources: set-up fees and recurring monthly fees. Set-up fees are specific for each connection a customer has with a trading partner and most of our customers have connections with numerous trading partners. Set-up fees are nonrefundable upfront fees that do not have standalone value to our customer and are not separable from the recurring monthly fees. All set-up fees and related costs are deferred and recognized ratably over the average life of the connection between the customer and the trading partner, which is approximately two years. We begin recognizing set-up fee revenue once the connection is established. Set-up fees for which connections have not yet been established are classified as long-term. We continue to evaluate the length of the amortization period as more experience is gained with contract cancellations and technology changes requested by our customers. It is possible that, in the future, the period over which such subscription set-up fees and costs are amortized may be adjusted. Any change in our estimate of the average connection life will affect our future results of operations. The recurring monthly fees are comprised of both fixed and transaction-based fees that are recognized as earned. Allowance for Doubtful Accounts We maintain an allowance for doubtful accounts for estimated losses resulting from our customers' inability to pay us. The provision is based on our historical experience and for specific customers that, in our opinion, are likely to default on our receivables from them. In order to identify these customers, we perform ongoing reviews 32-------------------------------------------------------------------------------- Table of Contents of all customers that have breached their payment terms, as well as those that have filed for bankruptcy or for whom information has become available indicating a significant risk of non-recoverability. In addition, we have experienced significant growth in the number of our customers, and we have less payment history to rely upon with these customers. We rely on historical trends of bad debt as a percentage of total revenues and apply these percentages to the accounts receivable associated with new customers and evaluate these customers over time. To the extent that our future collections differ from our assumptions based on historical experience, the amount of our bad debt and allowance recorded may be different. Income Taxes We account for income taxes using the liability method, which requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Deferred tax assets are reduced by a valuation allowance when it is not "more likely than not" that the deferred tax asset will be utilized. We assess our ability to realize our deferred tax assets on a regular and periodic basis. Realization of our deferred tax assets is contingent upon future taxable earnings. Accordingly, this assessment requires significant estimates and judgment. If the estimates of future taxable income vary from actual results, our assessment regarding the realization of these deferred tax assets could change. Future changes in the estimated amount of deferred taxes expected to be realized will be reflected in our consolidated financial statements in the period the estimate is changed, with a corresponding adjustment to our operating results. We recognize the financial statement benefit of a tax position only after determining that the relevant tax authority would "more likely than not" sustain the position following an audit. For tax positions meeting the "more likely than not" threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement with the relevant tax authority. Stock-Based Compensation Stock-based compensation is measured at the grant date, based on the fair value of the award, and is recognized as an expense over the vesting period of the award. Determining the appropriate fair value model and calculating the fair value of stock-based payment awards require the use of subjective assumptions, including the expected life of the stock-based payment awards and stock price volatility. We use the Black-Scholes option pricing model to value our award grants and determine the related compensation expense. The assumptions used in calculating the fair value of stock-based payment awards represent management's best estimates, but the estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change and we use different assumptions, our stock-based compensation expense could be materially different in the future. We expect to continue to grant stock-based awards in the future, and to the extent that we do, our actual stock-based compensation expense recognized in future periods will likely increase. Prior to becoming a public entity in 2010, historic volatility was not available for our shares. As a result, we estimated volatility based on a peer group of companies, which collectively provided a reasonable basis for estimating volatility. We intend to continue to consistently use the same group of publicly traded peer companies to determine volatility in the future until sufficient information regarding volatility of our share price becomes available or the selected companies are no longer suitable for this purpose. Valuation of Goodwill and Purchased Intangible Assets Goodwill represents the excess of the purchase price over the fair value of identifiable net assets acquired in a business combination. Assets acquired may include identifiable intangible