UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
☒
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended: September 30, 2019
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from to
Commission file number 001-34702
SPS COMMERCE, INC.
(Exact Name of Registrant as Specified in its Charter)
Delaware
41-2015127
(State or Other Jurisdiction of
Incorporation or Organization)
(I.R.S. Employer
Identification No.)
333 South Seventh Street, Suite 1000, Minneapolis, MN 55402
(Address of Principal Executive Offices, Including Zip Code)
(612) 435-9400
(Registrant’s Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol
Name of exchange on which registered
Common Stock, par value $0.001 per share
SPSC
The Nasdaq Stock Market LLC (Nasdaq Global Market)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
Accelerated filer
Non-accelerated filer
Smaller reporting company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
The number of shares of the registrant’s common stock, par value $0.001 per share, outstanding at October 18, 2019 was 34,839,275 shares.
QUARTERLY REPORT ON FORM 10-Q
INDEX
Page
PART I. FINANCIAL INFORMATION
Item 1.
Financial Statements
4
Condensed Consolidated Balance Sheets as of September 30, 2019 and December 31, 2018 (Unaudited)
Condensed Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2019 and 2018 (Unaudited)
5
Condensed Consolidated Statements of Stockholders’ Equity for the three and nine months ended September 30, 2019 and 2018 (Unaudited)
6
Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2019 and 2018 (Unaudited)
7
Notes to Condensed Consolidated Financial Statements (Unaudited)
8
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
22
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
28
Item 4.
Controls and Procedures
29
PART II. OTHER INFORMATION
Legal Proceedings
30
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Defaults Upon Senior Securities
Mine Safety Disclosures
Item 5.
Other Information
Item 6.
Exhibits
31
Signatures
32
Unless the context otherwise requires, for purposes of the Quarterly Report on Form 10-Q, the words “we,” “us,” “our,” the “Company” and “SPS” refer to SPS Commerce, Inc.
2
SPECIAL NOTE REGARDING FORWARD-LOOKING INFORMATION
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements regarding us, our business prospects and our results of operations are subject to certain risks and uncertainties posed by many factors and events that could cause our actual business, prospects and results of operations to differ materially from those that may be anticipated by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those described under the heading “Risk Factors” included in our Annual Report on Form 10-K/A for the year ended December 31, 2018 as filed with the Securities and Exchange Commission (“SEC”), as may be updated in our subsequent Quarterly Reports on Form 10-Q from time to time. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this report. In some cases, you can identify forward-looking statements by the following words: “anticipate,” “assumes,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “ongoing,” “plan,” “potential,” “predict,” “project,” “should,” “will,” “would,” or the negative of these terms or other comparable terminology, although not all forward-looking statements contain these words. We expressly disclaim any intent or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Readers are urged to carefully review and consider the various disclosures made by us in this report and in our other reports filed with the SEC that advise interested parties of the risks and factors that may affect our business.
3
PART I. – FINANCIAL INFORMATION
Item 1.Financial Statements
SPS COMMERCE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited; in thousands, except per share amounts)
September 30,
December 31,
2019
2018
ASSETS
CURRENT ASSETS
Cash and cash equivalents
$
149,727
133,859
Short-term investments
51,446
44,537
Accounts receivable, less allowance for doubtful accounts of $1,500 and $1,392, respectively
29,383
27,488
Deferred costs
34,583
34,502
Other current assets
8,385
9,229
Total current assets
273,524
249,615
PROPERTY AND EQUIPMENT, less accumulated depreciation of $49,168 and $41,175, respectively
20,757
20,957
OPERATING LEASE RIGHT-OF-USE ASSETS
13,648
—
GOODWILL
76,366
69,658
INTANGIBLE ASSETS, net
23,844
22,741
OTHER ASSETS
10,998
10,973
Deferred income tax asset
4,839
10,456
Other assets
2,621
1,723
Total assets
426,597
386,123
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES
Accounts payable
4,367
4,440
Accrued compensation
17,660
20,415
Accrued expenses
4,874
4,558
Deferred revenue
30,351
25,328
Deferred rent
1,781
Operating lease liabilities
3,281
Total current liabilities
60,533
56,522
OTHER LIABILITIES
2,601
2,512
5,371
16,224
Deferred income tax liability
1,169
1,376
Other non-current liabilities
1,002
1,368
Total liabilities
81,529
67,149
COMMITMENTS and CONTINGENCIES
STOCKHOLDERS’ EQUITY
Preferred stock, $0.001 par value; 5,000,000 shares authorized; 0 shares issued and outstanding
Common stock, $0.001 par value; 55,000,000 shares authorized; 36,026,218 and 35,515,256 shares issued; and 34,901,884 and 34,691,472 outstanding, respectively
36
Treasury stock, at cost; 1,124,334 and 823,784 shares, respectively
(40,645
)
(25,679
Additional paid-in capital
349,014
332,574
Retained earnings
39,811
15,261
Accumulated other comprehensive loss
(3,148
(3,218
Total stockholders’ equity
345,068
318,974
Total liabilities and stockholders’ equity
Shares and per share data have been adjusted for all periods presented to reflect a two-for-one stock split effective August 22, 2019.
See accompanying notes to these condensed consolidated financial statements.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Three Months Ended
Nine Months Ended
Revenues
70,928
62,868
206,391
183,051
Cost of revenues
23,263
20,411
68,330
60,571
Gross profit
47,665
42,457
138,061
122,480
Operating expenses
Sales and marketing
16,937
16,952
52,404
54,023
Research and development
7,743
5,146
20,444
15,571
General and administrative
10,725
11,174
33,674
31,278
Amortization of intangible assets
1,327
928
3,897
3,086
Total operating expenses
36,732
34,200
110,419
103,958
Income from operations
10,933
8,257
27,642
18,522
Other income (expense)
Interest income, net
843
628
2,233
1,589
Other income (expense), net
(165
(219
(541
Change in earn-out liability
366
Total other income, net
700
409
2,627
1,048
Income before income taxes
11,633
8,666
30,269
19,570
Income tax expense
2,692
605
5,719
2,839
Net income
8,941
8,061
24,550
16,731
Other comprehensive income (expense)
Foreign currency translation adjustments
(958
76
73
(2,155
Unrealized gain on investments, net of tax of $38, $41, $105, and $88, respectively
115
123
315
264
Reclassification of gain on investments into earnings, net of tax of ($48), ($11), ($109) and ($64), respectively
(145
(33
(326
(191
Total other comprehensive income (expense)
(988
166
62
(2,082
Comprehensive income
7,953
8,227
24,612
14,649
Net income per share
Basic
0.26
0.23
0.70
0.49
Diluted
0.25
0.68
0.48
Weighted average common shares used to compute net income per share
35,015
34,438
34,966
34,334
35,932
35,482
35,952
35,114
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(Unaudited; in thousands, except share amounts)
Accumulated
Additional
Other
Total
Common Stock
Treasury Stock
Paid-in
Retained
Comprehensive
Stockholders'
Shares
Amount
Capital
Earnings
Income (Loss)
Equity
Balances, June 30, 2018
34,319,638
35
631,082
(17,684
313,869
59
(1,590
294,689
Stock-based compensation
2,973
Exercise of stock options and issuance of restricted stock
338,008
6,680
Repurchases of common stock
(52,502
52,502
(1,998
Unrealized gain on investments, net of tax
Reclassification of gain on investments into earnings, net of tax
Balances, September 30, 2018
34,605,144
683,584
(19,682
323,522
8,120
(1,424
310,571
Balances, June 30, 2019
34,936,212
1,007,478
(34,645
344,232
30,870
(2,160
338,333
2,804
80,350
1,902
Employee stock purchase plan
2,178
(116,856
116,856
(6,000
Balances, September 30, 2019
34,901,884
1,124,334
(Accumulated
Deficit)
Balances, December 31, 2017
34,254,012
34
244,294
(5,815
301,846
(8,611
657
288,111
9,040
749,936
1
11,800
11,801
40,486
836
(439,290
439,290
(13,867
(190
Balances, December 31, 2018
34,691,472
823,784
10,312
483,492
5,273
32,992
1,155
(300,550
300,550
(14,966
Settlement and subsequent return of shares
(5,522
(300
Adoption of ASU 2018-02
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited; in thousands)
Cash flows from operating activities
Reconciliation of net income to net cash provided by operating activities
Deferred income taxes
5,360
1,934
(366
Depreciation and amortization of property and equipment
8,143
6,308
Provision for doubtful accounts
2,429
1,780
11,316
9,978
Other, net
(551
(255
Changes in assets and liabilities
Accounts receivable
(3,670
(4,279
(151
(3,813
Other current and non-current assets
(820
(681
181
382
(3,716
(592
(84
(718
4,929
7,039
647
Operating leases
(487
Net cash provided by operating activities
50,960
37,547
Cash flows from investing activities
Purchases of property and equipment
(8,387
(9,875
Purchases of investments
(61,967
(64,434
Maturities of investments
55,225
60,000
Acquisitions of businesses and intangible assets, net of cash acquired
(11,500
(381
Net cash used in investing activities
(26,629
(14,690
Cash flows from financing activities
Net proceeds from exercise of options to purchase common stock
Net proceeds from employee stock purchase plan
Net cash used in financing activities
(8,538
(1,231
Effect of foreign currency exchange rate changes
75
(5
Net increase in cash and cash equivalents
15,868
21,621
Cash and cash equivalents at beginning of period
123,127
Cash and cash equivalents at end of period
144,748
NOTE A – General
Business Description
SPS Commerce is a leading provider of cloud-based supply chain management solutions that make it easier for retailers, suppliers, grocers, distributors and logistics firms to orchestrate the management of item data, order fulfillment, inventory control and sales analytics across all channels. The solutions offered by SPS Commerce eliminate the need for on-premise software and support staff by taking on that capability on the customer’s behalf. The solutions SPS Commerce provides allow our customers to increase their supply cycle agility, optimize their inventory levels and sell-through, reduce operational costs and gain increased visibility into customer orders, ensuring that suppliers, grocers, distributors, and logistics firms can satisfy exacting retailer requirements.
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements include the accounts of SPS Commerce, Inc. and its subsidiaries. All intercompany accounts and transactions have been eliminated in the condensed consolidated financial statements, which have been prepared in conformity with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, these condensed consolidated financial statements do not include all of the information and notes required by GAAP. We have included all normal recurring adjustments considered necessary to provide a fair presentation of our financial position, results of operations, stockholders’ equity, and cash flows for the interim periods shown. Operating results for these interim periods are not necessarily indicative of the results to be expected for the full year. For further information, refer to the consolidated financial statements and accompanying notes for the year ended December 31, 2018 included in our Annual Report on Form 10-K/A filed with the SEC.
Effective January 1, 2019, we adopted the requirements of Accounting Standards Update (“ASU”) No. 2016-02, Leases (Topic 842), and used the effective date as our date of initial application. Consequently, financial information was not updated and the disclosures required under the new standard were not provided for dates and periods before January 1, 2019. The new standard provides several optional practical expedients in transition. We elected the “package of practical expedients,” which permits us not to reassess under the new standard our prior conclusions about lease identification, lease classification and initial direct costs. We did not elect the use-of hindsight or the practical expedient pertaining to land easements, the latter not being applicable to us. The new standard also provides practical expedients for an entity’s ongoing accounting. We elected the short-term lease recognition exemption for all leases that qualify, which means we will not recognize right-of-use (“ROU”) assets or lease liabilities for these leases. This includes not recognizing ROU assets or lease liabilities for existing short-term leases of those assets in transition. We also elected the practical expedient to not separate lease and non-lease components for all leases.
On July 25, 2019, the Company announced that its board of directors declared a two-for-one stock split of the Company’s common stock, effected in the form of a 100 percent stock dividend as of the record date on August 8, 2019. The stock split dividend was distributed on August 22, 2019. Earnings per share and weighted average shares outstanding are presented in this Quarterly Report on Form 10-Q after the effect of 100 percent stock dividend. The two-for-one stock split is reflected in the share amounts in all periods presented in this Quarterly Report on Form 10-Q.
Use of Estimates
Preparing financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
Lease Policy
We determine if an arrangement is a lease at inception. Operating leases are included in operating lease ROU assets, current lease liabilities, and long-term lease liabilities in our consolidated balance sheets.
ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. We estimate the discount rate for a similar collateralized asset by reviewing quoted costs of borrowing. We use the implicit interest rate when readily determinable. The operating lease ROU asset also includes any lease payments made and lease incentives that have been incurred. The options to extend our leases are not recognized as part of our right-of-use assets and lease liabilities unless it is reasonably certain that we will exercise that option. Lease expense for lease payments is recognized on a straight-line basis over the lease term. For all leases we combine non-lease components with the related lease components and account for it as a single lease component. The ROU assets are subject to the same impairment process as our long-lived assets. Additionally, we review our lease liabilities for remeasurement whenever there is a triggering event or when relevant facts and circumstances change.
Recently Adopted Accounting Pronouncements
Standard
Date of Issuance
Description
Date Adopted
Effect on the Financial Statements
ASU 2016-02, Leases and all related amendments
February
2016
Requires all leases with a term greater than 12 months to be recognized in the statements of financial position and eliminates current real estate-specific lease guidance, while maintaining substantially similar classification criteria for distinguishing between finance leases and operating leases.
January
The adoption of this standard and related amendments resulted in the recognition of approximately $15.7 million in right-of-use assets and lease liabilities on our balance sheet as of January 1, 2019. Comparative periods will continue to be measured and presented under historical guidance, and only the period of adoption and future periods will be subject to this ASU. There was no cumulative effect on retained earnings or other components of equity at the adoption date. For more information see Note H.
ASU 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220)
Allows a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act of 2017 and requires certain disclosures regarding stranded tax effects in accumulated other comprehensive income.
The adoption of this standard did not have a material impact on our consolidated financial statements.
9
Accounting Pronouncements Not Yet Adopted
Date of Required
Adoption
ASU 2016-13, Financial Instruments - Credit Losses (Topic 326), Measurement of Credit Losses on Financial Statements
June
The amendment in this update replaces the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses on instruments within its scope, including trade receivables. This update is intended to provide financial statement users with more decision-useful information about the expected credit losses.
January 2020
We are currently evaluating the impact of the adoption on our condensed consolidated financial statements.
ASU 2018-13, Fair Value Measurement (Topic 820), Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement
August 2018
This ASU adds, modifies and removes several disclosure requirements relative to the three levels of inputs used to measure fair value in accordance with Topic 820, Fair Value Measurement.