assets, such as subscriber 33-------------------------------------------------------------------------------- Table of Contents relationships, which are recognized separately from goodwill. Historically, we have engaged a third-party valuation firm to assist us in the determination of the value and useful lives of the purchased intangible assets using certain estimates and assumptions. We test goodwill for impairment annually at December 31, or more frequently if events or changes in circumstances indicate that the asset might be impaired. The impairment test is conducted by comparing the fair value of the net assets with the carrying value of the reporting unit. Fair value is determined using the direct market observation of market price and outstanding equity of the reporting unit at December 31. If the carrying value of the goodwill were to exceed the fair value of the reporting unit, the goodwill may be impaired. If this were to occur, the fair value would then be allocated to assets and liabilities in a manner similar to a purchase price allocation in order to determine the implied fair value of the goodwill. This implied fair value would then be compared to the carrying amount of the goodwill and, if it were less, an impairment loss would be recognized. Results of Operations Year Ended December 31, 2013 Compared to Year Ended December 31, 2012 The following table presents our results of operations for the periods indicated (dollars in thousands): Year Ended December 31, 2013 2012 Change % of revenue % of revenue $ % Revenues $ 104,391 100.0 % $ 77,106 100.0 % $ 27,285 35.4 % Cost of revenues 31,781 30.4 22,040 28.6 9,741 44.2 Gross profit 72,610 69.6 55,066 71.4 17,544 31.9 Operating expenses Sales and marketing 39,621 38.0 30,037 39.0 9,584 31.9 Research and development 10,870 10.4 8,166 10.6 2,704 33.1 General and administrative 17,189 16.5 13,524 17.5 3,665 27.1 Amortization of intangible assets 3,158 3.0 1,767 2.3 1,391 78.7 Total operating expenses 70,838 67.9 53,494 69.4 17,344 32.4 Income from operations 1,772 1.7 1,572 2.0 200 12.7 Other income (expense) Interest expense - - (27 ) - 27 (100.0 ) Interest income 112 0.1 46 0.1 66 143.5 Other expense (147 ) (0.1 ) (248 ) (0.3 ) 101 (40.7 ) Total other expense, net (35 ) - (229 ) (0.3 ) 194 (84.7 ) Income before income taxes 1,737 1.7 1,343 1.7 394 29.3 Income tax expense (686 ) (0.7 ) (121 ) (0.2 ) (565 ) 466.9 Net income $ 1,051 1.0 $ 1,222 1.6 (171 ) (14.0 ) Due to rounding, totals may not equal the sum of the line items in the table above Revenues. Revenues for 2013 increased $27.3 million, or 35%, to $104.4 million from $77.1 million for 2012. The increase in revenues resulted from two primary factors: the increase in recurring revenue customers and the increase in average recurring revenues per recurring revenue customer, which we also refer to as wallet share. • The number of recurring revenue customers increased 10% to 19,690 at December 31, 2013 from 17,977 at December 31, 2012. 34 -------------------------------------------------------------------------------- Table of Contents • Average recurring revenues per recurring revenue customer, or wallet share, increased 24% to $4,920 for 2013 from $3,964 for 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 2013, compared to 88% for 2012. We anticipate that the number of recurring revenue customers and wallet share 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 2013 were $31.8 million, an increase of $9.7 million, or 44%, from $22.0 million for 2012. This increase was primarily due to increased headcount in 2013 which resulted in higher personnel costs. We also incurred higher expenses for depreciation, occupancy and network services in 2013 as compared to 2012. As a percentage of revenues, cost of revenues was 30% for 2013 compared to 29% for 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 2013 increased $9.6 million, or 32%, to $39.6 million from $30.0 million for 2012. This increase 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 incurred 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 2013 compared to 39% for 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. Research and Development Expenses. Research and development expenses for 2013 were $10.9 million, an increase of $2.7 million, or 33%, from $8.1 million for 2012. This increase was primarily due to increased headcount in 2013 which resulted in higher personnel costs. Also contributing to the increase were higher expenses for depreciation, software subscriptions, stock-based compensation and occupancy in 2013 as compared to 2012. As a percentage of revenues, research and development expenses were 10% for 2013 and 11% for 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 2013 increased $3.7 million, or 27%, to $17.2 million from $13.5 million for 2012. This increase was 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 compared to 2012. In addition, legal expenses in 2013 decreased slightly as compared to 2012. As a percentage of revenues, general and administrative expenses were 17% for 2013, compared to 18% for 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 for the year ended December 31, 2013 included $290,000 for the impairment of a certain non-competition agreement. Income Tax Benefit (Expense). Our 2013 provision for income taxes was $686,000 and included current state and foreign income taxes as well as deferred federal and state income taxes. It also included