Significant Accounting Policies
Except for the accounting policy for leases that was updated as a result of adopting ASU 2016-02, there were no material changes in our significant accounting policies during the nine months ended September 30, 2019. See Note A to the consolidated financial statements included in our Annual Report on Form 10-K/A for the year ended December 31, 2018, as filed with the SEC, for additional information regarding our significant accounting policies.
NOTE B – Business Acquisitions
MAPADOC
On August 26, 2019, we completed our asset acquisition of the MAPADOC business, an operating unit of SWK Technologies, Inc., a leading provider of EDI System Automation solutions for the Sage and Acumatica markets. Pursuant to the asset purchase agreement, the purchase price is $11.8 million, of which $11.5 million has been paid in cash and $0.3 million is due to the seller as part of the initial net working capital adjustment. The net working capital adjustment will be paid in cash upon final net working capital settlement. The purchase accounting for the MAPADOC acquisition has not been finalized as of September 30, 2019. Provisional amounts are primarily related to intangible assets and net working capital. We expect to finalize the allocation of purchase price within the one-year measurement period following the acquisition.
Purchase Price Allocation
We accounted for the acquisition as a business combination. We allocated the purchase price to the tangible and identifiable intangible assets acquired and liabilities assumed based on their estimated fair values as of the acquisition date. We engaged a third-party valuation firm to assist us in the determination of the value of the purchased intangible assets. The excess of the purchase price over the fair value of net tangible and identifiable intangible assets acquired was recorded as goodwill. Goodwill is attributed to a trained workforce and other buyer-specific value resulting from expected synergies, including long-term cost savings, which are not included in the fair values of identifiable assets. The final purchase price is subject to a net working capital adjustment to be determined by the sellers and us, pursuant to the terms of the purchase agreement.
10
The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the acquisition date (in thousands):
Current assets
612
Goodwill
6,570
Intangible assets
4,900
11,782
Purchased Intangible Assets
The following table summarizes the estimated fair value of the purchased intangible assets and their estimated useful lives:
Estimated
Fair Value
Life
(in thousands)
(in years)
Developed technology
3,500
Subscriber relationships
1,400
The purchased intangible assets are being amortized on a straight-line basis over their estimated useful lives. Amortization expense for the period from August 26, 2019 through September 30, 2019 was not material.
EDIAdmin
On October 3, 2018, we completed our asset acquisition of EDIAdmin, a privately held company providing end-to-end integration solutions, featuring a dedicated Integration Platform as a Service (“iPaaS”) called Cloud Hybrid Integration Platform (“CHIP”) and collaborative managed services for leading systems and applications, both cloud-based and on-premise. Pursuant to the asset purchase agreement, we paid $7.5 million in cash to the owner of EDIAdmin. The purchase agreement also allowed the seller to receive up to $1.7 million in cash, which becomes payable in first quarter 2020 and 2021 contingent upon the completion of certain revenue milestones at December 31, 2019 and December 31, 2020. The fair value of this contingent consideration was $1.3 million at the date of acquisition and $1.0 million at September 30, 2019. Due to the remeasurement of the contingent liability, we recognized an insignificant amount of income and $0.4 million of income for the three and nine months ended September 30, 2019, respectively, in our condensed consolidated statements of comprehensive income. See Note E for further disclosures on the remeasurement of the contingent liability.
We allocated the purchase price to the tangible and identifiable intangible assets acquired and liabilities assumed based on their estimated fair values as of the acquisition date. The excess of the purchase price over the fair value of net tangible and identifiable intangible assets acquired was recorded as goodwill. Goodwill is attributed to a trained workforce and other buyer-specific value resulting from expected synergies, including long-term cost savings, which are not included in the fair values of identifiable assets. The purchase accounting for the EDIAdmin acquisition was complete as of December 31, 2018. The consolidated balance sheet as of December 31, 2018 reflects the final allocation of the purchase price to the assets acquired and liabilities assumed based on their estimated fair values at the date of acquisition.
CovalentWorks
On December 18, 2018, we completed our asset acquisition of CovalentWorks, a privately held company providing cloud-based EDI solutions to small- and medium-sized businesses. Pursuant to the asset purchase agreement, we paid $19.4 million in cash and issued $3.4 million in common stock, or 80,956 shares, as adjusted for the two-for-one stock split, to the owners of CovalentWorks.
We allocated the purchase price to the tangible and identifiable intangible assets acquired and liabilities assumed based on their estimated fair values as of the acquisition date. The excess of the purchase price over the fair value of net tangible and identifiable intangible assets acquired was recorded as goodwill. Goodwill is attributed to a trained workforce and other buyer-specific value resulting from expected synergies, including long-term cost savings, which are not included in the fair values of identifiable assets. The purchase accounting, purchase price allocation and net working capital adjustment for the CovalentWorks acquisition were finalized during the first quarter of 2019 and there have been no subsequent adjustments.
11
NOTE C – Revenue
We derive our revenues primarily from the following revenue streams (in thousands):
Recurring revenues:
Fulfillment
55,546
48,482
161,685
140,326
Analytics
9,422
8,750
27,540
25,639
1,458
1,412
4,303
3,969
Recurring Revenues
66,426
58,644
193,528
169,934
One-time revenues
4,502
4,224
12,863
13,117
Revenues are recognized when our services are made available to our customers, in an amount that reflects the consideration we are contractually and legally entitled to in exchange for those services.
We determine revenue recognition through the following steps:
-
Identification of the contract, or contracts, with a customer
Identification of the performance obligations in the contract
Determination of the transaction price
Allocation of the transaction price to the performance obligations in the contract
Recognition of revenue when, or as, we satisfy a performance obligation
Recurring revenues consists of recurring subscriptions from customers that utilize our Fulfillment, Analytics, and Other cloud-based supply chain management solutions. Revenue for these solutions is generally recognized on a ratable basis over the contract term beginning on the date that our service is made available to the customer. Our contracts with our recurring revenue customers are recurring in nature, ranging from monthly to annual, and generally allow the customer to cancel the contract for any reason with 30 to 90 days’ notice. Timing of billings varies by customer and by contract type and are either in advance or within 30 days of the service being performed.
The deferred revenue liability for recurring revenue contracts are for one year or less and recognized on a ratable basis over the contract term. We have applied the optional exemption under Accounting Standards Codification (“ASC”) 606-10-50-14(a) and will not disclose information about the remaining performance obligations for contracts which have original durations of one year or less.
One-time Revenues
One-time revenues consist of set-up fees from customers and miscellaneous one-time fees.
Set-up fees are specific for each connection a customer has with a trading partner and many of our customers have connections with numerous trading partners. Set-up fees related to our cloud-based supply chain management solutions are nonrefundable upfront fees that are necessary for our customers to utilize our cloud-based services. These set-up fees do not provide any standalone value to our customers. Except for our Analytics platform, we have determined the set-up fees represent a material renewal option right to our customers as they will not be incurred again upon renewal. These set-up fees and related costs are deferred and recognized ratably over two years, which is the estimated connection life between the customer and the trading partner. For our Analytics platform, we have determined the set-up fees do not represent a material customer renewal right and, as such, are deferred and recognized ratably over the estimated initial contract term, which is one year.
12
The table below presents the activity of the portion of the deferred revenue liability relating to set-up fees (in thousands):
Balances, at beginning of period
10,063
9,886
9,857
10,031
Invoiced set-up fees
2,599
2,697
7,965
7,807
Amortized set-up fees
(2,584
(2,596
(7,744
(7,851
Balances, at end of period
10,078
9,987
The entire balance of set-up fees will be recognized within two years and, as such, current amounts will be recognized in the next 1-12 months and long-term amounts will be recognized in the next 13-24 months.
Miscellaneous one-time fees consist of professional services and testing and certification. The deferred revenue liability for these one-time fees are for one year or less and recognized at the time service is provided. We have applied the optional exemption under ASC 606-10-50-14(a) and will not disclose information about the remaining performance obligations for contracts which have original durations of one year or less.
NOTE D – Deferred Costs
Deferred costs consist of costs to obtain customer contracts, such as commissions paid to sales personnel and to third-party partners for customer referrals, and costs to fulfill customer contracts, such as customer implementation costs.
Sales commissions relating to recurring revenues are considered incremental and recoverable costs of obtaining a contract with our customer. These commissions are calculated based on estimated annual recurring revenue to be generated over the customer’s initial contract year. These costs are deferred and amortized over the expected period of benefit which we have determined to be two years. Amortization expense is included in sales and marketing expenses in the accompanying condensed consolidated statements of comprehensive income.
Customer implementation costs are considered incremental and recoverable costs of obtaining a contract with our customer. These costs are deferred and amortized over the expected period of benefit which we have determined to be two years. Amortization expense is included in cost of revenues in the accompanying condensed consolidated statements of comprehensive income.
The table below presents the activity of deferred costs and amortization of deferred costs (in thousands):
45,528
42,544
45,475
39,933
Incurred deferred costs
12,676
12,391
36,888
36,807
Amortized deferred costs
(12,623
(11,204
(36,782
(33,009
45,581
43,731
NOTE E – Financial Instruments
We invest primarily in money market funds, certificates of deposit, highly liquid debt instruments of the U.S. government and U.S. corporate debt securities. All investments with remaining maturities of less than one year from the balance sheet date are classified as short-term investments. Investments with remaining maturities of more than one year from the balance sheet date are classified as long-term investments. As of September 30, 2019 and December 31, 2018, all of our investments held were classified as short-term.
Our short-term marketable securities are classified as available-for-sale. We intend to hold marketable securities until maturity; however, we may sell these securities at any time for use in current operations or for other purposes.
Our marketable securities are carried at fair value and unrealized gains and losses on these investments, net of taxes, are included in accumulated other comprehensive loss in the condensed consolidated balance sheets. Realized gains or losses are included in other income (expense), net in the condensed consolidated statements of comprehensive income. When a determination has been made that an other-than-temporary decline in fair value has occurred, the amount of the decline that is related to a credit loss is realized and is included in other income (expense), net in the condensed consolidated statements of comprehensive income.
13
Cash equivalents and short-term investments consisted of the following (in thousands):
September 30, 2019
Amortized
Unrealized
Fair
Cost
Gains (Losses)
Value
Cash equivalents:
Money market funds
124,046
Certificates of deposit
6,747
Marketable securities:
Corporate bonds
19,821
(11
19,810
Commercial paper
9,961
41
10,002
U.S. treasury securities
14,778
109
14,887
175,353
139
175,492
December 31, 2018
Gains
109,265
7,000
15,194
40
15,234
9,889
9,965
12,300
38
12,338
153,648
154
153,802
We do not believe any of the unrealized losses represent an other-than-temporary impairment based on our valuation of available evidence as of September 30, 2019. We expect to receive the full principal and interest on all of these cash equivalents, certificates of deposit, and marketable securities.
Recurring Fair Value Measurements
We measure certain financial assets at fair value on a recurring basis based on a fair value hierarchy that requires us to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The three levels of inputs that may be used to measure fair value are:
•
Level 1 – quoted prices in active markets for identical assets or liabilities
Level 2 – observable inputs other than Level 1 prices, such as: (a) quoted prices for similar assets or liabilities, (b) quoted prices in markets with insufficient volume or infrequent transactions (less active markets), or (c) model-derived valuations in which all significant inputs are observable or can be derived principally from or corroborated by observable market data for substantially the full term of the assets or liabilities. We obtain the fair values of our level 2 available-for-sale securities from a professional pricing service.
Level 3 – unobservable inputs to the valuation methodology that are significant to the measurement of fair value of assets or liabilities.
For the earn-out liability related to the EDIAdmin acquisition, the Company utilized the Monte Carlo simulation method to estimate the fair value of this contingent liability as of the reporting date. Thousands of iterations of the simulation were performed using forecasted revenues to develop a distribution of future values of recurring revenue which, in turn, provide indicated earn-out payments. The total estimated fair value equals the sum of the average present values of the indicated earn-out payments. Changes in assumptions described above could have an impact on the payout of contingent consideration with a maximum payout being $1.7 million. The earn-out liability has been measured as Level 3 given the unobservable inputs that are significant to the measurement of the liability.
14
The following table presents information about our financial assets that are measured at fair value on a recurring basis and indicates the fair value hierarchy of the valuation techniques utilized to determine such fair value (in thousands):
Level 1
Level 2
Level 3
Assets:
130,793
44,699
Liabilities:
Earn-out liability
116,265
37,537
Nonrecurring Fair Value Measurements
The Company measures certain assets and liabilities at fair value on a nonrecurring basis. Assets and liabilities that are measured at fair value on a nonrecurring basis include long-lived assets, goodwill and indefinite-lived intangible assets, which would generally be recorded at fair value as a result of an impairment charge. Assets acquired and liabilities assumed as part of business combinations are measured at fair value. For additional information on the Company's business combinations and the related nonrecurring fair value measurement of the assets acquired and liabilities assumed, refer to Note B, Business Acquisitions.
Other Fair Value Disclosures
The carrying values of the Company's short-term financial instruments, including cash and cash equivalents, accounts receivable, and accounts payable, when applicable, approximate their respective fair values due to their short-term nature.
15
NOTE F – Goodwill and Intangible Assets, net
The changes in the net carrying amount of goodwill for the nine months ended September 30, 2019 are as follows (in thousands):
Balance, January 1
Goodwill acquired during the period
138
Balance, September 30, 2019
Intangible assets subject to amortization primarily include subscriber relationships, non-competition agreements and acquired technology and are amortized over their respective useful lives (ranging from 1 to 10 years). Intangible assets, net included the following (in thousands):
Gross
Foreign
Carrying
Currency
Amortization
Translation
Net
43,640
(26,178
17,538
Non-competition agreements
2,495
(2,334
168
Technology and other
8,502
(2,372
6,138
54,637
(30,884
91
43,212
(23,284
(623
19,305
2,560
(2,247
(28
285
5,199
(2,012
(36
3,151
50,971
(27,543
(687
The estimated annual amortization expense related to intangible assets subject to amortization for the next five years is as follows (in thousands):
Remainder of 2019
2020
5,309
2021
4,471
2022
3,367
2023
3,297
Thereafter
5,988
NOTE G – Other Assets
The changes in the net amount of capitalized implementation costs for internal-use software from hosting arrangements for the nine months ended September 30, 2019 is as follows (in thousands):
455
Capitalized implementation fees
670
Amortization of implementation fees
(52
1,073
There were no impairment losses in relation to the capitalized implementation costs for the period presented.