a one-time tax benefit 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. If this one-time tax benefit were excluded, our 2013 provision for income taxes would have been $803,000. Our 2012 provision for income taxes was $121,000 and included current state and foreign income taxes as well as deferred federal and state income taxes. It also included one-time tax benefits related to true-up 35-------------------------------------------------------------------------------- Table of Contents adjustments for prior years and increased state effective tax rates. If these one-time benefits were excluded, our 2012 provision for income taxes would have been $418,000. See Note K to our consolidated financial statements, included in this Annual Report on Form 10-K, for additional information regarding our income taxes. 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. In 2013, other adjustments included the impact of a use tax refund related to items previously expensed. The following table provides a reconciliation of net income to Adjusted EBITDA (in thousands): Year Ended December 31, 2013 2012 Net income $ 1,051 $ 1,222 Depreciation and amortization 8,051 4,918 Interest expense - 27 Interest income (112 ) (46 ) Income tax expense 686 121 Other (105 ) - EBITDA 9,571 6,242 Stock-based compensation expense 4,203 2,755 Adjusted EBITDA $ 13,774 $ 8,997 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. The following table provides a reconciliation of net income to non-GAAP income per share (in thousands, except per share amounts): Year Ended December 31, 2013 2012 Net income $ 1,051 $ 1,222 Stock-based compensation expense 4,203 2,755 Amortization of intangible assets 3,158 1,767 Non-GAAP income $ 8,412 $ 5,744 Non-GAAP income per share Basic $ 0.55 $ 0.44 Diluted $ 0.53 $ 0.41 Shares used to compute non-GAAP income per share Basic 15,201 13,056 Diluted 15,931 13,910 36 -------------------------------------------------------------------------------- Table of Contents Year Ended December 31, 2012 Compared to Year Ended December 31, 2011 The following table presents our results of operations for the periods indicated (dollars in thousands): Year Ended December 31, 2012 2011 Change % of revenue % of revenue $ % Revenues $ 77,106 100.0 % $ 57,969 100.0 % $ 19,137 33.0 % Cost of revenues 22,040 28.6 15,366 26.5 6,674 43.4 Gross profit 55,066 71.4 42,603 73.5 12,463 29.3 Operating expenses Sales and marketing 30,037 39.0 23,836 41.1 6,201 26.0 Research and development 8,166 10.6 5,838 10.1 2,328 39.9 General and administrative 13,524 17.5 11,151 19.2 2,373 21.3 Amortization of intangible assets 1,767 2.3 643 1.1 1,124 174.8 Total operating expenses 53,494 69.4 41,468 71.5 12,026 29.0 Income from operations 1,572 2.0 1,135 2.0 437 38.5 Other income (expense) Interest expense (27 ) - - - (27 ) * Interest income 46 0.1 89 0.2 (43 ) (48.3 ) Other expense (248 ) (0.3 ) (140 ) (0.2 ) (108 ) 77.1 Total other expense, net (229 ) (0.3 ) (51 ) (0.1 ) (178 ) 349.0 Income before income taxes 1,343 1.7 1,084 1.9 259 23.9 Income tax benefit (expense) (121 ) (0.2 ) 12,619 21.8 (12,740 ) * Net income $ 1,222 1.6 $ 13,703 23.6 (12,481 ) * Due to rounding, totals may not equal the sum of the line items in the table above * Percentage is not meaningful Revenues. Revenues for 2012 increased $19.1 million, or 33%, to $77.1 million from $58.0 million for 2011. The increase in revenues resulted from two primary factors: the increase in recurring revenue customers and the increase in average recurring revenues per recurring revenue customer. • The number of recurring revenue customers increased 11% to 17,977 at December 31, 2012 from 16,129 at December 31, 2011. • Average recurring revenues per recurring revenue customer increased 15% to $3,964 for 2012 from $3,440 for 2011. This increase 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. Recurring revenues from recurring revenue customers accounted for 88% of our total revenues for 2012, compared to 85% for 2011. Cost of Revenues. Cost of revenues for 2012 increased $6.7 million, or 43%, to $22.0 million from $15.4 million for 2011. The increase in cost of revenues was primarily attributable to increased headcount which resulted in higher personnel costs. Also contributing to the increase were higher expenses for depreciation, network services, stock-based compensation and occupancy. As a percentage of revenues, cost of revenues was 29% for 2012 compared to 27% for 2011. Sales and Marketing Expenses. Sales and marketing expenses for 2012 increased $6.2 million, or 26%, to $30.0 million from $23.8 million for 2011. The increase in sales and marketing expenses was primarily due to 37-------------------------------------------------------------------------------- Table of Contents increased headcount, which resulted in higher personnel costs, as well as increased commissions earned by sales personnel from new business. We also had increased expenses for marketing, stock-based compensation and depreciation in 2012, as compared to 2011. As a percentage of revenues, sales and marketing expenses were 39% for 2012 compared to 41% for 2011. Research and Development Expenses. Research and development expenses for 2012 were $8.1 million, an increase of $2.3 million, or 40%, from $5.8 million for 2011. The increase in research and development expenses was primarily due to increased headcount, which resulted in higher personnel costs. Depreciation expense also increased