16
NOTE H – Leases
We are obligated under non-cancellable operating leases, primarily for office space and certain equipment, as follows:
Remaining
Right-of-Use
Term (years)
Asset (in thousands)
Minneapolis, MN lease
10,823
Little Falls, NJ lease
1,674
Other leases
< 1 - 3
1,151
Some of our leases may include options to extend the leases for up to 5 years. The options to extend our leases are not recognized as part of our ROU assets and lease liabilities as it is not reasonably certain that we will exercise those options. Additionally, our agreements do not include options to terminate the leases.
On December 20, 2017, we executed the fourth amendment to our lease agreement for our current headquarters located in Minneapolis, Minnesota where we lease approximately 189,000 square feet under an agreement that expires on April 30, 2025. We have agreed to expand our headquarters premises by approximately 25,000 square feet during 2020. Our lease agreement also includes a further expansion right and a right of first offer to lease certain additional space and two options to extend the term of the lease for five years at a market rate determined in accordance with the lease. Incentives of $6.4 million are included as a lease component.
On February 25, 2016, we executed the first amendment to our lease agreement for our Little Falls, New Jersey location where we lease approximately 26,000 square feet under an agreement that expires on June 30, 2023. The agreement includes an option to extend the term of the lease for five years at a market rate determined in accordance with the lease. Incentives of $0.9 million are included as a lease component.
The components of lease expense were as follows (in thousands):
Operating lease cost
650
1,956
Variable lease cost
721
2,360
1,371
4,316
Operating lease cost for short-term leases was not material for the three and nine months ended September 30, 2019.
Supplemental cash flow information related to leases was as follows (in thousands):
Cash paid for amounts included in the measurement of lease liabilities
Operating cash flows from operating leases
1,109
3,246
ROU assets obtained in exchange for operating lease liabilities
The ROU assets obtained in exchange for operating lease liabilities excludes the transition amount of $15.7 million.
Supplemental balance sheet information related to leases was as follows:
Weighted-average remaining lease term - operating leases
5.1 years
Weighted-average discount rate - operating leases
4.5
%
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At September 30, 2019, our future minimum payments under operating leases were as follows (in thousands):
1,125
3,635
4,483
4,042
3,855
4,816
21,956
Less: imputed interest
(2,451
19,505
At December 31, 2018, our future minimum payments under operating leases were as follows (in thousands):
4,209
3,542
4,414
24,878
NOTE I – Stock-Based Compensation
On August 22, 2019, we effected a two-for-one stock split of the Company’s common stock. There was no change in the number of authorized common shares of the Company. All share and per share data have been adjusted for all periods presented to reflect the stock split.
Our equity compensation plans provide for the grant of incentive and nonqualified stock options, as well as other stock-based awards including restricted stock and restricted stock units (“RSU”), to employees, non-employee directors and other consultants who provide services to us. We also provide an employee stock purchase plan and 401(k) stock match.
Restricted stock awards result in the issuance of new shares when granted. For other stock-based awards, new shares are issued when the award is exercised, vested or released according to the terms of the agreement. In February 2019, 2,081,488 additional shares were reserved for future issuance under our 2010 Equity Incentive Plan. At September 30, 2019, there were approximately 12,255,888 million shares available for grant under approved equity compensation plans.
We recognize stock-based compensation expense on a straight-line basis over the vesting period, except for expense relating to retirement-eligible employees which is recognized immediately upon the employee becoming retirement-eligible.
Stock-based compensation expense was allocated in the condensed consolidated statements of comprehensive income as follows (in thousands):
778
535
2,027
1,587
784
691
2,208
2,054
697
287
1,822
973
888
1,753
5,259
5,364
Total stock-based compensation expense
3,147
3,266
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Stock-based compensation expense by plan type was as follows (in thousands):
Stock options
619
677
2,548
2,670
Performance share units
152
74
1,226
960
Restricted stock units
1,719
1,976
5,581
4,727
Restricted stock awards
128
137
352
186
547
332
401(k) stock match
343
293
1,005
937
As of September 30, 2019, there was approximately $21.3 million of unrecognized stock-based compensation expense under our equity compensation plans, which is expected to be recognized on a straight-line basis over a weighted average period of 2.6 years.
Stock Options
Stock options generally vest over four years and have a contractual term of seven to ten years from the date of grant. Our stock option activity was as follows:
Weighted Average
Options
Exercise Price
(#)
($/share)
Outstanding at December 31, 2018
1,746,468
25.93
Granted
184,194
53.92
Exercised
(309,310
21.57
Forfeited
(39,818
30.57
Outstanding at September 30, 2019
1,581,534
29.93
Of the total outstanding options at September 30, 2019, 1,129,294 were exercisable with a weighted average exercise price of $27.03 per share. The total outstanding options had a weighted average remaining contractual life of 3.2 years.
The weighted average grant date fair value of options granted during the first nine months of 2019 was $16.86 per share. This was estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions:
Volatility
33.2
Dividend yield
0
Life (in years)
4.4
Risk-free interest rate
2.41
Performance Share Units and Restricted Stock Units and Awards
In February 2017, our executive officers were granted performance share unit (“PSU”) awards with vesting contingent on successful attainment of pre-determined revenue targets over the course of a three-year performance period (fiscal years 2017 – 2019). The fair value is measured as the number of performance shares expected to be earned multiplied by the grant date fair value of our shares. The number of performance shares expected to vest during the current service period is estimated and the fair value of those shares is recognized over the remaining service period less any amounts already recognized.
In February 2018 and 2019, our executive officers were granted PSU awards with vesting contingent on the Company’s total shareholder return as compared to indexed total shareholder return over the course of a three-year performance period (fiscal years 2018 – 2020 and fiscal years 2019 – 2021, respectively). The grant date fair value was estimated using a Monte Carlo simulation that utilizes multiple input variables that determine the probability of satisfying the performance conditions stipulated in the award and calculates the fair market value for the PSUs granted. Expense is recognized on a straight-line basis over the vesting period, regardless of whether the market condition is satisfied.
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RSUs vest over four years and, upon vesting, the holder is entitled to receive shares of our common stock. With restricted stock awards, shares of our common stock are issued when the award is granted and the restrictions lapse over one year.
Activity for our PSUs and RSUs was as follows:
PSUs and RSUs
Grant Date Fair Value
754,670
29.95
272,454
55.90
Vested and common stock issued
(190,624
28.76
(28,144
33.14
808,356
38.86
The number of RSUs outstanding at September 30, 2019 included 88,196 units that have vested, but for which shares of common stock have not yet been issued pursuant to the terms of the agreement.
Our restricted stock awards activity was as follows:
Restricted Stock
Weighted Average Grant
Awards (#)
Date Fair Value ($/share)
3,664
37.22
Restricted common stock issued
9,840
51.80
Restrictions lapsed
(8,584
45.58
4,920
Employee Stock Purchase Plan
We have an employee stock purchase plan which allows participating employees to purchase shares of our common stock at a discount through payroll deductions. The plan is available to all employees subject to certain eligibility requirements. Participating employees may purchase common stock, on a voluntary after-tax basis, at a price that is the lower of 85% of the fair market value of one share of common stock at the beginning or end of each stock purchase period. The plan consists of two six-month offering periods, beginning on January 1 and July 1 of each calendar year, respectively. A total of 2.0 million shares of common stock are reserved for issuance under the plan.