in 2012 compared to 2011. As a percentage of revenues, research and development expenses were 11% for 2012 and 10% for 2011. General and Administrative Expenses. For 2012, general and administrative expenses increased $2.4 million, or 21%, to $13.5 million from $11.2 million for 2011. The increase in general and administrative expenses was due to increased headcount, which resulted in higher personnel costs, as well as increased expenses for stock-based compensation, accounting, credit card processing, software maintenance and depreciation. As a percentage of revenues, general and administrative expenses were 18% for 2012, compared to 19% for 2011. Income Tax Benefit (Expense). For 2012, we recorded income tax expense of $121,000. Our provision for income taxes included current state and foreign income taxes as well as deferred federal and state income taxes. Our tax provision also included $135,000 of tax benefit related to true-up adjustments for prior years and $162,000 of tax benefit related to increased state effective tax rates. If these one-time benefits were excluded, our tax expense would have been $418,000. For 2011, we recorded an income tax benefit of $12.6 million, primarily resulting from the reversal of a substantial portion of the valuation allowance on our deferred tax assets. See Note K to our consolidated financial statements, included in this Annual Report on Form 10-K, for additional information regarding our income taxes. 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 benefit (expense) and non-cash, stock-based compensation expense. The following table provides a reconciliation of net income to Adjusted EBITDA (in thousands): Year Ended December 31, 2012 2011 Net income $ 1,222 $ 13,703 Depreciation and amortization 4,918 2,647 Interest expense 27 - Interest income (46 ) (89 ) Income tax (benefit) expense 121 (12,619 ) EBITDA 6,242 3,642 Stock-based compensation expense 2,755 1,768 Adjusted EBITDA $ 8,997 $ 5,410 38 -------------------------------------------------------------------------------- Table of Contents 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 minus the deferred tax valuation allowance reversal divided by the weighted average number of shares of common stock outstanding during each period. The following table provides a reconciliation of net income to non-GAAP income per share (in thousands, except per share amounts): Year Ended December 31, 2012 2011 Net income $ 1,222 $ 13,703 Deferred tax asset valuation allowance reversal - (12,802 ) Stock-based compensation expense 2,755 1,768 Amortization of intangible assets 1,767 643 Non-GAAP income $ 5,744 $ 3,312 Non-GAAP income per share Basic $ 0.44 $ 0.28 Diluted $ 0.41 $ 0.26 Shares used to compute non-GAAP income per share Basic 13,056 11,960 Diluted 13,910 12,744 Liquidity and Capital Resources At December 31, 2013, our principal sources of liquidity were cash and cash equivalents totaling $131.3 million and accounts receivable, net of allowance for doubtful accounts of $11.6 million compared to cash and cash equivalents of $66.1 million and accounts receivable, net of allowance for doubtful accounts of $10.9 million at December 31, 2012. Our working capital at December 31, 2013 was $137.2 million compared to working capital of $77.0 million at December 31, 2012. The increase in working capital from December 31, 2012 to December 31, 2013 resulted primarily from the following: • $65.2 million increase in cash and cash equivalents, due primarily to the $47.6 million of net cash received from our November 2013 common stock offering, $18.2 million of cash provided by operations and $5.1 million of cash received from the exercise of stock options and net proceeds from our employee stock purchase plan, all reduced by the $5.7 million of cash used for capital expenditures; • $671,000 million increase in net accounts receivable, as new accounts slightly exceeded collections of outstanding balances in 2013; • $1.7 million increase in deferred costs, current for expenses related to increased implementation resources and commission payments for new business; • $460,000 decrease in deferred income taxes, current primarily related to the decrease in the amount of federal net operating loss carryforwards that we expect to utilize in 2014 as compared to 2013; • $2.6 million decrease in prepaid expenses and other current assets, primarily related to the Edifice acquisition in 2012; • $59,000 decrease in accounts payable, primarily due to timing of payments; • $1.9 million increase in accrued compensation and benefits, due to increased headcount and related increases in salary, vacation and commission accruals; • $1.7 million increase in accrued expenses and other current liabilities due primarily to the future payments required under a software licensing agreement, and • $886,000 increase in deferred revenue, current due to new business in 2013. 