For the offering periods that began on January 1, 2019 and January 1, 2018, we withheld approximately $1.2 million and $0.8 million from employees participating in the plan. For the offering periods that began on July 1, 2019 and July 1, 2018, we withheld approximately $0.7 million and $0.5 million from employees participating in the plan as of September 30, 2019 and 2018, respectively.
The fair value was estimated based on the market price of our common stock at the beginning of the offering period using the Black-Scholes option pricing model with the following assumptions:
0.5
2.56
401(k) Stock Match
We sponsor a 401(k) retirement savings plan for our U.S. employees where employees can contribute up to 80% of their compensation, subject to the limits established by law. We match 50% of the employee’s elective deferrals, up to the first 6% of the employee’s pre-tax compensation for each pay period. A portion of our match is in company stock, which is purchased from the open market by our plan provider and immediately deposited into the employee’s 401(k) account.
20
NOTE J – Income Taxes
We record our interim provision for income taxes by applying our estimated annual effective tax rate to our year-to-date pretax income and adjust the provision for discrete tax items recorded in the period. Differences between our effective tax rate and statutory tax rates are primarily due to the impact of permanently non-deductible expenses partially offset by the federal research and development credits. Additionally, excess tax benefits generated upon settlement or exercise of stock awards are recognized as a reduction to income tax expense as a discrete tax item in the quarter that the event occurs creating potentially significant fluctuation in tax expense by quarter and by year. Our provisions for income taxes include current foreign and state income tax expense, as well as deferred tax expense.
As of September 30, 2019, we do not have any unrecognized tax benefits nor any material accrued interest or tax penalties.
NOTE K – Net Income Per Share
Basic net income per share has been computed using the weighted average number of shares of common stock outstanding during each period. Diluted net income per share also includes the impact of our outstanding potential common shares, including options, PSUs, RSUs and restricted awards. Potential common shares that are anti-dilutive are excluded from the calculation of diluted net income per share.
The following table presents the components of the computation of basic and diluted net income per share for the periods indicated (in thousands, except per share amounts):
Numerator
Denominator
Weighted average common shares outstanding, basic
Options to purchase common stock
634
790
687
586
PSUs, RSUs and restricted stock awards
283
254
299
194
Weighted average common shares outstanding, diluted
Antidilutive shares (in thousands)
240
164
54
NOTE L – Subsequent Event
Subsequent to September 30, 2019, the Company’s board of directors authorized an increase and extension of its previously announced stock repurchase program pursuant to which the Company may, from time to time, purchase shares of its outstanding common stock. The stock repurchase program originally authorized the Company to purchase up to $50.0 million of its outstanding common stock and that amount has been increased by the board to $100.0 million. As of September 30, 2019, $9.3 million remained available under the previously unused stock repurchase program. The board also authorized an extension of the original expiration date of the stock repurchase program from November 2, 2019 to November 2, 2021. The number of shares to be purchased and the timing of purchases will be based on the price of the Company’s common stock, general business and market conditions and other investment considerations and factors.
The program does not obligate the Company to repurchase any specific number of shares and it may be suspended or discontinued at any time without prior notice. The Company intends to finance the share repurchase program with cash on hand.
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Overview
SPS Commerce is a leading provider of cloud-based solutions that make it easier for retailers, suppliers, grocers, distributors and logistics firms to orchestrate the management of item data, order fulfillment, inventory control and sales analytics across all channels. The solutions offered by SPS Commerce eliminate the need for on-premise software and support staff by taking on that capability on the customer’s behalf. We derive the majority of our revenues from numerous 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 the three months ended September 30, 2019, our revenues were $70.9 million, an increase of 13% from the comparable period in 2018, and represented our 75th consecutive quarter of increased revenues. Total operating expenses increased 7% for the same period in 2019 from 2018. For the nine months ended September 30, 2019, revenues increased 13% and operating expenses increased 6% compared to the same period in 2018.
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 three and nine months ended September 30, 2019, 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/A for the year ended December 31, 2018 as filed with the SEC.
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 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 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 condensed consolidated financial statements, which are prepared in accordance with GAAP and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. 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.
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 relating to uncertain matters that could have a material effect on our financial condition and results of operations. Accordingly, we believe that our policies for revenue recognition and business combinations are the most critical to fully understand and evaluate our financial condition and results of operations.
During the three and nine months ended September 30, 2019, there were no changes in our critical accounting policies or estimates. See Note A to our condensed consolidated financial statements included in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K/A for the year ended December 31, 2018, as filed with the SEC, for additional information regarding our accounting policies.
Results of Operations
Three months ended September 30, 2019 compared to three months ended September 30, 2018
The following table presents our results of operations for the periods indicated (dollars in thousands):
Three Months Ended September 30,
Change
% of revenue
100.0
8,060
12.8
32.8
32.5
2,852
14.0
67.2
67.5
5,208
12.3
23.9
26.9
(15
(0.1
10.9
8.2
2,597
50.5
15.1
17.8
(449
(4.0
1.9
1.5
399
43.0
51.8
54.4
2,532
7.4
15.4
13.1
2,676
32.4
1.2
1.0
215
34.2
Other expense, net
(0.2
(0.3
(54
(24.7
0.0
0.7
291
71.1
16.4
13.8
2,967
3.8
2,087
345.0
12.6
880
Revenues. The increase in revenues resulted from two primary factors: the increase in recurring revenue customers and the retainment of annualized average recurring revenues per recurring revenue customer, which we also refer to as wallet share.
The number of recurring revenue customers increased 14% to 30,551 at September 30, 2019 from 26,869 at September 30, 2018.
Annualized average recurring revenues per recurring revenue customer, or wallet share, decreased slightly to $8,793 for the three months ended September 30, 2019 from $8,838 for the same period in 2018. The slight decrease in wallet share is due to the increase in recurring revenue customers.
Recurring revenues from recurring revenue customers accounted for 94% of our total revenues for the three months ended September 30, 2019, increasing from 93% for the same period in 2018. We anticipate that the number of recurring revenue customers and wallet share will increase as we increase the number of solutions we offer and increase the penetration of those solutions across our customer base.
Cost of Revenues. The increase in cost of revenues for the three months ended September 30, 2019 was primarily due to an increase in personnel-related costs of $1.9 million, driven by increased salaries and benefits due to business growth and by increased headcount, consulting, and contract labor. As we continued to invest in the infrastructure supporting our platform, depreciation expense increased by $0.6 million.
Sales and Marketing Expenses. The decrease in sales and marketing expense for the three months ended September 30, 2019 was primarily due to a decrease of $0.3 million in variable compensation earned by sales personnel and referred partners, offset by an increase of $0.1 million in salaries and benefits and an increase of $0.1 in stock-based compensation
Research and Development Expenses. The increase in research and development expense for the three months ended September 30, 2019 was primarily due to increased headcount which resulted in an increase in personnel costs of $2.0 million and an increase in stock-based compensation expense of $0.4 million.
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General and Administrative Expenses. The decrease in general and administrative expense for the three months ended September 30, 2019 was driven by a decrease in stock-based compensation of $0.9 million primarily due to the timing of the Chief Executive Officer’s 2019 RSU grants compared to his 2018 RSU grants, offset by an increase of $0.2 million in cloud-based and software subscriptions and an increase of $0.2 million in miscellaneous service fees.