39 -------------------------------------------------------------------------------- Table of Contents Net Cash Flows from Operating Activities Net cash provided by operating activities was $18.2 million for 2013 compared to $6.8 million for 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 provided by operating activities was $6.8 million for 2012 compared to $4.5 million for 2011. The $12.5 million decrease in net income, principally due to the reversal of a substantial portion of the valuation allowance on our deferred tax assets taxes in 2011, was more than offset by the changes in non-cash expenses, including increased depreciation, amortization, and stock-based compensation, and the changes in our working capital accounts, resulted in the overall increase in net cash provided by operations Net Cash Flows from Investing Activities Net cash used in investing activities was $5.7 million for 2013, all for capital expenditures. In general, 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. For 2012, net cash used in investing activities was $32.2 million, including $26.3 million for the acquisition of Edifice and $6.0 million for capital expenditures. For 2011, net cash used in investing activities was $13.4 million, including $10.8 million for the acquisition of Direct EDI and $2.6 million for capital expenditures. Net Cash Flows from Financing Activities Net cash provided by financing activities was $52.7 million for 2013, and primarily represented $47.6 million of net proceeds from our common stock offering in November 2013 and $5.1 million related to the exercise of stock options and proceeds from our employee stock purchase plan. Net cash provided by financing activities was $59.5 million for 2012, and primarily represented $57.8 million of net proceeds from our common stock offering in September 2012 and $2.0 million of cash received from the exercise of employee stock options and net proceeds from our employee stock purchase plan. Net cash provided by financing activities was $452,000 for 2011, representing cash received from the exercise of stock options offset by payments of capital lease obligations and stock offering costs. Credit Facility We have a revolving credit agreement with JPMorgan Chase Bank, N.A. which provides for a $20 million revolving credit facility that we may draw upon from time to time, subject to certain terms and conditions, and will mature on September 30, 2016. Proceeds from the credit facility are anticipated to be used for acquisitions and our capital needs. Interest on amounts borrowed under the credit facility is based on (i) an Adjusted LIBO Rate (as defined in the revolving credit agreement) plus an applicable margin of 175 to 225 basis points based on our net working capital, or (ii) JPMorgan's prime rate (provided it is not less than the Adjusted One Month LIBO Rate (as defined in the revolving credit agreement)) plus an applicable margin of -25 to 25 basis points based on our net working capital. Interest is payable monthly in arrears. Availability under the credit facility is subject to a borrowing base equal to the sum of 250% of our eligible monthly recurring revenue (as defined in the revolving credit agreement) and all borrowings are due in full no later than the maturity date of the agreement. The revolving credit agreement contains customary representations, warranties, covenants and events of default, including, but not limited to financial covenants requiring us to maintain a fixed charge coverage ratio of 40-------------------------------------------------------------------------------- Table of Contents not less than 1.20 to 1.00, cash and cash equivalents of not less than $10 million and a minimum number of recurring revenue customers. If an event of default occurs, among other things, the applicable interest rate is subject to an increase of 2% and all outstanding obligations may become immediately due and payable. There were no borrowings under the revolving credit agreement in 2013. In connection with the acquisition of Edifice in 2012, we borrowed $11.0 million under our line of credit to fund a portion of the cash paid for the acquisition. On September 11, 2012, this debt was repaid in full with a portion of the proceeds received from our public offering of common stock on that date. As of December 31, 2013, there were no borrowings outstanding, approximately $20.0 million was available for borrowings, and we were in compliance with all covenants under the revolving credit agreement. Adequacy of Capital Resources Our future capital requirements may vary materially 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 and the response of competitors to our solutions and applications. 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 cash flows from our operations will be sufficient to meet our working capital and capital expenditure requirements for at least the next twelve months. During the last three years, inflation and changing prices have not had a material effect on our business and we do not expect that inflation or changing prices will materially affect our business in the foreseeable future. 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. Contractual and Commercial Commitment Summary Our contractual obligations and commercial commitments as of December 31, 2013 are summarized below: Payments Due By Period Less Than More Than Contractual Obligations Total 1 Year 1-3 Years 3-5 Years 5 Years (In thousands) Operating lease obligations $ 11,537 $ 1,965 $ 3,703 $ 3,425 $ 2,444 Seasonality The size and breadth of our customer base mitigates the seasonality of any particular retailer. As a result, our results of operations are not materially affected by seasonality. Recent Accounting Pronouncements We have evaluated all recent accounting pronouncements and believe that none of them will have a material effect on our consolidated financial statements. 41-------------------------------------------------------------------------------- Table of Contents |