Other Income (Expense). Interest income, net, other expense, net, and change in earn-out liability for the three months ended September 30, 2019 increased primarily due to increased interest income from investments, offset by realized foreign currency exchange gains, and decrease in the fair value of the earn-out liability. The change in fair value of the earn-out liability for the three months ended September 30, 2019 was driven by an adjustment to the fair value of the EDIAdmin earnout liability due to estimated revenue at the earn-out measurement dates, December 31, 2019 and December 31, 2020.
Income Tax Expense. The increase in income tax expense for the three months ended September 30, 2019 was primarily due to an increase in pre-tax income, as well as a decrease of $1.5 million in third quarter discrete tax benefits, primarily driven by a decrease in stock activity. Under ASU 2016-09, excess tax benefits generated upon the settlement or exercise of stock awards are recognized as a reduction to income tax expense and, as a result, we expect that our annual effective income tax rate will be volatile.
Adjusted EBITDA. Adjusted EBITDA, which is a non-GAAP measure of financial performance, consists of net income adjusted for depreciation and amortization, interest expense, interest income, income tax expense, stock-based compensation expense, and other adjustments as necessary for a fair presentation. Other adjustments included the impact of the fair value adjustment for the EDIAdmin earn-out liability. The following table provides a reconciliation of net income to Adjusted EBITDA (in thousands):
2,819
2,132
(843
(628
Stock-based compensation expense
(22
Adjusted EBITDA
18,061
14,364
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 stock-based compensation expense, amortization expense related to intangible assets, and other adjustments as necessary for a fair presentation, divided by the weighted average number of shares of common stock outstanding during each period. Other adjustments included the impact of the fair value adjustment for the EDIAdmin earn-out liability. The following table provides a reconciliation of net income to non-GAAP income per share (in thousands, except per share amounts):
Income tax effects of adjustments
(1,606
(3,008
Non-GAAP income
11,787
9,247
Shares used to compute non-GAAP income per share
Non-GAAP income per share
0.34
0.27
0.33
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Nine months ended September 30, 2019 compared to nine months ended September 30, 2018
Nine Months Ended September 30,
23,340
33.1
7,759
66.9
15,581
12.7
25.4
29.5
(1,619
(3.0
9.9
8.5
4,873
31.3
16.3
17.1
2,396
7.7
1.7
811
26.3
53.5
56.8
6,461
6.2
13.4
10.1
9,120
49.2
1.1
0.9
644
40.5
569
105.2
0.2
Total other income (expense), net
1.3
0.6
1,579
150.7
14.7
10.7
10,699
54.7
2.8
1.6
2,880
101.4
11.9
9.1
7,819
46.7
Annualized average recurring revenues per recurring revenue customer, or wallet share, stayed level at $8,622 for the nine months ended September 30, 2019 compared to $8,612 for the same period in 2018. The consistent wallet share is due to the increase in recurring revenue customers.
Recurring revenues from recurring revenue customers accounted for 94% of our total revenues for the nine months ended September 30, 2019, increasing from 93% for the same period in 2018. 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. The increase in cost of revenues for the nine months ended September 30, 2019 was primarily due to an increase of $5.4 million in personnel-related costs and $0.4 million in stock-based compensation, driven by continued business growth and by an increase in headcount and contractor labor. As we continued to invest in the infrastructure supporting our platform, depreciation expense increased by $1.6 million compared to the same period in 2018.
Sales and Marketing Expenses. The decrease in sales and marketing expenses for the nine months ended September 30, 2019 was primarily due to decreased headcount which resulted in a decrease of $1.8 million of personnel-related costs, offset by a $0.2 million increase in stock-based compensation.
Research and Development Expenses. The increase in research and development expenses for the nine months ended September 30, 2019 was primarily due to increased headcount which resulted in an increase in personnel costs of $3.6 million and an increase of stock-based compensation of $0.8 million.
General and Administrative Expenses. The increase in general and administrative expenses for the nine months ended September 30, 2019 was driven by continued business growth which resulted in an increase in personnel-related costs of $1.0 million, software subscriptions costs of $0.8 million and bad debt expense of $0.6 million.
25
Other Income (Expense), net. Interest income, net, other expense, net, and change in earn-out liability for the nine months ended September 30, 2019 increased over the same period in 2018 primarily due to increased income from investments and settlement and subsequent return of escrowed shared from the acquisition of Toolbox Solutions, Inc. (“Toolbox”) in 2016, offset by realized foreign currency exchange gains, and decrease in fair value of the earn-out liability. The change in earn-out liability for the nine months ended September 30, 2019 was $0.4 million in income driven by an adjustment to the fair value of the EDIAdmin earnout liability due to estimated revenue at the earn-out measurement dates, December 31, 2019 and December 31, 2020.
Income Tax Expense. The increase in income tax expense for the nine months ended September 30, 2019, as compared to the same period in 2018, was primarily due to an increase in pre-tax income, as well as a decrease of $0.3 million in discrete tax benefits, primarily driven by a decrease in stock activity. Under ASU 2016-09, excess tax benefits generated upon the settlement or exercise of stock awards are recognized as a reduction to income tax expense and, as a result, we expect that our annual effective income tax rate will be volatile.
Adjusted EBITDA. Adjusted EBITDA, which is a non-GAAP measure of financial performance, consists of net income adjusted for depreciation and amortization, interest expense, interest income, income tax expense, stock-based compensation expense, and other adjustments as necessary for a fair presentation. Other adjustments included the impact of the fair value adjustment for the EDIAdmin earn-out liability, returned escrow shares related to the Toolbox acquisition, and an impairment of internally developed software. The following table provides a reconciliation of net income to Adjusted EBITDA (in thousands):
(2,233
(1,589
(483
50,909
37,353
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 stock-based compensation expense, amortization expense related to intangible assets, and other adjustments as necessary for a fair presentation, divided by the weighted average number of shares of common stock outstanding during each period. Other adjustments included the impact of the fair value adjustment for the EDIAdmin earn-out liability, returned escrow shares related to the Toolbox acquisition, and an impairment of internally developed software. The following table provides a reconciliation of net income to Non-GAAP income per share (in thousands, except per share amounts):
(5,972
(5,188
33,308
24,607
0.95
0.72
0.93
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Liquidity and Capital Resources
At September 30, 2019, our principal sources of liquidity were cash, cash equivalents, certificates of deposit and marketable securities of $201.2 million and accounts receivable, net of allowance for doubtful accounts of $29.4 million. Certificates of deposit and marketable securities are invested in accordance with our investment policy, with a goal of maintaining liquidity and capital preservation. Our cash equivalents and marketable securities are held in highly liquid money market funds, commercial paper, federal agency securities and corporate debt securities.
The below table summarizes the activity within the statement of cash flows:
Net Cash Flows from Operating Activities
The increase in operating cash flows was driven by continued business growth which resulted in increased net income and decreased deferred tax assets and was driven by continued acquisitions and business expansions which resulted in increased depreciation and amortization, offset by increased compensation due to an increase in headcount.
Net Cash Flows from Investing Activities
The change in net cash used in investing activities was primarily due to $11.5 million used for the MAPADOC acquisition.
Net Cash Flows from Financing Activities
The change in net cash used in financing activities was primarily due to the decrease in net proceeds from stock option exercises, offset by an increase in cash used for share repurchases.
Effect of Foreign Currency Exchange Rate Changes
Our results of operations and cash flows were not materially affected by fluctuations in foreign currency exchange rates. We maintain approximately 5% of our total cash and cash equivalents outside of the U.S. in foreign currencies, primarily in Australian and Canadian dollars. We believe that a significant change in foreign currency exchange rates or an inability to access these funds would not affect our ability to meet our operational needs.
Adequacy of Capital Resources
Our future capital requirements may vary significantly from those now planned and will depend on many factors, including:
costs to develop and implement new solutions and applications, if any;
sales and marketing resources needed to further penetrate our market and gain acceptance of new solutions and applications that we may develop;
expansion of our operations in the United States and internationally;
response of competitors to our solutions and applications; and,
use of capital for acquisitions, if any.
Historically, we have experienced increases in our expenditures consistent with the growth in our operations, and we anticipate that our expenditures will continue to increase as we expand our business.
We believe our cash, cash equivalents, certificates of deposit, marketable securities 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.
27
Inflation and changing prices did not have a material effect on our business during the nine months ended September 30, 2019 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 September 30, 2019 are summarized below:
Payments Due By Period (in thousands)
Less Than
More Than
Contractual Obligations
1 Year
1-3 Years
3-5 Years
5 Years
Operating lease obligations, including imputed interest
3,966
8,286
7,581
2,123
Our contractual obligations and commercial commitments as of December 31, 2018 are summarized below:
7,956
7,896
4,817
Interest Rate Sensitivity Risk
The principal objectives of our investment activities are to preserve principal, provide liquidity and maximize income consistent with minimizing risk of material loss. We are exposed to market risk related to changes in interest rates. However, based on the nature and current level of our investments (primarily cash and cash equivalents, which approximate fair value due to their short maturities, certificates of deposit and marketable securities), we believe there is no material risk exposure. We do not enter into investments for trading or speculative purposes.
We did not have any outstanding debt as of September 30, 2019. Therefore, we do not have any material risk to interest rate fluctuations.
Foreign Currency Exchange Risk
We have revenue, expenses, assets and liabilities that are denominated in currencies other than the U.S. dollar, primarily the Australian dollar and Canadian dollar. As of September 30, 2019, we maintained approximately 5% of our total cash and cash equivalents outside of the U.S. in foreign currencies. We believe that a significant change in foreign currency exchange rates or an inability to access these funds would not affect our ability to meet our operational needs. As we expand internationally, our results of operations and cash flows may be impacted by changes in foreign currency exchange rates, and would be adversely impacted when the U.S. dollar appreciates relative to other foreign currencies. We have not used any forward contracts or currency borrowings to hedge our exposure to foreign currency exchange risk, although we may do so in the future.
Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this Quarterly Report on Form 10-Q, our management has evaluated, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934). Disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of September 30, 2019.
For the year ended December 31, 2018, management’s assessment of internal control over financial reporting excluded the internal control of EDIAdmin and CovalentWorks, which were acquired on October 3, 2018 and December 18, 2018, respectively. Pursuant to the SEC’s general guidance that an assessment of a recently acquired business may be omitted from our scope for a period not to exceed one year from the date of acquisition, the scope of our most recent assessment did not include EDIAdmin or CovalentWorks. Our assessment of the effectiveness of internal control over financial reporting as of December 31, 2019 will include EDIAdmin and CovalentWorks. As of December 31, 2018, EDIAdmin and CovalentWorks represented approximately 2% and 6% of our total consolidated assets, respectively, and each represented less than 1% of our consolidated revenues as of and for the year ended December 31, 2018.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting during the quarter ended September 30, 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Disclosure regarding changes, if any, in internal control over financial reporting resulting from the acquisitions described will be included in the annual report in which the Company’s assessment that encompasses the acquired business is included.
For the quarter ended September 30, 2019, management’s assessment of our internal control over financial reporting excluded the internal control over financial reporting of the MAPADOC business, an operating unit of SWK Technologies, Inc., which was acquired on August 26, 2019. Pursuant to the SEC’s general guidance that an assessment of a recently acquired business may be omitted from our scope for a period not to exceed one year from the date of acquisition, the scope of our most recent assessment did not include MAPADOC. For the three and nine months ended September 30, 2019, MAPADOC represented approximately 3% of our total consolidated assets and less than 1% of our consolidated revenues.
PART II. – OTHER INFORMATION
We are not currently subject to any material legal proceedings. From time to time, we may be named as a defendant in legal actions or otherwise be subject to claims arising from our normal business activities. Any such actions, even those that lack merit, could result in the expenditure of significant financial and managerial resources. We believe that we have obtained adequate insurance coverage or rights to indemnification in connection with potential legal proceedings that may arise.
There have been no material changes in our risk factors from those disclosed under the heading “Risk Factors” in our Annual Report on Form 10-K/A for the year ended December 31, 2018 as filed with the SEC.
(c) Share Repurchases
The following table presents the total number of shares of our common stock that we purchased during the third quarter of 2019, the average price paid per share, the number of shares that we purchased as part of our publicly announced repurchase program and the approximate dollar value of shares that still could be repurchased at the end of the applicable period.
Period
Total Number
of Shares
Purchased
Average Price
Paid per Share
Purchased as
Part of Publicly
Announced
Program (1)
Approximate
Dollar Value of
Shares that
May Yet be
Under the
Program (1)(2)
July 1 - 31, 2019
72,384
51.28
11,643,000
August 1 - 31, 2019
44,472
51.45
9,355,000
September 1 - 30, 2019
Total third quarter 2019
51.35
(1)
Pursuant to a $50.0 million share repurchase program that was announced by our board of directors on November 2, 2017. Under the program, purchases may be made from time to time in the open market through November 2, 2019.
(2)
Subsequent to September 30, 2019, our board of directors amended our share repurchase program to increase the amount of outstanding common stock it is authorized to purchase to $100.0 million and to extend the original expiration date of the program to November 2, 2021. For further information, see Note L.
Not Applicable.
Number
3.1
Certificate of Incorporation (incorporated by reference to Exhibit 4.1 to our Registration Statement on Form S-3 (File No. 333-182097) filed with the Commission on September 13, 2012).
3.2
Amended and Restated Bylaws (incorporated by reference to Exhibit 3.1 to our Current Report on Form 8-K (File No. 001-34702) filed with the Commission on October 12, 2017).
31.1
Certification of Principal Executive Officer pursuant to Rules 13a-14(a) under the Securities Exchange Act of 1934, as amended (filed herewith).
31.2
Certification of Principal Financial Officer pursuant to Rules 13a-14(a) under the Securities Exchange Act of 1934, as amended (filed herewith).
32.1
Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Sec. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).
101
Interactive Data Files Pursuant to Rule 405 of Regulation S-T (filed herewith). The XBRL instance document does not appear in the Interactive Data File because its tags are embedded within the Inline XBRL document.
104
The cover page from the Quarterly Report on Form 10-Q for the quarter ended September 30, 2019, formatted in Inline XBRL.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Dated: October 25, 2019
/s/ KIMBERLY K. NELSON
Kimberly K. Nelson
Executive Vice President and Chief Financial Officer
(principal financial and accounting officer)